Thursday, April 28, 2011
Business Economist
Adam Smith was a critic of the 18th century corporations that circumvented the operation of the market by obtaining monopoly power from the State. The way he analyzed the role of government in business affairs and the framework that explained the free market still holds true.
From
15th to 18th century, the European economies were endured by the
theory of mercantilism. In those days, the primary source of wealth was
gold and silver, and the State could acquire wealth by encouraging
trade, or rather export, by private companies. Their success would
contribute to the State revenue and in return, the State would
guarantee their mercantile success. In the process, the world’s first
commercial corporation – the British East India Company (EIC) came into
existence, which, established to trade with the East Indies, became a
monopoly of British overseas trade everywhere, and governed India from
the 1770s to 1858. During this period, it expanded into a vast
enterprise, conquering the regional powers in India and exercising a
total monopoly on trade. The magnitude of the company was that, it
ruled over a fifth of the world’s population with a quarter million of
private army.
India’s Encouraging Conditions
India’s
foreign trade during the 1770s included textiles and spices in
exchange for gold and silver. Indian goods enjoyed a tremendous
reputation in the European markets and in the Middle East. India came
to be known as the ‘land of precious metals’. On the other hand, most
of the European goods like woollen garments, lead, tin, coral, Iron
etc., brought to India were either exchanged with certain commodities
or remained unsold for quite sometime. Import of foreign goods did not
prevent India from absorbing a large portion of the gold and silver of
the world, gained through a variety of channels.
The
EIC made huge profits by trading with India. The export of bullion by
the company to the East were estimated to be anywhere around £800,000
per annum. The company exported no fewer than a million pounds of goods
annually during the year 1698-1700. The growth of trade during this
period was the most important factor in the development of the company,
which flooded Europe with the Indian goods, especially cloth.
Adam Smith (1723-90)
The
18th century Scottish political economist and philosopher, and the
founding father of free trade who became famous for his influential book
“An Inquiry Into the Nature and Causes of the Wealth of Nations”
(1776), laid the intellectual framework that explained the free market
which still holds true. He is often remembered for the expression “the
invisible hand,” which he used to explain how self-interest guides the
most efficient use of resources in a nation’s economy, with public
welfare coming as a by-product.
Adam
Smith argued that investment at home generates more “revenue and
employment” than investment in foreign trade. Self-interest motivates
the entrepreneur to invest at home than in foreign trade. He saw the
interests of big capitalists conflicting with those of the public:
capitalists seek high profits, which corrupt and impoverish society. He
criticized the way British mercantilism divided the world into parcels,
granted the merchants’ business monopolies, and the corruption of the
EIC. Adam Smith emphasized the importance of free market and free
trade. To him, there was a convergence of individual and social
interests through a free market economy. His premises of free trade are
as follows:
• National wealth comes from agricultural produce.
• The farmer and the state shared the same pool of money.
• High tariffs on imported goods meant higher prices for the farmers, and less money for the state.
•
Higher tariffs would lead to less investment on the farm hence farmer
could not raise crop yield the following year, and this would decrease
the tax base for the state.
•
Higher tariffs will also lead to: 1) trade monopoly in England that
would raise prices, and 2) depletion of farmers’ resources.
Adam
Smith expounded the scientific rules for the study of economics and
government intervention in economic activities. He championed the cause
of the small and medium sized merchants and traders, and in that sense
was “progressive” by today’s standards. Smith’s portrayal of the free
market economy remains the centerpiece of economic theory. Smith
developed much of the theory about markets that are regarded as standard
theory even today.
In
1772, Adam Smith’s friend William Pulteney recommended him to the
directors of the EIC, as a member of a commission of inquiry in their
administration to be sent to India. Adam Smith, in a letter, dated
September 5, 1772, accepted the appointment. Adam Smith highlighted the
government-granted monopoly of the EIC and its abuses and
inefficiencies. He argued that the Bengal drought was turned into a
famine due to the EIC’s incompetence.
Adam
Smith suggested that the workers must be made stakeholders to achieve
the greatest possible productivity from them. He quantified the
benefits of mechanization but also graphically illustrated the
alienation caused by monotonous factory work. He described the
divergence of interest that resulted from the separation of management
from ownership in large corporations; he recognized that top management
would not be motivated to create personal wealth unless they too are
corporate stakeholders.
Greedy Mercantilist System
Most
European nations, between 16th and 18th century adopted mercantilist
policies, which resulted in the colonial expansion. The goal of these
policies was, supposedly, to achieve a favorable balance of trade that
would bring gold and silver into the European region. The mercantilist
theorists like David Hume (Smith’s mentor) and Adam Smith believed that a
country should have an excess of exports over imports i.e., favorable
balance of trade, to bring in money (wealth) into the country. They
recommended legislation to restrict the use of foreign goods, encourage
exports, and forbid the export of bullion.
However,
the British merchants tried to accomplish this by promoting the
imports of cheap raw materials and exports of finished, manufactured
goods. The colonies were forced to purchase these goods from the
British and had no alternatives i.e., the British had established trade
monopolies. Nonetheless, Adam Smith and David Hume were two important
opponents of these policies and considered them unfair and inefficient.
Adam Smith promoted a laissez-faire approach for governments to
operate. He stated that a government should not create monopolies
because they could be “dangerous to prosperity.”
Also,
government should not keep wages low for its workers and force people
into jobs. Adam Smith also did not like the idea of subgroups
controlling the economy. He also felt that trade should not be a
zero-sum game, but rather a positive-sum game. The comparative
advantages of nations should be utilized, but in mercantilist policies,
these advantages remain unexploited. Adam Smith saw that monopoly
ruined the market system, and the fact that the government created
monopolies was one reason that led him to advocate a minimal economic
role for government.
The
EIC criticized from time to time by the British Parliament for its
pursuance of ‘mercantilist policy’ as it was considered not in the
interest of the country. In defense of the company, Sir Dudley Digges
published his famous pamphlet in 1615 entitled, “A Defense of Commerce”,
which stated that re-export of Indian exported from England to India.
He proved that the English Nation had from the time of establishment of
the EIC saved 70,000 pounds a year, in price of pepper and spices and
had further benefited from commerce with India by the increase in
customs revenue and the building of great ships and the employment of a
large number of Englishmen in the Company’s business.
Henry Martyn
However,
Henry Martyn, Merchant in the East India trade, was right from today’s
perspective. He recognized that wealth might point in one direction
while welfare in another. Henry Martyn’s book “Considerations upon the
East India Trade”, written to oppose the EIC’s monopoly, had already
anticipated most of what is right and wrong about the theory of free
trade: “Things may be imported from India by fewer hands than as good
would be made in England, so that to permit the consumption of Indian
manufactures is to permit the loss of few men’s labor...A law to
restrain us to use only English manufactures, is to oblige us to make
them first, is to oblige us to provide for our consumption by the labor
of many, what might as well be done by the labor of few, is to oblige
us to consume the labor of many when that of few might be sufficient.”
Whatsoever,
many economists opine that Adam Smith had prophetic insights on the
dominant form of corporate business in his days: the so-called “joint
stock company.” During Adam Smith’s lifetime, this risk-sharing system
had evolved into a dynamic driver of an expanding global economy. It
brought into being the famed East India Companies backed by the Dutch,
French, and British governments. They further say, just as Adam Smith
was a harsh critic of the 18th century corporations that circumvented
the operation of the market by obtaining monopoly power from the State,
he would likely to have been equally critical of the powerful
oligarchic companies of the 19th through 21st centuries.
Selected Quotes from “The Wealth of Nations on Multinationals”
“The government of an exclusive company of merchants is, perhaps, the worst of all governments for any country whatever.”
“...The
rate of profit does not, like rent and wages, rise with the prosperity
and fall with the declension of the society. On the contrary, it is
always low in rich and high in poor countries, and it is always highest
in the countries, which are going fastest to ruin.”
“The
interest of the dealers . . . in any particular branch of trade or
manufactures, is always in some respects different from, and even
opposite to, that of the public... (They) have generally an interest to
deceive and even to oppress the public, and accordingly have upon many
occasions, both deceived and oppressed it.”
“Our
merchants frequently complain of the high wages of British labor as
the cause of their manufactures being undersold in foreign markets; but
they are silent about the high profits of stock. They complain about
the extravagant gain of other people; but they say nothing of their
own.”
“Perpetual
monopolies were harmful to the long-term trading interests of any
nation. They raised prices artificially, encouraged waste, fraud and
abuse and, in India, had interfered with the sovereign interests of the
British government.”
“While
the East India Company had been a trading endeavor, it had provided
great service to the state and its people, justifying the monopoly
privileges and helping its stockholders' dividends to growth. After
territorial expansion occurred, this role and its privileges required
revision, for Company interests were at cross purposes with those of the
state.”
N Janardhan Rao, Lead Economist
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