If you are looking for any further evidence that Adam Smith is, deep down, a pragmatist, then check out paragraph 30 of the last part of 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. The first three sentences of this paragraph describe three examples of temporary monopolies that are perfectly justified: copyrights, patents, and … wait for it … overseas trading companies like the East India Company! Or in the immortal words of Adam Smith:

“When a company of merchants undertake, at their own risk and expense, to establish a new trade with some remote and barbarous nation, it may not be unreasonable to incorporate them into a joint stock company, and to grant them, in case of their success, a monopoly of the trade for a certain number of years. It is the easiest and most natural way in which the state can recompense them for hazarding a dangerous and expensive experiment, of which the public is afterwards to reap the benefit. A temporary monopoly of this kind may be vindicated upon the same principles upon which a like monopoly of a new machine is granted to its inventor, and that of a new book to its author.” (Smith 1784, pp. 74-75)

Smith further adds that any military bases (“forts and garrisons”) built by overseas trading companies to protect their foreign investments should be expropriated by the home government (Britain):

“But upon the expiration of the term, the monopoly ought certainly to determine; the forts and garrisons, if it was found necessary to establish any, to be taken into the hands of government, their value to be paid to the company, and the trade to be laid open to all the subjects of the state.” (Smith 1784, p. 75)

Despite Smith’s concession in favor of certain types of temporary monopolies, Smith is adamantly opposed to perpetual monopolies. Smith provides two reasons why perpetual monopolies are bad and are never justified:

“By a perpetual monopoly, all the other subjects of the state are taxed very absurdly in two different ways: first, by the high price of goods, which, in the case of a free trade, they could buy much cheaper; and, secondly, by their total exclusion from a branch of business which it might be both convenient and profitable for many of them to carry on. It is for the most worthless of all purposes, too, that they are taxed in this manner.” (Smith 1784, p. 75)

But wait, there’s more! There’s an additional reason why perpetual monopolies are so bad. According to Smith, giving a company a perpetual monopoly will end up subsidizing, in Smith’s words, “the negligence, profusion, and malversation” of the employees of the company protected by such a perpetual monopoly:

“It is merely to enable the company to support the negligence, profusion, and malversation of their own servants, whose disorderly conduct seldom allows the dividend of the company to exceed the ordinary rate of profit in trades which are altogether free, and very frequently makes it fall even a good deal short of that rate.” (Smith 1784, p. 75)

Smith concludes his survey of East India Company with a general point about all joint stock companies that are engaged in the business of overseas trade. According to Smith, such joint stock companies cannot survive without a monopoly: “Without a monopoly, however, a joint stock company, it would appear from experience, cannot long carry on any branch of foreign trade.” (Id.) Why not? Because the directors and managers of large joint stock companies can’t respond to market conditions as quickly or astutely as smaller competitors can:

“To buy in one market, in order to sell, with profit, in another, when there are many competitors in both, to watch over, not only the occasional variations in the demand, but the much greater and more frequent variations in the competition, or in the supply which that demand is likely to get from other people, and to suit with dexterity and judgment both the quantity and quality of each assortment of goods to all these circumstances, is a species of warfare of which the operations are continually changing, and which can scarce ever be conducted successfully without such an unremitting exertion of vigilance and attention as cannot long be expected from the directors of a joint stock company.” (Smith 1784, pp. 75-76)

Smith then applies this general lesson to the specific example of East India Company:

“The East India Company, upon the redemption of their funds, and the expiration of their exclusive privilege, have right, by Act of Parliament, to continue a corporation with a joint stock, and to trade in their corporate capacity to the East Indies in common with the rest of their fellow-subjects. But in this situation, the superior vigilance and attention of private adventurers would, in all probability, soon make them weary of the trade.” (Smith 1784, p. 76)

Notice what Smith is doing here. He is describing is a kind of political-economic paradox, a classic catch-22 or “damned-if-do, damned-if-you don’t” situation. On the one hand, monopolies are doomed to fail because monopolies tend to produce “negligence, profusion, and malversation” on the part of employees. But at the same time, a joint stock company engaged in overseas trade cannot survive unless it is awarded a monopoly over that trade. Hence the catch 22!

Does this paradox have a solution? What is the ultimate lesson of the East India Company? The Smithian solution is to grant “temporary” monopolies, just like the we do for copyrights and patents. But how long should these each of these “temporary” monopolies last? That is, how temporary is temporary? Alas, Smith does not say.

Nota bene: We have now surveyed the first 30 of 40 paragraphs of the last part of Smith’s 1784 pamphlet. I will review the last 10 paragraphs (31 to 40) of his pamphlet and wrap up my Adam Smith series next week.