International sourcing and factor allocation in preference areas

Creation of the North American Free Trade Area (NAFTA) has focused attention on trade in intermediate goods and on offshore sourcing in the context of preferential trade liberalization. Although intermediate goods trade as a general phenomenon has been thoroughly examined in the literature, its role in the trade of preference areas has been relatively minor until the advent of NAFTA. Intermediate goods play a key role in the theory of effective protection, the application of which to preferential trade areas (PTAs) suggests that the protective or anti-protective of preferential trade liberalization may depend on the relative roles of intermediate and finished goods covered by the exercize. This paper combines insights from several strands of the literature in order to ascertain the extent to which the welfare effects of preferential trade liberalization are influenced by the presence of intermediate products. This is done in the specific context of preferential trade liberalization between an advanced, industrialized country like the United States and a developing, industrializing country like Mexico. One of the policy "problems" NAFTA was supposed to alleviate was that of the northward migration of unskilled workers. If NAFTA could speed up industrialization and economic growth in Mexico, it might generate enough new jobs to reduce, and perhaps ultimately eliminate, the flow of Mexican workers to the United States. Such a development was widely believed to be welfareenhancing from the U.S. perspective. The maquiladora phenomenon had demonstrated the extent to which specialization, not along finished product lines, but in terms of production stages and processes, could exploit the peculiar complementarities of the two countries, create jobs south of the border, and bring welfare gains to both countries. The critics of NAFTA, on the other hand, saw the issue less in terms of complementarities than of competitive substitution and rivalry. They saw labor migration from Mexico as one type of threat to American workers and globalization as another. The welfare effect of globalization depends on whether it occurs in a country's exportables or importables industries. This paper focuses on globalization in the importables sector, because it is the less straightforward of the two cases. The issue is examined in the context of preferential trade liberalization between two economically unequal partners. It shows that trade liberalization which leads to offshore sourcing may reduce welfare in the advanced country.