Thursday, December 6, 2012

Pins and Boats

Adam Smith was born in 1720 in Kirkcaldy, Scotland. He never met Mr. Keynes, who was not born until 1883, although strangely the two men share a birthday.[1] Smith came of age during the height of the Scottish Enlightenment, and profited enormously from correspondence with contemporary thinkers including Francis Hutchinson, David Hume and Francois Quesnay. He spent much of his life at the University of Glasgow, where he served as the chair of moral philosophy and lectured, among other topics, on “the progress of opulence.[2]” He really was absent minded; his biographers say that on one occasion he became so engaged in a conversation that he walked into a tanning pit and had to be rescued, and that on another he stirred bread and butter into a pot of hot water and declared his tea to be “the worst he had ever met with.” In 1776 the good natured, scatterbrained professor published An Inquiry into the Nature and Causes of the Wealth of Nations, which would become a bestseller in his lifetime and is today regarded as the first great book about economics.

The Wealth of Nations is long and packed with brilliant insights on a thousand different facets of economic life, but while modern writers have been taught to frame, follow up and hammer home their points, Smith’s book is nearly as distracted as his personality was said to be. He may have been one of the first great economists, driven by desire to rationalize and simplify a complicated world, but he was also one of the last great empiricists, who in the spirit of Aristotle approached knowledge as reflection on physical observation. As an empiricist, Smith conveys many of his ideas though stories, only sometimes pausing to name the principle behind observation, and therefore exposing his ideas to the perils of interpretation. Some of his casual phrases have provoked centuries of study and squabble; for instance, he mentioned the famous invisible hand only once. At other points he rambles on in mind-numbing detail about the historical price of wheat or the flaws of the apprenticeship system in Scotland. Smith’s lack of organization is at once exciting—every page is an adventure—and infuriating, especially when one considers how many years of confusion could have been saved by a little bit of clarification.

Like most authors, Smith puts his most important ideas up front. In Chapter II, Of the Principle Which Gives Rise to the Division of Labor, he delivers the most famous line after the invisible hand: “It is not from the benevolence of the butcher, the baker or the brewer that we expect our dinner, but from their regard to their own interest.”[3] Smith uses the story of the butcher, the baker and the brewer to explain the advantage of self-interest, the concept behind the invisible hand and the most talked about idea from The Wealth of Nations. Smith’s self-interest has been usefully applied by thousands of economists, businessmen and policymakers, but it has also been employed as an argument against all government and sometimes twisted into a justification for exploitation or inequality, interpretations that other passages in The Wealth of Nations make clear were not Smith’s intent. More than anything, the story of the butcher, the baker and the brewer reflects Smith’s optimism for the future: if humans are naturally self-interested, and self-interest produces growth, then growth is guaranteed.

Smith tells two other stories at the beginning of The Wealth of Nations: one about pins, and one about boats.

The story about pins is also famous. In Chapter I, Of the Division of Labor, Smith observes that while an ordinary man could scarcely produce a few pins a day, a pin factory where “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… could make among them upwards of forty-eight thousand pins in a day.” Smith notes that the division of labor within the pin factory is not essentially different from the division of labor between different trades, as in the case of the baker and the brewer, or the division of labor between countries, as in the case of French silks and English woolens. The factory workers exchange the product of their labor during the process of the production and the baker and the brewer exchange the product of their labor after the process of production, but division and exchange occur in both cases nonetheless.

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Smith does a good job of drawing the principle of the division of labor out from the story of the pin factory (as the first worker draws the wire), but he doesn’t grind his observation all the way down to a point. Division of labor increases the wealth of nations because it increases the average use value each citizen can produce. 48,000 pins provide more value in use than two pins, and in the hypothetical town of two Mr. Smith and Mr. Keynes can produce more bread and beer as baker and brewer than they can if each both baked and brewed. Education or practice increases use value in the same way; a single experienced pin maker can make many more pins than a single novice. Likewise, technology and tools increase the average ability to produce value: today industrial machines multiply the efficiency of Smith’s pin factory ten-fold. Division of labor is part of a larger principle, the efficiency of production, that Smith glimpsed but did not completely recognize, or simply did not completely write down. In “The Capacity for Production” I will relate how extraordinarily long it took economics to recognize the efficiency of production as an essential constraint, and why fragments of other systems continue to persist today.

The story about boats is often forgotten. Smith begins Chapter III, That the Division of Labor is Limited by the extent of the Market, with the words:
“As it is the power of exchanging that gives occasion to the division of labour, so the extent of this division must always be limited by the extent of that power, or, in other words, by the extent of the market. When the market is very small, no person can have any encouragement to dedicate himself entirely to one employment, for want of the power to exchange all that surplus part of the produce of his own labour, which is over and above his own consumption, for such parts of the produce of other men's labour as he has occasion for.”
Smith uses the next few paragraphs to illustrate his point by describing an isolated village in the Scottish Highlands, and then suddenly he pivots and starts talking about boats.

“As by means of water-carriage 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 itself...”
Smith goes on to detail the precise tonnage a boat can carry and to compare the number of men needed to transport goods from London to Leith by water and by land. Next he claims that the great civilizations of the world arose largely because of their proximity to navigable waterways: the Nile in Egypt, the Mediterranean Sea in Ancient Greece, and the Rhine in Germany, no trivial allegation considering that he titled his book An Inquiry into the Nature and Causes of the Wealth of Nations. He never returns to his opening paragraph.

Whereas the story of the pin factory and the story of the butcher, the baker and the brewer have become familiar economic parables, the story about boats has fallen into relative obscurity, only occasionally quoted by authors writing about globalization or ancient history. Why? Perhaps because while Smith draws out the division of labor from the story of the pin factory, he barely skims the surface of the story of the boats. Yes, his observations are accurate, yes his observations are interesting, but he doesn’t securely anchor water-carriage to the larger concept of the extent of the market, or connect either to a simple, core principle. After the clarity of Chapter I and the eloquence of Chapter II, the unrefined genius of Chapter III is easy to gloss over.

Boats essentially reduce the time it takes to exchange things. So do roads, so do carriages, and so do cars, trains, and planes. If Smith lived today, he would agree. Though static, cities reduce the time it takes to exchange things, much like boats. In Chapter III, Smith recognizes that the division of labor is greater in a large town than in the countryside, and so I judge that again, he would agree. However, other institutions that Smith does not mention in Chatper III also serve the same purpose. Money reduces the time it takes to exchange things by allowing the teetotaler butcher to easily purchase bread from the vegetarian baker who buys beer from the carnivorous brewer. In a barter economy such a three-way exchange would certainly be possible, but it would probably not be as easy. Traveling merchants reduce the time it takes to exchange by matching farmers or artisans to buyers in distant villages. Retailers with permanent shops allow consumers to quickly compare and purchase a wide range of goods. Financial institutions and debt markets reduce time spent waiting for paychecks or for enough savings to make a large purchase.

The jump then is to recognize that the time required to exchange, not the extent of the market, acts as the true limit to the division of labor. Smith’s story of boats nears but never quite makes the jump. Different economic thinkers have approached this idea from a thousand different angles over the years, but have never quite landed on a single, universally agreed upon definition; a shame, because when appended to a model of the economy, a limit to exchange makes a whole lot of sense.

Adam Smith deserves his reputation as the father of economics, and the modern penchant for beginning books (including this one) with one or two of his quotes has not yet become cliché. But he wasn’t infallible, and to call for a return to “the economics of Adam Smith” is to argue for a dismissal of two hundred and fifty years of the accumulation of knowledge. Adam Smith’s stories are a useful beginning, and it is our task to draw the principles out.

[1] Sort of. Smith’s actual date of birth is unknown, but he was baptized on June 5th, the same day as Keynes’ birth 163 years later.
[2] The term “economics” was not commonly used until the late 1800s. 
[3] In my introduction, I used the story of the butcher, the baker and the brewer to explain the three constraints that define economies of exchange, although as economic minimalist and former vegetarian, I decided to ditch the butcher.

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