Adam Smith was a Scottish economist, philosopher and author, and a very successful one at that
His masterpiece, The Wealth of Nations was released in 1776
and was at that time considered very controversial, but it has laid out the groundwork for pretty much all economics since
Smith is often referred to as "the father of economics" or "the father of capitalism" for good reasons
The Wealth of Nations main message is probably that we must trust in incentives
Adam Smith was a pragmatist who knew that people will always act in their own
self-interests, and therefore, every economic policy introduced must always take that into account
Secondary and tertiary effects must always be considered
A society can do no better than to set up the correct incentives so that humans will act in the best way possible
This is a top 5 takeaway summary of The Wealth of Nations, written by the father of economics Adam Smith
And this is The Swedish Investor, bringing you the best tips and tools for reaching financial freedom through stock market investing
... who apparently also likes to go off topic sometimes and talk economics. Well!
Takeaway number 1: Productivity is king
The people of a nation will be better supplied with all the products and services that they have occasion for
if one or two of the following happens:
First, an increase in the number of people who have a job compared to those who don't
And secondly, an increase in the productivity of those jobs
This could be said to increase their "wealth"
It depends much more on the latter than the former
Thousands of years ago, our ancestors were employed, all of them
Every day, everyone had the job of catching food for themselves
Yet today, even the poorest people of a western civilization
are wealthier than the kings and queens from those times!
Consider this story:
A man was handed the task of inspecting the construction of a waterway in a certain communistic land
When he arrived at the site, he saw a thousand people digging with spades while great digging machines stood idle nearby
He asked the manager of the project:
"Why don't you use the machines over there instead?"
"Well, sir, that's because these people would be unemployed in no time!"
The inspector thought about this for a minute and then returned home
The next day he went back to the site and went straight to the manager
He handed him a spoon
"Why don't you use a thousand of these instead?"
To the wealth of a nation, productivity is king. It is improved by three factors primarily:
- Dexterity or skill in doing something
- Avoiding loss of time changing from one task to another; and
- Proper use of machinery
The two first factors come from the division of labor
Instead of having everyone in a society doing everything themselves,
we should each do what we are best at, and then trade products and services with each other
The greater the extent of this trade (or the greater the market) the greater the possible division of labor and thereby
the greater the productivity
Just think about all the specialized products and services that we exchange with each other in a great city
You would probably not find a store like this one in a small country village, but in the great city of New York, you can
The division of labor increases as transportation is improved. Adam Smith gives an example from his experience in the 18th century:
6-8 men can, by water carriage, transport the same amount of goods in the same time with a single ship
as 100 men with 50 broad wheeled wagons and 400 horses
This is why rivers and sea coast towns often develop faster. They allow a greater division of labor as they extend the market of trade
So ...
Ships were much better than horses,
but I think that Adam Smith would be jealous if he looked at us today, because now we have Amazon!
Takeaway number 2: Money: What is it, and why do we use it?
When the division of labor is established, every man supplies himself with but a small amount of the goods that he actually needs
Instead, he participates in exchanging
But in the beginning,
it must have been very inefficient to try to trade with one another when supply and demand didn't always match ...
Hey Franky!
Look at this nice spear that I just created!
Could I get some of that tasty meat that you have if I give you my spear?
No deal, Bob. I already have like 10 spears, but I could use a pound of salt
Hey Randy! Look at this nice spear that I just created!
Could I get like a pound or two of your salt if I give you my spear?
No deal Bob. You know that I'm too old to go hunt these days, but I could use a new shirt.
Hey George! Look at this nice spear that I just created! Could I get a shirt if I give you my spear?
Yeah, of course Bob. I'll be happy to trade a spear for a shirt
Nice!
Oh, but I think that one spear is probably worth more than one shirt. How many shirts have you got?
I only have one shirt to spare at the moment, unfortunately
Well, then no deal George!
This was quite inconvenient to say the least
Enter: Money
Money facilitates the exchange of commodities that we produce
To get back to the first takeaway, one can say that they increase the productivity of exchange
Quite early, metals were used as money and they have at least two qualities which make them suitable for this purpose:
They basically do not perish and they can be divided into many parts and then fused again
Some things have value in use - like spears, meat, salt and shirts
Other things have value in exchange - like bills, coins and metals
That which has high value in one, often is quite worthless from the other standpoint
You can't use a dollar bill for anything. I mean you can't eat it or anything
Similarly, a spear might be quite useful but it doesn't work well for exchange, as we just saw
As long as people trust that money can be exchanged for something else that they are in need of later,
they are happy to trade their own produce for that money
It all boils down to that: Trust
Warren Buffett has said that it is quite misleading that on the backside of every dollar bill, it says "in god we trust"
Because, what it should actually say is "in The Federal Reserve we trust"
Takeaway number 3: The three components of price
The real price of everything is its price in labor
Something that takes more time, energy or resources to bring up often has a higher real price
Bob didn't want to make that final deal with George because he thought that his spear had a higher real price than George's* shirt
However, there's also a nominal price and that is the price as measured in money
Because it's difficult to measure and compare labor, we've come to estimate real prices in terms of money instead
The price of everything that is produced resolves itself into either one or more of the following three components:
- A wage, to pay the labor who did the work
- A profit, to pay for the capital that was laid out for the work to happen
- And a rent, to pay the holder of the land where the work and or exchange must take place
We all know that wages can differ a lot between different occupations
Just look at the average salary of a McDonald's cashier and compare that to the salary of a neurosurgeon
Similarly, profits differ from industry to industry, but not as much, and also they should average out over time,
something that we'll get to later
These are the average profits measured as return on equity for different industries during the period 1999 to 2019
And the factor that can differ the most is of course rents
In New York, for example,
you'll have to pay about $5,200,000 per acre of land, while in the country village of Eksjö in Sweden, you'll pay only about $20,000.
How much you have to pay to buy land correlates well with how much rent you can get for it
Because of this, the proportions that make up the price of a certain product or service differs a lot depending on its type and
where it is bought
A massage for example costs $60 an hour in the previously mentioned Eksjö,
while it costs $105 an hour on Manhattan in New York
The difference in price between the two locations can pretty much fully be contributed to the difference in rents
And some of it in the difference in wages that are necessary to sustain someone in New York
The price of a certain product or service is determined by the supply and demand
Actually, it is determined by something called the "effectual demand",
which is those that demand the product at a price so that it allows for the wages of workers,
the profits and replacement of capital of businessmen, and often some rent for landowners
I mean ..
I want a Tesla. It's just that i'm not ready to pay $70,000 for it yet
Thus i'm a part of the demand, but not the effectual demand, that can actually bring the product to the market
Takeaway number 4: The three components of price, part II
Let's have a look at these three components separately
A worker will always demand a wage so that he can at least purchase the necessities of life for himself and his family
This is the bare minimum which even the simplest type of job must pay, because otherwise,
such workers will cease to exist over time
In countries where no minimum wages exist, the simplest jobs will tend to be at this level and not higher
This is because workers are at a natural disadvantage when trying to bargain how much of that price which was mentioned earlier
which should go towards their salary
They typically exist in abundance compared to capital and land and
moreover, they typically do not have much money spared so they can't afford to wait for a better opportunity
But salaries can differ a lot which we shall see later
A businessman is someone who employs his capital to earn a profit within a specific trade or industry
The more capital that is employed in a certain industry, the higher the competition there becomes, and the lower the profits tend to be
So it must be in society as a whole too. If there are no intelligent ways to employ capital anymore returns will be low
Over time, even though some companies can hold on for very long, returns on capital will even out across industries
This is because where returns are high, there will be incentives to move capital, and where returns are low,
there will be incentives to remove capital
This restores an equilibrium of sorts
If you want to know more about which types of industries that can withstand competition the longest, head over to my summary of "Competitive Strategy"
An owner of land will either try to sell his land for a profit or lend it out for a rent
Either way,
someone down the line will eventually try to lend it out for a rent,
or use the land themselves, and then it is they who gain the rent
Rents vary A LOT depending on location
Some types of land basically afford no rent at all. while those that people find attractive -
land in cities or beautiful beach properties - earn a lot of it
Something that should be noted is that rent is quite like a monopoly price
After normal wages have been paid and the businessman have been able to replace his capital with a decent profit,
the owner of the land will pretty much take what's left
Land is immovable and irreplaceable,
and is therefore peculiar compared to the two other types of revenues that can be earned
Takeaway number 5: Why some jobs pay more than others do
So ...
Profits of industries should average out over time,
and more rent is given to the person who holds a property in a city or at a beach, okay ...
But why the **** does my neighbor have a higher salary than me, even though I'm much smarter than him?!
The wages of labor are decided by supply and demand, like everything else
The following five factors tend to affect this to increase the wages of a specific job
- The expenses and difficulties of learning it
- The inconsistency of payments
- The trust and responsibility
- The improbability of success; and
- The hardship dirtiness and disagreeableness of the job
In the 18th century a blacksmith had to be an apprentice for many years before he was allowed to open his own trade
During this time, he earned very little or basically nothing at all
The higher wage that he got once finished is a compensation for those years, and the apprenticeship
helps in limiting the supply of such workers
A mason could only work during good weather conditions, and so his hourly wage had to be compensated for those idle hours
A greater responsibility means that fewer people are suited for that type of work and therefore wages are higher
Back in the days, lawyers and doctors had such roles (and they still have by the way)
The improbability of success is another factor that matters
The expected wage of a job with a very high fail rate is often even lower than normal jobs,
but the person who succeeds typically gets the salary of those who fail too (kind of)
People searching for gold or treasure belonged to that category
And in the 18th century the most dirty and disagreeable job one could possibly get
was probably that of the public executioner, and the pay was thereafter
Today, a difficult and expensive job to get would be that of the previously mentioned neurosurgeon
An inconsistent one might be that of a real estate broker
A job which requires a lot of responsibility. is that of a pilot
Improbability of success is high among elite athletes and musicians
And the dirtiest and most disagreeable job is probably that of a hedge fund manager!
This book is more than 900 pages long, so I'm definitely going to make a part 2 on this with 5 additional takeaways
In part 2 we'll cover topics such as globalization,
free trade, and the purpose of a government
So you'll probably get to hear more about incentives in part 2!
See you soon! Cheers!