Protectionism And The Stimulus: The spirit of Smoot-Hawley lives on in stimulus bills' 'Buy American' language.

During the past few months, as the severity of the recession has become clearer, drawing parallels with the Depression of the 1930s has been a staple of economic commentary. Rightly so: This may yet turn out to be the worst economic setback for 70 years, and the Great Depression says something about how bad things can get if governments fail to respond quickly and about the need to learn from history.

Speaking of that, remember Smoot-Hawley? One can overstate its role, no doubt--it did not actually cause the Depression--but most economists, I think it fair to say, believe that the effort in the 1930s to boost domestic output by restricting imports made things worse. The collapse of world trade, and hence global output, was helped along by deliberate policies in the United States and abroad, as governments tried to keep employment high at home by shifting unemployment overseas. In the end, everybody was worse off.

I had thought this lesson had sunk in. Smoot-Hawley is a byword for economic incompetence and illiteracy. In a global slowdown, "Beggar thy neighbor" is a formula for disaster. Who dissents? The issue, I had supposed, arouses no controversy--causing far less disagreement than how to mend the banking system; less than whether a big fiscal stimulus is needed to revive demand; and less than whether tax cuts or increases in public spending are the best way to stimulate. Yet both the House and the Senate have drafted stimulus bills that include protectionist "Buy American" language. The spirit of Smoot-Hawley lives.

The House measure calls for U.S.-made iron and steel to be used in the public works financed by the bill. I had naively supposed that the Senate, in its greater wisdom, would take this out. In fact, it did the opposite in the early drafting of the measure. It widened the provision by calling for the government to buy U.S.-made manufactures wherever possible. On Wednesday, it defeated Sen. John McCain's attempt to delete the provision altogether, but softened it by affirming U.S. obligations under existing trade treaties. The trouble is, trade treaties leave a lot of wiggle room. Even as amended, the measure has plenty of protectionist potential.

If thinking back to the 1930s strains the mental resources of legislators, perhaps they could think back as far as November 2008. At the G-20 summit in Washington--an emergency meeting of world leaders summoned to agree to a coordinated response to the crisis--the governments' communiqué said: "We underscore the critical importance of rejecting protectionism and not turning inward in times of financial uncertainty. In this regard, within the next 12 months, we will refrain from raising new barriers to investment or to trade in goods and services." The summit failed to do much else, as I complained at the time. But it did at least say that. No more Smoot-Hawleys. That was something. Less than three months later, Congress has expressed its contempt for this commitment.

So what, you might say. At a time like this, the national economic interest must override legal technicalities and so-called promises to cooperate with friends abroad. Expressing such an attitude is an odd way for this new Democratic Congress to introduce itself to the country's trading partners, especially at the dawning of the age of Obama. What was that about restoring America's standing with its allies? Yet put that aside for a moment. Would these provisions actually serve the national economic interest?

No. Gary Clyde Hufbauer and Jeffrey Schott of the Peterson Institute for International Economics have looked at the numbers. (You can read their study, "Buy American: Bad for Jobs, Worse for Reputation," on the institute's website, Of course it is impossible to be precise. Exactly how the measures would be implemented is unclear, and you can calculate the direct and indirect effects on the economy in various ways. But the IIE economists' best judgment is that the House bill's Buy American provision would preserve or create about 1,000 jobs. Set that against a total labor force of 140 million, and against the administration's estimate that its fiscal stimulus would save or create nearly 4 million jobs.

The first number is so small mainly because steel is an extremely capital-intensive industry. The original Senate measure would, in the first instance, be more effective, preserving or creating approximately 9,000 jobs, according to the study.

Better than none, you might say--but consider the likely reaction of other governments. Trading partners will retaliate, and American exporters will find their access to foreign-government buyers curbed in return. Hufbauer and Schott quote Fred Smith, the CEO of FedEx: "If the Congress passes this Buy American provision, I can assure you--and we operate in 220-some-odd countries around the world and are a huge part of the import-export infrastructure of the United States--we will get retaliation, and it will be American jobs at risk."

The IIE economists reckon that about $100 billion of annual U.S. exports go to foreign-government procurement. If 1 percent were lost through trade retaliation, it would cost about 6,500 American jobs. In what Hufbauer and Schott call an "extreme case"--10 percent of the government procurement trade lost through retaliation--approximately 65,000 American jobs would go. Set that against the 9,000 protected by the broad Senate measure. "To summarize," they say, "the negative job impact of foreign retaliation against Buy American provisions could easily outweigh the positive effect of the measures on jobs in the U.S. iron and steel sector and a few other industries."

In fact, this is putting it mildly. The real risk is not a Buy American initiative, followed by a measured foreign response, with that being the end of the matter. Congress and the administration would next face pressure to retaliate against the retaliation. They would respond, and thus provoke further trade restrictions abroad, and so on. If an outright trade war broke out, the world would face an economic death spiral--and, though unlikely, it is a real possibility. Governments were aware of the danger in November. That is why they made the promise whose spirit, at least, Congress now wants to violate.

Defenders of the Buy American provisions see themselves, above all, as political realists. Winning support for a big fiscal stimulus, they say, demands an assurance to the American public that the money will not leak away into promoting employment abroad. Well, I question that. Until Congress brought it up, there was no great outcry for this hostile economic unilateralism. Now, in fact, there may be--but to begin with, this was something Congress dreamed up by itself.

The political realities of the situation must indeed be kept in mind. Suppose, as the Senate now intends, that treaty obligations (though not promises made at G-20 summits) are honored. Also suppose that the U.S. imposes new restrictions that would apply to nations that are not parties to the World Trade Organization's optional procurement agreement--India or China, say. Either nation could then retaliate with legal protectionism of its own, for instance by shifting government purchases (of aircraft, or power plants) from U.S. to European suppliers. Would the quarrel end there?

What is the hard-headed realist's assessment of the likelihood of foreign trade retaliation, followed by U.S. retaliation against the foreign retaliation, and so on? This is a road that realists, more than anybody, should be careful not to start down.

President Obama and his spokesmen said this week that the bill's language will be changed as necessary to prevent a trade war. The revised Senate language is helpful, but does not go far enough. Protectionism that is technically consistent with treaty obligations is still an attack on trading partners. The spirit of co-operation is as important as the letter. In the current climate, legal protectionism could quickly degenerate into a cycle of illegal retaliation and counter-retaliation.

Both bills include a standard-issue public-interest waiver, which says that the provisions should not be applied in cases "inconsistent with the public interest." The public interest requires, first, that the stimulus bill does not violate U.S. treaty obligations. But it also requires co-operation with trading partners. If Congress fails to make further changes, the president must make it clear that he will use his discretion, under the terms of the waiver, to void the Buy American provisions. He needs to signal to the country's trading partners that they need not be concerned. With language of some sort still in the bill, maybe Congress would feel its honor had been satisfied. What matters even more than the dignity of Congress, though, is that any harm to America's jobs, incomes, and reputation abroad would then be reduced.

Republicans are the ones who were supposed to be disdainful of international opinion, determined to act unilaterally and ultimately at great cost to the country, uninterested in multilateral solutions to pressing global problems, unwilling to accept responsibility and lead by example. Democrats spent the better part of eight years attacking the Bush administration for those attitudes. The Obama administration and the new Democratic Congress would put an end to all that, they promised. Three weeks in, they face their first test.

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