April Freeman Banner 2014


Whatever Happened to the Division of Labor?

A neglected concept in development economics.


Very early in The Wealth of Nations Adam Smith discusses the concept of the division of labor and its importance for economic development. That discussion, so central to Smith’s framework, appears in some form in nearly every introductory textbook in economics and is one of the ideas most closely associated with Smith. (I would say it’s at least on a par with the concept of the invisible hand.)

In Book 1, Chapter 1 Smith explains how dividing a particular task into several stages of production, with a different person or firm responsible for one or more stages, multiplies the output of a day’s labor many times. His example of the pin factory has become iconic in the history of economic ideas:

“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…” and so on. He informs us that one person doing all 18 steps on his own might at most produce 20 pins in a day; but that he has seen a pin factory in which ten people, each specializing in a subset of those steps, collectively produces as many as 48,000 pins in a day. The average output of each worker then becomes 4,800 pins, or 240 times greater than if each were to work alone.

Its Minor Role in Mainstream Economics

For Smith the division of labor (DOL) thus plays a crucial and ongoing role in the material progress of society, and it holds a central place in the intellectual tradition of the classical economics he inspired.

Yet—and I’m sure I’m not the first note this–the DOL seems to do little of the theoretical heavy lifting in modern treatments of economic development.

For example, textbooks draw on some aspects of the DOL to explain why people, firms, and countries tend to specialize in activities where their opportunity costs are lowest. But that (static) proposition owes more to Smith’s follower, David Ricardo, than to Smith. And it doesn’t express Smith’s more important insight that as the DOL expands (with the extent of the market) it lengthens and increases the complexity of the production process within firms and across firms in the economy, continually multiplying output and sparking some forms of innovation. That seems to have pretty much disappeared from the modern mainstream. Why?

One Possible Explanation

I believe it’s because mainstream economics treats production as timeless and capital as homogeneous. That is, it describes production as an instantaneous transformation of inputs into output. In mathematical form: Output = f(Labor, Capital), where “f” stands for a mathematical function that turns labor and capital into output. Now “capital” in this expression would have to stand for the wire, the cutters, the whitener, and other things that go into pin production, which implies that all kinds of capital inputs are perfectly interchangeable with one another–that is, homogenous. For some purposes that may be a useful simplifying assumption, such as when explaining why adding units of (homogenous) capital at some point increases output at a decreasing rate, the principle of the diminishing marginal product.

But treating production as timeless and capital as homogenous doesn’t allow us to distinguish different stages of production (or capital heterogeneity, as Austrian economists would call it) from one another and it doesn’t allow us to include the passage of time in the production process. It does, however, sometimes allow economists greatly and unhelpfully to simplify certain concepts in microeconomics, such as market competition, as well as allow them to use the kind of aggregates we see in current versions of macroeconomics, such as Keynesian macroeconomics.

Heterogeneous capital and the passage of time, or what taken together has been called the “time structure of production,” are not only features of Adam Smith’s DOL; as you might suspect, they are also essential for understanding how real economies develop. Fortunately, those Smithian insights are today still a vital part of Austrian economics, especially in Austrian theories of capital and the business cycle.

For excellent treatments of Austrian capital theory, see Ludwig M. Lachmann’s Capital and Its Structure or Israel M. Kirzner’s An Essay on Capital. For the most up-to-date thinking on capital, macroeconomics, and the business cycle, see Roger Garrison’s Time and Money, Peter Lewin’s Capital in Disequilibrium, and Steven Horwitz’s Microfoundations and Macroeconomics.

Many libertarians harbor an understandable suspicion bordering on hostility toward modern macroeconomics, given the crony bailouts and economy-distorting stimulus policies that a number of macroeconomists have advocated in recent years. Beware though of tossing the Smithian baby out with the Keynesian bathwater!



Sandy Ikeda is an associate professor of economics at Purchase College, SUNY, and the author of The Dynamics of the Mixed Economy: Toward a Theory of Interventionism. He will be speaking at the FEE summer seminars "People Aren't Pawns" and "Are Markets Just?"

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