The origin of growth in economics

Dhaka,  Thu,  20 July 2017
Published : 13 Jul 2017, 19:56:19

The origin of growth in economics

Hasnat Abdul Hye
Having written two articles in this column on growth back to back last month in the context of inequality it behoves me to trace its origin with a view to finding out if the issue of inequality surfaced, even as green shoots, at the early stage.

As economists know, in the seventeenth century pre-classical economics was more interested to judge economic performance than to analyse its impact on various classes. It was mainly pre-occupied with such ethical questions as what constituted the just price and whether usury was morally defensible? As these issues receded to the background classical economics directed its attention to the importance of an economic surplus. Here the views of classical economists clashed with those who came to be known as Mercantinists. 

The latter emphasised the importance of a surplus of exports over imports and called for state intervention to achieve this goal. The English classical school of economists pursued the same goal of achieving economic surplus but differed with the mercantilists on the means of ensuring this. They argued that surplus arose from production of manufactured goods and not from trade. 

This view was compatible with the requirements of emerging industrialism in the eighteenth century. As they saw, surplus earned in manufacturing would yield capital to further industrialisation. According to them regulation and restrictions on the movement of labour and goods would retard efficiency and growth. Thus, the overriding concern of the classical economists became the theme of economic growth. Adam Smith became the pioneer exponents of growth and this was reflected in the full title of his work, An Inquiry into the Nature and Causes of the Wealth of Nations. Put in more modern terms, he was concerned with developing a theory of economic growth. 

He gave his major explanation for economic growth in the early part of his book with a phrase, 'the division of labour'. The full benefits of division of labour were available, however, only to a society (economy) in which production for exchange could take place. From this it followed that the division of labour was limited by the 'extent of market'. Measures widening the market whether geographically through improvements in transport and communications or economically through removal of government restrictions on the movement of goods and labour where in the interest of economic growth. 

Adam Smith was a strong supporter of laissez-faire or free market principles and opposed the mercantilist policy of government restrictions. But in pursuing economic growth through accumulation of capital by promoting manufacturing he expected government to improve infrastructure for widening the market.

After making his recommendation for widening the market to take full advantage of division of labour for capital accumulation through greater exchange Adam Smith turned to an analysis of distribution of income. He divided national income arising from economic growth based on manufacturing and exchange into three components: wages, profits and rents. He then proceeded to explain the mechanism governing the 'natural rates' of these shares of income. In order to do so, he made a tri-partite division of society into what he called 'orders' (classes in modern parlance) each of which received a specified income - wages were paid to labourers doing productive work, profits accrued to owners of capital and industries (or owners of stocks) and rents were collected by landowners. These distinctions corresponded roughly to the major class divisions of his time though some overlap took place. While formulating his analysis of income distribution around these three 'orders' (classes) Smith did not regard these divisions as permanent and immutable. As economic growth progressed with the widening market and there was competition among the producers, benefits of growth accrued to all classes in accordance with the principle of natural rates. 

What is important about Smith's theory of distribution of income among the three 'orders' is that capital accumulation as the promoter of economic expansion could not be analysed in isolation from it (distribution of income). Capital accumulation was contingent on the distribution of income, particularly between the capitalist and the owner of land who were able to save for further investment. Wage earners, on the other hand, were unlikely to be paid enough to generate surplus in excess of their requirements for subsistence because that would lead to increase in population bringing down the natural rate of wages. In Smith's view, if the surplus funds accrued to capitalists and landowners were saved and later invested that would enlarge production. Smith, however, doubted if land owners would save and invest being more prone to high living and luxury. In the event, the profit earned by capitalists became the basic determinant of capital accumulation and through it the pace of growth. This analysis of capital accumulation rounded out Smith's account of the main structural condition crucial for economic growth. His theoretical model and his attitude towards policy issues (e.g., distribution of income) were intertwined. He regarded economic growth as the basic goal and the adequacy of this policy should be measured by its impact on accumulation of capital and specialisation of labour through division of labour. While emphasiing the crucial role of the owners of capital in promoting growth he recognised unregulated private interest might behave in ways that could suppress 'progress of improvement' (his synonym for 'growth'). He saw competition and economic growth as mutually re-enforcing. On the other hand, expanding demand for labour was needed to neutralise the power of capitalists to exploit unorganised workers. He recognised that labour was at a disadvantage in bargaining with the owners of capital because of their tendency to increase in number as their wages rose. Adam Smith was, therefore, not an apologist for unregulated business enterprises. He warned: 'People of the same trade seldom meet together, even for merriment and diversion, but the conversation ends in a conspiracy against the public or in some contrivance to raise prices.' As regards policy interventions made by the government on behalf of capitalists he was of the opinion that 'It comes from an order of men, whose interest is never exactly the same with that of the public, who have generally an interest to deceive and even to oppress the public, and who accordingly have, upon many occasions, both deceived and oppressed it.' (The Wealth of Nations, vol-1). 

It is apparent from the above quotation that Adam Smith, the first exponent of the theory of economic growth did not fail to see its dark side. Though his analysis did not directly refer to inequality of income the inherent tendency of capitalists to exploit and deceive that is mentioned in the above quotation hints at the reality of the capitalist class to appropriate more than their due. This they seek to achieve by subverting competition in the market and manipulating laws and regulations in their favour. He, therefore, expressed his doubt whether the policy of laissez-faire, while promoting growth, actually led to the best of all possible worlds.

Editor : A.H.M Moazzem Hossain
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