Classical economics

Adam Smith's The Wealth of Nations in 1776 is usually considered to mark the beginning of classical economics. Active throughought the 19th century, neoclassical economics took prominance within Britain starting around 1870. There is some debate about what is covered by the term "Classical Econmics," particularly when dealing with the period from 1830–75, and in how the classical economics relates to neoclassical school. [1] In more recent times, those economists who see major flaws with the heavy theoretical basis of mainstream economics have looked to classical economics for more realistic perspectives, and as a way of making economics understandable to the average citizen. As such, classical economics has in many ways become synonomous with the idea of realistic economics within heterodox circles and their lay audience.[2] Moreover, the words of Adam Smith himself gives credence to the idea that realism lies at the heart of the classical school. [3]

Classical economists observe that markets generally regualte themselves, when free of coercion. Adam Smith referred to this as a metaphorical "invisible hand," which moves markets toward their natural equilibrium, at least when buyers are able to choose between various suppliers, and companies which do not serve their needs are allowed to fail. [3]

Adam Smith did acknowledge that there were areas where the market does not serve as the best way to serve public good, such as with education.[3] This is why the economists featured in the Ross Ashcroft documentary Four Horesemen describe Classical Economics as more of a realist school, and why they see the current vogue of Keynesianism and other neoclassical schools as focused on the world "as it should be, rather than how it is."[2] Through its support of policies like deficit spending, Keynesianism is considered by many classical economists to be the cause of the vast amount of turmoil and loss of productive capital currently occuring in many parts of the developed world.[2][4]

Unlike Keynesian economics, classical economics assumes flexible prices both for goods and wages, and predicts that supply can create its own demand – in other words, that production will generate enough income to allow its own products to be purchased.[5] Of course this can only hold true for a market which is reasonably free in the first place.[3] The Model T Ford serves as real world example this idea, which can be generalized when approached under the realistic contitions that the good being produced is both made affordably, and has a clear and obivious benefit to the buyer.[2]

Much of classical economics is built upon a foundation of currency pegged to a real asset such as gold. [3] The pervasive use of fiat currencies helps explain why discrepences have appeared in the short term. Interestingly, some economists featured in Four Horesemen contend that in the long run, economic systems can't help but behave classically, since under the realist outlook this is just the natural way in which a complex economy and society is built (see: Evolutionary Psychology).[2] A quote from Voltaire is used to sum up the what these classical economists predict will be the end result of what they consider a gamble with currency debasement in the guise of fiat currency: "All paper money returns to its inherent value, zero." [2]

Those economists who stand juxtaposed against the mainstream assert that the current financial crisis exemplifies the truth and predictive power of classical economic ideas. [2][4] They see a dire future for those who do not change course, but equally predict ways to reverse the trends for those nations willing to implement major reform (such as by Debt Cancelation, and by taxing consumption instead of production). [2]

Only time will tell whether they're right.


History

The classical economists produced their "magnificent dynamics"[6] during a period in which capitalism was emerging from feudalism and in which the industrial revolution was leading to vast changes in society. These changes raised the question of how a society could be organized around a system in which every individual sought his or her own (monetary) gain. Classical political economy is popularly associated with the idea that free markets can regulate themselves.[7]

Classical economists and their immediate predecessors reoriented economics away from an analysis of the ruler's personal interests to broader national interests. Adam Smith, and also physiocrat Francois Quesnay, for example, identified the wealth of a nation with the yearly national income, instead of the king's treasury. Smith saw this income as produced by labour, land, and capital. With property rights to land and capital held by individuals, the national income is divided up between labourers, landlords, and capitalists in the form of wages, rent, and interest or profits.

Henry George is sometimes known as the last classical economist or as a bridge. The economist Mason Gaffney documented original sources that appear to confirm his thesis arguing that neo-classical economics arose as a concerted effort to suppress the ideas of classical economics and those of Henry George in particular.[8]

Modern legacy

Classical economics is generally agreed (but see section Debates on the definition of classical economics below) to have developed into neoclassical economics – as the name suggests – or to at least be most closely represented in the modern age by neoclassical economics, and many of its ideas remain fundamental in economics. Other ideas, however, have either disappeared from neoclassical discourse or been replaced by Keynesian economics in the Keynesian revolution and neoclassical synthesis. Some classical ideas are represented in various schools of heterodox economics, notably Georgism and Marxian economics – Marx and Henry George being contemporaries of classical economists – and Austrian economics, which split from neoclassical economics in the late 19th century.

Classical theories of growth and development

Analyzing the growth in the wealth of nations and advocating policies to promote such growth was a major focus of classical economists. John Hicks & Samuel Hollander,[9] Nicholas Kaldor,[10] Luigi L. Pasinetti,[11][12] and Paul A. Samuelson[13][14] have presented formal models as part of their respective interpretations of classical political economy.

Value theory

Classical economists developed a theory of value, or price, to investigate economic dynamics. William Petty introduced a fundamental distinction between market price and natural price to facilitate the portrayal of regularities in prices. Market prices are jostled by many transient influences that are difficult to theorize about at any abstract level. Natural prices, according to Petty, Smith, and Ricardo, for example, capture systematic and persistent forces operating at a point in time. Market prices always tend toward natural prices in a process that Smith described as somewhat similar to gravitational attraction.

The theory of what determined natural prices varied within the Classical school. Petty tried to develop a par between land and labour and had what might be called a land-and-labour theory of value. Smith confined the labour theory of value to a mythical pre-capitalist past. Others may interpret Smith to have believed in value as derived from labour.[15] He stated that natural prices were the sum of natural rates of wages, profits (including interest on capital and wages of superintendence) and rent. Ricardo also had what might be described as a cost of production theory of value. He criticized Smith for describing rent as price-determining, instead of price-determined, and saw the labour theory of value as a good approximation.

Some historians of economic thought, in particular, Sraffian economists,[16][17] see the classical theory of prices as determined from three givens:

  1. The level of outputs at the level of Smith's "effectual demand",
  2. technology, and
  3. wages.

From these givens, one can rigorously derive a theory of value. But neither Ricardo nor Marx, the most rigorous investigators of the theory of value during the Classical period, developed this theory fully. Those who reconstruct the theory of value in this manner see the determinants of natural prices as being explained by the Classical economists from within the theory of economics, albeit at a lower level of abstraction. For example, the theory of wages was closely connected to the theory of population. The Classical economists took the theory of the determinants of the level and growth of population as part of Political Economy. Since then, the theory of population has been seen as part of Demography. In contrast to the Classical theory, the determinants of the neoclassical theory value:

  1. tastes
  2. technology, and
  3. endowments

are seen as exogenous to neoclassical economics.

Classical economics tended to stress the benefits of trade. Its theory of value was largely displaced by marginalist schools of thought which sees "use value" as deriving from the marginal utility that consumers finds in a good, and "exchange value" (i.e. natural price) as determined by the marginal opportunity- or disutility-cost of the inputs that make up the product. Ironically, considering the attachment of many classical economists to the free market, the largest school of economic thought that still adheres to classical form is the Marxian school.

Monetary theory

British classical economists in the 19th century had a well-developed controversy between the Banking and the Currency School. This parallels recent debates between proponents of the theory of endogeneous money, such as Nicholas Kaldor, and monetarists, such as Milton Friedman. Monetarists and members of the currency school argued that banks can and should control the supply of money. According to their theories, inflation is caused by banks issuing an excessive supply of money. According to proponents of the theory of endogenous money, the supply of money automatically adjusts to the demand, and banks can only control the terms (e.g., the rate of interest) on which loans are made .

Debates on the definition of classical economics

The theory of value is currently a contested subject. One issue is whether classical economics is a forerunner of neoclassical economics or a school of thought that had a distinct theory of value, distribution, and growth.

The period 1830–75 is an timeframe of significant debate. Karl Marx origianlly coined the term "classical economics" to refer to Ricardian economics – the economics of David Ricardo and James Mill and their predecessors – but usage was subsequently extended to include the followers of Ricardo.[1]

Sraffians, who emphasize the discontinuity thesis, see classical economics as extending from Petty's work in the 17th century to the break-up of the Ricardian system around 1830. The period between 1830 and the 1870s would then be dominated by "vulgar political economy", as Karl Marx characterized it. Sraffians argue that: the wages fund theory; Senior's abstinence theory of interest, which puts the return to capital on the same level as returns to land and labour; the explanation of equilibrium prices by well-behaved supply and demand functions; and Say's law, are not necessary or essential elements of the classical theory of value and distribution. Perhaps Schumpeter's view that John Stuart Mill put forth a half-way house between classical and neoclassical economics is consistent with this view.

Georgists and other modern classical economists and historians such as Michael Hudson argue that a major division between classical and neo-classical economics is the treatment or recognition of economic rent. Most modern economists no longer recognize land/location as a factor of production, often claiming that rent is non-existent. Georgists and others argue that economic rent remains roughly a third of economic output.

Sraffians generally see Marx as having rediscovered and restated the logic of classical economics, albeit for his own purposes. Others, such as Schumpeter, think of Marx as a follower of Ricardo. Even Samuel Hollander[18] has recently explained that there is a textual basis in the classical economists for Marx's reading, although he does argue that it is an extremely narrow set of texts.

Another position is that neoclassical economics is essentially continuous with classical economics. To scholars promoting this view, there is no hard and fast line between classical and neoclassical economics. There may be shifts of emphasis, such as between the long run and the short run and between supply and demand, but the neoclassical concepts are to be found confused or in embryo in classical economics. To these economists, there is only one theory of value and distribution. Alfred Marshall is a well-known promoter of this view. Samuel Hollander is probably its best current proponent.

Still another position sees two threads simultaneously being developed in classical economics. In this view, neoclassical economics is a development of certain exoteric (popular) views in Adam Smith. Ricardo was a sport, developing certain esoteric (known by only the select) views in Adam Smith. This view can be found in W. Stanley Jevons, who referred to Ricardo as something like "that able, but wrong-headed man" who put economics on the "wrong track". One can also find this view in Maurice Dobb's Theories of Value and Distribution Since Adam Smith: Ideology and Economic Theory (1973), as well as in Karl Marx's Theories of Surplus Value.

The above does not exhaust the possibilities. John Maynard Keynes thought of classical economics as starting with Ricardo and being ended by the publication of Keynes' own General Theory of Employment Interest and Money. The defining criterion of classical economics, on this view, is Say's law which is disputed by Keynesian economics.

One difficulty in these debates is that the participants are frequently arguing about whether there is a non-neoclassical theory that should be reconstructed and applied today to describe capitalist economies. Some, such as Terry Peach,[19] see classical economics as of antiquarian interest.

Sometimes the definition of classical economics is expanded to include the earlier 17th-century English economist William Petty and the contemporary early 19th-century German economist Johann Heinrich von Thünen.

See also

Notes

  1. ↑ 1.0 1.1 The General Theory of Employment, Interest and Money, John Maynard Keynes, Chapter 1, Footnote 1
  2. ↑ 2.0 2.1 2.2 2.3 2.4 2.5 2.6 2.7 [Four Horsemen (film)|Four Horsemen]], Ross Ashcroft,
  3. ↑ 3.0 3.1 3.2 3.3 3.4 An Inquiry into the Nature and Causes of the Wealth of Nations, Adam Smith,
  4. ↑ 4.0 4.1 Cato Institute, A topical source of news relating to world events approached from a classical economic perspective, , and for there publication which deals with longer term issues see:
  5. ↑ Content summarized from unsourced original for clarity. Because the conclusions seem to match the general idea of the classical approach, they'll be left in, and await verificaton or refutation
  6. ↑ Baumol, William J. (1970) Economic Dynamics, 3rd edition, Macmillan (as cited in Caravale, Giovanni A. and Domenico A. Tosato (1980) Ricardo and the Theory of Value, Distribution and Growth, Routledge & Kegan Paul)
  7. ↑ Derek, Iggy; Steven M. Sheffrin (2003). Economics: Principles in action. Upper Saddle River, New Jersey 07458: Pearson Prentice Hall. p. 395. ISBN 0-13-063085-3.
  8. ↑ Gaffney, Mason (2006). The corruption of economics (PDF). London: Shepheard-Walwyn in association with Centre for Incentive Taxation. ISBN 0856832448.
  9. ↑ Hicks, John and Samuel Hollander (1977) "Mr. Ricardo and the Moderns", Quarterly Journal of Economics, V. 91, N. 3 (Aug.): pp. 351–69
  10. ↑ Kaldor, Nicholas (1956) "Alternative Theories of Distribution", Review of Economic Studies, V. 23: pp. 83–100
  11. ↑ Pasinetti, Luigi L. (1959–60) "A Mathematical Formulation of the Ricardian System", Review of Economic Studies: pp. 78–98
  12. ↑ Pasinetti, Luigi L. (1977) Lectures on the Theory of Production, Columbia University Press
  13. ↑ Samuelson, Paul A. (1959) "A Modern Treatment of the Ricardian Economy", Quarterly Journal of Economics, V. 73, February and May
  14. ↑ Samuelson, Paul A. (1978) "The Canonical Classical Model of Political Economy", Journal of Economic Literature, V. 16: pp. 1415–1434
  15. ↑ Smith, Adam (1776) An Inquiry into the Nature and Causes of The Wealth of Nations. (accessible by table of contents chapter titles) AdamSmith.org ISBN 1-4043-0998-5
  16. ↑ Krishna Bharadwaj (1989) "Themes in Value and Distribution: Classical Theory Reppraised", Unwin-Hyman
  17. ↑ Pierangelo Garegnani (1987), "Surplus Approach to Value and Distribution" in "The New Palgrave: A Dictionary of Economics"
  18. ↑ Samuel Hollander (2000), "Sraffa and the Interpretation of Ricardo: The Marxian Dimension", "History of Political Economy", V. 32, N. 2: 187–232 (2000)
  19. ↑ Terry Peach (1993), "Interpreting Ricardo", Cambridge University Press

References

Further reading

External links