NAFTA and agriculture: A great example of complexity

Canada, USA, MexicoMichael Swanson, Ph.D., Wells Fargo Chief Agricultural Economist

With all the talk about renegotiating NAFTA (whatever that means), it makes sense to do the unthinkable and look at the trade facts. Perfectly free trade remains a “black board” exercise for the academics, but NAFTA represents an imperfect agreement to get “freer” trade. Agricultural trade within NAFTA illustrates some of the basic principles of economics such as comparative advantage and exchange rates.

Whether you’re happy with the impact of NAFTA on your market depends on whether it puts money in your pocket, or takes it out. More often than not, the consumer benefits are spread out while the producer pain is concentrated, making for a tough political situation. Also, given that the U.S., Canada, and Mexico don’t share a common currency, for which we should be thankful every day, changes in exchanges muddy the waters on an ongoing basis.

Net Trade with NAFTA millions of Dollars

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In 2011, the U.S. was running just under a $1 billion trade deficit within NAFTA for agricultural and food products. In 2011, the U.S.’s GDP was $15.5 trillion, making this trade deficit about 0.006% of the total economic activity. In 2016, the agricultural and food trade deficit ballooned to $14 billion, now making it 0.008% of the U.S. GDP. Put another way, the current U.S. population is 325 million which means we run a daily agricultural and food trade deficit of 12 cents per person. In aggregate, NAFTA agricultural and food trade isn’t even a rounding error to the overall economy. However, this misses the point because for some of the participants, NAFTA agricultural and food trade makes up 100% of their business. And, it’s a legitimate question as to whether NAFTA creates a fair or unfair advantage.

Net Trade with Mexico in Millions of Dollars

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So why does the U.S., the world’s agricultural and food manufacturing superpower, import anything? Evidently, it’s easier to grow avocados in the Michoacán region of Mexico than in Boston, Massachusetts. And it’s tough to enjoy the Super Bowl without guacamole.

Fresh fruits and vegetables offer the classic example of comparative advantage. The U.S. runs a trade deficit with Mexico in fresh fruits and vegetables, and it runs a trade surplus with Canada in these same categories. The warmer and longer growing seasons further south allow higher productivity and different seasonality for growing fresh produce, and it makes sense to most people to allow the products to flow north to improve both varieties and access. Likewise, the U.S.’s grain belt has outstanding soils and climate for grains and oilseeds compared to that of Mexico’s hotter and drier regions. So, Mexico’s 120 million inhabitants rely on the U.S. to supply over 22 million metric tons of grains and oilseeds to achieve a world-class level of food availability. Taking advantage of strengths and mitigating weaknesses through trade makes the world a better place for consumers and producers.

There are, of course, some trade examples that illustrate the fact that consumers just want what they want for some inexplicable reason. The U.S. runs approximately $3 billion in trade deficit with Mexican beer made with U.S. barley and hops and combined with Mexican tap water. Evidently, our barley and hops shipped to Mexico and mixed with their tap water becomes more attractive to U.S. beer drinkers. Additionally, the U.S. consumer will pair a fresh lime and some guacamole with the beer, further increasing the trade opportunity. We should tip our hat to the Mexican brewers and marketers for their successful efforts to convince U.S. drinkers of the appeal of Mexican beer. The fact that countries simultaneously import and export almost identical foods and drinks shows that consumers eat and drink the story and the brand as well as the product. NAFTA has allowed consumers in the U.S., Mexico, and Canada to develop a taste for variety not possible 25 years ago.

Net Trade With Canada in Millions of Dollars

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There are other examples of agricultural trade that also shine a light on the vexing issue of differences in regulatory and environmental issues. One of the biggest drivers of the U.S. agricultural trade deficit with Canada is the importation of timber and forest products. It seems that the comparative advantage of the Canadians is that their forests are free from the fearsome spotted owls which, in the U.S., carry off timber men and logging equipment, making it difficult to compete. An alternative explanation involves different timber ownership arrangements, logging regulations, and exchanges rates. If you have a couple of free days, sit down with one of our Wells Fargo timber experts to discuss the issues driving this dynamic. It’s safe to say that comparative advantage doesn’t drive the timber and forest products trade like it does fresh fruits, grains, and oilseeds.

Now 25 years into NAFTA, the U.S. timber and forest products sector continues to evolve, adapting to the current agreement which continues to be debated. Many U.S. and Canadian timber and forest products companies decided it makes sense to operate in both countries in order to take advantage of the opportunities as economic conditions dictate. Unfortunately for some of the smaller producers, they can’t, or won’t, operate in both countries, leaving them exposed to the vagaries of exchange rates and regulations. Is this an area where it makes sense to “renegotiate NAFTA”? No doubt, some U.S. producers would love to see changes in the NAFTA agreement, but there might also be some aggrieved Canadian avocado producers who seek some relief from California avocados.

Real Exchange NAFTA Currency per USD

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For U.S. agriculture, no doubt NAFTA is an imperfect trade agreement that could be improved through negotiation, but that’s in an ideal world. NAFTA has been a good deal for most producers and consumers. It allows many participants to take advantage of comparative and competitive differences. These advantages sometimes get swamped by the exchange volatility which has nothing to do with agricultural trade. As shown earlier, agriculture and food account for a small percentage of the overall economy. The Federal Reserve doesn’t set interest policy based on the agricultural and food sectors. These sectors are just along for the ride. So it’s important not to confuse cyclical exchange rate opportunities and problems with the NAFTA agreement. Given all of the complexity, renegotiating NAFTA for agricultural purposes might be a classic example of “be careful what you ask for, because you just might get it”.