Executive Summary: In the summer of 1929, the Dow Jones Industrial Average was making new highs, Wall Street almost certain the U.S. Senate would block the protectionist Smoot-Hawley trade legislation when it returned after Labor Day. The Dow peaked on Sept. 3 and the market crashed in October. The parallels to today's world economy are striking, Wall Street again assuming the virulent protectionist threat rampant on Capitol Hill will be blocked by President Reagan. This time the market may be right and serious world economic disorders will be avoided. But until the pressures are relieved by global fiscal and monetary reform, the threat will remain. Vice President Bush cannot be counted upon to resist these forces, which is hwy the President's health takes on added importance. Some relief can come through a marginal easing of Fed policy, which would lift the whole world's economy. But the massive trade deficit will remain until the rest of the world cuts tax rates or the U.S. is pushed into serious recession.
The Protectionist Threat, 1929/1985
In the week of the Great Crash of October 1929, readers of The Saturday Evening Post were treated to an interview with Professor Albert Einstein, then 50 years old and already the certified genius of the age. The interview was conducted several weeks earlier, but how ironic that it appeared in the October 26 issue just as the collapse on Wall Street was foretelling the onset of the Great Depression. For in the interview, Einstein is asked if there is "such a thing as progress in the story of human effort." To which he replies:
The only progress I can see is progress in organization. The ordinary human being does not live long enough to draw any substantial benefit from his own experience. And no one, it seems, can benefit by the experiences of others. Being both a father and a teacher, I know we can teach our children nothing. We can transmit to them neither our knowledge of life nor of mathematics. Each must learn its lesson anew.
I came across this quote a few weeks ago while reading through materials written in the 1920s, to refresh my recollections of the period especially the events leading up to the Crash. The Einstein observation struck home in a chilling way because I had, until very recently, assumed that there was no chance that history could repeat itself along the lines of 1929. In my 1978 book, The Way the World Works, I'd demonstrated conclusively, I'd thought, that the Great Crash was triggered by key decisions made in that October week by the United States Senate decisions that led to enactment of the Smoot-Hawley Tariff Act of June, 1930. Why would anyone want to repeat this horrendous decision?
Even those economists who question or ignore the linkages I found between the market collapse and Smoot-Hawley have long acknowledged the destructiveness of that protectionist legislation in the 1930s. Yet here we are in the summer of 1985, with the world economy unfolding in a way that parallels the late 1920s. And we observe that the only thing standing in the way of protectionist legislation that would again wreck the world economy is the likelihood of a Presidential veto. In Ronald Reagan, perhaps, we have an exception to Einstein's theorem, a political leader who has lived long enough to benefit substantially from his human experience.
But can we really count on Reagan? At the moment there's little doubt that it would "make his day" to veto the kind of trade bill that is taking shape on Capitol Hill. But in August 1929, it seemed just as unlikely that Smoot-Hawley, which had passed the House in March, would be able to make its way through the Senate and be signed into law by President Hoover. The Dow Jones Industrial Average was hitting record highs that August, climbing from 347 on July 31 to a peak of 381 on September 3. It was after Congress returned from its August recess that a slow slide began. The free trade forces didn't seem as sure of themselves, as Senate supporters of free trade reflected the pressures from the grass roots they had picked up during the recess.
Another element at work was a general sense among the free-traders that the legislation was so bad it couldn't possibly make it into law; it was a vehicle members of Congress were using to pacify their special-interest constituents, believing it wouldn't get anywhere, a charade.
The same process is at work now. In the July 31 front-page report in The Wall Street Journal on the protectionist mood sweeping Congress, the point is made that "many of the 300 trade bills that have been introduced are thrown in the hopper just to please some domestic constituent." At this stage, Rep. Richard Cheney of Wyoming says that "What members want to do is be able to go home and tell their laid-off steelworkers, look the administration has a program to deal with this."
But in the absence of such a "program," the Journal reports, some analysts "expect Congress to go on another 'Japan-bashing' binge after the August recess." This would increase the risk that one of the less sweeping trade bills the textile-quota measure, for example could become the vehicle for dozens of protectionist floor amendments. Rep. William Frenzel, a Minnesota Republican on the Ways and Means Committee and a staunch free-trader, says: "Congress is so frustrated over the trade issue that the odds make it extremely likely we're going to have some very bad legislation by the end of the year."
In 1929, the free-trade forces were concentrated in the Senate, with Herbert Hoover aligned with the traditional Republicans of the Eastern Establishment captains of industry and the National Association of Manufacturers. This is why the markets reacted so violently to the actions of the Senate in October, expecting that Hoover would eventually sign. In 1985, the Senate is already a hotbed, of protectionism. The only member of the Senate Finance Committee who can be counted a staunch free-trader is Bill Bradley of New Jersey, a Democrat. Senator Danforth of Missouri, a Republican, and Sen. Bentsen of Texas, a Democrat, are almost lunatic in their leadership of the "forces of darkness," those who simply refuse to learn from experience and history. Senate Majority Leader Dole and his sidekick, Domenici of New Mexico, could not be counted on to help block an override of a presidential veto, should one eventually be necessary. They are furious with President Reagan anyway, for his determined siding with the economic-growth forces on budget and tax issues. They would act simply out of pique. One has to assume that House Republicans would stand with the President on a veto, but this was the assumption about the Senate in 1929. There are strange dynamics to trade protectionism, and there are racial overtones in the current outcry that were not part of the problem in 1929.
My own anxieties were heightened, leading me back to the readings that produced the Einstein quote, with the reports of President Reagan's cancer and surgery. If there were to be a relapse, or a separate episode that would threaten the President's longevity, it would be prudent to assume Mrs. Reagan would prevail in urging him to turn the office over to Vice President Bush. George Bush, of course, is a product of the Eastern Establishment, and like Hoover would be far more subject to the pleas of the captains of industry to "do something" about the trade deficit. This isn't to say that Bush would join the protectionist camp as President. More likely, as in 1930, protectionists would present him legislation he could insist contained mechanisms that actually fostered free trade. In running amok, Missouri's Sen. Danforth nevertheless insists his proposals are not at all protectionist; they are designed to bash the Japanese into becoming free traders! President Hoover was provided just such free-trade fig leaves that he cited even in signing Smoot-Hawley. In any case, it's clear protectionist forces are greater now than at any time since 1929, and it's no longer safe to assume history will not repeat itself.
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It's not surprising that protectionist forces have massed as they did in 1929. The economic history of the Twenties broadly parallels recent history, in the following way: In the Twenties, the United States was virtually alone as a vigorously expanding industrial power, the result of the Mellon supply-side tax cuts under Presidents Harding and Coolidge; in the Eighties, the U.S. economy has surged with the spur of the Reagan supply-side tax cuts of 1981, a policy resisted by our major trading partners.
In the Twenties, marginal tax rates in Europe remained at the high levels to which they had been pushed during WWI and the economies of Europe remained sluggish relative to the United States. Europe had borrowed heavily from the U.S. in the immediate postwar years, as it rebuilt its industry and agriculture, and U.S. trade surpluses soared. But from 1922 to 1927, as the U.S. economy boomed and Europe remained impeded by the WWI tax rates, the U.S. trade surplus dwindled and at the same time the domestic economy underwent a dramatic restructuring.
With 1913 records taken as 100, the averages for 1922-27 show the physical volume of imports increasing 66 percent and the volume of exports growing by 33 percent. The dollar value of exports increased by 81 percent, but the dollar value of imports climbed by 117 percent.
The U.S. economy as a whole advanced rapidly through productivity increases, but there were segments within the economy that could no longer compete for capital and labor as the economy moved to a higher level of efficiency. Low value-added agricultural and manufacturing enterprises were forced out of business as the "high tech" industries took the cream of capital and labor.
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One of the most astute economists of the era was Wesley Clair Mitchell, research director of the National Bureau of Economic Research, who in 1929 wrote a Review of Recent Economic Changes that took note of these developments. In one remarkable section under the heading "Hardships Caused by Increasing Efficiency," we are reminded that the phrase "technological unemployment" was coined in the 1920s:
Among all the hardships caused by increasing efficiency, most publicity has been given to the decline in the number of wage earners employed by factories. That is a matter of the gravest concern in view of the millions of families affected or threatened by the change, and in view of their slender resources....
The new phrase coined to describe what is happening, "technological unemployment," designates nothing new in the facts, though the numbers involved may be large beyond precedent. Ever since Ricardo shocked his rigid disciples by admitting [in the 1820s] that the introduction of "labor-saving" machinery may cause a temporary dimunition of employment, economists have discussed this problem. Granting Ricardo's admission, they have nevertheless held that, in the long run, changes in method which heighten efficiency tend to benefit wage earners.
Mitchell observes that American agricultural employment is hard hit by the technological boom, with 860,000 workers leaving the farm between 1920 and 1927 to seek employment elsewhere:
One of the most conspicuous changes in methods of farming has reacted most unfavorably upon the demand for farm products. The number of tractors in use on farms is estimated to have increased from 80,000 in January, 1918, to 380,000 in 1922, and 770,000 in January 1928. This change has been accompanied by a decrease in the number of horses and mules on farms from about 26,400,000 in 1918 and 1919 to 20,100,000 in 1928. An even greater decline was occurring at the same time in the number of horses and mules in cities. A not inconsiderable branch of animal husbandry thus lost much of its market. What was worse, at least 15 to 18 million acres of hay and grain land lost its market also.
In another section bearing on international factors, Mitchell sounds remarkably current:
(1) Foreign conditions on the whole have been none too favorable to American business, and they have been eminently unfavorable to American agriculture. Important branches of industry have enjoyed a large increase in foreign sales; but had Europe been prosperous, American prosperity would have been less "spotty" and more intense. (2) Such prosperity as we have enjoyed has been earned by many-sided and strenuous efforts, in which millions of people have shared, to improve our technical methods, our business management, our trade-union policy, and our Government administration. (3) While increasing efficiency has added to real income, it has put pressure, often rising to severe hardship, upon competitors, direct and indirect. The factory hand competing with the "automatic" machine, the horse farmer competing with the tractor farmer, the lumber industry competing with the cement industry, the New England cotton mill competing with the North Carolina cotton mill, the independent retailer competing with the chain store, the clothing trade competing with the makers of automobiles and radios for slices of the consumers' dollars have had a hard time.
In a concluding section, Mitchell tells us "How Matters Stand in the Spring of 1929:"
Even on the face of affairs, all is not well. Americans have seen more uniformly fortunate times: for example, in 1906, when the Secretary of the Treasury was praying that the country might be delivered from more prosperity. The condition of agriculture, the volume of unemployment, the textile trades, coal mining, the leather industries, present grave problems not only to the people immediately concerned, but also to their fellow citizens. How rapidly these conditions will mend, we do not know. Some may grow worse. Nor can we be sure that the industries now prosperous will prolong indefinitely their recent record of stability.
Mitchell is quoted here at length to illustrate the parallels with today's world economy, the "growth recession" in the United States and economic stagnation abroad. The parallel isn't exact, to be sure: The world was on a gold standard in the Twenties, which meant that trade flows were not exaggerated or blamed on exchange-rate differentials. But the pressures on Washington for relief were no less intense, with economic cataclysm the end result.
What is becoming so alarming about the current protectionist craze in the United States is that so many people and institutions that had been defenders of free trade are climbing on the bandwagon. Some of this has to do with the Democratic Party completing its transformation away from internationalism to nationalism. The New York Times hasn't yet given up its commitment to free trade in principle, but in practice it repeatedly insists that something be done about the trade deficit. And it has been unusually warm in its welcome to protectionist arguments in its opinion pages.
Leonard Silk, the Times' most influential economic commentator, has been promoting the blatantly protectionist arguments of Professor John Culbertson of the University of Wisconsin, while assuring his readers the professor "insists he is not advocating protectionism." Culbertson has been asserting that free trade may have been okay for the U.S. in the past, but in these modern times it is "impoverishing" the United States and the western world in general by destroying industries in a global wage competition.
Silk writes in his June 26 column: "Although such proposals will strike most economists as heresy a case for government regulation of trade, market-sharing and restricted access to one's home market the political process and actual economic trends are moving the United States and Western Europe, with its high levels of unemployment, in that direction."
In the Sunday Times of July 28, Culbertson actually shows up in the business section with the first of two essays on the dangers of free trade that not long ago would have had him pitched out the back door of the Times. And the cover of the Times Magazine of the same date is given over to an hysterical piece by none other than Theodore H. White on "The Danger From Japan," complete with a blood-red rising sun explicitly designed to evoke memories of sneak attacks, Bataan death marches, prison camps. White, who served in the Pacific War and has been a lifelong "Jap-basher," somehow gets the Times to put this on its cover: "Today, 40 years after the end of World War II, the Japanese are on the move again in one of history's most brilliant commercial offensives, as they go about dismantling American industry. Whether they are still only smart, or have finally learned to be wiser than we, will be tested in the next 10 years. Only then will we know who finally won the war..."
To this "Yellow Peril" string on the protectionist fiddle has been added a political one, a noisy assertion that the American people are eager to vote for protectionists. John Connally ran for the COP nomination in 1980 as an economic nationalist, whipping political audiences to a frenzy with his "docks of Yokahama" speech. But hardly anyone voted for him. Walter Mondale ran as a muted protectionist in 1984, with Chrysler's Lee lacocca at his elbow, and he was buried in the Reagan landslide. But still the protectionists insist the public at large loves a good old-fashioned trade war.
The most articulate spokesman for the protectionists is journalist Kevin Phillips, whose wife Martha is minority economist on the House Ways and Means Committee a protege of former Rep. Barber Conable. (Conable, one of Vice President Bush's closest political advisors, has recently joined the Board of Directors of Corning Glass, a focal point of protectionist sentiment in corporate America.)
In the April/May issue of Public Opinion, Phillips glorifies "The Politics of Protectionism" and of its growing appeal:
No chronology can be precise. Labor's fidelity to free trade was the first to go in the late 1950s and early 1960s, as the first major wave of imports washed over the shoe, textile, and other industries. Public opinion began to solidify on the neoprotectionist side in the late 1960s and early 1970s. At that point elites were firmly committed to free-trade doctrine.
Given low national esteem for union leaders, it was not surprising that labor's early reaction against free trade did little to affect policy. It allowed support for a more self-interested U:S. trade posture to be painted as the parochialism of old-line unions and redundant, labor-dominated industries. That image still clings today, pushed by importers, retailers, foreign lobbyists, free-trade theorists, and Yuppie would-be purchasers of dhurrie rugs and capuccino machines. Yet it could not be more out of kilter with the overwhelming statistical reality of public opinion. Not just a thin slice, but a broad majority of Americans have long favored restricting foreign-access to the U.S. market. High-tech as well as basic industries are now in the vanguard in demanding policy assertiveness....Since 1973, solid national majorities of 63-68 percent have steadily favored government restrictions on "imports of goods from other countries that are priced lower than American-made goods of the same kind."
Such public-opinion polling is the kind that wrecks politicians who take it seriously, like Connally and Mondale. The aim of the protectionists is to persuade politicians to vote a trade bill before the 1986 elections, then take credit at the polls. (Senator Smoot and Rep. Hawley were both voted out of office after their bill was signed into law in 1930.) "In 1986," warns Kevin Phillips, "the COP could lose heavily in depressed areas, and the 'economic nationalist' swing Democrats who voted for Ronald Reagan in 1984 could be among the first voters to backslide."
Phillips argues that voters were confused into thinking Reagan was the economic nationalist, although he ran as the internationalist and Mondale ran as the nationalist. In the same way, he simply asserts his way over the facts in 'explaining away the impact of Smoot-Hawley:
The supply-side (tax cutting) faction among the Reaganites has long believed that the great U.S. depression of the 1930s was substantially caused by Congress's spring 1930 passage of the Smoot-Hawley Tariff. Coolidge-era tax cuts, financial speculation and income maldistribution (all somewhat implicated today) were not responsible, they say: Trade restraints did it. This is an exaggeration industrial production was eroding rapidly in the United States in late'1929, long before enactment of Smoot-Hawley.
As Wesley Mitchell observed in 1929,jhe problems associated with the U.S. expansion would have been alleviated had there been economic expansion in Europe. Germany has been smothered with taxes to pay war debts and indemnities, where the solution should have been tax relief. Great Britain also resisted the American example ancl kept rates at wartime levels, France finally adjusting rates down in the summer of 1925.
The protectionist pressures bearing down today on the Washington political establishment in large, part result from the reluctance of U.S. trading partners to adjust their tax rates for the impact inflation had on progressivity in the last dozen years. Economic growth spurred by supply-side marginal tax cuts in Europe, Japan and the Third World would increase world exports to the United States, but increase U.S. exports to the world at a much more rapid rate. This is the only high-growth scenario to reducing the U.S. trade deficit. Protectionist legislation would also reduce the trade deficit, but it would also product a smaller U.S. economy and a smaller world economy.
The Keynesian approach to reducing the U.S. trade deficit shies from outright trade restraints, focusing on capital flows instead. That is, if the rest of the world can't send the U.S. as much capital to acquire financial assets, ipso facto it can't send as many goods to acquire the capital in dollars. Richard Cooper of Harvard, President Carter's Undersecretary of State for Economic Affairs, recommends a domestic tax increase to reduce the budget deficit which supposedly will reduce interest rates and make U.S. investments less attractive to the rest of the world. Fed Chairman Paul Volcker, on the other hand, thinks a reduced budget deficit will make dollar assets more attractive to foreign investors which would increase the U.S. trade deficit! (Cooper is right, that reducing the budget deficit by tax increases would make U.S. investments less attractive; Volcker is right that reducing the budget deficit by spending cuts would make dollar assets more attractive.)
The only feasible way for the U.S. to reduce the trade deficit without causing slower growth in the economy would be through monetary policy, easing to both put upward pressure on sensitive commodity prices and downward pressure on the exchange value of the dollar. There's a little room for such ease without rekindling inflationary expectations, but not enough to make a major impact on the trade deficit. For that, only economic expansion in the rest of the world will do the trick. This means that until we see greater evidence of fiscal reforms outside the U.S. leading to economic resurgence, the protectionist threat will remain serious. We have to count on President Reagan, a young college economics major in 1929, benefiting from his experience and seeing us through these next few years.
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