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Globalization > Unit 2 > Part 3

Unit 2: Why Trade?

Part 3:  Adam Smith’s Paradigm Shift

 

PerhapsPerhaps the most cited critique of mercantilism was written by Adam Smith in An Inquiry into the Nature And Causes of the Wealth of Nations, 1776. Smith pointed out that the mercantile system worked by coercion and political means, and so the gains from mercantile trade mostly wound up benefiting a small part of the public—namely, those who either had political power or access to it. In contrast, Smith imagined a world in which people freely pursued economic activity because of the incentives drawn by the market. As he imagined it, people’s enlightened self-interest would attract them to profitable activities, and the market would aggregate all such people to benefit the community as a whole. The baker would be free to trade bread for meat, shoes, fabric, and whatever else her needs were; likewise for the farmer, the butcher, and the shoemaker. If each person did what they do most profitably, according to Smith, everyone would be wealthier. Mercantilism, by failing to deliver the liberty to engage in market activity, failed on this count.

WEBSITE: For more on Adam Smith, read:

Adam Smith
http://www.econlib.org/library/Enc/bios/Smith.html

The contrast between Smith’s idea and the mercantilists’ ideas could not be clearer. For the mercantilists, the economic pie was more or less finite, like the amount of gold that could be accumulated by running export surpluses. So coerced trade, as in the colonial outposts of Europe, and politically-driven economies, such as those in the metropolises themselves, made sense.

For Smith, on the other hand, people at liberty to follow the incentives of the market made the economic pie bigger by virtue of specialization and the division of labor. For example, the baker, who is really good at baking but not nearly so good at making shoes, might make either four loaves of bread or one pair of shoes in an hour. On the other hand, the shoemaker might make two pairs of shoes or two loaves of bread in an hour. In The Wealth of Nations, Book Four: Of Systems of Political Economy. Chapter II, Smith argues that each worker has an absolute production advantage in his or her chosen occupation, and this advantage should be exploited through trade for the good of all.

http://www.bus.lsu.edu/academics/
economics/links/portrait/smith.jpg

How absolute production advantage works. For example, suppose the baker gave up trying to make her own shoes for an hour and concentrated on making bread, while the shoemaker left the kitchen for an hour and spent that time in the shop, and then they traded. What would happen? Well, the baker’s hour in the kitchen would make four loaves of bread, but she would no longer have that time available to make one pair of shoes; likewise, for the shoemaker, that time in the shop would make two pairs of shoes, but two loaves of bread would be lost. By trading, however, they would both get back more than they lost. For the baker’s extra hour spent baking bread she would receive two pairs of shoes—double the single pair she could have made had she spent that hour making her own shoes. And in exchange for trading two pairs of shoes, the shoemaker would get four loaves of bread—double the two he could have made had he spent his hour in the kitchen. In fact, with the same amount of time spent working, the baker and the shoemaker essentially double their joint production (and consumption!). Clearly, so long as the baker and the shoemaker each want what the other produces, specialization and trade makes both better off.


WEBSITE:
To learn more about Adam Smith and this theories, click:
The Wealth of Nations, Book Four: Of Systems of Political Economy. Chapter II


The world and/or pie slices getting bigger via trade.
www.wycliffecaribbean.org/

The advantage of Smith’s theory.
Such was Smith’s argument about international trade. Nations, like individuals, should specialize in the things they do most productively. By doing so, they make the entire community of trading nations wealthier. His argument, so seemingly simple today, was so profound at the time that it literally changed how people viewed the world. No longer was trade about “stealing” someone else’s slice of the economic pie, but rather about making the whole pie bigger, so that everyone could enjoy a more fulfilling life. Smith’s insights literally created a paradigm shift in how people, and nations, perceived the economic interactions of the world in which they lived.



Absolute Advantage Table: What Producers Should Spend Their Time Doing

  Shoemaker output/hr Baker output/hr
Shoes 2 Abs adv 1
Bread 2 4 Abs adv


VIDEO: Wealth of Nations and Absolute Advantage

 


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