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Shame on You, Mr. Obama, for Pandering on Trade

Author: Jagdish N. Bhagwati
February 6, 2012
Financial Times

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President Barack Obama infamously killed the multilateral Doha Round last December by instructing his representative at the World Trade Organisation to be a "rejectionist" negotiator. He compounded the folly by instead floating the trans-Pacific Trade Initiative that is conceived in a spirit of confronting China rather than promoting trade, and is also a cynical surrender to self-seeking Washington lobbies that would have made John Kenneth Galbraith blush. Not content with these body blows to the world trading system, which his predecessors had built up over decades of US leadership, Mr Obama pulled off the remarkable feat of making things yet worse with his State of the Union address.

In particular, he decried outsourcing: "We will not go back to an economy weakened by outsourcing." He also celebrated manufacturers: "Tonight, I want to speak about an economy that's built to last an economy built on manufacturing." Both are costly fallacies that deserve no quarter from our leadership. They hurt the US economy; they also guarantee that the US will undermine further the world trading system.

Outsourcing is a bogeyman. The deception that Mr Obama buys into goes back to the populist commentator Lou Dobbs, who denounced the firms that bought components from abroad as Benedict Arnolds – the rogue who became a byword for treachery when he changed sides during the American war for independence.

The fact is that Mr Obama is guilty of promoting at least two wrong but prevalent notions. When firms are denounced for "losing" jobs by outsourcing, the fallacy is one of looking at only primary impacts. When Senator Barbara Boxer blamed her rival Carly Fiorina in the last election for eliminating 30,000 jobs at Hewlett-Packard, the proper response would have been: in this fiercely competitive world, Hewlett-Packard would have lost 100,000 jobs if she had not lost 30,000.

Second, there is already evidence that significant insourcing is occurring in parallel. Indian information giants such as Wipro are increasingly outsourcing to the US. Walk down Madison Avenue and you will find that trade in variety or "trade in similar products" is now important and almost everyone is in each other's markets. Again, Dell has discovered that outsourcing troubleshooting for its computers does not work well: geographical proximity works a lot better.

But if Mr Obama is wet behind the ears on outsourcing, his surrender to the "manufactures fetish" is a disaster. As Bill Emmott, former editor of The Economist, once remarked: "Unless one can drop a product on one's foot many believe it is not worth making." The fallacy goes back to Adam Smith who, in a rare lapse into folly in The Wealth of Nations, condemned as unproductive the labours of "churchmen, lawyers, physicians, men of letters of all kinds, players, buffoons, musicians etc".

Mr Obama's surrender stems from at least four errors. First, he has bought into the fallacy, promoted by the economist Michael Spence, that manufactures are declining in the US, but his work suffers from conceptual flaws. Take just one problem: services splinter off from manufacturing even as vertical integration yields to specialisation. Over time, manufacturing yields to services. This gigantic change that is taking place has nothing to do with outsourcing.

Second, the notion that manufacturing is more productive than services is not supported by research. Dale Jorgenson, a leading researcher on productivity, has shown that the most progressive sector is retailing, which has been transformed by IT innovation.

Third, the general disillusionment with the financial sector has been seized on by the manufacturing lobby to argue that therefore manufacturing should be supported. But that is a non-sequitur. The value added in the financial sector is probably a quarter at most of the total services sector. Why not opt for DHL, transport and communications, for example, instead of cement mixers?

Finally, the manufacturing sector in the US is already heavily subsidised. With the exception of New Jersey and New York, which compete for the financial sector, the main competition among US states is for attracting manufacturers through generous tax holidays, free land etc. Again a little-known tax provision, Section 199, gives tax relief for "domestic production activities", which mostly support manufacturing.

So the campaign for more manufacturing is a boondoggle. Jeff Immelt of General Electric, a splendid businessman and confidant of Mr Obama, has succumbed: who would look a freebie in the eye? Clyde Prestowitz, a Republican who earned Bill Clinton's plaudits in the 1992 campaign, is now celebrating on his blog that Mr Obama is his new convert. Mr Clinton regained his sanity in a year. This time it is likely to be a long slog.

This article appears in full on CFR.org by permission of its original publisher. It was originally available here (Subscription required).

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