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On NAFTA, The Trump Administration Is Using The Wrong Yardstick

On NAFTA, The Trump Administration Is Using The Wrong Yardstick

Phil Levy , Forbes CONTRIBUTOR

On the eve of the third round of renegotiation talks for the North American Free Trade Agreement, Commerce Secretary Wilbur Ross upped his attacks on the deal. He still errs, but he does so in interesting ways. The data, and Ross’ arguments, highlight a core Trump administration confusion on trade: they are trying to comprehend a global trading landscape while blinkered by a focus on bilateralism.

First, the interesting new data. Sec. Ross, in the Washington Post, claims that a new report from his department vindicates NAFTA skeptics’ critiques. To Ross’ credit, the new data does present a more sophisticated look at trade flows between NAFTA countries (Canada, Mexico, and the United States) and the rest of the world. Rather than looking at the gross value of trade flows, the new report works with “value added” figures.

Depending on what argument one is trying to make, this can be a substantial improvement. To see why, imagine that the United States sends $4k of auto parts to Mexico, which then uses those parts to build a $10k vehicle that is exported back to the United States. In gross terms, the United States has imported $10k in this transaction; in value-added terms, only $6k.
Ross uses the new Commerce Department study to argue that there is less U.S. content in imports from NAFTA partners than we previously thought. Focusing on a single sector, he writes: “Hundreds of thousands of Americans go to work every day in the automobile manufacturing industry. The declining U.S. share of content in imports from Canada and Mexico puts those jobs at risk.” He takes the falling share of U.S. content in imports as an indictment of NAFTA’s provisions.

What can we actually glean from the data? The report covers the 1995-2011 time period and shows (Table 1) that the NAFTA share of value added in U.S. manufactured imports (not just autos) fell from 26.9% in 1995 to 22.1% in 2011. However, it is interesting to break that time period down. In the immediate aftermath of the 1994 NAFTA agreement, the NAFTA share rose; it climbed to 29.0% by 2000. The aforementioned drop came only after the turn of the century.

And here the plot thickens. That turning point was roughly when China joined the World Trade Organization – the start of a period that has become popularly known as the “China shock.” Could the declining NAFTA share be due to China grabbing market share? China goes from 4.2% in 2000 to 15.5% in 2011. That would more than explain the NAFTA share drop.

Here we get our first glimpse of the problems with a bilateral fixation in a multilateral world. China’s share did grow, but most of that net share increase appears to be China’s displacement of other Asian countries. From 2000 to 2011 East and Southeast Asia (including China) rose only from 32.4% to 34.7% as a share of U.S. manufactured imports.

The part of the world with the biggest net jump 2000-2011 was not East and Southeast Asia; not the European Union; not South and Central America. It was “Rest of World,” which climbed from 13.2% to 18.8%. To the extent we want to interpret this rise, the most likely explanation is that this reflects a world of ever greater integration and diversification – global supply chains.

Later breakdowns in the report seem to tell a similar story. The U.S. share of manufactured imports from Mexico falls from 1995-2011, but so does the Mexican share! The same is true for the U.S. and Canadian share of manufactured imports from Canada.

So we have interesting new data demonstrating what we already suspected – that manufacturers are distributing production globally to get the best quality they can for the lowest price.

As an aside, there is an intricate question here about “rules of origin” – how much North American content is required to secure NAFTA preferences. Note that the new data does not specify which goods came in under NAFTA preferences, so it is not especially informative in this regard.

Now, we come back to Sec. Ross’ policy arguments. He interprets the data as demonstrating NAFTA’s failure. As he puts it, “We cannot forget that the point of a free-trade agreement is to advantage those within the agreement — not to help outsiders.” There are two key errors here.
The first mistake is to assume that value added in manufacturing imports is a sufficient measure of the well-being of the United States, Mexico, and Canada. It is a slightly more sophisticated measure than bilateral trade balances, but still far from meaningful. There are careful studies about the overall effects of NAFTA; they generally find small positive effects. That’s unsurprising, since U.S. tariffs on Mexico and Canada pre-NAFTA averaged only 2.7 percent and these studies look at the effects of tariff changes.

The second mistake is the narrowness of the goal for NAFTA. In fact, two major U.S. objectives extended well beyond bilateral U.S.-Mexico trade flows (there was already a trade agreement between the U.S. and Canada). The United States wanted an economically-stable partner on its southern border, and it wanted the global propagation of rules that worked to its advantage. NAFTA achieved both.

In the wake of NAFTA, Mexico signed free trade agreements with Chile (1999), the European Union (2000), the European Free Trade Area (2001), Uruguay (2004), Japan (2005), Colombia (2011), Israel and Peru (separately, 2012), Central America (2013) and Panama (2015). Mexico was thus following a pattern set by the United States, which also pursued a series of trade deals over the same time span. This has turned Mexico into a viable manufacturing hub. It has helped achieve the U.S. goal of a stable southern partner. It also means, incidentally, that if the United States blocks imports, Mexico has options.

As to the propagation of favorable rules, the trade deals pursued by the United States and its partners did just that. This process was to culminate in the Trans-Pacific Partnership, until President Trump torpedoed U.S. participation. Mexico and the other 10 erstwhile TPP countries are proceeding without the United States.

Supporters of President Trump sometimes argue that he is playing 4-dimensional chess against more limited opponents. Sec. Ross’ latest arguments and data on trade show they are struggling to deal with even two dimensions. They are making bilateral policy in a multilateral world.

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