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It is not the economic impact of tariffs that is most worrying

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The Economist

Mar 07, 2025 11:41 AM IST

If the direct economic impact of the tariffs has been overstated, their overall impact has not.

Editor’s note (March 6th): Since this article was published, Donald Trump announced that tariffs on Mexican and Canadian goods covered by the North American trade agreement (roughly half their total exports to America, according to the White House) would be paused until April 2nd.

FILE PHOTO: US President Donald Trump had a message to farmers and consumers of the country.(REUTERS) PREMIUM

FILE PHOTO: US President Donald Trump had a message to farmers and consumers of the country.(REUTERS)

Canada’s business press remained sanguine. Belligerent statements by the American president, one Toronto-based newspaper wrote, were mere campaign rhetoric; he would ultimately decide against tariffs that might “arouse resentment in href="https://www.economist.com/the-americas/2025/03/06/canadas-trumpian-nightmare-is-the-liberal-partys-dream" target="_blank" class="manualbacklink">Canada”. Such confidence turned out to be gravely misplaced. In 1930 Herbert Hoover signed into law the infamous Smoot-Hawley tariffs, named after their congressional sponsors. The average levy on American imports increased from 40% in 1929 to 60% by 1932, and the global trade system unravelled.

Now the world may be in for a repeat. The Smoot-Hawley tariffs were meant to protect farmers, but grew owing to congressional “logrolling”, as representatives sought advantages for their local industries. At the time, few thought the whole package was wise. This newspaper responded to the bill’s passage by calling it “tragic-comic”. Much the same could be said of today’s tariffs. At a minute past midnight on March 4th, Donald Trump imposed 25% levies on Canadian and Mexican imports (later offering carmakers a reprieve), as well as an extra 10% on Chinese imports, despite the fact there is little appetite among Americans for a trade war with the country’s allies, let alone any economic rationale.

What can be learned from the earlier episode? America’s Smoot-Hawley tariffs have been blamed for the Depression, but this is inaccurate. Economic historians instead finger unintended monetary tightening as the downturn’s cause. The Federal Reserve failed to react to bank collapses, leading money supply to contract. This exacerbated the impact of protectionism: deflation lifted effective tariff rates, which were often levied as cents on the weight of imports, rather than as a percentage of value.

If the direct economic impact of the tariffs has been overstated, their overall impact has not. The worst damage came from the division of democracies into rival trade blocs. During the 1920s the League of Nations, a precursor to the United Nations, managed to negotiate a “tariff truce”. The Smoot-Hawley tariffs incensed America’s allies, who were infuriated by their economic punishment, but even more so by a sense of betrayal that it had been inflicted by an ally. In 1931 Neville Chamberlain, the British chancellor, set out to institute “imperial preferences”, creating a tariff wall around the British Empire. This was brought into reality by the Ottawa Agreements in 1932, signed by Britain, Australia, Canada, India, New Zealand and South Africa. Similar policies in the Dutch and French empires also caused damage. For instance, Japanese exports were shut out of both India and Indonesia, then a Dutch colony, undermining liberals in Tokyo.

This time round, the democracies of the world will hold together: they are exploring how to deepen trade relations. Yet the danger of division is not history’s only warning. The Smoot-Hawley tariffs undoubtedly helped one export: anti-Americanism. Cuba, which depended on sugar exports to America, fell into a recession. Its economic collapse led to an anti-American revolution in 1933 and a short-lived government that was overthrown by an American-backed coup. Relations between the two countries have been frosty ever since. Canada’s Liberal Party called a snap election after retaliating against America by raising duties on commodities such as eggs and wheat. The even more anti-American and pro-tariff Conservative Party proceeded to win it. Today the Liberals, now seen as more anti-Trump than the Conservatives, are the beneficiaries. They have shot up in the polls ahead of an election that could take place in a matter of weeks.

During the 1930s many countries had treaties with America that prevented them from retaliating with tariffs. Instead, they employed more subtle techniques such as import quotas for cars, then the cutting edge of American manufacturing, as well as bottom-up boycotts. The Italian Royal Automobile Club called for consumers to avoid American cars, saying that it was unpatriotic to be seen driving one. Consider it an interwar equivalent of today’s boycotts of Tesla, an electric-car company run by Elon Musk, who is a close ally of Mr Trump. Kris Mitchener of the Leavey School of Business, Kevin O’Rourke of Sciences Po and Kirsten Wandschneider of the University of Vienna find that, even in countries which did not formally retaliate, imports from America dropped by 15-20% more than economic conditions implied.

Second time also as farce

Tariffs also interacted explosively with monetary policy. The gold standard, an exchange system in which currencies were pegged to the price of gold, was the culprit (as it was for the Fed’s mistakes in responding to bank failures). Britain left the gold standard in 1931. Weaker sterling made its exports, and those of its colonies that also used the pound, more competitive, finding extra buyers in foreign markets. This led others to impose higher tariffs on British goods or bring in exchange controls to prevent the outflow of gold from their own treasuries. An inability to secure the currency needed to buy imports did more to stop international trade than tariffs did. At first, America and France defected from the exchange-rate system, hoarding gold, before quitting altogether.

Students of financial crises should worry. Nowadays the dollar, as the global reserve currency, plays a role akin to that of gold in the interwar period. Around half of global trade is invoiced in the currency. Its role is buttressed by America’s military might. Indeed, Barry Eichengreen of the University of California, Berkeley, and his colleagues find that countries with American military alliances are more likely to hold dollar reserves, and the Fed is consequently more willing to act as a lender of last resort for the global economy. In 2008 and 2020 swap lines between America and its allies helped prevent a repeat of the Depression. In this new, more transactional world, will such a backstop still be available?

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