The Price Was Right

The Gist: America was founded by free trade radicals in a costly revolution.

A review of Clashing over Commerce by Douglas A. Irwin.

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Have you ever wondered what was the price of American freedom in 1776?

Bob Barker

Figure 1. “Here is the first item up for bids today: it’s an exciting trip to liberty! You and guests will ride one-way for a multiple century luxury stay courtesy of the Continental Army! And that trip goes to the one of you who bids nearest to the retail price without going over…”

 

Over the 8 years of the Revolutionary War, the new citizens suffered a “sharp decline in real per capita income, nearly as severe as the reduction during the Great Depression of the early 1930s.”’

The Revolution, in short, was an economic disaster. And independence from our now bitter largest trading partner only further complicated matters. Today we review the first part of Douglas Irwin’s magisterial history of American trade relations, Clashing over Commerce, and discover how our relationship with Britain dominated the economics of the early United States as well as how the Founders set up the first of three eras of American tariff policy.

Sugar Cube

Figure 2. Actually, we might have been more bitter: after the Revolution, our sugar trade was much curtailed.

 

From an economic point of view, life in America before the Revolution was pretty darn good. Incredibly, “real per capita income in the colonies was at least 50 percent higher than in England between 1700 and 1774.” The colonies had long been dependent on trade to provide things difficult to acquire on the frontier and Great Britain actively subsidized key products like gunpowder and silk “that lowered their price to American consumers.” Irwin quotes other economic historians: “Whatever the costs of membership in the British Empire, they were largely offset by the benefits: naval protection; access to a large free-trading area; easy credit and cheap manufactures; and restricted foreign competition.” Furthermore, in the years leading up to the Revolution, Great Britain had financed the French and Indian War, which did little long term about the Indians but practically eliminated from North America the principal European security threat. As a result, Britain’s debt increased over 2/3 and servicing it required over half of the British annual budget while maintaining a standing army in North America “amounted to [an additional] nearly 4 percent.” Which made America’s taxation relevant: Grover Norquist concludes that Americans were paying a fraction of what Brits were and “by 1775, the British government was consuming one-fifth of its citizens’ GDP, while New Englanders were only paying between 1 and 2 percent of their income in taxes.

revolutionary soldier

Figure 3. That’s what America is all about: if we ever have to pay more than 2% of our income in taxes, we revolt! 

 

Inauspiciously for Great Britain, there were two powerful (though relatively small) groups that felt adversely affected by British trade policies: Virginia tobacco farmers (like George Washington and Thomas Jefferson) and Boston merchants (like John Hancock and the clients of John Adams). Their principal initial objection was to a costly, inefficient, mercantilist British law that required about 20% of imports and 75% of exports to first stop in Britain (or in some cases, the West Indies) before proceeding to their final destination. The merchants were upset that “this artificial routing through Britain involved extra fees, commissions, warehouse rents, and transportation costs and is estimated to have raised the costs of imports of European and Asian goods by about 20 percent.” The Virginians understood that “if tobacco… could be sold directly to European customers, the income of tobacco planters would have been anywhere from 15 to 35 percent higher.

British leaders thought it perfectly reasonable for the rich colonies to help pay for their defense and tried to impose new taxes that were common at home and would have paid for less than half of the expense of maintaining the standing army in North America. But those taxes – the infamous Stamp Act on printed materials, more trade duties – were especially borne by the commercial class that was already upset at the increasingly mercantilist policies of Britain. Tellingly, the legendary Boston Tea Party was not a reaction to taxes on tea – which were actually being lowered – but to the fact that Britain was setting up a state monopoly in the lucrative trade. Local merchants like Hancock, who were already living out their free trade principles as accomplished smugglers, felt compelled to resort to the extraordinary countermeasures that would spark the Revolution. Concurrently, a 1773 financial crisis in Britain prompted a collapse in the price of tobacco (by half!) and the reduction of credit available to farmers, “leading to a wave of foreclosures and imprisonment” – not to mention increased bitterness about their expensive, impeded access to non-British markets.

TV

Figure 4. Today may require a Boston Comcast Party. But, speaking of imprisoning debtors, my favorite Balanced Budget Amendment to a state constitution is Alabama’s, which threatens state officials with both personal fines and jail time if they incur any excess debt not used to “repel invasion or suppress insurrection.” Now that’s commitment.

 

 

 

Without a voice in Parliament (“no taxation without representation!”), Americans had tried to use their economic power by boycotting British goods, which prompted a pattern: “when new British taxes were imposed, a non-importation movement would begin, and British policymakers would retreat.” But “non-importation only had a significant impact when it coincided with an economic downturn in Britain; the colonies could have only a modest influence on the country, because just 15 percent of British exports were destined for America in 1765.” From a position of strength and irritation, Britain eventually banned all foreign trade with the colonies in 1775. “On April 6, 1776, in defiance of Britain, Congress declared that the colonies were no longer bound by British mercantile regulations and that American ports were open to trade with all countries except Britain.” John Adams believed that the April proclamation was America’s true declaration of independence.”

Walmart

Figure 5. Millions of Americans celebrate the holiday by buying goods of foreign origin.

 

Ultimately, the vast majority of Americans did not participate in the Revolutionary War. Of those who did, the majority fought on the side of the British. Relatedly, the vast majority of Americans worked in agriculture that did not export anywhere and, as noted at the beginning, may have enjoyed more economic benefits than detriments of British rule. Irwin concludes: “Only a minority of the colonial population is believed to have actively supported independence in 1776, and this vocal and politically powerful minority may have been precisely those most affected by Britain’s trade policies.”

As might therefore be expected, the Founders were trade radicals who “favored free and open commerce among nations and the abolition of all restraints and preferences that inhibited trade.” John Adams went so far as to draft a “template commercial treaty” in which “the United States would seek ‘national treatment’ from other nations, meaning that US merchants and ships (if not goods) would receive the same standing in foreign countries as their own domestic merchants and ships” which “was far more demanding than the standard most-favored-nation (MFN) treatment” under which “US goods and ships would be treated the same as the most-favored foreign nation in the country’s market.” Irwin quotes another historian: “the United States was demanding special consideration, privileges such as no European country had ever granted to another.” No one agreed. Ben Franklin, who insisted “it is best for every country to leave its trade entirely free from all encumbrances,” even went so far as to ask, when negotiating peace with Britain, for America to retain its privileged access to British markets. Amazingly, the British government initially was interested and even introduced legislation to that effect, but aghast nationalists killed it in Parliament.

So America was now on its own after suffering a near equivalent of the Great Depression. Our great dreams of open trade were dashed by the requirement that other people had to agree. Even worse, because we had 13 different (though relatively open) trade regimes and a weak federal government under the Articles of Confederation, we were in a terrible negotiating position: we couldn’t threaten access to our markets in exchange for other countries dropping their barriers. In the lead up to the Constitutional Convention, Madison wrote to Jefferson, “Most of our political evils may be traced to our commercial ones.”

The Constitution that emerged was a brilliant response to the contemporary political crises and set America up for centuries of success. For this newsletter, let’s focus on the trade-related outcomes: first, the federal government would derive their revenue from tariffs, i.e. taxes on imports. Though the Founders favored the elimination of trade barriers, they viewed tariffs as a necessary evil – something easily collectible at ports, crucial to government operations, and permissible so long as they were evenly imposed and non-discriminatory. Until the introduction of the income tax in the 20th century, this would be the primary source of government revenue (over alcohol taxes and land sales). Second, the federal government would have the power to regulate foreign trade but be forbidden from taxing exports. Most students of American history are familiar with the bargains struck by the South to protect slavery, but Southerners had a broader goal to protect their main source of income: agricultural exports. This will become extremely relevant in our next edition but, for now, I’ll just note that George Washington and James Madison were the only Southerners who opposed this provision, believing that America was such a central player in the global tobacco marketplace that they could effectively raise revenue without diminishing output by passing along the costs to eager (addicted?) foreigners. Third, and relatedly, treaties with foreign governments would require the approval of 2/3 of the Senate, another attempt by the South to secure regional interests. 

The first years of the Republic would be a vigorous battle between the Founding generation over the nature of trade. The Federalists – George Washington and Alexander Hamilton – saw the United States as a burgeoning economic powerhouse – “Hercules in a cradle” –  that would balance manufacturing and agriculture and benefit immensely from close commercial ties with our former master, the leading Navy of the world, a familiar and complementary economy with easy credit who happened to share a language: Great Britain. The Democrats – Thomas Jefferson and James Madison – yearned for a nation of yeoman farmers, grounded in rural and revolutionary values, and saw kinship in the blood-soaked regicidal ideals of America’s first ally but legally distinct, commercially inferior, and reluctant creditor with more limited global power projection: France.  

The Federalists came to power first and, as Secretary of the Treasury, Hamilton was especially and understandably obsessed with our credit worthiness:In 1792, the interest alone on US debt soaked up 87 percent of total revenue.” As a result, he was desperate to avoid another war: costs would skyrocket while tariff revenues would plummet. If with Britain, we would not only lose our best trading partner but they could also effectively blockade our coast, limiting trade with others. Irwin’s interpretation of Hamilton is a welcome revision to the conventional portrayal of our first Treasury Secretary as an unbridled protectionist: “Hamilton was skeptical of high protective tariffs because they sheltered both inefficient and efficient producers, led to higher prices for consumers, and gave rise to smuggling, which cut into government revenue.” Instead, in order to pay off our debt, Hamilton insisted on “modest tariffs” – in 1790, they were about 20% and, again, the primary tax the federal government imposed. By assuming debts incurred by the states during the Revolution, Hamilton also “enabled states to reduce [their own] direct taxes by as much as 75 percent.”

Still, Hamilton did support some government intervention in the marketplace to support manufacturing. He conceded that “if the system of perfect liberty to industry and commerce were the prevailing system of nations,” then the United States could pursue whatever was its comparative advantage. But he felt that other countries unfairly helped their industry and perverted American incentives. Hamilton’s preferred remedy was a direct government subsidy to nascent industries, which “unlike import tariffs, did not create scarcity and artificially raise domestic prices.” But, importantly, he thought it only “justifiable” when the industry was new and thought continuous subsidy “questionable.” Of course, the Democrats believed, not unreasonably, that direct subsidies by the federal government to businesses were unconstitutional and, relatedly, were keen to preserve the agricultural character of the American economy.

But the bigger debate was always about how to deal with Britain. Democrats “believed that the nation’s political independence could not be fully realized unless the country had its economic independence as well. Madison complained that Britain ‘has bound us in commercial manacles, and very nearly defeated the object of our independence.’” In order to achieve economic independence, they wanted to impose strict economic boycotts of British trade in order to jolt Britain into allowing further market access. While Hamilton and the Federalists certainly desired better market access, they considered this move to be insane brinkmanship with severe tax, credit, economic, and military implications. “Madison contended that the country was in a position ‘to wage a commercial warfare,’ because it exported foodstuffs and raw materials that were essential to Britain, while it imported manufactured goods and other trifles that it could do without.” Irwin counters: “In terms of economic leverage, the figures on bilateral trade seem to confirm Hamilton’s view. While Britain sent nearly 20 percent of its exports to the United States, only 6 percent of its imports came from the United States [and it had other alternatives for the same goods]. On the other hand, about 90 percent of US imports and 25 percent of exports were with Britain.” 

Still, an important takeaway is that the conventional view of the Federalists as pro-tariff and Democrats as anti-tariff is too simplistic: instead, the Federalists saw the tariff as necessary to maintaining the good credit of the United States and Democrats saw the tariff as a bludgeon to get free trade. 

All around this time, France and Britain were in near continuous war with each other. Reflecting America’s radical belief in the rights of commerce, our ships tried to trade with both sides. The Federalists tried their best to appease British concerns, even blocking trade with France, managed to avert war, but ended up sparking a domestic political firestorm that helped sweep the Democrats into office in 1800. As trade resumed with France, the British began to seize hundreds of American vessels while “ships suspected of aiding France were detained and sent to Halifax, Nova Scotia, to face prosecution under British law. Even if a ship’s goods were not confiscated, the resulting delays could be very costly.” Most outrageous, the British conscripted thousands upon thousands of American sailors into their Navy. 

Seizing the righteous anger about American dishonor, hellbent on punishing the British, President Jefferson rejected any compromise and self-imposed a total prohibition on American ships sailing to foreign ports as well as foreign ships taking on cargo in the United States. “The embargo was the most dramatic, self-imposed shock to US trade in its history [and] brought America’s foreign commerce to a grinding halt” for 15 months. Unsurprisingly, this prompted a depression – according to one estimate, a dramatic 5% decline in American GDP. It also led to a steep decline in revenue, leading to America’s first fiscal deficit. Why did Jefferson ban ALL trade, as opposed to just with Britain? Because, sounding more like an Albanian isolationist than the man who once wrote “all the world would gain by setting commerce at perfect liberty,” Jefferson insisted that it would be too easy for ships to claim alternative destinations but still trade with Britain. The same types of merchants who had been motivated to join the Revolution were appalled and tried their best to undo the policy. Bewildered, Jefferson “concluded that merchants were simply treasonous and therefore even stricter enforcement was required,” including a new bill with “provisions [that] may have violated the search-and-seizure provisions of the Fourth Amendment.)” Irwin concludes: “The embargo must be considered a failure: it imposed large costs on the economy but failed to achieve any of its objectives” – the British continued to prey on our ships while denying America full and free market access. Similar to the calculations leading to the Revolution, the problem was that Jefferson had imposed his embargo at a time when Britain was enjoying the height of their business cycle and easily shifted its imports to alternative providers of American goods. Irwin warns that “had the administration persisted with the embargo, its enforcement would have led to a national crisis” but Jefferson insisted he needed only a few more weeks.

Apple

Figure 6. Just try to imagine life for more than a year without any international trade. Or, to give some modern sense of the size of the economic decline, imagine the total annihilation of Apple – no more stores, no more computers, no more phones, no more apps – which is worth about 5% of America’s GDP. Add into the scenario that the government relied nearly totally on Apple for its budget and you have some sense of the situation.

 

Unfortunately, the stumbles would continue into the Madison administration. As Congress ended the embargo, they dangled a carrot for France and Britain: whoever stopped harassing American shipping would get the benefit of America stopping imports from the other country. France, whose harassment was relatively limited to privateers, was the obvious potential beneficiary and they hinted they would accept the bargain. But Madison jumped too soon, restricting imports from Britain before France had even decided. Importantly, the law still allowed exports to Britain. Politically, this made sense: it hurt Madison’s political opponents (the northeastern shippers and merchants) while helping his base (Southern farmers) and doing something bad about Britain fit into the party ethos. But it was strategically stupid: at this moment, Britain desperately needed American food to supply its army in Spain fighting Napoleon. So the tensions continued, and American sailors continued to be shanghaied into the British Navy, until Madison decided that the only way to protect our honor was to fight Britain again in a war. Maybe we could also liberate Canada along the way.

Terribly inconveniently, our declaration of the War of 1812 was being sent over the Atlantic at precisely the same time that Britain sent over a new policy suspending harassment of American shipping. Irwin explains: “Already suffering under heavy taxes due to the war against France, Britain did not welcome the prospect of another war in North America. The weak economy and pressure from labor and industry helped persuade the British government to relax its policy toward neutral shipping.” Madison conceded that he would not have declared war if he had known but the fight was on. Weakened Federalists “were incredulous that the country would take the side of a French despot bent on military conquest (Napoleon) against a country with constitutional government that happened to be an important customer for American goods.” Irwin details the devastation: “The combination of war, non-importation, and blockade squeezed US trade to the lowest levels in recorded history… exports dropped almost 90 percent, while imports shrank more than 80 percent between 1811 and 1814… and the federal debt tripled between 1812 and 1816.” With Napoleon headed for defeat, Britain redeployed forces to the United States that blockaded the east coast (initially excluding New England) and, most embarrassingly, burned down the White House. We concluded the war in 1814 in a peace treaty that offered zero assurances about the impressment of sailors and Canada remained under British rule. But at least we got a cool national anthem – and an American hero in the victor of the Battle of New Orleans: Andrew Jackson, who will be a star of our next segment.

email

Figure 7. You think missed communications might have declined with technology but the crucial decision of George W. Bush not to check his spam folder missed an email from HotBaathParty1937@hotmail.com about giving up WMDs through a Nigerian intermediary if he could get out of debt, work from home with an online degree, and secure a lifetime supply of Viagra and Xanax.  

 

Ironically, all of the self-inflicted disruption in foreign trade led to a transformation of the American economy. Despite the Democrat dream of a rural paradise, their policies had led to dramatic increases in the prices of manufactured goods which unintentionally invited Americans to create industry to produce substitutes. While export-oriented industries were devastated, domestic manufacturing became a new and important political constituency that was able to push the first major tariffs really designed to protect producers rather than simply generate revenue. The South, caught up in the patriotic fervor of the war, initially provided crucial support but would soon realize that they had to pay the costs. This regional divide, whether the tariff should be for revenue only or also protection, enhanced dramatically by the debate over slavery, would dominate American politics until the Civil War. In the meanwhile, British tensions would fade as they embraced a radical global free trade model the Founders had desired so fervently. We’ll conclude with a quote from Madison that defines this book:

“Shall domestic manufactures be encouraged, and in what degree, by restrictions on foreign manufactures? are questions which would be differently decided by the landed and the manufacturing classes, and probably by neither with a sole regard to justice and the public good…It is in vain to say that enlightened statesmen will be able to adjust these clashing interests, and render them all subservient to the public good.”

Clashing over Commerce

Figure 8. Click here to acquire Clashing over Commerce 10/10 – a magisterial retelling of American history through the important lens of trade, filled with insight into the events that defined the country over its three eras of tariffs: for revenue only (through Civil War), for protection (through World War II), and for reciprocity (through today). One more interesting item: the Founders were deeply influenced by the father of capitalism, Adam Smith, but underappreciated is that Smith, for all his endorsement of free trade, believed in three exceptions: first, for revenue, as discussed; second, to encourage reciprocity, as the Democrats desired and America would eventually adopt (in a far milder form); and third, to protect industries vital to national security.

 

Thanks for reading!  If you enjoyed this review, please sign up for my email in the box below. I read over 100 non-fiction books a year (history, business, self-management) and share a review (and terrible cartoons) every couple weeks with my friends. Really, it’s all about how to be a better American and how America can be better. Look forward to having you on board!

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