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Trump’s Trade Disaster
Jun 8, 2018 ANNE O. KRUEGER
In the second year of his presidency, Donald Trump has doubled down on his “America First” brand of economic nationalism, by making impossible demands of US allies and escalating a multi-front trade war of his own making. In doing so, however, he has all but guaranteed that Americans themselves will bear the costs.
WASHINGTON, DC – US President Donald Trump may fancy himself a builder, but when it comes to international treaties and norms, he has proved to be a one-man wrecking crew. And now, the chaos appears to be spreading and deepening.
In the last few months alone, Trump’s “America First” administration announced commercial sanctions against the Chinese tech giant ZTE, but then reconsidered that decision, in the interest of – wait for it – saving Chinese jobs. And just weeks after Secretary of the Treasury Steven Mnuchin put a trade war with China “on hold,” the administration declared that it would impose tariffs on $50 billion worth of Chinese imports after all, while also slapping sweeping import tariffs on steel and aluminum.
Of course, even if Trump’s advisers have sent mixed messages on trade, it may be the only issue on which Trump himself has remained consistent, much to the detriment of US alliances and economic relations. Almost immediately upon taking office, Trump mothballed the Transatlantic Trade and Investment Partnership (TTIP) and withdrew the US from the Trans-Pacific Partnership (TPP). The TPP would not just have united the US and 11 other Pacific Rim countries within a single trade bloc; it also would have established region-wide rules and standards that even China might have been forced to follow, despite its exclusion.1
But whereas Trump had little trouble scrapping the TTIP and TPP, the North American Free Trade Agreement between the US, Mexico, and Canada has continued to draw his ire. NAFTA – and particularly Mexico’s role in it – seems to epitomize all of the hot-button issues that fired up Trump’s base during his 2016 presidential campaign. To hear Trump tell it, the agreement is a source of lost manufacturing jobs, and a perfect example of the supposed “unfairness” of all trade pacts. So he promised his supporters to use the threat of abandoning NAFTA to force Mexico to pay for his “border wall,” and to stem the flow of undocumented immigrants – whom he has described as “rapists” and “animals” – across the border.
That strategy has not worked. But over the past year, the Trump administration has been meeting with the Mexican and Canadian governments to renegotiate the terms of NAFTA, and those talks are now approaching their crunch point. Given that Trump has laid waste to every US commitment he has touched, Mexico and Canada – and the world – have every reason to prepare for the worst.
THE TRUTH ABOUT NAFTA
For decades after World War II, Mexico pursued many of the same disastrous economic policies as other developing countries. It maintained high protectionist barriers for manufactured goods, and relied heavily on commodity exports, particularly oil. As a result, it experienced recurrent stop-go cycles, whereby accelerating inflation and ballooning balance-of-payments deficits would force a round of austerity, only for the process to repeat itself after increases in commodity prices, but at a slower rate of growth each time. Not surprisingly, the growth rate during these years waxed and waned dramatically, and by the start of 1989, Mexico’s per capita income was around $2,393 – about 11% that of the US.
But then came the early 1990s, when Mexican President Carlos Salinas and his economic team reversed the country’s trade policy and set the stage for negotiations on a free-trade agreement (FTA) with the US. President Bill Clinton’s administration welcomed Salinas’s new economic approach and quickly agreed to talks, which included Canada, because it already had an FTA with the US. The US had long wanted Mexico to liberalize its trade regime and permit more economic competition, and it now had a chance to see those changes through.
Before NAFTA, between two-thirds and three-quarters of Canada and Mexico’s total trade was with the US, and about one-quarter of total US trade was with Canada and Mexico. But at the time, the average US tariff on manufactured imports was around 2%, while Mexico’s average tariff on US exports was around 10%. It was clear from the start that the US would gain more from improved access to the Mexican market than vice versa.
Yet, despite the obvious benefits, there was a great deal of political dissent within the US about the prospect of Mexican workers threatening American jobs. In a 1992 presidential debate, the independent candidate Ross Perot famously warned that an FTA with Mexico would result in “a giant sucking sound going south.” Of course, nothing of the sort happened.1
NAFTA entered into force on January 1, 1994, and between 1993 and 2000, US unemployment fell from 6.9% to 4%. Today, it stands at 3.8% – its lowest point in almost two decades. Professional economists generally consider an unemployment rate of 4-4.5% to represent an economy near “full employment” – meaning that virtually all who are willing and able to work can find a job.
Put another way, total US civilian employment in 1993 was around 120.3 million, compared to 136.9 million in 2000 and 148.8 million in 2016. The rate of turnover in jobs today is about 20% annually, with only a small share of the gains or losses attributable to Mexico. Overall, though some American jobs were lost over the lifetime of NAFTA, more were gained, owing not just to the additional exports resulting from lower Mexican tariffs, but also to the falling costs of inputs for US producers, which boosted their international competitiveness.
With NAFTA in place, US-Mexico trade grew rapidly, in part because cross-border value chains multiplied. Mexican producers employing unskilled labor exported components for cars and other goods to the US. And the US manufacturers that imported those less expensive inputs were better positioned to compete with Japanese, European, and other firms that already had access to cheaper components from South and Southeast Asia and Eastern Europe. Moreover, US firms also invested in Mexican facilities, which enabled Mexican firms to expand their capacity faster and meet the growing demand from US producers.
These invest t and trade activities have undoubtedly benefited both countries. Access to cheaper components has lowered US producers’ costs, while exports to Mexico have increased. Meanwhile, Mexican output, employment, and wages have grown more than they would have otherwise. For all three signatories, NAFTA represents a win.
BAD FAITH AND WORSE OUTCOMES
Nevertheless, the Trump administration has insisted on renegotiating NAFTA. To be sure, there are a number of ways that the agreement could be updated to account for changes in economic activity, including those spurred by technological advances, since the early 1990s. But that has not been Trump’s focus. Instead, US trade negotiators have demanded amendments to NAFTA that would turn it into a lose-lose-lose deal.
Some of the demands directed at Mexico, in particular, are so outrageous that no country could ever accept them. Others, such as the US proposal for more stringent rules of origin (which require that a certain percentage of an imported article be fabricated within the NAFTA trade bloc), are very problematic, but a compromise can probably be reached.
Unfortunately, the Trump administration’s extreme approach has made meaningful progress impossible, even in areas that actually could stand to be improved. One of the US’s most disruptive tactics has been to demand that Mexico bring its auto workers’ pay up to the level of their US counterparts. The minimum wage in Mexico is currently around $4 per day, and around $6 per day in manufacturing industries. But the wage floor US negotiators have reportedly demanded is $16 per hour – 21 times the average wage in Mexican manufacturing. That is the equivalent of asking the US to raise its auto workers’ wages to $588 per hour (based on the $28 average hourly wage for unionized auto workers).
Needless to say, no producer in the world could absorb or pass on such a cost increase. Mexican firms would either have to close or demand tariff protection, which, at best, would allow them to produce only for the smaller Mexican market. And it is inconceivable that the Mexican electorate would stand for one segment of workers earning $128 per day while everyone else still earned an average of $4-6 per day. The social and political backlash would be unmanageable. In fact, the Trump administration’s demand is so absurd that even the US auto industry opposes it , not least for what it would do to US producers’ value chain.
Another impossible US demand, which would affect Canada as much as Mexico, is a sunset clause that would force each government to renew the renegotiated NAFTA every five years. The fact that the entire deal could potentially expire every five years would create a permanent state of uncertainty for businesses throughout North America. Most companies base their investment decisions and output plans on a time horizon of at least five years, so it is hard to believe that any would make investments in Mexico to sell to the US market under such conditions.
TINNY TRADE LOGIC
As if the situation was not bizarre enough, the Trump administration has now subjected Mexico and Canada to import tariffs of 25% on steel and 10% on aluminum, after first trying to use exemptions from such tariffs as a bargaining chip in the NAFTA negotiations. The sweeping metal tariffs – which have now also been imposed on America’s European allies – are highly objectionable for obvious reasons. They will raise costs for all US firms that use steel and aluminum inputs – a group that of course includes the auto industry.
The Trump administration has justified the tariffs on national-security grounds, which makes absolutely no sense when one considers that US allies are bearing the brunt of the costs. The exception is South Korea, which was exempted from the tariffs because it agreed to quotas limiting its steel exports to the US.
The Trump administration’s approach to both allies and adversaries represents the worst kind of “managed trade,” which the US and other countries with market-based economies have long condemned. South Korea did not achieve strong, sustained growth until it liberalized its trade and other economic policies, starting around 1960, with the encouragement of the US.
But under its new managed-trade agreement with the Trump administration, South Korea must now create an administrative apparatus to limit its steel producers’ exports to the US. That means tracking 52 different categories of steel to ensure that exports remain at or below 70% of their 2014-2017 levels. It is estimated that South Korea has already met its quota for this year for nine categories of steel.
At the same time, there is a need to monitor and regulate the inflow of steel and aluminum, whether by the US, South Korea, or both. For the US, expanding its own customs service to perform this task would carry enormous administrative costs; and the new dispensation will likely lead to all manner of influence peddling as firms try to win scarce licenses from customs officials.
DESTINED FOR FAILURE
There is little reason to think that Mexico or Canada will accept the Trump administration’s demands unless they are significantly watered down. But even if they do accept them in some form or another, the result will be the opposite of what Trump and his team intended.
There are around 80,000 jobs in the US steel industry, more than 900,000 jobs in the US auto industry, and millions more in other industries that use steel or aluminum. The Trump administration’s metal tariffs will drive up the price of cars and reduce domestic demand, thus offsetting any increase in auto-industry employment that Trump might have hoped for. And if Trump were to follow through on his threatened tariffs of 15-25% on imported autos, car sales across the US would decline, and the hundreds of thousands of workers who sell and service them would bear the costs.
Beyond the auto industry, the prices for all products that use steel and aluminum will increase, thus depressing demand and threatening output and employment across a wide range of sectors. Many steel- and aluminum-using producers compete directly with producers from around the world. But by protecting domestic producers, the Trump administration is raising steel and aluminum prices within the US, while reducing them in the rest of the world. In essence, Trump is conceding even more cost advantages to non-US producers, for no good reason.
After World War II, the US led the way in establishing a rules-based trading system, first with the General Agreement on Trade and Tariffs, and then with its successor, the World Trade Organization. The past 73 years have shown that when there are legitimate grievances between trading partners on issues such as high-tech secrets, bilateral efforts to resolve them often prove ineffective, whereas action taken through the WTO has a strong track record. Unless and until the Trump administration recognizes this fact, Americans themselves will bear the costs of its disastrous trade policies.1
Writing for PS since 2014
Anne O. Krueger, a former World Bank chief economist and former first deputy managing director of the International Monetary Fund, is Senior Research Professor of International Economics at the School of Advanced International Studies, Johns Hopkins University, and Senior Fellow at the Center for International Development, Stanford University.