Former Cleveland Fed president Jerry Jordan sent to me the following, excellent e-mail in response to this Cafe Hayek post. (I share, in full, Jerry’s e-mail here with his kind permission.)
Don, I liked todays’s post on the tax on Mexican-produced goods, both because it is correct as far as it goes, but also because it demonstrates how economists think about such issues. It can be a very useful classroom exercise–illustrated with good old fashioned supply and demand diagrams–about elasticities and shifting of curves vs moving along curves. Trump’s economic ignorance can become a great teaching moment in the hands of an instructor well grounded in micro principles.
However, at the intermediate or more advanced level, the instructor will need to bring in the further complication of exchange rates. Implicitly, today’s post assumes a common currency or fixed exchange rate. In the floating world we have seen the US$ prices of all goods produced in Mexico falling (and peso prices of US-produced goods rising) as the peso has taken a nose-dive since Trump began his Mexico-bashing tweets. Not only US investors, but also Japanese, Chinese, Europeans, et. al. will now find Mexico a less attractive place to invest as a result of Mexico’s largest export market becoming protectionist (with the caveat that movement along curves is occurring at the same time that curves are shifting in search of a new equilibrium!)
Further, as you suggest, Mexico’s production possibility boundary will be affected to the extent that Mexico’s out-migration is altered. Carlos Salinas had told G.H.W. Bush that goods bought by American consumers will be produced by Mexican workers, it is only a question of where those Mexican workers live! If Trump truly wants Mexican workers to stay put, he should want a lower peso/$ exchange rate and more capital investment in job-creating plants in Sonora, etc. Someone should ask team Trump to make up their mind—do they want fewer Mexican workers to head north looking for jobs, or fewer Mexico-produced goods filling American consumer’s shopping carts? If the answer is less of both, then surely it is a very dangerous world. As someone said in earlier times, when goods cannot cross borders, armies will. Today, that Mexican army will not be carrying guns, but tool boxes looking for ways to support their families.
NAFTA included lots of provisions in addition to tariff reductions. Mexico agreed to never again nationalize their banks and never again unilaterally convert US$ deposits in Mexican banks into peso deposits. As Salinas told me (and another official visitor) on one occasion, the greatest achievement of NAFTA was that he had “imported the rule of law.” He explained that the treaty included provisions that he could never have gotten through the Mexican Congress, and even if he had done so or even amended the Mexican constitution, that could easily be changed by his successors. However, even nutty Mexican politicians would be reluctant to violate a treaty with the US and Canada—NAFTA was more binding than legislation or the constitution! Trump is ignorantly throwing that all away and no one can predict the consequences. Returning to a condition of “failed state” in Mexico will be a disaster on our borders, as only the WSJ editorial page seems to understand.