Good Government

Optimistic as Smith was, he didn't see growth as inevitable. According to Smith, the potential for economic growth would only be realized under "good government."

That is, the virtuous circle could be broken. In the virtuous circle, increased productivity leads to rising wages, rising incomes, and thus more demand and bigger markets, setting the stage for more division of labor and another round of growth. However, if government were to create monopolies, the monopolies would limit output in order to keep profits and prices up. That means higher productivity would not lead to higher incomes, markets would not expand, and thus growth might grind down to a halt. Similarly, government measures to limit trade would prevent the expanding division of labor that could lead to higher productivity and all the rest. "Good government," as Smith understood it, would be a government that would maintain order and protect property and contracts, but not put any of these barriers in the way of the expansion of trade.

We see that Smith saw rising wages as a sign of a healthy economy. Perhaps surprisingly, he was not so enthusiastic about rising profits. Smith remarked that high profits are much more inflationary and anti-growth than high wages.