N.B.: To commemorate the 250th anniversary of the publication of The Wealth of Nations (9 March 1776), I will be posting my chapter-by-chapter reflections on Adam Smith’s timeless magnum opus on my blog.

What’s better: bilateral or multilateral trade agreements? Adam Smith scrutinizes bilateral trade treaties in the first half of Chapter 6 of Book IV of The Wealth of Nations. More specifically, he singles out the Methuen Commercial Treaty of 1703 between the kingdoms of England and Portugal in which England agreed to reduce its duties (taxes) on wines from Portugal in exchange for Portugal opening up its market to English textiles. (For more information about this historic treaty, see here and here.) Although mercantilists celebrated this treaty “as a masterpiece of the commercial policy of England” (WN, IV.vi.8), Smith the skeptic pushes back. But his argument in this chapter is a subtle one: it’s not that these types of treaties are “bad” in some absolute sense. Instead, Smith’s critique is that a country that negotiates selective or bilateral trade treaties ends up leaving money on the table, so to speak:

“Such treaties, however, though they may be advantageous to the merchants and manufacturers of the favoured, are necessarily disadvantageous to those of the favouring country. A monopoly is thus granted against them to a foreign nation; and they must frequently buy the foreign goods they have occasion for dearer than if the free competition of other nations was admitted. That part of its own produce with which such a nation purchases foreign goods must consequently be sold cheaper, because when two things are exchanged for one another, the cheapness of the one is a necessary consequence, or rather the same thing with the dearness of the other. The exchangeable value of its annual produce, therefore, is likely to be diminished by every such treaty…. Even the favouring country, therefore, may still gain by the trade, though less than if there was a free competition.” (WN, IV.vi.6)

In other words, although he concedes that English textile companies are able to sell more textiles to Portugal than they would have in the absence of the treaty, his larger point is that England as a country would have been even more better off overall if she had opened her markets to all foreign countries instead of negotiating selective or bilateral trade treaties. The gains to consumers from free trade outweigh the gains from English textile companies under the 1703 Methuen Treaty. As such, the end result of this treaty was to line the pockets of English wine merchants and English textile manufactures at the expense of the general public.

Although Chapter 6 of Book IV of Smith’s magnum opus is titled “Of Treaties of Commerce”, the Scottish philosopher changes gears (so to speak) in the second half of this chapter (Paragraphs 16-32). There, he takes direct aim (yet again!) at his true target: the “silly” doctrine of the balance of trade. (To be continued …)