Studying the Wealth of Nations (Part 7)

Should We Be Concerned About Foreign Export Subsidies?

This is the seventh part of a weekly project marking the 250th anniversary of Adam Smith’s Wealth of Nations. You can find the sixth installment here. Part eight of this series will be published on March 17^th, after the conclusion of spring break.

Continuing last week’s theme on trade, Chapters IV through VI of Book IV of The Wealth of Nations (WoN) examine three trade policies in 18th-century England: drawbacks, bounties, and treaties. Of these, bounties deserve special attention for how they are treated by politicians today—as a form of economic warfare. Adam Smith treated them as self-inflicted wounds.

Export bounties are subsidies designed to encourage the export of domestic goods. In modern debate, the focus is less on our own subsidies than on those used by other countries—most prominently China.

A bounty, as Smith explains, allows merchants to “sell their goods as cheap, or cheaper than their rivals in the foreign market.” When another country does this, we call it “dumping”—an attempt to undercut American producers, drive them out of business, and later raise prices once competition disappears.

Smith does not engage that strategic narrative directly. Instead, he asks a more basic question: what do bounties actually do to the country that imposes them?

His answer has two parts: first, they destroy capital; second, they impose dual taxes on domestic citizens.

Capital Destruction

If an export bounty is necessary, it must be because firms cannot profitably sell the product abroad. They can export only at a loss. That loss does not vanish simply because the state steps in. It is merely shifted.

Imagine you are a carpenter who produces dining tables. You combine lumber, valued at $50, with your time and labor valued at $150 to create a dining table that you then sell for $300. You have transformed $200 of resources into something worth $300. The $100 profit reflects the value you created.

Now imagine you produce that same table for $200 but can sell it for only $150—perhaps because better or cheaper tables are widely available. You have transformed $200 of resources into something worth $150. You have destroyed $50 of value.

The profit-and-loss system tells entrepreneurs which activities create value and which waste it. Profits signal they should continue or expand production; losses signal they should cease. A bounty interrupts this signal by shifting the loss onto taxpayers. It does not turn a loss-making activity into a value-creating one.

As Smith explains:

The bounty is given in order to make up this loss, and to encourage him to continue, or perhaps to begin, a trade of which the expense is supposed to be greater than the returns, of which every operation eats up a part of the capital employed in it, and which is of such a nature, that, if all other trades resembled it, there would soon be no capital left in the country.”

Operating at a loss consumes capital. Generalizing this pattern across an economy is a recipe for stagnation and capital depletion.

Dual Taxes

The second effect of bounties is that they create a dual tax on domestic citizens. The first, and obvious tax, is the one paid to finance the bounty. Whether through direct taxation or deficit spending, the burden falls on domestic households. Deficits merely postpone the bill—and may bring inflation or slower growth in the meantime.

The second tax is less visible but just as real. By encouraging exports, the bounty shifts goods out of the domestic market. With fewer goods available at home, domestic prices rise. Citizens pay once as taxpayers and again as consumers.

What Should We Do About Foreign Export Bounties?

So how should we respond when another country—say, China—imposes export subsidies?

One answer is: we should not.

Chinese bounties mean higher taxes and higher prices for Chinese citizens. They encourage the use of capital in activities that cannot stand on their own. The cost is real, but it is borne in China.

But what if American firms are driven out of business? The purpose of dumping in a foreign market is to eventually raise prices and earn a monopoly profit. But if prices later rise, profit opportunities reappear. That draws capital and competition back into the industry until the profits are eliminated.

Meanwhile, American consumers benefit from lower prices in the present. As Sir Matthew Decker—quoted in the footnotes of WoN—observed of English bounties, they “serve to feed the French cheaper than our own people.” The same logic applies today. Chinese export subsidies reduce prices for Americans—at the expense of Chinese taxpayers.

There are many trade policies worth debating. Foreign export subsidies are not one of them, nor are they the economic warfare they’re made out to be. Thus, a second reasonable response to foreign export subsidies may be:

“Thank you.”