Adam Smith

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Adam Smith

The accumulation of capital and the division of labor are what Adam Smith believed to be the driving forces of economic growth in any nation. Smith found that when the division of labor had broken down the production of almost any commodity into a series of simple operations it was more natural for tools and machinery to be invented that replace hand labor and expedite the entire production process, thereby increasing worker productivity. This increased productivity combines with the growing capital stock to increse national output which enables society enjoy higher levels of consumption, constituting a genuine rise in the wealth of the nation according to Smith.

Smith’s theory of economic growth can be formulated in a simple algerbraic equation. Where G equals the growth rate, K equals the ratio of productive to unproductive labor, P equals the productivity rate and W equals the real wage:
G= KPW

From this equation it becomes clear that for growth to occur, the product of the ratio of productive to unproductive labor and the productivity rate must increase more than the real wage. It would seem obvious that an easy way to do this would be to avoid any increase in the real wage, and indeed this view was accepted by many later classical economists who assumed that the nation had nothing to gain from an increase in wages. This was not Smith’s view at all. If an increase in capital enlarges the wages fund from which workers workers are paid, and if this increase is greater than the increase in the number of laborers, than it is only natural for the real wage to increase. On top of that Smith was a believer in what modern economists call the efficiency wage theories which hold that higher wages both enhance the vitality of the workers and reduce employee slacking and labor turnover, the latter two of which lower productivity and profitability.

In the equation above it the product of K and P that is responsible for economic growth. It would appear then that K, the ratio of productive to unproductive labor, and P, the productivity rate are equally important factors in this determinance. However, Smith says that this is not so. The ratio of productive to unproductive labor does not change much over time, says Smith.

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