At S&P Global, we’ve looked closely at the possible impact of a demise of the North American Free Trade Agreement, a radical restructuring or some other unknown outcome as renegotiation talks proceed. We’ve been looking at the issue both recently and for much of last year; for example, our Latin American economists, Joaquin Cottani and Elijah Oliveros-Rosen, published a paper in March 2017 declaring their conclusion in the title: "The North American Free Trade Agreement is a Good Deal for both Mexico and the U.S.” This web feature also draws from recent work by chief U.S. economist Beth Ann Bovino and chief Canadian economist Robert Palombi. Cottani and Oliveros-Rosen also wrote a more recent paper on the NAFTA negotiations. Our question and answer here looks at some of the key conclusions we have reached about the impact of NAFTA so far and the consequences of its demise or radical scope reduction.
How much has NAFTA meant for increased economic activity?
All of our conclusions are that the impact has been positive. In her recent commentary on NAFTA, chief U.S. economist Beth Ann Bovino described the impact as “modest…adding several billion dollars to economic growth each year.” It’s a “drop in the bucket” against the size of the total U.S. economy, but is a far cry from descriptions of it as a “disaster.”
The Cottani-Rosen paper looks at the statistics, and says since NAFTA was enacted in 1993, Mexico’s annual exports to the U.S. rose from $40 billion to $296 billion, and U.S. exports to Mexico jumped from $42 billion to $236 billion. (If $40 billion in 1993 had just tracked inflation, it wouldn’t have even doubled, to give some perspective on the size of the growth). Still, those Mexican exports are less than half—about 40%--what the U.S. imports from China each year.
The Trump administration has signaled that one of its goals is a significant reduction, if not outright elimination, of the more than $60 billion trade deficit that the U.S. currently has with Mexico. Is this a feasible goal?
A more recent Cottani-Rosen paper makes clear that it isn’t. If NAFTA goes away and Most Favored Nation tariffs are put in place as a substitute, it won’t be enough to eliminate the trade deficit. What might work? Our economists are clear: nothing. “(T)rade deficits are a macroeconomic occurrence that results from a shortage in domestic savings relative to investment; to reduce a trade deficit the U.S. would have to increase national savings by lowering consumption or investment, or by reducing its budget deficit,” the more recent Cottani/Rosen paper writes. “Recent proposals out of the White House to reduce corporate and individual tax rates would challenge the latter option.”
Does NAFTA simply shift economic activity from one country to another? Are there actual winners and losers?
With so much focus on jobs lost, are there jobs at risk in the U.S. if NAFTA fails?
As Bovino notes in her paper, “The Organization for Economic Cooperation and Development found that 2.8 million U.S. jobs that involve storing or shipping final goods could be lost if NAFTA is unwound.” The U.S. Chamber of Commerce says the job count from Canada/Mexico/U.S. trade is approximately 14 million employees. Many of those existed before, but they found that nearly 5 million net jobs are supported by the higher trade levels thrown off by NAFTA. Describing a job as "supported by NAFTA" does dodge the question of whether a job was created by NAFTA—or destroyed—is the same thing as a job being supported by the treaty.
There’s a third country in there: Canada. What’s been the net benefit to that country?
If you strip out energy—granted, a big if—the U.S. runs a trade surplus with Canada. (The total trade deficit including energy was $11 billion in 2016). As S&P Global’s chief Canadian economist Robert Palombi wrote in a recent paper, it’s a $1.4 trillion relationship, with the U.S. being the customer for 75% of Canadian exports, and Canada’s import flows coming two-thirds from the U.S. Palombi cites a report by ImpactECON that sees Canadian job losses at more than 125,000 over 3-5 years if NAFTA collapses and is replaced by trade governed by the rules of the World Trade Organization.
Whereas Mexico has seen various increases in manufacturing—Cottani/Rosen reports a gain of 300,000 workers since 2007 in the automotive field-- Canada has not seen a boost in manufacturing jobs under NAFTA. Palombi reports that manufacturing jobs are down 20% since the late 1980’s, but “blaming the decline entirely on international trade and an offshoring of production ignores a larger set of changes, including automation, that have influenced labor market dynamics.”
Is there too much focus just on job loss numbers?
Possibly. As Palombi notes in reviewing the Canadian experience, “Focusing on jobs lost to offshoring or those permanently eliminated by automation might create the impression that international trade has left Canadian workers behind.” An economy can try to adapt to shifting trends; on a microeconomic level, so can individual workers train for new professions. The degree to which it has happened in Canada is unclear (and by extension, Mexico and the U.S.) “Increasing numbers of displaced workers, on the other hand, could increase income inequality—something free-trade critics highlight when advocating for effective government policy to do more to support disadvantaged workers,” Palombi writes. “The data for Canada is mixed."
There are out-of-work manufacturing employees who can cite to a specific plant closing, activities taken to Mexico, that would clearly cite NAFTA as a “disaster.” Isn’t NAFTA responsible for the decline of the U.S. manufacturing sector?
It is debatable whether there’s a decline. As Bovino notes in her paper, all measures of manufacturing productivity and growth are pointing to what she describes as a “mini-renaissance of sorts.” But jobs in the field were at a peak of 19.6 million in 1979 and stand at 12 million today, and that is up from a bottom of about 11.5 million in 2010. Re-emphasizing the size of these losses compared to the total job market, she writes: “There are about 1.7 million layoffs in the U.S. labor market every month under normal conditions in a jobs market that employs around 150 million people.”
Has there been an impact on wages?
Cottani/Rosen spell out an academic argument that if goods that can be imported are labor-intensive—and the general assumption is that goods going to the U.S. from Mexico generally are—that will hurt real wages of non-skilled U.S. workers. The opposite happens for those more capital-intensive products that go from the U.S. to Mexico. “In a nutshell, all of these factors have the potential of increasing the real income of U.S. capitalists and skilled workers at the expense of that of non-skilled workers.” But still, the paper says “empirical evidence” is that the impact in the U.S. from that commerce with Mexico has been small, as opposed to China, where it has been more substantial.
Has the U.S. lagged in manufacturing jobs because of productivity?
To the contrary - when measured by productivity, the U.S. manufacturing sector is in good shape. Deloitte, in its 2016 Global Manufacturing Competitiveness Index, rated the U.S. manufacturing sector second-most competitive in the world, after China. It also expects the U.S. to surpass China by 2020 in that measure, with advanced technologies driving the improvement.
If it is having minimal impact, and there are at least some jobs that can be cited as having been lost because of it, why continue with NAFTA?
It mostly comes down to the consumer. As Bovino writes: “Higher prices on imports from Mexico and Canada could crimp U.S. consumer demand, hurting businesses’ revenues and resulting in less need to hire workers—particularly in low-skilled jobs.”
In less academic circles, defenders of NAFTA describe it with anecdotes, e.g., “So if I can buy that car cheaper as a result of Mexican imports, yeah, it hurts an auto worker in the U.S., but I’ve been satisfied and I’ve got an extra $1,500 in my pocket that can be spent somewhere else.”
But wouldn’t it be good for the U.S. to reduce its trade deficit with Mexico?
Fundamentally, the economic definition of a trade deficit is that it is the difference between a country’s aggregate saving and a country’s aggregate investment, in the economists’ definition of investment which is more of an all-encompassing definition of economic activity. As a country seeks to forcibly reduce its trade deficit, floating currencies will need to adjust. If the U.S. takes steps to drive down its deficit with Mexico, that will necessarily result in a decline in the value of the peso. This can lead to the actions taken to cut the trade deficit to do the exact opposite. In a more recent paper by Cottani/Rosen, they write: “(A)s the exchange rate depreciates, net exports increase, partly offsetting the drag on GDP originating from weaker domestic demand. According to our results, the exchange rate depreciation of the Mexican peso more than offsets higher import costs. In other words, under a scenario in which NAFTA ends and MFN tariffs apply, we would expect the trade balance between Mexico and the U.S. to improve in Mexico’s favor.
Beyond the very straightforward title in the Cottani/Rosen paper, how else can you sum up S&P Global’s views on the impact of NAFTA?
As for Canada, Palombi is clear in his paper that the higher level of international trade has been a winner for that country. Imports are about a third of GDP, which means that “the additional purchasing power from low tariffs is significant.” If purchasing power declines because of the imposition of new tariffs as Canada, Mexico and the U.S. go back to the pre-NAFTA days (or in the case of Canada, before an earlier deal known as CUSFTA), Canadian GDP could drop as much as 0.8%, That’s more than half of Canada’s 2016 growth rate.
Bovino’s paper is also consistent in its conclusions on the positive impact of NAFTA.
- “NAFTA may have helped keep some jobs in place—and may even be responsible for creating employment—as the U.S. continued its decades-long march toward being a services-heavy economy, rather than a goods-producing one."
- (On the supposed benefits of ending NAFTA): “It's difficult to see the economic benefits of increasing prices on Mexican and Canadian imports for 45 million low-income Americans (as well as everyone else) in an effort to save just some of the jobs in an industry that accounts for roughly 85 of every 1,000 full-time jobs in the U.S. labor force.
- (On a post-NAFTA trade regime): “All of this assumes that the unwinding proceeds without any retaliation, and that all actors abide by World Trade Organization rules on tariffs.” The Trump administration has suggested it could ignore some WTO rules and rulings.