The Wealth of Nations. The Theory of Moral Sentiments

Under the mercantile system, wealth consists of money. Under such a system, a wealthy person or nation is one who has accumulated great quantities of gold and silver. The mercantilist system then, prioritizes accumulating large quantities of gold and silver by any means, and consequently favors foreign trade and colonizing, but disfavors allowing that money to leave the nation. Mercantilist nations, as Smith illustrates, frequently have prohibitions on exporting gold and silver, and base much of their policy on obtaining more gold and silver.

Smith argues that the mercantilist system emphasizes to too great a degree exporting goods for the purpose of accumulating gold and silver. He argues instead that domestic trade, which is ignored by mercantilists, is more important to the growth of a nation’s economy. Smith argues that most wealth is created and consumed domestically, that wealth does not consist of money but rather of commodities and labor, and that the more frequently money changes hands, the more valuable it is.

Smith argues that the North American colonies did not enrich Europe by providing them with gold and silver, but rather by providing them with a new market for European goods and the importation of new goods. Smith explains that gold and silver have no more exchangeable value than any other commodity, and therefore that it wasn’t the exportation of gold and silver from the colonies that enriched the motherland, but rather the opening of a new market for trade of all goods. He argues that the sole benefit nations derive from trade is that of allowing nations to exchange their surplus for something, which satisfies their own needs.

Smith explains:

By restraining, either by high duties, or by absolute prohibitions, the importation of such goods from foreign countries as can be produced at home, the monopoly of the home market is more or less secured to the domestic industry employed in producing them (142).

Smith’s argument is that restraints on trade benefit specific domestic industries by granting them an advantage, but disadvantage domestic purchasers of those goods by ensuring a higher price than would have been demanded under conditions of free trade. Because of this, Smith reasons that such restraints can never benefit a nation. He reasons that when foreign goods are cheaper to purchase than domestic goods, it’s wasteful to make the goods domestically. Smith proposes that a better course of action is to purchase the foreign goods cheaply and redirect the domestic resources to where they can be most productively utilized. Smith’s analysis relies on the free market to determine prices without the nuisance of government intervention. Smith identifies as situations in which trade should be restricted only those industries necessary to war and in response to restrictions imposed by other nations. 

Smith argues in favor of freedom of trade on three counts: (1) even if the balance of trade between two nations favors one of those nations, it does not mean that the other nation is disadvantaged by such trade; (2) goods traded for, even in an unfavorable relationship, may be re-exported to other nations, where they are sold at a profit; (3) no criterion exists by which to judge favorable or unfavorable trade between two nations.

He argues against a prevailing doctrine at the time of the balance of trade, which “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” (154). Smith explains that all free exchanges are fair and balanced. The only measure of whether a given trade is advantageous or disadvantageous is whether the parties agree to the deal. Therefore, Smith argues, there should be no restrictions on trade.

Smith further contends that tariffs on foreign goods hurt a nation because nations are more likely to grow rich from trade if their neighbors are also rich, industrious, commercial nations, rather than if they are poor. While the wealth of neighboring nations can be a threat in times of hostility, by permitting them to maintain superior armies, during peacetime, wealthy neighbors make good trading partners, permitting both nations to grow even wealthier together.

These two arguments comport with Smith’s assertion that a free market is the best economic system. He argues in favor of free trade, even when one’s side is ostensibly on the losing end of the deal, and argues that a nation should wish to enrich the fortunes of their neighboring countries, so they may grow rich together from trade.

Smith disapproves of any interference with the free market. Of the several interferences on foreign trade—drawbacks, bounties, and treaties of commerce—he views drawbacks to be the least harmful. Drawbacks are the practice of an exporter claiming back domestic tax, or reclaiming import duties upon re-export. Smith’s believes drawbacks, rather than benefiting industry, restore it to what its natural level would have been in the absence of the original tax. Because drawbacks bring the part of the economic system they address closer to the natural state of a free market, Smith views them as the least disadvantageous imposition on trade. However, he notes that the complex nature of the drawback rules invites fraud.

Modern terminology refers to bounties as subsidies on exports. In Smith’s era, and today, industries petition the government for bounties, or subsidies, which are payments to producers of certain commodities intended to ensure production of that particular commodity regardless of fluctuations in market and price conditions, and allow the commodity to be priced more competitively when traded internationally. Smith explains the logic behind bounties as such: “A greater quantity, it is said, will thus be exported, and the balance of trade consequently turned more in favour of our own country” (159).

The objective of bounties in mercantilist theory is to increase foreign trade in industries that would be unprofitable without them, which would have the effect of bringing more gold and silver to the home country. Smith’s argument against bounties is that if merchants did not receive the bounty, they would invest their capital in more profitable industries, thus restoring the market to its natural perfection. Smith claims that subsidies produce a double tax on the public. The public must pay to finance the subsidy and then again in the increased price of the commodity, which they could have purchased from a less expensive source.

Treaties of commerce permit countries exclusive rights to import goods at a lower tariff than offered to other countries. Such treaties grant nations monopolies on the international trade of specified goods between the parties to the treaty. Smith explains that such treaties benefit the merchants and manufactures in the exporting country, but are disadvantageous to the receiving country because they deny the country access to freedom of trade and potentially lower prices from other suppliers.

Here, Smith engages in a lengthy analysis of colonies, those both historical and current to his time. He includes the factors required for their prosperity, and their benefits and disadvantages to their mother countries. He notes that the colonies of ancient Greece and Rome were created out of necessity as the population increased. He states of the European colonies in America:

The establishment of the European colonies in America and the West Indies arose from no necessity; and though the utility which has resulted from them has been very great, it is not altogether so clear and evident. It was not understood at their first establishment, and was not the motive, either of that establishment, or of the discoveries which gave occasion to it; and the nature, extent, and limits of that utility, are not, perhaps, well understood at this day (176).

Smith concludes that the American colonies were founded simply to mine gold in the furtherance of mercantilist objectives.

Smith addresses the causes of prosperity among certain colonies and lack of prosperity among others. He notes as the chief causes of prosperity for the British colonies in North America an abundance of land and natural resources, and the British policy of remaining out of their affairs as much as possible. Smith believes that the colonies contain the necessary ingredients for economic progress, and that the British colonies have succeeded, while the French and Spanish have failed, because the British infrequently meddle in the colonists’ affairs. British colonists are permitted their own government, which they fund with their own taxes, and regulate themselves as they see fit, without interference from the crown. Further, Britain collects few taxes and meddles in the trade of its colonies infrequently, forcing very few exclusive trade restrictions and permitting the colonies to grow on their own.

Smith contends that the practice of forcing American colonies to trade certain goods only with their mother countries both inhibits the growth of the colony and hurts the trade of the mother country as well. He analyzes that such practices remove capital from other markets and concentrate it in the colonies, placing an unnaturally large proportion of their industry at risk in a distant, risky, and overgrown market. Smith concludes that rather than creating economic progress, the colonial trade conducted in this manner has instead diverted capital into distant markets where it garners slow returns, rather than the more frequent and larger returns that could be achieved by utilizing such capital in domestic trade. In this manner, the colony trade has decreased European productivity and depressed wages.

Smith’s solution is to relax the rules granting European countries trade monopolies with their colonies, and to permit free trade among the colonies. Smith’s true belief is that the colonies should be abandoned as a losing venture and left to govern themselves as independent states, but he pragmatically notes that will not happen except by means of rebellion of the colonies. The best option then, is to permit them free trade and self-governance. 

Smith summarizes his objections to the mercantile system. Mercantilist policies benefit a wealthy few who endeavor to influence legislation in their favor, while hurting most of a nation. Smith states of mercantilist policies that encourage exporting goods, but discourage importing anything but gold and silver, that “the effect of these regulations has been to depress the price []” (207).

He contends that mercantilist policies artificially redirect trade away from domestic markets, which are more economically productive than foreign markets. Smith argues that consumption is the purpose of all production, and that the consumer’s interests should be given priority to the producer’s interests, but that the mercantile system has plainly done the opposite:

But in the mercantile system, the interest of the consumer is almost constantly sacrificed to that of the producer; and it seems to consider production, and not consumption, as the ultimate end and object of all industry and commerce (210).

Smith’s conclusion, in plain terms, is that the mercantile system has been developed by merchants for the benefit of merchants, at the expense of everyone else.