NNAMDI AZIKIWE UNIVERSITY, AWKA, ANAMBRA STATE
FACULTY OF SOCIAL SCIENCES
DEPARTMENT OF ECONOMICS
PROGRAMME: MSC 2022/2023
NAME: OLUCHI HAPPINESS ORJI
MATRIC NUMBER: 2022116006FA
COURSE: HISTORY OF ECONOMIC THOUGHT
LECTURER: PROFESSOR SAMUEL OSELOKA
TOPIC: A CRITICAL ANALYSIS OF THE VIEWS OF
MERCANTILISTS, PHYSIOCRATS, MARX, AND KEYNES ON
THE CREATION OF NET WEALTH IN AN ECONOMY.
TABLE OF CONTENT
Introduction to history of economic thought…………………………….
2-4
A critical Analysis of views of mercantilists on
Creation of net wealth in an economy……………………………………..
5-11
From Mercantilist to market economy…………………………………….
11- 12
Present day Mercantilist…………………………………………………...
12-13
Critism of Mercantilist…………………………………………………......
14-14
Justification for Neo- Mercantilist…………………………………….…...
14-15
A critical Analysis of views of Physiocracy
On creation of net wealth in an economy……………………………….....
16-18
Tableau Economique………………………………………………………
18-32
A critical Analysis of views of Karl max
On creation of net wealth in an economy…………………………………
33-37
Scientific Socialism………………………………………………………..
37-39
Three mistakes that changed
The course of history………………………………………………………
39-54
A critical Analysis of views of John Maynard
Keynes on creation of net wealth in an economy…………………………..
55-61
Expectation is determining output and employment……………………….
62-65
Income, savings and investment……………………………………………
65-73
Conclusion………………………………………………………………….. 74-75
References………………………………………………………………….
pg. 1
76-87
INTRODUCTION ON HISTORY OF ECONOMIC THOUGHTS
History of economic thought is the study of how economics have evolved over time.
This study helps us have an insight into the ides and thinking of various economics
thinkers. It keeps students the opportunity to compare and contrast the ideas of these
thinkers. It helps students to know the mistakes made by various thinkers and how
they have been modified and evolved over time.
Economic thought would be taken to cover the set of theories, doctrines, laws, and
generalizations, and analysis applied to the study and solution of economic
phenomena and problems. Economics is a dynamic science, a feature that it acquires
on account of various reasons. This characteristics of it partly follows from the fact
that it is a social science. It brings forth a body of generalizations which, as in other
sciences, involve cause-effect relationships. But from amongst the set of casual
forces at work, the relevant ones have to be sorted out for the problem at hand; and
similarly on the side of effects a sifting grocess has to be undertaken. These tasks
admit of a difference of judgment and opinion. Since human society is a complex
phenomenon, a very large number of causes are likely to be at work in most cases
and different investigators could very well differ as to the choice of the most relevant
causes at work. Investigation could have unearth those forces which were hitherto
thought irrelevant or not of particular importance. Moreover, the identification of
the causal forces at work does not imply that these causes would not change till their
final outcome is encountered. Overtime, the vary roles of specific forces are likely
to undergo a change. The response of economic units (individuals, firms,
governments, etc.) would vary from one situation to the other in view of the
prevailing moral, political, religious and social philosophy as also the institutional
framework of the society.
An economy is a dynamic phenomenon and therefore economic science is a dynamic
one, with social change, new economic questions present themselves. And man‘s
thinking is influenced by his social and physical environment. Economic thought is
influenced by his social and physical environment. Economic thought develops
along two lines. On the one hand, the very dynamism of the an economy provides a
basis for further investigation which provides a basis for further investigation. In a
static and stagnant economy, there is not much scope for furthering the science of
economics. But a changing economy poses newer challenges which economic
pg. 2
thinkers have to meet. Normally over time a dynamic economy would increase in
complexity and would thus demand new and better tools and techniques of analysis,
as also a wider coverage of economic issues.
A study of economic thought, therefore covers both these aspects of the development
of economic thoughts, therefore covers both these aspects of the development of
economic science. The role and growth of each significant theory, the set of theories
and policy prescriptions provided by each ‘school’ and even the significant
contributions by individual economist must be viewed in the context of the prevalent
economic environment. At the same time, the study must take note of the way
economic thought influenced the movement of economies and the resultant effects
on economic science itself. In this connection, it may be pointed out that an
important motivating force in the growth of economic science has been the concern
of the economists with the overall enhancement of efficiency of the economic system
and economic welfare of the society as a whole or its particular sections.
The result is that Economic science is always undergoing a change. Over successive
time intervals, specific sets of economic ideas, theories, doctrines, tools and
techniques acquire recognition and acceptance implying thereby that in different
contexts we have different systems of economic thought. The study of the history of
economic thought, therefore, automatically becomes a study of these various
systems of economic thought. However with the passage of time, there has been a
development in the concepts acquired greater precision and new concepts were
continuously introduced to cope with the emerging theoretical and practical
problems. Along with the development of concepts there has also been a sharpening
of the tools and technique of analysis.
In this connection, we should keep in mind the distinction between economic ideas
as such and economic science or economics proper. Economic ideas have been there
since time immemorial, but it is only recently that they assumed the form of a system
of thought which may be termed economic science or economics. Reference to
economic questions were scattered almost everywhere in old literature. They found
Plato, Aristotle and others, for example, discuss currency, population and slavery.
But in all these cases, we have only fragments of information and analysis. So long
as we are not able to adequately generalize on these economics ideas and economics
ideas and economic views with great significance, we cannot claim the emergence
pg. 3
of economic thought. In that sense the time when these ideas started getting
crystalized into economic thought is around the time of mercantilism. ’The birth of
economic science might have coincided with the rise of physiocracy, because it is in
the system that for the first time we find a comprehensive economic theory. There
are theoretical underpinnings of the economic investigations and policy
prescriptions. There is logical reasoning involved in the process of arriving at
conclusions, and there is also an aspect of abstract theorizing. It is only at this stage
the formation and cohesion that economic ideas collectively becomes economic
thought.
It should be noted that in the early stages of Economic development, the share of
economic problems, in the totality of social life was a small one, both in absolute
and in relative sense, and therefore, there was not much to study by way of pure
economics. Early human civilization grew and prospered in warmer climates, near
arrears where nature was bountiful. There was not much of a difficulty in procuring
the means of livelihood for the simple life which those people led. As a result
economic problems did not appear as pressing as they did in later times. The lack of
interest in a number of problems naturally hindered the growth of economics. The
typical Organization and philosophy were such that there was not much concern
about the economic welfare of the society as a whole.
With the passage of time, the forces restricting the development of economics have
given way to those which favor it. The expanding economic activities of modern
governments are playing an active role in the development of economic science.
Their operations provide an important segment of the totality of economic
phenomenon on the one hand and have helped in the provision of necessary
infrastructure for the growth of economic science on the other.
Though it is therefore realized that the least government can do is to ensure that its
budgetary and other activities do not cause obstruction in the way of the society in
achieving its goals, in practice, the governments are actively engaged in guiding and
influencing their economies along proper lines.
pg. 4
A CRITICAL ANALYSIS OF VIEWS OF MERCANTILISTS ON
CREATION OF NET WHEALTH IN AN ECONOMY
Originating in 16th-century Europe, mercantilism began with the emergence of the
nation-state. The dominant economic theory was that the global supply of wealth
was finite, and it was in the nation’s best interest to accumulate as much as possible.
During that time, wealth was measured by a country’s quantity of silver and gold.
To accumulate more wealth, European countries, such as Britain and France, would
focus on maximizing their exports and minimizing imports, which resulted in a
favorable balance of trade.
For countries with a negative trade balance with a mercantilist country, the
difference would be paid back in silver or gold. To maintain a favorable trade
balance, the early mercantilist countries would enact imperialist policies by setting
up colonies in smaller nations.
The aim was to extract raw material to send back to the home country, where it
would be refined into manufactured goods. The goods would then be resold to the
colonies, allowing early mercantilist nations to accumulate wealth through a positive
trade balance.
MERCANTILIST IDEOLOGY
Mercantilism originated in a series of sixteenth, seventeenth and eighteenth
century writings in England that had their origins in policy pamphlets, and evolved
into larger disquisitions and debates on trade policy (Malynes 1601; Mun 1664;
Misselden 1622; Coke 1670; Child 1693; Steuart 1767). Mercantilists frequently
disagreed with each other on actual policy, but there was a common core to their
writings. In many ways, the content of mercantilism itself is less interesting than the
historiography of mercantilism over the subsequent two centuries. Because
economists have long rejected its tenets, mercantilism has been defined more by its
adversaries than its proponents (Schumpeter 1956:336; Irwin 1996).
As an economic theory, mercantilism relies on government intervention to regulate
international trade and protect domestic industries. Mercantilist policies involve the
protection of domestic corporations through regulations and the promotion of trade
surpluses. In the context of international trade, a favorable trade balance is achieved
through government regulations, such as tariffs and restrictions on imports.
pg. 5
On the domestic side, mercantilist policies support domestic industries by
establishing monopolies and allocating capital to encourage growth. Such policies
are a form of economic protectionism meant to encourage self-sufficiency and are
in direct opposition to the free-market economics of trade and globalization.
Indeed, the term “mercantilist,” like “protectionist,” is strictly used as a pejorative
in modern economic discourse. Krugman (1997:114), for example, laments: “The
implicit mercantilist theory that underlies trade negotiations does not make sense on
any level…but it nonetheless governs actual policy.” To be sure, this scorn has some
intellectual validity, but it also emanates from two additional factors. First,
neoclassical economics is uncomfortable with factoring in the pursuit of noneconomic objectives – an essential feature of mercantilist thought (Maneschi 2004).
Second, there is an unresolved debate over placing mercantilism in the proper
historical context.
Mercantilism involves

Restrictions on imports – tariff barriers, quotas or non-tariff barriers.

Accumulation of foreign currency reserves, plus gold and silver reserves.
(also known as bullionism) In the sixteenth/seventeenth century, it was
believed that the accumulation of gold reserves (at the expense of other
countries) was the best way to increase the prosperity of a country.

Granting of state monopolies to particular firms especially those associated
with trade and shipping.

Subsidies of export industries to give a competitive advantage in global
markets.

Government investment in research and development to maximize the
efficiency and capacity of the domestic industry.

Allowing copyright/intellectual theft from foreign companies.

Limiting wages and consumption of the working classes to enable greater
profits to stay with the merchant class.

Control of colonies, e.g. making colonies buy from Empire country and taking
control of colonies wealth.
pg. 6
The policy prescriptions of mercantilists were hardly uniform, but there was
consensus on three points. First, in the absence of domestic mines, states should
secure a favorable balance of trade in order to acquire as much specie – gold and
silver bullion – as possible. To affect the increase in bullion, states should secure a
positive balance of trade. In a typical passage, Thomas Mun (1664:7) wrote, “the
ordinary means…to increase our wealth and treasure is by foreign trade wherein we
must ever observe this rule: to sell more to strangers yearly than we consume of
theirs in value.” Smith (1776:159) noted that, “the encouragement of exportation,
and the discouragement of importation, are the two great engines by which the
mercantile system proposes to enrich every country.” Mercantilists proffered
multiple reasons for this policy preference – increasing the amount of money in
domestic circulation, boosting domestic employment, raising prices – but the first
reason was almost always the hoarding of money in the form of specie. Indeed, as
Wilson (1950:152) points out, even the motivation to boost employment appears to
have been “seen as a means to increase bullion supplies rather than vice versa.” Viner
observed that, “statements involving…the attribution of value to the precious metals
alone…abound in the mercantilist literature.” (1930:266)
Second, mercantilists preferred a particular composition of traded goods.
Manufactures were to be exported, because they contained more embodied labor and
value-added, while commodities were to be imported. Again, this flowed naturally
from the mercantilist effort to secure a positive balance of trade; In his Report on
Manufactures, Alexander Hamilton observed a positive correlation between the
“abundance of specie” and a “flourishing state of manufacture.” The growth of
domestic manufactures also had a direct effect on power and plenty. Hamilton wrote,
“Not only have the wealth but the independence and security of a country appeared
to be materially connected with the prosperity of manufactures. Every nation, with
a view to these great objects, ought to endeavor to possess within itself all the
essentials of national supply.” (1791[1913]:33).
Third, and most important, mercantilists held that commerce was supposed to
augment state power. The rise of mercantilism as a doctrine matched the rise of the
nation–state as the primary political unit in Europe. Mercantilist ideas supplanted
older feudal and scholastic doctrines, serving to overcome the “medieval
particularism” of prior doctrines (Heckscher 1935; De Roover 1955). Heckscher
observes that, “the state was both the subject and object of mercantilist economic
pg. 7
policy.” (1935:21). Mercantilists believed that the creation of a favorable balance of
trade would increase state power. The hoarding of specie, for example, was primarily
useful for paying the large standing armies that became the norm in seventeenth
century Europe.
Examples of mercantilism

England Navigation Act of 1651 prohibited foreign vessels engaging in
coastal trade.

All colonial exports to Europe had to pass through England first and then be
re-exported to Europe.

Under the British Empire, India was restricted in buying from domestic
industries and was forced to import salt from the UK. Protests against this salt
tax led to the ‘Salt Tax Revolt’ led by Gandhi.

In seventeenth-century France, the state promoted a controlled economy with
strict regulations about the economy and labor markets

Rise of protectionist policies following the great depression; countries sought
to reduce imports and also reduce the value of the currency by leaving the
gold standard.
Some have accused China of mercantilism due to industrial policies which
have led to an oversupply of industrial production – combined with a policy
of undervaluing the currency.

However, the extent of mercantilist policies are disputed
Many of the ideas that made up classical mercantilism have been discredited. The
equation of specie with wealth represented a clear flaw of economic logic. Similarly,
the emphasis on production overlooks the role that domestic consumption plays as a
key source of modern economic growth (Smith 1976[1776]) – as well as modern
economic power (Drezner 2007).
There has been a fierce debate within the history of economic thought over the
precise motivations of the mercantilists. Smith (1776[1976]:180) accused
mercantilist writers of developing policy prescriptions based on the interests of
producers at the expense of consumers. Viner (1937:59) concurs, noting that, “the
pg. 8
great bulk of the mercantilist literature consists of tracts which were partly or wholly,
frankly or disguisedly, special pleas for special economic interests.” Ekelund and
Tollison (1981) characterize mercantilism as a rent-seeking strategy by its
proponents. This would suggest that mercantilism functioned primarily as an
intellectual “hook” for ideas that served particularistic interests (Krasner 1993).
This assertion is far from clear, however. Schumpeter (1954:347) dismisses the
claim that mercantilists were only making self-serving arguments as “bad
sociology.” He points out that at various times mercantilists acknowledged either the
short-term economic costs of their policy prescriptions, or argued against narrow
self-interest. Even skeptics (Viner 1937:117–8) acknowledge that mercantilist ideas
had an autonomous effect on policy. Other powerful interests – such as the landed
gentry – were unable to develop ideas that rebutted the ideas of mercantilists. In part
this was because the policy prescriptions of mercantilists – thrift and security –
resonated with the sentiments of the era (Appleby 1976; Coleman 1980). At a
minimum, these ideas were powerful enough to keep the British economy closed off
from France following the 1713 Treaty of Utrecht. Economic, political, and
intellectual historians of the era have observed that the mercantilist doctrines
independently affected both foreign economic policy and grand strategy (Appleby
1976; Sofka 2001; Nye 2007).
Given the economic and political realities of the era, there was an inherent logic to
mercantilism. Heckscher (1935:25) observes that mercantilism “was bound up with
a static conception of the total economic resources of the world.” Recent research in
economic history (Clark 2007) suggests that in fact the size of the English economy
had been stagnant for much of the previous two millennia. In a world in which the
total size of the economic pie appeared to be fixed, the pursuit of both power and
plenty demanded a relative gains calculus. Even if one does not accept such a strong
assertion about pre-1800 growth, the logic is still compelling. The discovery of new
colonies, resources and markets in Asia and the Western hemisphere appeared to be
the primary impetus for growth during the mercantilist era. With a one-off increase
in wealth available to those states with the power to control the trade, mercantilist
writers like William Petty (1690:82) still believed “there is but a certain proportion
of trade in the World.” Josiah Child (1693:160) urged the government to expand its
share of trade, to the detriment of other great powers. Clearly, both relative and
absolute gains logics led to mercantilist policy prescriptions (Irwin 1991; 1992).
pg. 9
Many economists do acknowledge that the political conditions made mercantilist
policies a natural equilibrium (Schumpeter 1954:339; Hirschman 1977:79). War,
imperialism, colonization and conquest were constant features of the sixteenth,
seventeenth and eighteenth centuries. Monarchs across the continent were engaged
in a sustained effort to consolidate the power of the state and develop a monopoly
over coercive force (Tilly 1992). In such a climate, the need for reserves and the
pursuit of power were hardly noneconomic objectives (Wilson 1950). It is not
surprising that mercantilist tracts in England focused on the Netherlands during the
seventeenth century and the French in the eighteenth century (Viner 1937). This
corresponded to when those states challenged England for primacy in Europe and
elsewhere. Similarly, Hamilton (1791) focused on the myriad ways in which
European states blocked manufacturing imports from the United States. On the other
hand, the effect was likely reciprocal; mercantilist attitudes undoubtedly contributed
to the trade wars of the time (Sofka 2001).
In this kind of international environment, deviation from mercantile policies was not
necessarily the rational course of action (Schmoller 1897:73; Sofka 2001). Findlay
and O’Rourke (2007:239) point out the incentive incompatibility of unilaterally
attempting to apply the doctrine of free trade during the mercantilist era: “One has
to ask, what was a realistic counterfactual for an individual European nation state
choosing to unilaterally embrace peaceful free trade? In the absence of anything
resembling an effective collective security mechanism, or a clearly defined
hegemonic power, military defeat and exclusion from foreign markets seems to us
as plausible an answer as any.”
Mercantilism lost its intellectual vitality during the first half of the nineteenth
century. David Hume (1997 [1752]) had already attacked the monetary dimension
of mercantilism, with the development of the price–specie–flow mechanism.
Smith’s Wealth of Nations attacked the trade dimension of mercantilism. With the
publication of David Ricardo’s (1817) Principles of Political Economy and
Taxation, mercantilism’s intellectual credibility in England collapsed – though it
took another generation for laissez-faire ideas to seep into Britain’s economic
culture and British foreign economic policy (Rohrlich 1987). Since then, mercantilist
ideas have re-emerged in two situations. Rising and developing powers have
occasionally embraced the doctrine as a pathway to accelerate political and
pg. 10
economic development. Great powers in perceived decline have also been receptive
to the idea as a possible means to reverse their fall.
The German Historical School was premised on the belief that national economic
policies should flow from the verstehen that builds up within nation–states
(Swedberg 1991). Modern scholars of economic nationalism (Helleiner 2002;
Pickel 2003; Nakano 2004) argue that this approach differed from classical
mercantilism, focusing more o development than trade or finance. It is certainly true
that the German Historical School was less concerned about specie than the English
and continental mercantilists. Still, beginning with Friedrich List, this school of
thought shared many traits with classic mercantilism, including the emphasis on
using trade policies and tariffs as a means to promote domestic economic
development. List (1841[1856]:354) stressed that the anarchical structure
profoundly affected the patterns of international economic exchange: “The imports
and exports of independent nations…depend mostly on commercial policy and the
power of a country, on its importance in the world, its influence over foreign nations,
its colonial possessions and institutions of credit, finally, on peace and war.”
From Mercantilism to the Market Economy
By the end of the 18th century, scholars, such as Adam Smith and David Hume,
began to evaluate and critique the merits of mercantilist theory. Contrary to
established beliefs, the scholars realized that wealth was not finite, but could be
created through the productive allocation of labor.
Mercantilist policies also failed to account for the benefits of trade, such as
comparative advantage and economies of scale. When countries specialize in the
production of goods for which they enjoy a comparative advantage, trade can result
in mutually beneficial deals. Such a realization resulted in the emergence of the
market economy, where prices and means of production were driven by the forces
of supply and demand.
Under a mercantilist system, the restriction of imports meant consumers obtained
access to fewer goods at higher prices. Under a system of free trade, consumers
benefit from lower prices due to increased competition and greater access to goods
from across the world. Mercantilism stands in contrast to the theory of free trade –
pg. 11
which argues countries' economic well-being can be best improved through the
reduction of tariffs and fair free trade.
The younger generation of the German Historical School was less interested in the
policy particulars of mercantilism and more interested in the statebuilding dimension
of the doctrine. Schmoller (1897:50–51) observed that mercantilism “in its
innermost kernel, it is nothing but state making – not state making in the narrow
sense, but state making and national economy making at the same time; state making
in the modern sense, which creates out of the political community an economic
community, and so gives it a heightened meaning.” Schmoller, like List, was not
implacably opposed to free trade. Both writers, however, pointed out the correlation
between a nation–state’s position in the international distribution of power and its
economic policy preferences. Only after the United Kingdom achieved economic
primacy did official British policy switch to laissez-faire. This observation is
thoroughly consistent with realist takes on how a state’s position in the international
system structures their preferences in the global political economy (Krasner 1976;
Grieco 1990).
PRESENT-DAY MERCANTILISM
Although mercantilism is mostly viewed as an outdated economic theory, there has
been an emergence of mercantilist policies in recent times. Present-day mercantilism
typically refers to protectionist policies that restrict imports to support domestic
industries. It can sometimes be referred to as neo mercantilism.
Modern mercantilist policies include tariffs on imports, subsidizing domestic
industries, devaluation of currencies, and restrictions on the migration of foreign
labor. Mercantilist policies can also explain the recent escalation of tariffs and trade
restrictions between the US and China.
In the modern world, mercantilism is sometimes associated with policies, such
as:

Undervaluation of currency. e.g. government buys foreign currency assets to
keep the exchange rate undervalued and make exports more competitive. A
criticism often levelled at China.

Government subsidy of an industry for unfair advantage. Again China has
been accused of offering state-supported subsidies for industry, leading to
pg. 12
oversupply of industries such as steel – meaning other countries struggle to
compete.

A surge of protectionist sentiment, e.g. US tariffs on Chinese imports, and US
policies to ‘Buy American.’
In economics, the emergence of strategic trade theory (Brander and Spencer
1985; Krugman 1986) provided some mercantilist policies with a formal
theoretical foundation. In sectors with increasing returns to scale, export bounties
and domestic protection could increase national income. It is interesting to note
that in Brander and Spencer’s original model, utility was derived strictly from
production and not consumption – much like the mercantilists of the sixteenth
century. Indeed, Irwin (1991; 1992) used strategic trade theory to explain the
trade wars of the seventeenth century. The chartered trading companies of the
mercantilist era shared some of the qualities of posited firms in the strategic trade
model. Nevertheless, strategic trade theory had a short half-life, as other
economists highlighted the fragility of the model’s assumptions. (Horstmann and
Markusen 1986) By the early nineties, even sympathizers like Paul Krugman
(1992) acknowledged that the policy applications of the theory were
exceptionally narrow.
Mercantilist thought has clearly evolved over the centuries. The obsession with
specie faded away. The emphasis on the balance of trade lessened, though not
disappeared. The composition of the trade balance has waxed and waned and waxed
in importance. As Gilpin (1975:25) concludes:
One must distinguish…between the specific form mercantilism took in the
seventeenth and eighteenth centuries and the general outlook of mercantilistic
thought. The essence of the mercantilist perspective, whether it is labeled economic
nationalism, protectionism, or the doctrine of the German Historical School, is the
subservience of the economy to the state and its interests – interests that range from
matters of domestic welfare to those of international security.
CRITICISMS OF MERCANTILISM

Adam Smith’s “The Wealth of Nations” (1776) – argued for benefits of free
trade and criticized the inefficiency of monopoly.

Theory of comparative advantage (David Ricardo)
pg. 13

Mercantilism is a philosophy of a zero-sum game – where people benefit at
the expense of others. It is not a philosophy for increasing global growth and
reducing global problems. Trying to impoverish other countries will harm our
own growth and prosperity. By contrast, if we avoid zero-sum game of
mercantilism increasing the wealth of other countries can lead to selfish
benefits, e.g. growth of Japan and Germany led to increased export markets
for UK and US.

Mercantilism which stresses government regulation and monopoly often lead
to inefficiency and corruption.

Mercantilism justified Empire building and the poverty of colonies to enrich
the Empire country.

Mercantilism leads to tit for tat policies – high tariffs on imports leads to
retaliation.

The growth of globalization and free trade during the post-war period showed
possibilities from opening markets and respecting other countries as equal
players.

Economies of scale from specialization possible under free trade.
Justification for neo-mercantilism
Despite many criticisms of mercantilism, there are arguments to support the
restriction of free trade in certain circumstances.

Tariffs in response to domestic subsidies. Supporters argue that since China’s
steel is effectively subsidized leading to a glut in supply, it is necessary and
fair to impose tariffs on imports of Chinese steel to protect domestic producers
from unfair competition. US tariffs on imports of steel from China 266%. In
Europe, tariffs are 13%.

Protection against dumping. If some countries have an excess supply of goods,
they can sell at a very low price to get rid of the surplus. But, this can make
domestic firms unprofitable. Protectionism can be justified to protect against
this dumping. Examples, include EEC dumping excess agricultural
production on world agricultural markets and China’s dumping of steel.
pg. 14

Infant industry argument. For countries seeking to diversify their economy,
tariffs may be justified to try and develop new industries. When the industries
have developed and benefited from economies of scale, then the tariffs and
protectionism can be dropped.
pg. 15
A CRITICAL ANALYSIS OF PHYSIOCRATS ON CREATION OF NET
WHEALTH IN AN ECONOMY
The physiocrats were French economists of the 1700s who helped launch the field
of economics as a science. Economists study the transfer and policies behind money
in society. At a time when France was a monarchy and the economy was suffering
from wars and poor taxation policy, the physiocrats opposed the common market
policy of the time. They developed what was seen as a radical approach that stressed
the importance of agriculture and elevated the status of the farmer, who had been on
the lowest rung of the socio-economic ladder but was then hailed as the engine of
the entire economy. Influenced by Enlightenment philosophers such as René
Descartes and John Locke, physiocracy contended that a perfect God created a
perfect universe and that economic intrusions such as high tariffs and price controls
upset the natural state that, if left alone, would lead to prosperity and human
flourishing. They believed the best policy was one of laissez-faire, French for "let it
be," that called for minimal governmental interference in the economy.
In 18th-century France, the economy was suffering as a result of several expensive
wars, such as the Seven Years' War, the French and Indian War, and the AngloFrench War. As a result, taxes were necessary to keep the country afloat. However,
because taxes were not paid by royalty or clergy but only by the working poor,
revenues decreased while poverty increased. Tax collectors were paid based on how
much they collected, so they were heartless in taking the little wealth and few
possessions of working citizens. Artisans and farmers were unable to afford what
they needed to do their jobs, and as a result, the entire economy suffered. From this
problem, the physiocrats shaped their ideas.
At the same time, the Dutch and British economies, which were more industrial and
exported goods that were built or crafted, were much better than France's, which was
dominated by agriculture. To protect their industries, the Dutch and British
governments put high tariffs in place, causing people with wealth in France to pay a
premium for foreign goods that suited their lavish lifestyle. Seeing how an
agricultural output without tariffs worsened their economic state, France
implemented similar policies.
In reaction to France adopting the British and Dutch approach, the new French
school of physiocrats arose, proposing a different set of policies to bolster the French
pg. 16
economy. Instead of seeing industry and craft as the foundation of the economy, they
argued that agriculture was the basis of all wealth. Because artisans took raw
materials and combined them, they created nothing new, but farmers were unique in
generating new goods. One ear of corn used as seed could give rise to dozens of new
ears of corn. They argued that agriculture is the source of growth on which the rest
of the economy is based. As such, physiocrats believed government policy should
support agriculture first and foremost, instead of treating the amount of wealth at the
top of the socio-economic ladder as the primary concern.
Physiocracy was launched with the work of Victor de Riqueti, Marquis de Mirabeau,
who wrote a book of economic philosophy, L'Ami des hommes ou Traité de la
population (The Friend of Man, or Treatise on Population). Mirabeau took a holistic
view of the economy instead of focusing only on the outcomes for people with
wealth. He compared the country to a tree, with agriculture as its roots, labor as the
trunk, and artistic and commercial output as the leaves.
Physiocracy is a school of thought founded by François Quesnay (1694-1774), a
court physician to King Louis the 15th. At one point in time Physiocracy constituted
a sort of religious movement that attracted a number of outstanding and extremely
fervent believers, and exerted no small influence on real politics. The history of the
Physiocratic movement is thought to have begun in 1757, when Quesnay met
Mirabeau the elder (1715-89), and come to an end in 1776, with the fall of Turgot
(1727-81). The actual members of the Physiocratic school referred to themselves not
as Physiocrats but as économistes. The term “physiocracy” apparently came into
general use after having first appeared in 1767, with the appearance of a collection
of Quesnay’s works published by Pierre du Pont under the title Physiocratie, ou
Constitution Naturelle du Gouvernement le Plus Avantageux au Genre Humain. The
term is of course a combination of “physio” (nature) and “cracy” (rule), thus
meaning the “rule of nature.” This expresses the school’s fundamental idea that there
is a natural order, as opposed to artificial systems, and that the mission of scholarship
and politics being to understand this natural order and bring it into existence, thereby
bringing about this rule of nature.
The physiocrats argued that a robust agricultural sector would create additional
wealth that would spread throughout an entire economy. Economic growth was
pg. 17
literally grown from the soil, they thought. As a result, domestic production and sales
ought to be the focus of government economic policy.
French economic advisers of the period who had the ear of the king preached the
mercantilist line: that the king's treasury most benefitted by exporting more than they
imported, creating a positive trade imbalance. But this approach required creating
new markets and ensuring a constant flow of cheap, raw materials. This required
colonization, which in turn required a robust military. Its soldiers would need to be
paid, fed, housed, and armed with weapons that would need to be replaced. This was
a drain on the nation's labor force and treasury. The physiocrats pointed out that
reorienting the economy to an agrarian basis limited these costs. The country would
focus on feeding itself and exporting any surplus, but that little bit sent abroad would
have minimal impacts on the amount of food for the citizens and the local prices.
They argued that, instead of the governmental intrusions in the markets with high
taxes, high tariffs, and fixed prices, the market should be allowed to find its own
natural state with little interference. This was a policy of the government allowing
the market to find its own natural state of functioning with little interference, termed
"laissez-faire," a phrase popularized by well-known physiocrat Jacques Claude
Marie Vincent de Gournay. This policy would allow the economy to become selfcontained and self-sustaining.
Tableau Economique
Quesnay’s Tableau Economique, which is the essence of his system of political
economy, is a diagram that depicts the process of social reproduction under the
“natural order.” It was printed at Versailles in 1758, with a print run of just four
copies. Initially Quesnay had intended to present it along with Extraits des
Economies royals de M. de Sully but gave up this idea on the advice of Madame de
Pompadour. But the manuscript containing it, written in Quesnay’s own hand, was
discovered among the papers of Mirabeau in 1890 in the Archives Nationales by
Professor Stephan Bauer. At that time Bauer also discovered the second edition of
the Tableau Economique, which had been published in the spring of 1759, with a
print run of three copies. At the end of that year a third edition of three copies was
published, which was later discovered by Gustave Schelle. In addition to these
editions, there is the Tableau Economique avec ses Explications included in
Mirabeau’s L’Ami des Hommes (1760), as well as the table in
pg. 18
Mirabeau’s Philosophie Rurale (1763) and L’Elements de la Philosophie
Rurale (1767), and the tables that appear in other works. The figures in the various
tables are somewhat different, but the basic structure is the same.
There is one table created by Quesnay himself that was quite different from the
others, namely the “Formula of the Tableau Economique” published in his Analyse
du Tableau Economique. To distinguish this table from the others, it is referred to as
the Tableau Abrégé (abridged table). Quesnay set out in Analyse du Tableau
Economique to clarify the true significance of his economic table, in a manner
accessible to the general public, and the table was revised accordingly. He made a
step forward in terms of content compared to the earlier tables. Most importantly,
whereas previous tables had depicted the circulation between the three main classes
as circulation between individuals belonging to each of those classes, the Tableau
Abrégé depicts this from the outset as circulation between classes as a whole. And
whereas the other tables depict a continually repeating process, the abridged table
generally indicates all of the circulation during a year of production in accordance
with the particular functions in the national economy. Furthermore, the relations of
reproduction for each type of “advance” (capital) are clarified to a much greater
extent. Thus, although the Tableau Abrégé, as its name indicates, is much more
simplified, Quesnay’s simplification eliminated the extraneous and held on to the
necessary. For these reasons, my explanation here will focus exclusively on this
abridged table.
pg. 19
Quesnay’s Tableau Abrégé in Analyse du Tableau Economique is displayed above
(Diagram I), and below it is the revised version of Prof. Bauer (Diagram II). [2]. In
the Tableau Economique, the country is broadly divided into three classes: the
productive class (classe productive), the class of proprietors (class des propriétares),
and the sterile (or unproductive) class (classe sterile).
The productive class comprises those involved in agriculture. We should note,
however, that the term refers to capitalist entrepreneurs who rent land and hire
workers, so it is premised here that agriculture is conducted under capitalistic
methods. This class is said to be “productive” because it alone is thought to produce
the produit net (net product), which is the surplus over and above what is consumed
in production. The class of proprietors includes proprietors in a particular sense, i.e.
landowners, as well as the lords and the tithe-owners who earn a ten percent tax
(décimateur). This class lives by obtaining profit created by the productive class,
pg. 20
rather than engaging in productive endeavors themselves. Finally, the sterile
class includes those engaged in affairs outside of agriculture. This class is called
“sterile”—or unproductive—because they were thought to only add to the value of
the raw materials—which are supplied by the productive class—the value of the
materials of livelihood that they also received from the productive class.
Quesnay’s economic table seeks to elucidate the manner in which simple
reproduction is carried out in a closed-off nation that comprises these three classes.
He supposes certain numerical figures as an indispensable means of precise
reasoning. These figures were apparently based on the results of a survey of
capitalist-run agriculture in one region of France, with Quesnay supposing that the
same production methods are carried out nationwide. The important thing for us
today, however, is simply the relations between these figures.
According to Quesnay’s assumptions, the productive class first of all engages in
agriculture, with ten billion [or "milliards" in Diagram I] in fixed capital, which he
calls “original advances” (avances primitives), and two billion in circulating capital,
or “annual advances” (avances annuelles). Of course, the ten billion in fixed capital
is not used up every year, and the annual cost of maintaining this fixed capital is
estimated to be one-tenth of its total value, or one billion (which Quesnay calls les
intérets des avances primitives). The productive class, therefore, expends a total of
three billion on production every year.
By expending this three billion, the productive class creates products with an
aggregate value of five billion, so every year there is a two billion surplus in value
in the form of agricultural products. This surplus of two billion, or rather the surplus
agricultural products valued at two billion, is what Physiocrats call the “net product”
(produit net). This net product is subsequently paid to the class of proprietors in the
form of rent, the 10-percent tax, etc. It is assumed, however, that this is a monetary,
not an in-kind, payment. So it is also supposed that at the end of the year of
production, the productive class will have, in addition to an agricultural product with
a value of five billion, two billion in money that can be used to pay rent.
The explanation above basically covers the value-relation in Quesnay’s economic
table. Turning to its material content, the three billion in money the productive class
spends during a year of production is made up of two billion in agricultural goods
and one billion in manufactured goods, which by the end of the production process
pg. 21
has been transformed into five billion in agricultural goods. Thus, comparing the
beginning and the end of annual production, we see first of all that the two billion in
agricultural goods has been reproduced in that same form, as agricultural goods, and
the one billion in manufactured goods has been replaced by one billion in agricultural
goods, while there are two billion in newly created agricultural goods as well.
Incidentally, for the total product of five billion, the first, two billion component
does not enter circulation and is used instead to replenish one part of the capital of
the productive class. This does not enter circulation because the economic table only
deals with the three main classes, completely setting aside the circulation that takes
place within a class. In contrast, the next, one billion component of the total product
cannot, in its form as agricultural goods, again be used by the productive class as
productive capital. In order to return this capital of the productive class to a form
that is useful in production, it needs to be exchanged for one billion in manufactured
goods. Finally, the remaining two billion component of the product, which
represents the surplus, covers the two billion in value that must be paid as rent.
Therefore, the nature of this two billion in money used to pay rent is such that after
it has flowed back to the productive class it is exchanged with that other class. Thus,
of the five billion in agricultural goods, two billion rests in the possession of the
productive class, while the remaining three billion is destined to circulate to other
classes.
Next, it is supposed that the class of proprietors receives two billion in income every
year. This yearly income, as noted already, represents the net product (surplus in
value) created through agriculture in a year, and is payment for the use of land.
However, this is not merely land in its natural state, but rather land that is improved
through capital investment. Therefore, this two billion in revenue also includes the
value to replace the capital invested in the land (which Quesnay calls les avance
forcièrs—i.e. the capital invested for the initial reclamation of the plot of land, the
construction of buildings needed for cultivation, and the creation of irrigation canals,
drainage, and roads). It is assumed that this revenue is paid in money, not in-kind.
Finally, it is assumed that the sterile class invests one billion of capital on raw
materials and consumes one billion in materials of livelihood during the course of
the year of production, thereby creating two billion in manufactured goods.
Furthermore, because it is also assumed that these raw materials and materials of
pg. 22
livelihood are composed of agricultural products, it is necessary for the total product
of this class to enter circulation and be exchanged for the one billion in raw materials
and one billion in materials of livelihood.
The circulation depicted in the economic table, under the conditions outlined above,
begins with two billion in rent being paid by the productive class to the class of
proprietors. This rent comes from the two billion surplus in value created in a year
by the productive class, and is paid in money as is suitable to capitalistic production.
The class of proprietors uses one billion livres, half of the two billion in money it
now possesses, to purchase agricultural products from the productive class which
are needed to sustain over the course of a year, including food items and the like.
One billion of money is thus returned to the productive class, which has now
disposed of one-fifth of its total product (in Bauer’s diagram the downward I arrow
represents the flow of money, while the commodity the money is exchanged for
flows in the opposite direction).
With its remaining one billion livres, the class of proprietor’s purchases
manufactured goods from the sterile class, such as furniture, clothing, etc. So the
sterile class converts half of its product into money. This money is then used by the
sterile class to purchase needed agricultural goods, such as food, which results in a
further one billion in money returning to the productive class, which has thus
disposed of the second fifth of its total product.
The productive class then spends the one billion in money received to purchase
manufactured goods from the sterile class, such as agricultural implements to replace
those worn out in the course of production. As a result, one billion in money flows
to the sterile class, which thus discards the remaining one billion of its total product
that was worth two billion. The sterile class then uses the one billion in money to
purchase from the productive class the food items needed over the course of a year.
This means that one billion in money again flows to the productive class, which has
unloaded the third fifth of its total product.
If we examine the outcome of this circulation, the entirety of the two billion product
of the sterile class and three-fifths of the five-billion product of the productive class
have been successfully sold, reaching the hands of the intended consumers. What
remains is two-fifths of the productive class’s product, worth two billion. As already
pg. 23
noted, however, this remaining product is made up of the grain and foodstuffs the
productive class itself requires. Instead of entering the circulation between the three
main classes, this is used as is straight away in order for the capital of the productive
class to again assume a productive form. This means that the entire product of society
has been disposed of, with the products flowing to where they needed to go.
That is not all, however. At the same time, two billion in money has returned to the
hands of the productive class, and the two billion in yearly advances and the one
billion that is the worn-out part of the original advances are covered and replenished.
Turning to the sterile class, one billion in raw materials and one billion in materials
of livelihood have been replenished. Finally, the class of proprietors possesses the
one billion in agricultural goods and one billion in manufactured goods that make
up its yearly materials of livelihood. This means that the conditions for a year of life
are fully in place, for each of the classes of society, thus ensuring their continued
existence, while at the same time putting in place the necessary conditions for
production to be carried out on the same scale as initially premised. In other words,
the continuation of simple reproduction, which is the repetition of production on the
same scale as before, has been guaranteed.
Here we have presented the gist of Quesnay’s economic table. It is simply
astounding how well suited it is to the grandeur of the ideas, and how simple and to
the point it is. Mirabeau may miss the mark in various ways when he says that “there
have been, since the world began, three great inventions” with the first being the
“invention of writing” the second the “invention of money” and the third the
“economical Table,” [4] but it is an undeniable fact that Quesnay’s table is one of the
most revolutionary achievements within the history of political economy,
representing the moment when this field of study finally reaches the point of
constituting a scientific system. Not only was the Tableau Economique the
first system of political economy, it is also remarkable in the sense that it was the
only attempt, prior to Marx, to depict the reproduction of the total social
capital. [5] Marx appropriately noted that:
[Quesnay’s Tableau Economique] was an attempt to portray the whole production
process of capital as a process of reproduction, with circulation merely as the form
of this reproduction process; and the circulation of money only as a phase in the
circulation of capital; at the same time to include in this reproduction process the
pg. 24
origin of revenue, the exchange between capital and revenue, the relation between
reproductive consumption and final consumption; and to include in the circulation
of capital the circulation between consumers and producers (in fact between capital
and revenue); and finally to present the circulation between the two great divisions
of productive labor—raw material production and manufacture—as phases of this
reproduction process; and all this depicted in one Tableau which in fact consists of
no more than five lines which link together six points of departure or return, this was
an extremely brilliant conception, incontestably the most brilliant for which political
economy had up to then been responsible.
In Quesnay’s economic table, instead of each type of economic relation being
abstractly observed in isolation, they are observed synthetically. I have just
mentioned that Quesnay and Marx were the only ones in the history of political
economy to seek to comprehensively consider this issue, but I should note that the
former was the creator of political economy as a system whereas the latter brings
political economy to its culmination. Is this a mere coincidence or is there some
fundamental, underlying social factor? It seems to me that the need to
comprehensively consider the economic movement of society is first keenly felt
when the economic structure of society as a totality first comes to be an issue. For
this reason, it seems natural that within the history of modern political economy—
which begins in the midst of the deadlock of the feudal system with the desire to
establish capitalism, and comes to an end with a comprehensive critique of
capitalism that coincides with the broad unfolding of its contradictions—the desire
to consider the process of reproduction would appear at the beginning and then at
the end. I think it could be said this desire gradually recedes from the time of
Quesnay to that of Smith, and even further from the time of Smith to Ricardo, as a
reflection of the steady establishment of capitalist production and the situation where
the inner contradictions of the capitalist system had yet to be broadly exposed.
The Physiocrats argue that a sphere of production must generate a net product to be
productive, but we need to consider their understanding of the term “net product.”
In the economic table, the productive class expends three billion livres every year
and ends up creating an agricultural product with a value of five billion livres. In
other words, the net product is the surplus agricultural product of two billion livres
created during the year. Therefore, even though the net product, to some extent, is
understood as arising from the bounty of nature, and is thus grasped in terms of usepg. 25
value, it is not mere use-value but rather use-value as the bearer of two billion livres,
signifying this value component within a total agricultural product worth five billion
livres. It is precisely because of their value that the products are sold to become two
billion in money. This money in turn is handed over as rent to the class that enjoys
exclusive ownership of the land, which is the fundamental labor requirement for
agriculture, and the money makes up the revenue of that class of proprietors. Thus,
the net product, which the Physiocrats posited at the center of their doctrine as the
sole source of a nation’s net revenue, is grasped as use-value and as a surplus
product, but in the relation above it is understood in the sense of value or surplusvalue instead. In other words, their “net product” can be described as value grasped
in the form of a material thing, and at the same time as surplus-value cognized in the
form of a surplus agricultural product. Surplus-value is of course the pivot of the
capitalist economy, the ultimate objective and fundamental impetus of capitalist
production. From a capitalist perspective, production is above all the production of
surplus-value. Thus, Quesnay gets to the heart of modern production when he places
net product at the center of his system, making a distinction between productive and
unproductive labor on the basis of whether a net product is generated or not.
This basic idea is not particular to Quesnay and his school of thought alone,
but rather is a keynote of modern political economy in its various forms. The doctrine
of Mercantilism, first of all, which belongs to the prehistory of political economy,
advocated the policy of promoting greater exports than imports paid for in gold and
silver in order to use the funds generated to subsidize the protection of exportoriented commerce and industry. This position is an expression of the
aforementioned view, in its crudest form. The balance of trade, in the form of an
increase of gold and silver, is the most visible form of a national surplus in value,
and what brings it about, directly speaking, is export-related commerce and industry.
The fact that Mercantilists held fast to this highly visible form, overlooking the
ultimate source, reveals their theoretical crudity and that they were unable to shake
free of the realm of practical affairs. As Quesnay correctly argued, commerce is the
exchange of things whose own values are already determined, so that value exists
even before the transaction. In the case of commerce, as long as equivalents are
exchanged, no surplus of profit can be generated, while in the case where nonequivalents are exchanged, the gain on one side is a loss on the other. Exchange is
merely the realization of already existing value in the form of money, or the transfer
pg. 26
of value that is in the hands of another individual or nation. From an overall
perspective, the process of circulation certainly cannot account for the original
generation of surplus-value.
Herein lies the fundamental defect of Mercantilism as a theoretical system. In order
for political economy to constitute itself as a science, it was necessary to move from
a partial, to an overall perspective, advancing from the subjective standpoint of
merchants and politicians to an objective and theoretical standpoint, tracing our way
back from matters concerning the mere realization and distribution of value, to arrive
at its original creation. The focus of attention shifted from the process of circulation
to the process of production. And here we have the groundbreaking significance of
the Physiocrats’ distinction between productive and unproductive labor. As Marx
notes, “The Physiocrats transferred the inquiry into the origin of surplus-value from
the sphere of circulation into the sphere of direct production, and thereby laid the
foundation for the analysis of capitalist production.” [8]
The Physiocrats managed to raise this issue, but at the same time they failed to clarify
what constitutes value. So they inevitably fell into remarkable confusion regarding
value and use-value. On the one hand, they grasped relations pertaining to value in
the form of use-value, while on the other hand they confused problems inherent to
use-value with problems that pertain to value. As a result, numerous contradictions
and a great deal of confusion arose within their doctrine, as is manifested most
clearly in their view on the productive character of agriculture.
First of all, when Physiocrats insist on the productive character of agriculture, this
character refers to the production of surplus-value; at the same time, however, as
long as it is not made clear what value stems from, it is impossible for them to clarify
the general law of the production of surplus-value. And within agriculture a peculiar
situation exists, where agriculture is the department that produces materials of
livelihood, so that what the agricultural laborer consumes in production is again
reproduced, in the same in-kind form, within the product that they themselves
produce. They consume agricultural products to create agricultural products.
Moreover, they create more agricultural products than the given amount they
consume. Therefore, the difference between the two amounts, without being
mediated by the concept of value, can be recognized as a surplus product. [9] This is
not the case in the realm of industry, where the things workers consume and what
pg. 27
they create are of a completely different nature. Therefore, the surplus-value created
by industrial workers cannot be recognized in its given form of use-value. Just as ten
kilograms of wheat cannot be deducted from one carpet, the materials of livelihood
of industrial workers are only first replenished through the exchange of their
products. The difference between what the industrial workers consume and what
they produce is something abstract and hard to pin down, which can only first be
understood through the value-analysis of simple labor. It is this circumstance that is
the primary factor underlying the belief of the Physiocrats that only agriculture is
productive.
Because the Physiocrats did not clarify the character of value, they only grasped the
production of surplus-value in the form of the production of surplus use-values. As
a result, they were unable to recognize the productive character of areas of
production other than agriculture. Meanwhile, they directly confused matters
inherently related to use-value with those related to value, thus generating even more
confusion regarding the distinction between the concepts of productive and
unproductive. They believed that agriculture occupies a special place within a
society’s economy, as the sphere that produces the foodstuffs that are the key
requirement for human life. Accordingly to this view, without agriculture, and
therefore without the production of foodstuffs, people would be incapable of
maintaining their existence. This means that agriculture is the most fundamental of
all the spheres of production, and the reason that some can live without engaging in
agriculture is the result of the fact that those engaged in agriculture have created a
surplus product in excess of their own consumption. In other words, the surplus
agricultural product (“net product”) is the foundation for the lives of all the other
classes, with the independent existence of commerce, industry, and other endeavors
merely being flowers that bloom thanks to those agricultural roots. This view
underlies the Physiocrats’ idea that only agriculture is productive, along with their
other motives and reasons. Quesnay also says that the productive class is always
independent through the outcome of their own labor, whereas the other classes are
isolated because they are unable to obtain the materials of livelihood through their
unproductive labor. He sees manufacture as a mere offshoot of agriculture, saying
that the expansion of the “sterile class” that occurs along with the increase in
population and national wealth is made possible by the productive class and the
wealth it creates.”
pg. 28
Granted, such views in and of themselves are not mistaken. Indeed, they reflect an
extremely interesting viewpoint, both theoretically and historically (although the
Physiocrats did not developed them in a sufficiently conscious or accurate form).
Still, these are problems that clearly pertain directly to use-value, and cannot be the
direct criteria for a distinction between the concepts of productive and unproductive
in terms of value. It is inappropriate and conceptually confusing to introduce such a
view into the discussion of the distinction between productive and unproductive. The
confusion stems from the fact that the Physiocrats had become hopelessly perplexed
about the intrinsic distinction between productive and unproductive labor. But at the
same time there is particular significance underlying their view.
From the perspective of the historical process of capitalist development, there is
great significance in the line Quesnay drew between agriculture (as the production
sphere of the fundamental materials of livelihood) and the other spheres of
production, and in his emphasis on the development of the former being the
necessary premise for the development of the latter. This historical significance
needs to be underscored, in light of the commonly held view that the agriculturecentered position of the Physiocrats was nothing more than a valuing of agriculture
for its own sake, attributed as a mere reaction against Mercantilism. In fact, however,
the journey of history is not a sort of meaningless repetition of action and reaction,
but rather a developmental journey that unfolds by means of action and reaction.
Likewise, the history of schools of thought cannot be understood if this relation of
development is overlooked. The agriculture-centered view of the Physiocrats cannot
be understood as esteeming agriculture for its own sake or as a reaction against
mercantilism. The true historical significance of Physiocracy can first be grasped in
line with the necessity of capitalistic production as a developmental process. We
need to consider the exact significance of this agriculture-centered characteristic of
the Physiocrats, which may at first glance seems anti-capitalistic, from the
perspective of the development of capitalistic production. Since the sphere of
production particular to the development of capitalism is industry, not agriculture,
what possible relationship could there be between the Physiocrats’ emphasis on
agricultural development and the development of capitalistic production?
Certainly capitalism did first spring forth within industry, and ultimately achieved
its own particular development within industry. But in order for the capitalistic
production that sprang forth within industry to achieve its own development therein,
pg. 29
it had to make use of agriculture and was able to achieve the capitalistic
transformation of agriculture to some extent. Still, the premise and indispensable
precondition for the large-scale development of capitalistic production in the
industrial sector is the existence of large numbers of property-less laborers and the
materials of livelihood that their wages are converted into. These human and
material elements only come into existence as the result of the capitalistic
transformation of agriculture. This transformation means an increase in the
productive power of agricultural labor and at the same time a curbing of the
consumption of the agricultural laborers themselves. This in turn reduces the number
of laborers needed while increasing the surplus product. Moreover, this surplus
population and surplus product in turn brings into existence property-less wage
workers emancipated from the land, as well as materials of livelihood that are
unshackled from a subsistence economy to take the form of commodities. Thus, the
wage-laborers and materials of livelihood that emerging industry requires are
“separated” from agriculture. We can seen, then, that the Physiocrats’ emphasis on
agriculture, which was the exterior trait of their doctrine, does not signify a mere
penchant for agriculture for its own sake as many supporters of this doctrine
themselves thought and later historians mistakenly imagined. Rather, quite contrary
to its feudalistic appearance, the Physiocratic position was a manifestation of the
need for the capitalistic transformation of agriculture, as a necessary stage in the
development of capitalistic production. Indeed, the primary concern of Quesnay was
not the particular interests of landed property in the sector of agriculture, nor the
interests of the feudal landowning class, but the accumulation of capital within
agriculture and the interests of capitalist agricultural entrepreneurs. Moreover,
capital was not to be limited essentially to the domain of agriculture. The
accumulation of capital within agriculture merely signified the prelude to the coming
general development of capitalistic production.
The capitalistic essence of the Physiocratic school is also manifested in the two main
policies it advocated: (1) A single tax on rent (impêt unique) and (2) and a laissezfaire economic approach. It hardly merits further mention that both of these polices
were clear expressions of the pressing demands of capital at the time.
In the discussion thus far, we have analyzed the Physiocrats’ view that only
agriculture is productive, which ultimate led to the collapse of this school of thought.
We saw that they considered the character of being productive in terms of producing
pg. 30
surplus-value, and that they were quite correct as far as grasping the gist of surplusvalue. Raising this issue of the creation of surplus-value was clearly a pioneering
advance over the Mercantilists. At the same time, though, their understanding was
inevitably limited due to the defects in their analysis of value, and their inability to
recognize the production of surplus-value in non-agricultural spheres was the natural
outcome of not reducing value to general labor. We have also seen that this same
defect led them to confuse problems pertaining to use-values with problems
pertaining to value, thus introducing, within the fundamental distinction between
productive and unproductive, another distinction based upon a separate perspective.
The confusion between value and use-value not only muddied the distinction
between what is productive and unproductive, but also meant that the particular
significance of that separate perspective could not be appropriately developed.
Finally, we looked at the historical significance of the Physiocrats’ viewpoint for
their own era, which was the dawn of capitalistic production.
Through our analysis I think we were able to clarify a number of points. Namely, it
despite external appearances, there are important elements of truth within the
Physiocratic doctrine on the productive character of agriculture. However, these
elements became entangled—due to confusion between problems pertaining to value
and those pertaining to use-value—with a bias towards agriculture that at first glance
seems nonsensical. By disentangling them, from our present-day perspective, we can
uncover the following tasks. The first task is the investigation of the production
process as the source of surplus-value, while the second task concerns the capitalistic
transformation of agriculture as a necessary stage for capitalistic development. The
latter, practical task, was subsequently forcefully achieved on a global scale though
the development of history itself, but the first task is inherent to political economy,
and therefore its satisfaction remained necessary for the further development of
political economy. How was this second task achieved? We have already clarified
that the root cause of the Physiocrats’ failure to solve this problem was the defect in
their analysis of value. Thus, the higher development required to solve this problem
must of course begin with the analysis of value. It was the Classical school,
developed in England, that analyzed value to reduce it to “labor” and clarified that
surplus-value could be generated in any sphere of production.
In summary, the physiocrats made a significant contribution in their emphasis on
productive work as the source of national wealth. This contrasted with earlier
pg. 31
schools, in particular mercantilism, which often focused on the ruler's wealth,
accumulation of gold, or the balance of trade.
Like many Enlightenment thinkers, and contrary to the Mercantilists, the Physiocrats
believed that the wealth of a nation lay not in its stocks of gold and silver, but rather
in the size of its net product. But it was the identification of that net product solely
with agriculture that the Physiocrats were distinct.
The physiocratic concept of net product was the outcome of their nature philosophy.
Physiocrats held agriculture supreme among all occupations, since it was the source
of wealth. It is in agriculture that nature works along with man.
pg. 32
CRITICAL ANALYSIS OF VIEWS OF KARL MAX ON THE CREATION
OF NET WEALTH IN AN ECONOMY
England of the mid-nineteenth century, in the throes of the Industrial Revolution,
was not a pleasant place to work. Anyone who entertains the contrary idea need
merely consult the writings of the economists of that period, or its historians, or even
its novelists, such as Dickens.
It was against a background of the disintegration of the agricultural economy of
England, and the human chaos incident to the industrialization of production that
Karl Marx set himself the task of improving the lot of the factory worker.
Beginning slowly during the first seventy-five years of the eighteenth century and
reaching a crescendo during the last quarter of that century and the first half of the
nineteenth century, incalculable changes took place in the lives of laboring people.
The transformation was initiated first by the intensification of the division of labor
and later by the crowding of workers into hand or hand-and-machine factories. This
phase was, in factory after factory, followed by the mechanization of progressively
more of the manual tasks, shifting to animal power, then water power and wind
power, and then to steam for basic motive power. The resulting disorganization in
the lives of the people affected was stupendous and frightful. Only the few who were
quick to adapt themselves to the era of the machine were able to avoid the
destruction—frequently successive destructions of their means of livelihood through
the radical changes resulting from rapid technical obsolescence of the methods of
production. The impact of these swift transformations was more than could be safely
digested and absorbed by the farm populations which began to turn to the industrial
cities for their means of living.
The division and subdivision of tasks once calling for the most highly developed
skills until the tasks could be performed in many instances by women and children
provided the opportunity, and the indigence entailed in the shifting from an
agricultural life to dependence upon the fluctuating employment in factories
provided the inducement: thousands of parents exploited their children by forcing
them into the factories. Wives neglected their families to become factory employees.
The full fury of competition between man and machine, between merchants,
between manufacturers and between nations was unleashed among people who had
not the faintest idea of its implications. Methods by which producers could become
pg. 33
reasonably informed about markets were almost wholly lacking. Laws against
adulteration of products had not yet been enacted. Industrial safety codes and means
of compensating the dependents of injured workmen were unknown. The sanitary
conditions of factories in general were incredibly bad. An employer who worked the
men, women and children in his factories only twelve hours a day was something of
a public-spirited paternalist. Foreign trade brought the local supplier into
competition with foreign producers he had never seen or heard of.
Newly born industrial enterprises and the people whose fortunes were tied to them,
learned the nature of industrial production primarily by successive bitter
experiences. Businesses ran through constantly recurring cycles of expansion, boom,
over-production, liquidation and depression. Superimposed upon this disorganizing
parade of booms and slumps were the disrupting effects of primitive money and
credit systems providing mediums of exchange containing built-in erratic gyrations
of their own. The money system of Great Britain, like that of other countries
experiencing the industrial revolution, suffered not merely from irresponsible
banking, inadequate knowledge, poorly designed regulatory laws and rampant
exploitation of the opportunities for financial fraud, but also from the results of
heavy importations of gold and silver–the monetary metals–from the New World.
Without analyzing here the causes, we need merely note that the problems of the
workers fell upon deaf political ears in Britain and elsewhere as the Industrial
Revolution progressed, until agonized suffering reached the notoriety of an un
suppressible public scandal. Even then, the factory owners, who could point proudly
to the fact that for the first time in history, per capita increase in the output of goods
and services was beginning to race ahead, had no basis in experience for knowing
whether they could at once be humane in their labor relations and still maintain their
positions in the unprecedented hurly-burly of competition.
Labor Theory of Value
The labor theory of value is a major pillar of traditional Marxian economics, which
is evident in Marx’s masterpiece, Capital (1867). The theory’s basic claim is simple:
the value of a commodity can be objectively measured by the average number of
labor hours required to produce that commodity.
pg. 34
If a pair of shoes usually takes twice as long to produce as a pair of pants, for
example, then shoes are twice as valuable as pants. In the long run, the competitive
price of shoes will be twice the price of pants, regardless of the value of the physical
inputs.
Although the labor theory of value is demonstrably false, it prevailed among
classical economists through the mid-nineteenth century. Adam Smith, for instance,
flirted with a labor theory of value in his classic defense of capitalism, The Wealth
of Nations (1776), and David Ricardo later systematized it in his Principles of
Political Economy (1817), a text studied by generations of free-market economists.
So the labor theory of value was not unique to Marxism. Marx did attempt, however,
to turn the theory against the champions of capitalism, pushing the theory in a
direction that most classical economists hesitated to follow. Marx argued that the
theory could explain the value of all commodities, including the commodity that
workers sell to capitalists for a wage. Marx called this commodity “labor power.”
Labor power is the worker’s capacity to produce goods and services. Marx, using
principles of classical economics, explained that the value of labor power must
depend on the number of labor hours it takes society, on average, to feed, clothe, and
shelter a worker so that he or she has the capacity to work. In other words, the longrun wage workers receive will depend on the number of labor hours it takes to
produce a person who is fit for work. Suppose five hours of labor are needed to feed,
clothe, and protect a worker each day so that the worker is fit for work the following
morning. If one labor hour equaled one dollar, the correct wage would be five dollars
per day. Marx then asked an apparently devastating question: if all goods and
services in a capitalist society tend to be sold at prices (and wages) that reflect their
true value (measured by labor hours), how can it be that capitalists enjoy profits—
even if only in the short run? How do capitalists manage to squeeze out a residual
between total revenue and total costs?
Capitalists, Marx answered, must enjoy a privileged and powerful position as owners
of the means of production and are therefore able to ruthlessly exploit workers.
Although the capitalist pays workers the correct wage, somehow—Marx was terribly
vague here—the capitalist makes workers work more hours than are needed to create
the worker’s labor power. If the capitalist pays each worker five dollars per day, he
can require workers to work, say, twelve hours per day—a not uncommon workday
pg. 35
during Marx’s time. Hence, if one labor hour equals one dollar, workers produce
twelve dollars’ worth of products for the capitalist but are paid only five. The bottom
line: capitalists extract “surplus value” from the workers and enjoy monetary profits.
Although Marx tried to use the labor theory of value against capitalism by stretching
it to its limits, he unintentionally demonstrated the weakness of the theory’s logic
and underlying assumptions. Marx was correct when he claimed that classical
economists failed to adequately explain capitalist profits. But Marx failed as well.
By the late nineteenth century, the economics profession rejected the labor theory of
value. Mainstream economists now believe that capitalists do not earn profits by
exploiting workers (see profits). Instead, they believe, entrepreneurial capitalists
earn profits by forgoing current consumption, by taking risks, and by organizing
production.
Alienation
There is more to Marxism, however, than the labor theory of value and Marx’s
criticism of profit seeking. Marx wove economics and philosophy together to
construct a grand theory of human history and social change. His concept of
alienation, for example, first articulated in his Economic and Philosophic
Manuscripts of 1844, plays a key role in his criticism of capitalism.
Marx believed that people, by nature, are free, creative beings who have the potential
to totally transform the world. But he observed that the modern, technologically
developed world is apparently beyond our full control. Marx condemned the free
market, for instance, as being “anarchic,” or ungoverned. He maintained that the way
the market economy is coordinated—through the spontaneous purchase and sale of
private property dictated by the laws of supply and demand—blocks our ability to
take control of our individual and collective destinies.
Marx condemned capitalism as a system that alienates the masses. His reasoning
was as follows: although workers produce things for the market, market forces, not
workers, control things. People are required to work for capitalists who have full
control over the means of production and maintain power in the workplace. Work,
he said, becomes degrading, monotonous, and suitable for machines rather than for
free, creative people. In the end, people themselves become objects—robotlike
mechanisms that have lost touch with human nature, that make decisions based on
pg. 36
cold profit-and-loss considerations, with little concern for human worth and need.
Marx concluded that capitalism blocks our capacity to create our own humane
society.
Marx’s notion of alienation rests on a crucial but shaky assumption. It assumes that
people can successfully abolish an advanced, market-based society and replace it
with a democratic, comprehensively planned society. Marx claimed that we are
alienated not only because many of us toil in tedious, perhaps even degrading, jobs,
or because by competing in the marketplace we tend to place profitability above
human need. The issue is not about toil versus happiness. We are alienated, he
maintained, because we have not yet designed a society that is fully planned
and controlled, a society without competition, profits and losses, money, private
property, and so on—a society that, Marx predicted, must inevitably appear as the
world advances through history.
Here is the greatest problem with Marx’s theory of alienation: even with the latest
developments in computer technology, we cannot create a comprehensively planned
system that puts an end to scarcity and uncertainty. But for Marxists to speak of
alienation under capitalism, they must assume that a successfully planned world is
possible. That is, Marx believed that under capitalism we are “alienated” or
“separated” from our potential to creatively plan and control our collective fate. But
if comprehensive socialist planning fails to work in practice—if, indeed, it is an
impossibility, as we have learned from Mises and Hayek—then we cannot be
“alienated” in Marx’s use of the term. We cannot really be “separated” from our
“potential” to comprehensively plan the economy if comprehensive planning is
impossible.
Scientific Socialism
A staunch antiutopian, Marx claimed that his criticism of capitalism was based on
the latest developments in science. He called his theory “scientific socialism” to
clearly distinguish his approach from that of other socialists (Henri de Saint-Simon
and Charles Fourier, for instance), who seemed more content to dream about some
future ideal society without comprehending how existing society really worked
(see socialism).
pg. 37
Marx’s scientific socialism combined his economics and philosophy—including his
theory of value and the concept of alienation—to demonstrate that throughout the
course of human history, a profound struggle has developed between the “haves”
and the “have-nots.” Specifically, Marx claimed that capitalism has ruptured into a
war between two classes: the bourgeoisie (the capitalist class that owns the means
of production) and the proletariat (the working class, which is at the mercy of the
capitalists). Marx claimed that he had discovered the laws of history, laws that
expose the contradictions of capitalism and the necessity of the class struggle.
Marx predicted that competition among capitalists would grow so fierce that,
eventually, most capitalists would go bankrupt, leaving only a handful of
monopolists controlling nearly all production. This, to Marx, was one of the
contradictions of capitalism: competition, instead of creating better products at lower
prices for consumers, in the long run creates monopoly, which exploits workers and
consumers alike. What happens to the former capitalists? They fall into the ranks of
the proletariat, creating a greater supply of labor, a fall in wages, and what Marx
called a growing reserve army of the unemployed. Also, thought Marx, the anarchic,
unplanned nature of a complex market economy is prone to economic crises as
supplies and demands become mismatched, causing huge swings in business activity
and, ultimately, severe economic depressions.
The more advanced the capitalist economy becomes, Marx argued, the greater these
contradictions and conflicts. The more capitalism creates wealth, the more it sows
the seeds of its own destruction. Ultimately, the proletariat will realize that it has the
collective power to overthrow the few remaining capitalists and, with them, the
whole system.
The entire capitalist system with its private property, money, market exchange,
profit-and-loss accounting, labor markets, and so on must be abolished, thought
Marx, and replaced with a fully planned, self-managed economic system that brings
a complete and utter end to exploitation and alienation. A socialist revolution, argued
Marx, is inevitable.
Marx was surely a profound thinker who won legions of supporters around the
world. But his predictions have not withstood the test of time. Although capitalist
markets have changed over the past 150 years, competition has not devolved into
monopoly. Real wages have risen and profit rates have not declined. Nor has a
pg. 38
reserve army of the unemployed developed. We do have bouts with the business
cycle, but more and more economists believe that significant recessions and
depressions may be more the unintended result of state intervention
(through monetary policy carried out by central banks and government policies
on taxation and spending) than an inherent feature of markets as such.
Socialist revolutions, to be sure, have occurred throughout the world, but never
where Marx’s theory had predicted—in the most advanced capitalist countries. On
the contrary, socialism was forced on poor, so-called Third World countries. And
those revolutions unwittingly condemned the masses to systemic poverty and
political dictatorship. In practice, socialism absolutely failed to create the
nonalienated, self-managed, and fully planned society. It failed to emancipate the
masses and instead crushed them with statism, domination, and the terrifying abuse
of state power.
Nations that have allowed for private property rights and full-blown market
exchange, in contrast to those “democratic socialist republics” of the twentieth
century, have enjoyed remarkable levels of long-term economic growth. Freemarket economies lift the masses from poverty and create the necessary institutional
conditions for overall political freedom.
Marx just didn’t get it. Nor did his followers. Marx’s theory of value, his philosophy
of human nature, and his claims to have uncovered the laws of history fit together to
offer a complex and grand vision of a new world order. If the first three-quarters of
the twentieth century provided a testing ground for that vision, the end of the century
demonstrates its truly utopian nature and ultimate unworkability.
THREE MISTAKES THAT CHANGED THE COURSE OF HISTORY
The three errors which Marx made were these:
(1) His adoption of the labor theory of value which had previously been advanced
by David Ricardo.
(2) His failure to understand that the private ownership of property, including capital
instruments, is indispensable to political freedom; in short, his failure to understand
the menace to human freedom of the ownership of the means of production by the
state.
pg. 39
(3) His mistaking the wealth produced by capital for “surplus value”, i.e., value
which he thought was created by labor and stolen from the laborer by the capitalist.
Let us examine each of these mistakes. In the course of doing this, we shall see in
each case how closely Marx came to acknowledging the actual principles of
capitalism. Yet in every case, having grasped the principles, he also rejected them
because of his fundamental errors.
Error No. 1: The Labor Theory of Value
Except for the few wants which men can satisfy directly by things adequately
supplied by nature, human labor, for untold ages, had been the primary source of the
creation of wealth. Man, with his hands and his brain, has given value to raw
materials found in nature by imparting to them qualities which render them able to
satisfy his wants. Similarly, man has performed personal services for himself or for
others which have also satisfied needs. Nothing is more obvious than that man must
wrest his living from nature through the cleverness of his mind, the strength of his
muscles and the skill of his body. Since, at the outset, then, man was the only acting
force, the idea that all changes in nature’s raw materials were wrought by man alone
was both obvious and indisputable. The labor theory of value—the idea that labor is
the only agency capable of creating wealth, i.e., adding “value” to raw materials and
performing services–must have been approximately correct in primitive times and,
to a lesser degree, in pre-industrial economies. But once men applied their
intelligence to constructing tools and machines that were able to produce wealth, or
at least to co-operate with human labor in the production of wealth, a basic change
occurred, the significance of which was not at once fully appreciated. The fact that
all economic value was not created by labor, but rather by labor and capital together,
was obscured by the fact that, in the early stages of machine production, machines
were usually “operated” by their owners. As a result, the services of the machine
were indistinguishably commingled with those of the machine-owner and so there
was yet no occasion for recognizing the separate economic functions of each.
The significance of the labor theory of value is more than academic. If labor is the
source of all value created in the productive process, then labor has a valid moral
claim to all wealth created through production. Then the only moral claim of the
owner of capital is to have his capital restored to him, i.e., to get back the value of
his capital with compensation for the effects of wear, tear and obsolescence.
pg. 40
Honestly to reach his conclusion that the capitalist was thieving from the laborer,
Marx had only to believe that labor did in fact create all economic value (i.e., the
values added to raw materials found in nature).
But confronted with the fact that capital instruments were actually performing more
and more of the functions which added value to raw materials and were even
beginning to compete with labor in the performance of purely service activities,
Marx could not prove the proposition that labor was the sole creator of value and he
did not try. He merely asserted, again and again, that the proposition was historically
true and that its truth was of very recent discovery. All commodities, including
capital instruments, said Marx, “are only definite masses of congealed labor time”
(Capital, Modern Library Edition, page 46, New York.)
“The recent scientific discovery that the products of labor, so far as they are values,
are but material expressions of the human labor spent in their production, marks,
indeed, an epoch in the history of the development of the human race, but by no
means dissipates the mist through which the social character of labor appears to us
to be an objective character of the products themselves.” (Ibid. page 85; italics
added). Marx is here saying flatly what he elsewhere elaborates—that although
capital instruments appear to create wealth, this is merely an illusion, and that there
is some sort of mysterious “congealed labor” hidden in the capital instrument which
enables it to give value to its products.
At this point Marx actually saw one of the basic principles of capitalism: that capital
instruments do create wealth, just as labor does. But he rejected the idea as an
“appearance” only and held doggedly to his belief that only labor could create
wealth. By denying the obvious, that in an ever-increasing number of instances, the
performance of particular production tasks may be carried out alternatively either by
labor or capital instruments; and by asserting that regardless which method was used,
the capital instruments owned by a “capitalist”, were in fact, “labor instruments”;
and by concluding that whichever method was used, labor in fact created all the
value, Marx put the capitalist in the unethical role of getting something for nothing.
Today we are not merely familiar with the phenomenon of machines to make
machines, we are also acquainted with the trend to make automated machines with
automated machines. Nevertheless, tracing the process backwards through several
technological generations sooner or later brings one to the point where the
pg. 41
predecessor of a particular machine was made by hand labor. Since Marx regarded
human labor not only as an ingredient in an economic product, but as the only
ingredient other than raw materials provided by nature, the problem of machines
made largely by machines was a disconcerting one for him.
The value of a product, he said, is determined by the amount of labor time it contains.
After a few technological generations of producing machines primarily by machines,
what could be said of the machine which, although it contained almost no “value”
in terms of man-hours and required very little assistance from labor in the form of
an operator’s man-hours, turned out a vast quantity of products, all of which sold for
very good prices?
Marx actually considered this problem. How could he square the labor theory of
value with a machine containing very little “value” (in terms of man-hours of labor)
which at the same time is operated with very few man-hours of labor, yet which
produces a great amount of wealth? Confronted with this problem, Marx might have
announced another of the basic principles of capitalism: that the productiveness, the
“productivity”, of capital instruments, in comparison with that of labor (other than
the top echelon of labor consisting of management and technical workers) is steadily
rising. But here again Marx rejected the clearly discernible truth and supplemented
it with a corollary to the labor theory of value.
In this case, he said, the machine, after yielding up what little “value” it contains,
works gratuitously, just as the sun works ripening the corn in the field. Marx here
came within a hair’s breadth of recognizing the increasing productivity of capital
instruments in comparison with that of labor. Had he allowed himself to see the
point, it is safe to assume that a man of Marx’s sincerity would have cried, “If capital
instruments are the source of the increasing production of wealth in an industrial
economy, the owners of capital instruments are rightly the persons who should
receive the proceeds of the wealth so produced. Let us then set as our goal the
greatest possible accumulation and perfection of capital instruments for the greater
production of wealth. And let us so regulate our economy as to extend the
opportunity of engaging in production through the ownership of capital instruments
to an ever increasing proportion of the population.”
Marx missed this critical point. Faced with the spectacle of the production of vast
wealth through a large contributory effort by capital instruments and a negligible
pg. 42
contribution by labor, Marx could merely say: “In modern industry, man succeeded
for the first time in making the product of his past labor work on a large scale
gratuitously, like the forces of nature.” (Ibid, page 424). Thus did Marx substitute
for objective analysis the dogma he had borrowed from Ricardo?
Error No. 2: Marx’s Failure to Understand the Political Significance of
Property
Before examining Marx’s second critical error, it may be helpful to take note of what
the concept “property” means in law and economics. It is an aggregate of the rights,
powers and privileges, recognized by the laws of the nation, which an individual
may possess with respect to various objects. Property is not the object owned, but
the sum total of the “rights” which an individual may “own” in such an object. These
in general include the rights of (1) possessing, (2) excluding others, (3) disposing or
transferring, (4) using, (5) enjoying the fruits, profits, product or increase, and (6) of
destroying or injuring, if the owner so desires. In a civilized society, these rights are
only as effective as the laws which provide for their enforcement. The English
common law, adopted into the fabric of American law, recognizes that the rights of
property are subject to the limitations that
(1) Things owned may not be so used as to injure others or the property of others,
and
(2) That they may not be used in ways contrary to the general welfare of the people
as a whole. From this definition of private property, a purely functional and practical
understanding of the nature of property becomes clear.
Property in everyday life, is the right of control.
Property in Land. With respect to property in land, we need merely note that the
acquisition of an original title to land from a sovereign is a political act, and not the
result of operations of the economy. If the original distribution of land unduly favors
any group or type or persons, it is a political defect and not a defect in the operation
of the economy as such. A capitalistic economy assumes and recognizes the private
ownership of land. It may, as under the federal and state mining laws and federal
homestead acts, encourage private ownership of land by facilitating private
purchasing of mining, timber, agricultural, residential or recreational lands.
pg. 43
Property in Capital. In a capitalistic economy, private ownership in all other articles
of wealth is equal in importance to property in land. From the standpoint of the
distributive aspects of a capitalistic economy, property in capital—the tools,
machinery, equipment, plants, power systems, railroads, trucks, tractors, factories,
financial working capital and the like—is of special significance. This is true
because of the growing dependence of production upon capital instruments.
Of the three components of production land is the passive1 source of almost all
material things except those which come from the air and the sea, while labor and
capital are the active factors of production. Labor and capital produce the goods and
services of the economy, using raw materials obtained, for the most part, from land.
Just as private property in land includes the right to all rents, the proceeds of sale of
minerals and other elements or substances contained in land, private property in
capital includes the right to the wealth produced by capital. The value added to iron
ore by the capital instruments of a steel mill becomes the property of the owners of
the steel mill. So in the case of all other capital instruments.
Property in Labor. What is the relationship of the worker to the value which he
creates through his work? It has been said that no one has ever questioned the right
of a worker to the fruits of his labor. Actually, as was long ago recognized by John
Locke and Jean Jacques Rousseau, the right of the worker to the value he creates is
nothing more than the particular type of private property applicable to labor. Each
worker, they said, has a right of private property in his capacity to produce wealth
through his labor and in the value which he creates.
Marx and Property. Marx did not err in his understanding of the dependence of
capitalism upon private property. In fact, the Communists, following Marx,
appreciate this absolute dependence more than do non-Communists, many of whom,
influenced by the conviction that Marx is full of errors, have falsely entertained the
idea that this is one of them.
Marx, however mistaken he was in his program for achieving the economic changes
he thought were needed, cannot be charged with having intended to worsen the
economic and political condition of modern man. The facts of his life and character
permit us little doubt that his intention was to eliminate suffering by substituting a
fairer distribution of economic goods and services, and through this, a more
pg. 44
equitable distribution of leisure and the opportunity to lead a good life. Marx was
rightly, if also vehemently, critical of the exploitation of the many by the few.
Had Marx seen that the socialization of capital (i.e., its ownership by the state) would
of necessity place the control of capital in the hands of those currently wielding
political power, thereby unifying economic and political power, the two basic
sources of social power, we can assume that Marx would not have advocated the
destruction of private property in capital instruments. If the factory owners of the
nineteenth century, having political influence but not unlimited political power, were
in a position to exploit the workers, the bureaucrats of the twentieth century in a
socialized state, possessing not only unlimited political power, but also unlimited
economic power through ownership (i.e., control) of the instruments of production,
are infinitely better equipped to exploit workers and other non-bureaucrats. What
better proof of this than Russia and the Russian satellites?
The Communist Politician, A True Tyrannical Capitalist
It is the Communist politician who sees in Marxism the opportunity for personal
power and wealth which Marx, if we may take him at his word, failed to perceive.
The Communist politician perceives in Communism the personal advantage to
himself which comes with the transfer of property (working control) in the means of
production to the state, and the elevation of himself to a place in the management of
the state. The Communist politician is thus able to epitomize in himself the kind of
tyrannical capitalist Marx declaimed against, with the further opportunity for
unlimited despotism that is inherent in the fusion of political power and economic
power in the same hands.
Marx’s failure to perceive the political significance of private property has allowed
his doctrine to furnish the most perfectly designed ruse for potential tyrants that has
ever been devised. In the name of benefiting society as a whole, the actual control
of the capital instruments and land is placed in the hands of those wielding political
power!
Marx’s second great error prevented him from seeing that the ideal “classless
society”, of which he dreamed, is not one in which a political group in power has the
function of distributing wealth. It is rather the political economy in which the
individual ownership of property—particularly capital instruments—is spread over
pg. 45
the entire population. Only such a broad distribution of private economic power can
guarantee individual freedom and the power of the people as a whole to limit or turn
out at will a political group in power.
Marx was actually on the verge of recognizing that so long as men are what they are,
capitalism is the only possible classless society. His failure to do so derives from his
failure to understand the political significance of private property. He consequently
also failed to understand the political significance of state ownership in a socialist
state. To concentrate control over the means of production in a political group is to
establish that administration as a class—an all-powerful class—and to remove all
possibility, so long as such a group exercises its power fully and ruthlessly, to
overthrow such despotism by means other than force.
Marx recognized that the men who were the owners of productive property also
enjoyed “individuality”, leisure and opportunities for culture and education. (Ibid.,
page 581). This being so, it is nothing short of fantastic that he brought himself to
these illogical conclusions:
(1) Destroy private ownership of productive property.
(2) Make all men workers.
(3) Appropriate all wealth produced in excess of that required to sustain workers,
and let it be distributed by the state as its political leaders see fit.
The political commissars, however, who employ Marx’s ideas for their own
purposes–the exploitation of power and wealth which socialism offers to a ruling
bureaucracy–are not so illogical. The destruction of private property in the means of
production is their guarantee of self-perpetuation. There is a Marxian tenet that the
nature of a society is determined by the mode of production (whether agricultural or
industrial), and the ownership of the means of production. It is sound. The
conclusions here are within and consistent with this fundamental insight. Thus the
second great Marxian error caused Marx to seek in socialism what he could have
found only in capitalism.
pg. 46
Error No. 3: Mistaking the Wealth Created by Capital for Wealth Created by
Labor and Stolen by the Capitalists
Each of the three critical mistakes which Marx made in his study of capitalism arose
from the fact that he began his analysis with a study of distribution rather than with
a study of production. At the distributive end, something less than a tenth of the
population, for the most part owners of land and capital, were faring infinitely
better—receiving a proportionately greater share—than were the other nine tenths,
whose only participation in economic activity was as workers or as recipients of
public charity under the poor laws. The pattern of distribution was bad from
whatever standpoint it might be judged. Those who were receiving the great share
were the capitalists, the owners of the expanding industrial and commercial
enterprises.
For Marx, capitalism was simply what he observed in the European world around
him, and primarily in Great Britain. Since the distributive pattern was unsatisfactory,
capitalists and capitalism, he concluded, must be at fault. Labor had “historically”
been the source of all production of wealth, and the workers were now receiving a
progressively smaller proportion of the proceeds of production. Down with
capitalism!
Had Marx started with an objective analysis of production and a deeper insight into
the property-freedom relation, he might well have concluded with a declaration of
war against capitalists for hoarding capitalism.
Let us now examine once more the principles of capitalistic production that Marx
might and should have used as a starting point. In an exchange economy, and
particularly in an economy of freely competitive markets, each service and each
commodity is valued for its peculiar ability to satisfy a certain desire of the
consumer. Whether the service of commodity is produced by labor alone or by
capital alone or by the co-operation of these two, is unimportant to the potential
purchaser except as the method of production implants specific characteristics in the
thing marketed. It is the finished product which is demanded by the purchaser, not
the knowledge that it is produced in one way or another–a mere means by which the
product was brought forth. Contrary to what some sentimentalists think, there is
nothing sacred about the products of labor that is not equally sacred about the
products of capital or those produced jointly by capital and labor.
pg. 47
To effect any change in the nature or position of material goods or to perform any
kind of a service, material goods must be acted upon. Marx recognized this; but,
because of his obsession with the labor theory of value, he contended that only labor
could be credited with the value of material goods produced or services performed.
“Useful labor” he said, “is an eternal necessity imposed by Nature without which
there can be no material exchanged between man and Nature, and therefore no life.”
(Ibid. page 50). To effect such changes in matter, or to perform such services, purely
physical, i.e., mechanical means, must be used. With rare exceptions, pure thought
is not economically compensable. Speech, writings, mechanical action–all these
things performed by man, are capable of entering into economic transactions. The
thought behind such speech, writings, mechanical action, is not by itself capable of
entering into ordinary commerce.
Man as a non-scientific and non-managerial subsistence-laborer is, from the
standpoint of economics (aside from his separate nature and position as the
consumer), a primitive, low-horsepower engine, relatively clumsy and of brief
durability, for the production of economic goods. Man the worker, except in the
fields of science and management, has grown steadily less impressive since the onset
of the industrial revolution. He can work eight, ten or twelve hours at a stretch and
then must rest. His strength and speed of action are quite limited. He is subject to
numerous ailments, often adversely affected by climate, temperamental and not
infrequently lazy. He makes many mistakes. As a factor in the production of wealth,
man is progressively less successful in competing with capital instruments, except,
again, as a scientist or as manager.
It is not as a worker that man is master of the earth. It is as the intelligence behind
all production and as the consumer—the reason for production and the destiny of the
things produced—that he is supreme.
It may well be that confusion between man the worker and man the thinker–the
source of all ideas and plans–contributed as much as any cause to Marx’s failure to
recognize capital as a producer of wealth in the same sense that labor is. Mental
activity enters into economic transactions primarily in two ways:
(1) The mental activity of the scientist and manager is responsible for the invention,
development, improvement and production of capital instruments, and the
supervision of productive activity of both laborers and capital instruments. Scientists
pg. 48
and managers are in general the top echelon of labor –the professional level. Their
services include entrepreneurial activities, in which they provide the initiative in
organizing the capital and labor to institute or expand particular business activities.
A substantial portion of their services is rendered in improving the productivity of
capital instruments, thus promoting the substitution of machines for men and
otherwise reducing labor requirements, where to do so will reduce the costs of
production and render the businesses in which they are engaged more efficient and
competitively better. The steady improvements in capital instruments, systems of
production, and organization of productive processes, are the results of the mental
activity of the scientists and managers. Their ability to produce in these fields is the
secret of their rising productiveness and the increased demand for their services.
(2) Mental activity enters into non-scientific work and non-managerial work in
varying degrees. The intelligent direction by the worker in his own activities is
incidental to the mechanical work performed by him. Labor is compensated for a
particular type of service of a physical nature that could not be rendered in the
absence of intelligent direction on the part of the worker himself.
Marx recognized that machines and men are competitors in the sense that scientists
and managers, in carrying out their function to produce goods and services in a
competitive market, strive to eliminate labor costs and to improve upon hand
methods of production. “The instrument of labor [meaning, of course, machines, the
instruments of the capitalist] when it takes the form of a machine, immediately
becomes a competitor of the workman himself.” (Ibid. page 470) In speaking of this
competition, Marx comes as near as possible to recognizing that capital instruments
are active forces in the production of wealth, performing an economic function of
the same sort as labor, and frequently performing functions which can
interchangeably be performed by either.2
Marx observes that in the case of the handcraft industries, “the workmen are parts of
a living mechanism. In the factory, we have a lifeless mechanism independent of the
workman, who becomes its mere living appendage….By means of its conversion
into an automaton, the instrument of labor confronts the laborer, during the labor
process, in the shape of capital, of dead labor, which dominates and pumps dry living
labor power. The separation of the intellectual powers of production from the manual
labor and the conversion of those powers into the might of capital over labor, is, as
pg. 49
we have already shown, finally completed by modern industry erected on the
foundation of machinery. The special skill of each individual insignificant factory
operative vanishes as an infinitesimal quantity before the science, the gigantic
physical forces, and the mass of labor that are embodied in the factory mechanism
and, together with that mechanism, constitute the power of the ‘master’.” (Ibid. page
462). It may well have been Marx’s failure to recognize that capital instruments in
practice supplant not only physical forces, but intelligence that deterred him from
recognizing that capital “works” just as labor works.
Whether Marx could have closed his eyes to the facts of production in the nowdawning age of automation is an interesting speculation. Yet even in Marx’s own
day it should have been possible for him to recognize that the scientists (engineers)
in designing capital instruments build into these instruments the capability of
performing operations which, if performed by labor, would require the application
of brainwork. His obsession with the labor theory of value rendered him incapable
of this insight.
But today, with the development of feed-back, self-correcting and self-programming
machines, capable of automatically performing a sequence of logical operations,
correcting their own errors as they perform their productive tasks, choosing from
built-in instructions or characteristics their proper functions, it is likely that even
Marx would have broken through his barrier-obsession that labor does all the work.
Human minds ultimately direct the production of goods and services. This is true of
the functions of capital instruments as it is of workers. As a production process uses
more and more capital instruments, more of the human mental control of the process
of production is shifted away from workers to scientists (and their mechanical
progeny) and to management. Thus the private ownership of labor is not, in action,
essentially different from the private ownership of capital. Each involves the right
of control of an active means of production, the right to take the fruits of such
production, to produce where and when the owner desires, and to accept or reject
conditions of production. The most significant difference is that the owner of capital
instruments is not required to be personally present in the productive process; he
produces, or in any event he may produce, vicariously. Mental activity as such is not
the basis of the property rights of either labor or capital owners in wealth produced.
pg. 50
What difference would it have made to Marx’s theory of capitalistic economics
if he had recognized both the power of labor and the power of capital
instruments to create wealth? It would have made all possible difference.
If all wealth is created by labor, and if the total wealth created is in excess of that
distributed to labor on the basis of the market value of labor, then the excess is
“surplus value”. This surplus value, according to Marx, is something really stolen
from labor by the capitalist. It is elementary that wealth belongs to him who creates
it, and if only labor can create wealth and capital instruments cannot create wealth,
then the owners of capital have no possible claim to a share in the proceeds of
production. The most they could legitimately claim would be to have the value of
their original capital, which has been partly or wholly consumed in the productive
process, restored to them. In the socialist state, this “surplus value” is something that
would belong to society as a whole, to be distributed as the administrators of the
state decide.
In short, if labor is the only possible creator of wealth, then capital cannot be a
creator of wealth, and there can be no legitimate return to capital other than a return
of the original investment. The recognition by Marx of capital as one of the two
active actors creating wealth would have exposed the falsity of his own basic
theories. More than that, he would have been led inevitably to exactly the opposite
conclusions. If labor is entitled to a return in the form of wages for wealth created
by labor, then the owners of capital should be entitled to a return for the wealth
created by capital.
Strange as it may seem, Marx recognized the technological trend and even
acknowledged that it appeared to be the case that the net wealth remaining after
payment for raw materials and labor was wealth created by capital. Yet he refused
to believe this appearance, and simply asserted again and again that this excess was
“surplus value”. With regard to the increasing productivity of capital, he noted that
“every introduction of improved methods…works almost simultaneously on the new
capital and on that already in action. Every advance in chemistry not only multiplies
the number of useful materials and useful applications of those already known, thus
extending with the growth of capital its sphere of investment…. Like the increased
exploitation of natural wealth by the mere increase in the tension of labour power,
science and technology give capital a power of expansion independent of the given
pg. 51
magnitude of the capital actually functioning.” (Ibid. pages 663-664) With respect
to the apparent production of wealth by capital instruments, Marx acknowledged that
there appeared to be, as Sismondi had said, a “revenue which springs from capital “.
But he refused, to the very end, to believe that it was the wealth created by capital–
a possibility he saw but never understood or appreciated. To Marx, the wealth
created by capital remained “surplus value” to which the owners of capital had no
claim–surplus value stolen by the owners of capital from the owners of labor.
Marx’s Three Error, A Fateful Near Miss
But for the basic and demonstrable errors in his theory of capitalism—the three
errors discussed above—Marx would have reversed his views about capitalism and
socialism. His writings leave no doubt that he was making an honest search for the
truth about capitalism and the causes of misdistribution of wealth under capitalism.
But it is also true that his writings leave no doubt that, had he caught and prevented
himself from falling into his three foundational errors, he would have become as
defiant in his espousal of capitalism as he erroneously was vehement in its
denunciation.
If labor alone is a creator of wealth, there must be, as Marx and Engels said in the
Communist Manifesto, equal liability of all to labor. But if capital is a creator of
wealth, one may participate in the production of wealth either as an owner of labor
or as an owner of capital. Similarly, if land is a source of wealth, one may participate
in the production of wealth as an owners of land. But this basic capitalistic principle
goes further. If, as we know, the productivity of capital is increasing in relation to
that of non-managerial and non-scientific labor, and if the right to participate in the
distribution of the proceeds of production follows from the fact of participation in
production, the social justice which Marx sought lies in regulating the capitalistic
economy so that there emerges an ever-increasing proportion of capitalists.
The uneasy ghost of Marx must suffer the torments of the damned at the truth glaring
from the pages of history that one does not abolish property by transferring it to the
state. To put an end to private property in capital and land by establishing the
socialist state is to concentrate the vast aggregate of property rights in the wielders
of political power. There is no mystery in the fact that through a literal application
of the theories of the great seeker after social justice, the Communist countries have
achieved the exact opposite of what was promised. Marx wailed over the plight of
pg. 52
the helpless worker under the merciless lash of the powerful factory owner. What
would he say of the plight of the worker before the inescapably crushing power of
the dictator, the political clique, or the party which in fact (though never in name,
since everything is always done in the name of “the people “) owns all factories, all
instruments of production, all land, and fuses this power with political power?
There can be only one answer. The safety, the security, the dignity of the individual
which Marx sought in socialism can be found only under capitalism. The answer to
the charge that ownership of capital instruments is too concentrated lies in the proper
use of governmental regulation to reduce the concentration and to continuously
broaden the private ownership of the means of production.
What Marx almost discovered was that both the benefits and the success of
capitalism grow with the number of men who are capitalists. His error in failing to
discover this truth was the most fateful near-miss in history.
Max came from a middle class Jewish family. He was born in south eastern
Germany near Coblenz. The family changed its religion to Christianity
Marx was usually not very financially well off. He did not value money the way
others do. He once absurdly laughed at making 4 times his money off a stock he
owned in the stock market. Most are happy when this happens but Marx was more
interested in the stupidity of the stock outcome.
In conclusion, Marx was a revolutionary with revolutionary friends. His associates
and comrades recognized his brilliance and often pressured him to sit down and
write. They were willing to help him financially if he needed help. Marxs father
often helped him financially as well. When he passed away Marx received the large
inheritance. Marx donated a large portion of the money to the workers association
and he spent what was left. So it's hard determining a net worth for a rare man like
this. He didn't have that as a goal. He was trying to overthrow the system that
fetishized net worth. He didn’t have “wealth.” He earned a _living_ as a radical
journalist and editor while on the continent, then as a newspaper correspondent for
US newspapers in England. It wasn’t much of a living, and without the help of his
best friend and coauthor, Frederick Engels, who, in England, became a wealthy
capitalist, Marx and his family would have been in sorry straits indeed. More than a
century after his death, Karl Marx remains one of the most controversial figures in
pg. 53
the Western world. His relentless criticism of capitalism and his corresponding
promise of an inevitable, harmonious socialist future inspired a revolution of global
proportions. It seemed that—with the Bolshevik revolution in Russia and the spread
of communism throughout Eastern Europe—the Marxist dream had firmly taken
root during the first half of the twentieth century.
That dream collapsed before the century had ended. The people of Poland, Hungary,
Czechoslovakia, East Germany, Romania, Yugoslavia, Bulgaria, Albania, and the
USSR rejected Marxist ideology and entered a remarkable transition toward
private property rights and the market-exchange system, one that is still occurring.
pg. 54
A CRITICAL ANALYSIS OF VIEWS OF JOHN MAYNAD KEYNES ON
CREATION OF NET WHEALTH IN AN ECONOMY
Keynes and his followers believed that individuals should save less and spend more,
raising their marginal propensity to consume to effect full employment and
economic growth. In this theory, one dollar spent in fiscal stimulus eventually
creates more than one dollar in growth.
John Maynard Keynes (1883–1946) was an early 20th-century British economist,
best known as the founder of Keynesian economics and the father of
modern macroeconomics, the study of how economies—markets and other systems
that operate on a large scale—behave. One of the hallmarks of Keynesian economics
is that governments should actively try to influence the course of economies,
especially by increasing spending to stimulate demand in the face of recession.
In his seminal work, The General Theory of Employment, Interest, and Money—
considered one of the most influential economics books in history—he advocates
government intervention Keynes' father was an advocate of laissez-faire economics,
an economic philosophy of free-market capitalism that opposes government
intervention. Keynes himself was a conventional believer in the principles of the free
market (and an active investor in the stock market) during his time at Cambridge.
However, after the 1929 stock market crash triggered the Great Depression, Keynes
came to believe that unrestricted free-market capitalism was essentially flawed and
needed to be reformulated, not only to function better in its own right but also to
outperform competitive systems like communism.2
As a result, he began advocating for government intervention to curb unemployment
and correct economic recession. In addition to government jobs programs, he argued
that increased government spending was necessary to decrease unemployment—
even if it meant a budget deficit, as a solution to high unemployment. Keynes' father
was an advocate of laissez-faire economics, an economic philosophy of freemarket capitalism that opposes government intervention. Keynes himself was a
conventional believer in the principles of the free market (and an active investor in
the stock market) during his time at Cambridge.
However, after the 1929 stock market crash triggered the Great Depression, Keynes
came to believe that unrestricted free-market capitalism was essentially flawed and
pg. 55
needed to be reformulated, not only to function better in its own right but also to
outperform competitive systems like communism.2
As a result, he began advocating for government intervention to curb unemployment
and correct economic recession. In addition to government jobs programs, he argued
that increased government spending was necessary to decrease unemployment—
even if it meant a budget deficit.
Principles of effective demand
In a given state of technique, resources and costs, the employment of a given volume
of labour by an entrepreneur involves him in two kinds of expense: first of all, the
amounts which he pays out to the factors of production (exclusive of other
entrepreneurs) for their current services, which we shall call the factor cost of the
employment in question; and secondly, the amounts which he pays out to other
entrepreneurs for what he has to purchase from them together with the sacrifice
which he incurs by employing the equipment instead of leaving it idle, which we
shall call the user cost of the employment in question. The excess of the value of the
resulting output over the sum of its factor cost and its user cost is the profit or, as we
shall call it, the income of the entrepreneur. The factor cost is, of course, the same
thing, looked at from the point of view of the entrepreneur, as what the factors of
production regard as their income. Thus the factor cost and the entrepreneur's profit
make up, between them, what we shall define as the total income resulting from the
employment given by the entrepreneur. The entrepreneur's profit thus defined is, as
it should be, the quantity which he endeavours to maximise when he is deciding what
amount of employment to offer. It is sometimes convenient, when we are looking at
it from the entrepreneur's standpoint, to call the aggregate income (i.e. factor cost
plus profit) resulting from a given amount of employment the proceeds of that
employment. On the other hand, the aggregate supply price of the output of a given
amount of employment is the expectation of proceeds which will just make it worth
the while of the entrepreneurs to give that employment. It follows that in a given
situation of technique, resources and factor cost per unit of employment, the amount
of employment, both in each individual firm and industry and in the aggregate,
depends on the amount of the proceeds which the entrepreneurs expect to receive
from the corresponding output. For entrepreneurs will endeavour to fix the amount
pg. 56
of employment at the level which they expect to maximise the excess of the proceeds
over the factor cost.
Let Z be the aggregate supply price of the output from employing N men, the
relationship between Z and N being written Z = φ(N), which can be called the
aggregate supply function. Similarly, let D be the proceeds which entrepreneurs
expect to receive from the employment of N men, the relationship between D and N
being written D = f(N), which can be called the aggregate demand function.
Now if for a given value of N the expected proceeds are greater than the aggregate
supply price, i.e. if D is greater than Z, there will be an incentive to entrepreneurs to
increase employment beyond N and, if necessary, to raise costs by competing with
one another for the factors of production, up to the value of N for which Z has
become equal to D. Thus the volume of employment is given by the point of
intersection between the aggregate demand function and the aggregate supply
function; for it is at this point that the entrepreneurs' expectation of profits will be
maximised. The value of D at the point of the aggregate demand function, where it
is intersected by the aggregate supply function, will be called the effective demand.
Since this is the substance of the General Theory of Employment, which it will be
our object to expound, the succeeding chapters will be largely occupied with
examining the various factors upon which these two functions depend.
The classical doctrine, on the other hand, which used to be expressed categorically
in the statement that 'Supply creates its own Demand' and continues to underlie all
orthodox economic theory, involves a special assumption as to the relationship
between these two functions. For 'Supply creates its own Demand' must mean that
f(N) and φ(N) are equal for all values of N, i.e. for all levels of output and
employment; and that when there is an increase in Z ( = φ(N)) corresponding to an
increase in N, D ( = f(N)) necessarily increases by the same amount as Z. The
classical theory assumes, in other words, that the aggregate demand price (or
proceeds) always accommodates itself to the aggregate supply price; so that,
whatever the value of N may be, the proceeds D assume a value equal to the
aggregate supply price Z which corresponds to N. That is to say, effective demand,
instead of having a unique equilibrium value, is an infinite range of values all equally
admissible; and the amount of employment is indeterminate except in so far as the
marginal disutility of labour sets an upper limit.
pg. 57
If this were true, competition between entrepreneurs would always lead to an
expansion of employment up to the point at which the supply of output as a whole
ceases to be elastic, i.e. where a further increase in the value of the effective demand
will no longer be accompanied by any increase in output. Evidently this amounts to
the same thing as full employment. In the previous chapter we have given a
definition of full employment in terms of the behaviour of labour. An alternative,
though equivalent, criterion is that at which we have now arrived, namely a situation
in which aggregate employment is inelastic in response to an increase in the effective
demand for its output. Thus Say's law, that the aggregate demand price of output as
a whole is equal to its aggregate supply price for all volumes of output, is equivalent
to the proposition that there is no obstacle to full employment. If, however, this is
not the true law relating the aggregate demand and supply functions, there is a vitally
important chapter of economic theory which remains to be written and without
which all discussions concerning the volume of aggregate employment are futile.
The outline of our theory can be expressed as follows. When employment increases,
aggregate real income is increased. The psychology of the community is such that
when aggregate real income is increased aggregate consumption is increased, but
not by so much as income. Hence employers would make a loss if the whole of the
increased employment were to be devoted to satisfying the increased demand for
immediate consumption. Thus, to justify any given amount of employment there
must be an amount of current investment sufficient to absorb the excess of total
output over what the community chooses to consume when employment is at the
given level. For unless there is this amount of investment, the receipts of the
entrepreneurs will be less than is required to induce them to offer the given amount
of employment. It follows, therefore, that, given what we shall call the community's
propensity to consume, the equilibrium level of employment, i.e. the level at which
there is no inducement to employers as a whole either to expand or to contract
employment, will depend on the amount of current investment. The amount of
current investment will depend, in turn, on what we shall call the inducement to
invest; and the inducement to invest will be found to depend on the relation between
the schedule of the marginal efficiency of capital and the complex of rates of interest
on loans of various maturities and risks.
Thus, given the propensity to consume and the rate of new investment, there will be
only one level of employment consistent with equilibrium; since any other level will
pg. 58
lead to inequality between the aggregate supply price of output as a whole and its
aggregate demand price. This level cannot be greater than full employment, i.e. the
real wage cannot be less than the marginal disutility of labour. But there is no reason
in general for expecting it to be equal to full employment. The effective demand
associated with full employment is a special case, only realised when the propensity
to consume and the inducement to invest stand in a particular relationship to one
another. This particular relationship, which corresponds to the assumptions of the
classical theory, is in a sense an optimum relationship. But it can only exist when,
by accident or design, current investment provides an amount of demand just equal
to the excess of the aggregate supply price of the output resulting from full
employment over what the community will choose to spend on consurnption when
it is fully employed. This theory can be summed up in the following propositions:
(1) in a given situation of technique, resources and costs, income (both moneyincome and real income) depends on the volume of employment N.
(2) The relationship between the community's income and what it can be expected
to spend on consumption, designated by D1, will depend on the psychological
characteristic of the community, which we shall call its propensity to consume. That
is to say, consumption will depend on the level of aggregate income and, therefore,
on the level of employment N, except when there is some change in the propensity
to consume.
(3) The amount of labor N which the entrepreneurs decide to employ depends on the
sum (D) of two quantities, namely D1, the amount which the community is expected
to spend on consumption, and D2, the amount which it is expected to devote to new
investment. D is what we have called above the effective demand.
(4) Since D1 + D2 = D = φ(N), where is the aggregate supply function, and since,
as we have seen in (2) above, D1 is a function of N, which we may write χ(N),
depending on the propensity to consume, it follows that φ(N) − χ(N) = D2.
(5) Hence the volume of employment in equilibrium depends on (i) the aggregate
supply function, (ii) the propensity to consume, and (iii) the volume of investment,
D2. This is the essence of the General Theory of Employment.
(6) For every value of N there is a corresponding marginal productivity of labour in
the wage-goods industries; and it is this which determines the real wage is, therefore,
pg. 59
subject to the condition that N cannot exceed the value which reduces the real wage
to equality with the marginal disutility of labour. This means that not all changes in
D are compatible with our temporary assumption that money-wages are constant.
Thus it will be essential to a full statement of our theory to dispense with this
assumption.
(7) On the classical theory, according to which D = φ(N) for all values of N, the
volume of employment is in neutral equilibrium for all values of N less than its
maximum value; so that the forces of competition between entrepreneurs may be
expected to push it to this maximum value. Only at this point, on the classical theory,
can there be stable equilibrium.
(8) When employment increases, D1will increase, but not by so much as D; since
when our income increases our consumption increases also, but not by so much. The
key to our practical problem is to be found in this psychological law. For it follows
from this that the greater the volume of employment the greater will be the gap
between the aggregate supply price (Z) of the corresponding output and the sum
(D1) which the entrepreneurs can expect to get back out of the expenditure of
consumers. Hence, if there is no change in the propensity to consume, employment
cannot increase, unless at the same time D2 is increasing so as to fill the increasing
gap between Z and D1. Thus— except on the special assumptions of the classical
theory according to which there is some force in operation which, when employment
increases, always causes D2 to increase sufficiently to fill the widening gap between
Z and D1—the economic system may find itself in stable equilibrium with N at a
level below full employment, namely at the level given by the intersection of the
aggregate demand function with the aggregate supply function.
Thus the volume of employment is not determined by the marginal disutility of labor
measured in terms of real wages, except in so far as the supply of labor available at
a given real wage sets a maximum level of employment. The propensity to consume
and the rate of new investment determine them the volume of employment, and the
volume of employment is uniquely related to a given level of real wages—not the
other way round. If the propensity to consume and the rate of new investment result
in a deficient effective demand, the actual level of employment will fall short of the
supply of labor potentially available at the existing real wage, and the equilibrium
pg. 60
real wage will be greater than the marginal disutility of the equilibrium level of
employment.
This analysis supplies us with an explanation of the paradox of poverty in the midst
of plenty. For the mere existence of an insufficiency of effective demand may, and
often will, bring the increase of employment to a standstill before a level of full
employment has been reached. The insufficiency of effective demand will inhibit
the process of production in spite of the fact that the marginal product of labor still
exceeds in value the marginal disutility of employment. Moreover the richer the
community, the wider will tend to be the gap between its actual and its potential
production; and therefore the more obvious and outrageous the defects of the
economic system. For a poor community will be prone to consume by far the greater
part of its output, so that a very modest measure of investment will be sufficient to
provide full employment; whereas a wealthy community will have to discover much
ampler opportunities for investment if the saving propensities of its wealthier
members are to be compatible with the employment of its poorer members. If in a
potentially wealthy community the inducement to invest is weak, then, in spite of its
potential wealth, the working of the principle of effective demand will compel it to
reduce its actual output, until, in spite of its potential wealth, it has become so poor
that its surplus over its consumption is sufficiently diminished to correspond to the
weakness of the inducement to invest. But worse still. Not only is the marginal
propensity to consume weaker in a wealthy community, but, owing to its
accumulation of capital being already larger, the opportunities for further investment
are less attractive unless the rate of interest falls at a sufficiently rapid rate; which
'brings us to the theory of the rate of interest and to the reasons why it does not
automatically fall to the appropriate level, which will occupy Book IV. Thus the
analysis of the propensity to consume, the definition of the marginal efficiency of
capital and the theory of the rate of interest are the three main gaps in our existing
knowledge which it will be necessary to fill. When this has been accomplished, we
shall find that the theory of prices falls into its proper place as a matter which is
subsidiary to our general theory. We shall discover, however, that money plays an
essential part in our theory of the rate of interest; and we shall attempt to disentangle
the peculiar characteristics of money which distinguish it from other things.
pg. 61
EXPECTATION AS DETERMINING OUTPUT AND EMPLOYMENT
All production is for the purpose of ultimately satisfying a consumer. Time usually
elapses, however—and sometimes much time—between the incurring of costs by
the producer (with the consumer in view) and the purchase of the output by the
ultimate consumer. Meanwhile the entrepreneur (including both the producer and
the investor in this description) has to form the best expectations he can as to what
the consumers will be prepared to pay when he is ready to supply them (directly or
indirectly) after the elapse of what may be a lengthy period; and he has no choice
but to be guided by these expectations, if he is to produce at all by processes which
occupy time. These expectations, upon which business decisions depend, fall into
two groups, certain individuals or firms being specialized in the business of framing
the first type of expectation and others in the business of framing the second. The
first type is concerned with the price which a manufacturer can expect to get for his
'finished' output at the time when he commits himself to starting the process which
will produce it; output being 'finished' (from the point of view of the manufacturer)
when it is ready to be used or to be sold to a second party. The second type is
concerned with what the entrepreneur can hope to earn in the shape of future returns
if he purchases (or, perhaps, manufactures) 'finished' output as an addition to his
capital equipment. We may call the former short-term expectation and the latter
long-term expectation.
Thus the behavior of each individual firm in deciding its daily output will be
determined by its short-term expectations expectations as to the cost of output on
various possible scales and expectations as to the sale-proceeds of this output;
though, in the case of additions to capital equipment and even of sales to distributors,
these short-term expectations will largely depend on the long-term (or medium-term)
expectations of other parties. It is upon these various expectations that the amount
of employment which the firms offer will depend. The actually realised results of
the production and sale of output will only be relevant to employment in so far as
they cause a modification of subsequent expectations. Nor, on the other hand, are
the original expectations relevant, which led the firm to acquire the capital
equipment and the stock of intermediate products and half-finished materials with
which it finds itself at the time when it has to decide the next day's output. Thus, on
each and every occasion of such a decision, the decision will be made, with reference
indeed to this equipment and stock, but in the light of the current expectations of
pg. 62
prospective costs and sale-proceeds. Now, in general, a change in expectations
(whether short-term or long-term) will only produce its full effect on employment
over a considerable period. The change in employment due to a change in
expectations will not be the same on the second day after the change as on the first,
or the same on the third day as on the second, and so on, even though there be no
further change in expectations. In the case of short-term expectations this is because
changes in expectation are not, as a rule, sufficiently violent or rapid, when they are
for the worse, to cause the abandonment of work on all the productive processes
which, in the light of the revised expectation, it was a mistake to have begun; whilst,
when they are for the better, some time for preparation must needs elapse before
employment can reach the level at which it would have stood if the state of
expectation had been revised sooner. In the case of long-term expectations,
equipment which will not be replaced will continue to give employment until it is
worn out; whilst when the change in long-term expectations is for the better,
employment may be at a higher level at first, than it will be after there has been time
to adjust the equipment to the new situation. If we suppose a state of expectation to
continue for a sufficient length of time for the effect on employment to have worked
itself out so completely that there is, broadly speaking, no piece of employment
going on which would not have taken place if the new state of expectation had
always existed, the steady level of employment thus attained may be called the longperiod employment corresponding to that state of expectation. It follows that,
although expectation may change so frequently that the actual level of employment
has never had time to reach the long-period employment corresponding to the
existing state of expectation, nevertheless every state of expectation has its definite
corresponding level of long-period employment. Let us consider, first of all, the
process of transition to a long-period position due to a change in expectation, which
is not confused or interrupted by any further change in expectation. We will first
suppose that the change is of such a character that the new long-period employment
will be greater than the old. Now, as a rule, it will only be the rate of input which
will be much affected at the beginning, that is to say, the volume of work on the
earlier stages of new processes of production, whilst the output of consumptiongoods and the amount of employment on the later stages of processes which were
started before the change will remain much the same as before. In so far as there
were stocks of partly finished goods, this conclusion may be modified; though it is
likely to remain true that the initial increase in employment will be modest. As,
pg. 63
however, the days pass by, employment will gradually increase. Moreover, it is easy
to conceive of conditions which will cause it to increase at some stage to a higher
level than the new long-period employment. For the process of building up capital
to satisfy the new state of expectation may lead to more employment and also to
more current consumption than will occur when the long-period position has been
reached. Thus the change in expectation may lead to a gradual crescendo in the level
of employment, rising to a peak and then declining to the new long-period level. The
same thing may occur even if the new long-period level is the same as the old, if the
change represents a change in the direction of consumption which renders certain
existing processes and their equipment obsolete. Or again, if the new long-period
employment is less than the old, the level of employment during the transition may
fall for a time below what the new long-period level is going to be. Thus a mere
change in expectation is capable of producing an oscillation of the same kind of
shape as a cyclical movement, in the course of working itself out. It was movements
of this kind which I discussed in my Treatise on Money in connection with the
building up or the depletion of stocks of working and liquid capital consequent on
change. An uninterrupted process of transition, such as the above, to a new longperiod position can be complicated in detail. But the actual course of events is more
complicated still. For the state of expectation is liable to constant change, a new
expectation being superimposed long before the previous change has fully worked
itself out; so that the economic machine is occupied at any given time with a number
of overlapping activities, the existence of which is due to various past states of
expectation.
This leads us to the relevance of this discussion for our present purpose. It is evident
from the above that the level of employment at any time depends, in a sense, not
merely on the existing state of expectation but on the states of expectation which
have existed over a certain past period. Nevertheless past expectations, which have
not yet worked themselves out, are embodied in the today's capital equipment with
reference to which the entrepreneur has to make to-day's decisions, and only
influence his decisions in so far as they are so embodied. It follows, therefore, that,
in spite of the above, to-day's employment can be correctly described as being
governed by to-day's expectations taken in conjunction with to-day's capital
equipment. Express reference to current long-term expectations can seldom be
avoided. But it will often be safe to omit express reference to short-term expectation,
pg. 64
in view of the fact that in practice the process of revision of short-term expectation
is a gradual and continuous one, carried on largely in the light of realized results; so
that expected and realized results run into and overlap one another in their influence.
For, although output and employment are determined by the producer's short-term
expectations and not by past results, the most recent results usually play a
predominant part in determining what these expectations are. It would be too
complicated to work out the expectations de novo whenever a productive process
was being started; and it would, moreover, be a waste of time since a large part of
the circumstances usually continue substantially unchanged from one day to the
next. Accordingly it is sensible for producers to base their expectations on the
assumption that the most recently realized results will continue, except in so far as
there are definite reasons for expecting a change. Thus in practice there is a large
overlap between the effects on employment of the realized sale-proceeds of recent
output and those of the sale-proceeds expected from current input; and producers'
forecasts are more often gradually modified in the light of results than in anticipation
of prospective changes.
Income, Saving And Investment
During any period of time an entrepreneur will have sold finished output to
consumers or to other entrepreneurs for a certain sum which we will designate as A.
He will also have spent a certain sum, designated by A1, on purchasing finished
output from other entrepreneurs. And he will end up with a capital equipment, which
term includes both his stocks of unfinished goods or working capital and his stocks
of finished goods, having a value G. Some part, however, of A + G − A1 will be
attributable, not to the activities of the period in question, but to the capital
equipment which he had at the beginning of the period. We must, therefore, in order
to arrive at what we mean by the income of the current period, deduct from A + G −
A1 a certain sum, to represent that part of its value which has been (in some sense)
contributed by the equipment inherited from the previous period. The problem of
defining income is solved as soon as we have found a satisfactory method for
calculating this deduction. There are two possible principles for calculating it, each
of which has a certain significance;—one of them in connection with production,
and the other in connection with consumption. Let us consider them in turn. (i) The
actual value G of the capital equipment at the end of the period is the net result of
the entrepreneur, on the one hand, having maintained and improved it during the
pg. 65
period, both by purchases from other entrepreneurs and by work done upon it by
himself, and, on the other hand, having exhausted or depreciated it through using it
to produce output. If he had decided not to use it to produce output, there is,
nevertheless, a certain optimum sum which it would have paid him to spend on
maintaining and improving it. Let us suppose that, in this event, he would have spent
B' on its maintenance and improvement, and that, having had this spent on it, it
would have been worth G' at the end of the period. That is to say, G' − B' is the
maximum net value which might have been conserved from the previous period, if
it had not been used to produce A. The excess of this potential value of the equipment
over G − A1 is the measure of what has been sacrificed (one way or another) to
produce A. Let us call this quantity, namely (G' − B') − (G − A1), which measures
the sacrifice of value involved in the production of A, the user cost of A. User cost
will be written U. The amount paid out by the entrepreneur to the other factors of
production in return for their services, which from their point of view is their income,
we will call the factor cost of A. The sum of the factor cost F and the user cost U we
shall call the prime cost of the output A. We can then define the income of the
entrepreneur as being the excess of the value of his finished output sold during the
period over his prime cost. The entrepreneur's income, that is to say, is taken as being
equal to the quantity, depending on his scale of production, which he endeavours to
maximise, i.e. to his gross profit in the ordinary sense of this term;—which agrees
with common sense. Hence, since the income of the rest of the community is equal
to the entrepreneur's factor cost, aggregate income is equal to A − U. Income, thus
defined, is a completely unambiguous quantity. Moreover, since it is the
entrepreneur's expectation of the excess of this quantity over his outgoings to the
other factors of production which he endeavours to maximise when he decides how
much employment to give to the other factors of production, it is the quantity which
is causally significant for employment. It is conceivable, of course, that G − A1 may
exceed G' − B', so that user cost will be negative. For example, this may well be the
case if we happen to choose our period in such a way that input has been increasing
during the period but without there having been time for the increased output to reach
the stage of being finished and sold. It will also be the case, whenever there is
positive investment, if we imagine industry to be so much integrated that
entrepreneurs make most of their equipment for themselves. Since, however, user
cost is only negative when the entrepreneur has been increasing his capital
equipment by his own labour, we can, in an economy where capital equipment is
pg. 66
largely manufactured by different firms from those which use it, normally think of
user cost as being positive. Moreover, it is difficult to conceive of a case where
marginal user cost associated with an increase in A, i.e. dU/dA, will be other than
positive. It may be convenient to mention here, in anticipation of the latter part of
this chapter, that, for the community as a whole, the aggregate consumption (C) of
the period is equal to Σ(A − A1), and the aggregate investment (I) is equal to Σ(A1
− U). Moreover, U is the individual entrepreneur's disinvestment (and − U his
investment) in respect of his own equipment exclusive of what he buys from other
entrepreneurs. Thus in a completely integrated system (where A1 = 0) consumption
is equal to A and investment to − U, i.e. to G − (G' − B'). The slight complication of
the above, through the introduction of A1, is simply due to the desirability of
providing in a generalised way for the case of a non-integrated system of production.
Furthermore, the effective demand is simply the aggregate income (or proceeds)
which the entrepreneurs expect to receive, inclusive of the incomes which they will
hand on to the other factors of production, from the amount of current employment
which they decide to give. The aggregate demand function relates various
hypothetical quantities of employment to the proceeds which their outputs are
expected to yield; and the effective demand is the point on the aggregate demand
function which becomes effective because, taken in conjunction with the conditions
of supply, it corresponds to the level of employment which maximises the
entrepreneur's expectation of profit. This set of definitions also has the advantage
that we can equate the marginal proceeds (or income) to the marginal factor cost;
and thus arrive at the same sort of propositions relating marginal proceeds thus
defined to marginal factor costs as have been stated by those economists who, by
ignoring user cost or assuming it to be zero, have equated supply price to marginal
factor cost. (ii) We turn, next, to the second of the principles referred to above. We
have dealt so far with that part of the change in the value of the capital equipment at
the end of the period as compared with its value at the beginning which is due to the
voluntary decisions of the entrepreneur in seeking to maximise his profit. But there
may, in addition, be an involuntary loss (or gain) in the value of his capital
equipment, occurring for reasons beyond his control and irrespective of his current
decisions, on account of (e.g.) a change in market values, wastage by obsolescence
or the mere passage of time, or destruction by catastrophe such as war or earthquake.
Now some part of these involuntary losses, whilst they are unavoidable, are—
broadly speaking—not unexpected; such as losses through the lapse of time
pg. 67
irrespective of use, and also 'normal' obsolescence which, as Professor Pigou
expresses it, 'is sufficiently regular to be foreseen, if not in detail, at least in the large',
including, we may add, those losses to the community as a whole which are
sufficiently regular to be commonly regarded as 'insurable risks'. Let us ignore for
the moment the fact that the amount of the expected loss depends on when the
expectation is assumed to be framed, and let us call the depreciation of the
equipment, which is involuntary but not unexpected, i.e. the excess of the expected
depreciation over the user cost, the supplementary cost, which will be written V. It
is, perhaps, hardly necessary to point out that this definition is not the same as
Marshall's definition of supplementary cost, though the underlying idea, namely, of
dealing with that part of the expected depreciation which does not enter into prime
cost, is similar. In reckoning, therefore, the net income and the net profit of the
entrepreneur it is usual to deduct the estimated amount of the supplementary cost
from his income and gross profit as defined above. For the psychological effect on
the entrepreneur, when he is considering what he is free to spend and to save, of the
supplementary cost is virtually the same as though it came off his gross profit. In his
capacity as a producer deciding whether or not to use the equipment, prime cost and
gross profit, as defined above, are the significant concepts. But in his capacity as a
consumer the amount of the supplementary cost works on his mind in the same way
as if it were a part of the prime cost. Hence we shall not only come nearest to
common usage but will also arrive at a concept which is relevant to the amount of
consumption, if, in defining aggregate net income, we deduct the supplementary cost
as well as the user cost, so that aggregate net income is equal to A − U − V. There
remains the change in the value of the equipment, due to unforeseen changes in
market values, exceptional obsolescence or destruction by catastrophe, which is both
involuntary and—in a broad sense—unforeseen. The actual loss under this head,
which we disregard even in reckoning net income and charge to capital account, may
be called the windfall loss. The causal significance of net income lies in the
psychological influence of the magnitude of V on the amount of current
consumption, since net income is what we suppose the ordinary man to reckon his
available income to be when he is deciding how much to spend on current
consumption. This is not, of course, the only factor of which he takes account when
he is deciding how much to spend. It makes a considerable difference, for example,
how much windfall gain or loss he is making on capital account. But there is a
difference between the supplementary cost and a windfall loss in that changes in the
pg. 68
former are apt to affect him in just the same way as changes in his gross profit. It is
the excess of the proceeds of the current output over the sum of the prime cost and
the supplementary cost which is relevant to the entrepreneur's consumption;
whereas, although the windfall loss (or gain) enters into his decisions, it does not
enter into them on the same scale—a given windfall loss does not have the same
effect as an equal supplementary cost. We must now recur, however, to the point
that the line between supplementary costs and windfall losses, i.e. between those
unavoidable losses which we think it proper to debit to income account and those
which it is reasonable to reckon as a windfall loss (or gain) on capital account, is
partly a conventional or psychological one, depending on what are the commonly
accepted criteria for estimating the former. For no unique principle can be
established for the estimation of supplementary cost, and its amount will depend on
our choice of an accounting method. The expected value of the supplementary cost,
when the equipment was originally produced, is a definite quantity. But if it is reestimated subsequently, its amount over the remainder of the life of the equipment
may have changed as a result of a change in the meantime in our expectations; the
windfall capital loss being the discounted value of the difference between the former
and the revised expectation of the prospective series of U + V. It is a widely approved
principle of business accounting, endorsed by the Inland Revenue authorities, to
establish a figure for the sum of the supplementary cost and the user cost when the
equipment is acquired and to maintain this unaltered during the life of the equipment,
irrespective of subsequent changes in expectation. In this case the supplementary
cost over any period must be taken as the excess of this predetermined figure over
the actual user cost. This has the advantage of ensuring that the windfall gain or loss
shall be zero over the life of the equipment taken as a whole. But it is also reasonable
in certain circumstances to recalculate the allowance for supplementary cost on the
basis of current values and expectations at an arbitrary accounting interval, e.g.
annually. Business men in fact differ as to which course they adopt. It may be
convenient to call the initial expectation of supplementary cost when the equipment
is first acquired the basic supplementary cost, and the same quantity recalculated up
to date on the basis of current values and expectations the current supplementary
cost. Thus we cannot get closer to a quantitative definition of supplementary cost
than that it comprises those deductions from his income which a typical entrepreneur
makes before reckoning what he considers his net income for the purpose of
declaring a dividend (in the case of a corporation) or of deciding the scale of his
pg. 69
current consumption (in the case of an individual). Since windfall charges on capital
account are not going to be ruled out of the picture, it is clearly better, in case of
doubt, to assign an item to capital account, and to include in supplementary cost only
what rather obviously belongs there. For any overloading of the former can be
corrected by allowing it more influence on the rate of current consumption than it
would otherwise have had. It will be seen that our definition of net income comes
very close to Marshall's definition of income, when he decided to take refuge in the
practices of the Income Tax Commissioners and—broadly speaking to regard as
income whatever they, with their experience, choose to treat as such. For the fabric
of their decisions can be regarded as the result of the most careful and extensive
investigation which is available, to interpret what, in practice, it is usual to treat as
net income. It also corresponds to the money value of Professor Pigou's most recent
definition of the national dividend. It remains true, however, that net income, being
based on an equivocal criterion which different authorities might interpret
differently, is not perfectly clear-cut. Professor Hayek, for example, has suggested
that an individual owner of capital goods might aim at keeping the income he derives
from his possessions constant, so that he would not feel himself free to spend his
income on consumption until he had set aside sufficient to offset any tendency of his
investment-income to decline for whatever reason. I doubt if such an individual
exists; but, obviously, no theoretical objection can be raised against this deduction
as providing a possible psychological criterion of net income. But when Professor
Hayek infers that the concepts of saving and investment suffer from a corresponding
vagueness, he is only right if he means net saving and net investment. The saving
and the investment, which are relevant to the theory of employment, are clear of this
defect, and are capable of objective definition, as we have shown above. Thus it is a
mistake to put all the emphasis on net income, which is only relevant to decisions
concerning consumption, and is, moreover, only separated from various other factors
affecting consumption by a narrow line; and to overlook (as has been usual) the
concept of income proper, which is the concept relevant to decisions concerning
current production and is quite unambiguous.
Saving and Investment
Amidst the welter of divergent usages of terms, it is agreeable to discover one fixed
point. So far as I know, everyone is agreed that saving means the excess of income
over expenditure on consumption. Thus any doubts about the meaning of saving
pg. 70
must arise from doubts about the meaning either of income or of consumption.
Income we have defined above. Expenditure on consumption during any period must
mean the value of goods sold to consumers during that period, which throws us back
to the question of what is meant by a consumer-purchaser. Any reasonable definition
of the line between consumer-purchasers and investor-purchasers will serve us
equally well, provided that it is consistently applied. Such problem as there is, e.g.
whether it is right to regard the purchase of a motor-car as a consumer-purchase and
the purchase of a house as an investor-purchase, has been frequently discussed and
I have nothing material to add to the discussion. The criterion must obviously
correspond to where we draw the line between the consumer and the entrepreneur.
Thus when we have defined A1 as the value of what one entrepreneur has purchased
from another, we have implicitly settled the question. It follows that expenditure on
consumption can be unambiguously defined as Σ(A − A1), where A is the total sales
made during the period and A1 is the total sales made by one entrepreneur to another.
In what follows it will be convenient, as a rule, to omit and write A for the aggregate
sales of all kinds, A1 for the aggregate sales from one entrepreneur to another and U
for the aggregate user costs of the entrepreneurs. Having now defined both income
and consumption, the definition of saving, which is the excess of income over
consumption, naturally follows. Since income is equal to A − U and consumption is
equal to A − A1, it follows that saving is equal to A1 − U. Similarly, we have net
saving for the excess of net income over consumption, equal to A1 − U − V. Our
definition of income also leads at once to the definition of current investment. For
we must mean by this the current addition to the value of the capital equipment which
has resulted from the productive activity of the period. This is, clearly, equal to what
we have just defined as saving. For it is that part of the income of the period which
has not passed into consumption. We have seen above that as the result of the
production of any period entrepreneurs end up with having sold finished output
having a value A and with a capital equipment which has suffered a deterioration
measured by U (or an improvement measured by − U where U is negative) as a result
of having produced and parted with A, after allowing for purchases A1 from other
entrepreneurs. During the same period finished output having a value A − A1 will
have passed into consumption. The excess of A − U over A − A1, namely A1 − U,
is the addition to capital equipment as a result of the productive activities of the
period and is, therefore, the investment of the period. Similarly A1 − U − V; which
is the net addition to capital equipment, after allowing for normal impairment in the
pg. 71
value of capital apart from its being used and apart from windfall changes in the
value of the equipment chargeable to capital account, is the net investment of the
period.
Whilst, therefore, the amount of saving is an outcome of the collective behavior of
individual consumers and the amount of investment of the collective behavior of
individual entrepreneurs, these two amounts are necessarily equal, since each of
them is equal to the excess of income over consumption. Moreover, this conclusion
in no way depends on any subtleties or peculiarities in the definition of income given
above. Provided it is agreed that income is equal to the value of current output, that
current investment is equal to the value of that part of current output which is not
consumed, and that saving is equal to the excess of income over consumption—all
of which is conformable both to common sense and to the traditional usage of the
great majority of economists—the equality of saving and investment necessarily
follows.
In short- Income = value of output = consumption + investment.
Saving = income − consumption.
Therefore saving = investment.
Thus any set of definitions which satisfy the above conditions leads to the same
conclusion. It is only by denying the validity of one or other of them that the
conclusion can be avoided. The equivalence between the quantity of saving and the
quantity of investment emerges from the bilateral character of the transactions
between the producers on the one hand and, on the other hand, the consumer or the
purchaser of capital equipment.
Income is created by the value in excess of user cost which the producer obtains for
the output he has sold; but the whole of this output must obviously have been sold
either to a consumer or to another entrepreneur; and each entrepreneur's current
investment is equal to the excess of the equipment which he has purchased from
other entrepreneurs over his own user cost. Hence, in the aggregate the excess of
income over consumption, which we call saving, cannot differ from the addition to
capital equipment which we call investment. And similarly with net saving and net
investment.
pg. 72
Saving, in fact, is a mere residual. The decisions to consume and the decisions to
invest between them determine incomes. Assuming that the decisions to invest
become effective, they must in doing so either curtail consumption or expand
income. Thus the act of investment in itself cannot help causing the residual or
margin, which we call saving, to increase by a corresponding amount. It might be,
of course, that individuals were so tête montée in their decisions as to how much
they themselves would save and invest respectively, that there would be no point of
price equilibrium at which transactions could take place. In this case our terms would
cease to be applicable, since output would no longer have a definite market value,
prices would find no resting-place between zero and infinity. Experience shows,
however, that this, in fact, is not so; and that there are habits of psychological
response which allow of an equilibrium being reached at which the readiness to buy
is equal to the readiness to sell. That there should be such a thing as a market value
for output is, at the same time, a necessary condition for money-income to possess a
definite value and a sufficient condition for the aggregate amount which saving
individuals decide to save to be equal to the aggregate amount which investing
individuals decide to invest. Clearness of mind on this matter is best reached,
perhaps, by thinking in terms of decisions to consume (or to refrain from consuming)
rather than of decisions to save. A decision to consume or not to consume truly lies
within the power of the individual; so does a decision to invest or not to invest. The
amounts of aggregate income and of aggregate saving are the results of the free
choices of individuals whether or not to consume and whether or not to invest; but
they are neither of them capable of assuming an independent value resulting from a
separate set of decisions taken irrespective of the decisions concerning consumption
and investment. In accordance with this principle, the conception of the propensity
to consume will, in what follows, take the place of the propensity or disposition to
save.
pg. 73
CONCLUSION
Net wealth is the total amount of assets held by a household (gross wealth) deduction
made from the amount of capital it still owes on loans taken out to acquire property,
capital goods, or for any other personal or business purpose. We can see that the
various views of economic thinkers we studied above differ, but then they are interrelated. In difference with the mercantilists who, as we have seen, measured the
wealth of a country on the basis of the gold and precious metals it possessed, the
physiocrats held that a country's wealth should be measured by the income (the
product net) an economic system was able to produce each year, while the Keynes
and his followers believed that individuals should save less and spend more, raising
their marginal propensity to consume to effect full employment and economic
growth. In this theory, one dollar spent in fiscal stimulus eventually creates more
than one dollar in growth. Thus, whilst economists were accustomed to applauding
the prevailing international system as furnishing the fruits of the international
division of labor and harmonizing at the same time the interests of different nations,
there lay concealed a less benign influence; and those statesmen were moved by
common sense and a correct apprehension of the true course of events, who believed
that if a rich, old country were to neglect the struggle for markets its prosperity would
droop and fail. But if nations can learn to provide themselves with full employment
by their domestic policy (and, we must add, if they can also attain equilibrium in the
trend of their population), there need be no important economic forces calculated to
set the interest of one country against that of its neighbors. There would still be room
for the international division of labor and for international lending in appropriate
conditions. But there would no longer be a pressing motive why one country need
force its wares on another or repulse the offerings of its neighbor, not because this
was necessary to enable it to pay for what it wished to purchase, but with the express
object of upsetting. The equilibrium of payments so as to develop a balance of trade
in its own favor. International trade would cease to be what it is, namely, a desperate
expedient to maintain employment at home by forcing sales on foreign markets and
restricting purchases, which, if successful, will merely shift the problem of
unemployment to the neighbor which is worsted in the struggle, but a willing and
unimpeded exchange of goods and services in conditions of mutual advantage.
According to Marx, money is the product of commodity economy. Under the
condition of non-commodity economy, the general human labor does not manifest
pg. 74
itself as value, and there is no contradiction between use value and value, concrete
labor and abstract labor, social labor and individual labor, so there is no money. The
well-worn assertion that the rich get richer while the poor get poorer echoes Karl
Marx's theory of immiseration which said that capitalists could only become richer
by lowering wages, thereby reducing the living standards of workers until they had
no choice but to revolt. The bourgeoisie is the oppressive class, which Karl Marx
argued would be destroyed in the workers' revolution. Specifically, the bourgeoisie
was the class which controlled the means of production as well as almost all of the
wealth. To correct this injustice and achieve true freedom, Marx said the workers
must first overthrow the capitalist system of private property. The workers would
then replace capitalism with a communist economic system, in which they would
own property in common and share the wealth they produced.
In summary, we can say that the human nature drove all these views by different
economic thinkers, the human nature changes and evolves, so also does the views
and ideas of these great thinkers. Human nature was a complex rather than a simple
force. Thus, the wealth of nations would grow only if individuals, through their
governments, did not inhibit this growth by catering to the pleas for special privilege
that would prevent the competitive system from exerting its benign effect.
pg. 75
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