Adam Smith was a philosopher from Scotland, renowned as the Father of Economics. He was the most prominent thinker during the Scottish Enlightenment. Other influential thinkers from this era include David Hume, James Hutton, Walter Scott, and James Watt.

Adam Smith’s Philosophy

Adam Smith conceived the ideas that laid the foundation for the capitalist system. His economic theories on how markets function are still used worldwide today.

Adam Smith is most famous for his idea of the Invisible Hand, which is a metaphor for how individual actors, acting in their own self-interest, collectively drive the economy.

Adam Smith’s second most famous idea was Division of Labor and Specialization.

Adam Smith’s Pin Factory

In his book “The Wealth of Nations,” Adam Smith describes a pin factory.

Here’s how Adam Smith describes the division of labor for the theoretical pin factory:

“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; and the important business of making a pin is, in this manner, divided into about eighteen distinct operations, which, in some cases, are all performed by distinct hands.”

He then compares it to if you or I (lacking operational knowledge) were to start a pin factory:

“…a workman not educated to this business (which the division of labor 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 labor has probably given occasion), could scarce, perhaps, with his utmost industry, make one pin in a day, and certainly could not make twenty.”

With this example, Adam Smith illustrated how a company specializing in a task and having a clear division of labor can become 4800 times more efficient than a company where employees individually attempt to perform every task within the value chain.

Adam Smith’s idea that companies should specialize later developed into Taylorism, which became the most important and value-creating innovation of the 20th century, enabling the industrialization of the Western world.

One of the most famous examples of Adam Smith’s division of labor is Henry Ford’s assembly line.

Does the Economy Grow as a Function of Demand, or is it Constrained by Resource Supply?

During the 18th century, Thomas Malthus argued that increasing population growth and inadequate resource supply would lead to a breaking point where the world economy would cease growth and welfare would decline.

Adam Smith believed that human innovation, driven by our self-preservation and inventiveness, would lead to better division of labor even as the population grew. And that, in turn, would lead to new solutions and expand the economy.

In short, Thomas Malthus assumed that the economy had a fixed size, whereas Adam Smith believed the economy is a function of human ingenuity.

This line of thought has now evolved into what is called “Supply vs Demand side Economics.”

Who Was Right, Adam Smith or Thomas Malthus?

With hindsight, Adam Smith was significantly more correct than Malthus. It’s easy to see, noting that the large internet companies now account for the majority of the American stock market (if one chooses to measure the economy by market value).

It’s easy for us to laugh at Malthus’s dystopian outlook, but then we’re being wise after the event. It was difficult for Malthus and contemporaries to predict new technological discoveries and inventions.

Today, we have a pretty good handle on population growth and the amount of various resources, commodities, and deposits around the world. Despite this, we humans manage to come up with new smart solutions to become more efficient, produce more food, or extract resources at lower costs.

You May Also Want to Read:

• How is Value Created?
• Specialization: Why Most Companies Should Not Diversify Their Operations
• What is a Value Chain And How Can You Think About The Different Suppliers in an Industry?