By Dallin Overstreet

Although Adam Smith lived in the 18th century, the father of modern economics still has much to teach the world today. Smith’s world famous book Wealth of Nations is arguably the most important piece on economics in history. It greatly influenced other scholars, thinkers, and eventually policymakers away from the then-dominant global policy of mercantilism toward freer trade.

With the sharp change in views on trade in the U.S. due to the inauguration of President Donald Trump, Smith’s teachings on trade should draw renewed interest once again. Here are some short lessons from Smith on trade we should all remember.

Trade Can Make a Nation Wealthy, While Trade Restrictions Make Us Poorer

It isn’t well known that the full name of Adam Smith’s masterpiece is An Inquiry into the Nature and Causes of the Wealth of Nations, not just The Wealth of Nations. This should always be remembered, as Smith is explicitly trying to answer the question, “What makes a nation rich?” During his time, growth beyond being able to provide for the bare necessities of life was hard to come by and only accomplished in few places. Smith’s main inquiry into economics was discovering why some nations were rich while others were poor. His main discovery that he is known for from this book was that specialization and gains from trade were a primary driver of wealth-creation for all people.

Thus, a restriction on trade and specialization (tariffs or other trade barriers) do harm to a country in terms of growth. In Smith’s words:

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. […] The value of [a country’s] annual produce is certainly more or less diminished when it is thus turned away from producing commodities evidently of more value than the commodity which it is directed to produce [by trade policies]. […] The industry of the 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.

The Size of the Market Limits Specialization

One of Smith’s first sections in the Wealth of Nations speaks to the importance of trade in letting us specialize:

As it is the power of exchanging that gives occasion to the division of labour, so the extent of this division must always be limited by the extent of that power, or, in other words, by the extent of the market. 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 is saying here that a greater ability to buy from and interact with one another—across a community or across the globe—makes for a greater ability to specialize in any particular task. Specialization allows us to produce more goods and services with less time, effort, and materials, and a bigger market gives us more people to trade those goods and services with. With more individuals to trade with, more specialization can take place, increasing the efficiency and wealth of everyone involved.

Retaliatory Tariffs are Not Good Policy

Sometimes tariffs are justified on the premise of retaliating against other countries that are said to be “cheating,” which could mean the country is either applying tariffs to U.S. goods sent to their country or making their exports less expensive by subsidizing them through various forms of policy.

Smith anticipated this consideration as well, with a sort of economic take on the saying “two wrongs don’t make a right,” and a warning that retaliatory measures tend to spiral, to the detriment of all parties involved:

When there is no probability that any such repeal [of a tariff in a foreign country] can be procured, it seems a bad method of compensating the injury done to certain classes of our people to do another injury ourselves, not only to those classes, but to almost all the other classes of them. When our neighbours prohibit some manufacture of ours, we generally prohibit, not only the same, for that alone would seldom affect them considerably, but some other manufacture of theirs. This may no doubt give encouragement to some particular class of workmen among ourselves, and by excluding some of their rivals, may enable them to raise their price in the home-market. Those workmen, however, who suffered by our neighbours prohibition will not be benefited by ours. On the contrary, they and almost all the other classes of our citizens will thereby be obliged to pay dearer than before for certain goods. Every such law, therefore, imposes a real tax upon the whole country, not in favour of that particular class of workmen who were injured by our neighbours prohibition, but of some other class.

This line of thinking is particularly relevant today, with trade tensions with China escalating quickly and with trade barriers being justified due to “cheating” on the part of China. Over 200 years ago, these arguments were thought as sensible enough to set in motion a gradual climb away from protectionism and mercantilism and toward freer trade. Today, it’s generally well accepted in the economics profession. The United States and all countries should continue to fight for free trade and push back on any forms of protectionism.

 

Dallin Overstreet is a Senior Policy Analyst at the American Freedom Institute

 

Featured Image Credit: By Stefan Schäfer, Lich – Own work, CC BY-SA 4.0, https://commons.wikimedia.org/w/index.php?curid=34656567

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