The Hidden Implications of Trade Agreements
It’s clear that President Trump is going to shake up U.S. trade policy, but what exactly he will do and when remains unclear. Regardless, he seems to be moving toward an “America First” policy. But economic theory and experience offer little reason to believe that a move towards increased protectionism will benefit the United States.
The differing views we see today are rather a reflection of the fact that the benefits of increased global trade are spread across a wide constituency (consumers, educated workers) while the losses are very concentrated geographically, in terms of industries, and socio-demographically. In support of this, there is ample evidence that the main beneficiaries from U.S. trade with poorer countries are U.S. consumers. Thanks to international trade, clothes in the U.S. cost almost the same as in 1986, and furnishing a house as much (or as little) as in 1980, according to the Bureau of Labor Statistics Consumer Price Index.
Conversely, those most exposed and vulnerable to international competition, such as manufacturers and their employees in the Midwestern rustbelt and in the South, are the ones paying the price for the cheap imports. As we are seeing in the current political climate, the groups who are losing their jobs as a consequence of international trade are far more vocal in their denunciation of trade than the many who have benefited from cheaper clothes, electronics and other imports.
But to pin job losses solely on free trade is misleading. Research has shown that most of the deterioration for those constituencies cannot be accounted for by free trade, but is rather a consequence of technological change, which has led to a sharp increase in the skilled-worker wage premium. Unskilled, low-mobility workers are thus suffering both from international trade and their limited job market appeal in an economy that increasingly values education. For instance, while car making’s contribution to U.S. GDP has fallen by 10% in recent decades, there are 30% fewer jobs in the car making industry, and it is technological change - not outsourcing – that is to blame for this.
Withdrawing from international trade deals has the potential to unleash a slew of unintended consequences, such as increasing China’s sphere of influence in the world. The U.S. withdrawal from the 12-nation Trans-Pacific Partnership (TPP) is likely to lead to increased Chinese economic and political influence in the South-East Asia region. Competing trade talks on a proposed Regional Comprehensive Economic Partnership (RCEP) which includes China, but not the U.S., are already taking place, and China seems likely to fast-track negotiations. The RCEP would include 16 countries and cover 30% of the world economy. Unlike the TPP, the RCEP would exclude higher labor safety and environmental standards, which would have benefitted U.S. companies and workers by raising the cost of production abroad.
The Impact of U.S. Withdrawal from NAFTA: Winners and Losers
An assessment of who stands to win or lose from a possible U.S. withdrawal from NAFTA will invariably look at who has gained from it in the years since it was created in 1993. The main caveat is that quantifying the impact of a U.S. withdrawal from NAFTA cannot be reduced to assessing the value of mutual trade and bilateral trade balances, because over recent years regional supply chains have become highly integrated. For instance, Mexican-made parts are included in U.S. exports to China. It is debatable whether substituting those components for U.S.-made ones will not lead to lost market share in China due to lower price-competitiveness. The same argument applies to U.S. exports to third markets that compete with products made in cheaper locations.
The automobile sector suffered immediate losses on the stock market as the results of the recent U.S. elections came through. Many U.S., Japanese and European auto giants rely on Mexican plants for part of their production, and a breakdown of NAFTA would sharply increase their production costs due to them having to accept tariffs or relocate to the U.S.
U.S. exports of cars and car parts have increased from $10 billion in 1993 to $70 billion in 2013, while American Foreign Direct Investment in Mexico has increased from $15 billion in 1993 to $100 billion today, and a significant part of this is in the auto industry. Indeed, the top U.S. export to NAFTA partners is motor vehicle parts with motor vehicles as the third largest export, and machinery parts the fifth.
Another U.S. sector that is exposed to NAFTA is the energy sector. Non-crude petroleum products and crude petroleum are the second and fourth largest U.S. NAFTA exports. Overall, around 15% of total U.S. NAFTA trade is in petroleum products. Other U.S. sectors that would suffer from a withdrawal from NAFTA include the aerospace sector, trains, large agri-businesses, and appliance makers.
On the winning side of the U.S.’s withdrawal from NAFTA will likely be American clothing companies, which claim to have lost out to cheap imports from Mexico. In general, any U.S. manufacturing company, that relies on a labor-intensive process that is not highly automated or requires advanced technology, stands to win from a cessation of free trade with poorer countries.
Canada had a free trade agreement with the U.S. prior to NAFTA, so the impact of NAFTA on Canada- U.S. trade has been less significant than on Mexico- U.S. trade. The main debate in Canada is about why free trade has not led to a convergence in productivity levels, as Canadian productivity remains nearly 30% below U.S. levels.
However, there are sectors that have gained from the free-trade agreement. Canada has seen a large U.S. investment in its automotive sector, but the main beneficiaries are in natural resources. Canada’s largest export to the U.S. is mineral fuels, while the country is also the America’s largest supplier of agricultural goods. The Canadian wood and paper industry is also considered a NAFTA beneficiary. Canadian sectors that are deemed to have incurred losses because of NAFTA, and which would stand to gain from a U.S. withdrawal from the treaty, are some sub-sectors of steel production and processed food.
The issue is complicated by the fact that an U.S. exit from NAFTA would likely mean a reversion to the initial 1989 U.S.-Canada Free Trade Agreement. However, many of the groundbreaking aspects included in NAFTA were not included in the USCFTA such as intellectual property rights protection, specific cultural exemptions on broadcasting, film and publishing and trade dispute settlement mechanisms that appeared for the first time in NAFTA.
Mexico has clearly gained from NAFTA in terms of increased trade, jobs and investment. The main negative consequence from the NAFTA agreement for Mexico is that the increased trade has not led to an expected convergence in wage levels between Mexico and its far wealthier trade partners, as the country remains chiefly a cheap production base.
In relation to the automotive sector, it is not only U.S. companies, such as GM and Ford, that stand to lose, but also international car manufacturers such as Toyota, Nissan and Fiat which each have production bases in Mexico. In the last six years, global automakers have announced more than $24 billion in Mexican investments. German automakers like Volkswagen, BMW and Daimler are either already present in the country or are planning to move production/assembly lines to Mexico. Consequently, car output in Mexico is expected to more than double from 2010 to 2020, from two million to five million vehicles. These companies are likely to withdraw from the country should their access to the U.S. market be impeded due to the U.S.’s withdrawal from the treaty.
Mexico’s aerospace engineering sector, a recent success story, would also lose from a U.S. NAFTA withdrawal, as would Mexico’s farm exports which have more than tripled since the creation of NAFTA.
What Comes Next for the NAFTA Agreement?
The most likely course of action for the Trump administration is to try and renegotiate the NAFTA agreement, rather than repealing it. The negotiations will likely focus on measures that would raise the cost of labor in Mexico such as stronger labor provisions and environmental standards, and thus lower the incentive for moving U.S. blue-collar jobs to Mexico. Some sort of punitive measures for U.S. manufacturers moving operations to Mexico will also be on the cards.
Reaching a new agreement is complicated by three main factors:
- Mexican Approval—It may appear that as the far wealthier country and the source of most of the FDI in Mexico, the U.S. has the upper hand in the negotiations. However, domestic political considerations will play a part and may in some instances become more important than economic arguments, on both sides of the border. The other complication is the extent to which North American supply chains are integrated across U.S., Canada and Mexico, and the extent to which American companies exporting to the rest of the world depend on these regional, rather than strictly U.S.-based supply chains.
- Congressional Approval—The second main obstacle is U.S. Congress, where the new agreement would have to be approved in the face of competing and often opposing regional interests that cut across political party lines.
- Lower Corporate Profits—Finally, the above-mentioned integrated supply chains mean that a large number of U.S. companies are reliant on free cross-border trade and would incur severe losses should this change. The fallout, in terms of job losses, of cancelling or severely restricting NAFTA, will be far higher and certainly more immediate than any corresponding gain from jobs moving back to the U.S.
Based on a Dun & Bradstreet analysis, we assign a 70% probability that the new NAFTA agreement will include labor and environmental provisions but very little that could be labelled ‘trade barriers.’
Developments in the Trans-Pacific Partnership (TTP): Winners and Losers
Early in 2016, twelve countries, including the U.S., Japan, Canada, Australia and Mexico, signed the TPP trade deal, which would have created a new trade block that comprises 40% of the world’s GDP, the biggest trade agreement in history. For the U.S., the main winners would have been companies in the agricultural sector, particularly beef and pork, as the Japanese market would have opened up to these imports. U.S. companies that rely on intellectual property would have benefitted from the TPP’s increased protection of IP in signatory states. Services companies such as finance and telecoms would also have gained, as TPP would have liberalized trade in services, in which developed countries are generally far more competitive.
For U.S. carmakers, the net outcome is unclear. On one hand, Japan won a gradual elimination of tariffs on cars and car-parts and would have likely increased their exports to the U.S., but on the other hand, American companies would have benefitted from tariff reductions on the Malaysian and Vietnamese markets. The U.S. pharmaceutical sector had also voiced complaints about the deal.
While TPP is not mainly about tariff reductions, the U.S. stood to benefit from the few reductions that were planned. Moreover, the TPP was designed to enforce higher labor safety and environmental standards in member states, which would have driven up labor costs in emerging markets and lowered their cost competitiveness vis-à-vis the U.S.
President Trump’s decision to officially withdraw the U.S. from the TPP was to some extent symbolic; putting an end to President Obama’s signature trade policy allowed Trump to deliver on one of his campaign promises.
The move away from TPP has huge significance for global trade patterns going forward. First, it signals the shift in U.S. trade policy from multilateralism to bilateralism. The President has repeatedly said the U.S. will negotiate one-on-one with its trading partners to get better deals. The Transatlantic Trade and Investment Partnership (T-TIP), yet another proposed trade deal between the U.S. and the EU, is also unlikely to pass (some in the EU oppose it too). And it is not just the U.S. that is leaning towards that approach. Brexit, too, is an example of the UK’s intent to break away from a set of rules that govern multiple countries, in an effort to obtain more favorable concessions via one-on-one negotiations. Teresa May’s recent visit to the White House was demonstratively timed just as both the U.S. and UK make this pivot to bilateralism. Both motions are attempts to reach out to a voter base that in some ways sees globalization and trade as the cause of domestic hardships and unemployment. As a result, global trade policy will most certainly look different in the coming years.