Econofact

International Trade

How Much of your Car is Made in Mexico?

By Alonso de Gortari·June 20, 2018
Harvard University

The Issue:

Given the reliance on auto parts and labor from Canada and Mexico, an escalation of trade tensions is raising uncertainty for the U.S auto industry. My recent research finds that commonly held views of supply chain integration in automobile production among the three NAFTA countries understate the true depth of these linkages by a substantial extent. This suggests that imposing protectionist measures that disrupt the tight trade linkages in automobile production among NAFTA countries could cause greater economic disruption than what would be concluded based on traditional, lower estimates of international supply-chain integration.

The Facts:

Over the last five years, motor vehicles have accounted for around 7 percent of U.S. manufacturing GDP and 13 percent of U.S. merchandise trade. The NAFTA partners play an outsized role with 60 percent of U.S. vehicle exports shipped to Canada and Mexico and 50 percent of U.S. vehicle imports arriving from them. The modern nature of global supply chains implies that a large chunk of this trade represents vehicle parts that are shipped back and forth across borders several times before being delivered to final consumers.
In the face of global supply chains, the effects of trade restrictions on production-jobs spill over to other countries, often including the one that imposed the tariff or quota.
The firms exporting vehicles from Mexico to the U.S. have set up very deep supply chains between the two countries — much deeper than previously thought. About 74 percent of all the foreign parts used by vehicle assemblers in Mexico that export to the U.S. are imported from the U.S. itself. In contrast, only 18 percent of the imported parts used by Mexican firms exporting to Germany come from the U.S. (see chart). Because the parts that come from the U.S. also include inputs from other countries, it is important to account for international trade along all stages of the supply chain. I estimate that thirty-eight percent of the value of the average finished vehicle exported from Mexico to the U.S. is American value returning home, more than double the 17 percent figure that had been commonly considered.

What this Means:

Accurate measurement of supply chain linkages is especially important to gauge how changes in trade policy ripple across country borders. The auto industry in North America appears to be much more integrated in terms of supply chains than previously thought. This implies that U.S. protectionism against its NAFTA partners may be the equivalent of shooting oneself in the foot, at least in the short-term, since many American jobs could be lost as consequence of hurting the Canadian and Mexican supply chains on which these jobs depend. In the long term, destroying supply chains will have detrimental effects on the efficiency and competitiveness of the North American economy derived from countries specializing on the production stages on which they are each most fit.

International Trade

U.S. Trade Policy: Going it Alone vs. Abiding by the World Trade Organization

By Jeffry Frieden and Joel Trachtman·June 15, 2018
Harvard University and The Fletcher School of Law and Diplomacy, Tufts University

The Issue:

The Trump administration has complained that the World Trade Organization (WTO) is unfair to the United States, and seems to favor America acting outside WTO rules to induce other countries to enter into better deals with the U.S. Recent administration policies, such as unilateral tariffs imposed on steel and aluminum, and a wide range of other tariffs on China, may mark a departure from the United States’ advocacy of a rules-based system that has prevailed since the end of World War II. What does this mean for the United States, and for the world?

The Facts:

Over the course of several decades, the WTO (with its predecessor the General Agreement on Tariffs and Trade) facilitated substantial reductions of tariff barriers around the world, especially among developed countries.
China’s accession to WTO membership in 2001 has raised challenges. By using government influence to subsidize production and limit imports, China’s government has stimulated production of steel, aluminum, and other products in ways that have caused global gluts. Some WTO dispute settlement decisions have reduced the ability of the U.S. to raise its concerns about Chinese trade practices. This is in part because WTO rules address more transparent interventions made by governments in traditional market economies, rather than the pervasive control exercised by the Chinese government and Communist Party.
The Trump administration has undertaken unilateral trade measures that appear to be specifically forbidden by the WTO Treaty. These include punishing China for its intellectual property practices, and imposing extra tariffs on imports of steel and aluminum.
Unilateral action is sometimes attractive, especially to a large country like the United States. Supporters of the administration’s strategy argue that the U.S. can obtain better deals from its trading partners by acting on its own.
But unilateralism has costs and often induces retaliation. Canada, the European Union, and China have announced such retaliatory tariffs in response to the Trump administration’s actions. These will harm American producers, and if they proliferate they will create serious problems for the many American firms and farms that rely on foreign markets. This unilateral action will also further undermine the rules of the WTO. Even without retaliation, unilateral barriers raise the costs of goods to consumers and producers.
The administration’s course may leave the U.S. isolated. Already, eleven countries in Asia and the Americas are moving forward with a Trans-Pacific Partnership without the United States. The European Union has concluded a free trade agreement with Canada and is negotiating with Latin American countries for trade agreements that would not include the United States. China has been rapidly building up economic ties with countries in the rest of Asia, and in Africa, and will take advantage of America’s more belligerent position to strengthen its own. As these agreements reduce tariffs among the participants, the U.S. will face comparatively greater trade barriers, and find that its exports are less competitive.

What this Means:

Unilateral action violating WTO rules risks destroying a system that the United States has led for decades, and that has benefited this country. If America’s goal is to change Chinese policies, the United States might do better to join with its allies to pressure China. Whether or not President Trump is right that unilateral action aimed at China will secure the United States a better deal than it could get from the WTO system, there is little evidence that this is the case for American trade relations with Europe, Canada, Mexico, Japan, and its other trading partners. With regards to our allies in Europe, Japan, Canada, and elsewhere, there are real dangers in engaging in a “war of each against all,” which could reduce the welfare of the entire world, including the United States.

Social Policy

Will Social Security be There for You?

By Karen Dynan·June 12, 2018
Harvard University

The Issue:

The good news in the 2018 report of the Trustees of the Social Security Trust Fund, released in early June, was that the program is expected to have enough money to pay for scheduled retirement benefits for the next decade and a half. There are concerns, however, about the longer-run financing of the program. Because of population aging, Social Security is projected to exhaust its ability to fund full retirement benefits in 2034; after that time, the Trust Fund will be depleted and incoming revenues will only be sufficient to pay 77 percent of scheduled retirement benefits.

The Facts:

Social Security provides retirement benefits to more than 40 million Americans each year, as well as to millions more spouses, dependents, and survivors of deceased workers. Social Security benefits lifted 17 million people age 65 and older out of poverty in 2016 (close to 35 percent of that population).
Many of the Americans who are now approaching retirement age will be even more dependent on their Social Security benefits for financial security than today’s retirees. They are less likely to have income from private defined-benefit pension plans to supplement their Social Security income. Moreover, Americans nearing retirement age have done less of their own saving to finance their retirement compared with those of a similar age in the past. The median ratio of net worth to “usual income” for families with heads between age 55 and age 64 was 28 percent lower in 2016 than it was just prior to the crisis — and even a little below where it was in 1995. And, only about one-third of American families nearing retirement are using workplace retirement plans such as 401(k)-type accounts (see chart).
The law governing the Social Security program will need to be changed to make the program financially sound for future cohorts of retirees. The finances can be fixed by cutting benefits (including by raising the retirement age), raising taxes, or some combination of the two options.

What this Means:

Although the Social Security program has ample funding to pay retirement benefits for a number of years to come, we have long known that the program will eventually run short of the money it needs to fully finance scheduled retirement benefits. With families that are nearing retirement age today tending to have less of their own savings and being less likely to have private defined-benefit pensions, it is more important than ever to address the longer-term financial challenges faced by the Social Security program. Changing the law now to phase in changes that shore up the finances of the program would have the advantage of allowing Americans to make gradual adjustments to their work and saving behavior to compensate for these changes.

International Trade

What is the National Security Rationale for Steel, Aluminum and Automobile Protection?

By Menzie Chinn·June 6, 2018
Robert M. La Follette School, University of Wisconsin-Madison

The Issue:

The Trump administration has invoked a seldom-used provision of trade law to investigate whether imposing import restrictions on steel, aluminum and automobiles is justified by national security. The question is whether the threats to national security are genuine, or a means of protecting domestic industries under the guise of national security.

The Facts:

On February 16th, 2018, the Department of Commerce concluded that steel and aluminum imports constituted a national security threat. On March 8th, the President imposed trade sanctions but made some temporary exemptions. As of June 1st, tariffs of 25 percent on steel imports and 10 percent on aluminum imports entered into effect for the European Union, Canada and Mexico.
The administration initiated a new investigation to determine whether imports of automobiles, including SUVs, vans and light trucks, and automotive parts into the United States threaten to impair the national security on May 23rd, 2018. Public hearings on the issue are scheduled to take place on July 19 and 20, 2018, and the Commerce Department's findings and recommendations are due by mid-February, 2019, but could happen before then.
Investigations under section 232 regarding the threat that imports pose to national security have been very rare and in the majority of cases resulted in findings of no threat. The criteria used in past investigations have been fairly narrow, with the national security threat arising from either (i) excessive dependence on imports from unreliable or unsafe sources or (ii) threats to the viability of U.S. industries and resources needed to produce domestically goods and services necessary to ensure U.S. national security.
In contrast, the recent analyses have used an expansive set of criteria including issues such as "weakening our internal economy" or diminished innovation (in the case of cars). The top source for imports of steel and aluminum is Canada. Other traditional allies of the United States are also primary sources of steel imports. The top sources of automobile imports into the U.S. are American allies – Canada, Mexico, Japan, Germany, Korea, and the United Kingdom.
As a result of steel and aluminum tariffs, U.S. trade partners have already responded or are in the process of responding with their own retaliatory tariffs. Mexico imposed tariffs on about $3 billion worth of U.S. products including steel, cheese, apples, cranberries and bourbon on June 5, 2018.
Even in the absence of retaliation, imposition of these tariffs could have large negative economic effects. One estimate indicates a 40,000-job loss in the automobile industry (a heavy steel user) from the steel tariffs alone.

What this Means:

It is unlikely that import competition in the steel, aluminum and automobile industries poses a real threat to national security, given the relatively small demand by the military, and the presence of reliable alternative non-domestic sources in allied countries. The fact that the determinations for steel and aluminum have been in the affirmative demonstrates the Commerce Department is using a conveniently expansive definition of national security. The imposition of tariffs is likely to raise prices for downstream consumers in the defense industry, as well as the overall economy. The imposition of protectionist measures is also likely to damage our allies’ economies, and invite retaliation by our trading partners, that in turn will likely lead to a process of escalating protection.

This post is an updated version of "Import Limits on Steel and Aluminum: Protecting National Security or Protectionism?" which was originally posted on May 9,2017.

Energy and Environmental Policy

Oil Prices: Is it Déjà vu All Over Again?

By Gilbert E. Metcalf·June 3, 2018
Tufts University

The Issue:

Oil prices topped $70 a barrel in May 2018 for the first time since late 2014. Rising gas prices at the fuel pumps were not far behind. Also not far behind were the politicians from both sides of the aisle blaming the Organization of the Petroleum Exporting Countries (OPEC) and Saudi Arabia for driving prices up, bringing to mind the tensions with OPEC of the early 1970s. But there is more behind the higher oil prices than Saudi Arabia or OPEC.

The Facts:

Oil prices in May, 2018 were 50 percent higher than they were in 2017. A deal in effect since January 2017 between OPEC and non-OPEC countries, including Russia, sought to increase oil prices by decreasing oil production around 2 million barrels per day, which represented just a little over a 2 percent reduction in production.
Saudi Arabia has reportedly cut production by roughly one-half million barrels per day, in line with their production reduction target. But Russia and other OPEC countries reportedly failed to cut production as promised.
Oil production in the United States has grown strikingly to the point of rivaling Saudi Arabia and Russia. U.S. production has more than offset Saudi cuts so that oil production from Saudi Arabia and the U.S. combined has increased by seven percent since January 2017.
Why were oil prices rising so dramatically then? In large measure, the answers lie with the economic crisis in Venezuela and the Trump administration's decision to withdraw from the Iran nuclear deal. Venezuela’s fiscal situation is so dire that the state oil company can’t make needed investments to maintain its aging infrastructure, resulting in a precipitous decline in oil production. In addition, Iranian oil production has increased by nearly one million barrels per day since the nuclear deal was signed. The reimposition of sanctions will likely cut Iranian production.
U.S. jawboning has clearly led the Russians and OPEC to boost production to stop prices from rising further. One reason for their restraint is the recognition that high prices will trigger major increases in U.S. shale production, something OPEC and Russia would like to avoid. Major increases in U.S. production are possible but beware the bottlenecks. Pipeline constraints are bottling up oil in the West Texas Permian basin, as evidenced by the sharp price differential of $15 a barrel between oil sold in Midland Texas and oil sold in Houston. Given the price differential, they will eventually figure out a way to get their oil to market. But it could take a few months.

What this Means:

What should we be doing in the face of rising oil prices? Jawboning OPEC to increase production will only get us so far. Even though the United States has become a major oil producer, it continues to be a major consumer as well. Over seventy percent of oil in the United States is used in the transportation sector. If we really want to insulate ourselves from higher oil prices, we need to wean ourselves off oil. The best way to do that is to increase our fuel economy and speed the penetration of electric vehicles in the transportation fleet (less than one percent of oil is used to produce electricity). Unfortunately, the Trump administration’s rollback of CAFE fuel economy standards along with calls for cuts to energy R&D are taking us in precisely the wrong direction.