Interventionism of Free Trade

Macroeconomics with Mr. Burns. This assignment was covering a great economist; I chose Adam Smith, and covered a portion of The Wealth of Nations in which he talks about the detrimental effects of interventionism. I'm still in this class (this is my first year at PA Homeschoolers) but so far I'm really enjoying the content in general because I've always loved Economics and I've also really enjoyed the business game.

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The Wealth of Nations, authored by famous macroeconomist Adam Smith, presents various economically advantageous reasons for free, unfettered trade to exist as much as reasonably possible. In Chapter 2 of Book 4, Smith argues that letting each man instrumentalize his capital in the manner he sees fit will maximize a society’s economic advantage. Via a rigorous economic analysis of government prohibitions on international trade, Smith’s economic masterpiece teaches the lesson that interventionism, while appearing beneficial, is ultimately detrimental.

The goal of interventionism, according to Smith, is to maximize the production in one’s home country: “By restraining...the importation of such goods from foreign countries as can be produced at home, the monopoly of the home market is more or less secured to the domestic industry employed in producing them.” (Smith 347) As stated, if the government places prohibitions on domestic exports, a nation will be forced to increase production of that item. How does this allegedly increase economic prosperity? The fundamental idea is that an increase in national production will create a monopolistic effect, wherein the citizens of a nation can only buy from the local producers, for there is no foreign price with which to compete. Smith describes this: “That this monopoly of the home market frequently gives great encouragement to that particular species of industry which enjoys it...cannot be doubted.” (347)

From a consideration of opportunity costs and specialization, multiple reasons come to mind for why interventionism as a theory should be rejected. The notion of opportunity costs demonstrates that the increase of production for one type of item entails the decrease of production for another type of item. Thus, on the assumption that neither technology nor capital has drastically grown, prohibiting the import of foreign items, and consequently forcing domestic sources to produce those items, entails the decrease of another type of item. Smith states this idea succinctly: “No regulation of commerce can increase the quantity of industry in any society beyond what its capital can maintain.” (348) Furthermore, fusing the theory of opportunity costs with the notion of specialization, if the nation’s new wave of production demands entails a decrease in an area or areas of manufacturing in which that nation has specialized, the new wave of production is actually harming the said nation’s economic prosperity. Smith’s reference to specialization is as follows: “As long as the one country has those advantages, and the other wants them, it will always be more advantageous for the latter rather to buy of the former than to make.” (Smith 352)

As a hypothetical, think of a scenario wherein Country A has specialized in producing computers, while Country B has specialized in producing cellular phones. While each country has the production resource to manufacture both computers and cellular phones, each country has specialized in one or the other and thus when they trade with each other, each country receives a better deal than producing both products with domestic resources. To further this hypothetical, Country A has prohibited imports of cellular phones from Country B, in hopes to increase cellular phone production. As Smith argues, the cellular phone industry in Country A will benefit, while it appears the national economy will suffer. Why? Country A has limited resources. Increasing the production of cellular phones entails a decrease in the production of computers. Thus, Country A’s decision to grow an industry wherein it is not specialized harms the economy.

The last point which ought to be considered in this essay is the detrimental effects of interventionism on the consumer. Smith writes, “Merchants and manufacturers are the people who derive the greatest advantage from this monopoly of the home market.” (Smith 352) Again, from a consideration of specialization, this observation is apparent. If Country A does not have the specialized techniques in manufacturing cellular phones as Country B, then the price to produce cellular phones will rise. If the price to produce cellular phones increases, then the price to buy a cellular phone will also increase. Furthermore, since increasing the production of cellular phones entails decreasing the production of computers, the price of computers will also rise. The supply for computers will decline while the demand will remain constant.

To conclude, Smith’s view of interventionism pinpoints various problems. An analysis of the theory through the considerations of opportunity costs, supply and demand, and specialization will yield three primary conclusions. Interventionism only aids the merchants and manufacturers of a specific industry, harms the consumer, and harms the general well-being of a domestic economy. The theory focuses on one aspect of economics, increasing domestic production, while overlooking a multitude of others.