Download Smith, Marshall and Young on Division of Labor and Economic Growth

Smith, Marshall and Young on Division of Labor
and Economic Growth
Andrea Lavezzi¤
University of Pisa
[email protected]
Abstract
The aim of this paper is to reconstruct the theory of division of
labor and economic growth proposed by Adam Smith and developed
by Alfred Marshall and Allyn Young. In their approach division of
labor is the main engine of growth and plays a central role in capital
accumulation and technological progress. We suggest that, according
to their theory: 1) economic growth is endogenous; 2) it has the nature
of a cumulative, path-dependent process and 3) it can be described as a
disequilibrium process, supported by competitive forces. We argue that
these aspects make the contributions of Smith, Marshall and Young
still insightful for the development of growth theory, even in the light
of the modern approach of endogenous growth theory.
1
Introduction
The issue of economic growth regained importance in the economic profession with the development of endogenous growth theory (EGT). Romer
(1986) and Lucas (1988) are the …rst relevant contributions in which the
long-run growth rate of the economy is determined within the theoretical
model. In the family of endogenous growth models, this result generally
depends on the possibility to avoid diminishing returns from capital accumulation. Therefore, EGT overcomes the main problem of the neoclassical
model of Solow (1956), namely the lack of an explanation of the long-run
rate of growth, viewed as dependent on exogenous technological progress.
The resurgence of interest in economic growth motivates this article. We
propose a historical reconstruction of the theory of economic growth based
on the division of labor, advanced by Adam Smith and developed by Alfred
¤
This paper draws on my ”Division of Labor and Economic Growth: from Adam Smith
to Paul Romer and Beyond”, presented at the Conference: Old and New Growth Theories:
an Assessment. Pisa, October 5-7, 2001. I wish to thank D. Fiaschi, M. Morroni and N.
Salvadori for helpful suggestions. I am also grateful to two anonimous referees for many
insightful comments. Usual disclaimers apply.
1
Marshall, in particular in Book IV of the Principles, and by Allyn Young.
We argue that this ”old” approach is still relevant ”for today and tomorrow
... [in particular for] ... the economic theorist” (Groenewegen 1977, p. 161).1
Among the three authors, Smith and Young were explicitly concerned
with economic growth. They viewed growth as endogenous, hence anticipating the main theme of the new growth theory. However, we assert that
the Smith-Marshall-Young (SMY) approach still challenges modern growth
theory. This paper attempts to substantiate this claim, a companion paper
(Lavezzi, 2002) compares in more detail the SMY approach to the formalization of growth based on the division of labor in EGT, proposed by Romer
(1987). Speci…cally, here we argue that growth in the SMY framework is
not only endogenous, but has also two characteristics which the modern
approach does not entirely capture. Namely, that growth is a cumulative,
path-dependent process, and that it appears as a disequilibrium process supported by competition. The latter two aspects make the ”classical” approach
essentially di¤erent from the modern one, rooted in general equilibrium.
Also, in Lavezzi (2002) we argue that the ”new” approach di¤ers from the
”old” in the following aspects: (i) for the bias towards the supply side and
the partial neglect of demand; (ii) for an excessively important role attached
to …xed costs; (iii) for the vague use of the term ”external economies”, which
may be instead replaced by ”network externalities”.
The rest of the paper is organized as follows: Section 2 analyzes Smith’s
theory. The discussion of Smith is articulated in three points: the relation
between the division of labor, technological change and capital accumulation (Section 2.1); the role of the economic network and its relation with
the extent of the market (Section 2.2); the identi…cation of the qualitative
aspects of Smithian growth (Section 2.3). Section 3 analyzes the contribution of Alfred Marshall. Section 4 examines the development of the theory
by Allyn Young. Section 5 contains some concluding remarks.
2
Adam Smith
We divide the analysis of Smith’s theory of economic growth in three parts.
We begin from the structure of Smith’s reasoning on the relation between
division of labor and economic growth, focusing on technological progress
and capital accumulation. Then we discuss the extent of the market and
its relation with the economic network, and conclude our reconstruction by
identifying the nature of the Smithian growth process.
1
Clearly we do not o¤er a complete account of the numerous questions raised by the
consideration of the division of labor. In 2002, even after the advent of EGT, our aim is
similar to the one that motivated Groenewegen (1977, p. 162), namely ”to indicate that
the division of labour will probably supply su¢cient questions to keep researchers going
to 2076”.
2
2.1
Division of Labor, Technological Change and Capital Accumulation
In the …rst chapter of The Wealth of Nations, Adam Smith states that the
income level of developed countries depends on the high degree of division
of labor they attained. Division of labor in fact increases labor productivity,
which in Smith’s view is the principal factor a¤ecting growth of per capita
income. The other factor he mentions is the proportion of productive to
unproductive workers in the economy.2
Smith points out that the division of labor may be realized in two contexts: within …rms, by a reduction of the range of tasks of individual workers, and among …rms, by the creation of new …rms and sectors undertaking
certain phases of the production processes (WN I.i.3-4).3
Smith identi…es three positive e¤ects of the division of labor on workers’
productivity. When workers specialize, they (i) increase their skill (dexterity); (ii) save the time necessary to switch among di¤erent activities and,
(iii) have the possibility of inventing machines to facilitate their job (WN
I.i.5). In modern terms, we see how Smith had in mind the concepts of
(i) learning by doing, (ii) set-up costs, and (iii) endogenous technological
progress.4
Point (iii) is particularly relevant in the light of modern growth theory.
Smith does not place particular emphasis on the operations of ordinary
workers, probably capable of some minor inventions. On the contrary, he
emphasizes the specialization of individuals in producing machines, or in
pursuing inventive activity. Smith (WN I.i.9) refers to the process of division
of labor among productive units (…rms, departments, etc.), where two types
of specialized worker may appear, ”the makers of machines” and the ”men
of speculation”.
Therefore in this framework technological progress and, more generally,
increases of the stock of knowledge, are consequences of an increased division
2
According to this classi…cation, a worker is productive if his labor adds value to the
materials he utilizes. As such, his labor is ”…xed” in a good that may subsequently be
exchanged with other labor. On the contrary, the worker is unproductive when he produces
services which ”generally perish ... in the very instant of [his] performance, and seldom
leave any trace or value behind [it], for which an equal quantity of service could afterwards
be procured” (WN II.iii.1). Examples of unproductive workers are: servants, musicians,
lawyers, churchmen, etc. (WN II.iii.2)
3
In the literature, the division of labor within …rms or within an industry is de…ned as
”the manufacturing division of labor”, while the division of labor in society in di¤erent
employments is de…ned as ”the social division of labor” (see, e.g., Groenewegen, 1987, p.
901). In his examples, Smith generally refers to specialized workers and not explicitly to
specialized …rms, even if he mentions the work of specialized individuals as that of particular ”trades”. However, his reasoning on specialization applies in general to productive
units, individuals and …rms. The theme of the specialization of …rms and of industrial
di¤erentiation is emphasized by Allyn Young.
4
Groenewegen (1977, pp. 171-172 and 1987, p. 902) discusses some shortcomings of
this part of Smith’s analysis.
3
of labor within and among …rms. The division of labor may also apply to
the production of knowledge itself.5
Also capital accumulation, the fundamental issue for many (if not all)
growth theories, relates to the division of labor, and thus to labor productivity (see also Groenewegen 1977, p. 163). Smith maintains that capital
accumulation promotes and sustains the process of division of labor. First,
in Smith (WN II.4) the entrepreneurs seek the most pro…table way of deploying capital, and therefore choose the organizational structure, that is the
subdivision of labor, that warrants the highest level of labor productivity.
In order to increase the degree of division of labor, capitalists must proceed
with the accumulation of capital, and provide the workers with new tools,
machines, materials, etc. (WN II.3).6 This process is favored by an increase
in labor supply.7
Hence, in Smith the accumulation of capital (both …xed and circulating)
is not related to a mere replication of existing productive activities, but
is inextricably linked to qualitative changes. A qualitative change is one
which takes the form of new ways of subdividing labor within …rms, with
the implied organizational and technological changes, or among …rms, when
new branches of business are created, new products appear, etc.
Notice that, from the way Smith links capital accumulation to the division of labor and thus to productivity, it does not automatically follow
that an increase in the aggregate stock of capital must cause a decrease in
the rate of pro…t and thus in the incentive to accumulate. As Kurz and
Salvadori (1999, p. 233) note: ”[a]n increase in the economy’s capital stock
as a whole need not have an adverse e¤ect on the general rate of pro…t. It
all depends on how the real wage and the technical conditions of production
are a¤ected in the course of the accumulation of capital”.8
5
”[T]his subdivision of employment ... as well as in every other business, improves
dexterity and saves time. Each individual becomes more expert in his own peculiar branch,
more work is done upon the whole, and the quantity of science is considerably increased
by it” (WN I.i.8).
6
Here we mainly refer to capital in terms of tools, machines, etc. Smith (e.g. WN
II.iii.5) however has a ”wages fund” theory. Hence the investment in capital includes the
wages advanced to productive workers. This is related to the issue of ”savings” and to
the extent of the market (see below). Smith recognizes that the introduction of capital
goods in a …rm is conditioned by the degree of labor specialization, being unclear whether
the machines should mainly substitute or complement labor. However, according to Lowe
(1975, 419), in Smith: ”the introduction of machinery, is regarded as a complement of,
rather than a substitute for, labour”. Marshall and then, especially, Young emphasize the
aspect of the introduction of machinery in the process of the division of labor.
7
In particular, Smith (WN II.4) writes: ”But the number of workmen in every branch
of business generally increases with the division of labour in that branch, or rather it is
the increase of their number which enables them to class and subdivide themselves in this
manner ” (Italics added). We return on the issue of labor supply when discussing the
endogenous nature of growth in Smith.
8
As a matter of fact, Smith (WN I.ix.2) sustained the opposite, namely that ”[t]he
increase of stock, which raises wages, tends to lower pro…t. When the stocks of many
4
2.2
The Economic Network and the Extent of the Market
In this Section we analyze Smith’s thought on the relation between the
structure of social and economic interaction, the extent of the market, and
the viability of the process of growth based on the division of labor. First,
according to Smith, the important precondition for the development of division of labor in a society is ”a certain propensity in human nature: ... the
propensity to truck, barter and exchange one thing for another” (WN I.i.1).
That is, Smith assumes that individuals have a natural predisposition for
what can be broadly de…ned as socio-economic interactions.9
This allows individuals to specialize and obtain a gain from trading their
surplus products, that is the production in excess of their own consumption.
Such surpluses originate from the increased productivity due to the specialization. In Smith’s opinion, individuals choose to specialize, given a
structure of social interactions, on the base of a process of learning. When
an individual learns that he enjoys higher consumption levels by exchanging
a part of his production, i.e. he has the ”certainty of being able to exchange
all that surplus part of the produce of his own labour, ..., for such parts
of the produce of other men’s labour as he may have occasion for ”, he is
encouraged ”to apply himself to a particular occupation” (WN I.ii.3).
In particular, economic growth may be spurred by the creation of a network even of similar individuals, i.e. individuals not endowed with innate
or acquired talents, specialized skills, etc. Smith in fact maintains that individuals are similar at birth. The di¤erences ”which [appear] to distinguish
men of di¤erent professions, when grown up to maturity, is not upon many
occasions so much the cause, as the e¤ect of the division of labour” (WN
I.ii.4). Once connected, individuals will sort themselves out in di¤erent occupations, and increase their aggregate production. The consequential step
in Smith’s analysis consists in the generalization of the relevant aspect of
this reasoning: namely, that the extent of the market limits the division of
labor.10
Smith’s argument is the following: as noted, an agent has the incentive
to specialize, hence obtaining a surplus product, if he possesses ”power of
exchanging” that surplus, i.e. if su¢cient demand exists, allowing the agent
rich merchants are turned into the same trade, their mutual competition naturally tends
to lower its pro…t; and when there is a like increase of stock in all the di¤erent trades
carried on in the same society, the same competition must produce the same e¤ect in
them all”. However, this reasoning is unconvincing because, as Kurz and Salvadori (1999,
p. 233) observe: ”Smith erroneously tried to carry an argument that is valid in a partial
framework over a general framework.”
9
Loasby (1996, pp. 305-307) discusses this point. He disputes the interpretation of
this predisposition to interact as the result of rational, utility-maximizing behavior. See
also Houthakker (1956, pp. 181-182): ”Smith was carefully ambiguous about the question whether the propensity to truck can itself be reduced to more immediately rational
considerations”.
10
Young emphasizes that the relevant extent of the market may be the potential market.
5
to purchase other goods with the revenue from the disposal of his surplus
product. Therefore, in Smithian growth demand and supply are at least
equally important.11
In particular, coordinated specialization of di¤erent productive units
generates contemporaneous increases in the supply of commodities, since
specialization increases productivity, and in the demand for other commodities, since specialization implies demanding the goods whose production is
given up and the increased supply may provide the necessary means to support the exchange. From this discussion the social dimension of the division
of labor and economic progress emerges clearly, as they involve important
organizational aspects of economic activities, like the degree of coordination
and communication among agents, a theme highlighted by Marshall.12
Hence, demand may be ”endogenously” generated within the process of
the division of labour. Obviously, demand may also increase ”exogenously”,
with the development of means of communication (WN I.iii.3) or the increase
in urban population (WN I.iii.2).13 By recognizing the endogeneity of the
extent of the market in the process of division of labor, Young (1928) (i)
rephrased Smith’s claim as ”the division of labor is limited by the division
of labor”, (ii) highlighted the unsettling role played by feedbacks between
supply and demand and (iii) emphasized the disequilibrium aspects of this
process. The importance of the extent of the market is also re‡ected in
Young’s distinction between the economies from large production and the
economies from large scale production, a distinction only foreshadowed by
Marshall.
11
Lowe (1975, p. 420) highlights the importance of demand in the Smithian framework
when he writes: ”it is the rate of increase of aggregate demand that governs the rate of
increase in productivity.” The importance of demand in Smith emerges also from the
view on the existence of a ”natural” predisposition of ”consumers”, that supports the
development of the manufacturing sector, in which the division of labor can be carried out
further than in agriculture (WN I.i.4). Smith (WN I.xi.c.5) argues that ”[t]he desire for
food is limited in every man by the narrow capacity of the human stomach; but the desire
for conveniences and ornaments of building, dress, equipage, and household furniture,
seems to have no limit or certain boundaries.” Lavezzi (2002) remarks that the model of
growth and specialization in EGT is instead a supply-side model, and demand does not
play a central role.
12
See also Kaldor (1972, p. 1241): ”for Smith the existence of a ’social economy’ and
the existence of increasing returns were closely related phenomena”. Buchanan and Yoon
(2000, p. 45) have recently argued that ”the Smithean proposition that relates the division
or specialization of labor to the extent of the market is best captured by the notion of
generalized increasing returns, which implies only that the degree of specialization utilized
increases with the size of the whole nexus of economic interaction thereby increasing the
ratio of positively valued outputs to inputs” (Italics in the original text).
13
In addition, when we consider the importance attributed to Smith to the extent of
the market, therefore to demand, we can say that technological progress and capital accumulation, strictly connected in a Smithian framework as we have seen, are not only a
pre-condition for the expansion of production, but are also conditioned by it.
6
2.3
On the Nature of Smithian Growth
In this section we conclude our reconstruction of Adam Smith’s theory and
identify three features of the process of economic growth based on division
of labor: (i) economic growth is endogenous; (ii) it has the nature of a
cumulative process; (iii) it can be de…ned as a disequilibrium process. Marshall and especially Young will develop in important respects the insights of
Smith which justify this characterization of economic growth.
2.3.1
Economic growth is endogenous
In the recent de…nition, growth is endogenous if the long-run growth rate
is determined within the model, for instance when it depends on behavioral
parameters such as the saving rate.
In Smith’s analysis ”capitals are increased by parsimony ... Whatever
part of his stock a man employs as a capital, he always expect it to be
replaced with a pro…t” (WN II.iii.13 and 5).14 The accumulation of capital usually increases labor productivity and therefore necessarily a¤ects the
long-run rate of growth: ”As the accumulation of stock is previously necessary for carrying on this great improvement in the productive powers of
labor, so that accumulation naturally leads to this improvement” (WN II.4).
In other words, nothing in Smith’s argument points clearly to the possibility that, in the long run, the accumulation of capital in the aggregate
would encounter diminishing returns, in particular from a …xed factor.15 In
fact, labor cannot constitute a …xed factor since capital accumulation itself regulates its supply. Increases in the stock of capital raise the demand
for labor in the short run and therefore increase wages. The increase in
wages above the subsistence level improves the conditions of the workers,
and ”encourage[s] ... the marriage and multiplication of labourers” (WN
I.viii.89).
In Smith’s words (WN I.viii.38) ”the demand for men, like that for
any other commodity, necessarily regulates the production of men; quickens
when it goes on too slowly, and stops it when it advances too fast”. Thus,
the accumulation of capital generates the increase in the labor supply which,
as noted in Section 2.1, favors the subdivisions of productive tasks. Also,
the accumulation of capital a¤ects the number of people put to work and
hence the extent of the market for wage goods.
Moreover, scarce natural resources do not seem to constitute a constraint
on growth in Smith. As Lowe (1975, p. 417) synthesizes, Smith has ”an
optimistic view of nature’s bounty which, for all practical purposes, permits
14
See Groenewegen (1977, p. 164) for a concise discussion of ”thriftiness” in Smith. As
noted, the point is that ”savings” of capitalists have to be interpreted in part as wages
paid to productive workers.
15
We have already argued at the end of Section 2.1 that the competition among producers cannot be expected to reduce the general rate of pro…t.
7
the output of agriculture and of the extractive industries to adjust itself to
rising demand without any check on real output and income - at least, until a
dimly perceived but long-distant point of resource exhaustion is reached”.16
Therefore, following Kurz and Salvadori (1999, note 2, p. 258) we can
argue that ”in Smith it is not su¢ciently clear how a country’s potential
is de…ned”, and conclude that growth for Smith is endogenous.17 We also
remark that, in the mechanism that prevents labor productivity from falling
as the accumulation of capital proceeds, there exists a particular role for the
feedbacks of demand and supply in generating disequilibrium. We introduce
this aspect below in Section 2.3.3, and return to it when discussing Allyn
Young.
2.3.2
The cumulative process
Capital accumulation, as Smith introduces it into the picture, transforms
economic growth based on division of labor into a cumulative process: further division of labor is allowed by the accumulation of capital, and cannot
proceed unless some previous stage of division of labor has been reached.
Therefore, growth is characterized by path dependency, since the current
opportunities for increasing productivity, by means of further subdivision
of labor, depend on the past stages of division of labor reached. In this
sense, even small historical events that cause the initial specialization of an
economy may have permanent e¤ects, since they in‡uence the subsequent
production possibilities and therefore the growth potential of the economy.18
Kaldor (1972, p. 1245) draws strong implications from the recognition
of this aspect:
”When every change in the use of resources - every reorganisation of productive activities - creates the opportunity for a further change which would not have existed otherwise, the notion
of an ’optimum’ allocation of resources - when every particular
16
For a similar view see Kurz and Salvadori (1999, p. 232). Young shares the same
optimistic view. See Young (1999d) and Ely et al., (1919, p. 422): ”it is ... absurd to
make this fundamental tendency towards diminishing returns in agriculture a basis for
pessimistic views regarding the possibility to economic progress.” I owe this quotation to
an anonimous referee.
17
Smith (WN I.ix.14) mentions the hypothetical situation of a country which ”had
acquired that full complement of riches which the nature of its soil and climate and its
situation with respect to other countries allowed to acquire”. Such a country would be
”fully peopled in proportion to what either its territory could maintain or its stock employ”
(WN I.ix.14). However Smith (WN I.ix.15) immediately remarks that ”no country has
ever yet arrived at this degree of opulence”, with the exception perhaps of China. China,
however, had been stationary because of its ”laws and institutions”, which Smith judges
as detrimental to the development of trade and to the protection of property rights.
18
This theme is developed by Young. Currie (1981, p. 57) argues that in Young’s framework the current growth rate acts as a ”Youngian multiplier”, a¤ecting the subsequent
possible levels of growth.
8
resource makes a great or greater contribution to output in its
actual use as in any alternative use - becomes a meaningless and
contradictory notion: the pattern of the use of resources at any
one time can be no more than a link in the chain of an unending sequence and the very distinction, vital to equilibrium economics, between resource-creation and resource-allocation loses
its validity.”
Kaldor (1975, p. 355) concludes:
”[t]here can be no such thing as an equilibrium state with optimum resource allocation where no further advantageous reorganization is possible, since every such reorganization may create
a fresh opportunity for a further reorganization.”
This introduces us to the last characteristic we identify for Smithian growth,
that is its nature of a disequilibrium process.
2.3.3
Growth based on division of labor is a disequilibrium process
We argue that the process of growth envisaged by Smith has essentially the
nature of a disequilibrium process supported by competition. Namely, such a
process cannot be reduced to an allocation problem as in general equilibrium
models.19 The observation that growth based on division of labor can be
de…ned as a cumulative, path-dependent process and the mentioned passages
by Kaldor go in the direction suggested here.
Let us start by remarking that in Smith (WN I.i.9) economic growth is
associated with an increase in the complexity of economic activity, brought
about by the division of labor: ”It is the great multiplication of the production of all the di¤erent arts, in consequence of the division of labour,
which occasions, in a well-governed society, that universal opulence which
extends itself to the lowest ranks of people”. In Smith’s opinion, as noted,
pro…t-seeking capitalists are continuously trying to exploit the possibilities
o¤ered by both the division of labor within and among …rms.20
19
At any rate, for Smith growth is not an allocation problem (see, Groenewegen 1982,
pp. 6-9), but notice the opinion of one leading EGT theorist: ”[g]rowth is a general
equilibrium process” (Romer 1989, p. 70).
20
Smith (I.viii.55) summarizes this point in the following passage: ”The owner of the
stock which employs a great number of labourers, necessarily endeavours, for his own
advantage, to make such a proper division and distribution of employment, that they may
be enabled to produce the greatest quantity of work possible. For the same reason, he
endeavours to supply them with the best machinery which either he or they can think
of. What takes place among the labourers in a particular workhouse, takes place, for the
same reason, among those of a great society. The greater their number, the more they
naturally divide themselves into di¤erent classes and subdivision of employment”.
9
The very process of production of commodities, in particular manufactures, make their unit cost (and price) decrease in the long run, as Smith
(WN V.i.e.46) observes:
”[t]he increase of demand ... though in the beginning it may
sometimes raise the price of goods, never fails to lower it in the
long run. It encourages production, and thereby increases the
competition of the producers, who, in order to undersell one
another, have recourse to new divisions of labour and new improvements of art, which might never otherwise been thought
of.”
Therefore, in the long run a negative relationship exists between the price
and the quantity of a good. This relationship emerges from a competitive
process among producers, in which each producer tries to steal the market
from his competitors, by o¤ering the good at the lowest possible price. If
an extension of the market ultimately causes a decrease in the price of a
commodity, it can stimulate a further market extension, more division of
labor, etc.21
In other words, for Smith competitive behavior implies a more active
role by entrepreneurs, than that normally envisaged by standard theory,
where competitive behavior consists in the optimal allocation of productive
resources by price-taking …rms. Smith instead depicts the …rms as continuously striving for improving their e¢ciency by introducing organizational
and technological changes.22
On these aspects Richardson (1975) argues that, for Smith, competition operates in two contexts: in the well-known gravitation process of
prices towards their natural levels, and in the entrepreneurs’ quest for the
exploitation of new opportunities o¤ered by division of labor, both within
and among …rms.23 Richardson (Ibidem, p. 351) writes:
”Smith o¤ers us in e¤ect both a theory of economic equilibrium and a theory of economic evolution: and in each of these
21
Compare this passage by Smith with the introduction of Marshall (1910, p. 455) to
the case of ”commodities the production of which tends to increasing returns”.
22
As Semmler (1987, p. 540) reminds us, this type of competitive behavior is also
featured in Marx’s analysis. In Marx ”the reorganization of the …rm and technical change
are seen as the main weapons of competition. The goal of the …rm is to capture a transient
surplus pro…t and to transform it into long-run growth potentials”.
23
Richardson (1975) and Groenewegen (1982) are two important papers analysing the
place of equilibrium in Smith’s analysis. They both argue that Smith’s theory is not easily
reconcilable with modern general equilibrium theory. In particular Richardson (1975)
emphasizes the ”unsettling” e¤ects of the division of labor, while Groenewegen (1982)
discusses the ”gravitation process” of market prices towards natural prices. See also note
24.
10
competition has a key role to play. Within the The Wealth of Nations no obvious tension exists between the two theories, partly
no doubt because they are sketched out in a manner loose enough
to make it di¢cult to establish inconsistency. Later writers, however, in striving for greater analytical rigour, developed the theory of equilibrium in terms of a model of reality that is clearly
very di¤erent indeed from that implicit in Smith’s theory of evolution.”
The …rst context where competition has a role in Smith’s analysis is
static, in the sense that competition takes the form of a reallocation of
productive resources (land, capital and labor), from activities where the
actual price is below its natural level, to activities where it is above. In
this case competition exerts an equilibrating force, in the sense that the
di¤erences between natural and market prices tend to vanish (WN I.vi).24
The second context is dynamic, in the sense that competition is related
to technological changes and to changes in the structure of the economy:
as new opportunities for division of labor are exploited and new sectors
and products appear (both consumption and intermediate, goods). In other
words, in the …rst case competition operates within a given degree of division
of labor, in the second it operates by expanding this degree. If one accepts
the view that the opportunities of division of labor are practically in…nite,
as Richardson does, then the prevailing force must ultimately be the one
generating disequilibrium.25
Richardson goes further and claims that it is questionable to take the
”Walrasian” interpretation of the …rst type of competitive forces studied by
Smith as a basis to discuss growth,26 since (Ibidem, pp. 351 and 354):
”this view of the matter seems to be mistaken. It appears
plausible only so long as Smith’s theory of economic evolution is
left wholly out of account ... [p]erhaps therefore we need only
24
However, Groenewegen (1982, p. 9) points out that ”the mechanical analogy of the
pendulum ... is not applicable to Smith’s analysis of the e¤ects of competition on market
prices”. The reason is the fundamental asymmetry between the speed of adjustment
of the market price to its natural level. The speed is fast (slow) if the market price
lies below (above) the natural price (Ibidem, p. 9). Hence, even in the case of the
”gravitation” process, Smith should not be indicated as ”an important originator of the
general equilibrium tradition” (Ibidem, p. 6).
25
For an alternative view, emphasizing the nature of equilibrium growth in Smith, see
Lowe (1975). At any rate, Groenewegen (1999, pp. 226-227) highlights that Smith’s
discussion of value and of the ”gravitation” of prices towards their natural levels ”can ...
be partly seen as a digression in Smith’s account of economic progress and growth”. This
digression is important since it allows Smith to utilize the ”secular price trends for broad
groups of commodities ... to act as an indicator of the stage of growth arrived at by a
particular society”. However, the ”equilibrating” process of gravitation is subordinated in
importance to the theme of economic growth.
26
This view is in reality problematic, as shown in note 24.
11
remind ourselves that Smith is advancing here [i.e. in his discussion of economic evolution] a disequilibrium theory in the sense
that he views the economy as in a state of constant and internally generated change. Perpetual motion results from the fact
that the division of labour is at once a cause and an e¤ect of
economic progress ... It is therefore abundantly clear that Smith
had a conception of the working of the economic system very
di¤erent from that implicit in the formal models employed by
modern equilibrium analysis.”(Italics added).
We will see that Allyn Young would restate the impossibility of taking an
equilibrium approach to study endogenous growth.
In conclusion, in assessing Adam Smith’s theory of economic growth, we
can agree with Loasby (1996, p. 303) that ”if economics is to be faithful to
Smith’s central principle, it has to be, in Schumpeter’s phrase, an economics
of ’development from within’ ”. We can add that Richardson is probably
correct when using the term ”evolution” instead of ”growth” with respect
to Smith:27 when Smith studies a growing economy, he has in mind an
economy undergoing qualitative changes, moving from a simple to a more
complex structure.
3
Alfred Marshall
In this Section we analyze some aspects of Alfred Marshall’s thought on
the division of labor, increasing returns, competition and equilibrium. Our
aim is to highlight the general characteristics of the Marshallian dynamics,
and to indicate some instances in which Marshall’s contribution forms a
bridge between Smith’s insights and Young’s developments. Namely we refer
to Marshall’s introduction of the concept of ”organic growth” to approach
economic dynamics. Indeed, the term ”organic growth” may represent a
proper de…nition for the process depicted by Smith and Young.28
According to this idea the economy is a system where change is internally
generated and constantly taking place,29 in particular as a consequence of
the various forms taken by the division of labor. It is in this context that
the relation between increasing returns, competition and equilibrium has to
be evaluated. The basic point of this Section can therefore be synthesized
by a quotation from Loasby (1989), reported in Marchionatti (1992, p. 557):
27
Young (1999c, p. 412) also utilizes the term ”evolution”.
Allyn Young signi…cantly entitled a chapter for the Grolier Society’s Book of Popular
Science, 1929 Edition, ”Big Business: How the Economic System Grows and Evolves Like
a Living Organism”. See Allyn Young (1999c).
29
As Marchionatti (1992, p. 566) puts it: ”the never-ending product and technological
innovation process ... for Marshall too [i.e. as for Smith] ... represents the deep dynamic
nature of modern economy”.
28
12
”much of what is in Marshall is far more clearly revealed if we approach him
from Adam Smith rather than from modern microeconomics.”30
We approach Marshall’s ideas in particular from the contents of Book IV
of the Principles. In Book IV Marshall identi…es four factors of production,
adding a fourth factor, i.e. organization, to land, labor and capital. Organization increases the e¢ciency of labor and its explicit consideration as a
factor of production introduces the discussion on the division of labor (Marshall 1910, p. 240). After praising Adam Smith, Marshall (Ibidem, p. 240)
draws a parallel between the superior organisms, social and physical: they
are both characterized by an increased specialization of their component
parts, coupled with a ”more intimate connection between them” (Ibidem, p.
241).
Two keywords in this context are therefore ”di¤erentiation” and ”integration”. With respect to an economic system, the …rst is referred to the
specialization of skills and trades, of knowledge and of machinery, the second to the emergence of forms of connections among productive units (”the
separate parts of the industrial organism”) such as: credit markets, ”means
and habits of communication”, i.e. means of transportation of tangible and
intangible goods (e.g. information) respectively by sea, road and railway, or
by telegraph, post and press.
This idea of the functioning of an economic system is resumed later in
the Principles when, in a much quoted passage, Marshall (Ibidem, p. 461)
writes:
”we are here verging on the high theme of economic progress;
and here therefore it is especially needful to remember that economic problems are imperfectly presented when they are treated
as problems of statical equilibrium, and not of organic growth.
For though the statical treatment alone can give us de…niteness
and precision of thought, and is therefore a necessary introduction to a more philosophic treatment of society as an organism;
it is yet only an introduction. The Statical theory of equilibrium is only an introduction to the study of the progress and
development of industries which show a tendency to increasing
returns.”
30
Some authors argue that Marshall’s followers, e.g. Pigou, popularized the ”statical
analysis” of Marshall contained in Book V of the Principles. Di¤erently, important aspects
of the Marshallian dynamics, relevant for the present discussion, remained on a side. See,
e.g. Marchionatti (1992, p. 579): ”[t]his type of dynamic view [i.e. Marshall’s], in
which the dilemma [i.e. of the compatibility between increasing returns and competition]
turns out to be unimportant, is the part of classical economic thought which Marshall
appropriated ... It is with regard to this analysis that Marshall’s followers - Pigou above
all - and the cost controversy authors deeply diverged: so that in the twenties Marshall’s
dynamic approach went largely unrecognized. Among these economists the predominant
idea of dynamics had nothing to do with the Marshallian one.” See also Hart (1991) and
(1992).
13
Let us consider some aspects of this general view of the economy. First
of all, Marshall discusses the division of labor with respect to: i) the division
of labor among operatives and its relation with the use of machinery; ii) the
reciprocal e¤ects of the division of labor and the localization of industry; iii)
the advantages of the division of labor in relation to large-scale production;
iv) the emergence of specialized business management.
Marshall (Ibidem, p. 250) observes that the division of labor simpli…es
workers’ activities and increases their productivity. However, at a certain degree of simpli…cation, machines eventually replace labor (Ibidem, p. 255).31
This negative e¤ect on employment exerted by machines is counterbalanced
by positive e¤ects, since the introduction of machines allows ”to increase the
scale of manufactures and to make them more complex” (Ibidem, p. 256).
This means that the adoption of machines increases the scope for the division of labor. For instance, the introduction of machines creates the demand
for other types of specialized workers, from machine operators to workers
with a high level of judgement (Ibidem, p. 261).32
The point is the emphasis placed by Marshall on the division of labor
as a process of change. In particular a process in which qualitative changes,
like those occurring within a …rm, produce stimuli for other changes, such
as the generation of demand for other specialized activities that may lead
to the creation of other specialized machinery, etc.
The distinction between internal and external economies follows (Ibidem, p. 266), and introduces the discussion of the localization of industries.
From the analysis of localized industries it is worth remarking the following point. Marshall (Ibidem, p. 271), while discussing the emergence of
subsidiary trades to a localized industry, claims that ”the economic use of
expensive machinery can sometimes be attained in a very high degree in a
district in which there is a large aggregate production of the same kind, ...
subsidiary industries ... are able to keep in constant use machinery of the
most specialized character”.
This passage by Marshall foreshadows one of the main themes of Allyn
Young. Namely, that the economies of production depend on large production and not on large scale production. Here Marshall refers to the economic
use of expensive machinery (see below). Allyn Young will elevate this aspect
of the division of labor to a fundamental principle and will not con…ne it,
as Marshall did, to localized production.
However, Marshall discusses at length economies of large scale produc31
The theme of the introduction of specialized machines stands high in Allyn Young’s
discussion on the use of ”roundabout methods” of production. See also below the discussion of Marshall on the economies of machinery as an instance of the economies of
”production on a large scale”.
32
Marshall (Ibidem, p. 261) makes many examples from the printing trade, in which
demand may arise for ”those who know how to set up a good title-page ... [or] for those
who know how to give an accurate report in ten lines”.
14
tion (Ch. XI, Book IV): economies of skill, of machinery and of materials
(Ibidem, p. 278). For the present purposes we recall some aspects of the
economies of machinery.33 As mentioned above, Marshall claims that production on a large scale may allow the producers to adopt specialized machines. The reason is that the machinery can …nd ”constant employment”
(Ibidem, p. 280). Also, large …rms can sustain the …xed cost necessary for
inventing a new machine (or promoting a new product).
Overall, Marshall emphasizes the scale of production in the sense that he
mainly refers to the capital employed in a …rm, e.g. to the dimension of the
establishment (Ibidem, p. 283), and to the number of workers, when he turns
to the economy of skill.34 However, to argue that ”a small manufacturer
must ... have many things done by hand or by imperfect machinery, though
he knows how to have them done better and cheaper by special machinery”
(Ibidem, p. 280), and that some economies can be secured when a new
machine is introduced and can be constantly employed (Ibidem, p. 280),
points again to the aspect of economies from large production. This concept
has central importance for Allyn Young, and is related to the aspect of the
reorganisation of productive activities following an increase in the overall
market for a commodity.
The discussion by Marshall of points i) and iii) refers in general to internal economies and, since this relates to the emergence of monopoly, it
introduces to Marshall’s treatment of increasing returns, competition and
equilibrium.35 First of all, Appendix H of the Principles makes clear that
Marshall is well aware of the limitations of the statical method developed in
Book V to approach increasing returns.
Marshall (Ibidem, p. 318) de…nes ”the law of increasing returns” as follows: ”An increase of capital and labour leads generally to an improved organization, which increases the e¢ciency of the work of capital and labour”.
He does not overlook the organizational change implied in the process of securing increasing returns, for instance for the connected problems of ”measurement”. That is (Ibidem, p. 319): ”Increasing Return is a relation between a quantity of e¤ort and sacri…ce on the one hand, and a quantity of
product on the other. The quantities cannot be taken out exactly, because
changing methods of production call for machinery, and for unskilled and
33
The case of specialization in business management mentioned above at point iv) is
one important instance of the economies of skill depending on the increase in the scale
of manufactures, and is not discussed further. Let us just note that specialized business
managers favor the accumulation of knowledge of the trade in the …rm (Marshall, Ibidem,
p. 284). In this sense, Marshall’s point echoes Smith’s assertion on the role of the division
of labor in the accumulation of knowledge.
34
See also the de…nition of the law of increasing returns reported below, and Marshall
(Ibidem, p. 250 and 285), where economies of machinery and skill are put in relation to
…rms with ”large” or ”larger capitals”.
35
Marchionatti (1992) o¤ers a thorough discussion of this issue.
15
skilled labour of new kinds and in new proportions.”36 Young emphasizes
this aspect of qualitative changes by the concept of ”economies of specialization”.
At any rate, according to Marshall, production under increasing returns
does not necessarily lead to monopolization because:
i) some economies are external to the …rm. External economies may
derive from ‡ows of information among …rms in the same sector. This is
relevant for localized industries (Ibidem, p. 266), or for small …rms unable
to exploit economies of scale.
ii) Manufacturers mainly produce di¤erentiated goods, the demand for
which is negatively sloped, implying a de…nite limit to the expansion of the
…rm. For Marshall (Ibidem, p. 286) it is more common that commodities produced under increasing returns are specialized goods, i.e. they may
encounter di¢culties in selling.37
iii) Firms experience a life cycle: like the trees in a forest, sooner of later
even the most vigorous …rms ”age”, and become less dynamic, and their
established positions are constantly under the threat of potential new …rms.
Dynamics in an economic sector is such that ”at any one moment some …rms
[are] in the ascending phase and others in the descending” (Ibidem, p. 317).
The metaphor of the trees in the forest, the limitations of which are not
overlooked by Marshall,38 may be appreciated by considering his optimistic
view on the continuous possibilities of emergence of new businesses. Marshall
(Ibidem, p. 285) makes the example of a ”new man” starting a business in
presence of established large …rms, which have low unit costs by economies
of machinery and skill, and have ”large trade connections”. On p. 309
he synthesizes his optimistic view: ”There is then on the whole a broad
36
This remark is relevant to the standard textbook de…nition of increasing returns to
scale. According to this de…nition, a technology features increasing returns to scale if a
proportional increase of all inputs generates a more than proportional increase in output.
See also Hart (1991, pp. 101-102).
37
Does this mean that the Marshallian dynamics can be simply rendered in terms of
the modern approach of monopolistic competition? There appears to exist some controversy on this point. Whitaker (1987, p. 356) argues: ”The conception of competition in
Marshall’s manufacturing case is much closer to later ideas of imperfect or monopolistic
competition than to modern notions of perfect competition. Products are di¤erentiated
and …rms are not price takers, but face at any time downward-sloping demand curves”.
However, Hart (1992, p. 242) writes: ”[a] satisfactory solution to Marshall’s reconciliation problem [i.e. between increasing returns and competition] ... requires more than the
formal inclusion of market imperfections into more elaborate equilibrium frameworks. It
instead calls for techniques whereby the e¤ects of dynamic processes can be adequately
considered”. Note that many models in EGT, such as Romer (1987), utilize the framework
of monopolistic competition.
38
Marshall is aware that the advent of joint-stock companies, which do not age with
their founders, could reduce the force of this argument, but nonetheless believes in its
importance for many trades. Negishi (1989, pp. 369-375) suggests that technologies, and
not …rms, can be subject to a life cycle in the Marshallian dynamics.
16
movement from below upwards, maybe in two generations”.39 Apparently
Marshall does not see barriers to entry.
Among the reasons provided by Marshall we can list the following: the
amount of capital necessary for a ”fair start” (Ibidem, p. 308) may be high,
but the availability of capital loans may be higher. Also, initial capital
may be borrowed from those who will become suppliers of the new business
(Ibidem, p. 308). Some production may be characterized by the frequent
introduction of new appliances and new methods. In this case new …rms
may enter because, being younger, they have more ”energy” to adopt these
innovations than incumbent …rms (Ibidem, p. 287). This last (unconvincing)
statement may be reinforced by considering the risk of bureaucratization of
large …rms which, according to Marshall (Ibidem, p. 304), may threaten
their innovative capacity.40
Hence, the kind of competition Marshall has in mind is mainly related to
the aspect of freedom of entry (Groenewegen 1999, p. 230). In the industrial
dynamics featuring this type of competition, equilibrium is hardly a relevant
issue. Marshall fully recognizes the pervasiveness of increasing returns in
this process, and realizes that the statical analysis developed in Book V is
of little help for inquiring into it.41
To sum up, Marshall advances an idea of industrial dynamics and progress
which is strongly rooted in Adam Smith’s theory of growth and the division
of labor. The division of labor acts a powerful process pushing the productive units to continuous internal reorganization and the economy itself
to continuous structural change. Increasing returns are pervasive but the
ever-present tendencies towards monopolization do not prevent competition
to operate, leaving the system in a continuous state of change.42 We argue
that ”organic growth” synthetically describes the Marshallian dynamics.
The next step in the elaboration of this framework is by Allyn Young.
4
Allyn Young
The analysis of economic growth by Allyn Young (1928) is important since
he starts from Smith, explores the implications of some of Smith’s insights
39
Notice that Marshall (Ibidem, p. 298) analyzes not only the issue of the acquisition
of business ability, but also the di¢culties of its transfer across generations. This again
may be put in relation to his otherwise vague idea of ”aging” of a …rm.
40
In addition, in the process of growth the increase in wealth (which includes increases
in capital) is self-sustaining since it is associated with the creation of new wants, providing
the opportunity to new, highly rewarding forms of capital investments (Ibidem pp. 223224).
41
To the best of my knowledge, Newman and Wolfe (1961) is the only paper which attempts a faithful representation of the Marshallian industry dynamics, by using a Markov
Chain.
42
Young (1999c) o¤ers a similar picture of the competitive process among large and
small …rms.
17
and adds novel elements to his theory. The Marshall’s view on economic
dynamics, which was also in‡uenced by Smith, anticipates some themes
that take center stage in Young’s approach. Young is however critical to the
statical analysis developed by Marshall in Book V of the Principles 43 , and
not completely persuaded by the Marshallian distinction between internal
and external economies.
After a brief introduction, Young (1928, pp. 527-528) tackles the question of approaching increasing returns using the Marshallian concepts of
internal and external economies.
This distinction is considered ”fruitful”, but Young (Ibidem, p. 528)
immediately adds ”[t]he view of the nature of the processes of industrial
progress which is implied in the distinction between internal and external
economies is necessarily a partial view. Certain aspects of those processes
are illuminated, while, for that very reason, certain other aspects, important
in relation to other problems, are obscured.”
The explanation o¤ered for his skepticism is that
”although the internal economies of some …rms producing,
let us say, materials or appliances may …gure as the external
economies of other …rms, not all of the economies which are
properly to be called external can be accounted for by adding
up the internal economies of all the separate …rms.”(Ibidem, p.
528)
This happens because:
”[y]ear after year the …rm, like its competitors, is manufacturing a particular product or group of products, or is con…ning
itself to certain de…nite stages in the work of forwarding the products towards their …nal form. Its operations change in the sense
that they are progressively adapted to an increasing output, but
they are kept within de…nitely circumscribed bounds.”(Ibidem,
p. 528)
The last passage explains that Young, when considering economies stemming from an increase in production, does not refer to the exploitation of
economies of scale, merely referred to the dimension of the productive unit,
but to the economies of specialization in relation to the extent of the market.
The economies of specialization are those accruing to the …rm that specializes its operations, for instance by introducing organizational and technical
changes.44 In order to secure these economies the productive operations of
the …rm should undergo quantitative and qualitative changes.
43
See also Young (1999a).
In a comment to a passage of Frank Knight’s PhD dissertation, Young writes: ”Certain
economies are possible only with large demand. An increased output means more plants,
44
18
Thus, according to Young (Ibidem, p. 528), the increase in the output
of a …rm is not functionally limited by an increase in its size, but has to be
put in relation to what happens
”[o]ut beyond, in that obscurer …eld from which [the …rm]
derives its external economies, [where] changes of another order
are occurring. New products are appearing, …rms are assuming
new tasks, and new industries are coming into being. In short,
changes in this external …eld are qualitative as well as quantitative. No analysis of the forces making for economic equilibrium,
forces which we might say are tangential at any moment of time,
will serve to illuminate this …eld, for movements away from equilibrium, departures from previous trends are characteristics of it.
Not much is to be gained by probing into it to see how increasing
returns show themselves in the costs of individual …rms and in
the prices at which they o¤er their products.”
Hence Young does not believe that concentrating on partial analyses of
an individual (or representative) …rm can be useful and, moreover, in this
last passage he clearly departs from an equilibrium approach to economic
growth and indicates a ”simpler and more inclusive view, such as some of the
older economists ... ” (Ibidem, p. 528), as appropriate for his investigation.
This leads Young to a direct reference to Adam Smith. Young’s declared
aim is to develop the theme originating from the ”theorem that the division
of labour depends upon the extent of the market” (Ibidem, p. 529). From
Smith’s discussion of division of labor, Young analyzes ”the growth of indirect or roundabout methods of production and the division of labour among
industries” (Ibidem, p. 529).
That is, Young considers the division of labor mainly as the process
leading to the introduction of (highly productive) capital goods (i.e. the
use of indirect instead of direct labor), and to the increase of a network of
interdependent productive units. Young does not mention Marshall here but
his contribution may be more correctly described in continuity with Smith
and Marshall (Book IV).
Young …rst discusses the economies deriving from the use of specialized
machines in production. He emphasizes one aspect of the simpli…cation
of some phases of the production process, also treated by Marshall: the
possibility and incentive to introduce machines (a point also noted by Smith
of course, but the important thing is that they are not ’similar establishments’, but, in
general, more highly specialized establishments. As you know I di¤er from your notion
of decreasing costs. I hold them to be real, not necessarily tending to monopoly, and one
of the most important economic phenomena of modern times. They are not a matter
of ’proportioning of factors’. They are, in great part, a matter of the economies of the
division of labor, which, as Adam Smith observed, is limited by ’the extent of the market’
”. Quoted in Blitch (1995, pp. 169-170).
19
(WN II.3) himself). Therefore, the main question is to understand when
the …rm decides to face the (…xed) cost of a new, specialized machine, either
by building it or by purchasing it or, put it in other words, when the …rm
decides to use indirect rather than direct labor.
Young (Ibidem, p. 530) writes in a famous passage:
”[i]n the use of machinery and the adoption of indirect processes there is a further division of labour, the economies of which
are again limited by the extent of the market. It would be wasteful to make a hammer to drive a single nail, ... It would be wasteful to furnish a factory with an elaborate equipment of specially
constructed [machines] to build a hundred automobiles.”
According to this idea, anticipated by Smith (WN II.3) and noted also by
Kaldor (1972, p. 1242), the capital-labor ratio chosen by …rms depends on
the extent of the market and not only on relative factor prices.
This aspect has implications for the dynamics of the system. Namely
for the choice of the …rm’s internal organization and technology, and for the
feedbacks on the environment, for instance for capital-goods industries.45
We believe that this aspect is generally overlooked, and is more important
than the discussion of the role played by …xed costs (or indivisibilities) in
relation to the extent of the market, labor specialization and increasing
returns.46 According to Young, it is the extent of the market that determines
the decision to sustain a …xed cost for the introduction of machines; also
because, as we have seen, it is the extent of the market that determines the
degree of simpli…cation of workers’ activities.47
Young maintains that the economies ”which manifest themselves in increasing returns are the economies of capitalistic or roundabout methods of
production” (Ibidem, p. 531, italics added). An important passage follows
this statement:
45
”Every innovation, whether in the technique of production or in the organization
of business, a¤ects in some degree the conditions which govern the activities of other
producers.” Young (1999c, p. 411).
46
For instance Edwards and Starr (1987) argue that the division of labor is limited by
the extent of the market only if labor is indivisible or a nonconvexity is present (such as the
set-up costs mentioned by Smith). However, their analysis does not consider the aspect
of learning by doing deriving from specialization, as emphasized by Smith (WN I.i.6)
and Marshall (1910, pp. 250-254) and the implied issue of the introduction of machinery
when labor is su¢ciently simpli…ed. Hence they fail to take into account essential dynamic
features of the economies of specialization. Also, Romer (1989, p. 108) claims that Young’s
(and Marshall’s) story would be told in a ”more rigorous way in a model with …xed costs.”
In this manner he attaches to Young’s theory an excessive role for …xed costs (see Lavezzi,
2002).
47
Sandilands (2000, p. 315) remarks that …xed costs (the price of the capital good)
should therefore be considered in relative terms, that is relative to the extent of the
market.
20
”these economies lie under our eyes, but we may miss them if
we try to make of large-scale production (in the sense of production by large …rms or large industries), as contrasted with large
production, any more than an incident in the general process
by which increasing returns are secured and if accordingly we
look too much at the individual …rm or even, as I shall suggest
presently, at the individual industry.”(Ibidem, p. 531. Italics in
the original text)
Young therefore introduces what may be termed ”macroeconomic increasing returns”,48 whose nature is not captured by concentrating only on
representative …rms and on their negatively sloped cost curves, but has be
appreciated from an analysis of the entire economy, considered as a large
interactive system. The market is in fact de…ned by Young as ”an aggregate
of productive activities, tied together by trade.” (Ibidem, p. 533).
When Young (Ibidem, p. 531) claims that ”the economies of roundabout
methods, even more than the economies of other forms of the division of
labor, depend upon the extent of the market”, he refers to an ”inclusive
view [of the market, which is not] an outlet for the products of a particular
industry, and therefore external to that industry, but [i]s the outlet for goods
in general. [Therefore:] the size of the market is determined and de…ned by
the volume of production.” (Ibidem, p. 533).
This immediately leads him to the reformulation of Smith’s theory in
these terms: the division of labor is limited by the division of labor. Although reminiscent of the Say’s law, this argument is more far-reaching:49
it asserts that both demand and supply are endogenously determined according to the degree of division of labor prevailing.50 As noted, this amounts to
recognizing that the extent of the market is at least partially endogenous,
and that therefore an increase in the extent of the market is not only to be
understood as removal to barriers to free trade, construction of roads, railways, etc. This observation evidences a relevant aspect of the endogenous
nature of economic growth in the SMY framework.
The important implication is that:
”the counter forces which are continually defeating the forces
which make for economic equilibrium are more pervasive and
more deeply rooted in the constitution of the modern economic
system than we commonly realise. Not only new or adventitious
elements, coming in from the outside, but elements which are
48
This de…nition appears in Currie (1997) and is clearly compatible with the one proposed by Buchanan and Yoon (2000) and quoted in note 12.
49
Young (1999b, p. 145) in fact criticizes Say’s law as such.
50
This aspect is assumed in recent models such as Yang and Borland (1991) and Yang
(1999), where the agents are producers-consumers, and the structure of demand and supply
is simultaneously determined with the degree of division of labor.
21
permanent characteristics of the ways in which goods are produced make continuously for change. Every important advance
in the organisation of production ... alters the conditions of
industrial activity and initiates responses elsewhere in the industrial structure which in turn have a further unsettling e¤ect.
Thus change becomes progressive and propagates itself in a cumulative way.”(Ibidem, p. 531. Italics added).
Hence for Young, not only economic growth is endogenous, but the endogenous forces generate disequilibrium, in the sense that, in the growth process,
the structure of the economy and the technological opportunities cannot a
priori be considered …xed.
Young (Ibidem, p. 533) therefore judges the standard apparatus of supply and demand as incapable of exploring this sort of dynamics, since it may
”divert attention to incidental or partial aspects of a process which ought
to be seen as a whole”.51 He introduces the concept of reciprocal demand
as a tool which, in his approach, most closely resembles the concepts of the
apparatus he is criticizing.
Reciprocal demands among …rms are characterized by a certain level of
elasticity, to be interpreted as the capacity for the increased production of
a good to generate demand for other goods:
”demand for each commodity is elastic, in the special sense
that a small increase in its supply will be attended by an increase in the amounts of other commodities which can be had in
exchange for it. Under such conditions an increase in the supply
of one commodity is an increase in the demand for other commodities, and it must be supposed that every increase in demand
will evoke an increase in supply.”(Ibidem, p. 534. Italics in the
original text.)
Notice that Young considers an exchange of goods against goods. The elasticities are di¤erent for di¤erent products, so growth in the economy will be
di¤erent among sectors. In any case ”[e]ven with a stationary population
and in the absence of new discoveries in pure or applied science there are no
limits to the process of expansion except the limits beyond which demand
is not elastic and returns do not increase.” (Ibidem, p. 534).52
51
In the LSE lecture notes taken by Kaldor, we read: ”Seeking for equilibrium conditions under increasing returns is as good as looking for a mare’s nest. Certainly the
matter cannot be explained by this curve apparatus, which does not see things ’in their
togetherness’ ”. See Young (1999a, p. 45).
52
Note that Young points out that population growth is not necessary for economic
growth. Smith instead argued that increases in the supply of labor may facilitate the division of labor and that the increase in population is a by-product of capital accumulation.
22
The use of the concept of reciprocal demand once again addresses to
the vision of the economy as made up of interdependent productive units.
Increasing returns, by making available increasing quantities of goods at
lower prices, can stimulate further the interaction among …rms; interaction
among …rms in turn acts as stimulus to production, and favors the securing
of increasing returns. Young, like Marshall, does not believe that increasing
returns are naturally conducive to monopolization (see, e.g., note 44).
In particular, Young (1999c) depicts an industry dynamics similar to the
Marshallian one, where small …rms and large …rms coexist, and established
position are subject to disruption since ”economic evolution ... is ... always a
matter of successive adjustments to a situation which is forever new because
it is forever changing” (Ibidem, p. 412). Assuming that the growth process
can be studied in terms of an equilibrium of ”costs and advantages”, for
Young (1928, p. 535) ”amounts to saying that no real economic progress
could come through the operation of forces engendered within the economic
system - a conclusion repugnant to common sense.”
Economic growth, although based on such strong mechanisms, can nevertheless encounter obstacles. Young mentions: the presence of non reproducible resources, the emergence of certain problems entailed by change (like
the breaking up of existing trades and relations), the time necessary to accumulate new capital (both human and physical), the presence of uncertainty
and risks. However, some favorable factors can also be at work, like scienti…c
progress applied to industry, the discovery of new natural resources or the
increase in population (but see note 52).
In any case, if one has to indicate a single factor relevant for economic
progress, it is the extent of the market and, as Young (Ibidem, p. 536) points
out ”no other hypothesis so well unites economic history and economic theory”. The extent of the market relevant for the decisions of businessmen may
well be potential. Indeed, Young considers the attention paid by managers
of the modern industries to potential market a ”great change” (Ibidem, p.
536), with respect to the past. Therefore ”the search for markets is ... a
matter of ... …nding an outlet for a potential product” (Ibidem, p. 537).
Young then discusses the process of division of labor among industries.
He (Ibidem, p. 537) remarks that:
”industrial di¤erentiation has been and remains the type of
change characteristically associated with the growth of production. Notable as has been the increase in the complexity of the
apparatus of living, as shown by the increase in the variety of
goods o¤ered in consumers’ markets, the increase in the diversi…cation of intermediate products and of industries manufacturing
special products or groups of products has gone even further”.
If one recognizes the importance of this aspect of the division of labor,
for Young (Ibidem, p. 538) it follows that ”the representative …rm, like
23
the industry of which it is a part, loses its identity”. More important is
the observation that ”the largest advantage secured by the division of labor
among industries is the fuller realising of the economies of capitalistic or
roundabout methods of production.” (Ibidem, p. 539)
In fact, in the process of division of labor among industries, whenever
a new industry is created following an increase in the extent of the overall
market for the good it produces, the …rms in such industry bene…t from the
large overall industry output, in the sense that they may adopt specialized
machines, i.e. roundabout methods of production.
In conclusion, Allyn Young suggests to bring growth theory back to the
view of Adam Smith. Perhaps, the most distinctive feature of Young’s approach is his conceptualization of the economy, viewed in its ”togetherness”.
From our reading of Young, it is far from clear that he considers the ”togetherness” of the economy in terms of general equilibrium. Signi…cantly,
Kaldor (1972, p. 1243) expressed the opinion that Young’s paper was ”so
many years ahead of its time that the progress of economic thought has
passed it by”.
5
Conclusion
Motivated by the recent developments in growth theory, we reconstructed
Adam Smith’s theory of economic growth, and its development by Alfred
Marshall and Allyn Young. We have shown that in the Smith-MarshallYoung approach:
(1) economic growth is endogenous: competition among pro…t-seeking
entrepreneurs pushes them to continuously reorganize the productive activities. This happens by two forms of division of labor: within and among
…rms. The former is characterized by the introduction of organizational and
technological changes, the latter by a modi…cation of the structure of the
economy. The pro…t opportunities are themselves generated by the growth
of the extent of the market(s). This results in the endogenous increase of the
network of interdependent economic units, which allows for the exploitation
of the gains in productivity due to specialization, and generate economic
growth in the aggregate. The accumulation of capital fuels this process and
is inextricable from technological progress, the accumulation of knowledge
and population growth.
(2) Economic growth has the nature of a cumulative, path dependent process. The current opportunities for increasing productivity in the economy
depends on the degree of division of labor attained in the past. As noted,
the same concept may be expressed by saying the current rate of growth
a¤ects future rates of growth.
(3) Economic growth has the characteristics of a disequilibrium process, in
which the data of the system, e.g. the number of commodities and the
24
technologies available, are continuously changing under the pressure of competition. This results in the representation of the economy as an inherently
unstable system, in the sense that qualitative changes are constantly taking
place activating productive and technological feedbacks. In this context, increasing returns are to be understood as ”generalized” or ”macroeconomic”,
being related to the size of the network of specialized, interdependent units.
The growth of this network is what characterizes economic growth.53 A
proper de…nition of this process is Marshall’s notion of ”organic growth”.
How much of these characteristics of the growth process can be retraced
in the endogenous growth theory? Lavezzi (2002) attempts to answer this
question, arguing that aspects of the Smith-Young theory, as those indicated
at points (2) and (3) are not captured by the modern approach, and therefore
that the ”old” approach still provides insights for the development of a
modern theory of economic growth.
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