What Has Happened To Wages In Mexico Since NAFTA? Implications For Hemispheric Free Trade

1. What Has Happened To Wages In Mexico Since NAFTA? Implications For Hemispheric Free Trade NBER Working Paper By Gordon H. Hanson

2. NBER Working Paper Produced By: • Gordon H. Hanson • Professor of economics in the Graduate School of International Relations and Pacific Studies and the Department of Economics at the University of California, San Diego (UCSD). He is also a research associate at the National Bureau of Economic Research and coeditor of the Journal of Development Economics. In the past, he also served on the faculties of the University of Michigan and the University of Texas. He is the author of over 50 academic research publications that are largely in the area of international economics.

3. 1st Section – Discussion of recent literature on the labor-market consequences of Mexico’s economic reforms. • 2nd Section – Discussion on the rising skill premia in Mexico. • 3rd Section – Discussion on regional wage differences in Mexico. • 4th Section – Discussion on the convergence in Mexican and U.S. wages. • Final Section – Implications of Mexico’s experience with NAFTA, and speculation on the effects on a Latin American FTA with the U.S.

4. Important History in a Nutshell • 1917 Mexico adopts new Constitution • Amalgam of economic policies • Financial Crises of 1982 and 1994/95 • US bailout for Mexico during 94’/95’ Peso Crisis • NAFTA comes into force in 1994 • Free Trade Agreement between Mexico, Canada, and the United States • Extension of CUSFTA to Mexico • Act is phased in over time

5. Impact of Trade on Mexico • Trade accounted for 11.2% of Mexico’s GDP in 1980, but had grown to 32.2% by 2000. • FDI averages 1.3% of GDP from 1980-1994, but grows to 2.8% of GDP from 1995-2000 • 2/3rds of FDI comes from the United States • In 2000, Mexico sends 88.7% of its exports to and bought 73.1% of its imports from the United States.

6. Maquiladoras • Located along border with the United States • In 2000, accounted for 47.7% of Mexico’s exports and 35.4% of imports • Act as a sub-assembly sector for American industry. • Main driver behind growth in the Mexican economy!

7. More about Maquiladoras • Most Maquiladoras assemble one of three types of goods, apparel, electronics, or auto parts. • In 1995, these three industries accounted for 80.5% of total exports. • It is thought that Mexico has comparative advantage in assembly-type activities, which is why their industry is growing rapidly in this area as opposed to being more comprehensive.

9. Rising Skill Premia • Wage gains were largest for more educated workers that lived close to the border with the United States. • This factor relates to the rise of Maquiladoras, which account for 50% of the increase in the skilled labor wage share during the late 1980s. • Data appears to contradict Heckscher-Ohlin Theorem and other related trade theory due to Mexico’s presumed comparative advantage in low-skill activities

10. Heckscher-Ohlin Theorem • Theory of international trade that posits that differences amongst trading partners in physical and human capital (labor), will create productive differences that explain how trade occurs. • Based on the concept of comparative advantage. • Mexico has an abundance of low-skilled labor, thus giving it an edge in this area. Labor should then earn rents in international trade. Leontief Paradox?

11. Possible Explanations • Mexico had the most protection on low-skilled industries prior to liberalizing trade • Mexico does not trade with America in isolation. China and other Asian nations could account for this dilemma • NAFTA had not come into full effect by 2000. Many forms of American protectionism (with regard to agriculture) would not be done away with until roughly 2009.

12. Migration • Average of 400,000 Mexicans moved to the United States during each year in the 1990s. • Most of theses immigrants come from Agricultural regions in the Western portion of the country. These states are neither the poorest or the closest to the United States. • Longstanding regional networks help Mexican workers find jobs in the US.

13. Regional Wage Differences • In 1980, 5 years before trade reform began, 46% of Mexico’s manufacturing was located in the Federal District surrounding Mexico City. Only 21% was located in states on the U.S. border. • In 1993, 8 years after reforms began, the share of manufacturing in Mexico City had fallen to 29% and the share at the border had grown to 30%. • In 1998, 4 years after NAFTA, Mexico City had fallen further to 23% and the border had grown to 34%.

14. Continued… • Prior to trade reform, a 10% increase in distance from Mexico City was associated with a 1.9% decrease in the relative state nominal wage, and a 10% increase in distance from the United States was associated with a 1.3% decrease in the relative state nominal wage. • After trade reform, the regional wage gradient shifts, and distance from the United States results in greater decreases. • This data can most certainly be attributed to changing trade dynamics due to the United States

15. Convergence in U.S. and Mexican Wages • In a paper by Raymond Robertson, he found that a shock that would raise wages 10% would raise wages in Mexican interior cities by 1.8%, and wages in Mexican border cities by 2.5%. This suggests at least partial integration. • Additional data analyzed by Robertson suggests that the integration of the two economies still has a long way.

16. Continued… • Gordon Hanson further investigated this issue and discovered that there has been substantial variation in wage changes across labor-market groups, and this seems to suggest Raymond Robertson’s analysis (based on high frequency data) does not capture the entire picture. • A lot of these issues come down to policy changes and macro shocks to the economy.

17. Labor Data • Mexican wage growth has been swamped by higher relative inflation, which overtakes any nominal gains. • Young women are the only cohort to experience real wage gains. Especially women who have completed at least 12 years of education. • Turning to regions, all have shown real absolute and relative wage declines.

18. For border states, but not for interior states, wage growth is higher for cohorts where initial Mexican wages are lower relative to U.S. wages. • The wage growth in border states also appears to be correlated with wage growth in the United States. • After filtering the data, Hanson concluded that the real relationship that links wages in Mexico and the United States (be they trade, FDI, etc…) work through broad changes in the returns to education.

19. Implications for the FTAA • Will boost trade in areas that are close to ports and transit routes. • Will cause a more uneven distribution of income. Most other Latin American nations don’t have quite as many protections on agriculture so it might not be as severe. • Main beneficiaries will be educated city dwellers that live near the coast.

20. My Thoughts • Given the recent political instability across Latin American nations, I believe that the increased unevenness in the distribution of income could become potentially catastrophic for many central American nations. • It shouldn’t be a problem for countries like Columbia that have already liberalized trade to a large degree.