Adam Smith on Growth
Adam Smith viewed the growth process as strictly endogenous (see also Lowe 1954 [1987]: 108; Eltis 1984: 69; Rostow 1990: 34), placing special emphasis on the impact of capital accumulation on labour productivity.
He began his inquiry into the Wealth of Nations (Smith 1776 [1976], hereafter WN) by stating that income per capita “must in every nation be regulated by two different circumstances; first, by the skill, dexterity, and judgment with which its labour is generally applied; and, secondly, by the proportion between the number of those who are employed in useful labour, and that of those who are not so employed” (WN, I.3). According to Smith there is no upper limit to labour productivity. This is why Smith maintained that an investigation of the growth of income per capita is first and foremost an inquiry into “The causes of this improvement, in the productive powers of labour, and the order, according to which its produce is naturally distributed among the different ranks and conditions of men in the society” (WN I.5).Smith’s attention focused accordingly on the factors determining the growth of labour productivity, that is, the factors affecting “the state of the skill, dexterity, and judgment with which labour is applied in any nation” (WN I.6). At this point the accumulation of capital enters into the picture because of Smith’s conviction that the key to the growth of labour productivity is the division of labour which in turn depends on the extent of the market and thus upon capital accumulation. “The greatest improvement in the productive powers of labour”, we are told, “seem to have been the effects of the division of labour” (WN I.i.1), both within given firms and industries and, even more significantly, between them. In the first three chapters of book I of The Wealth of Nations Smith established the idea that there are increasing returns, which are largely external to firms, that is, broadly compatible with the classical hypothesis of a uniform rate of profits.
(Here we set aside the reasons put forward by Smith and Ricardo, why profit rates may permanently differ between sectors; see therefore Kurz and Salvadori 1995: ch. 11). In the first chapter he made clear how powerful a device the division of labour is in increasing labour productivity, and analysed in some detail its major features: (1) the improvement of the dexterity of workers; (2) the saving of time which is otherwise lost in passing from one sort of work to another; and, most importantly, (3) the invention of specific machinery (cf. WN I.i.6-8). In the second chapter he argued that there is a certain propensity in human nature “to truck, barter and exchange one thing for another”, which appears to be rooted in “the faculties of reason and speech”, that gives occasion to the division of labour (WN I.ii.1-2). In the third chapter the argument is completed by stressing that the division of labour is limited by the extent of the market (cf. WN I.iii.1): a larger market generates a larger division of labour among people and, therefore, among firms, and a larger division of labour generates a larger productivity of labour in all firms.Despite the presence of increasing returns, Smith retained the concept of a general rate of profits. His argument appears to be implicitly based on the hypothesis that each single firm operates at constant returns, while total production is subject to increasing returns. Even though some examples provided by Smith relate more to the division of labour within firms than to the division of labour among firms, Smith appears to be correct in sustaining that some of the activities which were originally a part of the division of labour within the firm may eventually become a different “trade” or “business”, so that the division of labour within the firm is but a step towards the division of labour among firms. In the example of pin making at the beginning of chapter i, Smith pointed out that “in the way in which this business is now carried on, not only the whole work is a peculiar trade, but it is divided into a number of branches, of which the greater part are likewise peculiar trades” (WN I.i.3).
Smith’s analysis foreshadows the concepts of induced and embodied technical progress, learning by doing, and learning by using. The invention of new machines and the improvement of known ones is said to be originally due to the workers in the production process and “those who had occasion to use the machines” (WN I.i.9). At a more advanced stage of society making machines “became the business of a peculiar trade”, engaging “philosophers or men of speculation, whose trade it is, not to do any thing, but to observe every thing; and who, upon that account, are often capable of combining together the powers of the most distant and dissimilar objects”. Research and development of new industrial designs becomes “the principal or sole trade and occupation of a particular class of citizens” (ibid.). New technical knowledge is systematically created and economically used, with the sciences becoming more and more involved in that process. More than two centuries before the invention of the term “knowledge society” Smith insists that “the quantity of science” available to a society decides its members’ productivity and wealth (WN I.i.9). The accumulation of capital propels this process forward, opens up new markets and enlarges existing ones, increases effectual demand and is thus the main force behind economic and social development (WN V.i.e.26).
Did Smith expect the endogenous growth factors to lose momentum as capital accumulates? He considered three potential limits to growth: an insufficient supply of workers, the scantiness of nature, and an erosion of the motives of accumulation. Smith saw that the scarcity and potential degradation of renewable and the depletion of exhaustible resources may constrain human productive activity and the growth of the economy (WN I.xi.i.3; see also I.xi.d). However, at the time when he wrote, the limits to growth deriving from nature were apparently still considered far away.
Smith also saw no danger that the process of accumulation might come to an end because of an insufficient supply of labour and any diminishing returns to capital.
He rather advocated a view, which was to become prominent among the classical economists: the supply of labour is generated within the socio-economic system, that is, endogenously. He drew an analogy between the multiplication of animals and that of the inferior ranks of people (cf. WN I.viii.39-40). Smith envisaged the growth of the labour force as endogenous, the determinant being the rate of capital accumulation. Real wages are higher, the more rapidly capital accumulates. As to the impact of high and rising real wages on the rate of profits, it appears that we cannot say anything definite, given Smith’s opinion that “the same cause... which raises the wages of labour, the increase of stock, tends to increase its productive powers, and to make a smaller quantity of labour produce a greater quantity of work” (WN I.viii.57).Adam Smith explained economic growth thoroughly as an endogenous phenomenon. The growth rate depends on the decisions and actions of agents, especially their saving and investment behaviour, and the creativity and innovativeness they come up with in given social and historical conditions and institutional settings. Special emphasis is placed on the endogenous creation of new knowledge that can be used economically. New technical knowledge is treated as a good, which is or in the long run tends to become a public good. There are no clear and obvious limits to growth. The additional work force needed in the process of accumulation is generated in that process itself: labour power is a commodity the quantity of which is regulated by the effectual demand for it. Diminishing returns due to scarce natural resources are set aside or seen to be of little significance vis-a-vis increases in productivity due to the division of labour.
While Smith saw “improvements” to take place in all major sectors of the economy - agriculture, manufacturing, commerce and trade (see WN I.x.b.43) - he was convinced that manufacturing was most susceptible to an ever deeper division of labour and thus a rapid growth of labour productivity. Alas, he vastly underrated the importance of the manufacturing sector as an engine of growth by assuming that it produces only amenities and luxuries. The idea that necessities, raw materials, tools and machines are produced by means of necessities, raw materials, tools and machines is not yet to be found in Smith. Mentally he was still rooted in the age of corn and had only glimpsed the dawn of the upcoming age of coal and iron. Others coming after him had seen more of the new age triggered by the Industrial Revolution and began to understand better the crucial role of machinery and industry. These included authors such as David Ricardo, Charles Babbage and Karl Marx.