Economic thought in American Landscape and Completion & Criticism of Classical Thought

Lecture 9 Prepared for Developments Theories and Perspectives course

Reviewing the personality of Money

In the beginning money was a commodity like any other. It served two purpose facilitate exchange and holding wealth. Any commodity to be used as money must have two characteristics:
It is non-perishable and can be divided into parts of specified weight. It has to have high enough worth in small enough bulk.

The separate identity of money was discovered with the establishment of banks in Italy in the thirteenth century. When Banks start lending men will be provided metals or checks that are based on a general claim on the total stored metal, and money had been created.

 (cont.)
Money creation further enhanced as some banks will enable borrowers to take his loan in bank notes. Though total notes and deposits in checks were in excess of the value of the metal, it was acceptable. Central banks were established to arrest the temptation of creating excessive money by the banks. And the central bank do this in two means first, by forcing smaller banks to made payment their notes with metal and second, by enforcing minimum level of metal reserves against deposits. So, a mechanism is established through banks by which the supply of money could be increased or sharply diminished at will.

 (cont.)
The final step in the discovery of the separate personality of money was the realization of prince and parliaments that the creation of money could be used as a substitute for taxes or as an alternative to borrowing. This discovery has an important political consequence continental notes by the Washingtons Armies, the assignats that helped finance the French Revolution, and the Greenbacks of the American Civil War were all issued by future governments even in absence of central bank. The quantity theory of money: P = (MV+M`V`)/T in the short run, an increase in M and M` directly affects the level of prices as V and T remains constant.

Refinements of Economic Thought

Tariff
Alexander Hamiltons Report of Manufactures sharply criticized the virtues of free trade saying the interest of a young country does not comply with the interest of a mature country. Henry Clay and Henry Carey would vigorously add to his case. But the South which is agriculturally dominant was against the protectionist policy. The tariff produced an embarrassing surpluses in the federal treasury. In 18 of the 21 years between 1815 and 1836, the budget was in surplus and by the last year, the federal debt was extinguished. This surplus was largely used to build a large military to fight with Europeans.

 (cont.)
Scientific tariff became the norms in USA in the name of protecting American standard of living from cheap imports. But from the beginning of 20th century, American economists took an adverse position on tariff in all the reasoning, the free trade is right. As global economy entered in Great Depression in late 1929, USA promulgated Smoot-Hawley Tariff Act of 1930 (tariffs increased in the range of 40 to 50 percent of import value) to protect jobs and farmers from foreign competition. Around 1028 economists united in an unsuccessful plea to president to veto the bill. Similar retaliatory tariffs by US trading partners reduced American exports and imports by more than half. This is now known as beggar-thy-neighbor policy.

 (cont.)
beggar-thy-neighbor policy is an economic policy through which one country attempts to remedy its economic problems by means that tend to worsen the economic problems of other countries. During and after second world war, American economic thought provided unanimous support for lower tariff and liberal trade regulation. The outcome is GATT in which major industrial countries would surrender some of their tariff setting power. However, in the 1990s and 2000s with the rise of Japanese, Korean and Chinese industrial competition, some economists would call for protection for some ailing industries. And they would find a new mechanism other than tariff an industrial policy with support,

Monopoly
After the civil war, many companies set up informal competition where output and prices are fixed and thereby accruing a certain amount of profit. Also some large companies like Standard Oil lowered kerosene price and take losses to eliminate local unaffiliated firms.

These aggressions led the passage of Sherman Act of 1890 - it prohibits certain business activities such as cartel and monopoly that reduce competition in the marketplace. Classical orthodoxy about competition is embraced not in Europe but in America.
But the increasing industrial concentration in USA remained hotly debated issue.

 (cont.)
In 1933, Edward H. Chamberlin and Joan Robinson argued that - between the general case of competition in the classical system , where no producer influenced or controlled his price, and the exceptional case of monopoly, where a single seller could set his price to maximize return, there was an array of intermediate possibilities. How? - The seller might have a distinctive brand for which there could be no exact substitute. This give the firm a limited but not necessarily insignificant ability to control the price. The firm can enhance his ability by advertising and deepening brand loyalty. This would now be called monopolistic competition.

 (cont.)
But in goods where brand loyalty is not an issue, there could be small number of firms in a sector. For these firms, price and profit are not significantly different from those of monopoly. The industries in oligopoly achieve this by setting a price that is the most profitable price for all. So, oligopoly requires intelligence and restraint. This enforced that the socially optimal price and output of competitive market does not hold for industrial economy in reality. Only the most defenders of classical orthodoxy the Chicago School resisted them and still believe in theoretical perfect competition.

Taxation
Henry Ward Beecher (1813-1887) God intended the great to be great and the little to be little. He was an apostle of Herbert Spencer. Sumner He was strongly in support of education and libraries as instruments of public enlightenment and social well being. But he opposed anything that subtracted from the income of the rich as well as any policy to uplift the poor. Henry George Single Tax on the accidental and unjust enrichment that come from the ownership of land.

Birth of Institutional Economics

Thorstein Veblen (1857-1929)

He established himself as a critic of the classical system. the central ideas of the classical system did not reflect a search for truth and reality; rather they were and are a celebration of approved belief. Economic theory is static in tendency, as is religion, but economic life is evolutionary. Theory of Business Enterprise Veblen employed his evolutionary analysis to industry. He saw them as a consequence of the growth of small business firms. The new industrial system provide lucrative opportunities for those who managed it and therefore conflict arises between businessmen and engineers, with businessmen representing the older order and engineers as the innovators of new ways of doing things.

 (cont.)
The Instinct of Workmanship Artisans motivation for his performance: I take pride in my work.

The Higher Learning in America The academic curriculum in University was kept on a close rein by the business interests ruling through board of trustees.
The Theory of Leisure Class the term leisure class is synonymous with the rich. The chief activity of the leisure class was "conspicuous consumption", and their economic contribution is "waste," activity that contributes nothing to productivity.

Joseph A. Schumpeter (1883-1950)

In the book - The Theory of Economic Development, he told that entrepreneur is the central figure in Capitalist system. The entrepreneur aided by bank credit, challenges the established equilibrium with a new product, a new process or a new type of productive organization. The result is to a new equilibrium. This new equilibrium would inevitably be disturbed and broken by the next innovator. And in this way economic life would continue and enlarge and this is the nature of economic development.

He also argued that the new innovation should be given monopoly because this was the way innovation is best financed, encouraged and rewarded.

Birth of Socialism

Emergence of an alternative system

After 1917, the new fact in economics was the existence of an alternative system socialism. In 1919, Lincoln Steffans visited Russia I have been over into the future and it works. Distinct characteristics of socialism
Private property ceased to exist The market no longer decide what to produce

Men and women would no longer work for selfenrichment; they would toil for the common good.

 (cont.)
But the chief problem was as Lenin correctly identified the bureaucratic structure that was needed to manage the process was heavy and could be inert and depressing which was the key reason for the fall of Russia. Emergence of socialism was a warning to capitalist system that revolution could occur. The suffering of great depression worsen this fear. This would motivate some economists to reform the classical system and introduce various social protection schemes to reduce the temptation of socialism. However, some economists saw this reform as a step toward Soviet reality similar path to serfdom.

 (cont.)
Lord Kaldor (1908-1986) He prepared the Beveridge Report the great postwar design for the British welfare state. And to finance this, he advocated progressive tax policy, including the taxation not of personal income but of personal expenditure the expenditure tax which has the effect of exempting savings and investment from levy. Ludwig von Mises (1880-1973) and Freidrich A. von Hayek (1899- ): Socialism, if one considers the variety of human wants and the complexity of the capital and labor structure for satisfying them, is a theoretical impossibility. And the social protection schemes hampers the human spirit of self enrichment.

Questions