Adam Smith on the Division of Labor and Relative Factor Prices

It is well known that the division of labor was the starting point of Adam Smith's theory of economic growth. Schumpeter (1954, p. 187) observed, with mild exaggeration, that “nobody, either before or after A. Smith, ever thought of putting such a burden upon division of labor. With A. Smith it is practically the only factor in economic progress.” Smith failed to explain the origins of the concept beyond the natural, human “propensity to truck and barter,” but he maintained that division of labor was a natural occurrence in a capitalist economy. Despite some misgivings about the monotony of repetitive tasks occasioned by specialization, which he expressed in Book V of the Wealth of Nations, Smith stressed the effect of division of labor and specialization upon the productive powers of labor. On this bedrock he built a theory of economic development: division of labor leads to increased output, which leads to higher levels of profits, out of which increases in fixed and circulating capital are financed. This leads to an increase in the wages-fund, and higher wages for labor, so long as increases in the demand for labor outstrip increases in the supply.