Legal Protectionism: A New Mercantilism

By Stormy

How does legal protectionism work? It has been my contention that many developing countries–those in Asia, specifically China–do engage in what might be called “legal” protectionism.

“The WTO rules are very porous,” said C. Fred Bergsten, director of the Peterson Institute for International Economics, a Washington think tank. “If you simply say live up to your rules, you still have massive scope for what I call legal protectionism.”

Pascal Lamy, director-general of the World Trade Organization,

But in a speech Wednesday, he sounded less sanguine, warning against the “dangers of sliding into isolationism and tit-for-tat measures, which have proven so devastating in the past.”

Several examples were singled out by Lamy in his Jan. 23 report. India raised tariffs on some steel products and issued notifications restricting imports of some steel products last November. The European Commission announced that it was reintroducing export subsidies for butter, cheese, and whole and skim milk powder starting in late January.

China increased value-added tax rebates on its exports of some textiles, clothing, bamboo products, plastics and furniture Nov. 1, and it increased tax rebates on exports of about 3,770 items Dec. 1. Starting Feb. 1, it eased taxes on 1,730 items bound for export.

Since issuing his report, Lamy also has urged U.S. lawmakers to reconsider a “Buy American” clause in stimulus legislation under consideration by Congress.

I have written extensively about export subsidies, export tax rebates…these goodies have been around for some time…and most economists have simply not addressed them. Why? The reason is simple: Mention protectionism and the knee-jerk reaction is: Tariffs. Clearly, they think, these are not tariffs. Well, the end result is the same, is it not?

Such is the thinking of those who never want to look under the covers. These ploys–and others–have been used for rapid industrialization. Need I mention currency exchange, or energy subsidies, or preferential loans to favored business? A modified version of mercantilism is alive and well…and it has been for some time. The game always has been trade. The question always has been: How do we game the system?

I have talked many, many times about China’s two-tiered tax system. It was the cleverest bit of mercantilism this decade. It violated no WTO rules. China used it as trigger for jump-starting rapid industrialization.

The plan was simple: Attract foreign corporations by taxing them at half the rate of indigenous firms. Firms from around the world fled to China, building an impressive export platform. WTO rules state that a country cannot place foreign firms at a disadvantage over indigenous firms. The WTO is quiet about indigenous firms being placed at a disadvantage. Only when the indigenous firms began to complain about this unfair advantage did China begin to modify its two-tiered taxation system.

Mercantilism is not dead; it has simply adapted to new rules, rules that are “porous,” capable of evasion if one is clever enough. Mercantilism is often associated with high tariffs, resulting in perpetual war as each nation vies for trade supremacy. Well, protectionism comes in many forms, as does mercantilism.

An avid anti-communist, Walt Rostow, about whom I have written a number of times, saw mercantilism as a path to rapid industrialization. China has taken his thinking and applied it with great success. I cannot…and will not…blame China. It simply understood the rules better than we did.

But ask yourselves–ask Krugman, ask Roubini, ask Martin Feldstein, ask any economist: What will be the engine of our economic recovery? The stimulus package can, at best, only blunt the worst effects of this economic crisis. And, the most overt forms of protectionism may come into play.

At the end of the tunnel, what will be the engine of our economy?