The first theme in The Wealth of Nations is that regulations on commerce are ill-founded and counter-productive. The prevailing view was that gold and silver was wealth, and that countries should boost exports and resist imports in order to maximize this metal wealth. Smith’s radical insight was that a nation’s wealth is really the stream of goods and services that it creates. Today, we would call it gross national product. And the way to maximise it, he argued, was not to restrict the nation’s productive capacity, but to set it free.
Another central theme is that this productive capacity rests on the division of labour and the accumulation of capital that it makes possible. Huge efficiencies can be gained by breaking production down into many small tasks, each undertaken by specialist hands. This leaves producers with a surplus that they can exchange with others, or use to invest in new and even more efficient labour-saving machinery.
Smith’s third theme is that a country’s future income depends upon this capital accumulation. The more that is invested in better productive processes, the more wealth will be created in the future. But if people are going to build up their capital, they must be confident that it will be secure from theft. The countries that prosper are those that grow their capital, manage it well, and protect it.
A fourth theme is that this system is automatic. Where things are scarce, people are prepared to pay more for them: there is more profit in supplying them, so producers invest more capital to produce them. Where there is a glut, prices and profits are low, producers switch their capital and enterprise elsewhere. Industry thus remains focused on the nation’s most important needs, without the need for central direction.
But the system is automatic only when there is free trade and competition. When governments grant subsidies or monopolies to favoured producers, or shelter them behind tariff walls, they can charge higher prices. The poor suffer most from this, facing higher costs for the necessities that they rely on.
A further theme of The Wealth Of Nations is that competition and free exchange are under threat from the monopolies, tax preferences, controls, and other privileges that producers extract from the government authorities.
For all these reasons, Smith believes that government itself must be limited. Its core functions are maintaining defence, keeping order, building infrastructure and promoting education. It should keep the market economy open and free, and not act in ways that distort it.
The Wealth Of Nations begins with Smith explaining production and exchange, and their contribution to national income. Using the example of a pin factory, Smith shows how specialisation can boost human productivity enormously. By specialising, people can use their talents, or acquire skill. And they can employ labour-saving machinery to boost production. Then they exchange those specialist products, spreading the benefits of specialisation across the whole population.
How far and how fast the benefit spreads depends on how wide and efficient is the market. Often, employers try to rig markets in their own interests, and call on governments to help them. But the best interests of ordinary people are served if policymakers avoid such interventions and promote open competition.
Smith goes on to say that building up capital is an essential condition for economic progress. By saving some of what we produce instead of immediately consuming it, we can invest in new, dedicated, labour-saving equipment. The more we invest, the more efficient our production becomes. It is a virtuous circle.
Thanks to this growth of capital, prosperity becomes an expanding pie: everyone becomes richer. But capital can be lost, through mistakes, or theft, or profligate government spending. Governments should aim to allow people to build up capital in the confidence that they will enjoy its fruits, and should be aware that their own taxation and spending will eat into the nation’s productive capital.
Just as individuals gain from specialisation, says Smith, so do nations. There is no point trying to grow grapes in Scotland, when they grow so plentifully in France. Countries should do what they are best at, and trade their products. Restrictions on international trade inevitably make both sides poorer. Legislators think too much of themselves when they believe that by intervening, they can direct production better than the market can.
Smith is critical of government and officialdom, but is no champion of laissez-faire. He believes that the market economy he has described can function and deliver its benefits only when its rules are observed – when property is secure and contracts are honoured. The maintenance of justice and the rule of law is therefore vital.
So is defence. If our property can be stolen by a foreign power, we are no better off than if our own neighbours steal it. And Smith sees a role for education and public works too, insofar as these collective projects make it easier for trade and markets to operate.
Where tax has to be raised for these purposes, it should be raised in proportion to people’s ability to pay, it should be at set rates rather than arbitrary, it should be easy to pay, and it should aim to have minimal side effects. Governments should avoid taxing capital, which is essential to the nation’s productivity. Since most of their spending is for current consumption, they should also avoid building up large debts, with draw capital away from future production.
Smith’s world was very different to ours, of course, before the Industrial Revolution changed everything. At yet, by showing how the freedom and security to work, trade, save and invest promotes our prosperity, without the need for a directing authority, The Wealth Of Nations still leaves us with a powerful set of solutions to the worst economic problems that the world can throw at us. The free economy is an adaptable and flexible system, which can withstand the shock of the new, and cope with whatever the future brings.