Gustave Doré's Over London by Rail (1870) shows the densely populated and polluted industrial environment
The
history of economic thought deals with different thinkers and theories in the field of
political economy and
economics from the ancient world right up to the present day. Although the British
philosopher Adam Smith is generally considered the father of economics, his ideas built upon a considerable body of work from predecessors in the eighteenth century. They in turn were grappling with wisdom received from centuries before and attempting to apply it to a modern setting. Economics was not considered a separate discipline until the nineteenth century.
Aristotle, the ancient Greek philosopher, grappled with the "art" of wealth acquisition, and whether property is best left in private, or public, hands in his works on
politics and
ethics. In mediaeval times, scholars like
Thomas Aquinas argued that it was a
moral obligation of businesses to sell goods at a
just price. Economic thought evolved through
feudalism in the
Middle Ages to
mercantilist theory in the
renaissance, when people were concerned to orient trade policy to further the
national interest. The modern
political economy of Adam Smith appeared during the
industrial revolution, when technological advancement, global exploration, and material opulence that had previously been unimaginable was becoming a reality. Changes in economic thought have always accompanied changes in the economy, just as changes in economic thought can propel change in economic policy.
Following Adam Smith's
Wealth of Nations,
classical economists such as
David Ricardo and
John Stuart Mill examined the ways the landed, capitalist and labouring classes produced and distributed national riches. In the midst of the London slums,
Karl Marx castigated the capitalist system of exploitation and alienation he saw around him, before
neo-classical economics in a new
Imperial era sought to erect a positive, mathematical and scientifically grounded field above normative politics. After the wars of the early twentieth century,
John Maynard Keynes led a reaction against governmental abstention from economic affairs, advocating interventionist fiscal policy to stimulate economic demand, growth and prosperity. But with a world divided between the
capitalist first world, the
communist second world, and the poor of the
third world, the post-war consensus broke down. Men like
Milton Friedman and
Friedrich von Hayek caught the imagination of western leaders, warning of
The Road to Serfdom and
socialism, focusing their theory on what could be achieved through better
monetary policy and deregulation. However the reaction of governments through the 1980s has been challenged, and
development economists like
Amartya Sen and
information economists like
Joseph Stiglitz are bringing a new light to economic thought in the twenty first century.
Early economic thought
| "A monk travelling back to Germany from a pilgrimage to Rome joined a band of merchants. He showed them a silver chalice he had purchased for his cathedral at home and told them what he paid for it. They laughed with astonishment and congratulated him, because he had made a killer of a bargain and they mused that an unworldly monk was able to drive an even better deal than any of them. The monk so was horrified at their reaction that he left immediately, and went back to Rome to pay more to the chalice maker for what should have been the just price." |
| The Parable of the Monk |
Chanakya,in ancient India, authored the
Arthashastra, the earliest known treatise on economic principles and guidelines for a progressive economy. The
philosopher Aristotle led one of the first important economic discussions, in
Ancient Greece. From the point of view of a slave owning society, but also a
city-state that produced a
democracy, albeit limited, he examined household spending, market exchanges, and motivations for human action. Aristotle spoke, as was done until relatively recently, about "economic" subjects as a part of
politics,
justice and
ethics. With the collapse of the Ancient world and the end of
Roman civilization, economic discussion in Europe flagged as societies were cast under the shadow of the
Dark Ages. The
Middle Ages were intensely religious, under a
feudal order as the
crusades went underway. The signs that the
Dark Ages had passed were found in the increase in trade across the continent, and the development of the
lex mercatoria. Many worried that the economic changes embodied a threat to old attachments to a moral order, which are represented by the
Parable of the Monk. This story illustrated the tension between old attitudes and an increasingly commercial world.
Aristotle
Plato and his pupil,
Aristotle, have had an unparalleled effect on the modern world
Aristotle was an
Ancient Greek philosopher. He was educated by
Plato, who in turn was taught by the philosopher and orator
Socrates. Aristotle was
Plato's most important critic, especially on the topic of what a perfect or ideal state might be. In
Politics (c.a. 350 BC) Aristotle examined different examples of a state (
monarchy,
aristocracy,
constitutitonal government;
tyranny,
oligarchy,
democracy) partly as a critique of Plato's book, the
Republic. Whereas Plato had advocated a state run by an educated class of "philosopher-kings", specially trained in
management of the country and based on the common ownership of resources, Aristotle viewed this model as an oligarchical anathema. In
Politics, Book II, Part V, he argued that,
"Property should be in a certain sense common, but, as a general rule, private; for, when everyone has a distinct interest, men will not complain of one another, and they will make more progress, because every one will be attending to his own business... And further, there is the greatest pleasure in doing a kindness or service to friends or guests or companions, which can only be rendered when a man has private property. These advantages are lost by excessive unification of the state."[1]
Though Aristotle certainly advocated there be many things held in common, he argued that not everything could be, simply because of the "wickedness of human nature".
[2] While one sees many disputes as a result of
private property it is easy to imagine the problems being exasperated by a more intensively communal ownership system. "It is clearly better that property should be private," wrote Aristotle, "but the use of it common; and the special business of the legislator is to create in men this benevolent disposition." In
Politics Book I, Aristotle discusses the general nature of households and market exchanges. For him there is a certain "art of acquisition" or "wealth-getting". "Of everything which we possess," writes Aristotle, foreshadowing
Karl Marx's theory of use and exchange value, "there are two uses... a shoe is used to wear, and is used for exchange."
[3] Money itself has the sole purpose of being a medium of exchange, which means on its own "it is worthless... not useful as a means to any of the necessities of life".
[4] Nevertheless, points out Aristotle, because the "instrument" of money is the same many people are obsessed with the simple accumulation of money. "Wealth-getting" for one's household is "necessary and honourable", while exchange on the retail trade for simple accumulation is "justly censured, for it is dishonourable".
[5] Aristotle disapproved highly of
usury and also cast scorn on making money through
monopoly.
[6] In
Nicomachean Ethics (c.a. 350 BC) Aristotle discusses further the use of money as a medium of exchange, and its reflection of the demand for goods and services.
[7]
Chanakya
The
Arthashastra (
Science of political economy) was a
treatise on
statecraft, economic policy and
military strategy written by
Chāṇakya (c. 350-283 BC), who was a professor at
Taxila University and later the prime minister of the
Maurya Empire.
The
Arthashastra argues for an
autocracy managing an efficient and solid economy. It discusses the
ethics of
economics and the duties and obligations of a
king. The scope of
Arthaśāstra is, however, far wider than statecraft, and it offers an outline of the entire legal and
bureaucratic framework for administering a kingdom, with a wealth of descriptive cultural detail on topics such as mineralogy, mining and metals, agriculture, animal husbandry and medicine. The
Arthaśāstra also focuses on issues of
welfare (for instance, redistribution of wealth during a famine) and the collective ethics that hold a society together.
Chanakya says that
artha (sound economies) is the most important quality and discipline required for a
Rajarshi, and that
dharma & kama are both dependent on it. Chanakya writes on the economic duties of a king:
According to Chanakya, a conducive atmosphere is necessary for the state's economy to thrive. This requires that a state's law and order be maintained. Arthashastra specifies fines and punishments to support strict enforcement of laws (the
Dandaniti).
Thomas Aquinas
St
Thomas Aquinas taught that raising prices in response to high demand was a type of theft
Thomas Aquinas (1225-1274) was an Italian theologian and one of the earliest writers on the topic of economic issues. He taught in both
Cologne and
Paris was part of a group of Catholic scholars known as the
Schoolmen who first moved their enquiries beyond theology to philosophical and scientific debates. In his treatise
Summa Theologica Aquinas dealt with the concept of a
just price, which was one necessary for the reproduction of the social order. Bearing many similarities with the modern concept of long run equilibrium a just price was supposed to be one just sufficient to cover the
costs of production, including the maintenance of a worker and his family. He argued it was immoral for sellers to raise their prices simply because buyers were in pressing need for a product.
"If someone would be greatly helped by something belonging to someone else, and the seller not similarly harmed by losing it, the seller must not sell for a higher price: because the usefulness that goes to the buyer comes not from the seller, but from the buyer's needy condition: no one ought to sell something that doesn't belong to him."[8]
Aquinas discusses a number of topics in the format of questions and replies, substantial tracts dealing with Aristotle's theory. Questions 77 and 78 concerned economic issues, mainly relate to what a
just price is, and the
fairness of a seller dispensing faulty goods. Aquinas argued against any form of cheating and recommended compensation always be paid in lieu of good service. Whilst human laws might not impose sanctions for unfair dealing,
divine law did.
John Duns Scotus
One of Aquinas' main critics
[9] was Duns Scotus (1265-1308) in his work
Sententiae (1295). Originally from
Duns, Scotland he taught in Oxford, Cologne and Paris. Duns Scotus thought it possible to be more precise than Thomas in calculating a just price, emphasising the costs of labour and expenses - though he recognised that the latter might be inflated by exaggeration. Because buyer and seller usually have different ideas of what a just price comprises, he thought an agreed price usually contains a ‘gift' element on either side, an early forerunner to the idea of trade being a "win-win" situation. If people did not benefit from a transaction, in Scotus' view, they would not trade. Scotus defended merchants as performing a necessary and useful social role, transporting goods and making them available to the public.
Ibn Khaldun
Statue of Ibn Khaldoun in
Tunis
| When civilization [population] increases, the available labor again increases. In turn, luxury again increases in correspondence with the increasing profit, and the customs and needs of luxury increase. Crafts are created to obtain luxury products. The value realized from them increases, and, as a result, profits are again multiplied in the town. Production there is thriving even more than before. And so it goes with the second and third increase. All the additional labor serves luxury and wealth, in contrast to the original labor that served the necessity of life. [10] |
| Ibn Khaldun on economic growth |
Perhaps the most well known
Muslim scholar who wrote about economics was
Ibn Khaldun of
Tunisia (
1332–
1406).
[11] Ibn Khaldun wrote on economic and political theory in the introduction, or
Muqaddimah (
Prolegomena), of his
History of the World (
Kitab al-Ibar). In the book, he discussed what he called
asabiyyah (
social cohesion), which he sourced as the cause of some civilizations becoming great and others not. Ibn Khaldun felt that many social forces are cyclic, although there can be sudden sharp turns that break the pattern.
[12] His idea about the benifits of the division of labor also relate to
asabiyya, the greater the social cohesian, the more complex the successful division may be, the greater the economic growth. He noted that growth and development positively stimulates both supply and demand, and that the forces of supply and demand are what determines the prices of goods.
[13] He also noted macroeconomic forces of population growth,
human capital development, and technological developments effects on development.
[14] In fact, Ibn Khaldun thought that population growth was directly a function of wealth.
[15]
Although he understood that money served as a standard of value, a medium of exchange, and a preserver of value, he did not realize that the value of gold and silver changed based on the forces of supply and demand.
[16] He also introduced the concept known as the
Khaldun-Laffer Curve (the relationship between tax rates and tax revenue increases as tax rates increase for a while, but then the increases in tax rates begin to cause a decrease in tax revenues as the taxes impose too great a cost to producers in the economy).
Mercantilists and nationalism
A painting of a French seaport from 1638, at the height of mercantilism.
From the
localism of the Middle Ages, the waning
feudal lords, new national economic frameworks began to be strengthened. From
1492 and explorations like
Christopher Columbus' new opportunities for trade with the
New World and Asia were opening. New powerful monarchies wanted a powerful state in order to boost their status. Mercantilism was a political movement and an economic theory that advocated the use of the state's
military power to ensure local markets and supply sources were
protected.
Tariffs could be used to encourage exports (meaning more money comes into the country) and discourage imports (sending wealth abroad). In other words a positive
balance of trade ought to be maintained, with a surplus of exports. The term mercantilism was not in fact coined until the late 1763 by
Victor de Riqueti, marquis de Mirabeau and popularised by
Adam Smith, who vigorously opposed its ideas.
Thomas Mun
An English businessman named Thomas Mun (1571-1641) in his book
England's Treasure by Foraign Trade represents early mercantile policy. Although it was not published until 1663 it was widely circulated as a manuscript before then. He was a member of the
East India Company and also wrote about his experiences there in
A Discourse of Trade from England unto the East Indies (1621). According to Mun, trade was the only way to increase England’s treasure and in pursuit of this end he suggested several courses of action. Important were frugal consumption in order to increase the amount of goods available for export, increased utilisation of land and other domestic natural resources to reduce import requirements, lowering of export duties on goods produced domestically from foreign materials, and the export of goods with inelastic demand because more money could be made from higher prices.
Philipp von Hörnigk
Philipp von Hörnigk (1640-1712, sometimes spelt
Hornick or
Horneck) was born in
Frankfurt am Main and became an Austrian civil servant writing in a time when his country was constantly threatened by
Turkish invasion. In
Österreich Über Alles, Wenn Sie Nur Will (1684,
Austria Over All, If She Only Will) he laid out one of the clearest statements of mercantile policy. He listed nine principle rules of national economy.
"To inspect the country's soil with the greatest care, and not to leave the agricultural possibilities of a single corner or clod of earth unconsidered... All commodities found in a country, which cannot be used in their natural state, should be worked up within the country... Attention should be given to the population, that it may be as large as the country can support... gold and silver once in the country are under no circumstances to be taken out for any purpose... The inhabitants should make every effort to get along with their domestic products... [Foreign commodities] should be obtained not for gold or silver, but in exchange for other domestic wares... and should be imported in unfinished form, and worked up within the country... Opportunities should be sought night and day for selling the country's superfluous goods to these foreigners in manufactured form... No importation should be allowed under any circumstances of which there is a sufficient supply of suitable quality at home."
Nationalism, self-sufficiency and national power were the basic policies proposed.
[17]
Jean Baptiste Colbert
Jean Baptiste Colbert (1619-1683) was Minister of Finance under King
Louis XIV of France. He set up national
guilds to regulate major industries. Silk, linen, tapestry, furniture manufacture and wine were examples of the crafts in which France specialised, all of which came to require membership of a guild to operate in. These remained until the
French revolution. According to Colbert, "It is simply, and solely, the abundance of money within a state [which] makes the difference in its grandeur and power."
British enlightenment
- See also: , , , and
Britain had gone through some of its most troubling times through the 17th century, enduring not only political and religious division in the
English Civil War, King
Charles I's execution and the
Cromwellian dictatorship, but also the
plagues and
fires. The monarchy was restored under
Charles II, who had catholic sympathies, but his successor
King James II was swiftly ousted. Invited in his place were Protestant
William of Orange and
Mary, who assented to the
Bill of Rights 1689 ensuring that the
Parliament was dominant in what became known as the
Glorious revolution. The upheaval had seen a number huge scientific advances, including
Robert Boyle's discovery of the
gas pressure constant (1660) and Sir
Isaac Newton's publication of
Philosophiae Naturalis Principia Mathematica (1687), which described the three laws of motion and his
law of universal gravitation. All these factors spurred the advancement of economic thought. For instance,
Richard Cantillon (1680-1734) consciously imitated Newton's forces of inertia and gravity in the natural world with human reason and market competition in the economic world.
[18] In his
Essay on the Nature of Commerce in General, he argued rational self interest in a system of freely adjusting markets would lead to order and mutually compatible prices. Unlike the mercantilist thinkers however, wealth was found not in trade but in human
labour. The first person to tie these ideas into a political framework was
John Locke.
John Locke
John Locke (1632-1704) was born near Bristol and educated in London and Oxford. He is considered one of the most significant philosophers of his era mainly for his critique of
Thomas Hobbes' defence of absolutism and the development of
social contract theory in
Leviathan (1651). Locke believed that people contracted into society which was bound to protect their rights of property.
[19] He defined property broadly to include people lives and liberties, as well as their wealth. When people combined their labour with their surroundings, then that created property rights. In his words from his
Second Treatise on Civil Government (1689),
"God hath given the world to men in common... Yet every man has a property in his own person. The labour of his body and the work of his hands we may say are properly his. Whatsoever, then, he removes out of the state that nature hath provided and left it in, he hath mixed his labour with, and joined to it something that is his own, and thereby makes it his property."[20]
Locke was arguing that not only should the government cease interference with people's property (or their "lives, liberties and estates") but also that it should positively work to ensure their protection. His views on price and money were laid out in a letter to a
Member of Parliament in 1691 entitled
Some Considerations on the Consequences of the Lowering of Interest and the Raising of the Value of Money (1691). Here Locke argued that the "price of any commodity rises or falls, by the proportion of the number of buyers and sellers," a rule which "holds universally in all things that are to be bought and sold."
[21]
Dudley North
Dudley North argued that the results of Mercantile policy would be undesirable
Dudley North (1641-1691) was a wealthy merchant and landowner. He worked as an official for the
Treasury and was opposed to all mercantile policy. In his
Discourses upon trade (1691), which he published anonymously, he argued that the assumption of needing a favourable trade balance was wrong. Trade, he argued, benefits both sides, it promotes
specialisation, the
division of labour and produces an increase in wealth for everyone. Regulation of trade interfered with these benefits by reducing the flow of wealth.
David Hume
David Hume (1711-1776) agreed with North's philosophy and denounced
mercantile assumptions. His contibutions were set down in
Political Discourses (1752), later consolidated in his
Essays, Moral, Political, Literary (1777). Added to the fact that it was undesirable to strive for a favourable
balance of trade it is, said Hume, in any case impossible. Hume held that any surplus of
exports that might be achieved would be paid for by imports of gold and silver. This would increase the
money supply, causing prices to rise. That in turn would cause a decline in exports until the balance with imports is restored.
The circular flow
Pierre Samuel du Pont de Nemours, a prominent Physiocrat, emigrated to the US and his son founded
DuPont, the world's second biggest chemicals company. In his book
la Physiocratie du Pont advocated low tariffs and free trade
Similarly disenchanted with regulation on trademarks inspired by mercantilism, a Frenchman name
Vincent de Gournay (1712-1759) is reputed to have asked why it was so hard to
laissez faire, laissez passer (free trade, free enterprise). He was one of the early physiocrats, a word from Greek meaning "government of nature", who held that agriculture was the source of wealth. As historian
David B. Danbom wrote, the Physiocrats "damned cities for their artificiality and praised more natural styles of living. They celebrated farmers."
[22] Over the end of the seventeenth and beginning of the eighteenth century big advances in
natural science and
anatomy were being made, including the discovery of
blood circulation through the human body. This concept was mirrored in the physiocrats' economic theory, with the notion of a
circular flow of income throughout the economy.
François Quesnay
François Quesnay (1694-1774) was the court physician to King
Louis XV of France. He believed that trade and industry were not sources of wealth, and instead in his book,
Tableau économique (1758, Economic Table) argued that agricultural surpluses, by flowing through the economy in the form of rent, wages and purchases were the real economic movers. Firstly, said Quesnay, regulation impedes the flow of income throughout all
social classes and therefore economic development. Secondly, taxes on the productive classes, such as
farmers, should be reduced in favour of rises for unproductive classes, such as
landowners, since their luxurious way of life distorts the income flow.
Jacques Turgot
Jacques Turgot (1727-1781) was born in Paris and from an old
Norman family. His best known work,
Réflexions sur la formation et la distribution des richesses (1766,
Reflections on the Formation and Distribution of Wealth) developed Quesnay's theory that
land is the only source of
wealth. Turgot viewed society in terms of three classes: the productive agricultural class, the salaried artisan class (
classe stipendice) and the landowning class (
classe disponible). He argued that only the net product of land should be taxed and advocated the complete freedom of
commerce and
industry. In August of 1774, Turgot was appointed to be Minister of Finance and in the space of two years introduced many anti-mercantile and anti-feudal measures supported by the King. A statement of his guiding principles, given to the King were "no
bankruptcy, no
tax increases, no borrowing." Turgot's ultimate wish was to have a single tax on land and abolish all other indirect taxes, but measures he introduced before that were met with overwhelming opposition from landed interests. Two
edicts in particular, one suppressing
corvées (charges from farmers to aristocrats) and another renouncing privileges given to guilds inflamed influential opinion. He was forced from office in 1776.
The Wealth of Nations
Adam Smith (1723-1790) is popularly seen as the father of modern political economy. His publication of the
An Inquiry Into the Nature and Causes of the Wealth of Nations in 1776 happened to coincide not only with the
American Revolution, shortly before the Europe wide upheavals of the
French Revolution, but also the dawn of a new
industrial revolution that allowed more wealth to be created on a larger scale than ever before. Smith was a Scottish moral philosopher, whose first break was
The Theory of Moral Sentiments (1759). He argued in this that people's ethical systems develop through personal relations with other individuals, that right and wrong are sensed through others' reactions to one's behaviour. This gained Smith more popularity than his next famous work,
The Wealth of Nations, which the general public ignored.
[23] Yet Smith's
political economic magnum opus was successful in circles that mattered.
Context
William Pitt, the
Tory Prime Minister in the late 1780s based his tax proposals on Smith's ideas and advocated
free trade as a devout disciple of
The Wealth of Nations.
[24] Smith was appointed a commissioner of
customs and within twenty years Smith had a following of new generation writers who were intent on building the
science of political economy.
[25] Smith expressed an affinity himself to the opinions of
Edmund Burke, known widely as a political philosopher, a
Member of Parliament.
"Burke is the only man I ever knew who thinks on economic subjects exactly as I do without any previous communication having passed between us".[26]
Burke was an established political economist himself, with his book
Thoughts and Details on Scarcity. He was widely critical of liberal politics, and condemned the
French Revolution which began in
1789. In
Reflections on the Revolution in France (1790) he wrote that the "age of chivalry is dead, that of sophisters, economists and calculators has succeeded, and the glory of Europe is extinguished forever." Smith's contemporary influences included
Francois Quesnay and
Jacques Turgot who he met on a stay in Paris, and David Hume, his Scottish compatriot. The times produced a common need among thinkers to explain social upheavals of the
Industrial revolution taking place, and in the seeming chaos without the feudal and monarchical structures of Europe, show there was order still.
Invisible hand
| "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 self interest. We address ourselves, not to their humanity but to their self-love, and never talk to them of our own necessities but of their advantages."[27] |
| Adam Smith's famous statement on self interest |
Smith argued for a "system of natural liberty"
[28] where individual effort was the producer of social good. Smith believed even the selfish within society were kept under restraint and worked for the good of all when acting in a competitive market. Prices are often unrepresentative of the true value of goods and services. Following
John Locke Smith thought true value of things derived from the amount of labour invested in them.
"Every man is rich or poor according to the degree in which he can afford to enjoy the necessaries, conveniencies, and amusements of human life. But after the division of labour has once thoroughly taken place, it is but a very small part of these with which a man's own labour can supply him. The far greater part of them he must derive from the labour of other people, and he must be rich or poor according to the quantity of that labour which he can command, or which he can afford to purchase. The value of any commodity, therefore, to the person who possesses it, and who means not to use or consume it himself, but to exchange it for other commodities, is equal to the quantity of labour which it enables him to purchase or command. Labour, therefore, is the real measure of the exchangeable value of all commodities. The real price of every thing, what every thing really costs to the man who wants to acquire it, is the toil and trouble of acquiring it."[29]
When the butchers, the brewers and the bakers acted under the restraint of an open market economy, their pursuit of self interest, thought Smith, paradoxically drives the process to correct real life
prices to their just values. His classic statement on competition goes as follows.
"When the quantity of any commodity which is brought to market falls short of the effectual demand, all those who are willing to pay... cannot be supplied with the quantity which they want... Some of them will be willing to give more. A competition will begin among them, and the market price will rise... When the quantity brought to market exceeds the effectual demand, it cannot be all sold to those who are willing to pay the whole value of the rent, wages and profit, which must be paid in order to bring it thither... The market price will sink..."[30]
Smith believed that a market produced what he dubbed the "progress of opulence". This involved a chain of concepts, that the
division of labour is the driver of economic efficiency, yet it is limited to the widening process of markets. Both labour division and market widening requires more intensive
accumulation of capital by the entrepreneurs and leaders of business and industry. The whole system is underpinned by maintaining the security of
property rights.
Limitations
Adam Smith's first title page
Smith's vision of a free market economy, based on secure property, capital accumulation, widening markets and a division of labour contrasted with the mercantilist tendency to attempt to "regulate all evil human actions."
[31] Smith believed there were precisely three legitimate functions of government. These were...
"...erecting and maintaining certain public works and certain public institutions, which it can never be for the interest of any individual or small number of individuals, to erect and maintain... Every system which endeavours... to draw towards a particular species of industry a greater share of the capital of the society than what would naturally go to it... retards, instead of accelerating, the progress of the society toward real wealth and greatness."
In addition to the necessity of public leadership in certain sectors, Smith pointed out two problems which could undermine the market. Firstly, Smith believed that
cartels were bad for their potential to limit production and quality of goods and services.
[32] Secondly, Smith criticised government support of any kind of
monopoly which always charge the highest price "which can be squeezed out of the buyers"
[33] However in both cases, Smith believed it was governments encouragement of such situations that needed to end, rather than the need for active intervention to prevent them. The existence of
monopoly and the potential for
cartels, which would later form the core of
competition law policy, could distort the benefits of free markets to the advantage of businesses at the expense of
consumer sovereignty.
Classical political economy
The
classical economists were referred to as a group for the first time by
Karl Marx.
[34] One unifying part of their theories was the
labour theory of value, contrasting to value deriving from a
general equilibrium of supply and demand.
Jeremy Bentham
Jeremy Bentham (1748-1832) was perhaps the most radical thinker of his time, and developed the concept of
utilitarianism. Bentham was an
atheist, a
prison reformer,
animal rights activist, believer in
universal suffrage,
free speech,
free trade and
health insurance at a time when few dared to argue for any. He was schooled rigorously from an early age, finishing university and being called to the bar at 18. His first book,
Fragment of Government (1776) published anonymously was a trenchant critique of
William Blackstone's
Commentaries of the laws of England. This gained wide success until it was found that the young Bentham, and not a revered Professor had penned it. In
The Principles of Morals and Legislation (1791) Bentham set out his theory of utility.
"Nature has placed mankind under the governance of two sovereign masters, pain and pleasure... On the one hand the standard of right and wrong, on the other the chain of causes and effects, are fastened to their throne... In words a man may pretend to abjure their empire: but in reality he will remain subject to it all the while. The principle of utility recognizes this subjection, and assumes it for the foundation of that system, the object of which is to rear the fabric of felicity by the hands of reason and of law."[35]
The aim of
legal policy must be to decrease misery and suffering so far as possible while producing the greatest happiness for the greatest number.
[36] Bentham even designed a comprehensive methodology for the calculation of aggregate happiness in society that a particular law produced, a
felicific calculus.
[37] Society, argued Bentham, is nothing more than the total of individuals,
[38] so that if one aims to produce net social good then one need only to ensure that more pleasure is experienced across the board than pain, regardless of numbers. For example, a law is proposed to make every bus in the city
wheel chair accessible, but slower moving as a result than its
predecessors because of the
new design. Millions of bus users will therefore experience a small amount of displeasure (or "pain") in increased traffic and journey times, but a minority of people using wheel chairs will experience a huge amount of pleasure at being able to catch public transport, which outweighs the aggregate displeasure of other users. Interpersonal comparisons of utility were allowed by Bentham, the idea that one person's vast pleasure can count more than many others' pain. Much criticism later showed how this could be twisted, for instance, would the
felicific calculus allow a vastly happy dictator to outweigh the dredging misery of his exploited populus? Despite Bentham's methodology there were severe obstacles in measuring people's happiness.
Jean-Baptiste Say
Say's law, that supply always equalled demand was gospel until the 20th century
Jean-Baptiste Say (1767-1832) was a Frenchman, born in
Lyon who helped to popularise Adam Smith's work in France.
[39] His book,
A Treatise on Political Economy (1803) contained a brief passage, which later became orthodoxy in political economics until the
Great Depression and known as
Say's Law of markets. Say argued that there could never be a general deficiency of demand or a general glut of commodities in the whole economy. People produces things, said Say, to fulfill their own wants, rather than those of others. Production is therefore not a question of supply, but an indication of producers demanding goods. Production
is demand, so it is impossible for production to outrun demand, or for there to be a "general glut" of supply. At most, there will be different economic sectors whose demands are not fulfilled. But over time supplies will shift, businesses will retool for different production and the market will correct itself. An example of a "general glut" could be unemployment, in other words, too great a supply of workers, and too few jobs. Say's Law advocates would suggest that this necessarily means there is an excess demand for other products that will correct itself. This remained a foundation of economic theory until the 1930s. Say's Law was first put forward by
James Mill (1773-1836) in English, and was advocated by
David Ricardo,
Henry Thornton[40] and
John Stuart Mill. However one political economist, Thomas Malthus, was unconvinced.
Thomas Malthus
Thomas Malthus (1766-1834) was a
Tory minister in the United Kingdom Parliament who, contrasting to Bentham, believed in strict government abstention from social ills. Malthus devoted the last chapter of his book
Principles of Political Economy (1820) to rebutting Say's law, and argued that the economy could stagnate with a lack of "effectual demand". In other words, wages if less than the total costs of production cannot purchase the total output of industry and that this would cause prices to fall. Price falls cause incentives to invest, and the spiral could continue indefinitely. Malthus is more notorious however for his earlier work,
An Essay on the Principle of Population. This argued that intervention was impossible because of two factors. "Food is necessary to the existence of man," wrote Malthus. "The passion between the sexes is necessary and will remain nearly in its present state," he added, meaning that the "power of the population is infinitely greater than the power in the Earth to produce subsistence for man." Nevertheless growth in population is checked by "misery and vice". Any increase in wages for the masses would cause only a temporary growth in population, which given the constraints in the supply of the Earth's produce would lead to misery, vice and a corresponding readjustment to the original population. However more labour could mean more economic growth, either one of which was able to be produced by an accumulation of capital.
David Ricardo
David Ricardo (1772-1823) was born in London, and by the age of 26 had become a wealthy stock market trader. He bought himself a constituency seat in Ireland to gain a platform in the
House of Commons in the
Parliament of the United Kingdom. Ricardo's best known work is his
Principles of Political Economy and Taxation, which contains his critique of barriers to international trade. The
Corn Laws of the UK had been passed in 1815, setting a fluctuating system of tariffs to stabilise the price of
wheat in the domestic market. Ricardo argued that raising tariffs, despite being intended to benefit the incomes of farmers, would merely produce a rise in the prices of rents that went into the pockets of landowners. Furthermore, extra labour would be employed leading to an increase in the cost of wages across the board, and therefore reducing exports and profits coming from overseas business. Economics for Ricardo was all about the relationship between the three "factors of production" -
land,
labour and
capital. Ricardo demonstrated mathematically that the gains from trade would outweigh the perceived advantages of protectionist policy. The law of
comparative advantage suggests that even if one country is inferior at producing all of its goods than another, it may still benefit from opening its borders since the inflow of good produced more cheaply than at home produces a gain for domestic consumers. Say that in two days in England an average worker produces a bushel of wheat and in one day a
yard of cloth, while the average French worker can do either in just a day. If England swops the wheat it produces (one day's production) for French cloth (while English cloth takes two days) then both sides can strike a bargain between the margin that is mutually beneficial. England by selling its wheat can get its cloth in a day, rather than two days, and France can get an extra bushel of wheat for selling its more efficiently produced cloth. This would lead to a shift in prices so that eventually England would be producing goods in which its comparative advantages were the highest.
John Stuart Mill
Mill, brought up on the philosophy of Jeremy Bentham, wrote the most authoritative economics text of the time
(1806-1873) was the dominant figure of political economic thought of his time, as well as being a
Member of Parliament for the seat of
Westminster, and a leading political philosopher. Mill was a child prodigy, reading Ancient Greek from the age of 3, and being vigorously schooled by his father
James Mill.
Jeremy Bentham was a close mentor and family friend, and Mill was heavily influenced by
David Ricardo. Mill's textbook, first published in 1848 and titled
Principles of Political Economy was essentially a summary of the economic wisdom of the mid nineteenth century.
[41] It was used as the standard texts by most universities well into the beginning of the twentieth century. On the question of
economic growth Mill tried to find a middle ground between Adam Smith's view of ever expanding opportunities for trade and technological innovation and Thomas Malthus' view of the inherent limits of population. In his fourth book Mill set out a number of possible future outcomes, rather than predicting one in particular. The first followed the Malthusian line that population grew quicker than supplies, leading to falling wages and rising profits. The second, per Smith, said if capital accumulated faster than population grew then
real wages would rise. Third, echoing
David Ricardo, should capital accumulate and population increase at the same rat, yet technology stay stable, there would be no change in real wages because supply and demand for labour would be the same. However growing populations would require more land use, increasing food production costs and therefore decreasing profits. The fourth alternative was that technology advanced faster than population and capital stock increased. The result would be a prospering economy. Mill felt the third scenario most likely, and he assumed technology advanced would have to end at some point.
[42] But on the prospect of continuing economic growth, Mill was more ambivalent.
"I confess I am not charmed with the ideal of life held out by those who think that the normal state of human beings is that of struggling to get on; that the trampling, crushing, elbowing, and treading on each other's heels, which form the existing type of social life, are the most desirable lot of human kind, or anything but the disagreeable symptoms of one of the phases of industrial progress.[43]
Mill is also credited with being the first person to speak of supply and demand as a relationship rather than mere quantities of goods on markets,
[44] the concept of
opportunity cost and the rejection of the
wage fund doctrine.
[45]
Capitalism
Just as the term "mercantilism" had been coined and popularised by its critics, like
Adam Smith, so was the term "capitalism" or
Kapitalismus used by its dissidents, primarily
Karl Marx. Karl Marx (1818-1883) was, and in many ways still remains the pre-eminent socialist economist. His combination of political theory represented in the
Communist Manifesto and the dialectic theory of history inspired by
Friedrich Hegel provided a revolutionary critique of
capitalism as he saw it in the nineteenth century. The
socialist movement that he joined had emerged in response to the conditions of people in the new industrial era and the classical economics which accompanied it. A political exile from his native Germany, Marx himself had lived until 1855 in the inner-
London slum of
Soho, before his wife Jenny inherited money enough to move to the north London suburb of
Kentish Town, then still in development. He wrote his magnum opus
Das Kapital at the
British Museum's library.
Context
Movement for reform of the conditions in which working class people lived was present long before Marx, and the notion of Capitalism. For instance,
Saint Thomas More as early as 1516 had used his
satire name
Utopia to criticise the displacement of the peasantry for sheep rearing of the landed gentry.
[46] Charles Dickens in the early nineteenth century was becoming popular for books where he had observed and shamed the nineteenth century business ethic in
Hard Times, the levels of poverty and crime in
Oliver Twist and the institutions of justice in
Bleak House.
Robert Owen (1771-1858) was one industrialist who determined to improve the conditions of his workers. He bought textile mills in
New Lanark,
Scotland where he forbade children under ten to work, set the workday from 6am to 7pm and provided evening schools for children when they finished. Such meagre measures were still substantial improvements and his business remained solvent through higher productivity, though his pay rates were lower than the national average.
[47] He published his vision in
The New View of Society (1816) during the passage of the
Factory Acts, but his attempt from 1824 to begin a new utopian community in
New Haven, Indiana ended in failure. One of Marx's own influences was the French philosopher
Pierre Proudhon, who concluded in his book
What is Property? (1840) that property is
theft. Compared to the classical
Mill, who had written that "partial taxation is a mild form of robbery",
[48] this strain of thought represented important and radical criticism. Marx had been a friend of Proudhon. But when Proudhon made a political economic attack on the classical "iron law of wages", among other things, in his book
The Philosophy of Poverty (1846)
[49] Marx replied with a cynically titled article,
The Poverty of Philosophy.
[50] Legend has it that they never spoke again.
[51] That same year the
Revolutions of 1848 took place and Marx, along with
Friedrich Engels published the
Communist Manifesto, calling for the workers of the world to unite and fear the loss of nothing but their chains. Engels himself was a published radical author. He released a book titled
The Condition of the Working Class in England in 1844[52] describing people's positions as "the most unconcealed pinnacle of social misery in our day." Engels himself was heir to a
Manchester factory, and though he detested the business,
[53] used his profits to help finance Marx's work. After Marx died, it was Engels that completed the second volume of
Das Kapital from Marx's notes.
Das Kapital
The title page of the first edition of
Capital in
German
Karl Marx begins
Das Kapital with the concept of commodities. Before capitalist societies, says Marx, the mode of production was based on
slavery (e.g. in
ancient Rome) before moving to
feudal serfdom (e.g. in
mediaeval Europe). As society has advanced, economic bondage has become looser, but the current nexus of labour exchange has produced an equally erratic and unstable situation allowing the conditions for
revolution. People buy and sell their labour in the same way as people buy and sell goods and services. People themselves are disposable
commodities. As he wrote in the
Communist Manifesto,
"The history of all hitherto existing society is the history of class struggles. Freeman and slave, patrician and plebian, lord and serf, guildmaster and journeyman, in a word, oppressor and oppressed, stood in constant opposition to one another... The modern bourgeois society that has sprouted from the ruins of feudal society has not done away with class antagonisms. It has but established new classes, new conditions of oppression, new forms of struggle in place of the old ones."
And furthermore from the first page of
Das Kapital,
"The wealth of those societies in which the capitalist mode of production prevails, presents itself as “an immense accumulation of commodities,”[54] its unit being a single commodity. Our investigation must therefore begin with the analysis of a commodity.
Marx's use of the word "commodity" is tied into an extensive
metaphysical discussion of the nature of material wealth, how the objects of wealth are perceived and how they can be used. The concept of a commodity contrasts to objects of the natural world. When people mix their labour with an object it becomes a "commodity". In the natural world there are
trees,
diamonds,
iron ore and
people. In the economic world they become
chairs,
rings,
factories and
workers. However, says Marx, commodities have a dual nature, a dual value. He distinguishes the
use value of a thing from its
exchange value, which can be entirely different.
[55] The use value of a thing derives from the amount of labour used to produce it, says Marx, following the classical economists in the
labour theory of value. However, Marx did not believe labour only was the source of use value in things. He believed value can derive too from natural goods and said refined his definition of use value to "
socially necessary labour time" (the time people need to produce things when they are not lazy of inefficient).
[56] Furthermore, people subjectively inflate the value of things, for instance because there's a
commodity fetish for glimmering diamonds,
[57] and oppressive power relations involved in commodity production. These two factors mean exchange values differ greatly. An oppressive power relation, says Marx applying the use/exchange distinction to labour itself, in work-wage bargains derives from the fact that employers pay their workers less in "exchange value" than the workers produce in "use value". The difference makes up the capitalist's
profit, or in Marx's terminology, "
surplus value".
[58] Therefore, says Marx, capitalism is a system of
exploitation.
Marx's work turned the
labour theory of value, as the classicists used it, on its head. His dark irony goes deeper by asking what is the socially necessary labour time for the production of labour (i.e. working people) itself. Marx answers that this is the bare minimum for people to subsist and to reproduce with skills necessary in the economy.
[59] People are therefore
alienated from both the fruits of production and the means to realise their potential, psychologically, by their oppressed position in the labour market. But the tale told alongside exploitation and alienation is one of
capital accumulation and
economic growth. Employers are constantly under pressure from market competition to drive their workers harder, and at the limits invest in labour displacing technology (e.g. an assembly line packer for a robot). This raises profits and expands growth, but for the sole benefit of those who have private property in these
means of production. The working classes meanwhile face progressive immiseration, having had the product of their labour exploited from them, having been alienated from the tools of production. And having been fired from their jobs for machines, they end unemployed. Marx believed that a
reserve army of the unemployed would grow and grow, fuelling a downward pressure on wages as desperate people accept work for less. But this would produce a deficit of
demand as the people's
power to purchase products lagged. There would be a
glut in unsold products, production would be cut back, profits decline until capital accumulation halts in an
economic depression. When the glut clears, the economy again starts to boom before the next cyclical bust begins. With every
boom and bust, with every capitalist crisis, thought Marx, tension and
conflict between the increasingly polarised classes of capitalists and workers heightens. Moreover smaller firms are being gobbled by larger ones in every business cycle, as power is concentrated in the hands of the few and away from the many. Ultimately, led by the
Communist party, Marx envisaged a revolution and the creation of a classless society. How this may work, Marx never suggested. His primary contribution was not in a blue print for how society would be, but a criticism of what he saw it was.
After Marx
The first volume of
Das Kapital was the only one Marx alone published. The second and third volumes were done with the help of
Friedrich Engels and Karl Kautsky, who had become a friend of Engels, saw through the publication of volume four. When the
World War I and then the
Russian Revolution broke out, Kautsky opposed the course of both. He was a member of the
Sozialdemokratische Partei Deutschlands and condemned
Vladimir Lenin's vision for the
Soviet Union. As he wrote in 1934 in
Marxism and Bolshevism: Democracy and Dictatorship,
"The Bolsheviks under Lenin’s leadership, however, succeeded in capturing control of the armed forces in Petrograd and later in Moscow and thus laid the foundation for a new dictatorship in place of the old Tsarist dictatorship."[60]
Marx had begun a tradition of economists who concentrated equally on political affairs. Also in Germany,
Rosa Luxembourg was a member of the SPD, who later turned towards the
Communist Party because of their stance against the
First World War.
Beatrice Webb in England was a socialist, who helped found both the
London School of Economics (LSE) and the
Fabian Society. She was married to
Sidney Webb, who worked as a minister for
Ramsay Macdonald's government. Her political support in Britain was for gradual change through Parliamentary democracy, rather than a Marxian revolution. Yet unlike Kautsky she supported Soviet Russia. Two more English theorists associated with the LSE were
John A. Hobson (1858-1940) and
Richard H. Tawney (1880-1963). Hobson argued for better social legislation, in terms of wider powers for
trade unions,
health and safety standards and a more egalitarian distribution of wealth. Tawney was primarily an economic historian, and was critical of the haphazard method of wealth allocation in the modern world. In his book
The Acquisitive Society (1920) he wrote, "It is foolish to maintain property rights for which no service is performed... for payment without service is waste." In his later book,
Equality (1931) he wrote "the pooling of surplus resources by means of taxation, and the use of the funds thus obtained to make accessible to all, irrespective of their income, occupation or social position, the conditions of civilization".
The new classical assumptions
In the years immediately following Karl Marx's publication of
Das Kapital, a revolution took place in economics. Marx's development of a theory of
exploitation from the
labour theory of value, which had been taken as fundamental by economists since
John Locke coincided with labour theory's abandonment. The new orthodoxy became the theory of
marginal utility. Writing simultaneously and independently, a Frenchman, an Austrian and an Englishman were reviving the idea. Instead of the value of a good or service reflecting the labour that has produced it, it reflects the usefulness (utility) of the last purchase (before the "margin" at which people find things useful no longer). This meant that an equilibrium of people's preferences determined prices, including the price of labour, so there was no question of exploitation. In a competitive economy, said the marginalists, people get what they had paid, or worked for.
Marginal utility
Carl Menger (1840-1921), an
Austrian economist stated the basic principle of marginal utility in
Grundsätze der Volkswirtschaftslehre[61] (1871,
Principles of Economics). Consumers act rationally by seeking to maximise satisfaction of all their preferences. People allocate their spending so that the last unit of a commodity bought creates no more than a last unit bought of something else. Stanley Jevons (1835-1882) was his English counterpart, and worked at
University College, London. He emphasised in the
Theory of Political Economy (1871) that at the margin, the satisfaction of goods and services decreases. An example of the
theory of diminishing returns is that for every orange one eats, the less pleasure one gets from the last orange (until one stops eating). Then
Leon Walras (1934-1910), again working independently, generalised marginal theory across the economy in
Elements of Pure Economics (1874). Small changes in people's preferences, for instance shifting from beef to mushrooms, would lead to a mushroom price rise, and beef price fall. This stimulates producers to shift production, increasing mushrooming investment, which would increase market supply leading to a new lower mushroom price and a new price equilibrium between the products. For many products across the economy the same would go,
if one assumes markets are competitive, people choose on self interest and no cost in shifting production. Early attempts to explain away the periodical crises of which Marx had spoken were not initially as successful. After finding a statistical correlation of
sunspots and business fluctuations and commenting on Mill's assertion of crisis being "the destruction of belief and hope in the minds of merchants and bankers", Stanley Jevons wrote,
"when we know that there is a cause, the variation of the solar activity, which is just of the nature to affect the produce of agriculture, and which does vary in the same period, it becomes almost certain that the two series of phenomena— credit cycles and solar variations—are connected as effect and cause.[62]
Mathematical analysis
Alfred Marshall wrote the main alternative textbook to John Stuart Mill of the day,
Principles of Economics (1882)
Vilfredo Pareto (1848-1923) was an Italian economist, best known for developing the concept of the circumstance under which nobody need be made worse off, and nobody better off through
wealth redistribution. When this situation exists, the economy is said to be "
Pareto efficient". Pareto devised mathematical representations for this optimal resource allocation, which when represented on a graph would yield a curve. Different points along the curve represent different allocations, but each would be optimally efficient. Rather than using the persuasive language of classical economists like Mill, the Pareto efficient curve could be represented with a precise mathematical formula:
.
Alfred Marshall is also credited with an attempt to put economics on a more mathematical footing. He was the first Professor of Economics at the
University of Cambridge and his work,
Principles of Economics[63] coincided with the transition of the subject from "
political economy" to his favoured term, "
economics". He viewed maths as a way to simplify economic reasoning, though had reservations, revealed in a letter to his student
Arthur Cecil Pigou.
"(1) Use mathematics as shorthand language, rather than as an engine of inquiry. (2) Keep to them till you have done. (3) Translate into English. (4) Then illustrate by examples that are important in real life. (5) Burn the mathematics. (6) If you can’t succeed in 4, burn 3. This I do often."[64]
Coming after the marginal revolution, Marshall concentrated on reconciling the classical labour theory of value, which had concentrated on the supply side of the market, with the new marginalist theory that concentrated on the consumer demand side. Marshall's graphical representation is the famous
supply and demand graph, the "Marshallian cross". He insisted it is the intersection of
both supply
and demand that produce an equilibrium of price in a competitive market. Over the long run, argued Marshall, the costs of production and the price of goods and services tend towards the lowest point consistent with continued production.
Collapse and reconstruction
The fallen at
Verdun,
Dulce et decorum est pro patria mori was still working on his last revisions of his
Principles of Economics at the outbreak of the
First World War (1914-1918). The new twentieth century's climate of optimism was soon violently dismembered in the trenches of the Western front, as the civilised world tore itself apart. For four years the production of Britain, Germany, France was geared entirely towards the industry of death in a
war economy. In 1917 Russia crumbled into revolution led by
Vladimir Lenin's Bolshevik party. They carried Marxist theory as their saviour, and promised a broken country "peace, bread and land" by collectivising the means of production. Also in 1917, the
United States of America entered the war on the side of France and Britain, President
Woodrow Wilson carrying the slogan of "making the world safe for democracy". He devised a peace plan of
Fourteen Points. In 1918 Germany launched a spring offensive which failed, and as the allies counter-attacked and more millions were slaughtered, Germany slid into
revolution, its interim government suing for peace on the basis of Wilson's Fourteen Points. Europe lay in ruins, financially, physically, psychologically, and its future with the arrangements of the
Versailles conference in 1919.
John Maynard Keynes was the representative of
Her Majesty's Treasury at the conference and the most vocal critic of its outcome.
John Maynard Keynes
John Maynard Keynes with his American counterpart at the
Bretton Woods conference
John Maynard Keynes (1883-1946) was born in Cambridge, educated at
Eton and supervised by both
A. C. Pigou and
Alfred Marshall at
Cambridge University. He began his career as a lecturer, before working in the British government during the Great War, and rose to be the British government's financial representative at the
Versailles conference. His observations were laid out in his book
The Economic Consequences of the Peace[65] (1919) where he documented his outrage at the collapse of the Americans' adherence to the
Fourteen Points[66] and the mood of vindictiveness that prevailed towards Germany.
[67] Keynes quit from the conference and using extensive economic data provided by the conference records, Keynes argued that if the victors forced
reparations to be paid by the defeated Axis, then a world financial crisis would ensue, leading to a second world war.
[68] Keynes finished his treatise by advocating, first, a reduction in
reparation payments by Germany to a realistically manageable level, increased intra-governmental management of continental coal production and a free trade union through the
League of Nations;
[69] second, an arrangement to set off debt repayments between the Allied countries;
[70] third, complete reform of international currency exchange and an international loan fund;
[71] and fourth, a reconciliation of trade relations with Russia and Eastern Europe.
[72]
The book was an enormous success, and though it was criticised for false predictions by a number of people,
[73] without the changes he advocated, Keynes' dark forecasts matched the world's experience through the
Great Depression which ensued in 1929, and the descent into a new outbreak of war in 1939. World War One had been the "war to end all wars", and the absolute failure of the peace settlement generated an even greater determination to not repeat the same mistakes. With the defeat of
fascism, the
Bretton Woods conference was held to establish a new economic order. Keynes was again to play a leading role.
The General Theory
The title page to Keynes' General Theory
During the Great Depression, Keynes had published his most important work,
The General Theory of Employment, Interest, and Money (1936). The depression had been sparked by the
Wall Street Crash of 1929, leading to massive rises in unemployment in the United States, leading to debts being recalled from European borrowers, and an economic domino effect across the world. Orthodox economics called for a tightening of spending, until business confidence and profit levels could be restored. Keynes by contrast, had argued in
A Tract on Monetary Reform (1923) that a variety of factors determined economic activity, and that it was not enough to wait for the long run market equilibrium to restore itself. As Keynes famously remarked,
"...this long run is a misleading guide to current affairs. In the long run we are all dead. Economists set themselves too easy, too useless a task if in tempestuous seasons they can only tell us that when the storm is long past the ocean is flat again."[74]
On top of the
supply of money, Keynes identified the
propensity to consume, inducement to invest, the marginal efficiency of capital, liquidity preference and the multiplier effect as variables which determine the level of the economy’s output, employment and level of prices. Much of this esoteric terminology was invented by Keynes especially for his
General Theory, though some simple ideas lay behind. Keynes argued that if
savings were being kept away from
investment through
financial markets, total spending falls. Falling spending leads to reduced incomes and unemployment, which reduces savings again. This continues until the desire to save becomes equal to the desire to invest, which means a new “equilibrium” is reached and the spending decline halts. This new “equilibrium” is a depression, where people are investing less, have less to save and less to spend.
Keynes argued that employment depends on total spending, which is composed of consumer spending and business investment in the
private sector. Consumers only spend “passively”, or according to their income fluctuations. Businesses, on the other hand are induced to invest by the expected rate of return on new investments (the benefit) and the rate of interest paid (the cost). So, said Keynes, if business expectations remained the same, and government reduces interest rates (the costs of borrowing), investment would increase, and would have a multiplied effect on total spending.
Interest rates, in turn, depend on the quantity of money and the desire to hold money in bank accounts (as opposed to investing). If not enough money is available to match how much people want to hold, interest rates rise until enough people are put off. So if the quantity of money were increased, while the desire to hold money remained stable, interest rates would fall, leading to increased investment, output and employment. For both these reasons, Keynes therefore advocated low interest rates and easy credit, to combat unemployment.
But Keynes believed in the 1930s, conditions necessitated public sector action. Deficit spending, said Keynes, would kick-start economic activity. This he had advocated in an open letter to
President Franklin Delano Roosevelt in the
New York Times (1933). The
New Deal programme in the US had been well underway by the publication of the
General Theory. It provided conceptual reinforcement for policies already pursued. Keynes also believed in a more egalitarian distribution of income, and taxation on
unearned income arguing that high rates of savings (to which richer folk are prone) are not desirable in a developed economy. Keynes therefore advocated both monetary management and an active fiscal policy.
Keynesian economics
Piero Sraffa
During the Second World War, Keynes acted as advisor to
HM Treasury again, negotiating major loans from the US. He helped formulate the plans for the
International Monetary Fund, the
World Bank and an
International Trade Organisation[75] at the
Bretton Woods conference, a package designed to stablise world economy fluctations that had occurred in the 1920s and create a level trading field across the globe. Keynes passed away little more than a year later, but his ideas had already shaped a new global economic order, and all Western governments followed the Keynsian prescription of deficit spending to avert crises and maintain full employment. One of Keynes' pupils at Cambridge was
Joan Robinson, who contributed to the notion that
competition is seldom perfect in a market, an indictment of the theory of markets setting prices. In
The Production Function and the Theory of Capital (1953) Robinson tackled what she saw to be some of the circularity in orthodox economics. Neoclassicists assert that a competitive market forces producers to minimise the costs of production. Robinson said that costs of production are merely the prices of inputs, like
capital. Capital goods get their value from the final products. And if the price of the final products determines the price of capital, then it is, argued Robinson, utterly circular to say that the price of capital determines the price of the final products. Goods cannot be priced until the costs of inputs are determined. This would not matter if everything in the economy happened instantaneously, but in the real world, price setting takes time - goods are priced before they are sold. Since capital cannot be adequately valued in independently measurable units, how can one show that capital earns a return equal to the contribution to production?
Piero Sraffa came to England from
fascist Italy in the 1920s, and worked with Keynes in Cambridge. In 1960 he published a small book called
Production of Commodities by Means of Commodities, which explained how technological relationships are the basis for production of goods and services. Prices result from wage-profit tradeoffs, collective bargaining, labour and management conflict and the intervention of government planning. Like Robinson, Sraffa was showing how the major force for price setting in the economy was not necessarily market adjustments.
The American way
The
Wall Street Crash of 1929 was the dramatic end of what had been referred to as the "
roaring twenties" in America. Many people, included one economist in particular, Thorstein Veblen, had warned of the tendency for wasteful consumption and the necessity of creating sound financial institutions. Veblen was a leader in a critical strand in American politics, which cautions against the excesses of "
the American way". While these authors spread over a long period, the common theme running through the work is a critique of typically American social, financial and business institutions.
Thorsten Veblen
Thorsten Veblen came from rural Mid-western America and Norwegian immigrant family
Thorsten Veblen (1857-1929) wrote his first and most influential book while he was at the
University of Chicago, on
The Theory of the Leisure Class (1899). In it he criticised
materialistic culture and wealthy people who
conspicuously consumed their riches as a way of demonstrating success.
Conspicuous leisure was another focus of Veblen's critique. In
The Theory of Business Enterprise (1904) Veblen distinguished production for people to use things and production for pure profit, arguing that the former is often hindered because businesses pursue the latter. Output and technological advance is restricted by the creation of monopoly. Businesses protect their existing capital investments, excessive credit, leading to depressions and increasing military expenditure and war through business control of political power. These two books, both focusing on criticism first of
consumerism, second of profiteering held back on advocating something different.
John R. Commons
John R. Commons (1862-1945) also came from mid-Western America. Underlying his ideas, consolidated in
Institutional Economics (1934) was the concept that the economy is a web of relationships between people with diverging interests. There are monopolies, large corporations, labour disputes and fluctuating business cycles. They do however have an interest in resolving these disputes. Government, thought Commons, ought to be the mediator between the conflicting groups. Commons himself devoted much of his time to advisory and mediation work on government boards and industrial commissions.
Adolf Berle
Adolf Augustus Berle, Jr.
Adolf A. Berle (1895-1971) was one of the first authors to combine legal and economic analysis, and his work stands as a founding pillar of thought in modern
corporate governance. Like Keynes, Berle was at the
Paris Peace Conference, 1919, but subsequently resigned from his diplomatic job dissatisfied with the
Versailles Treaty terms. In his book with
Gardiner C. Means,
The Modern Corporation and Private Property (1932), he detailed the evolution in the contemporary economy of big business, and argued that those who controlled big firms should be better held to account.
Directors of companies are held to account to the
shareholders of companies, or not, by the rules found in
company law statutes. This might include rights to elect and fire the management, require for regular general meetings, accounting standards, and so on. In 1930s America, the typical company laws (e.g. in
Delaware) did not clearly mandate such rights. Berle argued that the unaccountable directors of companies were therefore apt to funnel the fruits of enterprise profits into their own pockets, as well as manage in their own interests. The ability to do this was supported by the fact that the majority of shareholders in big
public companies were single individuals, with scant means of communication, in short, divided and conquered. Berle served in President
Franklin Delano Roosevelt's administration through the depression, and was a key member of the so called "
Brain trust" developing many of the
New Deal policies. In 1967, Berle and Means issued a revised edition of their work, in which the preface added a new dimension. It was not only the separation of controllers of companies from the owners as shareholders at stake. They posed the question of what the corporate structure was really meant to achieve.
“Stockholders toil not, neither do they spin, to earn [dividends and share price increases]. They are beneficiaries by position only. Justification for their inheritance... can be founded only upon social grounds... that justification turns on the distribution as well as the existence of wealth. Its force exists only in direct ratio to the number of individuals who hold such wealth. Justification for the stockholder's existence thus depends on increasing distribution within the American population. Ideally the stockholder's position will be impregnable only when every American family has its fragment of that position and of the wealth by which the opportunity to develop individuality becomes fully actualized.”[76]
John Kenneth Galbraith
Cover for The Essential Galbraith (2001)
John Kenneth Galbraith (1908-2006) worked in the
New Deal administration of Franklin Delano Roosevelt. Galbraith remained a leading critic of orthodox economics throughout the late twentieth century. In
The Affluent Society (1958), Galbraith argues that voters reaching a certain material wealth begin to vote against the common good. He coins the term "
conventional wisdom" to refer to the orthodox ideas that underpin the resulting conservative consensus.
[77] In an age of big business, it is unrealistic to think of markets of the classical kind. Big businesses set their own terms in the marketplace, and use their combined resources for
advertising programmes to support demand for their own products. As a result, individual preferences actually reflect the preferences of entrenched corporations, a "dependence effect", and the economy as a whole is geared to irrational goals.
[78] In
The New Industrial State Galbraith argues that economic decisions are planned by a private-bureaucracy, a
)
)
)
)
)
)
)
)
)
)
)
)
)
)
)
)
)
)
)
)
)
)
)
)
)
)
)
)
)
)