prior probability

Nota bene: I credit my colleague and friend John Alcorn with the idea of a “negative invisible hand”.

As I mentioned in my previous post, Addition #11 of Adam Smith’s 1784 pamphlet provides many reasons why the herring bounty is a scam.

Reason #1. Opportunity costs.

We saw this argument in my previous post. In brief, the true cost of the herring bounty not only includes the actual amount of the subsidy/payout; it must also include the cost of the tax revenue not collected from the duty-free salt provided to the herring fisheries.

Reason #2. Goodhart’s law.

In what has to be one of the most memorable passages in Smith’s entire corpus of writings, Smith writes (my emphasis):

“Secondly, the bounty to the white-herring fishery is a tonnage bounty; and is proportioned to the burden of the ship, not to her diligence or success in the fishery; and it has, I am afraid, been too common for vessels to fit out for the sole purpose of catching, not the fish, but the bounty.” (Smith 1784, p. 19)

According to Smith, the herring bounty was based on the size of the ship (the “tonnage”), not on how hard the crew worked or how many fish they caught, as a result, ship owners built big ships and went out to sea just to collect the cash reward (“the bounty”) instead of doing the hard work of fishing! (Cf. Goodhart’s law: “When a measure becomes a target, it ceases to be a good measure.” Here, ship owners were able to rig the system because the fishing subsidy was based on the size of the ship rather than the amount of fish actually caught. In other words, all incentive systems will be gamed.)

Reason #3. Unseen costs.

Next, Smith identifies the hidden costs of the herring bounty. In addition to the lost tax revenues (see Reason #1 above), Smith explains how the fishing subsidy also harmed the local boating industry via a kind of negative invisible hand (my emphasis):

“Thirdly, the mode of fishing for which this tonnage bounty in the white-herring fishery has been given (by busses or decked vessels from twenty to eighty tons burden), seems not so well adapted to the situation of Scotland as to that of Holland, from the practice of which country it appears to have been borrowed. Holland lies at a great distance from the seas to which herrings are known principally to resort, and can, therefore, carry on that fishery only in decked vessels, which can carry water and provisions sufficient for a voyage to a distant sea. But the Hebrides or western islands, the islands of Shetland, and the northern and northwestern coasts of Scotland, the countries in whose neighbourhood the herring fishery is principally carried on, are everywhere intersected by arms of the sea, which run up a considerable way into the land, and which, in the language of the country, are called sea-lochs. It is to these sea-lochs that the herrings principally resort during the seasons in which they visit those seas; for the visits of this and, I am assured, of many other sorts of fish are not quite regular and constant. A boat fishery, therefore, seems to be the mode of fishing best adapted to the peculiar situation of Scotland, the fishers carrying the herrings on shore, as fast as they are taken, to be either cured or consumed fresh. But the great encouragement which a bounty of thirty shillings the ton gives to the buss fishery is necessarily a discouragement to the boat fishery, which, having no such bounty, cannot bring its cured fish to market upon the same terms as the buss fishery. The boat fishery, accordingly, which before the establishment of the buss bounty was very considerable, and is said have employed a number of seamen not inferior to what the buss fishery employs at present, is now gone almost entirely to decay.” (Id. at pp. 19-20)

In Scotland, herrings swim directly into the deep, protected bays near the coast or “sea-lochs”. (Pictured below, for example, are the sea lochs of Argyll.) Scotland’s geography thus makes local, small-boat fishing more efficient absent a tonnage subsidy. In Holland, by contrast, fish are far out in the deep ocean, so the Dutch need large ships (called “busses”) with extra supplies. Since the herring bounty was based on the size of the ship, the big ships were able to outcompete the small boats, and a once-thriving local boat industry was ruined. How much harm was caused? Alas, as Smith explains, this harm was unseen by the government:

“Of the former extent, however, of this now ruined and abandoned fishery, I must acknowledge that I cannot pretend to speak with much precision. As no bounty was paid upon the outfit of the boat fishery, no account was taken of it by the officers of the customs or salt duties.” (Id. at p. 20)

Reason #4. Perverse price effects.

Here, Smith explains why the herring bounty may have actually ended up increasing the cost of this staple to the public (my emphasis):

“Fourthly, in many parts of Scotland, during certain seasons of the year, herrings make no inconsiderable part of the food of the people. A bounty, which tended to lower their price in the home market, might contribute a good deal to the relief of a great number of our fellow-subjects, whose circumstances are by no means affluent. But the herring buss bounty contributes to no such good purpose. It has ruined the boat fishery, which is, by far, the best adapted for the supply of the home market, and the additional bounty of 2s. 8d. [two shillings and eightpence] the barrel upon exportation carries the greater part, more than two-thirds, of the produce of the buss fishery abroad. Between thirty and forty years ago, before the establishment of the buss bounty, fifteen shillings the barrel, I have been assured, was the common price of white herrings. Between ten and fifteen years ago, before the boat fishery was entirely ruined, the price is said to have run from seventeen to twenty shillings the barrel. For these last five years, it has, at an average, been at twenty-five shillings the barrel. This high price, however, may have been owing to the real scarcity of the herrings upon the coast of Scotland. I must observe, too, that the cask or barrel, which is usually sold with the herrings, and of which the price is included in all the foregoing prices, has, since the commencement of the American war, risen to about double its former price, or from about three shillings to about six shillings. I must likewise observe that the accounts I have received of the prices of former times have been by no means quite uniform and consistent; and an old man of great accuracy and experience has assured me that, more than fifty years ago, a guinea was the usual price of a barrel of good merchantable herrings; and this, I imagine, may still be looked upon as the average price.” (Id. at pp. 20-21)

Although Smith entertains other possible reasons why the price of herrings may have gone up (e.g. overfishing and an increase packaging costs), he concludes that, at best, the herring bounty has had no effect on the price of herrings, “All accounts, however, I think, agree that the price has not been lowered in the home market in consequence of the buss bounty.” (Id. at 21)

Reason #5. Adverse selection.

Lastly, Smith makes an original “adverse selection” argument against the herring bounty. According to Smith, the bounty encouraged “rash undertakers” to enter the fishing industry for sole purpose of milking the government (again, my emphasis):

“When the undertakers of fisheries, after such liberal bounties have been bestowed upon them, continue to sell their commodity at the same, or even at a higher price than they were accustomed to do before, it might be expected that their profits should be very great; and it is not improbable that those of some individuals may have been so. In general, however, I have every reason to believe they have been quite otherwise. The usual effect of such bounties is to encourage rash undertakers to adventure in a business which they do not understand, and what they lose by their own negligence and ignorance more than compensates all that they can gain by the utmost liberality of government. In 1750, by the same act, which first gave the bounty of thirty shillings the ton for the encouragement of the white-herring fishery (the 23 Geo. II. chap. 24.), a joint-stock company was erected, with a capital of five hundred thousand pounds, to which the subscribers (over and above all other encouragements, the tonnage bounty just now mentioned, the exportation bounty of two shillings and eightpence the barrel, the delivery of both British and foreign salt duty free) were, during the space of fourteen years, for every hundred pounds which they subscribed and paid in to the stock of the society, entitled to three pounds a year, to be paid by the receiver-general of the customs in equal half-yearly payments. Besides this great company, the residence of whose governor and directors was to be in London, it was declared lawful to erect different fishing-chambers in all the different outports of the kingdom, provided a sum not less than ten thousand pounds was subscribed into the capital of each, to be managed at its own risk, and for its own profit and loss. The same annuity, and the same encouragements of all kinds, were given to the trade of those inferior chambers as to that of the great company. The subscription of the great company was soon filled up, and several different fishing-chambers were erected in the different outports of the kingdom. In spite of all these encouragements, almost all those different companies, both great and small, lost either the whole, or the greater part of their capitals; scarce a vestige now remains of any of them, and the white-herring fishery is now entirely, or almost entirely, carried on by private adventurers.” (Id. at pp. 21-22)

Again, we see Smith’s negative invisible hand in play. I will provide some closing thoughts on Smith’s critique of the herring bounty in my next post.

Happy birthday, Adela! (Also, my blog is 13 years old today, 6 July!) As I mentioned at the end of my previous Adam Smith post (see here), Smith devotes Addition #11 (pp. 13-22) of his 1784 pamphlet to the herring bounty. Here, he begins by making the best possible case for such bounties (my emphasis):

“Something like a bounty upon production … has been granted upon some particular occasions. The tonnage bounties given to the white-herring and whale fisheries may, perhaps, be considered as somewhat of this nature. They tend directly, it may be supposed, to render the goods cheaper in the home market than they otherwise would be.” (Smith 1784, p. 13)

Smith, however, lays his cards on the table. He concludes that such fishery bounties are a waste of money:

“In other respects their effects, it must be acknowledged, are the same as those of bounties upon exportation. By means of them a part of the capital of the country is employed in bringing goods to market, of which the price does not repay the cost together with the ordinary profits of stock.” (Id. at pp. 13-14)

The Scottish customs commissioner then tries to defend this subsidy on national security grounds (again, my emphasis):

“But though the tonnage bounties of those fisheries do not contribute to the opulence of the nation, it may perhaps be thought that they contribute to its defence by augmenting the number of its sailors and shipping. This, it may be alleged, may sometimes be done by means of such bounties at a much smaller expense than by keeping up a great standing navy, if I may use such an expression, in the same way as a standing army.” (Id. at p. 14)

Adam Smith, however, is not persuaded by this argument either. In fact, he concludes that the politicians who voted in favor of this subsidy policy have been fooled:

“Notwithstanding these favourable allegations, however, the following considerations dispose me to believe that, in granting at least one of these bounties, the legislature has been very grossly imposed upon.” (Id.)

In the remainder of Addition #11, Smith gives us four specific reasons why the herring bounty is counterproductive. First off, Smith claims “the herring buss bounty seems too large.” (Id.) Why too large? Because herring must be cured with salt, and the government delivered salt to the herring fish-curers without charging them the standard salt tax: “The salt with which these herrings are cured is sometimes Scotch and sometimes foreign salt, both which are delivered free of all excise duty to the fish-curers.” (Id. at pp. 14-15) As an aside, did Smith obtain this information about the provision of duty-free salt in his role as Commissioner of Scottish Customs and Salt Duties?

But in addition to waiving the salt tax, the government also paid fishermen a cash bonus (or “bounty”) for every barrel of herring they exported: “Upon every barrel of herrings exported there is, besides, a bounty of 2s. 8d. [i.e. two shillings and eightpence], and more than two-thirds of the buss caught herrings are exported.” (Id. at 15)

Next, Smith combines the lost tax revenue from the tax-free salt along with the cash export bounty and concludes that the government spent, in some cases, over one pound (£) to subsidize a single barrel of herrings!

“Put all these things together and you will find that, during these eleven years, every barrel of buss caught herrings, cured with Scotch salt when exported, has cost government 17s. 11 3/4 d. [80 pence]; and when entered for home consumption 14s. 3 3/4 d. [71.5 pence]; and that every barrel cured with foreign salt, when exported, has cost government 1l. 7s. 5 3/4 d. [£1.37]; and when entered for home consumption 1l. 3s. 9 3/4 d. [£1.19].” (Id.)

After making these careful but tedious calculations, Smith concludes that a barrel of herring sold for an average of about 21 shillings (one guinea): “The price of a barrel of good merchantable herrings runs from seventeen and eighteen to four and five and twenty shillings, about a guinea at an average.” (Id.) In other words, the total cost of the herring bounty was nearly equal to the actual market value of the fish! (See the figures in the indented passage quoted above.)

Before proceeding to his other three anti-subsidy arguments, Adam Smith dons his accountant’s cap, so to speak, and cross-checks his startling conclusion with the actual data. Here, Smith presents the relevant data in two tables. The first table (p. 16) shows the number of barrels of herrings caught as well as the bounties paid from the winter fishing season of 1771 to the winter fishing season of 1782, while the second table (p. 18) shows the number of bushels of foreign salt and Scots salt delivered duty-free to the herring fisheries during this same period of time (5 April 1771 to 5 April 1782). Nota bene: I will proceed to Smith’s three remaining anti-subsidy arguments in my next post.

🇨🇷 Greetings from under the volcano in La Fortuna, Costa Rica! 🇨🇷 According to Spotify (see here), this sexy song, by the 27-year-old Puerto Rican singer and songwriter Omar Courtz, is one of the most downloaded tunes in the Central American nation this week.

To my North American readers, happy 4th of July! In my previous post, we saw Adam Smith’s scathing critique of farm subsidies. (This critique appears in Additions #8 and #9 (pp. 10-12) of his 1784 pamphlet.) As it happens, the Scottish customs commissioner — recall that Smith had been serving as a royal customs official in Edinburgh since 1778 — picks up right where he left off in Addition #10 (p. 13). Here, Smith makes two further points about subsidies (“bounties”). First off, Smith launches a blistering attack on the “country gentlemen” (i.e. farmers) who have lobbied the government for farm subsidies:

“They loaded the public revenue with a very considerable expense; they imposed a very heavy tax upon the whole body of the people; but they did not, in any sensible degree, increase the real value of their own commodity; and by lowering somewhat the real value of silver, they discouraged in some degree, the general industry of the country, and, instead of advancing, retarded more or less the improvement of their own lands, which necessarily depends upon the general industry of the country.” (Smith 1784, p. 13) [*]

Next, Smith draws a general distinction between bounties upon exportation (i.e. subsidies designed to promote the exportation of the goods being subsidized) and bounties upon production (i.e. subsidies designed to promote local jobs):

“To encourage the production of any commodity, a bounty upon production, one should imagine, would have a more direct operation than one upon exportation. It would, besides, impose only one tax upon the people, that which they must contribute in order to pay the bounty. Instead of raising, it would tend to lower the price of the commodity in the home market; and thereby, instead of imposing a second tax upon the people, it might, at least, in part, repay them for what they had contributed to the first.” (Id.)

In other words, bounties designed to promote jobs should generate positive economic effects overall compared to bounties designed to promote exports. But Smith concludes Addition #10 with the following wry observation: “Bounties upon production, however, have been very rarely granted.” (Id.) But that said, there was at least one major “bounty upon production” in Britain at this time: the bounty for white-herring fish.

For his part, Smith was not only aware of this particular subsidy; he devotes 13 pages and 50-plus paragraphs of his 1784 pamphlet to this subject (Addition #11, pp. 13-22), where he shows how the herring bounty wastes taxpayer money, destroys local jobs, and increases food prices. I will therefore proceed to Addition #11 on Monday, 6 July (the 13th anniversary of this blog); in the meantime, the following questions are worth pondering: why do governments continue to subsidize production? (See, for example, the infographic pictured below.) Why has Adam Smith’s scathing critique of government subsidies fallen on deaf ears? (To be continued.)

* = This passage was placed at the end in paragraph 24 of Chapter 5 of Book IV of the third and subsequent editions of The Wealth of Nations, where Smith is discussing “our country gentlemen”.

Nota bene: Today’s post contains another installment of my multi-part review of Adam Smith’s 1784 pamphlet Additions and Corrections to the First and Second Editions of Dr. Adam Smith’s Inquiry into the Nature and Causes of the Wealth of Nations.

After exploring the markets for tobacco, textiles, and wine (see here), Smith devotes the next three “Additions and Corrections” (#7, #8, and #9) of his pamphlet to the market for wheat. More specifically, what was the cause of the gradual fall in the average price of grain, and what would be the net effect of giving grain farmers a bounty or subsidy? To begin, in Addition #7 Smith concludes, “It seems to be altogether impossible that the bounty could ever contribute to lower the price of grain.” (Smith 1784, p. 10) Instead, he draws a direct connection between the price of grain and the value of silver:

“It has happened in France, as well as in England, though in France there was, not only no bounty, but, till 1764, the exportation of corn was subjected to a general prohibition. This gradual fall in the average price of grain, it is probable, therefore, is ultimately owing neither to the one regulation nor to the other, but to that gradual and insensible rise in the real value of silver, which in the first book of this discourse, I have endeavoured to show has taken place in the general market of Europe, during the course of the present century.” (Smith 1784, p. 10)

Smith then explores the effects of farm subsidies in Addition #8. For starters, Smith restates the popular argument in favor of the “corn bounty”. According to this pro-subsidy argument, a bounty for the production of grain will increase the supply of grain in two ways (my emphasis):

“… first, by opening a more extensive foreign market to the corn of the farmer, it [a grain bounty] tends, they imagine, to increase the demand for, and consequently the production of, that commodity; and, secondly, by securing to him a better price than he could otherwise expect in the actual state of tillage, it [a grain bounty] tends, they suppose, to encourage tillage. This double encouragement must, they imagine, in a long period of years, occasion such an increase in the production of corn, as may lower its price in the home market, much more than the bounty can raise it, in the actual fate which tillage may, at the end of that period, happen to be in.” (Id.)

But then Smith explains why the logic of this pro-subsidy argument is totally wrong. Instead of lowering the price of grain in the home market, a bounty will have the opposite effect:

“I answer that whatever extension of the foreign market can be occasioned by the bounty, must, in every particular year, be altogether at the expence of the home market; as every bushel of corn which is exported by means of the bounty, and which would not have been exported without the bounty, would have remained in the home market to increase the consumption, and to lower the price of that commodity.” (Id. at pp. 10-11)

In other words, a corn bounty will encourage grain farmers to divert their grain to foreign markets; as a result, a bounty will lower (not increase) the supply of domestic grain and will thus increase (not lower) the price of grain to domestic consumers. Next, in one of the most original and penetrating passages of Smith’s entire magnum opus, Smith compares the corn bounty to a hidden tax. In fact, according to Smith, farm subsidies impose two hidden taxes on consumers:

“The corn bounty, it is to be observed, as well as every other bounty upon exportation, imposes two different taxes upon the people; first, the tax which they are obliged to contribute, in order to pay the bounty; and secondly, the tax which arises from the advanced price of the commodity in the home-market, and which, as the whole body of the people are purchasers of corn, must, in this particular commodity, be paid by the whole body of the people. In this particular commodity, therefore, this second tax is by much the heaviest of the two.” (Id. at p. 11)

Smith then illustrates his anti-subsidy argument with the following hypothetical example:

“Let us suppose that, taking one year with another, the bounty of five fillings upon the exportation of the quarter of wheat, raises the price of that commodity in the home-market, only sixpence the bushel, or four shillings the quarter, higher than it otherwise would have been in the actual state of the crop. Even upon this very moderate supposition, the great body of the people, over and above contributing the tax which pays the bounty of five fillings upon every quarter of wheat exported, must pay another of four shillings upon every quarter which they themselves consume. But, according to the very well informed author of the tracts upon the corn trade, the average proportion of the corn exported to that consumed at home, is not more than that of one to thirty-one. For every five shillings, therefore, which they contribute to the payment of the first tax, they must contribute six pounds four shillings to the payment of the second.” (Id.)

As a result, the true cost of the corn bounty will be borne by the poor, either directly or indirectly:

“So very heavy a tax upon the first necessary of life, must either reduce the subsistence of the labouring poor, or it must occasion some augmentation in their pecuniary wages, proportionable to that in the pecuniary price of their subsistence. So far as it operates in the one way, it must reduce the ability of the labouring poor to educate and bring up their children, and must, so far, tend to refrain the population of the country. So far as it operates in the other, it must reduce the ability of the employers of the poor, to employ so great a number as they might otherwise do, and must, so far, tend to restrain the industry of the country.” (Id. at pp. 11-12)

What about the effect of the corn bounty on grain farmers? Won’t the increase in the price of corn redound to the benefit of the grain farmers, the ostensible beneficiaries of the corn bounty? Smith addresses this question in Addition #9, and he concludes that the benefit to grain farmers will be negligible at best: “In the purchase of foreign commodities this enhancement in the price of corn may give them some little advantage. In that of homemade commodities it can give them none at all. And almost the whole expence of the farmer, and the far greater part of even that of the landlord, is in home-made commodities.” (Id. at p. 12)

As an aside, why do most economically-developed countries, including the U.S., continue to ignore Smith’s critique of farm subsidies? More generally, why do governments still favor farmers over consumers? Whatever the reason, Smith is not yet done with the subject of subsidies, for he will have much more to say about bounties in Additions #10, #11, and #12. (To be continued.)