What 'The Beverly Hillbillies' Could Teach Trump About Economics
Why shouldn’t Mexico and Canada be trembling over the Trump Administration’s threats to pull out of the North American Free Trade Agreement (NAFTA)? The answer should be obvious to anyone who has seen an old episode of The Beverly Hillbillies entitled “The Badgers”. It illustrates the fact that you have leverage over someone only if what you have over them means something to them, and nothing to you. NAFTA, however, is just as important to the U.S. economy as it is to the Canadian or even Mexican economy.
The Beverly Hillbillies of course was a 1960s fish-out-of-water comedy based on the notion of a poor family from the Ozarks striking oil and becoming millionaires. (Jed: “I’ve heard of gold dollars, silver dollars, paper dollars. What kind of dollars did that oil company man say he was giving me?” Granny: “Million dollars.”) In one episode during its fifth season, a con artist named Colonel Foxhall comes up with a scam aimed at blackmailing Jed Clampett. Foxhall arranges for a partner-in-crime to get her picture taken sitting on Jed’s knee, a photo that in the 1960s was still regarded as salacious. Foxhall thought this would give him blackmail leverage over Jed.
When Foxhall showed Jed the photo and told him he wants $25,000 for it, Jed demurred, saying: “That’s a nice picture Colonel, but $25,000 is a little steep.” Jed’s banker, Mr. Drysdale then tried to explain the situation, pointing out that if Jed didn’t pay Foxhall, the picture would be in the newspaper the next day. Jed broke into a big grin, and turned to his mother-in-law Granny, telling her: “That’s a good idea, we can just wait until tomorrow and cut the picture out of the paper.”
Foxhall thought the photo gave him leverage over Jed. But that is the crucial lesson: Leverage only works if you can use it to lever someone. And, by the way, that doesn’t work at all if you are also levering yourself.
Which brings us back to NAFTA negotiations. How much leverage does the Trump Administration have in the talks? Some, no doubt. But threatening to blow up the agreement only works if others are convinced you are prepared to blow up your own economy. And the fact that a pull-out might hurt Mexico or Canada more than it hurts you is irrelevant. If American farmers are hurt by the end of NAFTA, that’s almost all that matters in many parts of the United States. If cutting supply chains hurts the auto industry, the rust belt will be hurt – regardless of how blue-collar voters may feel about trade in the abstract.
A recent study by Canada’s Scotiabank, NAFTA: The Macroeconomic Consequences of Disruption, makes the point. The study found that U.S. withdrawal from NAFTA, assuming it prompts all three countries to revert to the imposition of Most Favoured Nation (MFN) tariffs on each other, would shave growth rates in all three countries – not a bright prospect for a president who has just cut corporate tax rates and wants to demonstrate the positive impact of the move. If such a U.S. withdrawal presaged a wider breakdown in American trade relations with the rest of the world, resulting in a global hike in tariffs, the negative impact would be greater, in all three countries.
The bank’s study found that while Canada and Mexico would stand to be relatively more affected than the United States by a breakdown in NAFTA, specific U.S. industries and regions that depend heavily on integrated markets under NAFTA would experience sharper pain from a disruption in continental trade.
The problem with pegging your policy based solely on the impact it would have on the average person is that you are trying to cater to someone who has 2.3 children and 1.4 cars. Most of us do not so easily fit into an average category. And one can drown in a river that on average is only seven inches deep. Some industries would be hit especially hard – such as farming and manufacturing. A recession would not weigh on every American equally, but that just means the economic fallout would be even greater for many.
Some Americans may take comfort from trade stats that show exports and imports do not constitute as large a percentage of the U.S. economy as its Mexican or Canadian counterparts. But the fact is, all three economies are totally submerged in the global economy. Virtually every good, and an increasing number of services, are potentially in trade. That means that, in effect, all modern economies are entirely in trade.
If a U.S.-based steel company wants to sell to GM, it had better make sure that its price and service levels take into account the potentially lower costs GM would face buying steel from China or Brazil. If an auto company wants to compete with Japanese or German automakers, it had better be in the right price range. Every industry and company – even one that sources exclusively in the domestic economy – is affected by the global economy, the availability of global capital, and the varying global levels of prices and wages.
Moreover, the ability of a U.S. company to introduce new products, and the opportunity for Americans to get the benefit of them, depends entirely on the openness of foreign markets. If the late Steve Jobs’ R&D people had told him that the economics of developing the iPad depended on initially selling it to Americans for $1800 each, he would have realized that was way over a feasible price point. But if the opportunity to sell to the wider global market meant the iPad would only have to sell initially for $700, therefore absorbing sunk costs, he would have given the go-ahead. Americans have access to iPads only because many non-Americans are prepared to pay for them as well – and only because Apple can sell in all markets.
Nowadays, virtually nobody develops anything of value exclusively for one market. High sunk costs demand access to a wide range of markets. Whether or not one can hope to successfully bring a product to market depends on that market’s size. The only market big enough to bring all potential products to market is the global one.
The Trump Administration can threaten to walk away from NAFTA, but it wouldn’t be simply a matter of killing the Mexican and Canadian economies. It would be more of a case of murder-suicide. How many U.S. domestic industries, or their employees, are prepared to actually drink the poisoned kool-aid?
If one believes that the importance of U.S. trade with Mexico and Canada gives the U.S government foolproof leverage over those two countries, one should learn the lesson Col. Foxhall was taught by Jed Clampett: Leverage only works if the other guy is prepared to be levered.