The literature on regional integration agreements (RIAs) is vast and deals with political, economic and political economy issues. The literature on the economics of RIAs deals mostly with static effects, and concludes that these effects are in general ambiguous. So far, there has been no empirical analysis of the dynamic effects of RIAs based on their impact on technology diffusion from partner and non-partner countries. This paper is a first attempt in this direction. It examines the impact of NAFTA on total factor productivity (TFP) in Mexico through its impact on trade-related technology transfers from OECD countries. Trade-related technology diffusion is estimated with the use of a measure of trade-related foreign R&D. Foreign R&D is constructed based on industry-specific R&D in the OECD, OECD-Mexico trade patterns, and input-output relations in Mexico. We separate the OECD into two parts, Mexico’s NAFTA partners (US + Canada) and the rest of the OECD. We find, first, that Mexico’s trade with its NAFTA partners has a large and significant impact on Mexico’s TFP while trade with the rest of the OECD does not. This is likely to be due to the fact that Mexico not only benefits from the R&D content of the trade with its Northern neighbors but also benefits from direct contact and close exchanges of information, especially for sub-contracting firms which are more closely integrated in the US and Canada production networks than with the production networks of the more distant countries of the rest of the OECD. Second, we simulate the impact of NAFTA and find that it has led to a permanent increase in TFP in Mexico’s manufacturing sector of between 5.5%and 7.5% and to some convergence to the economies of the US and Canada.
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