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Book 4, Introduction
Themes
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
Eighteenth-century Europeans think of wealth in terms of money, but other peoples use different measures (like cattle), depending on their economic systems. Some thinkers, like philosopher John Locke, view money as the best form of wealth because it is the least likely to be frivolously consumed. Others argue that, while a nation’s real wealth depends on its people’s access to consumable goods and not its money supply, paying for foreign trade and wars still requires money. As a result of these theories, European countries have focused on accumulating gold and silver.
As Smith explains here, mercantilism’s essential mistake is that it confuses money with wealth. Not only do different societies use different kind of currencies, but economic activity depends on the way that currency circulates, and not merely how much of it there is sitting around. Just as the world’s wealthiest people aren’t carrying around stacks of cash today—they invest their wealth or store it in the bank instead—the wealthiest nations aren’t necessarily the ones with the most silver and gold in the treasury. Smith’s purpose in Book IV is to offer a better, more accurate way to measure nations’ wealth and explain its policy implications.
Themes
When European countries started prohibiting gold and silver exports, merchants protested. They focused on the balance of trade, arguing that a nation can obtain more gold and silver by exporting more than it imports. (Indeed, gold and silver bans were often responses to an unfavorable balance of trade, or exportation that exceeded importation.) These bans also dramatically raised the price of imports by forcing merchants to rely on smugglers. But while merchants argued that these high prices sent even more gold and silver overseas in a vicious cycle, in reality, these high prices should lead people to reduce imports and restore the balance of trade. Still, the merchants prevailed in France, Holland, and England, where they convinced their parliaments to allow gold and silver exportation. But true wealth comes from domestic investment and trade, not foreign trade.
To understand mercantilism’s appeal, readers must understand that merchants used gold and silver, not national currency, to pay for imports and exports in the 18th century. Mercantilist policymakers banned gold and silver exports because that would prevent their nations from depleting their stocks of accumulated gold and silver. The merchants’ response also conformed to mercantilist logic, as it still defined its goals in terms of improving the balance of trade. But beneath this, it was really self-interested: their profits came from exporting gold and silver in exchange for imported goods. Regardless, the merchants and government were debating over something that scarcely mattered, because the balance of trade simply doesn’t determine nations’ wealth.
Themes
Countries will naturally import gold and silver to meet their economic needs, like with any other commodity. This happens very quickly, as gold and silver are very lightweight for their price. For instance, 50 tons of gold is worth the same as a million tons of grain. Due to the ease of transport, government policy cannot stop the international gold and silver trade, and gold and silver prices change gradually over time, while other commodities’ prices fluctuate wildly. Yet a country facing gold and silver shortages can easily turn to barter, credit, and paper money. Merchants frequently complain about money shortages, but this is often because they overextend their businesses and run out of credit.
Gold and silver’s use as money does make them unique in some ways—for instance, importing them only changes nominal prices, not real ones, and they can be replaced at near-zero cost with paper currency. But in general, they still obey the same supply and demand rules as any other commodity, which means that restrictions on them will only make the market less efficient. Once again, Smith warns his readers against taking merchants’ political messaging at face value. They shouldn’t have access to unlimited credit; rather, as Smith explained in his chapter on paper money, banks should limit their credit to a responsible level.
Themes
The value of a nation’s gold and silver money is part of its national wealth, but generally only a small part. Rather, money’s primary contribution is its usefulness as a medium of exchange. Because it is durable, people can accumulate a lot of it—but it’s a waste to have any more than is needed to circulate in the economy. Hoarding gold and silver is no more rational than hoarding unused pots and pans. Foreign wars do not even truly require gold and silver, as countries can provision their armies directly, or export rude produce or manufactures instead of gold and silver.
As Smith noted earlier, money is just one small part of society’s circulating capital. Accumulating too much of it amounts to preventing a portion of it from circulating, which actually harms economic activity. Indeed, while modern paper currency costs next to nothing to produce, the cost to mint gold and silver coins is the same as those coins’ value (minus any seigniorage). In other words, the British government can freely print £100 today, without foregoing investment in anything else. But in Smith’s era, minting £100 in coins actually meant spending £100 in capital—which then couldn’t be invested in anything else. This is why, the more capital a nation keeps in the form of excess currency, the less it can actually invest in growing its economy.
Themes
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A society’s gold and silver are usually divided between money in circulation, privately owned gold- and silver-plated art objects, and money in the treasury. But by the 18th century, none of these sources is sufficient to fund foreign wars. For instance, Britain funds its wars through commodity exports. Internationally, gold and silver also circulate in the form of bullion. The best kind of commodities to export are fine manufactures, which are more valuable by weight, and which often flourish during wartime. Exporting rude produce would never be profitable enough to fund a foreign war, which is why such wars seldom lasted long before the modern age. (Usually, monarchs funded them personally by accumulating and spending treasure.)
Mercantilists frequently argued that war required gold and silver, which were the only way to make large international payments. But as Smith points out here, this argument still confuses money with the real basis of economic activity: the goods and services that money buys. Any revenue-generating activity can fund a war economy; gold and silver exports were an attractive option only because they are cheaper to transport (in relation to their value) than almost anything else.
Themes
Foreign trade’s main benefit is that it advances the division of labor by replacing a nation’s surplus—the produce for which it doesn’t have demand—with products it actually needs. Both participating nations benefit, and merchants benefit most of all. Indeed, Europe has grown rich by colonizing America not because its gold and silver imports affected the real price of goods, but because the colonies served as a new source of goods and market for European manufactures. Free trade with wealthier Asian countries would enable Europe to grow even more, but the monopolies granted to East India Companies have prevented this trade from ever truly becoming free. Europe’s massive silver exports to Asia have virtually no economic effect.
Smith presents his thesis on international trade. Namely, free trade is a way of expanding the market, which creates better conditions for producers and consumers alike. Like the rest of his economic theory, this thesis stems from the basic principle of the division of labor. Different countries can specialize in exporting whatever they produce best, while importing what others produce best. This is just like how different people specialize in different jobs, then meet their needs through trade. And the division between the city and the countryside shows how this same process can take hold within a country. There’s no reason not to extend it to the whole global economy. Indeed, Smith views free trade as massively beneficial to all the regions that join in it, even if some fall into an unfavorable balance of trade or temporarily suffer under colonialism.
Themes
In summary, the mercantile system wrongly sees gold and silver as the measure of wealth, and it tries to build a nation’s wealth by modifying the balance of trade. It uses six kinds of policies, two to restrict imports and four to grow exports. The import policies restrict goods that compete with domestic production and goods from countries with which the home country has an unfavorable balance of trade. The pro-export policies are drawbacks (tax rebates) for exporters, bounties (incentives) for key industries, trade treaties with other countries, and colonization (which generally includes a monopoly on trade between a European country and its colonies). The next several chapters will address these policies one by one.
Smith has already explained why the mercantile system misunderstands the nature of wealth, then shown why free trade and the division of labor offer the surest path to economic growth. Now, in the rest of Book IV, he will explain why each and every one of the mercantilists’ specific policy proposals is misguided. This may seem excessive, but modern readers must remember that mercantilist policies were the norm throughout Europe in the 18th century. Smith’s ultimate goal was to reshape how scholars and statesmen would think about economic governance questions—and there is no doubt that he succeeded.
Themes
