PCDForum Column #45, Release date April 5, 1993

by James Stanford

Many labor representatives in the United States and Canada fear that a North
American Free Trade Agreement (NAFTA) will lead to a redirection of investment
toward low-wage regions of the continent, consequently reducing wages and
employment opportunities in higher-wage areas. Yet free trade advocates
regularly cite projections claiming that the agreement will create thousands of
new jobs and benefit workers in all participating countries. Free trade
economists dismiss the critics as economically illiterate or special interest
protectionists. The free trade advocates usually avoid mentioning that the
projections they cite are produced by computer simulations known as computable
general equilibrium (CGE) models based on assumptions that bear little
relationship to reality.

Consider an imaginary conversation between an auto worker in the Midwestern
United States and the architect of a CGE model. The worker expresses her fear

If NAFTA goes through Ford will surely move its Taurus plant to Mexico where
it can hire workers for a tenth of my pay with no independent union and export
cars back to the United States. With the labor market already depressed in this
part of the country I don’t see any prospect of finding a job at comparable pay.

The CGE modeler quickly reassures the employee.

Don’t worry, I’ve constructed a computer simulation that demonstrates you
will actually benefit from the trade agreement. Here’s how it works. In my model
I assume capital is immobile. Therefore Ford cannot move its plant to Mexico.
Nor would it want to, because I assume unit labor costs are the same in both
countries and in my model Americans have a clear preference for U.S. made
products, even if they are more expensive.

My model also assumes full employment and specifies that anything imported
to the U.S. from Mexico must be balanced by American exports, so new export
industries will necessarily spring up here to replace any industries that might
be displaced by Mexican imports. Since you earn above-average wages at Ford, you
obviously possess valuable skills. With full employment you will certainly find
another job very shortly in one of these new export industries, probably with
higher pay than your current job. So NAFTA will be great for you.

The discussion is hypothetical. However, as unreal as the assumptions cited
by the modeler may seem, nine of ten CGE NAFTA models I recently examined
included at least one of them. Two of the models included all of the
assumptions. While we might be impressed by the rigor with which the modeler in
the dialogue has identified the conditions under which NAFTA or other free trade
agreements might prove beneficial to the Ford employee, we might also forgive
the worker with real world knowledge for rejecting the free trade arguments of
an economist who proposes to cross a deep ravine by assuming there is a bridge.

Indeed, I found that the more realistic the assumptions of the simulation
model, the more likely it is to show that the prospective NAFTA agreement will
produce negligible or negative economic consequences for at least one of the
partners. Real world experience goes further in suggesting that the consequences
of NAFTA will be far more negative, particularly for the U.S. and Canada, than
projected by the most pessimistic of these models. Even though Canada and the
United States have relatively similar economies, the existing Canadian-U.S. free
trade has seriously damaged Canada’s economy as factories relocated to lower
cost regions in the United States, increasing unemployment in Canada and placing
downward pressure on Canadian wages. Given the much lower unit labor costs in
Mexico, skeptical workers who intuitively sense the gap between the economists’
theoretical models and the real world should not be dismissed as special
interest protectionists. Continental integration holds the possibility, not the
guarantee, of mutual benefit, but only if accompanied by coordinated
continent-wide measures to ensure balanced trade, strong demand, the recognition
and protection of labor rights and other standards, and the genuine sharing of
the gains from trade.

Ironically, labor would likely support a NAFTA enthusiastically if the
agreement guaranteed the same conditions assumed in CGE models. The modelers’
assumption of such conditions is somehow acceptable to free trade advocates. Yet
labor’s call for real-world measures to promote these conditions is brushed
aside as raising the specter of managed trade. A willingness by model builders
and trade negotiators to confront issues like investment diversion and
unemployment would be an important step toward lessening resistance to trade

James Stanford is a doctoral candidate in economics at the Graduate Faculty
of the New School for Social Research and a research fellow at the Brookings
Institution, 1775 Massachusetts Avenue, N.W., Washington, D.C. 20036-2188. The
column is prepared and distributed by the People-Centered Development Forum
based on his article "Continental Economic Integration: Modeling the Impact
on Labor," Annals of the American Academy of Political & Social
Science, 526, March 1993.

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