Adam Smith was a Scottish economist, philosopher, and author, and a very successful one at that. His masterpiece, the wealth of nations, was released in 1776 and was, at that time, considered very controversial. But, it has laid out the groundwork for pretty much all economics since.
Smith is often referred to as the “Father of Economics” or the “Father of Capitalism” for good reasons. The wealth of nations’ main message is probably that we must trust in incentives. Adam smith was a pragmatist who knew that people will always act in their own self-interests and, therefore, every economic policy introduced must always take that into account. Secondary and tertiary effects must always be considered. A society can do no better than to set up the correct incentives so that humans will act in the best way possible.
This is a top 5 takeaway summary of the wealth of nations, written by the Father of Economics, Adam Smith.
Takeaway #1 – Productivity is King
The people of a nation will be better supplied with all the products and services that they have a vocation for if one or two of the following happens:
-First, an increase in the number of people who have a job compared to those who don’t
-Secondly, an increase in the productivity of those jobs
This could be said to increase their wealth. It depends much more on the latter than the former.
Thousands of years ago our ancestors were employed. All of them. Every day everyone had the job of catching food for themselves. Yet, today, even the poorest people of a western civilization are wealthier than the kings and queens from those times. Consider this story:
A man was handed the task of inspecting the construction of the waterway in a certain communistic land. When he arrived at the site he saw a thousand people digging with spades, while great digging machines stood idle nearby. He asked the manager of the project, “Why don’t you use the machines over there instead?” “Well sir, that’s because these people would be unemployed in no time”. The inspector thought about this for a minute and then returned home. The next day he went back to the site and went straight to the manager. He handed him a spoon…”Why don’t you use a thousand of these instead?”
To the wealth of a nation, productivity is king. It is improved by three factors, primarily:
- Dexterity or skill in doing something
- Avoiding loss of time changing from one task to another
- Proper use of machinery
The first two factors come from the division of labor. Instead of having everyone in a society doing everything themselves, we should each do what we are best at and then trade products and services with each other. The greater the extent of this trade, or the greater the market, the greater the possible division of labor. Thereby, the greater the productivity. Just think about all these specialized products and services that we exchange with each other in a great city.
The division of labor increases as transportation is improved. Adam Smith gives an example from his experience in the 18th century. Six to eight men can, by water carriage, transport the same amount of goods in the same time with a single ship as a hundred men with 50 broad wheeled wagons and 400 horses. This is why rivers and seacoast towns often develop faster. They allow a greater division of labor as they extend the market of trade.
However, Adam Smith would be jealous if he looked at us today because now we have Amazon.
Takeaway #2 – Money: what is it and why do we use it?
When the division of labor is established, every man supplies himself with a small amount of the goods that he actually needs. Instead, he participates in exchanging. In the beginning, it must have been very inefficient to try to trade with one another, when supply and demand didn’t always match. Money facilitates the exchange of commodities that we produce. To get back to the first takeaway, one can say that they increase the productivity of exchange. Early in history, metals were used as money and they have at least two qualities that make them suitable for this purpose. Firstly, they hardly perish. Secondly, they can be divided into many parts and then fused again.
Some things have value in use, like spears, meat, salts, and shirts. Other things have value in exchange, like bills, coins, and metals. That which has a high value in one often is quite worthless from the other standpoint. For example, you can’t use a dollar bill for anything other than exchange, and, similarly, a spear might be quite useful but it doesn’t work well for exchange. As long as people trust that money can be exchanged for something else that they are in need of later, they are happy to trade their own produce for that money. It all boils down to that: trust. Warren Buffett has said that it is quite misleading that on the backside of every dollar bill it says, “In God We Trust” because what it should actually say is, “In the Federal Reserve We Trust.”
Takeaway #3 – The Three Components of Price
The real price of everything is its price in labor. Something that takes more time, energy, or resources often has a higher real price. There’s also a nominal price and that is the price as measured in money. As it’s difficult to measure and compare labor, we’ve come to estimate real prices in terms of money, instead. The price of everything that is produced can be separated into either one of the following three components:
- A wage, to pay the laborer who did the work
- A profit, to pay for the capital that was laid out for the work to happen
- A rent, to pay the holder of the land where the work and or exchange must take place
We all know that wages can differ a lot between different occupations. Similarly, profits differ from industry to industry, but not as much. Additionally, they should average out over time. This is something that will be covered later in the book summary. The factor that can differ the most is, of course, rent. In New York, for example, you’ll have to pay about five million dollars per acre of land, while in a country village in Sweden, you’ll pay only about twenty thousand dollars for the same amount of land.
How much you have to pay to buy land correlates well with how much rent you can get for it. Because of this, the proportions that make up the price of a certain product or service differs a lot depending on its type and where it is bought. For example, a massage costs sixty dollars an hour in Swedish villages, while it costs one hundred and five dollars an hour in Manhattan. The difference in price between the two locations can pretty much fully be attributed to the difference in rents and, some of it, in the difference in wages that are necessary to sustain someone in New York.
The price of a certain product or service is determined by supply and demand. Actually, it is determined by the effectual demand, which consists of demand for the product at a price that allows for the wages of workers, the profits and replacement of capital of businessmen, and often some rent for landowners. A perfect example of this is that you might want a Tesla. However, you might not be ready to pay seventy thousand dollars for it yet. This would mean that you are part of the product’s demand, but not the effectual demand that is required to bring the product to market.
Takeaway #4 – The Three Components of Price (Part Two)
A worker will always demand a wage so that he can at least purchase the necessities of life for himself and his family. This is the bare minimum, which even the simplest type of job must pay because otherwise such workers will cease to exist over time. In countries where no minimum wages exist, the simplest jobs will tend to be at this level and not higher. This is because workers are at a natural disadvantage when trying to bargain how much price should go towards their salary. They typically exist in abundance, when compared to capital and land. Therefore, they typically do not have much money saved, so they can’t afford to wait for a better opportunity. Importantly, though, salaries can differ a lot.
A businessman is someone who employs his capital to earn a profit within a specific trade or industry. The more capital that is employed in a certain industry, the higher the competition there becomes and the lower the profits tend to be. So it must be in society as a whole, too. Ff there are no intelligent ways to employ capital anymore, returns will be low. Over time, returns on capital will even out across industries. This is because where returns are high there will be incentives to move capital, and where returns are low there will be incentives to remove capital. This restores an equilibrium.
An owner of land will either try to sell his land for a profit or lend it out for a rent. Either way, someone down the line will eventually try to lend it out for a rent or use the land themselves. At this point, it is they who gain the rent. Rents vary a lot depending on location. Some types of land basically afford no rent at all, while those that people find attractive (land in cities or beautiful beach properties) earn a lot of rent. Something that should be noted is that rent is quite like a monopoly price. After normal wages have been paid, and the businessman has been able to replace his capital with a decent profit, the owner of the land will pretty much take what’s left. Land is immovable and irreplaceable. Therefore, it is different than two other types of revenues that can be earned.
Takeaway #5 – Why Some Jobs Pay More Than Others Do
Profits of industries should average out over time and more rent is given to the person who holds a property in a city or at a beach. Similarly, the wages of labor are decided by supply and demand.
The following five factors tend to increase the wages of a specific job:
- The expenses and difficulties of learning it
- The inconsistency of payments
- The trust and responsibility
- The improbability of success
- The hardship, dirtiness and disagreeableness of the job
In the 18th century, a blacksmith had to be an apprentice for many years before he was allowed to open his own trade. During this time, he earned very little or basically nothing at all. The higher wage that he got once finished is a compensation for those years. The apprenticeship helps to limit the supply of such workers.
A mason could only work during good weather conditions; therefore, his hourly wage had to be compensated for those idle hours.
A greater responsibility means that fewer people are suited for that type of work; therefore, wages are higher. In the past and still today, lawyers and doctors have such roles.
The improbability of success is another factor that matters. The expected wage of a job with a very high fail rate is often even lower than normal jobs, but the person who succeeds typically gets the salary of those who fail too. In the past, people searching for gold or treasure belonged to that category.
In the 18th century, the most dirty and disagreeable job one could possibly get was probably that of the public executioner. On the back of this, the pay was good.
Today, a difficult and expensive job to get would be a neurosurgeon. An inconsistent one might be that of a real estate broker. A job which requires a lot of responsibility is that of a pilot. Improbability of success is high among elite athletes and musicians. The dirtiest and most disagreeable job is probably that of a hedge fund manager.