What Happened to Wages in Mexico Since NAFTA?

Summary of working paper 9563
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Wage gains were largest for more educated workers living close to the United States and were smallest for less-educated workers living in southern Mexico.

The elimination of trade barriers under the proposed Free Trade Agreement of the Americas (FTAA) would likely have a profound effect on the distribution of incomes throughout Latin America. To assess the nature of this impact, NBER Research Associate Gordon Hanson uses as a test case the changes in Mexican wage structures brought about by the North American Free Trade Agreement (NAFTA) in the 1980s and 1990s.

In What Has Happened to Wages in Mexico Since NAFTA? Implications for Hemispheric Free Trade (NBER Working Paper No. 9563), Hanson divides his analysis into two parts. In the first part he examines the substantial research already done on NAFTA's impact on the Mexican labor market in the 1980s. The evidence suggests that tariff reductions increased relative wages for skilled workers, increased foreign investment, raised relative demand for skilled labor, and reductions in tariffs and quotas altered inter-industry wage differentials. Mexico's economic opening thus appears to have raised the skill premium and reduced industry rents going to labor. It also appears to have increased wages in states along the U.S. border relative to the rest of the country.

Hanson concludes from this analysis that Mexico's comparative advantage in low-skill activities was not as strong as many had thought. Trade liberalization exposed Mexico's vulnerability in very low-end manufacturing; thus producers of basic consumer goods in this area lost out to imports, especially from China and from elsewhere in Asia. However, Mexico appeared to have a cost advantage in assembly services for the U.S. economy. Therefore, Mexican manufacturing in effect reoriented itself from producing simple consumer products to being a subcontractor for more upstream industries in the North American economy. Meanwhile, the concurrent loosening of restrictions on foreign direct investment allowed plants in Mexico to become part of North American production networks, and this too played a role in the change in wage patterns.

In the second part of his study, Hanson uses Mexican census data from 1990 and 2000 to examine changes in wages over the period in which NAFTA was implemented. His most striking finding is that wage gains were largest for more educated workers living close to the United States and were smallest for less-educated workers living in southern Mexico. Hanson also notes that the dramatically increased openness of Mexico's economy to the rest of the world as seen over the past two decades was concurrent with shocks to wage levels. These include periodic if temporary wage declines (mostly related to such matters as Mexico's macroeconomic and currency problems), wage growth along the U.S.-Mexico border relative to wages in the rest of Mexico, and a steady increase in skills in the country. All of this, Hanson observes, resulted in a general increase in wage disparity in Mexico.

What then are the implications of the Mexican experience for the rest of Latin American wage structures in view of the proposed Free Trade Agreement of the Americas, which is to be implemented by 2005? For one thing, Hanson notes, prior to the trade reform in Mexico, the country had relatively high tariffs on less-skill-intensive industries. These industries thus bore the brunt of adjustment to Mexico's economic and trade liberalization. But similar tariff adjustments following an FTAA, says Hanson, are unlikely to be common in the rest of Latin America. One reason is that many countries have already liberalized their unilateral trade. Colombia, for example, reduced its trade barriers a decade ago, with special tariff reductions in its less-skill-intensive industries. Thus the shock of trade reform related to tariff reductions in low-skill industries, Hanson theorizes, may already have been absorbed in much of Latin America.

Hanson also maintains that the Mexican experience suggests that multinational firms and others in export-intensive sectors have a relatively strong demand for more skilled labor. Such firms, he adds, also appear to place a premium on locating in regions with relatively high-quality transportation and communication infrastructure. In Mexico, NAFTA evidently strengthened incentives for foreign direct investment. If an FTAA does the same in Latin America, therefore, it is likely that skilled workers will benefit first -- particularly those skilled workers living in larger cities or near international ports. At the same time, at least in the initial period of adjustment to trade reform, greater economic openness may mean greater disparity in wages (although average wage levels remain unknown). For a region where wage inequality is already widespread, says Hanson, this is not especially good news.

Hanson extracts a final lesson from Mexico's experience with NAFTA. This arises from the observation that foreign direct investment appears to significantly affect the pattern of specialization that emerges in an economy following a lowering of trade barriers. As noted, much of Mexico's export growth occurred in plants assembling parts manufactured in the United States. Such growth resulted from a combination of lower trade barriers, relaxed restrictions on foreign direct investment, and tariff breaks on imports to the United States. If an FTAA does not address restrictions on foreign direct investment in Latin America, Hanson surmises, it may not produce the same degree of specialization in export production seen in Mexico under NAFTA.

-- Matt Nesvisky