Wachovia Bank sign is seen at a branch in New York. Wachovia settled federal charges that it laundered nearly $400 billion in drug money from Mexican and Colombian traffickers in 2010.

Yesterday Global Financial Integrity released a new report, “Mexico: Illicit Financial Flows, Macroeconomic Imbalances, and the Underground Economy,” which provides an in-depth look at flows of illicit money from Mexico. The study finds that nearly $1 trillion in illicit capital left Mexico from 1970-2010, averaging about $50 billion a year this past decade. Illicit outflows have increased over time – in 1970 only $3 billion of illicit money left the country per year – and experienced particularly large upswings during macroeconomic crises. These flows decreased by more than 50 percent as a share of exports, though this is largely because exports overall increased dramatically as Mexico transformed from a relatively closed to open economy.

The report’s most interesting finding is that this illicit capital is not necessarily or mostly drug money. Instead it comes from Mexico’s large underground economy. In these markets the goods being traded are not necessarily in and of themselves illegal. What’s illegal is the under-the-table way that they are bought or sold. The report finds that the vast majority (80 percent) of the money leaving Mexico does so through a method called “trade mispricing.” This is when a company either undervalues exports or overvalues imports, and agrees with its trading partner (for many this is the same entity or owner) to transfer the balance to a bank account abroad. Just as when a restaurant doing cash business fakes the number of customers it receives to avoid paying taxes, companies doctor their trade records to allow money to flow out of a country untaxed.

In Mexico’s case, economic liberalization in the 1990s had the unintended effect of promoting this type of capital flight. The explosion of trade around NAFTA provided exporters and importers more opportunities than ever to manipulate the rules of the game.

Dealing with this challenge means tackling the informal economy, which both drives and is driven by illicit outflows. Mexico’s regulatory institutions need to catch up to the high volume of trade in the post-NAFTA era, strengthening auditing practices and tax authorities along the way. Another way of chipping away at the underground economy is to shrink the number of people working in it, by creating more formal sector jobs. This is good for workers, who get better social protections in the formal economy, and for businesses, which can get loans and other services needed to grow and expand. More formal sector enterprises will also generate much-needed tax revenue in Mexico (the country with the lowest rate of tax collection in the OECD and among the lowest in Latin America). These extra public funds will pay for more public schools, better roads and stronger police forces, benefiting Mexican society in the long run.

The United States also has a role to play in helping Mexico combat money laundering. As the number one destination of illicit funds from Mexico, U.S. banks could make it a lot harder to move money north by improving transparency and reporting more regularly on private deposits. Getting banks to do their part will require deeper cooperation between the United States and Mexico, with tougher rules and regulations on both sides of the border.

Published in conjunction with Latin America’s Moment at the Council on Foreign Relations.

A truck of the Mexican company Olympics bearing Mexican and U.S. flags approaches the border crossing into the U.S., in Laredo (Courtesy Reuters).

It is worth reading the Woodrow Wilson Center Mexico Institute’s new study by Christopher Wilson, entitled “Working Together: Economic Ties between the United States and Mexico.” The report is packed with examples and statistical evidence of the deepening integration between the United States and Mexico since 1993 (the signing of NAFTA), and concisely explains why this relationship is so important and beneficial for the United States.

In terms of trade, for nearly half of U.S. states, Mexico is the number one or number two export destination. For border states such as Texas, New Mexico, and Arizona, up to a third of all exports head to our southern neighbor. But it isn’t just a border issue – export industries in states as far flung as New Hampshire, South Dakota, Nebraska, and Missouri all depend on Mexican industries and consumers. And these are some of the most dynamic trading relations we have. Twenty U.S. states increased exports to Mexico by more than 10 percent each year over the last fifteen years. Investment also flourished. Mexican FDI in the United States, though starting at a low base, increased tenfold over the past two decades.

The report shows that trade with Mexico is particularly beneficial to the United States because these goods incorporate many parts and products produced in the United States. In fact, even though fully counted as imports in official trade data, an estimated 40 percent of the value of Mexican products is actually “made in the USA.” Only Canada comes close to this ratio (25 percent). In stark contrast, only 4 percent of the value of Chinese imports is made on U.S. soil.  This means that products coming from Mexico support homegrown industry and labor. In fact, 6 million American jobs – or 1 out of every 24 – depend on Mexican trade. The study breaks down employment by state – showing for instance that some 200,000 Georgians, 120,000 Indianans, and 100,000 Coloradans owe their jobs to Mexico. Other studies show that export oriented jobs pay more than others, further benefiting U.S. workers. And what is good for Mexico is good for the United States — Mexico’s strong 2011 economic growth should create 150,000 new U.S. jobs.

The report interestingly points out how the United States is now competing with China and others to supply parts and materials used in Mexican production. Here, worryingly, the United States is falling behind – losing market share to its Asian rivals. Part of the problem is the border. Overwhelmed infrastructure, and long and unpredictable wait times at crossings limit competitiveness, costing taxpayers billions in lost revenue and jobs.

There are some signs that these issues are at least appreciated. In 2010 three new border crossings opened, easing congestion along the dense 2,000 mile border, and under its “21st Century Border” project, the Obama administration is working to make commercial and other crossings more efficient and secure. But a conceptual shift is still needed. U.S. politicians, business owners, workers, and the general public need to understand that the path to improving U.S. global competitiveness –defending American industry in the process – runs through, rather than around Mexico (and Canada). Regional integration is vital for U.S. economic recovery and growth going forward.

Published in conjunction with Latin America’s Moment at the Council on Foreign Relations.

Often maligned in all three countries, NAFTA has, on balance, benefited the region. By creating one of the largest trading blocks in the world, this trade agreement not only tripled regional trade and generated an estimated 40 million new jobs during its first fifteen years, but also helped spur similar agreements world wide. Even as economic recession frightens North American citizens, it is precisely the growth of free trade that will be the basis for economic recovery in all three countries.  All efforts should be made to support its progress, resolve underlying disputes, and limit the barriers to economic integration.

Security too is a growing concern for all three North American leaders. While bloodshed so far has been concentrated in Mexico, Canadian and American citizens have also been caught up in the violence and the reach of organized crime and drug networks is apparent throughout the region. President Calderon has made a commitment to radically reduce the power of the drug cartels, but no unilateral solution is possible. The Guadalajara summit provides an opportunity to think creatively about cooperative action to address Mexico’s current challenge. Canada, as well as its NGOs , academic, and corporate communities , has a significant history of supporting democratization processes, fighting crime and corruption, and building institutions in the Commonwealth Caribbean. Lessons learned there could be helpful in dealing with similar issues on a much larger scale in its North American partnerships.
The most vivid recent example of the indelible ties between the North American nations – and the real benefits gained from close cooperation – occurred this last April with the discovery of the H1N1 virus. The spread of this flu respected no boundaries. Luckily, the response too crossed borders. With the initial cases found in Mexico, Canadian scientists first cracked the genetic makeup of the virus. As the virus spread, Canada and the United States sent epidemiologists to Mexico, who worked side by side investigating and controlling the outbreak. The three nations continue to share all data on the virus and its development in an unprecedented manner, and should use this moment to prepare together for the possible return of H1N1 this fall.

Joint programs and collaborative action to address climate change, environmental degradation, and renewable energy initiatives will make faster and deeper progress than individual activity in these areas. Mexico and the US announced in April a bilateral framework on clean energy and climate change. In July Canada announced that it will match US restrictions on greenhouse emissions. Just as NAFTA served as a catalyst for other extensive trade agreements, the US, Canada and Mexico should set the standard for regional cooperation on the global issues of climate change, cooperation in developing renewable energy technologies, and controlling carbon emissions.

Perhaps as important as the substance of trilateral relations going forward is the process. North American summits have suffered in recent years from the perception of exclusivity. As President Obama has done in other realms, it is time to open the process to a broad array of citizens, non-governmental organizations, labor unions, and private sector organizations. The recent Summit of the Americas in Trinidad and Tobago gave a strong voice and platform to these groups, as many leaders and their ministers attended a wide variety of events and discussions on regional initiatives with presentations from aboriginal groups, a youth forum, and a regional business forum in addition to the formal plenary summit sessions.  A more inclusive process would provide both a broader set of ideas and solutions, as well as greater support for summit outcomes.

As the three leaders head to their summit, they face significant tasks. Yet this is a time to take on the many challenging issues ahead, addressing issues concerning the environment, labor, and energy, and expanding on issues of most pressing concern to all three countries – economic recovery and security most importantly. The intertwining of peoples, businesses, and communities has brought these populations together; it is time the governments caught up. This Trilateral Summit presents an ideal opportunity to start this process.

Co-Authored with Jennifer A. Jeffs, Acting President of the Canadian International Council, and Senior Fellow at the Centre for International Governance Innovation