Clashing Over Commerce: A History of US Trade Policy (Markets and Governments in Economic History)

by Douglas A. Irwin

So what led to the great merger wave from 1897 to 1903, if not the tariff? Ironically enough, the antitrust laws may have been a contributing factor. In 1890, Congress passed the Sherman Antitrust Act prohibiting contracts or combinations in restraint of trade. Three key Supreme Court decisions in the late 1890s ruled that cartels, or horizontal agreements to fix prices, were illegal, but mergers that accomplished the same result were legal. By making informal business cartels illegal, the Sherman Antitrust Act may have triggered the mergers that resulted in legal consolidations.85

In 1908, the steel magnate Andrew Carnegie publicly stated that the tariff on imported iron and steel could be safely eliminated without any significant effect on domestic production. He argued that the iron and steel industry was well past the point of being an infant industry, and the industry could fend for itself without fear of foreign competition. Steel producers no longer needed protection “because steel is now produced cheaper here than anywhere else, notwithstanding the higher wages paid per man,” Carnegie (1908, 202) argued. “That there is a cult who regard [the doctrine of protection] as sacrosanct and everlasting, none knows better than the writer; but its members are few and not likely to increase, since our country has admittedly developed and gained, and is to continue gaining, manufacturing supremacy in one department after another until it reaches a position where free trade in manufactures would be desirable for it, all the markets of the world open to her, and hers to the world,” he continued. “Our difficulty will then be to get other nations to agree to free trade.”

With a sharp wit and incomparable command of business details, Carnegie humiliated his inquisitors and made them seem like ignorant, misinformed fools who were way out of their league in arguing that American industry still needed protection.

the 1913 tariff bill also contained an income tax.

This monumental change in the tax system severed the already tenuous link between protective import duties and the revenue requirements of the government. The income tax ended the dependence of the federal government on import duties for a substantial fraction of its revenues. In fiscal year 1913, customs receipts accounted for 45 percent of federal revenue. In fiscal year 1916, this had fallen to 28 percent. After World War I, the share was less than 5 percent.22 Because the nation’s personal and corporate income constituted a significantly larger tax base than just imports, the federal government now had access to a potentially enormous source of revenue. This set the stage for large increases in government expenditures in the future.

In January 1918, President Wilson delivered his famous “Fourteen Points” address before a joint session of Congress. Wilson set out his vision of how the United States could help establish a new postwar world based on national self-determination and international cooperation, bringing secret diplomacy to an end and making World War I “the war to end all wars.” The centerpiece of his proposal was the creation of a League of Nations that would guarantee political independence and territorial integrity, thereby preventing future military conflicts. Wilson’s second and third points related to trade policy. The second called for absolute freedom of navigation on the seas. The third proposed “the removal, so far as possible, of all economic barriers and the establishment of an equality of trade conditions among all the nations consenting to the peace and associating themselves for its maintenance.”39 In effect, Wilson was calling for international cooperation to reduce trade barriers and ensure that non-discrimination was the basis for commercial relations around the world.

During the war, the nation’s new central bank, the Federal Reserve, which had been created in 1913, banned the export of gold and agreed to purchase Treasury securities to help finance the war. The consequent monetary expansion resulted in a rise in domestic inflation, which reached nearly 20 percent by 1918.

By mid-1920, prices, output, and employment were all plummeting. The United States experienced one of the most intense deflations in its history: wholesale prices dropped 26 percent between June and December 1920; by June 1921, wholesale prices were 42 percent below where they had been a year earlier, and farm prices had fallen even more. Real output also declined sharply: farm production dropped 14 percent in 1921, and industrial production fell 26 percent in the year after June 1920. The unemployment rate jumped from 2 percent in 1919 to 11 percent in 1921.50

Once again, a battle between the agricultural Midwest and the industrial East was postponed. But the agrarian demands for tariff reform and new tariff legislation would force Congress to revisit the issue sooner than the Republican leadership had expected or desired. The insurgents demanded a revision that would reduce tariffs on industrial products and increase them on agricultural goods, thereby supposedly providing relief for America’s ailing farmers. It is ironic that the seeds of the Hawley-Smoot tariff were laid not by greedy industrial lobbyists or the Republican leadership, but by progressive Republicans from the Midwest.

The bill was then referred to the Senate Finance Committee, chaired by Reed Smoot of Utah. Smoot was widely recognized as an exceptionally capable and indefatigable legislator who was unquestionably the most knowledgeable member of Congress about the details of the tariff schedule. He was also a committed protectionist who, as a matter of principle, opposed almost any reduction in tariff rates.20 A leader in the Mormon church, Smoot was known as the “apostle of protection” and “the sugar senator” because of his staunch defense of Utah’s sugar beet industry.

With its work on the tariff unfinished, the Senate adjourned for the year in late November, just weeks after a major crash in the stock market. The Federal Reserve had started raising interest rates in January 1929 in an effort to reign in surging stock prices. This tightening of monetary policy began to slow the economy and eventually produced a sharp fall in asset prices. The stock market collapse in late October signaled uncertainty about the nation’s economic outlook. Some observers have linked the stock market crash to Congress’s consideration of the tariff, but it is highly unlikely that the congressional debate had any significant impact on financial markets.28

One of the ironies of the Hawley-Smoot tariff is that it did not originate as a result of pressure from manufacturers. Instead, it originated from progressive Republicans who thought a tariff adjustment—in the vain hope of achieving “tariff equality”—would help its agricultural constituents. The tariff revision was offered by politicians rather than demanded by interest groups. However, once the door was open to changing the tariff for some groups, others—namely, small and medium-sized businesses in manufacturing, even if not suffering from increased foreign competition—were only too happy to take advantage of the situation for themselves. The episode illustrates how politicians can use economic interests for their own purposes, not just the other way around.

Schattschneider (1935, 127–28) explained the imbalance between the forces in favor of higher tariffs and those opposed on the grounds that the “benefits are concentrated while costs are distributed.”

Because the Depression followed so closely on the heels of the tariff increase, many people at the time believed that the Hawley-Smoot tariff was responsible for the economic disaster. However, as in the case of previous downturns, the consensus among economic historians is that monetary and financial factors were the dominant cause of the Great Depression. Friedman and Schwartz (1963) contend that a banking panic in October 1930 led to a large, unanticipated fall in the money supply that turned what had been a fairly normal recession into the Great Depression. The panic led the public to withdraw currency from the banking system because there was no deposit insurance; if a bank failed, depositors would lose all of their money. The loss of deposits forced banks to curtail lending, which reduced investment spending, and contributed to the decline in the money supply, which led to deflation and reinforced all these problems. With deflation, real interest rates soared, and investment collapsed. Falling prices also increased the real burden of debt, making it harder for borrowers to repay banks, which in turn increased the fragility of the financial system. Many economists blame the Federal Reserve for not taking more aggressive action to stop the bank failures and the decline in the money supply, actions that could have prevented the Depression.68

Given the overriding importance of monetary and financial factors in bringing about the Great Depression, the Hawley-Smoot tariff almost surely played a relatively small role in the economic crisis. In 1929, dutiable imports constituted just 1.4 percent of GDP. It is hard to believe that an increase in the average tariff from 40 percent to 46 percent on those imports could lead to an economic collapse on the scale of the Great Depression. As we have seen in earlier chapters, there are no strong theoretical or empirical grounds for concluding that higher tariffs are driving factors in business-cycle fluctuations. For example, the much larger Fordney-McCumber tariff increase in 1922 was followed by an economic recovery, itself the result of other factors.

Finally, there was another factor at work: a severe drought in the late summer of 1930 that devastated the south-central United States.

“The Hawley-Smoot tariff in the United States was the signal for an outburst of tariff-making activity in other countries, partly at least by way of reprisals,” the League of Nations (1932, 193) reported at the time. “Extensive increases in duties were made almost immediately by Canada, Cuba, Mexico, France, Italy, [and] Spain.”

Thus, the entire multilateral system of world trade was shattered by events of the early 1930s. Trade was burdened not just with higher tariffs, but a proliferation of import-licensing requirements, quotas and quantitative restrictions, foreign exchange controls, bilateral and preferential trade agreements, bulk trading and barter arrangements, and so on.88 These policies severely impeded world trade, the volume of which fell by 26 percent between 1929 and 1933. Nearly half of this decline was due to higher tariffs and non-tariff barriers, according to Madsen (2001), many of which discriminated against the United States.

The Ottawa agreements of 1932 created a system of imperial preferences aimed at keeping US goods out of major export markets, such as Canada and Britain. Germany also established preferential trade arrangements with southeastern Europe, while Japan set up the so-called “Greater East Asia Co-Prosperity Sphere.” Standing outside of these trade blocs, the United States saw its share of world trade shrink.

Hull (1948, 357) later contended that “in both House and Senate we were aided by the severe reaction of public opinion against the Smoot-Hawley Act.” In fact, the passage of the RTAA simply reflected the massive change in the partisan composition of Congress, with Democrats replacing Republicans. After examining the votes of all members of Congress who voted on both Hawley-Smoot and the RTAA, Schnietz (2000) clearly shows that Congress did not “change its mind” about the wisdom of the Hawley-Smoot tariff. That would imply that members who voted for Hawley-Smoot later regretted its consequences and voted for the RTAA. Of the ninety-five members of Congress who voted in favor of Hawley-Smoot, only nine voted in favor of the RTAA. Of those nine, seven were Democrats; only two of eighty-six Republicans changed their view.

Thus, the immediate postwar period was an enormously eventful one for US trade policy. The main objective of policy had shifted decisively from restriction to reciprocity. A bipartisan consensus had emerged to support efforts to take gradual steps to free world trade from government-imposed trade barriers. The domestic debate was less about whether tariffs should be reduced in concert with other countries, but about the particular ways of helping a few import-competing industries cope with foreign competition. Furthermore, the US-led efforts to reduce trade restrictions around the world had borne fruit. Although the ITO had failed, the GATT largely established non-discrimination and unconditional MFN as benchmarks for trade policy among a core set of countries. The GATT signaled that the developed countries were not going to revert to interwar protectionism but would instead promote the expansion of world trade in the years to come.

Responsibility for negotiating the agreement fell to Undersecretary of State George Ball. It was not a task that he and other liberals relished. As Ball (1982, 188) recalled, “During his Presidential campaign, [Kennedy] had committed himself to taking care of textile import problems, and the industry promptly demanded that he redeem his promise. The President turned the problem over to me. It caused me more personal anguish than any other task I undertook during my total of twelve years in different branches of the government.” Ball fundamentally opposed protecting the industry and could not understand why domestic producers did not invest abroad to take advantage of lower wages in Asia: “Rather than concentrating 1.3 percent of our labor force on the production of textiles, our country might have shifted more rapidly to the capital-intensive and knowledge-intensive industries and services that befitted a nation with an advanced economy” (188).

What was happening to make Congress adopt a more protectionist outlook? Ever since the Reciprocal Trade Agreements Act in 1934, Congress had taken a step back from active control over trade policy. Although it refused to endorse the International Trade Organization in the 1940s and other trade initiatives in the 1950s, Congress had accepted most executive branch actions on trade policy. The Mills bill of 1970 represented a reassertion of congressional authority to regulate trade and threatened a significant departure from the trade policies established after World War II. This change reflected an important new development: some domestic industries were now facing much greater foreign competition than they had seen in many decades, if ever. Trade politics was about to become much more difficult simply because imports were starting to play a much larger role in the economy. After World War II, imports were less than 3 percent of GDP, an unusually low level in historical terms. Because the economic recovery of Western Europe and Japan from the war had taken so long, imports as a share of GDP were no higher in 1965 than they had been in 1950. Starting in the mid-1960s, however, imports began to rise while exports remained at about the same proportion of GDP.

Aside from the postwar economic boom, another factor behind the expansion in world trade was the container revolution.

In addition, the Office of the US Trade Representative (USTR) was formally created and given primary responsibility for formulating and coordinating trade policy in the executive branch. USTR had principal responsibility for negotiating trade agreements, but in doing so it had to reflect a balanced perspective from many government agencies, including those representing foreign-policy interests (State Department), business interests (Commerce Department), farm interests (Agricultural Department), worker interests (Labor Department), competition concerns (Justice Department), and consumers and economic efficiency interests (Council of Economic Advisers). Thus, USTR led an extensive, interagency consultative process that guided the formulation of US trade policy.

After rising by nearly 4 million during the 1960s, manufacturing employment oscillated between 18.5 and 21.0 million workers during the 1970s and 1980s. Large declines in manufacturing employment were seen in 1968–70, 1973–74, and 1979–82. In the first two periods, the declines were almost entirely cyclical, coinciding with recessions and largely unrelated to trade. But in 1981–82, when manufacturing employment fell 12 percent, a loss of nearly 3 million jobs, about a third of the employment decline was due to trade—the fall in manufactured exports and rise in imports—and the other two-thirds were due to the recession.6

The failure of agreements with Japan to put a significant dent in its large trade surplus should not have been unexpected: opening up particular markets on a piecemeal basis might help some exporters sell more in Japan, but the bilateral trade deficit did not exist because Japan imported “too little” in protected sectors. Rather, it existed because Japan was experiencing large capital outflows, a matter entirely outside the scope of trade negotiations.

Economists generally agreed with these conclusions and supported NAFTA. More than three hundred economists of all political stripes, including several Nobel laureates, signed a petition endorsing the agreement. Paul Krugman (1993) summarized NAFTA in five simple propositions: (1) that it would have no effect on the number of jobs in the United States; (2) that it would not hurt and might help the environment; (3) that it would produce a small gain in real income for the United States; (4) that it would probably lead to a slight fall in real wages of unskilled American workers; and (5) that NAFTA was really a foreign-policy issue rather than an economic issue. Along with most economists, Krugman (1993, 13) believed that “the intensity of this debate cannot be understood in terms of the real content or likely consequences of the agreement, nor is the debate’s outcome likely to turn on any serious examination of the evidence.” Instead, he argued, “the hard-core opposition to NAFTA is rooted in a modern populism that desperately wants to defend industrial America against the forces that are transforming us into a service economy. International trade in general and trade with Mexico in particular have little to do with those forces; clinging to the four percent average tariff the United States currently levies on imports of manufactures from Mexico might save a few low-wage industrial jobs for a little while, but it would do almost nothing to stop or even slow the long-run tren...

What was the economic impact of NAFTA? For all the fears about a “giant sucking sound,” the United States experienced an exceptionally strong labor market in the mid- to late-1990s. The unemployment rate fell to less than 4 percent by late 2000, manufacturing employment held steady, and wages rose even for less-skilled workers. Imports did not cause a pronounced increase in worker displacement. While NAFTA accelerated the decline in apparel employment, studies showed that the agreement did not have a major impact on either net employment or gross job flows in other trade-affected industries.47 Later studies found that NAFTA had a substantial impact on trade but modest effects on prices and welfare.48 NAFTA promoted rapid growth in bilateral trade, and the North American economy became more integrated. While critics focused on the growth of imports from Mexico, about 40 percent of the value of those imports consisted of US-made intermediate goods and components, although this suggested the loss of some labor-intensive assembly jobs. In all, NAFTA did not exacerbate or ameliorate many of the existing problems facing the two economies. In retrospect, Hufbauer and Schott (2005, 4) point out that “much of what was promised from NAFTA could never be achieved solely through a free trade deal; much of what has occurred since NAFTA was ratified cannot be attributed to policy changes that the trade pact mandated.”

Imports from China were also far from being the most important factor in the decline in manufacturing employment at this time. The production of manufactured goods was going through a revolution in which new technology and capital equipment, employing just a few skilled workers (such as engineers), were able to produce more and more goods with less and less labor. For example, in the 1980s it took 10 labor hours to produce a ton of steel; by 2015 that figure was down to 2 labor hours. One study attributed 87 percent of job loss in manufacturing between 2000 and 2010 to improved productivity and only 13 percent to trade. However, there were two outliers in which job losses due to trade were much higher: 40 percent in the case of furniture and 44 percent in the case of apparel and leather, both unskilled, labor-intensive industries.101

As a result, “the recent increase in US inequality has little to do with global forces that might be expected to especially affect unskilled workers—namely, immigration and expanded trade with developing countries,” Lawrence (2008, 73) concluded. “Instead, the sources of increased inequality have been the rising share of the super rich—a development in which trade is likely to have played only a small role—and the increased share of profits in income, much of which could be cyclical.”