Monday, May 12, 2008

On the merits of NAFTA

Put a goods-producing (manufacturing) worker in the room with a service-producing (financial services) worker, and the subject of NAFTA will almost certainly come up. The trade pact, NAFTA, was signed by Canada, the U.S., and Mexico and initiated on January 1, 1994. Recently, and in times of stress in the manufacturing sector, focus in the election has swayed away from the wars and toward economic topics such as losing manufacturing jobs to Mexico.

The common misconception is that the U.S. is worse off since the inception of NAFTA. In general, free trade is beneficial – it allows countries to specialize in the goods that they are best at producing. This means, if it is less costly for Canada to produce an auto part, then they will do that and the U.S. will import it for a cheaper price than if it was produced domestically. In general, free trade is a good thing, benefiting all countries involved.

However, NAFTA is not short of its critics, such as our Democratic candidates and much of the manufacturing industry. Let’s look at the data and some common misconceptions.

Misconception 1:

1. The U.S. is worse off since the inception of NAFTA. The figure below shows U.S. average income growth (how much better off the average person is year to year) spanning the years 1988 to 2008. Except for two recessions (1990-’91 and 2001), economic has been quite volatile, and rather strong the years after the signing of NAFTA…could there be a correlation?

2. The U.S. became a service-producing economy because of NAFTA. This is rather false. NAFTA certainly allowed us to specialize and trade the goods that we are best at with Mexico and Canada, but it was the rest of the world (about 5 billion more buyers of U.S. goods) that asked for more of our service goods. The figure below shows that the share of service production started to rise relative to goods production well after NAFTA was signed.

3. On average, earnings in manufacturing are higher, and workers in that sector are better off. The figure below shows the real average weekly earnings for different U.S. production sectors before and after NAFTA. Real earnings means that the effects of rising prices from 1979-2008 has been extracted. Thus, $12 is the same in terms of the amount it can buy in 1979 and in 2008. The figure shows that since 1979, real wages in manufacturing have been falling, while those in financial and professional services have been rising. And yes, this trend started after the signing of the NAFTA treaty.

There has been plenty of time to start training oneself to move out of the suffering industries (manufacturing) and into the higher paying industries (financial services or information). Let’s also note that the only reason that manufacturing pay has stayed so high is because workers are protected by unions (formal agreements to keep wages above a certain level). The labor market trends are here to stay: get out of manufacturing and into finance, education, health, or even construction!

4. NAFTA is bad. No free trade pact can be bad, and as I discussed above, all countries involved benefit. Sure, there are always details to be hammered out, but in the long run, it is a step in the right direction. Case study: one of the causes of the Great Depression (when the unemployment rate rose to 25% and American saving was wiped out) is because of high U.S. tariffs, effectively eliminated trade. Case study: In 1808 Jefferson effectively closed trade with the British and pushed America into poverty (the act was repealed). Is that what we really want?

Please leave any comments that you may have! Nonthruths

Chart Sources: All data comes from my research, the Bureau of Labor Statistics, the Census Bureau, and the Bureau of Economic Analysis.

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