Chapter 2d

Computing the Net Domestic Product

by Adam Smith Icon

37 When we compute the amount of industry which a society’s circulating capital can employ, we must account only the provisions, materials, and finished work.

The circulating capital which consists in money, and which only circulates those three, must always be deducted. Three things are needed to mobilize industry=

  • materials to work on,
  • tools to work with, and
  • wages or recompense for the work done.

Money is neither a material to work on, nor a tool to work with.

Wages are commonly in money. But a worker’s real revenue is in the money’s worth. The people’s real revenue is in what can be bought with money, and not in the physical money.41

38 The amount of industry which any capital can employ must be equal to the number of workers that it can supply with materials, tools, and a maintenance suitable to the nature of the work.

Money may be needed to buy=

  • the materials and tools of work, and
  • the maintenance of the workers.

The amount of industry which the whole capital can employ is equal to the materials, tools and maintenance that it mobilizes, not to the money that mobilizes them.

39 When gold and silver money is replaced with paper, the amount of the circulating capital as materials, tools, and maintenance might be increased proportional to the value of gold and silver used before.

The increased value of this great wheel of circulation is added to the goods it circulates. This operation resembles a factory owner who takes down his old machinery and replaces it with a newer and cheaper one of the same quality. He adds his cost-savings to the fund that provides materials and wages to his workers.

40 It is perhaps impossible to determine the proportion of a country’s circulating money to the whole value circulated by that money.

Money has been computed by different authors at 1/5, 1/10, 1/20, and 1/30 of the value of the annual produce. No matter how small money is compared to a country’s produce, it forms a great part of the stock used to maintain industry. When gold and silver money is reduced to 1/5 because of the introduction of paper money, the value of the remaining 4/5 is added to the funds for maintaining industry.

It adds greatly to the amount of that industry and to the value of the national produce.

41 This operation has been done in Scotland within the past 25-30 years by the establishment of new banks in every considerable town and in some country villages.

Its effects were precisely those above described.

The country’s business is almost entirely done with the paper of those banks through purchases and payments.

Silver very seldom appears, except in the change of a 20 shilling bank note, and gold still more seldom.

The country has derived great benefit from the banks even though they=

  • were not exceptional, and
  • were regulated by an act of Parliament.

I heard that Glasgow’s trade doubled 15 years after the establishment of the banks there. Scotland’s trade has more than quadrupled since the establishment of the two public banks at Edinburgh.

  • The Bank of Scotland was established by an act of Parliament in 1695.
  • The Royal Bank was established by royal charter in 1727.

I do not know whether the trade of Scotland or Glasgow has really increased so much during so short a period. It seems to be too great to be caused by banks alone.

However, I do not doubt that the banks contributed to the big increase in Scotland’s trade and industry during this period.

42 Before the union in 1707, the value of the silver money circulating in Scotland was £411,117.

It was immediately brought into the Bank of Scotland to be recoined after the union. There is no account of the gold coin.

The ancient accounts of Scotland’s mint show that the value of the gold annually coined exceeded that of the silver.

  • Many people did not bring their silver into the Bank of Scotland because of the diffidence of repayment.
  • Some English coin was also not called in.

The whole value of the gold and silver circulating in Scotland before the union cannot be less than £1 million.

  • £1 million seems to have been almost the whole circulation of Scotland.

The circulation of the Bank of Scotland was considerable and had no rival back then.

  • Its circulation made a very small part of the union’s whole circulation.

Presently, Scotland’s whole circulation cannot be less than £2m.

  • The gold and silver circulation probably does not amount to £500,000.

Scotland’s circulating gold and silver was greatly reduced during this period.

  • But its real prosperity was not reduced at all.
  • Its agriculture, manufactures, and trade have increased.

43 Most banks issue their promissory notes chiefly=

  • by discounting bills of exchange, or
  • by advancing money before they are due.

They always deduct the interest from the value that they lend, until the bill becomes due.

The payment of the due bill replaces to the bank the value that was lent, with a clear profit of the interest. The banker who advances a discounted bill (of reduced value) to the merchant in notes instead of gold and silver, is able to discount more, according to the total value of all of his circulating promissory notes. He can make his clear gain of interest on a larger sum.


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