The Wealth of Nations Summary
Adam Smith doesn't waste any time getting down to business at the opening of this book. He tells us that his goal is to figure out why some countries in the world are wealthier than others. Is it because the people of these countries work harder? Probably not. There are countries all over the world where people spend their entire lives working. So why do the people in other countries spend less time working while still leading more comfortable lives? Well for Adam Smith, the secret is… wait for it… free trade!
What is free trade? Well Smith is going to spend the rest of this book explaining just that. But first, he wants to walk us through the origin of money and why we use money to buy stuff. The reason for this is because money makes it way easier for us to get the things we want. After all, if we could only get stuff by trading thing we already had, then we'd only be able to trade with people who wanted our specific stuff. And that would slow things down a lot.
So yeah, we use money so that we can swap goods and services with people. And for Smith, all of this trade is like a magic wand. It makes everything about our lives more efficient and helps ensure that the marketplace will always fulfill our wants to the best possible extent.
Unfortunately, government often tries to butt in and mess with free trade by banning foreign products or taxing them so much they become super expensive. If they just took their hands off the steering wheel, Smith is convinced that the "autopilot" mechanism of the free market would make everyone a lot better off, even the poorest people in society.
If governments stay out of the market, then the people who create products will always work to make the biggest profit for themselves. And if they do this, they'll always spend their time and effort making things that the public has a big demand for. And if you follow all of that to its natural conclusion, the market will always work to satisfy all of people's most pressing wants as much as possible. Now the fact is that along the way, some people will get super rich and others will stay poor. But Smith thinks that this is just the price we have to pay for human freedom and an efficient market. And he's definitely willing to pay that price.
When he writes about the free market, Smith is reacting against the dominant form of economics in his time, which was called mercantilism. This system of economics basically assumes that one country can only get rich if another gets poor. It's a system of winners and losers, so every country tries as hard as possible to bring money into its borders without letting any escape.
But, according to Smith, this seemingly commonsense approach actually makes the country poorer in the long run. If another country can provide cheaper and better goods, you're actually letting your country's people down by not giving them access to these better products.
Adam Smith closes the book with a long talk about taxes and public expenses. Despite what many free-market folks think today, Smith definitely believed in government taxes and public institutions like schools and the police. Many people today think that schools, hospitals, and even the police should be privately owned, but Smith argues that some things can't possibly function well in the free market, so they need to be run by the government for the sake of the greater good.
Just be sure to read this section closely if you want to repeat these arguments, because some Adam Smith fans will yell and call you a liar if you tell them that Smith believed in taxes and public institutions. And they're dead wrong.
- Adam Smith starts his landmark book by making a basic statement, saying that he's going to talk about what counts as the "wealth" of a country and how certain countries tend to have more wealth per person than others.
- For starters, the wealth of a nation depends on the number of people who are productively employed compared to those who aren't. Next, you have to wonder about these people's level of skill and education.
- But Smith wants to figure out how many modernized countries have fared very differently when it comes to producing wealth. In other words, why have some succeeded more than others? Does it have to do with the people and land in that country, or can governments bring in specific policies that make the country wealthier? Of course, this is a question we're all still asking today. Just listen to two politicians argue about the economy and you'll see what we mean.
Book I, Chapter 1
Of the Division of Labour
- For starters, Adam Smith wants us to know that one of the biggest achievements of many wealthy countries is something called the "division of labor." In other words, the fact that we have specialized people for specialized tasks makes us much more productive than having a bunch of people who try to do every job well.
- Adam Smith uses the example of pin-makers in England to illustrate his point. An amateur who doesn't know anything about pin making could probably make one decent pin per day. But when you bring in someone who is specialized at stretching a wire, another one at cutting it, another one at pointing it, etc., then you can make thousands of pins a day.
- That's the secret of specialization and the division of labor. Any advanced system of manufacturing works this way.
- By dividing labor up into simple, specialized roles, we also give ourselves more opportunity to invent new machines that can do certain tasks for us (like the way robots weld metal onto cars today).
- For this reason, Smith believes that even the lower classes of developed countries are still better off than the richest people in some less developed ones. In his mind, much of this is due to the division of labor.
Book I, Chapter 2
Of the Principle Which Gives Occasion to the Division of Labour
- We learned in Chapter 1 that the division of labor is important, but one thing Smith thinks is even more important for creating a wealthy nation is to have open trade with other people and other countries. In other words, he thinks of trade as the killer app of modern capitalism.
- Anyone who creates something usually needs more than that one thing. For example, a shirt-maker needs more to survive than just shirts. So he has to make more shirts than he needs and trade some of them for food, money, or housing.
- As different people grow up, they realize they're good at different things. So they go into specialized jobs and use the product or service they create to exchange for other stuff they need. Seems simple enough, right? Well this is actually the key to modern wealth according to Smith. All of the least developed countries, he argues, are the ones who are most suspicious of trading with other countries.
Book I, Chapter 3
That the Division of Labour is Limited by the Extent of the Market
- So now we've got a division of labor and the exchange of products and services among these specialized people. It seems like there's no limit to what these two things can do. But Smith is quick to remind us that there is a limit, which is what he calls "the extent of the market."
- By this, he means that people can only exchange products or services if other people want them. So yeah, it's great if you love to make steak-flavored cookies. But you won't get far if no one wants them. (We want them. Mmm, steak.)
- In many cases, a person's job is limited by the kind of town they live in. If you're an expert plower of land, you probably won't live in the middle of a huge city because there's no land around to plow. So you move out to the country where people want your services.
- Smith also makes a point about how great it is to be near water, since water allows people to transport goods way more easily than over land. That's why even today, you'll find that most of the world's big cities are found near water that boats can use for shipping.
Book I, Chapter 4
Of the Origin and Use of Money
- So if we asked you, "Why does money exist?" what would your answer be? Well before you decide, you might want to check out this chapter of The Wealth of Nations. Because ol' Smithy is going to lay it out for us.
- Turns out that if you're a coat maker who makes a thousand coats a year, you're going to end up with 999 coats too many. So you want to trade those coats for other things you might need, like food. But why not just trade a coat for a hundred potatoes? Why does money have to come into the equation?
- Well for starters, maybe the only people who want to buy your coats are potato growers. But if you want something more in life than coats and potatoes, you're out of luck because the potato folks are the only ones you can trade with. That's why you need something that will allow you to sell your coats while still buying the products of people who don't want coats.
- Smith walks us through how shells, metals, and other little objects have been used as money in other societies, like dried cod in Newfoundland.
- But of all the different things used as money, people have tended to prefer metal because it's not easy to find and because it's so durable.
- But using metal as money can be inconvenient because you have to weigh the stuff every time you take it as payment. Just imagine yourself in the line at Starbucks and waiting for the barista to weigh every coin handed to them.
Book I, Chapter 5
Of the Real and Nominal Price of Commodities, or of Their Price in Labour, and Their Price in Money
- Adam Smith begins this chapter by reminding us that people are only rich or poor depending on how much stuff they can afford to buy. In other words, money itself doesn't have any value. It's only valuable insofar as it can buy "labour."
- Maybe we should explain. When you spend five dollars on pop and chips, you're not just paying for the pop and chips. You're paying for all the work a bunch of other people had to do to create those things. In Adam Smith's mind, all value is connected to human work. Therefore, the value of stuff is connected to the trouble someone took to make that stuff.
- But then again, Adam Smith reconsiders. Maybe the value of stuff isn't connected to labor, but to the value of other stuff that we're willing to exchange for.
- At this point, Smith feels like he has to make a distinction between the "real" and "nominal" value of things.
- The nominal value is the amount of money you pay for it. Sometimes gas is cheap and sometimes it's expensive, so its nominal value goes up and down. But the "real" value of something is the amount of necessary things (like food and shelter) that you can get for it.
- Smith calls this "real" value because it's connected to the real needs of human life, while money value can change with taste and fashion over time.
- For proof of this, just check out how much people were willing to pay for CDs in 2000… vs. today.
Book I, Chapter 6
Of the Component Parts of the Price of Commodities
- Why do some jobs pay more than others? For Adam Smith, there are several reasons, but one of the most obvious reasons is the fact that some jobs are tougher than others. Some jobs require more skill and expertise than others, which is another reason they're paid differently.
- In the first societies, workers got to keep all the profit of their own labors. But as some people started to build up stockpiles of stuff (which today we call "wealth"), they used this extra stuff to pay other people to work for them. That's when bosses started existing and taking a cut of the workers' profits. Then when private property gets invented, some people start charging other people rent to live on their land or in their buildings. And that's when you get landlords.
- When all is said and done, there are three things that make up the price of every product: the labor it took to make the product, the profit that the company wants to make, and the rent that the company gets charged on its buildings or its machines. The rent and labor (wages) make up a lot of the price, but anything beyond that is the company's profit.
- When you look at the big picture, the wealth of a country can also be broken into labor, profit, and rent.
Book I, Chapter 7
Of the Natural and Market Price of Commodities
- In any country, province, or town, there tends to be an average wage that people of a certain job make for their work. This is what you would call the market price of labor. And for Smith, this average wage works the same way for the prices of products, and it's all determined by the laws of supply and demand. The same forces control the price of rent.
- Smith refers to these average rates of wage, rent, and profit as the "natural" rates.
- The two main things you have to consider when looking at the price of labor or products are 1) the supply and 2) the demand. These two things always control how much stuff costs.
- For example, if you have tons of chips to sell but nobody wants them, you have high supply and low demand. So the price of the chips will be low because people don't want them all that badly. But if a bunch of people decide they want some chips, the price will start to go up. And if your supply of chips runs out while people's demand goes up, then the price will go even higher because people will be desperate to buy one of those last bags of chips.
- Whenever the price of a product is a direct reflection of how much people actually want the thing, then that's what Adam Smith calls the natural price of that product.
- If there's only one person who makes that product though, they have a monopoly and they can manipulate the supply of the product in order to make the price whatever they want it to be. That's when the nominal (money) price starts to get away from the natural price.
- The same forces are what control people's wages. When there's a sudden boom in business, a company has to expand and it needs new workers to do so. So as its demand increases, it pays more money to attract the workers it needs. That's why you hear about regular people making tons of money in places where a company has suddenly found oil.
- For Smith, there are all kinds of things that can make the nominal price of a product higher or lower than its natural price. But over the long run, he thinks that prices tend to hover around the "natural price."
Book 1, Chapter 8
Of the Wages of Labour
- As Smith mentioned in an earlier chapter, we live in a world where bosses pay wages to workers and earn a profit on whatever money they make beyond the cost of those wages. It's true that some people are self-employed, but the vast majority of workers have some kind of boss.
- Smith is quick to note that it's easy for a bunch of company bosses to get together and agree to drive the price of wages down.
- But we never hear about this in the papers. We only hear about it when workers organize to drive wages up.
- Smith doesn't agree with either tactic, but he admits that the public is more biased against unions than it is against corrupt business people. He even talks about how some people are run out of business just for paying their workers too much and making other companies look bad.
- Smith also makes a point of saying that workers' strikes tend not to make any long-term gains for workers. There are many who'd disagree with that, though.
- For Smith, there is a certain price that wages can't go below, and that's the price necessary to keep a worker alive. If wages ever went lower than the price of staying alive, then workers would begin to die off and they wouldn't bother working anymore because they'd know they couldn't continue living.
- But wages need to actually be higher than this because the workforce would die out if they didn't have the money to raise families.
- One time when the workers are in the driver's seat is when the economy is growing. The growing economy means that companies have a growing need for workers. And if this demand is constantly going up, then the bosses will have to pay more and more to attract the workers they need.
- Smith points to the example of America, which in 1776 is growing so quickly that people's wages are doubling and tripling every five years. Even though England is a richer country, wages aren't growing because the economy has a consistent size from year to year. So it's not about whether a country is rich, but whether it's growing. That's why you hear people obsessing so much about growth when they talk about companies or the economy.
- On the whole, Smith feels that the wages paid to workers in England have increased in value, not because people are getting paid more but because the cost of life's necessities (like food) has gone down.
- Adam Smith takes a moment here to talk about how wage laborers are far superior to slaves because wage laborers are cheaper. For example, a master has to make up for lost profits when a slave gets sick.
- But when a wage laborer gets sick, he needs to pay for his own expenses. Plus, slaves have no incentive to work hard, while laborers want to make more money and get promoted.
- Obviously, there are a bunch of better reasons for why slavery shouldn't exist, but Smith takes a moment here to say that it doesn't make sense even on an economic level.
- Adam Smith also makes an argument for a standard workweek (with weekends off) so that laborers will have a chance to rest and be better at work.
Book I, Chapter 9
Of the Profits of Stock
- You might think that when people and companies start to use more and more of their resources to produce stuff, their profits would increase. But it's actually just the opposite.
- That's because the more people there are producing stuff, the more competition there is. In an effort to get people to buy their stuff, people start dropping their prices and their profits end up shrinking. It's great for the people buying their stuff though, because who doesn't love low prices?
- Smith also mentions that countries that are open to trade with other countries always tend to be wealthier because they open their companies to international competition. This ends up driving down the price of stuff.
Book I, Chapter 10
Of Wages and Profit in the Different Employments of Labour and Stock
- Smith returns to the idea of why some jobs are paid more than others, and he gives us five reasons:
- the unpleasantness of the job;
- the easiness or difficulty of the job;
- the security of the job;
- the responsibility of the job, and;
- the likelihood of succeeding at the job.
- For starters, a job's wage will depend on how crummy it is to perform the job.
- Some jobs, for example, are so dirty and gross that you have to pay people a ton of money to do them.
- Second, some jobs require so much skill that you have to hire specialized people to do them. That means you'll have to pay more.
- Third, you'll probably have to pay more to attract someone to a job that is temporary or might go away at any moment. That's because the person will need extra money when they find themselves looking for a new job.
- Fourth, you'll have to pay more money if you're trusting a worker with a ton of responsibility. For example, you don't want to pinch pennies with a person who's running a nuclear reactor.
- Fifth, you have to pay more money to people who get jobs that are difficult to get. For example, a person wouldn't go through tons of years of medical school and rack up student debt if they didn't think they'd have a good-paying job at the end of it.
- Some jobs pay less because they involve work that people would do on their own time. For example, the salaries of journalists have gone down since the Internet became popular because there are tons of people out there who are prepared to write about the news as a hobby instead of a job. This ends up reducing the value of professional journalists.
- Adam Smith goes on to talk about how people are biased toward thinking that everything will work out for them. This is especially the case when people are young. They choose their careers based on what they like to do instead of basing their decisions on future wages or job security, so they end up taking risks on being artists or whatever and end up poor.
- Adam Smith admits that people sometimes make huge fortunes overnight by speculating in stocks. But he says that this kind of gamble has a huge risk and that for every rich stock guy there are a bunch of ruined ones.
- Sometimes, the wages of a certain job are lower because it's a job people tend to do in their spare time. Cottage industries are part of this, like when people knit sweaters in their free time and sell them. These knitted sweaters will be cheaper than their natural price because knitting them wasn't that person's day job.
- One of Smith's biggest beefs in this book is with government regulation, and here's the part where he starts sounding off about it.
- For starters, Adam Smith hates it when laws or government policies discourages competition in the marketplace. For example, certain policies around becoming a registered tradesperson can make it difficult for people to enter this business. For example, being an apprentice for seven years was part of becoming a legal carpenter in Smith's time.
- For Smith, this law is only in place to increase the salaries of working carpenters and to prevent these salaries from going down by having too many carpenters around competing for work. You'll see the same thing today with legal associations, which try to control the number of lawyers in the country in order to keep lawyers' wages high.
- Within every nation, there is always trade going on between town and country. The country provides the town with basic materials like food, wool, etc. The town pays them with stuff like manufactured goods (like machinery for their farms or TVs or other stuff). The town also has banks that lend money to the farms so the farms can expand.
- But Smith admits that the people of the towns have an unfair advantage because they can easily organize themselves against the farmers. Farmers are spread over a huge area and have a much more difficult time getting together and making sure they get fair prices for their crops.
- Smith also mentions that government taxes and restrictions on products from other countries tend to protect their own manufacturers from outside competition.
- This keeps prices up and profits high for these people, but everyone else suffers from paying more for these products.
- In some cases, government regulation actually drives down wages. For example, public school teachers don't make much because the government wants cheap education to be available to all children. This is good for the country, even though it comes at the expense of teachers by driving down their wages.
- Smith also hates government policies that prevent people from moving from one place to another for work. For example, people don't like it when immigrants move to their neighborhoods and drive down the wages by doing work for almost nothing.
- But Smith says that in the long run, this is a good thing. If businesses are able to move their factories wherever they want, then workers need to be able to move wherever they want, too. During Smith's time, England had harsh laws preventing workers from even moving from one town to another, which really messed up the labor market.
Book I, Chapter 11
Of the Rent of Land
- We can assume that when it comes to rent, landlords will always charge as much as their tenants are willing to play. Rent is also connected to the prices of products. For example, if the price of potatoes goes up, then so will the rent that people charge on land that's being used for potato farms.
- Rent will also change with the value of what comes out of the property. For example, if someone suddenly discovered a ton of coal on a piece of land, the landlord would jack up the rent on that land because people would start making tons of money off of opening coal mines. The same goes for land that starts producing more food than usual.
- Of all the people who make money in society, Smith thinks that landowners are the worst because they don't have to actually do anything to make their money. Bosses of companies help to produce products while workers create all kinds of new things. But landlords just sit back and do nothing for their money.
Book II, Introduction
- Book II is called "Of the Nature, Accumulation, and Employment of Stock."
- This part of The Wealth of Nations is all about people's personal stocks of wealth. As Smith point out, people have a hard time working without at least a tiny bit of wealth. For example, you need to live on something while you're waiting for your next paycheck.
- So that means you have to have at least a small pile of savings or stock, even if it's just enough to get you to payday. The more people build up their savings, the more likely they are to invest this money to make them even more money.
Book II, Chapter 1
Of the Division of Stock
- As mentioned earlier, people with savings will often use part of those savings to invest and make more money. There are two types of savings: the part that immediately allows you to buy stuff (like pocket money or walking-around money) and the part that you want to invest to make even more money.
- Adam Smith calls this second kind of savings "capital."
- And of all capital, Smith makes a distinction between "circulating capital" and "fixed capital." The first kind is always moving around, and it doesn't turn into any actual money until the owner cashes it in.
- For example, if someone invests a bunch of capital in pumpkins, then they won't actually make money until they sell those pumpkins for more than they bought them for. This capital is called circulating capital because it tends to move around and take on different forms (pumpkins, gold, machines) until the owner sells it off to get money back.
- The second kid of capital—fixed capital—is used to improve a piece of land. For example, a landowner might spend money to renovate a building.
- They will make more money off the rents of this building because the renovations will make it more desirable. But this capital always stays in the owner's direct possession, unlike circulating capital.
Book II, Chapter 2
Of Money Considered as a Particular Branch of the General Stock of the Society, or of the Expence of Maintaining the National Capital
- Now Smith wants us to understand the difference between gross and net revenue. Let's say you own an apartment building that earns two million in rent every year.
- But the annual repairs of this building cost two hundred thousand dollars and management of the building costs another two hundred thousand. The net revenue of the building is the gross (two million) minus the costs (repairs and management), which leaves you with 1.6 million dollars net revenue. The same is true with the revenue of entire countries.
- Another thing Smith wants us to understand is that people's wealth isn't measured in money, even though we might think this is true.
- That's because money only has value insofar as it's able to purchase goods. So let's say you make fifty thousand dollars a year, and the price of stuff in your country suddenly rises 500%. You might keep making the same wage, but the purchasing power of that money has shrunk by 500%. That's why money is only valuable insofar as it has purchasing power, and purchasing power is measured by the amount of goods you're able to buy with your money.
- When you put this all together, a country's wealth can only be judged by the amount of stuff it is capable of controlling.
- In short, you don't make a country richer by bringing more and more capital into it, but by making sure you use as much of the preexisting capital as you can. Employ more workers who buy more products and your business makes more money and the cycle goes on and keeps growing. Once you start firing people and shutting down factories though, there are fewer people to buy your products and the whole thing starts to shrink.
- And here's one thing that you probably didn't know about Adam Smith: He was hugely in favor of imposing strict government regulations on banks. The way he puts it, banks are in a unique position to cripple an economy if they get too risky or too greedy. Just look at the American financial crisis of 2008-2012 and you'll see why this is true.
- For Smith, there is just too much of a chance for fraud in banking for governments to let banks do whatever they want.
- And the fact that the entire economy is dependent on banks means that banks have to be strictly regulated.
- Plus, banks should be open to lots of competition in order to keep lending rates low. If too much power gets put in the hands of only a few banks, things can go sideways really quickly.
Book II, Chapter 3
Of the Accumulation of Capital, or of Productive and Unproductive Labour
- Smith distinguishes between two types of labor that he calls "productive" and "unproductive" labor. For example, a manufacturer performs productive labor by adding value to the objects that he/she is creating.
- But a household servant is engaged in unproductive labor because he/she doesn't add value to anything. The first person increases the wealth of the country overall, while the second performs a job that sucks up wages. Sure, your house might be tidier, but no additional wealth is created by the house servant.
- Imagine one person who hires a bunch of workers to make coats for her and another who hires a bunch of servants to clean his house. The first person will get richer over time because she'll make a profit by selling the coats.
- The second person will get poorer because he'll pour wages into his servants without creating any profit to replace this lost wage money. The same goes for a country, where emphasis should be on people who are creating wealth and having productive labor.
- In Smith's view, this is why some countries are richer than others. The focus more on producing new things, while the rich people in poor countries tend to spend their money on servants.
- Therefore, it doesn't matter how much money there is in a country. What matters is the amount of goods that country produces and how those goods are valued. A country that produces fewer and fewer goods can't hang on to money. It just doesn't work that way.
Book II, Chapter 5
Of the Different Employment of Capitals
- Some people might think that storeowners or merchants don't have productive labor because they don't actually make anything. But Adam Smith sees these people as a natural part of the division of labor. If they didn't spend their time buying and selling goods, the producers of good would have to do this themselves, and that would take time away from them making their product. So merchants actually do everyone a favor by letting the producers worry only about producing.
- For Smith, no one engages in more productive labor than a farmer, since the farmer is literally creating new valuable stuff right out of the ground. He thinks that the reason the colony of America has grown so steadily is because they put so much of their money into agriculture, which is pure productivity in his mind.
- Whenever a country produces more of something than there is a market for, it will export the surplus to another country.
- Adam Smith firmly believes that a country produces the most wealth when government leaves private business people alone. And why is that?
- Because business people will always put their money and resources where there is the most demand. As more people go into business, more competition drives down prices and drives wages up.
- That's how everyone (at least theoretically) makes better wages while prices go down. In Smith's formula, the economy is much better off when individuals all work for their private profit.
Book III, Chapter 1
Of the Natural Progress of Opulence
- Book III is called "Of the Different Progress of Opulence in Different Nations."
- Smith returns to his earlier discussion of the trade that happens between the town and the country. In Smith's mind, the farms are the most important things in the nation because they allow people to survive.
- That means that improving the land is a priority, but farmers need people from the town to do this. They need loans from banks to invest in new equipment, and they need the factories in the town to make this equipment.
- For Smith, the priority of a country's economy belongs with agriculture, then it goes to manufacturing, and then it goes to foreign trade.
Book III, Chapter 2
Of the Discouragement of Agriculture in the Ancient State of Europe After the Fall of the Roman Empire
- Smith goes way back in time to talk about how agriculture (and human progress in general) suffered after the fall of the Roman Empire. This happened because there were so many gangs and barbarians running around that it was hard to run a farm for more than a few weeks before some people came by and robbed you blind and burned your fields.
- It's tough to have agriculture without law and order.
- Smith goes on to talk about how people started using things like gender and age to figure out how to hand down property. It'd be nice if people got property based on merit, but Smith says this is too subjective to work long-term.
- That's why kings and landowners just decided they'd give their property to their oldest sons. This is how land started to fall into the hands of specific families, who then put money into making them better. And that's how agriculture made its return—through private property.
- Smith also goes back to his arguments for why slaves don't make sense. They have no motive to work hard on the land because they don't own it and there's no possibility of being promoted. Smith thinks that the only reason people bother having slaves is because they like the power, since slaves make no economic sense compared to wage workers.
- Smith then describes the process that saw slaves in modern Europe disappear in favor of farmers who worked the land and paid a percentage of their earnings to their lords in the form of rent. Smith argues that this method is much more beneficial for both the farmer and the boss.
- As far as the wealth of a nation is concerned, Smith thinks that the improvement of agricultural land is key. And he doesn't see this happening in situations where farmers have nothing to gain personally from this kind of improvement.
Book III, Chapter 3
Of the Rise and Progress of Cities and Towns, After the Fall of the Roman Empire
- Following the fall of the Roman Empire, many people became traveling salespeople, just walking from town to town and trying to sell stuff.
- Not only that, but towns tended to become like independent states because the local kings didn't really have the power to control them. This meant that it was hard to impose taxes, and free trade became common among the towns eventually. Adam Smith likes this.
- People in the countryside, though, didn't have the same level of protection as those in the cities. The world was practically lawless, and farmers had to deal with people constantly pillaging their farms. So these people eventually learned to keep anything they saved inside the cities, and that's how you got farmers keeping their money with city banks.
- Smith mentions that the cities of Italy were probably the first in Europe to become rich because of trade. They benefited by importing great products from all over Europe.
- In Smith's mind, the development of advanced manufacturing springs out of agriculture. For him, all productive activity begins with agriculture.
Book III, Chapter 4
How the Commerce of the Towns Contributed to the Improvement of the Country
- Adam Smith wants to lay out the ways that the increasing wealth of Europe's cities led to the improvement of the countryside. He sees this as happening for three main reasons.
- For starters, the towns provided markets where the people from the country could sell all the stuff they produced, which gave them the motivation to produce even more.
- Second, many merchants bought up a lot of the country land with the hopes of making it profitable. This led them to buy up a lot of land that had been useless before so they could turn it into productive agricultural land. In Smith's mind, merchants are often great improvers of land because they want to make it productive and profitable.
- Finally, the cities created forms of good government that provided freedom and security to the people of the area. And when you don't have to worry about getting murdered every day, you can focus on productive stuff.
- Over time, a relationship formed between the landowners and the farmers that resulted in a lot of Europe's land becoming more productive. You saw a population increase because the land could support more people.
- For Smith, a huge revolution in human happiness happened in the past. But it came about not because someone wanted to help humanity, but because specific groups followed their self-interest. The merchants and landowners wanted more money, and this just so happened to make the country land better for everyone.
- Smith returns to the idea of why the colonies of North America are growing wealthier so much more quickly than England, and it's because they are gobbling up new land for agriculture all the time.
Book IV, Introduction
- Book IV is called "Of Systems of Political Economy."
- For Smith, there are two main goals for the science that he calls "political economy": the first is to provide prosperity for the people of a country, and the second is to create enough funds for public institutions (like schools, roads, and hospitals).
- As far as he can tell, the world has tried two different ways of organizing the economies of countries. The first is called the "system of commerce" and the second is the "system of agriculture." Smith wants to start with explaining the system of commerce.
Book IV, Chapter 1
Of the Principle of the Commercial, or Mercantile Systems
- When we think of a rich person, we don't think of someone with a lot of sheep. We think of someone with a lot of money. And the same is true when we think of rich countries.
- But as Smith wants to show us, it's not always true that a country with a lot of money is well off.
- It's important to realize that if a country was completely separated from trade with other countries, it wouldn't matter if the country had lots of money. Money is only good if it can buy you something; it has no value on its own.
- Yet someone countries are so obsessed with keeping their wealth that they have made laws against people carrying money out of the country.
- The merchants eventually convinced the folks in charge that foreign trade would make the country richer by introducing cheaper goods into its market. If the price of goods goes down, then the value of money still in the country goes up.
- The eventual outcome of these theories is that countries focused on having a good balance of trade. In other words, countries decided that the only way they could get richer was to export more stuff than they imported. That meant that more wealth was coming in than going out. They restricted the importation of foreign goods and promoted the exportation of other goods.
Book IV, Chapter 2
Of Restraints Upon the Importation from Foreign Countries of Such Goods as can be Produced at Home
- Now we're going to learn about what happens when a country puts restrictions on the importation of foreign goods. So let's say your country says it doesn't want cheap goods coming in from China because that ruins the lives of people who want to make these same goods inside your country.
- So the government decides to protect these jobs by restricting the importation of the cheaper goods. This basically gives the makers inside your country a monopoly by cutting off competition from other countries.
- However, while this government regulation might be good for the people who have the monopoly, it has a negative effect on society as a whole. Smith wants to show you why.
- And here is where Adam Smith makes one of his most famous statements: he claims that the overall good of society is raised when everyone pursues their own selfish interests.
- That's because this behavior creates a lot of productive behavior that pushes prices down and constantly makes products better.
- Therefore, a government that gives its local businesses a monopoly over the domestic market is actually steering them to do more of that work than they would naturally do. The long-term effect of this is to hurt the economy, because it drives prices up, and people's money is worth less and less over time. If another country makes way better versions of a certain product, it is always a better choice to import that better version than to struggle to produce it at home.
- People tend to think of international commerce as a competition where one country is always trying to defeat another. But the truth is that countries need to focus on making themselves wealthier through cooperation and trade. Imposing trade barriers might seem to give your country a competitive advantage, but it makes you poorer in the long run by cutting off your access to better goods from other countries.
- Yes, many people will lose their jobs if their companies get out-competed by goods from other countries. But Smith is confident that these people will soon find jobs elsewhere because the economy as a whole will do better. Smith says this will happen as long as we get rid of restrictions on where people are allowed to live.
- Smith also admits that Britain will probably never have free trade because there are so many lobbying interests wrapped up in protecting their monopolies.
- Smith closes the chapter by conceding that some taxes on imports are necessary if the government is going to raise funds for its public institutions. He's going to discuss this later on.
Book IV, Chapter 3
Of the Extraordinary Restraints Upon the Importation of Goods of Almost All Kinds, from those Countries with which the Balance is supposed to be Disadvantageous
- So what happens if you open your country to free trade and your country starts importing more than it exports? Won't that eventually make your country poor because it's spending more than it's making? Adam Smith doesn't think so.
- For example, it doesn't make sense to import wine from Germany and Spain instead of France just because you already import too much other stuff from France. Besides, you can always import the stuff and re-export it to other countries at a profit.
- The next concern is that English people would become drunker if they started importing really cheap French wine. But Smith is convinced that the cheapness of liquor won't make it any more desirable.
- He points to the fact that the biggest drinkers in England are poor people who can barely afford the stuff. Wealthy people (who can afford liquor easily) barely touch the stuff. So having the money to buy more booze doesn't mean people will do that.
- When you think about the wealth of a country, you don't just need to think about the money it has coming in (from exports) and the money it has going out (from imports). You have to think about the value of what it produces compared to the value of what it consumes. If it consumes more than it purchases, then it will probably get poorer over time.
Book IV, Chapter 5
- "Bounties" refers to what people today would call subsidies, meaning that the government will sometimes give money to its own producers to encourage them to make more of a certain product so they can export it.
- Smith sees this as unnatural, since the government is basically paying people to produce more of something than the public wants to buy. Governments often give these bounties to companies that can't survive on their own. But you have to wonder if it's a good long-term idea to support a business that can't support itself.
- Taking money out of public funds to support failing businesses also takes money out of the public system, which means worse education for the public.
- Over time, people will suffer more because of these bounties, which might save a few jobs in the short run. The only people who benefit are the ones receiving the bounty.
- The fact is that a certain product (like corn) has a natural price that is determined by the overall supply and demand. Anything you do to try to mess with this price is doomed to fail or cause inefficiency over the long run.
- To illustrate, Smith goes on a rant about how England's policies on the sale of corn have had disastrous effects.
- Here, Smith repeats his argument about how merchants and dealers help farmers and manufacturers sell their stuff so that the farmers and manufacturers can just think about producing.
- Plus, merchants make it their business to know the proper prices for stuff.
- At the end of the day, Smith believes that whatever the free market says is automatically right, so there's no point in governments intervening and trying to manipulate it.
Book IV, Chapter 7
- Now it's time for Smith to talk about something that was a really big deal in his time: the creation of overseas colonies. Let's not forget that he published The Wealth of Nations in 1776, the same year America went to war to win its independence from Great Britain.
- Basically, a country creates colonies whenever it seems as though the wealth of that country has been mined. People on the bottom of society want a greater share in the wealth, but the folks up top don't want to share. So they send these folks off to some new country and wish them good luck with building their fortunes.
- Smith is actually very critical of the way that Europe has stomped across the world, killing the native peoples of countless lands and grabbing everything for itself.
- However, Smith also admits that new colonies create wealth more quickly than any other place on Earth. That's because they are constantly finding new land to farm, which creates more and more food and wealth. New land is practically there for whoever wants it, so more and more people make the land more and more productive by cultivating it.
- Adam Smith also finds that America has been more successful at growing its economy because it is a democracy. Democracy does a better job of running things efficiently than a monarchy because monarchs quite often don't know what they're doing.
- Smith returns to the concept of slavery, condemning it on both moral and economic grounds.
- One really bad thing about colonies is that the mother country prohibits them from importing goods from anywhere other than the mother country. This ends up hurting both economies in the long run because it manipulates the natural prices of things and makes producers less productive. In the end, less stuff gets produced and the society as a whole becomes poorer, even though some individuals might get richer.
- If you expose merchants to competition, they'll be much more careful with their money and more efficient in pursuing profit. And if you get all the merchants in an entire society acting this way, the overall wealth of that society increases.
- Adam Smith believes that both England and its colonies would be better off if England just gave up these colonies and allowed them to be independent. But he's not foolish enough to think this will ever happen. There are too many private interests at stake.
- Ultimately, he thinks England will have to give up its colonies because it will go broke by trying to keep them.
- Smith goes through several examples to show how England's many colonies end up costing it more money than they make.
Book IV, Chapter 8
Conclusion of the Mercantile System
- For Smith, mercantilism basically refers to when a government encourages exports while discouraging imports, with the thought that this will make the country wealthier. You actually still hear these kinds of ideas today whenever a government official talks about a trade surplus or trade deficit.
- In some cases, countries have prohibited the exporting of machinery to other countries because they're afraid those countries will use the machines to establish competing businesses. There have also been laws against English business people moving to other countries to practice the same business.
- What mercantilism gets fundamentally wrong is thinking that economies are based on production. He insists that they're actually based on consumption. Goods are worthless unless there are people ready to consume them, and all production eventually must meet the demands of consumption.
- In the end, it's clear that the general public of consumers were not the ones who created the mercantile system. It was the producers who wanted to protect their interests.
Book IV, Chapter 9
Of the Agricultural Systems, or of those Systems of Political Economy, which Represent the Produce of Land as Either the Sole or the Principal Source of the Revenue and Wealth of Every Country
- The other major way of organizing an economy is to put agriculture in a place of privilege. Smith can't think of any country that has ever made agriculture its only form of production, but some have come close.
- In Smith's view, agriculture is a form of pure production—a way of making something out of nothing. Manufactured goods are nice and all, but in Smith's opinion they don't add to the raw value of what gets pulled out of the land.
- Next, Smith talks about the importance of what he calls "neat produce," or what we today call "net produce." Net produce is different from gross produce, so let's talk about what we mean by these terms.
- Your gross produce is everything that you produce—all the crops and everything that you create. Your neat (net) produce is what you have left after you've paid for your expenses.
- So let's say you grow $100,000 worth of potatoes. You pay $20,000 to rent your farmland and another $20,000 to run your machines and pay your pickers. That leaves you with a neat produce of $60,000 worth of potatoes. For Smith, we must always look at neat produce when figuring out whether a country's wealth is growing or shrinking.
- But while farmers are the ones who produce the most value, Smith isn't ready to do away with merchants or manufacturers altogether. He admits that they actually increase productivity by tending to farmers' needs and giving them extra time to grow food.
- Even though Smith prefers agriculture, he doesn't want the government giving subsidies to farmers in order to make them produce more. He still believes the free market should decide these things.
- In a free society, the government only has three things to do: 1) protect the society from violence from outside (with an army), 2) protect it from violence from inside (with police), and 3) create certain public institutions (like schools) that couldn't do their job as well if they were private.
- The continued role of the government means that there will always be taxes and there will always be some institutions of the public good that can't become private.
Book V, Chapter 1
Of the Expenses of the Sovereign or Commonwealth
- Book V is called "Of the Revenue of the Sovereign or Commonwealth."
- The first thing a government needs money for is to pay the military to protect the country from foreign invasion. But different countries have very different spending habits when it comes to maintaining the military.
- In some countries, every full-grown man is considered a soldier who has to spring into action whenever there's trouble.
- For Smith, you can't have a society with agriculture unless you have some way of protecting the farms from foreign invaders.
- In a modern civilized society, only a small percentage of a population goes off to fight a war. So these people are paid out of the taxes of civilians. Thus the expense of maintaining an army gets higher as the country gets more advanced.
- If you're going to have justice within a society, you have to have a court system and a police force to enforce laws.
- And you can't make these things private because then a select group of people would control them for private gain. Smith is still willing to admit that, even in a public system, rich people tend to get an easier ride than poor ones.
- For the final part of this chapter, Smith turns to a discussion about institutions of the public good. Now this is important because you'll get a lot of Adam Smith fans nowadays saying that we should privatize all the public institutions (like water, sewage, garbage, you name it). But Smith believes that these institutions should be kept open with taxpayers' money because they'll never serve the public good if they're run for private profit.
- One public institution that Smith firmly believes in is the public school. He doesn't want to see schools become private establishments because he wants to make sure that every single child in a country has the opportunity to receive a good education.
- That said, Smith believes that teachers might do a better job if their salaries came directly from the students. He fears that people receiving government paychecks won't be as motivated to work hard.
- Smith fears that schools are built for the needs of instructors rather than students, and he thinks this relationship should be reversed. Maybe that's why so many schools now have students complete teacher evaluations.
- Smith thinks that education should meet the demands of the public, meaning that teachers should teach whatever people want to learn about. If a bunch of people want to learn how to fix cars, then teachers shouldn't spend five months teaching them how to read Latin.
- Even though different people have different needs, Smith thinks that every neighborhood should have a school where children can learn to read, write, and add. They need to know these things in life to keep other people from cheating them.
- For Smith, one of the biggest advantages to public education is the way it promotes social stability. In his mind, people who are educated in the ways of the world are less likely to rebel against the upper classes because they will understand how pointless it is to do so.
- Finally, Smith talks about how the country needs to set aside a portion of tax dollars for its ruler. In order to be respected by the people, the ruler needs to look rich and powerful. So the country needs to spend taxes to keep his palace looking spiffy. It's not clear whether Smith believes this or if he's just saying it to get on the king's good side.
- Smith also believes that rich people should be taxed at a higher rate than poorer people. He says this because one dollar can't possibly mean as much to a wealthy person as it does to a poor person.
Book V, Chapter 2
Of the Sources of the General or Publick Revenue of the Society
- Believe it or not, not all public expenses come straight from the taxpayer—at least not in Adam Smith's day. Some of it comes from the personal bank account of the king. The king, for example, pulls revenue from all the land he owns, and he uses part of this revenue to make his country nicer.
- But most of the money used for public stuff comes from taxpayers. Now today, you'll get a lot of talk about how high taxes hurt an economy. But Smith believes that some taxes are necessary if we're going to keep things working smoothly.
- It's also important to make taxes really clear and not to be shifty about them from year to year. You can't have the IRS or someone coming up to you and saying, "Uh yeah, how about you give us… ten thousand dollars?" Also, Smith thinks that people should pay tax at whatever point in the year is most convenient for them.
Book V, Chapter 3
Of Publick Debts
- Smith knows that in any society, some people will always want to hoard wealth. In other words, some people will always want to have more than other people, even if they have no use for all their stuff.
- Sometimes, it's clear that a country has to go into debt in order to wage a war. The public money isn't enough to mobilize an army of tens of thousands. Furthermore, countries tend to spend a bunch of money even in times of peace, which means they don't have any savings for when a war comes.
- A country will also go into debt in order to keep its justice system going during times when public money takes a dip. The country needs to continue functioning one way or another, so they borrow money to keep things running.
- Smith thinks that one day, public debt will ruin all the great countries of Europe. And if you look at Europe today, he might not be that far off. He also takes another opportunity to remind his readers of how England is currently racking up crazy amounts of debt by trying to keep all its colonies under its control.
- Adam Smith closes his book on a somewhat sour note, telling his readers that Britain is in a mediocre position as a country, even though everyone seems to think it's the greatest country on Earth. He says it's about time England accepted its circumstances and stopped trying to act more powerful than it actually is.