Classical Political Economy

1. What classical political economy is

Last week was Adam Smith and the onset of modern economics. This week covers the other members of classical political economy: Thomas Malthus, David Ricardo, Jean-Baptiste Say and John Stuart Mill.

The term “classical economics” was coined by Karl Marx. The school was not a monolithic entity — its members shared common ground (economic liberalism, self-interested behavior, the search for economic laws) but differed on value theory, policy and social reform. Marx dealt with quite similar problems and used classical methodology, yet differed from the classics in fundamental ways. The course therefore treats Marx and the other socialists in a separate week.

2. Context: the first half of the 19th century

Classical political economy was shaped by the political and economic storms of its time.

• The French Revolution and independence movements. Revolutionary ideas spread, and colonies and nations fought for independence.
• The 1848 revolutions. A wave of liberal and nationalist uprisings across Europe.
• The Napoleonic wars (1803-1815). Napoleon ascended the throne in 1799 after a military coup. He created a stable state with strong finances, a bureaucracy and an army, and waged wars against an array of European states.
• Free trade, especially from 1815 to 1873. England pushed other countries to pass free-trade regulations.
• Industrialization and the problems of the capitalist system. Factory work, unemployment and poverty raised hard questions about the liberal order.
• Globalization. Market integration, mass migrations and the exchange of ideas.

The lecturers opened the week with a class question: Is population growth good or bad for economic performance? Views differ sharply:

• Aristotle and Plato: population should be controlled.
• Optimists about growth: more labor force means more output — but what about more unemployment? More creativity and investment may lower unemployment again.
• Malthus: population is the source of happiness, but it should be controlled by moral restraints.
• Neo-Malthusians: limit world population as soon as possible — catastrophe is coming.

3. Thomas Malthus: population theory

Thomas Malthus (1766-1834) was born into a noble English family and graduated from Cambridge in 1788. He published An Essay on the Principle of Population in 1798 and Principles of Political Economy in 1820.

Two public debates framed his work: the poor laws debate (should the government support the poor?) and the corn laws debate (should imports of grain be taxed?). Intellectually, Malthus reacted against his father’s circle, who optimistically believed in the perfectibility of people and society. Malthus thought social problems were due to the prolific fertility of the human race.

The population principle

Population is the ultimate source of happiness — but also a great obstacle to capitalist development. When unchecked:

• Population increases geometrically: 1, 2, 4, 8, 16, 32.
• Subsistence (food) increases at best arithmetically: 1, 2, 3, 4, 5, 6.

The result is catastrophe. Population growth is pulled back into balance with the food supply by two kinds of checks.

If people could somehow overcome the positive checks, they would face starvation, because population growth would ultimately press upon the food supply.

Policy: the poor laws

Poverty and misery are the natural punishment for the failure of the lower classes to restrain their reproduction. Government aid would only produce more children and worsen the hunger problem. Therefore: no government relief for the poor. These ideas were adopted in the harsh Poor Law Amendment of 1834, which removed all poor relief.

4. Malthus: the market glut theory

The second half of Malthus’s system is his theory of market glut: a market economy left on its own produces excess output, because effective demand (spending) is not sufficient to buy everything produced.

The solution is spending by landlords. Rent is a surplus based on the difference between the price of agricultural products and production costs. Landlord spending adds only to effective demand, while wages, interest and profits increase production costs — so rent income that is spent, not saved into production, helps clear the market.

Policy implications

• The corn laws must be retained. Import tariffs enrich the landlords, and their unproductive consumption is essential to avoid economic stagnation.
• War or government spending on public works can also remove a glut in times of distress.
• But Malthus opposed excessive unproductive consumption financed by the government, because government officials need higher taxes to consume.

Note the contrast: Malthus wanted the corn laws kept, while Ricardo (below) opposed them.

The glut theory was well-received by landlords and later inspired Keynes, by emphasizing unemployment caused by a lack of aggregate demand. The population theory still lives on among neo-Malthusians.

5. David Ricardo: distribution, value and rent

David Ricardo (1772-1823) was born into a Jewish family and had no education after the age of 14. He trained in the stock brokerage business and gained great wealth there; his success in financial markets came from patience and not seeking huge profits at once. His method was the abstract method of reasoning — deductive theory, with no experimental or historical data. He supported policies that conflicted with his own interests. His main work is Principles of Political Economy and Taxation (1817).

The distribution of income

For Ricardo, the primary subject of political economy is understanding the distribution of income. There are three factors of production, three classes of people and three incomes:

Ricardo wanted to show how the total output of society is divided among wages, rents and profits.

Value: natural price vs market price

The value of most goods is determined by the amount of labor required to produce them — the labour theory of value. Two factors affect value:

• Scarcity: for rare items that cannot be reproduced by labor (unique paintings, antiques), value comes from how hard they are to obtain.

• Labour: for reproducible goods, value comes from the amount of labor used.

• Natural price: the long-term, stable price determined by the cost of production, mainly labor.

• Market price: the actual price in the market, which fluctuates with supply and demand but tends to move toward the natural price over time.

Changes in wages or rents do not affect value in the long run: if wages go up, profits may go down, but value stays tied to the labor required to make the good.

Diminishing returns and rent

The idea of diminishing returns goes back to Turgot; Ricardo’s reformulation later inspired the marginalist revolution. Rent is the payment to a landlord for the use of land (later also the return to long-run capital investments on land that increase productivity). According to Ricardo, rent emerges at both margins of cultivation:

• Extensive margin: bringing inferior (bad quality) land into use, which yields less output for a given amount of labour and capital.
• Intensive margin: applying additional inputs to existing (superior) land, which again gives less additional output.

Land fertility varies, and the best land is used first. When population increases, output can rise only by using worse land or by squeezing more from existing land — so there are diminishing returns to land.

The stationary state

As the economy grows, wages initially rise. Then population growth brings wages back down to the subsistence level. At that stage rents are high, the wage rate is at its minimum, population growth slows down, and profits fall to near zero. This is the stationary state of the economy.

Policy implications

• Wages should not be regulated, and no relief should be given to the poor.
• A tax on rent would affect only rent: landlords cannot raise rents to pay for it (marginal land pays no rent, and so no tax).
• Opposition to the corn laws: freeing grain imports lowers grain prices, which reduces rent and increases profits, leading to higher capital accumulation and higher wages.

6. Ricardo: machinery and comparative advantage

On machinery

Introducing new machines creates labor saving at first. In the long run, as machine use diffuses through the industry, the extra profits disappear through competition, and employment decreases. This technological unemployment may be partly offset by the extra employment created by growing demand for the industry’s products, but the additional demand will not be enough. This does not mean, however, that machinery should be discouraged.

The theory of comparative advantage

Views on trade had changed step by step:

The slides’ example: England and Portugal trade wine and cloth. Portugal has an absolute cost advantage in both goods — it can produce 3 units of wine with each unit of labor, while England can produce only 1 unit, and Portugal can also produce more cloth from a unit of labor than England. Under Smith’s absolute advantage, there would be no trade. Ricardo disagrees: the two countries compare opportunity costs — the other good given up to produce a unit. England gives up less by specializing in cloth, Portugal by specializing in wine. So England specializes in cloth, Portugal in wine, and both are better off.

Ricardo’s contributions were the use of abstract reasoning and the theory of comparative advantage. His weak point was an overemphasis on the law of diminishing returns to agriculture: technological advances and capital accumulation increased the productivity of labor and capital.

7. Jean-Baptiste Say

Jean-Baptiste Say (1767-1832) was a Frenchman who popularized Smith’s ideas on the Continent. He published A Treatise of Political Economy in 1803. His career was blocked by Napoleon, who disliked Say’s extreme laissez-faire views; after Napoleon’s defeat at Waterloo, Say became a professor of political economy after years in business.

Say opposed the classists’ labour theory of value, which he replaced with supply and demand, regulated by costs of production and utility.

Other contributions:

• Monopoly costs: monopolists not only create what today we call efficiency losses (deadweight losses), but also use scarce resources to obtain and protect their privileges.
• Entrepreneurship is a fourth factor of production, alongside land, labor and capital.
• Say’s law: equality between total output produced and total spending will always be maintained within a market economy — supply creates its own demand.

The policy implication: government should always encourage production, because the economy would always tend toward full employment.

8. John Stuart Mill

John Stuart Mill (1806-1873) was the last great economist of the classical school, and he systematized and popularized the classical doctrine. His father, James Mill, was also a political economist with utilitarian tendencies and a friend of Ricardo and Bentham. Growing up in an intellectual atmosphere, Mill rejected narrow and dogmatic utilitarianism — especially its reduction of human action to the selfish search for maximum pleasure. He was a big advocate of human rights, especially after his marriage to Harriet Taylor. Later he was influenced by Saint-Simon and Auguste Comte and developed some socialist tendencies, so his works reflect a mix of liberal capitalism and socialism.

Value theory

Mill rejects the distinction between use value and exchange value: the only value is exchange value. Price is the value stated in terms of money. Exchange value represents the power of possessing a commodity over other commodities. The value-creating factors fall into two groups: the utility of a commodity and the difficulty of obtaining it.

He classified commodities by the difficulty of obtainment:

The wages fund theory

Like Ricardo, Mill thought the wage is determined by demand and supply of labor and equals the subsistence level in the long run. Laborers and governments have no role in determining wages. Labor supply depends on the number of laborers; labor demand depends on the wages fund — the capital spared for the payment of wages.

If labor supply increases faster than the wages fund, wages fall; if the fund grows faster, wages rise. To some economists, this theory was just a way of blaming workers for low wages.

Rent and price

Mill accepts Ricardo’s rent theory and adds that the industrial sector can also create rent. This happens when commodities that have the same market price can be produced at varying costs. Example: a commodity produced on fertile land costs less to make, but it is considered homogeneous with the same good made on less fertile land — the firm on the fertile land obtains rent. Market price is determined by supply and demand, but the factors that affect supply and demand also affect the market price; the real value is determined by costs of production, and in the long run by the natural price.

Social reforms

Mill prioritized people’s needs and valued freedom and competition (the classical doctrine), but he also emphasized income inequalities and suggested social reforms:

• The wage system should be substituted by workers’ cooperatives.
• Rent on land should be taxed: the existing rent system is against individualism, and everyone should own the products of their labor, so agricultural rents should be transferred to society by way of taxation.
• The right to inherit should be restricted to remove wealth inequality.

But Mill did not criticize the heart of the capitalist regime as Marx did. To him there were imperfections and abuses that required correction — hence the class question of how to classify him: a liberal with socialist reform tendencies.

9. Criticisms and conclusion

Unemployment, poverty and bad working conditions cast doubt on the liberal capitalist system. Under these conditions, the classical doctrine was criticized mainly by three groups:

Main tenets of classical economics

• Economic liberalism and minimal government involvement
• Self-interested behavior and harmony of interests
• The importance of all economic resources and activities
• The existence of economic laws

Was Marx a classical economist? Maybe and maybe not: with respect to the similarity of the problems he dealt with, yes. Marx coined the term “classical economics” with special reference to Ricardo and was critical of what he called “vulgar economics.” Classical economics is not a monolithic term — Mill’s ideas on reform show how wide the school was.

Next week: Karl Marx, and how Marx and other socialists were concerned about inequality, poverty and misery, which they thought were created by the capitalist system.

Exam practice

Summary and review

• Classical political economy covers Malthus, Ricardo, Say and Mill after Smith. The term was coined by Marx (with special reference to Ricardo); the school shared methods and problems but was not monolithic.
• Context: French Revolution, independence movements, the 1848 revolutions, the Napoleonic wars (1803-1815, Napoleon’s coup in 1799) and the free-trade era (1815-1873), industrialization and globalization.
• Malthus (1766-1834): population grows geometrically (1, 2, 4, 8, 16, 32), food at best arithmetically (1, 2, 3, …). Preventive checks lower the birth rate (approved: moral restraint, delayed marriage); positive checks raise the death rate (famine, plague, war). Policy: no poor relief (Poor Law Amendment, 1834). Glut theory: effective demand can fail; landlord spending clears the glut, so retain the corn laws. His glut theory inspired Keynes.
• Ricardo (1772-1823): the subject of political economy is the distribution of income among landlords (rent), workers (wages) and capitalists (profits). Labour theory of value; natural price (cost of production) vs market price (supply and demand). Rent at the extensive (worse land) and intensive (more inputs) margins; diminishing returns lead to the stationary state (high rents, subsistence wages, near-zero profits). Opposed the corn laws and poor relief; a tax on rent affects only rent.
• Ricardo on machinery: long-run technological unemployment may not be fully offset, but machinery should not be discouraged. Comparative advantage: trade benefits both countries even when one is more efficient in everything (England cloth, Portugal wine).
• Say (1767-1832): popularized Smith in France; replaced the labour theory of value with supply and demand regulated by costs of production and utility; entrepreneurship as a fourth factor of production; Say’s law — supply creates its own demand, economy tends toward full employment.
• Mill (1806-1873): last great classical economist; only value is exchange value; commodities classified into nonreproducible (price by supply and demand), fixed-cost reproducible (price by production costs), and increasing-cost (price by production costs, value rises with demand — agricultural products). Wages fund theory (wage equals wages fund divided by laborers; subsistence in the long run). Industrial rent possible. Reforms: workers’ cooperatives, rent taxation, inheritance limits — liberal capitalism mixed with socialist tendencies.
• Critics: National Economic Doctrine (protectionism), German Historical School (no universal economic laws; history first), Marxist-socialists (capitalism collapses from internal contradictions).
• Key dates: Malthus’s Essay 1798, Say’s Treatise 1803, Ricardo’s Principles 1817, Malthus’s Principles 1820, Poor Law Amendment 1834, revolutions 1848.