IS U.S. AGRICULTURE A NAFTA WINNER OR LOSER? Testimony to the Special House Select Committee on NAFTA and GATT Brownsville, Texas September 21, 1994 Dr. Gary W. Williams GWWilliams@TAMU.EDU Professor of Agricultural Economics Director, Texas Agricultural Market Research Center Texas A&M University NAFTA proponents claim that the agreement will expand trade, boost economic growth, and lead to a net increase in employment in all three countries. Critics warn, however, that lowering trade barriers with a developing country like Mexico could encourage many U.S. industries to move to Mexico to take advantage of low cost labor and lax enforcement of environmental regulations. For agriculture, proponents argue that NAFTA will open the door to a huge new market in Mexico for U.S. agricultural and food products, especially feedgrains, beef, and processed foods. Critics claim that the agreement will primarily stimulate Mexican production and exports to the United States and a relocation of U.S. agricultural production and processing to Mexico. Which is it ... increased exports or lost production and processing? A close look at NAFTA clearly indicates that NAFTA will help boost exports and lead relatively few firms to simply pull up stakes and relocate to Mexico. Will NAFTA Boost U.S. Agricultural and Food Exports to Mexico? Mexico may be a potentially huge new market for U.S. agricultural and food products, but the NAFTA is not the primary reason, at least not in the short run for at least two reasons. First, over the last 5-10 years, Mexico has unilaterally opened its markets which have long been closed to international trade as part of an historic process of sweeping economic reform. At the same time, U.S. agricultural and food trade barriers are few. Consequently, relatively few explicit agricultural trade barriers remain to be eliminated. The effects of the unilateral opening of Mexican markets on U.S.-Mexico agricultural trade became quite evident much before NAFTA was implemented. By 1993, Mexico had emerged as the third largest market for U.S. agricultural exports, purchasing food and fiber valued at $3.6 billion, a 233% increase since 1986. And although imports of Mexican food and agricultural products have increased as well, the increase has been more modest, up just 30% since 1986 to $2.4 billion last year. More importantly, the unilateral opening of the Mexican market turned a $1.0 billion U.S. food and agricultural trade deficit in 1986 into a nearly $1.0 billion surplus last year. The second reason that the impact of NAFTA on U.S.-Mexico agricultural trade may be small in the short run is that the remaining trade barriers are being eliminated slowly over 5, 10, or 15 years. In addition, the agreement provides for special safeguards to protect against import surges for some of the most important commodities traded between the two countries. The important question, then, is what the effects of NAFTA on U.S.-Mexico food and agricultural trade might be over the long run. The critical factor that will determine the answer to that question is the future pace of economic development in Mexico. Increased market efficiencies as economic restructuring continues in Mexico and growing foreign capital investments in productive activities in the Mexican economy have generated some economic growth and boosted per capita incomes and purchasing power in Mexico. Continued economic growth in Mexico would likely have three general consequences for U.S. agricultural exports. First, continued growth in per capita incomes will intensify Mexican demand for the agricultural and food products that the U.S. is already exporting to Mexico. Second, economic growth in Mexico would be accompanied by an inevitable switch from low-value subsistence foods like corn and beans to higher value and more highly processed foods like meat and prepared foods. This would help boost the value as well as the volume of U.S. agricultural and food exports to Mexico and pay dividends to U.S. producers and processors alike. Third, income growth in Mexico would also likely restrict Mexican agricultural and food exports to the United States. As Mexican incomes grow, so will their demand not only for products imported from the U.S. but also for products they are currently exporting to the U.S., like fruits and vegetables. Consequently, given significant economic growth, Mexico would find it increasingly difficult to fill their own food needs much less export to the U.S. This is particularly the case given the limited land area and water resources available for agricultural production in Mexico and other restrictions. It is entirely possible, for example, that Mexican economic growth could be strong enough to turn Mexico into a net importer of even fruits and vegetables over time. NAFTA will serve a crucial role in fostering economic development in Mexico. NAFTA will send a signal to the global community that Mexico is a safe and profitable investment opportunity. NAFTA will intensify demand for many Mexican produced goods, create opportunities to attract private foreign capital, and invite expansion of U.S. business activities in Mexico, all of which will create employment opportunities and income in Mexico over time. Will NAFTA Lead to the Relocation of U.S. Agribusiness to Mexico? The more liberal trading arrangements between the U.S. and Mexico under NAFTA have lead to fears that U.S. agribusinesses will relocate to Mexico to lower costs with the intention of shipping their products back to the U.S. market. Our research, however, indicates that neither the patterns nor trends in agricultural production, processing, or trade among NAFTA countries are likely be altered significantly by the NAFTA. Any changes are more likely to result from economic growth related to economic reforms in Mexico and growing foreign capital investments. U.S. Department of Agriculture data show that U.S. processed food exports to Mexico have increased in recent years. The data also reveal that capital investments by U.S. food manufacturing and processing firms in Mexico are growing. These firms, however, appear to be investing in Mexico primarily to take advantage of the growing Mexican market and not to lower costs by relocating plants and operations to Mexico. With some exceptions, the data indicate that sales of U.S.-based food manufacturing and processing firms and their affiliates in Mexico are directed primarily to local rather than to U.S. markets. These firms and their affiliates are more concerned about Mexico as a potential market for their products rather than as a "platform" for export sales back to the United States. Increasing competition with multinational corporations has created some incentive for Mexican food processors to seek out joint venture opportunities with U.S.-based food processors, particularly since the majority of the competition is from Mexican affiliates of U.S. food processors rather than direct exports from the United States. Although NAFTA may be helping to attract foreign capital to Mexico, much of the increased foreign investment is related to recent changes in Mexican investment laws that ease restrictions on foreign ownership of Mexican businesses and land. Foreign direct investment in the Mexican agricultural production and food processing sectors, however, still only account for less than about 5% of overall foreign direct investment in Mexico. Will U.S Agriculture Be a Net Gainer or Loser from NAFTA? Research indicates that although U.S. agriculture as a whole will be a NAFTA winner, some parts of U.S. agriculture could lose. The most likely immediate gainers for U.S. agriculture include cattle and hog feeders, meat processors, grain and oilseed producers and processors, dairy producers and processors, producers of some fruits, and manufacturers of a wide variety of further processed and consumer-ready food products.. On the other hand, NAFTA is likely to strengthen the competitive threat of several Mexican agricultural industries, including labor-intensive melon, vegetable, and cow-calf production. Horticultural products: NAFTA will likely boost U.S. consumption of traditionally imported, high-dutied, Mexican horticultural products such as asparagus, tomatoes, lettuce, bell peppers, cucumbers, green chilies, squash, avocadoes, grapes, guavas, and mangoes. Imports of other Mexican horticultural products, such as broccoli, cauliflower, melons, eggplant, onions, and okra, might also increase although the U.S. may be at less of a competitive disadvantage and may even have the advantage in some areas during certain times of the year. NAFTA will certainly boost U.S. exports of primarily temperate-climate products to Mexico such as potatoes, apples, pears, peaches, and processed foods such as dried leguminous vegetables and corn. As argued earlier, however, Mexican economic and per capita income growth over time could outpace the ability of the Mexican fruit and vegetable industry to supply the growing fruit and vegetable markets in both countries - particularly if critically needed Mexican public and private investments in infrastructure, processing capacity and technology, distribution and transportation facilities, and irrigation capacity are not made. Citrus and citrus products: Because pre-NAFTA U.S. import tariffs on these products were relatively low, NAFTA will have only a small additional impact on U.S. imports of Mexican citrus. Non-tariff issues such as phytosanitary regulations to control the spread of insects, particularly the Mexican fruit fly, and pathogens harmful to citrus, and differences in other grades and standards and food safety regulations will continue to be the major policy issues facing fresh citrus imports from Mexico. Increased capital investments in Mexican citrus processing facilities as a result of a NAFTA could boost U.S. orange juice imports from Mexico. Grains: Mexico eliminated most of its tariff and non-tariff barriers on grain imports prior to the implementation of NAFTA except import restrictions on corn. NAFTA-induced economic growth, however, would have a sizeable impact on U.S. exports of food grains like wheat to Mexico. Also, increased Mexican demand for meat could stimulate Mexican livestock feeding and import demand for U.S. sorghum and other feedgrains. Livestock and meat: Much before NAFTA was ever implemented, Mexico had removed virtually all barriers to beef and live cattle imports, stimulating growth in Mexican imports of U.S. beef. Imports grew fast enough that Mexico slapped tariffs on fresh and frozen beef in about November of 1992 which were eliminated by the NAFTA in January 1994. Mexican imports of U.S. beef have recovered somewhat since NAFTA was eliminated but remain below peak levels of 1991 and 1992. Economic growth in Mexico should further stimulate the demand for beef and other meats in Mexico and provide incentives for both additional U.S. meat exports to Mexico and the growth of meat production in Mexico. Consequently, the most likely scenario for cattle and beef is that Mexico will continue to specialize in feeder cattle production and exports while the U.S. will continue to export meat, breeding stock, and genetic material to Mexico. Fat cattle trade in either direction will not likely amount to much. Dairy products: Mexico had also substantially reduced dairy product import barriers before NAFTA was implemented. Thus, the main NAFTA impact on U.S. dairy exports will be through the food demand expansion effects of Mexican economic growth stimulated by the agreement. Even given an increase in Mexican milk output at an annual rate of 5% (the approximate average annual growth rate over the last 30 years), annual Mexican consumption would far outstrip production if Mexican economic growth pushed per capita milk consumption levels up to U.S. levels by the year 2000. Substantial herd rebuilding has occurred in Mexico since 1987, however, making long-term trade prospects less certain. Nevertheless, a shift in Mexican dairy product demand away from low- quality basic products such as non-fat dry milk and filled cheeses to specialty products like ice cream and fine cheeses is expected as incomes in Mexico grow. Cotton: NAFTA provides Mexico with a relatively greater increase in access to the U.S. cotton market than for the U.S. in Mexico. Growth in Mexican incomes and increased cotton demand in Mexico for the production of textiles and apparel for domestic and export sales, however, will likely mean that cotton will continue to flow from the U.S. to Mexico despite the NAFTA cotton provisions. Sugar: NAFTA will have limited impacts on the U.S. sugar industry. Under the agreement, if either country achieves net surplus production status then that country can export up to 250,000 mt of sugar to the other. Whether Mexico could meet the conditions to export sugar to the U.S. has been the subject of some debate. If the Mexican soft drink industry converted to the use of high fructose corn syrup (HFCS), Mexico would have an estimated 500,000 mt surplus of raw sugar, half of which could be exported to the U.S. under NAFTA. This assumes, however, that HFCS can compete with raw sugar in Mexico and that an economic incentive exists for Mexico to ship sugar to the U.S. Mexico has exported raw sugar to the U.S. in only one of the last three years and does not currently appear to have a clear advantage in sugar production and export. Is There Anything that Might Change the Outcome of NAFTA for U.S. Agriculture? Whether or not U.S. ultimately is a net gainer from NAFTA will depend crucially on a number of factors, including: (1) Mexican economic growth, (2) foreign investment in Mexico, (3) changes in Mexican farm size and structure, (4) adjustments in Mexican labor markets and, and (5) the availability of new production inputs in Mexico. Unexpected changes in any of these factors could drastically affect the outcome of NAFTA for U.S. agriculture. Economic Growth in Mexico: Future growth in U.S.-Mexico agricultural trade will depend crucially on the pace of economic development in Mexico. A NAFTA that helps generate a sufficient rate of economic growth in Mexico to sustain long-term growth in Mexican employment and per capita income and, consequently, demand for agricultural commodities could provide the basis for adjustments and investments in U.S. agriculture to service the Mexican market. Such growth would likely also stimulate domestic and foreign investment in Mexican agricultural production and processing. There is no guarantee that such growth will occur, however. Absent significant growth in Mexican income and food demand, Mexican agricultural and food markets would continue to be serviced mainly by local suppliers with little or no significant increase in capital investments or technology improvements despite NAFTA. Foreign Investment: Foreign, private capital to lift Mexican capacity, technology, and infrastructure constraints is needed for Mexico to achieve its agricultural export potential. Also, such investments are key to U.S. export potential to Mexico. Foreign capital is an important source of expected growth in employment, income, and, in turn, the demand for food in Mexico. Mexican farm size and structure: Although popular in Mexico, especially among the rural poor, the land tenure laws that created the ejido system in the 1930s have been blamed for the poor performance of the Mexican agricultural sector and are considered one of the biggest constraints on productivity growth in Mexican agriculture. The Salinas Administration recently pushed historic land reform legislation through the Mexican Congress. If effectively implemented, the legislation could promote increased production efficiency, growth in farm size, a decline in the total number of farmers in Mexico, and increased competitiveness of the Mexican farm sector. Mexican labor markets and costs: The relatively low cost of Mexican labor provides Mexico with a relative advantage in labor-intensive industries like agriculture. In fact, a short term effect of NAFTA may be downward pressure on Mexican wage rates as increased agricultural imports from the United States displace Mexican agricultural labor in import-competing sectors. The consequence could be increased competitive advantage of Mexican labor-intensive sectors like fruits and vegetables in Mexico and greater pressure for migration of undocumented labor to the United States. Over the longer run, if the NAFTA fosters sufficient economic growth in Mexico to absorb the displaced labor, wage rates could recover and eliminate the short-run Mexican gains from low-cost labor. Again, however, the role of the NAFTA in generating economic growth in Mexico is critical. New Production Inputs: NAFTA will enhance the availability in Mexico of critical agricultural inputs, such as new and used farm equipment, spare parts, improved seeds and breeding stock, feeds and additives for animal nutrition, raw materials, and technical consulting to help lower production costs and improve land and labor productivity. The Mexican Government has drastically reduced government subsidies for irrigation, fertilizer, fuel and lubricants, credit, and technical assistance. Also, the deregulation of the Mexican banking industry has created a farm credit crisis. Credit to finance agricultural operations in Mexico is expensive and scarce and is a major constraint to expansion of productive activities in agriculture. The net effect may be relatively less availability of critical inputs to small farmers than to larger, commercial farms in Mexico. Conclusions Unilateral Mexican trade liberalization and other Mexican economic reforms over the last few years means that comparatively little of U.S.-Mexico trade in agricultural and food products remained to be liberalized when NAFTA was implemented in January of this year. Consequently, in the short run at least, little additional growth in trade of most agricultural and food products between the two countries will occur as the direct result of the trade agreement. Continued growth in U.S.-Mexico agricultural and food trade will depend primarily on the pace of overall economic and per capita income growth in Mexico as the result of continued economic reform and capital investments in productive activities in Mexico. Even if NAFTA achieved completely free trade between the U.S. and Mexico, there would be little or no additional U.S. agricultural exports to Mexico without growth in Mexican incomes and purchasing power. Eliminating barriers to trade with a developing country like Mexico simply opens the door to trade. Economic development is the engine which could create a growing market in Mexico for U.S. agricultural and food exports. The primary accomplishment of NAFTA could simply be to allow the U.S. agricultural and food sector to get its foot in the door to a potentially important market in a developing country. As development occurs in Mexico over time, the U.S. agricultural sector will have the advantage over its global export competitors in access to a growing Mexican market.