A protectionist NAFTA withdrawal would undermine tax reform gains

By Veronique de Rugy     

Last year’s massive tax code overhaul lowered corporate income tax rates to an internationally competitive level for the first time in decades. U.S.-based businesses can now compete against their foreign counterparts without starting from an immediate disadvantage, thanks to Uncle Sam. The change should result in faster growth, higher wages and more jobs. Unfortunately, those gains may be undone this year with a wrong step on trade.

Take the Trump administration’s recent decision to impose tariffs on washing machines and solar panels from Chinese and South Korean manufacturers. The cost to consumers could rise to a level where buying a washer isn’t worth the price. News reports mention similar measures being imposed on aluminum and steel imports.

Yet, no matter how costly these protectionist moves are, their effects pale in comparison with what the impact would be if we withdrew from the North American Free Trade Agreement. With negotiations dragging on and the threat of a U.S. withdrawal from the 24-year-old pact looming, President Donald Trump will soon have to decide whether placating his populist base is worth the cost of undermining his signature accomplishment to date — tax reform — as well as his record on the economy.

Among the working class, NAFTA and free trade in general often take the blame for the decades-long decline in manufacturing jobs. Trump successfully rode this public angst over globalization into office, but he must reconcile populist rhetoric with economic reality if he hopes to maintain a strong economy worth bragging about on Twitter.

Far from harming American manufacturing and other industries, NAFTA has benefited American business. As my colleague Dan Griswold explains, “Before NAFTA, Mexico imposed tariffs on U.S. agricultural and manufactured goods that were significantly higher than U.S. tariffs on Mexican goods. NAFTA reduced all duties in all directions to zero.”

The main culprit behind declining manufacturing jobs is progress. Even as manufacturing employment has declined — notably, there was no acceleration of the trend after NAFTA was implemented — real manufacturing output has steadily increased. Thanks largely to improvements in automation, American manufacturers can produce more today with less work. That’s a good thing.

And thanks to tax reform, American manufacturers and other businesses are now more competitive internationally. There’s much less incentive to move economic activity offshore solely for tax reasons. But ramping up economic protectionism would undermine these gains and harm the economy.

Many U.S. manufacturers have global supply chains, meaning they import materials and other inputs, even if the final product might then be exported. Raising the prices of these goods with tariffs makes it harder for U.S.-based businesses to compete.

Likewise, Canada and Mexico are our top trading partners. If they were to increase foreign tariffs on U.S.-manufactured goods — absent a free trade pact or as retaliation for new tariffs imposed by Trump — that would significantly harm U.S. exporters.

Agriculture is one sector that would be hit especially hard by terminating NAFTA. A report by Daren Bakst of The Heritage Foundation considers Canada and Mexico critical for U.S. agricultural trade and quotes the U.S. Department of Agriculture’s Economic Research Service: “With the productivity of U.S. agriculture growing faster than domestic food and fiber demand, U.S. farmers and agricultural firms rely heavily on export markets to sustain prices and revenues.” Ultimately, the whole economy would suffer. A study published by the Business Roundtable estimates that the fallout from terminating NAFTA would be a loss of 1.8 million U.S. jobs in the first year.

No friends to free trade themselves, Democrats would be all too eager to redirect the blame for an economic slowdown resulting from NAFTA withdrawal onto tax reform. They will take any excuse they can get to re-raise taxes and would be much likelier to find themselves with the political power to do so with a weakening economy during the next election.

There are areas in which NAFTA could be improved. Griswold identified several in a comment to the Office of the U.S. Trade Representative, such as “protecting data transfers, barring the forced localization of servers, adding additional disciplines against the abuse of antidumping duties, and further liberalizing the services trade, including U.S. maritime shipping and Mexican oil and gas drilling.”

The upcoming seventh round of the NAFTA renegotiations, the last currently scheduled, could still be productive if they’re focused on expanding the gains of liberalization by removing even more barriers to trade and preventing governments from picking winners and losers. But if the president were to insist on fulfilling his threat to withdraw from NAFTA entirely, it would do significant economic harm and tarnish his signature accomplishment.

Veronique de Rugy is a senior research fellow at the Mercatus Center at George Mason University in Virginia.

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