Basic Economics
Page 69
The inevitable gropings of pioneers include inevitable ambiguities and errors—and economics was no exception. Some of the errors of the mercantilists, which have been largely expunged from the work of modern economists, still live on in popular beliefs and political rhetoric. However, there is a coherence in the writings of the mercantilists, if we understand their purposes, as well as their conceptions of the world.
The purposes of the mercantilists were not the same as those of modern economists. Mercantilists were concerned with increasing the power of their own respective nations relative to that of other nations. Their goal was not the allocation of scarce resources in a way that would maximize the standard of living of the people at large. Their goal was gaining or maintaining a national competitive advantage in aggregate wealth and power over other nations, so as to be able to prevail in war, if war occurred, or to deter potential enemies by one’s obvious wealth that could be turned to military purposes. A hoard of gold was ideal for their purposes.
In a typical mercantilist writing in 1664, Thomas Mun’s book England’s Treasure by Forraign Trade declared the cardinal rule of economic policy to be “to sell more to strangers yearly than wee consume of theirs in value.” Conversely, the nation must try to produce at home “things which now we fetch from strangers to our great impoverishing.”{984} Mercantilists focused on the relative power of national governments, based on the wealth available to be used by their respective rulers.
Mercantilists were by no means focused on the average standard of living of the population as a whole. Thus the repression of wages by imposing government control was considered by them to be a way of lowering the costs of exports, creating a surplus of exports over imports, which would bring in gold. The promotion of imperialism and even slavery was acceptable to some mercantilists for the same reason. The “nation” to them did not mean a country’s whole population. Thus Sir James Steuart could write in 1767 of “a whole nation fed and provided for gratuitously” by means of slavery.{985} Although slaves were obviously part of the population, they were not considered to be part of the nation.
CLASSICAL ECONOMICS
Adam Smith
Within a decade after Sir James Steuart’s multi-volume mercantilist treatise, Adam Smith’s The Wealth of Nations was published and dealt a historic blow against mercantilist theories and the whole mercantilist conception of the world. Smith conceived of the nation as all the people living in it. Thus you could not enrich a nation by keeping wages down in order to export. “No society can surely be flourishing and happy, of which the far greater part of the members are poor and miserable,” Smith said.{986} He also rejected the notion of economic activity as a zero-sum process, in which one nation loses what another nation gains. To him, all nations could advance at the same time in terms of the prosperity of their respective peoples, even though military power—a major concern of the mercantilists—was of course relative and a zero-sum competition.
In short, the mercantilists were preoccupied with the transfer of wealth, whether by export surpluses, imperialism, or slavery—all of which benefit some at the expense of others. Adam Smith was concerned with the creation of wealth, which is not a zero-sum process. Smith rejected government intervention in the economy to help merchants—the source of the name “mercantilism”—and instead advocated free markets along the lines of the French economists, the Physiocrats, who had coined the term laissez faire. Smith repeatedly excoriated special-interest legislation to help “merchants and manufacturers,” whom he characterized as people whose political activities were designed to deceive and oppress the public.{987} In the context of the times, laissez faire was a doctrine that opposed government favors to business.
The most fundamental difference between Adam Smith and the mercantilists was that Smith did not regard gold as being wealth. The very title of his book—The Wealth of Nations—raised the fundamental question of what wealth consisted of. Smith argued that wealth consisted of the goods and services which determined the standard of living of the people{988}—the whole people, who to Smith constituted the nation. Smith rejected both imperialism and slavery—on economic grounds as well as moral grounds, saying that the “great fleets and armies” necessary for imperialism “acquire nothing which can compensate the expence of maintaining them.”{989} The Wealth of Nations closed by urging Britain to give up dreams of empire.{990} As for slavery, Smith considered it economically inefficient, as well as morally repugnant, and dismissed with contempt the idea that enslaved Africans were inferior to people of European ancestry.{991}
Although Adam Smith is today often regarded as a “conservative” figure, he in fact attacked many of the dominant ideas and interests of his own times. Moreover, the idea of a spontaneously self-equilibrating system—the market economy—first developed by the Physiocrats and later made part of the tradition of classical economics by Adam Smith, represented a radically new departure, not only in analysis of social causation but also in seeing a reduced role for political, intellectual, or other elites as guides or controllers of the masses.
For centuries, landmark intellectual figures from Plato onward had discussed what policies wise leaders might impose for the benefit of society in various ways. But, in the economy, Smith argued that governments were giving “a most unnecessary attention”{992} to things that would work out better if left alone to be sorted out by individuals interacting with one another and making their own mutual accommodations. Government intervention in the economy, which mercantilist Sir James Steuart saw as the role of a wise “statesman,”{993} Smith saw as the notions and actions of “crafty” politicians,{994} who created more problems than they solved.
While The Wealth of Nations was not the first systematic treatise on economics, it became the foundation of a tradition known as classical economics, which built upon Smith’s work over the next century. Not all earlier treatises were mercantilist by any means. Books by Richard Cantillon in the 1730s and by Ferdinando Galiani in 1751, for example, presented sophisticated economic analyses, and François Quesnay’s Tableau Économique in 1758, contained insights that inspired the transient but significant school of economists called the Physiocrats. But, as already noted, these earlier pioneers created no enduring school of leading economists in later generations who based themselves on their work, as Adam Smith did.
Here and there in history there have been a number of individual economists who produced work well in advance of their times, but who attracted little attention and had few followers—and who faded into obscurity until they were rediscovered by later generations of scholars as pioneers in their field. French mathematician Augustin Cournot, for example, produced mathematical analyses of economic principles in 1838 that did not become part of the analytical tools of economists until nearly a century later, when they were developed independently by economists of that later era.
One of the consequences of Adam Smith’s economic theories, developed in opposition to the theories of the mercantilists, was an emphasis on downplaying the role of money in the economy. This emphasis persisted throughout the era of classical economics, which lasted nearly a century. Understandable as this opposition to the mercantilists was, in light of the mercantilists’ over-emphasis on the role of gold, which was money in many economies, the classical economists’ statements that money was only a “veil”—obscuring but not essentially changing the underlying real economic activities—were often misunderstood by those who read them. The leading classical economists understood that contractions in the money supply could create reduced production, and correspondingly increased unemployment, at a given time.{xxxvii} But this was not always clear to their readers, and the classical economists’ own attention was seldom focused in that direction.
David Ricardo
Among the followers of Adam Smith was the great classical economist David Ricardo, the leading economist of the early nineteenth century who, among other things, developed the theory of comparative advantage in international
trade. In addition to his substantive contributions to economic analysis, Ricardo created a new approach and style in writing about economics. Adam Smith’s The Wealth of Nations was full of social commentary and philosophical observations, and closed with a strong suggestion that Britain should not try to hold on to its American colonies that were in rebellion the same year that his treatise was published. By contrast, David Ricardo’s Principles of Political Economy in 1817 was the first of the great classic works in economics to be devoted to analysis of enduring principles of economics, divorced from social, political and philosophical commentary, and emphasizing those principles more so than immediate policy issues.
This is not to say that Ricardo had no interest in social or moral issues. Some of his analysis was inspired by the particular economic problems faced by Britain in the wake of the Napoleonic wars but the principles he derived were not confined to those problems or that era, any more than Newton’s law of gravity was confined to falling apples. Contemporary policy issues were simply not what his Principles of Political Economy was about. What Ricardo brought to economics was a more narrowly focused system of analysis, using more sharply defined terms and more tightly reasoned analysis.
David Ricardo was not simply a reasoning machine, however. In his personal actions and private correspondence, Ricardo showed himself to be a man of very high moral standards and social concerns. When he became a member of Parliament, Ricardo wrote to a friend:
I wish that I may never think the smiles of the great and powerful a sufficient inducement to turn aside from the straight path of honesty and the convictions of my own mind.{995}
As a member of Parliament, Ricardo lived up to his ideals. He voted repeatedly against the interests of wealthy landowners, though he himself was one, and he voted for election reforms which would have cost him his seat in Parliament.{xxxviii}
What we today call “economics” was once called “political economy” up through much of the nineteenth century. When the classical economists referred to “political economy,” they meant the economics of the country as a whole—the polity—as distinguished from the economics of the household, or what might today be called “home economics.” The term “political economy” did not imply an amalgamation of economics and politics, as some have used that term in more recent times.
The principles of economics did not spring forth, ready-made, in a flash of inspiration or genius. Instead, profound and conscientious thinkers in successive generations groped toward some kind of understanding of both the real world of economic activity and the intellectual concepts that would make it possible to study such things systematically. The supply and demand analysis that can be taught to today’s beginning students in a week took at least a century to emerge from the controversies among early nineteenth-century thinkers like David Ricardo, Thomas Malthus, and Jean-Baptiste Say.
In one of many letters between Ricardo and his friend Malthus, discussing economic issues over the years, Ricardo said in 1814: “I sometimes suspect that we do not attach the same meaning to the word demand.” He was right; they did not. {xxxix} It would be decades after both men had passed from the scene before the term could be clarified and defined precisely enough to mean what it means to economists today. What may seem like small steps in logic, after the fact, can be a long, time-consuming process of trial and error groping, while creating and refining concepts and definitions to express ideas in clear and unmistakable terms which allow substantive issues to be debated in terms that opposing parties can agree on, so that they can at least disagree on substance, rather than be frustrated by semantics.
Say’s Law
One of the fundamental concepts of economics, over which controversies raged in the early nineteenth century and were re-ignited by John Maynard Keynes in 1936, was what has been called Say’s Law. Named for French economist Jean-Baptiste Say (1767–1832), though other economists had a role in its development, Say’s Law began as a relatively simple principle whose corollaries and extensions grew ever more complex in the hands of both its advocates and its critics, during the controversies between the two in both the nineteenth and twentieth centuries.
At its most basic, Say’s Law was an answer to perennial popular fears that the growing output of an economy could reach the point where it would exceed the ability of the people to buy it, leading to unsold goods and unemployed workers. Such fears were expressed, not only before the time of Jean-Baptiste Say, but also long afterward. As we have seen in Chapter 16, a best-selling writer of the 1960s warned of “a threatened overabundance of the staples and amenities and frills of life” which have become “a major national problem.”{996} What Say’s Law, in its most basic sense, argued was that the production of output, and the generation of real income for those producing that output, were not processes independent of each other. Therefore, whether a nation’s output was large or small, the incomes generated in producing it would be sufficient to buy it. Say’s Law has often been expressed as the proposition that “supply creates its own demand.” In other words, there is no inherent limit to how much output an economy can produce and purchase.
Say himself asked: “Otherwise, how could it be possible that there should now be bought and sold in France five or six times as many commodities, as in the miserable reign of Charles VI?”{997} A similar idea had been expressed even earlier by one of the Physiocrats, that aggregate demand “has no known limits.”{998} This, of course, did not preclude the possibility that, as of any given time, consumers or investors might not choose to exercise all the aggregate demand that was in their power. What Say’s Law did preclude was the recurrent popular fear that the sheer rapid growth of output, with the rise of modern industry, would reach a point where output would become so great that it would be impossible to buy it all.
As often happens in the history of ideas, an initially very straightforward concept became extended in so many directions by its advocates, and embroiled in so many controversies by its opponents, that meanings and distortions proliferated, even when the economists on both sides—which included virtually all the leading economists of the early nineteenth century—were earnest and intelligent thinkers who simply talked past each other. That was, in part, because economics had not yet reached the stage where the terms in which they spoke (“demand,” for example) had rigorous definitions agreed to by all. {xl} However tedious the students of a later time might find the process of rigorous definition, the history of economics—and of other fields—makes painfully clear the confusing consequences of trying to discuss substantive issues without having clear-cut terms that mean the same thing to all those who use those terms.
MODERN ECONOMICS
Today we think of economics as a profession with academic departments, scholarly journals, and professional organizations like the American Economic Association. But these are relatively late developments, as history is measured.
It was centuries before economics became a separate subject, even though philosophers from Aristotle to David Hume wrote knowledgeably about economic matters, as did theologians like Thomas Aquinas and members of the nobility like Sir James Steuart. But, even after some writers began to specialize in economics, they did not immediately begin to earn their livings as economists. Adam Smith, for example, was a professor of philosophy, and achieved renown for his book Theory of Moral Sentiments nearly twenty years before achieving lasting fame for The Wealth of Nations. David Ricardo was an independently wealthy retired stockbroker when his writings made him the leading economist of his times. When Thomas R. Malthus was appointed a professor of history and political economy in 1805, he became the first academic economist in Britain and probably in the world. Britain at that point produced most of the leading economists in the world, and would continue to do so for the remainder of the nineteenth century.
Aside from Malthus, most of the leading British economists of the first half of the nineteenth century did not derive a major part of their income from teaching or writing about e
conomics. Economics was a specialty but not yet a career. Nor was it yet enough of a specialty to have its own professional journals. Most leading analytical articles on economics during the first half of the nineteenth century were published in the intellectual periodicals of that era, such as the Edinburgh Review, the Quarterly Review or the Westminster Review in Britain or the Revue Encyclopédique or the Annales de Législation et d’Économie Politique in France. The first scholarly journal devoted exclusively to economics was the Quarterly Journal of Economics, first published at Harvard in 1886. Many more such journals were then created in many countries in the twentieth century. Those who wrote for these journals were overwhelmingly academic economists, with Americans now joining British, Austrian and other economists among the leaders of the profession. The first professor of economics in the United States was appointed by Harvard in 1871 and the first Ph.D. in economics was awarded by the same institution four years later.{999}
From the time of Alfred Marshall’s Principles of Economics in 1890 onward, economics began increasingly to be expressed to the profession and taught to students with graphs and equations, though purely verbal presentations have not completely died out even today. It was in the second half of the twentieth century that mathematical analyses in economics began to supersede wholly verbal analyses in the leading academic journals and scholarly books. While predominantly mathematical economic analysis can be found as far back as Augustin Cournot in the 1830s, Cournot was one of those pioneers whose work made no impact on the dominant economists of his time, so that much of what he said had to be rediscovered, generations later, as if Cournot had never existed.