US-MEXICO FREE TRADE AND THE NORTH AMERICAN AUTO INDUSTRY: A THEORETICAL AND APPLIED GENERAL-EQUILIBRIUM ANALYSIS Linda Hunter - Department of Economics San Diego State University James R. Markusen Department of Economics University of Colorado, Boulder Ii Thomas F. Rutherford ) Department of economics. I - - - University of Western Oiitario~ I -- Abstract - - - A theoretical and applied general-equilibrium analysis of the North American auto industry is constructed, motivated by the possibility of US-Mexico free trade. Special features of the model include (1) significant scale economies at the plant level, (2) imperfect competition among firms, (3) joint ownership of plants and production coordination across plants by each firm across the three North American countries, (4) an (initial) ability of North American firms to segment the three markets, (5) a separate treatment of non-North American firms in determining oligopolistic markups. Among the results we find that (A) the gains to Mexico are significant and the effects on the US and Canada are essentially zero following North American free trade if firms can continue to segment markets; (B) Because of the way that the North American multinationals determine markups, increased imports from Mexico do not result in a rationalization of US and Canadian production in the way it should if firm were strictly national. (C) Genuinely free trade for consumers (integrated markets) results in large gains for Mexico as the Mexican industfy is forced to rationalize; while losses to the US and Canada are very small. This is a very preliminary version of this paper. Some of the data needed for parameter calculations have not yet been assembled, and hence a few parameters are simply guesses at this point. The current version is thus for discussion only and should not be quoted or circulated. The authors thank the Fraser Institute and the Lilly Foundation for support.