History Of Economic thought I

PART ONE

INTRODUCTION AND EARLY CLASSICAL ECONOMIC THOUGHT

1.1. History of Economic Thought

H istory of Economic Thought may be defined as a critical account of the

development of economic ideas, searching into their origins, interrelations, and, in
some cases, their results. The history of economic thought concerns thinkers and theories
in the field of political economy and economics from the ancient world right up to the
present day. Economics was not considered a separate discipline until the nineteenth
century. For example, Aristotle, the ancient Greek philosopher, in his works on politics
and ethics have thought of ‘art of wealth acquisition’. He also considered the question
whether property is best left in private or public hands. In medieval times, scholars like
Thomas Aquinas argued that it was a moral obligation of businesses to sell goods at a just
price. Economic thought evolved through feudalism in the Middle Ages to mercantilist
theory during the Renaissance (when people were concerned to orient trade policy to
further the national interest). The modern political economy of Adam Smith appeared
during the industrial revolution, when technological advancement, global exploration,
and material opulence that had previously been unimaginable wasbecoming a reality. All
these and further developments are subject matter of history of economic thought.

Changes in economic thought have always accompanied changes in the economy, just as
changes in economic thought can propel change in economic policy. Economic thought
has at times focused on the aspects of human nature such as greed and selfishness that
generally work against the good of all; at other times, economic behaviour has been seen
as self-regulating and working toward a common purpose. As contemporary economic
thought deals with the issues of globalization and the emergence of a global economy,
economists have turned to the multitude of other disciplines which, like economics,
developed independently. Building on their discoveries, and united with them in pursuit
of the common goal of benefiting human society, economic thought may be on the road
to achieving a new level of understanding.

Compiled By: MamoEsayas (Msc in Economic Policy Analysis)

History Of Economic thought I

There are several ways to present the history of economic thought. (i) to analyse the
changingnature of economic theory in conjunction with the social and economic
development of society (ii) toemphasize economic thinking as part of the main currents
of philosophical and political ideas (iii) to emphasize the internal dynamics of the science
where new insights and results emerge as a consequence of economists’ awareness of the
shortcomings of the present state of the subject.

1.2. Economic History

Economic history is different from history of economic thought. Economic history is the
study of the economic aspects of societies in the past; the history of the economic use of
resources land, labourand capital; or the examination of the past performance of
economies. It is concerned with how people lived most of their lives, how many were
born and died, how they earned and spent, worked and played. Such variants, however,
reveal little more than the definition which once said simply that it was the sort of history
which required a knowledge of economics; though they are an advance on that which
defined an economic historian as one who wrote as little history as possible for as much
money as possible. Economic history asks economic questions – be they about the
demand and supply of goods and services, about costs of production, levels of income,
the distribution of wealth, the volume and direction of investment, or the structure of
overseas trade – it inevitably deals with large numbers, with aggregates. A study of
economic history is important because the historical economic phenomena to be
examined in any given period have no existence independent of the social, political,
cultural, religious and physical environment in which they occurred.

1.3. Preclassical Economic Thought

Classical economics is dated from the publication in 1776 of Adam Smith’s Wealth of
Nation. That, of course, is only a rough date; as we will see in the next chapter, the ideas
in Wealth of Nations were being developed during the Two hundred years before 1776.
We divide the prior period into two parts: an early-preclassical period from about
1393BC to 1500, and a preclassical era from 1500 to 1776. First, we deal with the early
preclassical period.

Compiled By: MamoEsayas (Msc in Economic Policy Analysis)

History Of Economic thought I

We divide the earlypreclassical period into fivesubperiods: (1) Ancient Hebrew

economic thought, (2) Early Eastern economic thought ofChinese as represented by the
writing of the seventh century BC figure Guan Zhong (725- 645 BC) and Hindan as
represented by Kautilya(350 BC-275 BC); (3) Greek thought, in which we focus on the
works ofHesiod(700 BC), Xenophon (430-355 BC) and Aristotle (384-322 BC); (4)
Arab-Islamic thought, in which we focus on the writings of IbnKhaldun (1332-1406); and
Abu Hamid al-Ghazali(1058 -1111)and(5) economic thought of the scholastics (middle-
age), in which we focus on the writings of St. Thomas Aquinas (1225- 1274).

1.3.1. Early Preclassical Economic Thought

Important Writers
Hebrew Prophets Old Testament 1400 BC
Guan Zhong GuanZi c. 700 BC
Kautilya Arthashastra c. 400BC
Plato The Republic c. 400 BC
Xenophon Ways & Means to Increase the Revenues of Athens c. 355 BC
Aristotle Politics c. 310 BC
Abu Hamid Al-Ghazali IhyaUlum al Din c. 1110
St. Thomas Aquinas Summa Theologica c. 1273
IbnKhaldun The Mugaddimahc.1377

Some Broader Generalization: Modern economic theory finds the source of all
economic problems in relative scarcity. Scarcity is a result of our desire to consume more
goods and services than our society can produce. Modern economies are market
economies; thus, modern economic theory focuses on how markets help to deal with the
problems of scarcity and gives much less attention to the use of force, authority, and
tradition. The early preclassical thinkers reflected on aspects of their economic lives but
gave greatest attention to nonmarket-allocating mechanisms. Unlike modern economists,
who are especially concerned with the efficiency of resource allocation, the early
Western preclassical thinkers considered the consequences of various types of economic
activities for justice and the quality of life. The early writers had little notion of the meaning

Compiled By: MamoEsayas (Msc in Economic Policy Analysis)

History Of Economic thought I

and implications of scarcity and how markets coordinated individual activities. This
observation does not denigrate the accomplishments of these intellectuals, for it was a long
and tortuous road to recognizing the meaning and implications of scarcity and realizing that
an economy existed that was capable of analysis. Historians of economic ideas acknowledge
that the early writers identified a number of concepts and tools that enabled later writers to
understand the developing market economy.

Two important themes emerge from early preclassical doctrine. One concerns the level of
inquiry appropriate for analyzing society. These writers believed that it was inappropriate
to separate any particular activity—economic, for example—from all other activities. The
very ability to make such abstract separation represents part of the intellectual apparatus
necessary for the “birth” of economics and the other social sciences. It is ironic that
although the Greek writers, Arab-Islamic scholars, and St. Thomas Aquinas rejected the
artificial separation of activities, in their development of abstract reasoning they gave the
social sciences a significant and prerequisite building block. A second theme is the focus
on broad philosophical issues, giving particular attention to questions of fairness, justice,
and equity. The preclassical writers examined exchange and price with the purpose of
evaluating their fairness, justice, and equity. Such concern makes sense in a premarket
society. These two themes—the illegitimacy of abstraction and the focus on equity—can
also be found within a good deal of heterodox economic writing from the eighteenth
century to the present.

1.3.1 (A) Ancient Hebrews Economic Thought

H ebrew were a nation of ancient civilization whose history dates back to 2500 B.C.
The main source of their history and ideas is the writing of the Hebrew prophets.
There ideas are contained in the rule of conduct and laws formulated by the sacerdotal
class. These commands were the standard of all thought and actions. The economic ideas
of the Hebrew prophets as expressed in their commands and laws can be summarized as
follows:

i. Usury or Interest: although the prophets did not use the term ‘interest’, they
prohibited the “usury of money, usury of victuals, and usury of anything that is lent

Compiled By: MamoEsayas (Msc in Economic Policy Analysis)

History Of Economic thought I

upon usury.” If the thing accepted in return was more in value than what was given
to the borrower, it was considered to be an act of usury. This rule was modified in
the times of Solomon when charging of interest at a low rate was justified.

ii. Commerce and Just Price. Hebrews exercised great care in formulating laws
against false weights and measures and adulteration of articles of consumption. The
rules for curbing monopoly and speculation were even stricter. The export of food
grains was not permitted. Retailers’ profits were fixed. All these provisions aimed
at safeguarding the interest of the poor. Thus, the Hebrew developed the basic
concept of a just price in its rudimentary form.

iii. Labor, agriculture and Industry. The Hebrews regarded all kinds of labor as
dignified, but the pride of place was given to agricultural labor. Hebrews did not
lay down rules for regulating the relations between the employer and the employee.
Payment of daily wages, protections to workers and penalties for those who
violated of flouted the rules.The Hebrews did not encourage manufacturing of
goods and commerce to any considerable extent. It is, thus, clear that laws were
conducive to the growth of agriculture while they discouraged industry and trade.

1.3.1(B) Non-Western Economic Thought

Guan Zhong (725-645 BC)

A seventh century BC Chinese writer, Guan Zhong (725-645 BC), in his book Guan Zi,
argued that when a good was abundant, it became light, and its price would fall. When it
was “locked away,” it became heavy, and its price would rise. There would be
movements of goods into and out of markets based on their lightness and heaviness, with
a definite tendency toward one price-equilibrium. Thus thelight/heavy theory is a
statement of the law of supply and demand. Guan Zhong also used this light/ heavy
theory to develop a quantity theory of money, asserting that when money was heavy, its
price should rise (prices of goods would fall), and when money was light, its price would
fall (prices of goods would rise). To stop that fluctuation, he advised that the state should

Compiled By: MamoEsayas (Msc in Economic Policy Analysis)

History Of Economic thought I

buy goods when money was heavy (thereby holding the price level up) and sell goods
when it was light (thereby holding the price level down).

The writings of Guan Zhong indicate that there is a universality to ideas of supply and
demand that transcends time and place. They are not Western ideas imposed on other
cultures; rather, they are aspects of reality that will show up in all institutional structures.
The general structure of economic ideas is universal. However, when it comes to policy,
the thoughts reflected in Guan Zialso suggest that economic insights have no direct
policy implications independent of institutional structure. Change the institutional
structure and one changes the policy implications. Guan Zhong actively structured policy
to fit the institutional structure of his time, but with an activism that worked with market
forces, not against them. Currently China is undergoing a significant economic
transformation and is turning to Western economics for thoughts about how to structure
and manage it. Coming as it does from a Chinese tradition, a study of Guan Zimight be
more relevant to Chinese economics than the more conventional analysis of its Western
counterpart, Wealth of Nations.

Kautilya(350 -275 BC)

Kautilya also known as Chanakya was an ancient

renowned writer lived in ancient Indian during the 4 th
century B.C. He was in the position of prime minister of
Chandra Gupta Mauryan emperor. He disclose the
conditions of the society under Mauryan Empire in his
masterpiece ‘Arthasastra’. In which he deal with the
social, political and economic conditions of that time.
An artist’s impression of
Kautilya (350-275BC)

Following are the major ideas of Kautilya in Arthasastra.

The Economy:Kautilya used the word ‘Vartha’ to represent the science of economics. He
also used the word ‘Arthasastra’ instead of using Vartha, which consist of every field of
human knowledge like politics, economics, ethics, national defense etc. Agriculture was

Compiled By: MamoEsayas (Msc in Economic Policy Analysis)

History Of Economic thought I

the primary occupation of the society. So, the ancient Indian society was purely based on
agriculture. Even though it was a labor based economy, the slavery system was rare. And
the lower class people were mainly engaged in the agricultural sector. So, the
specialization of labor worked well in the ancient Indian society. He disclose that ancient
Indian people had an advanced concept on the value of commodities and the rules and
regulations on trade.

Kautilya’s View on Wealth: Kautilya gives much importance about the role of wealth in
human life.Kautilya provides brief explanation on wealth. By wealth Kautilya means, it is
aimed to satisfy the wants of the wealth owner itself, his family and also for the welfare
of the society through doing charity. The ultimate aim of acquiring wealth must be for the
charity (darma), love (kama), wealth (Artha) and Salvation (Moksha).

Kautilya’s View on Public Economics: Kautilya’sArthasastra disclose many advanced

ideas on public economics or public finance. The main source of public revenue was
through taxes. The administrative authority collected different taxes to enrich the wealth
of the country. Taxes were imposed on goods produced in the country and also from
foreign trade. During that time high rate of taxes imposed on the importing of
unnecessary commodities like luxury goods. Similarly, the public expenditure was
mainly based for the national protection, social welfare etc. Major spending of the
administrative authority was for national defense, public administration officials, and
expenses for army etc.In short, Arthasastra of Kautilya is a valuable evidence for
studying the ancient history of India. In which he clearly mentioned many things
including economics, politics, public administration, army system etc.

1.3.1 (C) Greek Thought

Hesiod and Xenophon

Compiled By: MamoEsayas (Msc in Economic Policy Analysis)

History Of Economic thought I

Hesiod was a Greek poet generally

thought by scholars to have been active
between 750 and 650 BC, around the
same time as Homer. He is the first
European poetry. Ancient authors
credited him and Homer with
Hesiod (750-650 BC)Xenophon (430-350 BC)
establishing Greek religious customs

The ideas of Hesiod were orally presented during the eighth century BC. The most
important work attributed to Hesiod is an accounting of the birth of the gods, Theogony.
According to Hesiod, scarcity does not arise from a human condition related to limited
resources and unlimited desires; rather, it was one of the evils released when Pandora
opened the Box. Hesiod’s economic ideas are presented in Works and Days, in which he
initiates a pursuit of economic questions that continued for two centuries. Being a farmer,
Hesiod was interested in efficiency.

The early writers were not interested in efficiency at the level of society because they had
no real insight into the concept of scarcity, its implications, and an economy. As used by
the Greeks, however, the term refers to efficient management at the level of the producer
and/or the household. It is interesting that economics as a discipline was quite well
developed before a full and complete understanding of efficiency at the level of the firm
and household was established. (This took place at the end of the nineteenth century, with
the use of marginal analysis and differential calculus.)

The word economics, derived from Greek, was used by Xenophon as the title of his book
Oeconomicus. Xenophon, writing some four hundred years after Hesiod, took the
concepts of efficient management much farther than Hesiod and applied them at the level
of the household, the producer, the military, and the public administrator. This brought
him insights into how efficiency can be improved by practicing a division of labor.
Attention to the division of labor was continued by other Greek writers, including
Aristotle, and, later, by the scholastics. Some of his contributions are:

Compiled By: MamoEsayas (Msc in Economic Policy Analysis)

History Of Economic thought I

On wealth: Wealth, for Xenophon, is to be interpreted in relation to needs: the man of

simple tastes and little substance is wealthy in comparison with the man of great
possessions on whom excessive claims rest.

On Agriculture: He is known for his praise of agriculture. He said “If husbandry

flourishes, all the other arts are in good shape, but whenever the land is compelled to lie
waste, the other arts of landsmen and mariners alike will perish.”

On the law of diminishing returns: He approaches (or seems to approach) in a fumbling

(mishandling) way the law of diminishing returns. He said, “The landowners could all
tell you how many teams and how many laborers are required for their estates. If anyone
employs hands in excess of requirements, it is reckoned (computed) as a loss.”

On public Finance: He saw foreign residents as a source of revenue, and he argues for
the abolition of all regulations that inflict disabilities on this class. No less significant is
his suggestion to raise a capital sum to provide accommodation for merchants and shops
and houses for retail dealers. He said, in peace time wealth accumulated, in war time it is
spent.

On the law of increasing returns: He associated a property of increasing returns with

silver mining. The greater the number of people employed; the more prolific (fruitful), or
yielding becomes the ore. ‘There is no limit to the demand for silver’. ‘Silver ore will
never give out, and silver will never lose its value.’ Gold does not have this marvelous
property. “When an abundance of gold makes its appearance, its value depreciates, and
it sends up the price of silver”

On joint stock: In order to overcome the risks (interest in opening new cuttings, i.e., new
silver mines) he suggests something approaching to a joint stock method of operation.

Plato (423/428-348 BC)

Compiled By: MamoEsayas (Msc in Economic Policy Analysis)

History Of Economic thought I

Plato’s teachings are found in his books: ‘the Republic

and the Laws’. Plato is the supreme exampleof the
classical tendency to regard economics as a minor sub-
section of ethics and politics. His contributions are:

On State: According to Plato, the origin of the state is

attributed to economic considerations. He said “A state
raised out of the needs of mankind; no one is self-
Platto (423/428-348 BC) sufficing, but all of us have many wants.”

On Division of Labour: This line of argument, after a consideration of the essential

needs of mankind, leads to Plato’s discussion of division of labour. His idea of the
division of labour (whose starting point is ethical rather than economic consideration)
emanates from his belief that ‘there are diversities of natures among men, and each
should do what is natural to him.’ That there are diversities of natures among us which
are adapted to different occupations. As a consequence of this ‘all things are produced
more plentifully and easily, and of a better quality, when one man does one thing which is
natural to him and does it at the right time, and leaves other things’.

On communism: Plato has proposed a state based on communism. His ideal state is
basically to be constructed on the basis of his notion of the division of labour.

Aristotle (384 – 322 BC)

Compiled By: MamoEsayas (Msc in Economic Policy Analysis)

History Of Economic thought I

Aristotle went further than any other thinker in antiquity

in the direction of detaching a separate science of
economics. His contributions are:

On Private Property: According to him a system of

communism would not work, and that it violates natural
human instincts. For Aristotle, people pay most attention
to their own private property and less to that in which
Aristotle (384 – 322 BC)
they have but a part interest.

Aristotle was against communal property. He said that unity built on communism is in
fact an illusion; the common purse leads to quarrels arising out of trivial causes.
Moreover, there is an immense advantage in the sense of private property.Apart from the
dispute regarding communism, the main part of Aristotle’s economic teaching is to be
found in the first book of his ‘Politics’.

On Domestic Economy: In his discussion of what he calls Domestic Economy, he

identified the following relationships:

- that of master and slave

- that of husband and wife
- that of parent and children
- the art of finance

In a discussion on the relationship between master and slave, he defended slavery. The
principle of rule and subjugation is, he says, inevitable and beneficial, and there are
natural slaves, persons who are as far inferior to others as the body is to the soul, or a
beast to a man. Aristotle distinguishes between ‘natural’ and ‘legal’ slaves, the latter
being captives of war. His discussion on finance is more relevant to economic theory.

Aristotle distinguishes three kinds of finance.

- the natural (healthy) finance

- the unnatural finance, and
- the intermediate finance

Compiled By: MamoEsayas (Msc in Economic Policy Analysis)

History Of Economic thought I

The whole discussion of finance is very much related to wealth getting. Natural finance
refers to the acquisition of wealth or the means of subsistence through natural ways.
According to him the wealth acquired through natural finance is genuine wealth and has a
limit (the limit is provided by the means of subsistence; wealth must be limited by the
needs and the purpose of the household and the state.)

 Natural finance refers to the acquisition of the means of subsistence gathered in

natural ways, pre-requisites which nature ought to provide. Natural finance includes
such things as farming, husbandry and bee keeping.

 Unnatural finance, according to him, does not have natural existence. It is merely
money making. It produces money merely by means of exchange, and here wealth
is unlimited. Unnatural finance belongs to trade and comprises commerce, usury
and hired labour.

 For Aristotle the worst from of finance is Usury. For him the function of money is
for the purpose of exchange, and no more. Money, for Aristotle, is barren and
unproductive. While natural finance is considered to belong to his Domestic
Economy, unnatural finance does not.

 Aristotle’s intermediate finance comprises something common to each of the others.

This part is concerned with the products of the earth such as woodcutting and
mining (now described as extractive industries).

Aristotle is important not only for his contributions to philosophical thinking but for the
impact he had on economic ideas during the period of scholasticism. It was to Aristotle’s
views that St. Thomas Aquinas and other churchmen reacted in the period 1300 to 1500.

1.3.1 (D) Arab-Islamic Thought

Abu Hamid al-Ghazali(1058 -1111)

Al-Ghazali, like other Arab scholars, wrote within a framework that integrated the
philosophical, ethical, sociological, and economic facets of society into the overriding
religious beliefs of his time and place. He was among the most significant intellectuals of
Compiled By: MamoEsayas (Msc in Economic Policy Analysis)
History Of Economic thought I

medieval Islam, and his writings are known to have influenced St. Thomas Aquinas. His
description of the evolution of markets through voluntary exchange is remarkably
perceptive (sensitive) for one writing in the 11 thcentury, as was his insight into how
markets link and coordinate economic activities with the evolution of specialization and
division of labor. In earlier times, a loaf of bread may have resulted from the activities of
one family, who planted, harvested, and ground the grain, then prepared and baked the
bread. Al-Ghazali observed that in his time, a loaf of bread might be the product of a
thousand workers or more. Realizing that increasing specialization and division of labor
result in economic exchange, al-Ghazali was able to point to the difficulties of barter and
the consequent need for a currency to facilitate these exchanges. He also examined a host
of other economic topics: public expenditures, taxation, and borrowing; coinage and the
debasement of coins; interest and usury; and how best to levy taxes to appropriately
spread the tax burden on society.

Like his contemporaries and those who followed for nearly five hundred years, al-
Ghazali did not abstract economic from other activities. His insights and descriptions
were always made in the broader context of his strongly held religious views, which
constrained, and in some cases, proscribed, economic activity.

IbnKhaldun(1332-1406)

IbnKhaldun, likewise, was not interested in purely economic questions. His examination
of economic topics was always tangential and in the context of broader concerns.
Possibly his most interesting insight into economic issues arises in his broad, sweeping
(far-reaching, comprehensive) examination of how his society appeared to have what we
would today call a developmental cycle, moving from rural desert-life society with low
income, low craft skills, and small economic surplus to a non-nomadic society in which
agriculture predominated, with higher labor productivity and incomes, economic
surpluses, and population growth. From today’s vantage point, one can see many
“economic” topics being examined by IbnKhaldun: population, profits, supply, demand,
price, luxury, aggregate surpluses, and capital formation.

Compiled By: MamoEsayas (Msc in Economic Policy Analysis)

History Of Economic thought I

It has been said that IbnKhaldun represents the beginning of Islamic economics—al-
though some would argue that this distinction belongs to al-Ghazali— though this does
not denote the start of significant analysis of market economies. Like their predecessors,
Aristotle and Plato, whose thought had prevailed for a millennium before them, these
Arab philosophers in the course of examining issues of more fundamental importance
than the economy, achieved some interesting early insights into economic activity. In so
doing, they added steps to the ladder of economic understanding on which, when
economic activity became a more important social activity, the mercantilist writers would
be able to stand.

1.3.1 (E) Scholasticism (Medieval Economic Thought)

Scholasticism (The Schoolmen)refers to the school of economic thought that developed

inEurope during the medieval period (500-1500). Scholastic thinkers are known for their
moral and philosophical approach to the study of exchange, value, and ownership within
the context of the time period. Of the scholastics, St. Thomas Aquinas is widely credited
for his original, although sometimes ambiguous contributions to the early discussions of
value, price, private property, and usury (or interest). Until the arrival of Mercantilism in
the 14th century the Scholastics (or Schoolmen as they are commonly referred to today)
were at the forefront of the foundations of establishing economic theory within the
framework of philosophy.Probably the most influential economic thinker of the
Scholastic period was a Sicilian-born Roman Catholic by the name of Thomas Aquinas.

Scholasticism evolved amongst a societal structure known as feudalism. The feudal

society of Medieval Europe was one in which all authority was derived from God by the
church, which was headed by the Pope. The feudal system was one in which the king of a
land or region delegated power, responsibility, and land grants to his royal subordinates
(nobles, barons, lords, etc.). These barons would in turn sub-let land to landlords, with the
understanding that the baron had full control of the land, established his own laws and
taxes, and had the right to call all to serve under the crown. It was then the lowly
(humble, poor) serfs whose duty was to tend the land and provide free labour, food, and
service whenever it was demanded. The relationship between lord and serf was one

Compiled By: MamoEsayas (Msc in Economic Policy Analysis)

History Of Economic thought I

dictated by custom, tradition and authority. It was this class relationship that caused
religious theologians of the time to examine what moral and ethical implications were
addressed when two or more parties entered into an exchange, or contract.

St. Thomas Aquinas (1225 – 1274)

Saint Thomas Aquinas was an Italian Catholic Priest and

one of the most important Medieval philosophers and
theologians. He was immensely influenced by
scholasticism and Aristotle and known for his synthesis
of the two aforementioned traditions. Although he wrote
many works of philosophy and theology throughout his
life, his most influential work is the Summa Theologica.
St. Thomas Aquinas
(1225-1274 AD)

Aquinas’s economic thought is inseparable from his understanding of natural law. In his
view, natural law is an ethic (idea, code) derived from observing the fundamental norms
of human nature. These norms can be understood as the will of God for creation. An
unlawful act is that which perverts God’s design for a particular part of His creation.
Economic transactions, according to Aquinas, should be considered within this
framework, since they occur as human attempts to obtain materials provided by nature to
achieve certain ends.

Private property is a desirable economic institution because it complements man’s

internal desire for order. “Hence the ownership of possessions is not contrary to the
natural law,” Aquinas writes in the Summa Theologica, “but an addition thereto devised
by human reason.” The state, however, has the authority to maintain a legal framework
for commercial life, such as enforcing rules prohibiting theft, force, and fraud. In this
way, civil law is a reflection of the natural law. Further, Aquinas believed that private
ownership of property is the best guarantee of a peaceful and orderly society, for it
provides maximum incentive for the responsible stewardship of property.

Compiled By: MamoEsayas (Msc in Economic Policy Analysis)

History Of Economic thought I

Aquinas helped relax the traditionally negative view of mercantile trade that figured
prominently in, for example, Patristic thought. For Aquinas, trade itself is not evil; rather,
its moral worth depends on the motive and conduct of the trader. In addition, the risk
associated with bringing goods from where they are abundant to where they are scarce
justifies mercantile profit. The merchant, however, must direct his profits toward virtuous
ends.

On Exchange and Value: To Aquinas the issue of exchange was of significant

importance in bartersituations. It was his belief that the measure of exchange between
heterogeneous goods indicated thatsome value must be placed on each good and that an
ethical dilemma would arise. The only just exchange would be that of two identical goods
for the same quantity, but this would be redundant; therefore, some value would have to
be established for the goods in order for the exchange to be just to both buyer and seller
(or in his case traders, being that little to no market existed for surplus commodities).
This posed, for him, the ethical aspect of prices, raising issues of equity and justice”.

On Usury: Usury is defined today as the charging of excessive interest on a loan. During
the reign of the Scholastics usury applied to any charging of interest. During the
Medieval times a loan was usually of a good, and was hardly if ever intended as a method
of producing any wealth. The Second Lateran Council (1139) banned usury using direct
scriptural reference as their cause. Both Aristotle and Aquinas argued that the taking of
any interest on loans was unjust and in conflict with natural law.

On Good and Justice: Central to the theories of the Scholastics is the notion that man is
directed through his interactions with his society by free will, and autonomy. This moral
philosophy has been introduced into economics by Aquinas, Adam Smith, J.S. Mill, and
Karl Marx to name a few. “It is a matter of common experience that our conduct is
motivated by different aims: riches, honor, material pleasure, social positions, etc.” It is
the reconciliation of these aims with what is best for us and our community that reveals
the true good. Servitude or slavery for example is good for the man exercising authority
over another and may be good for the servant for lack of any other means of existence.
The private utility of another, however, is unjust and denies the respect and will of the

Compiled By: MamoEsayas (Msc in Economic Policy Analysis)

History Of Economic thought I

other. “As much as Karl Marx, St. Thomas is cognizant of the humiliation inflicted on
man by what Marx calls the alienation of work for the profit of another, and what St.
Thomas called more simply servitude”.

1.3.2. Mercantilism(Colbertism/Cameralism), Physiocracy, and Other Precursors

of Classical Economic Thought

Important Writers
Thomas Mun England’s Treasure by Foreign Trade 1667
William Petty Political Arithmetic 1696
David Hume Political Discourses 1752
Richard Cantillon Essay on the Nature of Commerce In general 1755
Francois Quesnay Tableau Economique 1758
Robert Jaquis Turgot Reflections on the Formation and Distribution of Wealth 1766

1.3.2 (A) Mercantilism

Mercantilism is the name given to the economic literature and practice of the period
between 1500 and 1750. Although mercantilist literature was produced in all the
developing economies of Western Europe, the most significant contributions were made
by the English and the French. Whereas the economic literature of scholasticism was
written by medieval churchmen, the economic theory of mercantilism was the work of
merchant businessmen. The literature they produced focused on questions of economic
policy and was usually related to a particular interest the merchant-writer was trying to
promote. For this reason, there was often considerable skepticism regarding the analytical
merits of particular arguments and the validity of their conclusions. Few authors could
claim to be sufficiently detached from the issues to render objective analysis. However,
throughout the mercantilistic period, both the quantity and the quality of economic
literature grew. The mercantilistic literature from 1650 to 1750 was of distinctly higher
quality; scattered throughout it are nearly all the analytical concepts on which Adam
Smith based his Wealth of Nations, which was published in 1776.

Every Person His Own Economist

Compiled By: MamoEsayas (Msc in Economic Policy Analysis)

History Of Economic thought I

The age of mercantilism has been characterized as one in which every person was his
own economist. Since the various writers between 1500 and 1750 held diverse views, it is
difficult to generalize about the resulting literature. Furthermore, each writer tended to
concentrate on one topic, and no single writer was able to synthesize these contributions
impressively enough to influence the subsequent development of economic theory.
Perhaps this was because economics as an intellectual discipline had not yet found a
home in the university; rather, it was largely studied by men of affairs who wrote
pamphlets about the particular economic problems that concerned them.

Theoretical Contributions of the Mercantilists

(1) Concept of Nationalism: Mercantilism was never more than a means. The true end
was political incharacter. That is creation of a strong state. The mercantilist emphasized
on national strength and prosperity. The building up of a nation state was put in the fore
front. Monetary and other economic devices were regarded merely as instruments to
make the state strong. State interventions was an essential part of mercantilist doctrine.
Mercantilists believed that every aspect of life was subject to regulation by rulers for
widening of market beyond medieval limit. Economically expansion of commerce and
trade and politically success in war were their natural goals. This can be achieved only by
a strong Nation built upon the spirit of nationality. For protecting the domestic trade and
for expanding the foreign market a strong central government becomes an important
element in mercantilist doctrine. So the mercantilists gave much importance for the
creation of a strong Nation. Thus the mercantilists demanded a state strong enough to
protect the trading interests and to break down the medieval barriers to commercial
capitalism.

(2) Importance of Treasure: To the mercantilists the most important concern was the
strength of the country. In considering the prosperity and strength of the country the true
mercantilist had always at theback of his mind a comparative standard. To the
mercantilists the strength of his country depends uponthe stock of wealth which the
nation possesses. By wealth they mean the stock of precious metals.According to the
mercantilists the great and ultimate effect of trade is not wealth at large but particularly

Compiled By: MamoEsayas (Msc in Economic Policy Analysis)

History Of Economic thought I

abundance of silver, gold and jewels, which are not perishable. Tile king who could
support a large army and maintain a powerful navy was the king who had behind him the
treasure necessary for this purpose. Hence the mercantilist attached great importance to
treasure and bullion as the most useful and generally accepted form of wealth. The
important slogans raised at the time were more “gold more gold, wealth more wealth”

(3) Foreign Trade and Balance of Trade: The mercantilist considered treasure (Gold,
Silver, precious metals) as wealth par excellence. What are the means to be adopted for
securing the desired treasure and wealth? Thomas Mun says “the ordinary means to
increase our wealth and treasure is by foreign trade and this ought to be encouraged”.
Thus the mercantilist considered foreign trade as the only source for acquiring gold and
silver. They believed that treasure gained by the balance of our foreign trade remained in
the kingdom. In respect of its exports a country must receive payments in the form of
silver or gold. On the other hand what it buys in the form of imports will have to be paid
for. Export represent money coming into the country and import represents money going
out. In order to increase the supply of Bullion in a country, it is necessary that there be a
“favourable balance of trade” represented by excess of export, over import. So it is easy
to conclude that all exports in the nature of goods are good and desirable whereas all
imports are evil and damnable, it is thus a primary principle of typical mercantilists to
maximize exports and to minimize imports. There was however, no uniformity of opinion
among the mercantilist writers, so far as the concept of favourable balance of trade was,
considered. Some of them advocated the balance of margin theory 'where every
individual transaction must bring forth a gain to the state’. While talking of a favourable
balance of trade, most of the mercantilist did not signify whether they meant on overall
favourable balance of trade or a favourablebalance with each country. The mercantilists
recognized the importance of invisible items of balance of trade such as freight income,
insurance, diplomatic and military expenditure abroad. Thus the mercantilist supported a
favourable balance of trade as the means to acquire more treasure.

(4) Industrial and Commercial Regulations: The mercantilists followed a number of

policies in order tomaximize the net gain from foreign trade. The main strategy is to
increase the production of exportable commodities in the domestic economy and to

Compiled By: MamoEsayas (Msc in Economic Policy Analysis)

History Of Economic thought I

reduce the import of articles from foreign countries. In order to maximize output in the
domestic economy, the mercantilist suggested the following methods. (a) Land resources
may be fully utilized and fallow lands may be brought under cultivation (b) Employment
opportunities should be increased, so that unemployed human resources can be utilized
for increasing production of goods meant for export (c) Better method and technique of
production should be introduced in the production process (d) In order to increase
production and employment, the mercantilists advocated a system of low wage level. (e)
Colonies can be utilized as source of raw materials to the mother country.

Along with this a series of trade regulations and policies were framed by the
mercantilists. These policies were aimed at export promotion and import restriction. The
important among them were

a. Restraints on the importation of foreign goods especially manufactured goods

b. Encouragement to the export of manufactured products
c. Restriction on the export of raw materials
d. Restriction on the industries which interfere with other industries or trades of
greater nationalimportance.
e. Ban on the export of bullion
f. Establishment of banks and the promotion of use of credit instruments.

(5) Role of Government: In order to execute all their schemes and programmes, the
mercantilists looked to abenevolently paternal government, which can interfere
everywhere. There was nothing the government might not do;there was nothing the
government ought not to do, if its activities help to promote the general wellbeing. Sothe
mercantilists attached great importance to state as the center of all economic activities.
The controland regulation of the government are essential for the attainment of
favourable balance of trade. The above listof proposals and government regulations
reflect the protectionist philosophy prevailing in the mercantilistliterature. Almost all
kind of protectionist arguments are available in the mercantilist writing. Themercantilist
protection argument can be summed up as follows

Compiled By: MamoEsayas (Msc in Economic Policy Analysis)

History Of Economic thought I

a. Protection may be granted to strategic industries. These industries which are

strategic for the nation both in terms of their export contribution and also in terms of
their contribution to economic development, can be earmarked by the government of
the country.
b. Protection may also be granted to the weak but promising industries which were at
the- infant stage of growth.
c. Protection may also be granted to the defense industries.
d. Those industries should be given protection which help for the attainment of self-
sufficiency and self-reliance for the country.
e. Protection may also be given to industries which are engaged in producing import
substitutable and export promoting goods.

From this, it appears that the mercantilist writers were well balanced in their ideas on the
different aspects offoreign trade.

(6) Ideas on Money: In mercantilist writing an important role was assigned to money.
The theoretical structure of mercantilist monetary system is based on three prepositions:

i. Wealth consists in money

ii. Money was not to be accumulated as treasure in the literal sense of stock of
valuable and early saleable objects
iii. Money was desired to be used as a medium of exchange. Just as an individual
saves out of his income, a country must spend less than its income, if it wants to
increase its wealth. Thus they identified favourable balance of trade with the
annual balance of income over consumption and money with capital.

To the mercantilist wealth of a nation lay in its productive capacity. Money strengthens
theproductive capacity of a nation by means of it being in circulation. Mercantilists
disfavoured the idea ofaccumulating money as treasure. Mercantilists believed that
money would be utilized in production of more commodities, it will also create new
demand for commodities through generation of employment. Thus it believed that
increased money supply would result in increasing output and employment without
allowing prices to rise. Thus mercantilist maintained the doctrine that money stimulates
trade.

(7) Particular Economic Theories

Compiled By: MamoEsayas (Msc in Economic Policy Analysis)

History Of Economic thought I

(a) Value: Value was inherent in commodities and depend upon human needs. Value was
regarded as a market phenomenon, which depends upon exchange. Mercantilists
distinguished between two types of value. That is intrinsic value and extrinsic value.
Intrinsic value is the power of the commodity to satisfy human wants. By extrinsic value,
the mercantilists mean only the cost of production. William Petty clearly mentioned that
value depends upon expenses of production. According to him market value was the
extrinsic value of commodity which fluctuated according to a rise or fall in the supply
and demand. John Locke indicated the importance of labour and its contribution towards
determination of value. He was the forerunner of labour theory of value which was
developed later.

(b) Production: According to mercantilists, production was a process of application of

human labour to resources and hence they advocated an increase of labour and resources.
Mercantilists regarded agriculture as insignificant. They believed that foreign trade alone
was the, roost productive. They made a distinction between productive and unproductive
labour. The labour of a merchant, a manufacturer and a farmer was considered
productive. Labour of professional persons like doctors, stock brokers and shop keepers
was considered unproductive.

(c) On Taxation: The views of mercantilist on taxation were quite interesting.

Mercantilists favoured a multiple tax system based on the basic principle of each should
pay according to the benefits received from the state. Thomas Hobbes held that man
should be taxed according to the expenditure incurred by him, in his opinion, a tax on
expenditure is the most equitable. Generally speaking the mercantilists favouredlaw
customs, excise duties, a tax on interest etc. Their chief cannon of taxation was that of
equity.

(d) On Population: Mercantilist favoured increasing population for maintaining military

strength. It was also advocated for increase in productive capacity of the economy. They
believed that cheap and abundant supply of labour would help in keeping the cost of
production at lower levels. They encouraged family life and parenthood.

Compiled By: MamoEsayas (Msc in Economic Policy Analysis)

History Of Economic thought I

(e) On Interest: There were no uniformity of opinion regarding the interest concept.
Thomas Mun, John Lockeand Deadly Dudley North favoured interest taking in money
lending. According to them money lending provided the necessary capital to the poor
merchants. Further it also led to gainful employment of the saving of widows, orphans
and others. But the mercantilists were opposed to high rate of interest.

1.3.2 (B) Colbertism and Cameralism

In France Mercantilism was known as Colbertism following Jean Baptiste Colbert.

Colbertism was characterized by far more restrictions than in England. Jean Baptiste
Colbert (1619–1683) was the French Minister of Finance from 1661 to 1683 under Louis
XIV. Colbert was a bullionist who believed that the strength of a state depends on its
finances, its finances rest on its collection of taxes, and tax revenues in turn are greatest if
money is abundant.He favored expanded exports, reduced imports, and laws preventing
the outflow of bullion from the country.Government regulation of business, which had a
strong feudal flavor in France, was an important feature of Colbert’s policies. Colbert
favored a large, hard-working, poorly paid population.Colbert regarded monks, nuns,
lawyers, and officials as unproductive, and he tried to reduce their numbers. (He
canceled 17 holidays, leaving only 24 in addition to Sundays). In an edict of 1666, people
were exempted from taxes for a number of years if they married early. Every father of
ten living children was also exempted from taxes. Interestingly enough, sons who died in
the armed forces were counted as living, but priests, nuns, and monks were not counted.

Cameralists were the German counterparts of mercantilists and their writings spread over
300 years in Austria and other German States. Kammer or Camera denotes the royal
treasure room, and therefore Cameralists were primarily concerned with filling the
‘Chamber’ or the treasure of the prince.The end objective was to fill the public treasury
and this was thought possible only by making the tax payers prosperous and through the
circulation of money and capital. The Cameralists had a great faith in government
regulation of the affairs of the economy. There were educating state regulations of all
kinds.To them a dense population and an abundant supply of money were essential and
helpful in the prosperity which in turn enabled the state to have strong armed forces and

Compiled By: MamoEsayas (Msc in Economic Policy Analysis)

History Of Economic thought I

enough of public revenue.They gave less importance to the question of balance of trade
and more to the question of royal revenue.

In general the following are the main representative of Mercantilism

1. Antonio Serra – 16th-century Italian philosopher and mercantilist

2. Jean Bodin(1530 – 1590) – French Mercantilist

3. Thomas Mun(1571 – 1641) – English Mercantilist

4. Philipp W. Won Hornick(1640 – 1714) – Austrian Mercantilist

5. Antoine de Montchretien (1576-1621) -French Mercantilist. He made the earliest use

of the phrase ‘Political Economy” in his work ‘Traicte’del’OeconomiePolitique’.

6. Jean Baptiste Colbert (1619–1683)– French Mercantilist

7. Sir William Petty (1923-87) –British Mercantilist and Regarded by Marx as one of the
Founder of Political Economy

1.3.2 (C) Influential Precursors of Classical Thought

Ideas do not generally come out of thin air. Instead, the germs of an idea are often in the
air long before that idea becomes central to a period. During the mercantilist period, the
ideas that would become the focus of the classical school were germinated. They were
formulated in various ways. Initially they were rejected by the majority of writers in the
period as outrageous; then they were accepted by a few, then by a few more, until finally
the mercantilist period ended and the formerly outrageous ideas became the central ideas
of the classical period. Thus, the ideas attributed to Adam Smith could take hold—
largely because of the earlier heterodox writers who dissented (disagreed) from the
mercantilist mainstream. To give a flavor of the diversity and quality of English writers
during the period from 1500 to 1750, we will briefly examine several thinkers: Thomas
Mun, William Petty, David Hume, and Richard Cantillon.

Compiled By: MamoEsayas (Msc in Economic Policy Analysis)

History Of Economic thought I

Thomas Mun(1571 – 1641)

Book IV of Adam Smith’s Wealth of Nations (1776) is

largely a refutation of mercantilistic theory and policy; in
it, Smith quotes Mun as a leading mercantilist. Munwas
born in England in 1571. He was a director of the East
India Company.

Thomas Mun (1571 – 1641)

Mun was a typical mercantilist—a proponent of governmental policies that benefited a

particular business interest. Mun’s first book, A Discourse of Trade from England unto
the East Indies, was published in 1621; it defended the East India Company against these
charges in a partisan (biased, one-sided) manner. His second book, England’s Treasure
by Foreign Trade, was produced in 1628 and was published subsequently in 1664 by his
son. The book had several editions, and its popularity was evidently the reason Smith
chose it for rebuttal (disproof). It is often said that Mun’s 1664 book is the classic of
English mercantilistic literature.

Mun asserted in the title of his book that England’s treasure was gained by foreign trade.
His thinking was typically mercantilistic in that he confused the wealth of a nation with
its stock of precious metals and therefore argued for a favorable balance of trade and an
inflow of gold and silver to settle the trade balance. He believed that government should
regulate foreign trade to achieve a favorable balance, encourage importation of cheap raw
materials, encourage exportation of manufactured goods, enact protective tariffs on
imported manufactured goods, and take other measures to increase population and keep
wages low and competitive.

Mun presented these mercantilistic ideas but refuted some of the cruder mercantilistic
notions that embodied criticisms of the East India Company. He pointed out that even
though a favorable balance of trade with all nations was desirable and an outflow of
precious metals to all nations was undesirable, the unfavorable balance of trade with and

Compiled By: MamoEsayas (Msc in Economic Policy Analysis)

History Of Economic thought I

export of precious metals to India was beneficial to England in that such practices
enlarged its trade balances with all nations and, thereby, its inflow of gold and silver. By
the time the last edition of Mun’s famous book was published in 1755, many of the more
perceptive mercantilists were seeing the serious errors of the mercantilistic paradigm.
These liberal mercantilists were beginning to articulate the intellectual foundation for
Smith’s Wealth of Nations.

Sir William Petty (1623-1687)

Petty is regarded by Marx as the founder of Political

Economy. He is remembered for his contribution inthe
field of statistical methods and economic theory. Petty
was a brilliant thinker who rose from poverty as a
weaver’s son and mastered Latin, Greek, French,
arithmetic, geometry, and navigation by the time he was
fifteen years old.
Sir William Petty(1623– 687)

He ended life as a wealthy man after spending time as a sailor, physician (he studied
anatomy in Paris with Hobbes), inventor, surveyor, and—most important—being the first
economic writer to advocate the measurement of economic variables. His economic
writings were not general treatises (dissertations); they were the result of his practical
interests in matters such as taxation, politics, money, and measurement.Petty’s ‘Political
Arithmetic’ was written in 1676 but not published until 1690. He seemed conscious that
he was breaking new ground by discussing the methodology of political arithmetic.

“The method I take to do this is not yet very usual. For instead of using only comparative
and superlative words and intellectual arguments, I have taken the course ... to express
myself in terms of number, weight, or measure; to use only arguments of sense, and to
consider only such causes as have visible foundations in nature.”

Compiled By: MamoEsayas (Msc in Economic Policy Analysis)

History Of Economic thought I

Petty apparently was the first to explicitly advocate the use of what we would call
statistical techniques to measure social phenomena. He tried to measure population,
national income, exports, imports, and the capital stock of a nation. His methods were
crude almost beyond belief, leading Adam Smith to indicate that he had little use for
political arithmetic.

A fairly typical mercantilist in his analysis and policy conclusions, Petty does represent
the beginning of an aspect of economics and the social sciences whose full conclusion
has yet to play out. One of the strongest traditions in economics has been a literary
methodology whereby problems are explored and theories are developed by the use of
language. Until the end of the nineteenth century, testing of hypotheses was done by
appealing to present circumstances or to history, and the use of statistics was minimal.
Petty’s seminal insight that ideas should be expressed in terms of numbers, weight, and
measure and that only arguments that have visible foundations in nature should be
accepted is the cornerstone of modern thinking in economics. His early use of statistics
was crude, but the methodological position he represents has a lineage from the empirical
inductionism of his time to the modern application of econometrics that is prevalent in
contemporary economics journals.

David Hume (1711-1776)

analytical abilities to questions of economics, but our

loss has been the gain of philosophy, politics, and
history. Hume was a close personal friend of Adam
Smith; their joint intellectual output is awesome in terms
of its impact on following generations.

David Hume (1711-1776)

Economics suffered by
the failure of David
Hume to devote more of
his brilliance and

Compiled By: MamoEsayas (Msc in Economic Policy Analysis)

History Of Economic thought I

Like many of his contemporaries, Hume could be called a liberal mercantilist; he had one
foot in mercantilism, but with the other stepped forward into classical political economy.
Hume took the insights of John Locke, who saw that the level of economic activity in an
economy depends on the quantity of money and its velocity, and presented a reasonably
complete description of the interrelationships among a country’s balance of trade, the
quantity of money, and the general level of prices.

In international trade theory Hume’s contribution has become known as the price specie1-
flow mechanism. Hume pointed out that it would be impossible for an economy to
maintain a favorable balance of trade continuously, as many mercantilists advocated. A
favorable balance of trade would lead to an increase in the quantity of gold and silver
(specie) within an economy. An increase in the quantity of money would lead to a rise in
the level of prices in the economy with the favorable balance of trade. If one country has
a favorable balance of trade, some other country or countries must be having an
unfavorable balance, with a loss of gold or silver and a subsequent fall in the general
level of prices. Exports will decrease and imports will increase for the economy with the
initial favorable trade balance because its prices are relatively higher than those of other
economies. The opposite tendencies will prevail in an economy with an initial
unfavorable balance. This process will ultimately lead to a self-correction of the trade
balances. The mercantilists paid little attention to Hume on this score, and it is interesting
that Adam Smith did not use Hume’s argument in his long and strongly worded
condemnation of mercantilistic theory.

Hume’s mercantilism is represented by his views on the consequences of a gradual

increase in the money supply on the level of real output and employment. The
mercantilists had argued that changes in the money supply could increase real output. The
classical maintained that real output depended not on the quantity of money but on real
forces: labor supply, natural resources, capital goods, and the institutional structure.
Changes in the money supply would change only the general level of prices. Hume
believed that although the absolute level of money in a nation would not influence real
output, a gradual increase in the money supply would lead to an increase in output.

1
Specie – in the form of coin rather than note

Compiled By: MamoEsayas (Msc in Economic Policy Analysis)

History Of Economic thought I

Two other, much broader, ideas put forth by Hume are worthy of mention. One may be
particularly relevant to the present, when many countries in Eastern Europe and the
former Soviet Union are restructuring their societies and economies. Hume searched for a
connection between economic freedom—the freedom to sell one’s resources, labor or
non-labor, when, where, and at what price one chooses; the freedom to produce and sell
the fruits of one’s activities; and the freedom to buy outputs or inputs without constraint
by outside forces— and political liberty. Hume maintained that the growth of economic
freedom went hand in hand with the growth of political freedom.

Finally, Hume was a precursor of the distinction made later by Nassau Senior, John
Maynard Keynes, and Lionel Robbins concerning the difference between positive and
normative statements. That what ought to be (normative statements) cannot be derived
from what is (positive statements) is called Hume’s Dictum.

Richard Cantillon(1680-1734)

Cantillonwas an unusual figure in the history of

economic ideas. He is from Ireland. He lived most of his
life in Paris and was successful in amassing a fortune as
a banker. His one book was evidently written around
1730 and was widely read in both France and England by
intellectuals who were interested in economics.
Richard Cantillon (1680-1734)

What is unique about Cantillon is that his book was unusually sophisticated and advanced
in its understanding of economic questions, yet it was not given much attention in
England after the publication of Smith’s Wealth of Nations in 1776. In 1881 William S.
Jevons rediscovered Cantillon’s book and heaped praise on it, describing it as “the first
systematic treatment in political economy” and “the cradle of political economy.”

What is Cantillon’s place in the history of economic thought? He evidently had little
subsequent influence on writers, although his book was read by the Physiocrats and cited
by Smith in his Wealth of Nations. Even though it is a brilliant and insightful work, its

Compiled By: MamoEsayas (Msc in Economic Policy Analysis)

History Of Economic thought I

only important influence that can be traced is on the Physiocrat François Quesnay.
Cantillon himself acknowledged the influence of John Locke, for his theory of money,
and William Petty, for his emphasis on the importance of measuring economic
phenomena. Cantillon was part Mercantilist (mostly in his views on foreign trade), part
Physiocrat (in his emphasis on the primary role of agriculture in the economy), and part
Physiocrat- classical (in his vision of the interrelatedness of the various sectors of the
economy). Unlike Petty, who produced works of a practical nature exploring various
topics in economics, Cantillon was modern in that (1) he started with the goal of
establishing basic principles of economics through the process of reasoning, and, more
important, (2) he wanted to collect data to use in the process of verifying his principles.
Unfortunately, his statistical work is lost.

Cantillon’s seminal vision, which was to a lesser extent possessed by some of the
Physiocrats and liberal mercantilists, was of a market system that coordinated the
activities of producers and consumers through the medium of individual self-interest. The
key actors in this self-regulating system were entrepreneurs, who, in their pursuit of
profit, produced social results superior to ones that could be produced by government
interference. Given competitive markets in which entrepreneurs pursue customers in final
goods markets and compete with one another in factor markets, Cantillon was able to
point to the adjustment processes as demands, costs, technology, and other factors
change. He did not make the plea for laissez faire with the force of Smith, however,
which may account for his neglected recognition.

He tended always to treat any element of the economy as part of an integrated structure;
for example, population changes were endogenous to his system, not exogenous. His
explanation of the forces that determine prices was surprisingly modern in that he
distinguished between market prices, determined by short-run factors, and what he called
intrinsic value, long-run equilibrium prices. He was able to apply his analysis of prices &
markets to international trade and view the adjustment processes that take place there.

Some of his most accomplished technical analysis was not in microeconomics but in the
macroeconomic aspects of the effects of changes in the supply of money on prices and

Compiled By: MamoEsayas (Msc in Economic Policy Analysis)

History Of Economic thought I

production. He divided the economy into sectors and analyzed the flow of income
between them; although he did not explicitly formulate an economic table to represent
these flows, he clearly influenced Quesnay, who did. Cantillon acknowledged his debt to
John Locke and his early statement of the quantity theory of money, but Cantillon was
able to see subtleties in Locke’s analysis that escaped Smith and his contemporaries. The
consequences of an increase in the quantity of money were not simply macroeconomic
effects on output or prices. In an early examination of the microeconomic foundations of
macroeconomics, Cantillon saw that the points at which the new funds entered the
economy would influence their impact. Accordingly, the general level of prices could
change, but relative prices could also change, with subsequent impacts on the various
sectors of the economy.

1.3.2 (D) Criticism of Mercantilism

Mercantilism was severely criticized. Advocates of laissez-faire argued that there was
really no difference between domestic and foreign trade and that all trade was beneficial
both to the trader and to the public. They also maintained that the amount of money or
treasure that a state needed would be automatically adjusted and that money, like any
other commodity, could exist in excess. They denied the idea that a nation could grow
rich only at the expense of another and argued that trade was in reality a two-way street.

Towards the end of 17th century, the mercantilist theories and practices were strongly
opposed by many writers who championed the cause of individual liberty and agricultural
productions. Even Petty, Locke and North of England criticized the state controlled
foreign trade as against freedom of trade. But severe criticisms were levelled by the
Physiocrats and Adam Smith. The following criticisms were levelled against
mercantilism by the opponents:

1. The mercantilists exaggerated the importance of Commerce to the extent of

depressing agriculture and other branches of human industry.

2. Undue importance was attached to gold and silver.

Compiled By: MamoEsayas (Msc in Economic Policy Analysis)

History Of Economic thought I

3. They were under erroneous belief that a favourable balance of trade alone would
bring prosperity to the country.

4. Their idea about value, utility capital and interest were vague and imperfect.

5. They are narrow minded nationalists and not cosmopolitans. They could not
conceive the ideas of mutually advantageous trade.

However we cannot dismiss their ideas as useless or impractical. The idea of nationalism,
self-sufficiency and economic strength were the outcome of their policies. The
mercantilist policy proved successful in France, England, Holland and Germany who
were competing for colonial supremacy.

1.3.2 (E) Physiocrats

The Physiocrats were a group of economists who believed that the wealth of nations was
derived solely from agriculture. Their theories originated in France and were most
popular during the second half of the 18th century. Physiocracy was perhaps the first well
developed theory of economics. They called themselves économistes(economists) but are
generally referred to as Physiocrats in order to distinguish them from the many schools of
economic thought that followed them. Physiocrat is derived from the Greek for
“Government of Nature”.

The principles of Physiocracy were first put forward by Richard Cantillon, an Irish
banker living in France,in his 1756 publication Essaisur la nature du commerce en
géneral(Essay on the Nature of Commerce inGeneral). The ideas were later developed by
thinkers such as François Quesnay and Jean Claude Marie Vincent de Gournay into a
more systematic body of thought held by a united group of thinkers.

The Physiocrats saw the true wealth of a nation as determined by the surplus of
agricultural production over and above that needed to support agriculture (by feeding
farm labourers and so forth). Other forms of economic activity, such as manufacturing,
were viewed as taking this surplus agricultural production and transforming it into new
products, by using the surplus agricultural production to feed the workers who produced
the extra goods. While these manufacturers and other non-agricultural workers may be

Compiled By: MamoEsayas (Msc in Economic Policy Analysis)

History Of Economic thought I

useful, they were seen as 'sterile' in that their income derives ultimately not from their
own work, but from the surplus production of the agricultural sector.

The Physiocrats strongly opposed mercantilism, which emphasized trade of goods

between countries, as they pictured the peasant society as the economic foundation of a
nation's wealth. The Physiocrats enjoyed some support from the French monarchy and
frequently met at Versailles. Adam Smith, who visited France as a tutor and
mentor(counsellor) to the Earl of Buccleigh's son's Grand Tour, was heavily influenced
by the ideas of the Physiocrats, and Karl Marx cites them as a reference in Das Kapital;
they popularized the modern version of the labor theory of value.

Physiocracy Defined

1. Physiocracy is a school of thought founded by François Quesnay (1694-1774), a court

physician to King Louis the 15 th. At one point in time Physiocracy constituted a sort
of religious movement that attracted a number of outstanding and extremely fervent
believers, and exerted no small influence on real politics. The history of the
Physiocratic movement is thought to have begun in 1757, when Quesnay met
Mirabeau the elder (1715-89), and come to an end in 1776, with the fall of Turgot
(1727-81). The actual members of the Physiocratic school referred to themselves not
as Physiocrats but as économistes. The term “physiocracy” apparently came into
general use after having first appeared in 1767, with theappearance of a collection of
Quesnay’s works published by Pierre du Pont under the title Physiocratie,ou
Constitution Naturelle du Gouvernement le Plus Avantageux au Genre Humain. The
term is of coursea combination of “physio” (nature) and “cracy” (rule), thus meaning
the “rule of nature.” This expresses the school’s fundamental idea that there is a
natural order, as opposed to artificial systems, and that the mission of scholarship
and politics being to understand this natural order and bring it into existence, thereby
bringing about this rule of nature.

2. Physiocracy (from the Greek for “Government of Nature”) is an economic theory

developed by thePhysiocrats, a group of economists who believed that the wealth of

Compiled By: MamoEsayas (Msc in Economic Policy Analysis)

History Of Economic thought I

nations was derived solely from thevalue of “land agriculture” or “land

development.”

3. The Physiocrats, or the “Economists” as they called themselves, were the first school
of economicthought. They represented a reaction against the policies of Jean Baptiste
Colbert [1619-1683] and Colbertism. There were a number of writers whobegan to
question the mercantilist policies of Colbert by the early 1700s (examples are
PierreBoisguillebert[1646-1714], Seigneur de Vauban [1633-1707] and later Richard
Cantillon [1680-1734]),however it was François Quesnay [1694-1774] who provided
the basic structure of the Physiocraticsystem in the late 1750's. The Physiocrats
represented an “alliance of persons, a community of ideas, and acknowledged
authority and a combination in purpose, which banded then into a society
apart.”They held in common the idea that all things are part of an interconnected
system that is rational andcomprehensible to the human mind.

Factors Responsible for the Rise of Physiocracy

Physiocracy was a revolt against mercantilism in France. This was due to the
deteriorating economic and social conditions at that time which were chiefly due to
mercantilist policies. The various factors responsible for the growth of physiocracy in
France are enumerated below.

1. Tyranny and Extravagant Court Life:France was experiencing an absolute monarchy

but without its potential benevolence. The life ofthe political administrators, from the
king downwards,was very luxurious and corrupt. Publicexpenditure was very
extravagant and wasteful. The result was an increasing indebtedness of thegovernment
and the need to levy extra taxes to finance the public expenditures. The
deterioratingeconomic conditions provided a new ground for new ideas and a welcome
change.

2. Regressive Taxation: In France, during the reigns of Louis XIV, taxation was unduly
heavy, unjust and inequitable. Thenobility and clergy owned about two-thirds of the
country's land, but they were hardly paying any taxeswhile the poor peasants were

Compiled By: MamoEsayas (Msc in Economic Policy Analysis)

History Of Economic thought I

being crushed under all sorts of levies in addition to the extortionist landrents. The
manner of tax collection was also highly deplorable. Obviously the farmers were
hardly leftwith any surplus which they could use for improvement of land or for
improving their own consumptionstandards. The peasants also had to bear the burden
of providing services to the feudal lords. Therewere many other oppressive taxes like
the salt tax, poll tax, the tithe etc.which were equallyburdensome for the poor sections
of the community. The tortured life led by the farmers gave animpetus to the
physiocratic policies and doctrines.

3. Decay of Mercantilism: Mercantilist policies had outlived their importance. Its

policies were severely criticized. Peoplewere looking for an alternative system. In
England agriculture was being revolutionized with theintroduction of large scale
farming. The achievements of this revolution reached the ears of the Frenchpeople
through the writings of Gourney, Mirabeau and Montesquieu.

4. Neglect of Agriculture: Agriculture in France was in a state of stagnation compared

with its increasing usefulness andprofitability in England. Colbertism was partly
responsible for this. Industrial development was takingplace in France at the cost of
agriculture. Investments were diverted from agriculture to manufacture.The value of
agricultural produce fell on account of restricted markets. Lower prices of
agriculturalproducts prevented capital accumulation in agriculture. Agriculture
suffered due to lack of capital andinitiative.

5. Emergence of a Group of Ambitious Agriculturists: In France a group of ambitious

agriculturists and landlords started seriously thinking of thedevelopment of agriculture
in France. They did not tolerate the suppression of French agriculture byking. One
such ambitious landlord was Quesnay. The on-going Agricultural Revolution in
Englandinfluenced very much these ambitious French landowners. They thought that a
similar revolution can bebrought about in France.

6. Subjective Factors: There were great subjective factors at work for change and
progressdiscarding mercantile policies. During the period of Louis 14, the people
could not criticize his policies.After his death the people of France got sufficient

Compiled By: MamoEsayas (Msc in Economic Policy Analysis)

History Of Economic thought I

liberty to express their opinion. This was thebeginning of breaking away from the
established policies, politics and religion.

7. Existence of Socio-economic Inequality: France witnessed an extreme form of

inequality between different classes of people andbetween different sectors of the
economy. There were both privileged and unprivileged classes. Thecommon people
were underprivileged who wanted an escape from this unwanted situation.

8. Influence of the Writers: Thinkers concerned with the ills of the society were trying
to figure out and convey suggestionsfor the reformation of the system. There were
analytical discussions and explorations regarding the ill-effectsof the existing system
and the type of the ideal system which should replace. They were allagreed that the
ideal system is Physiocracy.

9. Reaction against Mercantilist Policies: Physiocracy was the revolt of French people
against Mercantilism. By the middle of the 18 thcentury, the doctrine of mercantilism
lost its practical usefulness and applicability. InThomas Mun's own country - England
- the doctrine was much discredited. Mercantilist policies gaveundue emphasis to
trade. In England an agricultural revolution was taking place due to large
scalefarming. The advantages of the revolution was brought to the knowledge of the
French by writers likeMirabeau, and Montesquieu, The works of several English
writers were translated into French. Thisprovided an opportunity to the French
thinkers to understand the progress of Great Britain, which depended to a great extent
upon agricultural activities. The people were in search for an alternativesystem. They
were looking for a new system of socio-economic order which could
substitutemercantilism. This system was provided by physiocracy.

The following are the fundamental principles and policies of physiocracy

 Agriculture is the only productive occupation.

 Industry and trade are sterile occupations.
 Agriculture alone produces net product.
 There is a natural order which makes life happy and meaningful.

Compiled By: MamoEsayas (Msc in Economic Policy Analysis)

History Of Economic thought I

 There is harmony among all classes of people.

 The individual should get maximum liberty.
 State action should be limited to the minimum.
 Trade is a necessary evil, and there should be free trade.
 Value depends on utility. Wealth has value. Value and price are the same things.
 The wage level is at the subsistence level.
 There is interdependence in the economic system.
 Real wealth lies in tangible and consumable goods.
 Private initiative must be encouraged.
 Distribution of products is very essential.
 Money is a medium of exchange.
 All that is bought is sold and all that is sold is bought.
 Rent is a perfectly legitimate income of the landlords.
 There should be a single & direct tax on land, as it is the only productive source.
 Private property is essential.
 There is the possibility of overpopulation on land.

Physiocratic Doctrines:

The Economic Doctrines of the Physiocrats can be conveniently classified under the
following heads:

(1) Natural order or Natural philosophy

Natural order is the symbol of physiocratic system. Natural order, according to

Physiocrats, was an ideal order of things guided by the laws of nature, which has been
ordained by God for the happiness of mankind. It was really the providential
(preordained) order. It was eternal and unchangeable. ThePhysiocrats conceived of an
ideal order of things and a perfect arrangement of institutions guided by the laws of
nature.

Compiled By: MamoEsayas (Msc in Economic Policy Analysis)

History Of Economic thought I

Natural laws govern the activities of its members. The problem is to discover and obey
these laws. There are two types of natural laws. Natural-physical laws and natural-moral
laws. Physical laws govern physical universe. Natural moral laws are the laws of human
actions. They are laws which govern human behaviour. They include rules of prudent
individual conduct. It is the rule of justice, to be followed by individuals while dealing
among themselves. According to Physiocrats, natural order was an ideal order of things
created by God for the maximization of human happiness. The man made social orders
were artificial in nature. So the Physiocrats wanted the people to do away with artificial
manmaderules. Physiocrats believed that people suffer from social evils because the
social order did notconfirm to the natural order. In their opinion, the present organization
of state should be suitablymodified to bring the life, behaviour and ideas of the people
within the orbit of the natural order.

(2) The Net Product

The concept of Net Product was the direct outcome of the philosophy of natural order of
the Physiocrats. The mercantilists has maintained that the source of wealth lay in foreign
trade and that it consisted of precious metals. The Physiocrats differed from the
mercantilists on both these ideas. Physiocrats considered agriculture as the only source of
wealth. The only productive wealth was agriculture. To them the other occupations, other
than agriculture were unproductive and sterile. In agriculture nature labors along with
man. By the gift of nature (fertility) agriculture produces more than what the farmers
consumes. This surplus production in the agriculture sector is called as “Net production
of new wealth” from the amount of new wealth produced. This surplus is used to nourish
the other classes of people. It means that agriculture not only satisfied the needs of those
engaged in it, but also of others engaged in trade, manufacture, and other professions.
Thus the surplus can be taken as the difference between the quantum of production and
the quantum utilized in the process of production. Physiocrats considered commerce and
manufacture as unproductive. To the Physiocratsproduction means creation of surplus.
They therefore thought, only that agriculture to be productive because it increases the
wealth of the nation. In Industry merely raw materials are transferred into finished
products. In commerce and trade a mere transfer of wealth is taking place. In agriculture

Compiled By: MamoEsayas (Msc in Economic Policy Analysis)

History Of Economic thought I

alone a surplus is generated. So labour which was applied anywhere except to land was
sterile because man is not a creator. For Physiocrats, since agriculture was the sole source
of wealth, it should be promoted, interest in it should be increased and hindrance from its
way should be removed.

(3) The Circulation of Wealth

Based upon the concept of Net Product, the Physiocrats advanced the theory of
circulation of wealth. That is distribution of net product. Physiocrats were the first to
attempt to analyse the problem of distribution. The credit for putting the idea in a
systematic manner goes to Francois Quesnay. He skilfully and graphically analyzed the
concept of circulation of wealth, drawing 'analogies from the circulation of blood in the
body’. Being a doctor; he was able to describe it very eloquently. The circulation of net
product in the words of Turgot constituted the very life blood of body politics, just as the
circulation of blood of the physical. (François Quesnay's Tableau Économique is
discussed in detail later)

(4) Individualism and Laissez Faire

The Physiocrats, especially Turgot, believed that self-interest was the motivating reason
for each segment of the economy to play its role. Each individual was best suited to
determine what goods he wanted and what work would provide him with what he wanted
out of life. While a person might labourfor the benefit of others, he will work harder for
the benefit of himself; however, each person’s needs are being supplied by many other
people. The system works best when there is a complementary relationship between one
person’s needs and another person’s desires, and trade restrictions place an unnatural
barrier to achieving one’s goals.

(5) Private Property

None of the theories concerning the value of land could work without strong legal
support of ownership private property. Combined with the strong sense of individualism,
private property becomes a critical component of the workings of the Tableau.

Compiled By: MamoEsayas (Msc in Economic Policy Analysis)

History Of Economic thought I

(6) Diminishing Returns

Turgot was one of the first to recognize that “successive applications of the variable input
will cause the product to grow, first at an increasing rate, later at a diminishing rate until
it reaches a maximum”. This was a recognition that the productivity gains required to
increase national wealth hadan ultimate limit, and, therefore, wealth was not infinite.

(7) Investment Capital

Both Quesnay and Anne Robert Jacques Turgot, Baron de Laune recognized that capital
was needed by farmers to start the production process, and both were proponents of using
some of each year’s profits to increase productivity. Capital was also needed to sustain
the laborers while they produced their product. Turgot recognized that there is
opportunity cost and risk involved in using capital for something other than land
ownership, and he promotes interest as serving a “strategic function in the economy.”

(8) On Taxation

Physiocrats put forward a simple system of taxation. They advocated a Single Tax
System, namely the Land Tax, which should be paid by the proprietary class directly to
the government. The theory of taxation was closely linked with the concept of net
product. Some taxes were required for meeting the expense of the state for the
maintenance of security, spread of education and establishment of public works. The only
source which could be tapped was the net product and the only class who could pay taxes
were the landed proprietors. So they advocated a single tax on land. This single tax was
direct and hence cannot be evaded. It was simple to assess.

(9) On Value

Physiocrats had taken little interest in the theory of value. According to Turgot value
depended upon utility. But they did not regard value inherent in commodities, they also
differentiated value in use and value in exchange. But they treated price and value as one
and the same thing. Value according to Physiocrats was not fixed but changed from time

Compiled By: MamoEsayas (Msc in Economic Policy Analysis)

History Of Economic thought I

to time depending upon demand: Anyhow, the theory of value was not much important
part of the physiocratic school

(10) On Trade

As commodities of equal value were exchanged, trade and commerce were considered as
unproductive. According to them trade did not produce any real wealth. Hence all
commodity transition were sheer waste of time and energy. They wanted to counteract
(offset) the evils of commerce by advocating complete freedom in the field of commerce.

(11) Functions of the state

The Physiocrats were not anarchist. They suggested a state with minimum of civil laws
which place no hurdles in the way of the realization of the natural order. To them the best
state was the one in which there were the least number of laws. They advocated a state
with minimum of legislation and maximum of authority. The function of the physiocratic
sovereign were (a) To preserve natural order (b) To defend private property (c) To spread
universal education (d) To undertake a programme of public work.

François Quesnay (1694–1774)

The founder, leader of physiocracy was Dr. François

Quesnay. Quesnay served as the consulting physician to
King Louis XV at Versailles. Late in life he developed
an interest in economics, publishing his first book on the
subject in his 60s. With the support of Madame de
Pompadour, he and fellow Physiocrat Jean de Gournay
François Quesnay(1694-1774) became influential in the Secte des Économistes, whose
members looked to Quesnay as their leader.

Quesnay’s system of political economy was summed up in Tableau Économique (1758),

which diagrammed the relationship between the different economic classes and sectors of
society and the flow of payments between them. In his Tableau Quesnay developed the
notion of Economic Equilibrium, aconcept frequently used as a point of departure for

Compiled By: MamoEsayas (Msc in Economic Policy Analysis)

History Of Economic thought I

subsequent economic analysis. As the originator of the term laissez-faire, laissez-passer,

Quesnay believed, in opposition to the then-dominant French mercantilists (Jean-Baptiste
Colbert), that high taxes, high internal tolls, and high barriers to imported goods were the
cause of the grinding French poverty he saw around him. Quesnay wanted Louis XV, the
king from 1715 to 1774, to deregulate trade and to slash taxes so that France could start
to emulate (compete) wealthier Britain. The foundation of the Physiocrats’ economic
theories was first described in François Quesnay's Tableau Économique. The model
Quesnay created consisted of three economic movers:

 The Proprietaryclass consisted of only landowners.

 The Productiveclass consisted of all agricultural laborers.
 The Sterileclass is made up of artisans and merchants.

Quesnay’s Tableau Économique

Compiled By: MamoEsayas (Msc in Economic Policy Analysis)

History Of Economic thought I

Figure 1: Quesnay’s Tableau Économique (simplified slightly)

Compiled By: MamoEsayas (Msc in Economic Policy Analysis)

 History Of Economic thought I

Explanation of Quesnay’s Tableau Économique

The Productive Expenditures are employed in agriculture, meadows, pastures, forests,
mines, fishing, etc. to perpetuate riches in the form of grain, beverages, wood, cattle, raw
materials for the handicrafts, etc. The Sterile Expenses are made upon handicraft
products, housing, clothing, interest on money, servants, commercial expenses, foreign
commodities, etc. The sale of the net product which the Cultivator has produced during
the preceding year, by means of the annual Advances of 600 livres employed in
agriculture by the Farmer, furnishes the proprietor a revenue of 600 livres. The annual
advances of 300 livres in sterile expenses are employed for the capital and the expenses
of commerce, for the purchase of raw materials for the handicrafts, and for the
subsistence and other needs of the artisan until he has finished and sold his product.
Of the 600 livres of revenue, one half is spent by the Proprietor on purchases from the
productive class, such as bread, wine, meat, etc., and the other half on purchases from
the sterile class, such as clothing, furnishings, implements, etc.
The 300 livres of revenue which were devoted to productive expenditures in the table
bring back to this class, in money, advances which reproduce 300 livres net, which make
up a part of the reproduction of the Proprietor's revenue; And by the distribution of the
remaining sums which return to this same class, the total revenue is reproduced yearly.
These 300 livres I say, which return to the productive class at first through the sale of the
products which the Proprietor buys of them, are spent by the Farmer, half upon the
consumption of products furnished by this same class, and the other half upon clothing,
implements, tools, etc. which he buys of the sterile class. And they arise again with the
net product. The 300 livres of the Proprietor's revenue which were devoted to sterile
expenditures are spent by the artisan, half on productive expenditures in the purchase of
subsistence, raw materials, and for foreign commerce; the other half is distributed among
the sterile class itself for living expenses, and to restore the advances. This circulation
and this reciprocal distribution continues by subdivisions in the same order, down to the
last penny of the sums which pass reciprocally from one class of expenditures to the other
class of expenditures.
Circulation brings 600 livres to the sterile class, from which it is necessary to deduct 300
livres for the annual advances, leaving 300 livres for wages. These wages are equal to the
300 livres which this class receives from the productive class, and the advances are equal
to the 300 livres of revenue which go to this same sterile class. The productions of the
other class amount to 1200 livres, after deducting taxes, tithes, and interest on the
advances of the Husbandman, which will be considered separately, in order to avoid
undue complications in analyzing the expenditures. In the expenditure of the 1200 livres
of production, the Proprietor of the revenue buys 300 livres of them. Another 300 livres
goes to the sterile class, of which a half, or 150 livres, is consumed for subsistence by this
class; the other half, or 150 livres, being taken for foreign commerce, which comes under
this same class. Finally, 300 livres are consumed in the productive class, by the men who
produce them, and 300 livres for feeding and care of the cattle. Thus of the 1200 livres of
product this class expends 600 livres, and its advances of 600 livres are returned to it in
money through the sales which it makes to the Proprietor and to the sterile class. An
eighth of the total product enters into foreign commerce, either as exports or for raw

Compiled By: MamoEsayas (Msc in Economic Policy Analysis)

 History Of Economic thought I

materials and subsistence for the workers of the country who sell their products to the
other Nations. The sales of the Merchant balance the purchases of merchandise and of
gold and silver which are obtained from abroad. Such is the distributive order of the
consumption of the native products among the different classes of citizens, and such is
the idea we should have of the practice and the extent of the foreign commerce of a
flourishing agricultural Nation.
The reciprocal traffic of one class with the other distributes the revenue of 600 livres from
one side to the other; giving 300 livres to each side, over and above the advances which
are conserved. The Proprietor subsists by means of the 600 livres which he spends. The
300 livres distributed to each class, added to the product of the taxes, the tithe, etc.,
which are added to them, can support a man in one or the other class: thus 600 livres of
revenue and the supplementary sums can furnish subsistence to three heads of families.

Robert Jaquis Turgot(1727-1781)

Turgot was the French Adam Smith. His Reflections on

the Production and Distribution of Wealth, which
predated Smith’s The Wealth of Nations by ten years,
argues against government intervention in the economic
sector. Turgot recognized the function of the division of
labor, investigated how prices were determined, and
analyzed the origin of Economic Growth. Like Francois
Quesnay, Turgot was a leading Physiocrat who
R. J. Turgot (1727 – 1781) attempted to reform the stuffiest of his government’s
economic policies.

Probably Turgot’s most important contribution to economics was to point out that capital
is necessary for economic growth, and that the only way to accumulate capital is for
people not to consume all they produce. Most capital, he believed, was accumulated by
landowners who saved the surplus product after paying the cost of materials and of labor.
Turgot agreed with Quesnay’s notion of the circular flow of saving and investment,
where savings in one period become investment in the next.

Compiled By: MamoEsayas (Msc in Economic Policy Analysis)

History Of Economic thought I

In Reflections, Turgot analyzed the interdependence of different rates of return and interest
among different investments, noting that interest is determined by the supply and demand for
capital. Turgot distinguished between a commodity’s market price—determined by supply and
demand—and its “natural” price, the price it would tend to if industries were competitive and
resources could be reallocated. An increase in demand, for example, could increase a good’s
price, but if resources were free to enter that industry, the new supply would bring the price back
down to its “natural” level. In this reasoning Turgot anticipated Adam Smith.

Turgot also predated Smith in recognizing the importance of the division of labor for an
economy’s prosperity, and he was the first economist to recognize the law of diminishing
marginal returns in agriculture. Predating the Marginalists by a century, he argued that “each
increase (in an input) would be less and less productive.” Turgot applied many of his laissez-
faire economic beliefs during his thirteen-year appointment (1761–1774) as chief administrator
for the Limoges district under Louis XV and as minister of finance, trade, and public works from
1774 to 1776 under newly anointed Louis XVI. In the latter job one of his first measures was to
abolish all restrictions on sales of grain within France, a measure the Physiocrats had long
advocated. He ended the government’s policy of conscripting (recruiting) labor to build and
maintain roads, and replaced it with a more efficient tax in money. Turgot abolished the guild
system left over from medieval times. The guild system, like occupational licensing today,
prevented workers from entering certain occupations without permission.

Critical Appraisal of Physiocracy

The principal service of the Physiocrats to modern political economy was not the discovery
ofany one of their doctrines, but their attempt to formulate a science of society out of materials
already athand. It was from this system as a base that Adam Smith set out to give a new impetus
(motivations) to the study ofeconomic phenomena. Another important contribution consisted in
calling attention to the weaknessesof the mercantile system. Laissez faire was a good doctrine for
the eighteenth century because therewas need of a reaction, but it was a mistake to set it up as a
universal principle applicable under allconditions. The chief weakness in the physiocratic
teaching lay in its theory of value. While agriculturebrings forth the raw material of production,
commerce and manufactures are equally productive ofwealth. In a sense, the

Compiled By: MamoEsayas(Msc in Economic policy analysis )

History Of Economic thought I

Physiocratsrecognized this, but they held that in producing this wealth themanufacturing and
commercial classes use up an equivalent amount of value. This is a gratuitousassumption, but
even if true, the same thing could be said of the so-called productive class. Moreover, ifwages
were governed by the “iron law2” both in agriculture and in manufactures and commerce, as
thePhysiocrats assume, the “net product” would be made up of wealth created by the commercial
andmanufacturing classes as well as by the agricultural class. The theory of the import unique or
single taxrested upon the assumption that all incomes, except those of the proprietors, were at the
existenceminimum. Since this is not true, it is also not true that all taxes levied upon the other
classes willultimately be paid by the proprietors.The important criticism levelled against
physiocracy are as follows:

1. Their theory was drowned in normative statement. This is quite true of natural order
concept.

2. The Physiocrats failed to consider the labouring Class as a productive class. Moreover
their contentionthat manufacturing class is sterile is also subject to severe criticism.

3. The Physiocrats do not have a clear cut concept of value. They have confused value with
utility. Theyheld the view that value depend on utility.

4. Their conception of landlord as partly productive class is more based upon political
motive.

5. Physiocrats placed too much emphasis on agriculture and have neglected the non-
agricultural sector.

Anyhow physiocracy occupied an important place in the history of economic thoughts. They
arenotable in the history of Economic thought because of their constructive and positive
contribution forthe development of the science of Economics.

2
The Iron Law of Wages is a proposed law of economics that asserts that real wagesalways tend, in the long run, toward the
minimum wage necessary to sustain the life of the worker.

Compiled By: MamoEsayas(Msc in Economic policy analysis )