by Bobby Akart
Traders, of course, found these restrictions very inconvenient. So they argued that by allowing them to pay for some imports with gold and silver, they could actually make more money for the country by processing the imports and exporting them elsewhere, getting back even more gold and silver. This led to some easing of the rules: the prohibition on gold and silver exports from France and England was confined to coin, not bullion. Holland even dropped the coin restriction.
So attention then fixed on the balance of foreign trade, since this is what would determine the net inflows and outflows of gold and silver if they could be moved freely across borders. By contrast, domestic trade – though far more important – was ignored, on the grounds that no money came into or left the country as a result of it, so it could never make the country richer or poorer. But in fact the preoccupation with international trade is inappropriate. Very little of a country's trade comprises foreign trade, with gold or silver being imported or exported: most wealth is created and consumed domestically. Cross-border movements of gold and silver are hardly likely to ruin a great nation.
And it is a mistake to imagine that wealth resides only in money. Money is just a medium of exchange. It is useful, because everyone accepts it. Yet what people actually want when they do accept it is not the money, but the things that they can buy with the money.
Certainly, gold and silver have the merit of being more durable than some other commodities, and this adds to their usefulness as a store of value. But durability is not everything: we are perfectly happy to import wine from France and send them hardware in exchange.
Nevertheless, the French are not so stupid as to amass more pots and pans than they need to cook their food, just because they are more durable. It would be a complete waste of resources. By the same token, neither we, nor any country, should seek to amass more gold and silver than is needed to facilitate trade. It would be a waste too – dead capital that would come out of the available resources we need to feed, clothe, maintain and employ the people.
Money is a utensil, just like pots and pans
Having thus shown the error of the mercantilist belief that money equals wealth, Smith now moves on to attacking the trade restrictions that the mercantilists have erected, in the name of preventing money from leaking abroad. Prohibitions or high duties against imports – motivated by the mercantilist confusion about money – mean that the country's domestic producers are given an effective monopoly of the home market. Bans on the importation of live cattle, for example, give domestic graziers a monopoly on the supply of butcher's meat; woollen manufacturers benefit from bans on woollen imports, and silk manufacture has recently secured the same advantage, as have many other trades.
But, as explained earlier, the number of people who can be employed in a developed country is proportional to the capital that is mobilised there. Regulations such as these cannot possibly increase employment beyond what the available capital can maintain. All they do is to divert industry from one employment to another. But businesspeople naturally invest their capitals where they believe they can generate most value. Indeed, they are likely to be much better judges of this, understanding more about the local situation, than some distant regulator; and giving regulators such great economic power is dangerous in itself.
The only mention of the Invisible Hand in The Wealth of Nations occurs at this point above. However, while the invisible hand idea – a functioning social order produced by the private and indeed self-interested action of individuals – pervades Smith's work, this particular reference to it is rather elliptical.
If foreign goods are no cheaper than domestic ones, then giving a monopoly of the home market to domestic producers is evidently pointless. If, on the contrary, foreign goods are in fact cheaper, then the regulation is harmful, because it is wasteful to make at home what you can buy cheaper elsewhere. The tailor does not attempt to make his own shoes, nor the shoemaker his own clothes: and countries too should make what they can make cheaper, and buy in what would cost them more to produce.
By means of glasses, hotbeds, and hotwalls, very good grapes can be raised in Scotland, and very good wine too can be made of them at about thirty times the expense for which at least equally good can be brought from foreign countries. Would it be a reasonable law to prohibit the importation of all foreign wines, merely to encourage the making of claret and burgundy in Scotland?
Trade restrictions are also defended as a tool to prevent an adverse balance of trade. But as we have seen, foreign trade is relatively insignificant. And as long as a country is producing more than it consumes, it is saving and adding to its capital. Such a country could still import more than it exports – an adverse trade balance – and nevertheless continue to produce surpluses and grow richer.
Justified and unjustified trade barriers
Trade restrictions are a tax on the whole country. But they are often defended as being necessary to deal with 'special cases'. British tariffs on foreign wine and beer, for example, are justified on the grounds that they reduce drunkenness. It is a remarkable claim, since the wine producing countries such as France, Italy and Spain are among the soberest peoples in Europe. Certainly, alcohol may sometimes be abused, but it is still better if we can buy it – like anything else – more cheaply than we can brew it ourselves. And in any case, the fact that the tariffs favour Portugal, which British merchants say is a better customer for their manufactures, over France, gives the lie to their supposed justification. It is an example of how interest groups can pervert the policy of a great country.
In any event, we cannot prosper by trying to impoverish our neighbours. A nation is more likely to grow rich from trade if its neighbours are also rich, industrious, commercial nations, than if they are poor.
Here, Smith is attacking the common assumption that in any exchange there must be a winner and a loser. In terms of international trade policy, this led to the idea that a country could become rich only by taking money off others and making them poorer. Smith, of course, champions the modern view, that both sides benefit from voluntary trade, so the assumption is wrong and the policy is counterproductive. But Smith concedes that there can be some justification for at least temporary restrictions on foreign trade in limited circumstances, which he now enumerates.
A case can be made for tariffs when some particular industry is vital for the defence of the country, of course. The Navigation Acts, which aimed at reducing the naval power of Holland, are an example. But there is a cost; if foreigners are hindered from coming to sell into our markets, they may not come to buy, either. The embargo may make them less wealthy, or they may form trading alliances with other nations, and buy in their markets instead.
There is, too, a case for imposing a tax on imported articles if the same articles produced at home are taxed for some reason – as are soap, salt, leather and candles. This levels the competition between domestic and foreign producers. However, we should not let this policy be expanded, as domestic producers would like it to be, into imposing taxes on all foreign imports that might happen to compete with home industries. Taxes raise the prices of things, imposing a burden on consumers; and taxes on necessities are a particular evil.
There might be a case for retaliatory import tariffs or prohibitions as a way of forcing other countries to drop their trade restrictions against us. It is up to those insidious and crafty animals, the politicians, to negotiate and decide if such a policy is likely to work.
But if there is no chance of it working, why add further injury to ourselves by imposing tariffs? Some people argue that if trade has been interrupted by tariffs or prohibitions, it should be restored only slowly; that a sudden restoration of free trade would be disruptive. In fact, though, foreign trade is a small part of a country's industry, and any disruption would be small. Most of the people affected would easily find other employments – especially if labour-market restrictions were eased.
And in the process, the whole country would be the gainer. Drawb
acks, bounties, price controls and trade preferences. Drawbacks – where an exporter can claim back tax paid at home, or where import duties can be reclaimed upon re-export – cannot boost industry beyond its natural level. In principle, they merely restore activity to where it would have been in the absence of the tax. However, the specific rules on these tax concessions are so complicated that they do distort things, and often invite fraud.
Bounties – subsidies on exports – are designed to boost our foreign trade in lines of industry that could not profitably be exported without them. But again, if merchants did not receive the bounty, they would employ their capital in other, more profitable, industries.
Subsidies of any sort merely force the country's trade into a different, less advantageous direction. They are a double tax on the public: the public have to pay tax to finance the subsidy, then they have to pay more than they need for a commodity that could be bought cheaper from another source.
Subsidies are also open to fraud. The subsidy to the white herring industry, for example, is set according to the tonnage of the ship, rather than its crew's diligence or success in fishing. Not surprisingly, ships equip themselves for the purpose of maximizing their subsidy, rather than maximising their catch. In the process, the subsidy has ruined the local coastal fisheries and driven up the price of essential equipment (barrels, for example, have doubled in price from three shillings to six shillings).
The bounty to the white-herring fishery is a tonnage bounty; and is proportioned to the burden of the ship, not to her diligence or success in the fishery; and it has, I am afraid, been too common for vessels to fit out for the sole purpose of catching, not the fish, but the bounty.
Another form of intervention is price controls. The production of grain is an industry that has been subject to such controls. When harvests are poor, the price naturally rises. But when governments then try to help consumers by imposing price limits, it discourages the producers from bringing grain to market, or encourages consumers to buy it up so fast, that the season will surely end in shortages and famine. Bad harvests cannot be prevented: but the best way to temper them is to maintain the unlimited and unrestrained freedom of the farmers and merchants.
Another intervention in markets is import preferences, where particular countries are given the sole right to bring in particular goods, or the right to bring them in at a lower rate of tariff than faced by others. An example is the treaty that allows Portugal to import wines to England at two-thirds of the normal tariff. But while import preferences are obviously advantageous to the merchants and manufacturers of the exporting country, they are inevitably disadvantageous to the receiving country – which thereby denies itself access to world competition and ends up paying more to the monopoly importer.
Colonial trade restrictions
Countries even impose trade restrictions on their own colonies. In line with the mercantilist view, the usual motivation for founding colonies is the prospect of finding gold and silver. Since Columbus, the pious purpose of converting native peoples to Christianity might have sanctified the project, but the real motive was the hope of treasure. That is what carried Ojeda, Nicuesa, and Vasco Nuñes de Balboa to Darien, Cortez to Mexico, and Almagro and Pizarro to Chile and Peru. But the search of treasure is an uncertain and ruinous exercise. It was over a hundred years after the Brazils were first settled, before any silver, gold or diamond deposits were discovered there.
But there are compensations. Colonies that are planted on waste or thinly inhabited land advance more rapidly to wealth and greatness than any other society. The colonists bring with them agricultural and other useful skills. They have the habits of regular government, with the legal system and administration to support it. They have no rent to pay, and few taxes. But the land is so extensive, that even with every available hand, it is unlikely that any owner could make it produce even a tenth of what it is capable of producing.
Owners are eager, therefore, to collect more labourers, and are prepared to reward them liberally for their work. But these high wages, combined with the cheapness of the land, soon enable the labourers to set themselves up as landlords, who will seek to attract workers of their own, paying them equally liberally; and so the cycle continues.
For a new colony to prosper, the key seems to be plenty of good land, and the liberty to manage their own affairs. The English colonies in North America have grown faster than any: land is so cheap, and labour consequently so dear, that they can import from Britain almost all of the manufactures they need. The fact that Britain prohibits them from making certain manufactures in order to maintain a monopoly for its own producers therefore does them little practical harm. As their economy develops, however, such prohibitions could become really oppressive and insupportable.
The policy of forcing the North American colonies to trade only with the home country poses dangers to Britain too. It has drawn Britain's capital away from other markets and concentrated it in the colony trade. An unnaturally large proportion of Britain's industry is therefore at risk in this overgrown market. The threat of the trade being disrupted has accordingly filled the people of Britain with more terror than they ever felt for a Spanish armada or a French invasion.
The only solution to this is to relax the laws that give Britain the monopoly on trade with the colonies, and let other countries trade with them. Capital would then return to the many other uses that the monopoly has starved of it. To avoid doing permanent damage, this trade liberalisation would have to be gradual: for example, the sudden loss of trade to the ships which carry the 82,000 hogsheads of tobacco that Britain then re-exports to other countries, would in itself be a major economic shock.
But such is the mercantile system: it produces large distortions that are then very hard to remedy. The colonial trade monopoly has not boosted industry: indeed, by diverting industry into a market where the returns are slow and distant rather than frequent and near, it has made Britain's capital work less productively and has actually depressed incomes.
Since capital can only come out of income or savings, this means that Britain's capital is accumulated more slowly, and future incomes are lower than they would otherwise have been. Rents too are depressed by the monopoly, since by raising manufacturing profits, it discourages capital from going into land improvement.
And since it also depresses capital accumulation, in the long run, the amount of income earned as profits is smaller as well. In other words, wages, rent and profits are all damaged by the monopoly – just for the benefit of a few manufacturers.
Unnaturally high rates of profit, like those that come from monopoly, seem to destroy merchants' natural thrift. Instead of saving and reinvesting, they spend instead on expensive luxuries, and the capital of the country is consumed rather than accumulated. The exorbitant profits of the merchants in Cadiz or Lisbon, for example, have not augmented the capital of Spain or Portugal, nor promoted the industry or alleviated the poverty of those two beggarly countries.
London merchants enjoy lower rates of profit, but still seem better off. Profit rates in Amsterdam are even slimmer, but its attentive and parsimonious burghers are even wealthier than those in London.
Smith's interest in colonial policy is not entirely academic. He is writing just before the American colonists declared independence from Britain. He wants to advise the British authorities that only greater freedom of trade and more proportionate political representation can head off the crisis.
Unfortunately, his advice came too late. Ancient Rome's refusal to grant the privileges of citizenship to allies who had borne the cost of defending her precipitated the social war. Now, Britain insists on taxing its American colonists, but refuses them parliamentary representation. This has precipitated discontent, and turned the Americans from peaceful tradesmen into militant politicians. The only solution is for Britain to grant representation to the colonies, in proportion to what they contribute to the public finances.
As the colonies grow stronger, it
becomes harder for home nations to unjustly usurp the whole benefit of the trade with them. All they end up with is the expense of maintaining their authority. In the mercantilist system, producer interests come to dominate. But the whole purpose of production is actually consumption, and it is consumer interests that should rightly prevail.
Consumption is the sole end and purpose of all production; and the interest of the producer ought to be attended to, only so far as it may be necessary for promoting that of the consumer.
The agricultural system
The second theoretical system of economics suggests that the product of land is the sole source of national wealth and income. It divides society into three groups: first, the proprietors of land; second, the farmers and farm workers; and third, the artificers, manufacturers and merchants – whom they see as an unproductive class.
Proprietors, they argue, contribute to national income through the expense that they lay out on land improvement, such as buildings, drains and enclosures. Farmers too contribute to national income through their expenditures on husbandry, seed, livestock and the maintenance of farm workers. But in this system, the overall contribution of manufacturers is zero. The benefit of their labour is precisely offset by the cost of their wages, materials, and tools.
They may indeed be useful, adding value to particular parts of what the landowners and farmers produce, but they consume the same amount from elsewhere. They provide the equipment needed to grow wheat or raise cattle, for example, but they consume wheat and cattle products too.
Though unproductive, in the sense that they merely rearrange wealth, this class is still nevertheless very useful to the producers, providing them with markets, equipment and manufactures. The producers have no reason to oppress them: quite the opposite, in fact, since the more liberty they enjoy, the more competition there is between them, and the lower the cost of what they supply. Likewise, the more liberty enjoyed by the other two classes, the greater the surplus that their land produces, and the more there is available for the unproductive class. The best policy for promoting prosperity, according to this system, is one of perfect liberty.
