The effect of Free Trade Agreements on poverty: the case of Mexico

Hanako Taniguchi 272 Camden Road, Top Floor Flat, London NW1 9AB

Dissertation submitted in part-fulfilment of the Masters Course in Economics, UCL, September 2007.

I, Hanako Taniguchi, hereby declare that this dissertation is my own original work and that all source material used has been clearly identified and acknowledged. No part of this dissertation contains material previously submitted to the examiners of this or any other University, or any material previously submitted for any other examination.

Abstract The objective of this dissertation is to measure the impact of Free Trade Agreements signed by Mexico on its poverty levels, analyzed in a state level. We focused our investigation on the North American Free Trade Agreement (NAFTA) and the Free Trade Agreement between Mexico and the European Union (FTEUMEX) given the economic and commercial importance of these treaties. In order to measure the effect of these agreements, we based our analysis on the World Banks poverty line of one dollar per day, and applied it to the income levels of Mexican households in the 32 different states. Using the information of the National Surveys of Income and Expenditure of the Households for the years of 1984, 1989, 1992, 1994, 1996, 1998, 2000, 2002, 2004 and 2005, we calculated the quantity of people in each state that had a monthly income of less than one dollar per day or 30.42 dollars per month, and generated a panel of 32 states, that included the proportion of the population living under the poverty line, for the years of the surveys. We applied a pooled OLS model with dummy variables indicating the before and after NAFTA and before and after FTEUMEX to measure the impact of these trade agreements on state poverty levels. According to the results obtained, both NAFTA and FTEUMEX contributed to the diminishment of the proportion of the Mexican population living in poverty. In the short run, NAFTA contributed to the decrease of 3% in the poverty levels and in the long run, combined with the effects of the FTEUMEX, these agreements helped to reduce the poverty in the states by almost 18%.

I.

Introduction

Since it began its trade liberalization process in 1985, Mexico has signed 12 Free Trade Agreements with 43 different countries, and is considered to have the most opened economy in the world. Due to the economic impact and the importance of the United States in the world economy, the North American Free Trade Agreement (NAFTA) is considered the most important Free Trade Agreement signed by Mexico. On the other hand, for the first time in the modern history, the Mexican government decided to design a new methodology to measure the poverty levels in the country. When this methodology was applied to the National Surveys of Income and Expenditure of the Households of Mexico, the results showed that the poverty levels started to increase in 1994 and from 1998 to 2005, began to achieve lower levels (Corts, Hernndez, Hernndez, Szkely & Vera, 2002). The relationship between trade liberalization and poverty levels has been widely analyzed by different authors (e.g. Winters 2000), and although liberalization programs are not usually aimed at social concerns (Sheahan, 1997), most of them agree on the fact that openness and trade liberalization are key components to achieve economic growth, and as a consequence, to diminish the poverty. There are many different ways in which one can try to measure the impact of trade liberalization on the poorest population of a country. One way is to study the impact of trade to growth. This analysis is due to the fact that in Development Economics, the economic growth is considered one of the main instruments to diminish the poverty levels. Several authors (e.g. Frankel & Romer, 1999) have tried to prove the positive relationship between trade and growth, using different theoretical and empirical evidence. Most of the results of different cross country and panel growth analysis, as well as case specific studies, support the view that trade openness contributes to economic growth (Berg & Krueger, 2003). An empirical investigation of the impact of international trade on standards of living performed by Frankel and Romer (1999) showed that a rise in one percentage point in the ratio of trade to GDP increases income per capita at least by 1.5%. Furthermore, a cross section analysis of countries using data of 1990s made by Wacziarg and Horn Welch (2003) also showed that liberalization has positive effects on growth, openness and investment rates within countries. On the other hand, using a dynamic panel framework, Greenaway, Morgan and Wright (2001) presented evidence indicating that liberalization impact upon growth in the long run. In case specific

studies, Agosin (1997) concluded that in the Chilean case, exports and foreign investment, explained the sustained growth levels in the mid 1980s. Conversely, even when most of the authors have concluded that trade promotes growth, we can also find some articles that criticize the validity of these results. For example, Rodriguez and Rodrik (2001) argued that methodological problems with the empirical strategies employed in some papers leave the results open to diverse interpretations. Basing their analysis on papers by Dollar (1992), Ben David (1993), Sachs and Warner (1995) and Edwards (1998), they explained that the indicators of openness used by these authors are not the best measures of trade barriers and in other cases, the methods used to establish the link between trade policy and growth have serious shortcomings. On the other hand, Yanikkaya (2002) found that opposite to the conventional points of view, trade barriers are positively and significantly associated with growth, especially in the case of developing countries. A positive relationship between trade and growth can benefit the poor population, only if we have evidence showing us that growth helps diminishing poverty levels. Many papers have been written in this sense, as well. For instance, according to the results obtained by Dollar and Kraay (2002), after analysing a sample of 92 countries, they found out that growth benefits all the population of a country in the same way, hence, the purpose of any poverty alleviation policy should be based on the promotion of economic growth. Furthermore, after studying a data set of growth, poverty levels and inequality for 50 low and lowermiddle income countries, Adams (2002) found that when economic growth is measured by mean income of the population, there is a strong link between growth and poverty reduction. When economic growth was measured by GDP per capita, the same results were obtained, although the relationship was not so strong. On the other hand, based on the World Bank data set on income distribution, Edwards (1997) showed that there is no evidence that trade liberalization increases inequality. In this same sense, Cashin et al (2001) studied a data set of cross section of countries in the period 1975 to 1998, and tried to determine the impact of trade reforms using the human development index. They did not find any evidence that could establish a relationship between the ratio of foreign trade to GDP and poverty levels. Harrison et al (2003) developed a computable general equilibrium model to show that certain combination of policies can help the poor population to suffer less negative impacts as a consequence of free trade. Based on the experiences in Turkey, they

proposed the implementation of direct compensation mechanisms to avoid the poor households to be the losers of the trade liberalization process. One can also find many case specific studies relating trade liberalization and poverty, focusing its analysis in specific countries. For example, Moser and Ichida (2001) studied the relationship between economic growth and poverty reduction in 46 countries of Sub Saharan Africa. On the other hand, Ocran, Osei and Adjasi (2006), analyzed the household surveys of Ghana to see if the economic and trade reforms carried out in that country helped the poorest households to improve their conditions. Similarly, Niimi et al (2003), tried to establish a link between free trade and extreme poverty using the Vietnam Living Standards Survey and analyze the impact of trade reforms that were carried out in the 90s. Bigsten, Kebede, Shimeles and Taddesse (2003) studied the impact of growth over poverty levels using the evidence from Household Panel Surveys in Ethiopia. Finally, Surjit and Bhalla (2000) studied the case of India; Balisacan, Pernia and Asra (2003) analyzed the case of Indonesia and Janvry and Sadoulet (1999) the case of 12 Latin American countries. In all the cases mentioned, the authors found a positive relationship between growth and poverty alleviation. Alternatively, one paper that focuses specifically in the impact of free trade over poverty levels is Winters (2000). Through a theoretical approach, the author tries to give a general idea of the pathways the trade liberalization can have an impact on poverty. According to Winters, there are three ways through which trade liberalization can have a direct effect on poverty: price transmission; enterprises; and taxes and spendings of the government. In his paper, the author explains that when a country opens its markets to free trade, one of the most immediate consequences is the change in the prices of the liberalized goods. If the products consumed by poor households are affected by an increase in prices, there can be a direct impact over poverty levels. A decrease in prices also can have a negative impact over the poor households if they are producers of the goods. The enterprises can also be affected by trade liberalization process through the impact to its profits. This can have consequences over the economic situation of the households if the enterprises are obliged to increase or decrease the wage levels, or the quantity of employers hired by them. Winters (2000) explains that if wages are flexible and labor is fully employed, then price changes caused by trade liberalization will be

reflected in wage changes, with employment staying the same. But alternatively, if there is a large pool of workers who move in or out of jobs when circumstances change, then trade liberalization will cause changes in employment. Finally, free trade can affect poverty because there can be changes in the income that the government has through taxes, and as a consequence, there could be less public expenditure directed towards the diminishment of poverty (Winters, 2000). In the specific case of Mexico, Nicita (2004) performed an ex post analysis of the effects of the trade liberalization process in Mexico and studied its impact in the period from 1989 to 2000, using a farm house model and taking into account the regional differences of the economy. According to the author, the process reduced the cost of consumption of the households but also the agricultural incomes, which resulted in a bigger income gap between urban and rural areas in Mexico. This same effect was regarded between the states in the north and the south, as well as among skilled and unskilled workers, since trade liberalization process benefited the skilled workers and the northern states in a greater degree. However, the author concludes that it reduced the poverty by around 3%, which let almost 3 million people to stop living under the poverty line. This dissertation follows a similar approach by analyzing the impact of Free Trade Agreements signed by Mexico on the state poverty levels, using a panel of 32 states observed from 1984 to 2005. The results obtained were very similar to the conclusions Nicita (2004) reached, since according to our investigation, the North American Free Trade Agreement diminished the poverty levels by 3% and the Free Trade Agreement between Mexico and the European Union decreased it by almost 18%. After controlling for some economic activities that are normally considered as source of vulnerability towards poverty, such as agriculture, services, trade and manufactures, the results remained in the same sense. We also included interaction variables relating specific Free Trade Agreements with the economic activities, to see if a state specialized in any of them could have been affected in a higher level by the commercial treaties. According to this analysis, a state highly specialized in manufactures had less people living under the poverty line due to the effects of NAFTA, but the opposite effect was registered in the case of FTEUMEX.

In the Section II of this dissertation we will review the historical process that lead Mexico to the trade liberalization process and will give detail of the main characteristics of the most important Free Trade Agreements. We will also describe the new methodology designed by the Mexican government to measure the poverty levels. In Section III, we will present the hypotheses of the dissertation. In Section IV, we will describe the data used to measure the impact of the Free Trade Agreements on the poverty levels, as well as the econometric methodology used. In Section V we will discuss the results obtained, together with the interpretation of them. Finally in Section VII, we will present the conclusions. II. Background

Trade liberalization in Mexico The process of trade liberalization in Mexico began in 1985, when the country started to eliminate the import licences that were imposed to more than 90% of the products that entered from outside the country. This process was considered a fundamental part of an economic reform that followed a financial crisis in 1982, and by 1990 only 19% of the products still required this kind of permits. Beside these internal policies, Mexico also started to work actively to become a member of the General Agreement on Tariffs and Trade (GATT) and achieved its membership in 1986. As part of this process, Mexico started the negotiations for the North American Free Trade Agreement (NAFTA) with United States and Canada in 1991 and after two years of negotiations the treaty came into effect on January 1994. Before NAFTA, a Free Trade Agreement with Chile was signed and came into effect in 1992, but because of its economic impact, NAFTA is considered the main starting point of the trade liberalization process that was followed by the signature of another 10 Free Trade Agreements with 40 different countries. With these Free Trade Agreements, Mexico has a potential access to different regional markets of the world that can be translated as gaining an access to almost 1.1 billion potential consumers (Ministry for the Economy of Mexico). The importance of NAFTA comes from the fact that, even before the beginning of the negotiations, around 85% of the exports and imports were directed towards US and Canada, and after 1994, the proportion increased to 90%. According to the Ministry

for the Economy of Mexico (Ministry for the Economy of Mexico), in 2004, the exports of Mexico to its partners in North America increased almost three times compared to 1994, and nowadays more than 70% of the total Direct Foreign Investment received by Mexico comes from American and Canadian enterprises. According to the same official source, in 2005, the trade between Mexico and the US amounted 288 billion dollars, while the trade between Mexico and Canada reached 18 billion dollars. Due to the difference in the size of the American and Canadian economies compared to the Mexican when NAFTA came into effect, the parties agreed to give Mexico a longer tariff elimination process and in some sectors considered sensitive, such as the agricultural sector, they gave Mexico 15 years to conclude the tariff liberalization process. According to the tariff elimination calendar, by 2009 all the products are going to be fully liberalized in the trilateral trade (Ministry for the Economy of Mexico). After NAFTA, Mexico signed another 11 Free Trade Agreements with different countries. (See Table 1) Table 1
Year the Free Trade Agreement came into effect. 1995 Name of the Free Trade Agreement Free Trade Agreement with Venezuela and Colombia. Free Trade Agreement with Costa Rica. Free Trade Agreement with Bolivia. Free Trade Agreement with Nicaragua. Free Trade Agreement with the European Union. Free Trade Agreement with Israel. Free Trade Agreement with the European Free Trade Association. Free Trade Agreement with El Salvador, 2004 2005 Guatemala and Honduras. Free Trade Agreement with Uruguay. Economic Partnership Agreement with Japan.

1998 2000

2001

Of these later ten commercial agreements, the Free Trade Agreement with the members of European Union and the Economic Partnership with Japan are considered as the most important ones after the NAFTA, due to the size of the markets that Mexico

has access to, and because of the potential increase in trade volumes and economic benefits. The negotiations for the Free Trade Agreement between the European Union and Mexico (FTEUMEX) started in 1998, and came into effect in 2000. Through this treaty, Mexico opened its economy to the 15 original members of the EU, and four years later, to the 10 new European countries that entered to the EU. The tariff liberalization process agreed for the FTEUMEX was similar to the one achieved in NAFTA and allowed Mexico to have a slower tariff elimination process, especially in the sensitive areas. For example, for the agricultural sector, Mexico will eliminate all the tariffs applied to European products until 2010 (Ministry for the Economy of Mexico). For Mexico, the EU is the second most important commercial partner and source of Foreign Direct Investment. According to the Ministry for the Economy of Mexico, in 2003, the trade between the members of the EU and Mexico amounted 24.4 billion dollars, 7% of the total trade of Mexico with the rest of the world. Data of the Central Bank of Mexico (Banco de Mexico) indicates that in the fourth year of the FTEUMEX (2004), the trade between Mexico and the EU increased by 38.4% compared to 1999, a year before the treaty came into effect. In this same period, the exports from Mexico towards the EU countries have risen by almost 13% and the imports from the EU increased by almost 45%. Among the European countries, Germany is the most important commercial partner for Mexico (almost 34% of the total trade with the EU), followed by Spain (16% of the trade), Italy (11%), France (9.4%) and the United Kingdom (7.2%). Mexico exports to the members of the EU mainly products related to the automobile industry, oil, parts and accessories for computers, sugar, coffee and medicines. The negotiations for the Economic Partnership Agreement between Mexico and Japan started in 2002 and the treaty came into effect in 2005. Also in this case, the tariff elimination process established was faster for Japan and gradual for Mexico, and at the moment the agreement started to operate, Japan eliminated 91% of the tariffs it had over the products considered in the treaty, while Mexico liberalized only 44% of them (Ministry for the Economy of Mexico). Japan is the fourth most important commercial partner of Mexico and the exports from Mexico to Japan in 2004 amounted almost 2.2 billion dollars and increased 17% in 2005, reaching a total of 2.543 billion dollars. Since this is the most

recent commercial agreement for Mexico, the quantity of data available to make an evaluation of its impact is still small. However, according to the Japan External Trade Organization (JETRO), in the first year of operation of the FTA, the total trade between Mexico and Japan increased by 22.7%. In the same sense, the Ministry for the Economy of Mexico announced that the bilateral trade increased by 21.5%. Due to the economic importance of NAFTA and FTEUMEX, and considering that there are still not enough data to study the impact of the Economic Partnership Agreement between Mexico and Japan on poverty levels, in this dissertation we will only consider NAFTA and FTEUMEX in our analysis. Poverty measurement in Mexico In 2001, the Ministry for the Social Development of Mexico created the Technical Committee for the Measurement of the Poverty. The task of this committee was the design of a new methodology that allowed the measurement of the poverty levels in Mexico. The poverty levels in Mexico were measured based on a basket of products designed by the National Institute of Geography, Statistics and Informatics of Mexico and the Economic Commission for Latin America and the Caribbean (ECLAC) in 1992 that contained a group of products considered to be the necessary to survive under the most basic conditions. Based on this basket, the Committee established three poverty lines. The first level included the people, whom in August of 2000, gained less than the per capita monthly income necessary to acquire the products of the basket given by the National Institute of Geography, Statistics and Informatics of Mexico and ECLAC. In monetary terms, it included any person living in Mexico who had a daily income between 15.4 and 20.9 pesos, living in a rural or urban area, respectively. Under the second level of poverty, people unable to satisfy completely all their alimentary needs, as well as lacking enough income to spend the minimum necessary for clothing, education, and health services were included. In terms of the prices of August 2000, this meant that all the people having a daily income between 18.9 and 24.7 pesos, living in rural or urban areas of the country, respectively, were considered to be included in this level. Finally in the third level, people that could not afford to satisfy completely their alimentary needs, together with their needs in health, education, clothing, housing and public transport, were taken into account. Here, anyone who had a daily income

between 28.1 and 41.8 pesos and living in rural or urban areas, respectively, were considered. According to this classification and using the National Survey of Income and Expenditure of the Households of Mexico published every two years, it was concluded that, in 2000, 18.6% of the households in Mexico had the first level of poverty, 25.3% of the households were in the second level of poverty and the 45.9% of the households had the third level of poverty. This meant that, 24.2% of the population in Mexico had the first level of poverty, 31.9% were in the second level and 53.7% in the third level. Applying the same methodology to the National Survey of Income and Expenditure of the Households of Mexico of 1992, 1994, 1996 and 1998, Corts et al (2002), estimated the poverty levels, reaching the following results.
People living under poverty line according to the methodology of the Technical Committee for the Measurement of the Poverty (Table 2) Poverty Line (Households ) I II III (Population) I II III 22.5 28.0 52.6 21.1 29.4 55.6 37.1 45.3 69.6 33.9 40.7 63.9 24.2 31.9 53.7 17.4 21.8 44.1 16.1 22.7 46.8 28.8 36.5 60.8 26.8 32.9 55.6 18.6 25.3 45.9 1992 1994 1996 1998 2000

As we can see in this table, the proportion of the population living under any of these three poverty lines increased significantly from 1994 to 1996 and in 1998 started to fall. This same methodology was later applied by the National Council for the Evaluation of the Social Development Policies in Mexico to the National Survey of Income and Expenditure of the Households of Mexico of 2002, 2004 and 2005 to measure the evolution of the quantity of people living under these three poverty lines, and the proportion of people in poverty continued diminishing. According to the results obtained by National Council for the Evaluation of the Social Development Policies in Mexico, in 2002 the proportion of the population living under extreme poverty conditions diminished to 20.30%, in 2004 fell to 17.30% and in 2005 to 13.80%.

In this dissertation, we will analyze if the evolution of the quantity of people living under the different poverty lines were influenced by the different Free Trade Agreements signed by Mexico. III. Hypothesis to be tested The main hypothesis for this dissertation is that the great quantity of Free Trade Agreements that Mexico started to sign in the 90s affected the quantity of people living under the poverty line of one dollar per day. As most of the theories in Development Economics have stated, there could have been a negative impact in the short run, but in the long run, it could have helped to reduce the proportion of the population living in extreme poverty. In order to have a deeper analysis of the effects of the Free Trade Agreements over the poverty levels of Mexico, we would like to have a second hypothesis saying that, in the short run, the Free Trade Agreements had a greater impact in the poorest states of Mexico, especially in the southern part of the country. Given the economic importance of the North American Free Trade Agreement and the Free Trade Agreement between Mexico and the European Union, we would like to take into account these two agreements in order to analyze the impact of Free Trade Agreements on poverty levels in Mexico. In the particular case of NAFTA, we would also like to analyze if the trilateral agreement helped to diminish the poverty levels in the northern states, thanks to the enterprises that were established in the area and created new job opportunities for the inhabitants.

IV. The data

Empirical analysis

The National Surveys of Income and Expenditure of the Households of Mexico (Encuesta Nacional de Ingresos y Gastos de los Hogares) for 1984, 1989, 1992, 1994,

1996, 1998, 2000, 2002, 2004 and 2005 were used to define the national and state poverty lines. The sample size of the National Household Surveys for each year was: 11,396 for 1984; 27,790 for 1989; 36,698 for 1992; 34,374 for 1994; 38,671 for 1996; 36,712 for 1998; 34,229 for 2000; 56,980 for 2002; 75,338 for 2004; 80,070 for 2005.

Even though the size of the people surveyed in each sample increased over the years, they can be used as valid samples to analyze the evolution of the income of the Mexican families from 1984 to 2005, since all of them were randomly selected and the characteristics of the questionnaires used have remained the same along the 10 surveys. To measure if certain economic activities could have made the states or regions more vulnerable to the effects of the Free Trade Agreements and, as a consequence, impact the poverty levels, we used the data of state GDP from 1992 to 2005. From this data set, we selected only the main economic activities. In the regressions, we included the proportion these activities had in the state GDP, for the years available1. These economic activities were: agriculture, trade, services and manufacture. This data allowed us to measure if the initial condition of each state in these activities increased the effect of Free Trade Agreements on poverty and for the data after 1994, to see how these activities contributed to the long term effects of Free Trade Agreements on the state poverty levels. Both the National Surveys of Income and Expenditure of the Households and the state GDP were obtained from the National Institute of Geography, Statistics and
1

The sum of the four activities doesnt add 100%, since we only selected the proportion that these activities had in the state GDP, without considering other activities that also are part of the total state GDP.

Informatics of Mexico (Instituto Nacional de Estadstica, Geografa e Informtica, INEGI). Data description and poverty lines The methodology designed by the Technical Committee for the Measurement of the Poverty created the three poverty lines based on the prices of the goods included in the basket of products of INEGI ECLAC. This methodology divided the Mexican population in rural and urban. In order to analyze the impact of the Free Trade Agreements in the state poverty levels, we designed an alternative measure based on the World Bank international poverty line of people living under one dollar per day. We decided to take the poverty line of the World Bank because the data available to calculate the poverty based on the methodology of the Technical Committee for the Measurement of the Poverty divided the prices of the goods in different years using the average of the all the rural and urban areas in Mexico but not in state levels. Since the interest of this dissertation is also to analyze if living in a poorer state made people more vulnerable to the impacts of the Free Trade Agreements, we decided to establish a one dollar per day poverty line. The tendency of the evolution of the quantity of people living under the poverty line generated by the Technical Committee for the Measurement of the Poverty and the one generate by the author of this dissertation are very similar, as we can see in Graph 1.

Graph 1

Percentage of people living under poverty line in Mexico

0.5 Proportion 0.4 0.3 0.2 0.1 0
9 94 8 02 19 8 19 9 20 0 19 20 5

Poverty line based on World Bank 1 dollar per day Poverty line based on Technical Comitee for the Estimation of Poverty

Year

Even though we could not find an instrument that could help us differentiate the impact of the Free Trade Agreements to the effects of a financial crisis, we decided to analyze the effect of the Free Trade Agreements by generating time dummies that were used to measure the poverty levels before and after the NAFTA came to effect in 1994 and before and after FTEUMEX came to effect in 2000. Since our aim is to analyze the effect that the Free Trade Agreements had in the poverty levels in the 32 states of Mexico, we divided the data of the National Surveys of Income and Expenditure of the Households according to the state the people were living at the moment they took part of the survey and generated a panel that included the people living under the one dollar per day poverty line in each state from 1984 to 2005. In order to establish a poverty line that could be valid through different years, we used the exchange rate of peso dollar and applied it to the each year of the survey and calculated the monthly income to compare it to the monthly income of the persons that were part of the different surveys. According to these estimations, the poverty lines for each year were: 58400 pesos per month in 1984 75880 pesos per month in 1989 94140 pesos per month in 1992 231.18 pesos per month in 1996 278.40 pesos per month in 1998 287.77 pesos per month in 2000

294.14 pesos per month in 2002 343.38 pesos per month in 2004 331.36 pesos per month in 2005

Using these poverty lines, we calculated the quantity of people in each state that had a monthly income of less than one dollar per day or 30.42 dollars per month (365 dollars divided by 12 months). Methodology and empirical model Using the National Household Surveys, we generated a panel that includes the 32 states, considered from 1984 to 2005. Since we have a large population that was sampled randomly at different points in time, we applied a pooled OLS model with dummy variables indicating the before and after NAFTA and before and after FTEUMEX. To test if NAFTA and FTEUMEX increased the proportion of people living under the one dollar per day poverty line, we used the following empirical model:
PLit = o + 1 agricultur eit + 2 trade it + 3 services it + 4 manufactur es it + 1 NAFTA t + 2 FTEUMEX t + States i + it

Here PL is the poverty line in state i and year t, agriculture, trade, services and manufactures are the variables used as controls to measure if these economic activities make the states more vulnerable to increase its population living under poverty line, for the year t and state i. NAFTA and FTEUMEX are the dummy variables indicating the before and after these Free Trade Agreements were signed and State indicates the fixed effect given by the 32 different states of Mexico. it is robust standard error. To see if any economic activity made the sates more vulnerable to the effects of NAFTA and FTEUMEX, we established interactions between the NAFTA and FTEUMEX dummies and each economic activity.
PLit = o + 1agricultur eit + 2tradeit + 3 servicesit + 4manufactur esit + 1 NAFTAt + 2 FTEUMEX t + Statesi + (1 NAFTA * agricultur e) + (1 NAFTA * manufactur es ) + (1 NAFTA * trade ) + (1 NAFTA * services ) + ( 2 FTEUMEX * agricultur e) + ( 2 FTEUMEX * manufactur es ) + ( 2 FTEUMEX * trade ) + ( 2 FTEUMEX * services ) + it

Finally, we generated new dummy variables where a value of 1 was given if the proportion of the state GDP in any of the economic activities was greater than the national average and 0 if the proportion was less than the national average. These dummies were interacted with the NAFTA and FTEUMEX dummies to see if a greater proportion of state GDP could have made the states more vulnerable to the effects of these two Free Trade Agreements.
PLit = o + 1agricultureit + 2tradeit + 3 servicesit + 4 manufactur esit + 1 NAFTAt + 2 FTEUMEX t + Statesi + (1 NAFTA * agriplus ) + (1 NAFTA * manuplus ) + (1 NAFTA * tradeplus ) + (1 NAFTA * servplus ) + ( 2 FTEUMEX * agriplus ) + ( 2 FTEUMEX * manuplus ) + ( 2 FTEUMEX * tradeplus ) + ( 2 FTEUMEX * servplus ) + it

V.

Results

In order to measure the impact of the North American Free Trade Agreement (NAFTA) and the Free Trade Agreement with between Mexico and the European Union (FTEUMEX) in the state poverty levels, a first regression was run introducing the dummies indicating the years before and after these two Free Trade Agreements, and controlling for the proportion of the main four economic activities in the state GDP. According to the results of this first regression shown in Table 3, both NAFTA and FTEUMEX helped to diminish the poverty levels. In the case of NAFTA, the coefficient resulted with negative sign (-0.0308), and significant at 10%, indicating that this Free Trade Agreement helped to diminish poverty levels in the states by almost 3%. The results obtained are similar to the ones obtained by Nicita (2004), who stated that a diminishment of 3% in the poverty levels could have helped 3 million people to cross the poverty line. The dummy for the FTEUMEX also resulted with a negative sign in its coefficient (-0.1755) and it was significant at 1%. This showed us that the Free Trade Agreement with the members of the EU could have helped to diminish the poverty by almost 18%, but also could be interpreted as the cumulative effect of both Free Trade Agreements, given that both dummies were constructed based on the years they came into effect. Considering the fact that the trade volumes between Mexico and the members of the European Union have not increased as much as the trade volumes between Mexico, United States and Canada, it is more possible that the 18% of diminishment in the poverty levels is explained by the effect that both commercial treaties had on the quantity of people living under the poverty line in the states.

On the other hand, the results obtained in this study could be going in the same way of most of the economic theories that relate trade liberalization with poverty, since they indicate that the effects of opening a country to free trade are normally manifested in the middle and long run. Another issue to take into account from the results of this regression is the one related to the economic activities of the states. According to Table 3, a higher proportion of the state GDP generated by the manufactures can make a state more vulnerable to have more people living under the poverty line of one dollar per day. Besides, the coefficient of the control variable for manufactures resulted significant at 5% and with positive sign (0.0114), showing us that this economic activity has contributed to the increment of poverty levels in the states by more than 1%. Even when the regression was run including the 32 states, in the table, we present the F test for the state fixed effects. However, it is important to mention that, according to our results, some states resulted less vulnerable to have people living under poverty line, and actually had contributed to diminish poverty in Mexico (see Appendix), such as Aguascalientes, Baja California, Baja California Sur, Coahuila, Chihuahua, Mexico City (Distrito Federal), Jaslico, State of Mexico, Nuevo Leon and Queretaro. Among them we can find the states that have the highest contribution to the national GDP, such as Mexico City, Nuevo Leon and State of Mexico.
Table 3 Coefficients -0.0308 (0.0164)* FTEUMEX -0.1755 (0.0137)*** agriculture -0.0086 (0.007) manufactures 0.0114 (0.0056)** services -0.002 (0.0056) trade -0.000 (0.0072) constant 0.473 (0.563) State FE F(31,192) 1.7055 Prob>F 0.0163 R squared 0.6827

Variables NAFTA

224

Note: Robust standard error in parentheses. * indicates a coefficient significant at 10%, ** indicates the coefficient significant at 5% and *** indicates the coefficient significant at 1%.

In order to measure if NAFTA and FTEUMEX had different effects on poverty levels of the states depending on the composition of their GDP, we established interactions relating the NAFTA and FTEUMEX dummies with agriculture, manufactures, trade and services. According to the results obtained in this second regression, the dummy indicating the before and after FTEUMEX resulted with negative coefficient (-0.365) and it was significant at 1%. This means that FTEUMEX helped to reduce poverty levels by 36.5%, when we include the interactions. As we already explained for the first regression, given the smaller volume of trade between Mexico and the members of the European Union, compared to the trade volumes with United States and Canada, this should be interpreted as a cumulative effect of both treaties. In this regression, NAFTA resulted non significant in the determination of the proportion of people living under the poverty line in the states, but we consider that the dummy FTEUMEX includes also the effects of NAFTA. However, we decided to keep the NAFTA dummy to try to measure the short run effects. The interaction between NAFTA and the proportion of the state GDP generated by trade resulted significant at 10% with negative coefficient (-0.0033), indicating that if a state had a high percentage of its GDP given by trade, NAFTA helped to diminish the quantity of people living under poverty line by 0.3% in the short run. In the case of FTEUMEX, the interaction with trade also resulted significant at 10% but with a positive sign in its coefficient (0.0024). This means that, opposite to the effects caused by NAFTA, FTEUMEX could have increased the poverty levels by 0.2% in the states that had trade as an important activity. The coefficients of the interaction variables that resulted significant, somehow contradict the general results obtained in the same regression, especially for the FTEUMEX dummy. This could be due to specific effects of the Free Trade Agreements, and not the general effects that we had in the first regression.

Table 4 Variables NAFTA Coefficients 0.1488 (0.1387) FTEUMEX -0.365 (0.1388)*** agriculture -0.006 (0.0073) manufactures 0.012 (0.007)* trade 0.0012 (0.0087) services -0.003 (0.0062) NAFTA*agriculture -0.003 (0.003) NAFTA*manufactures -0.0018 (0.0021) NAFTA*trade -0.0033 (0.0019)* NAFTA*services -0.0015 (0.0023) FTEUMEX*agriculture 0.0007 (0.0025) FTEUMEX*manufactures 0.00135 (0.0017) FTEUMEX*trade 0.0036 (0.0020)* FTEUMEX*services 0.0024 (0.0022) constant 0.433 (0.635) State FE F(31.192) 1.71900 Prob>F 0.0151 R Squared N 0.6919 224

Note: Robust standard error in parentheses. * indicates a coefficient significant at 10%, ** indicates the coefficient significant at 5% and *** indicates the coefficient significant at 1%.

With the intention to see if this statement is true, we decided to create four new dummy variables that helped us to measure how a Free Trade Agreement could have affected the poverty levels in a state, if this state was highly specialized in one of the four economic activities. To define these dummies, a value of 1 was given if the percentage of the state GDP given by any of the economic activities was higher than the national average and 0 if it was lower than de national average. According to the results obtained the effect of FTEUMEX was still significant at 1% and with a negative coefficient (-0.2266) but in a lower degree than in the second regression, since in this case, FTEUMEX, and also the long run effects of NAFTA,

helped to diminish the poverty by 23%. Moreover, the states highly concentrated in trade, were still more vulnerable to the effects of the Free Trade Agreements. The interaction variable relating NAFTA and trade resulted significant at 5% with a coefficient with negative sign (-0.052) and the interaction between FTEUMEX and trade resulted also significant at 5% with a coefficient with a positive sign (0.071).
Table 5 Variables NAFTA FTEUMEX agriculture manufactures trade services NAFTA*high proportion of agriculture NAFTA*high proportion of trade NAFTA*high propotion of services NAFTA*high proportion of manufactures FTEUMEX*high proportion of agriculture FTEUMEX*high proportion of trade FTEUMEX*high proportion of services FTEUMEX*high proportion of manufactures constant State FE F(31.192) Prob>F R Squared N Coefficients 0.009 (0.036) -0.2266 (0.035)*** -0.0017 (0.0073) 0.016 (0.006)** 0.0026 (0.009) -0.0002 (0.006) -0.01 (0.028) -0.052 (0.025)** 0.015 (0.025) -0.049 (0.031) 0.028 (0.027) 0.071 (0.028)** 0.0075 (0.033) 0.047 (0.03) 0.251 (0.662) 1.555120 0.0392 0.702 224

Note: Robust standard error in parentheses. * indicates a coefficient significant at 10%, ** indicates the coefficient significant at 5% and *** indicates the coefficient significant at 1%.

VI.

Conclusions:

In order to analyze if the several Free Trade Agreements signed by Mexico, as part of its trade liberalization process, could have affected the poverty levels, we intended to

measure the effects of the main Free Trade Agreements signed by Mexico on the proportion of people living under the poverty line of one dollar per day. To determine the impact of the North American Free Trade Agreement (NAFTA) and the Free Trade Agreement between Mexico and the European Union (FTEUMEX), we performed an analysis of the evolution of the proportion of the inhabitants in each state living under the poverty line, using a pooled OLS model applied on a panel of 32 states and 10 different years (1984, 1989, 1992, 1994, 1996, 1998, 2000, 2002, 2004, and 2005). The findings suggest that NAFTA helped to decrease the proportion of people in living under the poverty line in Mexico by almost 3%. These results are similar to those obtained by other authors like Nicita (2004), who analyzed the impact of the trade liberalization process in Mexico using a farm household model. In the case of FTEUMEX the effect was higher, since according to our results, it helped to decrease the quantity of people living under the poverty line by almost 18%. The effect of both Free Trade Agreements were measured through the introduction of dummy variables indicating the before and after the agreements came into effect in 1994 and 2000, respectively. In the case of the dummy variable indicating the year that FTEUMX came into effect, it is highly possible that the impact on the poverty levels might include the long run effects of NAFTA, considering the fact that according to the economic theory and the results obtained by other authors that analyzed empirically the impact of free trade on poverty, the benefits of trade liberalization process can be detected easier in the long run than in the short run. So, we could say that in the short run, the trade liberalization process in Mexico contributed to the diminishment of the proportion of people living in poverty by 3% and in the long run contributed by 18%. To see how the Free Trade Agreements could have affected the different states through their main economic activities, some interaction variables were introduced in the regressions. According to the results, the states with a higher concentration in trade have been more vulnerable to have some kind of effect in their poverty levels. For example, NAFTA helped to diminish poverty in the states specialized in trade, but FTEUMEX made them vulnerable to have more poor people. Reconsidering the short and long run effects of the treaties, this could be telling us that in the short run the states with a higher proportion of its GDP given by trade had a decrease in the percentage of people living under the poverty line, but in the long run this effect was reversed.

As we can see, the results obtained in this dissertation are similar to the results presented in previous papers by different authors, in the sense that in the short run the effects of a trade liberalization process are less beneficial than in the long run. Apparently, in the case of Mexico, the short run effects were positive and helped to diminish the poverty levels, and furthermore in the long run the positive impact increased significatively.

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Appendix

VARIABLES FTEUMEX

Regression 1 Coefficients VARIABLES

Coefficients

-0.1755493 Nuevo Leon -0.3480485 (0.0137808)*** (0.1517778)** NAFTA -0.0308436 Oaxaca 0.0857088 (0.0164044)* (0.1983905) Aguascalientes -0.3336633 Puebla -0.1753266 (0.1715551)* (0.1690208) Baja California -0.329351 Queretaro -0.3677992 (0.1386543)** (0.175623)** Southern Baja California -0.0340329 Quintana Roo (dropped) (0.1770824) Campeche 0.0186901 San Luis Potosi 0.0641402 (0.3134773) (0.2003313) Coahuila -0.4158999 Sinaloa -0.1417573 (0.1816042)** (0.2178132) Colima -0.0138637 Sonora -0.1891694 (0.2639892) (0.1739295) Chiapas 0.1166755 Tabasco -0.0168178 (0.2569535) (0.2109285) Chihuahua -0.2671671 Tamaulipas -0.2179197 (0.1256594)** (0.1835571) Distrito Federal -0.3187916 Tlaxcala -0.2853377 (0.1416118)** (0.1926685) Durango -0.1174947 Veracruz -0.1497574 (0.2082525) (0.1877994) Guanajuato -0.2985867 Yucatan 0.0093621 (0.1843774) (0.1641978) Guerrero 0.1117029 Zacatecas 0.1777587 (0.14906) (0.2599519) Hidalgo -0.1717404 agriculture -0.0086318 (0.2085409) (0.0070529) Jalisco -0.2815501 trade -0.0000975 (0.1511095)* (0.0072585) State of Mexico -0.3926311 services -0.0021077 (0.162229)** (0.0055889) Michoacan -0.0392652 manufactures 0.0114533 (0.2087432) (0.0055864)** Morelos -0.200718 constant 0.4732637 (0.1873665) (0.5635899) Nayarit 0.0621839 (0.2151108) Note: Robust standard error in parentheses. * indicates a coefficient significant at 10%, ** indicates the coefficient significant at 5% and *** indicates the coefficient significant at 1%.

VARIABLES NAFTA

Regression 2 Coefficient VARIABLES

Coefficient

.1488768 Quintana Roo (dropped) (0.1387379)*** FTEUMEX -.3649235 San Luis Potosi .0736533 (0.1388825) (0.229717) Aguascalientes -.3203521 Sinaloa -.1350998 (0.1834322)* (0.2285074) Baja California -.3128241 Sonora -.1816585 (0.1512141)** (0.1912289) Southern Baja California -.0107603 Tabasco -.0065329 (0.2108736) (0.2440633) Campeche .0099735 Tamaulipas -.2103395 (0.3536018) (0.2008449) Coahuila -.4046225 Tlaxcala -.265434 (0.1874397)** (0.2095552) Colima -.0113785 Veracruz -.1380465 (0.3021141) (0.2079406) Chiapas .1306133 Yucatan .0283183 (0.2923961) (0.1865771) Chihuahua -.2627124 Zacatecas .1828818 (0.1329685)* (0.2920819) Distrito Federal -.2839674 agriculture -.0059761 (0.1617531) (0.0072937) Durango -.1095363 trade .0012298 (0.2277629) (0.008656) Guanajuato -.2871223 services -.003057 (0.1996967) (0.006239) Guerrero .1230236 manufactures .0119869 (0.170574) (0.0069941)* Hidalgo -.1569167 NAFTA*agriculture -.0030109 (0.2282034) (0.0028034) Jalisco -.2708087 NAFTA*manufactures -.0018366 (0.1617721)* (0.0021109) State of Mexico -.3776141 NAFTA*trade -.0032601 (0.1700093)** (0.0018659)* Michoacan -.0280572 NAFTA*services -.0015092 (0.2342703) (0.0023258) Morelos -.1875178 FTEUMEX*agriculture .0007008 (0.2067094) (0.0025367) Nayarit .0734494 FTEUMEX*manufactures .0013593 (0.2429078) (0.0017469) Nuevo Leon -.3260552 FTEUMEX*trade .0035921 (0.1630904)** (0.0020487)* Oaxaca .1008244 FTEUMEX*services .0024431 (0.2242842) (0.0022306) Puebla -.1580943 constant .4333138 (0.1827658) (0.6353501) Queretaro -.3550828 (0.1846609)* Note: Robust standard error in parentheses. * indicates a coefficient significant at 10%, ** indicates the coefficient significant at 5% and *** indicates the coefficient significant at 1%.

VARIABLES NAFTA

Coefficients

Regression 3 VARIABLES Queretaro Quintana Roo San Luis Potosi Sinaloa Sonora Tabasco Tamaulipas Tlaxcala Veracruz Yucatan Zacatecas agriculture trade services manufactures NAFTA*high proportion of agriculture NAFTA*high proportion of trade NAFTA*high propotion of services NAFTA*high proportion of manufactures FTEUMEX*high proportion of agriculture FTEUMEX*high proportion of trade FTEUMEX*high proportion of services FTEUMEX*high proportion of manufactures constant

Coefficients -0.4008187 (0.1926445)** (dropped) 0.0516774 (0.2370851) -0.270736 (0.2266039) -0.2401274 (0.1971913) -0.0174393 (0.2516855) -0.2275811 (0.2143152) -0.3335285 (0.2199174) -0.1802315 (0.2165222) -0.033286 (0.1908265) 0.0721591 (0.291609) -0.0017 (0.0073) 0.016 (0.006)** 0.0026 (0.009) -0.0002 (0.006)** -0.01 (0.028) -0.052 (0.025)** 0.015 (0.025) -0.049 (0.031) 0.028 (0.027) 0.071 (0.028)** 0.0075 (0.033) 0.047 (0.03) 0.251

0.009 (0.036) FTEUMEX -0.2266 (0.035)*** Aguascalientes -0.3668152 (0.1923754)* Baja California -0.3283142 (0.1661019)* Southern Baja California -0.0493188 (0.2152358) Campeche 0.1025635 (0.3679076) Coahuila -0.4585819 (0.1974795)** Colima 0.0125228 (0.314239) Chiapas 0.067665 (0.2947927) Chihuahua -0.2889916 (0.1441286)** Distrito Federal -0.3184226 (0.1690883)* Durango -0.1913147 (0.2307594) Guanajuato -0.331158 (0.2086172) Guerrero 0.081235 (0.1725638) Hidalgo -0.2068474 (0.2386646) Jalisco -0.3078007 (0.1722992)* State of Mexico -0.4341778 (0.1823206)** Michoacan -0.1309909 (0.2339422) Morelos -0.2514557 (0.2148762) Nayarit -0.0397565 (0.2399755) Nuevo Leon -0.373155 (0.1764084)** Oaxaca -0.0060588 (0.2220733) Puebla -0.2185293 (0.1905958)

Note: Robust standard error in parentheses. * indicates a coefficient significant at 10%, ** indicates the coefficient significant at 5% and *** indicates the coefficient significant at 1%.