# Book V, Chapter 1: Analysis of Public Expenditure Through the Viable System Model

## Chapter Summary

Book V, Chapter 1 establishes the fundamental framework for understanding public expenditure by identifying three essential duties of the sovereign: defence, justice, and public works. Smith systematically analyses how these obligations vary across different stages of societal development, from hunter-gatherer societies to advanced commercial economies. The chapter demonstrates that military expenditure evolves from citizen-soldiers who maintain themselves to professional standing armies requiring state funding. Similarly, the administration of justice transitions from informal arrangements to complex legal systems requiring substantial public investment. The analysis of public works reveals how infrastructure projects that benefit society as a whole must be funded collectively when private returns are insufficient. Throughout, Smith emphasises the principle that public expenses should be allocated according to their beneficiaries, with local benefits funded locally and general benefits supported by general revenue. The chapter concludes by establishing the theoretical foundation for public finance, examining various revenue sources and their economic effects.

## Entities Extracted

- **expense of defence**: The sovereign's financial obligation to maintain military forces capable of protecting society from external violence and invasion.
- **expense of justice**: The sovereign's financial obligation to establish and maintain an exact administration of justice protecting members from injustice.
- **expense of public works and public institutions**: The sovereign's financial obligation to erect and maintain public works and institutions that benefit society but cannot be profitably undertaken by individuals.
- **militia**: A military force composed of ordinary citizens who serve part-time while maintaining civilian occupations.
- **standing army**: A permanent military force maintained by the state during both peace and war, consisting of professional soldiers.
- **corvée**: A system of forced labour imposed on the rural population for public works such as road repair.
- **regulated company**: A trading company that admits members upon payment of fees and adherence to regulations, allowing each member to trade on their own account.
- **joint-stock company**: A trading company formed by pooling capital from multiple investors who share in profits and losses proportionally.
- **regulated company versus joint-stock company comparison**: The distinction between trading companies where members trade separately versus companies where capital is pooled.
- **public education institutions**: Organisations established and maintained by public authorities for systematic instruction of youth and people of all ages.
- **public works funding mechanisms**: Various methods of financing public infrastructure projects including tolls, local taxes, general revenue, and forced labour.
- **sovereign dignity expenses**: Additional public expenditure required to maintain the elevated status and ceremonial functions of the monarch.
- **public revenue sources**: Various streams of income available to the sovereign for funding public expenses including taxes, fees, rents, and other charges.
- **three duties of the sovereign**: The fundamental obligations of government consisting of protecting society from external violence, protecting individuals from injustice, and establishing public works and institutions.

## VSM Mappings

- **expense of defence → System 3 (Control / Operational Management)**: Strong
- **expense of justice → System 3 (Control / Operational Management)**: Strong
- **expense of public works and public institutions → System 3 (Control / Operational Management)**: Strong
- **militia → System 1 (Operations)**: Strong
- **standing army → System 1 (Operations)**: Strong
- **corvée → System 2 (Coordination)**: Moderate
- **regulated company → System 1 (Operations)**: Strong
- **joint-stock company → System 1 (Operations)**: Strong
- **regulated company versus joint-stock company comparison → System 2 (Coordination)**: Moderate
- **public education institutions → System 3 (Control / Operational Management)**: Strong
- **public works funding mechanisms → System 3 (Control / Operational Management)**: Strong
- **sovereign dignity expenses → System 5 (Policy / Identity)**: Strong
- **public revenue sources → System 3 (Control / Operational Management)**: Strong
- **three duties of the sovereign → System 5 (Policy / Identity)**: Strong

## VSM Coverage

The chapter demonstrates comprehensive coverage of the VSM framework, with all five core systems (S1-S5) represented through the economic entities and their mappings. System 1 (Operations) is well-covered through the analysis of military forces (militia and standing armies) and commercial organisations (regulated and joint-stock companies), representing the primary productive activities of society. System 2 (Coordination) appears in the discussion of corvée labour systems and the comparison between different forms of trading companies, showing how coordination mechanisms operate in economic organisation. System 3 (Control / Operational Management) receives extensive treatment through the analysis of public expenditure categories (defence, justice, public works), funding mechanisms, and revenue sources, representing the sovereign's regulatory and resource allocation functions. System 5 (Policy / Identity) is addressed through the articulation of the three duties of the sovereign and the discussion of sovereign dignity expenses, establishing the fundamental purposes and identity of the state within the economic system.

Notably absent is System 3* (Audit / Monitoring), which would involve mechanisms for verifying the proper use of public funds and the performance of public institutions. This gap reflects the chapter's focus on establishing principles rather than examining implementation and oversight mechanisms. The absence of S3* suggests an area where the analysis could be enriched by considering how public expenditure is monitored and audited to ensure proper use of resources.

## Gaps & Observations

The most significant gap in the VSM coverage is the absence of System 3* (Audit / Monitoring). While Smith extensively analyses how public funds should be raised and allocated, he does not address the mechanisms for ensuring proper use of these resources or verifying that public institutions perform their intended functions. This omission reflects the theoretical nature of the analysis, which focuses on establishing principles rather than examining implementation details.

The chapter demonstrates a strong emphasis on System 3 (Control / Operational Management) and System 5 (Policy / Identity), with these systems receiving the most extensive treatment through the analysis of public duties, revenue sources, and the sovereign's role. This pattern suggests that Smith viewed the proper scope and funding of government as fundamentally a matter of policy definition and operational management rather than coordination or audit functions.

The mapping of commercial organisations (regulated and joint-stock companies) to System 1 (Operations) reveals an interesting pattern: Smith views these organisational forms as primary economic activities that produce value through trade, rather than as coordination or regulatory mechanisms. This suggests that he saw commercial enterprise as fundamentally an operational activity that requires regulation but is not itself a regulatory function.

The treatment of public works funding mechanisms demonstrates how System 3 (Control / Operational Management) operates through different resource allocation strategies. The analysis of tolls, local taxes, and general revenue shows how the sovereign must choose appropriate funding mechanisms based on the beneficiaries of public expenditure, representing a sophisticated understanding of how operational management allocates resources in complex systems.

The absence of System 4 (Intelligence / Adaptation) is notable, as the chapter does not extensively address how the sovereign gathers information about changing economic conditions or adapts policies accordingly. While the analysis is forward-looking in establishing principles, it does not examine the intelligence-gathering mechanisms that would inform policy adaptation.

Future analysis could be enriched by examining how the principles established in this chapter would be implemented through monitoring and audit mechanisms (S3*), how information about economic conditions would be gathered and processed (S4), and how coordination between different economic actors and institutions would be achieved (S2). Additionally, exploring the recursive nature of these systems - how the principles apply at different scales of economic organisation - could provide deeper insights into the chapter's theoretical framework.