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1996

6 x 9 in.
368 pp., 9 figures

ISBN: 978-0-292-76046-2
$19.95, paperback
33% website discount: $13.37

 
 
 
     

Understanding NAFTA
Mexico, Free Trade, and the New North America

By William A. Orme, Jr.

 

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Table of Contents

  • Introduction. After the Fall
  • Chapter 1. Overview: NAFTA Myths and Misconceptions
  • Chapter 2. The Origins and Importance of NAFTA
  • Chapter 3. 'Via Positiva'
  • Chapter 4. The Year of Living Dangerously: 1992
  • Chapter 5. Jobs, Jobs, Jobs: The NAFTA Numbers Game
  • Chapter 6. Oil, Cars and Mortgages: The North American Investment Agreement
  • Chapter 7. The Wearing of the Green
  • Chapter 8. Lead or Silver: Mexico's "Guided" Democracy
  • Chapter 9. The Tex-Mex Axis
  • Chapter 10. What Will the Neighbors Say? Latin America After NAFTA
  • Chapter 11. The Hidden Target: NAFTA and Japan
  • Chapter 12. Toward a Common Market: The New North America Subject
  • Index
  • About the Author

Introduction. After the Fall

With the North American Free Trade Agreement finally in force, Mexico was supposed to leave the South and underdevelopment behind. But the new Salinista Mexico of cellular telephones and stock options suddenly gave way to scenes of helicopter gunships and defiant guerrillas. On New Year's Day 1994 Mexico was supposed to start looking like Texas. Instead, it looked like El Salvador.

By 1995, after the trade pact had been in effect for a year, the Mexican economy was hardly the dynamo NAFTA boosters had depicted. It seemed more like a smoking ruin. Economic achievements that NAFTA was supposed to consolidate and accelerate had instead been abruptly reversed. Inflation was roaring back from single digits to 50 percent or worse. An economy that was expected to expand by four percent yearly now faced a savage four percent contraction. Unemployment was rising, wages were falling, and money was flowing north, not south. Rocketing interest rates made new business ventures impossible and mortgages unpayable. The green eyeshades at Moody's, once expected to reward post-NAFTA Mexico with investment-grade securities ratings, had instead demoted Mexico to the risky ranks of the ex-Warsaw Pact economies.

***

The post-NAFTA reality north of the border didn't look much better. The fat U.S. trade surplus was evaporating, and along with it prospects for NAFTA-driven U.S. job growth. Halfway through 1995, when this new introduction to Understanding NAFTA was written, the United States was already $8 billion in the red in its Mexican trade account.

On the Mexican side, the new bilateral trade surplus was a setback falsely hailed as an economic triumph: it was accomplished not by a surge in exports, but by a drastic cut in imports. An industrializing nation like Mexico needs to buy a lot of foreign consumer products and capital goods. This is both healthy and efficient. NAFTA ensures that most of those imports will come from the United States. When Mexico is again posting regular deficits in its U.S. trade, it will be a solid indicator of recovery.

Mexico's climb out of this very deep and swiftly dug hole will take years. NAFTA makes the ascent easier, but critics of the pact could properly point out that NAFTA did not and could not prevent the fall.

NAFTA supporters (this author included) said the pact would propel Mexico into the first ranks of newly industrializing nations, creating a booming market for U.S. exports and raising Mexican incomes in the process. They expected the peso to hold steady or even strengthen as inflation stabilized in the middle single digits. NAFTA's architect, outgoing President Carlos Salinas de Gortari, was expected to graduate to a second career as an international economic statesman.

Detractors said NAFTA would simply prop up a venal political monopoly, triggering a massive loss of U.S. manufacturing jobs to low-wage workers who couldn't afford the goods they produced. They dismissed recent Mexican economic growth as an illusion built on borrowed dollars and an inflated peso; they said NAFTA's ratification would be followed by a steep devaluation, the disappearance of the U.S. bilateral trade surplus, and continuing economic hardship for most ordinary Mexicans.

***

The opponents were wrong about a lot of things, but they can certainly claim to have come much closer to describing post-NAFTA Mexico than NAFTA supporters did. Mexico remains a struggling nation of "grave needs and wants," as President Ernesto Zedillo has acknowledged. Half of the potential workforce is unemployed or underemployed. With the domestic market contracting, export manufacturers spending more on machines and less on labor, and a million new job-seekers coming of age every year, the employment problem is more acute now than it was when the NAFTA negotiations started. Those Mexicans who do have jobs are earning less in real terms than they were when NAFTA was ratified. In January 1994, when NAFTA legally came into effect, per capita income had passed the $4,000 mark, putting Mexicans in the upwardly mobile company of the East Asians and Southern Europeans. By January 1995, Mexico's per capita income had slid brusquely backwards to $2,600, erasing the gains of the previous three years. The destruction of wealth among ordinary Mexicans is retroactive as well: Inflation is savaging the savings of the middle class, while rewarding the moneyed minority who keep their cash in banks across the border.

Mirroring this drastic economic reversal was the spectacular decline in the personal and political fortunes of Carlos Salinas. The former president left Mexico for Europe not as the triumphant new chief of the World Trade Organization, as he had once confidently expected, but as a virtual fugitive, blamed by his countrymen for the collapse of the peso and the assassination of two of his closest political allies.

Does all this mean that NAFTA was a terrible mistake?

No. But it does show that many arguments made on NAFTA's behalf were flawed or specious, and many of the questions raised by critics were entirely valid. It is not enough to point out that Mexico's latest crisis was caused not by free trade, but by disastrously mismanaged currency policies. It is not enough to argue that without the trade pact Mexico's plight would be far more severe, to the detriment of all three North American economies. Supporters of NAFTA should acknowledge that NAFTA was never going to be a quick fix for a country whose problems are fundamentally social and political, not economic. Nor was NAFTA ever the key to making the giant U.S. economy "competitive" in the international marketplace.

NAFTA's supporters should also acknowledge that building a continental market requires constant attention, creativity, and a willingness to run risks. The new North American institutions created by NAFTA--the dispute resolution boards, the tripartite labor and environmental commissions, the border agencies and development bank--have only barely begun to function. Yet they have already forced environmentalists and their adversaries to sit at the same table in alliances that cut across national lines. American unions are now defending and collaborating with their Mexican counterparts, and together they have made crossborder employers more accountable for their labor practices. States and communities on both sides of the U.S.-Mexican border are beginning to work cooperatively on infrastructural planning and pollution control.

North America needs more of this, not less. The peso crisis of late 1994 underscored the urgency of better institutional communication and cooperation on monetary matters. The ugly backlash against Mexican immigrants in California dramatized the need to address migratory issues bilaterally, if not trilaterally. Continuing friction with Canada on antidumping allegations underlines the importance of eliminating anachronistic dumping rules within the NAFTA market. The passage of NAFTA signaled only the starting point of a process that will take decades. The North American Free Trade Area should be deepened before it is broadened: Chile and its Southern Hemisphere neighbors are being invited into a house that hasn't been built yet.

The political and economic crises of 1994 and 1995 highlighted NAFTA's importance as well as its shortcomings. Tellingly, Mexico's response was to push the NAFTA process faster--exporting more, privatizing more, bringing foreign capital more quickly into its banking system. In a truly revolutionary change, the Mexican government began releasing economic data--to its NAFTA partners, as well as to its own citizens--on a more regular and credible basis. In Washington and Ottawa, officials were jolted into the realization that after NAFTA they would have to pay even closer attention to Mexico's travails. The Clinton rescue package for Mexico, with its onerous conditionality, served to bind the North American economies even more tightly together.

Better communication and further policy coordination are essential if all three NAFTA nations are to maximize the benefits of interdependence and minimize cross-border economic shocks. The lesson of the new Mexican crisis was not that NAFTA didn't work, but that it didn't go far enough.

***

Understanding NAFTA was written during the two years that NAFTA was being negotiated and debated, and it chronicles the twists and turns of that public policy spectacle. Resisting the temptation to edit in retroactive prescience and excise undue economic optimism, I have left the text in this edition essentially intact. Despite Mexico's latest descent into recession, little of underlying importance has changed--except that NAFTA is now a fact.

The book's original intent was to scrutinize arguments and dispel myths propagated by NAFTA proponents and adversaries alike, while examining Mexico's motives for redefining its relationship to the United States. I tried to follow the NAFTA negotiations in the contexts of each country's vastly different political reality and to assess the agreement's likely impact on the North American economy. It was clear from the start that this impact would be felt first and most profoundly in Mexico. Changing Mexico, after all, was the pact's real purpose. The effect of NAFTA on the United States (and, more distantly, on Canada) would be the indirect repercussions of the Mexican economic transformation that NAFTA helped make possible.

That is why a book about the "new North America" is mainly about Mexico. What is new about North America after NAFTA is that Mexico has switched continents, leaving "Latin" America in order to enlarge and enrich the industrial societies of Canada and the United States. The United States and Canada were tightly interwoven long before Brian Mulroney and Ronald Reagan wrote new ground rules formalizing and liberalizing this relationship. Mexico, despite its deep dependence on U.S. markets and investment, had been a country proudly apart. Its membership in a North American free trade zone is more than a simple, structured acceleration of an ongoing integration process. It is a revolutionary attempt to integrate a poor developing economy and an industrial superpower. For Mexico, it marked the end of its 20th century, a century of great suffering, but also of celebratory nationalism and economic self-sufficiency. In a historic gamble, Mexico was willing to trade autonomy for prosperity. In the short term, it was left with neither. Yet NAFTA still gives Mexico an opportunity to prosper that it would never have had on its own.

In the Washington debate over NAFTA, both sides argued as if the pact's effects would be instantaneous. Opponents contended it would precipitate a mass southbound exodus of U.S. manufacturing jobs. Advocates suggested NAFTA would transform Mexico overnight into the Latin equivalent of an East Asian tiger--with the odd variant that it would contentedly rack up large and continuing trade deficits. NAFTA was always about something more difficult, and much more significant: the slow immersion of a great but poor nation into the economic mainstream of the planet's biggest industrial superpower.

***

In retrospect, it seems unsurprising that this radical experiment would prove less popular in the richer of the two markets. But it did not look that way in 1990, when President Salinas first decided to accept Washington's long-standing invitation to join a continental trade pact. He was braced for bitter resistance at home. Not only was he abandoning Mexico's long history of zealous protectionism, he was challenging the conventional wisdom that Mexico could survive anything except Uncle Sam's embrace. He expected his political opponents to accuse him of economic treason, and many of them did. Remarkably, though, most centrist Mexican politicians came to accept free trade with the North as the country's best strategic alternative, and NAFTA never became a bitter partisan issue.

Neither Salinas nor his American partners anticipated that the fiercest opposition would come from north of the border. But the more Americans heard about NAFTA, the less they liked it. When the negotiations began in late 1991 the free trade pact enjoyed broad but shallow support. Two years later, as the actual vote approached, few members of Congress were willing to campaign for the accord, and more than a hundred were working actively against it--most of them Democrats, despite their president's vigorous if belated support for the pact. For NAFTA's supporters, the most encouraging news in the fall of 1993 was that after nearly three years of negotiations half of all Americans surveyed were still unclear what NAFTA was all about. When the House of Representatives finally approved the pact, narrowly, after a contentious debate, it was more a tribute to President Clinton's persistence and horse-trading skills than to the success of the NAFTA lobby in selling the agreement to the country on its merits.

The great NAFTA debate of 1993 was not really about the agreement itself, or even about Mexico, but about competing domestic political agendas and irreconcilable world views. Appeals were made not to rational economic interest but to nationalistic fears. On one side, there was calculated alarmism about accelerating immigration and purported alliances between anti-NAFTA leftists and drug traffickers; on the other, there were crude appeals to the most xenophobic strains of American populism. Critics exaggerated the risks of more rapid economic integration while minimizing its rewards; advocates, no more responsibly, did just the opposite.

Discussions about Mexico itself degenerated into a war of caricatures. NAFTA boosters painted a picture of a country saved from destruction by Americanized reformers who would teeter and fall without Washington's support. Critics described a two-dimensional society where industrial peons work for inbred billionaires in factories spewing toxic waste. On both sides, the agreement's true purpose and likely effects were distorted and obscured.

When Presidents Salinas and Bush unveiled the trade initiative, each man was at the height of his political power. Salinas used all his domestic strength to build a public case for the agreement. Bush did not. North of the border, pro-NAFTA salesmanship was confined to politicking with business councils and editorial boards; the American people--increasingly worried about stagnant incomes and global competition--were largely ignored. And though Clinton was a much more forceful salesman for NAFTA than Bush, he also left NAFTA to low-ranking subalterns until the final critical weeks.

NAFTA's opponents exploited this leadership vacuum, turning NAFTA into a potent symbol for everything they disliked about American politics: the influence of foreign lobbyists in Washington; the cult of executive secrecy; the intrusion of international responsibilities in domestic affairs; the disregard of inside-the-beltway pundits for economic hardship in America's heartland. And they made Mexico itself a cunning metaphor for the problems America faces in adjusting to global competition from low-wage labor.

But Mexico isn't a metaphor. It is a country, it is not going away, and NAFTA is going to make it and us different.

As this book argues with perhaps tiresome insistence, NAFTA's success or failure can only be assessed fairly in a decade or more. Forecasts of dramatic instantaneous benefits and of immediate economic disaster were always equally wrong. Every serious analysis of NAFTA agreed that NAFTA's short-term economic impact on the United States would be marginal. It was also obvious to anyone who knew Mexico that its evolution into a modern industrial society would take decades, not years. But I still expected NAFTA to have a quick, visibly positive impact on Mexico's standard of living. Despite this book's warnings about the fragility of the Salinas free-trade experiment, I still overestimated Mexico's fundamental economic strength, and underestimated the skittishness of American institutional investors.

I also underestimated the commitment of policymakers in Mexico and Washington alike to the stability of the peso. The December 1994 devaluation not only slashed the currency's value in half, it made it much harder for Mexico to take advantage of NAFTA's potential for sustained real growth. As this book shows, NAFTA was the cornerstone of the Salinas sound-money strategy, which depended on a constant influx of foreign (mainly American) portfolio capital. This was in turn organically linked to the Salinas anti-inflation policy, which required stiff price competition from the imports permitted into the country by free trade.

As described within (see "1992: The Year of Living Dangerously"), the inevitable result was a ballooning current-account deficit. Mexico had been walking a monetary tightrope for three years. At the end of 1994 it lost its balance and fell.

***

The critics said they told us so. And they had. It wasn't just that NAFTA was followed by a drastic devaluation, as Ross Perot and other pact opponents had predicted. NAFTA's own champions based their economic claims on two central premises, each of which, just one year later, had seemingly been proven empirically wrong.

The first premise was that NAFTA would raise Mexican wages. This would create a vast new consumer market south of the border while reducing low-wage competition for manufacturing jobs. Critics of NAFTA were skeptical, so Salinas promised Clinton that after the pact's approval Mexico would boost its minimum wage in real terms for the first time in a decade. Instead, his successor ended up slashing wages in order to contain the inflation generated by his mismanaged devaluation--a strategy demanded by the Clinton Administration as a price for its financial aid. The devaluation already represented a steep salary cut for a workforce that was told it would regain the purchasing power it briefly enjoyed during Mexico's oil boom 15 years earlier. Now, by keeping wage increases far below the increase in the cost of living, the government was compounding the damage to family incomes.

In the long term, NAFTA will in fact help Mexican incomes rise. But the gap between U.S. and Mexican wages that had been narrowing for five years opened up anew to a ten-to-one chasm. More jobs will migrate south as a result.

The second premise was that free trade with Mexico would be a huge net producer of jobs within the United States because the United States would maintain a strong positive balance in this bilateral trade. That assumption was the sole basis for most pro-NAFTA job creation estimates. The Department of Commerce, private business lobbyists, and even independent sources such as the Institute for International Economics propagated the notion that NAFTA-generated employment could be extrapolated directly--so many billions of dollars equaling so many thousands of jobs--from projected bilateral trade surpluses. At the end of 1994 that surplus inconveniently disappeared. By mid-1995 Mexico was deepening the U.S. trade deficit by $1.5 billion monthly.

NAFTA advocates were reminded that their argument had a corollary: if the U.S. posted a deficit in its cross-border trade, that presumably meant more jobs were being eliminated under NAFTA than were being created. In the auto industry, for example, the devaluation sabotaged hopes that U.S. plants would soon be shipping yearly 100,000 or more vehicles south of the border. The United States could no longer count on a surplus even if the Mexican economy recovered; the rescue strategy fashioned by the U.S. Treasury was predicated on Mexico racking up continued surpluses. As if nothing had been learned from the debt crisis of the 1980s, Mexico was again forced to sign on to the standard International Monetary Fund layaway plan: recession, inflation, and fat trade surpluses stretching into the sunset.

The obsession with the trade balance has distorted the NAFTA argument on both sides. Before the December peso collapse, NAFTA boosters were claiming vindication because U.S. exports to Mexico had climbed 22 percent as of the close of the year's third quarter. Critics, meanwhile, groused that imports of Mexican goods had risen even faster, climbing by 23 percent--as if that fractional difference made the United States the loser in the deal.

NAFTA opponents cited as further evidence the claims put forward by unemployed U.S. workers who blamed the loss of their jobs on Mexican competition. Only a few thousand of the labor movement's estimate of 60,000 lost jobs in 1994 due to "NAFTA" could be convincingly documented, and those jobs would have likely left America with or without a trade pact. (Even 60,000 is equivalent to a week's fluctuation in the U.S. job market, and would have to be balanced against the 200,000 or more jobs that NAFTA created that year.) And these claims were evidence not of economic distress, but of the existence of NAFTA-linked provisions for job-training compensation to people who are unemployed because of imports coming from or jobs moving to Mexico. There is, after all, no analogous program for people thrown out of work because of competition from China or Japan, and therefore no point of comparison.

What is more significant is that despite Mexico's rocky year, crossborder trade still surged ahead in 1994, creating jobs in both countries. That was a direct result of NAFTA's elimination of trade barriers. Yet it was logical and defensible for NAFTA critics to judge the success of the pact by charting variations in the trade balance, since that was the measure used by proponents to sell the pact. Now, with the peso devalued and the U.S. facing a deficit in its bilateral trade, the NAFTA lobby would seem to have some answering to do.

***

They could find some of those answers, paradoxically, in the peso crisis of December 1994, which dramatized precisely why NAFTA is so crucial for Mexico, and so strategically useful to the United States.

Even among NAFTA supporters the devaluation debacle has been mythologized in retrospect as an economic morality play, an object lesson in the evils of currency overvaluation, current account deficits, and "speculative" foreign capital. A subplot of this fable features American and Mexican officials deliberately inflating the peso just to ensure NAFTA's safe passage.

This indictment is wrong in its premises, and in almost all its particulars. The real mistake the Salinas regime made was to stanch an outflow of cash in 1994 with massive sales of short-term dollar-pegged bonds. This was reckless, a big and ultimately bad gamble. But the Salinas administration was right to try to avoid a sudden devaluation at all costs. The key to Mexico's long-term recovery was and still is building confidence in the peso at home and abroad. By late 1994, when a devaluation was clearly unavoidable-because inherently unpredictable political shocks and a narrowing interest-rate gap were chasing both Mexican and American money back to the United States-astute monetary management and prearranged international financial support could still have kept the peso from falling more than 20 percent. Not even the most zealous devaluationists proposed chopping the peso in half. There was nothing inevitable, and certainly nothing desirable, about the massive devaluation triggered on December 20, 1994.

***

One new NAFTA myth is that Mexico deliberately set out to court portfolio capital while spurning long-term direct investment. To the contrary: the entire NAFTA enterprise was designed as an enticement for the kind of direct investors who think in terms of decades. Once it was clear that the Salinas government was serious and that NAFTA was likely to be approved, the strategy began to work. During the three years of the NAFTA negotiations direct investment--most of it American--rose by nearly $15 billion, double the inflow of the previous three years.

Stock and bond funds poured in far faster, however. Mexican officials were going to take whatever investment they could get, but they were acutely aware of the volatile imbalance between highly liquid and fickle portfolio capital and long-term investments in fixed assets. Mechanisms used by Chile and some Asian countries to control similar investment surges-including quantitative limits and repatriation rules for stocks and bonds bought by foreigners-were rejected as both unenforceable in a U.S. border economy and antithetical to Mexico's quest for economic integration with North America. Not unreasonably, the Mexicans saw the solution as attracting more direct investment, not as chasing portfolio capital away. NAFTA was the way they intended to redress this imbalance.

A free trade agreement was only half the equation, however.

***

The Salinas government originally sought a trade pact with Washington because it needed foreign investment, and there were limits to what it could accomplish on its own. Mexico had already given investors the three things they need most: political stability, a growing market, and predictable, intelligently managed macroeconomic policies. But it could not unilaterally guarantee access to the U.S. market, or even the longterm survival of Salinas's economic reforms. NAFTA did both.

Trade treaties cannot prohibit rude surprises, however. The painful irony of 1994 was that with NAFTA safely in place, Mexico could suddenly provide neither political stability nor economic predictability.

Assassinations and armed uprisings had not been part of Mexican political life for half a century, but the events of 1994 showed that the government remained extraordinarily vulnerable to such violent shocks. Equally unnerving to investors was the strategic ineptitude displayed by Mexico's financial managers in the period leading up to the December 20 devaluation. One thing these Ivy League technocrats had done, their political opponents would have then readily conceded, was master the inner workings of a modern international economy. Yet in those crucial weeks they bungled both the technical challenges of currency crisis management and the even more critical tasks of communication and coordination with the international financial markets.

There were ironies within ironies. The new finance minister responsible for handling the peso problem was Jaime Serra Puche, the chief negotiator of the free trade agreement. Serra saw the finance ministry as the final stepping stone in a career-long quest for the presidency. But his reputation was destroyed in a fortnight because he flagrantly disregarded the rules of the new borderless economy that he himself had painstakingly engineered. In the old days of prideful autarky, Mexico could conduct its economic affairs behind closed doors. The finance minister convened key players in business and government and together they would plot their course and strike their deals. Outsiders--foreigners, political antagonists, ordinary Mexicans--would be informed in due time, at least in part, on a need-to-know basis.

After NAFTA this was no longer possible. Mexico wasn't autonomous any more. Wall Street was more important to the Mexico City Bolsa than Monterrey. And, unlike Mexico's moneyed elite, the foreign investors who bought billions in Telmex ADRs through New York stockbrokers could afford to walk away. And walk away they did--with a vengeance.

***

Nothing mattered more to investors in Mexico than a sudden fall in the value of the currency. Yet Serra played his policy cards close to the vest, in the old PRI style, failing to forewarn allies at the U.S. Treasury and International Monetary Fund and refusing even to return the calls of foreign money managers who controlled billions in Mexican stock and bonds. The devaluation option was discussed by top officials with local labor and business leaders even as they issued steadfast denials of such plans. New York mutual fund managers listened nervously in early December to insider tales of savvy Mexican oligarchs moving hundreds of millions offshore. Yet they believed the reassurances of Mexican officials, largely because they had never been deliberately misled on such matters by the Salinas economic team. After NAFTA, they expected Mexican policymakers to be more forthcoming, not less. So when Serra suddenly volunteered on a local radio call-in show that the peso was being "adjusted," New York money managers were infuriated. They considered it a deliberate deception, a betrayal. They couldn't believe that Mexico City taxi drivers heard the news before Merrill Lynch did. They didn't care that Mexico's budget is balanced, that its banks and phone company are now privately owned, that oil dependence is a thing of the past. Irrationally or not, they withdrew foreign private money from Mexico en masse, making intervention with foreign public money unavoidable.

Within Mexico the devaluation was even more damaging. It is a rule of Mexican economics that peso devaluations are much more destructive than conventional analysis would suggest. Panic sales of the devalued peso drive its value down still further, accelerating inflation and scaring local savings into dollar havens across the border. The cheaper the peso gets, the more Mexicans wanted to sell them; the more pesos they sell, the less their remaining cash is worth. Smart money leaves quickly, then returns for undervalued bargains. Less smart money--more abundant in any society--leaves much later, much more expensively, and stays away for a long, long while.

This devastatingly self-perpetuating cycle kept Mexico impoverished for most of the 1980s. The Salinas team, anchored by Finance Minister Pedro Aspe and central bank president Miguel Mancera, had tried to break the pattern, keeping the peso strong, and fending off the pro-devaluation lobby of export manufacturers and IMF apparatchiks. Because of political shocks, rising U.S. interest rates, and Mexico's own policy errors, this strategy became unsustainable in late 1994.

This time, however, Mexico was working with a net: NAFTA. The trade accord gave solid guarantees to investors who would have worried about other economic policy reversals after a sudden devaluation. By the middle of 1995 foreign capital was flowing back into Mexico, despite an acute and deepening recession.

As critics correctly insisted, NAFTA was more an investment agreement than a trade agreement. It was designed to convince investors that Mexico was a safe place to do business. A paradoxical side-effect of the protracted NAFTA debate was that potential investors stayed away from Mexico; they weren't about to spend millions on a new factory until they knew exactly what the new rules were. The political upheavals of 1994 and the economic debacle of 1995 kept these investors on the sidelines. In that sense, NAFTA hasn't even started yet.

The Salinas Administration sought economic union with the United States because it foresaw the increasingly acute global competition for capital. Mexico badly needed private investment, in the tens of billions of dollars. So did scores of other emerging industrial nations. What distinguished Mexico from the rest of the developing world was its special relationship with the world's largest and richest economy. Yet its history of expropriations and debt troubles made Mexico unattractive to most U.S. investors. Mexican exporters, meanwhile, feared being shut out of the U.S. market through punitive tariffs or other barriers. Mexico needed to provide clear rules and guarantees to U.S. investors while securing permanent and privileged access to the U.S. market.

Ultimately, Mexico could prosper only by restoring the confidence of the Mexicans themselves in their own economy. From his days as economic czar in the De la Madrid administration, Salinas was intent on breaking the cycle that saw every recent presidency end with the peso shattered and money fleeing offshore. His strategy was built on two mutually reinforcing goals: reducing inflation and stabilizing the peso. The freemarket opening to trade and investment codified by NAFTA could accomplish both these things through price competition from imports, and the influx of investment capital needed to pay for those imports. And it was working: the transition from the De la Madrid to the Salinas administration was marked by currency stability and economic policy continuity. The disadvantage of the Salinas strategy--that it made Mexico beholden to Wall Street--was also part of its appeal, in that it brought both huge cash reserves and the threat of market discipline to an economy that needed both. The unsentimental speed with which investors later yanked their money out of Mexico showed how ruthless that discipline could be.

***

Far from proving Perot right, the events of December 1994 gave us a taste of what would have happened if the Clinton administration had lost the battle for the North American Free Trade Agreement in November 1993.

If NAFTA had been defeated, the Mexican currency crash would have been instantaneous and far more severe. NAFTA kept the peso's slide from accelerating into a free fall. Without NAFTA, not only portfolio investors but most direct investors in Mexico--including Mexicans--would have sought safe refuge in dollar holdings. There would have been no assurances that Mexico would not halt or reverse its economic opening. Since this would have been a crisis directly triggered by Washington, it could have prompted a nationalistic backlash against further reliance on American capital and policy counsel. The Clinton administration, meanwhile, would hardly have been able to justify a $20 billion bailout to a Congress that had just rejected the entire concept of a special economic relationship with Mexico. (In January 1994 the administration didn't dare subject the emergency loan package to a vote in Congress even with NAFTA in place, and six months later a majority of the House went on record opposing further such aid to Mexico.)

The response to the peso crash dramatized anew how the Mexican and U.S. economies have become inextricably intertwined. This interdependence is not new, but the market opening encoded in NAFTA multiplied our cross-border connections and made them both more binding and more visible.

The Mexican debt crisis of 1982 posed a far more acute threat to the U.S. economy: Leading American banks faced a real risk of insolvency, and the possible repudiation of debts by Mexico and other third world borrowers would have destabilized the entire international financial system. Yet it was a crisis that could be (and was) managed by fifty men in suits in a Manhattan board room. This time the cast of characters numbered in the thousands. The U.S. Treasury was forced to intervene, massively, not just to keep Mexico from sliding into default on dollar debts, but to protect the Big Three carmakers, the new industrial corridors of Texas, and the Middle America mega-investors who had bet big on Mexican stocks and bonds. Nervously watching the rescue efforts were tens of thousands of mom-and-pop stockholders who had turned Telmex into the Ma Bell of the 1990s. Few of them would have known the name of Mexico's president a decade earlier; now many wished they never had.

The political dynamics had also changed. The NAFTA battle left the White House and pro-NAFTA Congressional leaders with a vested interest in Mexican economic success. NAFTA's opponents, though seemingly vindicated by Mexico's distress, had no desire for a deeper crisis, since they too saw that depression in Mexico would mean recession in cities and industries throughout in the United States.

Critics charged that the Clinton administration was bailing out Wall Street. This was unquestionably true. But it was also bailing out Main Street. A collapsing peso threatened not only the financial markets but hundreds of thousands of American manufacturing jobs.

And the damage would not have been confined to Mexico. The spillover when the peso first went skidding south--what money traders sardonically termed the "tequila effect"--affected not just the cruzado and the quetzal, but the zloty and the bhat. Without American financial intervention in Mexico, the domino effect of collapsing currencies throughout the developing world would have put a swift end to global American export growth.

This, again, was fallout from the free trade pact. NAFTA represented a radical policy reversal by a repentant former exponent of economic nationalism, plus an equally radical U.S. commitment to reciprocate with open market access and capital. This was seen instantly around the world as a viable new development model. The NAFTA negotiators made the third world safe for bond salesmen: Mexico became the locomotive pulling a whole string of developing nations onto the trading floors of New York and London.

Private capital flows into developing nations nearly trebled between 1990 and 1993, as it seemed that country after country was converting to free-market economics. Mexico was the biggest single beneficiary, but this historic policy shift was transforming most of Latin America, most of the former Soviet bloc, and many poorer Asian nations that had only recently industrialized. The assumption was that capitalist virtue would be rewarded with cash. Now, however, if Washington abandoned Mexico in its first post-NAFTA crisis, that implicit bargain was off. Foreign capital would stampede out of all these fragile markets, and local policy makers would be tempted to reimpose tariff barriers and exchange controls. And the United States would lose critical ground in its newest and fastest-growing markets. The U.S.-I.M.F. $50 billion rescue package of early 1995 was essential; if it had been assembled faster, though, it would have been both cheaper and more effective.

The only redeeming aspect of the peso disaster was the marginal enhanced competitiveness of labor-intensive Mexican export industries. Without NAFTA, even that advantage would have been lost. The free trade pact gives Mexico assured access to the all-important U.S. market--a market where most of Mexico's competition comes not from North America, but from exporters in Asia and Latin America. Factoring in Mexico's newly reduced labor costs, NAFTA's competitive edge may prove decisive. The peso devaluation accelerated the NAFTA-induced relocation of laborintensive export manufacturing from Asia to Mexico, a trend that is beneficial to the United States as well. With Mexican assets suddenly cheaper in dollar terms, the devaluation also encouraged needed investment in tourism, real estate development, and natural resource industries.

Still, the effects of devaluation on post-NAFTA investment were overwhelmingly negative. Foreign investors will come to Mexico when they see it as a solid, growing market; the world is awash with cheap export platforms, and Mexico can never compete with Asia on wages. Mexico's domestic market is now paralyzed, with few prospects for quick revival, and its government is again considered ingrown and erratic. The kind of investment that a cheap peso typically attracts is not the kind that Mexico needs: it is predicated on low-paid unskilled labor, and does nothing to turn Mexico into a competitive industrial society. Mexican industrialists had been noisily urging devaluations for years, because it always seems easier to compete on cost than on quality. The Salinas administration wisely resisted-and manufactured exports still climbed by a remarkable 20 percent or more yearly. More importantly, the most successful exporters were the most technologically advanced. Now Mexico may revert to the low-tech maquiladora model, competing with Haiti and Bangladesh instead of Spain and South Korea. Disturbingly, maquiladora employment was rising quickly in 1995, when unemployment elsewhere grew more acute. Most of the export growth of which Mexico boasted after the peso crash was from this quick-turnaround border reassembly trade. This is precisely the fate NAFTA was intended to help Mexico avoid.

***

But there is one unquestionably positive outcome of the peso devaluation. We are now witnessing the withering away of the PRI, and NAFTA is speeding its demise. The transition to a new democratic Mexico is now unstoppable. This is the most profound effect of the free trade pact, and the most surprising.

Of the many arguments against NAFTA the most cogent was the case made by many Mexican opposition activists: that it would artificially prop up a decadent political monopoly, delaying democratic reform and ultimately making it harder for Mexico to modernize. This presumed that NAFTA would in fact spur economic growth and that the PRI would reap the rewards. Many students of Mexico (like their counterparts in Asia) saw democracy and economic dynamism as diverging choices, not mutually reinforcing goals. Even if that were true, it was hardly smart geopolitics for the United States to provoke an economic crisis in a friendly bordering nation on the off chance that it might accelerate the emergence of pluralism. Besides, business interests were more interested in stability than democracy. And many Mexicans who loathed the PRI were not ready to make the great leap of faith and vote in an opposition government of untested and largely unknown amateurs.

Now, however, such a leap seems like the only way to escape disaster. The present government's political incompetence and direct culpability for the current economic disaster has created a national consensus for change. Every state election now is bitterly contested, and the PRI under Zedillo is too weak and too closely watched to brazenly steal what it cannot cleanly win. By the midterm elections of 1997, nearly half of Mexico may be living under opposition state or municipal rule--a dramatic turnaround for a country that didn't have a single opposition governor until 1989. And by the presidential election of 2000, the PRI's opposition will for the first time in its history be able to field a slate of experienced politicians with strong local constituencies and national name recognition. With NAFTA's trilateral guarantees firmly in place, a change of government is no longer worrisome to investors. The descent may be turbulent, but the PRI is finally coming in for a soft democratic landing.

This was not the script NAFTA's architects had in mind. They had looked forward to 1994 as the year of free trade and of Luis Donaldo Colosio's long march to the presidency. José Angel Gurría, the debt negotiator who later became Zedillo's foreign minister, reminded a group of Japanese executives in December 1993 that the Salinas inner circle had already been running Mexico for twelve years. Gurría expansively assured them that he and his colleagues would stay in power for at least twelve more. Not only was the PRI's triumph a foregone conclusion in 1994, Gurría promised, but in the year 2000 as well, when the next president would also emerge from the cabinet. "Continuity in economic policy for 24 years ought to give you confidence," he said, "even for you Japanese, who tend to views things over such a long term."

Gurría's confidence sounds a bit ludicrous in retrospect, but it was rational enough at the time. Mexico was finally emerging from a decade of zero growth. The central bank held a record $26 billion in foreign reserves, more than enough to keep the peso aloft during the minor turbulence of an election campaign. With the passage of NAFTA one month earlier, the single great uncertainty about Mexico's economic future had been triumphantly resolved. Investment was surging, and the opposition remained conveniently fractured between right and left. The great 1988 threat, Cuauhtémoc Cárdenas, never a dynamic campaigner, seemed weary and wooden and out of ideas. The old confessionalist right, represented by the National Action Party, appeared uninterested in a real run for power now that Salinas had enacted most of its program. The PRI had never lost an election. And Colosio, the hand-picked heir, was beginning to emerge from Salinas's long shadow.

Chiapas ended all that. The presidential campaign was knocked off the front pages by the rebel forces led by Subcomandante Marcos, whose ski-masked visage was not the face Mexico had hoped to present to the world in 1994. Even secondary characters in the Chiapas drama became more compelling public figures than Colosio and his rivals. (First among them was Salinas's designated negotiator and former everything Manuel Camacho, Colosio's theoretically vanquished PRI rival, who courted dissidents and still openly pined for the presidency.) The Chiapas confrontation was the surprise first act in a national drama that would turn the election into a sideshow.

Objectively, the insurgency was a joke: a ragtag band of post-Marxist rebels seizing control of a few Maya villages and declaring "war" on the Salinas government. With their wooden rifles and green recruits, the self-styled Zapatista National Liberation Army never had a prayer of controlling the Chiapas highlands, much less of posing a military threat to the central government. (And for all their vaunted sophistication, they would have destroyed NAFTA, their avowed target, if they had staged their uprising just three months earlier.) But the Zapatistas punctured the hubris of the PRI technocracy like expert marksmen. They forced Mexico City to acknowledge that the Salinas industrial revolution was leaving the rural poor behind. At the very instant that Mexicans officially became North Americans, they had resurrected the defiantly Mesoamerican mythos of Zapata and Sandino.

The lightly armed insurgents became instant folk heroes, delighting Mexico City intellectuals and Tijuana street kids alike as they outwitted government negotiators and held the system hostage to its own revolutionary rhetoric. With the help of a surprisingly cooperative press corps, the Zapatistas became the standard-bearers of popular resentment against the PRI elite. For all the talk (from people like me) of the long-term democratizing benefits of freer trade, it took the shock of an armed challenge to force the PRI a few more begrudging steps towards political reform. Within one month the Zapatistas had forced concessions out of the government that the democratic opposition had been unable to achieve in ten years of electoral battles and peaceful street protests. The PRI agreed to stricter limits on campaign spending and independent scrutiny of election returns. Salinas, after initially opting for a ham-handed counterinsurgency response, was forced to restrain the military and their hard-line supporters within his increasingly unstable coalition. (Fidel Velázquez, the apparently immortal PRI labor patriarch, wanted the rebels "exterminated.") Salinas had to replace his strong-armed state security chief with Jorge Carpizo, a respected former attorney general and human rights ombudsman. The government even vowed to honor the Zapatista demand for more balanced television election coverage-an extraordinary acknowledgment of its control over private broadcasting and systemic refusal to let the opposition take its case to the country.

The Chiapas uprising also exposed how NAFTA had fundamentally changed Mexico's relationship with the United States. Wall Street investors pulled funds out of the Mexico City Bolsa when the rebellion first erupted and the government seemed poised for an army-led crackdown. As the Mexican exchange plummeted, Salinas switched strategies and sought to negotiate. When talks started and the fighting stopped, much of the money flowed back in: fund managers abhor instability above all.

But in 1994, instability would prove the order of the day. Money fled anew following the March murder of PRI candidate Colosio, the first such political assassination since the ruling party consolidated its power six decades earlier. The murder exposed the vacuum of power at the top of the PRI pyramid, and the pathological corruption of the country's criminal justice system. With his hand-picked heir dead and other contenders ineligible, President Salinas was forced to pick a far weaker candidate as the PRI standard-bearer. (To preclude internecine electoral challenges, sitting cabinet members cannot become candidates once the campaign is under way; Ernesto Zedillo had resigned his ministerial post months before to work on Colosio's campaign.)

Zedillo, the politically clumsy technocrat that Salinas was once incorrectly assumed to be, became an accidental president in a system that loathes surprises.

In a curious way, NAFTA helped legitimize Zedillo as a candidate and as a president. Unprecedented U.S. scrutiny of the 1994 presidential election focused overdue attention on the enormous advantages--slavishly favorable television coverage, total control of public works spending--that had sustained the PRI in power for 65 years. Because this spotlight made brazen fraud impossible, Zedillo's 50-percent victory was far more convincing than Salinas's identical claimed margin six years earlier.

With the August election behind them, the PRI hierarchy and the financial markets were enjoying a rare and heartening calm. Funds were returning, the peso strengthening. NAFTA was working.

Then came a new shock: the assassination of the new PRI majority leader and close Salinas associate, José Francisco Ruiz Massieu. Airbrushed after his death into a democratic reformer, Ruiz Massieu was (as noted in the chapter "Lead or Silver") a hard-edged power broker determined to preserve the PRI's franchise. His brother's sensational accusation that the murder was an internal PRI plot shook the country further. Even more fantastic and disruptive was the subsequent charge by the Zedillo government that the murder's mastermind was the former president's own brother, Raúl Salinas, and that both Carlos Salinas and Ruiz Massieu's brother connived to cover up this extraordinary fact. If nothing else, this was a soap opera of epic proportions, revealing the PRI's familia política to be even more rapacious and inbred than its critics had dared suggest, and making the Salinas regime in retrospect seem more a product of Palermo than Cambridge. The Ruiz Massieu assassination scandal directly precipitated the peso crash of December. More important than the political drama, though, was the fact that at every stage of this unfolding crisis, Mexican leaders had to take into close account the reactions of Washington, and New York, and Dallas, and Los Angeles.

Mexico had been dependent on U.S. trade and investment for decades before NAFTA. The fundamental change in the relationship since NAFTA was not economic but political. In 1994 Wall Street put Mexico's central bank on notice that it had lost its autonomy. Many powerful U.S. investors were vocal in their disappointment about the Zedillo cabinet--they wanted their confidant, Pedro Aspe, to retain control of the treasury. The fear that NAFTA would be revoked by the U.S. Congress--as it has the power to do, and as several powerful Congressmen threatened to do during the Chiapas uprising--was another new and unaccustomed constraint on Mexican presidential power. So was post-NAFTA scrutiny by American media and by grass-roots labor and environmental activists. (Human rights abuses in Chiapas sparked protests at Mexican consulates in New York and Los Angeles and Chicago by Mexican-American demonstrators, a warning that Mexico would have to revisit naive assumptions that it could one day wield indirect power in Washington as an ethnic voting bloc.)

Despite their own second and third thoughts, Mexicans had become North Americans after NAFTA. Cross-border economic integration is irreversible. So is cross-border political influence. The Cardenista opposition, sublimating its reflexive nationalism, invited U.S. and Canadian monitors to observe the 1994 election, and has tightened ties since with its anti-NAFTA partners in the U.S. labor and environmental movements. The biggest opposition group, the conservative National Action Party, is forging new bonds with Sunbelt Republicans. The PRI itself, by engineering NAFTA's passage, cemented its own alliance with American business interests and U.S. foreign policy mandarins.

Part of the PRI's bargain was the promise of democratic reform: This pledge was made implicitly by Salinas and his emissaries in innumerable speeches throughout the NAFTA debate, and explicitly by NAFTA's defenders in the White House. Zedillo's declared intent to democratize and instill respect for the rule of law is now a new unwritten codicil to the NAFTA contract. Enforcement will be up to Mexican and American public opinion. It will be fascinating (to use a Perot word) to see how many of the energetically engaged U.S. critics and defenders of NAFTA remain committed to monitoring Mexico's political and economic progress.

The great fault line of the NAFTA debate in the United States divided those who saw the Mexican and American economies as complementary and those who considered them inherently antagonistic. Almost every NAFTA argument flowed naturally from one of these two positions. If the bilateral relationship is fundamentally adversarial, then NAFTA had to be viewed that way, with one side winning and the other losing. If the two economies are a natural fit, however, then free trade is collaborative, not competitive, and both sides benefit.

This book is a brief for the latter analysis. The United States has much to gain from a developed, industrialized Mexico. Despite the setbacks of 1994 and 1995, the North American Free Trade Agreement will help speed that transformation. It was essential during the NAFTA debate to expose the myths and half-truths that obscured the agreement's historic importance. That was the original goal of this book, and it is even more important now.

William A. Orme, Jr.
July, 1995
New York City

 

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