Free Trade Vs. Protectionism: Why History Matters
Business + Economy

Free Trade Vs. Protectionism: Why History Matters

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There are two big reasons why policymakers tend to repeat the mistakes of the past. First, memories are short and policymakers simply forget the lessons of history. Second, academics, whose job it is to pass on the lessons of history, tend to be alienated from policy debates and are easily bored by issues on which there is no significant academic debate; they would rather study obscure issues of interest. This often leads them to concentrate on exceptions to general rules at the expense of impressing upon students and the public the truth of those rules.

This concentration on exceptions is nowhere truer than with international trade. Since the time of Adam Smith and David Ricardo, economists have known that free trade is the best policy. But it is always possible to construct unusual circumstances in which one country might temporarily gain a little bit at some other country’s expense by restricting imports, subsidizing exports, or finding some loophole to accomplish one of these in a way that doesn’t violate world trade law.

Support for protectionism is always
the popular approach with voters.

Furthermore, for a politician, supporting protectionism is always the popular approach with voters. For as far back as we can gauge opinion on this subject, the general public has always supported measures to restrict imports and protect jobs, and opposed free trade. And if anything, support for protectionism is rising and support for trade is falling. According to the NBC News/Wall Street Journal poll, the percentage of Americans who think that trade agreements are generally bad for the country has risen from 30 percent in December 1999 to 53 percent in September 2010. Over the same period, those with a favorable opinion of trade
agreements fell from 39 percent to 17 percent.

For these reasons, it is welcome to have a new history of the Smoot-Hawley tariff, the most infamous case of protectionism in history, “Peddling Protectionism” by Dartmouth economist Douglas Irwin. It is highly readable and will be enjoyed by anyone with an interest in the history of American politics. Irwin’s encyclopedic knowledge of the literature on Smoot-Hawley will make this the standard work on the subject for many years to come.

Principle Source of Revenue

Irwin begins by noting that tariffs were the federal government’s principal source of revenue from the beginning of the republic to the adoption of a permanent federal income tax in 1913. For this reason, Congress mostly avoided using the tariff for protectionist purposes, because the more successful a tariff is at keeping out imports, the less revenue it raises. Thus, historically, tariffs tended to be set at modest levels designed to maximize revenue.

But once the income tax became the federal government’s major source of revenue, Congress was free to use the tariff more for protectionist purposes. When Republicans – historically the party of protectionism – got control of the House, Senate, and White House after World War I, they quickly adopted the highly protectionist Fordney-McCumber tariff in 1922. But pressure for additional protection from the business community was heavy and only kept in check by opposition from labor, which feared a rise in the cost of living from protection – which would raise both the prices of imports and competing goods produced domestically – and from the farm lobby, which feared retaliation against U.S. agricultural exports if tariffs were raised on foreign manufactured goods.

Unfortunately, a prolonged glut of agricultural production throughout the 1920s weakened the traditional opposition of farmers to trade protectionism. At the same time, workers began seeing the benefits of trade restrictions in terms of protecting jobs, thus lowering their resistance to higher tariffs.

In Congress, Senator Reed Smoot, Republican of Utah and chairman of the Senate Finance Committee, was a very ideologically committed protectionist and anxious to pass a big piece of legislation with his name on it. His state’s principal crop in those days was sugar beets and sugar has long been among the most protected industries in the U.S. Willis Hawley was a Republican from Oregon and chairman of the House Ways and Means Committee. Less of an ideologue than Smoot, his main interest was promoting the Republican agenda.

Unholy Alliances

The critical factor that made Smoot-Hawley possible was the opposition to agriculture subsidies by President Calvin Coolidge. Desperate for relief from persistent deflation, this pushed farmers into an unholy alliance with manufacturers in an effort to raise agricultural prices. In 1928, Coolidge was replaced by Herbert Hoover, who gave the go-ahead for another tariff bill as long as he was provided with some flexibility to adjust tariff rates.

Work on Smoot-Hawley began in early 1929 and was extremely protracted, especially in the Senate. Political scientists have long been fascinated by the horse-trading and logrolling that went on as senators would repeatedly change their votes on the same exact tariff rate depending on what backroom deal had been made that day. An exhausted Congress finally passed Smoot-Hawley in June 1930 and Hoover signed it into law.

Economists have long debated the effect Smoot-Hawley had in triggering, deepening, or prolonging the Great Depression. A few, such as the late Jude Wanniski, thought it was the principal cause of the depression. Yet most think that international trade was simply too small a share of the economy to have had a major macroeconomic effect. Total dutiable imports amounted to only 1.4 percent of the gross domestic product; Smoot-Hawley raised their prices by just 5 percent.

Irwin explains that two factors made Smoot-Hawley important economically. First is that the money supply shrank by a third after 1929, as banks closed in the wake of the stock market crash and depositors lost all their money in an era before deposit insurance. This led to a widespread deflation that caused consumer prices to fall by 25 percent. This had the effect of sharply raising the real tariff level in cases where it was a flat dollar rate. As prices fell, the tariff stayed the same, thus raising it as a percentage of the import price.

The second factor was retaliation by America’s trading partners, which sharply curtailed U.S. exports. This beggar-thy-neighbor was especially pernicious because many countries were suffering from debt problems left over from the war. As world trade shrank, they lost the ability to service their debts, which further depressed growth and trade.

Remaking the World Economy

When Franklin D. Roosevelt was elected president in 1932, a key part of his campaign was to reform the tariff. True to his word, he appointed Cordell Hull, a committed free trader, as secretary of state. As a congressman from Tennessee, Hull had led the opposition to Smoot-Hawley in the House.

Smoot-Hawley was largely undone by the Reciprocal Trade Agreements Act of 1934. With the beginning of World War II, Roosevelt, Hull and others in the administration recognized that there would be a great opportunity after the war to remake the world economy and cement free trade in place for all time as a bedrock principle of international economic relations. Institutions such as the General Agreement on Tariffs and Trade (now the World Trade Organization), the Organization for Economic Cooperation and Development and others were established with the express purpose of preventing another outbreak of protectionism that would threaten world prosperity.

Although economists remain divided on the economic impact of Smoot-Hawley, I don’t think there are any who see it as a good idea that ought to be repeated. Politicians and the general public, on the other hand, are a different matter; I think many would support Smoot-Hawley levels of protection to protect jobs and incomes from Chinese imports and prevent American companies from outsourcing their production in low-wage countries.

The memory of Smoot-Hawley and its link to the Great Depression is one of the few things that keeps protectionism in check. For this reason, “Peddling Prosperity” deserves a wide readership.

Related Links:
Trade Deals No Threat to U.S. Sovereignty (Washington Times)
Krugman on Smoot-Hawley (New York Times)