Economic Policy and Theory - International trade

Although Adam Smith (1723–1790) is regarded today as the progenitor of "laissez-faire" economic theory—where self-interest, limited government, and the unbridled profit motive converge to produce the ideal political economy—his economic theory really began on much more limited grounds.

Beginning with the overarching belief that the best political economy produced a regime of high wages and low prices—and modest profits—Smith created what many regard as the first modern economic theory, a theory constructed squarely upon a critique of British international trade in the late eighteenth century. When Smith spoke of restraint in critical terms, for example, he most often referred to import restrictions, not restraint of the individual and his single-minded pursuit of wealth. With much of Smith's general theory lost to the questionable interpretation of his lofty, somewhat more malleable rhetoric, one is left mostly with a trenchant special theory. Like the French Physiocrats who preceded him, Smith constructed his theory upon the notion that government promotion of trade most often came at the expense of groups or individuals who were less powerful but more significant, economically, than the commercial exporters favored by such promotion. For the Physiocrats, these individuals were farmers; for Smith, consumers.

Thus began both a long-running debate on the economic merits of free trade versus protectionism and trade promotion, and on a course of theoretical formulations built partly on the criticism of policies that favored commercial interests over agricultural counterparts. Placing the consumer at the heart of his theory, rather than the producers favored in eighteenth-century British policy, Smith ensured that such consumers would always be represented in subsequent economic theory related to international trade. Favors granted by governments to resident exporters, Smith pointed out, might well benefit those producers only at the expense of resident consumers, leaving almost everyone less well off. Hereafter, these consumers would be removed from trade policy calculations only by ignoring relevant and advancing economic theory. Freer trade—perhaps anticipating the theory of the "second-best" enunciated by James Edward Meade and Richard Lipsey in the 1950s and the "scientific tariff" theories promulgated by Harry G. Johnson in the 1970s, became a means to improve domestic purchasing power for the first time under Smith's formulation.

Although it ultimately came to be submerged within later economic theories that often ignored its most immediate postulates, Smith's analysis was highly regarded in the early American republic. Indeed, Thomas Jefferson—attracted, perhaps, to Smith's reshaping of physiocratic, agrarian-centered critiques of commercial subsidy—regarded it as the paragon of contemporary political economy. Smith's trade theories would also help establish a general pattern for regional political battles in the early nineteenth century (for example, the 1828 "Tariff of Abominations"). Vice President John C. Calhoun's challenge to American protectionism, nascent despite its implicit connection to the special interests of southern slaveholders, may well have anticipated both the consumer-based populism in the American South during the late nineteenth and early twentieth centuries and the underconsumptionist economic theories of the mid-twentieth-century followers of John Maynard Keynes. His focus on the costs of effective and proposed U.S. tariffs was constructed squarely, if unwittingly, on the back of Smith's trade theory.

If Smith pointed economic theory toward the potential general benefits of freer trade—couched within a broader, somewhat more ambivalent philosophical treatise—then David Ricardo (1772–1823) transformed it into a more single-minded pursuit of improved economic analysis. Ricardo's masterpiece, The Principles of Political Economy and Taxation, first published in 1817, contributed greatly to the analysis of wage determination, pricing, and tax policy. But most famously, perhaps, it also gave us the law of comparative advantage. Explaining how a nation may gain by importing a good even if that good can be produced at home more efficiently (by allowing it to devote more resources to the production of goods at which it is most efficient), Ricardo revealed previously unrecognized advantages to a regime of freer trade. He also suggested the kind of rigorous analysis upon which all subsequent theory of international economics would have to rest. Indeed, few economists can yet escape Ricardian challenges, especially in the ongoing analysis of price determination and the relative importance of wage and profit levels. And though policymakers tend to conform to the characterization of the nineteenth-century British prime minister Benjamin Disraeli—encouraging free trade as an expedient rather than a principle—it is also likely that they can seldom avoid beginning the analysis of any trade policy regime without the admonishments of both Adam Smith and David Ricardo.

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