As promised, here is the second part of The Wealth of Nations, one of the most influential books ever written about economics. If you haven't read the first part yet I'd advise you to do that now, as some of the takeaways here build on those from the previous part Let's continue where we left last time ...
TAKEAWAY NUMBER 06 : ACCUMULATION AND EMPLOYMENT OF CAPITAL
What's the similarity between Michael and a country like the US, China or Sweden? It is that they get wealthy in the same way. Allow me to introduce Healthy Mind - Think Big's "Stairway to Money" All copyrighted and original content, of course Each different step represents a category that an individual can spend money on To become wealthy a person wants to spend money on the higher steps and not the lower ones At the bottom, we have services meant for consumption. These are the worst things that you can spend your money on, as you'll consume them instantly Vacations, dinners and video on demand all belong to this category. The next worst thing to direct your money towards is products meant for consumption. Products depreciating value from the time of purchase, but at least they're not as bad as services because you will still be able to sell them at a later stage, even though it may only be at a fraction of their original value Cars, clothes and phones belong to this category. Then we have products that do not depreciate in value and that often keep their value through inflation Important entries in this category are collectibles and a house to live in And at the top, we have investments This is a very broad category indeed, and anything which is expected to generate more cash in the future than the outlay of money is today, plus a reasonable return, belongs here Therefore - starting a business, educating yourself, investing in the stock market, or renting out properties all belong here It's the same with countries If a country buys services from another country, money flows right out from it without being replaced with something else that is valuable If a country buys products from another country, at least some of the value is still preserved as products can be sold again at a later stage. It is similar with a third step in our Stairway to Money A country gets rich by increasing its own productivity by starting businesses there, by educating its people so that their skill and dexterity increases, or by buying productive assets from other countries BUT ... ... and this is unimportant but Neither people nor nations should be afraid of having expenses just because of this Both people and nations, if they want to acquire wealth, should focus on what they are naturally good at and then outsource the rest. This is what we shall focus on next.
TAKEAWAY NUMBER 07 : GLOBALIZATION - THE SHORTCUT TO INCREASED WEALTH
Here we have. Michael Lewis, a 32 years old engineer. He's working at a job where he's paid a base monthly salary, but he's also compensated for overtime. For overtime hours, he nets approximately $30 per hour Given this, here comes a few questions for you: Should michael cook his own food? Should michael clean his own house? And, sorry now i'm getting a bit silly just to prove a point here, should michael build his own phone instead of buying one from apple? From a wealth standpoint the answer is no to all of these questions. It makes sense for Michael to do what he is best at, earning money from that and then hire other people to do what they are best at for everything else that he demands. Perhaps Michael can cook his own food, but it takes him about an hour to prep a single meal, which means that he does so at a cost of $30, because he could have spent that time working as an engineer. Therefore, it doesn't make sense for him to do it as he can just buy a meal outside for $15 Similarly, he can clean his own house, but it takes him 2 hours to do So that's $60 for Michael, while he can hire someone to do it for $40 And as an engineer, he is capable of building his own phone, but it might take him something like 200 hours plus $200 in materials That's a $6,200 phone! Why not just go buy the latest IPhone for $1,000? If it doesn't make sense to do something at 6 times the price it doesn't make sense to do so at 2 times the price, and probably not at 1.5 times the price either. It is the same with nations For nations to increase their wealth, they should be focusing on the things that they are really good at, and then hire other nations to do what they are best at For example .. The US is obviously a leader in many different businesses, but among others, in the fast food and entertainment industry. China is incredible at producing most products at very low prices And in Sweden, we are quite good at producing furniture ... ... sorry, I mean at making everyone else produce furniture for themselves, of course Now, should Sweden try to produce the same products that China can produce much cheaper? No. Should China compete head-to-head with Hollywood? Probably not. Should the US have everyone produce furniture for themselves? Definitely not! All these countries can be more productive, and in that increase their wealth, by simply doing what they are best at, and then trade goods with each other Also, to make another comparison between individuals and countries in their quest for wealth: Both of them will earn more by having rich neighbors or acquaintances People know that if they want to be rich, they should move where other people are rich And probably even more importantly - they should acquire rich friends It's the same with nations. A country should want their neighbors and trading partners to be wealthy, because eventually that wealth will spill over to them, too Just look at this map. But we've been getting this backwards for centuries now In the 18th century, Great Britain and France, probably the two wealthiest countries in Europe at that time, did everything they could to make business miserable for each other instead of cooperating. They even went to war with each other! Today, let's hope that the two most important economies of our time, the US and China, don't make that same mistake.
TAKEAWAY NUMBER 08 : WHY FREE TRADE IS SUPERIOR, AND WHY GOVERNMENTS SHOULDN'T INTERFERE
As we talked about in the previous blog - in a capitalistic society, money will naturally flow where the returns are higher and disappear from where their returns are lower. In a society where the government does not interfere, two rules will guide capital
- Capital is naturally employed where it can produce the greatest returns: This is actually a good thing, because businesses like these are more sustainable than anything else They will employ people where there is demand and a real competitive advantage.
- Capital is also naturally employed in the home market, as this comes with less risk: This is also good, because it creates working opportunities in the own country.
For these two reasons, it is totally unproductive when governments interfere with the market Just as an imaginary example: Say that we, in Sweden, would do something as silly as setting up a ban on movies created in Hollywood. What would happen when such a ban is introduced? Excluding potential retaliation, it will yield higher profits for the film industry in Sweden than what would naturally be the case. Therefore, more capital will be incentivized to flow to this industry But this business still isn't competitive on a global scale. Everywhere else than in Sweden, people will still watch movies from Hollywood! Moreover - the capital in Sweden which goes towards the creation of film is capital that could have been directed towards something where Sweden is competitive on a global scale, like the previously mentioned furniture. Generally, politicians must have a small dose of God Complex if they think that they are smarter than the aggregated thinking of the market when it comes to capital allocation decisions in businesses. There are two examples when it might be necessary to introduce duties, bans and tariffs though:
- For goods that are important for the defense or survival of the country
- And when a tax is imposed even on such domestically produced goods
You don't want to shift the favor to the foreign goods, at the very least Apart from that, governments should probably stay away from using duties, bans and tariffs on foreign goods. They should not incentivize certain industries or disincentivize others, because the market is likely to do this very well on its own, thanks to the before mention two There are a few areas where a government is absolutely necessary for the wealth of a nation though, and that is what we shall cover in the next takeaway.
TAKEAWAY NUMBER 09 : WHAT IS THE PURPOSE OF A GOVERMENT?
According to Adam Smith, there are some tasks in a society that the market and private people have little or no interest in solving. The four that Smith discusses are:
- The defense of a country
- The justice system
- Some type of infrastructure
- Basic education.
The defense of a country is absolutely necessary for its wealth to increase. Interestingly enough, a country is more and more likely to be invaded the richer it is Or so it was in the old days at least .. Consider the raids of Genghis Khan and his Mongolian savages of the much wealthiest cities of China Or how the vikings invaded many much more established societies in Europe. The savages actually had the advantage at this time, as they were much more skilled fighters. But that all changed with the invention of the firearms. Firearms were expensive to make, and no matter how skilled an army of spears and bows were, it couldn't beat one equipped with firearms And so, the odds changed in the favor of the wealthy nations, who could afford these supreme weapons Anyways ... A nation must be able to defend itself to sustain its wealth And as this benefits everyone in a society, it does make sense that a government has the responsibility of this task Justice, is similarly an expense that benefits everyone in a society In the old days, justice was often exercised by those in power, but one can easily understand how such a system can be very corrupt It is essential that justice and power are separated. Otherwise - who should bring justice to those in command? Similarly, a justice system that is based on profits tend to be very corrupt too, so it doesn't lend itself well to the free markets It used to be like this too, everyone that wanted justice had to bring a gift to the judges As you can probably imagine, the person who brought the greatest gift tended to get a little bit more "justice" than everyone else ... So to speak. Therefore, the task of bringing justice to its people should be paid for by a government But those that use the justice system often should probably pay extra for that Infrastructure, such as the most important roads and docks used for commerce of a country, is something that benefits everyone too But it doesn't invite the same conflict of interest as the justice system does, and should thereby often be held privately Infrastructure should be financed with revenue from the commerce which can be carried by means of it. Because in this way, money will much more seldom be wasted on infrastructure projects Some infrastructure projects can be important without being profitable, but in that case they should often come with a local tax, not a national one. Without some type of basic education being free and probably also mandatory, some of the country's inhabitants, those that are born into poverty, will most likely never learn how to read write or count. Such inhabitants are unlikely to increase the productivity of a nation. Therefore, we want to avoid that this happens A benefit such as learning to read, write and count benefits everyone and it should be one of the purposes of the government of making sure that this is done.
TAKEAWAY NUMBER 10 : HOW SHOULD A GOVERMENT BE FINANCED?
So .. with defense, justice, infrastructure and education, a publicly financed government seems to be the most fair and logical solution But there are many different options of financing something, and some are definitely better than others.
Here are 4 principles for creating good taxes:
Equality : Each person should contribute in proportion to his or her abilities and in proportion to the revenue which he earns under the protection of the state. It is difficult to make sure that the wages, profits and rents (the three sources of income which we discussed in the previous blog post) are all taxed equally, but they should at the very least be taxed equally individually.
Certainty: Time, quantity and manner of payment must always be clear. This is probably the most important principle. A little bit of uncertainty is worse than a great deal of inequality. Uncertainty leads to the potential corruption of the tax gatherer.
Convenience: Taxes should be due when the contributor is most likely to be able to pay. The consumer pays whenever he consumes a service or product, and the wage earner should pay taxes as soon as he gets the wage, not at some other time when he might already have spent it all.
Efficiency: A tax may never be more burdensome to the people than it is beneficial to the government For instance ...
- As few people as possible should be required for gathering the tax
- A tax should never discourage industry
- And the degree of visits and examinations of the people shouldn't make them feel oppressed
With these 4 principles in mind, i'd like to ask you a question: Do you think that it is a good idea for a country to have a wealth tax? In other words, a tax which is in proportion to the total assets of private people. Please comment with your answer down below! Alright, that's it for Adam Smith's Wealth of Nations. Cheers guys!