Capital Accumulation and Growth
The Wealth of Nations introduced a new way of thinking in which economic growth over indefinite periods of time is normal, provided there is reasonable security and a reasonable degree of freedom to produce and trade.
Growth, in this view, requires no special intervention by the government, other than to avoid policies which interfere with the natural process of growth (see Brewer, 2010: ch. 2).Smith did not use the word “growth” or the phrase “economic growth” in the way that we do today. Closest, perhaps, are a couple of places where he wrote of the “growth of a new colony” and one example of “the growth of public opulence”. Most often, the word “growth” refers to the biological process of growth, for example, of corn. Talking about what we would call economic growth, he used a variety of phrases such as “progress of opulence”, the “continual increase of national wealth”, and so on. For the sake of clarity, in this discussion the word “growth” will be used to mean a continuous increase in total output over indefinitely long periods of time, as opposed to once-and-for-all bursts of expansion in response to changed conditions. It is important to distinguish between total output and per-capita output, and it will be convenient to start the discussion here by focusing on growth in total output, even though Smith started the Wealth of Nations with per-capita output. Growth in total output may be accompanied by changes in the composition of output (because of changes in the relative prices of agricultural and non- agricultural goods or differing income elasticities of demand). Smith’s optimistic account of the division of labour implies that growth in total output is accompanied by increases in per-capita output, at least in manufacturing.
The key elements of this new analysis of growth are, first, that saving is normal, second, that saving is normally invested as additional capital, and that the capital market is sufficiently effective to direct investment to where it is needed and, third, that investment (capital accumulation) is the key factor in the growth of output.
All of these are clearly developed in the Wealth of Nations.It will help to say, first, that population is endogenous in Smith’s analysis, and in most other eighteenth- (and nineteenth-) century analysis. If the economy can support more people, then population will grow accordingly (given, of course, time). This argument was developed more fully by Malthus, a generation after Smith, but it had already been spelled out by a variety of writers (Scottish and otherwise) well before Smith. The “Malthusian” analysis of population was simply part of the intellectual background. The consequence is that capital accumulation can induce population growth and a general increase in the scale of the economy or it can induce an increase in capital per head.
Saving is normal. Here is Smith’s (very well known) explanation:
the principle which prompts to save is the desire of bettering our condition, a desire which, though generally calm and dispassionate, comes with us from the womb, and never leaves us till we go into the grave An augmentation of fortune is the means by which the greater part of
men propose and wish to better their condition... and the most likely way of augmenting their fortune is to save and accumulate some part of what they acquire... in the greater part of men, taking the whole course of their life at an average, the principle of frugality seems not only to predominate, but to predominate very greatly. (1776 [1976]: 341-2)
The “uniform, constant, and uninterrupted effort of every man to better his condition” is “the principle from which public and national, as well as private opulence is originally derived” (Smith 1776 [1976]: 343). Capital accumulation is necessary for economic growth, defined explicitly as an increase in the “annual produce of the land and labour” (ibid.: 343), since increased output requires either increased employment of productive labourers or increased productivity, and both require additional capital. Saving and the resulting accumulation are therefore necessary to growth.
Smith, at least implicitly, assumes that saving is also sufficient to ensure accumulation and hence growth. The saver either invests himself, in his own business, or lends to someone who invests (ibid.: 337).He went on to describe the resulting process of growth, in which the annual produce of a nation increases over time, “its lands are better cultivated, its manufactures more numerous and flourishing, and its trade more extensive” than before, adding “we shall find this to have been the case of almost all nations, in all tolerably quiet and peaceable times” (Smith 1776 [1976]: 343). He further went on, as if he were merely stating the obvious, to claim that “the annual produce of the land and labour of England, for example,” had increased in the previous century, in the period before that, and so on, back to the Norman conquest and to the invasion by Julius Caesar (ibid.: 344). Similarly, he claimed that “since [at least] the time of Henry VIII. the wealth and revenue of the country have been continually advancing, and... their pace seems rather to have been gradually accelerated than retarded” (ibid.: 106). It was not just England: most of Europe was “advancing in industry and improvement” (ibid.: 211), and had been advancing for many centuries (for example, ibid.: 199, 211, 220, 258).
Smith chose to start the Wealth of Nations with the division of labour, as the main explanation of the (per-capita) wealth of the nation, defined as the ratio of output to the number of people who consume it. His first example, the famous pin factory has led some readers to emphasize the division of labour in the factory, but Smith’s more general discussion of the importance of the division of labour emphasizes the division of labour across the whole system, what has been called the social division of labour.
In terms of some of the main concerns of the eighteenth century and of the Scottish Enlightenment, an extensive division of labour, permitted by extensive markets, is the characteristic of a highly developed commercial society, exemplified by Smith’s example (1776 [1976]: 22-3) of “the accommodation of the most common artificer or day- labourer”, where Smith devotes something over a page to the beginnings of a list of the occupations (and hence specialized workers) whose work goes into the simple consumption of a common worker.
The point here is that a productive division of labour requires investment to provide the worker with materials and tools to work with and with goods to maintain him (Smith 1776 [1976]: 276). Hence “labour can be more and more subdivided in proportion only as stock is previously more and more accumulated” (ibid.: 277). Accumulation increases total output in two ways: it increases the number employed and also, by permitting a wider division of labour, increases per-capita output.
Note here that Smith’s emphasis on the division of labour corresponds to a certain playing down of invention, of technical change, as a source of growth and of increased output per capita. Smith mentions, as third of three advantages of the division of labour, that “the invention of all those machines by which labour is so much facilitated and abridged seems to have been originally owing to the division of labour (Smith 1776 [1976]: 20). The logic seems to be that accumulation gives rise to a division of labour, which in turn gives rise to the corresponding inventions. Technical change need not be considered as an independent causal factor. A relevant factor in interpreting Smith’s intentions here is that in the eighteenth century “machine” or “machinery” meant any kind of tool, however simple, so that Smith’s (brief) comments on invention need not imply the sorts of development which we now associate with the industrial revolution. Thus, for example, the use of different types of hammer for different tasks would count as an example of the invention of machines as a result of the division of labour. He did, it is true, describe the introduction of a valve linkage for steam engines, but that is presented as a simple cost saving, no more. Adam Ferguson had little in the way of substantive economic analysis, certainly nothing to compare with the Wealth of Nations, but he did stress the almost unlimited potential of new inventions.
The idea of continuing growth as the normal result of everyday behaviour was substantially new.
The earlier generation of Scottish writers, led by Hume, had celebrated the fact of growth at least in England (both Hume and Smith most often drew on England for examples, without wholly ignoring their native Scotland), but their accounts can perhaps be read as a description of a once-for-all event rather than a continuing process. Smith recognized the series of once-for-all qualitative transformations that had occurred, such as the fall of feudalism, but added the quantitative process driven by accumulation summarized above. Quesnay, in France, recognized the need for investment, at least in agriculture, but thought that the French economy had declined catastrophically in the previous century or so, and emphasized a short- or medium-run process of recovery from this position. Neither Hume nor Quesnay considered the possibility of very-long-run growth and rejected it. They simply did not consider it at all.The one writer who can be said to have anticipated Smith’s growth theory is A.-R.-J. Turgot in France. His Reflections on the Formation and Distribution of Wealth, written in 1766 [1977], contains all the key elements of Smith’s theory as set out above - saving as normal, capital allocated by the market and output constrained by capital and increasing as a result of saving. That said, the growth theory is really quite well hidden and its implications are not spelled out. Almost all his readers missed the point (or, rather, missed that particular point while finding much else in what is a brilliant book) and the Reflections were in any case never widely circulated. There is, then, little doubt that this fundamental shift in economic thinking came primarily from Scotland and from Adam Smith.