Adam Smith (1723 – 1790)

‘Wealth of Nations’, Free markets, Division of labor

The year 1776 is best known for the signing of the Declaration of Independence and the birth of the United States. However, the year also holds global significance as the year in which Adam Smith’s seminal work Wealth of Nations was published. As the first major publication on economic principles, Wealth of Nations anointed Smith as the “father of modern economics”. The book was popular largely because of Smith’s ability to explain how society’s wealth can be measured in ways other than just the accumulation of gold. Beyond being an economist, Adam Smith was a moral philosopher and an influential writer, teacher, and thinker.

Smith was born in 1723 in Kirkcaldy, Scotland and educated at both Glasgow University and Oxford. He returned to Scotland in 1746 to pursue an academic career, initially at the University of Edinburgh and later at Glasgow University. Eighteenth century Scotland was experiencing a transition in political and economic theory that mirrored those taking place across Europe and the American colonies. Influenced by the broader societal changes, Smith began putting his lectures into writing and published The Theory of Moral Sentiments in 1759. In the book, Smith argued that human morality is governed by self-interest and sympathy for others.

The success of The Theory of Moral Sentiment and his proficiency as a lecturer increased Smith’s popularity across Europe. This led to an opportunity to travel across Europe for three years as the tutor for a young French duke. During his travels, he visited with many influential thinkers of the French enlightenment and had conversations that influenced his thinking about agricultural productivity. Upon returning to Scotland, Smith began documenting his thoughts in the Wealth of Nations.

In the 1600s and early 1700s, mercantilism was the dominate economic system. Under mercantilism, countries competed to maximize exports and limit imports, with an aim to generate wealth in the form of stores of gold. To maximize gold stores, economic markets were controlled by governments sponsoring large monopolies, such as the East India Company that accounted for half of the world’s trade by the mid-1700s. Mercantilism led to many unfavorable practices such as imperialism, colonialism, and slavery.

American colonists began to tire of British control during the mid-1700s and began expressing opposition to mercantilism and British taxes. Under mercantilism, colonists were not permitted to manufacture many of their own goods. They had to import things like tea, sugar, and textiles and exported only a few goods, such as tobacco and lumber. The infamous Boston Tea Party in 1773 was a protest against import taxes (tariffs) on tea. The colonists protested and eventually revolted against British mercantilism. Mercantilism influenced several of Smith’s lasting economic principles.

As a replacement for mercantilism, Smith proposed a system of free trade, details of which were provided in his now famous book, An Inquiry into the Nature and Causes of the Wealth of Nations (more commonly known as The Wealth of Nations). Among other ideas, the book introduced two groundbreaking economic concepts, the Invisible Hand and Division of Labor.

The Invisible Hand

The Invisible Hand principle conceptualizes a Free Market System in which individuals act in self-interest when buying and selling goods, i.e., government interference is minimized. Smith suggested this practice leads to prosperity because individuals participate directly in the economy. In a free market, the invisible hand of the market (individuals demanding goods and services) creates demand. Individuals and groups then compete to meet that demand. Prices are a function of demand and supply. Those more successful in meeting demand accumulate more wealth. The free market principle stands in contrast to a government-controlled economy in which governments control supply and price by explicitly controlling markets or influencing markets through trade policy and taxation. Many years after Smith died, his idea of a free-market economy evolved into what is now known as Capitalism.

Division of Labor

Self-interest and free markets create an incentive for individuals and groups to produce goods and services cost efficiently. Smith theorized that efficiency would be improved through, what he termed, Division of Labor, i.e., dividing a job into distinct tasks and assigning each task to a separate individual or group. The “specialization” of production tasks would lead to more efficient and productive use of resources,  and thus more wealth.  For example, instead of Jill making bread, raising cows, and sewing clothes, Jill will make bread, Joe will raise cows, and Tim will sew clothes.  Specializing on one task allows a laborer to be more efficient and the manufacturer to make more product with the same amount of labor. A surplus could then be traded for the surplus of others.

Smith famously illustrated the ‘specialization of labor’ idea by proposing an 18-step process to make a hair pin. He claimed that if one person had to complete all 18 steps they could only make a few pins per week. However, if those steps were split between ten people, then thousands of pins could be manufactured weekly. He claimed that workers who specialize get faster and better at their one job and can quickly move from one pin to another . However, workers who must do all the jobs have to be good at many things and thus take more time transitioning between tasks, slowing overall production time.

…the advantage which is gained by saving the time commonly lost in passing from one sort of work to another, is much greater than we should at first view be apt to imagine it.”

Smith proposed that ‘division of labor’ required two main conditions to be successful: a free market and communities large enough to support task specialization. More people also means more and varied producers and more consumers demanding different goods and services. Ultimately, Smith argued that a free and sizable market provides stability to support division of labor.

The Big Idea for Operations Management

The ideas of Adam Smith influenced the views of societal wealth and provided impactful strategies that quickly became important to the success of the industrial revolution. His ideas pushed forward the idea of free and open markets driven by competitiveness and efficiency.
This led to thinking about how to make product and services with lower costs in order to sell at more competitive prices. The division of labor concept critically altered the world view of manufacturing and it largely shapes modern manufacturing. As we will discuss later, the concept of an assembly line hinges on one individual being very good at one specific task.  While an assembly line is only one type of production process¹, it is the cornerstone of modern high volume production.

Sources

[1] R. H. Hayes and S. C. Wheelwright, Restoring our Competitive Edge: Competing Through Manufacturing. New York, NY: John Wiley & Sons, 1984.

[2] A. Hayes, “Adam Smith and ‘The Wealth of Nations,’” Investopedia, 2022. https://www.investopedia.com/updates/adam-smith-wealth-of-nations/

[3] R. Hanley, Adam Smith: His life, thought, and legacy. Princeton University Press, 2016.

[4] D. Henderson, “Adam Smith on U.S. Independence,” EconLog, 2012. https://www.econlib.org/archives/2012/07/adam_smith_on_u.html

[5] A. D. Dow and S. Dow, A history of Scottish economic thought. Taylor & Francis, 2006. doi: 10.4324/9780203486238.

[6] National Geographic, “Colonial Trade Routes and Goods,” National Geographic, 2022. https://education.nationalgeographic.org/resource/colonial-trade/