This paper is interested in Smith's critiques of bounties (read "subsidies") on exports. It is argued that Smith's analysis foreshadows the basic trade policy framework of modern liberalism.
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Adam Smith's analysis of bounties as an early example of
This paper is interested in Smith's critiques of bounties (read "subsidies") on exports. It is argued that Smith's analysis foreshadows the basic trade policy framework of modern liberalism.
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This paper is interested in Smith's critiques of bounties (read "subsidies") on exports. It is argued that Smith's analysis foreshadows the basic trade policy framework of modern liberalism.
Direitos autorais:
Attribution Non-Commercial (BY-NC)
Formatos disponíveis
Baixe no formato TXT, PDF, TXT ou leia online no Scribd
Adam Smith's analysis of bounties as an early example of
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Search: Search tipsAdam Smith's analysis of bounties as an early example of the concept of noneconomic objectives. From: The American Journal of Economics and Sociology | Date: 10/1/2004 | Author: Elmslie, Bruce Print Digg del.icio.us Smith uses his analysis of bounties to form one aspect of his overall critique of the mercantile system. He stresses the fact that the system of bounties has not promoted the development of the English economy. However, Smith also stresses that, as destructive as the system of export bounties is to public welfare, these bounties are not significant enough to greatly retard the growth of the English economy, which has more to do with secure property rights and securing investors their return on their investments. I Introduction IT SEEMS THAT economists have finally forgiven Adam Smith for not being David Ricardo. From Ricardo through Jacob Viner, most economic theorists have considered "Smith's contribution to the theory of international trade [to be] slight at best and erroneous at worst" (Maneschi 1998, p, 48) The main reason for this lowly opinion was Smith's failure to discover the theory of comparative advantage. This failure seems all the more glaring given that David Hume left Smith with all of the analytical tools necessary to develop such a theory: all Smith had to do was put the pieces together. This perception of Smith's contribution to trade theory began to turn with Myint's (1958) recognition that Smith's theories of trade were intimately connected with his overall theory of economic development. Today, it is generally recognized that Smith's emphasis on increasing returns and dynamic gains provides an analysis of trade and the gains from trade that is rich with insight (Blecker 1997) and internally consistent with Smith's overall system of natural liberty (Elmslie and Sedgley 2002). (1) While Smith's theories of trade have enjoyed a renaissance, his work on trade policy has "largely been ignored. This paper is interested in Smith's critiques of bounties (read "subsidies") on exports. I argue that Smith's analysis of bounties foreshadows the basic trade policy framework of distortions and noneconomic objectives that, since Bhagwati (1971), has formed the basis of neoclassical policy analysis. While Smith does not develop a coherent theory of distortions, he captures the logic of the theory of noneconomic objectives and attempts to rank policy alternatives based upon their relative social costs. Moreover, Say extended Smith's analysis of the effects of bounties to develop policy based on endogenous distortions. II Smith and the Theory of Noneconomic Objectives (2) NEOCLASSICAL THEORETICAL POLICY analysis is based upon a foundation of complete transparency. The policy prescriptions for the elimination of distortions and the most efficient manner to meet noneconomic objectives are the foundation of this analysis. The theory shows that if a distortion exists the first-best option is to eliminate the distortion directly rather than to erect a countervailing distortion in the system. The analysis of noneconomic objectives develops as a corollary to that of distortions: if a noneconomic objective exists, it is best to meet the objective as efficiently as possible by directing the policy measure (tax cum subsidy) specifically at the objective. (3) Given that the government policy is not directed at the elimination of a market-created distortion, intervention will create a distortion in the system. The idea here is to create as few distortions as possible while still meeting the objective. (4) A noneconomic objective of a government can be represented by a minimum output objective for an industry. The objective could be met, for example, by a subsidy on exports. However, such a policy will create other distortions elsewhere in the economy. If one industry is given a subsidy on exports, two external effects are created. First, the home price of the good will increase. This essentially makes home consumers pay for the subsidy twice. Not only must they finance the subsidy, but they are also taxed indirectly in the form of higher prices for the good in the home market. Moreover, a subsidy on exports of one industry taxes other industries through a Lerner effect. The expansion of the exports of one industry will either reduce the exports of other industries or increase imports that compete with domestic producers. A preferred solution is a direct production subsidy. A production objective is best met by a production subsidy. A policy directed at the objective creates fewer distortions in the system. The disincentive to other industries is lessened, while consumers pay the tax only once. Consumers may even get some benefit in the form of lower prices for the goods of the subsidized industry. All of the modern policy prescriptions for an output objective along with modern (Lerner) reasoning are evident in Smith's critique of export bounties. Smith is interested in developing a general theory of the effects of bounties, but his direct target is often England's bounties on corn. (5) How does Smith's analysis of bounties qualify as an analysts of a noneconomic objective? Specifically, does it assume that the government's policies are not directed at the maximization or increase of the consumption stream because the policy is not directed at the elimination of an endogenous distortion? After all, Smith admits that these and other mercantile policies were defended on the basis of an expected improvement in social welfare. Smith flatly rejects such arguments. He clearly states that policies that direct resources to and from industries on a basis other than competitive forces reduce welfare as defined by the value of national output. By implication, he also suggests that endogenous distortions are not present: A trade which is forced by means of bounties and monopolies, may be, and commonly is disadvantageous to the country in whose favour it is meant to be established ... But that trade which, without force or constraint, is naturally and regularly carried on between any two places, is always advantageous.... By advantage or gain, I understand, not the increase of the quantity of gold and silver, but that of the exchangeable value of the annual produce of the land and labour of the country, or the increase of the annual revenue of its inhabitants. (Smith 1994 [1776], p. 521) Later, Smith gives an explicit example of a policy directed at a minimal output level that costs society in terms of the value of national output but still may be warranted based upon the noneconomic objective of national defense. But even in this case, Smith argues that it should be clearly demonstrated that the industry could not be supported by the market. "If any particular manufacture was necessary, indeed, for the defence of the society, it might not always be prudent to depend upon our neighbours for the supply; and if such manufacture could not otherwise be supported at home, it might not be unreasonable that all the other branches of industry should be taxed in order to support it" (1994 [1776], p. 559, emphasis added). (6) Thus, it seems reasonable to think of Smith's analysis of bounties on exports and production as an early example of what we now refer to as noneconomic objectives. A. Smith's Analysis Smith understood that an export bounty causes "distortions" (to use the modern term) in both the domestic and foreign markets. Specifically, export bounties impose "two different taxes upon the people; first, the tax which they are obliged to contribute, in order to pay the bounty; and secondly, the tax which arises from the advanced price of the commodity in the home market" (1994 [1776], p. 543). Smith implicitly assumes that England is a large country in the corn market, as the bounty could cause the price of corn in international markets to fall. (7) Whatever be the actual state of tillage, it [the bounty on exports of corn] renders our corn somewhat dearer in the home market than it otherwise would be in that state, and somewhat cheaper in the foreign.... It enables foreigners, the Dutch in particular, not only to eat our corn cheaper than they otherwise could do, but sometimes to eat it cheaper than even our own people can do upon the same occasions. (1994 [1776], p. 549) The effect of this rise in the price of corn is to essentially tax the output of other industries. It raises the cost of production. This will, in turn, decrease the competitiveness of the home industry relative to foreign competitors. It [the export bounty] hinders our own workmen from furnishing their goods for so small a quantity of silver as they otherwise might do; and enables the Dutch to furnish their's for a smaller. It tends to render our manufactures somewhat dearer in every market, and theirs somewhat cheaper than trey otherwise would be, and consequently to give their industry a double advantage over our own. (1994 [1776], pp. 549-550) (8) Thus, as with modern analysis, the subsidy on exports creates distortions in other markets that unnecessarily decrease welfare and tax other industries. (9) Smith's policy prescription should sound familiar. The first-best policy (except in those occasions where a genuine national interest could be shown) is to reduce the bounty or, if possible, eliminate the policy altogether. "If bounties are as improper as I have endeavoured to prove them to be, the sooner they cease, and the lower they are, so much the better" (Smith 1994, p. 583). However, if the government must encourage the production of a particular industry, it is clearly more effective to subsidize production directly: To encourage the production of any commodity, a bounty upon production.... would have a more direct operation, than one upon exportation. It would, besides, impose only one tax upon the people, that which they must contribute in order to pay the bounty. Instead of raising, it would tend to lower the price of the commodity in the home market; and thereby, instead of imposing a second tax upon the people, it might, at least in part, repay them for what they had contributed to the first. Bounties upon production, however, have been very rarely granted. (1994 [1776], p. 553, emphasis added) Smith sets out a relatively complete argument that subsidies designed to artificially maintain or increase production levels of one industry (or group of industries) will negatively impact social welfare as he defines it. Moreover, he appears to be the first writer to explicitly rank policies on the basis of distortions or relative costs accruing to consumers and other sectors of the economy. He sees this as a very important point, emphasizing it in several places. A government that has what we now refer to as a noneconomic objective can achieve this objective with several different specific policies. Each policy alternative has different effects on the economy that can be ranked in terms of their relative impact on social welfare. (10,11) B. Subsidizing Innovation One final point may be made along this same line of inquiry. Modern trade policy analysis is set out utilizing static or comparative static tools. Smith did not see the economy in a static manner. Thus, while Smith clearly ranked a direct production subsidy above an export subsidy, this was not necessarily his first-best policy option for achieving a noneconomic objective. As with his theories of trade, Smith embodied his analysis of trade policy within a growth framework. In such a framework, he argued that the best policy to encourage the production of a particular industry was to subsidize innovation rather than production. In Smith's mind, these types of subsidies had two advantages. First, they were small relative to other subsidies, and second, of course, they encouraged the continual development of new ideas, which would naturally maintain the domestic industry in an otherwise competitive international market: Premiums given by the public to artists and manufactures who excel in their particular occupations, are not liable to the same objections as bounties. By encouraging extraordinary dexterity and ingenuity, they serve to keep up the emulation of the workmen actually employed in those respective occupations.... Their tendency is not to overturn the natural balance of employments, but to render the work which is done in each as perfect and complete as possible. The expence of premiums, besides, is very trifling; that of bounties very great. (1994 [1776], p. 560) When Smith sets out the case for premiums over production subsidies, he clouds the already opaque distinction between the theory of distortions and that of noneconomic objectives. After all, the failure of the market to properly compensate innovators may be a distortion. Why else would they be encouraging? Several suggestions are possible. First, Smith may have been thinking along the same national defense lines as outlined earlier. Second, he may have been following a line of theory developed by Hume that suggested a natural tendency for the rate of innovation to fall as the stock of knowledge accumulates. Or, finally, he may have been thinking along lines similar to the modern analysis of distortions due to technology spillover effects. Whether or not we interpret Smith's analysis of premiums given to innovators as an embryonic theory of distortions due to a positive externality is open to question. However, it is clear that Jean-Baptiste Say (1964 [1880]) used Smith's work on bounties to develop such a connection. He sets out a similar pattern of argument as Smith. "Though bounties are chargeable, and a dead loss to the gross national wealth, there are cases in which it is politic to incur that loss; (1) as when a particular product is necessary to public security" (Say 1964, p. 172). (12) He also develops the same policy ranking for noneconomic objectives. "When a bounty is paid, not at the moment of export, but at the commencement of productive creation, the home consumer participates with the foreigner in the advantage of the bounty; for in that case, the article can be sold below cost price in the home as well as in the foreign market" (1964, p. 171). Say also follows Smith's analysis of premiums: I have no fault to find with the honours, or even pecuniary rewards publicly given to artists or mechanics, in recompense of some extraordinary achievement of genius or address. Rewards of the kind excite emulation, and enlarge the stock of general knowledge, without diverting industry or capital from their most beneficial channels. Besides, they cost nothing in comparison of bounties of another description. (Say 1963, p. 175) Say goes on to argue that such rewardss are often necessary to overcome information failures that can occur when markets are left to their own accord. He specifically addresses an information failure in agriculture where "the interference of the public authority.... has generally been of a beneficial kind" (1964, p. 175). Say argues that information regarding the most efficient production techniques in agriculture is slowed by several factors and concludes that public welfare is enhanced by the "granting of premiums and encouragements, and to the diffusion of knowledge which has often contributed largely to the progress of this art" (Say 1964, p. 176). Say extended Smith's policy analysis found in the chapter "Of Bounties" to create a positive policy analysis designed to counter market failure. III Political Economy of Trade Policy IF SMITH COULD demonstrate that a subsidy on production would have a "more direct operation" than a subsidy on exports, why was the former so rare? Clearly, the lessons of the modern political economy of trade policy literature would not be lost on Smith. He tells the reader that such subsidies are rare because they are not in the vested interest of the group that lobbies for the encouragement. Smith makes this point on both general and specific levels. In general terms, mercantilists had persuaded the public that increased prosperity (welfare) is directly connected with exports, making export bounties seem naturally in the public interest: The prejudices established by the commercial [mercantile] system have taught us to believe, that national wealth arises more immediately from exportation than from production. It has been more favored accordingly, as the more immediate means of bringing money into the country. (Smith 1994 [1776], p. 553) Specifically, the subsidy on exports is more profitable to the recipient than one on production: [I]t is not the interest of merchants and manufactures, the great inventors of all these expedients, that the home market should be overstocked with their goods, an event which a bounty upon production might sometimes occasion. A bounty upon exportation, by enabling them to send abroad the surplus part, and to keep up the price of what remains in the home market, effectually prevents this. Of all the expedients of the mercantile system, accordingly, it is the one of which they are the fondest. (1994 [1776], p. 555, emphasis added) Clearly, Smith developed an analysis of lobbying that was the forefather of modern neoclassical political economy. Not only do interest groups lobby government for protection, they lobby for the form of protection that benefits them to the greatest extent. Once again, Say closely follows Smith's ideas and develops the analysis to include a collective action argument. The interests of manufacturers are highly concentrated due to their relatively small numbers, while the interests of consumers are diluted across great numbers. Thus, it is easier to measure the gains of polices such as bounties and difficult to understand the costs. "The reason why governments are so easily entrapped into measures of this kind is, partly because they see a statement of large profits.... [and this] profit is easily reduced to numerical calculation.... whereas the loss and mischief resulting to the nation are infinitely subdivided amongst the members of the community, and operate after all in a very indirect, complex, and general way, so as to escape and defy calculation." (Say 1964, p. 188) IV Conclusion IN THE WRITINGS OF ADAM SMITH, we find a strikingly complete analysis of policies relating to production goals. If such a target is to be granted, he demonstrates the most efficient policy for its achieving the objective. This is a very different question from whether the objective should be granted in the first place. Smith argues that bounties on exports or production are suboptimal given his competitive economy. Such policies create costs to society (distortions) that impact the current efficiency of resource use and ultimately slow the growth of industry. "The effect of bounties, like that of all other expedients of the mercantile system, can only be to force the trade of a country into a channel much less advantageous than that in which it would naturally run of its own accord" (Smith 1994 [1776], p. 541). Smith even shows an understanding of the modern concept of natural trade when he states that a bounty that forces exports to go against a country's natural advantage results in losses from trade. "[T]he trade which cannot be carried on but by means of a bounty [is] necessarily a losing trade" (1994 [1776], p. 552). While Smith's performance in this particular area of policy analysis is truly remarkable, it is not, upon reflection, surprising. Both analyses are formed from similar competitive frameworks and both reflect the proper working out of these frameworks to the issue of noneconomic objectives. In both instances, the policy rankings that are formed are the byproducts of a competitive economic system in which actors respond to market signals. While interesting in its own fight, the importance of Smith's analysis lies in its use in policy making and by other economists. Say further developed the logic of Smith's analysis to include a companion analysis based on distortions away from the classical competitive outcome. Smith uses his analysis of bounties to form one aspect of his overall critiques of the mercantile system. And he stresses the fact that the system of export bounties (especially corn bounties) has played no positive role in the development of the English economy. However, Smith also stresses that, as destructive as the system of export bounties is to public welfare, these bounties are not significant enough to greatly impact the growth of the English economy. England's policy of securing property rights (especially in securing the right to a return on one's investments), which allow the positive effects of individual self-interest to operate, are more than sufficient to counter the distorting effects of the bounties. Notes (1.) Maneschi (1998, p. 49) goes so far as to argue that "the various strands of Smith's trade theory make it much richer than the neoclassical theory which followed it a century later." (2.) This section follows and builds on Elmslie (2004). (3.) To a certain extent an economic versus a noneconomic objective is in the eye of the beholder. As described in Bhagwati, Panagariyz, and Srinivasan (1998), an economic objective is generally thought of as an objective that maximizes a social utility function that has only the flow of final consumption as an argument. Therefore, a noneconomic objective contains a production, consumption, national defense, or other argument in the utility function. Perhaps a more natural way to think about noneconomic objectives is as a constraint on the usual social utility function. For example, a government may act to maximize a consumption stream subject to an output objective for an industry due to national defense concerns. (4.) The concept of noneconomic objectives is developed more formally in Maneschi (2004). (5.) Smith's analysis of bounties has virtually been ignored by the secondary literature. One potential reason for this is Ricardo's rather violent reaction to one peculiarity of Smith's analysis of export bounties when applied to corn. Ricardo stated that, "Perhaps in no part of Adam Smith's justly celebrated work, are his conclusions more liable to objection, than in the chapter on bounties" (Ricardo 1990 [1817], p. 304). Specifically, Smith appears to rose a corn model to show that the bounty will not increase the real value of corn, and will thus not change land tents or increase domestic production. While this particular result is not the focus of this paper, it should be pointed out that Samuelson (1992, p. 10) supports Smith's conclusion based on a model that "both Ricardo and Smith occasionally found congenial." (6.) A similar argument is directed at the tonnage bounties given to the fishing industry (Smith 1994 [1776], p. 554). (7.) In the corn market Smith estimates that the domestic price rises by 4/5 of the bounty (Smith 1994 [1776], p. 544). (8.) This argument was not new in Smith. Viner (1975, p. 71) demonstrates that the link between the bounty on corn and the competitiveness of other industries was made by several authors prior to Smith. (9.) Another problem that Smith sees arising from the export bounty is the need for additional regulations to counter the adverse incentives created by the bounty. Specifically, the bounty on exports could make it profitable to import corn at the world price and then, re-export it to collect the bounty. This would make it necessary to raise import restraints on corn (1994 [1776], p. 577). (10.) Drawbacks are another example (Smith 1994: 533, 539). (11.) It is interesting that Ricardo (1990) explicitly denies that a bounty on production will have any effect on the value of a country's annual output for a country that is in autarky. However, for a country engaged in international trade, a Lerner effect similar to that offered by Smith is assumed: By altering the relative value of commodities and corn.... we should be applying a strong stimulus to the exportation of those commodities whose natural prices were lowered, and an equal stimulus to the importation of those commodities whose natural prices were raised, and thus such a financial measure might entirely alter the natural distribution of employments; to the advantage indeed of the foreign countries, but ruinously to that in which so absurd a policy was adopted. (Ricardo 1990 [1817], p. 326) In assessing the costs associated with an export bounty, Ricardo makes an interesting deadweight loss argument and calls an export bounty "[t]he worst species of taxation, for it does not give to the foreign country all that it takes away from the home country, the balance of loss being made up by the less advantageous distribution of the general capital" (1990 [1817], p. 314, emphasis added). However, Ricardo never extends his analysis to try to rank one policy against another. (12.) While the term "dead loss" bears an obvious similarity to the modern term "dead-weight loss," it is not obvious from his text what he meant. However, Say earlier (1964, p. 162) argued that "the loss of the consumer exceeds the gain of the monopolist" from various types of trade restraints. References Bhagwati, Jagdish. (1971). "The Generalized Theory of Distortions and Welfare." In Trade, Balance of Payments, and Growth: Papers in International Economics in Honor of Charles P. Kindleberger, edited by Jagdish Bhagwati et al. Amsterdam: North-Holland. Bhagwati, Jagdish, Arvind Panagariyz, and T. N. Srinivasan. (1998). Lectures on International Trade, 2nd ed., Cambridge, MA: MIT Press. Blecker, Robert A. (1997). "The 'Unnatural and Retrograde Order': Adam Smith's Theories of Trade and Development Reconsidered." Economica, 64: 255, 527-537. Elmslie, Bruce. (2004). "Adam Smith and Noneconomic Objectives." Review of International Economics 12: 689-692. Elmslie, Bruce, and Norman Sedgley. (2002). "Vent-for-Surplus: A Case of Mistaken Identity." Southern Economics Journal 68 (3): 712-720. Maneschi, Andrea. (1998). Comparative Advantage in International Trade: A Historical Perspective. Northampton, MA: Edward Elgar. --. (2004). "Noneconomic Objectives in the History of Economic Thought." American Journal of Economics and Sociology, 63 (4): 911-920. Myint, Hla. (1958). "The 'Classical Theory' of International Trade and the
Ricardo, David. (1990). On the Principles of Political Economy and Taxation. Edited by Piero Sraffa. Cambridge: Cambridge University Press. Samuelson, Paul. (1992). "The Overdue Recovery of Adam Smith's Reputation as an Economic Theorist." In Adam Smith's Legacy: His Place in the Development of Modern Economics. Edited by Michael Fry, New York: Routledge. Say, Jean-Baptiste. ([1880] 1964). A Treatise on Political Economy, or the Production, Distribution, and Consumption of Wealth, 4th ed. New York: Augustus M. Kelley. Smith, Adam. (1994). An Inquiry into the Nature and Causes of the Wealth of Nations. Edited by Edwin Cannan. New York: Modern Library. Viner, Jacob. (1975). Studies in the Theory of International Trade. Clifton, NJ: Augustus M. Kelley. BRUCE ELMSLIE, The author is at the University of New Hampshire, Department of Economics, Durham, NH 03824. His email is . The author thanks the Reginald F. Atkins Chair for financial support. He also thanks Jagdish Bhagwati, Lewis Davis, Jonathan Eaton, Timothy Ford, Douglas Irwin, Andrea Maneschi, and Norman Sedgley for helpful comments and encouragement on this and another related paper. COPYRIGHT 2004 American Journal of Economics and Sociology, Inc. This material is published under license from the publisher through the Gale Group, Farmington Hills, Michigan. All inquiries regarding rights should be directed to the Gale Group. For permission to reuse this article, contact Copyright Clearance Center. Print Digg del.icio.us Related articles from HighBeam Research: Smith's Gig: Alto Sacks; Redskins' Defensive End Approaching NFL All- Time Record The Washington Post; 10/19/2003; Nunyo Demasio; 2093 words; Bruce Smith's Sack Race; Back in Buffalo, Redskin Approaches NFL Milestone The Washington Post; 10/19/2003; Nunyo Demasio; 2096 words; WOLVES WOES: DAY 2; Nice guy made bad decisions; Joe Smith was a No. 1 pick with a sterling reputation. Where did things go wrong?(SPORTS) Star Tribune (Minneapolis, MN); 10/27/2000; Aschburner, Steve; 1815 words; Elihu Hubbard Smith's "The Institutions of the Republic of Utopia".(Critical Essay) Early American Literature; 9/22/2000; KAPLAN, CATHERINE; 7593 words;