NAFTA and Manufacturing Productivity in Mexico
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NAFTA and Manufacturing Productivity in Mexico

Mexico's negotiation and implementation of the North American Free Trade Agreement (NAFTA) represent a watershed in the country's economic history. The agreement will eventually open up most sectors of the Mexican economy to its largest trading partner, the United States, thereby buttressing the liberalization reforms implemented since the mid-1980s. The implications for the country's welfare are hard to understate. Until very recently, however, there has been little hard evidence on how the agreement has affected the Mexican economy.

This paper contributes to a better understanding of NAFTA's economic implications for Mexico by studying the degree to which the agreement has affected total factor productivity in the manufacturing sector. Economists view productivity as the main engine for economic growth. As in most of Latin America, Mexico's overall total factor productivity performance from the early 1980s through the mid-1990s was rather disappointing, with average annual growth between -1 and -2 percent.1 An understanding of the factors that hamper productivity in Mexico is crucial for the design of appropriate economic policies conducive to higher living standards.

The experience under NAFTA is interesting in itself. First, the Mexican case is particularly relevant for countries participating in the ongoing [End Page 55] negotiation of the Free Trade Agreement of the Americas (FTAA) or other regional trading arrangements (for example, between the United States and Chile or the United States and Central America). Some of the findings in this paper may offer important insights to the rest of the hemisphere. Second, while there have been several contemporaneous events that may confound studies on NAFTA (such as the devaluation of 1994), the agreement allows researchers to disentangle the different forces that have shaped the Mexican economy in recent years. For example, the present study exploits the fact that the tariff elimination calendar in NAFTA was put in place in 1992 to correct for the potential endogeneity of actual tariff levels.

In the paper I measure total factor productivity (TFP) using a panel of manufacturing plants spanning the 1993-2000 period. I apply an algorithm proposed by Olley and Pakes to address the possibility of sample selection and simultaneity problems in estimating a production function using panel data.2 With the TFP estimates in hand, I assess the impact that the dismantling of protectionist barriers and the rise in foreign manufacturing operations in Mexico have had on plant performance. I also look at the role of the reallocation of resources in explaining productivity improvements.

The paper is organized as follows. The next section provides background on the liberalization strategy followed by Mexico since the mid 1980s. It shows the substantial reorientation of the Mexican economy to the global and North American markets. The subsequent section reviews the theoretical and empirical literature on the relationship between openness and productivity. The paper then describes the methodology used in measuring total factor productivity in Mexican manufacturing and discusses the behavior of aggregate productivity. The following section explores NAFTA's impact on productivity at the plant level based on an econometric exercise that isolates the plant-specific, industry-wide, and macroeconomic forces that influence manufacturing efficiency. The paper concludes with final remarks.

Trade and Investment Liberalization in Mexico

Trade liberalization in Mexico began with the gradual elimination of import and export licenses and a simplification of tariffs between January [End Page 56] 1983 and July 1985. During this period, the fraction of imports subject to licensing requirements fell from 100 percent to 36 percent. After joining the General Agreement on Tariffs and Trade (GATT) in 1986, Mexico agreed to bind tariffs at a 50 percent level, to eliminate reference prices, and to continue eliminating import licenses. In December 1987 Mexico consolidated tariffs on industrial imports to five levels: 0, 5, 10, 15, and 20 percent ad valorem. Only 192 tariff-lines were subject to licensing requirements by 1993, and the average ad valorem tariff was 11.4 percent.3

Figure 1. Mexican Tariffs on U.S. Manufacturing Goods, by Tariff Range
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Figure 1.

Mexican Tariffs on U.S. Manufacturing Goods, by Tariff Range

NAFTA consolidated the liberalization of the Mexican economy and opened up the Canadian and...