A conversation with Guang Zhen Sun, for Man and the Economy

 sun  Holding a PhD in economics from Monash University, Australia, GZ SUN now teaches economics at the University of Macau, Macao Special Administrative Region, China. His research interests are mainly microeconomics and the history of economic thought.

  His joint work with collaborators helped establish the theoretical foundation of a literature on endogenous labor specialization. He has also published at times on topics in axiomatization, public choice, theory of the firm, evolutionary economics, etc., and on less-dismal-than-normal topics such as general equilibrium analysis of how large-scale societies of ants self-organize. Among the services he has provided to the scientific community of economists, the commitment he currently takes most seriously is his editorial job at a new journal, Man and the Economy, founded by the late Mr. Ronald H Coase.

  His book The Division of Labor in Economics: A History provides, for the first time, a systematic and comprehensive narrative of the history of one central idea in economics, namely the division of labour, over the past two and a half millennia, with special focus on that having occurred in the most recent two and a half centuries. Quite contrary to the widely held belief, the idea has a fascinating biography, much richer than that exemplified by the pin-making story that was popularized by Adam Smith’s classical work published in 1776.

  Grégoire Canlorbe: Adam Smith’s treatment of the division of labor in his magnum opus has given rise to much debate and controversy over his priority.

  It has been sometimes alleged that his views were essentially plagiarism of the opening chapters of Anne Robert Jacques Turgot’s Reflections on the Formation and the Distribution of Riches, published a few years earlier. The two books show indeed remarkable similarities in content.

  Other analyses consider that Smith’s thought had been anticipated in broad outline by the treatises of ancient Greek or Chinese philosophers. Kuan Chung, Hsün Tzu and Ssu-ma Ch’ien, as well as Xenophon, Plato and Aristotle among their Greek counterparts of the “Axial Period” of human civilization, had indeed already carried out sophisticated developments on increasing returns to specialization and the relation of specialization to the market mechanism.

  What would you retort to these recurring claims in defense of Smith’s profound originality in the history of ideas?

  Guang-Zhen Sun: Doubtless, Smith’s greatest achievement in classical economics is simply founding it, laying down a novel and powerful superstructure for what would come to be referred to as the classical political economy, into which many previously existing but otherwise scattered ideas are well weaved into a coherent body of thought and analysis. On top of that, Smith’s main priority in the intellectual history of the division of labor rests on two separable but closely related pillars of his economics: his historical jurisprudence, and his integrative analysis of the market and the division of labor. These two facets, in my view, constitute much of the core of his scholarship in economic science. This statement needs a great deal of elaboration, a task we can hardly expect to undertake in an interview, of course. But let’s take it as a good excuse to discuss a difficult topic in a conversational manner.

  About the first point, so much has been done in the past four decades in the study of the history of ideas, and of political thought in particular, especially by Donald Winch, Knud Haakonssen and Istvan Hont among others, that there is perhaps no need for further discussion. My small book draws upon their brilliant work to appreciate Smith’s definitive contribution to historical jurisprudence, which indeed took shape mainly in the hands of Smith himself and a few other Scots. Nonetheless, it may be worth stressing that it is in accounting for the historical origin and the nature of the commercial society – the last developed stage of the four-staged conjectural human history – that Smith organizes the exposition of his historical jurisprudence in his magnum opus The Wealth of Nations (WN). In elaborating the historical dimension of the division of labor, Smith develops his main thesis of the origin and evolution of property rights and the function of the government, and thereby made his fundamental contribution to this branch of the study of human society. Some otherwise paradoxical ideas or statements in that great work, if and when seen from this perspective, can well be resolved and even become natural.

  As far as economics is concerned, his study of the market and the division of labor is certainly far more important. As is perhaps not uncommon in the history of social thought, a high price Smith may have had to pay for the comprehensiveness and richness of his scholarship on this subject is that his theory is from time to time unduly narrowly interpreted, or misunderstood. Due to constraints of space, we may focus on two points only.

  Very few economists would doubt Smith’s depth in understanding of the nature of the market. How much his scholarship on this has been influential, not only among economists but among the public as well, might be measured by the popularity of the very term “the invisible hand.” Probably because the term invisible hand may well invoke some divine providence, the market mechanism – as well as the extent of the market for that matter is also so conceived as to claim a standing as a sort of “first mover” (proton kinoun) in Smith’s “inquiry into the nature and causes of the wealth of nations,” and particularly in his theory of how the market relates to the division of labor that sits at the heart of his whole theory. A case in point is what is named “the Smith theorem” by George Stigler in his well-known 1951 paper in Journal of Political Economy: that the division of labor is limited by the extent of the market. Nothing goes wrong with the statement per se, and indeed Smith himself uses this statement as the title of one important chapter in his masterpiece; it nonetheless fails to depict a complete picture. For the power of purchasing, in turn, largely depends upon the division of labor, and it is therefore no less meaningful to reverse the causality. Let’s quote a paragraph from Smith’s opening chapter in WN that follows immediately after articulation of the productivity advantages of the division of labor.

  “It is the great multiplication of the productions of all the different arts, in consequence of the division of labour, which occasions, in a well-governed society, that universal opulence which extends itself to the lowest ranks of the people. Every workman has a great quantity of his own work to dispose of beyond what he himself has occasion for; and every other workman being exactly in the same situation, he is enabled to exchange a great quantity of his own goods for a great quantity, or, what comes to the same thing, for the price of a great quantity of theirs. He supplies them abundantly with what they have occasion for, and they accommodate him as amply with what he has occasion for, and a general plenty diffuses itself through all the ranks of the society.”

  The observation by Smith upon the interdependence of the extent of the market and the division of labor was then fruitfully extended, especially by Edward Gibbon Wakefield, Alfred Marshall and Allyn Young. One section (Section 4.2) of my small book critically examines the development of this Smithian thesis by these men. It is to be noted in passing that Wakefield illustrates Smith’s two-sided theory of the market and division of labor by analogy with the roles of two legs in walking.

  What makes his scholarship of the market all the more remarkable is the comprehensiveness and profundity of his understanding of the nature of the market. It is, as far as I can see, much broader than what is demonstrated by the standard price theory in modern textbooks of economics. But we shall come to this point below when talking of another matter and make more detailed discussion then.

  Grégoire Canlorbe: In his 1981 international bestseller Wealth and Poverty, George Gilder is highly critical of Adam Smith for arguing that the extent of the market determines the possible range for the division of labor. In Gilder’s view, the progress of economies can indeed be measured by the extent of the system of exchange; but it is the process of increasing specialization that expands the market, not the other way around.

  As “the anthropology of the potlatch” suggests, gifts and counter-gifts are the essence of economic life. “The gift evokes the desire to reciprocate and thus induces exchange.” In this regard, “it is not the market that expands the division of labor” but “it is the process of invention and specialization—the production of new goods—that expands the market.” The gift comes first.

  What is your opinion on this influential criticism?

  Guang-Zhen Sun: Honestly, I don’t see much inconsistency between Mr. Gilder’s supply-side argument and Adam Smith’s theory of the interdependence of the market and the division of labor. Smith assigns a central role to the power of the division of labor in production, and the criticism of the demand-oriented doctrines by the supply-side economics can be well aligned with Smith’s theory, at least as far as the parts played by the system of exchange and specialization in economic progress are concerned. We have addressed this issue above.

  Grégoire Canlorbe: A crucial point advanced by Adam Smith is that the gains from the division of labor are realized most effectively and efficiently when competition is guided and constrained by a soundly functioning system of politic and economic institutions. Would you say this condition is met in contemporary China?

  Guang-Zhen Sun: My short answer is: Yes and no.

  Let me start with a few words on the positive side of the story. China’s economic performance in the past three and a half decades, its economic growth in particular, is dazzling. It is doubtless a significant event in human history, not least for having fundamentally changed and improved the lives of hundreds of millions of Chinese people and placed made-in-China products all over the world. Equally impressive is the vitality, vastness and complexity of its domestic market. The biggest puzzle about mainland China’s market economy is perhaps the coexistence of its highly centralized political system and the very decentralized and efficient economic system. Paradoxically, it is its unique political system that has thus far enabled China to achieve such impressive economic growth, which has largely centered on industrialization and urbanization.

  Does China stand as a counter-example to Smith’s central thesis that, as you nicely put it, “the gains from the division of labor are realized most effectively and efficiently when competition is guided and constrained by a soundly functioning system of politic and economic institutions”? I definitely don’t think so, and would stress instead that the fundamental driving force of the Chinese dynamics in economic life is precisely what Smith advocates: free choice, and expansion of the economic order featured by free choice in the market.

  To fully elaborate this point would take us very far. One crucial institutional factor underlying the economic growth of China is the commandery-county system under the centralized leadership of the Chinese Communist Party (CCP), of which an important feature is the keen competition between local governments, which often exploits the capability of the CCP system in mobilizing and utilizing resources. The major part of the economic change of China in the past twenty-five years is industrialization and urbanization, both fundamentally shaped by the inter-government competition. The immobile production factor, the land, is controlled in the hands of the local government as an effective leverage to boost local economic growth and to attract the more mobile production factors, especially FDI and migrant workers from the rural to the urban areas in hundreds of millions. In the recent few years, numerous controversies and debates have arisen about the pros and cons of so-called land financing (revenue gained from the land market constitutes a major source of the local government’s fiscal revenue), but the overwhelming emphasis of these has been on the cons. However, the significant contribution of land financing to industrialization before the global financial crisis can be too easily overshadowed by the detrimental consequences it has had. To thoroughly examine and assess the policy is to systematically evaluate the commandery-county system under the CCP’s leadership, calling for in-depth analysis of the politico-economic framework of China, a daunting task for any student of China. After all, the infrastructure system, the impressive mobility capability of the CCP-led governments, and the thriving commercial culture with a long and deeply entrenched tradition among the populace rapidly put China in a very competitive position in the global market.

  Is China’s method of economic development sustainable? I don’t think so. The real potential trouble of China’s market system is that the intergovernmental competition, which used to be a major engine of the economic growth of China for nearly two decades, is deeply embedded into the political and power structure of the Communist Party, ironically the same factor that has thus far played a major role in its successful industrialization. A glaring gap in China’s long-term development in the years or even decades to come is its national innovation system. Another serious challenge is its constitutional framework, the flaws of which will be more and more exposed over the course of massive urbanization. It is such urbanization, much more than industrialization, that brings about the significant part of what Smith and Montesquieu referred to as commercial society: heterogeneity and diversity, which is always the greatest enemy of dictatorship, and centralization of power in general.

  Grégoire Canlorbe: Most important advances in urban economics and the theory of the firm made in the past two decades are essentially, as you write, “revitalizations, with innovations, of the classical idea of creation and distribution of wealth by way of the division of labor in production and voluntary exchanges”. Could you explicit and develop this filiation? 

  Guang-Zhen Sun: It is perhaps not a bad idea to look at the two issues separately.

  Urban economics has witnessed an impressive and fruitful revival roughly since the early 1980s, largely due to the emergence of the New Economic Geography (NEG) literature as one important aspect of a sort of intellectual movement in economics that James Buchanan and Yong Yoon refer to as “the return of increasing returns.” As is widely recognized, increasing returns is such a sweeping and powerful idea that many economic phenomena of interest, new and old, become quite explicable and natural once increasing returns are appropriately treated in analysis. Fortunately, up to the late 1970s, economists have been equipped with some novel analytical devices for that purpose.

  One major concern of urban economics is the spatial dimension of the economic life, especially the spatial distribution of productive and commercial activities in the city. In the NEG literature, the pros and cons of concentration of such activities are then stripped down to the benefits of clustering and agglomeration on the one hand, and the price that has to be paid for making the agglomeration possible on the other. As such, most analysis carried out in NEG centers on how the tradeoff between agglomeration economies and transportation costs determines the spatial structure of economic activities. It is worth stressing that the former is conceptually another way to articulate the economies of the division of labor among clustering firms, while the latter is rather broadly interpreted as transaction costs, including “all impediments” to trade, as two leading scholars of NEG explicitly define the term in their influential book (Masahisa Fujita and Jacques-Francois Thisse, Economies of Agglomeration: Cities, Industrial Location and Regional Growth, Cambridge University Press, 2002, p.20).

  Concerning the modern theory of the firm developed in and since the 1990s, it is of interest to note that a large body of studies focuses on how the market mechanism, within or without the firm, helps to utilize the increasing returns to specialized human capital that is acquired through the division of labor. My small book devotes a chapter (Chapter 9, especially its second section) to this strand of research.

  As you’re well aware, modern economic theory of the firm originates from Ronald Coase’s seminal study of “the nature of the firm” (1937, Economica). The rationale for the existence of the firm that Coase offers in his 1937 article is not hard to understand: the firm comes into being to save transaction costs incurred in the price mechanism, and the cost is saved through the substitution of many short-term contracts regarding the inputs purchased through the price mechanism essentially by one contract regarding the use of factors, especially labor. A good deal of valuable work has been carried out in the recent few decades unraveling the very rich structure of the contracts within the firm that are utilized to exploit the economies of specialized human capital. It is fair to say that our understanding of the firm has thus been much enhanced.

  That said, some theorists are not quite happy with the development. One of them is Coase himself. He once remarked, in retrospect upon what has been done along the line of inquiry he pioneered, that his article “led to or encouraged an undue emphasis on the role of the firm as a purchaser of the services of factors of production and on the choices of the contractual arrangements which it makes with them. As a consequence of this concentration on the firm as a purchaser of the inputs it uses, economists have tended to neglect the main activities of a firm, running a business” (Coase 1988, “The nature of the firm: influence”, Journal of Law, Economics and Organization, 4(1), p. 38). Partially motivated to help rectify the weakness of the literature in overlooking the role of the firm as an organizer of production, Professor Coase founded a new journal, Man and the Economy, to promote what he referred to as “the industrial structure of production.” In some sense, I am one of the rats seduced by his magic flute to jump into the river, serving on the editorial team of the new journal, which is intended to make a small but real difference in economics.

  Grégoire Canlorbe: An important literature in sociology, dating back at least to Adam Ferguson, depicts the perverse effects of the division of labor. In his 1937 masterpiece, The Good Society, Walter Lippmann proposed a dense and accurate summary of the grievances commonly formulated by the commentators, while developing a nuanced approach.

  “To multitudes [the social division of labor] has brought, writes Lippmann, a very great improvement of their standard of life; to others a brutal disruption of their habits. Thus to some the nineteenth century seemed a century of progress, to others a century of degradation. Ample testimony could be given to support either view. For the division of labor produced much more wealth. But it also produced a proletariat. The division of labor made men interdependent and therefore founded their prosperity on the principle of peaceable collaboration with reciprocal benefits. But it also made them dangerously insecure against those who did not collaborate.

  Thus [the transition from the relative self-sufficiency of individuals in local communities to their interdependence in a worldwide economy] has been marked by an endless series of disconcerting paradoxes. There was progress and poverty. […] There was legal equality and social inequality. There was a great moral enlightenment which abolished slavery and caste, enfranchised men and women, purged and elevated the treatment of criminals, provided schools and universities open to all, liberated conscience and thought from the censorship of authority. And, on the other hand, there were the newly rich who were far less attractive lords of creation than the nobility whom they supplanted; there were the multitudes in the great cities, uprooted from the soil, deprived of their ancestral traditions, without significance to dignify their lives or faith to console them.”

Do you agree, at least in part, with this analysis?

  Guang-Zhen Sun: I do. As it happened, over the past two and a half centuries, sociologists have been paying more attention than economists to the consequences of the division of labor, especially its detrimental effects. In fact, the young Karl Marx’s brilliant notion of economic alienation, inspired by Hegel’s political alienation and Feuerbach’s religious alienation, is rooted in his study of the capitalist division of labor. This notion and its variants, as is perhaps well known to you, resonated throughout most of the twentieth century, as one interesting strand of social thought. Marx’s Das Kapital can in some sense be read as a treatise on the economics of a sociological theme.

  Separation of tasks among the members of society is certainly the foundation of economic prosperity and progress. But economic inequality does not automatically follow. There is a good deal for economists to learn from sociologists about how income and inequality are shaped in a segmented society, especially for the individuals and households whose major source of income is labor. But the fact that social division of labor does not necessarily deliver equality in labor income while making society as a whole wealthier does not necessarily justify redistributive intervention by the government. The distribution of capital income is far more serious, after all.

  Grégoire Canlorbe: A striking fact you point out in your book is that “the Smithian tradition of placing emphasis on the division of labor was discontinued in the mainstream neoclassical economics, which was preoccupied by marginal adjustments and the related equilibrium analysis, and which almost completely ignored the structure of the division of labor.”

  Using an analytical framework with consumers and producers, economies of specialization, and transaction costs, you tried with Xiaokai Yang and Lin Zhou to resurrect the spirit of the classical economics of the division of labor in a modern body of mathematical formalism.

  Could you come back on the main assumptions and results of this collective paper? How do you sum up the specificities of your formal model with respect to the standard Arrow-Debreu model?

  Guang-Zhen Sun: The assumption we made in the work is very weak and general, mainly for the sake of convenience in meaningfully exploiting the standard techniques of large-economy analysis to study how the structure of social division of labor emerges in a market economy. For instance, we assume (of course unrealistically) that if all labor in the whole economy is used to produce only one particular product, then some positive amount of that product can be produced and put into the market. Otherwise, such goods cannot possibly be found in the market (for instance, a long-awaited drug that cures liver cancer) and it does not make much sense to analyze what a particular price of it equals its demand to supply.

  Technically speaking, that work may be seen as an analysis of an extended exchange economy of the standard Arrow-Debreu model, but the extension is both substantial and limited. It is substantial in that it allows for, to use the technical jargon of the neo-Walrasian economic theory, non-convexity of the production set due to increasing returns to specialization/scale and thereby accommodates an endogenous structure of the division of labor and the market trade. But increasing returns to an individual’s labor allocation are localized, and hence not incompatible with the competitive regime. The extension is also limited in the sense that essentially only individualistic production is permitted in our model, excluding the organized complexity of modern economic life defined by a highly developed network of the division of labor, such as joint production, the complicated internal structure of the firm and so on.

  In short, the contribution of the work is to show why and how individuals specialize in a competitive economy, even in the absence of the Ricardian comparative advantages or scale economies at the firm levels, leaving many important issues unaddressed. A good deal of work remains to be done along this line of inquiry.

  Grégoire Canlorbe: You suggest that Adam Smith’s “invisible hand” should be understood in a much broader sense than that commonly implied by the standard price theory in modern textbooks of economics. This metaphor goes far beyond the simple idea that if each consumer is allowed to choose freely what to buy and each producer is allowed to choose freely what to sell and how to produce it, the market will settle on a product distribution and prices that are beneficial to all the individual members of a community.

  What it really means is that competition in the context of the division of labor channels the numerous interest-seeking individuals into an order that tends toward a social optimum. And this “because competition forces the individuals to make their best possible efforts to utilize the information of local circumstances and to best exploit the possible opportunities of mutually beneficial trade among the various parts of the socio-economic system.” In this sense, the Smithian “invisible hand” anticipates Hayek’s theory of the division of information.

  Could you elaborate on this crucial aspect of Smithian economics and the enriching developments allowed by Hayek?

  Guang-Zhen Sun: It is, as always, not an easy task to come to terms with the profundity of Smith’s scholarship on the market. Yes, I do suggest in my small book that Smith’s “invisible hand” should be understood in a much broader sense than that commonly implied by the standard price theory in modern textbooks of economics. For the sake of discussion, let’s call it the Smith inequality — market > price — and briefly focus on two aspects of it.

  Differing remarkably from David Ricardo and some other “pure” theorists in classical economics, Smith often laid down his theory with rather rich historical contextualization, and especially when dealing with the power of the market as a system of natural liberty. It is the expansion of the market order, in the form of the rise and growth of cities and towns after the fall of the Roman Empire, that eventually put an end to the feudal system by not only enhancing the productivity and wealth of the country, but also, far more importantly, bringing about order and good government, and the liberty and security of the populace (thus relieving them of the former servile dependence upon their superiors). In the meanwhile, the proprietors and merchants also benefited, even much more, from the massive expansion of commerce and the consequent progress in the social division of labor. Smith applauds the change, describing it as “a revolution of the greatest importance to the public happiness” (WN, the Cannan edition, 1937, p.391). The standard price theory found in the textbooks of microeconomics is essentially static, and does not and cannot offer anything useful in understanding the role Smith assigned to the dynamics of the market as such.

  Another remarkable feature of the standard price theory is its almost exclusive devotion to exchange economies, oversimplifying the structure of production as a consequence. Not surprisingly, it has little to say about how the structure of social production comes into existence and how the production is organized. But perhaps enough has been said on this point (see our conversation on the modern theory of the firm above).

  As to Hayek’s contribution to the Smithian economics, I think the significance of his work is twofold. First, drawing upon Smith’s thesis of how the invisible hand elicits the individuals’ best possible effort, Hayek identifies what he refers to as “the central question of all social sciences”, especially of economics of course, namely how utilization of dispersed knowledge in society is made possible. This is what is called “Hayek’s knowledge problem,” a term popularized by some scholars of modern Austrian economics. It was the central message conveyed in his Presidential Address to the London Economic Club in 1936 (published as a regular paper at Economica in 1937, 4(13)), which had the implicit and ambitious aim of redefining economics by suggesting the central question it ought to answer.

  Secondly, he offers a brilliant, and necessarily incomplete, answer to this “central question” in his 1945 paper in American Economic Review, “The use of knowledge in society” (and a couple of follow-up articles). His answer, in short, is that the market mechanism does this job, and does it well. The market functions well, Hayek forcibly argues, not merely in solving the problem of incentive compatibility between individuals’ private pursuit of self-interest and public benefits (the resolution achieved by Smith’s invisible hand), but also in economizing the information required to get things done. The market achieves this by the decentralized price system. Let’s quote perhaps the most important sentence from Hayek’s paper, which proved to be very prescient and influential in economic theory: “The most significant fact about this system is the economy of knowledge with which it operates, or how little the individual participants need to know in order to be able to take the right action”(American Economic Review, 35(4), 1945; p.526). This observation has inspired a very large and influential literature, namely the theory of mechanism design, a fact the founder of the theory Leonid Hurwicz, a former student of Hayek’s at London School of Economics back to the late 1930s, has explicitly and gratefully acknowledged on a few occasions. Another leading theorist of mechanism design, Eric Maskin, quite recently provided a succinct and elegant exposition (“Friedrich von Hayek and mechanism design”, Review of Austrian Economics, 2015, Vol. 28, pp. 247-252) of how Hayek’s profound insight that only the minimal possible information is required in the market solution has been rigorously verified and elaborated in modern microeconomic theory.

  When reflecting upon his work in economics over an unusually long and prolific career as an economic theorist, the late Hayek once remarked that his elucidation of the knowledge problem “seems to me in retrospective the most original contribution I have made to the theory of economics.” In retrospect, this remark perhaps remains valid.

  Grégoire Canlorbe: The classical theory of business cycle (Say, Torrens, Ricardo, Bagehot, Marshall, Lavington, Hawtrey, Röpke) is based on the idea that the social division of labor has double-edged consequences for the prosperity of a nation. On the one hand, it cheapens products by raising a greater quantity at the same or less charge of production. On the other hand, it makes men interdependent and creates a significant systemic risk.

  The different industries are indeed one another’s customers and colleagues in the context of the division of labor. As Jean-Baptiste Say eloquently wrote in his 1803 Treatise, “the success of one branch of commerce supplies more ample means of purchase, and consequently opens a market for the products of all the other branches”. But the reverse is true as well: “the stagnation of one channel of manufacture, or of commerce, is felt in all the rest.”

  In this regard, recessions are fundamentally due to mistakes on the part of entrepreneurs, who have overrated the expectations of buyers in some sectors (and thus underestimated their demand in other sectors). When overproduction occurs in some industries, they find their sales declining and suffer a reduction of income; the demand for the products of all other industries then contracts; the result is a general downturn in the economy and warehouses filled with unsold goods.

  This idea has been commonly reiterated during the XIXth century and advocated by none else than Alfred Marshall in his 1879 essay, The Economics of Industry, where he ascribes the origin of recession to “a state of commercial disorganization”, i.e., an erosion of the overall purchasing power following a partial overproduction. “Other trades, finding a poor market for their goods, produce less; they earn less, and therefore they buy less; the diminution of the demand for their wares makes them demand less of other trades. Thus commercial disorganization spreads, the disorganization of one trade throws others out of gear, and they react on it and increase its disorganization.”

  In a nutshell, due to entrepreneurial miscalculation, some goods happen to be produced in excess (with respect to the tastes of consumers), leading to a deficient aggregate demand by reason of the mutual interdependence of all producers. Until the emergence of Keynesian economics, this theory of business cycle framed in the economics of division of labor was widely adopted among mainstream economists. How would you account for this shift in the history of ideas?

  Guang-Zhen Sun: I agree that a major cost of expansion and deepening of the social division of labor is risks, and even systemic risks. Precisely as you describe, interdependence and very high correlation among the different parts of the economy, especially in the supply chain of industrial production, make it easy for local mismatch, overproduction, fluctuations et cetera to spread widely, even rendering global problems and a systemic crisis. I once co-authored a short paper with Ulrich Witt on the cycles of aggregate output caused by imperfect synchronization in the highly correlated production process (“Myopic behavior and cycles in aggregate output”, Jahnbücher für Nationalökomie und Statistik, 2002, 222(3)).

  But we economists still know too little about the systemic risks, and knew still less decades ago. It is not surprising that the sweeping Keynesian economics eventually came to dominate the economics of regression and business cycles, and continues to do so nowadays.

  That said, it is my firm belief that a sound theory based on the economics of social division of labor will emerge. But that takes time, a long time perhaps. The problem is that we lack a good theory of capital based on increasing returns to the division of labor, and as a consequence, we are a long way short of a powerful analytical framework to understand how the structure of capital informs the diffusion of systemic risks. Such a framework would make a significant difference in our understanding of an important dimension of modern economic life. It is a daunting challenge.

  Grégoire Canlorbe: You wrote a short note on Gordon Tullock’s thesis about how the interaction between preference functions and the environmental consequences of individual behavior coordinates the division of labor in non-human societies.

  You suggest that Tullock’s insight can be formulated by the fixed-point argument. As such, both what may be called the Tullockian environmental coordination and the conventional Walrasian pricing coordination in economics turn out to be special cases of a more general principle, into which further exploration remains to be made.

  Could you remind us of the essential points of your demonstration?

  Guang-Zhen Sun: I appreciate your notice of this short piece. When reflecting upon the central message this note is intended to convey (and at least partially succeeds in doing so), what comes to mind may be captured in a few key words: the impersonality of coordination, and the limited relevance — or simply irrelevance — of strategic thinking (even in the presence of so-called information asymmetry) in a more general theory.

  About the former, perhaps enough has been said, especially in economics. But it is worth emphasizing that the decentralized coordination by and in the price system is realized through the interaction between quantity and price, with the quantity adjustment being made by the numerous individuals throughout the system while the resultant price adjustment as a change of the environment in which the individual choices are made. Quite similar processes take place in non-human societies, as is articulated by Gordon Tullock in his wonderful small book, The Economics of Non-Human Societies (Pallas Press, 1994). The Wikipedia project stands as another example: it is participated in actively by many individuals and is open to all, as if it is a world full of sound and fury, but signifying something. The amazing thing about it is that a great many articles on it are eventually improved and perfected to such an extent that more and more readers refer to them for reliable reference and updates. Everyone essentially takes the information acquired from the internet as some signal from the environment, and some of them respond by commenting and revising. Such action altogether refines the parameters of the sub-community of the internet world.

  As to the second point, which is closely related to the first point but nonetheless merits separate discussion and more elaboration, I believe some things of importance to understanding how the market works remain to be explored in economic theory. As is well known, economic analysis of asymmetry of information and strategic behavior has largely reshaped microeconomics in the past several decades, and enhanced our understanding of how information and incentives interact to shape some important aspects of socio-economic life. But the detrimental implications of information asymmetry have attracted too much attention, at a high price indeed. A highly developed and efficient system of the social division of labor and market exchange necessarily embraces such information asymmetry. That economic progress in some important sense rests precisely upon such asymmetry has been largely overlooked, if not misunderstood.

  In many real-world markets, there is much less room for strategic behavior and thinking than is usually postulated in the literature of asymmetric information, and when such strategic action is at work its effects often turn out to be less significant than widely presumed. The reason is unlikely to be difficult to understand for a student of the market, partly because the strategic action that stems exclusively from information asymmetry, if delivering a noticeable surplus to anyone who practices it, would attract other individuals/firms to dissipate the rent by similar action, until the rent is fully dissipated. This is of course the central thesis of the theory of the contestable market, but framed herein for a special sort of market: the market of strategic behavior. The anonymity of the market game often appears to be the fundamental reason why a game-oriented model of the market often reproduces the result that is delivered in and by a competitive market.

  The very existence of the market implies the division of labor among the participants in the market game, and hence asymmetry of information among them, for otherwise the surplus to be generated from the trade would be very limited, if any. The more complicated the network of social division of labor and trade, the higher the asymmetry. Asymmetry is an intrinsic part of an economy that functions well.

  Grégoire Canlorbe: Our interview comes to its end. Would you like to add anything else?

  Guang-Zhen Sun: My small book has been translated into Chinese and was published last month, October 2015. In the Preface to the rendition, I devoted some words to speculation on the future of the economics of the division of labor. In my view, one particular research topic, among few others, may be especially rewarding: to elaborate and to develop a fully-fledged theory of the Babbage principle. The significant progress of the IT industry and automation has been reshaping our economic life in recent decades, yet its far-reaching implications remain to be fully understood. As an extension of Smith’s classical doctrine of the advantages of the division of labor, Charles Babbage’s principle of machinery specialization and the associated separation of tasks in and by the machinery system has great potential to help understand the enlargement of the supply chain in production and the resultant income distribution.

  Thank you very much, Grégoire Canlorbe, for your well-framed and thought-provoking questions, which inspired to me much new thought and insight.


  That conversation was initially published in the December 2015 issue of Man and the Economy, founded by Nobel Prize winning economist Ronald Coase.

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