“No Nation Was Ever Ruined by Trade” — Benjamin Franklin
(760 words, three-minute read)
After two years of tariffs and bellicose rhetoric, a revision of the North American Free Trade Agreement (NAFTA) was recently agreed upon. What really happened? The fact-based and rational answer is “not much.”
First, a quick review of the economics of trade from our prior Commentary entitled “Does Anyone Believe in Free Trade?”
Most economics textbooks begin with an explanation of “comparative advantage,” a widely accepted concept that provides the basis for trade. If country A builds a car more efficiently than country B, and country B grows corn more efficiently than country A, both are wealthier by specializing in what they do best and trading for the rest. Country A builds cars and trades them to country B for corn, and vice versa. This simple concept has driven the growth of trade and wealth since the beginning of humankind.
While trade makes consumers wealthier by lowering costs, it also subjects producers to non-local competition, and inevitably the high-cost producer loses. Given this, governments have often imposed tariffs to protect industries with political influence. With tariffs, consumers pay more for imported goods, and that higher price in the marketplace enables the less efficient local producer to survive. The protected producer wins, but the consumer at large loses.
Historically, the consensus has been that the benefits of trade outweigh the cost, and trade agreements designed to lower tariffs and increase trade have continued to flourish. The political problem of trade agreements is that it is easy to identify the losers—think empty steel mills and factories—while it is hard to identify the winners, because the winners are all of the individual consumers who benefit from lower prices. Some politicians exploit this phenomenon by pandering to the losers and promising them better protection. When in office, however, both parties have been pro-free trade. NAFTA, our current topic, was designed by President Reagan, advanced by President George H. W. Bush, and signed by President Clinton.
What did NAFTA do? NAFTA did several things, but the central one was to reduce or eliminate tariffs and other barriers to trade between the US, Mexico, and Canada. Producers who had been protected by tariffs had to compete in a free market, and there were winners and losers among them. For example, many Mexican farmers were unable to compete with US farmers, and many Mexican farmers failed. Some US manufacturers were unable to compete with lower labor costs in Mexico and either closed or shifted production to Mexico. Many US oil and gas producers were unable to compete with imports from both Mexico and Canada. Although negatively affected companies and workers lobbied for protection, trade grew dramatically and consumers everywhere benefited.
President Trump argued that NAFTA was a terrible deal, blaming it for the decline of US manufacturing jobs*. While increased trade has not been the sole cause of the decline in manufacturing employment (automation, manufacturing efficiency, AI, and skill mismatches are also factors), it is clear that some US companies were unable to compete without tariff protection. Nonetheless, once in office the president began the renegotiation process by raising tariffs on imports. As economists commonly observed, this was a tax on American consumers because it made foreign products more expensive. In effect, the president’s strategy was to reverse elements of the original NAFTA in order to improve it.
So what happened? Well, not much. Conceptually, in two areas the new free trade agreement is a bit less free than the last one, as new protections were added to protect the special interests of automobile manufacturing labor and pharmaceutical companies. It did so by lifting the requirement from 62.5% to 75% of automobile components that must be manufactured within North America in order to qualify for zero tariffs. It also increased from 40% to 45% the percentage of cars and parts that must be manufactured by labor paid a minimum of $16 per hour. With respect to the pharmaceutical industry, they won an extension from 10 to 12 years of protection from generic drug competition.
Scorecard: Automobile labor won, pharmaceutical companies won, and because the new requirements will increase the cost of automobiles, consumers and automobile companies lost, as did free trade.
A second change was the agreement by Canada to reduce certain protections of their dairy industry that remained in the old agreement, a change that should result in an increase in exports by US farmers to Canada.
Scorecard: The special interests of US farmers won, Canadian consumers won, Canadian farmers lost, and free trade won.
Finally, the agreement also updated and strengthened certain labor, environmental, patent, and copyright protections across the three countries. Several of these resulted from negotiation between the president and the Democratic House, a rare and welcome example of collaboration in Washington.
*The US economy is at full employment and the job participation is increasing. A valid question, therefore, beyond the scope of today is why the president feels manufacturing jobs are preferred over the non-manufacturing jobs that have resulted in full employment.