What did NAFTA really do?

Brad De Long has written a lengthy essay that defends NAFTA (and other trade deals) from the charge that they are responsible for the loss of manufacturing jobs in the U.S. I agree with much that he says – in particular with the points that the decline in manufacturing employment has been a long-term process that predates NAFTA and the China shock and that it is driven mainly by the secular trend of labor-saving technological progress. There is no way you can hold NAFTA responsible for employment de-industrialization in the U.S. or expect that a “better” deal with Mexico will bring those jobs back.

At the same time, the essay leaves me frustrated and uneasy. It seems to gloss over the distributional pain of NAFTA and overstate the overall gains.  

So what does the evidence say on these issues? We have now some good academic papers that address both overall gains and distributional impacts.

Let’s start with the big picture. Remember first that many advocates of NAFTA made at the outset some wildly optimistic claims about what NAFTA was going to achieve. The most extravagant of the studies, and the one that probably was the most widely circulated, was one produced at the Peterson Institute for International Economics (then just the Institute for International Economics). This study argued that NAFTA would be a net job creator for the U.S., thanks to a projected improvement in the U.S. balance of trade. (This study is apparently no longer available on PIIE’s web site, but excerpts can be found here; see p. 58 for projected impacts.)

This argument was always a red herring: trade agreements are not supposed to create net employment; they simply reshuffle employment. NAFTA neither subtracted, nor added substantial number of jobs to the U.S. economy. At best, it made the U.S. economy more efficient by reallocating workers to jobs that are more productive.

And certainly this happened. But the overall efficiency gains are quite small, much smaller than what the trade volume effects would lead you to believe. A recently published academic study by Lorenzo Caliendo and Fernando Parro uses all the bells-and-whistles of modern trade theory to produce the estimate that these overall gains amount to a “welfare” gain of 0.08% for the U.S. That is, eight-hundredth of 1 percent! See their Table 2 (here or here). Trade volume impacts were much larger: a doubling of U.S. imports from Mexico.

What is equally interesting is that fully half of the miniscule 0.08% gain for US is not an efficiency gain, but actually a benefit due to terms-of-trade improvement. That is, Caliendo and Parro estimate that the world prices of what the U.S. imports fell relative to what it exports. These are not efficiency gains, but income transfers from other countries (here principally Mexico and Canada). These gains came at the expense of other countries.

A gain, no matter how small, is still a gain. What about the distributional impacts?

The most detailed empirical analysis of the labor-market effects of NAFTA is contained in a paper by John McLaren and Shushanik Hakobyan. They find that the aggregate effects were rather small (in line with other work), but that impacts on directly affected communities were quite severe. It is worth quoting John McLaren at length, from an interview:

Q. According to your study, what are the key impacts of NAFTA on U.S. wages?

For the average worker, there is not much of an impact, but for certain important pockets of workers, the lowered import barriers resulting from NAFTA do seem to have lowered wage growth well below what it would have been. This is particularly true for blue-collar workers. We did not see much of an effect on college-educated workers, and executives at the other end of the spectrum did gain some benefit from globalizing their production line.

There is also a big geographic component. Even if you do not work in an affected industry, if you work in a town that depends on one of those industries, your wage growth was likely affected. For example, a waitress working in a town that depends heavily on apparel manufacturing might miss out on wage growth even though she does not work in an industry directly affected by trade. To me, this was one of our most striking findings.

Q. Among impacted workers, how did wages change?

The most affected workers were high school dropouts working in industries that depended heavily on tariff protections in place prior to NAFTA. These workers saw wage growth drop by as much as 17 percentage points relative to wage growth in unaffected industries. If you are a blue-collar worker at the end of the ’90s and your wages are 17 percent lower than they could have been, that could be a disaster for your family. That was the largest impact we saw, and it is important to remember that the impact is much smaller for the average worker.

Q. Which industries have borne the brunt of the impact?

Industries that had a big tariff drop because of NAFTA, and that produce something Mexico tends to export, were hardest-hit in terms of wage growth. According to our data, this included many old-line manufacturing industries, such as those manufacturing apparel, textiles, footwear or structural clay products like brick and tile.

Q. Which geographic areas were most vulnerable?

We found the largest impacts in parts of Georgia, North Carolina, South Carolina and Indiana, with areas like Washington, D.C., Northern Virginia and Maryland among the least vulnerable locales.

In the discussion surrounding NAFTA, you often hear about impacts in manufacturing states like Ohio and Pennsylvania. We did not pick up too much impact there, likely because we were only looking at the effects of reductions in U.S. tariffs against Mexican goods. This study did not look at the effects of reducing Mexican tariffs on products from the U.S., which, paradoxically, could cause problems for U.S. workers as manufacturers move production chains south. That is something that we are researching currently and it could explain what we are seeing in areas like Ohio and Pennsylvania.

In other words, those high school dropouts who worked in industries protected by tariffs prior to NAFTA experienced reductions in wage growth by as much as 17 percentage points relative to wage growth in unaffected industries. I don’t think anyone can argue that a 17 percentage drop is small. As McLaren and Hakobyan emphasize, these losses were then propagated throughout the localities in which these workers lived.

So here is the overall picture that these academic studies paint for the U.S.: NAFTA produced large changes in trade volumes, tiny efficiency gains overall, and some very significant impacts on adversely affected communities.

The consequences of NAFTA for Mexico are another topic which would require a separate post. Let me just say that the great expectations the country’s policy makers had for NAFTA have not been fulfilled. Despite the country’s integration into North American production chains, overall productivity has stagnated. Mexico has been one of Latin America’s underperformers.

So is Trump deluded on NAFTA’s overall impact on manufacturing jobs? Absolutely, yes.

Was he able to capitalize on the very real losses that this and other trade agreements produced in certain parts of the country in a way that Democrats were unable to? Again, yes.  

Comments

[Delong]

The U.S. went from 30% of its nonfarm employees in manufacturing to 12% because of rapid growth in manufacturing productivity and limited demand, yes? The U.S. went from 12% to 9% because of stupid and destructive macro policies--the Reagan deficits, the strong-dollar policy pushed well past its sell-by date, too-tight monetary policy--that diverted it from its proper role as a net exporter of capital and finance to economies that need to be net sinks rather than net sources of the global flow of funds for investment, yes? The U.S. went from 9% to 8.7% because of the extraordinarily rapid rise of China, yes? The U.S. went from 8.7% to 8.6% because of NAFTA, yes?

And yet the American political system right now is blaming all, 100%, every piece of that decline from 30% to 8.6% and every problem that can be laid its door on brown people from Mexico.

By not making it clear that you are talking about 0.1%-points of a 21.4%-point phenomenon, I think you are enabling that. I don't think this is a good thing to do...

[F.F. Wiley]

Thanks for the post.

I had a few objections to Economics Rules, but IMO Globalization Paradox offers the best framework for understanding Trump and Trumponomics, and especially your "fundamental political trilemma." You might even say it predicted Trump.

The intelligentsia (and media) should take a fresh look at your work.

[E_considine]

A good counter argument however I noticed two things:

1. You left out actual numbers. OK some workers were hit hard by NAFTA. How many? Best estimates are a few hundred thousand but keep in mind:
---There's about 100K dog groomers in the US
----In 79 or so there were maybe 200K coal miners, in 1990 that was down to 100K. Reagan was more or less economic genocide for coal miners.

Yet no one thinks the economy or even elections hinges upon the economic state of dog groomers.

2. DeLong noted that auto manufacturing jobs were helped by NAFTA. By being able to move low value added labor to Mexico, concentrate high value added labor here and Canada automakers got lower costs than Japan and Europe and outsold them thereby producing more jobs for everyone. But you cite the jobs hardest it as "apparel, textiles, footwear or structural clay products like brick and tile."

Let's be real here. Making bricks is never going to be a well paying career that will put any number of Americans in even the lower middle class. No amount of 'smart deals' or protectionism is going to bring back brick making jobs.

But the irony is that when people cheer at Trump bringing back manufacturing they aren't thinking of min. wage workers breaking their backs making tiles and bricks, they think of high value added auto workers building cars with good benefits, a 401K and health coverage. NAFTA was more helpful towards that end than not!

[Cassian Young]

This provides the basis for a very strong case against NAFTA.

Its easy (and lazy) to equate human welfare with financial aggregates. Experimental evidence proves that this relationship doesn't hold.

Rising GDP doesn't increase our welfare once GDP passes $20K per head. Most developed nations have shown flat lining levels of welfare since the 1950s.

But falling incomes and job security do effect welfare - strongly and negatively.

Ergo a policy which is very mildly positive for all with pockets of very negative impact is almost certainly net negative on human welfare.

Adair Turner's book Economics After the Crisis provides the background. Twin his results with this article and it looks like Trump's right about NAFTA.

[Mkevane]

It seems to me your own logic and summary of the empirics makes the strong case for NAFTA. A wealthy country, maybe then 5 times wealthier than its southern neighbor, generated very large welfare increases in its southern neighbor with limited, though concentrated, negative effects at home. (The abstract of the study you cite finds that agggregate welfare gains in Mexico were about 16 times greater than those in the US, and I assume they meant per capita.) The U.S. for decades has been subsidizing livelihoods in mid-size towns in rural America (did they pay the full cost of their electrification? postal service? air services? Internet? public libraries?), and this is not so different. Presumably you would be very supportive of trade deals like NAFTA if TAA were, say, tripled. Again, a fairly modest cost, for a large world welfare benefit, no? And when you consider the political economy implications (destabilized political economy in Mexico if no deal, increased migration) it seems like a bargain that no citizen thinking about the common good (or even thinking about America First! but taking into account that a stable neighbor is always better than an unstable one with a very large wall separating the two). Of course, the counterfactuals about political economy are just opinions, who knows what would have happened in Mexico without NAFTA and maquiladoras etc. And the investor protection clauses and IP clauses etc are not even the subject of the analysis, because in Trump's world only manufacturing, TV shows, and hospitality are "real" economic activities.

[baaadmoon]

Does anyone around here know?

IsKissingerDeadYet.com

[Sean Matthews]

For this point to have any weight, surely you would need to show that the consequences of NAFTA on the communities where it had bad effects was untypical and material compared to the consequences of non-trade-related technological change on other similar communities, and that those bad consequences represented a material proportion of all such bad consequences?

[Denis Drew]

Lost in all the fine and refined analyses ...

... see http://angrybearblog.com/2017/01/trade-agreements-have-harmed-manufacturing-employment.html ...

seemingly forever lost (!), is that most all today's $10/hr US jobs (e.g., Walmart cashier) could plausibly be paying more like $20/hr -- with German level union density. Given that 45% of today's US workforce is earning $15/hr or less this seems to make debating about a few percent more or fewer manufacturing jobs far from the most relevant show.

And don't forget health care looks like the next manufacturing -- even spread everywhere and eventually government funded.

[cut-and-paste]
THE MONEY IS THERE SOMEWHERE

You can't get something from nothing but, believe it or not, the money is there, somewhere to make $10 jobs into $20. Bottom 45% of earners take 10% of overall income; down from 20% since 1980 (roughly -- worst be from 1973 but nobody seems to use that); top 1% take 20%; double the 10% from 1980.

Top 1% share doubled -- of 50% larger pie!

One of many remedies: majority run politics wont hesitate to transfer a lot of that lately added 10% from the 1% back to the 54% who now take 70% -- who can transfer it on down to the 45% by paying higher retail prices -- with Eisenhower level income tax. In any case per capita income grows more than 10% over one decade to cover 55%-to-45% income shifting.

Not to mention other ways -- multiple efficiencies -- to get multiple-10%'s back:
squeezing out financialization;
sniffing out things like for-profit edus (unions providing the personnel quantity necessary to keep up with society's many schemers;
snuffing out $100,000 Hep C treatments that cost $150 to make (unions supplying the necessary volume of lobbying and political financing;
less (mostly gone) poverty = mostly gone crime and its criminal justice expenses.

IOW, labor unions = a normal country.