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This paper assesses the long-run bilateral trade relations between the US and Mexico. North American Free Trade Agreement (NAFTA) had no additional impacts on import functions. Gradual switching existed even before the agreement became effective.

The North American Free Trade Agreement (NAFTA) is prominent because the US, which is highly developed country and Mexico, which is relatively less developed agreed to construct a free trade area. This removal of trade barriers inevitably promotes their trade because of the difference in their development stages. This type of policy change might also introduce a structural change into their trade patterns. Of course, many researchers study NAFTA, but most neglect the possibility of gradual switching along with the phased reduction of tariffs (e.g., Casario (1996)). This paper assesses the long-run relations in the import functions between the US and Mexico, applying the Dynamic Ordinary Least Squares (DOLS) method by Stock and Watson (1993) together with the gradual switching model by Ohtani and Katayama (1985) and Ohtani, Kakimoto, and Abe (1990), for each country’s long-run import function.

This paper investigates whether NAFTA caused the structural change in the bilateral import functions between the US and Mexico. No additional impact was caused by NAFTA in either import function when NAFTA came into effect. There was a gradual shift in the long-run relation for each import function much earlier than the effectuation of NAFTA. Besides these empirical findings, the estimated import functions have implications on the free trade agreement between Mexico and the EU. Of course, with this policy, the Mexican policymaker intended to diversify trade partners and to promote Mexican exports. The estimated result shows that Mexican exports are going to become more sensitive to the condition of the US economy through gradual increase in income elasticity and the domestic price elasticity of the US’s imports, while Mexican exports still account for about eighty percent of the US imports. Under such a trade structure, it is a timely and preferable policy to diversify the trade partners by the free trade agreement. Additionally, the income elasticity of Mexican imports is significantly positive and stable in spite of the structural change. This result indicates that the growth of the Mexican economy worsens Mexico’s trade deficit. The free trade agreement also helps improve the trade balance and keeps economic growth steady.