Wednesday, January 22, 2014

The Wealth Of Nations, Book 2

Before we get on to Book 2, I'd like to add a couple of important concepts of basic economics that I omitted from the list in my post on Book 1.
  • Division of labor is a prerequisite for having an economy at all. If everyone is growing and/or hunting their own food, building their own house, making their own implements, then there is no economy.
  • Barter systems don't scale, so you need this stuff called "money".
Book 2 is titled "Of The Nature, Accumulation, And Employment Of Stock". I think that he defines "stock" as, "anything that someone owns that has value" -- so it can be produce, goods or money. Also, I think he defines "capital" as, "stock that has been invested with the expectation of it being used productively, rather than spent on expenses, and of it retaining its value and being returned in the future". In his words:
His whole stock, therefore is distinguished into two parts. That part which he expects is to afford him this revenue is called his capital. The other is that which supplies his immediate consumption ...
There are 2 ways of investing capital to yield a revenue or profit:
  1. "in raising, manufacturing, or purchasing goods, and selling them again at a profit." This he calls "circulating capital".
  2. in investing in land improvement, new machines, or other improvements to one's operation. This he calls "fixed capital". Later he says "The intention of the fixed capital is to increase the productive powers of labour, or to enable the same number of labourers to perform a much greater quantity of work."
An odd (and very dated) discussion at the end of chapter 1 about, of all things, treasure troves. In countries without much security, people would commonly bury their valuables, and then die or forget where they were buried. When a treasure trove was found, it belonged not to the finder, nor to the landowner of where it was found, but to the sovereign of the state! Sweet deal if you can get it, I guess.

In discussing the flow of money and capital, ("Money, ... the great wheel of circulation, the great instrument of commerce"), he talks about how the same money can be used to finance 3 or 30 transactions -- so there is a clear understanding of "multipliers", of which modern conservatives seem to want to deny the existence when it comes to government spending for fiscal stimulus.

He also talks about discounted "bills of exchange", which may correspond to modern default credit swaps, and about how they can get kited by unscrupulous bankers -- surely not! (Note, I don't know enough modern economics to know if these really are the same as default credit swaps.) He also talks about banks issuing their own paper money and thereby leveraging their gold and silver holdings. But, the reliance on precious metal reserves -- "The whole paper money of every kind which can easily circulate in any country, never can exceed the value of the gold and silver ..." -- is still there.

He also talks about "raising money by circulation", which I think was making short term low interest loans, but making them rapidly, so that the effective interest rate is driven up -- not sure I get that. He uses the term "projector", which I think means the same as "speculator".

Chapter 3 is very interesting. He introduces the concepts of productive vs unproductive labour. Productive labour is the good kind: it is factory workers or farmers producing things. They are being paid, but their wages are offset by their production, with profit normally additionally being generated. Unproductive labour, on the other hand, is the bad kind: it takes the wages, performs tasks, but produces nothing lasting. It includes what we would now call the service industry. Interestingly, also unproductive are: the king, the government, the army, the navy, the clergy, lawyers, physicians, scholars, actors, musicians. I think that, with the advent of recording, actors and musicians are no longer totally unproductive. ;->

I think tho, that this is another reason that Smith is down on government: he lived in a time when there were still kings and nobles who maintained courts whose primary function was to engage in conspicuous consumption. I think we'd all agree that's about as unproductive as you can get.

Here's a reference to a "proverb" which I have never heard:

Our ancestors were idle for want of a sufficient encouragement to industry. It is better, says the proverb, to play for nothing, than to work for nothing.
Ha ha, can't argue with that, I guess. This is in a discussion of the superiority in activity and wealth of towns containing industries to towns containing the court of a king or noble. So stock used as capital is good, stock used for everyday expenses is bad. More bashing of the government/religious/military complex:
Great nations are never impoverished by private, though they sometimes are by public prodigality and misconduct. The whole, or almost the whole public revenue is, in most countries, employed in maintaining unproductive hands. Such are the people who compose a numerous and splendid court, a great ecclesiastical establishment, great fleets and armies, who in time of peace produce nothing, and in time of war acquire nothing which can compensate the expense of maintaining them, even while the war lasts. Such people, as they themselves produce nothing, are all maintained by the produce of other men’s labour.
And yet more fine bashing:
But though the profusion of government must undoubtedly have retarded the natural progress of England towards wealth and improvement, it has not been able to stop it. ...

It is the highest impertinence and presumption, therefore, in kings and ministers to pretend to watch over the economy of private people, and to restrain their expense, either by sumptuary laws, or by prohibiting the importation of foreign luxuries. They are themselves always, and without any exception, the greatest spendthrifts in the society. Let them look well after their own expense, and they may safely trust private people with theirs. If their own extravagance does not ruin the state, that of the subject never will.

"Sumptuary laws" were laws which prohibited the lower classes from buying luxury items like the upper classes.

Increasingly I'm having to conclude, Smith really is a market-based libertarian. He doesn't seem to believe that government does anything good -- maybe back then it really didn't?!?!? He even has no use for the defense budget! Now that's a real libertarian! But he also seems to think that capitalists are going to be continuously reinvesting their profits into capital projects to grow business, while living relatively modestly and not wasting their capital on luxuries -- not too much like our modern captains of industry.

Chapter 4 is "Of Stock Lent At Interest". Not much seems to have changed from then to now. Borrowing money to pay expenses (as opposed to borrowing for a capital project), bad. Borrowing too much money and having to declare bankrupcy, bad.

Finally, chapter 5 is "Of The Different Employments Of Capital". Here he starts by basically defining 4 types of commerce:

  1. 1st order acquisition of produce: farming and mining;
  2. 2nd order production of goods from 1st order produce: manufacturing;
  3. transport of 1st and 2nd order produce to markets: wholesaling;
  4. breaking down produce into small quantities as needed by consumers; retailing.
He seems to favor farming over manufacturing as a more productive use of capital -- you get the "work of Nature" thrown in for free??? Not sure I've ever thought about it that way. But I guess, photosynthesis is not matched by anything yet produced by industry for capturing free (solar) energy, so maybe he has a point. Almost sci-fi, that growing stuff would be better than manufacturing it, nice!

Smith addresses issues of globalization, but I don't think that his conclusions agree with modern practices. "It is of more consequence that the capital of the manufacturer should reside within the country." Here he talks about what would happen if the Americans adopted protectionist policies and built their own industries, and I believe history has proven him dead wrong on this one:

Were the Americans, either by combination, or by any other sort of violence, to stop the importation of European manufactures, and, by thus giving a monopoly to such of their own countrymen as could manufacture the like goods, divert any considerable part of their capital into this employment, they would retard, instead of accelerating, the further increase in the value of their annual produce, and would obstruct, instead of promoting, the progress of their country towards real wealth and greatness.
Finally, there is a discussion of 3 types of wholesale trade:
  1. home trade;
  2. foreign trade of consumption (importing);
  3. carrying trade, which is trading within or between foreign countries.
Smith posits that involvement in carrying trade is a result of national wealth, rather than a cause thereof. At his time, Holland was the richest country and had the greatest carrying trade, while England was 2nd in both.

This book ends by noting that, as much as farming is the best use of capital, it is also much more capital intensive. So if you are seeking your fortune with a small amount of seed capital, farming is not where you will can succeed -- look to manufacturing or trade instead.

Book 2 was only about 1/2 the length of book 1, 100 vs 200 pages. So a sanity break, then on to book 3. I also got the link to the 1st lecture of the online course I'm going to try, The Age of Sustainable Development. Interesting to see how this goes.

1 comment:

Chris Heinz said...

The Onion is also checking out Adam Smith.,35016/