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Book 2, 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
Depending on how it is used, the same amount of capital can command different quantities of labor and add different amounts of value to a nation’s annual produce. It can be used in four main ways: furnishing society with rude produce, manufacturing goods out of that rude produce, transporting produce and goods to wherever they are sold, and dividing produce and goods into smaller portions for distribution to customers. People who work in these four kinds of activity—farmers, manufacturers, wholesalers, and retailers—are productive laborers.
In this last chapter of Book II, Smith explores the concept of productive labor in more depth by breaking it down into a four-part taxonomy. Farmers, manufacturers, wholesalers, and retailers contribute to the economy in fundamentally different ways, but they are all necessary for it to function. Any government that wants to grow its national economy by supporting its industries must first understand how these four groups interact to provide goods and services. Then, it can more reliably decide how to apportion its limited resources among them.
Themes
These four groups use their capital stock in different ways. Retailers spend their capital buying goods from wholesalers, which replaces the wholesalers’ original capital investment. The amount retailers add to the nation is equal to their profits. Wholesalers spend their capital buying goods from farmers and manufacturers. In the process, they replace those farmers’ and manufacturers’ initial capital, and their businesses add to the economy in two ways: through their profits and through the wages of the people they employ to transport goods by land and sea.
Capital and commodities flow in opposite directions. Commodities flow from farmers and manufacturers to wholesalers, then retailers, then consumers. As payment in exchange for those commodities, capital flows from consumers to retailers to wholesalers, and finally to farmers and manufacturers. Value gets added to the economy at each step in the process, but this isn’t always a good thing. For instance, wholesale monopolies can add a lot of value to the economy by price gouging, but nobody benefits from this but the monopolies.
Themes
Manufacturers use their capital to buy the instruments (fixed capital) and materials (circulating capital) that they need to make their products, as well as to pay their workers’ wages. In this way, a fixed quantity of capital adds more to the economy in manufacturers’ hands than retailers’ or wholesalers’. But farmers put even more capital into motion and add even more to the nation’s annual produce than manufacturing does. Farming involves working with nature to create rude produce, and it generally yields far more value than the labor put into it. Thus, agriculture is the most advantageous use for capital.
Smith explains the reasoning behind the common wisdom that manufacturing and agriculture are the foundation of any nation's economy. Retail only yields profit, while the wholesale trade yields profits and wages, and manufacturing yields profits, wages, and productivity improvements (through fixed capital investment). Farming offers investors the most bang for their buck because capital invested in agriculture goes primarily to land improvement, which is a particularly effective form of fixed capital investment. Farming generates extra revenue and raises everyone’s standard of living by increasing the supply of rude produce. As that produce has to pass through wholesalers’ and retailers’ hands on its way to consumers, expanding the farming sector also expands the wholesale and retail sectors, multiplying its economic benefits.
Themes
The capital that goes into agriculture and retail trade must stay within a country, as they are tied to specific geographical locations. While wholesalers’ capital can go anywhere, it doesn’t much affect a country’s annual produce. Manufacturers’ capital goes into their production facilities, which they can choose where to locate. As this capital adds much more value to the economy, its location is very important. But foreign manufacturing capital can still boost a country’s economy (like how English manufacturing supports flax and hemp growers in eastern Europe).
Agriculture and retail always benefit the local economy, while the wholesale trade seldom does. Manufacturing’s massive economic benefits do not necessarily go to the same place where the capital behind it is located. This is why deindustrialization and offshoring are now such controversial topics in the wealthy countries of the Global North. Indeed, Smith’s analysis of manufacturing shows how the world economy was starting to integrate across national lines in his day and age, which enabled nations to specialize in different sectors, but also led to unequal development and the profound global inequality we live with today.
Themes
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Most countries simply don’t have enough capital to cultivate all their land, reach their manufacturing potential, and transport all goods to market. Such countries ought to prioritize their resources in that same order: agriculture, then manufacturing, and then exportation. This is the best way to build up enough capital to eventually reach capacity in all three sectors. England’s North American colonies have grown so wealthy so fast because they started with the most profitable business: agriculture. In fact, China, ancient Egypt, and ancient India are the only countries to ever reach their potential, and none of them excelled at foreign trade.
Smith conceives of economic development as a nation achieving its full economic potential. This requires investing in the activities that offer the highest returns—usually because they boost productivity in the long run—until there are no substantial improvements left to be made. Of course, there is no true end point to development, since technological and social progress can continue to increase productivity indefinitely. But in a developed nation, capital will quickly rush in to fund and scale such innovations, quickly making them competitive with the rest of the market. As Smith notes here, access to capital is the most common hindrance to this development. After all, once a nation builds up enough capital, its owners will naturally allocate it towards the most profitable ventures.
Themes
Different kinds of wholesale trade also employ productive labor and add to the annual produce to different extents. Rather than sending their ships or vehicles home empty-handed, wholesalers generally trade in both directions, buying one commodity and selling another. For domestic wholesale trade, both sources of capital are within the country, but for international trade, only one is. International voyages also cover vaster distances and often include many trading stops, so they take far longer to return and contribute to the home country. They can trade all sorts of goods on their stops, including gold and silver, which are generally cheaper to transport because of their high value by weight. The carrying trade—or trading purely between foreign countries—doesn’t benefit the home country, except through the merchant’s profit (if they spend it at home) and the sailors’ wages (if they are from the home country).
It’s helpful to think of trade as a link between two places that brings them into the same market and enables them both to benefit. From the perspective of national wealth, domestic trade is preferable because it allocates resources more efficiently across the nation and all of the revenue from it goes into the national economy. In Smith’s day and age, overseas journeys took so long that the higher returns from international trade were not necessarily competitive with domestic trade. (In Book IV he will examine these dynamics in more detail, particularly as they pertain to the global trade in grain.) But modern shipping, aviation, rail, and automobile technology has fundamentally changed this calculation.
Themes
In general, then, it is more productive for a country to invest in domestic trade than foreign trade or the carrying trade. Still, exportation is useful when a country produces more of a good than it needs. Some countries over-import and re-export goods, like Britain with tobacco. When a country has even more capital than it needs to support its productive labor and total consumption, that capital tends to go into the carrying trade, which is thus a reflection of national wealth. This is why Holland and England dominate it. The carrying trade can expand infinitely across the world.
Smith argues that nations should prioritize domestic trade in general, but this doesn’t mean that they should entirely neglect foreign trade. Rather, just as nations should maximize their investment in agriculture before turning to manufacturing, they should also maximize their domestic trade before turning to the foreign or carrying trade. Of course, merchants may still choose to export goods before the domestic market is saturated, if consumers in other countries are willing to pay a much higher price.
Themes
People with capital decide where to allocate it based only on profit margins, and not on what is best for the economy as a whole. Thus, they tend to overinvest in manufacturing and trade—which make it easier to build a fortune in a single lifetime—than in agriculture, which still adds the most value to the economy. The next two books of this work will try to explain this chronic European underinvestment in agriculture.
Much like the sailors and soldiers that Smith discussed in Book I, Chapter 10, the investors he describes here systematically forego the economically rational choice because of greed and overconfidence. Just like their tendency to seek monopolies, employers’ tendency to seek massive fortunes (rather than steady long-term returns) limits the economy’s overall growth. In the rest of the work, he will look in more depth at how governments can counter these tendencies.
Themes
