Americas Program, Interhemispheric Resource Center

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The proponents were generalizing from the so-called“environmental Kuznets curve” (EKC) hypothesis. Thename derives from an analogy to the original Kuznetscurve—the theory that inequality first increases, thenlater decreases, as per capita income grows over time.Studies in the early 1990s reported a similar relationshipbetween environmental degradation and levels ofincome: environmental degradation may sharply increasein the early stages of economic development, but the risein per capita income past a certain “turning point”seemed to gradually reduce environmental damage.

Economists hypothesized that environmental improve-ment beyond the “turning point” happened for three rea-sons. First are so-called scale effects: increases in growthcorrespond with increases in pollution. However, scaleeffects can be offset by what are called composition andtechnique effects. Composition effects occur wheneconomies shift shifts toward services and other less pol-lution-intensive economic activities. Finally, techniqueeffects occur when increasing income eventually leads tohigher levels of environmental awareness, which trans-lates into more stringent environmental policies as thegrowing middle class demands a cleaner environment.

Early EKC studies suggested the “turning point” at whicheconomies would begin to get less pollution-intensive wasa per capita income of approximately $5,000. This led tothe policy prescription now heard in many negotiatingrooms: that the environment can wait, since economicgrowth will eventually (and naturally) result in environ-mental improvement. More recent studies, however, havecalled into question both the specific findings and thebroad generalizations from these early EKC studies.

Mexico reached $5,000 GDP per capita in 1985 (in PPPterms), precisely the year it began opening its economy.The data suggest, however, that subsequent rises in

Free Trade and the Environment:

Mexico, NAFTA, and BeyondKevin P. Gallagher | September 17, 2004

During the NAFTA negotiations, proponents of the agreement argued that free trade would lead toseemingly automatic improvements in environmental conditions in countries like Mexico. Opponentsof NAFTA said that the environment would automatically worsen in Mexico because Mexico’s lowerstandards would attract highly polluting firms from the United States. In effect, Mexico would serve asa pollution haven for U.S. industry. Ten years after NAFTA, what happened?

Air pollution in Mexico City is just the most well-knownof Mexico’s environmental problems. Cutbacks in gov-ernment environmental programs and trade-led growthhave intensified soil erosion, air and water contamina-tion, and solid waste disposal.

income have been small and environmental degradationhas been large. Statistics from Mexico’s National Institutefor Statistics, Geography, and Information Systems(INEGI) document how environmental degradation hasoverwhelmed any benefits from trade-led economicgrowth.

First, since 1985 real incomes have grown at just 2.5%per year, and less than one percent per capita. Second,according to INEGI, major environmental problems haveworsened since trade liberalization began in Mexico.Despite the fact that Mexico reached levels of incomebeyond the range of a predicted EKC turning point,national levels of soil erosion, municipal solid waste, andurban air and water pollution allworsened from 1985 to 1999.Rural soil erosion grew by 89%,municipal solid waste by 108%,water pollution by 29%, andurban air pollution by 97%.

The results have been costly toMexico’s prospects for develop-ment. The INEGI studies esti-mate the financial costs of thisenvironmental degradation at10% of GDP from 1988 to 1999, an average of $36 bil-lion of damage each year ($47 billion for 1999). Thedestruction overwhelms the value of economic growth,which has been just 2.5% annually, or $14 billion peryear.

The Pollution Haven Hypothesis

Is the Mexican environment worsening because Mexicois serving as a pollution haven for highly polluting indus-tries in the United States? A number of studies analyzethe extent to which economic activity in pollution-inten-sive industries expanded in Mexico before and afterNAFTA. One would expect that the amount of pollution-intensive industry would decrease in the United Statesand increase in Mexico. What was found, however, wasthat the amount of dirty industry decreased more inMexico than in the United States.

The reason why there is little evidence for pollutionhavens in developing countries is that the economic costsof environmental regulation and compliance are relative-ly small compared to other factors of production—espe-cially those that determine comparative advantage.Mexico has an abundance of unskilled labor that findsemployment primarily in manufacturing assembly plants.

On average, such production processes are less pollution-intensive than more capital-laden manufacturing activi-ties such as cement, pulp and paper, and base metalsproduction. Economic activity in the latter sectors hasactually fallen off in Mexico during the NAFTA period.Even at the margin, the costs of pollution control are toosmall to significantly factor into the average firm’s loca-tion decisions. In addition, many firms are simply toolarge and cumbersome to move to another location, andthey need to stay close to their product markets. Themarginal abatement costs are small relative to the trans-action costs of decommissioning and actually moving toanother country.

Although the majority of firmsthat move to Mexico do notmove there because of low envi-ronmental standards, this doesnot imply that when firms moveto Mexico they are model envi-ronmental corporations. In fact,the World Bank conducted asurvey of over 200 firms inMexico and found that, contraryto prevailing assumptions, for-eign firms were no more likely

than domestic firms to comply with Mexican environ-mental law.

Need for Strong Environmental Institutions

If the Mexican environment is worsening, but notbecause it is a pollution haven, what is driving environ-mental degradation? Costly degradation is occurringbecause the proper mechanisms were not put in place tohelp Mexico manage its economic growth in an environ-mentally sustainable manner. In the lead-up to NAFTA,Mexico doubled spending on environmental protectionand started a much-needed industrial environmentalinspection program. However, shortly after NAFTA wassigned and fiscal and financial woes set in, attention tothe environment nose-dived. According to INEGI, since1994 real spending on environmental protection declinedby the equivalent of $200 million, or 45%. Even at theirhighest levels, allocations for environmental protectionwere low in comparison to Mexico’s counterparts in theOECD; as a percentage of GDP, they were only one-fifththat of other OECD nations. Tellingly, the number ofindustrial environmental inspections has also decreasedby 45% over the same period.

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National levels of soil erosion,

municipal solid waste, and

urban air and water pollution all

worsened from 1985 to 1999.

The environmental “side” institutions created by NAFTAset some important precedents, but were not equipped toaddress these problems. At most, Mexico receives onlyone-third of the $9 million annual budget of the NorthAmerican Commission forEnvironmental Cooperation(NACEC). NACEC has been effec-tive in carrying out its limitedmandate, enabling citizengroups to monitor environmen-tal progress and conveningcross-national information shar-ing and research efforts in NorthAmerica. But its $3 millionbudget is dwarfed by Mexico’sbudget shortfalls and buried bythe $36 billion price tag of envi-ronmental degradation.

Environmental Lessons From NAFTA

There is no evidence that pollution has begun todecrease now that Mexico has passed the theoreticalturning point of $5,000 per capita. Nor have other envi-ronmental indicators begun to show improvement. Thisstudy also suggests that fears that NAFTA would create apollution haven for dirty industry in Mexico were not jus-tified overall, though the firms that have moved toMexico have not always followed environmental bestpractice.

Together, these findings suggest two important conclu-sions as countries continue to negotiate the terms underwhich they will integrate into the global economy. First, ifgrowth alone will not bring with it a long-term tendency

toward environmental improvement, or if the turningpoint is so distant as to make the environmental costs ofwaiting unacceptable, then governments need to put inplace the institutional mechanisms that can monitor

environmental impacts and pre-vent unacceptable levels of envi-ronmental destruction. Withoutenvironmental laws, regulations,and the willingness and capacityto enforce them, trade-ledgrowth will lead to increases inenvironmental degradation.

Second, since the evidencefrom Mexico suggests that envi-ronmental regulations andenforcement are not generallydecisive in most firms’ locationdecisions, governments should

have little fear in strengthening such safeguards.Governments will not be jeopardizing their access to for-eign direct investment by enacting strong environmentallegislation and enforcing it.

In short, governments need to act to protect their envi-ronments. The costs of doing so, in terms of lost invest-ment, are likely to be very low. The costs of inaction arelikely to be very high.

Kevin P. Gallagher is a research associate at the GlobalDevelopment and Environment Institute at the FletcherSchool of Law and Diplomacy and Tufts University anda frequent contributor to the IRC Americas Program.His latest book is Free Trade and the Environment:Mexico, NAFTA, and Beyond (Stanford UniversityPress).

www.americaspolicy.orgA New World of Analysis, Ideas, and Policy Options

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The INEGI studies estimate

the financial costs of

this environmental degradation

at 10% of GDP

from 1988 to 1999.

FOR MORE INFORMATION SEE:

NEW BOOK:Free Trade and the Environment: Mexico, NAFTA, andBeyondhttp://www.ase.tufts.edu/gdae/policy_research/

FreeTradeEnvBook.htm

NEW REPORT:Globalization and the Environment: Lessons from theAmericashttp://ase.tufts.edu/gdae/WorkingGroup.htm

FROM THE IRC AMERICAS PROGRAM:NAFTA, Foreign Direct Investment, and SustainableIndustrial Development in MexicoLyuba Zarsky and Kevin P. Gallgherhttp://www.americaspolicy.org/briefs/2004/

0401mexind.html

Sustainability Assessments: Tools for Effective TradePolicy in the HemisphereKevin P. Gallagher and Hernán Blancohttp://www.americaspolicy.org/briefs/2003/0304sa.html

NAFTA’s North American Agreement for EnvironmentalCooperation: A Civil Society Perspective Andrea Abelhttp://www.americaspolicy.org/reports/2003/

0303nacec.html

ORGANIZATIONS:North American Commission for EnvironmentalCooperationhttp://www.cec.org/

Action Network on Pesticides and Alternatives in Mexicohttp://www.laneta.apc.org/emis/ong/rapam/

Mexican Free Trade Action Network (RMALC)http://www.rmalc.org.mx/

Published by the Americas Program of the Interhemispheric Resource Center (IRC, online at www.irc-online.org). ©2004.

The Americas Program“A New World of Ideas, Analysis, and Policy Options”

Founded in 1979, the IRC is a small but dynamic nonprofit policy studies center whose overarching goal is to help forge a new globalaffairs agenda for the U.S. government and people—one that makes the United States a more responsible global leader and partner. Formore information, visit www.americaspolicy.org or email americas@irc-online.org.

Recommended citation:Kevin P. Gallagher, “Free Trade and the Environment: Mexico, NAFTA, and Beyond,” Americas Program (Silver City, NM: Interhemispheric Resource Center, September 17,2004).

Web location:http://www.americaspolicy.org/articles/2004/0409naftaenv.html

Production Information:Writer: Kevin P. GallagherEditor: Laura Carlsen, IRCLayout: Tonya Cannariato, IRC

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