The Benefit of Free Exchange
When the market is left to itself and exchanges are free, both sides benefit. Indeed, no one would enter into an exchange that comes at a loss to them. In foreign commerce, this means that imports and exports can both be very valuable to a society. One society's wealth does not have to come at the expense of another society. A society has more to gain if its trading partners are wealthy.
Gross National Product
The wealth of nations does not consist in the amount of gold and silver in its vaults, as mercantilists believed, but rather in the sum total of its annual production and its commerce. In making this observation, Smith articulates the concept of gross national product. This observation also allows him to make the argument that wealth is increased not by exports alone, but by commerce in general.
Economic Regulations are Counter-Productive
Governmental regulations of commerce are generally counterproductive and sometimes dangerous. The internal, organic wisdom of the market is the most effective regulator. This idea lines up with Smith's ontological views. Smith sees nature as being fundamentally ordered, and human society has a similar order, so long as it is free from interference.
Investments should be centered on improving the methods of production, and capital should be directed toward such investments, rather than consumed directly. This ensures a constant growth in the level of wealth of a society and an increase in income over time.
Governments Should Have Limited Powers
Prosperity grows in an open, competitive marketplace, where exchange is free of government interference. The role of government is to defend citizens and property, to ensure justice, and to establish the rule of law. These are the activities to which government should ultimately limit itself.
The Invisible Hand
Freedom in the market and self-interest on the part of individuals do not lead to chaos and disorder. On the contrary, they produce order and concord. This is what Adam Smith referred to as the "invisible hand" that guides society toward stability and harmony, while each individual pursues his or her own best interests.
Beware of Special Interests
When a certain group within society is allowed to exert undue pressure on government, convincing it to be swayed by its interests, the entire society suffers. Vested interests are always harmful, and government should therefore not involve itself in regulation at the behest of a certain social or economic group.
Quote from Book I, Part II, Section I
"To prohibit a great people, however, from making all that they can of every part of their own produce, or from employing their stock and industry in the way that they judge most advantageous to themselves, is a manifest violation of the most sacred rights of mankind."
This statement, in which the "great people" Smith is referring to are those subjects of the British crown that will, a few years later, become the first American citizens, is telling. Not only does the quote display Smith's belief that free trade constitutes one of the fundamental rights of man—a belief which, whether held by Smith or not, would come to be very important in the self-conception of the young Republic—the quote also foreshadows the fact that the major disputes between the Crown and its American colonies were economic. Smith's economic theory is ahead of its time in a number of ways. This statement in particular, however, had it reached the right ears, might have changed the course of history.`
Book I, Chapter I
Without the assistance and co-operation of many thousands, the very meanest person in a civilized country could not be provided, even according to, what we very falsely imagine, the easy and simple manner in which he is commonly accommodated.
The quote captures Smith's description of the complexity and scope of the division of labor, and its ability to increase the standard of living in a given society. Smith believes that the propensity to truck, barter and exchange is part of human nature, and it is precisely this capacity that best organizes the economic system in large scale societies. The cooperation of the many thousands, inspired by each person's self interest, is what allows for the economic system to flourish, spreading opulence and raising the overall quality of life. Since observations on the progress inspired by the division of labor begin the book, Smith uses the contemplation of simple items (pins, for instance) as a starting point for his theorizing on the organization of economics in general.
all persons who desire to purchase a certain commodity, whether or not they can reasonably afford it
balance of trade
the money difference between the value of exports and imports of a certain country compared with another country, measured over time
Bounties are subsidies on goods that will be exported, with the express purpose of making those goods more competitive in foreign markets, and of creating monopolies abroad. In the logic of the mercantile system, it is thought that bounties will swing the balance of trade in favor of the government that awards such bounties. Bounties are usually petitioned for by the manufacturers of a particular good.
the portion of stock which is employed not for immediate consumption, but for generating revenue
capital which gains revenue by changing hands, e.g., goods that are purchased to be sold at a profit
a good (manufactured or not) that is sold on the market
Drawbacks allow a merchant to "draw back" or to recuperate whatever taxes or inland duties are levied upon his good when he manages to export them. This lets him cancel out taxes he pays at home if he manages to sell goods abroad.
a person who desires to purchase a certain commodity, and also can reasonably afford to purchase it. It is effectual demanders, not absolute demanders, that regulate the market price of a commodity.
a special interest group which seeks to control the administration of a certain trade or to influence government to make laws to favor or disfavor certain trades
capital which does not gain revenue from changing hands, but rather from investing in productivity
a person who sells his labor for a wage; a person engaged in producing concrete goods
the price of a commodity that reflects the relationship between the effectual demand for and supply of a particular commodity in a given market
an employer; the person who provides wages to laborers
Mercantilism is the name for the economic theory and practical system that Smith was writing against. The major tenets of mercantilism were that money constituted wealth, and that exports would always benefit a country while imports would always harm it, because money comes into the country through exportation and leaves it through importation of goods. Smith believed this view was mistaken.
the price of a commodity which reflects only the cost of the labor, land and stock employed in bringing it to market
any labor that directly results in the production of a tangible commodity (factory work, mining work, construction work, etc.)
Public debt is incurred by the government when its expenses exceed revenue generated from taxes. Public debt is financed through private means, and usually stems from defense expenses.
A public good is often a public work that benefits all of society. Public goods can be enjoyed equally by all members of society
Public works are institutions or constructions (e.g., roads, lighthouses, bridges) constructed and funded by the state, and open for use by all citizens, sometimes upon the condition of paying a small fee.
money paid to a landowner for the use of land, necessarily a monopoly price, or the highest price that a tenant can afford to pay
stored wealth that lies in the hands of a master, or employer
Unproductive labor, according to Smith, is work that does not result in a tangible product. Unproductive laborers includes lawyers, government officials, and artists. Though the work of unproductive laborers may indirectly facilitate productive labor, the salaries of unproductive laborers ultimately rely on profits generated by what is produced by productive labor.
EQ #1: Adam Smith seems to argue that freedom promotes order. How is this to be understood? How does he construct his argument?
Adam Smith writes that individual freedom promotes social order. When people are free to make their own financial and business decisions, they generally choose what is of the greatest benefit to them. These decisions balance one another, distributing goods and services in the most efficient way possible, which creates social order.
EQ #2: What are the benefits of specialization and the division of labor?
The division of labor creates an enormous increase in output and occasions technological specialization, which further increases productivity. The enormous supply which results from the division of labor drives down the cost of goods. A society in which the division of labor is highly developed also involves more of its members in production, giving more people access to wages. These two factors make more goods available to more people, and ensure that more people will be able to afford them. This leads to what Adam Smith calls "universal opulence."
EQ #3: What kind of society does Adam Smith's observations most correspond to? A rural society, a small society, a large and diverse society?
Adam Smith makes the point that the division of labor, which is the starting point for his entire work and all the observations that follow, is to be observed even in quite primitive societies. However, he also writes that the division of labor flourishes best when the market is very large, and that the industry of the city is reinforced by that of the country. For him, then, his observations are most true of a large, complex society composed of both rural and urban areas, where technological innovation is appreciated and practiced.
EQ #4: How does Adam Smith account for value? What constitutes value?
In accounting for the particular value of various products, Smith argues that the value of a particular product reflects the labor that is invested in it. In an open exchange, one would not purchase a good that one could create oneself with less effort. However, Smith also recognizes that not all labor is equal. One process of production might require more ingenuity, education, attention, or training and experience than another. These inconsistencies are compensated by price. While this is the basis of Smith's understanding of value, he also develops his understanding to include issues of supply and demand, which further inform and complicate his idea of labor as the seat of value.
EQ #5: How are wages determined, and limited, according to Smith?
Wages are the result of an implicit negotiation between employers and the stock they employ (or masters, as Smith terms them), and laborers. The greater the stock in a society, the more competition there is between masters for labor, and wages are therefore increased. When stock is scarce and labor abounds, wages are driven down. Wages are also influenced by the nature of the work: its agreeableness, the difficulty and expense of education necessary to practice it, the likelihood of one being successful at it, its constancy, and the amount of trust placed in the practitioners of a certain trade. Finally, wages also depend on the economic growth of a society. Wages will always be low in a society where there is zero growth.
EQ #6: According to Smith, four kinds of people make up society: productive laborers, unproductive laborers, landowners, and merchants or farmers who possess stock. How do these four groups relate to one another? Which group is primary? Which groups, if any, are superfluous?
Merchants or farmers who possess stock are in a position to provide the capital necessary to begin or maintain a business. Productive laborers engage with capital in order to produce commodities. Laborers work upon land (whether in a factory or on plot of rural land), and the rent of the land they work upon is paid by a portion of the revenue that their products gain. With the other parts of this revenue, the wages of the laborers are paid and capital is replaced. Profits may be re-invested. Unproductive laborers are supported by the efforts of productive laborers, and from the surplus revenue gained from their labor--i.e., the revenue that is not devoted to paying wages, rent, or replacing capital. Unproductive laborers may be menial servants, or they may be lawyers, judges, politicians, etc., paid with money that is left over after the costs of production have been replaced.
EQ #7: What is the role of money for Adam Smith?
Money is a tool of exchange, which facilitates commerce. Wealth is determined and stored in what money purchases, not money itself. The amount of money circulating in a particular society is also no measure of the wealth of a society, because the same amount of money can constitute the income of several people, as it changes hands. That said, money that is not being used as a tool of commerce, but is lying around, is wasted. Since money always makes money, or capital represented by money can always be used in raising more capital and thereby increasing productivity, money always presents the opportunity to increase wealth.
EQ #8: What is the role of government according to Smith? To what extent should it regulate the markets? Who should it aim to protect in forming its economic policy?
For Smith, government should work on protecting the rules of the marketplace, while leaving the market to itself. That means that the government should protect property and make sure that the rules of law and justice are ensured (so that parties honor their contracts). Finally, governments should be responsible for defense of the society. Indeed, security is one of the most important preconditions of free and fair exchange. Adam Smith also recognizes that commerce depends on infrastructure. Some public works, he observes, could never repay their costs and therefore would never be undertaken by private entities. In these cases, governments may make themselves responsible for undertaking them. Education, Smith argues, is rather like infrastructure in that it is necessary for commerce to thrive. He touches on the fact that education also increases the quality of life, which increases security and productivity of laborers. While the state should not undertake the entire expense of education, it should certainly subsidize it.
EQ #9: How is wealth created, and how is prosperity maintained?
Wealth is created by means of the revenue that can be saved, revenue over and above the amount necessary to replace the cost of production. Since real wealth does not consist in money but in goods, wealth can only be real insofar as it is exchangeable for such goods. Wealth in its money form, though it may have a high exchange value, is too precarious to be considered real wealth for Smith. Prosperity in a particular society is maintained through growth. In a society where wages are stagnant, and the division of labor does not expand to meet a growing market, there is bound to be great misery and desperation. The quality of life must be on the rise in order for a society to maintain its prosperity, for stagnation results in a depreciation of the quality of life for those at the very bottom.
EQ #10: Why is Adam Smith opposed to a system of government that would oppress its laborers by enslaving them or levying high taxes upon them?
Smith's criticisms of these systems of government is based not on moral grounds, but on economic ones. Smith argues that not allowing a laborer to enjoy the fruits of his labor makes him disinclined to work, since it disrupts a natural incentive system. When laborers are disinclined to work, and can only be motivated to work through threats and violence, they are far less productive. Systems of government that oppress their laborers make the economic system less productive and efficient, lowering the quality of life for the entire society.
Wealth of Nations
The Wealth of Nations, published in 1776, is a careful, thorough, and brilliant criticism of the mercantile system that governed economic policy in Great Britain during Smith's life. Smith charts the evolution of mercantile principles from the fall of Rome, through feudal times, and into the age of commerce in which he was born.
Well-educated and relatively well-traveled, Smith was able to observe and learn from a number of trades. He also watched as poverty in Europe motivated many of the desperately poor to emigrate to the New World. The Wealth of Nations blends sound observations of the market with elements of moral philosophy and policy recommendations in order to create not just a criticism of mercantilism, but a rich economics text that has held up remarkably well through the centuries.