It’s Tariff Time: What Can Adam Smith Teach Us About Trade Policy Today?

March 2, 2018

I’ve argued in previous posts on transportation policy and tax policy that the 18th century economist Adam Smith still has a lot to teach us today. Students of history generally recognize Smith as one of the most influential thinkers in economics, as his book Wealth of Nations (1776) significantly influenced other scholars and ultimately policymakers away from the then-prevalent global policy of mercantilism and toward freer trade.

His work on trade should draw renewed interest today, as the Trump administration has just announced large tariffs on steel and aluminum imports, a stark reversal from the broad arc of public policy away from these sorts of protectionist measures (see this post from my colleague Erica York). Here are three lessons from Smith on trade that we would do well to remember.

Specialization is Limited by the Extent of the Market

One of Smith’s first sections in the Wealth of Nations dwells on the importance of trade in allowing us to specialize:

As it is the power of exchanging that gives occasion to the division of labour, so the extent of this division must always be limited by the extent of that power, or, in other words, by the extent of the market. When the market is very small, no person can have any encouragement to dedicate himself entirely to one employment, for want of the power to exchange all that surplus part of the produce of his own labour, which is over and above his own consumption, for such parts of the produce of other men’s labour as he has occasion for. (Bk. 1, Ch. 3)

Here Smith is saying that a greater ability to transact with one another—across a community or across the globe—makes for a greater ability to specialize in any particular task. Specialization allows us to produce more goods and services with less time, effort, and raw materials, and a bigger market gives us more people to trade those goods and services with in exchange for our wants and needs.

Trade is What Makes a Nation Wealthy, Trade Restrictions Make Us Poorer

Not everyone knows that the full name of Smith’s masterwork is An Inquiry into the Nature and Causes of the Wealth of Nations. This is important, as Smith is explicitly trying to answer the question, “What makes a nation rich?” At the time of his writing, growth above the level of bare necessities had only been established in a few corners of the earth, and Smith was trying to investigate why. One of his big answers was that specialization and gains from trade were a primary driver of wealth-creation for all people.

Important today, this also means that restrictions on trade like tariffs make a nation poorer. In Smith’s words:

If a foreign country can supply us with a commodity cheaper than we ourselves can make it, better buy it of them with some part of the produce of our own industry employed in a way in which we have some advantage. […] The value of [a country’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 [by trade policies]. […] 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. (Bk. 4, Ch. 2)

Retaliatory Tariffs are Still Bad Policy

Tariffs are sometimes proposed on the premise of retaliating against other countries that are deemed to be “cheating,” either applying tariffs to U.S. goods sent to their country, or by making their exports less expensive by subsidizing them with fiscal or monetary policy.

Smith addressed this consideration as well, with a sort of economic take on the adage “two wrongs don’t make a right,” and a warning that retaliatory measures tend to spiral, to the detriment of all parties involved:

When there is no probability that any such repeal [of a tariff in a foreign country] can be procured, it seems a bad method of compensating the injury done to certain classes of our people to do another injury ourselves, not only to those classes, but to almost all the other classes of them. When our neighbours prohibit some manufacture of ours, we generally prohibit, not only the same, for that alone would seldom affect them considerably, but some other manufacture of theirs. This may no doubt give encouragement to some particular class of workmen among ourselves, and by excluding some of their rivals, may enable them to raise their price in the home-market. Those workmen, however, who suffered by our neighbours prohibition will not be benefited by ours. On the contrary, they and almost all the other classes of our citizens will thereby be obliged to pay dearer than before for certain goods. Every such law, therefore, imposes a real tax upon the whole country, not in favour of that particular class of workmen who were injured by our neighbours prohibition, but of some other class. (Bk. 4, Ch. 2)

Two hundred and forty-two years ago, these arguments were deemed salient enough to set in motion a gradual climb away from protectionism and toward freer trade. Today, it’s hard to overstate how strong the agreement against these sorts of measures is in the economics profession.

A recent poll of economists in the Chicago Booth IMG Economic Experts Panel paints the picture quite convincingly. Among economists representing a diverse cross section of economic schools of thought, a full 100 percent of the expert panel disagreed or strongly disagreed with the statement, “Adding new or higher import duties on products such as air conditioners, cars, and cookies — to encourage producers to make them in the US — would be a good idea.”

Professor Robert Hall, one half of the well-known “Hall-Rabushka Flat Tax,” wrote in the comment box “Read Adam Smith!” On the other end of the spectrum, Austan Goolsbee, former chairman of the Council of Economic Advisors under President Obama, simply wrote “stupid.”

Thursday was a step backward on trade and tax policy.

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