nafta’s and cusfta’s impact on north american...

NAFTA’s and CUSFTA’s Impact onNorth American Trade

John Romalis∗- University of Chicago GSB, April 2002 (First Draft:February 2001).

AbstractThis paper finds that NAFTA and CUSFTA have had a substantial im-

pact on North American trade. The paper focuses on where the US sources itsimports of almost 5,000 different commodities and compares this to where theEuropean Union (EU) sources its imports of the same commodities. It identifiesthe impact of NAFTA using a differences in differences strategy, exploiting thesubstantial variation across commodities and time in the US tariff preferencegiven to goods produced in Canada and Mexico. The paper finds that the recentrapid growth in Mexico’s share of US trade would have been much slower with-out NAFTA while Canada’s share may not have increased without CUSFTA.Useful products of the empirical work are estimates of consumer willingness tosubstitute between different varieties of a commodity, an important parame-ter in welfare analysis of trade liberalization. Estimated average elasticities ofsubstitution typically range from 4 to 7. Elasticities of this magnitude implythat even modest trade liberalizations will have a pronounced effect on tradevolumes. One alarming result is that NAFTA may have produced substantialtrade diversion, because the largest tariff preferences are often in industrieswhere imports from outside North America represent a substantial proportionof domestic absorption.

∗I would particularly like to thank my advisors, Daron Acemoglu, Rudi Dornbusch and JaumeVentura. Thanks are also due to Mark Aguiar, Christian Broda, Gita Gopinath, Roberto Rigobon,Alwyn Young and participants at seminars and lunches at Chicago GSB, EIIT Conference 2001,Federal Reserve Bank of New York, University of Michigan, MIT and University of Pennsylvania.All errors are my own.

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1 Introduction

Preferential Trade Areas (PTAs) have received a great deal of analytical and empiricalattention since Viner (1950) distinguished between the trade creationary and tradediversionary effects of preferential tariff liberalization. Much of this attention is drivenby the ambiguous welfare implications of PTAs. Favorable effects (“trade creation”)result from removing distortions in the relative price between domestically producedcommodities and commodities produced in other members of the PTA. Unfavorableeffects (“trade diversion”) come from the introduction of distortions between therelative price of commodities produced by PTA members and non-members (Frankel,Stein and Wei 1996). Research has also been motivated by the political economyof PTAs, such as whether PTAs help or hinder movement towards the first best ofglobal free trade (for example, Baldwin 1996, Levy 1997, Bagwell and Staiger 1999).Much empirical work has been devoted towards evaluating trade and welfare effectsof PTAs (Baldwin and Venables 1995). This paper extends the empirical literature.It uses differences in differences estimation on very detailed trade and tariff datafor the US and the EU to estimate the extent to which the world’s second-largestPTA has affected trade, and to estimate a critical parameter in all analyses of tradeliberalization; the elasticity of substitution between different varieties of a product.

On January 1, 1994 the North American Free Trade Agreement (NAFTA) betweenthe United States, Canada and Mexico entered into force and incorporated the priorCanada-US Free Trade Agreement (CUSFTA). NAFTA has been described as themost comprehensive free trade pact, short of a common market, that has ever beennegotiated between regional trading partners (Hufbauer and Schott, 1993). It is byfar the largest free trade pact outside of the European Union and is the first reciprocalfree trade pact between a substantial developing country and developed economies.Further expansion is in prospect following the April 2001 Summit of the Americas.Ministers from almost all North and South American nations have been directed tonegotiate the Free Trade Area of the Americas (FTAA) by January 2005.

Since the advent of NAFTA one of the more striking occurrences has been therapid increase in Mexican trade. Mexico has become the US’s second largest tradingpartner, accounting for 11.5 percent of US merchandise imports in 2001 and 13.9percent of US exports, up from 6.9 and 9.0 percent respectively in 1993. Only Canadais a partner for more US trade. Mexico now accounts for a larger share of US tradethan Korea, Thailand, Singapore, Malaysia, Hong Kong and Taiwan combined.

Empirical studies often have great difficulty in identifying an effect of NAFTA.For example, Krueger (1999, 2000) does not attribute the increase in Mexican tradeto NAFTA, but to the real depreciation of the Mexican exchange rate in 1994 andto Mexico’s unilateral reduction of tariffs and quantitative trade restrictions after itsentry into GATT in 1986. By contrast, this paper finds that NAFTA has had asubstantial impact on North American trade. It does so by focusing on where one ofthe NAFTA partners, the United States, sources its imports of almost 5,000 6-digit

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Harmonized System (HS-6) commodities and compares this to the source of EuropeanUnion (EU) imports of the same commodities.

Figure 1A shows that Mexico’s share of US imports has increased most rapidlyin commodities for which it has been given the greatest increase in tariff preference,defined as the difference between the US tariff on a commodity sourced from Mexicoand the US’s Most Favored Nation (MFN) tariff rate for the same commodity.1 Forthe 389 commodities where the US tariff preference for Mexican goods has increasedby at least 10 percentage points, the simple average of Mexico’s share of US importshas risen by 223 percent since 1993. For the 2663 commodities where Mexico’s tariffpreference has not increased, its share has risen by a more modest 22 percent. Wasthis NAFTA or was this the result of some other factor such as the exchange rateor Mexico’s earlier trade liberalization? The timing and cross-commodity pattern ofMexico’s trade increase are themselves highly suggestive that trade was very respon-sive to NAFTA’s tariff preferences, and Figure 1B further supports the case. Figure1B shows Mexico’s share of EU imports from 1989-2000. Without the benefit of afree trade agreement until late 2000, the evolution of Mexico’s trade with the EUhas been very different. Its share of EU imports of commodites with high NAFTApreferences declined by 76 percent, while its share of EU imports of commoditieswhere NAFTA did not increase preferences rises by 82 percent. This paper estimatesthat approximately one-third of the post-1993 increase in US imports sourced fromMexico can be attributed to Mexico’s preferential treatment.

Canada’s share of US imports has also increased since CUSFTA came into ef-fect in 1989, and Figures 2A to 2C also suggest that CUSFTA/NAFTA was partlyresponsible. For commodities where there was no increased preference for goods ofCanadian origin, Canadian goods now account for a 4 percent smaller share of USimports than they did in 1988. But where the preference increased by at least 10percentage points, Canada’s share of US imports increased by 95 percent. The tim-ing and cross-commodity pattern again suggest that CUSFTA is at work. Figure2B shows Canada’s share of US imports from 1980 to 2000. For most of the 1980s,Canada’s share of US imports is declining in all tariff classes, but just before CUSFTA,Canada’s share begins to rebound for commodities where large tariff preferences werenegotiated. Figure 2C provides a comparison with Canada’s trade with the EU, whichdoes not have a preferential trade agreement with Canada. For the commodities withno CUSFTA preferences, Canada’s share of EU imports has increased by 15 percent.For commodities with high CUSFTA preferences, Canada’s share of EU imports hasdeclined by 15 percent. Figures 1A to 2C together suggest that NAFTA/CUSFTAhave had a substantial impact on North American trade, and even though US tariffsare typically low, trade appears to be quite sensitive to even small trade preferences.

Most studies examining the impact of actual PTA’s are either ex-ante simulationsusing Applied General Equilibrium (AGE) models or are ex-post studies examining

1The MFN tariff is the tariff applicable to imports from countries that have normal trade relationswith the US.

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changes in the direction of aggregate trade between countries or regions following theintroduction of the PTA. AGE models capture key production, demand and tradebarrier details both for the economies that are party to the PTA and for the rest ofthe world. They can generate predictions for the welfare, price, output and tradeconsequences of trade liberalization. Examples of AGE modelling of NAFTA areKehoe and Kehoe (1995), Brown, Deardorff and Stern (1995), Cox (1995) and Sobarzo(1995). All models predicted welfare gains for NAFTA members, with approximategains of 0.1 percent for the US, 0.7 percent for Canada and 5 percent for Mexico.Examples of ex-post studies that use aggregate trade data for NAFTA are Gould(1998) and Garces-Diaz (2001). Gould finds that NAFTA has increased US-Mexicotrade, but has had no effect on US-Canada or Mexico-Canada trade. Garces-Diazfinds that Mexico’s export boom is not attributable to NAFTA.

The most similar papers to this are Clausing (2001) and Fukao, Okubo and Stern(2001). Clausing was first to exploit tariff variation at the detailed commodity levelusing US import data from 1989 to 1994. Clausing finds that US import growth wasrelated to tariff preferences conferred on Canada and also concludes that NAFTAwas primarily trade creating. Fukao, Okubo and Stern analyze US imports at theHS 2-digit level for the period 1992-1998. Of the 70 sets of industry regressions theyrun, NAFTA tariff preferences had a significant effect on US imports in 15 cases.Research at an industry level also includes two papers on NAFTA by Krueger (1999,2000) who studies North American trade patterns at the 3 and 4 digit SIC industrylevel. Krueger finds no evidence that NAFTA has had any impact on intra-NorthAmerican trade. Head and Ries (1999) study the industry rationalization effects oftariff reductions and find that on balance, NAFTA has had little net effect on the scaleof Canadian firms. Trefler (2001) finds that Canadian industries that experienced thelargest tariff cuts under NAFTA experienced substantial labor productivity gains,but a decline in both output and employment. In studies of MERCOSUR, the PTAformed between Brazil, Argentina, Uruguay and Paraguay, Yeats (1997) finds thatthe fastest growth in intra-MERCOSUR trade was in commodities in which membersdid not display a comparative advantage, inferred from the lack of exports of thesecommodities outside MERCOSUR. This was interpreted as evidence of the tradediversionary effects of MERCOSUR. Chang and Winters (2000) look to Brazilianimport price data to examine whether preferential tariffs have depressed the pricesof excluded countries’ exports. They find the rather extraordinary result that due tothe tariff preference, Argentinian competition has led to significant and substantialreductions in American, Japanese, Korean and most other countries’ export prices toBrazil.

The key differences between this paper and Clausing are the use of a much longerdata series, the use of EU import data to control for unobserved cost shocks, and theuse of an actual tariff schedule that allows the tariff preference to be calculated evenif imports from Canada or Mexico are not observed. Data prior to 1989 suggest thatUS import growth was related to NAFTA tariff preferences many years prior to the

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FTA, so that Clausing’s conclusion that NAFTA was primarily trade creating is putin doubt. This paper estimates that over 40 percent of the increased Canadian andMexican exports to the US are due to trade diversion. Data after 1994 suggest a verydramatic effect of NAFTA on US trade with Mexico, a result at odds with Krueger(1999, 2000). I attribute the difference in this paper’s findings from Krueger to twofactors. Two more years of data have become available, but more importantly, thispaper gets very close to the level of commodity detail at which tariffs are set, ratherthan at a more aggregate level.2 This allows the use of better tariff data. Much ofthe cross—commodity variation in tariff preferences occurs even within quite detailedindustry sectors. Focussing at this detailed level minimizes the loss of variation intariff preferences, reduces the problems of aggregating across commodities, and allowsfor a greater ability to control for unobserved factors that may be affecting NorthAmerican trade.

This paper is organized as follows. Section 2 provides a brief review of NAFTA.Section 3 introduces a simple model of preferential trade liberalization that is usedto derive the estimating equations. Section 4 describes the data. Section 5 presentsand discusses the empirical results. Section 6 concludes.

2 NAFTA

The Canada-United States Free Trade Agreement (CUSFTA) came in to effect onJanuary 1, 1989 and provided for the gradual elimination of tariffs and for reductionsin non-tariff barriers to trade. By January 1, 1998, all US and Canadian tariffs ongoods produced in the US and Canada were eliminated, with the exception of over-quota tariffs on several hundred agricultural products (primarily sugar, dairy, poultry,peanuts and cotton). CUSFTA was incorporated into the North American Free TradeAgreement (NAFTA) on January 1, 1994. NAFTA was designed to increase tradeand investment among the United States, Canada and Mexico. Almost all tariffson goods originating in the US, Canada and Mexico will be eliminated by January1, 2008. NAFTA did not affect the phase-out of tariffs for US-Canada trade underCUSFTA. Some US tariffs applied to Mexican goods were, however, transitionallyincreased by NAFTA. Prior to 1994, Mexico as a developing country was a beneficiaryof the Generalized System of Preferences (GSP). Under the GSP, the US and otherdeveloped countries allow duty-free or concessional access for the output of developingcountries in several thousand HS 8-digit commodities, accounting for just under 10per cent of Mexican exports to the US in 1993. With NAFTA, the US ceased toconfer GSP benefits on Mexico.

NAFTA covers a much larger amount of trade than any other regional trading ar-rangement outside of Europe (Baldwin, 1996), and there are prospects for NAFTA’s

2The reason why I do not go right to the tariff-line level with approximately 10,000 commoditiesis that trade data is not harmonized across countries at this level. Most countries’ trade data isharmonized to the HS 6-digit level.

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incorporation into a free trade agreement covering the all of the Americas. WhileNAFTA is not a “deep” integration like the European Union and the Australia-NewZealand Closer Economic Relations Trade Agreement, it contains provisions that gobeyond mere removal of tariffs and quantitative trade restrictions, including disci-plines on the regulation of investment, transportation and financial services, intellec-tual property, government purchasing, competition policy, and the temporary entryof business persons (Hufbauer and Schott, 1993).

3 Theoretical Framework and Empirical Strategy

This paper seeks to exploit the commodity and time variation in the tariff preferencethat is afforded to goods originating in NAFTA partners to identify NAFTA’s effecton North American trade. The paper focuses on where the US and the EU sourcetheir imports of different commodities. It seeks to explain changes in US importsources using the preference afforded to commodities of Canadian and Mexican ori-gin. The idea is that where Canada and Mexico are afforded no special preference(where the MFN tariff rate is zero, for instance), NAFTA’s only impact should comethrough a general equilibrium effect on factor prices, or through reductions in “bordereffects” due to NAFTA provisions that go beyond tariff liberalization. For commodi-ties where NAFTA causes a preference to open up for Canadian and Mexican goods,the preference should have an additional effect causing US consumers to substitutetowards Canadian and Mexican goods and away from other sources of supply. Theempirical strategy can be derived from a simple model.

A. Model DescriptionFirms produce commodities under perfectly competitive conditions. Trade is

driven by preference for variety and by commodities being differentiated by coun-try of origin. Countries may impose ad-valorem tariffs on imports. Countries maythen enter into preferential trading agreements whereby each country in the agree-ment lowers tariffs on imports from partner countries but need not adjust the tariffon imports from other countries. This causes consumers to substitute towards theoutput of preferred countries and away from all other sources of supply, includingdomestic production. The model assumptions are set out in detail below.

1. Countries are denoted by c and time by t.

2. There is a continuum of industries z on the interval [0,1]. In each country,every industry produces a commodity under conditions of perfect competition withmarginal cost at (zc). Let q

St (zc) be the production of commodity z in country c.

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3. In every period consumers in each country are assumed to maximize identi-cal Cobb-Douglas preferences over their aggregate consumption of each commodity,

3The terms ‘industry’ and ‘commodity’ are essentially interchangeable in this framework.

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Qt (z), with the function of income spent on commodity z being b (z) (Equation 1).Expenditure shares for each commodity are therefore constant for all prices and in-comes. All income is spent so the integral of b (z) over the interval [0, 1] is 1 (Equation2).

Ut =

1Z0

b (z) lnQt (z) dz. (1)

1Z0

b (z) dz = 1. (2)

4. A CES demand structure is assumed. Each commodity is not a homogeneousgood. Although firms in the same country produce identical goods, production isdifferentiated by country of origin.4 Qt (z) can be interpreted as a sub-utility functionthat depends on the quantity of each variety of z consumed. I choose the CES functionwith elasticity of substitution σz > 1. Let qDt (zc) denote the quantity consumed ofcommodity z produced in country c. Qt (z) is defined by Equation 3:

Qt (z) =

ÃNXc=1

qDt (zc)σZ−1σZ

! σZσZ−1

. (3)

5. There may be transport costs for international trade. Transport costs are intro-duced in the convenient ‘iceberg’ from; gc0t (zc) units must be shipped from countryc for 1 unit to arrive in country c0; gct (zc) = 1, ∀c.5

6. Tariffs: τ c0t (zc) is the ad-valorem tariff imposed by country c0 on imports ofcommodity z from country c; τ ct (zc) = 0, ∀c. Tariffs are rebated as a lump-sum toconsumers.

B. EquilibriumIn equilibrium, consumers maximize utility, firms maximize profits and trade is

balanced. Because of the assumption of perfect competition, prices (exclusive of tariffsand transport costs) are equal to marginal cost, at (zc) . Consider the consumers incountry 1, which we will call the US. Tariffs and transport costs raise the price paidby US consumers for goods imported from country c to at (zc) g1t (zc) (1 + τ 1t (zc)).

4The model could be extended to allow Nct varieties to be produced in country c. This wouldhave no impact on the analysis.

5Transport costs are introduced only to clarify one of my identification assumptions, they playno other important role.

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Let T1t (z) denote tariff revenue collected in the US on imports of commodity z, letY1t denote US income, and q

D1t (zc) denote US consumption of commodity z produced

in country c. US income is equal to the sum of firm revenues plus tariff revenue.6

T1t (z) =Xc

τ 1t (zc) qD1t (zc) at (zc) , (4)

Y1t =

1Z0

at (z1) qSt (z1) dz +

1Z0

T1t (z) dz. (5)

US consumers maximize utility subject to expenditure being equal to income inevery period. Due to the unit substitution elasticity between industries, the share ofincome spent on commodity z is constant at b (z) :

Xc

qD1t (zc) at (zc) g1t (zc) (1 + τ 1t (zc)) = b (z)Y1t. (6)

Differentiating the Lagrangian for the consumers’ constrained optimization prob-lem with respect to consumption levels of each commodity, we find that the tariff onimported goods causes domestic consumers to substitute towards domestically pro-duced varieties. The amount of substitution depends on the level of the tariff and onthe elasticity of substitution between varieties:

∀z,∀c,∀t, qD1t (zc)

qD1t (zc0)=

µ1 + τ 1t (zc0)

1 + τ 1t (zc)

¶σZµat (zc0)

at (zc)

¶σZµg1 (zc0)

g1 (zc)

¶σZ

. (7)

Equilibrium conditions for all other countries are symmetric, which will be ex-ploited by the empirical work to control for the effect of unobserved cost shocks thatmay be correlated with tariff movements. Finally, all commodity markets have toclear, taking in to account output that melts in transit:7

∀z,∀c,∀t, qSt (zc) =Xc0qDc0t (zc) gc0t (zc) . (8)

C. Empirical StrategyEquation 7 will form the basis of the empirical examination of NAFTA. Equivalent

equations exist for every other country, specifically, let country 2 be the EU:

6Revenue from firm sales will all accrue to factors of production (inputs), which are assumed tobe domestically owned.

7Underlying factor (input) markets are not modelled.

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∀z,∀c,∀t, qD2t (zc)

qD2t (zc0)=

µ1 + τ 2t (zc0)

1 + τ 2t (zc)

¶σZµat (zc0)

at (zc)

¶σZµg2t (zc0)

g2t (zc)

¶σZ

. (9)

Using Equations 7 and 9 we can eliminate the effect of time-varying marginalcosts:

lnqD1t (zc)

qD1t (zc0)− ln q

D2t (zc)

qD2t (zc0)=σz

·ln1 + τ 1t (zc0)

1 + τ 1t (zc)− ln 1 + τ 2t (zc0)

1 + τ 2t (zc)

¸+σz

·lng1t (zc0)

g1t (zc)− ln g2t (zc0)

g2t (zc)

¸. (10)

Taking the time-difference of Equation 10 gives us:

∆

·lnqD1t (zc)

qD1t (zc0)− ln q

D2t (zc)

qD2t (zc0)

¸=σz

·∆ ln

1 + τ 1t (zc0)

1 + τ 1t (zc)−∆ ln

1 + τ 2t (zc0)

1 + τ 2t (zc)

¸+σz∆

·lng1t (zc0)

g1t (zc)− ln g2t (zc0)

g2t (zc)

¸. (11)

So long as we only examine countries c and c0 for which the EU does not change itsrelative tariffs, then ∆ ln 1+τ2t(zc0)

1+τ2t(zc)= 0. Furthermore, I do not have detailed transport

cost data, so to identify σZ I assume that the change in relative transport costs of

shipping commodities to the US and the EU,∆hln g1t(zc0)

g1t(zc)− ln g2t(zc0)

g2t(zc)

i, is orthogonal to

the change in US tariffs ∆ ln 1+τ1t(zc0)1+τ1t(zc)

.8 This produces the basic estimating Equation12, where σ will be a weighted average of σz, and εcc0z is a random disturbance term.

∆

·lnqD1t (zc)

qD1t (zc0)− ln q

D2t (zc)

qD2t (zc0)

¸= σ

·∆ ln

1 + τ 1t (zc0)

1 + τ 1t (zc)

¸+ εcc0z (12)

We can derive the equivalent expression for the change in the relative value ofimports from Equation 12:

8The assumption may not be completely innocuous. The most significant recent feature of in-ternational trade costs has been the relative decline in air-freight costs. This is likely to dispro-portionately benefit some commodities and some trade routes. See Hummels (1999) for a detailedexamination of international trade costs.

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∆

·lnat (zc) q

D1t (zc)

at (zc0) qD1t (zc0)− ln at (zc) q

D2t (zc)

at (zc0) qD2t (zc0)

¸= σ

·∆ ln

1 + τ 1t (zc0)

1 + τ 1t (zc)

¸+ εcc0z (13)

Now consider country c to be Canada or Mexico and country c0 to be any othercountry. NAFTA’s and CUSFTA’s increase in the US tariff preferences for Canadianand Mexican goods, ∆ ln 1+τ1t(zc0)

1+τ1t(zc), will increase their share of US consumption and

imports relative to their share of EU consumption and imports. A fraction of theincreased share of US consumption comes from reduced output of domestic suppliers(“trade creation”), and the rest comes from reduced imports from countries outsideNAFTA (“trade diversion”). The size of the increased share in an arbitrary industryz depends positively on the size of the increased US tariff preference, and positivelyon the elasticity of substitution σ between varieties of z.

4 Data Description

Since 1988 the EU and since 1989 the US have collected their trade data according tothe Harmonized Schedule (HS), a schedule that is now standard for many countriesup to the 6-digit level, or 5,109 commodities. The US International Trade Commis-sion (USITC) maintains a database at the 10-digit level of US imports classified bycommodity, country of origin, import program, month and port of arrival. Eurostatmaintains a similar database for the EU. US tariffs are almost invariably set at the8-digit level, comprising about 12,000 commodities by the year 2000. Changes in HScommodity classifications lead to some attrition, but we are able to track US andEU trade in 4,655 6-digit commodities annually from 1989 to 2000. Because Canadaentered into CUSFTA with the US in 1989, it is useful to collect data for earlier years.Prior to 1989, trade data was collected according to a different commodity schedule,the TSUSA. Concordances are available for this data, but revisions to the TSUSAalso lead to attrition. We are able to track 4,483 commodities continuously from 1988to 2000, and 3,592 from 1980 to 2000.

For each year I calculate the share of US imports of each commodity measuredby customs value (that is, exclusive of tariffs, freight and insurance) that originate ineach of the trading partners of the US. The change in the simple average of Canada’sand Mexico’s share of US imports by commodity is summarized in Figure 3. From1980 to 1988 Canada’s simple average share of US imports declined by 3.5 percentagepoints, but from 1989 to 2000 some of this decline was reversed, with the average shareincreasing by 2.1 percentage points. Between 1980 and 1985, Mexico’s share of USimports barely changed, rising by 0.2 percent. In 1986 Mexico joined the GATT andunilaterally liberalized is trade regime. Reducing extremely high import protectionhelped to promote exports, and Mexico’s share of US imports rose by 1.4 percentagepoints from 1985 to 1993. From 1994 with Mexico a part of NAFTA, its share of USimports increased a further 1.8 percentage points, but the first big increase occurred

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in 1995, leading to speculation that the devaluation in 1994 and not NAFTA wasresponsible.

The data also contains information on physical quantities imported for a largenumber of the commodities down to the HS 10-digit level, allowing the calculation ofunit price variables. Where possible, I calculate the price of Canadian and Mexicangoods relative to the price of goods sourced from the rest of the world, denotedRPt (zc). These prices will be used to make a very tentative search for NAFTA’sterms of trade effects.

US tariff rates for the years 1997 to 2000 are available from the USITC and tariffdata for earlier years was extracted from USITC files. Tariffs are almost invariablyset at the HS 8-digit level. While most tariffs are ad-valorem, there are still severalhundred specific tariffs applied. The USITC calculates the ad-valorem equivalent ofany specific tariffs. The distribution of MFN tariffs in 2000 is illustrated in Figure4A. The simple average of tariff rates is low at 5.5 per cent, but importantly thereis a large amount of dispersion, with the standard deviation of MFN tariff ratesbeing 12 per cent. Under NAFTA, all but a few hundred of these tariffs have beeneliminated for Canada and are in the process of being eliminated for Mexico, creatinga large variation in the preference given to goods of Canadian and Mexican origin(Figure 4B). Table 1 shows that much of this variation occurs even within fine productclassifications. Industry-level studies therefore ignore most of the tariff variation.

Complicating matters was the existence of preferential treatment for some Mex-ican and Canadian goods prior to CUSFTA/NAFTA. In 1965, Canada and the USnegotiated the Auto-Pact, allowing duty-free trade in many automotive goods. TheAuto Pact was incorporated into CUSFTA. Mexico was a beneficiary of the Gen-eralized System of Preferences (GSP), under which the US (and other developedcountries) gave developing countries preferential access to their markets. The USgave duty free access to the output of developing countries for several thousand HS 8-digit commodities, although goods where developing countries may have gained mostfrom preferential access were often excluded (notably many agricultural items andtextiles, clothing and footwear), and the preference could easily be removed under“competitive needs limitations” to the GSP. Upon entry into NAFTA, Mexico wasno longer entitled to claim GSP benefits for trade with the US.

For each HS 8-digit commodity, I calculate the preference afforded to Canadianand Mexican goods as the MFN tariff rate applicable to that commodity in January1999 less the tariff rate applicable to Canadian and Mexican goods respectively. Thedistribution of these preferences is illustrated in Figure 4B. But it is the increase inthe preference that matters. If there was a pre-existing preference under the GSP forMexico or the Auto-Pact for Canada, then this preference was simply the applicableMFN tariff rate. The preferences were aggregated to the HS 6-digit level, see the DataAppendix for details. One factor complicating the calculation of tariff preferences isthe existence of the maquiladoras, which exploited the fact that for many imported

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products the US did not charge duty on the US-produced content in imports. Forthese products, calculating preferences using the tariff schedule will tend to overstatethe new tariff preferences. Wherever trade in a product is observed, I also calculatetariff preferences using data on actual import duty paid.

A further complication is the existence of quantitative restrictions on imports ofmany textile, clothing and footwear commodities under the Multi-Fibre Agreement(MFA) and of many agricultural commodities. Many of these restrictions are binding,though most are not. They are extremely difficult to account for, many restrictionsencompass many HS commodities and most apply bilaterally. Special HS codes areoften created for these restrictions. I take two extreme approaches to the problem.One is to ignore the problem completely, and treat the tariff as the only measureof protection for these commodities, and the other extreme is to drop all affectedcommodities.

The preferences given to Canadian and Mexican production are systematicallyrelated to some of the characteristics of the commodities. This is to some extentevident from Figures 1A to 2B showing a systematic negative relationship betweenthe preference and Canada’s and, to a lesser extent, Mexico’s market share. Giventhat the most protected sectors are agriculture and simple manufactures like textiles,apparel and footwear, the highest preferences are mostly in these sectors, subject tothe existence of quantitative restrictions under the Multi-Fibre Agreement (MFA).This is especially true for simple manufactures because much agricultural protectionwas preserved under NAFTA. Where the preference exceeds 20 percent for eitherMexican or Canadian goods, 70 percent of the commodities are textiles, clothing orfootwear, 17 percent are agricultural commodities, and the remainder are light trucks(including many SUVs), glassware, bags, brooms and cheap watch movements.

The NAFTA preferences are strongly biased towards commodities in which de-veloped countries have a comparative disadvantage. This effect can be seen in Table2. This table examines the relationship between the relative price of Canadian andMexican exports to the US and NAFTA preferences for Canadian and Mexican goods.For each commodity, the unit price of Canadian and Mexican exports to the US (ex-clusive of tariffs) is divided by the unit price of exports from the rest of the world.The unit import price data contains some very extreme values, therefore I calculatethe median rather than the average relative price of exports, RPt (zc), for severalarbitrary tariff preference classes. Table 2 strongly suggests that the relative price ofCanadian goods was and is substantially higher in commodities where there is a largeNAFTA preference, a situation that has become noticeably worse where the prefer-ence is between 5 and 20 percent. This is consistent with the hypothesis that NAFTApreferences are skewed towards goods where developed countries have a comparativedisadvantage and suggests that NAFTA may have caused Canada to expand its shareof US imports in commodities where it is a relatively high cost producer.

One interesting feature of Table 2 is the behavior of relative prices for the com-

12

modities where the greatest preference was conferred. For both Canada and Mexicothe relative price of these goods declines, unlike commodities in other tariff classes.This last phenomenon admits many interpretations, although it has to be noted thatthe sample size is small. One interpretation is that NAFTA may have led to produc-tivity improvements in these very protected industries. An alternative explanationis that with a larger market under NAFTA, surviving firms producing these com-modities have been able to exploit scale economies and move down their average costcurve. A third explanation is simply that with the benefit of substantial tariff prefer-ences, Canada and Mexico are now able to profitably export to the US very low-valuevarieties of these commodities. Why this effect is only evident for the very highlypreferred products is hard to explain. [check EU data...].

The systematic association between NAFTA preferences and some underlyingsources of comparative advantage is of great concern for the empirical analysis becausethere is a need to distinguish changes in trade patterns that are due to NAFTA fromchanges in trade patterns that would have happened anyway due to shifting compar-ative advantage. This is done in two ways. The first way comes directly from themodel. Changes in comparative advantage will be reflected in production costs, butby including EU data in the analysis we can control for the effect of cost shocks usingEquation 10. The second way is to assemble a set of controls for commodity charac-teristics using USITC data and 6-digit NAICS industry data from the 1997 EconomicCensus. The commodity characteristics are the transport costs for the commodityestimated by dividing Cost including Insurance and Freight (CIF) by Free On Board(FOB) import values, and the units that the commodity is measured in. A commod-ity that is expensive to ship may have substantially different characteristics from onethat is cheap to ship. A commodity that is sold by the tonne may have differentcharacteristics to one sold by the dozen. The industry characteristics include factorintensity estimates: whether the industry is agricultural; skill intensity measured bythe proportion of non-production workers and by average compensation; and capitalintensity measured by the share of value added that is not total compensation. Otherindustry characteristics include firm size measures (average employment per estab-lishment and average assets per establishment) and the proportion of total sales thatis value added.

5 Results

A. Elasticity of Substitution

The mean elasticity of substitution σ is estimated using the following estimatingequation derived from Equation 13:

13

∆

·lnat (zc) q

D1t (zc)

at (zc0) qD1t (zc0)− ln at (zc) q

D2t (zc)

at (zc0) qD2t (zc0)

¸= σ

·∆ ln

1 + τ 1t (zc0)

1 + τ 1t (zc)

¸+ x0z.πc + εcc0z ,

(14)

where at (zc) qD1t (zc) is the FOB value of US imports of commodity z from country

c at time t; at (zc) qD2t (zc) is EU imports of commodity z from country c at time t;

τ 1t (zc) is the US ad-valorem tariff on imports of commodity z from country c at timet; xz is an additional set of controls with effects πc; and εcc0z is a random disturbanceterm. The parameter σ is of interest because it helps determine the effect of tradeimpediments on the volume of trade; it dictates the extent of trade diversion andtrade creation from the preferential trade liberalization; and because it is a criticalingredient of welfare analysis of trade liberalization. I estimate Equation 14 by OLS,where country c is alternatively Canada or Mexico, country c0 is the aggregate of allcountries that do not have a free trade agreement with the US or the EU and did notsubstantially change their preferential trade relations with either the US or the EUbetween 1988 and 1999. A list of these countries is provided in Appendix Table 1.1988 and 1999 trade data is used for Canada and 1993 and 1999 data for Mexico. Itshould be noted that the dependent variable is only defined for commodities whereimports from the relevant country are observed in both years, resulting in a substantialnumber of missing observations, especially for Mexico.9 Industry characteristics areprogressively controlled for, in case EU trade data does not provide an adequatecontrol for unobserved cost shocks that may be correlated with US tariff preferences.The results are reported in Tables 3A to 3C.

Table 3A reports OLS estimates in columns 1-3 and 7-9. The estimates of theelasticity of substitution typically range between 4 and 7 and are usually reasonablyprecisely estimated. Moving across the columns, adding extra industry controls de-creases the estimates based on Mexican trade data but increases them for Canada.One concern with the OLS estimates is that they are based only on those commoditiesthat were imported from the relevant country in both the base year and the year 1999.Approximately half of the observations are missing for Canada, and two-thirds forMexico. To see if selection bias is an issue, columns 4-6 and 7-9 report results from theHeckman (1976) selection model, with selection being modelled as a linear functionof the aforementioned industry characteristics and industry dummies. Countries maytend to specialize in industries that share certain characteristics. While the selectionvariables matter for the selection equation (not tabulated), controlling for selectionitself appears to make little difference to the substitution elasticity estimates.

The estimated substitution elasticity was allowed to vary across industry by in-teracting the NAFTA tariff preferences with other industry characteristics. Oncethe elasticity was allowed to vary with the tariff preference itself, no other industry

9Some of this attrition is due to changes in commodity classifications.

14

characteristic significantly affected the estimates. Table 3B reports results where thesubstitution elasticity was only allowed to vary with the tariff preference. For almostall products these estimates suggest higher elasticities than were estimated in Table3A. Interestingly, the interaction term is usually significantly negative, suggestingthat goods with higher tariff preferences are less substitutable across source. Thisis surprising given that these products are mostly agricultural goods or simple man-ufactures, and may reflect the existence of quantitative import controls on some ofthese items.

Table 3C repeats Tables 3A and 3B but seeks to correct for the effect of themaquiladoras on Mexican exports to the US by calculating tariff preferences usingUS data on actual import duty paid. The estimated substitution elasticities changelittle, and for a typical product range between 5 and 7. The interaction term changessubstantially though, with the coefficient always suggesting that the more highlypreferred products are more substitutable across source.

Table 3D reports equivalent results to Table 3A but estimates Equation 15 usingmore detailed US trade data at the HS 8-digit level. This roughly doubles the numberof observations but incurs the disadvantage of losing EU trade data as a control forunobserved shocks. The results are similar, with the typical substitution elasticitybeing between 5 and 7.

∆ lnqD1t (zc)

qD1t (zc0)= σ

·∆ ln

1 + τ 1t (zc0)

1 + τ 1t (zc)

¸+ x0z.πc + εcc0z. (15)

These elasticities of substitution suggest that consumers are quite willing to sub-stitute between different sources of a commodity. One implication of this willingnessto substitute is that small costs to international trade, whether due to natural barri-ers such as transport costs or artificial barriers such as tariffs, will have a large effecton trade volumes. With a substitution elasticity of 4, the median US tariff of 5.5 percent will reduce consumption of imported varieties relative to domestic varieties by 20per cent. With a substitution elasticity of 7, this reduction in relative consumption is31 per cent. But on some products the effect will be much more dramatic; US tariffsrange up to 350 per cent.

B. Trade Creation and Trade Diversion

The results reported above suggest that NAFTA preferences have had a pro-nounced effect on the source of US imports. But the results do not tell us whetherthe increased imports from Canada and Mexico are the result of new internationaltrade displacing US domestic production (“trade creation”) or result from displace-ment of imports from other sources (“trade diversion”). The model presented inSection 3 predicts that it will be a little of both. The model and the estimates of

15

σ can be used to estimate what proportion of increased imports from Canada andMexico is from trade creation, and what proportion is from trade diversion. To get atractable expression that can be used to approximate the relative importance of tradecreation and trade diversion it is convenient to hold production costs fixed or, in otherwords, to temporarily ignore the terms of trade effects of preferential trade liberal-ization. With production costs fixed there will be a very small decline in nominal USnational income resulting from the loss of tariff revenue on Mexican and Canadianimports, and given the assumed substitution elasticities [try nested CES...], nominalexpenditures on each commodity z will be little changed. A measure of the impor-tance of trade creation will be the decline in the share of US expenditure spent onUS production. A measure of the importance of trade diversion is the decline in theshare of US expenditure spent on production from outside NAFTA. From Equation7 we can derive Equations 16 and 17 for US expenditure shares on commodity z thatare spent on the output of country c0:

a.qD1,t=88 (zc0)

Σca.qD1,t=88 (zc)

=

"Σc

µ1 + τ 1,t=88 (zc0)

1 + τ 1,t=88 (zc)

¶σ µat=88 (zc0)

at=88 (zc)

¶σ−1µg1,t=88 (zc0)

g1,t=88 (zc)

¶σ#−1

. (16)

da.qD1,t=99 (zc0)

Σca.qD1,t=99 (zc)

=

"Σc

a.qD1,t=88 (zc)

a.qD1,t=88 (zc0)

µ1 + τ 1,t=99 (zc0)

1 + τ 1,t=99 (zc)

¶σ µ1 + τ 1,t=88 (zc0)

1 + τ 1,t=88 (zc)

¶−σ#−1.

(17)

Equation 16 gives the expenditure shares prior to CUSFTA and NAFTA, whileEquation 17 is a prediction based on the prior expenditure shares, the extent of pref-erential tariff liberalization and the substitution elasticity. The change in aggregateUS expenditure E1c on the output of country c is simply a weighted sum of pre-dicted shares in Equation 17 less actual shares in 1988, with the weights given by USconsumption b (z)Y1:

∆E1c0 =

Zz

b (z)Y1

" da.qD1,t=99 (zc0)

Σca.qD1,t=99 (zc)

− a.qD1,t=88 (zc0)

Σca.qD1,t=88 (zc)

#(18)

All the expenditure shares and tariffs are essentially observable, all that is neededto estimate Equation 18 is an estimate of σ, which was estimated above to be approx-imately 6. Expenditure shares are estimated at the 4-digit SIC industry level becauseof the need to utilize US production data. US production data for 1988 is industryvalue added data from the NBER productivity database. The amount of US produc-tion that is consumed domestically is estimated by subtracting US exports from US

16

production at the 4-digit SIC level using export data from the Center for Interna-tional Data at UC Davis. 1988 import data is also from the Center for InternationalData. This data and the estimated substitution elasticity suggest that CUSFTA andNAFTA should have caused a 10 percent increase in Canada’s share of US importsand a 21 percent increase in Mexico’s share of US imports. The actual increases sinceCUSFTA and NAFTA have been 11 percent and 66 percent respectively. CUSFTAand NAFTA appear to be responsible for almost all of Canada’s increased exports tothe US and one-third of Mexico’s increased exports to the US. The estimates also sug-gest that 59 percent of these increased exports have displaced US production, while41 percent have displaced exports from non-NAFTA countries. This high proportionof trade diversion is due to a very simple reason: the largest tariff preferences underNAFTA and CUSFTA are in industries where imports from outside of North Americarepresent a substantial proportion of domestic consumption.

C. Import Price DataUnit import price data also provide some evidence of the original Vinerian concept

of trade-diversion: incurring a real resource cost by paying more for imports frompreferred trading partners (exclusive of tariffs) because of the tariff preference. Thiseffect is examined by regressing the change in the relative price, ∆RP (zc), of importsfrom Canada and Mexico on the tariff preference extended to them. Table 2 suggeststhat the FOB price of US imports from Canada, and to a lesser extent Mexico, havebecome relatively more expensive where the NAFTA preference is between 5 and 20per cent, but any relationship is potentially clouded by relative price declines in asmall number of extremely preferred industries. Equations are estimated of the form:

∆RP (zc) = x0z.πc +

JXj=1

δcj.∆ ln

µ1 + τ 1t (zc0)

1 + τ 1t (zc)

¶j+ εcz (19)

where x0z is a vector of controls for industry characteristics, and ∆ ln³1+τ1t(zc0)1+τ1t(zc)

´is the increased US tariff preference for Canadian or Mexican goods due to CUSFTAand NAFTA. Figures 5A to 5B and Tables 4A to 4D report the regression results sepa-rately for Canada and Mexico. Extreme observations are prevalent in the unit importprice data, so median regressions are also estimated in addition to OLS regressionresults. Columns 1 to 3 of Tables 4A and 4B for Canada suggest a very weak positiverelationship between NAFTA preferences and the change in relative import prices,but columns 1 to 3 of Tables 4C and 4D for Mexico suggest a significant negativerelationship, providing no evidence of trade diversion in the unit import price data.But adding higher-order terms to the regressions changes this conclusion. Columns 4to 6 of each table report results where the square of NAFTA preferences have beenadded. For both Canada and Mexico it appears that at relatively low levels of prefer-ence the change in the relative price of their exports to the US is positively associatedwith the tariff preference, providing evidence of trade diversion. But beyond a point

17

this relationship changes. The turning point comes at approximately 15% preferencefor Canada and 10% for Mexico, and at very high preference levels relative importprices appear to have dropped. One interpretation of this result is that for at least alimited range of industries there have been substantial productivity improvements inthese very sheltered industries brought about by NAFTA. An alternative explanationis that with a larger market under NAFTA, surviving firms producing these com-modities have been able to exploit scale economies. A third explanation is that thelarge tariff preference has enabled Canada and Mexico to profitably produce very lowvalue versions of these products. For Canada the productivity explanation would beconsistent with a finding in Trefler (2001) that the clothing industry has experiencedsubstantial productivity gains. Mexico, as the only substantial developing economywith preferential access to the highly protected US clothing and textile market, mayhave also witnessed such productivity gains as it became an attractive location tosupply the US market. The regression results do not qualitatively change when fur-ther higher order terms are added, the results where a fifth-order polynomial in thetariff preference are used are depicted in Figures 5A and 5B.

6 Conclusion

This paper seeks to identify an effect for NAFTA by focusing on where the UnitedStates and the European Union source their imports of different commodities from.NAFTA appears to have had a substantial effect on North American trade. Mexicanand Canadian shares of US imports have increased most rapidly in commodities wherethe greatest NAFTA preferences were conferred, even though Canada appears to be ahigh cost producer of many of these commodities. The Canadian share of US importsdeclined in commodities where it was not given a new preference, while the Mexicanshare increased much more modestly. The results of this paper suggest that trade flowsare very sensitive to even small tariff preferences. The NAFTA preferences can beused to estimate how willing consumers are to substitute between different varieties ofthe same commodity. The implied average substitution elasticity is typically between5 and 7. Consumers are quite willing to substitute between different varieties of thesame commodity. Small changes in trade impediments, whether due to natural ornon-natural barriers, could therefore have substantial effects on international tradevolumes. Preferential liberalization will have substantial effects on the direction oftrade. One disturbing result is that NAFTA appears to have caused a substantialamount of trade diversion.

18

7 Appendix

7.1 Data

Tariffs were aggregated from the HS 8-digit to HS 6-digit level by solving the followingequation for t in each HS 6-digit category:

(1 + t)σ =

µPiMi (1 + ti)

σPiMi

¶, (20)

where Mi is the value of imports of each HS 8-digit product within the HS 6-digitcategory, ti is the HS 8-digit tariff, and σ is the elasticity of substitution betweendifferent sources of HS 8-digit products, which I estimate using US data to be ap-proximately 6.

19

References

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[2] Bagwell K. and R. Staiger (1999), “An Economic Theory of GATT”, AmericanEconomic Review, Vol. 89, No.1, pp.215-248.

[3] Baldwin R. (1996), “A Domino Theory of Regionalism”, in Baldwin R., P. Haa-paranta and J. Kiander eds., Expanding the Membership of the EU, CambridgeUniversity Press.

[4] Baldwin R.E. and A. J. Venables (1995), “Regional Economic Integration”, inGrossman G.M. and K. Rogoff eds., Handbook of International Economics, Vol-ume 3, North-Holland.

[5] Brown D.K., A.V. Deardorff and R.M. Stern (1995), “Estimates of a NorthAmerican Free Trade Agreement”, in Kehoe P.J. and Kehoe T.J. (eds.),ModelingNorth American Integration, Kluwer Academic Publishers, Dordrecht.

[6] Chang W. and A. Winters (1999), “How Regional Blocs Affect Excluded Coun-tries: The Price Effects of MERCOSUR”, World Bank Policy Research WorkingPaper No. 2157.

[7] Clausing K. A. (2001), “Trade Creation and Trade Diversion in the Canada-United States Free Trade Agreement”, forthcoming Canadian Journal of Eco-nomics, August 2001.

[8] Cox D.J. (1995), “An Applied General Equilibrium Analysis of NAFTA’s Impacton Canada”, in Kehoe P.J. and Kehoe T.J. (eds.), Modeling North AmericanIntegration, Kluwer Academic Publishers, Dordrecht.

[9] Deardorff A. and R. Stern (1994), “Multilateral Trade Negotiations and Pref-erential Trading Arrangements” in A. Deardorff and R. Stern (eds), Analyticaland Negotiating Issues in the Global Trading System, The University of MichiganPress, Ann Arbor.

[10] Frankel J., E. Stein and S. Wei (1996), “Improving the Design of Regional TradeAgreements. Regional Trading Arrangements: Natural or Supernatural?”, AEAPapers and Proceedings, Vol. 86, No. 2, pp.52-56.

[11] Fukao K., T. Okubo, and R.M Stern (2001), “Trade Diversion under NAFTA”,mimeo, The University of Michigan.

[12] Garces-Diaz D. (2001), “Was NAFTA Behind the Mexican Export Boom (1994-2000)?”, mimeo (on SSRN), Banco de Mexico, February.

[13] Gould D. (1998), “Has NAFTA Changed North American Trade?”, Federal Re-serve Bank of Dallas Economic Review, First Quarter, pp.12-22.

[14] Head K. and J. Ries (1999), “Rationalization effects of tariff reductions”, Journalof International Economics, Vol. 47(2), pp.295—320.

[15] Heckman J. (1976), “The common structure of statistical models of truncation,sample selection, and limited dependent variables and a simple estimator for suchmodels”, The Annals of Economic and Social Measurement, Vol. 5, pp.475-492.

[16] Hufbauer G. and J. Schott (1993), NAFTA: An Assessment, (Washington DC,Institute for International Economics).

20

[17] Hummels D. (1999), “Have International Trade Costs Declined?”, mimeo.[18] Kehoe P.J. and Kehoe T.J. (1995), “Capturing NAFTA’s Impact with Applied

General Equilibrium Models”, in Kehoe P.J. and Kehoe T.J. (ed.), ModelingNorth American Integration, Kluwer Academic Publishers, Dordrecht.

[19] Kemp M. and H. Wan (1976), “An Elementary Proposition Concerning the For-mation of Customs Unions”, Journal of International Economics, Vol. 6, pp.95-97.

[20] Krueger A. (1999), “Trade Creation and Trade Diversion Under NAFTA”, NBERWorking Paper No. 7429.

[21] Krueger A. (2000), “NAFTA’s Effects: A Preliminary Assessment”,World Econ-omy, Vol. 23, No.6, pp.761-75.

[22] Levy P. (1997), “A Political-Economic Analysis of Free-Trade Agreements”,American Economic Review, Vol. 87, No.4, pp.506-519.

[23] Sobarzo H.E. (1995), “A General Equilibrium Analysis of the Gains from NAFTAfor the Mexican Economy”, in Kehoe P.J. and Kehoe T.J. (eds.), Modeling NorthAmerican Integration, Kluwer Academic Publishers, Dordrecht.

[24] Trefler D. (2001), “The Long and Short of the Canada-U.S. Free Trade Agree-ment”, mimeo (on SSRN), University of Toronto, April.

[25] Viner J. (1950), The Customs Union Issue, (New York: Carnegie Endowment).[26] Wall H. (2000), “NAFTA and the Geography of North American Trade”, mimeo

(on SSRN), Federal Reserve Bank of St. Louis, November.[27] Yeats A. (1997), “Does Mercosur’s Trade Performance Raise Concerns about the

Effects of Regional Trade Arrangements?”, World Bank Policy Research WorkingPaper No. 1729.

[28] Office of the United States Trade Representative (1999), U.S. Generalized Systemof Preferences Guidebook, Executive Office of the President, Washington D.C.,March 1999.

21

Figure 1A

Figure 1B

NAFTA's Impact on Mexico's Share of US Imports

0.00

0.02

0.04

0.06

0.08

0.10

0.12

1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000Year

Sim

ple

Ave

rage

of S

hare

of U

S Im

port

s by

C

omm

odity

No new tariff preference (2629 commodities)New tariff preference >0% and < 10% (1556 commodities)New tariff preference >= 10% (298 commodities)

Mexico's Share of EU Imports

0.000

0.002

0.004

0.006

0.008

1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000Year

Sim

ple

Ave

rage

of S

hare

of E

U Im

port

s by

C

omm

odity

No new US tariff preference (2629 commodities)New US tariff preference >0% and < 10% (1556 commodities)New US tariff preference >= 10% (298 commodities)

Figure 1C

Figure 2A

Mexico's Share of US Imports 1980-2000

0.00

0.02

0.04

0.06

0.08

0.10

0.12

0.14

1980

1981

1982

1983

1984

1985

1986

1987

1988

1989

1990

1991

1992

1993

1994

1995

1996

1997

1998

1999

2000

Year

Sim

ple

Ave

rage

of S

hare

of U

S Im

port

s by

C

omm

odity


1986-2000 GATT/WTO 1994-2000 NAFTA

CUSFTA's Impact on Canada's Share of US Imports

0.00

0.05

0.10

0.15

0.20

0.25

1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000Year

Sim

ple

Ave

rage

of S

hare

of U

S Im

port

s by

C

omm

odity


Figure 2B

Figure 2C

Canada's Share of EU Imports

0.00

0.01

0.02

0.03

0.04

1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000Year

Sim

ple

Ave

rage

of S

hare

of E

U Im

port

s by

C

omm

odity


CUSFTA's Impact on Canada's Share of US Imports

0.00

0.05

0.10

0.15

0.20

0.25

0.30

0.35

1980

1981

1982

1983

1984

1985

1986

1987

1988

1989

1990

1991

1992

1993

1994

1995

1996

1997

1998

1999

2000

Year

Sim

ple

Ave

rage

of S

hare

of U

S Im

port

s by

C

omm

odity


Figure 3

Figure 4A

Canada's and Mexico's Share of US Imports 1980-2000

0.00

0.05

0.10

0.15

0.20

0.25

Year

Sim

ple

Ave

rage

of S

hare

of U

S Im

port

s by

C

omm

odity

(359

2 co

mm

oditi

es)

0.00

0.02

0.04

0.06

0.08

0.10

Sim

ple

Ave

rage

of S

hare

of U

S Im

port

s by

Com

mod

ity (3

592

com

mod

ities

)

Mexico (Right Scale)

Canada (Left Scale)

1980 1989 1994 2000

US Tariff Preferences for Canadian and Mexican Goods in 2000

0

500

1000

1500

2000

2500

3000

3500

4000

0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 >20MFN Tariff Rate (%) Less Tariff on Imports from Canada, Mexico

Num

ber o

f HTS

8 C

omm

oditi

es

CanadaMexico

Figure 5A: NAFTA Preferences and the Change in the Relative Price of

Canada’s Exports 1988-2000 Fitted values pct95

nafta_pref

pct5

0 .395

-.598161

.352256

Notes: The change in the log relative unit values of imports from Canada has been regressed on a 5th-order polynomial in the tariff preference. The fitted values and a 90% confidence interval have been plotted against the new US tariff preferences for Canadian exports under CUSFTA/NAFTA.

Figure 5B: NAFTA Preferences and the Change in the Relative Price of

nafta_pref

Mexico’s Exports 1993-2000

otted

Fitted values pct95 pct5

0 .336

-.570567

.15527

Notes: The change in the log relative unit values of imports from Mexico has been regressed on a 5th-orderpolynomial in the tariff preference. The fitted values and a 90% confidence interval have been plagainst the new US tariff preferences for Mexican exports under NAFTA.

Table 1: Percentage of HS 8-digit Tariff Variation Captured by Broader Classifications Classification Industries MFN Tariff Canada Preference Mexico Preference (A) (B) (A) (B) (A) (B) HS-2 97 0.205 0.351 0.199 0.363 0.181 0.367 HS-4 1241 0.280 0.470 0.279 0.542 0.251 0.530 HS-6 5109 0.330 0.555 0.321 0.671 0.289 0.671 Notes: Table 1 reports the percentage of MFN and preferential tariff variation at the tariff-line level that occurs within broader product classes. Columns headed ‘A’ include 10,178 tariff lines from Chapters 1 to 97. Columns headed ‘B’ exclude the 20 tariff lines where tariffs are in excess of 100%. Table 2: Tariff Preference and Relative Prices of Canadian and Mexican Exports Year 2000 Tariff Preference %

Canada: Median Log RPX Mexico: Median Log RPX

1989 1993 2000 No. 1989 1993 2000 No. 0 0.055 0.067 0.127 1280 -0.101 -0.019 -0.029 468(0,5] 0.026 0.034 0.061 1372 -0.106 -0.025 -0.028 277(5,10] 0.134 0.205 0.288 661 -0.184 0.018 0.056 272(10,20] 0.277 0.463 0.536 383 -0.201 -0.083 -0.057 173>20 0.730 0.770 0.687 111 -0.056 0.147 -0.144 65AutoPact 0.129 0.187 0.327 236 GSP -0.154 -0.033 0.007 1273Notes: By tariff class, the table reports the median log price of Canadian and Mexican exports to the US relative to the price of exports to the US from the rest of the world. The number of commodities for each calculation is also reported.

Table 3A: Estimates of the Elasticity of Substitution based on US and EU Import Data Canada 1988-1999 Mexico 1993-1999 (1) (2) (3) (4) (5) (6) (7) (8) (9) (10) (11) (12)

σ 4.23 (1.41)

4.35 (1.45)

5.50 (2.09)

5.17 (1.20)

4.13 (1.28)

5.77 (4.86)

7.09 (2.20)

6.53 (2.29)

3.82 (1.83)

6.85 (1.30)

6.13 (1.43)

3.81 (2.31)

Industry Characteristics

No Yes Yes No Yes Yes No Yes Yes No Yes Yes

Industry Dummies

No No Yes No No Yes No No Yes No No Yes

OLS Yes Yes Yes No No No Yes Yes Yes No No No Heckitt No No No Yes Yes Yes No No No Yes Yes Yes N 2096 2054 2054 4890 4890 4890 1477 1444 1444 4890 4890 4890 Observed 2096 2054 2054 2054 2054 2054 1488 1444 1444 1444 1444 1444

Notes: robust standard errors appear in parentheses beneath OLS coefficient estimates, regular standard errors appear beneath Heckitt estimates.

Table 3B: Estimates of the Elasticity of Substitution based on US and EU Import Data Elasticity varies with NAFTA tariff preference

Canada 1988-1999 Mexico 1993-1999 (1) (2) (3) (4) (5) (6) (7) (8) (9) (10) (11) (12)

σ0 9.26

(1.65) 8.27

(1.83) 8.01

(2.82) 9.56

(1.77) 7.98

(1.94) 8.27

(6.49) 13.86

(1.87) 13.88 (2.14)

1.38 (3.53)

13.51 (2.01)

13.39 (2.35)

1.40 (3.70)

2

1 '

1

1 ( )ln1 ( )

t ct

t c

zz

ττ

+∆ +

-11.09 (2.12)

-9.33 (2.28)

-11.07 (6.92)

-11.15 (3.29)

-9.02 (3.43)

-10.98 (18.55)

-14.88 (3.01)

-14.82 (3.17)

4.79

(3.97)

-14.49 (3.33)

-14.14 (3.64)

4.74

(5.78)



Industry Dummies No No Yes No No Yes No No Yes No No Yes OLS Yes Yes Yes No No No Yes Yes Yes No No No Heckitt No No No Yes Yes Yes No No No Yes Yes Yes N 2096 2054 2054 4890 4890 4890 1477 1444 1444 4890 4890 4890 Observed 2096 2054 2054 2054 2054 2054 1488 1444 1444 1444 1444 1444

Notes: robust standard errors appear in parentheses beneath OLS coefficient estimates, regular standard errors appear beneath Heckitt estimates. The estimated elasticity for a given NAFTA tariff preference can be calculated as σ0 plus the second reported coefficient multiplied by the NAFTA tariff preference 1 '

1

1 (ln1 (

t ct

t c

zz

))

ττ

++

∆.

Table 3C: Estimates of the Elasticity of Substitution based on US and EU Import Data NAFTA Tariff Preferences calculated from actual duty paid to adjust for the Maquiladoras

Mexico 1993-1999 (1) (2) (3) (4) (5) (6) (7) (8) (9) (10) (11) (12)

σ0 4.88

(1.27) 4.93

(1.31) 5.12

(1.45) 5.06

(0.93) 5.05

(0.93) 5.12

(0.91) 5.82

(1.48) 6.11

(1.51) 6.61

(1.53) 5.92

(1.02) 6.13

(1.04) 6.61

(1.01) 2

1 '

1

1 ( )ln1 ( )

t ct

t c

zz

ττ

+∆ +

3.47 (1.78)

4.01

(1.81)

5.63

(1.97)

3.08

(1.53)

3.71

(1.55)

5.63

(1.60)



Industry Dummies No No Yes No No Yes No No Yes No No Yes OLS Yes Yes Yes No No No Yes Yes Yes No No No Heckitt No No No Yes Yes Yes No No No Yes Yes Yes N 2096 2054 2054 4890 4890 4890 1477 1444 1444 4890 4890 4890 Observed 2096 2054 2054 2054 2054 2054 1488 1444 1444 1444 1444 1444

Notes: robust standard errors appear in parentheses beneath OLS coefficient estimates, regular standard errors appear beneath Heckitt estimates. The estimated elasticity for a given NAFTA tariff preference can be calculated as σ0 plus the second reported coefficient multiplied by the NAFTA tariff preference 1 '

1

1 (ln1 (

t ct

t c

zz

))

ττ

++

∆.

Table 3D: Estimates of the Elasticity of Substitution based on US HS-8 Import Data Only

Canada 1988-2000 Mexico 1993-2000 (1) (2) (3) (4) (5) (6) (7) (8) (9) (10) (11) (12)

σ 6.06 (0.74)

5.09 (0.81)

6.55 (1.11)

6.07 (0.78)

5.36 (0.84)

6.56 (1.06)

7.05 (0.95)

6.83 (1.07)

2.00 (1.70)

6.97 (0.94)

6.78 (1.13)

2.01 (1.50)



Industry Dummies


OLS Yes Yes Yes No No No Yes Yes Yes No No No Heckitt No No No Yes Yes Yes No No No Yes Yes Yes N 4931 4818 4818 9641 9641 9641 3026 2957 2957 9641 9641 9641 Observed 4931 4818 4818 4818 4818 4818 3026 2957 2957 2957 2957 2957

Notes: robust standard errors appear in parentheses beneath OLS coefficient estimates, regular standard errors appear beneath Heckitt estimates.

Table 4A: Change in Relative Price of Imports from Canada Dependent Variable: ∆RP89_00

Median Regression Results RHS Var. (1) (2) (3) (4) (5) (6) (7) (8) (9) (10) (11) (12) Pref 0.24

(0.30) 0.19

(0.34) 0.37

(0.39) 1.21

(0.64) 1.45

(0.71) 1.27

(1.78) -1.79 (1.15)

-0.59 (1.35)

DNC -4.62 (1.75)

-4.08 (1.63)

DNC

Pref2 -4.20 (2.49)

-5.36 (2.64)

-4.38 (5.66)

27.0 (10.8)

15.8 (12.5)

85.9 (26.9)

79.4 (25.0)

Pref3 -69.9 (23.6)

-47.7 (27.2)

-398 (130)

-376 (120)

Pref4 518 (189)

498 (174)

AutoPact Controls

Yes Yes Yes Yes Yes Yes Yes Yes Yes Yes Yes Yes



Industry Dummies


N 2003 1947 1947 2003 1947 1947 2003 1947 1947 2003 1947 1947 Notes: standard errors appear in parentheses beneath coefficient estimates. “DNC” denotes regressions that did not converge.

Table 4B: Change in Relative Price of Imports from Canada Dependent Variable: ∆RP89_00

OLS Regression Results RHS Var. (1) (2) (3) (4) (5) (6) (7) (8) (9) (10) (11) (12) Pref 0.23

(0.32) 0.37

(0.38) 0.74

(0.54) 0.89

(0.85) 1.29

(0.94) 2.13

(1.43) -0.52 (1.59)

0.23 (1.67)

1.79 (2.14)

-3.93 (2.53)

-3.46 (2.60)

-1.14 (3.10)

Pref2 -2.90 (2.89)

-3.99 (3.05)

-5.05 (3.94)

12.4 (13.4)

7.60 (13.9)

-1.30 (15.7)

78.8 (36.4)

79.8 (37.4)

56.2 (42.1)

Pref3 -34.4 (27.8)

-26.0 (29.0)

-8.36 (31.6)

-390 (166)

-410 (170)

-310 (190)

Pref4 546 (234)

587 (238)

456 (265)

GSP Controls Yes Yes Yes Yes Yes Yes Yes Yes Yes Yes Yes Yes Industry Characteristics


Industry Dummies


N 2003 1947 1947 2003 1947 1947 2003 1947 1947 2003 1947 1947 Notes: robust standard errors appear in parentheses beneath coefficient estimates.

Table 4C: Change in Relative Price of Imports from Mexico

Dependent Variable: ∆RP93_00 Median Regression Results RHS Var. (1) (2) (3) (4) (5) (6) (7) (8) (9) (10) (11) (12) Pref -0.46

(0.26) -0.63 (0.29)

DNC 1.57 (0.67)

1.22 (0.77)

DNC 3.56 (1.20)

2.73 (1.40)

DNC 1.77 (2.03)

1.07 (2.60)

DNC

Pref2 -8.00 (2.65)

-6.86 (2.87)

-30.4 (11.9)

-24.6 (13.3)

5.31 (32.7)

11.6 (41.3)

Pref3 53.5 (27.4)

43.3 (30.4)

-140 (163)

-159 (206)

Pref4 302 (253)

321 (317)



Industry Dummies


N 2003 1947 1947 2003 1947 1947 2003 1947 1947 2003 1947 1947 Notes: standard errors appear in parentheses beneath coefficient estimates. “DNC” denotes regressions that did not converge.

Table 4D: Change in Relative Price of Imports from Mexico

Dependent Variable: ∆RP93_00 OLS Regression Results RHS Var. (1) (2) (3) (4) (5) (6) (7) (8) (9) (10) (11) (12) Pref -0.36

(0.34) -0.68 (0.43)

-0.37 (0.53)

1.83 (1.00)

1.21 (1.17)

3.21 (1.69)

3.49 (1.97)

2.59 (2.14)

6.18 (2.86)

3.11 (3.56)

2.65 (3.72)

7.15 (4.57)

Pref2 -8.99 (3.26)

-7.34 (3.52)

-12.5 (4.65)

-28.3 (17.2)

-23.3 (17.8)

-44.6 (21.3)

-19.0 (52.5)

-21.8 (53.7)

-62.2 (59.6)

Pref3 46.5 (37.2)

38.1 (38.0)

74.3 (43.3)

-7.55 (241)

25.6 (247)

167 (263)

Pref4 89.9 (343)

23.7 (352)

-147 (366)



Industry Dummies


N 2003 1947 1947 2003 1947 1947 2003 1947 1947 2003 1947 1947 Notes: robust standard errors appear in parentheses beneath coefficient estimates.

nafta’s and cusfta’s impact on north american...

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