Guidebook to the Wealth of Nations: CH 7 Book III

BOOK III: Of Different progress of Opulence in different Nations

Chapter 1: of the natural progress of opulence

After the previous two books of what is often considered Smith’s economic theory, this book is often considered an historical book: an account of how Europe developed. But it is also possible to read this book as a continuation of the economic theories exposed before. We know that division of labor and capital accumulation are the foundation of prosperity. We know that it is our desire to better our condition that drives us to seek improvement, that the desire to better our condition can take different forms, depending on our habits. Here more explicitly than previously, Smith tells us how economic growth and development depend on human passions, some of them rational, some of them not rational. However one wants to look at these passions that drive the economy, the process of development is not planned, it is not intentional, and it is not mechanical. Price signaling plays a smaller role than vanity in the efficient allocation of resources over time, and human institutions mediate our vanity and passions, according to Smith.

So, Smith asks, given that division of labor and capital accumulation bring about prosperity, why are some countries richer than others? Why do some countries grow faster than others? Two factors play a role: “the natural inclination of man” and “human institutions.” The “natural inclination of man” generally leads development through some sort of more or less linear “order of things”, but “human institutions” make things unpredictable and nonlinear. Economic growth is therefore an unpredictable mix of economic forces, human passions, and human institutions.

The basic process of economic growth is based on the growth of commerce between towns and country. The towns receive their wealth and subsistence from the country, and the country finds in the towns both a market for its products and a supplier for its manufactures. The larger the number of inhabitants in towns and the larger their revenue, the larger is the market. So the more division of labor is possible.

We need to have something to live on first. Then we look for conveniences and luxury, so the improvement of the country “must necessarily be prior” to the increase of the town. In this sense it is true that towns cannot survive without the country, but this does not make one better off and the other worse off, as some may wrongly think, Smith says. Both gain from trade because of the increased division of labor. In another sense, the inhabitants of the country and of a town are “mutual servants” to each other (my emphasis). The employment of the town depends on the country demand, and the country demand depends on the improvement in cultivation.

If towns are in geographical locations where transportation is easy and cheap, like next to water, trade thrives. Recall Book 1, chapter 3, where Smith tells us that the division of labor is limited by the extent of the market? The towns that historically flourished the most are the ones that can take advantage of water carriage. Here Smith picks up that idea again. Towns do depend on the subsistence of the country. But that country does not have to be next door. If the towns are easily reachable (by water) they can easily receive subsistence from the country far away rather than depend on geographical proximity.

What about the natural inclination of man? Given a choice, and given similar profits, people would prefer investing in land than in manufacture because they prefer to keep things under their “view and control”. What we call “monitoring costs” today, will affect the allocation of capital. Furthermore, they think there is a lower chance of misfortune. A trader depends more on “winds and waves” and on “human folly and injustice” than a farmer. All else equal, what is our first choice for investing, given our natural inclination? Agriculture.

But here Smith kicks in his other, often more powerful explanation based on other natural inclinations, which are not necessarily economic inclinations: we are naturally attracted by the beauty of the countryside, by the pleasure and tranquility of country living, so we do prefer agriculture to manufacture also because we believe that cultivating the land “was the original destination of man.” A reference to Physiocracy? To Stoicism? Sarcasm? Genuine love of nature and agriculture? Look at the North American colonies, Smith says: All capital is used to improve uncultivated lands. They have no manufacture for distant sale. And the colonials, cultivating their land very much enjoy the feeling of being “master, and independent of all the world”!

Then Smith resumes. It is only when there is no more uncultivated land that capital goes to manufacture. Indeed, given the choice of manufacture and foreign trade, all else equal, people prefer manufacture for the same reasons why, all else equal, people prefer agriculture to manufacture: in manufacture, capital is more under “the view and control” of its owner and it is more secure, than in foreign trade.

Foreign trade can be carried equally by foreign or domestic capital. It does not normally matter. Unless there is not enough domestic capital. In that case foreign capital would be better to carry trade. Indeed, in many places trade is carried by foreigners: China, Egypt, Indostan, and even the North American colonies.

So the natural course of things is that first agriculture develops, then manufactures, then international trade. This must happen in one form or another in all countries, if “human institutions [had] never disturbed the natural course of things.” But human institutions do disturb the natural course of things. All the time. So much so that in Europe this natural course of things actually did not happen. In Europe the order is “entirely inverted”, not a little bit inverted, but entirely inverted. Europe developed foreign trade first, then manufacturers, then agriculture. The manners and customs that the nature of government introduced forced Europe into this “unnatural and retrograde order.” So much for the natural order of things.

III.2: Of the discouragement of agriculture in the antient states of Europe after the fall of the Roman Empire

The order of development of Europe is so “inverted” that not only the order of development is backward, but also, agriculture rather than developed first, was first actually discouraged. How did it happen? By accident. The German and Scythians invaded the Roman Empire and the institutional setting changed.

The barbaric invasions caused the interruption of commerce between towns and country. The towns became deserted and the country uncultivated. Poverty prevailed. The new leaders acquired all available land so that no piece of land remained without owner.

Primogeniture and entails prevent the division of landed estates. Primogeniture is the law that gives the entire estate to the eldest heir, and nothing to the other members of the family. Entails is the law that prevents an estate from being divided as gifts or other means. Under the circumstances, it makes sense to put aside the natural law of succession, which is to divide an estate equally between all the children, given that land is the primary source of subsistence. Now land becomes a means of power and protection, given the continuous wars and the uncertainty. The tenants become subjects of the landlords, and the landlords their judges, their legislators in peace, and their leaders in wars. It makes sense to keep the land undivided to better defend it and its inhabitants by preventing the weakening of power through its division.

But to whom should the land go? Merit is questionable and can start disagreement. Gender and age are less questionable. And so primogeniture is introduced. In Smith’s time, Smith tells us, primogeniture persists even if all the land is perfectly secure and there is safety for all. This makes the law not just useless, but also unjust as it benefits one child at the expense of all others. Why is it still there? Not for economic reasons, since it is now inefficient. But because it supports the pride of family distinctions. Similarly, we still have entails, which were meant to preserve a lineal succession to protect the security of thousands from the caprice of one man, even if today the law provides security. Today it is absurd to continue following the will of someone who died 500 years ago, especially since these regulations are based on the “absurd supposition” that “not all generations of men have a right to the earth.” Yet, we still have it because it preserves exclusive privileges for the nobility—some military and civil honors require noble birth.

What makes primogeniture (and entails) inefficient in times of secured laws is that big proprietors are generally not great improvers. They are useful in times of disorder because they provide defense. As they provide defense, they do not have time to think about improvement. In times of order, they do have time, but they unwilling and unable to do it. If they have some capital, they use it to buy more land, not to improve the existing one. An improvement that generates profits requires attention to small savings and to small gains. But someone born to great fortune can rarely do it. He cares more about his ornaments than his profits, since ever since he was a child he was taught to care for elegance more than anything else. To improve, for him, means to embellish, even if it comes at an expense 10 times more than what it is worth. Evidence? Compare old big estates with small proprieties: you will immediately see how unfavorable to improvement large estates are.

Note that despite the criticisms of the landlords, Smith maintains that there is no natural difference between landlords and non-landlords. What makes a difference is just habit.

If we expect little improvement from landlords, we expect even less improvement from tenants. Tenants are basically slaves. They have no incentives to improve. Even if they belong to the land, not to the master, and can be sold with it, not separately from it, they cannot acquire property.

For Smith, slave labor is the most expensive kind of labor because if you cannot acquire property, you will eat as much as you can and work as little as you can. If they work a bit more than mere subsistence it is because that labor is “squeezed out of him by violence only”.

So why do we have slave labor if it is so expensive and ineffective? Because we love to domineer: we think it is humiliating to have to persuade those whom we consider our inferiors. So, whenever the laws allow it, we prefer slave to free labor. The North American Quakers freed their slaves only because they were few and the cultivation of corn did not generate enough revenue to support that expense. Only sugar and tobacco can afford slaves because the profits are so high.

Again, note how Smith mixes economic incentives with human passions, not necessarily rational ones, as we would define rational today. Note also how the argument about slave labor in sugar and tobacco production is also normative: for Smith slavery is both wrong and inefficient. Having slaves (unjust) is possible only because the high profits allow that expense (inefficient), as opposed to having those high profits in sugar and tobacco because of slave labor and the zero expense on wage.

Smith suggests that the Church of Rome claims the merits of the abolition of this form of slavery, but in reality it was not listened to. The engine for abolition of slavery is actually the landlords and the king who is jealous of the great lords. Probably these freed slaves take the form of the metayers. Metayers are still a sort of slave, but at least they can own property. Yet, they do not have any capital of their own so they need to use that of their landlord. They then divide their produce between them and the landlord, keeping half of the crops (medium from which meta means half in Latin). By being able to keep half of the produce they have incentive to produce more. But having to give half of the produce to the lord is a 50% tax, which gives farmers little incentive to use their own capital to improve.

Eventually, tenants start to pay rent, even if they still have to perform many services to the landlord and to the public. They need to provide for the king’s troops, giving them horses, carriages, and provisions in case of wars. The public taxes are also still oppressive and irregular. The taille is an example of it. It is a tax on the profit of the farmer, which gives the farmer incentive to lie, and to appear to have as little as possible, discouraging improvement.

So now there are longer term leases, but they are still too short for real improvement. Landlords offer these leases to protect tenants against heirs and purchasers, but these are meant to favor the landlords themselves. The length of the lease is still not enough to incentivize improvement. Smith lapidary states: avarice and injustice are always shortsighted.

It is only when farmers pay rent to the landlord, and their leases are long term leases, that they have incentive to use their own capital to cultivate the land and, thus, to improve it. Add the security of possession of the land that a change in law brings, so that the tenant is guaranteed possession. Add also that the leasee is able to own enough now to get to vote for a member of parliament, gaining the respect of the landlords. And now you have all the elements that allows England to grow to its grandeurs.

So, who are the best improvers? The farmers who improve the most are the owners of land. The tenant-farmers will improve their land more slowly than the owner-farmers because the tenant-farmers need to pay rent. Part of the capital farming generated cannot be reinvested because it needs to go toward rent payment. Generally, all the great capital used in farming comes from farming, which, ironically, is the slowest way to accumulate capital. Small owners are therefore the greatest improvers.

And why didn’t ancient Europe grow much? Because the ancient policies of Europe were unfavorable to improvement: they prohibited the exportation of corn, restrained inland commerce, and gave privileges to fairs and markets.

Smith is telling the story of the order of events that brought wealth to Europe. The first step was agricultural decline. The second “retrograde” step is the rise of cities and towns.

III.3: Of the rise and progress of cities and towns after the fall of the Roman Empire.

The barbaric invasions not only cause the country to become abandoned and the improvement of it to stop and actually be discouraged, but it also causes changes in the nature of cities.

Before the fall of Rome, landlords live in cities surrounded by walls for defense. With the fall of Rome, the landlords move into fortified castles on their estates. The towns are left to merchants and artisans, who are in servile conditions and poor. They have to travel around from fair to fair with their goods to make a living. They have to pay taxes as they travel over bridges, roads, and to fairs.

But, sometimes, the king gives them some special exemptions in exchange for an annual pool-tax to compensate for their protection. These traders are known as free-traders because of their exemption from some other taxes. These exemptions are personal. But eventually they became impersonal, meaning that all burghers receive these exemptions. Burghers also benefit from being able to collect their taxes themselves and pay them directly to the king, freeing themselves from the “insolence” of the king’s officers. They are jointly and severally answerable for the whole rent of the land of the town. This rent eventually becomes perpetual and fixed, and with it also the exemptions become permanent, and therefore impersonal. This is when the burghs become known as free-burghs.

Smith here candidly admits he is speculating: “I cannot produce evidence,” he tells us, on whether the freedom to marry, to succession, to dispose of possession at will come with the freedom of trade or later. Regardless, Smith believes, free-burghers are now free “in our current sense of freedom”.

Since the burghers pay taxes directly to the king, they need some compulsory jurisdiction. The towns are thus elected into corporations, with their own magistrates, their own town councils, and their own militia. This is for Smith extraordinary: it is unprecedented that sovereigns exchange the right to collect taxes for a certain rent. It creates independent republics in the heart of the sovereign’s dominions.

How is it possible? This is the key explanation for the freedom and therefore growth of some parts of Europe to levels never seen before. This is also an example of the power of Smith’s analysis: combining economic incentives with human passions, recognizing the tensions between different interests and analyzing their balancing or unbalancing.

Sovereigns need to protect their subjects from the oppression of great lords or will lose their authority. The burghers are unable to defend themselves individually, but if combined in large leagues of mutual defense they can. These are regular incentives. Then there are our passions. The lords hate the burghers because they are envious of their wealth. They looked down at the burghers, as no more than emancipated slaves. And yet, they are getting rich (more on how in a bit). How horrible! The burghers hate and fear, for good reasons, the lords. The king hates and fears the lords too, but has nothing against the burghers. So the king and the burghers have the lords as common enemies. And since enemy of my enemy is my friend, the king grants the burghers their own magistrates and their own ability to defend themselves, which means security and independence. And to signal he means it, he grants the burghers the right to collect his rent. The princes on worse terms with the barons are the ones who give the most to the burghers. Not a surprise, given Smith’s analysis.

The problem is that sometimes, that security and independence is so great that cities do become independent, as it happened in Italy between the 12th and the 16th century. In France and England, instead, the king maintains some power over the cities, but can’t arbitrarily ask for more taxes. To so do, he needs the consent of the cities. So cities now send representatives to parliament, just like the clergy and the barons. They generally side with the king, creating a counterbalancing power to the great lords.

These conflicts among different interests are thus resolved in such a way to create order, good government, liberty, and security for the cities. In the country there is still violence, and therefore poverty. But whenever one has the security of enjoying the fruits of one’s own labor, one will exert himself to better his conditions. And after having provided for basic needs, one strives for elegance.

With their order and good government, freedom and security, industry grows in cities first. Framers, still oppressed with servitude, if they have a little capital, hide it and then run away from the lords into towns. Towns would give them protection. In this way, both people and capital run into cities “the only sanctuary in which it could be secured to the person who acquitted it.”

So you see how Smith builds on his theory? What are the causes of the wealth of nations? Division of labor; accumulation of capital; order and good government, and security and freedom. We humans desire to better our conditions and our passions somehow do the rest. But our passions have to be channeled into the right institutional settings (order and good government, and security and freedom), or it will not work.

Back to our history of Europe. The natural order of things implies the development of agriculture (country), manufacture (town), and international trade, in this order. In reality this does not happen. Not in Europe at least. In Europe the country does not develop, but is abandoned instead. On the other hand, the towns develop first. How is that possible? Well, through the development of international trade first, and of manufacture later. A complete reverse of the natural order.

Cities must derive subsistence from the country. But it may not be from the country closest to it. If a city is near the sea, or navigable rivers, it can get subsistence from far away, from anywhere in the accessible world. So cities start to carry trade for others to get subsistence, growing in wealth and splendor by trading with many countries, even when there is poverty near them. The Italian cities are the first to grow to opulence though commerce. They do it thanks to their location and thanks to the crusades (again, an exogenous random shock, that is, an uncontrollable event). The great armies going through the country need transport and supply their provisions. Venice, Genoa, and Pisa are here to help! In exchange, they import expensive luxuries from richer countries to feed the vanity of their landlords.

Foreign commerce introduced a taste for finer and improved manufactures. With an argument similar to David Hume’s, Smith tells us that when we discover these finer products and we establish a taste for them, people start to produce these products at home to save on transport cost. And so manufactures develop, again in reverse order. First foreign commerce, then manufacture.

Note, though, Smith tells us, that there are two kinds of manufactures. A rude one and a refined one. The rude one is always present because it is what gives small tools and common things to common people. This is produced domestically and is meant for the domestic market of the common people. It is not that interesting for this story. The manufacture that is relevant here is the refined manufacture, the manufacture of luxury goods. These are the only goods worth exporting or importing, given transportation costs. These are generally referred to as manufacture for distance sale.

Manufacture for distance sale is introduced in two ways. One we just saw. It is what Smith calls the introduction by “violent operation of the stock of a particular merchant”. It is the offspring of foreign commerce. It is introduced as imitation of foreign manufacture, most commonly in places near water carriage.

The other way is a more “natural” way which grows out of the gradual improvement of some existing coarse manufacture inland. If there is abundance of provisions, provisions are cheap. They attract workers there as they can more easily feed their families. The cheap provisions and the higher demand, in their turn, facilitate the growth of manufacture on the spot, therefore saving transportation costs. Manufacture keeps improving, eventually reaching the same refinement as the manufacturers destined for more distant markets.

Rude produce and course manufacture cannot support transport costs, especially by land. But the more improved manufacture can. Even if small in bulk, refined manufacture is high in value and can stomach transportation costs. This kind of manufacture is the offspring of agriculture, as it should be, but it does not often happen.

III.iv: How the commerce of the towns contributed to the improvement of the country

The last step in Smith’s account of the “inverted” order that Europe experiences is the development of the country, which in theory was to be developed first, but in reality develops last. Rather than the country improving the towns, the towns improve the country. Towns improve the country in three ways, according to Smith.

One: as cities grow bigger, they became larger markets for the country, therefore encouraging the improvement of the country, even far away country.

Two: merchants, lured by the idyllic appeals of country living, want to become country gentlemen, so when they retire, they buy land and move to the countryside. They prove to be the best improvers. They end up improving the land, and do a good job with it, because they are accustomed to using money profitably. They are not like the actual country gentlemen who instead are accustomed just to spend the money on immediate consumption. They are bold undertakers, while old landlords tend to be timid instead.

Three: calling out Hume by name as the first and only to recognize this, Smith tells us that commerce brings order and good government and liberty and security to all individuals. Before the introduction of commerce, there was servile dependency and continual violence.

Here is the story of this transformation that Smith tells us.

When foreign commerce is little known, where refined manufacture is little known, there is only rustic hospitality because there is not much on which to spend one’s revenue. So a landlord has a multitude of retainers and dependents. They must obey him since they have nothing to give back for the food they received. Indeed ancient hospitality exceeds today’s notion of it. Just think that Westminster Hall was meant as a dining hall, and was not even big enough to accommodate all the guests! The lord’s tenants are fed in their own homes too, provided for from the “landlord’s bounty and good pleasure.”

The ancient barons have thus power over their tenants and retainers as they are their judges in times of peace and their leaders in times of war. The king is too weak to do either. He is not strong enough to be a buffer between the landlords and the people they keep in servitude.

It is a mistake, Smith says, to think that territorial jurisdictions originate from Feudal Law. The lords had those rights centuries before the law. The Feudal Law may be seen as an attempt to moderate, not to extend, the authority of the lords. But it does not work. The king remains incapable of restraining the “violence, rapine, and disorder” that the lords create in the country.

“All the violence of feudal institutions” could never do what “the silent and insensible operation of foreign commerce” do. And what does commerce do? Foreign commerce gives to the great proprietors something in exchange for their whole surplus of their land. So “for a pair of diamond buckles, or something as frivolous and useless, they exchanged the maintenance of thousands of men and the authority it would give them.” “To gratify the most childish, the meanest, and most sordid of all vanities, they bartered away their power and authority.”

In the past, great lords would directly maintain 1000 families who were necessarily at their command. Today, they directly maintain 20 at best, but indirectly they maintain many more by contributing to 1/10, or 1/100, 1/1000, or even 1/10.000 part of their annual maintenance. They contribute to the maintenance of them all, but they are all more or less independent of him because they can live without him. Each tradesman has, 1000 customers. He is obliged to all but not dependent upon any of them.

This passage echoes the section in Smith’s other work, The Theory of Moral Sentiments, in the only other place where he mentions the invisible hand. There, even if in a different context, Smith tells us that the luxury consumption of the rich feed many, distributing wealth from the hand of a few people to the mouths of many. Here too, the luxury consumption of the rich distributes not just wealth but also power, from the hand of the very few, generating freedom for all.

The reason why the landlords lose power and authority generating freedom for their dependents and tenants is the following. The landlord’s expenditures are too high to sustain. He can’t afford both diamond buckles and immense banquets. He can have either one or the other. So he dismisses his retainers and asks his tenants for higher rent. The tenants agree, conditioning to longer leases. Longer leases mean independence for them. So now, without dependents, because the tenants are independent and the retainers dismissed, the great proprietor is no longer able to interfere with the regular administration of justice and to disrupt the peace. He sells his birth rights “for trinkets and baubles”.

So now we have regular government and nobody has too much power to disturb it!

In commercial societies, it is rare to have very old families with large estates, despite laws trying to maintain them. They are common in non-commercial societies instead, despite having no law to support them. If one can only spend on others, one will not go bankrupt. Benevolence is seldom so intense to try to maintain more than one can afford. But if one can spend on his own person, one can and does go bankrupt, because our vanity is boundless. Laws going against human passions are not effective, as Smith will explain later.

Smith concludes with his moral of the story. Commerce brings about “a revolution in public happiness.” Yes, it is the word happiness that he uses. Remember after all when he described a growing economy? A society with positive economic growth is a happy society, a stationary economy is dull, and a declining one is miserable. Economic growth brings prosperity, freedom, security, order, good government, and, yes, happiness. But unintentionally. The people who cause this silent revolution do not care about the public and do not intend to bring about public happiness. It is because of the “childish vanity” of the great proprietors and the “peddler principle of turning a penny where there is a penny to be made” by the merchants and artificers that the feudal system crumbles. Neither group of people had “knowledge or foresight of that great revolution which the folly of one and the industry of the other brought about.”

And so in Europe the order of development, contrary to the natural course of things, sees the development of commerce and manufacture of the cities as the cause of the improvement of the country, not the effect. It may be slow and uncertain, but it is there.

North America seems to be the closest place to see a possible natural course. And there it is fast. The North American colonies are based on agriculture alone and their population seems to double every 25 years. In Europe, population doubles every 500 years. In Europe, the law of primogeniture slows growth down. Estates are too large. It is difficult to know how to improve them. Not enough land can go on the market, leading to monopoly prices. Buying land thus is the most unprofitable use of small capital. Yet it is done because of the security that the land gives once one retires. Buying land is good for old people, not for young and ambitious ones. If there was no primogeniture law, the growth of Great Britain would be closer to the colonies’ because so much more land would be available on the market.

Would the North American colonies grow so fast without “the protection of the genius of the British constitution” as Smith claims in Book I? He does not mentioned it here… What he does mention is that the laws of England favor agriculture, both in a way that is “altogether illusory” and in a way that is really effective. The illusory way, as he will explain in the next book, is the one based on bounties on corn, duties on foreign corn, and no importation of live cattle from Ireland. These laws establish a monopoly against their countrymen for the two most important products of land: bread and butcher’s meat. The effective way, as explained in this Book, is that the farmers of England are as secure, as independent, and as respectable as the law can make.

The very end of Book III is additional fuel for who claims that Smith has a preference for agriculture. The capital acquired by commerce, he claims, is not secured until it is used to improve the land. The wealth coming from agriculture is solid and durable, and can be destroyed only by events such as the barbaric invasions. Revolutions, wars, and governments can easily dry up the sources of wealth coming from commerce only. And a merchant, not being a citizen of any country, can easily move his capital to different places.

The history that Smith presents here is a strange economic history. Economic growth and development cannot be separated. They depend on some economic incentives, but not necessarily on the signaling of prices. Human passions, rational or not, is what drive that silent revolution of commerce which is more powerful than any laws or armies. It is our childish vanity as well as our charm for the countryside. It is clashing interests and their reciprocal jealousy. It is a strange history also because it is an impersonal unheroic history. It is a history told in almost the opposite way form David Hume. Hume, in his History of England, goes through king after king, war after war, name after name. Smith tells a nameless history. It is an anonymous history. Changes do not come from kings, do not come from specific acts of parliaments. Changes come from the actions of several anonymous individuals who have no intention or knowledge of the changes they are bringing about. The real revolutions are the slow, impersonal, and silent revolutions of commerce. This is why this Book is read as an historical account of Europe, but also as a continuation of Smith’s economic theory.

Further readings

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