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.
Proximity Matters: The Importance of NAFTA for US Trade
As the United States Trade Representative (USTR) states on its website: “trade is critical to America’s prosperity” because it promotes economic growth, creates jobs, raises living standards and provides affordable goods and services to people. The open trading system that has evolved globally since the Second World War has been a boon to US companies and workers, delivering opportunities to build stronger markets for manufacturers and services producers while lowering consumer prices. NAFTA plays an important role in that development and is now an integral part in how the US economy organizes its production.
Just like in other parts of the world, regional trade in North America has grown rapidly and NAFTA countries are ever more integrated with each other. During the age of globalization, China and other emerging economies naturally became important trading partners for the US. However, NAFTA still ranks number one for US trade, both quantitatively and qualitatively, and as the profile of world trade and trade policy is becoming more regional the role of NAFTA for US trade will grow.
Neighboring countries are the key trading partners because of low transportation costs and greater market familiarity. Language and historic ties often play their part as well. And for these reasons, Canada and Mexico represent a big share in US trade – 24.8% in total US trade in 2016. Moreover, their role in US trade has been increasing: In absolute value terms US trade with its NAFTA partners grew more than with the rest of the world during the past two decades. In fact, since the entry into force of NAFTA, trade between NAFTA partners more than tripled – from 290 billion USD in 1993 to more than 1.1 trillion USD in 2016. Figure 1 shows the development over time for trade in goods and services, respectively.
Sources: Services trade from OECD International Trade in Services Statistics and merchandise trade from UN Comtrade data via WITS.
What explains the fact that NAFTA has increased its importance for the US at a time of globalization and emerging market growth? A study by the Peterson Institute for International Economics (PIIE) breaks down the two-way trade between the US and its NAFTA partners to three different sources. One share of the trade is attributed to trade levels as they were before NAFTA and the previous Canada-US FTA. Another share of the trade comes from GDP growth and the economic expansion. Finally, the remaining ‘extra’ trade is attributed in large parts (although not exclusively) to the trade-creating effects of NAFTA. According to this study, ‘extra’ trade – i.e. the trade mainly created by NAFTA – amounted to 635 billion USD for the US, which accounts for about 55% of the US trade with NAFTA partners.
NAFTA trade is crucial for the US economy also in absolute terms. For US merchandise trade, Canada and Mexico are even individually the two most important export destinations of US goods, accounting for 18.4% and 15.8% of US exports respectively in 2016. In terms of imports, Canada and Mexico are also the most important trading partners when taken together as one market, accounting for 26.4% of US imports. Only if they are counted individually, China exports more to the US than each of the two (China: 21.0%, Canada: 12.8%, Mexico: 13.6%), which is largely explained by the sheer size of China’s economy. For US services trade, which is less dependent on distance and regional supply chains, NAFTA plays a less important role with only 11.4% and 10.8% of US services exports and imports going to and coming from Canada and Mexico in 2016.
 Office of the U.S. Trade Representative (USTR). Benefits of Trade. Accessed at: https://ustr.gov/about-us/benefits-trade.
 Hufbauer, Cimino & Moran (2014). NAFTA at 20: Misleading Chares and Positive Achievements. Peterson Institute for International Economics Policy Brief Number PB14-13. Washington: Peterson Institute for International Economics. Page 15.
 This is the case only if the EU is not counted as one single entity. The following trade data are own calculations based on annual trade data provided by the Bureau of Economic Analysis at the US Department of Commerce.