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Economic Ideas: Adam Smith on Free Trade, Crony Capitalism, and the Benefits from Commercial Society

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Adam Smith’s central contribution to economic understanding was surely his demonstration that under an institutional arrangement of individual liberty, property rights, and voluntary exchange the self-interested conduct of market participants could be shown to be consistent with a general betterment of the human condition.

The emergence of a social system of division of labor makes men interdependent for the necessities, amenities and luxuries of life. But in the free, competitive market order every individual can only access what others in society can supply him with by offering them something in exchange that they value more highly than what is being asked from them in trade.

Thus, as Adam Smith memorably explained, as if by “invisible hand” each individual is guided to apply his knowledge, ability and talents in ways that serve the trading desires of others as the means of fulfilling his own self-interested goals and purposes. Furthermore, not only is the need for government regulation and control of economic affairs shown to be unnecessary for societal improvement, Smith went on to argue that such government intervention was detrimental to the most successful advancements in human material and cultural life. (See my article: “Economic Ideas: Adam Smith on Moral Sentiments, Division of Labor and the Invisible Hand.”)

Individual Freedom and Trade Among Nations

At the heart of Adam Smith’s criticisms of eighteenth century Mercantilism, with its presumption of a need for political direction and planning of economic activities for balance and prosperity, was his insistence that such political paternalism was needed neither in domestic trade and commerce nor in the buying and selling of imports and exports between countries.

Adam Smith argued that it was superfluous and counter-productive for government to attempt to manage and direct the importing or exporting of goods and services to maintain a presumed “favorable” balance of trade. Each individual tries to minimize the costs that must be incurred in achieving his goals and ends. He only makes at home what is less expensive to make than to buy from others. And he buys desired goods from others only when those others can provide them at a lower cost in resources and labor and time, than if the individual attempted to produce those desired goods through his own self-sufficient efforts.

Thus, goods are purchased from producers in other countries only when they can offer them at a lower cost than manufacturing them in one’s own country. And, in turn, one purchases those foreign produced goods by supplying the foreign seller with some good or service at a lower cost than if he tried to produce it in his own land.

When governments, through regulations and controls, force a product to be produced at home that could be less expensively purchased from abroad, it is misdirecting scarce resources and labor into wasteful and inefficient uses. The result must be that the wealth of that nation – and the material wellbeing of its citizens — is reduced by the amount by which more resources and labor must be devoted to making wanted goods than they could be obtained through a free system of international division of labor and peaceful, mutually beneficial exchange. Hence, it is more prudent for the prosperity of one’s own nation to leave production and trade to the self-interested actions of its individual citizens.

As Adam Smith explained in The Wealth of Nations (1776):

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

It is the maxim of every prudent master of a family, never to attempt to make at 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 a part of it, 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 to buy it of them with some part of the produce of our own industry, employed in a way in which we have some advantage . . .

It is certainly not employed to the greatest advantage when it is directed towards an object which it can buy cheaper than it can make it . . . The Industry of a country, therefore, is thus turned away from a more, to a less advantageous employment, and the exchangeable value of its annual produce, instead of being increased, according to the intention of the lawgiver, must necessarily be diminished by every such regulation.

All that was necessary, Adam Smith argued, was to leave men free to follow their own self-interests, and production and prosperity will be forthcoming in the directions and forms most advantageous to the members of the society as a whole, whether that trade is geared toward domestic or foreign demand and supply.

The Propagating of False Notions of Conflict Among Nations

Who were often the instigators for and beneficiaries of trade restrictions on imports and subsidies for exports? Adam Smith was scathing in his criticisms of manufacturers, merchants and agricultural special interests who wished to maintain or gain market share and greater profits from restricting the free flow of goods and services between countries through government action.

Those who today are usually labeled “crony capitalists” run to the government for favors, privileges, and protections from foreign and domestic competition, Adam Smith warned. Toward that end, they popularize fallacies and misunderstanding concerning the mutual benefits of trade among nations. Said Smith:

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 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 tranquility of any body but themselves.

Smith warned of the “interested sophistry” of those desiring anti-competitive interventions and protections in the private sector through the political power of governments by creating false notions that trade is a zero-sum game in which if one side wins the other side must have lost, or that imports and a trade deficit are inherently harmful to the material well-being of a nation. These distortions and errors had to be refuted so it would be better understood that, “In every country it always is and must be in the interest of the great body of the people to buy whatever they want of those who sell it cheapest.”

The Mutual Prosperity of Nations is Beneficial to All

In addition, the material success of existing or potential trading partners is never a threat to the well being of one’s own nation. To the contrary, the more prosperous other nations may be, the greater the trading opportunities for selling one’s own specialized output as the means to acquiring the true benefit of trade – the obtaining of imports that foreign suppliers can make available at lower costs and better qualities and varieties than if one had to rely simply on one’s own nation’s labor skills and resources. “A nation that would enrich itself by foreign trade,” Adam Smith said, “is certainly most likely to do so when its neighbors are all rich, industrious, and commercial nations.” To try to impoverish other nations is a sure way to undermine one’s own nation’s rise to improved prosperity.

Abolishing Trade Restrictions for Prosperity and Against Privilege

The best means of assuring access to the benefits from international trade and to weaken, if not fully eliminate, the influence of those private interest groups wishing to use the government for their own ends at the expense of the remainder of society was to abolish in the most expeditious manner all barriers to a freedom of trade among nations.

There were a number of exceptions and circumstances in which Adam Smith accepted government intervention in the patterns of trade. And he argued that when industries have long been secure behind trade barriers that have provided them with monopoly positions, to prevent severe disruption to the economic circumstances to those employed in these sectors of the economy it might be desirable to reduce the trade barriers gradually rather than all at once.

But he also emphasized that even if freedom of trade was established in short order, the displacement of even a significant number of workers would soon be remedied with alternative employments, as the economic gains from being able to purchase a variety of less expensive goods from aboard would provide the financial means for demanding many goods that previously consumers could not afford at the prior protected monopoly prices. Or as Smith more generally expressed it:

The natural effort of every individual to better his own conditions, when suffered to exert itself with freedom and security, is so powerful a principle, that it is alone, and without 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 encumber its operations.

The Prejudices of the Public and the Power of the Interests

In spite of the cogency and convincingness of his arguments against Mercantilism, Adam Smith was far from confident that his ideas and those of others like him would ever succeed in bringing about the end to this eighteenth century version of central planning, and in its place the establishment of a “system of natural liberty” with freedom of trade.

His pessimism was due to two influences and forces in society, he said: The prejudices of the public – by which he meant the difficulty of getting the ordinary citizen to understand the logic of the market and the positive benefits from the “invisible hand” of unintended consequences. And the power of the interests – by which he meant the special interest groups that benefit from government privileges and favors, and who would resist any and all attempts to reduce or eliminate government regulations and redistributions that benefit them at others’ expense.

In Adam Smith’s own words:

To expect, indeed, that the freedom of trade should ever be entirely restored in Great Britain, is as absurd as to expect that an Oceana or Utopia should ever be established in it.

Not only the prejudices of the public, but what is much more unconquerable, the private interests of many individuals, irresistibly oppose it . . .The member of parliament who supports every proposal for the strengthening this monopoly, is sure to acquire not only the reputation of understanding trade, but great popularity and influence with an order of men whose numbers and wealth render them of great importance.

If he opposes them, on the contrary, and still more if he has authority enough to be able to thwart them, neither the most acknowledged probity, nor the highest rank, nor the greatest public service, can protect him from the most infamous abuse and detraction, from personal insults, nor sometimes real danger, arising from the insolent outrage of furious and disappointed monopolies.

Fortunately for the material and cultural betterment of the world, Adam Smith was wrong in this prediction. Within one lifetime between his death in 1790 and the mid-1840s, Great Britain abolished virtually all its domestic and foreign trade restrictions, putting in its place a system of free enterprise and free trade. And through the Britain’s example and success with highly unrestricted freedom of trade, many other countries in Europe were influenced to follow the same course, if perhaps not as radically as in Great Britain or in the United States. Adam Smith, in other words, had underestimated the power of his own ideas.

Commerce as a Pathway for Improving Civil Society

The benefits of commerce and trade, Adam Smith argued, were not only the material improvements in man’s condition. It also served as a method for civilizing men, if by civilization is meant, at least partly, courtesy, and respect for others, and an allegiance to honesty and fulfillment of promises.

When men deal with each other on a daily and regular basis, they soon learn that their own wellbeing requires of them sensitivity for those with whom they trade.

Losing the confidence or the trust of one’s trading partners can result in social and economic injury to oneself.

The self-interest that guides a man to demonstrate courtesy and thoughtfulness for his customers, under the fear of losing their business to some rival with superior manners or etiquette to his own, tends over time to be internalized as habituated “proper behavior” to others in general and in most circumstances. Through this process, the other-orientedness that voluntary exchange requires of each individual in his own self-interest, if he is to attain his own ends, fosters the institutionalization of interpersonal conduct that is usually considered essential to a well-mannered society and cultured civilization.

Adam Smith explained this important and fortuitous benefit from commercial society in his Lectures on Jurisprudence (1766):

Whenever commerce is introduced into any country, probity and punctuality always accompany it . . . It is far more reducible to self-interest, that general principle which regulates the actions of every man, and which leads men to act in a certain manner from views of advantage, and is as deeply implanted in an Englishman as a Dutchman.

A dealer is afraid of losing his character, and is scrupulous in observing every engagement. When a person makes perhaps 20 contracts in a day, he cannot gain so much by endeavoring to impose on his neighbors, as the very appearance of a cheat would make him lose.

When people seldom deal with one another, we find that they are somewhat disposed to cheat, because they can gain more by a smart trick than they can lose by the injury that it does to their character . . . Wherever dealing are frequent, a man does not expect to gain so much by any one contract as by probity and punctuality in the whole, and a prudent dealer, who is sensible of his real interest, would rather choose to lose what he has a right to than give any ground for suspicion . . .

When the greater part of people are merchants they always bring probity and punctuality into fashion, and these therefore are the principle virtues of a commercial nation.

Commerce Led to the Unintended Consequence of Greater Liberty

Adam Smith also explained how the spontaneous emergence of commerce and opportunities for trade between foreign countries and faraway cities with the countryside slowly reduced the power of feudal lords and princes over those who lived and worked on their lands, thus setting in motion the processes that began the development of civil society with its more modern conceptions of individual rights and decentralized power.

In the self-sufficient environment of the medieval Manor, the only or primary source of needed necessities and luxuries desired by the Lord of the Manor was the output of those on his estate and the immediate village environment. The taxes and tithes that he received had no other outlet for being spent than on the employment of the several hundred of people over whom he ruled.

At the same time, the Lord’s expenditures represented for these tenants on his land and for the village craftsman virtually all the demand and income they might earn at any time. Thus, their obedience and subservience to the Lord of the Manor was not only based on his political authority and ownership of the land, but also because of their total dependency on his good graces in spending his wealth on those goods and services which they produced, partly to pay the taxes and tithes which they owed the Lord.

But with the emergence of commerce and trade from outside the confines of the Lord’s estate, he could now purchase desired goods from beyond his own community. This weakened his hold of dependency and obedience over those who lived and worked on his estate. At the same time, a growing market outside the estate meant that those village craftsmen and farming tenants now could find other markets for their goods besides the Lord. This reduced their dependency on his good graces and spending for their own survival and modest livelihood.

Adam Smith explained that this growing economic independence from the Lord served as a crucial element in people beginning to sense their freedom from his hold over them, and to demand formal liberty in their relationships with political authority without the fear, anymore, of his stranglehold over their material existence. In Adam Smith’s words in The Wealth of Nations:

In a country which has neither foreign commerce, nor any of the finer manufactures, a great proprietor, having nothing for which he can exchange the greater part of the produce of his lands which is over and above the maintenance of the cultivators, consumes the whole in rustic hospitality at home . . .

He is at all times, therefore, surrounded with a multitude of retainers and dependents, who . . . being fed entirely by his bounty, must obey him, for the same reason that soldiers must obey the prince who pays them . . . The occupiers on the land were in every respect as dependent upon the great proprietor as his retainers . . . In a country where the surplus of a large estate must be consumed upon the estate itself . . . a tenant . . . is as dependent upon the proprietor as any servant or retainer, whatever, and must obey him with as little reserve . . .

The silent and insensible operation of foreign commerce and manufactures gradually . . . furnished the great proprietors with something for which they could exchange the whole surplus of their lands, and they could consume themselves without sharing it either with tenants or retainers . . .

When the great proprietors of land spent their rents in maintaining their tenants and retainers, each of them maintains entirely his own tenants and his own retainers. But when they spend them in maintaining tradesmen and artificers, they may, all of them taken together, perhaps maintain as great . . . or a greater number of people than before.

Each of them, however, taken singly, contributes often but a very small share to the maintenance of any individual of this greater number. Each tradesman or artificer derives his subsistence from the employment, not of one, but of a hundred or a thousand different customers. Through in some measure obligated to them all, therefore, he is not absolutely dependent upon any one of them.

The slowly developing, but radical change in the relationships between the Lords and the commoners was an example, Adam Smith said, of those cases of human actions that transform society but are not instances of any intentional human design.

A revolution of the greatest importance to the public happiness was in this manner brought about by two different orders of people, who had not the least intention to serve the public.

To gratify the most childish vanity was the sole motive of the great proprietors . . . For a pair of diamond buckles perhaps, or something as frivolous and useless, they exchanged the maintenance, or what is the same thing, the price of the maintenance of a thousand men for a year, and with it the whole weight and authority which it would give them.

The merchants and artificers, much less ridiculous, acted merely from a view to their own interest, and in pursuit of their own peddler principle of turning a penny wherever a penny was to be got. Neither of them had either knowledge or foresight of the great revolution which the folly of the one, and the industry of the other, was gradually bringing about.

Prosperity, Independence and Freedom

John Miller, another Scottish philosopher who had been a student of Adam Smith’s at the University of Glasgow, highlighted how this change in relationships between the feudal lords and the commoner fostered the spirit and the politics of liberty and democracy in his own book, Origins of the Distinction of Ranks published in 1779, three years after Smith’s Wealth of Nations appeared. Explained Miller:

The further a nation advances in opulence and refinement, it has occasion to employ a greater number of merchants, of tradesmen and artificers; and as the lower people, in general, become thereby more independent in their circumstances, they begin to exert those sentiments of liberty which are natural to the mind of man . . .

While, from these causes, people of the low rank are gradually advancing towards a state of independence, the influence derived from wealth is diminished in the same proportion . . .

Thus, while fewer persons are under the necessity of depending upon him, he is daily rendered less capable of maintaining dependents; till at last his domestics and servants are reduced to such as are merely subservient to luxury and pageantry, but are of no use in supporting authority . . .

It cannot be doubted that these circumstances have a tendency to introduce a democratical government. As persons of inferior rank are placed in a situation which, in point of subsistence, renders them little dependent upon their superiors; as no one order of men continues in the exclusive possession of opulence; and as every man who is industrious may entertain the hope of gaining a fortune; it is to be expected that the prerogatives of the monarch, and of the ancient nobility will be gradually undermined, that the privileges of the people will be extended in the same proportion and that power, the usual attendant of wealth, will be in some measure diffused over all the members of the community.”

Adam Smith’s Contribution to the Cause of Liberty and Prosperity

Adam Smith’s significance cannot be overstated in formulating the ideas and insights of that “system of natural liberty” that helped to foster an understanding of the workings of the free market order and its institutional prerequisites of individual freedom, private property, voluntary association and unrestricted, peaceful competition. Or as the prominent nineteenth century economist and popularize of economic ideas, John R. McCulloch, said in 1853, “Adam Smith has an unquestionable claim to be regarded as the real founder of the modern system of Political Economy . . .The Wealth of Nations must be placed in the foremost rank of those works which have helped to liberalize, enlighten, and enrich mankind.”

He brought together in The Wealth of Nations many of the ideas about human nature, spontaneous order, competitive markets and more limited government that had been part of the central themes of the Scottish Moral Philosophers. Unique to Smith’s and the Scottish contribution in general is also the insight that whatever degree of liberty that has been acquired in the West has not been the result of a planned out linear process originating from some articulated “first principle.”

Liberty, as we understand its meaning and content today, emerged to a great extent as the unintended consequence of a series of unique historical events in certain parts of Europe, the full meaning and outcome of which the individual actors in this centuries-long drama often have had little or no inkling of in terms of the implications their own decisions and interactions were helping to bring about.

It should make us appreciative of the historical processes that have fostered liberty, and modest in our too frequent arrogance that it is in the power of some to remold men or remake society in some rarified conception of a “better world,” all according to socially engineered design. We do most for improving the conditions of mankind when we allow each individual to be free to use his own knowledge and abilities as he sees best in a setting in which market prices and competitive incentives direct him in how to apply himself in the social system of division of labor.

Or as Austrian economist, Friedrich A. Hayek, said at the time of the two hundredth anniversary of the publication of The Wealth of Nations in 1976:

The recognition that a man’s efforts will benefit more people, and on the whole satisfy greater needs, when he lets himself be guided by the abstract signals of prices rather than by perceived needs, and that by this method we can best overcome our constitutional ignorance of most of the particular facts, and can make the fullest use of the knowledge of concrete circumstances widely dispersed among millions of individuals, is the great achievement of Adam Smith.

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    Dr. Richard M. Ebeling is the BB&T Distinguished Professor of Ethics and Free Enterprise Leadership at The Citadel. He was formerly professor of Economics at Northwood University, president of The Foundation for Economic Education (2003–2008), was the Ludwig von Mises Professor of Economics at Hillsdale College (1988–2003) in Hillsdale, Michigan, and served as vice president of academic affairs for The Future of Freedom Foundation (1989–2003).