Lessons Learned—and Forgotten—From the Last Trade War

(Bloomberg) -- The U.S. and the European Union have agreed to a trade-war ceasefire -- at least for now -- but President Donald Trump remains locked in a tariff battle with China, has imposed tariffs on steel and aluminum from most of the world, and threatens to pull out of a trade agreement with Canada and Mexico unless it’s modified to his liking. It all evokes comparisons with the last global conflagration over trade during the Great Depression. Back then, President Herbert Hoover signed the Tariff Act of 1930, commonly known as the Smoot-Hawley law, which raised already-high tariffs on hundreds of imports. Other countries retaliated, paving the way for the spread of protectionism worldwide and worsening the Depression in the process. It took decades to reverse the damage. Is history repeating itself?

1. Why were higher tariffs imposed in the 1930s?

Hoover, a Republican, won election in 1928 with a promise to raise tariffs on agricultural imports to help heavily indebted farmers hit by falling commodity and land prices. The duties were extended to include manufacturers as lawmakers traded favors during a tortuous, 18-month legislative process. Despite opposition from more than 1,000 economists and such prominent newspaper columnists as Walter Lippmann, Hoover in June 1930 signed the measure, named for its main sponsors, Senator Reed Smoot of Utah and Representative Willis Hawley of Oregon. The stock market had already collapsed in October 1929.

2. What exactly did Smoot-Hawley do?

It raised tariffs on imports of almost 900 items, including everything from sugar and eggs to clothespins and oil drums. Tariffs on affected imports initially rose by about 15 percent to 20 percent, to more than 40 percent. As prices collapsed due to the Great Depression, the average tariff rate effectively rose further. That’s because many of the duties were expressed as a fixed dollar amount by volume or weight, not as a percentage of the import price. For example, the law raised the tax on sugar imports from Cuba to 2 cents per pound, from 1.76 cents -- a levy that was applied no matter what sugar cost, even if it fell below 2 cents a pound. Dartmouth College professor Douglas Irwin has written that the average tariff effectively peaked at more than 59 percent in 1932, exceeded only by the so-called Tariff of Abominations of 1828.

3. What happened once Smoot-Hawley took effect?

Over the next two years, the volume of U.S. imports and exports plunged by about 40 percent as trading partners retaliated with their own tariffs. Foreign producers cut back or stopped shipments to the U.S. because it was no longer profitable to sell there. Some U.S. exporters had to pay more for the imported materials they used to make their final products and faced higher trade barriers abroad. American farmers, who were supposed to be Smoot-Hawley’s main beneficiaries, saw their crop prices collapse and exports decline.

4. How do Trump’s tariffs compare?

Trump looks to be a bit of a piker compared with Hoover, although that could change if the truce with the EU breaks down. So far, he has slapped tariffs on imports of steel, aluminum, washing machines and solar panels from much of the world. He’s also put in place duties on $34 billion worth of products imported from China, and lined up a list of $16 billion more. All of that amounts to about 5 percent of U.S. imports. In 1930, about a third of imports were subject to duties. But if Trump imposes tariff hikes on virtually all of China’s shipments to the U.S. -- as he has threatened to do -- that would bring the proportion of imports covered to about 25 percent.

5. How else are Trump’s tariffs reminiscent of Smoot-Hawley?

Now, as then, the supposed beneficiaries of the tariffs are also the ones being hurt. Examples include Whirlpool Corp. and Harley-Davidson Inc., which have been caught in the crossfire of Trump’s trade war. The Trump Administration also has had to use the Commodity Credit Corporation, an agency created during the Depression to support crop prices, to fund a $12 billion aid package to compensate U.S. farmers, whose exports have been targeted by other countries with retaliatory tariffs. But the reactions of other countries so far have been different. While they’ve slapped retaliatory tariffs on exports from the U.S., they haven’t imposed duties on shipments from one another -- as they did during the 1930s. Some have even done the opposite by signing new trade agreements.

6. Could Trump cause another Depression?

Not likely. The outburst of protectionism in the 1930s contributed to the collapse of trade at the time. But many economists don’t think it was the trigger for the Great Depression. Instead, they blame the U.S. Federal Reserve and other central banks for their strict adherence to the gold standard, under which currency values were tied to that of a scarce commodity, gold. Instead of devaluing the dollar to help U.S. exports remain competitive, the Fed did the opposite by keeping interest rates high and monetary policy tight, even as the stock market plunged, banks went bust and the economy cratered, driving unemployment to about 25 percent. That’s a blunderbuss move that the current crop of policy makers won’t make.

7. So there’s nothing to worry about?

Not exactly. While central bankers have the smarts to avoid another depression, they can’t completely offset the ill effects of a trade war by cutting interest rates. A prolonged tariff conflict would probably push up inflation, slow down economic growth and, in a worst-case scenario, tip the U.S. and the rest of the world into recession.

The Reference Shelf

  • Two prominent economists argue in a research paper that protectionism was the result, not the cause, of the Great Depression.
  • This book chronicles the passage and consequences of the Smoot-Hawley tariffs.
  • These Bloomberg QuickTakes explain the likely effects of Trump’s threatened auto tariffs, what a trade war is, the World Trade Organization’s precarious situation, Trump’s pique with China and what became of the Trans-Pacific Partnership from which Trump withdrew.
  • A Bloomberg columnist explains how the trade war is becoming a currency war and a Bloomberg editorial welcomes recent trade-liberalizing agreements.

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