Peddling Protectionism: Smoot-Hawley and the Great Depression

Index

Preface to the Paperback Edition

WHEN PEDDLING PROTECTION was published in 2011, the United States was slowly emerging from its worst economic crisis since the Great Depression. The parallels between the two episodes were immediately obvious: both crises began with a stock market crash, bank failures, and financial distress, followed by a severe recession in which production fell and unemployment soared. Like the Great Depression, the new crisis was not limited to the United States, but quickly became a worldwide phenomenon, leading to a sharp contraction in world trade. Not surprisingly, the financial crisis of 2008 and the Great Recession of 2009 led to a resurgence of interest in the Depression and the economic policies – and policy mistakes – of the 1930s.¹

One of the biggest fears was that, with the world economy in freefall, countries might adopt protectionist trade policies as they had in the 1930s. During the Depression, countries restricted imports in a desperate attempt to insulate their economies from the downturn. Such policies contributed to a large decline in world trade: about half of the 25 percent fall in trade between 1929 and 1932 has been attributed to higher trade barriers. In the end these restrictions dragged down the world economy and became a trade-policy disaster.²

Was the world set to repeat this experience? At the time this book was published, the recovery was still fragile and the outcome for trade policy was still uncertain. The names of Smoot and Hawley were mentioned often as a cautionary tale about the dangers of protectionism. As you will discover in this book, Reed Smoot was a Senator from Utah and Willis Hawley was a Representative from Oregon. Together they were responsible for the Tariff Act of 1930, in which the United States increased import duties just as the world was tipping into the Depression. The Smoot-Hawley tariff has gone down in history as an example of what not to do in an economic crisis. This book was an attempt to explain how such a monumental policy mistake could be made.

Figure 1. Value of U.S. Imports, monthly, 1928–1931 and 2007–2010. Source: 1928–1932, Survey of Current Business, Business Statistics 1936, Annual Supplement, pp. 65–66. 2007–2010, from http://www.bea.gov/newsreleases/international/trade/trad_time_series.xls

Fortunately, the economic policy response to the 2008–2009 crisis proved to be very different from that in the early 1930s. Whereas the gold standard had constrained the ability of central banks to ease monetary conditions during the Depression, now they were free to pursue a more expansionary policy, including interest-rate cuts and aggressive lending to financially-distressed banks. And whereas governments in the 1930s were wary of using fiscal policy as a stabilization tool, now many of them enacted large, sometimes controversial stimulus programs to boost spending in the economy. And, as we now know, countries did not move toward protectionism. A global trade war did not erupt.³

Compared to the Great Depression, the response of monetary policy proved effective in stopping the down-turn and starting the recovery. This is reflected in the path of imports during the two episodes. As figure 1 shows, the value of US imports fell more quickly in late 2008 to early 2009 than it had in late 1929 to early 1930 as the crises began. But by mid-2009, less than a year after the contraction had begun, imports were growing again, whereas during the Depression they continued to decline for another three years.

Having learned the lessons of the past, apparently, policymakers avoided disaster: the global economy gradually recovered, world trade remained open and began to expand (albeit at a slow pace), and fears of a return to the days of Smoot and Hawley faded away. This book seemed to deal with a historical episode that no longer had contemporary relevance.

Then came the presidential election of 2016.

By this time, the economic recovery had made substantial progress. Trade policy seemed unlikely to become a major campaign issue until President Barack Obama closed in on concluding a large, regional trade agreement involving about a dozen Pacific Rim countries: the Trans-Pacific Partnership (TPP). This helped inject trade policy into the political campaign. (As this book illustrates, trade politics and election campaigns can be a dangerous combination: the Smoot-Hawley tariff itself originated in the 1928 presidential contest between Republican Herbert Hoover and Democrat Al Smith.)

On the 2016 campaign trail, Democrat Bernie Sanders vehemently attacked the TPP as good for corporations and bad for workers, pushing Democratic nominee Hillary Clinton into opposition as well. Although Republicans were generally supportive of TPP, a newcomer entered the race with a brand of economic populism not seen in many decades. Donald Trump excoriated trade agreements such as the North American Free Trade Agreement (NAFTA) as a disaster for working Americans and blamed them for the loss of jobs in manufacturing. Trump not only vowed to scrap bad trade deals such as TPP, he also threatened to slap a 45 percent tariff on imports from China and to punish American companies moving production to Mexico by imposing a 35 percent tax on their goods.⁴

Given his many outrageous statements on the campaign trail, no one seemed to think that Trump would win either the Republican nomination or the presidency. As the famous quip went, Trump’s supporters took him seriously but not literally, while the media and pundits took him literally but not seriously. To the surprise of most observers, Trump was elected president. He quickly proved that he had to be taken both literally and seriously.

In his inaugural address, Trump painted a bleak picture of how trade had ruined the American economy: One by one, the factories shuttered and left our shores, with not even a thought about the millions upon millions of American workers left behind. The wealth of our middle class has been ripped from their homes and then redistributed across the entire world. He promised an America First policy: Every decision on trade, on taxes, on immigration, on foreign affairs, will be made to benefit American workers and American families. We must protect our borders from the ravages of other countries making our products, stealing our companies, and destroying our jobs. Protection will lead to great prosperity and strength.⁵

In his first days in office, President Trump pulled the United States out of the TPP and said he would renegotiate NAFTA. The administration flirted with a border adjustment tax as a part of corporate tax reform, a step that would involve an across-the-board tariff on imports.⁶ The Commerce Department also opened an investigation of steel imports on the grounds that they might compromise national security. Then trade tensions with Canada were raised when a long-standing dispute over softwood lumber reemerged. The president was even prepared to announce the U.S. withdrawal from NAFTA to mark his hundredth day in office when cabinet officials, members of Congress, business executives, and the leaders of Canada and Mexico intervened to persuade him to stick with a renegotiation.⁷

Figure 2. Number of Newspaper Mentions of Smoot-Hawley. Source: Based on Lexis-Nexis database (newspapers only). Data for 2017 based on January, February, & March at annual rate.

The realization that Trump was serious about getting tough on trade led to fears in other countries that the administration might start erecting trade barriers and overturn America’s 70-year commitment to an open world trading system.⁸ Citing protectionist pressures, the World Bank shaved its forecast for world economic growth in 2017.⁹

Trump’s election and subsequent developments led to a new resurgence of interest in the Smoot-Hawley tariff. As figure 2 illustrates, from 2000 to 2007, the number of newspaper mentions of Smoot Hawley was flat, until they jumped around the 2008–2009 crisis. Mentions then subsided, but then rose again in 2016 during the election campaign and into early 2017.

These articles usually discussed what is thought to be the principal lesson from the Smoot-Hawley tariff: if the United States closes its market, other countries can and will retaliate. As chapter 3 recounts, the Smoot-Hawley tariff drew an immediate reaction from Canada, the largest U.S. trade partner, which responded by imposing duties on U.S. goods. There is little doubt that the same thing would happen today. In February 2017, a poll by Canada’s leading newspaper found that, if the Trump administration slapped new tariffs on Canadian exports, 58 percent of Canadians would support starting a trade war.¹⁰ Mexico also began preparing for how it might respond to any U.S. action that would threaten its exports, such as shifting its purchases of American corn to other suppliers.

Another lesson for today’s policymakers is that there are no winners in a trade war. Protectionism breeds protectionism and, since one country’s imports are another country’s exports, higher trade barriers are detrimental to all concerned. Furthermore, the consequences of a trade war today could potentially be far worse for the United States. Exports of goods and services now account for about 13 percent of U.S. GDP. The comparable figure in the late 1920s was about 5 percent.

In addition to its economic consequences, the Smoot-Hawley tariff had political repercussions. The U.S. tariff fueled the rise of nationalist politics in other countries. In Canada, it contributed to the election of the pro-British, pro-protectionist Conservative party that struck back even harder against the United States. Today there are similar indications that the Trump administration’s approach has stoked nationalist sentiment elsewhere, particularly in Mexico where U.S. trade threats have boosted the popularity of anti-American politicians. Trade tensions could also lead Mexico to question the value of bilateral cooperation on immigration, drug enforcement, national security, and other matters of mutual concern.

There is one important difference in today’s situation from that of the early 1930s. Back then, Congress was responsible for setting import duties; the president played a much smaller role and did not have the authority to impose tariffs on other countries’ goods. However, as chapter 4 notes, Smoot-Hawley was the last time Congress legislated tariff rates, as it soon began delegating powers over trade policy to the president. Ever since, presidents have had substantial power over trade policy. In general, they have sought to reduce trade barriers through trade agreements such as NAFTA and international institutions such as the WTO.¹¹ Although presidents sometimes used their power to limit imports of certain goods from certain countries, such measures usually affected only a tiny proportion of U.S. trade.¹²

The only example of a president imposing a higher, across-the-board tariff on imports was in August 1971, when President Richard Nixon ordered a 10-percent surcharge on imported goods. The surcharge was imposed not so much for protectionist purposes, but to persuade other countries to revalue their currencies against the U.S. dollar at a time when exchange rates were fixed. The move put pressure on other countries to resolve the problem, and it was in effect for just five months before the exchange rate dispute was resolved.¹³

Might President Trump eventually make good on his threat to pull out of NAFTA or impose high duties on Chinese goods, possibly triggering a trade war? Some of the president’s advisers know the risks of such a step and are aware of the Smoot-Hawley precedent. In his Senate confirmation hearing, Secretary of Commerce Wilbur Ross stated: Tariffs do have a useful role in correcting inappropriate practices. They also do have a useful role as a negotiating tool. But, he added, I am keenly aware of Smoot-Hawley and the effect [it] had on trade in general and on our trade in particular. If nothing else, we can learn from history that kind of approach didn’t work very well. It didn’t work very well then and likely wouldn’t work very well now.¹⁴

On the other hand, President Trump’s pick to become U.S. Trade Representative, Robert Lighthizer, may have a different view. He has lamented that Republicans have become the party of free trade and are no longer the Grand Old Protectionists they were in the days of Smoot and Hawley. He has attacked the utopian dreams of free traders and their ivory-tower theories that disregard the realities of everyday life. He has also complained about globalist bureaucrats bowing to the whims of anti-American bureaucrats at the World Trade Organization.¹⁵ In addition, Peter Navarro, the director of the president’s National Trade Council, has decried the country’s trade deficit and has lamented the offshoring of production, suggesting that the global supply chain should be brought back to the United States.¹ These advisers might push the president to adopt tougher trade policies that involve restricting imports.

In the past, as chapter 4 recounts, many presidents have invoked the names of Smoot and Hawley to warn Congress about the dangers of raising trade barriers. Now the roles have been reversed: members of Congress have warned the Trump administration about the risks of protectionism by reminding them of what happened in the 1930s. For example, Senator John McCain (R-Arizona) has said that that administration’s trade threats directed at Mexico will increase the likelihood that its citizens will elect a very left-wing, anti-American president. As for the idea of raising trade barriers, talk about harkening back to the 1930s, McCain remarked. It’s unbelievable to me that [the president’s advisers] somehow think if we start taxing goods coming across the border, that that’s somehow not going to be responded to by the Mexicans. Please. History shows this sort of action gets you into a trade war.

Somewhere, he concluded with a dark chuckle, Mr. Smoot and Mr. Hawley are smiling.¹⁷

Only time will tell what direction the Trump administration will take U.S. trade policy and what the reaction of other countries will be. Whatever path the administration takes, the story of Smoot and Hawley stands as a timeless lesson for all trade policymakers and serves as a warning against protectionism under the guise of economic nationalism.

Douglas Irwin

May 2017

¹ For an overview of the various analogies drawn between the two crises, see Barry Eichengreen, Hall of Mirrors: The Great Depression, the Great Reces­ sion, and the Uses and Misuses of History (New York: Oxford University Press, 2015).

² Douglas A. Irwin, Trade Policy Disaster: Lessons from the 1930s (Cambridge: MIT Press, 2012).

³ According to one study, only 0.02 percentage points of the 12 percent decline in world trade in 2009 was attributed to protectionist measures; see Hiau Looi Kee, Cristina Neagu, and Alessandro Nicita, Is Protectionism on the Rise? Assessing National Trade Policies during the Crisis of 2008. Review of Economics and Statistics 95 (March 2013): 342–346.

⁴ While it is difficult to know where these precise numbers come from, 45 percent was an old and crude measure of the undervaluation of China’s currency around 2005 and 35 percent was the corporate tax rate in the United States that Trump believed should be applied to foreign companies selling into the United States.

⁵ Inaugural Address: Trump’s Full Speech, on CNN Politics Website, www.cnn.com/2017/01/20/politics/trump-inaugural-address/

⁶ The proposed reform would tax companies that sold goods in the United States, instead of those that produced there, and would apply to all imports but exempt exports. If the border tax does not discriminate in favor of U.S. producers, but simply ensures that the same tax is imposed on all sellers in the U.S. market, it is not protectionist. But many feared that it might be designed to give domestic producers an advantage and thereby draw complaints at the WTO.

⁷ Binyamin Appelbaum and Glenn Thrush, Trump’s Day of Hardball and Confusion on Nafta, on the New York Times Website, www.nytimes. com/2017/04/27/us/politics/trump-says-he-will-renegotiate-nafta-orterminate-it.html

⁸ For an analysis, see Douglas A. Irwin, The False Promise of Protectionism: Why Trump’s Trade Policy Could Backfire. Foreign Affairs 96 (May/June 2017): 45–56.

⁹ World Bank Cuts Growth Forecast, Cites ‘Protectionist Pressures,’ on the CNN Money Website, money.cnn.com/2017/01/10/news/economy/world-bank-growth-downgrade-trump

¹⁰ Robert Fife and Adrien Morrow, Canadians Want Trudeau to Stand Up to Trump, Even if it Leads to a Trade War: Poll. Globe and Mail, 7 February 2017; Accessed at: http://www.theglobeandmail.com/news/politics/canadians-want-trudeau-to-stand-up-to-trump-even-if-it-leads-to-trade-war-poll/article3 3948451/

¹¹ On the factors behind this change in U.S. trade policy, see Douglas A. Irwin, Clashing over Commerce: A History of U.S. Trade Policy (Chicago: University of Chicago Press, 2017).

¹² Provisions in U.S. trade law giving the president the authority to impose duties include Section 232(b) of the Trade Expansion Act of 1962, which allows the president to impose tariff or quotas if imports are having an adverse impact on U.S. national security. Even more broadly, the International Emergency Economic Powers Act of 1977 gives the president almost unlimited authority to regulate all international transactions in the case of a national emergency, which the president has discretion to declare. For a review, see Gary C. Hufbauer, Could a President Trump Shackle Imports? In Assessing Trade Agendas in the US Presidential Campaign, Washington, DC: Peterson Institute for International Economics, September 2016., piie.com/publications/piie-briefings/assessing-trade-agendas-us-presidential-campaign

¹³ See Douglas A. Irwin, The Nixon Shock after 40 Years: The Import Surcharge Revisited." World Trade Review 12 (January 2013): 29–66. Soon there-after, developed countries moved toward a regime of floating exchange rates. Later, in the Trade Act of 1974, Congress gave the president the authority to impose a surcharge of 15 percent for up to 150 days against one or more countries if the United States was suffering from a large and serious balance-of-payments deficit. This authority has never been invoked.

¹⁴ Senators Question Wilbur Ross on Tariffs, Business Record, WWD Web-site, wwd.com/business-news/government-trade/senators-question-wilbur-ross-on-tariffs-business-record-10755416/

¹⁵ Robert Lighthizer, Grand Old Protectionists, New York Times, 6 March 2008. Available at: http://www.nytimes.com/2008/03/06/opinion/06lighthizer.html

¹⁶ Trump’s Top Trade Adviser Accuses Germany of Currency Exploitation, Financial Times Website,/www.ft.com/content/57f104d2-e742-11e6-893c-082c54a7f539

¹⁷ Robert Draper, Trump vs. Congress: Now What? New York Times Magazine Website, March 26, 2017, www.nytimes.com/2017/03/26/magazine/ trump-vs-congress-now-what.html

Introduction

ON NOVEMBER 9, 1993, Vice President Al Gore and Texas billionaire and former presidential candidate Ross Perot debated the controversial North American Free Trade Agreement (NAFTA) on CNN’s television program, Larry King