While nations can untangle themselves from international trade agreements they made in the past, it is about as impossible to return a previous “normal” as it would be to unscramble an omelet. That is, a nation can return its own laws to the exact legal situation that prevailed before it had entered into some treaty — but it cannot change the laws or policies of the other parties to the agreement.
Nor can it undo actions taken by private individuals or businesses in reaction to a newly renounced pact. In economic terms, it is just as impossible to return fully to what diplomats call the “status quo ante” as it is to reconstitute bits of scrambled egg yolk into a coherent mass.
That is in response to readers who asked me what will happen if the United Kingdom actually does exit the European Union or if the United States does repudiate the North American Free Trade Agreement. Our laws can revert back to what they were. But our economies will never be the same.
The U.K. faces the more immediate challenge and one that is orders of magnitude greater in economic importance. Last month’s referendum does not legally force its government to withdraw, but politically it will be very hard for any of the U.K.’s principal parties to ignore the results.
Advocates of “Brexit” implicitly argued that their country could maintain its current free trade relations with the other 27 EU members while shedding any onerous business or tax regulations and ending flows of money from the U.K. to the EU. But what will actually happen depends on complex negotiations between their country and the Union.
Continued favorable trade access is not impossible. When the EU first was formed, other European countries that remained on the outside for one reason or another formed a free-trade area. These included the U.K., all of Scandinavia, Austria, Switzerland and Portugal. They reduced barriers to trade between themselves nearly to zero, but unlike the EU itself, did not adopt common external tariffs for imports from the rest of the world. This was particularly important for Britain which still imported large quantities of food from Australia and New Zealand.
This EFTA, as it is known, has shrunk as most members joined the EU itself. But the remaining ones, notably Norway and Switzerland, enjoy near-open trade access to the EU. Britain may revert to this status. But there is no contractual reason why the Union need grant it.
Moreover, services are more complicated than merchandise trade. London is an enormous center of financial trading, banking and insurance, with a history going back four centuries. Many international financial firms thus chose to base their European operations there. But Paris, Frankfurt, Amsterdam and Milan all covet that business and there is no certainty London’s access to all of the continent will continue unchanged. Nor, for that matter, is it guaranteed that the U.K. can revert to barrier-free access for trade in goods.
On the NAFTA question, U.S. trade with Mexico is much simpler. Republican candidate Donald Trump calls for abolition of NAFTA and the imposition of 45 percent tariffs on imports from Mexico, along with a 35 percent levy on trade from Canada. Abolishing the agreement and levying tariffs are two separate issues.
If he persuaded Congress to pass the necessary legislation, our country could repudiate the NAFTA treaty, first signed by President George H.W. Bush in 1992. From the U.S. side, that would return Mexico to the status it had 25 years ago. It would simply be one of many other nations in the World Trade Organization and a poor one that still qualified, along with other low-income countries, for slightly preferential access to U.S. markets under the “generalized system of preferences” begun under the WTO’s antecessor organization, the General Agreement on Tariffs and Trade.
That would place U.S. tariffs on imports from Mexico at their pre-NAFTA average of about 3 percent. Those were not a major barrier to Mexico’s exports before 1993 and would not be now. To legally impose the promised 45 percent levels on Mexican imports would require that we apply them to those of all other WTO members. That essentially would mean U.S. repudiation of our participation in a key organization that we helped found 70 years ago. It would be a U-turn unprecedented in U.S. economic and diplomatic history.
Moreover, no U.S. president or Congress can force Mexico to change its own policies. The overlooked reality is that our country made very few changes in entering NAFTA. Most of the change was on the Mexican side, much of that consolidation of an economic-opening process that had begun 15-20 years earlier. The “maquiladora” program that fostered establishment of manufacturing firms in Mexico for the U.S. market came 30 years before NAFTA.
Mexico made many other changes to its laws that facilitated U.S. companies expanding their operations in that country. These changes were not made at U.S. insistence. Rather, they were part of an overt initiative of the Carlos Salinas administration to reform the Mexican economy and open it to the world. NAFTA was a political device to cast these changes in the stone of an international treaty so that it would be harder for any subsequent Mexican government, especially one from the left, to revert to a closed economy.
At its core, NAFTA was a U.S. administration acting as a willing foil so that a particularly friendly Mexican administration could achieve its own domestic political objectives. We can withdraw now, but that does not mean that Mexico would return to its hostile treatment of foreign firms first adopted in the 1920s. With U.S. tariffs boosted all the way back to 3 percent and Mexico still welcoming foreign business, it is hard to see how abolition of NAFTA would change that much.
The broader problem for those seeing withdrawal from the EU or NAFTA as an economic panacea is not one of government policy. It is that private firms have made investments over 43 years in the case of the EU and 24 years in the case of NAFTA.
Companies were bought, factories were built, offices were opened, sales and distribution chains were constructed. These private investments are now “facts on the ground,” to borrow a diplomatic term. They also are sunk costs in economic terms. We can change laws, but these investments create enormous inertia, politically as well as economically. Could a President Trump persuade Congress to repudiate NAFTA itself? Perhaps. Would returning to 1980s levels of tariffs change where U.S. auto companies now actually produce things? No. Raising tariffs to the 35/45 percent Trump calls for would indeed reduce imports from Canada and Mexico. That would be a devastating blow to North American auto production and to many other industries. It will never happen.