Splendid Exchange, A

by Bernstein, William L

  The protective system of our day is conservative, while the free trade system is destructive. It breaks up old nationalities and pushes the antagonism of the proletariat and bourgeoisie to the extreme point. In a word, the free trade system hastens the social revolution. In this revolutionary sense alone, gentlemen, I vote in favor of free trade.24

  By identifying who favors and who opposes open markets, Stolper-Samuelson helps to explain political alliances. In the twentieth century, the world would find out that the German coalition of xenophobic, protectionist landowners and capitalists arrayed against socialist, free-trading workers was a prescription for fascism. In nineteenth-century England, on the other hand, capitalists and workers united in favor of free trade against the old landowning oligarchy, a profoundly democratic development. (American capitalists and workers did the same, but with a different objective—protectionism.) Obviously, this interpretation of Stolper-Samuelson, developed by UCLA political scientist Ronald Rogowski, is a simple model that takes no account of race, culture, or history, and Rogowski himself repeatedly cautions that his model is only part of the story. That said, the insights it affords into political processes around the world are remarkable.25

  The rapid erection of tariff barriers between 1880 and 1914 should have choked off global commerce. In fact, no such thing occurred; between those two dates, the volume of world trade approximately tripled, driven by two forces. First, the steam engine continued to prove mightier than the customhouse, as savings on shipping costs more than made up for increased import duties. Second, the planet had grown much richer, with total world real GDP nearly quadrupling during that thirty-four-year period. All other things being equal, wealthier societies trade more, since they have more excess goods to exchange. This means that, in general, the volume of trade grows faster than wealth; between 1720 and 1998, world real GDP grew by an average of 1.5 percent per year, while the real value of trade grew by 2.7 percent per year.26

  Ever since the Civil War, American tariff policy had followed a monotonous cycle of protectionism under Republicans and moderation under Democrats. In the election of 1888, the Republican Benjamin Harrison narrowly defeated the Democrat Grover Cleveland (who actually won the popular vote). The Republican congressional delegation, led by Senator William McKinley, took this as a “mandate” to pass the notorious tariff named after him, which he rode to the presidency eight years later. After the election of the Democrat Woodrow Wilson in 1912, the McKinley Tariff was replaced by the Underwood Tariff, which gradually drove import duties to a historic low of 16 percent in 1920.

  The Underwood Tariff was to be a short-lived victory for American free-traders. Not long after it was passed, the Republicans recaptured the presidency and Congress. Two years later, in 1922, the protectionist Fordney-McCumber Tariff was signed into law by President Harding. Soon enough, import duties stood at over 40 percent.

  Besides being ludicrously high, Republican tariffs tended also to be “autonomous.” That is, they were set by Congress, and while they gave the president power to punish trading partners with higher rates, they did not allow him to decrease levels. Democratic tariffs, such as the Underwood Act, generally left open the possibility of reductions and talks with trading partners, although these options were rarely exploited, for fear of arousing Republican legislators.27

  Between 1830 and 1910, the costs of shipping by sea, canal or river, and land had fallen by 65, 80, and 87 percent, respectively. By World War I, most of the juice had been squeezed out of the transport efficiency orange. Certainly, great advances in transportation—the internal combustion engine, the airplane, and the shipping container—were made in the twentieth century. But by the outbreak of the Great War, even bulk cargoes such as ore, guano, and timber routinely rounded the Horn—and under sail at that. The slowing rate of improvement in transport efficiency no longer offset large tariff increases or a severe downturn in the world economy. Unfortunately, both a worldwide depression and a rapidly escalating tariff wall combined in the fiasco wrought by Herbert Hoover.

  A successful mining engineer who had turned to public service, Hoover rose to prominence directing relief efforts in war-torn Europe. When questioned about the wisdom of feeding Russians, some of who were Bolsheviks, in the aftermath of the revolution, he is said to have replied, “Twenty million people are starving. Whatever their politics, they shall be fed!”28

  Hoover had always been a protectionist, and he remained one during his tenure as secretary of commerce under Harding and Coolidge. Although conversant with mining textbooks, he had either not read or not understood Ricardo and believed that nations should import only those products that could not be produced domestically. In 1928 he overtly appealed to farmers, a traditional Democratic constituency, who had been hurt by falling crop prices:

  [We] realize that there are certain industries which cannot now successfully compete with foreign producers because of lower foreign wages and a lower cost of living abroad, and we pledge the next Republican Congress to an examination and where necessary a revision of these schedules to the end that American labor in these industries can again command the home market, may maintain its standard of living, and may count upon steady employment in its accustomed field.29

  It would have been more accurate to call the bill he eventually signed the “Hoover Tariff,” but that infamy fell instead to its two sponsoring Republicans, Senator Reed Smoot of Utah and Representative Willis Hawley of Oregon. Raising the average tariff on dutiable goods to nearly 60 percent, Smoot-Hawley was no bolt from the blue; it merely propelled the already high rates of the Fordney-McCumber Act into the stratosphere.

  Even before Smoot-Hawley’s passage, two groups reacted with horror: Europeans and economists. By the time the legislation reached the Senate, foreign ministries the world over sent protests to the State Department and boycotts were already under way; virtually all American economists of any stature—1,028 in all—signed a petition to Hoover pleading for a veto.30

  To no avail. On June 17, 1930, he signed Smoot-Hawley into law and so set off retaliation and trade war. Covering tens of thousands of items, the bill seemed designed to offend every last trading partner. It deployed many “non-tariff barriers” as well. For example, bottle corks constituted about half of Spanish exports to the United States; not only did the new law increase the tariffs on corks to prohibitive levels, it also required that they be stamped with their country of origin, a process that actually cost more than the cork itself.

  The act slapped high tariffs on foreign watches, particularly inexpensive ones that competed with American “dollar watches.” One Swiss worker in ten either labored in, or was closely connected to, the watch industry, and the issue galvanized the normally agreeable and peaceable nation into righteous anger. The watches and corks nicely illustrate the impotence of small nations; whereas shipments to the United States accounted for 10 percent of Swiss exports, trade in the reverse direction accounted for only one tenth of 1 percent of American exports. The feeling of helplessness among the Swiss and Spaniards magnified their anger.

  The Continent’s large nations, Italy, France, and Germany, were in a better position to land punches, and they did so against the pride of American industry: its automobiles and radios, raising average import duties on these items well above 50 percent. It took no small provocation to goad Benito Mussolini into action on this issue; an auto aficionado who loathed the indifferent quality of Italy’s largest manufacturer, Fiat, Il Duce had for years resisted the protectionist demands of its president, Giovanni Agnelli. Smoot-Hawley finally exhausted his patience, and he responded with tariffs approaching 100 percent that almost completely shut off imports of American vehicles.31 (Some things really never do change: the Agnellis continued to control Fiat, produce lousy cars, and demand protection almost into the twenty-first century.) By 1932, even free-trading England piled on, passing a 10 percent tariff on most imported goods and convening a Commonwealth Conference in Ottawa that erected a protectionis
t wall around the empire.

  So it went, all over the world, for three years after the passage of Smoot-Hawley in 1930, as French lace, Spanish fruit, Canadian timber, Argentine beef, Swiss watches, and American cars slowly disappeared from the world’s wharves. By 1933 the entire globe seemed headed for what economists call autarky—a condition in which nations achieve self-sufficiency in all products, no matter how inept they are at producing them.

  America had brought the world to the brink of international commercial collapse, and it would take an American to reverse the process. Born in a log cabin in tobacco-growing eastern Tennessee, Cordell Hull had acquired a homespun understanding of Ricardian economics and, more important, of the moral value of trade. His grasp of the subject is best revealed by this passage from his memoirs:

  When I was a boy on the farm in Tennessee, we had two neighbors—I’ll call them Jenkins and Jones—who were enemies of each other. For many years there had been bad feeling between them—I don’t know why—and when they met on the road or in town or at church, they stared at each other coldly and didn’t speak.

  Then one of Jenkins’ mules went lame in the spring just when Jenkins needed him the most for plowing. At the same time Jones ran short of corn for hogs. Now it happened that Jones was through with his own plowing and had a mule to spare, and Jenkins had a bin filled with corn. A friendly third party brought the two men together, and Jones let Jenkins use his mule in exchange for corn for the hogs.

  As a result, it wasn’t long before the two old enemies were the best of friends. A common-sense trade and ordinary neighborliness had made them aware of their economic need of each other and brought them peace.32

  As a Democratic congressman for nearly a quarter century, Hull fought a valiant rearguard action against both Fordney-McCumber and Smoot-Hawley, and in 1930 he won a Senate seat, only to resign it two years later when Roosevelt chose him as secretary of state. On his arrival at Foggy Bottom, he was confronted by no fewer than thirty-four formal protests against American tariffs from foreign governments.

  Like Cobden a century before, he took his message to the country, and then he took it abroad. With trade approaching a standstill and the world in the throes of depression, he reasoned to anyone who would listen that in the present sorry circumstances: “It should be obvious [that] high tariffs could not be the infallible and inevitable producers of prosperity they had been represented to be.”33 Foreign nations, he continued, could not be expected to purchase our products if they could not earn cash by selling to us.

  His toughest audience was the new president, whose fear of the Republicans drove him to almost immediately backtrack from his campaign promises of free trade. Hull gradually won him over by pointing out that the Fordney-McCumber and Smoot-Hawley tariffs emasculated the president’s ability to conduct international commercial relations. The wily Hull proposed to Roosevelt that Smoot-Hawley be merely “amended” to allow the president to increase or decrease its rates by half and to unilaterally offer foreign nations other limited concessions, such as a guarantee that an item on the duty-free list would remain there. The resultant legislation, the Reciprocal Trade Agreements Act of 1934, checked the world’s nearly half-century march toward protection and autarky. It ran for three years, and was then repeatedly renewed by Congress.

  Hull began modestly and first negotiated an agreement with Cuba, then peeled Canada away from the Ottawa Accords. Next, he negotiated agreements with most of the rest of the hemisphere, followed by treaties with the major European nations, Australia, and New Zealand before finally negotiating a largely symbolic agreement with England just as the lights were going out in Europe for the second time in a generation. Hull served the longest term as secretary of state in American history—just under twelve years—before finally resigning in 1944 because of poor health.

  There had, of course, been winners during the trade debacle of 1930– 1933: Fiat, wine growers in California, watchmakers in Waltham, Massachusetts, and radio manufacturers in Germany. But overall, damage had been done. How much? From an economic perspective, surprisingly little. In the first place, since economic growth is such a powerful driver of trade, proving an effect in the opposite direction—that protectionism makes the world poor (or that free trade makes it rich)—is problematic. Between 1929 and 1932, real GDP fell by 17 percent worldwide, and by 26 percent in the United States, but most economic historians now believe that only a minuscule part of that huge loss of both world GDP and the United States’ GDP can be ascribed to the tariff wars.

  A back-of-the-envelope calculation shows that this must have been true. 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.34 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.

  Even more impressively, the nations most dependent on trade did not suffer the most damage. For example, in Holland, trade accounted for 17 percent of GDP, and yet its economy contracted by only 8 percent in those years. By contrast, trade constituted less than 4 percent of the United States’ GDP, yet its economy contracted by 26 percent during the Depression.35 The inescapable conclusion: contrary to public perception, Smoot-Hawley did not cause, or even significantly deepen, the Great Depression.36

  If the 1930s trade war did not greatly harm the world economy, it certainly choked off international commerce. As just mentioned, world trade fell dramatically during the Smoot-Hawley years. Between 1914 and 1944, world trade volume remained stagnant, an unprecedented event in three decades of modern history, during which world GDP had approximately doubled in spite of two devastating global conflicts.

  Recently, economic historians have calculated that the tariff wars of the 1930s caused less than half of this falloff in trade, the rest being due to the Great Depression itself, which decreased demand for trade products. Interestingly, the combination of “specific tariffs” and deflation caused at least as much unintentional damage as the intentional increases in tariff rates. Specific tariffs are those calculated on a per pound or per unit basis; if the price per pound falls and the amount of tariff per pound does not, this unintentionally increases the effective ad valorem rates. That is, a specific tariff of twenty cents per pound on meat worth forty cents amounts to a 50 percent tariff; if the price of the meat falls to twenty cents, the effective ad valorem rate is now 100 percent.37

  The real long-term damage done by the tariff war was not to the world economy, which was minimal, or even to world commerce, which recovered relatively rapidly. Rather, it was the damage to the intangibles of trade: the expansion of consumption beyond domestic goods, commerce with and living among foreigners, and understanding their motives and concerns. Farmers Jones and Jenkins of Hull’s parable were finally made to understand that they were worth more to each other alive than dead, but in the run-up to World War II, the nations of the world did not realize this until it was too late. The political and moral benefits of trade had in fact been eloquently described by John Stuart Mill nearly a century before:

  The economical advantages of commerce are surpassed in importance by those of its effects which are intellectual and moral. It is hardly possible to overrate the value, in the present low state of human improvement, of placing human beings in contact with persons dissimilar to themselves, and with modes of thought and action unlike those with which they are familiar. . . . Commerce first taught nations to see with goodwill the wealth and prosperity of one another. Before, the patriot, unless sufficiently advanced to feel the world his country, wished all countries weak, poor, and
ill-governed but his own: he now sees in their wealth and progress a direct source of wealth and progress to his own country.38

  During the first half of the twentieth century, patriots around the world less and less felt the world their country, and this would cause no little grief. America learned the hard way that protection invites retaliation; a nation cannot trade out without trading in.

  America also learned that a trade war could start a real war, and even before the United States entered World War II, historians and statesmen sensed that its isolationism and protectionism had contributed to the cataclysm. The historian John Bell Condliffe, writing in 1940, presciently observed, “If an international system is to be restored, it must be an American-dominated system, based on Pax Americana.”39 Albert Hirschman, a participant in the events of the period, noted in 1945:

  [Trade wars] undoubtedly sharpen national antagonisms. They also provide excellent opportunities for nationalist leaders to arouse popular resentment . . . international economic relations provide them with an excellent instrument to achieve their ends, just as a promise of a quick and crushing victory by means of aerial superiority undoubtedly contributed in a most important way to the present war.40

  As the United States emerged from the horrors of World War II, it began the long, difficult job of dismantling the tariff walls erected over most of the preceding century. Those seeking the origins of today’s globalized, multinational-dominated economy will find it in a long-forgotten State Department report published in 1945, Proposals for the Expansion of Trade and Employment. Although this remarkable document originated within the American wartime bureaucracy, it was infused with the spirits of Smith, Ricardo, Cobden, and Hull.41