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Friday, September 12, 2003

The Smoot-Hawley Fallacy

In an otherwise excellent post about the dangers of China Bashing and global trade retrenchment, Stephen Roach repeats the point that Andy Xie was making yesterday, about protectionism and the 1930's recession.

In tough economic times, politicians always need a scapegoat. That’s what this wave of China bashing is really all about. It has little to do with economics and everything to do with the blame game. Yet this politically-inspired foray is symptomatic of a much deeper macro problem that now confronts an unbalanced world. The world’s sole growth engine is encumbered with the largest current account deficit in recorded history. Not only does that reflect the inherent pitfalls of a saving-short US economy but it also is a by-product of an utter lack of autonomous domestic demand growth elsewhere in the world. As America pulls the world economy along for the ride, it goes deeper and deeper into the quagmire of trade deficits, budget gaps, saving shortfalls, and excess debt accumulation. This is hardly a sustainable outcome for the US or for the rest of the world. It speaks of a worrisome and dangerous build-up of tensions in the global macro environment. Like steam in a teapot, ultimately these pressures need to be vented. Two options are available -- the economics of a US current-account adjustment or the politics of trade frictions and protectionism. The interplay between America’s jobless recovery and the presidential election cycle is shifting the odds from the economic to the political remedy. Right now those odds are low. But the risk is that they will rise.

In 1930, Senator Reed Smoot and Representative Willis C. Hawley jointly sponsored legislation that significantly raised the level of US tariffs. Courtesy of a recently popped equity bubble, the US economy was in recession, and a Republican administration favored the protectionist remedy as a means to provide relief for hard-pressed American workers. President Herbert Hoover signed the Smoot-Hawley Tariff Act into law in June 1930. Global trade retaliation quickly followed, as did a downward spiral of world trade. Many believe that was the decisive trigger for the Great Depression that was soon to follow. Such painful lessons should not be ignored in today’s post-bubble era. Yet that’s precisely the risk as politics now comes face to face with stresses and strains of globalization. Are we forever doomed to repeat the mistakes of history?
Source: Morgan Stanley Global Economic Forum

Now my point is: why follow-up an extremely good line of attack, with a very questionable one, all you do is weaken your argument. The idea in question: that it was the Smoot-Hawley tarrif that was the 'decisive trigger' for the Great Recession. This argument was advanced by Lloyd Metzler in the 1970's but has never been widely accepted by historians of the problem. My source and guide on this question is, as ever, Christopher Dow

The Hawley-Smoot tarriff of June 1930 has - erroneously, I think - been held responsible by Metzler for 'converting a sizeable recession into a severe depression'. (By June 1930, however, the depression was already severe). Metzler claims that the tarriff altered the 'division of national income', ie it raised the price of final output so that (he argues) output had to fall more. This reasoning assumes that the volume of nominal income in total (price and real components taken together) is fixed and predetermined - a style of logic which I dispute.............The effect of the tarriff was surely the opposite of what Metzler contends. The tarriff increased the effective rate of duty paid on imports by almost 50% between 1929 and 1932. By reducing foreign competition it will have diverted demand from imported to domestic supplies, and raised output.

In other words two things should be apparent. The earlier wave of globalisation did not come to an end in 1930 - most analysts date the change from the end of the first world war, and certainly by the time the US put a cap on immigration in 1922, and secondly, in the context of 1930 it is not clear what the impact of the tarriff was. The traded component at this stage was nothing like it is today. Now here we don't need to reach a final decision about whether Metzler or Dow is right, what we do need to see is that this comparison is ill-founded in that the situations are not comparable (the US is, at least officially, not even in recession) and because it opens the door to a whole host of arguments which are not helpful. Politics loves to get sidetracked.

Now there is one more argument available which might be more important, and that is the one of political credibility. The US has been one of the foremost champions, at least on paper, of globalisation. If the US was to make a U-turn now, apart from the direct economic impact of slowing down the growth of world trade, what - we should be asking - would be the geo-political impact? This argument could be a much more fruitful one to follow up.

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