But it still had immediate and long-term costs.
And just like today, the US got out-played by the rest of the world.
And just like today, the US got out-played by the rest of the world.
I recently listened to a lecture by Professor Jeff Borland
of the University of Melbourne. The topic was What happened in the global trade war in the Great Depression? An
historical perspective on Trump and tariffs. And two main points emerged
from the discussion:
1.
The trade war of the 1930s wasn’t the actual
cause or main driver of the Great Depression; and
2.
To the extent that you can actually do a trade
war ‘right’, the US stuffed up that trade war too.
THE GOLD STANDARD
The Gold Standard – the international monetary system of the
day – was the main cause of the Great Depression (as I’ve discussed previously). It was a truly
destructive system, not only causing the Depression, but hindering any recovery
and encouraging beggar-thy-neighbour trade and financial policies.
When the US started hording gold reserves during the ‘Roaring
20s’ (ironically as a hedge against future crises) rather than printing money
to ‘sterilise’ these gold inflows, other countries followed suit (starting with
France). Countries maintained high interest rates and refrained from printing
money to keep inflation rates down and attract gold, so they didn’t run out of
reserves in the face of this global rush for gold. This crippled global
consumption and investment and drove global inflation rates into a deflationary
spiral – now known as the Great Depression.
And to add insult to injury, the Gold Standard prevented
exchange rates from adjusting to support an economic recovery. It also
prevented countries from lowering interest rates and flooding their financial
markets with liquidity to end the downward spiral because this would risk
breaking their ‘pegging’. And internationally coordinated monetary stimulus
and/or system-wide wage cuts to restore balance while preserving the Gold
Standard proved to be administrative fantasies. So the downward spiral
continued.
Countries were very hesitant to abandon the Gold Standard.
Germany in particular, was especially paranoid of a repeat of its 1920s
hyperinflation[1]
and didn’t want to risk a depreciating exchange rate triggering another
inflationary episode. So even upon the collapse of a major Austrian bank, and
the ensuing financial crisis, Germany imposed tariffs and capital controls,
rather than abandoning the Gold Standard. And these capital controls froze the
assets of many European countries that had invested in Germany, thereby
spreading the crisis to the rest of Europe.
Britain did abandon in September 1931 (countries that
abandoned earliest tended to recover fastest and had the smallest falls – even modest
increases – in imports from 1929-35). And this triggered other countries to either
follow suit (including Australia and other Sterling Bloc countries), impose
capital controls (including Uruguay, Greece, Czechoslovakia, Colombia and Iceland),
or ratchet up their trade barriers even further (including France, Canada,
South Africa, Germany, and the Netherlands) to offset Britain’s new competitive
advantage (devaluation) without leaving the Gold Standard.
So this, rather than the trade war, was the main cause and
driver of the Great Depression – countries not adhering to the rules of the
international monetary system, and then stubbornly remaining within the
confines of that system while in the midst of the crisis.
THE TRADE WAR
Paul Krugman wrote that economics’ ‘dirty little secret’ is
that, while a trade war is unambiguously bad, we tend to oversell it.
Firstly, the Depression itself can actually be seen to have
worsened the trade war, rather than the other way around. This is because
tariffs were denominated in dollar terms, rather than percentage terms, and massive
price deflation associated with the Depression caused these tariffs to rise in
percentage terms, thereby automatically worsening the trade war. World trade
did collapse during the Great Depression by 25-30%. But again, the collapse in
trade was mostly driven by falling incomes associated with the Depression
itself, rather than falling incomes being driven by the collapse in trade. In
the US specifically, only about 10% of their reduction in imports was from the Smoot-Hawley
Act that triggered the trade war; about 20% from the automatic deflation-induced
tariff increases; and the remainder from Depression-driven falls in GDP.
I’ve also written previously about how the Depression was actually a driver of the
trade war, rather than the other way around. Because of the above constraints
of the Gold Standard, and the administrative obstacles to internationally coordinated
monetary policy or system-wide wage cuts, tariffs and capital controls were seen
as the only viable option to reflate the economy via price levels and import
substitution.
And in terms of declines in actual GDP too, the trade war
can’t really be attributed as a major cause. And today, with the advantage of flexible
exchange rates and Central Banks and governments that should now know how to
handle a downturn properly, a trade war is very unlikely to trigger a major
downturn.
But this isn’t to say the trade war didn’t have significant
costs in the 1930s, or that it wouldn’t today. The trade war certainly didn’t
help, and still had many costs of its own.
Firstly, a major trade war causes countries to start
producing what they formerly imported – goods and services in which they do not
possess a comparative advantage. This restructuring of global supply chains is
a seriously damaging disruption (think all the jobs lost in the transition towards free trade, but with losses in efficiency). And while demand
that is choked off by tariffs and barriers can be largely replaced by demand
for domestic produce, the distributional and efficiency losses accumulate over
time. A trade war is very hard to unwind, free trade very hard to re-establish.
And for all the years that trade barriers persist, these losses from having
production in less efficient locations accumulate into significant amounts of
lost output, productivity and innovation, well beyond when the trade war starts
to unwind. Imagine how long it’ll take to unwind a modern trade war, and the
subsequent cumulative losses.
And this isn’t even to mention the political ramifications. The
Smoot-Hawley Act did have big impacts on some surrounding countries – Cuba lost
an estimated 10% of its national income from the associated US sugar tariff! This
no doubt contributed to the subsequent revolution and overthrow of Cuba’s
pro-American government in 1933. No one can say this didn’t have very
long-lasting consequences.
There’s also the potential for trade wars to develop into
actual wars. Keynes noted the ability of free trade to create customers out of
potential enemies, thereby facilitating world peace. Who would wage war on a
trading partner? I mean, apart from Trump. And no doubt the breakdown of
international trade in the 1930s made it all the easier for countries to go to
war in WWII. Extensive losses of trade had already occurred. What more could be
lost from war? I mean, apart from the obvious.
If WWII was good for anything, it reinforced the need for
global cooperation to facilitate recoveries and trade. Trade wars undermine
this.
THE US'S STUFF-UP
But what was particularly interesting was how inept the US
was in the 1930s trade war too – just like today.
The Smoot-Hawley Act wasn’t a reaction to the Great Depression. It was imposed by the Republicans
beforehand in 1929 and intended to protect the agricultural sector which had
suffered in the 1920s. But the only agricultural products that had import competition
were sugar and wool, which had enjoyed significant tariff protection for
decades. More effective agricultural protection would have been subsidies, not
tariffs. Furthermore, the Act increased manufacturing tariffs more than
agricultural tariffs anyway. This included coal and lumber, which were actually
agricultural inputs. This means tariffs on these products actually hindered agriculture to such an extent
that the ‘effective’ rate of protection on agriculture from Smoot-Hawley was
actually negative.
The Act ended up imposing significant tariff increases on
hundreds on imported goods. Smoot himself even used the Act as an excuse to
limit the import of what he saw as ‘obscene material’. A news article at the
time used the heading “Smoot smites smut”. This should serve as a dire (though still
amusing) warning of how easily fondness for protectionism can spread beyond initial intentions.
It is also very similar to what is happening today – US tariffs
will save around 26,280 steel and aluminium-producing jobs, while costing
432,747 jobs elsewhere, including industries that use these materials as inputs
(such as the car industry).
Both times the US started a trade war. And both times, the
US shot themselves in the foot with their first attempt.
What is also similar is the reaction of the rest of the
world. Today, the EU, Canada and other countries are retaliating with tariffs
on, among other things, Kentucky bourbon, Iowa pork, Wisconsin motorcycles, and
Ohio washing machines – key exports, from states that voted for Trump in 2016. China
too, is going after US industries with powerful lobby groups that are most
likely to successfully pressure Trump into backing down. So while the US is
shooting itself in the foot, the rest of the world is expertly attacking Trump’s
own base, while leaving themselves plenty of alternative suppliers of such
goods.
Similarly in the 1930s, retaliation against Smoot-Hawley came
from Canada, Britain and Europe, not in the form of general tariff increases,
but in US-specific attacks. Britain increased tariffs on US imports, while
decreasing tariffs on imports from its colonies (a policy called Imperial Preference).
This offset the losses to itself while maximising the impacts on the US.
Europe, while not explicitly raising tariffs on the US exclusively (which would
have breached ‘most favoured nation’ rules), did raise tariffs on specific
goods which mostly came from the US – so the effect was the same.
So, whereas the US actually worsened protection of agriculture and triggered a trade war, the rest of the world was far more direct
and effective in its attacks on the US – and the US still gets the blame for
starting it all.
DON'T START A TRADE WAR!
I suppose it’s not surprising that the ‘winners’ in a trade
war are the second movers. When the rest of the world has a single country to
blame for starting it, it’s much easier for them to gang up on the single
country than for the single country (even one as big as the US) to beat the
rest of the world.
It’s one thing to ignore economists when we warn you against
starting a trade war. It’s quite another to ignore us when we’re actually
telling you how to fight it better.
[1] After WWI, the Treaty of Versailles
imposed massive war reparations on Germany, which it consequently paid by
simply printing massive amounts of its own currency, driving its inflation rate
up to 72.6 trillion percent! The US dollar went from buying 0.2-0.25 Mark to
4-5 trillion Mark. There were stories of people in Germany carrying
wheelbarrows full of cash to buy a loaf of bread, getting mugged for the
wheelbarrow instead of the cash.
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