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Doing a Job on NAFTA

Thursday, March 6, 2008

Obama’s criticism of the trade deal reflects either a willful disregard of the facts or a poor command of economics.

While Senator Barack Obama has been embroiled in a controversy over what his campaign team did or did not tell the Canadians about the North American Free Trade Agreement, his real sin has gone unnoticed. Obama attacks NAFTA because, he asserts, it cost America 1 million jobs. That number reflects either a willful disregard of the facts or a poor command of economics. 

After 14 years, you’d think we’d have a pretty good grasp of NAFTA’s economic impact. How hard can it be to tally up jobs gained and jobs lost and settle on a number? Actually, it’s pretty hard. And a presidential candidate who recklessly plucks one number from the bunch may encourage support for some disastrously bad policy decisions.

If nothing else had happened after NAFTA came into force in 1994, we could just look at the overall change in jobs since then. In 1993, U.S. civilian employment was 120 million. Last year it was 146 million. So does that mean NAFTA created 26 million jobs? 

Of course not. Plenty of other things did happen after NAFTA took effect. Young children grew up and joined the work force. We had an information technology revolution. Recessions came and went, both in the United States and in Mexico. Even on the trade front, NAFTA was quickly followed by a much broader agreement that created the World Trade Organization. 

If we want to find the true consequences of NAFTA, we need to disentangle this mess of events. We could be guided by the wisdom of economic theory, but it says, loud and clear, that trade agreements have no impact on overall employment. Trade substitutes better jobs for worse jobs, but leaves the job total unchanged.

This is the type of answer that drives politicians berserk. Economic policies are loved or loathed by the public on the basis of how many jobs they create. How can trade policies not affect overall employment? 

Manufacturing employment did hit a peak and then begin a steady decline. The problem is that the peak was in 1979, 15 years before NAFTA came into force.

The number of jobs in an economy is set by the size of the work force, the health of the labor markets, and macroeconomic fluctuations. Trade can certainly create new jobs with export opportunities or cheaper inputs. It can also destroy jobs when firms succumb to import competition. Lots of job creation and destruction occurs every year in the U.S. economy. In an average year, 17 million jobs are created and 15 million are destroyed, with a net job creation of 2 million. When net job creation matches growth in the labor force, the unemployment rate stays constant. 

So why couldn’t trade push the unemployment rate up or down? Among other reasons, the Federal Reserve is watching and would offset any trade-driven economic swings. In the decade before 1994, unemployment averaged 6.6 percent in the United States. In the decade after, it averaged 5.1 percent, which is near the level at which central bankers begin to worry about inflation.

What of Obama’s claim that NAFTA cost the United States 1 million jobs? Imagine this were right. Then, without NAFTA we would have had 1 million more jobs. In the year 2000, this would have made the unemployment rate just under 3.3 percent, rather than the 4 percent we actually enjoyed. But Federal Reserve governors would have been in a panic long before we got down to that level and would have raised interest rates to slow the economy. They would have known they had gone far enough when unemployment increased to a level they were comfortable with – the same as with NAFTA. 

Politicians, like their constituents, have little patience for economic reasoning and usually demand that economists say something more useful (if less truthful). That’s why we end up with a wide range of estimates for NAFTA’s effect on jobs. Economists use creative shortcuts to produce an answer. Here’s one popular trick: see how many people work in export-related industries; use that number to say that every $1 billion of exports is associated with a certain number of jobs; then say that a trade surplus equates with jobs gained and a deficit with jobs lost. 

This is, in fact, the basis for the largest estimates of NAFTA-related job losses. The U.S. trade deficit ballooned after NAFTA. That change occurred broadly, not just with NAFTA countries, and it was accompanied by a drop in the unemployment rate and significant job creation. But if one ignores these broader lessons, ignores the pre-existing free trade agreement with Canada, and ignores everything else that happened, one can come up with the number of 1 million jobs lost. And apparently this number strikes some people as plausible (or at least useful). 

NAFTA did some wonderful things in bolstering Mexico politically and economically. Most responsible estimates show that it had a small but positive effect on the U.S. economy. The minimal size of the impact was to be expected, since Mexico was economically small relative to the U.S. economy and the United States had very low tariffs even before NAFTA. 

But what about the factory workers in Ohio? Are they just imagining those lost jobs? Of course not. Manufacturing employment in the United States did hit a peak and then begin a steady decline. The problem is that the peak was in 1979, 15 years before NAFTA came into force. The long-term decline of American manufacturing jobs has much more to do with technological change than with trade. We’re producing more stuff with fewer workers. 

But is there any harm if someone decides to run the same old Washington textbook campaign, take a few shortcuts of reasoning, and hold NAFTA responsible for the pain of displaced workers? There is. It offers false hope. It leads beleaguered citizens to think that a U.S. withdrawal from NAFTA would make their lives better, when it would almost certainly make their lives worse. 

Can we demand better analysis and a more responsible approach from our aspiring political leaders? Yes, we can. 

Philip I. Levy is a resident scholar at the American Enterprise Institute.

Image by Getty.

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