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Adam Smith: Wealth of Nations (Summary)
Ökonomie und Markt (DLBOUM01)
IU Internationale Hochschule
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Adam Smith: The Wealth of Nations (1776)
Summary
Introduction
§ 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 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 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.
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.
§ 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 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. 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.
§ 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.
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.
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.
Adam Smith: Wealth of Nations (Summary)
Kurs: Ökonomie und Markt (DLBOUM01)
Universität: IU Internationale Hochschule
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