Adam Smith's Theory of International Trade in the Perspective of Economic

Development
Author(s): H. Myint
Source: Economica , Aug., 1977, New Series, Vol. 44, No. 175 (Aug., 1977), pp. 231-248
Published by: Wiley on behalf of The London School of Economics and Political Science
and The Suntory and Toyota International Centres for Economics and Related
Disciplines

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Economica, 44, 231-248

Adam Smith's Theory of International Trade in

the Perspective of Economic Development

By H. MYINT
The London School of Economics

Adam Smith is highly esteemed for his "immense understanding of the

forces that govern the structure and development of economies" (Stigler,
1952). But he is not esteemed as an international trade theorist. The main
criticism against him is that he failed to discover the principle of compara-
tive costs and this failure vitiated his whole approach to the subject. It has
also been said that his trade theory is mixed up with other dubious
doctrines, such as the capacity of equal capitals to put into motion different
quantities of productive labour and the "vent-for-surplus" theory, which do
not lend themselves to a clear and consistent interpretation. For a useful
summary of these criticisms by a distinguished line of economists including
Bastable, Robbins and Viner, see Bloomfield (1975). He recognizes the
importance of Smith's analysis of the growth-stimulating effect of foreign
trade, but substantially endorses the traditional view when he says: "Admit-
tedly, Smith was not a great trade theorist .... He did not come up with the
comparative costs, reciprocal demand or others of the concepts and tools
that were to be developed by the later, classical writers on international
trade" (pp. 456 and 480-481). There are also criticisms against the monet-
ary aspects of Smith's trade theory arising from his failure to give an explicit
formulation of Hume's specie flow mechanism in the Wealth of Nations. The
monetary aspects of Smith's foreign trade theory will, however, be omitted
from this paper.
The aim of this paper is to re-appraise the significance of the "real" as
distinct from the "monetary" aspect of Smith's international trade theory. It
will be argued that Smith's theory of foreign trade is so closely interwoven
with his theory of domestic economic development that the two have to be
considered together. This means that Smith's trade theory should not be
treated simply as a static cross-section analysis of the existing pattern of
trade based on the allocation of the given resources with the given produc-
tivity; rather it should be considered as an attempt to study the longer-run
mutual interaction between foreign trade and domestic economic develop-
ment, essentially involving an increase in the total volume of the resources
and a rise in their productivity.
The plan of this paper is as follows. In Section I we shall give a general
outline of Smith's trade-cum-development approach. It will be argued that,
while Smith's failure to discover comparative costs may have deprived his
static cross-section analysis of trade of its cutting edge, it has also brought
considerable advantages for his longer-run trade-cum-development ap-
proach. He was left free to incorporate into his trade analysis a richer and
more realistic model of the domestic economy than would have been
possible within the restrictive framework of the comparative cost theory.

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 232 ECONOMICA [AUGUST

Instead of the simple one-factor model of the Ricardian trade theory, Smith
was able to conduct his trade analysis on the basis of all three factors-land,
labour and capital-and this enabled him to anticipate the modern
Heckscher-Ohlin approach to international trade in terms of the differences
in the relative factor supplies and relative factor prices in different countries.
But instead of assuming the quantities and the productivity of resources to
be exogenously given (as is usual in the static Heckscher-Ohlin
analysis), Smith was able to incorporate the longer-run changes in factor
supplies and their productivity into his analysis as the outcome of the two
major forces of domestic economic development, viz. capital accumulation
and the division of labour. In Section II we shall consider the two controver-
sial trade doctrines of Adam Smith. It will be shown that the doctrine that
equal capitals are capable of putting into motion greater quantities of
productive labour in agriculture than in manufactures, and in manufactures
than in the carrying trade, did not seriously interfere with Smith's analysis of
the effect of capital accumulation on international trade, since in practice he
relied on the profit equalization principle in the allocation of capital between
the different sectors. It will, however, be argued that the "vent-for-surplus"
doctrine still remains an important element of Smith's trade theory in its
applications not only to the colonies and the underdeveloped countries but
also to the developed countries, notably the "landed nations" of Western
Europe such as England and France. In fact, the "vent-for-surplus" concept
in combination with Smith's dictum that "the division of labour is limited by
the extent of the market" provides the elements of the "open-ended" model
of the domestic economy which enables Smith to explore the effect of
foreign trade on domestic economic development. In Section III we shall
assess the significance of Smith's trade-cum-development approach in the
light of subsequent developments in economic thinking. We shall conclude
that Adam Smith has been underrated as an international trade theorist
because of the conventional practice of judging him by his contributions (or
lack of them) to the familiar and established doctrines of neoclassical trade
theory. A true measure of his work cannot be obtained until we judge him
by the insights which his approach can still offer to the unsettled questions of
the interrelationship of international trade and economic development, par-
ticularly in the setting of the underdeveloped countries.

As is well known, Adam Smith's analysis of foreign trade at a given cross

section of time is based on absolute differences in costs. International
differences in the costs of producing the traded commodities in different
countries are explained in terms of the differences in natural advantages
(such as soil, climate and situation) and in acquired advantages (such as
education and skills). While this "absolute advantage" theory lacks the
formal rigour of the comparative costs analysis, it enables Smith to state
clearly the advantages of free trade in terms of the efficient allocation of
resources.

If a foreign country can supply us with a commodity cheaper than we ourselves

can make it, better buy it off them with some part of the produce of our own

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1977] ADAM SMITH'S THEORY OF INTERNATIONAL TRADE 233

industry, employed in a way in which we have some advantage. The general

industry of the country, being always in proportion to the capital which employs
it, will not thereby be diminished...; but only left to find the way it can be
employed with the greatest advantage....

Again,

Whether the advantages which one country has over another, be natural or
acquired, is in this respect of no consequence. As long as 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. [Book IV, ch. 2, Vol. I, pp.
422-423]

But Smith is concerned not mereiy with the static gains from trade in
terms of consumers' "enjoyments", but also with the gains from trade in
terms of economic development. This is apparent in the well-known passage
setting out the "two distinct benefits" from foreign trade.

It carries out that surplus part of the produce of their land and labour for which
there is no demand among them, and brinigs back in return for it something else
for which there is a demand. It gives a value to their superfluities, by exchanging
them for something else, which may satisfy a part of their wants, and increase
their enjoyments. By means of it, the narrowness of the home market does not
hinder the division of labour in any particular branch of art or manufacture from
being carried to the highest perfection. By opening a more extensive market for
whatever part of the produce of their labour that may exceed the home
consumption, it encourages them to improve its productive powers, and to
augment its annual produce to the utmost and thereby to increase the real
revenue and wealth of the society. [Book IV, ch. 1, Vol. I, p. 413]

Typically also, the potential loss of savings and capital accumulation looms
larger than the static consumers' losses in his criticism of the restrictions on
foreign trade and of monopoly.

But the immediate effect of every such regulation is to diminish its revenue and
what diminishes its revenue is certainly not very likely to augment its capital
faster than it would have augmented of its own accord, lhad capital and industry
been left to find their natural employments. [Book IV, ch. 2, Vol. I, p. 423; also
Book IV, ch. 7, Part III, Vol. II, p.111]

Similarly, Smith described the advantages to Europe from the discovery

and colonization of America in terms of "the increase of its enjoyments"
and "the augmentation of its industry". But it is noticeable that he reserved
his eloquence for the latter.

By opening a new and inexhaustible market to all the commodities of Europe, it

gave occasion to the new divisions of labour and improvements of art, which, in
the narrow circle of the ancient commerce, could never have taken place for
want of a market to take off the greater part of their produce .... A new set of
exchanges, therefore, began to take place which had never been thought of
before, and which should naturally have proved as advantageous to the new as it
certainly did to the old continent. [Book IV, ch. 1, Vol. I, p. 414; also Book IV,
ch. 7, Part III, Vol. II, pp. 92-93]

The fact that Smith's theory of foreign trade is closely interwoven with
his theory of economic development which permeates the Wealth of Nations
can be seen in another way. In the Wealth of Nations what Smith has to say
on foreign trade is not confined to the chapters on the mercantile system and
the colonies in Book IV; it is widely scattered all through the book. For

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 234 ECONOMICA [AUGUST

instance, important elements of Smith's foreign trade theory may be found

in the chapter on rent (Book I, chapter 11); in the chapter on the different
employments of capital (Book II, chapter 5) and in the chapters on the
towns and country (Book III, chapters 3 and 4)(not to mention the sections
on the taxation of foreign trade in Book V). In contrast, in Ricardo's or J. S.
Mill's Principles, the analysis of foreign trade is neatly compartmentalized
into a few chapters. This reflects the significant changes which the discovery
of the comparative costs theory introduced into the theoretical structure of
classical economics.
Granted that Smith's principal concern is with long-run economic de-
velopment rather than with the static allocative efficiency of resources, is his
failure to discover comparative costs really a serious handicap to his work as
a trade theorist? This question may be answered by considering the theoreti-
cal costs that Ricardo and J. S. Mill paid for the privilege of discovering and
formalizing the comparative costs theory.
(a) In order to work the theory they were obliged to start from the
restrictive assumption that resources are mobile within each country but are
completely immobile between different countries.
(b) They were obliged to use two separate theories of value: one for
foreign trade, based on comparative costs and reciprocal demand, and
another for the domestic economy, based either on the labour theory or on
the cost of production theory.
(c) They were obliged to base their trade theory on a highly simplified
model of the domestic economy using only a single factor of production,
labour.
(d) To avoid excessive cumbersomeness, it became customary to adopt
the simplifying assumption of zero transport cost of commodities, both
within a country and between different countries.
(e) Above all, the two branches of the later classical economics came to
be oriented in different directions: the theory of foreign trade became
increasingly formalized in terms of the static theory of the allocative
efficiency of the given resources while the analysis of the domestic economy
continued along broader dynamic lines in terms of capital accumulation,
population growth and with an explicit recognition of the principle of the
diminishing returns from land.
Smith escaped all these disadvantages by failing to discover compara-
tive costs! The most significant benefit he obtained was that he was
free to incorporate into his analysis a richer and more realistic model of
the domestic economy than would have been possible under the restric-
tive assumptions required for the comparative costs theory. Instead of
having to use two separate theories of value, Smith was able to use a
single theory of value, "the natural price" theory, both for his analysis
of foreign trade and for his analysis of the domestic economy, and this
facilitated his trade-cum-development approach in three ways. (i) The
natural price theory reflecting long-run costs of production formed the basis
of Smith's theory of "absolute advantage" and provided him with a service-
able, though not rigorous, analysis of the allocative-efficiency aspect of
foreign trade. He applied the concept of the natural price and the natural
rate of profit not only to foreign trade, but also to short-run foreign

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1977] ADAM SMITH'S THEORY OF INTERNATIONAL TRADE 235

investment. Thus, instead of ruling out international mobility of capital by

assumption, Smith analysed how the allocation of capital funds between
domestic investment ("the near employment") and foreign investment ("the
distant employment") would be adjusted until the natural rate of profits in
the two were equalized (Book IV, ch. 7, Part III, Vol. II, p. 128). (ii) The
natural price theory also permitted Smith to conduct his trade analysis in
terms of all three factors of production, land, labour and capital, instead of
being confined to the single-factor model of the Ricardian comparative costs
theory. This enabled him to anticipate the modern Heckscher-Ohlin ap-
proach to international trade theory in terms of the differences in the
relative supplies of factors and their prices. (iii) The natural price theory is
expressly concerned with the longer-run changes in the supplies of factors
and their relative prices.

The natural price itself varies with the natural rate of each of the component
parts, of wages, profit and rent; and in every society, this rate varies according to
their circumstances, according to their relative riches or poverty, their advanc-
ing, stationary, or declining condition. [Book I, ch. 7, Vol. I, p. 65]

Thus, instead of assuming the factor endowments of a country to be given

exogenously, Smith was able to treat the broad pattern of changes in the
factor supplies and their prices as a part of the process of the long-run
development.
These points may be illustrated by considering the application of Smith's
trade-cum-development analysis to the two contrasting types of countries,
the newly settled colonies of North America and the ancient kingdoms of
Asia, notably China.
The North American colonies were characterized by Smith as having
abundant land and relative scarcity of labour and capital. Rents would be
lower and wages and profits higher than in Europe. Using the factor-
proportions analysis, Smith identified their advantage in foreign trade in the
export of agriculture and rude produce and in the import of the refined
manufactures.

Agriculture is the proper business of all new colonies; a business which the
cheapness of land renders more advantageous than any other. They abound,
therefore, in the rude produce of land and instead of importing it from other
countries, they have generally a large surplus to export. In new colonies,
agriculture either draws hands from all other employments, or keeps them from
going to any other employment. There are few hands to spare for the necessary,
and none for the ornamental manufactures. The greater part of manufactures of
both kinds, they find it cheaper to purchase of other countries than to make for
themselves. [Book IV, ch. 7, Part III, Vol. II, pp. 109-110; also ch. 7 Part II,
pp. 83-84]

But Smith's analysis goes further than a cross-section analysis of trade in

terms of the given factor endowments. It considers how relative factor prices
would affect not only the nature of exports and imports, but also the
longer-run supplies of factors. Thus, low rents would not merely encourage
agricultural exports, but would also have the effect of raising the rate of
profits in agricultural investment. This in turn would encourage a rapid
increase in saving and capital accumulation leading to an expanding demand

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 236 ECONOMICA [AUGUST

for labour and high wages. High wages in turn would stimulate the growth of
population. Hence the "rapidly advancing condition" of the colonies.

A new colony must always for sometime be more under-stocked in proportion

to the extent of its territory and more under-peopled in proportion to the extent
of its stock, than the greater part of other countries. They have more land than
they have stock to cultivate. What they have, therefore, is applied to the
cultivation only of what is most fertile and most favourably situated, the land
near the sea-shore and along the banks of navigable rivers. Stock employed in
the purchase and improvement of such lands must yield a very large profit and
consequently afford to pay a very large interest. Its rapid accumulation in so
profitable an employment enables the planter to increase the number of his
hands faster than he can find them in a new settlement. Those whom he can find,
therefore, are very liberally rewarded. [Book I, ch. 9, Vol. I, p. 94]

It is in this context that Smith also foreshadowed the later classical

doctrine of a secular decline in the rate of profit brought about by the
diminishing returns from land.

As the colony increases, the profits of stock gradually diminish. When the most
fertile and best situated lands have been all occupied, less profit can be made by
the cultivation of what is inferior both in soil and situation, and less interest can
be afforded for the stock which is so employed. [Book I, ch. 9, Vol. I, p. 94]

But Smith's prognosis of the future course of economic development of

the colonies was more optimistic than that of his successors. He believed
that the increase in the wealth and the income level of the colonies would
more than counterbalance the effect of the lower profit rate, and that saving
and capital accumulation would continue to increase.

The demand for labour increases with the increase of stock whatever be its
profits; and after these are diminished, stock may not only continue to increase,
but to increase much faster than before. It is with industrious nations who are
advancing in the acquisition of riches, as with industrious individuals. A great
stock, though with small profits, generally increases faster than a small stock
with great profits. [Book I, ch. 9, Vol. I, p. 94]

The ancient kingdoms of Asia, notably China, were characterized by

Smith as having abundant labour densely settled on the existing territory,
resulting in low wages and high rents. Smith considered that China was
approaching stationary conditions, having "acquired that full complement of
riches which the nature of its laws and institutions permit it to acquire".
Thus, profits would be low and there would be little or no capital accumula-
tion. The expansion of foreign commerce, which China had neglected, could
however give a fresh impetus to her economic development, and Smith
identified China's potential advantage in trade as consisting in the export of
manufactures. This conclusion accords well enough with the modern factor
proportions theory, but again Smith's analysis is richer. He stressed the
potentialities for a greater division of labour offered by China's large home
market, "perhaps, in extent, not much inferior to the market of all the
different countries of Europe put together".

A more extensive foreign trade, however, which to this great home market
added the foreign markets of all the rest of the world; especially if any
considerable part of this trade was carried on in Chinese ships; could scarce fail

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1977] ADAM SMITH'S THEORY OF INTERNATIONAL TRADE 237

to increase very much the manufactures of China and to improve very much the
productive powers of its manufacturing industry. [Book IV, ch. 9, Vol. II, pp.
178-179]

Smith then brought in the important relationship between the level of

Chinese wages and productivity in manufactures. He believed that "the
money price of labour" in China was much lower than in Europe not only
because of the slower rate of capital accumulation but also because of the
cheaper price of subsistence arising out of the higher physical productivity in
rice cultivation compared with that of wheat. But

... in manufacturing art and industry, China and Indostan, though inferior, seem
not to be much inferior to any part of Europe. The money price of the greater
part of manufactures, therefore, will naturally be much lower in those great
empires than it is anywhere in Europe. [Book I, ch. 11, Part III, Vol. I, p. 206;
also pp. 189-190]

Before we turn to the application of Smith's trade-cum-development

approach to the countries of Europe, it is necessary to bring in a vital
element of his analysis, viz. the transport costs of commodities, both within
each country and between different countries. In the static comparative costs
theory it is usual to proceed on the assumption of zero transport costs to
avoid cumbersome analysis and to assume that the corrections necessary for
transport costs can be subsequently added as plus or minus deviations from
the final equilibriumn position arrived at on a simplified analysis. In contrast,
in Smith's analysis, transport costs form an integral part of the process of
long-run economic development which can significantly affect the determi-
nation of the final position of equilibrium itself. "The division of labour is
limited by the extent of the market", and transport costs are a major factor
in determining the extent of the market. Smith considered this factor as
operating at all levels: at the local level determining the degree of specializa-
tion of the country workmen, the smith, the carpenter and the mason; at the
national level affecting the "great commerce of every civilized society ...
carried on between the inhabitants of the town and those of the country",
and at the international level affecting the commodity composition of
foreign trade.
Thus, Smith's estimate of the large size of the domestic market of China
is based not only on territorial size, population and the variety of climate,
but also on "the easy communication by means of water carriage" between
the different provinces, reinforced by the fact that, because of its depen-
dence on land tax, the government had an interest in maintaining good
roads and canals (Book IV, ch. 9, Vol. II, p. 178; Book V, ch. 1, Part III,
pp. 220-221). Similarly, Smith believed that England was

... perhaps as well fitted by nature as any large country in Europe to be the seat
of foreign commerce, of manufactures for distant sale, and all the improvements
which these can occasion ... on account of the natural fertility of the soil, the
great extent of the sea coast in proportion to the whole country and of the many
navigable rivers which run through it [which] ... afford the conveniency of water
carriage to the most inland parts of it. [Book III, ch. 4, Vol. I, p. 391]

Thus, a country's advantage in the export of manufactures depends on

the size of its domestic market and the scope for the division of labour and
increasing returns; and internal transport costs are a major factor in this

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 238 ECONOMICA [AUGUST

whole complex of relationships. There is another factor contributing to the

advantage in the export of manufactures, also closely connected with trans-
port costs: viz., the improvement of domestic agriculture and food produc-
tion. Smith traced the origin of manufactures to agricultural improvements.

But when by the improvement and cultivation of land the labour of one family
can provide for two, the labour of half the society becomes sufficient to provide
food for the whole. The other half, therefore, or at least the greater part of
them, can be employed in providing other things, or in satisfying the other
wants and fancies of mankind. Cloathing and lodging, houshold furniture and
what is called Equipage, are the principal objects of the greater part of those
wants and fancies. [Book I, ch. 11, Part II, Vol. I, p. 164]

He then extended this argument to what is nowadays called the "balanced

growth" relationship between the expansion of domestic agriculture and
domestic manufactures.

The inhabitants of the town and those of the country are mutually the servants
of one another. The town is a continual fair or market, to which the inhabitants
of the country resort, in order to exchange their rude for manufactured produce.
It is this commerce which supplies the inhabitants of the town both with the
materials of their work and the means of their subsistence. The quantity of
finished work which they sell to the inhabitants of the country, necessarily
regulates the quantity of the materials and provisions which they buy. Neither
their employment nor subsistence, therefore, can augment, but in proportion to
the augmentation of the demand from the country for their finished work; and
this demand can augment only in proportion to the extension of improvement
and cultivation. [Book III, ch. 1, Vol. I, p. 359]

This expansion of commerce between the towns and the neighbouring

countryside, Smith believed, was based mainly on the advantages of location
and low transport costs although there might be exceptions (Book III. ch. 3,
Vol. I, p. 377). His keen appreciation of the effect of internal transport costs
on the location of domestic industry comes out most clearly in his analysis of
the two different ways in which the manufactures "fit for distant sale", i.e.,
exports, are introduced into a country. The first is the development of new
tastes for "the finer and improved manufactures" introduced by foreign
commerce and the imitation of these by the domestic merchants and
undertakers. The second arises from the location of domestic agricultural
fertility and transport costs.

An inland country naturally fertile and easily cultivated, produces a great

surplus of provisions beyond what is necessary for maintaining cultivators, and
on account of the expence of land carriage, and inconveniency of river naviga-
tion, it may frequently be difficult to send this surplus abroad. Abundance,
therefore, renders provisions cheap, and encourages a great number of workmen
to settle in the neighbourhood, who find that their industry can there procure
them more of the necessaries and conveniences of life than in other places. They
work up the materials of manufacture which the land produces, and exchange
their finished work, or what is the same thing the price of it, for more materials
and provisions. They give a new value for the surplus part of the rude produce,
by saving the expence of carrying it to the waterside or to some distant
market.... The cultivators get a better price for their surplus produce and can
purchase cheaper other conveniences which they have occasion for.... [As] the
fertility of land has given birth to the manufactures, so the progress of manufac-
tures reacts upon the land, and increases still further its fertility. The manufac-
tures first supply the neighbourhood and afterwards, as their work improves and

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1977] ADAM SMITH'S THEORY OF INTERNATIONAL TRADE 239

refines, more distant markets. For though neither the rude produce nor even coarse
manufacture could, without the greatest difficulty, support the expence of a consid-
erable land carriage, the refined and improved manufacture easily may. In a small
bulk it frequently contains the price of a great quantity of rude produce. [Book III,
ch. 3, Vol. I, pp. 379-81; italics added]

Smith then extended this principle of small bulk in relation to high value
to the analysis of the transport costs of commodities between different
countries. In his view, next to gold and silver, the most easily tradeable type
of commodity would be the "refined" manufactures. Next in order of
tradeability would be the raw produce based on special advantages of
climate and soil. The least tradeable type of goods would be food and
provisions, which could be grown almost everywhere and which are bulky
relatively to their value (cf. Book IV, ch. 2, Vol. I, p. 424). Thus, except in
the case of "the very rich commercial countries such as Holland and the
territory of Genoa", Smith expected most European countries to be largely
self-sufficient in basic foodstuffs, importing only a small part of them from
neighbouring countries, usually to smooth out harvest fluctuations. In this
connection, Smith referred twice to the fact that the average quantity of
corn imported into England "does not exceed the five hundredth and
seventy one part of the annual consumption" (Book IV, ch. 2, Vol. I, p.
426; Book IV, ch. 5, Vol. II, p. 36). Evidently he regarded this as a fairly
normal case for all developed countries. Now the proposition that food,
because of its bulkiness, is the least tradeable type of commodity is of
far-reaching importance in Smith's analysis. It underlines the need for
domestic agricultural improvements as a prior condition for economic de-
velopment.
We can now put together Smith's views on the trading advantages of the
countries of Europe in which the factors contributing to domestic economic
development, viz. the size of the domestic market and the extension of
commerce between the towns and countries, are combined with the factor
proportions analysis. Smith divided the countries of Europe into three main
categories: (a) the highly advanced "mercantile states", such as Holland,
Hamburg and Genoa; (b) what may be described as the "developed"
countries of western Europe, such as England and France, which Smith
called "the landed nations", and (c) the poor and backward countries of
eastern Europe, such as Poland and Hungary. Because of the scarcity of
land combined with abundance of capital, the highly advanced mercantile
states would have an advantage in the export of manufactures and in the
carrying trade, importing food and raw materials from the other countries.
The developed countries of western Europe, having gone through the
internal development process of agricultural improvement and the extension
of the domestic market, would have an advantage in manufacturing over the
poor countries of eastern Europe, although these two types of countries
would have equal advantage in agricultural exports, subject to the differ-
ences in soil, climate and location. Smith called the advanced western
European countries "landed nations" to stress the belief that they still had
considerable scope for further improvements in agriculture.

In all the great countries of Europe, however, much good land still remains
uncultivated, and the greater part of what is cultivated, is far from being

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 240 ECONOMICA [AUGUST

improved to the degree of which it is capable. Agriculture, therefore, is almost

everywhere capable of absorbing a much greater capital than has ever yet been
employed in it. [Book I, ch. 1, Vol. I, p. 9; Book II, ch. 5, Vol. I, p. 354 and
Book IV, ch. 9, Vol. II, pp. 168-176]

By now it is evident that Smith's general policy of free trade, to be

applied equally to the newly settled colonies, to the ancient kingdoms of
Asia and to the developed countries of western Europe, is not based simply
on the static principle of the efficient allocation of the given resources.
Rather, Smith would regard free trade as a method of bringing out more
fully the longer-run productive potentialities of countries provided by an
increasing division of labour, capital accumulation and changing supplies of
factors of production.

II

If our interpretation of Smith's trade-cunr-development approach is

correct, then it does seem inadequate and out of focus to judge Smith's
stature as an international trade theorist on the simple criterion of whether
or not he discovered the comparative costs principle. One would have to
judge the strength and the weaknesses of his analysis in relation to the
ambitious task he set for himself; viz., the study of the long-run mutual
interaction between foreign trade and domestic economic development. And
this still remains one of the major unsettled questions of modern interna-
tional trade theory!
Smith's theory of international trade is frequently criticized for being
mixed up with various other doctrines which do not lend themselves to a
clear and consistent interpretation. The most notorious of these is Smith's
doctrine that "equal capitals are capable of putting into motion" varying
quantities of productive labour. Capital employed in agriculture is supposed
to put into motion the greatest quantity of productive labour.

After agriculture, the capital employed in manufactures puts into motion the
greatest quantity of productive labour, and adds the greatest value to the annual
produce. That which is employed in the trade of exportation has the least effect
of any of the three. [Book II, ch. 5, Vol. I, p. 346]

This proposition, first introduced in the chapter "Of the Different Em-
ployment of Capitals", merges into the general doctrine of the "natural order"
of the "Progress of Opulence" developed in Book III. Smith employed this
doctrine mostly negatively to show the undesirable consequences of govern-
ment intervention and monopoly in "forcing some part of the industry into a
channel less advantageous than that in which it would run of its own accord"
and thus "inverting the natural order", in which

... the greater part of the capital of every growing society is, first directed to
agriculture, afterwards to employments, till the profits of all return to their
proper level. This superiority of profit, however, is a proof that, in the actual
circumstances of the society, those distant employments are somewhat under-
stocked in proportion to other employments and that the stock of the society is
not distributed in the properest manner.... Though the same capital never will
maintain the same quantity of productive labour in a distant as in a near
employment, yet a distant employment may be as necessary for the welfare of
society as a near one. [Book IV, ch. 7, Part III, Vol. II, p. 128]

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1977] ADAM SMITH'S THEORY OF INTERNATIONAL TRADE 241

If Smith's doctrine of "the natural order" of the progress of opulence is

not concerned with laying down a pattern of investment priorities to
overrule the criterion of private profitability, what is its significance? It may
be used as a rough guideline for institutional reforms and the provision of
public services which would more effectively bring out the profitable private
investment opportunities implied by the different factor proportions existing
at the different stages of economic development. Thus, Smith argued that
the new savings in the North American colonies would be automatically
channelled by the market forces into agriculture, not only because of the
abundance of land (although that was of course very important), but also
because the institutional arrangements were such that small proprietors
could readily acquire the land "almost for nothing, or at a price below the
value of the natural produce". On the other hand, in many European
countries the law of primogeniture retarded agricultural development in two
ways: because the prohibition of the division of the great estates hindered
the multiplication of the small proprietors, "the most industrious, the most
intelligent and the most successful" improvers of land; and because "the
same regulations, besides, keep so much land out of the market, that there
is always more capital to buy than there is land to sell, so that what is sold
always sells at a monopoly price" (Book III, ch. 4, Vol. I, pp. 390-391).
Smith expressly denied that duties on the importation of foreign corn and
bounties on domestically produced corn would have any effect in encourag-
ing English agriculture. But he maintained that "Those laws and customs so
favourable to the yeomanry have perhaps contributed more to the present
grandeur of England, than all their boasted regulations of commerce taken
together" (Book II, ch. 2, Vol. I, p. 369 and Book IV, ch. 5, Vol. II, pp.
16-17). He also emphasized how the policy of improving internal transport
and communications, pursued by China and other ancient kingdoms of Asia,
had encouraged agricultural development (Book V, ch. 1, Part III, Vol. II,
pp. 220-221).
But even with favourable institutional conditions, Smith's trade-cum-
development approach requires "the invisible hand" or the competitive
market process to perform a somewhat complicated series of tasks beyond
the efficient allocation of a country's annual savings in a given year. For the
efficient allocation of capital during each year may be regarded as a series of
steps spanning the longer-run period during which changes are taking place
(a) in the domestic supplies of resources; (b) in the domestic pattern of
demand for commodities and (c) in the conditions of absolute advantage in
international trade reflected by the money costs of production or prices of
exports and imports at the given exchange rates. The market mechanism
must accurately reflect all these changes and make a complex set of
adjustments. It is only after all these adjustments have been correctly
carried out that the allocation of the annual savings of a country in
accordance with the principle of equalizing profits would automatically lead
to the maximization of the revenue available for the next year's consump-
tion and savings. A rigorous formulation of such a complex model was
clearly beyond the technical capacity of Adam Smith's times, but in broad
conceptual terms he may be said to have been groping towards such a
model.

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 242 ECONOMICA [AUGUST

But there is a further complication. In order to formalize such a model, it

is necessary to assume that the resources are fully employed at each
stage-otherwise there would be no point in insisting on the efficient
allocation of the availab e resources. Even then, such a model would only
show the one-way effect of the forces of economic development on the
pattern of international trade. Smith, on the other hand, was concerned with
the mutual interaction between foreign trade and domestic development. In
order to bring out the effect of foreign trade on domestic economic develop-
ment, he required a conceptually "open-ended" model of the domestic
economic system in which the incomplete development of the internal
economic organization would leave room for its long-run productive poten-
tialities to be brought out more fully by the forces introduced by foreign
trade. It is in this context that we should appraise the other controversial
trade doctrine of Adam Smith, viz. "the vent-for-surplus" theory.
In order to elucidate the "vent-for-surplus" doctrine, it is necessary to go
back to a passage which we have quoted at the beginning of this paper in
which Smith set out "the two distinct benefits" from foreign trade. Here,
after describing the static consumers' gains from trade, Smith went on to
describe the second benefit from trade, viz. the effect of trade on economic
development, as follows:

By means of it the narrowness of the home market does not hinder the division
of labour in any particular branch of art or manufacture from being carried to
the highest perfection. By opening a more extensive market for whatever part of
the produce of their labour may exceed the home consumption, it encourages
them to improve its productive powers and to augment its annual produce to the
utmost and thereby increase the real revenue and the wealth of society. [Book
IV, ch. 1, Vol. I, p. 413]

There are two related ideas in this passage. (i) By widening the extent of
the market, international trade improves the division of labour and raises
the general level of productivity of resources within the country. This may
be called the "productivity" theory. (ii) By widening the extent of the
market, international trade provides a market outlet "for whatever part of
the produce of their labour may exceed the home consumption". This
contains the germ of the "vent-for-surplus" theory. (See Myint, 1958, in
which this distinction was first introduced.)
As we have seen, Smith applied his fundamental principle that "division
of labour is limited by the extent of the market" to all levels of economic
activity, and at each level the phraseology and the concept of "vent-for-
surplus" is introduced whenever there is a widening of the market extending
the division of labour. Thus, at the microeconomic level "the certainty of
being able to exchange the surplus part of his labour, which is over and
above his own consumption... encourages every man to a particular occupa-
tion" (Book I, ch. 2, Vol. I, p. 17). The same mode of analysis is extended to
the trade between the inhabitants of the towns and the country. Thus, in a
passage already quoted above, the workmen who are encouraged to settle in
the neighbourhood of an inland country district because of the abundance
and cheapness of provisions are said to

... give a new value to the surplus part of the rude produce, by saving the
expence of carrying it to the waterside or some distant market.... The cul-
tivators get a better price for their surplus produce and ... are thus encouraged

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 1977] ADAM SMITH'S THEORY OF INTERNATIONAL TRADE 243

and enabled to increase their surplus produce by a further improvement and

better cultivation of land; and as the fertility of the land had given birth to the
manufactures, so the progress of the manufactures reacts upon the land and
increases still further its fertility. [Book III, ch. 3, Vol. I, pp. 380-381]

Finally, the argument is applied to international trade: each country "will in

this case afford a market for a part of the surplus produce of the other"
(Book IV, ch. 3, Part II, Vol. I, p. 452).
This close connection between the "productivity" theory and the "vent-
for-surplus" theory has prompted some commentators to question whether
they should be regarded as two distinct doctrines instead of merely being the
two aspects of the same theory (see Haberler, 1959; Bloomfield, 1975). It
has also been said that the "vent-for-surplus" theory would conflict sharply
with the allocative efficiency interpretation of Smith's theory which assumes
full employment of resources (see Hollander, 1973, Chapter 7). In what
follows it is hoped to show that the "vent-for-surplus" theory can be fitted
in with the rest of Smith's theoretical system to a greater extent than is
generally realized and that, for this purpose, it is necessary to draw a
distinction between the "vent-for-surplus" and the "productivity" doctrines.
The need for this distinction is suggested by Smith's well-known statement:
"The nature of agriculture, indeed, does not admit of so many sub-divisions
of labour, nor of so complete a separation of one business from another as
manufactures" (Book I, ch. 1, Vol. I, p. 7). But in order to widen the market
for the manufactures at the local level or within a closed economy, it is
necessary to have some alternative mechanism to increase the output of
agriculture to match the output of manufacture in a "balanced-growth"
pattern. It is, of course, possible to invoke autonomous agricultural innova-
tions to perform this function. But although Smith mentioned agricultural
innovations, this is not a plausible interpretation of his model. What he was
really seeking was not autonomous agricultural innovations but induced
agricultural innovations and the possibilities of increasing agricultural output
before land is fully utilized and agriculture is fully commercialized. This is so
because Smith's basic assumption is that agriculture is an underdeveloped
sector, both in the colonies and in the developed "landed nations" of
Europe, such as France and England. "In all the great countries of Europe,
however, much good land still remains uncultivated, and the greater part of
what is cultivated, is far from being improved to the degree of which it is
capable," (Book II, ch. 5, Vol. I, p. 354). The "vent-for-surplus" theory
based on "the extension of improvement and cultivation" of the
underutilized land provides the necessary mechanism. This is why he could
apply this doctrine not only to the colonies but also to "every society"
(though on his own showing, the highly advanced "commercial nations"
such as Holland and Hamburg would be exceptions to it in Europe).
The chapter on rent provides details of Smith's ideas on the nature of sur-
plus productive capacity in agriculture. First of all, there is land which always
pays rent on which basic human food or corn is grown. In an advancing state
of society with an expanding population, more food can be grown by taking
"unimproved wilds" under cultivation. More interesting for our present
purpose is livestock farming. Smith visualized peripheral or backward reg-
ions in the developed countries, lying just outside the fully developed circle
of commercial agriculture around the towns. Here cattle and sheep might be

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 244 ECONOMICA [AUGUST

raised on "the unimproved wilds" and pigs and poultry fed on kitchen
scraps or "the offals of the barn and stables". These would provide a
considerable surplus productive capacity, for the farmer could produce meat
without taking land away from corn growing. "They cost the farmer scarce
anything and so he can afford to sell them for very little". This surplus
capacity is fully used only when, with the widening of the market, further
expansion of meat production requires the reallocation of land from corn
growing to fodder and animal feeds. Even in the developed European
countries there would be a considerable surplus productive capacity for
"butcher's meat" until all the available land was fully cultivated and
improved (Book I, ch.11, Vol. I, pp. 187, 219-229).
We can now see how the "vent-for-surplus" theory of foreign trade may
be applied to a developed country such as England or France, which already
possessed a considerable manufacturing sector in a "balanced-growth"
relationship with its agricultural sector, before it is opened to foreign trade.
This country is a "landed nation", so that it is quite possible for it to have an
absolute advantage based on soil, climate and situation, in the export of
some agricultural produce. In this case, export expansion would take place
directly through the "vent-for-surplus" mechanism-by extending cultiva-
tion to the hitherto unused or underutilized land. If the country possesses an
absolute advantage in some manufactured product, then the "productivity"
theory would come into play, enabling the country to reap the gains in the
form of the economies of scale and increasing returns from the opportunity
to sell to a wider international market. But there is a further twist to the
story. The modern economist would imagine that such a country would go
on progressively specializing in the export of manufactures and importing
increasing quantities of food and raw materials. But this is not how Smith
would see the situation. It will be recalled that he regarded food as a
relatively non-tradeable good because of its bulkiness to value and because
it could be grown in almost every type of soil and climate. Thus, it is more in
line with his general thinking to argue that, instead of importing progres-
sively increasing quantities of food, a country like England or France would
find it more advantageous to grow the bulk of their food requirements at
home- "by the extension of improvement and cultivation". Thus, he would
maintain that one of the major benefits of foreign trade to a country that
exports manufactures is the indirect encouragement that this trade can give
to its domestic agriculture. The "vent-for-surplus" mechanism is brought
into play through the expansion of internal trade between the manufacturing
and the agricultural sectors.

It is chiefly by encouraging the manufactures of Europe, that the colony trade

indirectly encourages its agriculture. The manfacturers of Europe, to whom the
trade gives employment, constitute a new market for the produce of the land;
and the most advantageous of all markets; the home market for the corn and
cattle, for the bread and butchers-meat of Europe; is thus greatly extended by
means of the trade to America. [Book IV, ch. 7, Part III, Vol. II, p. 110]

Moreover, the export of manufactures from the advanced countries of

western Europe would not only encourage their own domestic agriculture,
but also encourage the economic development of the backward countries of
eastern Europe. Thus, in discussing the second advantage that Europe

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1977] ADAM SMITH'S THEORY OF INTERNATIONAL TRADE 245

derived from the colonization of America, viz. "the augmentation of indus-

try", Smith carefully distinguished three types of countries: firstly, countries
such as Spain, Portugal, France and England, which directly traded with the
colonies; secondly, countries such as Austrian Flanders and provinces of
Germany, which sent their goods through the medium of other countries;
and thirdly, countries such as Hungary and Poland, "which may never,
perhaps, have sent a single commodity of their own produce to America". It
was the burden of Smith's argument that the third type of countries would
also indirectly benefit from the expansion of the colonial trade.
Those commodities of America are new values, new equivalents, introduced into
Hungary and Poland to be exchanged there for the~ surplus produce of those
countries. By being carried thither they create a new and more extensive market
for that surplus produce. They raise its value and thereby contribute to its
increase. Though no part of it may ever be carried to America, it may be carried
to other countries which purchase it with a part of their share of the surplus
produce of America; and it may find a market by means of the circulation of
that trade which was originally put into motion by the surplus produce of
America. [Book IV, ch. 7, Part III, Vol. II, pp. 92-93]
If this interpretation is correct, Smith's "vent-for-surplus" theory does
not seem to conflict in any simple or obvious way with the allocative-
efficiency interpretation of his trade theory. He assumed full employment of
capital and of labour, at least for those European countries that had passed
beyond the stage of "household manufactures" (Book I, ch. 11, Vol. I, p.
246; also pp. 118-119 on the "Cotters").
But Smith's notion of "full employment" of labour would allow for the
possibility of increasing output, even in the short run, by recruiting the extra
labour for productive uses from the existing pool of "unproductive" labour.
He then assumed that there was a considerable amount of unused or
underutilized land to produce the extra agricultural output not only in the
colonies but also in the developed "landed nations" of western Europe (with
the exceptions of highly advanced "mercantile states" such as Holland
and Hamburg). This surplus output capacity, lie maintained, would not
have been utilized, directly or indirectly, in the absence of free foreign trade.
It has been suggested that the "vent-for-surplus" theory may be regarded as
"an extreme case" of the comparative costs theory with a zero opportunity
cost of exports, yielding large gains from trade. But this suggestion merely
has the effect of fitting Smith's theory into the procrustean bed of the
conventional theory in which the production possibilities of a country are
fully determined once the resources and technology are given, irrespective of
the internal state of the development of its domestic economic organization.
It is more illuminating to regard the "vent-for-surplus" and the "productiv-
ity" theories of Smith as the twin ingredients of an "open-ended" model of
the domestic economy which leaves room for the unrealized productive
potentialities of a country to be brought out by the interplay between the
forces of domestic economic development and the forces introduced by
foreign trade.
III
We may now assess the significance of Smith's trade-cum-development
approach in the light of the broad changes in economic thought which have
taken place since his time.

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 246 ECONOMICA [AUGUST

The essential virtue of Smith's approach is that it attempts to give a

unified analysis of foreign trade and the domestic economy, oriented to-
wards the problem of long-run economic growth. But as we have seen, the
discovery and formalization of the comparative costs theory introduced a
rift. In the hands of Ricardo and J. S. Mill, the theory of foreign trade
became increasingly formalized in terms of the static theory of efficient
allocation of the given resources, while the analysis of the domestic economy
proceeded along the broader dynamic lines of Adam Smith but with a more
emphatic recognition of the principle of diminishing returns from land. The
logical implication of this rift was concealed by the habit of concentrating on
the standard case of an industrially advanced country with a comparative
advantage in exporting manufactures and importing "corn". In this case, a
free trade policy could be unambiguously supported both in terms of the
static efficiency in the allocation of resources and in dynamic terms: viz., that
cheaper food imports and lower wages would raise profits and stimulate
economic development. On the same premises, there would however be a
conflict between the static and the dynamic considerations in the case of a
country that has a comparative advantage in exporting corn; for free trade
would hasten the diminishing returns from land and depress the profit rate,
exerting an adverse effect on economic development. This dilemma was not
squarely faced by the later classical economists. In contrast, Smith explicitly
recognized that the expansion of agricultural exports would lead to a
growing scarcity of land and to a decline in the rate of profits in the colonies.
But as we have noted, he nevertheless believed that the growing wealth of the
colonies would more than counterbalance the declining rate of profit so that
capital accumulation would still proceed rapidly. On the basis of his "open-
ended" model of the domestic economy, he would predict that the expan-
sion of agricultural exports from the colonies would promote their long-run
economic development by widening the size of the home market and paving
the way for the rise of domestic manufacturing at a later stage.

In their present state of improvement, those prohibitions [of the establishment

of domestic manufacturing industry in the colonies] perhaps without cramping
their industry, or restraining it from any employment to which it would have
gone of its own accord, are only impertinent badges of slavery imposed upon
them, without any sufficient reason, by the groundless jealousy of the merchants
and manufacturers of the mother country. In a more advanced state they might
be really oppressive and insupportable. [Book IV, ch. 7, Part III, Vol. II, p. 84.]

The rift in the structure of the later classical economy theory was passed
unnoticed by the neoclassical economists, who reunified the analysis of
foreign trade and the analysis of the domestic economy-but only at the cost
of subsuming both as branches of the static general equilibrium analysis. In
the heyday of neoclassical theory, the great issues raised by Adam Smith
concerning the relationship between international trade and economic de-
velopment dropped out of the ken of the international trade theorists. And
historians of economic thought, looking at Adam Smith through the neoclas-
sical spectacles, blamed him for his lack of contributions to the neoclassical
trade theory.
In recent times, however, the tide has turned. Present-day international

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1977] ADAM SMITH'S THEORY OF INTERNATIONAL TRADE 247

trade theorists, faced with the task of devising more effective theoretical
approaches to the problems of economic development, both in the industri-
ally advanced and in the underdeveloped countries, have increasingly turned
their attention to the issues raised by Adam Smith. (The beginning of this
trend may be traced to J. H. Williams' celebrated article, "The Theory of
International Trade Reconsidered" (1929). For models of the effect of
growth on trade, see Johnson (1968) and Findlay (1973). See also Kenen
(1975, Part I). Highly sophisticated formal models have been developed to
analyse the effect of the autonomously given forces of domestic economic
growth, viz. capital accumulation, population growth and technological
change, on the pattern of a country's foreign trade. But it is fair to say that
the other half of Smith's problem, the effect of foreign trade on the pattern
of domestic economic development, still remains one of the unsettled issues
of modern international theory. The main source of the difficulty may be
traced to the fact that modern international trade theory is still based on the
highly simplified model of the domestic economy depicted by the assump-
tions of perfect competition. Here Adam Smith's model of the domestic
economy may be obsolete for the study of the industrially advanced
economies, characterized by the giant multinational corporations, imperfect
competition and large-scale investment in research and development. But it
still has a greater relevance than the conventional perfect competition model
for the study of the underdeveloped countries, characterized by the large
traditional agricultural sectors which have still to attain the degree of
commercial specialization and the division of labour depicted in the perfect
competition model (see for example the comments by H. G. Johnson and J.
Bhagwati in Vernon, 1970; also Myint, 1976).
But unfortunately, it is in the underdeveloped countries that Adam Smith
is regarded with the greatest suspicion and distrust as the arch advocate of
laissez-faire and free trade policies. It has, therefore, been of some impor-
tance to show that Smith's free trade policy is based not only on the static
theory of the efficient allocation of resources- but also on a thorough going
exploration of the dynamic effects of foreign trade on long-run domestic
economic development. Smith recognized the importance of "learning-by-
doing" as well as any proponent of the "infant industry" argument for the
protection of domestic manufacturing industry (see in particular, Book IV,
ch. 9, Vol. II, pp. 169-170 and 179). But he believed that the "educative
effect" of an open economy would be greater because of "that mutual
communication of knowledge of all sorts of improvements which an exten-
sive commerce to all countries naturally, or rather necessarily, carries along
with it" (Book IV, ch. 7, Part III, Vol. II, p. 125). Perhaps the significance
of Smith's approach to the underdeveloped countries may be best summed
up by saying it offers a more sensible alternative to the two dominant opposing
views: the so-called "outward-looking" and "inward-looking" strategies for
economic development. The "outward-looking" approach emphasizes the
expansion of external trade as the "engine of growth" but tends to under-
play the fact that a country may not be able to take full advantage of its
external economic opportunities unless its internal domestic economic or-
ganization is strengthened and improved. This is a consequence of implicitly
assuming the perfect competition model. The "inward-looking" approach

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 248 ECONOMICA

emphasizes the promotion of a "balanced growth" between the domestic

agricultural and manufacturing sectors in an autarkic way, but tries to shut
out external economic forces as disrupting factors. As we have seen, Smith
attached great importance to the "balanced growth" between domestic
agriculture and domestic manufactures: "the greatest and most important
branch of the commerce of every nation ... is that which is carried on
between the inhabitants of the town and those of the country" (Book III, ch.
1 and Book IV, ch. 9, Vol. II, p. 183). But he was also perceptive enough to
see: (i) that the expansion of foreign trade and the promotion of the
domestic "balanced growth" are complementary and not competitive; (ii)
that the domestic balanced growth should be based on the extension and
improvement of agriculture and not by the protection of the manufacturing
sector; and (iii) that agricultural development can be best promoted by a
policy of allowing the market forces to allocate resources combined with a
policy of creating a favourable organizational framework based on the
improvement of transport and communications and institutional reforms
permitting a more effective utilization of the available land.

REFERENCES

BLOOMFIELD, A. I. (1975). Adam Smith and the theory of international trade. In Essays on
Adam Smith (A. S. Skinner and T. Wilson, eds.) pp. 455-481. Oxford: Clarendon Press.
FINDLAY, R. E. (1973). International Trade and Development Theory. New York: Columbia
University Press.
HABERLER, G. (1959). International Trade and Economic Development. Cairo: National Bank
of Egypt.
HOLLANDER, S. (1973). The Economics of Adam Smith. London: Heinemann.
JOHNSON, H. G. (1968). Economic developrmient and international trade. In Readings in
International Economics (reprint) (R. E. Caves and H. G. Johnson, eds.), pp. 281-299.
Homewood, Illinois: Richard D. Irwin, for the American Economic Association.
KENEN, P. B. (ed.) (1975). International Trade and Finance: Frontiers for Research. Cambridge:
University Press.
MYINT, H. (1958). The "classical theory" of international trade and the underdeveloped
countries. Economic Journal, 68, pp. 317-337.
(1976). The place of institutional changes in international trade theory in the setting of the
underdeveloped countries. The Nobel symposium on "The International Allocation of
Economic Activity", Stockholm.
SMITH, ADAM (1776). An Inquiry into the Nature and Causes of the Wealth of Nations. All
references are to the Cannan edition (1950), London: Methuen.
STIGLER, G. J. (1952). The Ricardian theory of value and distribution. Journal of Political
Economy, 60, pp. 187-207.
VERNON, R. (ed.) (1970). The Technology Factor in International Trade. New York: N.B.E.R.
WILLIAMS, J. H. (1929). The Theory of international trade reconsidered. Economic Journal, 39,
pp. 195-209.

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