Thursday, January 29, 2009

Looming Protectionism   [Stephen Spruiell]

It's been a bad week for trade. First, Timothy Geithner engaged in a little economic saber-rattling toward China, and now Congress is attempting to exclude foreign companies from competing for infrastructure projects in the stimulus package. The so-called "Buy American" provisions in the bill have the business community extremely concerned about the prospect of a trade war. In The Washington Post today, the CEO of Caterpillar — an American company that builds construction equipment — articulated some of these concerns:

"There is no company that is going to benefit more from the stimulus package than Caterpillar, but I am telling you that by embracing Buy American you are undermining our ability to export U.S. produced products overseas," said Bill Lane, government affairs director for Caterpillar in Washington. More than half of Caterpillar's sales — including big-ticket items like construction cranes and land movers — are sold overseas.

"Any student of history will tell you that one of the most significant mistakes of the 1930s is when the U.S. embraced protectionism," Lane said. "It had a cascading effect that ground world trade almost to a halt, and turned a one-year recession into the Great Depression."

The "Buy American" provisions in the stimulus bill would almost certainly be found to violate our WTO commitments, and the resulting scenario would be a familiar one. In a paper I wrote in 2005, I examined the consequences of two recent instances in which the U.S. was charged with violating WTO agreements. Neither ended well:

President Bush implemented tariffs on imported steel ranging from 15-30 percent in March of 2002 after the steel industry complained that underpriced imports were hurting business. The tariffs were immediately challenged by the EU and a number of countries through the WTO, and the United States claimed that the steel tariffs were a temporary safeguard allowable under WTO rules.

A WTO dispute-settlement panel disagreed and ruled that the United States should discontinue the tariffs. When the United States failed to comply, the EU drew up a list of products it planned to hit with $2.2 billion worth of retaliatory sanctions. Because the EU believed that Bush had implemented the tariffs to gain a political advantage in the steel-producing states of Pennsylvania and West Virginia, it targeted products from other politically important states—orange juice from Florida and textiles from the Carolinas, for instance. Citrus growers in the Lower Rio Grande Valley of Texas and apple growers in Washington state started to wonder why they had to pay the price for the steel industry’s inability to compete on a global scale. Steel consumers, like those in Michigan’s auto industry, had experienced higher steel prices as a result of the tariffs and had argued against them from the beginning. The industries targeted by EU sanctions now joined steel consumers to form a powerful coalition against the tariffs.

Only days before the retaliatory sanctions were to take effect, Bush removed the tariffs. In a statement, Bush insisted that the steel safeguards had “now achieved their purpose, and as a result of changed economic circumstances, it is time to lift them.” U.S. officials said that the tariffs had allowed the steel industry to undergo a restructuring that had made it more competitive and made the tariffs unnecessary. They also said that pressure from the EU had nothing to do with the decision to lift the tariffs.

The EU and the steel industry both disagreed. Headlines overseas read: “Bush Blinks First in Face of Trade War.”16 EU Trade Commissioner Pascal Lamy said that the sanctions “were there as a tool of compliance. They’ve complied, and the sanctions will disappear.” And United Steelworkers of America President Leo W. Gerard said, “Our trading partners obviously engaged the administration in a game of guts poker… Instead of telling them to ‘bring it on,’ the president blinked.”

Aside from the fact that steel tariffs were damaging economically and ineffective politically, they also proved to be humiliating internationally, as the United States appeared to have buckled under EU pressure. If President Bush had complied with the WTO ruling in a timely manner, before the threat of EU sanctions, his assertions that he had lifted the steel tariffs proactively might have carried more weight. [...]

At least in the case of steel tariffs, the remedy was appropriate and the only cost was wounded pride. The dispute over tax breaks for exporters, on the other hand, cost the United States between $300 and $800 million in punitive duties, plus an inappropriate remedy in the form of a bad law full of pork-barrel spending that failed to fully resolve the dispute. [...]

It all started with the unusual U.S. policy of taxing the income its citizens earn outside the United States as well as inside, creating what is known as a “worldwide” rather than a “territorial” system of taxation. Because almost no other countries including those in the EU practice this form of taxation, U.S. businesses experience a disadvantage in competing with their comparatively undertaxed overseas counterparts.

To remedy this disadvantage somewhat, the U.S. Congress passed legislation in 1984 creating an entity called the “Foreign Sales Corporation” (FSC), which enabled some exports to get out from under the tax. The EU brought a complaint to the WTO, claiming that the FSC exemption conferred benefits contingent on export performance in violation of the SCM Agreement. The U.S. argued that the exemption was necessary to offset the disadvantage created by worldwide taxation. The WTO agreed with the EU, writing:

The United States is free to maintain a world wide system, a territorial tax system or any other system it sees fit… What it is not free to do is to establish a regime of direct taxation, provide an exemption from direct taxes specifically related to exports, and then claim it is entitled to provide such an export subsidy because it is necessary to eliminate a disadvantage to exporters created by the U.S. tax system itself.

The United States repealed the FSC exemption and replaced it with another exemption that also was contingent on export performance. The EU complained that the United States had not fixed the problem, and the WTO agreed with the EU in the second dispute also. This time, the WTO authorized the EU to levy up to $4 billion per year in retaliatory sanctions on about 1,600 U.S. products.

The WTO determined that $4 billion was a fair amount, reasoning that the disputed tax exemption cost the United States about $4 billion in foregone revenue each year. The WTO granted this authorization in August of 2002, yet the United States did nothing. When the EU actually started charging these levies in March of 2004, starting at 5 percent and increasing by 1 percentage point each month, the U.S. Congress began scrambling to comply with the WTO ruling as complaints from sanctioned U.S. exporters started pouring into Washington.

Congress, under enormous pressure to act, saw a golden opportunity to load the bill with pet pork projects—anyone objecting to such opportunism was accused of obstructing progress, prolonging the sanctions and costing U.S. exporters millions of dollars with each month the process dragged on.26 Jewelry exporter James F. Marquart spoke for many when he said that the sanctions “have made our products very uncompetitive and just about dried up orders coming out of the EU.”

It took Congress seven months to finally agree on a bill to repeal the exemption. But rather than using the revenue recouped to finance a transition to a territorial system of taxation, which would have alleviated both problems of competitive disadvantage and EU sanctions, the bill wasted all the money on tax breaks and subsidies for bow-and-arrow makers, NASCAR racetrack operators and other special interest groups. In addition, the bill contained a connection to farm policy—$10 billion in subsidies to tobacco farmers.

Unlike the 2002 steel tariffs, the "Buy American" provisions of the stimulus bill are not something the Obama administration could simply undo if faced with the prospect of a catastrophic trade war. The consequences of "Buy American" would more closely resemble what happened when the WTO ruled against the FSC exemption — hundreds of millions in penalities assessed against blameless U.S. exporters, followed by a hasty fix that adds billions in pork to the federal baseline.

01/29 04:33 PMShare