ADAM SMITH’S SECOND EXCEPTION TO FREE TRADE

“The second case, in which it will generally be advantageous to lay some burden upon foreign for the encouragement of domestic industry is, when some tax is imposed at home upon the produce of the latter. In this case, it seems reasonable that an equal tax should be imposed upon the like produce of the former.” (Wealth of Nations, IV.ii.31)

What Adam Smith is saying here is that “targeted tariffs” (my term) on specific imports are justified when equivalent domestically-produced goods (such as soap, salt, leather, and candles) are subject to local excise taxes, and the rationale for Smith’s second exception to free trade is to “leave the competition between foreign and domestic industry, after the tax, as nearly as possible upon the same footing as before it” (Wealth of Nations, IV.ii.31). Otherwise, certain imports would enjoy an artificial price advantage in the home market and “our merchants and manufacturers … will be undersold at home” (ibid.).

But at the same time, Smith limits the scope of this second exception in two ways. Specifically, (1) the tariffs allowed under this second exception should not be extended to all imports, only to the imports of those foreign goods whose local equivalents are taxed, and (2) the tariffs on those specific imports should not exceed whatever the local tax on domestic goods is. In the next four paragraphs of Book IV, Chapter 2 of The Wealth of Nations (paragraphs 32 to 36), Smith explains why his second exception to free trade should not be extended any further. These four paragraphs also contain a fascinating digression on the effect of local taxes on “the necessaries of life”, i.e. essential consumer goods like soap, salt, leather, and candles (see WN.IV.ii.33). Stay tuned: I will explore this important digression in my next post …