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Book 4, Chapter 4
Themes
Key
LitCharts assigns a color and icon to each theme in The Wealth of Nations, which you can use to track the themes throughout the work.
Labor, Markets, and Growth
Capital Accumulation and Investment
Institutions and Good Governance
Mercantilism and Free Trade
Money and Banking
Summary
Analysis
Another way that manufacturers and wholesale merchants request support from the government is by requesting subsidies, or bounties, for exports. Bounties are only necessary for unprofitable kinds of trade that couldn’t survive otherwise, and subsidizing such trade squanders the nation’s capital. Without bounties, merchants will simply switch to more profitable kinds of trade. Britain’s grain bounty might have increased exports, but it led farmers to waste their capital producing grain instead of other commodities.
Bounties are the fourth kind of mercantilist policy, and Smith opposes them because he thinks that the industries they support simply shouldn't exist. Mercantilists support bounties because they compare how the grain industry looks with those bounties to how it looks without them. But Smith suggests that we should actually be comparing the effects of investing a certain quantity of capital in producing grain for export, versus the greater gains from investing it elsewhere.
Themes
British grain prices did fall after the bounty, but so did French grain prices, even though France banned grain exports. The rising price of silver caused these price drops, not the bounty. Rather, the bounty actually raises prices by encouraging merchants to export all excess grain when the harvest is strong. This prevents the nation from accumulating the reserve it would need to keep prices down in lean years. But many people wrongly think that the bounty reduces grain prices in the long term by encouraging more production. In fact, the bounty is really a tax on everyone in society, as they have to fund it and pay higher grain prices. This hurts the poor most of all. It also encourages people to purchase less grain, which suppresses production levels.
If British grain prices fell while French grain prices rose, then we would have reason to believe that the grain bounty achieved its intended effect. Instead, the much larger effect of rising silver prices caused grain prices to fall in both countries. Bounties may increase the production of certain goods, but they make matters far worse for domestic consumers. Smith has already argued that the best thing a nation can do for its economy is to invest massively in agriculture, so that food (and particularly grain) becomes cheap and abundant. At first glance, grain bounties may appear to help achieve this aim, but in reality, they profoundly undermine it. Indeed, these bounties amount to a huge transfer of wealth from the poor to wealthy grain wholesalers.
Themes
As this bounty doesn’t help farmers maintain more workers with the same amount of grain, it only increases nominal grain prices, not real ones. By increasing nominal grain prices, however, it reduces the real price of silver. Since grain is the basis for subsistence, nominal grain prices also regulate the nominal price of almost everything else, including labor, rude produce, and most manufactured goods. Thus, the grain bounty just makes everything more expensive. It doesn’t improve life for farmers and landlords at all.
Smith returns to his principle that the grain market is the foundation of the economy. First, by the 18th century, growing grain generally required the same amount of labor even as productivity improved, which meant that the real price of grain never changed. And second, everyone needs to purchase grain to survive. Together, these two principles mean that grain prices determine the real price of everything else—including silver. Intuitively, this makes sense: the more of their income people must spend on grain, the less they have for everything else. If grain becomes scarcer, its nominal (silver-denominated) price will rise, which really just means that more labor is required to earn the amount of money needed to buy grain. If grain and other foodstuffs become unaffordable, meaning the real wages from work no longer reach the real price of subsistence, then people even have to switch back from trades to farming.
Themes
Similarly, a worldwide fall in real silver prices has little effect on the real price of anything else, but if these prices only fall in a single country, they will impoverish it. For instance, nearly all of Europe’s gold and silver enters through Portugal and Spain, so these metals are cheaper there. While this isn’t a problem on its own, Spain hurts its economy by heavily taxing gold and silver, and Portugal by restricting their exportation.
Real silver prices fall if silver becomes far easier to acquire—like after the Spanish seized the Inca mines. As Smith has established, gold and silver are very easy to transport as compared to their value, so the gold and silver market is completely globalized and prices vary little from country to country. However, Portugal and Spain’s restrictions are an exception, because they actually separate those nations’ gold and silver markets from the global ones.
Themes
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These policies do not change the basic facts about how much gold and silver can comfortably circulate in these countries’ economies. Rather, they simply burden those countries with precious metals they can never sell. This raises the nominal price of other goods, discourages agriculture and manufacturing, and makes imports more expensive. If Spain and Portugal reversed these policies, their economies may shrink in nominal terms, but they would quickly start growing in real terms because they would trade their “dead stock” (excess gold and silver) for useful goods, thereby transforming it into “active stock” (capital that yields profit).
Smith has already established that a country’s level of economic activity determines how much gold and silver can circulate in it. If there is too little, merchants will import it, and if there is too much, they will export it. But Spain and Portugal’s policies trap unnecessary gold and silver in their economies as “dead stock.” Such policies may work for other kinds of goods, but not the commodities that make up the money supply. Indeed, this example shows how mercantilist policies can actually have the opposite of their intended effect.
Themes
Britain’s grain bounty functions just like these policies in Spain and Portugal: it raises nominal prices at home and lowers them abroad, harming other British exports in the process. The only people who benefit are grain merchants, as the bounty increases exports in fertile years and imports in lean ones. Ultimately, rural landlords only supported the grain bounty because they didn’t understand the basic difference between grain and manufactured goods, for which monopolies and bounties do increase real prices (but also waste society’s capital by funneling it into a losing trade).
The British grain bounty increases nominal prices at home by raising the real price of grain. In turn, this raises prices for everything else. These across-the-board higher prices make British exports more expensive, and thus less competitive. And the bounty lowers nominal prices abroad by flooding foreign markets with cheap grain. Once again, this policy is the result of some people’s folly mixed with others’ self-interested lies.
Themes
A better solution is to place bounties on commodity production, rather than exportation. This would reduce real prices for domestic consumers. But due to the mercantile system’s focus on international trade and manufacturers’ desire to keep domestic prices high, the government has rarely offered bounties for production.
Production bounties help domestic consumers, while only encouraging exportation when the market is actually ripe for it. (This happens when production levels outpace domestic demand, but employers do not have a more attractive place to shift their capital.)
Themes
One exception is the bounty for Scotland’s herring fisheries, which helps support British sailing and shipping, but is still a mistake for four reasons. First, the bounty is too high, and herring fisheries would be deeply unprofitable without it. Second, the bounty is based on a ship’s size, not the amount of herring caught, so it promotes waste and fraud. Third, the bounty supports large Dutch-style ships, when ordinary boats are better suited to Scotland’s environment. And finally, as a result of these factors, the bounty has increased herring prices instead of reducing them—all without meaningfully raising fisheries’ profits. (This work’s Appendix includes account books that prove these claims.)
Scotland’s herring bounty is a reasonable idea in theory, but Smith argues that it has been badly implemented for these four reasons. His analysis suggests that the people who designed the bounty knew relatively little about how herring fishing actually works. Thus, he underlines the importance of tailoring policy to real-world production and market conditions, rather than designing it based solely on theory (or demands by special interest groups). This potential for waste, fraud, and abuse often makes bad economic policy worse than no policy at all. Interested readers can see this effect quantified in the Appendix.
Themes
Production bounties are justified for goods necessary to national defense, as producing them domestically is far safer than importing them. And when a society is prospering, using production bounties to encourage the growth of certain favored industries is not unreasonable. Export incentives for goods that already face export taxes should be considered drawbacks, even though they are often wrongly called bounties. And prizes offered to extraordinary manufacturers and artisans are not bounties: they encourage better production techniques instead of changing “the natural balance of employments” and capital investment.
Defense is once again the great exception to the rule of free trade, for the consequences of cutting off that trade in wartime are simply too dire. Subsidies for chosen industries make the economy slightly less efficient overall, but they do concentrate growth into the chosen sector. When a nation already has a strong economy, Smith figures, it can generally withstand these minor shocks, while benefiting in the long term from this concentrated growth. Indeed, sometimes these subsidies are necessary to spur investment in highly risky industries—like certain kinds of research and development, whose effects are difficult to predict, and businesses that benefit the public but aren’t likely to return a profit for years or decades. Smith’s attention to the variety of bounty policies shows that these measures can always be adapted to a country’s particular economic, social, and political needs.
Themes
“Digression concerning the Corn Trade and Corn Laws.” This long digression will explain why the grain exportation bounty and the laws governing the grain trade don’t deserve the praise they receive. There are four kinds of grain merchants: inland traders, importers, exporters, and re-exporters (who engage in the carrying trade).
The rest of this chapter consists of a long, detailed analysis of Britain’s grain industry. This may seem tedious to contemporary readers, but it was absolutely essential for Smith, as the people who designed Britain’s grain laws (and had the power to change them) were in large part his peers and friends. Moreover, since grain prices are the foundation of the whole economy, understanding how they function is absolutely essential to designing an effective economic policy.
Themes
First, inland grain dealers want what is best for society as a whole: for grain prices to keep supply and demand in balance. If prices rise too high, they discourage consumption, leaving some grain unsold. If prices fall too low, they cut into the merchant’s profits and encourage people to buy up all the grain at the beginning of the season, which can lead to famines later on. By keeping prices at the right level, inland merchants ensure that society’s grain supply lasts precisely from one harvest to the next.
The vast majority of Britain’s grain trade depends on these inland (domestic) wholesalers. They essentially function as market makers, modifying prices according to supply and demand, so that grain is neither wasted nor scarce. In this respect, they operate essentially as they should. Undue government regulations don’t restrict their business, and they don’t prey on consumers by seeking monopolies.
Themes
If one company could establish a monopoly over the inland grain trade, it would likely destroy part of the crop and raise prices. But such a monopoly would be impossible to establish, even with the government’s support, because agriculture is such a massive, geographically dispersed industry. Historically, poor growing seasons (and not monopolies) have caused all grain shortages, but failed government policies have caused all true famines. After all, the market distributes grain efficiently, raising prices in years of drought and scarcity so that people buy less and the supply lasts the whole season. But when the government tries to guarantee ordinary grain prices in such years, either dealers never bring it to market because it isn’t profitable, or people buy and consume it all shortly after the harvest. Both contribute to famines. To avoid this, the law should protect the free grain trade.
Smith again warns about the danger of monopolies, which restrict supply in order to raise prices and profit margins. But fortunately, the grain trade is naturally decentralized, and decentralization is the opposite of monopoly. A decentralized grain market can weather shortages because of how low supply raises prices and reduces demand. But policy creates famines by trying to circumvent this logic—and unintentionally shutting down grain markets in the process. In this way, government regulation acts like a monopoly by setting prices for everyone. Even though such regulations are generally intended to serve the public interest—unlike monopolies, which only serve private interests—they often backfire nevertheless.
Themes
The people hate inland grain traders and even attack them during lean years, when they raise prices (and make the profits that allow them to sustain losses in better growing years). As a result, reputable people avoid the grain-trading profession. Historically, European countries banned grain trading, which forced farmers to sell their grain directly to consumers, but also banned manufacturers from selling their goods, which forced them to turn to merchants. But due to the division of labor, people can work more efficiently and produce goods for a lower price if they dedicate their capital and attention to a single activity, rather than splitting it between two.
Attacking grain traders is tantamount to shooting the messenger. These traders may comprise the nation’s grain market in the aggregate, but as individuals, they don’t have any power over market prices. If they sell under the market price out of sympathy for their local customers, they will run out of grain too soon—and then people will blame them for causing a famine. Once again, effective policies must take the logic of the market into account, even when it conflicts with common sense. Banning the grain trade may seem like a way to stop unpopular merchants who harm society, but it just makes the market less efficient, while doing nothing to satisfy the essential economic need to bring food to consumers.
Themes
Thus, the grain policy had a harmful effect, while the manufacturing policy may have actually accelerated the division of stock and labor. But both policies unjustly violated people’s natural liberty. Specifically, the grain policy discouraged land improvement by forcing farmers to split their capital between agriculture and trade. It thus backfired, making grain scarcer and more expensive over time.
Europe’s grain policy banned merchants, hampering the division of labor, but its manufacturing policy required merchants, which promoted the division of labor. Curiously, Smith argues that liberty sometimes weighs more than practical economic concerns. Put differently, the government cannot compel us to do certain things just because they are better for the economy—although it can certainly create a system of penalties and incentives to try and make things more efficient.
Themes
In reality, wholesale merchants support farmers and manufacturers by permitting them to specialize, invest all their capital in efficient production, and sell off their goods and rude produce immediately rather than waiting for customers or even retailers. This helps explain why Britain gradually eased its restrictions on the wholesale grain trade. The current policy permits wholesaling, so long as prices remain below a certain cap and merchants don’t resell the grain in the same market for at least three months. Yet these rules hamper the grain trade when it is most important: during times of scarcity, when prices rise and merchants should buy up grain at harvest time and sell it slowly over the course of the year to avoid famines. Opposition to grain merchants, like witchcraft, is just a form of scapegoating.
Smith reminds his readers that the economy’s separation into different sectors is an essential part of the division of labor. The more each part of this division functions smoothly on its own, the better the economy works as an interlocking whole. Farmers should specialize in farming, manufacturers in manufacturing, and traders in trading. Britain clearly realized this at some point in its economic history and improved its laws as a result, but Smith argues that there is still much more work to be done. Most importantly, the price cap could lead too much grain to sell, too fast, in lean years—and cause a famine as a result.
Themes
Britain’s inland grain trade is 570 times larger than its grain imports and 30 times larger than its exports. But even though the foreign trade is relatively insignificant, it’s still worth briefly exploring.
Smith’s numbers suggest that between 96–97% of Britain’s grain trade is domestic. This is largely due to transportation costs, but the situation has changed significantly since the 18th century. Still, the foreign grain trade’s insignificance helps explain why it’s deeply foolish for the British government to spend so much time, energy, and money subsidizing it.
Themes
Importers are the second kind of grain merchants. They help reduce nominal grain prices, but not real grain prices, as they don’t change the amount of labor that goes into farming. While Britain imposes high duties on imported grain, it suspends them in times of scarcity. These duties were only necessary to compensate for Britain’s bounty for grain exports. Otherwise, merchants would have just imported and re-exported grain to claim the bounty.
Grain importation’s main economic significance in Smith’s time was that it could make up for shortages during times of crisis. Thus, it was important for Britain to have the option of importing grain—even if it would seldom avail of it. Ironically, Britain took just the opposite stand in its colonies, refusing to allow food imports to Ireland and India—and causing some of the worst famines in human history as a result.
Themes
Exporters are the third kind of grain merchants. They contribute to the nation by ensuring that farmers can produce as much grain as possible, without flooding the domestic market. To this end, Britain removed all restrictions on grain exportation by 1700. Yet unlike inland traders, grain exporters sometimes want the opposite of what is good for the country. For instance, if Britain faced a grain shortage while another country faced a famine, exporters would make more profit by sending British grain to the famine-stricken country.
The same general principles that make Britain’s grain exportation bounty undesirable also explain why grain exporters’ interests are generally opposed to society’s. Namely, grain merchants seek high prices to maximize their profits, but the whole economy’s health depends on those prices being low. Accordingly, it’s probably not a bad thing that England only exported about 3% of its grain, even with the bounties incentivizing it.
Themes
It would be best if all countries left the grain trade free, as this would enable “the scarcity of any one country [...] to be relieved by the plenty of some other.” But since most countries place absurd restrictions on the grain trade, it’s often dangerous for small countries to allow free grain exports, which could lead to domestic scarcity. Ultimately, just like laws about religion, these grain laws are just the product of special interest groups pressuring the government.
Once again, free trade is the solution, and restrictions are only justified when they are necessary to counterbalance other restrictions. Simply because of their size, small countries have less resilient markets—and they must carefully adapt to their larger neighbors’ policies. They can use those policies to their advantage, such as by specializing in producing goods that the larger country cannot. But those policies can also crush small countries, particularly when they change abruptly. For instance, during a famine, a small European country might export grain to meet British demand, but then find its own people without food—and no other country willing to export to them. Smith has already pointed out how the Bank of Amsterdam hedged against similar risks in the financial sector by developing a new currency system.
Themes
Merchant carriers, who import grain and then re-export it, are the fourth and final kind of grain merchant. They often help the domestic market by selling grain locally when exportation is unprofitable. But the combination of import and export limits has, in effect, banned the grain carrying trade in Britain.
The carrying trade is generally the last kind of trade to develop in a country, because it involves using domestic capital to fund production and consumption that both take place overseas. It takes longer to achieve returns, does little to benefit the national economy, and exposes merchants’ capital to greater risk by sending it far overseas. This generally makes little sense for grain, except—as Smith points out—when it can occasionally push merchants to sell slightly more grain to the domestic market.
Themes
In sum, contrary to popular belief, Britain’s grain laws limit its prosperity rather than promoting it. However, Britain still has some of the freest trade laws of any country, which is why it’s among the most prosperous. For instance, Spain and Portugal are poorer than Britain because their restrictions on gold and silver are easier to enforce than Britain’s grain laws. The most recent updates to Britain’s grain laws are beneficial because they greatly reduce the duties on imports and bounties for exports, as well as eliminating duties on imports for the carrying trade. However, they also create a new bounty for oats and ban grain exports at unreasonably low prices.
Smith concludes his thorough takedown of Britain’s grain laws by putting things in perspective. Britain’s laws are far less restrictive than those of its peers, which has strengthened its economy and set a relatively good example. (Of course, none of this applies to the way Britain governs its colonies.) Still, Britain has much to improve on, and Smith sincerely hopes that his friends in government will take his advice. In fact, his expertise would go on to earn him the power to reshape import and export policy as Scotland’s Commissioner of Customs.
Themes
