Adam Smith’s Fallacy of Productive Labor

Photo by Anna Shvets on Pexels.com

This concept has been submitted to the Journal of Brief Ideas.

https://beta.briefideas.org/ideas/f19f83884619d0642e5713c18c96fe88

Adam Smith’s Fallacy of Productive Labor

Adam Smith was the brilliant moral philosopher who dispelled us of the persistent myths of mercantilism. However, as prescient as Smith was, he was far from being above reproach. One example was his inability to solve the Diamond-Water Paradox. Smith being unable to explain the Diamond-Water Paradox was not his only shortcoming. In his economic treatise, The Wealth of Nations (Book II, Chapter III) (1776), Smith surmises that any work that does not result in producing tangible goods is unproductive labor.

Smith writes: “…The labor of some of the most respectable orders in society…unproductive of any value.. does not realize itself in any…vendible commodity..”(p.423). Smith was even bold enough to add lawyers and physicians to the list of unproductive contributors in the workforce. This mistake is a corollary of the labor theory of value, the same principle that hindered his ability to address the value paradox. The value of a product or service is not determined by the amount of labor required to produce it but by whether consumers value it. If consumers values an intangible service and firms can provide such services and yield profits, then whether the enterprise creates tangible goods is immaterial.

The Paradox of Protectionism and Domestic Production

Photo by Frans Van Heerden on Pexels.com

This concept has been submitted to the Journal of Brief Ideas.

The Paradox of Protectionism and Domestic Production:

Economic protectionism is a fallacy that has never been extinguished but persists with varying degrees of political support from elected officials. Although, most economists agree that protectionist measures such as tariffs have a detrimental impact on the economy. Per William Poole’s Federal Reserve paper Free Trade: Why Are Economists and Noneconomists So Far Apart? (2004), 90 % of economists oppose tariffs citing that “.. tariffs…reduced the average standard of living..”. It is well established that tariffs operate like an implicit tax to consumers, but how do restrictions on imported goods impact domestic production?

Currently, many domestic industries rely on imported intermediate goods for producing finished consumer goods. Adam Smith was one of the first theorists to realize that tariffs harmed domestic production. Smith suggests in the Wealth of Nations (Book IV, Chapter II) that domestic production of inputs is economically efficient only if it is cheaper than importing the goods. Policies that restrict imports may be favoring one segment of the supply chain; simultaneously, harming another, resulting in outcomes contrary to the purposed purpose of these measures. 

Cooperation and Conflict

Photo by Alexander Suhorucov on Pexels.com

Staying within the structure of methodological individualism it is important to see how Smith’s Pin factory example (p.54-55) exemplifies the coordination of a group of economic agents. All working in unison towards the common goal of producing pins. All of these individual works comprise the overall assembly line. The totality of all the adjacent departments related to manufacturing makes up the internal structure of the firm. Any social institution whether it be a hobbyist club, social club, buyers club (e.g. Sam’s Club, BJ’, Costco), government, business, trade association, private governing bureau/authority (e.g. homeowners association), charitable foundation, research institute, study group, etc. are comprised of multiple individuals forming the group. It is flat-out erroneous to speak of the entire organization without any consideration for its members. The collective action of all the group members acting harmoniously to achieve the same ends is much more complex than treating these collective efforts as lumped together aggregate.

Each member of an organization has their internal objectives, thoughts, feelings, and desires. It can be said that all the active participants have their utility functions (p.25-26). Meaning that to some extent their wants, needs, and desires align with the overall group goals. For example, very few people like their jobs, but they voluntarily consent to the terms of employment because of their desire to earn money. Whether it is for the intrinsic satisfaction of possessing money or what currency can be redeemed for. Keeping within the theme of a Smithian analysis of social institutions, it is important to note that more than tangible goods are exchanged through interaction with others. We exchange ideas, culture, skills, knowledge, friendship, guidance, sympathy, morality, and moral support among other forms of desirable forms of social currency. Political activities tend to be a form of social association that is frequently marred by corruption and various forms of abuse. However, is the dynamic of politics overtly a zero-sum game? Not necessarily. As it can be viewed as a form of exchange, individual actors engage in various exchanges for mutual benefits (p.25). One example being logrolling the practice of lawmakers trading votes/favors.

The intangible exchange of social commodities cannot be understated in formulating effective working relationships. One crucial assumption of Smith’s Theory of Moral Sentiments (1759) that we seek the “approbation” of others. In other words, we seek to praise and approval from others. We are constantly seeking the acceptance of our peers. Being well-liked on the individual level wields a significant amount of social currency. If the ability to seek acceptance and cooperation is applicable on the individual level, couldn’t it also apply to the harmonious relationships between groups of people? After all the scope of social and economic interactions operates on a continuum of scale, what is applicable on a minuscule level should also work on a larger scale. The principle is a general maxim governing social interactions, therefore it should be transferrable. One of the best ways to overcome cultural barriers is through finding a form of social exchange desired by both parties. It does not mean that it must take the form of economic exchange. It possibly manifests itself in alliances and treaties among nations. Special agreements, pacts, contracts among nonpolitical social units. Most often it takes the form of economic trade between foreign nations. The necessity of unilateral trade agreements is refutable. Consumer sovereignty is the true impetus of international trade. Despite the bluster and theatrics of vociferous diplomats and other garden variety elected representatives.

Why voluntary association over other coercive means do we yield harmonious interactions? There isn’t a magic bullet answer to this question. However, some insights from Public Choice pioneer Gordon Tullock may help elucidate a potential variable that sheds some light on this occurrence. It is the ability to choose our partners in voluntary social arrangements that reduce the instance of Prisoner’s Dilemma. If our trading partner is not being cooperative, we can easily do business with someone else. Because of the mobility of free association (which is purportedly protected under the First Amendment) we do not need to be held captive by aggressive or hostile social relations. Due to this consideration, it is easy to see the original sentiment behind antitrust laws, but much like all laws, they suffer from loopholes and other issues. Even from the standpoint of the definition of a monopoly. One of the common attributes of monopolistic market behavior is assessed by is market concertation. However, this is problematic how do we determine which market is categorically correct for the assessment of market concentration? Nevertheless, we can freely choose our partners whether in trade or other forms of social situations it reduces the occurrence of the perverse incentives to be noncooperative. Sullying our reputation deprives us of the esteem that Adam Smith surmised we all crave.

Considering that trade is one of the forms of association that fosters cooperation. Even if free trade is not the key to world peace, it still makes us less apt to raise the sword to our geographic neighbors. To repudiate the previous administration’s trade policy, international trade should be encouraged. It is only natural to perceive David Ricardo’s concept of comparative advantage as an extension of Smith’s pin factory.  The premise of comparative advantage is that it can make production global and explains why we tend to import higher-order goods to produce commodities domestically. No one climate can best produce glass, grapes, and corkwood in the Cognac region of France. However, all of these components are required for assembling a commercially produced bottle of Cognac brandy. This specific region in France has some of the best grapes in the world for brandy production. The climate is wholly inappropriate for cultivating and harvesting the wood used in the stopper placed in every Cognac bottle. To avoid placing great restrictions on our ability to manufacture sophisticated goods, we need to trade with other nations. We can only truly achieve this through peaceful relations. Free trade in itself helps to facilitate peaceful relations.

Adam Smith’s Pin Factory

Photo by ELEVATE on Pexels.com

Below is Adam Smith’s famous Pin Factory example detailing the benefit of a specified Division of Labor. This single paragraph has evolved to be one of the most heavily referenced tropes in all of political economy. Detailing the advantage of job specialization over having one person complete production from start to finish. The proliferation of job specialization is what has allowed for technological advancement and the development of more complex goods.

“…TO take an example, therefore,’-‘ from very trifling manufacture; making, 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; mad 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…”(Wealth of Nations, 1776, p.54-55)

See Interactive Pin Factory at Adam Smith Works (Click Here).

Can Adam Smith Help Us Recover From COVID-19?

Photo by Yaroslav Danylchenko on Pexels.com

Over the past year, the COVID-19 pandemic has completely turned society upside down. Plagued by uncertainty the entire planet was alarmed in went into full panic mode. Leading us to the immediate question of how do we contain a novel virus when its origins are shrouded in mystery? Many of these reactionary policies may have modestly slowed down the spread of COVID-19, however, most of the state-sanctioned restrictions ended up causing unforeseen problems. The shelter-in-place orders resulted in the highest recorded rate of job loss since The Great Depression. The economic ramifications of various lockdown measures go beyond the immediate consequences. There was a November 2020 study conducted by USC projecting an overall GDP loss of $3-4 Trillion over the next two years.

Lengthy book treatments could be composed to fully detail all of the intricacies of the economic carnage of COVID-19. Unfortunately, the fall-out of the pandemic reaches well beyond the economic repercussions. Our overall health has been impacted. Not necessarily by the direct symptoms of COVID-19, but by a result of the lockdown orders. People have been less active leading to weight gain, which may lower an individual resistance to the virus. While physical health may be most salient to us because it can be observed by the naked eye, what about mental health? It is well documented that social isolation is a contributing factor to depression. A multitude of stories has been published describing the psychological struggles of Americans during the pandemic. The hardnosed statistician may be quick to dismiss these narratives as being purely anecdotal. However, many of the risk factors for suicide have been magnified since the beginning of the pandemic. There has been a notable increase in the suicide rate from 2019 to 2020.

The pandemic has also fractured relations between us and our fellow citizens. Clinging to our inner circles to avoid spreading COVID-19, we begin to become more tribal. The trust we once held for our neighbors has become eroded over the past year. Anytime someone sneezes we give them the side-eye. Fostering a climate of distrust and paranoia. This distrust has manifested itself in actual hate crimes and discrimination. Some reports estimate that hate crimes against Asian-Americans increased by 150 percent in 2020. What does this have to do with COVID-19? Quite a bit. It is speculated that the outbreak originated in the Wuhan province of China (p.2). Leading some to erroneously blame people of Asian ancestry for the spread of the virus. Creating friction between various communities across the country and only serving to make an already tumultuous situation worse. Asian Americans much like all other Americans have been grappling with the stresses of the pandemic. Adding racial tensions to the mix only serves to create more division and distrust. We need trust to have a stable society. 

Could a voice from the past help us navigate these difficult times? Provide us direction in helping us heal from the carnage caused by a global pandemic? I would argue yes. That voice of reason comes from no other than The Enlightenment-era moral philosopher Adam Smith Many readers are probably thinking to themselves “… isn’t this the guy that told us to follow our self-interest. In other words, to be selfish?”. In a sense, yes. However, limiting the body of Smith’s work to the following passage is nothing more than a caricature of his overall contributions to economics, never mind moral philosophy.

“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 interest. We address ourselves, not to their humanity but their self-love, and never talk to them of our necessities but their advantages. (The Wealth Of Nations, Book IV, Chapter II, p. 456, para. 9)”

The above paragraph may be the most famous one ever written by Smith, but it does not wholly define his breadth of work. Smith believes that markets and morality were inseparable, and you could not have one without the other. At the crux of voluntary trade is interaction. If we treat each other poorly and do not foster a good-working relationship trade cannot take place. To foster strong relationships, we as a society need a firm moral backbone. Morality provides us with the precepts to facilitate just and fair interactions despite conventional wisdom, this is crucial to success in business. If you are not running your enterprise justly your client will eventually find out and choose to do patronize another vendor. 

Business ethics and social morality are intimately interconnected, one cannot exist without the other. That is why the two great works of Smith were meant to be read in tandem. The Theory of Moral Sentiments (1759) addresses social morality and The Wealth of Nations (1776) details the inner mechanics of economic exchange (catallactics). Both books dovetail together so well, reading one leaves you with a missing piece of the puzzle. COVID-19 has unquestionably harmed society economically and socially and both books contain the wisdom to help us get back on the right track. I am a great admirer of economist Don Boudreaux, but I do have to take issue with his recent assessment of Smith’s possible perception of the impact of social isolation resulting from COVID-19. Dr. Boudreaux states that Smith could certainly empathize with and rationally understand the distress caused by social isolation. I do not disagree with his inference, but I would surmise that Smith would want us to draw lessons from his work. To apply the concepts in both books to help us as a society overcome the hardships imposed by COVID-19. His work was not intended to be confined to the postulations of lofty ivory tower discussions, but also for practical application. What good is moral philosophy if it is never put to practical use? Why not look to the works of Adam Smith for guidance and solutions to help us navigate the uncertainty that is the COVID-19 pandemic?

Success By Default is Not Truly Success

Photo by Anna Tarazevich on Pexels.com

In terms of formulating effective rules, one needs to have a panoramic understanding of the potential consequences. Even the downstream outcomes are not easily foreseen. Providing some validation of F.A. Hayek’s notion of the Pretense of Knowledge. No one person, organization, or collection of governing institutions has all of the information required to plan for every scenario. Making it foolhardy to enact inflexible rules that operate as if the definite outcomes can be methodically calculated. Treading down the path of the socialist calculation debate is fruitless as the refutations on both sides of the aisle have already been exhausted. The fall of the Soviet Union alone should serve as a historical anecdote of the fallacy of planned economies.

It should be noted that information asymmetries and unforeseeable outcomes are a natural consequence of having limited information. Explaining phenomena such as cobra effects, because certain repercussions cannot be known until it is too late. These distorted outcomes as the result of flawed rules can happen on a much smaller scale than that of the national economy or a country’s legal system. Something as mundane as a birthdate cutoff to participate in youth hockey can spur some surprise inequities in the trajectory of young hockey players. This example springing from the pages of Malcolm Gladwell’s 2008 book Outliers gives us some keen insights into the potential for implicit flaws in rule formulation. Gladwell details the observations of psychologist Roger Barnsley (p.22-23) upon perusing the program of the Canadian national youth hockey championship. Barnsley noticed that the majority of the players had birthdays ranging between January and March. Is it possible that there is a certain qualitative factor distinguishing children with birthdays earlier on in the year? If we examine the zodiac symbols of those born in January and February there are characteristics that are conducive to success. However, there is little scientific merit to astrology anyhow. Barnsley had another explanation for this discrepancy between Canadian Hockey players born in January versus July. 

Barnsley astutely directs us towards the factor of birthday cutoffs for eligibility to play youth hockey in Canada. This fact was substantiated when Barnsley discovered that roughly 40 percent of all elite hockey players were born between January-March, 30 percent between April-June (p.23) Demonstrating the role of the individual player’s birthday in determining success. Having a January first cutoff, privileged prospective players born in the earlier months of the year (p.24). The main difference being that the boys born in earlier months were more physically mature. In turn, received more attention from the coaches lending this dynamic to an early delineation between talented and untalented players (p.25). Due to the difference in age eligibility cutoffs in American youth football and basketball leagues, they did not exhibit the same distortions in the distribution of talent (p.26). Engendering a Matthew Effect or what is otherwise known as an accumulative advantage. Adam Smith even points to the concept of accumulative advantage in The Wealth of NationsExplaining how in a sense the poor pay the price for the poor decisions of their forefathers. 

Many proponents of meritocratic social arrangements may scoff at the idea of making rules that are fair. However, if the rules are providing a lopsided advantage to one group, are the results truly the result of superior performance or the distortion created by the rules? Few would ever view the occurrence of instances of regulatory capture or rent-seeking as a triumph of free-market competition. Rather just the opposite, it is an example of interest groups bending the rules to suit their own needs. Careful consideration needs to be made in how we set and enforce rules to avoid distorted effects that handsomely benefit a few and harm a great many. Gladwell succinctly sums up this point very eloquently: 

“Because we cling to the idea that success is a simple function of individual merit and that the world in which we all group up and then we choose to write society don’t matter at all.” (p.33)

While variables such as luck, talent, ingenuity, and hard work can all have a role in success, we cannot forget that how the rules are written can also have an inseparable impact on outcomes. Even rules that are inadvertently written in a manner to favor one group over another without consideration of merit is a flawed rule. Marred by an unforeseeable blind spot that nevertheless has generated distorted outcomes. These outcomes are not truly the byproduct of talent or work ethic but by technicalities that create illusory perceptions of actual skill.