by Spencer P Morrison, NEE
In 1993 President Bill Clinton promised that the North American Free Trade Agreement (NAFTA) would create “a million [American] jobs in the first 5 years.” He also said NAFTA’s “side agreements” would “make it harder than it is today for businesses to relocate solely because of very low [Mexican] wages or lax environmental laws.”
Bill Clinton lied.
Since 1993 a net 840,000 American manufacturing jobs have moved to Mexico—”solely because of very low [Mexican] wages or lax environmental laws.” Not only was Clinton wrong, NAFTA also caused numerous unintended harms: the post-NAFTA unemployment wave is largely to blame for the proliferation of Democratic governments in Midwest—a former GOP stronghold, I might add—wage stagnation, the opioid crisis, and general economic malaise.
President Trump is right: NAFTA is one of the “worst” deals in American history. And yet, the President’s replacement deal is little better—although it mitigates NAFTA’s downsides it fails to address the underlying problem: asymmetrical competition.
between scylla & charybdis
NAFTA was a bad deal, no question—and not just for Americans, most Mexicans and many Canadians also got burned. The only people who really benefited from NAFTA were the globe-trotting plutocrats.
America was hurt primarily through offshoring, the displacement of domestic production with imports. Before NAFTA, tariffs protected American industries from (asymmetrical) Mexican competition. This resulted in balanced bilateral trade—America actually ran a modest trade surplus with Mexico in 1992. NAFTA eliminated market barriers, forcing American workers to compete with far-cheaper Mexican workers. This remains true even today: America’s average annual wages are four times higher than Mexico’s (at purchasing power parity), according to the OECD.
Long story short: NAFTA unified its members’ labor supplies without harmonizing their labor laws or monetary systems (or addressing any of the other economic asymmetries). This created a powerful incentive to move American factories to Mexico—and move they did.
Lori Wallach, director the Public Citizen’s Global Trade Watch, estimates that NAFTA redistributed a net 840,000 American manufacturing jobs to Mexico. Meanwhile, the Economic Policy Institute estimated back in 2013 that NAFTA displaced a net 700,000 American jobs. Finally, US Trade Representative Robert Lighthizer noted in a press release that NAFTA cost America 700,000 jobs. Remember, these are net figures: they include the jobs NAFTA creates by boosting American exports.
Not only does NAFTA displace at least 700,000 American manufacturing jobs, it also displaces a large number of service jobs. This is because manufacturing is an anchor industry upon which predicate industries depend: a factory is like an oil filed or mine, it brings wealth into a community and supports an ancillary service sector that otherwise would not exist. Hairdressers and accountants need factory workers and miners—not vice versa.
This concept is well understood. In fact, the Bureau of Economic Analysis estimates that each dollar of manufacturing output supports $1.48 in spinoff service output. Thus, one factory job supports roughly 1.5 other jobs. This multiplier effect is real, and not subject to Henry Hazlitt’s popular “broken windows fallacy” critique for the simple fact that factories don’t redistribute wealth, they generate it. Accounting for this means NAFTA likely costs America a net 1.7 million jobs.
The geographic concentration of unemployment in America’s industrial heartland—now known as the rustbelt—magnified the problems. Factory closures impoverished whole towns overnight, flooding the labor market with job-seekers. This tidal wave of unemployment reduced wages for transient employees and stagnated the wages of those with permanent positions.
Moving beyond mere economics: a large number of unemployed and impoverished people turned to the government for help—after all, the government got them into this mess. The Midwest, once a Republican stronghold, turned blue. The Democrats then did what they do best: they made the economy worse by raising taxes to pay for their welfare schemes. Of course, the Republican solution was no better: if NAFTA got us into this mess then NAFTA 2.0 certainly won’t get us out.
dia de los muertos
Ironically, Mexico was also harmed by NAFTA.
In 1992 Mexico’s economy was highly bifurcated: a relatively advanced industrial core coexisted alongside an even larger traditional economy. This division is common among developing countries: India is paradoxically home to some of the world’s most innovative technology companies, and yet much of the country has changed little since the Gupta Dynasty.
In any event, NAFTA allowed America’s heavily-subsidized and highly-efficient agricultural industry to pulverize Mexico’s farmers. In total, over 1 million Mexican peasants lost their livelihood—it’s been 25 years and Mexico’s unemployment rate still hasn’t fully rebalanced. These people flocked to the cities, increasing the strain on Mexico’s infrastructure and saturating the job market.
Many also began working for Mexico’s drug cartels, which benefited from higher trade volumes and America’s growing addiction crisis. Although it would be overreaching to suggest that NAFTA caused Mexico’s war on drugs, it clearly boosted American demand and increased the cartel’s manpower—it made a bad situation worse. How many Mexicans died because of NAFTA is anyone’s guess, but with at least 130,000 dead, there’s plenty of blame—and blood—to share.
Finally, I must mention that many of those unemployed peasants sought sanctuary in America. In fact, the current wave of illegal immigration earnestly began just after NAFTA was signed. This shouldn’t be surprising: massive economic disruptions often have massive, unexpected social consequences.
Economists should expect the unexpected.
NAFTA 2.0
While it’s clear that NAFTA failed, it’s less clear what should be done. The most likely option is that President Trump will move forward with his new deal, which redresses some of NAFTA’s problems while preserving its core structure.
Of particular interest are the provisions regarding labor laws and those governing the automobile industry. Regarding labor laws: Mexico has agreed to let workers freely form unions and it will give all unions more teeth. Ideally, this will result in higher wages and better working conditions—thus bringing Mexico’s costs in line with America’s. Furthermore, Mexico says it will conform its labor laws with (higher) international standards, as set out by the United Nations.
Regarding automobiles: manufacturers must now produce 75 percent of the automobile’s value in North America to avoid punitive tariffs (up from 62.5 percent under NAFTA). Likewise, automakers must use more domestic raw materials, and must pay at some 40 percent of their Mexican workforce at least 16 USD an hour.
Basically, the deal will make Mexico more expensive, thus reducing the economic incentive for American companies to move abroad. This makes some sense, but it’s far too little too late. NAFTA is 25 years old and most of business that would gain from relocating production to Mexico have already left—you cannot retain what you do not have.
Furthermore, relocating a factory has a high transaction cost (it’s expensive and disruptive), so there’s little reason to relocate production unless the savings are significant and likely to last. For example, American automakers initially moved their factories to Mexico because they could cut their labor costs by over 75 percent—the savings were big enough to justify the capital costs and business disruption associated with offshoring.
Although Trump’s new trade does make Mexico more expensive, it doesn’t come close to reaching the tipping point where American businesses could save money by relocating to America. In fact, it doesn’t even equalize costs—Mexico will still be cheaper and will continue to attract American investment. NAFTA cannot be saved and it’s not worth saving. It’s the root of the problem.
If President Trump is serious about “bringing back our jobs” he needs to build tariff walls—not just physical ones.