Volume IV of the Wealth of Nations contains a critique of the mercantile (or commercial) system. Money is an instrument
of commerce, but the mercantile system is based on the principle that wealth consists of money. And its stated objective is to accumulate as much money (gold and silver) as possible. However real wealth, argues the author, consists of what money can purchase - the produce of land, labor and capital – and depends upon the abundance or scarcity of consumable goods. By analogy, the author states that it would not be possible to increase the amount of food or rations available to a family simply by increasing the number of kitchen utensils in their possession!
The purpose of foreign trade is not to accumulate as much gold and silver as possible by means of a favorable balance of trade; but to export the surplus produce of land and labor – for which there is no demand in the home market – and to import produce for which there is a demand. By opening new markets for commodities produced at home, the productivity of land and labor is also improved in the long term. In pursuit of this fallacy – a favorable balance of trade – it became the stated objective of most commercial nations to increase the export of domestic goods and to reduce the import of foreign goods. The author examines how this was sought to be achieved.
The only effect that high duties and taxes on the import of foreign goods (that could be produced at home) were to divert more land, labor and capital into a particular channel – into which it would not otherwise had gone. The author states that this should have been best left to the individuals concerned, as they know what is to their advantage. The crux of Adam Smith’s arguments is that what is to an individual’s advantage must also be to the advantage of society as a whole. Though that may not be his intention, by promoting his self interest he is also promoting the national interest. This is the “invisible hand” of which Adam Smith speaks…
The author says that no (rational) person would attempt to make at home what it would be easier – and cheaper – for him to buy. It is the author’s contention that what is true in the conduct of a private family must also be true in the conduct of a nation – which is a form of extended family. Every country has some natural advantage over another, which predisposes it to produce certain products more efficiently than others. The only people who benefit from restraints on free trade are the merchants and manufacturers, as they are (artificially) protected from the effects of foreign competition.
The author states that a policy of duties and taxes on foreign goods is tantamount to economic warfare – and may be motivated more by animosity (towards certain nations) or by a desire for retaliation than by sound economic sense. Duties and taxes are also imposed on those nations with which the balance of trade is disadvantageous. The author states that it would be ridiculous to do so because the balance of trade might be disadvantageous with a particular nation – but not with all nations taken together. Besides, it is a common trading practice to re-export many of the goods that are imported from a particular nation. All these trade restrictions achieve is to encourage smuggling (illegal trade) between the nations concerned.
The author states that the very premise of a balance of trade being disadvantageous to a particular nation is incorrect. All that a balance of trade implies is that a particular nation may gain somewhat more (or less) than the other nation. If the balance of trade is even, both nations will gain equally. The author wants that traders should be allowed to purchase their goods where they are available cheapest and best, without regard to any other consideration. He holds that as long as the annual produce of land, labor and capital is increasing, the revenue of the inhabitants will also keep on increasing. However, if a nation consumes more than it produces, it is living beyond its means and it will soon eat into its capital. A nation can keep on importing more that it exports – that is, it can have an unfavorable balance of trade – as long as its gross national produce is increasing.
The other side of the coin of restricting imports is the encouragement given to domestic exports. These take the form of drawbacks and subsidies. Drawbacks are given when the home products (subject to excise) are exported, or when foreign goods (subject to customs) are re-exported. The author is not against the giving of drawbacks, as they maintain the natural distribution of land, labor and capital. However, there is scope for misuse of this provision, as many goods meant for export are re-imported back into their country of origin.
Subsidies are given to encourage a particular industry or industries. The objective is to sell the goods cheaper than they would otherwise have been sold – and thus to sell a greater quantity of goods. The author feels that all subsidies achieve is the continuation of a losing trade where the expense is greater than the returns. The other objective is to expand the foreign market for these goods.