The History of Economic Thought
The Mercantilists 1500 – 1780 (Pertaining to trade)
· Were writers in the sixteenth and seventeenth century in Europe.
· They were living at a time when the nations were developing and merchants were increasing in importance because of the huge growth in international trade.
· The best-know Mercantilists were Sir Thomas Mun (1571 – 1641) and Jean Baptiste Colbert (1619 – 1683)
Main ideas
1. It is necessary to have a surplus on the balance of trade to increase the country’s wealth – this surplus would bring more gold & silver into the country
2. To achieve this exports should achieve this in any way possible
3. Goods should be exported at their “highest value added” – through manufacturing of raw materials
4. Imports should be discouraged e.g. – import duties
5. Imports should be purchased at a base level and then “worked up” through manufacturing
6. All exports should be paid for in gold or silver, whereas imports should be traded for other goods.
7. They believed in state intervention to aid the economy - thus a need for a strong political authority in the country
Sir Thomas Mun (1571-1641)
Believed that:
· Gold was the prime measure of a countries wealth.
· Exploitation of colonies.
· Protectionism.
Evaluation of Mercantilism
1. Mercantilists have been criticised for equating the wealth of a country with its stock of gold and silver.
2. Because they argued strongly in favour of self-sufficiency, this led to distrust and rivalry between nations which fuelled later conflicts.
3. Mercantilists did not see that international trade could benefit all countries – they were ignorant of the operation of the principle of comparative advantage.
The Physiocrats 1750 - 1800 (rule of nature)
· Were eighteenth century French writers and economists who believed in the rule of nature.
· The two most famous were Francois Quesnay (1694 – 1774) and Jacques Turgot (1727 – 1781), who wrote Reflections on the Formation and Distribution of Rules.
Main ideas
1. No state intervention except to uphold the natural law and to protect private property – this is known as laissez-faire. They believed Human Laws were imperfect and should be kept at a minimum.
2. Agriculture is the source of all wealth (all wealth derives from the soil), whereas manufacturing only changes the nature of wealth while trade only changes its ownership. Those who were not involved in agriculture were considered to be members of a “sterile” or non-productive class.
3. They advocated free international trade.
Francois Quesnay (1964 – 1774)
· Wrote Economic Table published in 1758, made the first attempt to analyse the interdependence of various sectors of the economy.
· This was a chart that traced the flow of money from one sector of society to another.
· Quesnay, who was a surgeon by profession, compared the movement of resources from one sector of the economy to another to the movement of blood through the human body.
Believed that:
· Wealth had its origin in agriculture.
· Private ownership of property important.
· Non-government intervention (except for laws).
· Free trade.
Evaluation of Physiocrats
1. The Physiocrats provided a firm foundation for later writers who wished to analyse the workings of an economy in greater detail.
2. Most writers since the Physiocrats have accepted the notion of a set of natural laws on which all human actions should be based.
The Classical Economists
· Were mostly English economists in the eighteenth and nineteenth centuries, they were the first real economists in the modern sense of the world.
· They argued in favour of the maximum freedom for the individual and the minimum state intervention in economic affairs – opposed protectionism.
· Their writings coincided with the Industrial Revolution in Britain and the development of capitalism.
Main Ideas
1. Laissez-faire: The government should only intervene in an economy to raise funds to maintain the legal system, to defend the country and to provide infrastructure.
2. The wages fund theory.
Adam Smith (1723 – 1790)
· Born 1723 in Kirkcaldy, Scotland.
· Won a scholarship to Oxford, where he first lectured at Edinburgh University and then the Glasgow University where he was appointed a Professor of Moral Philosophy.
· He studied economics (known then as political economy) as part of philosophy.
· He rejected the Physiocratic view that all wealth had its origin in agriculture, and gave equal importance to manufacturing.
· Published “The Wealth of Nations” in 1776.
Main Ideas
1. The Market Mechanism – Smith explained how perfect competition worked. If each person pursues their own individual interests, they will benefit society in general – free market and competition. He called it the invisible hand.
To earn profits, businessmen must produce what customers want, and the price was a signal to the businessman to produce the goods which the public most wanted. Products in great demand commanded high prices and yielded the most profits. If a good was in short supply its price would rise, and other producers would be attracted into the industry. If a surplus existed, prices fell and some firms left the industry. Supply and demand created the natural price. So Smith favoured free competition and was totally opposed to monopoly.
2. He believed strongly in the Division of Labour as a means by which total production (and therefore wealth) could be increased. By division of labour he meant dividing the process of production into many parts, each done by one man and productivity will increase. Called specialisation.
3. Labour Theory of Value – Smith maintained that labour is the source of all wealth. The value of an item is equal to the amount of labour that goes into producing it.
4. Smith advocated Laissez-faire. Government should not interfere in commerce and trade. The role of the government should be to maintain the legal system, to defend the country and to provide infrastructure.
5. He was an advocate of free international trade – opposed tariffs and quotas. Free trade would make the world better off. He believed that countries, like individuals, should specialise. He developed the idea of absolute advantage; each country produced what it was best at.
6. He laid down “The Canons of Taxation”. While Smith was opposed to government intervention in economic affairs, he did see a limited role for the government in providing a framework and essential services, within which private enterprise could flourish. This framework and essential services should be funded by taxation. Taxation should be based on the following rules or canons:
· Equity – Taxes should take account of people’s ability to pay the tax
· Certainty – People should know what their tax is going to be for the coming year, so they can set money aside during the year.
· Convenience – The method of paying the tax should be suitable to the taxpayer, not to the government.
· Economy – The cost of administrating the tax should be far less that the income generated by the tax.
Evaluation of Smith
1. Smith was writing before the worst effects of the Industrial Revolution. He did not concern himself with social issues arising from laissez-faire, poverty, low wages, long working hours, bad working conditions, exploitation of woman and children etc.
2. He was also naive to assume that individuals pursuing their own advantage will always benefit society as a whole.
3. Despite these faults, Smith’s contribution to the development of the subject cannot be overestimated. He produced the first complete assessment of the workings of an economy, and provided the framework in which subsequent contributions to the subject were made.
Thomas Robert Malthus (1766 – 1834)
· Was educated at St. John’s College, Cambridge, where he studied mathematics and philosophy.
· He became a clergyman in the Anglican Church.
· Subsequently he was made Professor of History and Political Economy at the East India Company College at Haileybury (in England) and is considered to be the first professional economist.
· Malthus is mostly remembered for “Essay on the Principle of Population”, published in 1798.
Main ideas
1. Theory of population – In his essay he argued that while population would grow by geometric progression (1,2,4,8,16,32…….) while food supply would only grow by an arithmetic progression (1,2,3,4,5……), thus leading to food shortages. He stated that this crisis could only be solved by war, famine or disease. He therefore saw that there would have to be a check on the growth of population, he identified two types of population checks:
· Preventative checks are those which lower the birth rate
· Positive checks are those which increase the death rate
He had little or no faith in the working class successfully practising preventative checks. Also being a cleric, he did not believe in artificial methods of contraception. Therefore, he advocated that there was a need for occasional positive checks on the growth of the population. Positive checks include war, disease and famine.
2. Iron Law of Wages – states that if wages rise above the subsistence level (minimum level required for survival), an increase in population results, which again forces wages down to the subsistence level as this would increase the supply of labour. This theory suited employers who felt it justified in paying low wages.
Evaluation of Malthus
1. Malthus’s gloomy forecast concerning population growth and starvation did not prove correct for a number of reasons.
· Improvements in transport and storage meant food became more widely available – less subject to perishability.
· Improvements in food production techniques (e.g. – Farming – higher yielding of crops) meant that output of food could be increased without increasing the land devoted to agriculture.
· As people’s income increased, the birth rate dropped, proving that the subsistence theory of wages is incorrect. As standards of living increase, there is a tendency for average family size to fall rather than rise.
2. Malthus is to be credited with focusing attention on the issue of overpopulation which is still very much a problem in many underdeveloped countries today. His theories are still relevant in those parts of the world where famine is a present threat.
David Ricardo (1772 – 1823)
· Born in London to Jewish parents.
· Ricardo had little formal education, despite this he set himself up as a dealer on the Stock Exchange where he made a fortune.
· At age 42 he retired and spent the remainder of his life studying and writing about economics.
· He became a Member of Parliament (MP) in 1820 but died suddenly in 1823.
· His major work was “Principles of Political Economy and Taxation”, published in 1817, which dominated Classical economics for the next 50 years.
Main ideas
1. He introduced the concept of economic rent. This is any payment to a factor of production above its supply price. If food prices increased fertile land would be more profitable. Landlords could then charge extra rent for fertile land – economic rent. Ricardo was not happy about economic rent on land as landlords benefited, but they spent it on non-productive purposes (e.g. - big houses). Industrialists suffered as they had to pay higher wages due to higher food prices. This transfer of wealth from industrialists to landlords angered Ricardo.
2. Like Malthus, Ricardo accepted the subsistence theory of wages. He therefore argued that the rise in wages above the subsistence level would cause population to increase.
3. He advocated free international trade in a laissez-faire society.
4. He developed the Law of Competitive Advantage to explain how countries could benefit from international trade. A country, even though it may be efficient in the production of two goods, should specialise in the good which it is relatively most efficient in and trade it for its other needs.
Evaluation of Ricardo
1. Like all main economists of his time, he believed that there should be no intervention by the state to restrict free international trade, he opposed tariffs. He developed the Law of Competitive Advantage, which is his main legacy to economics, to show that the benefits of free trade could be spread among all countries engaged in trade. The Law of Competitive Advantage is still used today to show advantages of free trade between nations.
2. Ricardo also developed the theoretical side of the subject, which had a profound influence on the methods adopted by later writers.
Jean Baptists Say (1767 – 1832)
· A French economist.
· Began lecturing economics in 1816, was appointed Professor of Political Economy at the College de France in 1831
· He is remembered for his “Treatise on Political Economy”, published in 1803, which contained what later became known as the Law of Markets or “Say’s Law”.
Say’s Law states that “supply creates its own demand”.
· He believed that people worked to supply the goods which they could produce most efficiently, so that they could then exchange their surplus production for money, which in turn could exchange for goods which they wanted i.e. demanded.
· Thus by creating a supply of goods they created a demand for other people’s goods. Therefore, the supply of goods created a demand for goods.
· As a result, there can never be overproduction of goods – each man’s supply constitutes his demand for other goods and so, the total demand must equal the total supply.
· If at times some income was saved and not spent on the goods of others the end result would still be the same – the accumulative of savings would lead to drop in interest rates and this would lead to a rise in demand for capital goods – the system was self-adjusting.
· Say is also credited with the division of the factors of production – land, labour, capital and enterprise.
John Stewart Mill (1806 – 1873)