Will the South Korean Trade Agreement Be Better Than NAFTA?

The Economic Policy Institute has published a paper authored by Robert E. Scott titled Heading South: U.S.-Mexico trade and job displacement after NAFTA. This publication provides a detailed look at the expectations for NAFTA and the results that ensued.

It would appear that neither country benefited from this agreement according to this analysis. The US had a small trade surplus of $1.6 billion with Mexico in 1993 the year before the agreement took effect. That surplus immediately became a deficit that in 2010 reached $97.2 billion. Scott claims that this deficit represents 682,900 displaced US jobs. Much of Scott’s article involves detailing these lost jobs, by industry, by state, even by congressional district.

Here the focus will be on the nature of NAFTA and where it went wrong, and in the evaluation of what the trade agreement with South Korea (KORUS FTA) might hold in store. Scott introduces this issue right at the beginning of his article.

“Growing trade deficits almost always result in growing trade-related job displacement. Like NAFTA, the KORUS FTA will likely result in growing trade deficits and hence U.S. job displacement, not economy-wide job growth.”

The original logic behind NAFTA was to lower tariff barriers for entry of US goods to Mexico. Since barriers in the US for goods from Mexico were already lower, one might assume that the US would come out ahead in this situation. So what happened?

Scott points out that both US and international firms immediately recognized the opportunity to profit from low-cost entry into the US via Mexico by moving their factories to Mexico. There they would have the advantage of both low tariffs and low wages. One’s first reaction to this might be: “How could they be so stupid that they didn’t anticipate that?”

Scott points out some aspects of the NAFTA treaty that are not often discussed but turned out to be very important.

“In addition to shifting trade balances, NAFTA altered the landscape for Mexican and Canadian workers. For example, prior to the implementation of NAFTA, Mexico had relatively high tariffs on industrial goods and agricultural commodities. It also maintained a “developmental state” which supported domestic development through an extensive set of regulatory policies that included local content regulations, requirements that foreign firms employ local managers, and other restrictions on the operations of multinational companies. Mexico also had a wide social safety net that included a public health insurance system and a system of rural property rights that supported subsistence farming and prevented agribusinesses from converting small plots to ‘industrial farms’.”

“NAFTA did much more than eliminate tariffs between both countries: It required Mexico (and Canada) to dismantle key components of their developmental states and also exerted great pressure on Mexico to pare back or privatize large parts of its safety net, as well as the national banking system. NAFTA included rules on trade in goods, technical barriers to trade, government procurement, investment, services, intellectual property rights, and administrative provisions, which included a “dispute settlement” process in the chapter on “Investment” (NAFTA Secretariat 2011, Chapter 11) that, for the first time, allowed corporations to sue governments for “takings” or the loss of potential profits as a result of new government regulations.”

In other words, conservative economic doctrine was being imposed on all three countries. And who benefited?

“From the standpoint of the business community, NAFTA’s most important achievement was that it made Mexico a much safer and more attractive location to invest and outsource U.S. manufacturing production. NAFTA’s investment provisions created new and improved safeguards for foreign investors, including new dispute settlement tribunals providing a mechanism for settling disputes with foreign governments outside of the Mexican legal system. By eliminating Mexico’s developmental state and use of local content rules, and other demands and conditions on foreign investors, the trade agreement greatly reduced the cost of doing business in Mexico, and increased the security of those investments.”

Those of you who are interested in conspiracy theories will certainly find something to ponder here. One could argue that those who constructed and voted for this trade agreement were either stupid, or in league with big business to make a few people richer and many, many people poorer.

NAFTA is history and we should learn from history. Scott implies that the lesson to be learned is that we should never accept an agreement that increases our balance of trade deficit because that will cost the US jobs. He then goes further to imply that KORUS FTA will have a similar effect. But is that correct?

Scott recognizes that Mexico and South Korea are two very different situations. He argues that our trade imbalance with South Korea comes mostly from the electronics and auto industries, and that the terms of the agreement are likely to be more advantageous for the Koreans. That is probably correct. The electronics industry is not likely to be affected since we gave up competition long ago. Interestingly, the head of the UAW voiced support for the agreement. By making it more profitable to manufacture autos in the US, it may be that the UAW thinks the agreement might generate more assembly jobs—people the UAW still hopes to represent some day.

If one examines the PR that comes out of the White House, the auto industry seems to be almost an afterthought. While there are some advantages gained by the US auto industry in gaining access to South Korea, the focus seems to be elsewhere.

“Under the agreement, U.S. exports of aerospace, automotive, consumer goods, electrical/electronic goods, metals, scientific equipment, and shipping and transportation equipment will gain duty-free access to the Korean market. Beyond tariffs, the agreement establishes strong new rules on how Korea will develop regulations applied to U.S. exports, and contains state-of-the-art protections on intellectual property rights (IPRs). Strong protection for intellectual property is critically important for U.S. industry’s knowledge-based manufactured goods.”

“Korea has agreed to match the high level of openness provided by the United States in a host of services sectors, ranging from energy and environmental services to financial services and distribution. The agreement’s provisions on cross-border services, telecommunications, and electronic commerce offer particular advantages to the information and communications technology service sector – an area where the United States excels – benefitting small- and medium-sized American enterprises without the resources to establish an office in every market they serve. The agreement also discourages Korea from setting technology standards or other requirements in a way that would give domestic producers an advantage over American service suppliers.”

“The United States is already Korea’s top supplier of agriculture products, including of a broad variety of farm products such as almonds, fresh cherries, hides and skins and corn. The U.S.-Korea trade agreement creates new opportunities for U.S. farmers, ranchers and food processors seeking to export to Korea’s 49 million consumers, giving American agricultural producers more market access in two ways – by getting rid of tariffs charged when U.S. exports come into Korea, and by laying out a framework to tackle other barriers to U.S. exports –even those that might arise in the future.”

“The financial services chapter in the U.S.-Korea agreement provides significantly improved market access into Korea for American financial services firms – supplementing and modifying the agreement’s rules on investment and services to allow American companies to provide financial services in the Korean market.”

“The U.S.-Korea agreement expands U.S. firms’ access to the $100 billion Korean government procurement market, creating new opportunities for exporters, and ensuring that U.S. firms will get to bid on contracts on a level playing field with Korean firms. At the same time, the agreement’s government procurement rules ensure that certain American business sectors – such as small businesses or textile companies bidding on Department of Defense procurement – do not face foreign competition for key government contracts here at home.”

While we have given up some things, it may be that we will actually come out ahead. This appears to be a great improvement over NAFTA. I will hope for the best and cast my virtual vote in favor of the agreement.