Xander's Reviews > Wealth of Nations

Whoa! I'm actually finished with this thing! It took me three days off and some evenings of fully committing myself to reading this monster. But I'm not disappointed, not in the least.

Adam Smith's most famous book (but maybe not his most important, read on) The Wealth of Nations (published in 1776) comes in two volumes and spans more than 1000 pages. Smith is a gifted writer and a brilliant scientist, and this shows on each page: the book is (surprisingly) written very well, for an eighteenth century book.

So what is it about? Basically, it's Smith's sociological study of economics. He uses various methods to accomplish this magnificent task: collecting tables of prices of grain (i.e. quantitative analysis), comparing different countries (i.e. comparative analysis), applying logic to problems (i.e. qualitative analysis). In short, Smith is the first philosopher that applied the scientific method - finding correlations between phenomena with quantitive analysis and then explain this by causal mechanisms with a theory - to the economy. He is definitely the first economist.

(I cannot help but remark that The Wealth of Nations reminds me of Montesquieu's d'Esprit de Lois, in which Montesquieu did something similar. Montesquieu tried to explain law in terms of sociological factors. Although Smith makes a much stronger case and his book is much more convincing because of the use of quantitive data and a much more rigorous, less speculative approach. But maybe it's unfair to compare the two and I should just end by saying that Smith did for economics what Montesquieu did for law).

For Smith economics boils down to the market. This is more than a superficial analogy (in his childhood, Smith's window looked out on the marketplace), for Smith all of economics is the continuous interplay between supply and demand. This mechanism is the infamous 'invisible hand'. We all try to satisfy our needs and lead happy lives, and in doing so interact with other people. Others have things we desire and we need to work together to accomplish goals. Out of this interplay emerges the market: the correlation between supply and demand of goods and services leads to particular prices.

Because situations of pure barter (trading bread for wine, for example) are scarce, an artificial means of valuing different commodities relative to each other is invented: money. Money will become the oil that makes the machine run smoothly. We save some and buy what we want later on. For Smith, money is the means by which we cooperate with other human beings. Focusing on the value of money is, according to Smith, the wrong way to look at things - we should focus on what money can buy. In other words purchasing power is the tool to use in economics.

It is surprising that Smith is known as that old, die hard capitalist for whom egoism is the spring of everything. This was my conception of Smith before reading The Wealth of Nations, and it's a conception one comes across frequently. After closing this tome, though, I have to correct this view. Smith advocates economic cooperation to accomplish goals. We all want things and desire goods and services; only by working together - worldwide - can we assure that each gets his or her share. So, Smith advocates egotism (striving to fulfil your desires), but at the same time he offers cooperation as the means to this. Capitalism is worldwide cooperation.

In this sense, Smith is the first marketeer. Nowadays, marketing is a specialized profession, but for Smith marketing is the only road to success. We should not look at what people produce, but at what people actually want: demand should determine production and not vice versa. This is why governmental tactics to artificially boost productions (by subsidizing the production of certain products or punish certain products of competitors) will lead to disasters - it distorts the market mechanism that ensures 'to each his or her own'. According to Smith, this way of looking at economics is the only road to success. Any other road will lead to unnecessary suffering and to the (relative) loss of one's competitive force.

Of course, one can add countless caveats to this, but one shouldn't lose Smith's objective while doing so. The Wealth of Nations is one big tirade against monopolies, mercantilism, and corporatism. For Smith, any governmental intervention or artificially created advantages are dangerous. It is in this light that one has to read Smith. This can be viewed as 'die hard capitalism' but (in my opinion) this is a shallow objection... The only (workable) alternative is socialism, in which someone or some party decided who gets what and who works where. Of course there are more options, but they all fall on the continuum between Smith's liberalism and Marx's communism - the only (political) question is how much the government distorts which markets.

But back to Smith. In the eighteenth century a handful of European nations dominated the world. For example, England still possessed her North American colonies while Smith was writing this book and Portugal and Spain possessed almost all of South America. This created a situation of monopolies. Spain and Portugal possessed most of the world's mines of gold and silver. This led to both countries owning all the gold and silver that was brought on the market. This looks beneficial, but Smith manages to show that in doing so, Spain and Portugal deflated the prices of gold and silver, making it cheaper for the other European countries to buy gold and silver and dearer for Spain and Portugal to buy consumable goods.

In the case of the American colonies, England created a monopoly of all the trade with these lands. This led, first of all, to smuggling (something Smith stresses time and time again) and, more importantly, to the fact that England had to pay dearer for the goods that were being traded. By knocking out all competition, England created artificially high prices for American goods. But this wasn't all. Since England needed all of her ships in the colonial trade, other European countries could specialize in the West Indian and inter-European trade, earning all the money and leaving England with nothing to show for it.

Another major market distortion in Smith's time was slavery. Alexis de Tocqueville, in his Democracy in America (1841), wrote that the Southern states have a characteristic lazy style. He traced this economic laziness to the institution of slavery. Owners of capital possessed an infinite amount of (almost) free labour; this led, according to Tocqueville, to the mindset of irresponsible economic behaviour. Southern Americans weren't (aren't?) motivated to produce anything or to seek means of increasing productivity; they could let others work for them - for free. Northern Americans had the economic incentives to work hard and seek means of increasing productivity - economically, they had to rely on themselves. This, Tocqueville noted, was the main difference between Northern and Southern Americans and the cause for the differences in wealth.

Applying Smith's thinking to slavery: it distorts the market by creating an infinite, cheap (free) labour force. This leads to artificially low prices of production costs, but also destroys the incentive to innovate and seek increased labour productivity. The slave has no reason to work hard (let alone, harder); the master can only increase productivity by punishing, but this will not result in real gains of productivity and has to be kept up at all time. At the same time, the owner of capital (i.e. the slave owner) gets a maximum amount of profit without doing anything. This will lead to distorted market prices for the goods.

One can summarize the whole of Smith's conception of economics in a few sentences. The price we pay for the products we buy, has to incorporate all the real values of the labour, capital and rent involved in producing these products. If one or more factors become distorted, this will show itself in the relative price of the products we buy. Clothes bought from H&M can be sold cheap to us, Westerners, because in Asia children will work long days in horrible conditions to produce these clothes. Smith would see this as a market distortion; somehow, there is no channeling of the (horrible) labour conditions into the market price. This can be solved by working on the demand side of the equation: we, as consumers, should be informed about these conditions, so we can either buy these same clothes in the knowledge that we support child labour, or else to make us buy other clothes, leading to a gradual change in working conditions for the people producing our clothes.

Smith's message is clear: any intervention in the market will lead to disaster. Governments should be small and focus on their core tasks: (1) offering society safety from foreign invasion, (2) distributing justice within their territory, and (3) making sure that the public works run smoothly (public education, roads, canals, etc.). These public expenditures should be localized as far as possible, since this will garantuee a situation in which one or more people actively participate in the project and make it their responsibility that the project works the way it is supposed to. If one wants to change the conditions of classes of people or individual people, one has to make them become 'worth more' to capital: developing new skills, learning new knowledge, etc. For Smith, this is the only way up, all other ways will lead to suppression. Demand determines production.

I will add some more thoughts on the book later on. For now, this is all I can come up with. It needs more time to click into place. I would have given this book five stars - for me its on par with Darwin's Origin of Species and Newton's Principia - were it not for the long and tiresome second volume. After reading 700 pages, just when you're almost able to breathe, you'll get bogged down in technicalities on government, public revenue and debts... Smith is so extensive and meticulous, that often one encounters endless digressions on, for example, the prices of grain in the past six centuries. If the book was 25% shorter and slightly less long winding, I might have given it the full five.

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Additional thoughts on Smith's ideas on public works, taxation and public debt (mainly book 5).

In Book 5, Smith is mainly concerned with explaining wherin consists public revenue. In other words: what institutions should be publicly funded? In essence, this boils down to four institutions. Public revenue, through taxation, should be used to (1) defend the nation with the use of a professional military force; (2) to keep up an impartial judiciary system that regulates society, garantuees the reliability of contracts, etc.; (3) to ensure a certain level of infrastructure (roads, canals, etc.), preferably with personal/regional responsibility; (4) and public education.

Smith is a realist, since he recognizes that private projects (like private education) are often qualitatively better than publicly funded altnernatives, yet without the garantuee of public defence, justice, infrastructure and education, society would degrade into anarchy. For Smith, public education is important, since it teaches human beings to value truth and to make them resistant to the rallying cries of monopolistic institutions (like the church).

A public infrastructure is, for Smith, the only solution to the 'tragedy of the commons' in which a commonly shared project lacks a person responsible (and thus liable) for the upkeep of the project, leading to the exhaustion of the shared means. Yet, Smith realizes his solution - public works - leads to debates about fairness. His answer, as with almost anything else in The Wealth of Nations, is proportionality. The user pays, leading to a system of proportional taxation that varies with use.

How does Smith want to pay all this? Smith's conception of taxation is liberal, meaning that he seeks the answer to economic problems on the consumer side of the equation - instead of government intervention on the production side. In general, Smith favors tax on property (i.e. land) and stays away from other means of taxation. This is pragmatic (i.e. less liable to corruption by hiding profit, income, etc. from the government), but also more fair: the landlord will delegate the government's tax on land to the person or family renting his land. So the consumer pays, and pays inversely proportional to the rent he or she pays the landlord.

Yet, the problem with Smith's way of collecting taxes is that his system is founded on a society in which land is the property of a small number of families. Nowadays, in most Western countries, most people own small pieces of land, leading to a problem of collecting enough money (let alone the expenses necessary for a public registration of all private property). But maybe this problem is impossible to solve, if we want to keep to Smith's valuation of a free market (at least as free - from artifical intervention - as possible).

Smith notices that - at least in his time - states would incure huge public debts by going to war (some countries almost perpetually). This notion is a popular one, for example it is clear that one of the major causes of the French Revolution was the bankruptcy of the French state, which was in itself mainly caused by the many wars France fought in the 18th century. England incurred huge debts by trying to defend its colonies and the state of Holland used a fair sum of money to upkeep its trade army. Smith sees that waging war by taxation takes away the motivation of the people necessary for the war. In other words, no cannon fodder in a war based on taxation. To overcome this problem, governments take loans from rich individuals, who are themselves better off in a safe and just society. Since governments are so important, not to mention durable, they are able to take loans against highly favorable conditions. In other words, the government sells bonds to finance its wars. (One should only look at the modern day USA to see Smith's point - the US government own trillions of dollars due to the wars it fought the last decades.)

So, to sum up, we see that Smith is in favour of public defence budgets, a public system of justice, public education and public infrastructure. This is a totally different conception, compared to contemporary mainstream conceptions of Adam Smith as a die-hard capitalist, who thinks everyone should just fend for themselves. True, Smith is highly critical of debts, taxes and public funding, and he in general promotes individual freedom and maximum rights to the fruits of labour. Yet, this is only healthy, since democracy has the tendency to corrupt people's minds in a peculiar way. We all vote for politicians who promise us to take money and derive rights of OTHER people, in favour for our OWN goals and freedom. We, for example, vote for politicians who finance our own valued projects by levying (higher) taxes on our fellow human beings. This is highly paradoxical and problematic, and the only answer to the problem is limiting governmental intervention as far as possible - all the while keeping human rights in sight.