Market access can have a big impact even when the numbers are small. For example, extending normal trading relations to China did not dramatically increase access to the U.S. market. But it did increase certainty: previously, China’s access was subject to annual Congressional votes. Remove that uncertainty, and poof, suddenly firms were willing to make long-term investments aimed at the American market. (The paper on this topic is here.)
The importance of permanence is why giant fluctuations in exchange rates should not be expected to have the same effects as small changes in tariffs. Exchange rates rise and fall subject to unpredictable economic forces. Tariff rates stay the same subject only to politics. Gabriel Mathy made that point here.
So what about ending NAFTA? Would it undo economic integration between the U.S. and Mexico?
Quite likely not.
Wait, what? Why would an end to NAFTA not benefit China and other low-wage manufacturers in Asia?
Well, simply put, they are too far away from America. In 2014, according to the Bureau of Transportation Statistics (see Table 10 and Table 11), the average container imported from Mexico carried goods worth $52,921. According to J.P. Morgan, the average cost of moving that container from Mexico was about $1,800. (The World Bank says $1,499, but that includes maritime and non-NAFTA shipments.)
So that is a cost of roughly 3.4% ... compared to 15% from China. (The number of containers from China comes from the Maritime Administration; the value is from the Bureau of Transportation Statistics.)
This is back-of-the-envelope, but very little of the stuff that Mexico exports to the U.S. is set to move to Asia, Europe, or South America if NAFTA falls apart. Mexico is too close and its labor costs are too low.
Still, a NAFTA collapse could move production back to the USA, no? After all, it is not like U.S.-made goods don’t need to be transported to market. They do. Domestic truck and rail shipments came to $8.8 trillion in 2007. (To prevent link rot: BTS, National Transportation Statistics, Table 1-58: Freight Activity in the United States: 1993, 1997, 2002, 2007 and 2012. I used 2007 because 2012 trucking freight rate data is not available.) The total cost of moving all that stuff came to $262 billion. That comes to an average freight cost of about 3.0%. In other words, and not unexpectedly, the cost of moving goods around inside the United States is roughly equal to the cost of moving them from northern Mexico to the United States. So one would expect a rise in tariffs from zero back up to 3% to have an impact.
But tariffs and transport costs are not the only trade costs! Total trade costs come to the difference in the markup between the factory gate and the final consumer between domestic goods and imported goods. When Dennis Novy (Warwick) used that approach (albeit indirectly) he found that NAFTA reduced the total trade cost from about 70% to around 33%. (Page 10)
How did that happen? The intuition is as follows. Signing NAFTA cut U.S. tariff rates from 3% to zero. Companies then established cross-border value chains. Those chains were not easy to set up, but once they were in place, it became far cheaper to export. Think of it this way: the first autoparts factory to open up in San Luis Potosí needed to figure out everything about selling to the United States. The fifteenth had a much easier time. Thus, NAFTA caused trade costs to drop by way more than the fall in tariffs.
The flip side of that, however, is that much of the fall in trade costs is not reversible. Abolishing NAFTA, therefore, might have remarkably little effect, taking trade costs up from 33% to 36%. Abolishing NAFTA plus a 20% border adjustment tax will reduce Mexican incomes (via depreciation) but would also have remarkably little effect on trade volumes.
It would take a straight-up tariff in the 20%+ range to seriously undo integration in any reasonable time period, at least for manufacturing. And even then the impact would be slower and smaller than we think. In fact, most of the impact would come in the form of European cars becoming suddenly competitive in the American market.
Agriculture would be a different story. I will discuss more if there is interest.