Studying the Wealth of Nations (Part 6)

The Invisible Hand Finally Appears

This is the sixth part of a weekly project marking the 250th anniversary of Adam Smith’s Wealth of Nations. You can find the fifth installment here.

[Update: I am grateful to a commenter on this post who alerted me to an article, found here, questioning the standard reading of WoN that Smith supported the Navigation Acts as discussed below.]

In the concluding minutes of our class last week, Professor Boudreaux gave some insight into the remainder of The Wealth of Nations. Books IV and V, he explained, cover the topics that Adam Smith first set out to explain and, as such, they contain his strongest and most impassioned arguments. Naturally, this is where he dives deep into trade.

Now that I’ve read the first half of The Wealth of Nations, I am less surprised than I would have otherwise been to find that Smith was much more pragmatic than dogmatic on trade policy. That’s not to say he wasn’t principled or ardently pro–free trade; he continues his disapproval of monopoly-granting privileges, questions the political effectiveness of duties as a remedy, and finally invokes his long-awaited “invisible hand.”

But he also acknowledges situations in which prohibitions on trade are justified, such as national defense, or at least worth serious consideration. In short, he is not the evangelist of “free trade always” that he is often made out to be.

What emerges from these early chapters of Book IV, then, is not a blanket rejection of trade restrictions, but a presumption against them—one rooted in Smith’s understanding of incentives, knowledge, and political power.

The Invisible Hand and the Use of Knowledge in Society

One of the first points that Smith makes is that prohibitions on trade cannot increase overall economic output: “No regulation of commerce can increase the quantity of industry in any society beyond what its capital can maintain.” Such regulations can only redirect resources to other ends, which necessarily reduces total output.

Why? Because the owner of capital, seeking what is in his own interest, is already “exerting himself to find out the most advantageous employment” of that capital—whatever will be most profitable to him. By doing so, he produces what is most valuable to society, supporting “domestick industry,” without any deliberate intention of serving the public good. Thus, it is as if that individual were “led by an invisible hand to promote an end which was no part of his intention.”

Herein lies the central problem with protectionism: it is the individual, not the politician or bureaucrat, who is best positioned to judge the proper uses of his capital:

The statesman, who should attempt to direct private people in what manner they ought to employ their capitals, would not only load himself with a most unnecessary attention, but assume an authority which could safely be trusted, not only to no single person, but to no council or senate whatever, and which would nowhere be so dangerous as in the hands of a man who had folly and presumption enough to fancy himself fit to exercise it.

In effect, the problem with protectionism is a knowledge problem—the same problem faced by central planning more broadly that F.A. Hayek would highlight nearly 170 years later in “The Use of Knowledge in Society.”

When Restrictions on Trade Are Justified

That is not to say that Smith was a purist on trade or that he never allowed exceptions to the rule of free trade. On the contrary, he considers several in Book IV, two of which he claims are “generally advantageous.”

First is national defense. Given the period and its geography, Great Britain’s defense relied heavily on its navy. To promote the number of sailors and ships necessary for that defense, Smith endorsed the Navigation Acts—a series of seventeenth-century maritime and cabotage restrictions that bear some resemblance to the modern Jones Act in the United States. In his view, this was “perhaps, the wisest of all the commercial regulations of England.” Defense, he argued, is of much more importance than opulence.

The second exception arises when there is a domestic tax on a particular commodity. In that case, a duty or tariff on similar imported goods may be reasonable to equalize tax treatment. Unlike his position on national defense, however, Smith goes to great lengths to show how easily this justification can be abused.

He notes that some would argue domestic taxes increase the cost of subsistence, causing laborers to demand higher wages. This would raise the price of every domestically produced commodity, not just those subject to the original tax. To equalize treatment between domestic and foreign industry, they conclude, “it becomes necessary… to lay some duty upon every foreign commodity.”

Smith offers two rebuttals. First, it was nearly impossible to determine how much wages have increased as a direct result of particular taxes. Second, it is contradictory to impose new taxes in order to compensate for the burden of existing ones:

To lay a new tax upon them, because they are already overburdened with taxes, and because they already pay too dear for the necessaries of life… is certainly a most absurd way of making amends.

The existence of one tax does not justify the imposition of a second. It’s safe to say that Smith did not believe those tariffs would make Britain great again.

When Prohibitions Should be Deliberated

Beyond those two “generally advantageous” cases, Smith identifies situations in which trade barriers may at least be worth deliberation: retaliation and large-scale employment disruptions.

On retaliation, Smith allows that trade barriers may be justified “when some foreign nation restrains by high duties or prohibitions the importation of some of our manufactures into their country.” But the mere existence of foreign restrictions is not sufficient grounds for retaliation. It is only prudent when there is a reasonable probability that retaliation will lead to a “repeal of the high duties or prohibitions complained of.”

Even here, Smith is skeptical. The recovery of foreign markets may eventually compensate for temporarily higher prices, he admits. But the decision is not entrusted to an impartial economist; it is made by “that insidious and crafty animal, vulgarly called a statesman or politician,” whose judgments are often shaped more by immediate political pressures than long-term economic concerns.

Thus, while retaliation is theoretically defensible, Smith doubts the capacity of political actors to wield it judiciously. Otherwise, we risk, as he warns elsewhere, compensating one injury by inflicting another upon ourselves.

The other case concerns industries that “employ a great multitude of hands.” When trade barriers have long protected a domestic industry, their sudden removal may cause significant disruption. Smith does not deny this. But he doesn’t propose permanent protection, either.

His solution is gradualism. Restrictions should be removed slowly and with advance notice, allowing capital and labor time to adjust. The argument here is grounded less in economic efficiency than in humanity. Abrupt change may be economically sound, but policy should account for the transitional burdens borne by real people.

Conclusion

Book IV, Chapter 2 is often remembered for a single metaphor. But the broader chapter reveals something more nuanced. Smith’s defense of free trade rests on a presumption grounded in knowledge and incentives: individuals are generally better judges of their own economic interests than legislators are of society’s.

At the same time, Smith is attentive to the political dynamics that complicate reform. Once established, commercial privileges tend to generate constituencies with both the incentive and the influence to preserve them, even after their original justification has weakened. Smith’s position, therefore, is neither absolute nor naïve. It begins with a presumption of liberty, allows for limited and carefully defined exceptions, and remains mindful of the political forces that make departures from that presumption difficult to reverse.