Hi there! I'm Shrijith Venkatrama, the founder of Hexmos. Right now, I’m building LiveAPI, a super-convenient tool that makes engineering life easier by creating awesome API docs from your code in minutes.

While I work on LiveAPI, I’ve been diving into economic ideas and sharing what I learn.

Adam Smith, widely regarded as the father of modern economics, provides a detailed perspective on the concept of "stock" and its role in society's wealth and economic dynamics.

This article explores his interpretation of stock, the relationship between wages and profits, the challenges in calculating profit, the connection between interest rates and profits, and the impact of profits and wages on the cost of goods.

What Adam Smith Means by "Stock"

According to Adam Smith, stock refers to accumulated resources, including:

1. Raw materials
2. Provisions
3. Machinery
4. Manpower

Some resources, such as food, may be immediately consumed, whereas others, such as machinery, can contribute to generating revenue in the future. The latter type, which holds the potential to produce future revenue, is referred to as capital.

What Happens When National Wealth Increases?

When societal wealth increases, wages tend to rise.

However, as societal wealth grows, individual business profits may decrease due to an increase in stock and heightened competition among employers.

Conversely, when societal wealth declines, wages decrease, and individual business profits tend to increase due to reduced competition.

In summary, there is often an inverse relationship between wages and profits: as wages increase, profits decrease in this context.

Average Profits on Stock Are Difficult to Calculate

The price of goods typically comprises three components: wage, rent, and profit. While wages and rent tend to remain relatively stable and predictable over time, the profit on stock is inherently volatile due to several factors:

• Price fluctuations in commodities
• The success or failure of competitors
• The success or failure of customers in their businesses
• Unpredictable events affecting goods in transit or storage

This volatility makes calculating average profits challenging, whether for an individual business or for an entire nation.

Interest Rates Reflect the Average Profit on Stock

Interest rates provide a useful indicator of the average profit on stock.

What Is an Interest Rate?

Interest rate is the price paid for the use of money.

In essence, it represents the cost of borrowing money. Lenders typically adjust interest rates based on their perception of borrowers' financial health:

• Higher interest rates are charged when lenders believe borrowers are profiting well from their stock.
• Lower interest rates are charged when borrowers are perceived to be earning less from their stock.

Thus, interest rates often mirror the underlying economic reality of stock profits. A higher interest rate generally signals that businesses are achieving strong returns on their deployed stock.

Why Government Attempts to Regulate Interest Rates Often Fail

Historically, governments have attempted to regulate interest rates with good intentions, such as capping them at a maximum value (e.g., 10%). However, these efforts often fail and lead to unintended consequences, such as:

• Usury or loan sharking, where lenders illegally charge higher rates.
• Borrowers, desperate for funds, agreeing to pay exorbitant prices.

Ultimately, market forces tend to override regulatory controls, making interest rate caps ineffective. For reference, here is a list of interest rates observed in various countries as of December 2024:

The Impact of Profits and Wages on the Cost of Goods

Both high wages and high profits contribute to increased costs of goods, but their effects differ:

• Wages typically increase prices in an arithmetic proportion.
• Profits tend to increase prices in a geometric proportion.

Merchants and manufacturers often attribute high prices to elevated wages. However, it is frequently the result of high profit margins.

More questions

The present chapter from the Wealth of Nation introduced me to some new ideas:

• Relation between wages and profits
• Relation between profits and interest rates
• Relation between profits and cost of goods

While that is helpful, I still have more practical questions, I'd love to explore in future posts such as:

• Why is Japan's interest rate so low?
• Of the countries listed above - which country is "doing well" overall - that is - which country is well-balanced?
• Is there a measure to quantify "balance" where there is good wage and good profit?

What do you think of Adam Smith's view on wages, profits, interest rates and cost of goods?

Any comments/criticisms/suggestions welcome - do leave a comment at the end of this page.