The Wealth of Nations: Book 4, Chapter 2 Summary & Analysis

Import taxes and bans help national industries establish monopolies over particular markets. Such monopolies prop up the British meat, grain, and wool industries. Rather than expanding a society’s overall economy, such policies just reallocate its resources toward particular activities. People generally prefer to invest their capital near home and in the industries that produce the most value. Since the best way for a country to invest its resource is by promoting the highest-value domestic industries, capital owners are “led by an invisible hand” to do what is best for society, even though they are only thinking about their own interests. This decentralized system is far better than letting a single politician or political council decide where to invest society’s resources.

As a result, all import restrictions are either useless or harmful. They are useless if domestic produce is already as cheap as imported produce, and they are hurtful if they lead a country to invest its capital in producing something that would be cheaper to import, instead of in more productive industries. These restrictions can help certain industries grow faster, but only in the short term. Since countries often have natural advantages in producing certain kinds of goods, it is always wiser to buy foreign goods than try to produce them. For instance, due to its climate, Scotland should buy foreign wine, not try to produce its own.

Since most foreign trade consists of manufactured goods, which are easier to transport, import restrictions mainly enrich manufacturers and merchants. The effect is much smaller for rude produce. For instance, massive cattle, salt, and grain imports would not bankrupt British farmers. The bounty on grain exportation might increase exports in most years, but to compensate, it also increases imports in lean years. Accordingly, it mainly affects merchants, not farmers or landowners.

Import restrictions are justified in two cases. First, they promote industries key to the national defense. Britain protects its shipping industry by banning foreign ships and crews, and by requiring ships to travel straight from exporting countries to Britain (rather than stopping on the way). These rules helped the British outcompete the Dutch, but also seriously limited British foreign trade. Second, for goods that already face taxes on domestic production, import restrictions are justified to preserve fair competition. Some people suggest that domestic taxes on necessities (like salt, leather, and soap) raise all prices, so all imported goods should face taxes, but this effect is difficult to measure. Countries benefit from producing whatever they can make cheaply and importing whatever they cannot, so taxing foreign industry to compensate for tax-burdened domestic industries is foolish. Indeed, only rich countries can afford to enact high import taxes, which are economically damaging.

In two more cases, import restrictions are sometimes justified. First, when one country raises taxes on a second country’s goods, the second country is justified in retaliating by taxing the first country’s goods—but only to pressure the first country into reversing course. Second, when a country already has large domestic industries and heavy import taxes, it should reduce those taxes gradually rather than suddenly, or else too many workers will lose their jobs and too many businesses will collapse. Still, under a free trade system, goods that are already being exported will remain competitive at home, and fast economic growth will give newly-unemployed workers many new opportunities, as it does to soldiers returning from war.

Unfortunately, Britain will never really establish free trade because monopolist manufacturers have too much money, power, and influence over Parliament. When their businesses fail, these manufacturers sell off their circulating capital, but they lose the value of their fixed capital. But the slower taxes fall, the less fixed capital they lose.