Michael Gre­gory

A Fine Bal­ance: Trade Deficits and the New NAFTA

Policy - - In This Issue - Michael Gre­gory

As with so many el­e­ments of pol­icy, Don­ald Trump has made it clear that he takes trade deficits per­son­ally. In its sub­mis­sion of its ne­go­ti­at­ing ob­jec­tives for the tri­lat­eral rene­go­ti­a­tion of NAFTA that be­gan in Au­gust, his ad­min­is­tra­tion listed the aim of im­prov­ing Amer­ica’s bal­ance of trade with Canada and Mex­ico. Here’s a break­down of the num­bers.

The first round of NAFTA ne­go­ti­a­tions be­tween the United States, Canada and Mex­ico was held in Wash­ing­ton, D.C. on Au­gust 16-20. In­ter­est­ingly, Au­gust 16 was the ear­li­est talks could com­mence af­ter the Trump ad­min­is­tra­tion for­mally no­ti­fied Congress (on May 18) of its in­ten­tion to re­open the 23-year-old trade agree­ment. The U.S. leg­is­la­tion man­dat­ing the min­i­mum 90-day con­sul­ta­tion pe­riod also com­pelled the ad­min­is­tra­tion to pub­li­cize its ob­jec­tives one month be­fore the open­ing of talks, which it did on July 17. The 17-page Sum­mary of Ob­jec­tives for the NAFTA Rene­go­ti­a­tion con­tained 117 “spe­cific ne­go­ti­a­tion ob­jec­tives” along with scores of sub-ob­jec­tives. The first spe­cific ob­jec­tive sums up the ad­min­is­tra­tion’s in­ten­tions suc­cinctly, to “im­prove the U.S. trade bal­ance and re­duce the trade deficits with the NAFTA coun­tries”, with re­spect to trade in goods. The U.S. goods and ser­vices trade deficit has sta­bi­lized in re­cent years, run­ning in the $450-to-$550 bil­lion range, which is well be­low the record short­falls reg­is­tered be­fore the Great Re­ces­sion (Chart 1). It ben­e­fit­ted from two trends; a grow­ing trade sur­plus in ser­vices (re­cently hit­ting record highs) and a shrink­ing trade deficit in petroleum (re­cently run­ning at 18-year lows ow­ing to the frack­ing boom). How­ever, this also means the U.S. trade deficit in non­petroleum goods has steadily de­te­ri­o­rated, now run­ning at record highs above $700 bil­lion. Un­for­tu­nately, re­duc­ing the trade short­falls with the NAFTA coun­tries won’t make much of a dent in Amer­ica’s to­tal trade deficit.

In 2016, the U.S. goods trade deficit (both petroleum and non-petroleum) to­talled $737 bil­lion, with China ac­count­ing for nearly half the short­fall (Ta­ble 1). This is five times more than the next largest con­trib­u­tor, Ja­pan (at 9.3 per cent). Ger­many ac­counted for slightly more of the deficit than Mex­ico, but the shares are com­pa­ra­ble (in the 8 per cent-range). Canada came in 15th at 1.5 per cent, with a sur­plus in trade in goods of $11 bil­lion, but when a U.S. sur­plus in ser­vices is in­cluded, the Amer­i­cans en­joy a $12 bil­lion sur­plus with Canada. As an

eco­nomic bloc, the euro area’s share of the U.S. trade in goods deficit was 17.1 per cent, much larger than NAFTA’s 10.2 per cent. So, even if NAFTA trade short­falls were sliced in half, the U.S. would still be run­ning $700 bil­lion-plus deficits.

The U.S. cur­rently runs sur­pluses in ser­vices trade with both Canada and Mex­ico, mir­ror­ing its global per­for­mance. The ser­vices sur­plus was $24 bil­lion with Canada in 2016, push­ing as noted above the to­tal goods and ser­vices trade bal­ance into sur­plus ter­ri­tory for the U.S. The ser­vices sur­plus was $7 bil­lion with Mex­ico, leav­ing the to­tal trade bal­ance deep in deficit ter­ri­tory. The ne­go­ti­a­tion ob­jec­tives also cover trade in ser­vices, cit­ing specif­i­cally telecom­mu­ni­ca­tions and fi­nan­cial ser­vices.

In ad­di­tion to rep­re­sent­ing a rel­a­tively small share of the to­tal trade deficit, U.S. trade with Canada and Mex­ico is much more eq­ui­table com­pared to the other deficit-con­tribut­ing coun­tries. Canada is Amer­ica’s largest ex­port mar­ket, fol­lowed by Mex­ico; Mex­ico is the U.S.’s sec­ond-largest im­port ori­gin (China is the largest), fol­lowed by Canada. In the case of Mex­ico, the seem­ingly large $64 bil­lion trade deficit re­flects $230 bil­lion in ex­ports and $294 bil­lion in im­ports, with the lat­ter 28 per cent above the for­mer. You can think of the im­port-ex­port ra­tio as a barom­e­ter of a trade im­bal­ance’s eq­ui­table­ness. Ex­ports cre­ate do­mes­tic em­ploy­ment and pro­duc­tion, but im­ports com­pete with do­mes­tic jobs and out­put. So, the smaller the im­port-ex­port ra­tio the more the ben­e­fits of ex­ports are off­set­ting the cost of im­ports. De­spite dis­play­ing sim­i­lar-sized deficits, Mex­ico’s ra­tio is well be­low Ger­many’s. China’s deficit is not only the largest by far but it’s also among the most in­equitable. Canada’s short­fall is the most eq­ui­table, when viewed through this nar­row lens. The press re­lease ac­com­pa­ny­ing the ne­go­ti­a­tion ob­jec­tives said “since NAFTA was im­ple­mented in 1994, the U.S. bi­lat­eral goods trade bal­ance with Mex­ico has gone from a $1.3 bil­lion sur­plus to a $64 bil­lion deficit in 2016.” While this is cor­rect (Chart 2), it would be in­cor­rect to con­clude that the trade im­bal­ance with Mex­ico is per­va­sive. In­deed, the U.S. ran a $74 bil­lion deficit with Mex­ico in mo­tor ve­hi­cle and parts alone in 2016, mean­ing it had a $10 bil­lion trade sur­plus across all other goods com­bined. Nev­er­the­less, Pres­i­dent Trump has been fix­ated on the loss of au­to­mo­tive jobs and pro­duc­tion to Mex­ico… re­call his threat to im­pose a 35 per cent tar­iff on ve­hi­cles im­ported from Mex­ico and brow­beat­ing of U.S. auto in­dus­try ex­ec­u­tives to as­sem­ble more ve­hi­cles at home. It should be noted that U.S. ve­hi­cle as­sem­blies are cur­rently not far off pre-re­ces­sion lev­els be­cause of ac­cess to cheaper parts from Mex­ico that help off­set higher U.S. labour costs.

The press re­lease didn’t cite the trade im­bal­ance with Canada, which, at $11 bil­lion in 2016, was ac­tu­ally smaller than what it was when NAFTA was im­ple­mented in 1994 ($14 bil­lion) (Chart 2 again). How­ever, at times, the deficit with Canada has been larger than Mex­ico’s, re­flect­ing episodes of high oil and other com­mod­ity prices (or an ex­ces­sively weak loonie). The re­cent trend of smaller trade deficits with Canada (with a sprin­kling of in­di­vid­ual months in which the U.S. posted trade sur­pluses) not only re­flects the collapse in oil prices. It also re­flects Canada’s loss of ex­port com­pet­i­tive­ness to Mex­ico (partly cur­rency re­lated) and ex­port ca­pac­ity dur­ing the Great Re­ces­sion that has been slow to be re­placed. In­stead, the press re­lease said: “Mar­ket ac­cess is­sues have arisen in Canada with re­spect to dairy, wine, grain and other prod­ucts— bar­ri­ers that the cur­rent agree­ment is un­equipped to ad­dress.”

Sim­i­lar to Mex­ico, Amer­ica’s trade im­bal­ance with Canada is also not per­va­sive. In 2016, the U.S. ran a $39 bil­lion deficit in en­ergy trade

with Canada (crude oil, petroleum prod­ucts, nat­u­ral gas and elec­tric­ity), mean­ing that it ran a $28 bil­lion trade sur­plus across all other goods com­bined. In­deed, be­cause the U.S. is not self-suf­fi­cient in en­ergy and there­fore must im­port to sat­isfy de­mand, Com­merce Sec­re­tary Wil­bur Ross re­cently re­ferred to the trade im­bal­ance with Canada as a “blame­less deficit” (as op­posed to a “blame­ful” one for which he didn’t cite a spe­cific coun­try). What is per­va­sive about Canada-U.S. trade is the num­ber of states that count Canada as their largest ex­port mar­ket, which was 32 in 2016 (Fig­ure1). Canada is num­ber 2 for an­other nine states. Mex­ico is the largest ex­port mar­ket for six states and num­ber 2 for 22 oth­ers. In ad­di­tion to deal­ing with trade im­bal­ances, the ad­min­is­tra­tion’s gen­eral ob­jec­tives in­clude “adding a dig­i­tal econ­omy chap­ter and in­cor­po­rat­ing and strength­en­ing la­bor and en­vi­ron­ment obli­ga­tions that are cur­rently in NAFTA side agree­ments.” They also in­clude elim­i­nat­ing “un­fair sub­si­dies, mar­ket-dis­tort­ing prac­tices by state owned en­ter­prises, and bur­den­some re­stric­tions on in­tel­lec­tual prop­erty.” In­ter­est­ingly, Canada and Mex­ico have al­ready agreed with the U.S. on some of the spe­cific ne­go­ti­a­tion ob­jec­tives in these ar­eas as part of the Trans- Pa­cific Part­ner­ship agree­ment. The Trump ad­min­is­tra­tion pulled the U.S. out of TPP and it ob­vi­ously wants some of its favourable (for Amer­ica) as­pects back. Hav­ing agreed be­fore, it should be rel­a­tively easy to agree again on TPP-like com­po­nents, but there are many other po­ten­tial bumps in the road to get­ting NAFTA 2 done, par­tic­u­larly for Canada.

Michael Gre­gory, CFA, is Deputy Chief Econ­o­mist of BMO Cap­i­tal Mar­kets. michael.gre­gory@bmo.com

Chart 1: NAFTA: Tale of the Tape Trade in Goods—United States (U.S.$ blns: 12-mnth m.s.)

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