As I write this, there is a dust-up in the American body politic concerning a threatened tariff on goods imported from Mexico, ostensibly to fund a wall dividing the two countries and to “level the playing field” with respect to trade. By the time you read this, it may be old news. Or it may have boiled over.
Whichever way the putt breaks, it will impact the auto industry in the United States. Here’s my take on the whole situation. Stay with me — this issue has a lot of moving parts.
How Cross-Border Trade Works
First things first: Trade between the U.S., Canada and Mexico has been governed by the North American Free Trade Agreement (NAFTA) since it came into being in 1994. While NAFTA is a tripartite agreement, all of the noise seems to be concerning the Mexican/American piece of the pie.
This is largely because (1) the U.S./Canada trade relationship is quite balanced, because we sell about as much stuff to Canada as we buy from them, and (2) there is no perceived risk from illegal Canadian aliens slipping into the United States across the Niagara River. (To be fair, there may be some concern on their side about Hollywood celebrities escaping north following our presidential election. I suggest detention camps.)
Second things second: Car dealers have a particular interest in U.S./Mexican trade. This is because, while the U.S. doesn’t export a lot of vehicles to Mexico, it exports a boatload (literally) of automotive parts. For purposes of this discussion, “boatload” is defined as around $30 billion per year. Those parts are then incorporated into finished vehicles that are exported to the U.S. at the rate of around 2 million units per year. So a 35% tariff on imports would devastate the American dealerships that sell the vehicles and the American manufacturers that make the parts that go into those cars. Plus, the cost of tequila would go up.
And third things third: There already is a wall between the U.S. and Mexico — it just doesn’t run continuously from San Diego on the Pacific coast to Brownsville, Texas, on the Gulf of Mexico. Of the 2,000 miles of land border between the two countries, around 600 miles has a physical fence. The gaps are secured by a “virtual fence” monitored by the U.S. Border Patrol. There is no real consensus that augmenting it with a tangible version would do much good. Most smuggling occurs in areas where the physical fence already exists.
Fun fact: Between 2009 and 2014, around 140,000 more illegal Mexican aliens returned to Mexico than entered the U.S. That trend is assumed to have continued. So would an enhanced wall have the effect of keeping the illegal aliens in the U.S.?
The presidential campaign season that resulted in Donald Trump’s election was acrimonious, but certainly not the most acrimonious ever. In 1968, there was literally blood in the streets. Even greater was the rioting after the 1876 election that gave us Rutherford B. Hayes. (Samuel J. Tilden won both the electoral college vote, which counts, and the popular vote, which does not, but Hayes got to pick the drapes for the White House.) And the 1860 election instigated the Civil War. So those who breathlessly contend that this was the most contentious election ever need to take a deep breath and read some history.
Still, politics happened and tempers continue to run hot. It needn’t be so. I filled in the circle for Trump, and Tom Hudson has gone on record as not having done so. Tom is a fine man whom I greatly respect. Next time we meet, he will buy me a glass of red wine (it’s his turn) and we will discuss these issues as grown-ups. It can be done.
All of which leads me back to the issue of the proposed tariff against Mexico. A wall to stem illegal immigration from Mexico and a tariff to fund it was part of Mr. Trump’s campaign platform. Having been elected, he needs to at least make an effort to fulfill that promise. (How novel!) He began that effort by signing an executive order in January to get the ball rolling. Now he needs to get the votes to give the EO some teeth. That’s called politics.
Wishing Won’t Make It So
What President Trump wants to do is less important than what he can do. This, in turn, brings us to the topic of geopolitics. Geopolitics is the study of the effects of human and physical geography on politics, especially international relations. In a nutshell, the “geo” part puts some very serious constraints on what the “politics” part can accomplish.
America’s three largest trading partners are China ($578 billion in 2014), Canada ($545 billion), and Mexico ($525 billion). Please note these figures only include “stuff,” not services or foreign direct investment.
There is a human geography reason for China being our largest trading partner: their massive population and the lower labor cost it creates. For Canada and Mexico, there is a physical geography reason for those trade numbers. They live right next door, and they’re not moving.
When it comes to trade relationships, those three are in a class by themselves. Our fourth largest trading partner? Japan, at $195 billion. Then Germany ($164 billion), South Korea ($112 billion) and the United Kingdom ($110 billion). Clearly, China, Canada and Mexico are the fat kids in the canoe. How we trade with those three means more to the United States than the countries in the No. 4 through No. 30 positions combined.
And that’s where President Trump’s politics will collide with geopolitical reality. I have no doubt that he desires to return manufacturing jobs to the United States. I have no doubt he wishes to “level the playing field” vis-à-vis Mexico. And I have no doubt he wants Mexico to fund those ends. But a trade war with Mexico neither will accomplish those goals nor can.
Casualties of a Trade War
The geography of the situation limits what a new tariff can do in the same way it limits what a nuclear warhead can do — when the other guy has them, too. Mexico would retaliate with tariffs of their own and a full-scale trade war would ensue. Mutually assured destruction is not limited to nuclear exchanges.
And trust me, there would be a trade war. This is because Mexico has domestic politics, too, and Mexican President Enrique Peña Nieto cannot allow a unilateral trade action to stand without retaliation, especially with his own reelection effort coming in 2018.
Neither side of the border wants the effects of a trade war. For some sense of scale, consider that the Center for Automotive Research estimates that ending NAFTA and implementing a 35% tariff would cost the United States 31,000 jobs in the automotive sector alone. Is that estimate accurate? Do you really want to find out?
So what can President Trump do, given the very real constraints geopolitics places upon his will? He could renegotiate parts of NAFTA, in particular the rules-of-origin requirements that define how much of a finished product must be manufactured in a NAFTA country to receive preferential treatment. The current requirement for light vehicles is 62.5%; raising it to, say, 90% could increase manufacturing jobs in the U.S. (or, for that matter, Mexico).
He can also beef up border security, declare victory, and move on to the next big thing. President Peña Nieto will declare victory, too — for standing up to the U.S. and preventing the threatened trade war — and carry that momentum into his own reelection campaign.
But there will be no 35% tariff, and there will be no trade war. That’s the reality, given domestic politics and the constraints of geopolitics. And tequila will remain affordable, so the cost of margaritas should remain stable. After all this agitation over nothing, we may all need one.
James S. Ganther Esq. is the co-founder and CEO of Mosaic Compliance Services. He is a dealer compliance expert and a prolific writer and speaker. Email him at [email protected]