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Comparison of Smith and Solow’s Take on Economic Growth

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Comparison of Smith and Solow’s Take on Economic Growth

Introduction
Adam Smith is renowned as the father of economics and his thoughts on economic
growth have been summarized in his famous book An Enquiry into the Nature and Causes of
Wealth of Nations that has changed the way people think about economic growth. On the other
hand, Robert Solow is an American economist who is celebrated as the founding father of
neoclassical growth theory whose exogenous growth model was named after him. Solow’s
moment of success came when he contributed to the theory of long-term economic growth and
his take on technological advancement being a harbinger of steady economic growth has been
good news for developing countries. On the other hand, Adam Smith feels that the division of
labor and accumulation of capital are the biggest factors that determine economic growth. While
Solow holds that technological progress is the best way to attain economic growth, Smith holds
that division of labor and capital accumulation would speed up technological progress and
economic output.
Adam Smith’s Explanation of Economic Development
Adam Smith advanced the policy of laissez-fare, which entailed non-involvement of the
régime in the economic goings-on of the individual (Ucak, 2015). Smith stressed on individual
freedom in carrying out the economic matters minus an obstruction or restriction by the
government. Smith further pushed for free trade among the many nations of the world,
encouraging the removal of restrictions on foreign trade as a way of promoting international
specialization to enhance the income of a nation. According to Smith, the core part of economic
growth is division of labor as a way of increasing productivity to increase economic development
(Ashraf, Camerer & Loewenstein, 2005).
Robert Solow’s Explanation of Economic Growth
During the 1950s, the narrative around economic growth was centered on capital
accumulation through saving capital slowly and steadily and then investing it to build a system
(Zhao, 2019). Armed with half a century’s worth of American statistics, Solow created a simple
theory that involved designing a mathematical model to figure out what enhances output in a
developed economy. It turned out that economic growth was more driven by technological
innovation, meaning that the best way to get sustained and hastened economic growth is having
sustained technological growth.
Comparison of Smith’s and Solow’s Explanation of Economic Growth
One of the most crucial contributions that Smith made to the assessment of the factors
that lead to expansion of output is the division of labor (Ashraf, Camerer & Loewenstein, 2005).
Smith argued that there is a natural inclination among people to truck, trade, and exchange good.
One of the key benefits of labor division is dexterity that saves the workers time when working
and leads to the invention of new and improved machines. Still, Smith feels that the extent of
labor division is delimited by the extent of the market. The division of labor would only remain
profitable if there is sufficient market for the manufactured goods. Smith thus pushed for the
expansion of global trad that would, in turn, widen the market for goods (Paganelli, 2020).
When tasks involved in the production of goods and services have been divided, the
employees and industries would yield a larger quantity of output. Smith’s observation of pin
factories revealed that just one employee alone can produce 20 pins per day but a small
establishment of 10 workers, some of whom may perform 2 or 3 of the 18 responsibilities needed
in pin-making, would produce 48,000 pins per day. Smith felt that a small fraction of workers
who specialize in specific tasks would yield much more compared to the same figure of
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employees who manufacture the whole good or service on their own (Ashraf, Camerer &
Loewenstein, 2005).
Firstly, Specialization in a given job description would allow a worker to focus on the
production parts where they excel (Ashraf, Camerer & Loewenstein, 2005). People possess
various skills and talents, meaning that they would be better at certain works compared to others.
The given advantages that such workers enjoy would be predicated on the particular worker’s
educational choice, that is further shaped by their interest and talent. For instance, only a person
with a medical degree can practice as a doctor. For certain goods and services, specialization
would be informed by the geographical location. For example, it is much easier to excel as a
wheat farmer in an area like North Dakota compared to an area like Florida (Ucak, 2015). On the
other hand, it is much easier to excel in the tourism business in Florida compared to North
Dakota. Additionally, the proximity to an urban center means that one can easily attract clients to
a dry-cleaning service or cinema compared to a rural setting that is often sparsely populated
(Hollander, 2019). Therefore, Smith argued that if people can specialize in producing what they
are best at, then they would be more productive compared to producing a combination of various
things that they may not be necessarily good at (Paganelli, 2020).
According to Smith, workers who specialize in a particular task would find it easier to
produce more units of the particular product they specialize in and with a higher quality (Ashraf,
Camerer & Loewenstein, 2005). Such a pattern can be witnessed in areas like the assembly line,
where workers find it easier to produce specific components, salons or barber shops where
workers style hair, or doctors performing heart surgeries. Specialized workers understand their
job well that they can suggest the innovative ways of doing their work faster and better. In
business, a firm that centers on one product, or its core competency, would be more successful
compared to corporations that produce a wide scope of goods (Paganelli, 2020).
Secondly, specialty would allow industries to take advantage of the concept of economies
of scale, whereby as the degree of production increases, the mean cost of manufacturing a single
unit would reduce (Paganelli, 2020). For example, if a manufacturing plant only produces 100
vehicles annually, every car would be costly to manufacture on average. Still, if the same
manufacturing plant ramps up production to 50,000 cars annually, then it can create an assembly
line with heavy machines and employees to perform the specialized tasks, thus bringing down
the mean cost of manufacture per car (Ucak, 2015). The decisive outcome of workers focusing
on their predilections and flairs, learning to do their dedicated tasks better, and working in bigger
corporations is that a country would be able to manufacture and consume far much more if
people tried manufacturing all of their goods and services (Ashraf, Camerer & Loewenstein,
2005).
Smith further sheds light on the concept of accumulation of capital as a way of driving
economic growth (Ashraf, Camerer & Loewenstein, 2005). Smith adds that it is still important to
save and accumulate capital because the productivity of most people is still quite low because
their capital stock is quite low. Capital stock is usually small since the people’s savings are
getting smaller and their incomes further decline. It follows that the best way out of such a
vicious cycle is urging the capitalist class that saves much of their profit to invest in capital
accumulation to accelerate the development of the economy. According to Adam Smith,
society’s habit of frugality would lead to more savings of capital that would drive the division of
labor (Ucak, 2015). Minus the accumulation of capital, the degree of labor division cannot be
enhanced as much. A rise in capital accumulation would lead to the manufacture of various kinds
of specialized apparatus that are run by various classes of employees trained and dedicated in
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different tasks (Hollander, 2019). Therefore, the accretion of capital coupled with division of
labor would enhance industrial output and employment, thereby increasing economic growth.
Solow feels that technological progress is the key to realizing economic growth. The
Solow-Swan model holds that in the end, economies will congregate to their stable state balance
and that steady growth would be attainable through advancement in technology (Boyko et al.,
2019). Solow felt that 80 percent of America’s economic growth can be attributed to
technological progress that has changed the way that people do business. According to Solow,
technological progress would allow poor countries to catch up with the wealthier nations. As
poorer nations receive improved technology and information, thy would eradicate the lags in the
distribution of knowledge and thus the differences in income would reduce. Moreover, an
effective allocation of global capital flows would work because the return rate on capital would
be higher in the poorer nations (Broughel & Thierer, 2019).
Solow feels that the improvements in business processes would be innovations required
to drive economic growth (Broughel & Thierer, 2019). One of the biggest fears around
technological advancement is that technology would lead to massive layoffs due to the
automation of the processes that are involved in production. However, it has actually been the
reverse because technology has created more employment opportunities even as repetitive jobs
have been eliminated. Solow feels that it would be a while before robots truly take over the job
market and render everyone jobless. Still, Solow feels that any kind of technological process
would lead to a winning and losing team, whereby the business sector that is automated gains
while the workers lose. Solow is hopeful that any meaningful society will always find a way to
provide for its people, especially those who lose their jobs to the machines. While education may
not be a solution to every problem created by technology, having an educated population would
be necessary for attaining progress in the society (Cvetanović, Mitrović & Jurakić, 2019).
One of the assumptions in the Solow-Swan model is that capital can be subjected to
reducing returns for any fixed economy (Cvetanović, Mitrović & Jurakić, 2019). For a fixed
stock of labor, the effect on the output on the unit of capital that has been amassed last would be
lesser than the preceding one. According to Solow, the reducing return on production would man
that the amount of newly generated capital would only be sufficient for the existent capital that
has been lost as a result of the devaluation. At such a point, due to the assumption of no
technological advancement or increase in labor, the economy would stop growing (Broughel &
Thierer, 2019). For Solow, a sustained increase in capital accumulation would increase the
economic growth rate intermittently since the ratio of capital to labor would increase. Still,
marginal products of extra units of capital may reduce when there are reducing return and a
country may revert to its long-run development curve. At such a point, the gross domestic
product (GDP) would grow at the same rate as the rise in the labor force. A steady economic
growth pattern would then be attained when the yield, capital, and labor have been increasing at
the same rate, meaning that the yield per employee and capital remain constant. A difference in
the pace of technological advancement between the nations would explain the variation in the
growth rates observed (Boyko et al., 2019). Therefore, according to the Solow school of thought,
an increase in technological growth would translate directly to economic growth and allow poor
countries to catch up with the richer ones.
Returning to Adam Smith, he feels that the economic growth process is cumulative.
While Solow feels that the effect on yield of the last unit of capital amassed would always be
less, Smith feels that once the economic growth process has been set in motion, it will only gain
momentum and then become cumulative as it feeds on itself. An increase in saving would cause
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more amassing of capital that would facilitate a higher degree of labor division and an increase in
productivity and level of income (Ashraf, Camerer & Loewenstein, 2005). Secondly, the higher
the income raised due to accumulation of capital, the higher the degree of division of labor that
would lead to a rise in the size of the market and a demand for products. The rise in the demand
for goods would cause a rise in nationwide yield and income, bringing more savings,
investments, and capital amassing. Thirdly, a rise in the size of the market and capital availability
would enhance technology and innovations. Smith thus offers good news to the developing
countries because if they can begin the development process in right way, they can be assured of
greater economic growth to allow them to catch up with the richer countries.
Conclusion
While Solow holds that technological progress is the best way to attain economic growth,
Smith holds that division of labor and capital accumulation would speed up technological
progress and economic output. According to Smith, specialized workers understand their job
well that they can suggest the innovative ways of doing their work faster and better. For Smith,
the ultimate outcome of workers focusing on their interests and specialized skills, learning to do
their dedicated tasks better, and working in bigger corporations is that a country would be able to
manufacture and consume far much more if people tried manufacturing all of their goods and
services. On the other hand, Solow feels that the improvements in business processes would be
innovations required to drive economic growth.
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References
Ashraf, N., Camerer, C. F., & Loewenstein, G. (2005). Adam Smith, behavioral economist.
Journal of Economic Perspectives, 19(3), 131-145.
Boyko, A. A., Kukartsev, V. V., Tynchenko, V. S., Eremeev, D. V., Kukartsev, A. V., &
Tynchenko, S. V. (2019, November). Simulation-dynamic model of long-term economic
growth using Solow model. In Journal of Physics: Conference Series (Vol. 1353, No. 1,
p. 012138). IOP Publishing.
Broughel, J., & Thierer, A. D. (2019). Technological innovation and economic growth: A brief
report on the evidence. Mercatus Research Paper.
Cvetanović, S., Mitrović, U., & Jurakić, M. (2019). Institutions as the Driver of Economic
Growth in Classic, Neoclasic and Endogenous Theory. Economic Themes, 57(1), 111-
125.
Hollander, S. (2019). The economics of Adam smith. University of Toronto Press.
Paganelli, M. P. (2020). Adam Smith and Economic Development in Theory and Practice: a
rejection of stadial model?. Journal of the History of Economic Thought, Forthcoming.
Ucak, A. (2015). Adam Smith: The inspirer of modern growth theories. Procedia-Social and
Behavioral Sciences, 195, 663-672.
Zhao, R. (2019). Technology and economic growth: From Robert Solow to Paul Romer. Human
Behavior and Emerging Technologies, 1(1), 62-65.