As President Trump imposes tariffs on China and elsewhere, much dark muttering is heard from the media and conventional economists about Smoot-Hawley and the 1930s. They are too gloomy. Two factors have changed since the 1930s: bloated government and the invention of computers, and their combination means that the Victorian dream of universal free trade is no longer optimal, even if it ever was. By upending conventional economic thought, Trump may well have improved the human condition.
The original Adam Smith enthusiasm for free trade was born in a world of very small government. Already, when David Ricardo propounded his Doctrine of Comparative Advantage in 1817, that world was temporarily past, with British government spending, mostly debt interest, running at about 20% of GDP in that year, even after the Waterloo Army and Navy had been run down to peacetime levels. Britain’s prime minister Lord Liverpool recognized this; in his great free trade speech of May 20, 1820, he pointed out that the need for revenue and the lack of an income tax (abolished four years earlier) meant that tariffs could be lowered only gradually.
With the growth in government, especially since two World Wars, the New Deal and the Great Society, a pure free trade policy is now highly imbalanced. If the government absorbs 40% of the economy, and international trade accounts for 20%, then domestic taxes must average 50% of domestic output for free trade to be followed. Given the diminishing revenue potential from very high rates of income tax, that can only be accomplished as it is in the European Union, by a Value Added Tax of 20% or more, which — as Liverpool would have and did put it — bears most harshly upon the lower orders of society. From this cause, as well as from the artificially sluggish economy produced by the Obama/Bernanke policies, stems the current yawning U.S. fiscal deficit.
That is not to say that high tariffs are cost-free. The U.S. government of the 1890s was small, but it financed itself entirely with tariffs, imposing tariffs well above 50% on numerous products. This was beneficial to the U.S. economy at that period, while Britain and its Empire were pursuing a quixotic policy of unilateral free trade – it allowed the U.S. build up world leadership in industries such as steel, where British companies had made the crucial technological breakthroughs. However, after 1929, when the British and Imperial economy was relatively much weaker and was moving to a policy of modest protection, the countervailing move by the United States through the 1930 Smoot-Hawley tariff to increase protection yet further proved disastrous. It caused world trade to collapse and the global economy to plunge into a decade of depression. Ever since, until Donald Trump came along, protectionism has been anathema.
