Question

This question is based on the general equilibrium analysis.

Suppose the world consists of two large countries - the U.S. and Mexico - which trade with one another. Both countries produce and consume two goods: cars (C) and textiles (T). The U.S. has a comparative advantage in the production of cars. Initially, the U.S. has no tariffs, but Mexico has a 10% tariff on its imports. In 1995, NAFTA (a free trade agreement) is implemented, and Mexico removes its tariff. What are the implications of NAFTA for the U.S.? First explain what happens to production and consumption of cars and textiles in the U.S. Support your answer with a PPF graph that shows the U.S. equilibrium both before and after the implementation of NAFTA (plot C on the x-axis). Second, could the U.S. economy be hurt by NAFTA? Explain.

Answer 1

1) NAFTA would help in bring liberalization in the trade between the two involved countries. This was also the aim of the plans of NAFTA. There are various economists who saw the US economy grow at 0.5% through the influence of NAFTA. There are varying estimates, stronger growth created jobs. According to a 2010 report, U.S. free trade agreements – the lion's share of which stemmed from the NAFTA agreement – directly supported 5.4 million jobs, while trade with these countries supported 17.7 million. Here is the change in PPF curve after the removal of tariff.

The US economy is definitely hurt by the introduction of NAFTA, it is through the loss of jobs that the country had to face. According to many articles,  loss of 500,000-750,000 U.S. jobs was observed after the plan was introduced. While other critics said, wage stagnation in the United States, driven by low-wage competition, companies were moving production to Mexico to lower costs, and this led to widening trade deficit.