Economics, war and Adam Smith

Adam Smith’s Wealth of Nations is generally regarded as the foundational text of modern economic theory and liberalism. I felt that such a tome, which was so influential on modern society, deserved a read. When it first arrived on my desk nearly two years ago, I was not expecting this 950 page behemoth. Since it was such a big read, I really only delved into it during long train trips. Last week, I finally finished it.

Wealth of Nations – the text

It goes without saying that Wealth of Nations, split into five books, is not an easy read. The language is a bit old fashioned, and many words he uses are archaic and no longer used in modern English. However, this is not the biggest issue that makes this a hard read. It is clear that Wealth of Nations was written without the aid of an editor. Smith often goes off on tangents and dense descriptions of the prices of things, details which a modern editor would say should go into an appendix. In particular, I found any discussion that made heavy use of contemporary money units to be incomprehensible. It is perhaps best exemplified when Smith discusses the national debt of Britain, which was over 100 million pounds – he gives the value down to the shilling.

That being said, when Smith writes on topics that are not technical in nation, it is absolutely beautiful, and justifies the high regard this text still enjoys. In particular, Book 4 (Of Systems of Political Economy) is a fascinating overview of late 18th century political systems, and probably could be enjoyed in isolation of the other components of Wealth of Nations.

The motivation of Adam Smith

Although most people regard Wealth of Nations as being the birthplace of free market capitalism, I do not really think his motivation was to create an economic system that currently exists that is called capitalism. I think it is simplistic to assume that his vision of a free market economy was a cold, impersonal system that did not require oversight from the government. To see why he thought the free market was the solution to problems, you have to understand what problems he wanted to solve. After reading the book, I think there are three main motivations on why he proposed this new economic system.

  1. He wanted to raise people out of poverty. One of the overarching themes throughout Wealth of Nations is how different government policies lead to low wages amongst poor people, and high prices for essential goods. One example was his evisceration of the Corn Laws, which meant that Britain would not import wheat unless prices rose to a certain level. He suggested this lowered prices for producers because they were essentially prevented from marketing their wheat to an international market, and also caused the price of wheat to be higher than natural due to the monopoly that the merchants had.
  2. He abhorred the practice of slavery, not just because if was morally reprehensible, but because it lowered the price of labour for freemen. In a free market, Smith argued that slavery would be undercut because free people would be far more efficient producers than slaves.
  3. Smith detested colonialism. By creating a free market system and dismantling the government backed trade monopolies that were enjoyed under the European mercantile system, it would not only provide cheaper products in Europe, but it would protect the indigenous inhabitants of colonies from exploitation and devastation.

A less oppressive economic system

Smith viewed the power that existed in the mercantile system to be driving inequality and injustice. He was very much in favour of limiting the power of the merchants, and saw them as being the worst people to be holding the strings of power.

The government of an exclusive company of merchants is perhaps the worst of all governments for any country whatever.

Smith wanted the end of the European colonizing companies, because it would end the cruelty and mismanagement of affairs in the colonies.

When it came to taxation, Smith favoured systems of taxation that put the least burden on the poor. The first of his four maxims of taxation is as follows:

The subjects of every state ought to contribute towards the support of the government, as nearly as possible in proportion to their respective abilities; that is, in proportion to the revenue which they respectively enjoy under the protection of the state.

Smith opposed taxes on goods, especially essential goods like food and clothing, because its impacts were felt most by those with the least. In the same way, the monopolies and trade barriers acted as an invisible tax on poor people, as the price of goods in real terms would increase. Another burden is that the price of labour would increase, since it would take a larger amount of money to allow people to afford necessities.

Deficit financing and War

Perhaps the most poignant chapter of this book is the last one “Of Public Debts”. With the spectre of global war growing larger, this was an especially eye opening.

Prior to when Wealth of Nations came out, there was what was perhaps the first global war: the Seven Years’ War. This war was notable in that it was the first to be financed extensively through deficit financing (a sinking fund). That is, Britain’s government was lent money from financiers for long terms (often decades or even a century in duration). In return, the financiers received a steady return over time. It was a very low-risk investment. During this war, Britain incurred a debt that was so large that it could never hope to pay off. However, rather than crippling the country, the wealthy financiers enjoyed the protection and prosperity of the state, and were all to happy to continue lending. Though Smith praised this system for giving the country flexibility in times of crisis, he very much opposed sinking funds for one major reason – the possibility of constant warfare:

By means of borrowing, they are enabled, with a very moderate increase of taxes, to raise, from year to year, the money sufficient for carrying on the war; and by the practice of perpetual funding, they are enabled, with the smallest possible increase of taxes, to raise annually the largest possible sum of money. In great empires, the people who live in the capital, and in the provinces remote from the scene of action, feel, many of them, scarce any inconveniency from the war, but enjoy, at their ease, the amusement of reading in the newspapers the exploits of their own fleets and armies. To them this amusement compensates the small difference between the taxes which they pay on account of the war, and those which they had been accustomed to pay in time of peace. They are commonly dissatisfied with the return of peace, which puts an end to their amusement, and to a thousand visonary hopes of conquest and national glory, from a longer continuance of the war.

Reading this, I had to wonder, if this is the purpose of many of the most recent wars, and the motivation to continue them. Could the wealthy who hold the debts of the nation, with little to lose from war, be pushing our countries further into debt for their own amusement and enrichment? Smith felt that a system where wars were funded by ordinary annual taxation revenue would lead to peace.

Wars would, in general, be more speedily concluded, and less wantonly undertaken. The people feeling, during the continuance of war, the complete burden of it, would soon grow weary of it; and government, in order to humour them, would not be under the necessity of carrying it on longer than it was necessary to do so.

I do not think that Smith’s warnings were ever taken under advisement by any country. Almost every country now does deficit financing, and the major economies have seemingly no qualms about starting conflicts in third party countries. By having a heavily progressive taxation system and the elimination deficit financing, could that prevent war? Alas, I do not know if such a system will ever take hold.