Importers and exporters know that trade has become part of the lifeblood of the American economy.
The numbers are astounding: 39 million jobs—including 6 million manufacturing positions—depend on trade, according to a 2019 study by Trade Partnership Worldwide. In 2018, American farmers exported $139.6 billion worth of agricultural products. And small- and medium-sized businesses make up 98% of U.S. exporters.
This is largely owing to the buildup of trade relationships with other countries. The United States is currently working on its 15th free trade agreement with its 21st trading partner, and it's hard to imagine a world without these partnerships. But less than a century ago, the landscape looked completely different.
There was no multinational organization setting guidelines, and bilateral agreements as we know them today didn’t exist. Duties were raised or lowered via bills passed in Congress instead of negotiated between trade partners. Both in the United States and abroad, governments focused on protecting domestic industry rather than international economic cooperation.
Fast forward to 2020, and trade barriers around the world have come down. There are 306 regional trade agreements in force globally, according to the World Trade Organization (WTO), which includes 164 countries as members and 24 as observers. Merchandise trade reached $19.67 trillion worldwide in 2018.
This has been impactful at home and abroad. Though it's impossible to completely separate the impact of trade agreements from technological advances and sociopolitical events, economists largely agree that lowering trade barriers has been an economic boon for the United States and the rest of the world.
Protectionism Breeds Tariffs
It wasn't always this way. Protectionism—insulating domestic industry from foreign competition by taxing imports—reigned in the early history of the United States. Prior to the Civil War, tariffs made up more than 90% of federal revenue. One of Congress's first attempts to fund the Civil War was the Revenue Act of 1861, which imposed tariffs on items including sugar, liquor and tea.
This mindset continued after the First World War. "The U.S. certainly had an isolationist bent following World War I that provided some backdrop for protectionism," said Dr. Alan Green, associate professor and chair of economics at Stetson University. "Particularly after the economy weakened starting in 1929, it was not a stretch to move from somewhat benign, economically anyway, isolationist attitudes into a demand for tariffs."
During WWI, European agricultural production steeply declined, while demand for food skyrocketed. This led to increased production on American farms, but also created an environment of borrowing and investing. Once Europe began supplying its own agricultural products again, prices declined precipitously, leaving American farmers saddled with debt. Policy was used to protect domestic agriculture from a slew of lower-priced imports.
While farmers struggled in the Roaring '20s, the U.S. economy boomed. Real gross domestic product (GDP) increased from $687.7 billion in 1920 to $977 billion in 1929. Unemployment fell to 2.4% in 1923 and stayed below 4% for most of this period. Stock prices ballooned. Over a five year period, the Dow Jones Industrial Average rose 500%. It enticed working-class citizens to buy on margin (paying a small percentage of the stock’s price and borrowing the remainder).
That is, until Oct. 24, 1929—Black Thursday. The market opened 11% lower than the prior day's close. Prices fell again the following Monday and the Tuesday after. The bubble had burst, and the stock market plunged, bottoming out in 1932.
The Great Depression, Retaliatory Tariffs
So began the Great Depression: between 1929 and 1933, GDP shrank by one-third, almost half of the country’s banks failed and the stock market lost 90% of its value. Unemployment jumped from 3.2% to 24.9%. Deflation was rampant, but even as the price of everything from homes to eggs collapsed, many Americans could not afford the cost of day-to-day living. Economists disagree on the precise end to the Great Depression, but estimates range from 1939 to after World War II.
It was under these conditions that the Tariff Act of 1930 became law. The bill initially intended to protect the agriculture industry, but other sectors quickly lobbied to be included. Soon, what started as a promise to aid farmers ballooned into legislation raising tariffs across the economy. The Smoot-Hawley Tariff, as it came to be known, levied new taxes on 3,218 items and raised taxes on 887 more. The law pushed tariffs up by 40-50% on average. It also taxed many imports at a specific dollar amount per item, instead of a percentage of their price.
The effects were deleterious. After President Herbert Hoover signed the bill into law, stocks crashed 20 points. Taxes on hundreds of items became prohibitively high, including hundreds of parts used to produce automobiles. As deflation depressed prices, fixed tariffs became an ever larger percentage of the cost of imports. By 1932, tariffs reached nearly 60% on an ad valorem basis. Farmers, the intended beneficiaries of the Tariff Act of 1930, saw their exports fall by a third.
The impact extended beyond the shores of the United States. In response to the Smoot-Hawley Tariff, 25 countries enacted retaliatory duties. Subsequently, U.S. exports fell from $7 billion in 1929 to $2.5 billion in 1932. "The Smoot-Hawley tariff made everyone worse off,” said Green. “Our partners in Europe implemented retaliatory tariffs, which raised prices. This made the Great Depression even worse."
Overall, world trade dropped 66% during this time. The reduced revenue made it harder for Europe to buy products from the United States or repay their debts from WWI. Some scholars suggest that the combination of lost revenue and beggar-thy-neighbor policies played a role in precipitating World War II.
Today, economists disagree on how much the Tariff Act of 1930 impacted the Great Depression, but you would be hard pressed to find someone who thought it was a good move. The U.S. Senate website calls it "among the most catastrophic acts in congressional history."
'The United States Is Open to Trade'
It was time for a new approach. In 1932, Hoover lost his re-election bid in a landslide and was replaced by Franklin D. Roosevelt. In June 1934, Roosevelt signed the Reciprocal Trade Agreement Act (RTAA), giving the president the authority to negotiate tariff rates without Congressional approval.
It was a strategic move. Roosevelt believed lower tariffs were needed to pull the United States out of the Great Depression. But at that time, Congress set import tax rates through legislation. A bill lowering tax rates—and potentially bringing a flood of imports—would have been impossible to pass in the economic climate. Meanwhile, trade partners were wary of lowering tariffs without mutual action from the U.S.
"The United States realized its mistakes with the Tariff Act of 1930," said Dr. Jonas Gamso, assistant professor of international trade at Arizona State University's Thunderbird School of Global Management. "By allowing the president to negotiate tariff rates, the Reciprocal Trade Agreement Act was intended to, and did, reduce the damage caused by the Smoot-Hawley tariff."
Not only did the RTAA authorize the president to enter into tariff agreements with other countries, but it also gave the president the authority to increase or decrease import taxes by up to 50%. It also applied the new tariff rates to imports from all countries on an unconditional, most-favored-nation basis. Going forward, new tariff rates negotiated with one country would apply to all others. "The RTAA signaled to the world that the United States is open to trade," Gamso explained.
One result of the RTAA was bilateral tariff cuts, if only on a commodity level basis. By June 1940, the United States had signed agreements with 21 countries, constituting 60% of the nation’s trade. By 1946, the average ad valorem tariff fell to 25.3%.
But the Roosevelt administration's vision was even broader. Secretary of State Cordell Hull viewed mutually lower trade barriers as a way to avoid international conflict. As a member of the House of Representatives in 1916, he called for an international trade conference to examine "trade methods, practices, and policies which, in their effects, are calculated to create destructive international controversies."
This did not come to fruition. Five years after the RTAA became law, WWII broke out, putting an end to negotiations. Even after the war ended, tariff negotiations did not immediately resume. Congress was still split on the direction that trade policy should take.
A New United Nations Takes on Trade
But attitudes were beginning to change. After two world wars and a deep, global economic depression, policymakers were wondering whether an alternative to isolationism was warranted.
Looking to take a more collaborative approach, world leaders created the United Nations in 1945. One of the U.N.'s earliest goals was to establish an International Trade Organization (ITO) that would serve as a governing body over global commerce and international trade policy. Although the ITO was eventually abandoned, thanks to lack of support from the United States, an agreement on future trade policies rose from its ashes.
In October 1947, 23 countries, including the United States, signed the General Agreement on Tariffs and Trade (GATT) to minimize trade barriers. Under this accord, countries would meet periodically to negotiate trade policy and reduce barriers to free exchange. During these meetings, or rounds as they came to be called, the countries gradually reduced quotas and tariffs, and perhaps most importantly, the entrenched most-favored-nation status between signatories. The first meeting became known as the Geneva Round.
It quickly got results. In 1947, the average ad valorem rate in the United States fell from 19.4% to 13.9%. The new tariff rates began on Jan. 1, 1948, and did not require congressional approval.
This initial success led to additional negotiating rounds: the Annecy Round (1949), the Torquay Round (1950-51), a second Geneva Round (1955-56) and the Dillon Round (1961-62). These sessions produced minor tariff reductions, but more importantly, they paved the way for future signatories to join and demonstrated a commitment to global economic cooperation that led to future developments.
Momentum picked up in 1964 with the Kennedy Round. By its conclusion in 1967, 62 countries, representing 75% of global commerce, agreed to cut tariffs to an average of 8.7%. Participants also began addressing non-tariff barriers, such as antidumping. At the time, it was hailed as the most significant multilateral trade agreement.
Six years later, 102 countries gathered for the Tokyo Round. They agreed to reduce duties on another $300 billion worth of goods. By the time the round concluded in 1979, tariffs between signatories were reduced to 6.3%. Further, some signatories also reached agreement on certain non-tariff barriers to trade. These Tokyo Round codes, as they were called, focused on antidumping and countervailing duties, subsidies, standards and government procurement.
Things were buzzing along by now, but there was a problem. As tariffs fell with each round, the benefit of decreasing them also fell. The law of diminishing returns applied—each additional reduction resulted in smaller economic benefits. Remaining non-tariff barriers stood out in stark contrast. Additionally, the GATT lacked an enforcement mechanism if a country violated an agreement. It was clear that a governing body was needed.
This shortcoming was addressed in the next round of negotiations, the Uruguay Round (1986-93), making it one of the most consequential. By now, 136 signatories were present. The meeting continued to address the need for tariff cuts and the reduction of non-tariff barriers, but it also tackled the larger topics of negotiation, enforcement and dispute resolution between countries.
The Uruguay Round was the longest and most complicated round, but it ended with several major achievements. Over seven and a half years, tariffs on goods were reduced by another 38% for industrialized countries. Most-favored-nation status was extended to trade in services through the General Agreement on Trade in Services (GATS). Governments came to an agreement on intellectual property rights and amended and made mandatory most of the voluntary agreements from the Tokyo Round.
But the largest achievement of the Uruguay Round was that it established the World Trade Organization (WTO). As a governing body, the WTO would replace the GATT as a permanent, international body dedicated to maintaining and enforcing global trade rules. Today, it acts as a forum to negotiate the removal of trade barriers, monitor agreed upon policies in member countries and settle disputes. The WTO says its primary objective is "to open trade for the benefit of all."
The results of these trade rounds were seen in international commerce. Aided by trade policy and technology improvements, firms began relocating production facilities internationally. According to the World Bank Group, international trade grew 68% faster than global GDP on average in the 1980s. By the 1990s, it had picked up to 140 times faster than world economic output.
U.S. Strikes Free Trade Agreements
As the world was coalescing around the principles of free and open trade, the United States took another step toward free exchange. The United States-Israel Free Trade Agreement, signed in 1985, became the first bilateral reciprocal agreement negotiated by the U.S. Its aim was to eliminate most tariffs and non-tariff barriers between the two countries by 1995. Since then, exports to Israel have increased by 456%. In 2017, the most recent data available, goods traded between the two countries reached $34.5 billion.
It was the first of its kind for the United States, but certainly not the last. In 1989, President Ronald Reagan signed the U.S.-Canada Free Trade Agreement, which eliminated most tariffs, pared down non-tariff barriers and set guidelines for trade in services. Shortly thereafter, Mexico approached the United States to request a similar accord. Mexico became enveloped in the agreement, and five years later, the North American Free Trade Agreement (NAFTA) was born.
The passage of NAFTA resulted in numerous economic benefits. A 2014 study from the Peterson Institute of International Economics shows that the United States grows $127 billion richer each year from trade within the North American bloc. The U.S. Chamber of Commerce estimates that six million jobs depend on trade with Mexico alone.
NAFTA’s Economic Impact
This new agreement did not come without controversy, however, particularly in the area of manufacturing. In 1992, presidential candidate Ross Perot warned that the agreement would create a "giant sucking sound" as factory jobs shifted from the United States and Canada to lower-wage markets in Mexico.
As Dr. Rob Scott of the Economic Policy Institute explains, "through 2010 alone, the United States lost 700,000 jobs just from trade with Mexico. Since then, the trade deficit with Mexico has increased to over 50%. The problem can particularly be seen in auto parts because of the way that companies have restructured."
Debate over the multilateral agreement continued well after its passage. But one thing that could not be disputed was that NAFTA fused together the economies of the United States, Canada and Mexico. Trade between the three countries rose from $290 billion in 1993 to $1.1 trillion in 2016.
In particular, the new tariff structure bolstered trade in intermediate goods. A study from the Wilson Center found that in 2016, 25 cents of every dollar of goods imported into the United States from Canada were actually produced in the United States. That number increased to 40% for goods imported from Mexico.
The United States-Mexico-Canada Agreement
But NAFTA was not the end of the story. On July 1, 2020, the 26-year-old agreement was replaced by the United States-Mexico-Canada Agreement (USMCA). This new agreement keeps many of NAFTA’s provisions (including its tariff structure), but adds new provisions in areas that were less relevant at the time NAFTA was signed. Currently in force, the agreement beefs up intellectual property protections, changes content requirements for automobiles made in North America and addresses digital trade.
Today, the United States has 20 trade agreements with 14 countries and counting. Over the years, the business of importing and exporting has increased wealth and created new opportunities, both in the United States and abroad. Exporters today are part of a proud tradition of worldwide economic cooperation.