THE WEALTH OF NATIONS SUMMARY (BY ADAM SMITH)

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 vocation 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 labour. 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 labour, and thereby the greater the productivity. Just think about all these 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 labour 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-wheel wagons and 400 horses. This is why rivers and seacoast towns often develop faster. They allow a greater division of labour 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 labour 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 Frankie, 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, salts 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 Bob'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 laborer 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 1999-2019. And the factor that can differ the most is, of course, rents. In New York, for example, you'll have to pay about $5.2 million per acre of land, while in the country village of Ia-Kö 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 Ia-Kö, 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 2 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 heck 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!