The fantastic trade collapse
The most known feature of the fantastic Credit Crisis, however, has been the collapse in international trade. As Figure 3 shows, trade fell a lot more steeply after April 2008 than it did in the entire year after June 1929, and the recovery to date has been relatively anaemic. World trade fell in August 2009, following three successive months of growth, but still remains 18% below peak. In comparison, trade fell in three successive years through the Great Depression.
Figure 3 The quantity of world trade, now vs then.
Sources: Eichengreen and O’Rourke (2009), updated with data from the CPB’s database at www.cpb.nl.
What explains the space and depth of the trade slump experienced after 1929, and what exactly are the key lessons that policymakers should draw from that experience? This chapter briefly surveys the literature on the partnership between trade and economic policy through the Great Depression, drawing some conclusions for our very own period.
Trade’s collapse: Lessons from the 1930s
In the first place the beginning, consider the sources of the Great Depression. During the Depression itself, observers such as for example Keynes put the blame squarely on excessively tight monetary policy. THE UNITED STATES Federal Reserve started tightening in 1928 so that they can halt runaway stock markets, which lowered investment and aggregate demand. This contractionary impulse was then spread internationally, as other countries were forced to check out suit because of the commitment to the gold standard.
It is crucial to stress that monetary interpretation of the Depression isn’t just Keynesian, since it was presented with a significant intellectual boost by Milton Friedman and Anna Schwartz, authoring the united states experience in the 1960s (Friedman and Schwartz 1963). Newer scholarship (e.g. Temin 1989, Eichengreen 1992) has retained the monetary interpretation of the fantastic Depression, but moved from a purely American to an internationally perspective.
Eichengreen (1992) and Temin (1989) both trust Friedman-Schwarz that the fantastic Depression was largely a monetary phenomenon, however they regard it as a global phenomenon rather than primarily American one, and to be due to many different structural factors, notably the gold standard, instead of to isolated policy mistakes. This interpretation is basically accepted by authors such as for example Bernanke (2000), whose analysis is actually complementary compared to that of Eichengreen and Temin, providing proof additional channels by which contractionary monetary policy depressed the economy.
The gold standard spread the original contractionary impulse and it implied that policy makers were not able to combat the Depression effectively. They cannot lower interest levels when this is required so as to combat unemployment, since this might have resulted in their currencies depreciating. Furthermore, expansionary fiscal policies were also thought to be dangerous, since by increasing imports they threatened to result in a drain in foreign reserves, that was again incompatible with countries’ gold standard commitments.
The results of adherence to gold could possibly be clearly observed in 1931, when several countries raised interest levels as their currencies were attacked, thus prolonging the Depression. It had been only once countries left the gold standard that these were in a position to adopt appropriate monetary policies, and began to recover. Britain did this in 1931, the united states in 1933. A little ‘gold bloc’ centred on France resisted until 1936, and experienced the longest Depression of most.
Beneath the circumstances, it really is hardly surprising that countries resorted to wholesale protectionism. With export markets gone the point is – due to falling demand and protectionism elsewhere – the perceived opportunity costs of protecting one’s market seemed much smaller than usual. In recent work, Eichengreen and Irwin (2009) show that it had been those countries who stuck to gold the longest who finished up protecting the most. Confronted with overvalued currencies and contracting economies, and bereft of other policy options, they imposed higher tariffs, and tighter non-tariff barriers to trade. Countries which abandoned the gold standard and allowed their currencies to depreciate used monetary policy to reflate their economies instead of protection.
Flawed macroeconomic policies, therefore, can explain both extent of the fantastic Depression, and the shift to protectionism. But that which was the impact of protectionism on the interwar economy, and specifically on the extent of world trade?
In keeping with its focus on monetary policy mistakes, the prevailing literature is not kind to the argument that the Smoot-Hawley tariff created the fantastic Depression. Indeed, the extent of falling income and output through the period was so excellent that Smoot-Hawley had not been a good major factor underlying the trade collapse of that time period. For instance, Irwin (1998) finds that even in the lack of any change in tariff rates (but accounting for the income declines of the time), US imports could have declined by 32% between 1930:II and 1932:III, in comparison with the 41% reduction that truly occurred. Even in the lack of the Smoot-Hawley revisions to tariff schedules (but accounting for the impact of income declines, and of deflation normally tariff levels), US imports could have fallen by 38% over the time, or by almost just as much as actually occurred. Trade declines were primarily because of falling income, with deflation also playing a significant role; Smoot-Hawley tariffs were a bit-player in the trade collapse.
All this is consistent with the knowledge of the fantastic Credit Crisis. The collapse in world trade has occurred with out a wholesale outbreak of protectionism. Falling output, instead of rising barriers to trade, appears to have been the primary culprit at this juncture as well.
How about the impact of protectionism on GDP? Once more, the prevailing literature has tended to find that tariffs in the 1930s weren’t such a big deal, in the context of the overall collapse of the time. In a few peripheral countries, such as for example Ireland, protection could even experienced some beneficial effects in the short run, giving rise to a burst of import substitution which created jobs at the same time of mass unemployment and limited opportunities abroad.
The true impact of interwar protectionism
However, none of the should be taken up to imply interwar protectionism was a benign phenomenon. It had been not.
As a beggar-thy-neighbour policy, any short-term gains attained by one country were at the trouble of others. More seriously, protection created new political constituencies against free trade who, oftentimes, could actually successfully lobby for a continuation of protection following the crisis was over. Ireland remained inward-looking through the 1950s with disastrous effects on growth and employment. In other parts of the world, such as for example Latin America, the protectionist legacies of the fantastic Depression can be discerned as late as the 1970s.
A whole lot worse were the geopolitical consequences of protectionism. These helped to fuel the international tensions of the time. For instance, in Japan the Smoot-Hawley tariff and British imperial protectionism helped to undermine the political position of the more liberal elements, and strengthened the hand of these who claimed that imperialism, instead of trade, was the proper way to ensure adequate supplies of primary products.
Today’s crisis and international politics
So far, the impact of the fantastic Credit Crisis on the international political system has probably on balance been positive. The impetus which it has directed at the rise of the G20, at the trouble of the G7, has been a particularly welcome development, in the beginning of a century where the world will need to face the twin challenges of climate change and a rapidly shifting geopolitical equilibrium. An outbreak of trade tensions would undo many of these achievements, and make the world a riskier place.
The lesson of the interwar period is that if you want to avoid such a scenario, we have to avoid a couple of things:
- The foremost is a slump which continues into 2010 or 2011.
Human systems are resilient, and will surmount crises of only 1 year’s duration with relative ease. It really is when these crises continue for quite some time that radical change occurs. It had been only in 1931 that the British abandoned free trade, a decision which gave rise to a wave of tit-for-tat retaliation elsewhere. It had been only in 1932 that the Nazis became the largest party in Germany. Our present world economic climate, using its generally liberal orientation, will presumably survive relatively unscathed if today’s recovery proves durable. A double-dip recession, however, could have unpredictable consequences. Policymakers have a responsibility to minimise the chance of this eventuality, for instance, by not withdrawing stimulus prematurily ..
- The next thing we must avoid is severe exchange rate misalignments, at the same time of rising unemployment.
The data in Eichengreen and Irwin (2009) shows clearly that exchange-rate overvaluation and protectionism went together through the interwar period. The problem of the renminbi peg to the dollar is one which should be confronted eventually, for everyone’s sake.
Bernanke, B.S. (2000). Essays on the fantastic Depression. Princeton: Princeton University Press.
Eichengreen, B. (1989). The Political Economy of the Smoot-Hawley Tariff, Research in Economic History 12: 1-43.
Eichengreen, B. (1992). Golden Fetters: The Gold Standard and the fantastic Depression 1919-1939. Oxford: Oxford University Press.
Eichengreen, B. and K.H. O’Rourke. (2009). AN ACCOUNT of Two Depressions.
Friedman, M. and A.J. Schwartz. (1963). A Monetary History of the united states, 1867-1960. Princeton: Princeton University Press.
Irwin, D.A. (1998). The Smoot-Hawley Tariff: A Quantitative Assessment. Overview of Economics and Statistics 80: 326-334.
Temin, P. (1989). Lessons from the fantastic Depression. Cambridge MA: MIT Press.