Monthly Article

November 2016 Monthly Article – The NAFTA Scenario

By Jerry Pacheco

Let’s paint a scenario: A U.S. manufacturer based in El Paso, Texas, makes plastic injection parts that it sells to a company in Juarez, Mexico manufacturing components for the auto industry. The Mexican company’s parts are combined with other suppliers’ parts from Canada, Europe, and Asia, and are incorporated into a General Motors vehicle being manufactured in Kentucky. The relationship between the El Paso and Juarez companies was made possible because the 1994 North American Free Trade Agreement (NAFTA) reduced the tariffs for the U.S. company to sell its products into Mexico, and for the Mexican company to sell its products to the Kentucky GM plant. 

The company in Juarez employs 200 and the company in El Paso 66 – I am using these numbers based on the formula that economists at agencies such as the Federal Reserve use, which states that for every 10 jobs created in Mexico’s maquiladora (twin plant) industry, three are created on the U.S. side of the border, in either manufacturing or logistics. The Mexicans working in the Juarez plant take the pesos they earn in their job and buy products/services on the U.S. side of the border, accounting for approximately one out of every eight dollars spent in El Paso’s retail sector. The Mexican workers also purchase U.S.-made products/services at places in Mexico such as Home Depot, Walmart, McDonalds and Applebee’s.

Enter President-elect-Donald Trump. Without understanding the intertwined nature of the U.S. and Mexican economies, which depend heavily on each other for their own economic health, he cancels NAFTA or weakens it. With the help of Republicans in Congress, he also manages to slap tariffs on Chinese imports. The Mexican government retaliates against new U.S. tariffs on its manufactured products, as does the Chinese government. The Juarez company finds that it is not cost competitive to manufacture its products in Mexico because of new U.S. tariffs on products manufactured in Mexico. It does production cost calculations and concludes that in spite of tariffs on Chinese imports to the U.S., the more economical labor in China is the best way to remain in business. It closes its plant in Juarez and gives the pink slip to 200 workers, who now do not have the money to buy U.S. products and shop in El Paso. Out of desperation, many of these workers will illegally cross into the U.S. to seek economic opportunities, thus increasing the flow of illegal immigration.

Mexico’s economy takes a hit because of the aggressive U.S. action, and the peso plunges. This makes U.S. goods sold in Mexico more expensive for Mexicans, who buy less of them. Conversely, it makes Mexican products sold in the U.S. cheaper for Americans, who gobble up more consumer electronics, furniture, medical products, and food. This causes the U.S. trade deficit to balloon.

Meanwhile, the El Paso company loses its major client in Mexico and decides to close its operation because it can’t compete against Chinese plastic injection operations. All 66 of its employees lose their jobs, and the economic multiplier effect of the company and its employees spending money to buy products and services in El Paso vanishes. The owner leasing the building to the plastic injection operation now has empty space. Maintenance costs and taxes accrue without good prospects to lease the space in the future, because what happened to the plastic injection company is happening to thousands of businesses on the U.S.-Mexico border that depend on a cross-border trade relationship free of tariffs and non-tariff barriers. Oh, and by the way, the new automobile that you were planning to buy will cost several thousand dollars more.

Although simple in its explanation, this is not a far-fetched scenario. The point is that in today’s interconnected global economy, you cannot tinker with one element and not expect effects in other areas. Unraveling NAFTA is an example of how a trade relationship can be damaged when trying to institute political rhetoric into reality to appease supporters after you have made free trade, NAFTA, and Mexico a scapegoat in the presidential campaign. I would expect a struggling and possibly uneducated person, who has seen automation and globalization transform traditional industry in the U.S. to view trade as a scapegoat. I am surprised that Trump, a self-declared business genius, would not understand the complexities of world trade. Perhaps he does, and he was smart enough to know that this wedge issue would help him get elected.

By Trump’s campaign rhetoric, he claims he will bring back all of the jobs to the U.S. that were lost to globalization. As we can see from my simple scenario, it is not that easy. Ironically, many people with whom this part of the Trump message resonated, are the uneducated, unskilled workers that will not be able to benefit from increasingly technical production jobs.

My biggest takeaway from the presidential election is the education component and how stratified the U.S. is becoming from an opportunity standpoint between those who have an education that allows them to get ahead in life, and those that don’t. This influences the ability of a person to understand complex world economics, while being in a position of having skills that can secure a good job and a promising economic future. Hopefully, the new administration and Congress will focus on bridging this education gap for the benefit of our country’s future, and stop demonizing trade, which will continue to create opportunities for U.S. companies in the future.