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.