Apples, oranges, and free trade deals

Claims that a 25-year long string of free trade agreements has greatly improved  America’s trade performance are staples of the case for similar deals sought by President Obama, and for legislation that would “fast track” them through Congress.  Yet close scrutiny of these 20 agreements shows that dramatically different lessons need to be learned to gauge the wisdom of the president’s Pacific Rim and European Union trade initiatives.

The data make clear that, in a highly diverse global economy, trade success depends on choosing partners with which mutually beneficial trade is plausible in the first place.  They reveal that a cookie-cutter approach to dealing with countries varying widely in economic structures and priorities can backfire badly on the United States.  And they indicate that the President’s proposed Trans-Pacific Partnership (TPP) in particular contains too many problematic current and likely members to serve U.S. interests.

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America’s current free trade partners are a hodgepodge ranging from large, high-income free market-oriented democracies like next-door neighbor Canada and distant Australia; to Korea and its state-directed, export-oriented economy; to the small, impoverished states of Central America.  Accurately assessing these deals’ effects means taking these differences into account. 

Two kinds of distinctions are paramount.  The first is between Canada and the rest of the FTA countries.  The second is among countries with highly industrialized economies, countries lacking globally competitive manufacturing, and countries that appeal to multinational businesses as sites for offshored production.  The non-Canada categories have the virtue of recognizing how dog-eat-dog worldwide competition still shapes world trade flows (especially important in an era of slow global growth), and how multinational companies’ drive to find ever lower-cost, less-regulated locations for their factories – whether at home or abroad – has fueled America’s recent trade diplomacy.

Accurately evaluating free trade agreements also requires leaving out trade in energy – which has been unaffected by these deals.  And focusing on manufacturing highlights a sector that has not experienced major price swings (like energy), as well as one that still dominates U.S. trade flows and thus has attracted special attention from President Obama.

Ignoring the wide differences among America’s free trade partners yields the numbers trade enthusiasts have touted.  From 2007 through 2013 – a period including a deep U.S. recession and a painfully slow economic recovery – the chronic U.S. manufacturing trade deficit with the world as a whole shrank by 15.6 percent.  But at just under $450 billion last year, it remained huge.  During this period, however, the U.S. manufacturing trade balance with free trade agreement countries changed from a $35 billion deficit to a $58.8 billion surplus.

The FTA effect looks big both during the 2007-2009 downturn and the ongoing recovery.  The recession saw the global manufacturing trade shortfall shrink by nearly 40 percent, as international commerce of all kinds took a much bigger hit than domestic economic activity.  But the U.S. balance with the FTA countries became a $20.48 billion surplus.  As economic growth has resumed, so has the worsening of the U.S. global manufacturing deficit – by 40.6 percent through the end of 2013.  But the U.S. manufacturing surplus with the FTA countries has nearly tripled.

Leave out Canada, though, and the numbers change dramatically – which makes perfect sense given Canada’s unique combination of proximity to America, largely free market economic system, openness to trade, and affluence.  As a result, Canada alone accounted for more than 53 percent of the improvement in America’s trade balance with the FTA countries, with a $400 million deficit in 2007 turning into a $49.7 billion surplus by 2013.

After Canada, the most successful U.S. free trade agreements have been those reached with countries that simply don’t have much manufacturing, or whose industry can’t hope to compete  with America’s.  Australia, Chile, and Panama unquestionably fall into this category, and the U.S. manufacturing trade balance improvement with this trio came to $20.3 billion between 2007 and 2013 – nearly 22 percent of the total gain.

Yet agreements have done nothing to improve America’s trade performance with countries that have boasted impressive manufacturing before the deals were signed.  This group includes Korea, Israel, and Singapore, and from 2007 through 2013, America’s manufacturing deficit with these countries has actually worsened by just over $3 billion. 

The free trade agreement record has been mixed when the target countries have had little world-class manufacturing, but have been seen as potential manufacturing and exporting sites for multinational companies.  The most commonly used set of trade statistics shows that between 2007 and 2013, America’s manufacturing deficit narrowed with Mexico – an archetype foreign export platform – by $16.6 billion, but widened with the Central American countries and the Dominican Republic by a total of $3.3 billion.

At the same time, America’s trade with these countries doesn’t all consist of the exchanges of finished goods that dominate popular conceptions of international commerce.  As much as half is made up of parts and components and materials that travel back and forth across borders in complex corporate supply chains.  In order to avoid double-counting, tricky intra-corporate pricing practices, and other distortions, it’s best to measure U.S. trade with these countries using narrower categories of imports and exports.  

This more realistic methodology produces strikingly different results, especially for Mexico.  Rather than shrinking by more than $16 billion between 2007 and 2013, the U.S. manufacturing deficit grows by $8.3 billion.   The shortfall with the Central American countries and the Dominican Republic increases by some $3.9 billion rather than by $3.3 billion. 

Just as important, a substantially new picture of U.S.-Canada trade emerges, too.   The American manufacturing deficit also swings from deficit to surplus.  But because so much bilateral commerce consists of this intra-industry trade as well, especially in automotive products, the improvement is considerably smaller  -- $35.3 billion instead of just over $50 billion. 

America’s lagging free trade results with fully industrialized partners sound an especially loud warning about the Trans-Pacific Partnership.  Its current members include countries like manufacturing-heavy Japan and Malaysia, whose mercantile policies have long presented big trade problems for the U.S. economy.  Knocking on the door are equally difficult Korea – whose manufacturing trade surplus with the United States has continued growing since its own free trade agreement with the United States went into effect in 2012 – Taiwan, and China.  President Obama’s trade team vows it will hold Beijing to the highest free trade standards before agreeing to its TPP entry, but its record of coddling predatory Chinese practices like currency manipulation, and China’s deep integration into Asian manufacturing networks, justifies major skepticism.

More broadly, trade enthusiasts’ portrayal of free trade deals as a major success violates a fundamental rule of sound analysis:  distinguish between apples and oranges.  Until the President develops a credible strategy for cracking the world’s toughest trade nuts as well as for grabbing the lowest-handing fruit, Congress should put his proposed agenda on ice.

Tonelson is a research fellow at the U.S. Business and Industry Council, which represents nearly 2,000 small and medium-sized domestic U.S. manufacturers, and author of The Race to the Bottom (Westview Press, 2002).