President Trump assumed office with one of the more purposeful trade agendas in modern history: he pulled the US out of the Trans-Pacific Partnership, launched a renegotiation of the US-Korea Free Trade Agreement, and is now threatening to take the US out of NAFTA. He is also considering other measures that would reduce trade activity – most of it supposedly to reduce the US trade deficit. The US Administration needs a new trade policy strategy if it wants to keep economic growth on track and reduce the trade deficit.
The most likely effect of a defensive and protectionist trade policy is that economic growth would slow and the US trade deficit would go up. In the case of NAFTA, US firms are deeply integrated into North American supply and value chains, and there is a large share of US value-added in the country’s imports from Canada and Mexico. Cutting access to the imports of intermediaries from NAFTA partners would drive up the cost of US production and cut its global competitiveness. Therefore, leaving NAFTA would reduce US exports, not only to NAFTA partners but to other markets as well. At the same time, increasing the trade costs with NAFTA partners would not lead to much repatriation of jobs to the US: it is more likely that other countries would substitute for production in Canada and Mexico that is now exported to the US.
The steel sector is a case in point. Steel is an input product for construction and industrial manufacturing, and raising the cost of inputs will drive down the competitiveness of these sectors (e.g. the automotive sector), leading to blue-collar job losses. US steel protectionism in NAFTA is misplaced if the argument is that the trade deficit should be reduced: NAFTA steel trade is in balance. US steel protectionism against other exporters to the US – for instance, through a Section 232 tariff hike – is not compatible with the ambition to raise US exports.
If the trade balance is your religion, free trade agreements should be your church. In other words, if the US Administration wants to reduce its trade deficit, it should rather deepen NAFTA. The rapid economic growth of India and China has obscured the more pedestrian fact that US-NAFTA trade has grown more than with any other trading partner over the past two decades.
Indeed, the US needs to pursue additional FTAs. The US trade deficit with non-FTA partners is nine times higher than its trade deficit with FTA partners, reflecting the simple fact that FTAs help to open foreign markets for more US exports. Contrary to the trade rhetoric of the Administration, the US could directly improve its trade balance through additional FTAs, which would also help to build pressure on countries like China to accelerate reforms to open up its economies.
Frank Lavin was the US Undersecretary of Commerce for International Trade between 2005 and 2007, and the US Ambassador to Singapore between 2001 and 2005. He is now the Founding CEO of Export Now. Hanna Deringer is Trade Policy Analyst at ECIPE, and Fredrik Erixon is the Director of ECIPE. The authors thank ECIPE colleagues Matthias Bauer for comments, and especially Julie Richert as well as Valentin Moreau for great research assistance.
Whatever one might think of President Trump, he has been extraordinarily successful in upending some seventy years of trade policy, of which the United States has been the prime architect, advocate, and beneficiary. There are many elements to Trump’s policy revolution, but at the center of it is his emphasis on the balance of trade rather than the historic emphasis on open trading systems. Indeed, Trump’s substitution of equality of outcomes over the long-standing goal of equality of opportunity is almost a religious conversion in trade policy. But this stated change in policy ignores what for the anti-trade constituency is an unpleasant truth: If the trade balance is your religion, then Free Trade Agreements (FTAs) should be your church. No single policy has moved the US closer to balanced trade than the FTAs.
The current US Administration is of a different conviction. President Trump does not just rail against trade agreements, he is actively seeking to undo, redo, rewrite, or withdraw from FTAs, in the name of reducing the trade deficit. This paper will examine the effect of this approach, using NAFTA and the steel industry as examples in discussing the impact of FTAs on the US economy. It will offer some general conclusions about possible next steps for the US.
One of the first decisions of President Trump was to pull the country out of the Trans-Pacific Partnership (TPP). The negotiation with Europe over a Transatlantic Trade and Investment Partnership (TTIP) is in the freezer. President Trump has re-opened the Free Trade Agreement with South Korea and threatened to cancel it altogether. And at the heart of the Administration’s current occupation is the renegotiating of the North American Free Trade Area (NAFTA) with Canada and Mexico. The Administration has called for a number of NAFTA revisions that would have a negative impact on both the volume and profile of trade between Canada, Mexico and the US. Hanging over these negotiations is the threat that the US may withdraw altogether from NAFTA.
It is the conclusion of this paper that pulling the US out of existing trade agreements will have a series of costs for the United States. It will reduce opportunities for American businesses; it will cost jobs; and most pertinent to President Trump’s policy goals, it is likely to expand the country’s trade deficit. The main effect of the United States withdrawing from NAFTA is likely to be a drop in both exports and imports with NAFTA partners, without much of an effect on the US bilateral trade balance with Canada and Mexico. Furthermore, the general trade deficit would likely increase. The US trade balance with its NAFTA and other FTA partners is fundamentally different from its trade balance with other key trading partners without FTAs: the US trade deficit with NAFTA and FTA partners is nine times smaller than with non-FTA partners.
But the indirect damage might be even greater than the direct damage. The effect on the US trade balance would go beyond the immediate or static consequences. Importantly, if the US leaves NAFTA, it is in many ways like leaving its home market. After a quarter century with NAFTA, and strong economic integration in North America, Canada and Mexico are now virtually part of the US home market in key manufacturing sectors. Outside the field of petroleum trade, the dominant feature of trade within NAFTA is supply and value-chain trade. This means that there is a lot of back-and-forth trade over the borders and, in trade parlance, that the US imports from its NAFTA partners have a high degree of US-based value added. In addition, US industries that import input goods from Canada and Mexico in order to export to the rest of the world would see their production cost go up – and their competitiveness to fall.
The key point is this: home market competitiveness and close economic ties with neighbors are component parts of a country’s global economic performance. All countries in the world show a strong degree of proximity in the way they trade with other countries: the closer countries (people) are to each other geographically, the more they tend to trade with and invest in each other’s markets. If those trade relations get significantly distorted, there will be a knock-on effect on how successfully a country competes on global markets as a large degree of today’s trade is trade in inputs. All successful trade-policy strategies therefore start with building a competitive home market and open markets with key neighbors. In other words, trade performance – like charity – begins at home.
Both US importers and exporters would suffer from new trade barriers and, more importantly, the decomposition of competitive NAFTA-centered value chains. Tariffs, regulatory barriers and ‘Buy American’ policies would suppress US productivity and its international competitiveness. And for that reason, mercantilist countries outside of NAFTA do not necessarily have much to fear from a US trade strategy that is occupied by a withdrawal from NAFTA. Many other countries would regret the collapse of NAFTA and the increase in US protectionism because they would slow down trade and economic growth. But the main consequence from an isolated action such as NAFTA withdrawal would likely be a decrease in US exports to other countries in the world due to lower competitiveness of US companies. Moreover, taking away the preferential trade arrangements in North America would likely entail that non-NAFTA exports to NAFTA countries will go up. Hence, other countries would substitute the trade that now takes place inside NAFTA.
In this paper, we will look closer at key aspects of US trade relations with other countries and put them in the context of the current US trade strategy, especially the threat of leaving NAFTA. The next four sections will cover the economics of current trade patterns, including a deeper look into the supply chain trade in one particular sector – steel – that has received a particular embrace by the current Administration. The final section will consider alternative ways for the US to design its trade strategy with the view of generating more economic growth and, to the extent possible, reducing the trade deficit by means of trade policy. That agenda is based on deepening NAFTA or “home market” trade while pursuing more Free Trade Agreements with countries that, like the United States, accept an open and rules-based world trading system. While the prospects for multilateral trade reforms are poor, an FTA-centered strategy would help to open markets that are more closed than the US market, and thus drive exports more than imports.
 Lavin, Frank. The Myth About NAFTA and Jobs. Foreign Affairs, November 2017.