Classical political economy

Classical political economy

In the years around 1800, the sciences and humanities were slowly disentangling themselves from philosophy and establishing an independent existence. Political economy was no exception. The Enlightenment philosophers had ranged across many disciplines without drawing any sharp boundaries. The school of political economists that emerged in Britain immediately after the Napoleonic Wars based itself squarely on Adam Smith, but on Smith’s Wealth of Nations and not on his work as a moral philosopher. Their work was prompted by immediate political issues like the Corn Laws and the Poor Laws, it influenced current political debates and was popularized by a variety of writers who set out to educate and influence the general public, but the classical school always thought of political economy itself as an objective science. These writers, including THOMAS ROBERT MALTHUS, Ricardo and John Stuart Mill, are now called the classical economists.

Malthus’s Essay on Population, published in 1798, exemplifies a view of population and living standards that went back much earlier and that continued to dominate thinking through much of the nineteenth century. If incomes were high, it was thought, population would grow until it outstripped food supplies. An increased population would mean increased competition for jobs driving wages down to subsistence, with population limited to the number the economy could support. This was not an unreasonable view. Wages really were pretty low. We now know from the experience of modern developing economies that population can grow at up to 3 per cent a year, while even in the Britain of the Industrial Revolution the economy was growing at less than half a per cent per year. Population clearly could outrun economic growth. The Malthusian view was not quite as bleak as it might seem. Food prices fluctuated with the harvest and skilled workers typically earned twice the unskilled wage, so a wage that allowed an unskilled worker’s family to survive a bad year would allow most people, most of the time, to live well above bare subsistence. In a growing economy, moreover, wages could remain some way above the subsistence minimum for as long as growth continued.

The Malthusian view, however, meant that economic growth would be matched by population growth, putting more and more pressure on food and on limited agricultural land. Eventually, the system must reach a stationary state, with wages forced down enough for population growth to be choked off by starvation and infant mortality. The Napoleonic Wars gave Britain a rather nasty shock, when a growing population and a series of bad harvests coincided with Napoleon’s blockade. Food prices shot up, and the limits seemed frighteningly close.

The Corn Laws of 1815, designed to protect British agriculture from foreign competition after the war, prompted furious debates and remained a key political issue until they were repealed in 1846. A by-product of the 1815 debate was a new theory of rent and profit, proposed by Malthus, Edward West, Robert Torrens and David Ricardo within weeks of each other during 1815. Ricardo’s Principles of Political Economy of 1817 developed the argument more fully. The basic idea is that the best land will always

be preferred for cultivation but, as the economy and the population grow, worse and worse land will have to be brought into use. Returns in agriculture fall, squeezing profits. As demand for food grows, the price rises, making it worth cultivating poorer land, but wages have to rise in line with food prices to allow workers to survive (the Malthusian

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wage theory). Good land still produces as much as before, but as it grows scarcer, the owners can demand more rent. Profits are squeezed between the two, progressively falling as the economy grows until the stationary state is reached. The policy implications followed directly. Corn imports relieve the pressure on the land and keep profits and growth up, allowing the manufacturing sector to continue growing. By restricting imports the Corn Laws served the interests of the landlords but of no one else. Ricardian economics was an analytical advance but it was also a weapon in the struggle against agricultural protection.

Ricardo’s main emphasis was on the special case of agriculture and the corn trade, but

he also developed a new, more general, theory of the gains from trade. Trade, he argued, depended on comparative, not absolute, advantage. Even if one country is less efficient at producing everything than its trading partners, it can still gain from trade. Ricardo’s example was trade in cloth and wine between Britain and Portugal. Suppose Portugal has lower real costs than Britain in both industries, but with a much greater advantage in the production of wine. Then it will still pay both countries if British cloth is traded for Portuguese wine, because what matters is the relative price at which the products are traded. Ricardo’s theory of growth and profit went out of fashion later in the century because it involved too many special assumptions and ignored technical change, but his theory of comparative advantage remained. Free trade became an article of faith for most nineteenth-century economists.

Adam Smith’s price theory was based on a distinction between ‘market’ and ‘natural’ prices. Market prices, the actual prices at which goods are sold, can vary from day to day or from hour to hour as supply and demand vary, but if prices get out of line with costs corrective forces come into play. Capital will flow out of activities yielding low profits, reducing supply and raising prices, towards those where profits are higher. After a disturbance, therefore, market prices will tend to return towards ‘natural’ cost-based prices that equalize returns between different activities. This account explains the general movement of prices and also shows how the system responds to changing circumstances. An increase in demand for a particular product, for example, will raise its market price, inducing increased production in response to demand.

As a description of the pricing process Smith’s analysis was generally accepted, but Ricardo was unhappy with the apparent implication that prices could be derived by adding up costs. If (real) wages increase, for example, it looks as though all prices would rise (because wages are a major element in costs) but Ricardo pointed out that profits would have to fall, counteracting the effect on prices. In his Principles of 1817, he suggested a drastic simplification: the price of each good should be proportional to the labour required to produce it. This is not quite as silly as it might seem, since the labour required was to include all labour required to produce materials, equipment and so on. Even so, it cannot be exactly true, as Ricardo himself knew. If capital-labour ratios vary (as they do), two goods produced by the same amount of labour but with different amounts of capital investment will have different prices. He argued, rather weakly, that the labour theory of value was a reasonably good approximation and his prestige and the lack of good alternatives was such that it continued to be taken seriously for a long time.

‘Classical’ political economy was given a new lease of life in 1848 by John Stuart Mill’s Principles of Political Economy. He developed the Ricardian framework, for example by adding a new emphasis on the role of demand in international trade and

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elsewhere, and added a quite different political slant. Adam Smith’s critique of special interests and Ricardo’s opposition to the Corn Laws had been radical in their day, but no longer seemed relevant. Mill saw real possibilities of improving the lot of working people. He favoured producers’ co-operatives and profit-sharing, with an enlarged role for the state, arguing that the laws governing the production of wealth were timeless, but that the distribution of wealth depended on human institutions that could, and perhaps should, be changed.