NAFTA Withdrawal Would Undermine Tax Reform Gains

America needs both low taxes and free trade to thrive in the 21st century.

Milyavsky/Dreamstime.com

Last year's massive tax code overhaul lowered corporate income tax rates to an internationally competitive level for the first time in decades. U.S.-based businesses can now compete against their foreign counterparts without starting from an immediate disadvantage, thanks to Uncle Sam. The change should result in faster growth, higher wages and more jobs. Unfortunately, those gains may be undone this year with a wrong step on trade.

Take the Trump administration's recent decision to impose tariffs on washing machines and solar panels from Chinese and South Korean manufacturers. The cost to consumers could rise to a level where buying a washer isn't worth the price. News reports mention similar measures being imposed on aluminum and steel imports.

Yet no matter how costly these protectionist moves are, their effects pale in comparison with what the impact would be if we withdrew from the North American Free Trade Agreement (NAFTA). With negotiations dragging on and the threat of a U.S. withdrawal from the 24-year-old pact looming, President Donald Trump will soon have to decide whether placating his populist base is worth the cost of undermining his signature accomplishment to date, tax reform, as well as his record on the economy.

Among the working class, NAFTA and free trade in general often take the blame for the decades-long decline in manufacturing jobs. Trump successfully rode this public angst over globalization into office, but he must reconcile populist rhetoric with economic reality if he hopes to maintain a strong economy worth bragging about on Twitter.

Far from harming American manufacturing and other industries, NAFTA has benefited American business. As my colleague Dan Griswold explains, "before NAFTA, Mexico imposed tariffs on U.S. agricultural and manufactured goods that were significantly higher than U.S. tariffs on Mexican goods. NAFTA reduced all duties in all directions to zero."

The main culprit behind declining manufacturing jobs is progress. Even as manufacturing employment has declined—notably, there was no acceleration of the trend after NAFTA was implemented—real manufacturing output has steadily increased. Thanks largely to improvements in automation, American manufacturers can produce more today with less work. That's a good thing.

And thanks to tax reform, American manufacturers and other businesses are now more competitive internationally. There's much less incentive to move economic activity offshore solely for tax reasons. But ramping up economic protectionism would undermine these gains and harm the economy.

Many U.S. manufacturers have global supply chains, meaning they import materials and other inputs, even if the final product might then be exported. Raising the prices of these goods with tariffs makes it harder for U.S.-based businesses to compete.

Likewise, Canada and Mexico are our top trading partners. If they were to increase foreign tariffs on U.S.-manufactured goods—absent a free trade pact or as retaliation for new tariffs imposed by Trump—that would significantly harm U.S. exporters.

Agriculture is one sector that would be hit especially hard by terminating NAFTA. A report by Daren Bakst of The Heritage Foundation considers Canada and Mexico critical for U.S. agricultural trade and quotes the U.S. Department of Agriculture's Economic Research Service: "With the productivity of U.S. agriculture growing faster than domestic food and fiber demand, U.S. farmers and agricultural firms rely heavily on export markets to sustain prices and revenues." Ultimately, the whole economy would suffer. A study published by the Business Roundtable estimates that the fallout from terminating NAFTA would be a loss of 1.8 million U.S. jobs in the first year.

No friends to free trade themselves, Democrats would be all too eager to redirect the blame for an economic slowdown resulting from NAFTA withdrawal onto tax reform. They will take any excuse they can get to re-raise taxes and would be much likelier to find themselves with the political power to do so with a weakening economy during the next election.

There are areas in which NAFTA could be improved. Griswold identified several in a comment to the Office of the U.S. Trade Representative, such as "protecting data transfers, barring the forced localization of servers, adding additional disciplines against the abuse of antidumping duties, and further liberalizing the services trade, including U.S. maritime shipping and Mexican oil and gas drilling."

The upcoming seventh round of the NAFTA renegotiations, the last currently scheduled, could still be productive if they're focused on expanding the gains of liberalization by removing even more barriers to trade and preventing governments from picking winners and losers. But if the president were to insist on fulfilling his threat to withdraw from NAFTA entirely, it would do significant economic harm and tarnish his signature accomplishment.

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Comments

[Scarecrow Repair & Chippering]

It’s easy to sympathize with people who want tariffs in retaliation for other countries subsidizing their exports. It’s a very natural instinct to retaliate against cheaters. The old prisoner game, with tit-for-tat, shows how instinctive it is. If someone cheats you, you cheat them.

But China subsidizing exports is not cheating us; it’s an expensive way for them to prop up their jobs, but it saves all of us far more money than the jobs it “costs”, and they spend more subsidizing cheap goods for us than if they simply put those workers on welfare. Both sized waste money inefficiently, spending several times more than the jobs are worth.

I’ve gone through the details with some people, and they understand, but still, it feels so natural to retaliate when the restrict imports from us, or subsidize their exports to us. “They aren’t playing by the rules!” One of the most basic human instincts, even chimpanzees understand fairness in such a basic way.

[buybuydandavis]

“The old prisoner game, with tit-for-tat, shows how instinctive it is”

It’s not merely instinct, but game theory. Variations of tit for tat compete well in most game circumstances. Always caving to pressure and uncertainty is a bad strategy.

“but it saves all of us far more money than the jobs it “costs””

This is an empirical question. It depends on the alternative use that can be put to the human widgets working in the competing US industry. Same for the capital base. Both the labor and capital of industries are not infinitely fungible.

Suppose they could be used for *nothing* else. Would your claim still be true? I think not.

But Reason takes these questions as a matter of faith, proven by someone once upon a time, though they never quite seem to bother to reproduce the proof themselves.

[DiegoF]

This is an empirical question. It depends on the alternative use that can be put to the human widgets working in the competing US industry…Suppose they could be used for *nothing* else.

Hunter and Coco subsist on meat and coconuts on a desert island; both prefer a good mix of meat and coconuts, in the ordinary manner of goods bundle preferences. Coco is a retarded person who cannot hunt. Hunter can both hunt and gather coconuts, perhaps even better than Coco, but the situation is such that both are best off if Hunter spends all day hunting and trades some of his meat to Coco for the coconuts he spends all day gathering.

One day their isolation is broken by a nefarious Chinese freighter that dumps an entire bargeload of coconuts on their shore every day for free. The most extreme kind of dumping! Is our society worse off for this apparent generosity?

Well, Coco is clearly fucked. Now he’s got nothing Hunter wants. He can gorge himself on coconuts, but that will never be compensation enough for never tasting meat again. Hunter is better off, because he can now keep all his meat, and gorge himself on more coconuts than Coco ever provided…

[DiegoF]

…But, of course, we can objectively say that the society is better off, which is surely what we’d expect intuitively. We express this by observing that if Hunter is feeling generous, he can simply donate to Coco the amount of meat he was previously trading to him. Now both he and useless Coco have as much meat as before, and even more coconuts.

Of course no such demonstration can disprove Adam Smith’s claim that tariffs could be useful gamesmanship. It’s a rather hard game to play because it requires so much deep political analysis; when a “country” engages in “unfair” trade practices, it is of course not acting as an agent of its society but as one of some bundle of crony industries.

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[mpercy]

Then the government comes in and destroys the coconut pile to keep coconut prices at historic market levels. And they tax Hunter to force him to provide meat to Coco, even though they’ve supposedly stabilized the market for coconuts and Coco can rejoin the workforce.

But Coco liked the free coconuts and not working while it lasted, and would prefer to get the meat provided by the tax and transfer program and will only pick up a few coconuts for himself if he really feels like it.

Hunter will have to do two jobs (hunt and get coconuts), since he’s not getting any coconuts from Coco anymore.

Then the government notices that Hunter has improved his situation and is flush with both coconuts and meat. The meat tax is extended to coconuts, so as to provide both for poor unfortunate Coco.

Coco sits back and eats his free meat and coconuts and stops even pretending to do for himself.

[Frank White]

The example doesn’t reflect the issues with manufacturing or IP. If China dumps solar panels, then it doesn’t make sense for the island’s natives to make their own. Yay! Free stuff! In the long term, nobody on the island invests in making solar panels. The Chinese become the sole supplier and become a monopoly on an item that is now critical to island society. Now there’s no profitable way for the islanders to play catch-up because the costs to make them locally will always be higher than the now established defacto manufacturer.

[Scarecrow Repair & Chippering]

And how long can that monopoly manufacturer keep up losing money?

There are no long term natural monopolies, only government-established ones. Numerous studies have failed to identify a single natural monopoly. People always find a way around them, whether with substitutes or better methods.

[Frank White]

Who says they’re losing money? They’re simply in a powerful position when it comes to startups. They have the money, the tooling, the knowhow and the IP. The costs to compete are a huge hurdle now.

[Scarecrow Repair & Chippering]

This topic started with complaints about China subsidizing their exports. By definition, that means losing money. Or maybe you have some other definition.

[prolefeed]

The example doesn’t reflect the issues with manufacturing or IP. If China dumps solar panels, then it doesn’t make sense for the island’s natives to make their own. Yay! Free stuff! In the long term, nobody on the island invests in making solar panels.

You mean the way American manufacturers produced all the pickup trucks for Japan and Korea a while back, resulting in Japanese and Korean workers finding alternative employment that resulted in goods and services Americans wanted in exchange for those cars, such as motorcycles and then later small cars? And how that initial investment by Americans forever prevented Japanese and Korean workers from entering the truck manufacturing industry despite still having the engineering skills developed by manufacturing motorcycles?

I mean, Toyota and Honda and Hyundai clearly don’t produce pickups or SUVs. How could they?

[DiegoF]

If China dumps solar panels, then it doesn’t make sense for the island’s natives to make their own. Yay! Free stuff! In the long term, nobody on the island invests in making solar panels…Now there’s no profitable way for the islanders to play catch-up

Well, “yay” indeed. Why on earth do the islanders need to “make their own”? What on earth are they “playing catch-up” to? Why do they need to “invest in making solar panels”? There are already perfectly good ones being made in China. What, a country has to make everything it consumes? This is begging the question rather profoundly on the very idea of free trade.

I do have to point out that this is supposed to be a pro-market, libertarian site, so most people here will be arguing with that perspective as a background assumption. Nothing wrong with commenting here from another perspective, of course; it’s just that that was the audience I was addressing with my own comment.

[Frank White]

Multiply the solar panel problem with the rest of the manufacturing industry and you have a population that makes nothing, but consumes everything. Now that it’s lost, it’s extremely difficult to get it back. Yes, I understand. There’s no law that says a country (or island) should manufacture everything it uses. However, a large part of the reason it becomes less attractive is not just cheaper labor costs abroad. It’s going to be more expensive to re-start up a manufacturing business from the ground up.

[prolefeed]

Well, Coco is clearly fucked. Now he’s got nothing Hunter wants.

It’s an odd sort of retardation you posit for Coco. He’s smart enough to perform a simple task like gathering coconuts, but somehow not smart enough to perform any other good or service that Hunter wants even if Hunter proposes those goods and services and supervises enough to get them done to his satisfactionn, such as cracking open the coconuts and serving them to Hunter, or providing fresh bedding of coconut fronds for Hunter, or sharpening the spears Hunter uses for hunting, etc.

Most people have an effectively unlimited set of desires, at least some of which even the least skilled among us can provide.

[DiegoF]

buybuy proposed a scenario, as an extreme case, where the trade-displaced worker is completely without other skill. I was following that.

[Scarecrow Repair & Chippering]

Idiot. Trade is a voluntary exchange. What would the Chinese gain by just giving away coconuts? Why not hypothesize an alien flying saucer dump bags full of giraffe heads, which Hunter hates with a passion because he had childhood nightmares when a giraffe stuck its head in his second story bedroom?

Fuck off, slaver.

[DiegoF]

You cannot be fucking serious here. I just can’t believe you could be.

Alright, deep breath, Diego. Deep breath.

This is not meant to be a fully realistic story. It is a “toy” story, a model. This is standard practice in literature from intro textbooks to the research frontier. You make a deliberate simplification for the sake of clarity, which is supposed to abstract away the irrelevant details to focus on certain ones. Then you can see how the model applies to real-life scenarios…

[DiegoF]

…Dumping occurs when a country supplies goods to another at prices that are allegedly “unfairly low.” For the sake of simplicity, I took this to an extreme by making the price free. (I also made Coco completely useless, a simplification buybuy himself had the intelligence to suggest.) If you want, imagine that China sells Hunter the boatload of coconuts for one monkeyburger of meat. This does little but complicate the scenario unnecessarily. In both cases the point is that “China” (i.e. the Chinese government) is not, indeed, relying on the islanders to pay the salaries of the Chinese coconut pickers; they are using their own wealth to operate a “make-work” program for them. That is what it means to subsidize exports. It makes no sense to ask, “What would the Chinese gain?” because indeed they do not, from the point of view of their entire society. Subsidies are domestic political cronyism disguised as an international issue; and the only reason any other countries object is their own domestic political cronyism.

[DiegoF]

Actually, now reading it I think it’s quite clear that you were kidding, although I have to say I still don’t quite get the joke. Oh well, I’ve given up hope on ever being good at picking up on this shit.

[DiegoF]

Ah, now I get what might be going on. (Again, assuming you’re not kidding.)

You are in fact a fellow supporter of free trade, who is unsatisfied by my demonstration that the island as a whole is better off. You are offended even by the suggestion that Coco was made worse off by the free coconuts, so you have attacked the model because you are under the impression that trade has no natural “losers.” This is a common belief among those who think they know economics but do not. (Much as a failure to understand the concept of abstraction is common among those who are unfamiliar with science of any kind.) Price theory does not support such an assertion, and no informed person makes it. What it actually asserts about trade is precisely what I explained in the original comment.

This is what I’m guessing you may have meant (if serious) by calling me a “slaver.” Perhaps you also were under the impression that my talk of “society” being better or worse off has no noncollectivist meaningfulness. This is also incorrect.

[DiegoF]

*Clarification: …relying on the islanders’ taste for coconuts to pay the salaries…

[Scarecrow Repair & Chippering]

Yea, assume a spherical cow.

If your damned model doesn’t stand up to scrutiny, then what use is it?

If you’re just telling fairy tales, then why insert them into a somewhat-serious discussion, and especially why get upset when someone points out they are not real?

Loser.

[DiegoF]

Models are not “real”; they are all fictitious. “Fairy tales,” as you put it, when it comes down to it. But they are very serious indeed. Abstraction is central to the methodology of all science.

It’s true that the bridging the gap between theory and practice is another central struggle of science. Often there’s some tension–good-natured and otherwise–between scientists working at different ends of the continuum. But no one seriously advocates getting rid of theory altogether–that wouldn’t be science.

The spherical cow joke pokes fun at theoreticians. It works because the scientist in that example has abstracted away the central challenges of the problem–thus discussions of the model are unlikely to be very enlightening. Under other circumstances the assumption of spherical objects in a vacuum can be very useful indeed! (Indeed, that’s why it was chosen for the joke.)…

[DiegoF]

…I have already explained why I made some of my simplifying assumptions, such as Coco’s lack of other skill and the exaggeratedly cheap dumping by the Chinese, and why they tell us what they do about real-life scenarios. If there are things you still don’t understand, or if you have any other objections you’d like answered, reply here; I will try to check back and answer them. (Or if you don’t it’s OK too; at this point I’m kind of just trying to put together something informative for future people who may come upon this comment page. No one but us is really here anymore at the moment!)

Also, I agree I was a bit rude. I apologize.

[loveconstitution1789]

Plus, there are so many reasons that some Americans companies are not competitive.

One major reason is all the government regulation and costs piled on companies especially those trying to compete in foreign markets. Congress is unwilling to tackle this yet but at least Trump has made moves to try this to help American companies. The tax reform was a good start.

[Frank White]

What’s the Libertarian solution to an unfair trade deal? It’s not military force, right? If we’re talking about the individual, an individual can choose to abstain from taking part in an unfair trade of goods or services. However, that’s not what NAFTA is. It’s an agreement between governments. If not threats of tariffs nor threats to dissolve the agreement, what other options are there?

[creech]

Buy even more subsidized goods?

[Scarecrow Repair & Chippering]

Ni such thing as an unfair trade deals, except those forced at the point of a gun, and those have a name — theft. Every trade deal is voluntary. You keep positing things which do not exist. If that is all your argument is based on, then you have no argument.

[Headache]

Why NAFTA, is it or could it be there is no application of free trade? Is it a drug induced fantasy of Libertarians? Free trade as defined by Libertarians would abolish the agreement, yet must scream when the agreement is threatened with abolishment.

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[buybuydandavis]

“10,000 page trade deals are free trade”

“President Donald Trump will soon have to decide whether placating his populist base is worth the cost of undermining his signature accomplishment to date, tax reform, as well as his record on the economy.”

Uh huh.

How about “Mexico and Canada will have to decide whether to lose America as a trading partner, or give in to Trump’s demands to cut the US a better deal”?

This is part of the Right’s problem for the last century: unwilling to risk rocking the boat, so *always* caving.

The US actually has a much stronger position for bilateral trade negotiations, yet we’re always the ones bending over backwards to preserve multilateral deals that put us at a disadvantage.

Play to win.

Not tired of winning yet!

[Crusty Juggler]

Play to win.

Not tired of winning yet!

lol

[chemjeff]

“The US actually has a much stronger position for bilateral trade negotiations, yet we’re always the ones bending over backwards to preserve multilateral deals that put us at a disadvantage.”

Yup! Winning means acting like an imperialist dick to the rest of the world.

“We are the world’s largest economy, so you will bend to our will, bitchez!”

[Headache]

The position of the U.S. dollar as the reserve currency is the only reason “We are the world’s largest economy, so you will bend to our will, bitchez!”

[Leo Kovalensky]

“Play to win. Not tired of winning yet!”

Recommended reading:
https://en.wikipedia.org/wiki/Zero-sum_thinking

[Alan Vanneman]

“But if the president were to insist on fulfilling his threat to withdraw from NAFTA entirely, it would do significant economic harm and tarnish his signature accomplishment.”

His “signature accomplishment,” Dr. de Rugy? Is that the one that adds about $150 billion to the national debt every year, a debt that, according to, you know, you, was already unendurable back when a Democrat was in the White House? The one that establishes double taxation for individuals (but not for corporations) with regard to state and local taxes, a provision deliberately written into the federal tax code to punish people for voting the “wrong” way (or at least for living in states where a majority of the population votes the “wrong” way)? The one that establishes elaborate, and ill-defined, “pass through” options for treatment of income, making the tax laws more complex and opening up all sorts of new opportunities for gaming them, something I think you’ve said you were against. But the new tax reform package certainly does benefit the rich (the “truly rich”), so I guess that makes you happy. Oy, the humanity.

[Rhywun]

Elections have consequences. If the voters in blue states choose to “double tax” themselves – whatever that means – that’s their choice.

But the new tax reform package certainly does benefit the rich (the “truly rich”)

It’s already been pointed out that 80% of taxpayers get a break. Some of them, I presume, are not the despised “truly rich”.

[DiegoF]

Finally a New Yorker with principle! I swear, this issue has united everyone in this state. There’s just enough there for libertarians to give themselves an excuse to complain about it.

[loveconstitution1789]

North American Free Trade Agreement (NAFTA)

Its not “free trade”, its managed trade. The managed part of trade is not as good as America can get.

Completely free trade is the best but its doubtful the US will have that.

[I am the 0.000000013%]

The main culprit behind declining manufacturing jobs is progress

I doubt it.

I work in manufacturing, and the thing that is most likely to drive us out of business is excessive regulation at all levels of the company. No other factor even comes close.

In other companies you can add government propped up unions as a huge incentive to move production to some other country.

[creech]

My career was in manufacturing. While regulation didn’t help, with all candor the thing most likely to impact us was not staying up with manufacturing techniques. You can’t compete against the guy whose cnc turns out twice as many widgets per man hour as yours does. Being able to write off equipment purchases in the year they are made will cause many more businesses to upgrade their processes when they need to be upgraded.

[Headache]

And that is one of the features of Trump’s tax reform.

[I am the 0.000000013%]

Acquiring machinery is made far more difficult by regulations. It makes large companies that have fleets of lawyers far more able to advance. Hiring employees to keep up with new techniques is far harder because of regulation, and even worse, firing someone who isn’t working out is both risky and tough.

I agree that keeping up with manufacturing techniques is critical. I also maintain that regulations make doing that far harder than it needs to be and too much capital is being spent on regulatory compliance and too little on skills and capabilities acquisition.

[Kenrm]

The intent of free trade is a balanced amount of value moving in two directions. Unfortunately, the way NAFTA was written, last year $65 billion more trade value went from Mexico to the USA. That trade value was mostly USA companies making products in Mexico for specific sale back into the USA. That WASN’T the intent of NAFTA. That is just eliminating USA labor for products sold in the USA by USA companies. Therefore, the loopholes in the trade agreement allowing such imbalances in trade need to be modified.

[Headache]

A study published by the Business Roundtable estimates that the fallout from terminating NAFTA would be a loss of 1.8 million U.S. jobs in the first year.

Most of which is Mexican, Haitian and other imported labor.

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