First published in The Times
When President Trump called his introduction of sweeping global tariffs “liberation day”, the echoes of the US Declaration of Independence in 1776 were surely deliberate.
But more significant still for the present debate about tariffs is the other great event of that remarkable year: the publication of the Scottish economist Adam Smith’s The Wealth of Nations. For it is that book more than any other that provides the key to understanding what is really going on here.
Smith is on any objective measure by far the most influential economist who ever lived, often described as the father of economics. He is celebrated for his advocacy of open markets, and for his analysis of how the basic human instinct to “truck, barter and exchange” creates economic value.
If I have saucepans and you have oranges, then we can both benefit from freely exchanging some of what we have with each other. Multiply those exchanges across a nation, and the result is a miracle of benign unintended consequences. A massive, co-ordinated economy emerges, with no central planner or directing organisation, working as though by an “invisible hand”, simply created by people freely buying and selling.
What matters for Smith is not the rhetoric of free markets, but the reality of effective competition. It is competition that creates shared economic value and keeps markets honest. Let a monopoly or cartel flourish, however, or impose a foolish tax, and that shared value can rapidly erode.
Yet Smith was far from naive: he recognised that while the actions of government could easily damage markets, it was government enforcement of the rule of law and of private contracts that allowed markets to function at all.
The same lesson about competition broadly holds, Smith believed, between one nation and another; both sides will usually benefit from the free exchange of goods and services. Indeed, as Smith’s great successor David Ricardo showed in his theory of comparative advantage, both nations can benefit even when one can produce all the relevant goods more cheaply than the other, or is far wealthier than the other.
These are among the foundational insights of modern economics. But they have a vital corollary: that distortions of international trade through monopoly, cartel or taxes can quickly destroy wealth and value.
In the 18th century, British domestic markets were ensnarled by thickets of guild, church and local regulation, jealously guarded by insiders with privileged access to government. But Smith also viewed many politicians as being under the sway of a specific economic doctrine, later known as mercantilism, at which he took special aim.
For Smith, the “mercantile system” was marked by its obsession with money, and a simple-minded equation of wealth with money. Just as a merchant seeks to acquire wealth by storing up money, so a mercantilist nation sought to acquire wealth by storing up gold and silver bullion.
How was this bullion to be obtained? In the 18th century, by foreign conquest and the acquisition of mines; but also, and more insidiously, by attempts to manage and manipulate the balance of trade. The mercantilist saw the import of goods not as a vital source of competition, but as a subversive force that undermined domestic manufacturing and stimulated the outflow of money, and so the loss of wealth.
The balance of trade thus lay at the centre of mercantilism. Complex systems of regulation and taxation were developed to promote exports and limit imports, and so also limit the outflow of money. These included duties, prohibitions, bounties, subsidies, reliefs, advantageous commercial treaties and colonies, with their attendant privileges and monopolies. It was of course Britain’s mercantilist Tea Act of 1773, with its duties on tea imports, that so outraged the American colonists and led to the Boston Tea Party.
Smith argued that mercantilism too had unintended consequences, and that these were potentially ruinous. Tariffs were a form of taxation, which raised the cost of imports to domestic consumers and provided subsidies to domestic manufacturers. Mercantilism thus distorted trade and investment, boosted short-term profits, discouraged competition and raised prices, and thus what we would now call inflation.
Worse, it fed the “monopolising spirit” of manufacturers and merchants, whom it taught to recognise that government action could increase their profits at little or no apparent cost. The result was a further boost to the growth of what would now be called business lobbies and special interests, and further detriment to customers and workers.
Smith’s verdict on such actions is damning: “The proposal of any new law or regulation of commerce which comes from this order ought always to be listened to with great precaution … It comes from an order of men … who have generally an interest to deceive and even to oppress the public.”
At its worst, mercantilism fed off, and was in turn stimulated by, an imperial impulse. Colonisation began as a route to the acquisition of raw materials, notably mines and so bullion. It had even extended to include trade in slaves, which Smith had roundly condemned long before the anti-slavery campaigns of Thomas Clarkson and William Wilberforce were launched.
As he saw it, chartered companies such as the East India Company had extracted exclusive privileges and trading monopolies, and had assumed sovereignty over entire countries by force of war. And war inevitably meant a catastrophic increase in public debt.
For Smith, therefore, the mercantile system and its flawed assumptions about trade and prosperity lay at the root of Britain’s imperialist ambitions — so much so as to be a principal cause of the American War of Independence itself.
Again, Smith was not naive about the realities of international trade. He recognised that sometimes tariffs and other temporary retaliations might be called for in order to keep the system honest, even though their continued use would tend to raise domestic prices, reduce competition and increase crony capitalism.
These were the ugly but sometimes necessary short-term expedients of what he called “that insidious and crafty animal, vulgarly called a ‘statesman’ or ‘politician’, whose councils are directed by the momentary fluctuations of affairs”.
Indeed, Smith supported the Navigation Acts, a long series of laws enacted throughout the 17th and 18th centuries, through which Britain used its naval power to exercise strict control over its colonial and other trade, insisting that it was routed through Britain. As he put it simply, “defence is of much more importance than opulence”.
But as to the basic logic and legitimacy of mercantilism, and its disastrous long-term effects, he was unsparing. As he put it: “Nothing … can be more absurd than this whole doctrine of the balance of trade.”
Trade was not a zero-sum game in which each nation could gain only by beggaring its neighbour, as the mercantilists imagined. On the contrary, such a view was not merely individually unwise but collectively incoherent.
There could never be a trading system of any kind in which every country ran a positive balance of trade. Indeed, some societies — notably the American colonies — could run a negative balance for decades while flourishing and creating enormous wealth.