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Modern Economic Problems by Frank Albert Fetter

Part 4 out of 9

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be increased. By constant additions of young members, this rise of
cost may be retarded. But when these members grow older, a still
larger addition of young members is required to keep down the average,
and the mathematically inevitable result is an increasing rate of
assessment. This keeps young men from entering, and finally results in
failure or in some form of "reorganization" that drives out the older
members. The assessment plan carries with it the seeds of its own

To meet these difficulties in part, various modifications of the
flat-rate assessment plan are employed, such as classification by age
at entry, so that each member pays a flat-rate according to age
at entry; or large initiation fees at entry which form a temporary
"reserve" to offset increasing mortality in late years. Finally,
the policies may be issued on the natural premium plan, by which the
members of each age class pay exactly what the insurance costs for the
year. Under this plan the company will remain solvent, but with this
and all the other expedients the surviving members are forced to drop
the insurance in later years.

Assessment insurance is sold by business companies organized
for profit, by fraternal orders, and by various types of mutual
organizations. The business companies have had a dismal history
of hardship to surviving members and of eventual failure. They are
disappearing under the influence of hostile legislation resulting
from a better popular knowledge of insurance principles. The fraternal
orders combine insurance with other objects of a benevolent and social
character. With good management, a favorable death rate, and very low
expenses, some of them have provided protection at very low rates for
many years. Others have failed with disappointment and disaster to
the older members. Still others are struggling with difficulties that
presage dissolution. Many now have some form of reserve accumulations,
and some have so improved their methods that they closely resemble
reserve companies. The assets of all the assessment companies are
now $1.37 per $100 of insurance in force, while the legal reserve
companies have $22.66. The assessment companies now get 10 per cent of
their total incomes from their funded investments, as against 24 per
cent for the old-line companies. Even with the favorable conditions
under which the fraternal orders conduct their insurance business they
are doomed to failure unless they adopt rates and policies based upon
adequate reserve accumulations. Many thousands of present members
are paying for insurance at rates which will not suffice to meet the
future losses. The assessment plan fails to eliminate the one great
risk, that of leaving the survivors without insurance in advancing

Sec. 10. # The reserve plan.# The reserve plan, if honestly administered,
gives complete protection against the difficulties just indicated. The
essential purpose of the reserve plan is to collect during the earlier
years of the insurance policy when the mortality is less, a sum larger
than is needed to meet the current losses. This sum, the reserve, is
kept invested and accumulating an income, sufficient to offset the
increase in losses as years advance. In reserve insurance, therefore,
the premium never increases from year to year, altho it may be so
arranged as to diminish or to cease entirely sometime within the term
for which the insurance continues.

The premium must always be fixed in advance. The calculations for
determining the premiums on different kinds of insurance policies are
many and complex, but all conform to a few general principles. The
three factors assumed are an average mortality table, a rate of
interest (or yield on investments), and an expense rate in proportion
to the premiums or outstanding insurance. Insurance on the reserve
plan is often called "scientific insurance" because, upon the basis
of these assumptions resulting from experience, it makes exact
mathematical calculations of the premiums and reserves needed for
insurance of any particular kind in respect to age of insured,
number of payments, method of paying the beneficiary, and any other
conditions. The premium thus fixed is, however, only a maximum, and
usually is reduced as the result of conditions more favorable than
those assumed.

Sec. 11. #The mortality table.# When large numbers of men are taken as
a group, a certain proportion of those at each age may be expected to
die. A mortality table starts with a group of persons, as 100,000, at
a given age, as 10 years, and shows the number who die and the number
who survive at each year of age until all are dead. The table most
widely used in the United States is the American Experience Table of
Mortality, constructed by Sheppard Homans in 1868. The figures of this
table, at different years, are given below:

Age Number Living Deaths each year Death rate
per 1,000

10 100,000 749 7.49
20 92,637 723 7.80
30 84,441 720 8.43
35 81,822 732 8.95
40 78,106 765 9.79
50 69,804 962 13.78
60 57,917 1,546 26.69
70 38,569 2,391 61.99
80 14,474 2,091 144.47
90 847 385 454.54
95 3 3 1,000.00

The actual number of deaths of any group of insured will not
correspond exactly with the figures of any mortality table. But this
is not an essential defect of a table so long as the figures of the
table are approximately correct and are at least as great in the
earlier years as the actual mortality. For any excess of premium thus
collected but increases the safety of the insurance and reduces later
payments. In fact the mortality in nearly all companies in the United
States is much below the figures of the American Experience Table,
partly because of the influence of medical selection on the recently
insured and partly because of the decided improvement in longevity
since the table was constructed.

Sec. 12. #The single premium for any term.# It is evident that the
natural assessment premium payable at the beginning of the year for
$1000 of insurance for that year is expressed by the death rate, e.g.,
at age 35, the payment of $8.95 by each of the 81,822 living at the
beginning of the year will provide the $732,000 needed to pay the

In the same manner would be determined the natural assessment premium
for each year of insurance. Now, when it is possible to invest the
premiums so as to yield a minimum rate of income it is a simple matter
to determine the amount of a single premium, at any age, that is
adequate to pay for insurance covering any selected number of years
(term insurance) up to the entire period of each insured person's
life (full life). It is necessary only to apply the formula of present
worth and that of compound interest on investments.[6] Thus the
expected losses of any year according to the table of mortality,
divided by 1 + rate of yield on investments raised to the power of
years distant, equals the present worth of insuring the entire group
for that year. The sum of the discounted cost of insurance for all the
years of the term divided by the number living at the beginning of the
period, gives the single premium for each of the insured. Let P be the
present worth of all the policies for a group of the same age, p the
present worth of one policy, X the total insured at the beginning of
the period, f the natural assessment premium this year, or the natural
premium required for any year. Then

f f1 f2 fn
P = __________ + _________ + ________ + _________
(l + r) (l + r)^2 (l + r)^3 (l + r)^n

p = _________

The payment in advance of the single premium for any selected period
provides a reserve fund sufficient, on the assumptions made, to carry
all the insurance without further payments. Each year there is added
to the fund the income earned on investments, and there is subtracted
the amount of the losses for the year, until the death of the last
member of the insured group. If the deaths in the earlier years are
fewer than were expected in the mortality table, this will be offset
eventually by more deaths at the advanced years; but in the meantime a
reserve larger than was expected is yielding income, thus providing
a larger sum than is needed to pay all the policies at maturity. This
surplus might be distributed as so-called "dividends" from time to
time to those surviving, or be added pro-rata, at intervals, to the
amount of the policies as accumulated dividends.

Sec. 13. #Level annual premiums and reserves.# It is a matter of no very
abstruse mathematics (in principle) to find the equivalent of this
single premium in any one of many other forms of premium payment.
The processes are mainly but variations of present worth and compound
interest calculations. Such calculations, however, lead into many
complexities of practical detail difficult to explain in brief
compass, and are the special task of the actuary (the mathematical
expert dealing with such problems in the insurance business). The most
useful actuarial equivalent of the single premium is the level annual
premium for any period (term or life). Almost all policies now written
have the level annual premium as a feature. The amount of the level
annual premiums at first is greater than the losses; this causes for
a time the steady accumulation of a reserve which yields income. Then,
as the losses grow, they overtake and finally surpass the amount of
the annual premiums. Therefore, the total reserve for any group of
insured increases year by year to a maximum and then declines until
it reaches zero with the payment of the last claim. The individual
reserve for each policy not yet matured increases steadily the longer
it is in force. The total reserve is essential to the solvency of
the company and the payment of all the policies as they fall due. The
companies which issue policies on the level premium plan or reserve
plan are known as "old line" companies, or as "legal reserve"
companies, because the state laws require every company of this type
to maintain the reserves calculated on the basis of a certain rate
of yield. The growth of the legal reserve companies in recent times
constitutes one of the financial marvels of the age.

Sec. 14. #Different features of policies.# The premiums thus far
discussed are "net premiums" estimated as just sufficient to meet the
actual payments required by the contracts in the policies. To provide
for the expenses of management an addition is made to the net
premium called the "loading." The entire premium is called the "gross

Reserve insurance is still carried on by a few stock companies, but of
late some stock companies have been transformed into mutual companies,
which are the prevailing type. The mutual company legally belongs to
the policyholders. The gross premiums in reserve insurance are, for
the purpose of safety, fixed at a figure larger than the expected cost
of the insurance, and normally the earnings from interest are higher,
the mortality is lower, and expenses are less than those on which the
calculation of rates is based. From the excess of income resulting,
the company sets aside a surplus and then divides the rest among
the policyholders. These returns, virtually but the refund of excess
premiums, are called "dividends" (a somewhat misleading term, not
to be confused with dividends on corporate stock). The policies
that receive dividends are called "participating" and are said to
participate in the earnings. Formerly the majority of policies paid
"deferred" dividends after 5, 10, or 20 years, according to various
tontine and semi-tontine plans, the survivors to these periods
receiving their dividends plus those of the other policyholders who
had died or had withdrawn from the company. This form of payment
having been found objectionable, it was made illegal in New York and
other states, and in most cases dividends are now paid annually. The
stock company, organized for profit, frequently charges lower premiums
for "non-participating" policies, and then retains such profits as may
result from keeping expenses below receipts.

The most popular policies are term policies (usually for 5, 10, 15,
or 20 years); ordinary life policies with annual premiums; limited
payment life policies (the policy payable at death, with premiums
fully paid up after 10, 15, or 20 years); and endowment policies (the
face of the policy payable after 10, 15, or 20 years if the insured is
still living). An endowment policy must be understood to be a regular
term policy of insurance for the specified number of years, plus a
plan of regular annual savings, which at compound interest, accumulate
to the face of the policy. Many persons are attracted to endowment
insurance by the oft expressed thought that "you don't have to die to
beat it." But this is a mistaken thought. For the premium in endowment
insurance is much higher than that for life insurance alone during the
same period, so that the endowment is merely a pretty convenient but
somewhat costly plan of saving, hitched on to an insurance policy,
with which "actuarially," it has no essential connection. In "scientific"
insurance the insured pays its full actuarial cost for each additional
feature of the policy that he buys. The various policies issued by a
company are approximately equivalent actuarially, on the basis of the
assumptions made, but they are of very different degrees of desirability,
in view of the circumstances of the insuring individual. The choice of
policies deserves a more careful investigation than it usually received.
Moreover, carelessness and ignorance in the choice of a company is
responsible for widespread loss and suffering.

Policies differ in respect to the mode of payment. The payment usually
takes the form of a lump sum payment at death or at the maturity
of the endowment. In recent times there has been a growing use of
optional forms of payment which give to the beneficiary annual or
monthly installments for a definite number of years or for life.

Sec. 14. #Insurance assets and investments as savings.# The discussion of
savings institutions in the last chapter left unmentioned insurance,
which probably is destined to be the most important of all. The assets
of life insurance companies in the United States have already attained
the enormous sum of $5,000,000,000, a sum equal to the reported
savings bank deposits. In the last twenty years life insurance assets
have more than doubled in each decade, and are now increasing by about
a quarter of a billion dollars every year.[7] These great funds,
which in equity nearly all belong to the policyholders, form already
approximately one thirtieth of all the private capital of the country.
They are invested in many ways, in real estate, in loans secured
by mortgages on real estate, in bonds--municipal, railroad, and
industrial. The problem of wise legislation for these organizations,
of their competent and honest management, and of their relation to the
social, business, and political life of the nation, is certain to be
of ever-increasing importance. We are hardly more than emerging from
the experimental stage of life insurance, hardly more than at the
beginning of its development.

The premium in personal insurance (life, accident, sickness,
invalidity, old age pensions) is in almost all cases paid out of some
current income. The premium paid is just so much subtracted from the
amount available for present direct use and applied to the purchase of
future incomes for one's self or family. The insurance method differs
from the method of depositing savings by its contingent nature, the
resulting income of any individual being possibly much greater than
the amounts actually saved (e.g., when the insured dies or is injured
soon after taking insurance), and possibly less or nothing at all. A
very desirable kind of insurance which is yet little developed is
that for a term ending with the usual retirement age (say 65 years)
combined with an old-age pension for life thereafter.

It is probable that abstinence will more and more express itself not
in accumulating large capital sums to provide for one's old age or for
survivors, but in providing insurance for survivors, and invalidity
and old-age pensions for the insured and others, payable as terminable
annuities. In any case the results to be expected in the changing
forms and magnitude of private fortunes are certain to be great.

Sec. 15. #Excessive costs of insurance operation.# So beneficent is
insurance that the enormous cost of transacting the business under
present methods is much to be regretted. A very large part of the
premiums paid by the insured is retained by the companies.[8] In the
case of reserve life insurance a considerable part of what is not
returned is, however, set aside as reserve virtually held in trust for
the policyholders. In the case of the other kinds of insurance, nearly
all of the amount not returned is either cost of operation or profits,
tho it must be recognized that a part of the cost of some kinds
of insurance is for real services, such as inspection and fire
prevention. It is remarkable that the percentage returned by the life
insurance companies, accumulating, as they do, large reserves in trust
for the policyholders, is greater than it is for the other kinds of
companies (fire, marine, casualty, surety, liability, accident, and
health insurance).

It is a striking evidence of the importance of the marginal
principle[9] that insurance at such a cost should still be desired by
men. The use of insurance would be much wider and its benefits greater
if this "tare and tret" of doing the business could be reduced. It
seems a reasonable hope, now that the experimental stages are passed,
that this may be done. In the case of all kinds of insurance as yet a
large expense for agents has been necessary to educate men to see
the value of insurance and to purchase it, as well as for many other
competitive expenses. It has been found that much of this expense
can be saved by insurance in groups (for all employees in an
establishment), by compulsory insurance (as of all working men), and
by central state administration serving to regularize and unify the
organizations. This important question will be further considered in
connection with "social insurance" as a measure to benefit the working

[Footnote 1: See Vol. 1, ch. 5, sec. 7.]

[Footnote 2: The Jeffries-Johnson prize-fight was insured, against
rain, for $30,000. Frequently, race-horses, the fingers of pianists,
the lives of ball-players, and the throats of singers, are now
insured. Summer hotels in England regularly insure for large sums
against more than so many days of rain per season.]

[Footnote 3: On the former, see Vol. I, pp. 365 and 374; and on the
latter, below, sec. 14.]

[Footnote 4: See Vol. I, labor-incomes, in Index.]

[Footnote 5: There is an appearance of a slight discrepancy due to
the omission of fractions of cents. If premiums are collected at the
beginning of the year and losses are paid at the end of the year, and
if interest can be earned meantime at the rate of 3-1/2 per cent, the
natural premium for a one year term policy is about $8.64, that being
the present worth of $8.95 due a year hence, interest being 3-1/2 per
cent. In these calculations there is no allowance for expenses, the
necessary "loading," on which see below, sec. 14.]

[Footnote 6: See Vol. I, p. 279.]

[Footnote 7: The following are the chief statistical facts regarding
the life insurance business in the United States, Jan. 1, 1914,
showing separately legal reserve and assessment companies, and the total.
| Number of | Policies | Insurance
| Companies | in force | in force
| | |
Legal reserve ..| 260 | 38,206,000 | $20,256,000,000
Assessment .....| 605 | 8,789,000 | 10,023,000,000
Total ..........| 865 | 46,995,000 | 30,587,000,000
| Premium | Total | Per cent income
| income | income | from premiums
| | |
Legal reserve ..| $715,000,000 | $946,000,000 | 75.6
Assessment .....| 138,000,000 | 153,000,000 | 90.2
Total ..........| 853,000,000 |1,099,000,000 | 77.6
| Payments to| Assets | Assets for each
| policyholders| | 100 insurance
| | | in force
| | |
Legal reserve | $470,000,000 |$4,659,000,000 | $22.66
Assessment .... | 106,000,000 | 195,000,000 | 1.37
Total ....... | 576,000,000 | 4,854,000,000 | 15.87

[Footnote 8: In 1913 the total premiums collected by all kinds of
insurance companies reported (Statistical Abstract of the U.S., 1914,
pp. 549-557) were about $1,512,000,000, and the amount returned to
policy holders the same year was $918,000,000, or about 61 per cent
of all premiums, the amount not returned ($584,000,000) being 39 per

Premiums received Returned to policyholders
Amount Percent

Life insurance
reserve companies ..$715,000,000 $470,000,000 67
assessment companies 138,000,000 106,000,000 76
Other kinds ......... 659,000,000 342,000,000 52
------------- ----------- --
Total ........... $1,512,000,000 $918,000,000 61

[Footnote 9: See above, secs. 2 and 5.]





Sec. 1. Political and trade boundaries. Sec. 2. Benefits of international
trade. Sec. 3. Choice of the more advantageous occupations. Sec. 4. Persistence
of differences between nations. Sec. 5. Doctrine of comparative
advantages. Sec. 6. Equation of international exchange. Sec.7. Balance of
merchandise movements. Sec. 8. Cancellation of foreign indebtedness. Sec. 9.
Par of exchange. Sec. 10. International monetary balance and price-levels.

Sec. 1. #Political and trade boundaries.# By international trade is
meant, in general, trade between persons resident in different
countries; comparatively rare is the case in which one of the two
parties to a trade is a whole nation acting through its government
as a unit (e.g., in the purchase of munitions of war in neutral
countries). Outside of a communistic group such as the family, trade
is a necessary accompaniment of division of labor. As territorial
division of labor began between neighboring tribes,[1] international
trade was the earliest kind of regular interchange of goods. Indeed
the very word "market" meant originally the boundary between tribes.
Thus, from primitive times when wandering savages gave bits of flint
or copper in return for salt or fish, individuals have sought to
adjust their goods to their desires through trade with men of other
political groups. With the progress of the world in the means of
communication and transportation, international trade has widened in
extent and grown in volume.

Economic relations never have been coextensive with political
relations. The economic groupings of men connected by a network of
trades never have and never will correspond very nearly with political
groupings of men bound together by common citizenship in particular
states. Indeed it is not uncommon for many of the residents in two
adjoining states to trade far more with each other than they do with
their own fellow citizens. Lawmakers and rulers from the beginnings of
formal governments have constantly tried to hinder this kind of trade.
They have done this chiefly because of their belief that they could
strengthen their states in political and economic ways, and could
favor some of their citizens, by confining economic relations within
political boundaries--if not exclusively, more closely than when trade
was left to take its natural course, guided by individual motives. The
regulation of international trade, therefore, has always constituted
an economic problem of great importance in the field of political

Sec. 2. #Benefits of international trade#. Now, bearing in mind that
international trade is carried on by individual traders in any two
countries, we may ask what motive impels men to trade across the
political boundaries of a state. The simple answer is that each trader
has something to give and desires to get something in return. Each
is seeking to get something that has to him a greater value than the
thing he gives, and believes he can do this in trade with a foreigner
better than by trading at home. In any trade, both parties gain, or
think they are gaining.[2] In international trade there is the same
chance for mistake as in domestic trade, but no more. In a single
transaction in either domestic or foreign trade one party may be
cheated, but the continuance of trade relations is dependent upon
continued benefits. The once generally accepted maxim that the gain
of one in trade is the loss of another is now generally rejected,
but often still it is assumed to be true of international trade.
The starting point for the consideration of this subject is in
this proposition: Foreign trade is carried on by individuals, for
individual gain, with the same motives and for the same benefits as
are found in other trade.

The advantages of international trade are indeed but those of division
of labor in general, in the particular case where it happens to cross
political boundaries. The great territorial divisions of industry are
determined first and mainly by natural differences of climate, soil,
and material resources. Thus trade arises easily between North and
South, between warm and frigid climates, between new countries and
old, between regions sparsely and regions densely populated.[3]

Territorial divisions of industry are determined secondly by social
and economic differences such as those with respect to accumulation
of wealth, amount of loanable capital, invention, organization and
intelligence of the workers, and the grade of civilization.

Foreign trade normally imparts increased efficiency to the productive
forces of each country. In most cases it is apparent that labor is
more effective and gets a larger product when it is applied in those
ways for which the country is best fitted and for which it offers the
best and most bountiful materials; and that, further, when special
branches of industry have developed at one place, they make possible
the advantages of large production and of high specialization.

Certain erroneous explanations of the advantages of foreign trade may
be dismissed with brief mention. It is said to give vent for surplus
production and to give a wider market to what would otherwise go to
waste. This involves the same fallacy as the "lump of labor notion,"
the destruction of machinery, and the praise of waste and luxury.[4]
If it were true that sale to backward nations were now necessary
to give an outlet for products which would otherwise rot in the
warehouses, a time would come at length when the world would have
an enormous surplus unless neighboring planets could be successively
annexed. Again it is said that the great purpose of foreign trade is
to keep exports in excess of imports so that the money of the country
may constantly increase in amount. The ideal of such theorists is an
impossible condition where the country would constantly sell and never
buy.[5] In the narrow commercial view of the subject the sole object
of foreign trade is to afford a profit to the merchants, regardless of
the welfare of the mass of the citizens.

Sec. 3. #Choice of the more advantageous occupations#. Let us consider
the cases of two countries somewhat differently situated, such as an
old country like England and a newer country such as was the United
States in the nineteenth century. Now the relative advantages of
various industries in two such countries are very unlike. The newer
country excels in its broad area, its abundant rich lands, its
bountiful natural resources of forests and mines. These are the
superior opportunities which give the economic motives for settlement
and for continued immigration from the other lands. Most of the
newcomers find it to their advantage to develop the peculiar
opportunities of the new land, rather than to go on producing the same
things in the same way as they did in the old country.[6] Thus they
get a larger quantity of products per day's labor, and are able to
gain by trading a part of these for the products of the older country.
Thus the characteristic industries of the two countries must differ.
Without any government supervision, therefore, but simply through the
choice of enterprises, each seeking the best investment of capital for
himself, industries are developed in which each country is either
most markedly superior, or least inferior, to its neighbors. If
either laborers or capitalists in the new country were to turn to
the less-favored industries they would be forced to accept a smaller
reward than they can earn in the more favored.

Sec. 4. #Persistence of difference between nations#. If both men and
wealth interchanged between industries and between countries with
perfect readiness and without any outlay whatever for transportation,
these differences would soon disappear, and perfect equilibrium
of advantage would everywhere result. In every country, in every
occupation, labor and wealth of given quality and amount would receive
the same reward. But the interchange of labor and of products between
countries is never without friction.

The laborers, enterprisers, and investors in a naturally rich country
are thus in a position of more or less enduring advantage relative to
those of older and poorer countries. Differences of the same nature
appear as between different parts of the same country, as between the
Northern and the Southern states of the American union, between the
Eastern and the Western states, and even between neighboring countries
of the same state. The differences between two countries, however, are
likely to be more marked, the circulation of factors being so active
within a country that it is allowable to speak broadly of prevailing
national rates of wages and of interest. Altho, as Adam Smith said, "a
man is of all sorts of luggage the most difficult to be transported,"
the higher wages in a new country attract constantly from the older
lands a portion of their laborers. The higher rate of interest in new
countries constantly attracts investments from abroad; yet, despite
these forces working toward equalization, the inequality may remain
and, through the working of other influences, may even increase in the
course of years.

Sec. 5. #Doctrine of comparative advantages.# It may be that two
countries both possess the necessary technical conditions for making
both articles that are to be traded for each other. It may even be
that the people in one country would be able to make not only one of
the two objects of trade, but both of them, more easily and with less
sacrifice and effort than the people in the other. If, for example,
American labor can produce two bushels of wheat in a day and English
labor but one bushel a day; and American labor can produce just as
much iron in a day as English labor--or more--the question always
arises: Is it not foolish and wasteful not to produce both the wheat
and the iron?

Now, exactly the same case is presented in almost every simple
neighborhood trade. The proprietor may be able to keep his books
better than does the bookkeeper whom he employs. The merchant may be
able to sweep out the store better than the cheap boy does it. The
carpenter may be able to raise better vegetables than can the gardener
from whom he purchases. Yet the merchant does not turn to sweeping and
the carpenter to raising vegetables, because if they did they would
have to quit or limit by so much their present better-paying work, and
would lose far more than they would gain.

So whenever the people in one country have a greater advantage in one
article than in another, relative to another country, the foreigners,
like the low-paid man, will be willing to exchange at a ratio that
will make it profitable to specialize in the product wherein the
greater superiority lies.[7]

But this is always hard doctrine for the popular mind, and
particularly for the commercial mind endeavoring to carry on a
business that can not be made "to pay" in the face of foreign
competition. It is easy to believe that a country ought not to import
goods unless it is at an _absolute_ disadvantage in their production.
It is often declared that as our country can produce any kind of goods
"as well" as foreign countries (meaning with as few days' labor),
there is a loss on every unit imported. The fundamental principle of
trade as applied to such cases shows that not the advantage which
one country enjoys over the other as to a single product determines
whether it will gain by producing at home, but the comparative
advantages enjoyed in the production of the two articles in question.

As a simple example, suppose that a day's labor in country A will
secure two bushels of wheat (2x) and two hundred pounds of iron (2y),
whereas in B a day's labor will secure 1x or 2y. Then A's comparative
advantage in producing x becomes a reason for A's not trying to
produce y. Trade can take place (aside from transportation outlay)
at any ratio between 2x = 2x (A's minimum) and 2x = 4y (B's maximum).
Evidently at any rate between these two ratios each party would gain
something by the trade, e.g., at 2x = 3y A would get 3 instead of 2y
by a day's labor, and B would get 1-1/3x instead of 1x for a day's
labor (2x for 1-1/2 day's labor instead of for two days'). If,
however, A could produce exactly twice as much of everything as B
could, then there could be no motive on either side for trade. But
this never happens.

Sec. 6. #Equation of international exchange.# Foreign trade of course
can take place as barter, and in earlier times, particularly, very
commonly did so. But in the existing monetary economy nearly all
trades are expressed in terms of monetary prices. Both the prices
of all the particular objects of international trade and the general
levels of prices in any two trading countries come to be pretty
definitely interrelated. Changes in the one country at once compel
readjustments in the other. To understand in the most general way
how this occurs, a knowledge at least of the elementary principles of
foreign exchange is required, and to this we may now turn.

Let us begin with the proposition known as the equation of
international exchange, which is sometimes given thus: the value of
the imports of a country must in the long run equal the value of
the exports. But this proposition (especially the words imports and
exports) must be understood in a much broader sense than that of
the movements of merchandise merely. The proposition might better be
expressed: the total credits of a nation (including money actually
sent abroad) must just equal its total debits (including money
imported). Into the balance of accounts between any two nations enter
many items: the cash values of the imports and exports of merchandise;
freights, insurance premiums, and commissions; the expenses of
citizens while traveling abroad; money brought in or taken out by
immigrants; the cost of the governmental foreign services (such as the
salaries of consuls and of diplomatic representatives); subsidies
and war indemnities received from or paid to foreign nations; the
investments of foreign capital; and credit items of many kinds, on
both sides of the account.

The effect of loans upon the equation differs at different periods
according as they are just being made, are continuing, or are being
repaid. When foreign capital is first invested in a country, whether
it is loaned to the government or to individuals or to corporations,
either gold must be remitted to the borrowing country or goods be
sent. But later the interest payments and the eventual repayment of
the principal of the loan act in the opposite direction. Accruing
interest must be offset annually by exports from the debtor country
and the repayment of the principal requires that either money or goods
be exported equal in value to the original obligations. In popular
opinion an excess of exports of merchandise is an index, if not the
real cause, of national prosperity; but evidently it is no true index
whatever on this point. An excess of exports may at any given moment
indicate that the country is rich and is lending abroad, or that it is
in debt and is paying interest, or that it is repaying the principal.
On the other hand, an excess of imports may indicate either that a
country is poor, and is borrowing from abroad, or that it is rich,
with many foreign investments, and is receiving the income from them
in the form of a regular shipment of goods from the debtors.

The following statistics of the foreign commerce (merchandise imports
and exports) of the principal countries of the world are given in
significant groupings which call for various explanations.

Figures are in million dollars ($1,000,000) and are mostly for the
year 1908, (Stat. Abst. 1908, p. 769). At the present writing the war
has altered all the lines of commerce.


|Excess %|Imports.|Exports.|
United Kingdom ..| 57 | 2886 | 1835 |
Germany ..........| 20 | 1824 | 1523 |
Netherlands ......| 30 | 1130 | 873 |
France ...... | 12 | 1089 | 975 |
Belgium ..........| 33 | 642 | 484 |

Italy ............| 68 | 562 | 334 |
Aust.-Hung .......| 7 | 487 | 457 |
Switzerland ......| 44 | 287 | 200 |
Spain ............| 10 | 168 | 153 |
Sweden ...........| 26 | 163 | 129 |
Denmark ..........| 16 | 191 | 165 |
Norway ...........| 58 | 101 | 64 |

Canada ...........| 34 | 298 | 222 |
China ............| 43 | 254 | 178 |
Turkey ...........| 59 | 135 | 85 |


|Imports.|Exports.|Excess %|
United States ....| 1312 | 1638 | 25 |
Russia ...........| 436 | 542 | 24 |

British Colonies .| 558 | 615 | 5 |
British India ....| 418 | 486 | 16 |
Australasia ......| 242 | 302 | 25 |
Japan ............| 196 | 206 | 5 |
Cuba .............| 84 | 116 | 40 |
Mexico ...........| 78 | 115 | 42 |
San Domingo ......| 5 | 10 | 100 |

Argentina ........| 263 | 353 | 34 |
Brazil ...........| 172 | 214 | 24 |
Chile ............| 98 | 116 | 18 |
Uruguay ..........| 35 | 37 | 6 |
Bolivia ..........| 21 | 24 | 14 |
Venezuela .... | 10 | 15 | 50 |

#Sec. 7. Balance of merchandise movements.# The first group evidently
consists of the older, creditor countries which are drawing some of
the income of their investments from abroad each year in the form of
food and of raw materials of many kinds. The second group includes
countries of very diverse conditions, possibly all having some
investments abroad; Italy receives large imports in return for the
services of many Italians working in foreign countries, and the three
Scandinavian countries (especially Norway) carry on a large commerce
for other nations which is paid for in these ways. The excess of
imports in the third group probably is the result of new investments
that were being made in Canada by English and American capitalists, in
Turkey especially by Germans, and in China by Americans and Europeans.

The countries in the second column are doubtless on the whole debtors,
but in varying degrees. The excess exports of some are insufficient
even to pay all the current interest, and they are borrowing still
more (possibly the British colonies, Japan and several South American
countries); others have ceased to borrow and are simply paying
interest; whereas the United States at least with its excess of
exports was at this time both paying interest and getting out of debt.
With the outbreak of the war in 1914 the United States began rapidly
buying up its foreign-held securities, and events are fast making it
a creditor nation. Its imports must therefore in future more nearly
equal if not exceed its exports, the actual outcome being dependent
as well on various other items in the balance as on those here

Sec. 8. #Cancelation of foreign indebtedness.# In the international
business of any two important countries to-day, such as England and
America, the number of credit and debit transactions is enormous. If
each trader had to attend to the forwarding of the means of payment
for his purchases he would, of course, deduct from the amount of his
indebtedness the amount due him from his foreign correspondent, and
might from time to time "remit" the balance in the form of a shipment
of gold. This simple offsetting and cancelation of debits and credits
would greatly limit the amount of gold that would have to be shipped.
But still, under such conditions, there must be a very large number of
shipments of gold by different individuals, and a large proportion
of these shipments would be going in opposite directions at the same
time. Now a merchant in New York called M may have a balance to pay in
London to X and at the same time a merchant in London called Y have a
balance to pay in New York to a man called N. If M can buy from N his
claim in the form of an order, draft, or bill of exchange, and send it
to X, the latter may through his bank collect the sum from Y. In this
way a further cancelation of indebtedness would occur.

When all persons having either debits or credits to be paid in New
York and in London, respectively, are dealing with the banks in these
cities, and the banks and special exchange brokers are constantly
buying and selling these bills, a market is created for London
exchange in New York (and conversely in London), and a much easier and
more nearly complete cancelation of indebtedness results. In effect,
all the debits and credits between the two countries are merged into
one big ledger balance, and the international shipment of gold bullion
finally made is just the amount needed to balance the accounts payable
at the time. Industrial indebtedness is represented in various forms:
bills of lading for goods shipped, drafts made by the creditor on his
debtor for goods shipped or property sold, checks or letters of credit
for travelers, bonds and notes public and private. These are the
objects dealt in by the bankers who are the agents to carry on the
work of exchange.

The balance of foreign exchanges is of essentially the same nature as
the domestic cancelation of indebtedness. It is going on constantly
between the two merchants in the same town, between two banks in
the same town who represent groups of merchants, between men in
neighboring towns, and between distant states like New York and
California.[8] The price of exchange to the individual is reduced
by the specializing of the business in the hands of a few dealers,
permitting the cancelation of indebtedness or offsetting of exchange,
and greatly reducing the amount of bullion to be transported in making
the payments. The cost to the bank of providing this exchange for its
customers varies as conditions change, but in any case is not great,
so that in domestic business when any charge is made it is usually at
a fixed rate, and is mainly for the service.

Sec. 9. #Par of exchange.# Foreign exchange from America to Europe is,
however, in two features different from domestic exchange: (a) the
cost of shipment of gold is greater; (b) the monetary units of the two
countries usually differ in name, weight, and fineness, and sometimes
in materials. We may define foreign exchange as the purchase and
sale of the right to receive a given kind and weight of metal or its
monetary equivalent in current funds at a specified time and place.
_Par of exchange_ between two countries using the same metal as
a standard is the number of units of the standard coin of the one
country that contains the same amount of fine metal as the standard
coin of the other country. There is no fixed par of exchange between
gold-using and silver-using countries: par of exchange between them
fluctuates with changes in the comparative values of the two metals.
The _gold shipping points_ for importing or exporting gold are
respectively par of exchange plus or minus the cost of moving the
actual metal. These points vary with means of transportation and
communication. The par of exchange between New York and London being
nearly $4.866 and the cost of expressing and insuring a gold pound
between New York and London being approximately $.02,[9] the shipping
point for the export of gold from New York is $4.886 and for the
import of gold to New York is $4.846. At these upper and lower limits,
there is a motive for shipping gold as a commodity.

When large sales have been made to Europe and credits are accumulating
in New York and the importation of gold is imminent or already begun,
the claims are bought by bankers in New York at less than par. At such
a time one needing to remit a sum to London can buy exchange for less
than par, for every such draft remitted reduces London's indebtedness
and, by so much, the need of shipping gold to this country. As a
rule then, accumulating credits here mean a low rate of exchange,
accumulating debits a high rate of exchange from this to the foreign

These are the merest rudiments of the subject. The many problems
arising, such as the adjustment of foreign credits to changing needs,
and such as arbitrage (the readjustment of the rates of exchange
prevailing among different financial centers) make foreign exchange
both a complex science and a difficult art.

Sec. 10. #International monetary balance and price-levels.# The balance
of all accounts for or against a country (including new loans, current
interest, and repayments) must thus eventually be settled in money.
This cannot fail to affect the general level of prices in both
countries, tho this is brought about often only in indirect and
gradual ways. The flow of money out of a country causes the loan
market of a country to tighten (interest and discount rates to rise)
in proportion as the reserves of the banks are reduced. Then "general
prices" begin to fall.[10] When prices fall, imports decline, as the
country is not so good a place in which to sell: when prices rise,
imports increase, as it is a better place in which to sell. The
opposite effect is produced on exports, and thus in a short time the
national credits and debits are again brought into equilibrium. A
slight movement of money in either direction is enough to influence
prices and set in motion forces to counteract a further flow of
money. Decade after decade the circulating medium of leading countries
changes very slightly in amount, and the fluctuations in its amounts
during periods of so-called "favorable balance of trade" and of
"unfavorable balance of trade" are only the smallest fraction of the
value of goods passing through the ports of the country.

It is therefore absurd to imagine, as is sometimes done, that a
country could, by continually importing goods, be drained of all its
money, or that by any possible set of devices it could forever have an
excess of exports to be paid for by a continual inflow of gold.
Long before either of such movements could go far, the automatic
readjustment of prices would inevitably check it, and secure and
retain for each country its due portion of the money.

[Footnote 1: See Vol. I, ch. 17, sec. 10.]

[Footnote 2: See Vol. I, ch. 5, secs. 1 and 7.]

[Footnote 3: See Vol. I, ch. 6, sec. 11, on the origin of markets.]

[Footnote 4: See Vol. I, chs. 36 and 37.]

[Footnote 5: Recall ch. 4, in general, on the nature of monetary

[Footnote 6: See Vol. 1 for numerous statements of the effects of
varying quantities of agents upon the economy of utilization; e.g.,
pp. 138, 163, 164, 213, 228, and chs. 34 and 35 entire.]

[Footnote 7: This theory has usually been presented under the name
of "the doctrine of comparative costs." The word "costs" is very
misleading in this connection because it is now always applied to
enterpriser's outlay. It seems best, therefore, to replace it in this
phrase by the word "advantages." Of course, it _never_ can be true
that an article can be "profitably" imported when its monetary costs
(all things considered) are higher in the exporting than in the
importing country. Indeed, the importation of any article is proof
conclusive that the importer thinks that the monetary costs of
an article would be higher in the importing than in the exporting
country. See further, ch. 15, secs. 11 and 13 (note).]

[Footnote 8: See ch. 7, sec. 7.]

[Footnote 9: This varies also with conditions; after the outbreak of
the war in 1914 it was for a time as high as $.05 because of high war
rates of insurance.]

[Footnote 10: The connection between a high rate of interest and
falling price is a dynamic phenomenon of a very temporary nature.
In long-time static conditions the general level of prices and the
prevailing rate of interest are dependent on entirely different sets
of forces. See on the theory of interest, Vol. I, p. 308. In long-time
movements of prices, in contrast with brief changes due to foreign
trade such as are referred to above, high rates of interest are
connected with rising prices, and _vice versa._ See above, ch. 6, sec.
8, on fluctuating price-levels and the interest rate.]



Sec. 1. Military and political motives for interference with trade. Sec. 2.
Revenue and protective tariffs. Sec. 3. Growth of a protective system.
Sec. 4. The infant-industry argument. Sec. 5. The home-market argument.
Sec. 6. The "two-profits" argument. Sec. 7. The balance-of-trade argument.
Sec. 8. The claim that protection raises wages. Sec. 9. Tariffs and
unemployment. Sec. 10. Exports and exhaustion of the soil. Sec. 11. Protection
as a monopoly measure. Sec. 12. Harm of sudden tariff reductions.

Sec. 1. #Military and political motives for interference with trade.#
The considerations set forth in the last chapter raise a strong
presumption in favor of the sovereign state permitting its citizens to
trade freely across its boundaries, as the best way to further their
own prosperity and, on the whole and in the long run, that of the
nation. Indeed, this presumption and belief has been held by
nearly all serious students of the question, with more or less of
modifications and qualifications, ever since Adam Smith published his
work on the "Wealth of Nations" in 1776.[1] But in conflict with this
belief has been the all but unanimous policy of nations from
early times, throughout the Middle Ages, and down to this day, of
interposing some special hindrances (of varying degrees and kinds) to
this kind of trade. Sometimes this has been done by prohibitions, but
more often by taxes imposed upon either imports or exports. Sometimes
the attempt is made to justify the policy of governmental interference
with foreign trade by arguments which crumble before the slightest
examination, and again it is admitted that free trade is true in
theory, but it is declared to be false in practice. The latter view
is not to be entertained for a moment. If free trade in theory (as an
explanation) is complete and true, it will in practice (as a plan of
action) be sound and workable. In truth, however, the practical policy
of governmental interference with foreign trade has always in part
rested on other than the simple economic grounds.

Interference with free trade with the foreigner has always been in
large measure due to political motives. In every petty medieval state
or self-governing city, the aim was to make the economic boundaries
coincide as nearly as possible with the political boundaries. Except
for the trade in a few articles of comparative luxury this aim was
at that time nearly attainable. The peasantry surrounding a fortified
town and enjoying its protection were compelled to trade there. Down
to our own time it has seemed to statesmen expedient to forbid or
discourage trade that might nourish the economic power of future
enemies. Sometimes governments have used embargoes, bounties, or
tariffs as weapons to injure the trade of other nations and to secure
diplomatic or commercial concessions. Often they have sought by
tariffs to encourage the building of ships and the manufacture of
armaments and of all kinds of munitions by private enterprise within
their own borders, even when the immediate cost of these products was
greater than if they were purchased abroad. In such cases it is
always a question whether an outright expenditure would not be better,
whether the government could not build its own arsenals and shipyards
more economically than it can foster private enterprise by means of a
protective tariff. However, the political (or military) argument for
protection recognizes that it is in itself a costly (not a profitable)
policy, and that the cost is only justified on the grounds that
military necessity warrants the outlay.

The military argument as applied to the preparation of ships and
munitions has no application to a tariff on those articles which have
no bearing upon military power. But the most recent application of
science and the mechanical arts to the uses of war has given new
significance to a larger policy of industrial preparedness for
military purposes. The year 1914 doubtless ushered in for the world
a new epoch of protective and discriminatory tariff legislation
determined by political rather than by direct economic considerations.

Sec. 2. #Revenue and protective tariffs.# An important distinction in
principle is to be made between a tariff for revenue and a tariff
for protection. A _revenue tariff_ is a schedule of duties on goods
entering or leaving a country, so arranged that the collection of
taxes causes the least possible disturbance to domestic industry.
Speaking generally, the duties may be on either imports or exports;
but, as export duties are unconstitutional in the United States, our
tariff discussions are concerned only with import duties. The most
completely revenue-yielding tariff is one touching only articles
which, even at the higher prices are not in the least to be produced
profitably in the home country. A _protective tariff_ is a schedule of
import duties so arranged as to give appreciably higher prices to some
domestic enterprises than they could obtain with free trade. It shuts
out some foreign goods which would otherwise enter, an in so far it
"protects" the domestic producer from the foreign competitors who
would sell at lower prices than those at which he can or will sell.
In other words, "protection" means governmental interference with the
freedom of trade.

The distinction between revenue and protective tariffs, thus clear in
principle, is not always easy to make in practice. It does not lie in
the intention of the taxing power, but in the actual effects produced.
Most tariffs combine the characteristics both of revenue and of
protective measures. A tariff that reduces imports but does not
cut them off entirely may be called either a revenue tariff with
incidental protection or a protective tariff with incidental revenue.
The difference is one of degree. But notice particularly that the two
features of protection and of revenue are mutually exclusive. To the
extent that one is present the other is impossible. A tariff rate
that in whole or in part excludes the foreign article to that
extent affords "protection" but does not yield revenue. Whenever the
government collects a cent of tariff taxes, the domestic producer in
so far and as respects that unit of goods is unprotected. Likewise,
whenever any domestic producer enjoys "protection" in respect to any
unit of goods, importation is in so far prohibited and the government
is deprived of any revenue whatever derived from the production and
sale of that unit of goods.

Sec. 3. #Growth of a protective system.# The protective policy developed
at first accidentally, as it were, out of the practice of levying
taxes for revenue only. Tolls, dues (or duties), customs (that is, in
former times the customary dues paid by merchants, now the dues fixed
by law), tariffs (that is, schedules or lists of rates of duties) were
at first intended to raise revenues for the sovereign, the city, or
the state. The unintended, and to some degree inevitable, result of
the taxation of goods in commerce, whether imports or exports, is
to prevent and discourage trade and to raise the prices of the goods
imported. Any change in tariff duties, therefore, at once alters
the previously existing adjustment of profits and of industries in a

The first effect of the tariff is the same as that of any new factor
in enterpriser's cost; the same, for example, as that of a new
domestic tax on an article or as that of a rise of freight rates--the
domestic price of the taxed article tends to rise. Other results then
follow. If the article cannot, even at the higher price, be produced
within the country (as in the cases of oranges, spices, and coffee
in England, Norway, and Sweden), its consumption is reduced. The
lessening of demand may, however, depress somewhat the price in
the producing country. But as such a tariff does not increase home
production of the taxed article, it is therefore for revenue, not for

But if the article can be profitably produced in the importing
country at the new price, "home industries" will start. Where the
transportation charges are low, as on the coasts and on the main lines
of railways, some imported goods may be bought, while farther inland
where transportation charges are higher home production of some or all
grades of such goods may take place. If the whole demand at home is
supplied and all imports stop, therewith cease all revenues to
the government from that source. A completely protective tariff is
completely prohibitive.

Experience abundantly shows that, with a few exceptions, due to
climate and natural resources, it is impossible to put into effect the
most moderate schedule of duties without the increase in price at once
causing some men to shift their occupations, and to begin producing
articles of the kinds that have risen in price. At once appears a
group of "protected industries," the owners of which are dependent for
the safety and profits of their investments, and the workmen in which
are dependent for the security of their present jobs (possibly for
the chance to continue the pursuit of highly skilled trades) on the
continuance, if not the increase, of the existing tariff rates. A
tariff may be adopted mainly from stress of financial need (as in our
own history in 1789 or in 1861), but its modification or repeal cannot
be decided by fiscal considerations. The "incidental protection" it
affords has created a wealthy and influential group of employers and a
large body of employees who are irresistibly tempted to exercise their
influence in politics almost solely in favor of continuing and of
increasing the rates to the sacrifice of the higher civic life of
their communities. Of course the beneficiaries of the tariff usually
believe sincerely that it is indispensable for the prosperity of the
country as a whole, and they can do much to persuade others to
the same opinion. This commercial motive for maintaining existing
protective tariffs explains in large part their wide prevalence,
whatever other reasons may be adduced in their justification.

Sec. 4. #The infant-industry argument.# Most free-trade writers concede a
limited validity to the claim that protection may be used to encourage
infant industries and thus diversify the industries of the country. If
the natural resources of a land are adapted to an industry, it may be
called into being earlier by a fostering protective tariff. This is
merely anticipating and hastening the natural order of progress. In
the American colonies the manufactures of such goods as iron, cloth,
hats, ships, and furniture sprang up and continued not only without
"protection," but despite numerous harassing trade restrictions made
in the interest of English merchants. Can it be doubted that many
of these industries would have developed and flourished after the
adoption of the Constitution with no other favoring influences than
those of rich resources and of economy in freights? In the Mississippi
Valley since 1880 natural gas, abundant coal, ore, and timber have
made possible a great growth of industries without protection against
the Eastern states. Industries capable of eventual self-support must
in most cases naturally appear in due time. Economic forces will bring
them out. The protective system has often been likened to a hothouse,
anticipating the season by a few weeks and at great cost. The question
is whether the mere possession of the hothouse is a luxury worth the
price, if meantime the products can be got more cheaply by trade.
English manufactures flourished in the nineteenth century because they
were well established, had excellent coal supplies, great stores of
iron ore, and low-paid labor which did not have the opportunity of
better alternatives, as did the American workman. If America had
imported more (it would not have been all) of her iron and coal, the
English mines would have begun to shown signs of exhaustion earlier,
and America's advantage surely would have asserted itself in time. Her
iron manufactures undoubtedly were hastened--they cannot truly be said
to have been created--by the protective tariff.

The peculiar advantages of a new country attract labor and
enterprise into a few lines. Industries are forced into an earlier
diversification by tariffs. Which is the better economic situation?
Contrast Iowa, Dakota, and Minnesota, or Kansas, if you please, with
New York and Pennsylvania. Is it so certain that a dense population
congested in cities and crowded in factories and mines is a more ideal
social aggregation than is a community of prosperous farmers? The
smoky industrialism fostered by protection often puts a premium on a
low grade of immigrants, crowds then into city slums and into forlorn
mill towns, and keeps them aliens to the American spirit. It would be
surprising if Americanism on the Western plains were not as sound
as in the crowded cities. But the infant-industry argument appeals
strongly to the enterprise and the speculative spirit of Americans,
who like to do all things rapidly and on a large scale. Every village
aspires to be a great industrial center. Americans are impatient of
the suggestion that things "will come in time"; they like things to
come at once.

It must, however, be recognized that in a new country there is often
a certain monotony and poverty of life because of the lack of
diversified industries. There are not sufficiently varied avenues for
the expression and use of the manifold talents of the nation. There
are unused materials and opportunities, but the initial expense of
experimentation, the initial difficulties of gathering and training a
working force, are discouraging to individual enterprise, prices being
as they are. A protective tariff is not necessarily and always the
best way, but it is one way of helping private enterprise to establish
and conduct such industries through their initial period. But as has
been pointed out by many writers, the infant-industry argument is
self-limiting, and involves always the assumption that the industries
selected as fit for protection are such as ultimately, and within a
moderately short period, can grow into self-dependence. The infant
must sometime grow to be a man and stand on his own legs, or he is
either a chronic invalid or a degenerate.

#Sec. 5. The home-market argument.# The home-market argument seeks to
show a more permanent need for a tariff. At the same time it appeals
to the farmers, whom it has been hard to reconcile to a policy which
in America[2] has been peculiarly favorable to manufacturers. The
home-market argument extols the advantages of having near to the
farms customers for agricultural products, and dwells on the greater
steadiness of domestic trade. War or political changes, it is said,
may change the demand for products. This is true, but no other changes
have affected American agriculture so radically as the peaceful
development of domestic transportation and the opening of the West.

The main economic claim made in the home-market argument is that the
shipping of food to Europe and the importing of manufactures involve
a great cost for double freights which could be saved by manufacturing
at home. The farmer is supposed to pay this cost. The obvious defects
in this view are: first, there is nothing to show that the freight is
not partly or entirely paid by the European, either the manufacturer
or the food consumer; secondly, home trade "saves the freights" for
the farmer only in case he can buy goods under a tariff with less
of his own labor and products than under free trade. The payment of
freight charges is true economy when the goods can be bought at a
distance on more favorable terms than near home. The freight argument
attempts to prove too much for it condemns every trade within the
country, of goods produced a stone's throw away from the consumer.

The home-market appeal is strongest when addressed not to all farmers,
but to one class of farmers, those whose lands are situated nearer the
manufacturing cities. As city population grows, some land is converted
from the extensive cultivation of corn and wheat to dairying, fruit-
and market-gardening in the neighborhood of cities, and perhaps at
length is used for factory sites or as city lots. There is, thus, a
partial validity in the argument as applied to a comparatively small
number of farmers, who gain as landlords, not as tillers of the soil.
Even greater gains have sometimes been reaped by the owners of timber
lands, ore mines, coal lands, and other natural resources, the values
of which have been raised by tariff legislation. But unless these
gains come from truly productive additions due to the tariff, there is
no benefit to the community as a whole.

#Sec. 6. The "two-profits" argument.# Somewhat related to this idea of
the saving of two freights is the "two-profits" argument. It is said
that the tariff keeps "two profits" at home, foreign trade gives but
one. The word "profits" is here used in the popular sense of gain from
a single transaction. Both parties are said to profit and both profits
are thought to be secured at home when two citizens are forced to
trade with each other. The view that there are "two profits" in a
trade is an advance upon the notion that "one man's gain is another's
loss,"[3] but there is an error in elementary arithmetic here, both as
to the number and as to the aggregate amount of profits. The purpose
of a protective tariff is to compel two of the citizens of a country
to trade with each other instead of trading with two citizens of a
foreign state; the number of profits made by each country is therefore
not increased by substituting domestic for foreign trade.

What, then, as to individual size and aggregate amount of the profits?
The gain is not the same in all trades; the trade is made if there
is a gain to each party, no matter how small it is; but the generous
"profit" on one transaction where the conditions of the two parties
are very different may be greater than the total of petty gains on a
dozen trades between two traders of evenly matched powers. Indeed,
the greater the difference in the conditions and the capacities of two
groups of traders, the greater is the sum of the profits which they
may secure through the members of each group trading with those of
the other, rather than by the members of each group trading only among
themselves. Can it safely be assumed that every trade with a foreigner
is less advantageous than one with a fellow-citizen? Diamond cuts
diamond, but two Yankees left to themselves surely should not be
worsted in bargains with the universe. If they could exchange to
better advantage with each other they probably would discover it as
soon as the interested manufacturers and political orators who can
prove so eloquently that they know the other man's business better
than he knows it himself. Forcing the home trade by making our
citizens trade with each other whether both wish to or not may be
to the advantage of one citizen, but it is not likely to be to the
advantage of both citizens.

Sec. 7. #The balance-of-trade argument.# At the foundation of nearly
all belief in the virtues of a protective tariff will be found the
"favorable balance-of-trade" notion. The ideal of the more thorogoing
upholders of a protective policy is to keep merchandise consistently
flowing out of the country, and to have nothing come in--in any case,
nothing that by any fair amount of effort (whatever that be) could be
produced at home. This is called maintaining a "favorable balance of
trade." Sometimes the emphasis is more on the advantages of an excess
of exports of goods, sometimes more on the importance of the need "to
keep money at home." The simple error in these opinions is clearly
apparent in the explanation of foreign exchanges and of the principles
regulating the international flow of money.[4]

An interesting commentary on the opinion before us is the fact already
noted[5] that an excess of exports is the usual situation in poor
debtor countries having constant interest payments to meet; while, on
the contrary, rich creditor countries have an excess of merchandise

The "favorable balance-of-trade" argument, with the emphasis on money
rather than on goods, is that the protective tariff keeps money at
home which, if trade is free, will be sent abroad to buy foreign
goods, thus impoverishing the country. This doctrine as presented
in the seventeenth and eighteenth centuries in Europe, was known as
_mercantilism_. It had great influence upon the commercial policies
of all the great European nations. A superficial glance at the trade
relations of an old, rich country with a new province seems to give
evidence for such a belief. A richer country that is lending capital
(sent to the debtor country in the form of goods) has at the same time
a larger supply of money. The lack of money and the poverty of the
newer country are looked upon by the protectionist as due to the
importation of goods. The common cause of the imports to newly settled
districts and of their scanty stocks of money, it need hardly be
repeated here, is the comparative poverty of settlers and pioneers.[6]
Often these are paying for imports by means of loans, and in any case
their monetary stocks are not decreased either by their foreign trade
or by their domestic trade with the older and richer parts of the same
country. Europe and the United States, in their trade with China and
South America, usually do not get gold in exchange, but merchandise
of various sorts. It is true that in the trade of England and New York
with great gold-producing districts, such as California, South Africa,
and Alaska, gold is received in return for merchandise, for much of
the gold in gold-producing districts is merely merchandise, and its
export does not drain them of their due portion of money. There was
a time when the states of Kansas, Nebraska, Iowa, and their neighbors
were filled with resentment against the money-lenders of the Eastern
states. There was a widespread belief that hard times were due to an
insufficient currency.[7]

Attempted action took the form of the greenback and free silver
movements, which were defeated by the opposition of the East, but
there can be little doubt that if the Federal Constitution had
not forbidden it, the discontented states would have established a
protective tariff "to keep their money at home." Few advocates of
protective tariffs are ready to admit that the money stock of the
country is dependent on the general wealth of the country and on the
methods of doing business, rather than on a protective tariff.

Sec. 8. #The claim that protection raises wages.# The most effective
popular claim made for protection is that it raises, or maintains, the
general scale of wages in the country. This argument takes two forms:
first, when wages are low in a country it is claimed that a tariff is
needed to raise them; and, secondly, when wages are high it is argued
that a tariff alone can preserve them. In Germany the fear is of the
higher paid and more efficient labor of England. In America, where
general wages at all times have been higher than in England, it was
first argued (in the time of Henry Clay) that because of the greater
cost of production, due to high wages, the tariff was needed to start
certain industries; but after the tariff had long been established
and the old argument had been forgotten (ever since 1865), it has
been urged that the tariff, being the cause of high wages, must
be maintained to protect against the "pauper" labor of the older
countries. The higher wages in new countries where a tariff exists are
always claimed to be the fruits of a protective policy. The true
cause of the high general scale of wages in America is the greater
efficiency of industry under existing conditions.[8] Labor is
surrounded here with advantages in the forms of rich natural resources
and of mechanical appliances such as never before were combined.
Because of the scarcity of workers in particular protected industries,
wages may be temporarily higher in them than in some other industries;
but such workers form a small fraction of the population, and it is
impossible to show that the general scale of wages in all occupations
is raised by the tariff protecting this fraction.

There is, of course, no question that every tariff change affects
certain enterprises and classes of workmen. Enterprisers already
acquainted with and engaged in a business always may hope to gain by
the higher prices immediately following a rise in the tariff rates
on their particular products. Though they are granted no enduring
monopoly by the protection, they for a time enjoy the advantage of
being on the ground, and may reap the first fruits of the favoring
conditions. The enterpriser usually profits when the price of his
product suddenly rises. Usually skilled workmen are affected slowly by
competition when there is any considerable increase of prices in their
special industries. The important question is, Who bears the burden of
the higher prices that result from a tariff? The burden is very soon
distributed. A part of it may be for a short time borne by the retail
merchants, but ultimately nearly the whole of it must be borne by
their customers, the unfortunate, less favored citizens. The weight
falling on each is usually small, often unsuspected, always hard to
measure. The increased benefit is concentrated in a few industries and
accrues to a comparatively few producers. Here is a recipe for riches:
get everybody to give you a penny; it's so little that no one will
miss it, and it will mean a great deal to you. Something like this
happens in the case of many protected industries; every consumer
of the article pays a few cents more, a small group of wage-earners
temporarily gains, and a few enterprises wax wealthy.

Sec. 9. #Tariffs and unemployment#. The claim that a low tariff is bad
for the workers is made with peculiar success in any period when
unemployment is greater than usual. It is vain in reply to show that
again and again equally bad periods of unemployment have occurred when
a high tariff was in force, and that often the most highly protected
industries are most affected. It is vain to suggest that fluctuations
of unemployment are related rather to the rhythm of industrial cycles
and panics, than to any particular level of the tariff, whatever it
be.[9] The fact that at the moment is seen is that here are some men
for the time out of work, and here are some foreign goods coming in.
Of course, what is not seen is that if we stop importing goods we
thereby eventually will stop the exportation of goods of equal value
now being sent in payment and this must throw as many men out of jobs
as we helped into jobs by raising the tariff. But the view easy to
take is the short view, and the ulterior consequences seem to the
popular mind to be vain imaginings.

Sec. 10. #Exports and exhaustion of the soil#. It has been ingeniously
argued that a tariff may keep some of the natural agricultural
resources of a new country from becoming quickly exhausted. The export
of food takes out of the soil and out of the country fertile qualities
never to be returned. The shipment of several hundred million dollars
of food products year after year represented a tremendous drain from
the soil of the United States, but this has now largely ceased.
The assumption, however, that the use of the food in this country
preserves the fertility of our own fields is in the main mistaken. The
fertile material in the food for human consumption hauled to a town
five miles away from the field is almost as entirely lost as if it
were shipped to Europe. Engineering skill has as yet succeeded in
returning economically to the fields from which it comes hardly a
fraction as much fertile organic matter as that which flows into the
sewers, that is dumped into river and ocean, and that is buried in
heaps at the borders of our own cities. Artificial fertilizers are
increasingly used, to be sure, but they are obtained in other ways.
On the other hand, the increased use of iron, coal, and timber, as a
result of encouraging manufacturers, has very effectually hastened the
exhaustion of the natural resources of the country.

Sec. 11. #Protection as a monopoly measure#. It has rightly been observed
that a new country has a limited potential monopoly in certain kinds
of products and that a tariff may make it effective. The rapid opening
up of America with its rich natural resources greatly benefited
the average consumer in Western Europe, altho it caused a loss to a
special class of landowners.[10] Whether the citizens of the older
or of the newer country shall reap the greater benefit in the trade
depends on the reciprocal demand for the two classes of goods, as was
seen in discussing the equation of international demand. A wide margin
of advantage may go to one party and a narrow margin to the citizen
of the more favored land. To put it concretely: America, having great
natural resources for agriculture, might continue to trade food for
manufactured goods even tho England reaped most of the benefits of the
trade. An American tariff on manufactures from England would, under
such conditions, check the demand for English products and compel some
Americans to leave farming. This reduction of the American supply
of wheat or corn and of the American demand for English manufactures
compels a new ratio of trade (expressed in prices). It is conceivable
that trading fewer goods with a larger gain on each trade would give
a larger total of gain to the favored nation. Thus, foreigners may
conceivably be compelled to pay a part of the tariff duties to
enjoy the favored market. This is but a special case of the monopoly
principle; the government by law artificially limits the supply of
goods offered by its citizens.

This argument is somewhat subtle, but probably is the soundest one in
the theory of protection. The supposed conditions seldom occur in
a marked measure, but they may exist, and probably have existed
in America. When the great system of internal transportation was
developed in the United States before that of the other new countries
(say from 1840 to 1894), this country had such peculiar advantages for
the production of food that the quantity was enormously increased
and agricultural prices fell.[11] At such a time the tariff may have
worked toward checking the fall and earlier reestablishing a more
favorable ratio. It did this by making prices of manufactured goods in
this country artificially higher and thus tempting men from rural to
urban callings. But the limited application of the principle must be
recognized. The potential competition of undeveloped countries on all
sides, seeking to develop their resources, and profiting by the higher
prices of food in the world-market caused by our tariff, threatens
the peculiar advantages of the favored land. Russia, Argentina, and
Australia have rapidly taken the place of America in supplying food to
Western Europe, in part, no doubt, because we refused to take Europe's
goods in trade. A great nation with its manifold interests is not
eminently fitted to practise the gentle art of monopoly.

The period in America from about 1840 to 1890 shows certain absurd
contradictions in economic policy. By governmental action, national,
state, and municipal, enormous grants of money and lands were made in
aid of transportation. Canals, roads, and railways were built into
new agricultural territory far faster than was healthy and normal. A
prodigal land policy put a premium upon a wastefully rapid extension
of the farming area. These things were done to favor the agricultural
states, but agricultural prices fell so greatly that our farmers for
a long period were nowhere prosperous, and great numbers of them,
both in the East and in the West, were ruined. At the same time a
high tariff on nearly everything the farmers needed to buy was the
political spoil obtained by the Eastern and Middle states. This
further depressed the condition of the farmers and forced them or
their sons into urban industries. A slower development would have
occurred without the waste of national resources in such conflicting
policies of artificial stimulation.

Sec. 12. #Harm of sudden tariff reductions.# It is rarely appreciated how
great is the tactical advantage which the advocates of a high tariff
enjoy in popular political discussion. They can so easily impress the
popular judgment with the evident fruits of their own policy and
with the immediate dangers of the policy of their opponents. When
a protective rate is first applied or is increased, it calls into
existence something visible and tangible, which can be measured in
terms of factories built, men employed, and products turned out. The
increased cost of these results is diffused among many consumers and
reaches them in such indirect ways and in such small increments of
price that they are quite unaware of the way they are affected.[12]

On the other hand, reduction of the tariff works in a direction the
reverse of the enactment. It may cause local crises and may even bring
on general crises. The benefits of the lower prices are diffused and
lost to view; the immediate injury is concentrated and strikingly
evident. Factories are closed, investments depreciate, laborers are
thrown out of employment. The organic nature of local industry causes
these evils to be felt by many classes. Merchants, professional men,
servants, and skilled laborers, that are tributary to the depressed
industry, suffer. The effects are transmitted to commercial and
financial centres and often credit is much shaken. Then follows a slow
and painful process of readjustment.

The low-tariff advocates in America undoubtedly have underestimated
these immediate effects. They have been too abstractly doctrinaire,
have argued too absolutely for the merits of free trade to be applied
instantly regardless of the existing distribution of investments and
of occupations. They have opposed one extreme system by another, with
no thought of the inexpediency and injustice of sweeping changes.
There is a strong feeling among business men that any tariff, be
it high or low, is better than a shifting policy. Despite the great
preponderance of domestic production over foreign trade, it is
perhaps too much to say that the tariff is unimportant in our present
conditions. It can, however, be truly said that business can adjust
itself in large measure to any settled conditions and that radical
changes, especially sudden and large reductions, are fraught with
evils. Long before a new tariff law goes into effect, even months in
advance of its passage, while it is merely in prospect, the course
of trade is abnormally affected. If the rate is likely to be raised,
large importations take place under the lower rate, and for a
considerable time after the law goes into effect imports are small,
while prices rise and domestic production gradually increases. But if
the rate is likely to fall, importations are for months meager, stocks
of goods are reduced to the lowest point, and when the lower rate
goes into effect, large importations follow to the injury of domestic
producers. In many cases a year or two of notice, time given to
enterprisers to adjust their business, would probably do away with a
large part both of the serious losses and of the lottery-like gains
that otherwise occur.

The obvious measure of precaution and of justice would be to put
any new rate into effect gradually.[13] The difficulties are of a
political nature and in the desire of the party in power to "make a
showing" at once of the results of its campaign pledges, in the one
case by starting and stimulating industries through a higher tariff
and in the other by reducing prices to consumers through a lower
tariff. Under the new permanent tariff board, constituted to suggest
tariff changes and to administer the tariff laws, it would be possible
to apply some such feature.

[Footnote 1: See above, ch. 2, secs. 12, 13.]

[Footnote 2: In European countries, on the contrary, the rates that
have been mainly effective have been those levied upon food products,
and the agricultural landholders have been the "protected interests,"
such as the England "landed aristocracy," the German agrarian
"Junkertum," and the French peasant landowners.]

[Footnote 3: See above, ch. 13, sec. 2.]

[Footnote 4: See ch. 4, sec. 6 and ch. 13, secs. 6-10.]

[Footnote 5: In ch. 13, sec. 7.]

[Footnote 6: See ch. 4, secs. 4 and 9.]

[Footnote 7: That there is a certain measure of truth in this opinion
is recognized in our discussion of the standard of deferred payments,
ch. 6, sec. 9. But the relation of a world-wide appreciation of the
standard money commodity with the burden that this change puts upon
debtors has nothing to do with the question now before us, viz.:
Does a protective tariff enable a country to keep and increase its
proportion of the world's stock of gold; and if it could, would it be
a general benefit?]

[Footnote 8: See Vol. I, especially p. 228, and chs. 34 and 36.]

[Footnote 9: See on wages in times of crises, ch. 10, secs. 6 and 7;
and on tariff changes, ch. 10, sec. 14, and ch. 15, sec. 13.]

[Footnote 10: See Vol. 1, pp. 361 and 443.]

[Footnote 11: See Vol. 1, p. 436, for average wheat prices in England,
practically in the world-market.]

[Footnote 12: See above, sec, 8. On the next paragraph, see ch. 10,
sec. 14.]

[Footnote 13: For example, the maximum alteration in any year might be
limited to 3.65 per cent of the value of the goods and in any case not
to exceed one tenth of the old duty, this change to be applied day by
day. Thus, if, on a valuation of $1000, the duty collected under the
old rate has been $400, and under the new law is to be $290.50, three
years would be required for the full change to become effective, the
reduction each day being $.10 per $1000 valuation. The administration
of such a rule would be simple, and it has been favored by men of
practical commercial experience.]



Sec. 1. Prevalence of protective tariffs. Sec. 2. Specific and _ad valorem_
rates. Sec. 3. Some technical features of the tariff. Sec. 4. The tariff,
1789-1815. Sec.5. The tariff, 1816-1845. Sec.6. The tariff, 1846-1860. Sec.7. The
tariff, 1861-1871. Sec. 8. The tariff, 1872-1889. Sec. 9. The tariff,
1890-1896. Sec. 10. The Dingley tariff, 1897-1909. Sec. 11. Sentiment favoring
lower rates. Sec. 12. The Payne-Aldrich tariff, 1909-1913. Sec. 13. The
Underwood tariff, 1913. Sec. 14. Some lessons from our tariff history.
Note on Tariff legislation and business depressions.

Sec. 1. #Prevalence of protective tariffs.# For a century and a half
most serious students of economics have favored a larger measure of
freedom, if not absolute freedom, in foreign trade. But the actual
practice of most nations has never been in accord with the principles
laid down by the philosophers. Great Britain alone among the larger
countries has, since 1846, steadily pursued a low tariff policy for
revenue only, and her example has been most nearly followed by Holland
and Denmark. Germany, which had always had restrictive duties, adopted
still more protective measures under Bismarck in 1879. France,
Italy, and most of the other nations of Europe have strong protective
tariffs. The United States has followed a restrictive policy since
near the beginning of the last century. The explanation of this
contradiction between precept and practice is not entirely simple.
Great interests are affected by foreign trade and certain of these
interests are able to influence opinion and to dominate legislation.
Free trade is not the most desirable thing for every one. The general
policy of free trade between nations, as advocated by most English
economists since Adam Smith, has usually been rejected by the people
and the legislators of other countries.

In its details American policy in tariff legislation under the
Constitution has been varied and vacillating. The changes have been
determined in most cases by motives of temporary partisan advantage or
by the political activity of the immediate beneficiaries rather than
by clear knowledge and consistent purpose of the electorate as a
whole. Thus its lessons for the student are largely of a negative
nature, but they well repay serious study.

Sec. 2. #Specific and _ad valorem_ rates.# Before entering upon the
history of the American policy let us make clear the meaning of
certain technical terms and explain certain methods which are
frequently referred to.

Rates (and duties) may be by either specific or _ad valorem. Specific
duties_ are those that are calculated and levied according to some
physical test, as so much per pound, per yard, per hundred-weight, or
per ton. _Ad valorem_ duties are those that are calculated and levied
according to the value of the goods (usually as it was at the place of
shipment) determined by an assessor, by invoice of sale, by statement
of the importer under oath, etc. The actual duty collected on any
article may result from various combinations of the two rates (as, to
take an actual example, $4.50 a pound and 25 per cent _ad valorem_
on cigars and cigarettes) or _ad valorem_ with a minimum valuation so
that on the cheaper goods the rate is specific.

Specific rates are more easily applied in administration, not offering
the temptation to undervaluation and misrepresentation that _ad
valorem_ rates do; on the other hand, specific rates do not adjust
themselves to price changes as _ad valorem_ rates do. If the prices of
goods go up the specific rate is relatively less and affords less of
"protection" to the domestic producer; whereas if prices go down (as,
in general trend, the prices of manufactured goods have done most
of the time) the specific duties are relatively greater. To take a
historical example, the specific rate of 6-1/4 cents a yard on cotton
goods in 1816 which was at first in fact only about 25 per
cent, within a few years became about 75 per cent and absolutely
prohibitive. For this reason specific rates have most often been used
in acts intended to increase the "protective" duties and often as a
device for immediately raising rates; while _ad valorem_ rates have
been more often used in acts prompted by the desire for less drastic
exclusion and for a more adequate revenue; but there is no essential
connection between the protective policy and specific rates. Indeed,
in the period from 1897 to 1909, when most prices were rising, many
of the specific rates under the Dingley Act, intended to be strongly
protective, afforded less and less "protection."[1]

Sec. 3. Some technical features of the tariff. All goods not subject to
duties are said to be on the _free list_. It is customary to group
articles in _schedules_, of which there are fourteen in the law of
1913, designated from A to N (for chemicals, pottery, metals, wood,
etc.), but the rates are not uniform for all the articles in each
schedule. _Drawbacks_ are a certain amount, the whole or a part, of
the duties that have been paid on imported commodities, which is
paid back by the government on the reexportation of the goods.
_Compensatory duties_ (or compensatory rates) are those levied on
certain manufactured articles with the purpose of raising their price
as much as domestic producers' costs are raised by a tariff on their
raw materials. Examples are a duty on woolen goods to offset a duty on
wool, or a duty on shoes to offset one on hides. They may be intended
to be partial or complete or more than sufficient, and are likely in
any case to work either more or less to the advantage of the domestic
producer than was intended. It may be that the conditions of supply
are such that the home price of the raw materials is raised little
or none by the tariff while the price of the finished product is
considerably raised, or _vice versa._

Sec. 4. #The tariff, 1789-1815.# The main difficulty of government in
1781-1789 under the Articles of Confederation was lack of the power
to obtain revenues by taxation. The separate states alone could levy
duties, and a good many tariff restrictions on freedom of trade
among them developed in this period. The Constitution established the
principle of entire freedom of trade among the states. The first act
of Congress under the Constitution levied a tariff, primarily for
revenue purposes, but clearly having a protective purpose, in the view
of some of the representatives. However, most of the separate rates,
as well as the general average rate, were the lowest ever levied by
Congress, except that there was no free list and that 5 per cent was
imposed upon all goods not otherwise enumerated. _Ad valorem_ duties
up to a maximum of 15 per cent (that on carriages) were laid upon
certain articles of luxury, and low specific duties on a few articles
such as glass, nails, iron manufactures, hemp, and cordage.

From 1789 until 1812, thirteen tariff laws, all told, were passed. One
after another many rates were raised to get larger revenues, but some
goods were put upon the free list. The foreign trade, in both imports
and exports, grew largely and with considerable regularity, rising
then rapidly to a maximum in 1807. Then followed troublous times,
with British Orders in Council and our embargo and nonintercourse
acts until 1812, and war until 1815, trade falling off at first to
one-half, and at last (in 1814) to less than one-twelfth of the
former maximum. Just as trade was, in the war period, sinking to the
vanishing point, the tariff rates were doubled in hopes of getting
increased revenues needed for the war, but in vain.

[Illustration: FIG. 3. IMPORTS INTO THE UNITED STATES. 1821-18565

Many statistics bearing upon tariff history are graphically brought
together here. This figure should be carefully studied in connection
with the following sections. Observe how invariably in the years
following a crisis, the amounts of dutiable imports and of duties
collected have diminished, whether the tariff meantime was changed or

Sec. 5. #The tariff, 1816-1845.# Tho rates had been rising, manufacturers
had been making efforts to secure higher rates for protection, even
as early as 1803. Effectual exclusion of foreign goods and consequent
stimulus to the establishment of manufactures in the eastern states
resulted, in the period 1808 and 1815, from the embargoes and the war.
On the return of peace imports were resumed on a large scale and the
call for a higher tariff was loud. In the revision of 1816, rates in
a number of cases were fixed higher than those before the war. Average
rates are said to have been about 20 per cent. The rate on both cotton
and woolen goods was 25 per cent (and the minimum on cotton goods was
a specific rate of 6-1/4 cents a yard). High rates were imposed on pig
iron (50 cents a hundred), hammered bar (75 cents a hundred), and
rolled bar ($1.50 a hundred, equivalent to about 100 per cent _ad
valorem_). Rates were raised on many other articles. The average _ad
valorem_ rates collected in 1821 attained the remarkably high figures
of 36 per cent on dutiable goods, and almost 35 per cent on free and
dutiable together.

In 1824 in response to the growing sentiment in favor of the so-called
"American policy of protection," many rates were still further
increased, as those on cotton goods and woolen goods (to 33-1/3 per
cent) and some kinds of iron. Cheap wool was now taxed 15 per cent and
that valued over 10 cents a pound at 20 per cent (to be 30 per cent
after 1826). In 1828, in the "tariff of abominations" which evoked
much bitter criticism, the rates on all these goods were again raised,
those on woolen goods being in some cases 100 per cent on the value,
and those on iron being from 40 to 100 per cent on the value, and
duties were levied on molasses, hemp, and flax. The results appear
in the statistics of 1830, showing the average _ad valorem_ rates on
dutiable imports to be nearly 49 per cent, and on free and dutiable
together to be over 45 per cent. This marks a temporary high point in
tariff rates. Revenues were then becoming excessive and that year the
rates on tea and coffee and some other goods were reduced.

Violent protests, especially from the South, were made against the
protective system, and the tariff became a more important political
issue. Then in 1832 a number of changes were made, mostly downward;
the iron tariff, for example, being reduced to about the level of
1824. Average rates were thus brought down to about 33 per cent on
dutiable goods. The compromise tariff act of 1833 provided for a
process of reduction during a period terminating in 1842, the cut to
be small at first, then to be made more rapidly to bring the maximum
rate on any article down to about 20 per cent.[2] These changes, while
as yet incompleted had, in 1840, brought the average rates on dutiable
goods down to but 30 per cent and on free and dutiable together to 15
per cent. The 20 per cent rate, however, remained in effect only two
months in 1842, when it was replaced by a tariff with higher rates
distinctly protective, passed by the Whig party and which remained in
force four years.

Sec. 6. #The tariff, 1846-1860.# The Democratic party coming into power,
passed the Act of 1846, called the Walker tariff, after the Secretary
of the Treasury. As he was a believer in free trade, this act is often
mistakenly described as a free-trade measure. It was, in truth, far
from that. Most of the rates were indeed lower than those that had
been in force between 1816 and 1846 (with the exception of those
between 1840 and 1842), but still some of the rates were high (a few
as high as 100 per cent) and many of them were strongly protective in
nature. The fact that tea and coffee were on the free list is marked
evidence that considerations of revenue did not dominate. The rate
on cotton goods was 25 per cent and the rates on many of the most
important other protected articles (iron, woolen goods, manufactures
of iron, leather, paper, glass, and wood) were 30 per cent. The
average rates under the act for its last eight years (to 1857) were
on dutiable 26 per cent, on free and dutiable 23 per cent. The country
prospered for eleven years under this tariff. In 1857, rates were
again reduced, the more important protective rates from 30 per cent
to a level of 24 per cent. This time partizan considerations played
no part in the discussion. The revenues of the government had been
excessive and the need of a reduction was admitted by nearly every
one. The average _ad valorem_ rates under the nearly four years of the
act of 1857 were about 20 per cent on dutiable and 16 per cent on free
and dutiable (the lowest in the century between 1812 and 1913).

Sec. 7. #The tariff, 1861-1871.# The reduction of rates in 1857 was
made just at the time when the country was at the height of a wave of
prosperity and of speculation which culminated in the financial crisis
of that year.[3] As always at such times, the government's revenues
fell greatly. The first purpose in the revision of the tariff in 1861
was simply to restore the rates in the act of 1846. But the Morrill
act which became a law just before Fort Sumter was fired upon,
contained many higher rates and its purpose was avowedly protective.
This necessarily involved a sacrifice of possible revenues for the
government.[4] Then from the beginning of the Civil War till its close
some rates were raised almost every month with little scrutiny or
debate. The average _ad valorem_ rate jumped from 19 per cent on
dutiable in 1861 (under the law of 1857) to an average of 35 per cent
in the three years, 1862-1865.

The most important tariff acts of the war were those of 1862 and 1864
by which large increases were made on many articles. These tariff
acts were passed in connection with far-reaching and burdensome
applications of internal revenue taxes on many kinds of manufactures.
The tariff rates were primarily intended to offset these taxes, "to
impose an additional duty on imports equal to the tax which had been
put on the domestic articles," as was said by the sponsors of the
bill. These rates were similar in purpose to compensatory rates, and
in many cases they were more than sufficient to offset the internal
taxes. Under the last of these acts the duties collected in the six
years from 1865 to 1870 averaged nearly 48 per cent on dutiable and
nearly 44 per cent on free and dutiable.

The remarkable fact was that soon after the war the internal revenue
taxes began to be repealed one after another, and by 1872 nearly
all those bearing upon general manufactures (apart from cigars and
alcoholic beverages) were gone. The tariff, however, remained almost
unaltered. This repeal of internal revenue taxation had the same
"protective" effect as raising the tariff rates by so much. As if
this were not enough for the protected interests, in 1867 the duty on
woolens was further raised and in 1870 numerous other increases were
made in the duties having a protective character. Some reductions were
made, but these were almost all on articles of a distinctly "revenue"
character such as tea, coffee, sugar, molasses, spices, wines.
Revenues were superabundant for current expenses of government, and
altho there was a large national debt, hardly any of it was redeemable
at the time. There was therefore need to reduce taxation, but the
attention of the consuming and tax-paying public was distracted by the
somewhat passionate political issues of the day. Besides, the public
had not the technical knowledge or the unified opinion on this subject
to protect itself against the greedy lobby in this process of tax
revision. And so, selfish commercial interests could get nearly what
they asked for in Congress, and the politicians at Washington, who had
come to have a well-nigh superstitious faith in the efficacy of very
high protective duties, could quietly use the opportunity to raise the
people's taxes for the people's good.

These virtual increases in the protective power of the rates in force
are not evident in the statistics of average _ad valorem_ rates,
because the higher rates in many cases were sufficient to exclude
relatively more of the foreign products to which they applied.[5] The
imports came, by a process of selection, to consist more largely of
goods subject to lower rates. So the year 1868 showed the highest
average rate on dutiable goods (48.6 per cent) of any year after the
act of 1828 until that of 1890, and the rate fell somewhat each year
until in the fiscal year 1872 it was 41.3 per cent.

Sec. 8. #The tariff, 1872-1889#. In 1872 the country was again, as in
1857, nearing the crest of a wave of prosperity and of speculation.
Imports and customs receipts attained new high points in our history,
and, despite the enormous reductions of internal revenue taxation,
the government's receipts continued to be excessive.[6] The important
revenue articles, tea and coffee, were then transferred to the free
list, as were also raw hides and paper stock and some other articles;
the rate on salt was reduced one-half and that on coal almost as much.
Many other specific rates were reduced and the _ad valorem_ rates on a
long list of articles were cut to "90 per cent of existing rates."
The effects of these reductions were mingled with those of the severe
financial panic occurring in 1873 and of the depression following,
which reduced especially the importation of luxuries bearing the
higher rates. The average rate of the three (fiscal) years 1873 to
1875 was 39 per cent on dutiable (a fall of 9) and 28 on free and
dutiable (a fall of 16). The ratio of imports entering free, which in
1872 was still only about 1 in 14, became the next year 1 in 4. But
government revenues falling short in 1874, advantage was soon taken
of the circumstance to repeal in 1875 with little discussion the
horizontal cut of tariff rates made in 1872. The specific rates that
had been reduced in 1872 were little changed, however. From 1876 to
1883 (8 fiscal years) nearly a third of the imports consisted of goods
on the free list. The average rate on dutiable was over 43 per cent,
and on free and dutiable was 30 per cent.

The tariff was a leading issue in the campaigns of 1876 and 1880. In
1876, the Democratic party's platform contained a plank for "a tariff
for revenue only." It was a time of great industrial depression, and
as is usual in such cases a large number of the electors held the
party in power responsible for business adversity (as in turn they
credit it with any more or less fortuitous prosperity). The Republican
candidate Hayes, after a long contest in Congress, was declared
elected by a margin of one electoral vote. His opponent, Tilden had
received a quarter of a million more votes in the country as a whole.
In 1880, when business prosperity was rapidly returning, the party
in power was successful by a goodly margin of votes in the electoral
college, tho having a bare plurality of the popular vote. Garfield,
the Republican candidate, was known as one of the more moderate
protectionists and his opponent, General Hancock, who was without any
political record, declared the tariff to be a "local issue," to be
determined in the Congressional districts. The tariff issue was thus
not very sharply drawn. The tragic death of President Garfield left
no clear leadership. The tariff question from 1876 to 1884 was
politically in the doldrums.

Yet there was undoubtedly a somewhat growing popular demand for some
moderation of the very high duties. To this demand the friends of
protection who were in power felt compelled to concede something--or
to appear to do so. Congress appointed a Tariff Commission of which
the Chairman was secretary of the wool manufacturers' association, and
after a report the tariff act of 1883 was passed. The net results were
almost nil. Some rates were lowered, while others were raised with a
definite protectionist purpose. The average rates for the next seven
years, 1884-1890, were 45 on dutiable (an increase of nearly 2 per
cent) and 30 on free and dutiable (unchanged as compared with the
period ending 1883). In 1884, the Democratic party elected its
presidential candidate (Cleveland) and a majority of the House, but
as it did not control the Senate it could not pass any of the various
proposed measures for a "reform" of the tariff. In 1888 the protective
principle was a leading issue in the campaign. Altho Cleveland
received a few ten thousands larger popular plurality than he had
obtained four years before, and held the electoral votes of 18 of the
states, he lost New York and Indiana by very narrow margins, a result
in which other issues played a large part. Harrison was elected and
the party favoring a high protective tariff came into power.

Sec. 9. #The tariff, 1890-1896#. The tariff act (known as the McKinley
act) of October, 1890, followed. This was a general extension of the
principle of protection. The rates on woolen goods were on the whole
increased and made in more cases prohibitive. The rates on wool were
increased. The rates on iron, which was already highly protected, were
little changed except by the increase of the duty on tin-plates. The
duty on sugar (in the main a revenue duty, yielding $55,000,000
a year) was removed and a bounty was granted to domestic sugar
producers. In the next three (fiscal) years, 1892-1894, the average
rate proved to be over 49 per cent on dutiable (4 per cent increase)
and 22 per cent on free and dutiable (the remission of sugar duties
accounting for the most of this fall of 8 per cent from the average
under the preceding law--4 per cent fall from the last year of its
operation). Particularly noticeable, however, was the increase in the
proportion of goods entering free, which was nearly 55 per cent of
all merchandise as contrasted with about 33 per cent between 1884 and

Again the political weather vane shifted. The month after the McKinley
bill became law, the Congressional elections (November, 1890) returned
an overwhelming Democratic majority in the House, altho this was a
period of business prosperity, a fact usually favoring the party in
power. In 1892, Cleveland, being again a candidate, was successful
over Harrison by a largely increased plurality of the popular vote,
and received almost double the electoral vote of his opponent.
The House was Democratic, and the Senate soon became so. Business
prosperity was rising again to a high level, but there were many
features of financial and speculative weakness in the situation,
intensified by growing fear of a cheap money (silver dollar) inflation
under the act of 1878 providing for the annual purchase of silver.
A financial panic occurred in September, 1893, six months after
Cleveland's inauguration.

Nevertheless Congress enacted the next year, Aug. 28, 1894, the Wilson
tariff act. The changes made by this legislation were not on the whole
very great, but were nearly all in the direction of the lowering of
the tariff. Most notable was the putting of raw wool upon the free
list. Some rates on woolen goods were reduced, but hardly more than
enough to offset the effects, upon manufacturers' costs, of the
reduction of the tariff on raw wool. Likewise small reductions were
made on cotton and silk goods, on pig iron, steel and tin plate
and many other articles; and larger reductions on coal, iron ore,
chinaware, and glassware. To make up for the expected reduction of
receipts from other sources, a duty was laid again upon raw sugar,
and an income tax law was passed (this soon, however, to be declared

Under this law, for three fiscal years (1894-1897) the average
rates were 41 per cent on dutiable and 21 per cent on free and
dutiable,--pretty high rates. The proportion entering free under this
act was actually less than under the McKinley act, partly because
of the sugar item, and partly, probably, because of general business

Sec. 10. #The Dingley tariff, 1897-1909.# The campaign of 1896 was waged
almost solely on the issue of free silver. Undoubtedly great numbers
of voters supported William McKinley rather despite of, than because
of, his high protectionist beliefs. But his inauguration was promptly
followed by the passage of the Dingley act of July 24, 1897, which
embodied a marked increase of protective rates. A duty was again
levied on wool, and also on hides which had been untaxed since 1872.
High rates were made for woolens, linens, silks, chinaware, and the
rate on sugar was doubled. Provision was made for some reduction of
rates by reciprocity agreements, but the conditions were so complex
that the effect could not be great. This high protective tariff, thus
enacted without popular discussion, remained almost unchanged for
twelve years, the longest life, by one year, of any tariff act in our
history,[7] The rate under the first full fiscal year of the law's
operation, 1899, was the highest on dutiable in our history, 52 per
cent, and was nearly 30 per cent on free and dutiable. In practical
operation, however, the average rate steadily became more moderate
because of the rapid rise of the general price level that was in
progress throughout this period, amounting to 35 per cent from 1898
to 1909.[8] The average rate of duties collected for the period of
12 years was 47 per cent on dutiable and 26 per cent on free and
dutiable. It was steadily falling and the last year, 1909, was 43 per
cent on dutiable and 23 per cent on free and dutiable.

Sec. 11. #Sentiment favoring lower rates.# While the Dingley act was thus
in operation showing declining average rates, sentiment was developing
in every part of the country in favor of a further moderation of the
tariff. This was due partly to the discontent resulting from steadily
rising general prices, in which change the rise in the prices of food
and of many other necessities was not fully compensated by the rise
of the wages and incomes of the masses. Partly the growth of this
sentiment accompanied the agitation against trusts and the belief
that protective duties in some cases were an aid to the formation of
domestic monopolies. But more fundamentally, this changing sentiment
was the result of the changing industrial conditions in America. The
character of our foreign trade had altered greatly since the early
nineties. We were importing relatively less and less of manufactured
and finished products, and more of raw materials; and we were
exporting less and less of raw materials and more of finished
products. A growing number of manufacturers were feeling the need of
cheaper raw materials and were looking hopefully toward an enlargement
of their foreign trade.

The Republican platform in 1908, in view of the changing public
sentiment, formulated a new rule for maintaining "the true principle
of protection," namely, that it "is best maintained by the imposition
of such duties as will equal the difference between the cost of
production at home and abroad, together with a reasonable profit to
American industries." This rule is very attractive in its suggestion
at the same time of the idea of a moderation of the tariff and of an
exact practical (not to say scientific) standard for the determination
of the proper rate in every case.

The rule is, however, fallacious. "Costs of production" mean here
the monetary costs of the enterpriser. Now a first difficulty is that
costs are not uniform for all establishments in any one industry, and
a tariff high enough to protect some is entirely too low to protect
others. As long as a tariff rate is too low to exclude every unit of
the foreign product its importation is conclusive proof that for some
home producers the tariff rates fall short of the "true principle"
(better proof, indeed, than the most elaborate investigation by any
tariff board could be). The indubitable truth is that no trade ever
can take place (in a monetary regime) unless the monetary price is
lower in the exporting than it is in the importing country. This
virtually means that the product cannot be profitably exported unless
the monetary costs of production ("together with a fair profit") of
the article exported are for each party less than those of the other
party in the other country.[9] The so-called "true principle" would
lead thus to absolute prohibition of every article to which it was

Sec. 12. #The Payne-Aldrich tariff, 1909-1913#. In the campaign of 1908
the Republicans admitted that the protective tariff needed to be
revised, but they declared that it should be revised by its friends.
It was doubtless the general understanding that "revision" in this
promise meant revision downward, tho this was left somewhat unclear in
a campaign wherein the tariff played a somewhat minor part. The tariff
act of 1909 (the Payne-Aldrich act) was the attempt of the successful

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