By Jack R. Binns. Mr. Binns, a retired Foreign Service officer, served as ambassador to Honduras. A consultant since his 1986 retirement, Ambassador Binns has been involved in Mexican trade and investment issues and currently resides in Tucson, Arizona.

Tremendous attention has been focused on trade negotiations with Mexico and the possible North American Free Trade Agreement (NAFTA), at the expense of the more important Uruguay Round of GATT negotiations. Our trade with Mexico accounts for about 7 percent of our total, while GATT rules regulate most of the rest. Emphasis has clearly been misplaced. And the North American Free Trade Area (FTA), on closer inspection, is one of those ideas that appear to carry greater risk than advantage.

The risk is heightened by the administration's initial deadline for completing negotiations--the beginning of 1992--haste, in this case, being a possible scenario for a faulty agreement. The FTA idea was "made in Mexico" by President Salinas de Gortari--which, I hasten to add, is not a negative factor--who apparently saw it as the best or only means to attract the kind of investment needed to get back on the path of sustained development. The fact that renewed growth may be critical to the survival of his party, the PRI, was probably not far from his mind. Viewed in the context of Mexican history and identity, it would seem to be a risky strategy. Even if the FTA should succeed in attaining the needed investment and growth, which is by no means certain, increased U.S. economic presence in the Mexican economy could trigger a strong domestic backlash. Although the recent Mexican election results suggest substantial public support for an FTA, the outlook could change rather quickly if the negotiated agreement does not meet Mexican expectations either in appearance or in practice, as has been the case in Canada. One might also ask how Mexicans will react to the major reduction in their ability to control their own economy, especially fiscal and monetary policies, that is implicit in the FTA concept.

While that may be a good thing in the long run, it is difficult to square with Mexican nationalism. President Bush, no doubt wishing to help Salinas and Mexico, thought it sounded like a good idea. There was apparently no serious examination of the FTA and its implications prior to our decision to proceed. Only later did the examination get under way.

It was right and responsible that Congress, in exchange for its extension of the fast track authority, demanded and received assurances that the administration will take specific actions to provide retraining for displaced American workers and ensure improvement in Mexican environmental practices. These were warning flags. The onus is now on the administration to meet these commitments and on the negotiators to work out an agreement that serves our national trade and economic interests. Although trade negotiations are not by definition a zero sum exercise, it is not yet clear whether a win-win agreement can be negotiated and ratified, as a number of direct conflicts and difficult issues must be resolved. The devil is clearly in the details. There are also political obstacles to overcome on both sides of the border.

Assessing the impact

The proposed FTA with Mexico and Canada is, in a very important sense, unique; not, certainly, as a free trade agreement, but as an arrangement of this type involving countries with profoundly disparate levels of income and development. The FTA with Canada is between two similar nations having comparable levels of social and economic development and personal income, as well as closely integrated economies. And many Canadians would argue that their FTA with us is looking suspiciously like a zero sum arrangement--with them on the short end. An agreement with Mexico will involve striking differences in per capita income, development levels and national economic structure. It is these differences, and the absence of comparable precedents, that ought to call into question many of the assumptions and claims made by those favoring the FTA.

Comparisons with the European Community (EC) are of limited utility. First, the income disparities between the EC's richest members (Germany before reunification and Denmark) and its poorest (Greece and Portugal) were in the range of 3 or 5 to 1; in the case of the United States and Canada compared to Mexico, they are in the range of 10 to 1.

Second, the EC is far more than a free trade arrangement. It is a mechanism for economic, social, and political integration. As such, it entails substantial transfer payments from the richer members to raise the development levels of the poorer members. In other words, the wealthier members of the EC provide direct financial subsidies to their poor partners. No such payments are envisaged in the proposed FTA. To the extent that the gap between the United States and Canada, on the one hand, and Mexico, on the other, is narrowed, it will be solely the product of commercial trade and investment, not transfer payments, subsidy, or economic assistance. "Trickle down," with all its problems and inequities, is the name of the game.

Facts or wishes?

Assertions that the FTA will represent an export bonanza for the United States are surely exaggerated. The value of our bilateral trade with Mexico more than doubled between 1985 and 1990 as a result of Mexico's entry into GATT and the consequent reductions in its trade barriers (tariffs were reduced sharply, to a current average of just over 8 percent, as compared to averages in excess of 30 percent previously, and extensive non- tariff barriers virtually eliminated). However, Mexico's low per capita GNP and its international debt situation impose finite limits on its ability to increase imports, while other disincentives currently discourage foreign and domestic investment. Per capita GNP is about $2,600 and growing very slowly, and its current account is expected to remain in deficit for the next few years. The absence of significant barriers to Mexican exports to the United States (except in agriculture, where sanitary standards and seasonal measures constitute important barriers and are unlikely to change much in the near term) suggests only modest room for growth in those earnings.

A KPMG Peat Marwick (KPMG/PM) economic model of the potential effects of the FTA tended to substantiate these conclusions. This model indicated that benefits to the United States and Mexico would be largely contingent upon the size of capital flows into Mexico resulting from the FTA. While Mexico has made substantial progress in reducing its barriers to foreign investment, it is still not competitive. Currently, foreign investment is either prohibited or specifically limited in the following sectors: petroleum/petrochemicals; computers; banking and financial services; automotive; transportation; mining; electrical power generation; radio and TV; and land ownership, which impacts directly on agriculture and real estate development. U.S. and Canadian negotiators will push hard to remove these barriers, but the extent to which Mexico will agree to a further opening of its economy to foreign investment is unclear. Mexico's history, the constitutional basis for investment barriers and domestic political considerations make it difficult to be optimistic.

Assuming the best case in eliminating investment barriers and other disincentives, the KPMG/PM model suggests a total capital inflow to Mexico of about $25 billion during the FTA transition period. It was 10 years in the case of the U.S.-Canada agreement and could be longer in the case of Mexico. If it should be 10 years (a 15- or 20-year transition period seems more likely), that would mean about $2.5 billion in new investment per year, made up of repatriated capital and foreign investment. If trade trends continue, we could expect about two-thirds of this investment, $1.6 billion per annum, to be spent in the United States. That would represent an increase of about 6 percent over our current level of exports to Mexico. That's a lot better than nothing, but less than the more enthusiastic claims would imply. It's also likely that Canada would get a part of this action, reducing the U.S. share. Compared to the growth rates in the 25 and 50 percent range experienced in the early years of Mexico's trade liberalization, these are not particularly impressive.

Runaways

Some FTA proponents claim growth of this magnitude would create as many as 40,000 jobs per year in the United States; others believe this overstates the case. On the down side, trends indicate our trade deficit with Mexico will increase, and potential job losses from "runaway" firms, much more difficult to quantify, are likely to be substantial. Arguments that run-away industry has already done its running, to Southeast Asia or elsewhere, don't stand up.

Canada's experience with the existing FTA may be suggestive. With wage and taxation rates significantly higher than those in the United States, there has been significant flight of capital and jobs to the U.S. side of the border. Some allege that the job loss in the first two years of the FTA was over 200,000 in Ontario alone. Though no doubt exaggerated, the loss of jobs has been significant and should flash an amber light for those who see the FTA as an unmitigated blessing. Moreover, a recent GAO study of the furniture industry in the Los Angeles area, perhaps a special case, demonstrated that U.S. manufacturers will move across the border to escape environmental regulation. Anyone who believes that Mexico could, under any circumstances, come close to meeting current U.S. environmental standards must be a stranger to the country or a credulous optimist.

It is one thing to move light assembly operations--e.g. textiles or electronic components--far offshore to take advantage of low wages, but quite another to move heavier industrial operations of those requiring major capital investment, especially when transport costs are an important factor. But new circumstances promising low wages, lower taxes, a secure investment environment, and proximity to the main (U.S.) market produce quite a different equation, as the FTA with Canada illustrates. If these conditions were met as regards Mexico, which the NAFTA promises, it would be folly not to expect a substantial movement of industrial and assembly operations south of the border. The upshot would be the loss of tens of thousands of relatively high-paying industrial jobs in the United States. And to the extent jobs are replaced, they are likely to be at the low end of the pay spectrum. The key point is that we are moving into uncharted areas, and that makes it very difficult to anticipate the full effects of our actions with any confidence.

A study by the Economic Strategy Institute (ESI) underscores the potential risk and the importance of careful negotiation of the FTA, which would appear jeopardized by the administration's rush to conclude the negotiations to meet the domestic political agenda. The ESI study suggests that a poorly negotiated agreement could seriously aggravate the existing trade deficit with Mexico and cost us up to 400,000 jobs; an optimal agreement, on the other hand, could produce a $9 billion trade surplus (excluding oil) and create a net 250,000 jobs by the turn of the century. As one would expect, the details of the agreement will determine whether it serves our interests.

Stumbling blocks

Having looked at the larger questions, the specific trade and technical issues the negotiators must deal with merit at least summary review. The U.S.-Canada FTA will serve as a starting or reference point for negotiations with Mexico. While no one expects Mexico to agree to an exact replica of that agreement, even with longer transition periods, it does suggest directions in which the northern nations will wish to move.

The U.S.-Canadian agreement treats a broad range of commodity categories (20 for "rules of origin") and devotes entire chapters to areas of special concern--agriculture, wine and spirits, energy (where Canada's sensitivities were not unlike those of Mexico), automotive goods, services, government procurement, investment, financial services, and temporary entry of businesspeople. Chapters are also devoted to technical issues such as "emergency action," exceptions for goods trade, government procurement, disputes procedure, and special exceptions (national security, standards, etc.). The FTA with Mexico is likely to have a similar structure.

Contentious sectors/issues are expected to include: agriculture; the automotive sector; finance and investment; petroleum/petrochemicals; pharmaceuticals; transportation; and labor market. Other potentially difficult areas, such as steel and textiles, should be amenable to resolution. Steel interests, particularly, seem to offer a basis for mutual advantage, while textile problems may be largely resolved in the Uruguay Round. Some other likely problem areas:

Agriculture:

This may prove to be the most complex and troublesome area for negotiators. Current trade favors the United States, and the U.S. government is seeking greater access to the Mexican market, elimination of non-tariff barriers, and improved investment conditions. The United States also wishes to continue protecting selected crops (a critical issue for some congressional committees) and retain sanitary, pest, and other standards.

The Mexicans regard many of the latter as disguised protectionism. Mexico, for its part, wants greater access to the U.S. and Canadian markets, elimination of seasonal tariffs and other barriers on Mexican produce, and an easing of sanitary and standards barriers. Mexico will seek to protect its land tenure restrictions and the ejidos, or communal farmland, both of which are sensitive constitutional issues. Nonetheless, it would seem that potential gains for all parties and the complexity of the issues, which offer multiple opportunities for trade-offs, provide a basis for the negotiators to find accommodation. The larger question is whether, having reached agreement in this sector, the results will be politically salable at home.

Automotive:

Objectively, this sector would appear to be one in which the negotiators could find sufficient mutuality of interest to strike a deal that would be win/win. The principal players/investors are the same in all three countries. But it is also an area of priority concern for U.S. labor in its opposition to the FTA, and that means a politically salable accord may be hard to come by.

Finance/Investment:

A top priority area for all parties. Mexico needs new investment badly, and the United States and Canada appear willing to provide at least some of it if the conditions are right. And if the conditions are right, Japanese and European investment will also come in. Mexico has already liberalized its financial and investment regimes, though they still fall far short of the provisions of the U.S.-Canada FTA. Clearly the northerners will insist upon greater liberalization, within a reasonable transition period, but even so it is doubtful that Mexico will be willing to go as far as its future partners would like. Elimination of "reserved areas" of the economy (e.g. petroleum, transportation, electrical generation) and of limits on foreign investment in other areas are probably impossible, but further liberalization is not. Securities and financial instruments will also be a troublesome area. The strong mutuality of interest ought to impel the negotiators toward accommodation, but perceptions in Mexico could accentuate fears of potential U.S. domination and consequent limits on Mexico's freedom of economic policy action. That would spell trouble.

Petroleum/petrochemicals:

This will be a very tough nut. The United States would like to see the elimination of the (constitutional) bar on foreign exploration and production. Mexico has already indicated this is not negotiable, and Canada probably has some sympathy for the Mexican position. There may be room for accommodation on joint ventures, but that is far from certain. Mexico, however, has already shown flexibility on petrochemicals. Although the "basic" industry remains reserved, the "secondary" has been opened to private investment, and a number of formerly "basic" products have been reclassified as "secondary." Since serious differences in this sector were resolved by the U.S.-Canadian negotiators, there are some grounds to believe they can be resolved in the trilateral context. But again, this is a potentially explosive issue in Mexico.

Pharmaceuticals:

The United States and Canada will insist upon better protection of intellectual property rights, increased market access, and liberalized treatment of investment. Protection of proprietary information and patents are likely to be key. Unfortunately, the Mexican Ministry of Health has interests apart from those of the trade and financial ministries and could be the decisive player within the Mexican government. It wants to keep prices to consumers low, even if that means turning a blind eye to product piracy. This one also has heavy political overtones.

Transportation:

This sector is currently off limits to foreign investors; railways are reserved for the state, while motor, air, and maritime transport are reserved for Mexican nationals. Although the United States and Canada don't have a problem with nationalized railroads, the other restrictions will not be acceptable in their present form. Motor transport, which will become increasingly important as intra-FTA trade grows, is also among the most politically sensitive sub-sectors in Mexico. Again, it is not clear how much the Mexicans are prepared or able to concede.

Labor Market:

There are direct conflicts in this area. Mexico seeks expanded access to the United States (and presumably Canada) for unskilled workers, a position that would seem to have no chance of success. The United States and Canada will probably try to manage the issue by offering concessions for professional and managerial workers (per the U.S.-Canada FTA) and a separate mechanism to study the issue of labor migration (the U.S.-Canada pact had several side agreements addressing tangential issues). That may not be sufficient for the Mexican government, which will be under pressure from its own constituencies, and attack from the left, for "seeling out" Mexico's interests in the investment and other areas.

Disputes Settlement:

These provisions will be among the most important, sensitive, and contentious, offering many opportunities for deadlock. In a very real sense this mechanism will be pivotal for success of the FTA. Disputes are a certainty and if they cannot be satisfactorily resolved, the entire FTA structure will be jeopardized. The Mexicans are most likely to have trouble with the notion of binding arbitration when bilateral/trilateral mechanisms fail to solve the problem--the suspicion that the northern countries can rig the outcome to Mexico's disadvantage will no doubt be near the surface and could be exploited against the Salinas government and the FTA itself.

No turning back

One more certainty: the FTA horse cannot be walked back into the stable. Political commitments have been made at the highest levels in all three countries, and President Salinas de Gortari has staked his administration on getting an FTA. He was clearly correct in his efforts to open the Mexican economy, deal with the staggering debt burden, and seek new investment; indeed, it can be argued that further liberalization of the economy in the GATT context, including the general elimination of "reserved" areas and other barriers to foreign investment, would be a better solution for Mexico than an FTA. But perhaps from his perspective an FTA, or something like it, is a prerequisite for attaining the political support necessary for further liberalization and, if necessary, constitutional amendment. In any case, the horse is out of the stable.

There is a wide range of possible outcomes to the FTA process, starting with an accord that is politically acceptable in all three countries, stimulates trade to the benefit of all, and gives the Mexican economy the kind of kickstart Salinas wants. This is the best, and probably Utopian, case. A partial list of the others, in a descending order of desirability, follows:

-- An FTA that is accepted by all three countries; is balanced, with the negative aspects for all offset by modest advantages; produces small but steady growth in trade; and improves the Mexican economy at the margin. Assuming the negotiators can pick their way through an agenda that resembles a mine field--and that's a big assumption--this could materialize; indeed, it may be the most likely of the "reach agreement" scenarios. Even so, the odds on its happening seem fairly slim.

-- An FTA that is accepted by each government, but is unbalanced and flawed; problems may or may not be resolved by a disputes mechanism, but continue to fester, with one or more parties feeling increasingly put upon; trade benefits are marginal and leave the polities of one or all three countries feeling misled or deceived. This scenario could lead to abrogation of the FTA, with a legacy of bitterness, or the participants might stoically accept the reality of the situation and live with it.

-- Negotiators fail to reach agreement and call it quits. With luck, none of the parties would scapegoat the others, and everyone would agree that there was just not sufficient mutuality of interest to make an FTA worthwhile. Of the "fail agreement" scenarios, this is by far the best. The likelihood, however, is that failure of the negotiators would produce a backlash against the United States in Mexico. Even so, this outcome is among the least bad.

-- Agreement is reached by negotiators, but is not ratified by one or more of the parties. This scenario has several variations. If the Mexicans should decide that the deal struck does not serve their interests, one might suspect the sigh of relief from the north would sound like a hurricane. This may not be far-fetched, especially if the negotiations drag on for a couple of years. With Salinas's term expiring in 1994, he may not be able to control events in Mexico after mid-1993. This outcome would clearly be the least damaging of the "fail" scenarios; the worst would be rejection by our Congress. One might hope, assuming agreement can be reached, that the administration will delay submission to Congress until the Mexicans have decided, though the risk is that the blow-back would be stronger if we reject the FTA after Mexico has accepted. Maybe we'll get lucky and the Canadians will save our bacon.

Reviewing the range of possible outcomes, one wonders whether there was a serious risk/benefit analysis. It is possible, of course, that one of the Utopian or less bad scenarios will eventuate. Let's be optimistic.

Nevertheless, an idea that seemed attractive could turn out to have unanticipated and potentially damaging implications beyond the strictly economic arena. The Economic Strategy Institute study affirms the need for careful negotiations, and thoughtful consideration underscores it. The bottom line is that the details of the FTA and meaningful assessment of its potential impact await conclusion of the negotiators' work. Only then can we intelligently decide whether the game is worth the candle. To hurry this process for political or other reasons is folly.