Adam Smith’s digression on “the necessaries of life” (his term), which occurs in paragraphs 32 to 36 of Book IV, Chapter 2 of The Wealth of Nations, presents one of his most original and compelling arguments in favor of free trade. Here, Smith assumes for the sake of argument that excise taxes on necessary or essential goods have the effect of increasing the overall cost of labor and thus the cost of “all other commodities”:

“Whether taxes upon the necessaries of life, such as those in Great Britain upon soap, salt, leather, candles, &c. necessarily raise the price of labour, and consequently that of all other commodities, I shall consider hereafter, when I come to treat of taxes. Supposing, however, in the meantime, that they have this effect, and they have it undoubtedly …” (Wealth of Nations, IV.ii.33, emphasis added)

Because local taxes on essential goods have the aggregate effect of raising the price of all consumer goods, Smith describes how proponents of tariffs want to extend Smith’s second exception to free trade (see my previous post) to encompass all imports:

“This second limitation of the freedom of trade according to some people should, upon some occasions, be extended much farther than to the precise foreign commodities which could come into competition with those which had been taxed at home. When the necessaries of life have been taxed any country, it becomes proper, they pretend, to tax not only the like necessaries of life imported from other countries, but all sorts of foreign goods which can come into competition with anything that is the produce of domestic industry…. Subsistence, they say, becomes necessarily dearer in consequence of such taxes; and the price of labour must always rise with the price of the labourers’ subsistence. Every commodity, therefore, which is the produce of domestic industry, though not immediately taxed itself, becomes dearer in consequence of such taxes, because the labour which produces it becomes so. Such taxes, therefore, are really equivalent, they say, to a tax upon every particular commodity produced at home. In order to put domestic upon the same footing with foreign industry, therefore, it becomes necessary, they think, to lay some duty upon every foreign commodity equal to this enhancement of the price of the home commodities with which it can come into competition.” (Wealth of Nations, IV.ii.32, emphasis added)

The Scottish philosopher-economist, however, wisely rejects this pro-universal tariff position for two reasons. One is the knowledge problem. Although Smith concedes that local taxes on essential goods will have the overall effect of raising the price of all consumer goods, we don’t know by how much, or in the immortal words of Smith himself:

“… how far the general enhancement of the price of labour might affect that of every different commodity about which labour was employed could never be known with any tolerable exactness. It would be impossible, therefore, to proportion with any tolerable exactness the tax upon every foreign to this enhancement of the price of every home commodity.” (Wealth of Nations, IV.ii.34)

Smith’s other reason for rejecting universal tariffs is even more compelling. For Smith, “taxes upon the necessaries of life have nearly the same effect upon the circumstances of the people as a poor soil and a bad climate” (Wealth of Nations, IV.ii.35, emphasis added). Why do local taxes have the same effect as “the barrenness of the earth” and “the inclemency of the heavens” (IV.ii.36)? Because all three — taxes, barren land, and an adverse climate — make consumer goods more expensive: “Provisions are thereby rendered dearer in the same manner as if it required extraordinary labour and expence to raise them” (IVii.35).

So, what is to be done? For Smith, the answer is absolutely nothing — just leave people alone, and they will figure out what to do for themselves:

“To be left to accommodate, as well as they could, their industry to their situation, and to find out those employments in which, notwithstanding their unfavourable circumstances, they might have some advantage either in the home or in the foreign market, is what in both cases would evidently be most for their advantage.” (Wealth of Nations, IV.ii.35)

But in any case, as Smith correctly notes, the argument for universal tariffs is a logically absurd one:

“To lay a new tax upon them [consumers], because they are already overburdened with taxes [i.e. taxes on essential goods], and because they already pay too dear for the necessaries of life, to make them likewise pay too dear for the greater part of other commodities, is certainly a most absurd way of making amends.” (Ibid.)

Q.E.D.! But wait; there’s more. In the last part of Book IV, Chapter 2 of The Wealth of Nations (paragraphs 37 to 45), the father of economics identifies two additional exceptions to free trade, so I will turn my attention to these last two exceptions in my next post.