The author thanks Zhongyi Tang for her research assistance and contributions to this post.
Earlier this week, the U.S. Trade Representative’s office sent a draft letter to Congressional leaders outlining the Trump administration’s objectives for a renegotiation of the North American Free Trade Agreement (NAFTA).
For companies, cities, and states reliant on North American trade, the stakes of a NAFTA renegotiation are potentially high. In January, my colleague Mark Muro and I explored how changing trade policy may influence U.S. metropolitan economies. Because Canada and Mexico are the nation’s two largest export markets, changes to NAFTA could matter greatly to these metros. In fact, the United States trades as much with Canada and Mexico as it does with Japan, Korea, and the BRICS—Brazil, Russia, India, China, and South Africa—combined. Millions of jobs in U.S. states depend on exports to Canada and Mexico. A recent analysis in The Economist finds that introducing higher tariffs or new border taxes for Mexican trade as part of a NAFTA renegotiation would particularly impact states like Texas and Michigan, where exports south of the border account for a large share of the economy.
Simply looking at how changes to NAFTA would affect state-level exports to Canada and Mexico misses the complexity and distinctiveness of North American trade. Beyond just using Canada and Mexico as export markets for final goods, many U.S. firms (and by extension, the states in which they operate) depend on supply chains that link their U.S.-based operations with suppliers in Canada and Mexico. As a result, much North American trade occurs in “intermediate goods”—materials or components that companies import and integrate into the production of a final good.
Why intermediate goods imports matter
Intermediate imports matter. At first glance, the benefits of imports to a state may seem counterintuitive. Sourcing imports internationally can result in higher transportation costs for firms, increase the risk of supply-chain disruptions, and displace domestic production and jobs. As we have argued, the country undoubtedly needs a more comprehensive suite of policies that help workers and communities adjust to rising import competition. Yet, evidence suggests that sourcing intermediate goods internationally also improves product quality and lowers product cost, making a firm’s products more competitive in the global marketplace and ultimately supporting jobs and wages at home.
Companies, cities, and states must import to compete in today’s integrated economy. The United States depends on intermediate goods imports from its North American neighbors more than from other parts of the world. In 2015, intermediate goods imports accounted for 43 percent of total U.S. goods imports. From Canada and Mexico, the share was 50 percent, much higher than the European Union (37 percent) or China (28 percent).
State dependence on NAFTA intermediate imports varies
Every state imports intermediate goods from Canada and Mexico, but the volume of those imports varies depending on industry makeup and geographic location. Data from the U.S. Census Bureau on state-level imports, classified by the United Nations’ definition of intermediate goods, provides a unique look at which state economies rely most on intermediate imports from Canada and Mexico, and are therefore most exposed to changes in NAFTA.
When measured by total volume, the nation’s largest states dominate intermediate goods imports from North America. Texas, Illinois, Michigan, New York, Ohio, and Washington all import more than $15 billion in intermediate goods, together accounting for over half of the nation’s total. Given the large size of their economies, disruptions to trade in these states have significant potential to influence national economic growth.
However, some states’ production relies more on NAFTA imports, measured by the share of total intermediate goods imports that come from Canada and Mexico. Table 1 ranks states based on this metric.
The states that rely most on NAFTA intermediate imports as a share of their total import base tend to be involved in one of two broad sectors: advanced manufacturing and energy.
Advanced manufacturing in many states greatly depends on intermediate imports from Canada and Mexico. Michigan’s automotive industry has long relied on suppliers in Canada and Mexico who provide 61 percent of Michigan’s total intermediate imports. Tens of billions of dollars’ worth of motor vehicle seats, ignitions, wires, and other parts flow into southeast Michigan to support local production. Beyond Michigan, North American supply chain relationships extend to the remainder of the industrial Midwest. Canada and Mexico supply Ohio with nearly $3 billion worth of automotive parts and Indiana with over $2 billion. As the auto belt has shifted south, so too has the North American supply chain. Texas imports nearly $6 billion in auto parts from Mexico alone. Tennessee imports over $2 billion in motor vehicle parts from North America while Kentucky imports nearly $1.6 billion.
North America’s most prominent shared industry is automotive manufacturing, but it also supports a burgeoning aerospace supply chain. Washington—led by the Seattle-Tacoma area—imports more than $1 billion annually from Canadian aerospace suppliers. Kansas—where aerospace manufacturing anchors the Wichita metro economy—receives at least $700 million annually in North American-sourced aircraft component parts. Arizona imports nearly $300 million worth of turbojets and turbopropellers from Mexico to supply its aerospace manufacturing base. In 2016, U.S. aerospace exports totaled nearly $147 billion overall.
Energy is the second major U.S. sector that relies on NAFTA intermediate imports. The United States is a major importer of crude oil from Canada, and to a lesser extent, Mexico. In 16 states—including Illinois, Texas, Minnesota, Oklahoma, Washington, Montana, and Colorado—crude oil is the largest intermediate good import from North America. Pipelines carry oil from Alberta into the northern and western United States where it is refined and sent into markets throughout the west. Further south, Mexican petroleum ships through the Gulf of Mexico to major refining and chemical manufacturing hubs in Louisiana, Mississippi, and Texas. Even as domestic energy production has expanded in recent years, U.S. states continue to rely on North American partners to create the basic inputs to everything from plastics to chemicals.
President Trump was elected on a platform that argued trade policy reform could support the American industrial base. Many feared that he may back out of NAFTA altogether, or at least insert policies that raised the price of Mexican imports. For companies that depend on North America’s integrated supply chains, this approach could raise the price of intermediate inputs for existing export industries, further degrading their global competitiveness. For instance, Michigan’s export prowess in auto manufacturing now relies upon a seamless supply chain that incorporates Canada and Mexico, among other trading partners. To export price-competitive cars, Michigan must be able to import cost-competitive components.
Leaders in states reliant on the NAFTA supply chain will be relieved to know that the draft USTR letter to Congress was not a drastic departure from previous suggested improvements to the agreement, according to the Wall Street Journal. Rather, the letter references several longstanding issues such as rules of origin, foreign investment, labor and environmental standards, eliminating barriers to services trade, and upgrading the agreement to include digital trade and cross-border data flows.
All these reforms could potentially incentivize inward investment and increased U.S. exports without disrupting continental supply chains with new tariffs or taxes, as my Brookings colleagues Josh Meltzer and Dany Bahar have argued. The letter did include on notable change: a “snapback” provision that would allow each country to raise tariffs should they deem a surge in imports to be a “serious threat” to a domestic industry. And this is only the start of the process. Shortly after the letter’s release, White House press secretary Sean Spicer said that it is “not a statement of administration policy.” It is entirely possible that the final contours of the White House’s negotiating position will not be finalized until Trump’s U.S. Trade Representative, Robert Lighthizer, is confirmed.
Of course, the NAFTA renegotiation is not the only potential policy that could influence trade within the continent. The House Republicans have introduced the idea of a border adjustment tax on all imports as part of a broader corporate tax reform plan. Brookings’ William Gale and Gary Hufbauer and Lucy Lu from the Peterson Institute have each estimated the potential impacts of a border adjustment tax. In the end, how the border adjustment tax influences U.S. exporters, importers, and consumers remains the subject of vigorous debate, and will ultimately depend on whether exchange rates adjust to offset the tax. Should exchange rates offset the tax, there will likely be no change in the terms of trade between the United States and foreign markets. However, if exchange rates do not offset the tax, then importing companies—especially retailers, oil refiners, and automakers—would bear the cost of the tax, and potentially pass that along to consumers to maintain profit margins.
The bottom line is this—any NAFTA renegotiation should acknowledge that Canada and Mexico are as much partners in production as they are trade competitors. As Richard Baldwin has written, the three countries compete together as “Factory North America” against similar regional production networks in Europe and East Asia. Currently, tariff-free trade allows these supply chains to operate relatively seamlessly across North America. Improvements can and should be made to NAFTA that maintain and strengthen these supply chains; recognize that U.S.-based firms rely on intermediate imports; and enhance economic growth at the state and national levels.