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Lesson 4: Trade and Jobs


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Economic Concepts:

Exports Imports Trade deficit
Free trade Labor Markets Voluntary Exchange
Human Capital Productivity

Content Standards:

Standard 5: Students will understand that: Voluntary exchange occurs only when all participating parties expect to gain. This is true for trade among individuals or organizations within a nation, and among individuals or organizations in different nations.

  • A nation pays for its imports with its exports.
  • When imports are restricted by public policies, consumers pay higher prices and job opportunities and profits in exporting firms decrease.

Standard 6: Students will understand that: When individuals, regions, and nations specialize in what they can produce at the lowest cost and then trade with others, both production and consumption increase.

  • Two factors that prompt international trade are international differences in the availability of productive resources and differences in relative prices.
  • Individuals and nations have a comparative advantage in the production of goods or services if they can produce a product at a lower opportunity cost than other individuals or nations.
  • Comparative advantages change over time because of changes in factor endowments, resource prices, and events that occur in other nations.

Standard 13: Students will understand that: Income for most people is determined by the market value of the productive resources they sell. What workers earn depends, primarily, on the market value of what they produce and how productive they are.

  • Changes in the structure of the economy, the level of gross domestic product, technology, government policies, and discrimination can influence personal income.
  • Changes in the prices for productive resources affect the incomes of the owners of those productive resources and the combination of those resources used by firms.

Standard 15: Students will understand that: Investment in factories, machinery, new technology, and the health, education, and training of people can raise future standards of living.

Lesson Overview

Economic change is not easy.  Whenever economies change, even if the overall change is positive, some individuals suffer losses.  Economist Joseph Schumpeter characterized the process of economic change as “creative destruction,” noting that the shifting of resources into different uses is a disruptive process.  When trade increases, as it has through the creation of freer trade zones like the European Union and NAFTA, wealth increases.  The outline below provides a case study of NAFTA as an example of the impact of increasing trade on jobs and employment.  The classroom activity following the outline helps students to identify groups and individuals who may benefit and those who may be left out of the wealth-creation that accompanies increasing international trade.

Key Points:

Background summary

  1. NAFTA, the North American Free Trade Agreement first envisioned by Mexican President Carlos Salinas, was signed by Salinas, U.S. President Clinton, and Canadian President Mulroney, taking effect January 1, 1994.
    • The free trade agreement, itself, is a one page document that simply commits Canada, Mexico, and the United States to allowing free movement of goods and services across the borders separating the three nations.
    • The complete NAFTA document comprises well over 2000 pages, the majority detailing the exceptions to the free movement of goods and services.
      • Some of the exceptions are permanent, but most are scheduled to be phased out over a 5 to 20 year period.
  2. The impact of NAFTA on the U.S. economy is hard to measure:
    • Because of the 5-20 year phase-out period of the free trade exceptions, much of the impact of NAFTA-reduced trade barriers has yet to be realized.
    • In the 1990s, the Mexican economy was just 5% the size of the U.S. economy, so its ability to create an overall impact on the U.S. was small.  (See Visual #1)
    • Most barriers to trade between the U.S. and Mexico had been systematically dismantled prior to NAFTA:
      • Mexico began a substantial program to reduce tariffs in the late 1980s, dropping average weighted tariff rates from 34% in 1985 to just 4% in 1991-92.
      • The U.S. has always pursued a relatively free trade policy with Mexico.
        • Since Mexico is a member of the World Trade Organization, it has Most Favored Nation status with the U.S. and is automatically entitled to the lowest U.S. tariff rates, regardless of NAFTA.
    • Additionally, Mexico has had a special trade status with the U.S. since the inception of the maquiladora program in the mid-80s.
    • Maquiladores, manufacturing plants located in northern Mexico, specialized in assembly operations for products to be exported from Mexico to the U.S. with special free trade rights.
    • Mexico allowed the duty-free importation of manufacturing inputs; the maquiladoras assemble the goods which were then exported back to the U.S. without tariffs or duties.
      • By 1990, well before NAFTA negotiations started, there were 281 plants, employing over 125,000 Mexicans. (See Visual #2
      • The implication is that trade and investment flows between the U.S. and Mexico were successful, growing, and bound to continue increasing even without NAFTA.
  3. Within the larger picture of relatively open trade between the U.S. and Mexico, NAFTA had two specific purposes:
    • 1st – NAFTA represented a commitment, particularly by Mexico, to maintain current free trade policies into the future.
      • The U.S. has always engaged in a policy of reducing world trade barriers in most sectors, and signing NAFTA really implied no change.
        • Because of the size differentials in the two economies, signing NAFTA was far less important to the U.S. than to Mexico.
          • In 1999, for example, U.S. total goods imports from Mexico were a mere 1.1% of U.S. GDP, while those same goods (exported from Mexico) were slightly over 20% of Mexican GDP.
          • Mexico has, at various times in the past, pursued strong anti-trade policies, and signing NAFTA was a commitment not just to be open now, but to stay open to trade in the future.
            • Mexico knew that such a commitment was necessary if it was to continue to attract U.S. investment, which was leery of the uncertainty suggested by Mexico’s trade history.
    • 2nd – NAFTA signified intent by the United States to open international trade in sectors that have historically been heavily protected.
      • In line with a consistent, historical policy of reducing trade barriers, the U.S. had begun to address those sectors of our economy that have been difficult to open due to entrenched special interests:  agriculture, textiles, and transportation.
        • Large-scale, multi-national negotiations under the auspices of the World Trade Organization were proving contentious and unsuccessful.
          • U.S. policy-makers had found it easier to pry open these sectors through local negotiations resulting in regional trade agreements.
          • Much of the post-NAFTA rancor that continues even today was directed toward reductions in agricultural, apparel-manufacturing, and transportation trade barriers.
            • For example, historically, Mexican trucks have been prohibited from transporting goods produced in Mexico (even in the maquiladoras) to their final destinations in the United States.  NAFTA provisions were to phase out this restriction within 5 years after signing. 
            • The Clinton administration, under pressure from U.S. truckers, prevented this provision from taking effect. 
  4. While the magnitude is difficult to measure precisely, NAFTA’s impact on the U.S. economy has been positive overall.
    • The first 7 years after the passage of NAFTA constituted the majority of one of the longest economic expansions in U.S. history, with high economic growth rates, low rates of unemployment, and very low inflation.
    • By 2001, the two sectors most directly affected by NAFTA were agriculture and apparel manufacturing.
      • These sectors experienced tariff reductions of 68% on goods exported to Mexico and 48% on goods coming into the U.S.
      • Trade volume between the U.S. and Mexico increased approximately 16% in the decade after NAFTA was signed.
      • (However, it should be noted that this is not a 16% increase in total trade volume for the U.S., as some was merely a shift in apparel manufacturing from Asia to Mexico as a result of tariff reductions.)
      • A UCLA study found that 88,000 jobs had been negatively impacted or destroyed and 91,000 jobs had been positively impacted or created in the U.S. economy as a result of NAFTA.  (See Visual #4) http://www.naid.sppsr.ucla.edu/pubs&news/nafta2000.html    (2000)

Answering Questions About NAFTA

Except for the occasional spat over some aspect of NAFTA – tomatoes or trucking, for example – there has been very little direct impact on the U.S. economy.  Yet there persists a widespread perception of NAFTA as having had a negative impact, and that perception fuels the fires of constituencies that seek to prevent future trade liberalization.

So, what has been the impact of NAFTA?  Has it created the “giant sucking sound” invoked by Ross Perot in his warning that U.S. companies would chase low wages south of the border and eliminate Americans’ jobs?  Were millions of jobs lost, as the AFL-CIO predicted?  Did wages plummet as American factory workers were reduced to flipping burgers for a living?  Considering that during the first 7 years of NAFTA the U.S. economy was stronger than at any point in the last 30 years, clearly the voices of doom were wrong.  To note the overall positive impact is not, however, to dismiss the concerns of labor activists.  As is the case in all economic change, freer and increased trade with Mexico could and did affect individual workers – some negatively and some positively.

1.   Does increased trade with Mexico mean fewer jobs in the U.S.?

  • Economic reasoning asserts that an increase in imports (i.e. goods produced in Mexico) must be met with an increase in exports in other sectors or a change in financial assets to pay for the imports.  (See Lesson 6 on Balance of Payments accounting.)
  • The increased production in export sectors will increase demand for workers in those sectors.
  • Therefore, any loss of jobs caused by substituting imports for domestically-produced products will be largely or wholly offset by job creation in the export sectors that expand to “pay” for these imports.
    • If this were not the case, we would see falling labor-force participation rates as NAFTA “sent” American jobs to Mexico.  In fact, however, the U.S. labor participation rate rose slowly and steadily from 1994-2000, showing no clear NAFTA effect. (See visuals #3 and #4 in download file linked above.)
  • The standard response to this by opponents of free trade is that the problem is not a change in the total number of jobs, but rather a loss of “good” jobs in the goods-producing sector, with job creation occurring in “bad,” burger-flipping jobs in the service sector.
    • In reality, while there has been a decline in employment in the goods-producing sectors from slightly less than 30% in 1980 to 20% in 2000, the rate of decline slowed after NAFTA went into effect. (See visual in download file linked above.
    • During the same period, consumption of goods as a % of total consumption dropped about 10%, from 52% in 1980 to 42% in 1999.
    • The shift in employment appears to be far more related to changes in patterns of domestic consumption than having anything to do with globalization; in other words, there are fewer goods-related jobs because consumers are increasingly purchasing services

2.   Does increased trade with Mexico lower the wages of workers in the manufacturing sectors of the United States economy?

  • Free market analysis would suggest that free trade lowers the prices of goods – and therefore, wages – in import-competing industries.
    • Since Mexican imports are primarily simple manufactured goods, if we see a NAFTA-related decrease in wages, it will be in the manufactured goods sectors
  • Production workers in all industries have seen a decline in real wages, as deflated by the Consumer Price Index (CPI), over the past 20 years.
    • Most of this decline occurred in the 1980s, before NAFTA. Real wages have been increasing since 1992.
      • It is worth noting, however, that wages in service industries have been growing faster than in goods-producing industries, but it is not clear whether this is due to shifts in demand (as discussed above) or to globalization
    • Deflating wages on the basis of the Producer Price Index (PPI) offers additional insight into the situation.
      • Real wages figured on the PPI basis have been rising steadily over the past 20 years, with only a slight decline seen in the late 1980s.
        • (Using the PPI standards allows comparison of wages to prices in the non-tradable service sectors (especially housing and health services) instead of in terms of produced products, as the CPI does.)
    • The solution to understanding declining wages, then, is to ask why prices in such things as housing and health services have gone up so much, rather than to blame trade with Mexico. (See accompanying visual in download file linked above.
      • Wages are a function of labor productivity, not of global competition.
      • Worker productivity is determined by a variety of factors, including:
        • Nature of human capital – skill, experience, and knowledge
        • Investment in capital equipment
        • Technology; and
        • Infrastructure
      • There is no consensus among economists as to whether trade plays any role in determining wage levels.
        • Data  (See visual in download file linked above) show that until the mid-1970s, wages grew faster than productivity in manufacturing, but since then, wages have grown more slowly than productivity.
      • Some economists believe this is due to skill-biased technological changes in manufacturing that have reduced the marginal product of labor, while others believe it is due to globalization.  Either explanation points to forces larger and more encompassing than NAFTA.

3.  Does increased trade with Mexico lead to larger trade deficits and a flow of investment out of the U.S.?

  • It is impossible for the U.S. to run a trade deficit and have the “giant sucking sound” of investment leaving the U.S. at the same time.
    • Basic balance of payments accounting (See Lesson 6) recognizes that the sum of the current account (goods and services) and the capital account (investment flows) must be 0.
    • Thus, if the U.S. runs a trade deficit with Mexico (importing more goods and services than we export), we must run a capital account surplus, meaning that Mexico must be investing in the U.S. rather than the other way around, as Perot feared.
    • The data bear out the prediction:  Except for a brief period in 1994, the U.S has run a trade deficit with Mexico and more capital has been moving from Mexico to the U.S. than from the U.S. to Mexico.  (In other words, the “giant sucking sound” is occurring north, not south, of the border.
  • As concerns the trade deficit itself, it appears that trade with Mexico helped the current account situation, rather than hurting it.
    • The U.S. trade deficit with Mexico is not a function of NAFTA but indicative of the overall pattern of the U.S. current account.
      • Imports from Mexico increased from 6.5% of total to 10.5% of total, an
      • Exports to Mexico increased from 8% to 12%.  (See Visual #1 in download file linked above.)
      • On the basis of this data, NAFTA and trade with Mexico help rather than hurt the current account balance.

(See accompanying data charts in download file linked above.)

Lesson 4 Activity:  The Giant Sucking Sound