Takeaways from Adam Smith‘s “The Wealth of Nations”

Quite a few years ago, as I stepped out the Walmart store in my neighbourhood, a man approached me for small change. I replied, “Sorry, I use a credit card and have no change.” Walking away with my bags of shopping, I looked back and saw a female Walmart employee come out to tell the panhandler to go away. Later, I went to a neighbourhood bank branch to get a roll of one-dollar coins (CAD), so that I could give small change in case I saw the man again. Since then, I am in the habit of giving him one coin when I see him.

On a recent evening, while passing by the neighbourhood movie house, I saw the man again. Sitting on the stone edge of a flowerbed in front of the theatre, he was asking two young girls for small change. I said, “Don’t bother them. I’ll give you one. O.K.?” Accepting the coin, he said, “God bless you.” He probably thinks I am well off and hopes to see me again soon. To put it in another way, he knows that only when givers like me stay “blessed” as he wishes, can he expect to receive help down the road. Simple economics: the poor needs help to come from the well off or the better off. The question is how to make that happen. “The Wealth of Nations” (by Adam Smith, published in 1776) may provide the answer.

Although I cannot tell how many people would find “The Wealth of Nations” an interesting read, I certainly believe that it is a must-read for all students of economics. Besides, it ought to be a must-read for politicians of all stripes, conservative or liberal, when they debate what fiscal measure would benefit whom. It seems that some of them don’t believe what benefits the rich may benefit the poor as well, or a situation that hurts the rich is likely to hurt the poor even more severely.

According to Adam Smith, in any civilized society, there are three types of revenue: first, the rent of land; second, the profits of stock and third, the wages of labour. Therefore, there are three orders of people: those who live on the rent of land, those who live on the profits of stock and those who live on the wages of labour.

While Adam Smith views most of those who live on the wages of labour as among “the inferior ranks of people” who are lacking in education and knowledge, as a result of their simple repetitive daily operations on the job limiting the capacity of their mind, his sympathies are apparently with the labouring people. He believes those who grow food, make clothing and build houses for the rest of society deserve to be properly fed, clothed and housed.

He also points out that there is a natural level of profit for capital that is regulated by the natural forces of the marketplace. If the profits of stock are excessively high in a particular sector, capitals will pour into it from different business owners, and the resultant competition will push the profits of stock downwards to the natural level. However, as the increased competing capitals put the industry of more labourers into motion, the demand for labour will augment, thereby driving the wages of labour higher. Besides, the profits of stock bear a natural proportion to the rate of interest, which is actually a rent paid to the owner of stock for its use. If the profits of stock fall, the rate of interest must go down as well.

Also according to Adam Smith, the real price of almost all manufactured goods diminishes gradually, as the improvements in machinery, dexterity and division of labour tend to reduce the quantity of labour requisite for executing any particular piece of work. He provides an example: “The first person that wore stockings in England is said to have been Queen Elizabeth. She received them as a present from the Spanish ambassador.” Since then, the price of stockings must have been falling like a stone.

I remember purchasing a bunch of ten pairs of black cotton socks at Walmart about ten years ago for only $7 and change before taxes. They are still serviceable today. Last month, I bought a new bunch of ten pairs of black cotton socks at the same Walmart store. The price? Still at $7 and change before taxes -- perhaps of a better quality. I guess Adam Smith’s theory on competition and improvement may in part explain the economic phenomenon of deflation or disinflation, though such terms may not have been available to him in the 18th century. At this moment, such deflationary forces as excessive competition, excessive capacity and excessive supply are manifest in certain sectors of the economy. Consolidation may be warranted.

Most importantly, (under ‘Profits of Stock’) Adam Smith points up the role capital plays in the economy: “It is industrious nations who are advancing in the acquisition of riches, as with industrious individuals. A great stock, though with small profits, generally increases faster than a small stock with great profits. Money, says the proverb, makes money. When you have got a little, it is often easy to get more. The great difficulty is to get that little.” In other words, unless one has capital and is capable of using it wisely (that is, industrious), one cannot advance “in the acquisition of riches”.

With his focus on the harsh realities of economic life, Adam Smith presents a vivid picture of the inescapable dilemma facing civilized society. For instance, the best way to help a man of no considerable means to stand on his own feet is to put him to work if he has the required skills. In the first place, somebody has to provide the requisite capital, but no one would cough up the money just for the sake of putting a jobless person to work. There has to be a reasonable profit of stock for its owner. Besides, as a rule, capital tends to flow from where taxes are high and profits are low, to where taxes are low and profits are high. You can shout as loud as you please, “Greed is one of the Seven Deadly Sins!” Yet, human nature won’t change overnight.

So, before help could even begin to emerge, the question is how to encourage the rich to invest their capital. By cutting business taxes or by raising business taxes? By adding business-friendly or unfriendly regulations? By ensuring the safety of capital investment or by launching a Marxist socialist revolution to threaten capital? Is there a rational means by which society can enrich the poor without making the rich even richer?

In 2007, the Dow Jones Industrial Average reached its all-time high of 14,000, but in 2008, a financial crisis sparked by sub-prime mortgage debt hit the U.S. economy. In November, Obama was elected president. His leftward political propensities were so apparent that many, in dismay, saw him as a socialist. Some conservative commentators even suspected him to be a Marxist, suggesting that his adviser, Ms Anita Dunn, who had helped get him elected, was an admirer of Mao‘s Marxist philosophy.

Uncertain of the future of American capitalism, investors sold their stock holdings in a panic, causing the Dow to plummet to less than 7000 in March 2009, which was way below the collective intrinsic value of America’s best-known blue-chip companies. As bearish market sentiments were exacerbated, the economic downturn deteriorated into a deep recession. No doubt, rich people suffered heavy losses as their portfolios depreciated drastically in value, but the recession hit the less fortunate even harder. Forced to retrench, corporations, large and small, announced their biggest layoffs in years. As business investment came to a halt, the jobless rate skyrocketed.

To rescue the economy, the Federal Reserve, which had already cut the overnight Fed funds rate to zero, unveiled its Quantitative Easing (QE) programmes of purchasing Treasury bonds to inject huge amounts of liquidity into the banking system. As this helped the economy to recover, though not at a fast clip, corporations began to rehire, and the Dow rebounded. In the spring of 2013, it surpassed its previous all-time high of 14,000. Then it kept rising towards 18,000. By early November 2016, the Dow was retesting the 18,350 resistance level.

In retrospect, those who sold out their stock holdings after the election of Mr. Obama in November 2008 may have underestimated the strength of American capitalism and America’s political institutions. For soon after the election, the forces of American capitalism staged a strong comeback in the form of the so-called Tea Party Revolution and retook the House of Representatives -- and then the Senate. In November 2016, they went even further by retaking the White House as well.

Despite his character flaws and frequent gaffes, the election of Donald J. Trump (America‘s super-salesman) as president of the U.S.A., in my view, embodies a great victory for American capitalism. That is why, since his election, the Dow Jones Industrial Average has risen sharply from 18,332.74 to where it is currently pushing the 23,500 resistance level. Investors know they are in a business-friendly environment of deregulation and promises of corporate tax reform. Undeniably, this benefits the rich, but others such as retirees also benefit from the stock market rally as their pension funds are invested in stocks too. Besides, as successful corporations expand and new capital pours in, new job opportunities emerge.

In the meantime, there is certainly another way to help the poor, which is by simply putting them on social welfare, but the social (or socialist) welfare state needs to be sustained with tax revenues. This means there has to be a capitalist free-market economy dominated by entrepreneurs capable of creating jobs and generating profits and tax revenues. As a booming economy makes the rich even richer, the total amount of taxes paid by them is bound to rise -- hopefully fast enough to cover the cost of the social welfare system.

As you can see, if you, like Senator Bernie Sanders, believe in socialism or the social (or socialist) welfare state, here is the irony: Bernie’s socialism is good -- of course, it is, with so many freebies, but it is obviously unsustainable without a parallel capitalist system that can create wealth and jobs and generate the requisite tax revenue to support it. No matter how society decides to help the poor, a robust capitalist free-market economy is indispensable.

On the other hand, if you believe in American capitalism, you probably think that the election of Donald J. Trump, who speaks loudly as if he were the man in the street, is likely to bring about new opportunities, since there is a palpable sense in the air that the animal spirits of capitalism are back ticking in anticipation of a prosperous new era.

By the way, quite a few commentators have turned intellectual snobs, calling Trump a crass vulgarian or blowhard. Well, they are not all wrong, but America is a pragmatic nation with a vulgar popular culture that eggs on shoddy manners. It is neither an elegant aristocracy, nor a civilization of Confucianism where scholars used to look down on the vulgar salesman. In that context, why would one care whether President Trump is a vulgarian or a blowhard, if he can get things done, have American goods and services sold abroad and lure overseas capital into the U.S. to put Americans to work? After all, only a people with a strong sense of humour could have produced such an entertaining reality show as the 2016 presidential election.

17 November 2017

By Robert M. Liu -- author of “Socialist Cuckooland”