THE WEALTH OF NATIONS
by
Adam Smith

(Part II, Economic Policy)

FUTURECASTS online magazine
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Vol. 5, No. 7, 7/1/03.

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  In this review, modern terminology is frequently used for the sake of clarity. The book was first published in 1776. However, material was added to subsequent editions through the next decade, so there are some references to conditions as late as 1784, especially with respect to the conflict that included the American Revolution.

Introduction

Discretionary resources:

 

 

&

  • The wealth of nations is measured by Adam Smith in terms of money - but does not include money.
  • It is generated by fixed assets - but does not include those fixed assets.
  • Fixed assets must at least generate subsistence consumables for the maintenance of human capital, and resources for the maintenance of physical fixed assets - but the measure of wealth used by Smith includes neither subsistence consumables nor resources expended for such maintenance.

  It is "net revenues" that are available for discretionary uses - either for investing or consuming - or for taxation that does not reach the level of capital levies - that is the measure of national wealth used by Smith. This is what a society can draw upon - without deferring maintenance or otherwise draining existing productive capital.  It is available for all discretionary purposes - profound or frivolous, consumption or investment, private or government. It is a measure of economic power - either in terms of money or in its labor and commodity equivalents - that is available without diminishing the productive capacity of the nation. (Smith's views about money are scattered widely throughout his book.)
 &
  In "An Inquiry Into the Nature and Causes of the Wealth of Nations," Smith explains how societies and individuals work through market mechanisms to build, accumulate and maintain capacity to generate their discretionary economic resources - and thus generate economic power. See, Adam Smith, "The Wealth of Nations," Part I, "Market Mechanisms." To an amazing extent - even after more than two centuries - this book still speaks to current economic processes, conditions and problems.
 &

Government economic policy:

  The superiority of market mechanisms over administered alternatives - whether directed by government, private associations, experts or intellectuals - is set forth by Smith with classic clarity.  &

"What is the species of domestic industry which his capital can employ, and of which the produce is likely to be of the greatest value, every individual, it is evident, can, in his local situation, judge much better than any statesman or lawgiver can do for him.  The statesman who should attempt to direct private people in what manner they ought to employ their capitals - - - [would] assume an authority which could safely be trusted, not only to no single person, but to no council or senate whatever, - - -."

  Each individual seeks to maximize his profits or wages by employing himself and his capital in the most valuable way. Regardless of human imperfections and limitations, the expertise that individuals gain concerning their own business and economic needs must inevitably be superior to that of any outsider.
 &
  Government restraints
and other interference with domestic and foreign commerce are both foolish and dangerous.

  "What is the species of domestic industry which his capital can employ, and of which the produce is likely to be of the greatest value, every individual, it is evident, can, in his local situation, judge much better than any statesman or lawgiver can do for him. The statesman who should attempt to direct private people in what manner they ought to employ their capitals would not only load himself with a most unnecessary attention, but assume an authority which could safely be trusted, not only to no single person, but to no council or senate whatever, and which would nowhere be so dangerous as in the hands of a man who had folly and presumption enough to fancy himself fit to exercise it."

  For over 200 years, advocates of mercantilism, communism, socialism, price controls, protectionism, industrial policy, social engineering and other administered alternatives have all rejected this wisdom. They have expended vast and varied efforts to improve on market results - and have all failed miserably - often with disastrous results that have blighted the lives of billions of people. Their "folly" was often vastly dangerous indeed.
 &
  All too frequently, administered policies are in reality efforts to promote personal interests above national interests. Competitive markets - even with competitive conditions that are far from perfect - easily achieve results superior to the most elaborate administered alternatives.

"[In choosing between domestic and foreign sources], 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."

 

"It is the industry which is carried on for the benefit of the rich and powerful that is principally encouraged by our mercantile system."

  Mercantilist policies - a particular problem in Adam Smith's times - are especially criticized.

  "[Thus,] every individual necessarily labours to render the annual revenue of the society as great as he can. He generally, indeed, neither intends to promote the public interest, nor knows how much he is promoting it. [In choosing between domestic and foreign sources], 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 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.

    "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 [in the sense of unnecessary] or a hurtful regulation." (Today, the word "monopoly" has a legal definition much narrower than the definition used by Smith throughout this work.)

  Just as specialization increases efficiency in the home market - just as tailors don't make their own shoes and shoemakers don't make their own clothes - it is wasteful and foolish to spend more for domestic products that can be more efficiently imported. "What is prudence in the conduct of every private family can scarce be folly in that of a great kingdom." Although justified in terms of the national interest, mercantilist restraints are almost always designed to favor special interests - in Smith's time, the manufacturers and merchants.

  "It is the industry which is carried on for the benefit of the rich and powerful that is principally encouraged by our mercantile system. That which is carried on for the benefit of the poor and the indigent is too often either neglected or oppressed."

  Nothing has really changed. It is no accident that the chief beneficiaries of tariff restraints and subsidies are rich agribusinesses and high wage unionized steel.

  "But the cruellest of our revenue laws, I will venture to affirm, are mild  and gentle in comparison of some of those which the clamour of our merchants and manufacturers has extorted from the legislature for the support of their own absurd and oppressive monopolies. Like the laws of Draco, these laws may be said to be all written in blood."

"These causes [of prosperity] seem to be: the general liberty of trade, - - -; but above all, that equal and impartial administration of justice which renders the rights of the meanest British subject respectable to the greatest, - - -."

  However, England benefited from having fewer mercantilist restraints than any other major European nation - easily overcoming the burdens of the restraints that existed.

  "These causes [of prosperity] seem to be: the general liberty of trade, which notwithstanding some restraints, is at least equal, perhaps superior, to what it is in any other country; the liberty of exporting, duty free, almost all sorts of goods which are the produce of domestic industry to almost any foreign country; and what perhaps is of still greater importance, the unbounded liberty of transporting them from any one part of our own country to any other without being obliged to give any account to any public office, without being liable to question or examination of any kind; but above all, that equal and impartial administration of justice which renders the rights of the meanest British subject respectable to the greatest, and which, by securing to every man the fruits of his own industry, gives the greatest and most effectual encouragement to every sort of industry."

Smith's political philosophy:

 

&

  As between the three economic classes, labor is viewed by Adam Smith as the most basic - and clearly receives his most sympathetic treatment. However, he has a very low opinion of the average government worker or official. The economic contribution of landlords drawing rents from mere possession of raw land is greatly disparaged, and they are viewed without sympathy.
 &

The primary objective is to maximize the prosperity of the economy for the welfare of the people and the financial capabilities of the state.

  With respect to capitalists, Smith is fairly evenhanded. He emphasizes equally their vital role and their many problems, along with their many weaknesses and abuses.
 &
  This exposition of the benefits of free competitive markets
and government policies that facilitate commerce is distinctly liberal in its point of view. Always, the primary objective of the author is to maximize the prosperity of the economy for the welfare of the people and the financial capabilities of the state.
 &

  There are no simplistic laissez faire rationales here. In general, Smith opposes interventions that favor individual market participants or groups of participants, but favors policies that facilitate commerce as a whole or that prevent private parties from interfering with market mechanisms. Modern policies that he would favor would include:

  • Antitrust laws and disclosure-based securities regulations - albeit with considerable skepticism about the likelihood of objectivity and effectiveness in their operation. These are designed to remove impediments to market mechanisms.

  • Infrastructure projects - although, wherever practical,  he preferred the private utility approach rather than government ownership. The need to properly regulate banks and the various aspects of the paper and virtual money supply and credit system also fall in this category as financial infrastructure. He recommends the efficiency of paper money, but recognizes that it is not self regulating in the absence of ties to precious metals.

  • Workers' rights. He would especially favor their union rights to counterbalance employer combinations and efforts to impose legal and contractual restraints on workers. However, he would definitely oppose union-shop unionism.

  • Laws protecting the national interests against private interests. One of the concerns that is most pervasive in The Wealth of Nations is the extent to which the private interests of merchants and manufacturers are contrary to the national interest. It is thus reasonable to believe that Smith would favor such legislative and regulatory efforts - albeit again with considerable skepticism about the likelihood of objectivity and effectiveness - as Environmental laws, Occupational Health and Safety laws, Food and Drug safety laws, etc. They would be accepted warily - and constantly judged on the practical basis of their balance of benefits and burdens.

  • Smith would oppose social security in the expectation that government will ultimately misuse the funds and ruin the program, while causing a diminution in private savings. He adamantly opposes payroll taxes, especially on poverty level wages.

BOOK IV: MERCANTILISM

The mercantile system:

 

"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."

  Misguided efforts to accumulate hard money - gold and silver - by various mercantile restraints are the subject of Book IV. "Monopoly of one kind or another, indeed, seems to be the sole engine of the mercantile system."

  "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. The maxim is so perfectly self-evident that it would be absurd to attempt to prove it. 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."

 "Neither is a country which has no mines more likely to be exhausted of gold and silver by this annual exportation of those metals than one which does not grow tobacco by the annual exportation of that plant."

  Restraints against capital exports - in Smith's time, gold and silver exports - undermine commerce that is dependent on foreign trade - increase costs - render the nation's commerce less competitive - and are anyways futile since they just encourage smuggling. To preserve or augment gold and silver money requires no more "attention of government than to preserve or to augment the quantity of any other useful commodities, which the freedom of trade, without any such attention, never fails to supply in the proper quantity."

  "We trust with perfect security that the freedom of trade, without any attention of government, will always supply us with the wine which we have occasion for; and we may trust with equal security that it will always supply us with all the gold and silver which we can afford to purchase or to employ, either in circulating our commodities, or in other uses."
 &
  "Neither is a country which has no mines more likely to be exhausted of gold and silver by this annual exportation of those metals than one which does not grow tobacco by the annual exportation of that plant. As a country which has wherewithal to buy tobacco will never be long in want of it, so neither will one be long in want of gold and silver which has wherewithal to purchase those metals."

  Indeed, it is easier to assure needed supplies of gold and silver, because of the ease of shipment, than of bulkier and less valuable commodities like wheat. In a pinch, credit arrangements and even paper money can be employed in place of precious metals.

 "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."

It is the productivity of the nation and not its wealth in money that is the ultimate source of economic power.

  However, credit is not so exactly regulated by the market. Merchants and promoters who overextend themselves periodically find themselves complaining of insufficient money to meet their obligations. "Overtrading" is especially common during prosperous times.

  Credit bubbles have always been with us. Credit and paper money do not govern themselves with sufficient precision to prevent excesses, and require active and prudent management at all times. Unfortunately, for this we are dependent on government - and for centuries government has failed to perform these relatively simple tasks adequately.

  Smith goes on at some length explaining that it is the productivity of the nation and not its wealth in money that is the ultimate source of economic power. England's recent war - 1755-1763 - was several times more expensive than all the circulating gold and silver in England, and yet there was never any shortage of coinage during that time. Some payment was undoubtedly made in bullion, but the war was primarily paid for by a great increase in the nation's exports. Indeed, the export trade that flourished during that vastly expensive war was peculiar to that war, and shriveled soon after the return of peace.
 &
  The goods relied upon for these exports were "the finer and more improved manufactures" which contained the most value added in their manufacture. Undeveloped nations must accumulate vast treasures of gold and silver to finance wars and meet other crises. Developed nations have no such needs "because they can generally draw from their subjects extraordinary aids upon extraordinary occasions." Indeed, instead of accumulating great treasures, governments of commercially developed nations indulge in great extravagances.

  David Ricardo explains the adjustment process by which money outflows increase exports. He evaluates and expands upon many of the concepts of Adam Smith. See, Ricardo, "On The Principles of Political Economy and Taxation."

The benefits of free trade:

 

Exports encourage a nation "to improve its produce to the utmost, - - -."

  Foreign trade broadens markets - induces vast expansion of that which a nation best produces - that which it supplies far more efficiently than that which it produces poorly or not at all. This encourages the further division of labor that increases productivity and prosperity.

  "By opening a more extensive market for whatever part of the produce of their labour may exceed the home consumption, it encourages them to improve its produce to the utmost, and thereby to increase the real revenue and wealth of the society."

  The discovery of America did not promote the economic development of Europe with the produce of its gold and silver mines (John Kenneth Galbraith to the contrary notwithstanding), but with the great increase in commerce, which the development of these new markets encouraged. The continuing backwardness of Spain and Portugal - the primary beneficiaries of the American mines - proves Smith's point.
 &
  With the new markets, the "productive powers of labour were improved, and its produce increased in all the different countries of Europe, and together with it the real revenue and wealth of the inhabitants." The opening of new trade routes to Asia could have been even more important if the various trading nations had not restricted the East Indies trade to great monopolies.
 &

Mercantilist trade restraints:

  Smith then criticizes the various mercantilist measures by which nations favor domestic industries and/or mistakenly seek to favorably influence their balance of trade to increase supplies of gold and silver. Among these mercantilist measures:

Restraints on foreign commerce have to be costly to overcome the cost advantages which make foreign commerce attractive.

  • Import restraints - such as high tariffs or the total exclusions of imports - were imposed to protect domestic industries or to counter trade deficits with particular nations.

  • Subsidies and tax relief were granted to encourage exports and favored domestic industries.

  • Trade treaties and colonial arrangements were used to obtain commercial advantages.

  • Monopolies were awarded to major trading companies.

  Industries favored by trade restraints in Smith's times included live cattle, salt, corn, and woolen and silk goods. "[It] is by no means certain that this artificial direction is likely to be more advantageous to the society than that which it would have gone of its own accord." Indeed, since domestic commerce has many natural advantages over foreign commerce - of cost, risks, and familiarity with customs and laws - restraints on foreign commerce have to be costly to overcome the cost advantages which make foreign commerce attractive.
 &

"[Capital] is certainly not employed to the greatest advantage when it is thus directed towards an object which it can buy cheaper than it can make."

  Capital used for import substitution production would not be diminished in the absence of protection - it would be freed to find more productive uses, Smith points out.

  "[Capital] is certainly not employed to the greatest advantage when it is thus directed towards an object which it can buy cheaper than it can make. The value of [the nation'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. - - - 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."

  Today, advantage to the nation is no longer even a credible issue. Steel tariffs, subsidies primarily for agribusinesses, quotas that protect sugar plantations, are everywhere blatant favors for political favorites. Unfortunately, these political favors not only burden the domestic economy, many of them have a widely and unconscionably devastating impact on struggling undeveloped nations.

 "Though for want of such regulation the society should never acquire the proposed manufacture, it would not, upon that account, necessarily be the poorer in any one period of its duration."

  Infant industries arguments are rejected by Adam Smith. The costs of mercantilist policies are so great that the nation might be better off even if some new industry is less rapidly established or even never established. The growth of net revenue might indefinitely continue faster even in the absence of the industry if the expenses for protection and/or subsidy are never incurred.

  "Though for want of such regulation the society should never acquire the proposed manufacture, it would not, upon that account, necessarily be the poorer in any one period of its duration."

  Smith never even considers the additional sums wasted on the many protected infant industries that never become competitive and thus indefinitely burden an economy with their costs.

  Very good wines from hothouse grapes can be made in Scotland, Smith notes, but it costs 30 times more than similar imports. While other examples would cost less - even much less - the logic remains the same. In those days - due to the costs of transport by sail - restraints on manufactured goods was far more damaging than restraints on bulk commodities like beef, salt and corn. "Merchants and manufacturers are the people who derive the greatest advantage from this monopoly of the home market."
 &

  An exception for defense industries is recognized by Smith. The Act of Navigation encourages the employment of British ships and sailors needed for the defense of the island nation. But the cost is considerable. Even though it restrains only the shipment of imports, it also inevitably reduces that nation's exports by reducing the number of buyers in England's commercial ports.

  "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."

  One of the enduring lessons of economic history is that restraints on imports also inevitably limit exports. Unfortunately, it is also one of the most frequently neglected.

 "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; - - -."

  The need to equalize tax burdens so that domestic commerce does not bear a heavier burden than foreign competition is also recognized. Unfortunately, instead of just leveling the playing field, Smith notes that domestic merchants and manufacturers always use this argument to impose far heavier tax burdens on their foreign competition.

  It is true that a nation could never collect business taxes if they resulted in putting the businesses out of business. However, the elimination of business taxes might be no bad thing, since taxes on business are in reality stealth taxes on consumers.

  Smith rejects the notion that tariffs should also be imposed to equalize the burdens imposed by the broad level of taxation. That it is impossible to calculate the extent of this burden is just the beginning of the problem.
 &
  The general level of taxation is the same as any natural obstacle to production. Tariffs cannot profitably compensate for the burdens of the nation's tax levels just as they cannot compensate for its natural economic limitations. The imposition of tariff burdens cannot in any way mitigate tax burdens on domestic commerce. They can only add to those burdens.

  "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."

"Not only the prejudices of the public, but what is much more unconquerable, the private interests of many individuals, irresistibly oppose [free trade]."

 

"The Member of Parliament who supports every proposal for strengthening this monopoly is sure to acquire not only a reputation of understanding trade, but great popularity and influence with an order of men whose numbers and wealth render them of great importance."

  Recent trade wars are then discussed by Smith. He recognizes that retaliatory trade restraints may be useful if they can be quickly effective in opening foreign markets. This difficult calculation must be left "to the skill of that insidious and crafty animal, vulgarly called a statesman or politician." However, they otherwise are self defeating since their great cost punishes the domestic market more than the foreign market.
 &
  Moreover, if they are left in place too long, the affected economic sector may get so addicted to them that any rapid removal might prove very disruptive. This disruptive impact is no more a reason for continuing either an individual restraint or a trade war than is the momentary unemployment of soldiers and war industries a reason for continuing a military war.
 &
  Adam Smith notes that the many soldiers and sailors demobilized a little more than a decade earlier after the previous great war were easily absorbed by England's healthy economy, since labor market rigidities were not applied to them. A similar removal of labor market rigidities would assure best employment for all Britain's workers and capital.
 &
  However, it may  be useful to remove protective restraints slowly so as not to initiate too great a disruption.

  For both political and economic reasons, Smith is probably wrong on this point. If it is to be done, it is probably best it should be done all at once.

  Indeed, the political and economic difficulty and disruption initiated by removal of protectionist measures is one of the most convincing reasons to avoid them.

    "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." (In the 19th century, the impossible became possible, and England prospered as never before.)

  Protectionist measures increase the number, wealth and influence of those dependent upon them, rendering it politically and even physically dangerous to try to relieve the public of these burdensome monopolies.

  "The Member of Parliament who supports every proposal for strengthening this monopoly is sure to acquire not only a 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 services can protect him from the most infamous abuse and detraction, from personal insults, nor sometimes from real danger, arising from the insolent outrage of furious and disappointed monopolists."

  Now - in both Europe and the U.S. - international commerce is burdened primarily with agriculture restraints and subsidies rather than commercial and manufacturing restraints, but nothing else has really changed in over two centuries.

  Tariffs at prohibitive levels designed to end the trade deficit with France are ridiculed by Smith. Like other high tariffs, they harm British commerce - France has retaliated in a similar fashion - and the tariffs are undermined by smuggling and by subterfuge by Holland and other nations that include French goods in their exports.

  Trade embargoes such as the current one imposed by the U.S. against Cuba are always ineffective and self defeating - far more burdensome to those imposing the embargoes than to the targets - unless they are nearly universal.

  The complexity of trade flows make judgments about nation-to-nation trade balances ridiculous. The many complicating factors make judgments based on payments balances even more impossible. Moreover, the market impacts of the export and import of money and bullion are such that any imbalance will always tend to be self correcting.

  Yet, these stupid arguments will not die. Even in recent times - to support their protectionist agendas - various vested interests and the economists and politicians who support them have raised the bogeyman of trade deficits with particular nations like Japan and China.

"It is a losing trade, it is said, which a workman carries on with the alehouse; and the trade which a manufacturing nation would naturally carry on with a wine country may be considered as a trade of the same nature."

 

"The sneaking arts of underling tradesmen are thus erected into political maxims for the conduct of great empire: for it is the most underling tradesmen only who make it a rule to employ chiefly their own customers. A great trader purchases his goods always where they are cheapest and best, without regard to any little interest of this kind."

 

"By such maxims as these, however, nations have been taught that their interest consisted in beggaring all their neighbors."

 

"That it was the spirit of monopoly which originally both invented and propagated this doctrine cannot be doubted; and they who first taught it were by no means such fools as they who believed it. In every country it always is and must be the interest of the great body of the people to buy whatever they want of those who sell it cheapest."

  Then, Adam Smith debunks protectionist arguments - again in his classic, clear prose. 

  "It is a losing trade, it is said, which a workman carries on with the alehouse; and the trade which a manufacturing nation would naturally carry on with a wine country may be considered as a trade of the same nature. I answer that the trade with the alehouse is not necessarily a losing trade. In its own nature, it is just as advantageous as any other, though perhaps somewhat more liable to be abused. The employment of a brewer, and even that of a retailer of fermented liquors, are as necessary divisions of labour as any other. It will generally be more advantageous for a workman to buy of the brewer the quantity he has occasion for than to brew it himself, and if he is a poor workman, it will generally be more advantageous for him to buy it by little and little of the retailer than a large quantity of the brewer. - - - [Trade restraints] favor the wine trade of Portugal, and discourage that of France. The Portuguese, it is said, indeed, are better customers for our manufactures than the French, and should therefore be encouraged in preference to them. As they give us their custom, it is pretended, we should give them ours. The sneaking arts of underling tradesmen are thus erected into political maxims for the conduct of great empire: for it is the most underling tradesmen only who make it a rule to employ chiefly their own customers. A great trader purchases his goods always where they are cheapest and best, without regard to any little interest of this kind.

  "By such maxims as these, however, nations have been taught that their interest consisted in beggaring all their neighbors. Each nation has been made to look with an invidious eye upon the prosperity of all the nations with which it trades, and to consider their gain as its own loss. 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. - - -

  "That it was the spirit of monopoly which originally both invented and propagated this doctrine cannot be doubted; and they who first taught it were by no means such fools as they who believed it. In every country it always is and must be the interest of the great body of the people to buy whatever they want of those who sell it cheapest. The proposition is so very manifest that it seems ridiculous to take any pains to prove it; nor could it ever have been called into question had not the interested sophistry of merchants and manufacturers confounded the common sense of mankind. - - - As it is the interest of the freemen of a corporation [town] to hinder the rest of the inhabitants from employing any workmen but themselves, so it is the interest of the merchants and manufacturers of every country to secure to themselves the monopoly of the home market." (Emphasis added.)

  It should be kept in mind that England and France were still great rivals - and would be involved in great conflicts in the future as in the past. Smith recognizes the primacy of defense needs, and having Portugal as an ally would prove very advantageous. Nevertheless, the economics of Smith's position is obviously correct.

It is obviously in the best interest of nations to have economically successful trading partners. Economics - for capitalist nations - is not a zero sum game, since capitalist economics will always rapidly increase the economic pie unless constrained by stupid policies.

  He shreds zero sum game arguments and arguments based on envy by pointing out that those that accumulate great wealth - whether nations or cities or individuals - are exactly the ones that provide the best markets and the most employment. It is obviously in the best interest of nations to have economically successful trading partners. Economics - for capitalist nations - is not a zero sum game, since capitalist economics will always rapidly increase the economic pie unless constrained by stupid policies.
 &
  But, again, he recognizes that great wealth in the hands of a potential adversary - like France - can be dangerous if conflict ever breaks out. However, he emphasizes that - whether due to animosity or mercantile jealousy - the restraint of trade between England and France has deprived both nations of probably their most profitable international commerce. "France - - - could afford a market at least - - - four-and-twenty times more advantageous than that which our North American colonies ever afforded."
 &

 "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 [mercantilist] commercial system would lead us to expect, have been enriched by it."

  He ridicules the declinists who invariably preach imminent ruin due to balance of trade problems. (Yes, they were with us then as now.) Holland is one of the freest trading nations of Europe and one of the wealthiest.

  "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 [mercantilist] commercial system would lead us to expect, have been enriched by it."

  The paper money created by banks in the 18th century - especially that of the Bank of Amsterdam - is described by Adam Smith. Even if all gold and silver is expended, Smith asserts that credit mechanisms and paper money can easily - and even more conveniently - fulfill the monetary role.

  Smith writes perceptively of the impacts and problems of 18th century bank money and financing mechanisms. However, what is most lacking for the modern reader are the impacts of modern fiat money and financing mechanisms - the proper regulation of which pose problems that Smith, of course, never contemplated.

If all trades needed bounties to be competitive, Smith points out, "there would soon be no capital left in the country."

  Subsidies to encourage exports are easily debunked by Smith. If all trades needed bounties to be competitive, Smith points out, "there would soon be no capital left in the country." Trade that depends on bounties is the only kind such that "one of them shall always and regularly lose, or sell its goods for less than it really costs to send them to market."
 &
  He demonstrates the irrationality of contemporary arguments favoring the bounty encouraging corn exports - and the great cost to the economy as a whole over and above the cost of the bounty itself. "The bounty upon corn alone has sometimes cost the public in one year more than three hundred thousand pounds."
 &
  It is the corn merchants who profit the most from this mercantilist program, and they are its most zealous advocates.

  "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."

  Far less convincing is Smith's argument that corn is such a basic commodity that most of the benefit to the farmers of the increased corn price due to the subsidized export demand is necessarily eaten up by a general inflation of all prices. He had earlier concluded that English labor had moved significantly above subsistence levels by maintaining its wage levels during the preceding century while overall costs - including that of corn - declined. Thus, the maintenance of corn prices somewhat higher than they otherwise would be would not result in the higher labor costs that could cause such inflation.

  But Smith is undoubtedly correct that such bounties diminish the productivity of a nation - damage the competitiveness of all other products both in export markets and as against imports - and tends to impoverish rather than enrich the nation. As a result, the Dutch spend less for English corn than the English do, which has to increase the overall competitiveness of Dutch products over those of England.

  "It tends to render our manufactures somewhat dearer in every market, and theirs somewhat cheaper than they otherwise would be, and consequently to give their industry a double advantage over our own."

Inflation of the gold and silver money supply "discourages both the agriculture and manufactures of Spain and Portugal."

  The restraints on capital exports by Spain and Portugal have been particularly disastrous in a manner similar to - albeit much more burdensome than - the corn subsidy, Smith notes. They therefore provide a clear example of the noxious impacts and futility of such mercantilist measures.
 &
  By means of taxes or outright prohibitions, Spain and Portugal have accumulated far more gold and silver than their economies need for monetary purposes. As a result, they were suffering under "the most oppressive burdens" of inflation.

  "[You] frequently find there a profusion of [gold and silver] plate in houses where there is nothing else which would, in other countries, be thought suitable or correspondent to this sort of magnificence. The cheapness of gold and silver, or what is the same thing, the dearness of all commodities, which is the necessary effect of this redundancy of the precious metals, discourages both the agriculture and manufactures of Spain and Portugal, and enables foreign nations to supply them with many sorts of rude, and with almost all sorts of manufactured produce, for a smaller quantity of gold and silver than what they [the Spanish and Portuguese] themselves can either raise or make them for at home. The tax and prohibition operate in two different ways. They not only lower very much the value of the precious metals in Spain and Portugal, but by detaining there a certain quantity of those metals which would otherwise flow over other countries, they keep up their value in those other countries somewhat above what it would otherwise be, and thereby  give those countries a double advantage in their commerce with Spain and Portugal."

More than a century before the disasters of socialist agriculture, Smith accurately points out that - while difficult weather may create shortages - it is almost always government mismanagement that is responsible for famine.

  The Corn Laws and their impacts upon corn markets and prices are particularly analyzed and criticized by Smith. More than a century before the disasters of socialist agriculture, he accurately points out that - while difficult weather may create shortages - it is almost always government mismanagement that is responsible for famine. (Except for war, nothing causes famine like socialist agriculture.)

  Smith frequently uses the term "corn" to refer to a variety of cereal grains.

  Smith provides a sketch of centuries of government stupidity in what today would be called "industrial policy." Even what are today called "windfall profits" and "speculative profits" are shown by Smith to play a vital role in mitigating shortages and preventing real food famines or disastrous shortages of other products - as long as there are reasonable levels of competition in the markets. (See, "Profits and Capitalist Productivity: A Bargain at Twice the Price.")
 &

"The trade which cannot be carried on but by means of a bounty [is] necessarily a losing trade."

 

 "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."

  Mercantilist measures impoverish a nation not just by distorting capital flows, but also by expending resources in ways that are actually disadvantageous.
 &
  Smith provides a detailed criticism of fisheries bounties. "The trade which cannot be carried on but by means of a bounty [is] necessarily a losing trade." However, he acknowledges that bounties to encourage sailcloth and gunpowder exports and manufacture may be justified on national defense grounds.
 &
  He also condemns export prohibitions designed to reduce the price of materials used by favored manufacturers. Export prohibitions are applied to wool, fuller's clay, hides, industrial metals, watch and clock works. Heavy duties are levied on exports of a wide variety of unfinished goods and industrial materials. Enforcement efforts for wool and similar restraints involve harsh criminal and civil penalties - restrictive handling requirements - reporting requirements - and an expensive enforcement bureaucracy. A considerable smuggling trade in these commodities is nevertheless evident.

  "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. But the prohibition certainly hurts, in some degree, the interest of the growers of wool, for no other purpose but to promote that of the manufacturers."

  Similar restraints were imposed against the export of textile technology and the emigration to alien lands by artificers.
 &

  The limited benefits of favored nation treaties is discussed by Smith in relation to the treaty with Portugal. The English designed this treaty to encourage the flow of gold from Portugal in return for English goods and other goods exported to Portugal by English merchants.
 &
  This gives Adam Smith an opportunity to discuss the arcane intricacies of gold coinage and problems experienced by the English mint because of English monetary policy. Among other things, he explains the benefits of having the mint charge a moderate seignorage for the minting of bullion into coins - something the English mint was not at that time doing.
 &

Colonialism:

 

"Folly and injustice seem to have been the principles which presided over and directed the first project of establishing [the Latin American] colonies."

  The various colonial movements from ancient times to the establishment of the American colonies are summarized by Smith. He heaps considerable scorn on the exploitative motives of the Spanish and Portuguese - their brutal conquests - and their self defeating quest for precious metals. The more of these metals that they obtained, the less the metals were worth - and the noxious influences of inflation undermined all other industry in those nations.

  "Folly and injustice seem to have been the principles which presided over and directed the first project of establishing those colonies; the folly of hunting after gold and silver mines, and the injustice of coveting the possession of a country whose harmless natives, far from having ever injured the people of Europe, had received the first adventurers with every mark of kindness and hospitality."

"The first regulations which [the mother country] made with respect to them had always in view to secure to herself the monopoly of their commerce; to confine their market, and to enlarge her own at their expense, and, consequently, rather to damp and to discourage than to quicken and forward the course of their prosperity."

  The settled colonies of the West Indies and East Indies, on the other hand, are of great benefit to both the colonists and the mother countries. The most prosperous are those of North America.

  "Plenty of good land, and liberty to manage their own affairs their own way, seem to be the two great causes of the prosperity of all new colonies."

  However, the success of the American colonies was frequently in spite of the policies of the mother countries. Religious intolerance played the major role in driving the most productive settlers to the colonies.

  "Upon all these different occasions it was not the wisdom and policy, but the disorder and injustice of the European governments which peopled and cultivated America."

  The colonial empires were primarily the work of bold adventurers and private associations and companies - with very little assistance from the mother countries.

  "When those establishments were effectuated, and had become so considerable as to attract the attention of the mother country, the first regulations which she made with respect to them had always in view to secure to herself the monopoly of their commerce; to confine their market, and to enlarge her own at their expense, and, consequently, rather to damp and to discourage than to quicken and forward the course of their prosperity. In the different ways in which this monopoly has been exercised consists one of the most essential differences in the policy of the different European nations with regard to their colonies."

"They carry out with them, too, the habit of subordination, some notion of the regular government which takes place in their own country, of the system of laws which support it, and of a regular administration of justice; - - -."

  The fundamentals required for economic development are clearly identified by Smith - (fundamentals ignored for decades by supposedly knowledgeable modern economists). 

  "The colony of a civilised 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.

  "The colonists carry out with them a knowledge of agriculture and of other useful arts superior to what can grow up of its own accord in the course of many centuries among savage and barbarous nations. They carry out with them, too, the habit of subordination, some notion of the regular government which takes place in their own country, of the system of laws which support it, and of a regular administration of justice; and they naturally establish something of the same kind in the new settlement."

  The greatest contribution of the mother countries to the success and prosperity of their colonies thus consisted of "the education and great views of their active and enterprising founders."
 &
  With modern skills - an established system of government - rule of law - an established legally and politically empowered civil society - and the limitless land and natural resources available to them - the colonists are in position to flourish. Resources are plentiful and labor never sufficient - providing prosperity for worker and owner alike.
 &
  Where governed by some "exclusive company" - like the East and West India trading companies - progress was retarded. Elsewhere, trade was managed in various ways to enhance the advantages of the merchants of the mother country. However, the great distance from the mother country and the ease of smuggling facilitated prosperity even in these colonies.
 &

By allowing access to world markets for their goods, trade greatly enlarges the markets for colonial goods and encourages all manner of production well beyond that which could be absorbed within the small colonial markets themselves.

 

Most important are property rights - not just to hold land but to dispose of it as the owner wishes.

 

Low taxes also greatly encourage development.

  The restraints on the trade of North American colonies were significantly less onerous than those imposed on most other colonies. By allowing access to world markets for their goods, trade greatly enlarges the markets for colonial goods and encourages all manner of production well beyond that which could be absorbed within the small colonial markets themselves.
 &
  Most important are property rights - not just to hold land but to dispose of it as the owner wishes. European restraints on alienation - such as primogeniture and limitations on the property rights that can be acquired - greatly hinder economic development outside the North American colonies.
 &
  Low taxes also greatly encourage development. With Great Britain picking up all of the expenses of defense - something it was then trying unsuccessfully to get the colonies to contribute to - the cost of government in the English North American colonies was extraordinarily cheap - and yet the quality of government was clearly superior. The colonies of the other European states were burdened with heavier taxes - and yet were subjected to wasteful and ineffective government. They were also burdened by tithes and other obligations to established clerisies.
 &
  Smith compares North American colonial governments most favorably with the "absolutist" governments of the colonies of other European states.

  "There is more equality, therefore, among the English colonialists than among the inhabitants of the mother country. Their manners are more republican, and their governments, those of three of the provinces of New England in particular, have hitherto been more republican, too."
 &
  "The government of the English colonies is perhaps the only one which, since the world began, could give perfect security to the inhabitants of so very distant a province."

  Ironically, the freedom and property rights of English colonial slaveholders frequently exposed the slaves in those colonies to harsher treatment than in the other European colonies. Government officials, even if they wished - as they sometimes did in other colonies - could not limit how the slaveholder dealt with his property.
 &

  The benefits that Europe has derived from the American colonies have been considerable. Smith views the colonies as a vast extension of European markets. Thus, the commercial benefits flowed throughout Europe. Even though extensively limited by the various mercantilist trade restraints, the benefits flowed not just to mother countries but also to those that sold goods to or bought goods from the colonies - and even to those that didn't but benefited by the increased prosperity of the European market.
 &
  However, the need to defend their weak colonies has cost the mother countries dearly. Only Spain and Portugal have reaped substantial financial resources from their colonies. For England, the colonies have been a substantial expense.
 &

"All the different regulations of the mercantile system necessarily derange more or less [the] most advantageous distribution of stock."

 

A free trade would increase capital and economic activity in the new markets without artificially drawing capital from and reducing economic prospects elsewhere.

 

Like all monopolies, the monopoly of colonial trade imposes costs throughout the rest of the economy and reduces the competitiveness of the rest of the economy.

  The mercantilist restraints on colonial trade greatly burden the colonies, and predominantly provide only relative advantages for the mother country. Adam Smith explains in considerable detail how these restraints distort and burden commercial and capital flows. "All the different regulations of the mercantile system necessarily derange more or less [the] most advantageous distribution of stock."
 &
  They don't benefit the mother countries - but they hurt them considerably less than they hurt the colonies and the countries excluded from the trade. That all other parties are hurt more than the mother country is the essence of the latter's relative advantage.
 &
  By removing mercantilist restraints on colonial trade, England "might, perhaps, have gained an absolute, but she would certainly  have lost a relative advantage." A free trade - by maximizing colonial prosperity and productivity - would reduce the cost of colonial products even for the mother country, and increase colonial demand for imports from everywhere. A free trade would increase capital and economic activity in the new markets without artificially drawing capital from and reducing economic prospects elsewhere.
 &
  Moreover, the system of mercantilist restraints distorts capital flows throughout the economy, encourages retaliation by other nations, and thus in various ways imposes unnecessary economic burdens. While the trade with her colonies has increased greatly with the growth of those colonies, it has drawn English capital away from more productive trade with Europe and the Mediterranean - thus predominantly resulting in a redirection of trade into inferior markets rather than an increase in trade over free trade levels.
 &
  Like all monopolies, the monopoly of colonial trade imposes costs throughout the rest of the economy and reduces the competitiveness of the rest of the economy.  Governments grant these monopolies against the interests of their own nation - and the interests of its people whose costs are thereby increased. 

  "Since the establishment of the English East India Company, for example, the other inhabitants of England, over and above being excluded from the trade, must have paid in the price of the East India goods which they have consumed, not only for all the extraordinary profits which the company may have made upon those goods in consequence of their monopoly, but for all the extraordinary waste which the fraud and abuse, inseparable from the management of the affairs of so great a company, must necessarily have occasioned." (Of course, members of government might well have had interests in the company.)

 The greatest beneficiaries are the merchants in the colonial trade. However, the economy now being largely dependent on this unnatural course of trade, England has been rendered increasingly vulnerable to its disruption - a disruption that increasingly looks likely as Smith writes this segment of his work.
 &

"[A] small profit upon a great capital generally [affords] a greater revenue than a great profit upon a small one, but [a monopoly] hinders the sum of profit from rising so high as it otherwise would do."

  However, the colony trade is so beneficial that, "notwithstanding the hurtful effects of that monopoly, [it] is still upon the whole beneficial, and greatly beneficial; though a good deal less so than it otherwise would be."

  "The effect of the monopoly has been, not to augment the quantity, but to alter the quality and shape of a part of the manufactures of Great Britain, and to accommodate to a market, from which the returns are slow and distant, what would otherwise have been accommodated to one from which the returns are frequent and near.  - - -

  "The monopoly of the colony trade, therefore, like all other mean and malignant expedients of the mercantile system, depresses the industry of all other countries, but chiefly that of the colonies, without in the least increasing, but on the contrary diminishing that of the country in whose favor it is established. - - -

  "The monopoly indeed raises the rate of mercantile profit, and thereby augments somewhat the gain of our merchants. But as it obstructs the natural increase of capital, it tends rather to diminish than to increase the sum total of the revenue which the inhabitants of the country derive from the profits of stock; a small profit upon a great capital generally affording a greater revenue than a great profit upon a small one, but it hinders the sum of profit from rising so high as it otherwise would do."

  Spain and Portugal suffer not only from a whole system of mercantile trade restraints, but also from domestic monopolies and restraints - feudal legal privileges and inadequate commercial law - and administered results.

  "Spain and Portugal were manufacturing countries before they had any considerable colonies. Since they had the richest and most fertile in the world, they have both ceased to be so."

  Indeed, to supply all manner of goods to their colonies, these nations must import these goods at great expense from other European nations. Thus, while the Spanish and Portuguese merchants reap great profits from this trade, and live in splendor, most of the actual economic benefits of those colonial markets is reaped by those other European nations - none of which must bear the expenses of empire - and the people of Spain and Portugal who produce little remain in poverty.
 &

"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."

 

"The interest of this debt alone is not only greater than the whole extraordinary profit which it ever 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."

  Smith estimates the immense sums that England has expended in two 18th century colonial wars and for the regular defense of the colonies and naval enforcement of the trade restraints. For all this, England has received neither revenues nor military forces from the colonies. For all this, the only benefits have accrued to the merchants in the colonial trade. (Much of the following was added well after the start of the American Revolution.)

  "Under the present system of management, therefore, Great Britain derives nothing but loss from the dominion which she assumes over her colonies."
 &
  "But in the system of laws which has been established for the management of our American and West Indian colonies, the interest of the home consumer has been sacrificed to that of the producer with a more extravagant profusion than in all our other commercial regulations. 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 ever 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."

  The difficulties that Great Britain was having in finding an effective way to get the colonies to pay for some of the expenses of their own defense is set forth at some length by Smith. He presciently foresees great difficulty - and great folly - in efforts to force the will of Parliament upon the colonists. He wisely asserts that "we ought to consider that the blood which must be shed in forcing them to do so is, every drop of it, blood either of those who are, or of those whom we wish to have for our fellow citizens." He advises providing the colonists with representation in Parliament equivalent to the revenues the colonies contribute to the state.
 &
  Indeed, Smith presciently speculates, if England were to free its North American colonies, and conclude a free trade treaty with them, it would not only unburden itself from its heavy defense burdens, but would trade upon a more advantageous basis and might well regain and retain sufficient affection to cement useful alliances for centuries into the future.
 &

Mercantile trading companies:

  Colonies governed by the great mercantile trading companies were everywhere misgoverned - generally stunted in their growth - and a disaster for the native peoples. These monopoly trading companies did not draw their revenues from the people, and so cared nothing for the prosperity of their subjects.
 &

  The great transgressions of these companies are set forth by Adam Smith at some length. Their interests as trading monopolies are directly contrary to the sovereign interests that they displace.

  "In almost all countries the revenue of the sovereign is drawn from that of the people. (Wouldst that it were so.) The greater the revenue of the people, therefore, the greater the annual produce of their land and labour, the more they can afford to the sovereign. - - - It is the interest of such a sovereign, therefore, to open the most extensive market for the produce of his country, to allow the most perfect freedom of commerce, in order to increase as much as possible the number and the competition of buyers; and upon this account to abolish, not only all monopolies, but all restraints upon the transportation of the home produce from one part of the country to another, upon its exportation to foreign countries, or upon the importation of goods of any kind for which it can be exchanged. It is in this manner most likely to increase both the quantity and value of that produce, and consequently of his own share of it, or of his own revenue."

  But the interests of the East India companies as merchants are exactly opposite to those of a sovereign.

  "Such exclusive companies, therefore, are nuisances in every respect; always more or less inconvenient to the countries in which they are established, and destructive to those which have the misfortune to fall under their government."

Where government revenues are less directly tied to the prosperity of commerce, governments are less attentive to the needs of commerce.

  Governments that depend on revenue from taxes that rise and fall with commerce are most attentive to the facilitation of commerce. Where government revenues are less directly tied to the prosperity of commerce, Smith notes, governments are less attentive to the needs of commerce.

  In some nations today - like Russia and Argentina - local governments draw their financial resources from the central government and are predictably careless about budgetary constraints and the needs of commerce. Easily exploited mineral wealth - like oil or diamonds - has been a curse for some nations whose governments have been thereby relieved of dependence on the prosperity of their people. In this, they are like the East India mercantile companies - which drew their revenues from the profits of their monopoly franchises rather than from the commerce of the peoples they governed.
 &
  Of course, there is always the problem of individuals in government who place their own interests above the national interest. Nevertheless, it is essential that governments have little revenue other than that which comes from the governed. The broader the tax base, the better will be the government.

Industrial policy:

  A critique of two French political economy rationalizations concludes this discussion of mercantilism.
 &

"[Industrial policy] 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."

  The first is a mercantile system consisting of rigid regulations to promote industry and commerce at the expense of agricultural interests. This system is identified with Colbert. The other is an opposite rationalization that glorifies agricultural interests as the whole productive component of an economy, and perfect liberty as needed for prosperity. This system is identified with "The Economists."
 &
  Adam Smith has little trouble debunking both rationalizations. Economics is not a zero sum game. All branches of economics benefit from the success of the other branches - and all are restrained by restraints on other branches - although particular favored interests may benefit from restraints that burden the whole.

  "It is thus that every system which endeavors, 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, 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." (Wouldst that this were read - and understood - in Japan - and by the "industrial policy" enthusiasts like Lester Thurow.)

BOOK V: THE PROPER ROLE OF GOVERNMENT

Defense, justice, and infrastructure:

  To facilitate commerce, Smith recognizes that government has several vital roles. Of primary importance is assuring the physical safety of persons and property from threats both foreign and domestic. Also vital is rule of law - to resolve disputes and enforce contracts and secure property rights. Also vital are the many infrastructure projects that facilitate the flow of commerce.
 &

 The security the military provides permits people to enjoy "a degree of liberty which approaches licentiousness."

  A standing army is essential. Smith provides an interpretation of military history relevant to this point.
 &
  It is "only by means of a well-regulated standing army that a civilised country can be defended." It is essential not only for protection against foreign invaders, but also to assure the authority of the sovereign at home.
 &
  Smith recognizes that a standing army may be a threat to the liberties of the people. However, he also points out that the security it provides permits people to enjoy "a degree of liberty which approaches licentiousness." It also permits magistrates and sovereign officials to function securely even amidst the civil tumults of a free people.

  One of the most profound reasons for the early and sturdy establishment of political and economic freedom and individual liberty in England was because that nation could be protected by a navy - and a navy is of little use in collecting domestic taxes or otherwise oppressing the populace. Of course, Japan, too, is an Island nation. But Japan chose to rely on its armies for defense, rather than on a navy.

"It is only under the shelter of the civil magistrate that the owner of that valuable property, which is acquired by the labour of many years, or perhaps of many successive generations, can sleep a single night in security."

 

Once the judges in France and England became dependent upon stipulated fees for their support, there was great incentive to provide reliable justice to attract business. The facilitation of commerce and the protection of property rights became guiding principles. The various courts began to recognize a broadening jurisdiction and provided novel remedies to increase their effectiveness.

  An exact administration of justice is essential to protect "as far as possible, every member of the society from the injustice or oppression of every other member of it." Protection of property rights is essential in a prosperous nation. Smith provides an interpretation of the history of civil government relevant to this point.

  "Wherever there is great property, there is great inequality. For one very rich man there must be at least five hundred poor, and the affluence of the few supposes the indigence of the many. The affluence of the rich excites the indignation of the poor, who are often both driven by want, and prompted by envy, to invade his possessions. It is only under the shelter of the civil magistrate that the owner of that valuable property, which is acquired by the labour of many years, or perhaps of many successive generations, can sleep a single night in security. - - - The acquisition of valuable and extensive property, therefore, necessarily requires the establishment of civil government."

  All people of property rally to the defense of property, no matter how little they have. By joining with the wealthiest among them, the least among them best protects what he has.

  "Civil government, so far as it is instituted for the security of property, is in reality instituted for the defense of the rich against the poor, or of those who have some property against those who have none at all."

  Recognizing and protecting the rights of the poor in whatever property they might have is essential not only for economic development, but for the development and stability of civil society as well.

  It was only when the sovereign became dependent upon the support of his subjects for sufficient revenues for his expenses, that the administration of justice was shifted from a petty revenue raising and corrupt practice to a professional service. Once the judges in France and England became dependent upon stipulated fees for their support, there was great incentive to provide reliable justice to attract business. The facilitation of commerce and the protection of property rights became guiding principles. The various courts began to recognize a broadening jurisdiction and provided novel remedies to increase their effectiveness.
 &
  Of course, the criminal courts must be financed from the general funds of the state. However, Smith believes that most of the expense of civil courts can be defrayed from court fees.

  This has proven to be a prescription for corruption in many places. To attract people of character and ability, it is essential that judicial salaries be set suitably high and that they and other judicial expenses be defrayed substantially from the state's general revenues.

"But upon the impartial administration of justice depends the liberty of every individual, the sense which he has of his own security."

  An independent judiciary is essential for the establishment of rule of law.

  "When the judicial is united to the executive power, it is scarce possible that justice should not frequently be sacrificed to what is vulgarly called politics. The person entrusted with the great interests of the state may, even without any corrupt views, sometimes imagine it necessary to sacrifice to those interests the rights of a private man. But upon the impartial administration of justice depends the liberty of every individual, the sense which he has of his own security."

  To be independent, judges must be secure in their office against capricious removal, and must be entitled to a regular salary.
 &

Government must provide for "the erection and maintenance of the public works which facilitate the commerce of the country, - - -."

  Appropriate infrastructure is essential to facilitate commerce. Government must provide for "the erection and maintenance of the public works which facilitate the commerce of the country, such as good roads, bridges, navigable canals, harbours, etc."
 &
  Smith favors making such infrastructure self-financing wherever possible - by means of tolls, port duties, seignorage for coinage, postage fees. Where forts and embassies are maintained to facilitate commerce with foreign lands, he favors financing the costs directly by suitable tariffs - limited to revenue raising levels - on that commerce.
 &
  He favors privatizing both the collection of these fees and the obligation of maintenance where lack of maintenance would completely block usage - as with canals and waterworks. This would not be the case for roads, which thus must be managed by government trustees or agencies of the executive - even though experience indicates that such sums will be diverted and dissipated and otherwise poorly spent. (Remember this the next time you hit a pothole.)
 &

"The abuses which sometimes creep into the local and provincial administration of a local and provincial revenue, how enormous soever they may appear, are in reality, however, almost always very trifling in comparison of those  - - - of a great empire."

  Local and provincial facilities should be managed by local and provincial authorities. London's street paving and lighting is financed by "a local tax upon the inhabitants of each particular street, parish, or district."

  "Were the streets of London to be lighted and paved at the expense of the treasury, is there any probability that they would be so well lighted and paved  as they are at present, or even at so small an expense? - - -

  "The abuses which sometimes creep into the local and provincial administration of a local and provincial revenue, how enormous soever they may appear, are in reality, however, almost always very trifling in comparison of those which commonly take place in the administration and expenditure of the revenue of a great empire. They are, besides, much more easily corrected."

Regulatory companies:

 

 

 

&

  The regulatory companies and great mercantile joint stock companies that have been given the monopoly franchise of arranging and protecting commerce with particular nations or regions have, on the other hand,  "proved, universally, either burdensome or useless, and have either mismanaged or confined the trade."

  Today, we have such private self-regulatory agencies as those governing the professions or the securities exchanges. They play useful roles, but Smith would not be surprised at their continuing problems.

"The directors of such companies, however, being the managers rather of other people's money than of their own, it cannot well be expected that they should watch over it with the same anxious vigilance with which the partners in a private copartnery frequently watch over their own. - - - Negligence and profusion, therefore, must always prevail, more or less, in the management of the affairs of such a company."

  Smith provides a history of the regulatory companies for European and African trade, and the mercantile joint stock companies. The former are no longer so burdensome - but are fairly useless. The latter - with the exception of the comparatively tiny Hudson's Bay Co. - are bloated, negligent and wasteful.

  "The directors of such companies, however, being the managers rather of other people's money than of their own, it cannot well be expected that they should watch over it with the same anxious vigilance with which the partners in a private copartnery frequently watch over their own. Like the stewards of a rich man, they are apt to consider attention to small matters as not for their master's honour, and very easily give themselves a dispensation from having it. Negligence and profusion, therefore, must always prevail, more or less, in the management of the affairs of such a company. It is upon this account that joint stock companies for foreign trade have seldom been able to maintain the competition against private adventurers. They have, accordingly, very seldom succeeded without an exclusive privilege, and frequently have not succeeded with one. Without an exclusive privilege they have commonly mismanaged the trade. With an exclusive privilege they have both mismanaged and confined it."

  Here, again, Smith emphasizes the importance of the ownership interest. Where the ownership interest is absent, waste, fraud and abuse is rampant. Where it is tenuous, inefficiency is the rule. This is just one of the major rocks on which socialism and communism would crash.

  The perverse incentives that drove the East India Company's misrule and plunder of its subjects in India are here explained by Smith. By 1784, it had become painfully evident that the company was "altogether unfit to govern its territorial possessions." Despite control of vast, wealthy and fertile lands, it was near bankruptcy. "Even the company itself seems to be convinced of its own incapacity" and seems now willing to give up its private empire in India for a government bailout.
 &

  Large limited liability joint stock companies are viewed with great disdain by Smith. He recognizes their utility for banking, insurance, and utilities that require great capital and "routine" management, but considers them inefficient and untrustworthy for ordinary competitive enterprise.

  Enron and similar scandals would not have come as a surprise to Smith. The tenuousness of ownership interests in major corporations remains a major problem , but they are - as Adam Smith notes - essential for the marshalling of large amounts of capital.
 &
  He would also not have been surprised by the continuing vitality of small business where reasonably free of government constraints. However, the general success of corporate America functioning under modern regulatory mechanisms certainly would have surprised him.

Education:

  Basic education is essential for the productivity and good order of society. It is essential that "the common people" learn "to read, write, and account" - and Latin, geometry and mechanics are also useful. The parish and charity schools fulfill that role, and they should be encouraged.
 &

"The more they are instructed the less liable they are to the delusions of enthusiasm and superstition, which among ignorant nations, frequently occasion the most dreadful disorders. An instructed and intelligent people, besides, are always more decent and orderly than an ignorant and stupid one. They feel themselves, each individually, more respectable and more likely to obtain the respect of their lawful superiors."

 Indeed, it is dangerous, Smith points out, to leave the bulk of the people without proper education.

  "Though the state was to derive no advantage from the instruction of the inferior ranks of people, it would still deserve its attention that they should not be altogether uninstructed. The state, however, derives no inconsiderable advantage from their instruction. The more they are instructed the less liable they are to the delusions of enthusiasm and superstition, which among ignorant nations, frequently occasion the most dreadful disorders. An instructed and intelligent people, besides, are always more decent and orderly than an ignorant and stupid one. They feel themselves, each individually, more respectable and more likely to obtain the respect of their lawful superiors. They are more disposed to examine and more capable of seeing through, the interested complaints of faction and sedition, and they are, upon that account, less apt to be misled into an wanton or unnecessary opposition to the measures of government. In free countries, where the safety of government depends very much upon the favourable judgment  which the people may form of its conduct, it must surely be of the highest importance that they should not be disposed to judge rashly or capriciously concerning it."

"The diligence of public teachers is more or less corrupted by the circumstances which render them more or less independent of their success and reputation in their particular profession."

 

Sophistry has been elevated over the useful arts and sciences.

  The universities of the day were viewed by Smith with considerable disdain He provides an interpretation of the history of education going back to the ancient Greeks.
 &
  The problem is that publicly supported professors who are not dependent on the quality of their teaching for their livelihood seldom meet the education needs of their students. Also, they make it almost impossible for private teachers to make a living, no matter how good the private teachers may be.

   "In modern times, the diligence of public teachers is more or less corrupted by the circumstances which render them more or less independent of their success and reputation in their particular profession. Their salaries, too, put the private teacher, who would pretend to come into competition with them, in the same state with a merchant who attempts to trade without a bounty in competition with those who trade with a considerable one. - - - The endowment of schools and colleges have, in this manner, not only corrupted the diligence of public teachers, but have rendered it almost impossible to have any good private ones."

  The result is an almost totally dysfunctional and useless university system, where little is taught that is useful and that little that is taught is generally useless. Sophistry has been elevated over the useful arts and sciences.

  Outside the useful arts and sciences, this is another tendency still in evidence. Indeed, even in such useful arts - practical arts - as sociology and economics - ideology, pretensions to levels of scientific certitude, and misuse of mathematical forms of reasoning afflict modern universities in ways Smith would find familiar.

  The universities, according to Smith, have been almost always late in acknowledging any advances in knowledge or science, and frequently have been the last bastions of discredited knowledge.

  "There are no public institutions for the education of women, and there is accordingly nothing useless, absurd, or fantastical in the common course of their education. They are taught what their parents or guardians judge it necessary or useful for them to learn, and they are taught nothing else. Every part of their education tends evidently to some useful purpose; either to improve the natural attractions of their person, or to form their mind to reserve, to modesty, to chastity, and to economy; to render them both likely to become the mistresses of a family, and to behave properly when they have become such. In every part of her life, a woman feels some conveniency or advantage from every part of her education. It seldom happens that a man, in any part of his life, derives any conveniency or advantage from some of the most laborious and troublesome parts of his education." (Well, there are some things that have changed, after all.)

Established religions:

  Relations between church and state are considered at some length by Smith.
 &

As in so many things - as in economics and politics - competition amongst religious sects is the most effective discipline and assurance against excess.

  He reviews the noxious impacts - both for religion and for the state - of state support for an established religion. Although he does not use the term, he clearly argues in favor of separation of church and state, and cites the good results in Pennsylvania where there is a tolerant approach to all religions.
 &
  Government should decide "both to let them all alone, and to oblige them all to let alone one another." As in so many things - as in economics and politics - competition amongst religious sects is the most effective discipline and assurance against excess.

  "In such a situation [the sovereign] would have no occasion to give himself any concern about them, further than to keep the peace among them in the same manner as among the rest of his subjects; that is, to hinder them from persecuting, abusing, or oppressing one another. But it is quite otherwise in countries where there is an established or governing religion. The sovereign can in this case never be secure unless he has the means of influencing in a considerable degree the greater part of the teachers of that religion." (This should be required reading for the Saudi ruling family.)

"The inferior ranks of the people no longer looked upon that order, as they had done before, as the comforters of their distress, and the relievers of their indigence."

  The waxing and waning of Roman Catholic influence over the centuries - and the tumultuous course of religious history in Europe - are analyzed by Smith. He asserts that, like the great lords, the clergy were debauched by the temptations of material wealth made possible by the rise of commercial cities and towns and the goods they could provide.

  "The inferior ranks of the people no longer looked upon that order, as they had done before, as the comforters of their distress, and the relievers of their indigence. On the contrary, they were provoked and disgusted by the vanity, luxury, and expense of the richer clergy, who appeared to spend upon their own pleasures what had always before been regarded as the patrimony of the poor."

  He views religions - whether independent or established - as a part of the governing structure of the state. The tithes and land rents that support the various churches are limitations on what the state can draw - they are limitations on the wealth of nations.
 &
  States that have wealthy churches have weak governments - and a wealthy clergy loses the respect of its flock. Where the clergy must make do with slender support, the states are frequently wealthy, and the clergy - unburdened by vanity and dissipation - is highly esteemed by the people.
 &

Taxation:

"No two characters seem more inconsistent than those of trader and sovereign."

  The failure of socialism would be no surprise to Smith. Indeed, over two centuries before the fall of the Berlin wall, he practically predicted that such systems must prove impossible.

  "No two characters seem more inconsistent than those of trader and sovereign. If the trading spirit of the English East India Company renders them very bad sovereigns, the spirit of sovereignty seems to have rendered them equally bad traders."

The post office "is perhaps the only mercantile project which has been successfully managed by, I believe, every sort of government." 

  Profits from particular branches of commerce were derived during those times by several small states. The post office "is perhaps the only mercantile project which has been successfully managed by, I believe, every sort of government." (The U.S. government has managed to screw up even this.) Hamburg profited from a public wine cellar and an apothecary. Many states derived profit from a public bank. But, not England.

  "But whether such a government as that of England -- which, whatever might be its virtues, has never been famous for good economy; which, in time of peace, has generally conducted itself with the slothful and negligent profusion that is perhaps natural to monarchies; and in time of war has constantly acted with all the thoughtless extravagance that democracies are apt to fall into -- could be safely trusted with the management of such a project, must at least be a good deal more doubtful."

  Smith would undoubtedly favor independent central banks.

    Moreover, "the unstable and perishable nature" of profits "render them unfit to be trusted as the principal funds of that sure, steady, and permanent revenue which can alone give security and dignity to government."
 &

"The revenue which, in any civilized monarchy, the crown derives from the crown lands, though it appears to cost nothing to individuals, in reality costs more to the society than perhaps any other equal revenue which the crown enjoys."

  Privatization is something Smith would highly recommend. Because of the "negligent, expensive, and oppressive management of his factors and agents," crown lands provide very meager revenues, and constitute almost dead assets. It would be far better to sell the crown lands and reap the revenues from economic growth as private owners transformed them into "well improved and well cultivated" lands.

  "The revenue which, in any civilized monarchy, the crown derives from the crown lands, though it appears to cost nothing to individuals, in reality costs more to the society than perhaps any other equal revenue which the crown enjoys. It would, in all cases, be for the interest of the society to replace this revenue to the crown by some other equal revenue, and to divide the lands among the people, which could not well be done better, perhaps, than by exposing them to public sale." (During the next two centuries, this would apply equally well to all efforts at government business management.)

"There is no art which one government sooner learns of another than that of draining money from the pockets of the people."

  Thus, it is taxation that predominantly must "make up a public revenue to the sovereign or commonwealth." Governments are always alert to new sources of tax revenue.

  "There is no art which one government sooner learns of another than that of draining money from the pockets of the people."

  However, all taxes ultimately are paid from rent, profit or wages.

  These are all the same thing - although they each have particular characteristics, as Smith notes. After covering maintenance expenses, rent is the profits of  land - wages are the profits of labor - profits are the profit of ownership capital - and interest is the profits of debt capital.

  Adam Smith offers several maxims to prevent taxation from becoming "much more burdensome to the people than they are beneficial to the sovereign."

"It is not very unreasonable that the rich should contribute to the public expense, not only in proportion to their revenue, but something more than in that proportion."

 

There "is not near so great an evil as a very small degree of uncertainty" in tax statutes.

 

Taxes on ground rents fall entirely on the landlord, and are the taxes least burdensome to the general economy.

 

"All taxes upon the transference of property of every kind, so far as they diminish the capital value of that property, tend to diminish the funds destined for the maintenance of productive labour."

  • Smith favors broad based taxes that do not fall unequally upon different groups of people. He thus favors flat rate taxation so that all contribute in proportion to their revenues. He also favors moderately graduated rates of taxation. "It is not very unreasonable that the rich should contribute to the public expense, not only in proportion to their revenue, but something more than in that proportion." He speaks with approval of the land tax of Silesia in Prussia that is somewhat higher for lands held in "noble tenure" than for those held in "base tenure." His tone is distinctly less favorable with respect to the many other states where noble tenure properties are taxed at favorable rates or are exempt. 
  • Smith favors clearly promulgated taxes. He would look favorably on the modern legal rule that tax statutes must be judicially interpreted against the government as the writer of the statutes. But the U.S. Tax Code and regulations would be viewed as an abomination. Uncertainty breeds corruption and extortion. There "is not near so great an evil as a very small degree of uncertainty" in tax statutes.
  • Smith favors taxes levied at the moment of transaction so that they do not involve a separate transaction and can be a part of the decision to execute the transaction. He would be against capital levies. However, he views favorably property taxes on major durable luxury items like automobiles or yachts. In his time, coaches and table plate were taxed annually.
  • Smith favors taxes on ground rents, but not on vacant land. The incidents of such taxes fall entirely on the landlord and, according to Smith, are the taxes least burdensome to the general economy. "The annual produce of the land and labour of the society, the real wealth and revenue of the great body of the people, might be the same after such a tax as before." The increase in ground rents based on location "are altogether owing to the good government of the sovereign. - - - Nothing can be more reasonable than that a fund which owes its existence to the good government of the state should be taxed more than the greater part of other funds, towards the support of that government." However, taxes on ground rents have nowhere been levied due to the perceived difficulty in distinguishing the ground rent from the return on buildings or other improvements - something that Smith considers relatively easy to figure out. (It should be related to land values and interest rates.)
  • Smith favors land taxes that are variable - based on the rental value of similar property. However, this should include suitable depreciation and amortization rates so as not to discourage investments to improve property. The advantages and disadvantages of making such taxes variable or fixed permanently or for a term is a subject that Smith discusses at length. He views taxes based on value assessments with considerable skepticism as inherently inaccurate and arbitrary - a potentially ruinous burden on those whose property has been improved or otherwise appreciated over time - and a disincentive to the improvement of real property. (Modern real estate taxes are nevertheless based on assessed valuations. They exhibit the defects that Smith warned about - and have unsurprisingly inspired tax revolts.)
  • Smith opposes inheritance taxes and gift and sales  taxes.  Taxes upon existing assets when transferred by sale or death or gift falls upon the value of capital. The burden is thus on the inheritor or donee, or on the seller. However, the burden of sales taxes imposed on newly manufactured items or on new homes are business taxes and are passed on to the customers. All tend to diminish the value of capital.

  "All taxes upon the transference of property of every kind, so far as they diminish the capital value of that property, tend to diminish the funds destined for the maintenance of productive labour. They are all more or less unthrifty  taxes that increase the revenue of the sovereign, which seldom maintains any but unproductive labourers, at the expense of the capital of the people, which maintains none but productive."

"The middling and superior ranks of people, if they understand their own interest, ought always to oppose all taxes upon the necessaries of life, as well as all direct taxes upon the wages of labour."

  • Smith opposes payroll taxes on the wages of subsistence workers. They are "absurd and destructive," but widely used in his times. "The declension of industry, the decrease of employment for the poor, the diminution of the annual produce of the land and labour of the country, have generally been the effects of such taxes." Payroll taxes on the wages of skilled workers may diminish the skills taxed. However, payroll taxes on the emoluments of offices - the officials not being involved in competitive commerce - seem quite proper and economically inoffensive to Smith.
  • Smith opposes sales taxes and other taxes on the "necessaries" of life. They are inflationary, lead to higher wages, profits and retail prices. Smith discusses this process in the context of an economy where unskilled labor receives only subsistence wage rates. This definition depends on what is customary for subsistence - the sums being higher in wealthy nations than in poor nations. Leather, salt, soap, and candles are cited by Smith as necessaries then taxed in England, leading to inflation that injures all consumers and landlords. In other European states, even bread is taxed - a ruinously inflationary practice.

"The middling and superior ranks of people, if they understand their own interest, ought always to oppose all taxes upon the necessaries of life, as well as all direct taxes upon the wages of labour."

Except for tolls sufficient for the maintenance of roads and canals, Smith opposes taxes on transportation as obstructive of commerce.

 

No matter how levied, the burden of sin taxes and taxes on other consumables falls almost exclusively on the consumers.

 

Tariffs - even when set at revenue raising levels - are expensive to maintain, discourage domestic commerce in many ways, create contempt for the laws, and generate an obnoxious bureaucracy and vexatious red tape.

 

Taxation should not be so complex as to "require a great number of officers, whose salaries may eat up the greater part of the produce of the tax, and whose perquisites may impose another additional tax upon the people."

 

Taxation that requires audits,  "by subjecting the people to the frequent visits and the odious examination of the tax-gatherers, - - - may expose them to much unnecessary trouble, vexation, and oppression."

 

The principal attention of the sovereign ought to be to encourage, by every means in his power, the attention both of the landlord and of the farmer, by allowing both to pursue their own interest in their own way and according to their own judgment;  - - -."

  • Taxes on the transportation of goods takes on the character of the goods being transported. Smith acknowledges that taxes on coastwise shipping of coal - a necessary commodity - provides so much revenue that it is unlikely to be discontinued. Except for tolls sufficient for the maintenance of roads and canals, Smith opposes such taxes as obstructive of commerce.
  • Smith favors sales taxes on discretionary items - especially sin taxes on tobacco, alcohol, sugar, chocolate. Taxes on beer and ale provided vast revenues. Tea was another item frequently taxed in those times. These do not necessarily raise the costs of subsistence living and so do not have the same inflationary impact. No matter how levied, the burden of  taxes on such consumables fall almost exclusively on the consumers.
  • Smith opposes tariffs, even if set at levels that would maximize revenues. They are expensive to maintain - discourage domestic commerce in many ways - create contempt for the laws - and generate an obnoxious bureaucracy and vexatious red tape. He provides a history of English tariffs.
  • Smith opposes tariffs and sales taxes set so high that they might tempt people to engage in smuggling. Smugglers as well as merchants - often one and the same - oppose any effort to end high tariffs. Such taxes create a substantial enforcement requirement and subject many citizens to criminal penalties. "The law, contrary to all the ordinary principles of justice, first creates the temptation, and then punishes those who yield to it; and it commonly enhances the punishment, too, in proportion to the very circumstances which ought certainly to alleviate it, the temptation to commit the crime."
  • Smith opposes taxes on intermediate goods. He would thus oppose value added taxes. He discusses the burdensome tax systems in Europe, and the oppressive and corrupt practice of tax farming. He attributes the ruination of Spanish commerce to its "alcavala." Interior commerce - with some exceptions - moves freely in Great Britain - "perhaps one of the principle causes" of its prosperity.
  • Smith opposes tithes and other gross receipts taxes, and capitation taxes. Gross receipts taxes are invariably unequal in their impact and tend to diminish commerce. The poll taxes are unequal and generally more burdensome on the lower ranks of people. They are tolerable only if very low.
  • Smith favors simplified forms of taxation that do not impose a substantially greater burden on the public than the actual payments themselves. Taxation should not "require a great number of officers, whose salaries may eat up the greater part of the produce of the tax, and whose perquisites may impose another additional tax upon the people." He would - correctly - view the U.S. Tax Code - which creates the need for a wide array of tax and accounting professionals - as an abomination.
  • Smith warns that economic incentives must not be undermined by the types or extents of taxation. Burdensome taxation "may obstruct the industry of the people," discouraging economic activity and destroying employment. He would be aghast at the double taxation of dividends. He would oppose high marginal tax rates.
  • Smith opposes forms of taxation that require audits. "[By] subjecting the people to the frequent visits and the odious examination of the tax-gatherers, it may expose them to much unnecessary trouble, vexation, and oppression." (Not just trouble and vexation - but oppression, also - has been the modern history of tax audits.)
  • However, Smith favors high taxes to discourage harmful activities. He is thinking about activities that are harmful to commerce, but this could obviously apply to other activities - presumably as long as the taxes do not encourage smuggling or discourage commerce.
  • Smith opposes tax manipulations to micromanage commerce. He would also oppose tax manipulation for social engineering. With respect to land taxes - but also obviously applicable to all taxes - he warns against even minor unintended disincentives.

  "No incitement to the attention of the sovereign can ever counterbalance the smallest discouragement to that of the landlord. The attention of the sovereign can be at best a very general and vague consideration of what is likely to contribute to the better cultivation of the better part of his dominions. The attention of the landlord is a particular and a minute consideration of what is likely to be the most advantageous application of every inch of ground upon his estate. The principal attention of the sovereign ought to be to encourage, by every means in his power, the attention both of the landlord and of the farmer, by allowing both to pursue their own interest in their own way and according to their own judgment; by giving to both the most perfect security that they shall enjoy the full recompense of their own industry; and by procuring to both the most extensive market for every part of their produce, in consequence of establishing the easiest and safest communications both by land and by water through every part of his own dominions as well as the most unbounded freedom of exportation to the dominions of all other princes."

  The economic impact of each type of tax is examined at length by Smith, but of course in light of economic conditions existing during his time. Much of this is not applicable to the present, and much of it is criticized by Ricardo. However, all of it is interesting as demonstrating how equity capital other than that consisting of raw land automatically sheds the real burdens of taxation - except for that equity capital that fails to survive the higher cost environment created by the taxes.
 &

  Markets shift almost all the burden of business taxes on to consumers, workers, landlords or debt capital. However, tax burdens on debt capital - whether direct or indirect - will cause capital flight and be very destructive unless they are very modest. Tax burdens on business - on equity capital - are invariably passed on to the customers as part of the cost of goods or services sold. Indeed, they are passed on with profit added for the extra expense of handling the taxes. Some of the burden may be passed on to the landlords in the form of lower rents.

  Businesses are not tax payers - they are tax collectors.

The public debt:

  Almost all modern governments are always in debt. Whether monarchy or republic, Smith notes that only a few - like Prussia and the canton of Berne in Switzerland - have not spent themselves into debt. Thus, when wars arise, a great increase in debt becomes inevitable. In advanced commercial nations, this need to borrow is more than matched by the willingness to lend.
 &

"The merchant or monied man makes money by lending money to government, and instead of diminishing, increases his trading capital."

 

By tax anticipation borrowing, "the state is in the constant practice of borrowing of its own factors and agents, and of paying interest for the use of its own money."

 

"They are unwilling [to raise war taxes] for fear of offending the people, who, by so great and so sudden an increase of taxes, would soon be disgusted with the war; - - -."

  No capital is absorbed by loans to the government of a prosperous commercial nation. The financial strength of governments of prosperous commercial nations is always many times more in its ability to borrow - in the purchasing power of its credit - than in any hoard of treasure that it might accumulate.

  "By lending money to government, they do not even for a moment diminish their ability to carry on their trade and manufactures. On the contrary, they commonly augment it. The necessities of the state render government upon most occasions willing to borrow on terms extremely advantageous to the lender. The security which it grants to the original creditor is made transferable to any other  creditor, and, from the universal confidence in the justice of the state, generally sell in the market for more than was originally paid for it. The merchant or monied man makes money by lending money to government, and instead of diminishing, increases his trading capital."

  However, this is not without ultimate cost. All the great nations of Europe have "enormous debts which at present oppress, and will in the long-run probably ruin [them]." Many, like England, are so much in debt that they have to engage in "perpetual funding." They continuously pledge future tax revenues - (like today's tax anticipation notes) - to raise additional funds. The future is left heavily indebted to ease the problems of the present.

  "Like an improvident spendthrift, whose pressing occasions will not allow him to wait for the regular payment of his revenue, the state is in the constant practice of borrowing of its own factors and agents, and of paying interest for the use of its own money."
 &
  "The ordinary expense of the greater part of modern governments in time of peace being equal or nearly equal to their ordinary revenue, when war comes they are both unwilling and unable to increase their revenue in proportion to the increase of their expense. They are unwilling for fear of offending the people, who, by so great and so sudden an increase of taxes, would soon be disgusted with the war; and they are unable from not well knowing what taxes would be sufficient to produce the revenue wanted." (Yet another perceptive comment that could as easily have been made about 20th and 21st century conditions as those of the 18th century.)

If after the conflict ends the revenues from the new taxes produce a surplus above what is needed for servicing the debt, those funds will be immediately spent rather than used for paying down the debt or reducing the new taxes.

 

If some modest sinking funds begin to accumulate - generally due to some reduction in interest rates - they will always be raided and spent for some new government purpose.

  By borrowing and perpetual funding of the loans, great wars are financed with just modest tax increases, and the public enthusiasm for the conflicts is not dampened by its financial costs. If after the conflict ends the revenues from the new taxes produce a surplus above what is needed for servicing the debt, those funds will be immediately spent rather than used for paying down the debt or reducing the new taxes. (Is he talking about the 18th century or the 20th and 21st centuries?)
 &
  Several of these wars were fought at least in part for the benefit of the American colonies, and Smith thinks it is only just that those colonies accept taxes to help defray the costs - but only if as a part of a political union and with representation in the government of the empire.

  "If any of the provinces of the British Empire cannot be made to contribute towards the support of the whole empire, it is surely time that Great Britain should free herself from the expense of defending those provinces in time of war, and of supporting any part of their civil or military establishments in time of peace, and endeavor to accommodate her future views and designs to the real mediocrity of her circumstances." (It would take until the 20th century - and a Labor government - to accept this wisdom.)

  If some modest sinking funds begin to accumulate - generally due to some reduction in interest rates - they will always be raided and spent for some new government purpose. Adam Smith provides a history of the national debt of England and its growth from one conflict after another beginning in 1688. The total before the worldwide conflict of which the American Revolution was a part was about 130 million. It would rise considerably more than 100 million in that conflict.
 &

With modest exceptions, government expenditures do not contribute to economic growth.

 

Government debt is a real burden. We do not just "owe it to ourselves."

 

The permanent taxes needed to service the debt depress investment and the value of equity capital. Capital flight will result if the tax burdens become too heavy.

 

 

  Government expenditures are not the equivalent of private expenditures. (Keynesians are still in denial on this obvious point.) With modest exceptions, they do not contribute to economic growth.
 &
  Major levels of indebtedness hurt the economy. We do not just "owe it to ourselves." (Many Keynesians are still in denial on this obvious point.) Inevitably, much of it is held abroad - in Smith's time, by the Dutch.
 &
  Even without this, those who hold the debt are different from those who pay the taxes. The owners of land and capital stock who have the ownership incentive to maintain, improve and expand the nation's productive capital are frequently different from the creditors of the public debt. The permanent taxes needed to service the debt depress investment and the value of equity capital. Capital flight will result if the tax burdens become too heavy.
 &
  "The practice of funding has gradually enfeebled every state which has adopted it." The Italian republics, Spain, France and other once thriving states "[languish] under an oppressive load" of debt. Even England, which has so far born vast financial burdens as a result of its many conflicts, may not forever be immune from this fact.

  The great conflicts - the assumption of welfare state obligations - and costly experiments with socialist practices - would finally bring down the finances of Great Britain in the 20th century.

"The raising of the denomination of the coin has been the most usual expedient by which a real public bankruptcy has been disguised under the appearance of a pretended payment."

  Inflation - a form of national bankruptcy - is the ultimate method of payment.

  "The raising of the denomination of the coin has been the most usual expedient by which a real public bankruptcy has been disguised under the appearance of a pretended payment."

  Debtors, including the government, in that way are able to pay their debts with money that is worth less than when the sums were borrowed. Purchasing power declines perhaps 20% or 50% or more due to the inflation of the money supply. Productive capital is penalized in favor of consumption. If it is a one time operation, the ordinary vigor of the economy will recover and repair the damage. (With paper and virtual money, devaluation can be persistent - and all the destructive forces of chronic inflation can become entrenched.)

  See, Adam Smith, "The Wealth of Nations," Part I, "Market Mechanisms."

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Copyright 2003 Dan Blatt