How Did Adam Smith Criticize Mercantilism

• Mercantilist ideas about wealth were nonsensical and untenable.

• Mercantilists’ efforts of accumulating gold and silver by trade surplus were in vain.

• Mercantilist trade theory was self-contradictory and logically confused.

• Invisible hand also guided foreign trade.

What Is Real Wealth? Mercantilism vs. Adam Smith

• The basic mistake of mercantilist ideas about wealth: They confused the precious metals, such as gold and silver, with the real wealth of the nation.

• What is real wealth: “The wealth of the country consists, not in its gold and silver only, but in its lands, houses, and consumable goods of all different kinds.”

Function of Trade to a Country

• Why did Adam Smith reach his conclusion about wealth? Only because he viewed foreign trade in the right light.

• As Adam Smith recognized, foreign trade could explore the overseas market and greatly encouraged development of production capability of a country and necessarily led to increase of the real wealth possessed by the country.

Some Quotations of Adam Smith

• “To import the gold and silver which may be wanted, into the countries which have no mines, is, no doubt, a part of the business of foreign commerce. It is, however, a most insignificant part of it.”

• “The importation of gold and silver is not the principal, much less than the sole benefit which a nation derives from its foreign trade.”

Commodity Exchanges vs. Exchanges of Gold and Silver

• “The transportation of commodities, when properly suited to the market, is always attended with a considerable profits; whereas that of gold and silver is scarce ever attended with any. When those metals are sent abroad in order to purchase foreign commodities, the merchant’s profit arises, not from the purchase, but from the sail of the returns. But when they are sent abroad merely to pay a debt, he gets no returns, and consequently no profit.”

• 适应市场需求的商品与商品交换总是伴随着相当可观的利润，而黄金和白银交易却不能带来任何利润。当这些贵金属运到国外去是用于购买外国的商品，这只能导致进口商人的利润增加，当然这种利润的增加只是源于他们销售进口的商品，而不是源于他们的购买行为。但是，当黄金和白银运往国外仅仅是为了偿付债务，则不会有任何商品的流入，也就更谈不上利润了 。

Mystery of Money and a Widespread Feint

• When people exchange with each other by using currency as the medium of exchanges currency merely stands for purchasing powers with which whatever goods or services can be bought whenever they are desired.

• That fact will be easily misunderstood as a widespread feint that wealth is only and exclusively expressed in terms of currency.

Conclusion of Adam Smith on Wealth

• On the whole, a country was wealthy only because it had fostered a tremendous production capacity thus could produce a lot of consumable goods and services not because it possessed some amount of gold and silver.

• It must be of insignificance for a country to merely accumulate gold and silver. Only those enjoying their large capacity of production, being active in foreign trade, and exporting more and more goods and services to their trade partners could become wealthy countries in the world.

• Therefore, the ideas about wealth of mercantilists were nonsensical and untenable.

Specie-flow Adjustment Mechanism • Based on Quantity Theory of Money

David Hume initiated Specie-flow Adjustment Mechanism.

• Hume argued that general price level in a society in which gold or silver were used as money would be rigidly determined by dividing the total amount of specie with the total amount of commodities exchanged in market.

Formula of Determining Price

• When P stands for the general price level, M stands for total amount of money stock and W stands for total amount of commodities, respectively, the following formula is concluded.

W

MP

Trade Surplus can Do Nothing in Accumulating Gold and Silver

• Even if mercantilists were glad that a large amount of gold and silver had been imported from abroad because the country’s trade surplus that must be too bad, not good, for the country since enlargement of its stock of money implied the overall increase in the general price level taking the total amount of commodities constant.

• Competitiveness of its exports would be reduced whereas goods produced in other countries would be more competitive in the home market. Gold and silver accumulated through innumerable trials and hardships would gradually out-flow till the country’s pool of money dried up. Consequently the country would at last inevitably surfer trade deficits.

• To sum up, Adam Smith wrote: “When the quantity of gold and silver imported into any country exceeds the effectual demand, no vigilance of government can prevent their exportation.”

Self-contradiction of Mercantilist Trade Theory

• According to “zero-or-sum game” what a country gained in trade was just the losses in trade suffered by the other country since the total wealth, in terms of gold and silver, of the world was constant.

• It must be assumed that all countries will follow the same principles of national economic egoism and desired to earn in trade.

Some Keen-edged Questions

• All countries want to benefit from trade who are willing to suffer.

• No country wants to suffer from trade then how can the other countries acquire the possible trade benefits?

• If that is true is it possible for different countries to trade with each other?

• From where can the world find a reasonable basis for trade?

The Basic Theoretical Falsehood of Mercantilist Trade Theory

• As a theory it entirely did not explore what is trade, why to trade, how to trade, and are there generally existing trade benefits?

• It was little more than a theoretical tool of the feudalist lords, rulers of the sovereignties and large merchants to exercise colonial exploitation and dilation flaunting the banner of trade.

• Trade, in the eyes of the mercantilists, was nothing but bald-faced spoliation.

• Mercantilist trade theory could only explain trade between the western European powers with the colonies. That must be a very special case of trade. The theory was not of general significance.

Invisible Hand in Foreign Trade

• Adam Smith introduced his theory of laissez faire into the analysis of trade problem. He criticized mercantilist trade policy of intervening and monopolizing trade business.

• Invisible hand would also guided trade just like it did in domestic economic performances.

Adam Smith’s Conclusion• “What is the species of domestic industry which his

capital can employ, and of which the produce is likely to be of the greatest value, every individual, it is evident, can, in his local situation, judge much better than any statesman or law giver can do for him.”

• 资本应投入国内工业的何种部门，从事何种生产可以创造最大的价值，每一个个人，从其所处的地位出发所能做出的判断，显然比任何发电制定者们为他们做出的判断要高明得多。

• Government must reduce and, at last, abandon the administrative control over foreign trade and free trade policies must be implemented.

Questions and Problems

• Try to differ mercantilist ideas of wealth from that of Adam Smith

• Why we say that trade theory of mercantilism was self-contradictory and logically confused?

• Why Adam Smith insisted that trade surplus was of no helpful to accumulate gold and silver.

• Try to describe the reasons for a country to implement free trade policies.