The economics of revoking NAFTA

Summary

Focus

Against a backdrop of rising protectionism, the paper sets out what could be at stake if the North American Free Trade Agreement (NAFTA) were revoked. It looks at two hypothetical scenarios. In the first, tariffs that were lowered under NAFTA revert to those under standard World Trade Organisation (WTO) rules while non-tariff trade barriers revert to pre-NAFTA levels. Non-tariff trade barriers include concessions such as preferential customs treatment or import quotas. In the second scenario, only tariffs revert to standard WTO levels.

Contribution

The paper uses NAFTA as an example to show how trade policy can affect individual regions and industries. The paper estimates the impact on real wages as well as economic output. It demonstrates NAFTA's importance for Canada, the United States and Mexico by nation, region and sector.

Findings

The paper finds that losses from revoking NAFTA would be widespread, given the interconnected nature of production in the three countries. Any benefits from reduced foreign competition would be offset by higher prices for imported intermediate goods and higher tariffs on exports. If tariffs and other trade barriers default to international norms, GDP would decline by 0.22% in the United States, 1.8% in Mexico and 2.2% in Canada. Total combined losses would be about US$ 99 billion a year. Real wages would fall in all Canadian provinces and Mexican states, and in all but one of the 435 US Congressional districts. Automotive workers would be hardest hit in Mexico and Canada; in the United States, it would be workers in oil refineries and coke production who stand to lose most. If tariffs increase but non-tariff trade barriers remain unchanged, annual combined economic losses would be less than US$ 5 billion. Most importantly, almost all regions in North America would see lower real wages in either scenario.

Abstract

In a world economy interconnected by global value chains (GVCs), domestic productivity depends on the availability of imported inputs and the vast majority of workers stands to lose from protectionism. To exemplify this, we provide a quantitative assessment of the aggregate and distributional effects of one hypothetical protectionist measure - the case of revoking the North American Free Trade Agreement (NAFTA). Using a multi-country, multi-sector, quantitative model of global production, we show that a full revocation extending to both tariffs and non-tariff trade barriers would result in a real annual GDP loss of US$ 37 billion in Canada, US$ 22 billion in Mexico, and US$ 40 billion in the USA. In contrast, annual combined losses would amount to less than US$ 5 billion if only tariff rates were to be increased. For both counterfactuals, the distributional impacts across sectors would be an order of magnitude larger than the aggregate effects. Combining these results with information on the geographic distribution of sectoral employment, we show that almost all regions in North America would record reductions in their average real wage.

JEL classification: F11, F13, F16, F62, J62, R13

Keywords: NAFTA, quantitative trade models, distributional effects, protectionism