The Wealth of Nations: Book 2, Chapter 5 Summary & Analysis

Depending on how it is used, the same amount of capital can command different quantities of labor and add different amounts of value to a nation’s annual produce. It can be used in four main ways: furnishing society with rude produce, manufacturing goods out of that rude produce, transporting produce and goods to wherever they are sold, and dividing produce and goods into smaller portions for distribution to customers. People who work in these four kinds of activity—farmers, manufacturers, wholesalers, and retailers—are productive laborers.

These four groups use their capital stock in different ways. Retailers spend their capital buying goods from wholesalers, which replaces the wholesalers’ original capital investment. The amount retailers add to the nation is equal to their profits. Wholesalers spend their capital buying goods from farmers and manufacturers. In the process, they replace those farmers’ and manufacturers’ initial capital, and their businesses add to the economy in two ways: through their profits and through the wages of the people they employ to transport goods by land and sea.

Manufacturers use their capital to buy the instruments (fixed capital) and materials (circulating capital) that they need to make their products, as well as to pay their workers’ wages. In this way, a fixed quantity of capital adds more to the economy in manufacturers’ hands than retailers’ or wholesalers’. But farmers put even more capital into motion and add even more to the nation’s annual produce than manufacturing does. Farming involves working with nature to create rude produce, and it generally yields far more value than the labor put into it. Thus, agriculture is the most advantageous use for capital.

The capital that goes into agriculture and retail trade must stay within a country, as they are tied to specific geographical locations. While wholesalers’ capital can go anywhere, it doesn’t much affect a country’s annual produce. Manufacturers’ capital goes into their production facilities, which they can choose where to locate. As this capital adds much more value to the economy, its location is very important. But foreign manufacturing capital can still boost a country’s economy (like how English manufacturing supports flax and hemp growers in eastern Europe).

Most countries simply don’t have enough capital to cultivate all their land, reach their manufacturing potential, and transport all goods to market. Such countries ought to prioritize their resources in that same order: agriculture, then manufacturing, and then exportation. This is the best way to build up enough capital to eventually reach capacity in all three sectors. England’s North American colonies have grown so wealthy so fast because they started with the most profitable business: agriculture. In fact, China, ancient Egypt, and ancient India are the only countries to ever reach their potential, and none of them excelled at foreign trade.

Different kinds of wholesale trade also employ productive labor and add to the annual produce to different extents. Rather than sending their ships or vehicles home empty-handed, wholesalers generally trade in both directions, buying one commodity and selling another. For domestic wholesale trade, both sources of capital are within the country, but for international trade, only one is. International voyages also cover vaster distances and often include many trading stops, so they take far longer to return and contribute to the home country. They can trade all sorts of goods on their stops, including gold and silver, which are generally cheaper to transport because of their high value by weight. The carrying trade—or trading purely between foreign countries—doesn’t benefit the home country, except through the merchant’s profit (if they spend it at home) and the sailors’ wages (if they are from the home country).

In general, then, it is more productive for a country to invest in domestic trade than foreign trade or the carrying trade. Still, exportation is useful when a country produces more of a good than it needs. Some countries over-import and re-export goods, like Britain with tobacco. When a country has even more capital than it needs to support its productive labor and total consumption, that capital tends to go into the carrying trade, which is thus a reflection of national wealth. This is why Holland and England dominate it. The carrying trade can expand infinitely across the world.

People with capital decide where to allocate it based only on profit margins, and not on what is best for the economy as a whole. Thus, they tend to overinvest in manufacturing and trade—which make it easier to build a fortune in a single lifetime—than in agriculture, which still adds the most value to the economy. The next two books of this work will try to explain this chronic European underinvestment in agriculture.