Book SummaryThe Wealth of Nations, by Adam Smith

1-Page Summary1-Page Book Summary of The Wealth of Nations

Many economists consider Adam Smith's The Wealth of Nations one of the major foundational texts of their discipline. Writing in 1776, Smith argues that free markets are the best institution for cultivating a nation's wealth. Free markets harness the power of rational self-interest to incentivize the production of useful goods while efficiently distributing surplus wealth. Because of this, Smith makes a case against heavy-handed market regulations that interfere with the natural wealth-generating processes of uninhibited markets.

Adam Smith was a philosopher who lived in 18th-century Scotland. At the time, the field of economics existed primarily as a hobby for philosophers in other disciplines. Smith's theories helped lay the groundwork for the development of...

The Wealth of Nations Summary Part 1: How Nations Produce Wealth

Smith states that a nation's wealth is determined by the ratio of what it produces to what it consumes. Wealthy nations are able to satisfy all their citizens' needs, either by producing the goods those citizens consume or by producing goods for export to other countries that can be exchanged for goods that are consumed at home. On the other hand, poor nations are unable to satisfy the needs of their citizens, either because they don’t produce enough goods directly to meet their citizens’ consumption needs or because they don’t export enough to other countries to receive sufficient goods for home consumption in exchange.

Throughout his book, Smith argues that the individual pursuit of self-interest maximizes a nation's capacity to produce wealth. In this section, we’ll define this concept, explain how it encourages the specialization of labor, and how this leads to greater prosperity in a large, market-based system.

How Self-Interest Promotes Wealth Production

Smith states that workers produce the goods that increase a nation's wealth out of a desire for personal gain. Because they can make the most money for themselves by creating things that others want...

The Wealth of Nations Summary Part 2: How Markets Exchange Wealth

In a capitalist society, everyone's a merchant. Smith contends that you cannot meet your needs without purchasing goods produced by others. Therefore, everyone must exchange value for value, wealth for wealth. Workers sell their labor in exchange for wages just as merchants sell goods in exchange for profits. But what are we really exchanging, and how do we do so? In this section, we will cover Smith's theories on what markets exchange and how they’re able to facilitate this exchange.

What Do Markets Exchange?

Markets exchange the value of labor. Smith explains that the value of every good is derived from the work people put into producing it. For example, when you buy a block of cheese at a grocery store, you are paying for the work of the farmers who raised and milked the cows, the farmers who raised feed for the cows, the dairy processors who turned the milk into cheese, the truck drivers who shipped the cheese to your grocery store, the store clerks who keep the shop open, the workers in the energy sector providing electricity for every step of the process, and so on.

Therefore, when you trade your labor for wages and then spend those wages on goods, you’re...

The Wealth of Nations Summary Part 3: How Markets Regulate Themselves

Smith argues that free markets are the most efficient way of directing the production and exchange of goods to grow a nation’s wealth (and thereby enable the specialization of labor). To understand how markets are able to do this, we'll first take a look at two sides of a mutually reinforcing system: how market conditions influence the price of goods, and how prices regulate market behavior. Then we'll take a look at the forces behind the scenes that determine the natural prices of goods in a balanced and competitive market.

How Markets Regulate Price

The ratio between supply and demand regulates the price of any good. The supply is the amount of a good sellers are bringing to market. The demand is the amount of a good customers want to buy.

Smith explains that if demand is higher than supply, the customers will have to compete with each other. They will compete by offering more money for the same good than the next customer, thus driving up the price. However, if supply outweighs demand, then the sellers will have to compete with each other by lowering prices.

The Role of Market Competition

For the supply and demand system to work, sellers must...

The Wealth of Nations Summary Part 4: The Natural Price of Goods

When supply and demand are in equilibrium, goods will be sold for their natural price. Smith explains that the natural price is the cost of bringing a good to market: It includes the costs of production along with the typical profit margins for each step of the process. The natural price is like the center of gravity around which the market prices fluctuate. If a customer gets a "good" or "bad" deal on a purchase, it is a good or bad deal in relation to the natural price.

Smith argues that the natural price of a good is determined by the costs of its production. A business can only continue bringing goods to market if it’s able to sell them for more than their cost of production. Otherwise, they’ll simply go bankrupt. Therefore, the natural price of a good will change in accordance with changes in any of the costs of production. Smith identifies three main costs that determine a good's natural price: wages, rent, and capital.

Cost #1: Wages and Labor Markets

The price of any good includes the wages of the workers who produced it. Businesses must pay their workers, who are also pursuing their own self-interest and therefore wouldn't work for free. Thus,...

The Wealth of Nations Summary Part 5: How Capital Grows a Nation's Wealth

Lending capital for profit plays an essential role in growing the wealth of nations. Smith identifies two main reasons: First, the self-interest of the lender encourages them to invest in productive labor. Second, the self-interest of the lender also guides them to invest in less-developed portions of the economy and help them develop.

Reason #1: Capital Naturally Seeks Productive Labor

Smith first contends that capital naturally seeks productive labor: labor that can generate surplus goods. Surplus goods add to a nation's overall wealth because they enter a nation's overall supply of circulating capital. For example, a brickmaker creates bricks all day for a construction project. They make more bricks than the project needs, and the excess bricks are sold to another construction project. The brickmaker increases the national supply of circulating capital, thereby growing the economy.

Smith suggests that when capital lenders are free to pursue their self-interest, they’ll naturally direct their wealth towards productive labor—which strengthens the nation’s economy and produces national wealth. This is because work that generates surplus goods can create greater...

The Wealth of Nations Summary Part 6: The Effects of Trying to Regulate Markets

Recall that the development of a nation's wealth depends on competitive markets in which participants are free to act in their own self-interest. Throughout The Wealth of Nations, Smith identifies government policies—often intended to grow a nation's wealth—that actually interfere with this process and slow down economic growth. In this section, we’ll explore two market-distorting policies that Smith critiques: restricting international trade and subsidizing industries.

Harmful Government Policy #1: Restrictions on International Trade

Many governments try to grow their nation's wealth by preventing the import of foreign goods that would out-compete domestic manufacturers. Either the country bans importing foreign goods completely (an embargo), or it imposes high taxes on the foreign goods to prevent them from being competitive in domestic markets (tariffs).

For example, let's say it's cheaper to produce cheese in Canada than in the US. This will allow Canadian cheese producers to offer lower prices than American cheese producers. If the US allows Canadian dairy farmers to export their cheese to the US, American customers will start buying Canadian cheese instead of...

The Wealth of Nations Summary Part 7: The Proper Role of Public Spending

In general, Smith opposes taxation and public spending. This is because taxation takes capital out of the hands of the private investors who would naturally invest it in the most profitable industries.

Therefore, Smith recommends that governments should collect taxes and spend public money only if it's on something that’s important for society as a whole and can’t be handled better by the free market. Smith contends that only four expenditures meet these criteria: defense, justice, education, and infrastructure.

(Shortform note: Smith does not include welfare for the poor among the important functions of government spending. However, it’s important to consider the structure of welfare systems in Smith's time. Welfare for the poor existed throughout 18th-century Britain, but as a responsibility of the church, not the state. Christian churches had cared for the poor in Europe since medieval times, but with an inconsistent, patchwork system. Queen Elizabeth I [standardized church welfare systems throughout the UK with the "Poor Laws'' of...

The Wealth of Nations Summary Part 8: How Governments Raise Revenue

Before governments can spend money on defense, justice, education, or transportation infrastructure, the money needs to come from somewhere. Smith identifies two principal sources of revenue: taxation and borrowing.

Revenue Source #1: Taxation

Smith views taxes largely as a necessary evil. He remarks that all taxation takes value out of the hands of private investors, whose self-interest encourages them to invest it in the industries that contribute most effectively to national growth. However, he recognizes that it may be impossible to fund important public works without taxes. Therefore, much of his discussion of tax policy is directed toward finding the least disruptive system of taxation.

To explore Smith's ideas on taxation, we'll first look at his general principles for how taxes ought to be collected and assessed. Then we'll examine specific forms of taxation and discuss Smith's analysis of how well they measure up to his guidelines.

Guidelines For Taxation

Smith outlines four guidelines for ethical taxation. These aren’t exact tax policies but rather ideals to guide legislators in deciding policy.

1. **Taxation is proportionate to income....

Shortform Exercise: Consider the Ideas of The Wealth of Nations

This exercise will give you a chance to reflect on Smith's main ideas and develop your own economic thinking.

Smith argues that people specialize their labor out of self-interest. If you had to choose between two jobs—one where you completed a repetitive task over and over but made lots of money, or one where you frequently switched between tasks but made less money—which one would you choose and why?