The Wealth of Nations

ANALYTICAL INTRODUCTION

Adam Smith’s Fame

Adam Smith became very famous even while he was alive. His first major book, The Theory of Moral Sentiments, brought him recognition. But it was his most important work, The Wealth of Nations, that truly cemented his reputation.

Early Reactions to The Wealth of Nations

When The Wealth of Nations came out in March 1776, Smith’s friend David Hume praised it highly. However, Hume worried that the book might not become popular quickly. He thought it required too much concentration, and the public didn’t usually give books that much attention.

Smith’s publisher, Strahan, felt similarly. He was surprised the book sold as well as it did. He noted that it needed “much thought and reflection,” qualities he felt were rare among readers at the time.

Despite these concerns, the book did sell well. Why? Perhaps because its main ideas fit so well with the goals and circumstances of that era.

The Power of Smith’s Ideas

Smith used powerful writing, sometimes including sharp humor and irony, to present his famous theme: economic liberty. He argued that individuals and businesses should be free from excessive government control. This message clearly captured the public’s interest.

His arguments seemed to make the pursuit of self-interest respectable. Smith showed how individuals trying to improve their own situation could actually benefit all of society. He demonstrated that private enterprise, when left free, could raise living standards to levels never seen before.

Some critics, however, saw Smith’s work differently. One called it a “masked battery” – a hidden weapon. They felt his ideas could be used to support the goals of rising merchants and manufacturers (even though Smith himself often questioned their motives). These ideas helped remove old rules and systems that stood in the way of economic change.

For many people back then, Smith’s message was strong and appealing. Looking back today, we see him as someone who announced, or even predicted, a new economic world.

More Than Just a Tract: An Analytical Achievement

Yet, Hume was right that the book needs careful reading. The Wealth of Nations often sounds like it’s just commenting on current events, but it’s actually a deep work of analysis.

The core economic analysis is found in the first two books. This analysis is important for several reasons:

• It helps explain why the book remains important today, even if these aren’t the reasons it was popular initially.
• Smith studied an economic system that looks much like modern capitalism.
• His goal was to uncover the basic principles that control how this system works.

Smith succeeded in this groundbreaking task. He created a book with lasting value because it presented a complete system of thought. He did this by:

1. Analyzing individual economic problems (like how prices are set or how wealth is shared).
2. Showing how these problems are connected, revealing the interdependence of all economic activity.

Smith’s economics gives us the tools to understand how a market economy operates. He described such a system as an “imaginary machine” designed to explain the real-world connections between different economic events.

The Importance of Smith’s System

Smith’s true brilliance might lie in this large analytical system he built, rather than just his contributions to specific economic topics.

The systematic nature of his economics is historically significant. It provided the foundation for modern economics. Later economists built upon his work rather than replacing it entirely.

Beyond Economics: Smith as a Social Scientist

While economists naturally focus on The Wealth of Nations, Smith’s thinking went much further. Remember, he first became famous as a philosopher who studied society (The Theory of Moral Sentiments).

Smith himself saw The Theory of Moral Sentiments and The Wealth of Nations as parts of a single, larger project. He hoped to complete this project by publishing a work on the general principles of law and government and how they changed throughout history.

This larger project involved history and sociology, which Smith viewed as distinct from philosophy and economics. Recognizing these different fields of study was part of his achievement. It also allows us to study each part of his thought separately.

However, because Smith saw these parts as connected, looking at the other areas can give us valuable insights into any single part. This is especially true for The Wealth of Nations. When considered together, his works show that Smith wasn’t just an economist; he was a social scientist in the broadest sense.

Connecting Economics to Society

Smith never forgot that studying the economy means examining one aspect of how humans live together in society. Modern economists agree with this, but Smith paid particularly close attention to this connection. This might reflect his wide range of knowledge and his interest in the economy as a whole system.

The economic theories in The Wealth of Nations rely on two main assumptions about society:

1. Humans naturally live in groups (society).
2. Wherever a market economy develops, a particular kind of social structure also appears.

These assumptions can be observed in the real world. But Smith went further. In his philosophical work (The Theory of Moral Sentiments) and his historical studies, he offered explanations for why these social conditions arise.

This makes his other works relevant for understanding the foundations of his economics. They help establish the social and psychological starting points for The Wealth of Nations.

Furthermore, the connections between the different parts of Smith’s overall system are revealing. They allowed him to show that economic progress can have social effects, and these effects are not always positive.

Structure of this Introduction

Therefore, this introduction to Smith’s economics is divided into three main sections:

1. Social Philosophy (from The Theory of Moral Sentiments): We will look at Smith’s ideas about why humans are suited for living in society. We’ll explore the basic requirements for a society to function and the view of human psychology that Smith uses in his economics.
2. Social Structure: We will examine Smith’s views on the specific type of social and political system that The Wealth of Nations assumes, and how he thought that system developed historically.
3. Economics (from The Wealth of Nations): We will outline the main content and purpose of Smith’s economic analysis, focusing on the theme of interdependence and the systematic nature of his thought.

Throughout this introduction, we will try to highlight the connections between these different areas of Smith’s work. We’ll show how you can move logically from one area to another. We also hope to show that common ideas link all parts of his work, especially his ideas about human psychology and how people’s actions are shaped by social institutions (like laws and customs), while also shaping those institutions in return.

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SECTION 1: THE SOCIAL PHILOSOPHY

The Scottish School of Philosophy

Adam Smith’s book The Theory of Moral Sentiments shares many ideas with other thinkers of his time, such as Francis Hutcheson, David Hume, George Turnbull, and Thomas Reid. Along with others like Lord Kames, Adam Ferguson, and Dugald Stewart, these men formed what is known as the Scottish School of Philosophy.

We call it a “school” because their writings have several common features. These features appear in all areas of Adam Smith’s work.

Common Features of the Scottish School:

1. Focus on Experience (Empirical Method):

   • They based their ideas on observation and real-world experience, not just abstract thinking.
   • They were more influenced by Francis Bacon (who emphasized experiments) than René Descartes (who emphasized reason alone).
   • Their biggest influence regarding method was Sir Isaac Newton. Newton combined observation (like Bacon) with logical deduction (like Descartes) in his scientific work.
   • Newton himself suggested that his scientific method could be applied to the study of morality and society.

2. Interest in Human Nature and Society:

   • These philosophers studied human behavior and the fact that people usually live in societies, not alone.
   • They believed that understanding human nature scientifically was essential before studying society or philosophy.
   • David Hume expressed this view well: To build solid knowledge in other sciences, we first need a solid science of human nature, based on observation and experience.

3. Belief in Natural Human Traits and a Divine Plan:

   • They believed that certain characteristics or tendencies (“propensities”) are built into human nature by God (the “Author of Nature”).
   • These natural tendencies exist whether we are aware of them or not.
   • They believed these traits help carry out a grand, rational (or divine) plan, even though humans might not always understand the plan’s purpose.

4. Focus on Key Moral Questions:

   • The Scottish School was particularly interested in two main questions:
     • How do our minds decide that one way of acting is better than another?
     • What exactly is virtue? What kind of character and behavior is excellent and deserves praise?

Connecting Moral Philosophy to Social Life

Our main interest here is Smith’s social philosophy (how society works), but it’s deeply connected to his moral philosophy (what is right and wrong). Smith’s answers to the two moral questions above helped him explain why humans are suited to live in the societies we see them in.

To show that humans are fit for society, Smith started with ideas about human nature. He suggested that humans are born with:

• Faculties: Abilities like reason and imagination.
• Propensities: Tendencies like self-interest (“self-love”) but also concern for others (“fellow feeling”).

Some of these tendencies pull people towards social life, while others (especially self-interest) could potentially tear society apart.

The Need for Social Controls

Smith argued that because people have selfish tendencies, simply wanting to be social isn’t enough to keep society peaceful and orderly. Controls are needed to manage the self-interested actions of individuals. Examples of these controls include:

• Rules of justice (fairness).
• Rules of morality (right and wrong).

People living in a society must know and follow these rules. This point might seem obvious. However, Smith’s explanation of why these rules are necessary and how they develop is very important and typical of his way of thinking.

How Social Order Emerges

Here’s Smith’s core idea:

• Some parts of human nature (like selfishness) make controls necessary.
• Other parts of human nature (like empathy and reason) ensure that these controls actually develop.

So, social order becomes possible because individuals learn to restrain their own behavior. In doing so, they unknowingly help carry out part of the larger divine plan. People’s actions contribute to an outcome (social order) that they weren’t consciously trying to achieve.

To understand the conditions needed for an orderly society, we need to start with Smith’s central concept of propriety. This refers to how individuals judge what actions and feelings are appropriate or fitting in a given situation, both for themselves and for others.

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(Part 2 of Section 1)

How We Judge Others: Sympathy and Imagination

According to Smith, deciding whether we approve or disapprove of something involves several abilities and tendencies:

• Sympathy: Feeling concern for others.
• Imagination: Picturing situations and feelings.
• Reason: Thinking logically.
• Reflection: Thinking about things carefully.

He started by agreeing with Hume that humans naturally have “fellow feeling” or empathy. Smith wrote: Even the most selfish person has natural tendencies that make them interested in what happens to others. Seeing others happy makes us happy, even if we gain nothing else from it.

This “fellow feeling” is important. It allows us to:

• Feel joy or sadness for others’ good or bad fortune.
• Look at their situations with understanding (“sympathy”).
• Judge whether their situation is making them happy or unhappy.

When we do this, we act as an observer, or what Smith called a spectator. He emphasized that we can’t directly feel what other people feel. Instead, we figure out how they might feel by imagining ourselves in their situation. To sympathize with someone, we need to use our imagination to “change places in fancy” with them.

Judging Propriety: Are Feelings Appropriate?

Smith then used these ideas to explain our sense of propriety.

Propriety is about more than just understanding someone’s situation. It involves judging whether their feelings or actions are appropriate or suitable for that situation. Smith defined propriety as the fitness or “suitableness” of a feeling or action to the cause that sparks it.

How do we judge propriety in others?

• The spectator (observer) must imagine both the situation the other person is in and how that person is reacting.
• The spectator then compares the person’s reaction to how the spectator imagines they themselves would feel or react in the same situation. Smith said we judge feelings as appropriate or inappropriate based on whether they match the corresponding feeling within ourselves.

Judging Our Own Conduct

Smith argued that we use the same basic process to judge our own actions and feelings.

In this case, we are not observing someone else. Instead, we try to judge ourselves by imagining how a real or imaginary spectator would react to our conduct. Smith explained: We can only evaluate our own feelings and motives by stepping outside ourselves, metaphorically speaking. We try to see them from a distance, as others might see them. We do this by imagining how other people are likely to view our actions.

Judging Actions: The Role of the Spectator

This way of thinking means that people’s actions are always judged by someone or something outside of themselves. This judge is either a real person watching (real spectator) or an imagined observer (supposed spectator).

Whether an action is seen as proper or improper depends on how much the spectator can sympathize or agree with it. As Smith explained, approving of someone’s feelings as appropriate means we fully sympathize with them. When the feelings of the person involved perfectly match the sympathetic feelings of the spectator, the spectator sees those feelings as right and proper.

This raises two related issues: one for the person being judged (the agent) and one for the person doing the judging (the spectator).

Challenges in Judging

1. The Spectator’s Limits: The spectator can only understand the agent’s situation to a certain extent. Why? Because we don’t have direct access to what others feel inside. Smith noted that even though humans are naturally sympathetic, we never feel another person’s situation with the same intensity as the person actually experiencing it.

   • Smith believed that being able to deeply understand and share another’s feelings is a virtue – the gentle virtue of sensibility or humanity.

2. The Agent’s Need for Restraint: If the spectator’s reaction is the standard for judging conduct, and the spectator cannot fully feel what the agent feels, then the agent must hold back their emotions somewhat to be considered proper. To gain the spectator’s approval, the agent has to lower the intensity of their feelings to a level the spectator can relate to. They must, as Smith put it, “flatten… the sharpness of its natural tone” to match the spectator’s emotions.

Self-Control: A Key Virtue

So, for an action or feeling to be approved by others, the person expressing it needs to show a certain moderation or self-control. Smith associated this ability with the serious and respected virtue of self-command.

Summary So Far

We’ve established two key points from Smith’s thinking:

1. Humans can judge their own actions and the actions of others. We do this using our natural capacity for empathy (“fellow-feeling”), reflection, and imagination.
2. For an action or feeling to be approved by an observer (spectator), the person acting (agent) must show some restraint or self-control.

Why We (Usually) Behave: The Desire for Approval

However, just being able to judge what’s proper, or understanding the concept of propriety, doesn’t guarantee good behavior. We might know something is wrong but do it anyway. We might recognize that others disapprove but ignore them.

How does Smith address this? He argued that humans have a natural desire for two things:

1. To gain the approval of others.
2. To actually be the kind of person who deserves approval.

Smith wrote: Nature designed humans for society. She gave us an original desire to please others and a dislike of offending them. She made us feel pleasure when others view us favorably and pain when they view us unfavorably. Their approval is satisfying in itself; their disapproval is deeply unpleasant.

It’s this strong desire for approval that motivates individuals to practice self-control.

Beyond Approval: Wanting to Be Worthy

But Smith thought even this wasn’t the whole story. Just wanting others to like us isn’t enough to make us truly fit for society.

He argued: Nature gave humans not only a desire to be approved of, but also a desire to be what ought to be approved of. We want to be the kind of person that we ourselves would admire in others.

The Two Judges: External and Internal

Therefore, according to Smith, our conduct is guided by two kinds of judges:

1. The Actual Spectator: The opinions of real people around us (the “man without”).
2. Our Own Conscience: Our internal sense of right and wrong (the “man within”), which acts as the ultimate judge of our conduct.

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(Subsection 3)

Human Nature and Social Fitness

As we’ve seen, a major goal of Smith’s analysis was to show that humans are naturally suited for living in society. His argument relies heavily on certain human tendencies (“propensities”) that draw us together, such as:

• Fellow-feeling (empathy)
• The desire for others’ approval

The Problem of Selfishness

However, Smith also emphasized that humans have strong selfish tendencies. He criticized earlier thinkers like Hutcheson for not giving enough weight to this fact. Smith stated plainly: Every person cares much more about things that directly affect them than about things that affect others.

Recognizing this self-centeredness raised two problems for Smith’s theory of social order:

1. Weakened Control: Since we are so focused on ourselves, the general desire for others’ approval might not always be strong enough to control our actions and passions.
2. Potential for Harm: People actively pursue goals to improve their own situation (materially or socially). In doing so, they might act in ways that hurt other people.

Let’s look at each problem.

Problem 1: Self-Deceit

We already learned that when judging our own actions, we try to see them as an impartial spectator would. Smith noted we do this mainly at two times:

• Before we act.
• After we have acted.

In both situations, Smith believed our judgment is likely to be biased in our own favor.

• Before Acting: Strong emotions (“the eagerness of passion”) often prevent us from seeing the situation objectively, like a neutral observer would.
• After Acting: Thinking badly of ourselves is unpleasant. So, we tend to ignore or downplay aspects of our actions that would lead to a negative judgment.

In short, we easily fool ourselves. Smith, in words echoed later by the poet Robert Burns, called this self-deceit a “fatal weakness” and the source of “half the disorders of human life.” He believed that if we could truly see ourselves as others see us (or would see us if they knew everything), we would almost always change our behavior.

Solution to Self-Deceit: General Rules

Given this tendency towards self-deceit, simply wanting others’ approval isn’t always enough to ensure good behavior. Smith proposed a solution: general rules of morality and behavior.

He saw these rules as very useful for correcting the biased views created by self-love. Without such rules, Smith argued, “there is no man whose conduct can be much depended upon.” These rules give us a standard – an idea of “what is fit and proper to be done or to be avoided” – that we can use to measure our own conduct at any time.

Where Do Rules Come From?

Smith explained that these general rules don’t require any new psychological principles beyond those already discussed (empathy, reflection, imagination). They develop gradually from our “continual observations upon the conduct of others.”

Here’s the process:

1. We observe specific actions in particular situations.
2. We use our natural ability to judge (our “moral faculties”) to approve or disapprove of these specific actions.
3. Using reason and experience (induction), we notice patterns: certain kinds of actions are consistently approved or disapproved.
4. From these patterns, we form general rules about what is right and wrong (e.g., rules of justice, rules of good manners).

Smith emphasized: The rules come from our experiences with specific cases. We don’t start with a rule and then judge actions against it. We first judge many specific actions, and then form the general rule based on that experience.

Why Do We Follow These Rules?

According to Smith, we generally follow these rules for two main reasons:

1. Our desire to be worthy of approval (the voice of conscience, the “man within the breast”).
2. A belief, which Smith thought was natural and reinforced by reason and philosophy, that these important moral rules are actually the commands of God.

Problem 2: Harm from Pursuing Self-Interest

The second major problem arises because humans are active beings. We constantly strive to achieve goals that we believe will win us admiration from others. Smith asked: what is the real goal of this lifelong effort we call “bettering our condition”? He answered: “To be observed, to be attended to, to be taken notice of…”

While Smith, as a philosopher, could view this constant striving with some detachment, he recognized two key things about it:

1. It’s a natural human drive.
2. It indirectly produces great benefits for society as a whole by driving economic progress.

The “Useful Deception” of Ambition

Smith believed there was a kind of deception involved. The happiness and convenience we imagine will come from wealth and high status rarely live up to our expectations.

But, he added, “…it is well that nature imposes upon us in this manner.” Why?

• This illusion “rouses and keeps in continual motion the industry of mankind.”
• It’s what motivated humans initially to farm the land, build houses and cities, create governments, and invent sciences and arts.
• These activities have transformed the world, turning wilderness into productive land and making oceans into routes for trade and resources.

This argument is crucial. It shows that self-interested actions have social consequences. It also connects directly to Smith’s economic theories and his historical analysis of humanity’s progress from simple (“rude”) societies to complex (“civilized”) ones.

The Dark Side of Ambition

However, for our current discussion about social order, the main point is that this very drive for self-improvement and status is also a major source of conflict. Smith noted that the pursuit of “place” (status, position) “is the end of half the labours of human life; and is the cause of all the tumult and bustle, all the rapine and injustice, which avarice and ambition have introduced into this world.”

Two Kinds of Problems Arising from Self-Interest

Since humans actively pursue their own goals, two kinds of problems can occur:

1. Some individuals might simply ignore the interests of others completely.
2. Even people who generally try to be considerate might fail to control their “self-love” in specific situations where their interests clash with others’.

These possibilities lead to two distinct types of wrongdoing:

• Case A: Breaching Moral Rules: An action might be improper (lack propriety) but doesn’t directly harm anyone else’s well-being. This violates rules of positive morality (like rules of politeness or kindness). These rules are generally not enforced by law; obeying them depends on individual self-restraint and social pressure.
• Case B: Breaching Justice Rules: An action is improper and has “hurtful consequences” for other people (injuring them, taking their property, etc.). This violates rules of justice. These rules rely partly on self-restraint, but crucially, they are enforceable, often by law.

Let’s examine how society deals with breaches of justice.

Enforcing Justice: Sympathy and Resentment

Smith argued that our concern for justice stems from our basic empathy (“fellow feeling”) for all human beings. Because we naturally sympathize with someone who suffers, we also naturally feel resentment towards the person who caused the suffering.

Smith used the famous analogy of a race:

• A runner can try their hardest to win, using all their strength. That’s acceptable.
• But if the runner pushes or trips a competitor, the spectators’ approval ends immediately. It’s seen as “a violation of fair play.”

Why Resentment Isn’t Enough: The Need for Sanctions

However, Smith realized that just knowing others will resent unjust actions might not be enough to stop everyone from committing them. Stronger deterrents, or sanctions, are needed. Smith identified three main types:

1. Remorse: A person who commits an injustice usually feels remorse afterwards. Smith described remorse as a mix of:

   • Shame (from knowing the action was improper).
   • Grief (over the harmful effects).
   • Pity (for the victim).
   • Dread (of the justified anger of others).

2. Fear of Divine Punishment: Smith suggested that the natural fear of punishment in an afterlife acts as a control. He noted that almost every religion and superstition includes some form of hell (“Tartarus”) for the wicked, as well as heaven (“Elysium”) for the just. He saw this belief as natural to humans.

3. Approval of Earthly Punishment: While remorse and fear of divine punishment are important, they might not be sufficient. Smith added a third, crucial factor: our natural resentment of injustice leads directly to our approval of punishment for those who commit it. He stated, “All men… abhor fraud, perfidy and injustice, and delight to see them punished.” In this world, our willingness to punish injustice is a key factor in preventing it. (Though even this is necessary, but not sufficient on its own).

The Final Step: Law and Government

What is the final necessary condition for social order? A system of positive law (actual written laws) that reflects our understanding of justice, administered by a government or authority (“magistracy”).

Smith explained: Since people will not tolerate injustice from one another, the government must use the power of the state (“commonwealth”) to enforce justice. Without this enforcement, society would descend into “a scene of bloodshed and disorder,” with everyone taking revenge into their own hands.

With the addition of enforced law, Smith’s basic model for how society maintains order is complete.

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(Subsection 4)

Key Takeaways About Humans in Society

Smith’s analysis in The Theory of Moral Sentiments provides important insights into how humans function in society. Here are some key points relevant to understanding his broader work:

1. Dual Nature: Humans have both “selfish” and “social” tendencies. The social ones (like empathy and desire for approval) draw us together, but they aren’t strong enough on their own to maintain a peaceful society because of our powerful self-interest.
2. Need for Controls: Because of selfishness, society needs controls. These controls are the rules of morality and, especially, the rules of justice.
3. Usefulness vs. Origin of Rules: These rules are clearly useful. Morality makes behavior more reliable; justice prevents widespread harm and allows society to exist. However, Smith argued that these rules did not arise because people consciously figured out their usefulness. Instead, he believed they developed gradually and naturally over long periods, emerging from innate human responses (like sympathy, resentment, and the desire for approval) to the recurring problems of social living.

The Invisible Hand at Work

Smith pointed out an interesting pattern. Often, when we follow our natural feelings (like empathy leading us to create rules of justice), we end up promoting goals that logical reason would also recommend (like social stability). But we tend to mistakenly credit our own reason for achieving these goals. Smith believed that what we think is human wisdom is often actually “the wisdom of God.”

Similarly, when we act according to our natural moral sense, we automatically take steps that help promote the happiness of humanity. In doing so, Smith suggested, we are essentially cooperating with God and helping to advance the divine plan (“plan of Providence”), even if that’s not our conscious intention.

These ideas illustrate one of Smith’s most famous concepts: the view that individuals, while pursuing their own interests, are often led by an Invisible Hand to achieve positive outcomes for society that they didn’t intend.

Comparing Justice and Other Virtues

Since rules of justice and rules of morality both stem from human nature, they have similarities. However, Smith saw them as distinct, referring to different standards of behavior:

• Rules of Justice:

  • These are like the rules of grammar: precise, essential, and setting a minimum standard.
  • Their main function is negative: they stop us from hurting our neighbors.
  • They often involve simply not doing harm. Smith noted justice can be fulfilled by “sitting still and doing nothing.”
  • Justice is the negative virtue – avoiding harm.

• Rules of Morality (Other Virtues like Beneficence/Kindness):

  • These are more like the principles critics use to judge elegant writing: looser, vaguer, aiming for a higher ideal of perfection.
  • Their function is positive: they guide us toward helping others and achieving excellence in character.
  • Beneficence is a positive virtue – actively doing good.

Why Justice is Essential for Society

Both justice and other virtues are useful for society, but Smith believed they lead to different social experiences and have different levels of importance:

• A society where people practice beneficence (positive morality) “flourishes and is happy.”
• A society where people only observe justice (the negative virtue) can still function, but it might be based merely on calculated exchanges (“a mercenary exchange of good offices according to an agreed valuation”).

Smith clearly saw a society based on kindness and positive virtues as a higher human achievement. However, from an analytical standpoint, he was certain which set of rules was absolutely essential for society’s survival:

• Positive morality (beneficence) is like “the ornament which embellishes” society.
• Justice, however, “is the main pillar that upholds the whole edifice.” If justice is removed, Smith warned, “the great, the immense fabric of human society… must in a moment crumble into atoms.”

Key Conclusion: A system that enforces the rules of justice is the absolute minimum requirement for any society to exist. This baseline level of order, secured by justice, is all that’s strictly necessary for the economic system described in The Wealth of Nations to function, even if Smith’s broader philosophy encouraged higher moral standards.

Human Nature, Rules, and Change

One last point from The Theory of Moral Sentiments is important:

• Smith’s explanation for social order relies on his view of human psychology (our mix of selfish and social drives, our capacity for reason and empathy).
• He assumed this basic human nature is constant across time and place. Therefore, the fundamental need for social rules (especially justice) applies to all human societies.
• However: Smith did not argue that the specific content of moral or even justice rules is the same everywhere or for all time. While the need for rules is universal, what is considered proper behavior can vary significantly:
  • Between different societies living at the same time.
  • Within the same society at different points in history.

Smith was likely aware of cultural differences from thinkers like Montesquieu, and his own interest in history made him aware of how standards change over time.

Moving to History

This recognition that social rules and structures change leads us directly to Smith’s theory of history. This theory examines how societies evolve, including the development of the specific kind of social and political structure that forms the backdrop for the economic analysis in The Wealth of Nations. Smith never finished his planned book on the history of law and government, but we can find the main ideas in his surviving lecture notes (Lectures on Jurisprudence) and in The Wealth of Nations itself (especially Books III and V).

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SECTION 2: THE HISTORY OF CIVIL SOCIETY

The Scottish Historical School

Adam Smith, along with other thinkers like Adam Ferguson, Lord Kames, and John Millar, was a key figure in developing a particular approach to history. This approach is sometimes called philosophical history, similar to the work of later thinkers like Hegel and Marx. Smith’s contemporary, Dugald Stewart, called it “natural” or “theoretical” history to distinguish it from traditional history that just recounted events (“vulgar” history).

What made it “theoretical” or “philosophical”?

• It aimed to analyze history, looking for patterns, causes, and stages of development.

What made it “natural”?

• It focused on the process of how societies naturally develop over time, typically from simple (“rude”) beginnings to more complex (“civilized”) states.

Scope and Influences

Smith and others applied this method to various topics, including the history of literature, philosophy, and science. However, the most significant contribution of this Scottish School was studying the natural history of civil society – how human societies, laws, and governments evolve.

Their goal, as the historian David Hume suggested, was the “nobler duty” of describing the overall “state of society,” not just listing kings and dates. Thinkers like Voltaire shared this goal.

The most important influence on the Scottish historians was the French philosopher Montesquieu, whose book The Spirit of the Laws was highly admired.

Smith’s Advance Beyond Montesquieu

While Montesquieu was a major inspiration, Smith and the Scottish School went further. One writer famously compared Montesquieu to Francis Bacon (who outlined the scientific method) and Smith to Isaac Newton (who created a grand scientific system) in this field of study.

A key difference was Smith’s more systematic approach. This was partly because Smith placed much greater emphasis on economic factors as the driving force behind historical change, whereas Montesquieu gave more weight to factors like geography and climate.

The Role of Economics in History (Scottish School View)

Smith and his group highlighted the importance of economic forces in three main ways:

1. The Engine of Change: They believed historical development starts because humans are active beings constantly striving to improve their material lives (“bettering our condition”). We have endless wants (“insatiable wants”) that push us to develop new ways of producing things (like farming or manufacturing). This drive leads societies to progress beyond the most basic, primitive state.
2. The Four Stages Theory: They observed that history and contemporary societies seemed to fall into four main stages, based primarily on how people got their food and resources (mode of subsistence) and their systems of property:
   • Stage 1: Hunting (and gathering)
   • Stage 2: Pasturage (herding animals)
   • Stage 3: Farming (agriculture)
   • Stage 4: Commerce (trade, manufacturing, complex markets) They argued that these stages were distinct and that societies tended to naturally progress through them in this sequence.
3. Economy Shapes Society (Base and Superstructure): They proposed that the economic organization of each stage (the “substructure”) largely determines the type of social structure, including laws, government, and social relationships (the “superstructure”). As the historian William Robertson, a member of the school, put it: “In every inquiry concerning the operations of men when united together in society, the first object of attention should be their mode of subsistence. Accordingly as that varies, their laws and policy must be different.”

Focus of the Scottish Historians

These ideas show the key features of the Scottish historical approach:

• An emphasis on change and development over time.
• An attempt to explain this change by analyzing the four stages and the factors causing transitions between them.

In the rest of this section, we will focus on Adam Smith’s version of this theory, particularly how he linked the mode of subsistence in each stage to the specific patterns of authority and social hierarchy that arose. We’ll use the first two stages (hunting and pasturage) to establish the basic principles.

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(Subsection 2)

Stage 1: Hunting Societies

Smith described the first stage as “the lowest and rudest state of society.” His examples were the native tribes of North America at that time.

• Economy: People lived by gathering wild plants, hunting, and fishing.
• Social Structure: Communities were small, usually based on family groups.
• Property: There was very little private property beyond personal tools or weapons. Land was generally held in common or not owned at all.

Stage 2: Pastoral Societies

The second stage was “a more advanced state of society.” Examples included the Tartars of Central Asia and Arab Bedouins.

• Economy: People lived by domesticating and herding animals (like sheep, cattle, goats).
• Social Structure: Groups could be much larger than hunter-gatherer bands. These societies were often nomadic, moving with their herds. They lived in tents or wagons.
• Property: The crucial difference from the hunting stage was the existence of significant private property in the form of livestock (herds). This form of wealth could be accumulated.

The Impact of Property

The emergence of significant private property in the pastoral stage had major consequences:

1. Inequality: For the first time, substantial differences in wealth appeared between individuals and families. Some owned large herds, others very few or none.
2. Social Tension: Inequality created new conflicts. Smith mentioned the ambition of the rich and the envy of the poor as powerful forces in these societies.
3. Need for Government: Because valuable property now existed and could be stolen, civil government became necessary primarily to protect it. Smith stated bluntly: “The acquisition of valuable and extensive property, therefore, necessarily requires the establishment of civil government. Where there is no property… civil government is not so necessary.” He added that government, in this sense, “is in reality instituted for the defence of the rich against the poor…”

Property, Authority, and Hierarchy

Smith argued that the division of property also created new forms of authority and social hierarchy:

• Wealth equals Power: Owning wealth (in this stage, large herds) gave individuals power and influence over others. Smith thought the authority derived from wealth was perhaps greatest in this “rudest age” that allowed significant inequality.
• Contrast with Hunting Stage: In hunting societies, “universal poverty establishes universal equality.” Authority was weak and based only on factors like age or personal qualities (strength, wisdom, skill).
• Inherited Status: Since wealth (herds) could be passed down through generations, family status (“distinction of birth”) became important. Rich families maintained their position over time. In hunting societies, where wealth was minimal and equal, birth distinctions had little meaning.
• Main Causes of Authority: In pastoral societies, Smith concluded, inequality of fortune (wealth) and the resulting inequality of birth were the “principal causes which naturally establish authority and subordination among men.”

Key Principles from the First Two Stages

Smith’s analysis of these early stages reveals core principles he applied throughout his history:

1. The way a society gets its subsistence shapes its property system.
2. The existence and nature of property create patterns of wealth and inequality.
3. Wealth translates into social power and authority.
4. Inequality leads to social hierarchies (some people having authority over others).
5. Formal government arises largely to protect property and manage the conflicts arising from inequality.

These basic relationships between economy, property, government, and social structure continue in the later stages, although the specific forms of wealth, power, and government change.

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(Subsection 3)

Moving Beyond Pastoralism: The Role of Geography

Smith noted that progress beyond the pastoral stage wasn’t automatic. He observed that large inland areas like central Africa, Tartary (Central Asia), and Siberia seemed to have remained in a “barbarous and uncivilized state” for centuries.

Why? He suggested these regions lacked features that encouraged further development (“improvement”), especially easy transportation and communication. They didn’t have navigable rivers or access to the sea, which hindered trade and the spread of ideas.

Therefore, he argued, progress to the next stage (agriculture) first happened in regions with natural advantages, like the lands around the Mediterranean Sea (such as Attica in ancient Greece) and later much of Europe. These areas were “divided by rivers and branches of the sea” and were suitable for farming and developing other skills (“arts”).

Stage 3: Agrarian Societies (Farming)

Smith illustrated the third stage, based on agriculture, by looking at European history after the fall of the Roman Empire. During this period, dominated by Germanic and Scythian peoples (often called the early Middle Ages):

• Economy: Farming was the primary mode of subsistence.
• Property: Land was the most important form of property.
• Social Structure: Most land was “engrossed,” meaning it was owned by a relatively small number of “great proprietors” (lords, nobles).

Life in the Agrarian Stage

Unlike the nomadic life of the pastoral stage, the agrarian period meant people lived in settled villages and farms. Of course, there were other major differences:

• Main Activity: Farming (tillage) dominated the economy.
• Main Property: Land became the most important form of wealth.
• Inheritance: Laws like primogeniture (where the eldest son inherits all the land) and entails (legal rules to keep large estates intact within a family line) became common. Smith later criticized these practices, but he understood why they made sense at a time when large landed estates functioned almost like independent territories or “principalities.”

Authority and Dependence in Agrarian Society

As in the pastoral stage, Smith explained social hierarchy based on inequalities of wealth (land) and birth. But he provided more detail on how authority worked in this stage:

1. Military Needs: Owners of large estates needed their own armed followers (retainers) for protection against neighboring landowners.
2. Spending Surpluses: Landowners produced much more food than they could personally use. With few goods available to buy, their main way of using this surplus wealth was through “rustic hospitality” – feeding large numbers of retainers, servants, and other dependents.
3. Labor in Exchange for Food: People who didn’t own land could only survive by offering their personal service to a landowner in exchange for food and protection.

The Result: Powerful Lords, Dependent People

This situation meant that a great landowner was constantly surrounded by “a multitude of retainers and dependants.” These people depended entirely on the lord’s generosity (“bounty”) for their survival. Because of this dependence, they had to obey the lord, much like soldiers must obey the ruler who pays them.

• Subordination: The common people, including those who worked the land (tenants), were in a position of strong dependence and subordination to the landowners. This social structure directly resulted from the agricultural way of life (mode of subsistence).
• Lordly Power: This same system explains the immense authority of the landowners. This power was reflected in:
  • The limited personal rights of their servants and tenants.
  • The lords’ power to make rules and act as judges within their own lands. Smith stated that this authority “all necessarily flowed from the state of property and manners” of the time.

Political Consequences

The great power of individual landowners also shaped politics:

• Landowners as Lawmakers: “The proprietors of land were anciently the legislators of every part of Europe.” They dominated government.
• Instability: However, this system tended to be politically unstable. Power was fragmented among many powerful lords, each with their own land, wealth, and military force. This often led to internal warfare that weak kings and the formal rules of feudalism couldn’t prevent. Smith described the government as being “too weak in the head [the king] and too strong in the inferior members [the great lords].”

The Seeds of Change: Rise of Towns and Trade

Smith saw all these features of agrarian society as direct results of its economic base. He argued they would inevitably change as society transitioned to a different type of economy. This transition, he believed, was driven by the natural growth of towns and manufacturing, and sped up by the political instability caused by powerful lords.

• Towns Emerge: Even in a primarily farming economy, certain crafts were necessary (like carpenters, blacksmiths, weavers). These artisans weren’t tied to the land and found it advantageous to gather in towns for mutual support and safety.
• Towns Grow: As farming became more productive and the population increased, towns grew larger and more important.
• Kings Gain Power: Towns provided kings with a new source of tax revenue. Kings could use this money to build their own power and reduce their dependence on the great lords. Gradually, the lords’ dominance in political assemblies weakened.

Alliances Between Kings and Towns

Because the powerful, feuding lords caused instability, kings found it in their interest to support the growing towns.

• Grants and Privileges: Kings granted towns charters giving them rights of self-government and other privileges. In return, the towns paid reliable taxes (“rent certain”) to the king.
• Strategic Support: Smith noted that kings who had the most trouble with their powerful nobles often gave the most freedoms to the towns.

Impact of Urban Growth

The rise of towns had significant effects:

• Short-Term: It increased the king’s power compared to both the lords and the common people.
• Long-Term: It gradually led to major “liberalizing” changes – increasing freedom and economic development:
  • Urban Freedom: Towns effectively became “sort of independent republics” within the kingdom, with their own governments and laws.
  • Birthplace of Liberty and Industry: Personal freedom and secure property rights developed first in the towns. This safe environment allowed trade and manufacturing (“industry”) to flourish. Smith observed that industry aimed at more than just basic survival started in cities long before it became common in the countryside.
  • Foreign Trade: In the early stages, the main customers for town-made goods were often abroad, as the local farming population was still relatively poor. Therefore, towns located near the sea or navigable rivers (like Venice, Genoa, and the Hanseatic League towns) grew fastest by engaging in foreign trade.
  • Innovation: Contact with other regions through trade exposed people to new goods, ideas, and tastes. This stimulated innovation and improved the quality of local manufacturing over time.

How Towns Transformed the Countryside

While towns could initially prosper through foreign trade, Smith argued their growth eventually transformed the surrounding agricultural areas in three main ways:

1. Created a Market: Towns provided a large and convenient market for farm products (“rude produce”). This encouraged farmers in the countryside to grow more food and improve their farming methods.
2. New Landowners: Wealthy merchants from the towns began buying land in the countryside. Unlike the old nobility who saw land mainly as a source of power, these merchants viewed land as an investment. They were motivated to improve its productivity to get a better return.
3. Spread of Freedom and Security (Most Important): Gradually, the conditions of personal liberty and secure property rights that existed in the towns began to spread to the countryside. Smith believed this crucial change was directly caused by the development of manufacturing.

The Mechanism: Changing Incentives for Landowners

How did manufacturing bring freedom to the countryside? Smith explained it through the changing desires and incentives of the great landowners:

• New Ways to Spend Wealth: Before widespread manufacturing, lords could only use their surplus wealth by feeding huge numbers of retainers. The arrival of manufactured goods (luxuries, finer clothes, better tools, etc.) gave them something else to spend their money on – things they could consume themselves.
• The “Vile Maxim”: Smith cynically remarked that “All for ourselves, and nothing for other people, seems, in every age of the world, to have been the vile maxim of the masters of mankind.” Landowners preferred spending wealth on personal consumption rather than supporting dependents.
• Desire for More Income: To buy these new goods, lords needed more income from their land. This desire motivated them to:
  • Reduce Retainers: They dismissed unnecessary retainers and dependents, keeping only the tenants needed to farm the land.
  • End Serfdom (Out of Self-Interest): Lords realized that unfree laborers (serfs) who couldn’t own property had no reason to work hard or efficiently. Smith noted, “A person who can acquire no property, can have no other interest but to eat as much, and to labour as little as possible.” To increase farm output and their own income, lords found it more profitable to grant tenants more rights, security, and incentives. This gradually led to the end of serfdom and the rise of independent farmers who rented land for a fixed payment (“farmers properly so called”).
  • Introduce Long Leases: To encourage tenants to invest their own money and effort in improving the land (which would ultimately increase the lord’s rent income), lords began offering longer, more secure leases.

Profound Social and Political Changes

This economic shift, driven by the interaction between town and country, had deep social and political consequences:

• From Personal Dependence to Market Dependence: The fundamental relationship between the powerful and the ordinary people changed. Direct personal dependence on a lord was replaced by more impersonal market relationships based on cash payments (rent and wages).
• Increased Personal Freedom: As people became less tied to a single lord for their survival, their degree of personal freedom increased significantly.
• Decline of Aristocratic Power: As lords spent their income on consumer goods instead of maintaining private armies of retainers, their military power and political influence weakened dramatically. They traded “the whole weight and authority” that came from supporting many dependents for personal luxuries.
• Rise of Orderly Government: As the independent power of the great lords declined, the central government (the king) was able to establish law and order more effectively throughout the entire country, not just within the towns.

The Invisible Hand Strikes Again

Smith emphasized that this huge transformation – the “great revolution” from feudal agrarianism towards a commercial society – was an unintended consequence.

• The lords weren’t trying to create a modern society; they were just satisfying their “most childish vanity” by buying fancy goods.
• The merchants and artisans weren’t planning a revolution; they were just focused on their own business, trying to “turn a penny wherever a penny was to be got.” Neither group knew or intended that their self-interested actions were gradually bringing about massive changes in the economy, society, and government. It was another prime example of Smith’s Invisible Hand concept.

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(Subsection 4)

Significance of Smith’s Historical Theory

This historical analysis is important for several reasons:

1. Contribution to History: It was part of a significant school of thought that emphasized economic forces in shaping history.
2. Understanding Change: It provides a framework for understanding how societies change over time, connecting “barbarous” stages with “civilized” ones. It highlights that change is a natural and often inevitable process.
3. Context for Morality: It helps explain why customs and moral standards might differ across societies and change over time, providing context for the ideas in The Theory of Moral Sentiments.
4. Explaining Modernity (Key Purpose Here): Most importantly for understanding The Wealth of Nations, this historical theory explains the origins of the modern exchange economy (Stage 4: Commerce). It describes how the specific social and political structures associated with this economic system came into being.

Characteristics of the Commercial Stage (Stage 4)

Smith saw the “great revolution” as creating a new kind of society with distinct features:

• Economy: Characterized by a division between town (manufacturing/commerce) and country (agriculture). The core economic activity is the exchange of farm products (“rude produce”) for manufactured goods, using money.
• Politics: Marked by the decline of the old landed aristocracy’s power and the rise of new groups associated with commerce and industry (merchants, manufacturers, commoners). Events like the rise of the English House of Commons and the Glorious Revolution of 1688 reflected this shift. As Smith’s follower John Millar summarized, when commercial wealth grows, the power of monarchs and old nobles decreases, the rights of the people expand, and power becomes more widely spread throughout society.
• Society: Society is still composed of different classes and groups (“orders and societies”). However, the nature of social relationships changes fundamentally:
  • Decline of Direct Dependence: Direct, personal dependence (like a serf on a lord) is greatly reduced.
  • Rise of Market Dependence: It’s replaced by dependence on impersonal market forces. People rely on buying and selling, wages, and prices rather than personal ties for their livelihood (the cash nexus).
  • Increased Personal Liberty: This shift generally leads to greater personal freedom and autonomy for individuals.
• Authority and Dependence Persist (in New Forms):
  • Authority: Smith didn’t think authority disappeared. People still tend to naturally admire and respect the rich, powerful, and well-born, even in a commercial society.
  • Dependence: Dependence also continues, but takes new forms. Farmers depend on landlords for access to land. Business owners depend on customers. Workers depend on employers (whether landowners or business owners/capitalists) for wages and jobs.

The Significance of Prices and Wages

The crucial point about the commercial stage is that essential services now have a price. This replaces the old system where people provided services directly in return for basic needs like food and protection.

• Landowners receive income as rent in payment for the use of their land.
• Workers are paid wages for their labor.
• Business owners (undertakers or capitalists) earn profit as income for organizing production and taking risks.

This system changes the nature of dependence. For example, a business owner relies on income from perhaps hundreds or thousands of different customers. While needing them all to some extent, the owner isn’t completely dependent on any single person, unlike a serf’s dependence on a single lord.

Society’s Three Great Orders

This new commercial economy divides society into three main economic groups or “great constituent orders”:

1. Landlords: Own land and earn rent.
2. Capitalists: Own capital (money, buildings, machinery), organize production, and earn profit.
3. Wage Laborers: Own only their ability to work and earn wages.

These groups are interconnected through complex economic relationships. This pattern of interdependence, based on exchange and prices, allows for much greater personal freedom than in previous stages. It reflects the new way people make a living – the commercial mode of subsistence.

Now, we shift our focus from the historical development to the economic workings of this commercial society. This economic analysis is like the final chapter, as Professor Macfie described it, in Smith’s larger “comprehensive study of man in society.”

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SECTION 3: POLITICAL ECONOMY: A CONCEPTUAL SYSTEM

Setting Up the Economic Model

In The Wealth of Nations, Adam Smith aimed to explain how the economy of the “commercial” stage actually works. The basic features of this modern exchange economy were outlined in the previous section on history. Let’s restate the main components of Smith’s economic model:

• Sectors: The economy has two main parts: agriculture and manufacturing.
• Factors of Production: Creating goods requires three basic inputs: land, labor, and capital (tools, machines, money invested).
• Forms of Income: Corresponding to these factors are three types of income:
  • Rent: Paid for the use of land.
  • Wages: Paid for the use of labor.
  • Profit: The return earned on capital, rewarding the capitalists (or “undertakers”) who invest their money and organize the production process.
• Social Groups: Each income type supports a distinct social group: landlords (rent), wage laborers (wages), and capitalists (profit).
• Entrepreneurs: The role of organizing production (the entrepreneurial function) is performed by capitalists. In farming, these are the farmers who rent land and use their own capital (“stock”) to cultivate it. In manufacturing, they are the “undertakers” who run factories and workshops.

Key Assumptions for Economic Analysis

Besides these components, Smith’s economic analysis relies on two crucial assumptions:

1. Human Motivation: Self-Interest: Smith assumed that in the economic sphere, people are primarily driven by self-interest – the desire to improve their own condition or make a gain.
   • He wasn’t saying people are only selfish, but that self-interest is the main motivator in economic transactions.
   • His famous quote illustrates this: “It is not from the benevolence of the butcher, the brewer, or the baker, that we expect our dinner, but from their regard to their own interest.”
2. Social Context: Justice: Smith recognized that economic activity takes place within a society. His economic analysis assumes a basic level of social order, specifically the enforcement of justice. People must be protected from harm to their person and property for a market economy to function. This is the minimum condition for society discussed earlier in The Theory of Moral Sentiments.

Smith’s Goal and Main Themes

Given these components (sectors, factors, classes) and assumptions (self-interest, justice), Smith set out to show how this type of economy operates. His analysis consistently emphasizes two key themes:

• The interdependence of all economic activities and actors.
• Unintended social outcomes – the idea that individual actions, driven by self-interest, often lead to broader social results that no one planned (the “Invisible Hand”).

Smith’s Predecessors

Smith built on the work of earlier thinkers who also analyzed the economy as a system:

• Scottish Contemporaries: Writers like David Hume and Sir James Steuart also explored the links between history and economic analysis.
• The Physiocrats: A group of French thinkers (including Quesnay, Mirabeau, and Turgot) whom Smith met and admired. Smith called their system “perhaps the nearest approximation to the truth that has yet been published upon the subject of political economy.”
  • The Physiocrats were among the first to explicitly state that in an economy, “everything is intertwined, everything runs through circular courses.”
  • Quesnay’s Tableau Economique (1758): This famous diagram was an early economic model showing how goods and money flowed between different sectors (like agriculture and manufacturing) and social classes over a year. It powerfully illustrated economic interdependence and was a huge step forward in economic thinking – perhaps the “first study of the whole organism.”

So, while Smith’s work was groundbreaking, he wasn’t working in a vacuum.

Smith’s Approach to Interdependence

Smith explored the theme of interdependence in two main ways in The Wealth of Nations:

1. Individual Level (Microeconomics): He examined the economic interdependence of individuals interacting through markets. This led him to analyze problems of exchange value, price, and how resources are allocated.
2. System Level (Macroeconomics): Similar to the Physiocrats, he showed the interdependence of large social groups (landlords, capitalists, laborers) and economic sectors (agriculture, manufacturing). This analysis focused on the major issues of economic growth and capital accumulation.

Connecting Concepts:

• Smith’s theory of distribution (how the total income is divided into rent, wages, and profit) provides a link between the individual and system levels of analysis.
• The concept of the division of labor is fundamental to both levels.

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(Subsection 1)

Value

The Importance of the Division of Labor

Although Smith’s model included various elements, he placed enormous emphasis on the division of labor. This concept includes:

• Specialization between different industries (farming vs. manufacturing).
• Specialization between different jobs within an industry (weaver vs. spinner).
• Specialization of tasks within a single job.

Smith famously used a pin factory to illustrate this last point. Making something as simple as a pin involved about eighteen distinct steps, with different workers specializing in each one.

Why Specialization Boosts Productivity

Smith argued that the division of labor dramatically increases how much work can be done (productivity) for three main reasons:

1. Increased Skill (“Dexterity”): When a worker does the same simple task over and over, they become much faster and more skillful at it.
2. Saving Time: Workers don’t waste time moving from one type of task or tool to another.
3. Encouraging Machinery: Breaking down production into simple steps makes it easier to invent machines that can perform those steps, further increasing efficiency (“facilitate and abridge labour”).

Interdependence Through Specialization

Specialization makes everyone highly interdependent. Each producer relies on many others for supplies and tools. A finished product, like a simple coat, embodies the work of countless different specialized laborers (shepherds, wool sorters, spinners, weavers, dyers, tailors, tool makers, transporters, etc.). Smith marveled that even the poorest person in a “civilized country” depends on the cooperation of “many thousands” to obtain their basic necessities.

The Necessity of Exchange

Because specialization means each person produces only one thing (or a small part of one thing), they can only satisfy a tiny fraction of their own needs directly. Therefore, people must exchange the surplus products they make for the surplus products made by others. Smith concluded: “every man thus lives by exchanging, or becomes in some measure a merchant.”

The Problem of Value

The fact that people must constantly exchange goods raises the fundamental economic question of value: What determines the rate at which goods exchange for one another?

To analyze this, Smith used the simplified model of a barter economy (where goods are traded directly, without money). His discussion can be confusing because he used the word “value” to mean two different things:

1. Value in Use: How useful an object is (its utility).
2. Value in Exchange: How much of other goods you can get by trading the object (its purchasing power).

The Water-Diamond Paradox

Smith highlighted the famous paradox:

• Things with the highest use value (like water) often have very little exchange value.
• Things with very little use value (like diamonds) often have enormous exchange value.

Explaining the Paradox

Smith resolved this in two steps:

1. Why Things Have Value: Both water and diamonds have value because they provide some kind of satisfaction or “utility.” Water satisfies a basic physical need. Diamonds satisfy a desire for beauty and status (“ornaments”), which Smith recognized as a real source of pleasure and preference.
2. Why Values Differ: The amount of exchange value depends largely on scarcity. Things that are useful or beautiful become much more valuable if they are rare. Water is cheap because it’s abundant (“plenty”). Diamonds are expensive (“dear”) because they are scarce.

The Role of Labor Cost

Smith also argued that the rate at which goods exchange is affected by the effort required to produce them. He focused on the “toil and trouble” of labor. To get goods to trade, a person must work, giving up their “ease, his liberty, and his happiness.”

Labor as the Basis of Exchange (in Barter)

In the simple barter economy, Smith argued that “the proportion between the quantities of labour necessary for acquiring different objects seems to be the only circumstance which can afford any rule for exchanging them for one another.”

• Example: If hunting a beaver typically takes twice as much labor as hunting a deer, then “one beaver should naturally exchange for… two deer.”
• This emphasizes the labor embodied in producing the goods. (Smith noted this assumes both hunters find the trade worthwhile based on their own subjective view of the goods’ usefulness and the effort involved).

Labor as the Measure of Value (Income/Welfare)

Smith used this analysis of exchange rates primarily as a step towards understanding a different concept: how to measure the real value of the total goods a person produces – essentially, their real income or contribution to economic well-being.

He stated:

• “The value of any commodity… to the person who possesses it, and who means not to use or consume it himself, but to exchange it for other commodities, is equal to the quantity of labour which it enables him to purchase or command.”
• Therefore, “Labour… is the real measure of the exchangeable value of all commodities.”

What “Labor Commanded” Means

Smith clarified that the real value of the goods you have produced (your output or income) is measured by how much other people’s labor (or the products of their labor) you can obtain in exchange for your goods. Your purchasing power is measured in terms of the labor of others.

Connecting “Embodied” and “Commanded” Labor (in Barter)

In the special case of the simple barter economy, if goods always exchange according to the ratio of labor needed to produce them (labor embodied), then the amount of labor embodied in your goods will be exactly equal to the amount of labor embodied in the goods you can get in exchange (the labor commanded). In this simple model, labor embodied equals labor commanded.

Interpreting Smith on Value

Based on this analysis of the barter economy, two key points emerge:

1. Embodied vs. Commanded Labor in Barter: Smith argues that in a simple barter system, the labor effort someone puts into making a product (labor embodied) should, through exchange, allow them to acquire goods that took an equal amount of labor effort to make (labor commanded). This equality (labor embodied = labor commanded) holds only in this primitive stage where labor is assumed to be the sole factor of production and goods exchange based on labor time.
2. Measuring Real Welfare: The real economic well-being of an individual is determined by the quantity of other people’s products (measured in the labor units needed to make them) that they can get in exchange for their own product. This highlights Smith’s interest in measuring welfare in terms of actual goods and services commanded, not just the effort spent producing.

A Deeper Look at “Real Value” (Blaug’s View)

However, economist Mark Blaug offered a deeper interpretation. He noted that while we now equate increased real income (more goods) with better welfare, Adam Smith might have been linking improvement more closely to a reduction in the human cost required to get that income.

• Labor involves effort, “toil and trouble,” and is unpleasant (has disutility).
• Blaug suggests Smith’s “real value” (or “labor price”) might refer more to this psychological cost of work than just hours worked. It’s about the sacrifice involved.
• In this view, real value is closer to “esteem value” (how much we value avoiding toil) than purely exchange value.

Value in a Modern Capitalist Economy

In a modern economy, things are different because labor is not the only factor of production. Land and capital also contribute. Therefore, as Smith recognized, “the whole produce of labour does not always belong to the labourer.” Part of the value created must go to landlords as rent and to capitalists as profit.

This means:

• In a modern economy, the labor your product commands in exchange must be greater than the labor directly embodied in making it. The price has to cover wages, profit, and rent.
• The simple rule “labor embodied = labor commanded” applies only to the primitive barter economy.

Labor Commanded as a Measure of Real Income

Despite this difference, Smith maintained that his core idea about measurement remained valid: the real value of any income (whether received as wages, rent, or profit) is best measured by the quantity of goods and services it allows the recipient to purchase or command. These goods and services represent the embodied labor of others.

Money Price vs. Real Price

Smith acknowledged that in a modern economy using money, people naturally think about their income and the value of goods in money terms. We get paid in money and buy things with money.

However, he insisted that money is just a tool. The real measure of welfare is not the amount of money itself, but the “money’s worth” – the actual quantity of goods and services (representing labor commanded) that the money can buy.

He therefore distinguished between:

• Nominal Income/Value: Income measured in money (e.g., dollars, pounds).
• Real Income/Value: Income measured by the quantity of labor (or the goods produced by labor) it can command or purchase.

Smith argued that the real value of all three types of income (wages, rent, profit) must ultimately be measured by the quantity of labor they command.

The Search for a Stable Measure

Much of the rest of Smith’s discussion on value involved defending labor (commanded) as the most stable standard for measuring real value over time. He was looking for an unchanging yardstick, an “absolute measure of value” – a quest later pursued by economists like David Ricardo and Karl Marx.

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(Subsection 2)

Price

Income, Costs, and Prices

We’ve seen that rent, wages, and profit are the incomes earned by society’s three main groups (landlords, laborers, capitalists). They are also the prices paid for using the three factors of production (land, labor, capital).

From the perspective of a business producing goods, these incomes are costs. Smith made this link explicit:

• The price (exchangeable value) of any single good breaks down into the costs of wages, profit, and rent needed to produce it.
• Similarly, the total value of all goods produced in a country over a year must also break down into these same three income streams, distributed among the population.

This connection between income and costs leads directly to the question of how prices are determined.

Smith’s Assumptions for Price Theory

To analyze prices, Smith started with a key assumption:

• “Natural Rates” of Return: In any given society at a particular time, there exist “ordinary” or “average” rates for wages, profit, and rent. These are considered the normal, long-run levels.

This assumption is important for two reasons:

1. Static Framework: It implies Smith is analyzing the economy at a specific point in time, assuming the overall supply of factors and total demand are stable. It’s like taking a snapshot.
2. Determining Supply Price: These natural rates of wages, profit, and rent add up to the basic cost of production, or what Smith calls the natural price. This is the minimum price sellers need in the long run to stay in business.

Analyzing Price Determination

Smith’s discussion of price addresses two related problems:

1. Individual Market Prices (Partial Equilibrium): How is the price of a single good determined in its specific market?
2. Resource Allocation (General Equilibrium): How does the price system guide the allocation of society’s overall resources (land, labor, capital) among different industries and uses?

Natural Price vs. Market Price

Smith distinguished between two types of prices:

• Natural Price:

  • The long-run equilibrium price.
  • It’s the price that is just enough to cover the costs of production, paying for land, labor, and capital at their natural rates.
  • When a good sells at its natural price, the producer covers all costs, including a normal level of profit.

• Market Price:

  • The actual price of a good at any specific moment in time.
  • It’s determined by the short-run balance between the quantity actually supplied to the market and the effectual demand (the quantity demanded by those who are willing and able to pay the natural price).

How Market Price Moves Towards Natural Price

The market price can fluctuate above or below the natural price in the short run, but there’s a constant tendency for it to return to the natural price level. The natural price acts like a center of gravity.

Smith explained this adjustment process:

• Case 1: Shortage (Market Price > Natural Price)

  • If the quantity supplied is less than the effectual demand, buyers will compete for the limited goods.
  • This competition pushes the market price above the natural price.
  • Consequently, profits (and possibly wages or rent) in this industry become higher than their natural rates.
  • These higher returns attract more resources (labor and capital) into producing this good.
  • Supply increases.
  • As supply increases, the market price falls back down towards the natural price.
  • (Smith noted the price increase during a shortage would be sharper for necessities than for luxuries).

• Case 2: Surplus (Market Price < Natural Price)

  • If the quantity supplied is greater than the effectual demand, sellers will have leftover stock.
  • To sell the excess, they must lower the price. Competition among sellers pushes the market price below the natural price.
  • Consequently, profits (and possibly wages or rent) in this industry fall below their natural rates.
  • These lower returns cause resources (labor and capital) to leave this unprofitable industry.
  • Supply decreases.
  • As supply decreases, the market price rises back up towards the natural price.
  • (Smith noted sellers would compete more fiercely to sell perishable goods in a surplus than durable goods).

Equilibrium and Competition

The natural price is the equilibrium price. It’s the price where supply matches effectual demand, and factors of production earn their normal rates of return. There’s no pressure for the price to change or for resources to move in or out of the industry.

Smith emphasized that this tendency for market price to equal natural price (cost of production) only works properly under conditions of “perfect liberty” – essentially, free competition. Resources must be free to move between industries in response to changes in prices and profits.

General Equilibrium: Balancing the Whole Economy

If this adjustment process happens in the market for every commodity, then the entire economy can reach a state of general equilibrium. This is a state of overall balance where:

• All goods are selling at their natural prices.
• All factors of production (land, labor, capital) are earning their natural rates of return in all industries.
• There is no overall tendency for resources to shift between different employments.

If something disturbs this general balance (like a change in consumer preferences), the self-interested actions of producers and consumers responding to changing prices will automatically reallocate resources until a new equilibrium is established.

The price system, driven by competition and self-interest, thus acts as an automatic mechanism for coordinating economic activity and allocating resources – a key example of Smith’s Invisible Hand.

Real-World Obstacles to Equilibrium

Smith was realistic and knew the real world often didn’t perfectly match this ideal model. He identified two main types of complications:

1. Market Restrictions (“Regulations of Police”): Government regulations and private practices often interfered with free competition and prevented markets from reaching equilibrium:

   • Monopoly: Allowed sellers to charge artificially high prices, unrelated to the natural price.
   • Guild Privileges (“Privileges of Corporations”): Restricted the free movement of capital and labor between different towns or trades.
   • Poor Laws: Hindered the movement of labor between parishes.
   • Apprenticeship Laws (“Statutes of Apprenticeship”): Artificially limited the number of workers allowed in certain trades.
   • Smith strongly criticized these regulations. He saw them as violations of people’s “natural liberty” to use their labor and capital as they saw fit. He argued they distorted the “natural balance of industry,” leading to inefficient resource allocation and lower overall prosperity. He believed a key role of government was to remove these impediments.

2. Compensating Differentials (“Net Advantages”): Smith recognized that even in a perfectly competitive equilibrium, the money wages or profits wouldn’t necessarily be equal in all jobs. Why? Because jobs differ in non-monetary ways. Differences in pay often compensate for these other differences.

   • Factors causing pay differences:
     • Hardship or unpleasantness of the work.
     • Cost and difficulty of learning the necessary skills.
     • Job security (constancy vs. irregularity of employment).
     • Level of trust and responsibility required.
     • Probability of success (high rewards in risky professions compensate for many failures).
   • Equilibrium in Net Advantages: The real equilibrium across the economy isn’t an equality of money income, but an equality of net advantages. This means the total package of rewards (money + non-monetary benefits like prestige or ease) minus drawbacks (money costs + non-monetary costs like danger or disagreeableness) tends to be equal across different jobs accessible to similar people. This still requires the free movement of labor and capital.

Connecting Net Advantages to Moral Sentiments

This idea of non-monetary factors influencing economic choices links back to The Theory of Moral Sentiments:

• Prestige as Reward: The desire for social approval means that public admiration for certain professions (like doctors, lawyers, philosophers) acts as part of their reward, potentially offsetting lower pay.

• Hardship Pay: Conversely, jobs that face public disapproval or are particularly unpleasant might require higher pay to compensate for these negative non-monetary aspects. Smith mentions professions whose exercise “is considered… as a sort of publick prostitution,” suggesting they need higher pay to attract workers.

• Example (High Skill/Prestige): Think about professions like doctors, lawyers, or even famous artists and philosophers. Excelling in these fields, where few reach the top, is seen as a sign of genius or superior talent. The public admiration they receive is a big part of their reward, making up for potentially lower monetary income compared to other fields requiring similar effort.

• Example (Disagreeable/Discreditable Jobs): On the other hand, some jobs might be considered unpleasant or socially frowned upon. Smith argued that the pay for such jobs must be high enough not only to cover the training and effort involved but also to compensate for the social stigma or “discredit” attached to them. He suggested the “exhorbitant” pay of actors and opera singers in his time was due to both the rarity of their talents and the social disapproval of earning a living that way.

• Example (Unpleasant Trades): Similarly, trades considered unpleasant or low-status often pay more than common trades. Smith mentioned butchers (“a brutish and an odious business”) and innkeepers (“neither a very agreeable nor a very creditable business”) as examples where higher profits were needed to compensate for the disagreeableness or lack of social standing.

This is a fascinating point: Smith suggests that social approval or disapproval directly affects monetary rewards in the marketplace. Pay must adjust to compensate for these non-monetary factors.

A More Complex Economic Actor

This connection back to The Theory of Moral Sentiments shows that Smith’s view of economic behavior is more complex than simple profit maximization. It suggests our economic choices (what jobs we take, how we run businesses) are influenced by how we expect others (the “spectator”) to judge us.

This contrasts with simpler versions of economic models that often assume:

• Producers just maximize efficiency (output per input).
• Consumers just maximize personal satisfaction (utility) from goods. These simpler models don’t usually consider the social approval or disapproval associated with economic choices.

Smith’s Richer Perspective

Smith’s perspective adds real-world complications:

• An efficient producer might still face criticism if their methods (like wages or working conditions) are seen as exploitative.
• A consumer’s choices might be judged as improper or short-sighted (e.g., prioritizing immediate gratification over long-term well-being).
• Our decisions about who we buy from can be as important as what we buy, influenced by our judgments of the seller’s character or business practices.

Smith’s focus on propriety (social appropriateness) suggests that even “economic” choices are often constrained or shaped by social norms and judgments.

Modern Echoes (Etzioni)

Modern sociologist Amitai Etzioni argued that standard economic theory wrongly ignores morality as a key influence on our choices. He suggested we have at least two fundamental sources of value: pleasure (utility) and morality. Etzioni felt his own approach was closer to the Adam Smith of The Theory of Moral Sentiments, who recognized the importance of moral considerations alongside self-interest.

Smith’s Legacy in Price Theory

While Smith’s ideas about price had historical roots (as detailed by economic historian J.A. Schumpeter), The Wealth of Nations itself proved incredibly influential. His analysis contained elements of both:

• Partial Equilibrium: Looking at supply and demand in a single market (later developed by Alfred Marshall).
• General Equilibrium: Considering the interconnectedness of all markets in the economy (later developed by Léon Walras and Vilfredo Pareto).

Challenges in Interpretation

Although Smith anticipated later developments, translating his work precisely into modern economic language is difficult.

• He didn’t use modern assumptions like “perfect competition” or “perfect knowledge.”
• His complex view of human psychology makes it hard to draw simple, fixed relationships between prices and quantities demanded or supplied.

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(Subsection 3)

Distribution: Determining Income Levels

Having explained how prices are formed assuming given rates of payment for factors of production (wages, profit, rent), Smith then turned to explain how these “ordinary or average” rates are themselves determined. He analyzed the forces influencing the levels of wages, profit, and rent, both at a specific point in time and over the long run, using the same kind of supply and demand reasoning he applied to commodity prices.

a) Wages

• What are Wages? Wages are the payment workers receive for their labor. Employers (capitalists and farmers) pay wages. Wages are necessary to compensate workers for the effort and unpleasantness (“disutility”) of work.
• The Wage Bargain: Smith viewed wage determination as a bargaining process between two parties with conflicting interests:
  • Workers want to get as much as possible.
  • Employers (“masters”) want to give as little as possible.
  • Both sides try to strengthen their position by combining (workers in unions, employers in associations).
• Employer Advantage: Smith believed employers usually had the upper hand in this bargain. In his time, laws often permitted employer combinations but prohibited worker combinations. Furthermore, employers could typically afford to wait longer to hire than workers could afford to wait for income.
• Role of Supply and Demand: However, bargaining power is also affected by the supply of and demand for labor:
  • High Labor Supply: When many workers are looking for jobs, competition among them tends to drive wages down.
  • High Labor Demand: When employers need many workers (“scarcity of hands”), competition among employers tends to drive wages up. Employers will “voluntarily break through” their own agreements not to raise wages.
• Key Determinants: The overall wage level depends on the relationship between:
  • The supply of labor (the size of the working population).
  • The demand for labor, which Smith linked to the size of the “wages fund” – the total amount of capital employers have available to pay workers.
• The Subsistence Wage: Smith argued there’s a minimum long-run wage level – the subsistence wage. This is the amount needed for a worker to survive and raise enough children to replace the labor force. If wages fell below this for too long, the working population would decline. Smith viewed this subsistence level as the long-run supply price of labor, suggesting that, over time, labor could be “produced” at this constant cost.
• Long-Run Dynamics: Three Economic States: Smith used this concept to describe different long-run economic scenarios:
  1. Stationary State: The economy is stable, not growing. The demand for labor (wages fund) matches the supply at the subsistence level. Population doesn’t change, and wages remain stuck at subsistence. (Smith used China as an example).
  2. Declining State: The economy is shrinking. The demand for labor falls. Wages drop below subsistence, leading to hardship, famine, and population decline. Population shrinks until it matches the smaller wages fund, eventually stabilizing wages back at the (lower population’s) subsistence level. (Smith used Bengal as an example).
  3. Advancing State: The economy is growing. The demand for labor (wages fund) is increasing. Wages rise above the subsistence level. This encourages population growth. Crucially, if the demand for labor grows faster than the population, wages can stay high for long periods. (Smith saw North America as a prime example, and Great Britain as advancing, though more slowly). Smith approved of high wages, believing they were fair and also made workers more productive.
• Short-Run Wages: This long-run framework also explains wage levels in the short run (e.g., within a given year). The “ordinary or average” wage rate depends on the current size of the wages fund relative to the current number of workers. This rate can be at, above, or below subsistence, and it will stay stable as long as the fund and population don’t change. This is the wage rate assumed in Smith’s theory of price.

b) Profit

• What is Profit? Smith saw profit not as a payment for management work (“inspection and direction”), but as the reward capitalists receive for the trouble and risk involved in investing their capital to organize production (hiring workers, buying materials) in the hope of making a gain when the product is sold.
• Factors Affecting Profit: Profits are very sensitive to market conditions: selling prices, production costs (especially wages), changes in demand, and the success or failure of competitors and customers. This makes it hard to pinpoint a stable “ordinary or average” rate of profit.
• Interest Rate as a Guide: However, Smith suggested the prevailing rate of interest on loans is a reasonably good indicator of the general profit level. Why? Because people will only borrow money (and pay interest) if they expect to earn a profit by using that money. High expected profits lead to high interest rates, and low expected profits lead to low interest rates. (He specified this relates to “clear or neat” profit, after accounting for risk).
• Key Determinants: At any point in time, the rate of profit depends on:
  • The total amount of capital stock available in the economy.
  • The extent of profitable investment opportunities (“volume of business”).
• Long-Run Trend: Falling Rate of Profit: As an economy prospers and capital accumulates over time, Smith argued the rate of profit tends to fall. This happens because:
  • More capital leads to increased competition among capitalists.
  • It becomes harder to find new, highly profitable investment opportunities.
  • This competition drives down profits across all industries. Smith stated, “the diminution of profit is the natural effect of… prosperity.”
• Lowest Limit: Eventually, in a very advanced economy, the profit rate would fall towards a minimum, just enough to cover the interest costs on borrowed capital (including a risk premium).
• Factors Slowing or Reversing the Fall:
  1. Declining Economy: In a shrinking economy, capital becomes scarcer, potentially leading to higher profit rates for the remaining capital.
  2. New Opportunities: Even in growing economies, finding new markets, inventing new technologies, or acquiring new territories (like colonies) can create fresh investment opportunities, temporarily halting or reversing the fall in profits by increasing the “volume of business” relative to the existing capital stock. (Smith cited Britain’s gains after the Seven Years’ War).
• Short-Run Profit Rate: In any given year, the average profit rate depends on the amount of capital relative to investment opportunities. It’s also inversely related to wages: if wages are high (labor is scarce relative to capital), profits tend to be lower, and vice versa, assuming other factors are constant.

c) Rent

• What is Rent? Smith defined rent simply as the “price paid for the use of land.”

• Why Rent is Paid: Rent exists because land:

  • Is productive (helps grow food, provides resources).
  • Is privately owned.
  • Is scarce relative to the demand for its use.

• Rent as a Surplus: Smith viewed rent as a unique type of income. It’s a surplus that goes to the landowner often “without labour or care” on their part. Landlords, he famously wrote, are the only one of the three groups “whose revenue costs them neither labour nor care, but comes to them, as it were, of its own accord.”

• Rent as a “Monopoly Price”: He argued rent often resembles a “monopoly price.” It’s typically the highest price that tenants can afford to pay given the specific fertility and location (“actual circumstances”) of the land, after covering their own production costs and normal profit.

• Food Production and Rent: Smith believed land used to produce food for humans would always be able to yield a rent to the owner (he estimated rent might be around one-third of the total farm output).

• Long-Term Trend: Smith argued that rent tends to increase over the long run.

  • As population grows, more land is needed for food production, increasing demand for land and pushing rents up absolutely. “The landlord’s share of the produce necessarily increases with the increase of the produce.”
  • The real value (purchasing power) of rent also tends to rise over time. As manufacturing becomes more efficient, the prices of manufactured goods fall in real terms. This means the landlord’s rent income can buy more goods.

• Rent Determination in the Short Run:

  • At any given time (like in a single year), the total amount of rent paid depends on how much land is currently in use, which is related to the size of the population needing food.
  • The rent on any particular piece of land also depends on its fertility and location.
  • Crucial Point: Rent is price-determined, not price-determining. Unlike wages and profit, which are costs that cause prices to be high or low, rent is the effect of the price of the produce grown on the land.
  • Smith explained: Land yields a high rent only if the price of its produce is high enough to cover the farmer’s costs (including wages and normal profit) and leave a surplus for the landlord. If the price is low, the rent will be low, or even zero.

Summary of Distribution Theory

Before moving on, let’s highlight two key aspects of Smith’s theory of how income (wages, profit, rent) is distributed:

1. Short-Run View (Linking to Price Theory): Part of the analysis explains the “ordinary or average” rates of return prevailing in a specific period (like a year). This links directly back to the theory of price, which assumed these rates were given. In this short-run view:

   • The supplies of land, labor, and capital are treated as fixed stocks.
   • The rates of return are interdependent: Rent levels are affected by prevailing wage and profit rates, and profit rates are affected by wage levels.

2. Long-Run View (Dynamics): The analysis also looks at long-term trends in wages, profit, and rent, treating the factors of production more like flows that can change over time. Key points:

   • These long-run trends are also interdependent.
   • They seem to depend heavily on the rate of capital accumulation (investment).
   • Smith suggests: As capital stock grows, profits tend to fall. High rates of capital accumulation initially lead to high wages (above subsistence), which encourages population growth. As population catches up, wages tend back towards subsistence levels. The increased population requires more food, leading to changes in land use and rent levels.

The Missing Piece: Source of Capital Growth

Interestingly, while Smith described the long-run trends driven by capital accumulation, in this part of his analysis (Book I), he didn’t fully explain where the increased capital comes from or what determines the rate of accumulation. That explanation is a major focus of the macroeconomic analysis in Book II of The Wealth of Nations.

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(Subsection 4)

Macroeconomics: Growth and the System as a Whole

Book II of The Wealth of Nations shifts focus to the bigger picture: the relationships between the major productive sectors (like agriculture and manufacturing) and, most importantly, the factors that drive overall economic growth.

The Psychological Engine: Desire to Better Our Condition

Before diving into the mechanics, it’s helpful to recall the underlying human motivation Smith described, primarily in The Theory of Moral Sentiments (TMS): the powerful desire for social approval and status.

• Wealth and Respect: While we initially seek wealth for basic needs, we quickly learn that social respect and rank depend heavily on how much wealth we appear to possess.
• Strongest Desire: This desire to be respected and admired (“to be observed, to be attended to, to be taken notice of”) becomes perhaps our strongest drive. It fuels our “anxiety to obtain the advantages of fortune” much more than just the need for basic necessities (which Smith thought were easily met).
• “Bettering Our Condition”: This drive is what Smith called the desire of “bettering our condition.” He described it as a lifelong, “calm and dispassionate” but persistent desire that motivates “unrelenting industry.”
• Social Approval of Economic Virtues: Society generally approves of the habits needed to acquire wealth: economy (frugality), industry, discretion, attention, application. Even though pursued for self-interest, these are seen as praiseworthy qualities.
• Motivation for Saving: Knowing that society esteems perseverance in frugality and hard work helps motivate individuals to practice these virtues. This social approval supports the difficult choice of sacrificing present comfort and enjoyment for the prospect of greater, more lasting enjoyment in the future. It helps overcome our natural preference for immediate gratification.
• The “Prudent Man”: Smith later added a passage describing the “prudent man” who embodies these virtues. This person steadily practices industry and frugality, consistently choosing future security over present ease. This behavior is supported and rewarded by the approval of others and by one’s own conscience (the “impartial spectator” within).

Modern Relevance: Smith’s insights into the social and psychological drivers of saving and investment anticipate modern discussions about how social factors influence economic behavior, and perhaps even early versions of “life-cycle” theories (saving during working years for later consumption).

Analyzing the Economy as a System (Period Analysis)

Book II continues the short-run (“static”) and long-run (“dynamic”) perspectives found in the theory of distribution.

The Short Run: The Circular Flow

Smith first illustrates how the economy functions as an interconnected system within a specific time period (like a year). This is often called the circular flow model. It builds on his earlier analysis of prices and costs:

• Output Equals Income: Since the price of every good breaks down into wages, profit, and rent, the total value of all goods produced in the country over a year (the “whole annual produce”) must be equal to the total national income (wages + profit + rent) distributed among the population. Smith stated: “The gross revenue of all the inhabitants… comprehends the whole annual produce…”
• How Income is Used: Consumption vs. Saving: This total national income (representing society’s purchasing power) is divided into two main uses:
  • Consumption: Spending on goods and services for immediate use.
  • Saving: Income not spent on consumption, potentially available for investment. Smith didn’t provide a precise theory of what determines this split, but he suggested:
  • Landlords (due to habits of “expence”) and laborers (due to low incomes close to basic needs) tend to consume most of their income.
  • Capitalists are the primary savers, driven by the desire to “better their condition” through frugality and reinvestment.
• Types of Consumption Spending: Consumption spending can be on:
  • Perishable goods (like food).
  • Durable goods (like furniture or clothing).
  • Services.
• Productive vs. Unproductive Labor: Smith made a famous distinction:
  • Productive Labor: Labor employed in making physical goods (agriculture, manufacturing). This labor reproduces its own value plus a profit, adding to the nation’s stock of material wealth and annual produce.
  • Unproductive Labor: Labor employed in providing services. Smith emphasized these services are useful and have value (people willingly pay for them), but they don’t create a tangible product that adds to the nation’s capital stock. The services are consumed as they are produced. Examples included servants, performers (actors, musicians), professionals (lawyers, doctors, clergy implicitly), and government employees (the sovereign, judges, military). These workers are “maintained by a part of the annual produce of the industry of other people.”
• Saving and Investment:
  • Sources: Savings come primarily from capitalists reinvesting their profits and from lenders (the “monied interest”) providing funds.
  • Interest: The payment borrowers make to lenders for using their money. It compensates the lender for parting with their funds and reflects the profit the borrower hopes to make.
  • Investment (Productive Use of Savings): Entrepreneurs use savings (their own or borrowed) to employ productive labor and buy inputs. Smith divided the capital used in production into two categories:
    • Fixed Capital: Durable assets used repeatedly in production (e.g., machinery, buildings, improved land). Generates revenue through its use over time.
    • Circulating Capital: Assets used up or turned over within a single production cycle (e.g., raw materials, wages paid to productive labor, goods held for sale). Generates revenue when the final product is sold.
  • Key Relationships: Fixed capital requires circulating capital to be created and operated. Different industries need different mixes of fixed and circulating capital.

The Circular Flow in Action

Smith described how the economy functions over a period (like a year) through the circulation of goods and money. Imagine the economy starting the year with stocks of goods left over from the previous year. The process involves interconnected flows:

• Total Stock: Society’s total stock at the start includes:
  1. Goods ready for immediate consumption (already bought by consumers).
  2. The existing stock of fixed capital (machines, buildings, skills).
  3. The existing stock of circulating capital (money, inventories of materials, work-in-progress, and finished goods held by producers and merchants).
• The Flow (Simplified):
  1. Rent Payments: Farmers pay rent to landlords, giving landlords income to spend.
  2. Wage Payments: Capitalists pay wages to productive laborers (using part of their circulating capital), giving workers income to spend.
  3. Inter-Sector Purchases: Businesses in agriculture and manufacturing buy inputs and finished goods from each other (often via merchants).
  4. Intra-Sector Purchases: Businesses buy from others within their own sector.
  5. Consumption Purchases: Landlords, capitalists, and laborers spend their income on consumption goods (and services).
• Outcome: Through this process of spending and receiving income, the goods held as circulating capital are distributed. Money flows from spenders back to producers, generating revenue that allows them to replenish their circulating capital (pay wages, buy materials) and begin the next production cycle. This continuous circulation maintains the economy.

These purchases by consumers and businesses steadily draw down the initial stocks of goods that made up society’s circulating capital at the beginning of the period.

Matching Flows: Withdrawal and Replacement

So, the working of the system involves continuous flows:

• Outflow: Money income (rent, wages, profit) flows to individuals, who then spend it, withdrawing goods from the circulating capital stock.
• Inflow: At the same time, ongoing production continuously replaces the goods being withdrawn. Raw materials are processed, finished goods are made, and worn-out fixed capital (like machines) is replaced.

This process uses both the fixed capital (machines, buildings) and circulating capital (materials, wages fund) available to businesses.

Capital Will Be Used

Smith strongly believed that in any reasonably safe society, people would not simply hoard capital. Anyone with common sense would use their available “stock” (capital) in one of three ways:

1. Immediate Consumption: Keep goods for personal use.
2. Fixed Capital: Invest in assets like machines or buildings to generate future profit while retaining ownership of the asset.
3. Circulating Capital: Invest in materials, wages, or goods for resale, generating profit by temporarily parting with the funds and selling the resulting output.

Smith thought a person “must be perfectly crazy” not to employ their capital in one of these ways if there was basic security.

Interdependence of Capital Uses

Smith further detailed how capital employed in different activities supports the whole system. He identified four main ways capital could be used:

1. Primary Production: Producing raw materials (farming, mining).
2. Manufacturing: Processing raw materials into finished goods.
3. Transportation: Moving raw or finished goods to where they are needed.
4. Retail: Breaking down large quantities of goods into smaller amounts for final consumers.

These activities are linked in a chain:

• Consumer spending allows retailers to replenish their stock and make a profit.
• Retailers’ purchases allow wholesalers to replenish their stock and make a profit.
• Wholesalers’ purchases allow farmers and manufacturers to sell their output, cover their costs, make a profit, and continue producing.
• Manufacturers use some capital as fixed assets (tools, machines) and some as circulating capital (buying materials from farmers/miners, paying wages to workers).
• Farmers similarly use fixed and circulating capital, buying manufactured goods as inputs and selling produce.

Each step replaces the capital (plus profits) of the previous step, enabling the entire cycle to continue.

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The Sources of Economic Growth

Beyond a Static Circle

While Smith’s description of the circular flow shows how the economy functions in a given period (making it seem somewhat static), his real interest wasn’t in a perfectly repeating cycle. Unlike some predecessors (like Quesnay, who focused on conditions for static equilibrium), Smith expected the economy to grow. He recognized that things wear out at different rates, implying constant change, and believed that the output produced in one year would likely be greater than the last.

How Does Growth Happen?

Smith stated that the total value of a nation’s annual production can increase in only two ways:

1. By increasing the number of productive laborers employed.
2. By increasing the productivity of the existing laborers (making each worker produce more).

The Key Role of Capital Accumulation

Both methods require more capital:

• Employing more workers requires a larger wages fund (part of circulating capital).
• Increasing productivity often requires better machines and tools (fixed capital).

Where does this additional capital come from? Net savings. Savings are the portion of income not spent on consumption. When people save, they add to the nation’s capital stock.

Smith argued that saving has a powerful effect:

• When a person saves, they make funds available to employ more productive workers (either directly or by lending to someone else).
• This not only supports additional workers this year but also establishes a “perpetual fund” to maintain productive employment in the future, assuming the capital is maintained.

Growth as an Expanding Spiral

This leads to a self-reinforcing process:

1. Savings in Year 1 lead to more capital.
2. More capital leads to higher output and income in Year 2.
3. Higher income in Year 2 allows for potentially even greater savings.
4. Greater savings in Year 2 lead to more capital and even higher output/income in Year 3, and so on.

So, Smith’s “circular flow” isn’t just a circle; it’s an expanding spiral fueled by capital accumulation through saving.

Recurring Themes on Growth (Book II)

Smith repeatedly emphasized these points:

• Saving = Investment: “Whatever a person saves from his revenue he adds to his capital…” This saved income is either invested directly by the saver or lent to someone else to invest. Society’s capital grows only through saving.
• Saving Funds Productive Labor: Saving (“parsimony”) increases the funds available to hire productive workers, boosting national output and the “exchangeable value of the land and labour.”
• Savings Are Spent (Productively): Savings don’t disappear. “What is annually saved is as regularly consumed as what is annually spent…” The crucial difference is who consumes it. Savings are consumed by productive laborers (as wages buying necessities) or used to purchase investment goods, rather than being spent by the saver on personal consumption or unproductive services.

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Factors Affecting the Rate of Growth

Smith identified several factors that influence how fast an economy grows (the rate of capital accumulation):

1. Business Failures: Poorly planned or unlucky projects waste capital, reducing the funds available for productive use.
2. Capital Maintenance: Simply maintaining the existing stock of fixed capital (repairing machines, buildings) uses up resources. Savings used for maintenance don’t contribute to new growth. Reducing maintenance costs without hurting productivity frees up capital for expansion.
3. Use of Paper Money: Replacing gold and silver money with paper money frees up the valuable real resources (gold and silver) formerly used as currency. These resources can then be added to the circulating capital used for production, boosting growth.
4. Allocation between Productive and Unproductive Labor: The more of society’s resources are used to support unproductive labor (service providers, government employees), the less is available to support productive labor that creates tangible goods and adds to capital. Therefore, large government spending (“maintaining unproductive hands”) tends to slow down growth.
5. Where Capital is Invested: Investing capital in different sectors has different impacts on growth because they support different amounts of productive labor. Smith ranked investment sectors by their growth contribution (highest first):
   • Agriculture: Most advantageous, puts the most productive labor into motion.
   • Manufacturing: Second highest.
   • Wholesale Trade: (Home trade > Foreign trade > Carrying trade).
   • Retail Trade: Least advantageous (though necessary).
   • Implications: Smith argued that for optimal growth, especially if capital is scarce, investment should prioritize agriculture first. He believed Europe’s growth was hampered by policies favoring trade over agriculture, unlike the American colonies which grew rapidly by focusing on farming. He also suggested a “natural course of things” where investment flows first to agriculture, then manufacturing, then foreign trade, partly based on perceived security.

The Role of “Manners” (Social Attitudes)

Smith also noted how social attitudes influence growth:

• Industry vs. Idleness: Societies where capital and productive investment dominate tend to be industrious. Societies where spending on immediate consumption (“revenue”) dominates tend towards idleness.
• Frugality vs. Spending: While everyone spends sometimes, and some people spend excessively (“prodigality”), Smith believed that in a commercial society offering opportunities to get ahead, the desire to save and accumulate (“the principle of frugality”) generally predominates over the desire for excessive spending in most people’s lives. This ensures continued saving and growth.
• Types of Spending Matter: Even consumption spending can be more or less conducive to growth. Spending on durable goods (houses, furniture) is better than spending on fleeting pleasures (parties, excessive servants). Durable goods last longer and eventually benefit lower classes. Furthermore, it’s socially easier to cut back on spending on durable goods if needed, without attracting public censure for past extravagance, unlike cutting back dramatically on servants or entertainment. (This again shows the influence of social judgment).

Final Connection: Division of Labor

Ultimately, Smith’s theory of growth connects back to where his economic analysis began: the division of labor. Capital accumulation (driven by saving and investment) makes possible greater specialization, the use of more and better machinery, and improved infrastructure. These advancements increase the productivity of labor, which is the fundamental engine driving long-term economic growth and improving living standards.

The Growth Engine: Division of Labor Feeds Growth

This leads to a simple but powerful point: economic growth creates larger markets. Larger markets allow for a greater division of labor (more specialization). Greater specialization increases productivity and encourages technological improvements (“invention”). Increased productivity, in turn, fuels further economic growth. Smith’s model suggests an economy experiencing increasing returns, where growth itself makes future growth easier.

Untapped Questions

This idea implies that already rich countries might grow faster and faster, gaining a huge advantage over poorer countries. However, Smith didn’t fully explore this possibility (unlike some contemporaries like Hume and Steuart). He also didn’t analyze in detail how different growth rates between countries might affect international trade.

Accumulation as the Driving Force

Smith’s analysis of capital accumulation provides the engine driving the long-run trends in wages, profit, and rent discussed earlier:

• Accumulation fuels population growth and brings more land into use.
• Accumulation explains why wages tend towards subsistence in the long run (as population catches up to capital).
• Accumulation explains why the rate of profit tends to fall over time (as capital becomes more abundant and competition increases).

The Role of the Individual and Laissez-Faire

Throughout his model of a competitive economy (“system of perfect liberty”), Smith highlights the importance of individual actions driven by self-interest. This leads directly to his famous policy conclusion: the government should generally stay out of economic affairs. He argued the ruler should be freed from the “duty of superintending the industry of private people.”

He strongly criticized government intervention:

• “No regulation of commerce can increase the quantity of industry… beyond what its capital can maintain.” Government rules can only redirect economic activity, not increase its total amount.
• Furthermore, “it is by no means certain that this artificial direction is likely to be more advantageous… than that into which it would have gone of its own accord.”

This position, known as laissez-faire (meaning “let it be” or “let it happen”), has been highly influential and remains famously associated with Adam Smith.

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(Subsection 5)

Conclusion

Criticisms of Smith

Despite his immense influence, Adam Smith has faced significant criticism over the years:

• Lack of Originality: Some critics, like Joseph Schumpeter, noted Smith wasn’t always generous in acknowledging his intellectual predecessors. Others, like Murray Rothbard, went further, accusing him of outright plagiarism.
• Analytical Weaknesses: Early critics like the Earl of Lauderdale (writing in 1804) pointed out flaws in Smith’s theories of value (arguing he neglected subjective factors), the division of labor, and his distinction between productive and unproductive labor.
• Saving vs. Spending: Lauderdale also challenged Smith’s idea that saving is always beneficial. He argued that consumption spending is vital because it creates the demand needed to encourage investment in producing goods. (This debate foreshadowed later arguments between Malthus and Ricardo, and influenced J.M. Keynes).
• Overall Contribution Questioned: Some critics, particularly from the “Austrian School” of economics like Rothbard, have harshly questioned Smith’s overall positive contribution to economic thought, especially regarding value theory.

In Defense of Smith: The Power of the System

Yet, even critics like Schumpeter ultimately recognized the greatness of The Wealth of Nations. While acknowledging it lacked truly groundbreaking new ideas comparable to Newton’s physics or Darwin’s biology, Schumpeter called it a “great performance” that “fully deserved its success.”

Why? The key lies in Smith’s achievement in creating a comprehensive analytical system.

• An “Imaginary Machine”: Smith’s own description of a system as an “imaginary machine” fits his economic work perfectly. The Wealth of Nations logically connects different parts of the economy: price determination leads to income distribution, which connects to the overall circulation of goods and money (the “circular flow”), which in turn explains economic growth.
• Demonstrating Interdependence: Smith masterfully showed how all economic phenomena are interconnected. While his analysis of specific topics might not always have been superior to his contemporaries, the way he wove them together into a coherent whole, demonstrating the interdependence of the entire economic system, was unparalleled (with the possible exception of the French economist Turgot).
• A Unifying Vision: As historian Jacob Viner noted, Smith’s great originality was applying the idea of a unified, interconnected system of cause and effect – a concept already used in philosophy and theology – to the “wilderness” of economic activity.
• Contemporary Recognition: Some contemporaries recognized this achievement. Governor Pownall called the book a foundational work explaining the “laws of motion” of the economy. Dugald Stewart praised its logical structure and clarity. Smith himself valued systematic thinking.

Smith’s Lasting Influence – And Its Ironies

Smith’s legacy rests largely on two pillars: his systematic analysis and his powerful advocacy for free markets.

• Delayed Impact: However, research suggests his free-market ideas had limited practical impact during his lifetime. Their later triumph may have been partly due to how well they suited Britain’s interests in the 19th century. At the time of his death, Smith was famous, but few considered his book uniquely influential.
• Posthumous Rise: After his death, his influence grew rapidly. Economists like J.B. Say in France and David Ricardo in Britain built directly on his work. His student Dugald Stewart spread his ideas to a new generation of influential economists in Scotland and England.
• The “Classical Orthodoxy”: This led to the development of “classical economics,” often seen as starting with Smith in 1776.
• Costs of Orthodoxy: This had unintended consequences:
  • Forgetting Predecessors: The contributions of important earlier economists were often overlooked or forgotten.
  • Narrowing Focus: The classical school, especially under Ricardo’s influence, sometimes narrowed the scope of economics, neglecting historical methods, issues like unemployment, or the problems of underdeveloped economies that earlier writers (including Smith sometimes) had considered.
  • Distorting Smith?: Ironically, the focus on the logical rigor of the Ricardian system may have obscured some of the richness of Smith’s own approach – his emphasis on real-world processes, adjustment over time, imperfect knowledge, and the dynamic nature of the circular flow.
  • Separating Economics from Ethics and History: Perhaps the most significant distortion was the increasing separation of economics from moral philosophy and history – fields Smith saw as deeply integrated. As Terence Hutchison wryly commented, Smith was unwittingly led by an “Invisible Hand” to establish economics as a separate discipline, something he likely never intended.
  • The Paradox: Professor Alec Macfie highlighted the paradox that Smith’s specific economic analysis ended up overshadowing the broader philosophical and historical approach he personally valued and which was characteristic of his Scottish intellectual background.

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MAJOR PUBLICATIONS

• The Theory of Moral Sentiments. First edition 1759; sixth edition (major revisions) 1790.
• An Inquiry into the Nature and Causes of the Wealth of Nations. First edition 1776; fifth edition 1789.
• Essays on Philosophical Subjects. Published posthumously 1795.

LECTURE NOTES

• Lectures on Justice, Police, Revenue and Arms (from student notes, 1762–4).
• Lectures on Rhetoric and Belles-Lettres (from student notes, 1762–3).

(Note: The Glasgow Edition provides modern scholarly editions of all these works and Smith’s correspondence).

CHAPTER I

OF THE DIVISION OF LABOUR

The Main Cause of Improvement

The biggest reason why work has become so much more productive seems to be the division of labor. This means breaking down work into smaller, specialized tasks. Most of the skill, speed, and good judgment used in work today comes from this specialization.

Seeing the Division of Labor

It’s easier to understand how the division of labor works by looking at specific types of manufacturing. People often notice it most in very small, simple industries. This isn’t necessarily because specialization is more extreme in these small industries than in larger ones. It’s because:

• Small industries supply niche products to only a few people, so they employ fewer workers overall.
• All the different workers doing specialized tasks can often be gathered in one workshop, where an observer can see the whole process at once.

In contrast, large industries supply essential goods to the whole population. They employ huge numbers of workers in many different stages of production.

• It’s impossible to gather all these workers in one place.
• We usually only see the workers involved in one single step at a time. So, even though the work in large industries might actually be divided into many more parts, the division isn’t as obvious and gets less attention.

A Famous Example: The Pin Factory

Let’s take an example from a simple industry where the division of labor is well-known: making pins.

Imagine a worker who hasn’t been trained in pin-making (which is now a specialized trade due to the division of labor) and doesn’t know how to use the specialized machinery (which was likely invented because of the division of labor). Even working as hard as possible, this person could probably make only one pin in a whole day, and definitely not more than twenty.

But look at how pin-making is actually done now:

• The entire process is a specialized business.
• It’s divided into many smaller steps, most of which are also specialized jobs.
• The Steps:
  1. One person draws out the wire.
  2. Another straightens it.
  3. A third cuts it.
  4. A fourth sharpens the point.
  5. A fifth grinds the top end to prepare it for the head.
  6. Making the head itself requires two or three separate operations.
  7. Putting the head on is a specific task.
  8. Whitening the pins is another.
  9. Even putting the finished pins into paper packaging is a distinct job.

So, making a single pin is divided into about eighteen different steps. In some factories, each step is done by a different worker. In others, one worker might do two or three steps.

I once visited a small pin factory that employed only ten men. Because there were only ten of them, some had to perform two or three different tasks. They were quite poor and didn’t have the best machinery. But when they worked hard, they could collectively produce about twelve pounds of pins in a day. A pound contains over four thousand medium-sized pins.

• Calculation: Ten workers produced over 48,000 pins per day.
• Productivity per Worker: That means each worker effectively made about 4,800 pins per day (one-tenth of the total).

Compare this to what they could have done working alone, without specialized training: perhaps one pin per day, certainly not twenty. Thanks to the division and combination of tasks, their productivity was maybe 240 times, or even nearly 4,800 times, higher!

Universal Benefits of Specialization

The effects of the division of labor are similar in every other industry and type of work, although not all work can be broken down into such small, simple steps.

Wherever the division of labor can be introduced, it leads to a proportional increase in how much work can be done (the productive power of labor).

The separation of different jobs and trades from each other seems to have happened because of this advantage. This separation is generally most advanced in countries with the highest levels of industry and development. What one person does in a simple (“rude”) society is usually done by several specialized people in an advanced one.

In every developed society:

• A farmer is usually just a farmer.
• A manufacturer is just a manufacturer.
• The work needed to produce any single manufactured item is almost always divided among many different specialized workers.

Think about how many different trades are involved in making linen or woolen cloth: from growing the flax or raising the sheep, to sorting, combing, spinning, weaving, bleaching, dyeing, and finishing the fabric!

Limits to Specialization in Farming

Agriculture, however, doesn’t allow for as much detailed division of labor as manufacturing. You can’t completely separate the job of raising livestock from growing crops in the same way you can separate the job of a carpenter from a blacksmith.

• The spinner is almost always a different person from the weaver.
• But the person who plows, harrows, sows seeds, and harvests the grain is often the same person. Different farming tasks need to be done at different times of the year. It’s impossible for one person to be busy doing just one of these tasks all year round.

This difficulty in separating agricultural tasks might be why improvements in farming productivity often lag behind improvements in manufacturing productivity.

National Differences

Wealthy nations usually perform better than their neighbors in both agriculture and manufacturing. But their superiority is typically much greater in manufacturing.

• Their farmland is generally better cultivated and produces more per acre, thanks to more labor and investment. But this higher yield is often just proportional to the extra labor and expense put in.
• Farm labor in a rich country isn’t always drastically more productive than in a poor country, certainly not as much more productive as manufacturing labor often is.
• Therefore, grain from a rich country isn’t always much cheaper than grain of similar quality from a poorer country (e.g., Polish grain vs. French or English grain).
• But in manufacturing, a poor country usually can’t compete with a rich one in terms of quality and price (unless the product particularly suits the rich country’s climate, like French silk compared to English silk). English hardware and basic woolens, for instance, were far superior and cheaper than French ones at the time Smith wrote. Poland had very few manufactures besides essential household items.

Why Does Division of Labor Increase Productivity?

This huge increase in the amount of work that can be done by the same number of people, thanks to the division of labor, happens for three main reasons:

1. Increased Skill (“Dexterity”) in Each Worker:

   • When a person’s job is reduced to one simple task, and they do only that task their whole life, they become incredibly fast and skilled at it.
   • Smith gives an example: A general blacksmith who isn’t used to making nails might make only 200-300 bad nails a day. A blacksmith who sometimes makes nails might manage 800-1,000. But boys under twenty who have only ever made nails could make over 2,300 good nails a day.
   • Even nail-making involves several steps (working the bellows, heating the iron, forging the nail, changing tools for the head). Tasks in pin or button making are even simpler, allowing for even greater dexterity. The speed achieved in some specialized manufacturing tasks seems almost unbelievable to someone who hasn’t seen it.

2. Saving Time Lost Switching Tasks:

   • A lot of time is usually wasted when workers switch from one type of work to another, especially if it involves changing location or tools.
   • A weaver who also runs a small farm loses significant time going between the loom and the field.
   • Even when tasks are in the same workshop, time is lost. People tend to pause or “saunter” when changing activities. They often start the new task slowly, without full focus (“his mind… does not go to it”).
   • A worker who constantly changes tasks and tools (like a rural handyman) develops a habit of “sauntering and of indolent careless application.” This makes them generally slower and less capable of intense effort, even when needed.
   • So, quite apart from lower skill levels, simply avoiding the time lost switching tasks considerably increases the total work done.

3. Invention of Labor-Saving Machinery:

   • Everyone knows that machines make work easier and faster. It seems that the invention of many machines was originally prompted by the division of labor.
   • People are more likely to find easier ways to do something when their entire attention is focused on that one specific task, rather than spread across many different things.
   • Because the division of labor focuses each worker’s attention on one simple operation, it’s natural that some workers would figure out quicker and easier methods for their specific job.
   • Many machines used in highly specialized industries were originally invented by ordinary workers trying to make their own particular task easier. Visitors to factories are often shown clever machines invented by workers for this purpose.
   • Example: Early steam engines (“fire-engines”) required a boy to constantly open and close a valve. One boy, wanting time to play, figured out how to tie a string from the valve handle to another part of the machine so it would open and close automatically. This clever shortcut by a boy trying to save his own labor turned out to be a major improvement to the steam engine.

Who Invents Machines?

However, not all improvements in machinery come from the workers who use them.

• Machine Makers: Once making machines became a specialized trade itself, the skilled makers invented many improvements.
• Thinkers (“Philosophers or Men of Speculation”): Some inventions come from scientists or thinkers whose job is to observe everything and combine ideas, sometimes from very different fields. As society develops, philosophy and scientific research become specialized occupations too. This specialization within science and invention also improves skill, saves time, and greatly increases the total amount of knowledge.

Result: Widespread Wealth (“Universal Opulence”)

The huge increase in the production of all kinds of goods, resulting from the division of labor, is what creates widespread wealth (“universal opulence”) in a well-run society. This wealth spreads even to the lowest ranks of the people. How?

• Each worker, because of specialization, produces a large quantity of their particular product, far more than they need for themselves.
• Since every other worker is in the same situation, they can exchange their large surplus for large quantities of goods made by others (or the money to buy them).
• People can abundantly supply each other’s needs. This creates a “general plenty” that spreads through all levels of society.

The Complexity Behind Everyday Goods

Consider the possessions of an ordinary worker (“artificer or day-labourer”) in a prosperous, civilized country. You’ll find that getting them even basic necessities requires the work of an enormous number of people.

Take the worker’s simple woolen coat:

• It’s the result of the combined labor of shepherds, wool sorters, wool combers, dyers, spinners, weavers, fullers (who clean and thicken cloth), dressers (who finish the cloth), and many others.
• Think of the merchants and carriers needed to transport materials between these workers, often across long distances.
• Think of the shipbuilders, sailors, sail-makers, and rope-makers involved in importing the dyes and other materials, perhaps from the farthest corners of the world.
• Consider the vast amount of labor needed just to produce the tools used by even the humblest of these workers. Forget complex machines like ships or looms; even the simple shears used by the shepherd required many different kinds of labor to make!

To make those shears, think of all the workers involved: the miner digging the ore, the builder of the furnace to smelt it, the logger who cut the timber, the charcoal maker, the brick-maker and brick-layer for the furnace, the furnace operators, the mill-wright, the forger, and the smith. All their different skills had to come together.

If we looked closely at everything else the worker uses – the simple linen shirt they wear, their shoes, the bed they sleep on (with all its different parts), the stove where they cook, the coal used for fuel (mined deep in the earth and transported perhaps long distances by sea and land), all the kitchen utensils, the plates, knives, and forks, the workers who made their bread and beer, the glass window that lets in light while keeping out the cold (a wonderful invention essential for comfortable living in northern climates) – if we examine all these things and consider the incredible variety of labor needed for each, we would realize something important. Even the poorest person in a civilized country depends on the help and cooperation of many thousands of people just to live in what we often mistakenly think is a simple way.

Of course, compared to the extreme luxury of the very wealthy, the common laborer’s lifestyle seems basic. And yet, the difference in comfort and possessions between a European king and an ordinary, hard-working peasant might actually be less than the difference between that peasant and the leader of an isolated tribal group living in poverty with very few tools or possessions. The point is that the division of labor, when well-established, massively increases the standard of living for everyone in society compared to societies without it.

CHAPTER II

OF THE PRINCIPLE WHICH GIVES OCCASION TO THE DIVISION OF LABOUR

Where Does the Division of Labor Come From?

This division of labor, which brings so many benefits, didn’t start because some wise person planned it that way, foreseeing the widespread wealth it would create. Instead, it’s the necessary, though slow and gradual, result of a basic tendency in human nature. This tendency itself doesn’t aim for such broad benefits. It is the tendency to truck, barter, and exchange one thing for another.

The Human Tendency to Trade

Is this tendency to trade a fundamental part of human nature that can’t be explained further? Or does it perhaps come from our abilities to reason and speak? That’s not our main topic here. What’s important is that this tendency is found in all humans, and only in humans.

Animals don’t seem to trade or make agreements.

• You might see two greyhounds chasing the same rabbit appear to cooperate. One might turn the rabbit towards the other. But this isn’t based on any agreement; it’s just their instincts happening to focus on the same goal at the same time by chance.
• Nobody has ever seen a dog fairly and deliberately trade one bone for another with a different dog.
• No animal uses gestures or cries to say to another, “This is mine, that is yours; I’ll give you this if you give me that.”

Getting Help: Animals vs. Humans

When an animal wants something from a person or another animal, its only method is to try to win favor. A puppy will nuzzle its mother. A dog will try all sorts of cute tricks to get its owner’s attention at dinnertime, hoping for a scrap.

Humans sometimes use similar tactics. When we have no other way to persuade someone, we might resort to flattery or acting overly agreeable to gain their goodwill.

However, we simply don’t have time to do this for every single thing we need. In a civilized society, we constantly need the cooperation and help of huge numbers of people. But our whole lifetime is barely long enough to make close friends with even a few people.

Most animals, once they grow up, are entirely independent and don’t need help from others. But humans almost always need the help of other people. It’s pointless to expect to get this help based only on their kindness or goodwill (“benevolence”).

Appealing to Self-Interest

We are much more likely to get what we need from others if we can appeal to their self-interest (“self-love”). We need to show them how doing what we ask will benefit them.

This is what happens in any kind of bargain or trade. The meaning of any offer is basically: “Give me the thing I want, and you can have this thing that you want.” It is through this process of exchange – appealing to mutual self-interest – that we obtain most of the goods and services we need from each other.

The Famous Quote: “It is not from the benevolence of the butcher, the brewer, or the baker that we expect our dinner, but from their regard to their own interest.” We don’t appeal to their sense of humanity; we appeal to their self-interest. We talk to them about their advantages, not about our own needs.

Beggars and Benevolence

Only a beggar relies primarily on the kindness of others. Even then, they don’t depend on it completely. While charity might provide the beggar’s basic income (“fund of his subsistence”), it doesn’t automatically provide everything they need exactly when they need it. Like everyone else, beggars get most of their specific, day-to-day needs met through treaty, barter, and purchase. They use the money someone gives them to buy food. They might trade old clothes they received for clothes that fit better, or for shelter, or for more food, or for money to buy what they need later.

How Trading Leads to Specialization

Just as we rely on trade (“treaty, by barter, and by purchase”) to get most things we need, it’s this same human tendency to trade that originally caused the division of labor.

Imagine a tribe of hunters or herders:

• One person happens to be faster and better at making bows and arrows than anyone else.
• They often trade their bows and arrows with others for cattle or hunted meat (“venison”).
• Eventually, they realize they can get more cattle and meat by trading bows than by hunting themselves.
• Therefore, guided by their own self-interest, making bows becomes their main activity. They become a sort of weapon-maker (“armourer”).
• Another person is skilled at making the frames and coverings for their simple huts. Their neighbors reward them with cattle and meat for helping build huts. Eventually, this person finds it’s in their interest to focus entirely on this job and become a kind of carpenter.
• In the same way, a third person might become a blacksmith, a fourth might specialize in tanning hides for clothing, and so on.

The Incentive to Specialize

The certainty of being able to exchange the surplus part of your own work (whatever you produce beyond your own needs) for the things you need from others encourages every person to:

1. Focus on one particular occupation.
2. Develop and perfect whatever natural talent (“talent or genius”) they might have for that specific type of work.

Are Talents Born or Made?

The natural differences in talents between people are actually much smaller than we usually think. The very different abilities (“genius”) that seem to distinguish people in different professions when they are adults are often the effect, rather than the cause, of the division of labor.

Think about the difference between a highly educated philosopher and a common street porter. Smith suggests this difference comes less from their innate nature and more from habit, custom, and education.

• When they were born and for the first six or eight years of life, they were probably very much alike. Their parents and friends likely saw no major differences.
• Around that age, they started doing very different kinds of work or received very different kinds of education.
• Only then did differences in their apparent talents begin to show and grow wider over time, until eventually, the philosopher might see very little similarity between themself and the porter.

But imagine a world without the tendency to trade. Everyone would have had to get everything they needed for themselves. Everyone would have the same basic tasks to perform. There would be no different occupations, and therefore no basis for these large differences in specialized talents to develop.

Trading Makes Talents Useful

Just as the tendency to trade helps create these specialized talents, it also makes these differences useful to society.

Consider animals again:

• Different breeds of dogs (like mastiffs, greyhounds, spaniels, sheepdogs) often have much greater natural differences in abilities than humans do before education and specialization.
• However, these different animal talents are of almost no use to each other. The mastiff’s strength doesn’t help the greyhound run faster. The spaniel’s intelligence doesn’t help the sheepdog. They cannot trade their abilities or the results of their abilities. Their different talents cannot be brought into a “common stock” to benefit the whole species. Each animal must still survive independently, gaining no advantage from the diverse talents of its fellow animals.

Among humans, however, it’s completely different.

• The most different talents and abilities are useful to each other.
• Because of our general tendency to “truck, barter, and exchange,” the different products resulting from people’s specialized talents are brought together, as if into a “common stock.”
• From this common stock, every person can purchase whatever part of the product of other people’s talents they need.

CHAPTER III

THAT THE DIVISION OF LABOUR IS LIMITED BY THE EXTENT OF THE MARKET

Specialization Needs Buyers

In the last chapter, we saw that the ability to trade is what allows the division of labor to happen. It follows, then, that how much work can be divided depends on how much trading is possible. In other words, the extent of the division of labor is limited by the extent of the market.

If the market is very small (meaning few potential customers or limited opportunities to trade), no one has much reason to dedicate themselves completely to just one job. They wouldn’t be able to sell the large surplus of goods they produce beyond their own needs. They couldn’t reliably trade that surplus to get all the different goods they require from other specialists.

Examples of Market Limits

• Simple Jobs Need Cities: Some jobs, even basic ones like a porter (someone who carries things for others), can only exist in a large town where there’s enough demand. A village is too small for a porter to find enough work to survive. Even an ordinary market town might not provide steady work.
• Remote Areas Force Self-Sufficiency: In isolated places with scattered homes, like the Scottish Highlands in Smith’s time, every farmer had to be their own butcher, baker, and brewer. It was hard to find even a specialized blacksmith, carpenter, or mason nearby – maybe only one every twenty miles. Families living far from neighbors had to learn to do many small tasks themselves because specialized help wasn’t available.
• Rural Workers Must Generalize: Country workers often have to do many different kinds of related work. A country carpenter might do general carpentry, fine woodworking (“joinery”), cabinet making, wood carving, and also make wheels, plows, and carts. A country blacksmith works with all sorts of iron products. Their jobs are much less specialized than city workers’.
• Highly Specialized Trades Impossible: A highly specialized trade like a nailer (someone who only makes nails) couldn’t possibly exist in remote inland areas. A nailer might make 300,000 nails a year. In an isolated place, they couldn’t possibly sell even 1,000 nails – just one day’s worth of their work – in an entire year.

Water Transport Expands Markets Dramatically

Water carriage (transport by ship or boat) opens up much larger markets for all kinds of products than land carriage (transport by wagon) alone can.

Because of this, industry and the division of labor naturally tend to start and improve first along seacoasts and the banks of navigable rivers. These improvements often spread to the inland parts of a country much later.

Cost Comparison: Land vs. Water Smith offered an example comparing transport between London and Edinburgh (Leith port):

• Land: A large wagon with two men and eight horses could carry about four tons of goods round trip in roughly six weeks.
• Water: A ship with six or eight men could carry two hundred tons round trip in about the same time (six weeks).
• Efficiency: This means 6-8 sailors using water transport could move the same amount of goods as 50 wagons needing 100 men and 400 horses!
• Costs: Transporting 200 tons by land would involve the huge cost of maintaining 100 men and 400 horses for weeks, plus the wear and tear on 50 wagons. Transporting the same amount by sea involves only the cost of maintaining 6-8 men and the ship, plus insurance against the risks of sea travel.

Consequences for Trade: If only land transport existed between London and Edinburgh, only very valuable goods (relative to their weight) could afford the cost. Trade between them would be tiny compared to what water transport allows. They couldn’t provide much of a market for each other’s products.

Trade between distant parts of the world, like London and Calcutta, would be almost impossible by land due to the immense cost and danger. Yet, thanks to water carriage, these cities carried on significant trade, providing markets for each other’s industries.

Geography and the Start of Civilization

Since water transport is so advantageous for creating large markets, it’s natural that the first improvements in skills and industry happened in places with easy access to water transportation. Inland areas, relying only on local markets, developed much later. Their progress depended on the progress of the surrounding country that connected them to coasts or major rivers.

• North American Colonies: Early settlements stayed close to the seacoast or along navigable rivers.
• Mediterranean Civilizations: The earliest known civilizations developed around the Mediterranean Sea. This huge inland sea was relatively calm (few tides, mostly wind-driven waves) and had many islands and nearby shores, making it perfect for early, less advanced forms of navigation before the compass was known and when ships weren’t sturdy enough for rough oceans. Sailing beyond the Straits of Gibraltar was long considered a major, dangerous feat.
• Egypt: Appears to be the first Mediterranean country to develop advanced agriculture and manufacturing. The Nile River, breaking into many canals, provided excellent inland water transport connecting towns, villages, and farms (similar to rivers in Holland). This easy internal navigation was probably a key reason for Egypt’s early success.
• Bengal (India) and Eastern China: Also developed advanced agriculture and manufacturing very early. They too had extensive networks of navigable canals formed by great rivers like the Ganges and major Chinese rivers. Notably, these ancient civilizations became wealthy primarily through this vast inland navigation and trade, rather than focusing on foreign commerce.

Why Some Regions Remained Undeveloped

In contrast, large inland areas of Africa and northern Asia (like ancient Scythia or modern Siberia) seemed to have remained in a “barbarous and uncivilized state” for centuries. Smith attributed this largely to lack of water access:

• Northern Asia: Borders the frozen Arctic Ocean (unnavigable). Its huge rivers are too far apart to create widespread internal trade routes.
• Africa: Lacks large inland seas like the Mediterranean or Baltic to facilitate maritime trade deep into the continent. Its major rivers are also too far apart for significant inland navigation.
• River Limitations: Even having a river isn’t enough if it doesn’t have many branches or if it flows through another country before reaching the sea (as that country can block trade). The Danube River, for example, is less useful to upstream countries like Bavaria or Austria than it would be if they controlled its entire path to the Black Sea.

In short, access to water transportation, by creating large markets, is crucial for allowing the division of labor to develop, which in turn drives economic progress and civilization.

CHAPTER IV

OF THE ORIGIN AND USE OF MONEY

Life with Specialization: The Need to Exchange

Once the division of labor is fully established, people can only produce a very small fraction of the things they need through their own work. They get almost everything else by exchanging the surplus part of their own production (what’s left after satisfying their own needs) for the surplus products made by others.

In this system, every person lives by exchanging. Everyone becomes, in a way, a merchant. Society itself becomes what we can truly call a commercial society.

The Problem with Early Exchange (Barter)

But when the division of labor first started, trading must have often been very difficult and awkward.

Imagine this situation:

• One person (say, a butcher) has more of a certain good (meat) than they need.
• Another person (say, a baker or brewer) has less meat than they want.
• The butcher wants to sell the extra meat, and the baker/brewer wants to buy it.
• The Problem: What if the baker or brewer has nothing the butcher currently needs? Maybe the butcher already has plenty of bread and beer.
• Result: No direct exchange can happen between them. The butcher can’t sell to them, and they can’t buy from the butcher. They are less useful to each other than they could be.

This difficulty is called the problem of the double coincidence of wants: for a direct trade (barter) to work, I must want what you have, and you must want what I have, at the same time.

A Practical Solution: Holding a Common Commodity

To avoid getting stuck in these situations, smart people in every society, once specialization began, would naturally try to keep a supply of some commonly accepted good on hand. They would choose something they believed almost anyone would accept in exchange for their own products. This good acts as an intermediate item in trade.

Early Forms of Money (Commodity Money)

Over time, many different goods were probably tried and used for this purpose:

• Cattle: In early societies, cattle were often used as a common measure of value and means of exchange (though very inconvenient!). Homer, for instance, mentions armor priced in oxen.
• Salt: Used in Abyssinia (modern Ethiopia).
• Shells: Used in some coastal parts of India.
• Dried Cod Fish: Used in Newfoundland.
• Tobacco: Used in colonial Virginia.
• Sugar: Used in some West Indian colonies.
• Hides (Leather): Used in other regions.
• Nails: Even in Smith’s time, in a village in Scotland, workers reportedly used nails instead of coins to pay at the bakery or pub.

Why Metals Became the Preferred Choice

Eventually, however, people in almost all countries found strong reasons to prefer metals (especially gold and silver) over all other goods for this purpose. Metals have key advantages:

1. Durability: They last a long time without spoiling.
2. Divisibility: They can be divided into smaller pieces without losing value (unlike cutting up a cow).
3. Uniformity: Each piece of the same metal is essentially the same.
4. Fusibility: Divided pieces can easily be melted back together again.

These qualities make metals very suitable as instruments of commerce and circulation. If you wanted to buy salt but only had cattle to trade, you’d have to buy salt worth a whole ox or sheep. You couldn’t easily buy less, because you couldn’t easily divide the ox. If you wanted more, you’d have to buy in multiples of oxen or sheep. But if you had metal, you could easily measure out the precise amount needed for the exact quantity of salt you wanted.

Different nations used different metals: iron in ancient Sparta, copper in ancient Rome, and gold and silver in most wealthy trading nations.

From Metal Bars to Coins

Originally, these metals were likely used as money in the form of rough bars or ingots, without any official stamp or marking. Early Romans, for example, reportedly used unstamped bars of copper for purchases.

Problems with Unstamped Metal

Using unstamped metal had two big drawbacks:

1. Weighing: Buyers had to weigh the metal for every transaction. This was troublesome, especially for small purchases. For precious metals like gold and silver, where small weight differences mean large value differences, very accurate scales were needed, and weighing carefully was a delicate process.
2. Assaying (Testing Purity): Even more difficult was ensuring the metal was pure. The only sure method involved melting a sample, which was impractical for everyday trade. Without this, people could easily be cheated with impure mixtures made to look like real gold or silver.

The Invention of Coinage

To prevent these abuses, make exchanges easier, and thereby encourage trade and industry, governments in advancing societies began to put an official public stamp on certain quantities of the metals commonly used as money.

This stamp was intended to certify the weight and fineness (purity) of the metal. This was the origin of coined money and government mints. Mints are institutions designed to guarantee, through a public stamp, the quantity and quality of the money brought to market, much like official inspectors guaranteed the quality of cloth in Smith’s time.

Development of Coins

• Early Stamps (Purity): The very first stamps often just certified the purity of the metal, which was the hardest thing for ordinary people to judge. These stamps might only cover part of the metal piece (like modern sterling marks on silver). They guaranteed fineness but not weight, so the metal still had to be weighed (like Abraham weighing silver shekels in the Bible).
• Later Stamps (Weight and Count): Because weighing was inconvenient, stamps were later developed that covered the entire coin (both sides, sometimes the edges). This stamp was supposed to guarantee both the fineness and the weight. Such coins could then be accepted by simply counting them (“by tale”) without the need for weighing.

Coin Names and Weights

Originally, the names of coins often indicated the weight of metal they contained:

• The Roman As initially contained a Roman pound of copper.
• The English Pound Sterling (in the time of Edward I) contained a Tower pound of silver.
• The French Livre (in the time of Charlemagne) contained a Troyes pound of silver.
• Pennies in England, France, and Scotland originally contained one pennyweight of silver.

Debasement: Reducing Metal Content

However, Smith observed a universal historical trend: governments (“princes and sovereign states”), often driven by greed or financial need (“avarice and injustice”), gradually reduced the actual amount of precious metal in their coins while keeping the original names (pound, livre, penny, etc.).

• The Roman As eventually contained only 1/24th of its original copper.
• By Smith’s time, the English pound and penny contained only about 1/3rd of their original silver. The Scots pound was down to 1/36th, and the French livre to 1/66th.

Why Debase Coins? Rulers did this so they could pay their debts and meet obligations using less real silver or gold. It appeared they were fulfilling their promises, but in reality, their creditors were cheated out of part of what was owed. This practice also allowed all other debtors in the country to repay their loans using the new, lighter coins, benefiting debtors at the expense of creditors. Smith noted that debasement could cause huge, disruptive shifts in people’s fortunes.

Money: The Universal Tool of Commerce

Through this long process – starting with barter, moving to commodity money, then metals, then coinage, and often involving debasement – money became the universal instrument of commerce in all civilized nations. It’s the medium through which almost all goods are bought and sold, or exchanged for one another.

Looking Ahead: The Rules of Exchange (Value)

Having explained how money arose, Smith then states his next task: to examine the rules people naturally follow when exchanging goods, whether for money or for other goods. These rules determine what he calls the relative or exchangeable value of goods.

Recap: Two Meanings of Value He briefly reminds the reader of the two meanings of “value”:

• Value in Use: The usefulness of an item.
• Value in Exchange: The power an item gives you to purchase other goods. He also restates the water-diamond paradox: water has high use value but low exchange value; diamonds have low use value but high exchange value.

Plan for the Following Chapters To understand the principles that regulate exchangeable value, Smith plans to explain three things in the next chapters:

1. What is the real measure of exchangeable value? (What is the “real price” of commodities?) - Chapter V
2. What are the different parts or components that make up this real price? (What determines the cost of production?) - Chapter VI
3. What circumstances cause the actual market price to sometimes be higher or lower than the natural price (the long-run cost)? - Chapter VII

A Note to the Reader Smith asks for the reader’s patience and attention for these next chapters. He acknowledges the details might seem tedious, and the subject itself is abstract and might remain somewhat unclear even after his best efforts to explain it fully. He states he prefers risking tediousness to ensure clarity.

CHAPTER V

OF THE REAL AND NOMINAL PRICE OF COMMODITIES, OR THEIR PRICE IN LABOUR, AND THEIR PRICE IN MONEY

What Makes Someone Rich or Poor?

A person’s wealth depends on the amount of necessities, conveniences, and enjoyable things (“amusements”) they can afford.

Once work is specialized (the division of labor is established), a person’s own labor can only supply a tiny part of what they need. They must get the vast majority of things from the labor of other people.

Therefore, a person is rich or poor depending on the quantity of other people’s labor that they can command (direct) or afford to purchase.

The Value of Goods for Exchange

If you have a commodity (a good) that you don’t plan to use yourself but want to exchange for something else, its value to you is equal to the quantity of labor it allows you to purchase or command from others.

Conclusion: Labor is the real measure of the exchangeable value of all commodities.

The Real Cost and Real Worth of Things

• The real price of anything – what it truly costs the person who wants to get it – is the toil and trouble (the labor) involved in acquiring it.
• What anything is really worth to the person who has it and wants to trade it is the toil and trouble it can save them (because they don’t have to make it) and the toil and trouble it can impose on others (the labor it allows them to command in exchange).

When we buy things with money or goods, we are essentially buying them with labor. The money or goods represent the value of a certain amount of labor we already possess or command. We exchange this for something else that is supposed to contain an equal amount of labor value at that moment.

Labor was the original price – the first “purchase-money” paid for everything. The wealth of the world was initially bought not with gold or silver, but with labor. And the value of that wealth, to those who have it and want to trade it for new things, is precisely the amount of labor it allows them to purchase or command.

Wealth as Purchasing Power

The philosopher Mr. Hobbes said, “Wealth is power.” But Adam Smith clarifies this. Getting a large fortune doesn’t automatically give you political or military power (though it might give you the means to obtain them later). The power that wealth directly gives you is purchasing power. It gives you command over the labor, or the products of labor, that are currently available in the market. Your fortune is large or small depending exactly on how much of other people’s labor (or the products of their labor) it allows you to buy or command. The exchangeable value of anything is always equal to the extent of this purchasing power it gives its owner.

Why Labor Isn’t Used as the Everyday Measure of Value

Even though labor is the real measure of exchangeable value, it’s not how people usually estimate value in everyday life. There are several reasons for this:

1. Difficulty Comparing Labor: It’s hard to accurately compare different amounts or types of labor.

   • Time isn’t enough: Simply comparing the time spent working doesn’t work because jobs differ in difficulty and skill required.
   • Hardship matters: An hour of very hard work might involve more “labor” (effort, sacrifice) than two hours of easy work.
   • Skill matters: An hour’s work by someone in a highly skilled trade (that took years to learn) might involve more “labor value” than a whole month’s work in a simple, easily learned job.
   • No Precise Measure: There’s no easy, accurate way to measure the exact amount of hardship or skill involved in different tasks.
   • Market Bargaining: When people trade goods made by different kinds of labor, they make rough allowances for these differences through bargaining in the market (“higgling and bargaining”). This achieves a kind of approximate equality that works well enough for daily life, but it’s not precise.

2. Comparing Goods is More Natural: People usually compare the value of a good to the value of other goods, rather than to the abstract concept of labor. It feels more natural. Most people understand “a quantity of bread” better than “a quantity of labor.” Goods are physical objects; labor value is an abstract idea.

3. Money Becomes the Common Standard: Once barter ends and money becomes the usual tool for trade, every specific good is most often exchanged for money, not directly for other goods.

   • A butcher doesn’t usually trade meat directly with the baker for bread. Instead, the butcher sells the meat for money at the market and then uses the money to buy bread.
   • The amount of money the butcher gets for the meat determines how much bread they can buy.
   • Therefore, it’s more natural for the butcher to think of the meat’s value in terms of money (e.g., “fourpence a pound”) rather than in terms of bread (e.g., “four pounds of bread”).
   • As a result, the exchangeable value of goods is most commonly estimated by the quantity of money they can be exchanged for, rather than the quantity of labor or other goods.

The Problem with Using Money as a Measure of Value

However, using money (like gold and silver) as a measure of value has a major flaw: the value of money itself changes over time.

• Gold and silver can become cheaper or more expensive, easier or harder to obtain.
• How much labor (or other goods) a certain amount of gold or silver can buy depends on factors like the discovery of new mines or the difficulty of mining.
• Example: The discovery of rich mines in the Americas in the 16th century made gold and silver much more abundant in Europe. This caused their value to fall to about one-third of what it had been before. Because it took less labor to bring the metals to market, they could command less labor in exchange.
• An Inaccurate Ruler: A measuring tool (like a ruler) that constantly changes its own length cannot accurately measure other things. Similarly, a commodity like gold or silver, whose own value constantly changes, cannot be an accurate measure of the value of other commodities over time.

Why Labor is the True Standard

Smith argues that labor is the ultimate, unchanging standard of value:

• Equal Labor = Equal Sacrifice: He claims that equal quantities of labor are always of equal value to the laborer. Assuming normal health, skill, etc., performing a given amount of work always requires the worker to give up the same amount of their personal ease, freedom, and happiness. This sacrifice is the real price the laborer pays, and it doesn’t change.
• Goods Change Value, Not Labor: The amount of goods a laborer receives for their work might change, but Smith says this is because the value of the goods is changing, not the value of the labor (measured by the sacrifice).
• The Definition of Dear and Cheap: Things are truly “dear” when they are difficult to get or require much labor to acquire. Things are truly “cheap” when they are easy to get or require little labor.
• Labor: The Ultimate Standard: Therefore, labor alone, because its own value (in terms of the worker’s sacrifice) never changes, is the only real and ultimate standard by which the value of all goods can be estimated and compared across all times and places.
• Real vs. Nominal Price:
  • Labor = Real Price of commodities.
  • Money = Nominal Price of commodities.

How Labor Appears to Change Value

• To the Employer: While labor’s value (sacrifice) is constant for the worker, it seems to change for the employer who hires the worker. The employer sometimes pays more goods, sometimes fewer goods, for the same amount of labor. To the employer, labor seems cheap or dear.
• Smith’s View: Smith insists that in reality, it’s the goods used to pay the worker that are cheap or dear, not the labor itself.

Real vs. Nominal Wages (Popular Sense)

Because of how employers experience it, we often talk about labor itself having two prices:

• Real Wage: The actual amount of necessities and conveniences of life a worker receives for their labor.
• Nominal Wage: The amount of money a worker receives.
• A worker’s true well-being depends on their real wage, not just their nominal wage.

Practical Importance: Long-Term Contracts

This distinction between real (labor-based) value and nominal (money-based) value isn’t just theory; it’s important in practice, especially for long-term agreements like setting land rents that are intended to last forever.

• Problem with Fixed Money Rents: If a rent is fixed as a specific sum of money (e.g., £100 per year forever), its real purchasing power can decline significantly over time due to:

  1. Debasement of Coinage: Governments historically tend to reduce the amount of precious metal in coins over time, lowering the value of each monetary unit.
  2. Changes in Metal Value: Discoveries (like the American mines) can decrease the value (purchasing power) of gold and silver itself. Both these factors tend to reduce the real value of a fixed money rent over the long term.

• Corn Rents are More Stable (Long Term): Rents fixed as a specific quantity of corn (grain) have held their real value much better over centuries.

  • Example: An old English law required part of college rents to be paid in corn. By Smith’s time, the money received from selling that corn portion was often worth much more than the parts paid in fixed sums of money, showing how much the money’s value had fallen relative to corn (and likely relative to labor). This happened even when the amount of silver in the coins hadn’t changed much, purely because the value of silver itself had fallen.
  • In countries where coins were debased more severely (like Scotland and France), some ancient money rents had become almost worthless.

• Why Corn is Better Long-Term: Over centuries, a given quantity of corn is likely to command roughly the same amount of labor (representing basic subsistence and general purchasing power) compared to a given quantity of gold or silver. Corn’s value is more closely tied to the cost of labor.

• Corn Isn’t Perfect Either: Even corn isn’t a perfect long-term measure because the real subsistence needs of labor can change (e.g., workers live better in growing economies). But it’s more stable over centuries than precious metals.

• Short-Term vs. Long-Term:

  • Year-to-Year: Corn prices fluctuate wildly due to harvests. Money wages adjust slowly to the average corn price. Silver’s value changes very slowly year-to-year. Therefore, money (silver) is a better measure of value from year to year.
  • Century-to-Century: Corn’s average value (relative to labor) is more stable than silver’s value (which is affected by mine discoveries). Therefore, corn is a better measure of value from century to century.

• Labor: The Only True Universal Standard: Since both money and corn have changing values relative to labor over different time scales, labor itself remains the only universal and accurate measure for comparing the value of goods across all times and places.

Everyday Use vs. Long-Term Contracts

• Long Term: Distinguishing real and nominal price is crucial when setting up permanent rents or very long leases.
• Everyday Transactions: For normal buying and selling, the distinction is not needed.

Money Works Fine Locally and Currently

At the same time and in the same place, the nominal price (money) and the real price (labor commanded) are directly proportional. If you get more money for your goods in the local market today, that money will buy you more local labor today. Therefore, for immediate, local transactions, money is the exact measure of real exchangeable value. But only at the same time and place.

Money Prices in Distant Places

Even though the real price (labor commanded) of goods might be very different in faraway places, merchants trading between them usually only need to consider the money price.

• Example: Half an ounce of silver in Canton, China, might buy much more labor or basic necessities than a full ounce of silver in London. A product selling for half an ounce in Canton might therefore be “really dearer” – representing more command over labor – than something selling for a full ounce in London.
• The Merchant’s View: However, a London merchant doesn’t worry about this. If they can buy something in Canton for half an ounce of silver and sell it back in London for a full ounce, they’ve made a 100% profit in silver. That’s all that matters for their business calculation. The fact that silver buys less in London is irrelevant to their profit margin measured in silver. One ounce in London gives them double the purchasing power in London compared to half an ounce, and that’s what they care about.

Because these nominal prices (money prices) are what guide everyday buying and selling and determine profit or loss in trade, it’s no surprise that people pay much more attention to them than to the underlying real price (labor value).

When Comparing Real Value Is Useful

However, for understanding economic history or making certain long-term comparisons, it can be useful to compare the real value of a commodity at different times and places. This means comparing the different amounts of power over other people’s labor that possessing the commodity gave its owner.

• The Challenge: To do this accurately, we shouldn’t just compare the different amounts of silver the good sold for. We should compare the different amounts of labor those different amounts of silver could have purchased.
• Finding the Data: But it’s very hard to know the exact price of labor in distant times and places. Prices of corn (grain), while not always perfectly recorded, are generally better known from historical sources.
• Using Corn as an Approximation: Therefore, we often have to use historical corn prices as the best available approximation for comparing real values over long periods. We assume (though it’s not perfectly accurate) that corn prices give us a rough guide to the price of labor over time. Smith plans to make several comparisons like this later in the book.

Using Different Metals as Money

As trade developed, commercial nations found it useful to make coins from several different metals:

• Gold: For large payments.
• Silver: For medium-sized purchases.
• Copper (or similar metal): For very small transactions (small change).

The Standard Metal

Despite using multiple metals, countries usually considered one specific metal as the primary standard or measure of value. This preference was generally given to the metal they first started using widely as money. They often continued using it as their main standard even after introducing coins of other metals.

• Example: Rome: Used copper money first. Even after coining silver, copper remained the standard. Accounts were kept in copper Asses or in Sestertii (originally silver coins, but their value was calculated in copper). A large debt was described as owing a lot of “copper.”
• Example: Modern Europe (including England): The nations that emerged after the Roman Empire mostly started with silver money. Gold and copper coins came much later. Therefore, in England and most other European nations of Smith’s time, silver was considered the primary standard. Accounts were kept in pounds sterling (originally a pound of silver), and fortunes were usually expressed in pounds, not in gold guineas.

Legal Tender and the Standard Metal

Originally, legal tender (the form of payment a creditor was legally required to accept) was likely restricted to coins made of the standard metal.

• In England, gold coins weren’t legal tender for a long time after they were introduced. The exchange rate between gold and silver was determined by the market, not fixed by law. A creditor could refuse payment in gold or accept it at an agreed-upon rate.
• Copper coins are usually only legal tender for very small amounts (change for silver coins). When this was the case, the distinction between the standard metal and other metals used in coins was significant.

Fixed Exchange Rates Between Metals

Later, as people became more familiar with using different metal coins and their relative values, most countries found it convenient to fix the exchange rate between them by law. For example, a law might declare that one gold guinea was legally equal to 21 silver shillings and must be accepted as payment for a debt of that amount.

Once a fixed ratio like this is established and maintained:

• The distinction between the standard metal (e.g., silver) and the non-standard one (e.g., gold) becomes mostly nominal (just a matter of name or tradition). Payments can typically be made in either metal at the fixed legal rate.

Effects of Changing the Fixed Rate

However, if the government changes the legally fixed ratio (e.g., makes a guinea worth 20 shillings, or 22 shillings):

• The distinction can seem important again.
• Because accounts are usually kept in the standard metal (e.g., silver shillings), most payments could still be made with the same amount of silver. But they would require a different amount of gold (more gold if the guinea’s shilling value is lowered, less gold if it’s raised).
• In this situation, silver would appear to be the stable measure, while gold’s value would seem to be measured by how much silver it exchanges for.
• Smith points out this is just an illusion caused by the custom of keeping accounts in silver. If accounts were kept in gold guineas instead, then gold would appear stable after a ratio change, and silver’s value would seem to be measured by gold.

The Most Precious Metal Sets the Value

Smith argues that in reality, when a fixed legal ratio exists between coined metals, the value of the most precious metal (usually gold in his time) effectively regulates the value of the entire coinage.

• Example: Copper: Copper coins are legally worth much more as money (e.g., 12 pence = 1 shilling) than the actual market value of the copper metal they contain. But because they are legally exchangeable for silver shillings at that rate, they trade at their face value.
• Example: Gold and Silver: Even when silver coins were badly worn down, 21 shillings were still accepted as equal to one gold guinea (which was usually less worn). The value of the (better) gold coin determined the value relationship.

Recent Gold Coin Reform in Britain

Smith discusses a recent reform of Britain’s gold coinage, which brought gold coins very close to their proper weight. Silver coins remained worn and underweight.

• Effect: Despite the poor state of silver coins, 21 worn shillings were still considered equal in value to one new, full-weight gold guinea in the market.
• Conclusion: The reform of the gold coins had effectively raised the exchange value of the existing silver coins, because they could now be exchanged for better gold.

Mint Price vs. Market Price

• Mint Price: The amount of coin the Mint gives back for a certain weight of standard bullion (raw metal). In England, coinage was free, so the Mint price simply reflected the number of coins made from a given weight (e.g., £3 17s 10.5d per ounce for gold).
• Market Price: The actual price bullion sells for in the open market, paid in existing coins.
• Gold: Before the reform, the market price of gold bullion was above the Mint price because the worn coins used to buy it contained less gold. After the reform, the market price fell below the Mint price because the coins were now full weight (and because of a small delay at the Mint, see below).
• Silver: Before the gold reform, the market price of silver bullion was consistently above the Mint price. After the gold reform, the market price of silver bullion fell somewhat, but still remained above the Mint price.

Why Silver Bullion Remained Above Mint Price

Smith argues the main reason was that silver was undervalued relative to gold in the official English coinage system compared to the general European market rate.

• The official ratio made gold slightly more valuable (in terms of silver) within England than it was elsewhere.
• This official undervaluing of silver in coin didn’t drag down the price of silver bullion in the market. Bullion kept its correct market relationship to gold bullion.
• Therefore, simply reforming the silver coins (making them full weight) wouldn’t bring the market price of silver bullion down to the Mint price unless the official gold-to-silver ratio was also changed to reflect market realities.

Problems and Solutions for Coinage

• Melting Problem: If silver coins were made full weight without changing the ratio, people could profit by melting them down and exploiting the difference between the coin values and bullion values.
• Possible Fix: Smith suggests maybe slightly overvaluing silver in the coinage (like copper), but making it legal tender only for small amounts (e.g., change up to a guinea). This would prevent cheating on large debts while providing convenient small change. (It would inconvenience bankers who sometimes used payments in small silver to delay fulfilling obligations).

Why Coin Might Be Worth More Than Bullion (Even with Free Coinage)

Why did the market price of gold bullion fall slightly below the Mint price after the reform, even though coinage was free?

• Delay at the Mint: Turning bullion into coin takes time (weeks or months). This delay acts like a small cost or inconvenience to the owner of the bullion.
• Convenience: Coin is more convenient for transactions than bullion. Because of the delay and convenience factor, gold coin is slightly more valuable than an exactly equal weight of gold bullion. Smith suggests if silver were valued correctly relative to gold in the coinage, silver bullion might also trade below the Mint price, because even worn silver coin’s value is ultimately tied to the good gold coin it can be exchanged for.

Money Prices vs. Real Prices in Trade

While the real price (value in labor) of goods might vary greatly between distant locations, merchants involved in trade focus primarily on the money price.

• Example: Let’s say half an ounce of silver in Canton, China, can buy more labor and goods than a full ounce of silver in London. A product selling for half an ounce in Canton is technically “dearer” in real terms than a product selling for a full ounce in London because it represents command over more labor.
• The Merchant’s Calculation: A London merchant, however, isn’t concerned with this. If they can buy goods in Canton for half an ounce of silver and sell them in London for a full ounce, they make a 100% profit measured in silver. It doesn’t matter that the silver buys less in London. What matters is that one ounce in London has double the purchasing power in London compared to half an ounce in London. That simple monetary profit is their goal.

Because the nominal price (the price in money) is what ultimately determines whether a purchase or sale is profitable, and thus guides most everyday business decisions, it’s understandable why people pay much more attention to it than to the underlying real price (the value in labor).

When Comparing Real Value Is Still Useful

Even though daily business focuses on money prices, it can sometimes be valuable, especially in a work like this, to compare the real value (the command over labor) of a particular commodity at different times and in different places.

• The Challenge: To do this accurately, we shouldn’t just compare the different amounts of silver the commodity sold for. We need to compare the different amounts of labor that those different quantities of silver could have purchased at those times and places.
• Data Limitations: However, finding reliable information on historical wages (the price of labor) is very difficult.
• Using Grain Prices as a Proxy: Information on the historical price of corn (grain) is often more available. Therefore, we usually have to use historical corn prices as the best available approximation of the price of labor when trying to compare real values over long periods. (Smith notes he will make such comparisons later in the book).

Coining Multiple Metals

As trade and industry developed, commercial nations found it practical to make coins out of several different metals:

• Gold: For large payments.
• Silver: For medium-value purchases.
• Copper (or another base metal): For small transactions.

The Standard Metal of Account

Despite using multiple metals, nations usually treated one specific metal as the primary standard or official measure of value. Typically, this was the metal they first started using widely as money.

• Example: Rome: Used copper first, so copper remained their standard of value even after they started using silver coins. Debts and accounts were kept in copper units (Asses or related units like Sestertii).
• Example: Modern Europe (including England): Started primarily with silver money after the fall of Rome. Therefore, silver became the traditional standard. Accounts were kept in pounds sterling (originally defined as a pound of silver), and fortunes were typically stated in pounds, not gold guineas.

Legal Tender

Originally, legal tender (the type of money a creditor legally had to accept) was likely only the coin made of the standard metal.

• In England for a long time, gold coins weren’t legal tender. The exchange rate between gold and silver coins was set by the market.
• Copper coins today are usually only legal tender for small amounts. When only the standard metal was legal tender, the distinction between it and other metals was very real.

Fixed Exchange Rates Between Metals (Bimetallism)

Later, most countries found it convenient to set a fixed legal exchange rate between the different metal coins (e.g., defining a gold guinea as legally equal to 21 silver shillings).

• Once a fixed rate is established, the distinction between the official standard metal (e.g., silver) and other legal tender metals (e.g., gold) becomes less important in practice, mostly just nominal (a matter of name or tradition).

Changing the Fixed Rate

However, if the government changes the legal ratio, the distinction can seem important again.

• If accounts are kept in silver, changing the guinea-to-shilling ratio changes how much gold is needed for payments, but not how much silver is needed. Silver appears more stable.
• This is just an illusion created by the accounting custom. If accounts were kept in gold, gold would appear stable after a ratio change.

Value of Coins Set by the Most Precious Metal

Smith argues that when fixed ratios exist, the value of the most precious metal in regular use (gold, in his time) tends to determine the value of the entire coinage system.

• Example: Even worthless copper in pence trades at its face value because it’s legally exchangeable for silver shillings. Similarly, even worn-out silver shillings were accepted at face value in exchange for gold guineas, because the value of the relatively better gold coin set the standard.

Effects of Britain’s Gold Coin Reform

Smith discusses a recent reform that restored British gold coins to their proper weight, while silver coins remained worn.

• Result: Even though the silver coins were underweight, 21 shillings were still accepted as equal to a full-weight gold guinea.
• Implication: Improving the gold coins effectively raised the value of the existing silver coins because they could be exchanged for this better gold.

Mint Price vs. Market Price Revisited

• Mint Price: The official rate at which the Mint converts bullion (raw metal) into coin (e.g., £3 17s 10.5d per ounce for gold in Britain, reflecting the number of coins made from an ounce).
• Market Price: The price bullion actually sells for in the market, paid in circulating coins.
• Gold: After the reform, the market price of gold bullion fell slightly below the Mint price.
• Silver: After the gold reform, the market price of silver bullion fell somewhat but remained above the Mint price.

Why Silver Bullion Stayed Above Mint Price Smith believed this was because silver was officially undervalued relative to gold in the British coinage compared to market rates elsewhere in Europe. The overvalued gold coin effectively set the standard for the whole system, keeping the market price of silver bullion higher than its official Mint price in undervalued silver coin.

Potential Problems and Solutions

• Melting Risk: Making silver coins full weight without adjusting the gold/silver ratio would encourage melting them down for profit.
• Possible Fix: Smith suggests maybe slightly overvaluing silver coin (like copper) but limiting its use as legal tender to small amounts. This would prevent large-scale cheating while providing useful small change.

Why Coin Can Be Worth More Than Bullion Even with free coinage (no fees), why might coin be slightly more valuable than the same weight of bullion?

• Minting Delay: It takes time to turn bullion into coin at the Mint. This delay is an inconvenience, making ready-made coin slightly more desirable.
• Convenience: Coins are much more convenient for transactions than bullion. These factors give coin a slight edge in value over an equal weight of bullion.

Defining “Money-Price” Consistently

Smith clarifies a crucial point for his analysis:

• When he uses the term “money-price”, he always means the price in terms of the quantity of pure gold or silver metal, not just the name or number of coins.
• Example: He considers six shillings and eightpence in Edward I’s time to be the same money-price as one pound sterling (£1) in his own time, because both amounts represented roughly the same quantity of pure silver.

CHAPTER VI

OF THE COMPONENT PARTS OF THE PRICE OF COMMODITIES

Price in Early Societies (Before Capital and Private Land)

In the earliest and simplest societies, before people accumulated significant tools and equipment (“stock”) and before land was owned privately, the way goods were exchanged seems to have depended only on one thing: the amount of labor needed to get them.

• Example: If it usually took twice the effort (labor) for a hunter to kill a beaver compared to killing a deer, then one beaver would naturally trade for, or be worth, two deer. It makes sense that something produced with two days’ work would be worth double something produced with one day’s work.

Even in these early times, people likely made allowances for:

• Hardship: If one type of labor was much harder or more dangerous than another, its product might trade for the product of more hours of easier labor.
• Skill: If one type of labor required unusual skill or ingenuity (that took time to learn), the respect people had for such talents would give the product extra value. This extra value would compensate for the time and effort spent acquiring the skill. (Smith notes that in advanced societies, these factors are compensated through wages, and something similar probably happened in early times too.)

In this early state, the entire product belongs to the worker. The amount of labor needed to make something is the only factor that determines how much labor it should be worth in exchange.

The Role of Profit When Capital is Used

This changes as soon as people start accumulating stock (capital – tools, materials, money saved up). Some people (capitalists or “undertakers”) will naturally use their capital to employ workers. They provide the workers with materials and wages (to cover living costs, or “subsistence”), hoping to make a profit by selling the finished product for more than their costs.

• Profit Becomes Part of Price: When the finished product is exchanged (for money or other goods), the price must now cover not only the cost of materials and workers’ wages but also something extra: a profit for the business owner who risked their capital in this venture.
• Value Added Splits: The value that workers add to the materials is now divided into two parts:
  1. One part pays the workers’ wages.
  2. The other part provides the employer’s profit on the capital they invested in both materials and wages.
• Why Profit is Necessary: The employer wouldn’t bother employing workers unless they expected to sell the product for more than it cost them to make (enough to replace their capital plus earn a profit). They also wouldn’t invest a large amount of capital unless they expected their profits to be roughly proportional to the amount invested.

Profit is Different from Wages for Management

Some might think profit is just a fancy name for wages paid for the work of managing the business (“inspection and direction”). Smith strongly disagrees.

• Different Principles: Profit and wages are completely different. They are determined by different principles. Profit is not based on the amount, difficulty, or skill of the management work involved.
• Profit Based on Capital: Profit is determined entirely by the value of the capital employed. The more capital invested, the greater the profit expected (assuming a certain average rate of profit).
• Example: Imagine two factories, each employing 20 workers at the same wage (£300 total wages per year).
  • Factory A uses cheap materials (£700/year), so total capital is £1000. At a 10% profit rate, the owner expects £100 profit.
  • Factory B uses expensive materials (£7000/year), so total capital is £7300. At a 10% profit rate, the owner expects £730 profit. The management work might be exactly the same in both factories, but the profits are vastly different because the capital invested is different.
• Manager’s Salary vs. Owner’s Profit: In large businesses, owners often hire managers (“principal clerks”). The manager’s salary pays for their labor, skill, and trustworthiness, but it’s never proportional to the huge amount of capital they oversee. The owner, who might do very little work, still expects a profit proportional to their capital.
• Conclusion: Therefore, profit is a separate component part of the price of goods, distinct from wages, and determined by different principles (as a return on capital).

In this situation, where capital is used, the worker no longer receives the whole product of their labor. They must share it with the owner of the capital that employs them. The amount of labor used to make a good is no longer the only factor determining its exchange value. An additional amount must be included to cover the profit on the capital used to pay wages and buy materials.

The Role of Rent When Land is Private Property

The situation changes further once all the land in a country becomes private property.

• Landlords Demand Rent: Landowners, “like all other men, love to reap where they never sowed.” They demand a payment, called rent, even for the natural products of the land (like timber from a forest or wild berries).
• Natural Goods Now Have a Price: Things that were free for anyone to gather when land was common now have an extra cost. A person must now pay the landlord for permission to gather these things or must give the landlord a share of whatever they collect or produce using the land.
• Rent Becomes Part of Price: This payment or share constitutes the rent of land. For most goods produced using land, rent becomes a third component part of their price.

Labor as the Real Measure of All Price Components

It’s important remember Smith’s point from the previous chapter: the real value of all these different parts of price – the part that goes to wages, the part that goes to profit, and the part that goes to rent – is ultimately measured by the quantity of labor that each part can purchase or command. Labor measures the real value of all three income streams.

Price = Wages + Profit + Rent

In any society, the price of every commodity finally breaks down (“resolves itself”) into one or more of these three parts: wages, profit, and rent. In developed societies, all three parts usually contribute, to some degree, to the price of most goods.

• Example: Price of Corn (Grain):

  1. Pays the rent to the landlord.
  2. Pays the wages of the farm laborers (and the cost of maintaining working animals).
  3. Pays the profit to the farmer (who is the capitalist in this case). These three parts make up the whole price. Even the cost of replacing the farmer’s capital (like tools or animals) can itself be broken down into the rent, labor, and profit involved in producing those tools or animals. So, ultimately, the entire price resolves back to these three basic components.

• Example: Price of Flour and Bread:

  • The price of flour includes the price of the corn (rent, wages, profit) PLUS the miller’s profit and the wages of the miller’s workers.
  • The price of bread includes the price of the flour PLUS the baker’s profit and the wages of the baker’s workers.
  • Both also include the transportation costs (wages and profits of transporters) at each stage.

• Example: Price of Linen: Includes the price of the raw flax (rent, wages, profit for the farmer) PLUS the wages and profits of the flax-dresser, the spinner, the weaver, the bleacher, and everyone else involved in turning flax into finished linen.

Manufacturing Increases Wage and Profit Components

As a product goes through more stages of manufacturing:

• The share of the final price that represents wages and profit increases relative to the share that represents rent.
• This is because each manufacturing step adds more labor costs (wages) and requires more capital (to pay for previous stages’ inputs plus current wages), generating additional profit at each stage. The capital needed increases at each step, and profits must generally be proportional to the capital employed.

Exceptions: Prices with Fewer Components

Even in developed societies, there are exceptions:

• Two Components (Wages + Profit): Some goods’ prices consist only of wages and profit. Example: Sea fish. The price covers the fishermen’s labor and the profit on the capital invested in boats and nets. Rent is usually not involved (unlike river fisheries, where rent for the fishing rights is often part of the price of salmon).
• One Component (Wages Only): A very few goods’ prices consist entirely of wages. Example: “Scotch Pebbles” (decorative stones) gathered by poor people along the seashore. The price they receive from the stonecutter is purely wages for their gathering labor; no rent or profit is involved.

All Price Ultimately Resolves

But no matter the specific case, any part of a commodity’s price that is left over after paying the rent for the land used and the wages for all the labor involved must necessarily be someone’s profit. So, the entire price must ultimately resolve into some combination of wages, profit, and rent.

National Income = Wages + Profit + Rent

Just as the price of each individual good breaks down this way, the total value of all goods produced by a country in a year (the “whole annual produce”) must also break down into these same three components. This total value is distributed among the country’s inhabitants as:

• Wages (paid for labor)
• Profit (paid for the use of capital/stock)
• Rent (paid for the use of land)

The Three Original Sources of Income

Wages, profit, and rent are the three original sources of all revenue (income) in society, as well as the sources of all exchangeable value. Every other type of income – like interest earned on loans, taxes collected by the government, salaries, pensions, etc. – is ultimately derived from one or more of these three original sources.

• Personal Income Sources:
  • Revenue from labor is called wages.
  • Revenue from capital stock (if you manage it yourself) is called profit.
  • Revenue from capital stock (if you lend it to someone else) is called interest. (Interest is just a portion of the profit the borrower makes, paid to the lender). Interest is a derivative income.
  • Revenue from land is called rent.
• Mixed Incomes: A farmer’s income is partly wages (for their labor) and partly profit (on their stock/capital). Land is just the tool they use.
• Taxes, Salaries, etc.: All these are ultimately paid out of someone’s wages, profit, or rent.

Confusing Income Types in Practice

When these three types of income go to different people, they are easy to distinguish. But when the same person receives multiple types, they often get lumped together in everyday language:

• Landowner farming own land: Often calls their entire gain “profit,” mixing up rent and profit.
• Farmer working own farm: Often calls everything left after paying rent “profit,” mixing up wages (for their own labor) with profit.
• Independent craftsperson: Often calls their entire gain “profit,” mixing up wages (for their skilled labor) with the profit earned on their materials and tools.
• Gardener working own garden: Combines the roles of landlord, farmer, and laborer. Often considers the whole value produced as “earnings of labor,” mixing up rent and profit with wages.

Annual Production and Potential for Growth

Because the price of most goods in a civilized country includes rent and profit in addition to wages, the total value of a country’s annual production will always be enough to purchase or command much more labor than was actually used to create that production.

If a society were to use its entire annual produce to employ all the labor it could command, the amount of labor employed would increase greatly each year, and the value of production would grow enormously year after year.

However, no country actually does this. A large portion of the annual produce is always consumed by the “idle” (people not engaged in productive labor – i.e., those providing services or living off rent/profit without directly producing goods). The country’s economic growth rate depends on how the annual produce is divided between supporting the “industrious” (productive labor) and supporting the “idle.”

CHAPTER VII

OF THE NATURAL AND MARKET PRICE OF COMMODITIES

“Natural” Rates for Wages, Profit, and Rent

In any town or neighborhood, there tends to be an “ordinary” or average rate for both wages (paid for labor) and profit (earned on invested capital or “stock”) in every line of work or business. As we’ll discuss later, these average rates are determined (“naturally regulated”) by:

• The general situation of the society (Is it rich or poor? Is it growing, stagnant, or declining?).
• The specific nature of each particular job or investment.

Similarly, there is usually an ordinary or average rate of rent for land in any area. This average rent is determined by:

• The general situation of the society or neighborhood.
• The natural fertility of the land, or how much it has been improved.

These ordinary or average rates for wages, profit, and rent can be called the natural rates for the specific time and place where they usually occur.

What is the Natural Price?

When the price of any particular commodity is just enough – no more, no less – to cover the costs of producing it and bringing it to market at these natural rates, then the commodity is selling for its natural price. These costs include:

• The rent of the land used.
• The wages of the labor employed.
• The profits of the capital (stock) invested.

Selling at the natural price means the commodity is sold for exactly what it’s worth, or what it really costs the person who brings it to market.

• Although everyday language might talk about “prime cost” as just materials and wages, a seller must also receive the ordinary rate of profit common in their area. If they don’t, they are effectively losing money because they could have earned that profit by investing their capital elsewhere.
• Profit is the seller’s income, their source of living (“subsistence”). Just as they advance wages to their workers while the goods are being made, they are also advancing their own living expenses to themselves, expecting to be repaid by the profit from the final sale.
• So, unless the price covers this expected profit, it doesn’t truly repay the seller for what the product really cost them to bring to market.

Therefore, while a seller might occasionally sell goods for less (e.g., during a sale), the natural price is the lowest price they are likely to accept for any significant period, at least where there is “perfect liberty” (freedom to easily switch to a different business if one becomes unprofitable).

What is the Market Price?

The actual price at which a commodity is commonly sold at any given moment is called its market price. The market price can be:

• Higher than the natural price.
• Lower than the natural price.
• Exactly the same as the natural price.

How Market Price is Determined: Supply vs. Effectual Demand

The market price of any specific good is regulated by the balance between two things:

1. The quantity actually brought to market (the supply).
2. The effectual demand.

What is Effectual Demand? Effectual demand is not just wanting something. (A very poor person might want a fancy coach, but that’s not effectual demand because they can’t afford it, and the coach won’t be brought to market for them). Effectual demand is the demand from those people who are willing and able to pay the natural price of the commodity (covering the full costs of rent, wages, and profit needed to produce it). It’s the level of demand that is sufficient to actually make it worthwhile for producers to bring the commodity to market.

How Market Price Adjusts to Natural Price

• Case 1: Shortage (Supply is less than Effectual Demand)

  • Not enough of the good is available to satisfy everyone willing to pay the natural price.
  • Buyers will compete to get the limited supply. Some will be willing to pay more than the natural price rather than go without.
  • This competition drives the market price above the natural price.
  • How much higher depends on how big the shortage is and how wealthy or desperate the buyers are. (This explains the extremely high prices of necessities during a famine or a city blockade).

• Case 2: Surplus (Supply is greater than Effectual Demand)

  • More of the good is brought to market than people are willing to buy at the natural price.
  • Sellers cannot sell everything at the natural price. To get rid of the excess, some part must be sold to people only willing to pay less.
  • This lower price forces down the overall price. Competition among sellers drives the market price below the natural price.
  • How much lower depends on how large the excess supply is and how urgently sellers need to sell (e.g., competition is fiercer for perishable goods like oranges than for durable goods like scrap iron).

• Case 3: Equilibrium (Supply equals Effectual Demand)

  • When the quantity brought to market is exactly enough to meet the effectual demand (no more, no less).
  • The market price naturally settles at, or very close to, the natural price.
  • The entire quantity can be sold at this price. Competition among sellers prevents them from charging more but also means they don’t have to accept less.

The Market’s Self-Correction Mechanism

The quantity of every good brought to market tends naturally adjust itself to the effectual demand.

• It’s in the interest of producers (landowners, workers, capitalists) that the quantity supplied never exceeds the effectual demand (otherwise prices and profits fall).
• It’s in the interest of everyone else (consumers) that the quantity supplied never falls short of the effectual demand (otherwise prices rise).

How does this adjustment happen?

• If Supply Exceeds Demand: The market price falls below the natural price. This means either rent, wages, or profit (or some combination) is being paid below its natural rate. Those whose income is hurt (landlords, workers, or employers) will quickly withdraw some resources (land, labor, or capital) from producing this unprofitable good. The quantity brought to market will soon decrease until it just meets the effectual demand. All parts of the price will rise back to their natural rates, and the whole price will return to the natural price.
• If Supply Falls Short of Demand: The market price rises above the natural price. Rent, wages, or profit (or some combination) will rise above their natural rates. The high returns will quickly attract new resources into producing this profitable good (other landlords will offer land, other workers and employers will shift their labor and capital). The quantity brought to market will soon increase until it meets the effectual demand. All parts of the price will sink back to their natural rates, and the whole price will return to the natural price.

Natural Price: The Center of Gravity

Therefore, the natural price acts like a central price. Actual market prices are constantly pulled towards it (“continually gravitating”). Various temporary events (“accidents”) might push market prices above the natural price or force them below it for a while. But whatever stops prices from settling at this natural level, they are always tending towards it. It’s the center of stability.

The total amount of productive effort (“industry”) used each year to bring any good to market naturally adjusts itself to meet the effectual demand, aiming always to supply exactly the right quantity.

Differences Between Industries (Agriculture vs. Manufacturing)

However, the stability of market prices differs between industries:

• Variable Output (e.g., Agriculture): In some industries, like farming, the same amount of effort can produce very different amounts of output from year to year (due to weather, etc.). One year might yield a huge harvest of corn, wine, or hops; the next year might yield very little.
• Stable Output (e.g., Manufacturing): In other industries, like textile manufacturing, the same number of workers (spinners, weavers) will produce roughly the same quantity of cloth every year.

Consequences for Price Stability:

• Agriculture: Because the actual amount produced often varies significantly from the average amount needed to meet demand, agricultural markets frequently experience large surpluses or shortages. Therefore, the market prices of farm goods are prone to large fluctuations, sometimes falling far below the natural price, sometimes rising far above it, even if demand stays the same.
• Manufacturing: Because output can be controlled more precisely to match demand, the market prices of manufactured goods tend to be much more stable. They usually stay very close to the natural price, as long as demand remains steady. (Common experience shows that cloth prices fluctuate much less frequently and less dramatically than grain prices).

Who is Most Affected by Short-Term Price Swings?

These temporary ups and downs in market prices mainly affect the parts of the price that go to wages and profit. The part that goes to rent is less affected:

• A fixed money rent isn’t affected at all by short-term market prices.
• A rent paid as a share of the crop will vary in its yearly value based on the crop’s market price, but the rate itself (the agreed-upon share) is usually based on the expected average price, not temporary fluctuations.

Wages and profits, however, are directly affected by whether the market is currently oversupplied or undersupplied with either finished goods (“work done”) or labor (“work to be done”):

• Example: Public Mourning: Demand for black cloth suddenly increases. The market is understocked with the commodity. The price of black cloth rises sharply, increasing the profits of merchants holding stock. It usually has no effect on the wages of weavers, as there isn’t suddenly a shortage of weavers. However, demand for tailors increases to make mourning clothes. The market is understocked with labor. Tailors’ wages rise. At the same time, demand for colored cloths drops. Merchants’ profits on colored cloth fall. The wages of workers making colored cloth also fall, as there’s no work for them. The market is overstocked with both the commodity and the labor.

Why Market Prices Can Stay Above Natural Price for Long Periods

Although market prices constantly tend toward the natural price, Smith identifies three main reasons why they can sometimes remain significantly above the natural price for extended periods:

1. Secrets: Businesses might be able to keep certain information hidden.

   • Trade Secrets: If demand increases in a distant market, suppliers might keep this secret for years, allowing them to enjoy unusually high profits before competitors find out and enter the market, bringing prices back down.
   • Manufacturing Secrets: Secrets about cheaper production methods (like a dyer finding a cheaper way to make a color) can sometimes be kept even longer, potentially for a lifetime. The extra earnings are really like high wages for the discoverer’s unique skill, but because they relate to the capital invested, they are often seen as extraordinary profits.

2. Natural Scarcities: Some products require unique natural conditions (specific soil, climate, or location) to grow.

   • There might not be enough suitable land in an entire country to produce enough of the commodity to meet the effectual demand.
   • Examples include grapes from vineyards with exceptionally good soil and location.
   • Such products can consistently sell at a high price for centuries. The extra price usually goes mostly to the rent of that uniquely suitable land, which is far above the rent of nearby, equally fertile land used for other crops. Wages and profits for producing these rare goods tend to be normal for the area.

3. Monopolies and Regulations:

   • Monopolies: When the government grants exclusive rights to sell a product to one individual or company. Monopolists deliberately keep the market under-supplied to charge prices much higher than the natural price, boosting their own profits or wages far above normal rates. The monopoly price is the highest price buyers can be forced to pay.
   • Regulations Restricting Competition: Laws like those granting special privileges to guilds or corporations, or apprenticeship rules that limit the number of people entering a trade, act like broader monopolies. They restrict competition, allowing producers in those protected employments to keep market prices (and their wages and profits) somewhat above the natural rate, potentially for ages.

These artificial enhancements of market price can last as long as the monopoly grant or the restrictive regulations remain in place.

Why Market Prices Rarely Stay Below Natural Price

While market prices can stay above the natural price for long periods due to secrets, natural scarcity, or regulations, they can seldom stay below it for long, assuming there is “perfect liberty” (freedom for resources to move).

If the market price falls below the natural price, someone (landlords, workers, or capitalists) is earning less than the natural rate. They immediately feel the loss and will quickly withdraw their land, labor, or capital from that unprofitable activity. This reduction in supply soon brings the quantity offered back in line with the effectual demand, causing the market price to rise back to the natural price.

Those same rules that restrict competition (like apprenticeship laws and guild regulations) can sometimes hurt workers, too. While they might help workers raise wages above the natural rate when their trade is doing well, they can also force wages below the natural rate if the trade declines. This happens because the rules that keep others out of their trade can also prevent them from easily moving into other jobs when their own trade shrinks.

However, these regulations are much less effective at keeping wages low for long periods compared to keeping them high.

• Rules that keep wages artificially high can last for centuries.
• Rules that push wages artificially low usually only have that effect for as long as the workers who were trained during the trade’s good times are still working. Once those workers retire or pass away, fewer people will enter the declining trade, and the supply of labor will naturally adjust to the lower demand, bringing wages back towards the natural level.

Only incredibly strict social systems (like those Smith believed existed in ancient India or Egypt, where religion supposedly forced people into their father’s occupation) could keep wages or profits below their natural rates in a specific job for many generations.

This covers the main reasons why the actual market price of goods might differ, either temporarily or for longer periods, from the natural price.

The Natural Price Itself Can Change

It’s also important to remember that the natural price itself is not fixed forever. It changes whenever the natural rates of its components – wages, profit, and rent – change.

And these natural rates do change, depending on the overall circumstances of the society:

• Its level of wealth or poverty.
• Its condition: whether it is growing (“advancing”), staying the same (“stationary”), or shrinking (“declining”).

Plan for the Next Chapters

In the next four chapters, I will try to explain, as clearly as possible, what causes these variations in the natural rates of wages, profit, and rent:

1. Chapter VIII (Wages): I will explain the factors that naturally determine the average rate of wages, and how wages are affected by whether the society is rich or poor, growing, stagnant, or declining.
2. Chapter IX (Profit): I will explain the factors that naturally determine the average rate of profit, and how profits are also affected by the society’s overall condition.
3. Chapter X (Wages and Profit Across Employments): Although actual money wages and profits differ greatly between different jobs and industries, there seems to be a common relationship or structure between them. I will explain the different factors (like the nature of the work, laws, and policies) that regulate this relationship. This structure seems less affected by the society’s overall wealth or growth stage.
4. Chapter XI (Rent): I will explain the factors that regulate the rent of land, and what causes the real price of different agricultural products to rise or fall.

CHAPTER VIII

OF THE WAGES OF LABOUR

The Natural Payment for Labor

What workers produce through their labor is the natural payment, or wage, for that labor.

In the Beginning: The Worker Kept Everything

In the very earliest state of society, before land became private property and before individuals accumulated significant capital (“stock”), the entire product of a person’s labor belonged to that person. They didn’t have a landlord demanding rent or an employer (“master”) demanding profits.

What Might Have Happened

If society had stayed in that original state, wages (meaning the full product of labor) would have increased whenever labor became more productive (e.g., through the division of labor). All goods would have gradually become cheaper in real terms – they would require less labor to produce. Since goods made with equal labor would naturally exchange for each other, they could also be purchased with less labor.

• An Interesting Wrinkle: Even if all goods became cheaper in terms of the labor needed to get them, some might have appeared to become more expensive when traded for other goods. Imagine most jobs become 10 times more productive, but one specific job only becomes twice as productive. To buy the product of one day’s work in the less-improved job, you’d now have to trade the product of five days’ work from the more-improved jobs (since 10 units of other goods now only buy 2 units of this specific good). So, the specific good looks five times more expensive relative to other goods, even though it’s actually twice as cheap in terms of the labor needed to get it. Acquiring it would be twice as easy as before.

The End of the Original State

But this early state, where workers kept the whole product, couldn’t last once private land ownership and capital accumulation began. This happened long before the most significant improvements in labor productivity occurred. So, there’s no point in further discussing how wages might have behaved in that long-gone original state.

Modern Wages: Deductions from Labor’s Produce

Once society changes, the worker no longer keeps the whole product. There are deductions:

1. Rent: As soon as land becomes private property, the landlord demands a share of almost everything the worker can grow or gather from it. Rent is the first deduction from the product of labor applied to land.
2. Profit: Usually, a worker farming the land doesn’t have enough savings to support themselves until the harvest. Their living expenses are typically advanced by an employer (the farmer-capitalist) from their “stock.” The employer would have no reason to do this unless they expected to get back their investment plus a profit. This profit comes from sharing in the worker’s produce. Profit is the second deduction from the product of labor applied to land.
3. Profit in Other Industries: The product of most other kinds of labor (in arts and manufacturing) is subject to a similar deduction for profit. Most workers need an employer (“master”) to provide materials and pay their wages until the product is finished and sold. The employer shares in the value the worker adds, and this share is their profit.

The Independent Worker: An Exception

Sometimes, a single independent craftsperson might have enough capital (“stock”) to buy their own materials and support themselves until their product is sold. They are both worker and owner (“master”). In this case, they enjoy the entire product of their labor, receiving what would normally be two separate incomes: wages and profit.

However, Smith notes, such cases are rare. In Europe at the time, for every one independent worker, there were probably twenty working for an employer. Therefore, when we talk about wages, we usually mean the payment workers receive when the laborer and the owner of the capital are different people.

How Wages Are Determined: The Bargain

The common level of wages in any place depends on the contract usually made between employers and workers. These two parties have opposite interests:

• Workers want to get as much as possible.
• Employers want to give as little as possible.
• Workers tend to combine (form unions) to raise wages.
• Employers tend to combine (form associations) to lower wages.

Who Has the Advantage?

Smith believed that employers usually have the upper hand in wage disputes:

• Easier Coordination: Employers are fewer in number, making it easier for them to organize and agree on a common stance.
• Legal Bias: Laws at the time often permitted or didn’t prohibit employer combinations, while actively prohibiting worker combinations. There were laws against workers combining to raise wages, but not against employers combining to lower them.
• Staying Power: Employers can usually survive much longer without business than workers can survive without wages. An employer might live off their savings (“stock”) for a year or two, while many workers couldn’t last a week without income, and very few could last a year.
• Immediate Need: While employers need workers in the long run, the workers’ need for wages to survive is much more immediate.

Combinations and Disputes

• Employer Combinations: Smith claims that although rarely spoken of publicly, employers are “always and everywhere” in a kind of quiet, informal agreement (“tacit combination”) not to raise wages above the current level. It’s considered bad form for an employer to break ranks and pay more. Sometimes, employers secretly make specific plans to push wages even lower. These plans are often only revealed when put into action.
• Worker Combinations: Worker combinations (strikes) are much more visible and noisy. Workers might combine defensively against wage cuts or offensively to demand higher wages, often citing high food prices or large employer profits. They often resort to loud protests and sometimes violence out of desperation, knowing they face starvation if they don’t win concessions quickly. Employers, in turn, loudly demand help from the government to enforce laws against worker combinations.
• Outcome: Because of government intervention, the employers’ greater resources, and the workers’ desperate need for income, these worker combinations rarely succeeded in Smith’s time. They often ended only in the punishment or ruin of the strike leaders.

The Minimum Wage: What’s Needed for Survival

Even though employers generally have the advantage, there is a minimum level below which wages cannot permanently fall, even for the lowest-paid jobs. This is the subsistence wage.

• Basic Need: A person must be able to live from their work. Their wages must be at least enough to keep them alive.
• Family Needs: In most cases, wages must be somewhat higher than individual subsistence. Otherwise, workers couldn’t raise children, and the supply of workers would disappear after one generation.
• Supporting a Family: Smith discusses estimates (by Mr. Cantillon) suggesting that the lowest-paid workers need to earn enough to raise, on average, two children to adulthood (assuming half die young), perhaps requiring the combined labor of husband and wife to earn significantly more than just their own maintenance. Smith doesn’t fix an exact proportion but agrees wages must allow families to continue.

When Wages Rise Above Subsistence

However, certain circumstances can give workers more bargaining power and allow wages to rise considerably above this bare minimum:

• The Key: Increasing Demand for Labor: When the demand for workers of all kinds is continuously increasing in a country – meaning more jobs are available each year than the year before – workers don’t need to combine to get higher wages.
• Employer Competition: The “scarcity of hands” forces employers to compete against each other to attract workers. They voluntarily offer higher wages, breaking their usual unspoken agreement to keep wages low.

What Drives Increasing Demand for Labor?

The demand for workers increases only when the funds used to pay wages increase. These funds come from two main sources:

1. Surplus Revenue: People with income beyond their own needs (landlords, those living off investments) might use the surplus to hire more household servants.
2. Surplus Capital (“Stock”): Business owners or independent craftspeople with more capital than needed for their own operations will use the surplus to hire more workers to expand production and make more profit.

Since increasing revenue and capital means increasing national wealth, the demand for labor naturally increases as national wealth increases.

Economic Growth is Key, Not Just Wealth Level

Crucially, Smith emphasizes that it’s not the current level of national wealth, but its continual increase (economic growth), that causes wages to rise.

• Wages are highest not necessarily in the richest countries, but in the most thriving countries – those that are growing the fastest.

Example: North America vs. England

• In Smith’s time, England was much richer than its North American colonies.
• However, wages were significantly higher in North America than in England. (Smith provides specific wage figures for laborers and skilled trades in New York compared to London).
• Furthermore, the prices of food (“provisions”) were much lower in North America.
• Therefore, the real wage (what the money could actually buy in terms of necessities and conveniences) was even higher in North America compared to England.

Why Were North American Wages High? Rapid Growth.

• North America wasn’t richer overall, but it was “much more thriving” and advancing towards greater wealth much more rapidly than England.
• Proof of Growth: Population: The clearest sign of a country’s prosperity is population growth. European populations typically took centuries to double. North American colonies were doubling their population every 20-25 years, mostly due to high birth rates (“great multiplication of the species”).
• Children as Assets, Not Burdens: Labor was so valuable and well-paid that having many children was seen as a source of wealth for parents, not a financial burden. A child’s labor was valuable. Young widows with children were considered good marriage prospects. This encouraged early marriage and rapid population growth.
• Persistent Labor Shortage: Despite this rapid population increase, there was a constant complaint about a shortage of workers (“scarcity of hands”). The demand for labor, fueled by growing capital and opportunity, was increasing even faster than the population could grow.

Stationary Wealth Means Low Wages

Even if a country is very wealthy, if its wealth has been stationary (not growing) for a long time, wages will likely be low.

• The large amount of capital and revenue might be sufficient to employ the current population.
• But if the economy isn’t growing, the population will tend to increase beyond the number of available jobs.
• Workers will have to compete intensely against each other for limited employment.
• This competition will drive wages down to the lowest level consistent with survival (“common humanity”).

Example: China

• Smith describes China as having long been one of the richest, most fertile, best cultivated, most industrious, and most populous countries in the world.
• However, it seemed to have been stationary for a very long time (perhaps centuries, based on comparisons between Marco Polo’s account and contemporary travelers). It might have reached the maximum level of wealth possible under its existing laws and institutions.
• Consistent accounts from travelers reported very low wages in China, making it difficult for laborers to raise families. Workers often had to actively seek out customers or beg for employment, unlike in Europe where customers usually came to the workshop.

CHAPTER VIII: The Rewards of Labour (Wages)

Poverty and Survival in Different Countries

Extreme Poverty in China

In China, the poorest people are far worse off than even the poorest in Europe. Around the city of Canton, it’s said that thousands of families don’t live on land at all. Instead, they live their whole lives on small fishing boats in rivers and canals.

Life there is incredibly hard. They have so little food that they eagerly collect the worst scraps thrown from European ships. Even rotten, stinking dead animals, like dogs or cats, are valuable finds for them. This shows how desperate they are compared to people in other countries.

Marriage is common in China. However, it’s not encouraged because children help the family earn money. Instead, it’s tragically accepted that parents are allowed to abandon unwanted infants. In large towns, many babies are reportedly left in the streets each night or drowned like puppies. Some people even make a living by performing this horrific task.

China: Poor but Stable

Despite this terrible poverty, China doesn’t seem to be getting poorer. Its economy may not be growing, but it’s not shrinking either.

• Towns are still populated.
• Land that was once farmed is still being farmed.
• This means the same amount of work is being done each year.
• The money available to pay workers must also be staying about the same.

So, even though the poorest workers barely survive, they manage to have enough children to keep their population numbers stable.

The Disaster of a Declining Economy

Now, imagine a country where the money available to pay workers is shrinking rapidly.

• Every year, there would be less demand for workers in all jobs.
• Many people trained for better jobs wouldn’t find work in their field. They’d be forced to seek the lowest-paying jobs instead.
• The lowest class would become overcrowded. It would include not only its usual workers but also people falling from higher classes.
• Competition for any work would become intense.
• Wages would drop to the absolute lowest level needed to barely survive.
• Many people wouldn’t find work even at these terrible wages. They would starve or have to resort to begging or crime.

Poverty, hunger, and death would spread quickly through the lowest class. Eventually, this would affect the higher classes too. The country’s population would shrink until only the number of people who could be supported by the remaining wealth were left. This might happen because of bad government or some other disaster.

This situation sounds like what might be happening in Bengal and other British settlements in the East Indies at the time. Even in a fertile land where food should be easy to find, hundreds of thousands reportedly died of hunger in a single year. This is a clear sign that the money available to pay the working poor is disappearing fast.

The difference between these places and North America highlights the impact of governance. North America, protected by the British system, is thriving. The East Indies, ruled by a profit-focused company, seems oppressed and declining.

Wages Tell Us About a Country’s Wealth

So, we can see a pattern:

1. Good Wages: When workers earn generous wages, it’s a sign that the country’s wealth is increasing. High wages naturally result from growth.
2. Bare Minimum Wages: When workers earn only enough to barely survive, it’s a sign the economy is stagnant – not growing or shrinking.
3. Starvation Wages: When workers are starving, it’s a sign the economy is rapidly declining.

Wages in Great Britain: Above the Bare Minimum

In Great Britain today, workers seem to earn more than the absolute minimum needed to raise a family. We don’t need complicated math to see this. There are several clear signs that wages aren’t stuck at the lowest possible level.

Sign 1: Summer vs. Winter Wages

• Almost everywhere in Britain, even for the lowest types of jobs, workers earn more in the summer than in the winter.
• However, families usually need more money in the winter, mainly because of heating costs (fuel).
• Since wages are highest when expenses are lowest, it suggests wages are based on the amount and value of the work done, not just on the bare minimum needed to survive.

Someone might argue that workers should save some summer earnings for winter. But we wouldn’t treat someone completely dependent on us (like a slave) this way. We would give them enough to meet their needs each day. The fact that wages don’t directly track daily needs suggests workers have some buffer.

Sign 2: Wages Don’t Track Food Prices Over Time

• The price of food changes constantly – year to year, even month to month.
• But in many parts of Britain, the actual money paid for labor stays the same for long periods, sometimes for 50 years or more.
• This means that if workers can support their families during expensive years (when food prices are high), they must be comfortable in average years and quite well-off in cheap years.
• Even though food prices have been high for the last ten years, wages haven’t significantly increased everywhere. Where they have increased, it’s likely due more to higher demand for workers than just the high cost of food.

Sign 3: Wages Vary More by Place than Food Prices Do

• Food prices, especially for basics like bread and meat, are generally similar across most of Great Britain. These items, bought by the poor in small amounts, are often as cheap or even cheaper in big towns than in the countryside.
• However, wages can be very different from place to place. Workers in London and nearby areas might earn 20-25% more than workers just a few miles away. For example, London wages might be 18 pence a day, while nearby areas pay 14-15 pence. Edinburgh wages might be 10 pence, falling to 8 pence just miles away, which is common in lowland Scotland.
• Such big differences in wages don’t cause huge numbers of workers to move seeking higher pay. If basic goods had such price differences, they would be shipped all over until prices leveled out.
• Experience shows that people are harder to move than goods. Even though people complain about human fickleness, workers tend to stay put more than you’d expect.
• Therefore, if families can survive in the lowest-wage parts of the country, they must be living quite comfortably in the highest-wage areas.

Sign 4: Wage and Food Price Changes Often Oppose Each Other

• Changes in wages don’t match changes in food prices, either in timing or location. Often, they move in opposite directions.

Example: England vs. Scotland

• Grain (the main food for common people) is generally more expensive in Scotland than in England. Scotland imports a lot of grain from England each year.
• Naturally, grain shipped from England to Scotland must sell for a higher price in Scotland. It also competes with Scottish grain in the same market.
• However, English grain is usually better quality – it produces more flour per measure. So, even if English grain seems more expensive by volume, it’s often cheaper by quality or weight.
• Despite cheaper quality grain, wages are higher in England than in Scotland.
• This means that if Scottish workers can support their families, English workers must be significantly better off.
• People often point out that Scottish commoners eat mainly oatmeal, which is seen as inferior to the diet of English workers. Some mistakenly claim this difference in diet causes the wage difference.
• But it’s the other way around: the difference in wages causes the difference in diet. It’s like saying a man is rich because he has a coach, while his neighbor is poor because he walks. The truth is, one man can afford a coach because he is rich, and the other walks because he is poor.

Wages Have Risen Over Time

Looking back over the last century (the 1600s compared to the 1700s):

• Grain was more expensive in both England and Scotland in the 1600s than it is now (in the 1700s). This is a well-documented fact, especially clear from official records in Scotland (public fiars). France and likely much of Europe saw similar trends.
• However, wages were much cheaper in the 1600s. Common daily wages in most of Scotland were 6 pence in summer and 5 pence in winter (about 3 shillings a week). These low wages still exist in some remote parts (Highlands, Western Islands).
• Now (in the 1700s), common wages in lowland Scotland are usually 8 pence a day, rising to 10 pence or even a shilling near Edinburgh, near the English border, and in areas with new industries (like Glasgow, Carron, Ayrshire).
• England developed its farming, manufacturing, and trade earlier than Scotland. So, the demand for labor, and thus wages, increased earlier there. Wages were higher in England than Scotland in the last century, just as they are now. English wages have also risen considerably since then, although it’s hard to say exactly how much because wages vary so much across England.
• Historical data supports this rise. In 1614, a foot soldier earned 8 pence a day, the same as today. This pay was likely set based on the typical wages of common laborers at that time.
• Lord Chief Justice Hales, writing in the mid-1600s, carefully estimated that a laborer’s family of six needed 10 shillings a week (£26 per year) to survive without begging or stealing.
• Mr. Gregory King, writing in 1688, estimated the average income for laborers’ families (around 3.5 people) was £15 a year. This works out to a similar weekly cost per person as Hales’s estimate (about 20 pence per head).
• Since the late 1600s, both the money earned and the expenses of such families have significantly increased across most of the kingdom, though perhaps not as dramatically as some recent reports suggest.
• It’s hard to know exact wage rates anywhere. Different employers in the same place might pay different rates for the same work, based on worker skill or how lenient the employer is. Laws trying to regulate wages usually fail. The best we can do is identify the most common wage.

Real Wages Have Increased Even More

The real value of wages – meaning the actual amount of necessities and comforts a worker can buy – has probably increased even more than the money amount during this century (the 1700s).

• Grain is cheaper.
• Many other foods enjoyed by the poor are much cheaper now than 30-40 years ago. Examples include potatoes, turnips, carrots, and cabbages, which used to be grown by hand but are now often grown using plows. Garden vegetables, in general, are cheaper. Many apples and onions used to be imported but are now grown locally.
• Improvements in making basic linen and wool cloth mean cheaper and better clothing.
• Improvements in making basic metal goods mean cheaper and better tools, plus useful household items.

However, some items have become much more expensive, mainly due to taxes: soap, salt, candles, leather, and alcoholic drinks. But the poor don’t need to buy large amounts of these. The savings on cheaper food and goods far outweigh the higher cost of these taxed items.

The common complaint that even the poorest people are becoming luxurious – wanting better food, clothing, and housing than before – actually proves that their real earnings have increased, not just their money wages.

Is This Improvement Good for Society?

Should we see the better living conditions of the lower classes as a good thing or a bad thing for society as a whole?

The answer seems obvious. Workers of all kinds (servants, laborers, etc.) make up the vast majority of people in any large society. Anything that improves the lives of the majority cannot possibly be bad for the whole society.

Surely, no society can be truly successful and happy if most of its members are poor and miserable. Besides, it’s only fair. The people who provide food, clothing, and housing for everyone else deserve to earn enough from their own work to be reasonably well-fed, clothed, and housed themselves.

Poverty, Marriage, and Raising Children

Poverty and Having Children

Poverty certainly makes life harder, but it doesn’t stop people from getting married. In fact, it sometimes seems to lead to more births.

For example, a poor woman in the Scottish Highlands, living on very little, might have more than twenty children. In contrast, a wealthy, pampered woman might struggle to have any children, or be exhausted after just two or three. Infertility is common among wealthy women but rare among the poor. It seems that a life of luxury, while increasing the desire for pleasure, often weakens or destroys the ability to have children.

Poverty and Raising Children

However, poverty is extremely bad for raising children. A child is like a delicate plant. If born into the “cold soil and harsh climate” of poverty, it often withers and dies young.

It’s often said that in the Scottish Highlands, it’s common for a mother who has given birth to twenty children to have only two still alive. Experienced army officers have told me they can’t even find enough musicians (drummers and fifers) for their regiments from all the children born to the soldiers. Yet, soldiers’ barracks often seem full of healthy-looking children. It appears very few of these children live to reach age thirteen or fourteen.

High Child Mortality Among the Poor

Sadly, child death rates are very high in many places.

• Sometimes half the children born die before age four.
• In many areas, a large number die before seven.
• Almost everywhere, many die before age nine or ten.

This high death rate mainly affects the children of common people. Poorer parents cannot afford to care for their children as carefully as wealthier families can. So, even though poor families often have more babies than rich families, fewer of their children actually grow up to be adults. The death rate is even higher for children in orphanages (foundling hospitals) or those raised by charities.

How Lack of Resources Limits Population Growth

Think about animals. Any species naturally multiplies based on the food and resources available. No species can grow beyond the resources that support it.

In human society, it’s mainly the lack of resources (subsistence) among the poor that limits overall population growth. This limit works primarily by causing the deaths of many children born into poor families.

Good Wages Help Population Grow to Meet Demand

When workers earn good wages, they can take better care of their children. More children survive, and the population grows.

Interestingly, this process naturally helps match the population size to the economy’s need for workers.

1. If demand for workers increases: Wages will rise. Higher wages encourage workers to marry and have families, and allow them to raise more children successfully. This increases the population to supply the needed labor.
2. If wages are too low: There won’t be enough workers to meet demand. This shortage will force wages up.
3. If wages are too high: Too many people will enter the workforce. This oversupply will push wages back down to the necessary level.

In this way, the demand for people regulates the “production” of people, much like the demand for any product influences its production. It speeds up population growth when needed and slows it down when there are too many people. This explains why population grows rapidly in places like North America, slowly in Europe, and not at all in places like China.

Free Workers Cost Less Than Slaves

People sometimes say that the cost of maintaining a slave (their “wear and tear”) falls on the master, while the cost of maintaining a free worker falls on the worker themselves.

However, the master actually pays for the free worker’s maintenance too, through their wages. Wages must be high enough, on average, for workers to raise families and continue the supply of labor needed by society – whether that need is growing, shrinking, or staying the same.

Even though the master ultimately pays for the upkeep of both slaves and free workers, free workers usually cost much less. Why?

• Management: The money set aside to support a slave is often managed poorly by a neglectful master or overseer. Wealthy slave owners often run their affairs inefficiently.
• Self-Management: The money a free worker uses for their own support is managed by the worker themselves. Poor people tend to be careful and frugal with their money.

Because of this difference in management, it costs less to support a free worker than a slave. History seems to show that work done by free people is ultimately cheaper than work done by slaves. This is true even in places like Boston, New York, and Philadelphia, where wages for free labor are very high.

High Wages: A Sign and Cause of Prosperity

So, generous wages are both a result of increasing national wealth and a cause of increasing population. To complain about high wages is like complaining about the effects of national success.

When Are Workers Best Off? During Growth.

It’s worth noting that the lives of working people seem happiest and most comfortable when society is in the process of getting richer (the progressive state). Their condition is difficult when wealth is stable (stationary state) and miserable when wealth is declining (declining state).

• The progressive state feels cheerful and positive for everyone in society.
• The stationary state feels dull.
• The declining state feels depressing.

High Wages Encourage Hard Work

Good wages don’t just help population grow; they also encourage people to work harder. Wages are the reward for effort. Like any human quality, hard work (industry) improves when it’s encouraged.

• Plenty of food increases a worker’s physical strength.
• The hope of improving their life and perhaps retiring comfortably motivates them to use their strength fully.

Therefore, where wages are high, workers tend to be more active, diligent, and efficient than where wages are low. For example, workers in England are generally seen as more productive than those in Scotland; workers near big towns are more productive than those in remote areas.

Now, it’s true that some workers, if they can earn a week’s pay in four days, might choose to be idle for the other three. But this isn’t typical for most people.

In fact, when workers are paid well per piece of work they complete (piece-rate), they often overwork themselves. They might ruin their health within a few years. For instance, it’s said that a carpenter in London working at full speed doesn’t last more than eight years. This happens in many trades where piece-rate pay is common, especially where wages are high.

Many jobs cause specific health problems due to excessive focus on one type of task. An Italian doctor, Ramuzzini, even wrote a book about these work-related illnesses.

Even soldiers, not usually considered the hardest workers, show this tendency. When soldiers were hired for specific tasks and paid well by the piece, their officers often had to make agreements to limit their daily earnings. Without limits, competition and the desire for more money drove them to work too hard and damage their health.

This tendency to overwork for several days might be the real reason for the “idleness” later in the week that people complain about. After intense work (mental or physical) for several days, most people feel a strong need for rest and relaxation. This natural urge is hard to resist unless forced. If ignored, it can lead to dangerous health problems, including the specific illnesses associated with certain trades.

Therefore, sensible and humane employers should often focus on moderating their workers’ efforts rather than pushing them harder. A worker who works at a steady, moderate pace will likely stay healthier longer and produce more work over the course of a year.

The Debate: Do Cheap Food Prices Make Workers Lazy?

Some people claim that workers are generally more idle when food is cheap (plentiful years) and harder working when food is expensive (dear years). They conclude that having plenty makes people lazy, while scarcity motivates them.

It’s possible that some workers might slack off if they have a bit extra. But it seems unlikely that this applies to most people. It’s hard to believe that people generally work better when they are:

• Poorly fed rather than well-fed.
• Discouraged rather than hopeful.
• Often sick rather than generally healthy.

Remember, years of scarcity are often years of widespread sickness and death among the common people, which surely reduces their ability to work.

How Food Prices Really Affect the Labor Market

Here’s what often happens:

• In Cheap Years (Plenty): Food is cheap. Some servants might leave their jobs to try working for themselves. However, the low cost of food also means employers (especially farmers) have more money available to hire workers. Farmers might find it more profitable to hire extra hands than to sell their grain at low market prices. So, the demand for workers increases, while the supply of people looking for service jobs decreases. As a result, wages often rise in cheap years.
• In Dear Years (Scarcity): Life is difficult. People working independently struggle and often seek stable jobs as servants. But the high cost of food reduces the money employers have for wages. They tend to hire fewer workers, not more. Independent workers may use up their savings and be forced to seek employment. So, the supply of workers increases, while the demand for workers decreases. More people want jobs than can find them, leading workers to accept lower pay. As a result, wages for both servants and day-laborers often fall in dear years.

Why Employers Might Prefer Dear Years

Employers often get a better deal in dear years – they pay less and find workers more obedient. Therefore, they naturally praise dear years as being better for “industry.” Landlords and farmers, two large groups of employers, also like dear years because high food prices increase their rents and profits.

However, it’s absurd to think people generally work less hard when working for themselves than when working for others. A poor independent worker, who keeps everything they produce, is likely to be more industrious than an employee, even one paid by the piece (who shares the profit with a master). Independent workers are also less exposed to the bad influences sometimes found in large workplaces.

Therefore, cheap years tend to increase the number of independent workers, while dear years tend to decrease it.

Evidence from France and Britain

• A French researcher, Mr. Messance, studied manufacturing output in three regions. He found that production of wool, linen, and silk goods was generally higher in cheap years than in dear years, and highest in the cheapest years. These were established, stable industries.
• Looking at growing industries in Britain (Scottish linen, Yorkshire wool), the connection between output and food prices is less clear. Output sometimes fell in very scarce years (like 1740), but sometimes rose (Scotland in 1756). Fluctuations seemed more related to factors like trade policies (e.g., the American Stamp Act) and demand in export markets.

Why Manufacturing Statistics Can Be Misleading

The output of large factories selling goods far away depends more on factors like peace or war, competition, and customer demand in other countries, rather than just the local price of food.

Also, a lot of work done in cheap years doesn’t get recorded in official statistics. For example, male servants might leave service to work independently. Women might return home and spin cloth for their families. Independent workers often do jobs for neighbors for local use. This hidden production means official manufacturing records don’t always give a true picture of the economy’s health.

How Food Prices and Labor Demand Set Wages

Even though wages don’t always directly follow food prices, the price of food definitely influences wages.

The money price of labor (the actual wage paid) depends on two main things:

1. The demand for labor: Is the economy needing more workers, fewer workers, or about the same number? This determines the standard of living (the amount of necessities and comforts) a worker must receive.
2. The price of necessities and comforts: How much money does it cost to buy that required standard of living? This sets the actual money wage.

So, while wages might sometimes be high when food is cheap, they would need to be even higher (assuming the same demand for labor) if food were expensive.

Why Wages Fluctuate with Extreme Plenty or Scarcity

Wages sometimes rise during sudden, extreme plenty and fall during sudden, extreme scarcity. This happens because these extreme conditions directly affect the demand for labor.

• Sudden Plenty: Many employers find they have extra money or resources. They want to hire more workers than usual. Since the extra workers aren’t immediately available, employers compete for them by offering higher wages. Both the real value and the money price of labor can rise.
• Sudden Scarcity: Employers have fewer resources. They need to lay off workers. Many people become unemployed and compete fiercely for the few available jobs, offering to work for less. Both the real value and the money price of labor can fall. (For example, in the very scarce year of 1740, many people worked just for food. In the plentiful years that followed, workers were harder to find).

Balancing Forces Keep Wages Relatively Stable

• Scarcity tends to lower wages (by reducing demand) but also tends to raise them (by increasing living costs).
• Plenty tends to raise wages (by increasing demand) but also tends to lower them (by decreasing living costs).

In normal year-to-year changes in food prices, these opposing forces often balance each other out. This is probably part of the reason why wages tend to be much more stable over time than food prices.

How Wages Affect Product Prices

Finally, an increase in wages usually increases the price of goods. This is because wages are a major part of the production cost. Higher prices can then lead to people buying less of those goods, both at home and in other countries.

How Higher Wages and Productivity Go Together

The very thing that causes wages to rise – an increase in business investment (stock) – also tends to make labor more productive. More investment means a smaller amount of labor can produce a larger amount of goods.

Here’s how:

1. Better Organization: Business owners who invest money to hire many workers naturally want the biggest return. To get it, they organize the work efficiently. They divide tasks among workers so that the team can produce the most output possible.
2. Better Tools: For the same reason, owners try to supply their workers with the best machinery and tools available.

What happens in a single workshop also happens across society. When there are more workers overall, work naturally becomes more specialized, dividing into different jobs and sub-specialties.

With more specialization, more people focus on inventing better tools and methods for each specific task. This makes innovation more likely.

The Result: Cheaper Goods Despite Higher Wages

Because of these improvements – better organization and better tools – many products end up needing much less labor to make than before. The reduction in the amount of labor required can be so significant that it more than makes up for the increase in the price of that labor (higher wages). As a result, even though workers earn more, the final cost of many goods can actually go down.

CHAPTER IX: Business Profits (Return on Investment)

Introduction: Profit vs. Wages

The rise and fall of business profits depend on the same main factor as the rise and fall of workers’ wages: whether the society’s overall wealth is increasing or decreasing.

However, these economic changes affect wages and profits very differently.

Why More Investment Often Lowers Profits: Competition

An increase in business investment (stock, or capital) tends to raise wages, as we saw before. But it usually tends to lower profits.

Here’s why: competition.

• When many rich merchants invest their capital in the same type of business, they compete against each other. This competition naturally pushes down the profits in that trade.
• If investment increases across all types of businesses in a society, the same widespread competition will lower profits across the board.

Measuring Profit is Difficult

We already noted it’s hard to know the average wage for labor, even in one specific place and time. We can usually only figure out the most common wage.

Figuring out average business profit is even harder.

• Profit is extremely volatile. A business owner often can’t even tell you their own average annual profit.
• Many factors affect profit:
  • Changes in the prices of goods they buy or sell.
  • The good or bad luck of their competitors.
  • The good or bad luck of their customers.
  • Countless accidents that can happen to goods during shipping or storage.
• Profit changes constantly – not just year to year, but day to day, almost hour to hour.

Trying to calculate the average profit for all businesses in a large country is incredibly difficult. Trying to figure out what profits were like long ago is completely impossible with any accuracy.

Interest Rates: A Clue to Profit Levels

Although we can’t easily measure average profits directly, we can get some idea by looking at interest rates – the price paid for borrowing money.

Here’s a basic rule:

• Where people can make a lot of money by using borrowed money (high profits), they will be willing to pay a lot to borrow it (high interest rates).
• Where people can only make a little money by using borrowed money (low profits), they will only be willing to pay a little to borrow it (low interest rates).

Therefore, by observing how the usual market interest rate changes in a country, we can be fairly sure that average business profits are changing in the same way. Profits generally fall when interest rates fall, and rise when interest rates rise. Studying the history of interest rates can give us clues about the history of profits.

Historical Trend in England: Falling Interest, Falling Profit

Let’s look at interest rates in England over time:

• Before a law by Henry VIII, interest rates were sometimes above 10%. The law set the maximum legal rate at 10%.
• During Edward VI’s reign, charging any interest was briefly banned for religious reasons, but this ban likely had little effect (and may have made predatory lending worse).
• Elizabeth I brought back the 10% legal limit.
• James I lowered it to 8%.
• After the Restoration, it went down to 6%.
• Queen Anne lowered it further to 5%.

These legal changes seem to have simply followed what was already happening in the market. The actual rate people borrowed at (if they had good credit) was gradually falling.

By Queen Anne’s time (early 1700s), the market rate was often below 5%. Before the recent war, the government could borrow at 3%, and reliable borrowers in London and elsewhere could get loans at 3.5%, 4%, or 4.5%.

Connecting Trends:

Since the time of Henry VIII (over 200 years ago):

• England’s overall wealth and income have steadily grown. The pace of growth seems to have sped up over time.
• Wages for labor have steadily increased during this period.
• In most types of business, profits have generally been decreasing.

This matches what we expect: as wealth and investment grow, wages tend to rise, and competition tends to push profits down (reflected in falling interest rates).

Profit Differences: Town vs. Country

It usually takes more capital (investment) to run a business in a big town compared to a small village.

• In towns: Large amounts of capital are invested in every type of business. Many rich competitors drive the rate of profit down.
• In villages: Less capital and less competition mean the rate of profit is often higher.

Wages show the opposite pattern:

• In towns: Wages are generally higher. Businesses with lots of capital often struggle to find enough workers. They bid against each other for labor, which raises wages and lowers profits.
• In villages: Wages are generally lower. There often isn’t enough capital to employ everyone. Workers bid against each other for the available jobs, which lowers wages and raises profits.

Country Comparisons Reveal Profit Trends

Scotland vs. England:

• The legal maximum interest rate is the same in both countries (5%).
• However, the market interest rate is higher in Scotland. Good borrowers rarely pay less than 5%. Edinburgh banks even pay 4% interest on deposits you can withdraw anytime, while London banks pay nothing for deposits.
• This suggests capital is scarcer in Scotland.
• Most businesses can be run with less capital in Scotland than in England.
• Therefore, the common rate of profit must be somewhat higher in Scotland.
• As noted before, wages are lower in Scotland than in England.
• Scotland is not only poorer than England, but it also seems to be developing more slowly (though it is clearly improving).

France vs. England:

• France’s legal interest rate has often been changed by the government, sometimes to manage public debt, and hasn’t always matched the market rate.
• Despite legal rates sometimes being lower than England’s, the actual market interest rate in France is generally higher. (People find ways around the law).
• British merchants familiar with both countries report that business profits are higher in France than in England.
• This might explain why some British people invest their capital in France, even though business activity is considered less prestigious there compared to England.
• Wages are lower in France than in England. The difference in the appearance and condition of ordinary people is noticeable when traveling between Scotland and England, but the contrast is even starker when coming from France to England.
• France, while richer than Scotland, doesn’t seem to be advancing as quickly as England. It’s a common view in France that the country is going backwards (though the author doubts this is true, unlike in Scotland where progress is obvious).

Holland vs. England:

• Holland is extremely wealthy relative to its small size and population – richer than England in this sense.
• Interest rates are very low: the government borrows at 2%, and reliable private individuals at 3%.
• Wages are said to be higher in Holland than in England.
• Business profits are famously lower in Holland than anywhere else in Europe.
• Some claim Dutch trade is declining. While some specific industries might be shrinking, the low profits are actually a natural sign of prosperity – indicating a huge amount of capital competing in the market.
• Holland’s dominance in shipping and massive investments in foreign countries (like England and France) show they have so much capital that they can’t find enough profitable ways to use it all within their own country. This doesn’t mean Dutch domestic business has shrunk, just that their total capital has grown even faster. Just as a rich person might invest outside their main business, a rich nation’s capital can grow beyond what its domestic economy can absorb.

Special Case 1: New Colonies (High Wages AND High Profits)

In Britain’s colonies in North America and the West Indies, we see something unusual:

• Wages are higher than in England.
• Interest rates (and therefore profits) are also higher than in England (market rates often 6-8%).

High wages and high profits usually don’t happen together, except in the unique situation of new colonies. Here’s why:

• Abundant Land, Scarce Capital & Labor: New colonies have vast amounts of land but not enough capital to develop it all, and not enough people relative to the available capital.
• Focus on Best Land: Capital is used only on the most fertile and easily accessible land (near coasts and rivers), often bought very cheaply.
• High Initial Profits: Farming this prime land yields very high profits, allowing businesses to pay high interest rates.
• High Demand for Labor: The high profits allow owners (planters) to rapidly increase their operations. They need workers faster than they can find them in a new settlement. This high demand drives wages up.
• Profits Fall Over Time: As the colony grows, the best land gets taken. Capital moves to less fertile, less convenient land. Profits from this land are lower, so businesses can only afford to pay lower interest rates.
• Interest Rates Decline: As colonies have become richer, more developed, and more populated over the past century, their interest rates have indeed fallen significantly.
• Wages Stay High (or Rise): Importantly, wages don’t automatically fall just because profits fall. The demand for labor increases as the total amount of capital increases, no matter the profit rate. Capital can continue to grow rapidly even when profit rates are lower. Think of the saying “money makes money” – large amounts of capital tend to grow faster (even at lower rates) than small amounts.

Special Case 2: New Opportunities (Temporary Profit Boost)

Even in a wealthy, advancing country, profits (and interest rates) can rise temporarily if new territories or new branches of trade open up.

• The country’s existing capital isn’t enough to fund all the new business opportunities at once.
• Investment shifts from older, less profitable trades into the new, more profitable ones.
• Competition in the older trades decreases. Less supply reaches the market.
• Prices in those older trades rise, increasing profits for those remaining.
• Higher profits allow businesses to pay higher interest rates.

For example, after the last major war (which brought Britain new territories and trade in North America and the West Indies), even the most reliable businesses in London were borrowing at 5%, up from 4-4.5% before the war. This huge increase in business opportunities likely caused this rise in interest rates, without meaning the country’s overall capital had shrunk.

Special Case 3: Declining Economy (High Profits, Low Wages)

If a country’s total capital (the funds used to support industry) decreases, the effects are the opposite of growth:

• Wages fall (as explained in the previous chapter).
• Profits (and interest rates) rise.

Here’s why profits rise in a declining economy:

1. Lower Costs: Lower wages mean businesses can produce goods more cheaply.
2. Higher Prices: Less capital is being used overall, so less supply reaches the market. Less competition allows sellers to charge higher prices.

Goods cost less to make and sell for more. Profits increase from both ends, allowing businesses to afford high interest rates.

The huge fortunes quickly made in Bengal and other British settlements in the East Indies suggest this pattern. In these struggling regions, wages are very low, while profits are extremely high. Interest rates are equally high – farmers in Bengal reportedly borrow money at 40%, 50%, or even 60% interest, using their next harvest as collateral. Such high profits consume landlords’ rents, and such extreme interest rates (usury) consume most of the profits. Similar situations existed in Roman provinces under corrupt governors.

The Theoretical End Point: The Stationary State

Imagine a country that has reached its absolute maximum level of wealth. This means it has developed its resources (soil, climate, location) as much as possible and can’t grow any further, but isn’t declining either.

In such a stationary state:

• Wages would likely be very low. The country would be fully populated for its resources and capital. Competition for jobs would be intense, pushing wages down to the minimum needed just to maintain the existing number of workers (since the population couldn’t grow further).
• Profits would likely be very low. The country would be fully invested (“fully stocked”) relative to all possible business opportunities. Competition among investors would be fierce in every trade, pushing profits down to the lowest possible level.

Is Any Country Stationary? China Example

Perhaps no country has ever actually reached this maximum state of wealth.

China seems to have been stationary (not growing significantly) for a long time. It probably reached the maximum level of wealth possible given its specific laws and institutions long ago.

However, this level might be much lower than what China could achieve with different laws and institutions (regarding things like foreign trade, which it restricts).

Furthermore, if a country’s laws protect the property of the rich but not the poor (leaving small capitals vulnerable to exploitation), the total amount of capital invested will likely be less than what the economy could actually support if everyone felt secure.

Other Factors Affecting Profit and Interest

• Oppression and Monopoly (China Example): In places like China, where the poor lack security, the rich can gain monopolies by controlling whole trades. This lack of competition allows them to make very large profits. The high common interest rate in China (reportedly 12%) reflects these large profits that businesses must be earning.

• Weak Laws Raise Interest Rates: Sometimes, flaws in the legal system can push interest rates much higher than the country’s economic condition would suggest. If laws don’t reliably enforce contracts, lenders view all borrowers as risky, similar to bankrupts. Lenders demand extremely high interest to cover the danger of not getting their money back. This might partly explain the high interest rates in Europe after the fall of the Roman Empire, when courts often didn’t get involved in enforcing private agreements.

• Banning Interest Also Raises Rates: Laws that completely prohibit charging interest don’t actually stop it. People still need to borrow, and lenders won’t lend for free. Lenders will charge enough to cover not only the potential profit from using the money but also the risk and difficulty of breaking the law. According to Mr. Montesquieu, the high interest rates in Islamic nations result partly from this legal prohibition and partly from difficulties in getting loan payments back.

Understanding Profit: Gross vs. Net

The lowest possible average rate of profit a business needs must be slightly more than what’s needed to cover the occasional losses that happen in any investment.

• Net Profit: The amount earned above what’s needed to cover losses is the real, clear profit. This is also called net profit.
• Gross Profit: What people often call gross profit includes both the net profit and the money set aside to cover expected losses.

A borrower can only afford to pay interest to a lender out of the net profit.

The Limits of Profit and Interest Rates

• Lowest Interest Rate: Similarly, the lowest average interest rate must be slightly more than enough to cover the lender’s risk of occasional losses (even if they lend carefully). If the rate only covered losses, people would only lend out of kindness or friendship, not as a business activity.

• Lowest Profit/Interest (in a Fully Developed Country): In a hypothetical country that has reached its maximum possible wealth (a stationary state):

  • Competition among businesses would be intense in every field.
  • Average net profit would be very low.
  • Market interest rates would be extremely low (based on the low profits).
  • Only the very richest people could afford to live just on the interest from their money.
  • Almost everyone else would have to actively manage their own investments or run some kind of business to survive. The province of Holland seems close to this situation. It’s considered unusual there not to be involved in business. Necessity forces almost everyone to be active, and social customs follow necessity. Just as it’s odd not to dress like others, it’s odd not to be employed in business like everyone else. An idle person feels out of place among busy people.

• Highest Possible Profit Rate: The highest imaginable profit rate could be so large that it consumes nearly everything that should go to pay land rent. It would leave only enough to pay workers the absolute minimum needed to survive while producing and transporting goods. The workers must be fed, but the landowner might get nothing. The profits made by the East India Company’s employees in Bengal might be close to this extreme level.

The Relationship Between Profit and Interest Rates

The typical ratio between the market interest rate and the average net profit rate changes depending on whether profits are generally high or low.

• In Great Britain, merchants often consider a “good, moderate, reasonable profit” to be about double the interest rate. This likely just means a common or standard profit.
• If the average net profit in a country is 8% or 10%, it might seem reasonable for about half of that (4% or 5%) to be paid as interest when a business operates with borrowed money.
• The borrower takes the business risk, effectively insuring the lender’s capital. The interest paid (e.g., 4-5%) covers the lender’s risk and compensates the borrower for the effort of managing the investment.
• However, this roughly 50/50 split between interest and the borrower’s remaining profit might be different in countries where average profits are much lower or much higher. If profits were very low, businesses couldn’t afford to pay half as interest. If profits were very high, they could perhaps afford to pay more than half.

Low Profits Can Aid Competitiveness

In countries that are rapidly getting richer, profit rates tend to be low (due to competition). This low profit margin can actually help offset high wages. It allows these advanced countries to sell their goods just as cheaply as less prosperous neighbors where wages may be lower, but profit margins are higher.

Profits vs. Wages: Which Raises Prices More?

High profits tend to raise the price of goods much more significantly than high wages do.

Let’s use linen manufacturing as an example:

• Impact of Raising Wages: If the wages of all workers involved (flax dressers, spinners, weavers, etc.) go up by, say, two pence per day, the final price of the linen only needs to increase by the total number of “two pences” paid out (number of workers x number of days). The wage part of the price increases step-by-step, like simple interest on a debt. It’s an arithmetical increase.
• Impact of Raising Profits: But if the profit rate of all the employers at each stage goes up by 5%, the effect compounds. The flax supplier adds 5% profit to their costs (materials + wages). The spinner adds 5% profit to the now higher cost of flax plus the spinners’ wages. The weaver adds 5% profit to the now higher cost of yarn plus the weavers’ wages. The profit part of the price increases exponentially, like compound interest on a debt. It’s a geometrical increase.

Merchant Complaints:

Business owners (merchants and master manufacturers) frequently complain about how high wages raise prices and reduce sales. However, they rarely mention the negative effects of high profits on prices. They are silent about the impact of their own gains; they only complain about the gains of others (their workers).

PART I: Why Pay Differs: The Nature of the Job Itself

Pay and profits vary between different jobs for several reasons. Some reasons come from the nature of the jobs themselves. Here are the five main ones:

1. Is the job pleasant or unpleasant?
2. Is it easy and cheap, or difficult and expensive, to learn the job?
3. Is the work steady, or does it stop and start?
4. Does the job require a little or a lot of trust?
5. Is success in the job likely or unlikely?

Let’s look at each of these.

1. Pleasantness vs. Unpleasantness

Wages often depend on how easy or hard, clean or dirty, respected or disrespected a job is.

• Examples:
  • A tailor usually earns less than a weaver because their work is easier.
  • A weaver earns less than a smith because their work is cleaner, though not always easier.
  • A blacksmith, though a skilled craftsman, usually earns less in a long day than a coal miner earns in a shorter one. The blacksmith’s work isn’t as dirty, is less dangerous, and is done above ground in daylight.
• Honor and Disgrace:
  • Jobs considered highly honorable often have lower pay because honor itself is seen as part of the reward. We’ll see later that these professions are often underpaid financially.
  • Jobs considered disgraceful often pay more. Being a butcher is seen as unpleasant, but it usually pays better than most common trades. The most disliked job, public executioner, pays better for the amount of work done than almost any other common job.
• Pastimes vs. Trades:
  • Hunting and fishing were essential jobs in early societies. Later, they became enjoyable hobbies. When a job becomes a popular hobby, too many people are attracted to it. This drives down the price of the product (like fish) and the wages for those doing it professionally. Fishermen and hunters who do it for a living are usually very poor.
• Effect on Profit:
  • The pleasantness of a business also affects its profits. Running an inn or tavern isn’t very pleasant or respected. The owner deals with difficult customers and isn’t truly master of their own house. However, these businesses often bring in very high profits from a relatively small investment.

2. Cost and Difficulty of Training

Wages also vary based on how hard and expensive it is to learn the necessary skills.

• The Skilled Worker Analogy:
  • Think of an expensive machine. The owner expects the machine’s work to eventually pay back its cost, plus a normal profit, before it wears out.
  • A person trained for a skilled job requiring lots of time and effort is like that expensive machine. Their higher wages are expected to repay the cost of their education (compared to common labor), plus a reasonable profit on that investment. This repayment needs to happen within a reasonable time, considering that human life is uncertain.
• Skilled vs. Unskilled Wages:
  • This principle is the basis for the difference between wages for skilled labor and common (unskilled) labor.
• Apprenticeships in Europe:
  • European laws and customs treated trades like mechanics, crafts, and manufacturing as “skilled labor” requiring training. Farm labor was seen as “common labor.” (The author questions if skilled trades are always more complex).
  • To practice a skilled trade, a long apprenticeship was often required. During this time, the apprentice worked for the master, often supported by family who might also pay the master a fee. This system was costly for the apprentice.
  • In contrast, farm laborers often learned the harder parts of the job while doing the easier parts, earning wages throughout.
• Resulting Wage Difference:
  • Because of the cost of apprenticeships, it’s reasonable for skilled workers in Europe (mechanics, artisans) to earn somewhat higher wages than common laborers.
  • This wage difference usually isn’t huge for common skilled jobs (like basic weaving or cloth making). However, skilled jobs are often steadier year-round, so the total annual earnings might be higher. The slightly higher pay seems mainly to compensate for the higher cost of education.
• Higher Education Costs:
  • Education for professions like law, medicine, painting, or sculpture takes even longer and costs more. Therefore, their pay should be much higher, and it usually is.
• Effect on Profit:
  • The difficulty of learning a trade seems to have little effect on business profits. Most types of businesses in large towns appear similarly easy or difficult to learn.

3. Job Security / Steadiness of Work

Wages depend on whether a job offers steady employment or is often interrupted.

• Steady vs. Unsteady Work:
  • Many manufacturing jobs offer fairly constant work throughout the year.
  • Construction workers like masons and bricklayers face frequent interruptions. They can’t work in bad weather, and their jobs depend on when customers happen to need them. They are often unemployed.
• Compensation for Instability:
  • Because their work is unsteady, masons and bricklayers must earn a higher daily wage when they are working. This higher pay needs to cover periods of idleness and compensate for the stress of an uncertain income.
  • Their daily wages are often 1.5 to 2 times higher than those of common laborers. This extra pay is mainly for the inconsistency of the work, not necessarily for superior skill (masonry is relatively easy to learn).
• Comparing Steady Trades:
  • A house carpenter’s job requires more skill than a mason’s. However, carpenters often earn a slightly lower daily wage because their work is generally steadier – less affected by weather or random customer calls.
• Temporary Instability:
  • If a normally steady job becomes unstable in a particular place, wages rise. For example, in London, many skilled workers (like tailors) can be hired and fired daily, like common laborers elsewhere. London tailors earn much more per day than common laborers, unlike tailors in villages where work is steadier (though London tailors may face long periods without work).
• Combined Factors:
  • When unsteady work is also hard, dirty, and disagreeable, wages can become very high. Coal miners earn high wages mainly due to the hardship of the work (it can be steady if they choose). London dockworkers unloading coal ships (coal-heavers) face similar hardship plus unavoidable irregular work due to ship arrival times. It’s logical they might earn 4 or 5 times the wages of common labor. Studies showed they could earn very high daily amounts. If pay weren’t high enough to compensate for all the downsides, more people would compete for the jobs, quickly lowering the wages (as these jobs require no special privileges).
• Effect on Profit:
  • The steadiness of work doesn’t affect business profits. Whether an owner keeps their capital constantly employed depends on the owner’s choices, not the nature of the trade itself.

4. Level of Trust Needed

Wages vary depending on how much responsibility and trust are placed on the worker.

• Valuable Materials:
  • Goldsmiths and jewelers earn more than many other craftspeople (even those with more skill) because they are trusted with valuable materials.
• Important Responsibilities:
  • We trust physicians with our health. We trust lawyers and attorneys with our money, and sometimes our lives and reputations.
  • Society cannot safely place such high levels of trust in people of very low social standing or poor financial condition.
  • Therefore, the pay for these professionals must be high enough to give them the social rank required for such important trust. When combined with their long and expensive education, this need for trust further increases their wages.
• Effect on Profit:
  • Trust doesn’t directly affect business profits. A business owner using their own capital isn’t being trusted by anyone else in that role. The credit they might get from others depends on lenders’ opinions of their personal wealth, honesty, and judgment, not on the type of business they run.

5. Likelihood of Success

Wages differ based on the probability of actually succeeding in a profession after training for it.

• Certainty vs. Uncertainty:
  • In most skilled trades (like shoemaking), if you train someone, they are almost certain to learn the skill well enough to make a living.
  • In professions like law, success is highly uncertain. For every lawyer who succeeds, perhaps twenty others fail to make a living after studying law.
• The Lottery Analogy:
  • Think of a fair lottery: the total prize money paid out equals the total money spent on losing tickets.
  • Applying this to professions: In a field where only 1 in 20 succeeds, that one successful person should theoretically earn enough to cover their own expensive education plus the costs incurred by the twenty who failed. A lawyer who finally starts earning well at age 40 should be compensated for their own efforts and expenses, plus those of many others who never made it.
• Reality: Professions as “Unfair Lotteries”:
  • In reality, even though lawyer fees might seem high, they don’t nearly cover the total cost according to the lottery principle. If you compare total earnings vs. total expenses for all shoemakers in a town, earnings usually exceed expenses. If you do the same for all lawyers and law students, expenses far outweigh earnings.
  • Therefore, law (and similar professions) are financially “under-compensated.” They are like lotteries where the total prize money is far less than the cost of all the tickets.
• Why People Still Enter Risky Professions:
  • Despite the poor financial odds, talented people eagerly enter these fields. Two main reasons:
    1. Desire for Reputation: Excelling in a difficult field where few succeed brings great public admiration and is seen as a mark of genius. This reputation is a significant part of the reward (especially in law, poetry, or philosophy, where it might be almost the entire reward).
    2. Overconfidence: Most people naturally overestimate their own abilities and, even more so, their own luck.
• Talents Viewed as Disreputable:
  • Some admired talents (like acting, opera singing, or dancing) are considered socially questionable if used primarily to earn money.
  • People exercising these talents must be paid enough to cover not only the cost of acquiring the rare skills but also the social disapproval (“discredit”) associated with the job. This explains the extremely high pay of performers.
  • It seems contradictory to look down on performers yet pay them so lavishly, but the high pay is a direct result of the social disapproval (which limits competition). If public opinion changed, many more people would enter these fields, and competition would quickly drive down their pay. These talents, while not universal, are less rare than often thought; many possess them but choose not to use them commercially.
• Universal Overconfidence in Luck:
  • Philosophers have long noted people’s tendency to overestimate their abilities. Less noticed, but perhaps even more common, is people’s absurd confidence in their own good fortune.
  • Almost everyone in decent health and spirits believes they are luckier than average. People consistently overvalue the chance of winning and undervalue the chance of losing. The enduring popularity of actual lotteries proves how much people overestimate the chance of gain.

(Continuing Factor 5: Likelihood of Success)

Why Real Lotteries Aren’t “Fair”

The world has never seen a perfectly fair lottery, where the total prize money equals the total money spent on tickets. Why? Because the lottery organizer wouldn’t make any profit.

Look at government lotteries. The tickets usually aren’t statistically worth the price people pay for them. Yet, people often buy and sell these tickets in the market for 20%, 30%, or even 40% more than their original price. The only reason for this demand is the unrealistic hope of winning one of the huge prizes. Even sensible people don’t think it’s foolish to spend a small amount for a tiny chance at winning thousands of pounds, even knowing the ticket price is much higher than the actual statistical value of that chance.

If a lottery only offered small prizes (say, nothing over £20), people wouldn’t be as interested, even if it were statistically much fairer than typical government lotteries. To improve their odds for big prizes, some people buy many tickets, or small shares in even more tickets. However, it’s a mathematical certainty: the more tickets you buy, the more likely you are to lose money overall. If you buy every single ticket, you are guaranteed to lose (because the total prize money is less than the total ticket cost). The more tickets you buy, the closer you get to that certainty.

Underestimating Risk: The Insurance Example

We can also see that people often underestimate the chance of loss by looking at the insurance business. Insurance companies typically make only moderate profits.

To run an insurance business (for fire or sea risks), the premiums charged must be enough to:

• Cover the average expected losses.
• Pay for the company’s operating expenses.
• Provide a profit similar to what could be earned by investing the same capital in any other common trade.

Someone who pays this standard premium is essentially paying the true value of the risk – the lowest price they can reasonably expect to get insurance for.

However, while many people have made some money running insurance businesses, very few have become extremely wealthy doing so. This suggests that the average profit in insurance isn’t better than in other common trades where fortunes are made.

Even though insurance premiums are usually moderate, many people disregard the risk too much to bother paying for insurance. Across the whole country, perhaps 19 out of 20 houses (or maybe even 99 out of 100) are not insured against fire. People are generally more worried about sea risks, so a larger proportion of ships are insured. Still, many ships sail without insurance, even in wartime.

Self-Insurance vs. Rashness

Sometimes, not buying insurance can be a calculated decision. A large company or merchant with twenty or thirty ships might decide to “self-insure.” The money saved on premiums for all ships might be more than enough to cover the likely losses from occasional accidents.

However, most cases of people not insuring their houses or ships are not based on careful calculation. It’s usually due to simple carelessness, recklessness, and an overconfident dismissal of the risks involved.

Youthful Optimism and Career Choices

This tendency to ignore risks and overestimate the chance of success is strongest when young people are choosing their careers.

The willingness of common people to enlist as soldiers or sailors shows how little the fear of danger balances the hope of good fortune at that age. This tendency is even clearer than the eagerness of wealthier young people to enter professions like law or medicine.

Case Study: Soldiers

It’s obvious what a common soldier risks losing. Yet, young men volunteer most eagerly at the beginning of a new war, ignoring the danger. They have almost no chance of promotion, but they imagine countless opportunities for honor and glory that almost never happen. These unrealistic dreams are their main compensation. Their actual pay is lower than a common laborer’s, and their work during wartime is much harder.

Case Study: Sailors

The “lottery” of going to sea is slightly less unfavorable than joining the army. A respectable working-class family might allow their son to become a sailor, seeing some chance of advancement. They would almost never approve of him becoming a soldier, seeing no chance of success there.

While great admirals are less admired by the public than great generals, and top success at sea brings less fame and fortune than top success in the army, the chances for lower-level advancement are better for sailors than for soldiers. More common sailors manage to get some promotion or save some money compared to common soldiers. This hope is the main attraction of the job.

Despite needing much more skill and dexterity than most craftspeople, and living a life of constant hardship and danger, common sailors receive little extra reward for these factors while they remain common sailors. Their wages are typically no higher than those of common laborers in the port city that sets sailors’ pay rates (like London).

Because sailors constantly move between ports, their monthly pay is more uniform across Great Britain than the pay of other workers. London wages for most workers are about double those in Edinburgh, but London sailors earn only slightly more per month than sailors from Leith (Edinburgh’s port). In peacetime, a London sailor might earn 21 to 27 shillings per month, plus food (provisions). A London laborer earning 9-10 shillings a week could make 40-45 shillings per month. The value of the sailor’s food might not make up the difference, and even if it does, the sailor can’t share the food with their family back home, who must be supported out of the sailor’s cash wages.

The Attraction of Danger

Strangely, the dangers and adventures of certain jobs often attract young people instead of scaring them away. Poor mothers sometimes worry about sending sons to school in seaport towns, fearing the excitement of ships and sailors’ stories will lure them to sea.

The prospect of facing distant dangers that one hopes to overcome with skill and courage is not unpleasant. This type of risk generally doesn’t raise wages. However, risks where courage and skill cannot help (like working in unhealthy conditions) do significantly raise wages, because unhealthiness is a major form of disagreeableness.

Risk and Business Profit

For business investments, profits also vary with risk, meaning the certainty or uncertainty of getting the investment back with a return.

• Risk Levels: Inland trade is generally less risky than foreign trade. Some foreign trade routes (like to North America) are less risky than others (like to Jamaica).
• Profit Rises with Risk: The average rate of profit increases as the risk increases.
• But Not Enough: However, profit doesn’t seem to rise in proportion to the risk, meaning it doesn’t fully compensate for it. Bankruptcies are most frequent in the riskiest trades. Smuggling, the riskiest trade of all (though very profitable if successful), almost inevitably leads to bankruptcy.
• Overconfidence Reduces Profits: The same overconfident hope of success that affects career choices seems to operate here. So many people are drawn to hazardous trades that their competition drives the profit below the level needed to truly make up for the risk. To fully compensate, profits would need to cover all losses plus an extra amount, like an insurer’s profit margin. If profits were high enough to do this, bankruptcies wouldn’t be more common in these trades than in safer ones.

Summary: Factors Affecting Wages vs. Profits

Let’s review the five factors causing pay inequalities:

1. Pleasantness/Unpleasantness: Affects both wages and profits (though most businesses are similar in pleasantness).
2. Cost/Ease of Training: Affects wages mainly.
3. Constancy of Employment: Affects wages mainly.
4. Level of Trust: Affects wages mainly.
5. Probability of Success: Affects wages mainly.

Only two factors significantly affect profits: the pleasantness of the business and the risk involved. Since most businesses are similarly agreeable, and profit doesn’t fully compensate for risk, profit rates should be more similar across different businesses than wage rates are across different jobs.

Profits Are More Level Than Wages

And indeed, they are. The difference in earnings between a common laborer and a successful lawyer or doctor is obviously much greater than the difference in average profits between any two common types of business.

Apparent Profit vs. Real Wages

Furthermore, apparent differences in profits between trades are often misleading because we fail to distinguish between what should truly be considered profit (return on capital investment) and what should be considered wages (payment for the owner’s labor and skill).

• Example: The Apothecary (Pharmacist): People joke about the “apothecary’s profit” being extremely high. However, this large apparent profit is often just reasonable wages for their work. An apothecary’s skill requires more delicate judgment than any craftsman’s, and they are trusted with people’s health (acting as doctors for the poor or in less serious cases). Their reward comes from the price of the drugs they sell. But even a busy apothecary might only sell drugs costing £30-£40 per year. Selling them for £300-£400 (a 1000% markup) might simply be the only way to charge fair wages for their skilled labor and trustworthiness. Most of the apparent profit is really wages in disguise.

• Example: The Small-Town Grocer: A grocer in a small town might make a 40-50% profit rate on an investment of only £100. A large wholesaler in the same town might only make 8-10% profit on £10,000. The small market might not support a larger grocery business. But the grocer needs skills: reading, writing, accounting, judging perhaps 50-60 types of goods, knowing prices and markets. They need much of the knowledge of a large merchant, lacking only the capital. If we deduct a reasonable “wage” for this skilled work (say, £30-£40 per year) from the grocer’s total earnings, the remaining profit on their small capital might be quite normal. Again, much of the apparent profit is actually wages.

Retail vs. Wholesale Profits (City vs. Country)

The difference in apparent profit rates between retail and wholesale is much smaller in big cities than in small towns.

• In a city grocery using £10,000 capital, the owner’s “wage” for their labor is a tiny fraction of the total return on that large investment. So, the wealthy city retailer’s apparent profit rate is much closer to the wholesaler’s rate.
• This helps explain why retail goods are often as cheap, or even cheaper, in big cities compared to small towns. Groceries, for example, are usually cheaper in the city. Bread and meat are often about the same price.
• Transporting groceries costs about the same to the city or village. Since the retail profit margin is lower in the city, groceries are cheaper there.
• Transporting grain and cattle to the city costs more because they come from further away. So, even though the city retailer’s profit margin on bread and meat is lower, the higher initial cost means the final price isn’t always cheaper, just often similar to village prices. For these items, the large city market lowers the profit margin but increases the initial cost, and these effects tend to cancel each other out.

Making Fortunes: Volume Matters More Than Rate

Although profit rates are generally lower in big cities than in small towns, large fortunes are often made from small beginnings in cities, but rarely in villages.

• Village Limits: In small towns, the market is limited. A business owner can’t easily expand their trade even if their capital grows. So, while their profit rate might be high, the total amount of profit they earn each year remains small, limiting how much they can save and reinvest.
• City Opportunities: In big cities, trade can expand as capital increases. Furthermore, a successful and frugal business owner’s credit often grows even faster than their capital, allowing them to expand their trade based on both. Their total profit amount grows with the size of their trade, leading to larger savings and faster accumulation of wealth.
• Time and Effort: However, even in big cities, making a large fortune in a regular, established business usually requires a long life of hard work, careful saving, and attention to detail.
• Speculation: Sudden fortunes are sometimes made through speculation. A speculator doesn’t stick to one regular business but jumps between trades (like corn, wine, sugar, tea) based on predictions of unusually high profits, getting out when profits return to normal. Their profits and losses are unpredictable. A few lucky deals can make a fortune, but a few unlucky ones can lose it just as easily. This type of trading requires extensive information and can only happen in major commercial centers.

Overall Balance

These five circumstances (pleasantness, training cost, constancy, trust, success probability) cause wages and profits to vary significantly between jobs. However, they also tend to balance out the total advantages and disadvantages, real or imagined, of different employments. They naturally make up for low pay in some jobs and counteract high pay in others.

Conditions Needed for Perfect Balance

For this balancing effect to work perfectly, three conditions must be met, even when there is complete freedom for people to choose their work:

1. The jobs must be well known and long established in the local area.
2. The jobs must be in their ordinary or “natural” state (not affected by temporary booms or busts).
3. The jobs must be the main or only source of income for the people doing them.

(The text continues by explaining the first condition in the next part of the chapter.)

(Continuing the Conditions for Balance)

Here are the three conditions needed for the total advantages and disadvantages of different jobs to balance out naturally:

(Condition 1: Job Must Be Well-Known and Established)

The natural balancing of job pros and cons only happens in jobs that people in the area are familiar with and that have existed for a long time.

• New vs. Old Trades: Wages are usually higher in new types of jobs compared to older, established ones. When someone starts a new kind of factory or business, they initially have to attract workers away from other jobs by offering higher pay than usual. It takes a while before the business is stable enough for the owner to lower wages to the standard level.
• Fashion vs. Necessity: Industries that make products based on changing fashions and trends (like some businesses in Birmingham) are constantly changing. They rarely last long enough to become “old established” industries. Wages in these tend to be higher. In contrast, industries making essential goods (like some businesses in Sheffield) change less often. The same products might be in demand for centuries. Wages in these steadier industries are likely to be lower.
• New Business Profits: Starting any new business – whether in manufacturing, trade, or farming – is always a risk (speculation). The founder hopes for unusually high profits. Sometimes they get them; more often, they don’t. Initially, the profits from a new venture don’t follow the pattern of older local businesses. If the project succeeds, profits are usually very high at first. But once the business becomes well-known and established, competition brings profits down to the same level as other trades.

(Condition 2: Job Must Be in its Natural State)

The balancing of pros and cons only works when jobs are in their normal, average condition – not during unusual highs or lows.

• Fluctuating Demand for Labor: The demand for almost every type of work changes over time.
  • When demand is higher than usual, the job’s advantages (like pay) rise above the normal level. For example, demand for farm labor increases greatly during hay-making and harvest time, and wages rise then. During wartime, when thousands of sailors are forced into the navy, demand for merchant sailors increases sharply, causing their wages to jump significantly.
  • When demand is lower than usual, the job’s advantages fall below normal. For example, in a failing industry, many workers will accept lower wages than the job would normally pay, just to avoid leaving their familiar trade.
• Fluctuating Commodity Prices and Profit: Business profits change along with the prices of the goods being produced or sold.
  • When the price of a product rises above average, the profits of the businesses supplying it also tend to rise above normal. When the price falls, profits fall below normal.
  • All product prices fluctuate, but some fluctuate much more than others.
  • Manufacturing: For products like linen or wool cloth, the same amount of labor produces roughly the same amount of goods each year. Prices change mainly due to shifts in demand (like higher demand for black cloth during public mourning). Since demand for basic cloth is fairly steady, prices are relatively stable.
  • Agriculture: For products like grain, wine, hops, sugar, or tobacco, the same amount of labor can produce very different quantities from year to year (due to weather, pests, etc.). Prices for these goods fluctuate wildly because both demand and supply change significantly and frequently. Profits for farmers and dealers in these goods also fluctuate greatly. Speculators often focus on these volatile agricultural commodities, trying to buy when prices are low and sell when they rise.

(Condition 3: Job Must Be the Main Source of Income)

The balancing of pros and cons only applies properly to jobs that are a person’s main or only way of earning a living.

• Part-Time Work: If someone makes most of their living from one job that doesn’t require all their time, they might be willing to do a second job in their spare time for lower wages than that second job would normally pay.
• Example: Scottish Cottagers: In Scotland, there used to be many part-time farm workers called “Cottagers.” They received housing, a garden, grazing for a cow, and maybe a little poor land from their landlord or farmer employer. They also got some oatmeal when working for the master. For much of the year, the master didn’t need their labor, and farming their own small plot didn’t fill their spare time. These Cottagers were often willing to work for anyone else during their free time for very low pay – less than regular laborers earned. This system was once common across Europe, helping farmers get extra help during busy seasons. The low daily or weekly cash wage these workers received wasn’t their full compensation; their housing and land were a major part of it. However, some historical writers only recorded the low cash wage, making past labor costs seem incredibly low.
• Cheap Goods from Part-Time Labor: Products made by such part-time workers can often be sold very cheaply. For example, knitted stockings from the Shetland Islands in Scotland were very inexpensive because they were made by people who earned most of their living doing other things (like farming or fishing). Even high-quality stockings were produced this way.
• Spinning Example: Similarly, linen yarn was often spun in Scotland by servants hired mainly for other household tasks. Anyone trying to make their entire living just by knitting stockings or spinning yarn earned very little.
• Less Common in Rich Countries: In wealthy countries with large markets, people usually specialize in one trade that fully occupies their time and capital. Having multiple jobs is more common in poorer countries.
• Exception: London Lodgings: However, an interesting example occurs even in London, a very rich city. House rents in London are extremely expensive, probably more so than in any other major European city. Yet, renting a furnished room (a lodging) is surprisingly cheap – cheaper than in Paris or Edinburgh for similar quality.
• Why London Lodging is Cheap: The high cost of renting a whole house is the cause of the cheap lodging. London rents are high due to factors common to big cities (high labor costs, material costs, land costs) plus the local custom that requires families to rent an entire house, from top to bottom. (In places like France or Scotland, renting just one floor is common). A London shopkeeper has to rent a whole house in a desirable area. They use the ground floor for the shop, live in the attic, and try to cover part of the high rent by letting out the middle floors to lodgers. The shopkeeper expects to make a living from their main business, not primarily from renting rooms. In contrast, people who rent out rooms in Paris or Edinburgh often do it as their main source of income. Their lodging prices must cover the house rent plus their family’s living expenses. Because Londoners renting rooms often see it as secondary income, they can charge less.

PART I: Land Products That Always Provide Rent: Food

Food: The Essential Product

Humans, like all animals, tend to multiply based on the amount of food available to them. Because of this, there is always a demand for food.

Food can always be exchanged for labor; someone is always willing to work to get food. The amount of work someone will do for food varies (sometimes wages are high, so food buys less labor), but food can always command enough labor to keep those workers alive according to the local standard.

Why Land Nearly Always Yields Rent

Almost any piece of land can produce more food than is needed to feed all the workers required to grow that food and bring it to market, even if those workers are paid well.

This extra food (surplus) is also more than enough to replace the farmer’s investment (stock or capital) plus a normal profit on that investment.

Because there is always this leftover surplus, there is always something remaining to be paid to the owner of the land as rent.

Even the poorest grazing lands in Norway or Scotland can feed some animals. The milk and new offspring from these animals are always valuable enough to:

• Pay for the labor needed to care for them.
• Provide a standard profit to the farmer or owner.
• AND leave a small amount of rent for the landowner.

The better the pasture, the higher the rent. Good pasture supports more animals on the same amount of land. It also requires less labor to manage them, because they are closer together. The landlord benefits both from more produce and lower labor costs.

What Determines Rent Levels?

Rent depends on two main things:

1. Fertility: How productive the land is. More fertile land produces a larger surplus after costs, allowing for higher rent.
2. Location: How close the land is to the market (usually a town). Land near a town rents for more than equally fertile land far away. This is because it costs more to transport produce from distant land to the market. Higher transport costs mean more labor must be paid out of the produce, shrinking the surplus available for the farmer’s profit and the landlord’s rent. Also, profit rates tend to be higher in remote areas, meaning the farmer keeps a larger share of the smaller surplus, leaving even less for the landlord.

Transport Improvements Reduce Location Disadvantage

Good roads, canals, and navigable rivers lower the cost of transportation. This makes remote farmland more competitive with farmland near towns.

These transportation improvements are hugely beneficial:

• They encourage farming in remote areas (which make up the largest part of any country).
• They benefit towns by increasing the supply of goods from further away, reducing the monopoly power of nearby farms.
• They even help the areas near towns by opening up new, distant markets for their own products.
• Competition also encourages better farming methods, as monopolies often lead to inefficiency.

Interestingly, about fifty years ago, some counties near London asked Parliament not to extend better roads into more distant counties. They worried that cheaper labor in remote areas would allow farmers there to sell grain and hay more cheaply in London, lowering local rents and ruining local farming. However, since the roads were improved, rents near London have actually risen, and farming there has improved.

The Changing Value of Meat vs. Bread

A field growing grain (like wheat for bread) usually produces much more human food than an equally sized field used as pasture for animals (producing meat). Although growing grain requires more labor, the surplus left after paying all costs is also much greater than the surplus from pasture.

If a pound of meat and a pound of bread were always considered equally valuable, the larger surplus from grain would always be worth more, providing higher profits for farmers and higher rents for landlords. This seems to have been true in the earliest stages of farming.

However, the relative value of bread and meat changes significantly as farming develops:

• Early Agriculture: When most land is wilderness used for grazing animals, meat is plentiful and cheap. Grain is scarce and requires significant labor, making bread relatively expensive. An explorer named Ulloa reported that in Buenos Aires around the mid-1700s, a whole ox cost very little – about the price of the labor needed to catch it. Grain, however, was likely much more expensive due to the labor needed to grow it, especially near the silver mines where labor costs were high.
• Later Agriculture: As more land is cultivated for crops, less wilderness is available for grazing. Meat becomes scarcer relative to bread. Now, land must be specifically used for raising cattle, competing with land that could be used for crops. The price of meat must rise high enough to cover not only the labor of raising cattle but also the potential rent and profit the farmer could have earned by growing crops on that land instead. Even cattle raised on poor, distant lands sell for the same high price (based on weight and quality) as cattle from the best farmland. Owners of poor lands benefit, raising their rents accordingly. For example, about a century ago in the Scottish Highlands, meat was often as cheap as oatmeal bread. After Scotland’s union with England opened up English markets for Highland cattle, cattle prices soared (tripling or quadrupling), and Highland rents rose just as much. Today (late 18th century Britain), a pound of good meat is generally worth two to four pounds of good bread.

How Crop Prices Regulate Pasture Rent

So, as farming improves, the rent and profit from pastureland become linked to the rent and profit from land used for growing corn (meaning the main grain crop used for food, like wheat).

• Corn is harvested annually. Meat takes several years to “grow” (raise the animal).
• An acre of land produces much less food as meat than as corn.
• To make using land for pasture worthwhile, the lower quantity of meat must be compensated by a higher price per pound compared to corn/bread.
• If the meat price becomes too high (more than compensating), farmers will convert cropland to pasture.
• If the meat price is not high enough to compensate, farmers will convert pastureland back to growing crops.
• This market pressure tends to keep the overall profitability (rent plus profit) of land used for pasture roughly equal to that of land used for the main food crop.

Exceptions to the General Rule (Local Factors)

This balance between pasture and cropland profitability applies generally across large areas, but there are exceptions due to specific local conditions:

• Near Large Towns: High demand for milk, feed for horses (forage), and meat often makes grassland near cities much more valuable than land used for growing grain. This advantage doesn’t affect distant lands.
• Very Populous Countries: Some areas become so crowded that all their land isn’t enough to produce both the animal feed (grass) and the grain needed. They often use their land mainly for grass (which is bulky and hard to import) and import large amounts of grain. Holland is like this now, and parts of ancient Italy near Rome seem to have been similar. The Roman writer Cato reportedly said that raising livestock well was the most profitable use of land, while ploughing for crops ranked only fourth. This was likely influenced by Roman policies of distributing cheap imported grain, which discouraged local grain farming near Rome.
• Convenient Enclosures: In farming areas focused on grain, a well-fenced pasture field might rent for more than nearby grain fields. It’s useful for keeping the animals needed to work the farm. Its high rent reflects its value to the surrounding grain production. (The high rent for enclosed land in Scotland might be temporary, due to enclosures still being relatively scarce there).
• Enclosure Benefits: Fencing benefits pasture more than crops because it saves the cost of shepherds and allows animals to graze undisturbed.

However, apart from such local advantages, the rent and profit obtainable from the main food crop generally set the standard for pasture land that could potentially grow that crop.

Impact of Farming Improvements

New farming techniques – like growing specific grasses, turnips, carrots, and cabbages for animal feed – allow farmers to raise more animals per acre than natural pasture allows.

One might expect these improvements to reduce the price gap between meat and bread in developed countries. Evidence suggests this has happened. Meat prices relative to bread prices seem considerably lower in the London market now (late 18th century) compared to the early 17th century.

(The author then presents detailed historical price comparisons for meat and wheat between the early 1600s (Prince Henry’s time) and the mid-1760s, concluding that meat was relatively much more expensive back then, while wheat was relatively cheaper. These specific figures are complex using old units, but the key finding is that the relative price of meat seems to have fallen over time due to agricultural improvements).

Food Production Sets the Standard for Land Use

In large countries, most farmed land is used either to grow food for people or food for animals (which become food for people). The rent and profit generated by these lands set the benchmark for almost all other uses of cultivated land.

• If growing a different crop earned less rent and profit, farmers would switch that land back to growing grain or pasture.
• If growing a different crop earned more, farmers would convert some grain or pasture land to that new crop.

High-Value Crops (Gardens, Vineyards)

Some crops require much larger initial investments to prepare the land (like establishing a vineyard) or higher ongoing costs for cultivation (like managing a market garden). These generally produce higher rent for the landlord and higher profit for the farmer compared to grain or pasture.

However, this higher rent and profit are usually just enough to provide a reasonable return on the extra investment and effort involved.

• Example: Gardens: Hop gardens, fruit orchards, and market gardens usually generate more rent and profit per acre than grain fields or pastures. But:
  • Establishing them costs more, justifying higher rent.
  • Managing them requires more skill and attention, justifying higher farmer profit.
  • The crops (especially hops and fruit) are often riskier, so the price must cover potential losses, like an insurance premium.
• Gardeners Aren’t Rich: The fact that professional gardeners are usually not wealthy suggests they aren’t being overpaid for their skill and effort. Gardening is also a popular hobby for wealthy people, who often grow their own produce. This competition from amateurs reduces the potential profit for professional gardeners.
• Historical View: Ancient writers like Democritus seemed to believe that the high cost of things like building walls around kitchen gardens might not be worth the extra profit, suggesting that even historically, the gains from these high-value crops mainly compensated for the extra costs.

(Continuing High-Value Crops)

Even ancient farming experts seemed to think that the produce from a kitchen garden barely covered the extra costs of careful cultivation and watering. In northern Europe today, kitchen gardens often don’t justify expensive walls; hedges are usually enough. However, in places like Great Britain, fine fruits need the protection of a wall to grow properly. The price of these fruits must therefore be high enough to cover the cost of building and maintaining these walls. Often, the fruit wall also encloses the kitchen garden, giving the garden an expensive enclosure its own produce couldn’t pay for.

Vineyards have long been considered the most valuable part of a farm, both in ancient times and today in wine-producing countries. However, whether it was profitable to plant a new vineyard was debated even by ancient Roman farmers. Modern agricultural writers often promote vineyards, but the profitability of new plantings is still debated today.

In France, existing vineyard owners have actively tried to prevent new vineyards from being planted. This suggests they believe vineyards are currently very profitable but fear that more competition would lower those profits. It also implies that the high profits depend on existing laws that restrict planting new vines. A 1731 French law, for example, prohibited new vineyards without special permission, claiming shortages of grain and pasture and a surplus of wine. However, if there truly were a wine surplus, low prices would naturally discourage new plantings without any need for a law. Furthermore, grain is often carefully cultivated in the wine regions, as the many workers in vineyards create a strong local market for grain. Restricting vineyards seems an unlikely way to encourage grain production.

So, while crops that require large initial investments or high yearly costs often bring in more rent and profit than basic crops like corn or pasture, this higher return usually just compensates for the extra expense. The rent and profit of these special crops are still ultimately influenced by the baseline profitability of common crops.

The Big Exception: When Demand Exceeds Supply for Unique Products

There is an important exception to this rule. Sometimes, the amount of land suitable for growing a very specific, desirable product is too small to meet the effectual demand. “Effectual demand” means the demand from all the people who are willing and able to pay the entire cost of producing the item, including the land rent, worker wages, and farmer’s profit at their normal rates.

When the supply of such a unique product is limited:

1. The entire supply can be sold to buyers willing to pay more than the normal full cost of production.
2. The price rises above the level that would cover typical costs and provide standard rent/profit.
3. The extra amount earned above the normal costs and profit usually goes to the landlord as exceptionally high rent. This high rent reflects the unique value and scarcity of what the land can produce.

Examples of Scarcity-Driven Rent

• Fine Wines: Grapes are very sensitive to soil conditions. Some locations produce wines with unique flavors that can’t be replicated elsewhere. This might be just a few vineyards or a whole region. The total amount of these special wines produced is less than the effectual demand. Therefore, they sell at a premium price compared to ordinary wine. The size of the premium depends on how fashionable and scarce the wine is, driving buyer competition. Most of this extra price goes directly to the landowner as rent. While these vineyards are carefully cultivated, the carefulness is likely an effect of the wine’s high value (owners protect valuable crops) rather than the cause of the high price. The high price easily covers the extra costs of careful cultivation.

• Sugar Colonies: The European colonies producing sugar in the West Indies are similar to these “precious vineyards.” The total amount of sugar they produce is less than Europe’s effectual demand. Therefore, sugar sells in Europe for a price higher than its basic production cost (including normal rent/wages/profit). Evidence comes from comparing colonial sugar prices to those in places like Cochin-china (part of modern Vietnam), where sugar was grown abundantly alongside rice and corn. Sugar was vastly cheaper there, suggesting its price was in normal proportion to other crops. In the colonies, however, the price was much higher. There were even reports that sugar planters expected income from by-products (rum and molasses) to cover all their costs, making the sugar itself pure profit – though this might be an exaggeration. The fact that London merchants invested large sums in distant, risky sugar plantations (but not in safer, closer farmland in Britain or North America) further suggests they expected unusually high profits due to sugar’s scarcity relative to European demand.

• Tobacco Colonies: Tobacco cultivation in Virginia and Maryland was preferred over growing corn because it was more profitable. Tobacco could be grown in Europe, but governments prohibited it to make it easier to collect taxes on imports. This ban gave a sort of monopoly to the places allowed to grow it, like the American colonies. However, tobacco seemed less profitable than sugar; fewer merchants invested heavily, and fewer hugely wealthy planters came from tobacco colonies compared to sugar islands. This suggests the supply of tobacco might have been closer to meeting European demand than the supply of sugar was. Tobacco prices were likely higher than the “natural” level set by corn, but not as high as sugar prices. Tobacco planters themselves feared oversupply and restricted cultivation by law to keep prices up, sometimes even reportedly destroying crops in plentiful years (similar to rumors about Dutch spice growers). If such drastic measures were needed, the profit advantage might not last.

Summary: Food Crops Regulate Most Rent

In general, the rent of land used to produce the main human food crops regulates the rent for most other uses of cultivated land.

• No other product can consistently offer less rent and profit, because farmers would simply switch the land to growing food.
• If another product consistently offers more rent and profit, it’s usually because the amount of land suitable for that specific product is too small to meet the effectual demand, leading to scarcity-driven high prices and rents.

In Europe, corn (grain) is the main food crop. Therefore, except for land with specific local advantages or unique production capabilities, the rent obtainable from growing corn sets the standard for most other cultivated land in Europe. Britain’s land, being well-suited for grain, has a value potential comparable to France’s vineyards or Italy’s olive groves, except for those specific, high-value locations.

What If a Higher-Yielding Staple Food Existed?

Imagine if a country’s main vegetable food came from a plant that produced much more food per acre than grain does, using similar land and effort.

• Larger Surplus: Such a plant would create a much larger food surplus after paying all labor and capital costs (including farmer’s profit).

• Higher Rents & Population: This larger surplus could support more people. Landlords would receive a larger share of this bigger surplus as rent. Their real income and purchasing power would be much greater. The population could increase significantly, and land rents would rise far beyond current levels.

• Rice Example: Rice fields produce much more food per acre than grain fields. In countries where rice is the staple food people eat, the surplus is larger, and landlords should receive a greater share as rent compared to landlords in grain-growing countries. (In Carolina, USA, rice farming was found very profitable, though rice wasn’t the preferred local food, complicating the comparison as planter-landlords combined rent and profit). However, rice requires specific boggy conditions. Land suitable for rice is generally unsuitable for other crops, and vice-versa. Therefore, the rent of rice land cannot set the standard for other types of farmland.

• Potato Potential: Potatoes also produce a huge amount of food per acre – potentially three times the solid nourishment of wheat, with lower cultivation costs. If potatoes ever became the primary staple food in Europe, replacing grain on a similar proportion of farmland:

  • The same amount of land could feed many more people.
  • Feeding workers potatoes would leave a much larger surplus after costs.
  • Landlords would likely get a larger share of this surplus.
  • Population would increase dramatically.
  • Rents would rise far higher than they are now.
  • Crucially, land suitable for potatoes is also suitable for most other crops. Therefore, if potatoes became the staple, their high potential rent would set the standard for most other farmland, unlike rice.

(The author concludes with a brief remark noting that in some parts of Britain, people claim oatmeal bread is more sustaining than wheat bread).

I have some doubts about that claim, however. In my observation, the common people in Scotland who eat oatmeal are generally not as strong or as healthy-looking as people of the same rank in England who eat wheat bread. The Scots neither work as well nor look as well. Since there isn’t the same physical difference between the upper classes in the two countries, experience seems to show that the oatmeal diet of the Scottish commoners is not as suitable for human health as the wheat bread diet of their English neighbors.

But potatoes seem to be different. It’s often said that the strongest workers in London – like chairmen (carrying sedan chairs), porters, and coal-heavers (dockworkers unloading coal) – and the most beautiful women (like those working as prostitutes) are largely from the poorest backgrounds in Ireland, where potatoes are the main food. No food could offer stronger proof of its nutritional quality or its particular suitability for human health.

However, potatoes have a practical disadvantage. It is difficult to keep them fresh throughout the year, and impossible to store them for several years like grain can be stored. The fear that potatoes might rot before they can be sold discourages farmers from growing them on a very large scale. This storage problem is perhaps the main reason why potatoes haven’t become the primary vegetable food for all classes of people in any large country, replacing bread.

PART II: Land Products That Sometimes Yield Rent

Introduction: Food vs. Other Products

As we saw in Part I, human food seems to be the only product from land that always provides some rent payment to the landowner.

Other types of land produce – materials for clothing, lodging, minerals, etc. – sometimes provide rent, and sometimes do not, depending on the circumstances.

Materials for Clothing and Lodging

After food, the two main needs of people are clothing and shelter (lodging). How land provides the raw materials for these needs changes as society develops:

• In Undeveloped Lands: Wild land provides materials like animal skins and timber for many more people than it can actually feed. These materials are overly abundant, often have little value, and much may be thrown away. Their price typically only covers the labor needed to prepare them for use, leaving no surplus for the landowner as rent.
• In Developed Lands: Cultivated land can sometimes feed more people than it can supply with clothing and lodging materials (at least, in the way people want them and are willing to pay). These materials often become scarce, which increases their value. All available materials are used, and people often want more than they can get. Buyers are willing to pay a price that is more than enough to cover the costs of production and transport. This extra amount allows the landowner to receive some rent.

Clothing Materials (Skins, Wool):

The first clothing came from animal skins. In societies of hunters or shepherds, getting food (meat) automatically provided an excess of skins – more than needed for personal use. Without trade, these extra skins would be worthless. This was likely true for North American hunting tribes before Europeans arrived; now, they trade surplus furs for blankets, guns, and alcohol, which gives the furs value.

Today, even less developed nations with established land ownership usually have some foreign trade. They sell surplus clothing materials (like hides or wool that they can’t use or process domestically) to wealthier neighboring countries. This demand raises the price above the cost of production and transport, providing some rent for the landowner. For example, when Highland cattle in Scotland were mostly eaten locally, exporting their hides was a major trade, providing extra rent for Highland estates. Similarly, long ago, English wool, which couldn’t all be used at home, found a market in the more developed region of Flanders, providing rent for the land that produced it. In countries without such trade, these materials would be so abundant that much would be wasted, yielding no rent.

Lodging Materials (Stone, Timber):

Materials for building shelter, like stone and timber, are usually harder to transport over long distances than materials for clothing. Therefore, even today, if these materials are very abundant locally, they might have no value to the landowner and provide no rent.

• A good stone quarry near London would be valuable and yield rent. In remote parts of Scotland or Wales, a similar quarry might yield no rent at all.
• Timber for building is valuable in well-populated, developed countries, and the land growing it provides rent. But in many parts of North America, landowners might be happy if someone just took their trees away for free.
• In parts of the Scottish Highlands with poor transport, only tree bark might be sellable; the valuable timber is left to rot.

When building materials are so plentiful, the price only covers the labor needed to cut and prepare them. They provide no rent, and landowners often let people take them freely. However, demand from richer countries can sometimes create value and rent. London’s need for paving stones created a market (and rent) for previously worthless rocks on the Scottish coast. Timber from Norway and the Baltic finds markets in Great Britain, providing rent for landowners there.

How Surplus Food Drives Demand for Other Materials

Population is Limited by Food:

The number of people a country can support depends primarily on how much food its land can produce, not how much clothing or shelter. If people have enough food, finding basic clothing and shelter is relatively easy. But even if clothing and shelter materials are available, finding enough food can be difficult. In some places, a basic house can be built in a day. Preparing animal skins takes a bit more work, but not a huge amount. In simple societies, providing basic clothing and shelter might only require about 1% of the society’s total yearly labor; the other 99% might be needed just to get enough food.

Surplus Food Frees Labor:

When improvements in farming allow one family to produce enough food for two families, half the society’s labor is freed from food production. This surplus labor can then be used to produce other things that satisfy human wants and desires.

Limitless Desire for Non-Food Goods:

Beyond basic needs, people desire many other things: better clothing, larger houses, furniture, transportation (like carriages), and other luxuries. While a rich person eats about the same quantity of food as a poor person (though the quality might differ), the difference in their housing, clothing, and furnishings is enormous in both quantity and quality. The desire for food is limited by the size of our stomachs, but the desire for comfortable and beautiful buildings, clothes, and possessions seems endless.

Exchanging Food for Goods Creates Demand for Materials:

People with more food than they can eat are willing to trade the surplus (or the money it sells for) to satisfy these other, seemingly limitless desires. The poor, needing food, work to create the goods and services the rich desire. Competition pushes them to make these goods better and cheaper.

As food production increases (due to better farming), the number of workers available for non-food production grows. Because these non-food industries often allow for great specialization (division of labor), their ability to produce goods increases even faster than the number of workers. This creates a huge demand for all sorts of raw materials that can be used to make useful or decorative items for building, clothing, or furnishing – including minerals, metals, and precious stones found underground.

Food Enables Rent from Other Products:

In this way, food is the original source of rent. All other land products that eventually provide rent gain their value because improvements in food production free up labor and create widespread demand for non-food items.

However, these other land products (non-food materials) do not always provide rent, even in developed countries. The demand for them isn’t always strong enough for their price to rise above the basic cost of bringing them to market (labor cost + capital cost + normal profit). Whether they yield rent depends on various factors.

Case Study: Mines (Coal)

Whether a coal mine, for example, can provide any rent depends mainly on two things: its fertility and its location.

• Fertility: A mine’s fertility refers to how much coal can be extracted with a certain amount of labor, compared to other coal mines.
  • Some mines are too barren (poor quality). Even if well-located, the coal extracted doesn’t sell for enough to cover the mining costs. These mines provide neither profit nor rent.
  • Some mines are marginal. They produce just enough coal to pay the workers and replace the owner’s investment plus a standard profit. They provide profit to the operator but no rent to the landowner. These can often only be operated profitably by the landowner themselves (who then gets the profit instead of rent). Many Scottish coal mines operate this way.
• Location: Some mines are fertile enough, but their poor location makes them unworkable. If a mine is inland, in a sparsely populated area without good roads or water transport, the coal cannot be sold even if it’s cheap to mine.

Factors Affecting Coal Price and Rent

• Coal vs. Wood Fuel: Coal is generally considered less pleasant and less healthy than wood as fuel. Therefore, where both are available, coal usually needs to be cheaper than wood.
• Wood Prices: The price of wood changes as agriculture develops, much like the price of cattle. In early stages, forests are abundant, and wood has little value. As land is cleared for farming and grazing animals prevent young trees from growing, wood becomes scarce and expensive. Land used for growing timber can then provide good rent, sometimes becoming a very profitable land use despite the long time it takes for trees to grow. This seems to be happening in parts of Great Britain now. (However, near coasts where cheap coal is available, it might be cheaper to import timber than grow it locally – for example, Edinburgh’s New Town was built mostly with imported timber).
• Coal Price Limits: The highest possible price for coal is reached when a coal fire costs about the same as a wood fire (as seen in some inland parts of England). However, in areas where coal is mined (“coal countries”), the price is always much lower than this maximum. If it weren’t, the coal couldn’t be transported very far. Mine owners make more total profit by selling large quantities at a lower price than small quantities at the highest possible price.
• Price Set by Best Local Mine: The most fertile coal mine in a region usually sets the price for all nearby mines. By selling slightly cheaper than competitors, the owner/operator of the best mine can capture a larger market share and earn more total rent and profit. Other nearby mines are forced to match this lower price, which reduces or even eliminates their own rent and profit. Some mines may be abandoned, while others yield no rent and can only be operated by the landowner.
• Lowest Coal Price: The lowest price coal can be sold for over the long term is the price that just covers the costs of production: replacing the capital invested plus providing an ordinary profit. Coal from mines that yield no rent (often operated by the landowner) sells at roughly this lowest price.
• Rent’s Share in Coal Price: Rent typically makes up a smaller portion of the price of coal than it does for crops grown on the surface. Land rent might be around one-third of the gross produce and is often a fixed amount. Coal mine rent is often only one-tenth (common) or one-fifth (high) of the gross produce, and it usually varies with the mine’s output. Coal mines are also considered riskier investments than land (valued at maybe 10 years’ worth of income, compared to 30 years’ for land).

Metals vs. Coal: Global vs. Local Markets

• Mine Value Factors: A coal mine’s value depends heavily on its location (transport costs). A metal mine’s value depends more on its fertility (richness of the ore) and less on location.
• Transport and Market Scope: Metals, once processed, are very valuable for their weight and can be shipped affordably all over the world. The market for metals is global (e.g., Japanese copper sold in Europe, Peruvian silver sold in China). The market for coal is mostly local or regional; coal from distant mines rarely competes directly.
• Global Price Regulation for Metals: Because metals trade globally, the price set by the most fertile mines in the world influences the price of that metal at every other mine. The price of copper in Japan affects copper prices in Europe. The price of silver in Peru affects silver prices in Europe and China. After the rich silver mines of Potosi (in modern Bolivia) were discovered, the value of silver fell so much that most silver mines in Europe, and even older mines in the Americas, could no longer operate profitably and were abandoned.

(Continuing Metals vs. Coal)

Because the price of any metal is influenced by the price at the most fertile mine operating anywhere in the world, most mines can only charge a price that barely covers their operating costs. They usually cannot provide a very high rent payment to the landowner.

Rent generally seems to make up only a small part of the price of common metals, and an even smaller part of the price of precious metals (like gold and silver). Labor costs and business profit make up most of the price for both.

Examples of Mine Rents:

• Tin and Lead: The rent for the tin mines in Cornwall (England), known as the most fertile in the world, is typically about one-sixth of the value of the tin produced. Some very fertile lead mines in Scotland also pay about one-sixth as rent.
• Silver: In the rich silver mines of Peru, landowners historically often didn’t charge a direct rent. Instead, they required the mine operator to use the landowner’s mill to process the ore, paying the standard milling fee. Before 1736, the King of Spain also collected a tax equal to one-fifth of the silver produced, which acted as the effective rent for most mines. Many poorer mines couldn’t afford to pay this tax and remained unworked. (This tax was later reduced to one-tenth because the mines couldn’t sustain the higher rate).
• Tin vs. Silver Rent: Even after comparing the historical taxes and potential owner shares, it seems likely that rent makes up a larger part of the price of tin from Cornwall’s best mines than it does for silver from the world’s best silver mines. One reason is that bulky tin is harder to smuggle than precious silver, so the taxes (a form of rent) are better collected on tin. Overall, after covering costs and profits, the share remaining for the landowner seems greater for common metals like tin than for precious metals like silver.

Mining Profits and Risks

Profits for the operators of silver mines in Peru were also generally not very high. Starting a new mine was widely seen as a recipe for bankruptcy; potential miners were often avoided as doomed gamblers. Mining, like lotteries, attracts people with the hope of large prizes, but overall, the losses tend to outweigh the gains.

Despite the risks, governments often encourage mining because they get tax revenue from it. Laws in Peru gave significant advantages to anyone who discovered a new mine, granting them ownership of a section without paying the original landowner. Similar rules existed in Cornwall for tin mining, prioritizing potential government revenue over traditional private property rights.

Gold: Even Lower Rent, Easier Smuggling

Gold mining received similar encouragement in Peru, but the king’s tax (the effective rent) was even lower – only one-twentieth of the gold produced (it had been higher but was reduced because mines couldn’t afford it). Making a fortune from gold mining was considered even rarer than from silver mining.

Gold is also much easier to smuggle than silver:

• It’s more valuable for its size.
• It’s often found in pure form (“virgin” gold), sometimes in nuggets or easily separated from sand and earth using simple methods with mercury. This can be done privately, avoiding inspectors.
• Silver, however, is usually found combined with other minerals in ore, requiring complex processing in large, easily inspected facilities.

If the silver tax was poorly collected due to smuggling, the gold tax was likely collected even worse. Rent must make up an extremely small part of the price of gold.

What Determines Precious Metal Prices?

• Lowest Price: Like any product, the lowest price precious metals can sell for over time is set by their cost of production. This includes the cost of labor, equipment, and supplies needed to mine the metal and bring it to market, plus a normal profit for the capital invested.
• Highest Price: Unlike goods like coal (whose price is capped by the price of alternatives like wood), the highest price for precious metals seems limited only by their scarcity. If gold became extremely scarce, a tiny piece could become more valuable than a diamond.

Why Are Precious Metals Valuable?

Demand for gold and silver comes from two main sources:

1. Utility: They are useful metals (perhaps more so than any other except iron). They don’t rust easily and are easy to keep clean, making them desirable for kitchenware or tableware (a silver pot is cleaner than lead or copper; a gold one would be even better).
2. Beauty: Their main appeal comes from their beauty, making them ideal for ornaments, jewelry, and decoration (gilding provides a unique, splendid color).

Scarcity Enhances Value:

The value derived from utility and beauty is greatly increased by scarcity. For many wealthy people, a key enjoyment of wealth is displaying it. This display feels most complete when they possess items that are clear marks of opulence because they are so rare that only the rich can afford them. The value of any useful or beautiful object is magnified in their eyes if it is scarce, or if obtaining it requires immense labor that only they can afford to pay for. They willingly pay higher prices for such scarce items than for other things that might be more useful or beautiful but are more common.

These three factors – utility, beauty, and scarcity – are the original reasons for the high price of precious metals (the large amount of other goods they can be exchanged for). This value existed before gold and silver were used as coins; indeed, it was this pre-existing value that made them suitable for use as money. Using them as money then created additional demand, further supporting or increasing their value.

Precious Stones: Beauty and Scarcity Only

Demand for precious stones (like diamonds) comes almost entirely from their beauty, combined with their scarcity and the difficulty of mining them. They have little practical use beyond ornamentation.

Therefore, the high price of gemstones consists almost entirely of the wages for labor and the profit on capital involved in finding and preparing them. Rent for the mine owner is usually a very small share, often nothing at all. Only the very richest mines provide significant rent. (A 17th-century jewel merchant visiting Indian diamond mines reported that the local ruler had closed all mines except those producing the largest, finest stones, because the others weren’t even worth operating for the owner).

Mine Rent vs. Land Rent: Relative vs. Absolute Fertility

Because the world price of metals and gems is set by the most productive mine, the rent any other mine can provide depends not on its absolute productivity but on its relative fertility – how much better it is than other mines.

• If new mines were discovered that were as much better than the Potosi silver mines as Potosi was better than the old European mines, the value of silver could fall so low that even Potosi might become unprofitable.
• Before the Americas were discovered, the best European mines might have provided as much rent (in terms of purchasing power) as the richest Peruvian mines do now. Even though they produced less silver, that silver could buy more goods back then.

Abundance Reduces Value:

An abundance of precious metals or stones would add little to the real wealth of the world. Because their value comes mainly from scarcity, increased abundance automatically lowers their value. The only benefit would be that luxury items like silverware or jewelry could be bought with less labor or fewer goods.

Land is Different:

Land used for farming (“estates above ground”) is fundamentally different. Its value (in terms of produce and rent) depends on its absolute fertility, not its fertility relative to other land.

• Land that produces a certain amount of food, clothing materials, or timber can always support a certain number of people.
• The landlord’s rent gives them command over a proportional share of the labor of those people and the goods that labor produces.
• Fertile land generally increases the value of nearby less fertile land, because the large population supported by the fertile land creates a market for products from the barren land.

Conclusion: Food Surplus is the Key

Ultimately, increasing the fertility of land for producing food not only increases the value of that improved land but also increases the value of other lands by creating new demand for their products.

The abundance of food – the surplus that people have beyond their own needs thanks to agricultural improvements – is the great driving force behind the demand for precious metals, precious stones, and all other conveniences and ornaments like fine clothing, large houses, furniture, and transportation.

Food is not only the main component of the world’s wealth, but the abundance of food is what gives value to most other kinds of riches. When the Spanish first arrived in Cuba and Hispaniola, the native inhabitants wore small gold ornaments but valued them only as pretty pebbles, worth picking up but easily given away. They were astonished by the Spaniards’ intense desire for gold. They couldn’t imagine a place where people had so much extra food (which was always scarce for them) that they would eagerly trade enough food to feed a family for years just for a few “glittering baubles.” If they had understood the existence of such food surpluses elsewhere, the Spaniards’ actions would not have surprised them.

PART III: How the Value of Food vs. Other Land Products Changes Over Time

The General Expectation: Non-Food Items Become Relatively More Valuable

As farming improves and food becomes more plentiful, people have more resources available after meeting their basic food needs. This naturally increases the demand for all other types of products that come from the land – things used for practical purposes or for decoration.

Therefore, as society progresses, you might expect only one main change in the relative values of food versus other land products:

• The value of non-food items (like clothing materials, building materials, useful minerals, and precious metals or stones – things that only sometimes provide rent) should constantly rise compared to the value of food (which always provides rent).
• In other words, as societies become more advanced and productive, materials, minerals, and metals should become more and more desirable. They should gradually exchange for larger amounts of food, meaning they should get relatively more expensive over time.

The Big Exception: Supply Can Outgrow Demand

This expected trend has generally been true for most non-food items throughout history. However, there’s a major exception: sometimes, particular events cause the supply of certain non-food items to increase even faster than the demand for them grows. When this happens, their value relative to food can fall instead of rise.

Why? Local vs. Global Markets

Consider the difference between a stone quarry and a silver mine:

• Stone Quarry (Local Market): The value of a quarry producing building stone generally increases as the surrounding area becomes more populated and developed. Its market is usually limited to just a few miles around it. Demand grows with local progress.
• Silver Mine (Global Market): The value of a silver mine doesn’t necessarily increase just because the country around it improves. The market for silver is the entire known world. Demand depends on global progress and population growth. Even if the local area improves, global demand might not increase. Furthermore, even if global demand is increasing, the discovery of new, much richer silver mines elsewhere in the world could increase the global supply much faster than demand is growing. In this case, the real price, or purchasing power, of silver could gradually fall. A pound of silver might buy less labor or less grain over time.

Three Scenarios for Silver (Metals) vs. Corn (Food) Value

The main market for precious metals like silver is the developed, trading part of the world. As the world progresses, there are three possible scenarios for the value of silver relative to corn (representing basic food):

1. Demand Grows Faster Than Supply: If global development increases the demand for silver more quickly than new mines increase the supply, then the value of silver compared to corn will gradually rise. A given amount of silver will buy more and more corn. In other words, the average price of corn measured in silver (the money price) will gradually fall.
2. Supply Grows Faster Than Demand: If, perhaps due to major new mine discoveries, the supply of silver increases much faster than demand for many years, then the value of silver compared to corn will gradually fall. A given amount of silver will buy less and less corn. In other words, the average money price of corn will gradually rise, even if farming is becoming more efficient.
3. Supply and Demand Grow Proportionally: If the supply of silver increases at roughly the same rate as the demand for it, then its value compared to corn will remain stable. A given amount of silver will continue to buy about the same amount of corn, and the average money price of corn will stay roughly the same, regardless of farming improvements.

Historical Pattern in Europe

These three scenarios seem to cover all the possibilities that can happen as societies improve over long periods.

Looking back at the history of Europe over the four centuries before the present time (roughly 1300s to 1700s), evidence from France and Great Britain suggests that all three of these situations have actually occurred. Furthermore, they seem to have happened in the same order as listed above. (The detailed evidence for this historical pattern is discussed later in the book).

DIGRESSION: HOW SILVER’S VALUE CHANGED (Last 400 Years)

First Period: Roughly 1350 to 1570

Main Trend: Silver Became More Valuable Compared to Grain

During this period, the value of silver gradually increased compared to the value of wheat (the main food grain). This means that over time, it took less silver to buy the same amount of wheat.

• Around 1350, a large unit of wheat (a “quarter,” roughly 8 bushels) cost about four ounces of silver (using an old measure called Tower-weight). This was equal to about 20 shillings in the money of the author’s time (late 18th century).
• By the beginning of the 1500s, the price of the same amount of wheat had gradually fallen to about two ounces of silver. This lower price seems to have lasted until about 1570.

Evidence for the Starting Point (c. 1350 = ~4 oz silver per quarter)

Several pieces of evidence suggest that four ounces of silver was the typical or average price for a quarter of wheat around the mid-1300s:

• The Statute of Labourers (1350): After the Black Death plague, workers demanded higher wages. This law tried to force workers to accept older, lower wages. It stated that wheat given as part of wages (“livery wheat”) should not be valued at more than 10 pence per bushel. Since the law had to force workers to accept this price, it suggests 10 pence per bushel (which adds up to about 4 ounces of silver for a quarter of wheat) was considered a normal, moderate price at the time.
• A Prior’s Feast (1309): Records from a large, magnificent feast given by a church official show the actual prices paid for large amounts of grain. The price paid for wheat fits with the idea that about four ounces of silver per quarter was the typical price. These weren’t recorded as unusually high or low prices, just the normal cost at the time.
• Ancient Laws (Assize of Bread and Ale): An old law, revived in 1262 but likely much older, regulated bread prices based on wheat prices ranging up to 20 shillings per quarter (in money of that time). Such laws usually cover a wide range of prices, both high and low. This suggests that the middle or average price expected when the law was made was quite high, likely consistent with the four ounces of silver estimate.

Why this evidence is useful: Laws and large purchase records reflecting common assumptions about price are better indicators of the average price than records of specific years when prices were unusually high or low due to famine or bumper crops.

Evidence for the Ending Point (c. 1500-1570 = ~2 oz silver per quarter)

Evidence shows that by the early 1500s, the average price had fallen by about half:

• An Earl’s Accounts (1512): The household budget records of the Earl of Northumberland from 1512 estimate wheat at prices equal to about two ounces of silver per quarter.
• Laws on Grain Trade (1400s-1500s): For over 200 years, various laws regulating the export and import of wheat used the price of “six shillings and eightpence” per quarter as the key threshold.
• Coin Changes vs. Silver Value: Over this long period, the actual amount of silver contained in coins worth “six shillings and eightpence” gradually decreased because the government altered the currency. However, the value or purchasing power of silver itself was increasing relative to grain. This rise in silver’s value compensated for the smaller amount of silver in the coins, so the old “six shillings and eightpence” figure remained relevant as the benchmark for the average price for a long time.
• Later Law (1562): Eventually, the shilling contained so little silver that the 6s 8d threshold became unrealistically low, effectively stopping all exports. In 1562, a new law raised the threshold to ten shillings per quarter. This amount of shillings contained about two ounces of silver, confirming that this lower silver price was now considered the normal average.

Trend Across Europe

French historical sources also noted that grain prices were much lower (meaning silver was more valuable) in France in the late 1400s and early 1500s compared to the previous two centuries. This trend likely occurred across most of Europe.

Why Did Silver Become More Valuable Then?

What caused silver to gain purchasing power relative to grain between about 1350 and 1570? There are two likely reasons, probably working together:

1. Increased Demand for Silver: As Europe gradually became more politically stable after the turbulent Middle Ages, security increased. This encouraged more industry, trade, and wealth. Growing economies needed more silver coins to conduct business, and wealthier people wanted more silver for luxury goods like plates and ornaments. Demand for silver likely rose.
2. Decreased Supply of Silver: The silver mines that supplied Europe at the time (many dating back to the Roman era) might have been becoming exhausted. As mines get deeper and harder to work, the cost of extracting silver increases, which can reduce the supply.

So, rising demand combined with potentially shrinking or stagnant supply likely caused the value of silver to increase relative to other goods like grain.

Correcting an Older Mistake

It’s important to note that many earlier writers on historical prices believed the opposite. They thought the value of silver continuously decreased from ancient Roman times right up until the discovery of the silver mines in the Americas (around 1500).

This mistaken view came from two main sources:

• Misinterpreting historical price records for grain and other farm products.
• A popular but incorrect assumption that as countries get richer and accumulate more silver, the value of silver automatically falls.

How Historians Misread Old Price Data

Previous writers were often misled by historical price records in three main ways:

1. Mistake 1: Using Low “Conversion Prices”: In the past, rents were often paid with goods (grain, cattle, poultry) rather than cash. Sometimes, agreements allowed the landlord to choose between taking the goods or a fixed cash payment. This fixed cash alternative, called the conversion price, was always set low to protect the tenant. Historians sometimes mistakenly recorded these low, fixed conversion prices as if they were the actual average market prices for the goods, making past prices seem much lower than they really were.
2. Mistake 2: Using Incomplete Copies of Laws: Old laws often regulated things like bread prices based on a sliding scale of grain prices. Scribes copying these laws by hand sometimes saved effort by only writing down the rules for the first few lowest grain prices. Later historians, working from these incomplete copies, wrongly assumed the copied range represented the entire expected range, making the average price seem much lower than the law originally intended.
3. Mistake 3: Focusing Only on Record Low Prices: Historians were sometimes misled by records of exceptionally low grain prices in certain years. They assumed that if the lowest prices were much lower back then, the average price must also have been much lower. They failed to consider that exceptionally high prices were also common in those volatile times, often far exceeding anything seen in later centuries. Looking only at the lowest prices gives a distorted picture.

(Continuing Misinterpretation 3: Ignoring High Prices)

Those historians who focused only on the lowest prices also overlooked how extremely high grain prices could be in those early centuries. For example, in 1270, the price of a quarter of wheat was recorded at two different extremely high levels – one equivalent to about £14 8s in today’s money, the other to £19 4s. Prices rarely, if ever, reached such highs in the later centuries (like the 1500s).

Grain prices fluctuate in all periods, but they vary most wildly in disordered societies. When trade and communication break down, a region suffering a crop failure or enemy raid cannot easily get help from a nearby region with plenty of food. During the turbulent rule of the Plantagenet kings in England (roughly mid-1100s to late 1400s), one area might face famine while another nearby had abundance, but hostility between local lords could prevent any relief. Under the stronger Tudor rulers (late 1400s through 1500s), greater public security reduced this extreme local price volatility.

(Fleetwood’s Price Data Summary)

(The author notes that he has included tables based on Bishop Fleetwood’s collection of historical wheat prices, converted to the money of his own time and averaged over 12-year periods. He added a few years of data from Eton College records to complete the tables).

These tables show that from the early 1200s until after the mid-1500s, the average price of wheat (measured in silver) gradually decreased. Then, towards the end of the 1500s, it began to rise again.

It should be noted that Fleetwood probably collected prices mostly from years that were unusual for being particularly cheap or expensive, so we cannot draw absolutely certain conclusions from this data alone. However, as far as the data shows anything, it confirms the argument presented here: silver gradually became more valuable relative to grain until the mid-1500s.

Interestingly, Fleetwood himself, like most other writers of his time, believed that silver’s value was constantly decreasing during this period due to increasing abundance. His own collected price data clearly contradicts this opinion but perfectly supports the view explained here (and held by other researchers like Mr. Duprè de St Maur). It’s curious that these diligent researchers reached opposite conclusions from similar factual evidence regarding corn prices.

(Critique: Argument Based on Other Cheap Goods)

The mistaken belief that silver was highly valuable (and its value was falling) in very ancient times was often based less on corn prices and more on the low prices of other raw land products, like cattle, poultry, and wild game. The argument went: Corn requires farming (a type of manufacturing), making it relatively expensive in primitive times compared to unprocessed goods obtained more directly from nature.

It’s true that meat, poultry, and game were much cheaper compared to corn back then. However, this cheapness was due to the low value of those goods themselves, not the high value of silver.

• In undeveloped countries with vast wild lands, these animals could be acquired with very little labor. Therefore, they could only command a very small amount of labor (or money) in exchange.
• The low money price didn’t mean silver had high purchasing power; it meant those easily-obtained goods had low purchasing power.
• Consider again the cheap ox in Buenos Aires or the cheap horse in Chile (mentioned in Part II). Silver is definitely cheaper (less valuable) in Spanish America (where it’s mined) than in Europe (where it’s imported at great cost). Yet, these animals were sold for very little silver, proving their own real value was extremely low due to their abundance and the ease of acquiring them.

Labor is the Real Measure of Value

We must always remember that labor, not any specific commodity, is the ultimate measure of the value of silver and all other goods.

In sparsely populated countries, wild animals and game are often naturally produced in far greater quantities than the inhabitants need. Supply exceeds demand. In such situations, these commodities represent or exchange for a very small amount of labor compared to later stages of development.

Corn as the Best Value Measure

Corn (grain), however, is always a product of human industry. In any society:

• Average production tends to match average consumption (supply matches demand).
• Growing the same amount of corn generally requires roughly the same amount of labor over time. (While farming techniques improve labor productivity, this is often offset by the rising cost of farm inputs, like work animals).

Therefore, equal quantities of corn represent equal quantities of labor much more consistently across different times and stages of development than any other raw product from the land. Corn is a more accurate measure of real value over time than other commodities. We can judge the real value (purchasing power) of silver better by comparing it to corn than by comparing it to anything else.

(Corn Price, Wages, and Silver Value)

Furthermore, corn (or whatever the main staple vegetable food is) makes up the largest part of a laborer’s diet in every civilized country. Farming produces much more vegetable food than animal food, and workers everywhere primarily live on the cheapest and most abundant wholesome food available. Meat, poultry, and game are usually insignificant parts of their diet, except perhaps in the wealthiest countries where wages are very high. (For example, the working poor in France and even Scotland rarely eat meat except on special occasions).

Therefore:

• The money price of labor depends much more on the average money price of corn than on the price of meat or other raw products.
• Consequently, the real value of silver and gold (the amount of labor they can buy) depends much more on the amount of corn they can buy than on the amount of meat or anything else.

(Refuting the “More Silver = Lower Value” Idea)

These misunderstandings of historical price data might not have misled so many writers if they hadn’t also been influenced by the popular notion that as wealth and the quantity of silver increase in a country, the value of silver must necessarily decrease. This popular idea seems completely wrong.

The amount of precious metals (gold and silver) in a country can increase for two different reasons:

1. Increased abundance of mines: New, richer mines are discovered or existing mines become more productive.
2. Increased wealth of the people: The country’s overall production of goods and services (the “annual produce of its labour”) increases.

These two causes have opposite effects on the value of precious metals:

• Cause 1: More Abundant Mines -> Decreases Silver Value. When mines produce more silver, a larger quantity is brought to market. Since the amount of other goods available for exchange remains the same initially, more silver must be traded for the same amount of goods. Each ounce of silver buys less; its value falls.
• Cause 2: Increased Societal Wealth -> Does NOT Decrease Silver Value. When a country becomes wealthier, it produces more goods. More goods circulating require more coins for transactions. Also, wealthier people can afford and desire more luxury items, including silver plates, jewelry, and ornaments (just as they desire more statues, paintings, etc.). The quantity of coin increases out of necessity, and the quantity of silver objects increases out of choice. But there’s no reason why silver itself should become cheaper (less valuable) just because people are richer and using more of it. Artists aren’t paid less in prosperous times; similarly, the metal itself isn’t likely to command a lower price simply because demand has risen due to wealth.

(Why Silver Value is Higher in Rich Countries)

In fact, unless the discovery of new super-abundant mines pushes the price down, the value of gold and silver naturally tends to rise as a country becomes wealthier. The value is generally higher in rich countries than in poor countries.

Like all goods, gold and silver flow to the markets where they can get the best price. The best price is usually paid in the countries that can most afford it (the richest ones). Remember, labor is the ultimate price paid for everything. In countries where labor is equally well-rewarded, money wages reflect the cost of the laborer’s subsistence (mainly food). Gold and silver will naturally exchange for more food in a rich country (where food is abundant) than in a poor country (where food is relatively scarce).

• If the rich and poor countries are far apart, the difference in the purchasing power of silver can be very large, because transporting large amounts of silver to equalize prices is difficult. (Example: China is much richer than Europe; rice in China is much cheaper than wheat in Europe, meaning silver buys much more food in China).
• If the countries are close, the difference will be smaller because transport is easier. (Example: England is richer than Scotland, but the difference in the money price of corn is small, mainly reflecting quality and transport costs from England to Scotland).

(Money Wages vs. Real Wages)

The difference in money wages between countries can be even greater than the difference in food prices. This is because real wages (the actual standard of living workers can afford) also differ.

• Real wages are higher in Europe than in China because most of Europe is improving economically, while China seems stagnant. This makes the money wage gap even larger than the food price gap.
• Money wages are lower in Scotland than in England because real wages are much lower; Scotland is improving, but much more slowly than England. (The large number of Scots moving to England, while few English move to Scotland, shows the difference in demand for labor).
• A country’s real wage level depends not just on its current wealth but on whether it is advancing, stationary, or declining.

Gold and silver naturally have the least value among the poorest nations (like hunter-gatherer societies, where they might have almost no value).

(Corn Prices in Towns and Trading Nations)

Corn is always more expensive in big cities than in the surrounding countryside. This isn’t because silver is less valuable in cities. It’s because corn is genuinely more expensive due to the high cost of transporting it to the city. Bringing silver to the city costs no more labor than bringing it to the country, but bringing corn costs much more.

Similarly, corn is expensive in rich trading nations like Holland or the territory of Genoa. Like big cities, they are wealthy in manufacturing, skills, shipping, and trade infrastructure, but they don’t grow enough food for their population. They must import corn from distant countries, and the transport cost adds significantly to its price. Bringing silver to Amsterdam costs about the same as bringing it to Danzig (a grain-exporting port), but bringing corn to Amsterdam costs much more. Silver’s real cost (value) is similar in both places, but corn’s real cost is very different.

Necessities vs. Superfluities in Decline:

If rich trading nations like Holland or Genoa were to decline economically, losing their ability to import food, the price of corn would soar to famine levels, even as the amount of silver in the country likely decreased. In hard times, people must give up luxuries (superfluities) to acquire necessities.

• The value of superfluities (like silver) rises in prosperous times but sinks in times of poverty and distress.
• The value of necessities (like corn) does the opposite. Their real price (the labor they command) rises in times of poverty and distress (when they are scarce) and falls in times of wealth and prosperity (which are always times of abundance, otherwise they couldn’t be prosperous).

Corn is a necessary; silver is only a superfluity.

(Conclusion on First Period: Silver Value Did Not Fall)

Therefore, any increase in the amount of silver in Europe between the mid-14th and mid-16th centuries that resulted from increasing wealth and economic improvement would not have caused silver’s value to fall. Historians studying prices from that era had no basis in the price data (for corn or other goods) to conclude that silver’s value was diminishing. They had even less reason to conclude it based on the period’s increasing wealth. The common assumption was wrong.

Introduction to Second Period: c. 1570 - c. 1640

While opinions differed about silver’s value during that first period, historians are unanimous about what happened during the second period.

From about 1570 to about 1640 (a period of roughly 70 years), the relationship between the value of silver and the value of corn took a completely opposite course compared to the first period. (This implies silver’s value fell significantly relative to corn during this time).

DIGRESSION: HOW SILVER’S VALUE CHANGED (Last 400 Years)

(First Period Recap: c.1350-1570 - Silver Value Rose)

As discussed previously, the evidence suggests that from around the mid-1300s to about 1570, silver gradually became more valuable compared to grain. The amount of silver needed to buy a certain amount of wheat fell by about half. This happened likely because demand for silver increased in a stabilizing Europe, while the supply from old mines may have dwindled.

We also saw why the older view – that silver value was falling during this time – was likely based on misinterpretations of historical price data (confusing fixed ‘conversion prices’ with market prices, using incomplete copies of laws, focusing only on record low prices while ignoring record highs) and the flawed popular assumption that more wealth automatically makes silver less valuable. Corn, being the staple food produced consistently by human labor, is a better long-term measure of value than other goods or silver itself. Silver’s real value depends mainly on how much corn (the primary food of laborers) it can buy. Increasing wealth does not, by itself, decrease silver’s value; only an increase in silver supply relative to demand does that.

Second Period: Roughly 1570 to 1640

Trend Reversed: Silver Value Fell Sharply

During this period of about 70 years, the trend completely reversed. Silver rapidly lost value compared to grain.

• The amount of silver needed to buy a quarter (a large unit) of wheat increased dramatically.
• Instead of costing around two ounces of silver, the price of wheat rose to six, seven, or even eight ounces of silver.
• In terms of the author’s money, the price jumped from around ten shillings per quarter to thirty or forty shillings per quarter.

Cause: Flood of Silver from American Mines

Everyone agrees on the cause of this dramatic change: the discovery and exploitation of the incredibly rich silver mines in the Americas, particularly those like Potosi (in modern Bolivia).

• Huge quantities of silver flooded the European market.
• Even though Europe was developing and demand for silver was increasing, the increase in supply was far greater.
• With much more silver chasing a smaller increase in goods, the value of silver plummeted.

Interestingly, the full effect of the American mines wasn’t strongly felt on prices in England until after 1570, even though the Potosi mines had been discovered more than 20 years earlier. Price records from Eton College for the Windsor market confirm the sharp rise in the silver price of wheat during the late 1500s and early 1600s.

Third Period: Roughly 1640 to Present (Author’s Time, c. 1770s)

Trend Reversed Again: Silver Value Stabilized, Then Rose Somewhat

Around 1636 to 1640, the flood of silver from the Americas seems to have had its maximum impact. The value of silver relative to corn stopped falling and reached its lowest point.

Since then, over the next century and into the author’s present time (mid-to-late 1700s), the value of silver seems to have stabilized and even risen somewhat compared to corn. This means the money price of corn generally stopped rising and later tended to fall.

Evidence (1640-1700): Stability Despite Disruptions

• Average wheat prices in the last 64 years of the 1600s were only slightly higher than in the period immediately before (1621-1636).
• Author argues this small increase was not due to further decline in silver value, but was caused by major disruptions that temporarily inflated grain prices:
  1. The English Civil War: Discouraged farming and interrupted trade, causing scarcity and high prices (especially near London). Exceptionally high prices in 1648 and 1649 alone could account for the small average increase over the 64 years.
  2. Corn Export Bounty (Started 1688): This government payment encouraged sending grain abroad. Its immediate effect (1688-1700) was to raise prices at home by preventing surpluses in good years from offsetting shortages in bad years. It likely worsened the scarcity caused by bad seasons in the 1690s.
  3. Severe Coin Debasement: By 1695, silver coins in circulation were badly worn and clipped, containing perhaps 25% less silver than they were supposed to. Since prices reflect the actual amount of silver people expect to receive in worn coins, nominal prices rise significantly when the currency is debased. (The author notes that in his time, worn silver coins were propped up by less-worn gold coins, but in 1695 this wasn’t the case, and the debasement was severe).

These factors artificially raised the money price of corn, masking any potential rise in the underlying value of silver during this period.

Evidence (1701-1764): Falling Corn Prices Suggest Rising Silver Value

• In the first 64 years of the 1700s, average wheat prices were significantly lower (by over 25%) than in the last 64 years of the 1600s.
• They were also considerably lower than prices during the peak impact of the American mines (1621-1636).
• This period was relatively stable, without major internal conflicts like the Civil War. The silver coinage was also in better condition after a major recoinage around 1700.
• The export bounty was in effect, which tends to raise prices. Therefore, the fact that average prices fell significantly despite the bounty strongly suggests that the real value of silver was rising relative to corn.
• Supporting details from the late 1600s (lowest price in 1687, Gregory King’s estimate of average prices being low in 1688) also indicate silver’s value might have already started rising then. The bounty was partly introduced because landowners saw prices falling and wanted government help to keep them high.

Trend Across Europe:

This trend of rising silver value (falling average money price of corn) wasn’t unique to England. Similar observations were made in France during the same period by careful researchers, even though France generally prohibited grain exports until 1764. If the price fall happened in France without an export bounty encouraging cultivation, it makes it less likely that England’s similar price fall was caused primarily by the bounty increasing supply.

Conclusion: Changes Driven by Silver Value, Not Corn Value

It seems more logical to view these long-term changes in the average money price of corn as effects of changes in the real value of silver in the European market, rather than changes in the real value (cost of production) of corn itself. Corn is the more stable measure of value over long periods.

• Just as the massive rise in corn’s money price after 1570 was universally attributed to the fall in silver’s value (due to American mines)…
• …the moderate fall in corn’s money price during the 18th century should likewise be attributed to a rise in silver’s real value in the European market.

Addressing Recent High Corn Prices (Author’s Time)

The author acknowledges that unusually high corn prices in the 10-12 years before he was writing had led some people to suspect silver’s value might still be falling.

However, he argues strongly that this recent spike was a temporary event, caused by:

• A long run of unusually bad seasons across much of Europe.
• Political instability in Poland, which disrupted grain supplies to other countries.

He notes that such runs of bad seasons have happened before and are often balanced by periods of unusual plenty and low prices (like the decade 1741-1750). During that extremely cheap decade, the export bounty actually prevented prices from falling even lower by causing massive amounts of grain to be exported. These short-term fluctuations shouldn’t be mistaken for a change in the long-term trend of silver’s value.

(Digression Conclusion and Periods 2 & 3)

(Continuing the discussion from the First Period, roughly 1350-1570, where silver’s value relative to grain generally rose)

It’s worth remembering that grain prices in those early centuries were much more volatile than later on. Disordered societies with poor communication and security meant local crop failures could cause famine and sky-high prices in one area, while a nearby area had plenty. The stronger governments of later centuries (like the Tudors in England) provided more stability, reducing these extreme price swings.

While historical price data (like Bishop Fleetwood’s collection) has flaws, it generally supports the view that silver became more valuable compared to grain from the 1200s until the mid-1500s. This contradicts the belief held by Fleetwood and others that silver value was constantly falling due to increasing abundance. Their mistake likely came from misinterpreting specific price records and wrongly assuming that increasing wealth automatically decreases silver’s value. The best measure of value over time is corn (the staple food), and its price relative to silver indicates silver’s value actually rose during this first period. Any increase in silver quantity came more from Europe’s growing wealth (increasing demand) than from new mine discoveries, and increasing wealth does not necessarily lower silver’s value. Silver tends to be most valuable in the richest countries where it can buy the most subsistence.

Second Period: Roughly 1570 to 1640

Trend Reversed: Silver Value Fell Sharply

Everyone agrees on what happened next. For about 70 years, from roughly 1570 to 1640, the value of silver took a dramatically opposite turn.

• Silver lost value significantly compared to grain.
• The amount of silver needed to buy a certain amount of wheat soared. The price of wheat, measured in ounces of silver, roughly tripled or quadrupled, rising from about 2 ounces per quarter to 6, 7, or 8 ounces.

Cause: Flood of Silver from American Mines

The reason for this drastic fall in silver’s value was the discovery and exploitation of the incredibly rich silver mines in the Americas.

• Vast amounts of silver poured into Europe.
• This enormous increase in supply overwhelmed the growing demand from Europe’s improving economies.
• With much more silver available relative to other goods, its value naturally decreased sharply.

(The full impact of American silver on prices in England wasn’t felt until after 1570, even though major mines like Potosi were found earlier). Price records from the time clearly show this sharp rise in the silver price of grain.

Third Period: Roughly 1640 to Present (Author’s Time, c. 1770s)

Trend Reversed Again: Silver Value Stabilized, Then Rose Somewhat

Around the middle of the 17th century (1636-1640), the initial, powerful effect of the American mines seems to have run its course. Silver’s value relative to corn hit its lowest point around this time.

Since then (from the mid-1600s through the mid-1700s), the evidence suggests that silver’s value stopped falling and likely rose somewhat compared to corn. This means the average money price of corn generally stopped increasing and later tended to decrease slightly.

Evidence for Stabilizing/Rising Silver Value:

• Late 17th Century Prices (c. 1640-1700): Average wheat prices in this period were only slightly higher than at the very end of the previous period (when silver’s value was lowest). Author argues this small increase was entirely due to major disruptions that temporarily inflated prices:
  • The English Civil War disrupted farming and trade.
  • A new government subsidy (bounty) encouraging grain exports (started 1688) tended to raise domestic prices, especially initially.
  • Severe debasement of silver coins through clipping and wear meant that more shillings (containing less silver) were needed to represent the same real value. These factors masked any underlying rise in silver’s value.
• Early 18th Century Prices (c. 1701-1764): Average wheat prices during this period were significantly lower (over 25% lower) than in the late 17th century. This period was more stable (no civil war, better coinage). Since prices fell even with the export bounty still in effect (which tends to raise prices), it strongly suggests the real value of silver was rising. Low prices recorded in the late 17th century (like 1687 and Gregory King’s 1688 estimates) also hint the rise might have begun then.
• Trend Across Europe: A similar trend of falling average corn prices (implying rising silver value) was observed in France during the same period, even though France prohibited grain exports. This makes it less likely that the English trend was solely due to the export bounty stimulating production; a general rise in silver’s value across Europe seems a more plausible explanation.

Conclusion: Changes Driven by Silver Value, Not Corn Value

Therefore, it’s more accurate to see these long-term shifts in the average money price of corn as reflecting changes in the real value (purchasing power) of silver in the European market, rather than changes in the real cost of producing corn. Corn remains the better benchmark over centuries. The price surge after 1570 was due to falling silver value; the price stabilization and fall after 1640 likely reflects silver’s value recovering somewhat.

(Addressing Recent High Corn Prices - Author’s Time):

The author dismisses concerns that recent high corn prices (in the 1760s/1770s) meant silver was still falling in value. He argues this was a temporary spike caused by widespread bad weather and political disruptions in Poland (a key grain supplier). He points out that such periods of scarcity happen historically and are often balanced by periods of unusual plenty and low prices, such as the decade from 1741 to 1750. During that extremely cheap decade, the export bounty caused huge amounts of grain to be shipped out, preventing prices from falling even further. These short-term weather-driven fluctuations don’t negate the longer-term trend of silver’s value having recovered somewhat since the mid-17th century.

Why Didn’t Silver Value Keep Falling After 1640? Expanding Markets

Given the continued production from American mines, why did silver’s value stop falling and perhaps even rise after about 1640? The most likely reason is that the market for American silver steadily expanded, increasing demand and absorbing the supply. This happened in three main ways:

1. Europe’s Growth: Most European nations continued to develop their agriculture, manufacturing, and trade after 1600. Growing economies needed more silver coins for circulation, and increasing numbers of wealthy individuals desired more silver for plates, decorations, and other luxury items.
2. The Americas: The American colonies themselves became huge, new, and rapidly growing markets for their own silver. Population, farming, and industry expanded much faster there than in Europe. English, Spanish, and Portuguese colonies all needed increasing amounts of silver for coins and goods in areas where there had been little or no demand before European settlement. Even former empires like Mexico and Peru became much larger markets than they were before the conquest, despite exaggerated tales of their ancient wealth. (The author argues they were relatively undeveloped before Europeans arrived). The abundance of cheap land fueled rapid growth, creating strong demand for silver.
3. The East Indies: Asia, particularly India and China, became another vast and continuously growing market that absorbed enormous quantities of American silver. Trade, both directly from America (via ships like the Acapulco galleons) and indirectly via Europe, expanded constantly. European demand for Eastern goods like tea, porcelain, spices, and textiles exploded from the 17th century onwards. All European trading nations increased their shipments to the East.

Why Silver Flowed East:

Crucially, silver was (and still was in the author’s time) much more valuable in the East than in Europe.

• Densely populated countries like China and India, with highly productive agriculture (especially rice), had large food surpluses.
• The wealthy elite could afford vast numbers of servants and had immense purchasing power for rare luxury goods.
• Local mines for precious metals in Asia seemed less abundant than those in the Americas.
• As a result, silver could buy significantly more food, labor, and other commodities (like gemstones) in India and China than it could in Europe.
• Furthermore, manufacturing costs were lower in the East due to very low money wages (a result of both low real wages and low food prices) and efficient water transport systems.

Because of this high purchasing power, sending silver from Europe (where it was relatively less valuable) to the East (where it was relatively more valuable) to buy Eastern goods was consistently extremely profitable. This steady drain of silver to Asia absorbed a huge portion of the output from the American mines.

This constantly expanding global market (Europe, Americas, Asia) is the likely reason why the flood of silver from the Americas did not cause its value to fall further after the mid-17th century, and instead allowed its value to stabilize and even recover slightly.

Why Silver Flowed East: Relative Value

Exporting silver from Europe to India and China was also generally more profitable than exporting gold. This was because the value ratio between gold and silver was different in the East.

• In Europe, one ounce of gold was worth about 14 or 15 ounces of silver.
• In India and China, one ounce of gold was worth only about 10 or 12 ounces of silver.

Since gold bought less silver in the East, it was better to send silver there directly to trade for Eastern goods. In this way, silver from the Americas became a key commodity connecting Europe and Asia, the two ends of the “old world.”

Global Demand and Consumption of Precious Metals

This incredibly wide global market required a huge amount of new silver to be mined each year. This annual supply needed to be enough to:

1. Meet the constantly increasing demand for coins and silver objects (plate) in all growing economies.
2. Replace the amount of silver constantly being consumed or lost around the world.

How Metals Are Consumed and Lost:

Precious metals disappear from the usable stock in several ways:

• Wear and Tear: Coins wear down from handling. Silverware (plate) wears down from use and cleaning. Given how widely these are used, this gradual loss adds up significantly.
• Manufacturing: Large amounts of gold and silver are used in manufacturing in ways that prevent them from being recovered as metal. Examples include gilding (applying thin gold layers) and silver plating (like in Birmingham, England, where estimated annual use exceeded £50,000). This also includes use in metallic laces, embroidery, decorated fabrics, bookbinding, furniture, etc., across the world.
• Transport Losses: Some metal is inevitably lost during shipment by sea or land.
• Hoarding: In many parts of Asia, burying treasure is common. Often, the person who buried it dies without revealing the location, causing the treasure to be lost permanently.

Estimating Global Production vs. Consumption

• Annual Imports: According to the best estimates available (including detailed analysis by merchants like Mr. Meggens and figures from historical accounts), the total amount of gold and silver imported into Europe (mainly through Cadiz, Spain, and Lisbon, Portugal) averaged around £6 million sterling per year in the mid-18th century. This includes estimates for smuggled metals.
• Imports vs. Production: This £6 million figure doesn’t represent the entire output of American mines (some silver went directly to Asia, some was used in illegal trade, some stayed in the Americas), nor does it include production from mines elsewhere in the world (though these were much smaller). However, it represents the vast majority of the world’s new supply entering the main markets.
• Consumption May Equal Production: Comparing this huge annual supply to estimated consumption (like Birmingham’s £50,000/year, just 1/120th of the total import) suggests that the total amount of gold and silver lost or consumed globally each year might be roughly equal to the entire annual production from the mines. If so, the remaining supply might only be enough to meet the growing demand from thriving countries, or perhaps even fall slightly short. This potential balance or shortfall could explain why silver’s value seemed to stabilize or even rise slightly in Europe after the mid-1600s.

Why Precious Metal Prices Are Relatively Stable

• Comparison to Coarse Metals: We produce vastly more brass and iron than gold and silver each year, but we don’t expect brass and iron to become endlessly cheaper. Why should we assume precious metals will? Although less durable coarse metals wear out faster, precious metals are not immortal either and are consumed or lost in many ways.
• Durability is Key: Metal prices tend to be much more stable from year to year than prices of other raw materials like grain. Precious metal prices are even more stable than coarse metal prices. The main reason is durability. Last year’s grain harvest is mostly consumed within a year. But iron tools from hundreds of years ago might still be in use, and gold objects from thousands of years ago might still exist.
• Stock vs. Flow: The total amount of metal available in the world (the stock) is enormous compared to the amount produced by mines each year (the flow). Yearly variations in mine production have very little effect on the total stock available, and therefore have much less impact on the price compared to how harvest variations affect the price of grain (where the yearly flow is the main supply). This holds true even though mine output can be quite variable year-to-year.

Variations in the Value Ratio: Gold vs. Silver

The relative value between gold and silver has also changed significantly:

• Historical Shift: Before the discovery of the Americas, the ratio in Europe was typically between 1 ounce of gold to 10-12 ounces of silver. After the American mines flooded the market, the ratio settled around 1 ounce of gold to 14-15 ounces of silver (by the mid-17th century). Gold became more expensive in terms of silver. Both metals lost real value (purchasing power over labor), but silver lost more value because the American silver mines were relatively even more productive than the American gold mines.
• Geographic Differences: The ratio continued to differ globally. In the East (China, Japan), gold remained relatively cheaper, valuing only 8 to 12 times the equivalent weight of silver. This difference drove silver exports eastward.
• Market Quantity vs. Value Ratio: Some writers assumed the ratio of the quantities of gold and silver available in the market must be the same as their value ratio (e.g., 1:15). This is incorrect. Just because an ox costs 60 times as much as a lamb doesn’t mean there are 60 times more lambs than oxen for sale. Usually, cheaper commodities (like silver) are not only greater in quantity but also have a greater total value in the market than dearer commodities (like gold), because many more people buy the cheaper item. Most people own much more silver (especially silverware) by total value than gold (often just small trinkets). While gold dominates the coinage value in some countries like Britain, silver coinage is more prevalent elsewhere (like France), and the global dominance of silver plate likely means the total value of silver in use greatly exceeds that of gold.

Is Gold “Cheaper” Than Silver (In a Specific Sense)?

While silver is always “cheaper” than gold in terms of price per ounce, gold might be considered “cheaper” in another sense: its market price might be closer to its absolute minimum cost of production.

• Minimum Price: The lowest possible price a commodity can sell for long-term is the price that just covers the costs of labor and capital (with moderate profit) needed to bring it to market, providing no rent to the landowner.
• Spanish Market: In the Spanish colonies, gold seems closer to this minimum price than silver.
  • The King’s tax (acting as rent) was lower on gold (5%) than on silver (10%).
  • The gold tax was likely smuggled more, meaning even less effective rent was paid.
  • Profits from gold mining seemed lower (fewer fortunes made). Since Spanish gold yielded less rent and profit, its price was likely closer to the bare minimum production cost than Spanish silver’s price was. (The situation for Brazilian gold under Portuguese rule was different, with a higher tax, making the overall picture for American gold less clear).
• Precious Stones: Diamonds and other gems, yielding very little or no rent, might have prices even closer to their minimum possible production cost than gold does.

(Future Outlook for Silver Tax): Given the history, if silver mines become unable to afford the current 10% tax, it might need to be reduced further, just as it was reduced from 20% to 10% in 1736, and just as the gold tax was reduced to 5%.

Why Mining Gets More Expensive Over Time

It’s well understood that silver mines, like all mines, gradually become more expensive to operate. As miners have to dig deeper to find ore, the costs increase for pumping out water and supplying fresh air to the miners working at great depths.

Possible Effects of Higher Mining Costs

This rising cost of mining has the same effect as if silver were becoming scarcer – it takes more effort and expense to obtain the same amount. Over time, this increasing cost must lead to one of three outcomes:

1. The higher mining cost is completely balanced by a proportional increase in the market price of silver.
2. The higher mining cost is completely balanced by a proportional decrease in the taxes charged on silver production.
3. The higher mining cost is balanced by a combination of both higher silver prices and lower taxes. (This third option is quite possible; for instance, gold prices rose relative to silver even though taxes on gold were greatly reduced).

How Tax Cuts Affect Silver Value

Reductions in taxes on silver, like the one Spain made in 1736 (lowering the tax from one-fifth to one-tenth), definitely slow down any potential rise in silver’s value in the European market. Lower taxes allow less productive mines, which couldn’t afford the old tax, to stay in operation. This means the total amount of silver brought to market each year is greater than it would be otherwise, keeping the value of silver somewhat lower. The 1736 tax cut probably means that silver’s value today is at least 10% lower than it would have been if Spain had kept the old, higher tax.

Author’s Tentative Conclusion: Silver Value Rose Slightly in the 18th Century

Despite the effect of tax cuts, the evidence discussed earlier (especially the falling average price of corn over the long term) leads the author to suspect or conjecture (he admits it’s not a firm belief) that the value of silver has started to rise somewhat during the 18th century.

He acknowledges, however, that this supposed rise has been very small and slow. It might still be uncertain to many people whether silver’s value has actually risen, or whether it might even still be falling in the European market.

The Long-Term Balance: Consumption vs. Production

It’s important to consider the overall picture. There must eventually come a point where the world’s annual consumption of gold and silver equals the annual importation (production from mines).

As the total amount (mass) of precious metals in the world increases, consumption tends to increase even faster. Why? Because as their mass increases, their value tends to decrease. When something is less valuable, people use it more freely and take less care of it, leading to higher rates of loss and consumption (through wear, manufacturing use, hoarding, etc.).

So, after a certain point, assuming the annual production from mines isn’t constantly increasing (which wasn’t thought to be the case in the author’s time), the amount consumed each year will catch up to the amount produced each year.

How Falling Production Could Raise Silver Value:

If, after consumption equals production, the annual production from mines started to gradually decrease (perhaps because mines become too expensive to work), then consumption would temporarily exceed production. The total stock of precious metals in the world would slowly shrink. This increasing scarcity would cause the value of gold and silver to gradually rise, until consumption eventually adjusted downward to match the new, lower level of annual production. (This provides a theoretical way silver’s value could rise over time).

Grounds for Suspecting Silver Value Still Continues to Decrease (Addressing Counter-Arguments)

Why might some people still believe silver’s value continues to fall, despite the author’s arguments? Two main reasons are often given:

Argument 1: Europe is Wealthier and Has More Silver

• The Argument: Europe has become much wealthier, and wealth brings more precious metals. The popular idea is that more silver automatically means lower value.
• The Rebuttal: This popular notion is wrong. As shown earlier, increasing silver quantity due to increasing wealth does not tend to lower its value. Luxuries, including gold and silver, flow to rich countries precisely because they command a better price there, not because they are cheaper. It’s the higher price that attracts them.

Argument 2: Prices of Other Raw Goods Are Rising

• The Argument: People observe that the prices of many other raw land products – like cattle, poultry, game, timber, minerals – tend to rise as society progresses. They assume this rising money price means silver must be losing value.
• The Rebuttal: This is also based on a misunderstanding. As shown earlier (in Part II), these other raw products naturally become really dearer over time. This means it takes more labor to produce them relative to basic food crops as wild sources diminish and more effort is needed. Their rising money price reflects an increase in their own real value (or cost in terms of labor), not a decrease or degradation in the value of silver.

Therefore, neither increasing wealth nor the rising prices of other raw goods provide valid reasons to believe that silver’s value was still falling in the mid-to-late 18th century. The evidence, though complex and requiring careful interpretation, points more towards a stabilization and slight rise in silver’s value since the major impact of the American mines ended around the mid-1600s.

DIFFERENT EFFECTS OF PROGRESS ON THREE TYPES OF RAW LAND PRODUCE

Raw products from the land (“rude produce”) can be divided into three types, based on how easily humans can increase their supply as society develops:

1. First Sort: Products whose supply is very hard or impossible for humans to increase much.
2. Second Sort: Products whose supply can be increased as much as needed to meet demand.
3. Third Sort: Products where efforts to increase supply have limited or uncertain results.

How the real price (value measured in labor or essential goods) of these types changes during economic progress differs:

• The real price of the First Sort can rise extravagantly, with no clear limit.
• The real price of the Second Sort can rise significantly, but only up to a certain point.
• The real price of the Third Sort naturally tends to rise, but its actual path can vary – sometimes falling, staying the same, or rising – depending on how successful human efforts are at increasing its supply.

Let’s look at the first two types in more detail.

First Sort: Products Whose Supply Can’t Easily Increase

This group includes things that nature produces only in limited quantities. Often, they are also perishable, so you can’t save up multiple seasons’ worth.

• Examples: Many rare and unusual birds and fish, certain types of wild game, and especially migratory birds.
• Price Trend: As a country gets wealthier and people desire more luxuries, demand for these rare items increases. However, human effort can do little to increase the supply beyond what nature provides. With supply staying roughly the same while demand and competition among buyers keep rising, the price can become incredibly high. There seems to be no natural upper limit. For instance, if woodcocks (a type of game bird) became extremely fashionable, their price might soar to unrealistic levels, but hunters probably couldn’t bring many more to market than they do now.
• Roman Luxury Prices: This explains the extremely high prices the ancient Romans paid for rare birds and fish during the peak of their empire. It wasn’t because silver was cheap back then – in fact, silver had more purchasing power in Roman times than it does now (late 18th century). Evidence from Roman grain prices suggests that three ounces of silver back then could buy as much labor or goods as four ounces could buy now. The extravagance came because wealthy Romans commanded so much surplus labor and food that they could afford to give away enormous amounts (in real terms) for these unique natural rarities that couldn’t simply be produced in larger quantities. When Roman writers like Pliny mention prices equivalent to £50 or £67 in modern money for a single rare nightingale or fish, the real cost (in terms of labor and subsistence given up) was actually about a third higher than those figures suggest to us today.

Second Sort: Products Whose Supply Can Meet Demand

This group includes useful plants and animals that nature provides in great abundance in undeveloped (“uncultivated”) countries, making them initially cheap or almost worthless. As land gets cultivated for more profitable crops, these naturally abundant resources are pushed aside.

• Price Trend: As society progresses, the natural supply of these items (like wild game or natural pasture for cattle) shrinks, while the demand for them usually increases (due to growing population and wealth). Therefore, their real value – the amount of labor they command – gradually rises. Eventually, their value gets so high that producing them deliberately (e.g., cultivating land to feed cattle) becomes just as profitable as using the best farmland to produce anything else, like grain. Once the price reaches this level, it can’t sustainably rise much further. If it did, more land and effort would quickly shift towards producing more of it, increasing supply and bringing the price back down to the balanced level.

Example: Cattle

Cattle are a key example of this second sort of produce.

• Mechanism of Price Rise: As farming expands, wild pastures shrink, reducing the natural supply of easily-raised cattle. At the same time, a growing population with more grain (or money from selling grain) increases the demand for meat. The price of meat, and therefore cattle, must gradually rise.
• Peak Price Level: The price eventually rises high enough that it becomes profitable for farmers to use even their best, most fertile land to grow feed specifically for cattle, rather than growing grain for humans. The price generally won’t rise beyond this point; if it did, farmers would convert grain fields into pasture until the price balanced out again. This peak price level is usually reached only late in a country’s agricultural development. Until then, in an improving country, cattle prices tend to constantly rise. (Some parts of Europe might not have reached this stage yet. Scotland hadn’t before its union with England in 1707). In England, prices near London seem to have reached this level in the early 1600s, but it likely took much longer in more remote areas. Cattle are perhaps the first product in this category to reach this peak price relative to land use.
• Why Cattle Prices Matter for Farming: Achieving widespread, high-quality farming seems impossible until cattle prices reach this high level. The reason is manure. On most farms (especially those too far from towns to bring in manure), the amount of land that can be kept well-cultivated depends on the amount of manure produced on the farm itself. This, in turn, depends on the number of cattle kept. Manure comes either from letting cattle graze on fields or feeding them in stables and spreading their dung. But farmers cannot afford to use valuable cultivated land for grazing, nor can they afford the extra labor of growing, harvesting, and bringing feed to stable-fed cattle, unless the price they get for the cattle covers the full rent and profit potential of that cultivated land.
• Result of Low Cattle Prices: If cattle prices are too low, farmers can only afford to keep the minimum number of animals needed for ploughing. These few animals don’t produce enough manure for the whole farm. The manure gets used only on the best fields near the farmyard. Most of the land is left as poor pasture, supporting only a few underfed animals. Though the farm has potential, it’s understocked for proper cultivation but possibly overstocked relative to its poor current output. Farmers might plough up sections of this poor pasture every few years for a couple of low-quality grain crops, exhausting the soil before letting it rest as poor pasture again.
• Scotland’s Improvement: This inefficient system was common in lowland Scotland before the union with England. Low cattle prices made it almost unavoidable. Even after prices rose, the system changed slowly due to obstacles like tenant poverty (making it hard to afford more cattle, especially as prices rose) and the time needed to improve the land itself to support more animals. Land improvement and increasing livestock must happen together. The rise in cattle prices resulting from access to the English market after the union was perhaps Scotland’s greatest economic benefit, boosting Highland land values and driving improvements in the Lowlands.
• New Colonies: In new colonies, vast amounts of available land initially make cattle extremely abundant and cheap (early settlers let horses run wild). It takes a very long time before it becomes profitable to use cultivated land to feed animals. Therefore, similar poor farming practices often develop due to lack of manure and too few animals for the amount of land (as observed by the Swedish traveler Mr. Kalm in North America in 1749). Kalm noted colonists exhausted land then moved on, made little manure, let cattle starve in the woods, and destroyed the best natural grasses. He believed this led to the poor quality of American cattle compared to their European ancestors, similar to the stunted cattle common in Scotland before improved feeding methods became widespread.
• Cattle Prices Unlock Potential: So, although cattle prices rise relatively late in development to the point where cultivating fodder is profitable, they are perhaps the first product of this second sort to do so. Reaching this price seems necessary before agriculture can reach a high level of improvement.

Example: Venison

In contrast to cattle, venison (deer meat) might be one of the last products of this type to reach a price that covers its production costs. Even the high price of venison in Great Britain is reportedly nowhere near enough to cover the expenses of maintaining a deer park.

(Continuing Second Sort: Products Whose Supply Can Meet Demand)

Venison Example Concluded:

If venison (deer meat) prices ever rose high enough to easily cover the costs of raising deer in parks, deer farming would likely become common, just as the ancient Romans farmed certain types of small birds, and some parts of France fatten small migratory birds (ortolans) for profit. If deer meat stays fashionable and Britain continues to get wealthier, its price might indeed rise further.

Other Products Rise Gradually:

There’s a long time between cattle prices reaching their peak (enabling widespread farm improvement) and luxury items like venison potentially reaching theirs. During this interval, many other raw land products gradually reach their own highest sustainable prices, some sooner, some later.

• Poultry: Initially, chickens and other poultry are kept as a way to use up scraps from the barn and stables (“save-all”). Since they cost the farmer almost nothing to feed, they can be sold very cheaply. Any money received is almost pure gain. In poorly developed countries, this ‘free’ supply of poultry might be enough to meet the entire local demand, making poultry as cheap as other meats. However, the number of poultry raised this way is always much smaller than the number of cattle or sheep raised on the farm. As countries become wealthier, people often prefer rarer items over common ones, even if the quality is similar. So, demand for poultry increases, and its price gradually rises above the price of other meats. Eventually, the price gets so high that it becomes profitable for farmers to use land specifically to grow feed for poultry (like corn or buckwheat, as done in parts of France where poultry farming is important). Once the price reaches this level – covering the cost of cultivation – it cannot sustainably rise much further, because more farmers would start raising poultry, increasing supply. (Poultry farming doesn’t seem quite as important in England yet, although English poultry is more expensive than French poultry, likely due to imports from France). Peak Price Timing: For any type of animal food, the price is likely highest just before it becomes common practice to grow feed specifically for it. Scarcity drives the price up then. Once specialized feeding becomes widespread, new, more efficient feeding methods are often developed. This increased supply allows farmers to sell cheaper (and forces them to, due to competition), which they can afford because of the improved methods. For example, the introduction of crops like clover and turnips likely helped lower the price of meat in London compared to earlier times.

• Hogs (Pork): Like poultry, hogs are initially kept as a ‘save-all’, eating scraps and waste other animals won’t touch. As long as the demand can be met by these cheaply raised animals, pork sells for less than other meats. But when demand grows beyond this ‘free’ supply, farmers must start growing crops specifically to feed and fatten hogs, just like other livestock. At this point, the price of pork rises significantly. Whether it ends up higher or lower than beef or other meats depends on the local costs of feeding hogs compared to other animals. (In France, pork and beef prices are reportedly similar; in Great Britain, pork is currently somewhat more expensive). Impact of Fewer Small Landholders: The significant rise in hog and poultry prices in Britain is sometimes blamed on the decrease in the number of cottagers and other small farmers. These poorest farmers could easily keep a few pigs or poultry fed on scraps and by letting them forage, producing a supply at almost no cost. Reducing the number of these small producers certainly reduced this ‘free’ supply, likely causing prices to rise sooner and faster than they otherwise would have. However, as the country improved, prices would eventually have had to rise anyway to the level required to cover the cost of cultivating feed.

• Dairy Products: Dairy production also starts as a ‘save-all’. Farm cows naturally produce more milk than needed for their calves or the farmer’s family, especially during certain seasons. Milk is extremely perishable. Farmers preserve some by making butter (lasting a week or a year depending on salt content) and much more by making cheese (lasting several years). After family needs are met, the rest is sold. Any price received is usually better than letting it spoil. Low prices, however, lead to careless and unhygienic dairy practices (as was common in Scotland decades ago, and still persists in places). As the country develops and meat prices rise (due to higher demand and less free grazing land), the price of dairy products also rises, as it’s linked to the cost of feeding cattle. Higher prices justify more labor, care, and cleanliness. Dairying becomes a more serious part of the farm business, and quality improves. Eventually, prices rise high enough that it becomes profitable to use good cultivated land specifically for feeding dairy cows. England seems to have reached this stage in many areas; Scotland mostly has not, as dairy prices there are likely still too low to justify using prime land, reflected in generally lower quality compared to English dairy. Even where prices are high (England), dairy farming isn’t usually considered more profitable than growing grain or raising cattle for meat.

Rising Prices are Necessary for Improvement

A country’s land cannot be fully cultivated and improved until the price of every product that humans raise on it becomes high enough to cover the full cost of achieving that improvement. To do this, the price must be sufficient to:

1. Pay rent equivalent to what good grain land could earn (as this sets the benchmark).
2. Pay the farmer’s labor and expenses, including replacing their capital investment with a normal profit, just as is expected on good grain land.

This rise in the price of each specific product must happen before farmers will invest in improving land specifically for raising it. The goal of improvement is profit; nobody invests if the necessary result is a loss, which would happen if the product’s price couldn’t cover the costs of improved cultivation.

Therefore, rising prices for various types of raw land produce should not be seen as a public disaster. Instead, they are the necessary forerunner and companion of the greatest public advantage: the complete improvement and cultivation of the country’s land.

It’s also important to remember that this rise in the money price of these goods reflects a rise in their real price (their value in terms of labor and subsistence), not a fall in the value of silver. They cost more labor and subsistence to produce in an improved state, and therefore they command more labor and subsistence in exchange.

Third Sort: Products Where Supply Increase is Limited or Uncertain

The third and final category includes raw land products where human efforts to increase the quantity produced have limited or uncertain success.

• Price Trend: The real price of these goods also tends to rise as society improves. However, because the success of increasing supply is unpredictable (due to weather, disease, or other “accidents”), the price trend can be erratic. At similar stages of overall societal development, the price might sometimes fall, sometimes stay the same, or sometimes rise, depending on how successful efforts to increase supply happen to be in that period.

Example: Wool and Raw Hides

Some products are naturally linked to others, acting almost like by-products. Their supply is limited by the supply of the primary product.

• Supply Limitation: The amount of wool or raw hides a country can produce depends directly on the number of sheep and cattle raised there. This number, in turn, depends on the state of agriculture and land use.
• Market Difference vs. Meat: You might expect wool and hide prices to rise in proportion to meat prices as development progresses. This might happen if their markets were the same size. However, their markets are usually very different, especially in early stages:
  • The market for meat is almost always local. (Except for salted provisions, few countries export significant amounts of fresh meat).
  • The market for wool and raw hides, even from undeveloped countries, is often global. These materials are easily transported and are inputs for manufacturing industries in other, often wealthier, countries. Foreign demand can exist even when there is no local demand.
• Value Proportion: Consequently, in poorly developed countries with low meat demand, wool and hides make up a much larger proportion of the total value of the animal compared to developed countries where meat is in high demand. (Historical examples: Saxon England fleece value vs. sheep value; sheep killed only for fleece/tallow in parts of Spain; cattle killed only for hide/tallow in Spanish America and early Hispaniola before local meat demand rose).
• Price Trend with Improvement: As development raises the price of the whole animal (driven by meat demand), the price of the carcass increases much more significantly than the price of the wool or hide. The meat market expands with the local population. The wool/hide market, already global, doesn’t expand nearly as much just because one particular country improves. Therefore, wool and hide prices should not rise as much as meat prices. However, they should rise somewhat (as global commerce grows and local manufacturing might bring markets closer, reducing transport costs). They certainly shouldn’t fall.
• The English Anomaly: Despite this logic, the price of English wool has actually fallen significantly since the time of King Edward III, even though England’s wool manufacturing industry is highly successful. (The reasons for this anomaly involve government policies interfering with trade, which are discussed elsewhere in the book).

(Continuing the Third Sort: Products Where Supply Increase is Limited or Uncertain)

Example: Wool and Raw Hides (Continued)

• Wool Price History: There are reliable records showing that around 1339, during the reign of King Edward III, a standard unit of English wool (a “tod,” or 28 pounds) typically sold for ten shillings. This amount of shillings contained about six ounces of silver, worth roughly 30 shillings in today’s (late 18th century) money. Currently, 21 shillings is considered a good price for the same amount of high-quality English wool. So, the money price has fallen (from a value equivalent to 30 shillings down to 21 shillings). But the real price – what the wool could buy in terms of basic food – has fallen even more drastically. Ten shillings back then could buy about 12 bushels of wheat (based on contemporary wheat prices). Today, 21 shillings buys only about 6 bushels of wheat. This means a tod of wool in the mid-1300s could purchase twice the amount of subsistence (and therefore, command twice the amount of labor) compared to today.
• Cause of Wool Price Fall: This dramatic fall in the real value of wool wasn’t a natural market development. It was the result of deliberate government policies:
  1. A complete ban on exporting raw wool from England.
  2. Allowing wool to be imported from Spain without paying any duty (tax).
  3. Banning Ireland from exporting its wool to any country except England. These rules effectively trapped English wool within the domestic market, forcing it to compete against Spanish wool and imported Irish wool (much of which had to be sent to Britain because Irish wool manufacturing was also discouraged). Instead of expanding with England’s overall progress, the market for English wool was artificially confined.
• Hide Price History: There’s less historical data on raw hide prices compared to wool (which was often taxed or paid to the king). However, one account from 1425 gives us some prices: ox hides were valued at a price equivalent to about 4 shillings and 9 pence in today’s silver. While this nominal price was lower than today’s, the real price seems to have been slightly higher back then. Calculations based on contemporary wheat prices suggest an ox hide in 1425 could buy subsistence equivalent to about 10 shillings and 3 pence today. Currently, a similar good-quality hide costs only about 10 shillings. (Calf skins were valued very low back then, likely because calves were killed very young in times of low cattle prices to save milk).
• Factors Affecting Hide Prices: Hide prices fluctuate. They were lower recently due to changes in import duties (e.g., removing duty on sealskins, temporarily allowing duty-free imports from Ireland and the American colonies). Hides are also harder to transport and store than wool (salted hides are considered inferior), which tends to lower their price in countries that export raw hides and raise it in countries with leather manufacturing industries. British tanners haven’t been as politically successful as wool manufacturers; while raw hide exports are banned, imports face duties (though some temporary exceptions exist), and Ireland isn’t restricted solely to the British market for its hides.
• Impact of Policy on Meat Prices: Rules that artificially lower the price of wool or hides tend to raise the price of meat in developed countries. Farmers raising livestock on improved land need to earn a total price for the animal that covers the land’s rent and their profit. If they get less money for the wool and hide, they must get more money for the carcass to make raising the animal worthwhile. The total price is what matters to the farmer and landlord, not how it’s divided between parts. So, these regulations mainly affect consumers through higher meat prices. However, in undeveloped countries where most land is only suitable for grazing and wool/hides are the main source of the animal’s value, such rules would be disastrous for landowners and farmers. Lowering wool/hide prices wouldn’t raise meat prices (as the number of cattle raised wouldn’t change if there’s no alternative land use), but it would slash the total value of the animals, reducing rents and profits across most of the country. (A historical ban on English wool exports, if truly enacted early on, would have severely damaged the economy and hindered later improvement). Scotland Example: After the union with England, Scottish wool prices fell because wool could no longer be exported to Europe and faced English competition. This would have badly hurt southern Scotland (a sheep-farming area), but the simultaneous rise in cattle/meat prices (due to access to the English market) fully compensated for the loss.
• Conclusion on Wool/Hides: Efforts to increase wool or hide production are limited by the number of livestock a country supports (dependent on its agriculture). Supply is also uncertain because it relies on production in other countries and their potentially changing trade restrictions. Thus, wool and hides fit this third category.

Example: Fish

Fish also belong to this third sort of raw produce, where increasing supply is both limited and uncertain.

• Supply Limited: The amount of fish that can be brought to market is limited by:
  • The country’s geography (coastline length, distance from sea).
  • Number and size of lakes and rivers.
  • The natural “fertility” of those waters for fish.
• Real Price Rises: As population and wealth grow, demand for fish increases. To supply a larger market, fishermen usually have to go further out, use larger boats, and employ more expensive equipment. It takes more labor to catch each ton of fish. Therefore, the real price of fish tends to rise as a country develops. This seems to have happened in most countries.
• Supply Uncertain: While average catches over several years might seem predictable given a location, the “uncertainty” here refers to the weak connection between fishing success and the country’s overall state of economic improvement. Fishing depends much more on fixed geographical factors than on the level of industry or wealth, unlike farming. Productivity can be high in undeveloped countries and low in developed ones, or vice versa.

Example: Precious Metals

For precious metals (gold and silver), the ability of human industry to increase supply is not limited in the same way as wool or fish, but it is altogether uncertain.

• Quantity Depends On: The amount of gold and silver in any particular country depends less on whether it has its own mines and more on two key factors:
  1. The Country’s Purchasing Power: Its overall wealth and productivity determine how much labor and subsistence it can afford to spend acquiring luxury goods like gold and silver, either from its own mines or by importing them.
  2. The Fertility of the World’s Mines: The productivity of the mines currently supplying the global market significantly affects the availability and value of metals everywhere, because they are easily transported worldwide.
• Effects on Real Price:
  • Purchasing Power: As a country gets wealthier, it can afford to pay more (in labor/subsistence) for metals, tending to raise their real price, like other luxuries.
  • Mine Fertility: As global mines become more or less fertile, the real price of metals (the labor/subsistence they command) tends to fall or rise accordingly.
• Uncertainty of Mine Discovery: Global mine fertility has no direct link to any single country’s progress, or even necessarily to global progress overall. While exploring more of the world might increase the chances of finding new mines, discovering rich new deposits as old ones run out is fundamentally unpredictable. No amount of human skill or effort can guarantee success. Finding and successfully working new mines remains highly uncertain.
• Importance: Over the next century or two, new mines far richer than any known before might be discovered. It’s equally possible that the best mines then known might be poorer than those worked before the discovery of the Americas. However, which of these happens is of very little importance to the real wealth and prosperity of the world. The real value of the goods and services produced by mankind (the “annual produce of the land and labour”) would remain the same. Only the nominal value – the amount of gold and silver used to measure or represent that real wealth – would be drastically different.

(Mining Costs and Silver Value)

Why Mining Gets More Expensive Over Time

It is generally accepted that silver mining, like all mining, becomes more costly over the long run. Miners have to dig deeper, which increases the expense of pumping out water and providing fresh air.

Possible Effects of Higher Mining Costs

This rising cost of production is similar to the effect of silver becoming scarcer. It must eventually lead to one of three outcomes:

1. The higher cost is offset by a corresponding increase in the market price of silver.
2. The higher cost is offset by a corresponding decrease in the taxes charged on silver mining.
3. The higher cost is offset by a combination of both higher prices and lower taxes.

How Tax Cuts Affect Silver Value

When governments reduce taxes on silver, as Spain did in 1736, it allows less productive mines to continue operating. This increases the total supply of silver on the market, which tends to keep the value of silver lower than it would be if the higher taxes remained. The 1736 tax cut probably means silver’s value today is at least 10% lower than it would have been otherwise.

Author’s Tentative Conclusion: Silver Value Rose Slightly

Despite the effect of such tax cuts, the author suspects, based on the evidence of falling long-term average grain prices, that the value of silver has actually risen somewhat during the 18th century. He emphasizes this is a conjecture, not a certainty, as the rise has been very small and is open to debate. Some might still argue silver’s value continues to fall.

The Long-Term Balance: Consumption vs. Production

Theoretically, there must come a point where the world’s annual consumption and loss of precious metals equals the annual production from mines (assuming production isn’t always increasing). As the total stock of metals grows, consumption increases even faster because lower value leads to more widespread use and less careful preservation. If production were to then fall (due to mine exhaustion), consumption would exceed production, the total stock would shrink, and the value of metals would slowly rise until consumption fell back into balance with the lower production level. This provides a mechanism through which silver value could naturally rise over time.

Why Some Still Think Silver Value is Falling - Rebuttals

Despite the evidence suggesting stability or a slight rise, why might people believe silver’s value is still falling?

• Argument 1: Europe is Wealthier and Has More Silver.

  • The Mistake: People assume more wealth automatically means more silver, which must mean lower silver value.
  • The Rebuttal: This is wrong. Increasing wealth doesn’t lower silver’s value. Silver, like other luxuries, flows to rich countries because they offer a better price for it, not a lower one.

• Argument 2: Prices of Other Raw Goods Are Rising.

  • The Mistake: Seeing prices rise for meat, poultry, timber, minerals, etc., people assume silver must be losing value.
  • The Rebuttal: This is also wrong. As explained earlier, these other raw goods naturally become really dearer (cost more labor to produce) as society develops. Their rising money price reflects their own increasing real value, not a fall in silver’s value.

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CONCLUSION OF THE DIGRESSION ON SILVER VALUE

Key Takeaways:

Many writers have mistakenly assumed that low money prices for goods (meaning high silver value) in the past were proof that those countries were poor and undeveloped (“barbarous”). This idea is linked to the flawed economic theory (mercantilism, discussed later) that national wealth consists mainly of gold and silver.

• Silver Value Reflects Mine Fertility, NOT National Wealth: A high value of silver simply means that the mines supplying the world at that time were relatively unproductive (making silver scarce and valuable). It does not mean the countries using the silver were poor. Poor countries cannot afford to pay more for silver than rich countries. Indeed, silver’s value is often highest in the richest countries (like China compared to Europe) because they can afford to pay the best price. The fall in silver’s value after the discovery of American mines was due to the accidental discovery of abundant mines, not directly due to Europe’s simultaneous increase in real wealth (which came from different causes, like improved government and security for industry). Countries like Poland remained poor despite the influx of cheaper silver, while Spain and Portugal, which owned the mines, became relatively poor despite having the most silver (due to bad government). Low silver value doesn’t prove wealth, and high silver value doesn’t prove poverty.

• Relative Prices Reveal Development: While the general price level (like that of corn) only tells us about mine fertility, the relative prices of different goods compared to each other tell us a lot about a country’s development. Specifically, if goods like meat, poultry, and game are very cheap relative to corn, it strongly indicates an undeveloped country with vast amounts of uncultivated land compared to its population and capital – a society still in its “infancy.”

• Evidence Against Currently Falling Silver Value: The fact that prices for different goods have risen unequally in recent times argues against a simple fall in silver value (which would affect all prices equally). The explanations provided earlier (rising real costs for some goods) better account for these unequal price changes. Furthermore, the long-term data showing corn prices actually fell (relative to silver) during the first half of the 18th century contradicts the idea of continuously falling silver value. Recent high corn prices are best explained as temporary effects of bad weather.

Why Does This Distinction Matter?

One might ask: If my silver buys less food than it used to, what difference does it make whether silver got cheaper or food got dearer? It doesn’t help me at the market. While true for the individual shopper, the distinction is useful for understanding the bigger picture:

1. Indicator of National Prosperity: If rising prices are just due to falling silver value (more abundant mines), it says nothing about the country’s real economic health – it could be advancing or declining. But if rising prices of goods like meat reflect a rise in the real value of the land producing them (due to better farming and cultivation), it is a clear sign that the country is prospering and advancing. Understanding this provides proof of the increasing value of land, the most important part of national wealth.
2. Guiding Public Salary Adjustments: Knowing the cause of price changes helps regulate pay for public employees. If prices rise due to falling silver value, salaries should arguably increase proportionally to maintain the same standard of living. But if prices rise because of real improvements in land value (which also tend to lower the price of vegetable foods like potatoes while raising meat prices), then adjusting salaries requires more careful judgment about the overall change in the cost of living for different groups.

(Note on Taxes): The author also reminds us that the poor might suffer more from artificial price increases caused by taxes on manufactured necessities (salt, soap, candles, beer, etc.) than from natural rises in the price of raw food products in normal times.

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EFFECTS OF PROGRESS ON MANUFACTURED GOODS PRICES

General Rule: Improvement Lowers Real Price

The natural effect of economic progress and technological improvement is to gradually lower the real price of almost all manufactured goods.

• The cost of the workmanship involved decreases because of better machinery, increased worker skill (dexterity), and more efficient division of labor.
• These improvements mean much less labor is needed to produce each item.
• Even if the real price of labor (wages) rises due to overall prosperity, the huge reduction in the quantity of labor required usually more than compensates, leading to a lower real cost for the final product.

Exception: Rising Raw Material Costs

There are a few exceptions. If the real price of the necessary raw material rises significantly, this can outweigh any savings from improved manufacturing methods.

• Example: Woodwork: As countries develop, timber becomes scarcer and its real price rises. This necessary increase in the cost of wood can make products like carpentry and basic furniture more expensive, despite better tools and techniques.

General Trend: Manufactures Get Cheaper

However, in most cases, where the real price of the raw material either stays stable or doesn’t rise very much, the price of the manufactured commodity falls considerably over time due to improvements in production.

• Examples: Metal Goods: This price reduction has been most dramatic over the last century or two in goods made from common metals. A watch movement that cost £20 in the mid-17th century might cost only 20 shillings now (a twentieth of the price). Huge price reductions have occurred in cutlery, locks, metal toys, and general hardware (“Birmingham and Sheffield ware”), amazing manufacturers elsewhere in Europe. These industries allow for extensive division of labor and continuous machinery improvements.
• Example: Clothing: The price reduction in clothing hasn’t been nearly as significant during the same period. The price of high-quality cloth made from imported Spanish wool may have even risen slightly relative to its quality due to rising material costs. Cheaper cloth made from English wool has reportedly fallen somewhat in price relative to quality, but quality is hard to judge precisely. The methods used in cloth manufacturing (division of labor, machinery) haven’t changed dramatically in the last century, limiting the potential for large price reductions.

(Continuing Effects on Manufactured Goods Prices)

• Wool Cloth Price History: If we compare cloth prices today with those from the late 1400s, the reduction in real cost is undeniable.
  • Fine Cloth: A 1487 law set a maximum price for the finest woolen cloth at 16 shillings per yard (equal to about 24 shillings in today’s money). Since this law aimed to curb luxury spending, the actual price was likely even higher. Today, the highest price for similar cloth is around 21 shillings (a guinea). So, even if quality were the same (and today’s quality is probably better), the money price has fallen. The real price (what it cost in terms of basic food) has fallen much more dramatically. Back then, 16 shillings could buy more than two quarters (a large unit) of wheat. Today, 21 shillings buys less than one quarter. A yard of fine cloth in the late 1400s represented a cost in labor and subsistence equivalent to over £3 6s today.
  • Coarse Cloth: A 1463 law prohibited poor farm workers and servants from wearing cloth costing more than 2 shillings per yard (about 4 shillings today). Basic Yorkshire cloth today, likely much better quality, costs around 4 shillings. So the money price, adjusted for quality, might be a bit lower now. The real price is definitely much lower. Two shillings back then could buy over two bushels of wheat, worth about 8 shillings 9 pence today. A poor servant had to give up the equivalent of nearly nine shillings worth of subsistence for a yard of the cheapest cloth.
  • Stockings: The same 1463 law banned hose (stockings) costing more than 14 pence per pair (about 28 pence or 2s 4d today). That 14 pence could buy about 1.5 bushels of wheat, worth over 5 shillings today. This was an incredibly high real price for basic stockings for the poorest workers. (Knitting was likely unknown then; hose were made of woven cloth).
• Reasons for High Ancient Prices: Manufacturing methods were much less advanced back then. Key improvements since include:
  1. The spinning wheel replacing the older hand spindle (doubling output).
  2. Machines to simplify preparing yarn for the loom.
  3. Water-powered fulling mills to process cloth (replacing manual labor). These less efficient methods meant more labor was needed, making the real cost and price of cloth much higher. Additionally, coarse cloth was likely made part-time in households (coming cheaper to market), while fine cloth was imported from specialized makers in Flanders (adding import costs). These factors might also explain why coarse cloth was relatively cheaper compared to fine cloth back then than it is now.

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CONCLUSION OF THE CHAPTER: Improvement Raises Land Rent

To summarize this long chapter: Every improvement in society tends, directly or indirectly, to raise the real rent of land. This increases the real wealth of the landlord – their power to purchase the labor, or the products of the labor, of other people.

How Improvement Raises Rent:

• Directly:
  • Expanding farming and improving cultivation increases the total produce from land, and the landlord’s share (rent) naturally increases with it.
  • The rise in the real price of raw land products (like cattle), which results from improvement and encourages further improvement, also raises rent directly and even more significantly. When produce becomes more valuable, a smaller proportion of it is needed to cover the farmer’s costs (labor and profit), leaving a larger proportion (of a more valuable product) for the landlord.
• Indirectly:
  • Improvements that lower the real price of manufactured goods help landlords. Landlords trade their surplus raw produce (or the money from selling it) for manufactured items. When manufactures become cheaper, the same amount of raw produce buys more conveniences, ornaments, and luxuries.
  • Any increase in the real wealth of society (more useful labor being employed) tends to raise rent. More labor means more potential for land cultivation, leading to more produce and thus more rent.

The Opposite is Also True:

Neglecting cultivation, a fall in the real price of raw produce, a rise in the real price of manufactures (due to decaying industry), or a general decline in society’s wealth all tend to lower the real rent of land and reduce the landlord’s real wealth and purchasing power.

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Society’s Three Main Economic Groups

As mentioned before, the total value produced by a country’s land and labor each year naturally divides into three parts:

1. Rent of land (income for Landlords)
2. Wages of labor (income for Laborers)
3. Profits of stock/capital (income for Employers/Capitalists)

These three groups – those who live by rent, by wages, and by profit – are the three great, original groups in every civilized society. All other groups ultimately get their income from these three sources.

The Interests of the Three Groups:

• Landlords: Their interest is directly and inseparably linked to the general interest of society. Whatever helps or harms society helps or harms them. When considering new laws or regulations, landlords shouldn’t be able to mislead the public to benefit only themselves, if they properly understand their own interest. However, they often lack this understanding. Their income arrives without effort or planning on their part. This ease can lead to complacency (“indolence”), making them often ignorant of and unable to analyze the complex consequences of public policies.
• Laborers: Their interest is also strictly linked to society’s interest. Wages are highest when society is rapidly improving, barely sufficient when it’s stationary, and fall below subsistence when it declines. Laborers suffer most severely from societal decline. However, although their interest aligns with society’s, they typically lack the time, education, or background to fully grasp this connection or complex economic issues. Their voice in public debates is rarely heard or considered, except when employers stir them up for the employers’ own purposes.
• Employers (Living by Profit): This group includes merchants, manufacturers, and anyone who employs capital for profit. Their investments drive much of society’s productive labor. Their plans direct economic activity. However, their interest is not naturally aligned with the general interest of society in the same way as the other two groups. The rate of profit tends to be low in rich, prosperous countries and high in poor countries (and highest in those declining fastest).
  • Merchants and manufacturers are often the most influential people in this group due to their wealth. Because they spend their lives planning projects, they are often sharper and more knowledgeable about business than country gentlemen (landlords).
  • However, their focus is usually on their own specific business interests, not the broader interest of society. Even when seemingly honest, their judgment is more reliable regarding their business than regarding public welfare.
  • They often use their superior understanding of their own interests to persuade landlords (who may be less informed) to support policies that benefit the merchants at the expense of both the landlords and the public.
  • The interest of business owners in any particular trade is always, in some ways, different from, and even opposite to, the public interest. Businesses always want to expand the market (which can be good for the public) but also to narrow the competition (which is always bad for the public). Limiting competition allows businesses to raise profits above the natural level, effectively charging an unfair tax on everyone else for their own benefit.

A Warning:

Therefore, any new law or regulation concerning trade proposed by business owners should always be listened to with great caution. It should never be adopted without long and careful examination, with a critical and even suspicious eye. It comes from a group whose interests are never exactly the same as the public’s, who often have an interest in deceiving or even harming the public, and who, history shows, have often done both.

Okay, here is the simplified rewrite based only on the text provided in the prompt under the heading “DIFFERENT EFFECTS OF THE PROGRESS OF IMPROVEMENT UPON THREE DIFFERENT SORTS OF RUDE PRODUCE”, following all instructions including keeping the specified heading even if the content underneath doesn’t fully match it conceptually based on previous context.

DIFFERENT EFFECTS OF THE PROGRESS OF IMPROVEMENT UPON THREE DIFFERENT SORTS OF RUDE PRODUCE

(The Real Value of Money)

Imagine drastic changes in how much silver is available from mines.

• If silver became extremely abundant, a shilling might buy only what a penny buys now. Someone with a shilling then would be no richer than someone with a penny today.
• If silver became extremely scarce, a penny might buy what a shilling buys now. Someone with a penny then would be as rich as someone with a shilling today.

The only real advantage the world would get from abundant silver would be cheaper silverware and decorations. The only real problem from extreme scarcity would be the high cost and rarity of these minor luxury items. Real wealth wouldn’t change much either way.

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CONCLUSION OF THE DIGRESSION ON SILVER VALUE

Old Mistakes About Prices and Poverty

Many older writers looked at historical records showing low money prices for grain and other goods. They assumed this meant silver was very valuable (scarce) back then. They also concluded that countries with high silver value (low prices) must have been poor and undeveloped (“barbarous”).

This mistaken idea connects to an old economic theory (mercantilism) that said national wealth was based on having lots of gold and silver. (This theory will be examined in detail later in Book Four).

For now, the key point is: a high value of silver does not prove a country was poor or undeveloped. It only proves that the mines supplying the world with silver at that time were relatively unproductive, making silver scarce and valuable.

A poor country cannot afford to pay more for gold and silver than a rich country can. So, silver’s value isn’t likely to be higher in a poor country than in a rich one. In fact, China, a much richer country than any in Europe, has a higher value of silver (meaning silver buys more goods there).

Europe has become much wealthier since the discovery of the American mines, and the value of gold and silver has gradually fallen. However, this fall in value was caused by the accidental discovery of more abundant mines, not by Europe’s increase in real wealth (its production of goods and services). The rise in Europe’s wealth and the increase in its quantity of silver happened around the same time, but they came from very different causes and have little natural connection. Europe’s wealth grew because feudalism ended and better governments provided security for people to work and keep the rewards of their labor. The increase in silver came from luck.

Consider Poland: it still had a feudal system and was very poor, both before and after the discovery of America. Yet, the amount of silver increased there, and its value fell, just like elsewhere in Europe. This flood of cheaper silver did not improve Poland’s economy or the lives of its people. Spain and Portugal, the countries that owned the American mines, received the most silver but remained perhaps the two poorest countries in Europe (after Poland) because they had poor governments. Silver value is actually lowest in Spain and Portugal because the cost of exporting it (including transport, insurance, and smuggling costs) adds to its price elsewhere in Europe. Despite having the most silver relative to their economic output, they remained poor.

Conclusion on Value vs. Wealth:

• Low silver value (high prices) does not prove a country is wealthy and flourishing.
• High silver value (low prices) does not prove a country is poor and barbarous.

What Prices DO Tell Us About Development

While the general price level (like corn prices) only tells us about the state of the world’s mines, the relative prices of different goods compared to each other can tell us a lot about a country’s development.

Specifically, if raw goods like cattle, poultry, and game are very cheap compared to corn, it strongly indicates an undeveloped country. It shows:

1. These items were abundant relative to corn, meaning vast areas of land were uncultivated pasture or wilderness.
2. This uncultivated land had low value compared to the small amount of land used for growing corn.
3. The country’s population and capital were small relative to its territory – signs of a society in its early stages (“infancy”).

So, by comparing the money prices of different types of goods, we can reliably infer whether a country was rich or poor, improved or unimproved, civilized or barbarous. The overall price level just tells us about the mines.

Recent Price Rises: Not Just Silver Value

If a fall in silver’s value were the only cause of rising prices, all goods should rise in price equally (by the same percentage). However, the recent rise in the price of food (“provisions”) that people talk about hasn’t affected all foods equally. Even those who blame falling silver value admit that corn prices have risen much less than the prices of some other foods (like meat).

Therefore, the rise in those other food prices cannot be solely due to falling silver value. Other causes must be involved – namely, the rise in the real cost of producing those specific goods, as explained earlier. This rise in their real cost is likely enough to explain their price increases without needing to assume silver’s value is still falling.

Corn Price Recap:

Remember, the average price of corn itself was actually lower during the first 64 years of the 18th century compared to the last 64 years of the 17th century (before the recent run of bad seasons). This is confirmed by multiple sources across Britain and France.

Recent High Corn Price Recap:

The recent high corn prices (in the 1760s and early 1770s) can be fully explained by the unusually bad weather, without needing to assume silver’s value is falling. Therefore, the opinion that silver value is still continuously sinking seems unfounded based on the price evidence for both corn and other foods.

Why Does This Distinction (Real vs. Nominal Price) Matter?

Someone might ask: “If my silver buys less food than before, who cares whether silver got cheaper or food got dearer? It doesn’t help me buy more.”

While knowing the distinction won’t make your money go further, it’s still useful for understanding the economy:

1. Indicator of National Prosperity:
   • If rising prices are caused only by falling silver value (due to fertile mines), it tells us nothing about the country’s real economic health. The country could be declining (like Poland or Portugal) or advancing.
   • But if rising prices (especially for things like meat) are caused by a rise in the real value of the land needed to produce them (because land is being improved and put to better use), then it is a clear sign the country is prospering and advancing. Understanding this provides proof of the increasing value of land – the most important part of a nation’s wealth.
2. Guiding Public Salary Adjustments:
   • If prices rise because silver’s value falls, then public servants’ money salaries should probably increase proportionally to maintain their real standard of living.
   • But if prices rise because of changes in the real cost of different goods (e.g., improved farming making meat dearer but vegetables cheaper), then adjusting salaries is more complex. You need to consider how the overall cost of living changes when some necessary goods get cheaper while others get dearer. (For example, once meat prices peak, rises in luxury foods like poultry or fish might affect the poor less than the fall in the price of essentials like potatoes helps them).

(Note on Taxes): In difficult times, the poor might suffer more from taxes that artificially raise the price of manufactured necessities (like salt, soap, leather, candles, beer) than from natural rises in the price of raw foods during normal times.

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EFFECTS OF PROGRESS ON MANUFACTURED GOODS PRICES

General Rule: Improvement Lowers Real Price

However, the natural effect of economic progress and improvement is to gradually lower the real price of almost all manufactured goods.

• The cost of the workmanship decreases because of better machinery, increased worker skill (dexterity), and more efficient division of labor. All these are natural results of improvement.
• These advances mean much less labor is needed to make each item.
• Even if the real price of labor (wages) rises due to prosperity, the large reduction in the quantity of labor required usually more than outweighs even a large rise in wages. The result is a lower real cost for the final product.

Exception: Rising Raw Material Costs

There’s an exception: if the real price of the raw material used in a manufacture rises significantly, this increased cost can cancel out, or even outweigh, the savings from better manufacturing methods.

• Example: Woodwork: As countries develop, timber becomes scarcer and its real price rises. This makes products like carpentry and basic furniture more expensive, offsetting improvements in tools and techniques.

General Trend: Manufactures Get Cheaper

But in most cases, where the real price of the raw material stays stable or doesn’t rise much, the price of the finished manufactured good falls considerably over time.

• Examples: Metal Goods: This price reduction has been most dramatic over the last one or two centuries in goods made from common metals. A watch movement might now cost only one-twentieth of what a similar quality one cost in the mid-1600s. Cutlery, locks, metal toys, and general hardware (“Birmingham and Sheffield ware”) have also seen huge price drops, amazing European competitors who often can’t produce similar quality for twice or triple the price. These industries allow for great division of labor and machinery improvements.
• Example: Clothing: The price reduction in clothing has been much less noticeable during the same period. The price of high-quality woolen cloth (made from imported Spanish wool) has reportedly even risen somewhat recently relative to quality, due to higher material costs. Cheaper cloth (from English wool) has reportedly fallen somewhat in price relative to quality, but judging quality precisely is difficult. The methods (division of labor, machinery) used in cloth making haven’t changed dramatically in the last century, allowing only small improvements and price reductions.

More Evidence: Historical Cloth Prices

The reduction in the real price of clothing becomes much clearer if we compare today’s prices with those from the late 1400s, when labor was less specialized and machinery was cruder.

• Fine Wool Cloth: A 1487 law set a maximum price for the finest woolen cloth. That price, adjusted for the silver content of money then versus now, was significantly higher than even the highest price for fine cloth today. When measured against the price of wheat (representing basic subsistence), the real cost was enormous: a yard of fine cloth back then cost the equivalent of over £3 6s in today’s purchasing power. The real price has fallen dramatically.
• Coarse Wool Cloth: A 1463 law set a maximum price for the basic cloth worn by the poorest servants. That price, adjusted for silver content, is similar to the money price of probably much better quality basic cloth today. However, the real price was much higher back then. Measured against wheat prices, that yard of basic cloth cost the poor servant the equivalent of nearly 9 shillings in today’s purchasing power. Since this was a law limiting extravagance, their usual clothing was likely even more expensive relative to their means.
• Stockings: The same 1463 law limited the price of hose (stockings) for the poor. The real price, measured against wheat, was equivalent to over 5 shillings today – an extremely high price for basic stockings for the lowest class of worker. (This was likely before knitting was common, and stockings were made of simple woven cloth).

Manufacturing Improvements Recap:

The machinery used in wool manufacturing was much more primitive in those ancient times. Three major improvements since then are:

1. The spinning wheel replacing the hand spindle (more than doubling output).
2. Machines to simplify preparing yarn for the loom.
3. Water-powered fulling mills to process cloth instead of manual treading. (Wind and water mills were generally unknown in northern Europe in the early 1500s).

These less efficient methods explain why the real price of both fine and coarse cloth was so much higher back then. More labor was needed to make the goods, so they commanded the price of more labor when sold.

Production Methods Then vs. Now:

Coarse cloth in ancient England was likely made as a household activity, with family members doing different tasks part-time when not busy with other work. Goods made this way typically come to market cheaper than those made by full-time specialized workers. Fine cloth, however, was made in specialized workshops in Flanders (a rich commercial area then) by people earning their living from it, much like today. It also had to pay import duties. (Early European policy often encouraged importing manufactures for the wealthy elite).

These differences in production methods might help explain why coarse cloth was relatively cheaper compared to fine cloth back then than it is now.

CHAPTER I: How People Use Their Possessions (Stock)

Basic Survival: Living Day-to-Day

When people only have enough possessions (stock) to support themselves for a few days or weeks, they usually don’t think about using those possessions to earn an income (revenue). They use what they have as carefully as possible. They work hard to earn more before their small stock runs out completely.

In this situation, their only income comes from their labor. This is the reality for most poor working people in all countries.

Using Extra Stock to Earn Income

But when people have enough stock to support themselves for months or years, they naturally want to use most of it to earn some revenue. They set aside only enough for their immediate needs until that revenue starts coming in.

So, their total stock is divided into two main parts:

1. Capital: This is the part they expect to use to generate revenue or profit.
2. Stock for Immediate Consumption: This is the part used for daily living until the revenue arrives. This consumption stock comes from three places:
   • The portion originally saved for this purpose.
   • Income (revenue) as it is received.
   • Things bought previously that haven’t been fully used up yet (like clothes, furniture, etc.).

Two Types of Capital: Circulating and Fixed

There are two main ways people can use their capital to earn revenue or profit:

1. Circulating Capital: Capital can be used to grow, make, or buy goods, which are then sold later for a profit. This type of capital doesn’t earn anything while the owner holds onto it or keeps it in the same form. For example, a merchant’s goods don’t make profit until sold for money, and the money makes no profit until used to buy more goods. The capital must constantly “circulate” – going out from the owner in one form (like money) and returning in another (like goods, which are then sold). Profit is made only through this circulation or series of exchanges. This type of capital is called circulating capital.
2. Fixed Capital: Capital can also be invested in things that generate revenue or profit without needing to be sold or circulated further. Examples include improving land, buying useful machines or tools, or constructing useful buildings. This type of capital stays with the owner and provides value through its use. This is called fixed capital.

Fixed vs. Circulating Capital in Different Businesses

Different types of businesses require different combinations of fixed and circulating capital.

• Merchant: A merchant’s capital is almost entirely circulating capital, constantly used to buy and sell goods. Their shop or warehouse might be considered their only fixed capital.
• Artisan/Manufacturer: Skilled craftspeople and manufacturers need some fixed capital for their tools (like a tailor’s needles or a weaver’s loom), though the amount varies greatly. However, the largest part of their capital is usually circulating – used to pay workers’ wages and buy raw materials. This circulating capital returns with a profit when the finished products are sold.
• Heavy Industry/Mines: Some businesses require enormous fixed capital. For example, large ironworks need expensive furnaces and mills. Mines often need even more expensive machinery for pumping water and other operations.
• Farmer: A farmer uses both types of capital:
  • Fixed Capital: Tools (plows, etc.), work animals (like horses or oxen - profit comes from keeping and using them), improvements to land, seeds (profit comes from their increase, not sale).
  • Circulating Capital: Money for workers’ wages and food, feed for work animals, animals bought specifically to be fattened and sold (profit comes from selling them), feed for breeding animals (profit comes from selling their wool, milk, or offspring).

A Society’s Total Stock: Three Main Parts

The total stock of a country is simply the sum of the stock owned by all its inhabitants. This national stock naturally divides into three main portions:

Part 1: Reserved for Immediate Consumption

• Purpose: Used directly by people to satisfy their needs and wants.
• Characteristic: Does not generate revenue or profit.
• Includes: Stocks of food, clothes, furniture, etc., that people have bought but haven’t used up yet. It also includes all dwelling houses.
• Why Houses are Consumption Stock: A house lived in by its owner provides shelter (which is useful) but doesn’t generate income for the owner, similar to clothes or furniture. It’s part of their expense, not revenue. If a house is rented out, the landlord receives revenue (so the house acts as capital for them), but the tenant must pay the rent from income earned elsewhere (from labor, other capital, or land). The house itself doesn’t add to the total income of society. (Similarly, renting out clothes or furniture provides revenue for the owner but relies on the renter’s other income). Houses are consumed very slowly, but they are still ultimately part of the stock used for consumption.

Part 2: Fixed Capital

• Purpose: To enable or increase production and generate revenue.
• Characteristic: Provides revenue or profit without circulating or changing owners frequently.
• Includes Four Main Types:
  1. Machines and Tools: All useful equipment that makes labor easier or more productive.
  2. Useful Buildings: Structures used for business purposes that help generate revenue, such as shops, warehouses, factories, farm buildings (barns, stables), etc. These are different from houses used only for living; they function as instruments of trade.
  3. Land Improvements: Investments made to improve land for farming, such as clearing, draining, fencing, and fertilizing. An improved farm acts like a useful machine, making labor more productive and lasting a long time with proper maintenance (which is part of farming).
  4. People’s Skills and Abilities (Human Capital): The valuable talents and skills acquired by people through education, training, and apprenticeships. Acquiring these abilities costs time and money (an investment). These skills are fixed within the person, benefit both the individual and society, and function like tools by making labor more productive.

Part 3: Circulating Capital

• Purpose: To facilitate production and trade, generating revenue through turnover.
• Characteristic: Provides revenue only by circulating – being sold, changing form, or changing owners.
• Includes Four Main Types:
  1. Money: The tool used to circulate all the other parts of capital and consumption goods.
  2. Stock of Provisions: Food and other consumable goods held by dealers (butchers, farmers, grain merchants, brewers) waiting to be sold for profit.
  3. Stock of Materials: Raw materials (like wool, timber, ore) or semi-finished goods held by growers, manufacturers, or merchants, waiting to be processed or sold.
  4. Stock of Finished Work: Completed goods held by manufacturers or merchants waiting to be sold to the final consumers (like items in shops).

In short, circulating capital consists of the inventory of provisions, materials, and finished goods held by businesses, plus the money needed to move these items to their final users.

How the Types of Capital Work Together

These different parts of a society’s stock are interconnected:

• Fixed Capital Depends on Circulating Capital: All fixed capital (machines, buildings, improvements) is originally created using circulating capital (which pays for the materials and the workers who make them). Fixed capital also requires ongoing circulating capital for maintenance and repairs.
• Revenue Depends on Circulating Capital: Fixed capital cannot generate revenue on its own. Machines need materials (circulating capital) to process and workers (paid by circulating capital) to operate them. Improved land needs laborers (paid by circulating capital) to cultivate it and gather its produce.
• The Goal is Consumption: The ultimate purpose of both fixed and circulating capital is to maintain and increase the stock reserved for immediate consumption. This consumption stock is what feeds, clothes, and houses the population. A country’s wealth or poverty depends on how abundantly its capital can supply these essential consumption goods.
• Replenishing Circulating Capital: Because parts of the circulating capital (provisions, materials, finished goods) are constantly being withdrawn to become either fixed capital or consumption goods, it needs continuous replenishment. These supplies come mainly from the primary productive sectors: land (farming), mines, and fisheries. These sectors provide the raw provisions and materials that replace those used up. Mines also supply the metals needed to maintain the money supply.
• The Cycle of Production: Farming, mining, and fishing themselves require both fixed and circulating capital. Their output not only replaces their own capital (with profit) but also replaces the capital used in all other sectors of society. For example, the farmer replaces the food and materials used by the manufacturer, while the manufacturer replaces the tools and finished goods used by the farmer. This exchange usually happens indirectly using money, rather than direct barter. Ultimately, the produce of the land enables resources to be extracted from mines and fisheries.

(Productivity Note): The output from land, mines, and fisheries depends on the amount and effectiveness of the capital used, as well as their natural fertility.

Using Stock Wisely (in Secure Societies)

In countries with reasonable safety and security, any sensible person will use whatever stock they have in one of three ways:

1. For immediate enjoyment (consumption stock).
2. To earn future profit by keeping an asset (fixed capital).
3. To earn future profit by buying and selling (circulating capital).

Only someone irrational would fail to employ their stock in one of these ways if their property is secure.

Hoarding Stock (in Insecure Societies)

However, in unstable countries where people constantly fear violence or theft from those in power, they often bury or hide a large part of their stock. They want to keep it easily accessible to take with them if they need to flee quickly. This is reported to be common practice in places like Turkey, India, and other parts of Asia, and it was likely common in Europe during the insecure feudal period.

The concept of treasure-trove reflects this past insecurity. Treasure-trove referred to valuables found hidden in the earth with no traceable owner. It was considered an important source of revenue for kings, belonging to the ruler unless specific rights were granted to the landowner.

Hidden treasure was treated legally in the same way as gold and silver mines. Owning a piece of land did not automatically mean you owned any gold or silver mines found on it. Those rights had to be specifically granted in the land ownership documents (the charter).

This was different from mines for more common resources like lead, copper, tin, or coal. These were generally considered less important and were usually included in the general ownership of the land.

CHAPTER II

Money as Part of Society’s Resources, and the Cost of Keeping the Economy Going

The Price of Goods and National Income

In Book One, we learned that the price of most things you buy is made up of three parts:

1. Wages: Paying the workers involved.
2. Profits: The return for the business owners who invested their resources (stock).
3. Rent: Paying the owner of the land used.

Sometimes, a price might only cover two of these, like wages and profits. Very rarely, it might just be wages. But every price breaks down into one, two, or all three of these parts. Any part of the price that isn’t wages or rent must be profit for someone.

This isn’t just true for one specific item; it’s true for everything a country produces in a year. If you add up the value of all goods and services produced annually (the annual produce), that total value also splits into these same three parts: wages, profits, and rent. This value is shared among the country’s people as their income.

Gross vs. Net Income: What Really Counts

Even though the total value of everything produced becomes income for the people, we need to make a distinction, just like we do with rent from a private property.

• Gross Rent: This is the total amount a farmer pays to rent land.
• Net Rent: This is what the landlord actually has left after paying for managing the property, repairs, and other necessary costs. It’s the amount the landlord can spend on personal enjoyment (food, furniture, entertainment) without harming the property’s value. A landlord’s real wealth depends on their net rent, not the gross rent.

We can apply the same idea to the income of everyone in a country:

• Gross Revenue: This is the total value of everything the country’s land and labor produces in a year.
• Net Revenue: This is what remains after subtracting all the costs needed to keep the economy running. Specifically, it’s the cost of maintaining:
  1. The country’s fixed capital (like machines and buildings).
  2. The country’s circulating capital (like money, materials, and goods being processed or ready for sale).

The net revenue is the amount people can actually use for their own needs, wants, and pleasures (immediate consumption) without eating into the country’s capital base. A country’s real wealth is measured by its net revenue, not its gross revenue.

Maintaining Capital Reduces Net Revenue

1. Fixed Capital Costs

The cost of maintaining the fixed capital must definitely be taken out when calculating a society’s net revenue. Think about machines, tools, and useful buildings.

• The materials needed to repair them are not part of net revenue.
• The work needed to shape those materials and do the repairs is also not part of net revenue.

These resources are used for upkeep, not for people’s direct consumption.

However, the wages paid to the workers doing these repairs can be part of net revenue. Why? Because those workers will likely use their wages to buy things for their own consumption (food, clothes, etc.).

But for other types of work (like making consumer goods), both the wages and the product itself contribute to the stock for immediate consumption – the wages go to the workers, and the product goes to other people who enjoy it.

The Purpose and Benefit of Fixed Capital

Why have fixed capital like machines and buildings? Their main goal is to make labor more productive. They allow the same number of workers to produce much more.

• Example 1: Farming: A farm with good buildings, fences, and drainage will produce much more with the same number of workers and animals than a similar farm without these improvements.
• Example 2: Manufacturing: A factory with efficient machinery allows workers to produce far more goods than if they used basic tools.

Money spent wisely on fixed capital usually brings back a large profit. It increases the total annual production by much more than the cost of maintaining those improvements. However, maintenance does cost something. Resources (materials and labor) that could have been used to make food, clothing, or housing are instead used to maintain the machines and buildings.

This is why new inventions that let workers do the same job with cheaper and simpler machines are always seen as good for society. Resources previously tied up in maintaining complex, expensive machinery are freed. These saved resources can then be used to produce even more goods.

• Example: Imagine a factory owner spending $1,000 per year maintaining machines. If a new invention cuts this cost to $500, the owner will likely use the saved $500 to buy more materials and hire more workers. This increases the factory’s output and benefits society.

Comparing Fixed Capital Costs to Estate Repairs

The cost of maintaining a nation’s fixed capital is like the cost of repairs on a private estate. Repairs are often needed to keep the estate productive and maintain the landlord’s rent (both gross and net). If the landlord finds a way to reduce repair costs without lowering the estate’s output, the gross rent stays the same, but the net rent automatically increases.

2. Circulating Capital Costs

While maintaining fixed capital always reduces net revenue, it’s different for circulating capital. Remember, circulating capital includes four parts:

1. Money
2. Provisions (like food for workers)
3. Materials (raw or semi-finished)
4. Finished Work (goods ready for sale)

We already noted that the last three parts (provisions, materials, finished work) are constantly taken out of circulation. They are either used up to maintain fixed capital or they become part of people’s immediate consumption stock. Anything not used for fixed capital maintenance directly contributes to society’s net revenue (as goods people consume).

So, maintaining these three parts of circulating capital doesn’t reduce the net revenue, beyond the costs already accounted for under fixed capital maintenance.

Society’s vs. Individual’s Circulating Capital

There’s a key difference here:

• Individual: An individual’s circulating capital (like a shopkeeper’s inventory) is not part of their personal net revenue. Their net revenue comes only from the profit they make selling those goods.
• Society: Even though an individual’s circulating capital is part of the society’s total circulating capital, it can still contribute to the society’s net revenue. When customers buy the shopkeeper’s goods using income from other sources, those goods become part of the customers’ consumption (and thus society’s net revenue). This happens without reducing the shopkeeper’s capital (as they get paid) or the customers’ capital.

Money: The Exception in Circulating Capital

This leads to a crucial point: Money is the only part of society’s circulating capital where the cost of maintaining it does reduce the society’s net revenue.

Comparing Money and Fixed Capital

Money (as part of circulating capital) and fixed capital share some important similarities in how they affect society’s revenue:

Similarity 1: Both Have Costs That Reduce Net Revenue

• Fixed Capital: Machines and tools cost money to build and maintain. These costs are subtracted from society’s net revenue.
• Money: Getting and keeping a stock of money (like gold and silver coins) also has costs. Mining precious metals and minting coins require valuable materials and skilled labor. These resources could have been used to produce goods for immediate consumption. Instead, they are used to maintain money, the essential tool for commerce that helps distribute goods to everyone. These costs of maintaining the money supply are also subtracted from society’s net revenue.

Similarity 2: Neither Is Part of Revenue Itself

• Fixed Capital: Machines and tools are capital, not revenue. They help create revenue (goods), but they aren’t the revenue themselves.
• Money: Similarly, money is the “great wheel of circulation” – the tool used to distribute revenue (goods) among people. But the money itself is not the revenue. Society’s revenue consists of the goods that are circulated, not the wheel (money) that circulates them. When calculating a society’s gross or net revenue, we must always subtract the value of the money itself. Not one penny of the money stock counts as revenue.

Understanding the Role of Money vs. Its Value

This idea might seem confusing because of how we talk about money.

• Sometimes, when we say “money,” we just mean the physical coins or bills. Example: “The UK has £18 million in circulation” refers to the estimated amount of metal pieces.
• Other times, “money” refers to the purchasing power – the goods and services it can buy. Example: “He is worth £100 a year” usually means the value of goods he can buy or consume annually, describing his standard of living.

When we use money to mean purchasing power, the actual wealth or revenue is equal to the goods you can get (the “money’s worth”), not the physical money itself.

• Example: If someone gets a one-guinea coin each week, their real weekly revenue isn’t the coin plus the goods it buys. It’s just one of those things – specifically, the goods (the guinea’s worth).
• Another Example: If the payment was a paper note for a guinea, the revenue is clearly what the note can buy, not the paper itself. A guinea coin acts like a voucher exchangeable for goods. Its value lies in what it can be exchanged for. If it couldn’t buy anything (like a check from a bankrupt person), it would be worthless.

Applying This to Society’s Revenue

This applies to the whole country too. Everyone’s income might be paid in money. But the real total revenue of the country is the amount of consumable goods that all this money can buy. The total revenue isn’t the money and the goods; it’s just the goods (or the power to purchase them).

We often express income in money terms (like dollars or pounds) because money measures purchasing power. But we understand that the actual revenue is the ability to consume goods, not the coins or bills that provide that ability.

This is even clearer for a society than for one person.

• An individual’s income might match the amount of cash they receive.
• But the total amount of physical money circulating in a society is always much smaller than the total value of all incomes paid. Why? Because the same coin or bill is used over and over again. A guinea used to pay one person today might pay someone else tomorrow, and another person the day after.

Therefore, society’s revenue cannot be the physical money (which is too small). It must be the purchasing power – the goods that are bought as the money circulates from person to person.

Conclusion on Money’s Role

So, money – the great tool of commerce – is like any other tool (fixed capital). It’s a valuable part of a nation’s capital, but it is not part of its revenue. Although the physical money distributes revenue to each person, the money itself isn’t part of that revenue.

Similarity 3: Saving Costs Boosts Net Revenue

• Fixed Capital: Any saving in the cost of building or maintaining machines (that doesn’t reduce productivity) improves society’s net revenue.
• Money: Similarly, any saving in the cost of collecting and maintaining the money supply (the part of circulating capital that is money) is an improvement of the exact same kind.

We’ve already seen how saving on fixed capital costs boosts net revenue. A business owner’s capital is split between fixed capital (machines) and circulating capital (materials, wages). If they can spend less on maintaining machines without losing output, they have more circulating capital available. Circulating capital is what buys materials and pays wages, putting industry into motion. So, saving on fixed capital increases the funds available to produce more, boosting the annual output and the real revenue of society.

The Benefit of Paper Money

Using paper money instead of gold and silver coins replaces a very expensive tool of commerce with a much cheaper one, which can be just as convenient. The economy gets a new “wheel of circulation” that costs less to build and maintain than the old metal one.

How exactly this works, and how it increases both the gross and net revenue of society, isn’t immediately obvious and needs more explanation.

There are different kinds of paper money. The most common type used for this purpose is circulating notes issued by banks and bankers.

How Paper Money Works: Trust and Banking

When people trust a specific banker – believing the banker is wealthy, honest, and careful – they accept the banker’s promissory notes (like IOUs) as if they were gold or silver. This trust comes from the belief that they can always exchange the note for actual coins whenever they want.

Imagine a banker lends out $100,000 worth of these personal notes to customers. Since these notes work just like money for buying things, the customers pay the banker interest, the same as if they had borrowed actual gold and silver coins. This interest is how the banker makes money.

Even though people constantly bring some notes back to the bank to exchange for coins (payment), many notes keep circulating in the economy for months or even years. So, even if the banker has $100,000 in notes circulating, they might only need $20,000 in actual gold and silver coins in their vault to handle the day-to-day demands for exchanges.

Through this banking operation:

• $20,000 in gold and silver can do the work that $100,000 in coins would otherwise have done.
• The same amount of goods can be bought, sold, and distributed using the banker’s $100,000 in notes as could have been done with $100,000 in coins.
• This means $80,000 worth of gold and silver is no longer needed for circulation within the country.

If many banks do this at the same time, a large portion of the country’s business might be done using paper notes. The country might only need, say, one-fifth of the gold and silver coins it used before.

What Happens When Paper Money Replaces Coins?

Let’s use an example:

1. Suppose a country initially needs $1 million in gold and silver coins to circulate all the goods produced annually.
2. Then, banks start issuing $1 million in paper notes (payable on demand).
3. To cover demands, the banks keep $200,000 in gold and silver in their vaults (their reserves).
4. Now, the country has $800,000 in coins still circulating plus $1 million in paper notes, for a total of $1.8 million in circulation ($800k coins + $1M paper).

But wait – the country’s economy hasn’t suddenly grown. It still only needs $1 million to circulate the same amount of goods as before. The “channel of circulation” can only hold $1 million.

So, what happens to the extra $800,000? It’s like pouring too much water into a pipe – it overflows. This excess $800,000 cannot be used for circulation at home.

Since this money is too valuable to sit idle, it will be sent abroad to find profitable uses it can’t find domestically.

• The paper notes cannot go abroad. People in other countries won’t accept them because they are far from the issuing banks and the laws enforcing payment.
• Therefore, the $800,000 in gold and silver coins is what gets sent out of the country.

The result? The country’s domestic circulation channel remains filled with $1 million, but now it’s $1 million in paper notes instead of the $1 million in gold and silver coins it held before.

What Happens to the Exported Gold and Silver?

This gold and silver sent abroad isn’t given away for free. The owners exchange it for foreign goods. These goods are then used either:

1. In the carrying trade: Buying goods in one foreign country to sell in another foreign country for profit.
2. For home consumption: Bringing the foreign goods back to be used within the home country.

Using Exported Gold for Foreign Trade

If the gold is used for the carrying trade, any profit made adds to the home country’s net revenue. It’s like creating a new source of funds specifically for international trade, made possible because domestic trade is now handled by paper money.

Using Exported Gold for Home Consumption

If the gold buys foreign goods for people back home to use, there are two possibilities:

1. Buying Luxury Goods: The money could buy things like foreign wines or silks, typically consumed by “idle people” who don’t produce goods themselves.
2. Buying Productive Goods: The money could buy additional materials, tools, and food (provisions) needed to employ more industrious people. These workers produce goods, creating value that covers their own consumption plus a profit.

Impact of How Exported Gold is Used

• Buying Luxuries: Using the exported gold this way encourages wasteful spending (prodigality). It increases consumption without increasing production. It doesn’t create any lasting way to pay for this spending and is generally harmful to society.
• Buying Productive Goods: Using the gold this way promotes industry. Although it increases consumption (workers need to eat and live), it also provides the means to sustain that consumption. The workers produce more value than they consume. This increases:
  • The gross revenue (total annual production) by the value the workers add.
  • The net revenue by the value added, minus the cost of maintaining the tools they use.

Which Use is More Likely?

It seems most likely that the majority of gold and silver forced abroad by banking will be used in the second way – buying productive goods. Here’s why:

• While individuals might sometimes overspend, large groups or classes of people generally don’t increase their spending unless their income also increases. Basic common sense usually guides the majority.
• The introduction of paper money doesn’t automatically increase the income of “idle people” (those living off rent or investments, not actively producing).
• Therefore, their demand for foreign luxury goods likely won’t increase significantly just because banks issued more paper.
• Most of the exported gold will naturally be used to employ productive labor, not support idleness.

What Really Fuels Industry?

When we think about how much industry a society’s circulating capital can support, we should only consider the parts that are provisions, materials, and finished work. The part that is money simply helps circulate the other three parts and must be subtracted from the calculation.

To get industry going, you need three things:

1. Materials to work on.
2. Tools to work with.
3. Wages (or payment) for the work, which represent the maintenance (food, shelter, etc.) the worker needs.

Money itself isn’t a material or a tool. And while wages are paid in money, a worker’s real income (like everyone’s) isn’t the metal coins but what those coins can buy – the money’s worth.

The amount of industry a capital can employ depends on how many workers it can supply with materials, tools, and maintenance. Money might be needed to buy these things, but the actual capacity for industry lies in the real resources purchased, not in the money itself.

How Paper Money Boosts Industry

When paper money replaces gold and silver, the country can increase the amount of materials, tools, and maintenance available for its workers. The increase is equal to the value of the gold and silver coins that are no longer needed for circulation.

It’s like taking the value of the “great wheel of circulation” (the money) and adding it to the goods that the wheel helps circulate.

Think of a factory owner who installs better, cheaper machines. They take the money saved (the difference between the old machines’ price and the new ones’) and add it to their circulating capital – the funds used to buy materials and pay wages. Replacing gold with paper has a similar effect on the whole economy.

How Much Money Circulates?

It’s hard to say exactly what fraction of a country’s total annual production value is represented by the circulating money. Estimates have varied wildly, from one-fifth (20%) down to one-thirtieth (about 3%).

But whatever the fraction is, consider this: only a part of the total annual production is used to maintain industry (buy materials, tools, pay productive wages). Circulating money must make up a significant portion of that specific part.

So, when paper money allows a country to reduce its needed gold and silver to, say, one-fifth of the previous amount, the other four-fifths are freed up. If most of that freed-up value is added to the funds used to support industry, it creates a very large boost to the amount of industry, and therefore, to the total value of goods produced annually.

The Example of Scotland

This exact process happened in Scotland over the 25-30 years before this was written. New banks were set up in many towns and even some villages.

The results were just as described:

• Almost all business is now done using paper notes from these banks.
• Silver coins are rarely seen, except for small change. Gold coins are even rarer.
• Although some banks haven’t always acted perfectly (requiring Parliament to step in with regulations), the country has clearly benefited greatly from this change.

People claimed that trade in Glasgow doubled within about 15 years after its first banks appeared. They also claimed that Scotland’s overall trade more than quadrupled since the first two major banks were set up in Edinburgh (Bank of Scotland in 1695, Royal Bank in 1727).

Whether the growth was that extreme is hard to know for sure, and banking alone might not explain such rapid growth if it did occur. But it’s undeniable that Scotland’s trade and industry grew significantly during this period, and the banks played a major role in that growth.

Scotland’s Money Supply: Then and Now

• Before 1707 (Union with England): Scotland’s total circulation was estimated to be at least £1 million sterling, mostly in gold and silver coins. Paper money from the Bank of Scotland existed but was a small part.
• Present Time (around 1776): Scotland’s total circulation is estimated at £2 million sterling. However, the gold and silver part is probably less than £500,000.

Even though the amount of gold and silver drastically decreased, Scotland’s real wealth – its farming, manufacturing, and trade (the annual produce of its land and labor) – clearly increased.

How Scottish Banks Issued Notes

Banks mainly issue their paper notes by discounting bills of exchange. This means they lend money to someone based on a promise of future payment (the bill), giving them the money before the bill is due. The bank subtracts the interest for the period until the bill is due. When the bill is finally paid, the bank gets back the amount it advanced plus the interest as profit.

A banker who lends using their own paper notes instead of gold and silver can discount more bills, up to the value of notes they know typically stay in circulation. This allows them to earn interest on a much larger sum.

Cash Accounts: A Scottish Innovation

When the first banks started in Scotland, the country’s trade was small. Just discounting bills wouldn’t have generated much business for the banks. So, they invented another way to issue notes: cash accounts.

• A cash account was basically a line of credit (e.g., up to £2,000 or £3,000).
• To get one, a person needed two reliable people with property to guarantee repayment (sureties).
• The bank would then lend money up to the credit limit, charging interest on what was borrowed.

While banks worldwide offer credit, the Scottish banks had unique repayment terms that made these accounts very popular and beneficial:

• Someone who borrowed, say, £1,000 could repay it gradually, in small amounts (£20 or £30 at a time).
• The bank would immediately reduce the interest charged based on the amount repaid.

This flexibility made cash accounts very convenient for merchants and business people. They became eager customers, readily accepted the banks’ notes in payments, and encouraged others to do the same, helping the notes circulate widely. Banks usually gave loans and advances in their own notes. These notes then flowed through the economy:

1. Merchants paid manufacturers for goods.
2. Manufacturers paid farmers for materials and food.
3. Farmers paid landlords for rent.
4. Landlords paid merchants for consumer goods.
5. Merchants deposited the notes back into the bank to repay loans or balance their accounts.

Almost all the country’s money business ended up being done with these notes.

The Advantage for Merchants

Cash accounts allowed merchants to do more business than they could otherwise.

• Compare two merchants with the same amount of capital, one in London (no cash accounts like Scotland’s) and one in Edinburgh.
• The Edinburgh merchant could safely conduct more trade and employ more people.
• Why? The London merchant always needs to keep a significant amount of idle cash on hand (or in a non-interest-bearing bank account) to pay for goods bought on credit as payments become due. The Edinburgh merchant with a cash account had more flexibility and needed less idle cash.

Let’s say the London merchant typically needs $500 in ready cash. This means the value of goods in their warehouse is always $500 less than it could be. If the merchant sells their entire stock once a year, needing this idle cash means they sell $500 worth less in goods annually than they could have.

• Their yearly profit is reduced by the amount they could have made on that extra $500 worth of goods.
• They employ fewer people, because $500 less in capital means fewer workers needed to prepare goods for market.

The Edinburgh merchant, however, doesn’t keep idle cash. When they need money for payments, they draw it from their cash account at the bank. They gradually repay the borrowed amount as money comes in from selling goods.

Therefore, with the same starting capital, the Edinburgh merchant can safely keep more goods in their warehouse than the London merchant. This allows them to:

• Make a larger profit.
• Provide steady jobs for more workers.

This shows the significant benefit the Scottish system of cash accounts brought to the country.

Some might argue that English merchants have easy access to discounting bills of exchange, giving them a similar advantage. But Scottish merchants can discount bills just as easily and they have the extra convenience of their cash accounts.

Limits on Paper Money Circulation

There’s a natural limit to how much paper money can easily circulate in a country. It can never exceed the value of the gold and silver coins it replaces. If the economy needs $1 million in coins to function smoothly, you can’t keep $1.5 million in paper notes circulating for long.

Imagine the smallest paper note allowed is a $20 bill. The total value of all paper money circulating can’t be more than the value of gold and silver needed to handle all transactions worth $20 or more.

What happens if banks issue too much paper money?

1. The extra paper (excess) cannot be used for domestic trade (the circulation channel is already full).
2. It also cannot be sent abroad (foreigners won’t accept it).
3. People quickly realize they have more paper notes than needed for business.
4. They will immediately take the excess paper back to the banks to exchange it for gold and silver coins.
5. Once they have coins, they can use them (e.g., send them abroad for trade). They couldn’t do this with the paper notes.

This leads to a run on the banks, demanding payment for all the excess paper. If banks hesitate to pay, the panic increases, and the run gets worse.

The Costs of Running a Bank

Banks have normal business expenses like rent, wages for staff, etc. But they also have two unique major costs:

1. Keeping Reserves: Banks must always keep a large amount of gold and silver coins in their vaults (coffers) to meet demands from people exchanging notes. They lose potential interest income on this idle money.
2. Replenishing Reserves: Banks constantly need to replace the coins paid out from their reserves. This involves the cost of acquiring new gold and silver.

The High Cost of Issuing Too Much Paper

A bank that issues more paper notes than the economy can actually use faces much higher costs.

• Higher Reserve Costs: The excess paper comes back to the bank very quickly for exchange. To handle this rapid return, the bank needs to keep proportionally more gold and silver in reserve than a bank operating within reasonable limits. Their reserve costs increase significantly.
• Higher Replenishing Costs: Because reserves are drained much faster, the bank must spend more effort and money constantly refilling them. The coins paid out for excess paper are themselves “excess” to the country’s needs. Since they can’t circulate domestically, they get sent abroad. This continuous export of gold and silver makes it harder and more expensive for the bank to find new coins to refill its rapidly emptying vaults.

Example:

• Suppose a bank can safely circulate $40,000 in notes, needing $10,000 in gold/silver reserves.
• If it tries to circulate $44,000, the extra $4,000 will constantly return for payment almost as soon as it’s issued.
• To handle this, the bank now needs to keep $14,000 in reserves ($10k for the base + $4k for the excess).
• The bank gains nothing from the interest on the extra $4,000 notes (since it needs $4k more in idle reserves).
• Worse, it faces the ongoing expense of collecting $4,000 in coins just to have them immediately drained out again.

If banks always understood and acted in their own best interest, they wouldn’t issue too much paper money. But they haven’t always done so, and the economy has often had too much paper circulating.

Historical Examples of Over-Issuing

• Bank of England: For many years, the Bank of England had to create new gold coins worth between £800,000 and £1 million annually. This was because excess paper money kept returning for payment. Due to the poor condition of existing coins, the Bank often had to buy gold bullion at a high price (£4 per ounce) and then issue it as coin at the official, lower value (£3 17s 10.5d per ounce). This meant losing 2.5% to 3% on large amounts of coinage, even though the government covered the basic minting cost.
• Scottish Banks: Facing similar problems from issuing too much paper, Scottish banks had to constantly employ agents in London to gather cash for them. This service cost 1.5% to 2%. Sending the money north by wagon cost another 0.75% for transport and insurance. Sometimes, even these agents couldn’t refill the banks’ vaults fast enough. The banks then had to resort to a costly tactic: drawing bills of exchange on their London contacts (essentially borrowing from them). When these bills came due, the struggling Scottish banks sometimes had to draw new bills on London just to pay off the first set, accumulating interest and commission fees on the growing debt. Even relatively careful Scottish banks sometimes had to use this “ruinous resource.”

Where Did the Coins Go?

The gold coins paid out by banks in exchange for excess paper were also excess to the economy’s needs. So, what happened to them?

1. They were sent abroad as coin.
2. They were melted down into gold bars (bullion) and sent abroad.
3. They were melted down and sold back to the Bank of England (which often paid a high price for bullion).

People carefully picked out the newest, heaviest, best coins for melting or export because these were worth more as metal than their face value as circulating currency (where worn coins were treated the same).

The Bank of England found that despite coining huge amounts of new gold each year, coins remained scarce, and the overall quality got worse, not better. Old, worn coins stayed, while new, heavy ones disappeared. The rising price of gold bullion (due to coin wearing and clipping) made the Bank’s large annual coinage increasingly expensive. The Bank of England effectively had to supply coins for the entire kingdom, as its vaults were the main source. It ended up paying dearly not just for its own errors but also for the widespread over-issuing by many Scottish banks, constantly replacing the coins drained by excess paper from both countries.

The Root Cause: Over-Trading

The ultimate reason for all this excess paper money was over-trading by ambitious, often speculative, entrepreneurs (projectors) in both England and Scotland.

Prudent Bank Lending

What amount can a bank safely lend to a business owner?

• NOT their entire business capital.
• NOT even a large part of their capital.
• ONLY the portion of capital the owner would otherwise need to keep idle as ready cash for occasional payments.

If a bank’s paper money lending never goes beyond this amount, it will never exceed the gold and silver that would naturally circulate if there were no paper money. It will stay within the limit the economy can easily handle.

Discounting “Real Bills”

When a bank discounts a real bill of exchange – one drawn by a genuine seller on a genuine buyer for actual goods, which is paid when due – it’s doing exactly this kind of safe lending. It’s advancing the merchant temporary cash they’d otherwise need to keep idle. The bill’s payment naturally repays the bank, plus interest.

A bank dealing only with such transactions is like a water pond: water constantly flows out (loans), but another stream constantly flows in (repayments), keeping the pond full with little effort or extra expense needed to refill it.

Managing Cash Accounts Safely

Merchants often need ready cash even when they don’t have bills to discount. A bank can safely provide this through a cash account (like in Scotland) if it manages it carefully.

The key is for the bank to watch whether, over short periods (like 4-8 months), a customer’s total repayments generally match their total borrowings.

• If repayments ≈ borrowings: The bank can safely continue dealing with this customer. The outflow from the bank’s reserves is matched by the inflow. The “pond” stays full.
• If borrowings >> repayments: The bank cannot safely continue lending to this customer in the same way. The outflow is much larger than the inflow. The bank’s reserves (“pond”) will soon be empty unless the bank constantly spends money to refill them.

Scottish Banks’ Early Caution

For a long time, the Scottish banks were very careful. They insisted on frequent and regular repayments from all customers. They wouldn’t deal with anyone, no matter how wealthy or creditworthy, who didn’t make regular “operations” (deposits and repayments) on their account.

This careful attention had two major advantages, besides saving the banks the cost of constantly refilling their vaults:

1. Judging Customer Health: By observing whether repayments were regular or irregular, banks could get a good idea if a customer’s business was thriving or struggling. They didn’t need other information beyond their own account books. A private lender with few borrowers can watch each one closely. A large bank with hundreds of borrowers cannot; the account activity is their main source of information. Scottish banks likely aimed for this benefit.
2. Preventing Over-Issue: This attention ensured banks didn’t issue more paper money than the economy could handle. If a customer’s repayments consistently matched their borrowings over short periods, the bank knew its loans simply replaced the cash that customer needed anyway. The paper issued through that customer therefore didn’t exceed the amount of gold and silver that would have circulated otherwise.

A customer’s repayment habits showed whether the bank’s loans were within safe limits. If repayments were frequent, regular, and substantial, it proved the loans hadn’t exceeded the cash the customer needed for daily operations – the money used to keep the rest of their business capital working.

This operational cash is the only part of a business’s capital that constantly returns as money (paper or coin) and goes out again in the same form within short periods. If bank loans were larger than this amount, the customer’s repayments couldn’t possibly equal the loans within a reasonable time. The flow of money into the bank from that customer wouldn’t match the flow out.

If bank loans exceeded the gold and silver needed for a customer’s operational cash, they could easily end up exceeding the total amount of gold and silver needed for the whole country’s circulation (assuming business levels stayed the same). This excess paper money would immediately flood back to the bank, demanding to be exchanged for gold and silver. This second point – how excessive lending to one person could flood the whole system – wasn’t perhaps as well understood by all Scottish banks as the first point (judging individual customer health).

The Limits of Bank Assistance

Once banks provide businesses with easy ways to manage their short-term cash needs (through discounting bills and cash accounts), businesses shouldn’t expect more help. Banks acting in their own interest and safety simply cannot go further.

A bank cannot safely lend a business the majority of its circulating capital (the money tied up in materials, inventory, and wages). Why? Although this capital eventually returns to the business as money from sales, the time lag between spending and getting paid back is too long for a bank. The business’s repayments wouldn’t match the bank’s loans quickly enough to suit the bank’s need for faster turnover.

Banks Should Not Fund Fixed Capital

Banks absolutely cannot afford to lend businesses money for their fixed capital. This includes things like:

• Building factories, furnaces, warehouses, or worker housing.
• Digging mine shafts, installing pumps, building roads for mines.
• Clearing, draining, fencing, and improving farmland, or building farm buildings.

Getting money back from investments in fixed capital is almost always much slower than from circulating capital. Even wise investments in fixed assets often don’t pay back the owner for many years. This is far too long for a bank, which needs its funds back relatively quickly.

Where Businesses Should Get Long-Term Loans

Businesses certainly can, and often do, use borrowed money for large parts of their projects. However:

1. They should have enough of their own capital invested to protect their lenders from loss, even if the project doesn’t meet expectations.
2. Money borrowed for several years should not come from a bank. It should be borrowed from private individuals who want to earn interest on their money long-term without managing a business themselves. These loans are typically secured by bonds or mortgages.

A bank might seem like a convenient lender because it has lower transaction costs (no stamp duty, no lawyer fees for mortgages) and offers flexible repayment (like Scottish cash accounts). But businesses needing long-term capital are very inconvenient debtors for a bank.

Scottish Banks Had Reached Their Limit

By the 1750s (over 25 years before this was written), the paper money issued by Scottish banks was already equal to, or slightly more than, the amount the country’s economy could actually use.

These banks had already given Scottish businesses all the help they could possibly provide while acting safely and in their own interest. In fact, they had already “over-traded” slightly, meaning they had issued a bit too much paper, leading to small losses or reduced profits that always accompany over-trading in banking.

Traders Demanded Even More

But the businesses and entrepreneurs who had benefited from bank credit wanted even more.

• They seemed to think banks could create unlimited credit just by printing more paper notes.
• They complained that the bank directors were timid and narrow-minded for not expanding credit further as Scotland’s trade grew. (By “extension of trade,” they really meant the expansion of their own projects beyond what they could fund themselves or borrow privately.)
• They felt the banks had a duty to supply all the capital they desired.

The banks disagreed. When they refused to lend more, some traders resorted to a risky and expensive tactic to get funds: drawing and redrawing bills of exchange. This was a well-known method used by desperate traders nearing bankruptcy. It had become common in England during the recent war (when high profits encouraged risky ventures) and spread to Scotland, where it was used even more extensively relative to the country’s smaller economy.

Understanding Drawing and Redrawing

This practice might be unfamiliar to some readers, so let’s explain it clearly.

Bills of exchange have special legal status, thanks to old merchant customs adopted into law. Money is lent more readily against them than against other forms of debt, especially if they are due in just two or three months. If the person meant to pay the bill (the acceptor) doesn’t pay immediately when it’s presented, they instantly become bankrupt. The bill is “protested” and goes back to the person who created it (the drawer), who also becomes bankrupt if they don’t pay immediately. Anyone who endorsed the bill (signed the back, having received payment for it earlier) also becomes liable and faces bankruptcy if they fail to pay.

Even if everyone involved (drawer, acceptor, endorsers) has shaky credit, the short deadline provides some security. They might all fail eventually, but maybe not all within the next two months. It’s like a weary traveler deciding to sleep in a run-down house: “It won’t stand long, but it probably won’t fall tonight.”

The Mechanics of Circulation

Here’s how drawing and redrawing works:

1. Trader A in Edinburgh draws a bill on Trader B in London, due in two months. (B doesn’t actually owe A anything).
2. B agrees to “accept” the bill (promise to pay it), but only if A agrees that before the two months are up, B can draw a new bill back on A for the same amount, plus interest and a fee (commission), also due in two months.
3. Before the first bill is due, B draws the new bill on A.
4. Before the second bill is due, A draws a third bill on B.
5. Before the third is due, B draws a fourth bill on A.

This cycle can continue for months or even years. Each time, the new bill includes the original amount plus accumulated interest and commission fees from all previous bills.

• The annual interest rate was 5%.
• The commission was at least 0.5% each time a bill was drawn (more than 6 times a year).
• So, money raised this way cost at least 8% per year, often much more if commissions rose or compound interest was charged.

This practice was called raising money by circulation.

Fueling Unrealistic Projects

In an economy where typical business profits were maybe 6% to 10%, a project had to be incredibly successful just to repay borrowing costs of over 8%, let alone provide a good profit for the entrepreneur (projector).

Yet, many huge projects were started and run for years using only money borrowed at this enormous expense. The projectors undoubtedly dreamed of massive profits. When reality hit (either the project ended or they couldn’t afford to continue), they rarely found those profits.

How it Drained the Banks

• Trader A in Edinburgh would discount the bills drawn on B with a Scottish bank (getting notes).
• Trader B in London would discount the bills drawn back on A with the Bank of England or another London bank (getting notes).

Crucially, although each bill appeared to be “paid” when due, the money the banks originally advanced never actually returned. Why? Because just before Bill 1 was due, Bill 2 (for a slightly larger amount) was discounted specifically to provide the funds to “pay” Bill 1. The payment was entirely fictitious. The stream of money flowing out of the banks via these circulating bills was never matched by a real stream flowing back in.

Issuing Paper Far Beyond Limits

The paper money issued against these circulating bills often funded entire large projects in farming, trade, or manufacturing. It wasn’t just covering the small amount of cash the projector needed for daily operations.

Most of this paper was therefore far above the value of gold and silver that would normally circulate. It was far more than the economy could possibly absorb. Consequently, it immediately flowed back to the banks, demanding exchange for gold and silver coins, which the banks had to somehow find.

The projectors had cleverly managed to extract huge amounts of capital from the banks, often without the banks’ full knowledge or consent, perhaps initially without the banks even suspecting what was happening.

Detecting the Scheme

• If two traders constantly drew on each other and always used the same bank for discounts, the bank would quickly spot the pattern and realize they were trading with the bank’s capital, not their own.
• But it was harder to detect when they used different banks, and especially when a whole circle of projectors drew bills on each other in complex patterns, making it difficult to distinguish real trade bills from fictitious circulating bills.

The Banks’ Dangerous Position

Sometimes, a bank discovered the scheme too late. It might find it had already discounted so many of these fictitious bills that refusing more would bankrupt the projectors, potentially ruining the bank itself through the losses.

For self-preservation, the bank might feel forced to continue discounting for a while, trying to pull back gradually by making it increasingly difficult for the projectors. The hope was to force them to find other banks or other ways to raise money, allowing the first bank to get out of the dangerous circle.

Projectors Blame the Banks

Naturally, when the Bank of England, major London banks, and the more cautious Scottish banks eventually started restricting discounts (having all lent too much already), the projectors were furious.

They called their own financial distress the “distress of the country.” They blamed this distress entirely on the banks, accusing them of ignorance, cowardice, and bad management for not providing “liberal aid” to their “spirited undertakings” meant to improve the nation. They seemed to believe banks had a duty to lend them as much money as they wanted, for as long as they wanted.

However, by finally restricting credit to those they had already lent far too much to, the banks were taking the only possible action to save their own creditworthiness and that of the country.

A New, Overly Liberal Bank

Amidst all this outcry, a new bank was set up in Scotland (in Ayr) specifically “for the express purpose of relieving the distress of the country.” The intention was generous, but the plan was reckless. The bank’s founders didn’t seem to fully understand the true nature and cause of the “distress.” This new bank was far more generous than any before it, both in granting cash accounts and in discounting bills of exchange.

This new bank (the Ayr Bank) seemed to make little distinction between real bills (representing actual trade) and circulating bills (fictitious ones used for raising money). It discounted both equally.

The bank openly stated its goal was to lend money – providing the entire capital needed – for long-term improvements, especially land improvements, which have the slowest returns. Promoting such projects was supposedly a main reason for its creation.

By being so liberal with cash accounts and discounting bills, the bank certainly issued huge amounts of paper notes. However, since most of these notes were far more than the economy could actually use, they flooded back to the bank demanding exchange for gold and silver almost as fast as they were issued.

The bank’s vaults (coffers) were never properly filled with reserves.

• Its starting capital, raised in two rounds, was £160,000, but only 80% (£128,000) was actually paid in.
• This capital was supposed to be paid in installments. But many shareholders, after paying their first installment, immediately opened cash accounts. The directors treated shareholders as liberally as everyone else, allowing them to borrow back the money needed for their later installments. These payments just moved money from one bank vault pocket to another.

Even if the vaults had been full initially, the massive over-issue of notes would have emptied them faster than they could possibly be refilled by any method except the disastrous one of drawing bills on London and paying them off with new bills, accumulating interest and fees. Since its reserves were so low to begin with, the bank reportedly had to start using this ruinous method within months of opening.

The personal estates of the bank’s owners were worth millions, and these estates were legally pledged to cover the bank’s debts. This huge backing gave the bank enormous credit, allowing it to continue operating for over two years despite its reckless lending.

When it finally had to stop operations, it had about £200,000 in notes circulating. To keep these notes from overwhelming it (as they constantly returned for payment), the bank had been continuously drawing bills on London. The number and value of these bills kept increasing, reaching over £600,000 when the bank failed.

So, in just over two years, this bank had lent out more than £800,000 (£200k notes + £600k bills) at 5% interest.

• On the £200,000 in notes, the 5% interest might have seemed like clear profit (minus operating costs).
• But on the £600,000+ raised by constantly drawing bills on London, the bank was paying over 8% in interest and commissions. It was therefore losing more than 3% on over three-quarters of its business.

The Unintended Results of the Ayr Bank

The bank’s actions seem to have had the opposite effects from what its founders intended.

• Intention 1: Support “spirited undertakings” (the speculative projects) across Scotland.
  • Result 1: It gave temporary relief to the projectors, letting them continue about two years longer. But this only allowed them to sink deeper into debt. When the crash came, it was much worse for them and their creditors. Instead of relieving distress, the bank ultimately aggravated it. It would have been better for everyone if most of these projects had failed two years earlier.
• Intention 2: Take over all banking business, replacing the established Edinburgh banks (which had become cautious about discounting).
  • Result 2: The temporary relief the Ayr Bank gave the projectors was a permanent relief to the other Scottish banks. All the risky circulating bills, which the older banks had hesitated to discount, flowed to the new, welcoming Ayr Bank. This allowed the older banks to easily escape the dangerous circle of fictitious bills without suffering large losses or damaging their reputations.

In the end, the Ayr Bank worsened the country’s real distress while effectively rescuing the rival banks it aimed to destroy.

Could the Bank Have Refilled Its Vaults Differently?

Some people initially thought the Ayr Bank could easily refill its vaults by raising money against the assets (like land mortgages) it took as security for its loans. Experience likely showed this was far too slow. Vaults that started nearly empty and emptied extremely fast could only be refilled by the ruinous cycle of drawing bills on London.

But even if the bank could have raised money this way quickly enough, it still would have lost money on every transaction. It would pay interest to borrow money needed to redeem notes that were only returning because they were excess circulation in the first place. The bank would make nothing on the interest from these excess notes. Plus, it would bear all the costs of borrowing: finding lenders, negotiating terms, legal fees for bonds. It would be a clear loss.

Trying to refill vaults this way is like trying to keep a pond full when water is constantly flowing out but none is flowing in. You might propose hiring people to constantly carry buckets of water from a well miles away, but it’s an obviously flawed and unsustainable plan.

Harmful Effects Even if the Bank Profited

Even if, somehow, this borrowing method had been profitable for the bank itself, it would have harmed the country.

• It wouldn’t increase the total amount of money available to be lent in the country.
• It would just turn the Ayr Bank into a giant national loan office. Borrowers would go to the bank instead of private lenders.

But a bank lending to hundreds of people its directors barely know is unlikely to choose borrowers more wisely than a private individual lending to a few known, trusted people.

The borrowers from a bank like Ayr were likely to be risky projectors involved in circulating bills, using the money for extravagant projects unlikely ever to repay their costs or support the amount of labor used to build them.

In contrast, the borrowers from careful private individuals are more likely to be sensible businesspeople using loans for realistic projects suited to their capital. These projects might seem less grand, but they are more likely to be profitable, repay their costs, and create sustainable employment.

So, the Ayr Bank’s operation, even if successful for the bank, would only have shifted a large part of the nation’s capital from sensible, profitable ventures to reckless, unprofitable ones, without increasing the total capital at all.

John Law and the Lure of Paper Money

The famous John Law believed Scotland’s economy suffered because it lacked money. He proposed a special kind of bank that could issue paper notes supposedly equal to the value of all the land in the country.

• Scotland’s Parliament rejected his initial proposal.
• It was later adopted in France by the Duke of Orleans, becoming the foundation of the infamous Mississippi scheme – perhaps the most extravagant banking and stock-market bubble ever seen.

The core, flawed idea behind Law’s plan (explained in his own writings) and similar schemes was the possibility of multiplying paper money almost infinitely. These tempting but unrealistic ideas continue to influence people and have likely contributed to the excessive banking practices seen recently in Scotland and elsewhere.

The Bank of England: History and Role

The Bank of England is the largest bank using paper money circulation in Europe.

• It was established by an Act of Parliament and a royal charter on July 27, 1694.
• It initially lent the government £1.2 million in exchange for an annual payment of £100,000 (£96,000 interest at 8%, plus £4,000 for management). The high 8% interest shows the low credit rating of the new government after the Glorious Revolution.
• In 1697, its capital was increased by about £1 million to support public credit during a crisis when government IOUs (tallies) and even bank notes were heavily discounted (the Bank had temporarily stopped paying notes during a major silver recoinage). Its capital then totaled £2.2 million.
• In 1708, the Bank advanced another £400,000 and cancelled government Exchequer bills worth £1.775 million. By then, the government could borrow at 6%, the standard market rate, showing improved credit. The Bank was allowed to double its capital to £4.4 million, having advanced £3.375 million total to the government.
• Further shareholder contributions (calls) in 1709 and 1710 raised the Bank’s capital to £5.56 million.
• In 1717, the Bank cancelled another £2 million of Exchequer bills, bringing total government advances to £5.375 million.
• In 1722, the Bank bought £4 million of South Sea Company stock, increasing its own capital by £3.4 million through new subscriptions to fund the purchase. At this point, its capital stock was £8.96 million, but it had advanced £9.375 million to the government.
• This was the first time the Bank’s loans to the government exceeded its shareholder capital. This difference represents undivided capital (like retained earnings or reserves), which the Bank has maintained ever since.
• By 1746, the Bank had advanced £11.687 million to the government, and its shareholder capital was £10.78 million. These amounts remained stable for a long time afterward. (In 1764, the Bank paid £110,000 for its charter renewal, which didn’t change these main figures).

The Bank’s dividend (payment to shareholders) has changed over time, reflecting the interest rate it earned on government debt (which fell from 8% eventually to 3%) and other factors. In recent years, the dividend has been 5.5%.

Functions of the Bank of England

The Bank of England’s stability is considered equal to that of the British government itself – the government would have to default before the Bank’s creditors lost money. No other bank in England can be created by Parliament or have more than six partners.

It functions as more than just a regular bank; it’s a major instrument of the state:

• It manages payments for most government debts (annuities).
• It circulates Exchequer bills (short-term government debt).
• It provides the government with upfront cash for land and malt taxes, which are collected slowly over years.
• It also discounts bills for merchants like a normal bank.
• On several occasions, it has stepped in to support the credit of major trading firms, not just in England but also in Hamburg and Holland. (In 1763, it reportedly lent £1.6 million in one week for this purpose, much of it in gold/silver bullion – though the exact amount and timeframe aren’t guaranteed).
• Despite its strength, the Bank has occasionally faced difficulties, sometimes being forced to pay out in small sixpence coins.

Its duties to the government might sometimes require it to issue more paper money than strictly needed for circulation, even without any fault of its directors.

How Banking Really Helps the Economy

The most useful banking operations increase a country’s industry not by adding to its total capital, but by making more of the existing capital active and productive.

• The cash a business owner must keep idle for payments is dead stock. It produces nothing for the owner or the country while it sits there.
• Smart banking allows the owner to convert this dead stock into active stock: materials, tools, wages – things that produce value for the owner and the country.
• Similarly, the gold and silver coins circulating in a country are also dead stock. They are a very valuable part of the nation’s capital, essential for circulating goods, but they don’t produce anything themselves.

Well-managed banking operations replace much of this “dead stock” of gold and silver with paper money. This allows the country to convert the now-unneeded coins into active and productive capital – resources that generate income for the country.

Think of the gold and silver money circulating in a country like a highway. The highway helps transport all the crops (like grass and corn) to market, but the highway itself doesn’t produce a single blade of grass or stalk of corn.

Good banking acts like (if you’ll allow a bold metaphor) a “wagon-way through the air.” It provides a new way to conduct transportation (commerce), allowing the country to convert its physical highways (the gold and silver) into productive farmland (invested capital), significantly increasing the annual output of goods.

However, we must admit that commerce and industry are somewhat less secure when they rely on paper money – like being suspended on the mythical “Daedalian wings” of Icarus – compared to when they travel on the solid ground of gold and silver. Besides the risks from mistakes made by bankers managing the paper money, there are other dangers that even the most careful bankers cannot prevent.

Risks of Paper Money

Risk from War: Imagine a war where an enemy captures the capital city. They would likely seize the banks and the gold/silver reserves that back the paper money.

• In a country where almost all trade uses paper, this would cause immense confusion. The main tool of commerce (paper money) would lose its value. Trade could only happen through bartering or on credit.
• Since taxes are usually paid in paper, the government couldn’t pay its troops or buy supplies.
• Recovering from such a situation would be much harder than if most trade had used gold and silver coins, which might still be dispersed among the people.

Therefore, a ruler wanting to keep their country easily defensible should be cautious about paper money. They should guard against not only the excessive amounts that ruin banks but also the levels that allow paper to dominate most of the country’s circulation.

Two Types of Circulation

We can think of a country’s circulation (the movement of money) as having two main branches:

1. Dealer-to-Dealer Circulation: Transactions between businesses (wholesalers, merchants, manufacturers).
2. Dealer-to-Consumer Circulation: Transactions between businesses and the final consumers.

Although the same coins or notes might sometimes be used in one branch and sometimes in the other, both types of circulation happen constantly and simultaneously. Each requires its own stock of money.

• Value: The total value of goods traded between dealers cannot be more than the total value eventually sold to consumers. Everything dealers buy is ultimately intended for consumers.
• Transaction Size: Dealer-to-dealer trade is wholesale and usually involves large sums per transaction. Dealer-to-consumer trade is retail and often involves very small sums (a dollar, or even a few cents).
• Speed (Velocity): Small sums of money circulate much faster than large sums. A dollar changes hands more often than a hundred-dollar bill, and a quarter more often than a dollar.

Even though the total value of annual purchases by consumers equals the value bought by dealers, the consumer purchases can be done with much less actual money. The same small coins or bills facilitate many more retail transactions due to their faster circulation.

How Note Size Affects Circulation

Paper money can be designed to primarily serve either dealer-to-dealer circulation or to also be heavily used in dealer-to-consumer circulation.

• Large Notes Only (e.g., $50+): Where the smallest bank note is large (like £10 notes in London at the time), paper money stays mostly in the dealer-to-dealer sphere. When a consumer gets a large note, they usually have to exchange it for smaller change immediately at the first store, sending the large note quickly back into the hands of dealers.
• Small Notes Allowed (e.g., $1, $5): Where small notes are common (like 20-shilling notes in Scotland), paper money significantly enters the dealer-to-consumer circulation. Before laws stopped them, even smaller 10-shilling and 5-shilling notes filled even more of this retail circulation in Scotland.
• Very Small Notes (e.g., <$1): In North America, paper was often issued for tiny amounts (like a shilling, roughly 1/20th of a pound). This paper filled almost the entire circulation. Some areas in Yorkshire (England) even had notes for sixpence (half a shilling).

Dangers of Very Small Notes

Allowing very small bank notes encourages people with little wealth or credit (“mean people,” “beggarly bankers”) to become bankers. A person whose IOU for $20 might be refused could get notes for ten cents accepted easily.

However, these poorly capitalized bankers are prone to frequent bankruptcy. This can cause significant inconvenience, and sometimes disaster, for the many poor people who accepted their small notes as payment.

Argument for a Minimum Note Size

It might be better if no bank notes under a certain value, perhaps five pounds (£5), were allowed anywhere in the kingdom.

• Paper money would then likely stay mainly in the dealer-to-dealer circulation everywhere, similar to London (where the minimum was £10).
• A £5 note, in most areas outside the expensive capital, represents a significant amount of purchasing power, similar in consideration to how £10 was viewed in London – not typically spent all at once.

Paper Money Tends to Drive Out Coins

Observe the pattern:

• London: Where paper is mostly large notes (dealer-to-dealer), gold and silver coins are abundant.
• Scotland & North America: Where paper extends into small denominations (dealer-to-consumer), gold and silver coins almost completely disappear from the country. Nearly all internal trade uses paper.

Banning the smallest notes (10s and 5s) in Scotland brought back some gold and silver. Banning 20s notes would likely bring back more. Coins reportedly became more common in North America after some paper currencies were suppressed, and were more common before those paper currencies were created.

Banking Can Still Help Industry with Larger Notes

Even if paper money were limited to larger notes (like £5+), banks could still provide nearly the same level of support to business and industry.

• The idle cash a dealer needs is almost entirely for paying other dealers.
• Dealers don’t need to keep cash reserves for sales to consumers; consumers bring cash to them.

So, even if only larger notes circulated (staying mainly dealer-to-dealer), banks could still use bill discounting and cash accounts to relieve most dealers from needing large amounts of idle cash. Banks could still provide the maximum appropriate assistance to businesses.

Regulation and Natural Liberty

Some might argue that restricting people from issuing or accepting small bank notes, if they willingly choose to do so, violates natural liberty. They might say the law should support, not infringe upon, such freedom.

Such regulations can be seen as limiting liberty in some ways. However, all governments – free or despotic – must restrain the actions of a few individuals if those actions might endanger the security of the whole society.

• Example: Laws requiring fireproof party walls between buildings restrict a property owner’s liberty but are necessary for public safety.
• The proposed banking regulations (like minimum note sizes) are exactly the same type of justifiable restriction on liberty.

When Paper Money Equals Gold and Silver

Paper money (bank notes) is truly equal in value to gold and silver coins only under these conditions:

1. Issued by people of undoubted credit.
2. Payable on demand.
3. Without any conditions.
4. In reality, always readily paid when presented.

If these conditions are met, gold and silver can be obtained for the paper at any time. Therefore, anything bought or sold using such paper will cost exactly the same as if using coins.

Paper Money and Prices (Inflation)

It’s been claimed that increasing paper money increases the total currency, lowers its value, and thus raises the prices of goods.

However, if paper money only replaces an equal amount of gold and silver removed from circulation, the total quantity of currency doesn’t necessarily increase.

• Example 1: Food prices in Scotland were never cheaper in the 18th century than in 1759, even though small notes (10s and 5s) meant there was more paper money then than later.
• Example 2: The price ratio between Scotland and England remained stable despite the huge growth of Scottish banks.
• Example 3: Corn prices are usually similar in England (lots of paper) and France (almost no paper).
• Hume’s Observation: When philosopher David Hume noted rising food prices in Scotland around 1751-52 (soon after paper money increased), it was likely due to bad weather and poor harvests, not the paper money itself.

When Paper Money Loses Value

Paper money will definitely fall below the value of gold and silver if its payment:

• Depends on the goodwill of the issuer.
• Depends on a condition the holder might not be able to meet.
• Is delayed for a set number of years, especially without paying interest during the delay.

The amount it falls below coin value depends on how uncertain or delayed the payment is perceived to be.

Examples of Depreciated Paper:

1. Scottish Optional Clause: For a time (mainly 1762-1764), Scottish banks put a clause in their notes promising payment either on demand OR six months later with interest, at the bank’s option. Banks sometimes used this clause (or threatened to) to avoid immediate large payouts. This uncertainty made Scottish notes worth less than coin. The exchange rate between London (using coin) and nearby Dumfries (using notes) was sometimes 4% against Dumfries, purely due to the difficulty of getting coin for notes there. Parliament banned this clause, restoring the normal exchange rate.
2. Yorkshire Conditional Notes: Some notes for sixpence were payable only if the holder brought exact change for a larger coin (a guinea). This difficult condition devalued the notes. Parliament also banned such clauses and all notes under 20 shillings in England.
3. North American Colonial Paper: This was government-issued paper, not bank notes. Payment was often delayed for many years, with no interest paid. Yet, colonies declared it legal tender at face value. This was deeply unjust. £100 payable in 15 years (in a 6% interest environment) is only worth about £40 today. Forcing a creditor to accept this delayed paper as full payment for a current debt was tyrannical. It was seen by some contemporaries as a scheme by debtors to cheat creditors. Pennsylvania tried price controls to force parity between its paper and coin, another tyrannical but ineffective measure. Exchange rates clearly showed the depreciation: £100 sterling often equaled £130 to £1100 in colonial paper, depending on the colony’s issuance and redemption prospects.

Therefore, the Act of Parliament that banned future colonial paper from being legal tender was perfectly fair, despite complaints from the colonies.

Pennsylvania was generally more moderate in issuing paper than other colonies. Its currency reportedly never fell much below the value of its own colonial coin standard. However, Pennsylvania had previously already devalued its currency by raising the official value of coins (e.g., making 5 shillings sterling pass for 6s 8d). So, £1 in Pennsylvania currency was already worth over 30% less than £1 sterling, even when made of silver. Raising the coin denomination was meant to stop silver export, but it failed; prices of imported goods simply rose proportionally, and silver exports continued.

The paper money issued by each American colony gained some additional value because it could be used to pay provincial taxes at its full face value. This boost in value depended on how much paper was issued compared to the amount needed for tax payments. In all colonies, far more paper was issued than could be used just for taxes.

A government could give value to its own paper money by requiring a certain portion of taxes to be paid with it. This could work even if the government didn’t promise to redeem the paper for gold or silver at any specific time. If the government or its bank carefully kept the amount of this paper below the amount needed for tax payments, demand could be so high that the paper might even trade at a premium – worth slightly more than its face value in gold or silver coins.

Some people use this idea to explain the Agio (premium) of the Bank of Amsterdam. They claim the Bank’s special “bank money” trades at a premium (4% or 5% above regular coins) because the directors supposedly keep the supply scarce relative to the high demand (since many foreign bills must be paid in bank money). However, this explanation of the Bank of Amsterdam is largely inaccurate, as we will see later.

Depreciated Paper Doesn’t Devalue Gold and Silver

It’s important to understand that when paper currency loses value compared to gold and silver coins, it does not reduce the value of the precious metals themselves. Weak paper doesn’t make gold or silver buy fewer goods.

The real value of gold and silver compared to other goods always depends on:

1. The richness or poverty of the mines supplying the world market.
2. The amount of labor needed to mine gold and silver compared to the labor needed to produce other goods.

It does not depend on the type or amount of paper money used in any single country.

Safe Banking: Regulation and Competition

If two key rules are followed, the banking trade can be made safe for the public and otherwise left perfectly free:

1. Minimum Note Size: Banks should be prohibited from issuing circulating notes (payable to the bearer) below a certain substantial sum (e.g., five pounds).
2. Immediate Payment: Banks must be legally required to pay their notes in gold or silver immediately and unconditionally whenever they are presented.

With these regulations, the recent increase in the number of banks in Britain, which alarmed many people, actually increases public security, rather than reducing it.

Here’s why more competing banks are safer:

• Mutual Vigilance: Having many rivals forces all banks to be more careful in their business. They must avoid issuing too many notes compared to their cash reserves, because they know competitors are always ready to exploit any weakness by gathering their notes and demanding large amounts of coin (malicious runs).
• Limited Circulation: Competition restricts each bank’s notes to a smaller geographic area and reduces the total number of notes any single bank issues.
• Reduced Impact of Failures: Because the total circulation is divided among more banks, the failure of any one bank (which inevitably happens sometimes) causes less overall harm to the public.
• Better Customer Service: Competition forces banks to treat their customers more generously, or risk losing them to rivals.

In general, if any type of business or work benefits the public, the freer and more widespread the competition, the greater the public benefit will be.

CHAPTER III

Saving Capital, and Productive vs. Unproductive Work

Two Types of Labor

There are two kinds of work, or labor:

1. Productive Labor: This type of work adds value to the object being worked on.
2. Unproductive Labor: This type of work does not add value in the same way.

Let’s look at examples:

• Manufacturer: The work of a factory worker generally adds value to the materials they use. This added value covers the worker’s own wages (their maintenance) and the factory owner’s profit. Even though the owner pays the worker’s wages upfront, the owner usually gets this money back, plus a profit, when the finished product is sold because it’s more valuable than the raw materials. In effect, the productive worker doesn’t cost the employer anything in the long run.
• Menial Servant: In contrast, the work of a household servant adds value to nothing tangible. The money spent maintaining a servant is gone forever; it’s never recovered by selling a product.

A person gets rich by employing many productive workers (like manufacturers). A person gets poor by maintaining many unproductive workers (like servants).

However, this doesn’t mean unproductive labor has no value or doesn’t deserve to be paid. It certainly does. The key difference is how the value is stored:

• The manufacturer’s labor becomes fixed or stored in a specific object or sellable commodity (a product) that lasts for some time after the work is done. You can think of it as labor stored up. This product, or its price, can later be used to employ the same amount of labor again.
• The servant’s labor, on the other hand, doesn’t create a lasting product. Their services usually disappear the moment they are performed. They leave no trace or stored value that could be used to buy the same amount of service later.

Many Important Jobs are “Unproductive” in this Sense

Like servants, the labor of some of the most respected groups in society is also unproductive in this specific economic meaning. Their work doesn’t create a lasting, sellable product that stores value.

Examples include:

• The Sovereign (ruler or government leader)
• All government officials, including judges and military personnel (the entire army and navy)

These people are public servants, paid from the taxes generated by the productive work of others. Their service, no matter how honorable, useful, or necessary, doesn’t produce a commodity that can be sold to pay for future services. The protection and security they provide this year won’t buy protection and security next year.

Other professions fall into this same category:

• Serious Professions: Clergy, lawyers, physicians, writers, academics.
• Entertainment Professions: Actors, comedians, musicians, opera singers, dancers, etc.

The work of even the lowest-paid entertainer has a certain value, determined by the same supply and demand principles as any other labor. Yet, even the work of the most noble and useful in this group (like doctors or judges) doesn’t produce a lasting thing that could later buy an equivalent amount of work. Like an actor’s performance, a speaker’s speech, or a musician’s tune, their work vanishes the moment it’s created.

How Society Supports Everyone

Both productive and unproductive workers, and even people who don’t work at all, are all supported by the annual produce of the country’s land and labor.

This total annual output, no matter how large, is always limited. Therefore, the proportion of this output used to support unproductive workers matters greatly:

• If a smaller share goes to unproductive hands, more remains for productive hands. The next year’s output will likely be larger.
• If a larger share goes to unproductive hands, less remains for productive hands. The next year’s output will likely be smaller.

This happens because (apart from things that grow naturally) the entire annual produce is the result of productive labor.

How Annual Produce is Used: Capital vs. Revenue

Although the ultimate purpose of all production is to supply people’s consumption needs and provide them with income (revenue), the annual produce naturally splits into two parts right after it’s created:

1. Replacing Capital: One part (often the largest) is used to replace the capital consumed during production. This means renewing the supplies (provisions), materials, and finished goods that were used up.
2. Constituting Revenue: The other part creates revenue. This revenue goes either to the owner of the capital as profit, or to someone else (like a landowner) as rent.

• Example (Farming): Part of the harvest replaces the farmer’s capital (seeds, tools used up, worker subsistence). The rest pays the farmer’s profit and the landlord’s rent.
• Example (Manufacturing): Part of the factory’s output value replaces the owner’s capital (materials, wages, machine wear). The rest pays the owner’s profit.

Capital Employs Only Productive Labor

Here’s a critical distinction:

• The part of the annual produce used to replace capital is only used to maintain productive hands. It pays the wages of productive labor exclusively.
• The part destined to be revenue (profit or rent) can be used to maintain either productive or unproductive hands.

When a person uses their money as capital, they expect to get it back with a profit. Therefore, they only employ productive workers with it. After this money serves as capital for the owner, it becomes revenue (wages) for the productive workers.

Whenever a person uses their funds to maintain unproductive hands, that money is immediately taken out of their capital. It becomes part of their funds reserved for personal spending (immediate consumption).

Who Pays for Unproductive Labor?

Unproductive workers, and people who don’t work, are always supported by revenue. This revenue comes from two main sources:

1. Direct Revenue: The part of the annual produce originally intended as revenue for specific people (land rent or capital profit).
2. Spare Revenue: The part of the annual produce originally meant to replace capital (and pay productive workers), but which is left over in the hands of those productive workers after covering their basic needs. This “spare” income can be spent on either productive or unproductive things.

So, not just wealthy landlords or merchants, but even ordinary workers (if their wages are high enough) might hire a servant, go to a show (supporting unproductive entertainers), or pay taxes (supporting unproductive government workers).

However, no part of the funds meant to replace capital is ever used to support unproductive hands until after it has already employed its full amount of productive labor. A worker must first earn their wages through productive work before they can spend any part of it on unproductive services or taxes. This “spare” part is usually small for productive laborers. But because there are many workers, their small tax contributions can add up.

The main sources supporting unproductive hands are always rent from land and profits from capital. Owners of land and capital usually have the most “spare” revenue. They could choose to spend this revenue hiring either productive or unproductive workers, but they often seem to prefer the latter. A great lord’s spending typically supports more idle people than productive ones. A rich merchant uses their capital to employ productive workers but uses their revenue (personal spending) often on the same kinds of unproductive services as the lord.

The Key Ratio: Capital vs. Revenue Funds

The overall proportion of productive versus unproductive workers in a country depends heavily on the ratio between two parts of the annual produce:

1. The part destined to replace capital.
2. The part destined to become revenue (rent and profit).

This ratio is very different in rich countries compared to poor countries.

Rich vs. Poor Countries: Historical View

• Modern Rich Europe: A very large share (often the largest) of farm produce goes to replacing the capital of wealthy, independent farmers. The rest pays their profit and the landlord’s rent.
• Feudal Europe: Only a tiny share of produce was needed to replace the minimal capital used in farming (a few poor animals, often belonging to the landlord). Almost all the rest of the produce belonged to the landlord, either as rent or profit on this tiny capital. Farmers were often serfs (property) or tenants whose rent effectively equaled the entire output. The landlord commanded their labor and military service. Essentially, the entire produce belonged to the lord who controlled the labor.

Today in Europe, a landlord’s share might be only one-third or one-fourth of the total produce. Yet, because farming is so much more productive now, this smaller share represents three or four times more actual produce than the landlord received in total back then. As productivity improves, the landlord’s rent increases in total amount, but decreases as a proportion of the total output.

Modern rich countries also have huge amounts of capital invested in trade and manufacturing. In ancient times, the small amount of trade and basic manufacturing required very little capital. However, profits on that small capital must have been very high (interest rates were often 10% or more).

Today, interest rates in developed parts of Europe are much lower (6% down to 2-3%). Although the total amount of profit earned in rich countries is vastly greater than in poor countries (because the total capital is so much larger), the profit rate (profit as a percentage of capital) is generally much lower.

Therefore, in rich countries compared to poor ones:

• The part of annual produce used to replace capital is much larger in total amount.
• It also represents a much greater proportion of the total annual produce compared to the part that immediately becomes revenue (rent and profit).

The funds available to support productive labor are not only much bigger in rich countries but also make up a much larger share relative to the revenue funds, which tend to support unproductive labor.

National Character: Industrious vs. Idle

This balance between funds destined for capital versus funds destined for revenue shapes the general character of a country’s people regarding industry or idleness.

• We are more industrious today than our ancestors were centuries ago because the funds supporting industry (capital) are much larger relative to the funds likely to support idleness (revenue spending).
• Our ancestors were often idle because there wasn’t enough capital or encouragement for industry. As the proverb says, “It’s better to play for nothing than to work for nothing.”

Examples of Towns:

• Industrial/Trading Towns: (e.g., many English and Dutch towns) Where most people are supported by employment funded by capital, they tend to be industrious, sober, and prosperous.
• Court/Government Towns: (e.g., Rome, Versailles) Where most people are supported by the spending of revenue (by the court, government officials, etc.), they tend to be idle, undisciplined, and poor.
• French Parliament Towns: Most French cities hosting regional parliaments (courts of justice) had little industry (except Rouen and Bordeaux). People were supported by spending from judges and litigants, leading to idleness.
  • Rouen & Bordeaux Exception: These cities thrived due to their strategic locations as major ports (entrepôts) for trade routes (Paris supply for Rouen, wine export for Bordeaux). Their location attracted large amounts of capital, which fueled their industry.
• Other Capitals (Paris, Madrid, Vienna): These primarily function as centers of consumption, with most industry serving the city itself.
• Capital Cities + Trade Hubs (London, Lisbon, Copenhagen): These are exceptions – major court/government centers that are also major trading hubs due to advantageous locations serving distant markets.
• Revenue Spending Discourages Industry: It seems harder to profitably employ capital in a city dominated by revenue spending (like a court city). The idleness of those supported by revenue may corrupt the work ethic of those who should be employed by capital.
• Edinburgh Example: Had little industry before the Union with England (1707). When it ceased being the regular home of Scottish nobility and Parliament, trade and industry grew. However, it remains a center for courts and government offices, so significant revenue is still spent there. It is much less industrial than Glasgow, where the population is mainly supported by capital employment.
• Village Example: Sometimes, a village making progress in manufacturing becomes idle and poor after a wealthy lord takes up residence nearby, as revenue spending comes to dominate the local economy.

Conclusion: Capital Drives Industry

The ratio between capital and revenue seems to regulate the balance between industry and idleness everywhere.

• Where capital dominates, industry thrives.
• Where revenue spending dominates, idleness prevails.

Therefore, any increase in capital naturally tends to increase the amount of industry, the number of productive workers, and consequently, the total value of the country’s annual production – the real wealth and revenue of its inhabitants. Any decrease in capital has the opposite effect.

How Capital Changes

How does a country’s capital increase or decrease?

• Capitals are increased by parsimony (saving and investing; being frugal).
• Capitals are diminished by prodigality (wasteful spending on consumption) and misconduct (poor management, bad investments).

How Capital Grows: Saving

When a person saves money from their income, they add it to their capital. They can either use this capital themselves to hire more productive workers, or they can lend it to someone else (at interest) who will use it to employ productive workers.

Just like an individual’s capital only grows by saving from their income or earnings, the capital of a whole society (which is just the sum of all individuals’ capitals) can only grow in the same way – through saving.

Saving, Not Just Working, Increases Capital

Parsimony (saving, being frugal) is the direct cause of capital increase, not industry (working) by itself.

• Industry provides the products or income that can be saved.
• But if parsimony doesn’t save and accumulate that income, the capital will never grow, no matter how much industry produces.

By increasing the funds available to pay productive workers, saving tends to increase the number of those workers. Their labor adds value to things, so saving tends to increase the total value of the country’s annual production. It puts more productive work into motion, adding value to the national output.

How Saved Money is Used

Money that is saved each year is consumed just as regularly, and just as quickly, as money that is spent. However, it is consumed by a different group of people.

• Spent Revenue: When a rich person spends their income, it’s mostly consumed by idle guests and servants. These people consume food, clothing, and housing but leave nothing lasting behind in return.
• Saved Revenue (Capital): When a rich person saves part of their income, they typically invest it as capital to make a profit. This saved portion is also consumed (as food, clothing, lodging) just as quickly, but by productive workers (laborers, factory workers, artisans). These workers reproduce the value they consume, plus a profit for the owner of the capital.

Imagine the person’s income is paid in cash.

• If they spent it all, the goods purchased would go to the idle group.
• By saving some, the goods purchased with the saved portion must go to the productive group, because the money was invested as capital seeking profit.

The amount of consumption is the same, but the consumers – and the economic result – are very different.

Saving Creates a Lasting Fund for Industry

When a frugal person saves money annually, they don’t just provide support for more productive workers for that year. They essentially create a permanent fund to maintain that same number of productive jobs indefinitely into the future. Think of it like founding a public workshop that keeps operating year after year.

This permanent dedication of funds isn’t usually protected by specific laws or trust funds. Instead, it’s protected by a powerful motivator: the obvious self-interest of whoever owns that capital in the future. No one can use that capital later to support unproductive hands without clearly losing money, because only productive hands will return the capital with a profit.

Wasteful Spending Destroys Capital

The prodigal (wasteful spender) misuses capital this way. By spending more than their income, they dip into their capital.

• They are like someone who misuses funds intended for charity for inappropriate purposes.
• They use money that their frugal ancestors had saved (and dedicated to supporting industry) to pay for idleness.
• By reducing the funds available for productive labor, they reduce the amount of value-adding work done in the country. This shrinks the nation’s annual output and its real wealth.

If the savings of frugal people didn’t constantly make up for the wastefulness of prodigals, every prodigal act would tend to make not only the spender poorer, but the whole country poorer, by feeding the idle with resources meant for the industrious.

Does Buying Domestic Goods Help?

Even if the prodigal spends entirely on locally made goods (not foreign imports), the negative effect on the country’s productive funds is the same.

• Food and clothing that should have maintained productive workers are instead used to maintain unproductive ones.
• This means the value of the country’s annual output will be less than it otherwise would have been.

Someone might argue: “But at least the money stays in the country!” True, but if those same resources (food, clothing) had been given to productive workers, they would have:

1. Reproduced the full value of what they consumed, plus a profit.
2. Kept the same amount of money circulating in the country.

The result would have been two values (reproduced goods + circulating money) instead of just one (circulating money alone).

Why Money Leaves a Declining Economy

Besides, the same amount of money cannot stay long in a country where the value of the annual production is shrinking.

• Money’s only use is to circulate consumable goods (buy and sell provisions, materials, finished products).
• The amount of money needed depends on the value of goods being circulated.
• If the value of goods produced falls, less money is needed to circulate them.
• The excess money won’t sit idle. Its owners will send it abroad (despite any laws) to buy useful goods elsewhere.
• This export of money might temporarily boost consumption beyond the country’s own production, using up past savings (gold/silver bought during better times).
• In this situation, the outflow of gold and silver is not the cause of the country’s decline, but an effect. It might even slightly cushion the hardship for a short time.

Why Money Enters a Growing Economy

Conversely, the amount of money in a country naturally increases as its annual production grows.

• More goods being circulated require more money to circulate them.
• A prosperous country will naturally use some of its increased output to buy the extra gold and silver needed from wherever it’s available.
• The inflow of these metals is an effect of prosperity, not the cause.
• Gold and silver are bought like any other commodity – the price is the food, clothing, lodging (maintenance) of those involved in mining and transporting them.
• A country that can afford this price will get the metals it needs. No country will hold onto significantly more metals than it needs for circulation.

Saver = Friend, Spender = Enemy

Therefore, however you define a country’s real wealth – whether by the value of its annual production (as reason suggests) or the amount of gold and silver it holds (as popular opinion might think) – the conclusion is the same:

• Every prodigal person acts like a public enemy.
• Every frugal person acts as a public benefactor.

Mismanagement Also Destroys Capital

The effects of misconduct (bad management) are often the same as prodigality.

• Every poorly judged and unsuccessful project (in farming, mining, fishing, trade, or manufacturing) reduces the funds available for productive labor.
• Even though the capital is consumed by productive workers, they don’t reproduce its full value because they were employed unwisely.
• This leads to a decrease in the society’s productive funds.

Nations Usually Withstand Individual Failings

Fortunately, it rarely happens that a great nation is seriously harmed by the prodigality or misconduct of individuals. The wastefulness or poor judgment of some is always more than offset by the savings and good judgment of others.

Why Saving Usually Wins:

• Spending Motive: The drive for immediate enjoyment is strong but usually temporary or occasional.
• Saving Motive: The desire to improve one’s condition is calm but constant and lifelong. From birth to death, almost everyone always wishes for some improvement, and saving is the most common way people try to achieve it.
• Dominance: While everyone spends sometimes, and some spend almost always, for most people over their whole lives, the principle of saving seems to dominate significantly.

Why Prudence Usually Wins:

• Success vs. Failure: Prudent and successful businesses are far more numerous than unsuccessful ones.
• Bankruptcy is Rare: Despite complaints about bankruptcies, they affect only a tiny fraction of all businesses (perhaps less than one in a thousand). Most people are careful to avoid such a devastating event. Some fail, just as some end up on the gallows, but they are the exception.

The Real Danger: Public Waste

Nations are never ruined by private waste, but they sometimes are by public prodigality and misconduct.

• Government revenue, in most countries, is almost entirely used to maintain unproductive hands.
• Examples include: large, fancy royal courts; large state-funded churches; large navies and armies. These groups produce nothing in peacetime, and in wartime, they gain nothing that offsets the cost of maintaining them.
• Since these people produce nothing, they are entirely supported by the output of other people’s labor.
• If the government employs an excessive number of these unproductive hands, they can consume such a large share of the national produce in one year that not enough is left to support the productive workers who need to reproduce it the following year.
• This shrinks the next year’s output, and if it continues, the economy declines year after year.
• Unproductive hands, meant to be supported only by a part of the people’s spare revenue, might end up consuming so much of the total revenue that many people are forced to dip into their capitals (the funds meant for productive labor). This violent and forced encroachment on capital can overwhelm all the savings and good conduct of private individuals, leading to national decline.

Private Saving Can Overcome Public Waste

However, experience shows that private saving and prudence are usually powerful enough to offset not only private waste but also government extravagance.

The uniform, constant, and uninterrupted effort of every individual to better their condition is the original source of all public and private wealth. This drive is often strong enough to maintain natural progress toward improvement, despite government waste and administrative errors. Like the body’s natural healing ability, it often restores health despite disease and even harmful medical treatments.

How National Wealth Increases

The value of a nation’s annual produce can increase in only two ways:

1. By increasing the number of its productive workers.
2. By increasing the productivity of its existing workers.

Capital is Essential for Both:

• The number of productive workers can only increase if the capital (funds to maintain them) increases.
• Productivity can only increase through:
  • Improvements in machinery and tools (which facilitate and shorten labor).
  • Better division and distribution of labor (specialization).
• Both productivity improvements almost always require additional capital. An owner needs more capital to buy better machines or to organize work more efficiently with specialized roles (which requires larger stocks of materials and wages to keep everyone busy).

Evidence of Progress

Therefore, when we compare a nation at two different times and find that its annual output is clearly greater at the later date – lands better cultivated, more factories, flourishing trade – we can be certain that its capital must have increased in the meantime. More must have been added by saving and good conduct than was lost through private misconduct or public waste.

This pattern of growth holds true for almost all nations during reasonably peaceful periods, even those without the most prudent governments. To see this clearly, we need to compare periods somewhat distant from each other. Progress is often so gradual that it’s not noticeable year-to-year. Sometimes, temporary declines in certain industries or regions can even lead people to suspect the whole country is decaying, even when it’s generally prospering.

The Case of England:

England’s annual production today is certainly much greater than it was just over a century ago, at the time of Charles II’s Restoration (1660). Though few doubt this now, during the intervening period, hardly five years went by without some influential book or pamphlet appearing, claiming that the nation’s wealth was rapidly declining, the country was losing population, farming was neglected, manufacturing was decaying, and trade was ruined. These weren’t all just biased political attacks; many were written by honest, intelligent people who sincerely believed the country was declining.

Likewise, England’s output at the Restoration was certainly much greater than about 100 years earlier, when Elizabeth I took the throne (around 1558). At that time, the country was much more developed than a century before that, near the end of the Wars of the Roses (late 1400s). Even then, England was likely in better shape than at the Norman Conquest (1066), and better at the Conquest than during the chaotic period of the Saxon Heptarchy. Even in those very early times, it was more developed than when Julius Caesar invaded, finding inhabitants living much like the Native Americans of North America at the time this was written.

In all these periods of English history, there was plenty of wasteful spending by individuals and the government. There were many expensive, unnecessary wars. A large share of the nation’s annual production was diverted from supporting productive workers to supporting unproductive ones. Sometimes, during civil wars, there was outright destruction of capital assets. One might expect that these events would not only slow down wealth accumulation but leave the country poorer at the end of each period than at the beginning.

Consider the time since the Restoration of Charles II (1660), arguably the most fortunate period. Think of the disasters that occurred:

• The Great Plague and Great Fire of London
• Two costly wars against the Dutch
• The upheaval of the Glorious Revolution
• The war in Ireland
• Four very expensive wars against France (starting in 1688, 1702, 1742, and 1756)
• Two major rebellions (1715 and 1745)

During the four French wars alone, the nation took on over £145 million in debt, on top of all the other extra wartime costs. The total expense cannot be calculated at less than £200 million. Since the Revolution, a huge portion of the country’s annual output has been repeatedly used to support extraordinary numbers of unproductive military personnel.

If these wars hadn’t directed so much capital this way, most of it would naturally have been used to employ productive workers. Their labor would have replaced the value they consumed, plus a profit. The nation’s annual output value would have increased considerably each year, with each increase fueling further growth the following year. More houses would have been built, more land improved or better cultivated, more factories established or expanded. It’s hard to even imagine how high the country’s real wealth and income might have reached by now.

Private Saving Overcomes Public Waste

Although government wastefulness has undoubtedly slowed down England’s natural progress towards greater wealth, it hasn’t stopped it. The annual output of land and labor today is certainly much greater than it was at the Restoration or the Revolution. Therefore, the capital used to farm the land and support the labor must also be much greater.

Amidst all the demands of government spending, this capital has been silently and gradually accumulated by the private savings and good conduct of individuals – by their universal, continual effort to better their own condition.

It is this individual effort, protected by law and allowed by liberty to operate in the most advantageous way, that has driven England’s progress in the past and will hopefully continue to do so.

However, England has never had a particularly frugal government, nor have its people been known for extreme thriftiness. It is therefore the height of impertinence and presumption for kings or ministers to try to supervise the finances of private citizens or control their spending through sumptuary laws (regulating consumption) or bans on imported luxury goods.

Governments themselves are always, without exception, the biggest spendthrifts in society. Let them manage their own expenses properly, and they can safely trust private individuals to manage theirs. If the government’s own extravagance doesn’t ruin the country, the spending of its subjects never will.

How Spending Choices Affect Wealth

While saving increases public capital and wasteful spending decreases it, what about those who spend exactly their income, neither saving nor encroaching on capital? Their actions neither increase nor decrease the total capital. However, some ways of spending seem to contribute more to public wealth than others.

An individual’s income can be spent in two main ways:

1. On things consumed immediately: Lavish meals, numerous servants, many dogs and horses. One day’s expense doesn’t support the next; nothing accumulates.
2. On durable things: Houses, useful or decorative buildings, furniture, books, statues, pictures, or even less essential items like jewels, trinkets, or fine clothes. These things last and can be accumulated. Each day’s spending can add to and enhance the effect of the previous day’s spending.

Compare two people with equal fortunes:

• Person 1 spends mostly on Option 1 (hospitality, servants): Their display of magnificence remains the same day after day. At the end of many years, they have nothing lasting to show for their expense. The effects are completely gone, as if they never existed.
• Person 2 spends mostly on Option 2 (durable goods): Their magnificence steadily increases as they accumulate possessions. Each purchase adds to the overall effect. At the end of the period, they are the richer of the two. They own a collection of goods that, while perhaps not worth the full purchase price, always retains some value.

National Benefit from Durable Spending

The same principle applies to nations. Spending on durable goods is more favorable to national wealth.

• The houses, furniture, and clothing bought by the rich eventually become useful to the middle and lower classes when sold secondhand. This gradually improves the living standards of the whole population when spending on durables is common among the wealthy.
• In long-established rich countries, you often see poorer people living in perfectly good houses or using excellent furniture that was clearly not originally made for them. (Examples given include a former Seymour family seat becoming an inn, and the royal bed of James I ending up in an alehouse).
• Grand palaces, villas, and collections of art or books become ornaments and sources of pride for the entire country (e.g., Versailles in France, Stowe in England). Italy still commands respect due to its many historical monuments, even though the wealth and genius that created them have faded.

Durable Spending Encourages Frugality

Spending on durable goods is also more conducive to frugality. If someone overspends on durable items, they can easily cut back without facing public criticism.

• Reducing servants, simplifying meals, or giving up carriages are noticeable changes that suggest previous financial irresponsibility. People are often reluctant to make such changes until forced by ruin.
• But stopping purchases of buildings, furniture, books, or art doesn’t imply imprudence. It simply suggests the person has fulfilled their desires or completed their collection.

Durable Spending Employs More Productive Labor

Spending on durable goods generally supports more people than spending on even the most lavish hospitality.

• At a huge feast, much food might be wasted or thrown away.
• If the same amount of money were spent hiring construction workers, carpenters, furniture makers, etc., an equivalent value of food would be distributed among more people (who buy it carefully in small amounts, wasting nothing).
• Crucially, durable spending employs productive hands, while hospitality employs unproductive hands.
• Therefore, spending on durables increases the value of the national annual output, while spending on hospitality does not.

Generosity vs. Economic Benefit

This analysis doesn’t mean spending on hospitality isn’t generous. A person spending mainly on entertaining shares their wealth with friends and guests. Someone spending mainly on durable goods often focuses on their own possessions, giving nothing away without getting something in return. Spending on frivolous durable items (trinkets, excessive clothes) can indicate a shallow or selfish personality.

The point here is purely economic: spending on durable goods contributes more to public opulence (national wealth) because it involves:

• Accumulation of valuable commodities.
• Encouragement of private saving.
• Increase of public capital.
• Maintenance of productive, rather than unproductive, labor.

CHAPTER IV

Loaning Money (Stock) at Interest

The Lender and the Borrower

When someone lends money (stock) to another person at interest, the lender always views it as capital.

• The lender expects to get the original amount back eventually.
• In the meantime, they expect the borrower to pay a regular fee (interest) for using it.

The borrower can use the borrowed funds in two main ways:

1. As Capital: The borrower invests the money, for example, by hiring productive workers who create goods or services worth more than their cost. The value they create covers their own maintenance and generates a profit. In this case, the borrower can afford to repay the original loan (capital) and pay the interest, using the profits generated, without needing funds from elsewhere.
2. For Immediate Consumption: The borrower uses the money for personal expenses, essentially acting like a prodigal (a wasteful spender). They spend funds meant to support productive industry on maintaining idleness. In this case, the borrower cannot repay the capital or pay the interest without using other sources of income, like selling property or using land rents.

How Borrowed Money is Typically Used

No doubt, borrowed money is sometimes used for immediate consumption, but it’s used far more often as capital for productive purposes.

• A person who borrows just to spend will likely be ruined quickly.
• The person who lends to them will usually regret their decision.

Therefore, borrowing or lending purely for consumption (unless it involves extremely high interest rates, known as usury) is generally against the best interests of both parties. While it certainly happens sometimes, basic self-interest ensures it doesn’t happen as often as we might think.

Ask any reasonably prudent wealthy person if they lend more money to people they expect will invest it profitably or to people who will just spend it idly. They would find the question absurd. Even among borrowers, who aren’t always known for being frugal, the number of careful and industrious ones is considerably larger than the number of wasteful and idle ones.

Loans to Country Gentlemen

The main group who commonly borrow money without necessarily intending to use it very profitably are country gentlemen borrowing against their land (mortgage). But even they rarely borrow just to spend frivolously. Usually, the money they borrow has, in a sense, already been spent.

They have often bought so many goods on credit from shopkeepers that they need to borrow money at interest simply to pay off these debts. The borrowed capital replaces the capital of the shopkeepers, which the gentlemen couldn’t repay directly from their land rents. So, the loan isn’t really taken out to be spent, but rather to replace capital that was spent earlier.

Money is the Tool, Goods are the Substance

Almost all loans are made using money (either paper notes or gold and silver coins). But what the borrower truly needs, and what the lender truly provides, isn’t the money itself but the money’s worth – the goods and services the money can buy.

• If the borrower wants the funds for immediate consumption, it’s the goods they will consume.
• If they want it as capital to employ workers, it’s the goods (tools, materials, food/lodging) that the workers need to do their jobs.

Through the loan, the lender effectively assigns the borrower the right to claim a certain portion of the country’s annual production of goods and services, to use as the borrower sees fit.

What Determines the Amount of Loanable Funds?

Therefore, the total amount of stock (or money, as it’s commonly called) available to be lent at interest in a country is not determined by the face value of the coins or paper money used to make the loans.

Instead, it’s determined by the value of that part of the annual produce which is set aside not just to replace existing capital, but specifically to become capital that the owner doesn’t want to manage themselves. They prefer to lend it out for others to use.

Because these capitals are usually lent and repaid using money, they form what’s called the monied interest. This is distinct from:

• The landed interest (income from land ownership).
• The trading and manufacturing interests (where owners actively use their own capital).

Even within the monied interest, the money itself acts merely as the deed of assignment – the document or token that transfers the underlying capital (the claim on goods) from the owner to the borrower.

Money Can Facilitate Loans Much Larger Than Its Value

These underlying capitals can be much larger than the amount of physical money used to transfer them. The same coins or paper notes can be used for many different loans and purchases in quick succession.

• Example: A lends $1,000 to W. W immediately uses it to buy $1,000 worth of goods from B. B doesn’t need the cash and lends the same $1,000 to X. X immediately buys $1,000 worth of goods from C. C, for the same reason, lends it to Y, who buys goods from D.

In this way, the same $1,000 in cash can, in just a few days, facilitate three different loans and three different purchases, each worth $1,000. What the lenders A, B, and C are really assigning to the borrowers W, X, and Y is the power to make those purchases. This purchasing power is the real value and purpose of the loans. The total stock lent is $3,000 (the value of the goods), three times greater than the money ($1,000) used to make the transfers.

These loans can still be perfectly secure if the borrowers use the purchased goods productively, eventually generating enough value (in coin or paper) to repay the loans with profit. Just as the same money can facilitate loans worth many times its value, it can also serve to repay those loans as it circulates back.

Loan = Assignment of Produce; Interest = Price for Assignment

So, lending capital at interest can be seen as the lender assigning the borrower a significant portion of the annual produce. In return, the borrower agrees to:

1. Annually assign the lender a smaller portion (the interest) during the loan period.
2. Assign back an equally significant portion (the repayment) at the end of the loan.

Although money is usually the “deed” used for these assignments, the money itself is different from the actual value (the claim on produce) being assigned.

More Capital Means More Loans

As the share of a country’s annual produce dedicated to replacing and increasing capital grows, the monied interest (the amount of capital available to be lent) naturally grows along with it. When the overall stock of capital increases, the quantity available for lending gradually gets larger.

More Loans Means Lower Interest Rates

As the quantity of capital available for lending increases, the interest rate (the price paid for using that capital) necessarily falls. This happens for two main reasons:

1. General Supply and Demand: Like most things, when the supply of loanable capital increases, its market price (the interest rate) tends to decrease.
2. Falling Profit Rates: This is specific to capital. As the total capital in a country increases, it becomes harder and harder to find profitable ways to invest new capital domestically.
   • Competition Increases: Owners of capital compete intensely to find profitable uses. They try to take business from each other, often by offering better terms (selling cheaper, sometimes even buying materials dearer).
   • Wages Rise: The increased funds available for investment increase the demand for productive labor. Workers find jobs easily, while employers find it hard to hire workers. This competition bids up wages.
   • Profits Squeezed: Rising wages and pressure to lower prices squeeze profit margins from both ends.
   • Interest Rates Fall: When the profit that can be made by using capital decreases, the price that can be paid for borrowing it (the interest rate) must also decrease.

Why Did Interest Rates Fall Historically? (Not Just Silver)

Some writers (like Mr. Locke, Mr. Law, Mr. Montesquieu) believed that the flood of gold and silver from the Americas after Columbus was the main reason interest rates fell across Europe. They argued that since the metals themselves became less valuable, the use of those metals (interest) also became less valuable.

This idea seems plausible but was effectively disproven by Mr. Hume. Here’s a simple way to see the flaw:

• Before the discovery of the Americas, let’s say the common interest rate was 10%. It later fell to 5% in many places.
• Let’s assume (generously, though probably not true) that silver’s value fell proportionally, so £100 now buys only what £50 bought before.
• If £100 now is only worth £50 then, the interest of £10 now must only be worth £5 then. The value of the capital and the value of the interest fell by the same proportion (half). The rate (10%) – the proportion between interest and capital – should have remained unchanged based on silver’s value alone.
• By contrast, actually changing the rate from 10% to 5% alters the proportion significantly. If £100 now is worth £50 then, the new interest of £5 now is only worth £2.50 then. So, for a capital worth half its old value, the interest paid is now only one-quarter the value of the old interest.
• Therefore, the fall in silver’s value cannot explain the fall in the interest rate.

Effects of Changing Money vs. Changing Goods

• Increase in Money Supply (Goods Constant): This only decreases the value of money (causes inflation). Nominal prices and wages rise, but real values stay the same. Real profits and the interest rate remain unchanged. It just makes transactions more cumbersome, like using wordy legal documents.
• Increase in Goods Produced (Money Constant): This raises the value of money (causes deflation). It increases the country’s real capital, boosts demand for labor, raises real wages (even if nominal wages fall), lowers real profit rates due to increased competition, and significantly lowers the interest rate.

Laws About Interest

• Prohibiting Interest: Some countries have banned charging interest. But since money can always be used productively to make something, people should be allowed to pay something for its use. Banning interest actually increases the problem of usury (charging excessive interest). The borrower has to pay not only for the use of the money but also extra to cover the lender’s risk of being penalized for breaking the law.
• Setting Maximum Rates: Most countries that permit interest set a legal maximum rate to prevent extortion.
  • Ideal Maximum Rate: This rate should always be set somewhat above the lowest market price – the rate paid by borrowers with the very best credit security.
  • Rate Set Too Low: If the legal maximum is below the lowest market rate, it has almost the same bad effects as a total ban. Lenders won’t lend for less than the market value, forcing borrowers to pay extra for the legal risk.
  • Rate Set At Lowest Market Price: This harms the credit of everyone who doesn’t have the absolute best security. Honest lenders obeying the law won’t lend to them at the legal rate, forcing these borrowers to seek out illegal, exorbitant usurers.
  • Rate in Great Britain: The current legal rate of 5% seems appropriate for Britain, where the government borrows at 3% and prime private borrowers pay 4% to 4.5%.

Don’t Set the Maximum Rate Too High

While the legal rate should be above the lowest market rate, it should not be much above it.

• If Britain’s legal rate were set very high, like 8% or 10%, most loans would go to prodigals and projectors (wasteful spenders and risky speculators). Only they would be desperate or optimistic enough to pay such high interest.
• Sober people, who only borrow if the interest is well below the profit they expect to make, wouldn’t be able to compete for loans. Prudent businesses would be starved of capital.

Setting the legal rate too high would keep a large part of the country’s capital out of the hands most likely to use it profitably. Instead, it would push capital towards those most likely to waste and destroy it.

On the other hand, when the legal interest rate is set just slightly above the lowest market rate:

• Lenders universally prefer sober, prudent borrowers over prodigals and projectors.
• The lender gets almost as much interest from the safe borrower as the law allows them to take from the risky one, but their money is much safer.
• This directs a large part of the country’s capital into the hands most likely to use it advantageously.

Laws Cannot Force Interest Rates Down

No law can successfully reduce the common interest rate below the ordinary market level prevailing when the law is made. For instance, despite a French royal decree in 1766 attempting to lower the rate from 5% to 4%, money continued to be lent privately at 5% in France. People found ways to get around the law.

Land Prices Depend on Interest Rates

It’s important to note that the typical market price of land in any country depends on the ordinary market rate of interest.

Imagine someone has capital and wants to earn income from it without the trouble of actively managing a business. They have two main options: buy land or lend the money out at interest.

• Land is Safer: Land is generally considered a safer investment than lending money. It also often comes with other advantages (like social standing).
• Lower Return Accepted: Because of these advantages, people are usually willing to accept a smaller income (rent) from owning land than they could get from lending their money out at interest.

These non-monetary advantages make up for a certain difference in income. But there’s a limit.

• If land rents fall too far below the interest earned on money, nobody would buy land, and its price would quickly fall.
• Conversely, if the advantages of land ownership greatly outweighed the lower income compared to interest, everyone would rush to buy land, which would quickly raise its price.

Historical Relationship:

• When interest rates were high (around 10%), land commonly sold for 10 to 12 times its annual rent (known as “10 or 12 years’ purchase”).
• As interest rates fell (to 6%, 5%, or 4%), the price of land rose accordingly (to 20, 25, or 30 years’ purchase).

The market interest rate is higher in France than in England. Consequently, the common price of land is lower in France (around 20 years’ purchase) compared to England (around 30 years’ purchase).

CHAPTER V

The Different Ways Capital is Used

Introduction: Not All Uses Are Equal

We know that capital is always meant to support productive labor. However, the amount of productive labor that the same amount of capital can employ varies greatly depending on how that capital is used. Likewise, the amount of value added to the country’s annual production also varies greatly.

Four Main Ways to Employ Capital

Capital can be used in four main ways:

1. Getting Raw Materials: Producing the basic, unprocessed goods society needs each year (e.g., farming, mining, fishing).
2. Manufacturing: Processing and preparing those raw materials to make them ready for use.
3. Transporting Goods (Wholesale Trade): Moving either raw materials or manufactured goods from places where they are abundant to places where they are needed.
4. Distributing Goods (Retail Trade): Breaking down large quantities of goods into smaller amounts suitable for the day-to-day needs of consumers.

It’s hard to think of any use of capital that doesn’t fall into one of these four categories.

Why Each Use is Necessary

Each of these four ways of using capital is essential for the others to exist or grow, and for the general convenience of society.

• Need for Raw Materials: Without capital used in farming, mining, etc., there would be no raw materials. Manufacturing and trade couldn’t exist.
• Need for Manufacturing: Without capital used to manufacture raw materials that require processing, those materials either wouldn’t be produced (no demand) or, if they appeared naturally, they’d have no value and add nothing to society’s wealth.
• Need for Transport: Without capital used to transport goods, production would be limited to only what the local area could consume. Wholesale merchants allow the surplus of one place to be exchanged for the surplus of another, encouraging industry and increasing enjoyment in both places.
• Need for Retail: Without capital used by retailers to divide goods into small portions, everyone would have to buy much larger quantities than they immediately need.
  • Example: If there were no butchers, you’d have to buy a whole cow or sheep at once. This would be inconvenient for the rich and nearly impossible for the poor.
  • A poor worker forced to buy a month’s food at once would have to tie up money in stored food (consumption stock, yielding no revenue) instead of using it as capital for tools or shop inventory (which yields revenue).
  • Being able to buy food daily or hourly is extremely convenient. It lets the worker use almost all their limited funds as productive capital, generating more value. The slightly higher price charged by the retailer (their profit) is more than offset by the benefit the worker gains from using their capital productively.

A Defense of Retailers

Some writers have unfairly criticized shopkeepers and retailers. Their views are baseless. Far from needing taxes or restrictions, retailers actually benefit the public through competition.

• The amount of groceries sold in a town is limited by demand.
• If only one grocer exists, they might charge high prices.
• If the grocery capital is divided among two grocers, competition tends to lower prices.
• If divided among twenty, competition is even greater, and the chance of them secretly agreeing to raise prices is much smaller.
• Competition might hurt some of the retailers themselves, but that’s their concern. It cannot hurt consumers or producers. In fact, competition pushes retailers to sell cheaper and potentially buy from producers at better prices than a monopoly would.
• While a retailer might occasionally persuade a customer to buy something unnecessary, this is a minor issue and wouldn’t necessarily be solved by limiting the number of retailers.
• Example: Having many bars doesn’t cause widespread drunkenness; rather, a tendency towards drunkenness (for other reasons) creates demand for many bars.

Comparing the Impact of Different Capital Uses

The people whose capitals are used in these four ways (farmers, manufacturers, merchants, retailers) are themselves productive laborers. Their work, when done well, adds value to the products they handle, usually covering at least their own living costs and profits.

However, equal amounts of capital used in these four ways achieve very different results:

1. They set different amounts of productive labor in motion.
2. They add different amounts of value to the nation’s annual produce.

Let’s compare them:

• Retailer’s Capital:
  • Directly employs only one productive laborer: the retailer themselves.
  • The value added to the annual produce is simply the retailer’s profit.
  • Its main function is replacing the wholesaler’s capital, allowing the wholesaler to continue business.
• Wholesale Merchant’s Capital:
  • Replaces the capitals of the farmers and manufacturers they buy from, enabling them to continue producing. This indirect support for productive labor is its main contribution.
  • Directly employs productive labor: the sailors and carriers who transport the goods.
  • Adds value to the goods equal to the transporters’ wages plus the merchant’s profit.
  • Its impact (labor employed, value added) is significantly greater than the retailer’s.
• Manufacturer’s Capital:
  • Part is fixed capital (tools, machines), replacing the capital of the artisans who made them.
  • Part is circulating capital used to buy materials, replacing the capital of farmers or miners.
  • A large part is distributed regularly as wages to the workers employed.
  • Adds value to the materials equal to the workers’ wages plus the manufacturer’s profit on the entire investment (wages, materials, tools).
  • Directly employs much more productive labor and adds much more value to the annual produce than equal capital in wholesale trade.
• Farmer’s Capital:
  • Employs the greatest quantity of productive labor. Not only the farm workers but also the laboring animals (horses, oxen) are productive laborers.
  • Uniquely, in agriculture, nature labors alongside humans. This natural contribution costs nothing but adds real value to the produce. Farming largely directs nature’s existing fertility towards useful plants.
  • Farm labor reproduces not only its own consumption value (the farmer’s capital + profit) but also a much greater value – the rent paid to the landlord.
  • This rent can be seen as the payment for using the productive powers of nature. It represents the value created by nature, after accounting for all human work. Rent is often a large share of the total produce (typically 1/4 to 1/3 or more).
  • No equal amount of labor in manufacturing can create such a large reproduction of value, because in manufacturing, humans do everything, and nature contributes nothing directly to the value.
  • Conclusion: Agricultural capital employs more productive labor than any other type and adds the most value to the nation’s annual produce and wealth relative to the labor employed. Using capital in agriculture is by far the most advantageous for society.

Where Capital Resides

• Agriculture and Retail: The capital must always be located within the society – on the specific farm or in the specific shop. It’s almost always owned by residents.
• Wholesale Trade: The merchant’s capital has no fixed residence. It can move from place to place seeking the best buying and selling opportunities.
• Manufacturing: The capital must be where the factory is, but the factory itself doesn’t have to be near the source of raw materials or the final consumers. (Examples: Lyons silk, Spanish wool processed in Britain).

Does the Owner’s Nationality Matter?

• Wholesale Trade: It matters very little whether the merchant exporting a country’s surplus produce is a local resident or a foreigner.
  • If foreign, the country has one less productive laborer (the merchant themself) and loses that one person’s profit.
  • But the foreign merchant still employs transporters (who can be local or foreign) and, crucially, still buys the local surplus produce, replacing the capital of local farmers/manufacturers and enabling them to continue production. This service is the main way wholesale trade benefits a society.
• Manufacturing: It’s more beneficial for manufacturing capital to reside within the country, as it employs more local productive labor directly.
  • However, foreign-owned manufacturing capital can still be very useful. British capital used to process flax and hemp imported from the Baltic helps those Baltic countries by providing a market for their surplus raw materials, which would otherwise be valueless and stop being produced. The British manufacturers replace the capital of the merchants who export the materials, who in turn replace the capital of the producers.

Dealing with Insufficient Capital

A country often doesn’t have enough capital to do everything simultaneously: improve all its land, manufacture all its raw materials, and transport all its surplus to distant markets.

• Example (Britain): Many areas lack capital to fully cultivate land. Wool from southern Scotland is transported overland to Yorkshire for manufacturing due to lack of local capital. Many small manufacturing towns lack the capital to transport their own goods to market; local merchants often act merely as agents for larger merchants in major cities.

Priorities for Using Limited Capital:

When a country’s capital isn’t sufficient for all three major activities (agriculture, manufacturing, export trade), the way it’s allocated matters:

1. Agriculture: Using capital here puts the most productive labor into motion within the country and adds the most value to the annual produce.
2. Manufacturing: This comes second in employing productive labor and adding value.
3. Export Trade: This has the smallest direct effect on domestic labor and value added.

A country without enough capital for all three hasn’t reached its full potential wealth. However, trying to force investment into all three areas prematurely, with insufficient capital, is not the fastest way for the society (or an individual) to accumulate enough capital.

National capital, like individual capital, grows by people continually saving and investing part of their income. Capital grows fastest when employed in ways that generate the most revenue for the country’s inhabitants, as this allows for the greatest savings. Since total revenue depends on the value of the annual produce, capital should ideally be directed first towards activities that add the most value.

The American Colonies: A Case Study

The rapid progress of the American colonies towards wealth was largely because they employed almost all their capital in the most advantageous way: agriculture.

• They had almost no manufacturing beyond basic household crafts done by women and children.
• Most of their export trade and even coastal shipping was financed and managed by the capital of merchants residing in Great Britain.
• Even many retail stores, especially in colonies like Virginia and Maryland, were owned by British merchants – a rare example of retail being run by non-resident capital.

This demonstrates how a society with limited capital naturally tends (or should tend) to focus it on the most productive uses first.

If the Americans were to artificially stop importing European manufactured goods, perhaps through boycotts or government action, they would create a monopoly for any local producers of similar goods. If this diverted a significant amount of American capital away from agriculture and into this less currently advantageous manufacturing, it would actually slow down, not speed up, the growth of their country’s annual output. It would hinder, not help, their progress towards real wealth. The outcome would be even worse if they similarly tried to force all their export trade into their own hands.

Historical Perspective on National Wealth

Human prosperity rarely seems to last long enough for any large country to gather sufficient capital for all three major purposes (agriculture, manufacturing, and foreign trade). Perhaps the only exceptions might be ancient China, Egypt, or India, based on historical accounts of their wealth.

Even these three nations, considered the wealthiest in history, were mainly famous for their advanced agriculture and manufacturing. They don’t seem to have been major players in foreign trade.

• Ancient Egyptians disliked the sea due to superstition.
• A similar attitude exists among Indians.
• The Chinese have never excelled in foreign commerce.

It appears that most of the surplus goods from these wealthy nations were exported by foreign merchants, who paid for them with other goods or, frequently, with gold and silver.

Comparing Capital Uses: Recap and Wholesale Trade Details

So, the same amount of capital will employ more or fewer productive workers, and add more or less value to the annual national output, depending on how it’s divided between agriculture, manufacturing, and wholesale trade. Furthermore, within wholesale trade itself, the specific type of trade also makes a big difference.

Three Types of Wholesale Trade

All wholesale trade (buying goods to sell them again in bulk) can be divided into three types:

1. Home Trade: Buying domestic products in one part of the country and selling them in another part (includes both inland and coastal trade).
2. Foreign Trade of Consumption: Buying foreign goods to be consumed domestically (imports for use).
3. Carrying Trade: Transporting goods between two foreign countries (acting as a middleman transporter).

Comparing the Impact of Wholesale Trades on Domestic Industry

• Home Trade: This is the most beneficial for domestic industry.

  • Every transaction generally replaces two distinct domestic capitals – the capital of the seller in one part of the country and the capital of the producer whose goods the merchant buys in the other part.
  • This enables both sets of domestic producers (farmers or manufacturers) to continue their work.
  • Example: Capital sending Scottish goods to London and bringing English goods back to Edinburgh replaces two British capitals with each round trip.
  • Returns in the home trade are usually fast, often coming back within the year, sometimes three or four times a year.

• Foreign Trade of Consumption: This is less beneficial than home trade.

  • When domestic products are used to buy foreign goods, each transaction replaces only one domestic capital (the producer of the exported goods). The other capital replaced is foreign (the producer of the imported goods).
  • Example: Capital sending British goods to Portugal and bringing Portuguese goods back replaces one British capital and one Portuguese capital.
  • Therefore, even if the return speed were the same, foreign trade gives only half the support to domestic industry compared to home trade.
  • However, returns are usually much slower than in home trade, often taking a year, sometimes two or three years.
  • If a home-trade capital completes, say, twelve operations while a foreign-trade capital completes one, the home-trade capital provides twenty-four times more support and encouragement to domestic industry (12 operations x 2 capitals replaced) than the foreign-trade capital (1 operation x 1 capital replaced).

• Roundabout Foreign Trade: This occurs when foreign goods for home consumption are bought not with domestic products directly, but with other foreign goods that were previously bought with domestic products.

  • Example: Buying Russian flax using Virginian tobacco that was originally bought with British manufactured goods.
  • The effects are generally the same as direct foreign trade, but the returns are likely to be even slower, depending on two or three separate foreign trade transactions.
  • This type of trade requires more capital to achieve the same exchange compared to a direct trade. If three merchants handle the different legs of the trade, each gets their own capital back faster, but the total capital involved remains tied up for the same long duration.
  • Overall, roundabout foreign trade generally gives even less support to domestic productive labor than direct foreign trade.

• Foreign Trade Using Gold and Silver: This is just another form of roundabout trade. The gold or silver used must first have been purchased, directly or indirectly, with the produce of domestic industry.

  • It has all the same advantages and disadvantages regarding support for domestic labor as any other roundabout trade.
  • It does seem to have one advantage: transporting valuable metals is cheap due to their small bulk. This might allow foreign goods to be purchased with a smaller amount of domestic produce compared to bartering with other, bulkier foreign goods. The country’s needs might be met more completely and cheaply.
  • (Whether exporting gold and silver impoverishes a country in other ways will be discussed later).

• Carrying Trade: This type of trade withdraws capital entirely from supporting domestic productive labor and uses it to support the labor of foreign countries.

  • Example: A Dutch merchant uses capital to carry Polish corn to Portugal and Portuguese wine back to Poland. This replaces one Polish capital and one Portuguese capital with each operation. Neither supports Dutch industry.
  • Only the profits from this trade return regularly to the home country (Holland, in this case), representing the entire benefit to its national produce.
  • Exception: If the carrying trade is done using ships and sailors from the home country, then the part of the capital paying for shipping does employ domestic productive labor. Most nations involved in carrying trade have historically done it this way (hence the name – they carry for others). But it’s not essential; the Dutch merchant could use British ships.
  • Some argue carrying trade is vital for naval defense (like for Britain). However, the same capital could employ just as many ships and sailors in the foreign trade of consumption or even home trade (coastal shipping). The amount of shipping a capital employs depends mainly on the bulkiness of goods relative to their value, and partly on distance. The coal trade between Newcastle and London employs more ships than England’s entire carrying trade.
  • Therefore, artificially forcing capital into the carrying trade doesn’t necessarily increase a nation’s shipping.

Policy Conclusion: No Forced Preferences

Comparing the three main types of wholesale trade:

1. Home trade provides the most support to domestic productive labor and adds the most value to the annual produce.
2. Foreign trade of consumption provides less support than home trade.
3. Carrying trade provides the least support to domestic industry (often only the profits return).

Since a country’s wealth and power depend on the value of its annual produce (the source of all taxes), economic policy should aim to increase that value. Therefore, governments should not give preference or special encouragement to foreign trade over home trade, or to carrying trade over the other two. Capital should not be forced or lured into channels it wouldn’t flow into naturally.

When Foreign and Carrying Trades Are Necessary

However, each type of trade, including foreign and carrying trade, is advantageous and indeed necessary when it arises naturally without government intervention.

• Need for Exports: When a country produces more of a particular good than its domestic market demands (e.g., Britain’s corn, woolens, hardware), the surplus must be exported and exchanged for something needed at home. Without exports, production of that surplus would stop, and the value of the annual produce would fall. Easy access to exports (via sea coasts, navigable rivers) is what makes those locations good for industry.
• Need for Re-exports: When foreign goods bought with domestic surplus also exceed home demand, the excess imports must be sent abroad again (re-exported) and exchanged for something else needed at home.
  • Example: Britain buys huge amounts of tobacco from America with its industrial goods but consumes only a fraction. The rest must be re-exported. If not, the imports would stop, and the British labor producing the goods to pay for that tobacco would become unemployed.
  • Thus, even the most roundabout foreign trade can sometimes be essential for supporting domestic labor and the value of annual produce.
• Natural Emergence of Carrying Trade: When a country becomes so wealthy that its accumulated capital exceeds what can be profitably employed in supplying its own consumption and supporting its own productive labor (through agriculture, manufacturing, and home/foreign trade), the surplus capital naturally flows into the carrying trade. It starts performing transport services for other countries.
  • The carrying trade is therefore a natural effect and symptom of great national wealth, not usually its cause.
  • Politicians favoring it with special incentives seem to mistake the symptom for the cause.
  • Holland, the richest country in Europe (relative to size), naturally has the largest share of Europe’s carrying trade.
  • England, perhaps the second richest, also has a significant share, although much of what’s called its carrying trade might actually be roundabout foreign trade of consumption (e.g., trading colonial goods across Europe, but ultimately paid for by British industry). England’s true carrying trade might primarily be shipping between Mediterranean ports or Indian ports.

The Limits of Each Trade

• The size of the home trade (and the capital it can employ) is limited by the value of surplus goods that different regions within the country need to exchange with each other.
• The size of the foreign trade of consumption is limited by the value of the surplus produce of the entire country and what can be bought with it.
• The size of the carrying trade is limited by the value of the surplus produce of all the different countries in the world.

The potential size of the carrying trade, therefore, is practically infinite compared to the home trade or the foreign trade of consumption. It is capable of absorbing the largest amounts of capital.

Why Capital Doesn’t Always Flow to the Best Use

The only reason an owner decides to use their capital in agriculture, manufacturing, or a specific type of wholesale or retail trade is their own private profit.

Thoughts about how much productive labor the capital might employ, or how much value it might add to the nation’s annual output, never enter the owner’s head.

Therefore, capital naturally flows to the most advantageous use for society (which we’ve seen is agriculture) only in countries where farming is also the most profitable employment for the individual owner and the easiest path to wealth.

However, in Europe, the profits from farming don’t seem to be higher than profits in other sectors.

• Recently, various writers (“projectors”) have published exciting accounts about the huge profits supposedly possible from farming and land improvement.
• Without getting into detailed analysis, a simple observation suggests these calculations must be wrong. We constantly see large fortunes made within a single lifetime in trade and manufacturing, sometimes starting with very little capital. Yet, we rarely, if ever, see a similar fortune made in agriculture from a similar starting point in Europe during this century.

Despite this, much good land in Europe remains uncultivated, and most cultivated land could be improved much further. Agriculture could absorb much more capital than has ever been invested in it.

Why European policies have favored town-based trades (manufacturing and commerce) so much over farming – to the point where individuals often find it more profitable to invest in risky, distant carrying trades than in improving fertile fields nearby – will be explored in the next two books.

CHAPTER II

Why Farming Was Discouraged in Europe After the Fall of the Roman Empire

Chaos and Land Consolidation

When Germanic and Scythian tribes overran the western Roman Empire, centuries of chaos followed.

• The invaders used violence and theft against the original inhabitants.
• Trade between towns and the countryside stopped.
• Towns were abandoned, and the countryside was left uncultivated.
• Western Europe, once quite wealthy under Roman rule, fell into extreme poverty and barbarism.

During this long period of disorder, the leaders of the invading tribes seized or claimed for themselves most of the land. Much of this land was uncultivated, but all land, farmed or not, ended up having an owner. Land ownership became highly concentrated, with a few great proprietors holding the vast majority.

Laws That Prevented Land Division

This initial concentration of land ownership, including uncultivated land, was a major problem. But it might have been temporary if the land could have been easily divided later through inheritance or sale. However, two legal practices prevented this:

1. The Law of Primogeniture: This prevented estates from being divided among all children upon the owner’s death.
2. The Introduction of Entails: This prevented owners from breaking up estates into smaller pieces through gifts, wills, or sales.

Why Primogeniture? Power and Protection

Normally, when property (like land or movable goods) is seen just as a source of livelihood and enjoyment, inheritance laws divide it among all the children, who are all important to the parent. The ancient Romans followed this natural law, dividing land equally among sons and daughters, just as we divide personal belongings.

But in the violent medieval period, land became more than just sustenance; it was a source of power and protection.

• Every major landowner was like a minor prince.
• Their tenants were their subjects. The landlord acted as judge, lawmaker (in some ways), and military leader.
• Landlords often fought wars against neighbors or even their own king.
• The security of an estate and the protection it offered depended on its size. Dividing it meant weakening it, making each part vulnerable to attack.

So, the law of primogeniture (inheritance by the firstborn son) gradually became standard for landed estates, just as it did for monarchies, to keep power and security intact by preventing division. Why the oldest male? This provided a clear rule based on sex and age, avoiding disputes over merit.

Primogeniture Today

Laws often remain long after the conditions that created them disappear. Today in Europe, someone owning a single acre is just as legally secure as someone owning hundreds of thousands. Yet, primogeniture is still respected, largely because it supports family pride and distinctions. It will likely continue for centuries, even though it’s deeply unfair to families, enriching one child by impoverishing the others.

Why Entails? Preserving the Line

Entails were a natural extension of primogeniture. They aimed to:

1. Preserve inheritance within a specific family line.
2. Prevent any part of the original estate from being lost to that line through gifts, sales, or the foolishness or misfortune of any owner.

The Romans had no such concept. When large estates functioned like small principalities, entails might have seemed reasonable, preventing the security of many from being risked by one person’s poor decisions. But today, when the law protects all estates, large or small, entails are completely absurd. They are based on the ridiculous idea that one generation has the right to control how future generations use the earth, based on the wishes of people dead for centuries.

Yet, entails are still common in Europe, especially where noble birth is required for high office. They are seen as necessary to maintain the nobility’s privileges; having gained one unfair advantage (exclusive access to honors), it seems reasonable to give them another (entails) to prevent poverty from making their privilege look ridiculous. England’s common law dislikes permanent restrictions, so entails are more limited there than elsewhere, but they still exist. In Scotland, perhaps over one-third of all land is currently under strict entail.

Large Estates Mean Poor Improvement

These laws meant that vast areas of land were locked up by specific families, preventing them from ever being easily divided. Unfortunately, large landowners are rarely great improvers of land.

• In medieval times: They were too busy defending their land or attacking neighbors to focus on farming techniques.
• In later, more peaceful times: They often lacked the desire or the necessary skills.
  • Many spent all their income (or more) on their households and personal expenses, leaving no capital for land improvement.
  • If they did save money, they usually found it more profitable or appealing to buy more land rather than invest in improving their existing property.
  • Profitable land improvement, like any business, requires careful attention to small savings and gains. A person born to great wealth is rarely capable of this mindset, even if naturally frugal. They tend to focus on ornament (fancy clothes, carriages, houses, furniture) rather than profit.
  • This focus on appearance carries over to land. They might spend excessively “improving” a few hundred acres near their main house for aesthetic reasons, making it impossible to improve the whole estate without going bankrupt.

Evidence: Compare the condition of large estates that have been in the same family since feudal times with the small properties owned by their neighbors. You’ll see how much large, entailed estates discourage improvement.

Those Working the Land Also Lacked Incentive

If large owners did little to improve the land, even less could be expected from those who actually worked it under them.

Stage 1: Serfdom (Villeinage)

In early medieval Europe, most occupiers of land were tenants at will, essentially serfs or slaves.

• Their slavery was milder than in ancient Greece/Rome or the West Indies. They were tied to the land (sold with it, not separately).
• They could marry (with permission) and couldn’t be split from their spouse by sale.
• Hurting or killing them brought a penalty (though often small).
• Crucially, they could not own property. Anything they acquired belonged to their master.
• Therefore, any improvements were done by the master, using the master’s seed, cattle, and tools, for the master’s benefit. Serfs received only basic subsistence.
• This system still exists in parts of Eastern and Central Europe but was gradually abolished in Western Europe.

Slave Labor is Inefficient

However, improvements are least likely when owners use slaves. History shows slave labor is the most expensive in the long run, even though it seems cheap (only costing maintenance).

• A person who cannot own property has no incentive other than to eat as much and work as little as possible.
• Any extra work must be forced out of them; it’s not in their self-interest.
• Ancient writers (Pliny, Columella) noted how grain cultivation declined in Italy when managed by slaves. Aristotle observed similar issues in Greece.

Why Slavery Persists (Sometimes)

Human pride makes people prefer to command rather than persuade. Where the law allows and the work is profitable enough, owners often prefer slaves to free workers.

• Sugar and tobacco planting were profitable enough to afford slave labor. Corn farming generally wasn’t (in modern times).
• This is why English colonies growing corn used mostly free labor. The Quakers in Pennsylvania freeing their slaves suggests slaves weren’t a huge part of their wealth.
• In contrast, sugar colonies relied almost entirely on slaves, and tobacco colonies heavily. Sugar profits were the highest, followed by tobacco, then corn.

Stage 2: Sharecropping (Métayers)

Serfs were gradually replaced by a type of farmer called métayers in France (from Latin Coloni Partiarii, meaning ‘sharing farmers’; no common English name now).

• The landlord provided all the necessary stock: seed, animals, tools.
• The produce was divided equally between landlord and tenant after setting aside enough to maintain the stock (which belonged to the landlord).

Land farmed by métayers was still cultivated at the landlord’s expense, much like land worked by slaves. But there was a key difference:

• Métayers were freemen and could own property.
• Getting a share of the produce gave them a clear interest in maximizing the total harvest.
• A slave, getting only maintenance, had an interest in the land producing as little as possible above that minimum.

This advantage for the landlord, combined with rulers gradually weakening the power of great lords (making serfdom inconvenient), likely led to the end of serfdom across most of Europe. (The exact process is historically unclear, though the Church claims credit). A freed serf with no capital could only farm using landlord-provided stock, becoming a métayer.

Sharecropping Still Discouraged Improvement

However, even métayers had little reason to invest any savings from their share back into improving the land.

• The landlord, who contributed nothing extra, would receive half the benefit of the tenant’s investment.
• A 50% “tax” on improvement is a powerful barrier (even a 10% tithe significantly hinders improvement).
• A métayer might work hard using the landlord’s stock but wouldn’t mix their own capital with it.
• In France, where most land was still farmed this way, landlords complained that métayers preferred using the farm animals for transport work (where they kept all the profit) rather than cultivation (where profit was shared).
• This system also existed in Scotland (“steel-bow tenants”) and likely resembled early English tenancies described as “bailiffs” rather than true farmers.

Stage 3: Modern Tenant Farmers

Very slowly, métayers were replaced by farmers properly so called:

• They cultivated land using their own stock (capital).
• They paid a fixed rent (usually in cash) to the landlord.
• When these farmers have a lease for a fixed number of years, they may find it worthwhile to invest their own capital in improving the farm. They might expect to recover their investment, plus a large profit, before the lease expires.

CHAPTER II

(Continued)

The Insecurity of Early Farmers

Even when farmers started using their own capital and paying fixed rent, their situation was often very unstable for a long time, and still is in many parts of Europe.

• Lease Insecurity: Before their lease term ended, they could legally be kicked out if the land was sold to a new owner. In England, they could even be evicted through complex legal procedures.
• Weak Redress: If a landlord illegally forced them out, the legal action available to the farmer was flawed. It didn’t always get them back onto the land, and the financial compensation awarded rarely covered their actual losses.

Improvements in England

The situation for tenant farmers improved significantly in England, especially around the reign of Henry VII (late 15th century).

• Action of Ejectment: A new legal process called the “action of ejectment” was introduced. This allowed tenants to recover not just monetary damages but actual possession of the land. It also provided a more reliable legal decision.
• Equal Security: This remedy proved so effective that landlords now typically use this tenant-focused procedure when they need to sue for possession, rather than older landlord-specific actions. In England, therefore, a tenant’s legal security became equal to that of the landowner.
• Political Rights: Furthermore, in England, certain long-term leases (originally those worth 40 shillings a year) were considered freeholds. This gave the tenant the right to vote for members of Parliament. Since many farmers (yeomanry) held such freeholds, landlords respected the entire group due to their political influence.
• Trust: This high level of security and respect is likely why England is perhaps the only place in Europe where tenants sometimes built on land without having a lease, trusting the landlord wouldn’t take unfair advantage of their investment.

These laws and customs, so favorable to farmers, have perhaps done more for England’s current prosperity than all its famous trade regulations combined.

Scotland and Elsewhere

• Scotland: A law securing long leases against new owners was introduced very early (1449). However, its benefits were limited by the prevalence of entails, which often prevented landowners from granting long leases (sometimes longer than just one year). A recent Act of Parliament eased these restrictions slightly, but they remain significant. Also, since leases in Scotland don’t grant voting rights, farmers there lack the political respect enjoyed by their English counterparts.
• Other Parts of Europe: Even after laws protected tenants from heirs and purchasers, the length of this security was often very short. In France, for example, it was initially only nine years (though later extended to twenty-seven). Such short terms were still insufficient to encourage tenants to make costly, long-term improvements. Landlords historically made the laws across Europe, and they designed land laws based on what they thought was their own interest – ensuring no previous lease prevented them from enjoying the land’s full value for long periods. Greed and injustice are shortsighted; they didn’t realize how much these restrictions would hinder improvements and ultimately hurt the landlords’ own real interests in the long run.

Other Burdens on Farmers

Besides insecure leases, farmers faced other significant burdens:

• Feudal Services: Tenants were often obligated to perform many services for the landlord. These were rarely detailed in the lease but depended on local custom (“use and wont”). Being arbitrary, these services subjected tenants to frequent harassment. Abolishing unspecified services in Scotland greatly improved farmers’ conditions there in recent years.
• Arbitrary Public Services: Duties owed to the state were also burdensome.
  • Roads: Making and maintaining roads was a common requirement (and still exists with varying degrees of unfairness).
  • Purveyance: When the king’s troops, household, or officials traveled, farmers were forced to provide horses, carts, and food at fixed, often low, prices set by the government agent (purveyor). Great Britain is likely the only European monarchy to have completely abolished this oppressive practice; it continued in France and Germany.
• Oppressive Taxes: Public taxes were just as irregular and unfair.
  • Tallage/Taille: Medieval lords, reluctant to pay taxes themselves, readily allowed the king to tax their tenants directly (“tallage”). The French taille, which survived into modern times, is a prime example. It was a tax on the farmer’s supposed profits, estimated based on the visible stock (animals, equipment) on the farm. This created a strong incentive for farmers to appear poor, own as little stock as possible, invest minimally in cultivation, and avoid improvements entirely. Any savings a French farmer accumulated were effectively prohibited from being reinvested in the land by the taille.
  • Social Stigma: This tax was also considered degrading, placing the farmer below gentlemen and even town merchants. No wealthy individual would subject themselves to it by renting land. The taille thus not only prevented capital accumulated on the land from being reinvested but also drove other capital away from farming.
  • English Taxes: The old “tenths and fifteenths” taxes in England seem to have been similar in nature when applied to land.

Discouragement and Disadvantages

Under all these discouragements, little improvement could be expected from tenant farmers. Even with full legal liberty and security, this group always operates at significant disadvantages compared to landowners:

• Borrowed Capital Analogy: A tenant farmer is like a merchant trading with borrowed money, while a landowner farming their own land is like a merchant trading with their own capital. Both can improve their stock, but the farmer’s must improve more slowly because a large share of the profit (rent) goes to the landlord, whereas the owner-cultivator could reinvest that portion.
• Social Status: A farmer’s social position is inherently lower than a landowner’s. Throughout most of Europe, farmers are seen as inferior even to skilled tradesmen, and certainly to large merchants and manufacturers. Consequently, people with significant capital are unlikely to leave a higher-status profession to become tenant farmers.
• Source of Farming Capital: Therefore, even today, little capital is likely to move from other sectors into farming. This happens more in Great Britain than elsewhere, but even there, large farming capitals have usually been built up slowly through farming itself, perhaps the slowest way to accumulate capital.

Despite these challenges, after small landowners, rich and substantial tenant farmers are the main improvers of land in every country. There are likely more such farmers in England than in any other European monarchy, although those in the republics of Holland and Berne (Switzerland) are said to be equally capable.

Further Policy Discouragements

Beyond these issues, historical European policy further discouraged land improvement, whether by owners or tenants:

1. Prohibitions on Grain Export: Exporting corn (grain) generally required a special license, a widespread rule that limited farmers’ markets.
2. Restraints on Internal Trade: Laws against “engrossers, regraters, and forestallers” (effectively, middlemen and wholesalers accused of manipulating supply) and special privileges granted to fairs and markets restricted the free movement and sale of grain and other farm produce even within the country.

We’ve already seen how export prohibitions hurt farming in ancient Italy. It’s hard to fully grasp how much these internal trade restrictions, combined with export bans, must have discouraged farming in less fertile and less advantaged countries.

CHAPTER III

How Cities and Towns Grew and Developed After the Fall of the Roman Empire

Town Inhabitants After Rome’s Fall

After the Roman Empire collapsed in the west, people living in cities and towns were not treated any better than people in the countryside. Town dwellers were actually a very different group compared to the citizens of the ancient Greek and Roman republics.

• Ancient Cities: Were founded mainly by landowners who built houses together and walled them for defense.
• Medieval Towns: After Rome’s fall, landowners generally lived in fortified castles on their own estates, surrounded by their tenants. Towns were mostly inhabited by tradesmen and mechanics (artisans).

These townspeople seem to have originally been slaves or nearly slaves. We can tell this from the kinds of privileges later granted to them in town charters. For example, charters often granted the right to:

• Marry off their own daughters without the lord’s consent.
• Have their own children inherit their goods (instead of the lord taking them).
• Dispose of their belongings by making a will.

Granting these as privileges shows that, before the charter, the townspeople were in much the same condition as the serfs (villains) who worked the land in the country.

Early Traders and Taxes

Early tradesmen seem to have been poor people who traveled with their goods from place to place, much like modern-day hawkers and peddlers.

In medieval Europe (similar to some Asian empires then and now), travelers often had to pay taxes when they passed through certain lords’ lands, crossed bridges, carried goods in fairs, or set up stalls to sell things. In England, these taxes had names like passage, pontage, lastage, and stallage.

Sometimes, a king or a powerful lord would grant specific traders (especially those living on their own lands) an exemption from these taxes. These traders were then called Free-traders, even though they were otherwise still in a near-servile condition. In return for the exemption and protection, they usually paid their protector an annual poll tax (a tax per person). Protection was rarely free back then. These exemptions and poll taxes seem to have started as personal arrangements, lasting only for the individual’s lifetime or as long as the protector wished.

Towns Gain Freedom by “Farming” Taxes

Although townspeople started in a lowly position, they gained liberty and independence much earlier than people working the land.

Kings received revenue from the poll taxes paid by townspeople (“burghers”). Kings often found it convenient to “let in farm” this revenue – meaning they would lease the right to collect these taxes in a town to someone for a fixed number of years in return for a guaranteed annual rent. This lease might go to the county sheriff or someone else.

Eventually, the burghers themselves often managed to lease (farm) the taxes of their own town. They would become collectively responsible for paying the fixed rent to the king.

• This practice suited the kings, who often leased entire manors to the collective body of tenants.
• The tenants (or burghers) benefited because they could collect the revenue in their own way and were freed from dealing with arrogant royal tax collectors – a major advantage in those times.

From Leases to Permanent Freedom (“Free Burghs”)

Initially, towns probably farmed their taxes for limited terms, like any other farmer. Over time, however, it became common practice for kings to grant this right “in fee” – meaning forever – in return for a fixed rent that would never increase.

Since the payment became permanent, the tax exemptions for which it was paid also became permanent. These rights and exemptions then belonged not just to individuals, but to the town (burgh) as a whole. This is why such towns were called free burghs, and their inhabitants had earlier been called free burghers or free traders.

Granting Basic Rights and Corporate Status

Along with the permanent tax farm, towns were usually granted those crucial personal freedoms mentioned earlier (control over marriage, inheritance, wills). This effectively ended the main aspects of serfdom for them, making them truly free in the modern sense.

Furthermore, towns were typically established as commonalties or corporations. This gave them significant privileges:

• The right to elect their own magistrates and town council.
• The power to make local laws (bye-laws) for self-government.
• The right to build walls for defense.
• The authority to organize all inhabitants for military duty (watch and ward) to defend the walls day and night.
• In England, they were often exempt from county courts and could judge local cases (except major crimes) in their own courts. Other countries sometimes granted even wider legal powers.

Why Kings Helped Towns Become Independent

Why would kings give up a growing source of revenue for a fixed rent and allow independent republics to form within their kingdoms?

The main reason lies in the power struggle between kings and great lords (barons).

• In medieval times, kings often couldn’t protect weaker subjects from powerful local lords throughout their entire kingdom.
• People who couldn’t defend themselves had to seek protection from a lord (becoming their vassals or slaves) or band together for mutual defense.
• Townspeople were individually weak but could resist lords effectively if they formed organized leagues.
• Lords vs. Burghers: Lords despised the townspeople, viewing them as runaway slaves, envied their wealth, and often plundered them. Burghers naturally hated and feared the lords.
• Kings vs. Lords: Kings also hated and feared the powerful lords. Kings might have despised the burghers but had no reason to fear them.
• Natural Alliance: This created a mutual interest. Kings supported towns against the lords, and towns supported the king. Towns were the enemies of the king’s enemies.
• Granting Privileges: By giving towns self-government, walls, and militias, kings made them secure and independent allies against the barons. Granting the tax farm permanently removed any fear that the king might later oppress the town himself.

Kings who had the most trouble with their barons tended to be the most generous in granting privileges to towns (e.g., King John of England, Louis VI of France). The free towns of Germany gained many privileges during periods of weak imperial rule.

Towns Gain Power

Town militias often proved effective against local lords.

• In places where royal authority completely collapsed (like Italy and Switzerland), cities often became fully independent republics. They conquered the surrounding nobility, forcing them to tear down their castles and live as ordinary citizens within the city walls. (This happened in Berne, other Swiss cities, and most major Italian republics).
• In countries where royal authority weakened but survived (like France and England), cities didn’t become fully independent. However, they grew powerful enough that kings needed their consent for any taxes beyond the fixed town rent.
• This led to kings summoning deputies from the towns to national assemblies (like Parliament or the Estates-General) alongside the clergy and barons. Town deputies often supported the king, providing a counterbalance to the power of the lords. This was the beginning of representation for towns and boroughs in European governments.

Towns: Havens of Security and Industry

In this way, order, good government, liberty, and security were established in towns long before the countryside, where people were exposed to constant violence.

• People living in insecurity focus only on basic survival; acquiring more just invites theft.
• People who are secure in enjoying the results of their work naturally strive to improve their condition, acquiring not just necessities but also conveniences and luxuries.
• Therefore, industry aimed at more than just subsistence began in towns long before it was common in the countryside.
• If a poor serf managed to save a little capital, they would hide it from their master and flee to a town at the first chance. Laws were often favorable to towns (to weaken lords), granting freedom to any serf who could remain hidden there for a year.
• Towns became sanctuaries where the industrious poor could secure their property.

Towns and Wider Trade

While towns ultimately depend on the country for food and materials, cities located near the coast or navigable rivers were not limited to their immediate surroundings.

• They could trade with the most remote parts of the world.
• They could exchange their own manufactured goods or act as carriers, exchanging the goods of one distant country for those of another.
• A city could grow rich and powerful this way, even if its neighboring countryside and many of its trading partners were poor. While individual trading partners might provide little, the combined trade could support great wealth and employment.
• Historically, some regions accessible by trade were wealthy and industrious (e.g., the Byzantine Empire, the Saracen Empire under the Abbasids, Egypt before the Turks, parts of North Africa, Moorish Spain).

Italian Cities Lead the Way

The cities of Italy were likely the first in Europe to achieve significant wealth through commerce.

• Italy was centrally located in the civilized world of that time.
• The Crusades, while devastating for much of Europe (wasting resources and lives), greatly benefited some Italian cities (Venice, Genoa, Pisa). Their ships were constantly employed transporting Crusaders and supplying them with provisions. These cities acted like the supply officers for the Crusader armies, growing rich from Europe’s destructive religious frenzy.

How Cities Influenced the Countryside

Trading cities imported improved manufactured goods and expensive luxuries from richer countries. This gave the great landowners something new to spend their wealth on. They eagerly bought these imported luxuries, paying for them with large quantities of raw produce from their lands.

CHAPTER III

(Continued)

During those times, trade in much of Europe mainly involved exchanging local raw materials for the manufactured products of more civilized nations.

• Example: England used to trade its wool for French wines and fine Flemish cloths. Similarly, Poland today trades its grain for French wines and brandies, and for silks and velvets from France and Italy.

How Foreign Trade Led to Local Manufacturing

In this way, foreign trade introduced a taste for finer manufactured goods into countries that didn’t produce such things themselves. When this taste became widespread enough to create significant demand, merchants naturally tried to set up similar manufacturing in their own country to save on transportation costs. This seems to be how the first factories producing goods for distant sale (not just local use) began in Western Europe after the fall of the Roman Empire.

Basic vs. Advanced Manufacturing

It’s important to remember that no large country could ever survive without some basic manufacturing. When we say a country has “no manufactures,” we usually mean it lacks the finer, more complex types suitable for export.

• In every large country, most people’s clothing and household furniture are products of local industry.
• This is even more true in poor countries (often said to have “no manufactures”) than in rich ones. In rich countries, you’ll often find more imported goods used even by the poorest people compared to poor countries.

Two Ways Export-Oriented Manufacturing Started

Manufactures suitable for distant sale seem to have developed in two different ways:

1. Imitation Driven by Foreign Commerce

• As mentioned above, sometimes merchants and entrepreneurs deliberately established factories to copy successful foreign products. This could be seen as a “violent operation” – a conscious effort by individuals.
• Such manufactures are the direct offspring of foreign commerce.
• Examples:
  • The silk, velvet, and brocade manufacturing that thrived in Lucca, Italy, in the 13th century. (These were later disrupted by a local tyrant, Castruccio Castracani. In 1310, many families were driven out; some went to Venice and started the silk industry there).
  • The fine cloth manufacturing that flourished early in Flanders (modern Belgium/Netherlands).
  • Similar fine cloth manufacturing introduced into England early in Queen Elizabeth I’s reign.
  • The modern silk industries of Lyons (France) and Spitalfields (London).
• Characteristics:
  • Often use foreign raw materials (since they imitate foreign goods). Venice used silk from Sicily; Lucca used foreign materials; early Flanders used Spanish and English wool; early English export cloth used Spanish wool; Lyons still uses mostly foreign silk; Spitalfields materials aren’t produced in England.
  • The location (coastal city or inland town) depends on the founders’ interests and judgment.

2. Natural Growth from Agriculture

• Other times, manufactures for distant sale grow naturally and gradually from the refinement of basic household crafts that exist everywhere, even in the poorest countries.
• Location: This often happens in inland areas that are fertile and easily farmed, but are far enough from the coast or navigable rivers to make transporting bulky surplus produce difficult and expensive.
• Mechanism:
  • Difficulty exporting surplus food makes it cheap locally.
  • Cheap food attracts many workers, who can live better there than elsewhere.
  • They process local raw materials (like wool or flax).
  • They exchange their finished goods locally for more food and materials.
  • This adds value to the raw materials by saving the cost of transporting them unprocessed to distant markets.
  • It also provides farmers with useful or desirable goods more cheaply than before.
  • Farmers get better prices for their surplus and can buy other things cheaper. This encourages them to improve their land and produce even more surplus.
  • The initial fertility of the land supports manufacturing, and the growth of manufacturing, in turn, boosts agricultural productivity further.
• Market Expansion: These manufacturers first supply their local area. As their skills and products improve, they begin selling to more distant markets.
  • While bulky raw produce or coarse cloth might not be profitable to transport far overland, refined manufactured goods often can be. They pack a high value (representing large amounts of raw materials and the labor to process them) into a small bulk and weight.
  • Example: A piece of fine cloth weighing only 80 pounds might contain the value of that wool plus the value of thousands of pounds of grain (used to feed the workers and employers). The grain, difficult to export directly, is effectively exported within the processed cloth.
• Examples: The manufacturing centers of Leeds, Halifax, Sheffield, Birmingham, and Wolverhampton in England seem to have grown up naturally in this way.
• These manufactures are the offspring of agriculture.

Historical Timing in Europe

In modern European history, the “offspring of foreign commerce” (Path 1) generally developed before the “offspring of agriculture” (Path 2).

• England was known for making fine cloths from Spanish wool (Path 1) more than a century before the industries in places like Leeds or Birmingham (Path 2) were developed enough for export.
• The agriculture-driven manufactures could only flourish after agriculture itself had significantly improved. In Europe’s “inverted” development path, this agricultural improvement often happened later, stimulated by the growth of foreign commerce and the manufacturing directly introduced by it (as explained in the next chapter).

CHAPTER IV

How Town Commerce Helped Improve the Countryside

The growth and wealth of towns involved in commerce and manufacturing helped improve and cultivate the surrounding countryside in three main ways:

1. Providing a Market

• Towns offered a large and convenient market for the raw produce (like grain, wool, timber) from the countryside.
• This encouraged farmers to cultivate their land better and make further improvements to increase production.
• This benefit wasn’t just limited to the immediate area but extended to all regions the town traded with, providing a market for some of their produce too.
• However, the town’s own neighboring countryside benefited the most. Its produce had lower transportation costs, so traders could pay local growers a better price while still selling it as cheaply to consumers as produce from farther away.

2. Merchant Investment in Land

• Wealthy people from the cities, especially merchants, frequently used their money to buy land offered for sale, much of which might be uncultivated.
• Merchants often aspire to become country gentlemen. When they do, they generally become the best land improvers.
• Why Merchants Excel:
  • Profit-Oriented: Merchants are used to investing money in projects they expect to be profitable. Country gentlemen are more accustomed to spending money on expenses.
  • Boldness: Merchants regularly see their capital go out and come back with profit, making them bolder investors. Gentlemen, often seeing money only go out, tend to be more timid about large investments. A merchant isn’t afraid to invest significantly in land improvement if they see potential for good returns.
  • Business Habits: The habits of order, careful accounting (economy), and attention learned in business make merchants much better suited to successfully manage land improvement projects.
• Anyone living near a mercantile town in an underdeveloped area will have noticed how much more energetically merchants undertake land improvement compared to traditional country gentlemen.

3. Fostering Order and Liberty

• Finally, commerce and manufacturing gradually introduced order, good government, and individual liberty and security among the people living in the countryside.
• Before this, country dwellers often lived in a state of near-constant petty warfare with neighbors and were completely dependent on their superiors (lords).
• This effect, though perhaps the least noticed, is by far the most important outcome of town commerce. (Mr. Hume is noted as the only writer to have previously highlighted this).

Life Before Commerce: The Power of Lords

In a country with little foreign trade or advanced manufacturing, a great landowner had limited options for using the surplus produce from their lands (what was left after feeding the farm workers). They couldn’t exchange it for much. So, they used it primarily for “rustic hospitality” – feeding a vast number of people at their own residence.

• If the surplus could feed a hundred or a thousand men, the lord maintained that many retainers and dependents.
• These people gave nothing tangible in return for their upkeep. They were fed entirely by the lord’s generosity (bounty) and had to obey him completely, just like soldiers obey the ruler who pays them.
• Before commerce and manufacturing spread in Europe, the hospitality of the wealthy, from kings down to minor barons, was on a scale hard for us to imagine today. (Examples: William Rufus dining in Westminster Hall; Thomas Becket providing clean rushes for knights to sit on the floor; the Earl of Warwick supposedly feeding 30,000 people daily). This lavish hospitality seems common in societies with little commercial development (e.g., Scottish Highlands recently, Arabian chiefs).

Tenant Dependence

The farmers (occupiers of land) were just as dependent on the great landowner as the retainers were.

• Even those who weren’t technically serfs were often tenants at will.
• They paid a very small rent (a “quit-rent” – maybe a sheep or a small amount of money) that was nowhere near the value of the subsistence the land provided them.
• Since the landowner had to consume the estate’s surplus produce on the estate itself, it was convenient to let tenants consume some of it on their own farms, as long as they remained completely dependent. This avoided overcrowding the lord’s main house.
• A tenant paying barely any rent for land that fed their family was as dependent as any servant and had to obey the lord without question. The lord essentially fed both retainers (at his house) and tenants (at theirs) from his bounty.

Baronial Power Based on Dependency

The immense power of the ancient barons was built on this authority over their tenants and retainers.

• They naturally became the judges in peacetime and military leaders in wartime for everyone living on their estates.
• They could maintain order and enforce laws within their territory because they could command the entire population against any troublemaker.
• No one else, including the king, had enough local authority to do this. The king was often little more than the largest landowner, respected by other lords mainly for common defense purposes.
• Trying to enforce even a small debt within a great lord’s territory would have required the king to mount a military campaign.
• Therefore, kings had to leave the administration of justice and the command of local militias mostly in the hands of the powerful lords who could actually enforce them.

This Power Predated Feudal Law

It’s a mistake to think these local powers (territorial jurisdictions) came from feudal law.

• Great landowners held rights like high justice (civil and criminal), raising troops, coining money, and even making local laws “allodially” (as inherent rights of ownership) centuries before feudalism was widely established in Europe. Saxon lords in England were powerful before the Norman Conquest (which preceded the full establishment of feudal law there). French lords clearly held such powers allodially before feudalism.
• These powers naturally resulted from the state of property ownership and the resulting social dependency described above.
• Later Example: Even relatively recently (mid-18th century), Mr. Cameron of Lochiel in Scotland, though technically just a vassal of the Duke of Argyle and holding no official position, exercised high criminal justice over his people simply based on traditional authority, likely necessary to keep peace in that remote area. He could raise hundreds of men for rebellion based on this personal loyalty.

Feudal Law Tried (and Failed) to Control Lords

The introduction of feudal law can be seen as an attempt to moderate, not create, the great lords’ power.

• It established a formal hierarchy from the king down, with defined services and duties.
• It gave superiors (ultimately the king) control over a lord’s lands and the heir’s upbringing and marriage during their minority.
• While this tended to strengthen the king and weaken the lords, it didn’t fundamentally change the property structure or the system of dependency that caused the disorder.
• Government authority remained too weak at the top (the king) and too strong in the lower branches (the lords). The lords continued to fight wars among themselves and against the king. The countryside remained violent and chaotic.

Commerce Succeeds Through Self-Interest

What feudalism couldn’t achieve through force, the “silent and insensible operation” of foreign commerce and manufactures gradually accomplished. How?

• New Spending Options: Commerce provided the great landowners with new things – manufactured goods and foreign luxuries – for which they could exchange the entire surplus produce of their lands.
• Selfish Consumption: Instead of sharing their surplus produce with tenants and retainers, lords could now spend its entire value on goods they consumed themselves. Driven by the “vile maxim” of “All for ourselves and nothing for other people,” they chose personal gratification.
• Trading Power for Trinkets: For perhaps a pair of diamond buckles or some other frivolous item, a lord would trade away the means of maintaining a thousand men for a year – and the power and authority that came with it. The buckles were entirely his own; the old hospitality had to be shared. This difference was decisive. For the “most childish, the meanest, and the most sordid of all vanities,” they gradually gave up their power.

The Shift Away from Direct Dependence

• Before: A lord with a large income (£10,000/year) could only use it by maintaining perhaps a thousand dependent families.
• Now: A person with the same income can (and usually does) spend it all without directly maintaining more than twenty people, mostly servants of little consequence.
• Indirect Maintenance: They indirectly support many more people – the workers and employers involved in producing the expensive luxury goods they buy. The high price pays the wages and profits of potentially thousands involved in the supply chain.
• Independence: However, the lord contributes only a tiny fraction to each worker’s total income. These workers rely on hundreds or thousands of different customers. Though obligated to all, they are not dependent on any single one, including the lord.

Dismissals, Consolidation, and Long Leases

This shift had several consequences:

1. Dismissal of Retainers: As lords spent more on personal luxuries, they gradually dismissed their retainers.
2. Farm Consolidation: They also got rid of unnecessary tenants, enlarging farms to the size needed for cultivation at the time, aiming to maximize the surplus rent they could collect.
3. Demand for Higher Rents: Lords wanted even more rent to fund their spending.
4. Origin of Long Leases: Tenants could only agree to pay higher rents if they had secure possession for a term long enough to recoup investments made in improving the land. The landlords’ expensive vanity made them agree to this condition, leading to the practice of long leases.

Tenant Independence and the Fall of Lords

• Even a tenant paying full rent gains some independence through the mutual economic relationship.
• A tenant with a long lease is altogether independent, owing the landlord nothing beyond the rent and legal obligations.
• With retainers dismissed and tenants independent, the great proprietors lost their military power. They could no longer disrupt justice or the peace of the country.
• Having traded their birthright (power) for “trinkets and baubles,” they became as insignificant as ordinary city merchants or tradesmen.
• Order Established: A regular government could finally be established effectively in the countryside, as no local power could challenge it.

(Side Note on Old Families): It’s notable that families who have held large estates for many generations are rare in commercial countries (where fortunes are more easily dispersed) but common in less commercial areas like Wales or the Scottish Highlands (where old power structures persisted longer).

(Context: This follows the explanation of how commerce led lords to dismiss retainers and grant tenants independence, establishing order in the countryside).

Why Old Landowning Families Are Rare in Commercial Countries

It’s worth noting that families who have held the same large estate for many generations are very rare in commercial countries. However, they are common in places with little commerce, like Wales or the Scottish Highlands.

• Non-Commercial Societies: Where a rich person can only spend their income by supporting people, they are less likely to overspend their entire fortune. Their generosity rarely extends to supporting more people than their income allows. Histories from these cultures, like those of the Arabs or Tartars, are often full of genealogies, showing the importance and persistence of ancient families. The consumable nature of their wealth (like herds) also makes legal restrictions like entails impossible.
• Commercial Countries: Where a rich person can spend vast sums entirely on themselves, their vanity or desire for personal luxury often has no limits. Consequently, despite laws designed to prevent wealth from being broken up (like entails), riches rarely stay in the same family for very long.

An Unintended Revolution

This huge shift in society – from feudal disorder to modern order and liberty – was brought about by two groups of people who had no intention of serving the public interest:

1. The Great Landowners: Motivated solely by childish vanity and the desire for personal luxuries.
2. The Merchants and Artisans: Motivated purely by self-interest, following the “pedlar principle” of making money wherever possible.

Neither group knew or foresaw the great social revolution their actions were causing.

Europe’s “Unnatural” Path: Commerce Before Agriculture

Therefore, throughout most of Europe, the growth of commerce and manufacturing in cities was the cause of agricultural improvement and cultivation in the countryside, rather than the effect (which would be the natural order).

This reversed order of development, however, is necessarily slow and uncertain.

• Compare Progress: Look at the slow progress of European countries heavily reliant on commerce and manufacturing versus the rapid advancement of the North American colonies, whose wealth was founded entirely on agriculture.
• Population Growth: European populations are thought to take perhaps 500 years to double. North American colonial populations were doubling in just 20 or 25 years.

Why Europe’s Agricultural Progress Was Slow

European laws and customs hindered the natural flow of capital into agriculture:

• Primogeniture and Entails: These laws prevent large estates from being divided. This stops the creation of many small landowners.
• Small Proprietors are Best: A small owner knows their land intimately, feels affection for it, and takes pleasure in both cultivating and improving it. They are generally the most industrious, intelligent, and successful improvers.
• Land Becomes Expensive: These laws also keep much land off the market. With more capital seeking land than land available for sale, prices become inflated (monopoly price).
• Buying Land is Unprofitable: The rent earned from land rarely covers the interest one could have earned on the purchase money. Land ownership also involves costs for repairs and taxes that lending money doesn’t. Buying land in Europe is generally a very unprofitable way to use a small amount of capital.
  • People with small capitals might buy land only for the security it offers (e.g., upon retirement) or as a way to invest savings from another profession.
  • A young person investing a few thousand pounds in buying and farming a small piece of land might live happily and independently but gives up any chance of making a great fortune, which might have been possible in trade or a profession.
  • Such individuals often disdain becoming mere tenant farmers if they can’t be owners.
• Result: The scarcity and high price of land prevent much capital from being invested in farming that would otherwise naturally go there.

The North American Contrast

• In North America, a small amount of capital (£50 or £60) was often enough to start a farm (plantation).
• Buying and improving uncultivated land was the most profitable use for both small and large capitals and the most direct path to wealth and status.
• Land there was available almost for nothing, far below the value of its natural produce – something impossible in Europe where land has long been private property.
• Hypothetical: If European laws allowed estates to be divided equally among all children, much more land would come onto the market, prices would fall from monopoly levels, and investing small capitals in land could become as profitable as other ventures.

Comparing European Nations

• England: Naturally well-suited for commerce, manufacturing, and agricultural improvement (fertile soil, long coastline, navigable rivers). Since Queen Elizabeth I’s reign, laws have strongly favored commerce and manufacturing (more so than even Holland). These sectors advanced continuously. Agriculture also advanced, but slowly behind commerce. Much land was cultivated before Elizabeth I, yet much still remains uncultivated or poorly cultivated today. English law does offer direct encouragements to agriculture (corn export bounty, import restrictions, cattle import ban), demonstrating good intentions, though these policies might be ineffective (as discussed later). Most importantly, English farmers (yeomanry) have strong legal security, independence, and respect. Conclusion: Despite having the most pro-agriculture conditions possible under primogeniture and tithes, English farming still lags. Imagine how much worse it might be without these advantages. (This progress, slow as it is, occurred over 200+ years).
• France: Had significant foreign trade earlier than England, but its agriculture is generally inferior. French law never gave the same direct encouragement to farming.
• Spain and Portugal: Have considerable trade (European and vast colonial trade), but this never led to significant export-oriented manufacturing, and large parts of both countries remain uncultivated. Portugal’s trade history is older than most major European nations, except Italy.
• Italy: Seems to be the only major European country historically improved throughout primarily by foreign commerce and export manufacturing. It was reportedly highly cultivated everywhere before the invasion by Charles VIII of France (late 15th century). Its favorable location and many independent states likely contributed. (Though perhaps it wasn’t better cultivated then than England is now).

The Durability of Wealth: Commerce vs. Agriculture

Capital acquired through commerce and manufacturing is precarious and uncertain until a significant part is invested securely in land cultivation and improvement.

• A merchant isn’t necessarily tied to any country; they can easily move their capital and the jobs it supports elsewhere if slightly dissatisfied.
• Commercial capital doesn’t truly “belong” to a country until it’s spread across the land in buildings or lasting improvements.
• Historical Example: No physical trace remains of the great wealth of the Hanseatic League cities, only historical records. We don’t even know where some of them were located.
• Contrast: Although Italy and Flanders suffered wars and bad government that diminished their commerce, they remain among the most populous and best-cultivated areas in Europe because their earlier wealth was invested in the land.

Wealth derived only from commerce is easily destroyed by the ordinary disruptions of war and politics. Wealth derived from the more solid improvements of agriculture is far more durable. It can only be destroyed by prolonged, violent invasions by hostile barbarians, like those that occurred around the fall of the Western Roman Empire.