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Trump’s tariffs are unlikely to plunge the global economy into a Great Depression

Posted by on May 10, 2018 in Blog, Economy | Comments Off on Trump’s tariffs are unlikely to plunge the global economy into a Great Depression

Trump’s tariffs are unlikely to plunge the global economy into a Great Depression

The Trojans had to beware of Greeks bearing gifts.

In the same way, politicians need to be suspicious of petitions signed by economists.

The vast majority of the UK economics profession backed Project Fear, which predicted a rise in unemployment of half a million by the end of 2016. Instead, unemployment has fallen almost continuously since the Leave vote in June of that year.

In 1981, 364 economists signed up to urge Margaret Thatcher’s chancellor, Geoffrey Howe, to end austerity. No sooner was the ink dry than the economy started to boom.

The latest petition, on the face of it at least, should be taken more seriously. Over 1,000 American economists, including 14 Nobel Prize winners, have written to President Donald Trump. His trade policies, they claim, repeat the mistakes of the 1930s and threaten to plunge the world into another Great Depression.

It is a big claim to make. The financial crisis recession of the late 2000s was a mere blip by comparison – GDP in the US fell by four per cent. In the early 1930s, it dropped by over 20 per cent.

These economists cite the Smoot-Hawley Tariff Act of June 1930 as being a major cause of the massive recession. Output was already falling sharply in America. The claim is that the Act exacerbated the problem. It increased tariffs on over 20,000 types of products imported into the US, and was followed by a string of retaliatory measures across the world.

But the 1,140 economists – at the last count – who have signed the petition ignore a very well established result in economic theory. This is the so-called “theory of the second best”, published by Richard Lipsey and Kelvin Lancaster in 1956.

The economies of the west owe much of their success to the fact that they are market based. But they are not entirely the free market ideal of the economics textbooks. It might be thought that making them a bit more free market would make them even better. Conversely, taking them further away from the ideal, by imposing a trade tariff for example, would make things worse.

Lipsey and Lancaster showed that in general this result could not be demonstrated theoretically. It might be true. But only empirical evidence could show whether it was or not.

The petitioners should also look at a paper just published in the American Economic Association’s prestigious Journal of Economic Perspectives (JEP). Arnaud Costinot and Andre Rodriguez-Clare, of MIT and UCLA at Berkeley respectively, pose the question: what if America abolished all trade? Not just impose a tariff, but no trade at all.

Their detailed empirical evidence suggests that the effects are rather small. GDP would be between two and eight per cent less. A fall, it is true, but hardly one to generate such a furore over a policy, not of abolishing trade, but just making it that bit more expensive.

The JEP paper also shows, not surprisingly, that trade tends to widen inequality. The poor might lose out, even if the economy overall benefits.

President Trump seems to grasp the political importance of this.

As published in City AM Wednesday 9th May 2018

Image: Great Depression via Wikimedia Commons is licensed under CC0.0