Sunday, April 13, 2014

The Wealth of Nations, Book 4

Before we get into Book 4 of "Wealth", a correction. My online course stated that "The Wealth of Nations" was published in 1776, not 1790 as I stated. The Wikipedia article on Adam Smith concurs with the 1776 date. But it looks like he continued to revise the book up until his death in 1790. There are references to a 1780 trade agreement, and to the American Revolution having already taken place ("Before the revolt of our North American colonies").

1776 was a banner year:

  1. The signing of the Declaration of Independence started the American Revolution.
  2. The invention of the steam engine by James Watt started the Industrial Revolution.
  3. "Wealth of Nations" was published, which is generally considered to mark the start of modern economics.

Book 4 is titled "Of Systems Of Political Economy". It is the longest book. It basically discusses trade between nations and the government's involvement in such trade via duties, tariffs, and bounties (basically inverse tariffs). He calls it The Mercantile System, but never really defines it. To me, his main points were:

  • Government attempting to protect or incubate industries by penalizing imports or exports via tariffs or outright bans winds up being a zero sum game. Favoring one industry segment penalizes other industry segments or consumers.
  • Balance of trade is really not worth worrying about.
  • Free trade, like free markets, will make everything work best in the end.
  • "Monopoly of one kind or another, indeed, seems to be the sole engine of the mercantile system."
There are more examples of how weird it makes things to have your currency based on precious metals. Because not only can the metal be used for coins, it can also be used for flatware!
The gold and silver which can properly be considered as accumulated, or stored up in any country, may be distinguished into three parts; first, the circulating money; secondly, the plate of private families; and, last of all, the money which may have been collected by many years parsimony, and laid up in the treasury of the prince.
In chapter 2, "Of Restraints Upon Importation From Foreign Countries Of Such Goods As Can Be Produced At Home", we meet the only actual reference in "Wealth" to the famous "invisible hand". It's import is actually somewhat limited, being used only to explain why merchants better promote the public interest by supporting domestic rather than foreign industry.
He generally, indeed, neither intends to promote the public interest, nor knows how much he is promoting it. By preferring the support of 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 was no part of his intention. Nor is it always the worse for the society that it was no part of it. By pursuing his own interest, he frequently promotes that of the society more effectually 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.
Here's a passage from chapter 5 which is more what people understand "the invisible hand" to mean:
The natural effort of every individual to better his own condition, when suffered to exert itself with freedom and security, is so powerful a principle, that it is alone, and without any assistance, not only capable of carrying on the society to wealth and prosperity, but of surmounting a hundred impertinent obstructions, with which the folly of human laws too often encumbers its operations: though the effect of those obstructions is always, more or less, either to encroach upon its freedom, or to diminish its security.
Here's an example of his favoring free trade:
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.
And another:
By diminishing the number of sellers, therefore, we necessarily diminish that of buyers, and are thus likely not only to buy foreign goods dearer, but to sell our own cheaper, than if there was a more perfect freedom of trade.
And another:
Every derangement of the natural distribution of stock is necessarily hurtful to the society in which it takes place;
And another:
The effect of bounties, like that of all the other expedients of the mercantile system, can only be to force the trade of a country into a channel much less advantageous than that in which it would naturally run of its own accord.
Interesting, also on bounties (government credit for producing certain goods) -- that they can lead to bubbles, similar to those we have seen in the last few decades. The housing bubble would have been less likely without the tax deduction on mortgages -- a government "bounty" paid to the consumer. I can't think of a similar incentive that led to the dot-com bubble of the late '90s.
The usual effect of such bounties is, to encourage rash undertakers to adventure in a business which they do not understand; and what they lose by their own negligence and ignorance, more than compensates all that they can gain by the utmost liberality of government.
He does make an exception for strategic materials required to maintain the nation's military equipment.

Smith is definitely not a fan of taxes. At the time of "Wealth", Holland was the richest country in the western world.

Such taxes, when they have grown up to a certain height, are a curse equal to the barrenness of the earth, and the inclemency of the heavens, and yet it is in the richest and most industrious countries that they have been most generally imposed. No other countries could support so great a disorder. As the strongest bodies only can live and enjoy health under an unwholesome regimen, so the nations only, that in every sort of industry have the greatest natural and acquired advantages, can subsist and prosper under such taxes. Holland is the country in Europe in which they abound most, and which, from peculiar circumstances, continues to prosper, not by means of them, as has been most absurdly supposed, but in spite of them.
Here's a surprisingly democratic result derived from Libertarian principles: that all people should be free to follow whatever trade they desire. I bet that he would not be opposed to anyone who felt they could be, say, a surgeon, putting a sign up and having at it -- buyer beware! Like when our own Random Paul created his own certifying board -- solid Libertarian principle in action.
Soldiers and seamen, indeed, when discharged from the king’s service, are at liberty to exercise any trade within any town or place of Great Britain or Ireland. Let the same natural liberty of exercising what species of industry they please, be restored to all his Majesty’s subjects, in the same manner as to soldiers and seamen; that is, break down the exclusive privileges of corporations, and repeal the statute of apprenticeship, both which are really encroachments upon natural Liberty, and add to those the repeal of the law of settlements, so that a poor workman, when thrown out of employment, either in one trade or in one place, may seek for it in another trade or in another place, without the fear either of a prosecution or of a removal; and neither the public nor the individuals will suffer much more from the occasional disbanding some particular classes of manufacturers, than from that of the soldiers.
It is interesting that the difficulties caused by currencies being based upon precious metals, such that coins can be clipped or become worn, led to the establishment of the first commercial bank, in Amsterdam in 1609.

Smith really does seem to be more Libertarian than what we would now call pro-business. He seems pretty disgusted by merchants and industries who succeed in getting favorable trade treatment from the government.

Commerce, which ought naturally to be, among nations as among individuals, a bond of union and friendship, has become the most fertile source of discord and animosity. The capricious ambition of kings and ministers has not, during the present and the preceding century, been more fatal to the repose of Europe, than the impertinent jealousy of merchants and manufacturers. The violence and injustice of the rulers of mankind is an ancient evil, for which, I am afraid, the nature of human affairs can scarce admit of a remedy: but the mean rapacity, the monopolizing spirit, of merchants and manufacturers, who neither are, nor ought to be, the rulers of mankind, though it cannot, perhaps, be corrected, may very easily be prevented from disturbing the tranquillity of anybody but themselves.
His attitude on having wealthy neighboring countries is interesting:
The wealth of neighbouring nations, however, though dangerous in war and politics, is certainly advantageous in trade. ... Private people, who want to make a fortune, never think of retiring to the remote and poor provinces of the country, but resort either to the capital, or to some of the great commercial towns. They know, that where little wealth circulates, there is little to be got; but that where a great deal is in motion, some share of it may fall to them. The same maxim which would in this manner direct the common sense of one, or ten, or twenty individuals, should regulate the judgment of one, or ten, or twenty millions, and should make a whole nation regard the riches of its neighbours, as a probable cause and occasion for itself to acquire riches.
Here is a succinct statement on his "don't worry about balance of trade" thinking. Nice too that he jibes at his fellow economists -- some things never change.
There is no commercial country in Europe, of which the approaching ruin has not frequently been foretold by the pretended doctors of this system, from all unfavourably balance of trade. After all the anxiety, however, which they have excited about this, after all the vain attempts of almost all trading nations to turn that balance in their own favour, and against their neighbours, it does not appear that any one nation in Europe has been, in any respect, impoverished by this cause. Every town and country, on the contrary, in proportion as they have opened their ports to all nations, instead of being ruined by this free trade, as the principles of the commercial system would lead us to expect, have been enriched by it.
But in contrast he is absolutely not a fan of deficit spending -- I guess we have to wait for Keynes to realize that borrowing money during slumps when it's cheap and paying it back during booms when revenues are up can work wonders.

Chapter 7 is titled "Of Colonies" and deals with all things colonial. Definitely relevant to an earlier time. It starts with a discussion of Greek and Roman colonies, about which I had totally forgotten. He appears to have been a fan of the American colonies.

The colony of a civilized nation which takes possession either of a waste country, or of one so thinly inhabited that the natives easily give place to the new settlers, advances more rapidly to wealth and greatness than any other human society.
One important difference in the colonies is that primogeniture is no longer universal. There is so much free land that this is not a problem. But Britain was practicing the standard colonial model, with the colonies restricted to exporting raw materials and importing manufactured products.
The more advanced or more refined manufactures, even of the colony produce, the merchants and manufacturers of Great Britain chuse to reserve to themselves, and have prevailed upon the legislature to prevent their establishment in the colonies, sometimes by high duties, and sometimes by absolute prohibitions.
And, you gotta give credit to Smith, he calls this out:
To prohibit a great people, however, from making all that they can of every part of their own produce, or from employing their stock and industry in the way that they judge most advantageous to themselves, is a manifest violation of the most sacred rights of mankind.
There is a discussion of the restrictive trade practices which the European countries adapted to maximize their profits on trade with the Americas and the Far East. And again, Smith is against all such practices.
But whatever raises, in any country, the ordinary rate of profit higher than it otherwise would be, necessarily subjects that country both to an absolute, and to a relative disadvantage in every branch of trade of which she has not the monopoly.
Surprisingly, globalization is already an issue in the late 18th century -- with business, just as now, not wanting to share the wealth.
Our merchants frequently complain of the high wages of British labour, as the cause of their manufactures being undersold in foreign markets; but they are silent about the high profits of stock. They complain of the extravagant gain of other people; but they say nothing of their own. The high profits of British stock, however, may contribute towards raising the price of British manufactures, in many cases, as much, and in some perhaps more, than the high wages of British labour.
More Smith goodness! Here he lauds full employment.
The most advantageous employment of any capital to the country to which it belongs, is that which maintains there the greatest quantity of productive labour, and increases the most the annual produce of the land and labour of that country.
There is some commentary on the American Revolution as seen from the British side. There was great consternation at the loss of their trade monopolies. But, following his Libertarian instincts, Smith actually proposed that Britain get rid of all its colonies, and the expense of protecting them, when the only ones benefitting from them are British merchants and manufacturers.
A great empire has been established for the sole purpose of raising up a nation of customers, who should be obliged to buy, from the shops of our different producers, all the goods with which these could supply them. For the sake of that little enhancement of price which this monopoly might afford our producers, the home consumers have been burdened with the whole expense of maintaining and defending that empire. For this purpose, and for this purpose only, in the two last wars, more than two hundred millions have been spent, and a new debt of more than a hundred and seventy millions has been contracted, over and above all that had been expended for the same purpose in former wars. The interest of this debt alone is not only greater than the whole extraordinary profit which, it never could be pretended, was made by the monopoly of the colony trade, but than the whole value of that trade, or than the whole value of the goods which, at an average, have been annually exported to the colonies. It cannot be very difficult to determine who have been the contrivers of this whole mercantile system; not the consumers, we may believe, whose interest has been entirely neglected; but the producers, whose interest has been so carefully attended to; and among this latter class, our merchants and manufacturers have been by far the principal architects. In the mercantile regulations which have been taken notice of in this chapter, the interest of our manufacturers has been most peculiarly attended to; and the interest, not so much of the consumers, as that of some other sets of producers, has been sacrificed to it.
And then maybe after the colonies are turned loose ...
By thus parting good friends, the natural affection of the colonies to the mother country, which, perhaps, our late dissensions have well nigh extinguished, would quickly revive. It might dispose them not only to respect, for whole centuries together, that treaty of commerce which they had concluded with us at parting, but to favour us in war as well as in trade, and instead of turbulent and factious subjects, to become our most faithful, affectionate, and generous allies; and the same sort of parental affection on the one side, and filial respect on the other, might revive between Great Britain and her colonies, which used to subsist between those of ancient Greece and the mother city from which they descended.
Ha ha, I guess that it didn't turn out that way for their American colonies. But Britain is the greatest ally of the US nonetheless. I see this more as the empire of the 19th century cozying up to the empire of the 20th century more than as "parental affection" and "filial respect".

I'm guessing Smith would have been aghast at the British Empire of the 19th century.

He also proposed that representatives from the colonies be given seats in the British parliament, in an attempt to buy off the leaders of the colonies.

Unless this or some other method is fallen upon, and there seems to be none more obvious than this, of preserving the importance and of gratifying the ambition of the leading men of America, it is not very probable that they will ever voluntarily submit to us ...
Smith is eerily prescient on the future of the American colonies. He really seems to have been a fan.
From shopkeepers, trades men, and attorneys, they are become statesmen and legislators, and are employed in contriving a new form of government for an extensive empire, which, they flatter themselves, will become, and which, indeed, seems very likely to become, one of the greatest and most formidable that ever was in the world.
Smith next goes into excruciating detail on many of the market goods of his time. I thought this one was kind of funny, about efforts of the English wool industry to get the government to give them special treatment.
This doctrine, like most other doctrines which are confidently asserted by any considerable number of people, was, and still continues to be, most implicitly believed by a much greater number: by almost all those who are either unacquainted with the woollen trade, or who have not made particular inquiries. It is, however, so perfectly false, that English wool is in any respect necessary for the making of fine cloth, that it is altogether unfit for it. Fine cloth is made altogether of Spanish wool. English wool, cannot be even so mixed with Spanish wool, as to enter into the composition without spoiling and degrading, in some degree, the fabric of the cloth.
Ha ha, his reference to "any considerable number of people" reminds me of Paul Krugman's Very Serious People (VSP).

Here is Smith recommending that if the game is zero-sum, then it shouldn't be played.

To hurt, in any degree, the interest of any one order of citizens, for no other purpose but to promote that of some other, is evidently contrary to that justice and equality of treatment which the sovereign owes to all the different orders of his subjects.
Another principle, which I guess can be regarded as Libertarian, is that when the government makes things too restrictive, the market will find a way around the government. Hello, war on drugs.
Their avidity, however, upon this, as well as upon many other occasions, disappointed itself of its object. This enormous duty presented such a temptation to smuggling, that great quantities of this commodity were clandestinely exported, probably to all the manufacturing countries of Europe;
Wow, there are just so many issues that are still with us today, in different form. Here's 18th century Intellectual Property (IP) law. And notice, the rights of the individual are completely subjugated to those of the merchant or manufacturer.
When such heavy penalties were imposed upon the exportation of the dead instruments of trade, it could not well be expected that the living instrument, the artificer, should be allowed to go free. Accordingly, by the 5th Geo. I. chap. 27, the person who shall be convicted of enticing any artificer, of or in any of the manufactures of Great Britain, to go into any foreign parts, in order to practise or teach his trade, is liable, for the first offence, to be fined in any sum not exceeding one hundred pounds, and to three months imprisonment, and until the fine shall be paid; and for the second offence, to be fined in any sum, at the discretion of the court, and to imprisonment for twelve months, and until the fine shall be paid. By the 23d Geo. II. chap. 13, this penalty is increased, for the first offence, to five hundred pounds for every artificer so enticed, and to twelve months imprisonment, and until the fine shall be paid; and for the second offence, to one thousand pounds, and to two years imprisonment, and until the fine shall be paid.
If any artificer has gone beyond the seas, and is exercising or teaching his trade in any foreign country, upon warning being given to him by any of his majesty’s ministers or consuls abroad, or by one of his majesty’s secretaries of state, for the time being, if he does not, within six months after such warning, return into this realm, and from henceforth abide and inhabit continually within the same, he is from thenceforth declared incapable of taking any legacy devised to him within this kingdom, or of being executor or administrator to any person, or of taking any lands within this kingdom, by descent, devise, or purchase. He likewise forfeits to the king all his lands, goods, and chattels; is declared an alien in every respect; and is put out of the king’s protection. It is unnecessary, I imagine, to observe how contrary such regulations are to the boasted liberty of the subject, of which we affect to be so very jealous; but which, in this case, is so plainly sacrificed to the futile interests of our merchants and manufacturers.
The final chapter of Book 4 is chapter 9, "Of The Agricultural Systems, Or Of Those Systems Of Political Economy Which Represent The Produce Of Land, As Either The Sole Or The Principal Source Of The Revenue And Wealth Of Every Country". Man, Smith is definitely the king of the run-on sentence. This goes back to the "agriculture is better than manufacturing" meme. He reviews a French theory, attributed to Colbert and Qttesnai, which places merchants, artificers and manufacturers into the "unproductive" class.
Artificers, manufacturers, and merchants, can augment the revenue and wealth of their society by parsimony only; or, as it is expressed in this system, by privation, that is, by depriving themselves of a part of the funds destined for their own subsistence. They annually reproduce nothing but those funds. Unless, therefore, they annually save some part of them, unless they annually deprive themselves of the enjoyment of some part of them, the revenue and wealth of their society can never be, in the smallest degree, augmented by means of their industry. Farmers and country labourers, on the contrary, may enjoy completely the whole funds destined for their own subsistence, and yet augment, at the same time, the revenue and wealth of their society.
I'm really not sure I get this. Smith goes back to the the open market being best.
Those systems, therefore, which preferring agriculture to all other employments, in order to promote it, impose restraints upon manufactures and foreign trade, act contrary to the very end which they propose, and indirectly discourage that very species of industry which they mean to promote.
It is thus that every system which endeavours, either, by extraordinary encouragements to draw towards a particular species of industry a greater share of the capital of the society than what would naturally go to it, or, by extraordinary restraints, to force from a particular species of industry some share of the capital which would otherwise be employed in it, is, in reality, subversive of the great purpose which it means to promote. It retards, instead of accelerating the progress of the society towards real wealth and greatness; and diminishes, instead of increasing, the real value of the annual produce of its land and labour.
So with regard to current US politics, Smith would advocate getting rid of all forms of corporate welfare.

Well, that's 4 books down, 1 to go. The last book is on the revenue of the state.

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