Smith to Rochefoucault, I November 1785, Letter 248. An Inquiry into the Nature and Causes of the Wealth of Nations, Volume I. Liberty Fund, Inc., 1981, page 267, footnote 12.
In a Country where Clamour always intimidates and faction often oppresses the Government, the regulations of Commerce are commonly dictated by those who are most interested to deceive and impose upon the Public.
Few are those who fully understand the workings and benefits of international commerce—especially so, it seems, President Donald Trump. That is surprising, as the economics of international trade are not difficult. After all, we economists have striven to explain them with simple reasoning and homely cases for more than a century now. It was in 1817 that David Ricardo took up Adam Smith's example of the benefits of importing claret or burgundy wine rather than producing it in Scotland, and presented his improved model of cloth and wine trade between England and Portugal. The Ricardo model is known as the model of "comparative costs". With it, he showed how a poor country with low productivity could prosper in the world of trade with no need to take protective measures—and vice versa for a rich country. My teacher Lord Lionel Robbins used to say that the theory of comparative costs was the pons asinorum of economic reasoning, alluding to the Euclidian theorem of the angles of an isosceles triangle that dim students had so much difficulty in getting over. The reason for this lack of understanding by intellectual donkeys is perhaps that the conclusions of the theory of international trade go against common sense. So say many: 'You cannot truly believe that foreign competition is good for us? Do you actually hold that commerce will reduce the number of the poor? Doesn't fair trade need a level playing field? Come on...!'
Freer trade from 1815 to 1870
This would not matter much if the lack of understanding of the economics of international trade did not result in grievous loss of well-being for the whole of humanity. Care for the poor is at the heart of the politics of free trade. This was the aim of the great movement in 19th century Britain, culminating in the repeal of the Corn Laws in 1846. Rather than Britain, I should say the United Kingdom, because it was the acute suffering of the Irish subjects of Queen Victoria during the potato famine of the 1840s that was the clinching argument of the free traders.
For more on the debates over the British Corn Laws and their effects on the poor, see "Speeches on Questions of Public Policy", by Richard Cobden, Library of Economics and Liberty; and "Free Trade and Other Fundamental Doctrines of the Manchester School", Francis W. Hirst, ed., Library of Economics and Liberty; and "The Myth of Free-Trade Britain", by John V.C. Nye, Library of Economics and Liberty, March 3, 2003; "Politics and Welfare: The Political Economy of the English Poor Laws", by George Boyer, Library of Economics and Liberty, December 2, 2002.
See also the EconTalk podcast episode Bernstein on the History of Trade; and "The 'Trade Deficit': Defective Language, Deficient Thinking", by Daniel B. Klein and Donald J. Boudreaux, Library of Economics and Liberty, June 5, 2017.
The Corn Laws restricted the importation of corn (not maize but cereals in general) into the United Kingdom; British agriculture had received some form of protection since at least the 17th century. The first modern Corn Law was passed in 1794, but the question became urgent on the return of peace after Waterloo, when British ports reopened to trade with Europe and America and cheap foreign corn was on offer again. In 1815, a law was passed limiting the import of wheat until its price on the home market was more than 80 shillings per quarter. This restriction was felt to amount to a prohibition of imports, and in 1828, Lord Wellington's government legislated a sliding scale whereby foreign wheat could in fact be introduced only when its price in the home market was 73 shillings per quarter or above. This Corn Laws were denounced as the most visible part of the traditional limitations of trade that Adam Smith had criticised as forming the 'mercantilist system'.
A motley alliance of economists, politicians, industrialists, agitators, and later trade unionists laid siege to the citadels of mercantilism. Adam Smith, Ricardo, his friend and mentor James Mill, John Stuart Mill, the son of James, and the whole group of 'philosophical radicals' around Jeremy Bentham, argued intellectually in favour of free trade in Parliament, in the literary reviews, and in the daily press. They were the learned arm of a much larger popular movement culminating in the founding of the 'Anti-Corn Law League' in 1839, under the leadership of Richard Cobden and John Bright. The League agitated for the dismantling of agricultural protection, in fact of all commercial protection. Finally, in 1846, Sir Robert Peel, the Prime Minister at the time, was swayed fully to free the import of corn.
Many historians have tried to besmirch the story of the movement that led to the unilateral dismantling of tariffs by the British in the years from 1815 to 1846. The story told by cynically inclined historians is that the advocacy of free trade, given the industrial supremacy of England, made foreign competition no danger; and that the anti-Corn Law coalition was motivated by special interests. First, there was no supremacy of British agriculture over world food producers within reach, given the progress of railways and steam sea transport. Then, even if class interest was one of the factors that explain the widespread backing of the repeal movement, there is nothing wrong with self-interest when it promotes the general good. Thus, the middle and popular classes were incensed by the rent the landholders extracted thanks to protection. Factory owners complained that interference with foreign trade not only reduced their profits but also lowered the standard of living of their workers. The high prices and low quality of food angered the popular classes. The electoral reform 1832 was wind in the sails of the free traders as it gave voice to middle class voters who resented the power of the Lords over the House of Commons. Nevertheless, a freer economy was advocated even when it went against industrial interests: for example, the prohibition of the emigration of expert artisans and workers to rival countries was derogated in 1824, and trade unions were legalised in that same year. The final repeal, however, needed the personal conversion of the great and the good, a conversion, as we shall see, based both on scientific analysis and on humane feelings.
Such was the situation when the Tory Sir Robert Peel again became Prime Minister in 1841. At the start of his premiership, he still believed in agricultural protection, though he was in general favourable to free trade. He began to change his views on the importation of food by a point of theory. Some protectionists rested their case on an argument of Ricardo's (taken out of context) that cheap sustenance made for low wages: Peel says in his Memoirs,2 that he was swayed "by the many concurring proofs that the wages of labour do not vary with the price of corn".
The other element of his change of views was the coming potato famine in Ireland and the loss of the wheat crop in England. In October 1845, a number of botanists told him that continual rain during the summer would result in the spreading of a blight and result in the general failure of the potato crop—the only food, he writes, of four million Irish peasants. Moreover, due to the failing crop, potatoes otherwise kept for seed would be eaten by the spring, further reducing the supply of food next year. Observers on the ground informed Peel that the weather had also made it impossible to reap the normal crop of wheat in England during the late summer. When he proposed a suspension of the tariff on the imports of food to his Cabinet, only three minsters backed him, and he resigned. The uproar in the country must have been so great and the plight of the Irish so miserable that even aristocratic landholders fundamentally opposed to the repeal, such as the Duke of Wellington, changed their position. Asked again by the Queen to lead the government, Peel got the full backing of the ministers and of a majority of the House of Commons for the repeal. As for him, he had taken "a course manifestly opposed to his own private and political interests;" he himself was a landowner, and the repeal split the Tory party asunder.
Most favoured nation
The repeal of the Corn Laws began a period of thirty years during which free trade agreements proliferated in Europe. The agreements of the 1860s were a consequence of the 'most favoured nation clause' (MFN) inserted in the 1860 Cobden-Chevalier Treaty between France and the United Kingdom. This kind of clause (present also today in the constitution of the World Trade Organization) automatically extends the 'favourable' clauses of the most recent commercial treaty of a country to all the parties of previous ones. Note that 'favourable' means the opening up of one's market to the other party in a treaty. This reflects the mercantilist idea that exports are good and imports are bad. Rather, it is the total amount of trade that matters for people's individual benefit. Nevertheless, over a period of fifteen years from the signing of the Cobden-Chevalier Treaty fifty-six other preferential trade agreements were signed in Europe. Markus Lampe explains the spread by a number of factors, mainly the attraction of trading in a larger market and the fear that not adhering to the movement would lead to trade diversion away from the outsider. However, the attraction of joining an existing free-trade area would diminish further the distance, as lower transportation costs would neutralise the gains from the MFN clause. This explains why the adoption of the clause was effectively limited to Europe.3
"Bilateral free trade agreements are immensely complicated, given the network of special interests they have to respect.... The gains are much clearer when countries free imports of goods and services unilaterally."
So, the spread of free trade agreements came to a halt in the 1880s, and tariffs came back to continental Europe, starting with Bismarck's 'rye and iron tariff' of 1879.4 This to my view shows that bilateralism has limited value for the free trade programme. Bilateral free trade agreements are immensely complicated, given the network of special interests they have to respect. In addition, their advantages for consumers and their effects on producers' competitiveness are difficult to perceive. The gains are much clearer when countries free imports of goods and services unilaterally—which is what the United Kingdom did after 1846 and should do now after Brexit.
Unilateral free trade may look to most of my readers as an unreachable ideal for democratic countries. The only recent example is to most people not very attractive—it is the free trade policy in Pinochet's Chile. The trade slogan of the 'Chicago boys' who advised the General's government was "aranceles bajos y parejos", "low and even tariffs". This has been the basis of the diversification of Chile's exports, and a clear contribution to its people's well-being (in economic parlance, growth). Can it be done in a democracy?
Adam Smith and David Ricardo on international trade
One of the causes of the political resistance to unilateral free trade is the general presentation of international trade theory in terms of advantage and disadvantage and then insensibly formulated in terms of national power. The 'Wealth of Nations' became 'The Wealth of States'.5 Bismarck's move and those of his rivals and imitators was a symptom of the illness that affected Western politics in the years leading to World War I: to wit, putting the productive capacity of capitalism at the service of nationalism, imperialism, and welfarism. Then came the Great War, where the productive powers of national economies at war brought about the Urkatastrophe, and the original catastrophe of the liberal West.
Adam Smith started his reflections on international trade at the correct point: with the trades of individuals and families. "It is the maxim of every prudent master of a family, never to attempt to make at home what it will cost him more to make than to buy." This he extended then to the whole country or, as he put it, "the produce of the land and labour [...] taken complexly": "What is prudent in the conduct of every private family, can scarce be folly in that of a great kingdom."6 This limited his argument to situations where the cost of producing a commodity was absolutely, though not relatively, above that that of another family or country, as when in another famous example he noted the folly of substituting wine produced in Scottish hothouses for claret and burgundy imported from France.
David Ricardo, in his Principles of Political Economy (1817), extended Smith's analysis to explain why trade was for the advantage of all parties even when the products of one country were more expensive than those of another in all lines of merchandise. If Portugal proved to use less labour to produce both wine and cloth, that did not mean that England was reduced to import both and produce neither. The outcome of trade depended on how much more productive Portugal was in wine than in cloth, even though superior in both to England. In that case, it would be more profitable for Portugal to apply its labour to the production of wine and import the cloth.
Paul Samuelson explained this with a more personal example. Although he was better at economics and at typing than his secretary, it was more advantageous for both that he should specialise in economics and have his letter typed by his assistant. The sacrifice of economics time spent by Samuelson to write his letters would be greater than the sacrifice of his assistant in giving up typing for economics, so they both specialised.
The belief that countries trade
Ricardo's model had one drawback. It has led many people to think of trade as a question of countries specialising, not of individuals and firms exchanging goods and services for their mutual profit. Planners of different hues became obsessed with how to make countries specialise in their comparative advantage, as if 'countries' were the subjects of international trade (in fact the active subjects of anything in economics) and could choose what they produce as if they were individuals. Modern economic production is scarcely reducible to a Ricardian model of exclusive specialisation: innovation mushrooms in unexpected locations, supply chains cross borders, and individual effort changes relative advantages. Geographic specialisation induced by government has had its day.
This outdated caricature of the Ricardian model was applied in the Soviet Empire, where the planners would concentrate all of a single industry in one region of their dominion, multiplied by the notion of increasing returns to scale. Such was the policy of the Gosplan in the USSR, not least under Nikita Khrushchev, as when they decided to concentrate car and lorry making around Moscow or in Nizhniy-Novgorod, textile towns between the Oka and Volga rivers, or scientific research in remote cities of science such as Akademgorodok in Siberia.
Unilateral free trade after Brexit
However, these thoughts are also applicable to British international trade policy after Brexit. Politicians of all shades speak as if international trade were a two-person power game, and more often than not zero sum, where 'concessions' have to be mutual. If trade were understood as a multi-person dynamic and positive sum game, protectionists would be seen for what they are, defenders of their own personal interest at the expense of the rest of the people.
First, there is no doubt that consumers, especially the poor, gain by the variety of supply and by the lower prices of what is on offer under free trade. Secondly, though it is true that the sudden opening to foreign trade will hurt some producers, general productivity will increase more than proportionately—just as technical advance embodied in robots will in the beginning displace some workers and cut into the value of obsolete capital. In any case, the cost to some producers' untamed foreign competition will be much smaller than protectionists say: supply from abroad will be less expensive and competition will force other British producers to be more efficient. When I watch show jumping championships, I rue how few are the horses left in this world now that they are no longer needed for transport. The internal combustion engine has displaced those not used for sport; but then horses cannot learn to drive, in contrast to humans. Naturally, coal miners in the United States will be displaced by imports of foreign coal, and more so by the competition from the fracking industry. This is the short-term price of progress and in any case would be alleviated if trade were totally freed.
If the European Union members try to exact a heavy price from the United Kingdom for Brexit, the free-trade reply should be the answer. As in the 19th century, Britain could pull down all tariff and non-tariff barriers. Then, in obedience to WTO rules, the same should be offered to all WTO partners. No thought should be spent on possible balance of payments deficits. Ever since David Hume, we know that the balance of payments of a country can be left to itself. The floating exchange rate will do the job, falling or rising to equilibrate the foreign sector—on the condition that the Bank of England behaves and does not unduly pump money into the system.
I was interested in the analysis of a free trade Brexit by Edgar Miller in The Conservative magazine last June. The standard growth model he has used allowed him to forecast that
... removing tariffs creates a long-term GDP gain of four per cent [for the UK], a fall of eight per cent in consumer prices, and an increase in Treasury revenue of more than seven per cent.7
The reasons for these gains are the removal of the Common Agricultural Policy and other barriers and the freeing of imports from the rest of the world. We know that models are not exact predictors, but these and other studies of the future of the British economy outside the European Union under free trade and with flexible exchange rates allay many of the worries peddled by the interventionists. Unilateral free trade is the answer.
Smith to Rochefoucault, I November 1785, Letter 248. An Inquiry into the Nature and Causes of the Wealth of Nations, Volume I. Liberty Fund, Inc., 1981, page 267, footnote 12.
Memoirs of the Right honourable Sir Robert Peel , edited by Earl Stanhope and Edward Cardwell M.P. London, 1857, page 182. Archive.org.
Lampe, Markus. (2010), 'Explaining nineteenth-century bilateralism: economic and political determinants of the Cobden-Chevalier network', Economic History Review.
Asaf Zussman, "The Rise of German Protectionism in the 1870s: a Macroeconomic Perspective," Stanford University, July 2002.
Such is the suggestive title of John M. Hobson 1997 book: The Wealth of States: A Comparative Sociology of International Economic and Political Change , Cambridge: Cambridge University Press, 1997.
Adam Smith, An Inquiry into the Nature and Causes of the Wealth of Nations. Paragraphs II.ii.2 and IV.ii.11-12. Library of Economics and Liberty.
*Pedro Schwartz is "Rafael del Pino" Research Professor of economics at Universidad Camilo José in Madrid. A member of the Royal Academy of Moral and Political Sciences in Madrid, he is a frequent contributor to the European media on the current financial and social scene. He currently serves as President of the Mont Pelerin Society.
For more articles by Pedro Schwartz, see the Archive.