THE WEALTH OF NATIONS
by
Adam Smith
(Part II, Economic Policy)
FUTURECASTS online magazine
www.futurecasts.com
Vol. 5, No. 7, 7/1/03.
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Introduction
Discretionary resources:
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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.) |
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.
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"[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.
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.
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"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.
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Smith's political philosophy:
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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:
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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."
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"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."
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.
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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.
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.
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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.
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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. |
Mercantilist trade restraints:
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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. |
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.
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"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.
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.
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"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.
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.
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"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.
Indeed, the political and economic difficulty and disruption initiated by removal of protectionist measures is one of the most convincing reasons to avoid them.
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.
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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.
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.
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"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.
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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. |
"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.
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.
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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."
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.
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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.
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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 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.
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. |
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.
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"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.
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.
The colonial empires were primarily the work of bold adventurers and private associations and companies - with very little assistance from the mother countries.
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"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 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." |
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.
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. |
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"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."
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."
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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.
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.)
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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. |
Mercantile trading companies:
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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.
But the interests of the East India companies as merchants are exactly opposite to those of a sovereign.
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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.
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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."
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BOOK V: THE PROPER ROLE OF GOVERNMENT
Defense, justice, and infrastructure:
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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.
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"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.
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.
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.
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"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.
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." |
"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."
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Regulatory companies:
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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."
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"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 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.
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Education:
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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.
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"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 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.
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.
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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.
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"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.
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. |
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.
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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.
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.
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"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.
However, all taxes ultimately are paid from rent, profit or wages.
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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." |
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"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." |
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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; - - -." |
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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. & |
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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.
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The public debt:
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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.
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.
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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?)
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.
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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.
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"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.
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.)
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Copyright © 2003 Dan Blatt