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From Panic to Depression?
The dangers of blaming free trade, low taxes, and flexible labor markets for our current troubles.


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Phil Kerpen

Blame for today’s financial panic can be assigned to a Federal Reserve that kept interest rates too low while a bubble inflated; unscrupulous lenders; people who bought homes they couldn’t afford; Wall Street wizards who overleveraged and wrote derivatives they couldn’t pay; and a Congress that set the policy goal of universal home ownership and recklessly grew Fannie Mae and Freddie Mac to pursue that goal.

But with so many real culprits out there, we cannot afford to blame the fake culprits of free trade, low taxes, and flexible labor markets. These are the fundamentals of a free economy. If we undermine them in response to the panic, we risk repeating the mistakes that followed another great panic and ushered in the Great Depression.

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First, trade. The Smoot-Hawley tariff was Congress’s first major policy blunder leading up to the Great Depression. Despite a warning from more than 1,000 prominent economists, Congress raised protective tariffs to record-high levels in June 1930. The result was that U.S. imports crashed while retaliation from abroad sunk U.S. exports. Some historians believe the political debate surrounding the Smoot-Hawley bill actually contributed to the initial stock market crash of 1929, and most believe it was a factor in turning that crash into the Great Depression.

The world economy is far more interconnected today. Trade volumes are much higher and large sectors of the U.S. economy are extremely trade-dependent. Thus, any protectionist response to the current panic would be even more disruptive. 

Unfortunately, China-bashing has become a bipartisan pastime in Congress. And Sen. Barack Obama is campaigning on poison-pill labor and environmental standards that many of our trading partners can’t afford. It’s a sure way to sink free-trade agreements.

Obama also promises new non-tariff barriers to trade that could spark a global trade war, such as direct subsidies for companies willing to locate production in the United States. Under undivided Democratic rule it appears unlikely that there would be any progress on a new global trade agreement. And the existing World Trade Organization framework could unravel under so-called “fair trade” pressure, or even from a return to explicit protectionism.

Second, taxes. President Herbert Hoover’s infamous Revenue Act of 1932 was the biggest and worst-timed tax hike in U.S. history. The bill was a bipartisan “achievement,” a compromise between the Hoover administration’s plan to raise income taxes and the Democratic Congress’s plan to institute a national sales tax. The top marginal income-tax rate was raised from 25 to 63 percent. New excise taxes were put on everything from cars and trucks to refrigerators, chewing gum, soft drinks, and electricity. The death tax was doubled.

And the results were tragic. By raising taxes during an economic downturn, the economic pain of the 1930s was made deeper and more permanent. The higher Hoover taxes discouraged work, savings, and investment, prevented capital formation, and depressed consumer spending.

Today, even liberal congressman Barney Frank of Massachusetts has said there should be no tax hikes in the next year because of the current economic weakness. Yet Barack Obama remains committed to a program of raising the top marginal tax rate from 35 percent to 39.6 percent while also hiking capital-gains taxes, dividend taxes, and the death tax. All this will put the brakes on economic activity right when we need to hit the accelerator.

Third, labor. Economists at UCLA have determined that President Franklin Roosevelt’s anti-competitive, pro-union policies prolonged the Depression seven full years. In particular, those policies led to artificially expensive products that discouraged consumer spending and artificially high wages that prevented employment from recovering.

Despite this lesson, congressional Democrats, including Obama, are today poised to give unions their greatest power boost since Roosevelt’s 1935 National Labor Relations Act. The vehicle this time is the shamelessly named Employee Free Choice Act, which, among other pro-union legal changes, would abolish secret-ballot elections for union organizing.

By way of a new procedure called card check, workers will be openly pressured to sign union cards, after which, if a majority of workers sign, unions will be automatically certified. Coercive tactics by union bosses would run rampant if this policy is ever enacted. And as unions gain in power and force wages unnaturally high, mass unemployment could be the unintended result.

It’s important that we avoid all these policy errors — not just for the sake of our prosperity, but for our survival. The Great Depression, after all, didn’t end until the advent of World War II, the most destructive war in the history of the planet. In a world of nuclear and biological weapons and non-state terrorist organizations that breed on poverty and despair, another global economic breakdown of such extended duration would risk armed conflicts on an even greater scale.

To be sure, Washington already has stoked the flames of the financial panic. The president and the Treasury secretary did the policy equivalent of yelling fire in a crowded theater when they insisted that Congress immediately pass a bad bailout bill or face financial Armageddon. Members of Congress splintered and voted against the bill before voting for it several days later, showing a lack of conviction that did nothing to reassure markets. Even Alan Greenspan is questioning free markets today, placing our policy fundamentals in even greater jeopardy.

But after the elections, all eyes will turn to the new president and Congress in search of reassurance that the fundamentals of our free economy will be supported. That will require the shelving of any talk of trade protectionism, higher taxes, and more restrictive labor markets. The stakes couldn’t be any higher.



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