Trump, NAFTA, and America First

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Kaza_01-2018

President Donald Trump has made the renegotiation of the North American Free Trade Agreement (NAFTA) a cornerstone of his economic policy.  Signed into law by Democrat Bill Clinton in 1993 with Republican support, NAFTA created a managed trade zone among Canada, Mexico, and the United States.  The multilateral agreement remains highly controversial among blue-collar voters a quarter-century after its inception.  President Clinton—and, at the time, his wife, Hillary—equated the provisions of NAFTA with the creation of jobs, yet manufacturing jobs in the six-state Industrial North region have declined by 1.3 million, according to the U.S. Bureau of Labor Statistics.

In his first debate with Democratic nominee Hillary Clinton, Trump called NAFTA “the single worst trade deal ever approved in this country.”  And during the third presidential debate, he declared,

We’re going to renegotiate trade deals.  We’re going to have free trade . . . But we have horrible deals.  Our jobs are being taken out by the deal that her husband signed, NAFTA, one of the worst deals ever.  Our jobs are being sucked out of our economy.  You look at all of the places that I just left, you go to Pennsylvania, you go to Ohio . . . Our jobs have fled to Mexico and other places.  We’re bringing our jobs back.  I am going to renegotiate NAFTA.  And if I can’t make a great deal—then we’re going to terminate NAFTA and we’re going to create new deals.

Trump’s persistent attacks on NAFTA resonated with American workers, including those in Michigan, Ohio, Pennsylvania, Wisconsin—a four-state bloc that Republicans last won in 1984.  Trump presented himself as Negotiator in Chief, a businessman with real-world experience who would not hesitate to use political leverage to advance U.S. economic interests.  In turn, those states provided a total of 64 electoral votes and secured Trump’s victory.

Was Donald Trump serious about ending NAFTA?  Were his attacks on it mere political theater, part of a strategy to win historically blue states?  Or are he and his administration engaged in realpolitik, crafting a measure capable of passing Congress, perhaps with Democratic votes?

On Trump’s first day in office he signed an executive order withdrawing the U.S. from the Trans-Pacific Partnership, a 12-country multilateral deal negotiated by his predecessor, Democrat Barack Obama.  Describing the executive order as a “great thing for the American worker,” Trump declared that “We’re going to stop the ridiculous trade deals that have taken everybody out of our country and taken companies out of our country, and it’s going to be reversed.”  Most media coverage of this was negative, which meant that one result went largely unnoticed: By withdrawing swiftly from the TPP, Trump increased his administration’s bargaining leverage during NAFTA’s renegotiations.  Critics characterized Trump’s opposition to TPP during the 2016 campaign as political rhetoric.  Today, Trump’s TPP withdrawal is understood to mean that his threat to withdraw from NAFTA is serious.

In late January 2017, Trump held trade talks with British Prime Minister Theresa May, raising the idea of a bilateral agreement with the Brexit-bound United Kingdom.  Trump discussed Brexit during the 2016 race, linking it to voter disgust with political establishments on both sides of the Atlantic.  UKIP leader Nigel Farage, one of Brexit’s chief proponents, visited Trump Tower before Prime Minister May came calling.  The Telegraph (November 11, 2016) reported that the U.K. “could become an ‘associate’ member of the North American Free Trade Area” after leaving the European Union.  The possibility that Trump would offer Britain a deal before the E.U. was noted by Trump trade advisor Dan DiMicco late in the campaign.  In remarks given to the BBC that were widely reported by the British press, former Nucor CEO DiMicco explained,

First off, [the British] are our friends, they have always supported us, and we’ve worked together, and they are leaving the EU in our estimation for the right reasons.  They have lost control of their economy, the job creation engine, so why shouldn’t we be working with like-minded people before we do a deal with anybody else?

Obama, by contrast, threatened to send Britain to “the back of the queue” while campaigning against Brexit.

In March, Commerce Secretary Wilbur Ross, an industrialist and registered Democrat until November 2016, noted Japan is also high on the list of potential bilateral trade partners.  Like Britain (seventh), Japan (fourth) is a major U.S. trade partner, Commerce Department records show.  The political message was clear: Trump’s administration will emphasize bilateral agreements, not multilateral deals like NAFTA.  The U.S., as the largest consumer market in the world, has other potential partners.  Regarding Mexico, the President may use such issues as immigration and the border wall in trade negotiations.

Trump, in late April, told Canadian Prime Minister Justin Trudeau and Mexican President Enrique Peña Nieto that he would renegotiate NAFTA, not pull the U.S. out of the deal.  But Trump retains the power to withdraw the U.S. if a new trade deal cannot be struck.  Mexico says she will walk away from negotiations if Trump withdraws the U.S. from NAFTA.

In mid-May, the White House served Congress notice that it would indeed renegotiate NAFTA.  Robert Lighthizer, shortly after his Senate confirmation as Trump’s appointed U.S. trade representative, explained, “For years, politicians have called for the renegotiation of this agreement, but President Trump is the first to follow through with that promise.”  He pledged consultation and transparency with Congress during the process.  Lighthizer, an Ohio native, was President Reagan’s deputy trade representative, negotiating bilateral pacts involving the steel industry.  The industry applauded his appointment.  In the 1980’s Lighthizer convinced Mexico to accept “voluntary restraint agreements” limiting steel exports to the United States.  Foreign Policy (January 9, 2017) said that Lighthizer “has a track record of trying to fix what’s broken without starting a trade war.”  A “self-proclaimed Hamiltonian,” he was an early Trump supporter.  As far back as May 9, 2011, he wrote (in “Donald Trump Is No Liberal on Trade,” the Washington Times) that, “For most of its 157-year history, the Republican Party has been the party of building domestic industry by using trade policy to promote U.S. exports and fend off unfairly traded imports.  American conservatives have had that view for even longer.”  The NAFTA renegotiation was delayed because Lighthizer’s nomination was opposed by Arizona Sen. John McCain, who lost every Industrial North state in the 2008 presidential race.  Lighthizer will seek to “modernize” NAFTA by addressing “digital trade,” which was in its infancy when the pact was inked in 1992.  According to Lighthizer’s office, digital trade is “a broad concept, capturing not just the sale of consumer products on the Internet and the supply of online services, but also data flows that enable global value chains, services that enable smart manufacturing, and myriad other platforms and applications.”

A significant challenge the Trump administration faces is to negotiate an agreement that can pass a GOP-controlled Congress that has demonstrated little ability to govern.  Details of his plan were released in mid-July.  The Wall Street Journal (July 18) noted, “Some issues show common ground between Mr. Trump, who has complained about unfair trade practices in Mexico, and Democratic lawmakers, who want much stronger labor and environmental provisions in Nafta to keep companies from cutting corners by moving abroad.”  Significantly, this indicated an attempt at attracting Democratic support.  Democrats have been noncommittal, though several have reached out to Trump.  U.S. Sen. Sherrod Brown (D-OH) sent Trump a four-part plan that emphasizes “buy American,” and labor and environmental standards.  Brown is one of ten Democratic senators up for re-election in 2018 in states won by Trump.  And during this election year, congressional action could come swiftly: A 2015 law allows trade deals to be expedited.

These developments serve as backdrop to the formal proceedings that began in mid-August.  As the talks began in Washington, Lighthizer’s remarks underscored the Trump administration’s hard line: The U.S. “is not interested in a mere tweaking of a few provisions and an updating of a few chapters.  We believe NAFTA has fundamentally failed many, many Americans and needs major improvement.”  Problems include “huge trade deficits,” “lost manufacturing jobs,” and “closed” businesses.  Lighthizer repeatedly spoke of the domestic auto industry: “In the auto sector alone, the U.S. has a $68 billion deficit with Mexico . . . Thousands of American factory workers have lost their jobs because of these provisions.”  He said the U.S. will insist that “rules of origin, particularly on autos and auto parts, must require higher NAFTA content and substantial U.S. content.”  This is important because, without the strict enforcement of the rules of origin that are built into a trade agreement, one party can effectively flout the agreement’s restrictions, passing another country’s products off as its own and giving itself an unfair advantage.  Ross has sought to establish these rules.  Lighthizer said that in the future the U.S. will also see to it that a manufactured item’s country of origin “be verified,” not simply “deemed.”  Labor provisions, currency manipulation, dispute-settlement provisions that respect national sovereignty, and third-party dumping by state-owned enterprises are also on the table.

Canada, for her part, is seeking strong

labour safeguards, integrated environmental protections, a new chapter on gender rights to promote gender equality, a chapter dedicated to Indigenous people and reforming the investor-state dispute settlement process to ensure governments can pass regulations in the public interest without facing corporate legal action.

The Liberal Trudeau government argues that “progressive elements” are “important to maintaining popular support for free markets.”  And, while Canada is participating in the NAFTA talks, parallel negotiations over the ongoing U.S.-Canada softwood lumber dispute continue; the Trump administration is imposing tariffs on government-subsidized Canadian lumber sold in U.S. markets.  Canada’s highly regulated dairy industry could emerge as an issue in NAFTA renegotiations as well, as Trump (joined by prominent Democrats such as Chuck Schumer and Andrew Cuomo, and Republican Paul Ryan of Wisconsin) has argued that Canada’s price-fixing has intentionally undercut American dairy farmers.  Canada’s private sector seeks to maintain highly integrated supply chains, especially in Ontario’s auto industry, while making cross-border movement of skilled tech workers easier.  (Trump appears open to the latter goal.)  The U.S. tech sector views a renegotiated NAFTA as an opportunity to expand into new markets.  It seeks to ban government regulations on service providers and a broader pact to end all tariffs on information technology.  Canada supports this goal.  Mexico has not taken action.

Trump and Trudeau may seem, at first glance, a political odd couple, but there is precedent for Liberal governments working with Washington on trade.  The Auto Pact (1965) removed tariffs on motor vehicles and parts, fostering integration.  The Canada-United States Free Trade Agreement (1987) was advanced as an idea by various Liberal leaders before Canada’s Red Tories reversed their opposition to it in the mid-1980’s.  Another factor: Both Trump and Trudeau have political bases that are made up of high-wage workers: Trump in the Industrial North; Trudeau in Ontario and Quebec.

Canada’s trade deal with the United States predates NAFTA.  If the NAFTA renegotiation fails, trade would revert to World Trade Organization (WTO) rules—i.e., tariffs would vary based on the industries and goods in question.

Mexico is more problematic.  The CIA World Factbook states,

Mexico’s $2.2 trillion economy has become increasingly oriented toward manufacturing in the 22 years since NAFTA entered into force.  Per capita income is roughly one-third that of the US; income distribution remains highly unequal.  Mexico has become the US’ second-largest export market and third-largest source of imports.  In 2014, two-way trade in goods and services exceeded $590 billion.

Despite this economic growth, Mexico is a narco-state heavily influenced by violent drug traffickers.  According to the CIA, “Since 2007, Mexico’s powerful drug-trafficking organizations have engaged in bloody feuding, resulting in tens of thousands of drug-related homicides.”  Mexico serves as a “major drug-producing and transit nation”; the “world’s second largest opium poppy cultivator”; “the primary transshipment country for US-bound cocaine from South America”; and a “major supplier of heroin and largest foreign supplier of marijuana and methamphetamine to the U.S. market.”  NAFTA wasn’t supposed to work this way.  The agreement was sold in part as a means of increasing Mexico’s stability.  Yet, as the CIA notes, “Ongoing economic and social concerns include low real wages, high underemployment, (and) inequitable income distribution.”

Low real wages include those paid to workers in Mexico’s durable-goods manufacturing sector.  Mexican autoworkers are paid a fraction of the wages made by their U.S. and Canadian counterparts.  The Center for Automotive Research (CAR) notes that Mexican nominal average hourly wages (2007-13) were $5.21 for light-vehicle manufacturing and $2.40 for automotive parts.  These wages are nearly one eighth and one fifth, respectively, of comparable U.S. wages.  But NAFTA was supposed to raise Mexican wages in the automotive industry while lowering American wages for the same jobs, according to the theory of Factor Price Equalization, as put forth by economist Paul Samuelson, whom Bill Clinton awarded with the National Medal of Science in 1996.  Put simply, when the price of “output goods” (a particular manufactured product) is equalized between two trade partners, the cost of “input factors” (including labor) will also be equalized.  In the case of the automotive industry, after the passage and implementation of NAFTA lower input costs provided an incentive for supply chains to locate or relocate near Mexican factories.  CAR reports that these lower cost factors have allowed Mexico to land 9 of 11 new North American automotive plants announced in the last six years.  The Trump administration’s plans to tighten the rules of origin would make it harder for Mexican maquiladoras to use Chinese-built parts in NAFTA-zone vehicles.  Mexico could retaliate by limiting U.S. agricultural exports, like corn.

The Trump administration has at least seven options in renegotiating NAFTA.  The first—maintaining the status quo—is off the table, given the political reality that Trump’s Industrial North base won’t accept broken promises if he intends to seek re-election.  As Pat Buchanan writes, if Trump

wishes to become the father of a new “America First” majority party, he must make good on his solemn promise: To end the trade deficits that have bled our country of scores of thousands of factories, and to create millions of manufacturing jobs in the USA.  Fail here, and those slim majorities in Michigan, Pennsylvania and Wisconsin disappear.

Trump’s predecessors, including both President Clinton and President Obama, maintained the status quo.  Trump’s legacy will rest on whether he reforms it—and how.

That Trump understands this is illustrated by his reaction to Ford and Fiat Chrysler’s announcement at Detroit’s North American International Auto Show in January 2017 that the firms plan to invest in the United States.  “It’s finally happening,” Trump tweeted.  “Thank you Ford and Fiat C!”

A second option is to renegotiate NAFTA in terms of national security, with a narrow focus on steel and other essential commodities.  NAFTA and other trade agreements are built on the intellectual edifice of Adam Smith’s theory of absolute advantage and David Ricardo’s theory of comparative advantage.  Both theories recognize national-security exemptions to free trade.  In April 2017, Trump signed an executive order granting steel import sanctions on national-security grounds.  Section 232 of the Trade Expansion Act (1962)—which is rarely invoked—allows Secretary Ross to probe the national-security implications of the U.S. reliance on steel imports used in defense armaments.  Ross has cautioned that a single domestic smelter produces the high-grade aluminum used in F-35 fighter jets.  In July, the New York Times reported that the White House has been exploring certain restrictive measures it would justify by arguing that national security is weakened by import dependence.  The Times admitted that the President has broad authority, under international trade agreements, to impose measures on the grounds of national security.  President Reagan threatened sanctions to persuade Japan to limit machine-tool exports.  Indeed, NAFTA’s Chapter 21, Article 2102, states that

nothing in this Agreement shall be construed . . . to prevent any Party from taking any actions that it considers necessary for the protection of its essential security interests . . . and to such traffic and transactions in other goods, materials, services and technology undertaken directly or indirectly for the purpose of supplying a military or other security establishment . . .

Trump, unlike several of his predecessors, has raised these issues, elevating national sovereignty over globalism.

Third, sanctions could be applied if a NAFTA signatory is judged to have failed to enforce environmental or labor laws adequately.  Under the terms of the pact, the United States, Canada, and Mexico created administrative offices for the purpose of enforcing these concerns.

Fourth, Trump could propose taxes or tariffs to reduce the U.S.-Mexican trade deficit and serve as economic disincentives to dissuade American manufacturers from moving production to Mexico.  One example of this, Paul Ryan’s border-adjustment tax, is a bad idea.  Sanctions, tariffs, and taxes are the worst options because they invite a trade war—a tit-for-tat retaliatory process leading to a contraction of economic activity.  Economic reasoning should always seek to identify secondary effects, a process ignored by politicians fixated on scoring short-term political points.

Fifth, a failure to renegotiate NAFTA could lead to new bilateral agreements in the future.  Canada and Mexico are the second- and third-largest trading partners of the United States.  If the Trump administration can’t negotiate a new NAFTA deal, two bilateral agreements could later be negotiated: one with Canada, another with Mexico.  The U.S., according to Ross, is concerned more about the substance of any trade deal, and less about its form.

Sixth, new partners could emerge if renegotiation fails; Britain and Japan are strong contenders.

Finally, Trump could simply end U.S. participation in the pact, according to the terms of the pact itself.  NAFTA’s Article 2205 states, “A Party may withdraw from this Agreement six months after it provides written notice of withdrawal to the other Parties.  If a Party withdraws, the Agreement shall remain in force for the remaining Parties.”

Free trade can benefit consumers and producers.  Yet NAFTA is less about free trade, and more about managed trade, than critics are willing to admit.  (Former Clinton trade representative Mickey Kantor admitted to NPR that NAFTA is technically concerned with “trade rules.”)  The text of NAFTA is hundreds of pages long and was criticized by libertarian economist Murray Rothbard for this reason in the early 1990’s.  NAFTA could be renegotiated on narrower grounds around U.S. national-security interests.  Or the Trump administration could achieve its stated goals by requiring tougher rules of origin and expanding the opening of Canadian and Mexican markets to U.S. services.  The worst possible outcome, if NAFTA ends, would be for the United States to fail to negotiate a new bilateral agreement with Canada.

According to his rhetoric and his actions during his first year in office, Trump understands, better than the Clintons and Establishment Republicans, that blue-collar voters in the Industrial North have a clear desire to see NAFTA renegotiated according to American interests, or abandoned altogether.  After five rounds of talks, it is not clear whether renegotiation efforts will succeed.  The financial press is assailing the Trump administration’s efforts at every turn, siding with Mexico and Canada, attributing ulterior motives to the desire to prioritize the wages of American workers, and insisting that Secretary Ross is hiding his vast connections to Russian meddlers.

What is clear is that this process wouldn’t be occurring at all, were it not for the upset election victory of Donald Trump.

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