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posted on 02 December 2017

NAFTA At 20 - Effects On The North American Market

from the Dallas Fed

-- this post authored by Justino De La Cruz

On June 5 - 6, 2014, the Federal Reserve Bank of Dallas held a conference, “NAFTA at 20: Effects on the North American Market," at its Houston Branch. The conference was sponsored by the Dallas Fed, the U.S. International Trade Commission, Canadian Department of Foreign Affairs, Trade and Development (DFATD), Mexico’s Instituto Nacional de Estad'stica y Geograf'a, and the Colegio de México.

The twoday conference aimed to review the impact of the agreement on the North American economy. Experts from academia, government, and multilateral institutions discussed a wide range of NAFTA-related topics, including growth, trade and welfare, foreign direct investment (FDI) and supply chains, wages and employment, external shocks and trade liberalization, rules of origin, the U.S.-Mexico border region, and the future of NAFTA. The conference began with a discussion on the challenges of predicting the effect of NAFTA using applied general equilibrium models.

Predicting the Effects of NAFTA: Can We Do Better Now?

In his keynote address, Timothy J. Kehoe noted that the applied general equilibrium models built to predict the impact of NAFTA failed to foresee the agreement’s impact on trade by industry. Kehoe commented, “If we look at the correlations of what we predicted with what happened, they average about zero." Addressing the question of how to improve these types of predictions, Kehoe indicated that those earlier models were based on the Armington elasticities of substitution. They, thus, did not take into account the extensive margin after an agreement entered into force - the huge increase in trade in new goods, or in goods that traded only in small amounts before the agreement.

Kehoe reported that he was able to significantly improve the trade predictions using a model that takes the margin into account. But “this model is atheoretical," he emphasized. To improve this model, Kehoe noted his intention to modify the Eaton-Kortum model to allow flexible comparative advantage and to apply the estimation methodology developed by Berry, Levinsohn, and Pakes (1995), which could generate very different cross-elasticities. He explained that this method of estimation allows the productivity of an exporter’s factors of production to vary across products due to deterministic differences in their suitability for a particular product. Examples would include the characteristics of an export firm’s land and climate, which affect the set of agricultural products in which it has a comparative advantage, or the education and skills of the workforce, which affect the set of manufactured products in which it has a comparative advantage. This will be addressed in Kehoe’s forthcoming work with Kari Heerman.


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