Late August Thoughts Jude Wanniski August 26, 1993

If the North American Free Trade Agreement is going to make it through the Democratic Congress this autumn, it will be the Republicans doing the heavy lifting. Organized labor has decided to bet all its chips on opposing NAFTA on the assumption that while it may increase the number of jobs nationwide, as economists predict, it will also reduce the number of dues-paying jobs in industries represented by labor unions. In a zero-sum game, they are probably right. Rust-Belt Democrats in the House of Representatives will form a united front against the treaty, lining up behind Majority Leader Richard Gephardt of Missouri and what seems to be the entire House Democratic whip organization. The AFL-CIO has told the White House it has a war chest that can be spent to defeat NAFTA or to support health reform, but not both. Pulled in several directions, President Clinton is going to be immobilized. If NAFTA passes, it will be because Senate Minority Leader Bob Dole not only helps out, but commits his intellectual and political capital to the debate. If Dole succeeds in keeping enough Republicans behind NAFTA to get it passed, even as the President is unable to hold his own party leadership on Capitol Hill, it would clearly place Dole head and shoulders above a second tier of GOP leaders.

What Dole and Clinton have to work with is a business community that, while generally supportive, is not as fervent as Labor is in opposition. The small-business community, in aggregate, is always reliably for free trade, and would normally be more enthusiastic, but it is currently preoccupied with President Clinton's health-care proposals. Mexico is barely on the scope. Big Business, which supports free trade with countries that are running trade deficits with the United States, is also supporting NAFTA, but with little passion. Part of the problem is that Mexico's economy, which seemed to be on fire between 1989 and 1992, has not seemed all that exciting this past year, its stock market off and official economy growing at rates not much higher than ours. When two economies are growing slowly, a merger comes close to a zero-sum game. The efficiency of the whole increases, but some special and regional interests will suffer distress. If both the United States and Mexico were growing rapidly, NAFTA would zip through Congress, with the AFL-CIO standing aside to avoid being trampled to death by commercial interests dizzy with profits. In just this way earlier this year, the Chinese economic boom easily offset attempts in Congress to kill its Most Favored Nation trade status.

One potential development that could change the political equation over NAFTA is if the Mexican economy heated up again. This could well happen in the next two months, the vote on NAFTA not expected until December. The Bolsa's stock index is off its lows and in recent weeks has been picking up steam. This is in large part because NAFTA's prospects have improved with the Clinton Administration's success in concluding the labor and environmental side agreements with Mexico and Canada, which were necessary for the process to go forward. Telmex, the bellwether stock, has crept back to 53, after its long slide from 59 to 41 last year. The government of Carlos Salinas de Gortari could have offset the slide by continuing the domestic tax reforms that brought Mexico out of its 75-year sleep to begin with. Instead, all of his energy and that of his Finance Minister, Pedro Aspe, were poured into NAFTA. Aspe, who may well be Mexico's next president, especially if NAFTA succeeds, can alter the political equation by announcing a new set of tax reforms in the budget the government will submit to Mexico's Congress November 1. In Mexico, tax cuts do not have to be approved by the legislature, only tax increases, so Aspe's reforms would have the immediate effect of law.

Aspe would like to do two things that would, I think, send the Bolsa on a tear. First, he would like to eliminate the capital gains tax entirely. Stocks traded on the Bolsa are exempt from capital gains, but all other assets that gain in value face taxation at income tax rates as high as 35%. In other words, the Big Guys keep the best for themselves, while new and small business is effectively cut out of the capital pool. Aspe would also like to adjust the income-tax rates at the lower end of the ladder, to effectively remove entry-level workers from the tax rolls by increasing the threshold at which they must face income tax. The combination of payroll tax and income-tax withholding in Mexico discourages industrialists from raising nominal wages, which get chewed up by tax bites exceeding 50%. Government revenues from both capital gains and entry-level workers are trivial, yet Aspe well knows these two reforms would, in combination, liquify so much capital and labor that revenues from all other sources would soar in the economic dynamic that would follow. As a side effect, the illegal migration of Mexican labor into southern California would almost certainly abate, as prospects in Mexico would exceed those in Gov. Pete Wilson's taxed-to-death California. In the next two years, we would begin reading of a net migration from southern California into Mexico -- with productive, entrepreneurial Mexicans going home, leaving behind those who prefer the benefits of the welfare state.

Big things follow bold strokes, which is why Aspe may be unable to sell his plan to the Salinas cabinet. Informed opinion in Mexico City is that NAFTA is now a 50-50 bet. So there will be a why-rock-the-boat faction in the government. Senator Dole, who is leading a delegation of GOP Senators to Mexico City this weekend to shore up Republican support for the treaty, might well tip the scales by offering private encouragement for the Aspe strategy when he meets with President Salinas. It certainly fits with the emerging Republican strategy at home of identifying with the interests of small business and entrepreneurial capitalism. It would also be a welcome relief to the Mexicans, who have become increasingly disgusted at the abuse hurled at them by NAFTA opponents, from Ross Perot on down. When California's Treasurer recently suggested that the state might save money by emptying state prisons of illegal aliens who had committed crimes, sending them back to Mexico, elite opinion in Mexico turned to wondering if it might be better if NAFTA collapsed. How many times does the bridegroom have to tell the bride how lucky she is, that such a handsome rich guy is marrying such a poor ugly gal, before she decides being single isn't such a bad idea?

If NAFTA collapses, what then? The AFL-CIO and Teamsters will celebrate. The environmentalists will have a party. President Clinton will have mixed feelings, but on the whole probably sense that an historic opportunity has been blown. In this August recess, the President has no doubt been cheered by the rising stock and bond market, but his economic team is privately wondering when and if any of that cheerfulness is going to translate into an increase in economic activity. Durable-goods orders down. Unemployment claims up. Noting the record low on the 30-year bond yield, The New York Times now wonders, "Where's the boom?" The only fresh juice in sight for the economy is NAFTA. If it gets swacked before Christmas, the Democratic political savants will have to be contemplating a forbidding 1994: Hillary's health reforms and their demands for higher taxes; an economy struggling under the load of the recent budget deal; small businesses pulling in their horns, hiring no extra help as they assess prospects of higher minimum wages and mandated health care; a President seeming to be increasingly irrelevant in Europe and Asia; and a unified Republican Party on the march under a supply-side banner.

On these languid late August afternoons, as we contemplate this most likely scenario, how can we be bearish about the future? Some of our old friends are still in a stew, fretting about the Clinton Administration's all-out assault on the Reagan Revolution. But if the forces of austerity have taken their best shot, throwing everything they had at us and making not more than a dent, it can only get better from here on in. History will owe Bill and Hillary a debt of gratitude for not pulling punches, so there would be no doubt that they were sincere in attempting to demolish everything the Gipper had wrought. The advance of civilization requires that successful revolutions be tested by counter-revolutions, which we are now observing on its last legs.

NAFTA, of course, is inevitable, maybe not this year, but soon, with a different bridegroom showing more respect for the bride. We should not forget that the idea of a North American customs union was first floated in 1980, during the Presidential campaign that year, by the former governor of California who went on to win. Reagan is now, what? 82? He'll be 85 in 1996, ready to watch the second leg of his revolution unfold behind a Dole-Kemp ticket. The forces of youthful exuberance, entrepreneurial aspiration, get-up-and-go dynamism that are at the heart of the revolution are now bursting at the seams. The Cold War is over and for young people the world over, of all colors and cultures, dreams can once again be dreamed. We really don't have much to worry about.