Trump is right: U.S., Mexico could benefit from a revised NAFTA

Yes, his August meeting with Mexico’s president was startling enough per se, and yes, the spat over paying for his southern wall inevitably hogged the headlines. But it’s still a shame that so little attention has been paid to Donald Trump’s remarks during his visit to Mexico about revising the North American Free Trade Agreement (NAFTA).

For Trump’s goal of “keeping industry in our hemisphere” would revive the only approach to the deal that made sense for the United States, Mexico, and Canada alike, and suggests a strategy for breaking the nation’s broader deadlock on trade policy.

As with most major policy initiatives, NAFTA was sold to Congress and voters with a variety of pitches. Most simply promised a huge windfall to American businesses and their employees from new opportunities to supply a big, rapidly growing Mexican market. But President Bill Clinton and others also spoke of an innovative approach to improving the entire continent’s then-lagging competitiveness. The key was recognizing that most major manufactured products — which dominate U.S. trade flows — consist of a large number of relatively simple and more advanced parts and components.

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According to these NAFTA supporters, American companies could cut their selling costs significantly by farming out production of low-value inputs from the United States to Mexico. In the increasingly integrated global economy, Mexican workers’ meager wages would be more appropriate for the less sophisticated work they performed. And because the final lower-cost products would have a competitive advantage over their European and Japanese products in particular, U.S. companies facing higher demand would also need more American employees to perform the more advanced work that justified their higher wages.

But NAFTA’s backers also realized that non-North American countries could easily respond with greater subsidies for their own firms — including currency policies that could slash their own selling costs. So incentives were created for moving European and Asian manufacturing to North America in the form of tariffs for anything they wished to sell in the new continental market that was made wholly or largely outside it.

Unfortunately, such NAFTA tariff penalties were too low to achieve these results. Even worse, the United States, Canada, and Mexico all proceeded to negotiate new free-trade deals with countries outside North America that largely dismantled most of even those meager barriers. Multinational companies from the three NAFTA countries benefited — they were free to source inputs from practically wherever they wished.

But this flexibility cost North America’s national economies major production and employment opportunities.

The United States lost out largely because ever more of the advanced manufactured products being sold in North America were being made outside the continent.

Mexico, however, lost out, too. Many of the Third World markets that new trade deals made safe as alternate low-cost suppliers to American customers proved far more attractive to multinational companies.

Until very recently, China in particular completely eclipsed Mexico in their outsourcing plans, and through the start of the current economic recovery, began winning shares of the American manufactures market from Mexico at a stunning pace. Worse, China’s greatest gains came in more advanced manufacturing sectors that became all but closed off to Mexican entrants.

As Trump pointed out during his Mexico visit, this leakage of NAFTA trade benefits outside the hemisphere has kneecapped economic development not only in Mexico, but in Central America, whose own trade agreement with the United States has failed to prevent continuing impoverishment and surging violence for similar reasons. Both failures, in turn, have intensified “pressures on cross border migration.”

Two big related NAFTA policy fixes could turn trade into a win-win-win for the United States and its closest southern neighbors (including in the Caribbean).

First, the standards for eligibility for duty-free treatment in North America for all products should be raised much higher than current levels — which generally require only that between 50% and 60% of a product’s value originate within North America. Since the new free-trade area would contain the full range of manufacturing capabilities in particular, there’s no apparent reason why the requirements shouldn’t mandate nearly 100% regional content.

Second, the tariff penalties for failing to meet these requirements should be high enough to create strong incentives to manufacture in North America.

Turning NAFTA and other porous hemispheric trade deals into a trade-diverting bloc surely clashes with the global trade rules now overseen by the World Trade Organization. But it is entirely consistent with major strategic interests of the United States: stabilizing and enriching its geographically closest neighbors, and preventing their problems from spilling over the southern border.

And it would finally turn NAFTA into the win-win for all North American economies originally envisioned by so many leading backers.

Alan Tonelson is the founder of RealityChek, a public policy blog. Follow him @AlanTonelson.

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