NAFTA’s Economic Impact

The North American Free Trade Agreement (NAFTA) was a trade pact between Canada, Mexico, and the United States, negotiated by their respective governments and enacted in January 1994. Its provisions gradually rolled out until January 2008 and removed most tariffs on goods traded among the three nations. The agreement primarily aimed to ease trade in agriculture, textiles, and automobiles. It also included measures to safeguard intellectual property, establish a system for resolving trade disputes, and, through additional agreements, address labor and environmental concerns.

NAFTA significantly changed economic ties in North America, fostering deeper economic integration between the developed economies of Canada and the United States and Mexico’s developing market. In the U.S., it had bipartisan support, originally negotiated by Republican President George H.W. Bush, approved by a Democratic-majority Congress, and implemented under Democratic President Bill Clinton. The agreement helped regional trade more than triple and led to a notable increase in cross-border investments.

However, NAFTA has been a recurring subject of debate regarding free trade. Critics, including President Donald J. Trump, argued that it harmed U.S. jobs and manufacturing. In response, his administration negotiated a new agreement with Canada and Mexico in October 2018, replacing NAFTA with the United States-Mexico-Canada Agreement (USMCA).

NAFTA’s Role in the Trade Policy Debate

When discussions for NAFTA began in 1991, the primary objective was to integrate Mexico's economy with the well-established, high-income markets of the United States and Canada. The expectation was that increased trade would lead to stronger and more stable economic growth in Mexico, generating job opportunities and reducing illegal migration to the U.S. For both the U.S. and Canada, Mexico represented a valuable emerging market for exports and an attractive location for cost-effective investments that could enhance business competitiveness.

While a free trade agreement between the U.S. and Canada had already been established in 1988, including Mexico in the deal was an entirely new step. Critics of NAFTA pointed to the stark wage gap, as Mexico’s per capita income was only about 30 percent of that in the United States. During his 1992 presidential campaign, Ross Perot warned that trade liberalization would cause a major shift in jobs across the border, draining employment from the U.S. Meanwhile, supporters such as Presidents George H.W. Bush and Bill Clinton argued that the agreement would generate hundreds of thousands of jobs each year. Mexican President Carlos Salinas de Gortari viewed NAFTA as a way to modernize his country’s economy and boost exports to strengthen domestic industries.

NAFTA played a key role in shaping the modern landscape of regional and bilateral free trade agreements (FTAs), particularly as global trade negotiations within the World Trade Organization (WTO) stalled. It also set a precedent by including labor and environmental protections in U.S. trade deals – provisions that have grown increasingly detailed in later FTAs.

Economists generally acknowledge that NAFTA has benefited the economies of North America. Trade within the region saw a significant rise over the first two decades of the agreement, climbing from approximately $290 billion in 1993 to over $1.1 trillion by 2016. Foreign direct investment (FDI) between the countries also expanded, with U.S. investment in Mexico growing from $15 billion to more than $100 billion in the same timeframe. However, determining NAFTA’s precise impact remains challenging due to other influential factors, such as technological advancements, expanded trade with countries like China, and economic changes within each nation. The agreement’s effect on jobs and wages remains a topic of debate – some industries and workers faced challenges due to heightened competition, while others benefited from expanded market access and new economic opportunities.

Impact of NAFTA on the U.S. Economy

Since the implementation of NAFTA, trade between the United States and its North American partners has expanded significantly, increasing more than threefold. This trade growth has outpaced the country’s trade expansion with the rest of the world. Today, Canada and Mexico rank as the top destinations for U.S. exports, making up more than one-third of total exports. Studies generally indicate that NAFTA had a modest but positive effect on the U.S. economy, contributing less than 0.5% to GDP growth. When fully implemented, the agreement added an estimated $80 billion to the economy, equating to several billion dollars in annual growth.

The benefits of increased trade are often spread across multiple sectors, making them less noticeable, whereas the challenges tend to be concentrated in specific industries, such as automobile manufacturing. Proponents of NAFTA estimate that approximately 14 million U.S. jobs are linked to trade with Canada and Mexico. Additionally, export-driven jobs created under the agreement typically pay 15–20% more than the roles that were displaced.

Despite these benefits, critics argue that NAFTA contributed to job losses and wage stagnation in the U.S. due to competition from lower-wage markets. Some companies relocated operations to Mexico to cut costs, leading to concerns over a growing trade deficit. The U.S. trade balance with Mexico shifted from a $1.7 billion surplus in 1993 to a $54 billion deficit by 2014. Some economic analysts, including those from the Center for Economic and Policy Research (CEPR) and the Economic Policy Institute, estimate that up to 600,000 U.S. jobs were lost due to rising imports. However, they acknowledge that at least some of this increase in imports would have occurred regardless of NAFTA.

Many economists argue that the challenges facing U.S. manufacturing are not primarily linked to NAFTA, pointing out that the sector was already under pressure long before the agreement was implemented. A study published in January 2016 by David Autor, David Dorn, and Gordon Hanson found that competition from China had a far greater negative effect on U.S. jobs, especially after China joined the WTO in 2001. Hanson, an economist at the University of California, San Diego, highlights that the steepest decline in manufacturing employment – dropping from 17 million to 11 million between 2000 and 2010 – was largely driven by trade with China and advancements in technology. He emphasizes that among these factors, China had the most significant impact on job losses, followed by technological changes, with NAFTA playing a considerably smaller role.

Hanson also asserts that NAFTA helped strengthen the U.S. automotive industry by fostering cross-border supply chains, reducing costs, and boosting efficiency. While some manufacturing jobs did shift to Mexico, he argues that without NAFTA, the losses would have been even more severe. The agreement allowed for the creation of an integrated regional industry where goods could move freely between the three countries, providing U.S. automakers with a competitive edge over China. Without NAFTA’s tariff reductions and intellectual property protections, these industry connections would have been much harder to maintain.

Edward Alden, a senior fellow at the Council on Foreign Relations, notes that concerns over trade agreements have intensified due to stagnating wages, rising income inequality, and a widening gap between labor productivity and earnings. He suggests that trade agreements have accelerated these economic trends by further integrating the U.S. economy into global markets.

Impact on the Mexican Economy

NAFTA significantly increased Mexico’s agricultural exports to the United States, with trade in this sector tripling since the agreement took effect. Additionally, the deal contributed to the growth of Mexico’s auto manufacturing industry, generating hundreds of thousands of new jobs. Most analyses indicate that NAFTA had a positive influence on Mexico’s productivity and helped lower consumer prices.

The agreement was part of a broader shift toward economic liberalization that Mexico had been undergoing for a decade. Before NAFTA, the country was one of the most trade-restrictive economies in the world. However, after joining the General Agreement on Tariffs and Trade (GATT) – the precursor to the WTO – in 1986, Mexico began reducing trade barriers. Despite these efforts, its average tariff rate before NAFTA remained at approximately 10 percent.

Mexican policymakers saw NAFTA as a way to accelerate economic reforms and solidify the progress already made. Alongside trade liberalization, the government worked to control public debt, implement a balanced budget policy, stabilize inflation, and strengthen foreign currency reserves. Although Mexico was severely impacted by the 2008 U.S. recession – losing 17 percent of its exports to the U.S. and seeing a GDP contraction of over 6 percent in 2009 – the country rebounded quickly. By 2010, economic growth had exceeded 5 percent, though it later slowed to about 2 percent in 2014 and 2015.

Mixed Results of Mexico’s NAFTA Experience

Despite the optimistic projections made by some of its supporters – who claimed the agreement would drive rapid economic growth, increase wages, and reduce emigration – Mexico’s actual outcomes under NAFTA have been more complex. From 1993 to 2013, the country’s economy expanded at an average annual rate of just 1.3 percent, even as Latin America experienced significant growth. Poverty levels have remained largely unchanged since 1994, and the anticipated wage convergence between the U.S. and Mexico never materialized. During this period, Mexico’s per capita income grew by only 1.2 percent annually, a much slower rate than that of other Latin American nations such as Brazil, Chile, and Peru.

Unemployment in Mexico also increased, with some economists attributing this to NAFTA’s impact on agriculture. The agreement subjected Mexican farmers, particularly corn producers, to competition from heavily subsidized U.S. agricultural products. A study led by economist Mark Weisbrot at CEPR estimates that nearly two million small-scale Mexican farmers lost their livelihoods due to the deal, leading to an increase in migration to the United States. Both legal and undocumented migration more than doubled after 1994, reaching a peak in 2007. However, after 2008, migration patterns shifted, with more Mexican-born individuals returning to Mexico than arriving in the U.S. Experts link this trend to tighter border controls, demographic shifts in Mexico, and fewer job opportunities in the U.S. combined with improved employment prospects within Mexico.

The Uneven Impact of NAFTA on Mexico’s Economy

Analysts often attribute Mexico’s mixed economic outcomes to the stark contrast between its regions. NAFTA fueled foreign investment, advanced manufacturing, and wage increases in the industrial north, while the more rural and agrarian southern regions largely remained disconnected from these benefits. Economist Mauro Guillen from the University of Pennsylvania suggests that Mexico’s growing income disparity is a result of trade-related industries in the north offering significantly higher wages than those available in non-trade sectors.

However, experts emphasize that Mexico’s economic trajectory has been shaped by factors beyond NAFTA. The 1994 peso devaluation played a role in boosting exports, while competition with China’s low-cost manufacturing industry may have constrained Mexico’s growth. Additionally, domestic policies unrelated to trade, such as land reforms that facilitated land sales and migration, also influenced economic trends. Economist Gordon Hanson from UCSD highlights internal structural challenges – such as underdeveloped credit markets, a sizable informal labor sector with low productivity, and inefficient regulations – as key factors limiting Mexico’s overall economic progress.

The Effect of NAFTA on Canada

Since NAFTA’s implementation, Canada has experienced a significant rise in cross-border investments. U.S. and Mexican investments in Canada have tripled since 1993, with U.S. foreign direct investment (FDI) increasing from $70 billion to over $368 billion by 2013. Given that U.S. investments make up more than half of Canada’s total FDI, this growth has played a vital role in Canada’s economy.

However, the most significant shift for Canada, gaining greater access to the U.S. market, its largest trading partner, was set in motion before NAFTA through the Canada-U.S. Free Trade Agreement (CUSFTA) in 1989. Following trade liberalization, total trade between the two countries surged. Canadian exports to the U.S. expanded from $110 billion to $346 billion, while imports from the U.S. saw nearly identical growth.

The agricultural sector benefited considerably, with Canada becoming the top buyer of U.S. agricultural goods. Trade in agricultural products between the two nations more than tripled since 1994, and Canada’s total agricultural exports to NAFTA partners saw a comparable rise.

Despite concerns that increased trade would harm Canadian manufacturing, employment in the sector remained stable. However, expectations that trade liberalization would rapidly boost productivity were not fully realized, as Canada’s labor productivity remains at 72 percent of U.S. levels.

The Future of NAFTA

NAFTA has been a frequent topic of political debate. During the 2008 presidential campaign, Barack Obama pledged to renegotiate the agreement to strengthen labor and environmental protections, but this promise was later abandoned. The discussion resurfaced in the 2016 election, with both Senator Bernie Sanders and Donald Trump criticizing NAFTA for contributing to U.S. job losses.

Policy experts continue to debate ways to lessen the negative impacts of trade agreements like NAFTA. Many suggest providing support to workers affected by job displacement, such as wage insurance that covers a portion of lost earnings for a certain period or programs that fund retraining for new careers. Federal Trade Adjustment Assistance (TAA), which helps displaced workers gain new skills or education, is another proposed solution to counteract job losses tied to trade agreements.

Originally introduced in the 1960s, TAA saw significant budget cuts in the 1980s, and many economists believe its current funding is inadequate to address the rise in trade-related job losses. Some argue that the struggles of certain communities highlight broader policy failures in helping workers and regions adapt to the economic shifts brought on by globalization.

The Renegotiation of NAFTA

Instead of adopting traditional policy proposals, President Trump followed through on his campaign commitment to renegotiate NAFTA. Formal discussions among the three nations began in August 2017. Throughout the negotiation process, Trump leveraged tariffs as a bargaining tool, imposing import duties on steel and aluminum in early 2018 and threatening similar actions on automobiles. His demands focused on raising standards for the auto sector, expanding access to Canada’s protected dairy market, improving labor rights, reforming dispute resolution mechanisms, and updating rules on intellectual property and digital trade.

In August 2018, the U.S. reached an agreement with Mexico, followed by Canada in September. The revised deal, which Trump named the U.S.-Mexico-Canada Agreement (USMCA), introduced several key updates. The new agreement increased the percentage of a vehicle’s components that must originate within member countries from 62.5 percent to 75 percent. It also introduced labor requirements, mandating that at least 40 percent of a vehicle’s parts be sourced from factories where workers earn at least $16 per hour. While Trump backed away from his threat to impose tariffs on Canadian and Mexican auto imports, the existing steel and aluminum tariffs remained in place. Additionally, the agreement reinforced protections for U.S. pharmaceuticals and other forms of intellectual property.

Canada agreed to grant more access to its dairy market, one of Trump's key demands. In exchange, Canada secured a few advantages, including the preservation of the Chapter 19 dispute resolution panel, which helps shield it from U.S. trade actions. The agreement also removed the proposed five-year sunset clause, instead setting a sixteen-year term with a review scheduled after six years. Before it could take effect, the agreement needed approval from all three countries’ legislatures, with the earliest U.S. congressional vote expected in early 2019.