Adam Smith

Adam Smith

1723-1790

Father of Economics

His theory that the increase in DOL would increasingly grow the wealth of a nation was largely correct.

Wealth of Nations (1776)

Adam Smith’s Pin Factory

He disagrees with the mercantilist belief that what determines the wealth of a nation is bullionism. He stated that the state of Britain was much wealthier than the Spanish Empire as the standard of living of the average British citizen was much higher than that of the average Spanish citizen. Spain at the same time, had massive colonial holdings in Latin America which gave them a huge quantity of gold. According to mercantilist theory that would suggest Spain is richer than Britain, which Adam Smith believed reflected the mistaken view of mercantilists. Adam Smith believed the Division of Labor and the output created by that division of labor (how much stuff can be produced by an economy in a particular period of time) is what determines the wealth of a nation. This measure of output is a measure known today as Gross Domestic Product.

Adam Smith’s Pin Factory

In a situation where we have 5 workmen that are each working separately producing sewing pins, each of these individuals probably could only produce maybe 3-4 pins a day if they were skilled craftsmen. A regular individual might struggle to make even 1. Adam Smith said that this was no longer the way production was structured. Instead of these individuals working separately they now work together in a factory. We now have a collective production process that Adam Smith refers to as Division of Labor. Individuals that might’ve previously been able to produce 5 pins could produce on the order of 10,000 pins a day. This reason this is possible is because division of labor results in two different things that both result in this dramatic increase in productivity.

Division of Labor

Results in specialization and innovation

Specialization

Prior to DOL each individual had to know how to do each step of the production process and distribute their time between each of those steps, therefore each individual remained intermediate at those steps. Under this new process each individual has a well defined and specific role therefore the individual is going to get better and better at that task over time. Each of the individuals getting better at that specific task results in this dramatic increase in productivity.

Innovation

When you have DOL, each of these individuals doing their own thing, you have the tendency for people to innovate or figure out how to do a specific task better. This leads to a dramatic increase in their productivity therefore leading to an increase in productivity of everyone involved meaning an increase in output

“Every undertaker in manufacture finds, that the more he can subdivide the tasks of his workmen, and the more hands he can employ on separate articles, the more are his expenses diminished, and his profits increased” - Adam Smith, Wealth of Nations

He believed the DOL was driven by the pursuit of profit rather than for their own consumption. The pursuit of profit is driven by markets.

“It is not from the benevolence of the butcher, the brewer, or the baker, that we expect our dinner, but from their regard to their own interest. We address ourselves, not to their humanity but to their self-love, and never talk to them if our own necessities but of their advantages.” - Adam Smith, Wealth of Nations

The process by which the butcher and the baker have incentives to produce goods in the most effective way possible is like an invisible hand that organizes society in an increasingly more productive way

Smith’s views

Division of labor (innovation & specialization) → wealth of nation

Virtuous nature of competition (“invisible hand”)

Inequality is good (so long as it incentivizes expansion)

Adam Smith less known beliefs

Under the division of labor where tasks are always the same and individuals don’t have opportunities to exert understanding or to exercise innovation those individuals become as stupid and ignorant as it is possible for a human creature to become.

While the DOL is productive, it also has detrimental aspects including dehumanization of the production process. This is shown today with individuals being seen as just cogs in a machine today.

“It is not very unreasonable that the rich should contribute to the public expense, not only in proportion to their revenue, but something more than in that proportion.” - Adam Smith, Wealth of Nations

DOL is very enriching to some (business owners and capitalists) rather than others (workers). The fact that some individuals derive so much wealth from the DOL probably suggests that these individuals owe a debt to society and that they should contribute to the public expense (their share of taxes) because their wealth ultimately derives from the division of labor among the workers.