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Adam Smith at 300

Jun 24,2023 - Last updated at Jun 24,2023

CAMBRIDGE — This year marks the 300th anniversary of the birth of Adam Smith, the founding father of modern economics. It comes at a time when the global economy faces several daunting challenges. Inflation rates are the highest since the late 1970s. Productivity growth across the West remains sluggish or stagnant. Low- and middle-income countries are teetering on the brink of a debt crisis. Trade tensions are rising. And market concentration has increased among OECD countries.

Against this backdrop, Smith’s tercentenary is an opportunity to reflect on his invaluable insights into the dynamics of economic growth and consider whether they can help us understand the current moment.

At the heart of Smith’s theory of economic growth, outlined in the first chapter of his seminal work The Wealth of Nations, is the specialisation facilitated by the division of labor. By breaking down production into smaller tasks, a process illustrated by Smith’s famous example of the pin factory, industrialisation enabled enormous gains in productivity.

But this process is not confined to individual firms. Since the division of labor, according to Smith, is “limited by the extent of the market”, the market as a whole must expand through exchange. After all, boosting daily widget production from 100 to 10,000 is pointless if no one wants to buy widgets. So, the division of labor is a collective process that involves a continuous process of structural economic change. When there is a larger supply of affordable widgets, the widget-using sectors of the economy can expand production and reduce prices. Meanwhile, the market’s increased size would allow upstream suppliers of materials required to produce widgets to reorganise production into more specialised tasks.

As the American economist Allyn Young noted in 1928, this is a dynamic story of increasing returns. The growth process is a virtuous circle of structural change that starts slowly and then accelerates, like an avalanche. The Industrial Revolution and the rapid growth of East Asia’s “tiger” economies during the 1980s and 1990s are perfect examples of the process Smith identified. And yet the stagnant growth that has plagued developed economies over the past decade raises the question of whether global progress toward what he described as “universal opulence” has ground to a halt.

Although the division of labour into specialised tasks has often enhanced the skills and expertise of workers, this may not always be the case. The emergence of generative artificial-intelligence models has fuelled concerns that employers will use these technologies to deskill human workers and cut costs, prompting calls for regulatory interventions to ensure that AI augments, rather than replaces, human capabilities.

Moreover, while economic growth since the onset of the Industrial Revolution has led to astonishing advances in health and well-being, it is important to recognise that the institutional frameworks and political choices that enabled this progress were the result of intense social struggles.

Another concern that is often overlooked stems from market size. Smith would likely have been shocked by the extent of specialisation in the twenty-first-century economy (and probably also pleased with his foresight). Today, manufacturing relies heavily on complex global production networks. Final products such as automobiles and smartphones comprise thousands of components manufactured in multiple countries. Many of the intermediate links in those supply chains are extraordinarily specialised. The Dutch company ASML, for example, is the only producer of the ultraviolet lithography machines needed to produce advanced chips, most of which are manufactured by the Taiwan Semiconductor Manufacturing Company (TSMC).

But the widespread nature of this phenomenon suggests that the global market for many products can sustain only a few companies capable of achieving economies of scale. This has long been the case for large manufacturers in sectors such as aerospace, but it increasingly applies to smaller markets for intermediate components.

Consequently, Smith’s other condition for economic growth, the presence of competition, is not met. Competition helps to ensure that economic growth is socially beneficial, because it prevents firm owners from monopolising the benefits of specialisation and increased exchange. As Smith put it in The Wealth of Nations, “In general, if any branch of trade, or any division of labour, be advantageous to the public, the freer and more general the competition, it will always be the more so.”

Although the decline of competition has been a growing concern in Western economies over the past few years, the debate has largely focused on high-profile sectors within domestic markets, such as Big Tech. Policymakers on both sides of the Atlantic have responded to concentration in the tech industry with new laws, such as the European Union’s Digital Markets Act, and tougher enforcement of existing antitrust laws, such as the US Federal Trade Commission’s recent decision to block Microsoft’s takeover of Activision.

The deeper policy question, however, is whether the level of specialisation in certain markets has reached a tipping point where there is a trade-off between Smith’s two prerequisites for growth. Has the division of labor reached its limit, and is the need to enhance competition therefore another reason to diversify supply chains and develop new sources of supply of production?

 

Diane Coyle, professor of Public Policy at the University of Cambridge, is the author, most recently, of “Cogs and Monsters: What Economics Is, and What It Should Be” (Princeton University Press, 2021). Copyright: Project Syndicate, 2023. www.project-syndicate.org

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