Adam Smith and International Trade: Between the Division of Labour and the Natural Order of Progress REINHARD SCHUMACHER 1

Transcription

1 Adam Smith and International Trade: Between the Division of Labour and the Natural Order of Progress REINHARD SCHUMACHER 1 A PRELIMINARY DRAFT WORK IN PROGRESS PLEASE TO DO NOT CITE INTRODUCTION During the 18 th century, a debate was going which is known today as Rich Country Poor Country debate. At the heart of this debate was the question if poor, economically less developed countries will converge with rich, economically more advanced countries over time and the role of international trade. The convergence side was taken mainly by David Hume who argued that rich nation are destined to be impoverished because poor nations can sell all goods cheaper due to its lower wages. He uses his price-specie-flow mechanism as his main argument to show how international trade will lead such convergence. The divergence side was represented most famously by Josiah Tucker, who argued that economically successful nations have certain advantages which will let them keep and even increase their lead over poor nations. Hume retained the position that all nations will finally reach a state of decay. Tucker disapproved of this position and argued that there is no reason why a nation should finally decay and that international trade will always benefit the richer nation more than it does the poorer. Today, Adam Smith is ascribed to the divergence side, though he has not participated in the debate himself. The recent interest in his theory of international trade has mainly focussed on 1 Contact: Reinhard Schumacher, Department for Economic and Social Sciences, Universität Potsdam, August- Bebel-Straße 89, Potsdam, Germany; rschumac@uni-potsdam.de

2 Smith s concept of the division of labour. At the beginning his economic magnum opus An Inquiry Into the Nature and Causes of the Wealth of Nations (WN), Smith embeds foreign trade in this concept. This is taken as evidence for his divergence position because it leads to the conclusion that a rich country is able to extend its leads over a poor country. There is a self-enforcing backwardness of the poor country. Yet, there exists another storyline in the WN, which he expounds as the book progress. Here, Smith argues that there exists a natural order of progress. A country will only participate in international trade after its agriculture and industry developed to a certain stage. Eventually, each country will reach a final state or a state of stagnation, in which economic development comes to a halt. This is derived from his theory of wages, profits, rents, capital accumulation and population growth. This state of stagnation will lead each nation into economically decline. This would lead to the conclusion that poor countries will, at least in the long-run, close the gap and catch up with rich countries. These two arguments place Smith on the convergence side of the debate. As a result, there are two seemingly opposing forces in Smith s writings about foreign trade. He is contradictory about the question how a poor nation develops in comparison to a rich nation. Smith himself does not give a definite solution of this contradiction, namely if there is a divergence or a convergence between rich and poor countries, and how this divergence or convergence is influenced by international trade. Rather, he refrains from any clear conclusion on how poor countries will evolve relative to rich countries. This is surprising considering that the rich country poor country debate took place among close friends of Smith. The content was known to him and yet, he does not refer to this debate in the WN. In this paper I will first discuss Smith s ideas of foreign trade, with a main focus on the development of poor and rich countries. It will be shown how Smith deals with the question of convergence or divergence in the WN. Both apparently opposing storylines will be traced, discussed and compared. Afterward I will outline the rich country poor country debate. Subsequently, Smith s ideas should be related to this debate. It will be discussed which ideas influenced Smith and how he came to the two seemingly contradictory developments. The development of Smith s ideas will be reconstructed by comparing the Lectures on Jurisprudence (LJ), the Early Draft of Part of the Wealth of Nations (ED) and the final version of the WN. In the last part, explanation for the existence of this contradiction in the WN are discussed.

3 ADAM SMITH, INTERNATIONAL TRADE AND ECONOMIC DEVELOPMENT THE ARGUMENT FOR UNEVEN DEVELOPMENT IN THE WEALTH OF NATIONS Smith has long been considered as a poor trade theorist (Schumacher 2012). In the last decades, however, there has been a revival of Smith s international trade theory. The focus has especially been laid on the relation of international trade and economic development. It is argued that Smith assumes that foreign trade facilitates economic growth and development. From his concept of the division of labour, it is inferred that trade between a rich, developed nation and a poor, less developed nation leads to an uneven development that amplifies this disparity between those nations. Though foreign trade is beneficial for the poor nation in absolute terms, it will benefit less compared to the rich nation and might even be locked-in a relative backwardness. The argument is derived from Book I of the WN. The division of labour, which Smith discusses extensively in the first chapters, provides the basis for his understanding of economic development in an industrial society. 2 He argues that the division of labour is responsible for the greatest improvement in the productive powers of labour (WN I.i.1). The division of labour leads to specialisation in different operations, which increases productivity, because workers become more efficient and dextrous and technological inventions are stimulated (WN I.i.5-8). There are two main restraints which influence the division of labour. First, it is limited first by the power of exchanging or the extent of the market (WN I.iii.1). The market size itself is determined by what Smith calls the effectual demand. A second limit to the division of labour is the accumulated capital: As the accumulation of stock must, in the nature of things, be previous to the division of labour, so labour can be more and more subdivided in proportion only as stock is previously more and more accumulated (WN II.3). However, both limits are not independent of the division of labour. Rather, they depend on the division of labour. There exists thus a self-enforcing mechanism between them. The extent of the market is broadened by an advanced division of labour, because it leads to an increase in wealth and thus income. This increase in wealth leads to a higher demand, which increases the extent of the market. Additionally, technological developments, which result from an advanced division 2 The division of labour requires a system of exchange, in which products can be traded. Otherwise, the division of labour would not neither be possible nor beneficial. That both, the division of labour and exchange, take place in a society is a consequence of the human "propensity to truck, barter, and exchange one thing for another" (WN I.ii.1). 2 This human propensity is the source of Smith s economic theory. For Smith, they represent the basic pattern of economic behavior (Lowe 1954, p. 132) in a commercial society.

4 of labour, might also directly widen the market, because they can lead to an improved infrastructure, so that more people might be able to participate in a certain market (WN I.iii.3). Thus, the extent of the market and the division of labour reinforce each other mutually. Similarly, capital accumulation and the division of labour reinforce each other. As the division of labour advances, national wealth grows, which will lead to more capital accumulation. In this way, capital is firmly subordinated to the division of labour; it is an intermediating constraint that allows greater specialization and productivity (Berdell 2002, p. 86). In essence, Smith s approach can be summarised by saying that the division of labour depends in large part upon the division of labour (Young 1928, p. 533). Once the market is extended, the division of labour can be enhanced, specialisation is increased, technological development is stimulated and the dexterity of the workforce rises. This leads to increased productivity and opulence. More capital will be accumulated and incomes will rise. This in turns means that the effectual demand is increased and exchange is augmented. The market is widened even further. This leads to a self-reinforcing mechanism of economic growth and development. This dynamic force of the division of labour resembles an ever rising spiral (Thweatt 1957, p. 228). Consequently, the division of labour presents a measurement of economic development according to Smith. The opulence and wealth of a nation are the direct result of its level of division of labour. Thus, the division of labour is more advanced in the most industrial nations (WN I.i.4). Likewise the extent of the market is bigger and more capital is accumulated in those nations compared to less developed nations. This might lead to the conclusion that trade between a rich and a poor nation is a one-way trade, because the all goods can be produced more productively in the rich nation. Here Smith s differentiation between different sectors of production and his wage theory play an important role in this context. Smith argues that the division of labour progresses not uniformly in all sectors of production. He argues that in agriculture, the improvement in the productive powers of labour [...] does not always keep pace with their improvement in manufactures (WN I.i.4). The reason thereto is that, the nature of agriculture...does not admit of so many subdivisions of labour, nor of so complete a separation of one business from another, as manufactures. It is impossible to separate so entirely the business of the grazier

5 from that of the cornfarmer as the trade of the carpenter is commonly separated from that of the smith (WN I.i.4). 3 The wage level in Smith s theory depends on the subsistence of the labourer (WN I.v.15), which in turn is dependent on the capital accumulation. The more capital is accumulated, the higher the wages are, because more capital is competing for the existing workers. This increased competition raises wages (WN I.viii.21). Workers in nations which have a higher level of development, i.e. an advanced division of labour, have higher incomes. They are able to buy more and better goods. Elmslie therefore argues that Smith has a sociological, rather than a pure biological, subsistence in mind when considering subsistence wages (1994, p. 267). Poor, less developed nations have a lower living standard and a lower wage level. Thus, the national wage level depends on a nation s overall economic performance. 4 The wage level is equal in the different sectors of an economy; otherwise workers would move from one sector to another. However, the division of labour and thus productivity in manufacturing grows faster than in agriculture, as we have seen, even though wages increase equally in both sectors inside a nation. As a result, the increase in productivity relative to the rise in wages must be greater in the industrial sector than in agriculture. 5 This development amplifies the advantage of industrial nations in manufacturing over poor and less productive nations, since wages are a main determinant of the production costs. In agriculture, however, national wages in rich nations grow faster than productivity. Wages in poor nations are lower, but their lag in productivity of agricultural goods is relatively smaller. Hence, poor nations might be able to offset the low productivity in agriculture with a lower wage level. They can than compete with and undersell rich countries in agricultural goods: The most opulent nations, indeed, generally excel all their neighbours in agriculture as well as in manufactures; but they are commonly more distinguished by their superiority in the latter than in the former. Their lands are in general better cultivated, and having more labour and expense bestowed upon them, produce more in proportion to the extent and natural fertility of the ground. But this superiority of produce is seldom much more than in proportion to the superiority of labour and expense. In agriculture, the labour of the rich country is not always much more productive than that of the poor; or, at least, it is never so much more productive as it commonly is in manufactures. The corn of the rich country, therefore, will not always, in the same degree of goodness, come cheaper to market than that of the poor. (WN I.i.4) 3 However, the division of labour in both sectors correlates as Smith points out in chapter 4 of Book III. Productivity increases in manufacture will also lead to productivity increases in agriculture, in part because technological innovations can be used in both sectors. 4 This leads Smith to the notion that high wages are the result of economic growth and never a cause of decreased competitiveness: The high price of labour is to be...regarded as what constitutes the essence of public opulence (Smith 1978a, p. 567). 5 Smith states that the wage level seldom rises in the same proportion as the improvements of industry and arts advances (Smith 1978b, p. 344). In one pin making example, the productivity of the worker is doubled but the wages increase only by one third (Smith 1978a, p. 566).

6 In agriculture, the lower wage level might compensate the lower level of productivity in poor nations. Smith illustrates his point with an example in which he compares Poland, France and England: The corn of Poland, in the same degree of goodness, is as cheap as that of France, notwithstanding the superior opulence and improvement of the latter country. The corn of France is, in the corn provinces, fully as good, and in most years nearly about the same price with the corn of England, though, in opulence and improvement, France is perhaps inferior to England. The corn-lands of England, however, are better cultivated than those of France, and the corn-lands of France are said to be much better cultivated than those of Poland. But though the poor country, notwithstanding the inferiority of its cultivation, can, in some measure, rival the rich in the cheapness and goodness of its corn, it can pretend to no such competition in its manufactures. (WN I.i.4) 6 According to this approach, poor nations may have a production cost advantage in agricultural goods, because the wage level is lower and the productivity gap is smaller in agriculture. However, in manufacturing, less developed nations will, as a result of their underdevelopment, have an production cost disadvantage. These nations are only able to specialise in agricultural goods if they participate in free trade. Their exports will consist of agricultural products, while rich nations specialise in manufactured goods and export them to poor nations. This development is more beneficial for the rich nations because the division of labour advances faster in manufacture. Rich nations invest in and expand their manufacturing sector which will yield technical growth, productivity growth and a faster accumulation of capital. Consequently, nations that specialise in manufacturing benefit to a greater degree from free trade because their productivity in both sectors and wealth will increase fastest and furthest. Their economies as a whole will grow faster because these nations are able to extent their division of labour more rapidly. Contrary, a nation that specialises in agriculture is not able to extent its division of labour in the same degree and will have a slower productivity and economic growth. As a result, international time increases uneven development and poor nation will not be able to catch up with rich nations. Disparities in economic and technological development, in national opulence and in income levels will increase over time as a result of trade. Rich nations will increase their lead, while poor nations will only be able to compete in agricultural goods on the international market. This development will continue as a result of free trade: This pattern, once begun, is self-perpetuating (Milberg and Elmslie 1993, p. 41). Poor countries are locked-in in the production and selling of agricultural goods 6 This example and the point illustrated by it should not be confused with theory of comparative advantage. Some writers (e.g., Blecker 1997; Bloomfield 1975; Elmslie and James 1993; Elmslie 1994), on different grounds, wrongly use this example to show that Smith had a rudiment of the theory of comparative advantage. Though Smith states a reason why even countries which lag in productivity might still be competitive, it has nothing in common with the static equilibrium analysis of the theory of comparative advantage. Neither relies it on the same narrow assumptions nor comes it to the conclusion that all nations must, by definition, be equally competitive.

7 (Elmslie 1994, p. 259). Differences in economic development and wealth are therefore not natural but they are the result of trade. This does not mean that poor nations cannot increase their opulence and living standard. Smith has a very optimistic view of free trade. International trade widens the market for agricultural goods and thus, the division of labour in agriculture will extent and also lead to economic gains. Poor nations might thus grow wealthier in absolute terms, though their underdevelopment increases relative to developed nations. STAGANTION AND THE NATURAL ORDER OF OPULENCE However, in the course of the WN, Smith s arguments seem to run into opposition to the argument of uneven development. Instead, Smith s theoretical considerations lead him to the conclusion that all nations will finally reach the state of stagnation in which the economy stops growing. Additionally, he argues that there is a natural order of progress which all nations are destined to follow if they do not interfere with the natural behaviour of humans. State of Stagnation The accumulation of capital is a prerequisite and a restraint of the division of labour. In order to enhance the division of labour, capital must be accumulated. However, Smith argues that the rate of profits, which regulates the accumulation of capital, will decrease with economic development. This is a result of his theory of wages, profits and rents. In Smith s theories, profits are directly opposed to wages (and rents). Thus, if wages increase, profits fall. Economic growth and development is characterised by increasing wages. Capital accumulation leads to a higher competition between different capitals for the same amount of labour: As capitals increase in any country, the profits which can be made by employing them necessarily diminish. It becomes gradually more and more difficult to find within the country a profitable method of employing any new capital. There arises in consequence a competition between different capitals, the owner of one endeavouring to get possession of that employment which is occupied by another. [...] The demand for productive labour, by the increase of the funds which are destined for maintaining it, grows every day greater and greater. Labourers easily find employment, but the owners of capitals find it difficult to get labourers to employ. Their competition raises the wages of labour, and sinks the profits of stock. But when the profits which can be made by the use of a capital are in this manner diminished, as it were, at both ends, the price which can be paid for the use of it, that is, the rate of interest, must necessarily be diminished with them. (WN II.iv.8) 7 7 See also WN I.ix.2 and I.x.c.26

8 Economic progress is thus intertwined with a falling rate of profits. Economic growth will, however, also lead to a population increase which mitigates this effect in the long-run. 8 But even population growth does not reverse this development, because it is restrained itself. The reason why the population increases is not a higher birth rate but that more children will survive and grow up. As a result, the wage funds, i.e. the funds which are destined for the payment of wages (WN I.viii.18), will increase with economic development to a higher degree than the amount of workers. Rising wages are in Smith s theory linked to an increasing wealth: The increase of revenue and stock is the increase of national wealth. The demand for those who live by wages, therefore, naturally increases with the increase of national wealth, and cannot possibly increase without it (WN I.viii.21). It should be stressed that high or increasing wages do not depend on the national wealth but on its continual increase : It is not, accordingly, in the richest countries, but in the most thriving, or in those which are growing rich the fastest, that the wages of labour are highest (WN I.viii.22). 9 Thus, both the wages and the rate of profits depend upon the increasing or declining state of the wealth of the society; but those causes affect the one and the other very differently (WN I.ix.1). Smith s approach does not mean that the rate of capital accumulation falls immediately after economic development has begun, because with greater capital but a lower rate of profit, the absolute rate of accumulation might still increase. However, at a certain point, the rate of profits will fall so far that the accumulation of capital will finally slow down and stop and with it the enhancement of the division of labour. This leads Smith to the conclusion that all countries will finally reach a state of stagnation. This state is characterised by a low rate of profit and low wages. Wages will fall because there is no increasing stock of capital that competes for the same amount of labour anymore. Smith concludes that: In a country which had acquired that full complement of riches which the nature of its soil and climate, and its situation with respect to other countries allowed it to acquire; which could, therefore, advance no 8 Every species of animals naturally multiplies in proportion to the means of their subsistence, and no species can ever multiply beyond it (WN I.viii.39). The liberal reward of labour, by enabling them to provide better for their children, and consequently to bring up a greater number, naturally tends to widen and extend those limits. It deserves to be remarked too, that it necessarily does this as nearly as possible in the proportion which the demand for labour requires. [ ] It is in this manner that the demand for men, like that for any other commodity, necessarily regulates the production of men; quickens it when it goes on too slowly, and stops it when it advances too fast. It is this demand which regulates and determines the state of propagation in all the different countries of the world, in North America, in Europe, and in China; which renders it rapidly progressive in the first, slow and gradual in the second, and altogether stationary in the last. (WN I.viii.40) 9 It is obvious, therefore, that high wages are a sign of economic progress for Smith. Therefore, he argues that high wages for labourers are good for a society: But what improves the circumstances of the greater part can never be regarded as an inconveniency to the whole. No society can surely be flourishing and happy, of which the far greater part of the members are poor and miserable. It is but equity, besides, that they who feed, cloath and lodge the whole body of the people, should have such a share of the produce of their own labour as to be themselves tolerably well fed, cloathed and lodged (WN I.viii.36). He argues that high wages are the liberal reward of labour and [t]o complain of it is to lament over the necessary effect and cause of the greatest publick prosperity (WN I.viii.42).

9 further, and which was not going backwards, both the wages of labour and the profits of stock would probably be very low. In a country fully peopled in proportion to what either its territory could maintain or its stock employ, the competition for employment would necessarily be so great as to reduce the wages of labour to what was barely sufficient to keep up the number of labourers, and, the country being already fully peopled, that number could never be augmented. In a country fully stocked in proportion to all the business it had to transact, as great a quantity of stock would be employed in every particular branch as the nature and extent of the trade would admit. The competition, therefore, would everywhere be as great, and consequently the ordinary profit as low as possible. (WN I.ix.14) This, however, leads to the conclusion that all nations will end up in more or less the same economic situation after they introduced a system of natural liberty, reap its benefits and go through its development. First, a nation accumulates capital and enhances its division of labour. This leads to economic progress and a self-reinforcing mechanism. More capital is accumulated and the division of labour is further enhanced. However, during this process wages will rise and the rate of profits falls. More economically developed nations have a lower rate of profits. In a final state of stagnation the rate of profit is so low that no more capital can be accumulated and the division of labour will not be enhanced any further. As a result, wages will fall and the society and economy will enter a state of decay. This approach of growth and decay features prominently in the WN (e.g., WN I.viii.24, I.ix.14 and II.iv.8). Natural Order of Opulence Smith s second argument that is opposed to the notion of lasting uneven development is that he assumed a natural order of opulence which every country would experience once it had established a system of natural liberty. Far from remaining backward, poor countries would with time establish manufactures and finally international trade. According to Smith capital owners have a clear preference when they employ their capitals: In seeking for employment to a capital, manufactures are, upon equal or nearly equal profits, naturally preferred to foreign commerce, for the same reason that agriculture is naturally preferred to manufactures. As the capital of the landlord or farmer is more secure than that of the manufacturer, so the capital of the manufacturer, being at all times more within his view and command, is more secure than that of the foreign merchant. (WN III.i.7) Thus, capital owner first employ their capital in agriculture. However, if there is a certain amount of capital employed in agriculture, the rate of profit decreases and capital owner are willing to employ there capital in manufacturing and later in foreign trade. There is a clear sequence in which capital will be employed in a liberal society: According to the natural course of things, therefore, the greater part of the capital of every growing society is, first, directed to agriculture, afterwards to manufactures, and last of all to foreign commerce. This order of things is so very natural, that in every society that had any territory, it has always, I believe, been in some degree observed. Some of their lands must have been cultivated before any considerable towns could be established, and some sort of coarse industry of the manufacturing kind must have been carried on in those towns, before they could well think of employing themselves in foreign commerce. (WN III.i.8)

10 Smith himself acknowledges that this natural order was not the norm in Europe s real development. Rather, it has, in all the modern states of Europe, been, in many respects, entirely inverted (WN III.i.9), because government intervened and altered this development path, so that the European states were necessarily forced them into this unnatural and retrograde order (WN III.i.9). Smith discusses this in detail in Book III. However, this natural order of things must have taken place in some degree in every such society (WN III.i.9) and the final point will be reached even if governments distort the order of progress. POOR COUNTRY RICH COUNTRY DEBATE During the 18 th century, a debate took place in Great Britain that revolved around the question if nations will converge or diverge over time. The issue of development was linked with international trade and its role in causing convergence and divergence. This debate reflects both of Smith s apparently contradictory position. It took place during Adam Smith s lifetime, but before he published his WN. Its proponents were David Hume on the one hand and Josiah Tucker and James Oswald on the other hand. I will scrutinise and discuss the debate, its main arguments and its course. The debate involves several questions. Do rich nations have the means to keep or even extent their advantage and superiority compared to poorer nations? What role do international trade and technological transfer play? Is there a final state which each nation might not be able to move beyond? HUME S CASE FOR CONVERGENCE David Hume was a proponent of the argument of growth and decay. According to this notion, nations will pass through a phase of growth until a high point and development stops. From this point onward, they will enter a phase of decay. In 1742, Hume argued in this way: That when the arts and sciences come to perfection in any state, from that moment they naturally, or rather necessarily decline, and seldom or never revive in that nation, where they formerly flourished (1890, p. 78). His arguments to support this growth and decay conclusion might sound a bit peculiar from today s point of view. He assumes that a person is discouraged from engaging deeply with a subject and generating improvements and technological innovations when his nation reached a certain level of development: If his own nation be already possessed of many models of eloquence, he naturally compares his own juvenile exercises with these; and being sensible of the great disproportion, is discouraged from any farther attempts, and never aims at a rivalship with those authors, whom he so much admires (Hume

11 1890, p. 78). Additionally, it is hard to achieve praise and glory in an occupation. This discourages newcomers from trying to achieve it (Hume 1890, p. 79). 10 In 1752 Hume published three essays that deal with this topic in relation to international trade and the economic development. In Of Commerce, he argues that [i]mitation soon diffuses all those arts; while domestic manufactures emulate the foreign in their improvements, and work up every home commodity to the utmost perfection of which it is susceptible (1890, p. 156). Technological transfer might thus be ruinous for more advanced nations because they lose their advantage. When the affairs of the society are once brought to this situation, a nation may lose most of its foreign trade, and yet continue a great and powerful people. If strangers will not take any particular commodity of ours, we must cease to labour in it (Hume 1890, p. 156). Hume elaborates on this argument in his essays Of Money and Of the Balance of Trade, in which he underpins his argument with economical reasoning. Thereto, he uses the pricespecie-flow mechanism, which has is connected to his name nowadays. 11 Hume argues that money is seen as neutral at least in the long-run. This means changes in the quantity of gold and silver have no real effect, only a price effect. 12 Money is only a means of exchange and as a corollary trade must be balanced. This is an important presumption of the price-specie-flow mechanism. According to this mechanism, changes in the quantity of gold (and silver), which was the means of payment at the time, have no real effect, only a price effect. 13 Thus, absolute 10 Therefore, Hume argues that [p]erhaps, it may not be for the advantage of any nation to have the arts imported from their neighbours in too great perfection. This extinguishes emulation, and sinks the ardour of the generous youth (Hume 1890, p. 78). As an example he argues [t]hat multitude of polite productions in the French language, dispersed all over Germany and the North, hinder these nations from cultivating their own language, and keep them still dependent on their neighbours for those elegant entertainments (Hume 1890, p. 78). This argument appears misplaced from today s point of view, since Gotthold Ephraim Lessing was already alive when Hume wrote this essay, and Johann Wolfgang von Goethe and Friedrich Schiller were born shortly afterwards. 11 Hume was probably not the first to develop the price-specie-flow argument. Richard Cantillion expounds a similar specie-flow theory. However, his work Essai sur la Nature du Commerce en Général, in which he outlines the price-specie-flow mechanism (Cantillon 1931, Part II, Ch. VI-VIII and Part III Ch. 1), was published only posthumous in See also Fieser (2005, p. xiii). 12 Money in Hume s theory is the instrument which men have agreed upon to facilitate the exchange of one commodity for another. It is none of the wheels of trade: It is the oil which renders the motion of the wheels more smooth and easy (Hume 1890, p. 167). Gold and silver have only one function, namely they serve as a mean of circulation and therewith rate labour and commodities. 13 However, in the short run a change in the quantity of money does matter. If money flows into a nation and thus the quantity of money is increased, then every thing takes a new face: labour and industry gain life: labour and industry gain life; the merchant becomes more enterprising, the manufacturer more diligent and skilful, and even the farmer follows his plough with greater alacrity and attention. The reason is, that prices to not rise immediately with the inflow of money but some time is required before the money circulates through the whole state, and makes its effect be felt on all ranks of people. [ ] [I]t is only in this interval or intermediate situation, between the acquisition of money and rise of prices, that the encreasing quantity of gold and silver is favourable to industry (Hume 1890, pp ). The opposite is true when the quantity of gold and silver diminishes and is therefore pernicious to industry (Hume 1890, p. 171). This effect occurs similarly only in the interval between the change of the monetary quantity and before matters be adjusted to their new situation (Hume 1890, p. 171). To put it in modern terms, inflation is better than deflation. Hume draws the conclusion in respect to the quantity of money that good policy of the magistrate consists only in keeping it, if possible, still

12 (gold) prices, wages, etc. depend on the quantity of gold that is available inside a nation. This mechanism is crucial for international trade and leads to the conclusion that nations will economically converge. To summarise the working of this mechanism, a more advanced nation which is characterise by higher productivity and a higher technological level, will be initially more competitive international and will be able to sell its products cheaper than a less advanced nation. This rich nation has a trade surplus and specie flows from the poorer nation to the richer one. The higher amount of specie will affect wages and commodity prices in both nations. In the rich nation, prices will increase due to the higher amount of specie while prices in the poorer nation decrease. As a result the rich nation will lose its competitive advantage, the poor nation will be able to sell goods cheaper and consumer stop buying goods from the rich nation and buy them from the poorer nation instead. The money outflow will continue until the prices of commodities and labour decrease to a level, at which trade will be balanced, meaning the quantity of exports will equal the quantity of imports (Hume 1890, pp ). 14 In this state, both nations are more or less equally competitive, though the rich nation is in a worse position than in the initial situation while the poorer nation in a better position. A nation that has a competitive advantage in international trade and experiences an inflow of specie is thereby also laying the foundation of its own decline: There seems to be a happy concurrence of causes in human affairs, which checks the growth of trade and riches, and hinders them from being confined entirely to one people; as might naturally at first be dreaded from the advantages of an established commerce. Where one nation has gotten the start of another in trade, it is very difficult for the latter to regain the ground it has lost; because of the superior industry and skill of the former, and the greater stocks, of which its merchants are possessed, and which enable them to trade on so much smaller profits. But these advantages are compensated, in some measure, by the low price of labour in every nation which has not an extensive commerce, and does not much abound in gold and silver. Manufactures, therefore gradually shift their places, leaving those countries and provinces which they have already enriched, and flying to others, whither they are allured by the cheapness of provisions and labour; till they have enriched these also, and are again banished by the same causes. And, in general, we may observe, that the dearness of every thing, from plenty of money, is a disadvantage, which attends an established commerce, and sets bounds to it in every country, by enabling the poorer states to undersell the richer in all foreign markets. (Hume 1890, p. 168) For Hume, this is an unavoidable fact: That provisions and labour should become dear by the encrease of trade and money, is, in many respects, an inconvenience; but an inconvenience that is unavoidable, and the effect of that public wealth and prosperity which are the end of all our wishes. It is compensated by the advantages, which encreasing; because, by that means, he keeps alive a spirit of industry in the nation, and encreases the stock of labour, in which consists all real power and riches (Hume 1890, p. 171). 14 Hume s adjustment process is actually more complex and takes not place immediately; it rather requires some time (Hume 1890, p. 170). The process can be summarised as follows: If exports increase (decrease), money will flow into (out of) the country. At first, no modification takes place. Then, wages of the workers of the export companies will increase (decrease) and thus they spend more (less) money, i.e. buy more (Hume 1890, pp ). This in return will increase (decrease) the price and thus the income of the sellers and, finally, the effect proceeds in the whole economy of that country until the whole at last reaches a just proportion with the new quantity of specie which is in the kingdom (Hume 1890, p. 170).

13 we reap from the possession of these precious metals, and the weight, which they give the nation in all foreign wars and negociations. (Hume 1890, p. 168) RESPONSES TO HUME S ESSAYS CRITIQUE OF THE CONVERGENCE ARGUMENT Concerning the argument of convergence, Hume became responses from James Oswald and Josiah Tucker, who both argue against Hume s position. The first response came from Oswald. He states his point of view in a long letter to Hume (Oswald 1854), which he wrote to him in Hume apparently sent him a draft copy of Of the Balance of Trade for comment. Oswald argues mainly against Hume s price-specie-flow mechanism and comes to the conclusion that international trade leads to a further divergence and not to a convergence between rich and poor nations, except the rich nation is guilty of severe policy mistakes. Oswald s main argument is that the increase of money in one country might not necessarily raise its wages and prices. If necessities for workers can be purchased abroad for the same price as before, wages would not go up in proportion to the increased amount of money, nor would commodity prices. However, as a result of a trade surplus some prices and wages will increase, which might even be beneficial to the nation because it would only serve, by attracting foreigner, to increase the number of useful inhabitants in proportion to the increased quantity of money (Oswald 1854, p. 96, italics in original). More workers mean more commodities can be produced and thus the national wealth increases. A trade deficit on the other hand will not lead to a decrease in prices: It will not necessarily follow that the price of all labour and commoditys will sink in the same proportion (Oswald 1854, p. 95). But it might lead to an emigration of workers. As a result, the competitive advantage of the rich nation will not vanish as Hume predicts. Oswald supports his thesis by arguing that as the propositions contained in your argument seem to me not true in general, so I think they are still less so when apply d to the different sorts of labour and commoditys, on all which indiscriminately the effect of the greater or lees quantity of money is supposed by the argument to be uniformly the same (1854, p. 96). Oswald quotes as an example Holland where the price of necessarys and materials of manufacture are not altered in proportion to the greater or less quantity of money in Holland only (1854, p. 100). From his arguments, Oswald comes to the conclusion that rich and poor nations will not converge. He makes a comparison to the domestic situation: The Capital has a constant balance in its favour. There, most kinds of labour and commoditys are constantly dearer than in the provinces, and a plenty of money always greater. But these effects 15 Hume apparently had sent Oswald a draft copy of Of the Balance of Trade for comment.

14 continue constant and without variation. The only difference observable is that the Capital goes on constantly increasing in its number of inhabitants, its buildings, arts, industry, and cultivation [...] The case, I presume, would be precisely the same with a countrey which should have a constant balance in its favour against the neighbouring nations of Europe, and with a rich trading Capital and its own provinces. Such a countrey would be enabled, by its plenty of money, to purchase, and would, (were artifical obstructions never thrown in the way,) purchase of its neighbours all necessarys of life and materials of manufacture, always as cheap, and often, by storing, afford them to its own inhabitants cheaper, (not through policy or patriotism, but the mere effects of moral causes,) than they could be had, even in the producing countreys. By which means the price of labour would be kept low, notwithstanding the plenty of money, which, tho ever so plenty, is never to be obtained without an equivalent. Such a country would attract inhabitants and people, by the temptation of high wages in such species of labour as require necessarily to be performed on the spot. (Oswald 1854, p. 104) Oswald concludes that [t]he advantages of a rich countrey in this respect, compared with the disadvantages of a poor one, are almost infinite, and all infallibly take place, after a free communication of the necessarys of life and materials of manufacture, and an easy settlement of new inhabitants, are established (1854, p. 104). Poor countries are therefore trapped: Poor countreys, with cheap necessarys, some cheap materials, and even cheap labour in some things, do not always, nay, seldom do, and but in a few cases, work up manufactures so cheaply as in the provinces of a rich countrey, and, what is most surprising, as even in its capital. The reasons are obvious: the materials of all manufactures are various, and poor countreys, while they have some cheap, have frequently most part dearer than in the wealthy countreys; which have or may have all (witness Holland), att the constant lowest level price of their neighbours. (Oswald 1854, p. 105) Poor countries might even lose, because the drain of people and industry (Oswald 1854, p. 107). Rich nations, on the other hand, does not need to fear international trade, if it has a good government, because it because may preserve its people and manufactures, and may safely trust its money to the course of human affairs; for it will always preserve and increase its wealth, without any danger of losing it (Oswald 1854, p. 107). In a short reply, Hume wrote to Oswald: Your enumeration of the advantages of rich countries above poor, in point of trade, is very just and curious; but I cannot agree with you that, barring ill policy or accidents, the former might proceed gaining upon the latter for ever (Hume 1932b, p. 143). He defends his position and argues that Oswald might have a point in the short-term, but that the price-specie-flow mechanism holds in the medium- and long-term. The criticism from Tucker came a few years later, again in form of a letter. Hume and Tucker did not correspond directly, but for some reasons via Henry Home Kames. The initial writings of Tucker seem to be lost. In his letter dated March 4 th 1758, Hume refers to Mr. Tucker s papers, so it is unclear what exactly he means by this. The earlier correspondence that might have taken place seems to be lost (see also Rotwein 1955, p. 199n.). However, Tucker uses this discussion as basis for the Tract I in his 1774 publication Four Tracts on Political and Commercial Subject. In the preface he states that this tract arose from a Correspondence in

15 the Year 1758, with a Gentleman of North-Britain, eminently distinguished in the Republic of Letters (1774, p. v). Though Tucker does not mention his name, it is obvious that he refers to Hume, whose arguments he summarises and wants to reject. In the preserves correspondence, Hume defends his position that rich nations at last come to a ne plus ultra, and check themselves, by begetting disadvantages, which at first retard, and at last finally stop their progress (1932a, p. 271). Hume argues that high prices and high wages in the rich country are such a disadvantage which enables the poorer country to rival them, first in the coarser manufactures, and then in those which are more elaborate (1932a, p. 271). Hume maintains that [g]reat empires, great cities, great commerce, all of them receive a check, not from accidental events, but necessary principles (1932a, p. 272). Tucker replied to this letter a few months later. His main defence is to point to empirical facts and demonstrates that the rich industrious country doth sell all manner of complete manufactures cheaper than the poor industrious country (1807b, p. 4, italics in original). He argues that the progress would be indefinite because no man can mark out the limits (1807b, p. 4). He concludes that though both countries may still go on in their respective improvements, the poor country, according to my apprehension can never overtake the rich, unless it be through the fault and mismanagement of the latter (1807b, pp. 5-6). Tucker gives a full account of his view in his work Four Tracts on Political and Commercial Subjects. He argues that rich nations are destined to keep and even to extend their advantage over poor nations, unless grave policy errors are made in the rich nation. Tucker gives several reasons, metaphysical and economical, for his own position. First, he asks if it could be possible that Divine Providence has really constituted the Order of Things in such a Sort, as to make the Rule of national Self preservation to be inconsistent with the fundamental Principle of universal Benevolence (1774, p. 12)? He answer to this question is predictably negative: I never could conceive that an all-wise, just, and benevolent Being would contrive on Part of his Plan to be so contradictory to the other, as here supposed (1774, p. 12). This metaphysical reasoning leads him to statement that I conclude a priori, that there must be some Flaw or other in the preceding [Hume s, R.S.] Arguments (1774, p. 12, italics in original). Tucker s main reasoning is however economically. He exemplifies his points by taking a richer nation, England, and a poorer nation, Scotland. He considers two cases how England has become richer. If England got all its money by idleness, e.g. by discovering a rich gold mine, England would soon lose its riches: In such a Case certain it is, that their industrious Neighbours would soon drain them of this Quantity of Specie, and not only drain them, so far

16 as to reduce them to a Level with the poor Country, but also sink them into the lowest State of abject Poverty (Tucker 1774, p. 16). However, if England has acquired its wealth by general industry, this resembles a society in which the Drones of Society may be converted into Bees, and the Bees be prevented from degenerating back into Drones (Tucker 1774, pp ). In this case, it might be true that a poor country has a manifest Advantage over the rich one in Point of its parsimonious Way of Living, low Wages, and consequently cheap Manufactures (Tucker 1774, p. 21). However, this advantage is overshadowed by the advantages that the rich country enjoys: the rich Country hath the following Advantages which will more than couter-ballance any Disadvantage that may arise from the foregoing Articles (Tucker 1774, p. 21). Tucker enlists seven reasons for this (1774, pp ): first, the infrastructure, technology, know-how and economic environment of the rich country are superior; second, the rich country has superior Skill and Knowledge...for inventing and making more ; third, the rich country has more capital for investing; fourth, the rich country will lure the most skilled workers from the poor country because of its higher wages and the superior economic environment; fifth, the division of labour is more advanced in the rich country; sixth, there is more competition in the rich country; seventh, the interest of money is lower in the rich country and thus vending is cheaper because the Superiority of the Capital. As a result, the poor nation will not be able to catch up or harm the rich nation. Rather, rich nations will extend their lead over poor nations, since there is no sign that economic and technological development will soon end: no Man can pretend to set Bounds to the Progress that may yet be made both in Agriculture and Manufactures; for who can take upon him to affirm, that our Children cannot as far exceed us as we have exceeded our Gothic Forefathers? And is it much more reasonable to suppose, that we are rather at the Beginning only, and just got within the Threshold than that we are arrived at the ne plus ultra of useful Discoveries? (Tucker 1774, p. 23, italics in original). Tucker states a general Proposition, which very seldom fails, That operose or complicated Manufactures are cheapest in rich Countries; and raw Materials in poor ones (1774, pp , italics in original). He gives empirical evidence of this claim (1774, pp ). According to Tucker rich trading nations can only ruin themselves by bad policy, but not by being industrious: no trading Nation can ever be ruined but by itself, so more particularly the Improvements and Manufactures of Scotland can never be a Detriment to England; unless the English do voluntarily decline their Industry, and become profligate in their Morals (Tucker 1774, p. 34, italics in original). Similar to Oswald, he compares the situation of international trade between different nations to domestic trade between different regions inside a nation. He argues that rich neighbours are better than poor neighbours for one s own economic development (Tucker 1774, pp ).