Explain how Free Trade Agreements like NAFTA can lead to unemployment and greater income inequality within a country.

The North American Free Trade Agreement (NAFTA), established in 1994 to strengthen trade and investment ties between the United States, Canada, and Mexico, was initially celebrated as a key accomplishment under President Bill Clinton. However, over the years, many Americans came to view the agreement as a major factor behind the decline in U.S. manufacturing jobs. This sentiment was strongly echoed by former President Donald Trump, who repeatedly criticised NAFTA during his campaign and presidency, arguing that it disadvantaged American workers. His administration eventually renegotiated the deal, replacing it with the United States-Mexico-Canada Agreement (USMCA) in an effort to better protect U.S. industries and jobs. 

a.Explain how Free Trade Agreements like NAFTA can lead to unemployment and greater income inequality within a country.[10]

Introduction
Free Trade Agreements (FTAs) such as the North American Free Trade Agreement (NAFTA) are designed to reduce or eliminate trade barriers—such as tariffs, quotas, and licensing requirements—between member countries. The intention is to promote greater trade flows, increase economic efficiency, and foster deeper economic integration. However, while FTAs can enhance growth at the aggregate level, they may also give rise to domestic adjustment problems, including structural unemployment and widening income inequality, particularly within large, diverse economies like the United States. These unintended consequences have fuelled significant political backlash against such agreements in recent decades.

How FTAs Can Lead to Higher Unemployment
FTAs enhance market access for member countries, enabling producers in lower-cost economies to export more competitively priced goods to higher-cost markets. In the case of NAFTA, Mexican manufacturers—benefiting from lower wages and operating costs—gained easier access to the U.S. market. Many U.S.-based manufacturing firms found it increasingly difficult to compete on cost and either downsized, shut down, or relocated production across the border to take advantage of Mexico’s cheaper labour.

This led to the displacement of workers, particularly in labour-intensive industries such as automotive, textiles, and electronics. The closure of factories—especially in regions dependent on manufacturing, such as the U.S. Rust Belt—contributed to a rise in structural unemployment, where workers who lost their jobs lacked the skills needed to transition into emerging service-based or high-tech industries.

While FTAs can theoretically lead to overall economic efficiency, the short-run frictions and uneven sectoral impacts are substantial. Displaced workers often face long periods of unemployment or are forced to accept lower-paying jobs, contributing to economic hardship and regional decline.

How FTAs Can Increase Income Inequality
FTAs can also worsen income inequality within a country, primarily by altering the relative demand for different types of labour. In an open economy, comparative advantage dictates that countries will specialise in the production of goods and services that they can produce at relatively lower opportunity costs. In developed economies like the U.S., this often means a shift toward high value-added industries such as finance, technology, and professional services, which tend to require skilled labour.

As trade liberalisation expands these sectors, the demand for skilled workers rises, pushing their wages upward. At the same time, lower-skilled workers in industries exposed to import competition—such as assembly line workers or textile labourers—face job losses or stagnant wages. This widening wage gap contributes directly to increased income inequality.

Furthermore, FTAs can exacerbate geographic inequality. While urban centres with a high concentration of skilled jobs (e.g., San Francisco, New York, Seattle) thrive, smaller towns and rural areas dependent on traditional manufacturing decline, leading to uneven development and political polarisation.

Conclusion

While FTAs like NAFTA aim to increase efficiency and promote growth by leveraging comparative advantage, they can also lead to job losses in uncompetitive sectors and widen income inequality, particularly when the economy is not sufficiently flexible to adjust to structural changes. These consequences, if unaddressed, can generate social and political backlash, as seen in the growing opposition to trade agreements in many advanced economies.

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