Policy-Makers Can Ease Transition to Free Trade

The North American Free Trade Agreement, which was completed this fall, would phase out virtually all barriers to trade and investment among the United States, Canada and Mexico.

The agreement, which still requires ratification and enabling legislation by Congress, has not become a major political issue in the Presidential campaign because Bill Clinton endorsed its broad outlines. But Clinton reserved the right to tailor legislation to ensure that his priorities, protecting U.S. jobs and the environment, were looked after.

NAFTA is no small matter. How Clinton frames this legislation will affect many U.S. workers and firms in the years ahead.

The arguments for free trade range from one of the most fundamental insights of economics to more complex ideas about keeping pace in a changing world. The fundamental insight is the law of comparative advantage, which shows that trading partners, whether people or nations, should each do what they do relatively best.

Imagine you and I are both capable of doing either plumbing or carpentry, but you can do either one faster than I can. If we can trade with each other, it still pays to stick with what you do relatively best, say carpentry, and pay me to do your plumbing, while I do the reverse.

Between nations, comparative advantage is most transparent when it arises from the presence or absence of natural resources and when it thus clearly corresponds to absolute as well as comparative advantages in producing. Japan imports almost all of its energy and raw materials and pays for them by exporting manufactured goods. Saudi Arabia exports oil and imports virtually everything else.

U.S. comparative advantage and trade patterns reflect not only static characteristics of the economy--such as our endowment of fertile land, which helps keep us a major exporter of agricultural products--but also our leadership in changing fields that require intensive research and development, technical skills, entrepreneurial talents and a relatively sophisticated work force.

U.S. policy in the postwar period has favored free trade as a way of opening markets for U.S. products in such fields. And as U.S. production has evolved in these directions, it has added to the nation’s overall prosperity and to the income of the average worker.

An additional dynamic argument for free trade comes from the import rather than export side of the story. Competition from abroad has spurred domestic productivity in industries such as steel and autos, where foreign producers have challenged domestic companies that had grown complacent and relatively inefficient.

Alongside these general arguments, the case for freeing trade with Mexico is further buttressed by some reasoning that is specific to the Mexican-U.S. relationship. First, trade with Mexico has been increasing for several years, well before the NAFTA agreement was made.

It has, on balance, been favorable to the United States, with our exports to Mexico rising more than our imports from them. Some complain that the export growth has been dominated by capital goods which will be used in part to produce goods for export to the United States. But that is bound to be the outcome of the comparative advantage in each country.

Second, many of the imports anticipated from Mexico will compete with products that would otherwise have been imported from other low-cost producers, especially in the developing Pacific Rim countries, rather than competing with production from domestic firms. This means that U.S. job displacement will be considerably less than the rise in imports from Mexico taken alone would indicate.

Third, and most compelling, with the border between Mexico and the United States as open as it is to immigration, expanding the base of good jobs in Mexico will to a degree replace job competition from Mexican immigrants with competition from Mexican imports.

On the other side of the debate, the serious argument against open competition from a low-wage country like Mexico ought to center on the uneven incidence of costs and benefits that would arise as new imports displaced domestic production from some firms.

If, through the force of comparative advantage, all of us were to become carpenters tomorrow rather than plumbers, we would all gain as consumers because we would have our plumbing done more cheaply. But as income earners, the distribution of gains and losses would be very uneven among different workers.

Today’s carpenters would see their incomes rise as their goods were sold on the world market. But those of us who were plumbers would face major disruptions and income loss: we would have to hone our skills as carpenters and some of us might be permanently worse off because we could never adequately manage the transition.

Such issues of fairness are difficult to factor into an economic analysis of policy change, because gains or losses to individuals are hard to balance against gains or losses for the average. But that is no reason for economic policy to ignore them.

Some economists brush the fairness issue under the rug, reasoning that change that helps poor countries, such as Mexico, is good on egalitarian grounds. However, U.S. policy should have U.S. workers as its main concern. What is more, it makes no sense to compare absolute income levels of Mexican job gainers and American job losers.

The cost to a U.S. worker who is displaced in the process of opening up trade can be devastating. In a company town, the closing of a plant can mean the end of any realistic hope of employment without moving elsewhere. For many such workers, moving means losing whatever wealth they have acquired through the equity in their homes. Fortunately, such worst-case scenarios figure to be very few in number. But even workers who do not have to relocate are likely to suffer unemployment and lose income if their present jobs are lost to import competition.

Those who lose when trade barriers come down, or, for that matter, when their jobs are destroyed for whatever reason, should be an important concern of policy makers. But the existence of losers does not justify erecting protectionist barriers, because the arguments for open trade are compelling on average and in the long run.

The cost of trade barriers has been carefully analyzed for individual commodities and industries, and is always shown to be shockingly high. It typically costs much more to the economy as a whole to protect a job than the total earnings of the worker whose job is protected.

If trade protection is not the answer, there is still a compelling case for easing the transition as trade barriers are removed:

* At present, people who lose jobs have an especially difficult time because the overall economy is so weak. An overall economic policy that generated a strong U.S. economic expansion would greatly reduce the costs of job loss stemming from import competition.

* Greater incentives to domestic business investment would keep some firms here that might otherwise shift production to Mexico.

* A gradual, rather than abrupt, reduction of trade barriers will make it easier for U.S. firms and workers to adjust without interfering with the longer-run allocation of production dictated by free trade.

* Finally, generous and well-designed financial, training and relocation assistance should be in place to aid workers as import competition grows.

Looking to the other side of the trade agreement, U.S. policy should be sure to obtain commensurate reductions in Mexico’s barriers to U.S. exports, which are now much steeper than our barriers to their exports. NAFTA should not repeat the mistakes of the past decade during which U.S. trade policy failed to open the Japanese economy sufficiently to goods and services from U.S. firms.

Reducing trade barriers with Mexico seems inevitable. Bill Clinton seems to appreciate both the global benefits of open trade and the individual costs that transition will bring. His skills in the political arena will be tested by how successfully he opens foreign markets for U.S. exports and how well he resists the more extreme protectionists while still providing adequate assistance and whatever security is possible to those workers who lose out to competition from abroad.