Trade Policy during the Interwar Period

Lecture 8 – Thursday, 6 October 2011J A Morrison 1

Michael HiscoxBarry WeingastJudy Goldstein

Lec 8: Interwar Trade Policy

I. The Global Trade Regime before WWI

II. The Interwar CollapseIII.Reconstructing the Global Trade

RegimeIV.Conclusions & Further

Questions

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Lec 8: Interwar Trade Policy

I. The Global Trade Regime before WWI

II. The Interwar CollapseIII.Reconstructing the Global Trade

RegimeIV.Conclusions & Further

Questions

3

Here’s a very quick and dirty review of the trade

regime before WWI.

(Check Krasner for more details.)

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Pre-war Trade Regime• 1815-1860: Britain moves towards

free trade; sets trend and pace for other countries

• 1860: Cobden-Chevalier Treaty– Britain brings arch rival France on board–Most-favored-nation clause

• 1870s-1914– Rise of Germany; “Merkantilismus” as

state-building (G Schmoller)– General continental retreat from free

trade– British retain free trade unilaterally

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World War I

• Economic warfare during war (even in GB)

• Shattered spirit of European cooperation

• Accelerated British relative decline, not so good for imperial relations

• Gave us Versailles (Oh joy.)

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Lec 8: Interwar Trade Policy

I. The Global Trade Regime before WWI

II. The Interwar Collapse• Reconstructing the Global Trade

Regime• Conclusions & Further

Questions

7

II. The Interwar Collapse

1. Who will take the reigns of power?2. The US: Smoot-Hawley3. Britain: Imperial Preference4. The Axis: Self-Sufficiency

The War reflected and inspired a crisis of global

economic leadership.

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Hostilities had largely been a product of competition

between competing visions and centers of power: GB, Germany, A-H, & the Turks.

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Beginning in 1860, Japan wanted to be set on an equal footing with the

Western powers.

Japan wanted, at a minimum, regional

hegemony in East Asia.11

After the War, Britain sought to retake the reigns of

power.

But, as we’ll see, Britain was incapable of doing so.

Too much had changed.

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The United States had the capacity but not the desire

to lead.

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The crisis of leadership shaped the course of events

that followed.

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II. The Interwar Collapse

1. Who will take the reigns of power?2. The US: Smoot-Hawley• Britain: Imperial Preference• The Axis: Self-Sufficiency

In the wake of the stock market collapse, the US felt

compelled to respond.

And the Smoot-Hawley tariff of 1930 was one of the

most significant responses.

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Smoot-Hawley Tariff

• Became law: 17 June 1930

• Authors– Senate: Reed Smoot (R-

UT)– House: Willis Hawley (R-

OR)

• Highest tariff rates of 20th Century– Fordney-McCumber Tariff

(1922): 38.48%– Smoot-Hawley: 41.14%

17Source: http://eh.net/encyclopedia/article/obrien.hawley-smoot.tariff

Smoot-Hawley: Effects• Triggered retaliation (particularly in

Canada)• But what were the total effects?– Total Decline in Real GDP (1929-1931):

16.5%– Exports (1929-1931): Max Decline 1.7% of

1929 real GDP– Estimated Multiplier Effect (x2) on GDP: 3.4%– Portion of 16.5% total decline caused by

decrease in exports: 21%

S-H lessened trade and deepened the depression 18

Source: http://eh.net/encyclopedia/article/obrien.hawley-smoot.tariff

And Smoot-Hawley, of course, has achieved

legendary significance…

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Ferris Bueller’s Day Off (1986). YouTube

Al Gore & Ross Perot on Larry King (1993) - YouTube 21

So, how do we explain the passage of Smoot-Hawley?

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Eichengreen explains S-H using Gerschenkron’s

model.

How does Gerschenkron’s model work?

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Gerschenkron on the “Marriage of Iron & Rye”

• The case: Bismarckian Germany• Nuanced view of “Interest Groups”– Agriculture: Large (Junkers) & Small– Industry: Heavy & Light

• Interest-Groups Model: Narrow, well-placed groups compromise & form coalitions to secure compatible objectives

• The Coalition: Heavy Industry + Large Agriculture 24

Eichengreen on Smoot-Hawley

• Agriculture– Unsheltered: Border states compete with

imports– Sheltered: Spoilage allows interior to be

insulated

• Industry– Heavy: US has comparative advantage in

heavy industry– Light: Specialty goods face competition from

abroad

• The Coalition: Light Industry + Unsheltered Agriculture

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The United States turned its back on the world economy with Smoot-Hawley (among

other things)...

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“Our international trade relations, though vastly important, are in point

of time and necessity secondary to the establishment of a sound national

economy. I favor as a practical policy the putting of first things first. I shall spare no effort to restore world trade

by international economic readjustment, but the emergency at

home cannot wait on that accomplishment.”

--FDR, First Inaugural (1933)

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Even with the election of FDR in 1932, the US still

saw restoring world trade as secondary to—and separate

from!—reinvigorating the American economy.

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What about the former hegemon, Britain—the

birthplace of free trade?

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II. The Interwar Collapse

1. Who will take the reigns of power?2. The US: Smoot-Hawley3. Britain: Imperial Preference• The Axis: Self-Sufficiency

The story in Britain is a bit complex.

In short, Britain’s declining position combined with its domestic politics to initiate

a major shift in its trade policy.

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British Domestic Politics• Conservatives (Tories) increasingly

support commercial management• But Liberals and Labour remain

committed to free trade• Throughout the 1920s, the Liberal-

Labour coalition is able to prevent protectionism

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The 1931 Financial Crisis

• As we’ll discuss, Britain had difficulty defending the gold standard in the 1920s

• The global “slump” in 1929 made things even more difficult

• In 1931, the Labour Government failed to defend sterling against attack

• This initiated a decade of Tory domination 33

After winning the largest electoral victory in modern British history, the Tories

pushed through extensive commercial regulation.

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British Protectionism• Import Duties Act (1 Mar 1932)– Introduced by N Chamberlain, son of J

Chamberlain– General tariff of 10% (excepting foodstuffs

& raw materials)– Specific tariffs ratcheted up to as much as

33%

• British Empire Economic Conference– “Ottawa” Conference; Summer 1932– Official abandonment of gold standard– Established “imperial preference” system:

tariffs highly favor empire goods 35

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“Buy Empire”

II. The Interwar Collapse

1. Who will take the reigns of power?2. The US: Smoot-Hawley3. Britain: Imperial Preference4. The Axis: Self-Sufficiency

The Treaty of Versailles (1919) unequivocally

established the subordination of Germany’s economy to the welfare of

the allied powers.

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The global economic slowdown hit Germany

particularly hard.

When unemployment rates rose above 30% in 1933, Hitler ascended to power, largely on a platform of reversing the effects of

Versailles. 39

Germany’s foreign economic policy was

carefully managed first by Hjalmar Schacht and later

by Hermann Goering.

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Nazi Germany’s FEP• Money– Abandoned Fixed Exchange Rate– Heavy capital controls, restrictions on

“foreign” ownership

• Trade– Heavily managed; high restrictions– Creation of German trading bloc

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Imperial Japan’s FEP• In 1930s, Japan relied heavily on

trade—particularly with US for oil (~80%)

• Second Sino-Japanese War (1937-1945)– After WWI, Japan took Germany’s sphere

of influence in China– Chinese resistance prompted crackdown

• July 1941: US imposed oil embargo• Japan became more deeply

committed to self-sufficiency 42

Agenda: Interwar Trade Policy

I. The Global Trade Regime before WWI

II. The Interwar CollapseIII.Reconstructing the Global Trade

Regime• Conclusions & Further

Questions

43

The first stepping stone back to liberalization was placed by the US with the

1934 Reciprocal Trade Agreements Act (RTAA).

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The RTAA

• Enacted 12 June 1934• Transfers power of setting tariffs

from Congress to President• Major provisions– Bilateral negotiations for reciprocal

reductions– Tariff reductions up to 50%– Continued most-favored-nation (MFN)

practice45

2 Key Questions about the RTAA

1. How do we explain the passage of the RTAA

2. How do we explain its durability?

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III. Reconstructing the Global Trade Regime

1. Bailey, Goldstein, & Weingast: Institutions

2. Hiscox: War3. Implications

Previous Explanations of RTAA

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Explanation Problems

Previous Explanations of RTAA

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Explanation Problems

Lazy Congress Possible to Do Nothing; Easier ways to streamline without abdicating authority

Lesson Thesis: Policy-makers learned lesson from Smoot-Hawley

Counter-intuitive; Partisan Voting

New Agenda-Setting Authority for President; Part of Larger Expansion of Presidential Power

Insufficient; Doesn’t explain shift in Congress’s preferences

What is the key variable that BGW suggest explains the shift in American trade

policy?

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BGW emphasize change in institutions. (309)

But that doesn’t mean that institutions matter more than ideas & interests.

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What are the key institutional features according to BGW?

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BGW: Key Institutional Features

• Power to the President– Broader district preference for more

liberalization– Presidents stop logrolling (like “line item veto”)

• Satisfying Congress with Reciprocity– Reciprocity created export opportunities– Now: Broadened Range of Acceptable Tariff Cuts– Later: Exporters become entrenched advocates

of liberalization

• Conclusion: RTAA jumpstarted export industry which never looked back

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III. Reconstructing the Global Trade Regime

1. Bailey, Goldstein, & Weingast: Institutions

2. Hiscox: War• Implications

So, that’s our explanation of the US move towards trade liberalization between 1930

and 1945?

-- The RTAA nurtured export-oriented industry.

Um…Aren’t we forgetting something?

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SAINT PAUL’S, LONDON

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STALINGRAD

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DRESDEN

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TOKYO59

Hiscox: Let’s not underestimate the extent to

which the complete evisceration of foreign

industrial capacity created export markets that the US wanted to ensure remained

open!60

“These changes reflected the dramatic, exogenous effects of World War II on U.S. export and import-competing industries as well as longer-term shifts in U.S. comparative advantage and in

party constituencies. In this alternative account of the RTAA

and U.S. trade liberalization,the historical coincidence of

several profound economic and political changes are central to the

eventual outcome.” (670) 61

III. Reconstructing the Global Trade Regime

1. Bailey, Goldstein, & Weingast: Institutions

2. Hiscox: War3. Implications

What are the implications of these differing interpretations?

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BGW: Institutions Matter

• Let’s build institutions• The institutional design matters

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Hiscox• Let’s not spin our wheels about

institutions• Underlying economic variables really

matter. Let’s focus on those. Maybe then we can at least see what’s coming.

“The dismal conclusion is that, if policy is settled in a protectionist equilibrium (that is, reform is needed), it is unlikely that a simple change in the policymaking rules will also be possible or sustainable for long in the absence of some serendipitous change in actor preferences”. (690) 65

Agenda: Interwar Trade Policy

I. The Global Trade Regime before WWI

II. The Interwar CollapseIII.Reconstructing the Global Trade

RegimeIV.Conclusions & Further

Questions

66

Key Insights about Trade Policy

• Interest Groups…– Must be understood narrowly (not just

“agriculture”) (BE)– Form, dissolve, & reform flexible coalitions (BE)– Shape policy; and are shaped by policy (BGW)

• Trade policy is formulated in context of other policies (e.g. unemployment policy) (JMK)

• Exogenous variables (like war) still matter (MH)

• Institutions might matter as well– They shape channels through which interests

exert pressure (BGW)67

Questions• The obvious question: what should be our

ideal trade policy?• Less obvious but equally important–Where should trade policy stack up in

preference hierarchies? Should trade policy be subordinate to other policy goals?

– Once we determine the trade policy we want, how do we go about securing it?

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