Adam Smith's Theory of Economic Development and Growth

Adam Smith’s (1723 – 1790) ‘An Inquiry into the Nature and Causes of the Wealth of Nations’ advocates his theory of economic development and growth as follows:

The Role of Self-Interest – Interestingly, the individual’s pursuit of self-interest (i.e. being selfish) is thought to be the basis for capitalism today.  When examined in isolation, being selfish is seldom good.  However, in the context of mutual exchanges of goods and services, the individual’s self-interests have to be weighted and often balanced by the other parties’ interests.  What results is an agreed level of benefits for both parties in the exchange that results in (hopefully) mutual satisfactions.

He wrote “It is not from the benevolence of the butcher, the brewer, or the baker, that we expect our dinner, but from their regard to their own interest.”  Smith also added that self-interest and economic self-reliance were perfectly natural grounded in “the desire of bettering our condition”.  How true.

The Division of Labor – It is believed that the wealth of a nation is dependent upon the production of goods and services, which translates into GDP in today’s context.  It is also believed that efficiency is achieved through specialization of labor into specific areas of work for maximum productivity.  A carpenter works on furniture, a farmer grows crops.  Sounds like common sense today, but in the 18th century, such things were not a common practice.

This argument also underpins the inter-dependency of people on each other for goods and services that they themselves cannot produce; the result is greater exchanges of goods and services i.e. trade, and the needed mechanism for economic growth.

Capital Accumulation – according to Smith, the capital stock of a factory owner consists of fixed capital and circulating capital.  The latter, a wage fund, grows as production and profits expand.  As profits are made through production by workers, and later saved, this leads to capital accumulation. National output grows from such accumulation, as these savings can be used to hire more workers, increase existing pool of worker’s salary i.e. capital accumulation causes job creation.  Job creation improves the purchasing power of workers, increasing demand for more goods and services for the economic.  This virtuous cycle leads to economical growth.