Saturday, March 26, 2011

Book Review, Wealth of Nations Book 4

Book IV, Of Systems of Political Economy.

Smith spends much of this book examining the system of commerce and agriculture, which he takes to be the "two systems of political economy." Much of this book focuses on the gains from trade and attacks mercantilists who are obsessed with forcing the nation to export more goods than it imports from other countries. The goal of mercantilism is to import more gold and silver than other countries and Smith shows how that's not the point-- a nation's wealth and standard of living depends on its ability to produce goods and services, not on how much gold it has. Trade expands the size of the market and allows for more specialization to occur--more efficient uses of resources. It allows producers and consumers to obtain things they otherwise could not:

"The importation of gold and silver is not the principal, much less the sole benefit, which a nation derives from its foreign trade...[Trade] carries out that surplus part of the produce of their land and labour for which there is no demand among them, and brings back in return for it something else for which there is a demand. It gives a value to their superfluities, by exchanging them for something else, which may satisfy a part of their wants and increase their enjoyments. By means of it, the narrowness of the home market does not hinder the division of labour in any particular branch of art or manufacture from being carried to the highest perfection...[Trade] encourages them to improve its productive power, and to augment its annual produce to the utmost, and thereby to increase the real revenue and wealth of the society."

Money, as it were, doesn't matter:

But if money is wanted, barter will supply its place, though with a good deal of inconveniency. Buying and selling upon credit, and the different dealers compensating their credits with one another, once a-month, or once a-year, will supply it with less inconveniency. A well-regulated paper-money will supply it not only without any inconveniency, but, in some cases, with some advantages. Upon every account, therefore, the attention of government never was so unnecessarily employed, as when directed to watch over the preservation or increase of the quantity of money in any country.

But local merchants and producers don't want to face increased competition from trade, either from the neighbor across the street or the stranger on the other side of the world. So, they lobby parliament to give them a monopoly. Elected officials and kings then say they are "pro-business," as President Obama often states. "Pro-business" is anti-market and anti-consumer.

"
Consumption is the sole end and purpose of all production; and the interest of the producer ought to be attended to, only so far as it may be necessary for promoting that of the consumer. But in the mercantile system, the interest of the consumer is almost constantly sacrificed to that of the producer; and it seems to consider production, and not consumption, as the ultimate end and object of all industry and commerce. ..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 so it continues today. Via Alex Tabarrok, here's a story about U.S. furniture manufacturers asking for (and receiving) payments from Chinese firms in order that those furniture manufacturers don't lobby Congress and the ITC for protection. La-Z-Boy would rather you buy the more expensive chair that is "made in America," because they pretend to be patriotic:

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The laudable motive of all these regulations, is to extend our own manufactures, not by their own improvement, but by the depression of those of all our neighbours, and by putting an end, as much as possible, to the troublesome competition of such odious and disagreeable rivals. Our master manufacturers think it reasonable that they themselves should have the monopoly of the ingenuity of all their countrymen."
All anti-trade legislation, be it "buy local" campaigns or "buy American," are all intended to "beggar they neighbor." They are therefore simply nationalistic, often inherently racist, policies.

The sad thing is that most people are unaware that by restricting trade in order to "increase wealth" of the nation, you end up robbing the nation by directing capital toward means other than what would best promote the welfare of society. You limit the size of the market, the specialization, and the technological progress and higher standard of living that would otherwise occur.

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When a landed nation on the contrary, oppresses, either by high duties or by prohibitions, the trade of foreign nations, it necessarily hurts its own interest in two different ways. First, by raising the price of all foreign goods, and of all sorts of manufactures, it necessarily sinks the real value of the surplus produce of its own land, with which, or, what comes to the same thing, with the price of which, it purchases those foreign goods and manufactures. Secondly, by giving a sort of monopoly of the home market to its own merchants, artificers, and manufacturers, it raises the rate of mercantile and manufacturing profit, in proportion to that of agricultural profit; and, consequently, either draws from agriculture a part of the capital which had before been employed in it, or hinders from going to it a part of what would otherwise have gone to it."
Smith is blasting not only import tariffs and quotas but also export bans and production subsidies. They always have perverse unintended consequences.

Smith also spends a good deal of Book IV examining England's trade monopoly with the American colonies. He speaks of the advantages that the American market has brought to England but also of how the restrictions harm both America and England. Smith is very sympathetic with the colonists' cries of "no taxation without representation." He warns England of a bloody war with a people he feels will eventually develop an empire similar to England. He proposes a compromise of giving the colonists representation:

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it is not very probable that they will ever voluntarily submit to us; and we ought to consider, that the blood which must be shed in forcing them to do so, is, every drop of it, the blood either of those who are, or of those whom we wish to have for our fellow citizens. They are very weak who flatter themselves that, in the state to which things have come, our colonies will be easily conquered by force alone. The persons who now govern the resolutions of what they call their continental congress, feel in themselves at this moment a degree of importance which, perhaps, the greatest subjects in Europe scarce feel. 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 prophecies that eventually the American colonies will surpass England in economic importance, and that, if united with England, eventually the capital of the United Kingdom will justly move from London to America!

Again, Smith's main points are that:
  • Restrictions on trade are violations of "natural liberty."
  • Restrictions on trade force capital to go where it otherwise would, causing inefficiencies.
  • Restrictions on trade benefit producers at the expense of consumers. They force consumers to have fewer choices and higher prices.
  • Obsessing about the balance of trade is fruitless-- a nation's standard of living depends on its ability to produce goods and services well and not on how much gold and silver it has.
  • For economic growth and higher standard of living to occur, workers must become more productive. This occurs by having gains from specialization due to increased trade and more capital invested in equipment that will help workers become more productive.
  • Savings = Investment, so the more profit that is saved, the more that is invested resulting in more capital accumulation, productivity, and future economic growth.
Smith ends Book IV with observations from the time he spent in France with Quesnay and the Physiocrats. He makes comments on the economic system Quesnay and his followers were proposing and quotes people of the time lauding Quesnay's "tableau economique." Smith differs with Quesnay somewhat on what groups of workers are "productive" and "unproductive," but seems to agree with Quesnay on the whole.

He finished Book IV by introducing Book V, with a summation of the role of the state: National defense, protection of property rights and justice, and provision of pure public goods.

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