Approches_Eco_Anal_Cours_2013
.pdfscarce. Adam Smith accused Locke and Law of believing that as the quantity of money increases and prices rise, the rate of interest must be fall because any given some of money will now buy fewer goods for barrowers; in other words, the demand for money will fall because the value of money over goods has declined.
This error, Smith pointed out, had been ‘fully exposed by Mr Hume’: given that the only effect of an increased supply of money is to raise the level of prices, it is obvious that the rate of interest will not be affected because the interest rate is merely a ratio of two sums of money.
Real theories of interest came to the fore with Cantillon, Hume and Turgot. All three criticised the monetary theories of interest of their predecessor but admitted that any increase in the supply of money could depress the rate of interest temporarily. If prices rose in proportion to the increase in money, however, equilibrium was impossible unless the rate of interest resumed its former height: at higher prices, more money would have to be barrowed to finance any project; hence, the demand for money loans would be increased, and equilibrium implied that it would be increased in the same proportion as the supply of money loans.
Generally speaking, however, the rate of interest was not thought to be uniquely related to the supply of money. The repercussion of an increase in the money supply could be traced by means of the Cantillon Effect: for example, if the new money flowed into the hands of entrepreneurs to be saved and invested, the rate of interest would probably fall; but, if it came first into the hands of the landowners, it would be spent on consumption and the rise in consumers’ demand would make entrepreneurs more willing and able to pay higher interest charges.
1. 4. The meaning of physiocracy, the Tableau Economique and the premises of the Laissez-Faire
As Screpanti and Zamagni remark in their seminal An Outline of the History of Economic Thought (1995): “The years 1751-76 are, in fact, for economics, the years of the laissez-faire revolution” (p. 44). Mercantilism was suddenly attacked from different positions and disappeared from the scene.
Physiocracy, as Adam Smith suggested, should be understood as a reaction to the mercantilist policies of Colbert during the reign of Louis XIV. The glory of the age of the Sun King was the growth of French industry and agriculture was consistently neglected. The War of the Spanish Succession and the
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magnificence of the Versailles court placed a severe burden upon taxable capacity and the land tax, being the main source of revenue, was steadily increased. By the time of the death of the Louis XIV in 1715, the plight of French agriculture had produced a wave of reactions against Colbertisme, fanned by the religious struggle against the Huguenots. Louis XIV, instead of recouping losses at home, threw himself into the Seven Years’ War with England, from which France emerged defeated, deprived of Canada and her Oriental possession, and reduced to a second-rate power in Europe. The stage was set for a back-to-nature movement, in return to rustic simplicity, of which the writings of Rousseau are familiar witnesses. The combination of smallholdings, antiquated methods and a maze of feudal obligations made it difficult for France to adopt the improvements effected by the much admired ‘agricultural revolution’ in England. It was only the effort to provide agrarian reform with a watertight theoretical argument that produced conclusions which struck observers even at the time as slightly absurd.
Quesnay’s Tableau Economique, published three to four years after the publication of Cantillon’s Essay, was regarded in its day as the crowning achievement of the physiocratic school. Quesnay inaugurated the tradition of regarding capital as consisting of a series of ‘advances’.
First, there is fixed capital in the form of ‘original advances’-livestock, buildings, and implements-interest on which at 10 per cent is included as depreciation in the table.
Second, there is fixed capital in the form of ‘landlord’s advances’-drainage, fencing, and other permanent land improvements-which do not figure in the table as such.
Last, there is working capital under the title of ‘annual advances’-the wages of agricultural labour, seeds, and other recurring annual costs.
The process of circulation is as follows: the gross value added by agriculture is 5 thousand, 3 thousand of which constitute costs of production incurred in cultivation. Farmers use two fifths of their own output for working capital; one fifth is sold to the ‘sterile’ artisans in exchange for goods required to replace worn-out fixed capital. Since farmers receive only ‘wages of management’
–it is land that is productive, not their labourthe remainder goes to landowners as
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rent. The landowners in turn exchange half of their 2 thousand revenue for manufactured articles while the sterile artisans purchase 2 thousand worth of raw materials and foodstuffs from the agricultural sector. The whole process may be conceived of in real terms, with three fifths of output entering into circulation, or, as Quesnay suggested, it may equally well be pictured in money terms.
At the beginning of the process, the farmers are in possession of the entire money stock of the economy (2 thousand). They pay this to landowners to purchase ‘rental services’, who in turn spend it on foodstuffs and fabricated commodities; the farmers now spend the 1 thousand just received to replace fixed capital, and the artisans spend their total receipts of 2 thousand on agricultural products. At the end, the farmers have received 3 thousand and spent 1; they are back where they started. The net effect of the sterile sector is nil, and the 2 thousand money is paid out once more to landowners as a new cycle of production begins. The Tableau as conceived by Quesnay involves a one-period income-spending lag: landowners spend the previous period’s rent, while the artisans always retain 1 thousand of the last period’s receipts for spending in the following period. Does this mean that Quesnay was thinking of output as identical with the annual harvest, the whole of which is consumed in the following 12 months. The Tableau can also be pictured with leads as well as lags, each sector simply spending in each income period the receipts of the same period. Therefore, the whole argument can be presented by a two-way transaction diagram in the manner of a Leontief input-output table: all factors required to produce a good are used in fixed proportions and the value of a sector’s output is entirely exhausted by the sector’s total payments to other sectors. In the Quesnay’s scheme there are three social classes and the flows of money by means of which they exchange goods. The political consequences of this model are: the natural ability of an economic system to reproduce itself (Quesnay was a medical doctor, and studied the economic system as if it were a natural organism), and the doctrine of the single tax to impose on the only productive factor, land, which would be paid with the net product.
Besides the Physiocracy, in Great Britain, the most important contributions in this period were made by David Hume (1752) and James Steuart (1767).
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In regard to money, Hume put forward a dynamic version of the quantity theory of money in which he recognized that an increase in the supply of money could have relevant, although temporary, real effects. He noted that the increase in prices caused by an increase in the money in circulation would be transmitted gradually from one sector to another as the initial inflow of money was spent. In this transmission process the increments in expenditure can also generate, together with price increases, an expansion in production and employment.
However, Steuart rejected the quantity theory of money. The crucial variable in the equation of exchange is the velocity of circulation, which, by means of variations of the amount of money hoarded, continually changes in such a way that the quantity of money in circulation is always adequate for the needs of trade. The volume of transactions depends on the level of output, while prices are determined by the forces of competition and the conditions of cost. Thus the value of the transactions depends on real factors. The quantity of money exceeding the needs of trade will be hoarded. If, on the other hand, money is scarce, stocks of hoarded money will be rapidly reduced and more coins minted. Steuart rejected the principle according to which the best way to serve the collective interest is to let private interests run free. In order to bring about full employment, the State would have to encourage exports by encouraging increased competitiveness of national products. Steuart suggested subsistence wages as a means to achieve this goal, but did not believe in any automatic mechanism of wage regulation, seeing this as one of the areas for government intervention.
2. The Smithian economics
Newton’s theory of universal gravitation contributed to the diffusion of the idea of an ordered and rational universe and exerted a great influence on illuminist thought. Natural phenomena, according to this idea, are reducible to the movements of atoms regulated by laws which are intrinsic to the state of nature. The world is completely self-regulating. In An Inquiry into the Nature and Causes of the Wealth of Nations, published in 1776, a milestone in modern economic thought, Smith makes it clear that his leading theme is economic development. The Wealth of Nations is the first full-scale treatise on economics, containing as it does a solid core of production and distribution theory, followed by a review of the past in the light of these abstract principles, and concluding with many policy
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applications. By ‘wealth’, Smith means the community’s income produced during a period of time –a flowalthough he did not always adhere consistently to this conception. The growth of income is dependent, in Smith’s work, upon the scope of the division of labour in society with division of labour so broadly defined as to include everything we would nowadays call technical progress.
The central theme that inspires the Wealth of Nations is the notion of selfishness, however morally reprehensible, may nevertheless provide a powerful fuel to a ‘commercial society’ (or merchant society). Smith says: “it is not from the benevolence of the butcher, brewer, or the baker, that we expect our dinner, but from regard to their own interest”, in underlying that under certain social arrangements, which we would nowadays call ‘workable competition’, private interests are harmonised with social interests as if by an “invisible hand”.
2. 1. The invisible hand
The problem of modern social thought was: how is social life possible if the two principles of Middle Age which maintained social consensus, authority and faith, are left aside. The first answer was given by Machiavelli and Hobbes: the natural egoism of man makes free social life impossible and the absolute State necessary. But with the emergence of social classes created by capitalist development, it was necessary to demonstrate that a free social life is possible even in the presence of selfish individuals. As the sphere of action of human egoism is economic activity, a change of focus from politics to economics was necessary.
The approach attempted is based on the assumption of the existence of a natural benevolence or moral sentiment which man experiences towards his fellows. If individuals are not naturally egoistic, they tend spontaneously to associate themselves and there is no need for external intervention to give sense to social life (neither God nor the State is necessary). With the theorem of the invisible hand, Smith simply aimed at demonstrating that individuals serve the collective interest precisely because they are guided by self-interest. Smith was strongly influenced by Quesnay’s work but in the Smithian scheme collective agents disappear and the scientific reference model is mechanics, and the objects studied are social atoms. Then Smith is considered to be founder of economic sciences not only by the classical but also by the neo-classical economists.
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The interest of the community is simply the sum of the interests of the members who compose it. Each man, if left alone, will seek to maximise his own wealth, therefore, all men, if unimpeded, will maximise aggregate wealth. That is the spontaneous harmony of interests doctrine, the obvious and simple system of natural liberty which aims to reconcile private interests and economic efficiency, a sort of automatic equilibrating mechanism of the competitive market.
2. 2. Accumulation, distribution and value
The division of labour is a process by which a particular productive operation is subdivided into a certain number of separate operations, each of which is carried out by a different person. With the division of labour the worker’s skill increases, the idle time in transferring a worker from one activity to another is reduced and technical progress is stimulated. However, the division of labour is limited by the size of the market and can be intensified only when the market is expanding. In turn, the market will be larger the more the transport and communications systems are developed, the more credit and monetary instruments, are diffused, and the faster the growth in the volume of production.
Smith believed there is a cumulative mechanism that operates in a capitalist system which proceeds according to the following sequence: division of labour enlargement of the markets increases in labour productivity. If it is the division of labour that triggers the growth process, it is the accumulation of capital that drives it. Smith subdivided capital into fixed capital, consisting in machinery, plant, buildings, etc., and circulating capital, which is used to buy raw materials and pay for labour and energy. The wages fund is that part of the circulating capital which is used to pay workers. In real terms, it is a part of the goods produced in a productive cycle which is used to pay the workers in the successive cycle. Wages are paid before the product is sold, and for the capitalist, who advances them, they are capital.
The theory of income distribution among social classes plays a fundamental role in Smithian theory. The three basic classes, capitalist, workers, and landlords, are distinguished both by the productive resources they hold -capital, labour, and landand by the way in which they spend profits, wages, and rents, their respective incomes. The landowners, who do not own productive capital, are not interested in its enlargement and they make no contribution to the growth of the
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wealth of the nation. The workers only possess their labour. With a subsistence wage the propensity to save must be zero. Therefore, not even the workers make a positive contribution to the growth of the wealth, although they make an essential one to its production. Finally, the capitalists possess the productive capital and aim to increase it. This means they have a very high propensity to save. It follows that the higher the proportion of the national income going to profits, the higher the growth in the wealth of the nation. The general interest of the nation therefore coincides with that of the bourgeois class.
In determining the question of the value in the economy, Smith recognizes that the structure of a productive process can be represented in terms of the series of quantities of labour employed to produce goods. In fact, even the loom that is used by the worker to produce cloth has been, in its turn, produced by means of labour aided by other means of production: “Labour, therefore, is the real measure of the exchangeable value of all commodities. The real price of everything, what everything really costs to the man who wants to acquire it, is the toil and trouble of acquiring it” (Wealth of Nations, p. 133). Therefore, the value of a good is measured by the quantity of labour it is able to command: the value of a commodity ‘to those who possess it, and who want to exchange it for some new production, is precisely equal to the quantity of labour which it can enable them to purchase or command”. When capitalists and landlords take part in the division of the product, the exchange value of a good must be such as to allow the payment of a profit and a rent besides a wage. This implies that the quantity of labour the good can pay for must be greater than that employed to produce it. In a capitalist society, embodied labour is no longer a good measure of the exchange value of goods. Smith said that the price depends on the incomes paid to produce the good as the sum of the incomes: wages, profits, and rents. We can remark easily that the theory of value based on labour commanded is correct as a price theory if it presupposes a theory of profit as a residue (for the sake of simplicity, we ignore rent). On this argument, Smith lets himself be led astray by misleading propositions.
2. 3. Market and competition
The Smithian price theory brings back the forces of demand as fundamental determinants of the price of goods. Coupled with a theory of profit as a normal
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remuneration of entrepreneurial activity, this theory seems to lend itself to the attempt to demonstrate the allocation efficiency (or even distributive justice) of the competitive equilibrium.
An important distinction here is the one between market price and natural price. The market price is the real price of a good at a given moment. The natural price is that which would allow the payment of workers, capitalists, and landowners at normal rates of remuneration. The market price depends on the forces of supply and demand. In the presence of an excess demand, the market price will rise, while it will fall if supply exceeds demand. The natural price is the central price to which the prices of all commodities are continually gravitating (Wealth of Nations, p. 160) thanks to the competition which regulates the operation of the markets. Let us give an example. If there is an increase in the quantity demanded of a good, supply being constant, competition among buyers will intensify and cause an increase in the price of this good.
When the market price exceeds the natural price of that good, the capital invested in its production will obtain a higher return than that attainable in other industries. The capitalists who produce that good will be stimulated to expand their production, while new capital will be transferred from other uses to its production. This will cause an increase in the supply of the good, which at a certain moment can even exceed the demand, and this will lead to a decrease in the market price. The adjustment process will continue until the market price returns to the natural level, say the equilibrium level. The fluctuations of the market price depend on the forces of demand, but regulated by the production conditions. Self-interest is the driving force of the system as an integral part of the market mechanism by which the economy adjusts itself to its natural equilibrium path. A large number of operators, a certain knowledge of the price conditions on the part of buyers and sellers, the mobility of capital, and the absence of entry barriers are all conditions that limit the ability of each single agent to influence the prices to his own advantage. Under such conditions, the market conditions ensure that exactly those goods in exactly those quantities are produced which best satisfy the final demand. In this view, the market is its own guardian and is capable of complete self-regulation.
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The Smithian invisible hand theorem states that, in conditions of competitive equilibrium, the productive system will produce those goods the consumers demand; the chosen production methods are the most efficient; and the goods are sold at the lowest price possible, which is the production cost inclusive of a
“normal” profit.
The main weakness of this construction is that it remained unproved! The proof will be presented, under particular hypotheses, in the 20th century by the neo-classical economists. Before them, a fundamental contribution to the theoretical development of the microeconomic component of Smith’s thought, to the detriment of the macroeconomic side, was given by Bentham, the founder of utilitarianism which provided a new way of conceptualizing human motivation towards action. As the belief spread that the economic agent is a selfish and competitive being, the idea also gained ground that all reasons for human action spring from the desire to obtain pleasure and avoid pain. This belief is the heart of utilitarianism, and its fundamental formulation is found in the writings of Jeremy Bentham in An Introduction to the Principles of Morals and Legislation (1780). Every human motivation, at every place and time, said Bentham, can be traced back to a single principle: the desire to maximize utility – that property of any abject, whereby it tends to produce benefit, advantage, pleasure, good or happiness, or to prevent mischief, pain, evil, or unhappiness to the party whose interest is considered. This theoretical vein is founded on the self-preference principle. Therefore, ‘All value is founded on utility… Where there is no use, there cannot be any value” (An Introduction to the Principles, p. 83).
3. Population and diminishing returns
The first edition of Robert Malthus’s Essay on Population was published in 1798. By emphasising the rigid dependence of population growth on the food supply, the Malthusian theory lent to support to the subsistence theory of wages and prepared the way for the Ricardian preoccupation with the land-using bias of economic progress; by explaining poverty in terms of a simple race between population and the means of subsistence, it provided the touchstone for a classical thinking about economic policy.
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3. 1. Malthus’s analytical schema
The Malthusian theory consisted of three propositions: 1) man’s biological capacity to reproduce exceeds his physical capacity to increase the food supply; 2) either the preventive or the positive checks are always in operation to hold back the super-fecundity of reproduction; 3) the ultimate check to reproductive capacity lies in limitations of the food supply. An unchecked multiplication of human beings must quickly lead to an impossible situation, whatever the plausible rates of increase that can be imagined for the means of subsistence. The famous contrast that Malthus drew between the two kinds of progressions, the geometrical increase in numbers and the arithmetical increase in food, carried the hypnotic, persuasive power of an advertising slogan. Additional people could reproduce themselves, hence the compounding factor, whereas additional food could not be automatically reproduced.
Malthus tried to show, identifying means of subsistence with foodstuffs that a rapid increase of food crops is out of the question since the supply of land is limited and technical improvements in agriculture do not come fast enough in this time. Malthus argued that capital accumulation and technical change could never offset limitations in natural resources. The theoretical position of Malthus is a pessimistic one. But one of the difficulties in interpreting Malthus is to give definite meaning to the concept of overpopulation, a population too large for maximum efficiency of production, so that a reduction in numbers would raise income per head. In the 1920s, this suggestion was crystallised into the so-called ‘optimum theory of population’: if the population of a particular area may be too small for maximum efficiency – the division of labour is limited by the extend of the market – as well as too large, it is obvious that there must be some point in between at which it is of optimum size. In other words, a population of optimum size is one that maximizes income per head. However, the history of Western countries disproves Malthus’s theory because the income per head rises with increasing population.
3. 2. The law of diminishing returns
The Malthusian theory of population focused attention on the limited supply of land. Among its consequences was the concept of diminishing returns. The year 1815 saw the appearance in Britain of the publications of West, Torrens, Malthus
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