How Trade Fell Apart Between the Wars

Between the two world wars, international trade contracted severely and did not recover for years. The mechanisms involved were cumulative, and understanding the sequence explains what the postwar system was built to prevent.

Tariffs rose in sequence rather than together

Countries facing falling output and employment raised duties to protect domestic producers, and each increase reduced the exports of its trading partners.

Those partners then faced the same pressures with less export income to offset them, and responded with increases of their own.

Because each step was individually defensible as a response to the previous one, the process continued well past the point where any participant benefited.

Quantitative restrictions replaced price measures

Tariffs still allow trade at a higher price, but as conditions worsened many countries moved to quotas and licensing, which cap volume regardless of price.

Import licences allocated by administrative decision replaced market allocation, and obtaining one became a matter of application rather than of paying a duty.

These measures are far more restrictive than equivalent tariffs and much harder to negotiate away, which is why the postwar rules treated them as presumptively prohibited.

Currency controls fragmented settlement

As convertibility was suspended, holders of one currency could no longer freely exchange it for another, which broke the multilateral settlement that trade had relied on.

Trade increasingly ran through bilateral clearing arrangements, where two countries balanced their exchanges directly against each other rather than through a common medium.

Bilateral balancing is far less efficient, because it requires each pair of countries to match, eliminating the gains from the wider pattern of specialisation.

Blocs formed around currencies and empires

Trade concentrated within groups sharing a currency or an imperial relationship, and preferential arrangements inside those groups deepened while trade between them declined.

The result was a set of partly separate trading systems rather than a single one, with the composition of trade shifting to fit the blocs rather than comparative costs.

Unwinding those preferences was itself a major negotiating task after the war and took decades to complete.

What the postwar designers took from it

The institutions built afterwards addressed each mechanism directly: binding tariff commitments, a presumption against quantitative restrictions, and arrangements to restore currency convertibility.

Non-discrimination was made a general rule specifically to prevent the re-formation of closed blocs, with defined exceptions rather than open discretion.

Whether that reading of the period was complete is debated by historians, but the design of the postwar system is unintelligible without it.