Political economist Marc Melitz weighs in on what the United States has to lose when trade agreements come undone.
By Michelle Nicholasen, Communications Specialist, Weatherhead Center for International Affairs
After President Trump withdrew the United States from the Trans-Pacific Partnership (TPP) trade agreement earlier this year, it seemed that NAFTA was next in his crosshairs.
But soon President Trump is expected to take a measured approach to the issue of trade and step away—at least temporarily—from his threats to dismantle the North American Free Trade Agreement (NAFTA) by signing an executive order calling for a comprehensive study of US trade imbalances. The Trump worldview has consistently blamed foreign trade deficits, especially those with China, for job losses here at home. He has wanted to take down NAFTA to purportedly save American jobs, calling it “the single worst trade deal ever approved in this country.”Much like healthcare, trade networks are complicated, and not all agreements have the same goals. It’s instructive to take a closer look at both TPP and NAFTA, two very different trade agreements, to evaluate how a more protectionist stance might play out.
Heavily promoted by the Obama administration, TPP would have allowed the United States to form a trade consortium with eleven Pacific Rim nations (representing 40 percent of the world’s GDP) to secure market access and protections for certain US industries. More than this, the political reason to join TPP was to provide a US-led counterweight to China’s growing dominance in the region’s economy.
Now that the opportunity is gone, the TPP signatory nations are wondering who will fill this leadership void. Some members, like Japan, are open to inviting China into the pact. Most likely the consortium will thrive, but the United States will not have a seat at the table and will therefore not be able to ensure that its interests are represented.
President Donald Trump never hid his distaste for TPP, whereas Hillary Clinton first supported the trade pact, then later stepped away from it. The prospect of giving Asian goods even freer access to US markets fed Trump’s campaign rhetoric that TPP would lead to job losses in the United States. But its greatest criticism was that it was primarily focused on protecting intellectual property in industries such as software, pharmaceuticals, and movies. And some of its provisions were seen as going too far, ultimately curtailing individual freedoms regarding use of digital property. For example, it called for restrictions on “fair use” of media, expanded copyright periods, and installed criminal sanctions for copyright infringement for non-commercial use. So maybe the loss of TPP membership is not such a profound one; after all, President Trump has vowed to fashion individual trade deals with each signatory country, ad hoc.
NAFTA, on the other hand, is a “non-theoretical” trade agreement that has a track record and measurable positive outcomes.
Since 1994, the North American Free Trade Agreement has allowed the United States, Canada, and Mexico an easier, tariff-free pathway for exporting and importing goods. NAFTA has been called a failure, and, in Trump’s words, “the single worst trade deal ever approved in this country.” It has been blamed for American job losses, and has fixed in our minds the image of factories transplanted south of the border. Who could forget Ross Perot’s prediction that if NAFTA passed, we would hear the “loud sucking sound” of factories leaving the country?
With enough time and data, even the most controversial questions can sometimes find new light. Today, economists widely agree that NAFTA has indeed increased trade between the three countries and along the way has also led to some positive gains for all three economies (in terms of GDP and wages).
“The view from most economists is that these kinds of agreements do three things: 1) They lower prices for consumers; 2) they change the distribution of jobs; and 3) they make the whole manufacturing process more efficient. They are not expected to raise—nor lower—the overall level of employment,” says Weatherhead Faculty Associate Marc Melitz, David A. Wells Professor of Political Economy at Harvard University.
In its 2015 review, The Congressional Research Service concluded that NAFTA “did not cause the huge job losses feared by the critics or the large economic gains predicted by supporters.”
Some economists point to the fact that after NAFTA, a trade surplus with Mexico turned into a slight trade deficit. They say the United States has lost 600,000 jobs over the last two decades due to a surge in imports, but they also admit that some of the import growth would have likely happened without NAFTA.
Melitz believes that looking only at trade balances misses the bigger picture. Today, Canada and Mexico are the United States’s two largest export markets. The three economies are deeply intertwined, and it’s been a good thing for all three countries, he says.
Looking at the auto industry, Melitz emphasizes the interconnectedness of all three markets in the production value chain. Cars bought in the United States today contain parts and labor from all three countries. The United States and Canada tend to specialize in parts such as engines, transmissions, and gearboxes, whereas Mexico produces relatively more labor-intensive parts such as dashboards, upholstery, and seats. Vehicle assembly has also been optimized: Mexico handles a higher share of the smaller vehicles and functions as a hub for exports to Latin and South America, whereas bigger vehicles are consolidated in the United States. You can see this with the Volkswagen system, where Golfs and Jettas are put together in Mexico and the US plant in Chattanooga assembles Passats.
“And we have seen this increased efficiency in the auto industry,” Melitz says. “It’s a win-win for all NAFTA countries as consumers benefit from lower car prices and workers benefit from higher wages.” The parts embodied in a newly assembled car may have crossed NAFTA borders multiple times before that final assembly stage is reached.
When factories are relocated and people lose jobs, the adjustment is deeply uprooting to a community. More vulnerable workers with lower education and limited job mobility bear the disproportionate brunt of these displacements. The US Trade Adjustment Assistance program provides extended unemployment coverage (for an additional year) and tuition reimbursement (for new job skill acquisitions) to workers who are displaced by a plant closure due to import competition or an overseas relocation to a country receiving preferential access to the United States. However, relatively few workers are able to qualify for this severely underfunded program, and those that do often need longer-lasting unemployment coverage. In addition, unemployment spells caused by either import competition or overseas relocations account for a very small fraction of the total involuntary displacements associated with extended mass layoffs. Melitz argues that “the best policy response to this serious concern is to provide an adequate safety net to unemployed workers—including new skill acquisitions and retraining—without discriminating based on the economic force that induced their involuntary unemployment.”
“You can always find a product made in Mexico and say this could be produced here, but at the same time there are some new jobs in the United States made possible by this new integration,” Melitz says. For example, the Department of Commerce figures show that US exports to Mexico supported an estimated 1.1 million jobs in 2014. Today, almost all of Michigan’s exports are concentrated in the auto sector going to Canada and Mexico, supporting 270,000 jobs.
If NAFTA were to be repealed or renegotiated, Melitz and others foresee serious supply chain disruptions. American auto companies would face higher parts costs from Mexico, forcing them to raise prices and become less competitive against foreign manufacturers. And losing global market share to foreign competitors will lead to job loss in the United States for those manufacturers. A shake-up would also negatively impact the agricultural goods and produce markets.
Determining the actual causes of job losses is politically and economically loaded. Indeed, an entire presidential bid can ride on the belief systems around this single issue.
Melitz notes that long before NAFTA and China’s entry into the World Trade Organization, manufacturing and factory jobs had been disappearing due to automation, innovation, and new technologies. It’s true that Chinese goods have flooded our market since 2001, and it’s also true that the early years of NAFTA triggered regional job loss “shocks.” But the overall trend downward, Melitz argues, began long before the big trade agreements. A quick representation of this decline in US manufacturing jobs (as a share of total employment) since 1960 is shown in the figure below, along with the explosive growth in US imports from China (as a share of US manufacturing production) four decades later. “It is hard to see the impact of either NAFTA or growing Chinese imports on this steady decline in the manufacturing employment share, which started several decades earlier,” says Melitz.
“If you do something across the board as it’s been proposed, like putting a tariff on all Mexican imports, it’s going to end up hurting the group that you are supposedly trying to help,” Melitz warns.
Given the mandate of today’s executive order, the Trump Administration is giving itself some time to assess the impact of trade relationships across the board, and NAFTA in particular. Perhaps, and this is only speculation, President Trump’s friends in the auto industry have asked him to slow down and use caution.
Weatherhead Center Faculty Associate Marc Melitz is the David A. Wells Professor of Political Economy at Harvard University. His research focuses on international trade and investment, and producer-level responses to globalization.
- NAFTA image by Kristin Caulfield.
Graph on “Share of U.S. Manufacturing Employment and Imports from China.”
Source: Marc Melitz