Free Trade and China? A Lesson from the Great Depression

Free Trade and China? A Lesson from the Great Depression
by Burton Folsom, Jr.
11/29/2011

“The Chinese are stealing our jobs,” Mitt Romney is telling Republican audiences. “We’re going to stand up to China.” President Obama seems to agree. Two years ago he endorsed a high tariff on Chinese tires.

But what’s wrong with loading up on cheap imports from China? If they can make tires or shoes better and cheaper, then send them over. In return, we will send them our planes, tractors and soybeans. Economists call this healthy trade “comparative advantage.”

The Romney-Obama alternative, if pushed too far, is a crippling trade war. America’s last big trade war was in 1930, when Congress passed the Smoot-Hawley Tariff, a law that soon made the emerging Great Depression​ more severe. We tariffed 3,218 foreign imports—887 of them were very sharply increased. When we refused to buy from other countries, they retaliated and refused to buy from us. That triggered a global trade war and deepened the Great Depression all around the world.

Because both President Obama and former Massachusetts Gov. Romney seem to like the idea of using punitive tariffs as a weapon, let’s look at the Smoot-Hawley Tariff in more detail. What happens when well-intentioned politicians bar imports from abroad?

The first example is a simple one: watches. In 1930, watchmaking was the chief business in Switzerland—and Swiss watches were the best in the world. Also, Americans were the biggest users of Swiss watches. We preferred under-$2.00 Swiss watches, which kept perfect time, to our New England-made watches, which were not only more expensive, but some ran the minute in 58 seconds. In return for watches, the Swiss bought American cars, typewriters and gasoline. It was a win-win.

Then came Smoot-Hawley. New England watchmakers lobbied their congressmen to increase the tariff on Swiss watches. A six-jewel watch priced at $1.41 cost $5.16 in the U.S. after the new tariff was added. That bumped sales up for the cheaper American watches, but it infuriated the soon-to-be unemployed Swiss watchmakers. They sponsored a ban on “all merchandise coming from the United States,” and that halted the sales of U.S. cars, wheat and refrigerators in Switzerland. One enterprising salesman in Switzerland began selling American-made vacuum cleaners from a Canadian office—to avoid the “made in America” label.

Granted, Switzerland is not a major U.S. customer, but the Smoot-Hawley Tariff also targeted Spanish grapes, Italian gloves, Canadian newsprint, British blankets, and 3,000 more imports, some of them crucial to national economies throughout the world. The retaliation was dreadful: U.S exports plummeted from $7 billion in 1929 to $2.5 billion in 1932. In specific terms, the U. S. sold 5.3 million cars and trucks in 1929, but that dropped to 1.8 million in 1933. The collapse of the foreign market was part of that decline, which was especially sad because U.S. cars in 1930, like Swiss watches, were the best in the world. Both countries lost exports in their best industries.

The Smoot-Hawley Tariff had other harmful effects. According to economist Alan Reynolds, “A tariff on linseed oil hurt the U.S. paint industry, a tariff on tungsten hurt steel, a tariff on casein hurt paper, a tariff on mica hurt electrical equipment, and so on.” Reynolds further notes, “There were 500 U.S. plants employing 60,000 people to make cheap clothing out of imported wool rags. The tariff on wool rags rose by 140%,” however, and thus caused more unemployment. Welcome Great Depression.

Trade wars often escalate beyond the tariff walls. When the U.S. refused to buy from Europe, the Europeans refused to pay back more than $10 billion in debts to the U.S. from World War I. Ultimately we forgave the Europeans their debts. But given that the entire national debt in the U.S. was only $16.2 billion in 1930, that European “default” was devastating to U.S. financial markets.

Let’s hope that Romney, President Obama and the other presidential candidates will stop blaming China for lost jobs, and focus on slashing federal spending, cutting red tape, and giving American businessmen the chance to win foreign customers in an atmosphere of free trade.
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To read another article about China, click here.