Adam Smith and the Digital Economy: Connectedness and Gains From Trade

How can an 18th-century Scottish philosopher and economist help us understand the digital economy and our modern, hyper-connected world? That’s a question I’m tackling in a series of three essays at

Digital technologies have increased our connectedness in profound ways. In the first essay I examine how Smith’s ideas about specialization and exchange combine with Ronald Coase’s analyses of transaction costs to help us understand how much easier and more convenient commerce is today than it was in the pre-digital world.

Although humans may have inherent propensities to truck, barter, and exchange, engaging in transactions is costly—they take time, parties have to find each other and acquire information about the goods and services being offered and the terms of the offers, and trade among strangers can be stymied due to a lack of trust. Reducing those transaction costs leads to increased specialization and exchange, amplifying the market extension effects that Smith described. Digital technologies are first and foremost transaction cost reducers. As transaction costs fall, and as patterns of transaction costs change in a dynamic economy, more exchange takes place. More innovation also occurs, as new connections create new ideas, new products, and new services.

Adam Smith’s insights about specialization and exchange give us important foundations for understanding how digital technologies have transformed our commercial relationships. Building on this foundation, in the second essay I’ll dig more deeply into digital technologies and trade.