The West in the Dock Over Free Trade – But Is It Fair?

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A WSJ article last week led with the headline, “Trade barriers once again threaten the global economy, and the U.S. isn’t helping”, and went on to criticize US “Buy American” policies as essentially protectionist in nature and damaging to US jobs.

Citing economists Laura Baughman and Joseph Francois, the article suggested that if foreign retaliation led US companies to lose just 1 percent of the potential sales opportunities created by foreign stimulus programs, US exporters would lose over 200,000 jobs. This would far exceed the 43,000 jobs expected to be created by the “Buy American” act and preferences included in the 2009 stimulus bill.

An article in the Economist takes a similar line, quoting World Trade Organisation (WTO) concerns that protectionist barriers are creeping back up, particularly among the G20 countries that currently control 85 percent of global trade.

Indeed, the article even holds out the suggestion that Western economies could be left behind as emerging markets increase bilateral trade at the expense of trade with the West. Examples taken include the booming trade between China and India, Russia’s growing trade with Asia and the creation in 2010 of the China-ASEAN Free Trade Area, covering close to 30 percent of the world’s population.

HSBC predicts that world trade will grow by 90 percent over the next 15 years, modestly at first because of the EU debt crisis but expanding more vigorously down the line, with much of the growth coming among emerging markets. While the EU has been a shining light in creating completely duty-free and barrier-free trade among its members and in reducing import tariffs with the rest of the world, pressures are growing on debt-stricken governments to try and protect what industry they have left and preserve precious jobs as unemployment soars above 25% in some countries.

But in reality, how serious a threat is protectionism, how much damage, if any, has been done so far and is the West really the worst offender? One of the authors of the WSJ article, Douglas Irwin, economics professor at Dartmouth College, admits in an FT article: “It is hard to see much impact on trade flows as a result of the limited actions taken so far,” while expressing concern that once imposed, barriers are hard to get removed.

Nor have Buy American provisions been vigorously enforced; considerable latitude exists for manufacturers, e.g. those in Europe, to compete for projects that are required to consider a Buy American policy. The reality is all countries engage in a degree of protectionism and most are worse than the US. As the FT article concludes, lesser-known but much more targeted than China’s persistent currency intervention is Beijing’s habit of changing rebates on value-added tax (VAT) to encourage exports.

Like many countries that apply VAT, China refunds the VAT paid by its exporting companies on imported inputs. Unlike most other big economies, where the tax relief regime stays fixed, Beijing has repeatedly tweaked those rebates to boost the profitability of particular sectors, changing rebates 13 times between 2007 and 2010. Quoting figures from Simon Evenett, a professor at St. Gallen University in Switzerland, 71 percent of Chinese exports were affected by a change in rebates in 2010, compared with just 4 percent in 2007.

Apparently, in 2010 Beijing paid out the equivalent of a fifth of total annual Chinese government spending in rebates. “Given that China’s VAT rates vary between 13 per cent and 17 per cent and that parts and component imports account for half the value added in many Chinese sectors, even small variations in these rebates can have a big impact on the profitability of exporting,” Evenett is quoted as saying, concluding “What’s more, all of this is WTO legal.”

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