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.
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 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
