prior probability

The second half of Article 1 of Part 3 of Chapter 1 of Book V of The Wealth of Nations (WN, V.i.e.1-40) is ostensibly about “Public Works and Institutions [that] are necessary for facilitating particular Branches of Commerce”, such as the Royal African Company (WN, V.i.e.19-20), the Hudson’s Bay Company (WN, V.i.e.21), the South Sea Company (WN, V.i.e.22-25), and the English East India Company (WN, V.i.e.26-28). In addition, Adam Smith also compares and contrasts “regulated companies” with a new form of private governance — new, that is, in Smith’s day: the “joint-stock company” or limited liability corporation.

By way of background, a regulated company was a privately-owned business that was authorized by a royal government charter to operate in a specific foreign market. The owners of the regulated company thus had the right to trade in that foreign market under company rules, but they did so using their own individual capital. A joint-stock company, by contrast, had the ability to issue shares of ownership in the company to private investors and to limit their financial risk to the amount invested in the company. But unlike traditional regulated companies, a joint-stock company was not run by its owner-investors. It was run by a small group of directors. This structure not only allowed the owners of a joint-stock company to pool their capital and minimize their legal risks; it also separated ownership and control.

With this historical background in mind, we can now proceed to Smith’s analysis of “regulated companies” and “joint-stock companies.” To begin, Smith has nothing good to say — and rightfully so, as we shall see in the passages below — about regulated companies:

“The usual corporation spirit, wherever the law does not restrain it, prevails in all regulated companies. When they have been allowed to act according to their natural genius, they have always, in order to confine the competition to as small a number of persons as possible, endeavoured to subject the trade to many burden some regulations. When the law has restrained them from doing this, they have become altogether useless and insignificant.” (WN, V.i.e.7)

“In all trades, the regular established traders, even though not incorporated, naturally combine to raise profits, which are no-way so likely to be kept, at all times, down to their proper level, as by the occasional competition of speculative adventure.” (WN, V.i.e.10)

But what about joint-stock companies? What does Smith have to say about them? In short Smith has mixed feelings about joint-stock companies. On the one hand, the incentives of a corporation’s directors are aligned with that of the company itself:

“The directors of a joint stock company, on the contrary, having only their share in the profits which are made upon the common stock committed to their management, have no private trade of their own of which the interest can be separated from that of the general trade of the company. Their private interest is connected with the prosperity of the general trade of the company, and with the maintenance of the forts and garrisons which are necessary for its defence. They are more likely, therefore, to have that continual and careful attention which that maintenance necessarily requires.” (WN, V.i.e.11)

But at the same time, the incentives of the directors and those of the shareholders might not be aligned, after all. In fact, they might even be diametrically opposed:

“This total exemption from trouble and from risk, beyond a limited sum, encourages many people to become adventurers in joint stock companies, who would, upon no account, hazard their fortunes in any private copartnery. Such companies, therefore, commonly draw to themselves much greater stocks than any private copartnery can boast of…. The directors of such companies, however, being the managers rather of other people’s money than of their own, it cannot well be expected that they should watch over it with the same anxious vigilance with which the partners in a private copartnery frequently watch over their own. Like the stewards of a rich man, they are apt to consider attention to small matters as not for their master’s honour, and very easily give themselves a dispensation from having it. Negligence and profusion, therefore, must always prevail, more or less, in the management of the affairs of such a company.” (WN, V.i.e.18)

How does Smith resolve this internal tension in corporate governance? In short, he imposes a two-part litmus test of sorts:

“To establish a joint stock company, however, for any undertaking, merely because such a company might be capable of managing it successfully; or to exempt a particular set of dealers from some of the general laws which take place with regard to all their neighbours, merely because they might be capable of thriving if they had such an exemption, would certainly not be reasonable. To render such an establishment perfectly reasonable, with the circumstance of being reducible to strict rule and method, two other circumstances ought to concur.” (WN, V.i.e.36; my emphasis)

So, what are these two circumstances or conditions? Here, Smith draws a distinction between (a) large-scale “undertaking[s]” or ambitious projects that will require a lot of capital to get off the ground and (b) presumably small-scale “common trades” that can be carried out by one person — Smith’s famous butcher, baker, and brewer immediately come to mind — or a small group of partners:

First, it ought to appear with the clearest evidence that the undertaking is of greater and more general utility than the greater part of common trades; and secondly, that it requires a greater capital than can easily be collected into a private copartnery [partnership]. If a moderate capital were sufficient, the great utility of the undertaking would not be a sufficient reason for establishing a joint stock company; because, in this case, the demand for what it was to produce would readily and easily be supplied by private adventures.” (ibid.; my emphasis)

Smith thus reveals his legalistic side — for his litmus test requires the “clearest evidence”, a heightened standard of evidence that reminds me of “the clear and convincing standard” used in certain types of law cases (e.g. punitive damages) — as well as his utilitarian side. Smith’s litmus test, however, has a blind spot: who is the judge or arbiter who is supposed to apply this test? Why not leave the question of utility to the market, to the investors themselves?

N.B.: I will proceed to Article 2 of Part 3 of Chapter 1 of Book V of The Wealth of Nations (WN, V.i.f.1-61) in my next two posts.

“That the erection and maintenance of the public works which facilitate the commerce of any country, such as good roads, bridges, navigable canals, harbours, &c. must require very different degrees of expence in the different periods of society is evident without any proof. The expence of making and maintaining the public roads of any country must evidently increase with the annual produce of the land and labour of that country, or with the quantity and weight of the goods which it becomes necessary to fetch and carry upon those roads. The strength of a bridge must be suited to the number and weight of the carriages which are likely to pass over it. The depth and the supply of water for a navigable canal must be proportioned to the number and tonnage of the lighters which are likely to carry goods upon it; the extent of a harbour to the number of the shipping which are likely to take shelter in it.” (WN, V.i.d.1; my emphasis)

Thus begins Article 1 of Part 3 of Chapter 1 of Book V of The Wealth of Nations (“Article 1”). To paraphrase Adam Smith: the government must erect and maintain harbours and highways and other channels of commerce — see, for example, the “&tc.” at the end of Smith’s initial list above — and the cost of these public works will be greater the more commerce is being carried out through them.

After establishing this fundamental premise, Smith then devotes the rest of Article 1 to the following question, Who should finance these “necessary” works: the taxpayers as a whole or the actual users of these public goods? And on this crucial first-order question Smith is clear: it is the actual users or direct beneficiaries who should pay. Or in the immortal words of Adam Smith:

“It does not seem necessary that the expence of those public works should be defrayed from that public revenue, as it is commonly called, of which the collection and application are in most countries assigned to the executive power. The greater part of such public works may easily be so managed as to afford a particular revenue sufficient for defraying their own expence, without bringing any burden upon the general revenue of the society.” (WN, V.i.d.2; my emphasis)

In fact, Smith tells us that some public works might generate so much public revenue that the government might even end up making a profit(!):

“A highway, a bridge, a navigable canal, for example, may in most cases be both made and maintained by a small toll upon the carriages which make use of them: a harbour, by a moderate port-duty upon the tonnage of the shipping which load or unload in it. The coinage, another institution for facilitating commerce, in many countries, not only defrays its own expence, but affords a small revenue or seignorage to the sovereign. The post-office, another institution for the same purpose, over and above defraying its own expence, affords in almost all countries a very considerable revenue to the sovereign.” (WN, V.i.d.3; my emphasis)

So, Smith asks, should the revenue generated by tolls and port-duties go into the government’s general fund, or should such user fees be narrowly circumscribed, allocated only for the erection and maintenance of highways and harbours? On this second-order finance question, Smith is also clear. If the revenue generated by tolls and port-duties were to go into the general fund, the government will most likely try to squeeze too much revenue out of its highways and harbours, and such a move would be counter-productive and self-defeating because high tolls and port-duties might have the effect of reducing commerce instead of promoting it:

“… if the tolls which are levied at the turnpikes should ever be considered as one of the resources for supplying the exigencies of the state, they would certainly be augmented as those exigencies were supposed to require…. But the turnpike tolls being continually augmented in this manner, instead of facilitating the inland commerce of the country as at present, would soon become a very great incumbrance upon it.” (WN, V.i.d.12; my emphasis)

Now, what about “those public works which are of such a nature that they cannot afford any revenue for maintaining themselves, but of which the conveniency is nearly confined to some particular place or district”? (WN, V.i.d.18) That is, what about small-scale or “local” public goods that do not generate any revenue, such as street lamps or traffic signals? Yet again, Smith’s answer is crystal clear: small-scale public works that benefit a local community should be erected, maintained, and paid for by a local or municipal government unit:

“Even those public works which are of such a nature that they cannot afford any revenue for maintaining themselves, but of which the conveniency is nearly confined to some particular place or district, are always better maintained by a local or provincial revenue, under the management of a local or provincial administration, than by the general revenue of the state, of which the executive power must always have the management. Were the streets of London to be lighted and paved at the expence of the treasury, is there any probability that they would be so well lighted and paved as they are at present, or even at so small an expence? The expence, besides, instead of being raised by a local tax upon the inhabitants of each particular street, parish, or district in London, would, in this case, be defrayed out of the general revenue of the state, and would consequently be raised by a tax upon all the inhabitants of the kingdom, of whom the greater part derive no sort of benefit from the lighting and paving of the streets of London.” (WN, V.i.d.18; my emphasis)

The Scottish philosopher then concludes the first half of Article 1 (WN, V.i.d.1-19) with a general observation about the relative scale or magnitude of local versus national government corruption. To paraphrase Adam Smith, all government units are corrupt, but some government units are more corrupt than others:

“The abuses which sometimes creep into the local and provincial administration of a local and provincial revenue, how enormous soever they may appear, are in reality, however, almost always very trifling in comparison of those which commonly take place in the administration and expenditure of the revenue of a great empire. They are, besides, much more easily corrected.” (WN, V.i.d.19; my emphasis)

But as they say in those low-budget but mildly-entertaining late-night TV infomercials: But wait, there’s more! For Adam Smith has yet many more important things to say about “Public Works and Institutions [that] are necessary for facilitating particular Branches of Commerce” in the second half of Article 1: WN, V.i.e.1-40. (To be continued …)

“The third and last duty of the sovereign or commonwealth is that of erecting and maintaining those public institutions and those public works, which, though they may be in the highest degree advantageous to a great society, are, however, of such a nature that the profit could never repay the expence to any individual or small number of individuals, and which it therefore cannot be expected that any individual or small number of individuals should erect or maintain.” (WN, V.i.c.1)

Adam Smith surveys the third and last major duty of government in Part 3 of Chapter 1 of Book V of The Wealth of Nations (available here or here): the provision of public goods. More specifically, Smith identifies two major types of public goods and public institutions:

A. Public works “facilitating the commerce of the society” (V.i.c.2), and

B. Education or public institutions “promoting the instruction of the people” (ibid.).

The Scottish philosopher further subdivides these two major categories — public works and education — into four distinct subcategories: transportation infrastructure (e.g. roads, bridges, street lamps, etc.), overseas military bases (e.g. forts and garrisons) to protect the property of British companies doing business overseas, education of youth (school age and college age), and adult education. As a result, Part 3 of this chapter has the following structure:

1. Article 1 is devoted to transportation infrastructure (V.i.d) and overseas military bases (V.i.e);
2. Article 2 is devoted to the education of school-age children and college-age youth (V.i.f); and
3. Article 3 is devoted to adult education or to “institutions for the instruction of people of all ages” (V.i.g).

Before proceeding any further, however, it is worth asking, If Adam Smith were alive today, what else would he add to his laundry list of public goods? Smith would no doubt add such essential public works as clean drinking water, sewage systems, and traffic signals, but what about “public art” or “affordable housing” or “universal health care” or a “universal basic income”? Do those more ambitious public programs count as public goods? With this key question in mind, I will proceed to Article 1 of Part 3 of Chapter 1 of Book V of Smith’s magnum opus in my next few posts.

An Inquiry into the Nature and Causes of the Wealth of Nations was published on this day (9 March) in 1776. I will resume my survey of Smith’s magnum opus in my next post; in the meantime, to mark this occasion, check out Ronald Coase‘s 1976 essay on “Adam Smith’s View of Man” (available here or here), Maria Pia Paganelli‘s previous tribute to Smith’s magnum opus, as well as the Smith installment of the late Professor Michael Sugrue‘s legendary lecture series on “The Great Minds of the Western Intellectual Tradition”:

Bonus link: “An Inquiry into the Nature and Causes of the Wealth of Nations, first edition”

To mark the 250th anniversary of the publication of The Wealth of Nations (9 March 1776) and Adam Smith’s timeless defense of natural liberty, I am reposting Shervin Hajipour’s haunting anthem “Baraye”, which he composed in response to his government’s brutal repression of the 2022 Mahsa Amini protests in Iran. As the child of Cuban exiles, the lyrics of this poetic protest song resonate with me. May the sons and daughters of Iran — and Cuba! — both be free of their religious and secular tyrants soon!

Alternative title: Adam Smith, an Enlightened legal realist

Among other things, Plato’s Republic contains a dialogue between Socrates and Thrasymachus about the nature of justice. Most educated people already know who Socrates was, but who was Thrasymachus? By all accounts, he was a 5th-century BC sophist and teacher of rhetoric. In his dialogue with Socrates in Book 1 of Plato’s Republic (see lines 336b to 354c, available here), Thrasymachus famously defines “justice” as nothing more than “the interest of the stronger.” In other words, justice is merely a convention imposed by the powerful to protect their own interests.

For his part, Adam Smith appears to take sides with Thrasymachus in Part 2 of Chapter 1 of Book V of The Wealth of Nations. Here, Smith surveys the second duty of government, “that of protecting, as far as possible, every member of the society from the injustice or oppression of every other member of it, or the duty of establishing an exact administration of justice ….” (WN, V.i.b.1) But as we shall see below, Smith does not paint an idyllic or idealized picture of law, for he has no illusions about the true nature of justice. Instead, the Scottish philosopher makes the following five timeless and realist points about law and government:

POINT #1 — THE ORIGINS OF LAW AND GOVERNMENT: PROPERTY RIGHTS

First off, government becomes necessary when people start to accumulate private property: “The acquisition of valuable and extensive property, therefore, necessarily requires the establishment of civil government. Where there is no property, or at least none that exceeds the value of two or three days labour, civil government is not so necessary.” (WN, V.i.b.2; my emphasis)

POINT #2 — LAW AND GOVERNMENT ARE THE INTEREST OF THE STRONGER

Secondly, Smith takes a Thrasymachean stance towards government: “Civil government supposes a certain subordination. But as the necessity of civil government gradually grows up with the acquisition of valuable property, so the principal causes which naturally introduce subordination gradually grow up with the growth of that valuable property.” (V.i.b.3; my emphasis) Smith leaves no room for doubt on this crucial point, for he further writes: “Civil government, so far as it is instituted for the security of property, is in reality instituted for the defence of the rich against the poor, or of those who have some property against those who have none at all.” (V.i.b.12; my emphasis)

POINT #3 — JUSTICE IS NOT FREE

There are no free lunches in law: “Justice, however, never was in reality administered gratis in any country.” (V.i.b.18; my emphasis)

POINT #4 — THE COST OF JUSTICE SHOULD BE PAID BY FIXED USER-FEES

Unlike Socrates or even Thrasymachus, Smith explores the economics of the administration of justice, and he proposes charging litigants fixed fees when they take their disputes to court:

“The whole expence of justice, too, might easily be defrayed by the fees of court; and, without exposing the administration of justice to any real hazard of corruption, the public revenue might thus be discharged from a certain, though, perhaps, but a small incumbrance. It is difficult to regulate the fees of court effectually where a person so powerful as the sovereign is to share in them, and to derive any considerable part of his revenue from them. It is very easy where the judge is the principal person who can reap any benefit from them. The law can very easily oblige the judge to respect the regulation, though it might not always be able to make the sovereign respect it. Where the fees of court are precisely regulated and ascertained, where they are paid all at once, at a certain period of every process, into the hands of a cashier or receiver, to be by him distributed in certain known proportions among the different judges after the process is decided, and not till it is decided, there seems to be no more danger of corruption than where such fees are prohibited altogether. Those fees, without occasioning any considerable increase in the expence of a law-suit, might be rendered fully sufficient for defraying the whole expence of justice.” (V.i.b.20; my emphasis)

POINT #5 — JUDGES MUST BE INDEPENDENT

Because law and government are the interest of the stronger, the judicial branch of government must be independent from the other branches, especially the executive:

“When the judicial is united to the executive power, it is scarce possible that justice should not frequently be sacrificed to what is vulgarly called polities. The persons entrusted with the great interests of the state may, even without any corrupt views, sometimes imagine it necessary to sacrifice to those interests the rights of a private man. But upon the impartial administration of justice depends the liberty of every individual, the sense which he has of his own security. In order to make every individual feel himself perfectly secure in the possession of every right which belongs to him, it is not only necessary that the judicial should be separated from the executive power, but that it should be rendered as much as possible independent of that power. The judge should not be liable to be removed from his office according to the caprice of that power. The regular the good-will or even upon the good œconomy payment of his salary should not depend upon of that power.” (V.i.b.25; my emphasis)

Nota bene: this Monday (9 March) is the 250th anniversary of the publication of The Wealth of Nations, so my next two blog posts will mark this occasion with some fun surprises. Then, on Tuesday (10 March), we will proceed to Part 3 of Chapter 1 of Book V of Smith’s magnum opus, to the third and last of the three duties of government: the provision of public goods.

Nota Bene: Adam Smith turns his attention to the role of government, law, and public finance in the fifth and final section of The Wealth of Nations (available here). In brief, Book V contains three chapters and is structured as follows: Chapter 1 surveys the essential duties that government must perform and thus the expenses it must incur in order to carry out these duties, while Chapters 2 and 3 survey the main methods a government can use to finance these expenses: taxes and public debt. Chapter 1, in turn, is divided into three separate parts, with each part corresponding to the one of the three main duties of government: national defense (part 1), the administration of justice (part 2), and public works (part 3). Today, I will discuss Smith’s thoughts on national defense (WN, V.i.a).

Are standing armies dangerous to liberty, as Alexander Hamilton warned, or do standing armies somehow end up promoting liberty? Adam Smith answers this key question in Part 1 of Chapter 1 of Book V of The Wealth of Nations as follows:

1. The noblest of all arts. First off, Smith says that national defense is not only the “first duty” of government (V.i.a.1); it is also “the noblest of all arts.” (V.i.a.14) Why the noblest? Because a strong and well-trained military protects people who are incapable of protecting themselves: “An industrious, and upon that account a wealthy nation, is of all nations the most likely to be attacked; and unless the state takes some new measures for the public defence, the natural habits of the people render them altogether incapable of defending themselves.” (V.i.a.15)
2. Standing armies > citizen militias. Although Smith is a champion of natural liberty, in this chapter he gives three irrefutable reasons why professional and permanent standing armies are hands-down “superior” over amateur and part-time citizen militias: training, reaction time, and the division of labor. (See especially WN, V.i.a.28-40.) After all, when the bullets start flying, who is more likely to stand their ground and fight: well-trained soldiers who are used to following the orders of a central command, or a bunch of rank amateurs under dispersed and local commanders? Also, in times of war or invasion, time itself is of the essence, and a standing army is ready and prepared to react to any emergency; a militia, by contrast, must be assembled and trained before it can join the field of battle.
3. Standing armies and liberty. But Smith’s most original and surprising observation appears in Paragraph 41 of Part 1 of Chapter 1 of Book V. Here, the Scottish philosopher turns the main argument against a standing army — that it will be used by the government to quash dissent at home — on its head(!):

“Men of republican principles have been jealous of a standing army as dangerous to liberty. It certainly is so wherever the interest of the general and that of the principal officers are not necessarily connected with the support of the constitution of the state. The standing army of Caesar destroyed the Roman republic. The standing army of Cromwell turned the Long Parliament out of doors. But where the sovereign is himself the general, and the principal nobility and gentry of the country the chief officers of the army, where the military force is placed under the command of those who have the greatest interest in the support of the civil authority, because they have themselves the greatest share of that authority, a standing army can never be dangerous to liberty. On the contrary, it may in some cases be favourable to liberty. The security which it gives to the sovereign renders unnecessary that troublesome jealousy, which, in some modern republics, seems to watch over the minutest actions, and to be at all times ready to disturb the peace of every citizen. Where the security of the magistrate, though supported by the principal people of the country, is endangered by every popular discontent; where a small tumult is capable of bringing about in a few hours a great revolution, the whole authority of government must be employed to suppress and punish every murmur and complaint against it. To a sovereign, on the contrary, who feels himself supported, not only by the natural aristocracy of the country, but by a well-regulated standing army, the rudest, the most groundless, and the most licentious remonstrances can give little disturbance. He can safely pardon or neglect them, and his consciousness of his own superiority naturally disposes him to do so. That degree of liberty which approaches to licentiousness can be tolerated only in countries where the sovereign is secured by a well-regulated standing army….” (WN, V.i.a.41; my emphasis)

Notice, however, how Smith qualifies his libertarian defense of standing armies with the words “in some cases.” So, how can we distinguish between those standing armies that expand the circle of liberty at home and those that reduce it? Between, for example, the armies of the two Koreas? Regardless, we will proceed to Part 2 of Chapter 1 of Book V in my next post.

Adam Smith sums up what is wrong with mercantilism and protectionism in two sentences at the very end of Book IV of The Wealth of Nations:

“It is thus that every system which endeavours, either by extraordinary encouragements [i.e. subsidies or bounties] to draw towards a particular species of industry a greater share of the capital of the society than what would naturally go to it, or, by extraordinary restraints [i.e. regulation or taxes], force from a particular species of industry some share of the capital which would otherwise be employed in it, is in reality subversive of the great purpose which it means to promote. It retards, instead of accelerating, the progress of the society towards real wealth and greatness; and diminishes, instead of increasing, the real value of the annual produce of its land and labour.” (WN, IV.ix.50)

The Scottish philosopher then concludes Book IV of his magnum opus with a ringing defense of “the obvious and simple system of natural liberty”:

“All systems either of preference or of restraint, therefore, being thus completely taken away, the obvious and simple system of natural liberty establishes itself of its own accord. Every man, as long as he does not violate the laws of justice, is left perfectly free to pursue his own interest his own way, and to bring both his industry and capital into competition with those of any other man, or order of men. The sovereign is completely discharged from a duty, in the attempting to perform which he must always be exposed to innumerable delusions, and for the proper performance of which no human wisdom or knowledge could ever be sufficient; the duty of superintending the industry of private people, and of directing it towards the employments most suitable to the interest of the society.” (WN, IV.ix.51)

So, when, if ever, is the heavy hand of state intervention in the economy justified? Smith tells us when at the end of Book IV:

“According to the system of natural liberty, the sovereign has only three duties to attend to; three duties of great importance, indeed, but plain and intelligible to common understandings: first, the duty of protecting the society from violence and invasion of other independent societies; secondly, the duty of protecting, as far as possible, every member of the society from the injustice or oppression of every other member of it, or the duty of establishing an exact administration of justice; and, thirdly, the duty of erecting and maintaining certain public works and certain public institutions which it can never be for the interest of any individual, or small number of individuals, to erect and maintain; because the profit could never repay the expense to any individual or small number of individuals, though it may frequently do much more than repay it to a great society.” (WN, IV.ix.51)

There are thus, for Smith, but three duties of government: national defense, the administration of justice, and the provision of other public goods. He will expound on the scope and substance of these three essential public duties in the fifth and final part of The Wealth of Nations, Book V. Suffice it to say, we will turn to Book V in my next post.

Adam Smith concludes Book IV of his magnum opus with a critical survey of one of the leading schools of political economy of his day (the Age of Enlightenment), that of the French économistes led by the incomparable royal doctor François Quesnay. In brief, if it took the Scottish philosopher all of eight lengthy chapters to survey and refute the main tenets of the so-called “mercantile system” and the doctrine of the balance of trade (or what I have been referring to as “mercantilism/protectionism” or “MP”), Smith is able to dispose of the system of his colleague and friend, Quesnay, in but a single chapter, Chapter 9 of Book IV of The Wealth of Nations.

Although Adam Smith concedes that the French économistes were right about many things — for example, they opposed mercantilist regulations and defended free trade and minimal government interference in the economy — Smith smells a rat: Doctor Quesnay and his followers committed a major theoretical blunder, one that undermined their entire economic theory. What was this fatal fallacy? Smith finally gets around to telling us in Paragraph 29 of this chapter: “The capital error of this system, however, seems to lie in its representing the class of artificers, manufacturers, and merchants as altogether barren and unproductive.” (WN, IV.ix.29; my emphasis)

Say what?!?!

The talented doctor Quesnay had even built and refined a beautiful macro-economic model, the inscrutable Tableau économique (pictured below) or what Smith refers to as “the Œconomical Table” (WN, IV.ix27), to prove this fallacious observation. In summary, Quesnay’s model consists of an idealized and self-contained economic system consisting of “three classes” or categories of economic actors, three Weberian “ideal types”, so to speak: (1) landowners, (2) artisans & merchants, and (3) farmers. To cut to the chase, what Quesnay’s model purports to show is that agriculture — and only agriculture — is a “productive” activity! Why? Because farmers produce a physical surplus of goods (e.g. grain) exceeding their costs of production. Artisans and merchants, by contrast, consume as much value in food and raw materials as they produce, thus creating no net gain for society. Manufacturing, for example, merely transforms existing raw materials; it does not add new intrinsic value to the nation’s wealth; while commerce (i.e. the buying and selling of raw materials and manufactured goods) merely moves existing sources of wealth around instead of creating new wealth. (See WN, IV.ix.13.)

Although Smith carefully and patiently picks apart Quesnay’s egregious economic fallacy in Paragraphs 30 to 37 of Chapter 9 of Book IV of his magnum opus, Smith graciously concedes that Quesnay’s system, “with all its imperfections is, perhaps, the nearest approximation to the truth that has yet been published upon the subject of political œconomy ….” (WN, IV.ix.38) Why? Because Quesnay and his disciples got two big things right:

“Though in representing the labour which is employed upon land as the only productive labour, the notions which it inculcates are perhaps too narrow and confined; yet in representing the wealth of nations as consisting, not in the unconsumable riches of money, but in the consumable goods annually reproduced by the labour of the society, and in representing perfect liberty as the only effectual expedient for rendering this annual reproduction the greatest possible, its doctrine seems to be in every respect as just as it is generous and liberal.” (WN, IV.ix.38)

Be that as it may, there is a larger lesson in this chapter: beware of grandoise systems, complex models, and ambitious blueprints that require absolute perfection. They are like little castles built of sand — they will crumble as soon as they make contact with the waves of the real world. For Smith, it was their fetish for perfection that led Quesnay and his economic sect astray:

“Some speculative physicians seem to have imagined that the health of the human body could be preserved only by a certain precise regimen of diet and exercise, of which every, the smallest, violation necessarily occasioned some degree of disease or disorder proportioned to the degree of the violation. Experience, however, would seem to show that the human body frequently preserves, to all appearances at least, the most perfect state of health under a vast variety of different regimens; even under some which are generally believed to be very far from being perfectly wholesome…. Mr. Quesnai, who was himself a physician, and a very speculative physician, seems to have entertained a notion of the same kind concerning the political body, and to have imagined that it would thrive and prosper only under a certain precise regimen, the exact regimen of perfect liberty and perfect justice. He seems not to have considered that, in the political body, the natural effort which every man is continually making to better his own condition is a principle of preservation capable of preventing and correcting, in many respects, the bad effects of a political œconomy, in some degree, both partial and oppressive. Such a political œconomy, though it no doubt retards more or less, is not always capable of stopping altogether the natural progress of a nation towards wealth and prosperity, and still less of making it go backwards. If a nation could not prosper without the enjoyment of perfect liberty and perfect justice, there is not in the world a nation which could ever have prospered.” (WN, IV.ix.28; my emphasis)

In other words, Adam Smith is, above all, a pragmatist: we must take economic and government actors as they are — warts and all — and not as we would like them to be!

“Though the encouragement of exportation and the discouragement of importation are the two great engines by which the mercantile system proposes to enrich every country, yet with regard to some particular commodities it seems to follow an opposite plan: to discourage exportation and to encourage importation. Its ultimate object, however, it pretends, is always the same, to enrich the country by an advantageous balance of trade.” (WN, IV.viii.1)

Thus begins Book IV, Chapter 8 of The Wealth of Nations (available here). Adam Smith not only concludes his epic takedown of the mercantile/protectionist system — a compelling and cogent critique that applies to our demagogic and crony capitalist trade policies of today — it is also here where Smith’s magnum opus moves from mere description into a full-blown stinging and timeless normative critique of corporate crony capitalism.

To begin, the Scottish philosopher smuggles in (so to speak) an egalitarian normative premise in Paragraph 30 of Chapter 8:

“To hurt in any degree the interest of any one order of citizens, for no other purpose but to promote that of some other, is evidently contrary to that justice and equality of treatment which the sovereign owes to all the different orders of his subjects.” (WN, IV.viii.30)

But according to Smith, mercantile and protectionist policies are rigged in favor of the “rich and powerful”:

“It is the industry which is carried on for the benefit of the rich and the powerful that is principally encouraged by our mercantile system. That which is carried on for the benefit of the poor and the indigent is too often either neglected or oppressed.” (WN, IV.viii.4)

Worse yet, mercantile and protectionist policies not only impose an economic cost on the general public; they also impose a political cost as well:

“It is unnecessary, I imagine, to observe how contrary such regulations are to the boasted liberty of the subject, of which we affect to be so very jealous; but which, in this case, is so plainly sacrificed to the futile interests of our merchants and manufacturers.” (WN, IV.viii.47; my emphasis)

It is in light of these normative admonitions that Adam Smith forcefully and categorically condemns well-organized and well-connected merchants and manufactures for “extorting” (IV.viii.4) mercantile and protectionist policies from the government in order to enrich themselves:

“Consumption is the sole end and purpose of all production; and the interest of the producer ought to be attended to only so far as it may be necessary for promoting that of the consumer. The maxim is so perfectly self evident that it would be absurd to attempt to prove it. But in the mercantile system the interest of the consumer is almost constantly sacrificed to that of the producer; and it seems to consider production, and not consumption, as the ultimate end and object of all industry and commerce.” (WN, IV.viii.49; my emphasis)

“But in the system of laws which has been established for the management of our [North] American and West Indian colonies, the interest of the home consumer has been sacrificed to that of the producer with a more extravagant profusion than in all our other commercial regulations. A great empire has been established for the sole purpose of raising up a nation of customers who should be obliged to buy from the shops of our different producers all the goods with which these could supply them. For the sake of that little enhancement of price which this monopoly might afford our producers, the home consumers have been burdened with the whole expense of maintaining and defending that empire.” (WN, IV.viii.53; my emphasis)

“It cannot be very difficult to determine who have been the contrivers of this whole mercantile system; not the consumers, we may believe, whose interest has been entirely neglected; but the producers, whose interest has been so carefully attended to; and among this latter class our merchants and manufacturers have been by far the principal architects. In the mercantile regulations, which have been taken notice of in this chapter, the interest of our manufacturers has been most peculiarly attended to; and the interest, not so much of the consumers, as that of some other sets of producers, has been sacrificed to it.” (WN, IV.viii.54; my emphasis)

In short, Smith exposes once and for all the true villains of his story: corrupt crony capitalists, i.e. merchants and manufactures who manipulate the government in order to enrich themselves at the expense of consumers and the public at large! Any questions? (To be continued …)