The urban economics of Adam Smith

The urban economics of Adam Smith

JOURNAL OF URBAN ECONOMICS u),291-311(1986) The Urban Economics of Adam Smith’ WILLIAM J. STULL Department oj Economics, School of Business Admin...

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JOURNAL

OF URBAN ECONOMICS

u),291-311(1986)

The Urban Economics

of Adam Smith’

WILLIAM J. STULL Department oj Economics, School of Business Administration, TempIe University Philadelphia, Pennsylvania 19122 Received July l&1984;

revised March 25,1985

The purpose of this paper is to show that location, transport costs, urbanization, and the urban hierarchy all play important roles in the economic analysis of Adam fhlith.

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I. INTRODUCTION In his 1956 volume Location and Space Economy, Isard [7, Chap. 21 criticized what he referred to as the “Anglo-Saxon bias” in the modem development of microeconomic theory. The main thrust of his criticism was that the dominant British and American traditions in this subject ignored the influence of geography and location on economic life. He contrasted this “spaceless” theory with an almost wholly independent line of German thought extending from von Thiinen [19] through Weber [20] and Liisch [8] where the central concern was the development of models in which transport costs, and hence location, significantly affect economic behavior. Since the publication of Isard’s book, these two lines of inquiry have been bridged by urban and regional economics as established subfields in microeconomics. Nonetheless, modem economists working in these areas remain cut off from the deepest traditions in their profession by the belief that their classical and neoclassical predecessors were little concerned with spatial matters. Recent work in the history of economic thought is beginning to challenge this conventional wisdom to the extent that it is applied to the early classical economists. 2 The present paper extends this line of research to include the greatest of the classicals, Adam Smith. The focus of the paper is Smith’s The Wealth of Nations (henceforth, WeaZth).3 The secondary literature on this great classic is enormous, but nowhere are its urban economic aspects given a comprehensive treatment, 1I am indebted to David Good, Michael Weinstein, Ingrid Rima, Karl de Schweinite, Eileen Appelbaum, Michael Leeds, and an anonymous referee for helpful comments and to Patricia Conboy and Fred G. Esposto for research assistance. Funding for the project was provided by Temple University. zSee Hebert’s [4] paper on Cantillon, and Beckmann’s [l] on Steuart. 3All page references are to the Cannan edition of Wealth published by Modem Library 1181. 291 0094-1190/86 CopyrightQ1986 Au rights of Rproduction

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particularly one which links them to Wealth’s theories of resource allocation and economic growth. The central purpose of the research reported here is to close this gap in the literature by showing that space in general and urban development in particular play important roles in Smith’s analysis. The paper is organized as follows: Section II sets the stage by presenting a brief overview of Smith’s stadial theory of sociohistorical development. Section III sketches a highly simplified version of his core theory of economic growth and shows how it becomes a theory of urbanization once transport costs are taken into account. Section IV describes the urban hierarchy which emerges out of the Smithian growth mechanism. Finally, Section V contains some brief concluding remarks. II. THE “FOUR

STAGES’

THEORY

A useful point of departure in the analysis of Smith’s urban economics is his version of the famous “four stages” theory discussed at the beginning of Book V.4 The theory is based on the proposition that a developing society passes through four stages in its evolution from a primitive to a modern state. Each stage is characterized by a particular mode of subsistence which determines the nature of its social, legal, military, and political systems. As Skinner [16], Meek [lo], and others point out, the theory is an early form of the materialist model of history which was to reach its maturity in the work of Marx. The first two stages of the development sequence are hunting and pasturage. These represent the “barbarous” stages of society in which the institutions of property, law, and government are the least developed. A social group at either of these stages typically has no permanent settlement and exhibits only a limited division of labor [18, pp. 15, 64,259,735]. Smith pays little attention to either of these stages in Wealth. They are referred to only occasionally and, as noted by Hollander [6], the transitions into and out of them are never discussed. Since both represent preurban forms of civilization, they are also of no relevance to the present paper. The third stage is agriculture. The dominant mode of subsistence here is farming, augmented by coarse household manufacturing. Land is a scarce input and usually privately owned. Landlords receive rent for their property which then becomes a component of market price [p. 491. During this stage agricultural productivity rises to the point where at least some workers specializing in nonagricultural activities can be provisioned by those who work the land. This represents a significant increase in the division of labor over the previous two stages. Such workers cluster to form small urban areas, and trade commences between town and country. 4The discussion which follows is necessarily abbreviated. For a more extensive treatment, see Skinner [17].

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Smith refers to two types of agricultural society in Wealth. The first is exemplified by Europe during the Middle Ages. This case, discussed in detail in Book III, represents a rudimentary form characterized by many institutional features from the pasturage stage. Smith sees this case as one in which historical events significantly impeded the “natural progress of opulence.” His argument is that political and military instability in the countryside early in the feudal period produced institutional forms which, once entrenched, operated to restrict factor mobility and trade for centuries after the original reason for those forms had disappeared. Agricultural progress was thus retarded and the “natural order” of development failed to establish itself. Instead; a “retrograde order” appeared in which urban areas in general, and cities specializing in foreign trade in particular, achieved a level of opulence much in excess of that which prevailed in their rural hinterlands. Because of this imbalance, economic progress for society as a whole was “slow and uncertain.” Smith’s second type of agricultural society is illustrated by the North American colonies [pp. 159, 359, 531-532, and elsewhere]. This more advanced form represents the natural order mentioned above and is characterized by the relatively free operation of market forces. Here exchange is unencumbered by feudal constraints and production is oriented toward the market. Town and country develop together in a mutually reinforcing way and “towns nowhere [increase] beyond what the improvement and cultivation of the territory in which they [are] situated [can] support; till such time, at least, as the whole of that territory [is] completely cultivated and improved” [p. 3571. Since this paper is primarily concerned with Smith’s economics rather than his historical analysis, its arguments are based on the assumption that the natural order prevails during the third stage unless otherwise noted. The culminating stage is commerce. Here the preponderance of labor is employed in either the trade or the manufacturing sectors. Capital is an important input and the price of the typical commodity includes a component for profit as well as for wages and rent [pp. 48-521. Overall, the economy exhibits both a fine-grained division of labor and extensive trade at the regional, national, and international levels. Cities are much more important than in the ‘previous stage and function as centers for the extension of both trade and the division of labor. All societies at this stage, as well as those at the previous stage developing under the natural order, have an economic system which approximates to a greater or lesser degree the Smithian ideal of “natural liberty.” Under this system, which is similar to perfect competition, production units are small, resources are mobile except for frictions imposed by transport costs, and resource owners are motivated by a desire to better their circumstances and to accomplish this by exchange. Inputs automatically flow from less to more remunerative

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activities, equalizing returns in equilibrium. Government plays only a limited role in this system, its primary responsibilities being the provision of external security, justice, and certain public works and institutions. Of the four stages, the commercial receives the most attention in Wealth. Indeed, the volume’s core theories apply only to societies which have reached this stage or are in the process of doing so. Smith’s theory of economic growth, in particular, is best understood as describing the dynamic process whereby an economy moves from the agricultural stage through the commercial stage under conditions of natural liberty. Since for Smith agriculture is always the industry of the country and commerce the industry of the city, society necessarily becomes more urbanized as this process unfolds. This suggests that Smith’s theory of growth can also be interpreted as a theory of urbanization.’ In the next section, I expand upon this insight and show in detail how the two processes are connected in smith’s thinking. III. URBANIZATION AND NATIONAL GROWTH Smith’s conception of the national growth process comprehends structural changes occurring simultaneously at several different levels of aggregation, both sectoral and spatial. Because. of the complexity of his analysis, the argument in the present section is developed in several steps. Part A presents an overview of Smith’s growth paradigm in which all differences among industries and regions are suppressed. Parts B and C provide a more disaggregated perspective. The former analyzes the sectoral shifts which accompany Smithian growth; the latter examines the spatial and urban implications of these shifts. A. The Smithian Growth Process There is no single chapter in Wealth where Smith gives a fully developed presentation of his growth theory. Instead, the reader is left to infer its characteristics from passages scattered throughout the volume. Fortunately, a number of scholars have undertaken the task of assembling these passages and constructing a formal statement of the theory from them.6 The version presented here is to some extent a composite sketch derived from these pioneering efforts. We begin with an economy in either the late agricultural stage or the commercial stage operating under conditions of natural liberty. Smith’s theory of growth in this setting is based upon two fundamental principles. 5 The term “urbanization” as used in this paper always refers to an increase in the share of national population living in urban areas. %e, in particular, the recent papers by Lowe 191, Eltis [3], Barkai [2], and Samuelson [14, 151.

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The first, one of the most famous in economics, states that the division of labor is limited by the extent of the market. The second, less prominent in Wealth but no less important analytically, asserts the reverse: the extent of the market is limited by the division of labor. Let us briefly examine these propositions separately and then put them together. Consider a set of competing firms producing for some market. Smith’s first principle says that the ability of these ohms to take advantage of the division of labor is constrained by the level of demand. If demand increases, price rises (at least in the short run), and tirms respond by increasing output. Smith’s central insight is that this quantitative change in the level of production is almost invariably accompanied by a qualitative change in its organization: “The increase of demand.. . encourages production, and thereby increases the competition of producers, who, in order to undersell one another, have recourse to new divisions of labor and new improvements of art, which might never otherwise have been thought of’ [p. 7061. These new divisions of labor and improvements of art manifest themselves in a variety of ways. Smith suggests that the typical firm will undertake one or more of the following: increased specialization of output [pp. 5, 151, vertical disintegration [pp. 496-4971, subdivision of production processes [pp. 4-51, and installation of new machinery [pp. g-101. Such changes in the organization of production cause parallel changes in the structure of the labor force. In particular, the range of the typical worker’s activities is compressed and his skill in their execution enhanced [pp. 7,114, 117, 246-2471, a process which eventually produces the so-called social division of labor wherein the labor force comes to be divided into highly specialized occupations and professions. Smith’s second principle says that the division of labor not only is determined by, but also determines, the extent of the market. As specialization diffuses through the economy, national income rises. Furthermore, as long as wages are above subsistence, population rises as well [pp. 70-71, 79-801. These changes combine to produce a general increase in demand-i.e., an extension of the market. Smith is most explicit about this effect in his discussion of trade between town and country: The town affords a market for the surplus produce of the country, or what is over and above the maintenance of the cultivators, and it is there that the inhabitants of the country exchange it for something else which is in demand among them. The greater the number and revenue of the inhabitants of the town, the more extensive is the market which it affords to those of the country. . [p. 356; see also pp. 476,650].

He also notes on various occasions that increases in population and in per capita income raise the demands for specitic commodities [pp. 202,218-228, 2351. When the two principles are joined, they create a self-propagating growth mechanism. Each increase in the division of labor produces a corresponding

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increase in income and population and, hence, an extension of the market. The latter in turn feeds back and leads to a further increase in the division of labor, causing the cycle to repeat itself. The rate at which growth proceeds as a result of this interaction is regulated by capital formation, the source of which is saving. Smith believes that the rate of profit declines as the economy advances [p. 3361. However, as long as there is social stability and this rate is above some low minimum, saving sufficient for long-run growth will occur more or less automatically [pp. 324-3251. When a society is advancing as a result of this growth process, Smith defines it as being in the “progressive” state.’ In the early, or acceleration, phase of this state the rate of growth of labor demand increases because of burgeoning investment opportunities, causing the real wage to rise. In the later, or deceleration, phase the rate of growth of labor demand decreases and the real wage falls8 Once the second phase is entered, both the real wage and the profit rate decline until they reach their minimum values: subsistence for the former, the profit rate at which net investment is zero for the latter. As soon as these minima are attained, the economy comes to rest in the Smithian “stationary” state and no further endogenous economic progress occurs [pp. 71,93-951. B. Sectoral Shifts As noted above, Smith’s growth analysis is not confined to the national level of aggregation. He is also concerned with the evolution of particular sectors and industries. He divides the economy into four sectors: agriculture, manufacturing, trade, and service. The first three are primarily engaged in the production and distribution of physical goods. Collectively, they constitute what Smith refers to as the “productive” portion of the economy. The fourth sector, service, makes up the “unproductive” portion.9 In the discussion which follows, we focus on the productive sectors since they are the ones involved in his theory of urbanization. Consistent with Smith’s overall emphasis in Wealth, we also assume that the economy is in the acceleration phase of the progressive state and, thus, that the living standard of the representative household is above subsistence and rising. ‘[p. 811. Unfortunately, Smith does not locate the progressive state very precisely within the historical framework provided by the four stages theory. For the purposes of this paper, I assume it begins as soon as some workers begin to specialize in commercial activities. *In Smith’s long-run dynamic model of the labor market, the real wage adjusts to equate the rate of growth of aggregate labor supply to that of labor demand. For an extended discussion of this formulation, see Hollander [S, pp. 157-1581. gSmith makes this distinction throughout Wealth. Productive worker8 are supported by the investment expenditures (“circulating capital”) of entrepreneurs, and unproductive workers by the consumption expenditures (“expense of revenue”) and tax payments of households. The four stages theory is best interpreted as applying only to productive workers.

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The principal output of.the agricultural sector is food. Smith asserts in one of his best-known passages that the demand for this complex of commodities is income inelastic due to “the narrow capacity of the human stomach” [p. 1641. It follows that the demand for food increases over time at approximately the growth rate of population rather than at the higher growth rate of aggregate income. The situation for manufacturing is the reverse. Smith believes that the demand for manufactured goods is income elastic; it thus grows more rapidly than does population during a period of rising real wages. The experience of the trade sector is similar to that of manufacturing. The demand for its services increases over time because of the ongoing extension of the division of labor. Firms and workers, as they become more specialized, satisfy an ever-increasing portion of their wants indirectly through the market rather than directly through their own production. Since the volume of trade per capita rises as the economy becomes more specialized, the rate of increase of this demand is greater than that of population. Under natural liberty, these secular trends have a profound effect on the allocation of national resources. The slow growth in the demand for food, coupled with increasing agricultural productivity brought about by the progressive division of labor, causes the agricultural share of the labor force to decline. At the same time, rapid growth in the consumption of manufactured goods fueled by rising incomes causes the share in this sector to increase.” Finally, the share in the trade sector also increases because of progress in the division of labor. The result is that in the Smithian growth model, the commercial labor force expands more rapidly than the agricultural labor force. C. Spatial Implications As just observed, the increases in the division of labor which occur as the economy develops necessarily lead to an expansion of trade. Trade, however, involves the movement of goods and thus transport costs. Smith is sensitive to the sign&ance of these costs and aware of the restrictions that they impose on spatial and temporal development. From a static perspective, he notes that the size of the market area for any good varies inversely with transport cost. This is shown by his comparison of land and sea modes “‘Under the retrograde order, income-induced growth in the consumption of manufactured goods is delayed because of their initial unavailability. This is the result of feudal impediments to factor mobility and exchange. The large landlords, who control most of society’s supernumerary income, instead purchase the services of numerous servants and retainers. Later, when manufactured goods do appear on the market as a result of the rise of cities, these dependents are dismissed. Smith assumes throughout this analysis that the income elasticity of demand for manufactured goods is much greater than that for personal services. For further discussion of this case, see Rosenberg [13].

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at the beginning of Book I [p. 181. He also observes that the size of the market areas for different goods varies with the goods’ value-weight ratios. Goods with high ratios, such as refined metals, have large market areas: “The coarse, and still more the precious metals, are so valuable that they can generally bear the expense of a very long land, and of the most distant sea carriage. Their market . . . extends to the whole world” [p. 1671. On the other hand, goods with low ratios, such as quarry stone, have small ones: “The market for the produce of a free-stone quarry can seldom extend more than a few miles about it” [p. 1751. In addition, Smith anticipates von Thtinen by observing that the rent obtainable from a source of low-value “rude produce” varies inversely with the cost of transporting that produce to market. As a result, “The rent of [agricultural] land not only varies with its fertility, whatever be its produce, but with its situation, whatever be its fertility” [p. 1471. The same is true for stone quarries, timber lands, and coal mines [pp. 163, 1651. From a dynamic point of view, Smith argues that transport costs are an important determinant of the pace and ultimate limits of economic progress. High transport costs, because they limit the size of market areas, also limit the degree to which the market for any good is extended in response to an increase in the division of labor. This, in turn, weakens Smith’s feedback mechanism wherein initial increases in the division of labor promote further increases by raising the general level of demand. The higher the transport costs, therefore, the slower and more uncertain the course of economic progress. In those regions where transport is extremely expensive the growth process may be stifled altogether [pp. 20-211. It is for these reasons that Smith argues strongly for the continual improvement of transportation facilities as a nation develops [p. 6821 and against the use of turnpike tolls as a source of general government revenue.‘l Because of their adverse effect on growth, Smith devotes attention to how transport costs can be reduced by human action. As noted earlier, one of the three duties of the sovereign under natural liberty is the provision of certain public works and institutions. Included in this category are transportation projects such as roads, bridges,‘harbors, and canals [pp. 147, U“ [I]f the tolls which are levied at the turnpikes should ever be considered as one of the resources for supplying the exigencies of state, they would certainly be augmented as those exigencies were supposed to require. According to the policy of Great Britain, therefore, they would probably be augmented very fast.. . But the turnpike tolls being continually augmented in this manner, instead of facilitating the inland commerce of the country, as at present, would soon become a very great incumbrance upon it. The expense of transporting all heavy goods from one part of the country to another would soon be so much increased, the market for all such goods, consequently, would soon be so much narrowed, that their production would be in a great measure discouraged, and the most important branches of the domestic industry of the country annihilated altogether” [pp. 685-686; see also p. 8451.

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6821. In Smith’s view, the optimal transportation system is one in which all such projects finance themselves through user charges and in which their number and capacity increase with growth in the volume of trade. He recognizes, however, that actual government operation is likely to fall short of this ideal [pp. 686-6891. Rather than rely solely on the uncertain action of government, Smith’s growth analysis also presumes that the market itself operates to reduce transport costs through its influence on the spatial arrangement of economic activity. This influence manifests itself in two ways. First, as the economy develops, production concentrates in regions with access to cheap water transportation since these have the greatest potential for the extension of markets: As by means of water-carriage a more extensive market is opened to every sort of industry than what land-carriage alone can atford it, so it is upon the sea-coast, and along the banks of navigable rivers, that industry of every kind naturally begins to subdivide and improve itself, and it is frequently not until a long time after that these improvements extend themselves to the inland parts of the country [p. 181.

Second, production in the commercial sector, which is usually not tied to a particular location as it is in agriculture, coalesces at discrete points in space to form urban areas. Smith sees this process as beginning after the invention of agriculture when the excess of food production over consumption becomes su5cient to support a significant number of nonagricultural workers.i2 As soon as the progressive division of labor takes hold in these circumstances and farmers begin to specialize in food production, the need to reduce the transport costs associated with the resulting higher volume of trade compels the newly formed and footloose commercial firms to locate close to one another. Smith discusses the economic logic of this phenomenon in his “first formation of villages” passage in Book III: Without the assistance of some artiticers, indeed, the cultivation of land caMot be carried on, but with great inconveniency and continual interruption. Smiths, carpenters, wheel-wrights, and plough-wrights, masons, and bricklayers, tanners, shoemakers, and taylors, are people, whose service the farmer has frequent occasion for. Such artiticers too stand, occasionally, in need of the assistance of one another; and as their residence is not, like that of the former, necessarily tied down to a precise spot, they naturally settle in the neighborhood of one another, and thus form a small town or village. The butcher, the brewer, and the baker soon join them, together with many other artificers and retailers, necessary or useful for supplying their occasional wants, and who contribute still further to augment the town [p. 3581.

The cost savings achieved as a result of this proximity

are now referred to

‘*Smith notes on several occasions that a food surplus is a precondition [pp. 163, 174, 357, 382-3831.

for urbanization

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as agglomeration economies. Anticipating the modern treatment of the subject, Smith recognizes that these economies can occur only in the presence of both internal scale economies and transport costs. The former make specialized firms possible in the first place (thus underpinning the progressive division of labor), while the latter induce such firms to cluster and form urban areas. These economies, in conjunction with the secular changes in demand discussed above, cause Smith’s theory of growth to be concomitantly a theory of urbanization. IV. TBE

URBAN

HIERARCHY

Smith notes on several occasions that growth does not proceed at the same rate in all urban centers. This is explained largely in terms of locational advantage. Those centers which are the most accessible to economic activity elsewhere grow more rapidly, and thus achieve greater size, than those less favorably situated. Since there are always more of the latter than of the former, the urban system which emerges is hierarchical with a large number of small centers at the base and a small number of large ones at the top. Unfortunately, nowhere in Wealth does Smith present a fully articulated model of this hierarchy, though he refers to it on numerous occasions. The main purpose of the present section, therefore, is to distill the essence of this model from the various passages in which it is discussed. Part A examines the distinction Smith draws between govemment centers and commercial centers. Part B focuses on commercial centers alone and describes the four size categories into which they are classified by his model. Finally, Part C shows how various economic magnitudes vary with city size. A. Government Towns Versus Commercial Towns In Chapter iii of Book II, Smith distinguishes cities whose primary activity is government from those whose primary activity is commerce [pp. 319-3201. His classification of various European towns using this dichotomy is given in Table 1. As observed earlier, Smith denotes that portion of the labor force engaged in the production or distribution of goods as productive and that portion engaged in the provision of services as unproductive. In government towns, the majority of workers are unproductive since they are supported by the “revenue” (i.e., income) of government officials or petitioners. Smith describes these workers as invariably “idle, dissolute, and poor.” In commercial towns, on the other hand, most workers are productive because they are supported by the capital of entrepreneurs in the trade or manufacturing sectors. Such workers, presumably because of their high wages [p. 813, are “industrious, sober, and thliving.”

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TABLE 1 Government and Commercial Towns in Europe” Government

Commercial

Both

Rome Madrid Vienna Edinburgh (before 1707) Versailles Compiegne Fontainebleau Paris Other French parliament towns (except Rouen and Bordeaux)

Glasgow Many English and most Dutch towns

London Lisbon Copenhagen Edinburgh (after 1707) Rouen Bordeaux

-

“From Wealth, Book II [pp. 319-3201.

Smith then hypothesizes that being a government seat seriously limits a town’s potential for commercial development. His argument is that capitalists avoid locating in centers where they have to employ members of a labor force corrupted by widespread dependence on revenue: In a city where a great revenue is spent, to employ with advantage a capital for any other purpose than for supplying the consumption of that city, is probably more difficult than in one in which the inferior ranks of people have no other maintenance but what they derive from the employment of such a capital. The idleness of the greater part of the people who are maintained by the expence of revenue, corrupts.. , the industry of those who ought to be maintained by the employment of capital, and renders it less advantageous to employ a capital there than in other places [p. 3201.

It follows that when government activities diminish, as was the case in Edinburgh after the union of Scotland and England in 1707, one can expect an acceleration in the growth of commerce. The only seats of government which can overcome this handicap are those favorably located with respect to the principal channels of trade. Some examples cited by Smith are listed in the third column of Table 1. He notes, in particular, that the locations of London, Lisbon, and Copenhagen, “perhaps the only three cities in Europe which are both the constant residence of a court, and can at the same time be considered as trading cities , . . . [are] extremely advantageous, and naturally fit them to be the entrep8ts of a great part of the goods destined for the consumption of distant places” [p. 3201. Smith’s theory of commercial development for government cities thus balances the advantage of their situation against the disadvantage of their predominately unproductive labor force.

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B. Levels of the Hierarchy for Commercial Centers

We turn now to an examination of the hierarchical model for commercial cities used throughout Wealth. The preponderance of textual evidence suggests that Smith customarily thought in terms of an urban system consisting of four levels. l3 These are given in the first column of Table 2. In the second column are some cities and towns in 18th~century Britain which can be assigned a position in this hierarchy on the basis of Smith’s commentary. Finally, the third column lists the occupations and industries which are representative of each level. In general, an activity is assigned to the lowest level in which it appears on a wide scale. Thus, while grocers and wholesale merchants can, of course, be found in London [pp. 112-1131 as well as in small towns and country villages, they are representative only of the latter level. The top position in the hierarchy is occupied by the nation’s largest urban center. Smith takes it for granted that this city will be both the economic and the political capital of the country.‘4 His prototype is London; it is mentioned in Wealth far more often than any other city and probably more than all other British cities put together. As this suggests, Smith finds London’s unique features useful for illustrating a variety of analytical points (some instances of which we examine below). In general, Smith sees the London economy as predominately mercantile with heavy involvement in international trade and finance. Its manufacturing activities are mentioned occasionally [pp. 119, 8401 but never emphasized. He also observes that it is the headquarters city for various joint stock and regulated commercial companies. The second tier consists of those “great towns” which are important enough to be mentioned by name in Wealth but which are clearly of lesser rank than the national metropolis. Some of these, such as Edinburgh, are primarily engaged in mercantile activities, but on a smaller, and less cosmopolitan scale than London. Others are centers for manufacturing for distant sale. In Chapter iii of Book III, Smith advances two alternative paradigms for explaining the origins of cities in this latter group. In some cases, manufacturers for distant sale are “the offspring of foreign commerce” in that they originate as a result of the process of import substitution [p. 3811. Cities whose manufacturing sectors exhibit this pattern of development are characteristic of the retrograde order discussed briefly in

13A case could perhaps be made for a five-level hierarchy in which “small market towns” are distinguished from “country villages.” See [pp. 17,120,281]. Smith does not consistently make this distinction, however, and usually he combines the two categories when discussing representative activities [pp. 104,112-113, 3581. 14Note that this is inconsistent with bis argument that government activity retards commercial growth.

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TABLE 2 The Urban Hierarchy in Great Britain” Level of hierarchy

Examples

Capital

London

Great towns

Birmingham Edinburgh Glasgow Manchester Sheffield

Small market towns and country villages

Kirkcaldyb

Very small villages

In the Scottish Highlands

Representative industries and occupations National and international trade [18-19, 110, 319,440-446,592] National and international banking (286-304,445-446,863-8661 Headquarters for joint stock and regulated commercial companies [93,488,693-697,714-7151 Manufacturing for distant sale [114-115,121,207-209,243,383] Merchant speculator [114] Full-time porter [17], cutler [119] Apothecary [112] Fortune hunter [113,461-4621 Local banking [281] Naihnaking [18] Wholesaling [112-1131 Grocer [112-1131 Butcher, baker, brewer [113, 3581 Tailor, shoemaker [104, 3581 Wheelwright, plot&wright [358] Country carpenter [17] Country smith [17] Jack-of-all-trades (171

“Page references to We& are in brackets. bKirkcaldy, Smith’s birthplace, is never mentioned by name in Weolrh. However, Cannan asserts that Smith “doubtless” had it in mind when he wrote about the “small sea-port town” in Book I, Chapter x [p. 1121. John Rae, in his Life of Adam Smith, notes that there were several naileries in Kirkcaldy during Smith’s boyhood [ll, p. 81.

Section II. In other cases, these manufacturers !‘grow up naturally, and as it were of their own accord, by the gradual refinement of those household and coarser manufactures which must at all times be carried on even in the poorest and rudest countries” [p. 3821. It is this process, characteristic of the natural order, which accounts for the emergence of the manufacturing centers in the Midlands. It should be noted that the second of these paradigms is simply a regional version of Smith’s theory of national development. Earlier we saw that under the natural order, small villages form in a society as soon as it is capable of producing a food surplus. Thereafter, the progressive division of

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labor takes hold and labor productivity, per capita income, quality of goods produced, trade, population, and the urban share of population increase together in a mutually reinforcing upward spiral. Smith hypothesizes that in certain regions-those which are very fertile but without access to water transportation-this process proceeds in a completely self-contained way until local manufactures have improved enough in quality to bear the cost of a lengthy overland journey and still be profitably sold. At this point, those cities in the region with sufficient capital begin to specialize in manufacturing for distant sale [p. 3461, enabling them eventually to achieve a size far in excess of what purely regional demand could support.ls The two remaining levels of the hierarchy are occupied by urban centers which never transcend their original local service function. The third level, small towns and country villages, is made up of centers which are large enough to support a variety of commercial enterprises such as shoemaking, brewing, baking, and nailmaking. These are patronized both by residents of the town and by nearby farmers. The fourth level, very small villages, contains the smallest settlements. These offer only the narrowest range of goods and services for sale, and their inhabitants must produce for themselves many commodities which would be purchased in more densely populated areas. C. Properties of the Urban Hierarchy

In addition to describing this hierarchical system, Smith also observes that many economic magnitudes vary systematically with city size. In general, the relationships identified derive from his fundamental principle that the division of labor is limited by the extent of the market. As we move up the hierarchy, the population of urban centers increases along with the demand for locally produced goods. It follows that the extent to which labor is divided also increases. Smith’s hierarchy thus exhibits the greatest division of labor at the top and the least at the bottom: There are some sorts of industries, even of the lowest kind, which can be carried on no where but in a great town. A porter, for example, can find employment and subsistence in no other place. A village is by much too narrow a sphere for him; even an ordinary market town is scarce large enough to offer him constant occupation. In the lone houses and very small villages which are scattered about in SO desert a country as the Highlands of Scotland, every farmer must be butcher, baker, and brewer for his own family. In such situations we can scarce expectto find even a smith, a carpenter, or a mason, within less than twenty miles of another of the same trade. The scattered families that live at eight or ten miles distance from the nearest of them, must learn to perform themselves a great number of little pieces ‘5This development pattern runs counter to Smiths general principle that growth proceeds the furthest in regions accessible to water transportation. An explanation for this amxmly is not provided until Book V where he asserts that the prime determinant of manufac&ng location in Britain is accessibility to cheap coal for domestic space heating [pp. K&826].

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of work, for which, in more populous countries, they would call in the assistance of those workmen [p. 171.

This feature of the hierarchy suggests that those variables which increase (decrease) with time during the acceleration phase of the progressive state should also increase (decrease) with city size at a given point in time because the division of labor is being extended in both cases. As we see below, many of the city size relationships identified by Smith exhibit this correspondence. Firm size and profit rate. Let us first consider variations in the size and profit rate of Ms. Recall from the previous section that during Smithian growth, the rate of profit declines and average firm size increases. On the basis of the argument above, one would predict that these variables behave in similar ways as city size increases and this is, in fact, what Smith argues: It generally requires a greater stock to carry on any sort of trade in a great town than in a country village. The great stocks employed in every branch of trade, and the number of rich competitors, generally reduces the rate of profit in the former below what it is in the latter [29, pp. 89-901.

Large cities thus have bigger firms and lower profit rates than do small ones. One difficulty with the profit rate relationship specified here is that it seems at variance with Smith’s general assumption of factor mobility, the cornerstone of the system of natural liberty. Unfortunately, Smith never directly confronts this apparent contradiction. One possible explanation, more implied than explicit in Wealth, is that the difference in profit rates between large and small urban centers is a compensating differential. The argument is as follows: In small towns and country villages “trade cannot always be extended as stock extends” because of the limited size of the local market [p. 1131. Thus, an entrepreneur starting a business in such a center knows in advance that his enterprise is never going to become large and, therefore, that he is never going to earn a supernormal profit. In large towns and in the capital, on the other hand, the possibility always exists that the business will grow to a significant size, perhaps enabling its owner to earn a “great fortune” [pp. 113, 461-4621. l6 Given Smith’s belief that all men overrate their prospects [p. 1071, it follows that the equilibrium profit rate in small centers must be higher than in large ones to compensate entrepreneurs for the foregone opportunity, however remote, of achieving great success. ‘%nith asserts that such fortunes are rarely made in a “regular. . branch of business, but in consequence of a long life of industry, frugality, and attention.” Quick fortunes, however, may be made in commodity speculation, a trade peculiar to large cities because it is only there that the “requisite intelligence” can be found [pp. 113-1141.

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cost of living. At various points Smith concerns himself with the cost of the “necessaries and conveniences” of life [pp. 70,74-78,113,821-8291. By assembling his remarks concerning how this cost varies over space, it is possible to infer how the cost of living for an urban family varies with city size. For the most part, Smith confines his analysis to the two most important components of the household budget, food and housing. Each is examined separately below. In his discussions of spatial variation in the price of food, Smith focuses on two categories of items. One is bread and butcher’s meat, and the other is grocery goods. Let us consider bread and meat first. The urban centers formed by the agglomeration process described earlier come to be surrounded by agricultural supply areas [p. 3571. Outside these areas, farmers produce primarily for their own consumption; within them they produce for sale in urban markets. In the latter case the most important commercial products are beef cattle and corn [p. 2271. As soon as trade between a town and its supply area is well established, growth in the two areas becomes reciprocal as a result of the dynamic relationship between the division of labor and the extent of the market. Supply areas therefore increase in size as one moves up the urban hierarchy with the capital (London) having the largest of all [p. 1931. The typical unprocessed agricultural good has a low value-weight ratio and hence is relatively costly to transport [p. 3831. In addition, its price in any center must be high enough to yield a profit for the most distant producer [p. 3571. It follows that corn and cattle are more expensive in large cities than in small ones because, on average, they are brought to market from a greater distance [pp. 113, 1901. This does not imply, however, that the bread and meat obtained from them also are more expensive. Smith argues that the greater size of bakeries and butcher shops in large cities enables the fixed cost of entrepreneurial wages, or “apparent profit,” to be spread over a larger output. Thus, as we move up the hierarchy, apparent profit per unit of bread and meat declines at the same time that transport cost per unit increases. In Smith’s judgment these two effects just about cancel out each other, at least in Great Britain: The extent of the market [in great towns], by giving employment to greater stocks, diminishes apparent profit; but by requiring supplies from a greater distance, it increases prime cost. This diminution of the one and increase of the other seem, in most cases, nearly to counter-balance one another; which is probably the reason that, though the prices of corn and cattle are commonly very different in different parts of the kingdom, those of bread and butcher’s meat are generally very nearly the same.. [p. 1131.

The retail prices of bread and meat thus do not depend on city size. Smith’s analysis of spatial variation in the price of grocery goods is brief and incomplete. The first problem is that he never defines this category, though it is perhaps reasonable to assume that it represents all food other

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than bread and meat. The second is that he simply asserts without argument that “[i]t costs no more to bring grocery goods to the great town than the country village.. . ” [p. 1131. If this latter proposition is accepted, however, it then follows from the shop size argument in the preceding paragraph that grocery goods will be cheaper in large centers than in small ones. Putting the results for the two categories of items together, we see that in his model the overall price of food varies inversely with city size [pp. 74-75,112-1131. We turn now to Smith’s analysis of the price of urban housing. He notes that this price, which he refers to as “house-rent,” is highest in the capital [pp. 117-1181. He does not comment directly on its level in lower-order centers, but his discussion implies that it declines as city size declines. House rent is high in the capital for three reasons: “the dearness of labour, the dearness of all the materials of building, which must generally be brought from a great distance, and above all the dearness of ground rent.” The first of these factors is discussed below. The second occurs because building materials, like corn and cattle, are both expensive to transport [pp. 162-1631 and supplied to the capital from a large area. The third is the result of the competition for building sites in the capital: “In every country the greatest number of rich competitors is in the capital, and it is there accordingly that the highest ground-rents are always to be found” [p. 7951. Combining the findings of the preceding paragraphs we see that the larger the city, the lower the price of food and the higher the price of housing. It follows that the overall relationship between city size and the cost of living is a function of the relative shares of the two commodity groups in the household budget. These shares, in turn, vary systematically with income: The proportion of the expence of house-rent to the whole expence of living, is different in the different degrees of fortune. It is perhaps highest in the highest degree, and it diminishes gradually through the inferior degrees, so as in general to be lowest in the lowest degree. The necessaries of life occasion the great expence of the poor. They find it difficult to get food, and the greater part of their little revenue is spent in getting it. The luxuries and vanities of life occasion the principal expence of the rich; and a magnificent house embellishes and sets off to the best advantage all the other lwruries and vanities which they possess [pp. 793-7941.

The housing share thus rises with income while the food share declines. The final conclusion of this subsection, therefore, is that in Smith’s model the cost of living varies directly with city size for those with high income and inversely with city sire for those with low income. Since there are many more of the latter than of the former, the typical relationship is undoubtedly inverse. Wage rate. The last relationship to be considered is that between city size and the wage rate. The general level of (real) wages in a commercial society

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is determined, as noted earlier, by the rate of growth of capital formation. Smith then explains differences in money wages across occupations and locations on the basis of occupational characteristics, deviations from natural liberty, and spatial variations in growth rates. We begin by examining Smith’s analysis of long-run occupational wage differences within a given urban center, thus holding location constant. Smith assumes that men have approximately equal natural talent prior to their education and training [pp. 15-161 and also that they have homogeneous tastes regarding the advantages and disadvantages of different occupations (Rees [12, pp. 339-3401). Under conditions of natural liberty, these assumptions are sufficient to ensure that the only wage differences which can exist in long-run equilibrium are compensating differentials. In Part I of Chapter x, Book I, Smith discusses the various factors which can account for these. In Part II Smith relaxes the assumption of natural liberty and notes that in 18th~century Europe, the structure of compensating differentials is everywhere distorted by government policies. In some occupations these policies operate to restrict the supply of labor and thus to raise wages; in others they do the reverse. Smith is of course much more concerned about the first than the second. He argues that the most pervasive restrictions in Europe are the result of exclusive privileges of corporations granted to individual trades by town charters. Such corporations, through the use of apprenticeship requirements, operate to raise the wages of incorporated trades relative to those of other occupations. Smith provides two explanations for the origin of these corporations. In part, he sees them as the product of a specilic historical circumstance-namely, the political independence achieved by many towns during the early Middle Ages [Book III, Chapter ii&l7 The governments of such towns fell into the hands of local artisans who then used their political power to incorporate the dominant trades [p. 1241. More generally, however, he argues that restrictive combinations of all kinds are a natural consequence of the spatial proximity characteristic of urban life. He notes, first, that “[pleople of the same trade seldom meet together, even for merriment and diversion, but the conversation ends in a conspiracy against the public. . . ” [p. 1281 and, second, that such meetings are far more easily accomplished in an urban than a rural setting [pp. 126,620]. One may infer from this argument that Smith considers the monopolization of local trades to be an inevitable consequence of urbanization in any form, whether under the natural or the retrograde order. Consider now a Smithian commercial economy consisting of a hierarchy of urban centers and the surrounding countryside. How will wages for the “It was this independence side during this period.

which

enabled

towns

to develop

more

rapidly

than the country-

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representative occupation vary across space in this setting? Smith’s answer has two parts. First, wages decline with distance from any center. They are, therefore, always higher in towns than in their hinterlands. Second, wages increase with city size, with the capital having the highest of all. Both propositions are illustrated in the following passage comparing London and Edinburgh: [TJhe wages of labour in a great town and its neighbourhood are frequently a fourth or a fifth part.. higher than a few miles distant. Eighteen pence a day may be reckoned the common price of labour in London and its neighbourhood. At a few miles distance it falls to fourteen and fifteen pence. Ten pence may be reckoned its price in Edinburgh and its neighborhood. At a few miles distance it falls to eight pence, the usual price of common labour through the greater part of the low country of Scotland.. , [p. 75; see also pp. 81-82, 90, 110, 1401.

Putting the two together, by a wage surface which urbanization. Smith provides, directly the shape of this surface. across cities of different constancy of employment

we conclude that Smith’s model is characterized shows wages varying directly with the degree of or indirectly, several alternative explanations for First of all, he notes that working conditions vary sizes. In particular, in certain skilled trades the declines as city size increases:

In London almost all journeymen artificers are liable to be called upon and dismissed by their masters from day to day, and from week to week, in the same manner as day-labourers in other places. The lowest order of artificers, journeymen taylors, accordingly, earn their half crown a day, though eighteen pence may be reckoned the wages of common labour. In small towns and country villages, the wages of journeymen taylors frequently scarce equal those of common labour. [p. 1041.

Workers in large urban centers also work harder than their counterparts in small centers and in the countryside [pp. 8-9, 81-821. It follows that at least a portion of the premium earned by urbanized workers is a compensating differential. Second, Smith suggests, without developing the point in detail, that the monopolistic enhancement of wages caused by exclusive corporations is usually greater in large centers than in small. In the latter, workmen are often compelled to practice several trades because of the narrowness of the local market [p. 161. In these circumstances entry barriers are less likely to be erected because they might prevent some trades from being practiced at all [p. 1201. Third, and most important, Smith argues that the growth rates of capital formation and labor demand are higher in more urbanized locations. In our analysis of his growth theory, we saw that increases in the rate of growth of labor demand over time cause wages to rise. Smith asserts that the same

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process also operates over space: But the wages of labor are generally higher in a great town than a country village. In a thriving town the people who have great stocks to employ, frequently cannot get the number of workmen they want, and therefore bid against one another in order to get as many as they can, which raises the wages of labour and lowers the profit of stock. In the remote parts of the country there is frequently not stock sufficient to employ all the people, who therefore bid against one another in order to get employment, which lowers the wages of labour, and raises the profits of stock ]P. w.

The resulting pattern of wage differences then persists because of the unwillingness of labor to move from low-wage to high-wage areas: Such a difference in prices [between urban and rural labor], which it seems is not always sufficient to transport a man from one parish to another, would necessarily occasion so great a transportation of the most bulky commodities, not only from one parish to another, but from one end of the kingdom, almost from one end of the world to the other, as would soon reduce them more nearly to a level. After all that has been said of the levity and inconstancy of human nature, it appears evidently from experience that a man is of all sorts of luggage the most difficult to be transported [p. 751.

The one occupation which does not exhibit this immobility, that of seamen, is also the one for which interurban wage differences are the smallest [p. 1101. Summing up, tie see that the direct relationship between city size and the money wage rate exhibited by Smith’s urban hierarchy model is primarily the result of growth rate differences in a world where labor is spatially immobile. Systematic differences in the characteristics of individual occupations and in the extent of natural liberty across cities of different size also play roles, however. In the previous subsection, we observed that the cost of living for the typical urban household varies inversely with city size. It follows, therefore, that real wages as well as money wages increase as one moves up the hierarchy. V. CONCLUDING REMARKS The primary tasks of this paper were, tirst, to show that urbanization is an integral feature of Smith’s core growth process and, second, to describe the urban hierarchy which emerges in commercial societies as a result of the operation of this process. Both of these have now been accomplished. Taken in its entirety, Smith’s urban analysis is a remarkable achievement. Not only does it anticipate much of the modem textbook treatment of urban growth and structure, but it also is integrated in a seamless way with the main corpus of his economic theory. The great question which remains is why Smith’s work in this area was not refined and extended by his 19th-century classical and neoclassical successors. That it could be ignored

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during a period when the societies of Western Europe and America were being transformed from rural to urban is powerful evidence in support of the proposition that economic analysis develops more in accordance with its own internal logic than in response to external events. REFERENCES 1. J. Beckmann, Land use theory then and now: A tribute to Sir James Steuart, Papers Regional Sci. Assoc., 48, l-6 (1981). 2. H. Barkai, A formal outline of a Smithian growth model, Quart. J. Econom., 83, 396-414 (Aug. 1969). 3. W. A. Eltis, Adam Smith’s theory of economic growth, in “Essays on Adam Smith” (A. Skinner and T. Wilson, Eds.). Oxford Univ. Press, Oxford (1975). 4. R. Hebert, Richard Cantillon’s early contributions to spatial economics, Economica, 48, 71-77 (Feb. 1981). 5. S. Hollander, “The Economics of Adam Smith,” Univ. of Toronto Press, Toronto (1973). 6. S. Hollander, Historical dimension of “The ,Wealth of Nations” in “Adam Smith and Modern Political Economy” (G. P. O’Driscoll, Jr., Ed.). Iowa State University, Ames, Iowa (1979). 7. W. Isard, “Location and Space-Economy,” MIT Press, Cambridge, Mass. (1965). 8. A. L&h, “The Economics of Location,” translated by W. H. Woglom and W. F. Stolper. Yale Univ. Press, New Haven, Corm. (1954). 9. A. Lowe, Adam Smith’s system of equilibrium growth, in “Essays on Adam Smith” (A. Skinner and T. Wilson, Eds.). Oxford Univ. Press, Oxford (1975). 10. R. L. Meek, Smith, Turgot and the “four stages” theory, Hist. Polif. Economy, 3, 9-27 (Spring 1971). 11. J. Rae, “Life of Adam Smith,” Kelley, New York (1965). 12. A. Rees, Compensating wage differentials, in “Essays on Adam Smith” (A. Skinner and T. Wilson, Eds.). Oxford Univ. Press, Oxford (1975). 13. N. Rosenberg, Adam Smith, consumer tastes, and economic growth, J. Polit. Economy, 76, 361-374 (May/June 1968). 14. P. Samuelson, A modem theorist’s vindication of Adam Smith, Amer. Econom. Rev., 67, 42-49 (Feb. 1977). 15. P. Samuelson, The canonical classical model of political economy, J. Econom. Lit., 16, 1415-1434 (Dec. 1978). 16. A. Skinner, Economics and history-The Scottish enlightenment, Scortish J. Polk Economy, 12, 1-22 (Feb. 1965). 17. A. Skinner, Adam Smith: An economic interpretation of history, in “Essays on Adam Smith” (A. Skinner and T. Wilson, Eds.). Oxford Univ. Press, Oxford (1975). 18. A. Smith, “The Wealth of Nations,” Modem Library, New York (1937). 19. J. H. von Thiinen, “Isolated State,” translated by C. M. Wartenberg and edited by P. Hall, Pergamon, New York (1966). 20. A. Weber, “Theory of Location of Industry,” translated by C. J. Friedrich, Univ. of Chicago Press, Chicago (1929).