Adam Smith's Theory of Economic Growth

Over the years, economists have given several different and interrelated answers to the question, "what causes economic growth?" We shall review a selection of these "theories of economic growth" and compare then and see how we can apply them. As we already noticed, economic growth was a central theme for the founder of the study, Adam Smith.

Adam Smith's theory of economic growth had two parts:

1) Increasing division of labor increases the productivity of labor.

We have discussed Smith's ideas on the division of labor in an earlier chapter. In several example, Smith described how workers in a modern economy do jobs that are different and that enhance the productivity of one another. Thus, a group of people working in this way (whether they are aware of it or not) produce much more per person than they would be able to produce if they worked independently. Smith saw this as the main reason for rising productivity and for high standards of living, or, in his words, "that universal opulence which extends itself to the lowest ranks of the people."

2) " That the Division of Labour is limited by the Extent of the Market"

This was the title of Smith's Chapter 3 and a key point in his theory of economic growth. He writes "the extent of this division [of labor] must always be limited by the extent of that power, or, in other words, by the extent of the market. When the market is very small, no person can have any encouragement to dedicate himself entirely to one employment, ...." Taking the example of nail-making, he goes on, " Such a workman at the rate of a thousand nails a day, and three hundred working days in the year, will make three hundred thousand nails in the year. But in [a small market in an isolated community] it would be impossible to dispose of one thousand, that is, of one day's work in the year." Thus large markets are essential to division of labor, and to high productivity, and growing markets are essential to increasing division of labor and growing productivity.