The Profound Wisdom—And Humanitarianism—Of Adam Smith

Born three hundred years ago, the Scottish thinker developed key insights into economies and the people who inhabit them

By David R. Henderson. He discusses both The Theory of Moral Sentiments and An Inquiry into the Nature and Causes of the Wealth of Nations as well as the American colonies (Smith made a good prediction). Here is an excerpt on economic policy:

"Mercantilism, protectionism, and free trade

One of Adam Smith’s major accomplishments was his systematic critique of mercantilism, along with his critique of protective tariffs and his defense of free trade.

Mercantilism, in brief, is the idea that the way for a nation to get rich is to limit its imports and increase its exports. The goal is to have exports exceed imports so that the country builds up its stock of specie (gold and silver).

Smith argued that wealth “does not consist in money, or in gold and silver; but in what money purchases, and is valuable only for purchasing.” Acquiring an unnecessary amount of gold and silver, he argued, “is as absurd as it would be to attempt to increase the good cheer of private families by obliging them to keep an unnecessary number of kitchen utensils.”

Because Smith was so aware that people in one nation trade with those in another only when they expect to gain, there was no particular reason for one nation to have a balance of trade with another. He wrote:

When two places trade with one another, this [balance of trade] doctrine supposes that, if the balance be even, neither of them either loses or gains; but if it leans in any degree to one side, that one of them loses and the other gains in proportion to its declension from the exact equilibrium.

But both sides gain whether or not there’s a balance.

Not surprisingly, therefore, Smith was a foe of protectionism. He argued that to give a “monopoly of the home market to the produce of domestic industry, in any particular art or manufacture, 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. If the produce of domestic can be brought there as cheap as that of foreign industry, the regulation is evidently useless. If it cannot, it must generally be hurtful.” Just as he analogized nations gaining gold and silver to households gaining excess kitchen utensils, Smith wrote that it “is the maxim of every prudent master of a family never to make at home what it will cost him more to make than to buy.”

To drive the point home, Smith wrote:

What is prudence in the conduct of every private family can scarce be folly in that of a great kingdom. If a foreign country can supply us with a commodity cheaper than we ourselves can make it, better buy it of them with some part of the produce of our own industry employed in a way in which we have some advantage.

Incidentally, while economists, including me, have always said that we had to wait until James Mill and David Ricardo to get the economists’ theory of comparative advantage, one can see the seeds of that theory in the last sentence of the above quote.

We often hear people, even today, claim that we should produce goods here rather than buy them abroad. To that idea, Smith had a beautiful reductio ad absurdum. He wrote:

By means of glasses, hotbeds, and hot walls, 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.

Then he followed with a rhetorical question: “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?” Smith’s point is that if we are willing to do things more expensively, it’s possible to produce everything at home. But why do that when we can buy cheaper abroad and deploy our labor and capital in more efficient ways? This applies whether producing at home is thirty times as expensive or only 20 percent more expensive.

Industrial policy

Although the term “industrial policy” was not used during Smith’s day, Smith nevertheless had a trenchant critique of industrial policy. He wrote:

What is the species of domestic industry which his capital can employ, and of which the produce is likely to be of the greatest value, every individual, it is evident, can, in his local situation, judge much better than any statesman or lawgiver can do for him. The statesman who should attempt to direct private people in what manner they ought to employ their capitals would not only load himself with a most unnecessary attention, but assume an authority which could safely be trusted, not only to no single person, but to no council or senate whatever, and which would nowhere be so dangerous as in the hands of a man who had folly and presumption enough to fancy himself fit to exercise it.

We can even see in this passage the seeds of Hayek’s insights into why socialism won’t work: the socialist planners don’t have, and can’t have, the information needed to plan an economy because this “local knowledge,” a term used by economists in the Hayek tradition, exists in the minds of the actual players.

Smith on antitrust

Many people, including economists, often recruit Smith to make their case for antitrust laws, using the following quote:

People of the same trade seldom meet together, even for merriment and diversion, but the conversation ends in a conspiracy against the public, or in some contrivance to raise prices.

This quote shows Smith’s hard-headed, unromantic view of businessmen and even, possibly, of laborers.

Rarely do those who thus argue for antitrust quote the next two sentences:

It is impossible indeed to prevent such meetings, by any law which either could be executed, or would be consistent with liberty and justice. But though the law cannot hinder people of the same trade from sometimes assembling together, it ought to do nothing to facilitate such assemblies; much less to render them necessary. (italics added)

Smith even went on to point out that one way government facilitated such assemblies was by requiring people in a particular trade to enter names and addresses in a government registry. Today, of course, government regulation has gone way beyond what Smith observed. People in various businesses have conventions at which they discuss how to deal with and possibly influence government regulation. While there, they might collude. Smith would probably not be happy that extensive government regulation has facilitated that."