“America, the Trump card on NAFTA is not your Ace of Spades!”

“America, the Trump card on NAFTA is not your Ace of Spades!”

By Cheng Xinyong

Background of NAFTA

Established fully in 1994, North American Free Trade Agreement (NAFTA) is a trilateral agreement between Canada, the United States of America and Mexico. The agreement was, then, signed by U.S President, George H.W. Bush, Canadian Prime Minister, Brian Mulroney and Mexican President, Carlos Salinas.

The aim of this agreement is to “reduce trading costs, increase business investment and help North America be more competitive in the global marketplace” (Amadeo, The Balance, 2018)(1) by eliminating trade barriers such as tariffs and by allowing movement of goods across the borders of these countries, freely. Although there were supporters for and detractors against NAFTA, the terms of the agreement have not changed.

Introduction

Since the election of U.S. President Donald Trump, who publicly denounced NAFTA as “the worst trade deal” ever signed by the U.S., the trade agreement appears to be hanging by a thread. Trump repeatedly wants a renegotiation of the deal, or worse, to completely pull out from it. Trump’s stance is reiterated by actions, such as imposing a 25% steel tariff and 10% aluminium tariff onto Canada and Mexico (Abedi M., May 31, 2018)(2) and finalizing a new trade deal between U.S. and Mexico which may or may not include Canada (Campbell, A.F., Aug 29, 2018)(3).

The reason for such measures is due to Trump’s belief that NAFTA allowed Mexico to “steal” jobs from the United States, causing job loss in the U.S., particularly within the manufacturing industry, and is, thus, the cause of the trade deficit that has plagued the country for a long period of time. (4)

However, the economic situation seems to conflict with Trump’s views. NAFTA’s impact on the U.S. job economy has been minimal and the trade deficit would have worsened if not for NAFTA. As such, it would be more sensible to react according to the current situation rather than to heed the advice of a U.S. President whose knowledge of trade appears to be limited. (5)(6)

Why Trump wants out of NAFTA?

Loss of jobs to Mexico

The main reason Trump cited for wanting out of NAFTA, was to bring jobs back to America. During Trump’s presidential election campaign in late 2016, he pledged to create 25 million jobs in the next 10 years. (7). However, this was not feasible, in Trump’s opinion, with the continuation of NAFTA. Since the inception of the 1994 agreement, a total of 850,000 jobs, mainly manufacturing in the U.S. rustbelt, were displaced. (11)

The manufacturing industry has also proven to be significantly important to the U.S. economy, generating $2.1 trillion in GDP (12.5% of total U.S. GDP), and employing 12 million workers in 2013 (8.8% of total U.S. employment). If the situation continues, U.S. would lose more jobs to Mexico and this would have a negative impact on the economy. (10)

Hence, to prevent the further loss of jobs to Mexico, it would be in the interest of the U.S. to leave NAFTA. Furthermore, besides preventing the loss of jobs, it would even bring jobs back to U.S. because the tariffs imposed on foreign goods, would entice companies to carry out production domestically.(10)

Cut down trade deficit

Trump has long argued that NAFTA is “unfair”, blaming the agreement as a factor for the trade deficit that U.S. has incurred over the years. In fact, Trump is basically anti-trade, evident with the pulling out from the Trans-Pacific Partnership (TPP) in 2017. In a speech in Illinois, Trump made a statement which clearly shows how he grossly misinterpreted the term, “trade”.

“If we didn’t trade, we’d save a hell lot of money.”

In Trump’s world, to solve a trade deficit, the solution is to simply cut off trade with all countries. That way, there will not be a trade deficit. Hence, it would not be surprising if Trump decides to pull out from NAFTA, given that Trump has led the U.S. to leave the Trans-Pacific Partnership in 2017, in order to “reduce” trade deficit. (8)

NAFTA is just a scapegoat, automation is the culprit

Unemployment across most developed nations can often be attributed to creative destruction. It is an inevitable process as countries seek progress, through eliminating low skilled jobs, and in return, creating higher skilled job opportunities. Although it is undeniable that in absolute numbers, NAFTA may be culpable for the loss of jobs in U.S., but the impact brought about by NAFTA is not as dramatic as Trump makes it out to be.

In fact, NAFTA’s impact on job loss is minimal, as agreed by most economists who have been studying the issue. Here is an example to demonstrate the case (not a real scenario), using production of fabric and clothes:

As part of NAFTA, U.S. made a deal with Mexico to drop trade barriers if Mexico uses American fabric to make clothes. This would be a fair deal because U.S. presumably produces better quality fabric, while cost of production is lower in Mexico to produce clothes. By tapping on each country’s comparative advantage, Mexico would get more jobs making clothes, and U.S. would get more jobs making fabric.

As seen from the above example, although U.S. may lose jobs on clothes production, but they gain jobs on producing better quality fabric. Assuming that both sectors are relatively similar in size, the loss of jobs to Mexico would not be too significant, which resonates with most economists’ point of view. In fact, these workers who lose their jobs are structurally unemployed, and would have to upskill and move up the value chain as better job opportunities await.

Keeping assumptions aside, a 2014 Peterson Institute for International Economics (PIIE) study of NAFTA’s effects found that about 15,000 jobs on net are lost each year due to the agreement, but that for each of those jobs lost, the economy gains roughly $450,000 in the form of higher productivity and lower consumer prices. This would justify the loss of jobs in absolute numbers, negating the impact NAFTA caused to the labour sector and the economy.

Besides, the real culprit at hand for the loss of jobs is automation. According to a report by McKinsey Global Institute, 73 million U.S. jobs would be eliminated by 2030 and up to 85% of the manufacturing processes in U.S. are attributable to technological change – largely automation – rather than international trade. Automation has increased productivity levels in U.S. factories, despite a fall in employment. (14)

Figure 1: Unemployment vs Real Output(14)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

As a result, profit-making companies would not be hesitant to replace workers with machinery. With the advent of technology replacing human capital, it is conclusive to say that automation is a bigger cause of concern for unemployment as compared to NAFTA.

 

A Trade deficit is not exactly bad

With reference to Trump’s speech, it seems to show that he does not understand what a trade deficit means. Over the years, U.S. has been a huge consumer and has had little savings, which justifies why U.S. trade balance is negative. In fact, being in a state of trade deficit is not always a bad thing. To prove it, Keynesian theory will be utilised to explain, in an open economy.

 

Keynesian theory: Y = C + I + G + NX —- (1)

Y = National Income,

C = Consumption

I = Investment

G = Government spending

(X – M) = Net exports

 

What is National Income?

Logically speaking, the income you earn should be equal to income spent, and income is spent on purchasing goods, placing it into your savings account, and paying your taxes.

Hence, national income is the sum total of consumption (C), savings (S) and taxes (T).

Y = C + S + T —- (2)

 

In an open economy: combine equation (1) and (2)

C + S + T = C + I + G + (X – M)

S + T = I + G + (X – M)

By manipulating the equation,

I = S + (T – G) + (M – X)

S + (T – G) = Personal savings + Government savings = National Savings

(M – X) = Trade Balance

 

For U.S., they are in trade deficit, meaning (M – X) > 0, hence their national savings would be negative. To counteract a negative national savings, they would have large amount of foreign investments. Therefore, deficit actually helps to sustain investments within U.S.

However, as with everything in existence, there is always a need for balance. Too much of a trade deficit would actually harm the economy. According to the U.S. Commerce Department, the country imported goods and services worth $182.5 billion in 2017, while exporting $121.2 billion, resulting in a trade deficit of $61.2 billion – 12% wider than former President Barack Obama’s final year in office. (15)

Figure 2: A graph of the balance of payments of the U.S. from 1992 to 2017(15)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

This is attributable to Trump’s decision to pull out from the TPP. Things seem to be heading south as U.S. is facing retaliation by Canada due to its imposition of steel and aluminium tariffs. As history suggests, a trade war would not do good for any countries involved, and U.S. being in a precarious position, certainly does not want to find itself deeper inside the trench. Therefore, it would be best for U.S. to stick to NAFTA.

 

Conclusion

With the free world being led by a President who can be irrational when dealing with economic issues, the last thing America needs is to pull out from NAFTA. After all, the impact of NAFTA on the labour market is minimal. Meanwhile for a trade balance, U.S. can afford to sustain a deficit, but it cannot sustain it if the debt becomes too large, or if the trade war with Canada becomes too fierce. Hence, the solution to the problems is to continue with NAFTA.

 

 

 

References:

  1. The Balance: History of NAFTA (Online)

https://www.thebalance.com/history-of-nafta-3306272

Accessed on : 8TH September 2018

  1. Global News: S. announces steel and aluminum tariffs, Canada hits back (Online)

https://globalnews.ca/news/4244344/us-steel-aluminum-tariffs-canada-exemption/

Accessed on: 8TH September 2018

  1. Vox: Trump’s trade deal with Mexico gives workers more rights than NAFTA. But there’s a catch (Online)

https://www.vox.com/2018/8/29/17791430/trump-mexico-trade-deal-nafta-labor

Accessed on: 8TH September 2018

  1. Financial Post: Trump’s obsession with the U.S.’s trade deficit is about to get worse (Online)

https://business.financialpost.com/news/economy/u-s-trade-deficit-shouldnt-annoy-trump-but-it-will

Accessed on: 8TH September 2018

  1. Market Place: Did NAFTA cost or create jobs? Both (Online)

https://www.marketplace.org/2017/03/21/economy/did-nafta-cost-or-create-jobs-both

Accessed on: 8TH September 2018

  1. Financial Post: Trump’s obsession with the U.S.’s trade deficit is about to get worse (Online)

https://business.financialpost.com/news/economy/u-s-trade-deficit-shouldnt-annoy-trump-but-it-will

Accessed on: 8TH September 2018

  1. The Balance: Can Trump Bring Back American Jobs? (Online)

https://www.thebalance.com/trump-and-jobs-4114173

Accessed on: 8TH September 2018

  1. The New York Times: Trump Claims the U.S. Would Save Money Without Trade. That’s Not What a Trade Deficit Represents. (Online)

https://www.nytimes.com/2018/07/26/us/politics/trump-trade-deficit-fact-check.html

Accessed on: 8TH September 2018

  1. Trading Economics: Labour Cost Figures (Online)

www.tradingeconomics.com/country-list/labour-costs?continent=america

Accessed on: 8TH September 2018

  1. Economic Policy Institute: The Manufacturing Footprint and the Importance of U.S. Manufacturing Jobs (Online)

https://www.epi.org/publication/the-manufacturing-footprint-and-the-importance-of-u-s-manufacturing-jobs/

Accessed on: 8TH September 2018

  1. Quartz: Trump is right to criticize NAFTA—but he’s totally wrong about why it’s bad for America (Online)

https://qz.com/917175/trump-is-right-to-criticize-nafta-but-hes-totally-wrong-about-why-its-bad-for-american-workers/  (for 850,000 jobs loss)

Accessed on: 8TH September 2018

  1. Financial Post: NAFTA unresolved, steel tariff threat still on after Freeland, Lighthizer meeting

https://business.financialpost.com/news/economy/freeland-kicks-off-two-day-washington-visit-with-meetings-at-ustr

Accessed on: 8TH September 2018

  1. News: Mexico is cautious on Trump declaring wat with NAFTA (Online) https://news.videonews.us/mexico-is-cautious-on-trump-declaring-war-with-nafta-2653471.html

Accessed on: 8TH September 2018

  1. Financial Times: Most US Manufacturing Jobs lost to technology, not trade

https://www.ft.com/content/dec677c0-b7e6-11e6-ba85-95d1533d9a62

Accessed on: 8TH September 2018

  1. Financial Post: US Trade Deficit shouldn’t annoy Trump but it will (Online) https://business.financialpost.com/news/economy/u-s-trade-deficit-shouldnt-annoy-trump-but-it-will

Accessed on: 8TH September 2018