Guidebook to the Wealth of Nations. CH 5: Book I.11

 

 

Chapter 5: WN 1.11

 

BOOK I, chap xi: of the rent of land

The last chapter of Book 1 is on the last component of price for Adam Smith: rent (for his ‘classical’ successors, rent does not enter into cost and is a price-determined surplus). But it is a lot more than just the explanation of the determinants of the natural rates of rent. It is an exceptional analysis of the problems with data analysis which can lead to gross misunderstandings and dangerous political manipulations. It is a great chapter.

For Smith, rent is the price of the use of land, and it is the highest the tenant can afford to pay, meaning that the landlord, when he can, will leave the farmer only with maintenance and will take the rest as rent. Of course, it is possible to have deviations from this: If the rent is a less (leaving the tenant a bit more than subsistence) it is just because the landlord are ignorant. If it is more (leaving the tenant a bit less than subsistence) it is because the farmer are ignorant, though this is unlikely.

Immediately Smith warns us of the challenges of understanding rent correctly. Some people may, incorrectly, think that rent is the profit or the interest on the capital (Smith still calls it stock, but it is capital, as he will tell us in the next book) used for improvement of the land. This cannot be right. The landlord charges rent also for the lands that have not been improved. As a matter of fact, when there is improvement, usually it comes from the capital (“stock”) of the tenant, not of the landlord. The landlord simply demands a higher rent after the improvement, with the renewal of the lease.

The landlord even asks for rent for lands that are not improved by human labor at all, such as rents for lands that give access to kelp (a seaweed used to make soap) or fishing in the ocean.

But if rent is not based on the cost of improvement, what is it based on? One of the challenges of this chapter is that Smith gives us a second account of price determination. We have a cost-based account for competitive markets, as described in the previous chapters and here we have a value-based account of price formation for non-competitive markets. Monopolists can and do charge more than cost, and indeed the price of a monopoly seems to be independent of costs. The rent of the land is for Smith “naturally a monopoly price”, so the rent of the land is not based on costs, but on willingness/ability to pay of the renter.

Thus, rent is a residual. If the price at which the produce sells is more than the expenses of producing it, then there will be rent. If the price is less or equal to the expenses, then there will be no rent. And the price, the market price, depends on the demand for the good. It is different from wages and profits. Changes in wages and profits cause price to change, but variations in rents are caused by variations in price instead.

Let us see what patterns of demand and price we can find to determine rent.

 

PART 1: Of the produce of land which always affords rent

Smith starts with a simple observation: as long as there are people, there will be demand for food. Indeed, as we know from the chapter on the wages of labor, Smith, like many 18th century economists—and their predecessors too, even back to biblical times (e.g. Ecclesiastes 5:11), believed that people multiply in proportion to the food they have.

Most of the time, the land produces more than what is needed to subsist. What is left, after paying all costs, including replacing the capital (“stock”) used, is rent. So rent will increase as there is more leftover after paying all costs.

For example, rent near towns is going to be higher than the rent in the countryside: the cost of cultivating the land is the same near or far from town, but the transport costs from the countryside are higher, so what is left near a town is going to be more than what is left in the countryside. Which is to say, rent, being a residual after all the expenses are covered, will be lower in the countryside because, given the same selling price of produce, the countryside produce faces the higher transport costs. Notice that here Smith still uses a cost-based approach.

It is not by accident that good transportation counts among the greatest improvements in society. Good transportation introduces rival commodities in old markets. It also opens new markets, forcing the countryside to improve its own production. Monopoly, which is what the countryside would have over its neighborhood if transportation is bad, is the greatest enemy of good management: only free and universal competition forces management to be good “for the sake of self-defence”, meaning that if you want to survive in a competitive environment, you will have to manage your resources well.

Similarly, in the days of rude agriculture, meat is cheaper than bread. As civilization progresses, meat becomes more expensive than bread. The reason lies in their relative cost of production. A corn field produces more than a pasture, but it requires a lot more work. Remember that corn means edible grains in this context. When agriculture is not much developed, fields are left to cattle, which grow there on their own. There is more meat than bread. So much so that, in Buenos Aries, in Smith’s time, an ox costs only the labor of catching it, but bread is quite expensive and rare.

On the contrary, with more sophisticated and extensive cultivation, cattle becomes less abundant and corn (read grains) less scarce. Cattle is no longer wild and is fed with pasture cultivated on land, land that now no longer be used to produce corn. The price of meat must now cover not only the cost of labor needed to care for it, but also the rent and profit forgone if corn were to be cultivated there. The price of meat will therefore be higher than the price of bread.

Now, the price of meat will be the same regardless of whether it comes from a moor or from a farm. Yet, the meat from a moor has a lower cost of production than the meat from a farm, so the landlord of the moor will receive a higher rent than the landlord of a farm.

This gives us Smith’s pre-Ricardian view of the general principle of rent determination: the rent of improved lands regulates the rent of the unimproved lands, while the rent and profits of the improved lands is regulated by the rent of corn. On the same land, one can produce corn or meat. Meat takes longer to grow than corn—four years as opposed to one, give or take. So, one can produce less meat than corn, which implies that the price of meat has to be higher than the price of corn to compensate for the lower output. If the price of meat would be more than enough to compensate all its costs, more land would be turned into pasture. If instead the price of meat was not enough to compensate for the cost of not producing corn, more land would be turned into corn fields.

At the end of the day, the rent one receives from using land for pasture or for corn production has to be the same, and it will be regulated by the rent of corn production, since corn is what is most demanded as primary source of food.

But this equality of profits and of rent for grass and corn has its exceptions. Near a great town, for example, the value of grass may be more than value of grain because in a great town there is a relatively high demand for milk and for forage for horses. So in general, in area with great population, the combined quantity demanded of corn and grass may be larger than the quantity supplied.

The land will be used as pasture because meat, dairy, and forage are more difficult to store and transport than corn. Corn is easy to store and transport so it can easily be imported.

Another exception comes from the cultivation of “artificial grass”, which is turnips, carrots, and cabbage. These “artificial grasses” can feed more animals than regular grass, so in this case the price of meat will be lower than otherwise.

What about other primary food? Corn may not be the primary food for everybody. Indeed in some nations, the primary form of nutrition is rice, in others it may be potatoes. But it is not easy to turn rice fields into fields for the cultivation of other things, so they cannot easily regulate the rents of the land. A field that produces potatoes on the other hand can easily produce other things too, so the rent of that land can regulate all other rents. Potatoes are actually more nutritious than wheat so the same amount of land can maintain more people. And if there is a large surplus of potatoes, population will grow and rent would increase too. But potatoes do not last very long, so it is unlikely they can become the principal vegetable of all people.

So, for Smith, the general principle of rent determination can be: in all great countries, rent and profits of land producing food for men and food for cattle regulate rent and profits of all other lands. If other products give more, less land will be used for food for man or cattle. If other products give less, more land will be used for producing food for men or animals.

There are no exceptions to this. What look like exceptions, such as special produce with special prices, do not actually generate special rent. They just have special costs. A fruit garden, for example, requires greater expense: it is more labor intensive, it requires more care, it is riskier, and it is practiced by the rich as an amusement. Vineyards producing expensive wines may have high profits only because of laws restraining free cultivation. These examples for Smith mean that the rents and profits of things that require extraordinary expenses just compensate those great expenses, and are regulated by the profit and rent of corn production.

The only real exception is for those special lands whose production is limited, so that its supply cannot equal its effectual demand. Some fancy wines, for example, can be produced only in limited parts of some countries. Fashion and scarcity induces some people to be willing to pay more for it, given that the quantity demanded is less than the one supplied. Price therefore goes up, as does rent. In these cases, it is the higher price that causes the more careful cultivation, not vice-versa. If the farmer is not careful, the wine may spoil, and he would lose a lot. Thus, given how much he can lose, he has all the incentives to take a lot of care.

Sugar is also one of those goods for which the effectual demand exceeds the supply, therefore increasing its price, profits, and rents.

Tobacco is another of these goods, but for different reasons. Tobacco could be produced in Europe, but its cultivation in Europe is prohibited. Why? Tobacco is heavily taxed, and it is easier to collect the taxes from a single custom office than from a large number of producers spread all over the country. Tobacco is thus monopolistically imported from the colonies, especially from Virginia and Maryland. Its supply thus is limited. But tobacco is not as profitable as sugar. The evidence? The limit of its cultivation seem artificial. There are rumors that some plantation owners burn the excess tobacco to keep its supply low and its price high. Which implies that the advantage over corn may not last long.

So in this part of the chapter Smith shows that for the land that always generates rent, the rent of the lands that produce human food regulate the rent of other lands. It can’t generate less rent for long, or production will shift. It can generate more rent, but only if there are ways to limit supply of the produce of land to be less than its effective demand.

 

Part II: Of the produce of land which sometimes does and sometimes does not afford rent

Man does not live on bread alone. We also need clothing and shelter. Land, not only gives us food, but it can also give us clothing and lodging. Yet, as important as clothing and lodging are for our existence, population increases only with abundant food, not with abundant clothing or lodging.

In a rude society, land can produce clothing more easily than food, but in an improved society the reverse is true. When hunting is the primary source of subsistence, game will provide for both food and clothing, and a lot of waste. When commerce is introduced, what was previously wasted may now be sold. If things are so abundant to be wasted, there can be no rent. But where there is scarcity, then someone will be willing to give more for what they want, so rent will be possible. This is why in rude societies, there are no rents. Rents are present in improved societies, though, due to scarcity.

In a rude society, the materials for producing lodging, being more difficult to transport, will not be an object of trade. As a consequence they cannot generate rent. As a matter of fact landlords often grant the uses of their land and their timber to whomever asks for it. This may not necessarily be the case in wealthier countries, though.

Smith goes on saying that once we have enough to eat, we want to satisfy our other wants: our wants for ornaments and distinction. A rich man consumes more or less the same quantity of food as a poor man, since the stomach of the rich is not significantly different from the stomach of the poor. Yes, the rich may eat better quality food and food with more elaborate presentation, but the desire of food remains limited by the size of our stomach, however rich or poor we are. But our desire for ornaments is infinite, or so Smith claims. Clothing, lodging, and furniture is where we can see significant differences between rich and poor, not just in quality but also in quantity.

The rich have more food than they need, and use it to gratify their endless desires. The poor gratify the rich to get food. So as the amount of food increases, so does the number of workmen, in its turn increasing the demand for food and therefore the rent on land producing food. The division of labor lets us produce more, as the demand for the materials for ornaments increases, which also increases rents as a consequence. What this means is that food is therefore the origin of all rent!

In a different context, Smith makes a similar argument to the one made here. The wealth of the rich does not stay in their hands. It trickles down to the poor. The desire for distinctions, that is typical of our nature, can find some satisfaction when the rich employ the poor to produce those means of distinctions. In this way, the rich share part of what they have with the poor. It is like there is an invisible hand that distributes wealth among people, so that the poor get some of what the rich have through the work they provide to the rich. This account comes from Smith’s other book, The Theory of Moral Sentiments, and it is the only other place in his published works where he mentions the invisible hand.

That said, let’s go back Smith’s analysis of rent. Smith just told us, again, that food is what matters to us. Food is what keeps us alive, what allows population to grow both in number and in wealth, and what regulates all rents. The comparison to what follows is therefore quite striking—it is a way of cutting the legs off the argument he is fighting against: precious metals are not wealth and do not create wealth. Believing so is incorrect and dangerous.

Mines differ from the land producing corn. They may or may not afford rents, and their rents depend on both the fertility of the mines and the historical circumstances in which the mines operate. The value of coal mines depends both on their fertility and their circumstances. The value of metallic mines mostly on their fertility.

Coal mines have to be in a convenient place (circumstance) to generate rent. A fertile mine in a sparsely populated place with poor transportation may not be mined. Similarly, some mines in good location may not be fertile enough to justify their mining. Yet, in all cases, the most fertile mines will regulate the price of coal of all other mines. The owner of the most fertile mine can undersell his competitors. They will need to lower their prices too. Profits and rent will go down too. For some, they will go down so much that they may have to close. So usually the price of coal will give no rent to the owner of the mine.

Smith estimates that the rent on land is about 1/3 of the gross produce, while the rent on mines is about 1/10. And coal mining is not that bad because it is not in long distance competition, as metallic mines are.

The market for precious metals is a world-wide market. Since precious metals are valuable, their price can cover transportation costs worldwide. So it is the most fertile mines in the world to determine the price of metals. In fact, the discovery of the fertile mines of Peru caused many European mines to close. Mining can eventually cover only its expenses. It is rare to have high rents. The price usually covers just wages and profits. Not surprisingly, now even in Peru profits are approaching bankruptcy levels.

For Smith, mining is like a lottery: many ruin themselves attracted by the fortune of few. It is rare to find someone who became rich by mining silver and even rarer someone who got rich mining gold. It does not help that the sovereign gets a revenue from mining. The sovereign creates laws that encourage mining: who discovers the mine gets it, without the owner of the land’s consent. This is a “violation of the sacred right of private property” which is sacrificed supposedly for the interest of public revenue. Note that, again, what is unjust happens to be also inefficient.

Smith continues with a surprising analysis which seems to effortlessly solve the water-diamond paradox he mentioned earlier in the book. The high price of precious metals comes from their demand and from their scarcity.

The demand for precious metals derives in part from their utility and in part from their beauty. We can clean a silver boiler more easily than a copper one. But we prefer it to a copper one mostly because we think it is more beautiful. And we think it is so beautiful because of its scarcity.

The great joy of the rich is parading their riches. And their riches are those signs of opulence that nobody else has. The value of something is in its beauty, in its utility, and mostly in its scarcity, which makes that object so expensive that nobody else can afford it.

It is therefore the utility, beauty, and scarcity that gives precious metals their high prices. This means that the value of metals is present before they are coined and exists independently from it. Coining precious metals may actually increase their scarcity for other uses, increasing their value. Precious stones work in the same manner. They may be used only as ornaments, and their beauty is enhanced by their scarcity. Diamonds too? One may ask…

Two things to notice here. One is the reliance on beauty and of our desire to show off as major motivation factors. This is a theme dominant in The Theory of Moral Sentiments. The thing we want most is for others to notice us. And, for Smith, the most effective way to attract people’s attention is to show off our wealth. Wealth glitters after all. This is not an endorsement of the behavior, but a simple matter-of-facts description of it.

The other thing to notice is the deepening of his Smith’s theory of money. Gold and silver emerge spontaneously as money because everybody wants them as a mark of opulence which can distinguish one person from another.

Smith concludes this section with a discussion that provides more ammunition against the mercantile system that he wants to criticize. More mines cannot and do not increase the wealth of the world because precious metals derive their value from their scarcity. The more abundant they are the less value they have. The only advantage there is to have abundant mines is to have cheap services of plate, that is, that silverware price will decrease.

And Smith concludes. Value comes from what is produced above ground, not below it. Producing more food creates more demand for the produce of other lands, increasing value and wealth. As the value of fertile land increases, the value of the barren lands also increases because the more people a fertile land can maintain, the more they create a market for the produce of the less fertile land. As the fertility of land increases, its value increases, bringing up the value of all other lands. The abundance of food creates the demand for metals and other ornaments too. It is therefore the abundance of food, not of metals, that gives value to other things.

 

Part 3: of the variation in the proportion between the respective values of that sort of produce which always affords rent, and that which sometimes does and sometimes does not afford rent

We just saw that when there is more food there may be more demand for other things, such as ornaments. This implies that the demand for clothing, lodging, and precious stones will increase too, and with that the price of those things will increase as well.

What if their supply changes too? For some things the supply may increase more than the demand. We need to be able to distinguish among all these different factors, as well as among nominal and real changes.

The value of silver, used to express monetary prices, can change for two different and unrelated reasons: because of improvements in society, and because of the discovery of new mines. The improvement in society will increase the demand for silver and thus its value will increase. But the discovery of new mines will increase its supply, decreasing its value. If the supply does not increase by the same proportion, the value of silver will be higher than the value of corn, meaning that the average money price of corn will go down. But if the supply increases more than demand, silver will become cheaper and cheaper, meaning that the money price of corn will go up. And if supply and demand of silver increase by the same proportion, the average money price of corn would stay about the same, despite the improvement in society.

The digression on silver which follows is Smith’s marvelous analysis of the distinction between nominal and real prices and of the importance of recognizing that what we see and commonly believe may not be correct.

 

Digression concerning the variations in the value of silver during the course of the four last centuries.

Smith opened Book 1 by noticing that what we commonly think is not necessarily correct. We are often misled by what we see. We see how the division of labor takes place in full in a small shop and we commonly think that is where it exists the most. But in reality the division of labor is more extensive in large manufactures. We do not commonly think so because we do not see all the pieces in one place.

Book 1 also ends by noticing mistakes we commonly make because we are misled by what we see: we commonly believe that the value of silver decreases with the increase in wealth. But we are mistaken. We see the nominal price and stop there, being misled by what we see. We just look at the nominal price, not at the real price, which is where value is. To understand the relation between value of silver and wealth we need to look with care at changes in relative prices, not nominal prices. Then we will notice that correlation is not causation. It just happened that Europe grew richer over the last 4 centuries and that the nominal value of silver decreased. But if we look at historical events and relative price changes, we see the mistake. The two phenomena happened simultaneously but independently. They are correlated, but one did not cause the other. They have separate and independent causes.

Smith is going to separate the last four centuries into three periods in which the changes in the value of silver and corn are compared, to show their disconnection and therefore the error that is commonly believed.

 

First period

Between the middle of the 14th and the middle of the 15th century the quantity of silver in silver coins tended to decrease. At the same time the value of silver increased. The two effects cancelled each other out.

But from the end of the 15th century the value of silver increases compared to the value of corn. This could be because the demand for silver increases while its supply stays the same, because the demand for silver stays the same while its supply declines, or both.

Indeed, between the end of the 15th and the beginning of the 16th century, Europe experiences an increased security, thanks to more stable governments, which allows industry and improvement to increase, fueling a demand for luxuries. More coins are therefore needed to circulate the larger quantity of produce. But European mines are old, so the supply of silver is not enough to keep up with the demand for it. The value of silver increases, that is, money prices decrease.

On the other hand, the popular, yet incorrect, notion that from the time of Julius Caesar to the discovery of America the value of silver diminishes, that is, prices increase –the idea that an increase in the quantity of silver is related to an increase in wealth so that the value of silver decreases as the wealth of a country increases—is groundless and is based on poor understanding of what one sees.

When one looks at the variations of the recorded prices of corn, one needs to understand what the records say, and not take for granted that they say what we want them to say. One needs to consider the three following factors. First, ancient records do not record market prices, but conversion prices of corn. Rent used to be paid in corn. The landlord could ask to covert the payment in money prices. That is the conversion price, which may not be the same as the market price. Second, we can’t assume that there are no mistakes in the records, especially since they were copied by hand, and copiers can be lazy. Third, what is often recorded are the lowest (and the highest) prices, not the actual market price. Prices do indeed look lower in the past, but it may be because we may not be looking at the right prices.

Many people look also at the price of “unmanufactured commodities” such as cattle and poultry, which are more common in rude ages. One sees lower prices. One sees lower nominal prices. One infers they are caused by the high value of silver, and their increase by the decrease value of silver. But… But one needs to look deeper than what one sees. Things are cheap, yes because of the high value of silver, but also, as is the case here, because those goods are able to buy less quantity of labor than in more advanced societies. The low money price here indicates that the value of those commodities is low, not that the value of silver is high. In the early stages of development, cattle are produced by nature and are abundant. There are also few people. The value of cattle is low, due to their relative abundance. They represent very little labor. In more advanced societies, on the other hand, when there are no longer more cattle than what people can consume, the value of cattle is higher, and they command more labor than before.

Looking at nominal changes in the price of cattle may tell us nothing about the changes of the value of silver.

Corn, on the other hand, is always produced by labor. With similar soil and climate, regardless of the level of improvement, producing corn always requires the same quantity of labor. Even when the improvement in the productive power of labor improves cultivation, the increased price of cattle (which is the principal instrument of improved cultivation) counterbalance it. Equal quantities of corn therefore will always more or less represent equal quantity of labor, regardless of the state of improvement of society. Corn is therefore a better measure of value and a better measure of value of silver. We knew this already. But it is worth being reminded of it because to evaluate the value of silver, we need to compare it to the value of something of stable value: corn. It is the relative price that matters, not the nominal one.

If there is no reason to infer that the value of silver decreases by looking at the nominal price of corn, there is even less reason to infer that a decrease in the value of silver is connected to an increase in wealth and improvement. We need to be careful about where we look and what we see.

Now, the quantity of precious metals increases for two different and independent reasons. One is the increased abundance of mines. In this case, the large quantity of silver will decrease the value of silver. The other case is the increase in production. But in this case the value of silver will not decrease. To the contrary, the value of silver will increase.

With an increase in wealth, we experience an increase in production which means that we need more coins to circulate that larger produce. An increase in wealth also means that we increase the demand for things that satisfy our vanity and our desire for ostentation. Our demand for plate will increase, just like our demand for paintings and statues. The price of gold and silver will therefore increase in the richer countries. More gold and silver will go there, like all other things for which there is a higher price.

Again, wealth increases the value of silver, not decreases it. Among savages, who are very poor, precious metals have scarcely any value.

Corn is more expensive in towns than in the countryside, but we would not say that it is because real price of silver is lower in towns than in the countryside, but because the real price of corn is actually more in towns: it costs the same to bring silver to towns or to the countryside. But it costs more to bring corn to towns than to the countryside. Substitute towns with rich commercial states, say Genoa or Holland, and countryside with poor agricultural state, say Poland. Price of corn is higher in Holland than in Poland because Poland produces corn and transports it to Holland, which produces manufactures instead. Now, imagine Holland without its wealth, without the power of getting corn for Poland. What would happen to the price of corn? It would skyrocket. It would require a very, very large quantity of labor to get corn. Corn is a necessity and we are willing to give up a lot of superfluities in time of scarcity to get necessities.

With poverty and/or dearth superfluities are cheap, and necessities are expensive. With wealth and/or abundance, necessities are cheap and superfluities become expensive. The real price of corn rises in times of poverty and falls in time of abundance. The real price of silver will move in the opposite way: it falls with poverty and rises with wealth, since silver is a superfluity, while corn is a necessity. The opposite of what is commonly believed! Careful what you look at, you may very well be misled by what you see…

 

Second Period

From 1570 to 1640 the value of silver sank and the value of corn rose nominally. This can be uncontroversially attributed to the discovery of the mines in America. The demand for silver also increased because of economic growth. But the supply of silver rose by much more. Easy enough.

 

Third Period

In this last period, the supply of precious metals increases at about the same rate as its demand, leaving the price of corn about the same.

By 1636 the effect of the new mines ends. The profits of the mines used to be quite high, but now are just enough to cover the expense of operating them, a sign their peak production is past. We also have to keep in mind that not all the gold and silver of America comes to Europe, just a part of it.

The demand for silver experiences a gradual increase. This gradual increase in the demand for silver which counterbalances its increase in supply happens because there is a larger market: Europe is growing, with the possible exception of Spain; the Americas are now a new market; even Mexico and Peru are now larger markets than before; and the East Indies are also a larger market. Add to this that some metal is lost during its transport, and that some is buried in the ground and then forgotten there. Furthermore, there is always an increasing demand for silver due to the consumption of the coins by wearing and the consumption of plate by wearing and cleaning (the continuous rubbing of metals against other things in people’s pocket or in their daily use causes the metals to wear out-the “wearing” of the coins and plate). This demand due to the wearing of silver is like the demand for brass and iron due to the wearing of the tools made with it. When we see an increase in iron and brass so that they can replace the worn tools, we do not think that the increase in this quantity was caused by a decrease in their price, but by the wear and tear of the tools made with them. The same works for silver: the increase in its quantity may not be caused by a decrease in its price but by an increase in its demand.

At the same time there are also events that caused the price of corn to increase. Here again we need to be careful to decompose the changes to see which ones depend on changes in the value of silver and which ones do not. There was a civil war, which caused the price of corn to rise, by making it scarce; there is a bounty (a subsidy) on the exportation of corn in combination with pretty bad season; there is also a great debasement of silver coins through clipping of the coins and wearing, which increases its nominal price. The value of silver therefore increased in proportion to the increase in the value of corn. And the nominal price of corn does not change much over this time.

But, yes, there is always a but in Smith, at the time of the discovery of American mines, the money price of corn increased. People thought that the real value of silver went down. They did not think that the real value of corn may have gone up. Similarly, we can think that around 1700-1764, the money price of corn goes down because the real value of silver goes up rather than the real value of corn down. Relying exclusively on nominal price changes is, not surprisingly, misleading. We need to understand if that change is caused by a change in money supply (the quantity of silver and therefore the value of silver) or by a change in the supply or demand of the corn itself.

Think of the effect of the bounty. It is true that a bounty on the exportation of corn will increase the real price of corn by increasing its scarcity both in good seasons, because of the subsidized exports, and in bad seasons, because the extra grain of the abundant years have not been saved but sold abroad. But it is also true that during those same years, France prohibits the exportation of corn, and yet its price goes up there too. This means that the increase in the price of corn in this era can be attributed to a monetary phenomenon—that the value of silver decreased. Otherwise we cannot explain how two opposite policies (prohibition and subsidized exports) can generate the same price effect.

Similarly, the money price of labor in Britain increases. But if at the same time it decreases in France, it is difficult to attribute these changes to a change in the value of silver. It is more likely they come from a change in the demand for labor and therefore a change in the prosperity of a country.

Also, it is true that a bad season increases the price of corn. But it is also true that a bad season is a temporary event and it will have a temporary and immediate effect. Changes in price due to changes in silver are instead very slow to observe. So whenever we have sudden changes in prices, we can be confident that those are due to accidental variation of seasons. Long trends are less likely due to seasons but more likely due to changes in silver. The price of metals tend to be remarkably stable year after year, especially compared with the prices of the produce of the land. The corn consumed this year is the corn produced last year. But the iron used today may be produced 300 years ago. Corn production is about proportional to its yearly consumption. The production of the mines can vary a lot from year to year, but because metals are very durable, they can be stored, so the yearly variation in production has almost no effect on price, which remains stable.

 

Variation in the proportion of the value of gold and silver + Grounds of suspicions on the decrease in the value of silver good

The quantity of silver in the market is probably more than the quantity of gold, even if the value of gold is more than the value of silver. This is consistent with the fact that generally the whole quantity of a cheaper commodity is greater and of greater total value than an expensive one. Bread is cheaper than meat, but there is much more bread than meat, and the total value of bread may exceed the total value of meat. Yet, the profits of gold mines may be less than the profits of silver mines.

Here Smith hammers home once again that mining is not a profitable activity. We see that mining costs are increasing because taxes on metals are decreasing. But this decrease in taxes will just postpone, not avoid, the increase in the value of metals. Especially since as wealth increases, the demand for gold and silver increases too, like the demand for all luxury goods does. This rise in nominal price is not rooted in a decrease in the value of gold and silver, but in an increase in their value, in an increase in their real price.

Imports of metals more or less matches their consumption. As we import more, the value decreases; and as the value decreases we use more metals and we use less care in handling them, wearing and tearing them more. So consumption increases to match imports. Then, Smith claims, we start importing less because the consumption is more than the imports, which pushes the value up and consumption down to match imports again.

 

Different effects of progress of improvement on the real price of 3 rude produce

We can see that the price of things can change independently from the changes in their value by looking at three different kinds of things: things that we cannot increase, things that we can increase, and things for which there is limit and uncertainty on what we can do.

If we can’t increase the quantity of a good, it may seem like the price may rise to no limit. For things that we can increase, price may increase but not by much, and for things that are uncertain there is uncertainty on the direction of change of the price.

First sort

Nature produces only a limited amount of some things. And they may be perishable. Rare fish or rare birds for example. As wealth increases, and their quantity cannot increase, their prices can reach extravagant levels. Those high prices are not an effect of the low value of silver but of the high value of their rarity.

Second sort

Human industry can multiply something in proportion to its demand. For example, there are animals, say cattle, that are abundant in nature but they can become scarce as civilization progresses, because we give space to more profitable produce. So, as civilization advances, the quantity of cattle decreases. Yet its demand increases. The value of cattle therefore increases so that it is worth producing.

Poultry, hogs, and dairy products work in a similar ways. They are “save-all” products. Pigs and chicken eat left-overs, so they cost little to maintain. They sell for little. Milk too is perishable and abundant; the extra quantity sells at very low prices. But with the increasing wealth and luxuries, the price of all of these increases, and it becomes profitable to use land to explicitly produce them. The only rude produce that still has not gone through this process, and unlikely will, is venison. Even a high price will not compensate the expense of maintaining a deer park.

In all these situations, the increase in the money price of the produce is not due to a decrease in the value of silver but to an increase in the real price of the produce. So the increase in their price is not a public calamity, but, on the contrary, a sign of greater prosperity.

Interesting enough, here is where Smith introduces the solution of a different problem: how do we get to increase the stock (capital, that is) that we will need to improve the land, given that without the improvement in the land we cannot increase our capital (“stock”)? Smith throws in the seed of his answer: with a long course of frugality and industry. The idea will be developed in the next book. Here we just have a taste.

Third sort

The third kind of goods whose price varies but not necessarily because of changes in silver value are those goods whose price would increase with improvement of society as well as accidents. The direction of change of these prices is therefore uncertain.

Wool and raw hides are good examples of these goods. In a sense they are like butcher’s meat: their price increases with the increase in wealth. But they differ from butcher’s meat because the meat market can be only domestic. In Smith’s time, with no refrigeration and no steam engine means of transport, it was too difficult to move fresh meat long distance. But the market for wool and hides is an international one, because they are easy to transport. At least they do not rot easily.

In poorly cultivated countries, as we saw already, the price of wool and of hides is more than the price of the whole animal. There are a lot of animals and meat, and they cannot be easily shipped abroad. Wool and hides can be sold abroad. But with progress and the increase in population that progress brings about, the price of the whole animal increases too.

Yet, in Smith’s time, both the real and nominal price of wool and row hides are low. Why? Because of “violence and artifice”, Smith claims. “Violence and artifice”? Yes, “violence and artifice”… The price of wool is low because there is an absolute prohibition of exporting wool, there is permission to import wool from Spain duty free, and there are impositions on Ireland so that they can export wool only to England. Why on earth does England have those kind of regulations? Smith explains it as it explains why the price of hides is low: The price of hides is low because British tanners are not as successful as clothiers in convincing the nation “that the safety of our commonwealth depends upon the prosperity of their particular manufacture.” The merchants and manufacturers of clothes want to have cheap inputs for their productions. They are able to convince “the nation” that to benefit them is good for everybody. Of course this is not true, but they encounter little resistance. Smith will more fully elaborate this few pages later, in the conclusion. Here he simply notices that the lack of resistance comes from the indifference of the landlords. When regulations decrease the price of wool or hides, the price of meat has to increase to compensate for it. What is not paid by wool or hides has to be paid by the meat. The landlord gets his rent independently by which part of the animal is sold at high or low price. But this kind of regulation would not fly as easily in poorer countries where the price of meat is very low because of its abundance and where the value of an animal comes almost exclusively from its wool or hides. The interest of the landlords and farmers here would be greatly affected by an artificial decrease in the price of wool or hides: their profits and rents would decrease.

With this solid economic logic, which today we would call Public Choice analysis, Smith concludes that the attribution of a prohibition of the exportation of wool in the 14th century has to be false. It would have been “the most destructive regulation which could well have been thought of.” What a jewel of analysis!

This was a long way —but Smith never loses a chance to attack what today we call special interest groups— this is a long way to say that the price of wool and raw hides may change independently from changes in silver, and in ways that are not strictly dependent on domestic production.

SO now we can go back to metals. The price of metals is also independent from the local situation, but rather dependent on the fertility of the mines world-wide. The quantity of metals in a country does not depend on its mines but on the state of its industry and the produce of its land, and on the barrenness and fertility of the mines in the world. But the fertility and discovery of new mines depend on luck. In addition, given that what matters is the real value, that is the real quantity of labor which something can command, which is independent from its nominal value, having more mines would bring only one advantage: cheap plate, that is, cheap silverware.

 

Conclusion of the Digression Concerning the Variation in the Value of Silver

Here we have the explicit justification of this long digression and its fundamental importance in Smith’s intellectual machine.

Past writers linked low money prices of corn, meaning high value of gold and silver, with barbarism and poverty. This way of thinking is grounded into the idea of gold being wealth. But as we just saw, the high value of metals is not a proof of poverty but only a proof of barrenness of the mines in the world.

Just because an increase in the quantity of gold and silver and an increase in manufacture and agriculture happened at the same time, it does not mean they came from the same cause and that are connected with one other.

Look: China is richer than Europe but the value of precious metals is higher than in Europe. Then think, since the discovery of the mines in America, the wealth of Europe has increased and the value of silver decreased. But the value of silver decreased not because of the increase in wealth but because of the increase in the number of mines.

The increase in gold and silver is a mere accident.

The improvement in agriculture is the result of the fall of feudal system and of the establishment of governments that offer tolerable security that one can enjoy the fruits of his own labor, which is the only encouragement that industry needs, as will be elaborated in Book III.

You do not believe it? Look at Poland. Poland is still a feudal system, it has no improvement in agriculture, yet the real value of metals has decreased there just like in rest of Europe. Similarly in Spain and Portugal, the quantity of metals increased but their industry did not.

Higher money prices, or a higher value of gold, is not a proof of wealth, just like low money prices, and low prices of corn in particular, are not a proof of barbarism. If money prices increase from a decrease in value of silver, then all prices would be equally affected. When you look at something, make sure you understand what you are seeing…

From low or high prices in general or of corn in particular we can only infer the fertility of mines.

We can infer if a country is rich or poor only from the relative price of some goods compared to others. As wealth increases, the price of some provision will increase too because of the increased value of land, due to the increase in its fertility. So the increase in wealth will not affect the price of all provision equally. Low money prices of cattle in proportion to money price of corn is a better estimator of poverty.

Why does this matter? Because some inferior servants may be on a fixed monetary compensation. If the prices increase because of a decrease in the value of silver, their monetary compensation needs to be adjusted or their real compensation will go down. If instead prices increase because of improvement, then it is more difficult to evaluate if the fixed monetary compensation needs adjustments.

An increase in the price of venison affect the poor less than an increase in the price of potatoes. Similarly, in times of economic growth, a change in the price of corn will affect the poor as much as changes in taxes on salt, soap, candles, malt and beer.

Why does this matter today? Because it is a powerful lesson in the importance of looking at relative prices rather than nominal prices as well as on the importance of understanding that correlation is not causation.

 

Effects of the Progress of Improvement upon the Real Price of Manufacture

Now let’s look at the last piece of the puzzle. The division of labor causes improvement and causes prices of manufactures to decrease. Less labor is needed to make the same things. But the increase in wealth causes the real price of labor to increase too. The increased quantity of manufactures compensate for the increase in the price of labor.

The price of some raw materials increases too, due to the higher demand, but the price of manufactures drops enough to compensate for it. The price decline is more present in the industries in which labor can be divided the most. So, for example, the decrease in price of coarse manufacture is less than the decrease in price of fine manufacture. At the time of Edward IV (in the 15th century) socks were made with common cloth and knitting stocking were nowhere to be found. Allegedly, the first person to wear stocking was Queen Elisabeth. Now they are commonly used.

 

Conclusion of the Chapter

Some improvements in society increase rent of the land. Add to this that the price of manufacture is dropping. This means is that the real rent on land is even higher. The landlord can buy more manufactures with the produce of his land. He can buy more and more ornaments.

But because those who live by rent live without having to work or to care, they tend to be indolent, ignorant and incapable of understanding the consequences of public regulation. This is too bad because this is a group of people whose interest coincide with the interest of society.

The interest of society also coincides with the interest of the people who live by wages. But they are also incapable of understanding it, because of their lack of time and education—a point elaborated later on. In public deliberation, they have no voice, unless they clamorously protest-a point previously elaborated.

The interest of society is instead opposite to the interest of those who live by profits. They want high profits, which means less competition, while society benefits from more competition and lower prices. Because of their wealth, they attract a lot of attention and admiration, so they are listened to (a point further developed in the Theory of Moral Sentiments). They know their interest well and they are able to persuade other groups that their own interest is somehow the same as the interest of society, despite being the opposite of it. These are Smith’s last words in this chapter-the foundation of what today we call Public Choice and of the criticism of mercantilism which will see its full power in Book 4: “The proposal of any new laws or regulation of commerce which comes from this order, ought always to be listened to with great precaution, and ought never to be adopted will after having been long and carefully examined, not only with the most scrupulous, but with the most suspicious attention. It comes from an order of men, whose interest is never exactly the same with that if the publick, who have generally an interest to deceive and even to oppress the publick, and who accordingly have, upon many occasions, both deceived it and oppressed it.”

 

Further readings:

??? Wilson and skinner collection?