An Inquiry Into the Nature and Causes of the Wealth of NationsBy: Adam Smith
Major Topic: Economics
Minor Topic: Politics
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Introduction
Every nation's annual labor fund is the source of all the nation's annual consumption. The relative size of the annual labor fund to the size of the population determines the well-being of the nation. This ratio of well-being is demarcated by two constituents: (1) the proficiency of the labor and (2) the ratio of productive laborers to non-productive people. The proficiency of the labor is the more potent of the two constituents. The first book deals with the causes of the increase in the proficiency of labor.
The number of productive laborers is always determined in proportion to the quantity and particular use of capital stock. The second book deals with the nature, the accumulation and the use of capital stock as well as the qualities of labor which it puts to use and augments. To explain the determinants of the well-being of the nation is the scope of the first two books.
Every country has followed different paths in development. Every path has had different results. Europe has encouraged the industry of the towns more than the industry of the country. The reasons for this are explained in the third book.
These plans, which were started by the private interest of different classes, have lead to different results and theories which have had enormous influence on people and princes. The fourth book deals with these theories and their effects. To explain the nature of the all the annual funds which have supplied nations with their annual consumption is the scope of the first four books.
The fifth book deals with government revenue. First, it deals with identifying the necessary expenses of the government. Of those necessary expenses, it deals with which should be paid for by all the society as a whole and which should be paid for by some particular part of society. Second, it deals with general taxation and its problems. Third, the fifth book deals with the reasons for and the consequences of government debt.
BOOK ONE
Chapter One: On the Division of Labor
The division of labor is the source of the greatest enhancement in the productivity of labor. When the whole work of a particular trade is divided into a number of branches each workman is able to produce great multitudes more of the product than if each workman were doing the whole work on his own. The division of labor, insofar as it can be applied to any art, will generate a proportionate increase in the productivity of labor. The advantage that comes from an increase in the productivity of labor seems to have spurred the division of labor and continues to expand it. Further it seems that the more advanced the country, the greater the division of labor in that country.
All industries cannot equally take advantage of the division of labor. Manufacturing seems to be best able to accommodate it but agriculture seems the least suited. This is due to the fact that agriculture jobs are dependent on the season and have such a wide work area. The result is that rich countries far exceed poor countries in manufacturing but only slightly exceed poor countries in agriculture.
The fact that a division of labor can increase the quantity of production per worker is due to three factors: (1) Doing only one job increase the dexterity of the workman beyond the scope of the untrained or inexperienced worker and therefore increase the output beyond the capabilities of untrained or inexperienced workers. (2) The time saved in not moving location and of not changing tools as well as the time saved by not having to change the focus of thought, that is by not having to change jobs, also increase output. (3) Since the mind is focused on one task the invention of machines to save labor is facilitated and this allows greater output from fewer men.
The division of labor applies to the learned arts too. For philosophers have divided up their subjects into more branches each of which gives employment to many and each man becomes an expert in his chosen field. The quantity of knowledge is thereby greatly increased.
It is this division of labor which has brought about the great increase in opulence in civilized countries. Consider the nearly uncountable number of workers and machines needed to make the coat of a regular man. The proportion in the number of workers and machines needed to fulfill the desires of a European prince compared to a poor man in England is not of greater proportion than between the poor man and an African king.
Chapter Two: The Principle for the Division of Labor
There seems to be a basic human proclivity to truck, barter and exchange one good for another. This propensity is not found in animals nor do they have a use for it for when animals are adults they are totally independent. We, on the other hand, live in civilized society and are in constant need of help from a great number of people; more people than we could ever befriend. Therefore, to get what a man wants he must be able to show other men that it is for their own advantage to do what he requires of them. This is the way most men conduct almost all of their business.
“It is not from the benevolence of the butcher, the brewer, or the baker that we expect our dinner, but from their regard to their own interest. We address ourselves, not to their humanity but to their self-love, and never talk to them of our own necessities but of their advantages. Nobody but a beggar chooses to depend chiefly upon the benevolence of his fellow-citizens.”
Even a beggar will use his gains in the same manner as other people: by treaty, by barter and by purchase. These three mannerisms plus the desire to transport (or tuck) are what give rise to the division of labor.
Men who have specialized in one job as a result of a natural disposition or talent find that they can exchange their surplus production for the production of others at a more favorable rate than if they were to grow, build and store all they need on their own. This encourages them to further specialize and bring to perfection their business.
Thus the natural differences among men are actually rather small. But as men get older they discern differences which are then further developed though specialization to the point that men claim there is not any similarity between philosophers and porters. But without the common proclivity to truck, barter and exchange all men would need to procure for themselves all of their material needs. In this way every man brings to a common market all that he produces but does not consume in order to exchange his product for the product of others that will make his life better.
Chapter Three: The Division of Labor is Limited by the size of the Market
The market for exchanging goods gives rise to the division of labor but it also limits it. If a producer cannot sell his good for other goods then there is no reason to waste time and resources creating unsellable surplus goods. It is for this reason that big cities have had a greater division of labor. Furthermore due to the relative efficiency and safety of sea transport over land transport, cities on the coast or on navigable rivers traded with each other first, more often and in greater degrees than with the inland areas of their own country. The division of labor has a tendency to increase the market and therefore inland areas eventual enter into the market.
Chapter Four: On the Origin and Use of Money
The division of labor allows a man to exchange his surplus product for part of the surplus of other men. In such a way all men become merchants and the society is properly called a commercial society.
But when the division of labor first began there were several problems that needed to be overcome. The first is the double coincidence of wants. In order for one man to trade with another, each must want the other's product at the same time and unless this were true, there would not be any trade. Prudent men in all times and places overcame this problem by having, in addition to their own produced commodity, enough of a secondary commodity that all men have been shown to want. At various times a wide variety of commodities have served this purpose. Many commodities are apt to rot and/or are hard to divide, therefore overtime, metals became the preferred choice as a medium of exchange due to their imperishableness and ease of division.
Two new problems arose as a result of trying to determine the value of a metallic medium of exchange: First, ascertaining the weight and second, ascertaining the purity. In order to avoid fraud in purity and weight before the advent of coined money, it became necessary to stamp certain quantities of metal with a declaratory stamp announcing a standard of uniformity and quality. This is the origin of the institution known as the mint.
To counter the possibility of fraud by chipping off parts of the metal bar around the stamp, coins were introduced in which a stamp was affixed to both sides and the edges. Such coins became a unit of tally or reckoning without the inconvenience of having to be weighed.
Shortly after the widespread acceptance of coined money in a society, the sovereigns (likely due to avarice) began to inflict an injustice on their subjects by having the real quantity of precious metal reduced. In so doing the sovereigns were able to pay their debts with a smaller amount of precious metal than they received. This defrauding of creditors benefited the debtors and has caused great hardship to the fortunes of some private citizens. [This problem still has to be solved.]
What are the rules of exchange? That is, what are the rules that determine the relative or exchangeable value of goods? The word “value” has two uses: value in use and value in exchange. Both of which contribute to a good's real value. Concerning value in exchange, the author will in the next three chapters elucidate: One, the real measure of the price of commodities (chap. 5). Two, the various parts of this real measure of price (chap. 6). Three, what are the causes of the possible differences between the exchange value and the natural price of a commodity (chap. 7).
Chapter Five: On the Price in Labor and in Money of a Commodity
A man is considered to be rich or poor depending on how many of the necessities, conveniences and amusements of life he can afford. More precisely, he is rich or poor depending on how much labor he can command to attain the necessities, conveniences and amusements of life. The value of a commodity to a man who does not want to consume it is equal to the quantity of labor which it allows him to purchase. Labor is the real and true measure of the exchange value of all commodities. Because labor was the first price paid for all things.
Wealth is power but not political power (although wealth may help a man acquire civil or military power, they are, however, not the same as wealth). The power that wealth brings is the power of purchasing labor in a market. The greatness or meagerness of a fortune is determined by its power to purchase labor.
Even though labor is the real measure of the exchangeable value, labor is not that by which value is actually measured. This is because the labor required is an abstract notion whereas the quantity or some other obvious quality is more easily understood. Furthermore, because today most commodities are exchanged for money, it is easier and more natural to estimate value in terms of money rather than labor.
The problem is that the commodity that is money (that is the precious metals gold and silver) is itself constantly changing in its value. This is due to the fact that gold and silver are being debased, the supply keeps changing and the quantity in a location also changes. A commodity that is continually changing in its own value cannot be an accurate measure of the value of other commodities.
Labor can be said to be the same in all places and in all times. Therefore the author claims, labor is the real standard by which the value of all commodities can be estimated and compared. Labor is their real price. Money is their nominal price.
Yet it appears that the value (and certainly the price) for labor changes. But in truth the value does not change; only the value of the goods used to pay the labor change. One reason for the continually changing values of goods is the debasement of the amount of precious metal in money. Another is the change in the amount of precious metals in a country.
The money price of labor also changes for these reasons and one other: it seems to accommodate the average price that is necessary for life.
In the world of most people the money or nominal price of goods is the quickest and easiest judgment of prudent decisions so the money price is the one most looked at by everyone. The frequent changes in the market price of money (gold and silver) arise from the same cause as the changes in price of other commodities. Namely: loss by accident, use as in gilding, plating and jewelry, the wear and tear of coin, importation into countries that do not have any mines, both successful and failed attempts by merchants to profit from changes in supply and demand. And one more: the debasement of the currency by the sovereign. In light of the last reason the price of goods comes to be valued in terms not of what the coin's official assayed value is rather on the actual amount of precious metal it contains.
Chapter Six: On the Factors of Production
In early pre-civilized times, that is before the advent of capital or stock and before the official enclosure of land, the whole produce of labor belonged to the laborer. For that was all there was. The wages for this labor may have been adjusted according to the skill and the difficulty of the labor.
As soon as some useful stock was saved or created the owners sought ways to improve their income. These owners of capital provided workers with the necessary materials and remuneration in order to try to make a profit for themselves. Thus the value that the laborers add to the capital stock resolves itself into two parts: one pays the laborers' wages the other pays the owners' profits. If the laborers took all the revenue then there would not be any reason for the capital stock owners to make their stock available to the workers. That labor cannot be responsible for the full value of a finished product is evident in the fact that laborers working with stock are not commonly involved in the acquisition of materials or tools.
The profits of stock are very different in nature from the wages of labor. The profits of stock are not determined by the skill or difficulty of supervision and management rather they are determined by the value of the stock employed. High value stock or large amounts of stock will (in a successful enterprise) garner higher total profits than low value or small amounts of stock.
When an enterprise is conducted on private land, the landlord will demand rent for the use of his land.
The real value of these three components (wages, profits and rents) of price are measured by the amount of labor that each can command. In other words labor measures wages, profits and rents.
A primitive society may have only labor. The more advance the society the more commodities are made up of all three factors.
Wages, profits and rents are the three original sources of revenue and all exchange value. Whoever makes an income must make it from either (or any combination of) the wages of his labor, the profit his stock or the rent of his land.
Chapter Seven: On Supply and Demand in Determining Prices
In every society or distinct district there exists an average rate of wages and profits for every different employment of labor or use of stock and an average rate of rent. These average rates are regulated by the particulars of the area. The author refers to these average rates as the natural rate of wages, profit and rent.
When a commodity is sold for the price which allows for the payment of wages profit and rent at the natural rate it is said to be sold at its natural price. That is the commodity is sold for exactly what it is worth when it is sold at its natural price. This price is not the lowest price rather it is the price which will enable the dealer to continue to sell the commodity for a long time.
The price at which a commodity is actually sold is the market price. It can be above or below or exactly equal to the natural price. The market price is determined by the proportion between the quantity brought to market and the number who are willing to pay the natural price. These people (the buyers) constitute the effectual demand.
If the quantity supplied is less than the effectual demand, some of the effectual demanders will be willing to pay more. A competition will begin between them and the price will rise above the natural price in accordance with the degree of the deficiency of the commodity and/or the wealth of the demanders.
Likewise if the quantity supplied is more than the effectual demand, some of the commodity will only be sold at a price below the natural price. A competition will begin between the dealers to liquidate their supply and the market price will fall below the natural price in accordance with the degree of oversupply or the amount of new demand from demanders who were not willing to pay the natural price.
The quantity of every commodity in the market, will bring itself towards the effectual demand. If the supplied commodity is in oversupply then some one (or many) of the factors of production is not getting its natural price. Workers who do not get their natural wages will look for other employment – thus reducing the supply. Stock holder will look for other uses for their stock if they do not get their proper profits – thereby reducing the supply. Landlords will look at shifting their use of land if they cannot collect their due rent – in so doing they take out some of the supply from the market and move the price closer to the natural price.
If the supplied commodity is in short supply then some one (or many) of the factors of production will be making higher wages and/or more profit and/or higher rents than is natural. This will induce more labor, stock and land to be directed to the production of the deficient commodity – in effect increasing the supply and moving the price closer to the natural price.
“The natural price, therefore, is, as it were, the central price, to which the prices of all commodities are continually gravitating.”
Yet there are fluctuations in the market prices of various commodities. This is due to various reasons. For example agriculture yield will vary in supply from year to year based on the weather. In such cases the fluctuations in market price will affect wages and profits more than rent. This is due to the fact that rent is often paid first and unexpected changes in circumstance happen quickly and suddenly.
Sometimes the market price may be kept artificially high for a long time. Owners of stock who notice a higher level of profit will often try to keep it a secret from their laborers and landlords in order to keep out competitors. This type of secret in trade is hard to keep. Secrets in manufacture (that is of technique or technology) are easier to keep for a longer time.
The market price will be kept artificially high by a natural cause if a landlord is lucky enough to own a piece of land that is uniquely suited for some enterprise. Or if a monopoly is granted to an individual or trading company in which case the monopolist will deliberately keep the market understocked. The price under a monopolist is always the highest price that can be obtained or squeezed out of buyers. The price under free competition is, on average over time, the lowest price which can bring the commodity to market.
Any exclusive privileges, such as those of guilds or cartels, have the same tendency as monopoly but to a lesser extent. Any such aggrandizements in price will last as long as the regulations are enforced.
The market price will never last long below the natural price because those who feel the loss will immediately adjust their affairs such that they stop their losses. This is effected most easily when some laborers and/or stock holders and/or landlords remove their labor and/or stock and/or land from the production of the oversupplied commodity.
In the following four chapters the author will elucidate on the causes of the variations in the natural rate of wages (chap. 8), profit (chap. 9), an observed proportionality in the natural rate of wages to profit (chap. 10) and rent (chap. 11).
Added on: 2010-05-29 07:02:09
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