Bureau of Business Research College and Graduate School of Business, University of Texas at Austin December 1991 The Texas Economy: Making North American Free Trade Work What is the North American Free Trade Agreement? Like all free trade agreements, this proposed Canada/US./Mexico pact is an attempt to improve general living standards in the signa­tory countries by reducing barriers to the free flow of goods, services, and investment capital. (Unlike common market arrangements, such as the European Community, that anticipate eventual economic and political union, a free trade agreement does not address the free movement of labor.) Such agreements usually are not easily accomplished (their track records during this century have not been inspiring). Among other things, they directly affect people ·employed in industries protected from foreign competition, people in service sectors strongly linked with protected industry, and powerful domestic and international investment interests. The main items on the NAFTA negotiating table are: nontariff barriers, the level of tariffs on traded goods, intellectual property rights, and rules governing foreign direct investment. Non­tariff barriers include licensing agreements, im­port quotas, customs procedures, and domestic subsidies, but also frequently extend to health, safety, and environmental standards. Not surpris­ingly, nontariff barriers pose the trickiest problems in large part because of the difficulties of distinguishing protectionist measures from legitimate attempts to protect the public welfare. In contrast, with tariff barriers, intellectual property rights, and foreign investment rules, it is relatively easy to define relevant categories and to identify and measure the degree of domestic protection. It is difficult to predict the specific provisions of the negotiated agreement (expected to be sub­mitted to Congress in mid-1992). Most people agree, however, that the existing Canada/US. free trade agreement provides the effective start­ing point for negotiations. Effective January 1, 1989, the Canada/US. agreement is organized around the fo11owing broad topics: • Trade in Goods. This includes the core of tariff-reducing provisions in manufactured goods and the "rules of origin" that define the content levels necessary to qualify for protected free movement. Tariff-reducing provisions establish, among other things, the schedule for reducing tariff rates for specific commodities to zero. The Canada/US. FTA limits phase-ins to a maxi­mum of ten years, but rumors have it that phase-ins of up to twenty years are being con­templated for some NAFTA sectors. Strict rules of origin reserve special NAFTA treatment for commodities with a high degree of North American content so that third party countries cannot use one signatory country as a platform for penetrating the markets of another. (A Korean apparel manufacturer, for example, could not enjoy NAFTA treatment for clothing exported to the United States through Mexico if the final product contained little Mexican value added.) The Canada/US. FTA generally requires that traded goods contain 50 percent North Ameri­can content to qualify for tariff-free treatment. There is significant pressure from some sectors (most notably from automobile-related interests) to require North American content of up to 70 percent in the trilateral agreement. • Government Procurement. All levels of government face tremendous pressures to favor domestic goods and services in their procure­ment practices and can do so with fewer risks than the private sector. However, reducing preferential treatment in the public sector is im­ ltl I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I llDr portant symbolically and can produce significant effects in some sectors (e.g., paper and computer equipment). • Services. Unlike goods, services can be difficult to identify and evaluate. It is therefore often more difficult to negotiate terms for ser­vices. The Canada/US. FTA liberalizes rules and licensing requirements governing trade and investment in construction (not expected to be covered in the NAFTA), tourism, insurance, telecommunications, computer services, and a host of other professional/consulting services. Also included are provisions for streamlining the temporary entry of business persons. Transporta­tion services are not covered in the FTA. • Financial Services. The FTA greatly reduced the discrimination that U.S. banks, savings and loan associations, insurance firms, securities firms, and other financial institutions had faced in Canada. While these same financial institu­tions would welcome the opportunity to operate in Mexico on equal terms, Mexican negotiators would prefer to delay making significant conces­sions until their banking sector recovers from almost ten years of stagnation under nationaliza-· tion. Reinforcing the tendency to go slowly is the fact that Mexican banking makes up only a little more than 1 percent of North American banking in terms of total assets. Financial ser­vices pose special challenges and uncertainties because operations are narrowly circumscribed by government regulation and have been pro­foundly affected by advances in telecommunica­tions and information technology. Predicting the state of U.S. financial services at the tum of the century is difficult enough without even con­sidering the possible impact of NAFTA. • Foreign Investment. The Canada/US. FTA provides for "national treatment" for the estab­lishment, acquisition, sale, and operation of busi­nesses (excluding transportation) in the other country. Historically, the United States had been quite open to Canadian firms; in fact, Canada is the second largest foreign investor in the United States. These provisions had the effect of dra­matically opening Canada to U.S. investment and operations. U.S. negotiators have pressed for Mexican commitment to national treatment un­der NAFTA, but many Mexicans argue that this exceeds their concept of free trade. • Dispute Resolution. The FTA establishes a set of independent binational review panels to replace national courts in resolving disputes arising from the implementation of the agree­ment, particularly with respect to charges of an­tidumping and the imposition of countervailing duties. In the two years since the FTA was signed, these panels have wrestled with the difficulties of distinguishing barriers to trade from regulations designed to protect health, safety, and the environment. (One illustration is a recent case involving U.S. restrictions on the import of hogs from Canada due to differences in meat inspection requirements.) The observa­ tion that the Canadians have made more effec­tive use of the dispute resolution mechanisms has fueled U.S. efforts to overhaul dispute reso­lution procedures in a trilateral agreement. What is the expected impact of NAFTA? Most economists agree that the agreement will have a small but positive effect on overall GNP and employment and will place downward pres­sures on the prices of commodities most affect­ed. Sophisticated economic modeling efforts support this view. Others, most notably or­ganized labor, point to job dislocation, depressed wages, and the wholesale movement of production to Mexico where working condi­tions do not meet U.S. standards. Almost every­one, however, agrees that Texas will be the primary U.S. beneficiary of NAFTA. About one-third of U.S. exports to Mexico are produced in Texas, and almost half pass through the state. Whatever shape the final agreement takes, its impact across industries will vary, one reason being the phase-in provisions that can call for immediate implementation of negotiated terms in some industries and gradual implemen­tation in others. The way NAFTA fits into the global trading system and into the General Agreement on Tariffs and Trade (GATT)-the multilateral insti­ tution responsible for shaping global trade in the postwar period-is an indicator of what kinds of changes are in store. Leaders of the three signa­ tory countries argue that NAFTA is an effort not to supplant GATT, but rather to move for­ ward with progressive regional arrangements that have proved to be sticking points in the multilateral negotiations that are part of the evolving GATT. Although notably successful in the postwar period in reducing trade and invest­ ment barriers in traded manufactured goods, GATT frequently founders on the more chal­ ) ltl I I I I II I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I llDr till I I I I iI I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I IDr Employment and Unemployment Rate by Metropolitan Area Total nonagricultural employment (thousands) Total employment (thousands) Unemployment rate Area Sept. 1991 Sept. 1990 Percentage change Sept. 1991 Sept. 1990 Percentage change Sept. 1991 Abilene 48.6 48 .8 -0.4 47.4 48.0 -1.3 6.7 Amarillo 78.6 78.8 -0.3 90.9 92.l -1.3 4.8 Austin 383.6 382.4 0.3 424.0 421.6 0.6 4.7 Beaumont-Port Arthur 150.3 144.2 4.2 160.0 154.9 3.3 7.4 Brazoria 68.9 66.5 3.6 84.8 82.7 2.5 5.5 Brownsville-Harlingen 77.4 75 .0 3.2 93 .8 92.4 l.5 11.6 Bryan-College Station 53.5 54.2 -1.3 58.8 60.0 -2.0 3.6 Corpus Christi 138.2 136.l l.5 155.5 153.6 l.2 7.7 Dallas 1,376.6 1,379.3 -0.2 l,356.9 1,363 . l -0.5 6.0 El Paso 209.8 208.6 0.6 226.I 224.7 0.6 10.2 Fort Worth-Arlington 587.2 593 .0 -1.0 690.9 700.4 -1.4 6.4 Galveston-Texas City 77.3 77.0 0.4 103 .7 102.4 l.3 6.5 Houston 1,636.8 1,612.2 l.5 1,658.6 1,649.6 0.5 5.7 Killeen-Temple 74.8 74.1 0.9 90.3 90.3 0.0 6.7 Laredo 45.3 45.0 0.7 47.5 47.9 -0.8 8.1 Longview-Marshall 69 .1 69.4 -0.4 72.4 74.l -2.3 7.7 Lubbock 98.0 99 .1 -I.I 108.8 110.6 -1.6 5.4 McAllen-Edinburg-Mission 102. I IOI.I l.O 129.7 130.l -0.3 16.1 Midland 45.5 43 .9 3.6 45.6 45 .0 l.3 5.4 Odessa 45.0 43 .7 3.0 49.4 48.2 2.5 6.8 San Angelo 37.0 36.3 l.9 41.5 41.4 0.2 5.5 San Antonio 523.4 520.8 0.5 564.6 563 .3 0.2 6.2 Sherman-Denison 37 .9 38.3 -1.0 44.2 44.9 -1.6 6.2 Texarkana 45 .8 46.9 -2.3 52.0 53.2 -2.3 7.6 Tyler 63.4 62 .6 l.3 69.3 69.7 -0.6 6.4 Victoria 29.6 28.2 5.0 35.0 33 .9 3.2 4.9 Waco 82.6 82.7 -0.I 86.9 88.0 -1.2 6.2 Wichita Falls 49 .9 50.3 -0.8 51.3 51.6 -0.6 6.4 Total Texas 7,135.8 7,061.4 I.I 7,978.2 7,965 . l 0.2 6.4 Total United States 109,317.0 110,478.0 -I.I 117,335.0 117,961.0 -0.5 6.4 Note: Data are not seasonally adjusted. Figures for 1990 have undergone a major revision; previously published 1990 figures should no longer be used. Revised figures are available upon request. All 1991 figures are subject to revision. Sources: Texas Employment Commission and U.S. Department of Labor, Bureau of Labor Statistics. Nonagricultural Employment In Five Largest Texas Metropolitan Areas (January 1984=1.00) 1.35 1.30 1.25 1.20 1.15 1.10 1.05 1.00 ) 0.95 0. 90 +---+---+---+---+---+---+----+­1984 19851986 1987 1988 1989 1990 1991 Total Employment In Five Largest Texas Metropolitan Areas (January 1984=1.00) 1.30 1.25 1.20 1.15 1.10 1.05 1.00 0.95 0. 90 +--+---t-----11-----t---+--;-----i-­ 1984 1985 1986 1987 1988 1989 1990 1991 till1111 ! I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I IDr tlll IIIIl IIIIIIIIIIIIIIIIIIIIIIIIIIIIIIIIIIIIIIIIIIIIIIIIIIIIIIIIIIIIIIIIIIIIIIIlIDr lenging issues of agriculture and services. These three areas also pose the greatest chal­lenges to NAFTA negotiators. It is likely that a trilateral agreement will have only a marginal or gradual effect on agriculture and services. The Lower Rio Grande Valley probably has fewer reasons for concern about imminent loss of jobs and production in its citrus and leafy vegetable industries than public opinion would otherwise suggest. And, as already mentioned, the realities of and uncertainties in banking make financial institutions an unlikely candidate for radical change. Mexican petroleum resources represent a third area in which only marginal changes in trade regulations can be expected. Basic petrole­um is even enshrined in the constitution as part of Mexico's national patrimony, and its exploita­tion by foreigners is officially not negotiable. This does not preclude some liberalization in trade and investment. Mexico's critical and grow­ing need for investment capital in petroleum­related sectors signals that some concessions should be in the offing, and, in fact, certain forms of joint ventures in oil drilling are already open to foreigners. Another area in which NAF­TA negotiations can expect to face obstacles is textiles and apparel. With a complicated array of tariff rates ranging up to nearly 40 percent, these industries produce goods that enjoy greater tariff protection from foreign competition than any other manufactured products in the United States and in Mexico. Granted that NAFTA will have its greatest or most immediate effects on traded manufactured goods, what kinds of changes can be expected? Generally speaking, Mexico can attract produc­tion processes that use proven, well understood, standard technology; are relatively labor inten­sive; and require relatively low capital invest­ment. Distinct U.S. advantages include high value-added production, relatively capital­intensive operations, innovative technology, sophisticated information and delivery systems, unique local inputs, and innovative and ex­perimental goods. It is a mistake to assume that NAFTA will cause the wholesale movement of entire businesses to Mexico, although some of this will surely occur. Instead, the agreement is more likely to result in an increase in US.­Mexican joint ventures and other forms of in­traindustrial linkages in which the location of the production process will be determined by the comparative advantages of each nation. This prediction is supported by the fact that approxi­mately three-quarters of U.S. commodity trade with Mexico consists of intermediate rather than final consumer goods, with most of this trade occurring within industries. The changes that will come in the wake of the North American Free Trade Agreement, on the whole, will benefit all parties. Nevertheless, concerns about environmental impacts, better job training programs for displaced workers, and the need to adapt Texas transportation, services, and other infrastructure to the emerging realities are legitimate. The Texas Department of Com­merce, which enjoys a direct line to people in­volved in the negotiations, is in a position to communicate the concerns and insights of busi­ness. Now is the time to do so if we are going to maximize the benefits of free trade for Texas. -Chandler Stolp, Associate Professor LBJ School of Public Affairs and Institute of Latin American Studies University of Texas at Austin Comparison (continued) growth may vary less across regions in the fu­ture. Traditionally, durable goods production de­mands greater ancillary services, such that the higher the percentage of durables in total manufactures, the stronger the expected correla­tion between growth rates in manufacturing and nonmanufacturing product. The fact that the Sunbelt and Snowbelt have become more homogeneous in the composition of regional manufacturing product supports our finding of relatively small variation in the role of manufac­turing across regions. In Texas, the increase in durable goods output as an annual percentage share of total state manufacturing product from 1963 to 1986 suggests that this state is showing greater alignment with regional and national trends. -Mina Mohammadioun, Ph.D. Senior &onomist & David Cowen Former Research Associate Bureau of Business Research * Mina Mohammadioun and David Cowen, "A Regional Comparison of the Impact of Manufacturing on Econom­ic Growth: The Case of the United States," Working Paper 1991-2 , Bureau of Business Research, 1991. tlll11 1 i IIIIIIIIIIIIIIIIIIIIIIIIIIIIIIIIIIIIIIIIIIIIIIIIIIIIIIIIIIIIIIIIIIIIIIIIIJir tlll I I I I lI I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I IDr An Interregional Comparison of the Impact of Manufacturing on Nonmanufacturing Output A major question about long-term trends in the U.S. economy is whether manufacturing is important to future economic growth-in partic­ular, as a stimulus to growth in other sectors. Rapid industrialization throughout much of Southeast Asia and the Far East, the resurgence of Latin American economies, and a potential North American free trade agreement represent a few of the challenges awaiting American manufacturers who want to remain competitive in the global economy. In a recent study, we attempted to assess the impact of manufacturing on total nonmanufactur­ing output in Texas and fourteen other states with the highest gross state manufacturing product in 1986.* In trying to determine if growth in the manufacturing sector is correlated to growth in the other sectors of the economy, we focused on two regions of the United States: the Sunbelt and the Snowbelt. For the period 1963-1986, several observations can be made about the two regions. First, the growth rate of real manufacturing product for each region followed a similar pattern over the business cycle. However, the degree of cyclical instability of manufactures was much greater in the Snowbelt than in the Sunbelt, as shown in the figure. Similar observations can be made in comparing growth rates of nonmanufacturing product for the two regions. Second, the annual percentage share of real U.S. manufactures produced in the five Sunbelt states changed significantly, increasing from 18.2 percent in 1963 to 26 percent in 1986. An even more dramatic change took place in the ten Snowbelt states, with this measure falling from 57.7 percent in 1963 to 44.8 percent in 1986. Although we do not attempt to explain this change-mainly why U.S. manufacturers tended to move toward the South and Southwest (or abroad)-this phenomenon has been attributed to several factors, including business climate, decline in labor productivity, and oil price shocks. Finally, the level of economic performance was more impressive in the five Sunbelt states than in the ten Snowbelt states. Between 1963 and 1986, the annual exponential growth rate of real manufacturing product was 4.6 percent in the Sunbelt states and 2 percent in the Snowbelt states. During the same period, the annual ex­ponential growth rates of real nonmanufacturing product in the Sunbelt states and Snowbelt states were 3.7 percent and 2.3 percent, respectively. While these two regions provide an interesting contrast of growth and decline in the manufac­turing base, our empirical results show signifi­cant positive correlation between growth rates in the manufacturing and nonmanufacturing sectors for both regions. This relationship is slightly stronger in the Sunbelt region. The more modest relationship in the Snowbelt states may be the result of greater emphasis on regional economic diversification, whereby growth in nonmanufac­turing sectors is less sensitive to changes in the demand for manufactures. For the Sunbelt states, a less mature and more rapidly expanding manufacturing sector may necessitate greater auxillary support from nonmanufacturing sectors of the economy. To the extent that intraregional firms provide the support; this would explain the higher correlation between rates of growth of manufacturing and nonmanufacturing product in Texas and other Sunbelt states. However, regional trends in the composition of manufacturing output suggest that the impact of manufacturing growth on nonmanufacturing (continued on preceding page) Annual Growth Rates of Real Manufacturing and Nonmanufacturing Products, 1964 -1986 Texas & Sunbelt states % Texas nonmfg. Sunbelt mfg. 15 05 ~--='\>"........J 00+-it-t--+-+-i.r+;P'f--+--+-'l--+-t-+-+-+-':'-f''MF'l-t~· ·05 · 10 Texas mfg. · 15 Sunbelt nonmfg. Snowbelt states % 15 05 00+-it-t-~+-f~-i\-+-+-V--l-F-l-+-+-'~f+ro-±-f+-l-+-l · 05 -10 • 15 Source: Original data from the Bureau of Economic Analysis, U.S. Department of Commerce; computation by authors. tlll I I I I iI I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I IDr SERIALS ACQUlS-GEN LIBRARIES UNIV OF TX AJ AUSTIN BUREAU OF BUSINESS RESEARCH PCl. 1.114 P.O. Box 7459 55451 CAMPUS Austin, Texas 78713-7459 Address correction requested. F.ditor: Lois Glenn Shrout Assistant F.ditor: Sally Furgeson Texas Business Review is published six times a year (February, April, June, August, October, and December) by the Bureau of Business Research, Graduate School of Business, University of Texas at Austin. Texas Business Review is distributed free upon request. The Bureau of Business Research serves as a primary source for economic and demographic data on the state of Texas. An integral part of UT Austin's Graduate School of Business, the Bureau is located on the sixth floor of the College of Business Administration building. Announcements Texas Industrial Expansion, BBR's monthly newsletter covering manufacturing activity across the state, will have a new look in 1992. Starting Jftl11111 I I I I I I I I I I I I I I I I I I I I I I I I I I I lltr in January, pages in the newsletter will be 8 V2 by 11 inches rather than 8V2 by 14 inches. This and subsequent changes are being made in response to a recent survey of subscribers. Although it is a supplement to the Directory of Texas Manufacturers, the newsletter can be purchased separately for $40 a year. For details, call (512) 471-5179. The Center for International Business Educa­ tion and Research (CIBER), headed by Robert T. Green, has compiled a comprehensive direc­tory of international business resources. Entitled Global Texas, the reference is both a directory and a guide for those needing trade data and in­formation on organizations that provide financial assistance, marketing services, trade leads, and so forth. The directory is being published by the Bureau and should be available shortly after the first of the year. For more information, call (512) 471-5179.