Preparatory Notes on HOFT
Dhrubajyoti Chakraborty
Jul, 2021
Contents
3
1 References
3
2 Mercantilism and Physiocrats
2.1 Questions . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
2.2 Notes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
2.2.1 Bullionism [SZ-1.2.1] . . . . . . . . . . . . . . . . . . .
2.2.2 Mercantilists’ Commercial Theory and Policy [SZ-1.2.2]
2.2.3 Demographic Theories and Policies [SZ-1.2.3] . . . . .
2.2.4 Theories of Value [SZ-1.2.6] . . . . . . . . . . . . . . .
2.2.5 The premise of a theoretical revolution [SZ-1.3.1] . . .
2.2.6 William Petty and ‘political arithmetick’ [SZ-1.3.2] . .
2.2.7 Locke, North, Mandeville [SZ-1.3.3] . . . . . . . . . . .
2.2.8 Protestantism and the Individualist Ethic . . . . . . .
2.2.9 Economic Policies of Individualism . . . . . . . . . . .
2.2.10 Questions posed by the physiocratic school . . . . . . .
2.2.11 Quesnay’s Economic Ideas . . . . . . . . . . . . . . . .
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3 Adam Smith
3.1 Questions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
3.1.1 The preconditions of the Industrial Revolution [SZ-2.1.1] .
3.1.2 The ‘mechanical clock’ and the ‘invisible hand’ [S.Z.-2.2.1]
3.1.3 Accumulation and Distribution of Income [SZ-2.2.2] . . . .
3.1.4 Value [SZ-2.2.3] . . . . . . . . . . . . . . . . . . . . . . . .
3.1.5 Adam Smith Problem [MB-60] . . . . . . . . . . . . . . . .
3.1.6 Market and competition [SZ-2.2.4] . . . . . . . . . . . . . .
3.1.7 Smith’s Three Souls [SZ-2.2.5] . . . . . . . . . . . . . . . .
3.1.8 Smith as an Institutionalist [SZ-2.2.6] . . . . . . . . . . . .
3.1.9 Smith’s Theory of Economic Welfare [KL-81] . . . . . . . .
3.1.10 The Smithian Orthodoxy: An era of Optimisim [SZ-2.3.1] .
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3.1.11 The Smithian Orthodoxy: Bentham and Utilitarianism [SZ-2.3.2]
3.1.12 The Smithian Orthodoxy: The Smithian economists and Say [SZ2.3.3] . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
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4 Ricardo
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4.1 Questions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
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4.2 Notes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
38
4.2.1 Thirty years of crisis [SZ-3.1.1] . . . . . . . . . . . . . . . . . . . .
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4.2.2 The Corn Laws [SZ-3.1.2] . . . . . . . . . . . . . . . . . . . . . .
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4.2.3 The Theory of Rent [SZ-3.1.3] . . . . . . . . . . . . . . . . . . . .
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4.2.4 Profits and Wages . . . . . . . . . . . . . . . . . . . . . . . . . . .
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4.2.5 Profits and Overproduction . . . . . . . . . . . . . . . . . . . . .
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4.2.6 Discussions on Value [SZ-3.1.6] . . . . . . . . . . . . . . . . . . .
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4.2.7 The Ricardians, Ricardianism, and the classical tradition [SZ-3.2.1] 48
4.2.8 The anti-Ricardian reaction [SZ-3.2.2] . . . . . . . . . . . . . . . .
48
2
1
References
• Screpanti, Zamagni- Sec: 1.2.1, 1.2.2, 1.2.3, 1.2.6, 1.3.1, 1.3.2, 1.3.3, 2.1.1, 2.1.2,
2.2, 2.3, 3.1, 3.2.1, 3.2.2, 4.3.1, 4.3.2, 4.3.3, 4.3.4, 4.3.5, 4.3.6, 5.1, 5.3, 6.2, 6.5.1,
6.5.2, 7.1, 7.2, 7.3
• Kunt, Lautsenheizer: Ch: 1, 2, 3, 4, 5, 9, 10, 11, 13, 15
2
Mercantilism and Physiocrats
2.1
Questions
1. Discuss the main political economic questions posed by the physiocratic school.
[2019]
2. What was the method suggested in Petty’s Political Arithmetick? Can we look at
it as the origin of development of demography? What were the reasons of making
a shift in the thought of these thinkers in post-mercantilist era? [2018]
3. When was mercantilist theoretical position becoming increasingly inadequate in
respect to economic reality, give three instances how were physiocrats building up
such explanations? [2017]
4. When the mercantilists a school of thought? [2016]
2.2
2.2.1
Notes
Bullionism [SZ-1.2.1]
• Bullionism was characterized by the conviction that money, or gold, was wealth.
• Although the conviction cannot be challenged, but the mistake, according to Adam
Smith, was the belief that it was the only form of wealth.
• There was a widespread opinion that treasure was the only type of wealth worth
accumulating.
• This idea accorded well with the merchant’s point of view for whom money was the
only form of capital capable of increasing in value.
• Therefore, money was thought of as a means of increasing wealth and power.
• However, the Bullionists did not admit the idea that this means should be used to
increase the welfare of people, the wealth of nations, as Smith proposed.
• The real mistake made by these economists was in the methods they suggested
for achieving this objective of increasing wealth and power. This was the main
distinguishing feature of these economists with the mercantilists of the following
century:
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- A wide circulation of money within the national borders was considered to
guarantee an extensive tax base, and hence higher revenues
- Therefore, the outflow of precious metals had to be prevented
- The simplest way to prevent precious metals flowing out of the nation was to
prohibit the export of gold and silver.
- Another measure often adopted was that of raising the purchasing power of
foreign currencies by law so as to induce an inflow of money from abroad.
- Attempts were also made to force national companies to pay for their imports
with goods rather than money.
• Another Bullionist mistake was the tendency to seek the causes of a systematic outflow of precious metals solely in monetary factors, namely in deviations of exchange
rates from the parity determined by the metallic content:
- Such deviations were attributed to illegal behavior, forgery and manipulations
by bankers and merchants.
- However, the Crown also, often willingly resorted to illegal monetary techniques such as 1. ‘clipping’, i.e., reducing the metallic content of the currency
in relation to face values, or 2. ‘raising’, i.e., increasing the official value of a
currency in relation to its metallic content by means of a proclamation.
• Investigations led to the formulation of Gresham’s law: bad money drives out
good money.
- If in a country, two types of currency circulate which have the same nominal
value but different intrinsic value (because one of the two has a lower content
of precious metal, because it is a forgery), then the public will tend to use the
bad money for internal payments. The good money will be hoarded, melted
down or used for international payments and therefore will disappear from
circulation.
2.2.2
Mercantilists’ Commercial Theory and Policy [SZ-1.2.2]
1. Gerald de Malynes: the basic causes of disequilibrium in the balance of trade lies
in the alterations in exchange rate.
• An exchange rate which is higher than the metal parity leads to the outflow
of precious metals, which diminishes the amount of money under circulation
in the country under consideration.
• This reduces prices and worsens the terms of trade. Consequently, trade deficit
increases.
• There are two interesting aspects in this line of thinking: the use of the Quantity Theory of Money and the implicit hypothesis of the low price elasticity of
imports and exports.
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2. Edward Misselden: It is the surplus or deficit on the balance of trade that makes the
rate of exchange vary, and not the other way round. Rather than worrying about
the exchange rates, the State should encourage exports and discourage imports.
3. Thomas Mun: Unlike emphasizing particular trade balances of one country with
other, what really mattered was the overall balance of trade. The inflow and outflow
of gold depends on the general balance of trade, and the State should pay direct
attention to this. Thus it was permissible to maintain commercial deficit with
some countries, such as those from which raw materials were imported, if this was
conducive to the increase of the national production of industrial goods.
4. From the point of view of birth of political economy, the identification of the interest
of one particular social class, the merchant class, with those of the collective was
very important.
• Economics ceased to be domestic and became political.
• The profits of the merchant class, profits upon alienation, were obtained as an
excess of the value of sales over purchases. This gap gave rise to accumulation
of money.
• The entire nation was considered as a great commercial company.
• Its net inflow of gold corresponded to the excess of its foreign sales over and
above its foreign purchases.
• As with the merchants, the nation would have to avoid keeping its stock of
money idle.
• It had to reinvest the money in the form of stock, in order to buy (import) the
goods necessary to produce new goods; with these it would be able to increase
sales (export) and profits (trade surplus).
• Only the excess of sales over purchases was seen as the source of profit, for
collectivity as well as for individuals.
5. The theory of economic policy that originated from this doctrine was simple:
• Commercial policy had to be protectionist.
• Export duties had to be abolished and import duties had to be raised.
• Moreover, exports had to be encouraged through incentives and imports hindered as far as possible and even forbidden in certain cases.
• However, certain very important exceptions were made: the import of raw materials, which were useful to the national industries, was not to be obstructed,
while the export of important raw materials should be forbidden.
• Mercantilist commercial policy favoured national shipping.
• This cultural attitude influenced colonial expansion policies, in relation to the
demand for the home country’s products and for the supply of low-cost raw
materials that were expected to come from colonies.
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• Policy of conceding privileges and monopoly rights to the great national commercial companies.
• The mercantilist industrial policy aimed at encouraging productive activity
within the national territories by the granting monopolistic privileges, State
subsidies and tax exemptions to national enterprises, as well as by importation of advanced technology, acquisition of manufacturing secrets, and the
encouragement of the immigration of skilled workers.
2.2.3
Demographic Theories and Policies [SZ-1.2.3]
1. Mercantilist theories and policies were also worked out in regard to demography.
2. The problem was how to ensure an abundant labour supply to satisfy the expansion
needs of emerging industries. The policy aimed at increasing population.
3. This obsession with demographic growth can be explained only partially by the
continual demand for soldiers in a period of permanent warfare.
4. The mercantilists had a peculiar wage theory according to which maximum labour
supply occurs at subsistence wage level. If the wage increases above this level,
labour supply would decrease rather than increasing.
5. One justification of this idea was given in terms of ‘morals’:
• Workers were depraved people, attracted by vices and excesses in eating and
drinking
• If they were paid more than subsistence wages, this would encourage depravity
and laziness and thus reduce labour supply.
6. A less ideological explanation was based on an understanding of the working conditions in the emerging industries and the difference in living conditions between
the countryside and the towns.
• Only a problem of physical survival would induce the workers to accept working
13-14 hours per day. In such a situation, an increase in wages could cause an
increase in the demand for leisure.
• This is the first cause of the peculiar shape of the labour supply curve forwarded by the mercantilist economic ideas.
• The rural-urban migration was of a push type (caused, for example, by the
enclosures movement) rather than being a pull type, since living conditions in
the towns were worse than that in the countryside.
• Thus, a slight increase in the industrial wages would not encourage any significant increase in the industrial labour supply.
• This factor accounted for the low elasticity of labour supply.
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2.2.4
Theories of Value [SZ-1.2.6]
1. During the early seventeenth century mercantilists had a common view towards the
theory of value, and that was directed to utility. But towards the end of the century
Petty, Locke found their soluton to the problem in the cost of productions.
2. Mercantilists looked mainly to exchange as the real source of wealth and profit.
3. Merchants earned profits not because they controlled the productive processes (a
control which, at least in the first phase of industrial development, was in the hands
of the craftsmen) but rather because of the power they exercised on the market.
4. The merchant’s profit originated from the difference between the selling and the
buying prices of goods.
5. Thus, merchants believed that the profits originated from the trading process.
6. Thus, a knowledge of the determinants of market prices was considered to be crucial
in order to understand the origin and the growth of profits.
7. In 1588 Bernardo Davanzati argued that the value of goods depends on their utility
and rarity. This theory was taken up again in 1680 by Geminiano Montanari,
(a disciple of Galileo), who argued that ‘it is the desires of men which measure
the value of things’, so that the prices of goods will vary, ultimately, according to
changes in tastes. He also made an interesting attempt to establish the ‘law of the
levelling of price’ of a good in different markets.
8. A few years later, Nicholas Barbon summarized mercantilist thought on the subject
of value in the following way• The natural value of goods is simply represented by their market price.
• The forces of supply and demand determine price.
• The use value is the main factor on which the price depends. The conditions
of supply play a role only in the sense that, given the demand, the price tends
to rise when the supply is insufficient and vice versa.
2.2.5
The premise of a theoretical revolution [SZ-1.3.1]
This discussion also answers question 3. With continuing capitalist accumulation, some
important changes rendered the mercantilist theoretical position increasingly inadequate
in respect to the economic reality.
1. Monopolistic positions of great companies were not preserved, the diffusion of trade
and competition tended to reduce the price differentials among regions and nations,
causing a reduction in commercial profit margins.
2. The fall in profits led to an increase in capitalist control over the production process.
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3. In many of the old guilds, the master craftsmen had already begun to transform into
organizers and controllers of the production process, with that a capitalist class
originated whose interests were in conflict with those of the merchant manufacturers.
4. A radical shift towards rethinking the traditional way of conceiving economic facts
was evident.
• Paternalistic State intervention in the economy came to be viewed with scepticism.
• Prices and profits, rather than demand forces, were thought to represent the
conditions of production. The notion that profit originated in the production
domain began to gain traction.
5. The new philosophy of individualism, together with developments in the Protestant
ethic, contributed as the bases on which the greats ideological edifice of classical
liberalism was to be constructed.
6. Towards the end of the seventeenth century and the beginning of the eighteenth,
adverse effects of administrative restrictions on economic activity initiated major
concerns. This, prompted to limit active state action, accompanied by recognition
and protection of property rights and connected function of enforcing contractual
agreements.
2.2.6
William Petty and ‘political arithmetick’ [SZ-1.3.2]
1. William Petty was one of many economists of his time, completely aware of methodological problems raised in making economic thought to a real science, still avoided
speculative reasoning and aspired empiricist base for economics.
2. The method in ‘political arithmetick’ was hinged on empirical facts. Qualitative
arguments ceased to be sufficient and method based on inductive reasoning from
quantitative evidence, viz., ‘numbers, weights and measure’, drew interest.
3. Petty intended to give to the new science— a science which, in the work of Petty
himself and his followers, often became confused with statistics, national accounting,
and demography. This methodological position has never prevailed in economics
(except perhaps in statistical economic research, which has always accompanied
but never conditioned the evolution of economic thought) until the foundation of
econometrics.
4. One method which did prevailed was proposed by North in ‘Discourse and Trade’
(1691).
• This method was based on deduction rather than induction.
• He believed the foundations of economics on self-evident truth.
• North’s Metodology - Starting from indisputable principles, it would be possible, simply by means of the rigorous use of logic, to deduce conclusions that
would be as clear and evident as the premisses.
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This habit has become almost a vice for a great deal of contemporary economic
theory.
5. Petty’s explanation of Value• He completely abandoned the subjective theory of value.
• He introduced the concept of natural valueThe prices of commodities would tend to adjust to the natural value by means
of small oscillations.
• Labour Theory of Valuei. He considered determinants of this natural value to be the cost of production. He maintained that these costs could be reduced to those of the
utilization of land and labour, but later he showed a preference for a calculation of value based exclusively on embodied labour. Later he abandoned
this attempt based on minimal contribution of land in respect to labour.
ii. The search for a unit of measure to translate the value of land into labour
is interesting, because in the process Petty managed to define the natural
price of labour. In fact, that unit of measurement consisted of the average
daily amount of food necessary to sustain a worker. The wage goods used
in this calculation must be those produced in the best conditions.
iii. Instead of answering why wages tended to adjust to the subsistence level,
he gave only the usual mercantilist justification of why wages must be
fixed at this level: because the labour supply would vary inversely to its
price, if its price were above the subsistence level.
6. Petty’s anticipation of classical theories• His perception on role played by labour in capital accumulation and relationship between existing division of labour and market size.
• His idea of surplus, which can be measured as calculated by subtracting from
the value of the product obtained from a given piece of land both the yield
which would have been obtained from it without the application of labour and
the wages paid to the employed workers. The way he defined surplus should
have been the product of labour but turned out to be rent.
• The formation of rents in explained in terms of differential returns.
7. Petty’s contribution in public finance ‘A Treatise of Taxes and Contributions’ includes more than a theory on cannons
of taxation: clarity and certainty, economy in collection, ease in payment, and
proportionality. The last criteria was justified as necessity of avoiding the use of
taxation to modify the distribution of income.
Petty was followed by a handful of his followers. Their applied research was impressive, amomg others the result of ‘King’s Law’ attracts mention.
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2.2.7
Locke, North, Mandeville [SZ-1.3.3]
John Locke and Dudley North, without being Petty’s direct followers, were certainly
influenced by him.
i. Locke’s Contributions• He attempted to justify private property by making use of the albour theory
of values.
Locke’s basic idea was that individual liberty implied the right to control one’s
own labour.
This would lead to the right to own the product of one’s own labour; moreover,
as land becomes productive and acquires value only with the application of
labour, the private ownership of land would also be justified.
• The natural right to control one’s own labour was independent of any institutional structure of a society. Same was true for land-ownership.
• Locke considered, in primitive societies and in economies with scarce land, men
being equal (their natural gifts of working ability not being fundamentally unevenly distributed) ownership of wealth, land in particular weren’t distributed
unevenly.
• The reason for the inequality which really existed in modern economies was
to be found in the ability of money to preserve value.
• Money on the one hand fuels the thirst for wealth and, on the other, allows
an indefinite accumulation of wealth. Therefore it would lead to an unequal
distribution of land if this is scarce.
• Money derives its value from social conventions, and is capable of preserving
value as long as people are willing to accept it as a means of payment. Thus it is
the society that legitimises an economic situation in which wealth is distributed
unequally.
• Locke didn’t believe that an unequal distribution of wealth makes private
property any less legitimate.
• Locke believed that the interests of the nation were different from the sum
of private interests, with all the consequences that this entailed for economic
policy; especially trade policy, on which his thought did not diverge greatly
from the traditional mercantilist position.
The decisive step in the direction of free trade was made by North and Mandeville.
ii. North• ‘The public is a beast’—North stated in his Discourse, reveals his disenchanted
view on human nature.
• He refused to base politics and economics on any elevated moral philosophy.
• The starting point, according to North, was the exorbitant appetites of individuals.
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• The ‘public’ is nothing more than the sum of private citizens; and the science
dealing with wealth and public welfare must begin with the appetites which
individuals try to satisfy.
• Harmony of interests is derived solely from the fact that nobody is able to look
after the interests of an individual better than the individual himself, so that
if the individuals are left free, they will prosper.
• Any measure that interferes with the individual’s attempts to pursue private
goals hinders the achievements of the public interest.
Policy Recommendations:
i. If collective interest depends on private interest and the individuals are
the best judges of their own interests, then the State should acknowledge
this.
ii. The best policy is no policy, no laws to regulate trade, none to regulate
the interest rate, nor to control the money supply.
Contributions in Monetary Theory:
(a) North reaffirmed the theory already proposed by Petty and Locke, according
to which the ‘just’ level for the rate of interest is simply that to which the
forces of the supply and demand for money ‘naturally’ lead it.
(b) As a result all the ‘usury’ problems that had contaminated mercantilist theory
for so long were simply swept away.
(c) In regard to the rate of interest, the monetary authorities had nothing to do
but stand back and watch.
(d) there is a theory of the money supply according to which the money supply
can never be inadequate for the needs of trade.
(e) The adjustment occurs through a process of hoarding (or melting down coins)
when the supply exceeds the demand and dis-hoarding (or reconverting the
bullion into coins) in the opposite case.
(f) North was also against sumptuary laws which, according to him, only hindered
the individual in the pursuit of his own objectives and thus discouraged any
private initiative.
iii. Mandeville(a) He not only insisted that the public welfare is fostered by leaving the individual completely free to satisfy his own ‘vices’—for example, by giving vent
to economic greed—but also considered some of the most acclaimed economic
and social virtues, such as savings, as socially less useful than their opposites.
(b) Ostentatious spending, for example, created more jobs than parsimony—an
argument for which Mandeville was fairly esteemed by Keynes.
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2.2.8
Protestantism and the Individualist Ethic
One of the most important examples of the individualist and middle-class philosophy
was the Protestant theology that emerged from the Reformation. The new middle-class
capitalists wanted to be free not only from economic restrictions that encumbered manufacturing and commerce, but also from the moral opprobrium that the Catholic Church
had heaped on their motives and activities. Protestantism not only freed them from religious condemnation, but eventually made virtues of the selfish, egoistic, and acquisitive
motives the medieval church had so despised. The principal originators of the Protestant
movement were quite close to the Catholic position on questions like usury and the just
price. On most social issues they were deeply conservative. Yet, despite the conservatism of the founders of Protestantism, this religious outlook contributed to the growing
influence of the new individualist philosophy.
1. The basic tenet of Protestantism, which laid the groundwork for religious attitudes
that were to sanction middle-class business practices, was the doctrine that men
were justified by faith rather than by works.
2. The Protestant doctrine of justification by faith asserted that motives were more
important than specific acts or rituals. Faith was ”nothing else but the truth of
the heart.” Each man had to search himself to discover if his acts stemmed from a
pure heart and faith in God; each man had to judge for himself. This individualist
reliance on each person’s private conscience appealed strongly to the new middleclass artisans and small merchants.
It was through this insistence on the individual’s own interpretation of God’s will that
the ”Puritans tried to spiritualize [the new] economic processes” and eventually came to
believe that ”God instituted the market and exchange. The new dogma that the protestants expected everyone to accept stressed the necessity of doing well at one’s earthly
calling as the best way to please God, and emphasized diligence and hard work. Within
the context of the new religious individualism, the capitalists found a religion in which,
over time, “profits ... [came to be] looked upon as willed by God, as a mark of his favor
and a proof of success in one’s calling.”
2.2.9
Economic Policies of Individualism
• Throughout the mercantilist period, this new individualism led to innumerable
protests against the subordination of economic affairs to the will of the state. From
the middle of the seventeenth century, almost all mercantilist writers condemned
state-granted monopolies and other forms of protection and favoritism in the internal economy (as opposed to international commerce).
• Many believed that in a competitive market that pitted buyer against buyer, seller
against seller, and buyer against seller, society would benefit most greatly if the
price was left free to fluctuate and find its proper (market-equilibrating) level.
• This belief-that restrictions on production and trade within a nation were harmful
to the interests of everyone concerned-became increasingly widespread in the late
seventeenth and early eighteenth centuries.
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• Many capitalists had struggled throughout the mercantilist period to free themselves from all restrictions in their quest for profits. Innumerable new merchants
and capitalists (with the new economic system that functioned on the basis of strict
contractual obligations between people) sought to undermine the privileged positions of the older merchant monopolies and to create a sociopolitical system more
conducive to free, uninhibited profit making.
• Profit seeking could be effective only in a society based on the protection of property rights and the enforcement of impersonal contractual commitments between
individuals. Within such an institutional framework, capitalists had to be allowed
to pursue their quest for profits freely. The new ideology that was firmly taking root
in the seventeenth and eighteenth centuries justified these motives and relationships
between individuals.
2.2.10
Questions posed by the physiocratic school
Introduction
The Physiocrats were a group of French social reformers who were intellectual disciples of
Franois Quesnay. Most of their ideas came directly or indirectly from Quesnay’s ‘Tableau
economique’. Their immediate influence in French economic and political affairs lasted
about two decades.
Contributions
1. They were interested in reforming France, which was experiencing economic and
social disorder caused primarily from a motley combination of many of the worst
features of feudalism and merchant capitalism.
(a) Taxation was disorderly, inefficient, oppressive, and unjust.
(b) Agriculture still used feudal technology, was small-scale and inefficient, and
remained a source of feudal power that inhibited the advance of capitalism.
(c) The government was responsible for an extraordinarily extensive and complex
maze of tariffs, restrictions, subsidies, and privileges in the areas of industry
and commerce.
(d) The results were the social and economic chaos that culminated in the French
Revolution.
2. The Physiocrats believed that societies were governed by natural law and that
France’s problems were due to the failure of her rulers to understand this natural
law and to order production and commerce accordingly.
3. On the basis of the model built by Quesnay explaining how a society should be
structured in order to reflect natural law, the Physiocrats advocated political reform: the abolition of guilds and the removal of all existing tariffs, taxes, subsidies,
restrictions, and regulations that hindered industry and commerce.
4. They proposed substituting large-scale, capitalist agriculture for the inefficient
small-scale farming that prevailed.
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5. The proposed reform for which they are most remembered was the recommendation
that all government revenue be raised with a single, nationwide tax on agriculture
(for reasons that will become clear in the following discussion).
Critique
1. The reforms were destined to be unattainable because the Physiocrats did not
question the right of the feudal nobility to receive the rents from their lands, while
the nobility perceived, quite correctly, that the Physiocratic schemes would lead to
the impoverishment of the land-owning class and a takeover by the capitalist class.
2. Social changes that require the displacement of one ruling class by another cannot
be achieved by reforms.
Conclusion
The Physiocrats’ influence was, therefore, primarily intellectual, not political.
2.2.11
Quesnay’s Economic Ideas
1. Tableau economique is basically a model of an economy, that shows the processes of
production, circulation of money and commodities, and the distribution of income.
2. The model assumes that production takes place in yearly cycles and that everything
produced in one year is either consumed in that year or becomes the necessary inputs
for the next year’s production.
3. The surplus income in the system that landlords received, performing no economic
function for which this is a payment, represented a surplus produced in the agricultural sector in excess of the consumption of the cultivators and the replacement
costs of the assets used up in producing the agricultural output.
4. The Physiocrats saw this surplus as a gift of nature and believed that only in
dealing directly with nature in extractive or agricultural production could human
labor produce a surplus.
5. Cultivators were therefore referred to as the productive class.
6. Producers of manufactured commodities were referred to as the sterile class, not
because they did not produce but because the value of what they produced was
presumed to be equal to the necessary costs of raw materials plus the necessary
subsistence wages of the producers.
7. No surplus or profits were thought to originate in manufacturing.
8. There were therefore three classes:
(a) The productive class (capitalists and workers engaged in agricultural production);
(b) The sterile class (capitalists and workers engaged in manufacturing);
14
(c) The idle class (the landlords who consumed the surplus created by the productive class).
9. After the landlord class receives its money rent, the Tableau goes through a long list
of transactions that show how the products of the agricultural and manufacturing
sectors are distributed or allocated and how the smooth circulation of money is
necessary for this allocation.
10. At the end of the entire process, if the transactions are aggregated, we see that the
economy is restored to its initial state.
11. Each period, the manufacturing sector reproduces the same value it uses up in
inputs (raw materials and subsistence consumption from the agricultural sector);
the agricultural sector reproduces the value of its inputs (seed grains, subsistence
consumption, and durable agricultural assets used up) and a surplus value, which
is appropriated by the landlord class and consumed in the form of agricultural
products and manufactured commodities.
12. The model illustrates that the two production sectors are interdependent, the output from each sector being a necessary input for the other.
13. The model also illustrates that the allocation of inputs and outputs requires the
continuous circulation of money.
3
Adam Smith
3.1
3.1.1
Questions
The preconditions of the Industrial Revolution [SZ-2.1.1]
The 35-year period from the beginning of the Austrian War of Succession in 1741 to the
American Declaration of Independence in 1776 was of critical importance for the history
of Europe as well as for the history of economic thought.
1. An important economic transformation of this period was the spread of capitalism
in the countryside, which was a fairly rapid process in France and England.
2. In the northern regions of France, a new social figure emerged: the fermier, a tenant
farmer who invested his own money in the improvement of productive techniques
and in the enlargement of his farm.
3. In England, the process was facilitated by the enclosure movement which, begun
more than two centuries before, experienced a real boom from 1760 onwards.
4. Among the most important consequences were the major technical innovations in
cultivation methods, the connected increase in agricultural productivity and production, and the acceleration of the expulsion of the agricultural workers from the
countryside.
15
5. An important precondition for the take-off of the Industrial Revolution was the
large number of technical innovations in the new industries, above all (but not
only) in the textile industry:
(a) Hargreaves’s spinning-jenny.
(b) Watt’s steam-engine.
(c) Arkwright’s water-frame.
(d) Cugnot constructed a steam-driven carriage, a prototype of the motor car, in
France.
(e) Volta in Italy invented the condensor electroscope and the electrophorus and
discovered methane gas.
6. Cultural Preconditions(a) This was the period of the eruption of that authentic cultural revolution known
as the Enlightenment.
(b) The roots of this movement can be traced back to seventeenth-century England
and, in particular, to the ideas of ‘reason’, ‘experience’, and ‘science’ with
which philosophers and scientists had tried to oust old idols and to sweep
away traditional intellectual servitude.
(c) This movement assumed special characteristics, becoming rationalist in the
homeland of Descartes and historicist in that of Vico.
7. Post-enlightenment boons(a) The Enlightenment supplied the philosophical bases of the attack the economists
of this period were attempting against mercantilist thought.
(b) The years 1751–76 are, in fact, for economics, the years of the laissez-faire
revolution.
(c) Mercantilism, a relatively homogeneous theoretical system was suddenly attacked from different positions, and disappeared from the scene in a quarter
of a century.
(d) The new economists did not present a homogenous theoretical approach.
(e) They did begin to group themselves into authentic ‘schools’ but there was little
theoretical homogeneity among the schools and little even within them.
(f) The only argument that united them was, in fact, a negative one: their struggle
against the traditional mercantilist orthodoxy and, connected to this (apart
from a few exceptions), their attempt to give a scientific foundation to the
laissez-faire doctrine.
3.1.2
The ‘mechanical clock’ and the ‘invisible hand’ [S.Z.-2.2.1]
The central problem of European political philosophy in the period from the beginning
of the Renaissance to the French Revolution was that of accounting for social life without
16
having to resort to metaphysical presuppositions. In the Middle Ages, social consensus
was maintained by two fundamental principles: authority and faith, both justified by the
assumption of the existence of God.
How is social life possible if those two principles and their metaphysical justification are
left aside?
1. Machiavelli and Hobbes:
(a) The natural egoism of man makes free social life impossible and the absolute
State necessary; the principle of authority is based on the monopoly of power,
and does not need to be legitimized.
(b) It is based on violence, and only obtains obedience through its strength.
(c) Civil society originates from repeated acts of obedience. The alternative would
be social disintegration and the law of the jungle.
(d) So power gives foundation to the State, and the State makes harmonious social
life possible.
This solution was certainly applicable to the absolutist States of the sixteenth and
seventeenth centuries but was no longer tenable after the proclamation of the English Commonwealth, and, above all, after the Glorious Revolution and the Declaration of Rights.
2. The emerging social classes created by capitalist development, and excluded from
government by the absolutist States, strived to obtain what they considered to be
their rights, if it is true that money is power.
3. On the one hand, therefore, was the need for a political philosophy by which the
civil society could justify itself independently of the State. On the other hand, it
was necessary that such a justification take into account the real processes of wealth
formation.
4. Natural Law Philosophy:
(a) The followers of this view believed in a ‘natural order’ that presupposes the
free expression of human activity.
(b) The ‘positive order’, based on laws and conventions, creates the State, but is
only legitimate if it is not in conflict with the ‘natural order’.
5. Moral sense Philosophy:
(a) A different path attempted by the English and Scottish empiricists and ‘moralsense’ philosophers was based on the assumption of the existence of a natural
‘benevolence’, or ‘moral sentiment’, which man experiences towards his fellows.
(b) If individuals are not naturally egoistic, they tend spontaneously to associate
themselves and there is no need for external intervention to give sense to social
life; neither God nor the State is necessary.
(c) It is sufficient to assume a particular structure of the human psyche.
17
(d) The main difficulty with it is that benevolence, not only runs against common
sense but also is not basically different from other metaphysical assumptions;
nor is it less arbitrary and easier to demonstrate.
(e) Both Hume and Hutcheson, Smith’s teacher, and Smith himself moved in this
direction.
6. Smith’s stroke of genius consisted, not in the rejection of the empiricist position,
but in taking it to its extreme logical conclusions, by leaving out even the arbitrary
hypothesis of benevolence.
7. With the ‘theorem of the invisible hand’, Smith simply aimed at demonstrating
that individuals serve the collective interest precisely because they are guided by
self-interest.
3.1.3
Accumulation and Distribution of Income [SZ-2.2.2]
Smith in his magnum opus identified that ‘improvement in the productive powers of
labour’ had major ramifications in the growth of wealth.
Division of labour A process by which a particular productive operation is subdivided into a certain number
of separate operations, each of which is carried out by a different person. It positively
affects production • Increases worker’s skills.
• Reduces delay related to frivolous act of transferring an worker from one activity
to other.
• Stimulates technical progress.
• Its only possible with significant market size and can be intensified through expansion of the market. Nothing limits the length to which specialisation can be carried
except the marketable volume of output.
Markets can be enlarged with better communications, major diffusion of credit and monetary instruments and growing volume of production.
Cumumaltive mechanism operating capitalist system: division of labour − > enlargement
of the markets − > increases in labour productivity, and so on; a real virtuous circle of
growth.
Capital Accumulation- The division of labour that triggers the growth process, it
is the accumulation of capital that drives it. Smith’s classsification of capitals 1. Fixed Capital- Machineries, plants, buildings etc.
2. Circulating Capital- Used to buy raw materials and pay for labour and energy.
The Wages Fund :
i. That part of the circulating capital which is used to pay the workers.
18
ii. In real terms, it is a part of the goods produced in a productive cycle which
is used to pay the workers in the successive cycle.
iii. Wages are paid before the product is sold, and for the capitalist, who advances
them, they are capital.
3. Smith’s Theory of Growth- The theory of income distribution among the social
classes plays a fundamental role in Smith’s theory of growth.
The three basic classes, capitalist, workers, and landlords, are distinguished both by
the productive resources they hold (capital, labour, and land ) and by the way
in which they spend their respective incomes (profits, wages, and rents).
The relationships among the types of productive resource held by the various classes,
and among the ways in which their incomes are spent, constitute the essential part
of Smith’s theory of capital accumulation.
• Landowners:
* The landowners, who do not own productive capital, are not interested in
its enlargement and have no inducement to save and accumulate capital.
* Their propensity to save is zero, and they make no contribution to the
growth of the wealth of the nation.
• Workers:
* The workers only possess their labour.
* The ability of the capitalists’ coalitions to influence the government and
parliament and the competitive forces on the labour market push real wages
down to subsistence levels.
* With a subsistence wage the propensity to save must be zero.
* Even being an essential part in production process workers cannot contribute in growth of national wealth.
• Capitalists:
* The capitalists possess the productive capital and aim to increase it.
* They have a very high propensity to save.
* The higher the proportion of the national income going to profits, the
higher the growth in the wealth of the nation.
* The general interest of the nation, therefore, coincides with that of the
bourgeois class.
4. Distinction between productive and unproductive labouri. [PL]: Employed in the production of goods, the latter in the supply of personal
services or in similar activities.
They were essential to sustain accumulation whereas unproductive labour is
not.
ii. [UPL]: Domestic staff who are employed by the ‘leisured class’.
As they had little to do with growth,means, a growing economy must reduce
to a minimum the percentage of workers engaged in unproductive labour.
19
3.1.4
Value [SZ-2.2.3]
Smith’s starting point in explaining the value of goods was to recognize that in all societies
the process of production can be reduced to a series of human exertions. A worker making
a loom is really contributing one of the several series of labour expenditures that culminate
in the production of cloth; viewed in this way, the loom is a kind of intermediate product
that can be seen as so much partially produced cloth. Thus Smith deduced that, a
necessary prerequisite for a good to have value is that it be produced by human labour.
1. Exchange Value(a) Determinants in precaptalist economies:- a labour cost theory of valuei. The exchange value of a commodity is determined by the amount of labour
embodied in that commodity, plus the relative allocation at different points
in time of indirect labour (that labour which produced the means of production used in producing the commodity) and direct labour (that labour
which uses the means of production to produce the commodity) used in
production.
ii. Thus, the value of a good is measured by the quantity of labour it is able
to ‘command’.
iii. The quantity of labour commanded coincides with the quantity of embodied labour in a system in which the whole product of the labour belongs
to the worker who the control of the means of production.
Deer-Beaver StoryIf among a nation of hunters, for example, it usually costs twice the labour to
kill a beaver which it does to kill a deer, one beaver should naturally exchange
for or be worth two deer.
(b) Post-capitalist control:- a labour command theory of valuei. Adding up Theory- After capitalists gained control of the means of
production and landlords monopolized the land and natural resources,
Smith believed that exchange value or price came to be a sum of three
component parts: wages, profits, and rents (three primary component).
ii. The profit component of a price did not have any necessary relationship to
the labour embodied in the commodity. In a capitalist society, therefore,
embodied labour is no longer a good measure of the exchange value of
goods.
Thus, the measure of value in labour commanded does not coincide with
the amount of labour embodied in the goods.
iii. Smith realized that competition tended to equalize the profits earned on
capitals of the same value.
iv. Thus, prices could remain proportional to the amounts of labour embodied
in commodities only if the value of capital per worker was the same in
different lines of production.
v. If the value of capital per worker differed among the various sectors of
the economy, then the addition of profits to wages would yield a sum that
20
would not be proportional to the labour embodied in the production of
the commodities.
CritiqueSmith could not see any way of showing how the labour embodied in production determined exchange value in these circumstances. It remained for David
Ricardo to show the general nature of the relationship between the labour embodied in commodities and their exchange values under these circumstances,
and for Karl Marx and subsequent theorists to work out a complete and logically coherent labour theory of value.
21
Illustration:
Assumptions(a) For the sake of simplicity, we will ignore rent. Let us imagine an economy
in which, on free land.
(b) Only one good is produced, corn, for example,by means of itself and
labour.
(c) The good, measured in tons, is used as a wage good as well as a capital
good.
(d) Let us assume, again for simplicity, that wages are paid after the work
has been done.
Analysis(a) The capital coefficient (k )- The quantity of seeds necessary to produce
one ton of corn.
(b) The labour coefficient (l )- The quantity of labour-hours directly used
to produced one ton of corn.
(c) If λ is the labour directly and indirectly embodied in a ton of corn, λk
will be that embodied in k tons of grain used as seedsλ = l + λk =
l
1−k
(d) Let, r be the rate of profit and , w and p the monetary wages and the
monetary price of one ton of corn.
Labour commanded by it: wp
Real wage: wp
(e) Price- The sum of the costs (labour cost, cost of capital, profit) sustained
in producing it and the profits earned by the capitalists.
p = wl + pk + pkr
Expressing the price in labour commanded:
p
l
= l + wp k + wp kr = 1−k(1+r)
w
22
Impications:
(a) The labour commanded is greater than the embodied labour precisely
because there is a profit, and that it becomes always greater as the profit
rises.
(b) The price of the good is nothing more than the sum of wages and profits
(and of capital) paid to produce it.
(c) The equation of labour commanded serves to determine labour commanded once the real wage is known.
(d) The rate of profit, the only unknown, is determined residually.
2. The theory of value based on labour commanded is correct as a price theory if it
presupposes a theory of profit as a residue(a) An increase in wages can lead to an increase in prices, rather than to a reduction in profits.
(b) Profit serves as a remuneration for the risk.
(c) Wages, profit and rent are the three original sources of all exchangeable value.
Taken together, these three propositions would induce a non-residual theory of
profit; which would lead to a logical error in a theory of value based on the cost of
production.
3. Conclusion(a) Primary sources of value- Wages and profits would be determined by the
forces of supply and demand in the ‘factor’ markets, so that their sum would
determine the value of the good.
(b) From the equation of labour commanded, if wages and profits are predetermined, there are no more variables to determine: the equation becomes overdetermined.
4. CritiqueNot only was Smith not completely aware of the reasons why a measure of value
in labour commanded is preferable to one in embodied labour, but he did not even
understand the dangers of a non-residual explanation of profit within a theory of
value based on the cost of production.
5. Use ValueUse value touched upon the concept of utility, but Smith was only concerned with
total utility. The concept of marginal utility had to wait for hundred more years
after Smith wrote Wealth of Nations.
Use value cannot determine market prices.
Water-Diamond Paradox- Water possesses high use value but low exchange
value, opposite to diamonds which have low use value and high exchange value.
23
3.1.5
Adam Smith Problem [MB-60]
1. Its odd enough to digest the fact that selfishness is by itself enough to produce all
the desirable results of competition.
2. Trust, honesty, good will, in short, moral rules of conduct act frequently beyond
the narrow realm of self interest rendering competitive exchange beneficial. Thus
people in a commercial society are not motivated solely by self-interest.
3. The relationship between Moral Sentiments, a book on ethical rules of conduct
grounded on the notion of ‘sympathy’ or what we would nowadays call ‘empathy’,
and the Wealth of Nations in which people are depicted as selfish without restraint.
That is what German critics have called the Adam Smith Problem.
3.1.6
Market and competition [SZ-2.2.4]
1. Smith’s Theory of Growth (revisited)
A necessary condition for the existence of a positive growth rate is that the labour
commanded by the net product is higher than the quantity of labour used to produce
it, as that would leave the surplus to follow capital accumulation.
2. Market Price V/S Natural Price
(a) Market Pricei. The actual price of a good at a given moment.
ii. It depends on the forces of supply and demand.
iii. The fluctuations of the market price depend on the forces of demand, but
are regulated by the production conditions.
(b) Natural Pricei. That price which would allow the payment of workers, capitalists, and
landowners at normal rates of remuneration.
ii. The natural price is the central price, to which the prices of all commodities are continually gravitating with competition in operation.
iii. The natural price is determined by the production costs, but realized on
the market.
(c) Market MechanismThe adjustment process described above is an integral part of the market
mechanism by which the economy adjusts itself to its ‘natural’ equilibrium
path, it is the movement through which the ‘invisible hand’ works.
3. Invisible Hand Theorem
(a) Self-interest is the driving force of the system, the force that prevents the slide
into chaos.
24
(b) A large number of operators, a certain knowledge of the price conditions on
the part of buyers and sellers, the mobility of capital, and the absence of entry
barriers are all conditions that limit the ability of each single agent to influence
the prices to his own advantage.
(c) Under such conditions, the market conditions ensure that exactly those goods
in exactly those quantities are produced which best satisfy the final demand.
(d) In an equilibrium situation, the forces of demand provide for the distribution
of capital among the various industries.
(e) While the conditions of supply determine the relative prices, the conditions of
demand determine the relative quantities of goods produced.
In this view, the market is its own guardian and is capable of complete selfregulation.
So that, while everybody is free to follow his personal interests, everybody is, in
fact, controlled by an impersonal force. Each person is induced by an ‘invisible
hand’ to contribute to the achievement of an economic end which was no part of his
intentions: this is Smith’s theorem of the invisible hand.
PropositionsUnder conditions of competitive equilibrium(a) The productive system will produce those goods the consumers demand.
(b) The chosen production methods are the most efficient, that is, those which do
not waste any resource.
(c) the goods are sold at the lowest price possible, which is the production cost
inclusive of a normal profit.
The main weakness of this grand construction is that it was yet to be proved.
Although recently the existence of such equilibrium is proved but still the issues of
uniqueness and stability are two crucial concerns in the respective field of study.
3.1.7
Smith’s Three Souls [SZ-2.2.5]
Three different components in Smith’s economic theory, viz., macroeconomic (the theory
of surplus), microeconomic (the theory of the individualist competitive equilibrium.) and
institutionalist components, are quite inter-related and hard to separate.
1. Micro Component(a) The empiricist and moral philosophy roots of the theory of competitive equilibrium are‘ from the influence of Hume, Hutcheson, and Shaftesbury.
(b) Provides the foundation to the theorem of the invisible hand, to the idea of a
competitive capitalist economy as a natural economic order.
(c) Also enlighten with the theory of additive prices in connection with the explanation of profit as remuneration for risk, and to the theory of wage differentials.
25
(d) The economic subjects which appear in this second component are no longer
collective agent (e.g., social class) but individuals (e.g., buyers and sellers of a
single good).
2. Macro Component(a) Theory of surplus had its roots in the natural-law roots and the influence of
Locke and Quesnay.
(b) The base of his theory of growth, and was in fact formulated in the attempt
to adapt Quesnay’s analysis to a non-stationary economy.
(c) This component comprised the conceptions of the social classes, the analysis
of their different types of income and expenditure behaviour, the distinction between productive and unproductive labour, the explanation of value in terms of
embodied and commanded labour and, finally, the theory of profit as a residual
income.
3. Interrelations- The explanation of the nature of labour and the level of its remuneration.
“The real price of everything, what everything really costs to the man who wants to
acquire it, is the toil and trouble of acquiring it. What everything is really worth
to the man who has acquired it, and who wants to dispose of it or exchange it for
something else, is the toil of our own body. That money or those goods save us this
toil. They contain the value of a certain quantity of labour which we exchange for
what is supposed at the time to contain the value of an equal quantity. Labour was
the first price, the original purchase-money that was paid for all things. It was not
by gold or by silver, but by labour, that all the wealth of the world was originally
purchased; and its value, to those who possess it, and who want to exchange it for
some new productions, is precisely equal to the quantity of labour which it can enable them to purchase or command.”(p. 133)
Interpretations(a) Ricardo and his followers, the Ricardian socialists, and Marx and the Marxists:
i. The ‘quantity of labour’ with which the goods are produced or which is
commanded by them is intended as an investment of energy, a productive
service that can be technically specified and measured in objective units,
for example, working hours.
ii. This good enters into the production of others on the basis of objective
technical relations, and is exchanged with others on the basis of objective
exchange relations.
iii. Its productive role and its value are independent from the choices of individuals and from psychological factors.
iv. The determination of its price and its productive role can be set out in
macroeconomic terms, completely ignoring single individuals.
26
v. This leads to a theory of distribution that, being based on the notions
of ‘wage’ as ‘natural wage’ and of ‘surplus’ as a ‘deduction from the produce of labour’, cannot but be a macroeconomic theory, and needs no
microeconomic foundations.
vi. In the same way, a theory of value based on embodied or commanded
labour cannot but be an objective theory of value, and needs no psychological foundations.
(b) Jevons’ view (influenced by Bentham and Gossen):
Jevons put emphasis on ’toil and trouble of labour’.
i. ‘A case of negative utility’ that is expressed in terms of ‘pain’, and is
impossible to define it objectively.
ii. Each individual has his own idea of how ‘painful’ his own work is.
iii. Subjective theory of value and distribution can incorporate the individual
psychology and choice in explaining such concepts.
(c) Neoclassical Similarities:
“The whole of the advantages and disadvantages of different employments of
labour and stock must, in the same neighbourhood, be either equal or continually tending to equality. If in the same neighbourhood, there was any employment evidently either more or less advantageous than the rest, so many
people would crowd into it in the one case, and so many would desert it in the
other, that its advantages would soon return to the level of other employments.
This at least would be the case in a society where things were left to follow
their natural course, where there was perfect liberty, and where every man was
perfectly free to choose what occupation he thought proper and to change it as
often as he thought proper. Every man’s interest would prompt him to seek the
advantageous, and to shun the disadvantageous employment.”
(pp. 201–2)
Interpretationsi. Smith’s concern on ‘every man’ and their freedom to ‘choose’ is clear
reference to individual choices.
ii. Smith’s conceptualization of the determinant of wage differentials includes
the ‘agreeableness or disagreeableness’ or the ‘ease or hardship’ of the
work, emphasising again on individual decision making.
iii. On equalization of the advantages and disadvantages of different employments, the wage differentials must reflect the differences in hardship (under
free competition).
Ricardo and Marx: Interpreation
i. Objective Determinant:
They emphasised on the high and low cost of training as the second determinant of wage differential.
ii. The training costs of a labour skill, as Marx proposed, is the quantity
of labour employed to produce a certain working ability, and can be determined by referring to the ‘educational technology’ available in a given
27
society in a given period, which is again an objective and macroeconomic
phenomenon.
(As refered to the theory of surplus as the macroeconomic component in
Smith’s thought.)
3.1.8
Smith as an Institutionalist [SZ-2.2.6]
The institutionalist foundations of Smith’s thought can be traced in The Theory of Moral
Sentiments and in the Lectures on Jurisprudence held at Glasgow University.
1. The theories attributed to Smith by the various free trade orthodoxies should be
reconsidered in the light of an institutionalist interpretation.
2. the thesis whereby the market mechanism is necessary and sufficient for the constitution of social cohesion fails to capture the full wealth of Smith’s thought.
3. Along with Smith’s conceptualization of market as a set of institutions, Smith also
opines that two other spheres of human action that play a fundamental role in
constructing social harmony: those of moral and legal rules.
4. Smith had a concept of man as a subject blessed with multiple selves, whose soul
was characterized by different and contrasting sentiments (selfish and altruistic
elements).
Selfish elements:
(a) The desire to improve one’s life;
(b) The desire for social esteem, to which pride and sense of honour are related;
(c) The desire to be admired by others, in other words, vanity;
(d) The desire to accumulate property and wealth, or avarice;
(e) The desire for power and domination;
(f) The desire to lead an easy life and avoid all effort.
These sentiments do not all boil down to utilitarian egoism, i.e. the inclination to
maximize one’s utility which the invisible hand could bend to serve the interests of
the community.
(a) Avarice
i. Some of these sentiments give rise to strong externalities and contribute
to obstruct the market mechanism.
ii. Avarice, for instance, accounts for the impulse to accumulate, but also for
the propensity to exploit others instead of applying oneself to the efficient
production of income. Nowadays this would be called ‘opportunism’.
iii. The need for social esteem and power contributes to obstructing the competitive mechanism when they lead to the build up of monopolistic situations.
iv. These sentiments lead to ‘man’s natural insolence’ which causes inefficiency precisely through opportunism.
28
v. The tendency to avoid effort may give rise to productive inefficiency, by
inducing idleness at work.
vi. Very wealthy people lose interest in economic activityLandowners from the aristocracy dedicate much of their life to lavish consumption and besides not worrying about putting by the income necessary
to increase their wealth, they do not even take the trouble to manage efficiently the production activities from which their wellbeing derives.
On the other hand, their bailiffs and agents have no incentive to increase
productivity, since they do not own the land or the wealth they manage,
and therefore tend to act in a ‘negligent, uneconomical and oppressive
manner’
vii. This problem is not confined to the aristocracy alone as it also affects the
bourgeoisie, as capitalists tend to lose their parsimonious spirit when they
earn very high profits.
viii. If ownership is organized in the form of a joint stock company, a separation between ownership and control arises which generates the well-known
problems of managerial inefficiency, with executives failing to manage
other people’s money with the same ‘concerned alertness’ that the owners
would use; ‘negligence and waste’ then ensue.
In conclusion, it can be said that for Smith self-interested behaviour is not
sufficient to generate social harmony in the presence of perfect liberty. Some
form of moral and institutional restraint is necessary.
(b) Benevolence
Human nature is also endowed with altruistic sentiments, like benevolence,
which prompts the individual to please his fellow men and directly generates
co-operative behaviour.
(c) Sympathy
Sympathy, is more ambiguous. Sympathy is the ability to imagine oneself in
the situation of others in order to assess their reactions to one’s decisions.
The love of praise
i. The desire for social approbation— ambiguous because it has both egoistic
and altruistic implications.
ii. The individual practises sympathy in order to gain his fellow’s approbation
and avoid his disapprobation.
iii. In this way, individuals endeavour critically to examine his own behaviour
towards others and that of others towards himself.
This is how the moral and behavioural rules that contribute to social
cohesion are created are accepted by a community and internalised by the
individuals who belong to it.
5. Invisible Hand Theorem in light of moral sentiments:
(a) In the market, economic agents do not exchange goods only, but also messages
of approbation or disapprobation, so that individuals, albeit behaving in a
29
self-interested way, tend to do so complying with the legitimate expectations
of others as well as moral rules.
(b) In this way opportunism is kept at bay and co-operative behaviour is stimulated.
(c) The invisible hand that contributes to constructing the good of all, appears to
be that of the impartial spectator rather than that of utilitarian greed.
(d) Free competition seems to be regulated by the law of sympathy not by that of
the jungle. And that is why the market works.
6. Smith did not treat human nature as a ‘natural’ fact, an exogenous datum(a) He pinpointed one very important personality building mechanism, which consists in the inclination of people to emulate individuals who rank higher on
the social ladder of wealth and prestige.
(b) Thus the thirst for enrichment, for example, is an attitude typical of a particular social setting, that of modern capitalist economies, within which it has
the function of stimulating initiative and innovation; but it tends to foster
exploitation and the formation of monopolies when the impartial spectator is
weak.
7. The legal rules are no less important than the moral rules(a) A too orthodox liberal interpretation have provided a partial and distorted
reading of Smith’s thought where the state is seen as a body that is neutral
and external to society.
(b) In this perspective the state is considered as a simple emanation of the will
of civil society, which on the ground of its capacity for self-constitution in the
exchange sphere, would delegate to the political authorities only the function
of producing a few essential public goods, such as justice, national defence,
economic infrastructures.
(c) Thus the harmony that society would naturally generate in markets, would not
be altered by the legal rules, nor would the latter contribute in any decisive
way to forming this harmony.
(d) Smith did not see it in quite the same light as he was perfectly aware of the
fact that, in the exchange sphere, the economic agents enter into a noncooperative type of relationship with each other which can impair public interest
than foster it.
(e) He observed that, in the endeavour to pursue their objectives, individuals
organize themselves into social groups directed at increasing their members’
power.
(f) He studied the state as an apparatus which is continually crossed by economic
conflict and an instrument with which coalitions pursue their particular interests.
(g) One field in which the powers of State are exercised in a strongly non-neutral
way is the regulation of the labour market and determination of wages.
30
(h) Smith, unlike the mercantilists, argued that a subsistence wage was a fact
rather than a normative principle. Smith did not think this tendency was
caused by natural economic mechanisms, such as the dynamics of the population and of labour demand.
(i) While he did not overlook the role played by these factors, he saw clearly that
this was privileged territory for social conflict and that the classes enter it with
political instruments which are powerful, yet asymmetrically distributed.
(j) The forces of demand and supply now and then avert the market wage from
the ‘natural’ wage but they cannot alter its basic trend.
(k) It should be added that subsistence consumption was not defined in purely
biological terms. On the contrary, it was considered as determined by the
habits and customs that prevailed in a given historical period and in a given
society.
Thus, not only is the magnitude of the real wage institutionally determined, but its
composition too.
8. Smith did not confine the state and the normative institutions to an external and
neutral sphere with respect to that of social action(a) They all operate within civil society and the markets, thus contributing in a
substantial way to control individual behaviour as well as the mechanisms of
production and accumulation of wealth.
(b) production and accumulation of wealth.
9. The predominant liberal interpretation of Smith was unsatisfactory(a) A recent version of this interpretation has been put forward by Coase, who
believes the market is a perfect substitute for benevolence— in the sense that
by arriving where benevolence cannot, it succeeds in achieving much more
than the latter.
(b) On the one hand, Coase admits that to work well, the market presupposes the
practice of benevolence and the respect of a mercantile moral code by all the
agents.
(c) On the other, he argues that market performance depends solely on the egocentric interests of those who take part in it.
(d) In other words, market existence presupposes the practice of certain virtues,
yet these practices have no bearing on the results of the market process.
10. Smith’s ‘schizophrenia’:
(a) The Wealth of Nations: ‘it is not from the benevolence of the butcher, the
brewer or the baker that we expect our dinner but from their regard to their
own interest’.
31
(b) The Theory of Moral Sentiments: ‘how selfish soever man may be supposed,
there are evidently some principles in his nature which interest him in the
fortune of others and render their happiness necessary to him though he derives
nothing from it except the pleasure of seeing it’.
Interpreting the contradiction:
i. The controversial passage in The Wealth of Nations presupposes in its
enunciation the theories set out in The Theory of Moral Sentiments, and
in particular those concerning the existence of a fundamental system of
‘rules of economic and civil morality’ based on sympathy.
ii. This system of rules guarantees orderly functioning of the market without
the individuals having continuously to resort to enforcement to compel
their counter-parties to play by the ‘rules of the game’.
iii. So the above maxim merely says that a market economy would be in a
position to function even if the ulterior motives of all the participants
were exclusively self-interested: it is an exaltation of the soundness of the
organization of the economic activities permitted by the market rather
than a negation of the relevance of the intrinsic motivations.
iv. Smith appears to argue that only within a relational type of social structure, systematically fuelled by the practice of ‘moral sentiments’, is it
possible for the pursuit of self-interest to produce positive results, in other
words, for ‘the gains of both (parties)’ to be ‘mutual and reciprocal’, as he
affirms in the chapter ‘Of the natural progress of opulence’ in The Wealth
of Nations.
3.1.9
Smith’s Theory of Economic Welfare [KL-81]
Smith’s definition of economic welfare was fairly simple and straightforward.
1. Economic welfare depended on the amount of the annual ”produce of labour” and
”the number of those who are to consume it.”
2. Another criterion of welfare, not explicitly stated by Smith but important in many of
his discussions, was that welfare could be increased as the composition of productive
output conformed more to the needs and desires of those who purchased and used
the output.
In analysing the forces that tended to increase economic welfare, Smith developed a model
that delineated the most important social and economic components of capitalism and
made explicit the principal motivation that propelled the system.
1. Capitalism was divided into two primary sectors of production-agriculture and manufacturing.
2. The production of commodities required three distinctive groups of inputs-land
(including natural resources), labor, and capital.
3. Corresponding to these three groups of inputs were the three principal social classes
of capitalism-landlords, laborers, and capitalists.
32
4. The legal and social bases of this class division were the laws of property ownership
and the distribution of actual ownership among the people.
5. The three social classes each received a distinct form of monetary return-rent, wages,
and profits.
6. These forms of class income corresponded to the three component parts of production costs and determined the prices of commodities.
7. Smith assumed that selfish, acquisitive motives characterized all economic behavior
(despite his admission that in noneconomic behavior people had other motives,
including those considered altruistic).
Laissez-faire capitalism: System that would maximize economic welfare:
Within the context of Smith’s theory of history, capitalism represented the highest stage
of civilization, and capitalism would reach its greatest height when it had evolved to a
state in which the government had adopted a laissezfaire policy, allowing the forces of
competition and the free interplay of supply and demand to regulate the economy, which
would be almost entirely unhindered by government restrictions or interventions.
Smith’s justification behind the conclusion1. The level of production in any society depended on the number of productive laborers and the level of their productivity.
2. Productivity, in turn, depended on specialization, or the extent of the division of
labor.
3. The extent of the division of labor was governed by two circumstances(a) There had to be a well-developed market, or a commercial exchange economy,
in order for extensive specialization to take place.
(b) When a market economy existed, the degree of specialization would depend
on the size of the market.
The most important or fundamental division of labor was that between rural agriculture and urban manufacturing. ”There are some sorts of industry,”
Smith wrote, ”which can be carried on nowhere but in a great town.” The
natural order of economic development was agriculture first, then urban manufacturing, and then foreign commerce. ”
When a commercial society had developed to a point where this urban-rural
specialization was possible, then the second circumstance governing the extent
of the division of labor became more important.
4. The accumulation of capital, then, was the principal source of economic progress,
and profits were the source of new capital.
5. Given this central significance of profits and capital accumulation, Smith placed
a great deal of emphasis on his distinction between productive and unproductive
labor. Smith advanced two definitions of productive labor33
(a) Laborers were productive when their labor resulted in revenues, accruing to
capitalists that were sufficient to repay wage costs and still leave a profit.
(b) Laborers whose labor was embodied in a tangible, vendible commodity were
productive.
The point of distinction is in between laborers who contributed to the process of
capital accumulation and those who merely sold their services to either wealthy
persons or the government.
6. The important point was that productive labor was the labor that furthered the
accumulation of capital. The new capital increased economic welfare because it
increased the productivity of labor.
7. Smith believed, according to the natural order of economic development capital
employed in agriculture was the most productive, manufacturing was next, then
came domestic trade, and last was foreign trade.
8. . If governments did nothing either to encourage or to discourage the investment
of capital in any particular sector, then the capitalists’ selfish quest for maximum
profits would cause economic development to take place in accordance with this
natural and socially beneficial order.
9. After agricultural production was developed in a ”system of natural liberty,” capital
would flow into manufacturing. Still, at this stage of development, domestic industry contributed more to human welfare than to foreign commerce. In describing
the flow of capital into domestic industry, under a ”system of natural liberty,” S
mith formulated the most famous statement of his thesis that in a free market the
selfish actions of individuals are directed, as though by an invisible hand, in such a
way as to maximize economic welfare.
Conclusion:
1. Government interventions, regulations, grants of monopoly, and special subsidies
all tended to misdirect capital and to diminish its contribution to economic welfare.
2. Such government actions tended to restrict markets and thereby to reduce the
rate of capital accumulation, to decrease the extent of the division oflabor, and,
accordingly, to reduce the level of social production.
3. Not only would free, competitive markets direct the employment of capital to those
industries in which it would be most productive, but they would also result, again
through the invisible hand directing selfish profit-maximizing into socially beneficial
channels, in those commodities being produced that people need and desire most
intensely.
3.1.10
The Smithian Orthodoxy: An era of Optimisim [SZ-2.3.1]
The forty years between Smith’s publication of The Wealth of Nations and Ricardo’s The
Principles, fuelled optimism in both English and continental middle class and encouraged
34
them in realizing the Enlightenment dream.
The Smithian Optimism:
The kind of political economy that was implanted in The Wealth of Nations with which
the economists, all over the Europe discovered for the first time that they were speaking
the same language and had the same ideas of the aims, limits, and scope of economic
science: those assigned to them by Smith.
Noted intellectuals of this period:
1. William Godwin- Noteworthy for his thesis about human perfectibility and his
radical reform programme.
2. Antoine Nicholas de Condorcet, with his idea of the continual progress of scientific
knowledge and the moral bases of social life.
Some pessimistic voices of work :
1. Robert Malthus published the Essay on the Principle of Population that was quite
against Godwin’s view of optimism.
2. The ‘Malthusian population principle’ is a sharp and clear expression of traditional
religious pessimism in the face of avaricious nature and the effects of human intemperance.
The principle:
The means of subsistence offered by nature grow according to an arithmetical progression, while the number of mouths to feed would increase at an exponential rate
if they were not curbed by natural scarcity.
The Consequence:
As the lower classes could not, unlike the others, use moral restraint to control the
natural catastrophes, let nature, therefore, look after itself which in turn means
charity and assistance to the poor must be discouraged and abolished.
Importance of the population principle:
(a) Ricardo and Torrens make use of it in connection with their theories of wages.
(b) It had important implications for the decreasing returns in agriculture.
The aspect most worth highlighting in the panorama of Smithian economics
is:
The few economists who did make some original contribution were all working within
only one of the three components of Smith’s thought, that of the individualistic competitive equilibrium, while they overlooked the macroeconomic and institutionalist components.
3.1.11
The Smithian Orthodoxy: Bentham and Utilitarianism [SZ-2.3.2]
The Utilitarianism:
1. Provided a new way of conceptualizing human motivation towards action.
35
2. The increasing specialization of labour and, more generally, the nature of capitalist
production had led to the consideration of individuals, not as integrated parts of an
interdependent whole, but as social atoms fighting with impersonal and unchangeable market forces.
3. Along with the pre-existing belief regarding the economic agents being self-interested
and competitive the idea also gained impetus that all reasons for human action
spring from the desire to obtain pleasure and avoid pain.
4. The normative formula of Utilitarianism was taken from Helvetius and Beccaria,
is: ‘the greatest happiness for the greatest number’.
5. Idea of utility MaximisationEvery human motivation, at every place and time, is guided by the desire to maximize utility—‘that property of any object, whereby it tends to produce benefit, advantage, pleasure, good or happiness’ or to prevent ‘mischief, pain, evil, or unhappiness
to the party whose interest is considered’.
6. A method for the quantification of pleasures:
‘The value of a pleasure or pain will be greater or less according to several circumstances: its intensity, its direction; its certainty or uncertainty; its propinquity or
remoteness; its fecundity; its purity; its extent’.
7. Another pillar of Bentham’s theory was the idea that human beings, besides being
hedonists, are also self-interested.
8. Utilitarian Ethics: Consequentialism(a) The moral judgement of an action refers to the consequences it produces and
not to the intentions of those who promote it.
(b) If the consequences are good, the action will be judged as morally good.
(c) Again, a consequence is considered good when it increases the utility of at
least one individual.
9. Smith rejected the conception according to which the exchange value can be explained by the utility of goods, in this context he used the Water-diamond paradox
as an illustration to the absence of a necessary relationship between utility and
value. Again, value in use is the basis of value in exchange.
10. The neoclassical economists were to explain later that it was not the total utility
of a good that determines its exchange value but the marginal utility, or rather the
increase in utility which is derived from a small increment in the availability of a
good.
36
3.1.12
The Smithian Orthodoxy: The Smithian economists and Say [SZ2.3.3]
1. Bentham was the first of the Smithian economists to seek the explanation of value
in use value rather than in the cost of production.
2. Friedrich Soden:
He transformed Smith’s distinction between use value and exchange value into that
of ‘positive’ and ‘comparative’ value, maintaining that only the former is a value in
the real sense; and that it depends on the utility the goods have in respect to the
needs they must satisfy.
3. Johan Friedrich Lotz:
He pushed forward in this direction until he managed to make the comparative
value, which expresses the comparison between two positive values, depend on the
scarcity of goods and on the sacrifice that must be made to make them available
for the satisfaction of needs.
4. James Maitland Lauderdale:
(a) He not only rejected Smith’s theory of value but also recognized the implications of such a rejection for the theory of production.
(b) Lauderdale concentrated his analysis on the forces of supply and demand,
endeavouring to explain the latter by the subjective factors that define human
needs and the former by the scarcity of the goods necessary to satisfy those
needs.
(c) In regard to production, he was one of the first to put forward the argument
that, to understand the role played by machinery in the productive process
and in the production of wealth, it is necessary to focus not so much on its
ability to co-operate with labour as on its ability to substitute for it. This
view logically leads to a theory of three productive factors, labour, land, and
capital and their combination in the production process.
5. Jean-Baptiste Say, the ‘optimist’ :
(a) Say combined the two basic arguments of the Smithian theory of value, the
one concerning the dependence of the variations of market prices on the forces
of supply and demand and the other relating to the dependence of natural
prices on the conditions of production.
(b) The value of goods depends on the forces of demand and the costs of production.
(c) The utility of goods acts on the former, whereas the difficulties met in supplying them underlies the latter.
37
4
Ricardo
4.1
Questions
4.2
Notes
4.2.1
Thirty years of crisis [SZ-3.1.1]
1. Age of Restoration(a) The thirty-year period from the Congress of Vienna (1815) to the 1848 revolutions.
(b) It was a period of deep economic and social changes and sharp political crises.
(c) The period was marked by the attempt of the aristocratic powers to restore the
traditional absolutist order just when the Industrial Revolution was definitively
undermining the economic foundations of that order.
(d) There were almost permanent civil wars in the countries affected by most
intense conflicts and social change although total peace prevailed in European
international relations.
(e) The Holy Alliance:
i. Managed to maintain internal order in all the nations of Central and
Eastern Europe, including Italy and Germany.
ii. In some of these countries, political uprisings led by democratic forces
occurred repeatedly and with increasing intensity during the thirty-year
period but they were always defeated.
iii. Reasons for defeat:
A. The existing social structures offered small mass base in the democratic movements.
B. Undoubtedly, the slow process of capitalist accumulation and the relative backwardness of the economic structures of these countries.
(f) Evolution of political conflicti. Assumed special characteristics in the two most advanced European countries, France and England.
ii. Their political systems were based on three great parties: reactionary, liberal, and democratic. This tripartite structure remained constant throughout the period.
iii. Well-defined social forces (the landlords, the bourgeoisie, and the proletariat) underpinning this structure gave the parties stability and political
context.
iv. In the first phase (1815–30) which was the Age of Restoration in the strict
sense, power was firmly held by the reactionary forces in the two countries.
v. An alliance against these of the Whigs and Radicals in England and Orleanists and Republicans in France provided the mass base which led, in
1830, to the July Revolution in France and the Whig election victory in
England.
38
vi. The result of the two victories was the institution of two constitutional
parliamentary regimes, albeit with very limited electoral bases.
vii. In France, the wealth requirements and the voting age were lowered so as
to raise the number of electors by just one per cent of the population.
viii. In England, where a parliamentary system had existed for some time, there
was an electoral reform in 1832, which eradicated the system of ‘rotten
boroughs’ which raised the number of electors.
Rotten boroughs:
The sparsely populated country boroughs, controlled by the landowners,
were much more highly represented in parliament than the more populous
town electoral districts, where a majority of bourgeoisie and industrial
proletariat lived
2. Post reform(a) The ‘industrialists’ were satisfied, the landowners gave up their hegemony, and
the proletariat had to start all over again.
(b) The democratic party became more radical in a socialist sense, and this gave
the liberals one more reason to break away from the alliance.
(c) In England, some of the Radicals joined with the trade union movement to
form the Chartist party (a political group that fought for the extension of
political rights to the workers as a condition for the attainment of some more
advanced economic and social goals).
(d) In France, a socialist movement formed that tended to differentiate itself more
and more clearly from the liberal forces and, as in England, tried to unite
democratic political claims with social-emancipation objectives which were
incompatible with the economic structure of a capitalist system.
3. Culmination:
(a) The class struggle, far from weakening, became more bitter after 1830.
(b) there was a qualitative change, with the conflict between the landowners and
the ‘industrialists’ becoming less important than that between the popular
masses and the privileged classes.
(c) The end result was the 1848 revolution, which in France turned into a proletarian blood-bath and the definitive attainment of the bourgeois hegemony
over the whole society.
(d) In England, where the workers’ movement was stronger and everybody had
expected a proletarian revolution, 1848 ended in a farce, with the presentation
of a Chartist petition to Parliament.
(e) In both countries, 1848 closed an era of conflict and opened one of social peace.
4.2.2
The Corn Laws [SZ-3.1.2]
The Age of Ricardo (in terms of economic theory ) 39
1. In England, the thirty years from the passing of the Corn Laws (1816) to their
repeal (1846).
2. The English economic research of those years widely discussed and got involved
with the Ricardian approach and even critiqued the political implications of his
theory.
Conflicts1. The first fundamental class conflict involved workers and capitalists. I
2. Another great conflict that marked English society in the period of its industrialization: that involving the landowners and the capitalists.
(a) The conflict mainly manifested itself in the battles for the control of Parliament, the real object of the fight being whether England should remain an
agricultural economy or should instead accelerate the rhythm of its industrial
growth.
(b) The Napoleonic wars drastically reduced the imports of food supplies, resulting
a substantial price hike in cereals, in particular corn; the prices of manufacturing goods, on the other hand, had increased less rapidly than agricultural
products and wages.
(c) At the end of a long period of war, the landowners managed to convince
Parliament to approve the famous new Corn Laws; tariffs were fixed at such
a high level that corn, the foreign prices of which were much lower than the
internal ones, could not enter the country at all.
Economic Implicationsi. The protectionist barriers allowed the maintenance of high land rents to
the detriment of profits, given the rigidity of real wages.
ii. The opposition of the manufacturers was strong, not only because of the
redistribution effects of the protectionist barriers but also because these
prevented English industry from taking advantage of its higher level of
productivity with respect to its European competitors.
3. The battle lasted for about thirty years, but in the end the persuasive force and
pressure that the bourgeoisie managed to exercise at the political and cultural level
led to the complete repeal of the Corn Laws.
4. This was made possible by Ricardo’s decisive theoretical contribution, sanctioned
the definitive hegemony of the bourgeoisie in the English society.
5. Ricardo’s principal opponent in this battle was Thomas Robert Malthus, who supported the landowners’ point of view in all the theoretical debates.
4.2.3
The Theory of Rent [SZ-3.1.3]
1. The theory of extensive differential rentThe Theory:
40
(a) Let’s assume, an extremely simple model of an economy in which the agricultural system only produces one good, let us say corn, by means of itself (seeds)
and labour.
Figure 1: Rent
(b) Suppose, there are five types of land A, B, C, D, E and their respective net
corn production- Ga , Gb , Gc , Gd , Ge arranged in decreasing order of fertility.
(c) Let us assume that a fixed quantity of seeds and a fixed quantity of labour,
say, one worker, are used on each acre of land.
(d) If we begin from a situation in which only one kind of land, A, is cultivated,
the production of corn net of seeds will be Ga .
(e) If the cultivation is extended to land B, the net production will increase to
Ga + Gb , and if land C is also cultivated the production will be Ga + Gb + Gc
and so forth.
41
(f) A movement to the right along the horizontal axis implies an increase in production and an increase in the plots of land cultivated.
(g) Let us assume that on the least fertile of the cultivated plots there is no rent;
and that the real wage wr is fixed.
(h) The capitalist who works on the least fertile plot, E, will produce an amount
of corn (net of seeds) equal to Ge and will make profits equal to (Ge − wr ).
(i) The other capitalists, working on the more fertile land, would obtain higher
profits if they didn’t have to pay rent,i.e.,
Ga − wr > Gb − wr > Gc − wr > Gd − wr > Ge − wr
(j) In this case, however, competition will raise the demand for the more fertile
plots; and this will allow the owners to extract higher rents. The more fertile
the land, the higher the rent.
(k) In competitive equilibrium all the capitalists will earn the same profit rate
since the product that can be obtained from intramarginal lands over and
above that of the marginal land will be entirely swallowed up in rent.
(l) The rents, in the figure, is represented by the shaded area, the total wages by
the area 0wr wr e and the profits by the area wr ππwr .
Critique:
The theory was criticized as it seemed to imply, against the evidence, that no rent
is paid on marginal lands.
In order to understand why differential rent is also paid on the marginal pieces of
land, we only have to reinterpret it as ‘intensive rent’.
Reinterpretation of the figure:
(a) All the land available in a country is cultivated..
(b) Let us assume that all the plots are equally fertile.
(c) In order to obtain increases in production, there must be further investment
of capital and labour on the already cultivated lands.
(d) The histogram in the figure now represents the increments in production that
can be obtained as the investment of capital and labour increases.
(e) Let us assume that the capital: labour ratio is fixed.
(f) Now the horizontal axis no longer measures the area of the cultivated land (all
the available land being cultivated), but the level of employment.
(g) A movement to the right along the horizontal axis no longer represents an
extension of the cultivation given the labour : capital : land ratios, but an
intensification of the cultivation with increases in the labour: land and capital
: land ratios.
(h) It is assumed that, with the increase in production and employment, the productivity of the last employed worker will fall.
42
(i) Ga is the productivity of the first worker, Gb that of the second, and so
forth. Therefore, the worker employed with the last investment unit, whose
net productivity is Ge, will produce no rent.
(j) Yet a rent will be paid which will be equal to the difference between the
productivity of the intramarginal units and the productivity of the marginal
one, as shown by the shaded area. This is the substance of the celebrated law
of decreasing marginal productivity of a variable input.
4.2.4
Profits and Wages
Ricardo’s reasoning that demonstrates the necessity of abolition of corn law1. Given the limited amount of land suitable for cultivation, if corn imports are impeded, this will force the national economy to increase its production by intensifying
investment in agriculture, thus increasing the rent share in the national income and
diminishing the profit share.
2. This slows capital accumulation, as most of the savings necessary to finance investment come from profits.
3. In fact, the landowners, who also earn very high incomes, do not save because
the accumulation of wealth is not among their aspirations; on the other hand, the
workers, who earn subsistence wages, do not save because they have nothing to save.
Long run: The law of falling profit rate
1. He simply assumed that technical progress would not be able, in the long run, to
overcome the economic consequences of decreasing returns in agriculture.
2. He admitted that technical innovations, by increasing the productivity of labour,
could also induce increases in profits.
3. He believed that such effects would only be temporary, however, as the increases
in profits themselves would stimulate further capital accumulation, thus increasing
employment, and would therefore reactivate the catastrophic effects of decreasing
returns.
4. The distributive problem was posed by Ricardo in terms of the decreasing function
linking wages to profits.Reconsidering the equation of labour commanded= l + wp k (1 + r) [Notations have their usual meaning as in Smith.]
The equation now refers to the production obtained from the marginal unit of
investment.
p
w
5. As a consequence of an intensification in cultivation, the productivity of the labour
utilized at the margins will decrease and pass from 1/l to 1/l′ with l > l′ .
The real wages will not change. Assume that the capital coefficient will not change
either. Then we would have,
p
w
= l′ + wp k (1 + r′ )
43
6. It is easy to see that, given w/p and k, the rate of profit will decrease as a consequence of the decrease in labour productivity. In Ricardo’s terms, it is also possible
to say that the profit decreases because, as a result of the intensification of cultivation, the product share necessary to pay for the wages will increase.
Accounting for the varying real wages:
Market Wage:
Depends on the forces of supply and demand for labour.
Natural Wage
When the population and the demand for labour grow at the same rate, wages are
at their natural level, i.e. the one that guarantees the workers, besides survival, the
possibility of reproducing themselves at the rhythm required by the accumulation
of capital.
Ricardo defined the natural wage as a subsistence income, and practically treated
it as if it were an exogenous constant.
7. The increase in the workers’ welfare will stimulate the birth rate and reduce the
death rate ⇒ Market wage > Natural Wage.
8. Thus the supply of labour tends automatically to adjust to demand.
4.2.5
Profits and Overproduction
Malthus’ position in the problem of corn law :
1. Both workers and landowners spend almost all their incomes on buying consumer
goods.
2. Therefore, wages and rents are resolved completely into effective demand.
3. On the other hand, profits are almost entirely saved and invested.
4. If the profit share increases in relation to the wage share, then the incomes paid
to the workers (the wages fund) is not able to provide a level of aggregate demand
sufficient to realize the value of the goods produced by them.
5. According to Malthus, this would lead to a lack of aggregate demand, unless the
rent share were sufficiently high to compensate for that lack; in such a case, the
demand that does not come from the productive workers would come from the
unproductive ones employed at the service of landowners.
6. The Corn Laws were welcome, therefore, if they served to redistribute incomes from
profits to rents.
Error in Malthus’ reasoning as found by Ricardo:
The surplus earned by the capitalists does not reduce the aggregate demand, for the
simple reason that the investments are also demand.
Maltus’ rebuttal :
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1. The profits saved are not necessarily spent; in other words, he would have had to
question the validity of Say’s Law.
2. Malthus did not believed that, ‘the power to purchase necessarily involves a proportionate will to purchase ... ’.
Reply by Ricardo:
1. If there is the purchasing power, there will also be the desire to purchase; savings decisions are motivated by the desire for accumulation, so that they generate
effective demand just as much as consumption decisions.
2. In other words, savings are investment, the decisions to save are decisions to spend.
Say’s law (not an economic law rather an arbitrary assumption), after it was accepted
by Ricardo and advanced again in his Principles, became almost a dogma for classical
economic theory.
Ricardo’s belief in the impossibility of ‘general gluts’ did not imply the thesis of full
employment.
Ricardo, like all classical economists, was convinced that in a competitive regime, not
altered by State intervention, there could be no permanent unemployment in the very
long run.
This was not due to the Malthusian population principle: in the long run the permanently
unemployed would be unable to survive.
In the chapter ‘On Machinery’ added to the third edition of the Principles, Ricardo
admitted that technological progress could force people out of work by replacing workers
by machines, without the rhythm of accumulation of fixed capital being able to reabsorb
them in the short run (as long as 20 years or so).
4.2.6
Discussions on Value [SZ-3.1.6]
Two conflicting views in regard to valueMalthus:
1. Malthus accepted Smith’s theory of price as a sum of incomes and, together with
it, the measure of value in labour commanded.
2. He thought the notion of labour commanded could serve excellently to demonstrate
the argument about the lack of effective demand.
3. The existence of a profit implies that the labour commanded by the goods which
make up the national product is higher than the labour commanded by the wages
fund utilized to produce them.
4. He referred to the price necessary to stimulate a level of production equal to demand.
If the demand was too low, the price of the goods would not allow for the payment
of the costs of production and normal profits.
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5. If Say’s Law is not assumed, this argument is applicable to all the goods produced.
6. Thus a lack in effective demand can trigger a deflationary process that can affect
both the quantities produced and the prices.
Critique:
1. Malthus should have limited himself to studying phenomena of disequilibrium dynamics in order to demonstrate his arguments about general gluts.
2. In fact, his use of the concept of ‘labour commanded’ (which is a natural price) in
relation to demand phenomena did nothing but increase the confusion.
Ricardo:
Ricardo, who undertook all his own studies in terms of natural prices, found it easy to
identify this confusion1. While Malthus calculated the price of the goods by adding up wages, profits, and
rents, Ricardo maintained that rents do not enter into the calculation of prices,
as these are determined at the margin of the cultivated land and therefore do not
include the cost of the use of land.
2. Apart from the question whether rent is or is not an element in the cost of production, Ricardo rejected the additive theory of price, as it conflicted with the
explanation of profits as residual income. We have already touched on this problem
in the previous chapter.
3. Solving the theory of profit as residue:
With reference to the corn model(a) Problems of valuation of the goods do not arise, and the distribution of income
can be determined in physical terms.
(b) To appreciate this it is only necessary to take the equation on p. ? and
normalize it with the price of corn.
1 = wp l + k (1 + r)
1 = wr l + k (1 + r) [as, p ≡ 1]
wr = 1l − kl (1 + r)
(c) An increase in real wages, wr , or a reduction in the productivity of labour,
1/l, results in a reduction of the profit rate, r.
(d) The existence of a decreasing function linking wages to profits is a fundamental
element of Ricardo’s economic theory.
Problems with the theoryProblems arose when this argument had to be demonstrated in an analytical context
in which wages are made up of different goods. The difficulty took various forms
in Ricardo’s analysis.
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(a) When wages increase, the prices of goods must change. Smith believed that
they would increase. In this case, how is it possible to argue that profits would
decrease?
(b) When the prices of all the goods vary, it would seem that the value of the
one chosen as a measure would also vary. How is it possible to distinguish the
variations of the former from those of the latter?
Ricardo believed that he could overcome these difficulties by using a measure of
value which is independent from the distribution of income(a) He rejected the measure in labour commanded, which is not independent.
(b) he adopted,as an approximation, a measure in embodied labour, which is, in
fact, independent from income distribution.
(c) The labour embodied in the net product depends solely on the techniques in
use and does not change with changes in the way in which that product is
distributed.
(d) However, the exchange values of the goods change with the distribution of
income. Therefore they do not depend only on the labour embodied in them.
Ricardo realized this problem and fought with it for all his life(a) He arrived at the solution when he admitted that values depend on the labour
embodied in the goods and on the time required to bring them to the market,
or, rather, on the different proportions in which the various goods are produced
with labour and means of production.
(b) The solution consists in expressing that ‘time’ and those ‘proportions’ in terms
of the time-structure of the labour inputs.
(c) The simplest way to understand thisi. Consider two goods which are produced only by labour.
ii. The techniques with which the goods are produced differ with regard to
the time in which labour is kept invested in the production processes.
iii. p1 and p2 are the monetary prices of the two goods.
iv. l1 and l2 the two labour coefficients.
v. l1 is invested for t1 years, l2 for t2 .
vi. Now let us assume the monetary wage, w, is paid in advance.
vii. Then the two prices, expressed in labour commanded, are:
p1
w
p2
w
p1
p2
= l1 (1 + r)t1
= l2 (1 + r)t2
= ll12 (1 + r)t1 −t2
viii. Relative value of the two good depends on the labours embodied, l1 /l2
and the times of their investment, t1 , t2 .
ix. The relative price is a ratio between the labours commanded.
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x. The measure in labour commanded does not conflict with the conception
of profit as a residue, nor with the thesis of the existence of a decreasing
function linking profits to wages.
This should have been the solution to Ricardo’s problem. Ricardo did not manage to solve this problem satisfactorily, even though he glimpsed the solutioni. The factor that prevented him from taking the decisive step was the notion
of ‘absolute value’.
ii. This notion defines a property of the goods which is intrinsic and independent of their exchange relations—a property linked to their production conditions but not to the way in which the goods themselves are
distributed among the social classes.
iii. This property of goods however, if it exists, cannot have anything to do
with value; yet Ricardo continued to search for the ‘real’ value in it.
iv. Even though he was aware of the difficulties involved with the notion of
‘absolute value’ he never abandoned it.
v. Rather, he attempted to get around the problem by seeking an ‘invariable measure’ of value: a good that, being produced in ‘average’ conditions with respect to the whole system, would possess the virtue, if
taken as a numeraire, of making the value of the net product, and of the
income shares of the various classes, coincide with the quantities of labour
employed in their production.
vi. If the value of net output were measured in terms of a good produced
with a technique in which the ratio between ‘immediate labour’ and ‘accumulated labour’ is equal to that of the whole economic system, then
the following phenomenon would occur: the increase in the prices of some
goods would be compensated by the fall in prices of some others, in such
a way that the value of the net product would not change.
vii. Ricardo knew that such a measure did not exist in nature, but persisted in
seeking a definition that would be acceptable at least theoretically. He was
fooling himself: such a measure is a chimera—in the words of Cannan—or,
according to Marx, a ‘squaring of the circle’.
4.2.7
The Ricardians, Ricardianism, and the classical tradition [SZ-3.2.1]
4.2.8
The anti-Ricardian reaction [SZ-3.2.2]
The socialist utilization of Ricardo’s theory of value and distribution induced many
economists to reject it. These economists formed a heterogeneous group posing ‘antiRicardian reaction’.
Attempts were made to explain value in subjective terms, motivated by the need to reject
the Ricardian labour theory of value. The latter, in the hands of the Ricardian Socialists,
had become a fearful political instrument, in that it seemed to imply that labour is the
only source of value and therefore, since profit is a residue, it also seemed to demonstrate
the exploitation of labour.
Hidden behind the rejection of the objective theory of value was a rejection of the residual
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theory of profit.
Bailey
1. The anti-Ricardian attack to the Ricardian value theory was initiated by Samuel
Bailey, who criticized the idea of ‘absolute value’.
2. According to Bailey, it is only possible to speak of ‘relative value’, a concept that
does not denote anything positive or intrinsic, but just the quantitative relationship
between two goods which are made objects of exchange.
3. Bailey also hinted that the value of a good is nothing more than the valuation given
to it by the economic agents, and that, as a consequence, ‘value’ only denotes an
effect produced in the mind.
4. Bailey avoided explaining value in objective terms.
Nassau William Senior
1. Stated that value depends on the conditions both of supply and of demand.
2. He treated the former in terms of the limitation that supply places on the satisfaction of demand, while he linked the latter to the utility of the demanded goods.
3. Senior also came close to the idea of decreasing marginal utility- “two articles of
the same kind will seldom afford twice the pleasure of one”.
4. He explained profit as a premium for the sacrifice sustained in putting capital at
the service of production. . Here is the famous theory of ‘abstinence’, mother of all
the neoclassical theories of capital.
5. Senior began by postulating that labour and land are the only original productive
forces.
6. He also maintained that the utilization of capital increases the productivity of those
primary factors. But a sacrifice must be made in order to supply capital, and this
represents a third productive requisite: abstinence, the postponement of pleasure
caused by the act of saving.
7. Profit is its remuneration. The rate of profit will therefore depend on the average
period of capital anticipation.
8. Among two different explanations(a) One is of a psychological nature, and treats the remuneration of capital as
depending on the sacrifice sustained in supplying it;
(b) The other, of a technological nature, makes the remuneration of capital depend
on the contribution by investments to the increase in the productive efficiency
of the other factors.
Senior favoured the first explanation.
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The principle of decreasing marginal utility was in the air; all the anti-Ricardian economists
were pondering it1. Longfield approached it with his analysis of the influence that the ‘intensity of
demand’ can have on prices.
Longfield also suggested that the use of machines ease the operations of the worker;
so that profit, being the sum paid for the use of the machines, should be regulated
by the efficiency with which the machines ease productive activity, that is, by the
efficiency of capital.
2. Richard Whately and William Forster Lloyd, the two successors to Senior in the
chair of economics at Oxford, also got very close to it(a) The former even proposed reducing economics to ‘catallactics’, the science of
exchange.
(b) The latter went so far along this path that he should be given credit for having
invented the principle of marginal utility.
Lloyd’s formulationValue depends on ‘a feeling of the mind, which shows itself always at the margin
of separation between satisfied and unsatisfied wants’, so that the demand for
goods depends on the satisfaction they procure, and will vary in relation to
the quantities the subject already holds.
George Poulett Scrope
Profit, according to him, must be considered as a legitimate income, in that it is
necessary to remunerate the capitalist for the period of time during which capital is
employed.
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