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Text From Adam Smith "The Wealth of Nations" (1776), Book IV, Chapter II (Pp 401-402)

March 17, 2011 | Comments: 0 | Views: 92

Adam Smith was a strong proponent of the division of labor, which he saw as an essential contributor to the 'wealth of nations.' In the first paragraph of the text, he encouraged specialization amongst the workforce along the lines of each workers' particular talents - i.e., the tailor makes clothes, shoemakers make shoes, farmer harvests crops. Out of self-interest, each of these workers is employed in their particular trade.

However, this activity yields another important characteristic of the 'economic man' for Smith, a propensity to exchange. Through the division of labor and specialization, labor productivity increases momentously. Each worker produces excess over their own subsistence with knowledge of consumer demands in order to trade part of their produce with others for "whatever else they have occasion for." It is the propensity to exchange that makes humans unique. If the farmer were to make their own clothes and shoes, this would be characterized as completely self-sufficient and, therefore, people would be no different than animals.

One of the painstaking tasks Smith set out to accomplish in his text was to describe how people in society can act in accordance to their own self-interest and, yet, the world still contains a natural order. Smith argued that it is beneficial for individuals to 'employ their capital,' based on how it would benefit them rather than considering the effects their actions have on the welfare of society at large. This is because Smith believed that buying from others goods if they are cheaper than goods made at home involves a harmony of interests.

Wealth, in the Smithian frameworks, referred to the level of consumption in real goods. Implied in the second paragraph of the text is the idea that a nation (and, therefore, individuals within that nation) would obtain wealth by employing labor endowment in industries it is most suited for and trading with foreign nations along the lines of absolute advantage. In doing so, individuals are better off because they have access to more and cheaper goods, while society as a whole is also improved because its industry is thus 'employed with the greatest advantage.'

Smith viewed capital to be an important discussion and, in fact, devoted Book II to the subject. The amount of industry in an economy, as seen in paragraph two of this text, will be 'proportional to the capital which employs it.' For this to be true, Smith distinguished labor into two categories - productive and unproductive labor. Only productive labor, such as manufacturing, adds value to an economy because the goods that are produced can be used to continually reproduce other goods throughout industry. The productivity of the aforementioned tailor, shoemaker, and farmer all greatly rely on tools and machines to perform their trade efficiently. Capital, therefore, determines the amount of industry in an economy due to its long-term use in producing real goods - essentially, wealth.

In paragraph three of this text, Smith argued growth in an industry depending proportionally on the growth of capital. A landowner who employs a substantial amount of musicians, servants, and other unproductive labor will see their industry shrink because their tasks provides no tangible value but disappears upon completion. Conversely, if the same landowner were to purchase tools and equipment to make his land more fertile, they would reap a harvest from it and enjoy a proportional growth in the industry.

Articulated in this example is an important prerequisite Smith emphasized in order for capital to augment through savings. Unlike self-interest or the propensity to exchange, saving is not a general aspect of human nature, but is followed by people who are clever and industrious in acknowledging time preference in making economic decisions. In short, an industry grows proportionally to growth of capital and capital, in turn, augments at a proportional rate to savings.

Smith was an advocate of laissez-fair, laissez-passer and, as such, was arguing against the mercantilists and their policies of bilateral trade agreements and the imposing of trade barriers. Essentially, as articulated in the first paragraph of this text, such regulations are either 'useless' or even 'hurtful' to domestic policy, according to Smith. Such mercantilist policies give the home market a monopoly, but disrupt the harmony and natural order of the world by altering the manner in which people decide to employ their capital. The immediate result, which Smith articulated in paragraph three, must necessarily be a decrease in one's wealth and the diminishing of both capital and industry. Therefore, developing a new enterprise interferes with the invisible hand of the economy and is strongly discouraged because it prevented capital and industry from 'find(ing) out their natural employments.'

David Stone, MBA is a recent business school graduate with sell-side equity research experience.

Source: EzineArticles
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