Adam Smith was More Preceptive Than We Give Him Credit For

My previous post sported a quotation from Adam Smith’s Wealth of Nations.  As I was going through that section again, I noticed the editor’s footnote I had overlooked last time.  It pointed me to Book IV, Chapter IX of the Wealth of Nations where Smith makes the following argument (Pages 680-681):

Except with Japan, the Chinese carry on, themselves, and in their bottoms, little or no foreign trade; and it is only into one or two ports of their kingdom that they even admit the ships of foreign nations.  Foreign trade, therefore, is, in China, every way confined within a much narrower circle than that to which it would naturally extend itself, if more freedom was allowed to it, either in their own ships, of in those of foreign nations.

The perfection of manufacturing industry, it must be remembered, depends altogether upon the division of labour; and the degree to which the division of labour can be introduced into any manufacture, is necessarily regulated, it has
already been shown, by the extent of the market.  But the great extent of the empire of China, the vast multitude of its inhabitants, the variety of climate, and consequently of productions in its different provinces, and the easy communication by means of water carriage between the greater part of them, render the home market of that country of so great extent, as to be alone sufficient to support very great manufactures, and to admit of very considerable subdivisions of labour. The home market of China is, 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 market of all the rest of the world; especially if any considerable part of this trade was carried on in Chinese ships; could scarce fail to increase very much the manufactures of China, and to improve very much the productive powers of its manufacturing industry, as by a more extensive navigation, the Chinese would naturally learn the art of using and constructing themselves all the different machines made use of in other countries, as well as q the other improvements of art and industry which are practised in all the different parts of the world. Upon their present plan they have little opportunity of improving themselves by the example of any other nation; except that of the Japanese.

The tl;dr version: Smith argued (along the lines of the QOD) that China, under their current regime of laws and institutions, has maxed out their ability to grow.  China has a great ability to manufacture, and yet a poorer than Europe.  Why?  Smith predicts that it is because of their disdain for foreign trade.  If they were to open their markets to foreign trade, China would become considerably more wealthy.

We are blessed, in the 21st Century, to be able to test Smith’s hypothesis.

Prior to the 1970’s and 1980’s, China was very much anti-foreign trade.  The desire to be self-sufficient and reject all “Western” influences was strong (eg the Great Leap Forward) and China was abjectly poor.  In 1981, approximately 81% of China’s population lived in extreme poverty (less than $1.25 a day).  Their economy was stagnant.

However, beginning in the 1980s and accelerating in the 2000’s, China opened itself up to international trade.  According to the Economic Freedom of the Word report, China dramatically reduced tariffs and more moderately reduced non-tariff barriers to trade between 1980 and 2015 (most recent data).  Coincidently, China’s growth skyrocketed.  After hovering around 0% for the 60’s and 70’s, China started to grow consistently at 8+%.  Poverty fell to about 12% by 2010.  China’s average standard of living (as measured by GDP per capita) while still quite low, is quickly converging to the world average.

Adam Smith appears to have been quite right.

On a related note, this paper from the Journal of Legal Studies (gated) is another example of the percipient nature of Adam Smith