Adam Smith � Theory of Trade and Government Intervention into Free Trade
Adam Smith, also known as the Father of Economics, was born in Scotland. Two of his books �The Theory of the Moral Sentiment� and �The Wealth of Nations� have made a tremendous impact on the economic behavior of the countries in the world. At the time when Mercantilist had the government completely woven under their spell, Adam Smith appeared as an imperialist through the promotion of Internationalism and the anti-England of policy and thought. In his book �The Wealth of Nations,� Smith discussed the issues of production of labor, the theory of division of labor, the changes in price, capital, profit accumulation and the nature of market economy. In discussing the above, he explicitly refuted against mercantilism, and promoted free trade. The thesis of my paper talks about Adam Smith�s view on mercantilism and trade, government intervention, and his rationalization into free trade.
In order to understand Smith�s opinion about trade, one must understand the basic ideas of mercantilist view of his time. Mercantilists viewed the wealth of the nation to be fixed. Hence, any increase in wealth and economic power of one nation resulted at the expense of the other. Therefore, they believed that the government should regulate the economy so that the workers would get a low wage for a cheaper production. The domestic consumption should be minimized so that more goods could be exported to collect gold and silver. About this, Smith wrote:
�In the meantime one of the principal effects of those discoveries (America and of the sea route to the East Indies) has been to raise the mercantile system to a degree of splendour and glory which it could have never otherwise have attained to. It is the object of that system to enrich a great nation rather by trade and manufactures than by the improvement and cultivation of land, rather by the industry of the towns than by that of the country.�
Adam Smith completely debated the mercantilist argument, saying that the wealth of the nation is not gold and silver, but it is the skill and the productivity of the labor. Hence the land and labor of the country should be used to produce goods rather than just bringing in goods as an intermediary to trade with little profit. Moreover, Adam Smith defined the role of production as consumption, and not the collection of bullion as the popular belief used to be. He suggested that the major focus of the country should be to consume more, and hence more production and availability of more goods is better for the country. In order for this to happen, Smith promoted the policy of Laissez Faire which he explained by means of his �invisible hand doctrine.�
��.every individual necessarily labours to render the annual revenue of the society as great he can. 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 again, 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.�
Smith was profoundly religious, and saw that the �invisible hand� as the mechanism by which a benevolent God administered a universe in which human happiness was maximized. He believed that God had created humans with a nature that leads them to act a certain way, and in this case, to maximize their own utility. He also believed that the world as we know is pretty perfect and everyone is equally happy. Despite equal happiness, the human nature leads us to think that we would be happier if we were wealthier. This leads us to struggle to become wealthier, thus increasing the sum total of human happiness through the mechanisms of exchange and division of labor. There is one important thing that one should note when analyzing Smith�s �Invisible Hand Doctrine�, and it is that moral norms are necessary for such a system to work, that in order for exchange to proceed, contracts must be enforceable, people must have good access to information about the products and services available, and the rule of law must hold. After the assumption of the perfect society, Smith thus advocates his views about trade, and this is where his Laissez Faire Doctrine stands out.
Mercantilism brought about improper allocation of resources. The fundamental problem that Smith pointed out in mercantilism was the fact that the merchants had manipulated the King to employ his money into helping merchants of the country bring in raw produce from foreign countries. Although Smith was pro-trade, he didn�t agree that the labor of Great Britain was being employed into manufacturing only. He observed that the sole purpose of the labor was to add �value� into raw materials by working for the forced minimum wage. The goods were then exported it to some foreign country in order to gain profit for the merchant and the King. He saw that it was doing little justice to the productive capacity of the laborers. After that, countries started focusing in self-sufficiency, and tried to do everything themselves in order to produce at the cheapest, and then export it so that the profit is more. This according to Adam Smith was the worst thing an economy could do because the productive capacity is much higher if trade was allowed.
Moreover, Mercantilist operate to keep commerce, labor, or capital from following the channels in which they would otherwise go, or they cause inefficiency because they attract to a particular species of industry a greater share of the factors than would ordinarily be employed in it. He cites the example of the pin industry, where if one man was to do all part of the process, he would make 20 pins a day, but when the task was divided, they made 200 pins a day. If the economy as a whole did this it would be beneficial for the society because the goods would be abundant, and they would be able to trade it with each other to fulfill their needs and wants. This is also known as his �Absolute Advantage� theory.
�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�..But if there would be a manifest absurdity in turning towards any employment, thirty times more of the capital and industry of the country, than would be necessary to purchase from foreign countries an equal quantity of the commodities wanted, there must be an absurdity, though not altogether so glaring, yet exactly of the same king, in turning towards any such employment a thirtieth, or even a three hundredth part more of either��it will always be more advantageous for the latter, rather to buy of the former than to make.�
Adam Smith thus believed that in order for the absolute advantage to take place in the economy, there should be �abolition of existing systems of governmental regulation, though [Adam Smith] nowhere brings the several items in the program together.� Smith advocates four major reforms when it comes to the rules of the government that should be changed. He believes that there should be free choice of occupations by abolishing apprenticeship regulations and settlement laws. There should be free trade in land through the repeal of laws establishing entails, primogenitures and other restrictions on the free transfer of land by gift, devise or sale. There should be internal free trade which should be established through removal of local customs taxes. Lastly, Smith believes that free trade in foreign commerce by abolishing duties, bounties, and prohibitions of the merchantilistic regime and the trading monopolies of the chartered companies.
Adam Smith revolted against the government intervention mainly because of his argument, as previously stated, that the wealth of nations depends upon the productivity of labor and the proportion of laborers who are usefully or productively employed. He recognized the serious conflicts between private interest and the public interest in the market. If the government puts on restrictions, or supports one particular industry through import restrictions, then the companies become unproductive due to lack of competition. They will know that whatever they are doing will be enough for them to profit, or to reach the breakeven point. Hence, they will not come up with new technology or better production method in order to stay competitive in the market. Smith argued that the trade allows the division of labor and specialization, which further increases the productivity of labor, therefore providing an opportunity to increase the wealth of the nation. Smith also introduced the concept of increasing returns as labor becomes more and more specialized in its task.
�When the market is very small, no person can have any encouragement to dedicate himself entirely to one employment, for want of the power to exchange all that surplus part of the produce of his own labour, which is over and above his own consumption, for such parts of the produce of other men�s labour as he has occasion for.�
Smith then argues about the monopolistic power and its negative effect on the country. Monopoly occurs due to government intervention. This occurs when one company controls the entire industry. Often, governments support one large company in order to support the industry. Since there will be one dominant supplier in the country, they can raise the price of the commodity more than the real price of the commodity. Hence, there is improper market occurring in the country. Smith also points out that the monopolists act in their own interest, and not for the benefit of the country. For example, he talks about the monopoly in the corn market, where the monopolist might destroy part of the crop in order to gain extraordinary profits on the crop.
�People of the same trade seldom meet together, even for merriment and diversion, but the conversation ends in a conspiracy against the public, or in some contrivance to raise prices. It is impossible indeed to prevent such meetings, by any law which either could be executed, or would be consistent with liberty and justice. [The cord dealer, on the whole, performs a useful service, but because of his] excess of avarice he does not perform it perfectly. [The merchant exporter sometimes finds it to his interest, when dearth prevails both at home and abroad], very much to aggravate the calamities of the dearth, [at home by exporting corn].
Lastly, Smith argues for free trade and lack of government intervention by discussing the determinants of the price of the commodity. Smith said that the price of a commodity is determined by the rent of the land, the wage of the laborers, and the profit to the merchants. Smith argues that the rent of the land and the wage of the laborers are pretty stable. When there is government intervention that protects the merchants it gives them the power to raise their profit. This leads to extraordinary prices for the commodities. Conversely, when there is no government intervention, the society works in balance, the society can revolt against higher prices for a commodity by choosing its substitute in the market. Therefore, this controls the merchants from exorbitantly raising the profits.
Adam Smith is the father of economics, in that he saw a broad spectrum which no one else of his time saw. He believed that the policy for international trade should be the same as that of the free trade at home. Trade should take place based on the absolute advantage each country has in comparison to that of the other country. If one country is better at making pins, and the other one is better at making cloth, then they should each specialize in pins and cloth respectively, and trade in order to benefit each other. There should be no government intervention in the country. Although he came up with the idea of specialization and division of labor, he failed to see that the division of labor impairs the intelligence, enterprise, marital courage, and moral character of the laborers. Smith had much sympathy for the laborers and farmers, but he had little trust in the government. He recognized some of the exceptions where perhaps the intervention of the government was needed, but he refused to acknowledge that there are both positive and negative sides to having a government intervention in any case. Although Adam Smith advocated laissez faire, and free trade with extensive historical examples, he did recognize the fact that this highly depends upon the circumstances the country is in. His historical examples, and depth of knowledge has made Smith, the greatest contributor in the history of Economics, and this particular theory of laissez faire and free trade has sculpted today�s world in the mold Smith advocated.
REFERENCES:
1. The Wealth of Nations, Adam Smith, Penguin Press
2. Adam Smith and Laissez Faire, The Journal of Political Economy, Jacob Viner, JSTOR
