Economics blog - Why protectionism did not cause the Great Depression

IveSeenTheLight

Protectionism wasn't the problem

• Stephanie Flanders
• 4 Feb 09, 08:50 GMT

Politicians and commentators keep warning that "protectionism is what made the Great Depression Great". It's a good line. Pity it isn't true.

Before you ask, I'm not endorsing protectionism. Or suggesting it could be a route out of our economic troubles. But it didn't cause the Great Depression.

If that sounds too heretical for the BBC Economics Editor, I should tell you that the US Federal Reserve chairman, Ben Bernanke, agrees.

Academics have been arguing over the causes of the 1930s slump for decades. I can't do justice to the arguments here. But I've been going back over the competing theories. Protectionism and the infamous Smoot-Hawley legislation raising US tariffs in 1930 are surprisingly low on the list.

A crude summary of the state of academic thought in this area would be "Friedman & Schwartz meet Eichengreen, in a world of bank panics and John Maynard Keynes".

Let me explain. In a classic work, Milton Friedman and Anna Schwartz say the US downturn of the 1930s was the Fed's fault, by failing to inject cash into a fragile banking system after the crash of 1929.

At a party for Friedman's 90th birthday, Bernanke (then a Fed Governor), said: " I would like to say to Milton and Anna: Regarding the Great Depression - you're right, we did it. We're very sorry. But thanks to you, we won't do it again."

But didn't protectionism help transmit America's problems around the world? Well, not really. Bernanke, Barry Eichengreen and other distinguished economists have established pretty convincingly that it was the gold standard that helped turn a mismanaged US stock market crash into a global slump - by causing a prolonged and devastating period of falling prices.

It was the gold standard - in effect, a fixed exchange rate system anchored by the price of gold - that led the world's leading economies into a deflationary spiral. That was because the only way for deficit countries to stem the resulting flow of gold - money - out of the country was by shrinking domestic demand, which led to a further downward spiral in prices and incomes.

Since everyone was doing the same thing (and surplus countries like the US were not allowing inflows of gold to stimulate demand), this didn't help countries out of their hole - they just collectively dug themselves deeper and deeper. The first countries to dump the gold standard were also the quickest out of deflation and the quickest to recover.

The depression certainly did see a collapse in global trade and capital flows, and a descent into protectionist tariffs and laws. But a fair reading of the evidence suggests these were more the result of the global downturn than the cause.

According to Peter Temin, a distinguished economist at the Massachusetts Institute of Technology, exports were 7% of American GDP in 1929. They fell by 1.5 percentage points in the next two years.

Given the fall in world demand in those years, not all of that fall can be attributed to other countries' retaliation against the US tariffs. And even if it were - overall, GNP over the same period fell by 15%.

So, on any reasonable assumptions, Temin says "the fall in export demand can only be a small part of the story." And, as he points out, even that loss in foreign demand from the tariff would have been partly offset by the fact that the tariff diverted demand from foreign to home-made goods.

His conclusion? "Any net contractionary effect of the tariff was small."

This shouldn't come as a surprise. Even the greatest fans of free trade would admit that the benefits of lower tariffs - or costs of higher ones - are fairly small beer when compared to the kind of collapse in incomes and employment we saw during the depression.

To repeat, I'm not endorsing protectionism, or a policy of "national self-sufficiency" (though intriguingly for his modern admirers, that's what Keynes supported in 1933).

The world is more interconnected than in the 1930s, and in the financial realm, especially, the crisis is going to require international cooperation to fix. That's not going to happen if countries are at each other's throats.

But in constantly warning against overt protectionism, governments may be once again overstating their capacity to affect events.

The better lesson of the 1930s may be that you don't need tariffs or a revolt against foreigners to cause a collapse in world trade and capital flows. A fully synchronised global downturn can do that all by itself.


http://www.bbc.co.uk/blogs/thereporters/stephanieflanders/

Generali

Protectionism didn't cause the Great Depression but it did make things far worse.

If you are going to be unemployed and so trying to live off GBP50 a week or whatever it is then would you rather pay GBP3 or GBP10 for a T-shirt from Tesco?

purch

It's on a Blog on the Internet.................so therefore it must be true :eek:

IveSeenTheLight

purch wrote: »

It's on a Blog on the Internet.................so therefore it must be true :eek:

:T Did the title not give it away:T

Its a blog from the BBC Economics Editor.
A sort of side discussion to allow peoples comments to be made

It's on a [STRIKE]Blog[/STRIKE] forum on the Internet.................so therefore it must be true :eek:

kennyboy66_2

The one thing that is certain, is that people will still be argueing about exactly what causes a Depression and what makes it worse in another 75 years.

I can see the reasoning why protectionism had less of an effect then than it would now.

The USA has never been as 'open' an economy as say the UK. If protectionism made the Global depression worse it should have had a proportionatly larger affect on the UK than the USA.

Protectionism now would be a unmitigated disaster - but I reckon 9/10 people struggle to understand the benefits of free trade.

The other risk is more long term, if the current central bank actions and government actions mitigate the recession, it will persuade them that they can do it again in the future. Probably an unwise assumption.

Andrew64

Here's another article that argues that protectionism didn't cause the Great Depression (and was beneficial for Britain!).

http://www.guardian.co.uk/business/2009/feb/04/protectionism-free-trade-recession

Is free trade the best way to beat recession?

"Nor is the lesson of the 1930s quite as clear cut as the free trade camp argues. The US Smoot-Hawley tariff of 1930 is blamed for turning the Wall Street crash of 1929 into capitalism's worst-ever depression - up until now, at least - but the American Paul Krugman has shown that this was a statistical impossibility, and that the immense contraction in the economy between 1929 and 1932 could not have been the result of higher tariffs. Instead, it was the result of a contraction in credit associated with policy errors by the Federal Reserve and the collapse of thousands of banks."

Generali

kennyboy66 wrote: »

Protectionism now would be a unmitigated disaster - but I reckon 9/10 people struggle to understand the benefits of free trade.

Kids should be taught Real Economics at school. I don't mean Sh i t Economics like economists learn but proper economics as it impacts on Real Life, e.g. what Supply and Demand really are and Ricardo (free trade).

Nobody should be allowed to vote unless they understand what Ricardo had to say. They needn't agree with him (although I've yet to meet someone who understands the argument that disagrees with it) but they should understand it.

vivatifosi

Ah, but if they read Ricardo they would realise that we don't have enough comparative advantages and would probably get depressed. Given that children aren't allowed to be exposed to anything negative these days (including, heaven forbid, snow) it will probably be against health and safety laws.

pjala

The Depression led to protectionism - the causes were a bubble and vast amounts of lending to buy and sell stocks on margin.
The problem with your argument is that you are not saying that protectionism led to conflict which led to war. Not a war where a few thousand died, but one in which conventional weapons (except of course for Hiroshima and Nagasaki), led to millions and millions of deaths worldwide. Petty racism, and worldwide anti semitism led to a party which in the name of nationalism murdered their own jewish people in their millions to placate the masses.
Protectionism is a short term measure for a single countries leaders to get their population off their backs, and get re-elected. Long term it causes war.

Sir_Humphrey

Actually, Paul Krugman made a similar argument on his blog the other day.
http://krugman.blogs.nytimes.com/2009/02/01/protectionism-and-stimulus-wonkish/
http://krugman.blogs.nytimes.com/2009/02/02/more-on-protectionism-wonkish/
I will take Generali's comments about the electoral franchise as a joke as I am sure it is intended.
If any can suggest how the world trade can be rebalanced without some form of limited protectionism, I would be interested to hear their ideas.

kennyboy66_2

Sir_Humphrey wrote: »

If any can suggest how the world trade can be rebalanced without some form of limited protectionism, I would be interested to hear their ideas.

1) Free floating exchange rates get there in the end.
2) I'm not sure that it matters that much. At least I can think of plenty of bigger issues.