Protectionists Hide in Your Wallet

by Bill Schwartz, Dmitriy Katsnelson of Bronfman E.L. Rothschild, 4/19/18

It is often fun (at least for us) to go back and re-read some of our prior quarterly missives. One of our favorites from a couple of years ago was about “Andrew Jackson”1 and the parallels of his presidential bid in the late 1820’s to the then impending election. If you remember, he ran on an economic platform of:

  1. Protect the American people from the rich and powerful.
  2. Reduce the national debt and reduce the government.
  3. Strip the Second Bank of the United States of its central bank status and charter.
  4. Use protective tariffs to protect vital industries to the country’s defense.

Little did we know how prescient the last bullet point would become.

As we often do in evaluating a situation, we lean on context. Specifically, we push back on the premise that what is happening today is unprecedented, or even worse, precedented and catastrophic. The trade-protectionism narrative today brings back memories of the Great Depression and the concurrent 1930 Smoot-Hawley Tariff (sponsored by Senator Reed Smoot of Utah and Representative Willis Hawley of Oregon). It raised 900 import duties on over 3,000 products, in some cases by roughly 60%. Nations across the world and our neighbors (particularly Canada) retaliated in kind, resulting in a substantial reduction in global trade volumes. Increasing protectionism during a recession was ultimately quite harmful, although over a short period US industrial production ticked up before resuming the Great Depression trend. Most economists do not blame the tariff for the Great Depression, but they do not believe it helped us return to prosperity either. There are many parallels to that era beyond trade including growing nationalism and xenophobia. In short, it is not the era Americans look back on with rose-colored glasses.

If one looks at the history of US trade policy, however, they will see prolonged periods of rising protectionism (Founding-1830, 1860-1935) and more openness (1830-1860, 1935-Present). The founding fathers were, to a great extent, protectionist. Alexander Hamilton (believed to be a staunch protectionist after his Report of Manufactures in 1791) was a dove compared to the policies put in place by Washington, Madison, and Jefferson. The latter, for example, set up a complete embargo from 1807-1809 in response to aggression against US shipping from Britain and France during the Napoleonic Wars. As economist Douglas Irwin described, “…the export-weighted average of the prices of raw cotton, flour, tobacco, and rice, which accounted for about two-thirds of U.S. exports in the United States, fell by one-third within a month or two of the embargo. The price of imported commodities rose by about a third as the number of ships entering U.S. ports fell to a trickle and imports became increasingly scarce.” An embargo is an exaggerated example of a trade war, but illustrates the basic economic principle. The prices of exported goods are expected to fall and imported to rise.

One massive caveat to the protectionist history of our nation is what the tariffs aimed to achieve. Although protecting infant industries was the goal of the likes of Hamilton, there was also another need. Specifically, there was no system of income tax in place in the US until the early 20th century. Our country was dependent on tariffs and duties as the primary source of income for the first 125 years or so, first, to pay off debt from the Revolutionary War, and thereafter, to fund government.