U.S. Trade with Canada and Mexico: A Short Primer

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1 Economics Group Special Commentary Jay H. Bryson, Global Economist (704) E. Harry Pershing, Economic Analyst (704) Executive Summary The North American Free Trade Agreement (NAFTA) has been controversial ever since negotiations began nearly 30 years ago, and its profile was raised again during the recent presidential election campaign. The transportation equipment industry in the United States has, by far, the largest value of two-way trade with Canada and Mexico. However, industries with the most trade exposure to Canada and Mexico (as a percentage of industry output) are the leather and allied products industry, the electrical equipment industry and the marine products industry. Presumably, these industries would be most affected by any changes to the NAFTA agreement that may occur in coming years. NAFTA may have played a role in reducing employment in the manufacturing sector over the past few decades, but, in our view, the imperative to lift productivity would have depressed factory jobs even if the trade pact among the three North American neighbors had never come into existence. Bilateral Trade Flows Have Increased Sharply Since 1994 NAFTA has been controversial in the United States ever since negotiations on the agreement began nearly 30 years ago. In 1993, then-vice President Al Gore and Ross Perot debated the merits of NAFTA in a widely watched televised appearance on the eve of Senate ratification. More recently, Donald Trump was highly critical of NAFTA on the campaign trail, at times vowing to either terminate the agreement or renegotiate it. Although it remains to be seen exactly what policy the incoming administration will adopt toward NAFTA after it assumes office in January, it may be useful to consider which industries would be affected the most if the current NAFTA agreement changes in the future. Before we analyze individual industries, however, we look at the broad trends in trade among the three NAFTA signatory countries since the agreement came into force in American exports to Canada and Mexico more than trebled to over $500 billion in 2015 from roughly $140 billion in 1993 (Figure 1). On the other side of the ledger, American imports from its two North American neighbors shot up to nearly $600 billion last year from $150 billion in 1993 (Figure 2). The charts below make it clear that American trade with both countries has increased markedly over the past two decades, but that trade with Mexico has grown proportionately more than trade with Canada in the post-nafta period. Which industries would be affected the most if the current NAFTA agreement changes in the future? This report is available on wellsfargo.com/economics and on Bloomberg WFRE.

2 WELLS FARGO SECURITIES Figure 1 Figure 2 $700B $600B U.S. Exports to Canada and Mexico In Billions of Dollars U.S. Exports to Mexico: $236.4B U.S. Exports to Canada: $280.0B $700B $600B $700B $600B U.S. Imports From Canada and Mexico In Billions of Dollars U.S. Imports From Mexico: $294.7B U.S. Imports From Canada: $295.2B $700B $600B $500B $500B $500B $500B $400B $400B $400B $400B $300B $300B $300B $300B $100B $100B $100B $100B Source: IHS Global Insight and Wells Fargo Securities Of course, exports and imports from most of America s trading partners have increased as well over the past 20 or so years. Figure 3 shows that Canada and Mexico, which took in about 30 percent of American exports in 1993, now account for more than 34 percent. In other words, American exports to the two NAFTA economies have grown faster than exports to other countries. In terms of imports, Canada and Mexico became more important trading partners for the United States in the first decade following the NAFTA agreement. However, the ratio has subsequently receded to its pre-nafta level because other countries have risen in importance relative to Canada and Mexico since the turn of the century. Figure 3 Figure 4 U.S. Trade With Canada and Mexico 40% 40% U.S. Trade Balances In Billions of Dollars 38% 36% 38% 36% 34% 34% % 32% -$400B -$400B 30% 30% 28% 28% -$600B -$600B 26% 26% -$800B -$800B 24% 22% Exports to CA & MX as a % of Total: 34.3% Imports from CA & MX as % of Total: 26.3% 20% % 22% 20% -$1000B Trade Balance with Canada: $-15.2B Trade Balance with Mexico: $-58.4B Trade Balance with World: $-737.1B -$1200B $1000B -$1200B Source: IHS Global Insight and Wells Fargo Securities NAFTA countries are generally not the source of America s trade deficit problems today. In that regard, Figure 4 traces the evolution of the U.S. trade deficit over the past 20 years. In 1993, the United States incurred a small trade deficit ($11 billion) with Canada, which has changed little on balance over the past two decades. The small trade surplus ($4 billion) that America racked up with Mexico in 1993 has turned into a modest deficit of $58 billion today. However, this small deterioration in the bilateral trade position with Mexico needs to be put into perspective. Over the past 22 years, the total U.S. trade deficit widened $600 billion to $737 billion in The vast majority of that red ink has been incurred with countries outside of North America. Specifically, the bilateral U.S. trade deficit with China mushroomed from $23 billion in 1993 to $367 billion in In other words, NAFTA countries are generally not the source of America s trade deficit problems today. 2

3 WELLS FARGO SECURITIES, LLC What Does America Trade With Canada and Mexico? So what exactly does the United States trade with Canada and Mexico? To answer that question, we used trade data that were disaggregated by North American Industry Classification System (NAICS) codes. The first line of Table 1 shows that the transportation equipment industry (Industry No. 336), which includes producers of automotive vehicles and parts and producers of aircraft and parts, had about $97 billion worth of exports to Canada and Mexico in Other industries with $40 billion or more of exports to Canada and Mexico in 2015 include the computer and electronic products industry ($68 billion), the chemical industry ($51 billion) and the machinery industry ($49 billion). Interestingly, there generally is a high degree of correlation between industry exports and industry imports. That is, industries with high values of exports to Canada and Mexico also tend to have high values of imports from those countries. For example, the transportation equipment industry, which has the highest value of exports to America s NAFTA partners, also has the highest value of imports from those countries. In other words, there tends to be a high degree of intra-industry trade among the NAFTA partners. The computer and electronic products industry ($65 billion), the chemical industry ($31 billion) and the machinery industry ($31 billion) also have high values of imports from the NAFTA countries. 1 Table 1 There tends to be a high degree of intra-industry trade among the NAFTA partners. U.S. Trade with Canada and Mexico by Industry Sector Exports Im ports T ransportation Equipm ent (336) $96.6B $168.5B Com puter & Electronic Products (334) $68.5B $64.9B Chem icals (325) $51.1B $30.6B Machinery, Except Electrical (333) $48.9B $31.3B Electrical Equipm ent, Appliances & Com ponents (335) $29.2B $29.5B Petroleum & Coal Products (324) $25.0B $13.1B Food & Kindred Products (311) $24.6B $22.0B Fabricated Metal Products, Nesoi (332) $22.3B $13.7 B Prim ary Metal Mfg (331) $21.9B $29.0B Plastics & Rubber Products (326) $20.4B $12.5B Agricultural Products (111) $13.8B $14.4B Oil & Gas (211) $13.6B $67.4B Source: U.S. Department of Commerce and Wells Fargo Securities One notable exception to the general rule of high export and import correlation is the oil and gas industry, which is shown in the last row in Table 1. Although the exports of this industry to Canada and Mexico are relatively low (about $14 billion in 2015), the United States imports a significant amount of oil and gas ($67 billion last year) from its NAFTA partners. Now that exports of crude oil have been liberalized, however, American exports of petroleum products likely will increase significantly in coming years. 1 For space considerations we limit Table 1 to the top twelve exporting industries. A complete list of industries is shown in the appendix. 3

4 WELLS FARGO SECURITIES One could argue that the industries referenced above have high values of exports and imports simply because the prices of their products are high. After all, it takes a significant amount of exports of, say, American wheat to Mexico to equal the value of one Boeing 747 sold to Air Canada. Perhaps a better way to measure exposure to Canada and Mexico is to express the value of an industry s exports and imports as a percentage of its U.S. industry output. We make those calculations in Table 2. Sure enough, the transportation equipment industry, which ranked No. 1 in the value of its exports to Canada and Mexico as well as the value of its imports from those countries, slips to No. 7 when its total trade with the other two NAFTA economies is deflated by the value of industry output. The industries most exposed to trade with Canada and Mexico include the leather and allied products industry, the electrical equipment industry and the marine products industry. These industries and the other industries that are located near the top of Table 2 would be most affected by any changes to the NAFTA agreement that may occur in coming years. 2 Table 2 U.S. Trade with Canada and Mexico (as a Percent of Industry GDP) Industry Exports Im ports Leather & Allied Products (316) 30.6% 34.4% Electrical Equipm ent, Appliances & Com ponents (335) 24.0% 24.2% Fish, Fresh/Chilled/Frozen & Other Marine Products (114) 11.5% 29.3% Com puter & Electronic Products (334) 17.7 % 16.8% Oil & Gas (211) 5.3% 26.4% Apparel & Accessories (315) 11.8% 17.8% T ransportation Equipm ent (336) 9.5% 16.6% Prim ary Metal Mfg (331) 9.6% 12.7 % Machinery, Except Electrical (333) 12.5% 8.0% T extiles & Fabrics (313) 15.3% 4.4% Source: U.S. Department of Commerce and Wells Fargo Securities Do You Hear a Giant Sucking Sound? As a presidential candidate in 1992, Ross Perot famously said that NAFTA would produce a giant sucking sound in terms of American jobs lost. Nearly 25 years later, Mr. Perot s prognostication appears to be prescient, at least at first glance. Since NAFTA went into effect in 1994, manufacturing payrolls in the United States have declined by nearly 4.6 million positions, on balance (Figure 5). However, more in-depth analysis indicates that there is less to Mr. Perot s claim than initially meets the eye. For starters, all of the job losses in manufacturing occurred during two episodes in which payrolls lurched lower, and both episodes were associated with recessions in the U.S. economy. Furthermore, all of the losses in manufacturing jobs in the past two decades have occurred since By that time, NAFTA had been in effect for six years. Indeed, the number of manufacturing jobs in the United States actually rose 400,000 between 1994 and If there had been a giant sucking sound associated with NAFTA, it seems that it would have been audible before A complete list of industries is shown in the appendix. 4

5 WELLS FARGO SECURITIES, LLC Figure 5 Figure 6 20 Manufacturing Employment Millions of Workers, 3-Month Moving Average Production & Jobs in Manufacturing Sector Index, Jan 1979= Total Manufacturing Employment: 12.3M Manufacturing Production: Manufacturing Employment: Source: U.S. Department of Labor, IHS Global Insight and Wells Fargo Securities Manufacturing employment in the United States peaked in 1979 (Figure 6), well before the implementation of NAFTA and the advent of Chinese industrial prowess. Although manufacturing employment has declined nearly 40 percent on balance since 1979, manufacturing production has doubled over that period. In other words, American manufacturers have been able to increase output over the past three decades by lifting productivity. A detailed discussion of job losses in the manufacturing sector is beyond the scope of this report. In short, however, foreign trade may have played a role in reducing employment in the manufacturing sector since 1979, but the imperative to lift productivity would have depressed factory jobs even if NAFTA had never come into existence. Conclusion U.S. trade with Canada and Mexico has ramped up significantly since NAFTA went into effect more than 20 years ago, and two-way trade between the United States and its NAFTA partners exceeds $1 trillion per year at present. Industries with the most trade exposure to Canada and Mexico (as a percentage of industry output) are the leather and allied products industry, the electrical equipment industry and the marine products industry. Presumably, these industries would be most affected by any changes to the NAFTA agreement that may occur in coming years. The claim that the United States has lost manufacturing jobs over the past two decades because of NAFTA seems to be overstated. NAFTA may indeed have contributed to the sharp decline in manufacturing employment over that period, but it is hardly the only reason for the falling number of blue collar jobs. American bilateral trade balances with Canada and Mexico are little changed, on balance, over the past two decades. If one wants to point a finger at a foreign economy for job losses in American factories, one should look closer at China rather than Canada and Mexico. Moreover, manufacturing employment began to decline well before the implementation of NAFTA and the advent of Chinese industrial prowess. The imperative to lift productivity via automation has played an important role, if not the preeminent one, in depressing factory employment in the United States over the past few decades. Manufacturing employment in the United States peaked in 1979, well before the implementation of NAFTA. 5

6 WELLS FARGO SECURITIES APPENDIX 1A U.S. Trade with Canada and Mexico by Industry Sector Exports Im ports T ransportation Equipm ent (336) $96.6B $168.5B Com puter & Electronic Products (334) $68.5B $64.9B Chem icals (325) $51.1B $30.6B Machinery, Except Electrical (333) $48.9B $31.3B Electrical Equipm ent, Appliances & Com ponents (335) $29.2B $29.5B Petroleum & Coal Products (324) $25.0B $13.1B Food & Kindred Products (311) $24.6B $22.0B Fabricated Metal Products, Nesoi (332) $22.3B $13.7 B Prim ary Metal Mfg (331) $21.9B $29.0B Plastics & Rubber Products (326) $20.4B $12.5B Agricultural Products (111) $13.8B $14.4B Oil & Gas (211) $13.6B $67.4B Miscellaneous Manufactured Com m odities (339) $13.3B $10.9B Paper (322) $11.0B $10.3B Minerals & Ores (212) $5.7 B $1.7 B Nonm etallic Mineral Products (327 ) $5.2B $4.6B T extiles & Fabrics (313) $4.7 B $1.4B Furniture & Fixtures (337 ) $3.5B $5.5B Apparel & Accessories (315) $3.0B $4.5B Printed Matter And Related Products, Nesoi (323) $3.0B $1.3B Bev erages & T obacco Products (312) $2.9B $5.2B Wood Products (321) $2.8B $8.4B Leather & Allied Products (316) $2.1B $2.4B T extile Mill Products (314) $2.0B $1.2B Fish, Fresh/chilled/frozen & Other Marine Products (114) $1.1B $2.8B Liv estock & Liv estock Products (112) $0.9B $3.6B Forestry Products, Nesoi (113) $0.5B $0.1B Source: U.S. Department of Commerce and Wells Fargo Securities 6

7 WELLS FARGO SECURITIES, LLC APPENDIX 2A U.S. Trade with Canada and Mexico (as a Percent of Industry GDP) Industry Exports Im ports Leather & Allied Products (316) 30.6% 34.4% Electrical Equipm ent, Appliances & Com ponents (335) 24.0% 24.2% Fish, Fresh/Chilled/Frozen & Other Marine Products (114) 11.5% 29.3% Com puter & Electronic Products (334) 17.7 % 16.8% Oil & Gas (211) 5.3% 26.4% Apparel & Accessories (315) 11.8% 17.8% T ransportation Equipm ent (336) 9.5% 16.6% Prim ary Metal Mfg (331) 9.6% 12.7 % Machinery, Except Electrical (333) 12.5% 8.0% T extiles & Fabrics (313) 15.3% 4.4% Agricultural Products (111) 7.3% 7.6% Plastics & Rubber Products (326) 9.0% 5.6% T extile Mill Products (314) 8.1% 4.8% Furniture & Fixtures (337 ) 4.6% 7.2% Paper (322) 6.0% 5.6% Wood Products (321) 2.9% 8.7 % Chem icals (325) 6.2% 3.7 % Fabricated Metal Products, Nesoi (332) 6.0% 3.7 % Nonm etallic Mineral Products (327 ) 4.5% 4.1% Petroleum & Coal Products (324) 5.0% 2.6% Minerals & Ores (212) 4.8% 1.5% Food & Kindred Products (311) 3.2% 2.9% Printed Matter And Related Products, Nesoi (323) 3.4% 1.5% Beverages & T obacco Products (312) 1.6% 2.8% Forestry Products, Nesoi (113) 2.4% 0.7 % Livestock & Livestock Products (112) 0.4% 1.8% Source: U.S. Department of Commerce and Wells Fargo Securities 7

8 Wells Fargo Securities Economics Group Diane Schumaker-Krieg Global Head of Research, Economics & Strategy (704) (212) John E. Silvia, Ph.D. Chief Economist (704) Mark Vitner Senior Economist (704) Jay H. Bryson, Ph.D. Global Economist (704) Sam Bullard Senior Economist (704) Nick Bennenbroek Currency Strategist (212) Anika R. Khan Senior Economist (212) Eugenio J. Alemán, Ph.D. Senior Economist (704) Azhar Iqbal Econometrician (704) Tim Quinlan Senior Economist (704) Eric Viloria, CFA Currency Strategist (212) Sarah House Economist (704) Michael A. Brown Economist (704) Jamie Feik Economist (704) Erik Nelson Currency Analyst (212) Misa Batcheller Economic Analyst (704) Michael Pugliese Economic Analyst (704) Julianne Causey Economic Analyst (704) E. Harry Pershing Economic Analyst (704) Donna LaFleur Executive Assistant (704) Dawne Howes Administrative Assistant (704) Wells Fargo Securities Economics Group publications are produced by Wells Fargo Securities, LLC, a U.S. broker-dealer registered with the U.S. Securities and Exchange Commission, the Financial Industry Regulatory Authority, and the Securities Investor Protection Corp. Wells Fargo Securities, LLC, distributes these publications directly and through subsidiaries including, but not limited to, Wells Fargo & Company, Wells Fargo Bank N.A., Wells Fargo Advisors, LLC, Wells Fargo Securities International Limited, Wells Fargo Securities Asia Limited and Wells Fargo Securities (Japan) Co. Limited. Wells Fargo Securities, LLC. is registered with the Commodities Futures Trading Commission as a futures commission merchant and is a member in good standing of the National Futures Association. Wells Fargo Bank, N.A. is registered with the Commodities Futures Trading Commission as a swap dealer and is a member in good standing of the National Futures Association. Wells Fargo Securities, LLC. and Wells Fargo Bank, N.A. are generally engaged in the trading of futures and derivative products, any of which may be discussed within this publication. Wells Fargo Securities, LLC does not compensate its research analysts based on specific investment banking transactions. Wells Fargo Securities, LLC s research analysts receive compensation that is based upon and impacted by the overall profitability and revenue of the firm which includes, but is not limited to investment banking revenue. The information and opinions herein are for general information use only. Wells Fargo Securities, LLC does not guarantee their accuracy or completeness, nor does Wells Fargo Securities, LLC assume any liability for any loss that may result from the reliance by any person upon any such information or opinions. Such information and opinions are subject to change without notice, are for general information only and are not intended as an offer or solicitation with respect to the purchase or sales of any security or as personalized investment advice. Wells Fargo Securities, LLC is a separate legal entity and distinct from affiliated banks and is a wholly owned subsidiary of Wells Fargo & Company 2016 Wells Fargo Securities, LLC. Important Information for Non-U.S. Recipients For recipients in the EEA, this report is distributed by Wells Fargo Securities International Limited ("WFSIL"). WFSIL is a U.K. incorporated investment firm authorized and regulated by the Financial Conduct Authority. The content of this report has been approved by WFSIL a regulated person under the Act. For purposes of the U.K. Financial Conduct Authority s rules, this report constitutes impartial investment research. WFSIL does not deal with retail clients as defined in the Markets in Financial Instruments Directive The FCA rules made under the Financial Services and Markets Act 2000 for the protection of retail clients will therefore not apply, nor will the Financial Services Compensation Scheme be available. This report is not intended for, and should not be relied upon by, retail clients. This document and any other materials accompanying this document (collectively, the "Materials") are provided for general informational purposes only. SECURITIES: NOT FDIC-INSURED/NOT BANK-GUARANTEED/MAY LOSE VALUE