Magazine | November 13, 2017, Issue

What NAFTA Does

Welcome to the continental shop floor

President Donald Trump has a thing about NAFTA. He doesn’t seem to know what’s in it — President Trump’s many public statements on the trade accord have not identified any substantive provision to which he objects — but he is sure that he hates it, that it is, in his tediously hyperbolic assessment, the “worst deal ever made.”

He has instructed his administration to renegotiate NAFTA, and Secretary of Commerce Wilbur Ross has set about doing so incompetently, making absurd demands of Canada and Mexico to which they could not consent even if they were inclined to, inasmuch as those demands would put those countries in violation of their legal obligations as members of the World Trade Organization. The Trump administration has demanded the elimination of NAFTA’s dispute-resolution mechanism — i.e., NAFTA’s institutional raison d’être — and Ross, who apparently believes that what U.S. investors and business managers really need is a little more suspense, has put forward a truly bonkers proposal to renegotiate NAFTA every five years, putting North American trade — that’s $3.3 billion a day in commerce and 14 million American jobs — in a constant state of regime uncertainty. The administration also wants to raise the required minimum percentage of North American components for NAFTA-traded automobiles. NAFTA already imposes the highest domestic-origin floor in the world, and the administration’s plan to raise it from 62.5 percent to 85 percent — with a 50 percent made-in-the-U.S.A. requirement — is both impracticable (it may in fact be impossible) and at odds with U.S., Canadian, and Mexican obligations under other trade compacts.

Trump has threatened to pull out of NAFTA if he does not get his way, a move that would be, in the estimate of the Wall Street Journal’s editorial page, the “worst economic blunder since Nixon.” The U.S. Chamber of Commerce shares this view, and hundreds of state and local Chamber affiliates signed a letter asking that Trump not inflict needless chaos on North American trade rules out of pure pique and malice and stupidity. (They did not put it quite like that.) The U.S. Automotive Policy Council is spooked by the prospect of losing NAFTA, a development that would constitute a “$10 billion tax on the auto industry in America.” The Boston Consulting Group says that losing NAFTA could cost 50,000 jobs in the auto-parts business alone, and American farmers do not want to see new tariffs on the $40 billion in farm produce they send to Canada and Mexico, two of our three largest export markets.

In the years since NAFTA was enacted, U.S. manufacturing has grown, trade has grown, exports have grown, employment has grown, wages have grown, the services industry has absolutely boomed, and consumer prices for many North American–traded goods have gone down. Why mess with a good thing?

The answer starts with “trade deficits,” a silly and misleading term that most Americans — including their economically illiterate president — do not quite understand.

‘Trade deficits” ought to be right at the bottom of our list of NAFTA concerns, inasmuch as we don’t have much of one vis-à-vis our NAFTA partners; in fact, we ran a modest trade surplus (about $12 billion) with them last year, led by American services companies. (“Services” means everything from product design to legal advice to medicine; bank and other financial services loom large in the U.S. services sector.) A great many Trump-style Babbitts sneer at services jobs — as opposed to jobs in factories — even though they include some of the most desirable and remunerative positions in the U.S. economy. The engineers and designers who dreamed up the iPhone X are in services; the workers snapping them together in exotic sweatshops are in manufacturing. Which job would you prefer to see your son or daughter doing?

Trade-deficit Chicken Littles exclude services from their calculations for no good economic reason. But even if, arguendo, we exclude services and look only at trade in goods, the issue is more complex than the anti-traders let on: In 2015, the U.S. ran a total deficit of trade in goods of $60 billion with the 20 countries with which we have free-trade partnerships. We imported $67 billion worth of oil and petroleum products — meaning that we ran a small surplus in non-petroleum goods. As you might expect, our biggest international oil suppliers are our neighbors: Canada (No. 1) and Mexico (No. 3). But it wasn’t NAFTA keeping down U.S. energy production and forbidding exports — it was the U.S. government. Most of our economic problems come from Washington, not Mexico City or Ottawa.

It is startling to think that the policy governing something as complex and important as North American trade would be shaped mainly by ignorance and cognitive bias, but that seems to be the case.

The term “trade deficit” obscures more than it illuminates. A trade deficit is not a deficit in the same sense as a federal budget deficit, and there is no cumulative effect analogous to the national debt. A trade deficit does not produce an obligation that has to be repaid. (And, even if it did, it would be quite small: The U.S. trade deficit has generally run right around 2 percent of GDP.) Trump has repeatedly promised to lower the U.S. trade deficit — it has in fact grown a little since he took office — and has complained that our “MASSIVE” (the president is very fond of his caps-lock key) trade deficit with Germany is somehow ruinous.

This simply is not true. The United States can continue to run trade deficits forever, with no negative economic consequences — and, indeed, with some positive consequences. As Daniel Hannan likes to point out, the United Kingdom has run a trade deficit in goods since 1828. The reason for that: The United Kingdom is very rich, and it has a very productive, innovative, trade-oriented economy. Britons buy a great deal of what the United Kingdom makes, and they also buy a great deal of the best of what the rest of the world has to offer.

And, like the United States, the United Kingdom is a magnet for global investment capital.

That is a critical point often obscured by panicked rhetoric about trade “deficits.” Producers abroad who sell goods to Americans get paid in American dollars, and there are only a few things they can do with those. First, they can use them to buy consumer goods from American producers; all that economic nationalism and neo-mercantilism in China hasn’t stopped the Middle Kingdom from being the world’s largest importer of American soybeans. Second, they can sit on those dollars, which many countries do as a hedge against fluctuations in their own currency. (China does a lot of that, too.) Third, they can invest that money in U.S.-based assets. The global flow of “foreign direct investment” capital — the money that international investors put into factories, firms, and facilities around the world — does not, for the most part, go to low-wage, low-cost countries, despite all that “race to the bottom” rhetoric from Bernie Sanders and other populist snake-oil salesmen. In reality, the largest ten recipients of FDI include only one relatively poor country — China, which is the fourth-largest destination for foreign investment capital. (Hong Kong, which is treated separately in this calculation, is No. 3.) The rest of the top destinations: the United States, topping the list, followed by the United Kingdom, Germany, Belgium, Switzerland, France, Canada, Singapore, and Ireland. (Mexico is down in 18th place, a little ahead of Russia and India.)

Money that is used for foreign direct investment is money that is not available for the purchase of consumer goods. Hence, the U.S. trade “deficit” is the mirror image of a net surplus of investment capital; the two move in tandem in the economic data throughout the years.

Trade deficits aren’t a problem, but, even if they were, renegotiating NAFTA would be an awfully dumb way to go about fixing them, since we don’t have a NAFTA trade deficit at the moment — and with U.S. firms now exporting oil (which had been prohibited by federal law) and U.S. domestic-energy production booming, there isn’t likely to be one, certainly not a large one.

Consider how many times you have heard this complaint: “I walk into Walmart, and everything says, ‘Made in China.’ Where are the ‘Made in the USA’ products?”

You know where you find a lot of “Made in the USA” products? In the overseas factories making goods destined for U.S. markets and the rest of the world. We sell a lot of consumer goods, but we also sell a boatload of capital goods, i.e. the machinery and equipment used to manufacture consumer goods.

The United States excels at the very high end of the manufacturing market and in the very demanding business of producing agricultural and mineral commodities. Hence, our largest exports are not shoes and plastic toys and garden tools and the rest of the “Made in China” stuff you see in Walmart — our largest exports are: machinery, including industrial machinery and electrical equipment; aircraft and spacecraft; vehicles, including commercial trucks and the like; oil; medical and optical equipment; pharmaceuticals; plastics, including commercial and industrial components; and organic chemicals.

The autarkic response to the shocking scale, variety, and efficiency of the United States economy is: “See, we don’t need NAFTA. We have everything we need.” But the complexity and scope of the U.S. economy is precisely why we need NAFTA and other free-trade accords — which are, after all, part of what makes that amazing economy possible.

Economic efficiency comes from comparative advantage, another frequently misunderstood term. It doesn’t mean that Henry is better at catching fish than Sam — it means that Henry is better at catching fish than he is at picking coconuts or growing pineapples, irrespective of how good Sam is at any of those things. Comparative advantage means letting everybody concentrate on doing what he is best at — which means trading for everything else.

Some kinds of comparative advantage are natural: Greenland will probably never be a powerhouse in the tropical-fruit market, and you can’t produce oil without the right geology. But complex modern economies involve a lot more than what’s in the ground or growing on the trees, and American companies reap tremendous benefits from being part of a continental supply chain enabled in part by NAFTA. Michael Davis of the Cox School of Business at Southern Methodist University points to the case of Navistar, an Illinois-based heavy-truck company that does most of its assembly in Mexico. It needed a new low-emission diesel engine a while back, and it did not have much luck coming up with a design on its own. Its solution was to ink a deal with Indiana-based Cummins, which now ships U.S.-made engines to Mexico, where they are bolted into Mexican-made Navistar trucks and exported to the United States. Those trucks may be “Mexican”-made, but the part that makes them go is made in Jamestown, N.Y. Prior to NAFTA, there would have been a tariff of up to 25 percent on those engines going into Mexico, and another (smaller) one on the trucks coming into the United States — along with all manner of bureaucratic hassle on both sides of the border. Ditto for U.S.-made GM parts going into Canadian factories and vice versa. U.S. companies benefit from having access not only to all of North America’s markets but also to business partners, suppliers, and vendors across the continent. This puts U.S. firms in an extraordinarily powerful position, with a ready supply of different kinds of labor at different price points, a wealth of raw materials, specialist services of every description, abundant and cheap energy, and transportation connections throughout the Americas and the world. Our companies can command the resources of three economically important countries with very little friction and low transaction costs. That’s what NAFTA did, and does: It isn’t just a North American free-trade area — it’s a North American supply chain, a continental shop floor.

Nafta could use some freshening up. There was no World Wide Web when NAFTA was being negotiated, and it needs a more developed digital-commerce protocol. Certain side agreements on environmental and labor standards should be strengthened and put into the main accord. There are intellectual-property issues that need to be addressed, and some unnecessary restrictions on U.S. financial-services companies’ operating in Mexico that are not in keeping with the spirit of the agreement.

But it is, overall, a smashing success, and one the Trump administration would be foolish to muck up. The short-termism at work is lamentable: U.S. trucking interests want to keep Mexican trucks off of U.S. highways in the interest of protecting a few jobs for Teamsters. But the Teamsters’ days are numbered, and it isn’t Mexicans coming to take their jobs — it’s robots. Trucking almost certainly will be one of the next industries to be overtaken by automation — and once those autonomous trucks are statistically less likely to get into litigation-inspiring accidents than are their human-operated counterparts, do you think the trucking companies — or their insurers — are going to sit pat? Of course not.

Criticisms of NAFTA tend to be either very vague or dramatically sweeping. But the economic data do not support the populist indictment of free trade and free-trade pacts. The overwhelming consensus among economists is that NAFTA has had a negligible to modestly positive impact on U.S. employment and wages, and a modest to substantial effect on GDP growth — adding as much as 0.5 percent annually by some estimates. It is true that manufacturing employment has declined in the NAFTA era. It was declining before that, too, beginning in the 1950s. As J. Bradford DeLong of Berkeley runs the numbers, the effect of free-trade pacts on manufacturing employment accounts for less than 5 percent of the job losses, and probably more like 1 percent. That “giant sucking sound” that H. Ross Perot so feared has not come to pass, and in certain high-paying industrial fields, such as automobile manufacturing, NAFTA has been a boon in unexpected ways: It is true that some manufacturing work has been outsourced to low-wage Mexico and to high-wage Canada, but access to an integrated North American supply chain and duty-free access to the three national markets are key parts of what brought the “transplants” — European and Asian automakers building in the United States with American labor — to places such as Texas and Alabama.

Prosperity always emerges in unexpected ways, and NAFTA is one way in which we get the bureaucrats and mandarins and central planners out of the way to let that happen.

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