Mexico's Four Big Threats to the U.S.

On the unhappy 20th anniversary of NAFTA, the country isn't advancing as rapidly as free-trade supporters predicted.

The North American Free Trade Agreement turns 20 this year, but don’t expect big celebrations on either side of the border. The economic, social and political differences that NAFTA was supposed to help bridge are widening.

Mexico’s lack of progress since 1992 is a looming challenge for the United States as well as for Mexicans trying to control the drug violence that is flourishing under a political system still rife with corruption. Free trade was supposed to supercharge the Mexican economy, opening a market of 100 million consumers -- an increasingly large proportion of them middle-class. Prosperity would reduce the incentive for illegal immigration from Mexico and speed along the democratization of one of the 20th century’s most enduring one-party states. But little progress has been made toward these goals and won’t be made until Mexico embraces economic and political reforms that don’t seem likely in the next few years.

Though Mexico’s economy is growing strongly this year, it’s largely because it contracted so sharply -- more than 6% -- in the Great Recession, the worst plunge in Latin America. Since NAFTA was enacted in 1994, Mexico’s gross domestic product has grown a meager 2.4% a year on average and per capita income has risen by less than 1% a year. That’s the least for any emerging economy and it leaves Mexico at the bottom of the 34 advanced nations in the Organization for Economic Cooperation and Development, which admitted Mexico in 1994 in a flush of optimism over NAFTA.

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The share of Mexicans living in poverty and the relative size of the Mexican middle class are nearly the same as when NAFTA was enacted. The gap between factory compensation in Mexico and in the U.S. hasn’t narrowed, it has increased. In 1996 Mexicans earned $3.05 an hour and Americans $22.47, a difference of about $19. In 2010, the difference was $28.

One reason for this growing gap is that the economic opening of Mexico through NAFTA and other reforms didn’t go far enough. Energy was excluded entirely, and now this sector is inefficient and starved for investment. Agriculture is still plagued by 100-year-old land use restrictions. Because NAFTA made no attempt to address antitrust problems, many Mexican industries remain effective monopolies or oligopolies. Carlos Slim, the world’s richest man, got there through his ownership of Telmex, which gouges Mexicans with some of the world’s highest phone rates. In each case, the failure to open the Mexican economy to competition stifles its growth.

The failure to achieve broad political reform also plays a role. Economic change hasn’t spurred political change. Below the level of the presidency, state and local government is weak and prone to corruption. Vested interests thwart competition. In July’s presidential election, Mexico is likely to return to power its long-time ruling party, which has promised to tone down antidrug efforts and is unlikely to push further political and economic reform.

For the U.S., Mexico’s lagging economy poses four big problems.

First, illegal immigration and the political conflict it engenders here will rise. Net immigration from Mexico, once as high as 500,000 a year, dwindled to near zero in 2010 due to the housing crash and bad U.S. economy. Also on hiatus is the bitter debate over what to do about 12 million illegals already here, 60% of them from Mexico. As the U.S. economy recovers, more illegals will force a battle that both Democratic and Republican leaders would prefer to avoid.

Second, the U.S. stands to lose a friendly source of petroleum near America’s major refineries. Mexico has the sixth-largest oil reserves in the world, seven times the total reserves in the U.S. But its lack of modern refineries means Mexico is importing huge amounts of gasoline from the U.S. Its crude output is actually dropping, and Mexico is on track to be a net crude importer in 2020.

Third, Mexico’s lack of economic progress nurtures the increasing influence of drug gangs, which have effectively taken over half of Mexico and are threatening civil order and democracy. The impact of this lawlessness on American business, tourism and border-area security has been relatively small so far, but it will grow. In one survey, nearly half of U.S. companies in Mexico said fear over drug violence was affecting their expansion plans. Colombia endured 20 years of chaos, terrorism and warfare with its neighbors due to drug gangs, and it’s scary to consider what these forces might do along the 2000-mile U.S.-Mexican border.

Finally, lagging growth means that the U.S. trade deficit with Mexico will continue to grow. Yes, exports to Mexico have quadrupled under NAFTA, but imports have grown even faster, and the $65 billion trade deficit with Mexico in 2011 will likely increase. Much of U.S. exports to Mexico are raw materials and other parts that return to the U.S. as finished goods. U.S. auto parts exports of $13 billion return in the $30 billion worth of cars and trucks imported from Mexico each year. Unlike Canada and Chile, the U.S.’s other established free trade partners, Mexico isn’t developing into a major consumer market for American products. Its people simply don’t have the money, and as long as Mexico fails to make the significant political and economic reforms it needs, they won’t.

This is not to say that free trade is bad -- NAFTA has been a plus for the U.S., preserving some jobs by moving to Mexico low-cost assembly that was making U.S. manufacturing uncompetitive. Many of those jobs were destined to leave the U.S. anyway. But NAFTA’s potential was oversold, and Mexico’s potential as a fast-growing and secure market for the U.S. was wishful thinking. Free trade isn’t a panacea, and can’t by itself overcome decades of statism and autocracy.

John Maggs
Senior Economics Editor, The Kiplinger Letter