Two Trade Deals – Hold the GDP Growth

The Trump administration landed two big trade deals this past week. The President signed the Phase One trade deal with a visiting Chinese delegation and the U.S. Congress approved the USMCA update to NAFTA. These were welcome political wins at a time when the President could use some positive headlines. But how important are the deals economically?

Treasury Secretary Steve Mnuchin quantified: “When we look at this (U.S.-China deal) and we look at the USMCA together, I think you’re going to see a good 50 to 75 basis points combined” in increased GDP (.5 to .75%).  If that were true, it would be remarkable. Before recent events, the U.S. Federal Reserve forecast 2.0% U.S. GDP growth in 2020; the World Bank estimated the same number at 1.8%. So an increase of the sort described by the Treasury Secretary would be a dramatic acceleration. 

But the numbers are implausible. There are two broad ways that trade agreements can spur economic activity:

1.  They can make that activity easier and cheaper by removing barriers to trade (real effect)

2.  They can boost public spirits in a way that spurs business investment or consumer purchases (sentiment)

This week’s trade deals do not seem likely to do either. 

Consider each effect in turn. The details of the USMCA – at least its initial version – have been around for longer, so we have careful economic analyses we can turn to. IMF researchers found that the USMCA would have zero effect on the U.S. economy. The official analysis of the U.S. International Trade Commission found that USMCA provisions would lower U.S. GDP by 0.12 percent (Table 2.6). 

Such dour assessments come from the fact that North American trade was already opened under NAFTA, so most of the gains were already realized. Further, the USMCA’s biggest change is meant to impede trade, by making it harder for cars built between Canada, Mexico, and the United States to qualify for lower trade barriers than it was under NAFTA. North American auto companies will either have to implement costly distortions to their supply chains or they will have to pay the 2.5% tariff on cars imported into the United States. The latter seems more likely. 

The China deal has its own problems. While there are provisions intended to improve conditions for U.S. companies operating in China, e.g. by protecting intellectual property, it is not at all clear that the Chinese commitments will change conditions much. For example, China pledges not to “require or pressure persons…to transfer technology.” (Article 2.2). But China has claimed all along that such transfers were voluntary business transactions, with no requirement or pressure involved. So how valuable is a restatement of existing Chinese policy?

The Phase One agreement’s commitments for Chinese purchases of U.S. manufactures, agriculture, energy, and services look more substantive, if less plausible. In agriculture, for example, the Chinese committed to increase purchases to roughly $32bn in 2020 and $39bn in 2021. The highest level of U.S. agriculture exports to China on record was only $26 billion in 2012, with just $9bn in ag exports in 2018. 

The first problem with these numerical commitments is their plausibility. Not only is it very difficult to see how the targets might be feasible, but there will be no check on whether the commitments are working until after the 2020 U.S. election. One can imagine a Chinese calculation that if President Trump loses, his successor is unlikely to share his numerical fixations; if President Trump wins, trade target shortcomings will be the least of their problems. 

In fact, these numerical commitments are damaging to the United States. It has been a longstanding U.S. goal to get China to reduce the role of the state in economic activity and to give a bigger role to market forces. Markets, left to their own devices, rarely strive to meet arbitrary numerical targets. The only way China could meet these targets is by increasing the role of the state. Further, the United States has pushed for and benefited from a global trading system that was based on a level playing field: importers should buy from the country that can best deliver the goods. This agreement seriously undercuts that principle and pushes the Chinese to cut purchases from other countries so as to buy from the United States instead.  

What about sentiment? Even if the agreements do not make trade easier, on balance, might they not provide an economic boost through making everyone feel better and averting trade breakdown? For both the USMCA and the Phase One China deal, the agreements allayed fears that the situation could have been much worse. USMCA advocates were aware that President Trump had threatened repeatedly to kill NAFTA. The China deal followed a year and half of steadily escalating tariffs and promised small reductions in those applied in September 2019 and forestalled those scheduled for mid-December. 

There are two problems with expecting much of an economic boost from this sort of optimism. The first is that businesses had largely anticipated that NAFTA would survive and that the Trump administration would strike some sort of China deal. Those expectations were baked into existing GDP growth estimates. The second problem is that President Trump has shown no evidence that he feels bound by trade agreements, whether his own or those signed by his predecessors. After signing USMCA in late 2018,  by spring 2019 President Trump threatened Mexico with new auto tariffs that would “supersede” the trade deal. With China, the Trump administration has reached at least five deals, with Phase One being the latest. Each of the earlier ones ended up being discarded or followed by further conflict. Trade uncertainty can have negative economic effects; it’s just not clear that either of these agreements will do much to alleviate it. 

Countries reap the economic benefits of trade agreements when they actually make trade easier. These two agreements do more harm than good in that regard. The agreements are more notable for the self-imposed damage they ostensibly prevent than for any net liberalization they achieve. It would undoubtedly be beneficial for businesses and their employees to get some relief from recent trade uncertainty, but these agreements don’t deliver much.