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Reproduced with permission from a private e-mail from Mahesh Johari

Some quick commentary only today.  The stimulus bill that just passed the House contains a “Buy American” clause, which forces materials purchased using funds from the stimulus package to come from American manufacturers.

Intuitively, this sounds both logical and appealing.  If we’re spending our taxpayer dollars, obviously we want those dollars to be spread throughout our economy.  It makes no sense to pass an economic stimulus package that sends our money to China.  So why not mandate that?

Unfortunately it’s not that simple.  The “Buy American” clause has great political appeal but will do nothing but defer job losses and prolong the overall process of adjustment that we are experiencing.

Here’s why: Let’s imagine (for example) a steel manufacturer in the U.S.  The manufacturer is unable to compete globally because their cost structure is too high.  They are facing the prospect of downsizing, of shuttering excess capacity, of laying off workers.  But wait! Here comes the stimulus package to save the day!

Now this uncompetitive sloth of a firm has a new lifeline.  They can sell their overpriced product to the stimulus package.  They can delay downsizing, cost cuts, and layoffs.  So as long as the stimulus package is around, they can keep being inefficient.  Meanwhile their international competitors are becoming ever more efficient, adjusting themselves to true market conditions.  The competitors are getting better.

When the stimulus package expires, the firm will be right back where it began: uncompetitive and burdened with an unsustainable cost structure.  Then what?  Of course the layoffs will come, the downsizing, etc.  Everything that should have happened will happen, just a year or two later.  The part of the stimulus used to overpay for those American materials will essentially have been used for zero long term benefit.  The overall economic adjustment process will be prolonged.

This type of waste why we have to be very careful when it comes to government spending.  Government spending packages tend to waste a lot of money.  Resources that are wasted produce no long term economic benefit.

So what should we do?  We don’t want companies to willy-nilly send our stimulus dollars to China.  Well, at least not when they can get the same stuff in the United States.

As long as we are creating websites and transparency, let’s go all the way!    We could require any purchases of commodity materials from international vendors to be subject to a domestic competitive bid first.  For example, if Caterpillar feels their most economical source for steel is based in Australia, let’s require them to accept competitive bids from American firms BEFORE they are allowed to place the order to the Australian firm.  If we keep the process open and transparent, it will bring the best American firms out to compete at peak efficiency – a very desirable outcome.

We have to be very careful here.  Subsidizing inefficiency is not the path to prosperity.

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