Wednesday, January 1, 2014

NAFTA at 20: A Step in the Right Direction Towards Liberalized Trade

Today is the twentieth anniversary of the North American Free Trade Agreement (NAFTA) coming into force. Ever since its enactment, NAFTA has become of a lighting rod of controversy in trade policy. Was NAFTA a pioneering step in economic development or has NAFTA truly created a giant sucking sound?

Before jumping into the question, a little background information. NAFTA was a trilateral trade agreement between the United States, Canada, and Mexico to create a trade bloc amongst the three nations. As I pointed out a few months ago when discussing "free trade agreements," it would be more accurate to call NAFTA a preferential trade agreement. The primary goal of NAFTA was to eliminate tariffs between the participating nations, although the agreement includes a plethora of provisions.

One of the arguments used against NAFTA is that it has caused a loss of American jobs. The Left-leaning Economic Policy Institute (EPI) found that NAFTA has caused larger trade deficits and a net loss of 682,900 jobs. If there is to be a true loss in jobs that is so overwhelming that overall job creation cannot outpace it, it would show up in the employment statistics. Taking a look at Bureau of Labor Statistics data, that is not the case. According to the Office of the U.S. Trading Representative, employment rose 24 percent from 1994 to 2007, and the average unemployment rate during that time was 5.1 percent (See the USTR's fact sheet dispelling other NAFTA myths). The Cato Institute is able to astutely refute EPI's analysis by pointing out that a) trade creates jobs through exports [see above], and b) 682,900 jobs over a 20-year period (i.e., about 40,000 per annum) is infinitesimally small compared to the 15 million jobs that are created and destroyed every year.

Opponents tend to complain that NAFTA caused the downfall of the manufacturing sector (e.g., depressed wages, lowered employment). In reality, the manufacturing sector has become more productive and less labor-intensive over time (Economic Report of the President, 2013, Table 51-B), i.e., there is a structural shift in the American economy. There was also concern about the Mexican farmers that were allegedly dislocated by NAFTA. However, the farm subsidies, combined with the removal of tariffs, translated into Mexican farmers being displaced because they couldn't compete with the subsidized exports. The displacement of Mexican farmers was more of an issue of Big Government subsidizing Big Agriculture than anything else. As a side note, any decrease in real wages in Mexico was due to the peso crisis of 1994, not NAFTA.

In spite of whatever flaws I can find with preferential trade agreements, trade between the three countries has increased. As the Congressional Budget Office pointed out back in 2003, NAFTA was not going to have a huge impact on the American economy because trade with Canada and Mexico is a small component of America's GDP. Opponents like to bring up increased trade deficits, but those are more due to China's ascension into the World Trade Organization. As the Congressional Research Service (CRS) illustrated in its report on the 20th anniversary of NAFTA, Canada already had a preferential trade agreement with the United States prior to NAFTA, which is to say (p. 18-20) that it had moderately positive impacts. Ultimately, the one who had the largest relative gains was Mexico's economy (CRS, p. 15; IMF, 2012).

Canada and Mexico are not America's competition; they are valuable trading partners. NAFTA has engendered increased trade, increased price-level synchronization, and more integrated markets (e.g., the U.S. Department of Agriculture shows greater integration of the agricultural market between the three countries with NAFTA), as the International Monetary Fund (p. 97) illustrates, as well as the U.S. Chamber of Commerce in its report on NAFTA. In spite of whatever flaws NAFTA might have (e.g., increased trade deficits that help perpetuate America's long-term debt issues, continued trade regulations not related to tariffs, environmental and labor regulations unrelated to trade), the American government should pursue more liberalized trade, not less.

May 12, 2014 addendum: Here is a policy report by the Peterson Institute of International Economics outlining the overall benefits of "NAFTA at 20."

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