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Book 1, Chapter 8
Themes
and Colors
Key
LitCharts assigns a color and icon to each theme in The Wealth of Nations, which you can use to track the themes throughout the work.
Labor, Markets, and Growth
Capital Accumulation and Investment
Institutions and Good Governance
Mercantilism and Free Trade
Money and Banking
Summary
Analysis
While a growing economy tends to raise wages, it generally reduces profits because it forces merchants to compete. Exact profit rates are difficult to measure, but interest rates can be used as a proxy for them. The rates set by the British crown have fallen significantly since the 1500s, at the same time as Britain’s economy has grown at higher and higher rates.
It may seem counterintuitive that economic growth causes profit rates to fall. But what this really means is that workers and consumers are keeping more of the wealth society produces, while capital owners are keeping less. Interest rates, or the profit rate earned from lending out money, are a good indicator of overall profit rates because capital owners can always resort to moneylending if they don’t have other, more profitable options. For instance, it would make little sense for capital owners to run a business at 4% profit if they can simply lend out their money for 5% interest.
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Trade is generally more expensive in cities than in villages, since more competition means higher wages and lower profit rates. The same dynamic applies to Scotland and England: although the legal interest rate is the same in both, the market interest rate is significantly higher in Scotland, and so is the rate of profit. Similarly, interest rates and profit margins are higher in France than in wealthier England (which is why many English merchants tend to invest in France). But the Dutch are even wealthier than the English. Dutch wages are high and profit rates low, which leads many Dutch merchants to lend money to foreigners.
A vibrant economy with low profit rates will still produce more overall profits for capital owners, simply because the total amount of capital invested is much higher. Dutch and English merchants invest their capital overseas to take advantage of the higher profit rates in less developed countries, much like investors in the Global North do today. But in the 18th century, unlike today, it took far longer for overseas investments to earn a return, because the capital literally had to be exported and reimported on ships. This discussion foreshadows Smith’s later focus on mercantilism, trade, and comparative advantage.
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But Britain’s American colonies don’t fit this pattern. Wages are highest there, but so are interest rates and profit margins. This is because the colonies are still underpopulated, relative to their land and natural resources. Land is cheap and people are only farming the very best of it, which is highly profitable. In fact, North American planters simply cannot get as many workers as they want. But as the colonies’ population increases and their best lands get taken up, profit rates fall—which is why interest rates have steadily gone down in North America.
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In general, countries will see their profit levels rise as they conquer new territories or absorb new industries, as their existing capital stock gets spread more thinly among a broader range of business opportunities. In this situation, people choose to allocate their capital and labor to the highest-profit sectors of the economy. Competition decreases, prices rise, profits increase, and so owners can afford higher interest rates. This happened across Britain’s colonies, like in Bengal, where interest rates often exceeded 50 percent.
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In contrast, a country that makes use of all its resources and achieves its maximum level of population will see both low wages and low profits, as there would be high competition among both workers and business owners. No country has ever been like this. While China has stagnated in some ways, it also limits its own economic growth by sharply limiting foreign trade and letting the wealthiest business owners suppress their competition. Interest rates there are still as high as 12 percent.
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Often, merchants raise interest rates because their country’s legal system does not effectively enforce contracts and they need to compensate for the risk. Some countries outlaw lending with interest, but people still do it in secret—and at higher rates. At a minimum, interest and profit rates must be high enough to compensate for unexpected losses. So in a very wealthy country, these rates would be very low, and only the richest could afford to live off interest. For instance, in Holland, almost everyone is a merchant or tradesperson.
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At the highest possible rates of profit, all revenue except workers’ subsistence-level wages go to profit. In Smith’s Britain, ordinary market profit rates are about double interest rates, but can vary within reason. This is why countries with high wages can compete by lowering profit margins. Lastly, high profits tend to drive prices up more than high wages do, as they make every transaction more expensive, and so their effects multiply in a way similar to compound interest.
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