4. Smith is often seen as a founder of capitalism. What is ‘capital’ and why should it have such a central role as to be used in the name of the system?
Smith introduces the idea of capital in Book 1 chapter 4. The idea of trade had been discussed, but proves to be inefficient if there is no demand for your product. Capital is important because it is universal and allows for universal exchange between goods. This led to the exchange of items like shells and metals, and the system of capitalism we use today. The term capitalism includes the word “capital” because it is essential for the system to work. Everything about capitalism (paying wages, increasing productivity, satisfying demand) all revolves around this exchange of capital. While everyone may have more than others, the usage of capital to obtain what one desires is universal.
In addition to that, I would argue that Smith employs the notion of capital as a necessary foundation for any sort of productivity. In this sense, capital would consist of any kind of resources, including money, land, equipment, materials, and other assets, that could be used to generate value. This newly created wealth could then be divided up, with some being saved up to replace and add to the previously spent capital stock, and the remaining revenue being the profit gained. This would be the fundamental method for the accumulation of capital in Smith’s eyes (and indeed remains so for modern firms in a capitalist society), where capital, combined with labor, is used to create wealth, some of which is saved and reinvested to increase the stock of capital, leading to even greater production, and so on as the cycle repeats itself but increasing in scale in an exponential manner. This then explains the workings behind the principle where the “increase or diminution of the capital of a country consequently increases or diminishes its annual produce” (367), as the two variables are directly related to each other. It must be also noted that a rational individual would only choose to spend capital and engage in such economic activity if “he expects it to be replaced to him with a profit.” (362) In other words, if one believes that he would end up with less total capital than he began with (i.e. making a loss), he would not engage in the said economic activity.
ReplyDeleteThe way that capital accumulates is also the reason why the act of saving is highly regarded by Smith, since “capitals are increased by parsimony or saving.” (368) By being frugal and saving up one’s income, one would be able to build up his capital stock over time, which would be used to generate more production and more income. On the other hand, if one is prodigal with his money, the income earned would be redirected toward spending on things instead of contributing to the capital stock, thereby diminishing the capital stock over time, making him less and less productive. The importance of saving in this manner is therefore still very relevant in today’s economy for firms and individuals looking to grow their capital.
Contextualizing the reason to understand capital as productive use of wealth, we may note that Smith wrote at a time when European nations garnered significant wealth from their colonies in the 16th - 18th centuries. While the Spanish and Portuguese acquired larger amounts of gold through their colonial expansion, the British and French still emerged wealthier because they put their capital to more productive use. Gold used for consumption will deplete over time, but gold used to invest in manufacturing and other activities that produce valuable outputs will create a growth of capital. This allows a sustainability and expansion of wealth, and relies on the ability to maximize output from a finite input.
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