Today we look at Adam Smith's
Theory of Growth
Smith begins the Wealth of Nations
With a discussion of
The Division of Labor
And it's appropriate for us to begin
There as well because
The Division of Labor was
Absolutely essential to Smith's thought
Indeed, you could say he was
consumed by this idea
Why?
Well, Smith gives his famous
Example of the pin factory
He said that ten people working
Separately could produce
Maybe, 20 pins each
Or 200 in a day all total
But in a modern pin factory
Modern for Smith
With the division of labor
It is where one man draws out
The wire, another straightens it
A third cuts it, and so forth
And machines to work with
To the invention of which
the same division of labor has
probably given occasion the same
10 people can produce 48,000 pins
in a day
Is it any wonder that Smith was
consumed by this idea?
By the division of labor increasing
productivity by more than
200 times?
It is for this reason that Smith
thought that increasing the division
of labor was absolutely critical
to generating economic growth.
Let's take a closer look.
So why does the division of labor
increase productivity?
Smith gives us three reasons.
First, the savings of time as workers
no longer have to move from
one task to the other task
to the other task.
Reduction of set-up costs.
That's probably one of the more
minor reasons.
Second, dexterity and education.
As workers specialize in a task,
they learn the best way to do that task.
They get deeper and deeper into
the task at knowledge, into the
secrets, if you like, the best ways
of doing that task.
This is what we would call
learning by doing.
You learn a lot more by
doing the task repeatedly.
Finally, and perhaps most importantly,
the invention of machines.
Smith says workers who specialize
in a task will naturally come to
think of ways of doing that task
with less labor.
So there's a lot of inventions of
common workmen,
which are important.
Even more important is the ingenuity
of the makers of the machines
because the division of labor is
not just within a factory.
It's across industries,
so we get whole industries
which are built on providing machines
for other industries,
and the workers in those industries
learn how to improve the machines,
which improves the productivity
of the workers
who use the machines.
So Smith gives us this quote.
He says, "In the progress of
society, philosophy or speculation"
Here, he means what we today
call research and development,
so R&D "becomes
like every other employment,
the principle or sole trade
and occupation of a particular
class of citizens.
Like every other employment too,
it is subdivided into a great
number of different branches.
Each individual becomes more
expert in his own peculiar branch,
more work is done upon the whole,
and the quantity of science
is considerably increased by it."
So in our textbook,
Modern Principles,
Tyler and I give the example of
doctors.
We don't just have doctors today.
We have specialists.
We have specialists in the feet,
we have specialists in the heart,
we have cancer specialists,
we have brain surgeons,
we have psychologists,
we have many, many different
types of physicians specailizing
in a particular branch
of knowledge,
and in this way, the total sum
of human knowledge can be
vastly increased beyond that which
could be held by any
single human mind.
So we use our minds,
we use our powers of our brains
as a society much much more
when we divide tasks,
specialize in labor,
and increase the total sum of
human knowledge which is
being effectively used.
So what makes the division
of labor possible?
It's trade.
It's the power of exchanging.
A shoemaker, for example, will
not specialize in making shoes
unless he expects to be able to trade
the product of his labor
the shoes, for
all the other goods.
For the shelter,
for the clothing,
for the food that he needs.
So if you want to increase
the division of labor,
you've got to find a way to extend
trade even further.
So let's look at how
we can extend trade,
how we can make trade easier.
What did Adam Smith say
about extending trade?
So how does one increase trade
in the division of labor
to get advantage of
those productivity improvements?
First, larger markets,
where Smith put it,
"the division of labor is limited by
the extent of the market."
Large markets increase,
for example,
incentive to specialize.
In a small town, we don't find
ear, nose, and throat specialists
because there aren't enough other
people who need those services
to justify someone specializing
in that field.
As a result, in a small town,
you dont get specialization,
and you don't get improvements
in knowledge in that field.
For that, you have to go to
a much larger town
where it makes sense for people
to specialize because there are more
demanders of that service.
Simiarly, larger markets increase
the incentive to invest in machines.
If you're only going to be producing
a few hundred pins, it doesn't
make sense to build a pin factory.
If you're only going to be producing
a few loafs of bread, you make
them at home.
If you're going to be producing
thousands of loaves of bread,
you build an entire bread factory,
which massively increases
productivity, which lowers your
cost per unit.
So what makes for larger markets?
Smith gives a number of possibilities.
Trust and good government,
free trade,
geography,
sort of exogenous factors, like sea
coasts as well as cities,
the system of natural liberty.
We'll look at each one of these
in turn.
Finally, another factor to increase
trade and the division of labor,
capital accumulation.
Let's take a look at larger markets
in more detail.
People won't trade with
one another if they don't trust
the other party.
So trust is a big factor,
a cultural factor,
which can underly trade.
Adam Smith talks more about this
in the theory of moral sentiments.
How do you generate
good will among men?
How do you generate trust?
How do you get peace?
Also important is justice,
and here, government can play
a role.
So Smith says "commerce and
manufactures, in short, can seldom
flourish in any state in which there
is not a certain degree of
confidence in the justice of
government."
And what he means by justice,
in this context,
is security of property, both from
the government itself and from
foreign invaders, including peace,
the enforcement of contracts,
including debt contracts,
labor contracts,
and the rule of law.
That is, there should not be
arbitrary taxation or arbitrary
confiscation of property.
Smith kind of sums up,
he says, little else is requisite to carry
a state to the highest degree of
opulence from the lowest barbarism,
but peace, easy taxes, and a tolerable
administration of justice;
all the rest being brought
about by the natural course of things
Smith , of course, was a famous
proponent of free trade
and an opponent of mercantilism.
He was against cartels,
he was against tariffs,
he was against subsidies and so forth,
and he said that the way to create
the best manufacturing nation,
the strongest mechants of your own
is to grant the most perfect freedom
of trade to all other nations.
Now why did he say this?
Again, it's the division of labor,
which Smith wants to increase.
To international specialization,
we get a greater division of labor,
we get greater incentives
to invest in research and development,
we get more learning by doing,
and we get greater improvements
in productivity, lowering of cost,
greater wealth, and so forth.
Smith made contributions
not only to economic theory,
but also to economic history,
and in a way which supports,
which gives evidence for his theory.
So Smith says,
look around the world,
where is it the civilization begins?
He says it begins on sea-coasts
and navigable rivers.
Why?
He says, as by means of
water-carriage, ship and boat,
a more extensive market is opened
to every sort of industry
than what land-carriage alone
can afford it, so it is upon
the sea-coast, and along the banks
of navigable rivers, that industry
of every kind naturally begins to
subdivide and improve.
Smith is saying it's much cheaper
to carry goods across the water
than it is to carry them across the land.
Because of this, along sea-coast
and navigable rivers, you get potentially
much larger markets.
Because you have larger markets, you get
specialization. Because of specialization,
you get development of knowledge,
you get investment in machinery,
investment in research and development,
and that means you get improvements,
lowering of cost, so this is where
civilization begins. It begins where
larger markets are possible, where you get
more and more trade. So we have here a
dynamic theory of growth, which explains
some of the origins of civilization,
and also explains, as Smith goes on,
why landlocked countries, where growth
is much slower to occur.
For more on that I recommend taking a look
at our videos on growth and development
and trade in our course of
development economics.
Liberty is also important for growth,
because liberty allows for self-interest,
and in the right circumstances,
self-interest leads to the social good,
the 'invisible hand' process.
So Smith says, given freedom and security
the natural effort of every individual
to better his own condition
is so powerfrul a priciple
that it is alone, and without
any assistance, not only capable
of carrying on the society to
wealth and prosperity, but of
surmounting a hundred impertinent
obstructions with which the folly
of human laws too often imcumbers
its operations. Quite so.
Capital accumulation also plays a role
in increasing the division of labor,
because to employ the labor in the factory
and to buy the machines, with which the
workers will work, there must be previous
accumulation, there must be previous
savings. So Smith says,
labor can be more and more subdivided
in proportion only as stock
is previously more and more accumulated.
He goes on to say that there's a two-step
process, however, because, self-interest
will in fact encourage capitalists
to do precisely this to divide labor.
So the person who employs his stock in
maintaining labor, necessarily wishes
to employ it in such a manner
as to produce as great a quantity of work
as possible. He endevors, therefore,
both to make among his workmen the most
proper distribution of employment,
subdivide labor, and so forth,
and to furnish them with best machines
which he can either invent or
afford to purchase.
So capital accumulation and
division of labor go together.
With division of labor you get more output
with more output there's more savings,
more savings, you can subdivide and
specialize labor and buy machines
and so forth.
To summarize, Smith argues that
increases in labor and
capital productivity were driven by the
greater division of labor
by specialization, in particular
by learning by doing, and by
investment in new technologies.
The greater division of labor was
brought about by capital accumulation
and by larger markets, both of which had
a policy component, a policy lever, namely
increases in trust and good government
could get you more capital accumulation
and larger markets. Similarly, good was
that policy of free trade, and promoting
the system of natural liberty.
If I had to evaluate the theory, I'd say
Smith put too much weight on those
extraordinary productivity improvements
he saw at the pin factory.
In more ordinary circumstances,
we would't expect improvements
quite that large. And I would say he
underemphasize exogenous improvements
in productivity brought about by science
and new technologies and so forth.
Nevertheless, this is a very impressive
and dynamic theory, and Smith put
his finger on a key idea, namely the
division of labor increases productivity.
For further resources, most obviously,
Adam Smith's Wealth of Nations.
Allyn Young has a classic paper from 1928
on increasing returns and ecnonomic
progess, which developed numerous
Smithian insights.
James Buchanan and Youg Yoon have an
important paper, A Smithian Perspective
on Increasing Returns. Also take a look
at another course, our course on
development economics has a video
Geography and Development, Trade,
which looks at the problems of landlocked
nations and growth, and further develops
the Smithian versus the Ricardian
perspective on trade. The video on
Paul Romer may also be useful.
Romer's work on growth can be understood
as a somewhat distant descendant, but
certainly as a descendant of Adam Smith's
views on growth. Our textbook
Modern Principles, the chapter on trade
looks at some of these Smithian arguments
in more detail than it's done in most
other textbooks, as opposed to just
focusing on the Ricardian comparative
advantage argument. And my talk,
my ted talk, focuses on the incentive for
research and development which are
created by larger markets and
the importance of globalization in
stimulating research and development.
Thanks!