This paper examines the North American Free Trade Agreement (NAFTA), established in 1994 among the United States, Canada, and Mexico, and its economic implications for the region. It discusses the Chiapas revolt and currency crisis as early challenges to the agreement, then analyzes why fixed exchange rate regimes are attractive to emerging economies such as Mexico — including reduced transaction costs, investment stability, and the elimination of competitive depreciation. The paper also addresses the inherent vulnerabilities of fixed rate systems, including susceptibility to speculative attacks and loss of monetary independence, before concluding with an assessment of NAFTA's long-term consequences for trade, employment, and cross-border investment.
The North American Free Trade Agreement (NAFTA) was a trade agreement reached between the United States, Canada, and Mexico in 1994 to create a large free-trading area among these countries. The main aims were to increase their competitiveness in the global market, reduce the cost of doing business by eliminating trade barriers, increase investment, and provide a more stable market for the goods and services produced in the region.
The Chiapas revolt and the assassination of a presidential candidate dealt early blows to the regional trade agreement. The Chiapas people of Mexico feared that NAFTA would threaten their low-technology agricultural economy by allowing cheap grains to be imported from the United States and Canada. A subsequent consequence for the Mexican economy was the failure to establish a fixed exchange rate between the peso and the dollar at three pesos per dollar — a measure that could have protected the currency from devaluation during the crisis (Direct Selling Education Foundation, 1998).
Fixed exchange rates are attractive for emerging economies such as Mexico for several reasons. Pegging the exchange rate against a hard currency cushions the weaker economy from the risks associated with high exchange rate variability. For emerging markets, a fixed exchange rate attracts investment and encourages international trade by reducing transaction costs and exchange rate risk. It also benefits traders in that goods and services are not subjected to price variability caused by exchange rate volatility, which could otherwise affect their imports and exports in foreign markets.
Fixed exchange rates also reduce competitive depreciation or competitive appreciation. This occurs when member economies create a less competitive atmosphere within the region, whereby no country holds a competitive advantage over another or attempts to gain a trade advantage through currency manipulation.
Additionally, fixed exchange rates help reduce speculative bubbles. By pegging a set amount of the domestic currency to the dollar or another stable currency, exchange rate fluctuations that could adversely affect other economies are eliminated. The effects of devaluation of a hard currency would therefore not be transmitted to neighboring countries, since the rate is fixed — an environment more conducive to attracting investment.
"Speculative attacks, reserve depletion, and monetary constraints"
"Trade growth, jobs, investment, and immigration pressure"
You’re 46% through this paper. Sign up to read the remaining 2 sections.
Sign Up Now — Instant Access Already a member? Log inAlways verify citation format against your institution’s current style guide requirements.