Montpellier University, Faculty of Economics

Master 1, 2016-2017
Robert Braid
HISTORY OF ECONOMIC THOUGHT IN CONTEXT
SYLLABUS
1. Moral Economy (Antiquity Middle Ages)
2. Mercantilism (16th 17th centuries)
3. Physiocrats (mid-18th century)
4. Classical Economics (late 18th - early 19th century)
5. Social Economics (early - mid 19th century)
6. Neo-classical economics (mid - late 19th century)
7. Keynes and Heterodox economists (early 20th century)
8. New Liberal Economic Theory (mid-late 20th century)
9. Welfare/Development Econ., New Institutional Econ., Behavioral Econ (late 20th cent.)
10. Neo Keynesianism, Wikinomics, Environmental Economics (early 21st century)
OBJECTIVES AND ORGANIZATION
This course has been designed to help students gain basic knowledge relative to the history of economic
theory, as well as analytical skills to understand it, that are necessary for university students in economics.
Each CM course is dedicated to a particular period in the history of economic thought and consists of a brief
analysis of the historical context, then a more in-depth study of the economic theories that were developed
in that context. At the end of each session, the professor presents students with questions or documents
that must be prepared for TD class.
EXAMS
All students will be required to take two small tests during the semester in TD and one final exam at the end
of the semester in CM, to evaluate whether they did the work required, learned the relevant information,
and developed the analytical skills taught. These exams could consist of multiple-choice questions, short
answer questions, essay questions, or a combination of these different types of question, designed to
evaluate your ability to express your knowledge of the class or on your ability to analyze a document.
NB - It is the students responsibility to come to every class. This course book is a guide and does
not contain all the information to do well on the exam. Only regular presence and individual reading of the
works below will allow students to gain a global understanding of the course.
REFERENCE WORKS
No one work covers the entire course. It is therefore recommended to consult the references indicated
below to reinforce the information given in class, not as a substitution for the class.

On-line resources :
Histoire de la pense conomique (on-line course material by Jean-Pierre Potier, ENS Lyon), and
Wikipedia page History of Economic Thought
Wikipedia pages Economic history of (France, Germany, Great Britain, the United States, etc.) to
understand the historical context of the intellectual trends in economics.

Paper editions (unfortunately, the university library only has texts in French)
Bailly (Jean-Luc), Buridant (Jrme), et al., Histoire de la pense conomique, Collection Grand Amphi
Economie , Rosny : Bral, 2008.
Blaug (Mark), Economic Theory in Retrospect, Cambridge: Cambridge University Press, first pub. 1962.
Jessua (Claude) : Histoire de la thorie conomique, Paris : P.U.F., 1991.
Martina (Daniel) : La pense conomique, Paris : A. Colin, coll. "Cursus", tome 1, Des mercantilistes aux
no-classiques, 1991, tome 2, Des no-marginalistes aux contemporains, 1993.
Poulalion (Gabriel), Histoire de la pense conomique, Paris : LHerms, 1995.
Wolff (Jacques), Histoire de la pense conomique. Des Origines nos jours, Paris : Montcrestien, 1991.
Schumpeter (Joseph-Alois), History of Economic Analysis, London: G. Allen and Unwin, 1954.
1

Introduction

Learning the history of economic thought in context

1. What do the following terms mean: history, economic, theory, context?
In general, the term history refers to the study of past events, but there are various ways to study
the past. Whereas, archeologists use objects to gain an understanding of how humans lived in the
past, historians generally base their studies on textual analysis. There are many types of documents
available to historians (philosophy, literature, laws, court cases, the press, personal correspondence,
etc.). Not all ideas, however, are expressed in documents, and the vast majority of documents
produced are lost or destroyed over time. Moreover, interpreting the documents written in ancient
cultures is particularly difficult. Historians must be particularly careful to think about why a document
was written, why it was preserved, and why it was written in a particular way.

Economics is the study of the production, distribution and consumption of goods and services.
Producing or otherwise acquiring, sharing and consuming products have always been the primary
activities of the vast majority of humans (and even animals!) since the world began. Long before
complicated mathematical formulae to understand these activities, and even before the invention of
money to facilitate trade, people have been thinking about the ways to eat, stay warm and dry and
provide for their families. The overwhelming majority of human thought dedicated to economics was
never written, and is therefore impossible for historians to take into account.
Not all ideas about economics, even those that were written, are part of economic theory. It is
generally considered that economic science began in the 18th century with Adam Smith, or even with
the French Physiocrat movement, when intellectuals began to develop theories and laws that would
explain how the economy functioned as a whole. But these authors borrowed lots of ideas from their
predecessors who had not integrated their own ideas into a coherent science. Adam Smith and Karl
Marx, for example, were first and foremost philosophers, and therefore very familiar with the ideas
relative to production and trade developed by ancient and medieval authors. It would be a mistake
to examine the works of economists without a proper understanding of their intellectual heritage.
But intellectuals are affected by more than the ideas of the authors they read. Their culture and
environment have a great impact on how they observe and interpret phenomena. By context, we
mean anything that may influence an author that is not explicitly expressed in the text itself. Most
importantly, the state of the economy that the intellectual is observing will determine to a large
extent his views about economics in general. But political events, social movements, scientific
inventions, etc., can all influence an economists views. Even the personal experience of an author
can often explain his point of view. How is it possible to understand Adam Smiths The Wealth of
Nations, if one does not consider the fact that, before writing it, he had travelled to France and met
with various Physiocrat authors? How can one understand Karl Marxs Capital without taking into
account his role in the 1848 Revolution? Would Hayek have been so fanatically against state
regulation if he had not grown up in Vienna, a city that was occupied by Nazis shortly after he left?
Many aspects of authors context will, therefore, be examined in order to bring light to the works
that have shaped modern economic analysis.

2. Why is it important that students of economics study the history of economic thought in context?
As an economist, you will be confronted with many different, and often conflicting, ideas about how
the economy functions. It is often useful to think about where the ideas come from in order to
properly understand the idea itself. But even outside of economic theory, young professionals need
to develop their ability to think critically about the views of people they will work with. Even if the
information learned in class is quickly forgotten by the student, the professor hopes that the ability
to interpret and think critically about ideas received will last.

Theory and reality according to J. M. Keynes:

The ideas of economists and political philosophers, both when they are right and when they are wrong, are
more powerful than is commonly understood. Indeed the world is ruled by little else. Practical men, who
believe themselves to be quite exempt from any intellectual influence, are usually the slaves of some defunct
economist.
John Maynard Keynes, General Theory of Employment, Interest and money, 1936, ch. 24.

According to Keynes, the link between economic theory and economic reality if clear: practical men
(meaning managers, government regulators, decision-makers) are dependent on the ideas developed by
intellectuals, even if they are unaware of it. It is true that many decision-makers often call on economists to
give their interpretation of a particular situation or to find a solution to a particular problem. However, it is
also obvious that intellectuals are heavily influenced by their context, and therefore by the practical men
who shape this context. Is it possible that Keynes gave greater importance to the influence of intellectuals
because he was one himself?

Quiz
(10 minutes)
1. _______________________ Greek philosopher (ca. 428-354 BC), disciple of Socrates, who is
the author of the first use of the word economic, meaning the proper management of a large
estate. He was also in favor of the specialisation of labor and explains how Athens could increase its
revenues.
2. ________________________ Scottish economist and philosopher (1723-1790), who published
in 1776 The Wealth of Nations, in which he explains how the economy regulates itself autonomously
because the acts carried out in the interests of each individual also fulfill the collective interest.
3. ________________________ French economist (1767-1832) of the classical school, who
favored a laissez-faire policy of free trade, he is known for his theory that production creates
opportunities, or a market, for exchanges.
4. _________________________ English economist (1772-1823), considered as one of the
founding fathers of the classical school, who began his career as a stockbroker in London, and who
became a Member of Parliament in 1819, who is known for his major work On the Principles of
Political Economy and Taxation, in which he defended free trade and developed a theory by which
the value of a good includes not only the labor required to produce it, but also the labor that was
necessary to accumulate the capital (machines, etc.).
5. _________________________ French economist (1834-1910), professor at the University of
Lausanne, co-founder of the neo-classical school, who is known for his general equilibrium theory
and for his extremely theoretical approach.
6. ________________________ British economist (1842-1924), of the University of Cambridge,
considered one of the greatest authors of the neo-classical school, who used theories of marginal
utility to elaborate a theory of partial equilibrium, all other things being equal (ceteris paribus).
7. _________________________ Austrian economist (1899-1992), defender of free trade, known
for his work The Road to Serfdom (1944) in which he demonstrates that the intervention of the
State in economic affairs leads to the reduction of individual freedom, he received the Nobel Prize in
Economics in 1974 for incorporating social and institutional aspects in his economic analysis
8. _________________________ British economist (1883-1946), and one of the main actors at
Bretton Woods, who is known for his theory that markets cannot always regulate themselves
efficiently, requiring State intervention, in particular to replace demand in the private sector which
drops off in times of economic difficulty.
9. ________________________ American economist (1943- ), professor at Columbia University,
former Chief Economist at the World Bank, he received the Nobel Prize in Economics and is known
for his criticism of liberal economic theory and globalisation. He is the most-cited economist in the
world (according to IDEAS/RePEc).
10. _________________________ American economist (1953- ), professor at Princeton, at the la
London School of Economics, Noble Prize winner in 2008 for his work on international trade and the
geographic concentration of wealth by examining the economies of scale and consumer preference.

NB - If you cannot answer correctly and from memory at least 8 of these questions, you will probably need
to spend extra time reviewing the basics of economic theory.

Chapter 1. Moral Economy (Antiquity Middle Ages)

The only documents that leave a trace of economic ideas that were preserved from this period are laws and
philosophical (or theological) treatises. Economic thought at this time is indissociable from morality (or law),
and therefore based on the virtuous (or legal) behavior of various agents. It is clear that peasants, artisans,
merchants, etc. thought about means of production, supply and demand, efficiency, trade, investment,
consumption, budgets, etc., even if they did not transcribe their ideas into texts. The ideas expressed in
written documents, it must be remembered, only represent the ideas of a small percentage of the
population.

Mesopotamia
The Hammurabi Code King of Babylon in the 18th century BC.
This is certainly the oldest text preserved (written on a stone tablet) which mentions economic activity. Like
all legal codes, this is a document that groups various rules on a wide variety of human activities in order to
maintain order in society. This code includes economic regulations (wage fixing, rules relative to lending and
renting, professional responsibility, etc.). It is not terribly interesting for our purposes because it was only
recently rediscovered and had no impact on our intellectual heritage. It is, however, a vestige of economic
thought from a very early period and is worth pointing out.

Chinese Antiquity
There are two major intellectual traditions in Chinese philosophy: Taoism and Confucianism.

Taoism
The Old Master, Lao Tseu (570-490 BC) is considered as the originator of ideas expressed in a later work,
Tao Te Ching or The Book of the Virtuous Way (4th 3rd century BC). This philosophy is based on the
principle of a binary universe (yin and yang). As in all philosophies, Taoism seeks to establish a code of
conduct to lead human beings to virtue. A fundamental component of Taosim is the non intervention of
humans in the universe. Harmony and virtue are attained by accepting the natural world. It is therefore
against culture, knowledge, desire, in order to return to a pure and original state.

Confucianism
The other major current in ancient Chinese philosophy is Confucianism. Contrary to the teachings of Taoism,
Confucius (551-479 BC) advocated a philosophy of which man was at the center. Virtue is attained through
living with others in society. Confucius therefore gives a major role to education and the State.
Some historians of economic theory attempt to read into these philosophies a certain degree of economic
reflection. Indeed, the non intervention of Taoism may be associated with liberal economic theory in which
markets regulate themselves (Smith, Marshall, Hayek, Freedman, etc.). Confucianism, on the other hand,
would support an economic theory that favors State intervention in economic affairs (Marx, Keynes, Stglitz,
Krugman, etc.). Unfortunately, these philosophies do not explicitly discuss the economy and it would be
dangerous to attribute economic ideas to texts that do not even mention economic activities. Moreover,
these philosophical currents had no direct impact on traditional Western philosophy or on the most widely
accepted economic theories.

Greek Antiquity
Contrary to Babylonian laws or traditional Chinese philosophy, the ideas articulated in ancient Greek texts
had a significant and direct impact on Western philosophy, and in particular on modern economic theory.
One must not forget that Adam Smith was a professor of philosophy and taught Plato and Aristotle at
university. Karl Marx wrote his doctoral dissertation on ancient Greek philosophy. Until relatively recently, all
university scholars, including economists, had to learn Latin and Greek and were familiar with the
fundamental texts of Western Civilization. Aristotle in particular had a profound impact on medieval
philosophy and many of his ideas were also transmitted from generation to generation to the present day.

Context
Before studying the ideas of any given period, it is important to understand the context in which they were
formulated. Ancient Greece is considered the cradle of democracy, yet it should be remembered that the
Greek economy was based on the labor of slaves. Slaves worked on agricultural estates and in urban trades,
and the notion of democracy expounded in ancient Greece had no intention of eliminating forced labor. One
should also remember that Greek philosophy could develop because the Greek economy was prosperous.
International trade was made possible by the advanced techniques in navigation. Greek ships sailed across
the Mediterranean, bringing goods, people and ideas. One will notice throughout this course that new ideas
were often developed during periods of economic expansion based on international trade. For our purposes
here, however, there is no real need to examine the Greek context in depth. It is sufficient to be familiar
with the economic ideas that were learned by scholars in all fields in the West.

Authors
Thales of Miletus (625-547 BC)
Thales did not leave any written record of his ideas, but Aristotle related and anecdote about this
philosopher which suggests that he had mastery of fundamental economic principles. According to Aristotle,
Thales was criticized for the uselessness of his philosophy. Indeed, as a philosopher, he was interested in
living virtuously, gaining knowledge and understanding, not in seeking wealth. However, in order to
demonstrate how his knowledge could be useful, Thales calculated the movement of the stars and planets to
predict agricultural cycles. Then he invested in oil presses at a moment when olive harvests, and therefore
the demand for oil presses and their prices, were low. Then he rented them out when harvests were
abundant and the demand was high. His profits soon turned into a fortune. He eventually managed to gain a
monopoly on oil presses, and consequently could charge any price he chose. Whether this anecdote is true
or not, it shows us that at this early period certain people were familiar with the basic economic concepts of
supply, demand, return on investment, economic cycles, profits and monopolies.
Socrates (470-399 BC)
Socrates is one of the best known Greek philosophers, despite the fact that he did not write any of his own
ideas. His philosophy is known to us through the writings of his students, Xenophon and Plato. Socrates,
however, did not dwell on questions of economics. On the contrary, he demonstrated a particular disdain for
material gain and the accumulation of wealth. His students, however, further developed Socrates methods
to highlight a certain number of economic ideas.
Xenophon (426-355 BC)
Socrates student Xenophon is the author of two works dealing with economic activity: Economics, andWays
and Means. He was the first known author to use the term economics. In this work - which comes from the
Greek words oikos (house) and nomos (order) - he explains the most rational method of organizing an
agricultural estate. His other work, Ways and Means, he expands his analysis to the entire region, discussing
the best methods of public investment in infrastructure and production, taxation and redistribution, in order
to enhance the collective wealth. Although he very clearly supported government intervention in markets,
and had a firm grasp on the economic benefits of such intervention, he did not develop the analysis of
economic activity into a science. This work could have been the basis for a new economic philosophy, but
this line of reasoning was not taken up by other authors. At best, most other authors in Antiquity wrote
works similar to his manual on the proper management of agricultural estates. Xenophons Economics does,
however, attest to the fact that complex economic ideas could and did exist, indeed it is hard to imagine
City-States or even empires as vast as those that existed in Antiquity without some thought to economic
activity, even though philosophers were generally more interested in writing about moral virtue.

Plato (427-348 BC)

Also a student of Socrates, Plato is best known for his work entitled The Republic. In Greek society, indeed
in all Western concepts of social organization until the 19th century, the population was divided into three
classes. In ancient Greece, magistrates and philosophers occupied the first, warriors the second, and
workers the third. In Platos utopian Republic, he advocated communal property for the first class.
Magistrates and philosophers had the intelligence and moral restraint necessary to share all their goods
(land, buildings, objects, even their wives who were considered part of ones domestic property). On the
contrary, for the rest of society, only a system of private property could maintain social order. This text
therefore establishes two economic systems in society, one communist, the other capitalist. This
recommendation, however, was not made with the intention of increasing collective wealth, but rather to
establish a system in which individuals could act in the most virtuous manner possible.
Aristotle (384-322 BC)
Aristotle, student of Plato, was by far the Greek author who had the greatest impact on future generations
of intellectuals, and in particular relative to economic thought. In his works (Nicomachean Ethics , Politics),
Aristotle not only discusses economic activity, but most importantly developed a philosophical method based
on dialectical reasoning, that was highly appreciated and adopted by many Western philosophers. Indeed,
when ancient Greek texts were rediscovered in Europe in the 13th century, Aristotles works profoundly
marked all subsequent works on philosophy and theology. Thanks to the popularity of his methods, his
works were read very closely and his ideas relative to economic activity were at the same time widely
disseminated.
Aristotle describes the process of economic development through specialization, a concept that was the
foundation of Adam Smiths The Wealth of Nations, though Smith himself did not invent it. Money, according
to Aristotle (and Smith), is simply a convenient way to exchange goods, not wealth itself. Indeed, Aristotle
relates how King Midas, who transformed everything he touched into gold, starved to death because he
could not eat without touching his food. He condones natural chrematistic, which is the accumulation of
wealth that is the result of increased production using money only as a means of exchanging goods, while
condemning mercantile chrematistic, which is the accumulation of wealth that is the result of manipulating
money, buying and selling without producing any useful good. It is not difficult to relate this dual perception
of the accumulation of wealth with more modern division of society into those who earn their wages by
working (proletarians) and those who make money simply by investing previously acquired wealth
(capitalists).

After reading this chapter, you should be able to answer the following questions:
1. Why is it essential to be familiar with the works of ancient Greek philosophers in order to understand
modern economic thought?
2. What economic themes are most prominent in ancient Greek philosophy?
3. Which ideas in ancient Greek philosophy are most similar to modern economic thought?
4. What part of the chapter above did you find most surprising?
5. If you had a few hours to dedicate to further research, what questions would you seek to answer?

Roman Antiquity

Context
The history of ancient Rome is relatively well known. Founded in the 8th century BC, the city becomes a
Republic then an Empire. Political expansion is supported by economic growth which is fueled in part by
technological innovations. Romans had learned how to master the power of flowing water to turn wheels to
raise stones or ground grain. The invention of cement made it possible to build ever bigger and more
resistant constructions. Aqueducts made demographic expansion possible. Roads and bridges facilitated
trade. Roman peace offered security, which lead to enhanced production and trade. Agricultural production
was based on the exploitation of great estates (latifundia), and work was supplied primarily by slaves. But
economic and political expansion reached their limits by the 4th century, leading to decline.
As far as the intellectual context is concerned, the Romans were largely dependent on the Greeks. Young
Romans from good families went to Greece to study logic and rhetoric. Consequently, all members of the
Roman elite mastered the Greek language and were well versed in the Greek intellectual heritage.

Authors
In the tradition of Xenophons Economics, many authors wrote treatises on the proper management of
agricultural estates: Cato the Elder (234-149 BC), Varro (116-27 BC), Lucius Columella (c. 4-70 AD), Pliny
the Elder (23-79 AD).
Rome was also known for its philosophers, in particular the Stoics. Perhaps the most famous stoic
philosopher, Cicero (106-43 BC), was also a powerful statesman, and rival of Julius Caesar. In one work, On
Duties, as in the Greek tradition, he explains how one is to act virtuously. But contrary to the Greek
tradition, Cicero includes all sorts of aspects of daily life, including economic activities. Honesty in business
transactions and fulfilling promises are recurrent themes. As a Stoic, he demonstrates a certain distain for
the search for material gain if this leads one away from virtuous conduct, but he does not suggest that the
two are totally incompatible. Cicero had a clear impact on other Roman philosophers, and as a statesman on
the political and economic reality of 1st century BC Rome, and he was even commonly cited by medieval
authors as a reliable source for sound advice on virtuous behavior.
Information about the economic thought of ancient Rome can also be found in legal texts. In particular,
Justinian I (483-565 AD) compiled a collection of Roman laws in the Corpus Juris Civilis (or The Justinian
Code), which set out basic rules of conduct in Roman society, including rules relative to economic activity.
Honesty in transactions (bona fides), respect of contracts, laws regulating rental contracts, the responsibility
of the buyer to be on his guard (caveat emptor), etc. Roman law also developed the concept of laesio
enormis, which establishes that an individual who paid 50% above the just price was entitled to
compensation. Unfortunately, Roman law did not explicitly explain how to establish the just price. It is
implied that the just price is the price practiced on a local market (see texts below). Roman law had a major
impact on Western civilization because, starting in the 12th century, it will become the foundation of all of all
legal treatises. The Justinian Code also served as a model for the Civil and Criminal Codes set up by
Napoleon after the Revolution in France and which are still the basis of French law.

Questions
1. In what ways was ancient Roman philosophy influenced by ancient Greece?
2. How does the heritage from ancient Rome differ from that of ancient Greece?
3. How did Rome have an impact on intellectual production in the future?

Patristic tradition

Context
The Patristic tradition is the heritage of the early Catholic Church in the first centuries AD. The Catholic
Church, first persecuted by the Roman Empire, finally developed and was eventually adopted by the majority
of Romans. The Emperor Constantine I The Great (272-337 AD) converted to Christianity and, through the
Edict of Milan in 313 declared tolerance towards all Christians in the Roman Empire, thereby favoring the
spread of this religion. It became the principal religion in Western Europe, where it had a monopoly on
knowledge and teaching. Its influence on Western society is profound.

Authors
If the Bible is considered the most important text of the Christian religion, and in particular the Vulgate (the
Latin version established by Pope Jerome at the end of the 4th century), the Catholic Church gives
considerable importance to the writings of the founding fathers of the religion (hence the term patristic).
The Catholic Church considered itself the direct heir of the Hebraic tradition and includes the Torah and the
Talmud in the Bible (the Old Testament). The various books of this part of the Bible offer a large collection
of norms and rules to follow. Among these obligations, one finds certain rules relative to economic activity.
For example, a master may not withhold the wages of a worker until the following day. Because workers
generally need their wages to purchase basic necessities, such as food, for their family, their masters are
required to pay it promptly at the end of the day worked. People must act charitably towards their servants,
as one should to anyone in a precarious position (orphans, widows, the elderly, etc.). Moreover, God
punished Adam and Eve by chasing them from the Garden of Eden and made them work to earn their
bread by the sweat of their brow. All men, therefore, must work and one must not abuse his superior
economic situation at the expense of others.
The New Testament, on the other hand, does not contain such clear regulations. Instead, it offers a general
attitude to adopt, which if practiced fervently by a majority of the population, would have a profound impact
on the economy. In particular, Christianity demonstrates a certain distain for wealth. Whereas Greek
philosophers criticized the accumulation of wealth without productive effort, the Bible recommends people to
get rid of all material goods. It also exhorts individuals to be charitable even to people they dont know. The
Bible does not seem to advocate for productive efforts and labor. Indeed, if Jesus came from a working class
family, nowhere in the Bible is he or his disciples seen working. On the contrary, they live only from charity
and the generosity of others, like beggars. The text of the Bible is primarily concerned with the search for
eternal salvation.
If the Bible itself is addressed to a multitude of individuals, the Church authorities must face the formidable
task of maintaining social order in the real world. Indeed, the best known authors of the early Catholic
Church Ambrose of Milan (340-397), John Chrysostome (ca. 349 - 407), Augustine of Hippo (354-430), were
bishops not monks. They advised Christians on basic moral conduct, but refrained from advocating behavior
that would jeopardize social cohesion. Total abandon of all worldly possessions is not conceivable unless it is
practiced by only a small percentage of the population. In fact, it is what is required only of monks and nuns
who live in communities with no private property (like the magistrate class described in Platos Republic).
Christians should act charitably, but not to the extent that it would reduce them to poverty. Moreover, there
is a clear accent placed on the importance to work, which is absent from the Bible itself. All wealth must
therefore be the result of some productive effort, and not from immoral gain (turpe lucrum) such as from
usury or profiteering.

Questions:
1. To what extent can one consider Christianity a mixed heritage?
2. What was the dilemma faced by early Christian authors?

Medieval Islam

Context
Most studies of the history of economic thought ignore Islamic thought. If the most famous authors of
modern economic theory were not directly influenced by Islamic scholars, it is important to underscore the
role played by Islam in preserving ancient culture. Indeed, without Islam, Greek and Roman culture would
have been lost after the fall of the Roman Empire. The barbarian invasions destroyed all of ancient
civilization in Europe, leaving only monuments that were too big to be destroyed (arenas, aqueducts,
theatres, bridges, etc.). The Greek and Roman intellectual heritage only survived thanks to the development
of Islam.
Mohammed (570-632) founded a religion which developed in the 7th and 8th centuries and eventually
covered a massive territory, from Morocco to Pakistan. The Arab Conquest, seeking the unification of vastly
different peoples, was at the heart of economic, political and cultural expansion. The conquest introduced
relative peace and the new links between peoples favored trade. To manage such a vast and varied
territory, the central institutions became increasingly sophisticated and great emphasis was placed on
science, learning and knowledge.

Authors
Arab intellectuals considered themselves to be the direct heirs of Greek culture and therefore transcribed
and translated Greek texts. The greatest minds of that time attempted to interpret Greek philosophy through
the Muslim religion. Al Farabi (870-950) wrote A Thesis on Politics which was directly inspired by Plato. Ibn
Sina, Avicenna (980-1037), who was mostly known for scientific and medical works, also wrote a work
inspired by Aristotles Politics. Ibn Rushd, Averroes (1126-1198), perhaps the most famous of all these
intellectuals, and who was even admired by Western philosophers, also attempted to establish a logical
concordance between Greek philosophy and the morality of the Koran. Al Biruni (973-1050), on the other
hand, was already attempting to develop a relationship between population and resources, a theme that
later made Thomas Malthus famous.
Basically, like Christianity, Islamic culture condemned monopolies and usury (loans in exchange for
payments of interest are forbidden by Sharia law). And as in Roman law, and pre-plague Christian morality,
the just price should fluctuate naturally according to the balance of supply and demand, and should not be
influenced by human intervention.

10

The Middle Ages in the West

The most important period for our purposes is the late Middle Ages in the West. The intellectual tradition
developed at this time has continued uninterrupted until today. Indeed, it was during this period that the
first universities were established, and which are still today where the concepts and models regarding
economic activity are primarily developed.

Context
The early Middle Ages (5th 10th centuries) were marked by the fall of the Roman Empire, barbarian
invasions, fragmentation and insecurity. This instability caused severe technological and economic decline.
At certain moments, Europe experienced a degree of stability and slight economic and cultural progress, in
particular during the reign of Charlemagne (742-814). But the most spectacular development did not start
until the end of the 11th century.

The economic and intellectual renaissance (11th 13th centuries)

Europe finally experienced a level of relative peace when knights and warriors turned their attention to
Palestine. Rather than attack each other, the Pope encouraged them to attack Muslims in a series of
Crusades (1095-1291). Domestic peace in Europe increased production and trade, favoring economic and
demographic growth. International fairs developed, for example in Champagne, bringing merchants from all
over Europe to exchange goods with each other. The Crusades also favored international trade outside of
Europe. The large numbers of massive Cathedrals and monasteries build during this period attest to the
improved economic situation.
Economic development led to a sophistication of government institutions. During this period, the primary
function of the monarchy class was to protect the realm and lead military campaigns abroad. To do this, the
crown needed to raise taxes and an army, and therefore depended on the aristocratic class. Nobles were
essentially members of a military class. Indeed, they were the only ones allowed to carry swords and until
late in the Middle Ages were the only ones to participate in military campaigns. In return for their military
services, the Crown granted them land, which was worked by peasants under their authority. To lead wars,
however, the king also needed cash (for weapons, horses, ships, food, etc.) and regularly had to request
that Parliament come up with the funds (taxes), but in return the Crown granted a certain number of
privileges to Nobles. The more money that was generated thanks to economic growth during this period, the
more that could be diverted to the coffers of the king. The Crown now relied on the cooperation of
Parliament, councils, and a fiscal and legal administration to increase its power.
The Church also grew in power and wealth during this period and developed its own legal and fiscal
administration parallel to the secular authorities (the Church was also represented in Parliament and royal
councils). Certain people (priests, monks, nuns, etc.) could only be tried in Church courts, and certain acts of
seculars (blasphemy, oaths, sexual behavior, morality) were also to be tried under religious authority. Since
it is often impossible to perfectly distinguish economic and moral activity, there was considerable dispute
about where certain cases should be tried. It should not be forgotten that exercising legal authority led to
financial gain through the imposition of fines. The law administered by the Church is called Canon Law.
Economic growth led to the development of universities as early as the 12th century. The first universities
developed in urban centers (Paris, Bologna, Montpellier, Oxford, Cambridge) and were always under the
authority and protection of the Church. Indeed, all Masters (professors) and a great number of the
students were clerics. And in addition to wealth seized from Muslims, Crusaders also brought back ancient
texts which had been lost from Europe. The writings of Roman philosophers as well as the legal codes and
treatises of the Roman Empire were transcribed, and Greek philosophical literature was translated, and
widely diffused among intellectuals in universities across Europe.

Economic and demographic decline (14th 15th centuries)

As the saying goes: All good things must come to an end. And indeed, economic expansion in Europe
slowed dramatically by the early 14th century. The population in many parts of Western Europe had grown
six times since the 11th century, and the resources to support the increased number of people had not
followed at the same pace. There were more and more peasants on ever smaller plots of land, and many
disinherited sons had begun to earn a living working for wages both in the countryside and in town. The
11

aristocracy found it more economically viable to work their own lands using hired labor, which was
increasingly cheaper, than through the traditional labor services supplied by peasants. Masters in urban
trades could hire larger teams of wage earners after their apprenticeship who never would become masters
on their own.
The limited resources and increasing population, as Malthus observed five centuries later, led to a number of
problems. First, Europe suffered a series of famines, in particular massive widespread famine in 1315-1317
and 1321 in all of Northern Europe. Second, limited resources also led to armed conflict. In 1337, Edward
III, direct descendant of Eleanor of Aquitaine, declared himself the rightful monarch of France and embarked
on the Hundred Years War to reclaim the throne. Political strife in Italy prevented pope Clement V, elected in
1305, from occupying the Vatican, causing him to set up temporary residency, along with the entire papal
administration, in Avignon for almost 70 years. Various aristocratic families fought each other for power.
Even the peasantry and working class increasingly rose up against the aristocracy as the latter made
excessive demands on an already impoverished population (for example the Jacquerie in northern France in
1358, or the Peasants Revolt in England in 1381).
Finally, and perhaps most importantly, a population that is poorly nourished is more susceptible to disease,
and epidemics are more likely to spread. Indeed, merchants coming back from Central Asia brought with
them the plague in 1348. With no previous exposure to the disease, the population of Europe and North
Africa fell victim to the worst demographic disaster in the history of mankind. Most estimates set overall
mortality at around 40% of the population, the epidemic sweeping through villages and cites and taking its
gruesome toll within less than a year in each locality. This first wave of epidemic, which in fact was renewed
every 15-20 years for three centuries, though with lower mortality rates each time, caused a general panic
and, as one can well imagine, severely upset economic activity. As food stocks remained high relative to the
drop in population, prices dropped and wages soared. But then as per capita money supply increased, so did
inflation. More importantly, many former wage-earners could now move onto their own plots of land left
vacant by victims of the plague, and thereby depleting the labor market and pushing the aristocracy to find
forceful methods of obtaining labor for their land. The Crown also lost almost half its tax base and sought
new methods to raise funds to continue its military campaigns. This radical shift caused authorities to begin
intervening in economic activity. Whereas regulation of markets was quite rare prior to the plague, after the
middle of the 14th century, it slowly became a primary function of local and central governments. The new
economic and political situation led to a clear shift in the views of intellectuals relative to the Just Price.

Authors
The late Middle Ages experienced a renaissance in intellectual activity, inspired by the rediscovery of ancient
texts, and financed by economic expansion. Paris became the center for theological and philosophical
studies, Bologna law and Montpellier medicine. As more and more masters and their students crowded these
urban centers in the 12th century, the Pope granted them special privileges and protection, calling the new
institution a university. This model was replicated throughout Europe and is today the primary intellectual
institution around the world.

Theology (Scholasticism)
Medieval theologians were primarily concerned with reconciling philosophical science (and principally the
method outlined by Aristotle in Ethics and Politics) and Christian morality (the Bible and patristic texts),
including relative to economic activity. Albert the Great (1193-1280) commented Aristotles texts in his own
works entitled On Ethics, Politics. He also commented on Plinys work in his Natural History. Thomas Aquinas
(1225-1274), student of Albert the Great, and perhaps the most influential medieval theologian, was heavily
influenced by Aristotle (referring to him simply as The Philosopher). His Summa Theologica, systematically
examines all aspects of Christian morality with an Aristotelian methodology. He also wrote texts intended for
the government authorities concerning their secular responsibilities (for example, On Royal Government),
including their moral duty to protect trade in order to allow the people to procure the goods necessary for
their survival. Other authors directly discussed economic activity: Peter John Olivi (1248-1298), Treaty on
Contracts, John of Gerson (1363-1429), On contracts.
These theologians were principally interested in explaining how Christians could achieve heavenly salvation
by adopting behavior that respected certain rules. These rules are practically the same as those explained by
patristic and ancient authors. Everyone must work (intellectual activity is also considered work). Christians
should be charitable (without endangering their own livelihood or social status). It is forbidden to lend
money at excessive interest rates (usury). Theologians also now dedicate much attention to the question of
12

the Just Price. These authors often use concrete examples of the economic activity of their time to illustrate
their teaching.
The work of Nicolas Oresme (vers 1320-1382), Treatise on the Origin, Nature, Law and Alterations of
Money, deserves special attention, for this author is one of the first to focus on the question of the
importance of a stable currency for economic growth. Most authors limited themselves to the Aristotelian
explanation which indicated the money simply represented a convenient method of exchange. Oresme,
however, examined the impact of devaluation of the currency on markets. Indeed, in order to increase royal
funds, in the 14th century, the French monarchy regularly devaluated the currency and minted many more
new coins with the same quantity of silver. Every once in a while, the whole monetary system was reevaluated. The effect was to create inflation and, even worse, insecurity since economic actors feared each
new devaluation. Oresme, who was private councilor to the king Charles V, exposed the negative economic
effects of such manipulations, but highlighted in particular the immorality of the king who artificially created
wealth without producing anything. On the contrary, he makes things even worse for everyone else by
creating economic instability. Although the question of the quantity of silver in circulation did not attract
much attention of intellectuals at this time, it will become the primary focus of writers of the mercantilist
period (16th-17th centuries).
One ought as well to cite John Buridan (v. 1300-1358), who is accredited with the anecdote called Buridans
ass. In this anecdote, an ass (a donkey) is confronted with the dilemma of chosing between a bucket of
oats and a bucket of water. Because the donkey is equally hungry and thirsty, it will die in the middle unable
to chose between the two. A human, of course, would chose the bucket of oats because it has a greater
value on the market. This anecdote demonstrates that during the Middle Ages, intellectuals already
understood the difference between value of use and value of exchange (further developed by Adam Smith).

Law
The intellectual renaissance was not limited to philosophy and theology. Numerous scholars flocked to
Bologna to study law. The sophistication of public administrations, and the rediscovery of the Justinian Code
gave rise to an avalanche of legal treatises which attempted to render coherent a large number of very
eclectic laws. Numerous examples of the Justinian Code were copied and distributed, each with specific
annotations (glosses) of respected scholars. Scholars of Canon Law (the law of the Church) put in place a
similar work assembling the decrees and edicts of various popes and bishops throughout the history of the
Catholic Church: Gratians Decretals (12th century), Raymond de Penaforts Decretals of Gregory IX (1234).

Questions
1. What factors gave rise to the renaissance of intellectual activity in the 12th-13th centuries?
2. To what extend are medieval authors indebted to ancient authors?
3. To what extent to their views differ from those of their predecessors?

13

Documents
The Just Price
(N.B. In the interest of space and students understanding of the texts, certain quotes represent brief
summaries of the passages indicated. Do not cite without consulting the original.)
A. Civil Law
Justinian Code
1. "A thing is worth the price at which it can be sold." (Digest, 13, 1, 14; Digest, 35, 2, 63: Digest 36, 1, 1,
16; Digest 47, 2, 53, 29.)
2. "The price of a thing does not depend on the use or the utility (utilitate) of that thing for an individual; it
is established communally. It must not take into account the expectations but must represent the present
value. However, the estimated value of a good, for example in an inheritance, does not always need to
follow exactly the price of the market of the moment, for very short periods of dearth can cause a surge in
prices that no longer correspond to the value of the thing. (Digest, 35, 2, 63.)
3. "In sales, it is naturally permitted to fool the other provided that no fraud be used. (Digest, 4, 4, 16, 4.)

Medieval laws
4. Charlemagne (June 794): That no one sell, neither in times of abundance nor in times of dearth, a
measure of oats more than two pence, a measure of rye more than three pence, or a measure of wheat
more than four pence. Twelve wheat loaves, of 2 pounds in weight, must not cost more than a penny. []
Synodus Franconofurtensis (Law of Charlemagne, June 794).Capitularia Regum Francorum, in MGH Legum,
sectio II, Alfred Boretius (ed.), 2 vols., Hanover, 1883-1897, t. I, pp. 73-78.
5. Philippe VI de Valois (18 March 1330): We want and have always wanted that every subject in our
realm be able to live reasonably from his labor, and for this reason, we rescinded our first ordinance fixing
prices and the workers wages, for they could not live appropriately according to the established rates. But
as soon as the way was open to them, they started to demand excessive wages. We order, therefore, that
appropriate wages be established according to the currency, the season and the prices of goods.
("Isambert": t. iv, pp. 383-384.)
6. Edward III (18 June 1349): Because a great part of the people, and especially workman and
servants, recently died of the plague, many seeing the necessity of masters and the great scarcity of
servants, will not serve unless they receive excessive wages, and some even prefer to beg in idleness, than
labour to get their living; We [...] have upon deliberation and treaty with the Prelates and the Nobles, and
learned men assisting us, of their mutual council ordained (that all people of the working class accept
employment at pre-plague wages, etc.) Statutes of the Realm, t. I, pp. 307-308.

B. Canon law
7. Jules I, pope (280-352): "Buying wheat or wine during the harvest, not by necessity but through
avarice, to resell two or three times more expensive later, is considered a form of usury and the profits are
considered turpe lucrum." (Decrees, II, 14, 4, c. 9)
8. Gregory IX, pope (1145-1241): "The priests of each parish must reprimand their parishioners who
demand of travelers and pilgrims prices above those that are practiced at the local market for the food they
sell to them." (Decree, III, 17, 1)
9. Henry of Susa, bishop (1200-1271): "Parties of a contract can naturally be fooled in the price.
(Summa super titulis Decretalium, II, 20, c. 42, 2)

14

C. Philosophy - Theology
10. Albert the Great (ca. 1200-1280): "The Just Price is that which a product can be evaluated at
according to the estimation of the market at the time of sale. (Comm Sent., IV, xvi, 46 in Opera Omnia, t.
29, p. 638.)
Thomas Aquinas (1224-1274)
11. "The value of a saleable thing must be different in different places, according to its abundance: where a
thing is more abundant, one can buy more of it for the same price. [] The price of a thing does not depend
on its natural condition, for sometimes a horse is worth more than a slave; it depends rather on the utility of
that thing for man. (Summa Theologica, II-II, 77, 2-3.)
12. Henry of Ghent (1217-1293): "If merchants bring several shiploads of horses to a market, someone
could buy a horse at a very low, but just, price, because of the abundance. But if all of a sudden, after this
one sale, all the merchants packed up and left with all their horses, there would be an extreme dearth on
the market. In this context of dearth, the horse which had been sold at a very low price could be sold at
a very high price one hour later, with no modification of the horse in question, and this high price would still
be considered the Just Price (iusto pretio)." (Quodlibet I, 40 in Opera Omnia, t. 5, p. 230)

13. John of Gerson (1363-1429): The law can justly fix the prices of things that are sold [] under
which the seller cannot give or above which the buyer cannot receive, whatever their desire to do so. As the
price is a sort of measure of equity to maintain in contracts, and since it is often difficult to find this measure
with exactitude, considering the various corrupt desires of men, it is important that the means be
established by wise men. [] In civil law, no one is wiser than legislators. So, they must, when it is possible,
fix the Just Price, which cannot be circumvented by private accord, and which must be enforced.
(De Contractibus., I, 19, in Opera Omnia, t. 3, I, V, 19, p. 175)

14. Dives et Pauper (treatise on morality written about 1405-1410): "The true value and the just price of a
thing depends on the price commonly paid on the market at that moment, so a thing is worth as much as it
can be sold for." (Dives and Pauper, t. II, p. 154.)

15. John Nider (1380-1438): "You must sell your grain according to the common estimation, or in other
words, at the market price. (De contractibus mercatorum, c. 2, 1. Cited in J. Baldwin, Medieval Theories of
the Just Price, p. 54.)

16. Bernardino of Sienna (1380-1444): "The prices of merchandise and of services should be
established by local authorities, for the common good, and not by free negotiation. De Evangelio aeterno,
35,. 2, c. 2, t. IV, p. 148.

Assignment

Think: On the basis of the above texts, explain the different points of view relative to the Just Price. Think
about the objectives of the different authors, about their historical context, and about the evolution of ideas
in time. Try to identify two main currents of thought. Is it possible to observe similar reflections in current
economic debates?

Write: Write a short essay of about 400-500 words (3 paragraphs) commenting on these texts. Begin with
an outline, writing a complete sentence (subject, verb and object) for each paragraph of your commentary.
Also write a full sentence summarizing your main idea.

15

Chapter 2. Mercantilists (15th 17th centuries)

It is the industry which is carried on for the benefit of the rich and the powerful that is principally
encouraged by our mercantile system. That which is carried on for the benefit of the poor and the indigent is
too often either neglected or oppressed.
(Adam Smith, Wealth of Nations, 1776, Book IV, ch. 8).
The term mercantilism was used for the first time by Adam Smith to designate an political-economic
system, not a school of thought. This system was supported by an intellectual framework, but it was first
and foremost a real political and economic system. According to Smith, this system acts against the interests
of the working class and benefits only the rich. Instead, Smith proposes a capitalist system that will increase
the global wealth of the nation and benefit all members of society. His work, The Wealth of Nations, was
written in order to argue against a political and economic system already in place at his time. In order to
understand this fundamental work of classical economic theory, it is first necessary to understand the
situation that he was seeking to replace.

Context
Economic
Economic and demographic recovery after the Black Death was slow. The reappearance of the plague and
armed conflict maintained the European economy in a rut for over a century. It was not until the end of the
15th century that the economy began to recover. Economic growth is accompanied by geographic and
political expansion. The discovery of America, the exploration of the African coast and the opening of a
maritime route between India and Europe, radically transformed the global economy. Massive quantities of
gold and silver, taken primarily from Latin America by the Spanish and Portuguese, flooded European
markets causing prices to rise dramatically. In order to compete with other countries, monarchies invested in
and granted monopolies to certain companies (such as the East India Companies of England in 1600 and
Holland in 1602), thus creating mega international trading companies. Moreover, monarchies, aware of the
military threat of their neighbors, were very keen on reinforcing the national economy by setting up
factories, controlling urban trades, and solidifying public finances through fiscal innovations.

Political
Despite economic growth, the political context during this period was conflictual. Charles Quint (1500-1558)
was at the head of the Holy Roman Empire, which encompassed all of Spain, and various Germanic
territories. The presence of an extremely powerful monarch puts pressure on the other monarchies to
reinforce their own ability to defend their borders. But there were also threats to internal stability. Various
political factions fought for power in Italian city-states (the case of Verona was rendered famous in
Shakespeares Romeo and Juliet). In England, different families had fought for power in the War of the
Roses until the very end of the 15th century, and internal political tensions were still very high in the 16th
century because of an uncertain succession.
It was perhaps the birth of new religious ideas that created the deepest factions in European society. This
cleavage between Catholics and Protestants, but also conflicts between different Protestants, caused
unprecedented internal violence in many European countries. In England, a country that very early
converted to Protestantism under the leadership of Henry VIII, radical factions of Protestantism (namely
Puritans) in the 17th century led to civil war and resulted in the decapitation of Charles I in 1649 (though the
England reinstituted the monarchy after 10 years as a Commonwealth).
In this unstable context, monarchs attempted to reinforce their authority at the expense of democratic
institutions, such as Parliament. The reign of Louis XIV, for example, king of France from 1643 to 1715, who
would later be called the Sun King, marks the apogee of absolutism. This centralized power also concerned
economic decisions. Richelieu (1585-1642), the main minister under Louis XIII, and Jean-Baptiste Colbert
(1619-1683), minister of finance under Louis XIV, both favored strong state intervention in many aspects of
the economy. In particular, the State was to lead protectionist policies (to reduce imports and favor exports
primarily of manufactured goods) and to invest in manufacturing, two fundamental principles of
mercantilism.
16

Religious
Protestant ideas existed already in the Middle Ages, but were not popular enough to mark the institutions or
threaten authorities. Indeed, since the Church held a monopoly on the production and diffusion of written
works before the invention of the printing press, there was little chance of heretical ideas spreading to any
large extent. Things changed dramatically several decades after the development of secular publications. It
was especially after Martin Luther (1483-1556) published his 95 Theses in 1517 that Protestantism took root.
Others followed him and questioned the dogma of the Catholic Church, for example Jean Calvin (1509-1564)
in his Institution of the Christian Religion in 1536. Others questioned the authority of the Pope in Rome, or
criticized clerics for immoral practices, without however questioning the teachings of the Church.
The Pope had granted the title Defender of the Catholic Church to Henry VIII (1491-1547), king of
England; but to maintain order in his realm, Henry VIII broke away from the Church and established himself
as head of the English Church in the Act of Supremacy in 1534. England had just come out of several
decades of conflict (The War of the Roses) between two factions that disputed the monarchy. Henry VII
finally managed to be accepted as king by all parties and transferred power to his legitimate son. Henry
VIIIs marriage with Catherine of Aragon only produced a daughter and the queen was now too old to bare
more children. Although a divorce would normally be easy to obtain from the Vatican, Charles Quint,
Catherines nephew, put pressure on Pope Clement VII to refuse Henry an annulment. The succession of the
throne and the stability of the realm were therefore in jeopardy. After a certain number of wives, he was
finally able to bear and heir who finally succeeded him as Edward IV.1 Moreover, high inflation caused by
Spains unprecedented wealth from its colonies in America, had disastrous effects on the royal budget. By
establishing himself as head of the English Church, Henry VIII was able to annul his marriage with Catherine
and at the same time confiscate and dispose of the Churchs lands and goods. Indeed, in 1536, he sold off
all the monasteries in England to reinforce his financial situation and to make allies among the aristocracy
who bought them. Englands transition to Protestantism was not without conflict, but there was nowhere
near the level of public violence that France experienced.
It was primarily in France with the social conflicts relative to the rise of Protestantism were the most severe.
The authorities went back and forth between repression and tolerance towards the Huguenots (French
Protestants). Numerous monasteries and churches were pillaged by the people and the clergy chased out,
tortured and murdered. The greatest manifestation of violence took place on August 24, 1572, when
thousands of people were murdered and thrown into the Seine River in Paris, an even known as the Saint
Bartholomews Day Massacre. Finally, in 1598, the Edict of Nantes offered a certain degree of protection to
Protestants and guaranteed a relative religious freedom in France, though it was abrogated a century later,
in 1685 by Louis XIV, marking a new era of intolerance.

Intellectual
All of the social conflicts, caused by political rivalries or divergent religious views, reinforced the desire of
authorities and intellectuals to reinforce central power. In The Prince (1513), Nicolas Machiavelli (14691527) defended any means necessary used by a ruler to maintain control and limit social chaos, even if it
was necessary to adopt behavior that did not adhere to Christian morality. This hypothesis clearly differed
from the works of the Middle Ages which advocated for a monarch that was to behave as a model Christian,
an argument repeated by Erasmus (1467-1536) in the Institution of the Christian Prince (1516), which was a
response to Machiavellis Prince. But the debate was launched and an increasing number of intellectuals
recommended an absolute central power. Thomas Hobbes (1588-1697), who witnessed the disintegration of
social order in England after the decapitation of Charles I, is perhaps the best known author who argues, in
Leviathan, that men are naturally egocentric and would devour each other if the central authorities did not
impose strict rules. This intellectual movement is all the more important for us since Adam Smith and other
classical economists formulated their new science by attacking this idea.
Other intellectual developments also deserve mention. In particular, there was a clear divergence in scientific
method that appeared in Europe. In England, Francis Bacon (1561-1626) elaborated an empirical scientific
1

Edward IV, however, was of poor health and died rather prematurely without an heir and was finally succeeded by his
half sister Mary (daughter of Catherine of Aragon), who was then overthrown for religious and political reasons and
replaced by her half sister Elisabeth I, a highly successful monarch. Since Elisabeth, women were accepted as rightful
heir to the throne in England.
17

method: no reasoning can be defended until it can be tested and proven through observation of reality. In
France, on the other hand, Ren Descartes (1596-1650) in his Discourse on Method, doubts the reliability of
observation, since the senses can sometimes deceive, and prefers to place his confidence in pure logic. Still
to this day, scholars in the English speaking world tend to apply an empirical method in their research and
teaching, whereas intellectuals and scientists in France prefer and more theoretical approach, without
worrying about its application in reality. It is quite easy to imagine the impact that these trends will have on
economic theory in either country.

Scientific
From the end of the Middle Ages, intellectuals increasingly focused their attention on natural and physical
science, often using mathematics to understand how nature works. Leonardo Da Vinci (1452-1519), also an
accomplished artist, is known for his many inventions and his application of mathematics to various fields
such as painting, sculpture, cartography, architecture, engineering, astronomy, etc. Nicolas Copernicus
(1473-1543), author of On the Revolutions of Celestial Spheres, is considered one of the first modern
astronomers. His work was continued by Galileo (1564-1642) in his Discourse and Mathematical
Demonstrations Relative to Two New Sciences, whose influence on the economic an d political philosophy of
William Petty is obvious (see below). But the scientist who had the greatest impact on economic theory was
clearly Isaac Newton (1643-1727). In Mathematical Principles of Natural Philosophy, Newton explained a
vast and complex physical system on the basis of a simple underlying principle, gravity. All other scientists,
including economists starting with Adam Smith, will attempt to explain how the economy functions thanks to
simple, fundamental and natural principles.
Technological advances also played a great part in the evolution of intellectual production. In particular, the
invention of the printing press in about 1439 by Johannes Gutenberg (1398-1468) made possible the wide
diffusion of knowledge that was previously unimaginable. In the Middle Ages, the Church had a quasi
monopoly on intellectual production and diffusion. Universities were religious institutions under the
protection and authority of the Pope. Moreover, books had to be copied by hands and this was done
primarily by monks who respected strict rules about what could be copied. Practically all authors of
intellectual works during the Middle Ages were clerics. Thanks in large part to the printing press, other
people could now produce and diffuse their ideas. Indeed, most of the important authors of the Early
Modern Period who discussed economics were not clerics, but merchants, lawyers, doctors, and politicians.
If many of the ideas that they expressed were not entirely new, they now had the possibility of sharing them
on a large scale and, most importantly, preserving them for future generations of historians who can now
understand how other people thought about economic questions.

18

Authors
The first thing that one should notice about authors of economic ideas during this period is that they are
almost all lay (meaning that they do not work for the Church, even if they are still Christians). Since the
invention of the printing press, the Church lost the monopoly on the production and diffusion of knowledge,
leaving room for men of action merchants, lawyers, politicians, etc. One should, however, beware not to
assume that the ideas that they are expressing in their published works are new. Indeed, a comparison of
these innovative works of mercantilist authors with other types of documents from the Middle Ages
(especially ordinances) shows that many of these new ideas were already quite old by the 16th century,
especially those relative to the role of the government. Its just that the merchants and secular authorities of
the Middle Ages had never communicated their ideas in a formal written treatise.

French
The first author generally studied for this period is Jean de Malestroit, about whom we know very little
except that he published a work entitled The Paradoxes of Sir Malestroit on Money in 1566. In this text he
observes the rapid inflation at this time and concludes that it was the result of monetary fluctuations. It is
not so much the ideas expressed in this work that are important, for they are quite similar to those
expressed by Nicolas Oresme already in the 14th century. Rather, Malestroit is important since he launched a
debate that led others to find other causes of inflation.
In his Reply to Malestroit (1568), Jean Bodin (1529-1597) argues that it is not the quantity of silver in each
coin but rather the overall quantity of silver in circulation that causes inflation, thereby elaborating a
Quantitative Theory of Money. This monetary analysis that focuses on the total quantity of precious metals
held by the government or in circulation is in fact a fundamental principle of the mercantilist movement.
Bodin is also the author of Six livres de la Rpublique (1576) in which he discusses the role of the State. Like
most intellectuals of this time, such as Machiavelli before him or Hobbes after him, Bodin believes in the
necessity of maintaining a strong central power, but he is one of the first to examine the proper method of
financing such a strong State and the impact of different types of taxation (see text below).
Another French author continues this train of thought relative to the role of the State in economic affairs.
After living in England for a while, in order to escape persecution as he was a Protestant, Antoine de
Montchestien (ca. 1575-1621) came back to France and published The State of France (1611) in which he
analyses the economic situation of his country, in particular in comparison with the situation across the
channel. Contrary to the works of authors of the Middle Ages, who were concerned primarily with the
economic activities of individuals, mercantilist authors of the Early Modern period focus on a macroeconomic
analysis. Indeed, in his work Treatise on Political Economy (1616), Montchrestien is the first to use this term
that will be included in the title of virtually every other work on economics for centuries afterwards (extract
below).
English
In England, works begin to appear that reflect some of the same themes exposed in France. As in France,
money becomes the focus of much of the analysis. Certain authors played an important role in the real
economy and were not simply intellectuals. Thomas Gresham (1517-1579) was active in finance and one of
the richest men in the kingdom. He was recruited as a financial advisor by Edward IV, then by Mary Mary
and Elisabeth, to give help the Crown direct its monetary policy. According to Gresham, it was better to
maintain a strong and single currency. Indeed, he noticed that when there are two or more monetary
systems in the same country (which was not uncommon at the time), economic agents tend to stock the
strong and stable currency, fearing a devaluation, and to spend the coins with low amount of silver which
might soon lose part of their value because of the monetary policy of the Crown. The strong and stable
currency thus disappears from circulation in favor of weak and volatile currency. In other words: Bad money
drives out good (Greshams Law).
Other authors focused on the question of international commerce and balance of trade. Thomas Mun (15711641) was an influential businessman, and even Director of the East India Company. In his works Discourse
of Trade from England unto the East Indies (1621) Englands Treasure by Foreign Trade (c. 1630), he
considered international commerce as a substantial source of wealth for the kingdom. He argued in favor of
an economic policy that favored the exportation all types of goods, for as he observed We must sell more
to strangers yearly than we consume of theirs in value. To do this, he primarily recommended reducing
19

tariffs on exports, which weighed heavily on trade though they brought considerable wealth to the Crown.
He is also known as one of the first authors to recognize the difference between a tangible and intangible
good.
Some scholars of the time shared some of the views of their contemporaries, but also expressed views that
set them apart from the others. William Petty (1623-1687), for example, had ideas that were rather
innovative for his time. Petty was a surgeon, entrepreneur, parliamentarian. In his works Essays on Political
Arithmetic (1672), Writings on Political Arithmetic (1690), like most mercantilist authors, he considered that
the quantity of precious metal detained by a country determined its wealth. Like Gresham, he favored a
strong currency, and like Mun a trade surplus. But contrary to many of his contemporaries, he recommended
economic freedom and saw in agriculture the fundamental source of wealth. These two ideas were the
fundamental tenets of the Physiocrats in the following century. Petty also argued that the value of a product
depended to a large extent on the cost of production and transportation, an idea central to Marxist economic
philosophy. He was also very attached to the use of mathematics in economic analysis; if scientists of his
period (Galileo, Newton) were convinced of the central place of mathematics in their analysis of the physical
world, economics did not become a mathematical science until the 19th century.
Finally, Joshua Child (1630-1699), aristocrat and businessman, also Director of the East India Company, had
many ideas that were similar to those of his contemporaries. In his works New Discourse of Trade (1665);
Brief Observations Concerning Trade and the Interest of Money (1668), he advocated for strong State
intervention in economic affairs and favored State monopoly of trade with the colonies. He rejected,
however, the idea that exportation of precious metals necessarily reduced the wealth of a country. And if he
favored State control of international trade, he considered that domestic trade should be carried out freely
with little government intervention.
If both of these authors had ideas which were innovative for their time and which would be taken up later as
fundamental principles of other schools of thought, it would be difficult to argue that they were somehow
the founders the Physiocrat school, and much less the classical economists!

Spanish
In Spain, the arguments of economic philosophers were essentially the same as those expressed in France
and England. The main difference, however, is that Spanish authors tended to be university scholars
(particularly from the university of Salamanca) rather than men of action. They were part of the Arbistrista
movement. They were not parliamentarians, or businessmen at the head of large trading companies, but
they did write letters to the Crown. The most famous author was Luis Ortiz. In his letter to the king,
Memorial del Contador Luis de Ortiz a Felipe II (1558), Ortiz advocated for the importation of agricultural
goods and the exportation of manufactured goods, in order to increase the overall balance of trade in terms
of value. He also recommended that the monarchy invest in the economy in order to promote industry.

German and Austrian

German-speaking authors differed very little from other European in their views relative to economics.
Authors such as Veit Ludwig von Seckendorf (1626-1692), State of German Princes (1655), Johann Joachim
Becher (1635-1682), Political Discourse (1668), and Philipp Wilhelm von Hornick (1640-1712): Austria Over
All (1684), all focused on the problems of the national economy and favored strong state intervention to
protect domestic production and create a trade surplus.

20

Themes
Basically, there are three themes of the mercantilist that cannot be observed in the writings of philosophers
in the Middle Ages and Antiquity. The first concerns money. Aristotle, and consequently all the medieval
commentators of Aristotles works, saw money as simply a convenient method to exchange goods (very
much like the classical economists of the 18th-19th century). Nicolas Oresme was the only pre-modern
author to examine the value of currency in the economy. But if he observed the disastrous effects of the
monetary policy of the French Crown, he focused principally on the immorality of the king in attempting to
generate more wealth for himself at the expense of others. In the Modern Period, massive quantities of
precious metals were taken from the New World invaded European markets causing rapid inflation.
Mercantilist authors did not fail to notice this inflation and the correlation between money supply and prices.
Moreover, noticing the power of the Spanish crown which controlled the New World colonies and their gold,
mercantilists tended to consider that the quantity of precious metal of a kingdom represented its wealth.
The economic policies recommended by these authors reflected this association between precious metals
and wealth.
Indeed, the role of the government, according to mercantilist authors, was to increase the quantity of gold
and silver in the kingdom. One way to do this was to protect the borders by favoring the exportation of
manufactured goods and the importation of raw materials and thereby generate a trade surplus. Because of
the high added-value of manufactured goods relative to agricultural goods, this type of trade increased the
flow of metal into the country. One should also point out that ships almost always travelled full, and
manufactured goods had a higher value per volume than agricultural products. Ships bringing agricultural
goods into a country and leaving with the same volume of manufactured goods invariably left gold and silver
behind. Moreover, monarchies should invest in factories to develop national industries. Also, the government
should regulate the production of goods in order to make it more efficient. Also, considering the social and
political problems of the time and the importance of maintaining a strong central government, it was
necessary to finance the State without overburdening the economy with excessive taxes. Mercantilist
authors therefore examined the best means to increase the public finances without diminishing national
wealth.
Finally, the role of the merchant and trade in general changed dramatically since the Middle Ages. For most
medieval theologians and ancient philosophers, the merchant invariably acted immorally by generating
wealth for himself without actually producing anything. Moreover, merchants tended to be dishonest,
cheating both producers and consumers, or creating artificial scarcity, to make a profit. In the Early Modern
period, however, trade was considered beneficial for everyone and the role of the merchant actually became
fundamental for the financial well-being and the stability of the realm. This shift should not be surprising,
however, because since the invention of the printing press, people other than clerics could now express their
views in formal treatises. In the Middle Ages, the Church retained a monopoly on intellectual production and
diffusion, but in the early Modern Period, the majority of influential authors were businessmen, lawyers, and
parliamentarians. A close examination of other types of documents leads one to understand that the ideas of
mercantilist authors were already widely accepted by men of action in the Middle Ages, but they were only
expressed in books after the invention of the printing press. (See documents below.)

21

Documents
A. Theories
Finances of the Republic according to Jean Bodin
Finances are the nervous system of the Republic, and there are seven ways in general to generate
funds, among which are included all others that one can imagine: 1) the estate of the Republic 2) conquest
of enemies 3) gifts from friends 4) taxes and tributes from allies 5) on traffic 6) on the merchants that
import and export their goods 7) taxes on subjects.
As regards the first, which is the estate, it seems to be the most honest and the surest of all. []
Generally, according to all the lawyers and historians, there is nothing more frequent than the division of the
estate into public and private. And so that princes are not constrained to burden subjects with taxes, or to
seek the means to confiscate their goods, all peoples and monarchs have considered law the conservation of
the estate of Republics, that it is ordinarily better run by the monarchy, than it is by the people or by the
aristocracy or by magistrates and superintendants of the treasury, who turn everything they can from the
public good to their own, and each attempts to gratify his friends [] at the expense of the public. []
[]
As regards the seventh means, taxes on subjects, one must always attempt to avoid it, unless all
other means have been exhausted, and necessity places the Republic in danger. Since the protection and
the defense of individuals depends on the conservation of the public, it is why everyone admits that the
taxes on subjects are very just, because there is nothing more just than what is necessary. []
There exists no cause of revolutions or the collapse of republics more frequent than excessive taxes.
The only means to avoid these inconveniences is to suppress subsidies and extraordinary taxes as soon as
the problem for which they were raised has been solved. But one should not run from one extreme to the
other, and abolish all taxes, aids and subsidies, as some have tried to do, having no funds or estate with
which to support the Republic.
And some, who think they understand business, fall into error by asserting that it is necessary to
establish the same rate of taxes as was in effect at the time of Louis XII, without taking into account the fact
that since then, gold and silver have arrived in such massive quantities from the new world, such as Peru,
that all things are ten times more expensive than they once were, as I have demonstrated against the
paradox of Sir Malestroit, by examining both the accounts of the realm and ancient contracts and affidavits,
in which we see the estimation of merchandise, goods and lands ten or even twelve times less than they are
at the present time. Since, gold and silver having entered France through the exportation of goods and
merchandise, which go continuously to Spain, the price of all things has increased, just as the wages of
officers and soldiers, the pension of captains, and all the expenses of the State. This is why taxes have
increased.
(Jean Bodin, Les six livres de la Rpublique, Paris, 1580, 855-882, adaptation R. Braid.)

22

The role of the State in economic affairs, according to Antoine de Montchrestien

In State affairs, just as in the family affairs, it is always advantageous to organize well men according
to their particular and proper inclination. And on the consideration of this relationship that they have
together, as concerns utility, it is quite possible to assert, against the opinion of Aristotle and Xenophon, that
one cannot divide economics from politics, and that the science of acquiring goods, which they call
economics, is common to both republics and families. As far as Im concerned, I can only be surprised that,
in their political treatises, which are otherwise diligently written, they forgot this aspect of public
organization, so necessary for the State, and to which the State must pay the greatest attention. []
The most royal course your majesty could take is to bring back to order what has gone astray, to
regulate the trades (industry), which have fallen into a montruous confusion, to reestablish trade which has
been disrupted for some time. []
As far as labor is concerned, divided into so many trades and crafts, it is important to point out to
your subjects to not mix them in one hand. The Germans and the Flemmish work at only one trade, and
therefore are much better at that trade. We the French, however, wanting to do everything, we are
condemned to do it all poorly. This is a great hindrance which keeps us from the right path that leads to the
perfection of one thing.
To remedy the situation and therefore prevent the inconsistancy of our inclination to change, your
majesty should allow, if he so desires, that in various provinces several factories be constructed which are
the most universally essential, giving the management of these facilities to enlightened and capable men, so
that they share the tasks between the artisans according to their knowledge and skill. And from this well
established order will be born the exquisite science and excellent practice of crafts and trades. for the good
and utility of your subjects, the recommendation of your prudence, and the glory of this State.
Firstly, I point out to your majesty, that all metalurgy necessary for the realm can be done abundantly
and at a reasonable price on your lands. To let in foreigners is to take away the living of several thousand of
your own subjects who have inherited this trade and who earn their living from this labor. It is also to
diminish your own wealth, which increases with that of your people. It is to cut the nerves of your State and
to seek to borrow from others the instruments of value. []
As far as cloth-making is concerned, it is impossible to deny that France produces a lot, but it is not
even half of what used to be produced. This stems mainly from the importation of foreign goods. []
Here, your majesty must remember that men reduced to doing nothing are led to do eveil. For the
good, the peace and the wealth of the State, you must conserve in all aspects, and by all means, the trades
of families, who are the breeding ground of the Republic, by repressing idleness which corrupts vigor and
chastity.
The greatest, the most liberal and the most magnificent princes have always been glorified for
inventing the means, and by imagining and setting up the rules by which they can enrich their subjects,
knowing full well that such wealth was the real and inexhaustible source of their spending and liberality. []
I believe to have, though the preceding argument, brought to the attention of your majesty, how
necessary it is, for all sorts of reasons, to employ the men of this realm, to allow them to practice their
trade, and thereby, to forbid the importation and use of foreign goods.
That no one persuade your majesty that your taxes will diminish by forbidding the foreign
merchandise which flows into this realm. There are a thousand other ways to recuperate the loss suffered by
the absence of tariffs on importation, without endangering the interests of your people. For, the wealth of
your subjects is yours, but that of strangers is not.
We must supply to the neighboring peoples that which is abundant in our country, which we dont
need, and which they need greatly. Foreigners block all avenues of profit for us, and then they say that we
are not allowed to intervene in their affairs. Our Republic is weak. And even worse, it is stripping itself to
clothe others, taking off its glory to transfer it elsewhere along with its wealth.
(Antoine de Montchestien, Trait dconomie politique, Rouen, 1615, ed. T. Funck-Brentano, Paris,
1889, adaptation R. Braid)

23

B. Royal Ordinances from the Middle Ages

1. That no one, of whatever condition he may be, dare export wheat, rye or other grains out of the realm,
without out special permission. (Charles IV, king of France, 1322, Ordonnances des rois de France, p. 768.)

2. "That no one import foreign material into the realm, under pain of confiscation of the merchandise.
(Edward III, king of England, 1337, Statutes of the Realm, t. I, p. 280.)

3. "That no one export wheat to foreign lands (except to supply the royal army) under pain of confiscation
of the said wheat. (Edward III, king of England, 1347, Calendar of Close Rolls, p. 281)

4. Because many able-bodied beggars, as long as they can live by begging, refuse to work, giving
themselves to idleness and vice, and sometimes theft and other abominations, that no one, under pain of
imprisonment, give anything to those who may work to earn a living. (Edward III, king of England, 1349,
Statutes of the Realm, t. I, pp. 307-308)

5. It is ordained that artisans and craftsmen practice only one trade, which they may chose between now
and February, [] only women who practice the trade of brewer, fish-monger, weaver, carder, [] and all
other women who perform manual labor, may continue to work as before. (Edward III, king of England,
1363, Statutes of the Realm, t. I, pp. 378-383, ch. 6.)

Assignment:
1. Summarize the texts from Bodin and Monchrestien in three lines each.
2. How does Bodin justify the increase in taxes since the time of Louis XII?
3. According to Bodin, what is the cause of the inflation that has affected France?
4. Explain Monchrestiens reference to Aristotle and Xenophon.
5. Which aspects of mercantilism can be observed in Monchrestiens text?
6. What are the ideas in these texts can be traced back to the Middle Ages?
7. What ideas continue on into the classical period?
8. What do the ordinances cited reveal about the link between theory and reality?
Howework:
Find information about the lives and particular context of Bodin and Montchestien that might explain why
they expressed such views. Write three lines explaining the link for each author.

24

Chapter 3. The Physiocrats (mid 18th century, France)

It is commonly accepted that economics became a science towards the end of the 18th century, particularly
thanks to the work of Adam Smith. A science is knowledge or a system of knowledge covering general
truths or the operation of general laws especially as obtained and tested trough scientific methods
(Merriam-Webster Dictionary). To a certain extent, then, it may be argued that the Physiocrats were the first
to turn economics into a science. Prior to the Physiocrats, intellectuals analyzed only certain aspects of the
economy (international trade, money supply), not how the whole system functioned. Moreover, they did not
outline any fundamental principals or laws. In the middle of the 18th century, and in particular in France,
intellectuals known as Physiocrats sought to understand how the entire national economy worked as a
system, much like the human body. They developed a theory by which all of society was divided into 3
groups (or classes) according to their role in the economy, and how the wealth of a nation is created and
circulated from one group to another. These theories do not become a full science, however, until Adam
Smith, a philosopher interested primarily in epistemology, described the universal law by which this
movement takes place, much as Isaac Newton explained how the entire physical world functioned based on
the principal of gravity. Moreover, Smith clearly outlined the method he used to arrive at this conclusion.

Context
Economic
It is important to remember that by the 16th century, the European economy had finally recovered from the
ravages of the Black Death. Exploration to foreign lands brought back wealth and power to Europe, but also
caused massive inflation. It was also a century during which the planet began to get colder, lowering crop
yields. Plague was not eradicated from Europe until the very beginning of the 18th century, and there were
also widespread political and social conflicts that led to increased mortality. Despite these setbacks,
population rose, reaching pre-plague population levels. And despite the technical progress in navigation,
there was little innovation in production until the very end of the 18th century. The spinning Jenny was not
invented until 1765, and mechanical looms in 1785. Steam engines did not appear until 1769 and were not
used in boats until 1807 and in trains until 1814. When Adam Smith wrote The Wealth of Nations, any
industrialization was based on advancements in the organization of men, not coal-powered machines.
There was considerable growth of agricultural production in England, but stagnation in France. Arthur Young
(1741-1820), a British farmer and agronomist, travelled to France and published his reflections on the state
of French agriculture in 1792. He reckons that grain yields in England were, on average, 12:1, and in France
5:1 (hardly better than grain yields in the Middle Ages!). More efficient agricultural production liberates labor
to work in industry, and it may be for this reason that England industrialized much sooner than France.
Surprisingly, despite the low production, there was demographic growth in France. Consequently, there was
a negative trade balance in France, which imported many manufactured goods from abroad. But the biggest
economic problem facing France was the increasing price of bread, on which the working class depended. It
is also necessary to highlight the power of urban guilds on industrial production in France and the negative
effects it had on general economic output.

Political
In the 17th century, England was ravaged by the Civil War (1642-1651). Tensions between different factions
of Protestants and resistance of Parliament to absolute Monarchy led to the decapitation of Charles I, and
the establishment of the Commonwealth of England under the leadership of Oliver Cromwell. The
Commonwealth only lasted 10 years, however, and Charles II was restored to the throne in 1660, though in
a much more democratic form (Parliamentary Monarchy). All the while, England continued to spread its
influence throughout the world. By the 18th century, the British Empire reached from America to India.
In France, Louis XIV (1638-1715, king in 1643) set up an absolute monarchy and maintained relative
domestic peace at the expense of individual liberties. In the 18th century, however, popular protests
increased, culminating in the French Revolution (1789-1799) and the decapitation of Louis XVI in 1793. A
period of political instability known as the Terror ensued, wiping out thousands of members of the
aristocratic class. In this power vacuum, Napoleon Bonaparte took control in 1799, first as Premier Consul,
and then as Emperor in 1804. To calm domestic violence and increase his influence, he led an expansionist
25

policy through a series of military campaigns throughout Europe. The Napoleonic Wars stimulated
industrialization to a certain extent, creating demand for uniforms, arms and ammunition, but drained the
French economy of young men and necessary investments in other non military sectors. They finally led to
the defeat of the emperor and the restoration of the monarchy under Louis XVIII in 1815.

Intellectual
It would be absurd to attempt here a complete examination of the scientific and intellectual production of
the 18th century, but it necessary to highlight its importance in the development of economic theory of the
time. The 18th century is known as the period of the Enlightenment. In their various works, French
Enlightenment philosophers defended individual liberty.2 Many others sought to broaden and democratize
knowledge.3 In England, already in the 17th century, the philosopher John Locke (1632-1704) wrote treatises
on economics,4 but his greatest influence was in the sphere of law and his defense of personal liberty.5 But
such ideas were quite new and at odds with the dominant political philosophy at the time, represented by
Thomas Hobbes (1588-1679). Clearly influenced by the political and social context that led to the
decapitation of Charles I, Hobbes argued that, to avoid the chaos of civil war, an absolute monarchy was
necessary, emphasizing the viciousness of man in his work Leviathan. Smiths work, to a large extent, is an
attempt to refute Hobbes philosophy on human nature and social order. The Physiocrat movement as well
was perfectly in line with the developing Enlightenment philosophy favoring individual freedom.

Authors
In general, French economists from the middle of the 18th century are known as Physiocrats. These
authors seek to understand how the global economy functioned. Mercantilist authors saw precious metals as
true wealth, and were interested in the balance of trade outside of the country, favoring government control
of markets to increase the nations wealth. Physiocrats, on the other hand, considered that the true source
of wealth of a nation was based on its agricultural production, and focused on how this wealth circulated
within a country. Those who worked the land were the real producers of wealth, and the other actors on the
economy (artisans, merchants, etc.) merely transformed these goods, but did not create anything new. The
wealth of a nation originated from working the land, but then circulated from one class to another (see texts
below). Physiocrats assumed that the system functioned best if it were left alone to regulate itself without
the intervention of government, coining the phrase laissez faire, laissez passer.6
As is the case of any school of thought, many of the fundamental ideas of the Physiocrats were in fact
developed before the movement. Pierre Boisguilbert (1646-1714) had already thought that agricultural
production was the main source of wealth and was favorable to free trade long before Quesnay integrated
these ideas into the Physiocrat school.7 Richard Cantillon (1680-1734), a rich Parisian banker, in his Essai sur
la nature du commerce en gnral, as well considered that wealth stemmed primarily from agricultural
production. He also attempted to understand how the economy functioned as a whole, dividing it into three
processes: production, distribution and consumption. In England certain mercantilist authors such as William
Petty and Joshua Child had also favored increased personal freedom in economics, at least on domestic
markets. But it was not until Franois Quesnay that these ideas were integrated into a coherent school of
thought.
Franois Quesnay (1694-1774) is considered the father of the Physiocrat movement. In his work, Tableau
conomique (1758), he explains that the real source of wealth lies in agricultural production, and this wealth
is passed from one class to another. This movement of wealth is called the economic circuit, and just as with
the circulation of the blood, it is best if it operates freely, unobstructed. Indeed, Quesnay trained to become
a medical doctor and practiced as a surgeon to King Louis XV. Quesnay went so far as to even attempt to

Voltaire (1694-1778): Lettres philosophiques (1734), Candide, ou lOptimisme (1759), Eloge historique de la raison
(1774) ; Jean-Jacques Rousseau (1712-1778): Discours sur lorigine et les fondements de lingalit parmi les hommes
(1755), Le Contrat social (1762).
3

Denis Diderot (1713-1784): Encyclopdie (1751-1772).

Some Considerations on lowering the interest rate and raising the value of money (1691).
Treatise on Government (1689).

5
6

Laissez faire economics is the term used in English to classify liberal economic views that condemn
government intervention.
7
Le Dtail de la France (1695), Trait sur la nature des richesses, de l'argent, et des tributs (1697-1707).
26

calculate the amount of wealth transferred from one class to another annually, though reliable calculations
of the GDP did not appear until the Great Depression of the early 20th century.
The other great Physiocrat was a famous statesman, Anne Robert Jacques Turgot (1727-1781). In
Rflexions sur la formation et la distribution des richesses (1776), Turgot supports Quesnays basic economic
ideas on free trade and the economic circuit.8 He modifies slightly the names of the three classes, without
changing their fundamental characteristics. Beyond the basic principles of the Physiocrats, Turgot also
elaborates a theory of diminishing yields which will be taken up and further developed by Ricardo. According
to this theory, yields increase when effort and capital are added, but this increase in yield is not always
proportional to the increase in investment. The improvement in yields diminishes each time, and after a
certain point, additional effort or capital brings no improvement in yields. Turgot is an important figure in the
history of economic thought also because, as Controller-General of Finance under Louis XVI between 1774
and 1776, he attempted to apply his economic theories to reality. As a Physiocrat, he believed that the
natural order would best determine the balance in domestic trade, so economic activities should free from
government intervention. He therefore tried to abolish the centuries-old privileges of graft guilds, tolls on
roads and bridges, feudal labor services and government capped grain prices. His policies, however, were
met with much resistance and the consequent increase in the price of bread led to a number of popular riots
leading up to the French Revolution. He lost all credibility and his position in less than two years.
Other philosophers added personal views to the Physiocrat school of thought. The Marquis de Mirabeau
(1715-1789), in his Trait sur la population (1756), used Physiocrat ideology and applied it to morality. Like
the economy, demographics responds to natural laws. According to Mirabeau, within each human, there are
two opposing characteristics. On the one hand, greed drives everyone try to increase his own wealth and
improve his own standards of living. On the other hand, people are inherently sociable, which makes them
seek the company of others, live in peace in society and form families. These conflicting desires are the main
cause of population increase. If this theory is not exactly the same as that of Malthus, it sets forth the
principle of natural laws that drive population increase fifty years before the English priest will elaborate a
theory on the same subject. More importantly, these two contradictory aspects of human nature described
by Mirabeau are the same that Adam Smith will attribute to men in his two main works. It would be
interesting to examine the extent to which this work from Mirabeau influenced Smith.
Another inspiration for Smith may have been the work of Pierre Paul Mercier de la Rivire (1719-1801). In
L'ordre naturel et essentiel des socits politiques (1767), de la Rivire describes the search for ones own
personal interest as advantageous for society. Contrary to many philosophers of the time who, like Hobbes,
considered that personal interest, or greed, could only lead to conflict, de la Rivire, and later Smith,
thought that by seeking their own individual advantage people were led collectively to the common good.
Other philosophers of this school of thought had original ideas that differed somewhat from those of their
colleagues. Etienne Condillac (1715-1780), for example, who also published a book on economics the same
year as Smith and Turgot, Le commerce et le gouvernement considrs relativement l'un l'autre
(1776),believed like the others that trade should be free and that all government intervention could only
have negative effects. Contrary to the others, however, he diminishes the importance of agricultural
production. For Condillac, value was determined not only be objective criteria of collective supply and
demand, but also was the result of personal psychology. The desires are different in each human and this
subjectivity has an impact on the value each person places on a good, highlighting a century in advance a
fundamental principle in neo-classical philosophy of Carl Menger.
Finally, one should mention Dupont de Nemours (1739-1817). This statesman was the primary editor of the
works of the Physiocrats. In Physiocratie (1767), he assembles the most important texts of Quesnay.
Without the support of wealthy benefactors, which often makes the diffusion of ideas possible, many
intellectuals and philosophers would never have had much influence.

Students will not fail to notice that the title is similar to that of Adam Smiths famous work and published
the same year.
27

Documents
Pierre Boisguilbert
1. Sweden and Denmark, counted together as they were 150 years ago, are much vaster than France, yet
their production, as much that of the prince as that of the people, does not come to one 10th of the
production of France.
2. The reason for this difference is that the territory of France is excellent for the production of staple goods,
and that of Denmark and of Sweden is no good at all.
3. Whatever the quality of the land, when it is not cultivated, it is the same for the owner and the prince as
if it was no good at all.
4. It is a fact that cannot be denied, more than half of France is abandoned or poorly cultivated, which is
much less that what it could be, et even less than it was before, which is even more disastrous than if the
entire territory were abandoned, for the production cannot cover the costs of cultivation.
[]
11. It is all a matter of finding the cause of this abandonment, to be able to, in 24 hours, make the King and
his people very rich.
12. There can only be two causes that keep a man from cultivating his land: either because a certain wealth
is necessary, which he cannot not procure, neither on his own nor by means of a loan; or because after
having cultivated it, he could not have the profit from his production as he did before, which means that he
would lose all his outlay (investment) and that it is in his interest to leave his land fallow.
[]
20. Thus, everything depends on the cultivation of the land which cannot advance as long farmers are
unable to make the necessary investment to cultivate them and to reap the returns that grow from them.

28

The Physiocrats and social classes

1. Quesnay and social classes
According to Quesnay, the nation is divided into three classes of citizens.
The productive class is the one which draws from the land through cultivation the annual wealth of
the nation, which advances the sums spent to work the land, and which pays the revenus of the owners of
the land. All the labour and all the expenses that are made until the first sale of this produce are the
responsibility of this class; it is by this first sale that the value of the annual reproduction of the wealth of
the nation is known.
The sterile class is formed by the citizens involved in other services and in other labour than
agriculture, and whose expenses are paid by the productive class and by the class of owners, who in fact
also draw their revenue from the productive class. []
The class of owners includes the king, nobles and other the land holders. This class subsists through
the revenue or net profit of the culture that is paid annually to it by the productive class, after the latter has
taken, from the reproduction that it creates annually, the wealth necessary to reimburse its annual expenses
and to maintain its production.
The Tableau conomique covers the three classes and their annual wealth and describes their trade.

2. Turgot
This is thus how all of society is divided into three classes, by a necessity founded on the nature of things.
The first one, through its labor, produces or rather draws from the earth the wealth continually reborn
which provides all of society with the subsistence and the materials to satisfy all its needs. The second one is
engaged in giving these raw materials the preparations and the forms which render them proper for mans
use, sells to the first its labor, and receives from that in exchange its subsistence. The first class can
therefore be called productive and the second stipendiary. [] Then into a third class of owners, the only
which, not being tied by need of subsistence to any particular job, can apply itself to the general needs of
society, like war and the administration of justice, either by a personal service, or by the payment of a part
of its revenues which the States or society uses to employ others to fill these functions. The name which
best fits it, therefore, is the available class.
A. R. J. Turgot, Rflexions sur la formation et la distribution des richesses (1776).
Translated and adapted by R. Braid.

Assignment
1. What is the difference between how Quesnay and Turgot divide society?
2. How do these divisions differ from the medieval division of society into three orders?

29

Chapter 4. Classical Economics (mid 18th early 19th century)

Context
Economic
It is well known that Great Britain began the process of industrialization roughly 50 years before other
countries on the continent. Most students attribute the economic progress to technical innovations. But most
of the important inventions were only developed starting at the very end of the 18th century, long after
Adam Smith wrote the Wealth of Nations. Even in England, machines did not make human labor significantly
more efficient until the very end of the 18th century. Railroads and steam boats had only just appeared by
the time Ricardo is writing. The greatest innovations that led to greater efficiency in production and which
led to Englands dominance in industrial production were primarily organizational and structural. There was a
thriving cottage industry in England in which large merchants worked with a network of small producers
outside of city centers. These merchants bought the ram materials and sometimes even the tools necessary
to produce different goods, in particular cloth. The various functions of the process (spinning, weaving,
fulling, etc.) were performed by different artisans whose work was coordinated by the merchants. This
system allowed investments and exchanges that were free from guild control, whereas in France industrial
production was dominated by rigid structures of urban guilds. In any case, it would be erroneous to claim
that the industrial production in Adam Smiths environment was highly industrialized.
In France, this process of industrialization was complicated by the social and political conflicts, first of the
French Revolution, then the Terror, and finally the Napoleonic Wars. As property was confiscated, the
political structure overturned and thousands of individuals executed, the French Revolution and the ensuing
Terror made production, trade and investment dangerous. If Napoleon brought a relative peace to France,
and his expansionist policies caused a certain level of investment in industrial production of military supplies,
France was depleted of much needed resources, not the least of which were young men who died in battle.
It was not until the restoration of the monarchy that France regained stability and could continue industrial
development. One should not, however, underestimate the importance of Napoleons structural changes to
the French political system. By centralizing the administration, he increased the governments ability to
invest in infrastructure. And by establishing uniform weights and measures throughout the realm, Napoleon
made trade simpler and less costly. If France was able to catch up with England by the middle of the 19th
century, the wars with Germany starting in 1870 once again slowed its development.

Intellectual
Perhaps the greatest influence on economic theory in the 18th century stemmed from developments in
sciences, but not necessarily because of the technical progress that they inspired. Beyond a doubt, it was
Isaac Newton (1643-1727), principally through his Mathematical Principles of Natural Philosophy, who had
the greatest influence on all sciences in the 18th century. Not only did he advance the understanding of the
physical world, but he established a principle by which all sciences should be judged. Through his
explanation of the entire and very complex physical world on the basis of a simple principle, universal
gravity, Newton inspired generations of scientists in other fields to do the same. One should remember that
Adam Smith was a philosopher who was interested in epistemology, and his first work (which wasnt
published until after his death), was on the History of Astronomy in which he clearly revealed his admiration
of Newtons work. Smith as well, both in moral philosophy and in economics, will attempt to use a basic
underlying principle that is capable of explaining how an entire system functions.
One should also point out the importance of the philosophy of David Hume (1711-1776) on Adam Smith.
Hume was a Scottish philosopher who wrote some works on economics in which he advocated for free trade
and argued that the economy functioned best when it was regulated by natural laws. But Humes influence
on Smith was primarily in relationship with his method. Hume is best known for his historical approach to
understanding the development of society (History of England, Natural History of Religion). Smith does not
only reveal the origin and evolution of money, like Aristotle, he examines the evolution of the whole
economic structure. He observes that nations progress throughout history as they increase their level of
specialization. The more industry can be specialized, the greater efficiency and therefore the greater levels
of production. Smith uses the example of a pin factory to demonstrate how well coordinated work can
increase production 240 times relative to uncoordinated work. As production across the nation increasingly
specialized, the more the nation as a whole becomes wealthy. Some countries, in particular England, started
this process much earlier than others, which would explain their economic dominance. Marx will continue
30

this historical analysis of the economic evolution to a further level. Hume and Smith are considered the
major actors in what is known as the Scottish Enlightenment.
Finally, it should be pointed out that Smith, a moral philosopher himself, was very much influenced by
Enlightenment philosophers. In the 18th century, many intellectuals began to advocate freedom and equality.
They attacked Hobbes view that humans are inherently greedy and their desires, if left unchecked by the
authorities, will lead to chaos. Smiths work clearly demonstrates his view that seeking ones own personal
interest actually leads to the common good and a natural order.

Authors
English
Adam Smith (1723-1790)
Method
Smith grew up in Scotland at a time when Great Britain was growing economic and political power. He
studied in Glasgow and at Oxford, and then returned to a teaching position in Glasgow. His first work was a
History of Astronomy, which was only published posthumously, in which he clearly demonstrated his
admiration of Newtons work. His First published work was Theory of Moral Sentiments (1759), in which he
attempted to establish a scientific logic to understand human sentiments. Perhaps surprisingly for many
people only familiar with his work on economics, in this first work Smith considers that every human being
has at least some degree of sympathy which drives him to act relatively peaceably in society (see text),
which is not unlike the Marquis de Mirabeaus understanding of human nature.
The Theory of Moral Sentiments met with great success and Smith was subsequently offered a position by
Charles Townsend as tutor of his step son Henry Scott, Duke of Buccleuch. This position led him to
Switzerland (Geneva) and France (Toulouse, Paris) where he met a number of leading intellectuals (Voltaire,
Quesnay, Turgot). He was attracted to the ideas of the Physiocrats, in particular as concerns natural laws
and laissez-faire economics, but clearly did not agree with their appraisal of the importance of agriculture.
Indeed, Smith went on to consider the activity of the Sterile class of the Physiocrats one of the primary
producers of wealth.
In The Wealth of Nations (1776), Smith attempts to systematize economic theories on the basis of a simple
principle, much as Newton explained the entire physical world on the basis of universal gravity. Smtih
considered that it was by seeking ones own personal interest that people were led to the natural order and
common good.

It is not from the benevolence of the butcher, the brewer or the baker, that we expect our dinner, but from
their regard to their own interest.9
Whereas Hobbes argued in favor of an absolute monarchy on the grounds that humans greed would lead to
social disorder, Smith thought that social order was derived from individuals search for their own good, as if
guided by an invisible hand.10 So, like the Physiocrats, Smith was in favor of allowing economic agents to
produce, distribute and consume goods freely without government intervention, which is a fundamental
principal of Classical and Liberal economic thought.
Value
In this work, Smith also highlights the difference between value in use (which represents the utility of a
good for the person who consumes it) and value in exchange (which represents the value of a good for the
person who owns it and can exchange it for another good). Like Aristotle, Smith did not attribute a
fundamental role to money, considering it as a convenient way to exchange goods. But Smith was still
interested in the question of price. He outlined two fundamental types of price:
1. Nominal Price: The nominal price is expressed in monetary terms, the one that is seen on the price tag
or on the bill. It is a price paid for a product regardless of the buyers means. This type of price can be
divided into two separate subcategories.

Adam Smith, The Wealth of Nations, 1776, book IV, ch. 2.

Students should be aware, however, that he uses the phrase invisible hand only once in his work The
Wealth of Nations, and it is present in his other works on astronomy and morality.

10

31

a. Natural price: This is the price that is established by the free play of supply and demand. It is
almost hypothetical because there is no real way for these two elements to interact without outside
influences.
b. Market price: This is the price usually paid for a good on the market. It takes into account supply
and demand, but also a large number of other factors (taxes, constraints, rules, social norms, etc.)
that distort to a certain extent the natural price.
2. Real Price: It is perhaps in his analysis of the Real Price that Smith is the most innovative. Indeed, Smith
observes that a nominal price has a significance according to the means of the buyer. The real price paid for
a good, therefore, can also be represented by the amount of labor, difficulty and sacrifice that a person
must make in order to purchase the good. For example, in order to buy a good that costs 100, a laborer
who earns 10 per hour must work 10 hours, whereas a lawyer who earns 200 per hour only needs to
work 30 minutes. The real price of the same good, therefore, is significantly higher for the worker than for
the lawyer.
At the same time, each product can be represented by the amount of labor that was required to produce the
good. A good that required 100 hours of labor will be priced much higher than a good that was produced in
one hour. There is, therefore, a certain value of labor integrated into the value of each product. This concept
will be further elaborated by Ricardo to include also the value of the labor that was necessary to generate
the capital used in the production. So the value of a shirt cannot only take into consideration the number of
hours that the laborers spent making the shirt, but also all the hours that were necessary to produce the
machines involved in cloth-making and sewing.
Social Classes
Like the Physiocrats, Smith attempts to organize all of society into three different classes according to their
economic role. Unlike the Physiocrats, Smith does not make the clear distinction between agricultural and
industrial production. Instead, Smith divides society according to the type of revenue each individual earns.
All revenue can be classified into three main categories.

Wages, profit, and rent, are the three original sources of all revenue as well as of all exchangeable value. All
other revenue is ultimately derived from some one or other of these.11
Workers who do not have any capital, whether they are engaged in agricultural or industrial activities, earn a
wage in return for the labor and skill they provide. According to Smith, each worker has an interest in
working well. Economic growth stems from both hard work and increased specialization and therefore the
skills of workers increase as the economy grows, and so therefore do their wages. This increase in revenue
in turn favors an increase in productivity and also in population, as workers can provide for larger families.
Working hard, therefore, is not an moral obligation, as Christian morality maintains, but rather in the interest
of each worker.
Investors, on the other hand, receive a profit in return for the capital that they used in production. The
proper use of capital through good investments leads not only to a greater return on investment, but also to
economic growth in general, which is good for everyone. Not only do they have an interest in investing in
new techniques and innovations to make production more efficient, they also have an interest in paying their
workers well, because workers who are poorly paid are less productive. It is in their own interest, and for
the collective good, then, that investors should use their capital wisely.12 According to Smith, then, amassing
wealth without producing anything useful is not so much immoral, as Aristotle would argue, but rather an
inefficient use of wealth and not in the interest of those who have the wealth.
Owners, finally, receive a rent in return for the land that they let others use. If they set their rents too high,
then this will lead to higher agricultural prices, and therefore will cause real wages in industry to fall and
lead to a drop in population. Because rents are directly linked to the size of the population, it is in the
owners interest to maintain reasonable agricultural rents to encourage population growth.

11

Adam Smith, The Wealth of Nations (1776), book I, chapter 6.

As Ricardo points out, however, that the more the economy develops, the smaller the returns on
investment will be (Theory of Diminishing Yields).
12

32

Not only does this definition of social division differ from that of the Physiocrats, it clearly demonstrates how
each classs interest leads to the collective good. This division will be further developed by Marx who groups
the last two classes together and divides society into those who have capital (capitalists) and those who
dont (proletarians).
Government
Smith is well known for his laissez-faire attitude to economic regulation. But rather than condemn all
government intervention, as some modern Libertarians would, he sets out a very clear role for government.
First, he criticizes the economic and political system in place at his time because it unjustly favors the rich to
the detriment of the poor.

It is the industry which is carried on for the benefit of the rich and the powerful that is principally
encouraged by our mercantile system. That which is carried on for the benefit of the poor and the indigent is
too often either neglected or oppressed.13
He attempts, therefore, to elaborate the principles of a new system that would be equitable for all. Marx and
other socialists will later demonstrate the inherent inequalities in the capitalist system, but lacking their
historical perspective, Smith can only perceive the advantages for everyone of his free market system. In his
work, he constantly makes reference to the common good and utility, highlighting in particular the
advantages of his system for the working class. It should be noted that, though he met with great success
during his lifetime which was accompanied by financial gain, Smith himself lived very modestly and gave
generously to charitable institutions.
Like the mercantilists, Smith outlines a clear role for government and also the ways in which this
government was to finance its activities. The State was to invest in services aimed at the collective good:
defense, diplomacy, a judicial system, infrastructure, public education, etc. To finance these activities, Smith
elaborated a system of taxation by which those who benefit most from a service would contribute the most.
(See text)

13

Adam Smith, Wealth of Nations, 1776, Book IV, ch. 8.

33

Thomas Robert Malthus (1766-1834)

Malthus was born to a wealthy noble family and educated at Cambridge. He became a priest and school
master in a small parish. His economic philosophy was principally focused on the question of demographic
growth and demand, rather than production and supply.
In Essay on the Principle of Population (1798) Malthus explained his The Law of Population. According to
this theory, each couple has on average 4 children if they have abundant resources. Population therefore
increases geometrically doubling every 25 years (2 > 4 > 8 > 16 > 32 ). Indeed, this is the rate of
growth that was observed in the United States at the time, a vast territory in which resources seemed
limitless. Resources, on the other hand, despite investments and technical progress generally increase only
arithmetically (1, 2, 3, 4, 5 ). Very quickly, then, population will outstrip resources, leading to a
subsistence crisis. These crises (now called Malthusian crises) generally took three different forms: famine,
epidemics and war. All had the result of bringing the population back down to a level that was sustainable
by the resources available, and were qualified by Malthus as positive checks.
This theory was in fact developed in response to a debate at the time. The British Parliament was
considering what to do in terms of aid for the poor (Poor Laws). Despite his vocation as a Christian priest,
Malthus was in fact against giving any aid to the poor, for this only encouraged them to have more children
without having the means necessary to support them. Malthuss solution consisted of moral restraint,
meaning that by limiting the resources of the poor, they would wait longer before getting married and would
also have fewer children, thereby slowing population growth and avoiding subsistence crises.
Such a position was not favored by all and fueled quite a bit of debate on the subject of welfare programs.
More importantly for our purposes is the fact that Malthuss views are in total contradiction with all other
opinions at the time about the advantages of population growth. Every other economist considered that
population growth was a fundamental motor to economic prosperity for a nation, not a source of crisis. Also,
Malthus clearly favors an economic analysis based on demand, whereas all other economists had been
concentrated on production and supply. Indeed, Malthus and Say maintained lively correspondence debating
their opposing views on the subject.
In his second major work, Principles of Political Economy (1820), Malthus reinforces his views on population
and clearly demonstrates the importance of population growth and demand in economic analysis. This focus
on consumption is quite innovative and will be favored by neo-classical authors. He also develops the theory
of effective demand by which the reduction of demand leads to overproduction, an argument which will
become the foundation of modern macro-economic analysis set forth by Keynes a century later.

34

Jean-Baptiste Say (1767-1832)

Say was from a Protestant family, rare in France which remained an essentially Catholic country. Relatively
young, between 19 and 21 years of age, he traveled to England, which familiarized him with British
economic thought and most notably that of Adam Smith. Back in Paris, he started a political journal during
the Revolution and studied economics. After publishing Trait dconomie politique (1803), he ran into
political problems. Indeed, Say was against Napoleons protectionist and interventionist policies and refused
to modify his work to please the Emperor. He then loses his right to be a journalist and editor and turns
towards industry. Indeed, his family had always been involved in international trade, the most famous being
his brother Louis Say who was the founder of the company which today bears the name Bghin-Say.
In his treatise, Say advocated economic liberalism against all forms of government intervention and
protectionism (perhaps not surprisingly from a member of a wealthy family involved in international trade),
placing him clearly in the Classical school of thought. Contrary to Malthus, however, Say focused primarly on
production rather than on demand.
He is best known for what is now called Says Law (la loi des dbouchs in French). According to this
theory, since products are ultimately paid for with products, production creates an opportunity for new
exchanges. Like Aristotle and Smith, Say considered that currency played only a minor role in the economy,
acting as just a means to exchange goods for each other. But before any trade can take place, a product
must be created. And globally, once a good is created, there is usually a market on which this good can be
sold. There is therefore very little chance of there being a crisis of overproduction.
If this theory has been totally debunked, and even demonized, by Keynes, it would be erroneous to accept
Keyness sarcastic dismissal of the theory as accurate. Indeed, according to Keynes, Say argued that Supply
creates its own demand. This is a grossly over-simplified interpretation of Says theory which has
unfortunately been repeated by so many economists that it is taken as accurate.
It should not be ignored that the economic context of the early 20th century differed vastly from that of the
early 19th century. At Says time, there probably was very little chance that a product could be produced
without anyone finding any utility for the product. Massive advances in industrial production in the century
separating the two economists, however, made it very possible to produce large quantities of goods that
could not be sold.
In any case, this is another example of how an intellectual, Keynes, developed an innovative theory and
became prominent by highlighting the weaknesses of another and widely accepted author. Smith as well
created an entire school of thought through his attempt to refute Hobbes version of human nature and to
denounce the established economic system that dominated England for over two centuries. It is this humble
professors opinion that, rather than accept blindly the knowledge and interpretations of the professors and
well-known economists, students should be encouraged to seek weaknesses in their ideas and attempt to
develop their own.

35

David Ricardo (1772-1823)

Ricardo came from a rich Jewish family of Portuguese origin. He worked from a young age with his father on
the London Stock Exchange. He later made his own fortune in finance, and eventually became a Member of
Parliament. After amassing a fortune, he turned to intellectual pursuits, principally studying economics.
Despite his lack of formal university training, Ricardos Principles of Political Economy (1817) is considered a
fundamental work of the Classical school of economic thought.
Value
Ricardo divided products into reproducible and non-reproducible goods. The latter being by definition rare
(works of art, diamonds, etc.), it is the demand that determines the value for these goods. Most goods, both
agricultural and industrial, however, are reproducible. Although they are often essential for humans (food,
clothing, shelter, etc.), because they can be reproduced in large quantities, their abundance keeps their
market value low.
To properly understand the value of a good, like Smith, Ricardo believes that it is necessary to take into
consideration the amount of labor and skill required to produce the good, or the amount of labor and skill
that is necessary to make the money to procure the good. But, unlike Smith, Ricardo also takes into
consideration the labor that is incorporated into the capital that was necessary to produce the good (tools,
machines, raw materials, etc.). A worker may spend the same amount of time producing a quantity of grain
and a piece of furniture, but since the furniture requires machines and tools, this product will be worth more
than the grain, which can be produced with very little investment. This notion of incorporated capital will be
a fundamental component of Marxs philosophy.
Economic Growth
Like all economists, Ricardo is concerned with the origins and nature of economic growth. But the originality
of his analysis resides in his recognition of the limits of growth. Based on the work of Smith, Ricardo
considered that wages increased in progression to general economic growth, this leads to an increase in
prices, thereby limiting any increase in real wages. Also, as Malthus pointed out, population must be limited
by the Earths ability to produce essential products to sustain them. As population increases, so do prices,
and the increase in prices limits further population growth. Most importantly, Ricardo points out that profits
are also limited. Investing the same amount of capital in land or an industry will produce each time a smaller
increase in yields (Theory of Diminishing Returns). This hypothesis of the limits of growth led Ricardo to
postulate on the Stationary State. According to Ricardo, capitalists will eventually have to seek foreign
markets to increase their margins, as domestic markets become increasingly saturated. Marx, however, will
recognize that in a situation when profits stagnate, capitalists will continually seek to lower costs of
production by lowering wages, thereby leading to a crisis of overproduction, an inherent condition in the
capitalist system. Ricardo does not yet see the fatalism in economic stability.
Government intervention
As a Classical economist, Ricardo is obviously against government intervention in the economy. More
important is his justification for the ineffectiveness of this intervention. At his time, Parliament was debating
whether to increase taxes to invest in the economy. Ricardo demonstrated that any such investments would
have little effect in stimulating the economy. In the face of increased taxes, consumers have less money to
spend. Even government borrowing of money will cause consumers to increase savings, and decrease
spending, in anticipation of a future increase in taxes. Therefore, it does not matter whether a government
finances its spending with debt or a tax increase, because the effect on the total level of demand in the
economy is the same. This theory was further developed by an economist in the 1970s, Robert Barro and
therefore bears the name Ricardo-Barro Equivalence.
Comparative Advantages
According to Ricardo, each region has natural advantages for the production of certain goods. England,
thanks to its climate, is naturally adapted to the raising of sheep and therefore the production of wool and
cloth. France, on the other hand, is naturally suited to producing grapes, and therefore specializes in wine
production. Since each country specializes in the production of certain goods, the production is more
efficient and less costly. Countries will exchange the goods to take advantage of their natural advantages.
But even if France could produce wool more cheaply than England, it would still have a tendency to produce
wine, the product that it is best suited for, to be able to take advantage of the higher value of that good. If

36

this were actually true, France would have an absolute advantage in the production of wool, but England
would still have a comparative advantage.
Documents
Adam Smith on the role of the state and taxation
We, the People of the United States, in order to form a more perfect union, establish justice, insure domestic
tranquility, provide for the common defense, promote the general welfare, and secure the blessings of
liberty to ourselves and our prosperity, do ordain and establish this Constitution for the United States of
America.
Constitution of the United States, 1789, preamble, Wikipedia.org, accessed September 2010

The expense of defending the society, and that of supporting the dignity of the chief magistrate, are both
laid out for the general benefit of the whole society. It is reasonable, therefore, that they should be defrayed
by the general contribution of the whole society, all the different members contributing, as nearly as
possible, in proportion to their respective abilities.
The expense of the administration of justice, too, may no doubt be considered as laid out for the benefit of
the whole society. There is no impropriety, therefore, in its being defrayed by the general contribution of the
whole society. The persons, however, who gave occasion to this expense, are those who, by their injustice
in one way or another, make it necessary to seek redress or protection from the courts of justice. The
persons again most immediately benefited by this expense are those whom the courts of justice either
restore to their rights or maintain in their rights. The expense of the administration of justice, therefore, may
very properly be defrayed by the particular contribution of one or other, or both, of those two different sets
of persons, according as different occasions may require, that is by the fees of court. It cannot be necessary
to have recourse to general contribution of the whole society, except for the conviction of those criminals
who have not themselves any estate or fund sufficient for paying those fees.
Those local or provincial expenses of which the benefit is local or provincial (which is laid out, for example,
upon the police of a particular town or district) ought to be defrayed by a local or provincial revenue, and
ought to be no burden upon the general revenue of the society. It is unjust that the whole society should
contribute towards an expense of which the benefit is confined to a part of the society.
The expense of maintaining good roads and communications is, no doubt, beneficial to the whole society,
and may, therefore, without any injustice, be defrayed by the general contribution of the whole society. This
expense, however, is most immediately and directly beneficial to those who travel or carry goods from one
place to another, and to those who consume such goods. The turnpike tolls in England, and the duties called
peages in other countries, lay it altogether upon those two different sets of people, and thereby discharge
the general revenue of the society from a very considerable burden.
The expense of the institutions for education and religious instruction is likewise, no doubt, beneficial to the
whole society, and may, therefore, without injustice, be defrayed by the general contribution of the whole
society. This expense, however, might perhaps with equal propriety, and even with some advantage, be
defrayed altogether by those who receive the immediate benefit of such education and instruction, or by the
voluntary contribution of those who think they have occasion for either the one or the other.
When the institutions or public works which are beneficial to the whole society either cannot be maintained
altogether by the contribution of such particular members of the society as are most immediately benefited
by them, the deficiency must in most cases be made up by the general contribution of the whole society.
The general revenue of the society, over and above defraying the expense of defending the society and of
supporting the dignity of the chief magistrate, must make up for the deficiency of many particular branches
of revenue.
Adam Smith, The Wealth of Nations, 1776, book V, conclusion.
Assignment
1. According to the preamble of the Constitution of the United States, what are the reasons for which the
founding fathers established a federal state?

37

2. According to Smith, what are the responsibilities of the government? In which cases should the state
finance activities by a general contribution? Which expenses should remain the responsibility of those who
benefit directly from them?

38

Adam Smith: The Invisible Hand and human motivation

For, it can be observed that, in all polytheistic religions, [] it is the irregular events of nature only that are
ascribed to the agency and power of their gods. Fire burns, water refreshes, heavy bodies descend, and
lighter substances fly upwards, by the necessity of their own nature, nor was the invisible hand of Jupiter
ever apprehended to be employed in those matters. But thunder and lightening, storms and sunshine, those
more irregular events, were ascribed to his favour, or his anger.
Adam Smith, History of Astronomy, III, 2, 1755, in W.P.D. Wightman and J.C. Bryce (eds.) Adam Smith
Essays on Philosophical Subjects, Oxford, 1981, p. 49.
However selfish man may be supposed, there are evidently some principles in his nature, which interest him
in the fortune of others, and render their happiness necessary to him, though he derives nothing from it
except the pleasure of seeing it. Of this kind is pity or compassion, the emotion which we feel for the misery
of others, when we either see it, or are made to conceive it in a very lively manner. That we often derive
sorrow from the sorrow of others, is a matter of fact too obvious to require any instances to prove it; for this
sentiment, like all the other original passions of human nature, is by no means confined to the virtuous and
humane, though they perhaps may feel it with the most exquisite sensibility. The greatest ruffian, the most
hardened violator of the laws of society, is not altogether without it.
Adam Smith, The Theory of Moral Sentiments, 1759, book I, 1.
The produce of the soil maintains at all times nearly that number of inhabitants which it is capable of
maintaining. The rich only select from the heap what is most precious and agreeable. They consume little
more than the poor, and in spite of their natural selfishness and rapacity, though they mean only their own
convenience, though the sole end which they propose from the labours of all the thousands whom they
employ, be the gratification of their own vain and insatiable desires, they divide with the poor the produce of
all their improvements. They are led by an invisible hand to make nearly the same distribution of the
necessaries of life, which would have been made, had the earth been divided into equal portions among all
its inhabitants, and thus without intending it, without knowing it, advance the interest of the society, and
afford means to the multiplication of the species.
Adam Smith, The Theory of Moral Sentiments, 1759, book IV, 1.

He generally, indeed, neither intends to promote the public interest, not knows how much he is promoting it.
By preferring the support of domestic to that of foreign industry, he intends only his own security; and by
directing that industry in such a manner as its produce may be of the greatest value, he intends only his
own gain, and he is in this, as in many other cases, led by an invisible hand to promote an end which was
no part of his intention. Nor is it always the worse for the society that it was no part of it. By pursuing his
own interest he frequently promotes that of the society more effectually than when he really intends to
promote it. I have never known much good done by those who affected to trade for the public good. It is an
affection, indeed, not very common among merchants, and very few words need be employed in dissuading
them from it.
[]

It is not from the benevolence of the butcher, the brewer or the baker, that we expect our dinner, but from
their regard to their own interest.
Adam Smith, The Wealth of Nations, 1776, book IV, ch. 2.

Assignment
1. Summarize each of the four passages in a single sentence.
2. How does Adam Smith use the term invisible hand in his three different works?
3. According to Smith, what are the main motivations that affect human behavior?
4. How does Smiths view of human behavior differ from Thomas Hobbess?
39

Smith on value
The value of any commodity, therefore, to the person who possesses it, and who means not to use or consume it
himself, but to exchange it for other commodities, is equal to the quantity of labour which it enables him to purchase or
command. 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. What
everything is really worth to the man who has acquired it, and who wants to dispose of it or exchange it for something
else, is the toil and trouble which it can save to himself, and which it can impose upon other people. What is bought with
money or with goods is purchased by labour as much as what we acquire by the toil of our own body. That money or
those goods indeed save us this toil. [] Gold and silver, however, like every other commodity, vary in their value, are
sometimes cheaper and sometimes dearer, sometimes of easier and sometimes of more difficult purchase. The quantity
of labour which any particular quantity of them can purchase or command, or the quantity of other goods which it will
exchange for, depends always upon the fertility or barrenness of the mines which happen to be known about the time
when such exchanges are made.
Adam Smith, Wealth of Nations, 1776, Book I, ch. 5.
Assignment:
1. What are the two main types of value according to Smith?
2. Which idea of J.-B. Say does this theory of Smith resemble?
3. On what factor does the nominal price (in terms of money) of a product depend? What mercantilist was the first to
develop this idea?

Ricardo on value
Possessing utility, commodities derive their exchangeable value from two sources: from their scarcity, and from the
quantity of labour required to obtain them. There are some commodities, the value of which is determined by their
scarcity alone. No labour can increase the quantity of such goods, and therefore their value cannot be lowered by an
increased supply. Some rare statues and pictures, scarce books and coins, wines of a peculiar quality, which can be
made only from grapes grown on a particular soil, of which there is a very limited quantity, are all of this description.
Their value is wholly independent of the quantity of labour originally necessary to produce them, and varies with the
varying wealth and inclinations of those who are desirous to possess them. These commodities, however, form a very
small part of the mass of commodities daily exchanged in the market. By far the greatest part of those goods which are
the objects of desire, are procured by labour, and they may be multiplied, not in one country alone, but in many, almost
without any assignable limit, if we are disposed to bestow the labour necessary to obtain them. In speaking then of
commodities, of their exchangeable value, and of the laws which regulate their relative prices, we mean always such
commodities only as can be increased in quantity by the exertion of human industry, and on the production of which
competition operates without restraint. In the early stages of society, the exchangeable value of these commodities, or
the rule which determines how much of one shall be given in exchange for another, depends almost exclusively on the
comparative quantity of labour expended on each. []
Adam Smith, who so accurately defined the original source of exchangeable value, and who was bound in
consistency to maintain, that all things became more or less valuable in proportion as more or less labour was bestowed
on their production, has himself erected another standard measure of value, and speaks of things being more or less
valuable, in proportion as they will exchange for more or less of this standard measure. Sometimes he speaks of corn, at
other times of labour, as a standard measure; not the quantity of labour bestowed on the production of any object, but
the quantity which it can command in the market: as if these were two equivalent expressions, and as if because a
man's labour had become doubly efficient, and he could therefore produce twice the quantity of a commodity, he would
necessarily receive twice the former quantity in exchange for it.
If this indeed were true, if the reward of the labourer were always in proportion to what he produced, the quantity of
labour bestowed on a commodity, and the quantity of labour which that commodity would purchase, would be equal,
and either might accurately measure the variations of other things: but they are not equal; the first is under many
circumstances an invariable standard, indicating correctly the variations of other things; the latter is subject to as many
fluctuations as the commodities compared with it. Adam Smith, after most ably showing the insufficiency of a variable
medium, such as gold and silver, for the purpose of determining the varying value of other things, has himself, by fixing
on corn or labour, chosen a medium no less variable.
D. Ricardo, On the Principles of Political Economy and Taxation, 1817, ch. 1.
Assignment:
1. What criticism does Ricardo make of Smith?

40

J. B. Say and Says Law

In every State, the more producers are numerous and the production multiplied, the more exchanges are
easy, various and vast. In places that produce a lot, the substance with which purchases are made is
created; namely value. Money fulfills only a transitory function in this double exchange; and, once the
transaction is complete, products have always been paid for with other products. It can thus be observed
that a product, once finished, immediately opens a vent (debouch) for other products of equal value.
Jean-Baptiste Say, Trait d'conomie politique, 1826, t. 1, p. 249-251.
Assignment
1. Summarize this passage in a single sentence.
2. To what extent is the common interpretation of Says Law (supply creates its own demand) erroneous?

J.-B. Say on the three processes

By observing the processes of human industry, whatever the object of the endeavor, one observes that
they are composed of three distinct operations. To obtain a given product, it was first necessary to study
how nature works, relative to this product. How could one produce a lock if one hadnt already understood
the properties of iron, and how to draw it from the mine, purify it, soften it, and work it? It was then
necessary to apply this knowledge to a useful practice, estimating that by working iron in a particular way, it
was possible to make a product that would be valued be men. Finally, it was necessary to execute the
manual labor indicated by both of these preceding operations, thus forging and filing the different pieces
that make up a lock.
It is rare that these three operations are executed by the same person. Most often, one man studies
nature; this is intellectual. Another takes advantage of his knowledge to create useful products. This is the
farmer, the manufacturer or the businessman, or to give a common name to all three, it is the entrepreneur,
the one who tries to create for his own advantage and wealth, and at his own risk, a given product. Finally,
another works according to the directions given by the two first men, this is the laborer. If we examine all
products one by one, we observe that they could only have existed after these three processes.
J.-B. Say Trait dconomie politique, 1803, libre I, ch. 6 (translation by R. Braid).

Assignment
1. What are the three main phases in all human production?
2. How does Say categorize men differently than Quesnay, Turgot and Smith?
J.S. MILL on the production and distribution of wealth
The laws and conditions of the production of wealth, partake of the character of physical truths. There is
nothing optional or arbitrary in them. Whatever mankind produce, must be produced in the modes and
under the conditions imposed by the constitution of external things, and by the inherent properties of their
own bodily and mental structure. [...] But it is not so with the distribution of wealth. That is a matter of
human institution solely. The things once there, mankind, individually or collectively can do with them as
they like. They can place them at the disposal of whomsoever they please, and on whatever terms. Further,
in the social state, in every state except total solitude, any disposal whatever of them can only take place by
the consent of society, or rather of those who dispose of its active force. Even what a person has produced
by his individual toil, unaided by anyone, he cannot keep, unless by the permission of society. Not only can
society take it from him, but individuals could and would take it from him, if society only remained passive; if
it did not either interfere en masse, or employ and pay people for the purpose of preventing him from being
disturbed in the possession. The distribution of wealth, therefore, depends on the laws and customs of
society. The rules by which it is determined are what the opinions and feelings of the ruling portion of the
community make them, and are very different in different ages and countries; and might be still more
different, if mankind so chose.
John Stuart Mill, Principles of Political Economy, t. 1, pp. 233-234.
Assignment
1. Summarize this passage in a single sentence.
2. According to Mill, how do the production and distribution of wealth differ?

41

Malthus and the errors of classical economists

Jean-Batiste Say, James Mill et David Ricardo, who are the principle authors of the new doctrines on
profits, appear to me to have fallen into some fundamental errors in the view which they have taken of this
subject. In the first place, they have considered commodities as if they were so many mathematical figures,
or arithmetical characters, the relations of which were to be compared, instead of articles of consumption,
which must of course be referred to the numbers and wants of the consumers. []
Another fundamental error into which the writers above-mentioned and their followers appear to have
fallen is the not taking into consideration the influence of [aspects of] human nature, as indolence or the
love of ease. [] It is taken for granted that luxuries are always preferred to indolence, and that the profits
of each party are consumed as revenue. [] That an efficient taste for luxuries, that is such a taste as will
properly stimulate industry, instead of being ready to appear at the moment it is required is a plant of slow
growth, the history of human society sufficiently shows ; and that it is a most important error to take for
granted that mankind will produce and consume all that they have the power to produce and consume, and
will never prefer indolence to the rewards of industry, will sufficiently appear from a slight review of some of
the nations with which we are acquainted. []
A third very serious error of the writers above referred to, and practically the most important of the
three, consists of supposing that accumulation ensures demand; or that the consumption of the labourers
employed by those whose object is to save, will create such an effectual demand for commodities as to
encourage a continued increase of produce. [] And while it is quite certain that an adequate passion for
consumption may fully keep up the proper proportion between supply and demand - whatever may be the
power of production it appears to be quite as certain that a passion for accumulation must inevitably lead
to a supply of commodities beyond what the structure and habits of such a society will permit to be
consumed. []
All I mean to say is that no nation can possibly grow rich by an accumulation of capital, arising from a
permanent diminution of consumption, because such accumulation being greatly beyond what is wanted, in
order to supply the effective demand for produce would very soon lose both its use and its value, and cease
to posses the character of wealth.
Th. R. Malthus, Principles of Political Economy, 1820, Book II.
Assignment:
1. According to Malthus, what are the three errors generally committed by classical economists?
2. According to Malthus, what desire often pushes man to act a certain way, but which is rarely taken into
account by economists?
3. Who does Malthus refer to when he refutes the hypothesis that accumulation guarantees supply?

42

Chapter 5. Socialism (early mid 19th century)

Political and Economic Context
France
The economic development of France was limited by social and political conflicts. Industrialization began in
France in the 18th century, but the Revolution and especially the period of the Terror during which 100,000
people were killed, among others Louis XVI in 1791, interrupted production and upset economic stability.
Napoleon became First Consul in 1799, then Emperor in 1804. During his reign, France regained a certain
social and political stability, the policy of the Emperor was based on military expansion which bled the
economic resources of the country. At first, France experienced great victories, and Napoleon was at the
head of all the kingdoms of Europe (except Great Britain). But very quickly, he met with humiliating defeat
and was finally exiled in 1814. In the end, these military campaigns were very costly in terms of human lives
and economic resources.
Despite the high cost of the war, Napoleon established a certain number of reforms in France which helped
economic development. Before the Revolution, and despite the efforts of monarchs for centuries, France
remained a relatively fragmented country. Under the Ancien Regime, the monarchy granted specific
privileges to certain lords and towns, resulting in different sets of weights and measures, different legal
systems, different tax systems, in each region. The Revolution abolished these privileges, and imposed a
certain degree of normalization (for example by setting up the metric system), but it was only under
Napoleon that the legal and tax system was centralized. (Students will remember that the Napoleonic Code
which is the basis for the current legal system in France was derived from the Justinian Code of the 6th
century Roman emperor). This centralization fostered the circulation of goods in the country, though it came
at a social cost. During the 19th century, France set up a series of policies to eradicate the cultures and
languages spoken in the different regions (Breton, Occitan, Catalan, Alsatian) which were considered an
obstacle to a homogeneous national identity. Still today, France remains a highly centralized and uniform
country, both politically and culturally. Moreover, despite the Declaration of Human Rights which was
established in 1789, France did not abolish slavery in its colonies until 1849, after the Revolution of 1848.
Only 26 years after the beginning of the Revolution, France restored the monarchy under Louis XVIII
(Bourbon). The country had undergone a number of changes during this quarter century that the monarchy
maintained, establishing a Constitution and guaranteeing a number of liberties obtained by the people. The
power, however, remained in the hands of the wealthy and a popular revolt overthrows Louis XVIIIs
successor Charles X. From 1330 to 1348, a new king, Louis-Philippe, reigned in France. This monarchy
defended the interests of the bourgeoisie (merchants, industrialists, financiers) at the expense of the
working class.
The deplorable conditions that were imposed on the working class pushed the people to a new revolution in
1848. This time, however, it was not a revolution of peasants as in 1789. During the first half of the 19th
century, France experienced rapid industrialization causing the emergence of a proletariat in urban centers.
This revolution spread across all of Europe and the Americas, with vastly different results. In France, the
movement put an end to the monarchy of Louis-Philippe and instituted the Second Republic, under the
leadership of Louis-Napoleon (Napoleon III). But since the constitution prevented Napoleon III from being
reelected in 1851, he usurped the control of the government and proclaimed himself Emperor of the Second
Empire.
His government lasted until the defeat of France at the hands of the Germans in 1870. A National Assembly
nominated Adolphe Thiers the president of the Third Republic, whose government was based in Versailles.
After a series of policies established by this government, the people of Paris revolted and instituted the
Commune de Paris, a socialist government that lasted only 2 months. This movement was severely
suppressed by the Versailles government (over 20,000 deaths).
Thanks to the various socialist movements of the 19th century, workers managed to obtain a number of
advantages, even under governments that were not particularly socialist. For example, in 1841, companies
could no longer hire children under 8 in factories, and those between 8 and 12 years of age could only work
8-hour days. And workers finally gained the right to strike in 1864. Working conditions remained relatively
miserable, however, for the vast majority of the working class until the end of the century. Despite the
turbulent political context, thanks to the policy of colonization and industrial development that the resources
from the colonies made possible, France became one of the most powerful countries in the world by the end
of the 20th century.
43

England
England experienced industrialization earlier than in France, and did not suffer from the same political and
social upheavals. England was at war with its American colonies, which wanted to liberate themselves from
English rule (1776-1781, and then again in 1812-1814). England also had to defend itself against the
ambitions of Napoleon (1803-1814). But these conflicts were significantly less expensive than the military
campaigns of France and they did not disrupt the process of industrialization. England was the first country
to ban slavery, first within the country (1772) and then in all of its colonies (1833). It paid 20 million pounds
in reparations to former slave owners to smooth the transition. The East India Company, the State monopoly
for all commerce between Great Britain and India which began in 1600, lost influence and was definitively
closed in 1874, leaving room for competition. The end of the 19th century, called the Victorian Age, after the
queen who reigned over this entire period (1837-1901), is considered as the height of British influence in the
world, shared only with France.
Germany
Germany suffered from the French invasion led by Napoleon, but pursued the process of industrialization
once peace was restored. Economic development was very quick in Germany, and all the social problems
linked with industrialization manifested themselves rather quickly. Socialist movements were very popular in
Germany, like in France, leading to the Revolution of 1848. As in France, if these movements brought some
advances for the working class, political power remained firmly in the hands of the capitalists. The King of
Prussia, Wilhelm I, and the Chancellor, Otto von Bismarck, succeeded in unifying Germany into the German
Empire in 1871, and also severely suppressed all worker movements.
United States
British colonies across the Atlantic declared independence in 1776, and after a very costly war, formed a
federation of 13 states. The constitution was ratified and the first president elected in 1789. The underlying
principles set forth in the Declaration of Independence and Constitution are democracy, liberty and
prosperity. At this time, the American economy was based on the exploitation of the countrys abundant
natural resources which were shipped to Europe for their transformation into manufactured goods. At this
time, the United States only occupied the East coast of the continent, but Napoleons pressing need to
finance his wars in Europe led him to sell Louisiana, a vast region west of the Mississippi, to the young
country. This purchase doubled the size of the nation, and the regions purchased became one by one
member states of the federation.
Despite its attachment to the principle of liberty expressed in the founding documents of the country,
agricultural estates in the South functioned almost entirely thanks to slave labor brought from Africa. IN the
middle of the 19th century, there were roughly 4 million Afro-Americans living in the country, of which 95%
were slaves in the South. The rapid industrialization of the 19th century and the rising need for unskilled
labor in the North, in addition to a general abolitionist trend in Europe, drove the northern states to liberate
the black slaves of the South. The conflict over this question transformed into a Civil War (1861-1865). As
the end of the war, slavery was abolished in the entire country (1865), but this conflict caused massive loss
of human life and weakened the union.
Economic Context - Technology in the 19th century.
It would be absurd to attempt here an analysis of the technological innovations of the 19th century. It is
useful, however, to recall that at the beginning of the century, people heated their houses with wood or
coal, lit their rooms with oil lamps, could only communicate at a distance by letter, and got around on
horseback and sail boats. At the end of the century, electrical grids are being set up, electric light bulbs
begin to light houses, people are taking photographs, and listening to records, communicating by telegraph
and telephone and are getting around by bicycle, car, train and (in 1903) airplane. Farmers are taking
advantage of advances in chemistry to enrich their soil and in mechanics to reap higher yields with less
labor, thereby liberating large quantities of labor for industry. Thanks to the technical advances in the use of
coal, factories can produce thousands of uniform goods for a significantly lower unit cost. The reduction in
the cost of transportation favored trade in raw materials and manufactured goods. Consumers have access
to all sorts of new products, but many were reduced to the miserable conditions of the working class.
Intellectual Context
It would also be quite difficult to give an accurate depiction of the intellectual advances of the 19th century in
Europe. Regarding economic theory, it is important to point out the influence of the German philosopher
44

George Friedrich Hegel (1770-1831). Hegel developed a philosophical method based on dialectical reasoning.
This method consisted of contrasting two diametrically opposing viewpoints in order to obtain a new idea.
This binary logic impregnated the philosophy of Marx, who no longer divided society into three classes (as
did his predecessors since antiquity), but rather into two: capitalists and proletarians. These two classes, in
Marxist philosophy, are in opposition in a capitalist regime, and this conflict will eventually lead, accord to
Marx, to the abolition of private property and a communist regime in which no classes would exist.

Authors
Observing the massive inequalities caused by industrialization, intellectuals began to examine the causes and
to seek certain remedies. They all recognized inherent inequity of the negotiation processes between
workers and employers as the origin of the problem. Because employers detained the capital and because
there were few employers relative to the number of workers, they were naturally in a better bargaining
position relative to those without capital seeking work. Workers had to earn their living every day or risk
starvation for them and their family; capitalists could of course wait longer and thereby force workers to
accept miserable conditions. Moreover, all the benefits of industrialization favored those who invested the
capital, while workers earned the wage that was offered by their employer, and this wage typically remained
at a subsistence level. So in a capitalist system, capitalists naturally became increasing wealthy, while
workers remained poor. In order to remedy the situation, socialist offered a number of solutions which
differed from one author to the next.
France
Jean de Sismondi (1773-1842) began, in On Commercial Wealth (1803), by supporting liberal economic
theories of Smith, Ricardo and Say. The search for private interest was advantageous for society and
markets could regulate themselves. But after a number of years of reflection, Sismondi turned these ideas
on their head. In New Principles of Political Economy (1819), he demonstrates how liberalism increase
wealth for a few and misery for the masses. He explains how competition drives down the cost of
production, and therefore primarily wages. Instead of improving working conditions, as Smith believed,
technical progress makes labor cheap and therefore lowers the living conditions of workers.
Sismondi identified the underlying problem with the liberal capitalist system. As Smith had already pointed
out, it is possible to classify individuals according to the type of revenue they earn. Workers receive a wage
for their labor and skill, whereas capitalists earn a profit, or a return on their investments. (For Smith, land
owners who received rents were also an integral part of the system, but by the early 19th century, most
attention was paid to the industrial process and the conditions of factory workers.) This difference between
workers and capitalists makes all negotiation between them inherently unfair. If workers are theoretically
free in the negotiation and cannot be legally constrained to accept conditions that they do not find
acceptable, when workers do not accept the terms of employment offered by capitalists, they lose a day of
work and therefore a day of wages, while the capital of the employer remains intact. Capitalists generally do
not rely on the profits of their investments to buy their daily bread. Also, large scale industrial production
means that there is a much largerer number of workers relative to the number of employers, whereas in
artisanal production this difference is much smaller. The supply of labor is therefore abundant, and the
demand for labor is elastic and can be reduced if the price is considered too high. Wages can therefore be
kept at a subsistence level. So all gains in productivity benefit only the employers who invest their capital,
while the living and working conditions of workers remain low.
He therefore rejected the law of Say and highlighted the inevitable problem of under-consumption and
therefore over-production. He did not, however, support the ideas of Malthus, who believed that poverty
came from over population which was fostered by charity. On the contrary, according to Sismondi, poverty
was the result of the poor distribution of wealth which is the result of the inherently unfair negotiation
process between workers and employers. This unequal distribution of wealth is not only unfair, but it is also
detrimental for the economy. A better distribution of national production could only stimulate consumption
and therefore production.
To correct this problem, Sismondi recommends the intervention of the state and a legal system which would
oblige the employer to maintain at an acceptable level the living and working conditions of the workers. For
example, the employer would have to take care of a sick worker, instead of abandoning him. Employers
would have to guarantee employment and offer decent wages. Indeed, he even favors a return to a more
primitive system of production in which capital and labor were not opposed, for example in artisanal
45

production where masters participated in the productive process and workers became part of the masters
family. Marx considered him a bourgeois socialist and Lenin called him a romantic socialist.
Claude Henri de Rouvroy de Saint Simon (1760-1825) was even more idealistic. Saint-Simon was from an
aristocratic family and received a good education. During the Revolution, he modified his name by dropping
the two de to avoid losing his life and actually took advantage of the situation by selling off the property of
the Church that was confiscated by the Revolutionaries, and became in fact quite rich. Following his financial
success, he turned towards reflection on economic theories and publishes in rapid succession a d series of
works: Industry (1817), Politics (1819), The Organizer (1820), The Industrial System (1822), The Catechism
of Industrials (1824), The New Christianity (1825). Instead of fearing technological advancement, SaintSimon creates a philosophy of social progress based on industrial development. Morality and social
responsibility would be inherently linked to economic and technological considerations. Science and progress
would become a sort of religion. In this system, industrialists would have, not only a legal, but a moral
obligation to improve the physical and moral conditions of workers.
Saint Simon did not see employers as antagonists. In fact, he wanted to give them an even greater role in
the organization of society:
The best way to procure for the people the greatest quantity of labor possible is to give to the
heads of industry the responsibility of directing public administration; for, by the nature of
things, the heads of industry (who are true leaders of the people, since they already direct their
work) will always tend to expand to the largest extent possible the activities of their companies.
Their efforts would result in the greatest growth possible in the amount of work to be
accomplished by the people.14
His solution was rather idealistic, but in developing his theory of social organization, he put forth very
innovative ideas. For example, he considered that humans were all connected in a sort of network:
modifying one element in the network has an impact on all the other elements. This is in fact a fundamental
principle of Network Theory which is being advanced today.
Other authors were even more idealistic. As mentioned in an earlier chapter, intellectual culture was heavily
influenced by Descartes who rejected the type of empirical reasoning put forth by Francis Bacon in favor of
pure theoretical reasoning. This intellectual culture pervades much of French economic theory until today,
and was apparent in the work of Charles Fourier (1772-1837).15 In his various works, Fourier sought
universal harmony, a sort of metaphysical application of the laws of Newton which only concerned the
physical world. Fourier classified human beings into 1620 categories of men and women, according to their
passions. After this almost psychological analysis he believed to be able to determine the organization that
would be most favorable for production and society. He develops the notion of a phalanstre a sort of
cooperative residence in which all the residents would be organized according to their passions and where
all the wealth would be distributed by a superior entity. If the ideas of Fourier seem rather far-fetched, he
was one of the first to support womens liberation and the creation of public day-care centers to allow
women to participate in production, ideas which were considered absurd at the time but which have become
an integral part of modern society.
Other socialist economists were much more down to earth. Pierre-Joseph Proudhon (1809-1865) was a
philosopher, a member of the First International, a member of Parliament and a self-proclaimed anarchist.
His version of anarchy, however, differed tremendously with those normally held today. Proudhon did not
despise order, just the power that certain order gives to people to exploit others. He advocated for
individual liberty and was against all forms of domination. (Almost one century later, Hayek will use the
same argument to support an ultra-liberal economy. See chapter 8.) Proudhon believes that economics could
not be considered independently of the all other philosophical considerations. It was one part of human
existence.16
14

Saint Simon, The Industrial System, 1821.

Sur les charlataneries (1807), De l'association domestique et agricole (1822, but begun in 1808),Thorie de l'unit
universelle (1823 - 4 volumes), La fausse industrie morcele rpugnante et mensongre et l'antidote, l'industrie naturelle
(1835), Le Nouveau monde industriel (1829).
15

16

I continue to believe that questions about God, human destiny, ideas, certainty, in other words, all the important
philosophical questions are an integral part of economic science, which is after all nothing more than their exterior
realization.
46

In Quest-ce que la proprit? (1840), Proudhon makes famous the saying "Property is theft", even though
he was not the author. Indeed, in the natural order, private property does not exist; it is an invention of
human society. Attributing ownership of a good to one individual means depriving others of that good.
However, despite the injustice of private property, he admits that it is a vehicle to exercise ones personal
freedom. He criticizes owners of property who do not contribute to the common good, but he does not
advocate abolishing private property. Nor does he advocate the equal redistribution of wealth regardless of
an individuals contribution, since this lead people to become lazy.
Proudhon is primarily concerned with the contradictions in the economic system.17 Mechanization, for
example, makes worker easier, but also puts the laborer out of employment. The division of labor increases
overall wealth, but makes men perform mindless tasks. People without capital are those who are the most in
need of access to credit, but are the ones least likely to receive it because they lack the capital to guarantee
it. Competition, ironically, always leads to monopoly, etc. He therefore favors an economic system that
abolishes privileges, but not private property. Indeed, he recommends a model in which each person would
be owner of his own small parcel of land and his own workshop. He also favors the creation of a national
bank to grant credit without interest to those who lack capital.
Other socialists were very active in elaborating government policy. Louis Blanc (1811-1882) was the son of a
high ranking administrator under Napoleon, had a good education, and became the tutor for the child of a
rich industrialist family in Arras. At this position, he had the opportunity to visit factories and was shocked by
the horrible working conditions. He then turns to the study of economics and political activity. In 1839, he
publishes L'organisation du travail (1839) and established the Revue du progrs. He criticizes the liberal
economic system, for it always leads to monopoly. Like other socialist authors, he observes that those who
own capital have an advantage in negotiations, which allows them to accumulate even more capital.
To correct this inequality between workers and owners in the labor negotiation, Blanc favors a system of
worker associations (today we would call them trade unions or just unions). Together, workers would
have greater weight in the negotiations with employers. These associations should be under the control of
the State (in a democratic, parliamentary republic). Thanks to these associations, the profits of improved
productivity could be better distributed.
Thanks to his implication in politics, Louis Blanc was part of the provisional government set up after the
socialist movement in 1848. During his term, he published a decree that attempted to put in place his
socialist ideas.
The provisional government of the Republic promises to guarantee the existence of workers
through labor. It promises to guarantee work [] to all citizens. It recognizes that workers
must bind together in order to take advantage of the legitimate fruits of their labor.18

So no only should the State favor the establishment of such worker associations, but it should also
guarantee work for its citizens. The ensuing political events led to the overthrow of this government, Louis
Blanc was judged, condemned and exiled. He came back for a short period during the next socialist
movement in 1870, but this party was never able to stay in power for long.
Another socialist implicated in politics was Auguste Blanqui (1805-1881), a republican revolutionary who
spent 37 years in prison because of his participation in the socialist movement. Contrary to Marx, Blanqui did
not advocate a massive popular uprising, but rather for a small coup dtat. A provisional dictatorship would
set up a communist system, though he did not clearly outline how this was to be done. Indeed, in his works,
such as L'Eternit par les astres (1872), he was interested primarily in a metaphysical socialism, organizing
society based on scientific knowledge. Another work, La critique sociale, only published after his death
(1886), is a collection of essays which outline economic evolution. As Aristotle, he explained how society
came about because of the need to exchange goods. Like Smith, he believes that this evolution leads to
increased wealth. But like Marx, he believes that society evolves naturally towards communism, after
capitalism.
17
18

Systme de contradictions conomiques (1846).

Louis Blanc, decree written for the provisional government, 1848.
47

The economic and social context does not always determine the orientation of economic ideas. Within a
given context, many ideas coincide. A good example of this is the case of the brother of Auguste Blanqui,
Adolphe Blanqui (1798-1854). Although they were brought up and educated in a very similar environment,
whereas Auguste was fierce defender of socialist ideology, his brother Adolphe was an economist of the
classical school and defender of the ideas of Jean-Batiste Say. Editor of economic reviews, he held the chair
in the economics department of the Conservatoire national des arts et mtiers, and then was director of the
lEcole Suprieure de Commerce in Paris, and even became member of parliament. He published a number
of works defending laissez-faire policy and rejecting socialist arguments.19 Some economists promoted new
socialist ideas, while others continued to support classical arguments. The birth of one school of thought
does not signify the immediate death of the preceding school.

England
The socialist movement in England was significantly less disruptive that the same movement on the
continent. Nevertheless, there were a number of intellectuals who favored certain ideas similar to the French
socialists. Indeed, one of the earliest socialist authors was English. Robert Owen (1771-1853) was a highly
successful industrialist. His financial success put him in a position to council Parliament on economic matters
and his advice was published in various works.20
According to Owen, people were the product of their environment; he therefore diminished the importance
of free will. He highlights the importance of public education and the human capital of a society. He also
harshly criticized all religion, for it transformed men in to docile animals, fanatics and odious hypocrites.
If, like Sismondi, Owen saw the advantages of an artisanal system of production where labor and capital
were united, he also thought that the heads of companies should understand their own interest in taking
good care of their employees. Most bosses of the time attempted to pay their employees in tokens which
they could only use at the factory store. Since this system eliminated all competition, the factory could
charge a very high price for the goods sold to its own workers, who if paid in cash could purchase the same
goods for much less on the market. But Owen argued that it was in an owners interest to purchase basic
necessities cheaply, thanks to economies of scale, which they would sell at a reduced price to their
employees. That way, their employees will be better fed and therefore more productive, a policy that he
applied in his own factories. Employers also had an interest in taking care of their employees children so
that the workers could focus more on their job than worry about their children.
But since Owen, operated his factories in a competitive context where other capitalists did not respect the
same principles, he decided to open an experimental factory in New Harmony, Indiana USA, in 1826 to test
his theories. For various reasons, which were not all linked to his managerial practices, this factory did not
function as well as planned and quickly went bankrupt in 1828. Since the British intellectual culture is based
on Francis Bacons empirical methods, where practical experiments are more trustworthy than theoretical
reasoning, Owen lost all credibility following this failure, though he continued to philosophical treatises long
afterwards.21 Socialist ideas therefore had very little impact on British economic thought.
Other intellectuals in Britain held ideas that resembled those of socialist authors, but which only concerned
social justice and political organization, not economic systems. John Stuart Mill (1806-1873) was the son of
James Mill (1773-1836), an economist, philosopher and historian who was very influenced by the ideas of
David Hume and Jeremy Bentham. In terms of political economy, James Mill was a defender of the classical
school of thought. But his utilitarian philosophy led him to educate his son John in a very rigorous way. John
was very gifted an excelled in many fields of study. As an adult, his intellectual production spanned a wide
variety of subjects.22
19

Rsum de l'histoire du commerce et de l'industrie (1826), Prcis lmentaire d'conomie politique (1826), Histoire de
l'conomie politique en Europe depuis les Anciens jusqu' nos jours (1837), Principes et leons dagriculture et
dconomie rurale (1843), Des classes ouvrires en France pendant l'anne 1848 (1849).
20
A New View of Society. Essays on the Formation of Human Character (1813), Observations on the Effects of the
Manufacturing System (1815).
21
The Revolution in the Mind and Practice of the Human Race (1849).
22
System of logic (1843), Essays on Some Unsettled Questions of Political Economy (1844), Principles of Political
Economy (1848), On Liberty (1859), Auguste Comte and Positivism (1865), Utilitarianism (1868), The Subjection of
Women (1869), Three Essays on Religion (posthumous -1874).
48

In his works on economics, John Stuart Mill, like his father, defended the basic paradigm of classical
economic theory. The natural order will drive individuals to seek their personal interest and free markets
tend to motivate workers, decrease inefficiencies and increase overall production. However, since J. S. Mill
was also a social philosopher, he held views that set him apart from classical economic authors. In
particular, he supported the notion of redistributive economic justice. Human society should not be solely
concerned with increasing aggregate production if it does not lead to a general improvement in human
conditions. He therefore favored a political and social system that would redistribute the increases in
production in such a way as to raise the standards of living, and therefore the moral conditions, of all
individuals in society. The State should, for example, tax the profits of owners to protect those who do not
have access to capital. He does not believe that private property is inherently legitimate, even though it
allows an efficient economic organization, so in a democratic society the legal system that protects private
property should also protect those who dont have access to it. These views had a major impact on partisans
of Welfare Economics in the late 20th century (see below).

Germany
The process of industrialization took place in other countries causing intellectuals to question the overall
benefits of a capitalist system of production in which only owners of capital benefited from advances in
productivity. There is, however, a particular trend in Germany that will have a profound impact on Marxist
philosophy. Frederic List (1789-1846) was not particularly socialist in his economic ideas, but he developed a
theory relative to the evolution of economic systems that differs from the classical authors.23 Whereas Smith
and Ricardo viewed economic evolution as a linear process, List considered that economic systems evolved
through stages. People first started to come together to raise animals, then for agricultural production. With
economic development, people began to specialize and create increasingly sophisticated products, and then
finally trade them. If the basic evolution is quite similar to that of Smith, List considers that social structures
adapted to the economy and passed from one type of regime to another. This vision of social evolution from
one stage to another will have a profound impact on Marx, even though Marxs interpretation of the various
stages is quite different from that of List.
Karl Marx (1818-1883) was first a philosopher and historian. In 1841, he defended a doctoral dissertation on

The Philosophical Difference Relative to Nature in Democritus and Epicurus. He only later turned to politics
and economics. He was the co-author with Engels of the Communist Manifesto (1848) and was exiled from
the continent after the Revolution of 1848 because of his subversive activities. He spent the rest of his life in
England.
A number of influences can be observed in Marxs philosophy which come together to form a solid
theoretical foundation, a quality often lacking in many socialist authors who seem too idealistic to be taken
seriously. First of all, one can notice echoes of Aristotles criticism of mercantile chrematistic in his analysis of
exchange. Aristotle denounced the use of money to generate more money, by purchasing and selling goods
without actually producing anything oneself; artisans, one the other hand, who used money as an aid to
exchange the goods that they produced, were acting virtuously. In the same way, Marx sees in the capitalist
system as the opposition of two classes of people. The first (capitalists) use their wealth to buy raw goods
and hire labor in order to make more money. The second (proletarians) work to produce a good and use
money to exchange it against other goods. The capitalists do what Aristotle would call mercantile
chrematistic, whereas the proletarians carry out natural chrematistic which is more virtuous.
This division of society also echoes Hegelian dialectic logic. All previous economic philosophers had divided
society into three classes. Physiocrats: productive, sterile and owner. Classical: Wage-earners, capitalists and
land owners. Jean-Batiste Say: intellectuals, entrepreneurs and workers. Even Aristotle, who was known for
his dialectical method saw society in three groups: magistrates/philosophers, warriors, workers. Marx based
his scheme on Smiths division of society, but grouped land owners and capitalists into the same category.
Moreover, whereas most other economists explained how these classes cooperated together to produce
goods and circulate wealth, Marx considered them diametrically opposed and in perpetual conflict. The
outcome of the conflict would eventually be a new social order.

23

National System of Political Economy (1841)

49

In fact, Marx uses an argument of Ricardo to demonstrate that the capitalist system is doomed to failure.
According to Ricardos theory of diminishing returns, profits tend to decrease with economic development,
and therefore so would wages, prices and population growth. This theory leads Ricardo to conjecture that
the economy would reach a stationary state, suggesting a relative state of equilibrium. For Marx, however,
like all other socialist authors, saw the inherent inequality in labor negotiations which always favored
capitalists at the expense of wage-earners. In the end, capitalists have the power to negotiated ever lower
wages. Because the primary cost of production is labor, by reducing wages, capitalists could maintain their
profits, despite the law of diminishing returns. But because workers are also consumers, their reduced
wages would not allow them to consume the goods produced by an economy.
The ultimate reason of all veritable crises still remains poverty and limited consumption of the
masses, confronted with the tendency of capitalist production to develop productive forces as if
their only limit was societys absolute capacity to consume.24
The basic structure of capitalism draws it naturally towards a series of crises of overproduction, until the
system would collapse and be replaced by another in which there would be no difference between classes,
since property would be held collectively.
In his conception of primitive accumulation, Marx also uses Ricardos theory of value. Value, according to
Ricardo, does not depend solely on the amount of labor that was used to produce a good, but also all the
labor integrated into the capital necessary to produce it (the purchase of raw materials, the production of
the tools that the workers use, energy, etc. For Marx, the value incorporated into capital was usurped long
ago from generations of oppressed peoples. (See text below.)
It is also possible to see Lists influence on Marxs theories. List considered that the evolution of the
economy passed through different stages. Marx as well saw different stages in economic and social
evolution, but he based his view on the means of production, not so much what was being produced, as
List. For Marx, there were five main stages in economic development: tribes, slavery, feudalism, capitalism,
and finally communism. The transformation to communism, in which capital would be owned collectively,
was inevitable, but the sooner it could be established, the better. And this final stage would mark the end of
economic and social evolution.
Marxs close collaborator Friedrich Engels (1820-1895) held similar views.25 Indeed, he co-authored the
Communist Party Manifesto with Marx in 1848. Like Marx, he thought that private property should be
abolished.
In the end, private property has transformed man into a commodity whose production and
destruction depend solely on demand, the system of competition has massacred and continues
to massacre millions of men. All this leads us to the abolition of this degradation of humanity
through the abolition of private property, of competition and of the struggle between labor,
landed property and capital.26
But most importantly, it is thanks to Engels that Marxs Capital was ever published, since he died before
completing it. Using Marxs notes, Engels finished the opus magnum of Marxist ideology. And this ideology
was adopted by generations of powerful political leaders across the globe in the 20th century.

24

Karl Marx, Capital, III, 1867, ch. 6.

Condition of the Working Class in England (1844)
26
Friedrich Engels, Outlines of a Critique of Political Economy, 1943.
25

50

Documents
J. S. Mill on worker motivation
The objection ordinarily made to a system of community of property and equal distribution of the produce,
that each person would be incessantly occupied in evading his fair share of the work, points, undoubtedly, to
a real difficulty. But those who urge this objection, forget to how great an extent the same difficulty exists
under the system on which nine-tenths of the business of society is now conducted. The objection supposes,
that honest and efficient labour is only to be had from those who are themselves individually to reap the
benefit of their own exertions. But how small a part of all the labour performed in England, from the lowestpaid to the highest, is done by persons working for their own benefit. From the Irish reaper [] to the chief
justice or the minister of state, nearly all the work of society is remunerated by day wages or fixed salaries.
A factory operative has less personal interest in his work than a member of a Communist association, since
he is not, like him, working for a partnership of which he is himself a member. It will no doubt be said, that
though the labourers themselves have not, in most cases, a personal interest in their work, they are
watched and superintended, and their labour directed, and the mental part of the labour performed, by
persons who have. Even this, however, is far from being universally the fact. In all public, and many of the
largest and most successful private undertakings, not only the labours of detail but the control and
superintendence are entrusted to salaried officers. And though the "master's eye," when the master is
vigilant and intelligent, is of proverbial value, it must be remembered that in a Socialist farm or manufactory,
each labourer would be under the eye not of one master, but of the whole community. In the extreme case
of obstinate perseverance in not performing the due share of work, the community would have the same
resources which society now has for compelling conformity to the necessary conditions of the association.
Dismissal, the only remedy at present, is no remedy when any other labourer who may be engaged does no
better than his predecessor: the power of dismissal only enables an employer to obtain from his workmen
the customary amount of labour, but that customary labour may be of any degree of inefficiency. Even the
labourer who loses his employment by idleness or negligence, has nothing worse to suffer, in the most
unfavourable case, than the discipline of a workhouse, and if the desire to avoid this be a sufficient motive in
the one system, it would be sufficient in the other. I am not undervaluing the strength of the incitement
given to labour when the whole or a large share of the benefit of extra exertion belongs to the labourer. But
under the present system of industry this incitement, in the great majority of cases, does not exist. If
Communistic labour might be less vigorous than that of a peasant proprietor, or a workman labouring on his
own account, it would probably be more energetic than that of a labourer for hire, who has no personal
interest in the matter at all. The neglect by the uneducated classes of labourers for hire, of the duties which
they engage to perform, is in the present state of society most flagrant. Now it is an admitted condition of
the Communist scheme that all shall be educated: and this being supposed, the duties of the members of
the association would doubtless be as diligently performed as those of the generality of salaried officers in
the middle or higher classes; who are not supposed to be necessarily unfaithful to their trust, because so
long as they are not dismissed, their pay is the same in however lax a manner their duty is fulfilled.
Undoubtedly, as a general rule, remuneration by fixed salaries does not in any class of functionaries produce
the maximum of zeal: and this is as much as can be reasonably alleged against Communistic labour.
That even this inferiority would necessarily exist, is by no means so certain as is assumed by those who are
little used to carry their minds beyond the state of things with which they are familiar. Mankind are capable
of a far greater amount of public spirit than the present age is accustomed to suppose possible. History
bears witness to the success with which large bodies of human beings may be trained to feel the public
interest their own. And no soil could be more favourable to the growth of such a feeling, than a Communist
association, since all the ambition, and the bodily and mental activity, which are now exerted in the pursuit
of separate and self-regarding interests, would require another sphere of employment, and would naturally
find it in the pursuit of the general benefit of the community. The same cause, so often assigned in
explanation of the devotion of the Catholic priest or monk to the interest of his orderthat he has no
interest apart from itwould, under Communism, attach the citizen to the community. And independently of
the public motive, every member of the association would be amenable to the most universal, and one of
the strongest, of personal motives, that of public opinion. The force of this motive in deterring from any act
or omission positively reproved by the community, no one is likely to deny; but the power also of emulation,
in exciting to the most strenuous exertions for the sake of the approbation and admiration of others, is
borne witness to by experience.
John Stuart Mill, Principles of Political Economy, 1848, II, 1. 11-12.
Assignment:
1. According to Mill, what types of workers are most motivated and why?
2. How does Mills conception of human motivation differ from Adam Smiths?
51

3. How can government improve worker motivation?

52

Marx on primitive accumulation

We have seen how money is changed into capital; how through capital surplus-value is made, and from
surplus-value more capital. But the accumulation of capital presupposes surplus-value; surplus-value
presupposes capitalistic production; capitalistic production presupposes the pre-existence of considerable
masses of capital and of labour power in the hands of producers of commodities. The whole movement,
therefore, seems to turn in a vicious circle, out of which we can only get by supposing a primitive
accumulation (previous accumulation of Adam Smith) preceding capitalistic accumulation; an accumulation
not the result of the capitalistic mode of production, but its starting point. This primitive accumulation plays
in Political Economy about the same part as original sin in theology.
[] The capitalist system presupposes the complete separation of the labourers from all property in the
means by which they can realize their labour. As soon as capitalist production is on its own legs, it not only
maintains this separation, but reproduces it on a continually extending scale. The process, therefore, that
clears the way for the capitalist system, can be none other than the process which takes away from the
labourer the possession of his means of production; a process that transforms, on the one hand, the social
means of subsistence and of production into capital, on the other, the immediate producers into wage
labourers. The so-called primitive accumulation, therefore, is nothing else than the historical process of
divorcing the producer from the means of production. It appears as primitive, because it forms the
prehistoric stage of capital and of the mode of production corresponding with it.
[] The spoliation of the churchs property, the fraudulent alienation of the State domains, the robbery of
the common lands, the usurpation of feudal and clan property, and its transformation into modern private
property under circumstances of reckless terrorism, were just so many idyllic methods of primitive
accumulation. They conquered the field for capitalistic agriculture, made the soil part and parcel of capital,
and created for the town industries the necessary supply of a free and outlawed proletariat.
[] The discovery of gold and silver in America, the extirpation, enslavement and entombment in mines of
the aboriginal population, the beginning of the conquest and looting of the East Indies, the turning of Africa
into a warren for the commercial hunting of black-skins, signaled the rosy dawn of the era of capitalist
production. These idyllic proceedings are the chief momentum of primitive accumulation. On their heels
treads the commercial war of the European nations, with the globe for a theatre.

Karl Marx, Capital, 1867, Livre I, ch. 26-27, 31.

Assignment:
1. How does Marx divide society?
2. How does this division differ from that of previous economists?
3. How does Marx see society evolve?

53

6. Neoclassical Economics (late 19th century)

Context

Economic
Industrial development came first to England, then in France and the rest of the European continent, and
finally to America. The process of industrialization relied on the availability of coal. Production was
increasingly carried out using machines, which were principally made of iron and steel. The production of the
goods and the machines that made them necessitated great quantities of energy. Moreover, as production
became increasingly mechanized, the products became increasingly uniform with mass production.
To transport the coal and raw materials necessary for production, and the goods once produced, great
systems of railroads began to cross all of Europe and the United States. The first train was invented in 1804
and the first railroad network in England was operational in 1811. In France, the first line was opened in
1832 and by 1850 over 300 km of rail crossed the country. In the United States, railroads allowed
entrepreneurs to transport goods from one coast to the other without having to go around the straights of
Magellan. Steam boats also could now carry ever larger cargoes and anywhere the captain wished despite
the flow of currents and winds. The result is that large quantities of goods were transported large distances
and at a relatively low cost, driving competition and greater levels of industrialization. Consumers were also
faced with increasingly uniform goods, while at the same time having to chose among a larger variety of
goods.
There were great innovations in the financial sector as well. Banking networks began to develop: Crdit
industriel et commercial (1859), Crdit Lyonnais (1863), Socit Gnrale (1864). Access to credit changed
the way people saved money and borrowed to invest. Distribution networks also adapted to mass
production. Department stores began to open, such as Le Bon March (1852), Le Printemps (1865), and La
Samaritaine (1869), allowing consumers to purchase a wider variety of goods in a single place, rather than
go to the section of town that was specialized in the production of whatever good they needed. And by the
end of the 19th century, the working class began to make gains in disposable income which would lead them
to have greater choice in their consumption habits. Economists, therefore, began to focus more on
consumption than on production.

Intellectual
Despite the development of socialist ideas, which had a considerable impact on political events of
the 19th century, intellectual economists in universities tended to remain influenced by the classical school.
Currents differed slightly from one country to another: in England, economists preferred Ricardo, Germans
and Austrians tended to be more influenced by the historical school (List), while the French stayed faithful to
Jean-Batiste Say. These liberal ideas will remain in vogue in intellectual circles all during the 19th century,
but will undergo a profound transformation towards the second half of the century.
In particular, economist will begin to find economic applications for the utilitarian philosophy and
hedonist psychology developed by Jeremy Bentham (1748-1832). Bentham was an English philosopher who
considered that it was possible to understand all human behavior as a result of ones search for pleasure and
flight from pain. Individuals make a sort of calculation of the consequences of their acts to find the behavior
which will procure for them a maximum of pleasure and a minimum of pain (felicific calculus). Adam Smith
demonstrated how the peoples search for their own personal interest was beneficial for society, but he did
not attempt to measure this personal interest. Economist starting in the middle of the 19th century began to
focus precisely on calculating and interpreting utility, through the theory of diminishing marginal utility.

54

The Theory of diminishing marginal utility

The behavior of consumers becomes the center of economic analysis. Economists sought to calculate the
utility of a product, on the basis of its nominal price, taking into consideration the utility changes according
to the number of units consumed.
Hermann Heinrich Gossen (1810-1858) was the first to develop the theory of marginal utility.27 Gossens First
Law (the law of diminishing marginal utility) states that the marginal utility of each homogeneous unit
decreases as the supply of units increases (and vice versa). Gossens Second Law (theory of maximum
utility) states that, because the resources of consumers are relatively limited compared with their desires,
people will make a choice between different goods and select those that maximize their utility. Such
premises had a profound impact on the economic models developed by economists around Europe.
William Stanley Jevons (1835-1882) was one of the most influential economists of the 19th century in
England, after Ricardo. He was particularly influential in turning economics into a theoretical subject, which
could be mathematically modeled. In his first major work, A General Mathematical Theory of Political
Economy (1861), and then in Theory of Political Economy (1871), Jevons began to evoke the question of
diminishing marginal utility, first elaborated by Gossen. Influenced by Jeremy Bentham (1748-1832), who
elaborated theories of utilitarian hedonism, Jevons elaborated a theory relative to the diminishing intensity of
pleasure and pain. The goal of each individual is to find pleasure and to avoid pain. Each individual does this
by making calculations.
[P]leasure and pain must be regarded as measured upon the same scale, and as having,
therefore, the same dimensions, being quantities of the same kind, which can be added and
subtracted.28"
In particular, Jevons observes that pleasure (or pain) diminishes in time. In the graph below, each rectangle
represents one minute of pleasure (or pain) and the size of rectangle corresponds to the intensity of that
pleasure (or pain). With each passing minute, the intensity of the pleasure diminishes.

Discontinuous curve of diminishing intensity of pleasure (or pain)

27
28

Development of the Laws of Human Relationships (1854).

Theory of Political Economy (1871), chapter 2.
55

Since pleasure (or pain) do not diminish noticeably after each minute, but rather gradually through time,
Jevons presents the phenomenon in terms of a continuous curve:
Continuous curve of diminishing intensity of pleasure (or pain)

Jevons does not, however, establish any units of measure of pleasure or pain, or clarify how one can
calculate it, which is the main criticism of this model.
In his second major work, The Coal Question (1865), for which he was initially better known, Jevons
examines the more practical question of the efficiency and price of a valuable source of energy which drove
all industrialization in England at the time. According to the Jevons Paradox, technological progress that
increases the efficiency with which a resource is used tends to increase (rather than decrease) the rates of
consumption of that resource. In the 19th century, technological improvements of the coal-fired steam
engine reduced the quantity of coal necessary to perform particular tasks. Jevons observed that these
improvements, rather than decreasing the total amount of coal consumed, actually increased the use of coal,
since it had become a more efficient source of energy. Overall output increased, but the depletion of coal
stocks in England became more rapid. The same observation may be made of advancements in the efficient
use of petroleum in the 20th century.
Independently from Jevons, the theory of diminishing marginal utility was developed also by Carl Menger
(1840-1921), a Polish-born professor who emigrated to Austria and who founded the very influential "Vienna
School" of economics (Hayek, Schumpeter, etc.). In his Principles of Political Economy (1871), Menger
focuses in particular on the choices that one must make based on the utility that each unit of a good can
procure for a consumer. He even allows to a level of subjectivity accepting that each individual places his
own value on a good. In order to understand the choice that a consumer makes, Menger sets up a table
(called Mengers Table).

Mengers Table

Goods in order of utility, and corresponding diminishing marginal utility

A
10
9
8
7
6
5
4
3
2
1

B
9
8
7
6
5
4
3
2
1
0

C
8
7
6
5
4
3
2
1
0

D
7
6
5
4
3
2
1
0

E
6
5
4
3
2
1
0

56

F
5
4
3
2
1
0

G
4
3
2
1
0

H
3
2
1
0

I
2
1
0

In this table, each letter represents a different good (for example, A is bread, B is cheese, C is sausage, D is
beer, etc.). Each unit of a good represents a fixed value (say 1) and has a different utility. For the
consumer in this example, 1 of bread has a higher utility than 1 of cheese, and 1 of cheese has a higher
utility than 1 of sausage, and so on. Moreover, according to the theory of diminishing marginal utility, the
first unit of a good consumed has a higher utility than the second unit of the same good. It is assumed that
each consumer will make choices in order to maximize her/his utility. If this consumer has 10, it follows
then that the s/he will purchase 4 of bread (10+9+8+7=34 units of utility), 3 of cheese (9+8+7=24 units
of utility), 2 of sausage (8+7= 15 units of utility) and 1 of beer (7 units of utility), which would total 80
units of utility. According to Menger, each consumer has his/her own criteria for attributing utility to different
products.
The theory of diminishing marginal utility was also developed in the French-speaking world. Lon Walras
(1834-1910) was born in France and educated as an engineer at the Ecole des Mines de Paris, but accepted
a position in economics in Switzerland where he founded the Lausanne school of thought. He is best known
for his Elments d'conomie politique pure (1874), which as its title suggests is a highly theoretical work
quite divorced from practical concerns. Most economists already agreed with the principle that individual
markets reach an equilibrium between supply and demand, which is expressed in the price of a good.
Through mathematical reasoning, Walras argued that such an equilibrium exists simultaneously also for all
markets. In this work, he posits that the condition necessary to bring a state of General Economic
Equilibrium is totally free or perfect competition where all desires would be satisfied, all workers 100%
active and the use of all capital maximized. This system is impossible and totally disconnected from reality.
All information on products and prices would have to be diffused perfectly among all economic agents,
everything is sold at auction, no bilateral exchanges, etc. Although his conception is hypertheoretical, this
makes it possible to use mathematical models to explain how it functions.
Indeed, for Schumpeter, Walras was the greatest of all economists. His system of economic equilibrium,
uniting, as it does, the quality of revolutionary creativeness with the quality of classic synthesis, is the only
work by an economist that will stand comparison with the achievements of theoretical physics.29 His work,
however, remained almost unknown to most English-speaking economists because he wrote only in French
and wasnt translated into English until the 1950s. (If this was the case for a 19th-century intellectual,
imagine what this means for a young professional in the 21st century!)
One of Walrass students was Vilfredo Pareto (1848-1923). Pareto, a French-Italian, was educated as an
engineer and also studied sociology. He eventually took over the Chair of Economics at the University of
Lausanne after Walras. He is principally known among economists for elaborating a theory relative to an
optimal state (Pareto Optimum: a situation in which it is impossible to increase the satisfaction of one
individual without diminishing that of another). But he is more widely known for his power rule relative to
the distribution of wealth. He argued that all human society followed the same pattern of wealth distribution:
80% of the wealth was owned by 20% of the people. Only a small proportion of these owners took any
significant decisions about the organization of society, while the mass of the population suffered from
poverty. How the elite managed to take control of the greater portion of the wealth and control the others
may change over time and from one society to another, but the proportions, he claimed, remained the
same. Thus his study of sociology explained why his rational optimal state did not exist in reality, since there
was not real freedom in markets.
Jevons, as well, has a very influential disciple. Alfred Marshall (1842-1924) was professor of economics at
Cambridge (where he was to become the mentor of Keynes and Pigou). His work Principles of Political
Economy (1890) became the reference manual on economics for English students of economics for decades.
Among his more innovative economic ideas is that of the elasticity of demand. According to marginalist
economists, the marginal utility decreases with each supplementary unit consumed. Jevons posited that the
utility of goods also evolves through time. Marshall also argued that utility evolves differently according to
the type of good. The demand for goods of primary necessity, for example food, is very inelastic, or rigid ;
no matter what the price is, people need to purchase them to survive. The demand for luxury goods,
however, is quite elastic, meaning that consumers will avoid buying a product if the price is too high.

29

J. A. Schumpeter, The History of Economic Analysis (1954), p. 795.

57

Marshall was also influenced by Jevons in his temporal approach to economic analysis. He argued that
producers can modify their production according to demand, but their ability to do so depends on the time
they have available. During the market period, the producer cannot adapt supply to the demand; even if
supply suddenly increases, the producer has only the supply previously produced and cannot satisfy total
demand. In the short period, the producer can modify the use of production capacity to make more or fewer
goods, so supply is thus somewhat flexible. In the long period, there is enough time to make big changes to
production capacity, through R&D, investment in new machines, etc., so supply is much more flexible. The
notion that supply adapts to total demand is an idea that will be a key feature of Keyness macroeconomic
theory.
Marshall is best known, however, for his theory of partial equilibrium. In order to understand how the
economy functions, rather than analyze all markets as Walras in his theory of general equilibrium, Marshall
focuses on one market. To do this, he must assume that all these are otherwise equal (rendering famous
among economists the term ceteris paribus). Overall, he argues that utility determines the price of goods in
the short run, while cost of production become a determining factor in the long run, as producers must
make a return on their investment. Marshall therefore reconciles classical theories of value and those of the
marginalists.

58

7. A. Keynes (early 20th century)

Political and economic context
The great technological innovations revolutionized not only production and distribution, but also warfare. By
the beginning of the 20th century, armies had at their disposal weapons and equipment that were by far
superior to those of their predecessors. At the beginning of the 19th century, Napoleon invaded all of Europe
on horseback and foot with rifles, swords and canon. At the beginning of the 20th century, armies used
tanks, airplanes, submarines, machine guns and especially toxic gas bombs. The numbers of soldiers also
takes on industrial proportions: 70 million men mobilized during this war, of which the great majority from
Europe. By the end of the conflict, over 9 million soldiers had died, not counting civilian casualties. The vast
majority of those who died were young men who otherwise would have integrated the workforce. Once
peace was restored, the destruction of the infrastructure and industrial facilities, as well as the loss of labor,
drove Europe into a tremendous economic crisis.
All countries involved in the war had to deal with the problem of reconstruction. In addition to the
reconstruction of its own country, Germany also had to face the payment of reparations to the Allied
nations, according to the Treaty of Versailles of 1919. To face this heavy debt, Germany began to print
massive quantities of deutschmarks, which caused radical inflation and destabilized an already suffering
economy. Russia fought on the side of the Allied nations, but after the Bolshevik Revolution of 1917, led by
Lenin, the Russian Empire fell and the new government signed a peace treaty with Germany. It was in fact
thanks to this war that the Bolsheviks were able to take control of the country, and then the rest of Eastern
Europe. Across all of Europe after the war, there was a movement towards strong central states: Bolshevism
in Russia (Lenin), Nazism in Germany (Hitler), Fascism in Italy (Mussolini) Spain (Franco), and Portugal
(Salazar). If France and Great Britain remained democratic, their economic turmoil left them in a vulnerable
position.
The United States, on the other hand, had not suffered from the war. It had only declared war on Germany
in 1917, and did not suffer from attacks on its own territory. In this way, America played a decisive role in
the resolution of the conflict without a significant human or financial loss. The United States came out of the
war with a new role in world politics, and was one of the only industrialized nations which did not suffer
immediate economic consequences from the war. The advantages of industrialization and the lack of
European competition created a boom in the 1920s (also called the Roaring 20s). But the boom was also in
part caused by a speculative bubble and irresponsible policies. In 1926, for example, it became possible to
purchase stock on credit; shifts in markets quickly led to unpaid debts and a banking crisis, leading to the
crash in 1929, first on Wall Street, then on European stock exchanges. The financial crisis affected the real
economy and drove the whole American economy into the Great Depression. With an unemployment rate
of nearly 25%, the political and social situation in the US was becoming critical. Fed up with the liberal
policies of the past, and driven by a strong popular movement of the working class, American elected
Franklin D. Roosevelt (FDR) as president on his platform of a New Deal in 1932. His policy consisted
primarily of an increased role of the Federal government: development of a retirement system (Social
Security), public assistance, federal guarantee of savings, great oversight of financial transactions (SEC),
public works projects, etc. FDRs policies were so popular that he was elected four times.

59

Economic Theory
This period was dominated by the economic theories of John Maynard Keynes (1883-1946). Keynes was a
student of Alfred Marshall at Cambridge. He had a brief career in government administration, and then
became professor at Cambridge himself. He had a remarkable private life, being an art collector, a member
of artistic circles, an amateur and benefactor of the opera and the ballet; he even acted as Director of the
British Arts Council. Keynes is considered today as the founder of modern macroeconomics and had a
significant impact the Bretton Woods negotiations after WWII, as well on virtually all government policy
since then.
Keynes was particularly attached to the resolution of real and current economic problems. He discards, not
without a certain degree of disdain, the importance of the theories of his predecessors who attempted to
analyze the conditions that would bring about a situation of equilibrium which is impossible to attain in
reality, existing in some hypothetical distant future. According to Keynes
In the long run we are all dead. Economists set themselves too easy, too useless a task, if in tempestuous
seasons they can only tell us, that when the storm is long past, the ocean is flat again.30

Indeed, immediately after WWI, he worked on a policy proposal for the British government to adapt to the
post-war period.31
But Keynes is most widely known for reintroducing the role of money into his economic analysis.32 He of
course was not the first to do so. The economic context of complex financial schemes, international banking,
and price volatility had driven many other economists to reflect on the how money actually functions in an
economy. In these works, through an extensive historical appraisal of the evolution of money in the
economy, Keynes already realized the importance of taking into account the multiple forms of money and
recognized the important role of the central banks in stabilizing prices by regulating benchmark interest
rates. But not all governments followed Keynes advice and financial markets across the developed world
were interconnected. The economic bubble in America burst in 1929, leading to shockwaves in financial
markets across the Atlantic and then to widespread economic problems in the real economy.
Confronted with economic crisis, Keynes formalized many of his views into his most well-known book: The
General Theory of Employment, Interest and Money (1936). Keynes demonstrates the impossibility of
optimal regulation solely through free market mechanisms and competition (also highlighted by his
contemporary and colleague at Cambridge Arthur Pigou). He rejects Says Law by arguing that it is perfectly
possible for aggregate demand to decrease, causing a glut in production. The amount of employment and
wage rates depend not on the marginal disutility of labor (according to neo-classic theory), but on the desire
and the possibility to consume on the one hand, and on the amount of investment on the other. Wage rates
are therefore not determined solely by the confrontation of supply and demand on the labor market. A
market economy therefore does not automatically lead to full employment and stability, so it is the
governments role to support consumption and to invest in order to stimulate production in times of
recession. He argues that government spending has a multiplier effect and will stimulate growth in the
private sector.
Keyness impact is difficult to evaluate. He outlined very clearly the mechanisms that would lead to economic
stability in order to avoid a crisis, and in the worst case scenario, to stimulate the economy in times of
recession. Yet many of the policies he recommended, particularly relative to government spending, had
already been put in place by governments before the publication of the General Theory. FDRs New Deal
policy instituted massive government spending on public works, social welfare, etc. in order to stimulate the
economy (and avoid a social crisis). Although it would foolish to deny the genius of Keynes, it would also be
wrong to attribute to him the basic notions that central banks stabilize prices by setting interest rates and
that government spending compensates for demand. But although such ideas had already existed, and were
even being put into practice, Keynes was able to model the mechanisms to explain how this is possible.

30

Tract on Monetary Reform (1923), chapter 3.

The Economic Consequences of Peace (1919).
32
Tract on Monetary Reform (1923), Treatise on Money (1930).
31

60

Keynes on monetary theory

The fundamental problem of monetary theory is not merely to establish identities or static equations
relating the turnover of monetary instruments to the turnover of things traded for money. The real task of
such a theory is to treat problem dynamically, analyzing the different elements involved, in such a manner
as to exhibit the causal process by which the price level is determined, and the method of transition from
one position of equilibrium to another.
The different presentations of quantitative theory, with which we have all been educated, are poorly
adapted to these questions. There are particular examples of numerical identities which present the relations
between different monetary factors. But none of them makes it possible to distinguish these factors by
which, in a modern economic system, the causal process is effectively carried out in a period of transition.
Moreover, they have an added flaw, in that the standard, as they call it, is never a work standard nor a
standard of purchasing power, but some other standard, more or less artificial: either the liquidity of
transaction standard or the cash balance standard []. This is a serious flaw, for these are the two
standards that are our true question. The expression of work and purchasing power in monetary terms are
fundamental in the sense that the levels of prices based on other types of spending do not exist. Human
effort and consumption are the ultimate subjects from which is drawn the meaning of economic operations.
All other forms of spending have importance only in their relation, sooner or later, to the effort of producers
or to the spending of consumers.
This is why I propose to break away from the traditional method that takes as its starting point the total
quantity of money, with no regard to the way in which it is employed, in order to substitute for it [] the
flow of profits of the community or monetary revenue, by differentiating them 1) in income earned through
production of consumable goods and equipment goods, and 2) in income spent respectively in consumption
goods and savings.
J. M. Keynes, A Treatise on Money, V, p. 120. (cited in Bailly., Histoire de la pense conomique, p. 264.
Partially retranslated into English by R. Braid from Baillys French, thus inexact. Do not cite.)

61

7. B. Heterodox Economists"
These economists are difficult to classify in any given school of thought. They sometimes had a significant
impact on economic theory, but generally very late in their career or even after they died. Although they
were active more or less at the same time as Keynes, they cannot be considered Keynesians.
Arthur Pigou (1877-1959) was also a student of Alfred Marshall and a contemporary of Keynes. He as well
doubted free market mechanisms ability to always create the best optimum. He also favors the intervention
of the State to support general economic growth. He points out that economic agents tend to underestimate
future satisfaction in favor of current satisfaction and they tend to look for short-term profits at the expense
of long-term advantages. In this respect, he could be considered a precursor to behavioral economists. He
also one of the first to explain the theory of externalities (that certain costs and effects on others are not
calculated in the maximization of private interests) which is a central part of certain neo-Keynesians, such as
Stiglitz and Krugmann. However, overall, Pigous intellectual production was overshadowed by Keyness
revolutionary ideas.33 Although the two men remained friends, Keynes was generally very critical of Pigous
theories.

Joseph Alois Schumpeter (1883-1950) is another author who is hard to categorize, and clearly the best know
of the three.34 He studied Greek and Latin history and sociology in Vienna (Austria), then economics under
Menger. He worked successively in London, Cairo, Vienna, Germany, then finally landed a position at
Harvard. And like the neoclassical authors, he advocated for free markets, believing them to be able to best
bring about economic growth. But rather than posit on their ability to bring about a future state of
equilibrium, he observed that they often generated cycles. He was therefore very attached to approaching
economics from the standpoint of dynamic analysis, and clearly breaks with previous schools of thought:
Physiocrats (Economic Circuit), Classics (Stationary state), and neoclassic (general or partial equilibrium),
though one could say that he was influenced by Marx.
Capitalism [...] is by nature a form or method of economic change and not only never is but never can be
stationary. [...] The fundamental impulse that sets and keeps the capitalist engine in motion comes from
the new consumers goods, the new methods of production or transportation, the new markets, the new
forms of industrial organization that capitalist enterprise creates. [...] The opening up of new markets,
foreign or domestic, and the organizational development from the craft shop and factory to such concerns
as U.S. Steel illustrate the same process of industrial mutation [...] that incessantly revolutionizes the
economic structure from within, incessantly destroying the old one, incessantly creating a new one. This
process of Creative Destruction is the essential fact about capitalism. It is what capitalism consists in and
what every capitalist concern has got to live in.35

The determining factor in economic evolution, according to Schumpeter, is innovation; introduced by the
entrepreneur, it drives production and consumption. His theory of creative destruction indicates that new
innovations destroy the older ones which are no longer adapted to the economic context. These renewed
waves of innovation are spurred by economic slowdown and usually lead to economic growth.

33

The Economics of Welfare (1920), The Theory of Unemployment (1933).

Nature and Essence of Economic Theory (1908), Theory of Economic Evolution (1911), Business Cycles (1939),
Capitalism, Socialism, Democracy (1942), History of Economic Analysis (1954).
35
J. A. Schumpeter, Capitalism, Socialism et Democracy, pp. 82-83.
34

62

Schumpeter had a French student, Franois Perroux (1903-1987), who was significantly less influential than
he mentor, but still deserves mention. He studied law in Lyon, and economics in Vienna under Schumpeter.
Contrary to his predecessors, he underlines the importance of verifying hypotheses with real facts. Neoclassical theory is too concerned with its own internal coherence and is completely divorced from the real
economy. But it wasnt until the 1930s that governments started to systematically collect data which would
allow them to lead a real statistical analysis of the economy. Most economists before this time generally
used mathematics to elaborate a hypothetical model, or explain general principles. Perhaps more importantly
was Perrouxs view that people were more than mere economic agents. They were the product of a social,
legal, religious context that formed the way they acted in all spheres, including economics. Social reality
heavily influences economic activity (production, consumption, investment). In this respect, he is a
forerunner of behavioral economics in the sense that he is doubting the principle of homo oeconomicus.
Behavioral economists, however, would tend to believe that humans act similarly, though irrationally, in any
culture. Their responses are hard-wired into the brain, much like when dogs salivate when they smell meat.
Also, as did John Stuart Mill, he distinguishes between economic growth and social, legal development.
Economic growth may very well lead to social injustice and exclusion.
Enterprises and their groups are unequal in dimension, in power of negotiation, in their capacity to create
and exploit external economies. Functional groups or social classes are unequal in their dimension, in
their capacity to resist others, even in their situation in the global structure. What is the result of these
inequalities, omnipresent but hidden by custom, implicitly normative of the concept of pure and perfect
market? First, real markets (national and multinational) are characterized, not only by the common traits
of a monopoly, but also by the more subtle and less controlled inequalities in common theory: these are
the inequalities in information received and information transmitted, the inequalities resulting from
innumerable tacit coalitions, inequalities stemming from collusion between industrial powers, financial
powers, and public power of the State or smaller governments.36

Such ideas will be further developed by Welfare Economists later in the century, such as Amartya Sen.

36

Franois Perroux, Lconomie du XXme sicle, p. 240 (Translated by R. Braid).

63

8. Neo-liberal Economics
Economic and political context
The economic and political situation changed radically after the Second World War. First, economic growth
returned. After a decade of high unemployment rates, decreased demand and sluggish production, the
massive government investment in weapons, artillery and military equipment put many Americans back to
work. In addition, the urgency of the situation allowed the government to impose rationing on its citizens,
causing civilian demand for basic products (salt, sugar, gas, etc.) to drop, and encourage savings by selling
government bonds to finance the war effort. Government debt was accumulated, but held in the hands of its
own citizens. After the war, rationing measures were removed, releasing pent-up demand, and savings rates
decreased as people began to consume more and cash in little by little their bonds. Except for the attacks on
Pearl Harbor, the United States also suffered virtually no destruction on its territory, contrary to the massive
destruction of infrastructure in Europe. There was also a great feeling of victory that pervaded American
society generating confidence in consumers. Demand increased, and therefore so did production. Population
also increased dramatically after the Second World War, in part because of increased fertility rates (Baby
Boom) but also because of immigration. Overall, the few decades following WWI are remembered as a
period of economic prosperity.
But this economic boom must be understood in its global political context. America had sent troops to both
Europe and Asia and proved its military power, not the least of which was the nuclear bomb. The United
States became a world superpower, but was not the only one. Russia as well had experienced rapid
industrialization since the Bolshevik Revolution in 1917 and also played a crucial role in defeating Nazi
Germany. Russia had, since the establishment of the Soviet Union in 1922, clearly outlined its expansionist
program and neither Lenin nor Stalin respected the principles of democracy that were held so dear in most
of Europe and the United States. In 1949, Chairman Mao Zedong (or Mao Tse-Tung) founded the Peoples
Republic of China (PRC), a socialist and non democratic nation. Everywhere in Eastern Europe, Asia and
Latin America, communist leaders took control of countries, often with the military and financial support of
the USSR and the PRC. Western countries (which also included Japan and Australia), but in particular the
United States, felt threatened by communist regimes. The development and proliferation of nuclear
weapons, capable of wiping out entire regions almost instantaneously and from a distance, only increased
tensions, though actual fighting against the Communist Threat were limited to the Korean and Vietnam
wars. America was also actively, albeit covertly, involved in overthrowing communist regimes in Latin
America, and replacing them with friendlier allies who proved to be worse dictators than their communist.
After WWII, and until the collapse of the Soviet Empire in 1991, the world entered into a Cold War. This war
not only opposed political ideologies, but was founded primarily on views relative to an economic structure:
communism vs. capitalism. Because it was difficult to mobilize the support of the masses for an economic
model than very often worked against their interests, it was necessary to associate capitalism with
democracy.
In addition to military weapons, the United States and Western European countries used economic influence.
Even before the war had ended, leaders of the Allied nations met in Bretton Woods, New Hampshire (USA),
to outline the economic structure of post-war international world. After the collapse of the international
financial system and the ensuing severe economic downturn which fueled the fascists rise to power and
which was a root cause of the war, leaders considered that the global economic stability was a condition for
peace. As US President Franklin D. Roosevelt remarked in his opening address at the conference: The
economic health of every country is a proper matter of concern to all its neighbors, near and far. Although
the Soviet Union sent representatives to this conference, they did not play an active role in constructing in
the institutions that resulted and all countries of the USSR pulled out of these institutions by the early 1950s.
Communist regimes, such as Yugoslavia could participate, but only after splitting from the Soviet Union in
1948. It is clear that the institutions were used as a means to extend political influence around the world.
These institutions were set up with the stated objective of ensuring international economic stability, but the
means employed were clearly favorable to a capitalist regime. Both the International Monetary Fund (IMF)
and the World Bank offer loans to countries in economic difficulty, but only if they agree to institute policies
that represent a capitalist model and favor foreign investment of western countries, the former to maintain a
stable currency and the latter to promote the development of infrastructure. The General Agreement on
Tariffs and Trade (GATT), which became the World Trade Organization (WTO) in 1995, was set up as a
forum for member countries to establish agreements that liberalized markets. Shortly after the conference,
64

in 1948, the Organization for European Economic Cooperation (OEEC), which became in 1961 the
Organization for Economic Cooperation and Development (OECD) extending to countries outside of Europe,
was founded to help execute the Marshall Plan, a financial package provided primarily by the United States
to rebuild the European economy. All of these institutions clearly advocate and financially encourage a world
economy based on a liberal economic model.
Domestically, the American government actively sought to eradicate communist and socialist views. A
commission set up by Senator McCarthy in order to lead inquests and punish individuals who supported
views linked with communism. This commission regularly interrogated university professors (including Paul
Samuelson who later received a Nobel Prize for his neoliberal theories!) suspected of promoting a non
capitalist model. Intellectual production in the United States was dominated by neoliberal views, principally
at the University of Chicago (hence the name Chicago School as an alternative for the neoliberal school of
economic thought). In the 1940s and 1950s, in America, it was virtually impossible to promote views that
did not correspond to a capitalist model without jeopardizing ones academic career and risk facing a trial
before the Senate.
The neoliberal economic view was also promoted in literature and philosophy. Ayn Rand (1905-1982) was a
Russian who emigrated to the United States in 1926 and who expressed her individualist philosophy through
fiction. She defended capitalism, liberalism and rational egoism in her novels, such as Atlas Shrugged or The
Virtue of Selfishness. She is against all forms of charity, which only encourages poor people to be lazy and
makes them dependant on others. She is also radically atheist. Despite her antireligious views, she was very
successful and appreciated by many American politicians, in particular by Ronald Reagan.
Overall, despite the popularity of Roosevelts New Deal policy, due to the Cold War with the Soviet Union,
America actively suppressed views in its own country and around the world which leaned towards socialism.
In this context, the only models that were accepted and promoted were those that corresponded to liberal,
free market policies.

65

Economic Theory
It would be erroneous to assume that neoliberalism only developed after the Second World War. Freemarket capitalism was already favored by many economists in America long before the Cold War. Despite
the influence of Keynes and the popularity of FDRs New Deal policies, many academics supported liberal
views all throughout the Depression.
Irving Fisher (1867-1947) was an American economist who is famous for claiming for years during the
Depression that economic recovery was just around the corner and that government intervention would
only slowdown the process. Among economists, he is best known for his innovative monetarist theories. In
The Money Illusion (1928) and other works, Fisher highlighted the importance of expressing values in real
terms, meaning comparing prices and wages with each other. Nominal wages may increase slightly, but if
their increase is less than that of prices, real wages in fact fall. Nominal values, therefore, can create a sort
of illusion. He also observes the phenomenon of sticky wages; prices are always more volatile than wages,
and the inability of sluggish wages to keep pace with inflation invariably leads to decreasing real wages. He
also develops a formal quantitative theory of money, building on the basic premise of Jean Bodin. This
model is expressed as MV = PT, where M is money, V is the velocity of money (meaning the average
frequency with which a unit of money is spent), P is price level, and T is the real value of aggregate
transactions. According to this model, any variation in the money supply implies a proportionate variation of
prices. He notices as well that debt drives deflation, because to pay their debts, people sell their goods,
which drives down prices and therefore increases the real value of debt. These views, although similar to
those of Keynes, were in fact used to promote an economic system that functioned best if agents were left
to act freely in their economic transactions, without government intervention. During his life-time, however,
the urgency of the Depression and the unrest of the masses caused his views to be overshadowed by those
of Keynes with favored government spending to stabilize markets.
Other economists also supported liberal models throughout the entire prewar period. Friedrich Hayek (18991992) was an Austrian-born intellectual who trained in Vienna. Although he is primarily remembered as an
economist, he was formally trained in law and political science. He accepted a position at the London School
of Economics (LSE) and became a British citizen in 1938 after the Nazis invaded Austria. He then held
positions at the University of Chicago, but also in post-war Germany. He received a Nobel Prize in 1974 for
his work on monetary theory and the interrelationship of social, economic and institutional phenomena, as
expressed in Prices and production (1931), Pure Theory of Capital (1941). But Hayek was also awarded
many other prizes in England and the US for his defense of neoliberal economic models, promoted in his
most famous work The Road to Serfdom (1944), and also in Law, Legislation and Liberty (3 vol. 1973-79).
His main argument is that massive state intervention in the economy reduces individual liberties. Indeed, he
equates fascism and Nazism with socialism in the sense that they all attempt to coordinate economic activity
and limit the freedom of citizens. Although government spending boosts aggregate demand, it does so in a
less efficient way than when economic agents are left to make their own decisions. At some point,
government spending must be financed through taxes, and taxation only takes funds out of the hands of
consumers and producers. Moreover, central banks encourage reckless behavior by offering artificially low
interest rates and favoring excessive credit that is unsustainable in the real economy. The result is an
economic boom that leads inevitably to a bust. Hayek is so radically opposed to government intervention
and believes so fervently in the fundamental advantages of totally free markets that he recommends the use
of currency issued by private banks, rather than the State-backed currency used around the world, and
allowing economic agents to estimate which currency they find most valuable.37
Other economists as well made the connection between economic and political freedom. Milton Friedman
(1912-2006) was a highly influential American economist and founder of the Chicago school of thought,
along with Hayek. He received the Nobel Prize in economics in 1976, coincidentally the same year as the
American Bicentennial celebration of its Declaration of Independence. Friedman was born of a Ukrainian
Jewish family who had immigrated to the United States. He grew up during the Roaring 20s, but spent his
early adult life as a struggling academic during the Depression. Despite his neoliberal views for which he will
become famous, he accepted a position created by FDRs government to support the employment of
academics. After the war, and for three decades, Friedman worked for the University of Chicago.

37

The Denationalization of Money, (1976).

66

In his various works, such as Capitalism and Freedom (1962) and Monetary History of the United States
(1963), Friedman was a fervent defender of free markets and opposed to all government intervention. He
argues that the multiplier of Keynes is erroneous. Like Hayek, he claims that all government spending takes
money out of the hands of investors and consumers through taxes (present or future see Ricardo-Barro
Effect). Moreover, the investment and consumption of the State is less effective to stimulate the economy
than the investment and consumption of independent economic agents. Stimulus packages, for example,
can only cause inflation and therefore hurt the economy more than they help it. Unlike Hayek, however, and
similar to Keynes, he believes that Central Banks play a vital role in stabilizing the economy. He favors a
slow and steady increase of the money supply and benchmark interest rates which should lead to stable
inflation (aiming for roughly 2%). Because he uses Keynesian monetarist views to support an otherwise
liberal economic model, he is considered as part of the neoclassical synthesis movement. His work greatly
inspired the economic policy of Ronald Reagan, who became president of the United States in 1981, and his
slogan Government is not the solution, government is the problem.
Like Friedman, Paul Samuelson (1915-2009) was also an American-born son of a Jewish immigrant family
from Poland and was a struggling academic during the Depression who went on to earn a Nobel Prize in
1970. He studied at the University of Chicago, but also at Harvard, and finally accepted a position at the
Massachusetts Institute of Technology (MIT) and is remembered for his most influential work Foundations of
Economic Analysis (1947), which he later transformed into a reference manual for young economists.
Samuelson is principally famous for using mathematical models from thermodynamic chemistry to explain
economic phenomena. Like heat in the physical world, wealth is distributed through the economy, meeting
sometimes with resistance that impedes its flow. He also developed an oscillator to trace and predict
business cycles. He elaborated a model based on the multiplier and accelerator principle of Keynes, adding a
Robertson delay, which takes into account the fact that current consumption is based on past revenue. An
independent increase in investment causes an increase in revenue and therefore in demand which in turn
causes increased investment. In this work, he also lays the theoretical foundations for Welfare Economics,
which attempts to understand why wealth is not evenly distributed throughout an economy.
Another influential neoliberal economist was the Canadian Robert Mundell (b. 1932). For economists,
Mundell is primarily known for his work on monetary dynamics and optimal monetary zones. In fact, Mundell
is responsible for laying the foundations for the framework of the European single currency (euro). The
Mundell-Flemming model on exchange rates, published in 1962, argues that it is impossible to maintain
simultaneously sovereign autonomy, price stability and a free flow of capital. Mundell predicted that
stagflation would result from a system of incremented taxes based on income. He favored the dramatic
reduction of taxes overall and a system in which the progression of rates was less pronounced. Contrary to
many of his neoliberal colleagues, however, he did not favor a return to the gold standard or a system of
fixed exchange rates. Instead, he thought that currencies would naturally become multinational. He
incorrectly predicted that over 50 countries would adopt the euro and all of Latin American would adopt the
dollar, while most Asian countries would adopt the Japanese yen. For the broader public, Mundell is mainly
remembered for his neoliberal views and his justification for the dramatic reduction of taxes.

67

9. A. Welfare or Development Economics

Although it has been argued that the predominant school of economic theory in America, the neoliberal
school, was conditioned by the anticommunist sentiment and general censure of any views that seem close
to those espoused by the Soviet Union during the Cold War, there were nonetheless a number of economists
who were concerned about the unequal distribution of wealth within a capitalist system. Indeed, although
the majority of Americans experienced improved economic well-being since the war, there were still a large
number of individuals who seemed unable to take advantage of the general context of prosperity. In the 19th
century, socialist economists clearly demonstrated how the capitalist system inherently favored those who
had previously accumulated capital and advocated for government intervention in the economy to correct for
this inequality. Welfare economists also are attached to the idea that the political structure must favor
greater equality in the economic system, in this context of Cold War, they are very careful to distance
themselves from socialism.
Welfare economics, which recently has turned into what is called Development Economics, generally uses
micro economics in macro economic analysis in order to understand economic well-being. Economic wellbeing is difficult to define. For many, it simply refers to the simple calculation of the GDP per capita. In the
19th century, neoclassical economists attempted to calculate utility, but in general considered all individuals
on an equal footing. Overall well-being would be measured by taking the aggregate of the all individuals
utility. The utilitarian (or Benthamite) welfare function treats all individuals the same, adding the utility of
each individual in order to obtain society's overall welfare. One extra unit of utility for a poor individual is not
considered to be of any greater value than an extra unit of utility for a rich person, although their utility for
an individual good may be different. The Austrian School (Karl Menger) allows for individual preferences and
therefore a more subjective interpretation of utility, but though individuals evaluation of utility varied, one
individuals utility was not considered more important than that of another. There was no attempt to correct
for the inherent inequalities of the capitalist system. On the contrary, neoclassical economists considered
that only free markets could bring about general economic well-being. Although Pareto demonstrated in his
sociological studies how a small segment of the population managed in all cases to take control of the
greatest part of the wealth, and claimed that this was unfair, his economic model did not correct for this
inequality, accepting this unfair distribution of wealth as inevitable. John Stuart Mill sought to correct for
inequality and therefore could be considered as a precursor to the Welfare Economics movement. But
whereas J. S. Mill separated the two spheres, Welfare Economists generally focus on how the political and
legal system influences the economic system.
The Welfare economists of the 20th century tended to favor more equitable distribution of wealth and sought
the institutional means to correct for market failures. Contrary to neoclassical conceptions of welfare, 20th
century economists have generally adopted a Min-Max model38 in which overall welfare is maximized when
the utility is the greatest for those who have the least. But in order to correct market induced inequality, it is
necessary first to measure it. Some have attempted to measure factors other than simple GDP per capita to
understand overall well-being, social or quality of life factors. The Human Development Index (HDI), for
example, depends on per capita income, life expectancy and level of education, and was one of the
instruments developed for the UN by Welfare economists such as Amartya Sen. Some economists have also
used life satisfaction to measure what behavioral psychologists and economists call experienced utility. In
particular, welfare economics has focused on how economic resources are distributed. The GINI index is a
statistical tool which allows economists to measure how income (measured as GDP per capita) is distributed
in a national economy; a GINI of 0 indicates that income is distributed perfectly equally, everyone receiving
the same amount, and a GINI of 100 indicated perfect inequality in which all revenue is received by one
person. In Norway, for example, where incomes are very similar from one family to the next, the GINI index
is around 25. In France, where the State attempts to redistribute wealth to alleviate poverty, the GINI is
about 33. In the United States and Brazil, where the rich are extremely rich and the poor are extremely
poor, the GINI is around 50. In South Africa, the country that has one of the most unequal distributions of
wealth, the GINI index has reached 65. Not only is the measure of income inequality a question of social
equality, it is also a question of efficiency. More and more economists are suggesting that the widening gap
between the rich and poor is not only unfair, but it is also inefficient and jeopardizes general economic
growth.

38

Also called a Rawlsian utility function because of the philosopher of justice, John Rawls (1921-2002) who inspired it.
See A Theory of Justice (1971).
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Most work in Welfare Economics stems from the ground-breaking work of Kenneth Arrow (b. 1921), and in
particular his Social Choice Theory and the General Impossibility Theorem as outlined in Social Choice and
Individual Values (1951). He demonstrates that it is impossible for individuals who act perfectly freely to
choose collectively perfect equality. This model is often explained using the example of a cake to be divided
between 3 people (A, B and C) who have to face the following 4 choices:
Choice
Choice
Choice
Choice

1:
2:
3:
4:

A gets nothing, B and C get half each.

B gets nothing, A and C get half each.
C gets nothing, A and B get half each.
divide the cake equally.

If they were asked to rank these choices, and we assume that they all act in their own personal interest,
they will all always rank choice 4 (the most equitable) second to last, just behind the choice in which they
get nothing. In this way, they will never collectively choose this option, and therefore Pareto Optimum can
never be achieved. Based on this principle, many Welfare Economists suggest that the government, or other
institution, should redistribute income in order to obtain greater equality, or at least better efficiency.
Arrow is also known for his pioneering work on Asymetric Information. In most negotiations, one party has
more information than the other. In general, the producer or seller of a good knows more about the product
and the market than the buyer does, and therefore has a natural advantage in the negotiation. Arrow
examined this question in particular relative to the medical profession in America. Doctors know significantly
more about a patients health than the patient himself does, and therefore can lead him to take virtually any
decision he wants. In order to correct for asymmetric information, it is generally acknowledged that the
government or professional institutions would seek to impose norms and regulations which would protect
consumers from taking dangerous decisions. Car safety, for example, is tightly controlled by the
government, regardless of whether or not consumers prefer to have cheaper cars even if they are unsafe.
Such ideas, of course, are criticized by neoliberal economists who prefer total freedom. This notion of
asymmetric information is vitally important in todays economy which is increasingly based on Information
and Communication Technology (ICT). It has been a central part of Joseph Stiglitzs work (see chapter on
neo-Keynesianism).
John Kenneth Galbraith (1908-2006) was a successful economist from Harvard who was particularly active in
government policy. He held various positions in the government, in particular in the Office of Price
Administration during WWII. He also served in the government of Harry S. Truman, but was particularly
influential under the J. F. Kennedy and L. B. Johnson administrations. His most famous works include
American Capitalism (1952), The Affluent Society (1958) and The New Industrial State (1967). Contrary to
neoliberal economists, Galbraith argued that America should make heavy investments in infrastructure, such
as roads, airports, and telecommunications networks, as well as in education, using funds derived from
general taxation. His argument differed from that of Keynes, however, for the goal was not to compensate
for a drop in private demand but rather to improve general economic well-being. Galbraith criticized the
assumption that continually increasing GDP is an indication of economic and social well-being. He
contributed to the economic and social policies of the US presidents J. F. Kennedy and L. B. Johnson and
their War on Poverty in the 1960s. In particular, by allocating resources to education, more individuals
could contribute in a more productive way to the economy, as well as gain individual advantages. Although
he never received a Nobel Prize for his work, he was by far one of the most widely-read intellectuals and
made economics a topic of discussion for common people. In many respects, his views and methods have
been taken up by Jeffry Sachs.
Jeffry Sachs (b. 1954) is an American economist who is Director of the Earth Institute at Columbia
University. Although having published numerous articles in academic journals, he is best known for his
bestsellers The End of Poverty (2005), Common Wealth (2008), and The Age of Sustainable Development
(2015). His main argument is that governments need to invest massively infrastructure to improve
transportation, irrigation, energy generation, and especially education, in order to maintain economic
growth. Contrary to the arguments of neoliberals, Sachs argues that such investments are in the common
interest, but that individuals and corporations will not make such investments on their own. It is therefore
the responsibility of the government to guarantee free education and health care, reliable telecommunication
and transportation networks, even if this means raising taxes. Concerning the extreme poverty in places like
Africa, he recommends that Western governments increase dramatically their foreign aid packages to
improve the health and economic prosperity of these regions who lack the resources to do so themselves. In
the end, he observes, it is in the economic interest of everyone to make such investments, which will
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eventually lead to greater international security and improved production and trading which benefits
everyone.
Another well-known economist of the movement is Amartya Sen (b. 1933). Born in British India (in a
province which is today part of Bangladesh), he was educated at Cambridge and held positions at Harvard,
and was awarded a Nobel Prize in 1998 for his contributions to Welfare Economics. In his works Collective
Choice and Social Welfare (1970) and Poverty and Famines: An Essay on Entitlement and Deprivation (1981)
he demonstrates how free market mechanisms do not always function in the most equitable or efficient way.
He was particularly influenced by the Bengal Famine of 1943 which he witnessed as a boy and during which
3 million people died. Studying the famine later, he observed that it was caused by an economic boom, not
because of a lack of food. Economic growth caused urban wages to increase, and therefore also food prices.
Wages for rural workers, however, did not keep pace and they were unable to purchase necessary supplies.
Inflation was exacerbated by military purchases and hoarding. There was an adequate supply of food, but
the economic mechanisms put certain wage-earners at a serious disadvantage, causing an unnecessary loss
of life.
Much of his research led him to the conclusion that liberty can be defined in two ways, summarized in his
capabilities approach. He differentiates between positive freedom (having the real means to act) vs.
negative freedom (not being impeded). For example, an individual may be allowed to vote, but may not
have the financial or physical means to get to a voting center or may be incapable of reading the ballot. In
economic terms, an individual may be allowed to work if he chooses, but may never have received the
training necessary to find employment. It is only in a situation when individuals have the real means to act
that they can be said to be free. Therefore, neoliberal models that always associate capitalism with freedom
are erroneous unless conditions are present to create positive freedoms (free public education, etc.).
Recently, many economists have noticed with great concern rising income inequality, particularly in America.
Because health care and education are in the private sector, only the wealthiest members of society have
access to them, thereby further deepening the gap between rich and poor, and even leading to great
inequalities in life expectancy. The presidential campaign in America which is currently underway has
spotlighted Bernie Sanders, a self-declared socialist, who is calling for greater income equality, free
university education and a public health-care system. Most economists today recognize that the rising gap
between the rich and poor in America is not only unfair, but is unattainable and may potentially lead to the
collapse of the American economy. Indeed, Jeffry Sachs was a vocal advocate of the Bernie Sanders
campaign. It is unlikely, however, that a political system in which campaign financing remains limitless and
secret will ever elect a candidate whose platform is based on redistributing the wealth.

70

9. B. New Institutional Economics

Founded by Ronald Coase, Oliver Williamson and Douglass North, New Institutional Economics focuses on
the importance of economic and non-economic institutions in the development and performance of the
economy. The International Society for the New Institutional Economics held its first meeting in St. Louis,
Missouri (USA) in 1997. Until this school of thought, most economists focused on the role of government as
the only institution that had an impact on the economy. Other than the government, all economic agents
were considered individuals. These economists have noticed that many economic, social, cultural and
religious institutions also have a major impact on economic behavior and structures.

The first to make this argument was Ronald Coase (1910-2013). A British citizen trained at the London
School of Economics (LSE), he carried out most of his career at the University of Chicago. He received the
Nobel Prize in 1991 for his ground-breaking work which examines the institution of corporations. His short
but very influential article, The Nature of the Firm (1937), attempts to explain why there are so many
business firms in the economy, instead of a multitude of independent, self-employed people who establish
contracts with each other. He argues that production could theoretically be carried out without any formal
organization, and explains that corporations and firms exist as a way to reduce transaction costs.
The argument begins with an analysis of the relationship between an entrepreneur and hired labor, since it
is possible to carry out production by outsourcing production rather than hiring employees to carry out
particular tasks. Theoretically, because the market is "efficient" (that is, those who are best at providing
each good or service most cheaply are already doing so), it should always be less expensive to outsource to
contractors than to hire employees. According to Coase, however, outsourcing generates transaction costs,
such as search and information costs, bargaining costs, maintaining trade secrets, and policing and
enforcement costs, all add to the overall cost of contracting with outside parties. Firms arise, therefore, to
reduce these costs by internalizing the production of goods and services.
In certain circumstances, however, it is more efficient to outsource activities, particularly when these
activities increase overhead costs and lead to mistakes in resource allocation. Firms tend to find the optimal
balance between internal and external activities for their sector and market. Many firms outsource
marketing activities (marketing research, advertizing, etc.), auditing, training, but some also outsource
production activities to limit the firms responsibility for workers (Nikes use of child and forced labor in
Indonesia, for example). In general, however, the law of diminishing returns (Ricardo) holds true: increasing
the size of the firm initially carries many advantages, but these advantages diminish as the size of the firm
increases. This prevents firms from growing indefinitely.
The obvious problem with this theory concerns social costs, or externalities, since the only costs considered
are those that are internalized by the firm. Attributing responsibility for externalities, for the firm to
internalize the costs formerly transferred to the community, changes according to legal, social and political
considerations, not purely economic.
Oliver E. Williamson (1932 - ), a student of Coase, who also went on to win the Nobel Prize in 2009, worked
primarily on transaction cost economics. In particular, by focusing on equivalences and differences between
market and non-market decision-making and management, Williamson was extremely influential in debates
on the boundaries between the public and private sectors that took place in the 1980s and 1990s.
Williamson distinguished between repeated case-by-case bargaining on the one hand and relationshipspecific contracts on the other. For example, the repeated purchasing from a market to meet the daily or
weekly needs of a company would represent case by case bargaining. But over time, a buyer is likely to form
ongoing relationships with a specific supplier, and the economics of the relationship-specific transactions will
be significantly different.
Another American, Douglas North (1920 - ), who won the Nobel Prize with William Fogel in 1993, is known
for his historical analysis of the evolution of a multitude of institutions that affect economic phenomena.
North defines institutions as humanly devised constraints that structure political, economic and social
interactions. These constraints can take the form of formal rules (constitutions, laws, property rights) or
informal restraints (sanctions, taboos, customs, traditions, code of conduct), which usually contribute to the
perpetuation of order and safety within a market or society. The degree to which they are effective is
subject to varying circumstances, such as a governments limited coercive force, a lack of organized state, or
the presence of strong religious precept.
71

Like Marx, North explains that economic development in society occurs in different stages. In a village, for
example, there is little specialization and most households are self-sufficient. Exchanges take place on a
small scale and within dense social networks of informal constraints, limiting the need for explicit trade
agreements and contracts. In time, production becomes more specialized, markets grow and regions
become interconnected. As the parties of a transaction become more geographically and socially distant, the
terms of exchange must be made more explicit. This increases transaction costs and makes it necessary to
develop institutions and formal trading centers to reduce the risks of being cheated. It also makes it
necessary to adopt standard weights and measures, and trading practices.
Economic development creates social capital and enables citizens to gain wealth. Technology plays an
instrumental role in the continued development of manufacturing sectors, and acts to lower transaction costs
in several ways. The most significant benefits are usually generated by improvements in transportation. The
final stage of development consists of dense urbanization. The transaction sector (distribution, marketing,
control, retail, etc.) becomes highly specialized and occupies a large percentage of GDP. Globalized
specialization and division of labor demand institutions to ensure property rights. North does recognize,
however, the importance of informal constraints that affect economic behavior.

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9. C. Behavioral Economics

In the post-war era, industrialization had reached a level in which companies could produce far more than it
was possible to consume. Prior to the mid 20th century, it was generally recognized that most goods, once
produced, could be liquidated (see Says law). In the second half of the 20th century, companies began to
lead market research to be sure that the products they were producing would match demand, and then lead
marketing campaigns in order to influence consumers decisions to purchase their products. They identified
markets by age, gender, income, educational background, ethnic origin, religion, etc. and identified the
economic behavior that corresponded to each group in order to sell them the greatest number of products
and make a maximum of profits. This led economists to begin to investigate the behavior of economic
agents in their economic analysis.
Behavioral economics revolutionized economic theory, but primarily from a methodological stand point. Until
then economic theory was based on observation of the outside world, either contemporary or historical. It
was non-interventionist, a bit like astronomers who watch the stars. But all economists since Adam Smith
assumed that economic agents acted in their own personal interest and could correctly calculate maximum
utility. Since this assumption is grossly inaccurate, some economists have sought to examine how economic
agents actually do react in different circumstances. They therefore place individuals in controlled
experiments, sort of like chemists who isolate different chemicals to observe their reactions in different
circumstances. Students of the University of Montpellier can participate in such experiments organized by
their professors who are interested in understanding how they take decisions regarding consumption,
production and trading.
On an intellectual level, this school of thought was largely inspired by behavioral psychology. In fact, it was
started when Ward Edward (1927-2005), an economist, attended a conference on psychology, the results of
which were published in a journal of psychology in 1954.39 Basically, behavioral economists attempt to bring
into question the neo-classical assumption of homo oeconomicus, that economic agents are rational and
calculating maximizers, that they always seek their own interest and that they have the information and
ability to do so.
Some of the most active scholars in the field are actually trained psychologists, such as Daniel Kahneman (b.
1934)40, who won the Nobel Prize in 2002, and his close collaborator Amos Tversky (1937-1996)41.
Examining human behavior in their economic activity, they have demonstrated that economic agents do not
at all react as economists have always assumed. They also collaborated with an economist Richard Thaler
(b. 1945)42 and together demolished the basic premise on which all economic theory had been based for the
last two centuries.
Using notions from hedonistic psychology (Bentham and the marginalist economists), they demonstrate how
complex the process of determining what makes an experience pleasurable or not. They also use advances
in heuristics (the science of the learning process) to understand how individuals take decisions with limited
or over abundant information. For example, the manner in which people predict the frequency of events or
phenomena, or the proportion of a population, is based on the ease with which they can imagine it, which is
largely based on that individuals personal experience rather than on data.
Behavioral economists have also replaced the basic notion of expected utility of classical economics with
prospect theory. Classical economics attempted to measure expected utility, whereby a person takes a
decision by comparing the possible gain with the risk involved. Prospect theory allows economists to
integrate the process by which individuals analyze probabilities in decision-making. For example, studies
show that people spend money more easily when it is won in a game or the result of some good fortune,
than when it was earned through a wage increase. According to classical models, there would be no
difference between the two types of money when evaluating the utility of a product.

39

"The Theory of Decision Making" (Psychological Bulletin, 1954).

40

Judgment and Effort (1973), Judgment under Uncertainty: Heuristics and Biases (1982), Choices, Values and Frames

(2000).
41

Foundations of Measurement (3 vols.).

The Winners Curse. Paradoxes and Anomalies of Economic Life (1992), Advances in Behavioral Finance (1993 &
2005), Quasi-rational Economics (1994).
42

73

Behavioral economists have also found that people also tend to overestimate low probabilities, leading them
to take out insurance policies for natural catastrophes which are extremely rare, and underestimate high
risks, making them believe that they do not need health insurance or a retirement plan. People are more
likely to play the lottery, for which there is an extremely low probability of winning, and less likely to gamble
in a casino where success rates are higher.
In classical economic theory exponential discounting (or discounted utility) suggests that the utility of a
decision changes value relative to the time necessary to realize the advantage. In Behavioral economics,
Hyperbolic discounting. Makes this process even more complex. For example, people generally prefer to win
$100 today rather than receive $110 in one week. Yet, people also generally prefer to receive $110 in 11
weeks rather than $100 in 10 weeks, even though the lapse of time is the same in both cases. Conversely,
people often prefer to wait to take advantage of certain pleasures. For example, people prefer a job that
provides a continually increasing salary, rather than one which offers a high salary immediately, even when
they would earn more in the long term under the second scenario.
According to classical theory, in each transaction, parties arrive at a state of equilibrium in which utility for
each is equal. Similarly, markets find natural equilibrium between supply and demand. In reality, people
adopt repetitive commercial and consumption practices, even if the result (utility) is not optimal. People
compare prices and quality of different brands a first time, then always buy the same brand, whatever the
evolution of its price or that of the competing brands. This is known as Experience-weighted attraction.
Perhaps most importantly, behavioral economists have demonstrated that individuals are not crudely
calculating maximizers, and are driven by a sense of Social utility. Classical theory assumes that individuals
seek to maximize their gain whatever the effect on others, even though Adam Smiths first work, Theory of
Moral Sentiments, clearly argues that all people are generally sympathetic and demonstrate to some degree
selfless generosity towards others. Laboratory experiments organized by behavioral economists have shown
that participants in a game who won the first rounds tend to help other players who have not had as much
luck in the game, without receiving any clear or predictable advantage. On the other hand, people generally
tend to accept a loss if someone else, who caused them to lose in the past, will lose even more.
Economists try to diminish the importance of these innovations by arguing that even if the fundamental
assumption of homo oeconomicus is false, it makes it possible to elaborate theories that give correct results.
They also claim that it is impossible to integrate the complexity of human behavior in the mathematical
models of economic analysis. Others criticize behavioral economics because it assumes that human nature is
innate. Behavioral economists do not sufficiently take into account sociological and cultural factors that
create subjectivity. They also tend to analyze behavior patterns in a static manner, not taking into account
how quickly an individuals behavior can change in different circumstances.
In any case, such theories have very profound implications for society. If it is assumed that individuals do
not always take decisions that are in their best interest, it is possible to argue that government should
intervene to protect them from themselves. This is the basic principle behind the recent work Nudge (2008)
by Richard Thaler and legal scholar Cass Sunstein (1954 - ). Since people are often optimistic and generally
dont save enough money for retirement or properly calculate their probability of falling ill, it is in everyones
interest that the government encourage them to make the right decisions through a system of incentives.
Such a view has great implications for political freedom and constitutionality. To what extend is a
government allowed to take decisions for individuals, even if it is possible to argue that it is in the
individuals best interest? In a constitutional democracy, can the government force people to do exercise or
forbid certain types of food, ban smoking, etc.?

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10. A. - Neo Keynesianism

This school of thought stemmed from critiques of Keynesian economics by neo-liberal economists and
attempts to provide a new microeconomic foundation for many of Keyness theories. New Keynesian
economists assume that markets have a number of weaknesses, for example unregulated markets generally
lead to less competition, not more. These failures of the market to regulate itself require government
intervention to steer the economy, in particular through fiscal and monetary policy, but also through other
legal and political mechanisms, in order to reach maximum efficiency.
Joseph Stiglitz (b. 1943) is professor of economics at Columbia (New York) and former Chief economist of
the World Bank. He won the Nobel Prize in 2001 and is one of the most influential economists alive today
both in intellectual circles and among average citizens. Stiglitz is known among economists for his research
on Information Economics. He examines the technique of screening, which economic agents use to extract
information from other parties. Since the ability to do so is not equal among all parties in an exchange, there
arises a situation of asymmetrical information, already studied by Kenneth Arrow.
Tradition neoclassical paradigms assumed that markets were efficient except in some limited ways which
lead to market failures. Stiglitz and other neo-Keynesians claim that markets are only efficient in exceptional
circumstances. Whenever information is asymmetrical (which is practically always), competitive markets do
not lead to a Pareto optimum. Governments therefore have a role in steering the economy towards optimal
efficiency. According to Stiglitz:
Whenever there are "externalities"where the actions of an individual have impacts on others for which
they do not pay or for which they are not compensatedmarkets will not work well. But recent research
has shown that these externalities are pervasive, whenever there is imperfect information or imperfect risk
marketsthat is always. The real debate today is about finding the right balance between the market and
government. Both are needed. They can each complement each other. This balance will differ from time
to time and place to place.

Because of asymetric information, totally free markets are not only socially unjust, but also do not lead to
economic efficiency, thus totally in contradiction to classical and neo-classical economic theory.
With Carl Shapiro, Stiglitz also worked on efficiency wages, through the Shapiro-Stiglitz model which helps to
explain 1) why unemployment exists even in economic equilibrium, 2) why wages are never negotiated
sufficiently low (in the absence of minimum wages) so that everyone who wants a job finds one, and 3) to
question whether the neoclassical model can explain involuntary unemployment. In 1984, these two
economists argued that the information structure of employment determines to a large extent the level of
unemployment. This analysis is based on two fundamental observations. First, unlike other forms of capital,
humans can choose their level of effort. Second, it is costly for firms to determine how much effort workers
are exerting.
This model explains certain phenomena:
1. Wages do not fall enough during recessions to prevent unemployment from rising. Falling demand
for labor decreases wages, but in a context of low wages, workers tend to exert less effort
(shirking). In order to maintain employment levels, wages would have to be negotiated down, but
this would produce higher rates of shirking and workers would be less productive than before. As a
consequence, in this model, wages do not fall enough to maintain employment levels at the previous
state, because firms want to avoid excessive shirking by their workers. Therefore, unemployment
must rise during recessions, because wages are higher than what the market would generally allow.
2. Sticky wages or wage sluggishness. In order to readjust wages to the market, it would be necessary
to renegotiate contracts on a regular basis and hire new employees who offer their labor at lower
rates. Yet this renegotiation, as well as the hiring of new employees, costs firms money which must
also be taken into consideration when considering readjusting wages. Firms, therefore, cannot cut
wages until unemployment rises sufficiently to make it possible to lower wages to a level which
would make the negotiation costs worthwhile.
The outcome is never Pareto efficient. Indeed, firms do are not directly responsible for the social cost of high
unemployment rates. On the contrary, firms generally benefit from a context of high unemployment because
it allows them to negotiate wages at very low levels. In other words, the marginal social cost high
unemployment generates a direct advantage for firms, thereby generating a negative externality.
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These economic theories have clear implications for economic policy-making, in particular relative to the
internalization of externalities. Stiglitz is, for example, a fervent critic of laissez-faire policies that allow
multinational corporations to exploit the resources of poor countries, to the detriment of the environment
and to the people. Although Stiglitz's main economic arguments are generally accepted as correct, they do
not consider broader questions about the legality, ethicality or constitutionality of coercive government
institutions and what the relation between the government and civil society should be. His most recent
books include the Price of Inequality (2008) and The Great Divide. Unequal Societies and What We Can Do
About Them (2015), which analyze the causes and impact of the widening gap between the rich and the
poor in America.
Another very influential neo-Keynesian is Paul Krugman (b. 1953), in particular in the realm of finance. In
1979, he demonstrated that fixed exchange rate regimes will unlikely come to an end without upsetting
markets. Instead, terminating these regimes usually leads to speculative attacks. Later, after witnessing the
global financial crisis of 2007-2008, Krugman suggested that multiplier effects also applied to international
finance. Financial institutions are very fragile when they are highly leveraged. In times of economic
downturn, even in only one sector, these firms are required to sell their international assets, thereby
depressing prices. This asset deflation puts pressure on the balance sheets of other firms. This creates a
snowball or multiplier effect that severely depresses financial markets.
Prior to Krugman's work, trade theory emphasized trade based on the Ricardos comparative advantage of
countries with very different characteristics, such as a country with a high agricultural productivity trading
agricultural products for industrial products from a country with a high industrial productivity. However, in
the 20th century, more and more trade occurred between countries with very similar characteristics, which is
difficult to explain by comparative advantage. 1979, Krugman published an explanation involving two key
assumptions: first, that consumers prefer a diverse choice of brands, and second, that production favors
economies of scale. Consumers' preference for diversity explains the survival of different brands of cars like
Mercedes and BMW. However, because of economies of scale, it is not profitable to spread the production of
BMWs all over the world. Instead, it is concentrated in a few factories and therefore in a few countries (or
maybe just one). This logic explains how each country may specialize in producing a few brands of any
given type of product, instead of specializing in different types of products. This specialization can possibly
lead to disadvantageous patterns of trade, economic dependency on particular industries and in certain
cases environmental degradation.
Krugman's theory also took into account transportation costs, which would later feature in his work on the
new economic geography. The home market effect states that, ceteris paribus, the country with the larger
demand for a good will, at equilibrium, produce a more than proportionate share of that good and be a net
exporter of it. Krugmans study of New Trade Theory eventually led him to develop theories on New
Economic Geography (NEG). The home market effect will cause certain regions to produce more of a
particular good and, thanks to economies of scale, these regions will produce more efficiently and attract
ever more production. This suggests that production will become increasingly concentrated in certain regions
will also attract migration and become more populated, thereby increasing demand. In other words, the
result of the interaction between increasing returns, trade costs and price differences will lead to
agglomeration.
Krugman is perhaps best known, however, for his highly published opinions regarding macroeconomic and
fiscal policy (he is a columnist for the New York Times and a very prolific blogger). Building on Keyness
theories regarding liquidity traps, he recommends innovative methods for injecting liquidity into markets in
order to stimulate production and exchange. In line with Keynesian economics, he also recommends
increasing government debt in order to invest in the countrys infrastructure and innovation which usually
lead to increased economic activity, thereby generating wealth, a portion of which will return to the
government in the form of taxes.

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10. B. Wikinomics
At many stages in history, it has been demonstrated that technological progress brings major innovations
and changes in society or the real economy, and therefore also in economic theory. The current situation,
with the dawn of a new information age, is no exception. Computers started to be developed in the second
half of the 20th century, but the real economic impact of computer technology began in the first years of the
21st century when personal computers were accessible to large numbers of people, and especially connected
through the internet. By making peer-to-peer communication and international bank transfers easier, the
internet has dramatically reduced transaction costs. Ronald Coase has argued that high transaction costs
drive corporations to hire employees directly rather than outsource production. The internet, by lowering
many of the costs, makes it possible and cheaper to hire subcontractors not only outside of ones company,
but also in other countries.
The pioneer of the field is the Canadian Don Tapscott (b. 1947). Although trained in psychology and
statistics, Tapscott is a leading contributor to our understanding of the economy in a digital world. His works
include Macrowikinomics. Rebooting Business and the World (2010), Wikinomics. How Mass Collaboration
Changes Everything (2006), Creating Value in the Network Economy (1999). In essence, Tapscott argues
that Information and Communications Technology (ICT) is transforming the corporate landscape by radically
reducing the transaction costs and by allowing companies and individuals to work together in new ways. The
advent of this new Technology coincides with the collapse of global economy in 2008. Traditional methods of
doing business, in particular the hiring of employees to carry out most aspects of production, has become
inefficient. Large corporations have either failed, for example General Motors which had to be bought out by
the US government to avoid bankruptcy, or innovated the way it organizes itself. For example, Proctor and
Gamble (P&G), the world leader in household chemicals with net annual turnover of over $83b, which was
founded in 1837, regularly hires engineers from outside its staff to find develop new products. Although
Tapscotts work is primarily intended for businesses who seek to modernize their operations to make a
profit, it has clearly laid the foundations for a new school of thought, or at least a new branch of New
Institutional Economics, which takes into consideration the impact of ICT on transaction costs, corporate
structures and the overall economy.

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10. C. Environmental Economics

Economic theory can also be influenced by environmental factors. It has become clear today that human
economic activity is leading to global warming. In particular, the production and consumption of fossil fuels,
on which much of todays economy relies, releases greenhouse gases into the atmosphere. The result will be
rising temperatures in much of the world and radically modified weather patterns. Agricultural production is
the most exposed to such shifts in weather. Drought in some regions and heavy rainfall in others, will lead
to widespread starvation and malnutrition, especially in Africa and India. Biodiversity is also threatened by
rising temperatures and economic practices or individuals who have no economic interest in preserving it.
Environmental economists seek the ways to encourage corporations and consumers to adopt behavior which
will ultimately lead to a healthier environment and more sustainable economic growth. Pavan Sukhdev (b.
1960) is one of the leaders in the field. Born in India and educated in Switzerland, the US and the UK, he
has led an impressive career in finance, notably for Deutsche Banks operations in the developing world.
Among other posts, he was appointed leader of a study group on The Economics of Ecosystems and
Biodiversity (TEEB). He is also the initiator of the Corporation 2020 initiative which seeks to help
corporations redesign their structure in four key areas (reporting, leveraging, advertising and taxation) in
order to adopt behavior that will lead to a better environment.
Basically, Sukhdev highlights that, under the current paradigm, most producers have no economic interest in
preserving the ecosystem. On the contrary, many have a clear interest in carrying out activities which are
detrimental to the environment, and which lead to massive negative externalities. Although it is easy to
demonstrate the value of the ecosystem for the global economy, it is difficult to capture this value in a way
that would encourage economic agents to protect the environment. For example, the owner of land on
which there is a section of the rainforest in Brazil has every economic interest in uprooting the trees, which
in fact bring him no wealth, and raising cattle, and activity which could be very lucrative. The loss of trees
and the consequent negative effect on the global climate is so widely shared that it is easily outweighed by
the direct reward of raising cattle for the owner of this land. The example offers a clear argument against
Smiths hypothesis that personal interest inherently leads to the common good, which is a fundamental
component of liberal economic views. If, however, this land owner could be paid to preserve the rainforest
on his land at a value similar to that of raising cattle, he would probably opt to keep the trees, rather than
take the risk and engage the effort necessary to raise cattle. Rather than the current model which generally
seeks to punish people for causing undue harm to others, Sukhdevs paradigm is based on the principle of
rewarding those who act responsibly. The problem is finding ways to canalize the funds necessary to
incentivize such economic agents to make decisions that are beneficial to the community rather than just in
their own personal interest.

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