Question

Adam Smith (1723-1790), widely known as the father of modern economics, placed markets at the center of the political economy (i.e., the study of how a country is managed or governed, taking into account both political and economic factors). Drawing on Smith’s 1776 book, An Inquiry into the Nature and Causes of the Wealth of Nations, construct an detailed viewpoint explaining multiple points that takes Smith’s thoughts and extrapolates them to a current or recent episode in history, OR a current Canadian policy issue.

Essay Question: What would Adam Smith think about trade tariffs?

Answer 1

After a long exile, tariffs are back, and they’re being levied on billions of dollars of traded goods, ranging from steel and aluminum to Harley-Davidson motorcycles. They’re part of a trade war between the U.S. and China, and between the U.S. and the EU. Tariffs are taxes imposed by a country that make imports more expensive. The U.S. enacted this recent round of tariffs as a response to its trade deficit.

But the greatest economists in history would be wary of imposing taxes to address a trade imbalance. The better way to reduce a trade deficit is to export more, not to reduce imports by making them more expensive.

Using tariffs to improve a country’s trade position was essentially what Britain rejected over a century ago. The argument was won due to the work of two great economists, Adam Smith, the father of economics, and David Ricardo, the father of international trade. When the UK repealed the Corn Laws, a piece of protectionist legislation, in 1846, it marked an era of greater opening for Britain, then the dominant trader in the world.

Unlike many economists, Smith had the chance to put his theories into action. As the commissioner of customs for Scotland, he advocated removing all trade barriers, which was qualified only by the need to raise revenue for what he considered to be the proper purposes of governing a country, such as providing roads. He supported levying duties on imports and exports at a moderate level, but not so high that smuggling would be profitable.

True to Smith’s beliefs about government policies not distorting the market, he would set duties to be equal for different producers and importers, so that one group or one country would not have an advantage over another. For instance, he saw the inequity of exempting the product of private brewing and distilling (which was imbibed by the rich) from excise duty while taxing the preferred tipples of the poor.

So, if tariffs were necessary, they should treat all traders and trading nations the same, so as to not distort the “invisible hand” (his most notable contribution in The Wealth of Nations) of the market allocating what producers should make.

Even as our understanding of the issues around trade has evolved, the central tenets laid out by the great economists from two centuries ago remain. Tariffs are a protectionist measure that is inefficient and also distortionary if higher taxes on some imports mean they become less competitive relative to others.

Countries have often used protectionism to foster home industries until they are able to compete with established firms. This was the case for the United States in the 19th century when competing against Britain, and is still the case for China in a number of sectors.

The great economists would likely say that there are better ways to improve a country’s trade position, such as opening up the global market for services trade. This would disproportionately benefit the U.S. as the biggest exporter of services worldwide, competing well even with trade barriers in place. If China opened up more of its services sector, as it is already warily looking to do, then that could increase U.S. exports to China and reduce the trade deficit, for one. The UK, the second biggest exporter, and other advanced economies such as the EU and Japan would also see an improvement in their trade position, as the bulk of these advanced economies comprises services. Even accounting for the fact that services are not always traded (for example, restaurants), the EU has pointed to the potential to sell more services that would better reflect what it produces. For example, the economy of the EU is 70% services, while services make up just a quarter of exports.

In sum, selling more, rather than importing less (and thus consuming less or producing with more-expensive components), is one of the lessons to draw from history’s greatest economists.

They argued for the opening up of markets around the world so that countries could sell more of what they produce — which would bring about greater prosperity. Their insights continue to underpin economics today. Politics, however, are another matter.