NAFTA AND USMCA: Is North American Free Trade Good for Texas?

NAFTA AND USMCA: Is North American Free Trade Good for Texas?

NAFTA AND USMCA: Is North American Free Trade Good for Texas?

 Doug McCullough, Director of Lone Star Policy Institute
 Adapted from comments at the TPPF 2019 Policy Orientation. Video available here courtesy of Texas Public Policy Foundation

Free Trade is Important for Texas and the United States. Texas is the nation’s largest exporter and the second largest manufacturer. Our top two trade partners are Mexico and Canada. NAFTA eliminated tariffs, reduced trade barriers, and established certain rules for resolving disputes. Texas’ top two trade partners are Mexico and Canada. The Lone Star State has arguably been the top beneficiary of the North American Free Trade Agreement (“NAFTA”) since it went into effect in 1994.

Benefits of NAFTA and Free Trade

Free trade is merely free enterprise that crosses national borders. The nature of free enterprise is to foster competition, reduce input costs, create economies of scale, specialization and innovation.  The US created 20 million more jobs across all sectors in the first 8 years after NAFTA. According to a recent report from Veronique de Rugy of Mercatus Center, the average hourly earnings of production workers in the United States rose rather steadily in NAFTA’s first 20 years in force. These wages were about thirteen percent higher, in real terms, in 2014 than they were back in 1994.

What’s wrong with tariffs?

 Tariffs are taxes… and they are a blunt instrument. They aren’t tailored to address specific problems.

The easy answer is that they are taxes paid by consumers. I think that is largely true. But, depending on other factors such as the elasticity of demand, tariffs may price some imports out of the market – meaning some import transactions won’t happen. In other cases, the seller or producer may bear some of the tariff cost. But tariffs do drive up costs on imports… and domestic products as well. If you are a Pennsylvania steel producer and your foreign competition costs 25% higher now, you will hike your prices. That’s what we are seeing with steel now. If you are a Texas driller, pipeline company or other steel consumer, your margins will either get tighter or you will pass the cost along to your customer… if you can. Your contract may not allow you to pass along the increased materials costs. In that case, your margins just get tighter.

The Relevancy of Trade Deficits

 A trade deficit is not a particularly useful metric for measuring the health of an economy.  Trade is not a zero-sum game. There is a perception that a trade deficit is inherently bad. In a free-market exchange, money is traded for goods of the same perceived value. Each side gets what they bargain for. It’s a win-win.

But looking at it another way, trade should balance globally when you balance all exports and all payments or investments. If you are a Texas company selling widgets, you don’t sell those widgets unless you get paid in return.

Another common problem with trade deficit computations is that it often doesn’t include services. That’s particularly baffling in the modern economy. The administration badgered Canada about a trade deficit, but once we factor in services, we actually have a trade surplus. Calculating trade balances without including services stems from a bias toward manufacturing or blue-collar jobs.  However, as Visual Capitalist recently showed, the export of services is surging.

Did NAFTA Kill Jobs?

NAFTA caused shifts in manufacturing with the creation of a North American supply chain. But, more than 20 million new jobs were created in the US across industries in the first eight years of NAFTA. Since 1994, manufacturing productivity has increased, and manufacturing wages have increased.

Jobs and industries exist today that didn’t in 1994. In 1994 (when NAFTA was adopted), the largest companies in the world were GM and Ford according to Fortune. The largest company in the world today is Amazon. Coincidentally it was founded in 1994, the year NAFTA was enacted. The point is that things change in a free market.

There were disruptions, job losses in specific industries, with the adoption of NAFTA. But, since American manufacturing was already in decline from its post-war peak, we can only speculate about whether manufacturing would have lost even more jobs in the absence of NAFTA liberalizing trade and making America more competitive.

There is often an argument about whether manufacturing job losses was caused by globalization or automation. I think that may be too simplistic of a question. Automation is appealing because of productivity efficiencies. But, I contend that automation is also attractive because it reduces labor costs and headaches. Robots don’t demand sick leave, pensions, or file law suits for wrongful termination.

And, if we blame global competition for manufacturing job losses, we should factor in the costs of, regulations and taxes that may make the US — or specific US places like Detroit — less competitive than other locations.

Ironically, if we back away from free trade now, we will suffer a new round of disruption and job losses as manufacturers sort out their supply chain.

How USMCA Compares to NAFTA

On November 30, 2018, the US, Canada and Mexico signed an agreement to replace NAFTA with the new United States, Mexico, Canada Agreement (“USMCA”). However, USMCA is not drastically different than NAFTA.

When judging the USMCA, we should consider both NAFTA and the TransPacific Partnership (“TPP” or “CPTPP”). President Trump pulled out of TPP shortly after taking office.

Despite all the bluster and the diplomatic damage, USMCA is, at best, a NAFTA with elements of TPP thrown in, but also a slightly more protectionist agreement. Despite the President saying NAFTA was the worst agreement ever made, USMCA leaves large sections of NAFTA untouched. Some of the modernization or liberalization provisions that are good are largely carried over from the TPP.

Pulling out of TPP and renegotiating NAFTA was a mistake. The WSJ editorial board published an editorial in January explaining that American producers and farmers are the biggest losers of America pulling out of TPP – a free-trade pact which includes 14% of the global market. The WSJ calls it one of the worst “own goals” in recent economic history.

By bullying Canada during the NAFTA renegotiations, we harmed the relationship with our closest ally just so we could get .34% more access to their dairy market than would have been available under TPP? We made the automotive industry more protectionist. And, we failed to remove the Section 232 national security tariffs on steel and aluminum. We are trying to work out other deals. But, China and the EU watched the USMCA negotiations.

On the negative side, imposes stricter rules of origin on the automotive industry. NAFTA required 62 percent of everything — like an automobile part or whole automobile —to be made in one of the three countries. Now that’s been raised to 75 percent. This will drive up consumer costs.

The USMCA deal requires that at least 40 percent of all auto content be made by workers earning at least $16 an hour or its equivalent. The change is intended to prod domestic companies to relocate manufacturing in the U.S. by eliminating Mexico’s main advantage in that area: lower labor costs.

According to reports that I have seen, average wages for autoworkers in Mexico are less than $8/hour, but closer to $20-35/hour in Canada and the US depending on seniority, etc.

Mexico has agreed to pass laws giving workers the right to real union representation, to extend labor protections to migrant workers (who are often from Central America), and to protect women from discrimination.

One provision that seems to really be directed at China is that the USMCA allows the US to pull out of the agreement if Canada or Mexico enters into an agreement with a non-market economy and the US disproves of the deal. Canadians are aggressively signing up free trade agreements around the world. They are promoting the concept of “diversification” because they don’t want to be beholden to the US. This provision may be intended to counter that and actually make Canada more reliant on the US.

Section 232 Tariffs: Steel and Aluminum

Under Section 232, Congress delegated its Article 1, Section 8 constitutional authority of regulating trade, and imposing tariffs to the President in cases necessitated by national security. In 2018, the president used the Section 232 national security tariffs to impose duties on steel and aluminum imported from allies, such as the European Union. The USMCA leaves in place the steel and aluminum tariffs. As a result, retaliatory tariffs from Canada and Mexico are also remaining in place. Canada is our top steel importer, comprising about 20% market share.

Workers in Texas, the nation’s top exporter and energy producer and second-largest manufacturer, will be disproportionately impacted by the president’s protectionist policies.

As the nation’s top consumer of steel, this is harmful to Texas companies. Texas imports more than $8.3 billion in steel and aluminum imports annually, which is twice as much as any other state. Because of the tariffs, the price of all steel, including American-made steel, is already on the rise. This will tighten operating margins and jeopardize Texas energy jobs. As our trading partners retaliate with tit-for-tat tariffs and restrictions, the pain will be felt across other Texas industries. The cost of the tariffs will ripple through the economy, but ultimately be borne by consumers.

The president’s claims that metals tariffs are necessary to protect the U.S. steel industry on the grounds of national security are belied by the facts that the U.S. Defense Department only requires about 3% of steel produced domestically, and that U.S. steelmakers enjoy a market share of about 74% of the domestic steel market. Rather than protecting an imperiled industry, it is estimated that the president’s steel and aluminum tariffs will save about 33,000 jobs while jeopardizing nearly 179,334 jobs nationally across all industries.