created by trade, therefore the trade must be based only on the exchange of equivalents, while money are no more than a means of exchange.
The physiocrats oppose to the active ("favourable") balance, as it results from the export of wealth (in the form of goods), and the import of money (which are not wealth). They fight to realise an equilibrated balance in international trade.
Quesnay
The founder of the Physiocratic School, Quesnay, in all probability heavily indebted to Cantillon, brought out the fact that the state of the balance of trade between nations is neither an indicator of the advantages of foreign commerce nor that of the wealth of nations. But he was the author of theory which contained the idea that when a country imports luxury goods, selling the most necessary or most useful commodities, it prospers, because it means that the people are able to produce beyond its basic requirements.
The Absolute Advantage Theory
The British school of "classical economics" began in no small measure as a reaction against the inconsistencies of mercantilist thought. Adam Smith was the 18th-century founder of this school; his famous work, "The Wealth of Nations", is in part an anti-mercantilist tract. In "The Wealth of Nations", Smith emphasized the importance of specialization: in a world where the productive resources are scarce and human wants cannot be completely satisfied, each nation should specialize in the production of goods it is particularly well equipped to produce; it should export part of this production, taking in exchange other goods that it cannot so easily turn out.
Adam Smith
Adam Smith's attack was probably the boldest one on the "mercantile system" which was already tottering both because economic changes had given some of these doctrines an antiquarian flavor and because the piecemeal invalidations of these doctrines by the many forerunners of economic liberalism hardly left it a "leg to stand on". All the same, without Smith's vigurous, forceful, and systematic statement of its weaknesses, it might have lingered much longer than it did.
On the other hand, Smith was unfortunately not capable of precisely formulating a general theory of international trade. Apart from his building up an imposing structure of arguments in favor of freedom from restrictions on foreign trade activities, his contributions to this theory are relatively minor, as Smith considered mistaken that a producer needs an absolute advantage to export its products.
The basic concepts of Smith's teory of international trade may be considered the following:
1. The international commerce is close related with the social division of labor.
2. The international trade after Smith is based apon the freedom of action and the incentives of economic agents.
3. In international trade the competition is free and perfect (without monopolies and any governmental restrictions in the form of protectionist policies).
From these concepts the following indications on international economic relations result:
1. In the result of labor division it is not necessary and even possible that every country produce inside all the products it needs. It is because different states are provided with the factors of production of different types and quality in different proportions. As the result every country must specialize in production of that goods, for which the costs of production are the lowest.
2. Every country imports the goods for which it pays a lower price than it would cost him in case it produced this product domestically.
3. The difference between the domestic cost of production and the import price is the absolute advantage obtained through the international trade, this rule being general for all countries.
4. At the domestic range the state must not interfere in economy, as it always disturbs economic agents from seeking the most efficient mode to invest factors of production it posesses.
5. In the international trade must be promoted the policy of free competition (without monopolies) and a policy of free exchange (non-discriminating).
Much as Smith was aware of the benifits of free trade and was able to influence the British economic thought, he was not an unqualified free trader. He singled out two primary cases which in his view justified the imposition of barriers on imports for the purpose of encouraging domestic industry.
First, some particular industries may be necessary for the defense of a country. From this point of view, the British Navigation Acts, inasmuch as they promoted the building up of a merchant marine to be used in peace and war alike, were perfectly sensible.
The second case is an application of the principle that normally competitive conditions should not be distorted by government intervention. Consequently, it will be proper to place a burden on foreign industry if this merely neutralizes the disadvantage under which domestic industry operates because it is burned with some taxes from which the foreign producers are exempt. After the imposition of a "matching" tariff duty, a form of equalizing adjustment no larger portion of domestic labor and capital would be devoted to the particular domestic industry of a country than what would naturally go to it. "It would only hinder any part of what would naturally go to it from being turned away by the tax, into a less natural direction..." Smith does not underrate the difficulty arising from the fact that imported commodities are seldom perfect equivalents of the domestic produced variety.
Adam Smith took up two secondary cases in which he held it to be a "matter of deliberation" whether or not to follow a laissez-faire policy.
The first deals with the advisability, pro and con, of imposing a retaliatory duty designed to bring about the repeal of a duty imposed by a foreign country. The success of taking such a step, Smith holds, will always be open to guess; and unless the odds are distinstly in its favor, the "...transitory inconviniency of paying dearer during a short time for some sorts of goods" would not be justified.
The second possibility, where the issue is not the imposition of a new tax but rather the return to free trade from the evils of protection, centers around the need of preventing a sudden painful shock to a domestic industry. This will be largely a question of size: only when a "great multitude of hands" would all at once be deprived of their ordinary employment and livelihood by the removal of high duties and prohibitions in some special regard to their welfare in order. Indeed, Smith feels, it becomes a matter of equity in this case that the return to exposure to competition from foreigners be undertaken "...slowly, gradually, and after a very long warning".
Bounties on exports, that is, government payments to exporters of goods who could not otherwise effectively compete with their foreign rivals, were, as we might expect, another device of the "mercantile system" scorned by Smith. They can only warp the natural allocation of resources. Since a country cannot force the buying of its exports on other countries, the next best expedient may be found in one country paying another for the buying of exports. But doing so, through bounties, will force a country's trade in less advantageous channels than that in which it would go if left alone. Domestic consumers will be the losers: under conditions of full employment they would pay a higher price for a smaller portion of the total supply, and in addition they would have to foot the bill for government payments to exporters.
Such are the highlights of the attack on the absurdities of mercantilist restrictions, which had flowered too long to suit Smith's disposition.
The Comparative Advantage Theory
Smith did not expand these ideas at much length; but David Ricardo, the second great classical economist, developed them into the "principle of comparative advantage", a principle still to be found, much as Ricardo spelled it out, in every textbook on international trade.
The principle of comparative advantage is based on what kind of product the country can produce best, in comparing not with other countries, but with the producing of other kinds of goods. In this case the country doesn't necessarily need an absolute advantage to specialize in producing and exporting it.
The major purpose of the theory of comparative advantage is to illustrate the gains from the international trade. Each country can gain by specializing in those occupations in which it is relatively efficient; it should export part of that production and take in exchange those goods in whose production it is, for whatever reason, at a comparative disadvantage. The theory of comparative advantage thus provides a strong argument for free trade - and indeed - for a laissez-faire attitude with respect to trade.
The supporting argument is simple; specialization and free exchange among nations yield higher real income for the participants.
The act that a country will enjoy higher real income as a consequence of the opening up of trade barriers does not mean, of course, that every family or individual within a country must share in that benifit. Producer groups affected by import competition obviously will suffer to at least some degree. Comparative-advantage theorists concede that free trade would affect the relative income position of such groups, and perhaps even their absolute income level. But they insist that the special interests of these groups clashes with the