US growth slowdown, energy production and ratification of USMCA

“The devil is in the details” is an eternal truth that applies overwhelmingly to trade agreements, which at their core incorporate painstaking compromises among the parties over the myriad details of international trade relationships. Even, or in particular, within a given nation, innumerable interests have conflicting objectives, a reality that explains why the U.S.-Mexico-Canada (USMCA) free-trade agreement remains unratified here (and by Canada).

But the ice may be cracking. Notwithstanding the deep divides of contemporary American politics, important voices that in most contexts would not support the policy initiatives of the Trump administration recently have argued in favor of congressional approval. The Washington Post editorial board: “Mr. Trump’s deal is a real improvement over the status quo.” The Progressive Policy Institute: “the UMSCA would be good for the United States and its neighbors.”

This emerging bipartisanship is likely to stem from more than a recognition of the vast adverse effects of a failure to implement USMCA, as important as those would be. Real (inflation-adjusted) GDP growth, 3.5 percent (annualized) in the fourth quarter of 2017, and then 2.9 percent for all of 2018, has declined to 2.0 percent for the second quarter of this year. Perhaps more important in the context of USMCA, growth in real private domestic investment, 4.4 percent in 2017 and 5.1 percent in 2018, declined by 6.1 percent in the second quarter of 2019. The effect of that decline was to subtract 1.1 percent from that quarter’s GDP growth.

Obviously, the U.S. is part of the world economy. The slowdown in global GDP growth has affected the U.S. economy adversely, and it is clear that trade frictions between the U.S., China, and others have exacerbated matters.

In particular, investment is strengthened by greater certainty, and the uncertainty attendant upon the murky future resolution of ongoing trade disputes cannot have salutary effects. The central policy goal in this context is preclusion of years-long tariff wars; accordingly, it is essential that USMCA be approved and implemented so as to remove this significant source of uncertainty.

Consider investment in the U.S. energy sector as a central example, with respect to which technological advances and a favorable legal environment have yielded production increases since 1980 of 69 percent for natural gas and 28 percent for crude oil.

Energy resources are a central component of the natural resource base – that is, of national wealth. And because the North American energy sector is highly integrated, it is essential that USMCA be finalized and ratified. Implementation of the agreement will preserve and expand the integration of U.S., Canadian and Mexican energy markets, reducing system-wide energy costs and facilitating investment flows.

Moreover, energy – petroleum, natural gas, and electric power – is a central input in the production of a vast array of goods and services. The reduction in energy costs yielded by the North American energy trade has and will yield benefits for all three economies across most economic sectors. Driven by market incentives to reduce costs, trade is about 6.7 million barrels per day of crude oil and refined products among the three economies; about 14.8 billion cubic feet per day of natural gas; and about 205.6 gigawatt hours per day of electricity.

An example of the efficiencies yielded by these trade flows is the U.S. importation of (cheaper) heavy crude oils (not produced in large amounts domestically) from Mexico and Canada, which then are refined in Gulf coast refineries into gasoline and other products. This allows lighter, more expensive crudes produced in the U.S. to be used in refineries designed to use them or to be exported, increasing the overall productivity of the petroleum market.

The recent approval by the Nebraska Supreme Court of the revised route for the Keystone XL pipeline illustrates the importance of USMCA. Keystone XL will reduce transport costs, further rationalize the allocation of various crude types among U.S. refineries, and improve the safety of crude oil transportation. In short, USMCA will advance the integration of the north American energy market, an economic process that will yield continuing economic benefits for Americans, Canadians and Mexicans. But those positive effects depend upon the implementation of USMCA.

For ordinary people, these efficiencies mean reduced costs for energy, both direct and indirect increases in energy consumption and production, and an increase in national wealth and employment. The simple correlation between energy consumption (as both inputs and final products) and real GDP is 0.71: A 1 percent increase in one is associated with a 0.71 percent increase in the other. The correlation between energy consumption and employment is 0.59. The overall correlation between household incomes and energy consumption is 0.92; it rises more-or-less monotonically as we move up among income quintiles. Correlation is not causation, but can anyone believe that those relationships are spurious?

Given that the North American energy sector is very large, reflecting the size and economic value of the geographic energy resource base, these conceptual realities and facts provide a strong case for implementation of USMCA. It would be wise for policymakers to complete the negotiations forthwith and for Congress to approve it. 

Benjamin Zycher is a resident scholar at the American Enterprise Institute.