Adam Smith and other classical economists had important contribution on the economic growth theory. Barro and Xavier I. Sala-i-Martin (2003) state that classical economists, such as Adam Smith (1776), David Ricardo (1817), and Thomas Malthus (1798), and, much later, Frank Ramsey (1928), Allyn Young (1928), Frank Knight (1944), and Joseph Schumpeter (1934) provided many of the basic ingredients that appear in modern theories of economic growth. These ideas include the basic approaches of competitive behavior and equilibrium dynamics, the role of diminishing returns and its relation to the accumulation of physical and human capital, the interplay between per capita income and the growth rate of population, the effects of technological progress in the forms of increased specialization of labour and discoveries of new goods and methods of production, and the role of monopoly power as an incentive for technological advance.
Rostow (1992) states that according to Adam Smith (1776), the main factors affecting the engine of economic growth are population growth, capital growth, the
division of labor (technological progress) and institutional framework of the economy (competitive-free traded market economy). Smith also stated the importance of stable legal framework in which invisible hand of the market could function, and open trading system (Viner (1927), Hutchison, (1976), Spengler, (1959a, 1959b) Rothschild (1992).
The Theory of Moral Sentiments begins with the following assertion: How selfish soever man may be supposed, there are evidently some principles in his nature, which interest him in the fortune of others, and render their happiness necessary to him, though he derives nothing from it except the pleasure of seeing it. Smith (1759) stated that every man is, no doubt, by nature, first and principally recommended to his own care; and as he is fitter to take care of himself than of any other person, it is fit and right that it should be so. Smith (1776) stated that … 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 (1776) also stated that The natural effort of every individual to better his own condition, when suffered to exert itself with freedom and security is so powerful a principle that it is alone, and without any assistance, not only capable of carrying on the society to wealth and prosperity, but of surmounting a hundred impertinent obstructions with which the folly of human laws too often in cumbers its operations; though the effect of these obstructions is always more or less either to encroach upon its freedom, or to diminish its security.
Smith (1776) stated that “... But the annual revenue of every society is always precisely equal to the exchangeable value of the whole annual produce of its industry, or rather is precisely the same thing with that exchangeable value. As every individual, therefore, endeavors as much as he can both to employ his capital in the support of domestic industry, and so to direct that industry that its produce may be of the greatest
value; every individual necessarily labors to render the annual revenue of the society as great as he can. He generally, indeed, neither intends to promote the public interest, nor knows how much he is promoting it. By preferring the support of domestic to that of foreign industry, he intends only his own security; and by directing that industry in such a manner as its produce may be of the greatest value, he intends only his own gain, and he is in this, as in many other cases, led by an invisible hand to promote an end which was no part of his intention. Nor is it always the worse for the society that it was no part of it. By pursuing his own interest, he frequently promotes that of the society more effectually than when he really intends to promote it. I have never known much good done by those who affected to trade for the public good. It is an affectation, indeed, not very common among merchants, and very few words need be employed in dissuading them from it.”
Technological progress could also increase growth overall. Smith's famous thesis that the division of labor (specialization) improves growth was a fundamental argument. Smith (1776) stated that “ ...this great increase of the quantity of work which, in consequence of the division of labor, the same number of people are capable of performing, is owing to three different circumstances; first to the increase of dexterity in every particular workman; secondly, to the saving of the time which is commonly lost in passing from one species of work to another; and lastly, to the invention of a great number of machines which facilitate and abridge labor, and enable one man to do the work of many...” Smith also saw improvements in machinery and international trade as engines of growth as they facilitated further specialization. Smith also believed that "division of labor is limited by the extent of the market" - thus positing an economies of scale argument. As division of labor increases output (increases "the
extent of the market") it then induces the possibility of further division and labor and thus further growth. Thus, Smith argued, growth was self-reinforcing as it exhibited increasing returns to scale. Output growth (gY) was driven by population growth (gL), investment (gK) and land growth (gN) and increases in overall productivity (gP).
Output growth model is (Rostow, 1992; The History of Economic Thought, 2009):
gY = f (gL, gK, gN, gP)
Smith’s economic growth model can be formalized as follows (Adelman, 1964; Rostow, 1992; The History of Economic Thought, 2009):
Y= F (K, L, N) Where
K: Capital L: Labor N: Land