Economists—and the world—breathed a sigh of relief when the United States, Canada, and Mexico stepped back from the brink of a trade war. That’s good news as far as it goes, but there’s still reason for concern.
Trade deals are better than no trade deals, generally speaking. But bad trade deals can set dangerous precedents. That was why in the 1990s, the staunch free trader Fred Smith, founder of the Competitive Enterprise Institute (where this author works), opposed the North American Free Trade Agreement’s (NAFTA) inclusion of side agreements that had nothing to do with trade. He worried that those provisions, mainly concerning labor and environmental standards, would set a precedent to elevate those goals above tariff reduction—the supposed point of trade deals.
Was he right? The conclusion of NAFTA’s renegotiation, the U.S.-Mexico-Canada Agreement (USMCA), suggests he was.
The USMCA not only elevates the side agreements to full treaty status, it does so in a way that no American free trade agreement has done before. It compels Mexico not only to introduce a new, high minimum wage for workers in the auto industry. It also commits Mexico to adopt the eight “core rights” of the International Labor Organization (ILO). These two provisions set a worrying precedent.
First, compelling a country to higher wage rates than its industries would otherwise offer reduces that country’s comparative advantage in trade. Comparative advantage is a core concept in trade economics, discovered by David Ricardo in the early 19th century. It states that a country should specialize in producing those goods that it can produce at least cost compared with others. That does not mean the country should produce what it is most efficient at producing. That is why America doesn’t produce bananas but instead designs iPhones (as Remy hilariously points out in the linked video).
In the case of Mexico, compelling higher wages might eliminate Mexico’s comparative advantage in producing automobiles. The distortion in the labor market introduced by the higher minimum wage might make it more affordable for an auto manufacturer to build cars in another country, say South Korea, and pay the tariff to import them into the United States. For highly paid American and Canadian auto workers—many of them unionized—it means less competition from their counterparts south of the Rio Grande. In that regard, it is an anti-free trade measure just as much as raising a tariff would be.
Second, imposing the ILO’s “core rights” will also affect Mexico’s comparative advantage. The ILO provisions include not just safeguards against child labor and forced labor, but also explicit labor policy planks like mandatory collective bargaining and union recognition. It is particularly rich for the U.S. to insist on this when it has only ratified two of the ILO’s same eight “core rights.” In fact, some parts of U.S. labor law, such as right-to-work laws, conflict with the ILO’s standards. Again, these requirements will reduce Mexico’s comparative advantage while maximizing that of the U.S. and Canada.
This process might seem to make tactical sense for the U.S., if the country were facing off against Mexico in a trade war, where there are winners and losers. But what are usually called trade wars are really trade tariff wars. Free trade benefits both sides. Yes, some people lose jobs because of another country’s comparative advantage, but many lose them to domestic technological innovation. Yet, few outside the Luddite fringe suggest hindering such technological progress.
Propping up inefficient industries via regulation or trade protection simply makes everyone worse off. Many new industries and jobs do not come into being. Consumers pay more for goods and services with no offsetting benefit.
Third, imposing policy via trade treaty undermines democracy by circumventing a country’s legislative process. And now that the precedent has been set, we can expect it to be used against us. The European Union might push for the U.S. to sign up to ILO requirements as well—with U.S. labor unions supporting the effort, no doubt. A “living wage” might become a requirement for the U.S. to rejoin the Tran-Pacific Partnership. As the saying goes, never claim a power that you would not want to be used against you.
This does not mean the USMCA is entirely a bad thing that should be opposed. Overall, the deal will ensure that the continental commerce on which industries and consumers across North America rely will continue uninterrupted—and that is worth celebrating.
However, it also offers a cautionary tale for future trade negotiations. Larding trade deals with side agreements like this may create a hostage to fortune that could make trade forever a secondary consideration in trade agreements. And that would be tragic. “The virtues of trade are unappreciated. Yet only trade can harness the self-interest of strangers to create wealth around the world,” as Fred Smith put it well. “To block trade is to block the first steps toward a better world.”