Our feud with Mexico is incomprehensible on many levels. Included in the mix is the wall that our president wants the Mexican people to pay for, the North American Free Trade Association (NAFTA) that he wishes to renegotiate, and the apparent flight of some U.S. companies south of the border in pursuit of lower labor and environmental costs. These are business decisions based on considerations of profits and regulations.
The issue of the wall likely has political as well as economic implications. One purported rationale for the wall is to stem the influx of drugs from Mexico to the US. It will also serve as a buffer against people entering the U.S. by circumventing legal means. The estimated cost of the wall (1300 miles and 40 feet high) varies $10 bilion. This is the low-end estimate; the high-end estimate doubles that amount. According to The World Fact Book, Mexico's GDP is $2.2 trillion and her population hovers in the neighborhood of 123 million people. Ten billion dollars represents less that 1 percent of Mexico's GDP and would hardly bankrupt the Mexican economy. From the data, it is easy to show that the wall will cost the average Mexican $8.12, which Mexican taxpayers will pay in the form of higher taxes. However you look at this, it is a pittance. But the political and nationalistic response is categorically no--Mexico says it will not pay for it.
At a macro level, there are two consequential effects if Mexico is forced to pay for the wall. First, given the assumption of the costs for the wall's construction, there will be a flight of capital of $10 billion, which will lower Mexico's GDP. This is like a direct transfer of funds from Mexico to the U.S.--a unilateral transfer since there is no quid-pro-quo. Second, the act of a Mexican government tax increase to pay for the wall is tantamount to the confiscation of purchasing power form the taxpayer to the government. If the government spent the money on domestic capital improvement, education, and the infrastructure, it would mitigate the effects of the tax increase on the economy, i.e. Mexico's GDP in the long term. What is mitigated is the reduction in consumption (household spending on consumer goods) and business investment (capital consumption) that have a multiplier effect on GDP. However, as this would pay for the wall, GDP in Mexico would be expected to decline.
Mexico would not be unduly burdened by paying for the wall. The cost of the wall would not matter much if it were solely an economic issue. But it is not. It is also a political issue imbued with national pride. Mexico will refuse to ever pay for the wall barring some extraordinary measures by the U.S. to make Mexico capitulate.
NAFTA appears to have led to greater economic integration between the U.S. and Mexico and transformed Mexico into a greater exporter of manufactured goods. Mexico's per capita income did not converge to the U.S.'s per capita income. Nor did U.S. employment benefit from it. Wages have stagnated in both countries while productivity has increased and with it increases in the income inequality. (See Wharton) NAFTA is seen in some quarters as a failure for not living up to expectations. It is blamed for the loss of U.S. jobs as well as U.S. industries.
Mexico is a significant American trading partner. The country represents the fourth largest source of imports for the U.S. at $25 billion (Sept. 16 figures) behind the Euro Area, European Union, and China. (See Trending Economics) Moreover, Mexico also buys U.S. goods, which accounts for $19.8 billion. (See Trending Economics) It is not at all surprising that with NAFTA, U.S./Mexico trade is so large. After all, trade between countries depend on, among other things, income levels, i.e. GDP's, and proximity, namely, the transportation costs of traded goods. Mexico is a neighbor.
Border taxes on goods originating from Mexico used as a cudgel to force payment for the wall is like biting off your nose to spite your face. A 20 percent tax on Mexican goods will raise the price in the U.S. by at least that much for American consumers. It will also reduce the amount of Mexican goods entering the U.S. That is the unintended consequence of such a tax. The resulting excess demand for Mexican products will be met by American producers who would need to employ more American workers. However, there is a bit of folly here. American will shift from a lower cost producer of goods imported from Mexico to higher cost American producers. This is an example of trade diversion in the lingo of economists.
The border tax will probably lead to higher profits in the U.S. import sector. Reducing regulations of business, getting rid of Dodd-Frank, weakening the EPA, massive tax cuts, and $1 trillion in infrastructure spending will likely boost economic growth and employment. The president inherited a U.S. economy that is in good shape, near full employment and the Dow over twenty thousand. The problem is with the distribution of income so skewed it is lopsidedly in favor of profits. A massive stimulus in this economic environment might have long-term implications for inflation and interest rates.
More restrictive immigration policies and the wall will likely create a relative labor shortage that will lead to bidding wages up. This is one way to drive wages up. An alternate approach recognizes that workers who are happy in their jobs, who are paid more (perhaps above market), tend to work harder. Higher wages also reduce job leaving propensities and the cost of training new workers. Overall, workers whose productivity is rewarded tend to be more efficient. Rewarding productivity mitigates income inequality. This is more benign than fear-driven wage increases due to labor shortages, resulting expelling undocumented workers and building a beautiful wall.