In an op-ed(link is external) in the Washington Post, Commerce Secretary Wilbur Ross raises concerns over fewer US parts being used in imports from Mexico and Canada than in the past. He argues that the North American Free Trade Agreement (NAFTA) needs stricter rules of origin and US specific content requirements to halt this decline. Such rules would limit NAFTA preferences to imports from Canada or Mexico with high levels of regional and US content.
His argument misses the main reason that the North American supply chain is valuable to the United States. The purpose of the supply chain is not to import from ourselves, but to lower production costs, making our firms more competitive globally. Supply chains allow countries to specialize in the stage of production in which they are most efficient, increasing productivity and lowering prices for consumers.
NAFTA already has the strictest rules of origin of any major trade agreement, so tougher rules or a US content requirement could reverse some of the existing productivity gains and hurt US manufacturing. Not only would they disrupt supply chains, damaging US industry, but they could also perversely lead to less US content in our imports because more goods will be imported without NAFTA preferences or from other countries.
Ross’s concerns stem from a new paper(link is external) from the Commerce Department, relying on the Trade in Value Added (TiVA(link is external)) database compiled by the Organization for Economic Cooperation and Development (OECD). The paper shows that US value added in manufacturing imports from Mexico and Canada has fallen from 1995 to 2011 (the most recent year in the database).
Such statistics on value added are useful to help us understand how supply chains function and how they are changing over time, but they should not be used to make value judgements about trade. For example, according to the TiVa database, among US imports from Mexico, paper and pulp have the highest US content, 21 percent, and mining and quarrying have the lowest US content, 2 percent (see chart). But that doesn’t mean paper imports are “better” than fuel imports. Producing fuel is costlier in the United States than in Mexico, so the United States saves money by importing fuel and using scarce resources for more efficient types of production instead.
The Commerce Department also does not show that tougher rules are needed to expand the US content share. For example, paper and pulp not only have the highest US content among US imports from Mexico, but US content also increased sharply from 16 percent in 1995 to 21 percent in 2011, bucking the downward trend among other manufactures. The increase had nothing to do with rules of origin. In fact, imports of paper and pulp face no tariff in the United States, so they do not even enter through NAFTA. The increase in US content happened under free trade with no rules of origin.
To the extent a decline in the US content of imports reflects a drop in the competitiveness of US production, we should be concerned, but content restrictions will, if anything, reduce US competitiveness further. Rules of origin or content restrictions add to the cost of production and trade because they force producers to use more expensive parts than they would otherwise, and there are administrative costs to documenting the origin of those parts.
Tougher rules could also magnify the decline in US content in some products, like cars, where existing rules are binding. If rules are very strict and tariffs are low, companies will be more likely to import products without using NAFTA preferences. Alternatively, companies with subsidiaries around the world might import products from other countries instead of from our NAFTA partners, where US firms are far less integrated into supply chains and the US content in imports is lower. In both cases, US manufacturing will be hurt and the US value added share of total imports will be reduced.
The way to expand North American manufacturing is by making it more competitive, and stricter rules will not achieve that important goal.
1. The database does not take into account processing zones in Mexico, which use US inputs more intensely than aggregate production, and hence has been shown(link is external) to understate(link is external) US content in imports from Mexico.
2. Manufacturers not elsewhere specified and recycling are excluded from the chart and have a 22 percent US content share.