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Book 2, Introduction
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
When people only have enough stock to maintain themselves for days or weeks, they simply try to stretch it out for as long as they can and replenish it by working. This is how most of the world’s working poor live. In contrast, when people build up enough stock to sustain themselves for months to years, they generally set aside a portion of it for their survival, while investing the rest—which is called capital—to make revenue.
Smith’s terminology might be confusing, but his point is simple enough. Some people live paycheck-to-paycheck. Others save enough to live comfortably, with a reserve for unplanned or emergency expenses. And a subset of these savers ultimately save enough to actually invest their savings in other kinds of economic activity, so that it produces revenue for them year after year. Today, we might think of investments in terms of stocks and bonds, but these were only just becoming common in Smith’s time. (Indeed, Smith will later explore how and why they were created, then offer his suggestions for regulating them successfully.) Instead, Smith pictures investment in the more conventional terms of starting a business.
Themes
There are two kinds of capital: circulating capital, or capital used to produce or obtain goods that are sold for profit, and fixed capital, or capital used to improve production processes by buying machines, improving land, and so on. Merchants have only circulating capital. Most tradespeople have mainly circulating capital, with a small amount of fixed capital in the form of their tools (like a weaver’s loom). Smiths, millers, and miners have even more fixed capital. Farmers have both significant fixed capital (in the form of agricultural tools) and significant circulating capital (which they spend hiring laborers). Sheep and cattle are fixed capital if kept for wool and milk, but circulating capital if slaughtered for meat.
Circulating capital is easy to replace during prosperous times and sell off at a discount during stressful ones, while fixed capital investment requires relative certainty about the economic future, because it generally takes several years to pay off. For this reason, fixed capital investment also represents a longer-term, deeper investment in a particular place than circulating capital does. Merchants can easily take their money elsewhere, but shutting down a factory is far more difficult—and far more consequential for the local community. Virtually all major productivity improvements require fixed capital investment, so nations must attract it if they truly want to achieve long-term economic growth.
Themes
Like an individual’s stock, a society’s stock is also made of three parts: circulating capital, fixed capital, and a reserve for immediate consumption. This reserve includes food, clothes, furniture, and owner-occupied properties. (But these can all turn into capital if lent out.) Society’s fixed capital stock comprises machines, buildings that earn revenue, land improvements, and the talents that people acquire through education and training. Finally, society’s circulating capital stock also has four parts: money, merchants’ unsold provisions, unused raw materials, and manufacturers’ finished but unsold products.
A society’s balance of fixed capital, circulating capital, and reserve for consumption plays an important role in its long-term economic trajectory. The more of its stock gets consumed, the less remains to invest. And the more it invests in long-term fixed capital improvements, the more its level of productivity will tend to improve. Crucially, the money supply is just one part of society’s circulating capital. Again, this points to where the mercantilists go wrong: they think that nations’ wealth comes from hoarding gold, silver, and the money derived from them. But in reality, a nation’s wealth comprises all of its capital, and nations that focus on acquiring money are too often reluctant to let it circulate—which undermines overall capital growth.
Themes
As these provisions, raw materials, and unsold products get sold, they either go to replenish the stock reserved for consumption, or they get invested into fixed capital. In turn, this fixed capital only produces revenue when combined with circulating capital—for instance, machines will produce nothing unless raw materials are fed through them and people are paid to operate them. And even though circulating capital is constantly sold and converted to fixed capital, this circulating capital is constantly replenished by agriculture, mining, and fishing. In turn, farms, mines, and fisheries require both fixed and circulating capital to operate—and, controlling for fertility, their productivity rises in proportion to the capital invested in them. In safe countries, people put all their stock into fixed capital, circulating capital, or the reserve for consumption. But in dangerous ones, they often bury much of it underground for safekeeping.
Smith notes that fixed and circulating capital have to work together to generate economic activity. Indeed, he presents a vision of the economy in which people extract circulating capital from nature, of which some gets consumed and some gets turned into fixed capital. (Housing construction is probably the clearest example of this: people take resources like wood from nature, circulate them throughout the economy, and then turn them into fixed housing.) Notably, buried treasure isn’t just a trope in books and movies: it was actually a very common way for people to deal with economic uncertainty, in situations when they could not trust banks to hold their deposits. But as Smith will soon explain, capital deposited in well-managed banks can remain safe, while also being lent out and leveraged to generate further economic activity. In contrast, buried treasure simply sits idle—and often gets lost or forgotten if its owner dies without recovering it. This is one reason why secure property rights encourage economic growth.
Themes
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