Introduction

Edmund Burke called the eighteenth century "the age of the economist,"
and the label is equally appropriate for our own time. The writings of
economists have defined the major social philosophies of the past two
hundred years. The chief ideological debates of the modern era involve the
basic ideas of great economists like Adam Smith, Karl Marx, and John
Maynard Keynes, who achieved their stature primarily because of the social
philosophies involved in their economic theories rather than the scientific
advances they made.

This fact was well understood by Keynes himself, who, doing battle with
ideas he was convinced were wrong and pernicious, wrote:

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 influences, are
usually the slaves of some defunct economist. Madmen in authority, who
hear voices in the air, are distilling their frenzy from some academic
scribbler of a few years back.

Economists became the high priests of a world of money, wealth, and

aspirations for material goods. Like the Schoolmen of the Middle Ages,
they defined for a secular world the relationships between people, the
individual and nature, and the individual and society. Their often esoteric
and highly complex theories were translated into a folklore understood by
millions and into policies adopted by nations. Although their base was
usually in the relatively secluded atmosphere of the university,
distinguished economists have served in recent years as prime ministers of
England, France, Germany,

Italy, and Greece and as secretary general of the United Nations. It would
be hard to name another discipline that has exerted as much influence on
the modern world.
This was not always the case. Only two hundred and fifty years ago there
were no economists known as such, and economic theory was a branch of
moral philosophy. Economics as we know it today hardly existed, and what
did exist was called "political economy," indicating that it was part of
national policy more than anything else and that it dealt with such matters
as taxes, public debts, and foreign trade.

Until very recently economics was the only social science with a generally
accepted body of theory whose validity almost every practitioner accepted.
Although economists sometimes joked about obtaining five different
opinions on any topic from any four economists, or about the old professor
who asked the same examination questions year after year but changed the
answers, the disputes among economists were not about fundamental
principles. The disagreements arose over applications, over the proper
policies to be adopted in given circumstances, and over judgments about the
importance of various factors in particular situations.

There was one major exception to this rule—the Marxists, who considered
Western economics to be merely ideological justification of an exploitive
system. They believed their own analysis of capitalism to be the correct
one, laying bare the flaws that would lead ultimately to the downfall of the
capitalist system. Their contempt for mainstream economics was
reciprocated by the attitude toward Marxism of the orthodox economists,
who considered that doctrine so wrong that most didn't even bother to read
Marx.

Today, however, the accepted principles of orthodox economics are in

trouble. The issues and problems for which economics provided answers—
the way a market economy functions, how to maintain prosperity—have
given way to new problems and issues for which answers are not readily
available. Growth of big business, big government, and big unions brings
economic power to the fore as a determinant of economic events. Economic
growth and affluence bring problems of resources, pollution, and energy.
An exploding world population seems to be a particularly intractable
problem. Great disparities in income and wealth within nations and among
nations create political and ideological conflicts over how economic
benefits are distributed. Although the collapse of the Soviet economy leaves
private-enterprise capitalism dominant in today's world, many issues remain
unresolved about how these problems will be managed, what the proper
mix of public and private control should be, and what our future will be
like. The debates and policies that emerge will be shaped, in part, by the
work of economists, and economics as a discipline will itself be forged in
today's cauldron of events.

This process is not surprising, since economics is a social science. Both

events and ideological debates have always been important to its
development. This presents a great paradox: Some of the most important
advances

in economics have resulted from political debates over social policy. In this
respect economics—like all other social sciences—differs radically from
the physical and biological sciences, which grew step by step from facts and
experimental evidence to theory, and from theory to further experiment and
more general theories. Both the social and the physical sciences developed
by means of grand integrating schemes, or systems, intended to explain
large interrelated portions of a discipline. In the physical sciences, the grand
designs emerged primarily out of an ordering of facts and evidence; in
economics, that source of scientific theory was supplemented by great
political and philosophical debates. Ideological systems, each with its
supporting facts, assumptions, and body of theory, spawned much that is
valuable in economics.

The ideas developed by Adam Smith in the eighteenth century comprised

one of those systems, and the theory of markets developed by Smith and his
followers represented the first great body of generally accepted principles in
modern economics. Challenged by Marx and others in the midnineteenth
century, this "classical" system and its laissez-faire ideology were remade in
the last quarter of the century into a new orthodoxy that prevailed until the
1930s, when John Maynard Keynes almost single-handedly built the
modern theory of national income and justified a policy of government
intervention in economic affairs. Between these two developments, a
variety of writers laid the foundations for today's welfare policies by
criticizing the economic societies and theories of their time. Throughout
these debates ideas emerged that were useful either in supporting or in
attacking the existing order, its distribution of income and wealth, and its
structure of power.

One of the great themes in the development of economics, then, is the

interaction of ideology and theory. Without ideological conflict the
discipline would not have evolved as it did. And because economics was
forged in the fire of ideological debate, it will always arouse emotions, no
matter how "pure" and "scientific" its representatives may try to keep it.

A second great theme is the relationship between economic theories and

practical problems. People everywhere have sought prosperity and justice,
freedom and order, individual betterment and the social good. The quest for
these sometimes contradictory goals has always involved choices, and the
theory of choice is a basic part of economic theory. One of the maxims of
economics is that the greater the economic surplus, the more numerous are
the alternative courses of action and the easier it is to achieve a multiplicity
of goals. As society brought a recalcitrant nature more effectively under its
control, ways and means of organizing and utilizing economic resources
became more numerous, and public policy toward economic affairs became
more important. With control comes choice, and choice begets policy. The
need for policy decisions brought forth the economist—to analyze and
advise and to develop a rational basis for choices.

For example, at the close of World War II the American people debated
whether to institute an extensive program of loans to aid the reconstruction

of Europe. The issue would have been strictly academic had not the United
States produced a large surplus above its minimum needs that could be
allocated to foreign aid. Since the surplus was available, however,
economists were called in to advise how best to mobilize it (whether under
public or private auspices), the form it should take (loans or grants, or
both), and the uses to which it should be put (consumer goods or machinery,
or both). Indeed, many economists look upon their discipline as the science
of rational choice among alternatives, both by individuals and in public
policy.

A third theme in the development of economics is its close relationship to

the climate of opinion. A problem is never analyzed in a vacuum. One
function of theory is to provide a context in which facts can be
systematically organized. But solutions to problems must be practical and
acceptable to the general public as well as to political leaders. If economics
is to have any usefulness, the economic theory of an era must be consistent
with the beliefs and concerns of the public, and it must provide beneficial
results. In this sense, economics has always been political economy.

Scholars often overlook the importance of the climate of opinion. They seek
the origins of ideas in the solid advances made by earlier scholars, tracing
an intellectual genealogy from one generation of thinkers to another, finding
the origins of modern ideas in the Old Testament, Aesop, and the
Upanishads. In some respects this is a worthwhile task, for older
generations were just as intelligent as we are; it is true, more often than not,
that if an idea is good someone else thought of it first. Yet in the social
sciences, at least, the more meaningful question is not "when did the idea
first appear?" but "why is the idea important now?" The answer to this
question involves the uses to which the idea can be put, the special interests
of those who use it, and its consistency with other beliefs of the people
affected by it. This climate of opinion is often more important than logical
consistency for the development and survival of ideas—more important in
the case of economic ideas, perhaps, than of those in any other social
science, owing mainly to the close relationship between economics and
public policy. Economists cannot escape the times in which they live—the
times determine the very questions asked—and nearly every adult is, in
some respect, an economist.

A fourth theme is the development of economics as a discipline. Over a

period of 250 years—a quarter of a millennium—basic principles were
developed concerning the ways in which markets function, the process of
economic growth, and the determinants of the level of economic activity,
among others. Like any discipline, a vocabulary of economic concepts has
evolved that defines its subject matter, and methods by which hypotheses
are tested, modified, and verified are adopted. Generations of theorists
developed systematic analyses, demonstrable conclusions, and broad
propositions.
There is a tendency to write the history of any discipline as if the entire past
were prologue, leading inevitably to the discovery of the truths of the
present, with the implication that the process will continue into the future as
scholars move ever closer to a fuller understanding of the subject. To some
extent that is true of economics—we know today far more about how a

market-oriented economy functions than we did a hundred or two hundred

years ago—but this view is an oversimplification. People in past eras were
intelligent, too, and, although their technology was perhaps simpler, the
problems they had to wrestle with were just as intricate as ours are today.
Their world was different from ours, and their view of that world also
differed. Inevitably, the social theories of the past were different from those
of today. Whether our theories are "better" or more advanced is debatable.

For example, the "classical" economists of the early nineteenth century

emphasized the economics of production and distribution in their analyses
of the economy, and assumed that the level of economic activity was not a
significant problem. That view is rejected today, as the emphasis is now on
exchange rather than production and on how to maintain "full employment"
levels of output. We might describe classical economics as if it were merely
a prelude to today's truths, but that would be a distortion of both classical
economics and the process by which we came to our present understanding
of market economies. It would also distort our understanding of the path
into the future, for if the past really is prologue we know that many of the
truths of the present will become the falsehoods of the future.

Economics is an ever-changing discipline. Partly a product of the great

ideological debates about the way human society ought to be organized, it
also influences the outcome of those debates. Partly based on a theoretical
search for abstract truths, it is also rooted in the realities of public policy
and the climate of opinion. Partly an explanation of how and why an
economic system functions, it is affected by the ways in which economic
systems change. Economics is a complex amalgam of scientific theory,
political ideology, public policy, and accepted truths.

Yet development of the discipline to its present position could not have
taken place without the work of many ordinary and extraordinary
individuals. The story of economics is also the story of a Scottish
philosopher, a London stockbroker, an Episcopalian minister, a German
philosopher and revolutionary, a Cambridge professor, a Norwegian-
American skeptic, and a host of others. The story reflects their personalities
and their convictions, their strengths and their weaknesses, their successes
and their failures. The Age of the Economist is an account of their work and
of the discipline they helped to build, of the interaction between facts,
problems, policy, philosophy, and institutions in the building process, and of
how we have come to think as we do about one of the most important
aspects of our lives.

ONE

ECONOMICS AND THE MARKET ECONOMY

The Rise of the Market Economy

The modern market economy is such an intimate part of our way of life that
most of us do not realize that it is a relatively recent development. The
organization of economic life around an interrelated system of markets—
markets that adjust prices, output, and incomes in an impersonal system—
did not emerge on a large scale until after the Middle Ages, that is, from the
fifteenth century onward. Prior to that time most of Europe's population
lived in an economy largely based on a social system of rights and
obligations rather than on an acquisitive, profit-oriented economy of buying
and selling.

The transformation of this society and its economy was observed by

contemporaries. Thomas Becon, an English cleric of the mid-sixteenth
century, for example, decried the growing materialism of his era and
inveighed against "greedy gentlemen, which are sheepmongers and
graziers" who "study for their own private commodity." Thomas Wilson,
writing fifty years later, noted how even the aristocracy was affected by the
change:
The gentlemen, which were wont to addict themselves to warres, are now
for the most part growen to become good husbands and know well how to
improve their lands to the uttermost as the farmer or countryman, so that
they take their farmes into their handes as the leases expire, and eyther till
themselves or else lett them out to those who will give most.

Becon and Wilson observed what many others of the time could also see.
The traditional pattern, in which each person was born to a definite place
and fulfilled a definite function throughout life, was passing away. Peasants,
long

Thomas Aquinas (c. 1225-1274), a Catholic theologian, analyzed the ethical

foundations of market exchange

accustomed to providing services and agricultural output for the lord of the
manor, increasingly paid money rents and sold a portion of their product in
order to get the money to do so. More than ever before, the lord used the
rents to buy needed goods, and the more progressive landowners began to
produce readily marketable products such as wool. Others gradually raised
the rents charged their tenants, who were forced similarly to orient their
crops toward marketable products. Middleman traders increased in number,
wealth, and importance as a result of the growing market.

The Middle Ages—the era from the breakdown of the ancient Roman
Empire to the mid-fifteenth century in Europe—were not without trade,
commerce, and markets, but the trade was, in large part, a long-distance and
interregional trade in luxury products consumed by the nobility and the
wealthy. Peasant communities, rural and largely self-sufficient, produced a
surplus paid to the lord in products, in labor, and sometimes in cash. This
surplus was the basis for purchases of luxuries by the aristocracy—fine
textiles, metal products, wine, and other items of the "good life." A dual
economy grew up, comprising the peasant village on the one hand and the
commercial town on the other. It was a regulated economy of organized
groups, such as manor, town, and guild, rather than one that operated
through free decisions freely negotiated. In its fundamental structure it was
much like the economic system that prevailed throughout the Near and
Middle East, Southeast Asia, and the Far East.

The great transformation of Europe to a market economy began in the

fifteenth century. The geographical discoveries of the fifteenth and sixteenth
centuries opened up tremendous opportunities for trade and commerce and
set in motion a large flow of capital into Europe in the form of gold and
silver treasures from both the New World and the East. The rise of national
states largely destroyed the political power of two bulwarks of the old order,
the nobility and the Church. New methods of warfare used by the emerging
rulers, featuring paid armies and large navies, required money and
administration: national tax systems emerged, and a flow of purchasing
power from taxpayer through government and back to the public further
stimulated the growth of markets. Cities like London and Amsterdam
became centers of commerce; they looked overseas for profits and
expansion, and they were supported by governments eager to increase the
tax base by expanding the wealth of the nation.

The new economy generated new attitudes. Medieval people, accustomed to

thinking and acting in traditional ways, gave way to market-oriented people
who would sink or swim by virtue of their individual decisions. The
successful ones were those who saved, who plowed profits back into the
enterprise, who calculated prices and costs carefully, who took risks in
order to make gains. In particular, there was little place for the attitudes of
feudal warfare and jousting. The future lay with commercial profits and
commercial wealth.

The new economy also generated the study of economics. The develop

ing market orientation of production and distribution led to a new

relationship between the individual and society, and between individuals,
with all the ethical issues that those relationships imply. The morality of the
new economic order had to be carefully analyzed and accepted rules for
ethical behavior devised. Theologians became the first "economists."
Religion and Economic Life

The theologians were concerned with reconstructing the ethical basis of

economic life. The older, medieval point of view had subordinated
economic life to both individual salvation and the needs of society as a
whole. Theologians had argued that earthly life was merely a prelude to
eternity, and moral laws had to prevail in all aspects of human endeavor.
This meant that in all human relationships, including the economic, the
individual had to keep the law of God continually in mind. The Church
knew that people must eat and clothe and house themselves, that the
ordinary functions of production and distribution had to be carried on; but
those functions had to be placed in proper perspective—salvation was the
proper business of life, and one must never forget it. Seeking wealth for its
own sake was sinful, since it took one's attention away from salvation and
pursuit of the moral life.

Nevertheless, the growth of trade and commerce from the eleventh century
onward forced theologians to come to terms with the growing market
orientation of life. Relationships between people were increasingly being
shaped by markets for goods, prices, and the ups and downs of business
conditions, rather than by the moral principles taught by the Church, and
the Church itself was becoming increasingly involved. The Catholic
theologians saw clearly that market price, more than moral law, was
becoming an important influence on human relationships. They began to
search for the ethical foundations of market exchange—a just price.

By the thirteenth century three closely related ideas had been developed by
the Schoolmen, the Catholic philosophers and professors. One idea, popular
in central Europe, identified the just price as that which would provide for
the continued reproduction of the social order. It would return to the
producer just enough to provide for the necessaries of life and maintenance
of the family, and to the merchant just enough profit to continue in trade.
The buyer, meanwhile, would obtain needed goods without depriving the
seller of the income necessary to continue in trade or production.

A more sophisticated analysis, but one consistent with the idea of

reproduction of the social order, identified the just price as the price a
modern economist would call the long-run price in a competitive market.
With all forms of monopoly and market control eliminated, competition
among sellers would hold the market price to a level that covered only the
costs of production and a normal profit. Costs of production would be high
enough to provide subsistence for the worker, including family
maintenance, education.

and acquisition of necessary skills. If less were paid to the worker, the
working population would decline, supplies in the market would diminish,
and prices would rise until the necessary work force was reproducing itself
in the long run. A similar process would occur if profits were too low to
enable traders to supply the amounts desired by buyers. On the other hand,
if prices rose above the necessary production costs, supplies would increase
and competition would drive prices down. In the long run, competitive
markets would generate prices of goods just equal to the socially necessary
costs of production. This argument, stated in different language, is found in
that great treatise on theology, the Summa Theologica of Thomas Aquinas
(about 1225-1274), an Italian theologian who taught at Cologne and Paris.
The analysis of market price, a key element in modern economics, was
begun by the Schoolmen.

The Schoolmen were also aware of the welfare aspects of market exchange.
An English monk of the thirteenth century, Thomas Middleton, and a Scots
theologian, Duns Scotus (about 1265-1308), who taught at Oxford as well
as Cologne and Paris and was a strong critic of Aquinas on theological
matters, developed the idea that both buyer and seller benefited from
market exchange: if they didn't, they wouldn't trade. Buying, selling, and
market exchange were seen as increasing individual welfare.

The economic attitudes embodied in the orthodox moral philosophy of the

Middle Ages were summed up in a famous parable. A monk on a
pilgrimage to Rome purchased a silver chalice for his cathedral. Traveling
back to Germany with a band of merchants, he showed them the vessel and
told what he had paid for it. The merchants congratulated him on his
purchase, telling him that he had bought it for far less than its true value,
and laughed that an unworldly monk could drive a better bargain than any
of them. Horrified, the monk left immediately, made his way back to Rome,
and paid the seller of the chalice enough to make up the fair price. It was
the only moral thing to do.

Such attitudes may have been consistent with an economy of customary

prices and accepted economic relationships, but they were out of tune with
the success-oriented, profit-motivated behavior of the market economy.
They may have been appropriate to people concerned with eternal salvation,
but they did not suit people who sought material wealth and success. They
may have worked in a society organized in stable groups, but they were
incompatible with an individualistic social order and a desire to rise in
wealth and status.

The rise of a market economy created a moral dilemma for the people of the
early modern era. On the one hand, the ethical teachings of religion told
them that each individual was morally responsible for others. These ideas
were found in the Old Testament story of Cain and Abel and in the New
Testament parable of the Good Samaritan, to cite only two widely known
examples. On the other hand, survival and success in a market economy
required that each person try to outreach, outsmart, and overcome others.

Rivalry, not brotherhood, was the necessary mode of behavior, and the
principle of caveat emptor —"let the buyer beware"—prevailed. Market
relationships were impersonal and transient compared with the permanent
and face-to-face relationships of an unchanging rural village. People were
judged more by their success in acquiring wealth than by the morality of
their behavior.

This moral dilemma—the conflict between salvation and success—was an

important factor in setting the stage for the Reformation. It was hard for an
urban merchant to believe that the business way of life was less proper than
any other. It was difficult to understand that the competition necessary for
survival was antagonistic to the moral law, that the single-minded pursuit of
profit that was fundamental to the very livelihood of business people was
frowned upon by the divines. So doubts arose. Were the theologians right in
their teachings about the modes of conduct required for salvation? After all,
they were only human, like everyone else, and subject to human error. What
did the Bible itself say about these matters? Such questions led to the
Protestant heresy—doubt of the infallibility of the Church and a desire to go
directly to the Bible as the repository of God's law, without the priest as
intermediary.

The theological arguments of the Reformation are of little interest to us

here, but out of them came a new economic ethic that gave the profit-
motivated market economy its moral letters of credit. Underlying the new
morality was the idea that God had intended a place on earth for each
individual, through which the individual could work out his or her destiny.
This place, or "calling," had to be sought and found by personal soul-
searching, and once found, it had to be diligently pursued. Salvation was
earned by hard work in one's calling, and any calling—even that of the
merchant—was equal in merit to any other in the eyes of God. But how was
one to identify one's calling? The theologians answered: partly through
inner feeling and partly through success. Worldly success indicated that one
had found the calling that God had approved. To achieve success, avoid
idleness, temptation, and luxury: work hard and save. These were the
prescriptions for ethical behavior hammered out during a half-century of
religious controversy, sermonizing, and polemics. They fitted the needs of
the growing urban middle class and promoted the hard work and capital
accumulation that led to economic expansion.

By the eighteenth century the new economic ethic had lost much of its
religious sanction and had become an almost universal way of life. That
American sage, Benjamin Franklin, stated it in the form of aphorisms,
which were repeated endlessly to generations of young people:

Early to bed, early to rise, makes a man healthy, wealthy, and wise.

The sound of your hammer at five in the morning, or at nine at night, heard

by a creditor, makes him easy six months longer.

What maintains one vice would bring up two children.

The new ethic was the basis of a secular and materialistic value system that
has dominated the climate of opinion in western Europe and North America
ever since.
But even though attitudes changed and the accepted goals of individual
action became heavily materialistic, a moral problem remained. Was it true
that economic failure meant unworthiness, that success and salvation were
synonymous? Did not the individual have a responsibility to others that
went beyond merely meeting one's contractual obligations in the
marketplace? Had the monk been correct in returning to Rome to pay the
merchant more for the chalice than his bargain called for?

The problem arises because of the inherent conflict between an ethical

principle—all humanity is one—and the competitive rivalry of the market
economy expressed in the legal principle of caveat emptor. The ethical
principle requires individuals to take responsibility for others, while the
legal principle calls for individuals to look out only for themselves.

This moral dilemma has puzzled philosophers and ecclesiastics from the
sixteenth century onward. Various solutions appeared in the religious
controversies of the sixteenth century, in the eighteenth-century philosophy
of noblesse oblige, in the writings of nineteenth-century socialists, and in
the welfare legislation of the twentieth century. Present in all these
approaches to the problem is a belief that the social system should not allow
an individual to be crushed and destroyed by the operation of impersonal
market forces. But the dilemma remains, and economists must be, in part,
moral philosophers, while philosophers must also deal with economic
issues.

TWO
THE EARLY DAYS

Jean-Baptiste Colbert (1619-1683) was a French minister of finance who

established a program of regulation of trade and commerce in seventeenth-
century France.

Practical people often argue over the most esoteric of subjects, for policy
decisions sometimes rest upon the most intricate of theories. One of these
debates took place during the eighteenth century, and from it emerged the
foundations of modern economics. The question at issue was the ultimate
source of national wealth, which some saw in trade, others in agriculture
and the natural forces of life, and still others in human labor. Although the
issue may seem, at first glance, to be devoid of practical significance, the
whole range of government economic policy depended on the outcome.

The Mercantilists
The mercantilists were the first to take the field. These writers were
concerned with the national states that developed during the sixteenth and
seventeenth centuries. They faced two different but related problems, one
internal and one external.

The domestic problem was one of unity. National power had to be built
from the localism of the Middle Ages. For the economy this meant a unified
monetary system and coinage, a national system of weights and measures,
elimination of internal tolls on roads and rivers, and a national system of
taxes and tariffs. These institutions, which today we take for granted, were
slowly forged by national rulers against the opposition of feudal lords, who
tried to keep as much control as possible over the economy of their regions.
The building of a national economy was predicated on the growing political
power of the monarchs against the great nobles.

In this struggle the monarchs found natural allies in several places. First in
importance were the rising commercial interests of towns and cities.
Merchants benefited from the widened trade made possible by a unified
economy in which local barriers to commerce were reduced. In turn, the
merchants augmented the monarchs' power by helping finance the armies
needed to subordinate the nobility. The interests of monarchs and merchants
further coincided in that both benefited from expanded foreign trade.
Merchants earned profits from trade with the newly opened lands in Asia
and the New World. To the extent that the merchants of one country
dominated trade with another area, profits would flow to the homeland and
domestic manufacturers would be stimulated by the export market. The
state gained from the tariff revenues derived from large trade, from the sale
of trade monopolies, from the development of strategic military industries
and personnel—shipbuilding and ship supplies, sailors and captains—and
from the general economic growth that provided a firm base for national
power. Two of the basic goals of national policy, therefore, were the
development of commerce and its counterpart, the growth of power in
international affairs.

A second group allied with the monarchs consisted of the smaller

landowners, who looked to the state as a counterweight to the powers of the
barons. This group was more interested in commercial agriculture than in
warfare, jousting, and family power, and wanted the monarchs to maintain
order and promote the growing markets from which they profited. They
knew that as the power of the state increased vis-a-vis that of the great
lords, their own wealth and power in local affairs would also increase.

Two other groups emerged from the rising market economy and national
states. One was the legal profession, whose members were needed to
interpret and define the vastly complicated economic relationships that
developed out of free association and private contract in the market
environment. Old and familiar legal relationships were being replaced by
new ones, and lawyers were needed to systematize them. The second group
comprised public administrators and the royal court. Although small in
numbers, these two groups were of great strategic importance. A "white-
collar" superstructure, allied with and dependent upon business and
government, supported the policies designed to strengthen unity and
national power.

Out of the political and economic alliances between crown, merchants, rural
gentry, and professional people emerged economic policies designed to
unify the nation under a single strong ruler, develop its military and naval
strength, and increase its wealth through both domestic production and
foreign trade. These policies and the theories underlying them have come to
be called mercantilism, the first systematic body of modern economic
thought.

One of the clearest statements of mercantilist policy was made by Phillip

von Hornick (1638-1712), an Austrian civil servant writing for a backward
country constantly threatened by the Turks. He wrote, in 1684, a widely
read tract called Austria over All, If She Only Will, listing "nine principal
rules of national economy":

To inspect the country's soil with the greatest care, and not to leave the
agricultural possibilities of a single comer or clod of earth unconsidered ....

All commodities found in a country, which cannot be used in their natural

state, should be worked up within the country. . . . Attention should be
given to the population, that it may be as large as the country can support . .
. gold and silver once in the country are under no circumstances to be taken
out for any purpose. . . . The inhabitants should make every effort to get
along with their domestic products. . . . [Foreign commodities] should be
obtained not for gold or silver, but in exchange for other domestic wares . . .
and should be imported in unfinished form, and worked up within the
country. . . . Opportunities should be sought night and day for selling the
country's superfluous goods to these foreigners in manufactured form. . . .

No importation should be allowed under any circumstances of which there

is a sufficient supply of suitable quality at home.
These basic policies of nationalism, self-sufficiency, and national power
were adopted in varying degrees by all the states of Europe. Manufacturing
was encouraged by subsidies, special privileges, patents, and monopolies.
Foreign trade was stimulated by acquisition of colonies and efforts to keep
wages down, and it was regulated by tariffs, navigation laws, and trade
restrictions. Agriculture was fostered by a variety of policies: in England
imports of food were taxed in order to keep out foreign competition, while
in France exports of agricultural products were taxed in order to keep
domestic production at home. In particular, the munitions industries were
promoted—guns, gunpowder, ships, and ship supplies.

In England, where trade quickly became the basis for increased wealth and
national power, a great deal of emphasis was placed on expansion of the
money supply as a stimulus to economic growth. In those days of limited
markets and inadequate purchasing power, one of the barriers to economic
growth was a lack of both hard cash in the hands of consumers and credit
available for business. Rulers often needed to borrow, and they would
similarly benefit from readily available cash and credit and from low
interest rates. Modem banking was only in its infancy, and the availability
of money and credit depended very heavily on the cash available—and that
meant gold and silver coins. It was inevitable, then, that monetary policy
was a major concern of the mercantilist economists. Basically, they favored
what we would call an "easy money" policy—plenty of available cash to
stimulate trade and keep interest rates down. On the other hand, they had to
keep inflationary pressures in check, for two reasons: (1) rising prices
created difficulties for the workers and the poor, because wage rates tended
to lag behind price increases, and political unrest would therefore follow;
and (2) rising prices would reduce foreign demand for domestic
manufactures and ultimatelv result in worsened economic conditions at
home.

Domestic and international economic policies, therefore, became closely

intertwined, and the English mercantilists were quick to realize that the
world economy was a web of interconnections. Elard experience as well as
sharp analysis taught them that if the domestic money supply and
purchasing power expanded more rapidly than the supply of goods
available for sale, domestic prices would rise, imports would increase, and
exports would fall. The fall in exports and rise in imports would then result
in an export of gold and silver to make up for the "unfavorable" balance of
trade. This in turn would reduce the money supply at home and cause the
domestic economy to languish. These relationships were soon well
understood, and a cardinal tenet of the mercantilists was encouragement of
a "favorable" balance of trade. If exports exceeded imports, they argued,
gold and silver would enter the country, money would be available,
economic growth would be stimulated, and national wealth would grow.

The best statement of English mercantilism is found in a brief book by

Thomas Mun (1571-1641), a businessman whose England's Treasure by
Forraign Trade was not published until 1663, almost a quarter century after
his death, although it circulated in manuscript long before then. Mun
suggested a variety of ways by which the English government could
stimulate trade, encourage exports, and promote a favorable balance of
trade and imports of gold to increase the money supply. By modern
standards the argument is crude, but the book remains a classic statement of
the idea that the economy needs direction from a strong government if
desired goals are to be achieved.

It should not be assumed that mercantilism was the same everywhere. There
were great differences between countries. In France, for example, where
luxury products such as silks and linens, tapestries, furniture, and wine were
of major importance, close regulation of the quality of goods was
emphasized. Under the leadership of Jean-Baptiste Colbert (1619-1683),
minister of finance for more than twenty years during the reign of Louis
XIV, national guilds were set up to regulate the major industries. Only
craftsmen who were guild members could operate, and they were subject to
the regulations of the national organization. The royal power, supported by
steady revenues from the salt tax, was strong enough to enforce the
regulations effectively, and the guilds remained powerful until the French
Revolution at the end of the eighteenth century.
Unlike France, the efforts of her Iberian neighbors, Spain and Portugal, are
a classic example of failure in applying the principles of mercantilism. So
much liquid wealth came into these countries from their empire possessions
that both nations felt little need in their complacency to turn to new
domestic manufacture to balance their economies. In a different vein,
Russia, the largest country in Europe, was backward agriculturally and
would remain so until the dynamic rule of Peter the Great in the early
eighteenth century.

In England, in contrast to France, regulation of domestic industry was not

successful because the government, always short of money, was never
strong enough to administer regulations effectively. English mercantilism
was devoted primarily to expansion of trade and encouragement of
manufactures. One result of this situation was that the medieval guilds
disintegrated, especially when cloth production developed in rural areas,
and industrial processes were far freer of restrictions than were those of
France. When the In

dustrial Revolution began in the late eighteenth century, this absence of

guilds and guild regulations gave English industry a long head start over
France and the other continental countries that had copied the French
example.

Nor was there always agreement on policies within nations. Popular

revulsion in England against government grants of monopoly to individuals
and companies was so great that in 1598 Queen Elizabeth I promised
reforms and in 1601 proclaimed the end of many monopoly privileges. Two
years later, in the famous "Case of Monopolies," the courts decided, in a
path-breaking decision, that even monopoly grants by the Crown were
subject to the common-law prohibitions on restraint of trade. Parliament
finally prohibited government grants of monopoly in 1624, completing the
legal foundations on which American antitrust laws are based.

The mercantilists recognized that wealth was produced by human effort, in

general, but felt that it would not be realized unless trade and commerce
were encouraged—unless exchange of goods enabled producers to make a
profit. For this reason they emphasized the growth of trade and commerce
as the key to increased national wealth, and expansion of the money supply
as the key to increased trade. To the question, "What is the source of the
wealth of nations?" the mercantilists gave the first answer, "Commerce."

In many respects they were right for their time. In the sixteenth and
seventeenth centuries the most powerful nations of Europe were those that
had developed their international and overseas trade to the greatest extent.
Trade seemed to stimulate both manufacturing and agriculture and to bring
prosperity, wealth, and power to the entire nation. Mercantilist doctrines
had a commonsense validity derived from what people could see going on
around them.

Opposition to Mercantilism
By the middle of the eighteenth century the mercantilists 7 preoccupation
with trade and national power had begun to grate on some of the economic
interests of the growing market economy. Mercantilist policies were fine for
the great merchants and financiers who operated in the international
economy; the basic goals of national power suited the rulers; and
government administrators and courtiers were often able to benefit
substantially, either directly or through bribes, from government grants of
special economic privilege. But the economy became more varied as it
grew, and both agricultural and industrial interests were increasingly
coming to find that mercantilist policies were often not in their best interest.
The policies were subjected to substantial criticism, and the theories on
which they were based were questioned.

Small businesses, in particular, felt hemmed in by the monopolistic

privileges granted to a few big financial and trading companies, and both
they and the smaller farmers resented the taxes imposed to maintain a
national power alien to their individual interests. A classic example is the
issue of "taxation without representation" in Britain's American colonies.
When the French and Indian Wars ended in 1763, the western frontiers of
the colonies

were relatively safe for colonization and development, and the colonists
were well aware that much of their economic future lay in the West. The
British government, however, long committed to development of the fur
trade and favoring the interests of the Hudson's Bay Company/ had
prohibited settlement beyond the Allegheny Mountains. Troops were
stationed in the colonies to protect the frontier and enforce the prohibition,
which protected the colonists from the Indians before 1763, but which
restricted colonial economic growth after the frontier was pacified. To make
matters worse, taxes on legal documents and tea were imposed in the
colonies to pay for the troops, who were sometimes quartered in the homes
of colonials. The colonists had to support the very troops who were
protecting English business interests against their own! One wonders what
attitude the colonists would have taken had the tax revenues been used to
open the frontier rather than close it.

The case of the American colonies, where the issue became political and
helped lead to the American Revolution, was a striking example of
opposition to mercantilist policies. In Europe, however, a debate about
purely economic issues arose. Was it true that economic expansion and
growth were best achieved through regulation and direction? Would not
better results be achieved in a free economy unhampered by the directing
force of a mercantilist government? The debate over these questions was
particularly strong in France and England.

In France, government regulation of production was so detailed that, for

example, it specified the number of threads per inch in the manufacture of
cloth. There was a multiplicity of taxes and tolls, and regulation of imports
and exports was strict. Yet the nobility was exempt from taxation, while
substantial taxes were levied on peasants and independent farmers.
Moreover, the government was corrupt and inefficient—indeed, this
probably made the system workable: the regulations and taxes could often
be evaded by judicious bribes or clever evasions. The situation was so bad
that one government inspector of trademarks, Vincent de Gournay (1712-
1759), disenchanted with mercantilist regulation, is reputed to have
originated the famous phrase laissezfaire, laissez passer, or "free enterprise,
free trade," in a free translation.

The Physiocrats
The most important French antimercantilists called themselves Physiocrats.
Their leader was Franqois Quesnay (1694-1774), court physician to Louis
XV. Quesnay disagreed with the mercantilist assumption that wealth
originated in industry and trade. He argued that only agriculture, by virtue
of the life-giving aspects of nature, could produce a surplus over and above
the

The royal family and members of the nobility were major stockholders in
the Hudson's Bay Company.

effort invested in production. Quesnay then went on in his famous

Economic Table of 1758 to show how the surplus from agriculture flowed
through the entire economy in the form of rent, wages, and purchases,
supporting all the social classes as it went. Two policy conclusions stemmed
from his analysis: (1) regulation of trade and industry impeded economic
development by hindering the flow of income and commodities on which
the economy depended; and (2) all taxes should be paid by landowners, as
distinguished from farmers, partly because they were not productive and
partly because their luxurious way of living distorted the flow of income.

Quesnay had been greatly impressed by the discovery of the circulation of

blood in the human body and likened the circulation of money and products
to that biological process. He believed profoundly that all wealth came
ultimately from the life-giving process created by God. A strong believer in
the supremacy of natural law, he felt that a regime of economic freedom not
only was natural but also would be both beneficial and self-regulating.

Another Physiocrat, Jacques Turgot (1727-1781), rose to become minister

of finance. In two short years he introduced a variety of antifeudal and
antimercantilist reforms and was supported by the king, but opposition from
the nobility forced him out of office. Even the "absolute" ruler of France
was unable to push through reforms over the opposition of the nobility, and
a few years later the old regime was swept away.*

All the Physiocrats agreed on one basic proposition, that wealth came
ultimately from the land. Only land contained the life-giving forces of
nature. Manufacturing could change only the form of wealth derived from
nature, and commerce could change only its location and ownership. Land
alone could produce a surplus. This was the second major theory of the
source of wealth.

The Economic Liberals

The physiocratic interlude was short, although its influence was felt even in
the United States, where a long line of statesmen from Thomas Jefferson to
Abraham Lincoln were convinced that the nation's future depended on
encouraging the small farmer. Far more important was the rise of economic
liberalism. From small beginnings in the late seventeenth and early
eighteenth centuries, it became the mainstream of economic thought in the
nineteenth century and lives on today as the classic capitalist ideology.

The early economic liberals—those who advocated the doctrine before it

was systematized by Adam Smith in the latter part of the eighteenth century
—attacked restrictions on international trade and fought for an end to

'During the Revolution another prominent Physiocrat, Pierre du Pont de

Nemours, emigrated to the United States, where he stayed for several years.
In 1802 his son founded a small gunpowder factory near Wilmington,
Delaware, the beginning of the great Du Pont chemical enterprise.

tariffs, monopolies, and regulations. They based their argument on the

social theory that individual motives, however selfish they might be,
resulted in benefits to society as a whole.

The first important economic liberal in England was Dudley North (1641-
1691), whose Discourses upon Trade was published anonymously in the
year of his death. Because North was a wealthy merchant and landowner
who became a treasury official, it is understandable that he was cautious in
publishing an attack on the nationalistic policies of mercantilism. His book
made a strong case for free trade and attacked the mercantilist assumption
that a favorable balance of trade was necessarily desirable. People trade, he
argued, because it is advantageous to both parties, promoting specialization,
division of labor, and the increase of wealth. Regulation interfered with
these benefits by reducing and restricting trade and inevitably reducing real
wealth.
North's argument was supported by the philosopher and historian David
Hume (1711-1776), who pointed out that an automatic economic process
would cause any favorable balance of trade to disappear: a surplus of
exports would be paid for by imports of gold and silver, which would
increase the money supply and cause prices to rise, which, in turn, would
cause a decline in exports until exports and imports were in balance. It was,
therefore, impossible for mercantilist policy to continuously maintain both a
favorable balance of trade and imports of gold and silver.

The logic of North and Hume destroyed the mercantilist arguments for
regulation of foreign trade. According to Hume, the policies would not
work, and North showed that the results would be undesirable if they did
work.

In the meantime, a fascinating, popular, and controversial book had

appeared in 1704, a doggerel poem called The Fable of the Bees, written by
Bernard de Mandeville (1670-1733), a Dutch doctor who had emigrated to
England. The poem's basic argument was that advances in civilization were
the result of vices, not virtues. Progress came from the selfish interests of
the individual—desire for ease and comfort, luxury and pleasure—not from
any natural propensity to work hard and save or from benevolent concern
for others. Prosperity and economic growth would be increased by giving
free play to the selfish motives of the individual, limited only by the
maintenance of justice. The vice of selfishness would spur people to
maximize their gains and thereby add to the wealth of the nation:

Thus Vice nurs'd Ingenuity,

Which joined with Tune and Industry,

Had carry'd Life's Conveniencies,

Its real Pleasures, Comforts, Ease,

To such a Height, the very Poor Liv'd better than the Rich before,

And nothing coidd be added more.

The book was suppressed by an embarrassed government, with the full
support of the guardians of morality. Yet, together with the theory of natural

economic adjustments described by North and Hume, the selfish motives

lauded by Mandeville became the basis of the next great economic theory—
economic liberalism.

The idea that rational self-interest, together with competitive market forces,
could lead to a regime of social order in a world of individual action was
beginning to develop. In the 1720s, Richard Cantillon (died 1734), an
Irishman who became a merchant in London and later a banker in Paris,
wrote An Essay on the Nature of Commerce in General. It was published
only in French in 1755; an English translation did not appear until 1931. It
was not an influential book in its time, but it illustrates how some people in
the early eighteenth century were thinking about the problem of economic
order in an individualistic society.

Cantillon generalized the ideas about competitive markets developed by the

Schoolmen of the thirteenth century into an early and crude version of what
a modern economist would call general equilibrium theory. The underlying
argument of his Essay was that rational self-interest on the part of traders,
operating within a system of freely adjusting competitive markets, would
lead to a network of mutually compatible prices and quantities traded.
Order would prevail in the economy through the operation of human reason
and rationality—an idea typical of the Enlightenment of the eighteenth
century. Cantillon consciously imitated the recently discovered mechanics
of Isaac Newton's physics, but with human reason and market competition
replacing the physical forces of inertia and gravity in creating a natural
equilibrium.

As to the source of wealth, the economic liberals of the eighteenth century

found it in neither trade nor agriculture, but in human labor. It was through
individual effort, they argued, that production takes place and the
wherewithal to satisfy human needs is provided. Nature produces few
materials that people can use in natural form: almost all natural products
must be transformed by human effort before they can satisfy human wants.
Without productive effort natural products are worthless.
This theory became known as the labor theory of value. It emphasized that
the production of wealth had as its ultimate purpose the satisfaction of
human wants. Wealth could not be considered an end in itself, nor was the
aggrandizement of national power its proper end. Wealth was wealth
because it bettered people's lives. The production of wealth, furthermore,
depended not on the fertility of the soil or on favorable trade balances but
on the individual incentives of ordinary people. The motive for work was
the need to provide food, clothing, shelter, and comforts. The greater the
incentive to work, the greater would be the production of wealth, and the
faster would humanity move toward a more abundant society.

John Locke (1632-1704), the English philosopher, tied together these ideas
about labor and production of wealth with private property, and in doing so
made the institution of property one of the cornerstones of the liberal
ideology. By adding labor to natural resources, people added part of them

selves to the final product, making the product "theirs" to use or consume.
Both wealth and private property were simultaneously produced by human
labor. In Locke's words:

God hath given the world to men in common. . .. Yet every man has a
property in his own person. The labour of his body and the work of his
hands we may say are properly his. Whatsoever, then, he removes out of the
state that nature hath provided and left it in, he hath mixed his labour with,
and joined to it something that is his own, and thereby makes it his
property.

Later economic liberals made much of these connections between labor,

wealth, and property. They argued that the first requisite for national
economic growth was the protection of private property, for unless the right
to property was sustained the incentive to work was reduced and the
production of wealth would decrease.

A favorite illustration of this principle was a comparison of the wealth of

the English and the poverty of the Turks. In ancient times, liberals pointed
out, the domain of the Turk was the wealthiest in the world, with
flourishing cities, prosperous agriculture, large exports, and world-famous
manufactures. But a despotic and arbitrary government seized wealth
without justification, imposed confiscatory taxes, and operated both justice
and government through a system of bribery. These actions brought an end
to prosperity. The Turk languished in poverty thereafter, unwilling to work,
to produce, or to accumulate capital because it would be seized or destroyed
by a corrupt government. Happy and prosperous England, on the other
hand, was growing in wealth because individual initiative was protected by
a rule of law that preserved for the individual the wealth he or she produced
and saved. Justice was evenhanded, not arbitrary. The sanctity of private
contracts was preserved, and no property could be taken for public use
without just compensation. Whatever one earned could be used as the
individual alone saw fit—within the limits of legality and decency.
According to the economic liberal, the functions of government were few:
protection of property, maintenance of justice, and national defense. The
economy would operate within this framework without additional aid or
regulation. Individual incentives would produce national wealth.

There were many variations on this theme. Some economic liberals would
grant broader powers to the national government; others put more stress on
the strength of individual incentives and competition, and still others on the
operation of supply and demand in free markets. But all agreed on the need
to free individual initiative from the limitations imposed by mercantilist
restrictions, on the importance of work in producing wealth, and on the
necessity of protecting and preserving property rights as the cornerstone of
economic policy.

THREE
ADAM SMITH
Adam Smith (1723-1790) was the great Scottish expounder of economic
liberalism and the policy of laissez-faire.

Adam Smith was the greatest of the economic liberals. A philosopher and
college professor, he is considered today to be the founder of modern
economics. Strangely, in his own lifetime he was known primarily for his
writings in philosophy rather than economics and had little influence on
public policy. He cultivated his academic garden, and his flowers did not
bloom until later.

The Philosophical Life

Smith was born in Kirkcaldy, Scotland, in 1723, a few months after his
father's death. His childhood was quiet and uneventful, and at age fourteen
he entered the University of Glasgow. He did well enough to win a
scholarship to Oxford, where he spent six years, dismayed by what he
considered to be the low level of intellectual activity and the immorality of
his fellow students. In 1751 he went to the University of Edinburgh to
lecture, and the following year he became professor of logic at Glasgow
when an opening suddenly appeared. Luck seemed to follow the young
professor, for the next year the professorship of moral philosophy—Smith's
favorite subject— became vacant and he was appointed to that post. He
lectured on ethics, and his book The Theory of Moral Sentiments was
published in 1759. To the modern reader it seems old-fashioned but
interesting. Its basic idea is that ethical systems develop by a natural
process out of individual personal relationships—a view that reflects the
eighteenth-century interest in natural law. The individual decides that
certain actions are proper or improper by observing the reactions of others
to his or her behavior. A social consensus

then develops / approving those patterns of behavior that benefit both

society and the individual. The process amounts to an early "other-directed"
theory of human action. The book was an immediate success and caught on
well with the intelligentsia. Smith's reputation grew, and students even
came from the Continent to study under him. He set to work writing a book
on economics and began lecturing on "Police, Justice, Revenue, and Arms"
at the university.

Then came his greatest stroke of luck, but one that he had thoroughly
earned. Charles Townshend, the politician who later as chancellor of the
exchequer was responsible for the tea tax and other taxes that helped bring
on the American Revolution, married a wealthy widow and acquired a
teenage stepson. An appropriate education for the young Duke of
Buccleuch became important, and Townshend resolved to get the best. He
had been very impressed by Adam Smith's book—and by the popular and
critical esteem in which it was held—so he asked the forty-year-old
philosopher to take a position as the young duke's tutor. To the surprise of
his friends, including the philosopher David Hume, Smith accepted the
post: it involved a three-year sojourn in France and a lifetime pension of
three hundred pounds a year (about fifteen hundred dollars, a large sum in
those days).

Much of the time in France was spent in Toulouse, where Smith, bored,
began writing a book on economics. Later, in Paris, Smith met the leading
physiocrats Quesnay and Turgot and discussed their doctrines.

Returning to Scotland, Smith lived on his pension and continued writing his
book. His friends wondered when it would be finished, for he seemed to
work on it interminably. Finally, in 1776, An Inquiry into the Nature and
Causes of the Wealth of Nations was published.* The book was successful
but not popular. Although it was read and appreciated by some, the general
public ignored it. William Pitt seems to have based some of his tax
proposals of the late 1780s on Smith's ideas, but it was not until twenty
years after Smith's death that a new generation of writers, intent on building
a new science of political economy, established Smith as the founder of
their science and a major genius. In the meantime, the author in 1778 was
appointed a commissioner of the customs, a post his father had held. His
death in 1790 passed almost unnoticed by his contemporaries.

Adam Smith did not lead a spectacular life. As a child of three he was
kidnapped by gypsies for a few hours, and, as a grown man, he was once
confronted briefly by a robber, but otherwise he had few adventures.
Typically, he was absentminded. Strolling in his garden at Kirkcaldy one
Sunday morning, wearing a dressing gown and lost in concentration, he
took a wrong turn down the turnpike and walked fifteen miles to
Dunfermline be

*Other important events occurred in 1776. Jeremy Bentham's Fragment on

Government and Richard Price's On Civil Liberty were published, as was
Edward Gibbon's The History of the Decline and Fall of the Roman Empire.
Parliament rejected a bill that would have provided for universal male
suffrage. Discontent continued in the American colonies. And the Boulton
and Watt steam engine was applied to factory machinery for the first time.

Individualism in English Life 25

fore his thoughts were interrupted by church bells. But, despite the colorless
personality of its author, the Wealth of Nations is a great book because it
resolved a key problem of social philosophy in its time.

The Problem in Social Philosophy: Order or

Chaos in Society
The key problem of social philosophy in the eighteenth century was how
social order emerges out of the potential chaos of an individualistic society.
The problem arose because the spreading market economy, penetrating
deeply into the daily lives of ordinary people, was gradually eliminating the
medieval patterns of social status and defined obligations.

In medieval times each person had a place as part of one or more organized
groups, each with its rights and duties. Lord and peasant, miller and priest,
were each part of a village community that continued to function on the
basis of traditional and often inherited obligations to others. Artisan and
merchant were members of guilds and citizens of towns, and each had a
place and function, at least in theory if not in practice, based on the charter
of guild or town. Religious doctrine held that there was a universal natural
order, ordained by God, that underlay both the order of nature and the order
of society. If many people worked to support the few who governed and
fought, while others prayed, it was because God had established a social
order designed to carry out all of those needed tasks.

Yet the medieval social system was rapidly passing and by the
mideighteenth century had largely disappeared in bustling cities such as
London, which were largely oriented toward international trade, banking
and finance, and the making of money. What was to take the place of a
social system of organized groups and established rights and duties? Could
society function at all when composed only of individual units—and selfish
ones at that—following their own bents and trying to outreach one another?
How could social harmony be achieved in this environment of
individualistic chaos?

Individualism in English Life

England in the eighteenth century was an open society in almost every area
of life outside of politics. Individual initiative and innovation were
becoming mass phenomena. In the practical and fine arts, it was the golden
age of English pottery and of the great furniture makers such as
Chippendale and Sheraton. English painting reached its greatest heights
with Gainsborough, Reynolds and Romney, and Handel composed his great
oratorios. New forms of literature appeared: the novel (Defoe's Robinson
Crusoe , Richardson's Pamela, and Fielding's Tom Jones), biography of a
new type (Boswell's Life of Samuel Johnson ), popular history (Hume's
History of England and Gibbon's The History of the Decline and Fall of the
Roman Empire), and the

periodical essay (those of Addision and Steele in The Tatler and The
Spectator). The first daily newspapers were established in London, and the
first monthly magazine appeared.
The British Empire was extended by the acquisition of Canada, Gibraltar,
Malta, and Ceylon. Robert .Clive and Warren Hastings achieved supremacy
in India for the British. Captain James Cook explored the Pacific from
Australia and New Zealand to California and Hawaii for more than a
decade. George Vancouver explored the northwest coast of America. James
Bruce penetrated Africa in a daring expedition and found the source of the
Blue Nile. Commercial and naval supremacy were won from the Dutch
early in the century, and London replaced Amsterdam as the foremost
center of shipping and finance in Europe.

Technological changes were building the foundations of industrialism. The

cotton textile industry was transformed by a series of innovations that
created the modern form of cloth manufacture, ushered in the Industrial
Revolution, and made Lancashire and Liverpool great manufacturing and
shipping centers. In 1738 John Kay invented a "flying shuttle" that greatly
speeded up weaving and created a shortage of yarn. This led to the
development of a spinning machine in the mid-1760s by James Hargreaves,
an illiterate weaver and carpenter. An improved spinning machine
developed by Richard Arkwright, a former barber, appeared a few years
later. By 1770 Samuel Crompton, son of a farmer, had perfected a spinning
"mule" that could produce the finest yarn in much larger quantities than was
previously possible. Crompton's invention was stolen, and he died in
poverty, but he gave the English cotton textile industry its greatest stimulus.
The ability to produce yarn in larger amounts vastly increased the demand
for cotton, and in America Eli Whitney developed the cotton gin, which
mechanically cleaned the cotton boll. The growing of cotton throughout the
world was greatly expanded, as was the plantation slavery system in
America.

Industrial innovations had been preceded by the development of new

machinery and methods in agriculture. Early in the eighteenth century
Jethro Tull, a gentleman farmer, developed a drill for planting seeds and
introduced the practice of planting in rows. Formerly, seed had to be
scattered by hand across the field. Charles Townshend, grandfather of
Adam Smith's benefactor and a prominent statesman, retired from political
life in 1730 to devote his time to the development of new crops, especially
fodder crops such as turnips and clover. This was an important
breakthrough. Formerly land had to remain fallow to recoup its fertility, but
now it could grow animal feed crops and still be "rested" for a year. Robert
Bakewell, another successful farmer, developed techniques of stock
breeding and introduced improved methods of livestock management.
Arthur Young, a great writer on agriculture, spent most of his life
publicizing the new methods and advocating enclosed fields as necessary to
their adoption. The new agricultural techniques required larger farms,
increased capital, and fenced-in fields, so from 1760 to 1830 the open lands
of England were extensively fenced and hedged. Small farms and the
village common lands disappeared in favor of

larger acreage. Increased agricultural output and lower costs of production

meant that greater numbers of the population could join the labor force in
the growing industrial cities.

These are only a few of the leading events and major personalities
associated with them. Thousands of other people in commerce and industry,
agriculture, exploration and empire building, the arts, and other aspects of
English life took advantage of opportunities with initiative and imagination.
Many were of humble origin. Even in politics, the last stronghold of
privilege, a few newcomers, like Edmund Burke, were able to work up to
positions of prominence and power.

This was the practical, everyday side of the social process that philosophers
like Smith tried to analyze. They could see all around them an economy in
ferment, with change the order of the day. Progress was being made because
of the individual efforts of thousands of people acting for themselves alone.
There seemed to be no order or no reason behind the process, yet humanity
was certainly moving onward—perhaps haltingly, but nevertheless onward
—to what appeared to be a better world. In one respect there was a
theoretical problem to solve—what were the principles that produced
orderly social relationships in an individualistic, competitive, changing
society? In another respect the problem was quite practical—would
government regulation and control impede or advance the progress of such
a society?

Natural Law in Science and Political Theory

A new view of the world was emerging in Adam Smith's time, and within
its framework writers in the social sciences were beginning to construct
new explanations of human and social relationships. The Renaissance
(fifteenth and sixteenth centuries) introduced a rational, scientific point of
view, and the Reformation (sixteenth century) greatly weakened religious
explanations of natural and social phenomena. In the seventeenth and
eighteenth centuries the development of science and mathematics greatly
strengthened naturalistic rather than theological explanations and led to
theories in which natural forces alone were sufficient to explain events.

The greatest advance in the natural sciences was made by the English
physicist Isaac Newton (1642-1727). His Mathematical Principles of
Natural Philosophy (1687) pictured a mechanical universe operating under
the influence of basic natural laws of motion, gravitation, and conservation
of energy to achieve a balance of forces, or equilibrium, in which all objects
had their proper place. A great theory, it was proved to the public by the
return of Halley's Comet in 1759, just as Edmund Halley had predicted after
calculating its orbit in 1682.

Other sciences were similarly developed on the basis of natural laws.

Robert Boyle discovered in 1660 that the volume of a gas varies inversely
with its pressure. Antoine Lavoisier proved the law of conservation of
matter through quantitative chemical analysis: matter changes its form but
not its

quantity. In biology, William Harvey discovered and demonstrated the

circulation of blood; and the regularity of nature was emphasized when
plant and animal forms were systematically classified in interrelated groups
by botanists and zoologists of the time.

Political theory was the first area in the social sciences to develop an
emphasis on natural law, regularity, and equilibrium. Hugo Grotius
(15831645), the Dutch legal theorist and father of modern international law,
stated the basic ideas. Grotius postulated that humans are inherently social
beings and cannot survive without some form of social organization.
Therefore, he argued, certain minimal conditions, or natural laws of society,
must be realized if human society is to exist. Grotius listed the natural
conditions of society as security of property, good faith and fair dealing,
and correspondence between individual efforts and rewards.

It was in England, however, that natural-law theories of the state evolved

most fully. The English were engaged, throughout the seventeenth and
eighteenth centuries, in changing a monarchy that claimed absolute
authority based on divine right to a constitutional government based on the
consent of the governed. The classical theory of democracy emerged from
these events and this debate.

People are inherently selfish, it was argued, and they institute governments
in order to protect their natural rights as individuals—life, liberty, and
ownership of property. A supporter of absolute monarchy, Thomas Hobbes
(1588-1679) argued for absolutism on the ground that the stronger the
power exercised by the sovereign, the more successful would be the social
restraint on the selfish, combative element in human nature. In opposition to
Hobbes, John Locke argued that order and freedom were compatible:
people institute governments to avoid chaos and preserve their natural
rights, but absolute power is granted to no one. The function of the state is
to enforce the laws of nature and punish infractions, the laws of nature
being superior even to acts of the state. Within this structure, Locke said,
individual action could be given free play. To these foundations of
democratic theory Locke and his followers added the theory of majority
rule: the interests of everyone in preservation of order were essentially
similar, and the best method of determining the common good was decision
making by a majority. Only the individual could know what was in his or
her best interest, and while a single person could be wrong in any one
instance, it was highly unlikely that the consensus of a large group would be
seriously in error. Finally, the Dutch philosopher Baruch Spinoza (1632-
1677) added the last link to the liberal political philosophy: checks and
balances within the government were necessary to temper power with
justice. English political theorists quickly integrated that idea into
democratic theory.

By the early years of the eighteenth century the political philosophers had
developed a theory of liberal democracy based on natural-law precepts. An
analysis of the economy in similar terms was next on the agenda. Toward
the middle of the century there were several unsuccessful attempts by a
variety of writers to produce systematic treatises on the natural laws of
economic life

and their relationship to individual freedom and government action. It was

to this problem in social philosophy that Adam Smith directed his efforts.
An Inquiry into the Nature and Causes of the Wealth of Nations was the
result.

Smith's System of Natural Liberty

Adam Smith advocated a "system of natural liberty," in which everyone
would be left free to pursue and advance their own interests. This system,
he argued, would result in the greatest wealth for both the individual and
society. Indeed, individual effort would bring maximum benefits for society
as a whole and for other individuals. This was the simple principle that
would enable social order to develop in an individualistic society.

The advocates of mercantilism and government regulation had assumed that

the selfish desires of individuals would lead to less wealth for all unless
human actions were regulated and controlled. More for me means less for
you, was the assumption, unless efforts were directed toward more for all.

This argument was wrong, said Smith. If I want something from you, I must
produce something you want and exchange it for what you have. Both of us
benefit, because we both give up something that has less value to us than
does the product we receive in exchange. The welfare of both is increased
over what it would otherwise be. As Smith phrased 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. We
address ourselves, not to their humanity but to their self-love, and never talk
to them of our own necessities but of their advantages.

According to Smith, self-interest in a free society would lead to the most

rapid progress and growth a nation was capable of achieving. People would
save in order to improve their own positions and in so doing would add
capital to the nation's resources. They would use that capital in the most
profitable way to produce the things that others wanted most. Even where
laws and regulations impeded freedom to invest, these motives would be so
strong that they would still lead to growth and wealth:

The uniform, constant, and uninterrupted effort of every man to better his
condition, the principle from which public and national, as well as private
opulence is originally derived, is frequently powerful enough to maintain
the natural progress of things toward improvement, in spite both of the
extravagance of government, and of the greatest errors of administration.

In Adam Smith's view, the greatest hindrance to economic progress was

government. In the system of natural liberty there were only three
legitimate functions of government: the establishment and maintenance of
justice, national defense, and "erecting and maintaining certain public
works and certain public institutions, which it can never be for the interest
of any

individual, or small number of individuals, to erect and maintain." Smith

did not admit much into this last category, however. Roads and
communications, yes—but their cost should be borne by the user through
tolls rather than by the general taxpayer. Education and religious
instruction, maybe— they were of general benefit, but Could be provided
by private enterprise or voluntary contributions as well as by government.
Any other government undertaking would be more harmful than beneficial,
even though the best of motives were behind it:

Every system which endeavors ... to draw towards a particular species of

industry a greater share of the capital of the society than what would
naturally go to it. . . retards, instead of accelerating, the progress of the
society toward real wealth and greatness.

Although Smith definitely looked with disfavor upon government

enterprise, it should not be supposed that he would give business a
completely free hand. He was aware of the tendency of business people to
conspire to their own advantage against the public:
People of the same trade seldom meet together, even for merriment and
diversion, but the conversation ends in a conspiracy against the public, or in
some contrivance to raise prices.

Nevertheless, Smith was not afraid of private monopoly. He lived in a

simpler age than ours, before the growth of great enterprises and giant
industrial plants. The only example of industrial production in his book is a
pin factory in which some two dozen handicraft workers were employed. In
those days the capital required for entry into most trades was small,
technology was simple and available to all, and monopoly existed only
where special privileges were granted and protected by government. Smith
was confident that no private monopoly unprotected by government could
long endure: monopoly profits would immediately invite competition,
which would destroy the monopoly.

The Self-Adjusting Market

If self-interest was the driving force of the economy, the mechanism
through which it worked was a system of self-adjusting markets.
Competition among sellers in an effort to make profits would naturally
result in a pattern of production fitted to the needs and desires of
consumers, while competition would hold profits to a minimum amount just
large enough to motivate producers.

Every commodity, according to Smith, has a "natural" price. In primitive

societies it is determined by the amount of labor needed for production. In
more advanced societies, those in which private property has developed,

the natural price depends on costs of production—the amount that must be

paid for wages, rent, and profit. Whenever the market price of a commodity
differs from its natural price, market forces are set in motion to move it
back. As Smith explained it:

When the price of any commodity is neither more nor less than what is
sufficient to pay the rent of the land, the wages of the labour, and the profits
of the stock [capital] employed in raising, preparing, and bringing it to
market, according to their natural rates, the commodity is then sold for what
may be called its natural price . . . precisely for what it is worth, or for what
it really costs the person who brings it to market. . . .

When the quantity of any commodity which is brought to market falls short
of the effectual demand, all those who are willing to pay . . . cannot be
supplied with the quantity which they want. . . . Some of them will be
willing to give more. A competition will immediately begin among them,
and the market price will rise. .. .

When the quantity brought to market exceeds the effectual demand, it

cannot be all sold to those who are willing to pay the whole value of the
rent, wages and profit, which must be paid in order to bring it thither. . . .
The market price will sink. . . .

These changes in price set in motion corresponding changes in the amount

produced. When the market price of a commodity is greater than its natural
price, more of that commodity will be produced and brought to market. On
the other hand, production will fall when the market price is below the
natural price and when, therefore, the resources used in production cannot
be paid at their natural rates. Again, Smith describes how production
responds to price relationships:

The quantity of every commodity brought to market naturally suits itself to

the effectual demand. ... If at anytime it exceeds the effectual demand, some
of the component parts of its price must be paid below their natural rate. If
it is rent, the interest of the landlords will immediately prompt them to
withdraw a part of their land; and if it is wages or profit, the interest of the
labourers in the one case, and of their employers in the other, will prompt
them to withdraw a part of their labour or stock from this employment. The
quantity brought to market will soon be no more than sufficient to supply
the effectual demand. All the different parts of its price will rise to their
natural rate, and the whole price to its natural price.

If on the contrary, the quantity brought to market should at any time fall
short of the effectual demand, some of the component parts of its price must
rise above their natural rate. If it is rent, the interest of all other landlords
will naturally prompt them to prepare more land for the raising of this
commodity; if it is wages or profit, the interest of all other labourers and
dealers will soon prompt them to employ more labour and stock in
preparing and bringing it to market. The quantity brought thither will soon
be sufficient to supply the effectual demand. All the different parts of its
price will soon sink to their natural rate, and its whole price to its natural
price.

The natural price, therefore, is, as it were, the central price, to which the
prices of all commodities are continually gravitating. Different accidents
may sometimes keep them suspended a good deal above it, and sometimes
force them down even somewhat below it. But whatever may be the
obstacles which hinder them from settling in this center of repose and
continuance, they are constantly tending towards it.

The whole quantity of industry annually employed in order to bring any

commodity to market, naturally suits itself in this manner to the effectual
demand. It naturally aims at bringing always the precise quantity thither
which may be sufficient to supply, and no more than supply, that demand.

In the last two centuries little has been added to this description of market
equilibrium. Contemporary economists use the term normal rather than
natural price, and they are more careful to spell out the exact conditions
under which it prevails. A much more complex analysis of production costs
has been developed, and the process by which the level of output responds
to price has been analyzed in greater detail. But the basic descriptions of
how supply and demand determine an equilibrium price, of how
competition pushes that price to a level that just covers production costs,
and of how production responds to demand have remained fundamentally
unchanged in the writings of successive generations of economists.

Smith's analysis of the self-adjusting market economy had tremendous

significance. It showed that production will automatically adjust to the
pattern of consumer demand, whatever that demand may be and however it
may shift and change. It showed that competition among sellers will drive
prices down to the lowest possible level consistent with continued
production at levels satisfactory to consumers. It showed that resources will
be used in the most efficient and economical manner—using as the criterion
of efficiency and economy the satisfaction of consumer wants at the lowest
possible prices consistent with continued production at the desired levels.
And it showed that all this could be accomplished through the free
operation of market forces, with no interference or direction from
government or any other agency of economic management.

Smith emphasized, however, that these ideal results could be precluded by

abridgments of full freedom in economic activity, such as "secrets in
manufactures," "secrets in trade," "singularity of soil and situation,"
"monopoly," and "all those laws which restrain . . . competition." Smith was
particularly opposed to monopoly in all of its forms, and some of his most
pungent comments point to its evils:

The monopolists, by keeping the market continually understocked, by never

fully supplying the effectual demand, sell their commodities much above
the natural price, and raise their emoluments, whether they consist in wages
or profit, greatly above their natural rate.

The price of monopoly ... is upon every occasion the highest which can be
squeezed out of the buyers. .. .

Whatever the source of the restrictions on economic freedom that led to

monopoly—whether government, business, or labor—Adam Smith was
opposed to it.

Two Qualifications
At this point it is important to note two limitations of Smith's analysis of the
free market. These limitations were at the heart of criticisms developed by
socialists of the nineteenth century, and theories of later economists have
not satisfactorily overcome them.

The first limitation concerns the nature of "effectual demand" and its
dependence on the pattern of income distribution. It is fine to argue that
production will match the pattern of consumer demand, but if the
distribution of income and wealth is highly unequal, that pattern will
provide much to the rich and little to the poor. Unless the distribution of
income is right and proper, it does little good to argue that production is
efficient and economical. If the distribution of income is inequitable, the
pattern of production will be inequitable as well, no matter how efficiently
the free market works to match production with demand. This basic
problem would soon be raised by the socialists spawned by the early
Industrial Revolution, and it would shortly thereafter be expanded by Karl
Marx into a theory of the breakdown of capitalism. Later generations of
economists have attempted to provide answers to the problem—most
successfully in the 1890-1910 period—with results that have not been fully
satisfactory, as we shall presently see.

The second limitation, closely related to that of economic justice, concerns

private property in land and capital. Adam Smith, as a good economic
liberal, supported the institution of private property as both natural and
necessary to the preservation of economic incentives. However, he granted
its necessity only in advanced societies. In primitive society only labor
needed a reward as a factor of production, and the cost of production
consisted of wages alone. In advanced societies with private property, rent
on land and profit on capital became part of the costs of production. In the
case of rent and profit, the costs of production were clearly the products of
social organization, not natural phenomena in the same sense as human
labor and the motive of self-interest. This qualification spoiled Smith's
grand scheme of an equilibrium of natural forces in the market.

Socialists were quick to seize upon these gaps in Smith's logic. Only a
return to labor was natural, they argued, and only when the full value of
output was gained by labor through social ownership of land and capital
would the natural state of society be recaptured. Economic justice could
then be achieved, since the entire product of society would go to those who
worked, and the pattern of effectual demand would not be distorted by
unearned income. In later chapters the dialogue on economic justice
between the critics and the supporters of the existing order will be explored
in greater detail.

Economic Growth
Adam Smith was not primarily concerned with these matters of justice in
income distribution, and they did not become topics of major concern to
economists until after the rise of socialism. Smith was far more concerned
with economic growth and the advancement of society to higher levels,
which he explained in terms of human motives inherent in the psychology
of the individual and, hence, natural and inevitable in a free society

The "progress of opulence," according to Smith, is the direct result of three

factors: division of labor, widening markets, and accumulation of capital.
As productivity rises because of these developments, "a general plenty
diffuses itself through all the different ranks of the society."

Specialization in production and division of labor rest upon an inherent

human "propensity to truck, barter and exchange one thing for another,"
according to Smith. Only humans show this propensity: "nobody ever saw a
dog make a fair and deliberate exchange of one bone for another with
another dog." Moreover the same psychological inclination that leads
people to trade, and thus gives rise to specialization, also makes them
dependent upon one another and thereby engenders the complex social
fabric of the market economy. This is an old-fashioned view, however. The
modern economist argues that people specialize in producing one thing
rather than attempt to produce everything they need because their
productivity and earnings are thereby increased.

Just as exchange gives rise to specialization and division of labor, Smith

said, "The extent of this division must always be limited ... by the extent of
the market." When the market is small, no one can produce only one
product. But when the market expands, producers can specialize and
thereby gain the advantages of increased efficiency. Wider markets lead to
greater specialization, higher productivity, and greater wealth, and to the
use of money in an effort to overcome the difficulties of barter in a system
of complex exchange relationships.

None of this economic growth can occur without large amounts of capital,
gathered out of savings, and used to further increase productivity and
promote still greater specialization and widening of markets. Accumulation
of capital was seen as one key to economic expansion, but the whole
process depended on security of property:

In all countries where there is tolerable security, every man of common

understanding will endeavor to employ whatever stock he can command, in
procuring either present enjoyment or future profit. ... A man must be
perfectly crazy who, where there is tolerable security, does not employ all
the stock which he commands, whether it be his own or borrowed of other
people. . . .

In those unfortunate countries, indeed, where men are continually afraid of

the violence of their superiors, they frequently bury and conceal a great part
of their stock ... a common practice in Turkey, in Indostan, and I believe in
most other governments of Asia.

Smith was well aware that economic growth brings change and diversity.
As capital is accumulated, the natural progress of opulence proceeds from
agriculture to manufacturing to commerce, and the affluent society exhibits
prosperity in all three areas. A developing agriculture gives rise to the
growth of towns, which in turn offer a larger market for agricultural
products, and a developed urban and rural society offers widened
opportunities for trade and shipping. Enlarged trade further stimulates
manufacturing and specialized agricultural production for export.
Population increases as productivity rises, facilitating still broader market
expansion and stimulating still more specialization and capital
accumulation.

By this process the economy moves forward to ever higher levels of

development, raising the whole social order with it. It simultaneously
maintains the orderly market equilibrium that continuously tends toward a
pattern of production fitted to effectual demand. The system of natural
liberty produces an equilibrium of forces moving always toward opulence.

Yet we should note an important aspect of Smith's ideas about economic

growth that differs from some contemporary beliefs. Smith's vision was one
of everyone working, saving, and specializing to increase his or her
productivity and wealth—a mass movement of economic advancement. We
do not find Smith arguing, as do some of today's apologists for great wealth,
that economic progress is brought about by the innovative individual or the
leaders of business and finance. Economic progress, according to Smith,
stems from “the uniform, constant, and uninterrupted effort of every man to
better his condition"—from a grass roots effort of the great mass of people
— rather than from the actions of a few.
Although Smith strongly advocated a policy of laissez-faire and free trade
without restrictions, his good Scottish common sense admitted some
exceptions. Scotland had high tariffs and trade restrictions designed to limit
the import of cheap English manufactures. These laws sought to protect the
livelihood of Scottish handicraftsmen—hand weavers, for example—and
the communities in which they lived. When Smith served as a
commissioner of customs he supported vigorous enforcement of the
Scottish tariffs and trade restrictions. He understood that economic
development and technological change destroyed the old while creating the
new. The effect of the agricultural revolution on village communities was
widely known at the time: Oliver Goldsmith's narrative poem The Deserted
Village had been published in 1770. Smith's theory glorified the progress
generated by a growing and changing economy, but he recognized that in
practice many could be seriously hurt as the new and better world
developed. We shall meet this theme again.

Smith's Achievement
Adam Smith's analysis of the market economy emphasized that
individualism resulted in order, not chaos. Even though each person
competed with all

others for wealth and profit, their very competition unleashed market forces
that led to an orderly increase in the wealth of the nation. The desire for
prosperity, coupled with a natural tendency to trade and exchange, led to
specialization, investment of capital, and stable economic growth. The free
economy served the individual,-whose needs and desires were met by the
natural tendency of producers to make and sell what consumers desired.
The welfare of the community was thereby maximized.

The moral dilemma of earlier writers was resolved by Smith's analysis, in

that there was no conflict between individual and social benefits. The whole
structure rested on the free, competitive play of individual selfishness. The
motives lauded by Mandeville a half-century earlier were shown by Smith
to be the source of economic growth, social order, and general welfare. The
path to brotherhood—at least in economic affairs—lay through competitive
selfishness. Thus, Adam Smith provided social philosophers and moralists
with answers to problems that had gone unresolved for a century.

In addition. Smith presented future economists with the analytical

framework of the discipline of economics. His vision of a competitive
market equilibrium following a path of growth to affluence and abundance
defined the problems that economists have wrestled with ever since. His
formulation of the solutions—the self-adjusting market and the process of
capital accumulation—was the starting point for a complex theoretical
system that later economists richly elaborated. Smith's purely scientific
contribution has been vast, and in its basic structure his framework still
remains the heart of modern economics.

It is easy to see why the Wealth of Nations is one of the great books of
Western civilization. On one level, it is a polemic written for its own time
and directed against the existing practices and policies of government. On
another, it is a philosophical treatise that deals with fundamental problems
of order and chaos in human society. Finally, it is a scholarly treatise that
analyzes the principles on which the economic system functions. All three
themes are so closely intertwined that no one aspect of the argument stands
alone; rather, each supports the others. It is a fascinating amalgam of
ideology, philosophy, and theoretic analysis.

FOUR
CLASSICAL
ECONOMIC

David Ricardo (1772-1823) was an English economist famous for his

theories of economic development and international trade.

Adam Smith founded a "school" of economics. Particularly strong in

England, Smith's followers dominated the field in both Europe and the
United States for almost a century. They represented the orthodox approach
to economic problems and policy until the last quarter of the nineteenth
century and were united by their acceptance of Smith's liberalism and his
system of natural liberty. Their analytical system was founded on Smith's
equilibrium of supply and demand in competitive markets and on the labor
theory of value. They generally favored freedom of action for business
enterprise, strong limitations on government, free trade, and free movement
of capital. Classical economics is the name usually given to this style of
thinking.

Four other economists made major contributions to the classical system.

They were Thomas R. Malthus, David Ricardo, Jeremy Bentham, and
JeanBaptiste Say. Working primarily in the turbulent first quarter of the
nineteenth century, when the world economy was percolating with the
changes wrought by war, revolution, economic change, population growth,
new technologies, and political upheaval, they sought to analyze the
economy in terms of a few basic underlying principles. In doing so, they
turned economics into the first social "science."

England's Reaction to the French Revolution

Adam Smith's Wealth of Nations had just been published when an age of
revolution began—the great political and social revolutions in the American
colonies and later in France that wiped away the last vestige of European
feudalism and the old aristocratic order. There was a good deal of sympathy

38 Classical Economics

in England for the American revolutionists, since many Englishmen felt that
their own society retained unwanted remnants of the old order. One of the
reasons for the success of the American Revolution was undoubtedly the
opposition of English liberals to continuing the war. Political reform was a
particularly strong issue in England, since many members of Parliament
represented districts with very small populations, while some large cities,
emerging as a result of economic change, had no representation at all.

Many Englishmen looked with favor upon the French Revolution, too. They
thought it would bring democracy to France, develop a society similar to
that of England, and establish peace between two nations that had been at
war intermittently for more than a hundred years. Charles James Fox, leader
of the liberal Whig party, praised the fall of the Bastille, calling it the
"greatest event.. . that ever happened in the world." Even William Pitt, the
Tory prime minister, felt that the Revolution would enable France to
become more like England, and he forecast years of peace and tranquillity
between the two nations.

There were, of course, conservatives who took a stand against the French
Revolution from the very beginning. Edmund Burke, for example, in his
Reflections on the Revolution in France (1790), opposed the treatment of
the French king and aristocrats by the French mob and feared that freedom,
justice, and order would be destroyed by the growing radicalism of the
"swinish multitudes."* When the Reign of Terror began, British opinion
shifted to support the conservative position. The intellectual leaders who
favored the Revolution—such as Thomas Paine, who wrote The Rights of
Man in 1790 as an answer to Burke—were discredited. Some changed their
minds to support the conservative position. Prime Minister William Pitt had
come into office on a platform of social and economic reform but turned to
a policy of uncompromising conservatism. At one point he stated, "Seeing
that where the greatest changes have taken place, the most dreadful
consequences have ensued .. . and .. . seeing that in this general shock the
constitution of Great Britain has remained pure and unchanged in its vital
principles ... I think it right to declare my most decided opinion, that. . .
even the slightest change in such a constitution must be considered an evil."
The policy of the British government became one of maintaining the status
quo, resisting reform, and—worse—suppressing voices of dissent.

When the wars with France began, legal action was taken in England to
"prevent disloyalty." In 1795 the Habeas Corpus Act was suspended for five
years; all secret associations were banned; all lecture rooms where
admission was charged were legally classified as brothels, in order to
prevent meetings; any meeting attended by more than fifty persons had to
be superintended by a magistrate; all printing presses had to be registered
with the government; export of English newspapers was prohibited; the
Correspond

*The title of this book, The Age of the Economist, is taken from a passage
in Burke's Reflections: "The age of chivalry is dead, that of sophisters,
economists and calculators has succeeded, and the glory of Europe is
extinguished forever." In those days the economist was considered to be a
liberal reformer.

ing Society, a group of reformers who tried to spread news of their cause by
writing letters, was suppressed in 1799. In that year and the next, the
AntiCombination Laws were passed, which prohibited any kind of
combination of either workers or employers for the purpose of regulating
conditions of employment. There is no record that the laws were enforced
against employers, but workmen were prosecuted and nascent labor unions
destroyed. An atmosphere of suppression prevailed.

Although reform was prevented, the march of events could not be halted.
The war years of the late eighteenth and early nineteenth centuries were
years of broad and rapid change. Industrialization was greatly stimulated by
wartime demand. The agricultural revolution was speeded up by wartime
increases in the price of food. Population was growing rapidly and shifting
from rural to urban. As cities grew, slums, inadequate sewage and water
systems, and other urban ills developed on a large scale. The multitude of
economic and social problems generated by these vast changes went
unsolved, while "the Establishment" concerned itself with holding the line
and rooting out the "radicals."
Malthus and the Theory of
Population
One of the most pressing problems that emerged during the years of the
French wars concerned the poor. They had always been present in England,
but in the former aristocratic, rural society, each parish had traditionally
cared for its own. A tax on landowners was expected to provide relief funds
for those who could not support themselves, while the parish was supposed
to find work for the able-bodied poor. A philosophy of noblesse oblige
prevailed.

This ancient system broke down, however. Wartime increases in food

prices, the agricultural revolution and the enclosures of common land,
which displaced many farmers from their small plots, the Industrial
Revolution, and growing cities and population brought on serious poverty.
Displaced farmers might have found work in handicraft manufacture of
cloth, which had long been a rural occupation, but industrialization
destroyed that opportunity; indeed, a whole generation of rural cottagers
lost their livelihoods with the rise of textile mills in the growing cities.
Growth of the armed forces offered a way out for some of the able-bodied
young men, but it was not a general solution.

The conservative reaction engendered by the French Revolution meant that

new measures to alleviate poverty were politically impossible. Anything
smacking in the least degree of reform was anathema to English
policymakers. Yet the great increase in the number of poor people put a
tremendous financial burden on the wealthier landowners. Something had
to give.

The solution was provided by an obscure young minister named Thomas

Robert Malthus (1766-1834). Like all good conservatives in a time when
serious problems abound, he found the cause of the crisis not in any recent
developments or changes that might be amended by policy actions.
but in large forces over which governments have little or no control. The
problem of the poor was essentially moral, he argued, and had its origins in
two fundamental propositions. First, "Food is necessary to the existence of
man." Second, "The passion between the sexes is necessary and will remain
nearly in its present state." These two facts led to the principle that "the
power of population is infinitely greater than the power in the earth to
produce subsistence for man." Any policies that attempted to alleviate
poverty would be futile in the face of these natural laws.

In other words, population would tend to increase unless it was held in

check by "misery and vice." If the supply of food were to increase, there
would be a corresponding increase in population until the amount of food
per person had fallen back to the subsistence level, at which point the
increase in population would stop. Wages would always tend toward the
subsistence level. Any increase in wages above that level would only cause
the working population to grow and wages to fall back once more to
subsistence. Conversely, if the price of food rose, wage rates would
likewise be forced upward to maintain a subsistence level. One way or
another, there was a natural rate of wages that always tended toward the
level of subsistence.

Consider the implications of this doctrine. Paying relief would not solve the
problem of poverty but would merely increase the income of the poor and
enable them to raise more children. Poverty would continue because there
would be no increase in food supplies for the larger population. It was not
necessary, therefore, to look to economic or social causes to explain the
problems of the poor. The old system of poor relief was itself responsible.
The solution was obviously to eliminate the relief system.

Assistance to the poor worsened the situation in another way, according to

Malthus. By increasing the numbers of the poor, the relief system shifted
wealth from those who used it productively to an idle poverty-stricken
population. Wealth that should have been invested to provide jobs was
wasted on maintaining the poor in idleness, and the economic growth of the
nation was slowed.

The Malthusian view had other important implications. The causes of

poverty were not rooted in the structure of society, in the distribution of
income, in inequalities in the ownership of wealth, or in any of the many
institutions of society. Neither the wealthy nor society as a whole was at
fault. The poor were responsible for their own fate. All they had to do to
eliminate their poverty was to have fewer children.

Even the formation of labor unions was useless, according to Malthus.

Higher wages would result only in a larger population and a rise in the cost
of food as more people used the wage increases to bid up food prices. The
end result would be a shift of wealth from businessmen through the hands
of workers into the pockets of unproductive landowners. The amount of
capital available for economic expansion would be reduced just as
population increased, leaving the nation worse off in the long run.
Furthermore, unions meant strikes, and strikes meant reduced output, lower
profits, and less capital accumulation. No, labor unions were not a solution.

Malthus's principle of population was indeed a dismal theorem—for the

poor. But it was a great doctrine for conservatives, because it gave them the
best of reasons for doing nothing about a serious problem. Malthus himself,
an educated, religious gentleman, felt compassion and pity for the poor. He
expressed this many times, and there is no reason to doubt his sincerity. But
his analysis told him that social action would hinder instead of help. The
only permanent solution was moral reform of the individual that would hold
sexual passions in check.

The Malthusian principle of population was to become one of the major

building blocks of classical economics, and it remained the basis of wage
theories for almost a century. Despite its essentially pessimistic point of
view, however, it did provide one avenue of hope for economic growth.
Economic expansion could provide increased food supplies that would then
cause increases in the labor force necessary to achieve further economic
growth. Malthus showed that the size of the labor force was not a barrier to
economic expansion. Labor resources would increase as the economy grew.
All that was needed was capital to get the process started.

Malthus also helped later economists clarify one of the key relationships
necessary for betterment of the human condition. Production had to increase
faster than population if there were to be any major improvement in living
standards. Europe and North America, in the ensuing era of
industrialization, succeeded in achieving that relationship and are vastly
better off today than they were in Malthus's time. Many other countries, in
which population growth exceeds expansion of production, have millions of
people who are doomed to the "misery and vice" of the Malthusian analysis.
Ricardo and Economic Growth
David Ricardo (1772-1823) was the apostle of capital accumulation. In his
view, the growth of capital was the great source of economic expansion, and
all economic policy should be directed toward promoting it. To prove his
point, he developed a theoretical model of the economy that dominated the
thinking of economists for fifty years. He believed that economic freedom
led to maximum profits, that profits were the source of investment capital,
and that a competitive economy would lead to profit-maximizing
investments. In Ricardo's view, policies that benefited business would lead
to maximum economic growth.

Born in London of Jewish parents, Ricardo married a young Quaker woman

when he reached the age of twenty-one, causing a break between himself
and his stockbroker father. Financed by friends, he became a trader on the
London Exchange. So adept was he at the intricate and risky business of
speculation that by the age of twenty-six he had amassed a large fortune. He
retired to a country estate in 1814, bought an Irish pocket-borough seat in
Parliament in 1819, and devoted the remaining few years of his short life to
public affairs and economics. A "millionaire radical," he advocated

reforms in banking and currency, poor relief, and the tariff, and supported
freedom of press and speech, as well as other reform causes. His only book
on economics carries the formidable title Principles of Political Economy
and Taxation. Its content is even more formidable, but it had tremendous
influence in its day.

In the years around 1815, at the close of the Napoleonic wars, one of the
great political and social issues in England was whether the nation should
try to preserve its agriculturally based economy or become more heavily
industrialized. Involved in the debate was the question of the place of the
landed aristocracy in the English social and political system. The issue was
fought out in Parliament over the Corn Laws, which dealt with the import
of wheat into England. (The English call wheat and other grains "corn," and
our corn is "Indian corn" or "maize.") English laws related to the import of
wheat were intended to promote domestic agriculture without causing major
increases in the price of food. When the price of wheat fell in England,
tariffs were raised on imports of wheat in order to keep out the foreign grain
that was depressing domestic prices and injuring the business of domestic
farmers. When the price of wheat rose above a given level, import duties
were reduced, thus encouraging more imports and keeping domestic prices
from rising further. In short, the British government tried to keep grain
prices between an upper and a lower limit by means of a sliding scale of
tariffs.

Nevertheless, during the French wars the price of food rose substantially,
and farmers were temporarily well off. Their production costs also rose and
remained high when peace came, wartime demand slackened, and the price
of food fell. Farmers began clamoring for higher duties on imported wheat,
fearing that they faced ruin unless protected by enforcement of the Corn
Laws. The landowner's point of view was reinforced by arguments that a
sound agriculture was necessary for England's national defense and for the
preservation of the old traditions and national vigor. There was a revival of
the physiocratic doctrine that economic growth depended on the natural
productivity of the soil. Pamphlets appeared, such as one entitled England
Independent of Commerce, which argued for the protection and
preservation of agricultural interests.

Business interests, on the other hand, opposed tariff increases, which, they
declared, would raise food prices and force wages upward. The result would
be reduced profits, decreased exports of manufactured products, and ruin
for English industry. Business interests argued that England's future lay
with industrial expansion, not with agriculture, and they demanded outright
repeal of the Corn Laws.

This was the state of the issue when Ricardo and other economists entered
the debate over Corn Law policy. Ricardo was on the business side of the
argument. He believed that landowners, not farmers, would be the chief
beneficiaries if the price of wheat in England was raised by a higher tariff.
The high price of wheat would enable cultivation to be extended to areas
that would otherwise be unprofitable. In older wheat-growing areas, rents
would be raised to take advantage of the higher prices farmers were
receiving. A larger proportion of the total national income would then flow
into

the hands of landowners, and this parasitic group would use its increased
wealth for luxury expenditures such as servants and country houses, not for
productive investment.

In addition, the enlarged cultivation of land would draw capital and labor
away from industry and distort the whole production pattern of the country.
Artificially high food prices would lead to a misallocation of productive
resources into agriculture and out of manufacturing, thereby hindering the
nation's natural development of industry.

Ricardo also pointed out that high prices for food would require high wage
rates and high costs of production in manufacturing. Since England had to
sell its manufactures throughout the world, competing with the products of
other countries, higher costs in English industry would result in reduced
business for English exports and a reduced level of output for English
manufacturers. Profits would also be reduced, and there would be a slower
pace of capital accumulation and economic expansion, due to the lack of
both incentive and funds to invest.

This was Ricardo's indictment of the Corn Laws (although he did not
advocate their complete repeal). It supported the business position on the
issue with a theoretical model of the economy that gave substance and
validity to his policy conclusions. Ricardo's theory was more than a
treatment of a contemporary policy problem. If that were all it had been, it
would have died as interest in the problem died. But Ricardo took it much
further and generalized it into a comprehensive theory of economic growth.

In the early stages of a nation's growth, he argued, the population would be

small and only a portion of the land would be cultivated. Under these
conditions the rent paid to landowners would be a relatively small
proportion, and profits a large proportion, of the total national income. The
profits, plowed back into industrial development, would result in a greater
demand for labor, which—following Malthus—would cause population to
grow while wages remained at the subsistence level. The growth in
population would require an extension of the cultivated area in order to
provide larger amounts of food. This extension could be accomplished only
by raising food prices to cover the higher costs of production incurred by
bringing less fertile lands into cultivation. The higher price of food would
enable landowners to raise the rents charged on the older cultivated lands,
because the higher food prices charged could bear higher rents. At the same
time, the higher cost of food would force employers to pay higher money
wages in order to maintain wage rates at the subsistence level. This in turn
would raise the cost of manufactured goods and thereby reduce the profits
obtained by manufacturers. The reduced profits would then leave less
wealth available for expansion and would also reduce incentives to invest.
Ricardo envisaged that this process of economic growth would continue,
with capital accumulation and growth gradually slowing down, until growth
halted after many decades of expansion. At this stage of development the
population would be large, cultivation extended, industry developed,
production high—but savings and capital accumulation would be adequate
only for replacement of capital, not for further expansion.

The picture Ricardo drew was one in which the economy, if left alone,
would achieve the maximum growth possible. To that end, business would
have to be freed of all restrictions that might reduce ability to maximize
profits, so that the maximum amount of saving and capital accumulation
could take place. Government intervention in the economy would lead to a
lower rather than a higher level of economic activity. Right or wrong, the
theory was on the side of the coming rulers of the social order—business
interests—and this in itself ensured it long life.
The International Economy
One of the strengths of Ricardian economics was its applicability to the
international economy. For the first time, an analysis of the domestic
economy based on the fundamentals of land, labor, and capital could be
applied rigorously to international economic relationships. This represented
a major step forward in the development of economics as a social science.
One of the goals of all scientific endeavor is the building of ever broader
generalizations that encompass an ever widening body of phenomena. A
discipline advances by stripping away details and constructing general laws,
and Ricardian economics did this by reducing all economic phenomena to
fundamental relationships between the factors of production.

The integration of the international economy into the Ricardian model was
done in two ways. First, Ricardo showed that international specialization
and division of labor was advantageous to all nations and that restrictive
trade policies designed to protect domestic producers would injure the
nation imposing them. Free trade was the road to economic well-being
internationally as well as domestically. The argument for this position,
embodied in the famous law of comparative advantage , is complex, but
Ricardo was able to prove its validity. He showed, for example, that as long
as it costs less to produce cloth in England than it does to produce wheat,
compared with costs in other countries, it would pay the English to shift
their resources to cloth manufactures, export cloth, and import wheat from
other countries.

Suppose it takes an English worker one day's labor to produce a yard of

cloth and two days' labor to grow a bushel of wheat; then a bushel of wheat
would cost twice as much as a yard of cloth. Suppose also that it takes a
French worker one day's labor to produce each product. In this case,
England should produce cloth (one day's labor), export it to France, trade it
onefor-one for wheat, and import the wheat back to England. In this way
the English would get, for one day's labor, the wheat it would otherwise
take them two days to produce. The French would also benefit. They could
produce wheat, ship it to England, trade one bushel for two yards of cloth,
and ship the cloth back to France. They would also receive products worth
two days' effort for one day's actual work. Both sides would benefit from
this specialization and free exchange.

But the process would not end there, as later economists showed. The
export of English cloth to France would drive its selling price down in
France, and increased domestic production would push costs of production
up. The same would happen for French wheat in England. As these price
changes took place, the growing import-export trade between the two
countries would establish an equilibrium of prices and trade. England would
produce and export much cloth, but its output of wheat would be small.
Most of the wheat consumed in England would be imported. The opposite
would be true of France. The two commodities would sell for equivalent
prices in the two countries, for if they did not, further shifts in production,
trade, prices, and costs would occur. In this way an international
equilibrium would be established in which the world pattern of production
would be optimized.

This analysis of international economic equilibrium was supplemented by a

second approach, this time in the field of economic development. The
preceding section of this chapter described the Ricardian theory of the fully
developed stationary economy, in which the return to capital was so low
that only replacement of worn-out capital equipment occurred. As the return
to capital in one country fell, however, profit-maximizing investors would
seek higher returns by investing in less well-developed countries abroad.
Capital exports from the mature economies would flow quickly to the
newly developing countries, and they in turn would be brought to higher
levels of production and wealth. Of course, they would have to offer
political stability and protection to private property, but aside from that
qualification the classical economist could look forward to a whole world
moving gradually toward opulence.

In this way economists applied Adam Smith's concepts of orderly growth

and market equilibrium to the international economic system. Only national
rivalry, with its tariffs, trade restrictions, and wars, could interfere with the
development process. It is perhaps ironic that the part of his theory that
Ricardo thought most important—the theory of economic growth—has
been largely discarded by modern economists, although they retain his
stress on capital accumulation. But the theory of international economic
equilibrium, which was only a minor part of the original analysis, remains,
almost in its original form, an integral part of modern economics.
Say's Law of Markets
Only one major element had to be added to classical economics to complete
its systematic analysis of the economy: an examination of production and
employment levels. It had been shown that a free market would allocate
resources so that production would adjust to consumer needs and wants,
that output would grow through savings and capital accumulation, that
income would be distributed among social classes according to natural
laws, and that the same principles applied to both domestic and
international economic

relationships. Still to be determined was whether a free market would also

maintain full employment of workers and capital.

The issue was not merely academic. The Industrial Revolution had brought
economic instability, aggravated in the early years of the nineteenth century
by the on-again, off-again wars against Napoleon. When peace came in
1815 the economic stimulus of government spending was withdrawn from
the economies of both England and the Continent. Demand for industrial
products fell from its wartime levels, and England was faced with
competition from the Continent for the worldwide markets it had kept
largely to itself. Soldiers and sailors returning to the civilian economy and
handicraft workers displaced by factory production increased the numbers
of workers seeking employment. These problems were compounded in
England by the fact that industrialization had proceeded furthest there.

England's economic situation was further aggravated by government

monetary policies that resulted in "tight" money and a shortage of credit just
when the economy needed a stimulus. During the war years prices had risen
substantially, credit had been much expanded, and the Bank of England had
stopped redeeming its paper currency in gold. Increases in the national debt
had been one of the major causes of the credit expansion and the price
increases. Economists, led by Ricardo, blamed the inflation on excessive
issuance of paper money and when the war ended prescribed that the Bank
of England again redeem paper currency in gold at the levels that had
prevailed before the war, even though there was not enough gold to sustain
the existing amounts of currency and credit then outstanding. This meant
that the supply of money and credit would fall. The economy was to be
given a dose of deflation.

This early application of principles of sound finance was based on an

incorrect diagnosis of the economic illness, and the remedy turned out to be
worse than the disease. Inflation had been largely due to expansion of total
spending during the war years, promoted in part by increases in the money
supply, at a time when output could be increased only slowly. Prices had to
rise, and the amount of currency and credit reflected this expansion. By
prescribing deflation as the cure for inflation, economists were able to bring
prices down, but only at the expense of output and employment. Like any
deflation after inflation, creditors and owners of financial assets benefited—
to the detriment of unemployed workers and profitless businesses. The
burden of England's economic difficulties was shifted from owners of
monetary assets to producers.

Hardship was widespread, and business activity was in a generally

depressed state for thirty years after 1815. The economy had its ups and
downs during this period. Economic growth continued, but there was hardly
a year in which England had full employment by modern standards. In
some years, unemployment rose to 40 or 50 percent of the work force in the
industrial cities of the midlands.

The instability of the economy had already aroused criticism of

industrialism and the new economic order. Even before 1815 Jean Simonde
de Sismondi (1773-1842), a Frenchman traveling in England, had seen the

industrial depressions and predicted that capital investment would

periodically force the capacity to produce to outrun the ability to consume.
His argument was echoed by an English Physiocrat, William Spence (1783-
1860), who pointed out in two pamphlets of 1807 and 1808 that capital
investment in commerce and manufacturing created economic instability
and insecurity, while the development of agriculture promoted economic
stability and security. Spence called particular attention to the possibility
that savings would reduce purchasing power and cause prosperity to
disappear. Both Sismondi and Spence were disenchanted with
industrialization, and each favored a different type of economic order—
Spence the old aristocratic society and Sismondi a system that emphasized
human and community values rather than individual gain. Their discussions
of depressions were only part of more comprehensive attacks on the
emerging business society.

Classical economists were quick to reply to these attacks. The basis of their
rebuttal was a brief passage in a work by Jean-Baptiste Say (1767— 1832),
a French popularizer of Adam Smith's work, whose A Treatise on Political
Economy had appeared in 1803. That work contained the first statement of
the principle that came to be known as Say's Law of Markets, a concept that
dominated the thinking of most economists about the level of economic
activity until the Great Depression of the 1930s.

Say argued that there could never be a general deficiency of demand or a

general glut of commodities throughout the whole economy. Certain
industries or sectors of industry might be plagued by overproduction,
because of miscalculation and excessive allocation of resources to those
types of production, but elsewhere in the economy there would inevitably
be shortages. The consequent fall of prices in one sector and their rise in
others would induce business firms to shift production, and the imbalances
would be quickly corrected.

People produce, he pointed out, not for the sake of producing, but to
exchange their products for other goods they need and want. Since
production is demand, it is impossible for production to outrun demand.
"Production creates its own demand" became the answer of the classical
economists to the problem of business depressions.

In England, Say's argument was put forth by James Mill (1773-1836), father
of the renowned philosopher and economist John Stuart Mill, in an answer
to Spence. The elder Mill wrote in 1807 that every increase in supply is an
increase in demand—the more there is to sell, the more will be bought. The
error in the theory of general glut, he maintained, is the confusion between
a temporary dislocation in the process of exchange, which would be
remedied by industry taking a new direction, and the impossibility of an
excess of wealth in general.
One economist remained unconvinced: Thomas R. Malthus. In his
Principles of Political Economy (1820) Malthus devoted a long last chapter
to developing a theory of economic stagnation based on inadequate
"effectual demand." His argument, in brief, was that wages, being less than
the total costs of production, cannot purchase the total output of industry,
and that this would cause prices to fall. The decline in prices reduces
incentives to

invest as well as profits that could be invested. The result is a general

inadequacy of purchasing power that could continue indefinitely. A similar
condition might result from excessive savings, which cause demand to fall,
prices to decline, and stagnation to follow. The remedy, according to
Malthus, was to reduce large incomes so thaTsavings would not be
excessive, to impose import tariffs and thereby promote a favorable balance
of trade, and to spend for public works during bad times. A program of
government intervention was needed because the free-market economy
could not regularly provide for full employment.

Malthus's argument was not developed with clarity and preciseness— he

was not a rigorous theoretician—and his good friend David Ricardo
severely criticized his theory of general glut in letters written to Malthus, in
"Notes on Malthus' Principles of Political Economy" circulated in
manuscript among other economists, and in discussions at London's
Political Economy Club. Since Ricardo's arguments were clear and precise,
he carried the day.

Ricardo's answer to Malthus recapitulated Say's Law of Markets in slightly

more elaborate form. Savings are made, not as an end in themselves, but in
order to employ labor in production. Mistakes can lead to a glut of a single
commodity, but demand for all other commodities is not thereby reduced. A
reallocation of productive effort will occur. Furthermore, unemployment
causes wages to fall, inducing business firms to hire the idle laborers with
the capital created by savings. In this way, all capital is put back into use
and all willing workers are once again employed. The basic cure, therefore,
is not income redistribution and public works but lower wages and higher
profits.
Ricardo's answer was supplemented by an extraordinarily perceptive
volume originally published in 1802, Henry Thornton's The Paper Credit of
Great Britain. This book had been written during the controversy over paper
money, gold, and inflation, but its argument was adapted to Say's Law and
the discussion of gluts. Thornton observed that if savings tended to become
excessive, the supply of funds in the money market would rise relative to
demand, and interest rates would fall. The lowered interest rates would both
encourage investment and discourage savings, the process continuing until
the two were equal. Any funds not used for consumption would, therefore,
find their way into investment. Changes in the rate of interest would ensure
that savings would be invested and the level of total spending maintained.
There could be no surplus of savings and no general glut of commodities.
Total spending on consumption and investment would then be adequate to
purchase the total output of industry.

These complicated arguments were extraordinarily important. At the purely

logical level they closed the theoretical system of classical economics by
showing that a free-market economy would utilize all its resources. In terms
of social philosophy or ideology they showed that unemployment and
instability were not caused by a private-enterprise economy but were the
result of noneconomic forces—psychological factors or other causes not

associated with the institutional structure and natural processes of economic

life. Finally, they prescribed a policy treatment for whatever depressions
might occur: (1) strengthen the financial sector of the economy so that the
processes determining saving and investment could work themselves out;
and (2) endure the crisis until declining wages and prices ultimately
encouraged enough investment to bring the economy back to normal. Such
is the strength of a logical and precise theory that these policies prevailed
for more than a century—at tremendous social cost, for the waiting period
often brought waves of bankruptcy and long-continued unemployment—
until the theory was finally demolished by a countertheory propounded
during the Great Depression of the 1930s.
Bentham and Interventionist
Liberalism
No discussion of classical economics is complete without an account of the
ideas of Jeremy Bentham (1748-1832), a lifelong reformer and
nonpracticing lawyer. His Fragment on Government, published
anonymously in 1776 when he was twenty-eight, was a brilliant attack on
the traditional legal interpretation of the English constitution as antithetical
to progress. He sought to show how political reform toward greater
democracy would promote "the greatest good for the greatest number." The
book created a sensation, but when it was revealed that the author was only
a young upstart and not one of the leading constitutional lawyers of the day,
it was quickly dismissed. Disillusioned, Bentham began his great
philosophical work, An Introduction to the Principles of Morals and
Legislation, which was privately printed in 1780 but not published for the
general public until 1789, after another of his books, A Defense of Usury,
became a popular success.’

Principles of Morals and Legislation is the key work in utilitarian

philosophy. In it Bentham argued that every act was morally valuable to the
extent that it resulted in happiness. Both human actions and moral
judgments were based on the poles of pleasure and pain:

Nature had placed mankind under the governance of two sovereign masters,
pain and pleasure. It is for them alone to point out what we ought to do, as
well as to determine what we shall do. On the one hand the standard of right
and wrong, on the other the chain of causes and effects are fastened to their
throne.

'Bentham's major work had been completed before he reached his fortieth
birthday, but he lived to be eighty-four and wielded great influence over a
small band of devoted followers. He was never again to write an influential
book but spent much of his later life devising complicated plans for prison
reform, poor relief, education, and legislative reform. He founded the
University of London with an endowment, and his will provided that his
body be embalmed and once a year seated at the meeting of the university's
trustees as a reminder of the principles on which the university was
established. This grisly ritual continued to be performed until recently,
using a wax head instead of the shrunken real one, which was kept in
storage.

This simple principle was more complex than it appeared. Bentham meant
that the social system should seek to maximize its total benefits and
distribute them as widely as possible. A small increase in happiness for
many was better than a large increase for a few. But, as critics were to point
out, that conclusion is not self-evident.

An important problem raised by critics was that of measurement. Increasing

human happiness involves choosing between alternatives. The cost of one
course of action is the elimination of others; that is, we can't have
everything. This means that comparisons of the magnitudes of benefits and
costs must be made in order to determine the best, or optimal, solutions. As
long as the discussion involved only total benefits, the problem was
insoluble. Not until the economists of the last quarter of the nineteenth
century began analyzing increments in benefits and costs—the famous
marginal analysis—were even partial solutions found.

A related question was whether happiness, or utility, could be quantified.

Bentham thought it could, at least in principle. Others argued that one could
only make comparisons; for example, "I greatly prefer Mary to Jane, but my
preference for chocolate over vanilla ice cream is not very strong." The
absolute amounts of happiness derived from being with Mary or eating
chocolate ice cream are, according to this view, impossible to measure and
are, furthermore, irrelevant to the choices made.

These fine points were less important to Bentham than was his argument
that people, in fact, made decisions on the basis of the amounts of utility
derived from the alternative courses of action open to them. This
"hedonistic calculus" was the principle underlying all human action, he
declared, and the means by which the welfare of society was maximized.
He believed that the selfishness of economic behavior was natural, rational,
and desirable.
At this point in the argument, Bentham introduced morals and legislation. If
people always act only for their own greatest pleasure when they should act
for the greatest happiness of all, is not a contradiction involved? Bentham
said there was not, because moral and legislative sanctions caused
individual action to coincide with the public interest. The sanctions
rewarded individual action that benefited all and punished action that
diminished public welfare. Both morality and government action (if it was
majority action) had a utilitarian foundation and rested on the principle of
greatest happiness. Bentham, then, was not opposed to government action if
it was based on democratic processes and did not reflect the narrow
interests of special groups. At the same time, he wished to give free play to
individual decision making within the framework of moral and legislative
sanctions. His goal was to reconcile individualism and social action.

Bentham's significance goes far beyond his rather narrow and outdated
view of human nature. In the first place, his ideas were important
throughout the nineteenth century and profoundly affected later
developments in economics. His view of humans as pleasure machines,
continually calculating the advantages and disadvantages of alternative
courses of action, became the accepted view, and rational economic
behavior was defined in

those terms. The assumption that individual decisions would lead to

maximum public welfare was inherent, of course, in the work of Adam
Smith and the other classical economists, but Bentham made it explicit. All
the later conclusions of orthodox economics were solidly based on, or at
least closely related to, this concept of human nature.

Even more important than his influence on economics was Bentham's

impact on liberal social philosophy. He brought to it an interventionist
emphasis quite at variance with the tradition of laissez-fnire, creating a
problem that even today remains unsolved.

The classical liberalism of the eighteenth century emphasized individual

freedom as the ultimate goal of all policy. Reacting against political
centralization and economic regulation, its advocates argued that any
restriction on freedom hindered the achievement of maximum welfare. In
the hands of Adam Smith, its greatest explicator, this philosophy advocated
minimizing the role of government, strictly limiting it to such essentials as
police, justice, and arms.

Bentham, however, saw that this philosophy was based on the assumption
that only individual action could create welfare. His practical mind told him
that the actions of one person in his or her own interest might reduce the
welfare of another. His legal training and his study of constitutional law told
him that the institutional arrangements within which people act could
significantly determine the outcome of their actions. The very fact that
human society was organized by institutional arrangements created by
people—that a social system existed—meant that conscious action could
create social forms that would enable people to live better lives. Benthamite
utilitarianism was potentially an interventionist doctrine.

Bentham and his followers in England—they called themselves

philosophical radicals—included the economists James Mill, David
Ricardo, and, later, John Stuart Mill. Advocates of democratic government
and majority rule, their major target for reform was the political system,
which in their day excluded large numbers of people from the right to vote
and did not provide fully for freedom of speech and the press. They
believed that the social system could bring the greatest good to the greatest
number only if it were fully democratic and subject to true majority rule.
They were also classical economists and expounded the advantages of a
freely competitive market system and laissez-faire policies. But their
utilitarian political philosophy was to have the gravest consequences for
their economic theories. Once political reform was achieved, the new power
of the enfranchised voter was used as an instrument of economic reform,
and the laissez-faire policy was discarded. The reforms were justified in
terms of individual and social welfare, and the greatest-good argument was
used again and again. The classical liberalism that had stressed
individualism gave place to an interventionist liberalism that emphasized
social welfare, and Bentham was its apostle.

In Bentham's time and later, there was a school of economists dedicated to

preserving the distinction between economics as an objective science and
the subjective judgments inherent in the law and government policy. These
economists emphasized the natural-law aspects of individual freedom and
rationality, along with the laissez-faire implications of that approach. For
example, Nassau Senior (1790—1864), one of the later classical
economists, argued that political economy should eliminate all value
judgments and stick to the purely scientific analysis of how an economy
works. The proper focus of economics should be "not happiness, but
wealth." He strongly opposed the interventionist policies of Bentham and
his followers.

Thus, the rise of Benthamite ideas gave rise to a division among economists
that persists to this day. At one extreme is the thoroughgoing laissezfaire
individualist. On the other is the dedicated social reformer. In between is a
wide range of opinion that accommodates some portions of each view. Yet
much the same theories, concepts, and methods of analysis are used.
Differing conclusions, however, rest on varying preconceptions about the
individual's place in the social order and the way in which economic
outcomes are generated. Mainstream economics, both now and in its early
days, could include a wide range of value judgments and policy positions.
Sismondi and Social Economics
Jean Charles Leonard Simonde de Sismondi (1773-1842), a Swiss native,
lived during a period of revolutionary turmoil and armed conflict—the
American and French Revolutions, the Napoleonic wars, and the events
leading to the revolution of 1848. Apprenticed as a young man to a silk
dealer in Lyons, he fled the French Revolution to a safe England, where he
experienced the political and economic changes going on there. At the age
of twenty-one he returned to Geneva, only to be jailed by the pro-French
government and to have the family estate confiscated. Released from jail,
he went to Italy, where he was jailed three more times by both sides in the
political turmoil. Finally released, he discovered he was descended from a
noble Italian family named Sismondi. He returned to Geneva in 1800 with a
new surname, Simonde de Sismondi, and published a systematic exposition
of Adam Smith's economics, De la richesse commercial (1803).

Sismondi modified Smith's economics by presenting a "absolutely new"

way of looking at the level of economic activity. Output in a given year, he
argued, was determined by investment in the previous year. This output,
though, might not be large enough to employ all those who wanted to work.
He illustrates this argument with arithmetic examples supported by
algebraic formulas and footnotes. A modern economist, accustomed to the
work of John Maynard Keynes a hundred years later, would be intrigued,
but people in the early nineteenth century ignored the book. Jean Baptiste
Say's Traite d'economie politique, in contrast, which presented Say's Law of
Markets, was published in the same year and went through five editions in
the next quarter century. Disappointed when his book did not sell, Sismondi
spent the next decade writing an eight-volume history of Italy.

Sismondi returned to economics in 1814 with a long article on "Political

Economy" for the Edinburgh Encyclopedia, in which he developed an
analysis

of what would be called "macroeconomics" today. This approach was

greatly elaborated in Sismondi's next works, Nouveaux principes d'
economic politique (1823), which appeared in the midst of the post-war
depression and a growing controversy over Say's Law of Markets.

During the Napoleonic wars, when government spending was high and
hundreds of thousands of young men were drawn into armies and navies,
the economies of the contesting powers seemed to achieve the goals of full
employment and an expanding economy. Private investment was
correspondingly high in those early days of the Industrial Revolution. But
when the Napoleonic wars ended in 1815, armies and navies were greatly
reduced, government spending and private investment fell, unemployment
rose and wages fell. The period from 1815 to about 1850 featured high
unemployment and low wages while the economy fluctuated at less than
full employment levels, culminating in the decade that would be called the
"hungry forties."

Sismondi elaborated his theory of equilibrium income to fit these postwar

problems. He argued that during a period of good times producers would
invest to produce more, while consumers would buy only what they had
bought in the previous period. Goods could not be sold at profitable prices
and output and employment would fall. In essence, Sismondi was arguing
that investment was volatile while consumption was relatively stable,
leading to recurring periods of overproduction and underproduction.

The tendency toward the uneven fluctuations typical of business cycles was
exacerbated by two other factors: underconsumption caused by the growing
wealth of the business classes, and the substitution of machinery for labor.
Low wages and technological change would keep consumption from
growing as fast as needed. Sismondi agreed with the advocates of Say's
Law of Markets that a satisfactory level of economic activity would be
achieved in the long run, but the adjustment would take a long time, with
"long and cruel sufferings." Both capital and labor adjust slowly to changes
in demand, he argued, not quickly as Ricardo, Say, and others were saying.
The process of market adjustment was imperfect and costly.

Sismondi's approach to economics differed from that of the English

economists who were concerned about the growth of wealth. He stressed
the enjoyment of wealth and its diffusion among the people at large.
Government, he felt, had a positive role: limitations on child labor,
regulations of hours of labor, public works to employ the unemployed, a
minimum wage, worker co-ownership of business enterprise, and
unemployment insurance paid for by the employer. These and other
government actions were discussed in the final two chapters of Sismondi's
Nouveau principes.

Largely ignored in his lifetime, Sismondi is now recognized as an important

economist of his time. He was one of the first to show the limitations of
laissez-faire and individual self-interest, to emphasize the need to have an
economy sensitive to the needs of working people, and to demonstrate the
need for government to take a positive role in economic affairs. He was the
forerunner of a group of dissidents who advocated a positive role for
government.
John Stuart Mill
No account of classical economics would be complete without discussion of
John Stuart Mill (1806-1873). The eldest son of James Mill, whom we met
earlier in explaining Say's Law of. Markets, John Stuart received an
extraordinary education at the hands of his father. He was started on Greek
at age three and Latin at eight. By the age of fourteen he had read most of
the Greek and Latin classics in the original languages and had read widely
in history, logic, mathematics, and science. His father started him on
economics at thirteen, with emphasis on Ricardo, Malthus, and Bentham.
After a session on economics taught by his father, the young scholar was
required to write a careful summary of the day's work. His father used these
papers as the basis for his own textbook. Elements of Political Economy
(1821), without mentioning that it was based on papers written by his son.
The son was so convinced of the correctness of Malthusian population
theory that at age seventeen he was arrested for publicly distributing
pamphlets advocating birth control and contraception as means of
improving the condition of the working class.

At sixteen John Stuart Mill went to work at the East India Company, where
his father was employed. He rose to an important managerial position by
the time the company was taken over by the British government in 1858.
Two events early in those years had a profound influence on his life. At age
twenty he passed through two years of what then was called a "mental
crisis," but that now would be described as severe depression. He emerged
with a mission in life, devoting himself to advocating political and
economic reform. There followed a series of writings that made him the
best known and most widely read nineteenth-century English philosopher.
A System of Logic (2 volumes, 1843) made the case for empirical science
as the source of knowledge, supplemented by logical deduction to arrive at
general propositions, not the other way around. On Liberty (1859) made the
case for the full freedom of each individual to develop his or her abilities
without hindrance from others or from social or economic constraints. The
only limitation was not to hurt others or limit their freedoms.
Considerations on Representative Government (1861) made the case for
democracy and majority rule but with the qualification that minorities must
be protected from majority authoritarianism. Utilitarianism (1862) argued
for a modified Benthamite society structured in ways that enabled everyone,
including working people, to obtain the good things in life. The Subjection
of Women (1869) advocated reforms that would end the laws and social
customs that made women second-class citizens subject to rule by men. As
a philosopher, John Stuart Mill focused on the great issues of his time, not
on metaphysical theorizing.

The second great defining event in Mill's life came shortly after his bout of
depression. He met Harriet Taylor (1808-1858). When the two first met.
Mill was twenty-five and Harriet was twenty-three. She was married, with
two children and a dull, unappreciative husband. The young man and
woman immediately became close friends. The husband agreed not to inter

fere in the relationship so long as it remained platonic. The young people

agreed, but the relationship was a scandal: the two lived and traveled
together, ignoring gossipy tongues. When the husband died in 1851, John
Stuart and Harriet waited an appropriate two years and then married.

John Stuart Mill always acknowledged Harriet Taylor's influence on his

thinking. In his Autobiography (1873) Mill wrote that she was "the inspirer,
and in part, the author, of all that is best in my writings." Her influence
seems to have been particularly strong on his writings in economics, to
which we now turn.

John Stuart Mill's Principles of Political Economy (2 volumes, 1848) was

the most important economics textbook for over a quarter of a century. It
was based on the Ricardian version of classical economics and on
Malthusian population theory but with some important modifications and
extensions. Where Ricardo had shown that international free trade provided
gains to each country. Mill determined how the gains would be divided.
Mill also showed that the market adjustment process involved changes in
income as well as changes in prices, an idea that had much in common with
the Keynesian economics of the 1930s and after. Mill also modified Say's
Law of Markets by arguing that a general oversupply of goods could
develop; but he also argued that such a condition would be a temporary one,
thereby denying the possibility of Malthus's chronic stagnation.
However, the most important innovation in Mill's Principles was the
distinction he drew between production and distribution. Following
Ricardo, Mill agreed that the principles regulating the production of wealth
are grounded in laws of nature and are therefore beyond human control. But
breaking with Ricardo and Malthus, Mill argued that, unlike the laws of
production, those of distribution are partly of human construction and are
subject to change. This distinction, which may have been influenced by
Harriet Taylor, is emphasized in the very first chapter and is followed later
in the book by an analysis of the land tenure and property rights that
influence the distribution of income and wealth. The poverty of Irish
farmers, for example, is clearly shown to result from the way land is
distributed—not a law of nature.

Mill argued that patterns of distribution of income and wealth were

characteristic of a particular type of society and were not necessarily
morally or ethically just. In an article on the revolution of 1848 in France,
he wrote that "no rational person will maintain it to be abstractly just, that a
small minority of mankind should be born to the enjoyment of all the
external advantages which life can give . . . while the immense majority are
condemned from their birth to a life of never-ending, never intermitting toil,
requitted by a bare, and in general a precarious, subsistence."

Although Mill agreed that an economic system based on private property

would continue to exist into the foreseeable future, he felt that it would
eventually be superseded by "a system of cooperative production"—
socialism! He welcomed an economy of worker cooperatives and worker-
owned enterprises as the ultimate resolution of the social ills bred by a
society

composed of a class of employers and a class of laborers. Mill did not

believe in revolution, however. He felt that enlightened action by free
people would bring experiments with voluntary associations, such as
worker's cooperatives and schemes for profit sharing, which would lead to a
better social order. John Stuart Mill did not believe that an economy
organized around individual enterprise, private property, freedom of
contract, and a minimum of government action—however productive it
might be—was the final consummation of economic progress.
Classical Economics Today
The great themes of classical economics are as important today as they
were in Ricardo's time. The economy has changed, of course, from
industrial revolution to mature industrial capitalism, but the
interrelationships of resources, people, and capital remain central to
problems of human welfare. As world population gallops strongly onward
and upward, the Malthusian population trap takes on crucial importance.
The advanced industrial nations were able to break the connecting link
between production and population—rising output does not trigger the
population growth that prevents income per person from rising. But many
less-developed countries find that growing populations literally eat up the
gains from economic expansion and billions of people remain embedded in
poverty. As this twenty-first century begins, however, the birth rate for
underdeveloped nations has fallen dramatically. Whether this continues or
not remains to be seen.

Meanwhile, in the advanced countries the processes of capital accumulation

and technological change continue to produce greater wealth and rising
standards of living: the twenty-five years after World War II showed the
largest and most sustained increases in material well-being in the history of
Western civilization. But this growth was followed by twenty years of
slowed growth and relative economic stagnation. Even in the United States
economic growth after the late 1960s was only half as fast as in the
preceding twenty years. At the same time, rapid technological change puts
increased pressure on the natural environment through both pollution and
increased use of exhaustible resources. A changing world economy brings
greater instability to the production sector of the economy, affecting both
workers and business firms. Through it all, trends toward big business and
financial speculation seem to accelerate.

These developments in the world economy have brought back into

prominence the fundamental relationships between population,
accumulation of capital, technology, and economic growth that were the
central concern of classical economics. Economic policy today is
increasingly concerned with those relationships, and economists are
returning both to them and to a renewed interest in the problems dealt with
by the classical economists.

FIVE
SOCIALISM AND
KARL MARX
Karl Marx (1818-1883) provided a revohdionary critique of capitalism and
a theoretic foundation for socialism.

Modern socialism emerged as a response to the industrial era just as

classical economics had, and just as the classical economists developed an
ideology for the new order, the socialists developed a critique of it.

Some socialists were impractical, idealistic dreamers, some were

hardheaded critics of the existing society, and others were revolutionists,
but all were united by their criticisms of the new industrial society and by
their belief in common rather than private ownership of the means of
production. Socialists had a different view of the nature of society than did
the classical economists, arguing that the social fabric was essentially an
organic whole composed of classes, rather than a collection of independent
individuals. They stressed the cooperative element in human nature, rather
than the individualistic profit motive of private capitalism, and they
advocated egalitarianism in place of the unequal distribution of income that
prevailed. The socialists could often point to actual economic conditions—
real defects in industrial capitalism—to support their arguments.

Socialism and the Climate of Opinion

The economic and political events of the half-century from 1775 to 1825
provide a background for understanding the rise of modern socialism. Of
primary importance was the Industrial Revolution. It provided substantial
increases in living standards and opportunities for acquisition of great
wealth for the new middle class. It was clear that the reasons for economic
growth were industrialization, capital investment, and higher productivity,
and that every widening of market opportunities made still further advances
possible.

To the socialist, however, industrialism had a different face. Workers in the

new factories were paid low wages. Although factory pay was high enough
to draw labor from the countryside, unemployment in rural areas meant that
workers were willing to accept very low wages. Hours of work were long,
women and children were employed in substantial numbers in difficult and
dangerous jobs, factory discipline was often harsh and rigorous, and in
some areas company-owned stores profited from exclusive selling rights
among employees. Particularly in the textile and coal industries,
competition kept selling prices low, and firms competed with each other by
squeezing labor costs whenever possible. These shortcomings were
particularly evident in the first half of the nineteenth century in England,
where the Industrial Revolution began.

The realities of industrial life created sharp contrasts between the growing
wealth of the new industrialists and bankers and the poverty of those
without property who formed the work force in the factories of the
slumridden cities. During the "hungry forties" in England Benjamin Disraeli
wrote of "the two nations"—the rich and the poor—while Charles Dickens
examined the business ethic in Hard Times. The public read Thomas Hood's
pathetic poem of the sewing woman. Song of the Shirt.

Poverty there had always been, and rich and poor had lived side by side for
ages. Many people always had to wrest a meager living from a stingy
natural environment. But industrialization promised abundance. For the first
time it seemed as though the economy might be able to produce everything
people could want, and that the great struggle for existence could be
resolved. Yet the gray slums of Manchester and the black country of the
coal mines told a different story. The promise and the reality were vastly
different.

A similar difference between ideals and reality prevailed in politics. The

French revolutionists of 1789 had proclaimed "Liberty, Equality,
Fraternity," and with that slogan the French had overthrown the privileges
of the old order and marched through Europe to sweep away the last
remnants of feudalism and aristocracy. New beliefs in freedom and equality
seemed to be creating a political order of full democracy, just as the
Industrial Revolution seemed to portend an end to poverty.

But the defeat of Napoleon brought reaction and repression—and

reestablishment of the old system of place and privilege. Even where
parliamentary government existed, as in England and France, participation
was limited to persons with property, and working people were excluded
from the vote. Democracy, apparently, was fine for the middle class but
dangerous if extended to the worker.

The Industrial Revolution and the French Revolution appeared to many as

means of realizing some of the ageless and ancient ideals of Western
civilization—abundance, an end to excessive toil, and the triumph of
brotherhood and equality. Yet in the darkness of the post-Napoleonic
reaction all this was betrayed, and postwar depressions seemed to produce
even greater poverty and want than before, since the unemployed worker
did not have even a small plot of land on which to grow food. To the early
socialists it was self-evident that private ownership of the means of
production was the

source of society's ills. Ownership of machines, factories, and other capital

enabled the owner to reap rich rewards, to sit back and rake in profits while
others worked. At the same time, economic position brought political
power. In the eyes of the socialist, fifty years of social revolution had given
wealth and power to a few owners of capital rather than to the great
numbers of common people. Society as a whole had been betrayed for the
benefit of a few.

Robert Owen, Utopian

The humanitarian and idealistic roots of early socialism are typified by the
work and writings of the Englishman Robert Owen (1771-1858).
Apprenticed to a linen-draper at ten years of age, he worked at various
establishments in the textile industry throughout his youth, including one
shop that "often worked their employees from 8 A.M. to 2 a.m." After
failing in business for himself, he became manager of a textile mill when
only nineteen years old. Seven years later he was able to buy control of
textile mills at New Lanark, in Scotland, and in 1800 he took over their
active management. The former management had used children from
orphanages as part of its labor supply, along with adults, many of whom
were "thieves, drunkards, and criminals of every sort." The workday ran
from 6 a.m. to 7 p.m. for children as well as adults, and the company town
was composed of wooden oneroom houses. These working and living
conditions were not considered bad for the time.

Owen was a religious man who believed that the workers of New Lanark
were evil because of their surroundings, so he decided to turn New Lanark
into a model community. He took no more children from workhouses or
orphanages and allowed no child under ten to work. The workday was set at
ten and one-half hours for both children and adults. He provided schools in
the evening for the working children (imagine a child of ten going to school
after working ten and one-half hours!) and set up nursery schools for
younger ones. For his adult workers he established a "register of character,"
which recorded drunkenness and other delinquencies, such as illicit sexual
behavior, so effectively that pubs quickly disappeared from the town, and
there were only twenty-eight illegitimate births in nine years. An elected
committee, called "bug hunters" by the women, inspected for domestic
cleanliness once each week. A support fund for the injured, sick, and aged
was established, into which workers were required to pay one-sixtieth of
their wages. Thrift was encouraged by establishment of a savings bank and
by provision of better houses for those who used the bank. Finally, Owen
established a store that sold food and other products to workers, charging
considerably lower prices and providing goods of higher quality than did
private shopkeepers.

How could Owen do all this and still make money in the highly competitive
textile industry? Apparently there were two reasons. First, his plants were
located in an area of labor surplus and his wages were low: An

investigating committee in 1819 reported that he paid 9 shillings, 11 pence

—about $2.40—per week to men, and 6 shillings—about $1.50—per week
to women, figures that were below average for the time. Second, even
though his methods were paternalistic, the attention he paid to workers
seems to have brought relatively high labor productivity. In 1819 profits
were 12.5 percent of the invested capital.

Owen recognized that the reforms at New Lanark had come from the patron
rather than from the workers themselves and that some form of industrial
self-government would have to follow. He published his views in 1816 in
one of the landmark books of the socialist movement. The New View of
Society, at a time when England was debating the first factory act, designed
to limit the hours of work and establish a minimum age for child labor.
Owen lobbied hard for the act, but failure of the bill adequately to cover
child labor disappointed him, and the unwillingness of other employers to
imitate the example of New Lanark drove him to more radical schemes.

He tried to establish cooperative communities, in which land was owned in

common, and in 1824 went to the United States to open one at New
Harmony, Indiana. But the community in America, and others in England,
failed, with substantial financial loss to Owen. More successful were the
cooperative retail stores established under Owen's leadership in England,
beginning the far-flung consumers' cooperative movement that has been
highly successful in England and Scandinavia and has developed to some
extent in the United States. Owen also tried to set up producers'
cooperatives—groups of workers who owned the factory in which they
worked—but these projects did not succeed.

Owen was a visionary who sought to reform society through workerowned

communities and enterprises in which profits were not permitted. He
expected that in such communities the life of the individual would achieve a
larger meaning through full integration into the cooperative life of the
group. In an individualistic era, his efforts were doomed to fail. Perhaps he
was right when he wrote to a business partner, "All the world is queer save
thee and me, and methinks at times that thou art a little touched."

Karl Marx, Revolutionary

In sharp contrast to the idealistic and impractical Owen was the intense
German, Karl Marx (1818-1883). Born and raised in the most economically
advanced part of Germany, the Rhineland, and son of a petty legal official
of the government, Marx displayed great intellectual ability at an early age.
Sent to the universities at Bonn and Berlin, he first studied law with a view
toward a governmental career, but his opposition to the autocratic
governments in Germany precluded that. The young Marx then turned to
philosophy, with the goal of a professorship, but his studies of philosophy
and religion at Berlin—his doctoral dissertation was on the Stoic and
Epicurean roots of Christian doctrine—led him to atheism, and this barred
him from a

university career. So Marx went into journalism and became editor of a

liberal Cologne newspaper in 1842. It was there, while writing on economic
problems, that he became convinced of the economic basis of politics—that
underlying political theories and political power lay the economic interests
of various groups in society. His newspaper was suppressed by the
government for its liberal views, however, and Marx went to Paris where he
married his childhood sweetheart, the daughter of a German baron/ and
became acquainted with a number of socialists.

One of them was Pierre Joseph Proudhon (1809-1865), a socialist leader

who influenced him very strongly. Proudhon's chief work was a book called
What Is Property? ("Property is theft," he answered to his own question), a
forceful statement that the whole product of industry should go to the
worker, and that private property in the means of production enabled the
capitalist to appropriate wealth that rightfully belonged to the worker. This
concept—not original with Proudhon—was a basic tenet of
nineteenthcentury socialism and fundamental to Marx's own view of
capitalism. Another of Proudhon's books, subtitled The Philosophy of
Poverty, attacked the orthodox economics of his time and especially the
"iron law of wages"—the Malthusian argument that wage rates tended
toward the subsistence level because of population growth. Convinced that
Proudhon's arguments were specious, Marx attacked his friend in a book
sarcastically titled The Poverty of Philosophy, and legend has it that
Proudhon never spoke to Marx again.

Another socialist whom Marx met in Paris was Friedrich Engels (1820—
1895), son of a wealthy German textile manufacturer who owned mills in
England and Germany. Marx and Engels formed a friendship that lasted
until Marx's death, and the two men collaborated in developing the ideas
that Marx was later to publish. Engels supported Marx and his family for
most of the next thirty-five years.

While in Paris Marx continued his journalistic career, writing articles

especially critical of Prussia, and he was soon expelled from France at the
request of the Prussian government. Moving to Brussels in 1848, just before
the outbreak of the revolutions of that year, Marx and Engels wrote The
Communist Manifesto: "A spectre is haunting Europe . . . Workingmen of
the world unite, you have nothing to lose but your chains!" Marx had
entered on his career as active revolutionary.

When the revolution broke out, Marx returned to Cologne, began editing his
newspaper again, and publicized the revolution sweeping Europe. But the
revolt was suppressed and Marx, expelled from Germany and

'Jenny Marx was herself a fiery radical. After the family settled in London
in 1849, a series of strongly stated revolutionary articles appeared in several
leftist English papers, under male pseudonyms, which recent scholarship
suggests were written by Jenny Marx. She also is reputed to have translated
The Communist Manifesto into English. The couple's family life was
marred when, in 1851, while Jenny was pregnant with their fifth child,
Marx fathered a child by a household servant. The child was adopted by
another family, with financial assistance from Marx's friend, Friedrich
Engels, who announced that the child was his in order to shield Marx when
rumors about the true parentage began to circulate. After that the
pseudonymous radical articles stopped.

unwelcome in France, went to England, where he spent the rest of his life.
He continued working in journalism from time to time. For a while he was
English correspondent for the New York Tribune, and he wrote about the
French Commune of 1871 for the London Times. But most of his time was
spent in scholarship, doing research on economics in the library of the
British Museum and writing his great work. Capital. This book was both a
denunciation of capitalism—Marx invented the word—and an explanation
of why it must fail. The first volume appeared in 1867 and was the only part
completed by Marx himself. The second volume, edited by Engels,
appeared in 1885, two years after Marx's death, while the third volume,
edited by Karl Kautsky, was not issued until 1894.

Scholarship did not completely replace revolutionary agitation, however,

for when the International—an international alliance of socialist parties—
was formed in 1864, Marx took a leading part. It was not enough to be a
theorist, he felt, for there had to be a revolutionary party to take control
when capitalism collapsed. He wrote extensively in support of the
proletarian revolutionary movement and in opposition to socialists whose
views differed from his own. Marx set a precedent in the use of vitriolic
denunciation that has continued to plague left-wing radicalism to the
present day.

Marx died in 1883 after having given to revolutionary socialism its

theoretical foundations. One wonders how different the world might be
today had not the rigid authoritarianism of post-Napoleonic Prussia barred
Marx from a career in government or university.

Marx's View of Capitalism

It is difficult to condense the grand scheme of Marx's thought without doing
injustice to the power and consistency of his reasoning. The very fact that
Marx's argument is long and intricate, with all parts of it logically
connected and integrated, makes almost any short summary a falsification.
Nevertheless, it is important that it be understood, if only because it is the
basis of one of the most powerful ideologies in the modern world.

Marx begins with the idea that economic relationships are the fundamental
driving force in any society. Particularly under capitalism, however, people
are motivated primarily by their own economic interests—but let him say it
in his own words, from the Preface to A Contribution to the Critique of
Political Economy (1859):

In the social production which men carry on they enter into definite
relations that are indispensable and independent of their will; these relations
of production correspond to a definite stage of development of their
material powers of production. The sum total of these relations of
production constitutes the economic structure of society—the real
foundation, on which rise legal and political superstructures and to which
correspond definite forms of social consciousness. The mode of production
in material life determines the general character of the social, political and
spiritual process of life.

Marx's View of Capitalism 63

In a capitalist society, according to Marx, the two great economic interests

are those of capitalist and worker. These two classes stand in opposition to
each other, since the capitalist can prosper only if the worker is exploited. In
this respect capitalism is only the latest in a series of social organizations in
which one class exists at the expense of another. The Communist Manifesto
(1848) puts it bluntly:

The history of all hitherto existing society is the history of class struggles.
Freeman and slave, patrician and plebeian, lord and serf, guildmaster and
journeyman, in a word, oppressor and oppressed, stood in constant
opposition to one another. . . . The modern bourgeois society that has
sprouted from the ruins of feudal society has not done away with class
antagonisms.

It has but established new classes, new conditions of oppression, new forms
of struggle in place of the old ones.

Marx started his attack on capitalism with the labor theory of value. Recall
that this theory, which was developed by the economic liberals and the
classical economists, stated that the true value of any product or service was
simply the amount of labor used in its production. A table that takes ten
hours of labor to make is worth twice as much as a chair that requires five
hours of labor, assuming labor of equal quality.

In Marx's view, labor under capitalism is exploited because it is not paid the
full value of the products and services it produces. The capitalist employs
workers at the current wage rate and works them for as many hours each
day as possible, making sure that the value of the workers' output is greater
than the wages paid. This difference between the wage and the value added
by the worker, which Marx called "surplus value," becomes the capitalist's
profit. Exploitation of the worker can be intensified, and the surplus value
appropriated by the capitalist can be increased, by an employer's efforts to
achieve lower wages, longer hours, and employment of a greater number of
women and children. Thus Marx explained some of the more widely
prevalent characteristics of the industrial economy of his time.

Exploitation exists in another sense as well. Marx saw capitalism as a

gigantic mechanism through which the labor time of the worker is
transformed first into profits and from profits into capital. Whereas labor
time is owned by the worker, capital is the property of the capitalist. In this
fashion the capitalist class grows increasingly wealthy out of the labor of
the working class: "They coin our very life blood into gold," to quote a
radical song from pre-World War I America.

This exploitation of workers is only the direct economic effect of capitalism

on the working class. It has psychological effects as well. Marx viewed
work as a continuing interaction between people, nature, and the product of
labor. Work was an essential element in the development of the human
personality, so a full realization of the self required a full and rich
development of the individual's relationship with the means of production
and the product. Yet under capitalism the worker is separated from both the
fruits of labor and the tools of production, which are the property of the
employer.

Full development of the self and the personality is prevented. The result is a
pervasive alienation that dehumanizes all personal and social relationships.
Market exchange and money payments take the place of human feelings
and human relationships, and life becomes dehumanized and pointless. The
result is a range of social and psychological pathology that pervades all
capitalist society and is inherent in its basic economic relationships.*

Exploitation and alienation are one side of capitalism. The other is

accumulation of capital and growth of wealth. This side of the economic
process also develops out of the relationships between capital and labor.
However much the employer tries to squeeze his labor, the labor market
itself will determine the level of wage rates, while hours of work are limited
by human endurance, and employment of women and children is affected
by a combination of technological factors and labor-market conditions. The
individual employer has relatively little flexibility in these matters and
cannot readily gain a competitive advantage over other capitalists except by
reinvesting profits (surplus value) in new machinery and equipment, which
raises productivity of labor and increases profits still further. Indeed, the
employer is compelled to do so to survive, because competitors will do the
same. The result is a continuing drive to expand investment. In this way
Marx explained the process of capital accumulation and the growing
productivity and increased output it generates.

Capitalism, then, presents two faces: capital accumulation and growth on

the one hand, exploitation and alienation on the other.
The Breakdown of Capitalism
Marx believed that capitalism was doomed, and he developed an intricate
analysis of the "laws of motion" of capitalist society to prove it. At one
level the argument has a moral basis: the inherent injustices of capitalism
lead ultimately to economic and social conditions that cannot be
maintained. At another level the argument is sociological: class conflict—
between a decreasing number of increasingly wealthy capitalists and a
growing and increasingly miserable working class—will lead ultimately to
social revolution. And, finally, the argument is economic: the accumulation
of capital in private hands makes possible economic abundance; yet
accumulation also leads to depressions, chronic unemployment, and the
economic breakdown of capitalism. At each level the idea of conflict is
emphasized: conflict between ideal and reality, between capital and labor,
and between growth and stagnation. Out of conflict comes change, and for
this basic reason, accord

Marx did not give great emphasis to these extraordinary insights into
modern society. He developed them in early essays that were not published
until after World War II and in two chapters of Capital that deal with them
in partial fashion. But even that was enough to profoundly influence many
modern psychologists and give us the concept of alienation as a source of
psychological disorders.

ing to Marx, capitalism must give way to another form of society in which
conflict is replaced by ethical, social, and economic harmony. Change
through conflict is the "dialectical process" by which socialism was
ultimately to replace capitalism. Marx felt that the process had an economic
basis in the division of society into workers and capitalists. Their
relationship was exploitive, with the owners of the means of production
having the upper hand. Conflict was inherent in this situation, he argued,
and it would build up until the whole fabric of society was torn apart.

Exploitation of labor is the starting point. It leads to inadequate purchasing

power and, through surplus value and capitalist competition, to
accumulation of capital. There is an inconsistency here, however. When the
economy is prosperous, business firms earn surplus value for their owners,
who reinvest it for expanded output. But purchasing power eventually lags,
partly because workers are not paid the full value of their labor and partly
because capital investment pushes output capacity upward. Sooner or later a
glut of unsold commodities appears on the market. Production is then cut
back and prices fall: unemployment increases, profit declines and then
disappears, and capital accumulation is halted. The capitalist "crisis"
continues until the glut of commodities has been disposed of: prices
recover, profits increase, and capital accumulation resumes once more,
continuing until the next glut appears. This process, argued Marx, creates
the recurring cycles of prosperity and depression that are an inherent failing
of capitalism.

Marx also argued that the crises would become more severe—longer and
deeper—as capitalism developed. The total capital and productive capacity
of the economy increase from crisis to crisis, and the ratio of capital to labor
rises. These changes cause the gluts to become larger and larger, to take
longer and longer to be disposed of, and necessitate greater and greater
cutbacks in production.

But why, one may ask, would the glut appear in the first place? Will not
rising prosperity cause increases in employment, wage rates, and
purchasing power? Marx answered that even during prosperity the "reserve
army" of the unemployed receives recruits—workers whose jobs are taken
over by machines. Capital investment leads to substitution of capital for
labor. Indeed, this is the only way in which capitalists can increase the rate
at which they accumulate surplus value. During prosperity, therefore,
capital accumulation creates technological unemployment and pushes
wages and purchasing power down, just as commodity gluts do during
periods of depression. In either case, the result is the immiseration of the
working class.

This is only half the picture, however. Changes also take place within the
capitalist class. First, the rate of profit declines as investment in machinery
and equipment gradually becomes an increasing proportion of total
investment. (Marx was thoroughly convinced of this when he wrote the first
volume of Capital , but the notes he left for Volume Three show that he was
not quite so sure that profit rates must necessarily decline as capital
accumulation proceeds.) Second, the business cycles engendered by
capitalism enable the big capitalists to gobble up the little ones. The firms
with the largest

financial resources survive, and over the years the ownership of industry
gradually becomes centralized in fewer and fewer hands until a few great
financiers control all. This remaining capitalist class becomes increasingly
wealthy, in contrast to the growing misery of the proletariat, which expands
as small businesses fail and the owners join the ranks of the working class.
The working class also becomes increasingly degraded as technological
change breaks down complex jobs into simple ones, skilled jobs become
semiskilled, and semiskilled become unskilled. Ultimately a revolution
occurs, a popular uprising of the vast majority against the wealthy few. Led
by communists, the working class seizes power and proceeds to build the
new society.

Marx was quite aware of the possibility that these economic trends could be
modified by political and social changes. Labor unions, originating in the
conflict between capital and labor, could reduce exploitation of labor, but
Marx feared that opportunistic union leaders might retreat from class
conflict in favor of class accommodation. Governments, although
dominated by capitalist political interests, could introduce social welfare
legislation to strengthen the economic system as a whole. And
parliamentary democracy could provide the appearance of popular
participation even while the economic basis of political power was
becoming more concentrated. Marx, however, was confident that the
underlying economic trends and conflicts would predominate and
ultimately create a revolutionary situation in which capitalism would be
more or less rapidly transformed into socialism.
The Marxist Vision
Marx's analysis of capitalist development was based on the assumption that
two great forces are continually at work in the development of human
society. One is the struggle of people against nature to obtain subsistence
and ease. The development of technology and improvements in methods of
production are one result of that struggle, and in its early stages capitalism
represented a major step toward abundance. Factory production and
machine technology greatly increased human command over nature, and
competitive capitalism forced business firms to reinvest their profits in new
and better methods of production. Capitalism's failure lay in its inability to
continue this process and in the periodic breakdowns, or crises, that
occurred.

In Marx's view, the struggle for existence led to the second great force that
causes economic and social change: the struggle of people against people.
Human beings are one type of productive resource, and control over them is
one way in which a few can increase their wealth and welfare. Therefore,
argued Marx, the struggle for existence inevitably leads to exploitation of
some by others. Early manifestations of this principle were the patriarchal
family, the slave-based economy of ancient times, and feudalism. The last,
in turn, developed into the wage system of capitalism. Each of

1 -1. Schematic Diagram of Marx's Theory of Capitalist Development

The Process of Capitalist Development

Exploitation of labor is the source of capital accumulation by capitalist

enterprises, which seek to increase surplus value by substituting capital for
labor. Loss of jobs, overproduction, and inadequate purchasing power bring
on business cycles, which tend to become increasingly severe as the
economy matures. The long-run trends (capital accumulation, substitution
of capital for labor, declining profit rates), together with worsening
economic crises, lead to (1) an increasingly wealthy capitalist class among
whom ownership of wealth tends to become more highly concentrated, and
(2) an increasingly immiserated working class that gradually becomes
conscious of its own class interests and its systematic exploitation under a
capitalist system.

these social developments represented a victory in the battle against nature

and marked an increase in human freedom—for some, if not all—and each
was made possible by advances in technology and the social organization of
production.

Ultimately, he argued, the economy could achieve widespread abundance

and produce enough for all, and at that point in human history all people
could be completely free, both politically and economically. Capitalism
could not achieve this goal, because it prevented the full development of
modern technology, resulted in the periodic stoppage of capital
accumulation, and created the conditions of social revolution. But socialism
could achieve the goal, because it eliminated exploitation and class
distinctions and because it removed the roadblocks hindering the advance
of production.

Marx concluded that an economy of abundance was possible only in a

classless society. When the abundant economy arrived, there would no
longer be any need for social or economic differences, and exploitation
would long before have ended. Distribution of income would be based on
the maxim "from each according to his abilities, to each according to his
needs." At this point the two great struggles of humanity—people against
nature and people against one another—would end. This was the positive
side of Marxism—its vision of a great world of abundance, equality, and
freedom.
Was Marx Right?
One of the least useful economic debates of the twentieth century has been
over the correctness of Marx's analysis of capitalism. As proof of Marx's
errors, his detractors point to the rising living standards of modern nations.
The working class has not been subjected to growing misery, and labor
unions have gained economic and political power in all the major
industrialized countries. Moreover, the working class has shared the
increased wealth, income, and economic benefits that have been spread
widely throughout all social classes.

Marxists answer that the extremes of exploitation have been shifted from
the domestic working class to that of colonial and less-developed nations.
Peoples dominated politically or economically by great capitalist nations
now bear the greatest burden of exploitation, enabling capitalists to ease
their treatment of the working class at home and allow its living standards
to rise. They also point to the continuing extremes of poverty and wealth
within nations, to the rise of big business and the prevalence of monopoly,
to the dominant influence wielded in politics by business interests, and to
the failure of capitalist nations to find a cure for depressions and
unemployment, as indications that the Marxist analysis was essentially
correct. In spite of all the "concessions" that have been made to the working
class— social welfare legislation, union organization, higher living
standards— Marxists contend that the basic defects of capitalism remain,
holding back

economic growth and postponing indefinitely the emergence of the

abundant society.

Yet even if the Marxist predictions of increased misery and a polarized

society were wrong, Marx's arguments must give us pause. No society can
long endure that excludes a substantial group of its citizens from enjoying
its benefits, as was the case for many workers and their families in Marx's
day and during the nineteenth-century decades of discontent and potential
upheaval in Europe. In many respects Marx's analysis was a theoretical
interpretation of actual conditions.

In the years after 1870, however, many important changes took place on the
European scene. The right to vote—political democracy—was gradually
extended to working people. National systems of welfare legislation
provided protection against the worst effects of the industrial system. The
growth of labor unions and the appearance of political parties representing
the interests of labor gave a new dignity to the worker and signified the
place industrial labor was making for itself. The "safety valve" of
emigration to North and South America and Australia enabled many
dissatisfied Europeans to start a new life in freer societies. And imperialism
offered significant economic opportunities, whatever else might be said
against it.

Social tensions would not have been sufficiently eased, however, in spite of
these developments, without growth in the European economy.
Industrialism opened many doors to the intelligent and the ambitious—
Robert Owen is only one example. Although it has always been true that
one gets ahead more easily if one begins near the top, it is also true that a
growing and changing economy offers more opportunity than a stagnant
one. Continued economic growth, both external and internal, gave Europe
time to adapt to the stresses of industrialization by instituting reforms that
gave political rights to workers and protected them from some of the
harshest effects of the market economy. One moral to be derived from
Marxism is that an economy must provide dignity and broad opportunities
for all if society is to remain healthy.

The Marxist prediction of the triumph of socialism and the creation of a

democratic, egalitarian, and nonexploitive society has not proved accurate.
The prediction of increased concentration of economic power in the
capitalist world has been borne out by events, although many economists
would argue that the reasons for that trend differ from those advanced by
Marx. And capitalism was placed on the defensive by the rise of communist
regimes in Russia and China, and by the spread of socialism through many
of the less-developed countries. But in most instances, these noncapitalist
economies developed authoritarian political regimes, new forms of
economic and social inequality, and new aspects of exploitation. The
humane goals that underlay Marx's rage at capitalism seemed no closer to
achievement in the noncapitalist regimes of the late twentieth century than
in the capitalist. This situation created something of a crisis among leftists
in the advanced capitalist countries, as they reevaluated Marxist theory in a
twentieth-century context.

We should also note that Marx had little to say about what specific forms
socialism might take after the revolution. We should not attribute either the
authoritarian command economy of the former Soviet Union or the
democratic evolutionary socialism of Western Europe to Marx, although
both claim him as godfather.
Marxism After Marx
Marx's critique of capitalism included a forecast of the inevitable
breakdown of capitalism, leading to a period of social revolution out of
which a classless, egalitarian, and communal society could emerge. Engels
was later to call the process "historical materialism." The idea was that in
the early days of capitalism the new "social relations" of capitalist and
worker had freed the "forces of production" from the fetters of feudalism,
leading to an era of growing abundance and freedom. But the contradictions
and conflicts within capitalism—exploitation of workers, elimination of
small enterprise, growth of big business, growing concentration of wealth in
fewer and fewer hands, and financial crises of increasing severity—would
lead to both an end to economic growth and authoritarian suppression of
dissent. The social relations of late capitalism once again would hinder
further development of the forces of production. Conflict, crisis, and
economic upheaval would follow. The working class could take command
and build a communal, egalitarian society in which conflict would be
eliminated and the forces of production would be free once more to usher in
a new era of abundance and freedom for all.

Marx's great vision was not to be. Marx had urged his followers not merely
to interpret the world, but to change it. Take action! As mass political
parties emerged on the left in the late nineteenth and twentieth centuries,
particularly after the Russian revolution of 1917, historical materialism
became not a theory of historical change but a rationale for revolutionary
seizure of power. By the 1930s it had evolved into an apologetic for
Stalinist authoritarianism in the Soviet Union.

Yet at the same time Marxist "revisionism" generated an entirely different

strategy among more moderate socialists. The revisionists rejected Marx's
theory of capitalist breakdown leading to a final crisis. Gradual reform and
democratic elections rather than revolution and seizure of power
characterized this outcome of the debates over Marxism after Marx.
The transformation of what came to be called "orthodox" Marxism started
shortly after Marx's death in 1883. The German Social Democratic Party
(SPD) was the largest socialist party in Europe in the late nineteenth and
early twentieth centuries. It organized a meeting of all socialist groups in
Paris in 1889, and another at Erfurt, Germany, in 1891, to produce a
socialist manifesto. The Erfurt Programme, as it was called, had two parts.
The first part was theoretical, written by Karl Kautsky (1854-1938), whom
we met earlier as the editor of the third volume of Capital. The second part

discussed policy, written by Eduard Bernstein (1850-1932), a journalist who

became the chief spokesman for Marxist revisionism.

Kautsky's part of the Erfurt Programme was a simplified version of Marx s

theory of capitalist breakdown. He wrote that society is breaking into two
hostile groups: an ever-expanding working class and an ever-shrinking
capitalist elite. The condition of the working class constantly deteriorates
while the elite grow wealthier. Economic crises become increasingly severe.
The goal of socialism moves closer as the final crisis of capitalism
approaches.

Bernstein's statement of immediate objectives, however, said almost

nothing about socialism or social ownership of the means of production. It
was a list of political goals: extension to everyone—including women—of
the right to vote; proportional representation in the legislature, referendums
for direct votes by the public; popular election of judges; separation of
church and state, particularly in education; control of foreign policy by the
legislature; a bill of individual rights; freedom of association and press; and
equal rights for men and women. There isn't much that is revolutionary
here, at least to us more than a hundred years later. These political goals
were supplemented by such measures as free medical care; legal aid
programs; free burial; free education at all levels, including higher
education; old age pensions; and full employment. Costs would be paid out
of progressive income taxes, property taxes, and death duties. Indirect
taxes, such as sales taxes, would be prohibited. There's not much here that's
radical. All of Bernstein's practical program could be accomplished in a
private-enterprise capitalist system—or by a communist party after a
revolutionary seizure of power.
Orthodox Marxism took the latter path, despite the fact that both Marx and
Engels recognized that England and the United States, for example, might
avoid a revolutionary confrontation between capital and labor because of
their democratic political institutions. Engels's later writings, however,
emphasized Marx's theory of the breakdown of capitalism in an era of
social revolution, leaving out, as Marx did not, the possibility of
developments that might modify the trend toward breakdown, such as labor
unions, welfare legislation, and parliamentary democracy.

Orthodox Marxists debated several strategies for seizing power in the name
of the working class. Rosa Luxemburg (1870-1919) advocated mass action
by the working class, using the general strike of all workers at a time of
crisis to bring monopoly capitalism to its knees. In Social Reform or
Revolution? (1900) she advocated revolution. In The General Strike (1907)
she laid down her revolutionary strategy. In Accumulation of Capital (1913)
she argued that the collapse of the capitalist system was imminent, carrying
Kautsky's rigid version of Marx's historical materialsm to its logical
conclusion. She was murdered by the military during the Spartacist revolt in
Berlin in 1919, a failed effort to stimulate a general strike and seize power.

Although Marx had argued that the working class would develop a
revolutionary consciousness, a program, and a strategy out of its experience
in a capitalist society, the Russian, V. I. Lenin (Vladimir Ilyich Mlyanov,
1870-1924) doubted that would happen. In a 1902 pamphlet. What Is To Be
Done?—Burning

Questions of Our Movement, he called for the formation of a party of

dedicated revolutionaries who could lead the masses during a time of crisis,
seize power, and proceed to build the new society. Members of the party
would work full time for the party and would be thoroughly trained in
revolutionary strategy and tactics—professional revolutionaries. The party
would maintain contact with other groups and organizations among the
working class and other exploited groups, but its members would remain an
elite and secret leadership.

Meanwhile, an important modification of the theory of the breakdown of

capitalism, by Rudolph Hilferding (1877-1941) in Finance Capital (1910),
gave added impetus to those Marxists arguing for revolutionary seizure of
power. While Marx had analyzed the development of competitive
capitalism, Hilferding argued that capitalism had evolved into monopoly
capitalism dominated by a few great financial institutions. This was the
final stage, and the social revolution was imminent, he argued. Orthodox
Marxists, including Lenin, immediately seized upon Hilferding's analysis as
further justification for a revolutionary seizure of power. Lenin, in
particular, used Hilferding's argument in his theory of revolution and
political action.

Lenin's revolutionary strategy developed during the tumult of events of the

World War (there was only one at the time). In Imperialism, The Highest
Stage of Capitalism (1916) he characterized the war as essentially an
imperialist war for control of investment opportunities in underdeveloped
parts of the world. He argued that as investment opportunities and rates of
profit declined in the advanced capitalist nations, and concessions were
made to the working class to avoid strife, colonies became essential as
outlets for surplus goods and surplus capital. Furthermore, exploitation of
labor in the colonies was intensified as unions grew at home and
exploitation of labor was relaxed. This analysis helped answer those critics
of Marxism who argued that, contrary to Marx and orthodox Marxism,
exploitation of labor was not increasing and the working class was not
being immiserated. It also served another purpose within Russia, where
Lenin could argue that Russian workers, in an underdeveloped country,
were subject to more intensive exploitation than workers in more advanced
western European countries and would therefore be more ripe for revolt.
Marxist theory was placed in the service of a political program.

The State and Revolution (1917) was even more important in the formation
of Lenin's political strategy. The revolution against capitalism would lead to
a "dictatorship of the proletariat." This phrase had been used by Marx, but
its meaning was not clear. Did it mean simply a government dominated by
workers, analogous to bourgeois dominance of the state under capitalism, or
did it mean an authoritarian government headed by a small revolutionary
political party? Marx himself was not clear on this point, sometimes using
the term in one context and sometimes in the other, and Engels had once
written that the United States might move to a dictatorship of the proletariat
by democratic elections, whatever that might mean. Nor was Lenin clear on
exactly what he meant (he used exactly one page to discuss the issue). In
practice, however, after the Bolshevik seizure of power in Russia in 1917,
die

tatorship of the proletariat meant authoritarian rule by a small group of

revolutionaries acting in the name of the working class as a whole.*

The State and Revolution also made a distinction between the lower stage
of communism and a higher stage.** Lenin argued that after the revolution,
during which the communist party comes to control the state, the powers of
government would be used to move toward socialism. But only after the
socialist system increased production to achieve abundance would it be
possible, in the higher stage, for the state to wither away and the principle
of "from each according to his work, to each according to his need" to be
applied. In the first stage—socialism—incomes would not be equal, and the
dictatorship of the proletariat would prevail.

With Lenin, orthodox Marxism developed into an economic and political

ideology that served the needs of Soviet authoritarianism. Engels's and
Kautsky's emphasis on the inevitable breakdown of capitalism, plus Lenin's
strategy of a revolutionary party and dictatorship of the proletariat,
combined with the concept of socialism as a lower stage of communism,
produced a bastard Marxism perfectly suited to Stalin and the authoritarian
Soviet regime.

While this development of orthodox Marxism was going on, an entirely

different path was pioneered by the revisionists. After the death of Engels in
1895, Karl Kautsky and Eduard Bernstein, the two authors of the Erfurt
Programme of 1891, were widely considered to be the foremost Marxist
theorists in Germany, where the Marxist tradition was strongest. Bernstein
had been editor of one of the important socialist newspapers from 1881 to
1890, published first in Zurich and then in London because of Germany's
laws banning socialism and socialist publications. While in London he
became friendly with Engels and met some of the English socialist leaders.
He served as co-executor of Engels's estate in 1895 and 1896. But Bernstein
had already begun to question the theory of capitalist breakdown stated so
forcefully by Engels. He returned to Germany when the antisocialism laws
were repealed, and between 1896 and 1898 he published a series of articles
on "Problems of Socialism" in the leading socialist newspaper Die Neue
Zeit. They were later expanded into a book with the cumbersome title of
The Presuppositions of Socialism and the Tasks of Social Democracy
(1899). An abridged English version, Evolutionary Socialism: A Criticism
and Affirmation, was published in 1931, at a time when the Great
Depression and the rise of fascism revived interest in socialist alternatives.

*One of the early slogans of the Russian revolution of 1917 was "All power
to the Soviets," which were local and factory governing bodies elected by
workers. I once asked an economist from the Soviet Central Planning
Commission, shortly after the death of Stalin, "What do you suppose the
world would be like today if Lenin had placed power in the hands of the
Soviets instead of in the Party?" I should have known better. His answer: "It
was an historical necessity"—Marxist historical materialism as political
ideology.

"Marx had made a similar distinction in an 1878 pamphlet. The Critique of

the Gotha Programme, in which he pointed out that there would have to be
an intermediate stage between capitalism and full communism. But he did
not specify what that stage would be like, leaving that to be decided by
those living and working at the time.

In his 1899 book Bernstein denied that he was rejecting the essential core of
Marxism, while he sought to revise what he considered to be outdated,
dogmatic, or ambiguous. In particular, he rejected the idea of an imminent
collapse of capitalism. He disputed the Marxist predictions of increasing
industrial concentration, the destruction of small business, and more acute
economic crises (Germany had recovered quickly from the depression of
the 1890s), as well as the theory of working-class immiseration. Instead, he
argued that the working class was steadily advancing both economically
and politically and a social reaction against capitalist exploitation was
reforming economic life. There would be no catastrophic crash.

Bernstein called for the Social Democratic Party (SPD) to forego ideas of
forcible revolution and the dictatorship of the proletariat and become a
party of reform. It should emphasize transforming the state "in the direction
of democracy" through extension of political and economic rights.
Ultimately, when the SPD gained power through a democratic election, it
could move toward socialist reform. Bernstein rejected both revolutionary
seizure of power and dictatorship of the proletariat.

Successive party congresses rejected Bernstein's views, although in practice

it adopted them. Bernstein was elected to the Reichstag and served as a
socialist delegate from 1902 to 1906,1912 to 1918, and 1920 to 1928.
During World War I he called for a peace settlement and in 1915 voted
against funds for the war effort. After the war he argued the case for
democratic socialism on moral and ethical grounds.

Bernstein's evolutionary socialism of reform from within rather than

revolution, of extending the scope of parliamentary democracy, of
introducing the socialist program step by step thorough majority vote, was
to become the program of socialist political parties in all of western Europe
and North America in the twentieth century. After the Second World War
socialist parties came to power everywhere in western Europe, usually in
coalitions with other liberal groups, and were able to legislate a variety of
socialist programs and economic reforms. Marxism after Marx took two
paths. One led from Engels through Lenin to the ideology of the Soviet
Union. The second, by way of Bernstein, evolved into the strategy of
democratic socialism.

Marxism, as an idea, has been an important force in the modern world. It

expresses a moral outrage at the condition of humanity. It holds up a grand
vision of what the condition might be. It viewed modern capitalism as a
dynamic system in which the very process of growth leads ultimately to a
crisis in which the system as a whole could no longer sustain itself. Its
class-oriented view of the social order provided a framework within which
much of what happens in the modern world can be analyzed. It provided a
basis for political action and an ideology around which dissent could rally.
These aspects of Marxism are far more important than whether its analysis
of individual issues is right or wrong. Wherever people feel oppressed,
Marxism can express their outrage and hope and offer a path to something
better. It is this characteristic of Marxism that made it a force to be
reckoned with in the modern world.

SIX