Adam Smith and International Trade Policy

What could a man born in pre-industrial Britain, whose only concept of international trade was that conducted in sailing ships, teach the masters of UK trade policy in today’s era of supply chains, digital trade and multiple trade agreements? Well, actually, quite a lot.

Smith’s theory of trade policy has been seminal. He was the first writer to lay out “a systematic, coherent framework for thinking about the economics of trade policy.” He argued, among other things, that it should be assessed against a national yardstick, rather than a sectoral one, and came very close to defining this in terms of national income.

Smith’s key observation was that the resources of a country are limited and thus that policy has to consider opportunity costs (i.e.: recognising that if you do X you have less capacity to do Y). This led to his general rule that “if a foreign country can supply us with a commodity cheaper than we ourselves can make it, better buy it of [sic] them with some part of the produce of our own industry, employed in a way in which we have some advantage…”

Four exceptions to this rule were recognised by Smith:

1) industries necessary for defence;

2) levying the same indirect taxes on imports as on domestic production (a level playing field);

3) retaliation against overseas trade restrictions – but only if the cost of retaliation was less than the damage suffered from the restriction and if the latter was likely to be rescinded in the face of retaliation;

4) where a reduction in an import tariff would cause “severe dislocation of domestic labour and capital” – which he considered possible but not likely.

All of these views are used and abused in current trade policy debates either nationally or within the World Trade Organization (WTO).

Maybe less famous than his “invisible hand”, was Smith’s equally strong argument that prosperity required sound institutions and “the tolerable administration of justice“, which required a legal system to protect private property and to enforce contracts and the repayment of debts. We need rules of the game to maintain personal freedom and to channel individualist pursuits into the common good. A substantial share of Smith’s Wealth of Nations is devoted to how institutions may (or often may not) work to enhance the public good. He saw sound institutions as necessary to guide and manage the behaviour not only of individuals and firms but also of the government itself.

Here, too, Adam Smith is salient to current policy debate in the UK. The “administration of justice” has become less “tolerable” recently as constraints on the executive behaviour have been eroded. As I state in my article on the subject, this is evident in the UK Government’s explicit planning to act unlawfully and in the way it has undermined other branches of government. For example, by seeking to by-pass Parliament, ignoring the advice of formal advisory bodies, reducing the scope for the judicial review of government action and, most of all, appropriating to itself the ability to change regulations (which bear so strongly in international trade) by secondary legislation that had previously been determined by primary legislation.

This decay is also evident at a humbler level of governance in the sad fate of the UK’s Trade Remedies Authority (TRA). Following Brexit, the TRA was created as an arms-length body to investigate cases for granting temporary import restrictions to specific products according to a reasonably well-defined and objective process. But from its first month of operation, government action undermined it by (illegally) over-ruling one of its decisions, changing its operating rules to get the ‘right answer’ and eventually changing the legal basis of its work. It turned the TRA from a useful administrative instrument into a fig leaf for a political process for granting protection to petitioners.

One cannot argue that the UK has entirely lost “the tolerable administration of justice”, but neither can one argue that it has not been diminished. And perhaps the most famous economist ever, Adam Smith, believed that such diminution has economic costs.

One has to be amazed at the breadth of Adam Smith’s vision. More than 250 years after he wrote them, his words bear on so many of the trade-policy decisions and debates of the 2020s.

L Alan Winters is a Professor of Economics at University of Sussex Business School, Brighton.