Book 22018-10-23T05:46:46+00:00

THE WEALTH OF NATIONS : BOOK 2

CHAPTER 1: THE DIVISION OF STOCK

If a man’s stock will not maintain him for more than a few days or weeks, he will consume it as sparingly as he can, while endeavoring to replace it, through labor, before it is all consumed. His revenue is in this case derived from his labor only. This is the situation for most of the working poor in all countries.

If, however, he has sufficient stock to maintain him for months or even years, he will endeavor to derive a revenue from the stock he does not need for his immediate consumption, reserving only the stock he needs until his revenue begins to come in. His stock is divisible into two parts. The part he uses to derive a revenue is called his capital. The other covers his immediate consumption, and consists first of the portion of his whole stock originally reserved for this purpose; secondly, of his revenue; and thirdly, purchases such as clothes and furniture.

There are two ways in which capital may be employed to yield a profit. Firstly, it may be employed in raising, manufacturing or purchasing goods, which are then sold on at a profit. This is called circulating capital. Secondly, it can be invested in the improvement of land, the purchase of useful machines and trade tools. This is called fixed capital.

Different occupations require different proportions of fixed and circulating capital. A merchant’s capital is circulating. A portion of the capital of every manufacturer will be fixed, in terms of the instruments of his trade; the greater part of the capital is circulated either in the wages of the workforce, or in purchase of materials, and is repaid by in price of the work.

The portion of a farmer’s capital invested in agricultural material is fixed; the portion used for wages and the upkeep of his staff is circulating capital. Dairy cows that are not for sale but for milk production, are fixed capital; their maintenance is circulating capital.

CHAPTER 2: MONEY, CONSIDERED AS A PARTICULAR BRANCH OF THE GENERAL STOCK OF THE SOCIETY, OR OF THE EXPENSE OF MAINTAINING THE NATIONAL CAPITAL

The price of a product can be divided into three parts: one which pays the wages of labor, another the profits of stock, and a third the rent of land. The value of produce must resolve itself into the same three parts, divided among the inhabitants of the country in the form of wages of labor, profits of stock, or rent of land.

The gross rent of an estate consists of the amount paid by the farmer; the net rent is what is left over for the landlord after deducting expenses. His real wealth is in proportion not to his gross but net rent. The gross revenue of a country’s inhabitants comprises the whole annual produce of their land and labor; the net revenue is what remains. Their real wealth is in proportion not to their gross but their net revenue.

The expense of maintaining fixed capital does not come from a society’s net revenue. Fixed capital is used to increase productivity. Any streamlining improvements to production processes and workforce are viewed as beneficial to a society. The expense of maintaining a large country’s fixed capital may be compared to the expense of repairs made to a private estate.

Money is the only part of a society’s circulating capital, and its maintenance can result in a decrease in neat revenue. Fixed capital, and that part of circulating capital which consists of money, are similar.

The amount of money circulating in a particular country incurs expense in terms of its collection and replenishment; both expenses are deducted from a society’s net revenue. A quantity of gold and silver, and of labor, instead of increasing the stock reserved for immediate consumption, is used to maintain commercial tool.

When we talk of a particular sum of money, we are referring to physical money. But when we say that a man is worth a hundred pounds a year, we mean not only his annual wage, but the value of the goods he is able to purchase annually.

Though a country’s inhabitants may receive monetary wages, their real revenue is measured in terms of the quantity of consumable goods they can purchase.

This is even more the case for a society. As money changes hands repeatedly, it can never be equal to the revenue of all of a society’s members; so the amount of money circulating in a country must always be of less value than the annual sum paid using it.

Machinery, which represents fixed capital, forms the monetary part of circulating capital: savings made in purchasing and maintaining these machines increases net revenue, so savings in terms of collecting and replenishing the monetary part of circulating capital is an improvement of the same kind.

Replacing gold and silver with banknotes replaces a very expensive tool of trade with a less costly one, making circulation less expensive to implement and maintain.

When people trust a banker implicitly in terms of lending promissory notes, these notes will have the same value as gold and silver. Such a banker can grant loans to his customers, of his own promissory notes; for example, for an amount of a hundred thousand pounds. His customers pay him the same interest as if he had lent them money; this interest will be his profit. Though he generally has notes in circulation of up to a hundred thousand pounds, amounts of twenty thousand pounds in gold and silver often suffice for occasional demands. If different operations of the same kind are carried out simultaneously by many different banks and bankers, the entire circulation may be conducted with only a fifth of the gold and silver which would otherwise have been required.

For example, say the entire circulating money of a particular country amounts to one million sterling; let us suppose that bankers issue promissory notes for an amount of one million, reserving two hundred thousand pounds for occasional requests; there would be eight hundred thousand pounds in gold and silver, and a million bank notes, or eighteen hundred thousand pounds of banknotes and money in circulation. But the annual produce of the land and labor of the country had before required only one million to circulate. This means there is an excess of eight hundred thousand pounds over and above what can be circulated in the country. This money cannot be absorbed by the country’s economy and will therefore be sent abroad to a market that can employ it. Banknotes cannot go abroad since it cannot be used far from its issuing bank, so gold and silver, to the amount of eight hundred thousand pounds, will be sent abroad.

If they employ it in purchasing foreign goods for home consumption, they may purchase unproductive goods such as wines, or they may purchase materials, tools and provisions to employ and maintain additional workforce.

Three things are required in order to establish an industry: materials to work on, tools to work with, and wages to pay for the labor involved. Money is neither a material to work on, nor a tool to work with, and though a worker’s wages are commonly paid to him in money, his real revenue consists not of the money but the money’s worth; i.e., not in the physical metal coins but in what he can buy for them.

Many years ago, Scotland saw the establishment of some of the first banking companies in almost every town. The effects of this were those described above. The country’s business is almost entirely carried out using the banknotes issued by various banking companies, for purchases and payments of all kinds. Silver and gold are used only rarely. Although the performance of these various companies has not been exceptionable, and required an act of parliament to regulate it, the country derived great benefit from their trade. Trade in Glasgow doubled within fifteen years of the establishment of the first banks there, and in Scotland it more than quadrupled since the establishment of the first two public banks in Edinburgh, of which the one, the Bank of Scotland, was established by act of parliament in 1695, and the other, Royal Bank, by royal charter in 1727.

The amount of banknotes circulating in a particular country should never exceed the amount of gold and silver that country possesses. Should this occur, there would be a run on the banks for these superfluous banknotes, and if they showed any problems in terms of payment, the alarm would necessarily increase the run.

The Bank of Britain is the main circulating bank in Europe. Incorporated through an act of parliament, by charter dated 27 July 1694, it at that time advanced a sum to the newly established government of £1,200,000 for an annuity of £100,000, or for £96,000 a year, at an eight percent interest rate, and £4,000 a year to cover management expenses. We can assume that the new government’s credit must have been very low for it to have been obliged to borrow at such a high interest rate.

The stability of the bank of Britain is equal to that of the British Government. All that it has advanced to the public must be lost before its creditors can sustain any loss. No other banking corporation in Britain can be established through an act of parliament or can consist of more than six members. It acts not only as an ordinary bank but as a great engine of state. It receives and pays the greater part of the annuities due to public creditors; it circulates exchequer bills; and it advances an annual amount to the government to cover land and malt taxes, which are frequently not reimbursed before several years. Due to these various operations, it may, at no fault of its directors, sometimes overstock in terms of the amount of banknotes in circulation.

A country’s monetary circulation can be divided into two types: that from one dealer to another; and that between dealers and consumers. Although the same pieces of money, whether notes or metal, may be employed in both of these circulations, since both are constantly ongoing simultaneously, each requires a certain stock of money, of one kind or another, in order to carry it out. The value of the goods circulated between the various dealers should never exceed the value of those circulated between dealers and consumers; whatever is bought by dealers is ultimately sold to consumers. Circulation between dealers, which is carried out wholesale, requires a relatively large stock of money; whereas between dealers and consumers, which generally involves retail, requires a relatively small stock.

In the currencies of North America, banknotes were used for sums as small as a shilling, and formed the bulk of the entire circulation. It is preferable not to issue bank notes for a value of under £5; as such, banknotes would probably be confined to circulation between dealers, as is the case currently in London where no bank notes are issued for a value of under £10.

Where banknotes is pretty much confined to circulation between dealers, as is the case in London, there is always plenty of gold and silver. Where banknotes is also used for much of the circulation between dealers and consumers, as is the case in Scotland and even more so in North America, gold and silver are practically not used at all in the country, with almost all ordinary transactions being carried out in banknotes.

The paper currencies of North America consisted not of bank notes payable to the bearer on demand but of a government paper, of which payment was not guaranteed until several years after its issue; and though the colony governments paid no interest to the holders of this paper, they made it legal tender of payment for the full value for which it was issued.

Indeed, the Government of Pennsylvania, when they first issued banknotes in 1722, pretended to render their paper of equal value with gold and silver, by enacting penalties against all those who made any difference between the price of their goods when selling them for a colony paper as opposed to for gold and silver.

CHAPTER 3: THE ACCUMULATION OF CAPITAL, OR OF PRODUCTIVE AND UNPRODUCTIVE LABOR

Productive labor adds value to its subject; unproductive labor does not. A manufacturer adds value to the materials he works on. A house servant adds nothing. Although the manufacturer receives wages from his boss, he is actually maintained by his boss at no real cost since the value of his wages is covered, including a profit, by the value he has added to the subject on which he has worked.

The labor of some jobs, such as house servant, is unproductive of any permanent value in a society. The sovereign, with all the officers of justice and war who serve under him, and the whole army and navy, are unproductive workers. The protection, security and defense of the commonwealth do not generate a profit enabling the purchase this protection, security and defense the following year. Some professions involving unproductive labor are churchmen, lawyers, physicians, actors and musicians. None of these are productive laborers.

Productive and unproductive laborers, as well as the unemployed, are all maintained by the annual produce of the land and labor of the country. This produce must have certain limits.

The produce of the land, whether farmed or manufactured by productive laborers, can be divided into two parts. The first, the produce of the land, is used to replace the farmer’s capital; the second pays his profit and the rent of the landowner, and thus provides a revenue both to the owner of the capital, as the profits of his stock, and to the person who owns the productive land, in the form of rent. In the case of a large business, the largest part goes towards replacing the capital of entrepreneur; the other pays his profit, and thus constitutes a revenue to the person who owns the capital. If his wages permit it, even a common laborer can hire a house servant, or perhaps spend his wages on entertainment, such as a theatre show; in this way, he contributes a share towards maintaining unproductive labor. Or he may pay taxes, thus contributing towards maintaining more useful, but equally unproductive, labor.

The proportion between capital and revenue regulates the proportion between industry and idleness. Wherever capital predominates, industry prevails; wherever revenue predominates, idleness prevails.

Capital is increased by frugality, and diminished by extravagance. Whatever a person saves from his revenue, he adds to his capital, and either employs it himself in hiring additional productive laborers, or enables another person to do so by lending it to him at interest, thus making a profit. As a person’s capital can be increased only by what he saves from his annual revenue or profit, likewise a society’s capital can be increased only in the same manner. Frugality, and not industry, is the immediate cause of the increase of capital. Industry, indeed, provides the subject which frugality accumulates; but whatever industry might acquire, if not saved up and stored through frugality, the capital would not grow.

What a frugal man saves annually can be used to hire additional productive laborers for the following year, but doing so means he will have to maintain this number of laborers in the years to come. If the extravagant spending of some were not compensated by the frugality of others, the extravagant spenders sponging off the industrious would lead to the country’s impoverishment.

However we view the real wealth and revenue of a country, prodigal spenders can be seen as the public enemy, and frugal people as public benefactors. Imprudent and unsuccessful projects in agriculture, mining, fishing, trade and manufacturing also tend to diminish the funds destined for the maintenance of productive labor.

Great nations are sometimes impoverished by public extravagance and misconduct; almost the entire public revenue is employed in maintaining unproductive labor; lawyers, churchmen, army and navy generals, who in time of peace produce nothing and in time of war acquire nothing which can compensate for the expense of maintaining them. Such people are all maintained, therefore, by the produce of other men’s labor.

The expense involved in leisure events such as festivals, where commodities are provided for a greater amount of people than those employed at the event, often result in as much as half of these commodities being thrown out afterwards, resulting in huge amounts of waste. If the expense invested in this entertainment had been put towards setting up a business of masons, carpenters, upholsterers, mechanics, etc., for example, a quantity of provisions of equal value would have been distributed among a still greater number of people, who would have bought them in monetary weight and not lost or thrown away a single ounce of them.

CHAPTER 4: STOCK LENT AT INTEREST

Stock lent at interest always represents capital for the lender. He expects it to be repaid in due course. In the meantime, the borrower pays him a certain annual fee for the use of it. The borrower can use it either as capital or for immediate consumption. If he uses it as capital, he will be investing in productive labor that will make him a profit. If he uses it for immediate consumption, he is contributing toward the idle what was destined to support the industrious.

Almost all interest-based loans are made in money—either banknotes, gold or silver; however, what the borrower really wants and what the lender provides is not the actual money but the money’s worth, or the goods it can purchase. By granting a loan, a lender is in effect assigning the borrower the right to a certain portion of the annual produce of the land and labor of the country, to be used as the borrower pleases.

In some countries, interest on money lending has been prohibited by law. Rather than preventing problems, this regulation has in fact increased them since the debtor is obliged to pay not only for the use of the money but for the risk his creditor runs, by accepting compensation for that use.

In countries where interest is permitted, the law to prevent extortion generally fixes the highest rate possible without incurring a penalty. In Britain, where money is lent to the government at a 3% interest rate and to private people at 4%, the present legal rate of 5% is the accepted norm.

The ordinary market price of land depends upon the ordinary market interest rate. A person who has capital from which he wishes to derive a revenue without taking the trouble to employ it himself may decide to invest it in land or lend it out at interest.

CHAPTER 5: THE DIFFERENT EMPLOYMENTS OF CAPITALS

Though all capital is destined for the maintenance of productive labor, the quantity of labor that can be employed for a specific amount of capital will vary depending on the type of employment, in the same way the value that employment adds to the annual produce of the land and the labor of the country.

Capital may be employed in four different ways:

  • procuring the crude products required for a society’s use and consumption;
  • manufacturing and preparing those products for consumption;
  • transporting the crude or manufactured products from their places of origin to those where they are wanted;
  • dividing particular portions of either into smaller portions to suit occasional demands from those who want them.

The capital of the retailer replaces, together with its profits, that of the merchant from whom he purchases goods, thereby enabling him to continue his business.

The capital of the wholesale merchant replaces, together with their profits, the capitals of the farmers and manufacturers from whom he purchases the crude and manufactured produce he deals in, thereby enabling them to continue their respective trades.

Part of the capital of the master manufacturer is employed as fixed capital in the instruments of his trade and replaces, together with its profits, that of the craftsmen from whom he purchases them. Part of his circulating capital is employed in purchasing materials and replaces, with their profits, the capitals of the farmers and miners from whom he purchases them. But a great part of it is distributed among the workmen he employs.

Capital invested in agriculture not only enables a greater quantity of productive labor than the same amount of capital employed in manufacturing, but adds much greater value to the annual produce of the land and labor of the country and to the real wealth and revenue of its inhabitants. Of all the ways in which capital can be employed, this is by far the most advantageous to society.

The revenue of all the inhabitants of a country will be in proportion to the value of the annual produce of their land and labor. The activity that adds the greatest value to annual produce is agriculture—as demonstrated by the rapid growth in wealth of American colonies, which focus primarily on agriculture. They have no manufacturing businesses, with the exception of private family-run household businesses managed by women and children. The greater part of America’s export and coastal trade is conducted with the capital of merchants located in Britain. Even the retail stores and warehouses in some provinces, notably Virginia and Maryland, belong to UK merchants.

All forms of wholesale trade can be categorized into three types:

  • Home trade, involving internal purchase and sale of produce of industries within that country.
  • Foreign trade, involving the purchase of foreign goods for home consumption.
  • Carrying trade, involving transactions of commerce of foreign countries, or trade of surplus produce from one country to another.

When an industry’s produce exceeds demand, the surplus must be marketed abroad, in exchange for something for which there is a demand. The land and labor of Britain generally produce more than the demand of the home market requires; the surplus is therefore marketed abroad, in exchange for something for which there is a demand at home. About 96,000 hogsheads of tobacco are purchased annually in Virginia and Maryland with part of the surplus produce of British industry, but Britain does not require more than 14,000; if the remaining 82,000 cannot be exported and sold in exchange for something more in demand at home, importation of these products must cease, and with it the productive labor of all the inhabitants of Britain currently employed in preparing the goods with which these 82,000 hogsheads are purchased annually.