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Book 1, Chapter 4
Themes
Key
LitCharts assigns a color and icon to each theme in The Wealth of Nations, which you can use to track the themes throughout the work.
Labor, Markets, and Growth
Capital Accumulation and Investment
Institutions and Good Governance
Mercantilism and Free Trade
Money and Banking
Summary
Analysis
All goods and wealth come either directly from one’s own labor, or from exchange for someone else’s labor. Thus, something’s real price is “the quantity of labour which it enables [its possessor] to purchase or command.” Obtaining two things with the same price should require the same amount of labor. Similarly, wealth is the power to command other people’s labor. It may be impossible to quantify the exact amount of labor that goes into different kinds of work, but “the higgling and bargaining of the market” does so approximately. While real prices are usually expressed in money, they aren’t really based on money, since gold and silver prices fluctuate over time. The only thing whose real value never changes is human labor—which is the ultimate basis for all real prices.
For all its complexity, this analysis of labor, prices, and money is central to Smith’s theory and arguably one of the most important passages in the history of economics. Smith’s fundamental insight here is that labor, not money, is the real basis of economic value. In everyday economic life, it’s natural to think about the value of the things we buy in terms of money, because money is the thing we use to measure value. This is why, if every dollar today were suddenly worth two dollars tomorrow, people wouldn’t become any wealthier—rather, all prices would double, and everything else in the economy would continue exactly as before. Smith's argument is important because, as readers will see in Book IV, mercantilists mistake money for value, which leads them to hoard gold and silver instead of embracing the free-trade policies that grow the economy by making that gold and silver circulate throughout it.
Themes
Real prices—how much labor or a commodity is worth in terms of “the necessaries and conveniences of life”—are different from nominal (money) prices. Long-term transactions like yearslong land rentals should be based on real prices, since nominal prices fluctuate due to the changing metal supplies and coin debasing. Indeed, as all nations continually debase their coins and new mines in America have increased the supply of precious metals, prices denominated in grain have remained far stabler over the centuries (and closer to real prices) than those denominated in metals. But grain prices still fall over time: as societies become wealthier, a fixed quantity of grain can buy less and less labor. As grain prices depend on harvests, they also vary more significantly from year to year than metal prices. Thus, labor is the only universal standard for comparing value over time.
The difference between nominal and real prices is based on the aforementioned difference between measuring value in money and measuring it in labor. Everyone understands that nominal prices tend to increase over time—this is why a dollar buys far less today than it did in previous decades. But real prices depend on how much labor is required to produce something, so they usually fall over time due to technological improvement and the division of labor. Thus, in the above example, where every dollar today is suddenly worth two tomorrow, the nominal price of everything would double, but real prices would not change. Policies like basing land rents and taxes on real prices help illustrate why effective governance requires accurately understanding the fundamentals of economic theory.
Themes
Ordinary commerce only involves nominal prices, not real prices, because it takes place at one time and place. Thus, money is a perfectly adequate tool for it. Even long-distance commerce is entirely about nominal prices: if the same goods fetch a half-ounce of silver in China but a full ounce in England, a merchant will buy them from China and sell them in England, regardless of how much labor and daily necessities each amount can really buy in each place. For this reason, most philosophers have focused entirely on nominal prices. But real prices will often be relevant in Smith’s work. He will use grain prices to approximate them, since it’s impossible to know exactly how much labor it has taken to produce different commodities in different places throughout history.
Unlike Smith, most people think mainly about nominal prices in their day-to-day life, and only deal with real prices when making comparisons across time (or across places with different costs of living). Whereas real prices generally depend on the structure and strength of a nation’s domestic economy, nominal prices also depend on the supply of money and international exchange rates. Smith approximates real prices using grain prices (corrected for year-to-year fluctuations) because the amount of labor required for agriculture varies much less than the amount of labor required to procure and produce other goods. (Of course, agriculture still can get more efficient, and industrial production methods devised in the centuries since Smith published this book have made it much more so.)
Themes
Most societies use several different metals for money, but they tend to treat the first they start using as the standard measure of value. The Romans used copper, but most modern European countries started with silver—including England, where debts and accounts were historically denominated in silver coin. However, the most valuable metal actually determines the value of all the coinage. For instance, England just reformed its gold coins to make sure they contain the right amount of gold, so an ounce of pure gold bullion has started trading for fewer gold coins than before. Thus, the coins’ value has risen. Since the exchange rate between gold, silver, and copper coins is fixed, the silver coin’s value has risen too, even though it wasn’t reformed (and still contains less silver than it should). In fact, if England reformed the silver coin, it would become more valuable melted down as bullion than as money.
Smith’s detailed analysis of the value of different metals may not be particularly relevant to our economic reality today, but it does show how governments often made poor policy decisions because they didn’t understand the basic dynamics behind their economies. Above all, Smith suggests that it is foolish for governments to let the face value of their coins fall below the value of the gold, silver, or copper contained within them. (This idea still surfaces today, for instance in debates about the U.S.’s penny.) By reforming its currency, Britain raised its real value without changing its nominal value. A reformed silver coin would have gotten melted down because its value as bullion would have exceeded its value as currency.
Themes
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There is no seigniorage in England—people don’t have to pay the mint to turn their gold bullion into gold coin. But the process does take several weeks, which is like paying a small tax. If England also started charging seigniorage, like France, then its coin would be worth more than its equivalent weight in bullion. Thus people would stop exporting and melting down coins. While the price of gold and silver bullion varies according to market factors (like demand and over- or under-importation), it generally holds stable over time. But most nations’ currency contains less gold or silver than it is supposed to, and merchants get used to adjusting all prices for the actual amount of metal it contains.
Seigniorage is the revenue that the government derives from minting money; in Smith’s era, this meant the fee that people paid to turn their bullion into coin. The cost of this fee gets priced into the value of the coin. This is why seigniorage makes coin more valuable than bullion. It also allows the government to raise revenue without actually taking anything out of the economy. Smith implies that England should start charging seigniorage, which is a good example of how—contrary to popular perceptions of him—he actually advocates for strict and sensible government regulation of the economy.
Themes
