The Looming NAFTA Disaster

 

The North America Free Trade Agreement (NAFTA) among Canada, Mexico, and the United States was put into place in November 1993 with the staunch support of the Clinton administration. A sweeping agreement that lifted major trade barriers among these three nations, NAFTA had its share of problems when it was implemented, including the dislocation of some workers. But the mutual gains from free trade dwarfed any losses associated with the agreement. Now, over twenty years later, NAFTA needs to be updated to take into account new technologies, such as those associated with the digital economy. As the agreement gets renegotiated, all three parties should make as few changes as possible to bring the agreement up to date without altering its fundamental structure. But that might not happen. Each of the three signatory nations has adopted a tough bargaining position that could result in a breakdown of the treaty, which would be the greatest trade disaster in recent years.

The American public seems to be mixed on free trade. On the one hand, during the recent presidential campaign, much of the electorate, including many Republicans, turned against the Trans-Pacific Partnership (TPP), a free trade deal among Pacific Rim nations, while still announcing their support for free trade in the abstract. But upon taking office, Donald Trump proudly but foolishly withdrew from the TPP, and since that time has taken every opportunity to denounce free trade and to express his frustration with NAFTA. Today, his demands on NAFTA, as communicated through his trade representative Robert Lighthizer, have effectively deadlocked negotiations going forward.

Trump’s position is particularly galling because of the total discontinuity between his approach on domestic and foreign economic issues. Just last week, I wrote a column that strongly defended Trump’s efforts to introduce competition and choice into the health care market. The same principles that work to make a domestic economy great apply with equal force to the international one. Giving consumers many choices induces suppliers to provide those goods and services that people want at prices that they can afford; otherwise, the suppliers will lose business to their competitors. To achieve success, firms must not only develop their own workforces, but deal with other firms to acquire the needed inputs, which are often more cheaply purchased than made. Some of these inputs will be acquired from overseas sources, so the objective of a sound trade policy should be a seamless interface between domestic and foreign markets—which is precisely what NAFTA helped achieve when it integrated the economies of its three separate signatories.

It is impossible to predict the exact patterns of trade that will develop, but that is just the point. The parties on the ground will have better knowledge of their comparative advantage, and will thus be able to coordinate their affairs better than any government could. The gains from free trade have led every major industry group, as well as the United States Chamber of Commerce, to stoutly oppose Trump’s anti-trade initiatives, which it regards as “highly dangerous.” These parties are even prepared to take the matter to court to oppose the President. They hope to find some sound constitutional arguments to show that Trump does not have the unilateral power to terminate the agreement without Congressional consent.

The President, without looking at any of the particular details, seems confident that NAFTA is a bad deal for America because it has led to trade deficits with Mexico ($55.6 billion in 2016) and Canada ($12.1 billion for 2016)—and to the displacement of some American workers. But this is sophomoric thinking. Free trade consists of three separate elements. First, there are the goods and services that move from the United States to Canada or Mexico. The firms that sell these goods and services make profits, as do the Canadian and Mexican firms that acquire them. Killing NAFTA would destroy those gains. Second, there are the goods and services that move into the United States from Canada and Mexico. The same happy scenario applies. Both sides to these transactions gain, and the gains to the American side include the ability to incorporate services and goods from foreign countries into the goods and services that we then sell into the global market. And finally, there is the net investment into, say, the United States if the balance of trade runs in favor of Canada or Mexico. That investment fuels the creation of new businesses (and new jobs) in the United States. But all of this gets smashed if NAFTA is upended.

Trump ignores these gains by pointing to the individual workers who are displaced when American plants close down and move to Mexico. It is the classic mistake of looking at the losses attached to particular persons—which, of course, are both unfortunate and inevitable in all thriving markets—without looking at the total number of jobs created in the United States because of the greater flow of goods, services, and investments into this country. Besides, there’s nothing to say that if those jobs do not go to Mexico they will stay put. The firms in question could fail because of their high cost structure, or they could choose to relocate, as many firms have, to other states that have more favorable business environments. There is no way to insulate individual workers from the changing rhythms of international—and domestic—trade.

But Trump continues to push his bogus America First agenda that will drive a wedge between the United States and its allies, even over the objection of Republican stalwarts like George W. Bush. In the NAFTA negotiations, Trump is making two mindless deal-breaking demands. First, he wants to incorporate a “sunset clause” which would “automatically” call for an end to the deal after five years unless all three signatories signed on for its extension. Putting in place a guillotine is madness. Investment and trade relationships need long-term time horizons to allow businesses to avoid having to write off their front-end costs immediately. The uncertainty that a sunset provision creates would cripple investment and trade even if NAFTA were otherwise retained. The case for free trade is so compelling that a far longer period is appropriate; renegotiation must be centered on bringing new goods and services into the free trade fold, not on blowing up the agreement entirely.

Next, Trump wants all trucks and cars imported from Mexico or Canada to contain a minimum of 50-percent American-made parts. First of all, that provision would create a huge administrative burden. Second, it would impose real losses on American automakers. It also invites retaliation by both Canada and Mexico. So, it’s clearly a lose/lose proposition that would make the United States an international laughing stock.

There is yet another dire consequence to Trump’s overreaching. It has inspired Canada (but, as of yet, not Mexico) to make outlandish stipulations of its own. The Canadian foreign minister Chrystia Freeland has put forward a list of 10 NAFTA demands, some of which make perfectly good sense like her opposition to “Buy American” rules. But she makes a grievous mistake in suggesting that NAFTA is the appropriate forum to thrash out the issues dealing with labor, gender, indigenous people, and environmental rights.

Each country’s internal business arrangement is its own affair. The great strength of free trade agreements is that the entry (and exit) of goods and services is a wake-up call that forces domestic parties to clean up their acts. The Canadian labor law is more protective of unions than its American counterpart; these Canadian rules introduce inefficiencies into the system that cannot last in the face of free trade. A good analogy is the competition between American states that have Right-To-Work laws and those that do not. If the Canadian system works, it should be able to withstand the competition. If it cannot, Freeland’s labor caveats introduce a closet protectionism that undoes much of the benefits of NAFTA.

Similarly, Freeland’s broad demand that no nation be allowed to weaken its environmental protection rules to attract foreign investment locks everyone into inefficient local laws—like Obama’s Clean Power Plan—that should be revised wholly without regard to NAFTA. Canada has a legitimate beef when it protests pollution emissions that cross over its borders. But those issues should be addressed as independent grievances outside of NAFTA. It makes no sense to let one nation determine the wetlands policy of its neighbor. The same logic applies to the rights of indigenous peoples and gender issues generally. The effort to find agreement here only creates additional opportunities to subvert free trade. Yet now that Trump has made his own unreasonable demands, the Canadian non-cooperative strategy looks like a reasonable form of retaliation. If the United States and Canada don’t back off, we could end up with a terrible result that is in nobody’s interest.

© 2017 by the Board of Trustees of Leland Stanford Junior University

There are 14 comments.

  1. ToryWarWriter Thatcher

    My country of Canada, refuses to treat this seriously. Certainly PM Harper would be a better person to have at this time. But Mr. Sunnways seems oblivious to whats going on.

    America sends billionaires to negotiate. We send an academic who literally cried when the Wallon nearly scuttled the European deal.

    However we will cave in the end. Cause America is a lot bigger than us, and we know what breads our butter.

    Also I look forward to having Trudeau forced to close down Supply Chain management.

    • #1
    • October 25, 2017, at 2:58 PM PDT
    • 2 likes
  2. Mitchell Messom Inactive

    Richard Epstein: There is yet another dire consequence to Trump’s overreaching. It has inspired Canada (but, as of yet, not Mexico) to make outlandish stipulations of its own. The Canadian foreign minister Chrystia Freeland has put forward a list of 10 NAFTA demands, some of which make perfectly good sense like her opposition to “Buy American” rules. But she makes a grievous mistake in suggesting that NAFTA is the appropriate forum to thrash out the issues dealing with labor, gender, indigenous people, and environmental rights.

    The silly demands by the Canadian delegation is seen by the Conservative opposition and Liberal insiders as grand standing for the Liberal base, so they can say “we brought it up!” it would have happened regardless of Trumps demands. Unfortunately the diary and poultry thing is for real.

    • #2
    • October 25, 2017, at 3:01 PM PDT
    • Like
  3. Mitchell Messom Inactive

    ToryWarWriter (View Comment):
    Also I look forward to having Trudeau forced to close down Supply Chain management.

    I actually hope that is one thing they compromise on and then I hope the Conservatives stay quite about for the next election.

    • #3
    • October 25, 2017, at 3:03 PM PDT
    • Like
  4. OccupantCDN Coolidge

    I think that both sides want to kill NAFTA, but neither side wants to take the blame for killing it.

    • #4
    • October 25, 2017, at 4:53 PM PDT
    • Like
  5. genferei Member

    So considering the consequences to individuals is sophomoricly impermissible, but we need long time horizons so firms can make profitable decisions. Chaos for human beings: suck it up, buttercup. Uncertainty for corporations: the end of the world!

    In the long run, and in aggregate, free trade beats “fair trade”. But to think it is easy to find the balance between “the losses attached to particular persons” with “the total number of jobs created … because of the greater flow of goods, services, and investments in [the] country” is surely naive. And in a democracy, these difficult matters of balance are left to the people, mediated via elections. If you want the “free trade” case to be convincing to the nation, a better job needs to be done than has been done in recent times. This article is not a great start.

    • #5
    • October 26, 2017, at 2:39 AM PDT
    • Like
  6. ToryWarWriter Thatcher

    Free Trade is a religion as much as environmentalism. Criticize it and point out its flaws to its exponents and you get the same response. Either silence, or denunciations.

    Protectionism is so terrible, except for the US during the 19th Century and the Chinese during the 20th.

    • #6
    • October 26, 2017, at 3:32 AM PDT
    • 1 like
  7. I Walton Member

    Epstein makes the usual and sound case for free trade and against attempts to micro manage an economy including its external sector. My general approach to these trade negotiations is that we are not as good at negotiating them as some of our partners. We have the disadvantage of having relatively fewer barriers to bargain with and those we have we won’t touch. Secondly, big trading partners like China and Japan do not use traditional barriers to trade so negotiations take us deeply into the their domestic affairs where we’re way out of our depth. Our current account deficit is the result of government deficits and low savings rate and have almost nothing to do with trade. The problem that drives the issue is our sluggish adjustment to changes in trade or technology. We used to adjust because older technologies allowed easier adjustment for workers and business and the regulatory and burdensome government superstructure, our poor educational system our lack of training, minimum wages, welfare and unemployment insurance etc. now make the formation of new business more difficult. Adjustment requires new investment, new efforts and requires new enterprises or efforts to form fast enough to absorb the dying edge of an economy. Big old business in contrast finds adjustment burdensome so they spend their adjustment dollars, (so to speak) lobbying Washington for protection and subsidies. In this latter we find the death of our economy and that is why we free trade guys don’t want any direct central government attempts to pick and choose winners and losers.

    There are approaches to all of these issues that do not require micro management of trade which will always be corrupt and harmful just like micro management of the domestic economy will always be corrupt and harmful. The dollar is the world’s currency so we can run deficits as long as countries are willing to hold and trade dollars, but this means we can’t adjust to trade imbalances through devaluation and it means when the world no longer wants to hold and trade in dollars it all over for us. So the issue is vital, but it’s not a trade issue. The issues are dynamism, adjustment and savings. These President Trump is addressing in deregulation, promises of educational reform and taxes. However, the tax plan we’re seeing is inadequate. It must address our low savings rate, i.e. our excess consumption. He could have addressed these through a number of approaches but it doesn’t appear that his tax plan does so. Still the focus on trade provides a powerful vehicle that both addresses his campaign promise and his focus on trade imbalances without getting into the harmful and corrupting process of micro managing traders. We could impose an across the board uniform tariff (alternatively a VAT)on the whole world, this would reduce deficits, tax consumption burden imports and provide negotiating leverage as trading partners want to come to our side of the tariffs.

    • #7
    • October 26, 2017, at 4:34 AM PDT
    • 1 like
  8. I Walton Member

    duplicate

    • #8
    • October 26, 2017, at 4:37 AM PDT
    • Like
  9. I Walton Member

    I say or a VAT because I strongly prefer that approach but it’s not yet in the cards while a uniform tariff might be because it plays to economists, free traders and anti free traders.

    • #9
    • October 26, 2017, at 4:42 AM PDT
    • Like
  10. OccupantCDN Coolidge

    ToryWarWriter (View Comment):
    Free Trade is a religion as much as environmentalism. Criticize it and point out its flaws to its exponents and you get the same response. Either silence, or denunciations.

    Protectionism is so terrible, except for the US during the 19th Century and the Chinese during the 20th.

    This also points to the ‘new normal’ of political discourse. Ideas are no longer debated, but rather representatives of those ideas are smeared and subjected to character assassination.

    With several caveats, I think most agree that freer trade is economically beneficial to both parties.

    Both Trudeau and Trump want NAFTA to end, so Canada comes forward with environmental, labor and other silly standards to attach to the treaty, and Trump puts a 220% tariff on Canadian jets. Each hoping the other would be so angered, that they’d end it.

    NAFTA’s ending could be good – if it gets replaced by real free trade, and not managed trade. I know a pipe dream when I see it.

    • #10
    • October 26, 2017, at 7:21 AM PDT
    • 1 like
  11. Randy Weivoda Moderator

    OccupantCDN (View Comment):
    NAFTA’s ending could be good – if it gets replaced by real free trade, and not managed trade. I know a pipe dream when I see it.

    NAFTA is not totally free trade. But it is substantially free-er than what we had pre-NAFTA. How about we amend NAFTA to make it more free, rather than dumping it and starting all over again? Unfortunately the changes that are being proposed — or at least the proposed changes that are making headlines — are moving us in the direction of less trade freedom, not more.

    • #11
    • October 26, 2017, at 7:43 AM PDT
    • 1 like
  12. OccupantCDN Coolidge

    Randy Weivoda (View Comment):

    OccupantCDN (View Comment):
    NAFTA’s ending could be good – IF it gets replaced by real free trade, and not managed trade. I know a pipe dream when I see it.

    NAFTA is not totally free trade. But it is substantially free-er than what we had pre-NAFTA. How about we amend NAFTA to make it more free, rather than dumping it and starting all over again? Unfortunately the changes that are being proposed — or at least the proposed changes that are making headlines — are moving us in the direction of less trade freedom, not more.

    Yes, that’s why I called it managed trade. The US – Canada trade has been managed for decades, beginning with Auto Pact in 1965 and (so far) culminating in NAFTA. Each trade agreement has been broader and more invasive management than the last trade agreement.

    • #12
    • October 26, 2017, at 7:48 AM PDT
    • Like
  13. I Walton Member

    OccupantCDN (View Comment):

    ToryWarWriter (View Comment):
    Free Trade is a religion as much as environmentalism. Criticize it and point out its flaws to its exponents and you get the same response. Either silence, or denunciations.

    Protectionism is so terrible, except for the US during the 19th Century and the Chinese during the 20th.

    This also points to the ‘new normal’ of political discourse. Ideas are no longer debated, but rather representatives of those ideas are smeared and subjected to character assassination.

    With several caveats, I think most agree that freer trade is economically beneficial to both parties.

    Both Trudeau and Trump want NAFTA to end, so Canada comes forward with environmental, labor and other silly standards to attach to the treaty, and Trump puts a 220% tariff on Canadian jets. Each hoping the other would be so angered, that they’d end it.

    NAFTA’s ending could be good – if it gets replaced by real free trade, and not managed trade. I know a pipe dream when I see it.

    Yes. Free trade is a term we use to battle against organized interests whether those interests focus on domestic or international trade. While highly open trade regimes have problems, like all freedom and relatively free domestic markets, the notion that a government can manage trade more effectively, efficiently and prosperously than free people engaging in trade is utter nonsense. This interventionist approach of central economic control is truly a religion because there is no evidence of it working effectively, no theory that justifies it, and it always ends poorly and has to be argued against from zero with each new generation.

    • #13
    • October 26, 2017, at 9:55 AM PDT
    • Like
  14. ToryWarWriter Thatcher

    Here are last PM gives a reasoned response to the whole crisis. If our PM Had two braincells to rub together he would send him down as our chief negotiator.

    https://globalnews.ca/news/3829819/stephen-harper-napping-nafta/

    • #14
    • October 28, 2017, at 7:50 AM PDT
    • Like