NAFTA and Convergence in North America: High Expectations, Big Events, Little Time

The North American Free Trade Agreement (NAFTA) was formally implemented on 1January 1994 by the United States, Canada, and Mexico. This treaty instantly gained global notoriety following the initiation of formal negotiations in 1991, not only because the initiative represented one of the most comprehensive trade agreements in history, but also because it seemed to be a breakthrough in establishing free trade in goods and services among developed and developing countries. The high expectations were that trade liberalization would help Mexico catch up with its northern neighbors. The ratio of Mexican GDP per capita to that of the United States did increase after unilateral trade reforms were implemented in 1986 and also after the implementation of NAFTA in the aftermath of the so-called tequila crisis. However, other Latin American economies also grew faster than the U.S. economy after the mid-1980s, especially Chile and, to a lesser extent, Costa Rica. Thus it is not obvious that NAFTA was particularly important in helping Mexico catch up with the United States. ¹

This paper assesses the extent to which these high expectations seem to be materializing. It examines trends and determinants of income and productivity gaps observed in North America, both across countries as well as within Mexico. The high expectations for NAFTA were supported by neoclassical growth and trade theories. The seminal work of Solow states that capital-poor countries grow faster than rich countries owing to the law of diminishing returns, as long as production technologies, population growth, and preferences are the same across countries. ² The neoclassical trade model (the Stolper-Samuelson theorem) similarly predicts that as the prices of goods and services converge, so will factor prices, including real wages. Hence income levels across borders will also tend to converge as prices converge. A key simplifying assumption of neoclassical economics is that all countries use the same production technologies, exhibiting either constant or diminishing returns to scale.

There is a lively debate about the evidence concerning the impact of trade liberalization on income convergence across countries, as well as an extensive literature on economic convergence within countries. ³ At least since the publication of Barro's early work, the economics profession has been aware that convergence might be conditioned by convergence in certain fundamentals that are believed to cause economic growth. ⁴ While there is admittedly much uncertainty about what these fundamentals are, the evidence of conditional convergence can be interpreted as evidence in favor of the neoclassical growth model or as evidence that there are fundamental differences that prevent income convergence. ⁵

For Easterly and Levine, as well as Pritchett, the "big story" in international income comparisons is that the rich grew richer while the poor got poorer. ⁶ Some studies focusing on cross-country differences in the levels of income per capita (or GDP per worker) argue that these differences are largely explained by institutional factors. ⁷ Other factors besides different fundamentals, however, might impede economic convergence among geographic areas even in the presence of free trade.

More recent theories of growth with increasing returns or technological differences across regions predict divergence in income levels and growth rates across regions. ⁸ Trade flows might help international technology diffusion when technical knowledge is embodied in goods and services, and theories of technology diffusion via trade have been the subject of a fast-growing literature. ⁹ A related literature focuses on the barriers that impede technological adoption to explain differences in the levels of per capita income. ¹⁰ The liberalization of trade can thus facilitate convergence even when production technologies differ across countries, although this would tend to be detected in convergence (divergence) of total factor productivity (TFP) levels within industries across countries. ¹¹ Even if trade liberalization allows poor countries to import production technologies from advanced countries, productivity levels might not converge if the factor...