October 10, 2010


Goodbye, Free Trade?: High tariffs and currency wars cost us big in the 1930s. We can avoid making the same mistakes again. (DOUGLAS A. IRWIN, 10/08/10, WSJ)

In his famous 1993 debate with Ross Perot over the North American Free Trade Agreement (Nafta), Vice President Al Gore claimed that Smoot-Hawley "was one of the principal causes, many economists say the principal cause, of the Great Depression in this country and around the world."

In fact, economists across the political spectrum reject this view. Previous tariff hikes, some even larger than Smoot-Hawley, had reduced trade and efficiency, but they didn't produce a macroeconomic catastrophe. When asked if Smoot-Hawley caused the Great Depression, the University of Chicago economist and Nobel laureate Milton Friedman replied: "No. I think the Smoot-Hawley tariff was a bad law. I think it did harm. But the Smoot-Hawley tariff by itself would not have made one-quarter of the labor force unemployed." As Mr. Friedman's own work showed, the money supply and domestic prices had fallen by a third during the Depression, largely because of a malfunctioning gold standard and inept monetary policy on the part of the Federal Reserve. These were the fundamental causes of the economic disaster.

The Smoot-Hawley tariff did not have a huge macroeconomic impact because at the time it was enacted, unlike today, the U.S. was not very open to international trade. Total imports were just a small fraction of gross domestic product, and two-thirds of those imports were consumer goods (coffee, tea) and industrial raw materials (silk, tin) that were exempt from the tariff. In 1929, dutiable imports amounted to just 1.4% of GDP. Smoot-Hawley increased the average tax on them from 38% to 45%. A tax increase of this size on 1.4% of GDP is not enough, by itself, to generate an enormous economic contraction.

That said, the Smoot-Hawley tariff fully deserves its notoriety. It was an ill-timed and ill-judged piece of legislation that backfired spectacularly.

In the first place, it was completely unnecessary. When the legislation was introduced, the unemployment rate was low, and imports were hardly flooding into the U.S. The House passed the bill in May 1929 (Ben Stein was ad libbing and got the date wrong), well before the peak of the business cycle and the stock-market crash.

If Smoot-Hawley lacked any good economic rationale, what motivated Congress to embrace this protectionist measure? The answer, of course, is politics—and here the lessons for today are especially pertinent.

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Posted by Orrin Judd at October 10, 2010 6:46 PM
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