Understanding NAFTA and Free Trade: A Texas Perspective

Understanding NAFTA and Free Trade: A Texas Perspective

A North American Common Market. The idea of a North American common market dates back at least to Ronald Reagan during his 1980 presidential campaign. Despite musing that it might take one hundred years to make the North American accord a reality, the North American Free Trade Agreement went into effect on January 1, 1994.

At the time of its passage, supporters like Michael Wilson hailed NAFTA as follows:

“The trade pact, which will eliminate tariffs on goods and services between the United States, Canada, and Mexico over a fifteen-year time span, will create the world’s largest market: some 360 million people, with an economic output of more than $6 trillion a year. The NAFTA thus guarantees that American workers will remain the most competitive in the world and that American consumers will continue to have access to the world’s finest goods and services.”

Years later, it is estimated that about fourteen million American jobs depend on trade with Canada and Mexico. Exports to Canada and Mexico make up 34% of all U.S. exports. But that doesn’t tell the entire story because the North American supply chain is so interconnected.  American inputs comprise about 40% of the value of imports from Mexico and 25% of imports from Canada. In light of the integrated supply chain, withdrawing from NAFTA would be deeply disruptive to U.S. manufacturing.

Understanding Free Trade. The United States of America, among other things, is a common market nearly the size of a continent. America has been blessed with abundant resources and enterprising people.  We have also benefited immensely from Constitutional restraints on interstate duties and tariffs.  The American common market has fostered nationwide competition, reduced consumer costs, expanded consumer choices, and widened markets for producers’ goods.

It didn’t have to be this way.

Laying aside constitutional restraints, imagine Texas imposing tariffs on non-resident companies like Amazon, Google, Microsoft, Apple, or Ford. Not only would Texas consumer costs increase, but Texas businesses utilizing these products would bear higher costs. This would put Texas businesses at a competitive disadvantage from neighboring states that did not impose such tariffs. By adding tariffs on non-resident goods, Texas would actually be harming itself rather than protecting its industries. The free market dynamics work the same way across international borders as they do across state lines.

Manufacturing, Jobs and Automation. Populist presidential candidate and NAFTA critic Ross Perot warned that NAFTA would cause a “giant sucking sound” as jobs rush to Mexico. But, the American manufacturing collapse didn’t happen. The United States is the world’s second-largest manufacturer and third-largest exporter. The Lone Star state is the nation’s top exporter. Texas manufacturers produced $227.46 billion of goods in 2015, making up 14.34% of total state output. Despite the dire predictions from NAFTA critics, the United States and Texas are still in the manufacturing business.

There certainly have been job losses in manufacturing since 1993. However, a 2015 Ball State study indicated that almost 88% of manufacturing job losses were the result of automation, not international trade. If this is accurate, adding tariffs on Canadian or Mexican goods won’t protect American workers from the real threat to their jobs: robotization.

Liberalizing North American Trade. Later this month, representatives from the U.S., Canada, and Mexico will meet in Montreal to negotiation changes to the North American Free Trade Agreement. Despite the benefits from NAFTA, the trade pact is not without flaws.  An appropriate goal of renegotiations is a further liberalization of trade. For instance, NAFTA failed to eliminate tariffs on some items like dairy, poultry and eggs. Any renegotiation should address technological advances since 1993 to ensure free flow of digital commerce.

Misguided Renegotiations. Since the enactment of NAFTA, total U.S. trade in goods and services with Canada and Mexico have grown by 125.2% to over $1 trillion in 2016. Despite such successes, President Donald Trump has called NAFTA “the worst trade deal in history”.  Libertarian lawyer, Richard Epstein, charges the President with “sophomoric thinking”:

“The President, without looking at any of the particular details, seems confident that NAFTA is a bad deal for America because it has led to trade deficits with Mexico ($55.6 billion in 2016) and Canada ($12.1 billion for 2016)—and to the displacement of some American workers.” Epstein continues:

“Free trade consists of three separate elements. First, there are the goods and services that move from the United States to Canada or Mexico. The firms that sell these goods and services make profits, as do the Canadian and Mexican firms that acquire them. Killing NAFTA would destroy those gains. Second, there are the goods and services that move into the United States from Canada and Mexico. The same happy scenario applies. Both sides to these transactions gain, and the gains to the American side include the ability to incorporate services and goods from foreign countries into the goods and services that we then sell into the global market. And finally, there is the net investment into, say, the United States if the balance of trade runs in favor of Canada or Mexico. That investment fuels the creation of new businesses (and new jobs) in the United States. But all of this gets smashed if NAFTA is upended.”

Misunderstanding Trade Deficits. What Epstein describes above is the commonly misunderstood “trade deficit”.  In layman’s terms, a trade deficit is the difference of exports less imports. There is a perception that a trade deficit is inherently bad. Exporting involves making a profit. Imports involves spending. Instinctively, it seems that making a profit must be morally superior than consumption. But, this is not the whole story. A trade deficit or surplus is just one side of the “trade balance” equation.

At the micro-level, in a free-market exchange, money is traded for goods of the same perceived value. Each side gets what they bargain for. But at a macro level, trade must balance. Give must equal take. [This is expressed in the equation “Savings – Investment = Exports – Imports”]. A nation’s trade deficit in goods will be balanced by an investment surplus of capital from foreign investors (or surplus savings from its own people).  You can visualize this as Americans buying cargo containers of Chinese fidget spinners in exchange for shares of Uber.

Local Content Requirements. Unfortunately, the Trump Administration’s renegotiation efforts are not designed to make the market freer. For instance, under current rules, a minimum of 62.5% of materials in a car or light truck manufactured in the NAFTA region must be from North America to avoid tariffs. The U.S. administration has proposed raising the amount of NAFTA content to 85% with a minimum of 50% originating in the United States, lest they be subject to tariffs. This would not only raise the costs of goods, it would put North American manufacturers at a global disadvantage because our supply chain is so interconnected.

Manufacturing and the Cross-border Supply Chain.  Judging from the aisles of Wal-Mart, shoppers may convince themselves that everything is now made in China. Because of Chinese cheap labor, China has a comparative advantage when producing cheap, low-tech consumer goods. But, thanks to our skilled workers, know-how, and modern industrial infrastructure, the United States excels at producing more advanced industrial equipment, machinery, and vehicles.

American manufacturers manage costs by incorporating less expensive “inputs” (e.g., components) into American-made products. As Scott Lincicome points out, “More than half of all imports (including those from China) are inputs and capital goods consumed by other American manufacturers to make globally competitive products. Raising these firms’ costs via tariffs would mean fewer employees, if not outright bankruptcy.” Imposing tariffs on the supply chain of North American automakers will make their vehicles more expensive for consumers and less competitive in the global marketplace.

Short-Term Thinking.  A short-sighted proposal from the administration would require the members of the trade pact to renegotiate NAFTA every five years. When making capital investment decisions, executives and boards consider long-term financial forecasts. The administration’s proposed rule would hamper decision-makers ability to make long-term plans for North American operations. Such political risk would tend to discourage multinational corporations from constructing manufacturing facilities in the NAFTA region.

Agricultural Exports. As a result of American agricultural productivity, American farmers rely on export markets to ensure strong prices and revenue. In 2016, Texas exported agricultural products valued at over $832 million to Canada and $834 million to Mexico respectively. A Texas A&M AgriLife Extension Service study estimates U.S. agricultural exports to Canada and Mexico supported 509,332 jobs in 2016.

Energy Exports.  Texas has led the nation in an energy renaissance.  The combination of hydraulic fracturing and horizontal drilling have made it economically feasible for the United States to access previously untapped oil reserves. Thanks in part to the 2015 repeal on the oil export ban, the United States now exports up to 1.7 million barrels per day of crude. Much of that is coming from the Permian Basin in West Texas. In addition, it is estimated that the U.S. will have the capacity to export 3.8 billion cubic feet per day of natural gas in 2018.

Canadian and Mexican markets are important for the U.S. petroleum industry. Canada remains the top importer of U.S. crude oil products, and Canada and Mexico are the top two importers of finished petroleum product exports, according to Robert Rapier.  Following the lift of the crude oil export ban, the U.S. should liberalize trade and open more markets for our products, not step away from global markets.

How Would Withdrawal Affect Texas? As the nation’s top exporter, withdrawing from NAFTA would be disastrous for Texas. The Lone Star State exports about $250 billion in goods annually. Our top trading partners are Mexico ($95m exports) and Canada ($20-25m exports).

If the United States were to withdraw from NAFTA, Texas would not only lose the benefit of duty-free goods and services from Canada and Mexico, our trade partners would likely respond with countervailing duties on American goods.  Texas consumers would pay more for products from Mexico and Canada, as well as American products (such as automobiles) that include cheaper Mexican or Canadian components.  Texas manufacturers paying more for inputs would be at a disadvantage in global competition. Texas farmers would be at a disadvantage when selling agricultural products across either border. It is hard to see any good coming from withdrawing from NAFTA and facing trade barriers with Canada and Mexico.

If we really want to put America first, free trade is the key.

Doug McCullough, Director

Photo credit: genmike www.123rf.com