July/august 1993 | Volume 44, Issue 4
Foreign trade—import and export alike—has been indispensable in building America from the very start, and many of our worst economic troubles have arisen when that trade wasn’t free enough. A historic overview.
It is not a coincidence that Adam Smith’s The Wealth of Nations and what would one day be the world’s wealthiest nation should both have burst upon the global scene in 1776.
Before Smith, the prevailing economic doctrine was mercantilism. This theory had at its core the notion that only one party benefited from an economic transaction. Economics, it held, was therefore a zero-sum game. If that was true, then it stood to reason that detailed regulations were needed to see to it that a country was on the winning side as often as possible when its merchants traded with foreigners.
The measure by which the success of these regulations was judged was the amount of gold and other precious metals that flowed into a country. Thus, in general, exports were encouraged and imports discouraged and often forbidden outright. This, of course, perfectly suited vested interests at home that didn’t want foreign competition anyway, and Smith put his finger precisely on the engine that actually powered so much of mercantilist regulation: personal self-interest. “People of the same trade,” wrote Smith, “seldom meet together, even for merriment and diversion, but the conversation ends in a conspiracy asainst the public.”
To put it another way, the greatest enemies of the capitalist system as a whole are individual capitalists. The reason, of course, is that people invariably pursue their own economic interests—which they can usually see clearly—rather than the good of the whole, always a much murkier matter. But capitalists do not just conspire among themselves to rig markets and fix prices. They also seek to influence government to protect them from competition. In Smith’s day theirs were often the only voices heard trying to influence economic policy, for’an independent press had not yet evolved. And even today no one lobbies only for the common good.
Thus mercantilism, in Smith’s view, was really just a splendid refuge for scoundrels. In The Wealth of Nations he quite simply annihilates the intellectual basis of it. In page after page of elegant, Augustan prose, he demonstrates that in a free market both sides benefit from a transaction or it won’t take place. Thus wealth is created on both sides, not just transferred from one to the other, and it is the volume of trade that measures a country’s economic strength, not the amount of gold in the treasury or even the balance of that trade.
Newly minted, the United States did not have many entrenched interests to protect the mercantilist legacy. Indeed, onerous and unfair British mercantilist regulations, along with a total lack of American political power in London to do something about them, had been a prime cause of the Revolution. When the Founding Fathers, most of whom had read Smith’s book or knew its reasoning intimately, created the Constitution a few years later, they were able to incorporate into it a thoroughly Smithian view of the economic universe.
Because they knew that individual state governments would respond to the interests of their own citizens rather than the general good of the Union, the Founders assigned the regulation of interstate commerce exclusively to the federal government, where countervailing state interests would tend to offset one another. Interstate tariffs on American exports were specifically banned by the Constitution.
As a result, the United States began its independent existence with the freest internal market in the world, and it has largely maintained that freedom, at least relative to other countries. Having the greatest freedom to create wealth, American citizens have proceeded to do exactly that in vast abundance.
But the history of America’s external market—its foreign trade, in other words—has been a more complicated story. First, in no other country has the importance of foreign trade varied so much over history as in the United States. In the early days foreign trade was essential to the very survival of the tiny colonies clinging precariously to the edge of a wilderness continent. So outward-oriented was the economy, in fact, that by the end of the colonial period, the American merchant marine was second only to Great Britain’s in size, and foreign trade accounted for 20 percent of the colonial gross national product. After the Revolution, however, building the vast internal market more and more absorbed the economic energies of the country. By the early twentieth century the American merchant marine had nearly ceased to exist, and foreign trade, while very large as a percentage of total world trade, was only about 6 percent of the American economy. We were for nearly all intents and purposes, self-sufficient. Foreign trade, while certainly profitable, was no more than the icing on the cake of the American economy.
Today the situation has reversed again, and foreign trade is a larger component of the American economy, in both scale and importance, than at any time since the early days of the Republic, about 15 percent and growing quickly. At the end of the twentieth century our self-sufficiency is long gone. Instead the United States has become the world’s largest exporter and importer of goods and services and the linchpin of a swiftly integrating global economy.
But there is also another reason why the history of America’s foreign trade has been very complicated: because the pressures to manipulate that trade for the benefit of particular domestic interests, rather than for the country as a whole, have always been hard for politicians to resist. After all, the relatively few individuals who greatly benefit from, say, protective tariffs—usually domestic producers and their workers—will always press the case against foreign competition with vigor, not to mention political contributions. The vast mass of citizens, who are usually only slightly harmed, however, often have no real means, and little individual incentive, to counter the pressure.
Take the case of sugar, for instance. The United States is at best a marginal producer of sugarcane, because efficient production requires a tropical climate and either large amounts of low-paid labor, as in Latin America, or vast economies of scale, as in Australia. In a free market there would be little, if any, United States production. But the American sugar market is anything but free.
Instead, a system of quotas and tariffs comfortably protects the handful of producers in Florida, Louisiana, and Hawaii. It also raises the cost of sugar to consumers by as much as 50 percent. Not even continuing exposés of the brutal exploitation of migrant workers in American canefields have budged Congress to redress this blatant latter-day mercantilism, because sugar is so small a part of any individual’s budget as to go unnoticed.
The first federal tariff, intended by the Founding Fathers to be the government’s primary source of revenue and enacted on July 4, 1789, was remarkably evenhanded. But in the years that followed, as the United States changed from an agrarian exporter of raw materials into an industrial giant, the Smithian inheritance would often be compromised for political purposes, as it had been with sugar.
Sugar, of course, is not a vital part of the American economy. But twice in our history disaster resulted from political meddling with foreign trade. It could happen again.
When the first colonists landed on the shores of what would one day be the United States, they were nearly as dependent on where they came from for the necessities of life as would be, today, the inhabitants of a lunar base. Game could offer a steady meat supply perhaps, but virtually everything else had to be brought from Europe. Weapons, cloth, tools, medicines, livestock, furniture, even enough food staples to see the colonists through the first growing season and beyond—all had to be imported. As early as 1628 a rule of thumb had developed that settlers in a new colony needed to bring with them eighteen months’ worth of provisions to be safe from famine.
There was one big problem: Those who sent the first colonists were not the officers of well-funded government agencies pursuing knowledge; they were capitalists pursuing profit. Eleven joint-stock companies were formed in the early seventeenth century to establish English colonies in Ireland and the New World, and their stockholders invested some thirteen million pounds, a huge sum by the standards of the day.
Naturally they wanted as immediate a return on their investment as possible. If the colonists were to provide it, as well as finance future imports, they had to find something to export and find it quickly. They were never quick enough to suit the investors. The backers of the Plymouth colony, for instance, severely criticized the Pilgrims not only for detaining the chartered Mayflower over the winter (they would surely have perished if they hadn’t) but, worse, for sending her back in the spring without a cargo.
The earliest schemes, not surprisingly, often foundered on the rocks of inadequate knowledge of New World realities. In Virginia the colonists at Jamestown were at first so bewitched by the prospect of El Dorado that many of them searched for gold rather than plant crops. Starvation was the result when the gold turned out to be non-existent.
The following year the Virginia Company, which had founded the colony, sent over glassmakers from Poland and Bavaria in hopes that tidewater Virginia’s abundant sand and wood (for fuel) could support a glassmaking industry that could profit from England’s rapidly growing demand for glass. Within a year the project was in ruins when the glassmakers returned to Europe, where they could make a far better living in far more comfortable surroundings. The new colony struggled desperately to survive, exporting a few furs, some timber, sassafras, and silk grass, from which mats were woven. At one point Jamestown was nearly abandoned.
Finally, in 1614, it began to export tobacco in small quantities, a commodity that found a swiftly growing market in Europe. But tobacco was a crop that required a lot of labor, much of it very unpleasant. At first indentured servants from England were used. But the long-term solution, at least from the point of view of the white settlers, was the importation of black slaves from Africa and the West Indies to do this work. Over the next nearly two centuries, about three hundred thousand slaves would be brought to North America in a tragic commerce.
The slaves, of course, were, in an economic sense, another import. But the value they added to the tobacco crop far more than paid for their purchase price and maintenance, and the slave population began to rise rapidly. By the middle of the seventeenth century, the system of plantation agriculture and slave labor was firmly in place in Virginia and Maryland and was spreading immediately to the other Southern colonies as they were founded.
By 1700 Virginia and Maryland were exporting annually more than three hundred thousand pounds’ worth of goods to England, mostly tobacco. Today’s equivalent, at least according to one authority, would be something on the order of a hundred million dollars. With a steady, indeed handsome income from tobacco sales in Europe, Virginia and Maryland did not need to establish strong trading ties with other areas, such as the West Indies, or develop their own manufacturing economy, as New England had begun to do.
When the Plymouth colony was founded in 1620, and, ten years later, the Massachusetts Bay at Boston, no cash crop was available, but the Northern settlers soon learned to eke out a living exporting fish, furs, barrel staves, and lumber (especially clapboards). The trouble was that there was not enough of a market for these products in England—or too much competition there. The New Englanders, therefore, soon began trading with the new colonies in the West Indies and with Africa and southern Europe. There they ran up the trade surpluses that financed their purchases in England.
This “triangle trade,” far more complex than simple bartering between two parties, soon gave the New Englanders considerable expertise in international commerce. In Boston, Newport, and other New England seaports, merchants began building their own ships in large numbers and trading for profit far and wide. Further, the triangle trade led directly to the first American industry, the distilling of West Indian molasses into rum.
Only in New Netherland did the original raison d’être of the colony—fur trading—turn out to be a viable proposition. This was largely because of the entirely fortuitous facts that the Hudson and Mohawk rivers provided an easy route deep into the interior and the Indians of that interior were sophisticated and well organized.
But the fur trade, another cash crop, did not require a large resident population. In order to secure a firmer hold on the colony of New Netherlands, flanked on both north and south by growing English settlements, the Dutch West India Company decided to encourage immigration. It offered vast tracks of land along the Hudson to those who would transport fifty families at their own expense to work the land.
These tenant farmers began to grow grain, and soon wheat was a major export, especially in the form of flour. Its importance to the early colony is reflected in the fact that both the flour barrel and the beaver are still found on New York City’s coat of arms. As they were founded in the late seventeenth century, the other middle colonies also became major producers of wheat and flour.
As settlers with particular skills and tools arrived and practiced their crafts, the utter dependence of the colonies on England for simple manufactured goods began to abate. Before the Industrial Revolution most manufacturing was done on a purely local, handicraft basis even in Europe. Wheelwrights, coopers, blacksmiths, and cabinetmakers began to produce their wares in America.
But American industry, often hemmed in by British mercantilist restrictions, remained what today would be called low tech. Pig-iron production, for instance, began as early as the 1620s. By the end of the colonial era, the colonies were producing thirty thousand tons a year, one-seventh of the world supply and a major export to Britain, where the Industrial Revolution was by then gathering steam. But steelmaking, an expensive, difficult process in the eighteenth century, was unknown on this side of the Atlantic.
Shipbuilding, however, was one major exception to this low-tech, cottage-industry rule. The first ship built in Massachusetts was launched only a year after the Puritans landed. By 1665 citizens of the colony owned no fewer than 192 seagoing vessels and had built many more than that and sold them elsewhere. Indeed, it was common for an American ship to carry a cargo to England and then to be sold cargo and all. By the end of the colonial period, fully 30 percent of the British merchant marine (2,342 out of 7,694 ships) was American-built.
By then American imports consisted largely of manufactured and precision goods from Europe and products from the West Indies, such as sugar and molasses, many of which were re-exported. Besides ships, the exports, meanwhile, were fish, agricultural and forest products, and primary manufactured goods derived directly from them, such as pig iron, barrel staves, lumber, rope, and naval stores.
By the 1760s the American colonies had become a major economic force in the British Empire. They supplied close to 12 percent of British imports and bought 9 percent of the mother country’s re-exports. Far more significant, fully a quarter of Britain’s domestic exports went to North America.
After the expensive British victory in the Seven Years’ War (called the French and Indian War on this continent), the British government woke up to the fact that there was an economic giant aborning across the Atlantic. It tried to make it a source of serious revenue, mainly by taxing its trade. The result was the American Revolution.
With independence the new nation found itself free to trade with the whole world. The whole world, that is, except the British Empire, wherein it had always done most of its trading. Much of the West Indies was now cut off, and exports to England were much restricted. Indigo, whose production had utilized about 10 percent of the slave labor in the South before the Revolution, was shut out of the British market, where indigo from India replaced it. The industry collapsed.
But new markets opened. Once forbidden to ship directly to northern European countries other than Britain, American merchants were by the early 1790s selling 16 percent of their exports to those countries. In 1784 the first American vessel bound for the Far East, the Empress of China , set sail from New York. It was not long before Americans were major players in the Far Eastern trade.
Soon American vessels could be found around the world, their captains sailing to wherever profit beckoned. “His vessel went to the West Indies,” one contemporary reported of the merchant Stephen Girard of Philadelphia, “where cargo was exchanged for coffee and sugar; then proceeding to Hamburg or Amsterdam, the coffee would be sold for Spanish dollars or exchanged for cargo which would secure him at the Spice Islands, Calcutta, or Canton the products of those climes.”
Most of the early great fortunes in the United States were based in whole or in part on foreign trade. John Jacob Astor, shipping furs to China, often cleared fifty thousand dollars a voyage. Girard left an estate of nine million dollars when he died in 1831, making him the richest man in the United States except, perhaps, for Astor.
New products were developed as well as new markets. Eli Whitney’s cotton gin made short-staple cotton a profitable export to Great Britain’s fast-rising textile industry. Within a few years it was the country’s greatest export, and by the Civil War the South was producing seven-eighths of the world supply and shipping four million bales a year to Europe.
New England, in the meantime, developed a brand-new product to sell on the world market: ice. Cut from New England ponds in the winter and stored under mounds of sawdust, cargoes of ice were sold in warm climates as far away as Calcutta. By the 1850s ice was the country’s largest export, on a tonnage basis, except only for King Cotton itself.
Trade grew rapidly in the years after the adoption of the Constitution. In 1790 total domestic exports amounted to $19,666,000 while imports that were not re-exported amounted to $22,461,000. By 1807 the figures were, respectively, $48,700,000 and $78,856,000. This apparent trade deficit, which lasted until the mid-1870s, was more than offset by freight charges and commissions earned by American vessels and by the steady inflow of capital from Europe and elsewhere.
(Indeed, the difficulty of figuring the actual trade balance, thanks to these so-called invisible earnings and numerous other complications, has over the years provided a rich and continuing opportunity for self-interested individuals and their political allies to create tendentious statistics. For instance, until the last twenty-five years, the merchandise trade balance—the import and export of physical goods—was not far from the total trade balance, and much easier to calculate. Today, however, services and intellectual property are major and very rapidly growing components of international trade, and notable American strengths. Regardless, those in this country seeking protection habitually use the merchandise trade balance as proof that the country’s competitiveness is failing. Very conveniently for them, if not for the truth, services and intellectual property are not counted in this statistic.)
The main cause of this rapid growth was the European war that broke out in 1793 and raged for most of the next quarter-century. As a neutral power the United States was at first in a good position to benefit, its flag protecting cargoes that actually originated in belligerent powers or their colonies. But as the conflict escalated between Great Britain and France, they sought more and more to fight by interfering with each other’s commerce. Neutrals inevitably suffered, as both sides tried to prevent neutral shipping from trading with the enemy. Ever more restrictive regulations were issued. Between 1803 and 1807 Britain seized 528 American ships, and the French seized another 389. Meanwhile, ships of the Royal Navy high-handedly stopped American vessels, even warships, and seized any sailors they claimed had deserted.
When in 1807 a British frigate fired a broadside into the newly commissioned USS Chesapeake , which was totally unprepared to receive it, national outrage resulted. Probably only because Congress was out of session at the time was a declaration of war averted. But President Jefferson felt obliged to do something. Unfortunately, as often happens in politics, his best course, perhaps most easily seen in retrospect, would have been to do nothing beyond exert what diplomatic pressure he could. Instead, on December 22, 1807, he signed the Embargo Act. This remarkable legislation forbade American ships to deal in foreign commerce, and the American Navy was deployed to enforce it. In effect, in an attempt to get Britain and France to respect neutral rights, the United States went to war with itself and blockaded its own shipping.
Albert Gallatin, the Secretary of the Treasury, warned that such a direct affront to the economic interests of American merchants would be perceived as tyranny and provoke a bitter and divisive reaction. But Jefferson, who viscerally loathed all things commercial anyway, was then at the height of his political power, a position in which so many grievous political misjudgments are made, and the Embargo Act was rammed through Congress with little debate.
If the Embargo Act was intended as a shot across the bows of the belligerent powers, it resulted only in the United States’s shooting itself in the economic foot, for it devastated American foreign commerce. This in turn crippled the American economy, especially in all the great port towns up and down the coast and in New England, which was so heavily dependent on foreign trade and shipping in general.
American domestic exports fell from $109 million in 1807 to $26 million the following year. Domestic imports dropped by 44 percent. And Gallatin had been right. As soon as news of the act reached a port, all the American ships in a position to do so immediately sailed away to avoid being interned. Smuggling flourished (indeed, it became so rife on Lake Champlain that Jefferson actually declared the surrounding country to be in a state of insurrection). A blanket of bureaucratic restrictions smothered internal commerce as well, lest any of it leak into illegal foreign trade.
The embargo’s effect on Britain and France was negligible, and their reaction was contempt, a dangerous emotion to engender in international politics. When Napoleon seized Spain in 1808, he seized as well 250 American vessels and their cargoes in Spanish ports. When the American ambassador demanded an explanation, the emperor calmly replied—one wonders what might be the French word for chutzpah— that he was only helping enforce the Embargo Act.
Jefferson knew just whom to blame for the “absurd hue and cry.” New England merchants, he wrote in a letter to a friend, wanted to sacrifice “agriculture and manufactures to commerce . . . and to convert this great agricultural country into a city of Amsterdam.”
Thanks to enormous political pressure, the Embargo Act lasted only fourteen months, and increasing loopholes and simple evasion—blockade-running, if you will—lessened its effect toward the end of its existence. The Non-Intercourse Act, which succeeded it, forbade trading only with Britain and France, overwhelmingly our major trading partners, and the deep depression in American shipping continued. Finally, in 1812, when Britain still refused to accede to American demands, the United States stumbled into a war it lacked the means to fight effectively.
At least now the blockade of American ports was carried out by an enemy fleet, not our own, and one larger than all the other fleets in the world combined. American foreign commerce all but ceased. In 1814 domestic exports were only one-eighth of what they had been seven years before, while imports were one-sixth.
So bitterly resented was the War of 1812 in New England and other centers of commerce that its continuation threatened the Union itself. Fortunately it did not continue, and the seas were opened once more.
All laws have unintended consequences. The Embargo Act and the Non-Intercourse Act had almost nothing but. Not only did they gravely injure American foreign commerce, these laws acted also as a prohibitive tariff. Imports, especially manufactured imports from Europe, were largely barred from the country, and local industries, already beginning to grow, prospered mightily as a result. Unfortunately, these new enterprises, once confronted with the threat of renewed trade with competing countries, immediately sought a real tariff.
The New England cloth industry demanded, and received, a duty of twenty-five cents a yard on cheap cotton cloth, effectively excluding competing British cloth from the American market. Other industries immediately sought their own protective tariffs, and some succeeded. A tariff to protect growing young industries always has a surface plausibility that enables politicians to more easily accept it and thus accommodate those self-interested constituents who are calling for it. But, in fact, there are always two solid reasons against a protective tariff, both elaborated at length in The Wealth of Nations .
The first is that the tariffs are ultimately paid not by foreign producers but by domestic consumers, to whom the costs are passed along. The second is that protective tariffs insulate producers from foreign competition. This not only allows them to raise their prices but also makes it less imperative for them constantly to seek ways to cut costs and improve quality. And it is the inescapable necessity to innovate and cut costs—in order to survive in a free market—that powers the great force for the general good that has come to be known, in Adam Smith’s famous metaphor, as the “invisible hand.”
Fortunately, the Smithian inheritance still held. And while specific industries were protected, such protection was always presented as an exception to the general rule, and American tariffs stayed low, compared with those of many other countries. New England shipping interests, of course, fought for a low tariff on all goods. But American manufacturing was growing with astounding speed in these years, and its political power along with it. In 1824 there were two million Americans engaged in manufacturing, ten times the number only five years earlier. American shipping, meanwhile, was stagnant or in decline.
Besides the shipping interests, the other great source of opposition to a high tariff was the South. With few industries, and ever more dependent on the export of cotton to the British market, the Southern planters wanted free trade. In those years it was the tariff, not slavery, that most divided North and South and threatened the Union. Under Northern pressure the tariff rose steadily, and in 1828 Congress passed what the South—as always a major exporter of catchy political phrases—called the Tariff of Abominations. This, in turn, led to the nullification crisis in 1832, when South Carolina declared that states had the power to rule federal laws unconstitutional, including the tariff.
A direct confrontation, and quite possibly civil war, were avoided only when a new tariff calling for gradually lower rates was adopted. After the crisis passed, the tariff continued to decline slowly until the Civil War began for real in 1861.
By that year American exports had topped $400 million, four times what they had been in the best year before the War of 1812. But as a percentage of the whole American economy they were much smaller than they had been then, for the economy had grown far faster than had foreign trade. In 1800 about 10 percent of the American gross national product was being shipped abroad. Sixty years later the United States was exporting only about 6 percent of a much larger gross national product.
There has long been an argument among scholars about whether foreign trade (and foreign capital) drove this dramatic domestic expansion or the other way around. The truth, in all likelihood, is that they acted together, each upon the other. Uniquely, the United States is both a continental and an island power. In the great sweep of its territory and the abundance and diversity of its resources, it possesses the inherent advantages of a Russia or China. Yet in its geographical isolation from possible aggression and its unhindered access to the ocean sea and its trade routes, it has the very attributes that made Japan and Great Britain rich. With the best of both worlds, America’s domestic market and its foreign trade together produced the greatest economic synergy the world had ever seen.
But at the outbreak of the Civil War, American exports were still largely agricultural products and raw materials (cotton would remain the leading agent until the 1930s). More than half of all imports were manufactured goods, especially cloth and iron products, including most of the railroad rails that were quickly knitting the country together. Manufacturing exports, however, were beginning to make inroads. In 1820 only about 5 percent of American exports were finished goods. By 1850 more than 12 percent were.
The Civil War changed American foreign commerce profoundly. It dealt a deathblow to the already declining American shipping industry. With Confederate raiders such as the CSS Alabama on the loose, American ships fled to the protection of foreign flags, usually British, and never came back. In 1860 about two-thirds of American foreign trade was carried in American bottoms. By 1865 barely a quarter was; by 1912, less than 10 percent.
Moreover, the cotton trade was temporarily halted by the Northern blockade of the Southern cotton ports. It would be 1875 before cotton shipments again reached their pre-war peak. And the tariff was greatly increased to help pay for the war. This, of course, had the effect of protecting American industry still further from foreign competition, giving it a tremendous short-term boost as it captured market share from foreign companies. The tariff, together with the demands made by the war and the prosperity the war brought to the Northern civilian sector, caused American industry to boom as never before.
By 1865, with the South now politically powerless, Northern industry’s demands for continued high tariffs met little opposition. Fortunately for the common good, the railroad had by this time transformed the once geographically fragmented domestic American market into the largest fully integrated market in the world. This, in turn, provided increasing domestic competition that forced cost savings and innovation, despite increased protection from foreign companies.
Northern industry began to grow so fast that by the turn of the century America was the world’s foremost industrial nation. This was reflected in a fundamental change in the nature of American exports and imports. While the United States remained, then as today, a major exporter of agricultural and mineral products (two new ones, petroleum and copper, were even added), it also became a major exporter of manufactured goods. In 1865 they constituted only 22.78 percent of American exports. By the turn of the century they were 31.65 percent of a vastly larger trade. The portion of world trade, meanwhile, that was American in origin doubled in these years to about 12 percent of the total.
Nowhere was this more noticeable than in iron and steel exports, the cutting edge of late-nineteenth-century technology. Before the Civil War the nation exported only $6,000,000 worth of iron and steel manufactures per year. In 1900 we exported $121,914,000 worth of locomotives, engines, rails, electrical machinery, wire, pipes, metalworking machinery, boilers, and other goods. Even sewing machines and typewriters were being sent abroad in quantity.
Europe had long imported raw materials from the United States and elsewhere and exported finished goods to America and the rest of the world. To alarmist economic commentators—all too often a redundancy then as now—it seemed that an American colossus had suddenly appeared to snatch this profitable trade away, threatening to reduce once mighty Europe to an economic backwater. Books with such ominous titles as The American Invaders , The Americanization of the World , and The “American Commercial Invasion ” of Europe began to fill the bookstores in the 1890s. (Their authors’ spiritual descendants, of course, would be turning out the very same books ninety years later, only with “Japanese” substituted for “American” in the titles.)
Actually, Europe was perfectly able to hold its own market for manufactured goods in the twentieth century, and it was in what we now call the Third World that the American-European rivalry in industrial products reached its height. And with a rapidly growing worldwide market for American manufactures, the high American tariff became more and more a liability to its own political backers, because it tended to generate opposing high tariffs abroad and thus limit American exports. In 1913, with the traditionally antitariff Democrats in control of both the White House and Congress, the tariff was significantly reduced for the first time in more than fifty years. And that year world trade reached heights it would not see again for a generation.
The outbreak of World War I radically transformed the world economy, and the war proved a bonanza for American business. With Russia (a major grain exporter until the advent of communism) cut off from overseas markets, demand for American wheat and meat soared, and American farms boomed. European orders for steel and munitions caused factories to operate around the clock. Lavish government subsidies rebuilt the American merchant marine. Americans were able to capture many markets that had once been firmly controlled by the now-distracted European colonial powers.
New York succeeded London as the world’s financial center, and world trade, which had formerly been financed almost exclusively with sterling acceptances, now used dollar acceptances as well. American loans to Britain and France transformed the United States, a debtor nation since the earliest days of the Republic, into the world’s greatest creditor. By 1916 the United States was running annual trade surpluses, exports minus imports, in excess of $3 billion, twice the total American exports alone at the turn of the century.
With an economy now larger than all of Europe’s, only the United States could lead the world back to the peaceful and fruitful free-trading patterns of the pre-war era. It failed to do so and, once more, injured itself far more than it injured other countries.
For one thing, the United States severely restricted immigration in 1921, depriving itself of the steady inflow of that most priceless of all economic assets, human capital. Far worse, the U.S. government ended the financing of food shipments to Europe eighteen months after the war ended. The market for food exports collapsed, and this helped push American agriculture into a depression from which it would not recover for twenty years. A decade later that depression would spread around the world.
Worse still, the United States refused to cancel war debts owed by its allies, despite their parlous financial state and their importance to us as trading partners. Indeed, about the only means the United States employed to sustain the world economy as a whole was to lend large sums of money to defeated Germany, which in turn used the money to pay reparations to Britain and France. They in turn sent the money back to the United States in payment of war loans. For a while this staved off disaster, but when U.S. lending dried up in the late 1920s, the world economy began to crumble.
It turned into a collapse when the United States tried to wall off its own economy with the Smoot-Hawley Tariff, the darkest day for the American Smithian inheritance. The United States had reversed the downward trend in tariffs of the Wilson years with the Tariff of 1922, which was primarily intended to help the increasingly distressed farmers.
Then, in the presidential campaign of 1928, Hoover sought the still-troubled farm vote with a promise to raise the tariff on agricultural products once again. He called a special session of Congress in 1929 to fulfill his promise to the farmers. But it soon turned into what can only be described as a special-interest feeding frenzy, as capitalists looked after their individual interests and no one at all looked after the common good.
Every major industry, and countless minor ones (tombstone makers, for instance), paraded before Congress, demanding protection against “unfair” foreign competition. (Unfair competition, in the peculiar lexicon of protectionism, means foreign competitors able and willing to sell to American consumers for a lower price than domestic manufacturers can and will.) With economic conditions unsettled after the stock-market crash and potent postwar xenophobia still abroad in the land, unstoppable political momentum developed. Hoover signed the greatest tariff increase in American history into law in 1930, despite a petition of more than one thousand economists who predicted disaster.
The economists were right for once. Other countries immediately retaliated with sharp hikes of their own, and American foreign markets vanished. U.S. exports in 1929 had been valued at $5.341 billion. Three years later they were a mere $1.666 billion, the lowest they had been, allowing for inflation, since 1896. They would not reach 1929 levels again until 1942, when a second catastrophic war finally ended what Smoot-Hawley, perhaps more than any other single factor, had caused: the Great Depression.
The Second World War, like the First, greatly strengthened the position of the United States relative to its international trading partners. All the other great trading nations had been badly damaged, if not utterly devastated, by the war, and at its end the United States had, temporarily, over half the global GNP. Once again only the United States could lead the world out of the disaster. This time, having learned the painful lessons of the twenties and thirties, it did so.
The United States was instrumental in establishing a new international financial order, called Bretton Woods after the New Hampshire town where it was negotiated. This agreement fixed the value of the dollar in gold and in effect restored the gold standard that had so promoted world trade in the years before World War I.
Further, the United States provided massive aid to countries devastated by the war, both allies and its former enemies, by means of the Marshall Plan, the World Bank, and the International Monetary Fund. Meanwhile, there was no talk of “reparations” or attempts to collect loans made during the war to allies.
Still more important, the United States abandoned the protectionism that had cost it so dearly in the 1930s and led the way on tariff reductions by means of the General Agreement on Tariffs and Trade, known as GATT. The result was a massive increase in world trade and, no coincidence, world prosperity. In 1953 world trade totaled about $167 billion. By 1970 the figure was $639 billion. And the unsustainable American lead in global GNP returned to its pre-war level by 1965 as the other great powers recovered.
In the immediate postwar years the United States was the world leader in nearly all high-technology and capital-intensive industries, such as automobiles and electronics. But as Germany and Japan recovered from the war and other countries, such as Korea and Taiwan, began to develop modern economies, competition intensified.
Further, having to start from scratch and to capture markets that had been dominated by American companies, foreign companies were often much more innovative, both in design and in manufacturing techniques. Foreign companies, in other words, were lean and hungry. American companies, used to the easy profits in the post-war American market that they had largely to themselves, were all too often fat, dumb, and happy. Our automotive industry, for instance, was as late as the 1970s selling cars whose engineering had not basically changed since the 1940s.
America’s once-huge trade surplus in manufactured goods began to slip away. Our self-sufficiency in raw materials also rapidly eroded. The trade balance in such vital commodities as petroleum, iron ore, and copper turned sharply against the United States. For a while the reversal of trade flows was masked by an increase in agricultural exports. In 1959, however, for the first time in this century, the United States ran a trade deficit.
Within a decade such bedrock American industries as steel and automobiles were losing their shares of world markets as well. Gold began to flow abroad, and in 1971 the United States unilaterally severed the link between gold and the dollar. Inflation took off. Then came the sudden increase in the price of petroleum after the 1973 Arab-Israeli War. Foreign automobile companies, which had long met their local markets’ demands for small, efficient cars, invaded the American market and took increasing chunks of market share from the stunned American giants. American exports rose in volume and value thanks to agriculture, aircraft, and very high-tech equipment, such as supercomputers. But imports rose much faster.
By the early 1980s the United States was running the largest merchandise trade deficits since colonial times, and calls for protection were more loudly voiced than at any time since the Second World War. In fact, these deficits were offset by two other trends. One was that in intellectual trade and services, notoriously hard to quantify and measure but growing explosively in the late twentieth century, the United States was ever increasingly the world leader. In movies, television, books, and music—multibillion-dollar industries all—the United States was first by a very wide margin and holding its lead.
In computer software the United States had, for all intents and purposes, no competition at all. In 1975 William S. Gates, then nineteen, founded Microsoft on a shoestring. By 1992 he was the richest man in the United States, and Microsoft dominated the software industry around the world. Hundreds of other American software firms were prospering alongside it and exporting increasingly.
Second, foreigners were investing more and more in the United States. These capital inflows offset the trade deficits and helped to fund the profound restructuring of the American economy in the 1980s. Faced with intense competition from abroad and at home, thanks to free trade, American companies and unions had little choice but to cut costs and to innovate. The invisible hand moved. Wages were held down; layoffs in inefficient industries multiplied while total employment increased sharply; productivity in manufacturing soared. By 1988 the United States had become the low-cost producer in many industries, and American exports, as a result, were booming. In 1980 American merchandise exports were $220.6 billion (1991 dollars). In 1991 they were $421.9 billion.
Even the American automobile industry, once the glory of the American economy, and in much of the eighties the despair, has largely closed the gap in quality and cost with its overseas rivals. The domestic market share of American automobile companies is rising significantly, and the largest-selling car in the American market is, once again, American designed and built, the Ford Taurus.
Today the American overall trade gap has nearly vanished. Vanishing with it is a world economy made up of separate sovereign national economies. Industrial companies have been operating in many countries since the 1920s, but until the sharp drop in shipping and communications costs, such multi-national companies tended to act as collections of independent units. Today intracompany trade over national borders is growing by leaps and bounds, and the question of where a particular product is “manufactured” is becoming increasingly meaningless. AT&T is Taiwan’s largest exporter of electronics.
These multinational companies are rapidly becoming effectively stateless. General Motors, deeply troubled as it is, last year had worldwide sales of $132 billion, a “gross national product” larger than all but a handful of countries. In 1990 Philip Morris exported $3.1 billion from the United States, but its overseas subsidiaries had sales of more than $13 billion.
Moreover, the ability of sovereign governments to determine their own internal economic policies (and thus which domestic interest groups to favor) is swiftly diminishing. To give just one example of why this is, when currencies began to float freely, international transactions became more complicated to negotiate. But floating currency values also made currency traders, now operating around the globe and around the clock thanks to the quickly falling cost of communications, an important force in the world economy. Today currency trading amounts to about $5 trillion a day, and no central bank or even combination of central banks can any longer effectively intervene to determine how that trading moves. When France elected a socialist government in 1981, and that government instituted traditional socialist policies, currency traders immediately began savaging the franc on world markets until the French government had no choice but to reverse course.
Today, whether individuals like it or not, the world is moving toward that singular blessing for society as a whole that Adam Smith was instrumental in giving the United States two hundred years ago, a borderless marketplace. But it will happen even sooner if we remember Smith’s most profound lesson: that the greatest enemy of capitalism is always the short-term self-interest of capitalists and, in our day if not in Smith’s, unions and those in government who protect and promote their special interests.
So far, despite intense political pressure to look after the few who fear competition rather than the many who will thrive on its effects, the United States is still leading the way. In 1988 we established a free-trade area with Canada. In 1992 Mexico joined what will be, when it is fully implemented, a North American common market of 365 million people. The latest round (the fifth) of negotiations on the General Agreement on Tariffs and Trade is nearly complete; it will do much to stimulate trade in services and intellectual property and foster the agricultural exports of Third World countries, strengthening their demand for manufactured imports.
A global economy is already a reality. If this country continues to lend its active support to a world wholly without economic borders, it will turn out that America’s Smithian inheritance will be the greatest of all our exports.