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A conversation with Andrew Wagner, production and manufacturing engineer, now in aerospace, but with experience also in the auto industry.

We trace how transaction costs shape production, from Adam Smith’s pin factory to Toyota’s SMED, and why empowering workers and redesigning tools can raise quality while cutting cost. An aerospace manufacturing engineer joins us to unpack Little’s Law, line reconfiguration, and the culture that makes flexibility real.

• division of labor limited by the extent of the market
• sub shop and Chipotle as live line-balancing examples
• Smith’s three productivity drivers applied to modern factories
• Little’s Law guiding WIP, stations, and throughput
• costly line changes and capacity planning in auto plants
• meta-tools, CNC, and multi-operation automation
• stamping dies, SMED, and Toyota’s flexibility edge
• just-in-time, early error detection, and quality economics
• U.S. responses: robotics, platforms, and Deming at Ford
• NUMMI proof: same workforce, new system, better output
• CAD parametrics, modular design, and clay by robot
• structure by design: darts, curves, and manufacturability
• specialization, ergonomics, turnover, and the $5 day
• worker empowerment as applied Hayekian local knowledge
• letter on bureaucracy, spending, and the social order book pick

Some links:

• Workload modeling and "Little's Law"
• Little on Little's Law
• "Just In Time" inventory and manufacturing
• Edwards Deming's "14 Principles for Management"

Book o'da'Month: Jacques Rueff, THE SOCIAL ORDER

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This episode explores Book 2 of Adam Smith's Wealth of Nations, focusing on his revolutionary concept of the "division of stock" and how capital accumulation drives economic growth.

• Smith distinguishes between fixed capital (machines, buildings, land improvements) and circulating capital (money, goods in transit)
• Money is described as "the great wheel of circulation" – necessary but not productive in itself
• Banking allows society to economize on expensive metallic currency by substituting paper money
• Smith's concept of productive versus unproductive labor helps explain which activities increase national wealth
• The acquisition of skills represents "human capital" – a concept Smith pioneered centuries before Gary Becker
• Interest on loans is justified as compensation for the productive use of capital, though Smith supports moderate usury laws
• Smith identifies four employments of capital: agriculture (most beneficial), manufacturing, wholesale trade, and retail
• Smith criticizes mercantilism for privileging foreign trade over domestic production
• Division of stock and modern financial markets solve the "time travel problem" by allowing entrepreneurs to access capital without primitive accumulation

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Book Two of Adam Smith's "The Wealth of Nations" provides the conceptual foundation for understanding how commercial society sustains growth through capital accumulation and the employment of stock. Smith challenges common misconceptions about wealth creation and offers profound insights on the role of capital in economic development.

• Capital is not capitalism – Smith wrote before "capitalism" was invented, using the term "stock" to describe accumulated resources
• Division of stock works alongside division of labor – capital must be accumulated before it can be employed productively
• Justice (protection of person, property, and promise) is prerequisite for investment – without security, people hide rather than invest their stock
• Fixed capital (tools, buildings, skills) versus circulating capital (money, wages, materials) form different branches of stock
• Money serves as "the great wheel of circulation" – facilitating exchange but not itself productive
• Banking allows society to operate with less precious metal – freeing resources for productive investment
• Productive labor creates vendible commodities while unproductive labor (government, services) perishes in performance
• Parsimony (saving) drives growth while prodigality reduces funds available for productive employment
• Interest is legitimate compensation for foregone use of capital – similar to rent on land
• Agriculture, manufacturing, wholesale trade, and retail are the four main employments of capital
• Modern financial markets solve Marx's "primitive accumulation" problem – entrepreneurs can sell shares of future profits

Let me know your thoughts on these ideas from Adam Smith in the comments below.

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Chris Cornette, a longtime securities trader who grew up in the business, reveals how the most important innovation that made US capital markets preeminent in the world was the exchange itself.

• Cornette's father worked in the P&S (Purchase and Sales) department on Wall Street, eventually becoming the controller of an American Stock Exchange specialist unit
• The original Buttonwood Agreement from 1792 created exclusivity among traders that helped establish trust in the market
• Exchange specialists subsidized trading in small-cap stocks using profits they made from large-cap stocks
• The phrase "your word is your bond" wasn't just a saying but the foundation of the trading system. Exclusion from the exchange was enough of a threat to discipline bad actors
• Specialists would ensure market liquidity and "continuity" in pricing, preventing wild price swings
• The transition to electronic trading and decimal pricing in the late 1990s fundamentally changed market dynamics
• High-frequency trading firms don't have the same ethical obligations that floor traders did
• The number of publicly traded companies has declined significantly since the move to screen-based trading
• Self-regulation through the exchange helped create trust that made markets function effectively. Not perfectly, but effectively.

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Corruption persists not because people like it, but because it becomes embedded in the incentive structure of the state, creating feedback loops that reinforce themselves and resist reform.

• A prebend is a type of benefice historically given to clergymen, now a useful concept for understanding corruption in developing nations
• Douglas North extended Coase's concept of transaction costs to explain why institutions matter in economics and politics
• Bad institutions create feedback loops through rent-seeking, patronage, and corruption that redistribute resources to entrench elites
• Mental models - our imperfect cognitive frameworks - resist change because belief systems are costly to abandon
• Lock-in occurs when early institutional choices create path dependencies that make reform nearly impossible
• Officials in corrupt systems treat public offices as prebends (sources of personal income) rather than public service positions
• In Nigeria, prebendalism meant officials used positions to enrich themselves and distribute benefits to their ethnic communities
• Russian corruption intensified post-Soviet era when state salaries plummeted and bribes became survival mechanisms
• Reform typically requires massive shocks, external enforcement, or exceptional leadership willing to impose significant costs on corrupt officials

The schedule is changing, because summer is over. Going forward, we'll have two episodes each month until January - one on Wealth of Nations and one interview. The next interview will be Tuesday, September 9th, and the next Wealth of Nations episode will be Tuesday, September 23rd.

Some links:

• Previous episode on corruption: Shruti Rajagopalan
• Richard Joseph and "Prebendal" Nigeria
• Douglass North and transaction costs/lock-in
• Douglass North on Institutions
• Denzau and North, "Shared Mental Models" (Kyklos)

Books o'da'week:

• Johan Norberg Peak Human: What We Can Learn from the Rise and Fall of Golden Ages
• Guy Gavriel Kay A Brightness Long Ago

• California's gigantic political theft of money for "High Speed Rail"

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Adam Smith's "The Wealth of Nations" developed from decades of lectures on jurisprudence, examining how market exchange creates prosperity through division of labor and specialized skills.

• Two core observations drive Smith's thinking: humans seek approval from others and have a propensity to "truck, barter and exchange"
• Exchange is Smith's key concept—not just for goods but for ideas, sentiments and social coordination
• Division of labor dramatically increases productivity through specialization, increased dexterity, and tool development
• Smith's famous pin factory example shows how 18 specialized workers produce thousands of times more than individuals working separately
• The extent of the market limits division of labor—larger markets allow greater specialization
• Smith argues that differences between philosophers and street porters arise from "habit, custom, and education" not innate capacity
• While profit is legitimate, Smith criticizes how powerful interests manipulate government to restrict competition
• Justice (respecting person, property, and promises) forms the essential foundation for any functioning commercial society
• Smith's work intended as a handbook for lawmakers, not ideological advocacy
• The Wealth of Nations represents applied moral philosophy addressing how societies become prosperous

Join us next time when we'll examine Book Two of Smith's masterpiece.

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The ancient tradition of Il Palio in Siena showcases a complex system of strategic corruption, neighborhood rivalries, and high-stakes horse racing that has endured for centuries. This 90-second race around Siena's central piazza involves extensive bribery, intense negotiations, and centuries-old vendettas that make speed secondary to political maneuvering.

• Horse assignments determined by lottery prevent wealthy neighborhoods from buying fastest horses but create opportunities for strategic corruption
• Jockeys accept bribes up to €80,000 to impede rivals or assist allies, with reputation determining future employment
• The "rincorsa" (starter horse) wields extraordinary power in determining when the race begins
• Enforcement of bribe agreements relies on reputation, trust, and fear rather than formal contracts
• Coming in second place is considered worse than finishing last, leading to public ridicule that can last generations
• Neighborhood identities and rivalries date back to medieval times, with memories of betrayals lasting decades

Book o'da'week: Okay, it's a film. But it's great!

• Book o da week: Il Palio documentary, 2015. Cosimo Spender, director and writer. https://www.imdb.com/title/tt3669520/

If you enjoy learning about the economics of unusual institutions, join us next week for the third installment of our Adam Smith podcast series with Adam Smith Works.

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Mike Munger explores insurance economics through the lens of transaction costs and risk management, culminating in an amusing case study about "bat-in-mouth disease."

• Insurance transfers risk from individuals to larger pools, reducing the expected variance of outcomes
• The fair price of insurance equals expected value (probability × potential loss) plus transaction costs
• Information asymmetry, subjective risk valuation, and strategic behavior complicate insurance markets
• Insurance faces two major challenges: adverse selection (who buys insurance) and moral hazard (behavior changes after getting insurance)
• Deductibles and co-pays help align incentives between insurers and insured
• Insurance history dates back 5,000 years to ancient China, Mesopotamia, Greece, and Rome
• The "bat-in-mouth disease" case study shows what happens when someone tries to purchase insurance after an incident
• Transaction costs explain why dogs sometimes stop climbing stairs and why freezing credit cards--ie, transaction costs--might prevent impulse spending. The piano player in a brothel story, and its history.
• The book o'da'month is Daniel Flynn, The Man Who Invented Conservatism.

Bat in mouth story: https://www.nbcnews.com/news/us-news/bat-flies-womans-mouth-arizona-costing-nearly-21000-medical-bills-rcna222463

Some background on insurance:

• Kenneth Arrow on the Uncertainty & Welfare Economics of Medical Care
• Anja Shortland on Kidnap: Inside the Ransom Business

"Piano player in a brothel" story origins:

• https://www.goodreads.com/quotes/93559-my-choice-early-in-life-was-either-to-be-a
• https://barrypopik.com/blog/dont_tell_my_mother_im_a_banker_she_thinks_i_play_piano_in_a_whorehouse

Daniel Flynn book: The Man Who Invented Conservatism

You can follow Mike Munger on Twitter at @mungowitz