Commerce, Liberty, and Finance in the Imperial Crisis

Can a nation or an empire be run like a business?

Every businessperson wants to crush its competition. An enterprise seeks out the right production mix, quantities, and prices for its products; and also plays its suppliers against one another to reduce the costs of inputs. The mercantilist perspective that can dominate the financial decisions of government treats the government like a large firm, pursuing what it perceives to be profits, the inflow of money, though that is a false analogy. Exports of high value goods and services are considered good. Imports of raw materials to be used in the manufacture of exports are also considered good. Imports of manufactured goods are discouraged, and every attempt is made to prevent rivals from access to raw materials that could increase competition in manufacturing.

Colonial Great Britain went a step further and attempted to internalize access to raw materials. Colonies were treated as within-the-firm suppliers of commodities and were often prevented from trading with rivals and even with each other, the way a McDonald’s franchise is not permitted to sell its special sauce to a Burger King franchise. Similarly, colonies were expected to source manufactured goods from the mother county. The McDonald’s franchise is expected to purchase its equipment and french fries from a supplier approved of by corporate headquarters.

The empire sought to capture all of the surplus from trade at its central headquarters, Great Britain. The producer of sugar in the West Indies would be prohibited from selling sugar to France, and even to the North American colonies, at a competitive rate. Great Britain was to have what would today be called “most favored nation” status, meaning that Great Britain was to be given the lowest rate possible in whatever quantities it desired and if any was left over it could be sold to others at a premium. Tar and furs were to be imported from the North American colonies rather than from Russia, again at favorable rates, though perhaps higher than what Russians would offer, so as to prevent the flow of money to Russia.

The flaws of mercantilism had been described by physiocrats in France and elsewhere, and some pamphleteers, such as Josiah Tucker, demonstrated an understanding, but Adam Smith’s comprehensive critique of mercantilism, An Inquiry Into the Nature and Causes of the Wealth of Nations (1776) had not yet been published.

The attempt to monopolize trade and to manage the flow of goods foreclosed upon Great Britain’s opportunities to purchase raw materials more cheaply and to export them more dearly. Great Britain sought to also control the means of transportation, including the ships that crossed the oceans, like the Jones Act in the United States today. Thus, it missed out on opportunities to ship those goods at lower cost. It treated those losses as a reasonable opportunity cost for maintaining dominance of the seas, analogous to the national defense argument for trade regulations sometimes argued today.

Opportunity costs can pile up. A large firm can run into decreasing economies of scale and scope. Smith explained that the division of labor, specialization, is limited by the extent of the market. As the market expands, increased specialization becomes more likely. At some point the relationship became more distant.

Dis-integration is more likely when the transaction costs of remaining integrated are greater than the transaction costs of splitting off (Stigler 1951). Maintaining Ireland as an annex of Great Britain, though not yet admitted into the United Kingdom, was not so hard to do. The distance was not great, and communication was regular and reliable. Communication to the American colonies was not so regular and not so reliable. Lags in communication impede governance.

Disintegration may also result if some tasks can be performed better if done outside the firm, provided transaction costs are low enough. A big firm’s brightest employees might disintegrate—decide to all quit together to form a startup that will on some margins compete with the mother firm. Some of the big firm’s operations were inefficient, thus  there is an opportunity for disintegration.

The rents captured by Great Britain, Inc. primarily were affecting the North American colony franchises’ salaries. Breaking away would increase efficiency, but some of the profits that had been flowing to GB HQ would instead augment the colonists’ quality of life. In the long run, even the mother firm would do better, no longer subsidizing inefficient processes, though it might lose some of its military influence.

The pamphlet, THE PRESENT STATE OF THE ΝΑΤΙΟΝ: Particularly with respect to its TRADE, FINANCES, &c. &c. ADDRESSED TO The KING and both Houses of Parliament, (1767) attributed to William Knox, provides an account of the finances of Great Britain after the 7 Years’ War (also called the French and Indian War). The cost of the war, to Knox’s estimates, amounted to roughly £ 70,000,000. Tax revenues had whittled down the debt incurred by the war a great deal but much remained. Rather than cutting other programs, the government sought out new sources of revenue, and the North American Colonies were targeted.

Knox reports the finances surrounding the war including: national debt, terms available for future borrowing, taxes collected, trade flows (with a special emphasis on trade imbalances), and potential sources of government revenue.

In Knox we encounter both grave errors and occasional gems. Knox explains that “The misfortunes of France had deprived her of credit; foreigners would not trust her with their money (p. 6)” demonstrating that military dominance greatly factors into the capacity of a nation to borrow at low interest rates. Many of the loans secured by Great Britain at 4 percent interest were readily refinanced after the war at 3 percent. Dominant empires may be tempted to overplay their hands by taking on too much debt (Ferguson 2001), but Great Britain in 1767 was not in bad shape.

Knox fails to apply marginal analysis to public finance. That sort of analysis didn’t really catch on until the 1870s. In the following generation, Ludwig von Mises applied marginal analysis to demonstrate that the sort of public finance being attempted by the government of Great Britain would fail. Mises (1922) applied his analysis to socialism, in some ways a rebirth of mercantilism. F.A. Hayek (1945) showed that central planning could not know what should be produced where and in what quantities. Great Britain’s industrial policy was bound to fail.

The British government was jealous to protect its manufacturing industries domestically, and did not want them to be undercut. Hayek’s logic can be extended to demonstrate that a government cannot know what the proper scale or scope of any particular business or plant ought to be. No individual firm can know it either.

The goal of the firm might be to develop a long sustainable enterprise that is healthy in each of its branches and plants. A firm will be more likely to survive amidst competition if it chooses among its inputs amounts that, at the margin, each increase productivity equally. The appropriate economy of scale for any enterprise or plant is the consequence of a discovery process that requires flexible prices.

Great Britain contested Spain’s and France’s attempts to colonize North America, won, and fell victim to the winner’s curse (Thaler 1992). An enterprise experiencing success might pursue expansion. The enterprise can guess but cannot really know what among its own particular qualities makes it successful. That enterprise can also guess, but will not really know, what might lead to its first or successive failures, and whether those causes might be internal or external, avoidable or not. Following the success of the 7 Years’ War Great Britain held colonies in the West Indies, the East Indies, and Africa. New England, perhaps its greatest success, would also be the first to disintegrate.

The North American colonies were not generating the revenue that Great Britain had hoped. The Stamp Act (1765) failed and was repealed. Some colonial (and some British) pamphleteers, saw the Stamp Act as a violation of the rights of colonists and unconstitutional. Knox proposed a tribute to be paid by the colonies, with the collection to be left up to the colonies to administer. This overcame some of the difficulties incurred in introducing the Stamp Act. But Knox only proposed such a tax (£ 200,000) as would contribute toward the costs of paying officials and military personnel stationed in the colonies. Great Britain would still be running its American Colonies at a loss.

Perhaps this could be justified by the gains from the West Indian colonies. The war had resulted in several lands coming into British possession, with many plantations providing sugar, rum, and other commodities both to Britain but also to the Colonies, in a closed trade circuit.

The West Indian holdings, however, were vulnerable to simply being retaken by foreign enemies, or at least to being nuisanced by them, apart from easy British warship access to supplies only readily available in Britain or the North American colonies. To maintain the West Indian Colonies it would be necessary to keep the North American Colonies. It certainly increased the complexity of the calculation as to whether the colonies are worth maintaining.

Should the colonies be “spun off” from Great Britain? Josiah Tucker (1776) proposed a simple dis-integration: just let them go. This contrasted with proposals from parliament (to maintain the supremacy of the mother country) and a proposal offered by Edmund Burke. Samuel Estwick opposed Tucker’s plan and responds with vinegar in A Letter to the Reverend Josiah Tucker, D.D. Dean of Glocester, in Answer to His Humble Address and Earnest Appeal, &c. with a Postcript, in which the Present War Against America is Shewn to be the Effect, Not of the Causes assigned by him and others, but of a Fixed Plan of Administration, Founded in System: the Landed opposed to the Commercial Interest of the State, Being as the Means in order to the End (1776).

Estwick, the Assistant Agent for the Island of Barbados, and a mercantilist, mocks (he calls Tucker “Josiah ben Tucker ben Judas Iscariot”) and ridicules, tosses in bits of unnecessary Latin and French for authority, and entertains.

Of Tucker’s argument for trade with a free America he says:

our trade-doctor here, his deanship, declares; that to cut off the resources of a kingdom is the ready means of increase, to its wealth and its power; that to leave the commerce of America open to the world, is the sure way of confining to Great Britain the advantages of it. If these positions were intelligible, who could believe them? (10).

Estwick believes that the loss of British dominion over the colonies will lead to anarchy, that an end to paying bounties (subsidies for certain imports) will result in a loss of reciprocal trade and leave Britain vulnerable to potential lack of access to essential supplies from other nations, and that the balance of trade ought always to result in an inflow of specie ( 42).

Tucker says, “it is freedom, and not confinement, or monopoly, which increases trade” but Estwick considers “this too general reasoning for so particular a subject” (46) because no empire followed that path to success. Estwick is bound by imperial ambitions.

Estwick is most concerned for the West Indies “The inhabitants of these islands are not only dependent on America for the materials necessary for the carrying on of their manufactures, but that food by which they are fed must be had from thence” (54).  If Great Britain no longer controls the North American colonies, then trade with the West Indies will increase “to the entire exclusion of [GB].” “Great-Britain without America can neither support nor protect the West-India islands, America without Great-Britain can do the former, and will be able to do the latter; and then rue the consequences of a separation, when too late to repent of the folly” (56).

Estwick has moments of insight, however. Among the challenges of managing a large enterprise is what Hayek (1945) described as the knowledge of the particulars of time and place and that Estwick calls “want of knowledge”. A fast-food company may want to promote a new sandwich, but the local manager will know best what appeals to the local customers. Similarly, a blunt instrument policy, like the Stamp Act, would not work well in many colonial settings. Estwick explains that the additional costs of the Stamp Act led many to give up pursuing legal matters and “the door of justice was shut upon them” (62). Taxes drive a wedge into relations, foreclosing upon opportunities for reconciliation.

Estwick also introduces a finer analysis of the difference between real and virtual representation, contributing to the constitutional debates among pamphleteers at the time. He supposes that a distinction in each category should be made between landed interests and commercial interests. Of the individuals who have real representation, “knights of the shire” have votes because they have freeholds in lands—the landed interests, and “citizens and burgesses” “have votes by charter, or custom… representing the monied or trading interest of the kingdom” (75). Of those virtually represented, those whose property is in the same territories as their virtual representatives “pay no other, nor higher taxes, but the same only, as the representatives themselves do.” However, those who do not have a vote but whose property is not “on the spot where the representatives themselves have, such as the Irish, the West-Indian, the North-American, [and] the South-American” may be taxed differently from their representatives. This misalignment of incentives means that their interests are not really virtually represented. If taxes are justified to fund protection of property, but property is only arbitrarily protected from taxation, liberty does not obtain. The British Constitution instead provided that people who were not represented could not be taxed by Great Britain but could establish taxes among themselves with just representation for financing the administration of government and justice.

Political economist and Nobel laureate James Buchanan (1985) described the constitutional stage of policy making as essential, the point at which a society came to a consensus upon “the rules for making rules.” Estwick’s understanding of the constitution anticipates Buchanan: “The public or political law of a country is one thing, the civil or municipal law thereof another. The constitution of England is this public or political law, the laws of parliament the civil or municipal law. The superstructure may be regulated, new modeled, or even created afresh by parliament, whilst the foundation remains fixed, and immovable only by the people” (89).

On net, the mercantilist sensibilities of Knox and Estwick led to fatal errors of analysis, but we can still learn from their analysis, and better understand how to avoid errors of our own.