Smith on growth and companies

One of the delights of this handsome new edition of Smith's Wealth of Nations is a wonderfully fatuous preface by George Osborne, who shows no sign of ever having read Smith, or indeed of ever having spoken to someone who has.
Osborne says that Smith's answer to the question of how to increase prosperity was "universal": "He recognized that it is the freedom to trade and compete that promotes individual interests and which also generates the wealth of nations."
The problem is, Smith's account of this process gives no place for Osborne's paymasters, companies.
The first sentence of the Wealth of Nations is:

The greatest improvement in the productive powers of labour, and the greater part of the skill, dexterity, and judgment with which it is any where directed, or applied, seem to have been the effects of the division of labour.

In turn, the division of labour is the result of a natural human impulse. It is "the necessary, though very slow and gradual, consequence of a certain propensity in human nature...; the propensity to truck, barter, and exchange one thing for another." For example:

In a tribe of hunters or shepherds a particular person makes bows and arrows, for example, with more readiness and dexterity than any other. He frequently exchanges them for cattle or for venison with his companions; and he finds at last that he can in this manner get more cattle and venison, than if he himself went to the field to catch them. From a regard to his own interest, therefore, the making of bows and arrows grows to be his chief business, and he becomes a sort of armourer.

Here we have an account of how men, given freedom, will develop the division of labour, markets and hence prosperity.
But there's a problem. In the real world the division of labour is mediated not merely by market exchange but by hierarchically-ordered companies. In Smith's famous pin factory the drawer of the wire does not sell his product to the straightener of wire, but is ordered to hand it over.
What's more, Smith gives us two reasons why this variant of the division of labour might not promote prosperity.
One is that companies, when owned by external shareholders, are wasteful:

The directors of such companies, however, being the managers rather of other people's money than of their own, it cannot well be expected that they should watch over it with the same anxious vigilance with which the partners in a private copartnery frequently watch over their own. Like the stewards of a rich man, they are apt to consider attention to small matters as not for their master's honour, and very easily give themselves a dispensation from having it. Negligence and profusion, therefore, must always prevail. (Book V ch 1.107 here)

Secondly, in companies, we lose one of the benefits of the division of labour - that in focusing men's knowledge upon a single object, they are more likely to "find out easier and readier methods of performing their own particular work."
It's easy to see how self-employed artisans have an incentive to improve productivity. But workers employed by others need not have such an incentive, or indeed the freedom to find such methods.
Smith's story of how freedom promotes prosperity, therefore, gives no place to companies - quite the opposite.
Now, there are several possible reactions to this. One is that Smith's account is incomplete, and that companies can promote growth. But then we weaken the link between freedom and growth, and Smith's prescriptions cease to be "universal."
Another is that Smith was in fact (partly) right, and firms can impede efficiency, growth and freedom.
But that's not what Osborne wants to read.

Comments

[James Deacon]

This is the worst blog post I've evr read.

[Gavin Kennedy]

Chris seems to restrict the benefits of the division of labour to independent people in ‘tribes of hunters or shepherds’, or to artisans, but not, for some reason, to companies (presumably even those run by Marxists) and he develops a theme that “the division of labour might not promote prosperity” when companies are formed.

This is a highly problematical assertion, especially when Chris bolsters his case by selectively quoting (WN V.i.e.18: p 741) from Smith’s criticism of joint-stock companies, as if the problems Smith’s alludes to about the ‘Chartered Trading Companies’ in the 18th century were analogous to shareholder companies in the 19th thru 21st centuries.

The contexts to which these and similar quotations refer cannot be separated from the institutional forms of the joint-stock trading companies, such as the East India Company to which Smith refers, and should not be attributed to the joint-stock shareholder companies of 19th century capitalism and beyond. These, unlike their 18th-century counterparts, are highly regulated by the Company Acts (as anybody running a limited company, let alone a Plc. can testify).

Smith’s critique of the corrupt colonial trading companies, granted monopoly status by Royal Charter or Acts of Parliament, and mostly operating up to a year’s return sailing time in, say, India (and therefore basically unsupervised, which is, universally, a sure recipe for malfeasance, perfidy and cruelty. Smith’s critique cannot be transferred with integrity by assumption to all joint-stock operations.

Indeed, Smith speaks highly of both the Bank of Scotland (1695) and the Royal Bank of Scotland (1727), which were joint stock companies, but neither had monopoly privileges. And for Smith that was the crucial difference; competition is one protection against directors acting against the public interest, and this applies to artisan tradesmen, partnerships, modern companies and multi-nationals (and to commissars in Soviet-run economies).

Chris argues further than companies operate a ‘variant of the division of labour [that] might not promote prosperity’. This is a weak case from reading Adam Smith on the division of labour. In his day, most workshops were fairly small affairs; owners of forges, pin factories, nail-makers, tanning works, spinning or weaving sheds, shipbuilders, coal mines, carriage makers, wheel makers, wholesale traders, and such like, employed a few to 20 or so employees.

Chris says: ‘In companies, we lose one of the benefits of the division of labour - that in focusing men's knowledge upon a single object, they are more likely to "find out easier and readier methods of performing their own particular work."
It's easy to see how self-employed artisans have an incentive to improve productivity. But workers employed by others need not have such an incentive, or indeed the freedom to find such methods.’

Now given that Smith (WN Book I, chapters 1,2,3) makes the point that the natural outcome of the division of labour was, initially at least, to raise labour productivity, this increased employment for labourers, and because more than one person is required to divide tasks among, it is inevitable that an artisan, noting how to gain the benefits from a division of labour (incentives!) would have to increase the numbers employed in his shop. Therefore, to leave the benefits of the division of labour to a self-employed artisan alone would only take the division of labour so far on Chris’s argument.

This was an improvement on single-labourer operations, but is no way to ensure continuing increasing returns. Indeed, the productivity gained from the division of labour, while significant even under the conditions of employing 10-20 labourers, would soon maximise.

Smith's 'third' advantage of the division of labour (after ‘dexterity’ and ‘time saving’) is ‘the invention of a great number of machines which facilitate and abridge labour, and enable one man to do the work of many’ (WN I.i.5: p17). Smith’s examples were what he saw in the small workshops of his time; this process was not limited to that situation.

Smith writes:

‘All the improvements in machinery, however, have been the inventions of those who had occasion to use the machines. Many improvements have been made by the ingenuity of the makers of the machines, when to make them because the business of a peculiar trade [e.g., ‘philosophers’] (WN I.i.9: p 21).

The 19th century experience of pin-making, with power-driven machinery, saw output per worker, operating machines that did most of the operations previously done by 18 men in 18th-century pin factories, were now done by a handful of men who produced millions of pins, in only 20 pin factories compared to the hundreds of such plants in Smith's day.

Moreover, the whole history of the inventions of machinery (James Watt) and new labour processes (Wedgwood, etc.,), show that companies, employing scores, hundreds, and thousands, have every incentive to search for new divisions of labour, new sources for their supply chains, and new products, and, looking at what has been achieved in productivity, this clearly happened under capitalism.

Whatever Chris Dillow’s points are, they are not supported either by Smith’s text nor in history and nor by experience today

[Keith]

Well, I think Chris has correctly identified the gulf between Adam Smith and modern self-proclaimed free-marketeers. They are not interested in any wealth other than their own. They proclaim a free market, but actually support one obscenely biased by power relationships and other distortions. They say freedom and prosperity, they provide servitude and poverty. Don't listen to them, watch what they do.

[B4L]

I took the original article to be about how *freedom* can promote productivity, and how companies can erode that same productivity. Gavin, I don't think anybody is unaware that mechanisation and the division of labour can/do both raise *overall* productivity, but whatever the individual gains from higher wages/shorter hours must be set against their loss of freedom/autonomy.

[Gavin Kennedy]

Chris may write a post linking freedom to productivity, or any such theme, to which I would not have the slightest objection and would judge his ideas on their merits.

But when he links ideas to Adam Smith which were not his ideas, nor supported in his Texts, then I am bound to comment for historical accuracy and in defence of Adam Smith's legacy.

[B4L]

Chris did write that post, it seems to me, supporting it with Smith's own words. It may not be a complete picture, but the productivity v. individual autonomy debate does seem more interesting and worthwhile than being told again that we should be grateful for the (unrelated) productivity advantages that come from large-scale organisation, ducking the question of how the *original* benefits come to be lost through the way these organisations (try/struggle to) manage themselves, whether monopolist or not.

[Kevin Carson]

Although the joint-stock companies Smith referred to were different in many ways from the corporations of today, the latter still have many of the same information and agency problems.

Mises' utopian visions of entrepreneurial control of the corporation through the magic of double-entry bookkeeping, and likewise Manne's "market for corporate control," both begged the question of how meaningful the data can even be that's generated from inside the corporation. Apparent profit rates often reflect the sorts of gaming that Robert Jackall called "starving" or "milking": i.e., stripping an organization of assets, deferring the most basic and necessary of maintenance costs, and generally running it into the ground in order to inflate the short-term balance sheet. That's the sort of stuff Nardelli got a $200 million bonus for.

And within the corporation, the agency problems created by absentee capitalist ownership and a managerial hierarchy conflict considerably with making meaningful use of the Hayekian distributed knowledge of production workers.

The hierarchical corporation, with all its agency costs, is from the capitalist standpoint the most inefficient choice of organizational form except for all its competitors. Self-managed workplaces, producer co-ops, and other forms of residual claimancy by labor all tend to make spectacular reductions in monitoring and agency costs, and to be much more effective at process innovations. The problem is that all these forms require actually giving the worker the fruits of his innovation and productivity. Hence, the hierarchical corporation, which is (to borrow Drucker's phrase) an efficient mechanism for doing what ought ought not be done at all. The corporate hierarchy is a Rube Goldberg contraption for overcoming agency problems to the limited extent possible, given an organization full of people who have no intrinsic motivation and no rational interest in what they're doing.

[dsquared]

[What's more, Smith gives us two reasons why this variant of the division of labour might not promote prosperity.]

Given how things actually developed over the last two hundred years, could we not consider the possibility that Smith might have been *wrong* about the joint stock company and see what might be salvaged from the rest of his economics, rather like we do with Marx?