The Answer Is Transaction Costs

Adam Smith Episode 7: The Errors of Mercantilism--Bullion, Balances, and Bounties

• Michael Munger

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Tracing out Adam Smith’s Book IV, chapters 1–6, to show how mercantilism mistakes money for wealth, how protection creates monopolies at home, and why free exchange raises real prosperity. Smith defends two narrow exceptions—defense and tax parity—while rejecting bounties and politicized treaties that entangle trade with war.

• mercantile vs physiocratic systems and their influence
• wealth as goods and industry, not specie
• balance of trade as a “pestilent error”
• make-or-buy logic and misallocation from tariffs
• invisible hand clarified and limited
• natural vs acquired advantages in specialization
• two exceptions: national defense and tax parity on imports
• drawbacks as refunds vs bounties as subsidies
• corn bounties, higher home prices, cheaper foreign prices
• specie hoards as dams that inevitably overflow
• treaties of commerce, Methuen example, political risk
• case for unilateral free trade over reciprocity

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If you have questions or comments, or want to suggest a future topic, email the show at taitc.email@gmail.com !


You can follow Mike Munger on Twitter at @mungowitz


Read the transcript.


This is Mike Munger, the knower of important Things from Duke University. This is episode seven of the series on Adam Smith and The Wealth of Nations. This series is produced in cooperation with AdamSmithWorks at Liberty Fund, and I'm pleased to acknowledge the partnership of Amy Willis. This episode takes up book four of the Wealth of Nations, which is entitled “Of Systems of Political Economy.” Now, book four is long and complex. We're only going to cover chapters one through six in this episode. Next month, in December, we'll take up chapters seven, eight, and nine, but even just the first six chapters of Book four give us plenty to work on straight out of Creedmore. This is TAITC.


 00:00:52


When it is costly to transact, institutions matter, and it is costly to transact. As I said, the title of book four is “Of the Systems of Political Economy” and not surprisingly, it is a very long book compared to the other parts of Wealth of Nations because it's a big subject. This is also what Smith has been building up to talk about the different systems of political economy because in the fifth book he wants to talk about public finance. That is what is the implication of all of this economics for what people, governors, legislators, magistrates should actually do. Title of book four says “Systems of Political Economy.” Title of chapter one is “Of the principle of the commercial or mercantile system.” So before we can think about the systems, he wants to talk about on what principles do they operate. He examines at the beginning two major systems of political economy that he says have guided European policy, the commercial or mercantile system which identified national wealth with money, gold, silver, and emphasized favorable balance of trade because wealth constituted the accumulation of gold and silver species.


The second system, the agricultural system or physiocracy, claimed that land and agricultural labor alone were the sources of true wealth. Now we talked about that a little bit in Book Three, but it's important in Book Four, although he spends most of his time in Book Four talking about the mercantile system. Smith notes that both of these systems influence policy across Europe, but that the mercantile system had been dominant in Britain and most trading nations. While the agricultural system was more influential in France, thanks to the people that Smith knew- [Pierre-Samuel] DuPont Nemours, [Francois] Quesnay, and the Physiocrats, the term Physiocrats originates from the Greek word phy for nature and kratos for power, meaning the rule of nature or the power of nature. And as we heard last time, laissez faire, it's supposed to represent a deference to the rule of nature or the power of nature. We're supposed to let the natural course of things play out.


In 1767, DuPont Nemours had published a book called Physiocracy or The Natural Constitution of Government Most Advantageous to Mankind and that he tried to highlight the importance of the word physiocrats. He had some sense of advertising and if you're going to be a school, you have to have a name. DuPont highlighted the central doctrine, which is natural order governing economic life through reason and science which government should respect. Now what's interesting is that science doesn't guide for DuPont de Nemours, and the Physiocrats’ science showed the reason that the economy need not be guided and that's very different from the modern progressive movement and a lot of Keynesian economists. So DuPont Nemours distinguished the physiocrats from other reformers by giving them a clear school identity. So when Smith refers to the system of the economists in the Wealth of Nations, he generally means the Physiocrats.


He usually called them the economists rather than the Physiocrats, but he was fully aware he corresponded with DuPont Nemours quite a bit, that they had that brand name. The central problem of Book Four is to identify the fact that political economy has two aims to provide a plentiful revenue or subsistence for the people, which increases the wealth of the nation by raising production and consumption and to supply the state with revenue to support public services. Especially defense. Smith thinks that defense is the central job of the state, and he will accept that revenue and subsistence for the people must sometimes give way to the problem of supplying the state with enough revenue to do public purposes such as defense. So he argues that systems of political economy should be judged by how well they achieve those two ends. Argument of Book Four is to try to show that the mercantile system distorted both policy and public understanding by equating wealth with money.


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So in chapter one he takes up the mercantile system in his view, the mercantile system. The basic assumption is that wealth consists in money or gold and silver, and there's something to that on just prima facie. These precious metals are universally accepted as payment governments and merchants came to identify them with the very essence of wealth that led to the balance of trade doctrine. Balance of trade doctrine is that if a country exports more goods than it imports, it would receive the balance in gold and silver and by that means becomes wealthier. If though it imports more than it exports, it loses wealth and becomes poorer. And so the central thermometer that we use to gauge the health of an economy is the balance of trade. Smith outlines the core mercantilist policies that flow from that principle. First, you want to encourage exports through subsidies, bounties, and protective measures to sell more abroad.


Second, you want to discourage imports, use tariffs, duties, outright bans on foreign goods. The imports of necessities, raw materials for domestic manufacturer were tolerated, even encouraged, but imports of finished goods were restricted in some cases almost prohibited. The system in effect aimed to create a perpetual favorable balance of trade to bring in bullion gold and silver or Smith also calls it plate Smith immediately criticizes the identification of wealth with money just on its face. So before we get to gold and silver, all of money is not wealth, money is not wealth in itself. It is merely a means of circulating goods and that's why Smith calls it the great wheel of commerce. A rich nation is not one with a full treasury of gold but one that has plentiful goods, abundant industry and labor that is devoted to productive rather than non-productive activities. By confusing money with wealth, mercantilist policy distorts the true end of economic activity and actually fails to accomplish either of the two objectives.


Remember, the two objectives are to have a prosperous opulent society of the people and to enable the state to be able to raise the revenues it needs to defend and carry out public policies. And if your focus is on gold rather than production, you'll fail in both of those things. Smith here anticipates what we would later identify with Bruce Yandle's Baptists and Bootleggers model of public policy and regulation. Smith points out the mercantile system of appealed to a lot of people's common sense. That is they thought, well that sounds right, that wealth is money and to merchant's interest because it is certainly true that giving people money to export and making people pay in order to import secures in effect a monopoly for the merchant interests of the domestic country. And of course that means they make a lot of profits they don't earn or they're not entitled to any of those profits because this is something that's happened as a result of public policy.


But that combination of a belief system and economic interest we now call the Baptist and Bootleggers model, but Adam Smith makes basically exactly that argument for how mercantilism spread and why it is so powerful to hear his discussion. I've quoted part of this before, but to hear his discussion about money and wealth, let's start on page 4 38. It's in book four, chapter one, page 438. 


It would be too ridiculous to go about seriously to prove that wealth does not consist in money or in gold and silver but in what money purchases and is valuable only for purchasing money. No doubt makes always a part of the national capital, but it has already been shown that it generally makes what a small part and always the most unprofitable part of it. It is not because wealth consists more essentially in money than in goods that the merchant finds it generally more easy to buy good with money than to buy money with goods. 

But because money is the known and established instrument of commerce for which everything is readily given in exchange, but which is not always with equal readiness to be God in exchange for everything, the greater part of goods besides are more perishable than money and he that is the merchant may frequently sustain a much greater loss by keeping them when his goods are upon hand too. He is more liable to such demands for money as he may not be able to answer than when he has got their price in his coffers. Over and above all this, his profit arises more directly from selling than from buying and he is upon all these accounts generally much more anxious to exchange his goods for money than his money for goods. But though a particular merchant with abundance of goods in his warehouse may sometimes be ruined by not being able to sell them in time, a nation or country is not liable to the same accident.The whole capital of a merchant frequently consists in perishable goods destined for purchasing money, but it's a very small part of the annual produce of the land and labor of a country which can ever be destined for purchasing gold and silver from their neighbors. 


Well, it's a very modern way to think of money when he says that we might use wheat, corn or manufacture products to purchase gold from another country. We tend not to think of it that way because we think that money is wealth, but do we need more gold and silver? Should we actually pay taxpayers money to try to send our products abroad to purchase their gold and silver? Do we have too little of it? And the question is how much gold and silver do we need? Smith is mocking the idea that there can never be enough, which the amount of gold and silver you want is always more.


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That's not true of any other commodity and Smith wants to argue it is also not true of gold and silver. To illustrate this, Smith uses an amazingly evocative and effective metaphor of pots and pans on page 439. 


Consumable commodities it is said are soon destroyed whereas gold and silver are of a more durable nature and were it not for this continual exportation might be accumulated for ages together to the incredible augmentation of the real wealth of the country. Nothing therefore it is pretended can be more disadvantageous to any country than the trade which consists in the exchange of such lasting for such perishable commodities. We do not however reckon that trade disadvantageous which consists in the exchange of the hardware of England for the wines of France and yet hardware is a very durable commodity and was it not for this continual exportation might two be accumulated for ages together to the incredible augmentation of the pots and pans of the country.


But it readily occurs that the number of such utensils is in every country necessarily limited by the use which there is for them that it would be observed to have more pots and pans than were necessary for cooking. The vittles usually consumed there and that if the quantity of vittles were to increase the number of pots and pans would readily increase along with it a part of the increased quantity of vittles being employed in purchasing them or in maintaining an additional number of workmen whose business it was to make them. That is pots and pans to attempt to increase the wealth of any country either by introducing or by detaining in it an unnecessary quantity of gold and silver 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.


Well that's really terrific. There's no reason to have any more gold and silver than you actually need and subsidizing our products to send them abroad to buy gold and silver that we don't really need makes no more sense than to say that the total wealth of the country depends on the number of pots and pans we have in our cupboards. Pots and pans have no use except for cooking gold and silver has no use except for buying things nonetheless because this doctrine of equating wealth with gold and silver makes sense. If you don't think much about it then a lot of people are taken by this idea that we should subsidize exports in order to buy more gold and silver from other countries. And the main thing is that merchants and manufacturers supported the system because both protectionism and the subsidy of exports benefited them directly.


And so that's the Baptists and Bootleggers coalition. Smith points out that the origin of this mistake, at least among those who believe that mercantilism is a good system, is a confusion about exchange within a country and exchange across countries. And it's interesting, this same confusion recently tripped up Oren Cass as Dan Klein pointed out in an interesting article. Oren Cass is just misreading Smith and you can tell that from this passage on page 430: 


If a nation could be separated from all the world, it would be of no consequences how much or how little money circulated in it. The consumable goods which are circulated by means of this money would only be exchanged for a greater or smaller number of pieces, but the real wealth or poverty of the country they allow would depend altogether upon the abundance or scarcity of those consumable goods.


But it is otherwise they think with countries that have connections with other sovereign nations and which are obliged to carry on foreign wars to maintain fleets and armies in distant countries, this they say cannot be done but by sending abroad money to pay them with and a nation cannot send much money abroad unless it has a good deal at home. Every such nation therefore must endeavor in times of peace to accumulate gold and silver that when the occasion requires it may have wherewithal to carry on foreign wars in consequence of these popular notions. All the different nations of Europe have studied though to little purpose every possible means of accumulating gold and silver in their respective countries. When countries such as France, Scotland, England, Spain became commercial merchants found that the prohibition of sending out gold and silver to buy things was upon many occasions extremely inconvenient. They could frequently buy more advantageously with gold and silver than with any other commodity. The foreign goods which they wanted either to import into their own or to carry to some other foreign country they reinstated therefore against this prohibition as hurtful to trade. They represented first that the exportation of gold and silver in order to purchase foreign goods did not always diminish the quantity of those metals in the kingdom. That on the contrary it might frequently increase that quantity because if the consumption of foreign goods was not thereby increased in the country, those goods might be re-exported to foreign countries and being there sold for a large profit might bring back much more treasure than was originally sent out to them. So pause the quote for a second. So what's interesting about that is that clearly if we send money abroad to buy something which we then repackage and resell to a third country for more money, we're obviously increasing the amount of gold and silver or dollars in modern terms that we have in the country.


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And so there are many kinds of imports that you don't want to restrict even if you believe in mercantilism. And so Smith is saying that you don't believe what you think you believe, even if you reject my major reasoning. Back to the quote now on page 431: 


Mr. Munn compares this operation of foreign trade to the seed time and harvest of agriculture. If we only behold says he the actions of the husbandman in the seed time he casteth away much good corn into the ground, we shall account him a mad man rather than a husbandman. But when we consider his labors in the harvest, which is the end of his endeavors, we will find the worth and plentiful increase of his actions. 


If I send gold and silver abroad to buy something and you say, Nope, can't do that, we have to have gold and silver keep it here. That would be like saying you have corn, you have to eat it, you are not allowed to plant it. Yes, maybe you're claiming that there'll be more corn as a result, but we don't care. We want to maximize the current amount of corn. That would make no sense, and it makes no sense by the same reasoning to prevent the import of products that we are then going to re-export for even more gold and silver. Smith is suggesting that the mercantile system has endured and in fact expanded not because it's true but because it has a naive intuitive appeal and it has enthusiastic support from influential economic interests that are getting paid. And so again, we're back to Baptist and Bootleggers. Chapter two of Book Four is entitled “Of restraints upon the importation from foreign countries of such goods as can be produced at home.” Smith begins by restating what he sees as a fundamental maxim and it's about what we would call the make or buy decision.


He claims it's generally better for a nation to purchase goods from abroad if they can be imported for a price that is less than they can be produced domestically. If you don't do that, what you're doing is creating monopoly profits for the home industry, meat, corn, wool, linen, all the things that you are blocking from coming in get higher profits, and it is true that those workers get higher wages but it's a net loss to the country as a whole because those workers should be employed in something more productive. It is true that it might not be better paying, but it would produce more in terms of the total amount of goods and services that come about as a result of allowing cheaper imports. The other things that's interesting is that even in Smith's time there was a kind of rudimentary antitrust law that contracts in restraint of trade could not be enforced in court.


Now we actually have a system of antitrust where if a company tries to monopolize an industry, we'll bring Sherman Act action against it maybe by the Justice Department, maybe by the Federal Trade Commission. Trade barriers are exactly the same as a contract and restraint of trade. The difference is they're much more effective from the perspective of the domestic industry and the reason is, instead of having to write a contract with a competitor, the government now uses guns to prevent the competitors from bringing products in and the company can just say, well we are very patriotic. We want to make sure that all the production here is home. Yes, I bet you do because by doing that you earn monopoly profits. So it makes no more sense to block imports than it would to create domestic monopolies by allowing contracts and restraint of trade doing that as a net loss to the country as a whole because the workers that you're employing in this artificially supported industry would be better off from the perspective of the society producing something in which the society has a comparative advantage.


Now it is true, let me emphasize that they might earn lower wages as a result, but those would be money wages, those wages would be worth more in the sense that they could purchase more real goods and services and that's the distinction that Adam Smith is making and it's something that we often get hung up on. Mercantilists are trying to maximize the wages, the pay of domestic workers. Well that doesn't help if the increase in the price of products increases by more than the amount that wages are increased. That's the argument against mercantilism. Smith discusses this on page 453: 


That this monopoly of the home market gives great enjoyment to that particular species of industry which enjoys it and frequently turns toward that employment. A greater share of both the labor and stock of the society than would otherwise have gone to. It cannot be doubted, but whether it tends either to increase the general industry of the society or give it the most advantageous direction is not perhaps altogether so evident the general industry of the society never can exceed what the capital of the society can employ as the number of workmen that can be kept in employment by any particular person must bear a certain proportion to this capital. So the number of those that can be continually employed by all the members of a great society must bear a certain proportion to the whole capital of that society and never can exceed that proportion. 


So pause for a second. What he's saying there is that regardless of the amount of gold and silver we have, we only have a certain amount of capital and deciding because capital is physical stuff that we're using to build things, if we use it to build something we could buy more cheaply somewhere else, we're not able to use that capital to make something that we are the best producers for the cheapest producers for and that's going to cost the society quite a bit. It's a net loss to the society even if the industry and the workers in the protected industry earn more as a result of the artificial monopoly restriction. Back to the quote: 


No regulation of commerce can increase the quantity of industry in any society beyond what its capital can maintain. It can only divert a part of that capital into a direction in which it would not otherwise have gone and it's by no means certain this artificial direction is more advantageous to the society than that into which it would've gone of its own accord. That is in pursuit of actual profits rather than artificial monopoly profits, every individual is continually exerting himself to find out the most advantageous employment for whatever capital he can command. It is his own advantage indeed and not that of the society which he has in view, but the study of his own advantage naturally or rather necessarily leads him to prefer that employment which is most advantageous to the society. 


Well that's only true if the profit that he's pursuing is real and not artificially created by either a monopoly restriction or by what is exactly the same thing. Trade restrictions. This is a direct extension then of his division of labor principle. Just as individuals specialize in exchange, nations should also specialize according to their comparative advantages, but nations will specialize according to the comparative advantage if the government doesn't prevent it, each person acting on his or her self-interest and out of concern for local knowledge and trust will invest at home first to divert domestic labor into producing something that foreigners can supply. More cheaply is a misallocation of resources that reduces total wealth. A few firms and workers benefit, but the rest of the society is harmed and the amount of the harm exceeds by a lot the amount of the benefit. Smith critiques the mercantile system's assumption that restraining imports strengthens domestic industry. Such restraints actually force domestic labor into less productive uses If another country can supply a good cheaper than buying it from abroad and using your own labor in more efficient channels is net wealth creating. It drives home this point. On page 455: 


A capital employed in the home trade necessarily puts into motion a greater quantity of domestic industry and gives revenue employment to a greater number of the inhabitants of the country than an equal capital employed in the foreign trade and one employed in the foreign trade of consumption has the same advantage over an equal capital employed in the carrying trade. 


So remember Smith has this hierarchy of first agriculture, then domestic manufacture, and then the export of products and then last the carrying trade. So back to the quote:


Upon equal or only equal capital in the manner in which it is likely to afford the greatest support to domestic industry and to give revenue and employment to the greatest number of people in his own country is the object of the individual's self-interest end. So the weak form of putting this is that the government doesn't need to do anything.


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The stronger form and Smith seems to be arguing for this is the government needs to not do anything. So notice the difference. It's not that the government doesn't need to do anything, the government really needs to not do anything because if the government responds to concentrated economic interests and to the naive beliefs of people who accept the doctrine that gold and silver is wealth, they're going to make the country worse off. And so you have to not do that. Import restrictions may help a particular domestic industry but they injure the nation's overall prosperity. They reduce domestic production by spending too much on something that could be purchased more cheaply than it could be made. Simplest way to think about this is suppose I have a hundred dollars. If I do not buy the thing that I want at the cheapest price, suppose that I could buy it for 30 and I buy it for 40, I only have $60 left.


The same thing is true for buying something from abroad or making it domestically. If it costs you more to make it domestically than it would to buy it, you have less actual wealth to use to buy the other things that you need. And so if you can buy it more cheaply than you can make it, you should always buy it from abroad rather than make it domestically. Quoting now from page 455:


The annual revenue of every society is always precisely equal to the exchangeable value of the whole annual produce of its industry or rather is precisely the same thing with that exchangeable value as every individual therefore endeavors as much as he can both to employ his capital in the supportive domestic industry and so to direct that industry that its produce may be of the greatest value every individual necessarily labors to render the annual revenue of the society as great as he can.


He generally indeed neither intends to promote the public interest nor knows how much he is promoting it by preferring the supportive domestic to that of foreign industry. He intends only his own security and by directing that industry in such a manner as its produce may be of the greatest value. He intends only his own gain and he is in this as in many other cases led by an invisible hand to promote an end which is no part of his intention nor is it always the worst for the society that it was no part of it. By pursuing his own interest, he frequently promotes that of the society more effectively than when he really intends to promote it. I have never known much good done by those who affected to trade for the public good. It is an affectation indeed not very common among merchants and very few words need be employed in dissuading them from it.


End of quote, Smith only uses the phrase invisible hand three times in all of his writings, once in Lectures on Astronomy, once in Theory of Moral Sentiments. And then here the passage we just read page 456 in Wealth of Nations. In none of those does he say “as if by an invisible hand.” So if you hear someone quote Smith and say as if by an invisible hand, stop them and say, why are you misquoting Smith? None of them say as if by an invisible hand. This is not a simile. It is a metaphor and it's not clear that Smith meant nearly as much by the metaphor as many people would attribute to him. The people would say that Smith's primary contribution is the notion of the invisible hand. I think that's not right and we've talked a little bit about it before. Smith's major contribution in economics is division of labor.


Now it is true that he thought that there was an aligning of self-interest and collective interest under some circumstances, but his argument for that is in Theory of Moral Sentiments. So just saying that markets automatically align individual and collective incentives is wrong, Smith did not believe that and attributing that view to Adam Smith's invisible hand claim is just a mistake. So we have to confront people and stop them from doing that because they're embarrassing themselves. Well, continuing the quote a little bit farther down on page 456: 


To give the monopoly of the home market to the produce of domestic industry in any particular art in 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 of foreign industry, the regulation is evidently useless. If it cannot, it must generally be hurtful. 


Pause for a minute. So if we're making something we could buy more cheaply abroad, we're actually hurting the country. If it's about the same price, it's useless. We're causing people to divert some of their capital into some other activity. Either way, don't do that. Back to the quote: 


It is the maxim of every prudent master of a family never to attempt to make it home. What it will cost him more to make than to buy the tailor does not attempt to make his own shoes but buys them of the shoemaker. The shoemaker does not attempt to make his own clothes but employs a tailor. The farmer attempts to make neither the one nor the other but employs those different artificers. All of them find it for their interest to employ their whole industry in a way in which they have some advantage over their neighbors and to purchase with a part of its produce or what is the same thing with the price of part of the produce, whatever else they have occasion for.


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. 


So it costs us more to make things than it does to buy things that we can acquire more cheaply from other country because we're diverting some of our limited capital from a productive use into a much less productive use. It may be hard to pick that out because it seems like there are big benefits domestically to having a monopoly. Well, of course there are benefits to having a monopoly, but we wouldn't allow that because we recognize that monopolies are a really bad problem of benefiting some workers and some owners of businesses at the expense of all consumers.


There is absolutely no different in making a monopoly by using a restriction on imports than it would be on creating a domestic monopoly. Smith then gives a remarkable example and it's one that I have often used in discussing these matters and it makes the point in a very striking way. It's on page 458: 


The natural advantages which one country has over another in producing particular commodities are sometimes so great that it is acknowledged by all the world to be in vain to struggle with them 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 30 times the expense at which at least equally good can be bought 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?


But if there would be a manifest absurdity in turning away any employment 30 times more of the capital and industry of the country then would be necessary to purchase from foreign countries an equal quantity of the commodities wanted in this case wine. There must be an absurdity though not altogether so glaring yet exactly of the same kind in turning towards any such employment, a 30th or even a 300th part. More of either whether the advantages which one country has over another be natural or acquired is in this respect of no consequence. As long as one country has those advantages the other wants them, it will always be more advantageous for the latter rather to buy of the former than to make. 


Okay, so there's a lot there. Let's unpack it. So some of the advantage, the example that I always use is that there is a pineapple industry in Sweden. They use some hothouses and they have some geothermal energy that they can use to produce pineapples and pineapples obviously don't grow naturally in Sweden. Pineapples in Sweden are pretty good, but they're very, very expensive. Should Sweden be trying to do that? Well, why is it that Sweden has difficulty and Hawaii has an easy time growing pineapple. The big reason is climate. That's not an acquired difference, that's just a fact. So you might be able to overcome the differences of climate by spending a lot of extra money and labor on creating ways to make it warm and create artificial light, but that doesn't make any sense. Smith says you're better off producing the things that you have an advantage and then buying the things that you can acquire more cheaply. But many of the advantages and perhaps most of the advantages in a modern world are not like the difference in climate between Sweden and Hawaii.


Most of those differences are a result of division of labor. And to understand this, we have to go back to Smith's really interesting metaphor about the street porter and the philosopher. Street porter and the philosopher were almost identical, but because they did different things, they acquired different skills, different levels of dexterity, knowledge of tool use and reducing time switching between tasks they got really, really good at one thing that is an acquired difference. And so when Smith says in that quotation whether the advantages which one country has over another be natural or acquired is in this respect of no consequence, he's explicitly referring to the fact that it makes no sense to grow pineapples in Sweden or grapes in Scotland, as with his example because of fundamental differences like climate. But it also makes no sense for one country to try to develop an advantage in one activity by exploiting division of labor if they can buy it more cheaply abroad, except two exceptions, our first national defense because Smith sees defense as being more important than opulence.


In fact, opulence without defense is just going to attract raiders. If you're a very wealthy country and have no defense, it means that you're going to be taken over by someone else. Smith recognizes that and the other is this is sometimes characterized as retaliation in trade negotiations. I would say that it is more along the lines of making sure that you are accounting for import fees for things that are re-exported. That way you can make sure that suffering no particular disadvantage from the fact that you're being a transshipment point or as an aspect of bargaining strength in trade negotiations. Well, let's consider the national defense example. First on page 463, Smith says: 


There seem to be two cases in which it will generally be advantageous to lay some burden upon foreign for the encouragement of domestic industry. The first is when some particular sort of industry is necessary for the defense of the country. The defense of Great Britain, for example, depends very much upon the number of its sailors in shipping the act of navigation. Therefore very properly endeavors to give the sailors and shipping of Great Britain the monopoly of the trade in their own country in some cases by absolute prohibitions and in others by heavy burdens upon the shipping of foreign countries. 


He then gives a number of examples of the Navigation aActs that require English goods to be shipped in English vessels. Those raised costs, some perhaps not that much. The British merchant Marine and Navy was very large, but it meant that the British ship building industry, which he saw as being vital for national security was maintained. So protection might be justified, but if it is, it's not on economics but on security grounds. I was interested in this. It's a discussion that's very similar to the modern debate over the Jones Act today, but the Jones Act in the US has very different effects.


The position of the US is quite different, but it is interesting to think about whether for example, a ship building industry, the capacity to build ships in particular is such an important part of national defense in the advent of war that you might want to maintain it even if the economic expense is pretty great. I think the creation of drones and drone warfare has made even that aspect of the Jones Act obsolete, and the Jones Act for the US- basically that and if you're going to ship something between two US ports, you have to use a US ship- means that the US buys a lot of lumber and natural gas from other countries because then we can use cheaper shipping. There's very little American domestic merchant Marine and that's in spite of the Jones Act. So I think we want to be careful in making the arguments that the Jones Act is like this same argument that Smith makes on page 463.


But there is an interesting parallel. In any case, Smith says that there is an exception to what he thinks should be a prohibition on protectionism and that is for national defense talks about the second instance on page 465: 


The second case in which it will generally be advantageous to lay some burden upon foreign for the encouragement of domestic industry is when some tax is imposed at home upon the produce of the latter. That is when some country other country imposes taxes on our goods. In this case, it seems reasonable that an equal tax should be imposed upon the like produce of the former, the other country. This would not give the monopoly of the home market to domestic industry nor turn towards a particular employment in a greater share of the stock and labor of the country than that would naturally go to. It would only hinder any part of what would naturally go to it from being turned away by the tax into a less natural direction and would leave the competition between foreign and domestic industry after the tax as nearly as possible upon the same footing as before it. In Great Britain, when any such tax is laid upon the produce of domestic industry, it is usual at the same time in order to stop the glamorous complaints of our merchants and manufacturers that they will be undersold at home to lay a much heavier duty upon the importation of all foreign goods of the same kind. 


So let's think of an example. Suppose we have a pretty large tax on liquor on whiskey. It would be strange if we did not also have the same tax on imported whiskey. That would be an artificial benefit for imports, which presumably wasn't the intent of the tax. So if we're going to have a tax on domestic industry, we should have a tax at least as large on imported whiskey. What Smith would argue is that there's no reason to have an even larger tax on the imported whiskey, but it's very plausible to tax imports if we already tax the domestic industry and to be taxed at the same rate.


(00:40:39):


Smith's a little concerned about that tactic because since it's a separate tax, it's likely that it'll escalate and then if we get rid of the domestic tax, we'll probably keep the import tax, but still it only makes sense to have everything in the same industry subject to the same tax. Smith's worried about monopolists and what we would now call special interests because those private interests work against the great body of the people. The groups are politically powerful and they have disproportionate influence. Some parts of the chapter in the interest of time, I can't quote them, but some parts of chapters three and four sound a lot like Mancur Olsen and the fact that a relatively small number of people get a substantial improvement in their economic situation, but at the cost of much higher payments by all taxpayers and consumers means that it's likely still to work well in politics.


So the general theme is that economic prosperity comes not from hoarding gold or sheltering industries, but from free exchange that's guided by natural advantage. Chapter two then lays out Smith's clearest and most systematic case for free trade while conceding to narrow exceptions for security and for the problem of ensuring fair treatment for domestic industry. 


The title of chapter three is “Of the extraordinary restraints upon the importation of goods of almost all kinds from those countries with which the balance is supposed to be disadvantageous.” So Smith liked really long chapter titles. He argues that extraordinary restraints on imports, especially those that come from fear of an adverse balance of trade are economically harmful, but perhaps more important they're based on a misunderstanding of how trade even works. Smith begins by examining this fear of an unfavorable balance of trade. According to that doctrine, Ian imports more that it exports, its losing money because gold and silver, which are supposed to be the essence of wealth, are sent abroad to pay for the difference.


Now that leads government to prohibit or heavily restrain imports from such countries where we have a bad unfavorable balance of trade. Smith criticizes this view as whit, he calls it “a vulgar prejudice rooted more in appearance than in reality”. His argument is that gold and silver are just the instruments of trade, the wheel of circulation, not the goods that the circulation delivers and that's the basis of wealth. The goods not the money are the basis of wealth. Even if species temporarily leaves the country, it flows back naturally through the balance of payments. The loss is only apparent and temporary. It's not real. So the obsession with a trade balance confusing money with wealth prevents the nation from growing wealthy. Now it is true that merchants and manufacturers have an interest in portraying imports as dangerous and they are competition is always dangerous, but we discount the idea that you should be protected from domestic competition.


Why would we credit the idea that you should be protected from foreign competition? Still legislators who are swayed by prejudice and special interest actually believe they're defending the public good. And when the self-interest of the manufacturers and the mistaken public interest of the legislators combined, you have a powerful political force. So Smith says that the doctrine of the balance of trade became a pestilent error leading statesmen to think that they have to prevent the export of species or the import of goods, both of which are good things, and Smith notes that even intelligent and well-educated policymakers fall into this trap because it seems so plausible. It looks like money, which we equate with wealth is leaving the kingdom whenever imports exceed exports. But in reality, trade naturally balances itself over time through changes in prices. So Smith takes several steps in his rebuttal. First is if you take a snapshot of a trade balance, you're going to get a misleading picture.


A country might import heavily from one nation but export more to another, making up the difference. So what matters is the overall balance of imports and exports, not the bilateral flows. The looking at and the Trump administration has done this a lot, looking at the specific bilateral trade balance and calling it unfavorable is just a mistake. He [Smith] gives an example on page 474 and 475. 


Suppose though we're certain that in the case of a free trade between France and England, the balance would be in favor of France. It would by no means follow that such a trade would be disadvantageous to England or that the general balance of its whole trade would thereby be turned more against it. If the wines of France are better and cheaper than those of Portugal or its linens better and cheaper than those of Germany, it would be more advantageous for Great Britain to purchase both the wine and the foreign linen, which it had occasion for of France rather than France, Portugal and Germany. Though the value of the annual importations from France would thereby be greatly augmented. The value of the whole annual importations would be diminished in proportion as the French goods of the same quality were cheaper than those of the other two countries. 


End of the quote. That quote was on page 475. The reason that England stopped buying from Portugal and Germany was that it could obtain all of the things cheaper from France, and so that would mean that the unfavorable trade deficit with France would go up dramatically. However, the total amount that England spends, if you add up all of the imports from Portugal, France, and Germany go down because it's cheaper. It has to be true. The only reason they switched was that it was cheaper. Well, that means that if you look at the overall balance of trade, England is better off, they're importing less, they're getting more stuff for a cheaper price. But it looks like if you are an unfavorable trade balance fanatic, look, we're buying everything from France. They're exploiting us. To the contrary. What we're doing is saying we're able to obtain things even more cheaply in France. We were importing them before from Germany and Portugal, now we're importing all of it from France. It's a benefit, not a harm. Lemme make sure this is clear with a more modern example. 


Suppose the US buys a million in goods from England, Japan, and China, and that's a million dollars each. A million dollars from England, a million dollars from Japan and a million dollars from China. But China gets better at manufacturing high quality low cost goods before the US was buying $3 million worth of goods, a million from England, a million from Japan, and a million from China. The US switches and buys everything from China and they pay 2.8 million.


Well, the amount that we're spending on imports has gone down from 3 million to 2.8 million. That means that we're better off. However, the trade deficit with China has now gone up because we're spending 2.8 million rather than just 1 million in buying stuff from China. Is China somehow exploiting or taking advantage of the us? No, the US is better off now. England and Japan are harmed because China has taken their market share, but that's not the US' problem and in fact, it's a benefit for the US. That's the nature of competition. Again, you can make the argument for national defense that the US should not rely too heavily on one country. That's not the argument that the mercantilists are making. If you want to make the argument that, well, we have to be careful about limiting our imports from any one country worried about supply chain, worried about national security, that's a fair argument, but it's a different argument.


You have to keep them separate. So that's the first part of the argument that Smith makes that we shouldn't worry about unfavorable trade balances, but that's a static claim. Dynamically, he argues that species flows are self-correcting. If gold and silver leave a country due to imports, the domestic money supply contracts and domestic prices will go down. Exports are cheaper, imports are dearer, and the exchange rates between different currencies in modern terms are going to change the relative prices. And you're going to see these trade flows be at least self-limiting, if not entirely self-correcting. The restraints that force consumers to pay higher prices or accept inferior goods actually reduce general wealth by so much that we're clearly better off allowing this exchange rate mechanism to operate than we are having to try to limit what we buy from any one country. The harm of trying to worry about unfavorable trade balances is larger.


So let's go back and take up Smith's reaction to this general doctrine about the favorability or unfavorability of the balance of trade. It's on page 488. 


In the foregoing part of this chapter, I have endeavored to show even upon the principles of the commercial system how unnecessary it is to lay extraordinary restraints upon the importation of goods from those countries with which the balance of trade is supposed to be disadvantageous. Nothing can be more absurd than this whole doctrine of the balance of trade upon which not only these restraints, but almost all the other regulations of commerce are founded when two places trade with one another. This doctrine supposes that if the balance be even neither of them loses or gains, but if it leans in any direction to one side that one of them loses and the other gains in proportion to its decension from the exact equilibrium.


Both suppositions are false. A trade which is forced by means of bounties and monopolies may be and commonly is disadvantageous to the country and whose favorite is meant to be established. But that trade, which without force or constraint is naturally and regularly carried on between any two places is always advantageous though not always equally so to both by advantage or gain. I understand not the increase of the quantity of gold and silver, but that of the exchangeable value of the annual produce of land and labor of the country or the increase in the annual revenue of its inhabitants. 


Dan Klein, the economist at George Mason University, has a nice article in Law and Liberty where he addresses the claim made most recently and explicitly by Oren Cass, among others that Smith favors free trade within but not among nations. And we'll put up a link to Dan Klein's article.


It's really quite well done. Smith concludes that the mercantile list of obsession with unfavorable balance is not only false in theory but also damaging in practice. It led to unnecessary restrictions, reduced the range of goods available to consumers and distorted the natural course of trade. There's a quote on page 491 and 492 that shows Smith's wry sense of humor. It's really quite droll. There's a lot of nice funny parts in Wealth of Nations and this is one of my favorites. So again, on page 491: 


It is a losing trade. It is said, which a workman carries on with the ale house and the trade which a manufacturing nation would naturally carry on with a wine country is considered as a trade of the same nature. I answer that the trade with the alehouse is not necessarily a losing trade in its own nature. It is just as advantageous as any other though perhaps somewhat more liable to be abused. The employment of a brewer and even that of a retailer of fermented liquors are as necessary divisions of labor as any other. It will generally be more advantageous for a workman to buy of the brewer, the quantity as occasion for than to brew it himself. And if he's a poor workman, it will generally be more advantageous for him to buy it little by little of the retailer than a large quantity of the brewer. He may no doubt buy too much of either as he may have any other dealers in his neighborhood or the butcher if he's a or of the draper. If he affects to be a bow among his companions, it is advantageous to the great body of workmen. Not withstanding that all those trades should be free, though this freedom may be abused in all of them and is more likely to be so perhaps in some than in others end.


Well, that's a terrific point. If you really believe that if you give money to someone and get stuff that you want in return in doing that you are losing, then you don't understand voluntary exchange. If I go to an ale house and buy a nice ale and drink it, I'm not being exploited. Now, maybe if I am an alcoholic, maybe if they put salty peanuts out or other bar food in order to make me buy more, I should be more careful. But Smith points out that's really no different from saying that we're going to buy wine from a wine producing country and that that exchange somehow is exploitative Smith here is giving a little precursor of subjectivism. The workman clearly believes that he is better off having some ale. If that's true, then the workman is better off buying the ale from someone who specializes in making ale and thereby can make it cheaper and better than he would be in making it himself.


Exactly the same principle applies to international trade. If we make something ourselves, but it is more expensive and worse, we're actually harming ourselves. Now the nature of the things that are being purchased are a separate question. I enjoy the idea that how this might appeal, particularly in England at the time where people were pretty heavy drinkers that people are being exploited by being able to buy wine and beer. We'll turn now to chapter four of drawbacks. Smith discusses a system of drawbacks, the practice by which governments refund upon exportation the duties or taxes that have been levied on imported goods. This was particularly a problem for England because it had colonies, and we'll talk about that next episode in December- about the particular difficulties that colonies presented because what happened was England would import a lot of raw products and then export a very substantial amount of manufactured goods.


If there was a tariff on the import, then there was a problem with making sure that that money was refunded, and that's what a drawback is. So on page 499, Smith says, 


Merchants and manufacturers are not contented with the monopoly of the home market, but desire, likewise, the most extensive foreign sale for their goods. Their country has no jurisdiction in foreign nations and therefore can seldom procure them any monopoly there. They're generally obliged therefore to content with petitioning for certain encouragement to exportation that is from the home country of these encouragement, what are called drawbacks seem to be the most reasonable to allow the merchant to draw back upon exportation. Either the whole or part of whatever excise or inland duty is imposed upon. Domestic industry can never occasion the exportation of a greater quantity of goods than would've been exported, had no duty been imposed, end of quote.


But of course what Smith's going to be worried about is that the drawback will actually edge over into what he calls a bounty. So a drawback is we just refund the taxes that you paid because you're going to export it. A bounty is an artificial subsidy for exports and bounties are truly bizarre. But in chapter four, which is a short chapter, Smith just talks about drawbacks and he sees the basic principle of drawbacks as sound and fair, domestic duties should not burden international trade. There are some problems, they may be abusive or excessive. Sometimes governments allow drawbacks that are larger than the duties actually paid, and that's sneaking in a bounty or subsidy as I said. And that is a distortion of trade in a form of favoritism to particular merchants. Also, interestingly bounties as we'll talk about this soon, make domestic products more expensive and reduce the price of goods that are exported, which seems very hard to explain unless you're obsessed with balance of payments and getting gold and silver, in which case it's easy to explain.


(00:57:58):


It's just dumb. Ultimately, for Smith drawbacks illustrate the incoherence of mercantilist policy. Governments impose restraints duties only to remove them and pay them back in ways that create opportunities for fraud and favoritism. But it's not irrational because in both cases it increases the power of government officials. And if you recognize from a public choice perspective that what government officials are trying to do is increase their own power and their own ability to take bribes and be corrupt, it's hardly surprising at all that these things are popular. In chapter five, Smith takes up a much longer and more complicated discussion of bounties. Now, in most modern editions, it is split into two parts, chapter five A and chapter five B. And the Liberty Fund edition does that. Smith himself just labeled it as one chapter five of bounties. So what usually is called five a discusses export bounties.


And the arguments are that bounties divert resources into less efficient industries. For example, the wheat bounty in Britain raised domestic prices of wheat hurt consumers, but particularly rewarded landlords and large farmers. And of course they are the ones with the political power. So that kind of bounty distorts agriculture and manufacturing alike. Contrary to public interest and hiding behind the fig leaf of, well, we need to sell things to get gold and silver is pretty bad. Second part recognizes that that is five B recognizes that there is a dynamic effect. If the only way your country can produce export competitive products is with subsidies, then eventually your industry is going to become dependent on state aid. It has no particular reason to compete effectively with foreign products because they can just ask for a larger bounty. It's always easier to take the money from taxpayers than it is voluntarily from foreign consumers who have alternatives.


Domestic taxpayers have no alternatives because the money for the bounty is taken from them at gunpoint. Smith begins his discussion of bounties on page 505. 


Bounties upon exportation are in Great Britain frequently petitioned for and sometimes granted to the produce of particular branches of domestic industry. By means of them, our merchants and manufacturers, it is pretended will be enabled to sell their goods as cheap or cheaper than their rivals in the foreign market. A great quantity, it is said, will thus be exported and the balance of trade consequently turned more in favor of our own country. We cannot give our workmen a monopoly in the foreign as we have done in the home market. We cannot force foreigners to buy their goods as we have done our own countrymen. The next best expedient it has been thought therefore is to pay them for buying. It is in this manner that the mercantilist system proposes to enrich the whole country and to put money into all of our pockets by taking money out of our pockets to balance trade.


That's the end of the quote, and I embellished a bit. He didn't have the part about first taking the money out of our pockets, but I think it's clearly implied. That's a pretty funny and sarcastic way of introducing. That's the very first part of the chapter on bounties. That's how he introduces them. So to be clear, Smith supports drawbacks but opposes bounties and the distinction may not be clear. A bounty is just a drawback that is more than the amount of the duty, if any, that was paid on the imported. Good bounties are an inverse tariff where we're paying a subsidy for someone who exports something. The idea being it doesn't matter how much it costs us, what matters is how much we get from them. And so the naivete of this idea that anyone who buys something from you is being exploited, is illustrated by the fact that we're paying them to do it.


How could it be exploitation if we're paying them to buy our products and they would not otherwise buy them? So the idea that if you buy something from someone, it is the buyer who's being exploited, I guess does imply that's true even if the seller pays the buyer to buy it, but that doesn't make any sense. Bounties then represent a mercantilist error confusing the interests of particular producers with the general interest of society and believing in the absurd doctrine of favorable balances of trade. Smith uses an interesting metaphor here as if we were damming up a river on page 511. Smith says,


Spain by taxing Portugal, by prohibiting the exportation of gold and silver, load that exportation with the expense of smuggling and raise the value of those metals in other countries so much more above what it is in their own by the whole amount of this expense. 


When you dam up a stream of water as soon as the dam is full, as much water must run over the dam head as if there were no dam at all. The prohibition of exportation cannot detain a larger quantity of gold and silver in Spain and Portugal than what they can afford to employ than what the annual produce of their land and labor will allow them to employ. When in coin plate gilding and other ornaments of silver, when they have got this quantity, the dam is full and the whole stream which flows in after must run over. So this is a different metaphor, but the same point as the pots and pans. The amount of gold and silver that we need is a certain amount. If we dam it up in order to make sure that it is impossible for gold and silver to leave, as soon as that amount is full, we'll still get the same flow, the same amount has to go over.


So if you dam up a river, there's a certain amount coming in. At some point the dam is full, the same amount of water that comes in has to leave. Now there's a big reservoir of water and maybe that's okay, maybe for national security reasons it's okay to have a big reservoir of gold and silver, but the idea of constantly using and Smith's metaphor of the dam here is export restraints. If we're going to restrict the exportation of gold and silver, or if we're going to try to subsidize using the bounty, reduce the price of our product so that we can acquire more gold and silver, the amount of gold and silver that we acquire is just going to run over the dam if we continue to have more gold and silver than the amount of exchange in our country can support. On page 513, Smith says, 


The bounty upon the exportation of corn necessarily operates in exactly the same way as this absurd policy of Spain and Portugal, whatever be the actual state of tillage, it renders our corn somewhat dearer in the home market than it otherwise would be and somewhat cheaper in the foreign. And as the average money price of corn regulates more or less all other commodities, it lowers the value of silver considerably in the one and tends to raise it a little in the other. It enables foreigners, the Dutch in particular, not only to eat our corn cheaper than they otherwise could do, but to eat it cheaper than our own people can do. Upon the same occasions we're assured by an excellent authority that of Sir Matthew Decker, it hinders our own workman from furnishing their goods for so small a quantity of silver as they otherwise might do. It enables the Dutch to furnish theirs for a smaller, it tends to render our manufacturers somewhat dear in every market and they're somewhat cheaper than they otherwise would be, and consequently to give their industry a double advantage over our own. 


It's such a terrific example. We have a certain amount of corn. We decide that we want to export some of it, and so we use taxes to provide a bounty for export. Now, since some of the corn gets sent abroad, that means that the price of corn in England is higher than it would be and the price of English corn in Holland is less than it otherwise would be. Ultimately, the Dutch are eating English corn at a price lower than the English people who made it are doing, and the only reason is so that you can store up in this giant dam the amount of gold and silver, but once you have an amount of gold and silver that is sufficient for the needs of the country, the rest of it just spills over the dam. It does no actual benefit. Which brings us to the last chapter for this month's episode, chapter six “Of treaties of commerce.”


(01:06:51):                      


Until now, the actions that Smith has considered have been unilateral. Treaties of commerce are obviously, at least bilateral treaties of commerce are formal agreements between nations that are designed to regulate or encouraged trade. They're often justified as mutually beneficial, but in Smith's view, they usually serve narrow interest and they carry very significant political and economic risks. Treaties of commerce are frequently used as political tools rather than economic ones. Nations enter into them not to expand mutual prosperity, to secure alliances or military support or some other kind of diplomatic leverage connecting politics and trade policy in Smith's view, entangles nations in wars or conflicts that have little to do with commerce themselves and that they might not otherwise enter into. So it's a terrible idea. He's skeptical that treaties of commerce benefit both parties equally. They typically grant exclusive privileges, preferences, or exemptions, and the people who benefit are the most powerful merchants in each country.


The central principle that commerce prospers best when it is left to what he calls “the system of natural liberty,” free unregulated exchange that's driven by mutual self-interest is violated by these bilateral exchange agreements and has often been said, I've heard Milton Friedman say it in a recording that there's no reason to have trade agreements. If you want free trade, all you have to do is not have any rules restricting trade. If you have a trade agreement, that means you have rules restricting trade and that's not free trade. Whatever it is, it's not free trade. A treaty may grant some temporary advantage, privileged access to some foreign market, but it does that by distorting trade flows and encouraging reliance on political concession rather than actually having to have economic competitiveness. Smith uses the example of the UNE treaty in 1703 between England and Portugal. England granted Portuguese wines favorable duties compared to French wines while Portugal admitted English woolens on favorable terms.


That is the tariff on English. Woolens was less than the tariff on other imported woollens. Now that gave some English producers an advantage, but it distorted the natural trade patterns. Britain bought Portuguese wine not because it was best, not because it was cheapest, but because the treaty artificially encouraged it by having a difference in price that was not inherent, but it was a result of a political negotiation. The inferior quality and higher prices of Portuguese wines relative to French wines mean that consumers are paying more and getting less than they would've if there had been no trade restrictions in the first place. Now, it's true that since the tariffs on French wines were so high that there was a reason to buy Portuguese wines because considering the difference in tariffs, they were cheaper, but they're not actually cheaper if you get rid of all the tariffs. Quoting, now on page 548: 


Almost all our gold that is said comes from Portugal with other nations. The balance of trade is either against us or not much in our favor, but we should remember that the more gold we import from one country, the less we must necessarily import from all others. The effectual demand for gold like that for every commodity is in every country limited to a certain quantity. If nine-tenths of this quantity are imported from one country, there remains a 10th only to be imported from all the others. The more gold besides that is annually imported from some particular countries over and above what is requisite per plate and for coin, the more must necessarily be exported to some others. And the more that most insignificant object of modern policy, the balance of trade appears to be in our favor with some particular countries, the more it must necessarily appear to be against us with many others. It is upon this silly notion that England could not subsist without Portugal, that towards the end of the late war France and Spain without either offense or provocation, required the king of Portugal to exclude all British ships from his ports and for the security of this exclusion to receive into them French or Spanish. Garrisons had the king of Portugal submitted to these ignominious terms, which his brother-in-law, the king of Spain, proposed to him. Britain would've been freed from a much greater inconvenience than the loss of the Portugal trade, the burden of supporting a very weak ally. So when provided of it for everything for his own defense that the whole power of England had it been directed to that single purpose, could scarce perhaps have defended him for another campaign. The loss of the Portugal trade would no doubt have occasioned a considerable embarrassment to the merchants at that time engaged in it, who might not perhaps have found out for a year or two any other equally advantageous method of employing their capitals.


And in this would probably have consisted all the inconvenience that England could have suffered from this notable piece of commercial policy. The great annual importation of gold and silver is neither for the purpose of plate nor of coin, but for foreign trade. A roundabout foreign trade of consumption can be carried on more advantageously by means of these metals than of almost any other goods. As they are the universal instruments of commerce, they are more readily received in return for all commodities than any other goods, and on account of their small bulk and great value, it costs less to transport them backward and forward from one place to another than almost any other sort of merchandise, and they lose less of their value by being so transported. Well, there was quite a bit there. 


The point is that England almost got itself involved in a war that it had no actual reason to be in. And the benefit, the economic benefit of the trade treaty that almost got them in the war was actually probably harmful because they would've been better off buying from France in the first place. The difference was that England wanted to depend on Portugal for obtaining all of its gold and silver, but gold and silver's commodity like any other. If you want to buy gold and silver, you have to pay goods, wine, wool, beef. You're giving up actual stuff in order to obtain things that you just want to keep in a vault. That's actually a reduction in wealth unless you're then going to use that gold and silver to buy other things, which is certainly possible, but not necessarily true. If what you want to do is accumulate species in the false belief like King Midas, that those things are wealth. What Smith wants to insist is that unilateral free trade, simply lowering one's own barriers, creates more durable and genuine advantage than treaties.


Nations should not wait for reciprocal concessions or bind themselves through commercial diplomacy. They should act in their own long-term interest by liberalizing trade unilaterally. Treaties by contrast are rigid and prevent a country from adapting its trade policy when conditions change, or for that matter, when political coalitions change. Treaties of commerce are inferior to simple natural liberty in trade, they're politically motivated, create artificial advantages and harms, and expose nations to diplomatic and military risks. Smith's prescription is that nations should just avoid being bound by commercial treaties and pursue open unilateral free trade. 


Well, the next episode, part eight, will be released on Tuesday, December 30th, where we will take up chapter seven, eight, and nine from Book Four where Smith develops his view of colonies and compares the mercantilist and agricultural theories of economies. Talk to you then.