History of Economic Thought

Lecture 1& 2
Pre-Classical Economics
Mercantilism & Physciocrats
The History of Economics

 Paralleling the evolution of the economy,

economics also constantly evolves.
 But economics is not a neutral science.
 Economic theories and ideas always
incorporate values and ideologies.
 They all aim to criticize or justify particular
economic arrangements, not just explain them.
 And economics responds to the problems and
controversies experienced in the economy.
The Politics of Economics
 There is no objective “truth” in economics.
 Economic theory has always tried to keep up
with changes in the economy.
 Economic debates have always reflected real-
world conflicts and struggles.
 Economics today is used to defend the
system.
Joan Robinson: “The purpose of studying
economics is not to acquire a set of ready-
made answers to economic questions, but to
learn how to avoid being deceived by
economists.”
 Main Periods in the History of
Economics
Pre-Classical (up to 1750)
Classical (1776-1870s)
Marginal Revolution (1870s-1890s)
Neoclassical Economics (1890s-to date)
Keynesian revolution (1936-1960s)
Formalist Economics (1945 to date)
Before Adam Smith: Pre-Classical
Economics

Pre-Classical Economics (18th century and earlier). The economic

knowledge that existed prior to the emergence of the Classical
School came from three main sources:
 Everyday experience
 Scholastic moral philosophy
 Mercantilist writings
 
Commonplace economics. Some economic ideas were so well
known even to common people that it makes no sense to try to
figure out who stated them first. Examples:
 
 Successive units of a commodity are less and less urgently needed
 Abundance reduces prices and scarcity increases them
 Demand is inversely related to price and supply is directly related
 More fertile and/or better-located land earns higher rent
 Trade occurs because natural resource endowments vary from
place to place
 
 Scholastic Economics. In the Middle Ages
(476-1453), some economic thinking was
carried out by Catholic priests and philosophers
teaching in the then emerging universities.
 Their initial motivation was to address ethical
issues related to economic activity.
 Thus philosophers of the Middle Ages
considered it their task not so much to describe
and interpret the way the economy works, but
rather to provide advice on morally
acceptable behavior in the field of
economic relations
Mercantilism. This school of economic thought arose in
England during the 16th through the 18th centuries. Many
of the contributors to this literature were merchants or
members of the mercantile class, hence the name. The
main themes of this literature were as follows:
 
 The ultimate objective of economic policy is the political
power of the state
 The power gained by one state is inevitably associated
with power lost by another state. Therefore, the interests
of nation states are perpetually in conflict.
 A nation’s power is measured by its population and its
stock of precious metals such as the gold and silver
embodied in the money in use at the time. A high
population could supply soldiers. Money (in the
government’s treasury) could pay for large armies and
navies.
 Population growth and a rich treasury could only come
from prosperous industry and trade.
 This prosperity could be brought about if the economy’s
 Mercantilism
• Mercantilism is an economic theory, thought to be
a form of economic nationalism
The prosperity of a nation is dependent upon its
supply of capital, and that the global wealth is
fixed. Trade was therefore always going to
produce winners and losers.
The theory assumes that wealth and monetary
assets are identical. Mercantilism suggests that
the ruling government should advance these goals
by playing a protectionist role in the economy by
encouraging exports and discouraging imports,
The theory dominated Western European economic
policies from the 1500s-late 1700s.
Economic assets = bullion (gold, silver, and
trade value), held by the state
Increased through a positive balance of
trade with other nations.
Mercantilist Policies
Creation of trade Monopolies
Colonization
Extensive Protectionism
Regulations on Domestic Production
Focus on Exchange, not Production
Large Working Class
 Mercantilist policies
• Every inch of a country's soil be utilized.
• That all raw materials found in a country be used
in domestic manufacture, since finished goods
have a higher value.
• Large, working population be encouraged.
• That all export of gold and silver be prohibited.
• All imports of foreign goods be discouraged as
much as possible.
• If imports are indispensable they be obtained at
first hand, in exchange for other domestic goods
instead of gold and silver.
• Imports be confined to raw materials.
• Opportunities be sought for selling a country's
surplus for gold and silver.
• That no importation be allowed if such goods are
supplied at home.
• England began the first large-scale integrative approach
to mercantilism during the Elizabethan Era (1558–1603).
"We must always take heed that we buy no more from
strangers than we sell them, for so should we
impoverish ourselves and enrich them. “

The period featured various but often disjointed efforts

by the court of Queen Elizabeth to develop a naval and
merchant fleet capable of challenging the Spanish
stranglehold on trade and of expanding the growth of
bullion at home.

These efforts organized national resources sufficiently in

the defense of England against the far larger and more
powerful Spanish Empire, and in turn paved the
foundation for establishing a global empire in the 19th
century.
Mercantilist thinkers
Thomas Mun (1571 – 1641)
- Initiated a shift of focus from bilateral positive b.o.p
to overall positive trade balance
- Advocated use of wasteland and idle labour to
produce imports (import substitution)
Fully utilize natural resources including
fisheries
- Export goods with inelastic demand—can charge
higher prices
- Reduce consumption of imports, particularly
luxuries
Mercantilist thinkers
Sir William Petty (1623 – 1687)
- His major contribution that holds relevance
for later thought is that he advocated the
use of statistical techniques to measure
social phenomenon.
- He worried about the 10% unemployment
rate. Similar to Keynes, he believed that
the government should intervene to
generate employment.
Mercantilist thinkers
Numerous French authors made French
policy around mercantilism in the 17th
century. This French mercantilism was
best articulated by Jean-Baptiste
Colbert (in office, 1665–1683)

Strongly advocated – (i) State regulation

(ii) promotion of
manufacture through subsidies and tariff
protection
Colbert
• Under Colbert, the French government became
deeply involved in the economy in order to
increase exports.
– Protectionist policies were enacted that limited
imports and favored exports.
– Industries were organized into guilds and monopolies
– Production was regulated by the state through a
series of over a thousand directives outlining how
different products should be produced.
– To encourage industry, foreign artisans and
craftsmen were imported.
– Favoured a large population, low wages and child
labor
Criticism and Decline
• Mercantilism fueled the intense violence of
the 17th and 18th centuries in Europe.
– Since the level of world trade was viewed as
fixed, it followed that the only way to increase a
nation's trade was to take it from another. The
unending warfare of this period also reinforced
mercantilism as it was seen as an essential
component to military success.
• It also fueled the imperialism of this era, as
each nation that was able attempted to seize
colonies that would be sources of raw
materials and exclusive markets. 
In Europe, academic belief in mercantilism
began to fade in the late 18th century,
especially in England, in light of the
arguments of Adam Smith and the classical
economists
Mercantilism never returned to popularity
among economists as the principles of
Comparative Advantage showed the gains
from international trade.
 Critics of Mercantilism
David Hume: specie-flow mechanism and
emphasis on trade restrictions as restricting
innovation
Physiocrats
- importance of agriculture
- Laissez-faire policy
Adam Smith
- Artificial stimulation of manufacturing and
trade (misallocation of resources)
- International specialization and mutual gains
from trade
Pre-classical thinkers
David Hume (1711 – 1776)
- Closest to Adam Smith’s ideas
- Precursor to the Nominative and Positive
distinction
 Major Contribution: Price Specie Flow
Mechanism
David Hume and the Specie-flow mechanism
Hume famously noted the impossibility of the
mercantilists' goal of a constant positive balance of
trade. As gold flowed into one country, the supply would
increase and the value of bullion in that state would
steadily decline relative to other goods. Conversely, in
the state exporting bullion, its value would slowly rise.
Eventually it would no longer be cost-effective to export
goods from the high-price country to the low-price
country, and the balance of trade would reverse itself.
Mercantilists misunderstood this, long arguing that an
increase in the money supply simply meant that
everyone gets richer.
 Physiocracy
Francois Quesnay (1694–1774) and his
followers are jointly referred to as the
Physiocrats.
The government’s support of
manufacturing and neglect of agriculture
along with rising Fiscal problems in France
provided a backdrop for the Physiocratic
thought.
They aimed to reorganize the French
economy by means of tax reforms and
by promoting a system of efficient large
scale farming.
EIGHTEENTH-CENTURY FRANCE
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 Physiocracy
Physiocrats believed in the Natural Law:
Only nature will give you more than you
started with “net produce”. All other sectors
are sterile.

The way to make agriculture most

productive (to maximize output) is to get
the government out of the way and let the
‘natural law” run its course.

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France (18th century)
Taxation was unjust/excessive and
inefficient
Agriculture was pre-dominantly feudal
Extensive tariffs and regulations - as a
result there was sluggish response to
changes in demand and supply.
Production was carried out in guilds which
were largely inefficient – this impedes free
entry into any occupation.
Physiocrat policies
Laissez faire, laisse passe
1. Abolition of guilds
- Guilds are seen as constraints to economic activity and
limit the freedom of the labouring class
2. Replace small scale agriculture with large
capitalistic farms
-replace tenant labour with hired labour
3. Replace all taxes with a single nation wide tax on
agriculture – based on the tax incidence argument
4. Less government intervention
State regulation slows internal commerce
5. Opposed the consumption of luxury goods –
hinders accumulation of capital goods
 Physiocrats
The physiocrats wrote spiritedly in favor of
reduced government intervention in the economy
and
free trade.
However, their support of free trade was
based not so much on an awareness of the
mutually beneficial nature of free trade but on
the belief that French farmers would benefit
from higher prices if they were allowed to
export their crops.
When agricultural exports were allowed, the
physiocrats were proven correct: prices of
agricultural goods rose.
Unfortunately, this led to social discontent and a
sharp fall in the physiocrats’ popularity in France.

26 EIGHTEENTH-CENTURY FRANCE
 Quesnay: tax incidence
 Quesnay contributed to our understanding of the
economic incidence of a tax.
 He argued that the multitude of taxes in France of
his time should be replaced by one tax on
agricultural income.
 As it was, all taxes were in the end being paid by
the agricultural sector anyway because, according
to Quesnay, it was the only sector in the economy
that produced a surplus
 The surplus is the excess of production over the minimum
amount of output needed to maintain the resources used
in production (subsistence).
 Therefore, the single tax would not change the
economic outcome in any way; it would only have
the added advantage of making the tax system
simpler.
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 Quesnay: circular flow
Quesnay analyzed the circular flow of
income using numerical examples that
showed
how one sector’s spending became another
sector’s income and
the idea that the output of one sector may be
another sector’s raw material.
 These numerical examples anticipated the
development of input-output analysis in the 1930s
by Wassily Leontief.

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 Turgot (1727 – 81)
 Minister of Finance (1774-1776)
Introduces a number of reforms based on Physiocratic
policies:
1. Ordered the freedom of internal gain trade
2. Abolished production within guilds
3. Started borrowing from foreigners – this reduced interest
rates
4. Ended the 15 days free labour for peasants and replaced it
with a tax on landlords

Contribution to later Economic thought: Iron Law of

Wages
> Competition among workers will drive wages down to
subsistence

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 Turgot (1727 – 81)
Turgot opposed government intervention
by France’s mercantilist government
“in general, every man knows his own interest
better than another to whom it is of no concer
n”
So, barriers to trade should be removed, taxes
should be simplified, people should be free to
work where they wanted to.
This unleashing of competition would improve
quality and reduce prices

30 EIGHTEENTH-CENTURY FRANCE
 Conclusions
The main thread is that the government
should not meddle
This idea emerged as a reaction against
the excesses of Colbert-style mercantilism
The ideas of the Physiocrats and others
strongly influenced English classical
writers, notably Adam Smith

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