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Free Trade and Development

H. Myint

• London School of Economics

“Adam Smith's Theory of International Trade in the Perspective of Economic Development.” Economica (U K) 44 (August 1977): 231–248.

Adam Smith's trade theory is highly relevant to underdeveloped countries, although they tend to view capitalism with deep suspicion. Smith is erroneously discounted as a good international trade theorist because he did not discover the law of comparative costs. (This law, later formulated by David Ricardo, holds that it is advantageous to everyone to have those persons or nations who are relatively more productive in some economic field specialize in what they most efficiently produce. This leads to an international division of labor and specialized markets.) However, Smith's trade theory, in the context of his views on economic development, contains many sound ideas.

Smith's trade theory is not a static analysis of trade based on given resources and given productivity. It attempts rather to study how foreign trade and domestic economic development interact and lead to increases in resources. Smith's theory realistically deals with the impact of trade on economic development and so anticipates the Heckscher-Olin analysis of the differences in relative factor supplies and prices in different countries.

His “vent (sale)-for-surplus” doctrine together with his dictum that “the division of labor is limited by the extent of the market” present an “open-ended” model of the domestic economy which enables him to investigate the effects of foreign trade on economic development.

By widening the extent of the market, international trade ignores the division of labor (the productivity theory) and provides an outlet “for whatever part of the produce of their labour may exceed the home consumption” (the “vent-for-surplus” theory).

Smith's ideas are quite serviceable to underdeveloped countries. Smith believed that the educative effect of the open economy would be greater than protectionism because of “that mutual communication of knowledge of all sorts of improvements which an extensive commerce to all countries naturally, or rather necessarily, carries along with it.” His analysis offers underdeveloped countries a superior strategy for economic development because Smith saw that (1) the expansion of foreign trade and the promotion of domestic “balanced growth” are complementary and not competitive; (2) domestic balanced growth should be based on the extension and improvement of agriculture and not on industrial protection; and (3) agricultural development is best promoted by allowing resources to be allocated via the market, and by a property system that permits the most effective utilization of the land.