Zakaria: The Trouble With Subsidies

I'm certainly not going to defend those AIG bonuses. But the trouble with populist outrage is that it bubbles over, sweeping from one justifiable issue across to many others. Waves of populism are now working their way through the American government on several fronts. The area I'm most worried about is trade, where populism leads to protectionism. The scandal of the moment, the bailout bonuses, will pass; in a year or two (one hopes) the U.S. government will no longer own banks and insurance companies. But protectionism and trade wars, once started, are hard to reverse.

This might sound alarmist. Free traders like myself are often accused of overstating the dangers to free trade. But in a report released last week, the World Bank has gathered some disturbing facts. Since the financial crisis began, countries around the world have proposed or implemented 78 trade measures. Of these, 66 turn out to be new restrictions on trade. For example, Russia raised tariffs on used autos; China has banned outright various European goods (Irish pork, Italian brandy, British sauces and some Belgian chocolates, if you're wondering). India has banned Chinese toys.

Rich countries tend not to raise tariffs, because they do protectionism another way: by subsidizing domestic companies. We are in the midst of the greatest orgy of subsidization for inefficient corporations in decades. Take the auto industry. The U.S. government's direct subsidies to Detroit since the crisis began are $17.4 billion. Canada, France, Germany, Britain and Sweden have also announced transfers to their companies. In total, worldwide governments are providing $48 billion in direct subsidies to carmakers. And then there are agricultural subsidies, which are set to rise as the price of food falls. In America, this means an additional $1.8 billion for agrobusiness this year. The lion's share of money, of course, has gone to subsidize banks and financial companies. This may be a necessary emergency measure, but the reality is that Western governments are subsidizing their banks in what was meant to be a competitive global market. The fiscal-stimulus packages across the world are all, in large measure, what were once called "non-tariff barriers" to trade because they are—almost by definition—subsidies to inefficient companies.

Every action by one government is producing a countermove by another, in a classic and depressingly predictable spiral. The United States shuts down a pilot program allowing a few Mexican trucks into the United States to deliver their goods—so Mexico, justifiably and legally, imposes duties on a number of American goods. The House puts a "buy American" clause into the stimulus package, and the Association of Southeast Asian Nations explains that its own "buy local" provisions are a justified response to Washington's measures. "Buy American" sounds great, except if Germany puts in a "buy German" provision and France a "buy French" one. Then who will buy American exports—which are the only part of the U.S. economy that has been growing for the past year?

Take the steel industry. The Peterson Institute for International Economics estimates that the "buy American" provision will result in an increased domestic production of about 0.5 million metric tons of steel every year. Unfortunately, steel is a highly mechanized industry, as are most manufacturing industries in the United States. The boost in production will translate into 1,000 jobs, which in a labor force of 140 million is insignificant. America's steel industry exports 9 million metric tons of steel every year. Even if 1 percent of those exports were lost because of retaliation by other countries—a very conservative assumption—that would result in 6,500 jobs being lost in the same industry. "In an extreme case that 10 percent of those exports are lost," the authors of the study write, "as many as 65,000 jobs could vanish." So we save 1,000 jobs and lose 65,000.

We seem to have forgotten that we are in a new world. Many countries are empowered and will flex their muscles if we flex ours. And the collective effect of this muscle-flexing is the first real retreat from globalization in 25 years—a period in which global GDP doubled and trade increased by 7.5 times—and the first sustained contraction of the global economy since the Second World War.