THE ‘Buy American’ provisions in the $819 billion stimulus bill passed by the House of Representatives on January 28 have put President Barack Obama in a catch-22 situation.

His full support to the provisions could set off a trade war and hurt the process of globalisation, and his opposition to them could mean a backlash from his supporters.

This is the first test of President Obama in less than a month of his presidency on trade policy. His administration maybe having second thoughts on some provisions which apparently violate trade deals the US has signed in recent years and the WTO agreement on expanding access to government procurements.

The Senate version, yet to be acted upon, goes further. It requires all stimulus-funded projects such as highways, bridges, energy grids and schools to use only American-made steel, iron and goods even if they are more expensive. The House bill requires that even the uniforms and other textiles used by the Transportation Security Administration be produced in the United States.

Supporters of the ‘protectionist’ bill who include steel and iron manufacturers and labour unions argue that it is the only way to ensure that jobs are created at home and not overseas. In 2008 alone, 2.6 million jobs were lost. They point out that much of the tax rebate cheques that went out last year to stimulate the economy went to Chinese-made televisions and Korean-made refrigerators.

The opponents which include some of the biggest names in the industry such as Caterpillar and General Electric say it amounts to a declaration of war against free trade and could spark retaliation from abroad against US companies and hurt their ability to win contracts abroad.

At Davos, where World Economic Forum held its annual meet, there were voices of gloom and alarm over growing economic nationalism in the US.

“We will resolutely fight protectionism,” Japanese Prime Minister Taro Aso said, referring to the stimulus bill. And, in fact the signs of retaliation have already begun to appear.

A spokesman of the European Union warned last week that if the Americans prohibited the sale or purchase of European goods on American territory that is “not something we will stand idly by and ignore.” The US and the EU are main trading partners, with trade flows worth $2.25 billion a day and have often clashed over questions of trade barriers. But this time, it will be a different clash with unforeseen consequences for the global trade and economy.

According to Anthony Faiola of The Washington Post, the world may be on the brink of “a gentler kind of trade war” with the passage of ‘Buy American’ bill. In 1930s too, he says, Congress had passed a “protectionist” bill aimed at saving American jobs. It effectively barred 20,000 imported goods, including French dresses and Argentine butter. Other nations had retaliated by raising their own barriers on US products, bringing global commerce to a halt. Hence, the ‘protectionist’ exercise not only prolonged but deepened the Great Depression.

But according to Gary Hufbauer, a senior fellow with the Peterson Institute for International Economics in the US, there are lots of ‘institutional firewalls’ to prevent trade wars that did not exist during the Great Depression. That could help now. But there is still a lot of room for damage, bad damage, that can be done in the grey area of the rules, he says.

Simon Johnson, a former chief economist of the IMF and professor of economics at MIT, is of the view that while the political leaders of the developed world were indulging in much rhetoric against protectionism, they may not be so serious about stopping protectionism. A case in point is that of the EU which is currently protesting against US protectionist policy, but at the same time, is reinstating subsidies on some dairy products to protect its farmers. It was in this context that Indian trade minister Kamal Nath warned the West last week that if there were protectionist measures India would be compelled to take appropriate measures against the countries concerned.

Several developed countries have begun to work out or implement their own stimulus packages to protect and boost their domestic economies while criticising the US as well. In fact, they find it difficult to practise at home what they preach internationally. China is among the countries preparing to spend billions of dollars on their stimulus projects. If Chinese companies are refused participation in US projects, American companies which are seeking contracts in China could face harsh retaliation.

British Prime Minister Gordon Brown last week made an impassioned plea to western nations to remain on the path of free trade. But, back home, his government is directing British banks with global operations now being rescued with taxpayers’ money to boost lending to British businesses and citizens first and then others. The countries that signed a November 15 agreement at the G-20 summit in Washington had promised to refrain from imposing protectionist measures for at least 12 months. Since then, however, a large number of them, from France to Indonesia, have broken that promise. French leaders, while facing strong protectionist pressures, are asking President Nicolas Sarkozy to alter his stance toward the economic crisis in order to prevent French job losses.

The Economist, London, argued in a recent analysis that protectionism is “individually appealing” but “collectively futile.” When the United States imposed the Smoot-Hawley Tariff in 1930, it generated a worldwide movement toward higher tariffs. Everyone tried to restrict imports and the combined effect was a deeper global economic slump. It took decades to undo the accumulated trade curbs of that period.

History, says The New York Times, has shown that “Buy American” provisions can raise the cost and diminish the effect of a spending package. For instance, in rebuilding the San Francisco-Oakland Bay Bridge in the 1990s, the California transit authority complied with state rules mandating the use of domestic steel unless it was at least 25 per cent more expensive than imported steel. A domestic bid came in at 23 per cent above the foreign bid, and so the more expensive American steel had to be used. Because of the large amount of steel used in the project, California taxpayers had to pay $400 million more for the bridge.

According to the NYT, it is the steel industry which has succeeded in prevailing over the House to insert a “Buy American” provision in the stimulus bill. Steel factories in some key steel-producing states – including Indiana, Ohio, Pennsylvania and Alabama – are running at 45 per cent capacity. While the demand for local steel is going down because it is costly, imports of Chinese finished steel is going up because they are cheaper. The money to be spent on stimulus projects, one may note, would be borrowed and hence add a huge sum to the federal deficit, which is already about $1 trillion, about seven per cent of the annual economic output. The spiraling deficit means increases in the nearly $11 trillion national debt. Much of the money would be borrowed from foreign creditors and would have to be repaid eventually. This would undermine the attractiveness of US Treasury debt to global investors, threatening America’s access to low-cost borrowing.

Latest reports indicate that the US Senate is proposing to dilute the ‘Buy American’ clause following Obama’s remarks that it could ignite trade wars.