106 Short class notes # 4
Adam Smith and the Division of Labor

I) What do we want?

II) Rich-Poor County Fears

III)The Wealth of Nations
    A. Introduction
    B. Chapter 1, The DOL
    C. Chapter 3, Transport, Politics and Geography
IV) Modern Lessons From the Wealth of Nations: The Long Run
    i. The Network Perspective
    ii. Rich Countries and Trade
    iii. Openness and Growth
    iv. Geography and Growth
    v. Education and the Size of the State
V) Modern Lessons From the Wealth of Nations: The Short Run
    (A Keynesian Reinterpretation of the WON)
    i) Why are modern economies unstable?

ii) Why are the sources of economic growth simultaneously the potential for economic instability?
I) What do we want?

Which world would you rather see us experience in the coming decade?

World A: USA growth 25% Japan 75%

World B: USA growth 10% Japan 10%

Robert Reich asked graduate students, US executives, Mass. State citizens, members of US State dept., and economists in late 1980's. Majorities of all groups but economists voted for World B. Thus people seem to care about relative gains rather than absolute gains.

Robert Reich, "Do We Want U.S. to Be Rich Or Japan Poor?" WSJ, 18 June 1990 p.A10. As cited in Michael Mastanduno, Do Relative Gains Matter? International Security, summer 1991, Vol. 16, No.1 pp73-113.

This is important since it means that we may sacrifice (absolute) economic growth for our relative standing in the world. The deep depression of the Japanese economy has "fortunately" (!?) removed this "threat" to relative US living standards and economic might. Prior to Adam Smith's time economic and political thought was largely "Mercantilist" in nature, and emphasized relative gains. Mercantilists wanted to generate a reinforcing pattern of economic and military growth. Military power and economic plenty were to further each other. Countries sought to capture export markets to boost their economies and to then use the tax revenues from economic growth to further their military capacity, so they might capture more export markets.

In contrast to the nationalisticapproach of the Mercantilits, Smith is a Liberal or cosmopolitan economist. The opening sentences of Adam Smith's WON try to focus our attention on absolute gains, and divert them from relative gains. Smith attempts to get us to look at, say, Japan as an addition to our productivity rather than a competitive threat.

II) Rich-Poor Country Fears

Rich countries fear the low wages of poor countries while poor countries fear the greater capital and technology of rich countries. Ross Perot often spoke of the "giant sucking sound" of jobs we would hear as they are drawn to Mexico. Yet job growth has been very strong, stronger than anyone would have dared to forecast.

Smith attempts to show that all countries gain from trade, that it will contribute to the growth of both countries.

II) The Wealth of Nations

A) Introduction
 

Read the first and second paragraphs.
THE annual labour of every nation is the fund which
originally supplies it with all the necessaries and conveniences of life which it annually consumes, and which consist always either in the immediate produce of that labour, or in what is purchased with that produce from other nations.   According therefore as this produce, or what is purchased with it, bears a greater or smaller proportion to the number of those who are to consume it, the nation will be better or worse supplied with all the necessaries and conveniences for which it has occasion.   here we see that national wealth is defined in a modern way as

per capita income = total product/total population

What determines whether a country is wealthy or poor? Two or Three factors.

Read the third paragraph.

But this proportion must in every nation be regulated by two different circumstances; first, by the skill, dexterity, and judgment with which its labour is generally applied; and,

secondly, by the proportion between the number of those who are employed in useful labour, and that of those who are not so employed. Whatever be the soil, climate, or extent of territory of any particular nation, the abundance or scantiness of its annual supply must, in that particular situation, depend upon those two circumstances.

 So we have three factors.

1) Skill, Dexterity, Judgement of labour

He later calls this the division of labour, we would say technology

2) # of useful people/# of not useful people

3) Natural resources.

PCI= (total output/employment)*(employment/total population)

PCI= labor productivity * Employment to population ratio

It is important that Per Capita Income depends mostly upon the first factor. For Smith, unlike the Adam Smith Club so prominent in Ronald Reagan's cabinet, reducing the size of the state is not the main problem, and not the main answer to how to get the economy moving. The issue is productivity.

The abundance or scantiness of this supply, too, seems to depend more upon the former of those two circumstances than upon the latter. Among the savage nations of hunters and fishers, every individual who is able to work, is more or less employed in useful labour, and endeavours to provide, as well as he can, the necessaries and conveniences of life, for himself, or such of his family or tribe as are either too old, or too young, or too infirm to go a hunting and fishing. Such nations, however, are so miserably poor that, from mere want, they are frequently reduced, or, at least, think themselves reduced, to the necessity sometimes of directly destroying, and sometimes of abandoning their infants, their old people, and those afflicted with
lingering diseases, to perish with hunger, or to be devoured by wild beasts. Among civilised and thriving nations, on the contrary, though a great number of people do not labour at all, many of whom consume the produce of ten times, frequently of a hundred times more labour than the greater part of those who work; yet the produce of the whole labour of the society is so great that all are often abundantl supplied, and a workman, even of the lowest and poorest order, if he is frugal and industrious, may enjoy a greater share of the necessaries and conveniences of life than it is possible for any savage to acquire. III B)Chapter One, The Division of Labour.
Smith starts with the division of labour within a firm: The effects of the division of labour, in the general
business of society, will be more easily understood by
considering in what manner it operates in some particular manufactures. It is commonly supposed to be carried furthest in some very trifling ones; not perhaps that it really is carried further in them than in others of more importance: but in those trifling manufactures which are destined to supply the small wants of but a small number of people, the whole number of workmen must necessarily be small; and those employed in every different branch of the work can often be collected into the same workhouse, and placed at once under the view of the spectator. In those great manufactures, on the contrary, which are destined to supply the great wants of the great body of the people, every different branch of the work employs so great a number of workmen that it is impossible to collect them all into the same workhouse. We can seldom see more, at one time, than those employed in one single branch. Though in such manufactures, therefore, the work may really be divided into a much greater number of parts than in those of a more trifling nature, the division is not near so obvious, and has accordingly been much less observed. Here we see that productivity growth and the DoL are the same thing for Smith. What is the DoL? Smith explains with an example. He says in the second paragraph that it is easiest to see in a trivial example, where everyone involved in production is in the same place.

To take an example, therefore, from a very trifling
manufacture; but one in which the division of labour has been
very often taken notice of, the trade of the pin-maker; a workman not educated to this business (which the division of labour has rendered a distinct trade), nor acquainted with the use of the machinery employed in it (to the invention of which the same division of labour has probably given occasion), could scarce, perhaps, with his utmost industry, make one pin in a day, and certainly could not make twenty. But in the way in which this business is now carried on, not only the whole work is a peculiar trade, but it is divided into a number of branches, of which the greater part are likewise peculiar trades. One man draws out the wire, another straights it, a third cuts it, a fourth points it, a fifth grinds it at the top for receiving, the head; to make the head requires two or three distinct operations; to put it on is a peculiar business, to whiten the pins is another; it is even a trade by itself to put them into the paper; and the important business of making a pin is, in this manner, divided into about eighteen distinct operations, which, in some manufactories, are all performed by distinct hands, though in others the same man
will sometimes perform two or three of them. I have seen a small
manufactory of this kind where ten men only were employed, and
where some of them consequently performed two or three distinct
operations. But though they were very poor, and therefore but
indifferently accommodated with the necessary machinery, they
could, when they exerted themselves, make among them about twelve pounds of pins in a day. There are in a pound upwards of four thousand pins of a middling size. Those ten persons, therefore, could make among them upwards of forty-eight thousand pins in a day. Each person, therefore, making a tenth part of forty-eight thousand pins, might be considered as making four thousand eight hundred pins in a day. But if they had all wrought separately and independently, and without any of them having been educated to this peculiar business, they certainly could not each of them have made twenty, perhaps not one pin in a day; that is, certainly, not the two hundred and fortieth, perhaps not the four thousand eight hundredth part of what they are at present capable of performing, in consequence of a proper division and combination of their different operations.

Note the huge productivity gain:

4,800 pins per person in a properly equipped group of ten people

vs

20 to 1 pin per individual worker.

This is the division of labour within a firm. But what makes the workers more productive?
 
 

1) dexterity

2) savings in time (re-tooling time)

3) specialized machines

Some machines are invented on the shop floor by workers.
Read paragraph 8 last on page 6/18.
Thirdly, and lastly, ......
What do you think happened to this young man? Did he keep his job?

Other machines are invented by "philosophers", people we would today call scientists and engineers.
Read paragraph 9 page 7/18.

All the improvements in machinery, however,.....


So we already begin to see that the DoL means not just specialization within a firm, but between firms, between industries and even between nations. The rise of industries which produce only research, and nothing that we directly consume, accounts for much of modern economic growth.

Smith gives us a very every day example of the international division of labour.

Read about the coat, paragraph 11 page 7/18.

Observe the accommodation of the most common artificer..

So we see that every article we consume has been produced by the joint activity, by a complex interacting network of people and firms. It is this interaction which allows instability. But let us pause for a moment to consider the present relevance of these very simple, indeed obvious, aspects of economic growth.

C) The role of transport.

Chapter three of the Wealth of Nations is titled `That the division of labour is limited by the extent of the market'.

The extent to which labour can be subdivided, and productivity improved, depends upon the size of the market. The size of the market is principally determined by transport costs. With lower transport costs markets become larger as goods can be sold across greater distances and to a larger number of customers.

Read first paragraph of chapter.

In this chapter we get the following interaction:

lower transport costs > more trade> greater DoL in manufacturing > more trade > lower transport costs > greater DoL > etc

Politics often interrupted this virtuous cycle and Smith urged that it should not do so.
 
 
 
 

IV) Modern Lessons From the Wealth of Nations: The Long Run
    i. The Network Perspective

Smith urges us to regard other nations as contributing to our productivity rather than challenging it.

ii.Rich Countries and Trade

       
      The pattern of world trade is dominated by the "triad" economies of N. America, Asia and Europe. Rich nations are each other's best trading partners because they demand and supply highly specialized products.

      There is little trade between the triad and Latin America or Africa. There is even less trade within these regions.
      (The latter point is even more troubling than the former.)
       

    iii.Openness and Growth
       
      Overall the pattern of growth from 1960-1992 was "divergent": the gap in incomes between the rich and poor counties got bigger.

      Some countries, such as the NICS, converged. For these countries the poor grew faster than the rich and so started to "catch up".

      This is the gist of:
      Jeffrey Sachs and Andrew Warner 'Economic Convergence and Economic Policies' NBER working papers #5039,  Available to you via Library Web site, go to databases then 'N'. NBER is an entry.  You can pull it up by paper # or author name.

      Separate nations by 5 criteria 1) socialist 2) unrest 3) extreme deprivation of civil or political rights 4) economic openness i) high import restrictions ii) export taxes and/or monopolies iii) distorted exchange rate

      LDC open 4.49    closed 0.69
      DC   open 2.29    closed 0.74

      for 1970-89
      Hence openness give faster growth and convergence.

      Problems:  this is for countries that stayed open.  Many could not do so due to political credibility and political problems (that may have been exaserbated by attempts to open the economy).
       
       

    iv. Geography and Growth
Sachs shows that geography still matters for economic growth. Places with lots of economic activity are still near water. There will be a big challenge to bring populations situated away from water into the market in the next decade.

Sachs, Jeffrey D., and John Luke Gallup with Andrew Mellinger, "Geography and Economic Development," presented at the Annual World Bank Conference on Development Economics, July 1998.

http://www.hiid.harvard.edu/pub/other/geoecd.pdf, accessed 05 Jan 2000.
 

 v. Education and the Size of the State  
In Book V of the WON Smith notes the debilitating impact of the DOL upon knowledge. He advocates a strong government response in the form of education, paid for by a combination of the recipients and the general public (via taxation). Here we see again that his point is not that the State should be small, but rather that the economy should be productive. V) Modern Lessons From the Wealth of Nations:The Short Run (A Keynesian Reinterpretation of the WON)
i)Why are modern economies unstable?
ii) Why are the sources of economic growth simultaneously the potential for economic instability?  
Because the network relationships of the economy allow expectations a critical role. If firms expect sales to be poor they will reduce output. That will reduce jobs and consumer incomes. The expected fall in sales will be created in reality.
 

Conclusion to Smith's WON.  In the long run we saw that one implication of his 'network' view of  the economy is that growth and openness go hand in hand. In the short run we saw that the network economy contained the potential for economic insability.  Smith overlooked, perhaps even denied, this possibility which was clealy articulated by Keynes.