The Answer Is Transaction Costs

Pins: Division of Labor is Limited by Transaction Costs

• Michael Munger

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Adam Smith's pin factory example from "The Wealth of Nations" demonstrates how dividing labor into specialized tasks dramatically increases productivity. Ten workers specializing in different aspects of pin-making could produce 48,000 pins daily, while individually they might struggle to make even 20 pins each—a productivity increase of at least 240 times. This division of labor, Smith argued, is limited by the extent of the market.

Transaction costs—expenses associated with exchanging goods across distances—determine this market extent. As railroads, steamships, and eventually air freight reduced these costs, pin manufacturing evolved from numerous small local producers to global consolidation. The largest pin producer today, Prim-Dritz Corporation (headquartered in South Carolina), conducts most manufacturing in Asia. Modern pin factory workers now produce approximately 800,000 pins daily—200 times more than in Smith's era.

This transformation wasn't about "exporting jobs" but rather the natural evolution of specialized production. Multiple attempts to form price cartels in the pin industry failed as producers leveraging greater division of labor could always undercut competitors. The pattern we see in pins repeats across countless industries: as transaction costs fall, markets expand, allowing for increased specialization and productivity.

Understanding this relationship between division of labor and market size helps explain why some manufacturing concentrates geographically, why attempting to "bring back" certain industries is economically challenging, and why consumer prices have fallen for many goods. Smith's insight continues to provide a framework for understanding economic trends in our increasingly interconnected global economy. 


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Michael Munger:

This is Mike Munger, the knower of important things from Duke University. Today I'll be talking about PINs and the reason that the division of labor is limited by the extent of the market. Spoiler alert the answer is transaction costs. There's two new twedges this week's letter, plus book it a week and more Straight out of Creedmoor. This is Tidy C. (Music)

Michael Munger:

Book 1, chapter 3 of the Wealth of Nation, adam Smith discussed the reason why division of labor is so important, and this is Book 1, chapter 3. It's early on. The title of that chapter is that the division of labor is limited by the extent of the market. Here's what Smith says. As it is the power of exchanging that gives occasion to the division of labor, so the extent of this division must always be limited by the extent of that power, or in other words, by the extent of the market. When the market's very small, no person can have any encouragement to dedicate himself entirely to one employment for want of the power to exchange all that surplus part of the produce of his own labor, which is over and above his own consumption, for such parts of the produce of other men's labor as he has occasion for. So if I can't exchange stuff, there is no reason for me to make more than I myself can consume. But Smith points out that division of labor is nonlinear. If I specialize in producing just one thing rather than producing everything for myself, I'll be able to exchange that for something that other people have specialized in producing and the total amount of stuff increases. That's the nonlinear part. Two people can produce far more than twice as much as one person working alone. There are increasing returns to scale.

Michael Munger:

The fact that the division of labor is the source of wealth and prosperity in capitalist and other nations is now widely accepted. Capitalist and other nations is now widely accepted. That the division of labor in each product is limited by the extent of the market in that good or product is rarely mentioned. Adam Smith's famous example of division of labor is the pin factory. Let me read what Smith said, quoting, to take an example, therefore, from a very trifling manufacturer but one in which the division of labor has been very often taken notice of the trade of the pin maker. 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 is probably given occasion, could scarce, perhaps, with his utmost industry, make one pin in a day and certainly could not make twenty.

Michael Munger:

But in the way in which this business is now carried on, not only the whole work is a peculiar trade. It is divided into a number of branches, of which the greater part are likewise peculiar trades. 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.

Michael Munger:

And the important business of making a pin is in this manner divided into about 18 distinct operations, which in some manufactories are all performed by distinct hands, though in others the same man will sometimes perform two or three of them. I have seen a small manufactory of this kind where ten men only were employed, where some of them consequently performed two or three distinct operations, but though they were very poor and therefore, but indifferently accommodated, with the necessary machinery, they could, when they exerted themselves, make among them about twelve pounds of pins in a day. Now there are, in a pound, upwards of four thousand pins of a middling size. Those ten persons, therefore, could make among them upwards of forty-eight thousand pins in a day. Each person, therefore, making a tenth part of forty-,000 pins, might be considered as making 4,800 pins in a day.

Michael Munger:

But if they had all wrought separately and independently, without any of them having been educated to this peculiar business, they certainly could not each of them have made 20, perhaps not one pin in a day. That is certainly not the 240th, perhaps not the 4,800th part of what they're present capable of performing in consequence of a proper division and combination of their different operations. And so that's sort of in archaic language. Let me paraphrase it briefly If each of the 10 people had worked to make pins by themselves, it's really hard to make even one pin. Certainly they couldn't have made 20. But if each of them work in separate jobs, they can make hundreds, even thousands of pins. The division of labor substantially increases their returns to labor. Each person is much more productive if they're doing a specialized task. So let's see if Smith really communicates the point about transactions cost. I found that he really doesn't.

Michael Munger:

Let me ask this question, and this is a question I often ask my students why is it true that a pin factory might have 18 or 10, nine different workstations, have 18 or 10, nine different workstations, each with a dedicated worker trained to that job? Why might a hat factory have only three different jobs? That is, there's a production line for making hats and it has three different stations. Well, it's tempting to say it's a technical problem only, but that's not true. Most jobs could be further subdivided into two or more jobs. Most groups of jobs in sequence could be done by a single person. It's not a technical problem.

Michael Munger:

Division of labor is limited by the extent of the market, and the extent of the market is determined by the transaction's cost of selling to more and more people further and further away. If it is inexpensive to transport, keep account, take care of property rights, make sure things are not stolen, actually return the money in good order, then you are able to sell things to more and more people farther and farther away. When Adam Smith saw that there were 18 different activities in a pin factory, it must be that the number of pins, given the technology of the time, that could be produced by 18 people equaled approximately the number of pins that they could sell, given the extent of the market. However, notice that division of labor wants to be global. We're constantly going to try to find ways to reduce the transactions cost of expanding the extent of the market and if we can do that, it means that one country is likely to take over the production of much, and maybe most of the production of pins.

Michael Munger:

Economists call this effect of division of labor non-linear the doubling of labor effort more than doubles output. Smith's claim rested partly on eliminating time wasted from switching one task or tool to another, as well as improved dexterity and tool design. That is, instead of switching from one task to another, which wastes times, I'm constantly doing the same task. By doing that same task I improve my dexterity. Through practice I get better at it, I can do it faster and with less thought required. And tool design because I'm always doing the same thing, I could imagine a tool, a small piece of metal, a piece of wood, a string, tied in a certain place. That would dramatically increase my productivity, and it's much easier for me to design tools if the job that I'm doing is smaller in terms of the extent. If I'm constantly doing the same thing, I'm likely to become more dexterous at doing it.

Michael Munger:

Increases in the quantity and specialization of capital on production lines, increase human productivity. Increased productivity increases wages, reducing costs and expanding output. So there's the miracle we can both pay higher wages, but because productivity has gone up, we can charge lower prices and there's more of the stuff. So Karl Marx's concern about the only way that we can reduce prices, squeeze labor, is false as long as productivity is increasing. And it is the increase of productivity that is specifically the thing that is accomplished by division of labor.

Michael Munger:

So what is the extent of the market For that matter? What is a market? Sometimes we use the something in a sentence I'm going to go to the market to get eggs, you need anything. That's not what Smith meant. It's certainly not what market means today. The market Smith was talking about was a number of potential and, in some important sense, actual customers for the product in question. That requires an elaborate infrastructure of exchange, transportation, fast-clearing financial system, absence of political or physical barriers to exchange. In Smith's example, that constraint was static, it was taken as given. But over time, the advent of railroads which of course Smith did not foresee he thought that you needed to be near a river in order to have availability of imports and exports Now airplanes, soon drones All of those things can increase the extent of the market.

Michael Munger:

The number of steps in a production process determines on the technology of reducing transactions costs that expand the extent of the market. You might not have expected that the number of steps in the process is only partly determined by technology. The more important factor is the number of pins the manufacturer thinks he can sell. Dividing labor into discrete steps then increases production more than the proportionate increase in the cost of labor that is employed. I buy more labor. I more than proportionately increase production. So as producers keep dividing labor and producing a lot more pins, eventually they can't sell additional units for more than their marginal cost and that's the optimal size of the pin factory.

Michael Munger:

The dynamic impact of Smith's observation is what is affecting us today in the globalizing market and as a result of that, we're seeing a backlash, because it means that it is very difficult to make pins, if the market that you're serving is anything less than the entire globe, because that market has become global and the division of labor in the countries that specialize in producing pins for global markets mean that it's hard for anyone else to enter that and be productive in terms of cost. Notice that what is blocking competition is low cost, not entry barriers. Having low cost means that others are going to have a hard time entering, other producers will have a hard time entering, but this is great for consumers and that actually is what capitalism is trying to accomplish. Well, 50 years before Smith wrote Wealth of Nations, pins in England were made almost exclusively in Bristol, gloucester and London, the centers of demand. Those were the places where pins were used for making clothing and other things. There were more than a hundred British manufacturing manufactories by the 1760s, by the time Smith was beginning to think about this problem, pin making had become a decentralized cottage industry, in part because sewing and other activities that used pins had also become more decentralized. And that's the period where Smith formed his impression. He saw pins being made by three or six or ten men in a small shop, each of whom performed several tasks at different points, and he noticed that there were likely savings that could be had.

Michael Munger:

So the Industrial Revolution, the advent of steam locomotives and steam ships changed that industry dramatically. In 1820, there were 11 pin factories in Gloucester that were employing 1,500 people out of a total population of 7,500. So many of the people in Gloucester were making pins. By 1870, there was no longer any pin factories in Gloucester, but the number of pins that were available to them was far more and the price was far less. By 1939, the number of manufacturers for pins in the entire United Kingdom had shrunk to about 12. In 1978, there's only two, the Newey Group and Whitecraft Scovel. They had opened by that time a factory in Gloucester. So the concentration of the trade in the UK evolved through mergers, takeovers, firms leaving the trade. I haven't looked lately at the UK. I had looked at this history about 10 years ago. I'm not sure that there's any major pin manufacturers in the UK at this point point.

Michael Munger:

The process of consolidation, the attempts of the industry to rationalize production and pricing policy in the 1840s were an attempt by the manufacturers to prevent low prices. So often we think of the problem of capitalism as price gouging. These manufacturers are trying to get higher prices. Well, in a sense they were. But what they were concerned about was low prices. In 1800, the main pin input was brass. Wire made up nearly three quarters of the total cost of the final product. Brass was available only from the Association of Brass Wire Manufacturers in England. Production process was pretty much the same everywhere. You could start a new pin factory for about 500 pounds.

Michael Munger:

May have been some differences in quality and there was some segmentation by brand name, and what that meant was that pins were not quite yet a commodity. The problem was that pins are essentially homogeneous. The cost savings that come to division of labor in economies of scale broke. There were five separate attempts at price association or cartelization in order to ensure a I'm making air quotes fair price for pins from manufacturers, but that failed Failed five different times. They tried to cartelize the pin industry. The extent of the market simply could not be limited and producers that used increased division of labor to reduce cost were able to undercut the price of competitors. So British pin makers sold to the whole of the UK In fairly short order. They started to export pins and then, not long after that, they were unable to match the prices of foreign producers and today we don't see pins manufactured in the UK. Interestingly, we also don't really see pins manufactured in the United States.

Michael Munger:

The largest pin producer in the world is the Prim Dritz Corporation. It's headquartered in Spartanburg, South Carolina. They had been a German company. William Prim's Brass Mill in Stolberg, germany, started in 1620, moved to the US in the 1920s. They bought a large American pin maker called Collins, as well as the British maker, the Newey Group, and that's one of the groups that actually firms that left Britain in 1980. So while Prim Dritz is still headquartered in Spartanburg, all of their production facilities, almost all of their production facilities, are in China and Malaysia. They have some presence in Hong Kong and Mexico. Now it is an American company but most of their production and sales occur outside of the US border.

Michael Munger:

Within the US border the largest four pin-making firms produce about half of the total output. The 20 largest firms produce three-quarters of the output. It's not overwhelmingly concentrated. Many firms require some registration or even a phone call to find out what their real prices are on bulk orders. I tried to find out. Just look, do the Ronald Coase things and see what actually happens. I had a terrible time getting actual prices for pins. You can get prices for small amounts but if you're looking for bulk orders, it's pretty difficult to find out what the prices are.

Michael Munger:

If you look at different industries right now there's about 5,000 employees in total pin factories in the US. That is down from 10,000 in 1997, so half as many. However, pin output has gone up, so the constant increase in mechanization has meant that each worker is more productive. So it's a mistake to think that those jobs were lost or the jobs were somehow exported. The whole world is losing jobs to productivity. Changes in productivity are hard to measure because the tasks have changed so much. Many people quote Smith's estimate that each laborer could produce something under 5,000 pins a day Right now per worker. Most factories can produce 800,000 or a million pins per day. That's per worker. So that's an increase of 200 times. Some of this productivity increase is due, of course, to secular improvement in technology and automation, but a considerable portion of it is due, just as Smith described it 250 years ago, to the increased division of labor that's fostered by expanding markets. Whoa, that sound means it's time for the twedge.

Michael Munger:

First. I enjoy traveling, so I decided to put a map up on my wall and put a pin every place that I visited. First I'm going to have to travel to the top two corners of the map so it doesn't fall off the wall. That's a great dad joke. Second, a true story about pins. Twenty years ago I was doing some research for some work on pins for Liberty Fund Went into a car drugstore here in North Carolina.

Michael Munger:

I found a clerk who honestly looked a little bit frightened, didn't feel like asking questions, but I wanted to ask some pointed questions about pins. Why do you have more than 35 kinds of energy bars but only one brand of straight pins? And why are the pins that you do have made in China? Why aren't your pins made in America? Now, the poor drugstore clerk was the 10th and final stop of my field research, so I had this wrap down now. The clerk said well, you can talk to the manager if you want. Manager comes over. There's a few seconds of whispered conversation with the clerk to prep the manager to talk to this insane pin guy. Manager comes to me and says is there a problem? And I said well, I'm not sure. Do you think it's a problem? You have 35 brands of energy bars but only one brand of pins and those not made in the United States. Now he thought about that he probably also thought about calling security. Sir, do you want a different kind of pin? You could go to a shop that sells sewing supplies we're a drugstore, after all and I persisted Ah, but you do sell pins. Why don't you sell American pins? Why are you selling Chinese pins? He said, sir, I really don't know, are purchasing people handle stock? I bet we could order you some American pins if you want, probably could have them within two weeks. Do you want to order them? That's the line I was waiting for. I smiled and said, nah, I'll stick with these. Nah, I'll stick with these.

Michael Munger:

I've gotten several letters of conversations that I've had recently have been too advanced too inside baseball and that I would have a larger audience if I just focused on more basic subjects. Some people have asked about various quality issues and said that I should hire some help. Look, folks, I talk to people I think are interesting. I talk about topics I think are interesting. I could probably double my audience. Right now I get about 3,000 downloads per episode and I bet I could monetize that and make $10 or $20 a week. I would rather accept the terms of the deal implicitly being offered by the listeners who complain. Feel free not to listen, because the podcast is well free. What do you want for nothing, rubber Bistit. The Book of the Week.

Michael Munger:

I want to propose three books for this week. I've done kind of a deep dive into Bill Maldon. I had recommended some of these before, but now there's a third. So as a group they're Bill Maldon's book from 1945, upfront, which is a book of his war experiences with his cartoons. Much later Bill Maldon wrote something like a memoir. It's called the Brass Ring. And the third book is a biography of Bill Maldon by Todd Pastino called A Life Up Front. And if those of you don't know who Bill Maldon is, you may have seen his name. Snoopy in the Peanuts cartoon always quaffs a few root beers with Bill every Veterans Day in November. Well, the next episode will be released next week, tuesday June 10th. We'll have a new topic, some letters and, of course, a hilarious new twedge. All that and more next week on Tidy C.