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Book 4, Chapter 8
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
No government has ever actually adopted the agricultural system of political economy, which equates a country’s revenue and wealth to the rude produce generated by its land. But French philosophers have advocated the system because Louis XIV’s government followed the mercantile system, banned grain exports, and devastated French agriculture. The agriculturalists divide people into three groups: landlords, farmers (or the “productive class”), and manufacturers and merchants (or the “unproductive class”). Agriculture requires landlords to invest in improving their land, and farmers in planting and cultivating it, so the cost of these investments—plus the land rent and an ordinary rate of profit—should be exempt from taxation.
Having concluded his critique of the mercantile system, Smith turns to its only significant competitor in 18th-century Europe: the French physiocrats’ agricultural theory. This model was new but would prove short-lived, as Smith’s theory would soon take its place as mercantilism’s primary challenger. The physiocrats would be largely forgotten, but as should be clear here, many of their ideas lived on through Smith’s work. Most importantly, Smith analyzes society in terms of the same basic classes and agrees that agriculture is the foundation of the economy, so mass land improvement is the best kind of investment a government can make.
Themes
The agricultural system treats artisans, manufacturers, and merchants as having zero overall impact on society’s annual revenue. They generate some revenue by manufacturing goods and exporting rude produce, but they withdraw the exact same amount back from the economy in the form of their wages. They only contribute to the national revenue if they earn less in wages than they need for subsistence. Yet they perform an important function by selling rude produce and supplying people with manufactured and imported goods. This indirectly supports landlords and farmers by enabling them to focus their time, energy, and capital on agriculture.
Smith disagrees with the agricultural system on this point. For the agriculturalists, manufacturers and merchants just transform rude produce and move it around, but they don’t add any real value to the economy. But for Smith, artisans, merchants, and manufacturers do add value to the economy. In fact, he sees manufacturing as offering the greatest productivity gains of any economic sector. While the agriculturalists’ perspective might have made sense in agrarian 18th-century France, modern readers will be well aware that non-agricultural sectors of the economy do far more than just save farmers time.
Themes
Since the so-called unproductive classes live off society’s agricultural surplus, it is unwise for them to oppress farmers and landlords. Similarly, unproductive merchant nations like Holland and Hamburgh support but also live off of the productive agricultural nations. Such agricultural nations benefit from free trade, which enables their manufacturers to improve, compete, and ultimately offer better and better goods for lower and lower prices. This grows the surplus of rude produce, manufactured goods, and capital, which eventually enables nations to start exporting goods and competing with one another.
The agricultural system’s vision of economic development resembles Smith’s in some important ways, including its emphasis on free trade and its principle that agriculture develops first, then manufacturing, and then trade. It also shares his observation that landlords and farmers’ interests align with what is best for the economy overall, while merchants’ and manufacturers’ do not. But it cannot account for his analysis of the gains from trade, which depends on different nations’ inherent advantages at producing different kinds of goods. Holland and Hamburgh don’t live off trade because they can’t farm, but because they have shifted from agriculture to more productive activities for which they’re better suited. Similarly, Amsterdam’s innovations in banking didn’t just help farmers move around their produce more efficiently, but actually drove economic growth throughout Europe by offering people a more secure way to store their wealth.
Themes
But agricultural nations that impose import duties and restrictions hurt their own agricultural sectors in two ways. First, by raising the price of foreign goods, they correspondingly raise the real price of their land’s rude produce. Second, they give a monopoly to domestic manufacturers and merchants, whose profit rates rise. This draws capital away from agriculture at a stage when land improvement is still the most productive investment for society. Yet just as the human body can flourish under a range of different diets and circumstances, owing to its natural propensity for self-preservation, human societies can prosper even under oppressive regulations or governments, due to people’s natural desire to improve their condition.
Smith largely agrees with this aspect of the agriculturalists’ argument: it’s inefficient to make imports more expensive and prop up industry before a nation has fully exploited its land. This shows that the agriculturalists also support free trade and oppose monopolies—although they always ultimately explain their goals in terms of supporting agriculture, and not in terms of their policies’ overall economic effects. Moreover, the agriculturalists share Smith’s view of markets as self-regulating: in the aggregate, people will respond to whatever constraints are put on them by making the decisions that will maximize productivity and wealth.
Themes
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The agricultural system is wrong to call artisans, manufacturers, and merchants unproductive. Even if they don’t produce a surplus like farmers, they still generate enough revenue to replace their capital investment and living expenses. This distinguishes them from truly unproductive labor, like menial servants and soldiers, whose work doesn’t yield any sellable goods. Indeed, a society can increase its annual revenue by either making labor more productive or increasing the total amount of labor. But machinery and training make it easier to increase productivity in manufacturing than in agriculture, and the agricultural system supposes that merchants and manufacturers are better than farmers at setting aside part of their revenue to pay for more laborers. Lastly, if a country’s revenue is really only measured by the number of mouths it can feed, as the agricultural system claims, then manufacturing and trade contribute to this by funding food imports.
The problem with the agricultural system is that it views merchants and manufacturers as unproductive. But in reality, the value of manufactured goods is more than just the cost of the materials and labor that goes into them. Rather, merchants and manufacturers’ work adds significant value to the economy by giving people access to specialized goods that meet their specific needs. For instance, the value of a knife is much more than the cost of the metal that goes into it, plus the time that an artisan spends crafting it, because it can help people perform all kinds of more specialized activities. In contrast, for Smith, the division between productive and unproductive labor is about revenue, not goods: the knifemaker is productive, even if energy or their material inputs get lost in the manufacturing process, because the economic value of what they produce is at least as much as their initial investment. Perhaps most importantly, the agriculturalists miss Smith’s insights about the benefits of specialization and the way productivity gains from manufacturing can drive rapid economic growth.
Themes
Despite its errors, the agricultural system is still the most accurate theory of political economy. It wrongly views merchants and manufacturers as unproductive workers, but it rightly defines a society’s wealth as the total product of its labor (rather than its reserves of money) and promotes “perfect liberty” in both domestic markets and international trade. This theory’s backers have helped improve France’s agricultural policies. Notably, while Europe has favored manufacturing and trade over agriculture, China favors agriculture instead, manufactures primarily for the domestic market, and conducts very little foreign trade. More foreign trade would benefit China, but its domestic market is as large, rich, and diverse as all the European markets put together. Ancient Egypt and India also favored agriculture and invested heavily in irrigation, while implementing elaborate divisions of labor through hereditary caste systems and conducting foreign trade (but only via other countries’ ships).
Smith views the agricultural system as an intermediate step between the dominant mercantilist theory and his new, more accurate one. While the agricultural system makes a serious mistake in classifying merchants and manufacturers—which will leave it poorly-suited for explaining the dynamics of a complex industrial economy—it generally understands development and trade correctly, so it usually leads to effective policies. The examples from India, China, and Egypt show how investment in agriculture was the key to early societies’ wealth, because it generated surpluses that enabled specialization throughout the economy. These countries’ lack of trade was not nearly as significant a hindrance as their investment in agriculture was a boon.
Themes
The sovereigns in China, Egypt, and India invested in agriculture largely because their revenue came from land taxes. Ancient Greece and Rome also preferred agriculture, but only because they discouraged trade and manufacturing (which was reserved for enslaved people, who do best by working as little as possible and keeping out of trouble, rather than working hard and innovating). As a result, fine cloth was incredibly expensive in Rome and Greece.
Smith foreshadows some of the arguments about taxation and economic policy that will take center stage in his final book. Land taxes encourage agricultural investment because they reward the government when land values rise. The best way to raise land values is by making agriculture more productive, and the best way to do that is by investing in land improvement. The Greek and Roman policies were less wise, but they had a similar effect because they also encouraged anyone with capital to invest to put it into agriculture.
Themes
The exchange of rude produce from the countryside for manufactured goods from towns is still the foundation of economic growth. As a result, anything that makes manufactured goods more expensive also makes rude produce cheaper, which disincentivizes investment in agriculture and thus slows growth in the whole economy. Thus, it’s foolish to try and promote agriculture by restricting trade and manufacturing. But it’s also foolish to promote trade and manufacturing when a society can still benefit more from investing in agriculture instead.
Limiting the price of rude produce may seem beneficial, since it benefits consumers, but it hurts overall economic growth because it gives investors little reason to invest in land improvement. In a society with improved land, rude produce grows cheaper because it becomes abundant and the economy grows. But the Greek and Roman policies just artificially held down rude produce prices, creating a disincentive for investment across the board.
Themes
Indeed, societies naturally invest their capital in the most productive way available to them, so every well-intentioned system that tries to reallocate capital toward certain kinds of investment will ultimately slow economic growth instead of promoting it. “The obvious and simple system of natural liberty” is the best solution: everyone should be allowed to pursue their private interests, and the government should only be in charge of the national defense, the legal system, and any necessary public institutions that would not be profitable to run privately. To pay for these functions, the government must collect revenue, which is the topic of Book V.
Smith’s praise for “the obvious and simple system of natural liberty” may be his clearest defense of the free-market principles that would become his legacy. Since a competitive market naturally allocates capital and labor towards the most productive activities, economic governance should focus on creating and preserving this kind of market, rather than supporting the industries favored by people in power. But this doesn’t mean that the government should just stay out of the market—after all, powerful companies all too often tread on people’s “natural liberty” in order to secure and maintain monopolies, and no private company can build the roads or raise the army that an economically free country needs to function. Rather, Smith means that the government should design institutions that promote a competitive free market. Book V will explain how.
Themes
