A review of Adam smith’s The inquiry into the nature and causes of the wealth of Nations

 Book 2 Chapter 2

Introduction 

Adam smith’s had a bigger and more global impact when he published “An inquiry into the nature and causes of the wealth of Nations” also referred to as The Wealth of Nations on the march 9th of march 1776.

Smith who is a Scottish moral philosopher by trade ,Author and a political Economist who also known as the father of Economics, wrote this book to describe the industrialized capitalist system that was upending mercantilist system.

Mercantilism held that wealth was fixed and finite and that the only way to prosper was to hoard gold and traffic products from abroad.

According to this theory, Nations should trade with buying anything in return (nations should sell their good in exchange for money and not goods

Adam smith’s among the first philosophers of his time that propounded theories that states: that wealth is created through self interest and productive labor he said that will make people put their resources into best use instead of trading spade for clothes or clothes for spade.

 

The distinction that Smith makes in Chapter II between gross and net income was a revolutionary one. This distinction has been an important one for analyzing business models and productivity, and it has endured to the modern day. Indeed, much of Smith's work serves to render a more complex and accurate account of how prices are structured, what they consist in, and how they are divided among various individuals, with various stakes in the factors of production. Distinguishing gross and net income, after having made so many groundbreaking observations about the factors of production, was the logical next step for Smith. The also talks about revenue and he divided it into two :Gross revenue /rent 

Net revenue /rent

The gross of rent he defines as whatever is paid by the farmer to rent land.

And Net rent is whatever the landlord is left deducting certain expenses.

Example: You’re paid le500,000 as rent(gross rent) and as a landlord you need to settle the water bills in the house at a cost of le20,000 , therefore the landlord is left with le480,000 (Net rent).

Of the accumulation of capital, or of productive and unproductive labor

Labor is of two kinds: productive and unproductive. Productive labor adds value to its subject, and unproductive labor does not. A manufacturer, for example, adds value to the materials he works with, therefore contributing to his own maintenance and his master's profit. Though the manufacturer receives his wages from a master, in reality the manufacturer is maintained by his master at no real cost. A menial servant, on the other hand, who produces nothing and whose work is without value, has his wages advanced to him at a cost to his master, who afterward has no product and no profit to show from this advancement of wages. A master who maintains manufacturers may, in this sense, grow rich, while a master who maintains menial servants will grow poor. Smith says that maintaining productive laborers who add value by producing material goods is like storing up wealth. Smith's idea of unproductive labor extends far beyond the profession of menial servants, to artists, churchmen, physicians, men of letters, soldiers and the sovereign himself. However valuable and necessary these individuals are to society, they are not productive laborers and are therefore maintained by the annual produce of the productive land and labor of the country. The amount of unproductive land and labor varies with the amount of productive land and labor, and is ultimately limited.

The produce of land and labor, upon completion or fruition, is divided into two parts. The first part is destined to replace lost capital, and the second constitutes the revenue of the person who owns the capital as the profit of his stock, or the person who owns the productive land as rent. The part of the annual produce destined to replace capital in fact goes toward the maintenance of productive laborers in the form of wages. The second part, which constitutes revenue, may go toward maintaining unproductive labor. If a common laborer's wages are so high that they exceed the amount necessary for his basic maintenance, he may spend them on non-necessary things, like entertainment or a personal menial servant. Thereby, the excess is likewise employed in maintaining unproductive labor.

The proportion between productive and unproductive labor is very different in rich and poor countries. In the ancient feudal system, a very small portion of the annual produce was sufficient to replace the capital employed in cultivation. During Smith's time, Europe devoted the greatest portion of its produce to replacing capital, or paying the wages of productive labor. In richer European countries during Adam Smith's time, considerable capital was devoted to trade and manufacturing, which was responsible for a considerable portion of the revenue of these countries. However, the profit margin, because of the proliferation of stock, was lower than in feudal times.

Of stock lent at interest

Stock lent at interest constitutes capital for the lender. The borrower, in turn, can also use the capital lent as such, investing in productive labor that brings a profit, or for immediate consumption. If the borrower chooses to use the capital for immediate consumption, he will have to encroach upon his property or his rent in order to repay the capital. Unwise use of lent capital is checked by the fact that a person who borrows in order to spend will soon find himself in financial ruin.

The amount of money lent in a society depends upon the amount of annual produce that is destined to replace a capital, but a capital which the owner does not deem necessary to use himself. Loans are often made with money, which ultimately represents capital. The same amount of money can be lent many times over (to person A who purchases from B, and then from B who in turn, with the value from the sale, lends to C, etc). In this way, the same amount of paper money may participate in a number of loans, all perfectly secured.

As the quantity of stock to be lent at interest increases, the interest diminishes. This has to do not only with the simple law of supply and demand, but with other causes as well. As capital increases, the competition between those who posses that capital increases as well, diminishing profits and raising wages. When profits of capital diminish, they become harder to employ, and therefore interest must diminish as well. 

Adam Smith goes on to consider the possible reasons behind the lowering of interest rates, which is not due, as was thought then, to the devaluation of silver. Interest rates are proportional to the value of money, so fluctuations in the value of silver would lead to similar fluctuations in the rate of interest. In general, the interest of money always keeps pace with the profits of stock.

Governmental regulation of interest rates is a tricky subject. Adam Smith argues that it is improper to forbid interest altogether, for money, invested well, makes a profit, and therefore a fee should be charged for its use. If a government fixes a limit on the interest, it should be slightly higher than the lowest market price. If the legal rate is fixed below the market rate, the effect is the same as a prohibition of interest, because the creditor will not feel inclined to lend his money. If the legal rate is fixed precisely at the lowest market price, it ruins the credit of those debtors who cannot ensure anything but the best security.

Land prices are also regulated by interest rates, because a person who has capital from which he desires to derive a revenue contemplates either lending it as capital or purchasing land. Land purchase offers greater security, and is therefore a priori a more attractive choice. When interest rates fall, the price of land rises, and vice versa. The values are indirectly proportional.

Of the different employments of capitals

A capital may be employed in four different ways. 

1) in procuring the rude produce that is required for the use and consumption of a society each year

2) in manufacturing and preparing the rude produce for immediate use and consumption

3) in transporting the rude or manufactured produce from the places where they abound to the places where they are lacking

4) in dividing particular portions of either into portions that suit the occasional demands of those who want them. 

Each of these four employments are necessary, either to the existence or extension of the other three, or to society in general. People who employ their capitals in one of the four above ways are themselves productive laborers, since their labor serves to augment the annual value and produce of the society to which they belong.

Capital used to support farming is the most productive. This is because, in the case of agriculture, nature's labor works alongside man's labor to produce commodities, and nature's labor costs no expense. After agriculture, the capital employed in manufactures puts into motion the greatest quantity of productive labor, and adds the greatest value to the annual produce. That which is employed in the trade of exportation has the least effect of any of the three.

Capital can be used to improve and cultivate the lands, manufacture and prepare rude produce for use and consumption, and to transport the surplus part of rude or manufactured produce to markets where it can be exchanged for something that is necessary at home. Indeed, these activities constitute farming, manufacture, and merchant trade, which are the categories of commerce in Smith's work. When a country has insufficient capital to carry out these activities, it should not attempt, with insufficient capital, to do all three. Instead, it should focus on the activity that adds the greatest value to the annual produce. This is agriculture. This focus on agriculture is evident in the colonies, which are still developing toward their optimal degree of opulence.

The capital that is used for trade at home will do more to encourage and support productive labor in that country than will an equal value of capital that is used for foreign trade and consumption. Foreign trade should only be carried out when there is a surplus produce that cannot be consumed at home. The same is true of surplus capital, which, when it cannot be used properly at home, must be more productive abroad.

Criticism

• . Discussion of modern economic problems would be far more productive if more people spent the few minutes necessary to think through Smith’s reminder that “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.” He emphasized that the competitive pressure exerted by free markets forces producers to act in ways that serve the interests of others, even if those producers are themselves motivated only by their own self-interest. 

 

Nor was he so naïve to believe that business interests and the public interest necessarily coincide. On the contrary, he cautioned that “People of the same trade seldom meet together, even for merriment and diversion, but the conversation ends in a conspiracy against the public, or in some contrivance to raise prices.” That was an important warning when Smith was writing in the late 18th century, and it remains important today, when established producers seek protection from competition by lobbying for regulations that raise the cost of entry into the market by potential rivals. Smith reminds us that competition is the “invisible hand” that channels private self-interest into public gain. 

 

Of course, there’s been further progress in economics since 1776. As a classical political economist, Smith was wedded to the labor theory of value, which has since been superseded by a broader understanding of production, consumption, and price determination. And even The Wealth of Nations needs to be read alongside Smith’s other great work, A Theory of Moral Sentiments, to gain a balanced understanding of his view on human motivation. Still, the insights contained in The Wealth of Nations make it essential reading for anyone who wishes to understand the way the world works. 

 

“As every individual, therefore, endeavors as much as he can both to employ his capital in the support of domestic industry, and so to direct that industry that its produce may be of the greatest value; every individual necessarily labor’s to render the annual revenue of the society as great as he can. He generally, indeed, neither intends to promote the public interest, nor knows how much he is promoting it. By preferring the support of domestic to that of foreign industry, he intends only his own security; and by directing that industry in such a manner as its produce may be of the greatest value, he intends only his own gain, and he is in this, as in many other cases, led by an invisible hand to promote an end which was no part of his intention. Nor is it always the worse for the society that it was no part of it. By pursuing his own interest he frequently promotes that of the society more effectually than when he really intends to promote it. I have never known much good done by those who affected to trade for the public good. It is an affectation, indeed, not very common among merchants, and very few words need be employed in dissuading them from it.”

Themes:

1. People personal stock of Wealth:

 Book 2 shows shows how individuals wealth is important in a society. As every country wealth depends upon the people personal wealth. And it shows how people can increase their product to have a bigger wealth. You can have a personal produce and exchange it as circulating till you are able to get fixed capital and become a reach labourer. 

2. 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.

3. 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.

4. 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.

5. Reinvestment.

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.

6. Governments Should Have Limited Powers.

Prosperity grows in an open,

7. 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.

8. 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.

9. Productivity:

The number of productive hands in a nation determines the wealth of that country. An increase in the number of productive hands (manufacturers) tends to an increase in the wealth of that country because the manufacturer adds more value to the product and thus increases in the value of the annual product of the land and labour of the country. Productiveness adds to the revenue of every country and thus every country must employ productivity.   

STYLE:

Like many others writers in the 60s/70s

Adam smith’s style of writing did not defer at all.

The olden English, backed with complex sentences.Smith was controversial in his own day and his general approach and writing style were often satirised by writers such as Horace Walpole. 

He used more of rhetoric and was very tactful in using emotions

Smith’s was logical and very practical in his writing. An instance is the fact that the whole book was centered around how one can be wealthy (Nations) but how can we achieve that when we don’t know what are the factors that causes these problems and possible solutions.

However, smith’s tried as much as possible so we could be able to understand these factors. After reading smith’s The wealth of Nation you would agree with me that most of the strategies and trick you would practice in your personal and business life and Nations as well can learn from that.

 CONCLUSION: 

In Adam smith’s The wealth of Nations, it emphasizes on the importance of free Market, self interest, division of labor, Development on Agriculture etc.

It is essence that we consider ways in with countries ,organizations and people adapt to even not all but most of the theories and tactics written by smith’s.

These theories cannot on help his generation but ours and as well the future. It’s all runs down to how nations can become wealthier but how can that be, he mentioned in one of his books that motivating self when it comes to productivity can contribute greatly in greater productivity resulting in to nations wealth.