Smithian Growth

A Formal Outline of A Smithian Growth Model Author(s): Haim Barkai Source: The Quarterly Journal of Economics, Vol.
83, No. 3 (Aug., 1969), pp. 396-414 Published by: Oxford University Press Stable URL: http://www.jstor.org/stable/1880528 . Accessed: 07/02/2014 11:32
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A FORMAL OUTLINE OF A SMITHIAN GROWTH MODEL

HAIM BARKAI
I. The aggregate production function, 396. II. The determinants of the state of technology, 398. III. The long-run pattern of social product, 400.IV. Capital and the profit rate, 404. -V. Investment and saving, 406.- VI. Saving, investment, and Say's law, 408.- VII. The pattern of growth, 410.VIII. The availability of resources for investment, 412.
Smith's vision of the economic system as an entity which could be represented by a small set of variables and their interrelated functional relationships - social product, labor, capital, technology, "accumulation" (investment), saving, the profit rate - is the conceptual framework of aggregate economics to this day. In what follows below, we attempt to single out the strategic hypotheses and theorems of his growth model, and restate them formally. We can thus study the nature of the relationships involved, follow the links which forge the various building blocks into a whole, and finally trace the workings of the integrated structure. The specification of the Smithian aggregate production function indicates the dominant role attributed to capital, and the strategic position of technology, specified as an endogenous variable, in his scheme. An analysis of the saving relation shows that it is different in a crucial sense from the conventional saving function attributed to the classics. The properties of the (implicit) investment function, and the assumed saving investment relationship brings into the open a specifically Smithian version of Say's law. Finally, the study of the time pattern of the model as a whole clarifies the significance of the Smithian version of the "infinity" of investment outlets hypothesis. This puts Smith's belief in the eternality of economic progress into its proper conceptual context. I.
PRODUCTION FUNCTION THE AGGREGATE
Smith identifies scarcity as the fundamental economic fact facing society and thus underlines the nature of the resource restriction which limits the size of the social product. He also clearly
* The comments of J. Atieh on several drafts, and of D. Levhari and the late R. Szereszewski on an early draft are gratefully acknowledged. Thanks are also due to an anonymous referee for helpful criticisms.
A SMITHIAN GROWTHMODEL
397
specifies the variables which determine its level. The nature of this basic relationship is forcefully put in the Wealth of Nations, as follows:
... the annual produce of the land and labour of the country .... be infinite but must have certain limits ................................. can never
[It] can be increased in its value by no other means, but by increasing either the number of its productive labourers, or the productive powers of those labourers who had before been employed. The number of its productive labourers . .. can never be much increased, but in consequence of an increase of capital .... The productive powers of the same number of labourers cannot be increased, but in consequence either of some addition and improvement to those machines and instruments which facilitate and abridge labour; or of a more proper distribution of employment. In either case an additional capital is almost always required .... When we compare, therefore, the state of a nation at two different periods, and find, that the annual produce of its land and labour is evidently greater at the latter than at the former ... we may be assured that its capital must have increased during the interval.... 1
Capital and technology are both specified as strategic determinants of aggregate product - the relevance of the latter and its dependence on endogenous variables of the model are particularly underlined. The Smithian aggregate production function accordingly relates social product to capital, labor, and the state of technology. Thus, writing Y for social product (national income), and K, N, and T for capital, labor, and the state of technology respectively, we have: (1) Y=Y[K, N, T(t, m)]
where Y is assumed to be an increasing function of each of its arguments. To trace the leading strains of Smith's argument, in which capital has been cast into a major role, it is advisable to follow his lead in diagrammatical presentation. In Figure I (p. 405) we thus measure the stock of capital and of social product on the horizontal and vertical axes respectively. The rising product curve such as Y (Ta) in Figure I represents obviously one section only of the production surface specified by equation (1). Since Smith does not offer a proposition on the rate of change of product in response to
1. A. Smith, The Wealth of Nations, ed. E. Cannan (New York: Modern Library, 1937), pp. 315 and 326. The italics are mine. Subsequent references to the Wealth of Nations will refer to this edition. Most elements of this summary statement on the nature of the aggregate relation between inputs and outputs are repeated by Smith elsewhere.
398
QUARTERLY JOURNAL OF ECONOMICS
the growth of one input - others constant - any form of rising product curves would be consistent with his approach. Smith also never assumed fixed capital-labor ratios - the classical concept of a dose of capital and labor is alien to his approach. He definitely allowed for changes in capital-labor ratios, and thus for corresponding changes in the level of product in response to a change in the size of the labor force only. A change in the size of the labor force, ceteris paribus, would be expressed by a corresponding shift of the product curve in Figure I. The several product curves in Figure I could thus represent alternative product levels due to differing sizes of the labor force for given levels of capital.
OF THE STATEOF TECHNOLOGY II. THE DETERMINANTS
Changes in the state of technology affect the relevant product will shift in response to corcurves of Figure I similarly -they responding changes in technology, from say Y(Ta) to Y(Tb). Two "extent of the market" aspects of this variable are identified -the and what could be dubbed as the "technical efficiency of equipment." Each of these two determinants of the state of technology are related to other endogenous and exogenous variables. A. The Extent of the Market Smith underlines the strategic relevance of the size of the market to the state of technology in his well-known title of Chapter Three of Book I of the Wealth of Nations - "That the Division of Labour is Limited by the Extent of the Market." Institutional and political factors and the level of social product, are specified as the determinants of the "extent of the market." The reduction in the barriers imposed on foreign trade - a political and hence an exogenous determinant in our context -is representative of the set of institutional factors.2 The hypothesis which specifies the dependence of the size of the market on social product is forcefully put as follows:
... the revenue of all the inhabitants of the country is necessarily in proportion to the value of the annual produce of their land and labours; . . . The
greater the . . . revenue of the inhabitants market . .. 3
. . .
the more extensive
is the
2. See Wealth of Nations, p. 415. 3. Ibid., pp. 347, 356.
A SMITHIAN GROWTH MODEL
399
Writing m for the extent of the market, we have accordingly: (2) m=m (Y) and m'(Y)>O.
The extent of the market increases with the increase of social product, and also in response to changes in the institutional data. The latter change would be expressed in terms of a change in the form of the function specified in (2). An increase in the stock of capital which according to the production function generates an increase of product, thus triggers off the technology mechanism through the extension of the market according to (2). In terms of Figure I this means that an increase in the stock of capital from, say, Ko to K1 implies not only a move along a product curve such as Y (Ta). In response to a change in technology induced by the extension of the market the curve itself shifts upwards at one and the same time to, say, Y (Tb). The product corresponding to K1 is accordingly Y2 at B on Y (Tb) and not Yj on Y(Ta), which would have been its value in the constant technology case.4 B. The Technical Efficiency of Equipment Consider now the other facet of technological change -the increase in the technical efficiency of equipment-"improvement to those machines and instruments which facilitate and abridge labour" as Smith put it. In addition to inventions induced by "philosophy and speculation" both of which are exogenous factors, Smith underlines the relevance of capital, as a crucial determinant in this context. He writes:
. . labour can be more and more subdivided in proportion only as stock
is more and more accumulated .... chines come to be invented .... and as the operations of each workman in order to give constant employment to an
are gradually reduced to a greater degree of simplicity, a variety of new maequal number of workmen, an equal stock of provisions, and a greater stock of materials and tools than what would have been necessary in a ruder state of things, must be accumulated beforehand.5 4. This formulation pinpoints at once the reversibility dilemma. Thus, what happens if capital decreases from K1 to Ko? Would this shift the product curve back from Y(Tb) to Y(T.), or is technological change nonreversible? In the latter case, income would not fall to Yoin response to a reduction in the size of capital K -it will decrease to Y', on Y(Tb) only. Though valid analytically and of some historical significance- vide the universal decline in the state of the arts in the wake of the dissolution of the Roman Empire -the reversibility issue seems to be out of context in a Smithian growth model, the focus of which is capital accumulation. 5. Wealth of Nations, p. 260.
400
The "technical efficiency"of equipment is accordingly specified as an increasingfunction of the capital-laborratio. Writing t for the technical efficiencyof equipmentwe have accordingly:
(3) t -t ;and t!( )> 0.
"Technical efficiency" (of equipment) increases with the increasein the ratio of capital to labor. It also increasesin response to "inventiveness" inducedby pure speculationor by the ingenuity of the men on the job. The latter are exogenousvariables. If they vary this will change the form of the technical efficiencyfunction (3). The impact of institutional and social factors, and of motivations, which Smith identified, among others, as relevant determinants of specialization,will also changethe form of (3).6 Capital accumulation,when it involves also an increasein the capital-labor ratio, thus brings into motion technology via the supply facet of economic activity, accordingto (3). In terms of Figure I, this, similarly to the extent of the market case, implies that an increaseof social capital does not signify only a movement along a product curve such as Y (Ta). If accumulationoutpaces the growth of the labor force, it may also imply an upward shift of the curve itself. III.
THE LONG-RUN PATTERN OF SOCIAL PRODUCT
A. The Long-Run Product Curve Let us now put together the various building blocks of the Smithianmacroeconomic conceptof production,specifiedby (1) the productionfunction, and by (2) and (3) -the relations which specify the endogenousdeterminantsof technology. This set of equations sets the equilibriumpattern of social product in a context of continuous"accumulation."Thus, an increase in the size of capital stock, generatesaccordingto the production function an increase in product. Since by (2) a higher product level implies an increase in the extent of the market, accumulationinducesconcomitantlychangesin technology. The technology argumentin the productionfunction, therefore, pushes the level of product beyond the point which it would have reached in
6. An interesting study of this facet of Smith's analysis of the determinants of the division of labor is given in N. Rosenberg,"Adam Smith on the Division of Labour: Two Views or One?" Economica, XXXII (May 1965).
401
responseto the growth of capital stock under the conditions of a given technology. The growth potential of social product due to the direct impact of capital on product, and to its indirect effect in response to extensionof the market,may be even greaterthan the one noted above. This will happenif the growthof the capital stock proceeds faster than that of the labor force. The resultant rise in the ratio of capital to labor, increases,by (3), "the technical efficiency of equipment."This pulls the technology argumentof the production function upwards, and correspondinglygenerates an even greater productfor the given level of capital stock. The same argumentcould be put in terms of Figure I. Suppose that the capital stock grows from Ko to K1. Output would thus increase from Yo to Y1 on the Y(Ta) curve. This, however, does not take into account the effect of changes in these two variables on technology. This increasein productincreases,by (2), the value of m which pulls the productcurve Y (Ta) upwardsfromits original position. This upward motion may or may not be reinforced,by forces emanating from the technical efficiency relationship (3), accordingto the ensuing change in the capital-laborratio. Thus investmentwhich increasesproductiondirectly activates at one and the same time a technology variable which pushes the curveupwards,to a level of say Y(Tb). The corresponding increase of income in responseto the growthof capital stock from Ko to K1 is (Y2- Y0), of which (Y2- Y1) may be attributedto inducedtechnological change. The Ye curve, joining points like A, B and C, drawn into the capital product plane of Figure I, is accordingly the long-run capital-productcurve. It expressesthe direct and indirect response of the entire productionsurface to "accumulation."Changesin the exogenousvariables-such as relaxation of feudal and mercantile restrictions,or spurts of inventive activity broughtabout by "pure speculation"of the late eighteenthcentury genre- affect the form of technology relations (2) and (3), and hence the location of the (constant technology) product curve similarly. A change induced by any of these exogenousparameters could obviously also shift
a curve as Y(Ta) towards Y(Tb) or Y(T,).
7. Smith's well-known comparisons of China and England could be easily understood by means of this apparatus. The former country's product curve for given levels of the capital stock may be lower due to institutional factors such as strict restrictions of foreign trade, difficulties in the legal enforcement of contracts, and the nature of Chinese abstract speculation which concentrates on semantics and shies away from natural philosophy. These imply low values of m and t and correspondinglyof product.
402
B. The Long-Run Capital Product Curve -
A Special Case
A special case, for which we could specify the structural subset of relations (1), (2) and (3) may offer additional insights on the properties and feasible values of the strategic parameters of the Smithian long-run capital product curve -the Y curve of Figure I. Thus, assume a Cobb-Douglas constant returns aggregate production function
(1') Y=TKa
Ni-a.
Assume also that the extent of the market, one of the determinants of technology, is proportional to the current size of per capita product. We have accordingly y m = a - where 0 < a<l. (2') The value of a is obviously positive. It also could not be greater than unity, since the long-run flow of (real) expenditure on social product, could not be larger than social product itself. Whether it is equal to or smaller than unity depends on other factors which are not relevant at this stage of the discussion. The "technical efficiency" relation, assumes that technical efficiency is proportional to the capital-labor ratio. Thus, (3') t= b() where b > 0.
Finally, assume a linear relationship between technology and its two determinants. This implies that technology will change even K if one of its determinants, say, kis constant. Write accordingly:
(3"1)
T== c a-N b
)-
By substituting (2'), (3') and (3") into (1'), we deduce the form of the long-run, technology induced product function Y,
lK 1+a bcf N J
(1") Y=N 1-ac /Ka N
8. To simplify presentation we assume that population and the labor force are identical. This assumption has no strategic bearing on the results. If we had assumed instead that the labor force is a constant proportion of population, the general form of the long-run product curve (1") below, would have been the same as though it had been multiplied by a constant.
403
This expression, deduced from the structural relations, reflects the Smithian equilibrium values of social product corresponding to the values of the endogenous technology variables and to the exogenously given parameters. The expression is finite and positive only if the denominator is positive, and this requires that the factor ac(
-)
should be smallerthan unity.
Assume now that a, the extent of the market coefficient, is not significantly different from unity. This premise, which means that most of any additional income is spent, is a dominant feature of Smith's approach, and imposes a restriction on the value of c, the (total) technology coefficient. The latter must be significantly smaller than unity, unless the capital-labor ratio, and the elasticity of product with respect to capital are very small. With a capital-labor ratio of say 2 and a of about 0.3, to use some empirically relevant orders of magnitude, the denominator of (1") would approach zero if c is of an order of 0.7. It will turn negative if larger than that. If we do not assume that the system explodes, in other words, that capital formation will generate at once an infinite growth of product, we must assume values of c which are significantly smaller than 0.7. This restriction on the value of c -the technology coefficient, underlines the nature of a basic restriction imposed on technology. Induced technological changes must be assumed to be small.9 This result holds presumably for any form of the aggregate production function. The specific case presented here underlines the induced effect of capital accumulation on technology. The distinctive feature of this process is thus not only its direct impact on production, but also its multiplicative effect on the production potential due to induced technical change. The latter implies a socalled "technology multiplier" as an element of the model.
9. The form of the extent of the market function (2') adopted above, where the extension of the market is assumed to be proportional to the change in per capita income, is not the only one consistent with the Smithian hypothesis. A more general form would be one which assumes that the extent of the market is an increasing function of social income. In the latter case, though not in the case studied in the text, an increase in social income which leaves per capita income constant would activate the technology factor of the model. This, however, does not change the nature of the results deduced on the basis of the more restrictive assumption. It rather strengthens the conclusion that for a stable system induced changes in technology must be
assumedto be small.
404

IV. CAPITAL AND THE PROFIT RATE
The capital-profit-rate relationship, the "law of the falling profit rate" in the terminology of classical economics, is obviously a strategic element in Smith's model. The property of this relationship is concisely stated:
The diminution of the The increase of stock ... tends to lower profits . .. of the . . raises . of the stock profit society capital stock.1
Unlike West and Ricardo, who deduced the law of the falling profit rate from their hypothesis on the diminishing returns property of the production function in agriculture, Smith does not derive this relationship from an underlying productivity hypothesis. His reasoning is in terms of the common-sense rule of competition:
As capitals increase in any country, . . . there arises in consequence a competition between different capitals, the owner of one . . . can hope to justle
that of the other out of . . . employment, . . . by dealing upon more reasonable terms. He must not only sell . . . somewhat cheaper, . . . he must someprofits which can be made by the use of a dearer .... times too buy ... capital are in this manner diminished ... at both ends. ..2
Smith, who does exclude diminishing returns as an explanatory variable, nevertheless assumes the relevance of an economic variable per se in this context - the nature of demand for final products. A negatively sloped market demand curve, does obviously imply lower price in response to an increase in supply - and hence generates a downward pressure on the price for factors. Thus though the Smithian profit rate theory is seriously weakened because of the absence of an explicit background productivity hypothesis, it is nevertheless anchored within the conceptual framework of economic behavior.3 Profits, are, by implication, related also to one other endogenous variable of the model - technology. In the course of his discussion on "Inequalities of Profit" Smith makes the following remark:
The establishment of any new manufacture ... of any new practice in agriculture, is always a speculation from which the projector promises himself
extraordinary profits .... If the project succeeds, they are commonly at
1. Wealth of Nations, pp. 87, 94. 2. Ibid., pp. 336-67. In the course of a historical survey of colonization though, Smith makes a passing reference to productivity as a determinant of profit. He writes: "When the most fertile and best situated lands have all been occupied, less profit can be made by the cultivation of what is inferior both in soil and situation."Ibid., p. 93. 3. The macroeconomic behavioral hypothesis which Smith uses here, is admittedly somewhat out of place in the macroeconomic context of the profit rate discussion.
405
y(...Tc) y
--
y~~~~(..Tb) y
7C.
So(y)
Sy
.IY -
/I -~A
y(..To
Y8
-O yo
-----
Yo/
Figure
IKo l
Kd
Figure
I I
'IO~~~~
Ko
I__
Io
Figure
m
FIGURE I-IV
Figure 1Z
first very high. When the trade or practice becomes thoroughly established . . . competition reduces them to the level of other trades.4
This statement definitely indicates that Smith did visualize that profits and hence the profit rate, for specific projects, do rise in latter being identified as response to a change in technology -the either a change in the method of production, or in the product mix. Moreover, he identifies this (expected) rise as the very mechanism which attracts resources into these novel activities. The statement leaves admittedly one crucial point open: It does not indicate the direction in which the equilibrium profit rate
4. Op. cit., p. 115.
406
may be expected to move in response to changes in technology. The observation made in the last sentence of the above passage that the initially extraordinary high profit rates due to changes in technology are in due course reduced to "the level of other trades," does not necessarily imply that the overall equilibrium rate itself is unaffected. In other words, the statement is certainly consistent with the possibility - though this in not explicitly mentioned - that the post-technological change equilibrium profit rate would be higher than the pre-technological change rate. This is also fully in line with the general bent of his thought on the implications of technological change on total product. Thus, writing r for the profit rate, the Smithian profit rate function is accordingly: (4) r=f (K, T) where fK<O andfT>O.
The "law" of the falling profit rate which is expressed by the negative sign of the derivative with respect to the first argument of (4), is represented by the negative slope of the curve in the profit rate capital stock plane drawn as Figure III. The level of this curve is determined by the value of T - the level of technology. A more advanced technology shifts the curve from, say, f (Ta) towards a curve such as f(Tb). An alternative and economically more meaningful way to put the same idea would be to say that the level of the profit rate which is consistent with a given capital stock would be higher, the greater the value of T -the higher is the level of technology applicable in this economy. Smith's dicta offers no hypothesis on the rate at which the profit rate is supposed to fall in response to capital accumulation. In other words, we have no specification on a feasible value or values of the slope of profit rate curves such as are drawn into Figure III. And this, though the economic implications of curves that have a small slope (in absolute terms) are prima facie quite different from those of curves that have a large slope. We shall, however, argue below, that this point is of minor significance in the context of the model as a whole. AND V. INVESTMENT SAVING A. The Investment Curve The investment capital relation is clearly defined by Smith. He uses the contemporaneous term "accumulation" as a synonym for our present day investment. Accordingly investment and capi-
A SMITHIAN GROWTHMODEL
407
tal are by definition positively related: "the capital . . . of a nation is increased . . . by continually accumulating and adding to it." 5 A relation between the profit rate and investment is to the best of my knowledge not explicitly mentioned. Yet by applying the investment capital relation it is possible to deduce at once a Smithian "investment profit rate" relationship. Since the profit rate is a decreasing function of capital and the stock of the latter is positively related profit rate is consequently a decreasing functo investment -the tion of investment too. Thus, we have (5) r=g(I, T) where g1(I, T) <0, and gT(I, T) >0.
The investment curves of Figure IV - in which the profit rate and investment are measured on the vertical and horizontal axes correspondingly, are accordingly negatively inclined. Similarly to the case of the capital profit rate relationship, higher profit rates are consistent with the same level of investment if technology is more advanced. Hence the upward shift of the investment curve in Figure IV, from g(Ta) to, say g(Tb) in response to changes in technology. B. The Saving Relation Consider now Smith's dicta on saving. The term is explicitly used, and hypotheses relating saving to other variables are time and again stated. Yet significantly he never specifies a relationship between saving and the profit rate or its money market representative -the interest rate. A conventional positive saving interest rate relation, which has been identified as a sine qua non of classical economics, is accordingly not an inherent element of the Smithian structure. A rising saving curve which figures in the diagrammatical presentations of the models of the classical economists from Ricardo onward, does not appear consequently in Figure IV. The level of income is identified by Smith as the strategic determinant of saving. This point is forcefully put as follows:
The capital of . . . a nation ... is likely to increase the fastest, therefore, when it is employed in the way that affords the greatest revenue to all the inhabitants of the country, as they will thus be enabled to make the greatest 6. Blaug underlines this point. See M. Blaug, Economic Theory in Retrospect (Homewood, Ill.: Irwin, 1962), p. 54. I doubt, however, whether Blaug's statement, made in this connection, that "Smith never suggests that saving is a function of . . . net revenue" is warranted. It is certainly inconsistent with Smith's statement quoted in the next paragraphof the text.
5. Op. cit., p. 347.
408
savings ... the revenue of all the inhabitants of the country is necessarily in proportion to the value of the annual produce of their land and labour.7
Savings is thus specifiedas a positive function of income- the social product. The corresponding saving relation could hence be written: (6) S=S(Y) whereS'(Y) >0. We have accordinglydrawn a rising saving curve into Figure II, where social product and saving are measuredon the vertical and horizontalaxes correspondingly. The location of this curve in the saving income plane, reflects the (average) propensity to save, and depends on behavioral and institutionaldata. Smith suggeststhat individualsdo differin their - "frugals" and saving behavior due to personal characteristics "prodigals" are Smith's extreme cases. The same applied to social - the notorious "extravaganceof governand political groupings ment" set against the net frugality of the private sector, is Smith's case in point. Smith's well-known realistic presumptionthat propensities to save out of wages, rent, and profits differ significantly, implies that changes in income distributionalso affect the location of the saving curve. Thus, a redistributionof income from rent to profit would shift the saving curve of Figure IV from say Sa(Y) to S(Y). Different propensitiesto save of entire societies and political entities are also mentioned,China and England serving as representative examples. These differencesare attributedto institutional factors-such as the rule of law which could enforce the sanctity of property and of contract-and also to national characteristics. The average propensityto save varies accordinglyin time and in space.
VI. SAVING,INVESTMENT, AND SAY'S LAW
Consider now Smith's handling of saving and investment. Figure IV bringsinto the open the essential elementof the problem. It portrays the demand facet of the (real) capital market in the form of a negatively inclined investment-profit rate curve. It does not feature, however,as we have argued in the previous section, a savings-profitrate curve. The structureof the Smithianmodel differs consequentlyon this crucialpoint fromthe commonrun of clas7. Wealth of Nations, p. 347.
409
sical models. Yet the saving investment framework is the very framework which servesin morethan one sense as the heart of these formal structures. It is the very mechanismwhich, within a more comprehensive context, settles, so to speak, the equilibriumlevel of one of the fundamentalvariables of the system- the profit (interest) rate. To put Smith's aggregatemodel lightheartedly under the classical umbrellais thereforeunwarranted. The implication of the absence of a saving curve in Figure IV is therefore of far-reachingsignificance,since it prevents the specificationof the equality of saving and investment as an equilibrium condition in the sense of an intersectionof two schedules. Yet if these two variablesare somehowmade equal, as Smith argues they are, they must be brought into this relationship in the only alternativesense possible- in terms of an identity. This is, as a matter of fact, Smith's message on the nature of this relationship. It is undoubtedlythe identity, and not the equality, variant of the saving investment relationshipto which Smith refers when he asserts:
As the capital of an individual can be increased only by what he saves from his annual revenue . . . so the capital of society, which is the same with that of all the individuals who compose it can only be increased in the same manner .... What is annually saved, is as regularly consumed as what is annually spent.8
The messageof this passage,presumably the most extremein formulation among several others in a similar vein, is clear cut. Saving
and investment at the macro as at the micro level are identical
all along the line. Thus we have the fundamentalidentity of the Smithianmodel, namely: (7) SaI. Hence though the income flow decomposesinto two flows consumptionexpenditure and a residual flow of saving- Smith assumesthat the latter which "for the sake of profit is immediately employed as capital"9 generatesby definition an identical expenditure on investment. The sequenceof output-income-expenditureoutput is consequentlynot liable to interruptionfrom the saving investmentmechanism. Even a growingsystem would consequently never be choked by an overflowof savings-they are ipso facto investment. The continuouslyincreasingflow of output would accordinglyalways be absorbedby consumersand capitalists qua in8. Ibid., p. 321. 9. Ibid., p. 321.
410
vestors. This evidently reduces to the assertion dubbed later on as Say's Law. The Smithian version is, however, an extreme version of this "law." It is obviously one thing to claim that saving could not generate a gap between the value of social product (at remunerative prices) and the expenditure flow, since the profit (interest) rate would vary in response to any (ex ante) gap between the two so as to adjust the two flows. This "conventional" classical line of reasoning assumes a positively sloped savings curve which, in the savings investment plane, assures intersection of the supply and demand scissors. It is, however, quite a different story if, as Smith's model implies, the respective saving and investment curves of Figure IV are identical so that these two are identical at any rate of interest.' In other words, the Smithian variant of Say's Law does not assume the existence of an economic mechanism which reacts to a disturbance by adjusting the appropriate variables -particularly the interest rate - so as to bring these flows and hence the system into equilibrium. Any disturbance related to these activities is assumed away in the first place, which means in effect Say's Law with a vengeance.
VII. THE PATTERN OF GROWTH
A. Stationary Conditions Consider now the growth pattern of the system as a whole. Let us start from a given position - a position where the capital stock is say - Ko (Figure I). By employing the given labor force at the current level of technology, this generates a social product Yo. Now suppose that the relevant savings curve in Figure II is the Sa curve, which intersects the product axis at the current level of product Yo. By the saving investment identity this zero saving level implies that at the current profit rate ro - read off the profit capital curve of Figure III - investment is zero too. We have accordingly a corresponding investment curve such as g - in Figure IV, which intersects the vertical axis at a zero level of investment.
1. This sounds queer analytically speaking, since the identity condition and the property of the investment curve, implies prima facie a negatively sloped saving curve. This should, however, not be taken too literally. Whilst the negatively sloped investment curve could be deduced from a background structural relation - the saving curve in the profit rate investment plane has no behavioral significance whatsoever. This underlines the previously mentioned lacuna in the Smithian structure.
411
The constant stock of capital - assuming a constant labor force - implies constant levels of the other endogenous variables social product, saving, the profit rate, technical efficiency of equipment, the size of the market. Economic activity will accordingly be going on in a recurrent and intermittent flow at a constant level, unless one or more of the exogenous variables - say invention induced by pure speculation or institutional factors such as better enforcement of the rule of law - pull the system off this track. This is a Smithian variant of the stationary state. Note that this account accords in more than one sense with Smith's interpretation of the case of China. His reading of the then current economic conditions of this country are neatly formulated as follows:
China seems to have been long stationary, and had probably long ago acquired that full complement of riches which is consistent with the nature of its laws and institutions. But.this complement may be much inferior to what, with other laws and institutions, the nature of its soil, climate, and situation might admit of. A country which neglects or despises foreign commerce .... in a country too, where, though the rich or the owners of large capitals enjoy a good deal of security, the poor or the owners of scarce capitals enjoy
scarce any
. . .
the quantity of stock employed .
. can never be equal to
what the.nature and the extent of that business might admit.2
B. The GrowingSystem
Smith's statement in the passage above puts the finger on two strategic factors which lead to stationary conditions. The one relates to an institutional determinant of the saving function; the other to an institutional factor which affects the "extent of the market" and hence factor productivity. A change in any of these two could start the system along a growth path. Thus a rise in productivity due to the lifting of restrictions on foreign trade would generate a greater output for the given level of capital Ko. Now even if the relevant savings curve in Figure II is the same Sa curve as before, the higher income level of say Y' on Y(Tb) will generate positive saving, hence positive investment. Similarly an increase in the propensity to save, in response to a change in an institutional factor, initiated by, say, the gradual imposition of the rule of law and the sanctity of contract, would also do the trick. This would be expressed in terms of a shift of the saving curve to the right and would thus generate positive capital formation at the current level of social product Yo.
2. Wealth of Nations, p. 95. The italics are mine.
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Let us pursue the latter line of reasoning somewhat further. Thus supposethat the average propensityto save at Yo is the one presentedby the S curve of Figure II. Saving would accordinglybe So, which by (7) is identical to 1. This investmentlevel will also be consistent with the ruling profit rate determinedby the given level of the capital stock K0. The level of activity would thus not stay constant. Whether the labor force grows,at a similarrate, or not, the resultingincrease in the stock of capital generates a greater product in the coming period. Thus even for a given labor force the system would move
to the right along the product curve such as Y(Ta) which repre-
sents the constanttechnology aggregateproductionfunction. A simultaneouslyincreasing labor force, implies at one and the same time an upward shift of the product curve towards say Y(Tb), and hence along the Y path. This obviously increasesthe rate of increaseof producteven more. One is thereforeinevitably tempted to ask whetherthis process could go on infinitely. Once saving, which is ipso facto investment, is at a positive level, would the recurrentprocess of capacity creation push the system along a growingpattern forever? It is at this point that we must put into the analysis the effect of the falling profit rate. Capital accumulationimplies- a move along the profit rate curve of Figure III - a falling trend of the profit rate. Smith clearly relates stationary conditionsand low profits:
In a country which . . . could . . . advance no further, and which was not going backwards, ... the profits of stock would probably be very low.3
Since growth generatespressureon the profit rate, this must eventually choke this very process. Stationary conditionsare therefore
presumably inevitable. OFRESOURCES FORINVESTMENT VIII. THE AVAILABILITY A. Capital, Product, Technology
Smith was, nevertheless, not bothered by this prophecy of doom which prima facie follows directly from the structureof his model. In more than one sense the basic message of the Wealth of Nations is rather that capital accumulationcould ensure eternal "progress."The reasonwhy Smith was not after all worriedlest the
depressing effect of capital accumulation on the profit rate reduce the growth potential of the system to nought, is due to a leading
3. Ibid., p. 94.
413
strain of his thought. This is his belief, which we have already in the strategicfunctionof technologicalchange,and the underlined, incorporation of technology as an endogenous variable of his model. Ouranalysis in the previoussection,in which we studiedthe workingsof the model as determinedby the interactionsof capital, social product saving, and investment, must therefore be extended to incorporate the effects of endogenouslyinducedtechnical change. An inspection of the specification of the production function in (1) and the two technology equations (2) and (3) indicates at once the nature of the other mechanism at work. Thus positive
saving hence investment - creates greater capacity and therefore
a greatersocial product. The growingcapital stock generatespressure on the profit rate. The movementalong a product curve such as Y (Ta) in Figure I, also implies a movementalong (Ta) in Figure
III. Yet since technical efficiency of equipment tis a positive
functionof the capital-laborratio, an inspectionof (3) and (1) suggests at once that if capital formation proceeds faster than the growthof the labor force, the value of T - the technologyvariable in the productionfunction- rises correspondingly.This, however, shifts the product curve of Figure I upwardstowards, say, Y (Tb) and correspondingly the profit rate curve in Figure III to the right, towards,say, f (Tb). This is, however,not the end of the story. We have yet to study the effect of these comings and goings on m -the extent of the marketvariable. The latter, according to (2), is positively relatedto social product. Consequently a growing product in response to capital accumulation triggersoff the technologyvariable in both the productionfunction and the profit rate function throughits impact on the extent of the market. Thus even if a movement along a productcurve such as Y(Ta) fails to operate on the technical effiand popciency variable- due to the fact that capital accumulation ulation growth proceed at the same rate the growing market would still do the trick. The market inducedtechnologicalchange will shift the product curve of Figure I towards Y (Tb) and corthe profit rate curve of Figure III towardsf (Tb) . The respondingly motion along these curves proceeds accordinglypari passu with a shift in them even assuminga constant t. The Smithian vision of eternal progressis thus obviously not based on the oversimplifiedassumption of unlimited investment outlets, in the sense that the investment and capital curves of Figures III and IV are asymptotic to the horizontal axis. According to this variant of the unlimitedinvestmentoutlets hypothesis,some-
414
times attributed to the classics, the profit rate could never fall to nought. Smith's belief that the profit rate, hence investment (and also saving), will not fall to zero as an inevitable consequence of growth,is, as we have seen, deduced from a more sophisticated and thus more complexview of the nature of the economicprocess. The capital and investment curves are not asymptotic to the horizontal axis at a positive interest rate. They could intersect it at a finite level of capital stock and investment. What the structuralpremisesof the Smithian model do imply is that growth generatesforces which continuouslyshift these two curvesto the right. It is obviouslytechnologywhich does the trick and prevents stagnation, by constantly removing the depressing pressureon the system, thus allowing it to lift itself continuously, so to speak, by its own bootstraps. B. Smith'sEulogy of Capital Our restatementof Smith's model indicates why it was capital which Smith identifiedas the strategic factor in the process of economic evolution. Capital is not only an input that together with others generates the social product. Capital accumulationfigures also as the sine qua non of technologicalprogress. It operates, on the one hand, through the productionincome nexus to extend the market, and hence to induce division of labor. On the other hand, by making possible a rising ratio of capital to labor it makes "embodied"technologicalchanges,to use a modernterm, possible. The technology relations that figure as integral elements of the Smithianstructureare admittedly oversimplified.This is, however, much less importantthan the fact that Smith posed the capital technology issue right on the agenda of political economy. After all, one may doubt whether we have in between improved upon his insights. To this day we are short of a meaningful and testable hypothesis for technology, which on most occasions is still definedin empiricalwork as a somewhatmysteriousresidual. Once we realize the cardinalposition of technology in Smith's vision, the reason for his worship of capital and of saving, which made an ineradicableimprint on the intellectual atmosphereof the professionto this day, comesinto its own.
THE HEBREW UNIVERSITY JERUSALEM

Smithian Growth

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A Formal Outline of A Smithian Growth Model Author(s): Haim Barkai Source: The Quarterly Journal of Economics, Vol.

A FORMAL OUTLINE OF A SMITHIAN GROWTH MODEL

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OF THE STATEOF TECHNOLOGY II. THE DETERMINANTS

the more extensive

2. See Wealth of Nations, p. 415. 3. Ibid., pp. 347, 356.

A SMITHIAN GROWTH MODEL

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B. The Long-Run Capital Product Curve -

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should be smallerthan unity.

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5. Op. cit., p. 347.

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the quantity of stock employed .

. can never be equal to

what the.nature and the extent of that business might admit.2

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