Lecture Two

1
Lecture Two

• Economic Thought from Mercantilists to Adam Smith

2
Recap

• Feudal ideology significantly anti-capitalist,
  anti-financier. But
• Merchants essential
• Exotic commodities from other lands
• Trade between different fiefs/kingdoms
• Finance essential
• Merchant activity
• Wars
• Merchants tolerated (but controlled, taxed)
• Usury laws circumvented

3
Medieval fiction to circumvent anti-usury laws

Same religion
Lends at no interest
B fails to repay A
Insures A in case B fails to repay
Pays C interest rate for insurance

• Effectively, a different set of books to
  disguise breaching the laws against usury

4
Medieval Breakdown

• Feudal system imposed many imposts upon
  merchants/tradesmen/moneylenders but social
  change went against feudalism
• Growth of specialist manufactures in towns the
  guilds
• Growth of specialist traders between nations the
  Mercantilists
• Revolt against religious strictures against
  merchants/lending, church hypocrisy
• Religious revolts beginnings of Protestantism
  bound up with growth of merchants/financiers
• A new ideology/analysis struggled for dominance
  Mercantilism

5
Mercantilism

• Justice out the window the aim is gain
• Buy cheap and sell dear sell lots and buy little
• suppose Pepper to be worth here two Shillings
  the pound constantly, if then it be brought from
  the Dutch at Amsterdam, the Merchant may give
  there twenty pence the pound, and gain well by
  the bargain but if he fetch this Pepper from the
  East-Indies, he must not give above three pence
  the pound at the most, which is a mighty
  advantage Mun, OREF 18

6
Mercantilism

• Focus is international trade, rather than
  internal commerce
• Nationalism essential promote nation by gain
  from trade
• Trade imbalance the object export more than
  import
• Self-sufficiency the domestic object
• Pro-commerce and finance, but many contradictions
• Promoted exports, restricted imports, no
  attention to system of production. A trader,
  rather than producer, perspective

7
Mercantilism

• It is needful also not to charge the native
  commodities with too great customes, lest by
  indearing them to the strangers use, it hinder
  their vent. And especially forraign wares brought
  in to be transported again should be favoured,
  for otherwise that manner of trading ... cannot
  prosper nor subsist. But the Consumption of such
  forraign wares in the Realm may be the more
  charged, which will turn to the profit of the
  kingdom in the Ballance of the Trade, and ...
  enable the King to lay up the more Treasure
  Mun OREF

8
Mercantilism

• Leading intellect Petty (1623-1687)
• Strong advocate of quantitative analysis
• Considered production (unlike many Mercantilists)
• Had cost-based theory of value (rather than
  utility-based)
• Did not believe that economy would automatically
  reach full employment (unlike later Smith, Say,
  Ricardo)
• Advocated public works to reduce unemployment
• Had concept of surplus, though no systematic
  analysis
• Regarded by Marx as father of political economy
  (over 100 years before Smith)

9
Mercantilism

• Foreign trade as the source of surplus
• No analysis of production
• In practice
• Added to feudal imposts on commerce
• Created government-sanctioned monopolies
• ostensibly to increase national wealth but
• often in practice enriched favoured individuals
• Point of criticism and departure for later
  Physiocrats Classical Economists, with emphasis
  upon laisser-faire, laisser-passer

10
Pre-Classicals Conclusion

• Pre-classical economists views on free exchange
  hampered by non-capitalist nature of production
  during their epochs
• Two concepts muddled
• That fairness in exchange meant commodities
  should exchange on the basis of the effort they
  embodied
• That fairness in exchange should reflect the
  buyers need for the product
• Concept of surplus barely appreciated (except for
  Petty)
• First systematic analysis of production
  undertaken by Physiocrats

11
Early Classicism

• The Physiocrats
• Developed in pre-capitalist, agricultural France
• Smith, Ricardo, Malthus and Say
• Development dominated by capitalist, Industrial
  Revolution England

12
The Environment of Physiocracy

• Feudal system (like England) but
• All-powerful king (vs. Magna Carta)
• Feudal lords concentrated at Versailles absentee
  landlords, no interest in farming
• Taxes used to extract surplus for consumption by
  lords/King
• Rural sector dominated by small peasant-owner
  farms (unlike rural estate England)
• Few capitalist farmers, investment discouraged by
  taxes many feudal/mercantilist imposts on trade
  (like England)
• Stagnant agriculture, vs England which had been
  transformed into capitalist farming system

13
Physiocracy

• Precursors Petty, Cantillon (see OREF)
• Founder Quesnay, doctor to Royal Court
• Underlying concepts of
• flows, as in blood in human body
• surplus
• Economy must produce a surplus for discretionary
  consumption growth
• Sought to promote capitalist farmers to increase
  output and available surplus
• First systematic analysis of economy
• Laid down in tabular form of flows from one
  sector to another

14
The Tableau Economique

• Explaining this

15
The Tableau Economique
Previous harvest
Rent to landlord
Landlord buys wheat and carriages
Farmer buys tools to grow wheat
Surplus product goes to landlord as rent
Process continues...
Artisans buy wheat
Recoups initial surplus
16
The Tableau Economique
17
Basic Features of Physiocracy

• Focus on production trade as component of
  production
• Key aspect of production the generation of a net
  surplus (produit net)
• Agriculture the only source of surplus farmers
  the productive class
• Manufacturing simply transforms agricultural
  surplus into different forms workers the
  sterile class
• Feudal lords/clerics sustained by share of
  surplus the proprietor class
• Outputs of manufactures needed to generate rural
  net product interdependence (multiplier,
  input-output concepts)

18
Basic Propositions of Physiocracy

• Agriculture only source of new value
• Land pre-dates man
• For man to survive, food must exist first
• Therefore land is the source of value
• Agriculture generates a surplus
• 1 unit of output requires lt 1 unit of input
• Sew 1 kilo of wheat as seed, get 10 kilos of
  wheat as crop
• Manufacturing simply converts form
• 1 unit of input, 1 unit of output (but in
  different form)
• Surplus key to wealth Wealth can be increased if
  gap between inputs and output in agriculture can
  be increased.

19
Input-Output

• Example
• System 1 with 100 hectares of land
• 1 hectare land 7/10 bushels wheat 1/10 kilo
  steel produces 1 bushel wheat
• 0 hectare land 1/10 bushel wheat 9/10 kilo
  steel produces 1 kilo steel
• 70 wheat 10 steel -gt 100 wheat
• 10 wheat 90 steel -gt 100 steel
• Net output 20 bushels wheat, 0 kilos steel

20
Input-Output

• System 2 with 100 hectares of land
• 1 hectare land 6/10 bushels wheat 1/10 kilo
  steel produces 1 bushel wheat
• 0 hectare land 1/10 bushel wheat 9/10 kilo
  steel produces 1 kilo steel
• 60 wheat 10 steel -gt 100 wheat
• 10 wheat 90 steel -gt 100 steel
• Net output 30 bushels wheat, 0 kilos steel
• Benefits of improved technology
• 16 reduction in necessary inputs
• 50 increase in net product

21
Physiocratic Policy

• Net produit of contemporary France limited by
• Small landholdings, absentee landlords, primitive
  techniques
• Heavy arbitrary feudal taxation
• Mercantilist restrictions on trade in rural
  produce
• Physiocrats
• favoured commercial farmers,
• single tax on land rent
• High corn price, free movement of rural goods,
  no manufacturing monopolies
• Object to encourage improved techniques in
  agriculture, hence higher surplus

22
Strengths Weaknesses of Physiocracy

• In many ways far ahead of their time
• Concept of surplus
• Input-output concepts
• Major advance over previous economists
• Lost until modern times (except for Marx)
• Aggregate level of output depended on
  re-investment of net surplus an
  investment-driven perspective
• Contraction of net surplus means contraction of
  economy an aggregate-demand perspective
• Belief that agriculture only source of surplus
• Development of input-output analysis hobbled by
  views on value
• Politically unpalatable advice meant early
  downfall

23
From Physiocracy to Adam Smith

• Focus upon domestic production (unlike
  Mercantilists international trade focus)
• Cost of production explanation for prices
• Search for the source of value
• Physiocrats nomination land
• Smith labour, and division of labour for its
  increase
• Beginnings of emphasis upon freedom of commerce
  (unlike Mercantilists government monopolies,
  duties on imports, etc.)
• Input-output aspects lost (until Marx)
• Concern for aggregate demand lost to Says Law
  (except for Malthus, Marx)

24
1776 The Wealth of Nations

• Writing less than 10 years after Watt devised his
  steam engine (1769) year first Watt engine
  installed (1776)

Agriculture already capitalist via enclosure
movement Crops for sale rather than consumption
on feudal estate Serfs evicted from land class of
landless labourers no rights to land (like
serfs), no assets (like guildsmen) must work for
a living wage labour Industry becoming
capitalist factories, labourers displacing
guilds, craftsmen
25
1776 The Wealth of Nations

• Domestic production now much more important than
  foreign trade
• Focus foremost on production, rather than
  exchange
• Early stage of capitalist development causes
  confusion
• Role of machinery not yet pervasive
• Class structure capitalist, but not yet clear

26
Basic Propositions

• Labour, not land, is the primary source of value
• The annual labour of every nation is the fund
  which originally supplies it with all the
  necessaries and conveniences of life OREF
  (Differs with Physiocrats)
• Increase in value from specialisation division
  of labour economies of scale essential part of
  his analysis
• Acknowledges role of machinery
• This great increase of the quantity of work ...
  is owing to the increase in the dexterity in
  every particular workman the saving of time
  which is commonly lost in passing from one
  species of work to another ... the invention of
  a great number of machines which facilitate and
  abridge labour, and enable one man to do the work
  of many. OREF

27
Basic Propositions

• But subsumes this too under division of labour
• (T)he invention of all those machines ... seems
  to have been originally owing to the division of
  labour. Men are much more likely to discover
  easier and readier methods of attaining any
  object, when the whole attention of their minds
  is directed towards that single object OREF
• Clarifies ancient dispute over role of utility in
  determining value/price
• The word VALUE ... has two different meanings,
  ... the utility of some particular object, and
  ... the power of purchasing other goods... The
  one may be called value in use, the other,
  value in exchange. OREF

28
Source of Value

• No role for value in use in determining price
• Commences with the diamond/water paradox
• Water has great value in use, but very low
  price
• Diamonds have little utility, but very high
  price
• The things which have the greatest value in use
  have frequently little or no value in exchange
  and, on the contrary, those which have the
  greatest value in exchange have frequently little
  or no value in use. Nothing is more useful than
  water but it will purchase scarce anything
  scarce anything can be had in exchange for it. A
  diamond, on the contrary, has scarce any value in
  use but a very great quantity of other goods may
  frequently be had in exchange for it. OREF 85

29
Source of Value

• Resolution of paradox
• Price reflects relative difficulty of
  manufacture
• Abundant water involves little effort
• Scarce diamonds take much effort
• Labour, therefore, is the real measure of the
  exchangeable value of all commodities. OREF
• Effort determines value perspective The real
  price of everything, ..., is the toil and trouble
  of acquiring it OREF
• Price reflects labour embodied in commodity If
  among a nation of hunters.., it usually costs
  twice the labour to kill a beaver which it does
  to kill a deer, one beaver should naturally
  exchange for or be worth two deer. OREF

30
Value and Price Problems

• What about capital?
• As soon as stock has accumulated in the hands of
  particular persons, some of them will naturally
  employ it in setting to work industrious people,
  ..., in order to make a profit by the sale of
  what their labour adds to the value of the
  materials something must be given for the
  profits of the undertaker of the work who hazards
  his stock in this adventure. OREF 90
• So two determinants of price?
• The value which the workmen add to the
  materials, therefore, resolves itself ... into
  two parts, of which the one pays their wages, the
  other the profits of their employer upon the
  whole stock of materials and wages which he
  advanced. OREF 90

31
Value and Price Problems

• What about land?
• As soon as the land of any country has all
  become private property, the landlords, like all
  other men, love to reap where they never sowed,
  and demand a rent even for its natural produce...
  (A)ll the natural fruits of the earth, which,
  when land was in common, cost the labourer only
  the trouble of gathering them, come, ..., to have
  an additional price fixed upon them. He must then
  pay for the licence to gather them and must give
  up to the landlord a portion of what his labour
  either collects or produces. ... (T)he price of
  this portion, constitutes the rent of land, and
  in the price of the greater part of commodities
  makes a third component part. OREF 91
• Adding up theory of costs/price

32
Value and Price Problems

• What measure of labour?
• Labour embodied?
• Hours of labour a commodity contains
• 40 hours to make a chair
• embodies 1 working week
• but price includes profit, rent, as well as wage
• Labor commanded?
• Hours of labour a commodity can buy
• Chair costs workers 2 weeks wages
• Commands 80 hours of labour
• What is labour? Not only his labouring
  servants, but his labouring cattle, are
  productive labourers.

33
Smiths Scorecard

• Gained (w.r.t. Physiocrats)
• Appreciation of labor/industrialisation
• Notions of capital, profit, rent
• Perceptive cynicism re landlords, merchants
• (?) Labour as source of value
• Lost
• Analysis of flows, input-output
• Notion of surplus
• Role of investment
• Analytic rigour
• Macroeconomic concerns investment, aggregate
  demand, employment
• Next week Smiths successors Ricardo Marx