This month marks the inauspicious 90th anniversary of the Smoot-Hawley Tariff Act, perhaps the most ill-advised bill on the economy ever enacted.
An object lesson in how to create a problem that did not exist.
This bill, signed into law by President Herbert Hoover on June 17, 1930, was the tipping point that pushed a nasty recession into the deep and long-lasting Great Depression. Protectionist economic policies,
Victorian-era piety and politics along with a healthy measure of nativism all contributed to a collapse in global trade. That collapse then set in motion the rise of authoritarianism and fascism across the globe, creating conditions ripe for another world war.
Just eight months after the stock market crash in October 1929, Hoover placed tariffs on 900 items with an average of 20%. Smoot-Hawley imposed tariffs on imports of agricultural and industrial goods in a misguided effort to solve what was then considered to be the joint problem of underconsumption and overproduction – too little money not buying too many goods.
U.S. trade partners then retaliated, setting off a chain reaction that resulted in a 65% decline in global trade, beggar-thy-neighbor economic policies and the mother of all banking and currency crises that brought the gold standard to an end.
If there was ever a series of misguided and ill-conceived set of economic and social polices put into place that policymakers would want to avoid, it would be those of the early 1930’s. The lesson that all too many have failed to learn is that the last dying echo of the old order resulted in the creation of economic problems that did not exist, which then set in motion a catastrophic economic collapse.
The U.S. economy after World War I went into hyperdrive due to the electrification of industry. Despite Henry Ford’s insight to pay his workers enough to be able to purchase his Model T’s, the rewards for that increase in productivity would have to wait another two decades. It took another world war and the democratization of opportunity before the wealth and consumption of the working class would be capable of matching the ability of industry to produce.
Smoot-Hawley was the last gasp of a pious, undereducated and unsophisticated ruling class that effectively acknowledged that the U.S. government had no real interest in global economic affairs, or the world order its economy had produced.
A naïve insularity created conditions for a decline in living standards that would not recover for 20 years.
Instead, a naïve insularity that refused to acknowledge the role that trade and global finance played in the economic well-being of American society created conditions for a decline in living standards that would not recover for 20 years. Or more cynically, it was a ham-fisted attempt by congressmen and senators to protect their farming and goods-producing constituencies and the money that kept them in office at the expense of the rest of the public.
Was there a need to protect domestic industry? As shown in the figure below, the merchandise trade balance (exports of U.S. goods minus imports of foreign goods) has rarely been in deficit and was averaging a surplus of $70 million to $100 million in the run-up to the Smoot-Hawley passage.
So instead of protecting U.S. industry from foreign competition, Smoot-Hawley was met by a chorus of retaliatory tariffs. Though imports dropped by a third, exports of U.S. goods to foreign markets dropped by two-thirds. And so a recession that was brought about by the insolvency of the financial sector became a demand crisis, aided and abetted by widespread unemployment and delayed or forgone consumption.
There is, of course, a sophisticated debate over the cause of the Great Depression. Was it the fault of mismanagement of the money supply or adherence to the gold standard, or was it the fault of diminished expectations and the onset of a deflationary spiral? One thing is true: Adherence to outdated and antiquated economic shibboleths such as the gold standard and trade protectionism caused greater economic misery and delayed recovery from the policy-induced catastrophe.
Research has shown that depressions and recessions never occur in a vacuum, but rather as a result of a slowing economy being pushed over the edge by an event — such as the stock market crash of 1929, the collapse of Lehman Brothers in 2008 or the coronavirus pandemic of 2020.
Whether the politicians liked it or not, the globalization of the world’s economy in the early 20th century could not be reversed.
So in 1930, a drought brought the agricultural sector to its knees and sent the struggling people from Oklahoma to California, while Smoot-Hawley ate away at the American industrial base.
Whether the politicians liked it or not, the globalization of the world’s economy in the early 20th century could not be reversed. Instead of creating a rising tide lifting all boats among our European and North American trading partners at the time, their retaliatory tariffs on U.S. exports worked in concert with U.S. isolationism to bring the global marketplace to its knees.
The Depression would eventually result in the abandonment of the gold standard and the acceptance of floating exchange rates, the rejection of mercantilism and protectionism, and the acceptance of free markets and the free exchange of goods and ideas.
Finally, it led to an evolution in modern economic thought. It is the role of government to step in to maintain adequate levels of demand and to protect the well-being and opportunity of its citizens. But it would take the slaughter of millions before isolationism was finally abandoned, allowing a new world order to emerge.
The austerity of the 1930s
As the figure below shows, increasing government spending to minimize economic downturns, to increase potential growth and to increase well-being did not come into acceptance until after the Great Depression. In fact, by 1937, with the economy beginning its climb to normalcy, Congress (and even President Franklin Delano Roosevelt) caught a bad case of austerity and clamped down on the budget deficit that had reached only 5% of gross domestic product.
This sent the economy back into a tailspin that for all intents and purposes did not truly recover until the federal government began increasing spending in preparation for the Second World War.
Since the war, the federal budget has rarely been in surplus. Yet congressional piousness caused spending to contract too quickly after the recession of 2007-9, slowing and stretching the recovery over the next decade.
Will the pandemic end globalization?
That’s the question posed by Nicholas Eberstadt in an essay published by the National Bureau of Asian Research.
The double-digit unemployment rate alone is an undisputable sign that the downturn in U.S. economic growth has been and will be exacerbated by the onset of a health crisis, whose breadth and duration can only be imagined at this point.
Not surprisingly, there have already been calls for shutting down American borders to people and goods, and abandoning progress in integrating all nations into the global community, which is desperately needed to fight this year’s virus and the ones that will inevitably come.
The center of economic gravity has moved from the Atlantic – and the relationship of industrialists in Europe with North America — to the Pacific and the relationship of industrialists in Asia with consumers and suppliers in the Americas and Australia.
According to Eberstadt, “Countries belonging to the Asia-Pacific Economic Cooperation (APEC) account for as much as 60% of the world’s estimated GDP and close to half of global trade. If we add India, which is not an APEC member, to that roster, the economic predominance of the region looks even more overwhelming.”
After 75 years of global integration and American prosperity, will the pandemic give us an excuse to now turn our backs to both Europe and Asia? Will policymakers make the same mistakes that they did during the Great Depression and the Financial Crisis? Given the civil unrest in American streets and the potent mix of recidivist politics in Washington, that risk cannot be ignored.
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