By A. Michael Spence, 2001 Nobel Laureate in Economic Sciences, Professor Emeritus of Economics and former Dean of Stanford University’s Graduate School of Business, and Member of SAGE’s Academic Committee
August 18 , 2025 — Tomorrow’s Affairs (Opinion)
Next year will mark the 250th anniversary of the ratification of the Declaration of Independence, the founding document of the United States. But another foundational document, fundamental to our understanding of economics, will reach the same milestone in 2026: Adam Smith’s The Wealth of Nations. At a time of rapid economic and structural transformation, its insights are worth revisiting. Two stand out.
One is that the “invisible hand” of markets efficiently allocates resources, as long as certain conditions – including a stable currency, a degree of trust and moral rectitude among economic actors, and credible property rights – are in place. Externalities (the unpriced impact of an entity’s activities on others) and informational gaps and asymmetries diminish the invisible hand’s efficiency and performance.
The second, arguably more important insight is that an economy’s efficiency and productivity are enhanced by the “division of labor,” known today as “specialization.” A specialized economy is powered by various pockets of knowledge and expertise, which take advantage of economies of scale, learning, and enhanced incentives for innovation. Since specialization does not work in the absence of a reasonably efficient method of exchange, it depends on Smith’s invisible hand. As specialization advances, so does the economy’s complexity. As Smith noted, however, specialization is limited by the “extent of the market”: a small market cannot create enough demand to sustain a wide variety of specialized businesses. That is why improvements in transportation and communication linkages, which lower the cost of addressing an expanding market, have enabled greater specialization.
Another important potential constraint on specialization is the risk it inevitably generates. Since an economy’s patterns of specialization are structural, they take time to change. So, if the trading system is disrupted, or certain skills or industries are rendered obsolete (such as by technological innovations or shifting demand patterns), individuals, firms, and even entire economies must undergo a transition, which may prove difficult and prolonged. In the nineteenth and early twentieth centuries, as economies became more specialized, various policies, institutions, and conditions – from antitrust to social safety nets to the maintenance of macroeconomic and monetary stability – gradually emerged to mitigate the associated risks. But these were largely national-level solutions, and, after World War II, specialization went global.
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