Economic nationalism is back again: What history can teach us about how to respond

As the United States economy looks to move beyond crisis-induced shocks, the appeal of protectionist and isolationist policies have increased. Sound familiar? It should.

The 1929 stock market crash, which led to widespread financial panic and eventually contributed to the onset of the Great Depression, paved the way for the Smoot-Hawley Tariff Act. The act, which led to a rise in economic nationalism, added roughly 20% to U.S. import duties, triggering reciprocal tariffs from more than 25 countries, causing global trade to plummet and deepening the impacts of the ensuing economic contraction. 

Historical trade policies and their impact

Fast forward nearly 80 years, and the collapse of the U.S. subprime mortgage market set in motion a series of events that culminated in the Great Recession. Still reeling from the resulting liquidity crisis, trade tensions around the world flared, currency wars erupted and restrictive trade policies flourished.

Today, as we look to put the economic effects of the pandemic distortions behind us, trade policy uncertainty is once again on the rise. Threats of tariffs, retaliatory responses and a general rise in protectionism have increased volatility and intensified the pressure on global trade. Add to that the ongoing war in Ukraine and a fragile ceasefire in the Middle East, and it’s no wonder that globalized businesses appear to be in perpetual wait-and-see mode.

But a look at the data provides sobering perspective. While some have suggested that the growing trend toward geo-economic fragmentation spells the end of globalization, history tells a very different story. Yes, periods of economic stress often create trade tensions and can lead to policy shifts aimed at protecting domestic industries. However, the lure of the gains from trade ultimately leads us back to pursuing comparative advantage. 

A 2014 study by economists Mariko Klasing and Petros Milionis shows that while the world’s level of trade openness indeed plummeted in the years after Smoot-Hawley, it bounced back in the decades that followed.

What’s more, in the post-war era, trade’s share of the global economy has been on a tear, rising from roughly 10% to more than 50% of global gross domestic product (GDP), with each geopolitically motivated setback more than compensated for in subsequent years.

The future of trade under rising economic nationalism

More recently, trade’s share of global GDP fell from a peak of 60% prior to the Great Recession to a pre-pandemic low of 56% in 2019. However, it quickly bounced back to an all-time high of 63% in 2022 and remained close to that level in 2023.

There’s no doubt that we’re in for a rough few years of global trade ahead. But, once again, we expect globalization to adapt rather than unwind. Countries are already looking to forge ties with willing partners, and evidence suggests that trade is being diverted toward geopolitically aligned blocs. While efforts will be made to close loopholes that enable so-called “connector” countries to bridge the gaps, supply chains can often innovate faster than policy.

The bottom line: Invest in productivity

While globalization was once exclusively focused on maximizing efficiency, many companies are reconfiguring supply chains to reduce vulnerabilities, even at the expense of adding an extra stage (and cost) to their value chains. This increased cost of doing business will require globalized businesses to double down on efficiencies elsewhere. Rather than putting investment on hold, now is the time for companies and governments to invest in productivity.

Economic nationalism may be back in style, but the gains from trade will inevitably be too appealing to resist longer term. Let’s not miss this opportunity to focus on resilience and emerge a more competitive economy.

This week, a very special thanks to Ian Tobman, manager of our EDC economics department. As always, at EDC Economics, we value your feedback. If you have ideas for topics that you’d like us to explore, please email us at economics@edc.ca and we’ll do our best to cover them.