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Smoot-Hawley Revisited


This started out as a comment to a podcast at Econtalk on Smoot-Hawley.

Justin P writes:

Russ,
I’m glad you and Dr. Rustici started the talk on how easily people try to disregard SH as one of the many causes of the GD. Far to often is the notion that a Government policy could wreck the economy discounted with no actual look at the evidence, merely because it doesn’t fit a priori views. In this case, that Government intervention is a “good thing.” This is my main problem with Keynesian economics. Keynes had some good ideas and some really crappy ones. I view his “General Theory,” as his absolute worst work. Paradox of thrift is one of the worst ideas, second only to the magik of G.
Smoot-Hawley flies in the face of the “Government is good” meme, so it’s no wonder why mainstream Keynesians stick their head in the sand and dismiss any such argument that SH was a major contributor.
The big flaw I find in their reasoning is the notion of Animal Spirits. Keynes never goes into the cause of recession, another big flaw in his theory, instead laying all at the feet of irrational people ie Animal Spirits. Why don’t they want to find out what spooked those spirits in the first place? As I see it, SH as a major cause of the Depression fits in quite nicely in the Keynesian framework of Animal Spirits.
People saw a major piece of legislation coming down the pipes and reacted to it, which is Rustici’s thesis.
Now why do they still disregard “SH as a cause” analysis, because they’d have to admit that G isn’t always benevolent. That G can be on net negative. I think for some, that’s just to hard, it’s much easier to ignore SH and therefore ignore the possibility that G can be bad. Then they can go about their merry way advocating more government spending as a solution to all life’s problems. Unicorns and Pixies dust I say to that.

There are a few things I want to clear up and go over and a few things I want to add to my original comment.

Government Failure vs Market Failure

For the purposes of honesty, I want to admit right now that I am of the belief that behind most
market failures are government legislation. Meaning, markets fail because government make them fail. Whether you agree with me or not, that is the basis for my line of reasoning. Now that that is out of the way we can continue.

I see the idea of Market Failure as a key ingredient to Keynesian analysis. I think it goes without saying that most, not all but most, Keynesians see that the answer to market failures are government intervention, either through regulations, taxation or spending (subsidization). The problem with this argument is that not all government action give a net benefit. I’d argue that most, if not all, government action produces a net harm to the economy. The current crisis is only one example, where government action to produce affordable housing, coupled with stupid Fed monetary policy produced the “Greatest Recession since the Great Depression.” The Market played within all the regalatory rules that Congress set forth. Banks bought and sold AAA rated securities. Why didn’t the SEC step in? Why didn’t the Fed step in? Maybe because they were utterly clueless that a bubble had formed and was on its way to pop. How can we be confident that government will save the day when they can’t see the problem staring them in the face. It was Government action that helped cause the Great Recession of 2008 and it was Government action that helped cause the Great Depression.

Why Keynesians don’t want to mention Smoot-Hawley

As my comment above states, Smoot-Hawley fits into a Keynesian Animal Spirits framework. Is it that hard to imagine massive government intervention in the export economy causing investors to freeze up investments? Is it that hard to imagine, the tariff war that ensued causing consumers to buy less stuff, both foreign and domestic stuff? It is perfectly rational for consumers to buy less, under a tariff war than under free trade condition. Tariffs raise the price of a product, this will cause a decrease in supply which will raise prices for domestic producers as well. Now think about how that effect the overall economy.

Another aspect of Smooth-Hawley that isn’t mentioned that much is how the decrease in net exports will effect the money suppy. Rustici talks about banks but in a Keynesian framework, there is a multiplier effect in play as well. Government spending isn’t the only thing that has the benefit of a multiplier, any consumption will have a multiplicative effect. Exports produce profits for domestic producers, which in turn pay their employees a salary, which they will spend on other consumer goods. Now once that export money enters the salary chain it goes through the same multiplicative mechanism as Government spending, hence a export multiplier. Companies don’t horde cash, they pay expenses and the rest they invest to try and earn a return.

Admission of error

Personally, I think the reason they don’t give Smoot-Hawley it’s due, is precicly because it puts doubt in the “Government is good” mentality. Think about it, generally anyone that wants to increase the power of the State, won’t want to talk about how the State can harm you and the economy. Why would they want to harm their case? It’s perfectly rational for them to try and dismiss any arguments that hurt their own. To admit that Smoot-Hawley had a devistating effect on the Economy, they would have to recognize that other Government action, in the name of helping a certain interest group oh like farmers, can have a disaterous and harmful effect on the economy.

You’d think they’d want to earn some good political points by pointing out how Hoover signed SH into law. Yet, that would mean they’d have to give up the Hoover as a “do nothing” President. They’d also have to give up the notion that it was the “free-market” that caused the Depression. It would be an admission of error on the whole concept of government being necessary to “fix” the market.

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Categories: Uncategorized
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  1. March 27, 2010 at 18:38

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