How Tariffs Can Help America: Economists Have Drawn the Wrong Lessons from the Failures of the 1930s [Foreign Affairs, Michael Pettis]

U.S. President-elect Donald Trump has promised to implement a suite of aggressive tariffs on American trade partners, including a blanket 20 percent levy on goods from abroad. Although his supporters claim that these tariffs will strengthen U.S. manufacturing and create jobs, critics contend that they will fuel inflation, suppress employment, and perhaps tip the economy into a recession. As a demonstration of what will go wrong, many cite the Smoot-Hawley Tariff Act of 1930, which raised U.S. tariffs across a variety of imports. “Judging by his proposed import tariff policy,” wrote the American Enterprise Institute economist Desmond Lachman, “it is evident that Donald Trump does not remember our country’s disastrous economic experience with the 1930 Smoot-Hawley Trade Act.”

But these claims only show how confused many experts are when it comes to trade—on both sides of the tariff debate. Tariffs are neither a panacea nor necessarily injurious. Their effectiveness, like that of any economic policy intervention, depends on the circumstances under which they are implemented. Smoot-Hawley was a failure at its time, but its failure tells analysts very little about the effect that tariffs would have on the United States today. That is because now, unlike then, the United States is not producing far more than it can consume. Ironically, the history of Smoot-Hawley says a lot more about how tariffs today would affect a country such as China, whose excess production more closely resembles that of the United States in the 1920s than does the United States of now.

Economists weren’t always so mixed up. In his classic 1944 book, International Currency Experience, Ragnar Nurkse wrote that “the devaluation of a currency is expansionary in effect if it corrects a previous overvaluation, but deflationary if it makes the currency undervalued.” Tariffs, which are close cousins of currency devaluation, act in the same way. They reduce domestic consumption and force up domestic savings rates. A country with low consumption and excess savings (like the United States in the 1920s or China today) tends to be one with an undervalued currency, in which case tariffs, like currency depreciation, are likely to be deflationary. But in a country with excessively high levels of consumption, like the modern United States, the same policy can be expansionary. Done under current circumstances, in other words, tariffs could increase employment and wages in the United States, raising living standards and growing the economy.