Book IV: Of Systems of Political Economy
Summary, Chapters 1-3
In the first chapter of this book, Smith vigorously criticizes the economy theory and policy that preceded his work. A number of policies were detrimental and opposed to the progression of public well-being and wealth.
First, Smith criticizes the idea that wealth consists in money (gold and silver). This confusion is based on the fact that money is used as an instrument of commerce, and is therefore used to obtain commodities or command of labor, which are the true measures of wealth. This confounding of money with wealth has led many governments to prohibit the exportation of gold and silver. Commercial countries, however, have since learned that the exportation of gold and silver, when it was used to purchase goods, did not always diminish the quantity of those metals in the kingdom. On the contrary, exportation might be found to increase the quantity through the re-exportation of goods. They also observed that a government prohibition could not in fact hinder the exportation of gold and silver, because it is easy to smuggle. The only way to discourage the exportation of precious metals was to properly attend to the balance of trade. Adam Smith agrees with the arguments of the merchants, but adds that governmental regulation is no more necessary to preserve or augment the quantity of these precious metals than it is to preserve or augment the quantity of any other commodity. The quantity of commodities is always best regulated by the market.
Second, he criticizes the idea that protectionist tariffs serve the economic interests of a nation, by encouraging development of home industry. The benefits of foreign trade are twofold: first, this trade carries out the surplus part of the produce of a particular country for which there is no demand at home, and brings back something else for which there is a demand. Second, it gives value to the surplus produce, which, because of a lack of demand, would otherwise have no value. Foreign trade broadens the home market, and by introducing new goods allows the division of labor to be carried out to the highest perfection. Smith provides the example of the American colonies. He argues that it is not the discovery of gold and silver in those lands which has enriched Europe, but the provision of a new and ample market with which to trade. This broad market, in turn, helped encourage the division of labor.
The erroneous idea that wealth consists in gold and silver, held by the mercantilists, leads to another, in Adam Smith's view, equally erroneous idea: that importation of foreign goods, because it sends gold and silver out of the country in exchange for commodities, necessarily impoverishes the country that imports. This belief, Adam Smith observes, has led to a number of restraints on importation. Some of these restraints were placed upon imported goods that could be produced at home, and others were placed on goods of all kinds, imported from countries with whom trade was thought to be disadvantageous. These restraints were accompanied by a number of measures that aimed to increase exportation, namely bounties, drawbacks, trade agreements, and the establishment of colonies. The harmful effects of these measures are detailed over the course of the next chapters.
In the book's second chapter, Smith argues that placing prohibitions on the importation of foreign goods that are produced at home creates a monopoly of the home market, and certainly benefits producers of those products. However, he argues, the general benefits of such a monopoly to the market as a whole, or to society as a whole, is doubtful.
In addressing this topic, Adam Smith sets out a number of his most famous maxims. Every individual, he claims, is constantly exerting himself to find the most advantageous employment for the capital that he commands. Each individual thinks only about the advantages which he himself can derive from this capital, but the actions that lead him to seek his own advantage also lead him to prefer the employment of capital which is most advantageous to society. When two options seem equally beneficial, most people prefer to employ their capital as near to home as possible.
Adam Smith goes on to argue that every individual who employs his capital in support of domestic industry also endeavors to direct that industry to produce the greatest possible value. Each individual labors to employ his capital in support of domestic industry, in order to direct that industry so that its produce is of the greatest possible value. So too does every individual labor to render the annual produce of society as great as it possibly can br.
When left alone, men are always led, in choosing the best option for themselves, also to choose the best option for society. When lawmakers create prohibitions on importation, they are, in a sense, telling people how best to employ their capitals. If foreign produce can be bought as cheaply abroad as it can at home, Smith writes, such a prohibition is generally useless, since people are motivated to employ their capitals as near to home as they profitably can anyway. If foreign goods can be bought more cheaply abroad than they can at home, the prohibition is harmful. Adam Smith argues that, on a small scale in every trade, the prudent businessman would never choose to make himself what it would be cheaper for him to buy.
In fact, Smith goes on to argue, prohibitions on the importation of foreign goods do nothing to actually augment the industry of a certain society over time. Though a particular industry may initially develop more quickly that it may otherwise have, the industry of a society can only grow as capital in the society increases, and the capital within a particular society can only be augmented by what can be saved from the revenue. However, the immediate effect on prohibiting foreign goods is to diminish revenue.
Adam Smith stipulates that, however superfluous or harmful it may be to prohibit the importation of foreign goods in general, there may exist a few cases in which such prohibitions are indeed necessary or prudent. The first is in cases where the development of a particular sort of industry is necessary for the defense of the country. Adam Smith gives the example of Great Britain, where commodities surrounding and supporting navigation are of primary military importance. Secondly, it would be advantageous to place tariffs to encourage domestic industry in cases where commodities are taxed at home. These tariffs would not serve to distort the market, but only to compensate for the tax place on the domestically produced product.
Adam Smith goes on to address the argument that, since many basic commodities have been taxed in most countries, all goods become more expensive as a result. Therefore, in order to offset this added expense and give domestic products a fair chance, it would be prudent to lay tax on all foreign commodities, not just those that directly compete with what is produced at home.
Just as there are two cases in which it may be considered advantageous to place tariffs on foreign goods in order to encourage domestic industry, there are also two cases in which it may not always be imprudent to reconsider the free importation of certain foreign goods that do not directly compete with the home industry. The first case is that of reciprocation for a certain nation imposing tariffs of goods from one's own country. This kind of retaliation has been very popular throughout history. It may be wise to implement this kind of tariff retaliation if it seems probable that, in the foreign country concerned, tariffs upon one's own goods will be reduced as a result. However, the imposition of such tariffs should be carried out in such a way that they can be quickly repealed (they should not become general laws, but should be left to policy makers). However, if it does not seem probable that retaliation will produce the desired effect, it is unfair to punish everyone in the society by imposing high tariffs (which raise prices). In the long run, tariffs placed on one's own country's goods affect only a small merchant or industrial class of people. The second case in which tariffs might be useful is when they have been imposed for some time, and production of the commodities they are meant to protect employs many people. In this case, freedom of trade may have to be restored in slight gradations in order to allow the home market to cope with the new competition.
In the third chapter, Smith shows how it is unnecessary to place high tariffs on the importation of goods. Even in cases where the balance of trade between two countries favors one country more than another, it does no harm to either country. It may also happen that the balance of trade between two countries greatly favors one, but is indirectly equal: in a situation where country B imports an abundance of materials from country A, country B may export the materials it has imported from country A to country C, leveling out its balance sheet among more than one trade partner. Third, Smith says there are no criteria by which we can judge where the balance of trade between two countries lies. Though the custom-house books and the course of exchange are often used to judge, these are largely unreliable because the method of valuation is very inaccurate.
High tariffs are also unwise on other principles. In this section, Smith attacks the very notion of the balance of trade, making the point that, when two countries exchange with one another in a free market situation, without the imposition of bounties or the strain placed by monopolies, that exchange is always advantageous, though not necessarily equally advantageous to both. If it were disadvantageous to one country, the trade would not be carried out in the first place.
Adam Smith goes on to explain that the prejudices and suspicions that exist in trade are based in fear and the desire for building monopolies. He argues that, contrary to popular belief, it is useful to have good neighbors, with whom one trades freely. While rich neighbors are dangerous in war, they are a great advantage as trading partners.
In this section, Adam Smith debunks the major tenants of mercantilism, and also indirectly reinforces some of the ideas about society and morality that run throughout the book. There are two ideas in particular that Smith refers to and develops in order to demonstrate how mercantilism has been a negative economic theory: the idea that money is a tool of trade rather than a marker of absolute value; and the idea that trade is not a zero-sum game, but that, when conducted freely, benefits all involved.
By debunking the perceived special status of money, Smith shows that the level of gold or silver in a nation's coffers are not a sign of economic health, and that an economic policy that tries to hold onto gold and silver is therefore of no real benefit to the economy. Secondly, the idea that that trade is not a zero-sum game allows Smith to show how trade with foreign nations benefits society by driving down prices and therefore stimulating growth, and how protectionist measures are often misguided.
Smith demonstrates a sensitivity to political issues when he allows for certain exceptions to the rule that the free market is always best. He shows a keen awareness of the demands on the economy that a system of defense might make, as well as the propensity of nations, despite potential economic losses, to punish one another through levying tariffs. These chapters provide further evidence of the fact that Smith had a career not only as an economist, but also as a political theorist and policy maker.
Smith also provides a glimpse into his moral philosophy in Chapter Two, when he describes how the market is best regulated by each individual acting in how own interest, unrestrained by governmental policy or regulation. It is this idea, which might be characterized as "virtue in freedom," that was particularly innovative in Smith's time, when economic and social theory were dominated by the development of complex, paternalistic systems that sought to attach social trends to overarching ideals. Smith did away with this methodology, embracing free-will and self-interest as his primary assumptions for human nature, and showing how these natural inclinations produced an ordered system. It is here that we come closest to an account of the famed idea of the "invisible hand," so often associated with Smith.
Finally, Smith writes that most mercantilist regulation is short-sighted and beneficial to only a small class of people or a particular sector. Smith demonstrates that, while such policy may benefit certain individuals in the short run, it indeed harms society in general and precludes those it benefits from achieving success in the long-run. These arguments demonstrate that Adam Smith has utilitarian principles in mind when he thinks about the effectiveness of certain policies, and that he is ever concerned with the average citizen. Good economic policy, for Smith, should better the life of the average citizen by increasing his options, his prosperity, and thereby his personal well-being.
Summary, Chapters 4-6
Merchants who are not content with the monopoly of their home market and also wish to sell their goods to the most extensive foreign market possible petition their governments to create incentives for exportation. Drawbacks are one kind of encouragement. They allow a particular merchant to recuperate a whole or a part of the duties that are imposed upon his domestic industry. The existence of drawbacks, Smith writes, can never direct a greater quantity of goods to be exported had there been no duty imposed. The existence of drawbacks also do not cause a greater amount of capital to be employed in the country than otherwise would, but they only counteract the tax imposed on the domestic industry, ensuring that the same amount of capital is devoted to it as would be if the tax did not exist.
Smith argues that drawbacks are largely useless, with the exception of cases in which the goods, for the exportation of which they are given, are exported to some foreign country altogether. However, there have been many examples in which the system of drawbacks was abused, and goods which enjoyed drawbacks for exportation were secretly smuggled into the home country for consumption there, hurting the business of fair merchants.
Bounties (subsidies) allow merchants of certain domestic products to sell their good as cheaply or even more cheaply than their competition in the foreign market. It is thought that, when bounties are imposed, a greater quantity of goods will be exported, and the balance of trade will turn in favor of the home country.
Adam Smith agrees that bounties should be granted to those branches of trade which cannot be carried on without them. But in every branch of trade where the price that the goods fetch replaces to the merchant the ordinary profits of stock as well as the capital employed in preparing and sending the goods to market, bounties are unnecessary.
Bounties are harmful because it is the only situation in which countries may carry on trade with one another in which one country is always the loser - it sells its goods for less than it cost to bring them to market. Merchants who enjoy bounties are not forced to employ their stock in a way that is actually productive, because they are protected from loss by the bounties. However, over time, the country will be forced into a kind of trade which greatly disadvantages it.
Indeed, bounties come always at a loss to the home market. They raise the nominal price of commodities, increasing the amount of gold and silver they exchange for, and discouraging manufactures without rendering any service. It does, of course, put money into the pockets of those who are involved in the production and sale of the commodity upon which bounties are placed. However, this money is worth little if it is lowered in value due to the inflation encouraged by bounties.
Countries entering into preferential trade agreements with one another create situations that mimic monopolies. Because of a lack of freedom of exchange, certain merchants are given considerable advantage over others. Though preferential trade agreements favor individuals, they disfavor the countries who welcome the goods of these individuals. By granting special access to a particular foreign nation, citizens are often obliged to pay more for the goods exported from that foreign nation than they would if there were free competition among trading partners. Because of an imbalance between the nominal and natural price of the foreign goods that flow into a country because of a preferential trade agreement, the country that welcomes these goods loses some of the purchasing power of its annual produce, since it agrees to exchange it for something less than it is worth.
The popularity of such treaties in Adam Smith's time is due to the incorrect belief that they are on the whole advantageous. It was expected that, in the whole commerce occurring between the countries involved, the country that has granted a foreign nation the monopoly would in fact sell more than it would buy, and therefore procure a greater amount of gold and silver than otherwise possible.
Adam Smith goes on to criticize a trade agreement made between Great Britain and Portugal. As Portugal was a great importer and holder of gold, it was imagined that this was an important way for Great Britain to increase or ensure that it would have access to gold. Smith notes again that gold, like any commodity, is only useful insomuch as it can be exchanged for goods.
In this chapter, Adam Smith also goes on a considerable digression about the practice of seniorage, which is a small percentual valuation of coined gold above gold bullion. This policy was implemented in some countries to counteract the fact that the market price of minted coins was somewhat less (due to the degeneration of the coin through use) than bullion. This persuaded people to melt coins into bullion in order to sell them for a higher price. Seniorage discourages people from melting down coins. It also guards against the exportation of the metals of which they are composed. As long as the seniorage is kept at a moderate rate, Smith argues, it neither significantly increases the expense of private persons nor the expense of the bank, when they are inclined to carry their gold to the mint. Adam Smith uses this as an argument of why the government should not actively defray the cost of coinage in order to motivate people to mint their gold.
In this section of the work, Smith makes a thorough and convincing criticism of special interest groups that seek to influence government policy. Though he attacks tenets of the mercantile system throughout the book, this section focuses more exclusively on how special interest groups unfairly seek to create or defend market advantage by creating government policies that will support their business or branch of trade. These policies are those that create drawbacks, grant subsidies, or establish preferential trade agreements.
These chapters, like many others in the work, contain extensive data tables and concrete examples of the trends that Smith is analyzing. His nuanced definitions of different aspects of economic policy, alongside his very precise criticisms of each aspect, demonstrate the existence of an extensive data set. This use of data is both innovative and necessary. Unlike other economic scholars of his day, Smith is results-oriented, and the data are symbolic of his devotion to results. The data are also especially useful to Smith because he is debunking long-established economic theory. Presenting data helps him to make compelling points in favor of what was in Smith's time a radical set of ideas.
Throughout his examples, Smith constantly points out how special interest groups deflect the economic harm of their policies onto social groups that did not or could not have a share in the creation of such policy. For example, Smith points out, Country A, benefiting from a preferential trade agreement with Country B, deflects the harm of the agreement away from itself and onto the citizens of Country B, who endure higher prices due to the agreement that the two countries have reached.
These examples are interesting because, in some sense, they seem to undermine one of Smith's most important arguments, namely that individuals acting in their own interest ultimately leads to social order and an increasing level of opulence. However, this supposed tension also points to another idea that Smith also implies, but does not necessarily insist on at any point in the work: the idea that humans are basically equal, and the government should serve to encourage equality, or at least not to actively discourage it. Special interest groups are destructive not because they are acting in their own interest, but because their members have special access to positions of power that allow them to make far-reaching policy decisions that affect the lives of others.
Individuals acting on their own free-will is encouraging to order only insofar as all individuals hold more or less equal positions under the law, and are equally free to make decisions about how to trade. If certain individuals have large amounts of political sway, as do special interest groups, for example, or if certain individuals are given an unfair monopoly of the labor of others, as in the feudal system, individuals are not sufficiently free to make decisions that will ultimately encourage trade and support economic growth.
Summary, Chapters 7-9
In the section entitled "Of the motives for establishing new colonies," Smith begins by contrasting the colonies in North America and the West Indies with the colonies established by ancient Greece and Rome. In the ancient world, colonies emerged primarily because of overpopulation of various territories or city-states, or in order to satisfy a demand for landownership. These colonies had strong cultural and military loyalties to the populations that established them.
The European colonies established in North America and the West Indies were not established out of necessity. However, they have since proven themselves highly useful to their colonizers. At the beginning of colonization, an enormous expense was endured, even though returns were consistently low. There was, therefore, a spirit of curiosity that motivated the initial explorations. It was rather a matter of luck that so many of the American colonies turned out to be rich in gold.
Adam Smith goes on to criticize the folly of searching for gold and silver mines. He says that these ventures have a very low probability of success, but, because of the nature of mankind, people are prone to believe that they will be lucky, and this encourages them to assume undue risk in searching for such mines.
Adam Smith goes on to consider the causes of the prosperity of the new colonies. He begins by remarking that a colony established by a developed country that takes possession of a tract of land with no or very few inhabitants will advance to wealth more quickly than any other kind of society. This is because the colonists bring with them advanced knowledge of agriculture and other arts, and each colonist gains a greater amount of land than he could ever possibly cultivate, and is not burdened by rent or taxes. Being the direct benefactor of his own labor, the fruits of which he does not have to divide with anyone, he is more motivated than his European counterparts to work hard and efficiently. Given the overabundance of stock, the wages of labor are also very high, and this encourages the rapid growth of a healthy, well-fed population.
Adam Smith goes on to say that, the more the mother country leaves its colonies to their own devices, the greater their freedom, in other words, the likelier they are to grow and expand. He gives the example of Brazil, which, after it was stripped by Portugal of all the gold that could be easily procured, was left to its own devices, and became a very powerful colony. Smith also says that, when colonies are controlled by a single company, progress is slower than in the new colonies, where trade is relatively free and left to the inhabitants of the colony to decide and regulate. For this reason, the English colonies in North America had been the most prosperous and successful at the time of Smith's writing.
The political institutions of the colonies have been most favorable to the improvement and cultivation of land and have given the English colonies in North America an advantage which, despite the better quality of their land, colonies of other nations have been without. The first is a law which stipulates that a person, upon procuring land, has a limited amount of time in which to improve and cultivate it so as not to lose it. Second, in many of the colonies at least, there is no right of primogeniture, and land is divided equally among children. Third, because of moderate taxes, labor affords a greater and more valuable produce, which acts as a further incentive toward improvement and cultivation. Finally, in the disposal of surplus produce, the English colonies have been more favored than any others in that is has been given the most extensive market for exportation.
First, Adam Smith outlines what Europe, considered as one great country, has derived from its American colonies. These benefits are divided into a further two categories, first, the increase of its enjoyments, and second, the increase of its industry. Those commodities that contribute to the increase of enjoyment may be those which increase convenience, pleasure, and contribute to ornament. In terms of increasing industry, the colonies present a greater market for the surplus of European products, and therefore encourage industry to increase its quantity. It may even be said that colonization has served to increase the enjoyments and augment the industries of countries that have never sent or received any commodities from America. These countries benefit from the opulence of their neighbors and trading partners, who have had their industries increased by trade with the American colonies. The level of enjoyments and the progress of industry is diminished below its natural level when trade is limited to the mother countries. This is because it lessens consumption, which cramps the industry of colonies, and therefore makes commodities more expensive for European trading partners, which also diminishes their enjoyment.
Smith goes on to outline the particular advantages that each colonizing country derives from its colonies, which he puts into two categories. The first category consists in those advantages which every empire derives from the provinces that it subjugates. These advantages consist in the military force which they furnish for its defense, as well as the revenue which they furnish for the support of its civil government. In the American example, the colonies have been historically non-beneficial in a military sense, and it had, at the time of Adam Smith's writing, only been the colonies of Spain and Portugal that had ever furnished revenue for their mother countries.
Adam Smith goes on to say that there are a number of benefits that the American colonies furnish that are peculiar to their case. These benefits, at least so considered by the mother countries, consist in the exclusive trade of a number of commodities that are native to the Americas, such as tobacco, which other European countries, due to the exclusivity of this trade, are forced to purchase only from England. Though this is considered the only benefit of the American colonies, which do not furnish military support to their mother countries, it actually serves to cramp the industry of the colonies, and is detrimental to Europe as a whole. The effect of the monopoly on England is that it draws capital from all other trades, to be employed in trade with the colonies. And it has kept up the rate of profit in all the branches of British trade higher than it naturally would have been had all nations been allowed a free trade to the British colonies. The fact that the ordinary rate of profit is higher than natural means that there is a relative disadvantage in every other branch of trade in which Britain does not have a monopoly. The disadvantage occurs because Britain's merchants cannot obtain the greater-than-normal profit without selling both the goods of foreign countries that they import and their own goods that they export more expensively than they otherwise would. This means that Britain both buys and sells more expensively than it would without the existence of a monopoly, and there fore both buys and sells less than it would otherwise. By turning so great a proportion of Britain's capital to one trade, it makes the economy more precarious than it might be were capital directed to a variety of different trades.
Monopolies also depress the industries of all the countries who do not hold it. It discourages the improvement of land by raising the rate of mercantile profit. The high rate of profit enjoyed by a small merchant class also destroys the parsimony which, in other circumstances, naturally characterizes the career of the merchant. While such monopolies may benefit a single class of merchants within the country that enjoys the monopoly, it is generally harmful both to the country as a whole and to the trading region that the country is active in.
Despite the disadvantages that Smith describes, it is important to recognize the benefits of colony trade in general. These benefits exist notwithstanding the harmful effects of a monopoly. The colony trade encourages the mother country to continually increase its industry by continually presenting new equivalents (presumably new and exotic kinds of produce) to be exchanged for the commodities produced by the mother country. Especially encouraged are the products of industry, as opposed to agriculture.
Smith goes on in the chapter to remark upon many of the tensions that exist between Great Britain and the North American colonies. He argues that the maintenance of the monopoly that Great Britain enjoys has been the principal purpose of its dominion over the colonies. At the time of writing, Great Britain had laid out an ample sum of money for the defense of its colonies. Paying in this way for their defense was, Smith writes, effectually paying for the defense of the monopoly. The colonies, in short, are indeed very expensive. Adam Smith goes on to remark that, if Great Britain were to give the colonies legal freedom to elect their own magistrates, enact their own laws, and to make peace and war as they think proper, they would be free from the expense of defending these colonies, and they would be freer to benefit from their existence. However, national pride would not allow even the most visionary statesmen to consider enacting such a measure. The monopoly as it stands places the costly burden of maintaining the colonies on the government, while allowing for a small private class of merchants to become rich. Equally harmful, to both the the populations with whom they interact and to their mother countries, are the monopolies established in the East Indies, where company heads preside over the political situation of the colonies.
In showing how even badly-managed colonies increase the level of industry and opulence enjoyed in their mother countries, Smith suggests that increasing the size of markets seems absolutely beneficial to economic development. Widening markets means that trade can be further diversified, which in turn increases productivity, puts downward pressure on prices, and increases opulence.
However, the creation of monopolies within the colonies, a trend which seems most often to accompany the colonization process itself, is detrimental in the long run. The prices fetched by colonial goods are so attractive that capital is drawn away from other areas. This distorts prices across the board for the colonizing nation, and distorts motives in the colonies. Smith warns against the temptation to sustain monopolies at some length.
Smith goes beyond these observations about monopolies and widening markets to express his political views on how colonies should be run if they are to produce ultimate economic benefit. Here, as elsewhere, Smith argues that the less regulation and limitation on the trade of colonies, the more strong and powerful the colonies will become. He goes on to point out that, when a mother country loosens its grip on a colony and gives up a monopoly, it will ultimately benefit from lower prices and will experience a greater trade volume, which in turn leads to increased revenues.
In support of his arguments, Smith discusses the North American colonies. He criticizes the British government for levying heavy tax burdens on the colonies and limiting the scope of their trade. He makes the point that these burdens interfere with the health of the colonies' economy, and reduce motivation and therefore efficiency. In a keen recognition of human nature, however, he writes that Britain will most likely neglect giving up some of its power. It is the nature of governments, Smith observes, to hold tightly to their power, even if increased freedom would benefit the people and the economy.
Finally, readers are given a glimpse into Adam Smith's views of the nature of governments. Smith writes that, no matter how clearly economically beneficial it may be for a country to loosen its authority over its colonies, it seems essentially opposed to the nature of governments to do so. This may be seen as yet another articulation of how the tendencies and inclinations of governments are ultimately disruptive to the fluctuations of a self-regulating market.
Conclusion of the Mercantile System
Of the Agricultural Systems, or of those Systems of Political Economy, which Represent the Produce of the Land, as either the Sole or the Principal, Source of the Revenue and Wealth of Every Country
In this chapter, Smith outlines those lines of thought that, in his time, presented the most serious concurrence to the mercantile system. These systems put forth agricultural development as the basis of wealth. However, unlike the mercantile system, these speculations on the nature of political economy have never been put into practice and have remained purely theoretical. These ideas have enjoyed the most prevalence in France. These ideas seem to have arisen in direct response to the flaws of mercantilism, which favors industry over agriculture.
In this system, the people are divided into three orders. The first consists in the proprietors of the land, the second in the cultivators of the land, and the third of the artificers, manufacturers, and merchants. This last order of people is considered to be unproductive.
Proprietors contribute to productivity by investing in the improvement of the land. Cultivators contribute likewise by laying out money for the instruments of husbandry, seed, and the other expenses associated with cultivating the land. In this system, the ground expenses of the landlord and the cultivators of the land are considered to be the only expenses which are productive.
The labor of artificers and manufacturers replaces only the stock which employs them, together with their ordinary profits. While the stock of the farmer yields him a profit and is also sufficient to pay the landowner, thereby maintaining another person, the expense laid out in employing and maintaining artificers and manufacturers does not, and therefore is not considered to produce any new value. Mercantile stock is similar in that it is equally barren and unproductive, only serving to repay the maintenance which its employer advances to himself during the time that he employs it. Therefore, the only method by which artificers and manufacturers can augment the revenue of their society is by depriving themselves of a part of the funds destined for their own existence in order to contribute them to their savings.
The unproductive class is maintained at the expense of the productive classes, that of the proprietors and cultivators, who furnish them with the materials for their work and also with the fund of its subsistence. The proprietors and cultivators pay both the wages of artificers and manufacturers, and the profits of their employers. In that way, the artificers and manufacturers are the servants of the cultivators and proprietors.
The productive classes to not oppress the unproductive classes because they want to encourage competition among the various trades in order to enjoy lower prices. The unproductive classes do not oppress the productive ones because the unproductive classes benefit from the surplus of the productive ones, and therefore the greater the surplus, the better the unproductive classes live.
Smith goes on to criticize the system. He makes his criticism on the grounds that it is inaccurate to represent the class of artificers and manufacturers as altogether barren and unproductive. First, because anything that is self-sustaining may not be defined as unproductive. Second, because it is improper to consider artificers and manufacturers as menial servants, because menial servants do not produce commodities, or anything of lasting value, but the fruit of their labor perishes in the moment in which it is performed. Finally, because the understanding of how the revenue of society is increased is misrepresented in the system. Despite its shortcomings, however, Smith considers these theories far better than the mercantile system because they recognize that the wealth of nations consists not in money, but in the consumable annual goods annually produced by the labor of the society, and also as representing perfect liberty as the only effective way to render the annual production the greatest possible.
The chapter that concludes Smith's analysis of the mercantile system is interesting in that it presents an alternative economic theory that had some currency in Smith's day. This alternative view is akin to Smith's view, in that it makes a sharp distinction between productive and unproductive labor, but it provides a far narrower definition of productive labor than does Smith. Productive labor is limited to agricultural production.
Smith criticizes the view on the grounds that other kinds of labor are equally productive. This defense seems to be in line with Smith's broader description of the benefits of the division of labor, which seem to necessarily result in the process of industrialized labor. Though industrialized labor may depend on some of the commodities provided by agriculture, it is also absolutely productive, resulting in added value, and goods that are consumable on the market.
Because Smith's view makes room for the process of industrialization, it might be seen as a more modern version of the view that he refutes. An economic theory that champions only agricultural labor as productive is obviously implausible in a world dominated by the industrial economy. Because Smith wrote during a time when the process of industrialization was in its infancy, it may have been easy to overlook these trends that would later prove so important to the course of history.
The alternative view is nevertheless interesting because it has little to say, whether in favor of or against, mercantilism as a system of international trade. This view seems to be more in line with Smith's views, if only because the major tenants of mercantilism are conspicuously absent. On the other hand, the alternative view would seem to favor the trend of primogeniture, in that it champions agricultural laborers and landlords, reinforcing the system of feudalism that bound people to the land.
Whatever place along the spectrum this alternative economic view seems to occupy between Smith's economic theory and the reigning mercantile approach, it is clear that its definition of productive labor is too narrow. Smith's view of the division of labor emphasizes this flaw. The agricultural sector depends upon the industrial sector, or life in the towns, to sustain itself. The broader market provided by the town is what allows agricultural production to flourish. As much as agricultural production depends on the land itself, it is also sustained by tools, it necessitates capital, and the costs of a quality, bountiful, and broad harvest can only be guaranteed by the prices it fetches in the marketplace.