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Market Talk with Charlie Bobrinskoy

Tariffs and Protectionism – What’s Old is New Again

The threat of tariffs, protectionism and trade wars have been weighing on the markets this year. It’s not the first time these issues have made headlines. Charlie Bobrinskoy provides historical insights on the topsy-turvy politics of tariffs and protectionism.

When the North American Free Trade Agreement (NAFTA) became law in 1993, it had the support of nearly 300 economists, including all living Nobel Prize-winning economists.

NAFTA was one example of the idea that free trade was good for markets and for people, a cornerstone of the Republican business philosophy since World War II. Opposition to free trade had more support in Democratic circles than in the GOP. But today’s Republican President Donald Trump is arguing the U.S. should embrace protectionism and erect tariffs to safeguard American jobs hurt by free trade. This year, Trump has imposed tariffs on steel and aluminum imports (with some temporary reprieves for certain countries) and put tariffs on Chinese goods. In response, Canada, Mexico, the European Union and China slapped tariffs on some American goods.

The stock market fell on these headlines. The Dow Jones Industrial Average dropped 420 points in March following the steel and aluminum tariffs news, and in April it fell 572 points on fears tariffs placed on China would spark a trade war. On the last day in May the Dow dropped 200 points, on new tariffs from Canada, Mexico and the European Union in retaliation against the U.S. The weakness in equities reflects conventional wisdom, which says tariffs such as the Smoot-Hawley Tariff Act caused the Great Depression. Recently over 1,000 economists, including 14 Nobel Prize-winners, wrote Trump a letter warning that economic protectionism puts the U.S. at risk of making the same mistakes from the 1930s.

The push for tariffs seems at odds with Republican business philosophy, but economic history shows it really isn’t.

Tariffs and protectionism were among the economic building blocks at the founding of the U.S. Alexander Hamilton, creator of the U.S. Treasury and “patron saint” of Wall Street, was a strong proponent of tariffs. In his “Report on Manufacturing,” presented to Congress in 1791, Hamilton posited the new nation needed tariffs to protect new American industries and to raise revenue through customs. Hamilton, and his boss President Washington, believed a strong domestic manufacturing base was also important in the production of war materials. Thomas Jefferson was originally against tariffs, but as president he saw them as a way to protect American manufacturing. The first Republican president, Abraham Lincoln, proposed tariffs to rebuild the U.S. after the Civil War and to pay for the transcontinental railroads. Teddy Roosevelt also supported tariffs.

The pro-protectionism Republican business view didn’t change until the end of World War II. Most of America’s manufacturing competitors, Germany, England, Japan – were in ruins, while American manufacturing was actually strengthened by investment in ship, plane and tank plants. With reduced competition abroad, it was in America’s interest to open markets globally so U.S. companies could sell their peace-time goods, everything from cars to grain.

After 1945, economists like Milton Friedman and other conservative economists promoted free trade and the concept of competitive advantage, leading to a gradual but significant increase in global trade as countries became interdependent and less isolated. Eventually there was an almost universal belief that tariffs and trade wars caused the Great Depression which led to the creation of the World Trade Organization. One of the WTO’s rules generally restricts tariffs and countries can sue if another imposed tariffs. There have been no all-out trade wars since the WTO’s founding.

That brings us to today, with the Trump administration’s protectionist push. In retaliation for the 1,300 tariffs the U.S. put on Chinese goods, China, Canada, Mexico and the European Union have placed tariffs on some American goods like planes, cars, soybeans and even bourbon. Fears of an all-out trade war are weighing on stocks and stocks have traded sideways since the spring announcements.

If the administration continues to echo pre-World War II Republican business philosophy, it’s hard to say how that will play out in modern times and a much more globally integrated economy.

Because of globalization, most U.S. businesses have suppliers around the world; that wasn’t the case in Alexander Hamilton’s day. Protectionism can be good for some industries, such as steel workers. But it isn’t good for U.S. soybean farmers who may be losing their No. 1 customer. There are clearly going to be winners and losers, and in trade wars the winners and losers can shift pretty quickly.

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