An Earthquake is Brewing in U.S. Economic History

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An Earthquake is Brewing in U.S. Economic History
Brian Domitrovic
Feb. 22 2011 - 5:13 am

Every nation has its "founding myth," as we are apt to hear from post-modern quarters. But is this ever true when it comes to our economic history. In curricula from K-12 to history graduate school, it is staple fare that as a new nation in the early nineteenth century, the United States nurtured its "infant industry" into adulthood by having a protective tariff that kept out cheap mass-made European goods. After a century of trade protectionism, the story goes, U.S. industry was so strong that it was the most productive in the world.

You can find this argument everywhere in historical scholarship and commentary, from textbook to shining sea. There is no need to name names; if you're someone in American historiography, you've made or otherwise acquiesced to this argument.

And yet it has never rung true in economics. Free trade is a major verity in that discipline, and for good reason. The case for it has been made nine ways to Sunday. In 1936, for example, the Adam Smith contention that tariffs make the domestic economy poorer got a powerful analytical lift in the elaboration of the "Lerner symmetry." The point -- proven geometrically by economist Abba Lerner -- is that tariffs hurt exporters as much as they help home industries. When a tariff raises the price level, enabling marginal domestic producers to survive, it also raises the cost of inputs to exporters. The whole thing is a wash as goes trade, and things are more expensive.

So how did the tariff nurture infant industries back in the old days again? It didn't, as has been the consensus in economics for decades. But given that economists can draw (as in graphs) and mark up equations better than they can write, the word never really got out. Historians, untutored in economics, and more interested in politics, society, and culture, followed the path of least resistance and associated the prodigious growth of the American economy in the 19th century with the fact that there was a tariff all the while.

Well, this holiday is about to come to an end. The dissertation recently completed by political scientist Phillip W. Magness (of the Institute for Humane Studies and American University) lays out the whole thing. Magness shows that it is nonsensical to hold that a reduction in aggregate real income -- the necessary result of a tariff -- could possibly cause an industrial boom. He essentially offers to introduce American history to American economic history, and bids that a new central narrative be written.

What might that be, given that we know that the U.S. (excepting the South, which, crucially, opposed the tariff) industrialized like gangbusters in the 19th century? How about this bombshell: Congress was robustly aware of the "Laffer curve" effects of the tariff in this period, avant la lettre. Magness has combed the Congressional debates, and he has determined that in the hurly-burly of tariff-setting in the 19th century, the balance of interests often lay where the tariff rate would result in the most federal revenue. Going past that rate, where the tariff would truly become protectionist as receipts flagged, could not muster a plurality. High tariff receipts are, of course, incompatible with the idea that imports are not coming into the country.

Magness goes on to suggest that what was lost with the rise of the income tax in the 20th century was the realism that had prevailed in tariff politics in the 19th century. Tariff debates centered on identifying the tipping point where tax increases become counterproductive. The tariff occupied more of Congress' attention than did any other issue in the 19th century, including during the slavery-laden antebellum years. It turns out that the touchstone of American political economy in the heroic period of industrialization was the Laffer curve. Who knew.

A tariff is overtly a tax on the many -- the whole nation -- for the benefit of the few -- business owners having a hard time competing. In contrast, the progressive income tax strives to soak the few and spread out the boon to the many. There is more incentive to stay on topic about the real effects of taxation in the former than the latter regime. No wonder we've lost a full point of yearly GDP since the U.S. in 1913 effectively traded the tariff for the income tax as its principal revenue source.

Here's hoping that historians will have the courage to upset the settled narrative about American development and, indeed, rewrite the textbooks. There is nothing to be embarrassed about. In the music of J.S. Bach, you spend a lot of time building up a chord structure before getting the sense of nearing something ethereal. But just before you get there, the music goes back to rebuilding the groundwork, with a few salient revisions, just to get it right. Phil Magness is showing us how to make American economic history well-tempered.

http://blogs.forbes.com/briandomitrovic/2011/02/22/an-earthquake-is-brewing-in-u-s-economic-history/