Free Trade Has Not Always Led To Economic Growth

Are tariffs good or bad for economic growth? There is now a consensus among economists, based on extensive empirical evidence for the late 20th century, that free trade is best. But what is true for one time period is not necessarily true for all. The results of a study by Kevin O''Rourke of University College Dublin, published in the latest issue of the Economic Journal, suggest that tariffs were in fact positively related to growth rates during the late 19th century, in sharp contrast with the experience of the late 20th century.

O''Rourke calculates the correlation between growth rates and tariffs for ten countries between 1875 and 1913. The calculation indicates that a 10% increase in average tariffs was associated with an increase in annual growth rates of nearly 0.2% a year, a surprisingly large effect in what would nowadays be thought of as the ''wrong'' direction.

What explains this result? One possibility is that tariffs lowered the relative price of investment goods, thus encouraging investment and growth. Nowadays, tariffs lower the growth rate, in part by making investment goods such as equipment and machinery relatively more expensive: since they are largely traded across international frontiers, tariffs increase their price, hence discouraging investment. In the late 19th century, construction was a much more important component of investment, and construction costs were largely unaffected by tariffs. Thus, tariffs lowered the price of construction and investment, relative to heavily-tariffed manufactured or agricultural goods, with the result that more resources were devoted to investment.

A second possibility is that tariffs accelerated the movement of low-productivity agricultural workers into higher-productivity manufacturing jobs. If this was the mechanism by which tariffs raised growth rates, then the reason for the contrasting contemporary results becomes clear: at least in OECD economies, there are no longer large reservoirs of low-productivity agricultural workers who can be deployed to more productive work. O''Rourke suggests that we should be cautious in extrapolating the lessons of one period to other periods: the underlying processes driving economic growth may vary across time.

Indeed, they may also vary across space. The countries included in this study were all rich by the standards of their day: Australia, Canada, Denmark, France, Germany, Italy, Norway, Sweden, the UK and the US. It may be that these were atypical countries, in the sense that they were capable of developing successful manufacturing industries behind trade barriers. Less developed countries might not have been able to emulate their example, even if they had started during the late 19th century, rather than in the aftermath of the Great Depression. Nonetheless, the results of the research make it more difficult to argue that free trade has always been the right growth strategy for all countries.

''Tariffs and Growth in the Late 19th Century'' by Kevin O''Rourke is published in the April 2000 issue of the Economic Journal. Dr O''Rourke is at University College Dublin.