...had more countries been willing to abandon the gold standard and use monetary policy to counter the slump, fewer would have been driven to impose trade restrictions.
The Great Depression was a breeding ground for protectionism. Output fell, prices declined, and unemployment rose, pressuring governments to do something to revive their economies, even if that meant limiting imports. But contrary to popular perception, some countries went much further down this protectionist road than others, according to The Slide to Protectionism in the Great Depression: Who Succumbed and Why? (NBER Working Paper No. 15142). Co-authors Barry Eichengreen and Douglas Irwin conclude that a key factor behind this variation in trade policies was nations' adherence to the gold standard. Those countries that clung to the gold standard were more likely to restrict trade than those that abandoned it.
Previous research has shown that countries that remained on the gold standard tended to endure sharper and longer downturns than those that allowed their currencies to depreciate. Eichengreen and Irwin offer an important trade-policy corollary: without the flexibility to depreciate their currencies, many gold-standard nations turned to trade restrictions in hopes that these would boost their domestic industries and curb unemployment. Thus, the 1930s' rush to protectionism was not so much a triumph of special-interest politics as it was a result of second-best macroeconomic policies, the authors write. Their study "suggests that had more countries been willing to abandon the gold standard and use monetary policy to counter the slump, fewer would have been driven to impose trade restrictions."
Eichengreen and Irwin focus on three groups of countries that emerged from the wreckage: Britain and the sterling bloc, which abandoned gold and largely avoided boosting trade barriers; France and the gold bloc, which stayed on the gold standard and resorted to protectionist measures; and a group of countries led by Germany that imposed draconian controls on trade and payments in a way that also effectively protected their economies from imports. By looking at three measures of commercial policy -- import tariffs, import quotas, and exchange controls -- the authors are able to gauge how these blocs reacted to the pressures facing them as trade began to collapse in mid-1931.
Although each measure is relatively crude, all three paint the same broad picture. Between 1928 and 1938, the average tariff (as a percentage of the value of imports) did not change in any major way for three of the four sterling-bloc nations. (The exception, Britain, raised tariffs for internal political reasons, the authors contend). By contrast, the average tariff soared between 1928 and 1935 for all four gold-bloc countries (France, Belgium, the Netherlands, and Switzerland) and three of the five exchange-control nations (Austria, Germany, and Italy). The two exceptions -- Czechoslovakia and Hungary -- had such rigid foreign-exchange controls that they didn't need high tariffs to keep out imports.
League of Nations data on import quotas for eight nations in 1937 points to the same trend: the sterling-bloc countries relied on them less than gold-bloc countries did. Similarly, few sterling-bloc and other currency-depreciating nations imposed exchange controls while those that stuck with the gold standard often did. Between 1928 and 1935, exchange-control nations on average reduced imports some 26 percent more than what would be expected from the change in their real GDP, the authors calculate. 'This suggests that controls were a significant factor in reducing international trade,' they write.
In a more detailed analysis of changes in tariffs and exchange rates for a group of 21 mostly European nations and a larger sample of 40 countries between 1928 and 1935, the authors find the same trend: those that abandoned the gold standard were less likely to increase import tariffs. There is fair bit of variation from the average, though, partly because of certain national idiosyncrasies (such as Britain's internal political dynamics), partly because of additional factors across countries (such as whether they were international financial centers or had recently experienced high inflation). Either of these latter factors would have made a nation more reluctant to abandon the gold standard, the authors argue. Indeed, when they control for these factors, the results reinforce the conclusion that there is a strong relationship between the change in the exchange rate and the change in import tariffs.
Remaining on the gold standard fueled protectionism, but the countries that left the gold standard began to liberalize their trade policies. The United States, for example, delinked in 1933 and a year later enacted the Reciprocal Trade Agreements Act, which gave the President the authority to trim import duties in foreign-trade agreements. Once France went off gold in 1936, it began eliminating import quotas.
Parallels between the Great Depression and today have raised fears of a new slide toward protectionism. But the policy tools in the modern era are different, the authors write. In the 1930s, stimulus meant monetary stimulus, which tended to depreciate the nation's currency and make its products cheaper in export markets. Such moves tempted other nations to impose trade barriers. Today, besides monetary stimulus, nations are using fiscal stimulus that boosts domestic demand and helps not only the nation that uses it but also those countries that export to it. Thus, the temptation to restrict imports now rests with nations enacting such stimulus. The "Buy America" provisions in the 2009 U.S. federal stimulus package are one example.
-- Laurent Belsie