Emergency reflation.
Even Keynes, previously
a staunch free-trade supporter, revised his opinions of tariffs in light of the
mass unemployment of the Great Depression – but only as a second-best option
behind a properly functioning international monetary system.
Today, there is no
Gold Standard, no Depression, and no need for tariff-led emergency reflation.
But there are still special interests that would take protectionism too far.
KEYNES, PRE-DEPRESSION
John Maynard Keynes, before the Great Depression, was very
much of the free-trade mentality. In regard to the post-WWI reconstruction of
Europe, Keynes strongly supported free trade as a policy “to which no exception
is admitted”. Even without international reciprocity, Britain should still set
an example for the global economy.
And departure from free trade was “an imbecility and an outrage”, both morally
and rationally, and risked Britain’s economic supremacy which Keynes believed
was caused by nearly 100 years of
free trade.
During the 1923 election, Keynes criticised the Conservative
Party’s view that tariffs could reduce unemployment, calling it the “protectionist
fallacy in its grossest and crudest form”. After WWI, Keynes even saw trade as
the primary, albeit indirect, means of bringing about international peace, as
it made “customers out of potential enemies”. He believed that the mutual
benefits of trade, which were a foundation of liberal economics, were enough to
make people reluctant to disrupt them with war, thus making international peace
more likely and easier to sustain. He even saw the value of allowing Germany to
retake its place as a powerful European country so as to participate in trade
and establish lasting peace after WWI (though that wasn’t likely any time soon,
given the burden placed on Germany by the Treaty of Versailles, specifically
designed to prevent them from ever
becoming a superpower that could threaten European stability again).
This was very much in line with the argument against Malthus’ Corn Laws – the idea
that Britain need not worry about France cutting off their corn supply if the
hostilities of the Napoleonic Wars were to resume because such a trade war
would bankrupt France, rendering a French war effort unaffordable. So if you’re
interested in national security, surely greater global trade integration is
better, not protectionism that drives countries apart. After all, you’re far
less likely to declare war on a business partner. But driving countries apart
actually makes it easier to declare war because you have less to lose.
Keynes did acknowledge the potential for war if trade were
pursued along the lines of imperial, exclusive terms, where nations attempted
to secure exclusive export markets and sources of raw materials. But the solution
here was not to abandon free trade, but to encourage the spread of democracy,
where empires would still be open to trade and would allow any colony to “pursue
its own destiny, in its own way … because our ideal is democratic”. This
applies now to China – if we’re worried about their non-democratic monopolisation
of export markets and raw materials, we should continue to encourage their democratisation,
not their ongoing insularity.
KEYNES, POST-DEPRESSION
But with Britain’s higher unemployment levels from 1924, and
then the outbreak of the Depression, massive unemployment and deflation, and
the inability of the international monetary system (the Gold Standard) to help
countries depreciate and recover, I guess Keynes found an exception which could be admitted. He began to rethink
the use of tariffs – something that was most distressing to orthodox economics –
believing classical theory to be “vicious in its practical implications”.
Government intervention was needed:
“both as the
only practicable means of avoiding the destruction of existing economic forms
in their entirety and as the condition of the successful functioning of
individual initiative”.
Classical economics postulated that, as a mathematical
certainty, demand could never be deficient relative to supply. Therefore, there
could never be the kind of demand deficiency-driven unemployment witnessed in
the Depression. This was known as ‘Say’s Law’ which was more simply (mis)interpreted
to mean “supply creates its own demand” (even though Say never actually coined
this expression). But Keynes (as well as Malthus as a matter of fact) began to
question this in light of the evidence of demand deficiency-driven mass unemployment,
stating that in a society where goods and services are traded for money,
instead of for each other, demand could indeed be deficient relative to supply –
production didn’t always finance consumption, supply didn’t beget demand, and
prices don’t always move to clear markets.
Smith argued that protectionism could only redirect
resources to less efficient ends, not increase productive capacity. But this
assumed the economy was already at full employment, which makes sense. If
resources are already being fully utilised where they are valued most highly,
protection can only reallocate them somewhere less highly valued. In times of
deficient demand though, government intervention can improve productive capacity
by utilising resources that would not
otherwise be used (rather than just reallocating them between uses). Specifically, tariffs could help at “redirecting
market forces rather than superseding them”.
Keynes arguably blamed Britain’s 1920s slump and the
subsequent Depression on the Gold Standard. By fixing the exchange rate too
high (at its pre-WWI parity), and given the downward ‘stickiness’ of wages, the
only thing that could reflate an economy ‘naturally’ without government
intervention was prolonged and mass unemployment until internal price deflation
did in fact re-establish a country’s relative competitiveness.
Preferably, a floating exchange rate (plus appropriate government
fiscal and Central Bank stimulus) would do this a lot faster and without the
prolonged hardship and human costs. But under a Gold Standard, weaker countries
(deficit countries, which included Britain at the time) were forced to have
high interest rates and costly wage and price deflation to maintain their
external balance (i.e. protect their gold reserves from being exhausted). And
because wages and prices were downwardly ‘sticky’ because of unions[1]
and international integration, mass unemployment was inevitable – making the external
balancing of the Gold Standard inconsistent with internal balance (employment
and prosperity).
The Macmillan Committee, of which Keynes was a part,
recommended international monetary cooperation (coordinated money printing) to
increase the global price level and end the deflation of the Depression without
needing to abandon the Gold Standard. But many on the Committee thought this kind
of cooperation was a fool’s dream, with massive administrative and logistical
difficulties.
The Macmillian Committee also acknowledged the value a
fiscal boost could provide the economy, and the multiplied effect it has during
recessions. In their view, it was conceivable that the extra cost of funding
these investments would be outweighed by the relief to the Unemployment Fund
and the extra tax revenue generated from a larger workforce. But they also
acknowledged the sluggishness with which such government projects often took to
conceive, design, develop and implement – often years. So for future reference,
they recommended the government keep an ‘inventory’ of projects ready to begin,
but only to be initiated in times like this (see my infrastructure body idea blog). This could
include rebuilding and replanning of larger towns and industrial centres which
had lost their maintenance, beauty and convenience, modernisation of some
staple industries, electrification of the railways system, etc. But again, such
an idea wasn’t particularly useful for the immediate-term crisis Britain was
facing.
So, in light of this mass unemployment, the apparent failure
of classical economics, the lack of a functioning international monetary order,
and the sluggishness of government fiscal policy, Keynes became “reluctantly
convinced” that, in the absence of a devaluation of the British pound (or
abandoning the Gold Standard all together) or a national agreement that could
slash wages and salaries, tariffs may be the only option. Where a system doesn’t
automatically tend towards full employment, so the benefits of free trade can’t
be fully enjoyed, it’s a mistake to think of free trade as a universal cure for
all economic ills. Theoretically, by making imports more expensive and encouraging
demand for domestic products, tariffs (plus other supports for exports and
increased government investments) would create an immediate jump in inflation,
ending the downward spiral of deflation and helping finally reflate the
economy. And given the dire short run circumstances facing Britain, it was
acceptable to sacrifice some long run efficiency through the use of tariffs. Furthermore,
other countries had already started imposing tariffs (France and Belgium had
also unilaterally devalued their exchange rates), effectively exporting their unemployment
problems to Britain. So his earlier arguments about trade facilitating peace
were outweighed by an economic emergency.
But Keynes acknowledged this was only a second-best (and only
a short run) option. Flexible exchange rates and a monetary policy that focused
on internal stability (i.e. low interest rates and emergency liquidity) and an
expansionary fiscal policy would be better. Keynes believed tariffs were
beggar-thy-neighbour, only increasing domestic employment at the expense of
foreign employment (though reducing global employment in total), thus probably
eliciting retaliation[2]. Currency depreciation/competitive devaluation also stole
from other countries but was better than tariffs because it “might permit
coordinated reflation without seriously disrupting trade and production”.
Furthermore, Keynes also saw the danger of protectionism
being spread far beyond the initial intention, and all the evils that followed
(just like the critics of
Ashley earlier in the century). Keynes was “frightfully afraid of
protection as a long run policy” in light of the danger that a temporary tariff
might become permanent or distorted by special interests. And when he became
aware that abandonment of the Gold Standard was inevitable (i.e. the external
constraint would be no longer binding), he abandoned his calls for tariffs and
instead called for reflationary measures consistent with free trade – an
immediate 25% devaluation of the pound and accompanying expansionary fiscal and
monetary measures. Unfortunately, the wave of post-Depression protectionism
still pushed forward. And Keynes must have been kicking himself that this
post-Depression pro-protectionist Conservative movement actually employed his
very arguments to push (successfully) for the very protectionism of which he
was afraid, culminating in the Import Duties Act of February 1932, after the external constraint of the
gold standard had been removed.
TODAY
After the damaging trade wars of the 1930s, and WWII, the
process of trade liberalisation has gone virtually unabated, once again showing
the preference of free trade over protectionism.
As for Trump and the US, they are not currently in
Depression (they are in fact pushing the limits of full employment), and they do
not require a sudden reflationary boost. Even if emergency reflation was needed, the modern world’s flexible
exchange rates, plus a government willing to borrow at the crazy-low interest
rates that Central Banks (should) facilitate in such circumstances, would be
preferable, not forcing other countries to foot the bill through tariffs on
their exports.
So the circumstances that may have justified tariffs in the
1930s no longer exist. But as the still-incoming news headlines indicate, just
like before, this protectionism could indeed spread into an all-out trade war.
[1]
Not blaming them, this is just their job.
[2] Bertrand
Russell too suggested that Britain’s abandonment of free trade would provoke
the "far greater readiness of foreign governments to combine against
us".
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