Studying the Wealth of Nations (Part 9)
Why the Gains from Trade Cannot Be Monopolized Through Colonies
This is the ninth part of a weekly project marking the 250th anniversary of Adam Smith’s Wealth of Nations. You can find the eighth installment here.
Smith calls the discovery of America one of the greatest events in human history. He also argues that the system built on that discovery—the American colonies—was a mistake.
How can both be true?
The answer lies in a distinction Smith draws—implicitly but consistently—between the expansion of markets and the political control of them. The former generates widespread gains. The latter distorts, redirects, and often destroys them.
Why Colonize in the First Place?
Smith is clear that nations do not establish colonies without expecting some return. He groups those expected returns into two categories: common advantages and particular advantages.
The common advantages are those that any extension of dominion is supposed to provide—greater military strength and additional public revenue. But in the case of European colonies, Smith argues that these advantages largely fail to materialize. The colonies of Europe, he notes, have “never yet furnished any military force for the defence of the mother country,” and in many cases have required defense themselves. Rather than strengthening the state, they divert military resources away from it.
The fiscal case is no stronger. With few exceptions, colonial revenues did not cover the costs of administration and protection, particularly in times of war. What was expected to be a source of strength was instead a source of expense. Noting England’s colonies specifically:
The taxes which have been levied upon [them]… have seldom been equal to the expence laid out upon them in time of peace, and never sufficient to defray that which they occasioned in time of war. Such colonies, therefore, have been a source of expence and not of revenue to their respective mother countries.
If colonies do not provide these common advantages, then their justification must rest on what Smith calls their particular advantages—namely, the exclusive trade secured by the mother country.
But this justification rests on a deeper mistake. It assumes that the gains from trade can be contained—that they can be captured and held within political boundaries.
As he puts it:
After all the unjust attempts, therefore, of every country in Europe to engross to itself the whole advantage of the trade of its own colonies, no country has yet been able to engross itself anything but the expence of supporting in time of peace and of defending in time of war the oppressive authority which it assumes over them. The inconveniencies resulting from the possession of its colonies, every country has engrossed to itself completely. The advantages resulting from their trade it has been obliged to share with many other countries.
Nations can monopolize political control. They cannot monopolize the economic gains from expanded trade. Those gains diffuse outward through exchange, while the costs of maintaining empire remain concentrated at home.
This failure is not accidental. It reflects something deeper about how the gains from trade operate: they are not confined to the parties who initiate exchange, and they cannot be contained within political boundaries.
You Don’t Need to Trade With a Country to Benefit From It
It is easy to see that when two countries trade, both benefit. It is less obvious that the discovery of a new market benefits countries that trade with it indirectly. Smith goes further still: countries can benefit from a new market even if they neither export to it nor import from it at all.
He illustrates this with Hungary and Poland—countries which may never have “sent a single commodity of their own produce to America.” And yet, he insists, their industry is nonetheless improved.
Here is Smith’s key passage:
Those commodities of America are new values, new equivalents, introduced into Hungary and Poland to be exchanged there for the surplus produce of those countries. By being carried thither they create a new and more extensive market for that surplus produce. They raise its value, and thereby contribute to encourage its increase. Though no part of it may ever be carried to America, it may be carried to other countries which purchase it with a part of their share of the surplus produce of America.
What Smith is describing is not bilateral trade, but a system of circulation. American goods enter the broader commercial system and expand the purchasing power of those who first receive them. That increase in purchasing power then spreads outward, enlarging markets well beyond the original point of exchange.
The same mechanism that allows Hungary to benefit without trading directly with America is what prevents Britain from capturing those gains.
Smith then pushes the point even further:
[The discovery and colonization of America] may even have contributed to increase the enjoyments, and to augment the industry of countries which not only never sent any commodities to America, but never received any from it. (emphasis added)
Once new goods enter circulation, their effects are not confined to where they first arrive. They expand the total mass of commodities available, lowering prices, raising real incomes, and encouraging further production—even in countries with no direct connection to the original trade.
This is why the attempt to monopolize those gains fails. Trade expands the size of the market itself—and while that expansion can be limited, it cannot be contained.
Why Colonies Persist
If Smith is correct that colonies impose net costs on the mother country, then their persistence requires explanation.
On economic grounds, the conclusion is unambiguous. “Under the present system of management,” he writes, “Great Britain derives nothing but loss from the dominion which she assumes over her colonies.” The case for separation, in purely economic terms, is straightforward.
And yet, Smith is equally clear that such a policy will not be adopted:
To propose that Great Britain should voluntarily give up all authority over her colonies… would be to propose such a measure as never was, and never will be adopted, by any nation in the world. No nation ever voluntarily gave up the dominion of any province… Such sacrifices… are always mortifying to the pride of every nation…
The obstacle is not economic—it is political. To abandon the colonies would require admitting that the system itself had been mistaken, at a cost to national prestige and to those who benefit from its administration.
Smith emphasizes this point:
…they are always contrary to the private interest of the governing part of it, who would thereby be deprived of the disposal of many places of trust and profit… of many opportunities of acquiring wealth and distinction…
The persistence of colonial rule is therefore not a puzzle once we shift from national interest to political economy. What is costly to the nation as a whole may still be beneficial to those who govern it.
That logic is not confined to colonial systems. Policies today are often sustained not because they generate broad economic benefits, but because they serve concentrated interests or avoid politically costly admissions of error.
Smith’s critique is therefore not just about empire, but about the persistence of policies whose economic case has collapsed but whose political foundations remain intact.