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Obama Must Fight the Protectionist Virus

Author: Jagdish N. Bhagwati
February 4, 2009
Financial Times

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President Barack Obama faces protectionist pressures. These are not just from the labour lobbies that have led Joe Biden, US vice-president, to chide "pure free traders" and to ask for "fair trade"; and which, astonishingly, have also led the US president to use his first meeting with President Felipe Calderón of Mexico--overwhelmed by the brutal fight against drug cartels caused by the US failure to legalise drugs--to urge on him tougher labour standards, a protectionist demand that is clearly aimed at raising Mexican costs of production. The pressures come also from the lobbies pushing for a Detroit bail-out that is inconsistent with the World Trade Organisation.

Through all this, the "no-drama" Mr Obama has kept a low, indeed invisible, profile. With his innate ability to moderate highs and lows, he has been America's first "lithium president". Fortunately, on Tuesday he stepped up to the plate on the Buy American provisions in the stimulus package, leaving little doubt as to where his sentiments, and his policy preferences, lie.

Yet, protectionism is a dangerous virus that requires a passionate response. Indeed, Mr Obama faces his two most serious protectionist challenges from the Buy American provisions that have infiltrated his stimulus package and from the China-bashing on "currency manipulation" that surfaced in the confirmation hearings of Tim Geithner, Treasury secretary .

The Buy American provisions, which would require that companies use US steel and manufacturing products in projects funded by the bill, seem reasonable. If the US has a stimulus package, why should the benefit of it extend to other countries? An influential columnist has suggested this is not what we economists call "beggar my neighbour" policy: the US is not diverting a given amount of aggregate world demand to itself at other countries' expense. Rather, it is a case of not rewarding your neighbours when you stimulate spending and are adding to world demand: neighbours should reflate their own economies. Such protectionism by the US will therefore stimulate other nations into creating their own stimulus packages.

This is a naive argument, because other nations will not see the US action in this light. Instead, they will respond in kind, as they did after we enacted the Smoot-Hawley tariff in 1930 and as many are already threatening to do. So, if the Buy American legislation does get enacted, count on trade wars breaking out, so that Americans learn history, which they do not study enough at school, by seeing it repeated in their own lifetime.

Yet some do worry about thus undermining the WTO, which has inherited from the General Agreement on Tariffs and Trade the many roadblocks to re-enacting that history of mutually harmful outbreaks of trade barriers. They have argued, therefore, that the US can enact WTO-consistent procurement rules by excluding from US procurement China and India, among other developing countries, which have not signed the optional procurement code. But remember that these nations can also retaliate in WTO-consistent ways. They often have "bound tariffs"--ceilings, which are significantly above the "applied", that is, actual, tariffs; and it is possible to raise the applied tariffs towards the bound levels without any restraint at all.

Nothing would prevent India and China from choosing to raise tariffs thus on items of export interest to the US. Besides, they could shift their own purchases of aircraft away from Boeing to Airbus, and of nuclear reactors from American to French companies. The response would, of course, be for the enraged US congressmen to start enacting their own retaliation. The game would become lively.

The accusation that China "manipulates" its exchange rate, which also promotes protectionism towards it, is another important cause for worry. Most senators are convinced the issue is clear-cut. It is not. The Washington magazine, The International Economy, once asked more than 60 economists: at what level should the Chinese currency be set? The answers, including those from some of our deepest thinkers on exchange rates, were revealing. Some wanted a float. Ron Mckinnon and Richard Cooper wanted to keep the currency at existing levels. And those who wanted revaluation fell into 11 groups ranging from 5 per cent revaluation to 40 per cent and above.

President Bill Clinton marred the first year of his presidency by indulging the Japan-bashers whom he had cultivated in his campaign. President George W. Bush succumbed also to steel protectionism in his first year. They had time to change, however. But Mr Obama, in the midst of a historic economic crisis, can ill afford to repeat this pattern: he has to fight protectionism right away or live to see the virus spread beyond control.

 

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

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