One imagines that in writing his book, Smith consider Volumes 4 and 5 to be the knockout blows. Sure, he’s alluded already to “spendthrift” governments, expounded upon the nature of money (especially metal currency), and anticipated a critique of capitalism that would make Marx famous a century later.
Volume 4 deals with systems of political economy, which must “enrich both the people and the sovereign.” It is a not-at-all-veiled dunk on the prevailing ideas of his age—ideas which were soon to fall out of fashion.
Volume 5 deals with what governments ought to provide, and what means are best employed for achieving the ends sought.
Mercantilism and Its Fallacies
Volume 4: Of the System of Political Economy
Mercantilism Defined and Dated
In the three centuries preceding Smith, much of European political economy was conducted along the lines of the “mercantile” system, which Smith also sometimes refers to as the “commercial” system. The fundamental principle of such a system is “that wealth consists in money, or in gold and silver.” To Smith, this is confusing form with substance, as money is valued not for what it is, but for what can be obtained by it. Yet the mercantile system boasted many eminent proponents, including John Locke, who, in Smith’s words, believed that “gold and silver are the most solid and substantial part of the moveable wealth of a nation; and to multiply those metals ought, he [Locke] thinks, upon that account, to be the great object of its political economy.”
Part of this, as Smith recounts, is because most nations are not “closed systems”, isolated from the rest of the world. If they were so, a mercantile system might lack a raison d’etre. “Others admit, that if a nation could be separated from the entire world, it would be of no consequence how much or how little money circulated in it…the real wealth or poverty of the country, they allow, would depend altogether upon the abundance or scarcity of those consumable goods. But it is otherwise, they think, with countries which have connections with foreign nations, and which are obliged to carry on foreign wars, and to maintain fleets and armies in distant countries. This, they say, cannot be done, but by sending abroad money to pay them with; and a nation cannot send much money abroad, unless it has a good deal at home Every such nation, therefore, must endeavor, in time of peace, to accumulate gold and silver, that when occasion requires, it may have wherewithal to carry on foreign wars. In consequence of those popular notions, al the different nations of Europe have studied, though to little purpose, every possible means of accumulating gold and silver in their respective countries.”
Thus we should not be surprised that the principles of mercantilism roughly date from the beginnings of European discovery and colonization of other lands.
A First Refuting
Smith does not mince words about the mercantile system: “it would be too ridiculous to go about seriously proving, that wealth does not consist in money…but in what money purchases. And again: “It is not because wealth consists more essentially in money than in goods, that the merchant finds it generally more easy to buy goods with money…but because money is the known and established instrument of commerce, for which everything is readily given in exchange.”
Thus from the beginning Smith considers the underlying assumptions of the mercantile system to be incorrect. As his exposition continues, he continues to dismantle the whole structure.
Mercantile Policy
The first natural policy springing from mercantile principles was the prohibition of “carrying gold or silver forth [from] the kingdom.” Such a policy was the greatest form of protectionism, essentially banning any purchase of foreign goods with specie.
The merchant class, who depended most upon the carrying on of foreign trade, found such prohibitions “extremely inconvenient.” They thus argued that “the exportation of gold and silver, in order to purchase foreign goods, did not always diminish the quantity of those metals in the kingdom…because, if the consumption of foreign goods was not thereby increased in the country, those goods might be re-exported to foreign countries, and being there sold for a large profit, might bring back much more treasure than was originally sent out to purchase them.” Further, gold and silver could “easily be smuggled” if such laws were not relaxed.
Such complaints led nations to shift their mercantile strategies: “The attention of government was turned away from guarding against the exportation of gold and silver, to watch over the balance of trade.” Thus government policies sought to incentive exports, retain their nations as net exporters (a positive trade balance or trade surplus), and ultimately encourage merchants and manufacturers to sell abroad rather than to their own people. This last aligned with the mercantile ideal, as internal trade “neither brought money into the country…nor carried any out of it.”
Mercantilism in Action
The twin objectives of mercantilism must be to restrain imports and encourage exports. Smith breaks down these objectives into different components.
“We Have Imports at Home”
The first broad category of restraints on imports is those for “such goods as can be produced at home.” The result of tariffs or other restrictions on such goods means that “the monopoly of the home market is more or less secured to the domestic industry.” This is foolish, says Smith, for two reasons:
- Given equal or similar profits, “every individual endeavors to employ his capital as near home as he can.”
- Because of this, “every individual who employs his capital in the support of domestic industry necessarily endeavors so to direct that industry that its produce may be of the greatest possible value.”
This is where Smith makes his most famous comment in the entire work: “By pursuing his own interest, he frequently promotes that of the society more effectually than when he really intends to promote it.” And: “he is…led by an invisible hand to promote and end which was no part of his intention.”
By extension, then, the giving of any monopoly or favors in domestic industry is “in some measure to direct private people in what manner they ought to employ their capitals, and must in almost all cases be either a useless or a hurtful regulation.”
The worst such example of this are restrictions on food imports, which can sound like some sort of Malthusian nightmare. “To prohibit…the important of foreign corn and cattle, is in reality to enact, that the population and industry of the country shall, at no time, exceed what the rude produce of its own soil can maintain.”
But there are still two cases where Smith will admit of such restrictions.
- For any industry “necessary for the defense of the country.” The classic example in Smith’s time was shipping: Britain had a national interest in maintaining a large fleet and large force of sailors, and the original Navigation Act was passed to protect British shipping from competition, especially by the Dutch. Today, I think of domestic aerospace and defense companies as covered under similar interests—which is why I consider Boeing and others “too big to fail”.
- For any industry “when some tax is imposed at home upon the produce of the latter.” In this sense, the tariff is in place to level the playing field rather than to favor domestic industry.
Smith includes as aside on taxes, particularly those placed upon the “necessaries of life”, which result from such policies. “Taxes upon the necessaries of life have nearly the same effect upon the circumstances of the people as a poor soil and a bad climate…Such taxes…are a curse equal to the barrenness of the earth.” One can only imagine how he would feel about sales taxes today.
He finally admits that to expect ultimate freedom of trade is “as absurd as to expect…Utopia…Not only have the prejudices of the public, but, what is much more unconquerable, the private interests of many individuals, irresistibly opposed it.”
China Was Once Called France
The second group of restrictions on imports are more targeted: against “those countries with which the balance [of trade] is supposed to be disadvantageous.” In Smith’s day, he mostly refers to France. In our day, we can think of China.
One reason against such restrictions is, Smith insists, that it’s just too dang hard to measure the actual balance of trade. Doing so requires quibbling about value of currencies (which has only gotten more difficult in the era of central banking chicanery), and further about the value of the goods themselves. Smith sees this as inevitable because “national prejudice and animosity, prompted always by private interest” compels claimants to make different judgements.
But even aside from this, there are two further reasons, which amount to the same principle: that trade is not a zero-sum proposition as the mercantilists would have us believe.
- A balance of trade may be “in favor of France, [but] it would by no means follow that such a trade would be disadvantageous to England.”
- For nations with active merchant fleets, “a great part of [such goods] might be re-exported to other countries…being sold with profit.”
Any concept that trade is zero-sum must serve to teach nations “that their interest consisted in beggaring all their neighbors.” (Again, his remarks on the “impertinent jealousy” of the commercial interest takes a realistic view of human nature which Marx also recognized in the shortcomings of capitalism—although Marx forgot everything he’d ever learned about human nature once he began considering possible alternatives.) Such remarks on jealousy render it hardly surprising that Smith saw the “spirit of monopoly” as joined at the hip with the mercantile system—one which truly discourages liberty and competition.
Smith concludes the matter with what I consider the finest mic-drop in the entire book.
“There is no commercial country in Europe, of which the approaching ruin has not frequently been foretold by the pretended doctors of this [mercantile] system, from all unfavorably balance of trade…There is another balance, indeed, which has already been explained, very different from the balance of trade, and which…necessarily occasions the prosperity or decay of every nation. This is the balance of the annual produce and consumption…The balance of produce and consumption may be constantly in favor of a nation, thought what is called the balance of trade be generally against it.”
At root, this is the same basic economics we can learn in school. Yet it is profound wisdom easily forgotten by profligate governments.
“Go Add Value Somewhere Else”
Exports can be encouraged in a handful of ways. Of these, Smith considers the “drawback”, a tax break for domestic goods marked for export, the “most reasonable.” However, even this is ripe for abuse, as “drawbacks…are useful only in those cases in which the goods…are really exported to some foreign country, and not clandestinely re-imported into our own.”
“Bounties”, or direct subsidies for domestic industry, “ought to be given to those branches of trade only which cannot be carried on without them,” and “the effect of bounties, like that of all the other expedients of the mercantile system, can only be to force the trade of a country into a channel much less advantageous than that in which it would naturally run of its own accord.”
Treaties of commerce tend to convey advantage the nation favored by them. This suggests that many such treaties were one-sided, compelling one country to accept the goods of another without reciprocity. However, Smith mentions that when such treaties are reciprocal, they can in fact in advantageous to both parties—citing as an example a 1703 treaty between Britain and Portugal.
Smith also digresses at length upon colonies as a means of encouraging export: essentially by fostering captive markets the trade policy of which one may dictate. On this score, Smith insists that British colonial policy has been “upon the whole…less illiberal and oppressive” than those of other nations—ironic given that as he wrote the American colonies were already rising in revolt and would declare their independence in the same year that The Wealth of Nations was published.
Conclusion on Mercantilism and Other Economic Policies
Smith’s final indictment of the mercantile system is that it enables production to supplant consumption as “the ultimate end and object of all industry and commerce.” This may be confusing given that Smith appeared earlier to give greater weight to production than did many other economists, but that was in the sense of what drove the sources of a nation’s wealth and prosperity. The proper end of production, however, is meant to be consumption; and mercantilism improperly subordinates the latter to the former.
Concluding even further on systems of political economy in general, Smith takes the Enlightenment recourse to a natural order based on individual action and interest. Thus Smith appears to think little of most systems of political economy: “Every system which endeavors…to draw towards a particular species of industry a greater share of the capital of the society than what would naturally go to it…retards, instead of accelerating the progress of the society toward real wealth and greatness; and diminishes, instead of increasing, the real value of the annual produce of its land and labor.”
Therefore Smith envisions, or hopes for, a state of economy without political economy—a state that seeks to grow the size of the pie, while political economy is concerned with society’s members fighting jealously over their shares thereof.
Government: What it Should Do
Volume 5: Of the Revenue of the Sovereign or Commonwealth
A cursory study of this volume will have to suffice, as it tends more toward the geopolitical rather than the economic field.
Smith gives a quick teaser of his final volume at the end of Volume 4, explaining three duties of government “according to the system of natural liberty”.
- “Protecting the society from the violent and invasion of other independent societies,” or defense.
- “Protecting, as far as possible, every member of the society from the injustice or oppression of every other member of it,” that is, justice, or equality before the law.
- “Erecting and maintaining certain public works, and public institutions, which it can never be for the interest of any individual…to erect and maintain,” that is, provision of necessary public goods that markets cannot adequately provide.
Defense: the First Task of Government
The cost to the sovereign of providing defense depends greatly on the state of the society. The hunter-gatherers and pastoral steppe nomads of Smith’s day were communities in which “every man is a warrior…he maintains himself by his own labor.” Agriculture gave rise to settlements, which were often defended by militias of the citizens in those settlements, often at their own individual expenses.
Yet the continued progress of society renders a self-funded army less tenable in two ways:
- Introduction of non-agricultural industries. A farm is well enough to be abandoned for a campaign, provided the battle “begins after seedtime, and ends before harvest…But the moment that an artificer…quits his workhouse, the sole source of his revenue is completely dried up.” Thus, manufacturing workers cannot quit their professions to serve as soldiers unless paid to do so.
- Advancements in the art of war itself. As wars “cease to be determined…by a single irregular skirmish or battle,” soldiers must be maintained for longer periods, at greater distances from home, and with more advanced weapons. Thus from the time of early Rome, even part-time soldiers began to receive pay for their time in the field.
All this trended to the establishment of standing armies and navies as opposed to irregular militias. Notably, long periods of peace did not have a deleterious effect upon such forces, although “in a long peace, the generals…may sometimes forget their skill.”
Justice (Not Equality)
The “exact administration of justice” is hardly at all necessary in a primitive state of society preceding the accumulation of stock in private hands. To Smith, justice is a bulwark to establish protection to property rightfully acquired—and prevent abuses of the power such property might wield.
This is essentially to say that justice is only necessary when inequality exists. As Smith puts it:
“Wherever there is a great property, there is great inequality. For one very rich man, there must be at least five hundred poor, and the affluence of the few supposes the indigence of the many. The affluence of the rich excites the indignation of the poor, who are often both driven by want, and prompted by envy to invade his possessions. It is only under the shelter of the civil magistrate, that the owner of that valuable property, which is acquired by the labor of many years, or perhaps of many successive generations, can sleep a single night in security. He is at all times surrounded by unknown enemies, whom, though he never provoked, he can never appease, and from whose injustice he can be protected only by the powerful arm of the civil magistrate, continually held up to chastise it. The acquisition of valuable and extensive property, therefore, necessarily requires the establishment of civil government. Where there is no property, or at least none that exceeds the value or two or three days [sic] labor, civil government is not so necessary.”
Smith’s concept is therefore one of justice, and not strict equality. Indeed, inequality struck Smith as perfectly natural, and stemming from four sources:
- “Superiority of personal qualifications,” such as intelligence, strength, wisdom, etc.
- “Superiority of age.” Smith cites that age is in every society a mark of respect and deference—something toddlers intuitively understand.
- “Superiority of fortune,” that is, wealth.
- “Superiority of birth…[which] presupposes an ancient superiority of fortune in the family of the person that claims it.”
Public Goods: Education
Many of the public works that Smith describes in his final chapters concern works of commerce, such as roads, bridges, canals, and harbors. Yet the passages on education are the ones which I found particularly interesting. A few quotes worth sharing on this score will be a fitting close to our survey of Smith’s work.
“In every profession, the exertion of the greater part of those who exercise it, is always in proportion to the necessity they are under of making that exertion.” And how might this apply to tenured professors in universities? “The teacher is prohibited from receiving any honorary or fee from his pupils, and his salary constitutes the whole of the revenue which he derives from his office. His interest is, in this case, set as directly in opposition to his duty as it is possible to set it.”
And what about publics schools, or in Smith’s terms, bestowing the “common people” with “the most essential parts of education”? “For a very small expense, the public can facilitate, can encourage and can even impose upon almost the whole body of the people, the necessity of acquiring those most essential parts of education.”
Smith’s solution: the teacher being “partly, but not wholly, paid by the public; because, if he was wholly, or even principally, paid by it, he would soon learn to neglect his business.” To put this in modern terms, it is as if Smith advocates for private schools with state subsidies to ease the burden of tuition upon the families of students, but not outright state-funded educational institutions.
Whether Smith is right about this is beyond our scope here—the pitiful state of American education is worth covering in its own post. This will have to wait, however, as we continue our series on economic theories, with a breakdown of Karl Marx’s Das Kapital.
