US President Donald Trump has been tweeting again, this time about trade. This reopens a debate that many economists thought had been concluded many years ago: Do Free Trade Agreements (FTAs) increase trade between nations.
NAFTA provides a good study case to address this question. Trade agreements aim to lower or eliminate tariff barriers to increase the flow of goods and services across borders, and in that way strengthen commercial and sometimes political ties.
Tariffs are not the only hurdles to cross-border trade, and FTAs address such issues as copyright and intellectual property protections, as well commercial dispute resolution in order to reduce friction in trade flows.
The motivation behind FTAs stems from the assumption that free trade increases productivity and contributes to higher economic growth for all partners. Manufacturers get access to to cheaper commodities, less developed economies gain insights into new technologies, and consumers benefit from lower prices.
However, there are some noted disadvantages:
- FTAs create a wider labour market, which sends work to the lowest-cost location.
- Reducing tariffs on imports exposes companies to competition from lower-cost providers across the border, which burdens labour-intensive sectors.
- Even when FTAs include intellectual property protections, there is still leakage of trade secrets and other knowledge from the developed to the less developed economies, which reduces the initial advantage of the companies that paid for the innovation. Leakage can occur because the agreements are not well crafted or because of a lack of enforcement.
- In the less developed countries, opening the borders can lead to an erosion of the rural economy as small farms face the onslaught of cheaper products from the industrialized agriculture sector in the more developed trading partner. The industrialized farms in North America and western Europe are not only more efficient but also subsidized, sometimes heavily, by the state
So it is not an easy question to answer. To get a better understanding, we have looked at some of the USA's biggest trade deals.
North American Free Trade Agreement (NAFTA)
NAFTA is an agreement signed by Canada, Mexico, and the United States, creating a trilateral trade block in North America. It came into force on January 1, 1994.
The US International Trade commission noted in 2003 that NAFTA is a region-wide trade agreement aimed at progressively eliminating tariff and non-tariff barriers to trade in originating goods, improving access for trade in services and establishing rules for investment. Most tariff and non-tariff barriers on eligible industrial products will be gradually eliminated over 10 years, including barriers to textiles and apparel that have substantial regional content. Moreover, the agreement provides that tariffs and most non-tariff barriers on agricultural products will be phased out over 15 years
US trade data with Canada and Mexico shows a substantial impact of the agreement, with strong increase of imports and exports after the agreement was signed.
The major drivers behind the high growth were the automotive and agricultural sectors. Car parts and finished cars mostly moved into the US from Canada, where the market is smaller, and Mexico where costs and consumer buying power were lower. Agricultural exports flowed the other way, with US mechanized and digitized farms easily out-competing the farm sector in Mexico. The US holds a high trade surplus in services with both its neighbours.
Critics argue that this increase in the flow of goods and services would have occurred without the agreement in the course of the increasing globalization of the world economy.
Central America Free Trade Agreement (CAFTA)
CAFTA is an FTA between the United States and a group of smaller developing economies of Costa Rica, El Salvador, Guatemala, Honduras, Nicaragua, as well as the Dominican Republic. CAFTA promotes stronger trade and investment ties, prosperity, and stability throughout the region and was implemented in 2012.
The impact on overall trade is less clear than for NAFTA. The data in the graph shows that the agreement had a negative impact on trade for this region, with US exports decreasing over the assessment period. Indeed, if the position of Panama is considered in isolation, one year before the agreement came into force, the moving average through the previous five years confirmed growth of 26%, but three years after this agreement was running, the average growth for the then previous five years was only 2%.
One conclusion could be that this FTA was not working because it discouraged trade between the US and Panama, although the situation is more complex. Panama is an unusual example because the Panama FTA was not the main driver of trade when the agreement came into force in 2012. This is because the Panama Canal was being expanded and purchases of large amounts of construction equipment and other US goods for the project contributed to a rise in US manufactured goods as exports and then when the project was completed, Panama’s imports dropped.
The CAFTA example highlights the importance of examining the detail when discussing the pros and cons of FTAs. The development of “one-time” major infrastructure projects can distort the picture, as shown with the Panama Canal expansion example. This project in particular has created numerous other benefits to increase trade through by allowing larger ships to pass through the waterway. Indeed, Panama’s container ports can see the benefits of additional container handling from larger ships calling at ports like Balboa, PSA Panama International terminal and Manzanillo Intermodal Terminal, providing a boost to their volume throughputs.
The US reached its first FTA with a Mid-East country in 1995 with Israel, which was followed by similar arrangements with Jordan (2002), Bahrain (2006) and Oman (2009).
This geographical comparison is more complex to assess because those countries do not have comparable economic structures:
- Israel - a large part of its bilateral goods trade is in diamonds, with New York being the world’s major diamond wholesaler and Tel Aviv the leading diamond-cutting markets. So, large amounts of diamonds are shipped from New York to Israel for cutting and returned as much higher value products
- This is reflective in the trade balance where the imports index is almost twice as high as the export index.
- As a result, while the FTA helps increase two-way trade in manufactured goods, the balance is influenced by the structure of the diamond industry.
With respect to the other Middle East countries, which are all more reliant upon production of gas, oil and minerals, the US benefitted from the FTAs in place by increases in its levels of exports. Indeed, exports of vehicles, aircraft and machinery were particularly strong after the FTA accord was reached.
On the import side of this FTA, Jordan has done well in exporting more apparel and precious stones to the US, while Oman and Bahrain suffered from the increasing self-reliance of the US on its domestic energy sector and less on imported petroleum and related products.
Bilateral Agreements with Latin American Countries
Chile was the first country in Latin America to sign an FTA with the US, in 2004, with Peru and Colombia following in 2009 and 2012, respectively. An assessment of US exports shows that the implementation of the FTAs improved US exports to these countries right after the FTAs came into force, although this does not take into account the impact of macroeconomic cycles.
Nevertheless, the moving average of growth exports have always been positive for these countries and it can be assumed that the elimination of trade barriers has helped improve trading exchanges between nations as well as helping create new markets.
Asia and Australia
The US commenced the 21st Century with a desire to develop and improve its trading relationships throughout Asia and the Pacific. This resulted in FTAs with Australia and Singapore in 2004 and with South Korea in 2012.
This wider region offers a lot of potential for high-volume trade exchanges in commodities and manufactured goods.
Assessing historical data indicates that Australian and South Korean markets really benefitted from the removal of the tariffs barriers, with clear increases of both the imports and exports indexes after the FTAs had been signed – although, at the same time, it also appears that the growth was already occurring.
The position is Singapore is less clear because, historically, this country has always traded with very low tariffs in place due to its economy relying on commercial activity over manufacturing and natural resources. As a result, the trend here would follow macroeconomic trends instead.
Are trade deals good for business?
Trade agreements are an important facilitator of trade. Unfortunately, so many factors influence the growth rates of imports and exports: the level of development of a country, the state of the international economy, commodity prices, exchange rates and technological changes amongst many others. So with the data available, it is very difficult to isolate the impact of signing a trade deal over other impacts.
We have looked to broadly isolate these points by looking at import and export growth with free trade partners to import and export growth overall. Looking at trade growth overall helps account for the key global and macroeconomic drivers. We have compared the differential between overall trade growth and trade growth with specific partners for the four years before a trade agreement was signed and the four years after.
This shows as broad a range as you would expect. The success of a deal really depends on the goods traded, the relative state of the economies and global conditions. But the table above shows that with the right partners, a trade deal can give a significant boost. Other deals are less impactful. CAFTA, for example, has been a non-event.
But to reply to Donald Trump’s assertion that NAFTA was the worst trade deal ever signed? In terms of widening the balance of payments with lower exports and more imports – maybe. But in terms of giving access to broader manufacturing and giving US manufacturers and consumers cheaper access to the goods they need, probably not.