The Wealth of Nations: Book 5, Chapter 1 Summary & Analysis

Militias can rise to the level of standing armies in some instances, but Smith’s analysis suggests that they face a significant disadvantage in the early part of a war. Yet his predictions about the American Revolution were remarkably accurate, and they show that an army or militia’s level of skill, discipline, and morale can vary widely depending on the circumstances. For instance, the American militiamen stood to gain far more from winning the war than Britain’s soldiers did from losing it, which certainly affected morale.

The Punic Wars again show how an untrained militia can turn a war around after a series of early defeats, but the sacking of Rome shows how military success led to complacency and undermined military readiness. But if Rome had kept a standing army of trained soldiers instead of a militia, it may have successfully defended itself. Indeed, this is similar to the logic of competition and monopoly: competitive firms are the best-run and most efficient, while firms with monopolies grow complacent and inefficient. Herding nations’ militias are stronger for the same reasons Smith outlined above: they tend to obey the same leaders in peace and war, and they generally spend significant amounts of time fighting, so gain training equivalent to a standing army’s.

Even if militias can sometimes outmatch standing armies, they are no substitute for a nation that wants to be sure of its ability to defend itself. After all, capital owners need a guarantee of security in order to be sure that they will see the returns from their investments. Smith’s vision of a disciplined standing army controlled by the sovereign, which can deter revolutions rather than launching them or having to suppress dissent to prevent them, is fundamental to most modern democracies.

Not only do the military’s gains from specialization follow the same logic as economic development in general, but with the rise of advanced military technology, economic development also determines who wins wars. Smith sees the domination of the poor by the rich as a civilizing influence, because it can prevent random violence and spread the institutions that make rich countries rich, but his analysis of colonialism also suggests that these same factors can encourage oppressive monopolies.

The justice system develops as the division of labor progresses, much like the military (and every branch of the economy). Specifically, it depends on the accumulation of capital, the same development that makes investment and economic growth possible, but also brings about economic inequality. Hunters’ livelihood is organized around labor, while herders’ depends on property (their livestock), so it’s little surprise that herders have more unequal societies with more robust systems of justice. But these justice systems still do not need to be professionalized, with lawyers and justices in charge. Rather, the existing social hierarchy simply resolves disputes, in addition to governing society.

Judges have a strong incentive to abuse their power, which blurs the line between justice and corruption. In fact, the herding tribes’ system may be the  epitome of corruption, as it combines political, economic, and juridical power in one person’s hands. The solution to this corruption is clearly to separate judicial fees from judges’ earnings.

As Smith noted in Book I, honor is one of the factors that can reduce a job’s salary, since people are willing to do prestigious work for less than the market value of their labor. This is still common today: in many countries, wages are significantly lower in the public sector than the private sector, but public sector jobs are still prized.

Both the English and French systems are less than ideal, as tying pay to any kind of performance metric simply incentivizes people to maximize that metric (while their actual performance suffers). Even today, lawyers still go to great lengths to maximize their billable hours. But on the other hand, simply paying legal professionals a flat salary risks removing any incentive for them to do their best work.

The separation of powers is based on the same principle as the division of labor, applied to government. The more that different people can specialize in different governing functions, the more effective they—and the overall system—are likely to become.

The bulk of this chapter will focus on infrastructure, state-chartered corporations, schools, and churches. While these may often be privately-run today, Smith sees them as essential public services that the government must provide, both to support the economy and to ensure that citizens live dignified lives. 

Major projects like roads, bridges, ports, and now airports and transit systems greatly reduce the cost of doing business. No country can grow economically powerful without this kind of infrastructure—although it’s no coincidence that major commercial centers like London are generally port cities that require less of it. Smith’s point about classifying infrastructure projects separately from the general revenue may seem like a minor accounting issue, but it’s actually crucial. It means that infrastructure investment actually pays off for the government in the long term, so as long as it can afford the initial capital expenditure, it should practically always pursue them. Many of the other people who live at the government’s expense (like soldiers and judges) are unproductive laborers, but the people who build infrastructure are among the most productive laborers in the whole economy.

Smith continues to lay out specific policy proposals that he hopes Britain can use to govern more wisely. He once again implies that Britain is foolish not to charge seigniorage, and he proposes proportional tolls so as not to disadvantage smaller shipments. After all, merchants could game the system otherwise, for instance by transporting all their goods together in particularly large shipments to save on toll costs (and deprive the government on revenue). The same principle applies to shipping mail through the post office. Still, Smith’s principle that public services should be publicly owned remains controversial—for instance, Britain privatized its postal service in 2013.

Each kind of infrastructure project has its own particular requirements, and advancements in technology have significantly changed them. But the principle behind Smith’s analysis is still clear and relevant: the closer the correlation between what yields profit and what benefits the public, the more reasonable private ownership becomes. Canals cannot function without a profit motive, but roads cannot function with it.

The comparison among Britain, France, and China is a clear example of how different governance systems shape the quality of infrastructure—and, in turn, the ease of doing business. Smith’s proposals for Britain’s roads show that facilitating commerce is more important than maximizing tax revenue. After all, the growth in trade will generate extra revenue in its own right. And his proposal to let local governments oversee roads once again suggests that infrastructure ought to be managed by the people who have the greatest, most direct economic incentives to keep it in good working order for the public.

Readers already know that Smith supports a competitive system of private enterprise in most sectors of the economy, but international trade involves many special considerations that justify some level of government involvement. In this section, Smith will explain how European governments have privatized the dimensions of international trade that should be public (like tax collection), while giving monopolies to publicly-chartered companies in the areas of trade that should be private. Even if trading nations may no longer build forts or charter exclusive companies, Smith’s commentary is still relevant. After all, ambassadors and trade associations are still important today.

Regulated companies are similar to the corporations (or guilds) that Smith decried in Book I. Merchants must pay to join them if they want to participate in a certain branch of international trade. And if they did maintain forts to protect British merchants and their cargo, Smith suggests, maybe they would be viable. But instead of facilitating commerce, these companies just act as monopolies to various degrees. Smith clearly thinks that they should be dismantled, so that merchants can trade freely. Moreover, by comparing them side-by-side, Smith points out that one company’s loss is another’s gain. For instance, the Turkey Company’s monopoly makes trading with Turkey undesirable, so merchants are likely to put their capital into trading with other countries instead.

The publicly traded joint-stock company was a relatively new invention in Smith’s time. He had no way of knowing that it would become the dominant structure for businesses in the centuries after his death, or that the concept of limited corporate liability would become so widely accepted as to be taken for granted throughout the world. Of course, none of this invalidates Smith’s critique of limited liability—which many contemporary legal scholars share.

The Royal African Company’s monopoly was specifically for the slave trade—in fact, it was most likely the largest slave-trading institution in human history. Smith only addresses this in passing, but contemporary readers should pause to consider the implications of his analysis. Today, we often assume that Europeans enslaved Africans because this was cheaper for them, and the slave trade was profitable. But actually, the Royal African and South Sea Companies went bankrupt. In other words, Smith suggests that the transatlantic slave trade was not just inhumane but also a disastrous business mistake that didn’t even benefit the enslavers.

The East India Company is only staying afloat because it has seized land and resources by force. Its profit comes from plunder, not productive trade. Smith’s analysis of the East India Company is also interesting in historical perspective. He was writing at the very beginning of more than a century of Company rule in India, which only came to an end when Indian soldiers in the Company’s army mutinied against its extreme cruelty and poor governance. The crown was forced to take India over, in an attempt to clean up the Company’s proverbial mess. In this way, Smith encourages us to rethink the commonsense distinction between private corporations and public institutions. The East India Company’s history shows how the corporate system privatizes the gains from commerce, while forcing the public to bear the costs.

Smith sees the majority of joint-stock companies as mismanaged disasters, in large part because of the concept of limited liability.. This is yet another reminder that, even if Smith’s analysis of free and competitive markets is the foundation for how experts think about the economy today, this doesn’t mean he would favor expanding corporate power or agree with the way our economic institutions are run today. He only supports joint-stock companies in banking, insurance, canals, and aqueducts because he sees any other corporate structure as unlikely to raise the requisite amount of capital.

Smith spent his whole career as a scholar and professor, so his remarks on education are grounded in his personal experiences and frustrations. For instance, he famously complained that the teaching at Oxford was far worse than at the much poorer University of Glasgow because Oxford’s wealth and fame made its professors complacent. This is part of why he supports tying teachers’ compensation as directly as possible to their performance. That system would make education more competitive, reward the best teachers, and better serve students. Unlike in many of the other sectors that Smith covers, university administration has not unified around a single model. For instance, American universities are more likely to have endowments today, while German ones generally depend on annual public funding.

Even as he praises universities for teaching important but impractical knowledge, Smith is remarkably critical of his own profession. Indeed, his analysis of university philosophy curricula reveals his professional biases. Contemporary readers may be surprised to see him argue that the most significant philosophical research was happening outside of universities, since today virtually all philosophy happens within them. But Smith suggests that his contemporary universities merely repeat what philosophers thought in the past, without actually teaching students to think philosophically.

Smith’s call for practical rather than liberal education may seem strange, but his point is that universities don’t truly provide a liberal education either. And his disdain for wealthy young people’s Grand Tours around Europe is curious, because he spent three years taking his young patron on such a tour before starting to write this book.

Putting aside Smith’s prejudices against music, he clearly thinks that Greece and Rome offered citizens a better education than modern England because they treated it like a competitive market. This enabled the best teachers to rise to the top, reach more students, and spread their ideas. The best ideas would thus spread the furthest. Smith also points out how, unlike modern education, ancient education taught critical thinking and drew clear connections between theory and practice. There is little doubt that curricula have moved back in this direction since he was writing in the 18th century.

Like so many of Smith’s other observations, these comments clearly no longer apply to the present day, when professorships are coveted and education is no longer gender-segregated. But again, the basic principles behind his argument still make sense. Namely, the more practical, specialized, and personalized the education, the closer relationship there is between the quality of that education and students’ life outcomes. Accordingly, teaching will be more competitive and superior in quality.

Readers may be shocked to hear Smith argue that the division of labor, which he has consistently praised throughout this whole work, actually makes people “stupid and ignorant.” Only universal public education can ensure that specialized workers know about the world outside their narrow area of focus. And humanistically-minded readers may ask whether a wealthy society full of “stupid and ignorant” people is truly preferable to a poorer but wiser one. Indeed, critics of capitalism have long seized on this point as a key issue with building society around the division of labor.

The division of labor may make most people “stupid and ignorant,” but it gives a select few the opportunity to specialize in acquiring knowledge and using it for the public good. These people, of course, are philosophers. (In Smith’s time, philosophy comprised much more than it does today—including most of the disciplines now taught in the modern university.) Unfortunately, access to intellectual life depended on social class, but society could move marginally towards educational equality by providing public education to all—and additional opportunities for the most capable youth.

At the beginning of this chapter, Smith outlined the difference between a militia and a (more effective) standing army. Here, he proposes building training into the education system in order to have both: a larger citizens’ militia to supplement a smaller, specialized army. His comments about stupidity and ignorance indicate that public education also helps people make better collective decisions and keep the government accountable.

Some countries (including the UK) still have a state religion and government-supported churches, but the vast majority of the world’s population now lives in legally secular states. But even if religion is no longer the state’s responsibility and religious education has grown less important in many places, Smith’s discussion of it can still help us understand why some organized religions are growing today (and others are shrinking). As with schools, he analyzes religions as a competitive market, with their success largely depending on how closely they connect with their followers’ lives.

David Hume was a close friend of Adam Smith’s and arguably the central figure of the Scottish Enlightenment. Like many other philosophers throughout history, he recognized religion’s great moral, social, and emotional power over people—and argued that a healthy society needed to use that power for good rather than evil. His distinction between intrinsically valuable and state-regulated professions is really just the distinction between work that serves private and public interests.

On Hume and Smith’s view, religion’s power is never truly politically independent. Even when religious sects don’t fight for power, receive money from the government, or take specific political stances, their influence always depends on the ruling political institutions. And when they do get involved in government, they can easily sow conflict. These are all good reasons to regulate them.

People still commonly view elites as sinful, decadent, greedy, and out of touch. Smith chalks this up to economic class divisions—and specifically the distinction between living off capital or land and living off wages. Education and entertainment for the public can help bridge this gap, but it’s not clear to Smith if the people will eventually get tired of their rulers’ lavish lifestyles and overthrow them. While this wasn’t quite what was happening in the American colonies, it would occur forcefully a decade later in France, during the French Revolution. Turning zealots into entertainers is a way to make them support broader social goals instead of challenging them.

Even if their ultimate goals and interests differ, Smith suggests that the church and the state both benefit greatly from remaining unified. If economic elites join them, they can typically form a stable ruling class for generations. But effective government requires achieving this kind of stability, without the corruption that so often accompanies it. While there’s no concept of democracy anywhere in Smith’s work, his argument for persuasion over violence shows that he does see the consent of the governed as crucial to the state’s legitimacy.

In many respects, the church’s traditional structure resembles the feudal system. It simply collected rents without doing any work, and it consumed or hoarded its surplus instead of investing it in economic improvements. For most of Europe’s history, the church was the most powerful institution throughout the continent because it was the only one with a foothold in virtually every community. As compared with the weak, absent, or indifferent monarchs who ruled in theory, the church was the state.

Smith encourages his readers to view the Protestant Revolution in historical perspective, as part of the broader process of social transformation that brought the Middle Ages to a close. The feudal system and the church’s power declined in lockstep, as the division of labor made it possible to trade with or invest an agricultural surplus (instead of just hoarding or consuming it). This encouraged clergymen to squeeze the greatest possible surplus out of their property, which in turn enabled agricultural improvements to drive further growth. In many cases, the clergy’s tactics backfired, and citizens took the opportunity to seize more political and economic power for themselves. Today, many historians see the city-states that formed during the Reformation as the first true democracies in Europe since antiquity.

Due to the Protestant Reformation, different European countries took different approaches to political and economic management. The Lutherans and Church of England adopted a structure reminiscent of the Catholic Church from which they broke away.

Competition may benefit the economy as a whole by rewarding the most successful firms, but it’s undesirable within the church, whose power depends on its unity. Still, the Calvinists’ humility and dependence on the people for their power made them more effective religious leaders. They had to actually provide a valuable service, because they lacked strong institutional backing. Smith’s point about university versus church employment reflects this: as the best scholars go to whichever institution treats them the best, society benefits greatly from having a stronger university system than church system. Indeed, the Reformation’s success in Scotland partly explains why the Scottish university system was so successful—and produced so many significant intellectuals like Smith.

Even if some of the church’s activities benefit the public, it still mostly just enriches itself at the public’s expense. Tithes mean that people essentially have to pay rent twice, once to landlords and once to the clergy. They keep less of their own revenue, so it becomes harder for them to build wealth (and accumulate the capital that they must invest for the economy to grow). Smith will explore the consequences of taxation much more in the next chapter, but suffice it to say that the less the government and church spend in order to provide essential services, the better it is for the population. For instance, if tithes cover all government expenses in Switzerland, then there is no need for additional taxation—and the people can keep more of their income.

In economic terms, political leaders are unproductive laborers. Their work doesn’t yield a direct revenue, and so the state has to cover their expenses. They maintain close relationships with other social elites not just out of vanity, but because they depend on that class’s approval in order to stay in power and govern. Inequality makes this even more extreme, and it’s not uncommon for monarchs to ruin their national economies by living well beyond their means, just because nobody can stop them.

Smith concludes by briefly returning to each of the activities he thinks the government should perform, as well as breaking down how it should structure its accounts. In each case, he argues that the population who benefits from a public good should be the one who pays for it. This is why everyone should share the cost of defense and administration, but only the people who use roads and educational institutions should have to pay for them. Of course, modern nations have dealt with these challenges in a variety of ways, with some developing much larger centrally-funded public sectors than others.