Covarrubias: Beyond Reciprocity: Market Size and North America’s Industrial Advantage

President Trump’s administration’s America First Trade Policy, reinforced by the recently announced “Fair and Reciprocal Plan,” represents a significant shift in U.S. trade strategy. At its core, the policy presents an appealing narrative: If other countries impose higher tariffs on U.S. goods than the U.S. does on theirs, then equalizing these tariffs should naturally lead to more balanced trade.

This seemingly straightforward logic, however, overlooks a fundamental economic reality that recent International Monetary Fund (IMF) research has documented: market size and saturation, not tariff differentials, largely drive persistent trade deficits. Studies show that macroeconomic factors and market size differences account for 70-90% of bilateral trade imbalances, while tariff changes explain less than 5%.

Consider the administration’s examples: Brazil’s 18% tariff on U.S. ethanol versus the U.S.’s 2.5%, or India’s 39% agricultural tariffs versus the U.S.’s 5%. The implied solution, raising U.S. tariffs to match, assumes these countries could buy more American goods if only their markets were more open. But this misdiagnoses the problem.

The U.S. market, with 335 million consumers, a GDP of $25.5 trillion, and a per capita income of $86,601, is considerably larger than most trading partners. Despite their large populations, Brazil’s $2.1 trillion economy (with a per capita GDP of $10,296) and India’s $3.7 trillion economy (with a per capita GDP of $2,698) cannot absorb dramatically more U.S. exports regardless of tariff levels. While some argue China stands as an exception because of its similarly large economy and rising middle class, even there, structural and geopolitical factors limit the extent to which reciprocal tariffs alone can meaningfully alter the overall trade balance.

The same dynamic plays out in North America. While Canada maintains a highly developed economy with a per capita GDP of $53,834, its $2.2 trillion GDP represents less than 10% of the U.S. economy. Similarly, Mexico’s $1.8 trillion economy and $13,972 per capita GDP, despite significant growth under the USMCA, cannot match U.S. consumption capacity. These market size differentials, rather than tariff policies, largely explain why the United States maintains trade deficits of $63 billion with Canada and $177 billion with Mexico. The fundamental constraint isn’t market access. It’s market capacity.

Japan’s experience offers a particularly instructive example. Following bilateral trade negotiations in the 1980s and 1990s, Japan significantly reduced trade barriers. Yet this didn’t eliminate the U.S. trade deficit with Japan because Japanese consumers, despite their high-income levels, couldn’t absorb enough additional American goods to balance the massive U.S. appetite for Japanese products. Recent economic modeling from the IMF demonstrates that even eliminating all bilateral tariff asymmetries would reduce trade imbalance variance by only 25%, as structural factors like market size continue to dominate trade patterns.

Japan’s case highlights a broader pattern that extends beyond any single bilateral relationship. Looking at the bigger picture, we must consider an even more fundamental factor driving U.S. trade balances.

The persistence of U.S. trade deficits since 1978 across varying tariff regimes points to an even more fundamental reality: America’s unique role in the global financial architecture. As the primary issuer of the world’s reserve currency, the United States must necessarily run trade deficits to supply dollars to the international system. This unique position enables global commerce but requires the U.S. to absorb approximately three-quarters of the world’s excess savings, a structural position that naturally creates trade deficits regardless of tariff policies.

The United States maintains a substantial services trade surplus that balances a portion of its goods trade deficit, an economic reality often overlooked in trade discussions. In 2024, while the U.S. recorded a goods deficit of $1,211.7 billion, it achieved a services surplus of $293.3 billion, a 5.4% increase from the previous year. This brought the combined trade deficit to $918.4 billion. The services surplus stems from America’s competitive advantage in high-value sectors: intellectual property rights, travel services, financial services, and education. This trade pattern reflects America’s position as a technological and innovation leader in the global economy.​​​​​​​​​​​​​​​​

The administration’s focus on reciprocal tariffs also doesn’t fully address the complex reality of modern global supply chains. For example, in the automotive sector, when a car manufactured in Mexico crosses the border, roughly 40% of its content typically originates in the United States. Imposing reciprocal tariffs on such imports would effectively tax U.S. content, disrupting the integrated production networks that enhance American competitiveness.

What’s often overlooked is that NAFTA’s original vision went far beyond eliminating tariffs between neighbors. It aimed to create a self-reliant North American economic bloc capable of competing with any global rival. A key objective was reducing the region’s growing dependence on Asian manufacturing by building integrated supply chains that could substitute imports and strengthen North American industrial capabilities. While intra-regional trade has grown from $290 billion in 1993 to $1.8 trillion today, this deeper strategic purpose of coordinated industrial development has faded.

Rather than pursuing balanced bilateral trade through tariff adjustments, the United States needs to spearhead a new era of North American industrial collaboration. The region’s combined strengths, U.S. technological innovation, Canadian resource wealth, and Mexican manufacturing expertise, create natural synergies that no tariff policy could replicate. Together, these complementary capabilities, backed by a market of 500 million consumers and a $30 trillion GDP, form a foundation for global competitiveness.

Success requires moving beyond traditional trade metrics to focus on strategic industrial coordination. Key priorities should include:

First, coordinated innovation hubs that connect Mexico’s manufacturing corridors with Canadian research facilities and U.S. technology clusters should be established. This approach would create integrated supply chains in critical sectors like semiconductors and electric vehicles, reducing collective vulnerability to external disruptions.

Second, joint investment frameworks that prevent counterproductive competition between North American partners while maintaining each country’s policy autonomy should be developed. This could include shared infrastructure development and harmonized technical standards facilitating seamless regional production.

Third, building self-sustaining industrial ecosystems that leverage each country’s natural advantages. For instance, linking Canadian critical minerals with Mexican manufacturing capabilities and U.S. technological innovation could create a resilient electric vehicle supply chain that reduces dependence on Asian suppliers.

Implementing this vision requires practical mechanisms to transform aspirations into reality. A systematic approach would establish the institutional architecture needed for coordinated industrial development.

This could start with creating a North American Industrial Coordination Council composed of representatives from key economic ministries, industry associations, and research institutions across all three countries. Unlike existing trade bodies that focus primarily on dispute resolution, this council would actively identify strategic sectors for development and set measurable targets for regional production, investment, and technological advancement.

Building on this institutional approach, a recently published proposal I co-authored through the U.S.-Mexico Foundation advocates for creating a binational customs agency between the United States, Mexico, and potentially Canada. This initiative would go beyond traditional cooperation to establish unified inspection processes, real-time risk assessment technology, and joint professional development for customs officials.

While some have proposed a new “External Revenue Service” (ERS) to collect tariffs from trading partners, such unilateral revenue-raising mechanisms overlook the complex realities of North America’s integrated production networks. A binational customs agency would instead coordinate inspection procedures, compliance verification, and revenue collection under a shared framework that acknowledges modern manufacturing ecosystems. Rather than prioritizing tariff extraction through a separate bureaucracy, this collaborative approach would reduce processing redundancies, respect cross-border value chains, and ultimately enhance North American competitiveness in the global marketplace,all while still fulfilling each country’s legitimate revenue needs.

The current customs infrastructure faces unprecedented pressure, processing over 7.3 million cargo trucks annually at the U.S.-Mexico border alone. At the same time, it confronts evolving security threats from drug trafficking and illegal weapons. A binational agency would deliver substantial benefits: reduced processing times, enhanced security protocols, improved revenue collection, and strengthened regional competitiveness. Experience from successful models like the International Boundary and Water Commission and NADBANK demonstrate that institutional cooperation can transcend political cycles while preserving national sovereignty.

Alongside this council and agency, a North American Standards Harmonization Office could address the regulatory fragmentation that hampers integration. This office would prioritize sectors where divergent standards create unnecessary barriers to cross-border production. For example, harmonized battery safety standards and charging protocols for electric vehicles could significantly accelerate regional production scaling. Similar semiconductors, medical devices, and renewable energy efforts would create the regulatory foundation for seamless manufacturing integration.

With institutional foundations in place, the next phase would focus on strategic investments in physical and knowledge infrastructure. Border-crossing modernization represents a critical priority for enhancing regional trade efficiency.

Digital infrastructure presents another key opportunity. A secure, integrated supply chain visibility platform could dramatically enhance regional competitiveness by reducing inventory costs, improving planning capabilities, and accelerating response to disruptions.

Investment coordination represents perhaps the most challenging implementation hurdle. Rather than competing through duplicative incentives, North American partners could develop complementary investment packages that strategically distribute economic activity while maintaining collective competitiveness. For semiconductors, this might mean focusing advanced logic chip production in the southwestern United States, memory chip manufacturing in northern Mexico, and specialized analog production in Canada, each supported by coordinated but distinct investment packages.

Workforce development requires equally careful coordination. The region currently faces mismatched labor markets, with skill shortages in some areas and underemployment in others. A North American Skills Passport program could help address this imbalance by creating standardized certification frameworks recognized across borders. Combined with targeted education investments and worker exchange programs, this approach could build the skilled workforce needed for advanced manufacturing while ensuring a more equitable distribution of economic opportunities.

Crucially, this implementation must move beyond government-led initiatives to include private sector leadership. Industry-specific coordination bodies  could bring together major manufacturers, suppliers, research institutions, and government representatives to align investment plans, technology roadmaps, and skills development.

While addressing trade imbalances remains important, the limitations of bilateral reciprocity suggest a different path forward. North America needs a comprehensive industrial policy that builds on NAFTA’s original vision of regional self-reliance. The region can develop the scale and capabilities required to compete effectively in the global economy by fostering deep industrial coordination among the United States, Canada, and Mexico. This coordinated approach, not tariff adjustments, offers the most promising route to sustained North American prosperity.

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Editor’s Note: The above guest column was penned by Dr. Daniel Covarrubias, director of Texas A&M International University’s A.R. Sanchez, Jr. School of Business Texas Center for Economic and Enterprise Development. The column appears in the Rio Grande Guardian International News Service with the permission of the author. Covarrubias can be reached by email via: dcova@tamiu.edu.

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