This month marks the 250th anniversary of Adam Smith’s monumental work, The Wealth of Nations. The Liberty Fund print edition spans 950 pages (not counting the editorial additions) and is a treasure trove of economic wisdom. While it certainly has its imperfections, we rightly honor this text as a significant leap forward in our understanding of economic principles.
As a trade economist, I find myself particularly drawn to Book IV, titled Of Systems of Political Œconomy, where Smith deftly critiques the tenets of mercantilism and protectionist policies. Toward the conclusion of this book, Smith asserts:
“All systems either of preference or of restraint, therefore, being thus completely taken away, the obvious and simple system of natural liberty establishes itself of its own accord. Every man, as long as he does not violate the laws of justice, is left perfectly free to pursue his own interest his own way, and to bring both his industry and capital into competition with those of any other man, or order of man. The sovereign is completely discharged from a duty…of superintending the industry of private people, and of directing it towards the employments most suitable to the interest of the society” (pg 687).
Smith was undeniably an advocate for free trade. He strongly opposed tariffs that impede the natural flow of commerce, although he found revenue tariffs somewhat less objectionable. Nevertheless, Smith acknowledged exceptions to his free-trade ideal, which he elaborates on in pages 463-471. For a deeper dive into these exceptions, you might check out my piece for Adam Smith Works, “Would Adam Smith Have Supported the Jones Act?,” or Don Boudreaux’s insights in his book Globalization.
Among these exceptions is the debate over whether tariffs that restrict trade can ever be beneficial. Smith suggests that if tariffs can be utilized as a retaliatory measure to encourage another country to lift its own trade barriers, then temporary tariffs might be warranted:
“There may be good policy in retaliations of this kind, when there is a probability that they will procure the repeal of the high duties or prohibitions complained of. The recovery of a great foreign market will generally more than compensate the transitory inconveniency of paying dearer during a short time for some sorts of goods” (pg 468).
However, if such a repeal is unlikely, Smith argued it would be wiser to maintain a tariff-free environment (ibid). The intricacies of negotiation complicate this process, as they are steeped in the capricious nature of politics. Smith wittily referred to the negotiators as “that insidious and crafty animal, vulgarly called a statesman or politician, whose councils are directed by the momentary fluctuations of affairs” (ibid). This suggests that personal interests and global dynamics often muddy the waters of tariff discussions.
This argument has been dubbed the “Crowbar Theory” or “Aggressive Unilateralism.” Under certain conditions, the theory posits that a sufficiently large Country A can impose tariffs on Country B, improving A’s trade terms with B, while simultaneously worsening B’s terms. This dynamic could incentivize Country B to negotiate with A to avoid a beggar-thy-neighbor scenario. However, most trade economists dismiss this theory, echoing Smith’s concerns: political self-interest often trumps economic principles, leading to potential miscalculations and spiteful retaliation.
Historically, aggressive unilateralism presents a mixed bag of outcomes. In many instances where tariffs were leveraged as a crowbar to pry open markets, the result has been disastrous—leading to trade wars or, at times, actual warfare. Smith himself pointed to the conflict between France and the Dutch in the 1670s as a prime example of this approach gone awry. More recently, the Franco-Italian Tariff War of 1887–1898 serves as a cautionary tale of Italy’s attempt to use tariffs to compel France to open its markets, resulting in economic ruin for Italy.
Yet, Franklin Delano Roosevelt managed to employ aggressive unilateralism successfully to de-escalate the trade war ignited by the Smoot-Hawley Tariffs. The measures he implemented in the late 1930s laid the groundwork for the proliferation of free trade agreements that characterized the latter half of the 20th century.
What enabled Roosevelt to succeed where others faltered? The answer may lie in Adam Smith’s insights. In an upcoming working paper, I contend that Smith’s observations point to an essential institutional component: the success of aggressive unilateralism hinges on the frameworks within which negotiations are conducted. Specifically, how do institutions shape the actions of “that insidious and crafty animal” to prioritize liberal principles over transient political whims?
From a game theory perspective, we can visualize trade negotiations as a classic prisoners’ dilemma. Imagine two negotiators at a table, each faced with the choice to cooperate (lower tariffs) or defect (raise tariffs). The following is a simplified representation:
The ideal outcome occurs when both countries cooperate, yielding mutual benefits from lower tariffs (+,+). If Country A defects while Country B cooperates, A gains significantly (++) while B incurs losses (–). The reverse is equally true: if B defects while A cooperates, B benefits while A suffers. The worst-case scenario arises if both countries defect, plunging them into a trade war and leading to a mutually detrimental outcome.
The prisoners’ dilemma illustrates that, regardless of the other player’s choice, a self-interested individual is likely to defect. This results in a stable yet sub-optimal equilibrium, where both parties are worse off.
Proponents of aggressive unilateralism argue that the logic of the prisoners’ dilemma justifies the imposition of tariffs: cooperation yields the best result. Hence, negotiations can foster cooperation (binding agreements can help mitigate prisoners’ dilemmas).
However, within the context of aggressive unilateralism, the first mover has already signaled a readiness to defect. Consequently, Country B is left with a choice: cooperate in hopes of A honoring its commitments, or defect to avoid being worse off. In the face of uncertainty over A’s cooperation, B’s rational response is to retaliate, thus initiating a trade war.
The dynamic shifts if B can secure a credible commitment to de-escalate from A. This would incentivize B to cooperate as well, as long as A’s institutional framework supports such commitments.
In 1933, representatives from 66 nations convened in London to discuss resolving the trade war that had engulfed the globe, but they left without agreements. By 1934, however, FDR was striking deals left and right, concluding 19 trade agreements between 1934 and 1939. What changed during that year? The institutional landscape in which FDR operated.
The turning point came with the passage of the Reciprocal Trade Agreements Act (RTAA) in 1934. Prior to this act, tariffs were largely viewed as tax policy, set by Congress without regard for foreign policy implications. Efforts to leverage tariffs to open markets were treated as treaties, necessitating a two-thirds Senate ratification. This left room for sectional interests and public choice issues to derail any negotiated tariff reductions. In essence, credible commitments to de-escalate were unattainable. The RTAA, however, allowed Congress to delegate some of its authority to the President, permitting tariff negotiations as executive agreements, which required only a simple majority in Congress. This significantly lowered the barrier for tariff changes and made it more challenging for special interests to intervene. The RTAA transformed the institutional framework, establishing a credible commitment to de-escalation.
Smith’s concerns about the political hurdles to free trade were well-founded, acknowledging the risk of self-interested politics. Yet, as demonstrated in 1934, the right institutional framework can indeed alter those outcomes.
Further Reading:
- Clashing Over Commerce by Douglas Irwin
- “Trade Wars: A Comparative Study of Angle-Hanse, Franco-Italian, and Hawley-Smoot Conflicts” by John Conybeare. World Politics, 38(1) 1985, pp147–172.
- “The Institutional Roots of American Trade Policy: Politics, Coalitions, and International Trade” by Michael A. Bailey, Judith Goldstein, and Barry R Weingast. World Politics, 49(3) 1997, pp. 309–338.
