Download Econ4950 Lecture Note 2 26 Jan. 2011

Econ4950 Lecture Note 2
26 Jan. 2011
1. Introductiory remark
We are moving along a timeline starting from Greek philosophers in -4C and jump over a
very long interval in history to come to the next topic.
What you learn today, ten years into 21C, naturally is rooted in 20C but very much will also
have strong roots in 19C. Some may even have roots before 19C. In your textbok stuff you
may struggle over indifference curves in demand theory or isoquants in production theory, or
elementary macro model or ISLM or a 2-by-2 game theory model or the simplest formulae in
growth theory and you really have little idea how they have originated or where the concepts
and terms have come from. The textbook will only very rarely tell you. Often the history
behind these building bricks for economists turn out to be quite intricate. Occasionally, it
happens that a practitioner in some field of economics looks backs in the old books, takes the
bother of reading what was originally said and gets an inspiration for how the theory can be
taken further.
We will continue in England 17C with William Petty. Arguably the two most names we skip
are Thomas Aquinas c.1225-74 and Nicole Oresme c.1320-1382. They are both great
intellectuals and well covered in Backhouse. Aquinas interprets and applies the Aristotelian
theory of just price and refines the reasoning to the situation of his time. Oresme may
similarly be said to apply Aristotelian thinking on the origin of money and the uses of money
to the situation at his time.
We note in passing that Backhouse, indeed also Sandmo, are centered very much Engalnd and
France with USA coming in at a late stage. The most important omission implied by this is
the cameralism (Cameralwissenschaft) in the German dominated part of Europe.
In addition we deal in this chapter with Richard Cantillon, François Quesnay, and Anne R. J.
Turgot.
2. Mercantilism
Mercantilism refers to the economic thought and policies that were characteristic of the
dominant western European trading nations during the transition from medieval feudalism to
modern capitalism from the 16th to the late 18th century. Adam Smith coined the term
mercantilism and was very negative towards it. Mercantilist policies included the granting of
monopoly privileges, regulation of prices and business practices and especially prohibitions,
tariffs, subsidies and other regulations regarding the conduct of international trade.
But import restraints and encouragement to exportation were mercantile policies that would
enrich and empower the newly emerging nation-states. The mercantile era emerged after the
discovery of the New World and the East Indies. Shipping and trading grew in importance
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during this period as did the frequency of military battles at sea and in the colonies. AngloFrench rivalry remained intense. Mercantile economic warfare complemented the military
objectives of the antagonistic nations and served to unify each nation against an external
threat.
The granting of monopoly privileges was a relatively more important form of state protection
during the earlier part of the mercantile era, such as the British East India Company which
was granted a monopoly charter in 1600. Such privileges were intended to benefit the
developing shipping and long-distance trading industries themselves as well as to provide
revenues to the state either directly, in the case of state monopolies, or indirectly through
modest duties on imports of the private monopolies. Cromwell introduced the first Navigation
Act of 1651, stipulating that all goods imported into England or her territories had to be
carried in English ships, unless they were carried directly from a European country of origin
on ships owned and crewed by citizens of that country of origin.
Mercantilism has often been depicted as the school of thought that confused money with
wealth. There was a belief that inflow of precious metals would increase the wealth of the
nation and that foreign but not domestic or internal trade was the only way to increase the
wealth of a nation that did not possess gold or silver mines.
Mercantilism was the background for increasing discussion of economic issues in England.
Economics was not a field yet and we are still a bit away from the Industrial Revolution. We
shal look at the ideas of William Petty. 17C England is an interesting period with progress in
many knowledge areas, not least science. England was on the rise economically towards the
completely dominating period it would achieve. It had a more efficient agriculture and was a
much more integrated economy than for instance France. Together with the Netherlands
England ruled over the oceans. But it was also a turbulent period politically. Charles the First
was executed, Cromwell usurped power. Different from France the parliament exerted power
and prevented the absolutism of the monarchy. There ws censorship but also relativ efreedom
of expression. Lots of pamphlets were printed.
3. William Petty 1623-87
William Petty studied medicine and became Professor of Anatomy in Oxford in 1650 and was
also appointed to a Chair of Music in London. He then set out to apply the new scientific
methodology of the 17C century to the practical economic problems of the modern nation
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state.
Petty contributions to the origin of classical political economy involved method, concepts,
and analysis. His best known work and main contribution on methods was Political
Arithmetick, written in the 1670s, published after his death; the method of political
arithmetick he defined as follows:
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;
leaving those that depend upon the mutable Minds, Opinions, Appetites and Passions
of particular Men, to the Consideration of others. (Petty, 1899, p. 244)
The empirical and inductive approach suggested here is clearly inspired by the scientific
revolution which reached a climax in the second half of the 17th century.
[Petty was a contemporary with Robert Boyle and thus lived between Galileo Galilei and
Isaac Newton.) Francis Bacon was the philosopher representing this wave of science with
conviction that the first step in the advancement of human understanding in any sphere of
knowledge – whether in astronomy or in chemistry was to lay a foundation of direct,
empirical observations.
To quote Bacon's Novum Organum:
The roads to human power and to human knowledge lie close together, and are nearly
the same; nevertheless, on account of the pernicious and inveterate habit of dwelling
on abstractions, it is safer to begin and raise the sciences from those foundations which
have relation to practice and let the active part be as the seal which prints and
determines the contemplative counterpart.]
Petty's political arithmetick implied that beyond recording and describing reality ‘in terms of
number, weight or measure’ i.e. economic statistics, he aimed at expressing reality in such
terms, identifying ‘such causes, as have visible foundations in nature’. The underlying view
was that reality obeyed natural laws, the task of the scientist was to discover these natural
laws beneath the surface of apparently erratic phenomena experienced by our senses. The aim
was to locate reality's inner structure, not the descriptive details. Petty applies his political
arithmetick to measure social phenomena in a search for the characteristics of human societies
and for the nature and causes of social wealth. He attempted to calculate national income and
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also major components of the national income, although data sources were largely absent. The
estimate of national income was partly based on an estimate the population which he also
made. His methods in these and other estimates were very simple. Petty's only statistical
technique was the use of simple averages.
Then to concepts, Petty's notion of money was specified through a human-body metaphor
suggesting the three functions of money: unit of measure, means of exchange, and store of
value.
Money is but the Fat of the Body-politick, whereof too much doth as often hinder its
Agility, as too little makes it sick … As Fat lubricates the motion of the Muscles, feeds
in want of Victuals, fills up uneven Cavities, and beautifies the Body, so doth Money
in the State quicken its Action, feeds from abroad in the time of Dearth at Home;
evens accounts by reason of its divisibility. (Petty, 1899, p. 112)
In relation to money, Petty clearly perceived the notion of the velocity of circulation further
made the point that banks, in creating paper money, allow society to save on the cost of
acquiring the precious metals necessary for ensuring the required monetary circulation. He
launched ideas on the optimal taxation, with the chaotic situation then prevailing the
prevailing, and spelled out preconditions for modern fiscal institutions, introducing the notion
now known as fiscal pressure, i.e. the ratio between the amount of taxation and the level of
national income.
Petty did not seem to perceive, however, the productive interrelationships connecting city and
countryside, industry and agriculture, the productive interrelationships which Richard
Cantillon drew attention to and which constituted the main analytical contribution of
Quesnay's Tableau économique.
The notion of the surplus is one of Petty's fruitful contributions. He expressed the surplus in
the economy in physical terms, as the amount of product (corn) exceeding the required means
of production, and identified it with rent. In this way he avoided the problem of the
determination of the profit rate, which in turn involves the problem of relative prices, since
relative prices are required for evaluating both capital advances and the net product. Such
problems became the concern of classical economists from Ricardo to Marx, more recently,
by Piero Sraffa. Marx would later express his appreciation of these shades of Marxian surplus
notion in labour terms, he called Petty the ‘founder of Classical political economy’].
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Petty's strictly analytical contributions to the origins of classical political economy are more
limited than his methods and conceps, but nonetheless relevant. In the theory of prices he
attempted to find a way of expressing one of the two means of production, labour and land, in
terms of other, in order to obtain a single magnitude expressing production cost. [It was a
fairly primitive idea, but it served as a starting point for Richard Cantillon to take further and
in turn influence Quesnay's economic thinking.]
Petty also made an important conceptual distinction between ‘actual’ and ‘natural’ prices or,
that is exchanges actually taking place, and theoretical prices based on the factors influencing
current prices. His concept of ‘natural price’ as an objective notion, was distinct from the
notion of the ‘just price’, the moral rule of behaviour for sellers and buyers, as writers on
economic issues had dealt with for centuries before Petty's time. [Both ‘surplus’ and ‘natural
price’ were early contribution to classical value theory.]
Most of Petty's pamphlets on economic questions were circulated privately and published
posthumously, for the second half of the 17th century was an age in which giving politicoeconomic advice to governments was a perilous occupation. The distinctive message running
through these writings was the importance of basing public economic policies on
systematically compiled empirical evidence and reasoned quantitative estimates of the
nation's human and material resources. Petty is sometimes credited with having founded the
first ‘school’ of economic thought, more to the point is perhaps that he had launched first
scientific research programme in political economy.
Petty’s immediate followers (for example, Gregory King and Charles Davenant) definitively
established the sciences of demography and economic statistics, while Petty's conceptual
framework, adopted by Cantillon, exerted a decisive influence on the development of. In this
way (as well as through other less direct channels) Petty influenced both Smith and Ricardo,
even if they do not refer directly to his writings.
A further note on political arithmetic
Petty's importance for 17C culture is undeniable. His search for an ‘objective’ science
contributes to the paradigm shift that was taking place at the time.
A friend of Petty’s, John Graunt, took in 1662 the first steps in the formulation of the modern
science of demography by using the death returns and other data to make the first reasoned
estimates of total population. Graunt was thus a more careful statistician than Petty but not an
economist at all. Graunt and Petty were also influenced by philosopher John Locke (1632–
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1704), regarded as founder of the British empiricist tradition. Locke is credited with the first
use of a most important analytical idea in economics, the demand-supply reasoning in
determining price.
Another who practiced political arithmetic was Gregory King who produced demographic
estimates and estimates of national income, more meticulously justified, more detailed, more
internally consistent, and hence more credible in their delineation of the dimensions of the
economy and in international or intertemporal comparisons than Petty’s own work. Another
person who gave a famous contribution to political arithmetic was Halley, better known as
astronomer (“Halley’s comet”) who made the first life insurance tables from a brilliant
analysis of demographic data.
Political arithmetic continues into 18C but faded totally after that. Today we can lok a [The
improved life tables, with proper probabilistic underpinnings, were to break away from the
main political arithmetic and become part of a statistical/probabilistic tradition that would
develop independently in Europe in the next two centuries.]
It was early econometrics, as Schumpeter indeed calls it. Petty's estimates of national income
were often cited without any attempt at updating. The new discipline of political economy that
took shape in the late 18th and early 19th centuries took off in more theoretical, less Baconian
directions, political arithmetic lost its capacity to attract innovative exponents. Perhaps Adam
Smith gave the coup de grâce to the whole approach when he announced in The Wealth of
Nations that he had ‘no great faith in political arithmetick’ – though he was not above
borrowing some of the political arithmeticians’ estimates when they served the purpose of his
argument.
4. Economic thinking in 18C France
During 17C there was no French counterpart to the discussions of economic issues in
England. It was the time of Louis IV whose Minaister of Finance Colbert attempted to
promote the wealth and power of the monarchy through the regulation of commerce. By the
end of the 17th century reflection on economic matters was just beginning, and the monarchy
was increasingly conscious of the gravity of the problems that recurrent dearth and high levels
of debt represented. This created the conditions for the questioning of economic policy with
respect to both the provisioning of markets and taxation.
On contribution was Pierre de Boisguilbert writing in 1695 understood the close connection
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between income and consumption endorsing laissez-faire as the sole condition permitting the
emergence of the ‘proportionate price’, a price at which each gained from participating in
exchange and in which each party to the exchange adhered to his budget constraint. He argued
that both good and bad harvests disrupted economic activity because they would bring about
violent price changes if, as was the case in France, free competition was absent. The price of
wheat was vital to the subsistence of populations. Since the wheat market determined the level
of many agents’ income, variations in the price of wheat affected other markets. Expectations
on the part of agents, whether justified or not, disturbed the economy, and government
intervention was not capable of stabilizing the market since such intervention was in turn
perceived to be the sign of an even more serious crisis.
After the death of Louis XIV in 1715, the Scotsman John Law turns up and convinces the
regent that France's poor economic performance was due to an inadequate money supply. In
1716, he founded Banque Générale which later became Banque Royale, a bank which had the
creation of paper money as its principal function; this paper money was supposed to substitute
for coins and to permit a refinancing of government debt. A commercial company was
granted an exclusive right to trade with Louisiana and the company's shares could be
purchased only with billets d’Etat (government securities) at their face value instead of being
discounted about 70 per cent, but the public could hope for capital gains if the company's
trade was well managed. The company gained in this way an exclusive right to the
exploitation of vast wealth, and the state transformed its floating debt into long-term debt with
a lower interest rate.
The merging of the company and the bank permitted monetary expansion and at the same
time boosted the value of the company's own shares. At the end of 1719 Law became
Comptroller General of Finance – money issue was strong (around a million livres) and the
rate of interest touched a low point of two per cent. The price of the company's own shares
was stabilized by an office which intervened in the market. The system collapsed as soon as
agents sought to exchange their shares and securities for cash. But Law's collapse had a
lasting impact. The chance of modernizing the public finances had been missed, and for the
entire 18th century the collapse weighed heavily on the capacity of the French monarchy to
finance its military conflicts with Britain. In addition, a marked suspicion of fiduciary money
and banking prevailed right up to the Revolution.
Discussion of monetary matters continued in the early part of the 18th century, but gave way
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to an interest in commerce from the perspective of the legislator, as in Richard Cantillon's
Essai sur la nature du commerce en général (written around 1728–30 and published in 1755).
From 1750, economic publications multiplied and this growth accelerated in the years leading
up to the Revolution. New contributors to the genre emerged with François Quesnay and the
Physiocrats during a troubled political period including the Seven Years’ War (1756–63) and
the Treaty of Paris, under which a large part of the French colonial empire was lost.
5. Richard Cantillon 1697-1734
Richard Cantillon is a somewhat mysterious figure. He was born in Ireland and active in
banking in Paris between 1716 and 1720. Brilliantly anticipating the fate of John Law's
scheme, he was also daring enough to profit immensely by it and is asserted to have ‘made a
fortune of several millions in a few days’. Back in London in 1734, Cantillon's luck ran out, at
the height of his success and his brilliance, he was robbed and murdered.
Only one work of Cantillon is known, the Essai sur la Nature du Commerce en Général
(Essay on the Nature of Trade in General) published in 1755, no complete English
translation until from 1931. Cantillon’ Essay became known to the English-speaking world by
Jevons in 1881 who noted that Cantillon had presented a treatment of currency, foreign
exchanges, banking and credit which, judged against the work of its period, he felt to be
‘almost beyond praise’.
It was recognized that Cantillon had set out the leading ideas of Adam Smith's doctrine
concerning wages in different employments and that the Essay contained what Jevons
(perhaps somewhat exaggeratedly) called ‘an almost complete anticipation of the Malthusian
theory of population’. Jevons also praised Cantillon's treatment of ‘the whole doctrine of
market value as contrasted to cost value’ (1881, p. 345). It was later also recognized that
Cantillon made important contributions to the founding of allocation theory.
In the Essay while land is a given non-produced input, labour was a produced commodity
available in return for subsistence. A reproduction structure thus exists, and surplus may be
defined. Cantillon was he concerned with the allocation of surplus output, an idea taken over
by François Quesnay, who embodied it in a formal model and passed it on to later classical
economists.
Cantillon made several important contributions. He offered an early analysis of the respective
roles of produced and non-produced inputs in a commodity reproduction structure.
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Developing Sir William Petty's concept of a ‘par’ between land and labour, Cantillon
investigated the assumptions upon which a reduction of labour to land is legitimate, or more
precisely reducing labour to the produce of land, that is, to corn. He noted that ‘as those who
labour must subsist on the produce of the Land it seems that some relation might be found
between the value of labour and that of the produce of the Land’ (Cantillon 1755). Cantillon
had entered an area which even today is problematic concerning the aggregation of
heterogeneous objects. Leaving aside the difficulties of heterogeneous labour and
heterogeneous land with multiple uses, the par is the quantity of corn needed for the
subsistence of a labourer and his family during a given period. To get a consistent model, corn
must be treated as the only commodity strictly necessary to the reproduction system. Other
outputs have to be treated as luxury goods (non-basics), so that one can accommodate the
changing modes and fashions of Cantillon's prince and landowners.
Cantillon's treatment of surplus strongly suggest that it arises only in agriculture. All those in
a state, we are told more than once, subsist at the expense of the proprietors of land, although
there are passages where he seems to be recognizing that profits can arise in manufacturing.
Cantillon, however, did pioneering work in developing the theory of the allocation of surplus.
His model is remarkably sophisticated. It is an isolated economy – one might think of it as an
island – ruled by a prince or landowner. Cantillon considered the prince’s choice in using the
surplus and how that would affect the prices. This lead him into reasoning about prices
current prices deviating from natural prices, or intrinsic values. Cantillon, of course, was by
no means the first to make some kind of distinction between market and natural prices, w
ehave noted that petty made this distiction. But in Cantillon the distinction between market
and natural price is an integral part of a whole economic model. The natural price, or intrinsic
value of a commodity ‘is the measure of the quantity of Land and of Labour entering into its
production’ (1755). Labour is then reduced, through the par, to subsistence units, which, as
we have seen, can either be measured in corn or in quantities of a composite commodity.
These intrinsic values are assumed to be invariant. Market prices may deviate from intrinsic
values following a change in demand, as we have seen, but the actions of profit-maximizing
capitalist farmers will then lead to supply changes, initiating the gravitation process.
Cantillon shows that he is quite aware that a planned economy directed by the prince, and a
system of prices, can each achieve the identical allocation of surplus output – a result whose
formal proof had to wait until the 20th century, and which lay fallow after Cantillon as
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classical political economy developed in other respects.
Cantillon was later embraced by the Austrian School economists in 20C who find rudiments
of business cycle theory similar to their own. Joseph A. Schumpeter found Cantillon's
treatment of the international specie flow mechanism a brilliant performance and insisted that
‘the automatic mechanism that distributes the monetary metals internationally is … almost
faultlessly described’ (1954, p. 223).
6. François Quesnay 1694-1774
Quesnay studied medicine in Paris and became a surgeon. In the 1740s he became the private
physician of Madame de Pompadour, Louis XV's mistress. For his medical services to the
royal family he received a noble title. Around 1750 he became a member of the French
Académie des Sciences, left the medical profession and took up an interest in economics,
particularly agricultural matters.
He was in contact with many D'Alembert and Diderot, Buffon, Helvetius and Condillaca and
others associated with the Encyclopédie, for which he wrote some articles. He also met Victor
Riquetti, Marquis de Mirabeau from an old noble family. Mirabeau held the view that the
main cause of national wealth was the number of people. Quesnay convinced him that
agriculture was much more important than population, because it produced the commodities
which were necessary for men's subsistence, Mirabeau became the most faithful propagator of
Quesnay's ideas.
In 1758 Quesnay published the first edition of the Tableau économique. The year 1763
marked the beginning of a period of active intervention by the Physiocrats in economic
debates. Quesnay contributed to the development of Physiocratic ideas with articles
presenting further versions of the Tableau. This new Tableau was also used by Quesnay in the
Premier problèmes économique, which appeared in the same periodical. Quesnay was the
uncontested leader of the Physiocrats; new disciples joined the group and his ideas found
some application in French economic policy. But by 1768 the cultural and political impact of
Physiocracy began to decline and Quesnay's theory was bitterly criticized. He spent his last
years studying geometry and died in December 1774, a few months after the death of Louis
XV.
Although he wrote much the analysis of Quesnay's economic writings presents a problem; he
did not write a single major text as a summary of his entire thought, but instead wrote small
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pieces, articles for the Encyclopédie and for the periodicals controlled by the Physiocrats,
usually discussing only one economic issue at the time.
It is a very important feature of Quesnay's thought that he explained economic facts and
individual actions on the basis of a view of society as a general interrelated system. Therefore,
he believed that all aspects of social life were linked together and that it was possible to find
the underlying causal relationships, which were nothing else than the outcome of natural laws.
The Tableau économique is one of those works in the history of economics which have often
been regarded as an anticipation of modern theories. The Tableau has been considered a first
rough presentation of Keynes's multiplier and by Schumpeter as a sort of general equilibrium
system of a Walrasian type. For others, the Tableau is an input–output table. The Tableau has
also been interpreted as the first classical system of price determination, anticipating Marx's
reproduction schemes and Sraffa's price system. All editions of the Tableau have the three
columns whose figures are related to each other by means of descending lines crossing the
table, the so called zig-zag version of the Tableau.
The Tableau is a synthetic way of describing the circulation of money and commodities in
relation to both the expenditure of revenue and the technical and social relationships between
the two main sectors of the economy. The Tableau gives a concise description of the way in
which the process of circulation of revenue reproduces the economy.
The main features of the economy described in the Tableau are as follows. First, in agriculture
there are the best methods of cultivation, with large capital stock and high productivity, so
that the annual advances can produce a surplus of the same size. A second assumption relates
to the fiscal system; all duties and excises which exist in France ought to be substituted by a
single tax on agricultural surplus. Third, free competition rules both in domestic and foreign
trade in agricultural products, thus there is a bon prix for primary commodities and cultivation
is a profitable activity. A fourth hypothesis relates to the landlords, who have made all the
necessary ground advances, such as drainage, transport facilities etc. We could, of course, add
other assumptions which clearly appear in the articles which precede the 1758 zig-zag. The
State guarantees the ownership rights for all citizens and not only for landlords. In particular,
the State protects the capital invested by cultivators as original advances.
It goes without saying that the society examined in the Tableau is not the actual French
economy but an ideal country where all reforms and economic measures advocated by the
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Physiocrats have already been implemented. According to Quesnay, England is the country
which most resembles this ideal society, and this explains why England is so prosperous and
wealthy. The Tableau is a normative benchmark for the government; it describes the
circulation and distribution of the social product and surplus, and it shows the final effects of
these exchanges on future production.
In several of his writings Quesnay uses the Tableau to study what happens when government
regulations or the behaviour of landlords does not conform to this natural order. For instance,
he analyses the consequences of several forms of indirect taxation. The Tableau is also used
to examine what happens when the landlords modify their pattern of consumption.
The Tableau économique is the most original aspect of Quesnay's economics, but it does not
exhaust his economic theory. The Tableau immediately conveys the view of the economy as a
single system which must reproduce itself. The analysis of the conditions which have to be
satisfied to guarantee this reproducibility is the main object of economic science. This
analysis indicates the factors which lead to an increase of national wealth.
For Quesnay, productivity increases are strictly dependent on the amount of means of
production available and hence on the original advances of the cultivators. The main way of
increasing national wealth was by securing the existence of a large agricultural sector with
wealthy farmers.
While the notion of surplus can be detected in the economic analysis of some authors who
preceded Physiocracy – for instance in Petty, it is only with Quesnay that net product is
defined precisely as the difference between the social product and its means of production.
The main problem in Quesnay's analysis is the nature of wealth and the ways in which it can
be created. From this point of view Quesnay clearly set out the main economic issues which
were subsequently examined by Adam Smith in the Wealth of Nations.
Agriculture is in Quesnay’s analysis the only productive sector, and taxation of surplus is the
only way of avoiding damage to future production. The stock of productive capital must not
be reduced by taxes, otherwise it would be impossible to maintain the same level of activity as
the previous year. Hence rent is the only taxable magnitude.
Commentators have interpreted Quesnay's economics as a purely physical model: in
agriculture the same goods are both the inputs and the outputs of the same process of
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production and the surplus can be measured simply as the difference between two physical
quantities of agricultural product. The entire economic system can be described as a ‘corn
model’ where the product and its means of production are homogeneous commodities; thus
there is no need for a price theory. The manufactured products used in agriculture can simply
be regarded as primary commodities which have changed shape thanks to the work of
artisans. Other authors maintain that prices exist in Physiocratic economics and that the
agricultural output and its means of production are heterogeneous goods. However, they
believe that Quesnay took the exchange ratios between the products of industry and those of
agriculture as given, and fixed.
Price theory is the final piece required to complete the picture of Quesnay's economic analysis
of the ways of achieving growth and development. There are several steps to reach the wellordered economy described in the Tableau. The implementation of free trade stimulates the
effective demand for primary commodities and raises their current prices. This leads to higher
profits for the farmers. If the fiscal system is based on the single tax on rent profits can be
entirely reinvested in agriculture, thus raising the advances of cultivation. Capital
accumulation in the productive sector of the economy leads to productivity increases. The
surplus rises both in absolute terms and as a share of the social product; more and more
resources can be reinvested in production, and national wealth grows. Quesnay develops a
theory of growth which is based on the notion of surplus.
Quesnay's main contributions to economic science are certainly the concept of surplus and the
Tableau économique. But one must also stress that for the first time there is a complete and
relatively coherent theory designed to answer the most important problems of economic
systems on the basis of a general analysis of all their main features. All economic issues are
examined with the help of precise concepts and on the basis of a theoretical approach.
Economic policy proposals derive from theoretical speculation, and are part of a single
general model of the growth of national wealth. Finally all the aspects of Quesnay's
economics are linked, in one way or the other, to his notion of surplus, which provides a sort
of unifying thread to his thought. Quesnay can quite appropriately be regarded as the founder
of that approach to the analysis of economic events which is called theory of surplus
7. Anne Robert Jacques Turgot 1727-81
Turgot was born in Paris, he studied first for a career in the Church, later he studied the
philosophical systems of Newton and Locke. He is known as an economist, philosopher and
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administrator. After prominent positions as administrator he became the Minister of Finance
under Louis XV but fell from grace in 1776 as his proposals were rejected.
Turgot's first meeting with Quesnay cannot be precisely dated. It may not have occurred till
1756 or 1757 when their mutual association with the Encyclopédie may have brought them
together. Another enduring friendship was made with the philosopher and mathematician,
Condorcet whose interest in public affairs during the Revolution gave rise to his essays on
social mathematics applying calculus and the theory of probability in social science.
(Remarkable is Condorcet’s voting paradox, which in a simpler fashion anticipates Kenneth
Arrow’s ‘impossibility theorem’ in 1951, see Sandmo 2011.)
In 1761 Turgot was appointed Intendant of Limoges with responsibilities for collecting direct
taxation, rectifying justice, promoting the arts of agriculture, encourage industry and
commerce, etc. His administrative work permitted regular but infrequent visits to Paris where
apart from the French intelligentsia, he also acquainted foreign notables like Hume, Adam
Smith, Franklin and Gibbon.
Louis XVI's succession to the throne in 1774 marks the next stage in Turgot's career; his
membership of the Royal Council as Minister of Finance (Comptroller General) 1774 to
1776. As minister he restored the domestic free trade in grain, abolished many small, local
duties and other constraints on trade, and the January 1776 implemented measures, of which
partial suppression of the guilds and replacing the corvée with a more general land tax were
the more controversial measures. But then he fell from grace. The reforms Turgot had
accomplished were reversed within six months from his downfall.
The Physiocratic School gained in importance during the 1760s and played a role in economic
administration. In 1764–5 the Comptroller General, Bertin, liberalized trade in wheat and in
flour; together with Turgot, Inspector in Limousin, and Pierre Paul Le Mercier de la Rivière,
Inspector in the Antilles, the highest reaches of administration opened up to Physiocracy. The
doctrine spread abroad: to Baden, Austria, Poland, Russia and Sweden. However, a
succession of poor harvests in the later 1760s put an end to those tentative efforts at trade
liberalization. Quesnay lost interest in political economy; the baton was taken up by a small
number of writers, among whom Turgot was pre-eminent.
Turgot is close to Physiocracy, but he differs in theoretical points and practical matters. He
was close in so far as he was a strong advocate of a complete freedom of trade, distancing
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himself from the slogan ‘liberty and protection’; and he adopted Quesnay's analysis of the
price of wheat in respect of the theory of the net product and the single tax. But Turgot never
made use of the Tableau Economique; he was, he said, happy to employ its metaphysics,
meaning the competitive process upon which it was founded.
This led Turgot to a number of significant findings: the formation of markets upon the
foundation of mutual interest between buyers and sellers constrained by transport costs; a
theory of price (estimated value) proceeding from a discussion of the scarcity (quoted value)
of a good for parties to an exchange – although Turgot stopped at two agents and two goods;
the justification for interest upon loans and its determination according to market forces; a
theory of the formation of a uniform rate of profit, or a stable hierarchy of such rates
(Réflexions, 1766). If one adds to this list the discovery of the principle of decreasing returns
to capital in agriculture it is clear that Turgot's theoretical contribution was a considerable
one.
Turgot presents a fascinating analysis on both the uses of capital and its origins through
accumulation and thrift. Turgot discusses accumulation and thrift both historically and
analytically. Historically, accumulation is associated with slavery and surplus product from
land: analytically, prudence and a desire for self-improvement are seen as major motives for
thrift. Turgot argues that the savings process is greatly facilitated by the introduction of
money but that this raises new complications such as a need to distinguish saving, hoarding
and investment. Turgot's saving–investment analysis denied the possibility that money
savings were able to induce substantial leakages from the circular flow because hoarding was
seen as irrational and money had only a limited role as a store of value.
Turgot's analysis of the productive use of capital and its social implications is presented in the
second and third parts of the Reflections. These reveal the degree to which his economics had
departed from Physiocracy and anticipated views subsequently developed by Adam Smith.
First of all, Turgot's exposition extends the use of capital to all sectors of industry thereby not
confining it to agriculture as Quesnay had done. Secondly, Turgot, like Smith, links an
increasing need for capital in production with extensions of the division of labour and a
consequent lengthening of the time period of production. Thirdly, Turgot associates the
provision of capital to industry with a new class of society, the capitalist/entrepreneur as
owners of moveable wealth, who invest these resources to reap a return. Hence the working
classes of agriculture, manufacturing and trade ‘may be divided into two orders of men, that
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of the Entrepreneurs of Capitalists, who make all the advances, and that of the mere wage
earning workmen’ (Turgot, 1766). Of special significance for analysing distribution, this new
class appropriates the resources by which it can live without labour through the creation of
interest and profit as a new income type. Profit in this context, is clearly associated by Turgot
with a return on productive investment, comprising an interest component, a premium for risk
and remuneration for the time and trouble of the entrepreneur in supervising the investment.
Having shown that ‘capitals are the indispensable foundation of all lucrative enterprises’ and
that the continual reproduction of these capitals ‘with a steady profit’ constitutes ‘the true idea
of the circulation of money’ the disturbance of which may cause economic decline (1766a,
pp. 75–6), Turgot analyses the mutual interrelationship of the returns on various types of
investment and the rate of interest. Interest itself is shown by Turgot to be determined by the
demand for and supply of loanable funds, the demand arising from both consumption and
investment needs. These investment needs, or employments of capital as Turgot calls them,
are described as: purchasing a landed estate, which yields least; lending a capital at interest
the return of which is greater; and investing in agricultural, manufacturing or commercial
enterprises, the return of which is greatest. Irrespective of these inequalities in yield to the
various employments of capital, Turgot argues that competition combined with capital
mobility causes a tendency to equilibrium between them.
As soon as the profits resulting from an employment of money, whatever it may be, increase
or diminish, capitals turn in that direction or withdraw from other employments, or withdraw
and turn towards other employments, and this necessarily alters in each of these employments,
the relation between the capital and the annual product. This investment analysis must be seen
as a substantial advance on the earlier literature, and hence as a major contribution to
economics.
Turgot therefore developed the classical position which saw ‘natural prices’ as the centres of
gravitation for market prices. Turgot's famous analysis of the ‘law of variable proportions’
(Schumpeter, 1954, pp. 260–1) may also be noted here. This arose in criticism of a common
Physiocratic assumption that product was invariably proportional to advances. Turgot (1767b,
pp. 111–12) argued instead that as ‘advances are gradually increased up to the point where
they yield nothing, each increase would be less and less productive’, thereby clearly
recognizing the possibility of diminishing returns. On the basis of these contributions,
Schumpeter (1954) argued the Turgot was a writer in advance of his time by anticipating
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much of what became important after the ‘marginal revolution’. His development of the
Physiocratic notion of reproduction (Turgot, 1763; 1766a, pp. 75–6) and his emphasis on the
principle of competition as regulator of the rate of interest, wages and values in general, are
firmly within that ‘classical tradition rehabilitated by Sraffa’.
Turgot's strong laissez-faire position turned him into the patron saint of the French liberal
economics tradition of the middle of the 19th century. This rested on the principle that
unrestrained self-interest yields the best results in economic activity, a principle he applied
wherever he could during his administrative career. It justified his pleas (1770b) and
subsequent imposition of domestic free trade in grain, his criticism of the prevalent regulation
of lending at interest (1770a), and the suppression of the guilds in one of his famous 1776
Edicts. More important is his discussion of taxation principles. Turgot's major paper on the
subject (Turgot, 1763), after setting out some general principles, defends the concept of the
single tax on net product on the basis of Physiocratic theory. However, he identifies
difficulties in its implementation. These need detailed examination if the benefits of the policy
are to be achieved. More generally, it can be said of his policy implementation that though
based on broad principles, these were in practice always modified to cater for actual
circumstances.
Turgot's work and its importance in the history of economics have occasionally been
vigorously debated, most notably in the controversies over the degree of influence he exerted
on Adam Smith and Böhm-Bawerk's interpretation of his capital and interest theory. An
assessment of the evidence suggests that Turgot influenced Smith on only a few fairly specific
points and that the broad similarities (and differences) in their economic systems are largely
explained by their common heritage of British and French predecessors.
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