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NAFTA and the Peso Crisis


NAFTA Is More Important Today than Before the Peso Crisis

Chris DeLong, Brad DeLong, and Sherman Robinson

Open the newspapers, and read the conventional wisdom: that the Mexican peso crisis of winter 1994-1995 has dashed the hopes for Mexican development raised by NAFTA; that the rationale for NAFTA has vanished because the peso crisis caused the "rapid unraveling of the Mexican economic achievements of 1988-1993."

But the conventional wisdom is dead wrong. The case for NAFTA is much, much stronger after the peso crisis than before.

The political rebellions and assassinations and the economic distress that Mexico has suffered in the past year and a half raise the stakes at risk in U.S.-Mexican relations, and make the NAFTA a more advantageous gamble for the United States.

The first thing to recognize is that the direct benefits NAFTA offered Mexico were very limited. NAFTA did offer a material increase in Mexico's access to U.S. markets today, but U.S. markets were already largely open. NAFTA offered two more important benefits to Mexico: the first was the U.S. promise that no sudden wave of U.S. protectionism in the future would bankrupt Mexico's businesses and destroy the jobs of Mexico's workers.

The second, and more important, benefit to Mexico was that NAFTA tied the continuation of Mexican reform to a formal international agreement. After NAFTA, it is much harder for any Mexican government to abandon its reform program. In all developing countries the value of neo-liberal reforms depend on their actual and on their perceived permanence. For governments struggling to sustain growth, the worst trap of all is to enact policy reforms that hurt politically powerful interests, but to fail to reap any benefits because foreign investors and domestic businesses fear that the policy reforms will prove transitory. NAFTA has helped and will help Mexico avoid this trap.

The direct economic costs and benefits of NAFTA for the U.S.? The direct effects were always small, and always honestly estimated as small. The Mexican economy is the size of Los Angeles's. Increased trade with Mexico is probably a small net plus for the U.S. economy. But increased trade with Mexico is not going to significantly raise or lower the standards of living of large groups of Americans (save for some living in Texas, Arizona, New Mexico, and Califonia).

The indirect benefits for the U.S. are large. Mexico sits on the U.S.'s southern border. Mexico is not going away. The U.S. will have an easier time, and be a better country, if Mexico rapidly becomes a middle-income staunchly-democratic country than if it remains the low-income semi-democratic country it is today. A richer Mexico provides more opportunity for Mexicans at home, and so reduces the stresses placed on the U.S. by migration. Government officials in a richer Mexico are harder for narcotics traffickers to bribe. A NAFTA that strengthens Mexico's pro-growth reforms advances the U.S. national interest.

In the wake of the peso crisis, foreign investors find Mexico less attractive; thus the guarantee of Mexican access to the U.S. market is more important in helpng Mexico draw on foreign capital to boost its productivity and its standard of living.

In the wake of the peso crisis, the political tendencies that argued for reform in Mexico--as opposed to business-as-usual for the system that has retarded Mexico's political and economic development for half a century--are weaker. So the commitments to fundamental reform embodied in NAFTA have given reformers what may become a crucial edge.

In the wake of the peso crisis it is clear that Mexico is not going to have as easy a time becoming an industrial democracy as we had hoped three years ago; America's interest in Mexico's stability and development has become greater, and the forward push given Mexico by NAFTA should loom larger in Americans' minds.

Thus every single argument for NAFTA has become stronger and more important as a result of the winter 1994-1995 peso crisis.

Professor of Economics J. Bradford DeLong, 601 Evans
University of California at Berkeley; Berkeley, CA 94720-3880
(510) 643-4027 phone (510) 642-6615 fax