Protectionism Had Nothing to Do with The Great Depression

http://www.reuters.com/article/ousiv/idUSTRE51C2FG20090213

Like other free trade shills, German Finance Minister Peer Steinbrueck, in advance of a G7 meeting in Rome, is raising the specter of The Great Depression, which he disingenuously blames on protectionism.  It’s time to set the record straight.  Protectionism had nothing to do with The Great Depression.

The free traders always begin their revisionist history of the cause and effect relationship between protectionism and the depression with the passage of the Smoot-Hawley Tariff Act, as though Smoot-Hawley represented some foolish turn away from free trade toward protectionism, triggering a global trade war that plunged the world into depression.  Nothing could be further from the truth.

First of all, at the time of passage, Smoot-Hawley was only the latest in a long history of tariff legislation successfully employed by the U.S. to maintain a balance of trade.  The previous Fordney-McCumber Tariff Act of 1922 had set the ad valorem tariff rate on a wide range of products at an average of about 38.5%.  “Ad valorem” basically means “percentage.”  Tariff rates were always set in terms of percentages.  This meant that the customs people tasked with enforcing the tariffs had to then translate these ad valorem rates into dollar amounts, starting a contentious process of determining the real value of the import so that the ad valorem rate could be translated into dollar terms.  They complained about all the hassle and pressed for legislation that would set the tariffs in dollar terms. 

This was the whole purpose of Smoot-Hawley, to merely streamline the way tariffs were set, aiming to keep the ad valorem rates about the same, but saving the customs people all of the hassle.  They did a pretty good job.  By the time that Smoot-Hawley was enacted, the average ad valorem rate on the same basket of commodities had risen to 41.1%, only 2.6% higher than under the previous Fordney-McCumber Tariff Act.  And since the dollar value was fixed, it was anticipated that inflation would slowly reduce the ad valorem rate.  What no one anticipated was the deflationary spiral of The Great Depression, something that had never before happened.  Then, since the rates were now set in fixed dollar terms, the effective ad valorem rates rose.  The main lesson to be learned from this is that tariffs should always be set in ad valorem terms. 

Free traders would also like for you to forget that Smoot-Hawley wasn’t even signed into law by Hoover until June of 1930, a full eight months after the October, ’29 stock market crash.  Now it doesn’t seem so likely that a turn toward protectionism is what caused The Great Depression, does it? 

Nor do free traders want you to know how little a decline in trade actually factored into the depression.  At the height of the depression in 1933, America’s trade balance had declined $0.67 billion, contributing only 2% to an overall decline in GDP of $33.1 billion (from its previous high of $101.4 billion in 1929).  The fact is that it was the depression that caused the decline in trade, not vice versa.  We’ve already seen this same thing in our current recession.  Our trade deficit has dropped precipitously – by a third – in the past few months, as has global trade in general.  Once again, it has been the recession that has caused a decline in trade. 

In fact, it could be argued that it was an over-reliance on free trade that has triggered this recession (depression?).  Thirty-three straight years of a trade deficit that totals $9.2 trillion has literally bankrupted America, and the downward pressure on incomes resulting from the destruction of our manufacturing sector is the real root cause of the explosion in foreclosures that triggered the global financial collapse. 

Of course, nations like Germany, Japan, China, Korea and others, all beneficiaries of huge trade surpluses with the U.S. and eager to sustain the parasitic relationship they enjoy with their host, the U.S., want you to forget all of this.  Don’t be fooled.  It’s the enormous imbalances of global trade that have gotten us into this mess and it is only a return to sensible trade policy designed to restore balance that will get us out of it.

8 Responses to Protectionism Had Nothing to Do with The Great Depression

  1. Clyde Bollinger says:

    Strange, how reversing the order of things can make such a profound difference in the story you want to tell. Tariffs produced income for the expenses of running our government for more than half of our national life which were also some of our most successful years, yet when we discontinued them in favor of taxing ourselves (income tax) for the same purpose, it was a ‘good’ thing. Yet what followed was the most severe economic times in our modern history. Tariffs werer not a cause, they were the victim.
    The same relationship exists in the climate change arguement. Historically temps have climbed to excessive levels and several hundred years later CO2 levels go up. This cycle has been repeated several times in the same order, yet today there are those that claim CO2 drives temp. increases. Neither arguement makes logicval sense.

    • Pete Murphy says:

      I wonder how many people realize that tariffs once made it unnecessary to have a federal income tax. I’ll bet there’d be a lot more clamoring for a return to that kind of trade policy if they knew.

  2. […] article reports on the same upcoming G7 meeting in Rome that I posted on yesterday.  (See “Protectionism Had Nothing to Do with The Great Depression.”)  But it boils down the whole global economic collapse with one key observation:  […]

  3. Clyde Bollinger says:

    The extent of ignorance in the area of basic civics is appalling in this country. I can excuse some of the pundits from other countries and cultures when they decry tariffs, as an example. It is possible that their culture is the source of their misinformation. When our own “experts” make such similar claims and complaints, it can only be attributed to their politics. A fair and balanced analysis of the economic situation in the years prior to the ‘great depression’ will show the value of the tariff as a means of financing the cost of government. Certainly some were bad, some were excessively protective and stifled competition, yet on the whole produced a healthy economic environment.
    To a significant extent, our decline started about the same time as passage of the 16th amendment. Sure, we’ve has some fantastic periods of growth and prosperity since then, but the whole economic atmosphere changed it seems and not for the better. We’ve become more of a ‘dog-eat-dog’ society overly focused on the next quarterly profit estimate.
    Just think of the benefit, to the general population and the poor in particular, of having NO corporate income tax, for example. I know what the typical response will be, “The added cost of the tariff would exceed the cost of the tax.” History says not so. Take the cost of the corporate income tax out of the price of goods and the difference will surprise you. Additionally, removing the constant maneuvering corporations have to make to comply with the tax code will further reduce the cost of goods. We have the capacity to produce virtually everything that the general population needs to sustain life without buying imports, thus freedom from the burden of tariffs. Replace the personal income tax with a consumption tax and we’ve made genuine progress.

    • Pete Murphy says:

      Very well put, Clyde. We certainly have become more of a “dog-eat-dog” society. No doubt about that.

      Regarding the issue of replacing the personal income tax with a consumption tax, do you think that this would shift more of the tax burden from the wealthy to the poor and middle class, since the latter spend virtually all of their income on consumption while the wealthy are able to save a much higher percentage of their income? That’s always been my biggest concern with a consumption tax.

  4. Clyde Bollinger says:

    Pete,
    Your whole theory is based on reality. Let’s apply the same thinking to the burden of government. It falls on the middle class already.
    Were we to implement a consumption tax with exemptions for food items to be prepared at home, clothing(work and school), rent below a reasonable level and 3 years and older cars, we will have eased the burden on the poor and lower income middle class. Tax everything else at the point of sale at a rate, that when added to tariff income would be sufficient to maintain government.
    Saving, as in the wealthy saving, is in reality (there’s that word again) the source of funding for job creation. Most folks with money don’t buy and hoard gold, they invest, thus jobs.
    I may be wrong. There is no doubt about the scheme we’re following now.

    • Pete Murphy says:

      I see, Clyde. That would seem to work. My only concern now is that elimination of the income tax (and replacing it with tariff and a consumption tax) would eliminate one of the key incentives I proposed in my book for encouraging people to choose smaller families. (That is, revising the federal income tax to lower the base rates and then raise the rate for each additional child above two, perhaps.) That doesn’t mean it’s a bad idea. We’d just have to come up with other incentives. Any ideas?

  5. Clyde Bollinger says:

    Oops!, Would you say this is a case of unintended consequences? My first pass at a solution produces a roadblock to one of your really good ideas. No, I don’t yet have an idea that would replace yours. I’ll keep thinking.

Leave a Reply

Fill in your details below or click an icon to log in:

WordPress.com Logo

You are commenting using your WordPress.com account. Log Out /  Change )

Google photo

You are commenting using your Google account. Log Out /  Change )

Twitter picture

You are commenting using your Twitter account. Log Out /  Change )

Facebook photo

You are commenting using your Facebook account. Log Out /  Change )

Connecting to %s

%d bloggers like this: