Tuesday, February 21, 2017

Specialization and the Extended Order

In earliest society, the number of jobs that were available to men and women were limited. They were also strictly allocated on the basis of gender. Goods were allocated amongst a community according to one’s position in the hierarchy. As society grows larger, this structure of cooperation is difficult to maintain. Groups tend to divide at Dunbar’s number, which lies somewhere between 150 and 300 persons. When groups split in two, there will likely remain contact and cooperation between the groups, but as groups grow more numerous they become more difficult to manage. The structure of society must become more sophisticated if many parts are to form a coherent whole.

In a world where resources are scarce, humans must necessarily be value creating if they are to survive. At its core, this value consists in the provision of goods that promote survival. In pre-modern society, this may consist only of finding goods and shelter. As society grows more complex, many agents are expected to acquire more skills and means to augment their labor.  One person’s livelihood may depend on his Volkswagen van to deliver mail in rural Nebraska. The van is a means to providing the income that maintains his life. Others must develop specialized skills, a form of human capital, in order to offer a service that generates income. Plumbers, lathe operators, auto mechanics, programmers, and many other fall under this category. Blue collar and white collar jobs typically fall within this domain.

Specialization requires the development of technology and capital that embodies this technology. To move from a society of hunter-gatherers to a society of farmers, the technology for farming must be developed and spread. One cannot farm without knowledge of the seasons and of planting. One must also have available means of protecting one’s crops from hungry animal and thieves. All of this is technology that would otherwise be unnecessary and relatively costly in a world where food is abundant. As regions become more crowded, inhabitants face two options: move to regions with fewer people or begin farming. Hunter-gathering groups cannot remain in these areas. Herders are forced to the outskirts of this society as farmers develop land for intensive cultivation. The movement from a life in transit to a relatively sedentary existence enables the formation of a governing structure that is also stable. This may not happen immediately, but it does not take long. We will discuss this further in the next lecture.

Specialization and Technological Development

Specialization also enables the development of technology and capital. Imagine two castaways stranded one an island. We often use the story of Robinson Crusoe in this manner. Crusoe, stranded on an island, must find the means to satisfy his desire for food and shelter. He cannot work simultaneously to achieve both. Thus, he must spend some portion of his time fishing or harvesting coconuts and another portion to dedicated to building and maintain shelter. As long as Robinson Crusoe is alone, it is difficult for him to develop means for either. When Friday arrives on the island, he brings with him similar demand for food and shelter. Yet, the economic problem becomes more complex and, therefore, provides more possibilities. If Friday enjoys fishing, he can spend his time gathering food in this manner while Robinson Crusoe concentrates his energies on providing shelter. Perhaps Friday can catch enough fish for Robinson Crusoe in 6 hours. If he likes, he can spend the rest of the day resting. However, since Robinson Crusoe is working on the other side of the island, he may feel an obligation to contribute to the team so as to leave everyone better off. Suppose that Friday would like to be able to catch more fish in less time, so he spends his free time trying to create a net. At first, this is a laborious process as he lacks the knowledge for this, so he must spend time experimenting. Perhaps Friday needs two months two develop a proper net. Once he has discovered a successful strategy for building nets, he dedicate less time to fishing. Further, the time taken to create a new net will be less as it will not require the initial costs of discovery that Crusoe first faced. Now Crusoe can spend his time searching for new food sources. Or if he would, he can work with Robinson Crusoe to improve their shelter.

Once shelter is built, Robinson Crusoe and Friday will need clothes to stay warm at night. If the productive potential of both persons for each good is given, we can perform some simple operations to understand how specialize improve outcomes in a world of exchange. Imagine that, if Robinson Crusoe and Friday specialized, their maximum production of either good is as follows.
Table 1
Production Possibilities
Frontier

RC
F

Clothing
20
20
Fish
10
30

If both Robinson Crusoe and Friday split their productive energies evenly between the two goods, they will produce the following amounts.
Table 2
Production absent
 Specialization
and Trade

RC
F

Clothing
10
10
Fish
5
15

This is not the most efficient outcome. Robinson Crusoe must sacrifice 2 units of clothing for every fish he catches, while Friday sacrifices 2/3 units of clothing for every 1 fish he catches. Inversely, he sacrifices 1.5 fish for every 1 unit of clothing he creates. If they were to specialize, they would produce as follows
Table 3
Production
with Specialization
and Trade

RC
F

Clothing
20
0
Fish
0
30

Robinson Crusoe will be willing to trade up to 2 pieces of clothing for 1 fish. Let’s assume that Friday is willing to trade fish at a price of one piece of clothing, which he would surely accept because the opportunity cost of producing one unit of clothing himself is 1.5 fish. That represents a discount of 1/3 for Friday. In the final allocation, Robinson Crusoe has 5 more fish than he could produce on his own. Friday also has 5 more fish. As fish provide positive utility to both parties, we observe a pure pareto improvement as a result of specialization and exchange.

Table 4
Final Quantities
with Specialization
and Trade

RC
F

Clothing
10
10
Fish
10
20

If both Robinson Crusoe and Friday develop technology to improve their efficiency, we may see their production possibilities frontier shift out. We could perform the same exercise and see that, assuming that specialization enables the development of technology, the situation of both parties will continue to improve so long as technological advancement is possible.

Table 5
New Technology Shifts
Production Possibilities
Frontier

RC
F

Clothing
40
20
Fish
10
50

One change enables another. The development of a more cost efficient form of production can support larger populations and more complex societies. Before this change, it may be difficult for metallurgists to survive. To the extent that one can develop and maintain a social position for oneself with a specialization such as this, he can maintain his well-being through production and exchange. Likewise, this change in society opens the opportunity for carpenters who have specialized knowledge of constructing and repairing buildings. Underlying this change is the fundamental principle we identified early on: humans act to improve the state of the world as they perceive it.

Decision to action occurs in light of the costs and benefits that such action is expected to generate. Humans rarely imagine radical change. Even that thought be radical is usually marginal in light of the present state. Thomas Edison’s discovery of the light bulb, while unexpected by many, required a combination of elements that were readily available to him. This innovation required a search through the vast space of possibility that exists at the fringes of existence. Once found it may enable and encourage many other innovations that were not previously possible. The development of the light bulb, for example, made valuable the provision of electricity in cities. This further provision opened up many opportunities as it allowed for technical development and specialization that would have otherwise been impossible.

Comparative Advantage and Opportunity Cost

So far, we have been thinking of action solely in terms of the exploitation and creation of profit opportunities. If we also integrate the notion of the opportunity cost that inherently exists as a result of living in a world of scarcity, we add another dimension to specialization. Ricardo first spoke of this dimension as comparative advantage. Consider the job of Stephen Curry who plays for the Golden State Warriors. Stephen Curry is a phenomenal leader and basketball player. He seems to make best use of his talents playing for the Golden State Warriors. Curry is not just a talented player, his presence is a unifying force that has helped move the team to win a championship and a heartbreaking miss last season. The opportunity cost of Curry’s participation with the Golden State Warriors is likely participation with another team. The value he creates for the Golden State Warriors is substantial enough that the team has retained him since his entrance in 2009. Although Curry would likely be valuable for any team on which he plays, he has a comparative advantage playing for the Golden State Warriors.

This becomes more obvious if Curry were to change his occupation altogether. Curry may be a fantastic manager. When he graduated from college, he could have entered a field that allowed him to exploit his leadership ability through management. Even if Curry was one of the best managers, it would be difficult for him to surpass his current pay and other benefits he receives playing for the Warriors. This is to say that Curry may have an absolute advantage in comparison to others both in his management ability and his ability on the basketball court. Market prices, however, inform Curry that the most valuable use of his skills will leave him playing for the Warriors, even if he had an absolute advantage as a manager and as a basketball player, he has a comparative advantage in playing basketball.

Comparative advantage allows us to explore areas that may, at first glance, seem to be a source of waste or laziness. Bill Gates, who is estimated to be the world’s wealthiest person in 2017, generates a tremendous amount of value with his time. It makes little sense for Bill Gates to spend time preparing meals or cleaning his own home. Every moment he spends engaged in this activity, he could be dedicating to create more value elsewhere. Cleaning and cooking is especially costly for Bill Gates. He is better served by purchasing cleaning and cooking services than by performing these tasks himself. He may choose to do this simply out of enjoyment of the activity or belief in the personal enrichment from such activity. In terms of value as measured by money prices, he is incurring great cost if he chooses to do so.


Development of specialization that arises due to comparative advantage plays a significant role in the provision of knowledge in society. Specialization itself allow individuals to develop knowledge of a particular category of activity. Gold refining processes could not be developed unless individuals were allowed to spend their time and creative energies developing them. The same can be said of computer processors, means of transportation, mass production, and so forth. The development of cost-reducing technology that allowed much farmland to be tended by far fewer people has allowed individuals to invest their labor in other ventures. It is no coincidence that, within a century of this shift, we live in a world that is dominated by technology. The pace of change appears only to increase as freedom to develop technology and organization also increases.

(Table structure borrowed from Don Boudreaux's article on comparative advantage.)

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