Of the Different Employment of Capitals

Core idea

Capital can be employed in four distinct ways, ranked by how much productive labour each pound supports per turnover:

1. Procuring rude produce — agriculture, mining, fishing. Capital in this sector activates the productive powers of both nature and labour. Smith argues nature itself works alongside the farmer; the labour of cattle and the growth of plants count as a free contribution.
2. Manufactures — turning rude produce into finished goods. Capital here employs only human labour; no natural force does free work.
3. Wholesale trade — moving goods from where they are produced to where they are needed. Capital here employs only the labour of carriage and storage.
4. Retail trade — selling goods in small parcels to consumers. Capital here employs the smallest number of productive hands per pound and produces no good itself — only convenience.

This is one of the most controversial moves in the entire book: Smith asserts a hierarchy of capital-uses by social productivity. Agriculture beats manufactures beats wholesale beats retail.

Why it matters

The topic is the analytic foundation for Book III — Smith's account of the natural progress of opulence. If agriculture is the most productive employment of capital, a nation should be expected to develop agriculture first, then manufactures, then trade. Book III is mainly the story of why Europe did not follow this order, and what consequences flowed from the inversion.

Why agriculture ranks highest

Smith's argument for agriculture's primacy is not sentimental. It is mechanical:

• In manufactures, "nothing is done by nature; the whole is done by man." Capital employs only the labourer and the depreciation of his tools.
• In agriculture, nature performs an enormous quantity of unpaid work: rain falls, plants grow, livestock reproduces, soil regenerates. The farmer captures this natural surplus and combines it with his own labour.

This argument has been heavily criticised since — modern economists do not generally rank agriculture above manufacturing in any meaningful productivity sense, and the post-1800 industrial revolution made the hierarchy look inverted. But the underlying intuition (that some industries combine human capital with free natural processes while others do not) survives in resource economics and the analysis of "rents" from natural endowments.

Why foreign trade ranks lowest

Smith's most consequential argument concerns foreign trade. A pound of capital employed in domestic agriculture or domestic manufactures employs domestic labourers, who are paid wages that they spend domestically, generating further rounds of domestic activity. A pound of capital employed in foreign trade (importing a French wine to sell in England) might pay French growers, Dutch carriers, and English warehouse-keepers — most of the productive labour it employs is foreign, not domestic.

This is not a protectionist argument in the modern sense — Smith makes clear elsewhere that obstructing foreign trade by tariffs is foolish. The argument is about where capital, if left to gravitate naturally, will tend to be employed. Capital pursues profit, but in pursuing profit a domestic owner has natural preferences (familiarity, lower risk, shorter feedback loops) for nearer ventures. Smith expects, under free conditions, that capital will be drawn first into the home market and only second into foreign ventures — and that this is socially desirable, because home capital supports home labour.

The home-bias intuition

This passage is one of the most cited in modern economics, especially in the literature on home-bias in international investment and in protectionist policy debates. Smith's claim is descriptive (capital naturally tends home) and normative (this tendency is good for national productivity). Both have been argued over for two and a half centuries.

The carrying trade

Smith also analyses the carrying trade — capital employed in carrying goods between two foreign countries without ever passing through the home country. This employs no domestic labour at all, except for the few sailors and merchants involved. Smith treats it as the least productive of all employments from a national-wealth perspective, though potentially profitable for the merchant himself.

Key takeaways

Mental model

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Practical application

Smith's hierarchy has been refined and partly inverted by two centuries of subsequent economic analysis. The industrial revolution clearly demonstrated that manufactures can outproduce agriculture by enormous margins on a per-worker basis. Modern services (software, finance, education) can produce more value per worker than either.

But Smith's underlying analytical move — classify economic activities by how much domestic productive labour each unit of capital supports — still organises modern policy debates:

• Industrial policy revives this question explicitly: where should a government direct capital to maximise productive employment?
• Re-shoring of manufacturing draws on the home-bias intuition Smith makes explicit here.
• Resource economics distinguishes activities that capture natural rents (oil, mining, fertile land) from those that depend on pure human capital — Smith's first category survives in this form.
• Sovereign wealth fund strategies vary by how much they tilt toward domestic vs. foreign assets, weighing productivity per pound against diversification.

Example

Compare three uses of £1 million of investment capital. The first builds a vineyard in Sussex: the soil, sun, and rain do most of the work; a small permanent staff plus seasonal labour produces the wine; almost all expenditure flows to British workers, British materials, and British landlords. The second buys a 49% stake in a software firm with engineers in Berlin and Bangalore: the capital supports highly productive labour, but most of it is not British. The third buys a portfolio of US Treasury bonds: the capital earns a safe return but employs no productive labour anywhere; the interest is paid out of US tax revenue, supporting US public spending.

Smith's framework ranks these by domestic-productive-labour per pound: agriculture first (vineyard), then foreign manufactures (software), then pure financial holdings (Treasuries). Each is rational for the individual investor; the social mix is what determines whether the country accumulates productive capital or merely transfers claims around.

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