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April 9, 2010

Protectionism Didn't Cause the Great Depression

By Ian Fletcher
The debate over free trade is riddled with myth after myth. One that keeps resurfacing, no matter how many times it is discredited, is the idea that protectionism caused the Great Depression. One occasionally even hears that this same protectionism -- specifically, the Smoot-Hawley tariff of 1930 -- was responsible in significant part for World War Two! This is nonsense dreamed up for propaganda purposes by free traders, and it can easily be debunked.

Let's start by reminding ourselves of a basic fact: The Depression's cause was monetary. The Federal Reserve had allowed the money supply to balloon excessively during the late 1920s, causing it to pile up in the stock market as a bubble. The Fed then panicked, miscalculated, and let the money supply collapse by a third by 1933, depriving the economy of the liquidity it needed to breathe. Trade had nothing to do with it.

The Smoot-Hawley tariff was simply too small a policy change to have so large an effect as triggering a depression. For a start, it applied to only about one-third of America's trade: about 1.3 percent of our GDP. One point three percent! America's average tariff on goods subject to tariff went from 44.6 to 53.2 percent -- not a very big jump at all. America's tariffs were higher in almost every year from 1821 to 1914. Our tariffs went up in 1861, 1864, 1890, and 1922 without producing global depressions, and the great recessions of 1873 and 1893 spread worldwide without needing the help of any tariff increases.

If Smoot-Hawley had caused a global trade disaster, it would necessarily have been by triggering a sharp decline in American imports of goods subject to the increased tariff. Did this happen? The data say no. In the words of economic historian, former member of the U.S. International Trade Commission, and avowed free trader Prof. Alfred E. Eckes,

Official data show that higher U.S. tariffs had little impact on American imports. From 1929 to 1932, imports of dutiable and duty-free goods fell almost the same percentage, suggesting that higher tariffs had little impact on most trading partners ... The sharpest drop in exports involved commodity-exporting countries, including some like Brazil, largely unaffected by higher U.S. tariffs.

World trade did indeed decline, but this was due to the Depression itself, not higher American tariffs. This is no surprise, as declines in the values of the currencies of America's major trading partners wiped away much of the effect of the tariff anyway.

In light of the facts noted above, it is, in fact, true that just about every serious economist or economic historian -- as opposed to the ideologues of the editorial pages or the think-tanks -- who has examined this question in detail has come to the same conclusion. This is not a liberal vs. conservative issue, either: Famous economists who have denied that Smoot-Hawley caused the Depression range from Milton Friedman on the right to Paul Krugman on the left. 

The same fact can be ascertained by looking at Smoot-Hawley's impact on the world economy at large. As the economic historian (and free trader) William Bernstein puts it in his book A Splendid Exchange: How Trade Shaped the World,

Between 1929 and 1932, real GDP fell 17 percent worldwide, and by 26 percent in the United States, but most economic historians now believe that only a miniscule part of that huge loss of both world GDP and the United States' GDP can be ascribed to the tariff wars. ... At the time of Smoot-Hawley's passage, trade volume accounted for only about 9 percent of world economic output. Had all international trade been eliminated, and had no domestic use for the previously exported goods been found, world GDP would have fallen by the same amount -- 9 percent. Between 1930 and 1933, worldwide trade volume fell off by one-third to one-half. Depending on how the falloff is measured, this computes to 3 to 5 percent of world GDP, and these losses were partially made up by more expensive domestic goods. Thus, the damage done could not possibly have exceeded 1 or 2 percent of world GDP -- nowhere near the 17 percent falloff seen during the Great Depression. ... The inescapable conclusion: contrary to public perception, Smoot-Hawley did not cause, or even significantly deepen, the Great Depression.

The oft-bandied idea that Smoot-Hawley started a global trade war of endless cycles of tit-for-tat retaliation is also mythical. According to the official State Department report on this very question in 1931:

With the exception of discriminations in France, the extent of discrimination against American commerce is very slight ... By far the largest number of countries do not discriminate against the commerce of the United States in any way.

That is to say, foreign nations did indeed raise their tariffs after the passage of Smoot, but this was a broad-brush response to the Depression itself, aimed at all other foreign nations without distinction, and not a retaliation against the U.S. for its own tariff. The doom-loop of spiraling tit-for-tat retaliation between trading partners that paralyzes free traders with fear today simply did not happen.

The myth of Smoot-Hawley continues to poison U.S. policymaking even today, as it renders the U.S. government fearful of retaliating against problems like Chinese currency manipulation. But hopefully, the present controversy over free trade will eventually provoke enough public debate that this hoary myth can finally be put to bed forever. 

Ian Fletcher is the author of Free Trade Doesn't Work: What Should Replace It and Why (USBIC, $24.95) and an Adjunct Fellow at the San Francisco office of the U.S. Business and Industry Council, a Washington think-tank founded in 1933. He may be contacted at ian.fletcher@usbic.net.
on "Protectionism Didn't Cause the Great Depression"