Tuesday, May 29, 2018

The Alleged Austerity of the United Kingdom

1 MIN READ - The Short Read from the Cautious Optimism Correspondent for Economic Affairs and other Egghead Stuff questions seriously the decade-old presumption of budget "austerity" in Europe.

Nearly a decade after the global financial crisis, the New York Times continues to propagate the myth of European "austerity" with a front page story this week about the long-term impoverishing effects of ten years of "budget cuts" in the United Kingdom (see article link).


Has the New York Times even bothered to look at the British government’s budgets for the last ten years?

From HMTreasury National Archives. Note that spending has risen every single year since 2008 and is up 40% since the financial crisis. If this is their definition of "austerity" then what does it take to be considered profligate spenders?

2008       582.23 £ billion
2009       633.81 £ billion
2010       673.10 £ billion
2011       714.34 £ billion
2012       720.87 £ billion
2013       740.73 £ billion
2014       746.12 £ billion
2015       761.11 £ billion
2016       762.28 £ billion
2017       780.27 £ billion
2018       814.02 £ billion

Saturday, May 26, 2018

The USA: "Undisputed Oil and Gas Leader in the World Over the Next Several Decades"

Click here to read the original Cautious Optimism Facebook post with comments

1 MIN READ - From the Cautious Optimism Correspondent for Economics and other Egghead Stuff.

Regarding America's alleged inability to "drill ourselves" out of energy supply problems, from Quartz magazine's "US oil and gas production is leaving Saudi Arabia and Russia behind."

"The [Energy Information Administration (EIA)] independent energy statistical agency describes the US as 'the undisputed oil and gas leader in the world over the next several decades.'”

In its last paragraph, Quartz attempts to frame the US energy success story as potentially catastrophic for the planet--a feeble failure as 99% of readers will walk away from their own story remembering the impressive scale of America's energy success instead of yet more global warming scaremongering.

Thursday, May 10, 2018

Lessons from the Great Depression: Trade, Protectionism, and The Smoot-Hawley Tariff (Part 2 of 3)

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Sen Reed Smoot (R-UT) and Rep Willis Hawley (R-OR)


Quantifying Smoot-Hawley’s economic consequences and addressing historical criticisms and defenses of the tariff is a complex task. Several other factors were in play during the 1930’s and calculating precisely how much of the economic downturn was attributable to which factor is equal parts art and science. However we will try to lay out the main factors as best we can here and lead to more general than specific conclusions.

First, critics of Smoot-Hawley sometimes resort to hyperbole, describing it as “the greatest tariff hike in American history.” But Smoot-Hawley duties were actually somewhat small compared to those of other previous tariff acts. Professor Doug Irwin of Dartmouth, an international trade specialist, estimates that Smoot-Hawley added about 7-8 percentage points to the price of dutiable imports in 1930. That makes it a smaller hike than the 1922 Fordney-McCumber tariff, much smaller than the 1828 Tariff of Abominations, but larger than the 1890 McKinley tariff.

But unlike previous tariffs, Smoot-Hawley duties were tacked upon the antecedent Fordney-McCumber tariff. This is very significant since the sum of both tariffs resulted in closer to a 38 percentage point duty on imports. And what’s more important than the amount is the timing. Had Congress not passed Smoot-Hawley, the original Fordney-McCumber tariffs would have remained in effect, but having already been in place since 1922 would almost certainly not have sparked overseas anger and retaliation in 1930.

Furthermore, two-thirds of Smoot-Hawley duties were “specific duties,” or a fixed dollar amount on imported goods (in contrast to “ad valorem” duties that levy a specific percentage on the price of import). The United States suffered a devastating price deflation from 1929-1933, so as the nominal price of imported goods fell around 28%, specific duties remained constant and therefore raised prices of those imports in real terms. Professor Irwin calculates that by 1932 the average tariff on dutiable items had risen from 38% to 59% due to deflation alone. A 59% tariff places the combined Smoot-Hawley/Fordney-McCumber tariff near record territory; the only higher American tariff being the Tariff of Abominations which topped out at 61% in 1830. So by 1932, the combined tariff had become very burdensome and in fact was nearing a record itself.

Some economists argue that the increasing burden of the tariff, being due partly to deflation, can’t be blamed on Smoot-Hawley but rather on falling prices. This is only partially true. As we shall see in a moment Smoot-Hawley also likely contributed to the deflation itself by setting off Midwestern bank failures in agricultural areas which in turn launched banking panics.

There is also no question that after the tariff was signed, both U.S. and international trade plummeted. U.S. exports fell from $7 billion in 1929 to $2.4 billion in 1932, contracting by nearly two-thirds. Adjusting for deflation the drop is slightly less severe: “only” 54.3% in real terms. International trade collapsed by nearly the same amount. U.S. imports, which were smaller than exports, also fell 40% from 1929 to 1932 (Irwin).

How much of these declines was attributable to the tariff and retaliation is difficult to quantify. Why? Both U.S. and international consumers cut back their purchases due to general depression conditions and reduced demand for all goods—domestic and imported. Also starting in late 1931 several trading partners began leaving the gold standard and devaluing their currencies against the dollar which made U.S. goods even more expensive to import (and their exports slightly less expensive to U.S. consumers).

Regarding the devaluation claim, it is true that going off gold and devaluing their currencies enabled countries to more easily sell their goods abroad. The USA and most of Europe were suffering from chronic deflation—the consequence of the damaging inflation their central banks had enacted in concert under the new paper/bullion hybrid gold-exchange standard of 1925-1931 (UK and Europe) and more conventional inflation of 1927-1929 (USA)—and going off gold or gold-exchange was an easy, attractive way to reinflate the money supply.

However trade and tariffs were also a factor in international decisions to go off gold. After the passage of Smoot-Hawley some countries, not wanting or not able to resort exclusively to retaliatory tariffs targeting the United States, resorted to devaluation as a surrogate tariff instead. Domestic reinflation was almost certainly a consideration as well, but so was compensating for U.S. protectionism. As some countries devalued to counter Smoot-Hawley their “beggar thy neighbor” monetary policies applied pressure to their neighbors who were reluctantly forced into devaluation or protective tariffs themselves. The result was a domino effect of import/export barrier construction around the world. So some of the decline in U.S. exports attributable to foreign currency devaluation can be blamed on Smoot-Hawley’s instigation after all.

Very generally speaking, a sampling of statistics suggests that the tariff was responsible for more of the loss in U.S. exports than the “depression conditions” alternative suggests. For example, in the aforementioned Spanish tariff on American cars, auto sales fell 94% in the ensuing three years. No matter how bad the Great Depression’s impact on domestic demand, it can’t explain a plunge in auto imports of that magnitude—especially as auto imports from other European countries was rising.

American automobiles were in fact a common target for tariffs in Europe as the United States was synonymous with car imports. By 1932 U.S. car exports to Europe had fallen by 82%, again impossible to explain simply due to depression conditions in Europe.

The same can be said for U.S. agriculture. After Canada imposed retaliatory tariffs shipments of U.S. eggs north of the border fell from 919,000 dozen in 1929 to a mere 7,900 dozen in 1932. A decline of over 99% can’t be explained by lower consumer demand due to Canadian economic conditions. With the average European country losing about 15% of GDP during the early 1930’s, the tariff and retaliations clearly played the larger role in U.S. export declines.

And no one was hurt more than the constituency the tariff was officially drafted to help: American farmers. Agriculture suffered a double-blow. First, duties on imported goods raised the price of tools, machinery, and equipment that farmers used. Then retaliations, often targeted towards American agriculture, choked off overseas markets for their crops.

And there is a financial/banking element to the tariffs as well. Those areas of the country where banking failures were most common, and where banking panics sparked before spreading to the rest of the country, were typically the same that had been most severely affected by retaliatory tariffs. Midwestern banks famously failed in waves, the result of farm failures, an inability to repay farm debts, and restrictive unit banking laws that prohibited banks from branching geographically and diversifying their loan portfolios outside of agriculture alone.

It’s also not a coincidence that Detroit was a banking basketcase as U.S. auto exports to Europe fell by the previously mentioned 82%. American iron and steel exports fell by 85% due mostly to Canadian retaliation, leading to the late 1931 failure of eleven of Pittsburgh’s largest banks with $67 million in deposits; equal to about $17 billion in 2018 when measured as the same share of GDP. Retaliation against U.S. mineral exports hit mining-reliant Nevada  and led to the failure of the Wingfield chain of banks with 65% of all Nevada deposits and 75% of all commercial loans.

And on a final banking note, the banking and financial industry’s warnings to Hoover materialized into their worst fears. The USA was the world’s largest creditor nation, but since trading partners were less able or even unable to sell their products to the United States, dollars for repaying loans to American banks dried up. In response foreign governments launched debt payment moratoriums, throwing the U.S. financial system into further turmoil and panic.


For several decades after the Great Depression a general consensus formed among economists and historians that the Smoot-Hawley tariff was the cause of the Great Depression. However in 1962 Milton Friedman and Anna Schwartz published their famous book “A Monetary History of the United States” which proposed primary blame for the Great Depression lied instead with bad polices at the Federal Reserve.

The thesis of the Fed as greatest single instigator of the depression has been universally accepted in the decades since and justifiably so. But in recent years Smoot-Hawley’s impact has been diminished to near “insignificance.” Indeed Nobel Laureate Robert Lucas has used that exact word to describe his own assessment of the tariff’s effect (along with “trivial”). Harvard’s Gregory Mankiw offers a somewhat more denunciatory view when he concludes the tariff “did not cause the Great Depression, but it contribute to a plunge in world trade and undoubtedly was a step in the wrong direction.“ I think Mankiw’s position is the correct one, and that the evidence doesn’t support the dismissive view.

For example, there are economists who argue “Yes, the result was a sharp dropoff in exports, but exports were a much smaller share of the U.S. economy at the time: only 7% compared to 12% today.” Those figures are accurate, but U.S. exports (which are a net contributor to GDP) fell by 54.3% in real terms. 54.3% of 7% of GDP equals 3.8% of GDP which is a greater loss than the Volcker Recession of 1981-82 where the unemployment reached 11% (source: NBER).

Also, at the trough of the depression America had lost 26% of GDP. If 3.8% of that loss is attributable to falling exports, a full one-seventh of the entire nation’s loss of output can be attributed to the consequences of Smoot-Hawley. Given all the other policies that were being enacted during the Hoover and early FDR years (Fed policy, tax, spending, wage, NIRA pricing, labor, agricultural, and banking policies) a single legislative act precipitating a full one-seventh of all GDP loss is hardly insignificant.

Yes, some of the export loss can be attributed to depressed demand overseas and currency devaluations, but as we’ve already shown, some currency devaluations were in and of themselves retaliations against Smoot-Hawley, and the falloff in those US exports that were emphatically targeted overseas (82%, 94%, 99%) are simply too great to attribute mostly to depression conditions but rather to retaliation.

Finally Smoot-Hawley’s impact on GDP goes beyond simply the mathematical loss of exports since farm failures and stress in other impacted industries launched widespread bank failures and financial turmoil which produced further deleterious effects for the domestic economy.

Finally a less common argument is “Imports fell by 40%, partially offsetting the 54% drop in exports.” This is a more Keynesian argument, the logic being money that would have been spent on imports was simply shifted to domestic goods. Professor Irwin’s research concludes there is no evidence supporting this outcome, which is consistent with at least two fatal flaws in the theory.

First, many of the targeted imports that dried up simply could not be replicated in the United States. For example, no matter what the shift in demand the USA was simply incapable of replacing lost banana, rubber, cocoa bean, or silk imports that can’t be easily produced stateside. America had no practical abundance of rubber trees or silkworms, and its climates are mostly inhospitable to growing banana trees and cocoa beans. Even if it were possible, it would have taken years to increase the production capacity of rubber and banana trees, cocoa plants, and silkworm farms to fully replace pre-tariff import levels—an example of barriers dismantling the international division of labor and its benefits.

Also, for other targeted imports such as manufactured goods the U.S. may have been able to shift to production of its own replacements in new or refitted factories, but such a shift would require large capital expenditures, expertise, and appetite for entrepreneurial risktaking. During a time of widespread bank failures, scarce credit, and collapsing output, capital and risk tolerance were in scarce supply. It was simply impossible to ramp up a new, huge industrial production base to replace imported goods overnight.

Stay tuned for Part 3 of this installment where we will examine the demise of the Smoot-Hawley Tariff and present-day efforts to draw comparisons against the Trump administration’s tariff proposals.