Download Introduction: After NAFTA, what`s next

After NAFTA:
An Informal Integration without a Foreseeable Monetary Union
Julio Alejandro ESPINOZA ALVAREZ
Baku, March 25, 2010
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Contents
What’s next after NAFTA? ........................................................................................................ 3
Integrationists and Skeptics, between a Partnership and a Community .................................... 6
Vision of a Monetary Union in North America ......................................................................... 9
America and Mexico do not Need a Monetary Union yet… and Canada neither! .................. 11
After NAFTA: an Informal Integration without a Foreseeable Monetary Union .................... 15
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What’s next after NAFTA?
This work presents elements to debate the direction of the North American economic
integration. It aims to offer a synthesis of the American and Mexican standpoints regarding a
possible monetary union. The first section analyses the integrationists and skeptical streams
of thought to understand how all this debate began in North America after the Mexican crisis
of 1994 and the high volatility of the Canadian dollar during the 1990s. The second section
deals with a landscape of a hypothetical monetary union in North America. The third part
explores the economic and political unfeasibility of a monetary union for the US and Mexico.
The Canadian position deserves more than few words, but --for the lack of time-- I have not
focused on Canada. I will do it in the future, when there will be more favorable conditions.
Definitive conclusions are not sought, because the topic is under debate and complex
empirical research for the three countries is required, which exceeds the purpose of this work.
After the entrance in force of the Euro, in North America there was a flow of ideas on
the adoption of a common currency, perhaps the American dollar or a new currency. The
Mexican crisis (1994) and the Asian crisis (1997) created the atmosphere in North America to
debate on the relevance of fixed or floating exchange rates between the US dollar, the
Canadian dollar and the Mexican Peso.
The Fox Administration (Mexico, 2000-2006) intended to advance North America
beyond a free trade area. President Fox encouraged the idea of a “NAFTA plus”, a deeper
economic integration with a limited flow of the factors of production (being capital fully
liberalized and labor partially liberalized by means of a hypothetical Mexico-U.S.
immigration agreement).
Recently, the Security and Prosperity Partnership and the Merida Initiative add two
more regimes to NAFTA and the US-Mexico binational commission, but are not yet enough
to consider North America in a formal process of integration, made of a legal framework and
institutions that enforce harmonizing policies to America, Canada and Mexico.
In North America, two schools of thinking exist sixteen years after the entrance in
force of NAFTA. The integrationists look for a deepening and institutionalizing the
interdependence of the three North
American countries, mainly the economic
interdependence, perhaps throughout a dollarization process, a monetary board or an
economic union with a single currency. The skeptics consider impossible to move from a free
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trade area to an economic union with a single currency for the disparities of the three NAFTA
economies and for their necessity of economic autonomy.
The truth is that North America is far from achieving a common currency if we
consider that any economic integration is a progressive phenomenon beginning with an area
of free trade, continuing with a customs union and a common market, an economic union and
ending up with a monetary union.
According to my research and professional experience, I find that if the economic
integration is proportional to the political will and economic development of the countries,
unless the United States and the elites in Canada and Mexico consider convenient the union
to happen and they promote it, hardly will it be to materialize such an idea. In this case, for
the mid term, better can we expect a spontaneous integration, being forced by the inertia of
the market and the threats to the national security. I would expect that such spontaneous
integration could develop into a sui generis common market with a constant and illegal flow
of labor and the informal harmonization of macroeconomic policies between the central
banks, as is already happening.
The reader will find that I recognize the lack of feasibility for a North American
Community with a single currency in the foreseeable future, but I do also recognize myself as
an integrationist. I hope that in the long term there will be better chances to think of NAFTA
as the foundation of a broader and deeper integration that eventually could lead to the
creation of the United States of North America.
In this sense, I do agree with the research of Robert Pastor and some members of the
Mexican Council for Foreign Affairs, mainly Rafael Fernandez de Castro. They all propose
to start thinking Mexico and the US, North America in general, as a free trade area slowly
becoming into a community made of institutions for intraregional cooperation.1 Over several
documents it is Pastor who advises to pursue a multi-stage integration. In the short term,
NAFTA can foster harmonization and cooperation to optimize the intraregional performance
of the three economies. In the middle term it will be possible to create a North American
Community, which might be based on pragmatic solutions favoring multilayer cooperation
over sovereignty arguments. In the very long term, the Community might only arrive to a full
convergence of macroeconomic policies and close the gaps in development. (See Pastor
2001, among other works of his)
1
See Rozental, Andres and Smith, Peter (2005). The United States and Mexico: Forging a
Strategic Partnership. Washington: Woodrow Wilson International Center for Scholars and
Consejo Mexicano de Asuntos Internacionales.
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Myself being an integrationist, after doing this research, I would advise to pursue a
passive, without the public’s awareness, and spontaneous, led by the market forces, Mexican
integration into North America, because pegging the Mexican peso to the American dollar
could result into a costly process of convergence and the lack of economic sovereignty to
deal with the downturns of the business cycle. Therefore, the Presidency would face
difficulties when selling the idea of abandoning the so far successful autonomy of the central
Bank of Mexico.
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Integrationists and Skeptics, between a Partnership and a Community
The integrationists are up to a community beyond the market. In the center of the
integrationist thought there is the belief that the uncertainty of the exchange rate is the main
obstacle for economic development. The integrationists consider that overcoming the
volatility of the exchange rates is more valuable than the loss of independence in monetary
and exchange policies. They believe that NAFTA is a success, because it has dismantled most
restrictions on trade and investment and increased US trade with Canada and Mexico twice as
fast as did its trade with the rest of the world. (Sullivan 2009, 31) Therefore, this school
recommends that a monetary union (based on dollarization, a monetary board or a common
currency) should be established.
The NAFTA economies have similar interests; and on the base of interdependence,
they need to meet them in a joint manner. The necessity of security, stability and prosperity
motivates NAFTA countries to move towards a convergence of economic, foreign and
national security policies. The three countries face common threats such as terrorism,
organized crime, environmental degradation and decontrolled immigration flows. Canada,
Mexico and the U.S. in face of the rise of other geopolitical regions (Europe, Asia and South
America), need to foster intraregional competitiveness to sustain economic growth. For the
integrationists, the integration had already taken place well before NAFTA and has gained
momentum after NAFTA. For them, the integration could be passive or active.
Passive integration is driven by means of the market forces, unleashed by NAFTA,
because implementing macroeconomic harmonization by a binding framework is unfeasible.
After all, the three major macroeconomic indicators (interest, exchange and inflation rates)
show a more responsible monetary and fiscal policy on the Mexican side, because, along with
the business cycle in North America, monetary and fiscal policies in the three countries have
being moving together. For example, after the Mexican crisis of 1994-1995 the fundamentals
of the Mexican economy have remained stable and moving at the same pace as the American
and Canadian ones do. In this regard, the integrationists propose a harmonization of domestic
economic policies to foster regional cooperation in strategic sectors of NAFTA, being the
most important the labor and the energy markets. (Council on Foreign Relations 2005, 1-32)
Active integration is pursued by means of common policies and institutions leading to
some convergence. (Fernández de Castro y Rozental 2006, 90-92) Thanks to the strong
economic interdependence, the three countries have the opportunity to create a North
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American community, which will sit on pragmatic solutions favoring free markets policies
and leaving aside arguments on sovereignty and discourses on total integration. On the base
of the regional competitiveness, it is needed to advocate for more economic cooperation and
institutionalization to reduce the disparity of the GDP per capita between the three nations,
improve regional infrastructure, prevent financial crisis and homogenize bordering and
customs controls. (Pastor 2004, 124-135)
The skeptics are for a society based on the market and nothing more. In the
center of the skeptic thought, in addition to the belief in sovereignty, we can find the
economic assumption that flexible exchange rates are compatible with economic growth in an
environment of financial volatility. For the skeptics a fixed exchange rate lacks viability and
implies economic and social costs in the event of negative external shocks, due to the
inability of using the monetary policy to foster growth and employment. (Ibarra and MorenoBrid 2001, 10-11) The skeptics at some degree believed that NAFTA has paid few gains to
Mexico in terms of economic development.
NAFTA was born not as the milestone for a deeper economic integration, but as
mechanism of economic liberalization. It is easier to deepen economic interdependence when
the concerned parties are relatively homogeneous, like France and Germany, than when the
countries are more different like Canada, Mexico and the U.S. The three North American
countries have chosen to keep NAFTA membership close to three members and expand free
trade by means of bilateral free trade agreements between the NAFTA countries and third
parties. Because NAFTA has grown outwards not inwards, it is clear that integration has not
been a priority for Canada, Mexico and the U.S. NAFTA countries have subscribed free trade
agreements with third parties instead of advancing into a common external tariff or
discussing the possibility of working permits for the surplus in the labor market for example.
So far, North America, although trying to increase political dialogue and cooperation,
lacks institutional means to deal with economic, political, social and security issues at the
highest level. Canada is still skeptic about the concept of a community with the U.S. and
Mexico. The Canadian public and leaders have been so proud of its special relationship to the
U.S. that hardly may they start thinking in terms of the Mexican national interest. The U.S.
after September 11 became more aware of other regions except for the Americas and
increased the level of its traditional isolationism. Mexico is in the middle of a domestic
struggle against organized crime and its political spectrum is divided between the proAmerican rightists in power and the anti-imperialistic leftist in the opposition.
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In Canada, Mexico and the US, now there is little political support to a North
American Monetary Union. The business sector of America, Canada and Mexico favor more
monetary integration to foster stability and growth; however the general public and the
Legislative Branches are indifferent in the three countries. The fact that each country is
dealing with domestic skepticism about a North American Community hinders advancing the
integration.
In the short and middle terms, the creation of a customs union or a common market is
not probable, let us not say the instauration of monetary union. Although the private sectors
of the three countries agreed on a deeper integration for the sake of reducing the costs of
transaction, it would be required political consensus between the ruling elites and their
oppositions, which would be very difficult to achieve given the still strong nationalisms in the
three countries. (Santillán 2003, 18)
Additionally, looking for escalating NAFTA from a free trade area to a customs union
would imply to deal with the complex system of free trade agreements between NAFTA
members and third countries and then establishing an agreement between NAFTA and its
trading partners. By the same token, a common market is still impossible given the lack of
will to allow the free flow of labor in North America, even this flow was given through
temporary working permits in specific sectors of the economy.
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Vision of a Monetary Union in North America
Seen from a long term perspective, there are chances of a monetary union to take
place along with a Central Bank of North America. Such CBNA might have norms,
procedures, officials (appointed and monitored on a tripartite basis that guarantees
representativeness and accountability to three bands) and a single objective (to control
inflation even at the risk of full employment). After implementing converging monetary and
fiscal policies during a certain period, just as it happened in the European Union, there would
be a common currency in North America, perhaps called Amero or Americus. Canada and
Mexico would change their national currencies to an exchange rate that does not alter the
competitiveness and the wealth of each country. In the three countries the prices of the goods
and services, wages, assets and liabilities, would be converted simultaneously to Ameros.
(see Grubel 2001, he probably is the most outstanding Canadian advocate for a common
currency)
The most of the benefits of a monetary union are in the macroeconomic level. One
can expect that the elimination of national currencies in favor of a common currency will lead
to improvements and gains in economic efficiency. These gains in efficiency would come
after the elimination of transaction costs associated with the change of foreign currencies.
A monetary union would also assure the liquidity in the region since the CBNA would
be the lender of last resort. There would not be losses for Canada and Mexico due to the
seignorage in American dollars. For the Canadian dollar and the Mexican peso there would
not be any risk of depreciation against the American dollar, as in the past. However, the
country risk would remain latent because of the regional threats to the national security:
terrorism, organized crime and the possible arousal of separatists movements in Quebec
Canada and Chiapas Mexico. The three fiscal policies would homologate savings and
expenditure in North America. Even the sovereignty of America, Canada, and Mexico in
macroeconomics decreased, the Amero would counterbalance the Euro in the international
arena.
In spite of the possible advantages, there are some restrictions that hinder a monetary
union to take place. The integration requires political will to create supranational institutions
that guarantee a long process of economic convergence; emphasis does exist on topics of
security but not in economic affairs. The integration requires that the variables of the
economy come to common places between the involved countries, which is now only
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happening in a spontaneous way, and –even if convergence took place in a planned way– it
could be economic and politically costly for Mexico because the convergence could decrease
inflation at the expense of unemployment. According to the theory of Optimal Monetary
Areas, the integration requires flexible wages and free mobility of the manpower, which are
non-existing conditions in North America.
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America and Mexico do not Need a Monetary Union yet… and Canada neither!
A common currency would not be perceived by the American people as a public
good bringing outstanding benefits. (Morales Castañeda 2001, 481, 493-494). Washington
would reject the monetary union, due to the role of the American dollar as the main currency
of the international monetary system. Such a role brings prestige and economic privileges in
terms of seignorage. Many American leaders would not agree to share their decision power in
economic issues. Additionally, until now the Federal Reserve has accomplished its objective
of create stability and growth; in that sense there is not reason for the Fed to share its
authority with other central banks. (Pintado Rivero 2000, 61) It is highly probable that the
American political parties would advocate a very skeptic stance and could claim that the
intention of creating a momentary union is unconstitutional, because there is no law that
enables the Fed to share its economic responsibilities with foreign powers.
For the US the micro and macroeconomic gains might be minimal. In microeconomic
terms, the gains obtained due to the boost in the economic efficiency would roughly equal a
tenth of one percentage point of the American GDP. Prices could gain transparency
considering that a significant amount of the American population and firms are located next
to the US north and south borders. However, even trade would gain efficiency due to the
absence of exchange fluctuations, the supply and demand of goods and services would not
increase necessarily. The expansion of the US financial institutions to Canada and Mexico
only would bring minimal gains, because the combined populations of Canada and Mexico
represent almost a third of the US, and the combined economies of Canada and Mexico
represent almost the combination of the economies of Alabama, Florida and Texas. (Truman
2003, 75-79). It is also important to consider that the reductions of the fluctuations in the
exchange rate could decrease the gains that firms get from speculative production.2
In macroeconomic terms, even the monetary union could bring more regional
stability, preventing exchange rate crisis, the instability of the Canadian and Mexican
economies would be more important for Ottawa and Mexico City than for Washington, due
to the Canadian and Mexican deep dependence on the American market. The US does not
expect an increase in economic growth given the harmonization of economic policies,
because the interest rates, the inflation rates and the exchange rates of the three countries
2
When there is uncertainty in the exchange rate, export sector firms speculate with prices to increase production
and profits.
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have been naturally converging during the last years. Moreover, although the economic
theory suggests that a reduction in the interests rates and the stability in the exchange rate will
increase the economic growth rate, empirically the opposite has happened; in the European
Union during the 1980’s the average investment and production rates of the European
Monetary System (EMS) were lower than those rates of non-EMS countries, whose exchange
rates were flexible. (Pérez Valdespín 2006, 97-98)
If inflation rates, interest rates and exchange rates remain stable in Mexico,
there will be no need for talking about a monetary union in North America, especially if
after the 1994 crisis, a free floating peso with an autonomous central bank has delivered good
results. Mexico needs to keep the current regime, because it has contributed to smooth the
impact of external shocks and has not been an obstacle to stabilize the economy. The
exchange rate has remained stable as well as the inflation and the interest rates. (Morales
Castañeda 2001, 485-486)
Behind the proposal of pegging the Mexican peso to the American dollar (by means
of dollarization, a monetary board or a monetary union) we can find the concerns about the
high inflation and constant devaluations that the Mexican economy had registered in the last
four decades. The advocacy for a monetary union reflects more than sound arguments,
ideological standpoints about the North American integration or simply the desperation of
businessmen, bankers and workers in view to find quick remedies to the former financial
instability in Mexico. (Ibarra and Moreno-Brid 2001, 15-16) For Mexico, the depreciations of
1976, 1982, 1987 and 1994 and the high interest rates during 1995 to 1996 are no longer
convincing references due to the fact that the autonomy of the Bank of Mexico and a floating
exchange rate regime bring the possibility of avoiding inflationary cycles and consequent
depreciations. (Morales Castañeda 2001, 483)
The European example demonstrates that achieving a monetary union is a long term
and complex process. The European integration shows that besides the intention it is
necessary to comply with political criteria (democracy, administrative efficiency, zero
tolerance to corruption, human rights protection, law enforcement and minorities protection),
economic criteria (stable free market economy, structural reforms and structural funds to
foster competitiveness and cohesion), and legal and institutional criteria (a common legal
framework and regimes to drive the integration like a regional central bank). NAFTA just
does not include any program for neither macroeconomic coordination nor economic
integration. For Mexico a monetary union with America and Canada is a distant scenario,
because there is no consensus in North America about moving beyond NAFTA and there is
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no strategy and no institutions for reducing the economic, social and political differences
between the three countries. (Pérez Valdezpín 2005, 37)
In spite of its responsible macroeconomic policy during the last years, Mexico is still
far from a full convergence with Canada and the US, which have a stronger level of
convergence between each other in comparison to Mexico. It would be costly for Mexico to
converge to its northern neighbors’ economic policies. If Mexico took part in a convergence
process with economies with lower rates of inflation, the social and political costs would be
high in the short and middle term. Along with the decrease in the inflation, unemployment
and underemployment could raise. (Guzmán Reyes 2004, 150 and Pérez Valdespín 2005, 38)
In Mexico wages are rigid and in North America the labor mobility is limited, so the
demand of manpower is basically met illegally. Such constraints to labor would inhibit the
creation of an optimal monetary area, which would be able to throw factors of production
wherever it would be necessary to satisfy the demand and keep constant prices. For example,
under an optimal monetary area, the unemployed Mexican manpower would move legally to
the US to meet the excessive demand for workers. This movement would forbid wages in
Mexico to fall and wages in the US to rise. (Morales Castañeda 2001, 492-493)
Mexico could lose its ability to deal with negative external shocks. A monetary union
could be costly for Mexico in order to counterattack the downturns of the business cycle by
means of monetary policy. For example, what could Mexico do if the oil price decreased or
the US inflation increased when both happenings represent asymmetric reactions in Mexico
City and Washington? A decrease in the oil price would make Mexico to implement an
expansionary monetary policy, while the US would implement a contractionary monetary
policy. On the other hand, the inflation in the US might not be always controlled and the
American inflation rate and the interest rate could pick up making the hypothetical CBNA to
implement a contractionary monetary policy that could hinder economic growth in Canada
and Mexico. How the US, Canada and Mexico would come to terms in the hypothetical
CBNA if they had to pursue asymmetrical reactions to external shocks like in the examples?
Probably the US interests would prevail over the Canadian and Mexican needs, because of
the American hegemony.
Finally, it is important to call attention to the Canadian position. In Canada, since the
1990’s there has been an intense debate on how to handle the unfavorable effects of the
floating exchange rate regime. Still, before substituting the floating rate for a fixed rate in
terms of the American dollar, Canada might better look for strengthening its currency by
structural reforms instead of a monetary integration, because, according to Arndt, recent
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macroeconomic experience demonstrates that greater monetary coordination is not needed.
He continues: “Canada is outperforming the United States on the inflation front. Nor does
Canada need to be rescued from major policy misadventures. And the political climate is
indifferent to monetary cooperation.” (Arndt 2002, 25)
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After NAFTA: an Informal Integration without a Foreseeable Monetary Union
The skeptics are right since the North American monetary union seems to be
unfeasible in the short and middle terms. If the three NAFTA countries decide to deepen its
economic flows and cooperation, they will need time, strategies and institutions. Skeptics are
also right when suggesting for Mexico to keep an autonomous central bank and a free
floating exchange rate regime, because pegging the Mexican peso to the American dollar will
reduce Mexico’s competitiveness and increase its GDP and employment vulnerability in face
of external shocks, which could prevent the Mexican economy from growing and put at risk
the social and political stability in Mexico. (Ibarra and Moreno-Brid 2001, 4)
In spite of the lack of feasibility and necessity for a North American monetary union,
the integrationists are right when stating that the economic integration is already happening.
It is not being fostered by the governments, but by the private sectors. It is true that there are
differentials in the major macroeconomic indicators, but these indicators have closed the gaps
between each other (except for the PIB per capita) during the last years.
North America is already in a marriage of convenience, mainly because the NAFTA
economies are complementary to each other in terms of the endowment of the factors of
production and commodities markets. Either North Americans let themselves be dragged by
the market forces or do they start building common institutions to drive the passive and
informal integration now occurring.
A good starting point could be to achieve agreements to stabilize the Mexican peso in
critical moments and mitigate the financial volatility that endangers economic growth in the
three economies. The three governments must pursue the reduction of divergences in
inflation, interest rates and fiscal accounts by means of coordination in macroeconomic
policies. (Pastor 2001, 116)
Finally, any deeper and broader integration in North America could happen as a
reaction to increase the competitiveness and enforce the security of North America in face of
economic and political threats. For example any other terrorist attack similar to 9-11 and the
rise of other regions could drive Mexico City, Ottawa and Washington to create a common
security perimeter with tight military, immigration and customs cooperation, which
eventually could derive into a customs union. For that reason, although unfeasible in the short
and middle terms, a monetary union will remain as a hot debate in some North American
lobbies.
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Sources of Information
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del Norte: los Retos de la Integración. In La Agenda Internacional de México 2006-2012, ed.
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