STL #8: Wealth of Nations Book 4: Impressions

My Thoughts On: April 6th, 2004

Continuing my study into the works of Adam Smith, founder of modern economics, I've finished a very important stretch of his treatise "The Wealth of Nations" by completing Book 4. I've read so much Smith lately that I've begun to get past the dryness and straight to the content. Inside this article, I'll explore the vast implications of this latest book.

My "See the Light" series is dedicated to explaining basic ideas that are important to how we view the world today. Recently I've been consumed digesting Adam Smith's compilation of books, "The Wealth of Nations", which was one of the first attempts to ever explain and justify the basic principles of free market economics that would later come to be called by it's most fervent critics "Capitalism". Yes, it was Socialist opponents to the free market who gave it the name we know today. As you might suspect from a philosophy named by it's enemies, there are many misunderstandings of Smith's ideas, and misunderstandings about their modern relevance. As you could see in my archives of See The Light essays, Books 1-3 were hard, long reads that recapped many important ideas. We continue here with Book 4, "Of Systems of Political Economy", with Smith discussing the theories behind political policy making on trade.

Smith opens by telling us that the two primary concerns of political policy making are sustaining the people while acquiring an adequate fund for government works. Makes sense, after all. In his time, two major political policy models were working, and he discusses those - commercial mercantile systems and agricultural systems.

The commercial mercantile system is rife with the basic misunderstanding that the more money one has, the more wealthy one is. Earlier in the series Smith laid out the groundwork behind the flaws of mindless accumulation of gold (the base unit of money in his time) as a substitute for real wealth. Regardless, at the time money was more important to politicians, and when prohibitions on gold trading were realized as utter failures, merchants lobbied with politicians to create a "balance of trade" - to make sure that between exports and imports there is always the right amount of gold staying in the country, perhaps even tipping the balance in their favor to collect more gold would be best. Well, at least in their minds.

Smith chimes in right off the bat by saying that the complaint of scarcity of money only means that it becomes difficult to borrow - money's value is based entirely on it's scarcity. Wealth does not consist of money, as he made clear throughout the course of his works. Smith's vision of a free market means that real wealth is the national produce. Of that, he explained earlier, money is perhaps the least profitable part of the system, however necessary, it's merely a medium for exchanging things of real value and a measure to estimate real values. The durability of money is not an excuse to accumulate more money than one would want, Smith even goes on to say that wars can be paid for without huge accumulations of money wealth (they can be financed by exporting any number of things). The real benefit of foreign trade is not in importing more money than is taken out, since the value of real national wealth is not really affected much by the accumulation of paper money or even gold/silver coined money. The real benefit lies in carrying out surplus produce for which there is no demand and in it's place bringing back something for which there is.

He goes on to say that the American colonies of Britain (this was written right at the brink of the American revolution) did not benefit Europe by making gold and silver cheaper to acquire (because America was at the time abundant in both metals). It benefited Europe because America provided a huge new market which made the powers of labor more productive. He says that either way, even those who agree wealth doesn't consist of money forgets this in analyzing political policies. So policies tend to lean towards putting restraints on imports of foreign goods (to prevent their money from leaving the country) and encouraging exports (to bring new money in). In 1776, Smith published this work, and in it he said this over and over and over - MONEY is not WEALTH. That is the single virtue understanding of the free market, and more importantly, the system we call "Capitalism". Interesting how easily people forget simple ideas like this.

So, either way, Smith breaks down different types of policies regarding foreign trade, to discuss what really helps and what really hurts real wealth, and what misguided money-hoarding policies actually hurt the economy. Today, just as it was then, high duties and prohibitions on imports are common. Their intended result is to create a domestic monopoly, most policies aiming to create a domestic sector to replace the foreign one. Such policies may encourage a single industry, but it does nothing for general industry, and doesn't give it the best direction. Smith points out that only a certain number of people overall can be employed in a society (there can only ever be so many workmen at any given time, due to the finite limits of national wealth), and domestic monopolies arising from hurting or prohibiting imports divert those limited numbers of workmen to less advantageous aims.

Government doesn't need to get involved to protect domestic trade, Smith says. Domestic business is always inherent because there is the natural land advantage of space favoring doing business at home. Continuing his defense, Smith says that the best person to estimate the best way to produce is the employer himself, not the government officials who are usually not qualified to make that judgement. Trade restrictions force people to direct their capital towards producing at home what they can buy cheaper - it's silly for a nation to make dearer what can be bought cheaper, and the same applies to individuals. Sure, such regulations might make one a trade advance quicker than it would have, but it would most likely make capital grow slower, which is backwards thinking especially considering that sometimes it's not even a necessity to have the trade be domestic at all (sometimes it's better to adopt a total foreign source in favor of creating new domestic industries elsewhere). Such legislation is often a struggle over small advantages here and there, which is a waste of time and energy. The people to profit most from such policies are the businessmen, not the consumers. Taxes to support this system are a hard thing to estimate and the known negative effects are nearly impossible to estimate, despite their prominence.

Next Smith focuses on the restraints put on imports from countries which the "balance of trade" is unequal with. This means, a country where more money is spent on foreign imports than on selling home exports. Economists have for years viewed this situation as "losing" wealth (in fact, they think that to this day regarding America's foreign trade with countries like China and India), but going back to the core teachings of Adam Smith, MONEY is not WEALTH. Smith points out that no foreign trade with a single nation can dictate if the nation's overall imports/exports are uneven with the world, since one nation may import more than it buys while another buys more than it imports, likewise, one might buy a nation's imports only to re-export them for a sizeable profit. More to the point, such trades do not dictate absolutely the overall increase of production (wealth) in a nation. I'll save you the digression Smith goes on about the bank of Amsterdam, since most of that is relevant to a specific banking structure, which I suppose touches on ideas still relevant today but kinda hard to equate.

The sheer idea of a "balance of trade" is utter absurdity, according to Smith. Countries would not trade with each other unless both gained in some way from it. Sure, one country may gain "more" than the other one gains at any given time, but irregardless, they both gain in some way. Both have people who profit in their transactions and if they didn't, they simply wouldn't trade voluntarily. Smith blames the misunderstanding on zealous merchants who seek monopoly power to profit off the backs of consumers, he says that having wealthy neighbors can help a nation and individuals at home become even wealthier. Since real wealth is not money, Smith says the more important balance isn't the balance of money flow, but the balance of production to consumption.

Continuing on, Chapters IV and V both talk about the benefits and problems of drawbacks (special reductions on taxes to encourage trade) and bounties (government grants given to encourage production). Smith warns that drawbacks, while good and probably best if applied to everything, should not be encouraged if they are in the spirit of letting the privileged few gain a monopoly from it. Drawbacks should be granted to independent countries, not oppresive ones which will monopolize trades through their terms. Bounties, on the other hand, force trade into disadvantageous channels. The purpose of bounties is to give businesses the money backing to sell lower in foreign countries, to encourage a rise in exports. What Smith says it does is instead encourages people in foreign trades and domestic trades to stop what they are doing and get into the trade with the bounty, which creates abnormal accumulations of capital in a trade which, by it's own nature, is disadvantageous (if it was a sincerely good trade, who would propose the extra bounty?). Bounties come at the expense of heavy taxation, which also likewise prevents people from putting their capital where it would otherwise go to benefit them most, in the long run sometimes diminishing the very ability of the business they mean to encourage.

But if a bounty (government grant) renders the commodity more profitable, then won't that encourage production, regardless of all these complaints? Smith answers that the effect of the bounty is not to offer a real enhancement to the price of the product, but to simply a way to artificially lower it's price. By having more money, a business can sell lower, and sell more, but the only real enhancement to the price of the product comes from additional production, which is hard to measure. Who knows how much would've been produced had things been left to their natural aims? The businessman, with the handout, often has less incentive to produce any more than they did before, knowing full well that there is the extra gain with no additional work. Produce regulates the price of other produce through competition, so any kind of lowering a price artificially might cause to the national ability to produce will affect all prices negatively in some way. So businessmen do not necessarily benefit at all from the handout.

Smith, as an example, talks about bounties in the corn trade (a stand out market in his time). Governments would price fix corn during hard times and cause famines, Smith said, by ordering corn be sold lower government either stood in the way of it being brought to market or ensured that it left so quickly that there wasn't enough to go around. Smith makes many great points about the corn trade of his time, but that's kinda antiquated so I'll skip through that section some.

In Chapter VI Smith talks about Treaties, which is important considering so many foreign trade deals going on in today's global economy. He opens by pointing out that when a trade deal is exclusive, it benefits the merchants and manufactures by giving them a monopoly over the nation in question, and then naturally hurts the nation that the pact is made obliging the trade to. As a side note, throughout the entire works of Adam Smith, he discusses monopolies a lot, but not free market monopolies that arise from natural competition - monopolies governments make by intervening with their policies to create demand shortages and give private people extra powers to profit from it. That's important because many people think of monopolies as something that arises naturally and requires government intervention to end, not as something that arises on account of government intervention. Getting back on track here, Smith demonstrates through several examples showing how exclusive trading impedes the flow of wealth more than free trading, and that too much worrying about money totals only fixates the problem on a false idea.

Chapter VII was a very interesting analysis Smith launched into colonial settlements, the relationship colonies (like the 13 American colonies that were at the year this book was published, signing a Declaration of Independence to revolt) have with their mother countries. He talks first about how futile the effort of original American explorers were in searching for gold (when they found it, the imagined wealth became a real loss of wealth for those who kept money, because it devalued the value of gold by reducing it's scarcity), and how the real benefits of the American colonies did not come until real produce was made. Colonies on new lands grow fast, and are very prosperous simply because of natural abundance and a lack of people to utilize it. He notes the Americas are growing faster than other major settled colonies (Canada and Brazil being two points of comparison), and that a lack of linear-heritage rights of ownership, moderate taxes, and moderate domination by the mother country are the reasons for it. Most of these other colonies have a single company that comes in, buys up the major resource, and limits the trade aiming to monopolize it. That hurts the overall growth of the colony and the Americas were a major area where those practices were not very prevalent. Britain did limit trade but left many fields of trade unregulated, other colonies (especially the Spanish and Portugeze) were under much harsher administration.

It's interesting to see the stance Smith takes on the American colonies. He says that the policies that Britain sets forth did not hurt the colonies as much as other policies have, and at the same time, claims that they still have not done anything to benefit them either, besides providing an explorer to find the land and a state that was not total anarchy with regards to basic laws. Britain (like other mother nations) sought monopolies on trading with American colonies, which Smith found extremely selfish on Britain's part. He says likewise that the colonies offer a benefit to Britain only in the form of exclusive trade. The colonial monopoly has concentrated capital in Britain towards particular trades when it would otherwise have gone elsewhere, and keeps profit rates very high, benefitting a few at the expense of overall productivity and real growth of national wealth. This also discourages any trade where there is no monopoly, and makes those trades buy and sell less than they otherwise would, allowing foreigners to undersell them. Likewise, the myth that colony trade is better than foreign trade is dispelled with a simple reminder from Smith that distant trade is more roundabout, and that nearby trade is always preferred to distant trade (a basic principle he hit on in earlier books). The monopoly forced trade into distant, roundabout channels, where returns by virtue of their distance are more infrequent. Likewise, the capital of Britain goes into a carrying trade to support the funnelled capital the exclusive monopoly trade causes, diverting even more resources into this one exclusive condition. Smith says that the only reason the effects are not more noticeable is simply because the American trade is so advantageous that in spite of these disadvantages, they still overall benefit to do business. Of course, he goes on to list even more typical disorders caused by this kind of monopoly (reduced wages at home, raised profits, lowered rents, overall reduction of absolute profit, destruction of the original sources of revenue, and it brought in quicker rates of profit - which has historically discouraged saving, which is an important economic vehicle). Then he questions the policy of the exclusive trade as being one solely of merchants and interested businesses (the private interest groups), and makes it much more trouble than it's actually worth. Smith even proposes the American colonies seperate for the advantage of both nations, ironic considering the American colonialists were deciding that for themselves the very same year this book was published.

He sums up by saying that the monopoly of trade even with such a hugely beneficial market like the new American colonies is dazzling but messes up the natural distribution of stock and capital and the rates of wages and profits, preferring distant, somewhat unimportant employments over sensible, relevant nearby trade. The monopoly too prevents the natural balance lowered profits has on a trade, by allowing manipulation of the rate of profit. Smith attacks private companies creating exclusive deals just as he does with nations, saying they have different, but likewise harmful overall effect. The interests of these companies are not the best interests of a nation, however lobbyists have much success distracting politicians from figuring that out. He takes care not to blame so much the men involved, but the system that allows this to happen, and declares such exclusive companies "nuisances". Smith concludes this overview of the commercial mercantile system by saying it unjustly discourages exportation and likewise unjustly encourages importation, and that both policies are not wise. The people who contrive this system are those who profit the most, and they are not to be trusted, if even for their own sakes (as there is a negative effect these things have on overall accumulation of real wealth, which in the end hurts them).

The final chapter of the book discusses the second system that political economies and policy-making can concentrate on, agriculture. It's less lengthy than the previous chapters but full of equally problematic situations. Agriculture should never be viewed as the only productive trade since the labor of those others does in fact increase the real revenue of society. Smith vaunts freedom of trade as the solution to help solve problems with agricultural trade. He notes that even in nations like China, foreign trade and manufactures would be very beneficial, instead of the narrow view on agricultural success. Everything which rises the price of manufactures (such as prohibitions on them or government kickbacks) hurts agriculture, as when profit rates and capital moves to these trades or away from them, it necessarily retards the ability of agriculture to acquire it's appropriate share of trade (the share that meets the real demand better than before).

All this considered, since Smith argues so steadily for free trade, he says in the end that really leaves government for three central duties: the defense of the country, the administration of justice, and the maintenance of certain public works. This is the subject of the final book of his inquiry into the nature and causes of the Wealth of Nations. Thanks for keeping up with me, Smith is dry and I know I can't make it any easier to read than it really is by nature. I will be more than happy to report my findings and finish up this series when I finish reading Book 5.

- Good ol' PA