The Directed Life

Date read: 2/27/2023

Wanted to read it because I felt like my Economics major would be meaningless without being able to say I read Wealth of Nations

Also because of Charlie Munger’s quote on becoming friends with Adam Smith

Taleb also cites Adam Smith in the Prologue of Fooled by Randomness as one of the few great Enlightenment / Post-Enlightenment thinkers

Notes come from the Capstone Reader Edition which excludes some repetitive chapters and keeps the most important passages / ideas from Smith.

Introduction by Tom Butler-Bowdon

Average person has to use labor instead of capital to sustain their life; however, through industry and frugality an individual can slowly become a capitalist by living off profits of a business or interest from investments rather than mainly off week-to-week and daily labor. (xxvi)

Only labor that results in something tangible can be considered productive—think difference between a manufacturer and a servant. (xxvii)

Smith shifted the notion of foreign trade from one party benefitting at the expense of another to something that both countries can mutually benefit from. (xxxiii)

Smith saw economics not as an exact science as how some may view it today, but rather a lens of what drives humans, chiefly emotions and the desire to improve their lives. (xxxviii-xxxix)

The Wealth of Nations

The division of labor increases the productivity of labor. (15)

The increase in productivity stems from specialization, saving time lost from task-switching, and the invention of machines / technological advancement. (18)

It is the great multiplication of the productions of all the different arts, in consequence with the division of labor, which occasions, in a well-governing society, that universal opulence which extends itself to the lowest ranks of the people … a general plenty diffuses itself through all the different ranks of society. (22)

The ability to exchange occasions the division of labor and incentivizes specialization in a craft. (28)

Our predisposition towards trade allows us to use our production surplus to purchase others’ surplus produce as “common stock.” (30)

• Our tendency towards barter drives the division of labor
• Labor is the primary form of value, but it’s hard to define so we use money (capital) instead as a holding place
  • Lincoln addresses the value of labor compared to capital several times, which is cited in Biography of a Writer

A commodity’s true value is equal to the quantity of labor that he would employ to purchase it. (48)

The 3 parts of price are rent, labor, and profit. (58-59)

The market price is effected by quantity produced and quantity demanded. (63-65)

There is many times a time delay between the price in the market and the commodity’s “natural price”— oftentimes implying an overvaluation that will soon be reset. (69)

Difference between a master and a workman—a workman is reliant on the master for resources and wages to employ his labor. However,

It sometimes happens, indeed, that a single independent workman has stock sufficient both to purchase the materials of his work, and to maintain himself till it be completed. He is both master and workman, and enjoys the whole produce of his own labour, or the whole value which it adds to the materials upon which it is bestowed. It includes what are usually two distinct revenues, belonging to two distinct persons, the profits of the stock, and the wages of labour. (76)

On national wealth:

The increase of revenue and stock is the increase of national wealth. (81)

From pleasure to necessity:

Hunting and fishing, the most important employments of mankind in the rude state of society, become, in its advanced state, their most agreeable amusements, and they pursue for pleasure what they once followed from necessity. (93)

Probability of success and power laws:

Fifthly, the wages of labour in different employments vary according to the probability or improbability of success in them … In a perfectly fair lottery, those who draw the prizes ought to gain all that is lost by those who draw the blanks. In a profession, where twenty fail for one that succeeds, that one ought to gain all that should have been gained by the unsuccessful twenty. (99-100)

Our bias to revere our own abilities and luck:

The chance of gain is by every-man more or less over-valued, and the chance of loss is by most men under-valued, and by scarce any man, who is in tolerable health and spirits, valued more than it is worth. (102)

Young people often ignore risk and focus on the prospect of success when they try to pick a profession—a prime subset of people as example of the idea that we undervalue risk and overvalue our own talents and luck. (104)

The rate at which someone’s business is profiting typically varies with the certainty and uncertainty of returns; the level of risk associated with the business also affects the rate of profit. The example Smith uses is foreign trade to North America vs. foreign trade to Jamaica. (105)

Fixed capital vs circulating capital: fixed capital involves increase of the asset size as opposed to its sale. Circulating capital is when profit comes from the sale that allows purchasing power (more capital, fixed or circulating). (117-118)

You can profit by viewing yourself as your personal hoard of fixed capital, using education and skill development to increase your value. Smith on this idea:

The acquisition of such talents, by the maintenance of the acquirer during his education, study, or apprenticeship, always costs a real expense, which is a capital fixed and realized, as it were, in his person … The improved dexterity of a workman may be considered in the same light as a machine or instrument of trade which facilitates and abridges labour, and which, though it costs a certain expense, repays that expense with a profit. (120-121)

Men employ stock either in “present enjoyment or future profit.” The profit is realized either by “staying with him, or by going from him.” If you aren’t employing your capital either for present enjoyment, as fixed capital or circulating capital, Smith deems you “must be perfectly crazy.” (124)

There’s productive labor and unproductive labor. Productive labor adds some sort of tangible value to a realized product, whereas unproductive labor leads to no added value creation (think of a servant). (133)

Relationship between capital and revenue: (143)

The proportion between capital and revenue, therefore, seems everywhere to regulate the proportion between industry and idleness. Wherever capital predominates, industry prevails; wherever revenue, idleness.

As the capital of an individual can be increased only by what he saves from his annual revenue or his annual gains, so the capital of a society, which is the same with that of all the individuals who compose it, can be increased with only the same manner.

Smith compares a frugal man to a prodigal man. A frugal man saves his surplus and slowly accumulates capital which allows him to employ more labor on his behalf; a prodigal man does not confine “his expense within his income” he has no surplus of capital which renders him unable to employ labor and produce extra value. (144-145)

Going back to the 3 types of ways to employ your capital, Smith explains the difference in motive between employing capital for present enjoyment vs. accumulating fixed or circulating capital:

With regard to profusion, the principle which prompts to expense is the passion for present enjoyment; which, though sometimes violent and very difficult to be restrained, is in general only momentary and occasional. But the principle which prompts to save, is the desire of bettering our condition … An augmentation of fortune is the means by which the greater part of men propose and wish to better their condition. (148-149)

You always have the choice between immediate consumption or capital accumulation—either spending for today and saving for tomorrow. (150)

Merchants use their money for projects that incur more profits; “country gentleman” uses his money for expenses. Smith on the difference between the two archetypes:

The habits, besides, of order, economy, and attention, to which mercantile business naturally forms a merchant, render him much fitter to execute, with profits and success, any project of improvement. (199)

On the relationship to capital and industry:

Every individual is continually exerting himself to find out the most advantageous employment for whatever capital he can command. It is his own advantage, indeed, and not that of the society, which he has in view. But the study of his own advantage naturally, or rather necessarily, leads him to prefer that employment which is most advantageous to the society. (236-237)

• My own idea connected to this quote: interesting that now the avenues of employment for capital aren’t necessarily the ones that are most advantageous for society. This is true in venture capital where employing money can build the next big company and the country’s wealth grows as an extension from it, but not true in other forms of investing or finance where people are making money at the expense of others, large fees and incentives for selling certain assets that may turn out to be worthless, etc.— Naval , Nassim Taleb, Peter Thiel’s Zero to One, The Power Law

Smith’s invisible hand: we inadvertently pursue the best interest of society when we pursue our own best interest. (240)

It’s always better that individuals make their own choices in how to employ their money instead of having government or law do it for them. (240)

Expanding on the infringements of government:

To promote a great people, however, from making all they can of every part of their own produce, or from employing their stock and industry, in the way that they judge most advantageous to themselves, is a manifest violation of the most sacred rights of mankind. (261)

Smith is very anti-regulation, but concedes in the example of the East Indies trade that monopolies are able to form in this view of markets, with this interesting quote:

Monopoly of one kind or another, indeed, seems to be the sole engine of the mercantile system. (286)

The establishment of the free market / natural liberty system:

All systems, either of preference or of restraint, therefore, being thus completely taken away, the obvious and simple system of natural liberty establishes itself of its own accord. Every man, as long as he does not violate the laws of justice, is left perfectly free to pursue his own interest his own way, and to bring both his industry and capital into competition with those of any other man, or order of men. (297)

The responsibilities of government: (298)

• protecting from invasion from other countries
• protecting its members from injustice and violence from other members
• maintaining public institutions of which would not be profitable in the private sector