ourselves.
Extending this division of labour a little further up the scale, it becomes clearly beneficial if there is specialization by firms. A modern car is made up of many hundreds of components manufactured by different firms. Such specialization enables the cost of the car to be much lower than if a single firm attempted to make every part. In the 1980s there was a revolution in British industry when manufacturing firms contracted out to independent suppliers many tasks, from cleaning and maintenance to distribution. They were following Adam Smith.
The process does not have to end within countries. The argument in favour of foreign trade, indeed of free trade, is essentially a division of labour argument. With the right investment in hot-houses and specialist equipment, Britain could in theory provide for all her wine needs and never import a drop from abroad. It makes more sense, however, to buy it from countries with the climate and expertise to do it better and more cheaply. The basis of trade is that countries specialize in the things they are best at. The gains from trade result from this specialization. This is why action to restrict trade usually impoverishes us all. What happens if a country is no good at anything? I’ll come back to that later.
The invisible hand
The part of The Wealth of Nations that every schoolchild knows – or if not they should – gives us Smith’s most famous idea. He wrote: ‘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 their self love.’
To understand it fully, it is necessary to tie it to another, related section which, in slightly edited form, reads: ‘Every individual who employs capital and labours neither intends to promote the public interest nor knows how much he is promoting it … he is led by an invisible hand which was no part of his intention. By pursuing his own interest he frequently promotes that of society.’
What was this invisible hand? Because of its later importance, you might think there are references to it dotted throughout the pages of The Wealth of Nations . In fact the above is the only one. Some writers have speculated that it could have had religious connotations; others that Smith unconsciously lifted it from Shakespeare’s Macbeth , where there is a reference to the ‘bloody and invisible hand’.
There is no need to get too fancy about this, however. What Smith was sketching out was the market mechanism, the laws of supply and demand we have already touched on, although it was left to later economists to fill in the details. This was no paean of praise to businessmen. Whenever they met ‘the conversation ends in a conspiracy against the public, or in some contrivance to raise prices’. The point was that the market did not let them get away with it, or at least not for long. Customers would abandon profiteers in favour of competitors offering lower prices. Attempts by groups of firms to fix prices by agreement – forming a cartel – would fail as long as it was possible for new firms to enter the market and undercut them. The invisible hand is the market, and through its operation the best possible, or optimum, outcome is achieved. Of course in any economy there will be lots of different markets, not only for all the various products and services, but also, for example, for labour. One of the great debates sparked off by Smith was, in fact, over labour. What was to stop workers being permanently exploited in this new industrial revolution, of being paid no more than necessary for the very basics of existence? Smith pointed out not only that competition for workers among employers would make this unlikely but also that the process of industrialization and of the development of mass market products would require that workers – as the new consumers – be paid above the subsistence level,
Extending this division of labour a little further up the scale, it becomes clearly beneficial if there is specialization by firms. A modern car is made up of many hundreds of components manufactured by different firms. Such specialization enables the cost of the car to be much lower than if a single firm attempted to make every part. In the 1980s there was a revolution in British industry when manufacturing firms contracted out to independent suppliers many tasks, from cleaning and maintenance to distribution. They were following Adam Smith.
The process does not have to end within countries. The argument in favour of foreign trade, indeed of free trade, is essentially a division of labour argument. With the right investment in hot-houses and specialist equipment, Britain could in theory provide for all her wine needs and never import a drop from abroad. It makes more sense, however, to buy it from countries with the climate and expertise to do it better and more cheaply. The basis of trade is that countries specialize in the things they are best at. The gains from trade result from this specialization. This is why action to restrict trade usually impoverishes us all. What happens if a country is no good at anything? I’ll come back to that later.
The invisible hand
The part of The Wealth of Nations that every schoolchild knows – or if not they should – gives us Smith’s most famous idea. He wrote: ‘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 their self love.’
To understand it fully, it is necessary to tie it to another, related section which, in slightly edited form, reads: ‘Every individual who employs capital and labours neither intends to promote the public interest nor knows how much he is promoting it … he is led by an invisible hand which was no part of his intention. By pursuing his own interest he frequently promotes that of society.’
What was this invisible hand? Because of its later importance, you might think there are references to it dotted throughout the pages of The Wealth of Nations . In fact the above is the only one. Some writers have speculated that it could have had religious connotations; others that Smith unconsciously lifted it from Shakespeare’s Macbeth , where there is a reference to the ‘bloody and invisible hand’.
There is no need to get too fancy about this, however. What Smith was sketching out was the market mechanism, the laws of supply and demand we have already touched on, although it was left to later economists to fill in the details. This was no paean of praise to businessmen. Whenever they met ‘the conversation ends in a conspiracy against the public, or in some contrivance to raise prices’. The point was that the market did not let them get away with it, or at least not for long. Customers would abandon profiteers in favour of competitors offering lower prices. Attempts by groups of firms to fix prices by agreement – forming a cartel – would fail as long as it was possible for new firms to enter the market and undercut them. The invisible hand is the market, and through its operation the best possible, or optimum, outcome is achieved. Of course in any economy there will be lots of different markets, not only for all the various products and services, but also, for example, for labour. One of the great debates sparked off by Smith was, in fact, over labour. What was to stop workers being permanently exploited in this new industrial revolution, of being paid no more than necessary for the very basics of existence? Smith pointed out not only that competition for workers among employers would make this unlikely but also that the process of industrialization and of the development of mass market products would require that workers – as the new consumers – be paid above the subsistence level,
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