The Case for NAFTA
Jude Wanniski
November 4, 1993


The North American Free Trade Agreement is a tax cut, nothing more, nothing less. When Jones, an American, and Smith, an American, trade goods in the U.S. marketplace, the government takes a cut, which we call a tax. When Jones, an American, and Sanchez, a Mexican, trade goods in the U.S./Mexican marketplace, the governments of both countries take two cuts. They tax Jones and they tax Sanchez in the production process, and they tax them a second time during the exchange -- this time called a tariff. It is as simple as that. Whenever a tax is raised or lowered, the effect on economic activity is the same as when a tariff is raised or lowered. When a tax is lowered, economic activity increases as Smith and Jones find it makes sense to trade more things. The same occurs when a tariff is lowered.

In each instance, the lowering of a tax rate or tariff also creates new opportunities. Goods that are not tradeable at one tax rate because the return on investment is insufficient, given the cost of production, suddenly become tradeable, as the after-tax return on investment rises. In the domestic economy, a lower tax will also change the composition of the basket of goods being traded by Jones and Smith. This is especially true if the tax rate being lowered is a tax on capital rather than a tax on labor or land -- the other factors of production. In other words, some jobs are eliminated while others are created. Nobody notices this going on, because in an economy the size of the United States, the number of jobs being created and destroyed in any week or month is high to begin with. A lower tax draws more of all the factors of production into play, and the general effect on the population is a pleasant one. Insofar as relatively more capital is brought into play, the jobs being created will be better (higher paying).

The opposite occurs when a tax or tariff is raised. The after-tax return on investment to Smith and Jones, or Smith and Sanchez, is reduced. Fewer goods are tradeable, and economic activity diminishes while the composition of the basket of goods is rearranged. Insofar as capital is withdrawn, the jobs being created to replace the jobs being destroyed will be lower paying.

Great passions have been aroused in the NAFTA debate, especially by Ross Perot and organized labor who have been portraying it as a measure that will destroy U.S. jobs. They are of course correct, but only insofar as all changes in the tax or tariff laws eliminate jobs while others are created. The actual impact of NAFTA, though, would be unambiguously a pleasant one on both sides of the border. The roughly 5% tariff levied by the United States on goods sent from Sanchez to Jones will be phased out over several years. The roughly 10% tariff levied by Mexico on goods sent from Jones to Sanchez will be eliminated. The amount of goods being traded across the border will increase, which means more of the factors of production -- labor, land and capital -- have to be brought into play on both sides. Which side benefits more? Both sides benefit exactly, precisely the same, which is what negotiated trade is all about. If one side or the other is dissatisfied in any transaction, the trade will not occur. If the trade occurs, it means both sides reached a point of equal satisfaction.

With so much to gain from NAFTA, why does it appear to be headed toward defeat in the House of Representatives? It is because members of the House believe that if they vote for NAFTA, the organized opposition will cause them to lose their seats in next year's election. It is quite unlikely, though, that anyone who votes for NAFTA will lose his or her seat for that reason, because the benefits of NAFTA so thoroughly outweigh any distress it might cause. This is why free-trader Jack Kemp could win his congressional seat in Buffalo with 80%-90% of the vote year after year, even with the AFL-CIO and the steelworkers demanding trade protection. If the voters can be fooled into thinking a tariff increase will be good for them, they can also be fooled into thinking a tax increase will be good for them. Throughout the history of public finance, people have willingly voted tax or tariff increases when revenues are needed. They never do so merely in order to prevent their trading partners from lowering the price of their goods. If ordinary people could be fooled into thinking they should pay higher prices, the marketplace would not work, nor would democracy. (We recently noted a comment by one House member that if the lights were turned out, NAFTA would pass overwhelmingly, by at least two-to-one.)

NAFTA is a tax cut. It is the only tax cut the American people are likely to get from the federal government in the next year. If it passes, the economy will grow faster in 1994 than it did in 1993 -- not merely because of increased trade between the United States and Mexico in '94, but also because of an increase in business activity in preparation for '95 and beyond! The stock market, which anticipates the future beyond single calendar years, would capitalize the effects of NAFTA's passing by much more than a single year of trade increases. It would also capitalize the increased chances that NAFTA's success would lead to similar "tax cuts" with Europe, through the GATT negotiations, and the increased chances that other countries of Latin America would follow Mexico. For the same reason, a defeat of NAFTA would have negative effects on the stock market exceeding the actual immediate effects on trade flows between the two countries. The weakness in the stock market this week can easily be attributed to the steady stream of news coming out of Washington that NAFTA is in deep trouble. Wall Street has probably built into its calculations a high probability that NAFTA would pass. In that sense, this is a "mega-vote" in the House of Representatives. A defeat would be one of form over substance, an abdication of global leadership by the United States that would be hard to overcome.

There are gradations here as well. If Senate Minority Leader Bob Dole and House Minority Whip Newt Gingrich (who will be House Minority Leader in '95) can combine for a full-court press on NAFTA, we would have a more promising outlook. That is, Dole/Gingrich must be prepared to persuade the electorate that if NAFTA fails, because the President and his party went into hiding, they will have to send more Republicans to Congress in '95 to get the job done. Some of the cynicism of the electorate was moderated this week with the outcome on Election Day. (All the Republican candidates, by the way, publicly endorsed NAFTA.) The GOP leadership has to pull out all the stops, though, to the point of making their commitment to free trade and an open world economy an embarrassment to the Democrats. Shaming the Democratic leaders into action may be the only way of mobilizing them at this point. As it is, the anti-NAFTA forces are using the Democratic defeats on Tuesday to their own ends, trying to persuade wavering Democrats in the House that President Clinton is a loser on NAFTA too. For his part, the President seems shell-shocked, unable to lead, his wife hounding him to forget all but her health-care plan. Leadership on NAFTA falls into the hands of the shadow President, Bob Dole.

There is nobody in Washington more concerned about the fate of NAFTA than Federal Reserve Chairman Alan Greenspan. In the last several months, it has seemed always near the front of his mind to those who have engaged him in discussions about the economy. At the head of the chief central bank of the world economy, the global implications of NAFTA are clearer to him than to anyone, although he knows so much that is secret, he can't really discuss the dimensions of what is at stake. Obviously, the integration of Europe, stalled-out because of a failure of leadership there, would be dealt a further setback if the United States fails as well. Greenspan's own problems at the Fed would increase if NAFTA fails, since the demand for liquidity would decline toward a new equilibrium. The rise in the price of gold gives us that signal. It would, of course, mean a tightening of monetary policy, however slightly, to prevent the inflationary implications from damaging the bond market. The currently wounded Democrats in Congress might not stand still for that.

There is still plenty of time for the full-court press. Every member of Congress must be made to understand that in the end, NAFTA is about the future of America. Are we to be a forward-looking, optimistic and dynamic people, confident of our ability to continue prospering in a competitive global economy? Or, are we going to surrender, believing that the challenges of this era are simply too much to face, kidding ourselves that victory can be found in merely maintaining the status quo. The vote on NAFTA could be a self-fulfilling prophecy, either way.