The Smoot-Hawley Tariff has been given considerable “credit” for the Great Depression in history books going back to the 1940s.
One of the most hotly debated causes of the crash is the Smoot-Hawley tariff. Protectionists like Alfred Eckes and Pat Buchanan argue that it could not have affected the market because the law was not passed until 1930, long after the crash. Although this is true, much of the legislative activity took place in 1929. As economist Alan Reynolds convincingly demonstrated in National Review (November 9, 1979), actions favoring passage of the tariff bill correlate quite well with declines in the stock market during 1929, culminating on October 29.
The reason why the market crashed well in advance of the tariff becoming law is because markets are forward-looking, and quickly capitalize any policy that will impact on future profits.
President-elect Obama has made quite a bit of noise about protectionism, and at one point, an advisor, Austan Goolsbee, was sent to Canada to reassure them that it was just campaign talk. This resulted in a major flap and Goolsbee was shipped off to campaign Siberia.
Well, Obama is elected now and what is the situation?
Well, for one thing, Smoot-Hawley is being resurrected by Obama supporting economists.
How much of a boost to economic activity will a fiscal stimulus provide? For those who believe that we have entered a Keynesian world of shortage of aggregate demand–me included–the answer depends on the Keynesian multiplier.
Democrats are all Keynesians, of course. Republicans became supply siders under Reagan. The difference ? Keynes advocated spending and politicians like spending. That way they get to determine where the money goes.
Now suppose that we had a way to raise the multiplier by more than half, from 1.8 to 2.8. The same fiscal stimulus would now produce an increase in GDP of $2.8 trillion–quite a difference. Nice deal if you can get it.
In fact you can. It is pretty easy to increase the multiplier; just raise import tariffs by enough so that the marginal propensity to import out of income is reduced substantially (to zero if you want the multiplier to go all the way to 2.8). Yes, yes, import protection is inefficient and not a very neighborly thing to do–but should we really care if the alternative is significantly lower growth and higher unemployment? More to the point, will Obama and his advisers care?
Spoken like Mr. Smoot and Mr. Hawley.
Protectionism will prevent US citizens, who get government handouts, from spending the money outside the country, for Japanese cars or Chinese toys, for example. A century ago, they called this “Mercantilism.” Mercantilism was an economic theory that advocated maximizing exports and minimizing imports. Carried to its extreme, the mercantilist country would keep accumulating money by beggaring its trade partners. China does this in part.
Megan McArdle doesn’t like it, but that may not be enough. People who think they can plan an economy are not easily convinced they are wrong. Witness the current consequences with Fannie Mae and Freddie Mac. The politicians and Obama have not accepted any blame for that fiasco yet.
The alternative to all this stimulus money being handed out is a tax cut. Why not cut the corporation and capital gains tax rates to zero for a couple of years ? The only problem I see with that is that it allows the people who pay taxes to determine what to do with the money. Politicians don’t like that.
UPDATE: Here is some sober comment on the zero interest t-bill auction this week. If people are buying t-bills at zero interest, the stock market may not be as much of a bargain as some people are saying. I expect it to go lower, a lot lower.