Summary: The Wealth Of Nations — Adam Smith

According to Adam Smith in his book The Wealth of Nations, Society’s productivity is increased by creating a division of labor that permits individuals to specialize. The ensuing surplus can subsequently be exchanged or invested in accordance with one’s self-interest. This also serves society’s greatest interests, which is why the government should step back and let the free market flourish.

Adam Smith

A division of labor boosts production, while a marketplace allows workers to specialize.

Assume you want to build a factory to make pins and recruit an unskilled worker to do it.
Your worker completes all 18 stages in the process of manufacturing one pin by himself, with the result that he barely produces a single pin in a work day.
But what if you recruited a team of 18 unskilled people and divided the job such that each person specialized in one of the 18 steps?
Will the end outcome be only 18 pins each day? Not at all; the crew could generate almost 50,000 pins each day!

A division of labor significantly increases productivity. But how does it work exactly?
It takes time for a worker to switch between different sorts of employment. One individual may focus on one talent by employing a division of labor, transforming wasted time into productive time.
Furthermore, when people’s full attention is concentrated on a particular task, they are more likely to innovate. As a result of innovation, productivity grows.
For example, the earliest fire engines were much improved when a child used a string to open and close the truck’s water valve. Surprisingly, the boy’s previous responsibility was to physically open and close the valve!

As production rises, there is frequently a surplus of undesired items that may be sold away. For example, if a butcher has an excess of meat, he may exchange it for bread from the baker.
But what about items that aren’t in high demand? What if the baker isn’t interested in the butcher’s meat?
Money was established to solve this problem. The butcher may sell his meat to anyone is willing to buy it at the market and then use the proceeds to buy bread from the baker.

What happens if the butcher prefers cheese over bread? He could go to the market and buy cheese with the money he got from selling his meat.
In this way, people might specialize in their different crafts or fields, which is another kind of division of labor. A division of labor increases output, which in turn provides a market for craftsmen to exchange surplus goods.

The production of marketable commodities via labor is more significant than gold reserves in terms of a country’s wealth.

Nations used to assume that economic prosperity was largely determined by how much gold and silver they hoarded. This technique was known as mercantilism, and it dominated economic thought in the eighteenth century.
Furthermore, governments restricted imports through trade tariffs to prevent money from flowing out of the country, while encouraging exports through subsidies to allow money to flow in from other countries. This was referred to as protectionism.
This way of thinking, however, was founded on two erroneous premises.

First, it was thought that gold and silver were the ultimate wealth markers, whereas, in fact, these precious metals are tradeable commodities, just like grain or meat.
Second, it was thought that nations could only flourish by impoverishing their neighbors. Even if their neighbors are equally wealthy and affluent, nations will definitely get wealthier as a result of trade.
Labor is far more essential than gold and silver since only labor can generate tradeable goods or services. As a result, the quantity of effort involved in manufacturing an object represents its real value.

Let’s take a deeper look at why making things is beneficial to society.
Producing pins, for example, generates three types of income. Wages are paid to workers for their labor; earnings from selling pins are paid to factory owners, and rent is paid to the owner of the land on which the factory is constructed.
Stock is the end result of all work. The stock has two outcomes: part of it is used immediately to maintain the owner, but a portion of it may potentially be used to generate money on its own, in which case it is referred to as capital.
It is fixed capital if the capital remains with the owner in the form of a pin-sharpening machine.

If the capital must leave the owner’s hands in order to make a profit, such as a merchant’s stocks, it is circulating capital.
To summarize, a country’s wealth is determined by its capacity to create marketable products rather than its gold and silver stockpiles.

adam smith’s invisible hand visualized

At work is the “invisible hand”: behaving in your own self-interest can help society as a whole.

Many individuals regard selflessness as a virtue. However, acting in one’s own self-interest benefits not just the person but also the entire nation.
Let’s look at why this may be the case.
People have an inherent proclivity for self-interest. It is our self-interest, not compassion toward others, that drives us to trade.
Your neighborhood butcher or grocer does not provide you meat or fruit out of compassion, but rather out of self-interest; that is, they are interested in the money you pay them for their commodities.
This same self-interest motivates them to continually strive to provide high-quality items, lest you take your business elsewhere.

Thinking about their own long-term self-interest keeps them from exploiting clients by charging high prices or providing low-quality goods.
This type of self-regulation is an advantage of trade. This also implies that government control is only required when self-regulation is insufficient to prevent merchants from exploiting customers.
Individual self-interest can benefit society as a whole. When we have the cash to invest, we prefer to put it in home sectors rather than international ones because it seems safer.

Second, because we are self-serving, we will always invest our capital in a way that maximizes our profit.
Despite the fact that both of these acts are selfish, they can assist enhance social revenue overall. More money is invested in domestic industry, and capital is provided to successful businesses, which generate more income.
Because higher-income derives from more output, our capital investment is basically directing society to create more in general, resulting in even more wealth for the nation.
It’s as if an unseen hand is guiding us to promote the interests of society, even if this was never our goal!

Because a free market maximizes economic growth, the government’s participation in it should be restricted.

So, given that it is beneficial for people to act in their own best interests, where does this leave the government?
Simply defined, the government’s function should be restricted to a few duties.
Even during peasant revolts, a government should keep a standing army of professional troops to safeguard society against violence or invasion.

It should also uphold the rule of law by upholding legal rights and prosecuting offenses.
A government should also construct and maintain public works, particularly those that are too difficult or expensive for people to maintain, such as roads and bridges. Furthermore, the state should assist trade and education, such as by providing universal basic education.
A government should not go beyond this, as it would have a detrimental influence on economic growth.
Rather than taxing or regulating commerce, the government should support a free market in which buyers and sellers can freely purchase, sell, and trade across borders at any mutually agreed-upon price.

There should be no trade barriers or limitations, as in mercantilism.
Taxation should be reduced in a free market to pay just the expense of the government’s limited obligations. Individuals should pay taxes in proportion to their income, and anybody who profits from transactions should pay taxes on them.
A free market optimizes economic growth because people know what is best for them, and hence what is best for society, better than the government.

For example, while wine grapes might be grown in greenhouses in Scotland, it would be considerably more expensive than in France.
Based on the ancient adage that one should never create something at home that is cheaper to buy, any rational person would see that manufacturing wine in Scotland is pointless.
Nonetheless, under mercantilism, the government would have attempted to manufacture Scottish wine in order to avoid imported wine and boost wine exports.
A free market assists us in avoiding such expensive blunders!

A Quant Trader | Data Scientist | can I help you? linkedin.com/in/ali-h-askar