Global industrial bail-outs: the Smoot-Hawley Tariffs of 2009?

January 26, 2009

The story of the Smoot-Hawley Tariffs should be a cautionary tale to present-day policymakers. The tariffs did not cause the Great Depression, but they deepened its severity and duration. All of the economists of the time opposed the measure, to no avail. As the House and Senate debated the bill, they barely considered the potential response from other countries. The tariffs were passed, leading to global retaliation. Global trade plunged from $5.3 billion in January 1929 to $1.8 billion in June 1933.

In difficult times, despite the lessons from the past, politicians always find it tempting to prop up domestic jobs and incomes with export subsidies, import tariffs, and cheaper currencies. In today’s globalized economy with far-flung supply chains and just-in-time delivery, it would take much less than the Smoot-Hawley Tariffs to disrupt trade.

In November the leaders of the G20 group of big, rich and emerging economies promised to eschew any new trade barriers for a year. Within days, Russia and India raised tariffs on cars and steel respectively. It has actually been surprising how few direct protectionist calls there have been so far in the US even though tariffs are currently low enough that on average they could triple without breaking WTO rules. It may be that to avoid appearing protectionist, politicians won’t increase tariffs but will resort to other means. Global competitive industrial bailouts are currently the main source of concern.

Unfortunately, large bank bailouts are unavoidable as businesses and consumers need credit to function. While the economy cannot operate without an effective banking system, the same cannot be said of other commercial institutions, be they in services or manufacturing.

There have been mostly calls to bail out companies in manufacturing, but the distinction between services and manufacturing is largely artificial. Designers, analysts, the sales force, and financial support staff at Rolls Royce, an aero-engine maker in “manufacturing”, do the same jobs as their counterparts at ARM, which designs, sells, and markets its processors, but is in “services” because other people make its processors. The distinction owes more to government statisticians than anything else.

Regardless, a bailout is a discriminatory subsidy. It’s very possible that bailouts in one country will lead to bailouts in other countries. As during the Smoot-Hawley Tariff discussions in Congress, the global response to bailouts such as the one for the Detroit automakers has not been considered. Nicolas Sarkozy has already said that Europe would become an “industrial wasteland” if it does not follow the US’s lead in propping up manufacturers.

A global misallocation of capital, throwing good money after bad through bailouts and thus by definition under-allocating capital to promising companies, would deepen and lengthen the severity of the current downturn much as the Smoot-Hawley Tariffs did during the Great Depression.

On the bright side, the current administration seems pragmatic and I am still hopeful that the bailouts will be limited and that politicians will have the courage to let failed companies die.

Fingers crossed!

Concur totally on the effective equivalency of bailout == another form of tariff because of the discriminative nature.

Disagree totally on the Obama Admin being anything near pragmatic. What has differentiated U.S.A. in the past is that we avoided the liberal power grabs that would have put us in the same boat as royalist Europe of yesteryear. The potential for self dealing with these bailouts are enormous. Enormous to the point its unbelievable to think it could go any other way. Critical test is the imaginary liberal religion of global warming. They are still beating those drums in spite of ample evidence the world is now in a long term cooling trend. Why? Because it would simply pay too well if they can manage to tax carbon. Carbon the basis of all life itself and they have managed to stigmatize it. This is far from pragmatic and goes beyond dishonesty into the region of truly neurotic pathological behavior.

I don’t really think there’s much to worry about. The probability of other countries responding to a bailout with a tariff raise is very low, for the following reasons:

1. The point of raising import tariffs is to raise prices on goods from abroad and thereby encourage domestic consumption. With a current account deficit as big as the United States’s (about $200B on goods in Q3 alone), raising tariffs against us is about equivalent to building a missile defense shield against Switzerland. Think about it – the US bails out the auto industry, which does maintain consumption of US autos, blocking Japanese cars from coming in. But would there be any effect to Japan raising import tariffs on US cars in response? It might upset all 3 Japanese people who were planning on buying US cars next year, but it can’t significantly hurt US consumption of US cars, and therefore won’t have a noticeable impact on the industry. Japan could fight back by granting export subsidies, lowering the prices of its own Japanese exports for US consumers, but while tariffs are an easy lever to pull in a depression because they create revenue for the government, subsidies are much harder as they represent a fiscal outflow at a time when many budgets are strained.
2. The game theory doesn’t hold. Think about how it plays out: Country A bails out an industry. Country B raises their tariffs 5%. Country A then raises their tariffs 5%. Country B then raises their tariffs another 5%. And so on and so forth until you are even worse off than before, with Country A still having bailed out an industry and both sides hurting their consumers with unreasonably high tariffs. The advantage is still there for Country A, but you’ve made a mess in the meantime. This is especially bad in situations where there is a trade imbalance such as the Japanese auto example, as the ending position means that Japanese cars are now more expensive in the U.S. and demand will therefore be lower, while the decrease in domestic demand for US cars has not been that affected because it was so low to start with.
3. Additionally, this is a repeated game. Bailouts are usually for strategically important industries at key times, and no country wants to limit its future bailout options by responding hastily now. If any country were to raise a tariff in response to a bailout today, it opens up the possibility for other countries to respond similarly to its own bailouts later.
4. Politically, tariffs are much different than bailouts. Bailouts are definitionally multilateral – if the US bails out the steel industry, it affects every country we transact with (or theoretically could). If Germany responds by increasing tariffs, it finds itself between a rock and hard place: it can either raise tariffs on all imported steel, punishing partners who haven’t done anything, or it can raise tariffs only against the US, singling them out politically and potentially justifying a trade war.
5. For all of the reasons above, historically the response to a bailout has almost always been legal action with the appropriate authority (European airline bailouts, for instance). It’s a much neater way to restore competition without subjecting yourself to the spiraling escalation of the Smoot-Hawley days.

Totally agree about bailouts in non-finance sectors. Creates tons of incompetence.

Someone sent me a quote (though I question if it’s legit)

“Owners of capital will stimulate the working class to buy more and more expensive goods, houses and technology, pushing them to take more and more expensive credits, until debt becomes unbearable.
The unpaid debt will lead to the bankruptcy of banks, which will have to be nationalized, and the State will have to take the road which will eventually lead to Communism. ”
Karl Marx, 1867.

http://edition.cnn.com/2009/BUSINESS/01/30/davos.wef.friday.wrap/index.html

German Chancellor Angela Merkel warned Friday that U.S. efforts to prop up its failing auto industry with bailout money amount to a form of protectionism that threatened to distort the global economy.

Not sure if your link was meant to be a response to me, but just to be clear:

I completely agree that any US bailout is a protectionist measure that leads to distortions in the global economy – the US should clearly be reallocating its resources to industries where it has a larger competitive advantage (you could argue that the bailouts are just compensation for bad government policies on unions that distort the balance of trade the other way, but I won’t get into that).

My point was simply that your point that it might lead to a tariff war is probably invalid. I even noted in point 5 that there would probably be diplomatic response. I just think that for reasons 1-4, economic policy response, especially tariffs, is unlikely. We’ll see how the next few weeks shape out . . .