Adam Smith and Mercantilism
In Adam Smith’s seminal work An Inquiry into the Nature and Causes of the Wealth of Nations (1776), he rejects the basic tenets of mercantilism and argues that the division of labor and the market process it allows for are the phenomena behind economic growth. Yet, almost three centuries later, mercantilism as an ideology remains alive and well among the media, policymakers, and the academy. At the same time, the book’s fundamental question — Why are some nations rich while other nations are poor? — remains an active area of scholarship and public concern. In this video series, F. A. Hayek Program Senior Fellow Donald J. Boudreaux answers questions about Adam Smith and mercantilism, both in the past and present, and explores the Smithian foundation of mainline economics.
Adam Smith’s Stance on Mercantilism
In The Wealth of Nations, Adam Smith discussed the importance of trade and the issues of mercantilist policies. Can you briefly describe his stance?
According to Boudreaux, Smith criticizes the mercantilist view of both aspects of the inquiry of the nature and causes of the wealth of nations, as his tome’s title highlights. Mercantilists argue that a nation’s wealth is tied to its stocks of money, particularly the acquisition of precious metals. By this logic, any money leaving a country — including money traded for imports — means a loss of national wealth. As a result, mercantilists advocate for protectionist trade policies.
Smith rejects this view. He contends that the cause of the wealth of nations is not the acquisition of precious metals but the division of labor, which allows individuals to specialize in skills at which they excel and to trade with others for goods and services they need to survive and thrive. As the extent of the market grows, so does the wealth and standard of living of those in society. Indeed, for Smith, the nature of a nation’s wealth is not its money stocks, as “the most abundant mines either of the precious metals or of the precious stones could add little to the wealth of the world.”[1] Instead, wealth consists of the real goods and services exchanged in the market; money is merely the medium of exchange for satisfying demands and securing wealth.
Smith criticizes the mercantilist view of both aspects of the inquiry of the nature and causes of the wealth of nations, as his tome’s title highlights.
To what extent was Smith influenced by the Physiocrats who heavily criticized mercantilists earlier?
Smith was not alone in his disagreements with the mercantilists, offers Boudreaux in this second video. In fact, he was heavily influenced by a group of free-trade supporters known as the Physiocrats. Among them was François Quesnay, who is credited with coining the term “laissez-faire”[2] and whom Smith mentions by name in The Wealth of Nations. Though Smith was influenced by the Physiocrats’ stance on free trade, he disagreed with their understanding of value. The Physiocrats believed that all wealth was ultimately derived from land and agriculture. As a result, they argued that commerce and manufacturing were not productive undertakings, which Smith rejected.
Is it wise to use protectionist policies to bolster national defense? What was Adam Smith’s position on this policy?
One of the most common justifications for tariffs, even among supporters of free trade, is national defense. The argument is as follows: we should refrain from relying on other countries for goods that might be necessary in wartime so that we do not find our supply of those goods suddenly cut off if we get into a war with them or their allies. Smith does acknowledge a political exception for tariffs for the purpose of national defense, though he emphasizes that these tariffs impose an economic cost, just like any others.
This exception, however, should also be understood in conjunction with Smith’s skepticism that politicians will not incur unnecessary expenses in trade policy: “Let [politicians] look well after their own expense…If their own extravagance does not ruin the state, that of their subjects never will.”[3] Politicians could easily abuse this genuine exception by using it as an excuse to impose wide-ranging tariffs on goods that have little to do with national defense.
Adam Smith says that there are certain situations in which it is a matter of deliberation whether to enact tariffs if another country does the same. How can we make the case for free trade when supporters of tariffs quote Smith on this point?
Building off of the last video, Boudreaux notes that Smith makes an economic exemption to a policy of free trade: retaliatory tariffs. In principle, if one nation were to enact a tariff against another, the targeted nation could pressure the offending nation into reversing its policy by retaliating with another tariff. Smith recognizes the cost of this policy, but he writes that the cost is justified by the benefit: were such tariffs to be effective, “the recovery of a great foreign market will generally more than compensate the transitory inconveniency of paying dearer during a short time for some sorts of goods.”[4]
However, Smith does not guarantee that retaliatory tariffs will achieve their desired goal. First, he cautions that it is not wise statesmen who determine tariff rates, but rather politicians “whose councils are directed by the momentary fluctuations of affairs.”[5] Since retaliatory tariffs could produce short-term political gains but incur long-term economic costs, relatively short-sighted politicians have misaligned incentives. Second, according to Smith’s student and biographer Dugald Stewart, Smith’s acknowledgment that retaliatory tariffs could work in theory did not constitute support of such tariffs but merely recognition of their logical possibility.[6] In fact, historical evidence shows little success in the use of retaliatory tariffs. Multilateral agreements, rather than retaliatory tariffs, have been the most effective for lowering tariff rates.
Contemporary Mercantilism
What does the mercantilist debate have to say about current debates surrounding industrial and trade policy?
Trade policy has been a popular topic for decades, but it is especially prominent today. And though in the past Americans have been reticent to openly embrace mercantilist principles, the last few years have seen a reemergence of what Boudreaux calls “proud mercantilism” on both sides of the aisle. Proud mercantilism often manifests in industrial policy, a kind of protectionism that uses import tariffs and export subsidies to choose economic winners and losers from domestic industries. The justification for this policy is an extension of mercantilism’s proposition that trade is a zero-sum game: no nation can get rich without impoverishing another. However, the rapid global economic growth over the last 200 years debunks this theory by showing that it is possible for all nations to experience simultaneous economic growth.[7] In fact, industrial policy is more likely to harm the global economy than help any one nation, although it will benefit the particular industries and companies protected by the policy. As Smith writes, “[Protectionism] comes from an order of men, whose interest is never exactly the same with that of the publick, who have generally an interest to deceive and even oppress the publick, and who accordingly have, upon many occasions, both deceived and oppressed it.”[8]
What recent versions of mercantilist policies hamper trade relations today?
Though many parts of our present-day reality would be unfamiliar to Adam Smith, our trade rhetoric would sound all too familiar. From exceptions for national security to retaliatory tariffs and from protectionist impulses to industries campaigning for concentrated benefits, the fundamentals of the trade debate have not changed since Smith wrote The Wealth of Nations. Although the countries that bear the brunt of trade-related fears change over time — Boudreaux names Japan and China as examples [9] — protectionists continue to maintain that industrial policies are necessary for economic growth.
The market process and resulting trade, not industrial policy, deserve the credit for economic growth.
However, by erecting barriers to trade, modern mercantilism hampers the very economic growth it claims to advance. Since World War II, the global economy has grown while tariffs have simultaneously decreased. Boudreaux explains that Japan’s industrial policy hindered rather than helped its economy, and China grew after transitioning from central planning to a market economy, not the other way around. The market process and resulting trade, not industrial policy, deserve the credit for economic growth.
Is it feasible to do away with balance-of-trade accounting?
Mercantilism began with concern for trade’s effect on the royal household, and for the monarchies of the time, it was not a far leap from accounting for the royal household to the entire country. Balance-of-trade, or international trade, accounting reflects this aspect of mercantilist thought by attributing common household economic indicators, such as budgets and incomes, to countries. However, countries do not have budgets and incomes in the same way that households do, so it is not as much of a cause for concern if a country imports more than it exports.
For instance, the most prominent feature of international trade accounting is the trade deficit. A trade deficit is often assumed to be a sign of impending doom, but it is nothing of the sort. In the simplest terms, the United States runs a trade deficit when it receives more goods and services from other nations than it sends abroad — but other nations are not sending us free goods out of pity, nor are they hoarding the dollars that Americans spend on their exports. Those dollars are used to invest in new ventures and to buy goods and services, fueling the global economy. This outcome is hardly worthy of alarm. Yet, few ideas are as adept at stirring up economic anxiety as the trade deficit, making international trade accounting useful fodder for demagogues.
How important are ideas in terms of policy? For example, most economists today would agree that tariffs reduce general welfare, and yet they still exist to a great degree.
Humans are an ideas-driven species. We communicate with each other not only to warn each other of impending danger as other species do, but also for the purpose of transferring and discussing ideas. Those ideas are crucial for human interaction and societal coordination: the formal institutions that affect our political, economic, and social lives are unlikely to stick unless they are supported by informal institutions such as ideas.[10] Put simply, ideas matter, and promoting good ideas and debunking bad ones is of paramount importance. Deirdre McCloskey advances this line of thought in her Bourgeois Trilogy, in which she posits that the “Great Enrichment” — the explosion in global economic growth that occurred during the last few centuries — resulted from increasingly favorable views of commerce, trade, and entrepreneurship. McCloskey argues that seeing those pursuits as noble rather than merely tolerable enabled unprecedented economic growth.[11]
The Wealth of Nations itself is one example of the power of ideas. Though Smith invented neither capitalism nor self-interest, he explained how the market works and extolled its benefits. His work further paved the way for the wider acceptance of the market that, according to McCloskey, was necessary for economic growth. Ideas have power: Smith’s ideas and those of his contemporaries changed history.
The Story of Society
If Adam Smith explains what wealth actually means, why do you think there are economists that do not get it yet? What economic theory supports their position?
Generally, economists understand markets and trade better than non-economists, but the economic profession’s understanding of markets and trade has diminished in recent years, Boudreaux contends. Economists have turned from big questions to narrow analyses, viewing economics as an observational, objective science. Though economics is indeed a science, it is a social science of complex, ever-changing societies rather than replicable natural phenomena. Studying economics is a matter of not only collecting data, but also understanding the stories behind them.
Studying economics is a matter of not only collecting data, but also understanding the stories behind them.
In a 1986 paper, Don Lavoie draws from F. A. Hayek’s work to distinguish between knowledge, which is inarticulate and personal, and data, which are articulate and objective.[12] Statistics are important, but they cannot speak for themselves. Allowing them to do so separates cut-and-dry data from the unarticulated knowledge behind them. Smith illustrates this principle in The Wealth of Nations by presenting data through the lens of theory, telling a story about what he observes.
Data must be contextualized in the story of society, and to tell that story, economists need to engage with society in all its complexity. This requires not only a solid grasp of basic economic theory — including the works of Armen A. Alchian, Ronald H. Coase, James M. Buchanan, and Harold Demsetz — but also an understanding of fields like philosophy, history, political science, and literature. As F. A. Hayek put it, “Nobody can be a great economist who is only an economist.”[13]
Today, the profession of economics seems divided into so many subdisciplines, whereas Smith’s economics seemed more general, interdisciplinary, and philosophical. Do you think economics should go back to those roots?
Despite the many economic textbooks depicting dollar signs on their covers, economics is not the study of money, Boudreaux observes. Instead, it is an aspect of the study of society, and society is composed of human beings who (among other interactions) exchange with one another. James M. Buchanan recognizes this in his 1963 Presidential Address to the Southern Economic Association (SEA) entitled “What Should Economists Do?”[14] Buchanan argues that economists should return to their Smithian roots by studying human beings’ unique “propensity to truck, barter, and exchange.”[15]
In a way, Buchanan is warning economists against viewing society through a mercantilist lens. At the time that Buchanan gave his SEA Presidential Address, mainstream economics had become a science of resource allocation. Economists analyzed society as if it was one big household or firm. Yet, although a household or firm has a set of purposes, society does not. Rather, society emerges from the interactions of purposeful people. Instead of measuring economic activity against the national interest or social welfare, Buchanan argues, economists should return to studying interactions between individuals, making economics a study of society and exchange once again.
Mercantilism and Beyond: The Smithian Foundation of Mainline Economics
Adam Smith’s response to mercantilism in The Wealth of Nations was more than a commentary on industrial policy. By addressing the misunderstandings of trade, productivity, and wealth at the core of mercantilist thought, Smith was actually addressing the enduring question: Why are some nations rich and others poor?
In the two and a half centuries since Smith first wrote The Wealth of Nations, a subset of social scientists has explored the facets of this question within the tradition of what Peter Boettke calls mainline economics. Mainline economists, among them Nobel Laureates F. A. Hayek, James M. Buchanan, and Elinor C. Ostrom, have produced wide-ranging research about property rights, the price system, bureaucracy, voting, and bottom-up collective action. Despite its diversity, however, their work builds on a common foundation: a Smithian understanding of economics as a study of society.
Donald J. Boudreaux is a Senior Fellow with the F. A. Hayek Program for Advanced Study in Philosophy, Politics, and Economics at the Mercatus Center at George Mason University, a Mercatus Center Board Member, and a professor of economics and former economics-department chair at George Mason University.
Read More:
- Peter J. Boettke, Stefanie Haeffele, and Virgil Henry Storr, eds., Mainline Economics: Six Nobel Lectures in the Tradition of Adam Smith (Arlington, VA: Mercatus Center at George Mason University, 2016).
- Donald J. Boudreaux, “The Case for and Against a Policy of Unilateral Trade Liberalization,” Mercatus Policy Brief (Arlington, VA: Mercatus Center at George Mason University, November 19, 2020).
- Donald J. Boudreaux, “Today’s Relevance of Adam Smith’s Wealth of Nations,” The Independent Review 24, no. 4 (2020): 487–97.
Notes:
[1] Adam Smith, An Inquiry into the Nature and Causes of the Wealth of Nations, 2 Volumes, R. H. Campbell and A. S. Skinner, eds., William B. Todd, textual ed. (Carmel, IN: Liberty Fund, 1982), Volume I, Book I, Chapter 11, 192.
[2] “François Quesnay,” Econlib, Accessed March 3, 2021, https://www.econlib.org/library/Enc/bios/Quesnay.html.
[3] Smith, Volume I, Book II, Chapter 3, 346.
[4] Smith, Volume I, Book IV, Chapter 2, 468.
[5] Smith, Volume I, Book IV, Chapter 2, 468.
[6] Dugald Stewart, Account of the Life and Writings of Adam Smith, L.L.D. (London: Henry G. Bohn, York Street, Covent Garden, 1853), https://oll.libertyfund.org/title/smith-the-theory-of-moral-sentiments-and-on-the-origins-of-languages-stewart-ed#lf1648_head_001.
[7] “History’s Hockey Stick: Real Gross Domestic Product per Capita (1000–2016) Using the Ratio Scale,” Our World in Data, Accessed February 18, 2021, https://ourworldindata.org/grapher/historys-hockey-stick-real-gross-domestic-product-per-capita-finn-using-the-ratio-scale.
[8] Smith, Volume I, Book I, Chapter 11, 267.
[9] John West, “As Global Protectionism Rises, Japan Emerges as Asia’s Free Trade Champion,” BRINK, May 30, 2019, https://www.brinknews.com/as-global-protectionism-rises-japan-emerges-as-asias-free-trade-champion/; Weizhen Tan, “US-China Cold War and Rising Protectionism Could Split World Order,” CNBC, September 25, 2019, https://www.cnbc.com/2019/09/25/us-china-cold-war-and-rising-protectionism-could-split-world-order.html.
[10] Peter J. Boettke, Christopher J. Coyne, and Peter T. Leeson, “Institutional Stickiness and the New Development Economics,” American Journal of Economics and Sociology 67, no. 2 (2008): 331–58.
[11] Deirdre N. McCloskey, The Bourgeois Virtues: Ethics for an Age of Commerce (Chicago: University of Chicago Press, 2006).
[12] Don Lavoie, “The Market as A Procedure for Discovery and Conveyance of Inarticulate Knowledge,” Comparative Economic Studies 28 (1986): 1–19.
[13] F. A. Hayek, “The Dilemma of Specialization,” in Studies in Philosophy, Politics and Economics (Chicago: University of Chicago Press, 1967), 123.
[14] James M. Buchanan, “What Should Economists Do?,” Southern Economic Journal 30, no. 3 (1964): 213–22.
[15] Smith, Volume I, Book I, Chapter 2, 25.
