Though better known for his treatments of philosophy, history, and politics, the Scottish philosopher David Hume also made several essential contributions to economic thought. His empirical argument against British mercantilism formed a building block for classical economics. His essays on money and international trade published in Political Discourses strongly influenced his friend and fellow countryman adam smith.
British mercantilists believed that economic prosperity could be realized by limiting imports and encouraging exports in order to maximize the amount of gold in the home country. The American colonies facilitated this policy by providing raw materials that Britain manufactured into finished goods and reexported back to the colonial consumers in America. Needless to say, the arrangement was short-lived.
But even before the American Revolution intervened in mercantilistic pursuits, David Hume showed why net exporting in exchange for gold currency, hoarded by Britain, could not enhance wealth. Hume’s argument was essentially the monetarist quantity theory of money: prices in a country change directly with changes in the money supply. Hume explained that as net exports increased and more gold flowed into a country to pay for them, the prices of goods in that country would rise. Thus, an increased flow of gold into England would not necessarily increase England’s wealth substantially.
Hume showed that the increase in domestic prices due to the gold inflow would discourage exports and encourage imports, thus automatically limiting the amount by which exports would exceed imports. This adjustment mechanism is called the price-specie-flow mechanism. Surprisingly, even though Hume’s idea would have bolstered Adam Smith’s attack on mercantilism and argument for free trade, Smith ignored Hume’s argument. Although few economists accept Hume’s view literally, it is still the basis of much thinking on balance-of-payments issues.
Considering Hume’s solid grasp of monetary dynamics, his misconceptions about money behavior are all the more noteworthy. Hume erroneously advanced the notion of “creeping inflation”—the idea that a gradual increase in the money supply would lead to economic growth.
Hume made two other major lasting contributions to economics. One is his idea, later elaborated by friedrich hayek in The Road to Serfdom, that economic freedom is a necessary condition for political freedom. The second is his assertion that “you cannot deduce ought from is”—that is, value judgments cannot be made purely on the basis of facts. Economists now make the same point by distinguishing between normative (what should be) and positive (what is).
Hume died the year The Wealth of Nations was published, and in the presence of its author, Adam Smith.