NAFTA, the North American Free Trade Agreement, went into effect on January 1, 1994. The Agreement phases out most tariffs between the United States, Canada, and Mexico. Tariffs, which are taxes on imports, increase the price of foreign goods and thereby benefit domestic producers. The participants in NAFTA agreed to reduce tariffs by 50 percent immediately and to reduce them to zero over the following 15 years. Industries suffering the most because of the increased competition from foreign goods would be given extra time to adjust to the elimination of tariffs on their foreign competitors' products.

KEY CONCEPTS

Absolute Advantage, Comparative Advantage, Exports, Gross Domestic Product (GDP), Imports, Specialization

STUDENTS WILL

  • Explain the concepts of absolute and comparative advantage.
  • Present the arguments for and against free trade.
  • Examine data concerning the effects of NAFTA on employment in the United States.

INTRODUCTION

 NAFTA, the North American Free Trade Agreement, went into effect on January 1, 1994. The Agreement phasesNorth America out most tariffs between the United States, Canada, and Mexico. Tariffs, which are taxes on imports, increase the price of foreign goods and thereby benefit domestic producers. The participants in NAFTA agreed to reduce tariffs by 50 percent immediately and to reduce them to zero over the following 15 years. Industries suffering the most because of the increased competition from foreign goods would be given extra time to adjust to the elimination of tariffs on their foreign competitors' products.

Economists are generally in agreement that free trade benefits both parties involved in the exchange. Their argument rests on the principle of comparative advantage. An individual or country may be more efficient in producing all goods. However, both parties will benefit if each individual or country specializes in producing goods in which it is relatively efficient and voluntarily trades for those goods in which others produce more efficiently.

Example

Teachers wanting to devote time to the theory of comparative advantage can use the following example to illustrate how both parties to a trade can gain. Assume there are two countries, France and Italy, capable of producing two goods, croissants and pizzas. The following tables indicate the amounts of each product both countries can produce during a given time period.

France

 

Italy

 

Croissants

Pizzas

 

Croissants

Pizzas

 

80

0

 

100

0

 

60

10

 

80

20

 

40

20

 

60

40

 

20

30

 

40

60

 

0

40

 

20

80

 
     

0

100

 

[Given its resource endowment, Italy is more efficient in producing croissants and pizzas. It has an absolute advantage in producing both products. However, Italy only has a comparative advantage in producing pizzas; France is relatively more efficient in producing croissants. Assume France is producing only croissants and wants 10 pizzas. To produce 10 pizzas costs France 20 croissants; the cost of each pizza is 2 croissants. The cost to France of 1 croissant is, therefore, 1/2 of a pizza.

If Italy is producing 100 pizzas and wants to acquire 20 croissants, it must reduce its production of pizzas by 20. The cost to Italy of producing each croissant is 1 pizza (or the cost to Italy of producing 1 pizza is 1 croissant). While Italy is more efficient in producing both goods, it is only relatively more efficient (in terms of what it must give up, its opportunity cost) in producing pizzas. In other words, Italy has an absolute advantage producing both goods but a comparative advantage only in producing pizzas.

Assume that France is producing only croissants and Italy is producing only pizzas. Both desire some of what the other is producing. France can say to Italy, we will give you 20 croissants for 15 pizzas. Italy agrees. After the trade France has 60 croissants and 15 pizzas; the best it could do without trade would be 60 croissants and 10 pizzas. Clearly, France has gained from the transactions. Italy now has 20 croissants and 85 pizzas; if Italy produced the 20 croissants, it would have had only 80 pizzas. Italy has also benefited from the trade.]

The theoretical argument for free trade is persuasive. Nevertheless, many people object to the removal of trade barriers because they believe free trade will have a negative impact on employment and income. Others contend that the net benefits of free trade are positive and that tariffs protect the inefficient to the detriment of the country as a whole.

The International Debate Education Associate (IDEA) presents a debate over the pros and cons of the free trade debate. Students could be quizzed on the arguments and asked to take a stand on the issues. [The arguments for free trade fall under the following headings: (1) gains from comparative advantage, (2) consumer sovereignty, (3) efficient allocation of resources,(4) costs of tariffs relative to their benefits, (5) retaliation from countries affected by the imposition of tariffs, (6) effects of tariffs on both imports and exports, and (7) the negative effects of tariffs on domestic competition. The arguments of those opposing free trade fall under the following headings:(1) the potential job loss due to foreign competition, (2) the factor price equalization theorem, (3) environmental and worker safety issues, (4) national security issues, (5) protection of infant industries, and (6) advantages of managed trade.]

The debate in the United States on NAFTA centers on potential job losses because of competition with Mexico. Specifically, individuals such as Reform Party founder Ross Perot and presidential candidate Patrick Buchanan argue that lower wages in Mexico will result in United States businesses moving to Mexico. This would mean job losses in the United States. Others counter that although wages are higher in the United States, so is worker productivity. The net result in most industries is that costs in the United States are lower than in Mexico. [For example, if workers in Mexico are paid $5 per hour and produce 10 units of a product each hour, the cost of each additional unit produced is $0.50. If workers in the United States are paid $20 per hour and produce 60 units each hour, the cost per additional unit produced is $0.33. Edward Lazear, in his textbook Personnel Economics for Managers, reported data from various sources indicating that costs per dollar of Gross Domestic Product (GDP) in the United States and Mexico are virtually identical. He notes that in 1992 GDP per worker in the United States was $45,728 and the average manufacturing wage was $22,049 per year. The cost per dollar of GDP in the United States was $0.482. For the same period in Mexico, GDP per worker in United States dollars was $5,968 and the average annual wage in United States dollars was $2,884. The cost per dollar of GDP in Mexico was $0.483.]

The effect of NAFTA on the United States economy can be determined only by a look at the data. We must see what has happened to trade since the Agreement took effect and attempt to draw conclusions about its effects.

MATERIALS

  • International Debate Education Association (IDEA):  This site offers a debate on the impact of free trade.
    www.idebate.org/debatabase/topic_details.php?topicID=154
     
  • International Trade Administration:  The International Trade Administration in the Department of Commerce gathers and publishes data on foreign trade.
    trade.gov/index.asp
     
  • BLS Databases, Tables, & Calculators by Subject:  This site provides information from the Bureau of Labor Statistics organized in tables and databases.
    www.bls.gov/data/

PROCESS

A Look at the Data

The effects of NAFTA on United States trade with its North American trading partners begins with examining macroeconomic data. Subsequently, we look at disaggregated or micro economic data, i.e., data at the industry and state level. Finally, an examination of employment data will give clues with respect to the impact of NAFTA on the United States economy. [A note to teachers: some of the following exercises require several activities within a website. Students could work in teams to complete the work. Alternatively, students could be assigned to a specific activity and report their findings to the class.]

The International Trade Administration in the Department of Commerce gathers and publishes data on foreign trade. The data can be found at their website.

Students should enter this site, click on the topic "Trade Statistics" and then click on the topic "U. S. Foreign Trade Highlights." Once they get into the foreign trade highlights, students should click on "U. S. Aggregate Foreign Trade Data, 1998 & Prior Years." The tables in this section contain data on United States trade with foreign countries. The students should examine the data in the various tables, do the suggested exercises, and answer the following questions.

1. Which countries are our three top trading partners (see Table 9)? [Canada, Mexico, and Japan.]

2. Construct one table and/or one graph showing the dollar volume of trade with Canada, Mexico, and Japan from 1991 through 1998. Construct similar tables and/or graphs for the dollar volume of exports (see Table 10), imports (see Table 11), and our balance of trade (exports minus imports,Table 14) for the same countries over the same years. What do the data show? [Canada has been and remains our major trading partner until recently and trade with Canada has been increasing. Trade with Japan, which has been our second largest trading partner, has remained relatively stable. Trade with Mexico has increased dramatically, and Mexico now rivals Japan as our second largest trading partner. Our trade deficits with these countries have increased over this period of time. Students could examine Tables 12 and 13 to see with which countries we have trade surpluses and trade deficits.]

The aggregate, macroeconomic data clearly indicate that the volume of trade with Mexico and Canada has increased. Trade with Japan has been steady (flat). Given the very significant increase in exports from the United States to Mexico, it is difficult to state on the aggregate level that the United States has lost jobs to Mexico. Clearly, some industries have gained, while others have probably lost jobs. To attempt to identify gainers and losers from trade with Mexico, look at exports to and imports from Mexico in specific industries. Information on industry-specific foreign trade can be found by returning to the "U. S. Foreign Trade Highlights" page and clicking on the topic "U. S. Commodity Trade by Country (Top 20 SITC-3 and all SITC-1 products), 1994-98."

3. Scroll down the country list on this page until you find Mexico. Students should enter the site showing trade by commodity with Mexico and should select three industries: high tech, low tech, and the apparel industry (which has been losing jobs to foreign countries for years).

Students then should construct the tables or graphs similar to those they constructed in the previous exercises.

  1. What does the data show?
     
  2. Are there any industries that appear to be winners?
     
  3. Are there any industries that appear to be losers?

The International Trade Administration’s website contains data on exports by state and by commodity. Data for imports into states are not available. Given that individual states’ resource endowments differ and they produce different goods and services, it is reasonable to expect exports will differ across states. It is also reasonable to assume that imports across states are similar and in relative proportion to a state’s population. State export data can, therefore, give us some information about the impact of NAFTA on individual states and industries within those states.

4. Students should return to the "U. S. Foreign Trade Highlights" page and enter the "State Export Data" section. This section contains data on state exports to foreign countries. Scroll down to the "State Export Totals to Leading United States Export Destinations" and select "Mexico." Scroll to "Export Markets For Each State Ranked by 1998 Export Value" and pick two or three states. Access the files and examine the export data.

  1. Have the United State's exports to Mexico increased or decreased?
     
  2. In what industry have the United State's exports to Mexico increased or decreased?
     
  3. What has their overall experience been? [There is no one answer; experiences will differ from state to state. The same exercises can be done for Metropolitan Statistical Areas (MSAs) – specific labor markets – if so desired. The results will differ somewhat from state data. However, since the MSAs are the largest labor markets within states, they tend to dominate state data.]

Finally, an examination of employment data over the last decade gives some indication whether the United States’ economic performance has been affected negatively by trade with Mexico. Data on employment at the national and state levels and by industry can be found on the Bureau of Labor Statistics ’ website.

5. Students can access various historical data series (Tables A and B and the State and Area employment, hours and earnings table in the Employment and Unemployment section in this site) and examine various data series. For example, they can determine what has happened to total United States employment since 1989; they can examine what happened to employment in Minnesota in various industries since 1989; they can examine what happened to non-manufacturing employment in Mississippi since 1989 (it decreased). They can determine what happened to the employment situation in states they have previously examined.

  1. Is there any relation between our volume of trade and level of employment?
     
  2. Is there any relation between the size of our trade deficit, with the total deficit or the deficit with Mexico, and the level of U.S. employment?

Students can construct tables or graphs to determine the answer to these questions. [They are positively related, i.e., the greater the volume of trade or the size of the deficit, the higher the level of employment.]

CONCLUSION

The debate on NAFTA, and United States foreign trade in general, usually centers on the potential negative effects of imports on the economy. It is relatively easy to identify who is harmed, because imports displace workers in industries where the comparative advantage lies elsewhere. At the same time, others benefit. Firms whose exports increase clearly benefit. Consumers get the same or higher quality products at lower costs. Are these gains costless? No; some firms lose sales and some individuals lose their jobs. Is protecting firms or industries that are likely to lose costless? No; we lose the gains from trade, and those who would have benefited because they could have increased exports never get the chance to do so.

The purpose of this lesson is to acquaint students with the concept of comparative advantage (relative efficiency) and the arguments for and against foreign trade. Understanding the theory, the debates surrounding the theory, and the relevant data will help students to think clearly about optimum public policy concerning free trade.

EDUCATOR REVIEWS

  • “I believe that NAFTA has sucked America dry of employment. I have seen good hard working citizens be laid off, because companies go over seas to find cheaper labor, then they get tax cuts out of it.”

    Larry M.   POSTED ON March 6, 2008

  • “That was brilliant. You are the best.”

    gary d, Los Angeles, CA   POSTED ON November 27, 2009

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