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

Abstract

The negotiations of NAFTA in the early 1990s immediately raised high expectations for economic convergence in North America. These hopes were grounded in neoclassical economics. This paper examines the evidence concerning the impact of NAFTA on economic convergence in North America. Any such analysis is hampered by the big-events-little-time problem, which makes the identification of the NAFTA effect difficult due to contemporaneous big shocks and the relatively little time that has transpired since 1994. Time series evidence shows that the debt crisis of the early 1980s and the Tequila crisis of 1995 stalled a process of convergence that might have accelerated after trade liberalization in Mexico and NAFTA. Cross-country evidence indicates that a substantial share of the current income gap between the U.S. and Mexico can be explained by an institutional gap. Panel data evidence indicates, nevertheless, that NAFTA might have had a substantial effect on manufacturing TFP convergence. But initial conditions determined which regions within Mexico benefited the most, and thus the post-NAFTA period has been characterized by economic divergence within Mexico. We conclude that NAFTA has been helpful but free trade alone will not necessarily lead to economic convergence in North America.