Sunday, December 22, 2013

Economic History Roundup

So I thought I'd finish out our latest discussion of the evolution of economics with a few historical articles to bridge the gap between ancient systems and today

Most people in the Middle Ages under Feudalism lived under an economic system called Manoralism. Then we saw how an expanding economy due to increased luxuries imported into Europe during the Crusades, medieval market fairs, paper finance instruments, Lombard banking, and the like, led to increased trade, which led to Arabic numerals and double-entry bookkeeping. What this led to was an economic system known as mercantilism. To some extent, mercantilism made sense. When trading between countries, you can't use you countries' own respective currencies - you can't accept Pounds for British goods in France because you can't spend them in France and vice-versa. So, the mutually-agreed-upon currency was gold. But if you buy more stuff than you sell, at the end of the year you have less gold in your vaults and your trading partner has more. Why was this important? Well, gold was how you raised, paid for, and provisioned armies. So having less gold than your rival (and this was an era of incessant warfare) meant that you were vulnerable (today dollars are used for international trade, which leads to a whole host of issues you may have heard about)
At the heart of mercantilism is the view that maximising net exports is the best route to national prosperity. Boiled to its essence mercantilism is “bullionism”: the idea that the only true measure of a country’s wealth and success was the amount of gold that it had. If one country had more gold than another, it was necessarily better off. This idea had important consequences for economic policy. The best way of ensuring a country’s prosperity was to make few imports and many exports, thereby generating a net inflow of foreign exchange and maximising the country’s gold stocks.

Accumulating gold was thought to be necessary for a strong, powerful state. Countries such as Britain implemented policies which were designed to protect its traders and maximise income. The Navigation Acts, which severely restricted the ability of other nations to trade between England and its colonies, were one such example...One often reads in mercantilist tomes that foreign trade would be more beneficial than would domestic trade. And some of the early mercantilists, like John Hales, were enchanted by the idea of an overflowing treasure chest...on the whole... Few mercantilists were slaves to the balance of payments. In fact, they were alarmed by the idea of hoarding gold and silver. This is because many mercantilist thinkers were most concerned with maximising employment. Nicholas Barbon—who pioneered the fire insurance industry after the Great Fire of London in 1666—wanted money to be invested, not hoarded. As William Petty—arguably the first “proper” economist—argued, investment would help to improve labour productivity and increase employment. And almost all mercantilists considered ways of bringing more people into the labour force.

Mercantilism is thought to have begun its intellectual eclipse with the publication of Adam Smith’s "Wealth of Nations" in 1776. A simple interpretation of the economic history suggests that Smith’s ruthless advocacy for free markets was squarely opposed to regulation-heavy mercantilist doctrine. But according to research by Lars Magnusson of Uppsala University, Smith’s contribution did not represent such a sharp break. The father of economics was certainly concerned with the effects of some mercantilist policies. He saw the damage that overweening government intervention could do. Smith argued that the East India Company, a quasi-governmental organisation that managed parts of India at the time, was responsible for creating the huge famine in Bengal in 1770. And he hated monopolies, arguing that greedy barons could earn “wages or profit, greatly above their natural rate”. Smith also grumbled that legislators could use mercantilist logic to justify stifling regulation.

But Smith points out circumstances in which government interference is necessary. He was in favour of the Navigation Acts. And in Smith’s lesser-known "Lectures on Jurisprudence", he outlines other cases where government intervention in trade is useful. Smith was not opposed to regulation per se, but rather instances where individuals and governments could abuse their position of power for personal gain.

Nicholas Phillipson, who recently wrote a biography of Smith, argues that the notion of “free markets” was alien to the father of economics. Smith made it clear that governments would always play a part in making markets—and could not conceive of a market where the government did not play a crucial role. And in this sense, his contribution does not represent such a sharp break from mercantilist thought. The question was not whether, but how much, of a role the state would play.
What was mercantilism? (Free Exchange)

Following mercantilism, and contemporary with Adam Smith were the physiocrats in France. If you're wondering when economics became codified as a "science", this is it. The Physiocrats believed in universal, "scientific" rules for economic exchange, and believed they should never be violated. Although dismissed now, partuclarly for their notion that only farmers produced suplus, and that manufacturing was a "dead" industry, their thinking still inflicts the economics discipline today - particularly their ideas about universal, unchanging mathematical rules to describe economic behavior and  their advocacy of "free trade:"
Before physiocracy, economics was not a very scientific discipline. As we discussed in a previous blog post, mercantilist thinkers sometimes assumed that amassing gold was the best economic strategy. Economic efficiency was a pretty alien idea.

But Quesnay was a scientist (for most of his life, he was a medical doctor). And he wanted to apply the scientific principles of medicine to the study of wealth. The "Tableau Economique", which shows in a single page how an entire economy functions, is Quesnay's most famous contribution. Quesnay showed that the economy was something to be respected, analysed and understood—much like a human body. It could not simply be moulded to suit the will of a self-important monarch.

This was a hugely important step forward. The Comte de Mirabeau, an important figure during the Revolution, considered Quesnay's Tableau to be one of the world's three great discoveries—equalled only by the invention of printing and the discovery of money.

Familiar notions of contemporary liberal economics derive from Quesnay's scientific approach. The physiocrats, like many other thinkers of the eighteenth century, subscribed to the idea of a "natural order". They showed that unchanging laws governed all economic processes. Consequently, it is generally thought that the physiocrats were opposed to government intervention. The dead hand of the state would only corrupt the natural evolution of the economy. Jacob Viner, the Canadian economist, referred to the physiocrats as one of the “pioneer systematic exponents” of laissez-faire (alongside Adam Smith).

A good example of the physiocrats’ new, scientific approach to economics is found in the writings of a little-known disciple, Louis Paul Abeille. Abeille, writing in the 1760s, discussed the grain trade. He opposed mercantilist ideas of what to do during a period of food scarcity—for example, after a bad harvest. Received wisdom suggested that during a period of scarcity, a government should step in and forcibly lower the price of grain, so that people could afford to buy it. Governments might also choose to ban grain exports.

But Abeille argued that government intervention in the grain trade was self-defeating. With lower prices, he argued, grain producers would produce less. They would also make less profit—and therefore have less money to invest in the next year’s harvest. Government intervention, in other words, would disrupt the efficient working of the free market in grain, which would ultimately turn scarcity into a famine.

So he argued that the government should step back and let local prices rise. Producers in other parts of the country would respond to the high prices, and the area would be flooded with grain. Problem solved. But Abeille recognised that there would be a time lag between the price rise and the demand response. And so according to some writers, the implication of Abeille’s argument is that people who cannot afford grain should be allowed to die. Efficient economic management trumped humanitarianism.

Unsurprisingly, many writers criticised the physiocrats for their dogmatism. Adam Smith, in an amusing passage towards the end of the "Wealth of Nations", reckoned that they were carried away by the desire for perfection. Smith, aware that Quesnay was a medical doctor, argued that:

    Some speculative physicians […] have imagined that the health of the human body could be preserved only by a certain precise regimen of diet and exercise, of which […] the smallest, violation necessarily occasioned some degree of disease or disorder […] however [...] the human body frequently preserves, to all appearances at least, the most perfect state of health under a vast variety of different regimens […] Mr. Quesnai […] seems to have entertained a notion of the same kind concerning the political body.

Smith reckoned that the physiocrats wanted a perfect system of laissez-faire economic management—or no system at all.

But on this occasion, Smith got it wrong. The physiocrats were less dogmatic than most people think. Turgot, for example, subscribed in theory to the idea that free trade in grains was the best way of resolving scarcity. But he was responsible for dealing with an actual famine in south-west France in 1770. And in practice, Turgot supported a variety of programmes that cannot be described as laissez-faire: a programme of public employment and support for imports, among other policies. The Marquis de Condorcet, another writer associated with the physiocratic school, was also in favour of expanding public employment during periods of dearth.
Who Were the Physiocrats? (Free Exchange) To add to that, I recommend listening to this podcast from In Our Time: The Physiocrats (BBC). Some highlights:
Helen Paul: They were the first real school of economic thought. They called themselves the economists, but everyone else calls them the Physiocrats. Their founder is really Francois Quesnay. They were reacting against earlier patterns of thinking called Mercantilism. And they were the first to think in terms of model-building the economy; the kind of abstract model-building the Tableau Economique is about. So in a way, they tried to combine an existing social order with new techniques based on scientific principles, which was their way forwards because science at the time was all the rage, and ordinary gentlemen would be interested in science. They were trying to think about the economy as a scientific thing, as something to be studied in the same way.

What was really new about them was that they had this idea that you could use science to study a thing like the economy, and that was new. Quesnay was a doctor and he understood the circulation of the blood, he understood how the body functioned like that and he thought about the economies almost as a similar type of organism, with a circulation sources flowing from part to part in the economy, from group to group. And that was quite new. Most thinkers before that had used a lot of normative ideas about the economy operating in a particular way.

Melvin Bragg: what does normative ideas mean?

HP: Well, just how things should be based on religious principles rather than how they actually worked... They were different because the mecantilists who  preceded tham had insisted on how to build up, in some cases bullion, but in other cases just resources within...

MB: So the more coinage and wealth that you had in solid form, the more gold and silver and whatsit, the better off you were.

HP: That's a very bullionist idea. The bullionists were part of the mercanilists. Basically, the mecantilists wanted to regulate trade, and try to restrict the amount of imported goods into the economy, all of these things then, their ideas built up a huge nest of regulations and taxes and goodness know what, and the physiocrats wanted to undo all of that and go for a freer trade regime, primarily domestic free trade, they weren't really talking about international trade. But that was new. And it certainly went against a lot of traditional ideas.

MB: We have this tableau economque, economic tablet on one sheet of paper. What were the main points he made and how radical were they?

HP: His main idea, just to make this very abstract and simple, basically, he thought all wealth really sprang from the land, and that the resources used by the people who actually worked on the land, once they consumed everything they needed, the leftover product was what he called the net product or the produit net. And then that itself was shared out between people who owned the land, the proprietors, and what he called the sterile class. They're the merchants and the artisans, these people didn't actually create wealth he thought. He didn't quite understand the added value from manufacture. But the produit net circulated back around this system and it was reproduced every year. So it was very similar if you like to the circulation of the blood or some idea like that. So you could see it - think of this if you like as a model or a diagram, easy to understand. And because it was abstract of course it is a simplification but you have to do that with economic models to start off with in order to have an easy way to understand the economy.

Richard Whatmore: Quesnay's vision is, I have seen the laws of nature. The natural way the economy operates. and in a system where there are blockages and corruptions andall sorts of problems and we need to get rid of those and restore what he later calls the 'natural progress of opulence' where wealth is natural. in order to do that, you have to get away from merchants and bankers who threaten politicians, who corrupt politicians and take their wealth out of the state if the state doesnt venerate them. You want people with a stake in the soil because they cannot take their wealth away. Those are the peole you can trust politically; those are the people ho you want to give a greater voice to  rather than the radical elements that Helen just mentioned.

Certainly it is the vison of Quesnay, there is a special natural order. It comes really direcly from Newton the idea that there are natural laws, universal laws which govern the way the plants revolved around the sun for instance. And one of Quesnays aims really is to try to find out if nautral laws would be applicable to society, particulary civilized society and in doing that he tries to find out which of these basic blocks, if you want, of civilization, consider that simply surviving reproducing yourself is an element of every individual ...
If that's not enough economic history for you, try these:

Budget Wars - 1575 Version (VoxEU) Yes, this kind of stuff has been going on a long time.

Medieval Monetary Practices (VoxEU) and Medieval Regulations Establishing a Sound Coinage (Economist's View)

And finally, Vincent Huang: On the Nature of Money (Naked Capitalism). This doesn't deserve to be at the end, because it's very important. It's a long read, and sometimes slow going, but it's worth it. Basically, what he's arguing is that the "myth of barter" naturally leads to the assumption in economics that totally ignores the role of money. In conventional economics, money is just a "convenience" that facilitates transactions, but its role in the economy is incidental. So it's considered "exogenous," which is economic-speak for anything we don't want to talk about. Put another way, people want to make stuff, not money, so they just use money to facilitate the exchange of stuff.

By contrast, if you think about money as primarily based in social relations based on debits and credits, the role of money in economics is completely different. Since it is government that ultimately requires and validates the use of money, you cannot ignore it in economic analysis. What this leads to is the idea that people want to make money more than stuff, and they sell stuff mainly to make more and more money. That is, they need to make more money than they started with by the sale of stuff, leading to ever-increasing supplies of money (or Capital in Marxist-speak). That is, making money, not making stuff, is the end goal. Thus, money is essential in understanding the economy and how it functions. Interesting stuff.

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