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When the new cost structures of the automotive supply chain are effective, it will be clear that free-trade era of global economics is over.

The Price of Free Trade

Sept. 1, 2018
Once NAFTA is history, we may finally understand all it achieved, whether or not it was a fair deal.

If in a year or two we are speaking of the former North American Free Trade Agreement, I will understand. I did not think NAFTA was so vulnerable a year ago, even though it had been under verbal attack from its beginning. NAFTA was born under criticism, but it remained invincible for almost 25 years. Now the trilateral agreement has been subsumed by a bilateral agreement between the U.S. and Mexico — part of a wider trend in global trade — and while it may be that Canada is worked into this new arrangement we can see what NAFTA has become: a deal that sets the price for “free trade”

“They used to call it NAFTA,” President Trump said when announcing terms of the new agreement. “We’re going to call it the United States-Mexico Trade Agreement,” implying that the trade terms will not be free but codified in order to be used as tools (or weapons) to get predetermined financial and/or political prizes.

The revised deal alters especially the rules governing automotive production in Mexico, resetting the global cost structures of that industry’s supply chain. The new terms would require cars sold in North America to contain at least 75% (up from 62.5%) of its contents made in the region, in order to avoid tariffs. Similar rules would define steel and aluminum contents and labor costs. Apart from any shock to automakers and their customers when the new cost structures are effective, the new agreement will make clear that free-trade era of global economics is over.

NAFTA is being overturned because it succeeded spectacularly at what it set out to do in 1994: to make it possible to sell more things to consumers in Canada, Mexico, and the U.S. at lower overall production cost. It failed spectacularly at convincing individuals across North America that this was to their benefit.

To make it easier to sell things NAFTA created conditions in which it was less expensive to manufacture things. It lowered tariff barriers so that Mexico would become a first-rate manufacturing center, but with lower overall costs than in the U.S. or elsewhere. Mexico drew in many billions of dollars of capital investment, and NAFTA made it easier to sell expensive things (cars and trucks), popular things (TVs, appliances), and ordinary, high-volume things (toothpaste, printer cartridges.)

This success is now so transparent that we may fail to realize the changes NAFTA initiated in the North American economy. How the cost of SUVs or toothpaste is set does not matter to a consumer. But, devising NAFTA for this purpose built into it a lasting vulnerability: resentment. Manufacturing things in lower production-cost in Mexico made it inevitable that NAFTA would be identified as the primary reason for the decline in manufacturing employment in the U.S.

And people do care about that decline. They believe the U.S. government should take steps to correct it. They accept the facile criticism because it’s easier to view free-market economics as an ordered sequence of causes and effects, rather than a dynamic system of changes, where rules may alter procedures but not outcomes. That is, the vulnerability of U.S. manufacturing existed prior to and separate from NAFTA. NAFTA presented an opportunity for investors, and then consumers, to turn that vulnerability into opportunity.

While some beneficiaries ignored NAFTA’s improvements, others just moved on to other projects. The post-free-trade era is a time in which planning and executing an economic program is small change to capital markets that demand steady and forecastable returns. They prefer the information and technology stocks over hard-goods businesses. Manufacturers must cooperate with governments because they cannot operate in the ether.

On this point it must be said that that NAFTA failed on the separate, more ideological objective of making Mexico a stable and equitable economy for its citizens. The unhappy civil affairs of the country are the proximate reason for the border tensions between the two economic partners, and thus a new line of attack on NAFTA. Mexican citizens are better consumers, but it’s far from clear that NAFTA made their country a happier, safer, more secure place to live.

The free-trade era offered the promise of economic prosperity and individual autonomy. We may learn in retrospect whether or not it was a fair deal.