Adam Smith on Portuguese wine and English cloth

Half a century before David Ricardo’s famous numerical example of the exchange of Portuguese wine for English cloth under the Methuen Treaty as illustrating trade creation and comparative advantage, Adam Smith denounced the Methuen Treaty as an instance of trade diversion, displacing British imports of French wines with higher cost, lower quality Portuguese wines. Relying on his argument that the division of labour is limited by the extent of the market, Smith insisted that a treaty of commerce with France would be more beneficial, and supported Eden’s Treaty (1786). Smith also rejected the argument of Cantillon and mercantilists that the exchange of English cloth for Portuguese wine benefitted Britain by bringing in gold and silver, arguing that an excess demand for precious metals in Britain would by itself cause an inflow of gold and silver. Smith’s critique of the Methuen Treaty and his posing of the question of which commercial treaties would be trade-creating rather than trade-diverting have been largely overlooked.