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Book 2, Chapter 2
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
Some labor is productive, because it adds value to the object it acts upon, and some labor is unproductive because it does not. For instance, manufacturers’ labor is productive because it adds value to the things it creates, which can then be sold to procure a greater quantity of labor, while menial servants’ labor is unproductive because it doesn’t “leave any trace or value behind.” Government officials, soldiers, “churchmen, lawyers, physicians, men of letters,” and entertainers are also all unproductive laborers.
Like the distinction between fixed and circulating capital, the difference between productive and unproductive labor may seem fuzzy or confusing at first, but it is absolutely essential to understanding what makes the economy grow. Productive labor generates revenue, which usually means it is a net positive for the economy: the productive worker creates at least as much value as they are paid in wages. In contrast, unproductive labor is like luxury consumption: it just eats up the invested capital. This is why the balance between productive and unproductive laborers shapes economic growth. But this doesn’t mean we should simply do away with unproductive labor, much of which is absolutely essential to the functioning of society. In fact, many contemporary critics reject the notion that the labor that happens at home is truly unproductive, because no productive economic activity could take place without it. Many feminist scholars see this distinction between productive and unproductive labor as a key tool for writing women out of economic theory.
Themes
The more a country’s laborers are productive, the more it will produce in the future. Indeed, its annual produce must maintain all its laborers, both productive and unproductive. One part of this produce goes to replace the capital stock used up in production, which means it must go to productive labor. (However, once they receive that money, productive laborers can in turn choose to spend it on unproductive labor.) A second part goes to the producer’s profits, and a third part goes to the landlord; these can go to productive laborers, but they mainly go to unproductive laborers and people who do not work.
Productive labor expands the nation’s capital stock by generating more revenue than was invested in it. In contrast, unproductive labor shrinks the capital stock, because the capital invested in it does not yield returns. Thus, one valuable way to raise economic growth is by reducing the proportion of unproductive labor (and making the unproductive labor needed to fulfill crucial social functions as efficient and low-cost as possible). Smith’s point about the way money circulates is also crucial here: every laborer, employer, and landlord can choose how to spend their wages, profits, or rent. Their basic subsistence expenses on food, clothing, and provisions are generally unproductive. But they generally have discretion to spend their excess income on either productive or unproductive labor, as they see fit. The more they spend on productive labor, the better it is for the economy.
Themes
Thus, the proportion of revenue that goes to replace capital helps determine the ratio of productive to unproductive labor. This portion is high in 18th century Europe, both in agriculture and trade, but was much lower in the past. This means that more and more Europeans have become productive laborers over time. The difference between trade and manufacturing towns where most of the people are industrious and ones that live off revenue, where most people are idle, is abundantly clear in Europe. English and Dutch towns are usually the first, and French and Italian ones the latter. In general, “the proportion between capital and revenue [...] regulate[s] the proportion between industry and idleness.”
Like Smith’s analysis of falling grain prices in Book I, his analysis of Europe’s shift toward more productive labor demonstrates its steady economic growth. Smith will later explain in greater depth how English and Dutch governance and Protestantism encouraged industriousness and the development of commercial societies. His conclusion about “the proportion between capital and revenue” is that the more revenue a given amount of capital generates, the more it was invested in productive labor.
Themes
People can grow their capital by saving a portion of their annual revenue to invest. This enables them to employ more productive labor and increases the value of their annual produce. Rich people may spend some of their revenue on productive labor, but frugal people save that money so they can employ productive labor in perpetuity. Irresponsible people spend it away, destroying their (and their country’s) wealth. When a country’s annual produce shrinks, it starts to have too much money circulating, and some of it goes abroad. Conversely, as a country’s annual produce grows, more and more money flows into it.
Capital is merely the portion of revenue that gets invested rather than consumed, so any worker with disposable income can choose to start investing some of it as capital. Smith also points out that money follows economic activity, rather than generating it: money flows into prosperous countries and out of declining ones. This once again foreshadows his case against the mercantilists by showing that they confuse cause and effect. Increasing the money supply (or amassing gold and silver) will not cause a nation’s economy to grow.
Themes
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Frugality is thus a public good. It’s also the most reliable way for people to better their financial condition, and so it tends to predominate. Most private business ventures are prudent, and most businesspeople manage to avoid bankruptcy. The same isn’t true of public funds, which tend to be spent on unproductive workers. When their number grows too high, the economy starts to shrink. But responsible private individuals generally outnumber and compensate for “the public extravagance of government.”
Today, the stock market makes investing one’s disposable income easy, but in Smith’s time, it generally meant launching a business, investing in someone else’s, buying banknotes, or becoming a smalltime merchant by purchasing and reselling goods. His analysis shows that the distinction between workers and employers is not fixed; indeed, the large population of independent merchants and investors in Britain was one of the main reasons for its democratic innovations and imperial ambitions over the centuries. And his suspicion of public spending persists in debates over policy today—even though he will also point out in Book V that many forms of public spending are actually the most productive investments a country can make.
Themes
Increasing a nation’s annual produce requires additional capital stock. Nearly all countries steadily increase their capital stocks and revenues during peacetime. England grew steadily over the previous few centuries, and it would be far richer if it hadn’t waged so many unnecessary wars. But private frugality was enough to compensate for public wastefulness.
Again, Smith’s arguments lay the foundation for today’s common economic wisdom: peace is good for markets, while wars destroy them. Indeed, for Smith, war is the paradigmatic example of wasteful public spending. He will explore and quantify its destructive effects in Book V.
Themes
People who spend on long-lasting products end up wealthier than those who spend on perishable ones. The same applies to a nation. For instance, the houses and furniture built for the wealthy can eventually pass into the hands of the middle class. Buying durable things is easier to stop and employs more people than simply paying unproductive laborers.
It’s tempting but misleading to evaluate products solely by price. Rather, consumers should think in terms of cost per use and the relationship between price and quality. While it's still a form of consumption rather than investment, buying quality goods is like an investment because it helps people forego additional expenses in the future. Middle-class people’s tendency to move into wealthy people’s houses shows that income and wealth levels are growing across society. In the 21st century, this tendency is still the norm in much of the developing world, but housing crises in the developed world mean that people are actually transitioning into worse and worse housing.
Themes
