Sunday 2 March 2008

NAFTA and Reality

NAFTA has raised its ugly head again in the campaign debates, and a HELADA member has asked for my opinion on this. Before responding to this, I'd like to ask a rhetorical question: "What is NAFTA?" While this may be a pithy response, the truth is that the issue is extraordinarily complicated, different people understand and attribute different things to or by NAFTA, and there are viewpoints which are uninformed by economic cause-and-effect.

First of all, let’s look at actual campaign demands. The Obama website has this “platform” under “Issues - Trade”

Amend the North American Free Trade Agreement: Obama believes that NAFTA and its potential were oversold to the American people. Obama will work with the leaders of Canada and Mexico to fix NAFTA so that it works for American workers.

On the Clinton site, I don’t find any direct mention of NAFTA, except the following indirect parts of a press release:

· Appoint a trade enforcement officer within the office of the United States Trade Representative (USTR) and double the size of USTR’s enforcement unit. The Bush administration has been extremely lax about enforcing our trade agreements, and workers are suffering as a consequence. Hillary will appoint a trade enforcement officer within USTR who will be responsible for ensuring that our trade agreements are vigorously enforced. She will also double the size of the enforcement unit. The current staff is too small to monitor and enforce the increasingly complex agreements.

· Overhaul the Trade Adjustment Assistance (TAA) program to ensure that workers who have lost jobs because of global competition get the support they need. TAA provides job training, income support, a health care tax credit, and job placement assistance. Hillary will modernize the program to ensure that it is truly helping workers hurt by global trade. First, she will extend TAA benefits to service workers. Today, workers who produce a service rather than a product are ineligible for TAA, leaving everyone from call-center operators to radiologists, without assistance. Second, Hillary will broaden TAA to cover all workers whose plants have moved abroad. Workers are currently ineligible for TAA if their plants relocated to countries with which we have not signed free trade or trade preferences agreements. This outdated rule means that when plants shift from America to low-wage countries like India and China, laid-off workers are ineligible for TAA. Third, Hillary will double funding for TAA’s job training program to $440 million. And fourth, she will overhaul the Health Coverage Tax Credit (HCTC) to ensure that it is actually making health care affordable for laid-off workers. She will increase tax credit to 90% of premiums from the current 65%. And for laid-off workers without access to COBRA or a qualified state plan, she will make other options, she will allow them to use the HCTC to buy into the Federal Employees Health Benefit Plan (FEHBP).

Judging from these two “Platforms”, Obama’s is far too vague to be practical in any sense of the word, while Clinton’s is a good micro-level initiative that will do nothing to offset prevailing trade patterns and their commensurate job losses.

Rather than providing complicated statistics andsources, I’m going to summarise the current situation with trade and wider economic patterns in the US:

1. The US has a massive overall trade deficit that is caused by fundamental imbalances between supply, demand, the government deficit, the structure of the US economy, and the way trade statistics are kept. This is an extremely complex subject, and I’m happy to answer any specific questions.

2. The top 5 US trade partners in 2007 for merchandise trade (trade in goods) are:

3. The merchandise trade deficit does not include financial, tourism or other service trade flow between these partners. It also does not differentiate between goods made by US companies in these countries and exported to the US.

4. The only global standard regulating trade is the World Trade Organisation (WTO), which establishes tariff and quota levels for merchandise categories between countries. Under WTO rules, for instance, Indian-based companies can export a certain number of tonnes of cotton medical gauze to Europe under a quota without tariffs, followed by a second quota with a certain tariff level, and so on.

5. There are no globally-recognised and adopted standards on either labour or environment. If there were, it is almost certain that the United States would not meet some if not many such standards. For instance, US standards of pesticides and organic products are much less strict than European ones; on the other hand, they may be much more strict than Brazilian ones. US "right to work" standards enable US employers to fire workers much easier than equivalent European regulations. such disparities will apply with current national regulations in NAFTA as well.

6. NAFTA is a trilateral trade agreement that is permissible under WTO regulations. However, the only emphasis under the present agreement is on tariff levels. There are no labour or environmental standards in the agreement which would reverse trade flows or increase the economic competitiveness of American workers.

7. Past attempts to regulate merchandise imports (and traffic) by the US have been unilateral and have created significant economic damage to Mexico and Canada. The example of Mexican trucks operating in Texas, or Canadian beef and timber exports to the US, are prime examples.

The current patterns in trade have nothing to do with NAFTA, but with American production and consumption patterns, and with the way statistics are recorded. In 2007, America had a trade surplus with very few countries: the main ones were The Netherlands ($ 14.6 bln); Hong Kong ($ 13.09 bln); Australia ($ 10.59 bln); United Arab Emirates ($ 10.27 bln); and Belgium ($ 10.01 bln). As you can see, our trade surplus is dwarfed by our deficit.

For the most part, these trade trends are irreversible. It would take an inconceivable investment in manufacturing capacity to reverse trade flows, requiring massive government subsidies to bring value-adding industries to competitive retail prices. There are very few historical examples that support such trends in specific industries, although the military and aerospace industry is a good one, and may explain the powerful influence of these lobbies on US foreign policy. In most consumer technologies, however, subsidies and labour requirements have already been tried in IT, shipping, or appliances, or steel, and have failed.

I won’t go into this in too much depth, but the basic fact is the we are operating in a global knowledge economy, and the process of re-engineering cars or washing machines or computers (for consumers) is remarkably easy. Therefore, there are no barriers to investment, capacity expansion and competition in this area, particularly give the global supply chain and the transparency of the internet. In this environment, investment (in production capacity) will follow the path to areas with the lowest-cost production (with acceptable transport links), while sales strategy will follow the path to the market with the highest margin on sales.

Now, to come to the specific issue of NAFTA:

1. The structure of the US trade deficit with Mexico and Canada will continue. The US does not have the same competitive advantage that these two countries have. Canada’s surplus with the US is driven by raw materials and natural resources, including agri-food. Mexico’s surplus is driven by low-cost textiles, consumer appliances and components, as well as some agri-food and natural resources categories.

2. Both Mexico and Canada are far more open to US imports that vice-versa (you can examine, for instance, the number of complaints brought to the WTO as a good indicator of this). This implies that if the US pushes for different environmental and labour standards, Mexico and Canada will probably implement these far faster and more effectively that the US will. This viewpoint is confirmed by the fact that implementation in the US depends on 50 states, which have a fragmented approach and lack resources for cost-effective national implementation.

3. Barack Obama states that [to paraphrase] “NAFTA has to be fixed to be good for US workers.” The only way this can be done, presumably, is by protective tariffs on imports into the US. This is legally impossible under current NAFTA rules, and there would be no reason for Mexico and Canada to accept this without equivalent tariffs on US exports (such as vehicles or equipment), which would simply hurt workers in other sectors while making consumer products, energy and food more expensive for everyone.

4. One correct response would be to amend national policies and incentives to enhance the competitiveness of US manufacturing. The legacy costs of health care to US manufacturing are disastrous, and a main cause of low trade competitiveness. However, as I’ve written in other entries, this would mean above all reforming health care and education. Such reforms take time and a bipartisan approach: I doubt they would be effective in the short term.

5. Hillary Clinton’s recommendation for expanding the TAA is a better one, because it is more targeted. However, it can only be a short-term fix, which over time would only lead to a further decline of key manufacturing competitiveness absent an effective manufacturing strategy.

If the US is to compete in global trade, it needs to manufacture goods that consumers in other countries want, at an acceptable price. There are many structural factors that preclude this. The fact that US firms have been offshoring for years now - establishing subsidiaries in lower-cost countries, or simply licensing manufacturing abroad - means that traditional industries will be lost in any case. There are solutions to this, but they are extremely complex to explain, and have a high variance from industry to industry, and region to region.

This brings me back to my original question: "What is NAFTA?" My impression from the current election is that NAFTA is a convenient stalking horse for both candidates, neither of whom seems to understand why America is losing its competitiveness, or how to combine long-, medium, and short-term policy changes to improve competitiveness. Of the two candidates, however, Hillary has much better, more targeted micro-interventions, but is probably missing the big picture. As much as I like Obama (and I voted for him), on the economy, he’s simply posturing on the economy: there are few substantive details in his policy recommendations.

I'm sorry to say this, but the debate on NAFTA among political circles is, at present, a useless diversion. It's a sop to the party faithful, but irrelevant to reality, and offensive to two of our strategic partners, Canada and Mexico, who are only playing by the rules, and doing so better than we are.

I’m more than happy to answer or explore specific questions.

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