tends to increase or diminish the real quantity of industry, the number of productive hands.' 1

Here he not only confuses the proportion which the first part of produce bears to the second with its absolute magnitude, but identifies that part of the annual produce 'which is destined for replacing a capital' with the capital itself. He thus makes the capital of the country a part of its annual produce instead of a part of its stock; it becomes a thing which must be said to be worth so much per annum instead of so much at a point of time. As a matter of fact, the capital of England, even understood in the restricted sense attributed to it by Adam Smith in Book II. Chapter i., must be three times as great as the whole annual produce, and a part can scarcely be three times greater than the whole.

The confusion which prevailed on this subject in Adam Smith's mind was probably increased by some imperfect understanding or partial adoption of the physiocrat theory of avances primitives (original capital) and avances annuelles (annual working expenses), but its origin is to be found in the fact that the capital of a business is commonly conceived as the amount on which profits are earned, and profits are in some cases calculated as a percentage on two entirely different things. When a man makes a profit' of ten per cent in any business, this means that he makes an annual gain equal in value to one-tenth of the sum which is invested in his business, that is to say, the value of his plant, machinery, and. other stock-in-trade at any one time. But when a man makes a profit of ten per cent on any given transaction, this merely, means that he has made a gain equal to one-tenth of the sum he expended with an immediate view to that particular transaction. It is difficult to express the distinction in a manner free from all objection, but an example will make it

1 P. 149 a.

That the proportion between part i. and part ii. determines the proportion between industry and idleness does not prove that increase of part i. will necessarily increase industry, because (a) part ii. may increase still more than part i., so that the proportion which part i. bears to part ii. will diminish, and (b) the number of persons among whom industry and idleness is to be shared may diminish.

3 As an example, the following extract from a prospectus may be given :'We have examined the accounts relating to the Consignments of Bacon from

perfectly clear. The same shopkeeper may be said to make a profit of 20 per cent, and also to make a profit of 50 per cent. In the first case, what is meant is that he makes 20 per cent on the amount he has spent in setting up shop and getting together a stock of goods; in the second case, what is meant is merely that he sells his goods for 50 per cent more than he gives for them. If the amount of his annual gain is £200, and the expense of setting up shop £1000, this is 'a profit of 20 per cent' [on his capital]. If the amount of his annual gain is still £200, and the amount he has expended in buying goods in the year is £400, this is also a profit of 50 per cent [on his annual outlay in purchases]. The two sums on which these profits are calculated have nothing to do with each other. The £1000 is the capital invested in the business, and the £400 is merely a part of the annual working expenses. Adam Smith, however, was in the habit of confounding the two. Considering the origin of the term 'capital,' and the signification which it now bears in ordinary language, no one can doubt that the capital' of our imaginary shopkeeper must always have meant to persons versed in accounts the £1000, and not the £400. But in the very first place in Book I.1 of the Wealth of Nations where he uses the word 'capital,' Adam Smith calculates the annual profits of manufacturing stock' as a percentage on a sum called by him the capital annually employed,' which corresponds to our shopkeeper's £400, and not to his £1000:

'Let us suppose,' he says, 'for example, that in some particular place where the common annual profits of manufacturing stock are 10 per cent, there are two different manufactures, in each of which 20 workmen are employed at the rate of £15 a year, or at the expense of £300 a year in each manufactory. Let us suppose, too, that the coarse materials annually wrought up in the one cost only £700, while the finer materials in the other cost £7000. The capital annually employed in the one will in this case amount only to £1000, whereas that employed in the other will amount to £7300. At the

Russia in February last, and find that the profit on the sale thereof amounts to 42 per cent upon the cost price, after deducting cost of freight, commission, and incidental charges.-HERMAN LESCHER AND Co.'

1 'Capital stock' is spoken of in the 'Introduction and Plan,' but that was doubtless written after Book 1.

rate of 10 per cent, therefore, the undertaker of the one will expect a yearly profit of about £100 only; while that of the other will expect about £730.'1

Here the real capital of the undertakers, their factories, their machinery, and the stocks of goods and materials in their hands at one time, is left out of account altogether, and 'the common annual profits of manufacturing stock' are calculated on what Adam Smith calls the capital annually employed,' which would now in most cases be called the annual working expenses."

Immediately afterwards Adam Smith remarks that, in the progress of the manufacture of an article,

'every subsequent profit is greater than the foregoing; because the capital from which it is derived must always be greater. The capital which employs the weavers, for example, must be greater than that which employs the spinners, because it not only replaces that capital with its profits but pays, besides, the wages of the weavers.' 3

He evidently imagines that the capital which employs the weavers must be greater than that which employs the spinners' because thread is worth more than the material out of which it is spun. But this fact could not possibly be supposed to prove that the true capital invested in weaving, the machinery and stock-in-trade of the master-weavers, is greater than the true capital invested in spinning, the machinery and stock-in-trade of the master-spinners, while it might very well be supposed to prove that the amount annually spent in employing one weaver (that is, in paying his wages and supplying him with thread) is greater than the amount annually spent in employing one spinner (that is, in paying his wages and supplying him with his material).

1 Bk. I. ch. vi. p. 22 b.

2 The example is the more striking because the confusion between working expenses and capital leads Adam Smith to make a statement which is obviously contrary to fact. It is not true that 'the undertaker of the one will expect a yearly profit of about £100 only; while that of the other will expect about £730,' unless, of course, the true capital invested in the one business is £1000 and the true capital invested in the other £7300, which is not said by Adam Smith to be the case, and, considering the facts stated by him, seems wildly improbable. Unless the circumstances of the two undertakers are very exceptional, the probability is that their true capitals (and consequently their true profits) will not be nearly so different in magnitude as £1000 and £7300. 3 P. 23 b.

These instances, it may be objected, are removed by a considerable distance from Book II. Chapter iii. But in that very chapter Adam Smith calculates the current rate of interest as a percentage on a part of the annual produce or expenditure, instead of on the true capital. Being desirous of showing that

'that part of the annual produce, therefore, which, as soon as it comes either from the ground or from the hands of the productive labourers, is destined for replacing a capital, is not only much greater in rich than in poor countries, but bears a much greater proportion to that which is immediately destined for constituting a revenue either as rent or as profit,' 1

'1

he first proves, or rather alleges, that 'in the progress of improvement, rent, though it increases in proportion to the extent, diminishes in proportion to the produce, of the land,' and then, in order to show that profit similarly diminishes in proportion to the produce, says:

In the opulent countries of Europe, great capitals are at present employed in trade and manufactures. In the ancient state, the little trade that was stirring, and the few homely and coarse manufactures that were carried on, required but very small capitals. These, however, must have yielded very large profits. The rate of interest was nowhere less than ten per cent, and their profits must have been sufficient to afford this great interest. At present, the rate of interest in the improved parts of Europe is nowhere higher than six per cent, and in some of the most improved it is so low as four, three, and two per cent. Though that part of the revenue of the inhabitants which is derived from the profits of stock is always much greater in rich than in poor countries, it is because the stock is much greater; in proportion to the stock, the profits are generally much less.'2

Here it is obviously assumed that a decline in the rate of interest or profit, though of course consistent with an increase in the total or aggregate absolute amount of profits, is necessarily accompanied by (or identical with) a decline in the proportion which the total of profits bears to the total of produce. But as a matter of fact, the rate of profit on the true capital of a country tells nothing about the proportion of the produce which falls to the share of profit, unless both

the amount of the capital and the amount of the produce are given quantities, which is not here the case. Three per cent on a capital of a may be a greater or less proportion of a produce b than ten per cent on a capital of c was of a produce d. Three per cent on a capital of ten thousand millions may even be a greater proportion of a produce x than ten per cent on a capital of two thousand millions was of a produce y. We must conclude, then, that Adam Smith was calculating the rate of interest, not as a rate on the true capital, but as a rate on the capital considered as that portion of the annual produce which is neither rent nor profit.

1

'But,' it may be urged, 'Adam Smith immediately goes on to teach that capitals are increased by parsimony, and that whatever industry might acquire, if parsimony did not save and store up, the capital would never be the greater." This surely shows that he considered the capital to be not a part of incoming produce, so much a week, or so much a year, but stored up produce, so much on January 1st, or September 30th, 1772, for instance.' Unfortunately for this objection, Adam Smith's notion of the manner in which parsimony saves and stores up is quite consistent with what is saved and stored up being a part of incoming produce, and quite inconsistent with its being in reality accumulated. Not only the part of a community's stock to which Adam Smith in Book II. Chapter i. gave the name of capital, but the whole of its stock is saved and stored up. The existence of a stock of the produce of past labour in a country is clearly due, not only to the things having been produced, but also to their not having been consumed. If consumption had always equalled production, no such stock could exist. If at the end of any given period, all that had been produced during that period had been consumed, the stock could not have been increased during that period. The existing stock of houses, furniture and clothes, to which Adam Smith denies the name of capital, is just as much a part of the surplus of production over consumption, and, therefore, the result of saving, as the stock of warehouses, machinery, and provisions, to which he grants the name of capital. It is true that an individual does not usually regard what he spends upon books and clothes as

1 P. 149 b.