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February 12, 2009

Protectionism Will Hurt Global Recovery

Shang-Jin Wei
N. T. Wang Professor of Chinese Business and Economy
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New debate over protectionism has emerged in the past week about a clause in the stimulus bill that stipulates that firms building public works must “buy American.” The language has now been softened to comply more consistently with U.S. trade obligations. The irony in the situation is that proponents of the bill, such as many U.S. steel companies, don’t want to be forced to buy their own inputs from only U.S. companies. They know this could raise their cost substantially and that American consumers and firms may not want to pay for that. However, even with new qualifiers, there is still potential for the clause to endanger global recovery in several ways.

1. It violates international trade obligations
This is a violation of the United States’ international treaty obligations as both a member of the World Trade Organization and as a member of bilateral/regional trade agreements such as NAFTA. A fundamental principle of the WTO obligations is “national treatment,” meaning that foreign- and domestic-made products receive the same treatment. When all countries participate, consumers and firms enjoy the benefit of lowest possible costs. This is the principle that the United States — a long-time champion of taking down trade barriers — has been pushing for the last six decades. The United States often accuses other countries, such as China, for not living up to their WTO obligations and for having protectionist policies. But the “buy American” clause does exactly what U.S. has asked other countries not to do.

2. As others may follow suit, this could be self-defeating
Other countries may feel justified to enact their own protectionist measures, following the U.S. example. As a result, American firms such as GE and Caterpillar will be able to sell fewer American-made products in other markets, and that will cost the U.S. more jobs than the stimulus package can save.

3. It opens the door for WTO cases against the U.S.
Not only could the clause itself could be the basis for a WTO case against the United States, it may also lead other countries to challenge the financial sector bailout package that the Obama administration is still designing and expanding. Why? At the moment, no country has challenged the United States for its bailout packages, such as TARP, which are separate from the stimulus package and designed to help its troubled financial institutions. However, other countries might argue that these bailout packages effectively offer government subsidies to the cost of capital for U.S. manufacturing firms, giving U.S. exporting firms an unfair advantage in the world market. This is the sort of thing — launching a WTO case — that the U.S. trade representative often threatens to China, charging that Beijing’s majority state-owned banks are subsidizing the cost of capital for its exporting firms.

The European Union and Japan may not launch such a WTO case as they are also buying non-performing bank assets at an above-the-market price. Others may be willing to give the United States some breathing room to sort out the financial mess. But there are some major trading partners who do not have the same kind of banking-sector problems, such as China, India and Brazil, and their inhibition to launch a case against the United States may be removed if they see that Washington is making some protectionist maneuvers.

4. It undermines broad foreign policy objectives in the long term
The United States prides itself as a nation of principles; it is also looked up to for its ideals as least as much as for its military supremacy (or so we would like to think). This clause will undermine the six decades of U.S. leadership in the global economy, especially in the area of multilateral trade liberalization. If the clause becomes law, it will encourage a cynical perception by other countries that there is a gap between the Americans’ lofty words and selfish deeds. This cynicism could spill over to non-economic spheres, undermining U.S. foreign policy objectives more broadly.

Photo credit: Vards Uzvards