NAFTA 1994-2030

Jobs foe or competitiveness tool?

By Sergio L. Ornelas, Editor MEXICONOW


Have you ever thought or noticed which is the most important part of a deceased person’s tombstone inscription or epitaph?

Ironically, it is the smallest print character in the information. As in “Joe Smith RIP 1940 – 2014”, the hyphen, the punctuation mark between Joe’s birth and death years represents how Joe spent and managed the 74 years of his life.

Take a moment and think about it. And yes, you are right there today, somewhere in the length of your hyphen. 

Just a philosophical thought inspired by the title of this article.

The North American Free Trade Agreement came into effect on January 1, 1994; and in our analysis, we do not mean to kill the North American Free Trade Agreement (NAFTA) in the next few years, 2030 is just our forecast time frame.

As you may suspect, we actually hope NAFTA enjoys a long life hyphen. But there are skeptics.

However, the detractors of NAFTA in the U.S. would be surprised to learn that the trade agreement is not a one-sided deal in favor of Mexico, as many believe. In fact, the U.S. obtains many benefits that are not broadly known.

Many U.S. media and politicians like to associate NAFTA with the loss of jobs in manufacturing, but there are actually very advantageous aspects for the U.S. related to NAFTA. We will review them in this article after we explore the background of NAFTA. 

Why free trade?

All year round, 24/7/365, over one million dollars worth of goods is traded every minute between the U.S. and Mexico.

Born and raised in controversy and blamed by default, NAFTA just turned 22 years young with solid quantitative results and doubts about its benefits.

NAFTA and other free trade agreements have taken center stage in the race for the White House. Republicans and democrats alike, either sincerely or for the sake of votes, oppose free trade.

There have been a lot of ink, saliva and brain cells invested in the discussion of free trade. Is free trade a case of zero-sum, is it a win-win for the partners or are there winners and losers? 

Free trade would not be an issue at all if countries had not opted to tax foreign goods as a source of income in the first place. 

Since the ancient times of the Silk Road between Rome and Asia, traders had to pay taxes and tariffs to the states in control along the way. And that became pretty much the standard practice around the world for centuries.

During the industrial revolution, protectionism gained a lot of clout with countries that wanted to develop a domestic industrial base; protectionism was the technocratic excuse given by governments to defend tariffs and other barriers to international trade.

Mexico was in this league for many years, protectionism and substitution of imports by domestic producers were the strategies to build an industrial base up to the mid-80’s.

But this practice resulted, for the most part, in the development of non-competitive manufacturers and expensive goods for consumers. Whether imported or made in Mexico products were costly, and in many cases lower quality or scarce. 

Paradoxically, since the early 70’s, Mexico had anchored the most successful international manufacturing program in the world. The maquiladora program grew very strong in a virtually complete free-trade environment. In 1994, when NAFTA was kicked off, maquiladoras already employed over 600,000 workers.

In light of a weakening of its foreign economic relations and a trade deficit that heavily contributed to the country’s indebtedness, in 1985 Mexico pursued negotiations to join the General Agreement of Trade and Tariffs (GATT) sponsored by the U.S. in 1947 to liberalize and regulate the international trading system with the participation of over 100 countries.

During a trip from Davos, Switzerland upon returning from the annual world summit in the now retired presidential airplane, former President Carlos Salinas de Gortari instructed the then Minister of Commerce and Industry Jaime Serra Puche to initiate formal negotiations with U.S. officials to establish a free trade agreement between the U.S. and Mexico.

During the course of the talks, the two countries decided to invite Canada to make a trilateral agreement. Canada and the U.S. had an existing treaty dating back to 1998.

Behind a strong Republican vote, and after many emotional discussions, both U.S. houses passed the agreement in late 1993.

The goal of NAFTA was to eliminate barriers to trade and investment between the U.S., Canada and Mexico. It brought the immediate elimination of tariffs on more than one-half of Mexico's exports to the U.S. and more than one-third of U.S. exports to Mexico. Within 10 years, all U.S.-Mexico tariffs would be eliminated. Most U.S.-Canada trade was already duty-free.

NAFTA also sought to eliminate non-tariff trade barriers and to protect the intellectual property rights on traded products.

Those favoring trade liberation argued that besides the evident benefit to consumers who would pay lower prices for imports and thus use their higher disposable income to buy more goods and propel economic growth, with the expanded markets, all producers along NAFTA-land would increase their output and hence their jobs.

In addition, factories in the three countries would produce at a larger and more efficient scale, and overall industry global competitiveness would increase by distributing and sharing production in the country that would be most efficient and cost effective in each segment of the value chain.

On the other side, opponents were concerned that free trade would have negative effects on the economy, with the possibility of capital and jobs flight as a result of international outsourcing. 

We can unequivocally state that the happiest people with the activation of NAFTA were the consumers in Mexico. Suddenly, a great array of goods from the U.S. were available at affordable prices; imports from the U.S. almost tripled in the first five years of NAFTA going from US$50 billion in 1994 to US$136 billion in 2000. 

We can also definitely state that the most outraged people in the first few years of NAFTA were the Mexican owners of thousands of small and mid-size fabricating and commerce outfits, which succumbed under the huge commercial wave of U.S. products, retailers and franchises.

In spite of all the negative press and political arguments about the U.S. losing jobs to Mexico, the U.S. gained 800,000 manufacturing jobs during 1994-1998, many attributable to NAFTA, reversing a 13-year trend during which the U.S. lost two million manufacturing jobs.

And today, according to the U.S. Chamber of Commerce, increased trade with NAFTA supports five million jobs!

By the numbers

During the last 20 years, trade of goods between the U.S. and Mexico has increased over five times fold from US$100 billion in 1994 to US$531 billion in 2015 as shown in Exhibit #1.

The first five years of NAFTA experienced the highest growth while the lows were felt during the dot-com years in 2000-2003 and the great recession in 2009-2011.

Historically, Mexico has had a positive trade balance with the U.S. At the bottom of the exhibit the annual U.S. trade deficit with Mexico is shown as a percentage of total trade between the countries. 

The U.S. deficit peaked in 2005 at 17.1% and has been in the decline since. It will likely be in single digits after 2020 as a result of energy products exports from the U.S. to Mexico.

Our forecast is conservative with estimated trade between the two countries at US$630 billion in 2020 and US$851 billion by 2030.

Shifting positions

Public knowledge has it that Mexico is an oil producer country and an important exporter of petroleum to the U.S. But the truth is that for this commodity, the NAFTA partners are actually rapidly shifting positions.

Mexico is currently the #1 importer of U.S. exports of total petroleum and related liquids. According to the U.S. Energy Administration, in 2015, Mexico bought from the U.S. over 250 million barrels of oil related products representing 16% of all U.S. exports; Canada was the #2 U.S. customer with 192 million barrels.

U.S. exports of oil related products to Mexico are rapidly increasing, growing by 53% in the last 5 years; Mexico bought 163 million barrels in 2010 from U.S. sources.

The U.S. is Mexico’s #1 customer for oil: in 2015, Mexico exported 276 million barrels of mostly crude oil to its NAFTA partner. And although this is an impressive figure, it is significantly lower than in previous years: in 2010 the U.S. took in 469 million barrels from Mexico. This represents a drop of 42% in only 5 years.

In fact, in the month of July 2015, the U.S. became a net oil exporter to Mexico for the first time in more than 20 years as output from shale fields continues to take the U.S. to energy independence. In contrast, Mexico’s production and reserves have fallen.

But this is an analysis counting barrels only. The difference in the value of shipments from each country is very different: while Mexico’s oil related exports to the U.S. are mostly of the crude oil type, U.S. oil exports to Mexico are mainly processed petroleum liquids such as gasoline, lubricants and jet fuel.

On average, each U.S. oil export barrel is worth about 50% more than the Mexican counterpart.

And since the U.S. recently lifted the four-decade ban on selling U.S. crude overseas, it is reasonably to expect that the U.S. will score a barrel positive net trade balance with Mexico in 2016. 

In addition, as massive natural gas pipelines are built from U.S. fields to Mexico, it is expected that by 2020 American shipments of natural gas to Mexico will at least quadruple, making the U.S. Mexico bilateral energy relationship the largest ever in the world.

The U.S. will benefit and will have an ample energy surplus with Mexico. But the latter will also greatly benefit as well in a classical example of free trade win-win cases between countries.

Mexico plans to use the natural gas imports for electricity generation. Other than competition from China, the biggest hurdle that Mexico has faced to develop more industry is the costly and often times unreliable supply of power.

The surge of U.S. shale gas into Mexico will make domestic and foreign manufacturers more cost competitive.

Trade of intangibles

NAFTA is generally perceived as an agreement about physical products and commodities, but it also includes an important chapter for the trade of services between the participating countries.

This is an important item and one in which the U.S. has the upper hand over Mexico.

Trade in services between the U.S. and Mexico reached about US$52 billion in 2015. The U.S. exported US$31 billion worth of services to Mexico, and imported US$21 billion from its southern neighbor.

The main services traded between the partners include: financial, maintenance, insurance, business operations, travel, medical and other services such as charges for intellectual property, software development, R&D and design and engineering.

The trade in services support high-paying jobs on both sides of the border and the amount traded is by no means petty-cash representing almost 10% of the total trade between the countries; trade in services is also a fast growing category, it increased 5.6% in 2015 from 2014.

Most reports and statistics, like the U.S. Census Bureau separate trade of goods and services. But if we compute them together, the U.S. trade deficit with Mexico shrinks. For example, for 2015, the U.S. goods trade deficit with Mexico was 10.9% as a percentage of total merchandise trade, but this figure is reduced to 8.2% if goods and services are considered together (total goods and services trade of US$583 billion with a U.S. deficit of US$48 billion). 

In the big picture, it is evident that the U.S. is becoming more of a services economy and less a manufacturing one. And this is probably where an advanced economy wants to go, to more services and innovation with higher paying jobs and less manual labor. 

NAFTA and autos

Since NAFTA was enacted, the U.S. auto industry has lost about 250,000 jobs, the majority of them from the Detroit Big Lakes area.

Unions and political candidates blame NAFTA and particularly Mexico for these loses. The argument is that the U.S. workers were put in direct competition with Mexican workers earning about a fifth of their wages.

NAFTA might have had something to do with these job dynamics, but the complete story is that U.S. auto workers were not just competing with low-cost workers in Mexico, they were also competing with union-free American workers in the southern states of the U.S., where many foreign OEM’s have assembly plants.

The Detroit workers were also competing with innovation and technology in the form of robots in the Japanese and South Korean assembly plants on U.S. turf and abroad.

And according to several studies and analysts, without the support of Mexico auto manufacturing, there would not be much left of Detroit at all today.

Indeed and for example, all of those vehicles being assembled in Mexico contain about 40% of parts made in the U.S. Furthermore, about another 30% of the parts in those autos are made in Mexico by U.S. corporations.

The U.S. is not loosing jobs to Mexico; a job created in Mexico by auto OEMs and auto parts makers is an investment in global competitiveness. 

Globalization and the need to compete effectively in world markets versus global producers is not NAFTA’s fault, on the contrary, NAFTA is a tool to effectively compete in the world marketplace.

With the ability to move operations to low-cost Mexico, the U.S. auto industry has possibly avoided a complete crash of its industry, which is 800,000-jobs strong today.

The U.S.-Mexico regionalization, integration and production-sharing of the auto industry and its complementary workers and supply chain make the NAFTA-land auto-manufacturing platform the most competitive in the world.

A lack of interest?

One may argue that foreign trade is not the highest priority for the U.S. With its large market and productive resources it is one of the most self-sufficient countries in the world.

If anything, the U.S. imports goods for the sake of competitiveness in prices for consumers and exports to improve its global markets positioning.

Exhibit #2illustrates international trade of goods as a percentage of GDP for selected countries. Export/import intensive economies such as Vietnam, Hungary and the Netherlands rely on foreign producers and markets to satisfy their population needs.

Germany, Mexico and Canada are relatively high in this scale and are rather export-oriented economies. The U.S. is a much more modest international trader at just 23% foreign commerce versus its large GDP.

The real “villain”

There is no substitute in the markets for competitiveness. Take for instance China, a country that doesn’t even have a trade agreement with the U.S. but it is its #1 trading partner today. 

And this is definitely a one-sided relationship, as the U.S. deficit in trade with China wasUS$366 billion of their US$598 billion total trade. 

Exhibit #3 shows the U.S. top bilateral trading partners for 2009-2015. Note how China just took over Canada recently for the top spot and how all of the trending lines have flattened out or declined recently mostly as the result of the strength of the dollar and its negative impact on U.S. exports.

One may argue that the real “villain” in this play of commerce is China. The flocking of U.S. and Mexico’s manufacturing operations that went to China during its first dozen years tenure in the World Trade Organization (WTO) cost an estimated loss of manufacturing jobs of 350,000 in Mexico and 2.4 million in the U.S.

Most labor-intensive products went to China at that time where US$0.50 cents per hour wages attracted production lines. This has significantly changed, as Chinese labor costs have skyrocketed to almost US$3.00 per hour and labor-intensive production has moved to Vietnam, El Salvador and other low cost countries.

And yes, many jobs are coming back home to the U.S. and Mexico, where for example, projects looking for competitive utility costs land on the former and operations in need of low labor costs set foot on the latter. 

Going forward

By having a strong integration with its southern neighbor low-cost advantages, the U.S. is actually keeping at bay an even stronger flow of goods from China and other Asian countries.

Those opposing NAFTA do not seem to grasp the inner and complete dynamics of international trade. If they succeed in limiting or scraping NAFTA, they would be doing China a huge favor.

But that is unlikely to happen. Even if an extremist anti-trade politician makes it to the White House, there are two very strong armors protecting NAFTA.

One of them is a legislative protection as the Presidents of the U.S. and Mexico, and the Canadian Prime Minister cannot change NAFTA unilaterally, they would need the blessing of their legislators.

And the strongest protective covering for NAFTA is of a business nature: it is of course the deep, integrated supply chains across many industrial sectors. They just make great business sense.

At this stage of the game, the U.S. would be shooting itself not only on the foot but also on the knee if it disrupts the existing international production sharing value chains.

Unfortunately, given the anti-trade feelings in the U.S. other free-trade agreements in the making are going to face a very steep hill.

The trans-Pacific Partnership (TPP), recently signed in February 2016 by the U.S. and 11 Pacific Rim countries, including Mexico and Canada, still has to pass ratification by the congresses of the signatories within the next two years.

And the Transatlantic Trade Agreement and Investment Partnership (TTIP) between the U.S. and the European Union would possibly be set back as well. Although negotiations are underway, it will likely not happen before 2020, if at all.

We expect NAFTA’s life hyphen to survive for many years to come in its present form or an improved version. 

As noted before, bilateral trade of goods and services between the U.S. and Mexico will be over US$700 billion by 2020 to represent the largest bilateral economic relationship in human history.