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Trade off?
Kellogg professors ponder White House steel stance — and what it means for the future of free trade

By Rebecca Lindell

In terms of global trade, it was the shot heard around the world. President George W. Bush’s decision to impose tariffs of up to 30 percent on imported steel left many U.S. trading partners furious and threatening retaliation.

The administration claimed the March move would give the nation’s beleaguered steel industry a chance to regain its vigor. But is the enmity created worth the potential benefit to the economy? And should the government be engaging in such protectionist measures, particularly in this era of free trade?

Two Kellogg School professors, both experts on international business, say the answer is an unequivocal “no.”

  Sergio Rebelo
Finance Professor Sergio Rebelo
“Suppose foreign countries became so efficient at producing steel that its international price became almost zero,” says Sergio Rebelo, chairman of Kellogg’s Finance Department and the Tokai Bank Distinguished Professor of International Finance.

“Certainly, this would be bad news for the U.S. steel industry. But it would be great news for industries that use steel as an input and for the consumers who buy their products,” Rebelo says.

“It’s true that the capital invested in the U.S. steel industry would have to be reallocated and would lose a lot of its value,” he acknowledges. “Also, jobs would be lost in the steel industry and its workers would have to find other jobs. But it is difficult to imagine that the capital loss and the cost of worker reallocation could be larger than the benefits that would accrue to consumers of steel products from having cheaper steel forever.”

  Daniel Diermeier
Managerial Economics & Decision Sciences Professor Daniel Diermeier
Daniel Diermeier, a political economist and the IBM Professor of Regulation and Competitive Practice, says that he, along with many other economists, sees “hardly any economic justification” for the tariffs.

“That suggests we should look for the political motivations behind the decision,” he says.

Diermeier lists three such possible motivations: the importance of steel-producing states to the presidential elections of 2000 and 2004; the impending midterm congressional elections, six to 10 of which Diermeier estimates may hinge on the steel issue; and the president’s desire to push his trade promotion authority through Congress, a necessity to negotiate future agreements to liberalize world trade.

The last of the three is clearly in jeopardy, as Bush’s political opponents in the Senate seek concessions on labor and environmental issues in exchange for the fast-track negotiating power Bush desires. And with nations around the world threatening or enacting tariffs on products from politically sensitive states — such as grapefruit from Florida and apples from Washington — the hopes for electoral gains may be in danger as well.

“Basically, it’s brinkmanship,” Diermeier says. “You’re always catering to domestic interests, up to the point that you can avoid a trade war. Because once you’re in a trade war, the conse- quence for the world economy will be dire.”

Rebelo notes that the United States had built a reputation over many years as being much less protectionist than Europe or Asia. America has been able to leverage this reputation to persuade other nations to dismantle their trade barriers, a move that has significantly benefited the world economy. That reputation, he says, has been tarnished.

“Countries like Brazil built an efficient steel industry under the assumption that they would be able to export to the U.S.,” Rebelo says. “Now that these expectations are frustrated, it is only natural that Brazilians will be tempted to retaliate with tariffs on U.S. exports. And these types of trade squabbles end up being very expensive for the countries involved and for the world economy.”

Bush approved the tariffs March 5, after considerable lobbying by the steel industry and a controversial presidential election in which several steel-producing states proved pivotal to his eventual victory.

“I take this action to give our domestic steel industry an opportunity to adjust to surges in foreign imports, recognizing the harm from 50 years of foreign government intervention in the global steel market,” Bush said upon approving the measure.

The tariffs were actually lower than those sought by steel industry, which had lobbied for levies of 40 percent. The administration also denied the industry a $10 billion bailout in pension and health care costs for hundreds of thousands of steelworker retirees. Those benefits were promised in union contracts, but companies now argue they cannot afford the cost.

The European Commission immediately registered its outrage, threatening to impose retaliatory tariffs of 100 percent on everything from rice, grapefruit, shoes, and nuts to bib overalls, billiard tables and ballpoint pens. Japan, Brazil, South Korea and China soon followed with their own retaliatory threats. “Mr. Bush really has unified the world, at least on this issue,” one pundit wrote.

Domestically, Bush’s move was far from unanimously embraced. Opponents have predicted that the higher tariffs would raise prices on all sorts of items used by consumers, including cars, houses and appliances.

Few would argue that the U.S. steel industry doesn’t need some sort of help. More than 30 steel makers have declared bankruptcy since 1998, when the Asian financial crisis resulted in a surge of cheap steel into the United States and sent steel prices plummeting to 20-year lows.

The question of how to aid the industry without harming the economy could be a pivotal issue in November’s congressional races, and could even be a factor in Bush’s re-election bid in 2004.

Yet any attempt to protect steel workers’ jobs against the global market is bound to be expensive for one constituent or another, notes Diermeier. “The cost of protecting even one extra job in the steel industry is tremendous,” he says.

Protectionist overtures also invite appeals from other troubled businesses: “Any industry could knock at the door and say, ‘We’re going bankrupt too, why don’t you help us?’”

The solution both Rebelo and Diermeier see may strike some as harsh, but others as ultimately the most humane: to let capitalism take its course while cushioning the blow to individual workers.

“The unions are saying they’re being hurt by unfair competition, but the truth is, the integrated steel companies are not competitive,” Diermeier says. “They have outdated technology and expensive labor. Economic analysis would say the right way to solve the problem is to let them go bankrupt. If you’re concerned about the individual worker, the federal government can help them, for example, with their pensions and health care benefits.”

The government could do much to help smooth the transition of labor and capital from steel plants into other industries, Rebelo says. “Providing more generous unemployment benefits to steel workers would be a way to at least partially compensate some of the losers while allowing the overall economy to capture the gains from free trade,” he adds.

But by propping up an ailing industry with protectionist measure, “you’re prolonging the inevitable — but in a very inefficient way,” Diermeier says. “It makes it more expensive for the consumer, and for everyone else.”

©2002 Kellogg School of Management, Northwestern University