THE GLOBAL MACROECONOMICS OF NAFTA

Previous empirical studies of NAFTA have commonly used trade models th at do not allow international capital flows to adjust to changes in re gional trade arrangements such as NAFTA. This paper explores the dynam ic implications of NAFTA with particular focus on the short-run and lo nger-run adjustment of financial capital. This adjustment affects the global allocation of physical capital and therefore changes the growth prospects for a country such as Mexico. Our results suggest that Mexi co and the world economy gain more from NAFTA than merely a static rea llocation of production possibilities. In the short run, the adjustmen t of financial capital affects nominal and real exchange rates. This a djustment is far more important for the short-term allocation of trade flows than partial equilibrium adjustment of trade based only on chan ges in long-term price differentials.