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Adam Smith’s Views
On Customs and Trade

Mark K. Neville, Jr.

As this article marks the 200th presentation I have shared with you, I thought it fitting to mark this bicentennial celebration with a look backward, so that we can properly appreciate that some of the customs and trade issues of our present day were also vexing in that earlier time. I look back beyond the 1976 celebration in the U.S. which was marked by the“tall ships” sailing through the Narrows entrance into New York Harbor – yes, I was there at Fort Hamilton that sunny July afternoon—but to an even earlier day, when it was only sailing ships that ruled the waves. We are going back to the time of Adam Smith (1723-1790). Many will know Adam Smith as the Father of classical economic theory. His treatise, The Wealth of Nations, first published in 1776 – that year which is so important in U.S., and in British, history – set forth a comprehensive, systemic argument for free trade. He is best known for being the first and still the most notable proponent of free market capitalism and his notion of the “invisible hand”¹ refers to the unseen forces that drive a market, as opposed to a state-managed, economy.

But Adam Smith was one of those Renaissance or Enlightenment polymaths whose range of interests and scholarly expertise is astonishing in this age of specialization. He was a philosopher – after all he held the Chair in Moral Philosophy at the University of Glasgow for a time – and demonstrated expertise in astronomy, ethics and jurisprudence to name but a few other areas of interest. The trick that he and so few others have mastered was to have an expertise that was as broad as it was deep.

I expect that there will be some readers who will have been aware of that last point, but I would hazard a guess that the number who are already aware of the next point I will be making is but a few in a thousand: Adam Smith was a customs professional. In fact, he was a Commissioner of Scottish Customs (1778-1790). Not only that, he was from a family with extensive customs service, his father being a Comptroller of Customs in Scotland and other relatives serving as customs officers besides.

So, what can a moral philosopher and political economist, for such are the badges normally assigned to him, tell us about customs? It turns out to be quite a lot Plus ça change.

We can leave to another time a discussion on the role of a positive balance of trade – so extolled by some of President Trump’s economic advisors (hint: Smith shreds the validity of the doctrine, calling it absurd). Likewise, we can leave to another time a study contrasting the.Smithian agenda and that of the Hamilton Tariff Act of 1789 and the later Report on Manufactures (1791) which was an apologia for that Tariff Act and a statement of the protectionist principles underlying the economic and trade policies– the American System – promoted by Alexander Hamilton, the very same Hamilton for whom Fort Hamilton was named

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A longer side-by-side comparison would be very interesting. One point that merits mention here is the cavalier attitude of Hamilton on the possibility of rapprochement between the Northern industrialists who sought tariff protection for their infant manufacturing endeavors, e.g.,in the Blackstone River Valley of Rhode Island and Massachusetts, and the Southern agricultural magnates who sought free trade access to Great Britain and other export markets for their cotton, tobacco and other crops. The Southerners feared that high tariffs imposed by the U.S. would beget high tariffs in their export markets, impeding access to those markets. In his Report on Manufactures, Hamilton seriously underestimated the regional antagonism which came to be at the center of raging conflict at the time of enactments of the Tariff Acts of 1828 (termed “The Tariff of Abominations”) and 1832 (this was the occasion of the first “Nullification”crisis) and that lasted during the run up to the Civil War.

All of this discord over trade policy fueled the sectional rancor that resulted in the Civil War. In 1791 Hamilton wrote:

It is not uncommon to meet with an opin[ion] that though the promoting of manufactures may be the interest of a part of the Union, it is contrary to that of another part. The Northern & southern regions are sometimes represented as having adverse interests in this respect. Those are called Manufacturing, these Agricultural states; and a species of opposition is imagined to subsist between the Manufacturing a[nd] Agricultural interests…Ideas of a contrariety of interests between the Northern and southern regions of the Union, are in the Main as unfounded as they are mischievous. The diversity of Circumstances on which such contrariety is usually predicated, authorises a directly contrary conclusion. Mutual wants constitute one of the strongest links of political connection, and the extent of the[se] bears a natural proportion to the diversity in the means of mutual supply. Suggestions of an opposite complexion are ever to be deplored, as unfriendly to the steady pursuit of one great common cause, and to the perfect harmony of all the parts.

The Civil War proved how imperfect was Hamilton’s understanding of the issue—or the extent of his disingenuousness.

We find another error in Hamilton’s attempt to blunt the attack that a domestic industry freed of foreign protection by sheltering behind protective tariff walls would not simply raise prices in the U.S. market:

It is not an unreasonable supposition, that measures, which serve to abridge the free competition of foreign Articles, have a tendency to occasion an enhancement of prices and it is not to be denied that such is the effect in a number of Cases; but the fact does not uniformly correspond with the theory But though it were true, that the immedi[ate] and certain effect of regulations controuling [sic] the competition of foreign with domestic fabrics was an increase of price, it is universally true, that the contrary is the ultimate effect with every successful manufacture. When a domestic manufacture has attained to perfection, and has engaged in the prosecution of it a competent number of Persons, it invariably becomes cheaper. Being free from the heavy charges, which attend the importation of foreign commodities, it can be afforded, and accordingly seldom or never fails to be sold Cheaper, in process of time, than was the foreign Article for which it is a substitute. The internal competition, which takes place, soon does away every thing like Monopoly, and by degrees reduces the price of the Article to the minimum of a reasonable profit on the Capital employed. This accords with the reason of the thing and with experience.

Whence it follows, that it is the interest of a community with a view to eventual and permanent economy, to encourage the growth of manufactures. In a national view, a temporary enhancement of price must always be well compensated by a permanent reduction of it.

In translated summary, Hamilton argued that any increases in prices occasioned by protective tariff walls would be temporary only. Assuming this to be sincere, this was expounded at the dawn of the Industrial Revolution so perhaps we might be forgiving. But taking our long experience with the effect of protective tariffs and other measures, my reaction at this juncture is, “He is clearly deluded and seeks to delude the reader.”

We can leave Mr. Hamilton’s musings and look to the Smith description of the measures that had been taken to shore up the mercantile system in his day. The two great engines for enriching the country with mercantilist designs were restraints upon importation and encouragements to exportation.

The restraints upon imports were of two kinds. The first was of general restraints on imports of goods, regardless of origin, which are also available in the country of importation. The second variety was broader, not focused on domestic goods facing import competition but looking, instead, to restraints on imports of most goods from countries with which the importing country is running a supposedly disadvantageous balance of trade. The restraints took the form either of high duties or outright prohibitions…

As for the encouragement of exports, those measures took the form of drawbacks, bounties (we would term them subsidies²), advantageous trade treaties or the establishment of foreign colonies. All of these measures were in aid of increasing the quantity of gold and silver, reckoned at the time to be the only measure of a country’s wealth. The increase in the money supply would be seen as improving a country’s balance of trade. Smith criticized this simplistic approach, and reckoned the better measure of country's wealth as the total of its annual produce, a concept in line with today’s calculation of Gross National Product(GNP) as the ultimate measure of the size or health of an economy. Before we proceed further, it is well to recognize that the trading system described by Smith could have been applied to the trade system that prevailed until the advent of the post-World War II free trade order ushered in by the General Agreement on Tariffs and Trade 1947(GATT 1947) and later by the World Trade Organization (WTO) and the adoption of GATT 1994. That earlier time was a zero-sum game, marked by protectionist tariffs, colonial preferences, and subsidies galore.

It also bear sufficient deterrent effect against China’s aggressive trade tactics fueled by mercantilist ambitions. Indeed, many of those current abuses would seem quite familiar to Smith.

Restraints on Imports

Coming first to the issue of restraints on imports competing with domestic industry, it is important to first recognize that the general rules under the GATT allow for interference in the exercise of free market trade only in certain delineated exceptions. These include provisions in Article XX of the GATT 1994 for restraints based on such concerns as morals, health, exportation of gold or silver, the protection of intellectual property rights, prison labor and short supply. Article XIX of the GATT1994 sets forth the circumstances underwhich “escape clause actions” – so named because they allow a WTO member to escape from its obligations and to impose import restraints – may be put into place.³ As a result, the U.S. trade law provisions, such as 19 U.S.C. § 1337 and 19 U.S.C. §1307, are consistent with the GATT 1994. Departures from unadulterated free trade, and the active interference of government in the importation of goods that compete with domestic goods, are also foreseen with Article XXI, GATT 1994, which allows for trade restraints for national security purposes. See 19 U.S.C. § 1862. Unfair competition is not allowed to persist under the WTO system, and the Antidumping Agreement and the Agreement on Subsidies and Countervailing Measures both ensure that dumping and the conferring of unfair subsidies will not be tolerated. See 19 U.S.C. § 1673 and 19 U.S.C.§ 1671 for the U.S. domestic law expressions of those programs.

One brief historical note is in order: The Tariff Act of 1816 was the first openly protectionist U.S. legislation.⁴ It aimed to protect the still-growing iron industry, to be sure, but its aim in imposing significant ad valorem duties on cotton and woolen goods was actually an antidumping measure in all but name, as those products were being dumped onto the U.S. market by Great Britain traders after the conclusion of the Napoleonic Wars. One observation: unlike today’s antidumping regime, the duties were not targeted against British imports but extended across-the-board. I do not believe that the trade remedy term “dumping” – briefly defined as the selling of a product in a foreign market at below costs of production or below the prices in the home market – was ever directly employed by either Smith or Hamilton.

While the focus of the GATT is on the impact on foreign companies which have seen market access reduced or eliminated altogether for their exports, Smith’s focus was on the creation of a monopoly against their countrymen in favor of the domestic industry. The effect of the monopoly was to encourage the particular industry, to be sure, but at the expense of the country, because the natural application of capital and industry has been artificially diverted by the monopoly. It would have been stimulating to have witnessed a Smith vs.Hamilton debate.

To be sure, Smith’s approach on this first category of restraints did allow for exceptions. Indeed, with obvious implications for Hamilton, these burdens were said to be advantageous for the encouragement of domestic industry. The first was for national defense, and the example Smith gave was the prohibitions against certain carriage by foreign vessels or differential tonnage tax imposed on foreign vessels. Incidentally, these same features are found in the Duties on Tonnage Act of 1789⁵ and you will note that the Jones Act⁶ still prohibits foreign vessels from participating in the coastal trade today. You should also know there is a duty imposed on vessel repair costs incurred in foreign shipyards absent an emergency.⁷

The second permissible restraints Allowed by Smith was for a response/retaliation to a tax being imposed in the foreign market on the like domestically produced goods. You will see in this scheme the basis for two comments. First, you can see the logic of the destination tax principle in regard to indirect taxes, such as VAT being imposed on imports but being remitted on Exports. Hence, the fact that the U.S. does not have a federal level VAT has given rise to decades’ long complaints of unfairness in some U.S. circles. Second,the suitability of retaliation for unfair treatment is grounded in the guarantee of national treatment in Article III of the GATT 1994 and in Section 301 of the Trade Act of 1974.⁸ Still, Smith advised caution, observing that retaliation may be a good policy when there is a probability that they will procure the repeal of the offensive practices. In the absence of such a probability, however,Smith saw it as a bad business for the country. He saw it as a real tax on all of the other members of the society.

As an aside, it is worthwhile to note that Smith did make a mistake when he wrote that to reintroduce free trade by lifting import restrictions all at once would not create serious disorder. He noted that such a move would not affect exports and that workers that might be displaced by an import surge could easily find employment elsewhere. The recent experience with the surge in imports from China into the U.S. after it was granted permanent Most Favored Nation status belies that sanguine view. Encouragement of Exports

For Smith, the first export-enhancing program was duty drawback , allowing for a refund upon the export of duties previously paid when the goods or the materials that went into the exported fin-shed products had been imported. This program has been an integral feature of the U.S. customs law since the Tariff Acton 1789⁹ and it is now set forth in Section 313 of the Tariff Act of 1930.¹⁰ An interesting side note for the role of drawbacks in Hamilton’s world: in the Report on Manufactures, he was so focused on promoting the growth of the cotton “white goods” of New England (“to let our infant manufactures have the full benefit of the best materials on the cheapest terms”)that he was looking to allow for the draw-back of duty on imported cotton fiber as that was reckoned to be superior to the domestic industry. To compensate for this, his plan was to confer a bounty on the national cotton when it was wrought at a U.S. cotton mill and a further bounty when the finished products were exported.¹¹

This takes us to the subject of bounties ,our second category of export. In our day,subsidies which are (i) made contingent on export, (ii) which support import substitution or which (iii) are domestic subsidies and specifically granted to a business or industry are recognized as the trade distorting practices that they are.¹² They are proscribed. In Smith’s time, bounties were widely available. If the bounties were provided on exportation, he observed that they were made available only for losing trades. Smith saw that the grant of a bounty upon export was tantamount to a payment to a foreign buyer to buy the goods. He rejected the practice which, under mercantilist principles, was supposed to benefit the country by means of an improved balance of trade. Smith saw it as an injurious distortion. As for bounties on production, Smith perceived them as more effective and less restricting than export bounties but commented that they were relatively rare in Great Britain. Hamilton suggested production bounties for such diverse product sectors as sail cloth, cotton products and glass, refined sugars and chocolate. But he first noted a warning about bounties:

It is a familiar objection to them, that they are difficult to be managed and liable to frauds. But neither that difficulty nor this danger seems sufficiently great to countervail the advantages of which they are productive, when rightly applied. And it is presumed to have been shewn, that they are in some cases, particularly in the infancy of new enter-prises indispensable.

He also signaled a limitation:

any bounty, which may be applied to the manufacture of an article, cannot with safety extend beyond those manufactories, at which the making of the article is a regular trade.

Smith further tempered his views on bounties when it came to national defense,noting that:

If any particular manufacture was necessary, indeed, for the defence [sic] 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.

Smith gave the examples of bounties on exports of sail cloth and gun powder,coincidentally two industry sectors that Hamilton likewise thought important. In our time, you will recall that import-restricting measures taken for valid national security purposes are permitted.

Smith also clarified that the common use of the term bounty to refer to the ex-port of a finished article that had been manufactured with an imported material was a misnomer.¹³ In fact, it was a draw-back of the duty that had been paid on the material, but the customs parlance of that day reserved the term drawback to the exportation of the previously imported article. One of the examples he gave was of the gunpowder bounty being a draw-back of the duty on the imported saltpetre[sic] and brimstone. It would appear that Hamilton, too, used the term drawback on manufactured articles in our modern sense.

Treaties of Commerce

Smith saw that treaties of commerce might be advantageous to one country—the favored country – but disadvantageous to the other – the favoring country. He analyzed the Methuen Treaty (1703) between England and Portugal and concluded that Portugal was the favored and England was the favoring country. The question of balance in and benefits of treaties is very much alive today. As we saw in a recent article,14 organized labor has succeeded in promulgating a “worker centric” approach to free trade agreement (FTA) negotiations such that the risk of disadvantage for U.S. workers through offshoring is lessened by insisting on standards that raise production costs in the other country. Such a tactic changes the competitive environment by reducing any differential in production costs. Given the relative lack of success to make more progress at the WTO, we have seen more attention to bilateral trade agreements. We can expect that close scrutiny will be paid to the issue of fairness in therein the same measure as in FTA negotiations.

While they may not arise to the status of treatie, there is one species of trade measures where it is understood from the outset that the arrangement will not be fair or mutually beneficial at least in direct, commercial terms. This is the number of unilateral trade preference programs such as the Generalized System of Preferences and its regional varieties, under which the qualifying goods imported directly from beneficiary developing counties (BDCs) to use the GSP term,gain duty-free access to the U.S. market.¹⁵ Neither Adam Smith nor Alexander Hamilton would understand these politically motivated trade preference programs that are not designed to directly benefit the UK or the U.S. or their manufacturing bases. Parenthetically, most other developed countries have similar programs in place. The benefit provided to the BDC is immediately apparent. The benefit to the U.S. and the other developed countries might be the raising of their standard of living and their industrial development and the moderation of geopolitical tensions. At least in the U.S., some products will not be eligible as they will seem to be too competitive to the U.S. industry, and some countries are not eligible for BDC status, e.g., Communist countries and those that support terrorism. So, there is filter on the generosity.

The last program that Smith cited as encouraging exports was the establishment of foreign colonies.

Colonies

Admittedly it had been generally assumed that we have been living in a post-colonialage. Recent events have shaken that assumption. First, the actions by China in its Belt and Road and other initiative shave all the earmarks of a colony-building enterprise, especially but not only in Africa. Second, Venezuela might be safely categorized as a colony of Cuba and not simply a client state of the latter. Finally,it is clear that Russia has had colonial designs on Ukraine, with its storied grain belt and its recently discovered mineral wealth, and other Eastern European states that threw off the Russian/Soviet yoke. and finally the French and British colonies,makes for an interesting background. He concludes that the monopoly on trade be-tween the mother country and the American colonies actually exerted a distortion which redounded to Great Britain’s detriment.

What is truly fascinating is to review his thoughts on how the antagonism between the two participants might be resolved. The first edition of The Wealth of Nations was published in 1776 when the hostilities which resulted in the rupture between the two had already reached a boiling point. Smith was well acquainted with American attitude sand on the challenges to rapprochement as he was a friend of Benjamin Franklin, who had resided in London throughout the 1760s and as late as 1775. Smith was also a great friend of Edward Gibbon and Edmund Burke, and it is notable that the conservative views of the latter were ultimately rejected by George III and his cabinet. What Smith proposed was that the colonies should have a direct representation in Parliament, in direct proportion to the tax revenue raised. Considering the natural progress expected from the colonies, the far-seeing Smith even floated the remarkable notion of the British Parliament being shifted to America:

Such has hitherto been the rapid progress of that country in wealth, population and improvement, that in the course of little more than a century, perhaps, the produce of American might exceed that of British taxation. The seat of the empire would then naturally remove itself to that part of the empire which contributed most to the general defence and support of the whole.

Wow! If that were so, maybe – or maybe not – Samuel Adams and James Otis, they of the “no taxation without representation”rallying cry in the run up to the Revolutionary War, would have nothing to say to the notion of taxation with representation. And, obviously, 1776 and 1976 would have had no historical significance. At this point you should appreciate this closing quotation from Oscar Wilde:

He to whom the present is the only thing that is present knows nothing of the age in which he lives. To realise one’s own century one must realise every century that has preceded it and that has contributed to its making.

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