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11-Sep-2006
Specialization and the Division of Labor, by Victor Niederhoffer

Inspired by the sad passing of Crocodile Hunter Steve Irwin, and some wisdom from a 19th Century book on trading, I have been considering the benefits to society and the individual from the division of labor -- the separation of a job up into parts usually performed by different individuals. The division of labor is so common in our society, and so much good comes from it, that we often take its benefits for granted and forget about the harms from not following it. It seems good to gain perspective by starting with some scholarly work from the field, so that basic principles can be considered.

The division of labor is usually associated with the contributions of Adam Smith in the Wealth of Nations where he states that it is the main engine that is responsible for the wealth of societies. He gives the example of a pin factory. He shows there how the division of labor enables each laborer to produced 2400 times as much as each working separately without specialization and separation.

One man draws out the wire, another straightens it, a third cuts it, a fourth points it, a fifth grinds it,... and the important business of making a pin is in this manner divided up into eighteen distinct operations .. which in some manufactures are all performed by different hands.

Charles Babbage in the Economy of Machinery and Manufactures gives numerous other examples were ingenious methods of separation of the manufacturing process lead to ingenious and astounding improvements in output. At a more general level, the process of making something as simple as a pencil, has so many parts, and so many people involved, that not only would output be minimal without a division of labor, but few people would know how to do it all, since so many raw materials and transportations and communications are involved. This is all ably illustrated in the classic I, Pencil by Leonard Reed.

Smith believed that improvements to productivity by the division of labor were based upon:

These concepts have now been subsumed in economics as increasing returns to scale, and the great improvement in output or profits that come from continuing until variable costs are more than the marginal costs without regard to the high fixed costs in many processes. The concept has been generalized by growth economists into a beneficent circle. Increasing the division of labor leads to enhanced output from improvements in the productivity of labor. This increases incomes and demand, and leads to larger markets. With larger markets, more division of labor can occur starting the circle over again.

The major contribution to the benefits of the division of labor from the biology field was Charles Darwin. He pointed out that there was much variation in a species, that the variations that were good for survival and reproduction tended to be inherited, and that these inherited differences led to specialization among the progeny, thus creating niches where specialization would contribute to further survival and reproduction.

A major reason that specialization works in economics and biology is that everybody is different. Roger Williams in his book Free and Unequal shows that not only does everyone have different degrees of aptitudes, and appearance, morphology and physiology, but that everyone's internal organs are different. These differences lead us to be able to perform different tasks with different degrees of efficiency and productivity, and make the benefits of specialization great even when improvements in machinery are not available.

Another set of principles as to why the division of labor works comes from the work of Emile Durkheim in his book the Division of Labor in Society. He points out that people specialize in different occupations in a society, and this tends to bind them all together, as they depend on each other, but at the same time creates a sense of helplessness, or anomie, because no one person is responsible for the whole job. That is the reason that often the division of labor is not carried as far as it should be.

Let us apply some of these principles to trading. Fowler in his 1874 book, 10 Years on Wall Street concluded that most traders lose. And the reason is that people with abilities in one field feel that their success is transferable from their own field to trading. They come to Wall Street and do not realize it is a world of its own, with its own mechanisms for survival, and specializations for success, and thus:

The sudden collapse of fortunes, closing of elegant mansions, the selling off of plate, and horse at auction, the hurling of men down from first class positions to subordinate posts is an everyday occurrence in New York. In almost every case, these reverses result from outside trading and meddling with matters foreign to one's legitimate business

The attempt of a given person to move from one field of trading to another should be considered also as a major source of disaster. There are too many specialized rules involved, too many abilities needed to change willy nilly without a lengthy training period, careful study, and practice trading on a very small scale.

The feeling that one can transfer skills from one field to another is closely related to hubris, a lack of humility in realizing the importance of specialization and individual differences. It seems that this led directly to the death of Steve Irwin . Study of his career shows that he was raised from infancy in a croc zoo run by his parents. He knew everything about how to capture and escape from crocs. Indeed on on my visit to the Zoo in Western Australia the keepers pointed out that the crocs were particularly hateful when Steve was around because they knew it was him that had captured them all. They have good memories.

It is sadly predictable that Steve would die when dealing with something outside of his normal ken where he did not have the advantage of the division of labor and specialization to help him. Usually his side kicks are standing ready with equipment and knowledge to help him at all times, yet by failing to take account of the specialized knowledge required to deal with aquatic creatures like the stingray, Steve met his death as many traders on Wall Street do who succumb to an improper respect for the division of labor.

Vic adds:

An entire book could be written about the lengths to which specialization has been taken by the tennis doubles team of Bob Bryan and Mike Bryan. To watch them play, one could be looking at the ecology of the vent worms it is so specialized. In practice, each brother sticks to their side. Their shots are completely attuned to their side of the court and they hit with a minimum of backswing and angle directly at their opponents, saving all their energy. They practice with a game of doubles played cross court only and from their side only. This is called one on one doubles that is specialized training, and completely new in the last 5 years. It teaches the split step, volley off the serve, return of serve, and keeping it away from the net player. Their serves have no backswing and go directly in at 130mph or so, giving their opponents no chance for any errors. No wonder they have won the grand slam in doubles and are the most successful doubles team ever.

They have a coach who hits shots to them to practice, for the first, second and third shot that they are likely to hit from their side. They are identical twins, and predictably they seem to have a telepathic sense of what the other is doing. It is amazing they lost at the open but I noticed that they did much publicity, and perhaps lost their concentration. They could not make the Davis Cup for a long time, even though they were the best, because of the old time fairy tales about it being imperative to be a great singles player to be a good doubles player. Bob Bryan also just won the mixed doubles title with Navratilova.

It reminds me of the Renshaw brothers, the Doherty Brothers, the Guliksons and the Jensens, showing the importance of genetic factors in developing specialization and communication. There is much more to be said about the beautiful experience of watching these teams play and practice.