Paul Krugman, who is very upset with Republicans on both sides of the Trump divide, ridiculed Mitt Romney’s attack on Trump for being a protectionist. Romney warned that if Trump implemented his proposed protectionist policies, the result would likely be a trade war and a recession. Now I totally understand Krugman’s frustration with what’s happening inside the Republican Party; it’s not a pretty sight. But Krugman seems just a tad too eager to find fault with Romney, especially since the danger that a trade war could trigger a recession, while perhaps overblown, is hardly delusional, and, as Krugman ought to recall, is a danger that Democrats have also warned against. (I’ll come back to that point later.) Here’s the quote that got Krugman’s back up:
If Donald Trump’s plans were ever implemented, the country would sink into prolonged recession. A few examples. His proposed 35 percent tariff-like penalties would instigate a trade war and that would raise prices for consumers, kill our export jobs and lead entrepreneurs and businesses of all stripes to flee America.
After all, doesn’t everyone know that protectionism causes recessions? Actually, no. There are reasons to be against protectionism, but that’s not one of them.
Think about the arithmetic (which has a well-known liberal bias). Total final spending on domestically produced goods and services is
Total domestic spending + Exports – Imports = GDP
Now suppose we have a trade war. This will cut exports, which other things equal depresses the economy. But it will also cut imports, which other things equal is expansionary. For the world as a whole, the cuts in exports and imports will by definition be equal, so as far as world demand is concerned, trade wars are a wash.
Actually, Krugman knows better than to argue that the comparative statics response to a parameter change (especially a large change) can be inferred from an accounting identity. The accounting identity always holds, but the equilibrium position does change, and you can’t just assume that the equilibrium rate of spending is unaffected by the parameter change or by the adjustment path the follows the parameter change. So Krugman’s assertion that a trade war cannot cause a recession depends on an implicit assumption that a trade war would be accompanied by a smooth reallocation of resources from producing tradable to producing non-tradable goods and that the wealth losses from the depreciation of specific human and non-human capital invested in the tradable-goods sector would have small repercussions on aggregate demand. That might be true, but the bigger the trade war and the more rounds of reciprocal retaliation, the greater the danger of substantial wealth losses and other disruptions. The fall in oil prices over the past year or two was supposed to be a good thing for the world economy. I think that for a lot of reasons reduced oil prices are, on balance, a good thing, but we also have reason to believe that it also had negative effects, especially on financial institutions holding a lot of assets sensitive to the price of oil. A trade war would have all the negatives of a steep decline in oil prices, but none of the positives.
But didn’t the Smoot-Hawley tariff cause the Great Depression? No. There’s no evidence at all that it did. Yes, trade fell a lot between 1929 and 1933, but that was almost entirely a consequence of the Depression, not a cause. (Trade actually fell faster during the early stages of the 2008 Great Recession than it did after 1929.) And while trade barriers were higher in the 1930s than before, this was partly a response to the Depression, partly a consequence of deflation, which made specific tariffs (i.e., tariffs that are stated in dollars per unit, not as a percentage of value) loom larger.
I certainly would not claim to understand fully the effects of the Smoot Hawley tariff, the question of effects being largely an empirical one that I haven’t studied, but I’m not sure that the profession has completely figured out those effects either. I know that Doug Irwin, who wrote the book on the Smoot-Hawley tariff and whose judgment I greatly respect, doesn’t think that Smoot Hawley tariff was a cause of the Great Depression, but that it did make the Depression worse than it would otherwise have been. It certainly was not the chief cause, and I am not even saying that it was a leading cause, but there is certainly a respectable argument to be made that it played a bigger role in the Depression than even Irwin acknowledges.
In brief, the argument is that there was a lot of international debt – especially allied war loans, German war reparations, German local government borrowing during the 1920s. To be able to make their scheduled debt payments, Germany and other debtor nations had to run trade surpluses. Increased tariffs on imported goods meant that, under the restored gold standard of the late 1920s, to run the export surpluses necessary to meet their debt obligations, debtor nations had to reduce their domestic wage levels sufficiently to overcome the rising trade barriers. Germany, of course, was the country most severely affected, and the prospect of German default undoubtedly undermined the solvency of many financial institutions, in Europe and America, with German debt on their balance sheets. In other words, the Smoot Hawley tariff intensified deflationary pressure and financial instability during the Great Depression, notwithstanding the tendency of tariffs to increase prices on protected goods.
Krugman takes a parting shot at Romney:
Protectionism was the only reason he gave for believing that Trump would cause a recession, which I think is kind of telling: the GOP’s supposedly well-informed, responsible adult, trying to save the party, can’t get basic economics right at the one place where economics is central to his argument.
I’m not sure what other reason there is to think that Trump would cause a recession. He is proposing to cut taxes by a lot, and to increase military spending by a lot without cutting entitlements. So given that his fiscal policy seems to be calculated to increase the federal deficit by a lot, what reason, besides starting a trade war, is there to think that Trump would cause a recession? And as I said, right or wrong, Romeny is hardly alone in thinking that trade wars can cause recessions. Indeed, Romney didn’t even mention the Smoot-Hawley tariff, but Krugman evidently forgot the classic exchange between Al Gore and the previous incarnation of protectionist populist outrage in an anti-establishment billionaire candidate for President:
GORE I’ve heard Mr. Perot say in the past that, as the carpenters says, measure twice and cut once. We’ve measured twice on this. We have had a test of our theory and we’ve had a test of his theory. Over the last five years, Mexico’s tariffs have begun to come down because they’ve made a unilateral decision to bring them down some, and as a result there has been a surge of exports from the United States into Mexico, creating an additional 400,000 jobs, and we can create hundreds of thousands of more if we continue this trend. We know this works. If it doesn’t work, you know, we give six months notice and we’re out of it. But we’ve also had a test of his theory.
GORE In 1930, when the proposal by Mr. Smoot and Mr. Hawley was to raise tariffs across the board to protect our workers. And I brought some pictures, too.
[Larry] KING You’re saying Ross is a protectionist?
GORE This is, this is a picture of Mr. Smoot and Mr. Hawley. They look like pretty good fellows. They sounded reasonable at the time; a lot of people believed them. The Congress passed the Smoot-Hawley Protection Bill. He wants to raise tariffs on Mexico. They raised tariffs, and it was one of the principal causes, many economists say the principal cause, of the Great Depression in this country and around the world. Now, I framed this so you can put it on your wall if you want to.
You can watch it here