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The Misunderstood Adam Smith

Adam Smith is commonly regarded as the father of modern economics. Free traders claim he is also the father of free trade and credit him with the first systematic attack on government regulation of trade ever written.

This is true as far as it goes. This is not to say, however, that Adam Smith was a free trader in the same sense that the term is promoted today. Since David Ricardo and the Austrians took hold of it, the term has acquired a dimension and a purpose that was, to paraphrase Smith, no part of his intention. Or, in any event, it was no part of his definition.

Smith’s argument for trade was rooted in what economists today refer to as “Absolute Advantage”; it was left to the crafty mind of David Ricardo half a century later to invent a justification for trade on the basis of the far more subjective “Comparative Advantage” that today the economists tell us we need to consider instead.

While the dull, pencil-headed, pocket calculator logic of Comparative Advantage works fine for the textbook laboratory example of two nations and two products, it falls apart entirely the minute real-world constraints or considerations are introduced. It becomes absurd when you attempt to factor “comparative advantage” across three nations and three products, let alone the hundreds of nations and millions of products of the real world. Try it—you will lose your mind.

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All Comparative Advantage amounts to, reduced to its essential components, is a sophistic argument for international division of labor—for global economic union—without dealing with any issues of political union. It is the economic equivalent of living in sin, so to speak. For whatever intuitive sense it claims to have, this argument relies on a fundamental confusion between trade—economic activity between economic systems—and division of labor—economic activity between individuals in a single economic system.

At bottom, this argument is a bait-and-switch for a global system, not a plan for any one nation to become wealthy, least of all the United States, which, according to the law of equilibrium, would be forced under a free-trade regime to sustain massive losses of jobs and wealth to pull all other nations up in the new global wage and price structure.

Precisely that is happening today. Five-year planners for the various failed socialist regimes of the 20th century attempted to divine all human activity within their sphere according to a similarly flawed economic calculus that they labeled “scientific socialism.” Comparative Advantage is rooted in the very same flawed “labor theory of value” as Marx’s scientific socialism. And it reeks of an arrogant, academic do-good-ism, as if government-appointed econometrics majors, and not business people, are more competent to discern what nations, not individuals, should be producing and how much.

Nor did Smith have the opportunity to see what the American founders, who were struggling more or less contemporaneously to create a new nation from scratch, added to his ideas. Our founders (unlike our modern professorial elite) really did read Smith’s famous 1776 treatise The Wealth of Nations before they embarked upon the Union. Alexander Hamilton’s work in particular reveals Smith’s clear influence on his reasoning, as in his Report on Manufactures.

Interestingly, virtually no one since Hamilton has really bothered to inquire, after the manner of Smith, into the “nature and causes” of American wealth. Today such matters are spoken of as a metaphysical given, and often-metaphysical justifications are produced to explain it. While God has truly blessed our nation, it was sound economics that transformed us in less than one century from a backwards, agrarian hodge-podge of disparate colonies into the economic powerhouse of all time.

Intrepid researchers soon learn that our founders instituted a deliberate program of development and national self-sufficiency with the very first law on the books of the very first Congress. The founders were inspired by the genuine insights of Smith the economist.

This program of self-sufficiency was based on the tariff revenue system. Rather than attempting to regulate the minutiae of trade to the benefit of any one particular industry of the moment, which is what tariffs in the past had unwisely been used to attempt to do, they wisely and simply defined the American market in a deliberate fashion to encourage all American industry and manufactures. They asked foreigners to pay a flat, ad valorum percentage “cover charge” for access into that market. Internally, the American market was a genuine free trade zone (“free trade” being understood here properly as “division of labor,” not trade in the international sense free traders tend to confuse).

And the best part of all? Americans paid no income tax whatsoever for the first 150+ years of the Republic; instead, foreigners paid the entire revenue of the United States for the privilege to do business here. If they moved here, of course, they paid nothing at all.

Moreover, no great skill in literary interpretation is required to discern, if one would but read Smith in the original, that the modern interpretation of his famed “invisible hand” passage is patently false.

Smith would have advised the peoples of the world to do what human nature or Providence or whatever he meant by the invisible hand already guides them to do: support their domestic industry. If you are American, buy American; if you are Russian, buy Russian; and so on. For this is the way to prosperity.

That’s the real message of the invisible hand and the entire preceding 300-page discussion on the uses of capital, not that cheap Hollywood wisdom of Gordon Gecko that counsels every capitalist to glorify greed as good and self-interest as the ultimate moral imperative.

His thesis was that of the three high-level uses of capital available to a nation for the purpose of creating national wealth—domestic production for domestic consumption, domestic production for foreign consumption, and foreign production for domestic consumption—domestic production for domestic consumption is twice as efficient as either of the other two. Adam Smith saw fit to observe, upon concluding that argument, how fortunate it was that an invisible hand guided people naturally to prefer domestic over foreign industry, even if it was more expensive. For this, he concludes, is how wealth accumulates to a nation. And it is in this context, and only in this context, that his invisible hand passage makes any sense.

Yet we have taught our children differently. We have taught them to buy Japanese if it’s cheaper and not to worry about American workers. They will find new jobs elsewhere once the market or the government figures out what to do with them.

And his conclusion is further supported by, believe it or not, the pro-free-trade Austrians, who in their sober moments, when not proselytizing on the issue of free trade, identified the per capita capital investment in labor as the sole determinant of a nation’s standard of living.

Considered in light of Smith’s insight regarding the uses of capital and the Austrian insight regarding standards of living, is it any wonder America became the most mighty economic force on the planet during a relatively short period when it actively protected and encouraged its domestic industry? That is to say, when our government promoted capital investment in support of domestic over foreign labor? And is it really any wonder why in a similarly short period of time, with the policy of “free trade,” America’s once powerful industrial base has since been all but scrapped and our economic security slashed in half such that now two incomes are needed just to make ends meet for the average family?

While Smith was brutal in his attack on government bureaucrats who would pretend to know better than a private citizen how best his needs can be met. Smith operated under the assumption that everybody, yes, even capitalists, was fundamentally patriotic and well meaning, even if he occasionally confused his narrow interest with the public good. Modern global culture, nurtured by an ideology of global capitalism no less virulent and ambitious than the ideology of global communism with which it locked horns in the last century, has done much to undermine that assumption.

The great goal of a nation’s political economy, according to Smith, is simply “to increase the power and riches of that country”—not, as some seem to think today, to make the world safe for transnational corporations and globalist institutions of command and control.

Once the baby-boom generation comes of retirement age, and the pressures on government spending eclipse the earning capabilities of the remaining working population, maybe then, after everything is broken and America’s tragic industrial collapse can no longer be whitewashed at the Office of Management and Budget as it has been on Wall Street and the boardrooms of Enron—maybe then the unthinkable will become thinkable again.

Maybe, just maybe, America will be ready to return to principles of truly limited government, economic patriotism, and resolve to rebuild the only free market economy that matters to us, or should matter to us: our own. That’s self-interest the way Smith theorized it and our Founders practiced it.

R. B. Calco is a policy analyst at the Center for the National Security Interest.

6 Comments (Open | Close)

6 Comments To "The Misunderstood Adam Smith"

#1 Comment By todd mahaffey On August 23, 2013 @ 2:16 pm

So if I get this correct, because we don’t have consumption of domestic produce at heart we therefore need tariff law to head off our greed – a national greed morally or pragmatically trumps personal greed. National corporatism (Federal enrichment)is what makes some of us not so gullibly patriotic. What if domestic product is of sufficient quality as well as more expensive? This dovetails nicely with neoconservatism…..and I’m not even a globalist. But I am a liberty proponent.

#2 Comment By Joseph On June 12, 2018 @ 8:04 am

“This argument relies on a fundamental confusion between trade—economic activity between economic systems—and division of labor—economic activity between individuals in a single economic system.”

Explain to me how it counts as “economic activity between individuals” when I buy a car made in Detroit, but not when I buy one made in Tokyo. Are the Japanese workers not individuals?

Objectively, there is no difference between one situation and the other. You may make a moral argument for feeling differently about the Detroit worker, but that’s not what you’re doing here. You’re pretending that there’s an objective distinction between the two situations, and you’re wrong.

Division of labor and trade are the same whether they’re occurring within a town, across state lines, or around the world. Tell me, if I live right on the border with Canada, why it should be considered “economic activity between individuals” when I trade with someone in Florida, but “economic activity between economic systems” when I walk down the street and trade with a Canadian neighbor.

“Americans paid no income tax whatsoever for the first 150+ years of the Republic; instead, foreigners paid the entire revenue of the United States for the privilege to do business here.”

Did these foreigners sell their products here out of altruism? Or did they make a profit? Something tells me their prices compensated for the tariffs, meaning that American consumers were indeed footing the bill.

#3 Comment By 2VNews On October 19, 2018 @ 11:25 pm

Change your name to: The American Nationalist Candlestick Makers

#4 Comment By Stefan On October 20, 2018 @ 8:54 am

If you want people to take you seriously, you should probably know what you’re talking about when writing a critique of a phenomena central in economic theory which is widely accepted among economists.

This column shows a fundamental misunderstanding of trade in general, and offers no clear definition of what comparative advantage is, just a condemnation of it as “subjective”, the “economic equivalent of living in sin”, using the fallacy appealing to consequences in calling it a “sophistic argument for international division of labor—for global economic union—without dealing with any issues of political union” and comparing it (without elaboration) to the Marxist theory of labour.

Trade on a national level is no different than trade between individuals simply because it still is trade between individuals. The only difference is that they are living in different geographical areas. Division of labor based on comparative advantage secures the highest productivity among any group, whether it be people of the same village or city, or of different countries. You appear to mistake globalization in terms of division of labor and free trade with globalization in terms of centralization of power into supranational entities. The former is good and the latter is bad. Got that?

If you want to learn what comparative advantage actually means, check of these two videos on the topic on MRU:

[1]

[2]

#5 Comment By Nicolas On October 21, 2018 @ 10:20 pm

This is the worst piece I’ve ever read in TAC, and among the many excellent articles there lurk some doozies. The Twitter teaser suggested such bad economics that I figured Buchanan might have written it.

#6 Comment By James Pier On May 21, 2019 @ 6:18 am

Where to begin?

This does not read like it was written by someone intimately familiar with economics. Distorted understandings of comparative advantage AND Austrian economics are glaring. But Adam Smith, too, gets treated shabbily from an intellectual point of view.

Math is hard. Economics is also hard. The money quote: “as if government-appointed econometrics majors, and not business people, are more competent to discern what nations, not individuals, should be producing and how much.”

Who are these supremely wise “business people” who should decide? Are they in government? When trade is free, business people do decide these things — based on what consumers will buy and for how much. The enormity of wealth and improved standards of living everywhere that results has dwarfed whatever benefits any short-term gain favored producers might receive from government trying to make such decisions.

Mr. Calco – the arguments you deride and so misrepresent here are eloquently propounded at cafehayek.com, should you wish to acquit yourself more convincingly on the subject.