Trade wars then and now: Smoot-Hawley all over again

The revival of protectionism started by the Trump administration has been accompanied by warnings of a repetition of the 1930s when a surge in protectionism that started with the Smoot-Hawley Act of 1930 added to the problems of the Great Depression. In fact, from a game theoretical perspective it is the fear of a repetition of the 1930s that is causing countries to try to avoid a full-scale trade war. However, to what extent can we compare the current trade conflicts to the 1930s? We discuss three important similarities and two crucial differences.

President Hoover signed the Smoot-Hawley Act into law in 1930, raising tariffs on more than 20,000 goods by 20% on average. The calls for protectionism during Hoover’s election campaign in 1928 and Trump’s campaign in 2016 were both motivated by jobs. In both campaigns foreign competition was blamed for the loss of employment in the US. Both presidential candidates were convinced that the promise to raise import tariffs would attract voters.

The Hoover campaign focused on the loss of employment in the agricultural sector. After a surge in foreign demand for US agricultural products during World War I and land price speculation many farmers became highly leveraged in the early 1920s. An unforeseen drop in commodity prices and monetary tightening by the Fed caused a lot of trouble for farmers in the ‘roaring twenties’. Therefore, during his presidential campaign, Herbert Hoover promised to keep foreign agricultural products out of US markets, thereby protecting production and jobs in the US agricultural sector[1]. In the 1930s the agricultural sector still represented almost a quarter of the total labour force.

The Trump campaign had a stronger emphasis on the manufacturing sector (only 9% of the labour force) and blamed China and Mexico for the loss of jobs, but also the German car industry. According to Trump, the large trade deficits with these countries are caused by unfair trade practices that have undermined the competitive position of US manufacturing firms and cost many Americans to lose their jobs.

[1] In contrast, in the 19th century US protectionism was focused on the manufacturing sector. However, by the 20th century manufacturing had acquired a strong competitive position. Therefore, the attention of politicians was initially targeted at the agricultural sector. In fact, during the 1928 election campaign the Republicans promised to protect the agricultural sector by the same tariff walls as the manufacturing sector. However, against Hoover’s wishes the influential manufacturing lobby managed to persuade the Republicans in the House of Representatives and the Senate after the elections to also raise tariffs for manufacturing imports.

A second similarity between the Smoot-Hawley years and the Trump era is that the decision to raise tariffs was taken during an economic expansion and not as a reaction to a recession (see figure 1). The Smoot Hawley Act of 1930 was a response to the problems in the US agricultural sector caused by falling food prices due to foreign competition. Smoot-Hawley was not a reaction to the Great Depression. The tariffs in the Smoot-Hawley Act of 1930 were already accepted by the House of Representatives in the earlier Hawley bill on 28 May 1929. This was well before the stock market crash of 24 October 1929 (‘Black Thursday’). However, the deterioration in the economic outlook helped the tariffs – including manufacturing – to pass the Senate, which made it possible for President Hoover to sign Smoot-Hawley into law on 17 June 1930. The tariffs became effective the next day.

President Trump is also embarking on a protectionist course during an economic expansion[2]. The most recent GDP report showed that the US economy was growing at 4.1% (quarter-on-quarter, at an annualized rate) in 2018Q2 and Rabobank is forecasting 2.8% real GDP growth for 2018 and 2.3% for 2019.

[2] Although it could be argued that the Great Recession and its aftermath have played a role in Trump’s successful bid for the presidency and therefore indirectly contributed to the rise in protectionism.

The hike in tariffs caused by the Smoot-Hawley Act led to angry reactions abroad. The US was a net exporter and the higher tariffs made it more difficult for other countries to repay their debt from World War I. There was immediate retaliation by Canada, Mexico, Cuba and Spain who raised their own import tariffs in reaction to the Smoot-Hawley Act. France followed one year later. Germany took restrictive measures during the banking crisis in 1931, while the British gave up their free trade policy after the financial crisis had reached the UK in the same year. In the 1930s the major trading partners of the US retaliated – either immediately or one year later – against the protectionist measures taken by the US. The protectionist measures taken by the Trump administration have also led to retaliation by most countries, often even faster than in the 1930s.

While the similarities between the 1930s and the Trump era are striking, there are two important differences. In the first place, tariff walls were a lot higher to begin with before the start of the 1930s. Secondly, due to the now widespread value chain integration, import tariffs could backfire on the industries of countries that raise the tariffs.

Smoot-Hawley raised US tariffs on more than 20,000 imported goods by 20% on average. While the Smoot-Hawley Act of 1930 started a worldwide surge in protectionism, tariffs were much higher than today (see figure 2). This is also clear from a comparison of tariffs as a percentage of import value (table 1). This rose from 40.1% to 47.1% in the period 1929-1930. Nowadays this percentage is approximately 1.7%. Although the current protectionist measures by the US will likely raise the average import tariff, this will still be small compared to the 1930s.

However, today’s protectionism is predominantly reflected by non-tariff barriers (NTBs), such as import licenses, import quotas, product standards etc. In fact, while tariffs have been stable or declining in recent years, this has not been the case for NTBs. Data from the WTO show that the US has introduced by far the most NTBs: 2250 in total (see figure 3). This compares to only 540 NTBs implemented by China. There is also a clear trend toward increased protectionism through NTBs in the US: in 2000 there were still only 1135 measures in place. What’s more, there are many more NTBs in the pipeline, which could raise the total number of NTBs applied by the US to 5717. Other countries also have more NTBs in the pipeline: China is working on the implementation of 2284 NTBs and the EU has also 1572 initiatives to raise NTBs. These NTB’s either force producers to adapt their products to the regulations of the destination area (thus implicitly raising costs) or decide not to supply their products abroad at all.

An important lesson is that both in the 1930s and in this century protectionism has been widespread. Although in the 1930s import tariffs were much higher than today, non-tariff barriers are the prevalent form of protectionism in modern times. The US has been leading in NTBs.

Another important difference with the 1930s is that world trade nowadays consists for a large part of integrated supply chains. Multinational firms are exploiting international comparative advantages, which have enabled them to produce more efficiently and improve their competitive position. For example, they benefit from low labour costs in Asia in the assembly of goods, while marketing and R&D are performed at home. This means that goods are no longer fully produced in one country and then exported to another country. Different phases of production processes take place in different countries and parts may cross borders several times..

Due to this change in trade patterns, and higher import-to-GDP and export-to-GDP ratios, tariffs may now have a much larger impact than in the relatively closed markets in the 1930s. By cutting up the value chain firms have become vulnerable to import tariffs on intermediate products or commodities from abroad. In the end these cost increases either reduce profits or will be passed on to consumers. The recent US tariffs on Chinese imports (50$bn) apply primarily to intermediate products and capital goods (see figure 4). Consequently, only about 40% of the tariffs are borne by Chinese firms while the remaining 60% by foreign firms that are active in China. The tariffs on electrotechnical products are even borne for 87% by foreign firms. This shows that nowadays it is much more difficult to implement a protectionist policy without shooting oneself in the foot.

The protectionism of the Trump era is similar to the 1930s in terms of motivation, timing, and retaliation. The differences lie in the shift of protectionism through tariffs to non-tariff barriers and the unintended consequences of modern day protectionism caused by the international value chain, which makes the impact of protectionist measures less predictable. In the end, the costs of redesigning global value chains could erode the support of US firms for Trump's protectionist policies.

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