An Outline of the history of economic thought - Chapter 2 ppsx

Four points inparticular are worth underlining:a the notions of productive and unproductive labour, by means of whichthe real source of wealth was found in the net product obtained byapp

2 The Laissez-Faire Revolution and

Smithian Economics

2.1 The Laissez-Faire Revolution2.1.1 The preconditions of the Industrial Revolution

The 35-year period from the beginning of the Austrian War of Succession in

1741 to the American Declaration of Independence in 1776 was of criticalimportance for the history of Europe as well as for the history of economicthought It was a period of profound political crisis, as shown by the 25 years

of war, among the most barbarous in European history, at one time oranother involving each of the great powers: the Austrian War of Succession(1741–8), the colonial war between England, France, and Spain (1754–63),the Seven Years War (1756–63), and the Russian–Turkish War (1768–74).One of the main results of this political crisis was the beginning of England’smilitary, political, and economic dominance in Europe

An important economic transformation of this period was the spread ofcapitalism in the countryside, which was a fairly rapid process in France andEngland In France, at least in the northern regions, Picardy, Normandy,and the province of Paris, a new social figure emerged: the fermier, a tenantfarmer who invested his own money in the improvement of productivetechniques and in the enlargement of his farm In England, the process wasfacilitated by the enclosure movement which, begun more than two centuriesbefore, experienced a real boom from 1760 onwards Among the mostimportant consequences were the major technical innovations in cultivationmethods, the connected increase in agricultural productivity and production,and the acceleration of the expulsion of the agricultural workers from thecountryside If we add the fact that, beginning from 1740, there was anacceleration in demographic growth, it is easy to understand why the take-off of the Industrial Revolution that occurred towards the end of this periodwas not hindered by lack of workers (and ‘means of subsistence’) which hadbeen one of the main concerns of the mercantilists Thus industrialemployment could increase rapidly from the 1770s onwards

An important precondition for the take-off of the Industrial Revolutionwas the large number of technical innovations in the new industries, aboveall (but not only) in the textile industry: Hargreaves’s spinning-jenny wasinvented in 1764, Watt’s steam-engine in 1765, and Arkwright’s water-frame

in 1768 This process was not limited to England To give only a few moreexamples: in 1769 Cugnot constructed a steam-driven carriage, a prototype

of the motor car, in France; while Volta in Italy invented the condensorelectroscope in 1775, and constructed the electrophorus and discoveredmethane gas in 1776 Thus all the economic, social, and technologicalpreconditions for industrial take-off were laid down in this period

Most important of all, however, were the cultural preconditions This wasthe period of the eruption of that authentic cultural revolution known asthe Enlightenment The roots of this movement can be traced back toseventeenth-century England and, in particular, to the ideas of ‘reason’,

‘experience’, and ‘science’ with which philosophers and scientists such asBacon, Locke, and Newton had tried to oust old idols and to sweep awaytraditional intellectual servitude On the Continent, by grafting itself ontodifferent national traditions, this movement assumed special characteristics,becoming rationalist in the homeland of Descartes and historicist in that ofVico Its most destabilizing impact on the culture of the period occurredbetween 1751 and 1776, the years in which the Encyclope´die was published.The Enlightenment played an important role in the history of economicthought It supplied the philosophical bases of the attack the economists ofthis period were attempting against mercantilist thought The years 1751–76are, in fact, for economics, the years of the laissez-faire revolution Mer-cantilism, a relatively homogeneous theoretical system that had dominatedEuropean thought for 300 years and had almost created an internationalscientific community, was suddenly attacked from different positions, anddisappeared from the scene in a quarter of a century

In their turn, however, the new economists did not present a homogenoustheoretical approach, either within each nation or at the international level.They did begin to group themselves into authentic ‘schools’, or almost, such

as that of the physiocrats in France and the Milan and Naples schools inItaly; but, as we will see later, there was little theoretical homogeneity amongthe schools and little even within them The only argument that united themwas, in fact, a negative one: their struggle against the traditional mercantilistorthodoxy and, connected to this (apart from a few exceptions), theirattempt to give a scientific foundation to the laissez-faire doctrine It wasnecessary to wait for Smith’s 1776 synthesis to find the conditions that were

to lead, in the following forty years, to the formation of a new orthodoxy on

a Continental scale

2.1.2 Quesnay and the physiocrats

The physiocratic school that prevailed in France during this period was atrue school of thought, with a doctrine to defend and propagate, a recog-nized master, Franc¸ois Quesnay, and a fervent group of followers We haveinsufficient space here to mention all the physiocratic economists; so we will

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limit ourselves to presenting the essential lines of thought of the master,whose most important economic work was the Tableau e´conomique (1758).The physiocratic scientific contribution was outstanding Four points inparticular are worth underlining:

(a) the notions of productive and unproductive labour, by means of whichthe real source of wealth was found in the net product obtained byapplying labour to land;

(b) the idea of interdependence among the various productive sectorsand the related idea of macroeconomic equilibrium;

(c) the representation of the economic exchanges as a circular flow ofmoney and goods among the various economic sectors;

(d ) the displacement of scientific interest from the stock of wealth to theflow of net product

Quesnay assumed that the productive cycle lasted one year, and that the finalproduct of each year was partially consumed and partially re-utilized as anecessary input for the following year He focused on agricultural produc-tion, the only sector capable of producing a surplus over replacement costsand the only real source of wealth The physiocrats considered the surplus as

a kind of natural gift from land The farmers, therefore, formed the ductive class’ The people employed in manufacturing industry, on the otherhand, made up the ‘sterile class’, not because they did not produce usefulgoods, but simply because the value of their output was considered to beequal to the overall value of the inputs Finally, there was the class oflandlords, or ‘distributive class’, whose economic role was to consume thesurplus created by the productive class and to begin, by the expenditure ofthe rents, the circulation process of money and goods among the variouseconomic sectors The physiocrats called this circulation process ‘distribu-tion’ This is the derivation of the name ‘distributive class’: its function was

‘pro-to ensure an effective ‘distribution’ of the income and goods among thevarious sectors

The tableau e´conomique model is fairly simple In one year the agriculturalsector produces an output of five milliard livres From this total, 1 milliardreplaces the means of production consumed in the agricultural process, andtwo milliard are used to pay the wages of the farm hands and the profits ofthe fermiers as well as to provide seeds for the following year The other twomilliard represent the surplus, the produit net The manufacturing sector has

an output and an input of two milliard livres

The tableau shows how the products of the two sectors are ‘distributed’ inthe system and how the circulation of money ensures a continual repro-duction of the system Fig 2 shows the three social classes and the flows ofmoney by means of which they exchange goods At the beginning of the year,the productive class pays two milliard in rent to the distributive class and onemilliard to the sterile class to buy manufactured articles, and spends two

milliard within the agricultural sector to buy raw materials, wage goods, andmeans of production The distributive class will spend its income in thefollowing way: one milliard to the sterile class and the other one milliard tothe productive class to buy, respectively, manufactured goods and agricul-tural products The sterile class, which has received two milliard, half fromthe distributive class and half from the farmers, will spend it all on theproductive class to buy its inputs and necessary consumer goods Finally, thethree milliard that the productive class has spent outside the agriculturalsector will come back to it; so that the cycle can begin again.

Quesnay derived two important political consequences from this model.The first concerns the ‘natural’ ability of an economic system to reproduceitself, as long as it is not obstructed by interventions of the politicalauthorities The reproduction equilibrium in which the system finds itself can

be defined as a situation in which each sector supplies the other sectors withexactly the quantity of inputs requested, so that functional relationships areformed among the various sectors and classes which are very similar to thosesuggested in Menenio Agrippa’s apologue Quesnay was a medical doctor,and studied the economic system as if it were a natural organism Theequilibrium in which the economy naturally found itself was seen as amanifestation of the natural order of things Here the influence of natural-lawphilosophy is apparent In drawing out political implications, however,Quesnay was more coherent and extremist than Locke, who had also beenstrongly influenced by natural-law philosophy With respect to the naturalorder, the best that could be done by the ‘positive order’, or the laws andinstitutions of organized society, was not to interfere In this way, so it seemed,Gournay’s maxim—‘laissez faire, laissez passer les marchandises’—was

‘scientifically proved’ In fact, the goods would go by themselves where theyhad to go to satisfy society’s reproduction conditions

The second political implication of the physiocratic model concerns thedoctrine of the impoˆt unique This brought to its logical conclusions an argu-ment that had already been sketched out by Vauban and Boisguillebert at the

Distributive class

Fig 2

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beginning of the century: that the best that could be done by the centralauthorities in regard to public finance was to eliminate all that complicated andinefficient fiscal apparatus, inherited from the Middle Ages, which only hin-dered the free circulation of goods and free private initiative, besides making taxcollection expensive and difficult The plan was to impose a single tax on theonly productive factor, land, which would be paid with the net product.The other incomes would be spent on ‘necessary consumption’ essential to theproduction process, so they could not be eaten away in real terms Taxes raised

on these incomes would have been transferred and would in the end, in any case,have fallen back on rents It would be better, therefore, to tax the latter directly.Quesnay had numerous followers, but we have no space to recall all ofthem Something however has to be said about Anne Robert Jacques Turgotand E´ tienne Bonnot Condillac, two economists who, while being influenced

by physiocratic thought, distanced themselves from it in various respects.The former criticized the physiocratic thesis according to which only land isable to produce a surplus Besides this he put forward some interesting ideasabout the decreasing returns generated in agriculture by the intensification ofinvestment Finally Turgot tried to formulate an estimative theory of value,based on concepts such as utility and scarcity—a theory that did not fit verywell with the physiocratic conception of the prix fondamental, namely, theconception of cost value as determined by production conditions It is alsoworth mentioning the more systematic subjective theory of value put for-ward by Condillac, a theory much influenced by Galiani’s work, especially inthe treatment of exchange between present and future goods Condillacdiffered from Galiani in that he adopted a traditional concept of utility,considering it as an intrinsic quality of goods He also distanced himself fromTurgot when he refused to accept the view that contracting parties draw thesame advantage from an exchange

Lastly, Achylle Nicolas Isnard, an engineer who devoted his life to nomics, also deserves a word of mention Although influenced by Physio-cratic thought, he rejected the theory that only the land is productive Inpoint of fact, the agricultural sector had begun to lose its economic superi-ority in France already in Quesnay’s time This partly explains the rapiddecline of the Physiocratic contribution at the end of the eighteenth century.Isnard, however, assimilated the idea of sectoral interdependences andproposed them initially as a mathematical model of general economicequilibrium that took production, money, capital and exchange intoaccount Isnard developed perhaps the first rudimental, yet surprisinglymodern, model of general economic equilibrium

eco-2.1.3 Galiani and the Italians

The period 1750–80 has been defined by Bousquet as the aˆge d’or of Italianeconomic thought It was as if the Enlightenment in Italy had chosen

economics as its favourite subject There were numerous interesting nomists in this period, of whom we mention here only the most significant.First of all, Ferdinando Galiani, the most important exponent of the

eco-‘Neapolitan school’ In Della Moneta (1751) he made an ambitious attempt

to construct a general theory of utility value, while, in Dialogues sur lecommerce des bleds (1768), he attacked physiocratic thought and its theories

of economic policy Other two notable Neapolitan economists are AntonioGenovesi, who was considered the ‘head of the great family of Italianeconomists’, and Gaetano Filangeri, who proposed a vast illuminist project

of economic and political renovation Two economists of the Milaneseschool are Cesare Beccaria and Pietro Verri, while Giammaria Ortes, aneconomist from Venice, did not belong to any school

One of the common traits of Italian Enlightenment during this period wasits insistence on public happiness as the main subject of study in economicscience The word happiness appears in the title of almost all the treatises ofthese economists In point of fact, this budding discipline was given the task

of discovering the conditions for enhancing public happiness, intended as

a form of interesse (interest) that was superior to the individual one Thus

it was in the context of the innovative atmosphere of the NeapolitanEnlightenment, during the reign of Charles III of Bourbon (1734–59), thatthe civil economy theoretical system began to take shape, as a modernre-visitation of typical civil humanism themes In 1753, the University ofNaples set up the first academic chair in economics in the world—moreprecisely, in ‘Civil and Mechanical Economy’ Its first professor, theSalernitan Antonio Genovesi, chose the title of Lezioni di economia civile(Lectures on Civil Economy) for his treatise of 1765 He wrote: ‘Labour inyour own interest; no man can work other than for his own happiness; for hewill be less than a man; but if you are able, and as far as you are able, strive

to make others happy It is the law of the universe that we cannot achieve ourown happiness without achieving that of others’ (Autobiografia, p 449).Civil humanism contributed two central ideas to economics: firstly, thattechnology—and scientific research in general—should be studied as a meansfor civilizing and improving people’s well-being rather than as an end tothemselves; this encouraged mass education programmes Secondly, the ideathat ‘public faith’ ( fides), is the main resource for economic development.Genovesi wrote: ‘Nothing is more essential to widespread and promptcirculation than ‘‘public faith’’ ’ (Lezioni, p 148), to which he added thefootnote: ‘This word fides means cord, which ties and joins Public faith istherefore the bond that unites families in a companionable life’ This fides

is in turn fuelled by the principle of reciprocity and therefore by the market,intended as an economic institution practising ‘‘reciprocal assistance’’.Here we have more than just a simple outline of the present-day notion ofsocial capital, an essential requisite for any socially acceptable developmentprocess

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Galiani’s most important contribution in the field of theoretical researchconcerns the theory of utility value, which he took up from his Italian pre-decessors and developed as much as was possible in a pre-marginalist period.

He borrowed the theory, according to which value depends on the utility andscarcity of goods, from Davanzati and Montanari, without, however, fullyacknowledging the debt Then he made the following steps forward First, heargued that value is not an intrinsic quality of goods, as most of the theorists

of the cost of production tended to believe, but is a quality deriving from thechoices of economic subjects Second, he established that it is necessary tostart from individuals in order to define these choices Both utility andscarcity depend on the needs of individuals Thus, the same good has dif-ferent utilities for an individual according to the quantity of it that he hasalready consumed The more of the good consumed, the lower the utility will

be, up to the point of becoming zero The concept was only sketched, but itwas already a theory of diminishing ‘final’ utility Third—and this is perhapsthe most interesting part of his work, the part that probably led Pareto toconsider him as one of his precursors—Galiani endeavoured to study indi-vidual behaviour in terms of choice among demanded quantities of morethan one good, that is, in terms of the composition of demand The funda-mental argument is that

value is an idea of proportion between the possession of one thing and that of another inthe mind of a man So, when one says that ten bushels of grain are worth one cask ofwine, one expresses a proportion of equality between having one or the other;therefore men, always cautious not to be cheated out of their own pleasures, exchangeone thing for another, because in the equality of exchange there is neither loss norfraud (p 39; our italics)

Except for the absence of the term ‘rate of substitution’, one would not besurprised to find this passage in a modern microeconomic textbook Alsonote the hypothesis of individual rationality expressed in the idea of ‘caution’

of choices

Not only Pareto but also other neoclassical economists could have sidered Galiani an important precursor He was well aware of the line thateconomic theory was taking in England in his times, and endeavoured tointegrate into his work some of the arguments of the economists of thatcountry, especially in regard to the cost of production In doing so, however,

con-by following a procedure of assimilation and deformation similar to thatwhich was later to be followed by Marshall, he produced something thor-oughly original Thus he was able to state that, for the goods whose supplycan be increased by the utilization of labour, value depends on the ‘fatigue’( fatica) sustained in producing them; a view that some people have tried tointerpret in terms of a labour theory of value

To understand that it is not so, it is not even necessary to reflect on themeaning of the term fatica, which, in the Neapolitan dialect, while being used

as a synonym for work, has a less abstract meaning with a clear implication

of toil and sacrifice It is sufficient to follow Galiani in his calculation of thecontribution given by fatica to the value of goods This contribution dependsnot only on the time and quantity of labour employed but also on its price.Already this argument is incompatible with a pure labour theory of value.But things become even clearer when Galiani tells us that it is from the

‘different values of human talents [that] the different prices for the ‘‘fatigues’’originate’ (p 49) He also maintained that ‘the value of talents’ has to beestimated ‘in the same way as for inanimate things, and that it rests on thesame principles of rarity and utility taken together’ In other words, this is atheory of the ‘real’ cost of production measured in terms of fatica, or toil oflabour (or, rather, labours, as talents are heterogeneous), and valued at aprice that depends on the utility and scarcity of natural endowments.Galiani also anticipated the more recent neoclassical theories of the rate ofinterest He tried to explain the interest rate by linking it to the price thatmust be paid to equate the value of present to that of future money Thenecessity of paying this price is derived from the fact that future money isvalued less than present money In fact,

among men only pleasure has a price and only comforts are bought; and, as onecannot receive pleasure without damaging and disturbing others, one pays anythingelse than the damage and the deprivation of the pleasure caused to others Theanxiety caused to somebody is hardship, so it is necessary to pay for this What iscalled the fruit of money, when it is legitimate, is nothing more than the price foranxiety (p 292)

Interest is the ‘intrinsic price’ of the ‘risk’ and the ‘inconvenience’ connectedwith the ‘delivery of a thing with an agreement to have the equivalent back’(pp 291–2) in such a way that there is ‘equalization between present money’and future money (p 290) Because of the risk connected with the futurerepayment of money (although the same point is also valid for real goods),the two sums paid at different times are evaluated as equal only if they aredifferentiated by the ‘fruit of money’

Finally, it is important to mention Galiani’s theory of equilibrium and thepolitical consequences he drew from it In Dialogues sur le commerce desbleds, he criticized some of the physiocratic doctrines Galiani did not sharethe Physiocrats’ passion for agriculture He argued that industry offersadvantages for exploitation by the political authorities In the first place,industrial production is not affected by changes in climate, therefore theprices of its products are more stable than those of agricultural products.Secondly, agricultural production is restricted by the scarcity of land,whereas industrial production is potentially unlimited since it increases withthe level of employment Third, industrial expansion is useful also to agri-culture since it increases the demand for its products Galiani acceptedthe Physiocrats’ idea of natural order, which he reformulated in the view

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that the economy tends spontaneously towards equilibrium: nature ‘settleseverything in equilibrium’, as if it were controlled by a ‘supreme hand’; but

he introduced an interesting dynamic consideration, by observing that anyadjustment would be achieved only in the long run In the short run, dis-orders and malfunctions could well manifest themselves But the short runcould also last a long time Therefore, there would be ample leeway andexcellent reasons to try to correct those disorders and malfunctions by law.Laissez-faire policy would not be justified in the short run At all events,Galiani did not admit the possibility of establishing general criteria for stateintervention in the economy The most suitable measures would depend to alarge extent on the time and place in which they were taken

This pragmatic attitude towards laissez-faire was also present in otherItalian economists of the period Genovesi, Beccaria, and Verri, for example,were in favour of economic freedom, which they considered from an illu-minist point of view as a manifestation of the more general principle ofhuman freedom They justified this theoretically with the idea that naturetends to bring human things towards equilibrium if left free to do so—anidea that Genovesi supported with an argument similar to Hume’s price–specie-flow mechanism In practice, however, they limited this application offree trade to within national boundaries In regard to foreign trade, theybelieved that the State had to guide and regulate the flows of imports andexports in the national interest, which might not coincide with the interests ofthe individual citizens Generally speaking, it could be said that these eco-nomists had a tendency towards theoretical eclecticism and political prag-matism For example, they took up the ideas of the French economists on thenet product and, more cautiously, on the single tax, while from Galiani theyadopted the theory of value In regard to policy, especially in monetarymatters, they basically remained within mercantilist thought

Filangeri and Ortes were more extreme supporters of laissez-faire Theformer took great steps forward in the construction of an illuminist norm-ative system, and professed a strong faith in laissez-faire, justifying it with theobservation that a reduction of imports would lead to reprisals by competingstates and would therefore be followed by a reduction in exports Ortes, onthe other hand, justified his free-trade position with the argument that, in theabsence of protectionist barriers, exports and imports of a country wouldtend to balance He also constructed an original theoretical system, basing it

on the presupposition that national production would be limited by the size

of the population, which, in turn, could not grow beyond the provisionsmade available by the natural endowment of the country Ortes was also one

of the many ‘forerunners’ of Malthus in regard to the population principle,and also anticipated the theory of decreasing returns in agriculture

It is also worth noting some original contributions of Beccaria and Verri.Beccaria sketched out a theory of the division of labour and of increasingreturns in industry, besides having an insight about the indeterminacy of

prices in a duopoly Verri developed an elementary theory of the demandcurve, which he specified in the form of an equilateral hyperbola Verri wasmore critical than Beccaria of the physiocrats His criticism of the argumentthat the ‘sterile class’ did not produce a surplus was extremely interesting,and in many ways similar to the one later put forward by Smith Verrimaintained that the production of the various industries must be calculated

in value, and that, in terms of value, all the activities which pay profits overand above wages and replacement costs produce a surplus

Beccaria and Verri shared a subjectivist and hedonistic conception ofeconomic phenomena Starting from a sensist and materialist philosophy,they tried to explain human behaviour in utilitarian terms, by maintainingthat individuals are driven, in their economic choices, exclusively by thesearch for pleasure and the fear of pain It was not only in this that the twoMilanese economists anticipated Bentham, but also in the proposal that theState should aim at creating—in Beccaria’s words—the ‘maximum happinessdivided among the greatest number’ Pleasure was even thought to bemeasurable, and Verri considered that this could be done in monetary terms.2.1.4 Hume and Steuart

In Great Britain, the most relevant contributions in this period were made byDavid Hume and James Denham Steuart Hume’s Political Discourses areimportant for the history of economic thought especially because in them,developing the ideas and methods of Petty and Locke, the foundations werelaid down for English free-trade economics We will briefly outline the theory

of the adjustment on the balance of payments based on the price–specie-flowmechanism, already mentioned in section 1.2.5 According to this theory, asurplus on the balance of trade does not produce permanent benefits, as itautomatically activates a re-equilibrating process In fact, the inflow of goldgenerated by the trade surplus would cause internal prices to rise, whiledecreasing those of the competing countries in deficit Owing to the con-sequent changes in competitiveness, the trade balances would graduallyadjust The free trade implications of this theory are obvious

In regard to money, Hume put forward a dynamic version of the quantitytheory in which he recognized that an increase in the supply of money couldhave relevant, although temporary, real effects He noted that the increase inprices caused by an increase in the money in circulation would be transmittedgradually from one sector to another as the initial inflow of money was spent

In this transmission process, which is rather similar to the multiplier, theincrements in expenditure can also generate, together with price increases, anexpansion in production and employment This is a remarkable acknow-ledgement of the validity of mercantilist theories, at least to the extent thatthe time interval in which the multiplier process occurs is not well defined Itwould have been sufficient to recognize, as Keynes suggested later, that life is

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always in transition But nobody was able to employ this insight in defence ofmercantilism.

Hume also attacked on two other fronts, and succeeded in both First, hedenied that the volume of international trade was fixed, and therefore thatone country could only increase its wealth at the expense of another Rather,

he maintained that an increase in the wealth of one country—to the extentthat it was an increase in real wealth, namely in the level of output—wouldlead, through imports, to a parallel increase in output in other countries.Second, he denied that the rate of interest would necessarily vary inverselywith the money supply Instead, he observed that it was the increase ineconomic activity itself that, by increasing the real capital stock of a country,would cause a decrease in the rate of profit and, as a consequence, a decrease

in the rate of interest

Hume’s four fundamental arguments, the price–specie-flow mechanism,the quantity theory of money, the theory of the growth of the volume ofinternational trade, and the explanation of the diminution of interest as areal phenomenon, were to be accepted en bloc by English and Europeanthought, and were to form the pillars (even if in revised and correctedversions) of nineteenth-century free-trade theories

If this first systematic attack on mercantilist thought was of greatimportance, however, its last defence, attempted fifteen years later by Steuart,was no less notable In An Inquiry into the Principles of Political Economy(1767), Steuart rejected the quantity theory of money along lines not dis-similar to those drawn by North The crucial variable in the equation ofexchange is the velocity of circulation, which, by means of variations ofthe amount of money hoarded, continually changes in such a way that thequantity of money in circulation is always adequate for the needs of trade.The volume of transactions depends on the level of output, while pricesare determined by the forces of competition and the conditions of cost Thus,the value of the transactions depends on real factors The quantity of moneyexceeding the needs of trade will be hoarded If, on the other hand, money isscarce, stocks of hoarded money will be rapidly reduced and more coinsminted

Steuart rejected the principle according to which the best way to serve thecollective interest is to let private interests run free He defined demand interms of the need for goods accompanied by the ability to pay for them, anddenied that the needs and the ability to pay for them are always sufficient toguarantee full employment Furthermore, he pointed out that the intro-duction of machinery could create unemployment, for reasons that were notvery different from those to be suggested by Ricardo half a century later: thereabsorption of the workforce into other sectors would not occur auto-matically Therefore, it would be the job of the State to ensure reabsorption

In order to bring about full employment, the State would have to fosterexports by encouraging increased competitiveness of national products

Steuart suggested subsistence wages as a means to achieve this goal, but didnot believe in any automatic mechanism of wage regulation, seeing this asone of the areas for government intervention.

In regard to wages, Steuart was involved in a debate that occupied Englisheconomic thought for the whole transition period from mercantilism toclassical liberalism On one side, were those who argued for the necessity tomaintain wages at a low level to discourage ‘vice and idleness’, an oldmercantilist argument which was still being put forward with force in 1757

by Malachy Postelthwayt Demographic growth could help in this matter,but the State had to contribute, for example, by discouraging ‘charity’towards the poor and by abolishing related laws On the other side werethose who argued that high wages could contribute to the stimulation ofhuman effort and the improvement in working ability It is a first hint at themodern theory of efficiency wages Robert Wallace, Nathaniel Forster, andThomas Mortimer were in this group; Steuart was not

Steuart also put forward an interesting historicist theory of economicgrowth which has rightly been considered as the best historical justification

of mercantilism The economic growth of a nation occurs in three stages Inthe first stage, the effective demand capable of driving growth is provided,above all, by the voluntary expenditure of the wealthy classes The increase

in production stimulates the introduction of machinery in industry andproductive improvements in agriculture, thus prompting an increase inlabour productivity At the same time it enables the production of an agri-cultural surplus necessary to sustain the growth of the industrial sector Thesecond growth stage is reached when the country is able to produce a surplusfor export At this point luxury should give way to thrift Growth would besustained by the trade surplus The third phase occurs when the country is nolonger able to maintain a permanent surplus on its balance of trade At thispoint, growth should return to being sustained by internal demand, andluxury could again play its role as a stimulus In the third phase, however,there is a reduction in the rate of growth In all three phases there is room forState intervention, both in the regulation of internal demand (for example,with sumptuary laws), and in the regulation of trade flows (with the usualmercantilist measures)

2.2 Adam Smith2.2.1 The ‘mechanical clock’ and the ‘invisible hand’

Newton’s theory of universal gravitation contributed to the diffusion of theidea of an ordered and rational universe and exerted a great influence onilluminist thought Natural phenomena, according to this idea, are reducible

to the movements of atoms regulated by laws which are intrinsic to the state

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of nature God created the universe together with the laws that regulate itand then he stood aside There is no need for his continual intervention tohold the world together, as it is completely self-regulating Furthermore, asthe natural order is rational, it can be understood by human intelligence.This was the extreme outcome of a philosophical conception that had alreadybeen advanced by Descartes: rational understanding is possible, and themore abstract it is the more precise it will be Mathematics is its most efficientand potent instrument, more powerful than observation itself This con-ception, which the Scottish universities helped to spread throughout GreatBritain, crossed the boundaries of the natural sciences and enjoyed enormoussuccess even in moral philosophy, where its influence intertwined with that ofnatural-law philosophy The idea of a ‘natural order’ played a fundamentalrole in the birth of classical political economy, and the conviction gainedground that human relationships were regulated by objective mechanicallaws, with which positive law, which was formulated by man himself, shouldtry its best not to interfere.

However, the influence exerted in the eighteenth century by the naturalsciences over the social sciences cannot be ascribed only to the great prestigeattained by the former In fact, it can be better explained by a theoreticalneed which arose within the social and political thought of the period.The central problem of European political philosophy in the period fromthe beginning of the Renaissance to the French Revolution was that ofaccounting for social life without having to resort to metaphysical presup-positions In the Middle Ages, social consensus was maintained by twofundamental principles: authority and faith, both justified by the assumption

of the existence of God The problem of modern social thought was: how issocial life possible if those two principles and their metaphysical justificationare left aside?

A first answer to this question was given by Machiavelli and Hobbes: thenatural egoism of man makes free social life impossible and the absoluteState necessary; the principle of authority is based on the monopoly ofpower, and does not need to be legitimized It is based on violence, and onlyobtains obedience through its strength The citizens, mindful of a primitive

‘social contract’ of subjection and driven by the survival instinct and thedesire for security, can do nothing else but obey Civil society originates fromrepeated acts of obedience The alternative would be social disintegrationand the law of the jungle So power gives foundation to the State, and theState makes harmonious social life possible Now, this solution was certainlyapplicable to the absolutist States of the sixteenth and seventeenth centuries

It was no longer tenable after 1649, the year of the proclamation of theEnglish Commonwealth, and, above all, after the Glorious Revolution (1688)and the Declaration of Rights (1689)

The emerging social classes created by capitalist development, andexcluded from government by the absolutist States, strived to obtain what

they considered to be their rights, if it is true that money is power On the onehand, therefore, was the need for a political philosophy by which the civilsociety could justify itself independently of the State On the other hand, itwas necessary that such a justification take into account the real processes ofwealth formation If Hobbes’ Leviathan assumed the natural egoism ofindividuals in order to justify the State, then it was necessary to demonstratethat a free social life is possible even in the presence of selfish individuals.Moreover, as the sphere of action of human egoism is economic activity, achange of focus from politics to economics was necessary Finally, as ametaphysical justification had to be excluded, it was also necessary to for-mulate such a justification in ‘scientific’ rather than purely speculative terms.Natural-law philosophy was one of the paths attempted The followers ofthis view believed in a ‘natural order’ that presupposes the free expression ofhuman activity The ‘positive order’, based on laws and conventions, createsthe State, but is only legitimate if it is not in conflict with the ‘natural order’.This was a dangerous path to take, as was demonstrated by the difficultiesLocke encountered in justifying the inequality in the distribution of propertyand wealth, and even more so by the radically egalitarian results which thatphilosophy was to produce in France.

A different path was attempted by the English and Scottish empiricists and

‘moral-sense’ philosophers Their approach was based on the assumption ofthe existence of a natural ‘benevolence’, or ‘moral sentiment’, which manexperiences towards his fellows If individuals are not naturally egoistic, theytend spontaneously to associate themselves and there is no need for externalintervention to give sense to social life; neither God nor the State is neces-sary It is sufficient to assume a particular structure of the human psyche.Now, apart from the fact that this way of thinking succeeds in solving theproblem simply by ignoring its existence, the main difficulty with it is that theassumption on which it depends, benevolence, not only runs against com-mon sense but also is not basically different from other metaphysicalassumptions; nor is it less arbitrary and easier to demonstrate

Both Hume and Hutcheson, Smith’s teacher, and Smith himself moved inthis direction However, according to a widespread and quite orthodoxinterpretation, Smith’s main contribution, the one which made him thefather both of economic science and of modern liberalism, came precisely atthe moment when he introduced innovations within that tradition Hisstroke of genius consisted, not in the rejection of the empiricist position,but in taking it to its extreme logical conclusions, by leaving out eventhe arbitrary hypothesis of benevolence With the ‘theorem of the invisiblehand’, Smith simply aimed at demonstrating that individuals serve thecollective interest precisely because they are guided by self-interest

A similar attempt had been made by Quesnay, a medical doctor, who,however, from the philosophical point of view, had remained tied to anatural-law position, while, in order to demonstrate the natural tendency of

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social agents to produce order, tried to use a biological analogy Quesnay’snatural order was very similar to Menenio Agrippa’s apologue, and failed tofocus on the role of individual actions in ensuring social equilibrium Theeconomic subjects to which Quesnay referred were collective social agents,classes of individuals, not individuals Smith was strongly influenced byQuesnay’s work, and it is possible to say that the truly ‘classical’ component

of Smith’s thought, that which was later to be developed by Ricardo and hisfollowers, originated precisely from his attempt to assimilate some ofQuesnay’s fundamental ideas and to correct some of his secondary errors.However, there is a component in Smith’s thought that clearly distances himfrom the physiocratic position, and it is that which aims at demonstrating theinvisible-hand theorem Here, collective agents disappear and the organicistanalogies become meaningless The scientific reference model is mechanics,and the objects studied are social atoms It is not by chance that Smith isconsidered to be the founder of economic science not only by the classicalbut also by the neoclassical economists

This, we repeat, is the most diffused interpretation of Smith’s thought

We will mainly follow it, but we will take the freedom to contest it insection 2.2.6

2.2.2 Accumulation and the distribution of income

In 1776 Smith published An Inquiry into the Nature and Causes of the Wealth

of Nations, a milestone in modern economic thought The work begins with

an analysis ‘of the causes of improvement in the productive powers oflabour’—improvement immediately identified as the main condition for thegrowth of real wealth The division of labour is a process by which a par-ticular productive operation is subdivided into a certain number of separateoperations, each of which is carried out by a different person With thedivision of labour the worker’s skill increases, the idle time in transferring aworker from one activity to another is reduced and, above all, technicalprogress is stimulated However, the division of labour is limited by the size

of the market, is only possible when the economy can produce for a ciently large market, and can be intensified only if the market is expanding

suffi-In turn, the market will be larger the more the transport and nications systems are developed, the more credit and monetary instrumentsare diffused, and the faster the growth in the volume of production Smithbelieved there is a cumulative mechanism that operates in a capitalist sys-tem which proceeds according to the following sequence: division oflabour—enlargement of the markets—increases in labour productivity, and

commu-so on; a real virtuous circle of growth

If it is the division of labour that triggers the growth process, it is theaccumulation of capital that drives it Smith subdivided capital into fixedcapital, consisting of machinery, plant, buildings, etc., and circulating capital,

which is used to buy raw materials and pay for labour and energy The wagesfund is that part of the circulating capital which is used to pay the workers Inreal terms, it is a part of the goods produced in a productive cycle which isused to pay the workers in the successive cycle Wages are paid before theproduct is sold, and for the capitalist, who advances them, they are capital.The theory of income distribution among the social classes plays a fun-damental role in Smith’s theory of growth In fact, the three basic classes,capitalist, workers, and landlords, are distinguished both by the productiveresources they hold—capital, labour, and land—and by the way in whichthey spend profits, wages, and rents, their respective incomes The relation-ships among the types of productive resource held by the various classes, andamong the ways in which their incomes are spent, constitute the essentialpart of Smith’s theory of capital accumulation.

The landowners, who do not own productive capital, are not interested inits enlargement and have no inducement to save and accumulate capital.Their propensity to save is zero, and they make no contribution to the growth

of the wealth of the nation On the other hand, the workers only possess theirlabour Both the ability of the capitalists’ coalitions to influence the govern-ment and parliament and the competitive forces on the labour market pushreal wages down to subsistence levels But with a subsistence wage the pro-pensity to save must be zero Therefore, not even the workers make a positivecontribution to the growth in a nation’s wealth, although they make anessential one to its production Finally, the capitalists possess the productivecapital and aim to increase it This means they have a very high propensity tosave It follows that the higher the proportion of the national income going toprofits, the higher the growth in the wealth of the nation The general interest

of the nation, therefore, coincides with that of the bourgeois class

Smith also made an important distinction between productive andunproductive labour The former is employed in the production of goods, thelatter in the supply of personal services or in similar activities Smith had inmind the difference existing between workers who are employed by capit-alists and domestic staff who are employed by the ‘leisured class’ Accu-mulation is the accumulation of goods Thus productive labour is essential tosustain accumulation whereas unproductive labour is not This means that agrowing economy must reduce to a minimum the percentage of workersengaged in unproductive labour

2.2.3 Value

Smith also made an important contribution to the explanation of the value ofgoods, but he did not manage to formulate a completely successful theory ofvalue His starting-point was to recognize that the structure of a productiveprocess can be represented in terms of the series of quantities of labouremployed to produce the goods In fact, even the loom that is used by the

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worker to produce cloth has been, in its turn, produced by means of labouraided by other means of production: ‘Labour, therefore, is the real measure ofthe exchangeable value of all commodities The real price of everything, whateverything really costs to the man who wants to acquire it, is the toil andtrouble of acquiring it’ (p 133) Smith deduced from this fact that a necessaryprerequisite for a good to have value is that it be produced by human labour.

On the other hand, 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, andwho want to exchange it for some new production, is precisely equal to thequantity of labour which it can enable them to purchase or command’.Smith clearly saw that the measure of value in labour commanded doesnot coincide with the amount of labour embodied in the goods Such acoincidence could only occur

in that early and rude state of society which precedes both the accumulation of stockand the appropriation of land If among a nation of hunters, for example, it usuallycosts twice the labour to kill a beaver which it does to kill a deer, one beaver shouldnaturally exchange for or be worth two deer It is natural that what is usually theproduce of two days’ or two hours’ labour, should be worth double of what is usuallythe produce of one day’s or one hour’s labour In this state of things, the wholeproduce of labour belongs to the labourer; and the quantity of labour commonlyemployed in acquiring or producing any commodity is the only circumstance whichcan regulate the quantity of labour which it ought commonly to purchase, command,

or exchange for (pp 150–1)

Under these special conditions, therefore, the quantity of labour commandedcoincides with the quantity of embodied labour

Things change when one passes from a system in which the whole product

of the labour belongs to the worker to one in which the control of the means

of production, and therefore the production, is no longer in the workers’hands When capitalists and landlords take part in the division of theproduct, 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 labourthe good can pay for must be greater than that employed to produce it In acapitalist society, therefore, embodied labour is no longer a good measure ofthe exchange value of goods

Labour commanded is a relative price; it is the value of a good expressed interms of the value of another: the labour that can be bought with it SinceSmith maintained that the price depends on the incomes paid to produce thegood, he expresses it as the sum of those incomes: wages, profits, and rents.Here, for the sake of simplicity, we will ignore rent Let us imagine an eco-nomy in which, on free land, only one good is produced, corn, for example,

by means of itself and labour The good, measured in tons, is used as a wagegood as well as a capital good Let us assume, again for simplicity, that wagesare paid after the work has been done k is the capital coefficient, namely, thequantity of seeds necessary to produce one ton of corn; l is the labour

coefficient, namely, the quantity of labour-hours directly used to producedone ton of corn If l is the labour directly and indirectly embodied in a ton ofcorn, lk will be that embodied in k tons of grain used as seeds Therefore:

l¼ l þ lk ¼ l

1
kNow, let r be the rate of profit, w and p the monetary wages and the mon-etary price of one ton of corn p/w will be the labour commanded by it, andw/p the real wage The price of corn will be equal to the sum of the costssustained in producing it and the profits earned by the capitalists The cost oflabour is wl, the cost of capital pk, the profit pkr Therefore, p = wþ pk þ pkr.Expressing the price in labour commanded:

‘additive’ theory of value emerged, a theory which determines the value of agood by the sum of the incomes paid to produce it When we speak of themistakenness of such a theory, we are referring, not so much to the idea thatthe price of the good is expressed as a sum of the incomes, but to theinterpretation that considers incomes as the primary sources of value In such

an interpretation, wages and profits would be determined by the forces ofsupply and demand in the ‘factor’ markets, so that their sum would determinethe value of the good But from the equation of labour commanded it is easy

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