Economics, History of

I

Introduction

Economics, History of, the birth of economics as a separate subject of study, independent of politics and philosophy, may be traced to the year 1776, when Adam Smith published his Inquiry into the Nature and Causes of the Wealth of Nations. There was, of course, economics before Adam Smith: the Greeks made significant contributions, and so did the medieval exponents of scholasticism. From the 15th to the 18th century an enormous pamphlet literature appeared that developed the implications of economic nationalism, a body of thought now known as “mercantilism”; for a brief period in the 18th century the French “physiocrats” developed a fairly sophisticated economic model; and several other 18th-century figures can compete with Smith for the title of “founder of economics”. Nevertheless, Adam Smith wrote the first full-scale treatise on economics and, by his magisterial influence, initiated what later generations were to call (despite Smith’s Scottish nationality) “English Classical Political Economy”.

II

The Work of Adam Smith

The Wealth of Nations, as its title suggests, is essentially a book about economic development, and about policies that promote or hinder development. In its practical aspects, it is an attack on the protectionist doctrines of the mercantilists and a brief for free trade. But in the course of attacking “false doctrines of political economy”, Adam Smith was led to analyse the workings of a free enterprise system. In a competitive free market economy each individual, being one among many, can exert only a negligible influence on prices; each must take prices as they come and is free only to vary the quantities bought and sold at given prices; yet the sum of all individuals’ separate actions determines prices. The “invisible hand” of the market, as Smith was fond of saying, assures a social result that is independent of individual intentions; it is an instrument capable of converting “private vices” (like selfishness) into “public benefits” (like maximum production). But this is only true if competitive markets are embedded in an appropriate legal and institutional framework, an insight that Adam Smith developed at length but that was largely forgotten by later generations. Within this great tome on the theme of rich and poor nations were contained a simple theory of value (or prices), a crude theory of distribution, an even cruder theory of international trade, and a primitive theory of money; but with all their imperfections, these were the building blocks of all later classical and post-classical economics. The book’s very fecundity gave it strength because it left so much for disciples to tidy up.

III

The Ricardian System

Principles of Political Economy and Taxation (1817) by David Ricardo was, in one sense, a critical commentary on the Wealth of Nations; in another sense, it gave an entirely new twist to the developing science of political economy. Ricardo invented the concept of an “economic model”, a tightly knit logical apparatus consisting of a few strategic variables that was capable of yielding, after some logical manipulation, results of enormous practical import. At the heart of the Ricardian system is the notion that economic growth must sooner or later peter out, owing to the rising cost of growing food on a limited land area. An essential ingredient of this argument is the Malthusian principle—enunciated in An Essay on the Principle of Population (1798) by Thomas Robert Malthus—that population constantly tends to increase up to the limits set by existing supplies of food. As the labour force increases, extra food to feed the extra mouths can be produced only by extending cultivation to less fertile soil, or by applying capital and labour to land already under cultivation, with diminishing results. Although wages are thereby held down, profits do not rise proportionately, because tenant farmers outbid each other for superior land. The chief beneficiaries of economic progress, therefore, are landowners.

Since the root of the trouble, according to Ricardo, is the declining yield of wheat per unit of land, one obvious solution is to import cheap wheat from other countries. Eager to show that Great Britain would benefit from specializing in manufactured goods and exporting them in return for food, Ricardo seized for proof on the “law of comparative costs”. He assumed that labour and capital are free to move within countries in search of the highest returns; between countries, however, they are not free to move. In these circumstances, Ricardo showed, the benefits of trade are determined by a comparison of costs within each country, rather than by a comparison of costs between countries. It pays a country to specialize in the production of those goods that it can produce relatively more efficiently and to import everything else; although Portugal may be able to produce everything more efficiently than Britain, Portugal is nevertheless well advised to concentrate its resources on wine production, in which its efficiency is relatively greater, and to import British textiles. The beauty of the argument is that if all countries take full advantage of the “territorial division of labour”, total world output is certain to be larger than it would be if some or all countries tried to become self-sufficient. Ricardo’s law became the fountainhead of 19th-century free trade doctrine, which would have been enough, if he had written nothing else, to give him a place in the economists’ pantheon.

The influence of Ricardo’s treatise was felt almost as soon as it was published, and for over half a century the Ricardian system dominated economic thinking in Britain. In 1848 the restatement of Ricardian thought by John Stuart Mill in his Principles of Political Economy brought it new authority. After 1870, however, most economists turned their backs on the range of problems that had concerned Ricardo and began to re-examine the foundations of the theory of value; that is, they became almost exclusively interested in the theory of why goods exchange at particular prices.

IV

Marxism

A few words must be said, however, about the last of the classical economists, Karl Marx. The first volume of Marx’s Das Kapital appeared in 1867, the second and third posthumously, in 1885 and 1894. If Marx may be called “the last of the classical economists”, it is because to a large extent he found his economics not in the real world but in the teachings of Smith and Ricardo. They had espoused a labour theory of value, which holds that products exchange roughly in proportion to the labour costs incurred in producing them. Marx worked out all the logical implications of this theory and added to it the “theory of surplus value”, which rests on the axiom that human labour alone creates all value and hence constitutes the sole source of profits. It is an axiom in the sense that it cannot be established in terms of the theory itself: it must be imported from without. To say that an economist espouses Marxist economics is in effect to say that he shares the value judgement that it is socially undesirable for some people in the community to derive their income merely from the ownership of property. Since few professional economists in the 19th century accepted this ethical postulate, and most were indeed inclined to find some social justification for the existence of private property and the income derived from it, Marxist economics fell on deaf ears.

Marx’s system, moreover, culminated in three great generalizations: the tendency of the rate of profit to fall, the growing impoverishment of the working class, and the increasing severity of business cycles, of which the first is the linchpin of all the others. Marx’s defence of the “law of the declining rate of profit” was unconvincing, and with it all of his other predictions fell to the ground. In addition, Marxist economics had little to say on some of the practical problems that are the bread and butter of economists in any society. That is enough to suggest why Marxist economics failed to make many converts among academic economists. Marxists would reply that the reason is simply that academic economists are and always have been “lackeys of the capitalist class”. Perhaps so, but the fact remains that Marx had no influence on economic thought after 1870.