Book Outline: The Wealth Of Nations
The Wealth of Nations
By Adam Smith (a Scotsman)
Originally published 1776
ISBN-13: 978-0-7607-5761-1, ISBN-10: 0-7607-5761-5
This outline created 11/13/08, Brian Jacobs
Book I,
Of the Causes of Improvement in The Productive Power of Labour and of the Order According to which its Produce is Naturally Distributed Among the Different Ranks of the People
Book 1, Chapter 1, Of the Division of Labour
To improve from a subsistence society, division of labour allows a civilization to produce more than its immediate needs, leading to increased trade. Transportation is also a key, so that the larger group of people can act as a single market.
The division of labour allows for greater productivity because:
• One person can become an expert at one given operation, and thus more efficient
• When a manufacturing process is broken down into simple steps, less skill is needed for any given step.
• It is easier to invent better tools for one operation than for a whole process. Many such improvements come from workers who perfom the job being improved on.
• Time is wasted when switching between kinds of work (changing tools, or people just taking a break)
Brian comment: Mr. Smith did not address and perhaps did not conceive of the effect of the division of labor on job satisfaction. He wrote long before Ford invented the assembly line. Some people call it dehumanizing if your job is to put the bottle caps on 10,000 bottles per day. Other people say that it doesn’t matter, that few jobs are fun anyway, especially farther back in history.
Book 1, Chapter 2, Of the Principle Which Gives Occasion to the Division of Labour
• The author proposes that humans are the only animal to take advantage of the division of labour.
• We are also the only animal that trades, which allows us to take advantage of each others unique talents.
Book 1, Chapter 3, That the Division of Labour is Limited by the Extent of the Market
The larger a group of people is, the greater the potential for division of labour. Larger markets allow for sufficient volume of business to sustain a wide variety of very specialized jobs.
Transportation allows smaller markets to combine into larger ones. Water transport being more efficient than that by horse, the first civilizations were based around bodies of water such as rivers and seas.
Book 1, Chapter 4, Of the Origin and Use of Money
The use of money arose because of the inconvenience of barter. The people selling what you seek may not have a use for what you have to offer in trade.
Historically, it was common that a people settle upon one or another kind of metal to use for money.
The first metals as money were used in bars. Later, the bars had a small stamp. Next, the metal was minted into coins, which are essentially stamped across their entire surface. This was done to help prevent cheating. The value of money was never too stable, saw a lot of variation historically.
There are two values for a commodity, the value of use (such as corn you can eat), and the value for trade. The value in trade depends partly upon its scarcity.
Book 1, Chapter 5, Of the Real and Nominal Price of Commodities, or of their Price in Labour, and Their Price in Money
The value of a commodity comes from the hours of labour to produce it, and when we trade we try to exchange our labour for an equal amount of labour.
The value of labour is also affected however by the difficulty of the work, the hours invested to develop needed skills, or other hardships.
The value of gold and silver varies as supply expands (new mines are found), or shrinks (ships full of gold sink).
Governments (kings, at the time) often dilute the amount of pure metal in their coin so as make it easier for them to pay off their own debts, although the citizens are affected as well. They rarely increase the pure metal of their coin though.
Book 1, Chapter 6, Of the Component Parts of the Price of Commodities
The three component parts of the price of a commodity are:
• Labour Wages
• Land Rent
• Profit for Stock
Book 1, Chapter 7, Of the Natural and Market Price of Commodities
There are “natural” rates for wages, profit, and rent, for a given time and place. Unusual circumstances can drive the price above or below this price, but the average price will gravitate towards this “natural” value. It is an equilibrium point.
Agricultural commodities vary in the quantity brought to market (and therefore price) much more than manufactured goods due to the vagaries of the weather.
The price can rise above the natural price for extended periods of time (perhaps due to monopoly, or unusual demand), but can not long stay below the natural price.
Guilds can interfere with the natural inclination of a worker to abandon an unprofitable trade because other trades have guilds of their own preventing the worker from joining.
Book 1, Chapter 8, Of the Wages of Labour
Originally, the wages of labour was the only component of prices. The appropriation of land (land as private property) took away from the value of labour, as rent now has to be paid. The profit of stock took away as well once the cost of raw materials was high enough to require the borrowing of money.
Pg 56: It is easier for the providers of stock to combine (to lower the wages of labour) than it is for workers to combine (to raise wages). Stockholders are fewer in number, and typically have the law on their side. In a battle of wills (possibly a strike), workers do not usually have enough money to outlast the stockholders. When workers combine, they try to draw as much attention as possible. When stockholders combine, they try to be as quiet as possible. There is a lower limit to wages in the long run though, since workers must be able to sustain themselves.
Pg 59: “It is not the actual greatness of national wealth, but its continual increase, which occasions a rise in the wages of labour.”
Brian’s note: I find this a very significant argument. In the context of global climate change, it has bothered me that economic theory assumes that humanity will continually expand, forever and ever. The ecology of the planet runs in a closed, sustainable cycle, we cannot assume that there will be more of the planet tomorrow than what there is today. But economic theory assumes it desirable that tomorrow there will be more people making more stuff, and the next day even more. This statement seems to be the source of that assumption.
We need to either find a new economics, or find extra planets to expand onto.
In periods of high wages, children can be considered an asset for the value of their labour (before they would leave to make homes of their own).
China is given as an example of a country with a stable, mature economy, where wages are very low.
When wages are high, workers work harder (than when wages are low). This is in opposition to the idea that they will work just enough to make the same amount as they previously made under lower wages.
Pg 68. The work of freemen comes cheaper than that of slaves, in the end. This is because freemen are very careful to be efficient, since it is their own resources being used.
Pg 69. The happiest societies are ones with expanding economies. Stagnant ones are hard, and declining ones miserable.
Book 1, Chapter 9, Of the Profits of Stock
It is hard to know the average profit of a business. But it is possible to make some judgment of it based on the interest rate being commonly charged. Profit goes down as the volume of trade goes up, because there is more stock generated which competes for the business.
A great stock earning smaller profits, will still increase than the smaller stock earning larger profits.
The laws of a country also affect whether the rate of growth reaches its potential. Minimizing foreign trade means that trade will not be maximized, for instance.
When the laws protect the rich, permitting them monopolies, the amount of stock employed in the economy will also not be maximized.
Unnaturally high interest rates can also result if the government does not enforce contracts, because lenders need high profits from borrowers that do pay off to compensate for borrowers that refuse to (although they could).
When law forbids charging interest, interest is still charged in “unofficial” side deals.
The lowest rate of profit from stock must be something more than to make up for average losses from bad debts, to make lending worth while.
Higher wages raise the price of a commodity just by the dollar amount that they went up, like simple interest. Higher profits raise the price of a commodity like compound interest, because profit is taken as a percentage at each step along the way.
Book 1, Chapter 10, Of Wages and Profit in the Different Employments of Labour and Stock
Under ideal circumstances, there would be no advantage to employing labour or stock in one industry or another. A self enforcing equilibrium would make it so. But this assumes that workers are at liberty to switch employment.
The chapter is divided into two parts, addressing the two factors which detract from the concept of perfect equality in wages. The first cause is differences in the jobs. The second cause is public policy (specifically in Europe).
Part I, Differences due to the nature of the employment
In reality, liberty is much less than perfect. Here are the 5 factors observed.
• Work can be pleasant or unpleasant.
• A job can be easy or hard to learn to do
• Work might be seasonal, or otherwise inconstant
• There may be a significant amount of trust placed in a job
• The probability of success in that trade
The profit of stock does not seem to depend upon the difficulty of the trade involved, since the investor doesn’t have to know that trade.
He brought up the idea that the rate of people who study a trade compared to those who succeed is like a lottery. In a perfect lottery the one who succeeds would get all the wages which the others who failed would have received. But this doesn’t happen.
Brian’s note: He states that some talents are not supposed to be sold on the market, and that we despise those who do sell such talents. The example is artists such as opera singers. He says we pay them well, but we’re disgusted that they would take money for their performances. I don’t see it.
He discusses the idea that people over estimate their chances of success and under estimate their chances of failure.
Only two of the five factors that affect wages also affect profits: Whether a job is pleasant or not, and whether a business is more or less risky.
Sometimes an apparent high profit is really a high wage in disguise, to make up for extensive education. The example was the high cost of drugs, when the raw material is cheap, but the cost comes from the education of the apothecary.
It is more difficult to expand your stock in a small town than a large, because the market is limited in size.
The rules about wages only apply strictly when the job is a person’s primary employment. If the employment is a 2nd job, they will likely take a lesser wage than someone who does such work as their primary position.
Part II, Differences due to policy
He lists three causes of inequality due to policy.
• Restraining competition in some industries
• Artificially expanding competition in others
• By preventing the free circulation of labour and stock, both from place to place and from employment to employment
RESTRICTING COMPETITION
A number of practices are discussed that restrict competition in order to raise prices. He considers this the main purpose of guilds, despite their claim that they guarantee qualified workmen. He feels that the marketplace will guarantee quality work. He states that apprenticeships last much longer than the time needed to learn the crafts.
He states that a man’s labour is the original, fundamental, private property, and considers it sacred.
Towns have the advantage over the country because they tend to have guilds. They send finished goods to the country, and the country sends raw produce to them. The imported goods found in the country passes through the town’s merchants, which can mark them up. Towns restrict the number of apprentices and stipulate long apprenticeships in order to restrict trade. The country doesn’t commonly use apprenticeships at all.
Once a town has run out of opportunities to invest stock, stock will eventually be employed in the country, restoring some measure of equality.
He stated that whenever business owners gather for social purposes, the conversation always turns to ways in which to prop up their prices, which of course is at the expense of the public. He doesn’t feel that there is any practical way to avoid such collusion, however. Nevertheless, markets are never truly free, and competition is never really open.
Forming a guild forces unity among its members. Where a merchant might undercut prices, the by-laws of the guild will compel cooperation in raising prices.
EXPANDING COMPETITION
Various sorts of public sponsorship can lower the cost of entering a given business, giving rise to more competition than what is natural. Priests historically gained education not at their own expense. “Men of letters” had this benefit too.
RESTRICTING MOVEMENT FROM PLACE TO PLACE OR EMPLOYMENT TO EMPLOYMENT.
Towns used to have laws which restricted moving. They were intended to prevent the poor from moving in which resulted in the public taking care of them (church donations for example). But they called for the new person to rent a house for a certain amount for a certain time. This prevented workmen from moving unless they had a significant savings, which typical labourers did not.
Required membership in a guild meant that one industry might be starved for labour right next door to one that has an over abundance.
Stock typically did not have as much trouble moving from place to place or employment to employment.
Book 1, Chapter 11, Of the Rent of Land
He states that the rent of a land is the most that the tenant can afford (but does allow for some profit for the tenant). Brian’s note: I find this interesting because I would expect the rent to be determined by competition from other landlords.
Rent is the return for the landowner’s outlay for purchasing the land. But landlords will charge rent even for unimproved land.
He considers rent as a monopoly price. It is not related to the price of the land or improvements to it. It is not based on what the landlord can afford to accept, but what the tenant can afford to pay.
Rent as a portion of the price of a good enters into that price in a different way than wages and profit. High wages and profit are the cause of high prices. High rents are the effects of high prices (not the cause).
This chapter is divided into three parts.
1) The produce of land which must always afford a rent.
2) The product of land which may or may not afford a rent
3) As the progress of improvement advances, the variations which naturally occur at each stage.
1) THE PRODUCE OF LAND WHICH MUST ALWAYS AFFORD A RENT
Food is an example. Since people will reproduce to the extent that food is available, food is always in demand.
Food bought farther out in the country is cheaper than that bought nearer to town, because of the expense of transporting it. That is why farmers near town may oppose extending roads.
Page 128: Monopoly is an enemy to good management.
He says that the rent of land will be determined by the price of the dominant food stuff. In his time, that was corn. So, for instance, the landlord would be comparing their profit from cattle to that from corn, in deciding what use to put the land to.
He discusses at considerable length the history of the specific prices of corn and cattle, tobacco and sugar. He also writes on vineyards, rice, potatoes, pork. And whether it is worthwhile to enclose a garden. Brian’s note: I wasn’t able to glean much in the way of general principals in this.
2) THE PRODUCE OF LAND WHICH MAY OR MAY NOT AFFORD RENT
Human food is the only produce of land which is guaranteed to provide a rent.
Human needs are food, clothing, and shelter. Land in its original unimproved state will always provide clothing and shelter, but not necessarily enough food.
The materials of clothing and shelter will be so abundant as to have little or no worth. When killing an animal for food, the hunter incidentally provides himself with clothing in the form of the hide or pelt. Based on the number of animals he must kill to feed himself, he will have more material for clothing than he needs and probably discards many hides.
The material for lodging cannot easily be transported far, so they may not afford a rent to a landlord if the local need is small. A landlord may very well give away lumber to those who are willing to take it away.
During the course of improvement, the additional capacity produced will go largely towards clothing and shelter. A rich man is not able to eat much more than a poorer one since both have the same size stomach (although the rich man will have food of a higher quality). But a rich man will have a huge palace of a home and fine clothes.
So these other products of land besides food may or may not afford for rent.
He notes that some coal mines do not afford rent. The only one who can mine those lands are the owners who do so for the profit and don’t pay themselves any rent.
He talks about the price of wood. When the country was largely unimproved, wood was over abundant and therefore of little worth. As agriculture turned more and more land to tillage, wood became more valuable.
Brian’s note: His unspoken assumption that unimproved land is forested. This may have been true in Europe, but wouldn’t always be true as in the great grasslands in America.
He notes that large bulky items such as coal are hard to transport, and their market may be very local as a result.
He says that since metal is much less bulky, it is easier to transport, and metal mines generally must compete with those in a much larger region, even globally. This is even more the case with the precious metals gold and silver. So he says these mines are even less likely to afford a rent since the competition is the greater. The most fertile metal mines will set the price and those mines will pay a rent. But less fertile mines must match the price and therefore afford less rent.
Silver is easier to tax because refining it requires a building dedicated to that, and the tax collector can monitor the production. Gold is hard to tax because it is usually found pure and can be processed without a dedicated building. Brian’s note: Interesting, but I think he is wandering a bit from the topic of rent.
Gem mines typically pay little rent.
Precious metals and gems add little to the overall wealth of the world. While they are valuable, they are scarce, so the overall wealth is a small percentage of that of the whole world.
The rent for land used for mines comes from their relative fertility. The rent for land used for crops comes from their absolute fertility.
3) THE NATURAL PROGRESSION AS IMPROVEMENT ADVANCES.
He examines the natural progression of improvement to virgin lands. He notes that during the course of improvement, the value of a produce will rise, fall, or stay the same depending on whether production increases slower then demand, faster than demand, or at a pace with demand.
He therefore divides produce into three types based on the ability of people to produce more of it.
I) Produce which it is not in the power of human industry to multiply
II) Produce which we can multiply in proportion to the demand.
III) Produce which we can multiply but with uncertainty.
For Item I, his only examples are rare fish or birds. He only devotes a couple paragraphs to this.
For Item II, he cites various corn crops, and cattle as produce where humans can affect the quantity produced.
But whether we will produce more depends on price. He notes a natural progression affecting the price of cattle. In the early stages of improvement, wild cattle are numerous and therefore cheap. As more land is tilled, less is available for the wild cattle which become less numerous and therefore rise in price. Eventually the price rises high enough to devote land to crops for feeding cattle. The rise in price stops when the profit for raising cattle becomes equal to that of growing grain for people.
Raising poultry and hogs start as side efforts, where little energy is put into them. The animals are little tended and are fed with what is considered waste. It is only when grain is sufficiently cheap that the demand for these items goes up, and the price with it. Eventually the price is high enough to make it worth while to grow food specifically to feed them, thereby producing them in quantity and creating an industry.
Dairies are also a luxury item compared to corn and meat, and so become profitable only when grain is already abundant enough to be cheap.
For Item III, he talks of the value of an animal’s hide versus the value of the meat. He talks about cattle hides and the wool of sheep. He notes that early on in the course of improvement, there may be value in the hide and none in the meat. Therefore an animal might be killed and the skin taken with the meat left to rot.
Brian’s note: This seems a bit off the topic of produce where it is uncertain whether people have the capacity to produce more. But maybe the uncertainty results from the price?
He notes that increasing the quantity of fish harvested can be uncertain as the demand goes up, because you can deplete the local fish population, and have to go farther out. Success generally becomes less certain then.
He talks about metal mines as well. The ability to produce more is uncertain because we might just not find more mines that are fertile.
EFFECTS OF THE PROCESS OF IMPROVEMENT UPON THE REAL PRICE OF MANUFACTURES.
Improvement results in a lowering of the real price of manufactures. While the price of labour might go up, the productivity of labour goes up even more so that the real price drops. The productivity of labour goes up because of new machines and the division of labour. He provides some history of products and their prices over time to support this supposition.
CONCLUSION OF THE CHAPTER
He discusses the three kinds of income, and the effect on them of improvement.
The general improvement of society will raise the rent of land, either directly or indirectly. As products become more abundant, the landlords share of the price increases as well. Therefore it is in the interest of land owners that society should generally improve. But since they don’t really have to work to earn their money, they are often complacent and don’t even know what their own best interests are.
It is also in the interest of wage earners that society should improve. Their wages increase while the demand for labor is continuously increasing, which is the case when society continues to improve. But wage earners typically have little time to think about their own best interests and are also uneducated and may not know their own best interests.
However, the profit of stock is not like the other two. It does not rise with prosperity and fall with descension. In fact, profit is low in rich countries and high in poor countries. It is actually highest in countries that are falling into decline. This class is generally involved in various projects and of the three classes is most familiar with their own interests.
Therefore any proposition from the stock holding class should not be given any trust, but should be very closely examined (page 181).
Brian’s note: If he doesn’t trust suggestions on public policy from the holders of stock, how wise would he consider it to let rich people actually be the policy makers, to hold office (as is becoming the rule today)?
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Book II, Of the Nature, Accumulation, and Employment of Stock
Introduction
Stock becomes important once the division of labour becomes widespread, since people no longer produce all the things they use and must trade for these things.
Part II has 5 chapters
• Chapter 1, classifies different kinds of stock
• Chapter 2, about the expense of maintaining money
• Chapter 3, about using stock in industry
• Chapter 4, about lending out stock at interest
• Chapter 5, about the different uses of stock
Book 2, Chapter 1, of the Division of Stock
Stock consists of:
• Stock you intend to invest (Capital)
o Used to run your own business
? Circulating capital (raw materials). Profit is made by parting with this capital.
? Fixed capital (machines, buildings). Profit is made by keeping this capital.
o Money you lend out for interest
• Stock for immediate consumption
o Stock you started with
o Stock you earned
o Stock in the form of goods not yet consumed
The classification written above for an individual can be said of an entire country as well.
• First, stock for immediate consumption
o Houses
o Clothes
o Anything which is being consumed by the end user (after being sold)
• Second, fixed capital
o Machines
o Productive buildings (manufacturing plants)
o Improvements to land
o The acquired and useful abilities of the inhabitants of a society
• Third, circulating capital
o Currency (the actual bills and coins)
o Unsold provisions
o Raw materials
o Finished but unsold goods
The sole end of both circulating and fixed stock is the stock for immediate consumption, the maintenance and increase of it.
In any country with tolerable security (force of law), all reasonable people will seek to employ all their extra stock for profit. In countries where contracts are not enforced, people will hide their stock (treasure troves).
Book 2, Chapter 2, Of Money Considered as a Particular Branch of the General Stock of the Society, or the Expense of Maintaining the National Capital
Gross revenue – total income before expenses
Neat revenue – remaining income after expenses
Of circulating capital (money, provisions, materials, finished goods), hard currency is the only one whose expense of maintenance is not part of a nation’s neat revenue.
Money (hard currency) resembles fixed capital in its relation to increasing the wealth of society.
Paper money is less expensive to maintain than precious metals. The “fractional reserve” approach lets bankers issue “notes”, and allows a larger money supply (still assumes notes are backed by gold/silver).
Banks made loans by discounting Bills of Exchange, & by credit accounts.
Banks who issue more paper than the economy needs will see it redeemed quickly, for gold or silver. So it is against their interest to do so, because they will need larger reserves.
Brian’s note: This argument seems to ignore the possibility of inflation, I’m not sure why that wouldn’t apply.
Smith thinks that banks should only make loans equal to a merchant’s working capital, which he otherwise would have to keep in gold/silver. He doesn’t want to loan money for fixed capital, like forges for a smithy. Such loans should be through bonds or mortgages.
Brian’s note: I believe he feels that way because bonds/mortgages are secured debt, where a simple loan is unsecured debt.
The circulation of hard currency can be divided into two parts, bank-to-bank and bank-to-consumer transactions. By making the smallest denomination of paper too large for the average bank-to-consumer transaction, it is possible to confine paper money to banks.
Bank promissory notes must be payable immediately & without condition if they are to be valued equally to gold/silver. Some banks in Scotland in 1762-1764 gave themselves the option of paying off a note 6 months after it was presented, which suppressed them below face value.
Book 2, Chapter 3, Of the Accumulation of Stock, or of Productive and Unproductive Labour
Productive Labour (adds value to an object of permanency): Example, manufacturing labour.
Unproductive Labour (doesn’t add value): Example: a butler.
• All government workers are “unproductive”
• Musicians, doctors, lawyers, clergy, innkeepers.
Brian’s note: I imagine that all “service sector” jobs of today would be unproductive labour.
In poor, unimproved countries, capital generates a larger percentage profit than in improved. But the pool of stock is larger in the improved country, and the absolute value of the profit much larger as well.
Productive labour is maintained by capital, unproductive labour is maintained by revenue.
As a country improves, a smaller & smaller percentage of the people are “idle”.
Brian’s note: It isn’t clear why people in towns dominated by revenue spending (seat of government, court of justice) would be more idle. Perhaps he just means more people are employed in service jobs. Or does the government just give away food, but only in the capital? Doesn’t seem likely.
Once a sum of money is put into a fund of capital, he considers it a perversion to remove it (to revenue).
He feels that frugality is the natural inclination of the vast majority of people.
Prodigious private spending will never prevail so as to impoverish a nation (he says).
Prodigious public (government) spending sometimes can impoverish a nation.
He wrote here in favor of everyone deciding for themselves what is most to their personal advantage. Brian’s note: “Greed is good”.
Of frivolous expenses, there are two kinds. One, durable goods which retain value (build a fancier house). Two, expenses which don’t have a lasting value (throw a lavish party).
Book 2, Chapter 4, Of Stock Lent at Interest
When you lend money, the borrower can either invest it and probably will be able to repay you, or they will waste it, in which case they won’t repay you or would have to repay you from other of their own money.
Capital consists of the monied interests, the landed interests, the trading interests, and manufacturing interests.
As a country improves, the profit of stock diminishes. Partly because there is more stock then before and competition drives down the returns. He also says that labour shortages drive up expenses which also reduce profit.
He explains that interest is not tied to circulating money supply & prices. Prices are related to the annual produce divided by the money supply. Interest rates are related to the supply of capital versus possibly investments.
Laws prohibiting interest will be circumvented. Laws on maximum interest rates should set it just above the market rate for reputable borrowers.
There is a balance between the rent of land versus profit of stock affecting the decisions of investors. Land has the advantage of offering security.
Book 2, Chapter 5 Of the Different Employment of Capitals
There are 4 different employments
• Procuring rude produce
• Transport
• Wholesalers
• Retailers
As you work from retailers to wholesalers, to manufacturers to farmers/miners, an equal amount of capital puts into motion greater amounts of productive labour. He counts the cattle as productive labour as well.
Brian’s note: Strange. Does he count the manufacturer’s machines too?
He says that in agriculture, nature does ¼ to 1/3 of the work.
Brian’s note: He doesn’t say what the unit of measurement is, or how he calculates it.
He says that farms & retail must be locally owned to be run well. He says that wholesale and manufacturing can be remotely owned (without too much loss of supervision).
Since agriculture puts the most productive labour in motion for a given capital, a young country should import foreign manufactured goods, and let foreigners handle shipping. This will let them grow their capital the fastest. The American colonies are his example.
Countries are usually interrupted in growth & set back before they have enough capital for all three areas (produce/manufacture/wholesale trade). Egypt, China, and Indostan came closest.
The effectiveness of capital in wholesale trade depends on the type.
• Home trade (start and end points in home country)
• Foreign trade (either start or end point in a foreign country)
• The carrying trade (both start and end point in foreign countries).
The home trade has the quickest turn around, and all the profit stays in the country.
He writes in favor of free markets, not trying to “unnaturally” grow or inhibit the three different branches of trade.
Foreign trade results when the country produces more of something than it can consume.
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Book 3, Chapter 1, Of the Natural Progress of Opulence
The most fundamental type of commerce is that between the town & the country.
The town & the country are not rivals, they supplement each other.
Towns can’t develop until the country is producing enough surplus food.
People prefer to employ capital with minimum risk, so close by is the best. Therefore agriculture first, because you also get the security of the land. Then manufacturing, then finally foreign trade, which is the riskiest. He considers this the natural order for these to develop.
End of book (short book)
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Book 4, Introduction. Of Systems of Political Economy
A system of political economy should enrich both the people & the sovereign. It allows people to help themselves, and provides to government just enough revenue for the services provided.
There are two main systems, one based on agriculture and the other on commerce.
Book 4, Chapter 1, Of the principals of the “Commercial”, or “Mercantile” System
Wealth consists not in money but in what you can buy with it.
If you inject a large amount of gold & silver into a poor country, it is not suddenly wealthy (based on the standard of living of the average person).
The Spanish conquistadors asked about gold when they landed in a new country to decide if it was worth conquering. The Huns asked about sheep for the same reason. They both asked after what they valued.
• Exportation of gold/silver can be advantageous for a country.
• Prohibiting export of gold/silver won’t stop it, just cause smuggling.
• An imbalance of trade doesn’t cause a greater imbalance. Foreign goods become more expensive which corrects the imbalance.
Mercantilism tries to enrich a nation by increasing its supply of gold/silver. The home economy just circulates the gold/silver already there & so is irrelevant in this view. The focus therefore is on foreign trade, & specifically on trying to create a trade imbalance, of greater exports than imports.
He discusses a common complaint of shortages of currency, and calls them false.
He says that foreign wars can be sustained by directly supplying consumables, not only by supplying money.
The importation of gold/silver isn’t the principal benefit of foreign trade. It gives value to your country’s excess goods, and brings in valued foreign goods. By expanding the market, it allows a greater division of labour.
The real benefits of discovering America was in its population growth, which gave European goods a larger market, allowing a greater division of labour. In this way was the wealth of Europe increased, not by bringing back gold/silver from new American mines. The unjust behavior of the Europeans ruined a relationship that should have been far more mutually beneficial.
European countries have never benefited from their trade with the East Indies as they have with the Americas because they all handed their East Indies trade to single companies, to monopolies.
Mercantilism therefore pursues two strategies
1) Restrict imports
2) Encourage exports
How they restrict imports
• Restrict specific products, if it is something you can make at home.
• General restrictions against a particular country simply to lower the imbalance with that country.
Means of encouraging exports
• Drawbacks
• Bounties
• Advantageous treaties
• Establishing colonies
Book 4, Chapter 2, Of the Restrictions of Import of Such Goods as can be Produced at Home.
Restrictions on importing a commodity gives and advantage to the home country producers, but doesn’t increase the wealth of the country.
Regulation doesn’t increase capital but can direct it.
The individual’s choice is usually good for the country.
Every wholesale merchant prefers the home market, then the foreign trade of consumption, then the carrying trade. As said before, the home trade puts the most labour in motion.
Individuals try to maximize the value produced by the capital.
He feels that individuals can best choose where to employ their capital to best effect, rather than politicians.
Just as tailors don’t make shoes and cobblers don’t make clothes, no country will be good at everything. It makes sense to buy what others can make cheaper.
Merchants & manufacturers gain from restricting imports at the expense of their country & countrymen.
Domestic farmers & cattlemen don’t benefit much from import restrictions because of the bulk of the grain & cattle, which make them expensive to ship anyway.
Farmers are least liable to the wretched spirit of monopoly. They tend to share “trade secrets” unlike manufacturers.
There are two reasons to restrict imports to encourage domestic industry.
• Defense related industries, to not be dependant on foreign goods for your military.
• If you tax domestic industry, to maintain a level playing field. Some argue in favor of taxing not only the affected foreign goods but many more, because the domestic tax increases all labour costs. This is a bad idea because 1) We wouldn’t be able to calculate how much labour costs were affected by the tax. 2) We would be adding yet another tax to the affected consumers, not providing relief.
Only strong counties can withstand such taxes. They may thrive in spite of, not because, such policies.
No country will ever have truly, completely free trade. Rich manufacturers will be able to use their money to influence politicians & prevent it.
Book 4, Chapter 3, Import Restrictions Against Specific Countries to Eliminate Trade Deficits
Part I Why Such Restrictions Make No Sense Even Within the Rules of the Mercantile System
Countries sometimes place such high duties against another’s goods as to be a prohibition (France & Britain did so).
• The country running a deficit is still a more productive than one avoiding trade altogether.
• The balance of trade is hard to calculate accurately. The goods imported might be exported again for profit, but that won’t be taken into account in calculating the balance of trade.
• There is not a sufficiently precise method of calculating the balance of trade generally anyway. The valuation of goods at customs houses is inaccurate. The rate of currency exchange is also inaccurate. Merchants sometimes (often?) pay debts in the currency of a third country, affecting its rate without affecting the balance of trade. Also, the quality of money affects the rate of exchange which isn’t reflected in the calculated balance of trade. Older money may be “clipped” and you need more of it when obtaining new money. Also, coining money is paid for by the state in some countries and by the owner of the gold/silver in others, which affects exchange rates. Also, the faith in some banks’ money gives it a premium, an “agio”.
Part II, The Unreasonableness of Import Restrictions Based on Other Reasons
The doctrine of balance of trade is absurd. It supposes that an even balance means neither side loses or gains. But if it is unbalanced, the country with the deficit loses in proportion to the imbalance.
But a forced trade is commonly a disadvantage to the country it intends to favor. A free trade is advantageous to both, even if more so to the one. Advantageous not in gold/silver, but in the increase in the annual produce of each.
Gold/silver are just commodities that will exist in a given country to an extent that satisfies the demand.
Traders should not favor their clients by only buying from them, they must always seek the best trade.
Mercantilism teaches nations that their interest consists in beggaring their neighbors.
Commerce ought to be a bond of union & friendship.
The jealousies of merchants and manufacturers has been more fatal to the repose of Europe than the capricious ambition of kings & ministers.
Mercantilism was invented & propagated by the spirit of monopoly. The interest of the great body of people is always to buy where cheapest. In this regard, the interests of merchants & manufacturers is directly opposite that of the great body of people.
The wealth of a neighboring country is dangerous in war & politics, but advantageous in trade.
It is always more advantageous to trade with neighbors who are rich than ones who are primitive savages.
Merchants & manufacturers repeatedly foretell doom due to an imbalance in trade, which never happens.
The proper balance to be concerned with is that between your annual production & consumption.
Book 4, Chapter 4, Drawbacks
A Drawback is an encouragement for re-exportation of imported foreign goods. When a foreign good brought in is then exported, a portion of the duties paid are returned.
He feels that drawbacks don’t alter the distribution of capital among the different industries.
The revenue of customs benefits from having a portion of the flat fee where without drawbacks it would have none (due to a lack of a market).
Book 4, Chapter 5, Bounties
Bounties encourage export of home made goods. It is a flat payment as opposed to drawbacks which repay a tax already paid.
A bounty tends to raise the price in the home market since it encourages export.
A bounty puts 2 taxes upon people.
1) Their direct contribution to the bounty.
2) The higher prices they pay for that commodity (the heavier by far).
He works through an example with corn.
The import/export merchant is the only real beneficiary of a bounty.
Some commodities (corn is the example) are fundamental and have the effect of regulating the price of others. Bounties on these commodities are particularly bad.
Book 4, Chapter 6, Treaties
He discusses a treaty between Great Britain & Portugal motivated by a desire to maintain access to gold from Portugal. He says it was a foolish treat, because gold can be had elsewhere.
Basically, he doesn’t believe in treaties affecting commerce, prefers the free market.
Book 4, Chapter 7, Colonies
Greeks founded colonies to relieve excess population, and considered these colonies as their fully emancipated children.
Rome wasn’t overpopulated but founded colonies in conquered lands to allow landless citizens to have estates. These colonies had allegiance to Rome and its laws.
The reasons for establishment of colonies in America were less simple.
He then discusses the East Indies & the voyage of Columbus. The motivation for the trip was trade with the East Indies, but having found America instead, the only justification for the exploration effort was gold, since nothing else of value was found. However, not that much gold was found. He explains how poor the odds are for gold prospecting, explains how the Spanish explored as much as they did out of the wish for gold, and their poor rate of success.
Brian’s note: The chapter doesn’t really discuss any general economic principal.
Book 4, Chapter 8, Conclusion of the Mercantile System
He notes that manufacturers push just as hard for advantage in reducing costs of their raw materials as in raising the price of their finished goods. They push for import duties on competing finished goods. They push to exempt their raw materials from import duties to increase the competition against their domestic suppliers and thus lower the prices of their raw materials.
The mercantile system principally benefits the industry carried on for the rich & powerful. That for the poor & indigent is too often neglected or oppressed.
Some prohibitions against exporting certain goods went so far as to cutting off hands & even death. Anyone who enticed an artificer to move to a foreign country, and the artificer if they agreed, were subject to punishment. If the artificer moved and didn’t move back upon discovery, they lost any property or inheritance. The manufacturers didn’t want skilled labour leaving, and didn’t want foreign tradesman learning from their skills.
Mercantilism doesn’t improve the domestic manufactures but seeks to depress that of all neighbors.
Manufacturers feel they should have a monopoly over skilled craftsmen. They limit the number of apprentices and impose long apprenticeships.
Consumption is the sole end & purpose of all production, and the interest of the producer should only be attended to in promoting that of the consumers. Mercantilism almost constantly sacrifices the interest of the consumer to that of the producer.
While the empire established by Britain in the Americas & West Indies benefited the producers, the home consumers paid higher prices plus the cost of defending that empire.
Brian’s note: Only the last two pages tried to sum things up. Much of the chapter until then listed a great many examples of specific duties, was quite boring, and seemed a bit pointless.
Book 4, Chapter 9, The Agricultural System
The agricultural system was created by French philosophers reacting to an overly mercantile minister of Lewis XIV, Mr. Colbert. He favored the towns over the country to a great extent. The agricultural system by Mr. Quesnai favors the county.
Three classes
• Proprietors of land (productive class)
• Farmers and country labourers (productive class)
• Manufacturers, artificers, merchants (the barren, or unproductive class)
Proprietors of land
• Ground expenses (improvements)
Farmers
• Original expenses
• Annual expenses
The profits of the landlord are “productive”. The profits of the unproductive class are considered as expected as a matter of course. And since the capital holder spend those profits, they are viewed as only replacing exactly the original capital & therefore are “unproductive”. The capital holder is considered to be his own employee, with a wage that counts as expense.
Brian’s note: Even though the capital holder doesn’t work.
The productive class augments the values of society automatically. The unproductive class can do so only through parsimony, by depriving themselves in some fashion.
The unproductive class are employed & maintained at the expense of the productive class, and are properly their servants.
The productive class should not restrain or discourage the unproductive class since they allow the productive class to focus on their proper work (growing).
Free trade is still endorsed as being in a country’s best interest.
Mr. Smith’s response:
Merchants etc. cannot be called barren because
1) Even if you just replace the invested value, you are not barren, any more than a marriage with two children is barren.
2) Merchants etc. add value, and shouldn’t be lumped in with menial servants or soldiers whose efforts have no lasting effect.
3) Even replacing your own value adds to society, again compared to a servant or soldier who doesn’t replace any value.
4) The productive class can only augment the capital of society through parsimony too.
5) Other things being equal, a country with trade & manufactures will always have a greater production than one without.
This system still offers a truth not found in others, that the wealth of nations consists not in the money it has, but in the consumable goods produced by its labour, and that free trade maximizes production. Free trade between town & country is just as applicable as free trade between countries.
He mentions that the next book will cover the three duties of the sovereign.
• Protection from outside threats (military)
• Protection of citizens from each other (justice)
• Erecting public works or institutions which individuals could not profitably do, although the sovereign can.
———————————————————————————————————–
Book 5, Chapter 1, Expenses of the Sovereign
Part I, Defense
The military of a barbarous country of hunters maintains itself and doesn’t incur any expense for the sovereign.
The militia of a barbarous nation is superior to that of a civilized nation. A civilized standing army is superior to both.
He feels that a standing army can be a danger to liberty but isn’t necessarily so, if led by the sovereign.
As civilization advances, the military becomes more expensive.
Part II, Justice
He discusses how to avoid any expense for judges to the sovereign by charging court fees, and says that the entire cost could be on the participants without corrupting the outcome.
Part III Public Works, Public Institutions
These are mainly for facilitating commerce & for education
Article I, section 1, Commerce, in general
(roads, bridges, harbours, post office, etc)
He suggests building & maintaining them by usage fees. Tolls, use stamps.
This also helps ensure building them where truly needed. He likes private parties to get the money & be responsible for maintenance instead of government appointees. Such as for canal locks.
For roads, the road would be passable even if neglected by a private party, so he prefers government appointees.
He likes public works to be in the hands of local government.
Article I, section 2, Particular branches of commerce
An example, public expense might be in maintaining ambassadors in foreign countries, to help merchants. This practice started at the end of the 15th or beginning of the 16th century.
Adams wants to pay these expenses through taxes on the merchants.
Sometimes governments have let private entities handle the protection of trading with poor results in the long run.
Regulated companies – merchants in the company are financially independent, use their own inventories.
Joint stock companies – shared inventory, risk, profit.
Brian’s note: Sounds much like a modern corporation
When a company establishes a new trade, to a new foreign country, they should get a monopoly from the state, but only for a limited time. Long term monopoly results only in overly high prices and waste.
Joint stock companies don’t long succeed in trade without a monopoly, based on experience. A Frenchman, Abbi Morellet made a list of 55 such companies which failed from mismanagement, between 1600 & 1776.
Without a monopoly, only ventures with strict easy to follow rules are suitable for joint stock companies: Banking, insurance, canals, water supply pipes to cities.
Joint stock companies should only be created when certain circumstances force it. 1) The undertaking is of greater & more general utility than the greater part of common trades, 2) It requires more capital than can be easily collected into a private copartnery.
Brian’s note: I wonder if he would approve of today’s mega corporations, and of the idea that corporations are legal persons. I suppose that point 2 would be offered as justification by proponants.
Article II Expense, Institutions of Education for youth.
He feels that students should pay tuition, and that schools should have endowments. That schools shouldn’t be paid for from government coffers.
Article III Expense, Institutions of Education, People of all Ages
Mainly churches. Students should pay. Or possibly an endowment.
Part IV, Expense, Supporting the Dignity of the Sovereign.
That one, government should pay, and pretty well too.
Conclusion
• Defense should be paid for by the state
• Justice by the state, offset by some court fees
• Localized expenses should be paid by localized taxes.
• Roads by the state, although tolls are good for long stretches
• Education by the state is ok, although tuitions and endowments are good
• There are many cases when it isn’t possible to have specific beneficiaries pay, where the state must. Therefore … taxes. See next chapter.
Book 5, Chapter 2, Revenue of the Sovereign
Brian’s note: B – ooooooooooooo – oring. This is the most boring chapter of the book. Painful.
Part I, Revenue Belonging to the Sovereign or Commonwealth
A sovereign can own land & rent it or capital & lend it. Or run a business.
Historically a sovereign only gets a significant part of revenue from personal ownership of a business in primitive cultures. Example: An Arabian chief as principal Sheppard of his own herd.
Governments have successfully run post offices.
Princes who run businesses often fail & need to be bailed out with state funds.
When a business takes on sovereign duties, their clerks begin to think themselves ministers.
The characters of sovereign & trader are inconsistent with each other.
Banking & lending money have been more successful, as has renting out of land. But rent of land is usually poorly managed and would be better for the sovereign to sell it into private hands, both for the selling price and the future taxes.
Part II, Taxes
Private revenue can be divided into rent of land, profit, & wages. This part will be divided into 4 main articles.
• Taxes on rent of land
• Taxes on profit
• Taxes on wages
• Taxes intended to fall on all three
Many of these are paid from a revenue other than the one intended.
Four maxims for taxes
• Taxes should be in proportion to revenue (so not flat taxes)
• Taxes should be clearly defined. Vaguely defined taxes wind up at the discretion of the tax collector and lead to corruption.
• Taxes should be levied at a time when the citizen is most able to pay. Farm taxes paid at harvest time, for instance.
• Taxes should be collected so as to maximize the revenue to the sovereign.
o with minimal overhead (tax collector salaries)
o Shouldn’t discourage the industry by being overly high
o Shouldn’t be so high as to encourage smuggling.
Article I, Taxes upon rent, Taxes upon rent of land
The tax on land is affected by
• How often the value of land is assessed.
• Whether the economy generally improves or degrades
• Whether the value of money rises or falls
He recommends against regular assessments as being too cumbersome upon the government. He recommends recording leases and taxing that. Also improvements made by landowners can be written off over time. For owners working their own land, estimate what the lease would have been based on comparable leases.
Taxes based on the produce of the land
These amount to taxes upon the rent of land, because farmers can negotiate less rent equal to the tax. Rent of land is as much as the tenant can afford.
This is a very unequal tax as the value of the rent can be half the value of the produce or up to 90% of the produce value. This tax discourages the landlord from making improvements & the farmer from raising more expensive crops.
Taxes upon the rent of houses
House rent is divided into Building Rent & Ground Rent. This tax is directly paid by the tenants, but ultimately is paid by the tenant & the landlord. The builder doesn’t share any of it.
The rent of land is for a productive asset. The rent of houses is unproductive.
Article II, Taxes upon profit, Revenue arising from stock
Profit of stock is divided into two parts
• Interest (for what the businessman borrows, must be paid to the owner of the stock)
• Surplus (which is the part the businessman gets to keep)
Tax upon profit actually falls upon
• The rent of land (if farming)
• Consumers, as higher prices (trading)
• The rate of interest, forcing it lower
While the interest of money seems good to tax, there are two problems.
While it is easy to calculate the value of land, someone’s total worth is secret and constantly changing.
Land will remain in its own country regardless of tax rate, but owners of stock can employ it in another country if taxes are too high.
Taxes upon particular employments
These taxes are ultimately paid by the consumer, not the dealer.
Taxes that are a flat fee per dealer (instead of a % of revenue), such as a liquor license, still falls ultimately on the consumer, but favor larger entities who can make it back with a smaller price increase than what a small entity must do. Flat taxes per shop are therefore uncommon.
Brian’s note: Smith says several times that stock holders / business owners “must have” their “reasonable” profit and that therefore taxes are passed on. But he doesn’t explain that as well as I’d like. I would rename it a “minimum” profit. I agree that at zero profit, owners of capital wouldn’t lend. But how low a profit will motivate them to lend? What if an owner is making more than the “minimum” profit? I think that whether they pass along the tax depends on how much sales will fall, and how much more than the minimum profit they are making. I think he means long term, but if all opportunities were affected, it seems the stock holder would have to accept less profit. Smith did not foresee the extent to which modern businesses must report to government. He didn’t think that every transaction would be tracked, but today they can be, and must be documented in case of audit.
Taxes upon trade cause the merchant to reduce supplies until prices rise (can lay off workers). But for taxes upon agriculture, it is not in the interest of the farmer to reduce crop size because he still has to pay rent on the entire land. Therefore the tax will reduce rent on the land in the long run.
Appendix to Articles I & II
Taxes upon the capital value of land, houses, & stock
Real estate taxes (the land remains under the same ownership) are not intended to reduce its capital value, but is intended to take from a revenue from that land.
He recites a number of feudal tax laws as examples. Taxes can be a % of sales price or a flat fee (stamps, registration).
Taxes upon sale of land fall upon the seller. The buyer takes the taxes into account in what they will pay for the land. Taxes on the sale of new houses fall upon the buyer, not the builder. Taxes on sale of existing houses fall upon the seller as with the sale of land.
All taxes on sale of land diminish funds for productive labour.
Secret registries lead to abuse and should be banned. Registries must be public.
Taxes on consumption (leisure) fall upon the consumer.
Article III, Taxes on the wages of labour
As stated earlier in the book, worker wages are regulated by demand for labour & the price of provisions.
Taxes upon labour will just raise wages (demand and provisions remaining constant). Wages rise by the proportion of the tax & then some (since the additional wages are also taxed). These are passed on to the employer, who adds his own profit before then passing it on to the consumer. Taxes upon country labour are ultimately taken from land rent.
Brian’s note: So crop prices won’t go up?
A tax upon wages won’t be completely passed on if it causes less demand.
He considers taxes upon wages to be absurd & destructive although common.
Article IV, Taxes intended to fall indifferently
These are:
• Capitation taxes
• Taxes upon consumption
Capitation Taxes
Shouldn’t be a tax based on revenue or overall fortune because it changes constantly and cannot be known accurately without an intolerable invasion of privacy
Brian’s note: Today we tolerate such governmental intrusion and pay income tax.
Capitation taxes can be a flat fee based on rank or employment (a duke must pay X, a blacksmith must pay Y). Such a tax, if extended to commoners, is just a tax upon wages with all of the same problems.
Tax upon consumable commodities
• Necessities (includes expense that local custom demands, like shirt and shoes)
• Luxuries (tobacco, liquor, chocolate, tea, sugar)
A tax on necessities is a tax on wages, with same effect mentioned before
A tax on luxuries is paid by the consumer, and does not raise any other prices, and fall indifferently.
Consumables can be taxed at the dealer or the consumer
• At the dealer is appropriate for goods with a short shelf life
• At the consumer is appropriate for goods with a long shelf life.
He then works through a number of examples. Some of these involve import/export & he revisits his earlier points about mercantilism.
He points out that a small luxury tax paid by the larger body of poor/middle class will generate more revenue than a large luxury tax against the rich.
Sometimes government charges tolls on roads & waterways intended to maintain them. They should be run at the local level. When regional or national government runs them, the fees are much higher, yet the road/waterway is neglected. Funds get diverted or wasted. These taxes should be based on weight of cargo, when based on value, they are more like excise taxes.
Luxury taxes measure up well against the first three maxims of tax, but not well at all against the fourth (maximizing the net revenue).
Tax collectors should work directly for the government. Contracting out of tax collection to private companies leads to abuse & waste and other ill effects. Private profit is always high in this case.
Book 5, Chapter 3, Of Public Debts
In primitive civilization, w/o commerce or manufacturing, a rich person can only use their revenue by maintaining a large number of people. The revenue is food & coarse clothing and cannot be kept and accumulated. Under these circumstances, such a person is highly unlikely to go into debt & ruin themselves. In those times, trading was considered disgraceful to a gentleman. Lending money at interest was usury & unlawful. People hoarded valuables, had treasure troves. This was true of the sovereign as it was of the people. Standing armies don’t exist, and so do not burden the sovereign with their expense.
Once commerce & manufacturing come to be, luxuries become available. Rich people and the sovereign as well spend on them, often as much as their excess revenue allows. They no longer save. And this is during peace.
When war starts, there is no money in the treasury for it. Even raising taxes would only raise revenue after some months. But the expenses of war are immediate, so the government borrows. The commercial state of society lends government to this situation, but also provides the capacity of society to lend in the form of merchants & manufacturers who have stock. Lenders trust that the government will pay them back, and the terms are usually more profitable than normal lending.
The progress of debt among the great nations has been pretty uniform, and probably will eventually lead to ruin.
A nation’s unsecured borrowing can be of two kinds.
1) Short term, paying no interest
2) Long term, paying interest
When the government can no longer entice lenders to provide unsecured credit, it must commit portions of specific revenues to attract new creditors. Sometimes the rate of repayment is set so as to retire the debt in a specific time (“Anticipation”), and sometimes the payment is just enough for the interest (“Funding”) with the government intending to address the principal at some other time.
Funding makes wars less burdensome to the people, so they start more readily & last longer. The people see a tax increase, but not as much as it would to pay the entire expense. But upon peace, the taxes remain.
Problems arise because often war breaks out again before the debt is paid off, or because payments were diverted to other purposes. There are unexpected expenses even during peace.
Mr. Smith rebuts an unnamed author’s claim that public debt is harmless. The author considers government funds as another capital, employing the country’s citizens. But often public debt is held by foreign countries. He cites that the Dutch held English debt. Also, much of government is unproductive labour.
“Anticipation” debt hinders formation of new capital. “Funding” actually destroys old capital but less hinders the formation of new capital, however, only during the war. Over the long run, funding is worse.
He says that it is better to keep money in private hands, who are more motivated to use it efficiently & productively, than in government hands.
The practice of funding started in Italy, best he can tell.
When public debt reaches a certain level, there will be a bankruptcy. Sometimes government admits it, but often it devalues the currency, which affects all debts, public & private. Creditors to the government are typically creditors to private debt too & lose in both ways when this happens. Smith feels that openly admitting bankruptcy is less harmful & less dishonorable.
The Wealth of Nations
By Adam Smith (a Scotsman)
Originally published 1776
ISBN-13: 978-0-7607-5761-1, ISBN-10: 0-7607-5761-5
This outline created 11/13/08, Brian Jacobs
Book I,
Of the Causes of Improvement in The Productive Power of Labour and of the Order According to which its Produce is Naturally Distributed Among the Different Ranks of the People
Book 1, Chapter 1, Of the Division of Labour
To improve from a subsistence society, division of labour allows a civilization to produce more than its immediate needs, leading to increased trade. Transportation is also a key, so that the larger group of people can act as a single market.
The division of labour allows for greater productivity because:
- One person can become an expert at one given operation, and thus more efficient
- When a manufacturing process is broken down into simple steps, less skill is needed for any given step.
- It is easier to invent better tools for one operation than for a whole process. Many such improvements come from workers who perfom the job being improved on.
- Time is wasted when switching between kinds of work (changing tools, or people just taking a break)
Brian comment: Mr. Smith did not address and perhaps did not conceive of the effect of the division of labor on job satisfaction. He wrote long before Ford invented the assembly line. Some people call it dehumanizing if your job is to put the bottle caps on 10,000 bottles per day. Other people say that it doesn’t matter, that few jobs are fun anyway, especially farther back in history.
Book 1, Chapter 2, Of the Principle Which Gives Occasion to the Division of Labour
- The author proposes that humans are the only animal to take advantage of the division of labour.
- We are also the only animal that trades, which allows us to take advantage of each others unique talents.
Book 1, Chapter 3, That the Division of Labour is Limited by the Extent of the Market
The larger a group of people is, the greater the potential for division of labour. Larger markets allow for sufficient volume of business to sustain a wide variety of very specialized jobs.
Transportation allows smaller markets to combine into larger ones. Water transport being more efficient than that by horse, the first civilizations were based around bodies of water such as rivers and seas.
Book 1, Chapter 4, Of the Origin and Use of Money
The use of money arose because of the inconvenience of barter. The people selling what you seek may not have a use for what you have to offer in trade.
Historically, it was common that a people settle upon one or another kind of metal to use for money.
The first metals as money were used in bars. Later, the bars had a small stamp. Next, the metal was minted into coins, which are essentially stamped across their entire surface. This was done to help prevent cheating. The value of money was never too stable, saw a lot of variation historically.
There are two values for a commodity, the value of use (such as corn you can eat), and the value for trade. The value in trade depends partly upon its scarcity.
Book 1, Chapter 5, Of the Real and Nominal Price of Commodities, or of their Price in Labour, and Their Price in Money
The value of a commodity comes from the hours of labour to produce it, and when we trade we try to exchange our labour for an equal amount of labour.
The value of labour is also affected however by the difficulty of the work, the hours invested to develop needed skills, or other hardships.
The value of gold and silver varies as supply expands (new mines are found), or shrinks (ships full of gold sink).
Governments (kings, at the time) often dilute the amount of pure metal in their coin so as make it easier for them to pay off their own debts, although the citizens are affected as well. They rarely increase the pure metal of their coin though.
Book 1, Chapter 6, Of the Component Parts of the Price of Commodities
The three component parts of the price of a commodity are:
- Labour Wages
- Land Rent
- Profit for Stock
Book 1, Chapter 7, Of the Natural and Market Price of Commodities
There are “natural” rates for wages, profit, and rent, for a given time and place. Unusual circumstances can drive the price above or below this price, but the average price will gravitate towards this “natural” value. It is an equilibrium point.
Agricultural commodities vary in the quantity brought to market (and therefore price) much more than manufactured goods due to the vagaries of the weather.
The price can rise above the natural price for extended periods of time (perhaps due to monopoly, or unusual demand), but can not long stay below the natural price.
Guilds can interfere with the natural inclination of a worker to abandon an unprofitable trade because other trades have guilds of their own preventing the worker from joining.
Book 1, Chapter 8, Of the Wages of Labour
Originally, the wages of labour was the only component of prices. The appropriation of land (land as private property) took away from the value of labour, as rent now has to be paid. The profit of stock took away as well once the cost of raw materials was high enough to require the borrowing of money.
Pg 56: It is easier for the providers of stock to combine (to lower the wages of labour) than it is for workers to combine (to raise wages). Stockholders are fewer in number, and typically have the law on their side. In a battle of wills (possibly a strike), workers do not usually have enough money to outlast the stockholders. When workers combine, they try to draw as much attention as possible. When stockholders combine, they try to be as quiet as possible. There is a lower limit to wages in the long run though, since workers must be able to sustain themselves.
Pg 59: “It is not the actual greatness of national wealth, but its continual increase, which occasions a rise in the wages of labour.”
In periods of high wages, children can be considered an asset for the value of their labour (before they would leave to make homes of their own).
China is given as an example of a country with a stable, mature economy, where wages are very low.
When wages are high, workers work harder (than when wages are low). This is in opposition to the idea that they will work just enough to make the same amount as they previously made under lower wages.
Pg 68. The work of freemen comes cheaper than that of slaves, in the end. This is because freemen are very careful to be efficient, since it is their own resources being used.
Pg 69. The happiest societies are ones with expanding economies. Stagnant ones are hard, and declining ones miserable.
Book 1, Chapter 9, Of the Profits of Stock
It is hard to know the average profit of a business. But it is possible to make some judgment of it based on the interest rate being commonly charged. Profit goes down as the volume of trade goes up, because there is more stock generated which competes for the business.
A great stock earning smaller profits, will still increase than the smaller stock earning larger profits.
The laws of a country also affect whether the rate of growth reaches its potential. Minimizing foreign trade means that trade will not be maximized, for instance.
When the laws protect the rich, permitting them monopolies, the amount of stock employed in the economy will also not be maximized.
Unnaturally high interest rates can also result if the government does not enforce contracts, because lenders need high profits from borrowers that do pay off to compensate for borrowers that refuse to (although they could).
When law forbids charging interest, interest is still charged in “unofficial” side deals.
The lowest rate of profit from stock must be something more than to make up for average losses from bad debts, to make lending worth while.
Higher wages raise the price of a commodity just by the dollar amount that they went up, like simple interest. Higher profits raise the price of a commodity like compound interest, because profit is taken as a percentage at each step along the way.
Book 1, Chapter 10, Of Wages and Profit in the Different Employments of Labour and Stock
Under ideal circumstances, there would be no advantage to employing labour or stock in one industry or another. A self enforcing equilibrium would make it so. But this assumes that workers are at liberty to switch employment.
The chapter is divided into two parts, addressing the two factors which detract from the concept of perfect equality in wages. The first cause is differences in the jobs. The second cause is public policy (specifically in Europe).
Part I, Differences due to the nature of the employment
In reality, liberty is much less than perfect. Here are the 5 factors observed.
- Work can be pleasant or unpleasant.
- A job can be easy or hard to learn to do
- Work might be seasonal, or otherwise inconstant
- There may be a significant amount of trust placed in a job
- The probability of success in that trade
The profit of stock does not seem to depend upon the difficulty of the trade involved, since the investor doesn’t have to know that trade.
He brought up the idea that the rate of people who study a trade compared to those who succeed is like a lottery. In a perfect lottery the one who succeeds would get all the wages which the others who failed would have received. But this doesn’t happen.
Brian’s note: He states that some talents are not supposed to be sold on the market, and that we despise those who do sell such talents. The example is artists such as opera singers. He says we pay them well, but we’re disgusted that they would take money for their performances. I don’t see it.
He discusses the idea that people over estimate their chances of success and under estimate their chances of failure.
Only two of the five factors that affect wages also affect profits: Whether a job is pleasant or not, and whether a business is more or less risky.
Sometimes an apparent high profit is really a high wage in disguise, to make up for extensive education. The example was the high cost of drugs, when the raw material is cheap, but the cost comes from the education of the apothecary.
It is more difficult to expand your stock in a small town than a large, because the market is limited in size.
The rules about wages only apply strictly when the job is a person’s primary employment. If the employment is a 2nd job, they will likely take a lesser wage than someone who does such work as their primary position.
Part II, Differences due to policy
He lists three causes of inequality due to policy.
- Restraining competition in some industries
- Artificially expanding competition in others
- By preventing the free circulation of labour and stock, both from place to place and from employment to employment
RESTRICTING COMPETITION
A number of practices are discussed that restrict competition in order to raise prices. He considers this the main purpose of guilds, despite their claim that they guarantee qualified workmen. He feels that the marketplace will guarantee quality work. He states that apprenticeships last much longer than the time needed to learn the crafts.
He states that a man’s labour is the original, fundamental, private property, and considers it sacred.
Towns have the advantage over the country because they tend to have guilds. They send finished goods to the country, and the country sends raw produce to them. The imported goods found in the country passes through the town’s merchants, which can mark them up. Towns restrict the number of apprentices and stipulate long apprenticeships in order to restrict trade. The country doesn’t commonly use apprenticeships at all.
Once a town has run out of opportunities to invest stock, stock will eventually be employed in the country, restoring some measure of equality.
He stated that whenever business owners gather for social purposes, the conversation always turns to ways in which to prop up their prices, which of course is at the expense of the public. He doesn’t feel that there is any practical way to avoid such collusion, however. Nevertheless, markets are never truly free, and competition is never really open.
Forming a guild forces unity among its members. Where a merchant might undercut prices, the by-laws of the guild will compel cooperation in raising prices.
EXPANDING COMPETITION
Various sorts of public sponsorship can lower the cost of entering a given business, giving rise to more competition than what is natural. Priests historically gained education not at their own expense. “Men of letters” had this benefit too.
RESTRICTING MOVEMENT FROM PLACE TO PLACE OR EMPLOYMENT TO EMPLOYMENT.
Towns used to have laws which restricted moving. They were intended to prevent the poor from moving in which resulted in the public taking care of them (church donations for example). But they called for the new person to rent a house for a certain amount for a certain time. This prevented workmen from moving unless they had a significant savings, which typical labourers did not.
Required membership in a guild meant that one industry might be starved for labour right next door to one that has an over abundance.
Stock typically did not have as much trouble moving from place to place or employment to employment.
Book 1, Chapter 11, Of the Rent of Land
He states that the rent of a land is the most that the tenant can afford (but does allow for some profit for the tenant). Brian’s note: I find this interesting because I would expect the rent to be determined by competition from other landlords.
Rent is the return for the landowner’s outlay for purchasing the land. But landlords will charge rent even for unimproved land.
He considers rent as a monopoly price. It is not related to the price of the land or improvements to it. It is not based on what the landlord can afford to accept, but what the tenant can afford to pay.
Rent as a portion of the price of a good enters into that price in a different way than wages and profit. High wages and profit are the cause of high prices. High rents are the effects of high prices (not the cause).
This chapter is divided into three parts.
1) The produce of land which must always afford a rent.
2) The product of land which may or may not afford a rent
3) As the progress of improvement advances, the variations which naturally occur at each stage.
1) THE PRODUCE OF LAND WHICH MUST ALWAYS AFFORD A RENT
Food is an example. Since people will reproduce to the extent that food is available, food is always in demand.
Food bought farther out in the country is cheaper than that bought nearer to town, because of the expense of transporting it. That is why farmers near town may oppose extending roads.
Page 128: Monopoly is an enemy to good management.
He says that the rent of land will be determined by the price of the dominant food stuff. In his time, that was corn. So, for instance, the landlord would be comparing their profit from cattle to that from corn, in deciding what use to put the land to.
He discusses at considerable length the history of the specific prices of corn and cattle, tobacco and sugar. He also writes on vineyards, rice, potatoes, pork. And whether it is worthwhile to enclose a garden. Brian’s note: I wasn’t able to glean much in the way of general principals in this.
2) THE PRODUCE OF LAND WHICH MAY OR MAY NOT AFFORD RENT
Human food is the only produce of land which is guaranteed to provide a rent.
Human needs are food, clothing, and shelter. Land in its original unimproved state will always provide clothing and shelter, but not necessarily enough food.
The materials of clothing and shelter will be so abundant as to have little or no worth. When killing an animal for food, the hunter incidentally provides himself with clothing in the form of the hide or pelt. Based on the number of animals he must kill to feed himself, he will have more material for clothing than he needs and probably discards many hides.
The material for lodging cannot easily be transported far, so they may not afford a rent to a landlord if the local need is small. A landlord may very well give away lumber to those who are willing to take it away.
During the course of improvement, the additional capacity produced will go largely towards clothing and shelter. A rich man is not able to eat much more than a poorer one since both have the same size stomach (although the rich man will have food of a higher quality). But a rich man will have a huge palace of a home and fine clothes.
So these other products of land besides food may or may not afford for rent.
He notes that some coal mines do not afford rent. The only one who can mine those lands are the owners who do so for the profit and don’t pay themselves any rent.
He talks about the price of wood. When the country was largely unimproved, wood was over abundant and therefore of little worth. As agriculture turned more and more land to tillage, wood became more valuable.
Brian’s note: His unspoken assumption that unimproved land is forested. This may have been true in Europe, but wouldn’t always be true as in the great grasslands in America.
He notes that large bulky items such as coal are hard to transport, and their market may be very local as a result.
He says that since metal is much less bulky, it is easier to transport, and metal mines generally must compete with those in a much larger region, even globally. This is even more the case with the precious metals gold and silver. So he says these mines are even less likely to afford a rent since the competition is the greater. The most fertile metal mines will set the price and those mines will pay a rent. But less fertile mines must match the price and therefore afford less rent.
Silver is easier to tax because refining it requires a building dedicated to that, and the tax collector can monitor the production. Gold is hard to tax because it is usually found pure and can be processed without a dedicated building. Brian’s note: Interesting, but I think he is wandering a bit from the topic of rent.
Gem mines typically pay little rent.
Precious metals and gems add little to the overall wealth of the world. While they are valuable, they are scarce, so the overall wealth is a small percentage of that of the whole world.
The rent for land used for mines comes from their relative fertility. The rent for land used for crops comes from their absolute fertility.
3) THE NATURAL PROGRESSION AS IMPROVEMENT ADVANCES.
He examines the natural progression of improvement to virgin lands. He notes that during the course of improvement, the value of a produce will rise, fall, or stay the same depending on whether production increases slower then demand, faster than demand, or at a pace with demand.
He therefore divides produce into three types based on the ability of people to produce more of it.
I) Produce which it is not in the power of human industry to multiply
II) Produce which we can multiply in proportion to the demand.
III) Produce which we can multiply but with uncertainty.
For Item I, his only examples are rare fish or birds. He only devotes a couple paragraphs to this.
For Item II, he cites various corn crops, and cattle as produce where humans can affect the quantity produced.
But whether we will produce more depends on price. He notes a natural progression affecting the price of cattle. In the early stages of improvement, wild cattle are numerous and therefore cheap. As more land is tilled, less is available for the wild cattle which become less numerous and therefore rise in price. Eventually the price rises high enough to devote land to crops for feeding cattle. The rise in price stops when the profit for raising cattle becomes equal to that of growing grain for people.
Raising poultry and hogs start as side efforts, where little energy is put into them. The animals are little tended and are fed with what is considered waste. It is only when grain is sufficiently cheap that the demand for these items goes up, and the price with it. Eventually the price is high enough to make it worth while to grow food specifically to feed them, thereby producing them in quantity and creating an industry.
Dairies are also a luxury item compared to corn and meat, and so become profitable only when grain is already abundant enough to be cheap.
For Item III, he talks of the value of an animal’s hide versus the value of the meat. He talks about cattle hides and the wool of sheep. He notes that early on in the course of improvement, there may be value in the hide and none in the meat. Therefore an animal might be killed and the skin taken with the meat left to rot.
Brian’s note: This seems a bit off the topic of produce where it is uncertain whether people have the capacity to produce more. But maybe the uncertainty results from the price?
He notes that increasing the quantity of fish harvested can be uncertain as the demand goes up, because you can deplete the local fish population, and have to go farther out. Success generally becomes less certain then.
He talks about metal mines as well. The ability to produce more is uncertain because we might just not find more mines that are fertile.
EFFECTS OF THE PROCESS OF IMPROVEMENT UPON THE REAL PRICE OF MANUFACTURES.
Improvement results in a lowering of the real price of manufactures. While the price of labour might go up, the productivity of labour goes up even more so that the real price drops. The productivity of labour goes up because of new machines and the division of labour. He provides some history of products and their prices over time to support this supposition.
CONCLUSION OF THE CHAPTER
He discusses the three kinds of income, and the effect on them of improvement.
The general improvement of society will raise the rent of land, either directly or indirectly. As products become more abundant, the landlords share of the price increases as well. Therefore it is in the interest of land owners that society should generally improve. But since they don’t really have to work to earn their money, they are often complacent and don’t even know what their own best interests are.
It is also in the interest of wage earners that society should improve. Their wages increase while the demand for labor is continuously increasing, which is the case when society continues to improve. But wage earners typically have little time to think about their own best interests and are also uneducated and may not know their own best interests.
However, the profit of stock is not like the other two. It does not rise with prosperity and fall with descension. In fact, profit is low in rich countries and high in poor countries. It is actually highest in countries that are falling into decline. This class is generally involved in various projects and of the three classes is most familiar with their own interests.
Therefore any proposition from the stock holding class should not be given any trust, but should be very closely examined (page 181).
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Book II, Of the Nature, Accumulation, and Employment of Stock
Introduction
Stock becomes important once the division of labour becomes widespread, since people no longer produce all the things they use and must trade for these things.
Part II has 5 chapters
- Chapter 1, classifies different kinds of stock
- Chapter 2, about the expense of maintaining money
- Chapter 3, about using stock in industry
- Chapter 4, about lending out stock at interest
- Chapter 5, about the different uses of stock
Book 2, Chapter 1, of the Division of Stock
Stock consists of:
- Stock you intend to invest (Capital)
- Used to run your own business
- Circulating capital (raw materials). Profit is made by parting with this capital.
- Fixed capital (machines, buildings). Profit is made by keeping this capital.
- Money you lend out for interest
- Used to run your own business
- Stock for immediate consumption
- Stock you started with
- Stock you earned
- Stock in the form of goods not yet consumed
The classification written above for an individual can be said of an entire country as well.
- First, stock for immediate consumption
- Houses
- Clothes
- Anything which is being consumed by the end user (after being sold)
- Second, fixed capital
- Machines
- Productive buildings (manufacturing plants)
- Improvements to land
- The acquired and useful abilities of the inhabitants of a society
- Third, circulating capital
- Currency (the actual bills and coins)
- Unsold provisions
- Raw materials
- Finished but unsold goods
The sole end of both circulating and fixed stock is the stock for immediate consumption, the maintenance and increase of it.
In any country with tolerable security (force of law), all reasonable people will seek to employ all their extra stock for profit. In countries where contracts are not enforced, people will hide their stock (treasure troves).
Book 2, Chapter 2, Of Money Considered as a Particular Branch of the General Stock of the Society, or the Expense of Maintaining the National Capital
Gross revenue – total income before expenses
Neat revenue – remaining income after expenses
Of circulating capital (money, provisions, materials, finished goods), hard currency is the only one whose expense of maintenance is not part of a nation’s neat revenue.
Money (hard currency) resembles fixed capital in its relation to increasing the wealth of society.
Paper money is less expensive to maintain than precious metals. The “fractional reserve” approach lets bankers issue “notes”, and allows a larger money supply (still assumes notes are backed by gold/silver).
Banks made loans by discounting Bills of Exchange, & by credit accounts.
Banks who issue more paper than the economy needs will see it redeemed quickly, for gold or silver. So it is against their interest to do so, because they will need larger reserves.
Brian’s note: This argument seems to ignore the possibility of inflation, I’m not sure why that wouldn’t apply.
Smith thinks that banks should only make loans equal to a merchant’s working capital, which he otherwise would have to keep in gold/silver. He doesn’t want to loan money for fixed capital, like forges for a smithy. Such loans should be through bonds or mortgages.
Brian’s note: I believe he feels that way because bonds/mortgages are secured debt, where a simple loan is unsecured debt.
The circulation of hard currency can be divided into two parts, bank-to-bank and bank-to-consumer transactions. By making the smallest denomination of paper too large for the average bank-to-consumer transaction, it is possible to confine paper money to banks.
Bank promissory notes must be payable immediately & without condition if they are to be valued equally to gold/silver. Some banks in Scotland in 1762-1764 gave themselves the option of paying off a note 6 months after it was presented, which suppressed them below face value.
Book 2, Chapter 3, Of the Accumulation of Stock, or of Productive and Unproductive Labour
Productive Labour (adds value to an object of permanency): Example, manufacturing labour.
Unproductive Labour (doesn’t add value): Example: a butler.
- All government workers are “unproductive”
- Musicians, doctors, lawyers, clergy, innkeepers.
Brian’s note: I imagine that all “service sector” jobs of today would be unproductive labour.
In poor, unimproved countries, capital generates a larger percentage profit than in improved. But the pool of stock is larger in the improved country, and the absolute value of the profit much larger as well.
Productive labour is maintained by capital, unproductive labour is maintained by revenue.
As a country improves, a smaller & smaller percentage of the people are “idle”.
Brian’s note: It isn’t clear why people in towns dominated by revenue spending (seat of government, court of justice) would be more idle. Perhaps he just means more people are employed in service jobs. Or does the government just give away food, but only in the capital? Doesn’t seem likely.
Once a sum of money is put into a fund of capital, he considers it a perversion to remove it (to revenue).
He feels that frugality is the natural inclination of the vast majority of people.
Prodigious private spending will never prevail so as to impoverish a nation (he says).
Prodigious public (government) spending sometimes can impoverish a nation.
He wrote here in favor of everyone deciding for themselves what is most to their personal advantage.
Of frivolous expenses, there are two kinds. One, durable goods which retain value (build a fancier house). Two, expenses which don’t have a lasting value (throw a lavish party).
Book 2, Chapter 4, Of Stock Lent at Interest
When you lend money, the borrower can either invest it and probably will be able to repay you, or they will waste it, in which case they won’t repay you or would have to repay you from other of their own money.
Capital consists of the monied interests, the landed interests, the trading interests, and manufacturing interests.
As a country improves, the profit of stock diminishes. Partly because there is more stock then before and competition drives down the returns. He also says that labour shortages drive up expenses which also reduce profit.
He explains that interest is not tied to circulating money supply & prices. Prices are related to the annual produce divided by the money supply. Interest rates are related to the supply of capital versus possibly investments.
Laws prohibiting interest will be circumvented. Laws on maximum interest rates should set it just above the market rate for reputable borrowers.
There is a balance between the rent of land versus profit of stock affecting the decisions of investors. Land has the advantage of offering security.
Book 2, Chapter 5 Of the Different Employment of Capitals
There are 4 different employments
- Procuring rude produce
- Transport
- Wholesalers
- Retailers
As you work from retailers to wholesalers, to manufacturers to farmers/miners, an equal amount of capital puts into motion greater amounts of productive labour. He counts the cattle as productive labour as well.
He says that in agriculture, nature does ¼ to 1/3 of the work.
He says that farms & retail must be locally owned to be run well. He says that wholesale and manufacturing can be remotely owned (without too much loss of supervision).
Since agriculture puts the most productive labour in motion for a given capital, a young country should import foreign manufactured goods, and let foreigners handle shipping. This will let them grow their capital the fastest. The American colonies are his example.
Countries are usually interrupted in growth & set back before they have enough capital for all three areas (produce/manufacture/wholesale trade). Egypt, China, and Indostan came closest.
The effectiveness of capital in wholesale trade depends on the type.
- Home trade (start and end points in home country)
- Foreign trade (either start or end point in a foreign country)
- The carrying trade (both start and end point in foreign countries).
The home trade has the quickest turn around, and all the profit stays in the country.
He writes in favor of free markets, not trying to “unnaturally” grow or inhibit the three different branches of trade.
Foreign trade results when the country produces more of something than it can consume.
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Book 3, Chapter 1, Of the Natural Progress of Opulence
The most fundamental type of commerce is that between the town & the country.
The town & the country are not rivals, they supplement each other.
Towns can’t develop until the country is producing enough surplus food.
People prefer to employ capital with minimum risk, so close by is the best. Therefore agriculture first, because you also get the security of the land. Then manufacturing, then finally foreign trade, which is the riskiest. He considers this the natural order for these to develop.
End of book (short book)
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Book 4, Introduction. Of Systems of Political Economy
A system of political economy should enrich both the people & the sovereign. It allows people to help themselves, and provides to government just enough revenue for the services provided.
There are two main systems, one based on agriculture and the other on commerce.
Book 4, Chapter 1, Of the principals of the “Commercial”, or “Mercantile” System
Wealth consists not in money but in what you can buy with it.
If you inject a large amount of gold & silver into a poor country, it is not suddenly wealthy (based on the standard of living of the average person).
The Spanish conquistadors asked about gold when they landed in a new country to decide if it was worth conquering. The Huns asked about sheep for the same reason. They both asked after what they valued.
- Exportation of gold/silver can be advantageous for a country.
- Prohibiting export of gold/silver won’t stop it, just cause smuggling.
- An imbalance of trade doesn’t cause a greater imbalance. Foreign goods become more expensive which corrects the imbalance.
Mercantilism tries to enrich a nation by increasing its supply of gold/silver. The home economy just circulates the gold/silver already there & so is irrelevant in this view. The focus therefore is on foreign trade, & specifically on trying to create a trade imbalance, of greater exports than imports.
He discusses a common complaint of shortages of currency, and calls them false.
He says that foreign wars can be sustained by directly supplying consumables, not only by supplying money.
The importation of gold/silver isn’t the principal benefit of foreign trade. It gives value to your country’s excess goods, and brings in valued foreign goods. By expanding the market, it allows a greater division of labour.
The real benefits of discovering America was in its population growth, which gave European goods a larger market, allowing a greater division of labour. In this way was the wealth of Europe increased, not by bringing back gold/silver from new American mines. The unjust behavior of the Europeans ruined a relationship that should have been far more mutually beneficial.
European countries have never benefited from their trade with the East Indies as they have with the Americas because they all handed their East Indies trade to single companies, to monopolies.
Mercantilism therefore pursues two strategies
1) Restrict imports
2) Encourage exports
How they restrict imports
- Restrict specific products, if it is something you can make at home.
- General restrictions against a particular country simply to lower the imbalance with that country.
Means of encouraging exports
- Drawbacks
- Bounties
- Advantageous treaties
- Establishing colonies
Book 4, Chapter 2, Of the Restrictions of Import of Such Goods as can be Produced at Home.
Restrictions on importing a commodity gives and advantage to the home country producers, but doesn’t increase the wealth of the country.
Regulation doesn’t increase capital but can direct it.
The individual’s choice is usually good for the country.
Every wholesale merchant prefers the home market, then the foreign trade of consumption, then the carrying trade. As said before, the home trade puts the most labour in motion.
Individuals try to maximize the value produced by the capital.
He feels that individuals can best choose where to employ their capital to best effect, rather than politicians.
Just as tailors don’t make shoes and cobblers don’t make clothes, no country will be good at everything. It makes sense to buy what others can make cheaper.
Merchants & manufacturers gain from restricting imports at the expense of their country & countrymen.
Domestic farmers & cattlemen don’t benefit much from import restrictions because of the bulk of the grain & cattle, which make them expensive to ship anyway.
Farmers are least liable to the wretched spirit of monopoly. They tend to share “trade secrets” unlike manufacturers.
There are two reasons to restrict imports to encourage domestic industry.
- Defense related industries, to not be dependant on foreign goods for your military.
- If you tax domestic industry, to maintain a level playing field. Some argue in favor of taxing not only the affected foreign goods but many more, because the domestic tax increases all labour costs. This is a bad idea because 1) We wouldn’t be able to calculate how much labour costs were affected by the tax. 2) We would be adding yet another tax to the affected consumers, not providing relief.
Only strong counties can withstand such taxes. They may thrive in spite of, not because, such policies.
No country will ever have truly, completely free trade. Rich manufacturers will be able to use their money to influence politicians & prevent it.
Book 4, Chapter 3, Import Restrictions Against Specific Countries to Eliminate Trade Deficits
Part I Why Such Restrictions Make No Sense Even Within the Rules of the Mercantile System
Countries sometimes place such high duties against another’s goods as to be a prohibition (France & Britain did so).
- The country running a deficit is still a more productive than one avoiding trade altogether.
- The balance of trade is hard to calculate accurately. The goods imported might be exported again for profit, but that won’t be taken into account in calculating the balance of trade.
- There is not a sufficiently precise method of calculating the balance of trade generally anyway. The valuation of goods at customs houses is inaccurate. The rate of currency exchange is also inaccurate. Merchants sometimes (often?) pay debts in the currency of a third country, affecting its rate without affecting the balance of trade. Also, the quality of money affects the rate of exchange which isn’t reflected in the calculated balance of trade. Older money may be “clipped” and you need more of it when obtaining new money. Also, coining money is paid for by the state in some countries and by the owner of the gold/silver in others, which affects exchange rates. Also, the faith in some banks’ money gives it a premium, an “agio”.
Part II, The Unreasonableness of Import Restrictions Based on Other Reasons
The doctrine of balance of trade is absurd. It supposes that an even balance means neither side loses or gains. But if it is unbalanced, the country with the deficit loses in proportion to the imbalance.
But a forced trade is commonly a disadvantage to the country it intends to favor. A free trade is advantageous to both, even if more so to the one. Advantageous not in gold/silver, but in the increase in the annual produce of each.
Gold/silver are just commodities that will exist in a given country to an extent that satisfies the demand.
Traders should not favor their clients by only buying from them, they must always seek the best trade.
Mercantilism teaches nations that their interest consists in beggaring their neighbors.
Commerce ought to be a bond of union & friendship.
The jealousies of merchants and manufacturers has been more fatal to the repose of Europe than the capricious ambition of kings & ministers.
Mercantilism was invented & propagated by the spirit of monopoly. The interest of the great body of people is always to buy where cheapest. In this regard, the interests of merchants & manufacturers is directly opposite that of the great body of people.
The wealth of a neighboring country is dangerous in war & politics, but advantageous in trade.
It is always more advantageous to trade with neighbors who are rich than ones who are primitive savages.
Merchants & manufacturers repeatedly foretell doom due to an imbalance in trade, which never happens.
The proper balance to be concerned with is that between your annual production & consumption.
Book 4, Chapter 4, Drawbacks
A Drawback is an encouragement for re-exportation of imported foreign goods. When a foreign good brought in is then exported, a portion of the duties paid are returned.
He feels that drawbacks don’t alter the distribution of capital among the different industries.
The revenue of customs benefits from having a portion of the flat fee where without drawbacks it would have none (due to a lack of a market).
Book 4, Chapter 5, Bounties
Bounties encourage export of home made goods. It is a flat payment as opposed to drawbacks which repay a tax already paid.
A bounty tends to raise the price in the home market since it encourages export.
A bounty puts 2 taxes upon people.
1) Their direct contribution to the bounty.
2) The higher prices they pay for that commodity (the heavier by far).
He works through an example with corn.
The import/export merchant is the only real beneficiary of a bounty.
Some commodities (corn is the example) are fundamental and have the effect of regulating the price of others. Bounties on these commodities are particularly bad.
Book 4, Chapter 6, Treaties
He discusses a treaty between Great Britain & Portugal motivated by a desire to maintain access to gold from Portugal. He says it was a foolish treat, because gold can be had elsewhere.
Basically, he doesn’t believe in treaties affecting commerce, prefers the free market.
Book 4, Chapter 7, Colonies
Greeks founded colonies to relieve excess population, and considered these colonies as their fully emancipated children.
Rome wasn’t overpopulated but founded colonies in conquered lands to allow landless citizens to have estates. These colonies had allegiance to Rome and its laws.
The reasons for establishment of colonies in America were less simple.
He then discusses the East Indies & the voyage of Columbus. The motivation for the trip was trade with the East Indies, but having found America instead, the only justification for the exploration effort was gold, since nothing else of value was found. However, not that much gold was found. He explains how poor the odds are for gold prospecting, explains how the Spanish explored as much as they did out of the wish for gold, and their poor rate of success.
Brian’s note: The chapter doesn’t really discuss any general economic principal.
Book 4, Chapter 8, Conclusion of the Mercantile System
He notes that manufacturers push just as hard for advantage in reducing costs of their raw materials as in raising the price of their finished goods. They push for import duties on competing finished goods. They push to exempt their raw materials from import duties to increase the competition against their domestic suppliers and thus lower the prices of their raw materials.
The mercantile system principally benefits the industry carried on for the rich & powerful. That for the poor & indigent is too often neglected or oppressed.
Some prohibitions against exporting certain goods went so far as to cutting off hands & even death. Anyone who enticed an artificer to move to a foreign country, and the artificer if they agreed, were subject to punishment. If the artificer moved and didn’t move back upon discovery, they lost any property or inheritance. The manufacturers didn’t want skilled labour leaving, and didn’t want foreign tradesman learning from their skills.
Mercantilism doesn’t improve the domestic manufactures but seeks to depress that of all neighbors.
Manufacturers feel they should have a monopoly over skilled craftsmen. They limit the number of apprentices and impose long apprenticeships.
Consumption is the sole end & purpose of all production, and the interest of the producer should only be attended to in promoting that of the consumers. Mercantilism almost constantly sacrifices the interest of the consumer to that of the producer.
While the empire established by Britain in the Americas & West Indies benefited the producers, the home consumers paid higher prices plus the cost of defending that empire.
Brian’s note: Only the last two pages tried to sum things up. Much of the chapter until then listed a great many examples of specific duties, was quite boring, and seemed a bit pointless.
Book 4, Chapter 9, The Agricultural System
The agricultural system was created by French philosophers reacting to an overly mercantile minister of Lewis XIV, Mr. Colbert. He favored the towns over the country to a great extent. The agricultural system by Mr. Quesnai favors the county.
Three classes
- Proprietors of land (productive class)
- Farmers and country labourers (productive class)
- Manufacturers, artificers, merchants (the barren, or unproductive class)
Proprietors of land
- Ground expenses (improvements)
Farmers
- Original expenses
- Annual expenses
The profits of the landlord are “productive”. The profits of the unproductive class are considered as expected as a matter of course. And since the capital holder spend those profits, they are viewed as only replacing exactly the original capital & therefore are “unproductive”. The capital holder is considered to be his own employee, with a wage that counts as expense.
Brian’s note: Even though the capital holder doesn’t work.
The productive class augments the values of society automatically. The unproductive class can do so only through parsimony, by depriving themselves in some fashion.
The unproductive class are employed & maintained at the expense of the productive class, and are properly their servants.
The productive class should not restrain or discourage the unproductive class since they allow the productive class to focus on their proper work (growing).
Free trade is still endorsed as being in a country’s best interest.
Mr. Smith’s response:
Merchants etc. cannot be called barren because
1) Even if you just replace the invested value, you are not barren, any more than a marriage with two children is barren.
2) Merchants etc. add value, and shouldn’t be lumped in with menial servants or soldiers whose efforts have no lasting effect.
3) Even replacing your own value adds to society, again compared to a servant or soldier who doesn’t replace any value.
4) The productive class can only augment the capital of society through parsimony too.
5) Other things being equal, a country with trade & manufactures will always have a greater production than one without.
This system still offers a truth not found in others, that the wealth of nations consists not in the money it has, but in the consumable goods produced by its labour, and that free trade maximizes production. Free trade between town & country is just as applicable as free trade between countries.
He mentions that the next book will cover the three duties of the sovereign.
- Protection from outside threats (military)
- Protection of citizens from each other (justice)
- Erecting public works or institutions which individuals could not profitably do, although the sovereign can.
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Book 5, Chapter 1, Expenses of the Sovereign
Part I, Defense
The military of a barbarous country of hunters maintains itself and doesn’t incur any expense for the sovereign.
The militia of a barbarous nation is superior to that of a civilized nation. A civilized standing army is superior to both.
He feels that a standing army can be a danger to liberty but isn’t necessarily so, if led by the sovereign.
As civilization advances, the military becomes more expensive.
Part II, Justice
He discusses how to avoid any expense for judges to the sovereign by charging court fees, and says that the entire cost could be on the participants without corrupting the outcome.
Part III Public Works, Public Institutions
These are mainly for facilitating commerce & for education
Article I, section 1, Commerce, in general
(roads, bridges, harbours, post office, etc)
He suggests building & maintaining them by usage fees. Tolls, use stamps.
This also helps ensure building them where truly needed. He likes private parties to get the money & be responsible for maintenance instead of government appointees. Such as for canal locks.
For roads, the road would be passable even if neglected by a private party, so he prefers government appointees.
He likes public works to be in the hands of local government.
Article I, section 2, Particular branches of commerce
An example, public expense might be in maintaining ambassadors in foreign countries, to help merchants. This practice started at the end of the 15th or beginning of the 16th century.
Adams wants to pay these expenses through taxes on the merchants.
Sometimes governments have let private entities handle the protection of trading with poor results in the long run.
Regulated companies – merchants in the company are financially independent, use their own inventories.
Joint stock companies – shared inventory, risk, profit.
Brian’s note: Sounds much like a modern corporation
When a company establishes a new trade, to a new foreign country, they should get a monopoly from the state, but only for a limited time. Long term monopoly results only in overly high prices and waste.
Joint stock companies don’t long succeed in trade without a monopoly, based on experience. A Frenchman, Abbi Morellet made a list of 55 such companies which failed from mismanagement, between 1600 & 1776.
Without a monopoly, only ventures with strict easy to follow rules are suitable for joint stock companies: Banking, insurance, canals, water supply pipes to cities.
Joint stock companies should only be created when certain circumstances force it. 1) The undertaking is of greater & more general utility than the greater part of common trades, 2) It requires more capital than can be easily collected into a private copartnery.
Brian’s note: I wonder if he would approve of today’s mega corporations, and of the idea that corporations are legal persons. I suppose that point 2 would be offered as justification by proponants.
Article II Expense, Institutions of Education for youth.
He feels that students should pay tuition, and that schools should have endowments. That schools shouldn’t be paid for from government coffers.
Article III Expense, Institutions of Education, People of all Ages
Mainly churches. Students should pay. Or possibly an endowment.
Part IV, Expense, Supporting the Dignity of the Sovereign.
That one, government should pay, and pretty well too.
Conclusion
- Defense should be paid for by the state
- Justice by the state, offset by some court fees
- Localized expenses should be paid by localized taxes.
- Roads by the state, although tolls are good for long stretches
- Education by the state is ok, although tuitions and endowments are good
- There are many cases when it isn’t possible to have specific beneficiaries pay, where the state must. Therefore … taxes. See next chapter.
Book 5, Chapter 2, Revenue of the Sovereign
Brian’s note: B – ooooooooooooo – oring. This is the most boring chapter of the book. Painful.
Part I, Revenue Belonging to the Sovereign or Commonwealth
A sovereign can own land & rent it or capital & lend it. Or run a business.
Historically a sovereign only gets a significant part of revenue from personal ownership of a business in primitive cultures. Example: An Arabian chief as principal Sheppard of his own herd.
Governments have successfully run post offices.
Princes who run businesses often fail & need to be bailed out with state funds.
When a business takes on sovereign duties, their clerks begin to think themselves ministers.
The characters of sovereign & trader are inconsistent with each other.
Banking & lending money have been more successful, as has renting out of land. But rent of land is usually poorly managed and would be better for the sovereign to sell it into private hands, both for the selling price and the future taxes.
Part II, Taxes
Private revenue can be divided into rent of land, profit, & wages. This part will be divided into 4 main articles.
- Taxes on rent of land
- Taxes on profit
- Taxes on wages
- Taxes intended to fall on all three
Many of these are paid from a revenue other than the one intended.
Four maxims for taxes
- Taxes should be in proportion to revenue (so not flat taxes)
- Taxes should be clearly defined. Vaguely defined taxes wind up at the discretion of the tax collector and lead to corruption.
- Taxes should be levied at a time when the citizen is most able to pay. Farm taxes paid at harvest time, for instance.
- Taxes should be collected so as to maximize the revenue to the sovereign.
- with minimal overhead (tax collector salaries)
- Shouldn’t discourage the industry by being overly high
- Shouldn’t be so high as to encourage smuggling.
Article I, Taxes upon rent, Taxes upon rent of land
The tax on land is affected by
- How often the value of land is assessed.
- Whether the economy generally improves or degrades
- Whether the value of money rises or falls
He recommends against regular assessments as being too cumbersome upon the government. He recommends recording leases and taxing that. Also improvements made by landowners can be written off over time. For owners working their own land, estimate what the lease would have been based on comparable leases.
Taxes based on the produce of the land
These amount to taxes upon the rent of land, because farmers can negotiate less rent equal to the tax. Rent of land is as much as the tenant can afford.
This is a very unequal tax as the value of the rent can be half the value of the produce or up to 90% of the produce value. This tax discourages the landlord from making improvements & the farmer from raising more expensive crops.
Taxes upon the rent of houses
House rent is divided into Building Rent & Ground Rent. This tax is directly paid by the tenants, but ultimately is paid by the tenant & the landlord. The builder doesn’t share any of it.
The rent of land is for a productive asset. The rent of houses is unproductive.
Article II, Taxes upon profit, Revenue arising from stock
Profit of stock is divided into two parts
- Interest (for what the businessman borrows, must be paid to the owner of the stock)
- Surplus (which is the part the businessman gets to keep)
Tax upon profit actually falls upon
- The rent of land (if farming)
- Consumers, as higher prices (trading)
- The rate of interest, forcing it lower
While the interest of money seems good to tax, there are two problems.
While it is easy to calculate the value of land, someone’s total worth is secret and constantly changing.
Land will remain in its own country regardless of tax rate, but owners of stock can employ it in another country if taxes are too high.
Taxes upon particular employments
These taxes are ultimately paid by the consumer, not the dealer.
Taxes that are a flat fee per dealer (instead of a % of revenue), such as a liquor license, still falls ultimately on the consumer, but favor larger entities who can make it back with a smaller price increase than what a small entity must do. Flat taxes per shop are therefore uncommon.
Brian’s note: Smith says several times that stock holders / business owners “must have” their “reasonable” profit and that therefore taxes are passed on. But he doesn’t explain that as well as I’d like. I would rename it a “minimum” profit. I agree that at zero profit, owners of capital wouldn’t lend. But how low a profit will motivate them to lend? What if an owner is making more than the “minimum” profit? I think that whether they pass along the tax depends on how much sales will fall, and how much more than the minimum profit they are making. I think he means long term, but if all opportunities were affected, it seems the stock holder would have to accept less profit. Smith did not foresee the extent to which modern businesses must report to government. He didn’t think that every transaction would be tracked, but today they can be, and must be documented in case of audit.
Taxes upon trade cause the merchant to reduce supplies until prices rise (can lay off workers). But for taxes upon agriculture, it is not in the interest of the farmer to reduce crop size because he still has to pay rent on the entire land. Therefore the tax will reduce rent on the land in the long run.
Appendix to Articles I & II
Taxes upon the capital value of land, houses, & stock
Real estate taxes (the land remains under the same ownership) are not intended to reduce its capital value, but is intended to take from a revenue from that land.
He recites a number of feudal tax laws as examples. Taxes can be a % of sales price or a flat fee (stamps, registration).
Taxes upon sale of land fall upon the seller. The buyer takes the taxes into account in what they will pay for the land. Taxes on the sale of new houses fall upon the buyer, not the builder. Taxes on sale of existing houses fall upon the seller as with the sale of land.
All taxes on sale of land diminish funds for productive labour.
Secret registries lead to abuse and should be banned. Registries must be public.
Taxes on consumption (leisure) fall upon the consumer.
Article III, Taxes on the wages of labour
As stated earlier in the book, worker wages are regulated by demand for labour & the price of provisions.
Taxes upon labour will just raise wages (demand and provisions remaining constant). Wages rise by the proportion of the tax & then some (since the additional wages are also taxed). These are passed on to the employer, who adds his own profit before then passing it on to the consumer. Taxes upon country labour are ultimately taken from land rent.
Brian’s note: So crop prices won’t go up?
A tax upon wages won’t be completely passed on if it causes less demand.
He considers taxes upon wages to be absurd & destructive although common.
Article IV, Taxes intended to fall indifferently
These are:
- Capitation taxes
- Taxes upon consumption
Capitation Taxes
Shouldn’t be a tax based on revenue or overall fortune because it changes constantly and cannot be known accurately without an intolerable invasion of privacy
Brian’s note: Today we tolerate such governmental intrusion and pay income tax.
Capitation taxes can be a flat fee based on rank or employment (a duke must pay X, a blacksmith must pay Y). Such a tax, if extended to commoners, is just a tax upon wages with all of the same problems.
Tax upon consumable commodities
- Necessities (includes expense that local custom demands, like shirt and shoes)
- Luxuries (tobacco, liquor, chocolate, tea, sugar)
A tax on necessities is a tax on wages, with same effect mentioned before
A tax on luxuries is paid by the consumer, and does not raise any other prices, and fall indifferently.
Consumables can be taxed at the dealer or the consumer
- At the dealer is appropriate for goods with a short shelf life
- At the consumer is appropriate for goods with a long shelf life.
He then works through a number of examples. Some of these involve import/export & he revisits his earlier points about mercantilism.
He points out that a small luxury tax paid by the larger body of poor/middle class will generate more revenue than a large luxury tax against the rich.
Sometimes government charges tolls on roads & waterways intended to maintain them. They should be run at the local level. When regional or national government runs them, the fees are much higher, yet the road/waterway is neglected. Funds get diverted or wasted. These taxes should be based on weight of cargo, when based on value, they are more like excise taxes.
Luxury taxes measure up well against the first three maxims of tax, but not well at all against the fourth (maximizing the net revenue).
Tax collectors should work directly for the government. Contracting out of tax collection to private companies leads to abuse & waste and other ill effects. Private profit is always high in this case.
Book 5, Chapter 3, Of Public Debts
In primitive civilization, w/o commerce or manufacturing, a rich person can only use their revenue by maintaining a large number of people. The revenue is food & coarse clothing and cannot be kept and accumulated. Under these circumstances, such a person is highly unlikely to go into debt & ruin themselves. In those times, trading was considered disgraceful to a gentleman. Lending money at interest was usury & unlawful. People hoarded valuables, had treasure troves. This was true of the sovereign as it was of the people. Standing armies don’t exist, and so do not burden the sovereign with their expense.
Once commerce & manufacturing come to be, luxuries become available. Rich people and the sovereign as well spend on them, often as much as their excess revenue allows. They no longer save. And this is during peace.
When war starts, there is no money in the treasury for it. Even raising taxes would only raise revenue after some months. But the expenses of war are immediate, so the government borrows. The commercial state of society lends government to this situation, but also provides the capacity of society to lend in the form of merchants & manufacturers who have stock. Lenders trust that the government will pay them back, and the terms are usually more profitable than normal lending.
The progress of debt among the great nations has been pretty uniform, and probably will eventually lead to ruin.
A nation’s unsecured borrowing can be of two kinds.
1) Short term, paying no interest
2) Long term, paying interest
When the government can no longer entice lenders to provide unsecured credit, it must commit portions of specific revenues to attract new creditors. Sometimes the rate of repayment is set so as to retire the debt in a specific time (“Anticipation”), and sometimes the payment is just enough for the interest (“Funding”) with the government intending to address the principal at some other time.
Funding makes wars less burdensome to the people, so they start more readily & last longer. The people see a tax increase, but not as much as it would to pay the entire expense. But upon peace, the taxes remain.
Problems arise because often war breaks out again before the debt is paid off, or because payments were diverted to other purposes. There are unexpected expenses even during peace.
Mr. Smith rebuts an unnamed author’s claim that public debt is harmless. The author considers government funds as another capital, employing the country’s citizens. But often public debt is held by foreign countries. He cites that the Dutch held English debt. Also, much of government is unproductive labour.
“Anticipation” debt hinders formation of new capital. “Funding” actually destroys old capital but less hinders the formation of new capital, however, only during the war. Over the long run, funding is worse.
He says that it is better to keep money in private hands, who are more motivated to use it efficiently & productively, than in government hands.
The practice of funding started in Italy, best he can tell.
When public debt reaches a certain level, there will be a bankruptcy. Sometimes government admits it, but often it devalues the currency, which affects all debts, public & private. Creditors to the government are typically creditors to private debt too & lose in both ways when this happens. Smith feels that openly admitting bankruptcy is less harmful & less dishonorable.