In the race for the White House, both Republican Donald Trump and Democrat Hillary Clinton have incorporated skepticism about free-trade pacts into their presidential campaign platforms. While Trump has attracted more attention than Clinton by arguing that the U.S. should seriously consider pulling out of the three-nation North American Free Trade Agreement and the 164-nation World Trade Organization, both candidates have criticized the impact of NAFTA on U.S. jobs growth, and opposed U.S. membership in the Trans-Pacific Partnership (TPP) on the grounds that the 12-nation free-trade bloc, yet to be enacted, would have a harmful impact on U.S. economic growth and job creation.
In the case of the United States and Mexico, what are the hidden risks and costs of making such a radical change in U.S. trade policy? The patterns of U.S.-Mexico economic and social interdependence are often overshadowed by dramatic rhetoric about job losses in the United States. Nevertheless, last year Mexico was the United States’ third largest goods trading partner with $531 billion in two-way goods trade during 2015, surpassed in volume only by Canada and China. Since NAFTA’s enactment in 1994, trade and investment between the U.S. and Mexico have mushroomed at a spectacular rate. U.S. exports to Mexico have risen from $41.58 billion in 1993, the last year before NAFTA, to $235.7 billion in 2015 — an almost six-fold increase. Over the same period, U.S. imports from that country have risen from $39.91 billion in 1993, to $296 billion in 2015, an increase of more than seven-fold. Since NAFTA was enacted, Mexico’s exports to the U.S. and Canada have grown more than five-fold from $53 billion to $319 billion in 2015.
The stock of U.S. Foreign Direct Investment in Mexico has also increased, from a cumulative total of $17 billion in 1994 to $101.5 billion in 2013, an almost six-fold increase, because of the NAFTA-related liberalization of Mexico’s restrictions on foreign investment in the late 1980s and the early 1990s. Over the same period, the cumulative stock of Mexican FDI in the United States increased eight-fold, from a mere $2.069 billion in 1994 to $17.6 billion in 2013.
On the other hand, the growing interdependence of the U.S. and Mexican economies makes both countries more vulnerable to the impact of anti-trade (“protectionist”) measures imposed from either side of the U.S.-Mexico border. On balance, Mexico would be more susceptible than the U.S. to damage from any sustained trade war between the U.S. and Mexico, notes Daniel Villegas, an economist at UNAM, the Mexican national university. Villegas says, “Trump has threatened that the United States could leave or renegotiate [its membership in] NAFTA because he considers that agreement unfair for his country, and he believes that only Mexico and Canada have benefitted from that agreement.” However, he adds, “one of the main goals of [NAFTA] is to create a free flow of goods” between the three countries, so that “consumers benefit by getting the best products at competitive prices” in all three countries. Nevertheless, he adds, “The agreement has been more important for Mexico [than for the U.S.], because more than 95% of Mexico’s exports to NAFTA countries have been [shipped to] the United States,” rather than to Canada, notes Villegas.
“Trade restrictions made the Great Depression worse. Let’s hope it does not happen this time again.”–Mauro Guillen
For Mexico, whose governments were long noted for their protectionist trade politics, membership in NAFTA and multiple other free trade agreements has become a cornerstone of its national economic policy. According to ProMexico, the country’s investment promotion agency, Mexico has a network of 10 free-trade agreements with 45 different foreign countries; 32 Reciprocal Investment Promotion and Protection Agreements (RIPPAs) with 33 countries; 9 trade agreements within the Latin American Integration Association (ALADI). Not to mention, Mexico has signed on to the Trans-Pacific Partnership Agreement, and is an active member of the WTO, and the OECD. So while Mexico is banking more than ever on free-trade, the U.S. may be turning in the opposite direction.
Heavily Invested in Integration
Separating U.S. firms from their partnerships in Mexico may be a much riskier task than many supporters of protectionism yet realize. Integrated supply chains now link Canada, the United States and Mexico, so much of what is produced in each of these NAFTA members has content previously imported from its neighbors, notes Gary Clyde Hufbauer, senior fellow at the Peterson Institute for International Economics. For example, about 70% of the value of any Honda CR-V built in Jalisco, Mexico, comprises inputs imported into Mexico from the United States and Canada. To establish these supply chains, private firms in all three countries have invested heavily in their neighbors: U.S. companies have invested about $387 billion in Canada and $108 billion in Mexico. Canadian firms have invested $348 billion in the United States and $14.8 billion in Mexico.
Further investments are needed to enhance the competitiveness of NAFTA as a whole, and generate more of the kinds of high-quality jobs that NAFTA’s critics crave, Hufbauer notes. “Each of the three governments must enhance its country’s economic competitiveness by domestic reforms in areas such as education, infrastructure and tax policy. But by cooperating” – with one another, rather than trying to protect their markets from foreign competition – “they can spur the entire North American economy.” Most major firms are aware of the opportunities ahead. According to Kirk Sherr, president of Clearview Strategy Group, a Virginia-based energy consultancy, “For most U.S. large businesses that produce any kind of tangible goods, the likelihood that they have a significant presence in Mexico is very high. Most of them have tremendous investments [there], and it is frequently the case that their Mexican factories and their Mexican production are among their most profitable.”
Moreover, if the next U.S. president moves to leave NAFTA, such a decision might lead the government of Mexico to take retaliatory measures that would have significant negative costs for the U.S. economy and for the large number of U.S. corporations that do business in Mexico. In one possible scenario, argues Hufbauer, the next U.S. president could try to use the six-month termination clause in the NAFTA agreement to negotiate enough concessions from Mexico to preclude the U.S. from actually having to leave NAFTA.
NAFTA “has been more important for Mexico [than for the U.S.], because more than 95% of Mexico’s exports to NAFTA countries have been [shipped to] the United States.”–Daniel Villegas
“My thinking is that it is a three-way negotiation between the Mexican government, Trump or his new trade czar, and U.S. companies,” Hufbauer explains. “What [Trump] really wants to do is to create some story line where jobs are created in the United States. There are a lot of companies in the U.S. that use Mexico as part of their supply chain, which is critical for what they are producing. Presumably, he would lean on those companies to enlarge their factories in the U.S.; to build new factories in the U.S.; to do something that would give some visible headline numbers for new employment in the U.S. as the price for not putting tariffs or new tariffs on those particular products. I can imagine Trump doing this and hoping to get a lot of companies [in the U.S.] to pledge to build in the U.S.”