The Bear’s Lair: Smoot-Hawley and no EPA — it’s a Deal!

The Republican establishment, and National Review in particular, has been emitting a “Hymn of Hate” about Donald Trump, their likely nominee for President. One of their charges is that Trump is protectionist, making Hillary Clinton economically preferable. I too dislike protectionism, but that may be going too far, because protectionism is by no means the only factor destroying current economic performance. So, a thought experiment: if Trump offered us one of his trademark Deals, promising to abolish the Environmental Protection Agency (which alas he hasn’t promised), but also re-imposing the 1930 Smoot-Hawley protective tariff, should we take his YUUUUGE offer?

There is no question that Smoot-Hawley was a particularly foolish piece of legislation. Passed as a response to the Wall Street Crash by the activist President Herbert Hoover in response from protectionist legislators, it raised tariffs to the second highest level in U.S. history, a “dutiable rate” of 59%, beaten only by the Tariff of Abominations of 1828 (which was passed only a result of a political miscalculation by John C. Calhoun and reversed by the incoming Andrew Jackson Democrats in 1832).

The legend is that other countries then retaliated, causing world trade to spiral downwards. However, the main object of FDR-era scorn for retaliation was the British Empire’s 1932 Imperial Preference scheme, which simply ended Britain’s economically suicidal 1846-1932 policy of unilateral free trade, imposing a common imperial tariff of only 10%, far below the Smoot-Hawley level, and indeed below U.S. tariff protection at any time in its history to that date.

The other factor not considered when denouncing Smoot Hawley is that by 1932 two thirds of goods admitted to the U.S. were not dutiable, so that the true average tariff rate imposed by the measure was only19.8%, well below most of the “free and dutiable” tariff levels imposed throughout the nineteenth century. Thus when we consider a Trump re-imposition of Smoot-Hawley, we should consider the imposition of a free and dutiable average tariff rate of 19.8%, not 59%. That is admittedly a sharp increase from the current free and dutiable tariff rate of 1.3%, but well below the average 25% imposed by the sainted Abraham Lincoln through the infamous Morrill Tariff of 1862, which began the reversal of half a century of British-led progress towards global free trade.

Trump’s desire to impose protectionism is thus squarely in the Republican party tradition. It would also not by itself reduce world trade by anything like the 60% by which global trade declined in the early 1930s. Smoot-Hawley raised the average U.S. free and dutiable tariff rate from 13.8% to 19.2%. Even with proportional retaliation from other countries, that is simply not enough for it alone to have reduced global trade so much.

Other factors were responsible. One was the collapse of U.S. money supply caused by the closure of one third of the banking system. A second was the 1932 increase by Hoover of the top income tax rate from 25% to 63% — income tax increases reduce economic activity just as surely as tariff increases, and the massive size of this increase, and its negative supply-side effects were particularly damaging. Finally, there was the January 1933 advent to power in the world’s third largest economy of a genocidal nutcase, and the 1931 advent to power of militarist/protectionist forces in Japan. Smoot-Hawley was damaging, but only moderately so.

There is no question an increase of 18.5% in average U.S. tariff rates by a Trump administration, replicating Smoot-Hawley’s overall level though doubtless different in its details, would be highly economically damaging. However, we must now consider the offsetting benefit from the other element in the postulated Trump Deal, abolition of the EPA.

The EPA is one of a number of regulatory agencies founded in the early 1970s, a period which coincided with a sharp downturn in productivity growth. Annual U.S. labor productivity growth declined from an average of 2.9% in 1947-73 to 1.9% in the period between 1973 and 2010, with a further shocking drop to 0.4% annually in the era of extra-aggressive regulation and funny money since 2010.

The precise division in responsibility between the EPA and other regulatory agencies such as the OSHA for the decline in productivity growth will never been known. In recent years, since 1995 or so, distortion of the economy by over-aggressive monetary policies undoubtedly also plays a part in the productivity growth slowdown. However, we can say as an absolute mathematical fact that if U.S. productivity growth had remained at its 1947-73 level, we would today be no less than 63% richer, in other words GDP per capita would be $86,600 instead of $53,300. You can get rid of a hell of a lot of existential blue-collar angst for an extra $33,300 on everybody’s output and living standards.

That’s why Trump’s postulated Deal makes sense. Even if only a third of the productivity slowdown is due to the EPA directly, and the other two thirds is due to other agencies, foolish monetary policy and other factors, the EPA has over the past four decades cost us 21% in our living standards. A new Smoot-Hawley, on the other hand, increasing tariffs by 18%, could not possibly cost us as much as 18% in our living standards, even taking into account retaliation by other countries setting their policies at what was best for them in the light of the new U.S. protectionism. As an estimate we may suppose it would reduce our living standards by about 10%. Of course, the new Smoot-Hawley and the retaliatory measures taken would reduce living standards in the rest of the world by a similar amount, some more, some less.

The new Smoot-Hawley’s effect on our living standards would be immediate, increasing the cost of imported goods by an average of 18%. On the other hand, the economic benefit to living standards of abolishing the EPA would be felt only over several decades, as productivity growth rebounded to its pre-1973 level, or even rather above it, as there would be some catch-up.

However, the beneficial effect on blue-collar life from the combined package of measures would be felt immediately. There would be a massive increase in domestic manufacturing, as companies sought to reorient or abolish global supply chains because of Smoot-Hawley II’s effect on their cost structure, while taking advantage of the new freedom from environmental regulations to establish new, polluting but highly efficient factories in places such as Detroit and Appalachia where labor was especially cheap. Foreign countries, especially those which kept free trade, would also benefit from cheap U.S. manufactured goods produced in a system free from most environmental regulations.

This would have a gigantic effect on prospects for blue-collar workers, provided President Trump kept his promise of clamping down on illegal and worker-exploiting immigration – otherwise all the new jobs would go to $1 a day Vietnamese on dodgy H1B and H2B visas, spurious “guest-worker” permits or simply illegal entrants.

The environmental trade-offs from EPA abolition would be minor. Water quality in Flint, Michigan would be unaffected; the EPA hadn’t been doing its job there anyway. Akron, Ohio would remain a “rust-belt pole of innovation” in Antoine van Agtmael’s imaginative phrase, but its principal innovations would come in the tire sector, where manufacturing would be resumed, protected by the new Smoot-Hawley tariff and free from hyper-expensive EPA regulations.

Naturally, the city would once again be smelt from 10 miles away, as it was in 1971 when I first drove through there, but for most residents of the Eastern Ohio rust-belt without STEM PhDs, the trade-off would be worth it, for the high-paying stable manufacturing jobs such as their fathers had enjoyed. Likewise, the fires on Cleveland’s Cuyahoga River would become a tourist attraction, to be enjoyed by the next Republican Convention in that city. With auto imports devastated by the tariff and the huge U.S. auto market opened up to domestic production, South Bend, Indiana would once again become the hub of activity in a revived Studebaker auto company, tail fins and all (in the years of President Trump, tail fins would surely return, maybe gold plated!)

EPA abolition would also lead to U.S. global leadership in energy production, with its unparalleled resources of newly-economic coal, as well as fracked oil and natural gas (all of which would avoid most pollution because of local ordinances and the threat of lawsuits.) There has already been some U.S. industrial revival on the back of cheap energy; the triple effect of cheap energy, international tariffs and relative lack of environmental regulations would bring a tsunami of further activity.

Of course, there would be winners and losers. California, with its taste for foreign automobiles and imported goods generally and its penchant for imposing state environmental regulations more stringent than elsewhere, would become almost deserted, with few inhabitants beyond billionaires in Teslas and bums seeking welfare. Even the young techies would seek opportunities elsewhere, in the burgeoning entrepreneurial economies of the Midwest, the Plains and the South.

Conversely, states with light regulations, natural resources and cheap labor, like Kentucky, would find themselves hubs of new prosperity. Coal mines in the eastern Kentucky hills would hum, fracking would take place all over the state, mining opportunities would multiply and new factories in its cities would resonate with new import-replacing activity. Kevin Williamson’s dismal broken families and meth addicts would dry out, shape up and enjoy a new blue-collar prosperity, as new job opportunities in fracking, light manufacturing and mining gave them irresistible opportunities to improve their lives.

Ideally, we would keep free trade, while combining it with major cutbacks, not only in the EPA, but in other regulatory agencies including those in finance that have destroyed so much productivity in recent years, and, together with counterproductive monetary and fiscal policies, turned many solid blue-collar families into derelicts. Maybe we’ll get lucky and elect Ted Cruz. But in this life we are not often permitted perfection, and if indeed he is nominated and elected, a President Trump who chose both protection and deep deregulation would at least be a lot better than the statist Hillary Clinton.

(The Bear’s Lair is a weekly column that is intended to appear each Monday, an appropriately gloomy day of the week. Its rationale is that the proportion of “sell” recommendations put out by Wall Street houses remains far below that of “buy” recommendations. Accordingly, investors have an excess of positive information and very little negative information. The column thus takes the ursine view of life and the market, in the hope that it may be usefully different from what investors see elsewhere.)