
International_Economics_Tenth_Edition (1)
.pdffreely to other countries. The second is the flexibility of prices and wages: The country must be able to adjust these in response to a disturbance. The third is some automatic mechanism for transferring fiscal resources to the affected country.
The theory of optimal currency areas concludes that for a currency area to have the best chance of success, countries involved should have similar business cycles and similar economic structures. Also, the single monetary policy should affect all the participating countries in the same manner. Moreover, there should be no legal, cultural, or linguistic barriers to labor mobility across borders; there should be wage flexibility; and there should be some system of stabilizing transfers.
Europe as a Suboptimal
Currency Area
Although Europe may not be an ideal currency area, forming a monetary union has some advantages. A monetary union may improve economic efficiency through lowering transaction costs of exchanging one currency for another. Tourists are familiar with the time and expense of changing one currency into another while traveling in Europe. Eliminating the transaction costs would benefit both consumers and businesses. A single currency would also facilitate genuine comparison of prices within Europe. Another advantage is the elimination of exchange-rate risk; businesses would more readily trade and invest in other European countries if they did not have to consider what the future exchange rate would be. EMU would also stimulate competition and would facilitate the broadening and deepening of European financial markets.
The overall magnitudes of these gains appear to be relatively small. The European Commission estimates that savings in transaction costs will be about 0.4 percent of the ED's gross domestic product.' Even though small, the efficiency gains are greater the more a country trades with other countries in the monetary union. For example, the Netherlands, whose trade with Germany has typ-
sCommission of the European Communities, Directorate-General fur Economic and Financial Affairs, "One Market, One Money: An Evaluation of the Potential Benefits and Costs of Forming an Economic and Monetary Union," European Economy, No. 44, October 1990, p. II.
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269 |
|
~~f |
ically exceeded 20 percent of its total trade, would |
|
benefit considerably by a monetary union with |
|
Germany. In contrast, only about 2 percent of the |
|
total trade of the Netherlands has typically been |
|
with Spain, making the benefits of monetary |
|
union with Spain much smaller. |
|
A main disadvantage of EMU is that each partic- |
|
ipating European country loses the use of monetary |
|
policy and the exchange rate as a tool in adjusting to |
|
economic disturbances. If one country experiences a |
|
recession, it can no longer relax monetary policy or |
|
allow its currency to depreciate to stimulate its econ- |
|
omy. The use of fiscal policy, too, may be limited by |
|
the need to keep budget deficits under control under |
|
EMU. Economic revival depends on wage flexibility |
|
and perhaps the ability and willingness of labor to |
|
move to new locations. Because wage rigidity in |
|
Europe is considerable and labor mobility is low, |
|
recovering from a recession could be difficult, lead- |
|
ing to political pressure for an easing of the single |
|
monetary policy, or increased government debt of |
|
the country in recession. |
|
Are the members of the EU an optimum curren- |
|
cy area? In other words, do the microeconomic |
|
gains of greater efficiency outweigh the macroeco- |
|
nomic costs of the loss of the exchange rate as an |
|
adjustment tool? Several economists have suggested |
|
that the costs exceed the gains for the countries as a |
|
whole, and thus monetary union is not a good idea |
|
for all countries." For a smaller set of countries, |
|
however, the gains may exceed the costs, and mon- |
|
etary union makes sense. Trade among the smaller |
|
set of countries is much higher than trade with all |
|
countries, so that the efficiencygains are higher. |
|
Challenges for EMU |
|
The economic effect of EMU on Europe and on |
|
the United States will depend mostly on the poli- |
|
cy decisions that are made in Europe in the years |
|
ahead. The actual move to a single currency, by |
|
itself, will likely have only a relatively small effect. |
|
Perhaps the most important monetary policy |
|
challenge for EMU is the ability of the European |
|
Central Bank to focus on price stability over the |
|
long term. Some are concerned that, over time, |
|
monetary policy may become too expansionary, |
|
'Paul DeGrauwe. The Economics of Moneta,)' Inteqration (New York: Oxford University Press, 1994), pp. 89-94.
Regional Trading Arrangements
given the large number of countries voting on monetary policy, and the fact that strong antiinflationary actions are not well ingrained in countries such as Portugal, Spain, and Italy.
The operation of monetary policy may also present some challenges. If there is wide difference in economic growth rates among EMU countries, it may be difficult to decide on appropriate shortterm interest rates. Tightening monetary policy to reduce int1ationary pressures may be appropriate for some countries, while loosening monetary policy to stimulate activity may be appropriate for other countries. Therefore, determining monetary policy for the eurozone as a whole, which the European Central Bank is required to do, may be difficult at times.
Although fiscal policy remains the province of national governments, avoidance of excessive budget deficits is important for the success of EMU. Because large budget deficits can lead to high interest rates and lower economic activity, budgetary restraint is desirable by itself. Most countries had considerable difficulty in reducing budget deficits and debts to meet the convergence criteria of EMU. Cutting government expenditures, especially on well-established social programs, was (and is) politically difficult. In the face of aging populations in most countries, pressures on budgets may grow even stronger.
Finally, the need for structural reform in European countries presents a challenge for EMU countries. Labor-market flexibility is probably the most important structural issue. Real (inflationary adjusted) wage flexibility in Europe is estimated to be half that of the United States. Moreover, labor mobility is quite low in Europe, not only between countries, but also within them. Incentives to work and to acquire new skills are inadequate. Regulations that limit employers' ability to dismiss workers make them unwilling to hire and train new workers. Also, high taxes and generous unemployment benefits provided by European governments contribute to sluggish economies.
Analysts note that structural reforms are necessary for several reasons. First, they would lower the EU's persistently high structural unemployment rate. Second, firms would provide needed flexibili- ty in adjusting to recessions, especially those that
affected one or a few countries in the eurozone. If prices and wages were flexible downward, for example, a decline in demand would be followed by lower prices, tending to raise demand. Increased labor mobility would be particularly useful in adjusting to recessions.
EMU and the United States
Is EMU good for the United States? At present, the U.S. dollar is by far the most widely used currency in international trade and finance. Many internationallytraded goods, such as oil, are priced, and paid for, in dollars. Bank loans and securities often are denominated in dollars. The dollar's international role is based on the strength of the U.S.economy and financial markets and also the large size of U.S. international trade and investment flows.
Many analysts agree that EMU, if successful, will eventually lead to decline in the dollar's role as an international payments and reserve currency. However, this decline would likely occur slowly, not suddenly, for several reasons. First, the dollar is the predominant currency in Asia and Latin America; it is unlikely the euro will replace the dollar in those areas any time in the near future. Second, the dollar serves as a safe haven at times of political and economic uncertainty. Simply pur, European financial markets are unlikely to be transformed overnight; the u.s. financial market will probably remain the most liquid in the world for a long period of time.
Over the years, the U.S. government, which has a strong interest in a prosperous and stable Europe, has supported European efforts at economic integration. The policy on EMU has generally been that if it is good for Europe, it will be good for the United States. It will be good for Europe if the conditions for sustained economic growth, particularly monetary policy credibility, sustainable fiscal deficits, and structural reforms, are achieved by European governments. If these concerns are addressed, EMU will likely stimulate economic growth and competitiveness in Europe, which should benefit the United States. Because U.S. trade with the eurozone is small relative to the size of the U.S. economy, the effect of EMU on bilateral trade flows is expected to be fairly low.

North American Free Trade
Agreement (NAFTA)
The success of Europe in forming the European Union has inspired the United States to launch several regional free-trade agreements. During the 1980s, for example, the United States entered into discussions for a free-trade agreement with Canada, which became effective in 1989. This paved the way for Mexico, Canada, and the United States to form the North American Free Trade Agreement (NAFTA), which went into effect in 1994.
NAFTA's visionaries in the United States made a revolutionary gamble. Mexico's authoritarian political system, repressed economy, and resulting poverty were creating problems that could not be contained at the border in perpetuity. Mexican instability would eventually spill over the Rio Grande. The choice was easy: Either help Mexico develop as part of an integrated North America, or watch the economic gap widen and the risks for the United States increase.
The establishment of NAFTA was expected to provide each member nation better access to the others' markets, technology, labor, and expertise. In many respects, there were remarka ble fits between the nations: The United States would benefit from Mexico's pool of cheap and increasingly skilled labor, while Mexico would benefit from
Chapter 8 |
271 |
Ll.S, investment and expertise. However, negotiating the free-trade agreement was difficult because it required meshing two large advanced industrial economies (United States and Canada) with that of a sizable developing nation (Mexico). The huge living-standard gap between Mexico, with its lower wage scale, and the United States and Canada was a politically sensitive issue. One of the main concerns about NAFTA is whether Canada and the United States as developed countries have little to gain from trade liberalization with Mexico, a developing country. Table 8.3 highlights some of the likely gains and losses of integrating the Mexican and U.S. economies.
NAFTA's Benefits and Costs for Mexico and Canada
NAFTA's benefits to Mexico have been proportionately much greater than for the United States and Canada, because Mexico integrated with economies many times larger than its own. Eliminating trade barriers has led to increases in the production of goods and services for which Mexico has a comparative advantage. Mexico's gains have come at the expense of other low-wage countries, such as Korea and Taiwan. Generally, Mexico has produced more goods that benefit from a low-wage, low-skilled workforce, such as tomatoes, avocados, fruits, vegetables, processed foods, sugar, tuna, and glass;
Winners and Losers in the United States Under Free Trade with Mexico
U.S. Winners |
U.S. Losers |
Higher-skill, higher-tech businesses and their workers benefit from free trade.
Labor-intensive businesses that relocate to Mexico benefit by reducing production costs.
Domestic businesses that use imports as components in the production process save on production costs.
Consumers in the United States benefit from less expensive products due to increased competition with free trade.
Labor-intensive, lower-wage, import-competing businesses lose from reduced tariffs on competing imports.
Workers in import-competing businesses lose if their businesses close or relocate.
1Il1111
272 Regional Trading Arrangements
labor-intensive manufactured exports, such as appliances and economy automobiles, have also increased. Rising investment spending in Mexico has helped increase wage incomes and employment, national output, and foreign-exchange earnings; it also has facilitated the transfer of technology.
Although agriculture represents only 4 to 5 percent of Mexico's GDP, it supports about a quarter of the country's population. Most Mexican agricultural workers are subsistence farmers who plant grains and oilseeds in small plots, which have supported them for generations. Mexican producers of rice, beef, pork, and poultry claim that they have been devastated by u.s. competition in the Mexican market resulting from NAFfA. They claim that they cannot compete against imports from the United States, where easy credit, better transportation, better technology, and major subsidies give U.S. farmers an unfair advantage.
For Canada, initial concerns about NAFTA were less to do with the flight of low-skilled manufacturing jobs, because trade with Mexico was much smaller than it was for the United States. Instead, the main concern was that closer integration with the U.S. economy would threaten Canada's European-style social welfare model, either by causing certain practices and policies (such as universal health care or a generous minimum wage) to be considered as uncompetitive, or else by imposing downward pressure on the country's base of personal and corporate taxes, thus starving government programs of resources. However, Canada's social-welfare model currently stands intact, and in sharp contrast to the United States. As long as most Canadians are willing to pay the higher taxes necessary to finance generous governmental services, NAFTA poses no threat to the Canadian way of life.
Canada's benefits from NAFTA have been mostly in the form of safeguards: maintenance of its status in international trade, no loss of its current free-trade preferences in the U.S. market, and equal access to Mexico's market. Canada also desired to become part of any process that would eventually broaden market access to Central and South America. Although Canada hoped to benefit from trade with Mexico over time, most
researchers have estimated relatively small gains thus far because of the small amount of existing Canada-Mexico trade.
Another benefit of NAFTA for Canada and Mexico is economies of large-scale production. To illustrate, Figure 8.4 represents the Canadian auto market, in which Canada is assumed to be a net exporter to the United States. Assume that prior to the elimination of U.S. trade restrictions, the U.S. demand for Canadian autos is D u.s.o' Also assume that the Canadian auto demand is Dc. The overall demand schedule is thus denoted by Dc + Du.s.o· Economies of scale are denoted in the downwardsloping cost schedule AC. For simplicity, assume that Canadian manufacturers price their automobiles at average cost. In the absence of a free-trade agreement, the total number of autos demanded is 100 units, and the price received by Canadian manufacturers is $10,000 per unit.
Under bilateral free trade with the United States, Canadian auto companies encounter a danger and an opportunity. The danger is that competing U.S. manufacturers may undercut Canadian companies that maintain prices at $10,000. But bilateral free trade also provides the Canadian companies an opportunity. The elimination of Ll.S. trade restrictions results in a shift in the export demand schedule faced by Canadian manufactur-
ers from Du.s.o to Du.s.l ; thus, the overall demand schedule is now Dc + Du.s. !, The total number of autos supplied by Canadian manufacturers increas-
es to 120 units, and the resulting cost reductions permit the price charged by Canadian manufacturers to decrease to $8,000. Economies of large-scale production thus permit Canadian firms to adopt more competitive price policies.
For Canadian consumers, the $2,000 price reduction results in an increase in consumer surplus equal to area a, located under demand schedule Dc. Note that the gain to the Canadian consumer does not come at the expense of the Canadian manufacturer! The Canadian manufacturer can afford to sell autos at a lower price without any decrease in unit profits because economies of scale lead to reductions in unit costs. Economies of large-scale production therefore can provide benefits for both the producer and the consumer.

Chapter 8 |
273 |
Economies of Scale in Canadian Auto Manufacturing: Benefits to Canada of Abolishing U.S. Trade Restrictions
OJ
U
"C
c,
10,000
8,000
AC (Canadal
100 120
Quantity of Autos
With bilateral free trade, competing U,S. automakers may undercut Canadian manufacturers who maintain pricesat $10,000.But longer production runs for Canadian manufacturers, made possible by the opening of the U.S. auto market, can result in cost reductions with economies of scale.
I" . 11111 liJIIltllill[~UI |
7 71111111 I1111 |
lUI III 1111111 |
Although NAFTA has succeeded in stimulating increased trade and foreign investment, NAFTA alone has not been enough to modernize Mexico or guarantee prosperity. This has been a disappointment to many Mexicans. However, trade and investment can do only so much. Since the beginnings of NAFTA, the government of Mexico has struggled to deal with the problems of corruption, poor education, red tape, crumbling infrastructure, lack of credit, and a tiny tax base. These factors greatly influence a country's economic development. For Mexico to become an economically advanced nation, it needs a better educational system, cheaper electricity, better roads, and investment incentives for generating growth-things that NAFTA cannot provide.
What NAFTA can provide is additional wealth so government can allocate the gains to things that are necessary. If a government doesn't allocate new wealth correctly, the advantages of free trade quickly erode.
NAFTA's Benefits and Costs for the United States
NAFTA proponents maintain that the agreement has benefited the U.S. economy overall by expanding trade opportunities, reducing prices, increasing competition, and enhancing the ability of U.S. firms to attain economies of large-scale production. The United States has produced more goods that benefit from large amounts of physical capital and

274 Regional Trading Arrangements
a highly skilled workforce, including chemicals, plastics, cement, sophisticated electronics and communications gear, machine tools, and household appliances. U.S. insurance companies have also benefited from fewer restrictions on foreign insurers operating in Mexico. Ll.S, companies, particularly larger ones, have realized better access to cheaper labor and parts. Moreover, the United States has benefited from a more reliable source of petroleum, less illegal Mexican immigration, and enhanced Mexican political stability as a result of the nation's increasing wealth. In spite of these benefits, the overall economic gains for the United States are estimated to be modest, because the U.S. economy is 25 times the size of the Mexican economy and many U.S.-Mexican trade barriers were dismantled prior to the implementation of NAFTA.
But even ardent proponents of NAFTA acknowledge that it has inflicted pain on some segments of the U.S. economy. On the business side, the losers have been industries such as citrus growing and sugar that rely on trade barriers to limit imports of low-priced Mexican goods. Other losers are unskilled workers, such as those in the apparel industry, whose jobs are most vulnerable to competition from low-paid workers abroad.
U.S. labor unions have been especially concerned that Mexico's low wage scale encourages
liABLE 8.4
U.S. companies to locate in Mexico, resulting in job losses in the United States. Cities such as Muskegon, Michigan, which has thousands of workers cranking out such basic auto parts as piston rings, are especially vulnerable to low-wage Mexican competition. Indeed, the hourly manufacturing compensation for Mexican workers has been a small fraction of that paid to U.S. and Canadian workers, as seen in Table 8.4. Although studies have shown that wages are not necessarily the driving factor in busi- ness-location decisions, the huge disparity between U.S. and Mexican wages cannot be ignored.
Another concern is Mexico's environmental regulations, criticized as being less stringent than those of the United States. U.S. labor and environmental activists fear that polluting Mexican plants might cause plants in the United States, which are cleaner but more expensive to operate, to close down. Environmentalists also fear that increased Mexican growth will bring increased air and water pollution. However, NAFTA advocates counter that a more prosperous Mexico would be more able and more willing to enforce its environmental regulations; more economic openness is also associated with production closer to state-of- the-art technology, which tends to be cleaner.
Proponents of NAFTA view it as an opportunity to create an enlarged productive base for the
Hourly Manufacturing Compensation Costs for Production Workers (in U.S. Dollars)
Year |
United States |
Canada |
|
Mexico |
||
1989 |
|
$14.32 |
$14.77 |
|
$1.43 |
|
1991 |
15.58 |
17.16 |
|
1.84 |
||
1993 |
16.51 |
16.43 |
|
2.40 |
||
1995 |
17.20 |
16.03 |
|
1.51' |
||
1997 |
17.74 |
16.68 |
|
1.53 |
||
1999 |
19.11 |
15.65 |
|
2.09 |
||
2001 |
20.60 |
15.80 |
|
2.33 |
||
2002 |
21.33 |
16.02 |
|
2.38 |
||
III |
|
I ill |
I I I 7 |
1111 II i llil Ilfl |
II all II I11II |
|
|
|
|
*From 1994 to 1995, the Mexican peso depreciated against the U.s. dollar from 3.3 pesos per dollar to 6.4 pesos per dollar. thus reducing Mexican labor compensation expressed in dollars.
Source: U.s. Department of Labor, Bureau of Labor Statistics, Foreign Labor Statistics: ttcurly Compensation Costs in U.S. Dollars, 2003, at http://www. bls.gov /bls/ newsrels. hun.

Chapter 8 |
275 |
entire region through a new allocation of productive factors that would permit each nation to contribute to a larger pie. However, an increase in U.S. and Canadian trade with Mexico resulting from the reduction of trade barriers under NAITA would partly displace U.S. and Canadian trade with other nations, including those in Central and South America, the Caribbean, and Asia. Some of this displacement would be expected to result in a loss of welfare associated with trade diversion-the shift from a lower-cost supplier to a higher-cost supplier. But because the displacement was expected to be small, it was projected to have a minor negative effect on the U.S. and Canadian economies.
In order to make the NAFTA treaty more agreeable to a skeptical U.S. Congress, the president negotiated side agreements with Mexico and Canada. Concerning the environment, an agency was established in Canada to investigate environmental abuses in any of the three countries. Fines or trade sanctions can be levied on countries that fail to enforce their own environmental laws. As for labor, an agency was established in the United States to investigate labor abuses if two of the three countries agree. Fines or trade sanctions can be imposed if countries fail to enforce minimum-wage standards, child-labor laws, or worker-safety rules.
On balance and to date, the effects of NAITA on the U.S. economy have been relatively small. These effects have included increases in overall U.S. income and increases in U.S. trade with Mexico, but little impact on overall levels of unemployment,
although with some displacement of workers from sector to sector. For particular industries or products with a greater exposure to intra-NAITA trade, effects have generally been greater, including displacement effects on individual workers.
What are the effects of NAFTA concerning trade creation and trade diversion? As seen in Table 8.5, over the period 1994 to 1998, the flow of U.S. imports from Canada was estimated to have increased by $1.074 billion because of NAFTA, with $690 billion of that trade expansion representing trade creation and $384 billion representing trade diversion-imports that previously came into the United States from other lower-cost countries but now come from Canada, the higher-cost producer. Overall, the table suggests that NAFTA resulted in greater trade creation than trade diversion for the United States, thus improving its welfare. However, NAFTA is estimated to have a significant excess of trade diversion over trade creation in the cases of Canadian imports from Mexico and Mexican imports from Canada. If these estimates are accurate, outside-world producers of the products involved (e.g., automobile engines, data processing equipment, paper, and paperboard) would not appreciate the effects of NAFTA.
It is in politics, not economics, that NAFTA has had its biggest impact. The trade agreement has come to symbolize a close embrace between the United States and Mexico. Given the history of hostility between the two countries, this embrace
~ra e Effects of NAFTA: Trade Creation and Trade Diversion (Thousands of Dollars) |
\ ~~r..<:{f;()'-,u~ |
|||||
|
|
|
~C--l' |
"" |
~ |
~ |
|
|
/" '(UJI'\.'It; |
\. ""~ |
|
""' |
|
Trade Flow |
Trade Expansion |
Trade Creation |
Trade Diversion |
|
||
U.S. imports from Canada |
$1,074,186 |
$689,997 |
$384,189 |
|
|
|
U.S. imports from Mexico |
334,912 |
284,774 |
50,138 |
|
|
|
Canadian imports from the United States |
63,656 |
38,444 |
25,212 |
|
|
|
Canadian imports from Mexico |
167,264 |
3,321 |
163,943 |
|
|
|
Mexican imports from the United States |
77,687 |
50,036 |
27,651 |
|
|
|
Mexican imports from Canada |
28,001 |
902 |
27,099 |
|
|
m |
7 |
IIII |
Source: David Karemera and Kalu Ohah. "An Industrial Analysis |
of Trade |
Creation and Trade Diversion of NAFTA," Journal of Economic |
lnteqration, September 1998, pp, 419-420. |
|
|
276 Regional Trading Arrangements
is remarkable. Its cause was the realization by U.S. officials that their chance of curbing the flow of illegal immigrants would be far greater were their southern neighbors wealthy instead of poor. Put simply, the United States bought itself an ally with NAFTA.
Supreme Court Justices Let
Mexican Trucks Roll In
Achieving a global market isn't as easy as it looks. Consider the conflict between free traders, who desire the efficiency of a deregulated trucking system, and social activists who are concerned about highway safety.
The safety of the trucking system is of concern to Americans and Canadians. The United States and Canada have laws on their books limiting the number of consecutive hours a trucker can be on the road. We periodically test our drivers for drug or alcohol use. We inspect every vehicle. We have a computerized database to check the validity of licenses and the prior violations of anyone licensed to operate a tractor-trailer. We require thorough training for every U.S. trucker on the road. In contrast, Mexico has no roadside inspection program or drug testing for drivers. It does not require logbooks or have weighing stations for trucks. It does not have a requirement for labeling of hazardous or toxic cargo, or a system to verify drivers' licenses.
According to the NAFTA agreement, the United States, Mexico, and Canada agreed to open their roads to each other's rigs. However, in 1995 President Bill Clinton, in violation of our treaty obligations, unilaterally imposed restrictions on Mexican trucks, confining them to stateside areas within 20 miles of the Mexican border. Mexican goods traveling farther than this arbitrary zone must first be loaded onto American trucks. Therefore, Mexico imposed a border ban against U.S. truckers: U.S. rigs can cross the Mexican border but cannot leave a commercial zone that extends no more than 20 miles. Like Mexican drivers on the other side, they drop loads at transfer points, from which Mexican trucks and drivers complete the delivery.
In Mexico, as in the United States, there are two trucking businesses: long-haul companies that use newer, better-maintained vehicles, and
short-haulers with more aged fleets who need to travel just short distances. For example, Mexican products rolling into the United States arrive at a Mexican border depot on long-haul trucks. They are loaded onto short-haulers that go back and forth over the border between depots on each side. Finally, an American long-haul trucker takes the cargo from the American border depot to its United States destination. This requires 3 to 5 trucks to cross one line. Indeed, analysts note that the movement of goods across the border is immensely inefficient.
A main purpose of the NAFTA agreement is to cut transportation costs. By allowing Mexican longhaul trucks to transport goods directly into the United States and likewise for U.S. long-haul trucks into Mexico, the need for storage and warehousing would decline. The reduction in short-haul truckers would cut costs to shippers, and, because they normally do not backhaul, would reduce traffic and congestion on the border by lowering the number of empty trucks.
In 2001, a NAFTA arbitration panel ruled that the United States was in violation of its treaty obligations, noting that it discriminated against Mexican truckers. However, the U.S. government refused to modify its standards on the grounds that 37 percent of Mexican trucks inspected at the border are removed from the road for safety violations, compared with about 24 percent of American trucks inspected nationwide.
In 2004, the Supreme Court, dealing the Teamsters union a defeat, ruled that Mexican trucks have unrestricted access to American highways. Mexican trucks, of course, have to meet the same safety, environmental, and insurance standards as their American competitors. This decision ended a dispute that had festered since the beginnings of NAFTA.
The short-term effect of implementing the Supreme Court's ruling will likely be gradual as Mexican firms contend with several stumbling blocks including a lack of prearranged back hauls, higher insurance and capital costs, and expensive border-processing delays. In the long run, Mexican drivers and trucks will continue to dominate the crossings at the border, but the pattern of operation will change. The use of shuttle truckers is likely to decrease as they lose part of their market share to

Mexican long-haul carriers. The most common trips for these carriers will likely be from the Mexican interior to warehouse facilities in the United States or to nearby cities in the border states. Operating beyond the border states at a profit would almost always necessitate an arranged back haul. In contrast, relatively few U.S. firms are anticipated to apply for operating authority in Mexico. Most are expected to operate through their Mexican partners or subsidiaries.
Is NAFTA an Optimum (\}.~
Currency Area? "'::::>"
The increasing convergence of the NAFTA countries has stimulated a debate on the issues of adopting a common currency and forming an American monetary union among Canada, Mexico, and the United States. Of central relevance to the economic suitability of such a monetary union is the concept of the optimum currency area, as discussed in this chapter.
According to the theory of optimum currency areas, the greater the linkages between countries, the more suitable it is for them to adopt a single official currency. One such linkage is the degree of economic integration among the three NAFTA members. As expected, trade within NAFTA is quite substantial. Canada and Mexico rank as the first and second, respectively, largest trading partners of the United States in terms of trade turnover (imports plus exports). Likewise, the United States is the largest trading partner of Canada and Mexico.
Another linkage is the similarity of economic structures among the three NAFTA members. Canada's advanced industrial economy resembles that of the United States. In the past decade, Canada's average real income per capita, inflation rate, and interest rate were very close to those of the United States. Mexico, however, is a growing economy that is aspiring to maintain economic and financial stability with a much lower average real income per capita and significantly higher inflation and interest rates compared with those of Canada and the United States. Moreover, the value of the peso relative to the Ll.S, dollar has been quite volatile, although the peso has been more stable against the Canadian dollar. Other problems endured by Mexico are high levels of external
Chapter 8 |
277 |
debt, balance of payments deficits, and weak financial markets.
Some analysts are skeptical whether Mexico's adopting the U.S. dollar as its official currency would be beneficial. If Mexico adopted the dollar, its central bank would be unable to use monetary policy to impact production and employment in the face of economic shocks, which might further weaken its economy. However, adopting the dollar offers Mexico several advantages, including achievement of long-term credibility in Mexican financial markets, long-term monetary stability and reduced interest rates, and increased discipline and confidence as a result of reducing inflation to the levels of the United States. Put simply, most observers feel that the case for Mexican participation in a North American optimum currency area is questionable on economic grounds. However, the Mexican government has shown interest in dollarizing its economy in an attempt to develop stronger political ties to the United States.
Canadians have generally expressed dissatisfaction concerning the adoption of the u.s. dollar as their official currency. In particular, Canadians are concerned about the loss of national sovereignty that such a policy would entail. They also note that there is no added benefit of credibility to monetary and fiscal discipline, since Canada, like the United States, is already committed to achieving low inflation, low interest rates, and a low level of debt relative to gross domestic product. Put simply, the case for Canadian participation in any North American currency area is less strong on political grounds than economically. At the writing of this text, the likelihood of a North American currency area in the near term appeared to be dim.
IFree Trade Area of the Americas
"Never in America has there been a matter requiring more good judgment or more vigilance, or demanding a clearer and more thorough examination." So said Jose Marti, Cuba's independence hero of the first effort by the United States to unite the two halves of the Americas in 1889. By the early 2000s, the region's governments were still stumbling on toward that goal, but hardly in step.

278 Regional Trading Arrangements
Attempting to widen the scope of North American economic integration, in 1994 the United States convened the Summit of the Americas, which was attended by 34 nations in North and South America; this included all of the nations in the hemisphere except Cuba. The cornerstone of the conference was a call for the creation of a Free Trade Area of the Americas (FTAA). The idea dates back to the 1820s, when Henry Clay, speaker of the House and secretary of state, sought to strengthen U.S. ties with the new Latin republics.
If established, an FTAA will represent the largest trading bloc in the world. It would create a market of more than 850 million consumers with a combined income of more than $14 trillion. It also would level the playing field for U.S. exporters who, at the turn of the century, faced trade barriers more than three times higher those of the United States. The United States tangibly demonstrated its commitment to this objective by entering into a free-trade agreement with Chile in 2003, thus providing momentum for negotiations with other nations in Latin America.
Over the past two decades, Latin America has embraced progressively more open trade policies, intra regionally and with the world, as part of its overall economic platform. The larger economies of
Latin America, once known for their collective indebtedness, are considered among the more promising emerging markets for trade and investment opportunities now in the 2000s. Three economicpolicy shifts in Latin America paved the way for this new perspective: (1) reduced roles for government in managing the economies, with greater reliance placed on markets, private ownership, and deregulation; (2) use of conventional and generally restrictive macroeconomic policies to promote economic growth and stability; and (3) the movement away from protectionism, often by way of unilateral reductions in tariffs and other trade barriers.
However, there are obstacles that need to be addressed in order for the FTAA to become a reality. One challenge involves the FTAA's allowance for other trade agreements in the hemisphere. Countries in the hemisphere are members of 21 free-trade agreements as well as four customs unions that span the region. Although these agreements can become a "spaghetti bowl" of conflicting arrangements, an FTAA presents an opportunity to simplify these arrangements under a single agreement. Table 8.6 identifies the major regional trade agreements that exist throughout the Americas.
Another concern is that smaller partners in the hemisphere should be given special assistance.
MajorWestern Hemisphere Regional Trade Agreements
Agreeme:lt |
Members |
Year Effective |
Free Trade Area of the Americas |
34 countries |
Negotiating |
North American Free Trade |
Canada, Mexico, United States |
1994 |
Agreement (NAFTA) |
|
|
Southern Cone Common Market |
Argentina, Brazil, Paraguay, Uruguay |
1991 |
(MERCOSUR) |
|
|
Caribbean Community and |
Antigua, Bahamas, Barbados, Barbuda, Belize, |
1973 |
Common Market |
Dominica, Grenada, Guyana, Haiti, Jamaica, |
|
|
Montserrat, St. Kitts, Nevis, St. Lucia, St. |
|
|
Vincent, Surinam, Trinidad, and Tobago |
|
Andean Community |
Bolivia, Colombia, Ecuador, Peru, Venezuela |
1969 |
Central American Common Market |
Costa Rica, EI Salvador, Guatemala, Honduras, |
1961 |
|
Nicaragua |
|