Wednesday, 27 February 2008

The protectionism of Barack Obama? (updated x2)

From outside the US the most worrying thing about the current nomination races is the protectionist positions the candidates are taking. Barack Obama looks the most likely Democratic presidential candidate and thus his policies are being closely looked at. In this column, The dangerous protectionism of Barack Obama by Willem Buiter and Anne Sibert, at, his idea of tax breaks for US corporations that invest at home rather than abroad is studied. The title of the article gives the authors view.

The article summaries the Obama plan as:
The legislation would provide a tax credit equal to one percent of taxable income to employers who fulfill the following conditions:

· First, employers must not decrease their ratio of full-time workers in the United States to full-time workers outside the United States and they must maintain corporate headquarters in the United States if the company has ever been headquartered there.

· Second, they must pay a minimum hourly wage sufficient to keep a family of three out of poverty: at least $7.80 per hour.

· Third, they must provide a defined benefit retirement plan or a defined contribution retirement plan that fully matches at least five percent of each worker’s contribution.

· Fourth, they must pay at least sixty percent of each worker's health care premiums.

· Fifth, they must pay the difference between a worker’s regular salary and military salary and continue the health insurance for all National Guard and Reserve employees who are called for active duty.

· Sixth, they must maintain neutrality in employee organising campaigns.
Buiter and Sibert discuss each of the conditions is the following terms:
The first restriction is distortionary. Companies ought to decide the location of their headquarters and their domestic and foreign employment levels without being subjected to fiscal incentives. It is also unenforceable. Foreign branches of domestic companies, whose workers count as employees of the parent, would be changed to subsidiaries, whose workers no longer count as employees of the parent. Companies ever headquartered in the United States would be sold to shell companies or shut down and immediately reopened with a different name and legal identity, headquartered abroad. Let Commerce Department lawyers try to use corporate DNA fingerprinting to determine the ancestry of these new corporations! Unfortunately, idiotic legislation that is unenforceable is not harmless – it breeds contempt for laws and institutions.

While requirement two is less damaging than raising the Federal minimum hourly wage (currently $5.85) to $7.80, Sen. Obama ought to realise that the natural response of firms to higher wages is to hire less labour and, even with a tax credit equal to one percent of taxable income, not every employer in the United States can provide these subsidies and still make enough of a profit to stay in business. The least skilled workers -- those who would be hired at a wage of, say, $6.50 an hour and who would be out of work when the wage is $7.80 -- are likely to find the passage of this act to be just another example of a (possibly) well-intentioned Democratic proposal unintentionally benefiting those not too badly off at the expense of the truly badly off.

The employers’ contributions to employee retirement plans, mentioned in the third requirement, are a cost of employment as much as wages are and the above discussion applies. Moreover, requirement three does little to correct problems associated with retirement plans. Any real solution must make the investment and management of retirement plans independent of the employer. This ensures portability and stops employers from raiding them. A demise of the corporate defined-benefit pension fund would be a small loss. Companies do not have the expected life span or employee base to run proper defined benefit pension funds; the government is the natural agent to do this, through the (unfunded) Social Security retirement scheme. In addition, defined benefit plans are not always required to be fully funded at all times and part of these costs can be deferred. This has led to such pension fund liabilities being ‘forgotten’, hidden, or not viewed as debt at all: consider the plans of the US automobile industry or the remnants of the US steel industry.

Similarly, employers’ contributions to employee health care costs are also a cost of employment. However, tax incentives, current or proposed, that link health insurance with being employed rather than with being alive, are distortionary and unfair. It discourages labour mobility and transfers income away from the self employed, the unemployed and the inactive.

Requirement five is a wonderful example of a policy that would end up hurting those it is intended to protect. It would create a strong incentive for companies not to hire any new employees who are National Guard or Reserve employees, and to fire any they already employ! If society deems it desirable that serving in the National Guard or Reserve not involve any loss of salary or benefits for the Guard member and his or her family, then society should pay for it, with general tax revenues.
Over at the Free Exchange blog they take a different view of the Obama plan. They write:
In short, Mr Obama deserves a slap on the wrist. He does not, in my opinion, deserve the rhetorical pounding he receives. Why not?

This bill is much less bad than it could be, primarily because the restrictions it contains are optional. The things it asks of employers are steps that firms would have already taken if they were likely to boost productivity, so we can assume they entail certain costs. The more costly the restrictions are to a business, the less likely it is that the tax credit will make the changes worth the firm's while. In other words, optionality ensures that firms will only adopt these measures if it's relatively cheap (and minimally distortionary) to do so.

Mr Buiter and Ms Sibert are also right to point out that the retirement and health plan provisions of the bill won't increase worker compensation but merely shift it from wage payments to benefits. This, too, will help to minimise the cost of the legislation. Workers seeking the package of benefits prescribed by Mr Obama's bill will be drawn to compliant firms. Those who value wages more highly will work elsewhere. Some inefficiencies could obviously result from changes in labour distribution, but once again, if the inefficiencies grow large for any one firm, that firm will decide not to participate in the program.

There is a case to be made that Mr Obama is the most economist-friendly candidate out there. One would hope that he'd use his growing popularity as an excuse to defend good but unpopular economic policies. He hasn't done that with this Patriot Employer Act, and he deserves a dose of criticism.
The Free Exchange makes the point that while parts of the bill are bad, its not really dangerous. By comparison, when you look at some of the anti-trade proposals that have been seen elsewhere in the campaign, you are see the point. But still much of what is coming out of all the campaigns is protectionist and that can't be good for the rest of the world. See The Candidates and Trade for a look at the views of the presidential contenders on trade. And its not pretty. A free trading US is the best thing that a US President could give the world.

Update: Greg Mankiw comments here that he doubts Obama's economic advisors will support his anti-NAFTA rhetoric. Tyler Cowen comments here.

Update 2: Daniel Griswold comments on the Obama and Clinton debate over which of them is the strongest critic of the North American Free Trade Agreement.

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