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Revolution or Renaissance

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D. Paul Schafer

Part I - The age of economics

2. Evolution of the Economic Age

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In the history of economic ideas four major analytical traditions—the classical, Marxian, neoclassical, and Keynesian—stand out. Each was organized around a different set of questions. The circumstances that spurred their formulation have been considerably altered by subsequent events. Nevertheless, many of the central questions on which the pioneer formulators of these “master models” focused are re-asked at later moments in time. When this occurs, we again encounter the theoretical problems with which they wrestled. The study of these systems thus has a perpetual relevance.—William J. Barber (1991), p. 15

1The industrial revolution, capitalism, and the theories of Adam Smith proved infectious in the years following the appearance of The Wealth of Nations in 1776. In conjunction with many other developments taking place in Europe about the same time—notably, the French Revolution, which espoused liberty, equality, and fraternity, and the Enlightenment, which emphasized reason over passion—this had the effect of generating a rather rosy picture of the future in the minds of many scholars who followed in the footsteps of Adam Smith at the end of the eighteenth century.

2One of these scholars was William Godwin, the English political and social philosopher who published An Enquiry Concerning Political Justice and Its Influence on General Virtue and Happiness in 1793. In this book Godwin provided a rather glowing account of the future of humanity, despite the fact that his reading of the situation in Britain and the rest of Europe at the time was far more sober. Godwin believed that human beings have a natural inclination to virtue that is corrupted by bad institutions. This inclination would triumph in the end, according to Godwin, thereby making it possible for humanity to create a world free of crime, war, disease, anguish, melancholy, resentment, and bad government, regardless of how far away this might be. Another scholar working in this tradition was the French philosopher, mathematician, and political theorist Marie-Jean-Antoine-Nicolas de Caritat, marquis de Condorcet, whose Esquisse d’un tableau historique des progrès de l’esprit humain (Sketch for a Historical Picture of the Progress of the Human Mind) appeared in 1795, the year after his death. Condorcet traced human development up to his own time through nine stages, ending with the French Revolution of 1789, and then predicted a “tenth stage” in which, he thought, human perfectibility would be fulfilled. Undoubtedly some of the optimism contained in these and other works can be traced back to Adam Smith and his evocative theories concerning the creation, augmentation, and distribution of wealth.

3The only problem with this was that it was not consistent with the type of world that was unfolding in Britain, France, and the rest of Europe at the end of the eighteenth and the beginning of the nineteenth centuries. At the same time as Godwin and Condorcet were predicting a world free of war, vice, violence, and misery, and extolling the perfectibility of humankind, actual conditions were moving in a very different direction. While living standards were improving for landlords, capitalists, and even numerous labourers, a number of negative signs were appearing on the horizon. Most prominent among these signs were the huge concentrations of labourers in highly centralized locations; the intensifying exploitation of labour, particularly child labour; deteriorating social conditions; increases in the cost of living; growing disparities in income and wealth among the three main classes in society; the appearance of slums and shanty towns; and the tendency for increases in population to eat up a large proportion of the gains realized through industrialization, the spread of capitalism, and economic growth.

4These signs were seized on in different ways by three very distinguished pioneers of what is now called economics: Thomas Robert Malthus, who was also an Anglican clergyman; David Ricardo, who was also a politician, financier, and landlord; and John Stuart Mill who was also a Utilitarian philosopher, social activist, and humanist. In combination with James Mill (John Stuart’s father), Robert Torrens, John Ramsey McCulloch, William Nassau Senior, and others, they comprise what is now seen as the “classical” school of economics, spearheaded by Adam Smith. Since this school was destined to have a profound effect on the evolution of the economic age, particularly in the first half of the nineteenth century, it pays to examine the thoughts of these three remarkable individuals at some length.

Classical Economics

5While Malthus, Ricardo, and John Stuart Mill each had their own particular views on a variety of economic, political and social matters, they shared many common convictions concerning the economy, markets, and economic theory. Despite their common debt to Adam Smith, the tone of their writing was distinctly different from that of The Wealth of Nations. Whereas Smith was optimistic about the long-term prospects facing humanity, Malthus, Ricardo, and Mill were more pessimistic. Their pessimism sprang from the conviction that a “stationary state” would eventually be reached in human affairs, where little or no economic growth, capital accumulation or wealth creation would take place, largely as a result of the law of diminishing returns. Moreover, whereas Smith visualized a society where there was harmony among all three classes in society—labourers, landlords, and capitalists—as well as rising standards of living for all, Malthus, Ricardo, and Mill visualized a society in which there would be a great deal of conflict among the classes and a rising standard of living for only one, or, under certain conditions, two of these classes. This caused these three writers to direct much of their energy and attention to the way in which wealth is distributed, whereas Smith had directed much of his energy and attention to the way in which wealth is produced.

6Despite these differences, Malthus, Ricardo and Mill did share a great deal in common with Smith. For one thing, they believed, as Smith did, that labour is the principal source of all value and wealth. Unlike Smith, however, they were far less optimistic about the possibility of the labouring class benefiting significantly from this fact. They believed that labourers would respond to increases in wealth primarily by having more children, thereby creating a labour force that was too large. This would have the effect of driving wages down to the subsistence level, rather than keeping them above it. This became known in economics as “the iron law of wages,” referring to the constant tendency for wages to return to the level of subsistence.

7In addition, and more importantly, Malthus, Ricardo and Mill believed that after a certain point was reached “the law of diminishing returns” would cause output to decrease rather than increase, as more and more of the variable factor of production, labour, was added to the fixed factor of production, land. This was because more land would be brought into cultivation to feed an expanding population and this land would be of inferior quality compared to the land already in cultivation. The only exception to this general rule was when technological advances, or improvements in the “state of technique” as the classical economists called it, offset the law of diminishing returns. In this case, diminishing returns could be postponed for a time, but not indefinitely, because sooner or later a limit would be reached where all the land available for cultivation would be exhausted, or the additional land brought into cultivation would be so poor in quality that improvements in the “state of technique” would not be sufficient to offset the law of diminishing returns. This was of great concern in Britain, with its small and fixed land mass, finite resources, limited natural base, and rapidly expanding population.

8Malthus was the first person to confront the implications of the complex connection between the quantity, quality, and fixity of land and resources, on the one hand, and population growth, production of the means of subsistence, and the law of diminishing returns, on the other. He did so by attacking the theories of Godwin and Condorcet, particularly those concerned with the perfectibility of humankind and the eventual arrival of a Utopian state in human affairs. In fact, according to most authors, Malthus derived much of his passion, or, as some say, venom, for the writing of his Essay on the Principle of Population as It Affects the Future Improvement of Society, with Remarks on the Speculations of Mister Godwin, Monsieur Condorcet, and Other Writers (1798) from his desire to expose what he saw as the flaws in their popular ideas. This is how his essay begins (as quoted in Barber, p. 59):

I think I may fairly make two postulata. First, That food is necessary to the existence of man. Secondly, That the passion between the sexes is necessary, and will remain nearly in its present state... Assuming, then, my postulata as granted, I say, that the power of population is indefinitely greater than the power in the earth to produce subsistence for man. Population, when unchecked, increases in a geometrical ratio. Subsistence only increases in an arithmetical ratio. A slight acquaintance with numbers will show the immensity of the first power in comparison with the second.

9According to Malthus, population tends to grow at a geometric rate (1, 2, 4, 8, 16, 32 and so on), doubling roughly every twenty-five to thirty years. The means of subsistence, in contrast, tend to grow at an arithmetic rate (1, 2, 3, 4, 5, 6 and so on). He concluded that there is a constant tendency for population growth to outstrip the means of subsistence.

10Since this is not possible in fact because people must eat in order to survive, this means that certain “checks” must be brought into play to keep population growth in line with the means of subsistence. These checks were of two types. First, there were “preventive checks”: abstaining from sexual relations, late marriage, and, particularly, moral restraint. Second, there were “positive checks”: famine, plague, pestilence, disease, starvation, poverty, war, infanticide, and the like. If the preventive checks failed to do the job, the positive checks, whatever their negative effects on individuals, must come into play, because population cannot exceed the means of subsistence.

11In raising this issue Malthus put his finger on one of the most difficult and complex problems in economics and human affairs, namely, the relationship between people and population growth, on the one hand, and the means of subsistence and the natural environment, on the other. This brought to the fore both the positive and negative aspects of population growth. On the one hand, population growth acts as a spur to the creation of wealth and to economic growth because it increases the demand for “the necessaries and conveniences of life,” as Adam Smith called them. On the other hand, population growth puts considerable strain on natural resources and the natural environment, because of the need to increase the means of subsistence to feed an expanding population. This was especially difficult for Britain in view of its limited domestic supply of natural resources, and its heavy dependence on natural resources and raw materials from abroad, which helps to explain why Britain was so committed to, and dependent on, colonial development and international trade in the eighteenth, nineteenth and twentieth centuries.

12Given Malthus’s views on this complex and difficult subject, it is easy to see why classical economics took a pessimistic turn after the publication of Malthus’s strident polemic. Not only did Malthus believe that there was a constant tendency for population to outstrip the means of subsistence, he was also very pessimistic about the capacity of “preventive checks” to limit population growth, largely because of the inability of the labouring class to control its sexual desires and exercise constraint. Interestingly, this led Malthus to oppose the Poor Law, the English system of state aid to the very poor, because he believed that it discouraged sexual restraint, limited the mobility of labour (since aid was given only to long-term residents of each parish, not to incomers from other parishes), and led to increases in population and deteriorating prospects for the labouring class. He also believed that more and more of the “positive checks” would be brought into play, a prospect that he and others did not relish.

13None of this augured well for the types of improvements that Smith wrote about in The Wealth of Nations, especially the ability of the economy to produce an expanding supply of goods and services capable of enhancing living standards for all classes in society. In fact, according to Malthus, precisely the opposite could and most likely would be the case. Destructive rather than constructive changes would take place as the population expanded, and more and more pressure was exerted on land and existing resources. This helps to explain why Malthus’s views on population in general, and his Essay on the Principle of Population in particular, generated a great deal of attention and debate in his day. It also helps to explain why Thomas Carlyle called economics “the dismal science” after reading Malthus’s essay.

14What made matters worse, in Malthus’s view, was the possibility of “market gluts.” These could occur when some of the products produced in a given period were not taken off the market because consumers lacked the funds to purchase them. While most of the other classical economists dismissed this possibility, because they believed that “supply creates its own demand” according to the law propounded by the French economist Jean-Baptiste Say, it was clear that Malthus had pinpointed a very serious problem in the functioning of economic systems and markets. This was the possibility of overproduction, underconsumption, market gluts, and business cycles, and whether or not there is a self-regulating and self-correcting mechanism at work in the economy and the market causing things to return to normal when there is a deviation from the norm. Despite this, one hundred years and more were to pass before Malthus’s views on this set of issues were recognized and given their due. It was when “market gluts” became a reality during the Great Depression of the 1930s that interest in Malthus’s views intensified and it was discovered that in his Principles of Political Economy (1820) he had foreseen many of the economic problems encountered at the end of the nineteenth and in the early years of the twentieth centuries.

15If classical economics took a pessimistic turn with Malthus’s population theory, his views on the Poor Law, and the possibility of market gluts, it took an even more pessimistic turn after the publication of David Ricardo’s Principles of Political Economy and Taxation in 1817. By then the whole nature and tenor of Britain and the rest of Europe had changed substantially in the wake of the Napoleonic Wars and a series of bad harvests in Britain. Ricardo’s classic treatise did a great deal to strengthen the theoretical side of economics, making the case for a more scientific and empirical approach to economic theory, consolidating the classical tradition, and broadening and deepening understanding of the ways in which complex economic systems function. It also did much to reinforce the pessimistic conclusions arrived at by Malthus. As Robert L. Heilbroner has observed (p. 82), whereas Smith had “looked at the world and had seen in it a great concert, Ricardo saw a bitter conflict.”

16Ricardo followed Smith in one very important respect, in being interested in how production and distribution are handled in complex economic systems. Whereas Smith had been largely concerned with production, however, Ricardo was far more concerned with distribution (as indicated earlier). By the time Ricardo arrived on the scene the rapidly changing conditions in Britain and the rest of Europe were revealing chat distribution was not proceeding in a manner consistent with Smith’s conviction that all classes would benefit from increases in production and wealth. Indeed, according to Ricardo, only one class was benefiting from the increases in production, the landlord class. To make matters worse, it was benefiting at the expense of the other two classes, the labourers and the capitalists. This caused Ricardo to state in his Principles that the interests of the landlord class are opposed to the interests of all other classes in society.

17Precisely why this was so Ricardo set out to explain. He did so by creating a hypothetical economic system, similar to the British economic system of his day, which was divided into the three main classes of landlords, labourers, and capitalists. Ricardo then asked what would happen if wealth is increased and economic growth takes place. According to Ricardo, wages, profits, and rents would all increase initially, meaning that all classes would be better off. However, over a longer period of time labourers would respond to the increase in wealth by having larger families, thereby contributing to population growth and driving their own standard of living down rather than up, as they endeavoured to feed, clothe, and house additional members of their families. In response, landlords would bring more land into cultivation to feed the expanding population. Since the land they brought into cultivation was always inferior to the land already in cultivation, and since the price of products is always determined by the costs of production on the last land brought into cultivation, or, in Ricardo’s terms, “at the margin,” rents would rise on the better land. This would mean that landlords would be better off.

18According to Ricardo, capitalists would respond to the increase in population by expanding their output. This would be favourable to the capitalists initially, because their profits would increase rather than decrease, but eventually it would be detrimental because capitalists would be compelled to pay more out of their profits for wages as subsistence costs increased and inferior land was brought into cultivation. Since Ricardo believed that rent is always zero on the last land brought into cultivation, and that price is always determined at the margin, this meant that there had to be an inverse relationship between wages and profits. The higher wages rose to cover the increased costs of subsistence, the lower profits would fall. Ultimately a point would be reached where profits would fall to zero and no capital accumulation would take place. While landlords reaped a double reward from increases in output and prices as more and more land was brought into cultivation, the interests of the labourers, capitalists, and the economy generally deteriorated. For Ricardo this trend amounted to a prescription for social, political and economic disaster. Not only did it possess the potential to produce continuous conflicts between the three main classes in society, but it also rewarded the class that contributed least to the creation of wealth, production, and economic growth. Behind this, of course, was the law of diminishing returns, ever ready to decrease production and productivity, and usher in “a stationary state” whenever technology proved insufficient to meet the limits imposed by fixed amounts of land, scarce resources, and an expanding population.

19If this situation disturbed Ricardo a great deal, what particularly irked him was the ability of the landlord class to pass legislation that favoured their interests at the expense of everybody else, thereby reinforcing and perpetuating basic inequalities and injustices in the economic system and society generally. They were able to do this through, for example, the Corn Laws, which kept foreign grain out of Britain when prices for these basic foodstuffs were skyrocketing as a result of the Napoleonic wars and the bad harvests at home. Just how important grain was to Britain at the time can be confirmed by the fact that Ricardo used grain in general and corn in particular, rather than gold, silver, money or precious metals, to demonstrate how the British economy functioned, and how production and distribution were determined in his hypothetical economic model. The reason for this is not difficult to detect. On the one hand, grain was the most important item in the diets both of the labouring class and of the livestock required for agricultural production. On the other hand, grain was the most important output in an economy still heavily dependent on agriculture, despite the fact that the industrial revolution was in full swing and was beginning to assume gigantic proportions. It was logical, then, for Ricardo to use grain to measure and assess the changes that were taking place in the British economy, as well as in prices, incomes, wages, profits, and rents.

20This is what made the Corn Laws such a crucial issue for Ricardo. The landlords were able to exploit this staple, turning the trade and consumption of grain to their advantage. They did this by imposing duties and a sliding scale on imports of foreign grain into Britain. The lower the foreign price for grain fell, the higher went the duty. Thus a floor was established that kept low-priced foreign grain permanently out of Britain and also kept domestic prices artificially high. Just how onerous this was for the labouring class can be understood when it is realized that a bushel of wheat cost labourers in Britain twice their weekly wages. This became too much for the labouring class, the capitalists, and the classical economists to accept, particularly when the landlords were lobbying Parliament to raise the duty on foreign grain even higher in order to protect their stranglehold on the domestic market. At this point the capitalists rebelled, organized a powerful lobby, and flooded Parliament with more petitions than it had received on any other issue up to this time. Fortunately, grain prices moved back to more acceptable levels following Napoleon’s defeat in 1815. Unfortunately, it took another thirty-one years before the Corn Laws were repealed, in 1846.

21There are two additional aspects of Ricardo’s economic theory that should be mentioned here because they were destined to have an important impact on the evolution of the economic age, and the development of economic theory and practice. The first is his theory of comparative advantage and international trade, the second his theory of taxation.

22Unlike Smith, who believed in the “law of absolute advantage” as it applied to international trade, Ricardo believed in the “law of comparative advantage.” A country may possess an absolute advantage in the production of all products over other countries, but it may be able to produce some of these products much more efficiently than others, thereby giving it a comparative advantage in the production of these products (as compared to other products and other countries). Even though Britain had an absolute advantage in the production of all products, it paid Britain to specialize in the production of products for which it had a comparative advantage and let other countries specialize in the production of products for which they had a comparative advantage. In a global sense this would yield an international system where countries specialized in making and exporting products for which they had a comparative advantage, while importing products for which they had a comparative disadvantage. This is pretty much what happened during the nineteenth century, as, in conjunction with the development of the colonies and colonization, Ricardo’s views came to be used to justify a whole series of trading policies, practices, and relations among Britain, France, and other countries. These were well-suited to the capitalist class in Britain, which tended to see international trade based on the law of comparative advantage as a powerful tool for increasing exports while simultaneously reducing the cost of imports. They were also well suited to an age in which Britain was rapidly becoming “the workshop of the world.” It depended on other countries to provide it with the raw materials, basic staples, and markets that were needed to fuel industrial development, and overcome domestic resource deficiencies through imports from abroad. This had a powerful effect on the division of the world into two unequal parts, “developed” and “developing,” that has become a standard feature of the present economic age and the modern world system.

23Ricardo’s other major contribution to the development of the economic age and classical economic theory was his theory of taxation. Given his commitment to economic and political liberalism, competition, laissez faire, and international trade, it is not surprising that he devoted a great deal of time and attention to this subject, and became one of the first economists to delve deeply into matters of fiscal policy and public finance. What concerned Ricardo was not only the incidence of taxation (who actually pays the taxes), but also how taxes affect the three main classes of society, and are shifted from one class to another and from one sector of the economy to another. For example, Ricardo felt that a tax on rent would fall largely on the landlord class and would not be shifted to other classes in society because the landlord class would not be able to increase the price of output at the margin of cultivation. However, other taxes might fall on labourers, consumers or capitalists, depending on specific circumstances. For example, a tax on wages would tend to be borne by capitalists in the form of lower profits because wages were usually at or near the subsistence level and labourers simply could not afford to pay any higher taxes. Taxes on output or land, however, would probably be shifted to labourers and consumers, in the form of higher prices for products.

24It is clear from the foregoing that Ricardo’s theories on a variety of economic and political matters were destined to have a profound effect on economic theory and practice, and on the development of the economic age. What counted were not only Ricardo’s theories themselves—the labour theory of value, the theory of differential rent, the analysis of economic situations at the margin, the law of comparative advantage and international trade, the theory of taxation, and the rest—but also the ways in which the theories were developed and used by others. Unlike Smith, Malthus, and other economists who relied largely on general observation and the inductive method to make their case, Ricardo relied heavily on abstract theorizing and the deductive method to make his case. He was the first economist to use hypothetical models in the search for “scientific laws” capable of explaining economic behaviour. In so doing he set in motion a tradition that has steadily gathered momentum since his time, and has been used to great advantage by economists.

25Moreover, and more importantly as far as the evolution of the economic age is concerned, Ricardo was the first economist to advocate looking at problems from a strictly economic point of view, before taking other factors into account. While he had a highly successful career in finance and politics, and was involved in numerous political, commercial, agrarian and governmental affairs, he believed that it was necessary to search for economic solutions to economic problems, develop models that were predicated on economic considerations rather than other considerations, and draw conclusions that were economic in nature. It was only after this rigorous economic process was completed that, Ricardo believed, the political, ethical, philosophical and social implications and consequences of actions and decisions should be taken into account. This conviction too has had a profound impact. It made economics the most important discipline in society, thrusting it into a powerful position in society and the political process. This is probably why Ricardo is regarded as “the economist’s economist” by the large majority of economists. While Adam Smith played a crucial role in creating the theoretical and practical foundations for the economic age, it was Ricardo who carried the economic age into adulthood. He did so by making economics the highly specialized discipline it is today, as well as an independent rather than dependent factor in society. It is for reasons such as these that Ricardo and Ricardian economics dominated economic thought and practice in Britain and elsewhere in Europe in the middle of the nineteenth century.

26John Stuart Mill continued in the Ricardian tradition in virtually all respects, but there is one respect in which he differed somewhat from Ricardo. Whereas Ricardo was pessimistic about the prospects confronting Britain, the rest of Europe, and humanity in general, Mill was more optimistic. He believed that it was possible to separate “the laws governing production” from “the laws governing distribution,” which led him to very different conclusions about the distribution of wealth than those reached by Ricardo. He also believed that the “stationary state” could be a universal blessing rather than a diabolical curse, especially if it was understood and dealt with properly.

27Mill is much better known today for his social and political writings and activities than for his economic ideas, particularly for his contributions to Utilitarianism, and to both theoretical liberalism and British political Liberalism, as well as for his pioneering writings on women’s rights, proportional representation, labour unions, socialism, the education of the poor, and agricultural cooperatives. However, he made many valuable contributions to the advancement of economics as a discipline through his attempts to consolidate and strengthen the classical tradition, and to place economics on a much firmer empirical and scientific foundation.

28Some of Mill’s most effective writing on economic subjects concerned international trade. In 1829 and 1830, for example, he wrote a series of Essays on Some Unsettled Questions of Political Economy that substantially broadened and deepened understanding of the law of comparative advantage advanced by Ricardo. Whereas Ricardo was content to state the law and emphasize its importance, Mill was interested in the ways in which the gains from international trade are shared and distributed among the various trading partners. This led him into such areas as the reciprocal demand for products; the way the terms of trade are determined between countries; the strength and elasticity of demand for international commodities and resources; the effect of tariffs on trading practices and the terms of trade; and how the adjustment mechanism works among countries involved in international trade. As a result, Mill helped to lay the foundations for the modern world’s emphasis on international trade, free trade, free trade zones, and globalization, and for the virtually universal commitment to international trade and exchange as a key component in economic growth.

29These contributions were enhanced considerably when Mill’s landmark publication, Principles of Political Economy, was published in 1848. Mill recognized that broadening and deepening understanding of the causes and consequences of production and distribution lay at the heart of classical economics. However, he believed that there are fundamental differences between the laws governing production and those governing distribution. The laws governing production are, in his view, fixed and immutable, because they derive largely from technical and physical factors such as the quantity and quality of land, the application of labour and capital to land, the skill and dexterity of workers, and the operation of the law of diminishing returns. The laws governing distribution, however, are very different. According to Mill, they are not fixed and immutable, but are socially and humanly determined, largely because they are based on such factors as values, value systems, and, especially, the ways in which institutions and societies decide to conduct and regulate their domestic and international affairs. Simply put, Mill’s argument was that, once societies have created wealth, they can distribute it in any way they please.

30This distinction between the laws governing production and those governing distribution made it possible to reinterpret classical economics in more positive terms. However, this was not possible, in Mill’s view, without governments playing a much larger, stronger, and more direct and active role in the economy and markets. Smith, Malthus, and Ricardo had been firmly opposed to state intervention in the free functioning of the economy, but Mill argued that the state should play a “civilizing role” in society, largely by evening out fluctuations in economic activity, making investments in public works, undertaking worthwhile social programmes, and, especially, educating labourers, for Mill believed that their ignorance lay at the root of the distribution problem. Educating labourers would allow society to break the vicious circle created by population growth, the propensity for the labouring class to have more children, the iron law of wages, and the tendency for wages to return to the subsistence level. If the labouring class could be educated to have smaller families when wealth was increased and economic growth took place, their wages would rise above the subsistence level, the pressure of their numbers upon subsistence would be reduced, and the wealth and well-being of all in society, and not just the landlord class, would be improved.

31These views were carried over into Mill’s interpretation of “the stationary state.” While Mill believed, as Malthus and Ricardo had before him, that the stationary state was inevitable, largely because of the law of diminishing returns and the inability of improvements in technology to offset the law in the long run, he was much more optimistic than they had been about what might be achieved once the stationary state was reached (Mill, pp. 748 and 751):

I cannot, therefore, regard the stationary state of capital and wealth with the unaffected aversion so generally manifested towards it by political economists of the old school. I am inclined to believe that it would be, on the whole, a very considerable improvement on our present condition.
... It is scarcely necessary to remark that a stationary condition of capital and population implies no stationary state of human improvement. There would be as much scope as ever for all kinds of mental culture, and moral and social progress; as much room for improving the Art of Living, and much more likelihood of its being improved, when minds ceased to be engrossed by the art of getting on.

32It is clear why there was much more enthusiasm and excitement in Britain and elsewhere over Mill’s theories than there had been over Malthus’s or Ricardo’s. Mill provided a way out, an escape from the relentless march of the Malthusian theory of population, the iron law of wages, and the Ricardian theory of rent. Rather than looking forward to a future of poverty, negativity, exploitation, and class tension, Mill was much more encouraging. Through foresight, planning, government involvement in the economy and markets, and, especially, the education of the labouring class, it would be possible to lift the mass of the population out of the economic and social doldrums, and achieve a realistic standard of living and a satisfactory way of life for all. For the first time in more than fifty years, a ray of hope had appeared on the horizon.

33This shift towards hopefulness was strengthened by the fact that the stationary state was not emerging in the way the classical economists had predicted. In fact, it was not emerging at all. Technological advances were outstripping the law of diminishing returns, and an international system was evolving that made it possible for Britain and other European countries to overcome their domestic economic deficiencies by drawing on resources, products, materials, and markets in other parts of the world, most notably Canada, the United States, South America, the Caribbean, Asia, Africa, Australia, and New Zealand. While this was to have profound consequences for the evolution of the economic age and the development of the world system, especially through the division of the world into colonized and colonizing countries, dependence on technology to fuel economic growth, and the changing relationship between human beings and the natural environment, these consequences were not fully recognized at the time.

34What was recognized at the time was that the rapidly changing conditions in Britain and elsewhere in Europe were causing more and more problems for classical economics. A number of economic, social and political thinkers were becoming increasingly uneasy about the highly theoretical nature of classical economics, especially as it was manifested in Ricardian economic theory, even though, for most of them, Mill’s more optimistic vision of the future still seemed far-fetched. What is known as the “historical school of economics” came into being, spearheaded by scholars and historians such as John Ingram, Cliffe Leslie, Walter Bagehot, and Richard Jones in Britain, and Friedrich List, Wilhelm Roscher, Bruno Hildebrand, Karl Knies, Gustav von Schmoller, Arthur Spiethoff, and Werner Sombart in central Europe. They believed that economics should be based on history rather than theory, on historical analysis, empirical observation, actual experience, and induction rather than abstraction, theoretical analysis, model-building, and deduction. The “historical economists” did not object to the quest to discover laws capable of explaining economic behaviour, and of guiding public and private policy- and decision-making. What they strenuously objected to were the methods and techniques used to discover these laws. They believed that it was necessary to examine history in great detail before any such laws could be detected and formulated. This was particularly important in view of the fact that public and private policies were predicated on these laws.

35While the historical economists failed to generate a great deal of interest in the inductive rather than the deductive approach to economics, except in a few isolated and esoteric cases, John Stuart Mill’s vision of the future was coming increasingly into question, despite the enthusiasm and optimism it generated in certain quarters. Most prominent among the rapidly changing conditions that challenged Mill’s optimism were the disruptions, dislocations, and transformations that were being experienced as a result of the industrial revolution and the spread of the factory system of production. The industrial revolution was in full swing, reaching its zenith by the middle of the nineteenth century. A much larger proportion of Britain's population was working in manufacturing than in agriculture, resulting in a rapidly burgeoning urban population, huge concentrations of labour and capital in very specific locations, a great deal of monotonous and tedious work, overcrowding, poverty, shanty towns, squalor, misery, and the factory system of production. The pain, suffering, and turmoil caused by this situation were captured by numerous novelists and authors writing at the time. One need only read Charles Dickens’s novels Oliver Twist, David Copperfield, Bleak House, Hard Times or Great Expectations to realize how oppressive economic, social and political conditions were for many people by the middle of the nineteenth century.

36With the industrial revolution came greater emphasis on science, technology, industrial development, and materialism. As more and more products poured out of European factories, and as more and more technological inventions and innovations were introduced into the production process, the whole tenor of European life changed. These developments were reinforced by a more scientific view of life, as well as a quantitative rather than qualitative approach to development. This situation was profoundly affected by the appearance of Charles Darwin’s On the Origin of Species (1859). Not only did Darwin take a highly scientific and empirical approach to the human condition, largely by emphasizing the need to examine situations empirically and delve deeply into the facts of the matter, he also placed a great deal of emphasis on evolution, materialism, competition, and the need to adapt to constantly changing environmental conditions and ecological circumstances. This emphasis was magnified by Darwin’s followers, particularly Herbert Spencer, who coined the term “survival of the fittest,” which came to epitomize the Darwinian revolution.

Marxian Economics

37It was into this highly materialistic, competitive and industrialized world, with all its major social, economic and political problems, inequalities, and dislocations, that Karl Marx stepped in the middle of the nineteenth century. Marx was not, of course, the first scholar to be concerned with the impact of the industrial revolution, and the rapid changes it induced in economic and social conditions, on the labouring class and on society in general. Numerous economic and social thinkers—including Jean-Charles-Léonard de Sismondi, Henri de Saint-Simon, Charles Fourier, and Pierre-Joseph Proudhon in France, Robert Owen and John Francis Bray in Britain, and Karl Robertus in Germany—had expressed concerns about the adverse effects of industrialization, the factory system of production, and massive technological change. Moreover, they were endeavouring to do something concrete and constructive about it in their research, writing, and political activities. With this came questioning of classical economics, as well as the reasons, motives, and objectives behind it. Was classical economics designed to uncover the laws governing economic behaviour and the nature of economic truth? Or was it designed to advance the interests of the rich and privileged classes of society, and to perpetuate the established order? It was questions such as these that Marx, in his turn, set out to address.

38While Marx rejected classical economic theory because he believed that it distorted the nature of economic truth and the real character of historical development, he depended heavily on classical economics in most other respects. For example, he adopted “the labour theory of value” propounded by the classical economists, but also claimed that capital is “stored up” or “congealed” labour. This is because capital can be broken into two components, according to Marx: the raw materials used in production, which are given by nature, and the labour required to produce the capital. This made labour the central pillar in Marx’s entire economic system. Marx followed in the classical tradition in another very fundamental respect by accepting the basic distinction the classical economists had made between production and distribution. However, Marx believed that it was necessary to analyze these two basic components of the capitalist system together rather than separately, since distribution affects production every bit as much as production affects distribution.

39Like Malthus, Ricardo, Mill, and the other classical economists, Marx was also very concerned about the distribution of wealth. The reason for this is not difficult to detect. By the time Marx arrived on the scene the social costs of industrialization were proving to be very substantial, particularly for the labouring class. People were pouring into the newly established urban centres looking for work, social conditions were rapidly deteriorating, pollution was mounting, there was a great deal of poverty and unemployment, labour, particularly child labour, was being exploited unmercifully, and capital was replacing labour at a disturbing rate. This situation troubled Marx very deeply, and caused him to focus attention on who benefits the most and who the least from the creation of wealth within the capitalist mode of production.

40By Marx’s time capitalists rather than landlords formed the most powerful class in the societies in western Europe that Marx lived in and studied, making it possible for Marx to view society in terms of two classes rather than three. On the one hand, there were the labourers, who had nothing to sell but their labour, despite the fact that they were the real creators of all value and wealth. On the other hand, there were the capitalists, who owned the machinery, the equipment, and, often, the land used by labourers in production. Although the capitalists produced very few products themselves, they had all the advantages in the production process, because they were able to exploit labourers who had nothing to sell but their labour. This in turn made it possible for capitalists to gain “surplus value” on the capital they used in production by compelling labourers to work many more hours for their subsistence than was actually required to produce their subsistence. Whereas it might take labourers two hours a day to produce their subsistence, for instance, they might end up working ten to twelve hours a day for capitalists because the capitalists possessed all the economic advantages. This gave rise to what Marx called “the rate of exploitation” of labour and labourers by capital and capitalists. Whenever and wherever there was a great deal of unemployment in the economy, which was common during the industrial revolution because labour was constantly being replaced by capital, capitalists could increase surplus value and the rate of exploitation by drawing on “the industrial reserve army” caused by technological change and the replacement of labour by capital. This made it possible for capitalists to compel labourers to work even longer hours to produce their means of subsistence.

41It was the exploitation of labour and the labouring class by capital and the capitalist class that caused Marx to direct more and more of his time, energy, and attention to understanding “the real nature of capital” and the capitalist system of production (see Sweezy). His views on this subject were set out in Capital, his unfinished magnum opus. The first volume, the only one completed by Marx himself, appeared in 1867, but the other two volumes, compiled and edited by Marx’s collaborator Engels, did not appear until 1884 and 1894, after Marx’s death.

42According to Marx’s analysis in Capital, Volume III, there is a tendency inherent in the capitalist mode of production for the rate of profits to fall. This may seem a rather curious conclusion, in view of the fact that capitalists were able to exploit labourers and extract surplus value from them, but it was consistent with the view of most of the classical economists, though they held it for entirely different reasons than Marx. According to Adam Smith, the rate of profits would fall because more and more competition would take place among capitalists, or manufacturers as Smith called them. According to Ricardo, the rate of profits fell because there was an inverse relationship between profits and wages, such that profits would fall as wages rose to cover increases in the cost of living. In Marx’s analysis, however, the rate of profits fell because of the composition of capital itself. Since, according to Marx, only variable capital generated surplus value, and since profits derive from variable capital rather than from fixed capital, the rate of profits must fall as more variable capital is added to the stock of fixed capital. The only thing that can prevent this is a rise in “the rate of exploitation” as capitalists force workers to work longer hours, use more women and children in production, or increase the productivity of labour. While this was possible to a certain extent, according to Marx, the situation could not be sustained for a long time without the “immiseration of the masses,” especially as more and more capital was accumulated, and capitalists tried harder to increase their profits. Eventually, more and more pronounced dislocations, inequalities, and disruptions would take place. As the labouring class became more and more immiserated, there would be more and more unemployment, causing the industrial reserve army to grow. As a result, labourers would have less and less income to purchase the products produced by the capitalist system. This could result in overproduction, underconsumption, and gluts in markets, just as Malthus had predicted, as well as more and more economic fluctuations and instability. This would heighten the conflicts and tensions between the capitalist class and the labouring class.

43In The Communist Manifesto, written with Engels and published in 1848, Marx argued that this situation could not prevail indefinitely because of the “inherent contradictions in capitalism.” These contradictions were numerous for Marx. One resulted from the fact that it was the labourers who were responsible for the creation of all value and wealth, but it was the capitalists who reaped the benefits. Another was due to the fact that the capitalists were able to receive surplus value and exploit labour while, at the same time, there was a tendency for the rate of profits to fall rather than rise in the capitalist system. Still another was due to the fact that, as more and more capital accumulated, the incentive to accumulate capital and increase production was reduced. For Marx, all these factors, and others, would eventually lead to more and more pronounced and erratic disruptions, depressions, and crises in the capitalist system. While international development, imperialism, and colonialism might postpone the collapse of capitalism for a time, they could not postpone it indefinitely. Eventually “the workers of the world” would unite and overthrow the capitalists, and with them, the capitalist system of production. The workers would then abolish the capitalist system and introduce communism. In this state of affairs society and production would be controlled by labourers rather than by capitalists, and would evolve in a manner consistent with the interests and needs of the labouring class rather than the capitalist class. Ultimately, the state would “wither away” because there would no longer be any need for it.

44If Marx’s views had been confined to an extensive analysis of capitalism, the need for communism, and his impact on economic and political thought and practice, his influence on subsequent events and the evolution of the economic age might well have been far less substantial than it turned out to be. However, Marx’s influence does not end with his stinging indictment of capitalism and his prognosis with respect to communism. Marx laid the philosophical and historical foundations for the economic age, just as Adam Smith created the theoretical and practical foundations for it. Marx did this by way of what is often called, perhaps misleadingly, his “economic interpretation of history.”

45The practice of dividing societies into an economic (or “material”) “base” and a non-economic “superstructure” has been evident in the works of most economists, before, during and after Marx’s time, whether they belong to the classical, neoclassical, Keynesian, post-Keynesian or development schools of thought. However, these terms have come to be associated with Marx and Marxism in particular. According to Marx, the economic base consists of the material conditions of life and the attendant mode of production in a given society. The arts, ethics, education, religion, philosophy, politics, spirituality and the like form in their turn the superstructure, which depends on the productive base for its existence.

46Marx and Engels both emphasized, repeatedly and at length, that there is a reciprocal relationship between base and superstructure, so that changes in one can cause changes in the other. However, many Marxists, and many other interpreters and critics of Marx’s ideas, have treated the model as if the base was always and everywhere a “cause,” and the superstructure merely the “effect.” Thus, while Marx and Engels sought to show how the various elements of the superstructure originated from the base but then developed along their own paths, influencing the base as they did so, it is often assumed that they believed that everything is reducible to economics.

47Nevertheless, of all of Marx’s ideas, it is the “economic interpretation” of history that has had the most powerful effect, however simplified and misleading some versions of it have been since Marx. In The German Ideology (1845), an early philosophical polemic rather than economic analysis, he and Engels boldly asserted that (Gardiner, p. 129):

Morality, religion, metaphysics, and other ideologies, and their corresponding forms of consciousness... have no history, no development; it is men, who, in developing their material production and their material intercourse, change, along with this, their real existence, their thinking and the products of their thinking. Life is not determined by consciousness, but consciousness by life.

48In the same work they set out the basis of their programme of research and analysis, again in broadly philosophical terms (Gardiner, p. 126-127):

The first premise of all human history is, of course, the existence of living human individuals. The first fact to be established, therefore, is the physical constitution of these individuals and their consequent relation to the rest of Nature.... Men can be distinguished from animals by consciousness, by religion, or anything one likes. They themselves begin to distinguish themselves from animals as soon as they begin to produce their means of subsistence, a step which is determined by their physical constitution.... What individuals are, therefore, depends on the material conditions of their production.... This conception of history, therefore, rests on the exposition of the real process of production, starting from the simple material production of life.... From this starting point, it explains all the different theoretical productions and forms of consciousness, religion, philosophy, ethics, etc., and traces their origins and growth.

49By 1859, when Marx wrote his Preface to a Critique of Political Economy, his focus was more narrowly on economic issues, and the power of the “mode of production” to “determine” the superstructure (Gardiner, p. 131):

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

50However, as many Marxists have pointed out since this was written, human beings live in buildings, not in their foundations. In other words, Marx was concerned to analyze the whole of each “mode of production” (feudal, capitalist, communist or other), comprising both base (“foundation”) and superstructure, and not just the base. Marxists have also spent years debating exactly what he meant by “determines”: does the base merely set limits to what can happen in the superstructure, or does the word have a stronger meaning of causation? It is interesting in this regard that according to Marx the mode of production determines “the general character” of other processes, not their specific forms.

51Despite these problems of interpretation, Marx’s ideas have tended to be adapted to support an ideological view of the centrality of economics and economies, which is by far the most powerful ideology in existence today. It is an ideology based on the conviction that economics and economies should be made the centrepiece of society, and the principal preoccupation of individual, institutional, municipal, regional, national and international development. Economics as a discipline had already been moving in this direction, particularly with Ricardo and Ricardian economics, but since Marx’s day it has become so powerful and pervasive that it is the central axiom of the economic age, the cornerstone on which everything else is erected. Its power emanates from its claim to universal validity in space and time, as well as the fact that people desperately need an interpretation of the past in order to comprehend the present and confront the future.

52Aside from the ideological impact of the economic interpretation of history, to which Marx contributed at the cost of being misrepresented, Marxian economics comprises a range of ideas and analyses, from the labour theory of value, the division of societies into base and superstructure, the rate of exploitation, and surplus value, to the theory of class conflict and confrontation, the nature of capital, capitalism and capitalist production, the immiseration of the masses, the industrial reserve army, the overthrow of the capitalists, and the introduction of communism. While Marxian economics has taken different forms and directions in different countries and parts of the world, the powerful effect it has had on the world as a whole can be confirmed by the fact that throughout the better part of the twentieth century the entire world was divided along capitalist and communist or, at least in theory and rhetoric, Marxist and non-Marxist lines.

53This process commenced when scholars and practitioners in Britain, France, Germany, Austria and elsewhere in Europe began searching for alternatives to Marxian economics and communism that would either strengthen capitalism or provide other socialist alternatives to it. In Britain, a number of socialist thinkers such as Bernard Shaw, Sidney and Beatrice Webb, G. D. H. Cole, and H.G. Wells, all members of the Fabian Society, became deeply committed to the creation of labour unions, the nationalization of key industries, the creation of public enterprises, and the establishment of public utilities to counteract or thwart the advance of Marxism, Marxian economics, and communism. Eventually, however, the entire world became divided along capitalist and communist lines. On the one hand, there was “the communist world” of the Soviet Union, its satellites in central and eastern Europe, China, and a few other countries. On the other hand, there was “the capitalist world” of the United States, western Europe, Canada, Australia, New Zealand, and Japan. Not only was a “Cold War” fought between these two opposing parts of the world throughout the latter part of the twentieth century, particularly between the United States and the Soviet Union, but it is also only recently that interest in communism and Marxian economics has faded in many parts of the world. There are many reasons for this, including the triumph of capitalism and democracy; the inability of communism and Marxian economics to deliver the Utopian promise of a classless society with proletarian rule; and, especially, the ability of capitalist countries and capitalism to improve standards of living for labourers as well as capitalists.

54While Marx is much better known today for his theories of capitalism and communism than for his economic interpretation of history, it is his economic interpretation of history that, albeit indirectly and in distorted forms, has had the most profound impact on the world, the world system, and the evolution of the economic age. Through the economic interpretation of history Marx plunged the world fully and forcefully into the economic age. This is perhaps understandable in view of the fact that Marx was living at a time when the industrial revolution was at its zenith, and everything was assuming a highly economic and materialistic orientation. In that sense, he reflected the spirit of the age, rather than creating it. Under these circumstances it is easy to understand how and why the economic interpretation of history gripped the entire world.

Neoclassical Economics

55We now turn to examine another revolution that was beginning to take shape in economics in the latter part of the nineteenth century, the revolution in price theory, or, as it is called today, the “marginal revolution.” It was also destined to have a profound effect on economic theory and practice, and thus on the development of the economic age. Its importance lay in the fact that, as more and more emphasis was placed on economics, economies, and markets, by Marxists and non-Marxists alike, economists became less interested in the inherent value or worth of everything, as had been the case for the classical economists as well as for Marx, and more interested in the prices that were paid for goods, services, land, labour, capital, and the like.

56This eventually came to be seen as the key to understanding the entire economic system: the buying and selling of products, supply and demand, producers and consumers, and the networks of production, distribution, and consumption. If economists could be successful in unlocking the secret of price, the basic code of the economic system could be broken, and everything would fall naturally and logically into place. Since this eventually gave rise to a preoccupation with markets, the individual as consumer, the power and centrality of corporations, profit maximization and competition, capitalism and the capitalist system of production, distribution, consumption, and many other matters that are standard features of the current economic age, the marginal revolution, and the “neoclassical” economics that gave rise to it, need to be examined in some detail. It is impossible to understand the world we are living in today without doing so.

57If expanding the size of the market is the key to increasing wealth, as Adam Smith had contended, then it only made sense to focus attention on how prices are determined in the market, since this is the key to understanding how the market functions. While economists continued to be interested in questions related to the production and distribution of wealth, a new set of questions was beginning to occupy their minds in the last part of the nineteenth century. Foremost among these was the question of price determination. This triggered a series of initiatives aimed at understanding how the economy and the market function in fact, how individuals and institutions behave, how prices are determined in different types of markets, and, especially, how economic systems and markets allocate scarce resources among competing wants through the vehicle of prices.

58Most of the neoclassical economists’ questions emanated from the fact that the price and value theories of the classical economists and Marx did not stand up to empirical verification or vigorous economic analysis. Those theories were predicated largely on the supply side of the economy and the market, particularly on the amounts of labour embodied or congealed in production and production costs. Yet economists were becoming aware that there were many situations where these were not the main factors in determining prices. While the historical economists referred to earlier had not been successful in their attempts to root economics in history and the inductive method, rather than abstract theory and the deductive method, perhaps they were successful in compelling economists to achieve a reasonable measure of consistency between abstract theories and historical and contemporary realities. If abstract theories did not mesh with historical and contemporary realities, then it was the abstract theories that had to be changed.

59Exactly what was it about the price and value theories of the classical economists and Marx that did not mesh with historical and contemporary realities? Surely it was the fact that people were paying prices for products, and that products were selling for prices in the market, that bore little or no relationship to the amount of labour embodied or congealed in production, production costs, and the supply side of the economy. In struggling to find answers to this problem, economists shifted attention from labour, production costs, and the supply side of the economy to utility, marginal utility, and the demand side of the economy. Prices might bear little or no relationship to the amount of labour embodied in them, but instead reflected the demand for products. While this observation may appear straightforward and sensible in retrospect, it was revolutionary at the time. It transformed the entire nature of economics as a discipline, and produced the marginal revolution.

60Three highly creative individuals—William Stanley Jevons in Britain, Carl Menger in Austria, and Léon Walras in France and, later, Switzerland—were at the forefront of this development. What makes their contributions to the founding of the marginal school of economics and neoclassical economics particularly fascinating is that they worked in comparative isolation from one another, but nevertheless came to very similar conclusions. While each had his own specific ideas and views on a variety of economic matters, they all believed that utility in general, and marginal utility in particular, were the main determinants of price, value, production, distribution, and exchange. This caused the focus in economics to shift abruptly. Whereas the focus of the classical economists and of Marx had been on macroeconomic questions of production, distribution, wealth creation, and economic growth, the focus of the neoclassical economists was on microeconomic questions of prices, markets, scarcity, resource allocation, and individual and corporate behaviour in markets. This caused Joan Robinson, herself a member of the second generation of neoclassical economists, to describe the shift from classical to neoclassical economics as one that replaced bigger and more general questions with smaller and more specific questions, such as “why does an egg cost more than a cup of tea?” (quoted by Barber, p. 165).

61In seeking answers to questions of this type, the neoclassical economists were forced to confront the problem of price determination in a totally new way. The first person to tackle this problem in any depth was Jevons (although, unbeknownst to him, Augustin Cournot in France, and Johann Heinrich von Thünen and Hermann Heinrich Gossen in Germany, had been wrestling with the problem of price determination from the standpoint of utility for many years). Jevons was well-suited to the task. He had a strong background in economics, mathematics, science, logic, and statistics, and was steeped in the Utilitarian ideas that were still influential in Britain in his youth (he was born in 1835 and died in 1882). Jeremy Bentham, the consummate Utilitarian theorist and practitioner, had concluded that social life was about achieving “the greatest happiness of the greatest number” by way of endeavours to “maximize pleasure and minimize pain,” since pleasure and pain were, in Bentham’s view, “the twin sovereign masters” of life. Bentham’s concern was with the pleasure, pain, and happiness of human beings in general, rather than with those of specific individuals. It is here that a subtle shift started to take place, away from the political philosophy of Adam Smith, which was based on “enlightened self-interest” and “the invisible hand,” towards the political philosophy of acting to secure “the greatest happiness of the greatest number.”

62Given his background in Benthamite Utilitarianism, it is not surprising that Jevons decided to cut into the problem of price determination through utility, marginal utility, and the demand side of economics. According to Jevons, people will pay more for products than the amount of labour embodied in them and the cost of producing them if the demand for these products is high, and a great deal of utility or satisfaction is derived from purchasing and consuming them. In fact, generally speaking, the greater the utility or satisfaction, the higher the price that people are willing to pay. Conversely, the less the utility or satisfaction, the lower the price that people are willing to pay. It was this fact that caused Jevons to shift attention from the “objective side” of economics to the “subjective side,” from society as a whole, the economy, economic growth, and the creation of wealth to the individual and his or her needs and wants in society. Just as beauty is in the eye of the beholder, so the most important factor in determining prices, in Jevons's view, is how much satisfaction or utility individuals get from the products they want, purchase, consume, and possess.

63This shift of emphasis led Jevons away from Utilitarianism, with its rather abstract view of general human needs, towards the study of individuals, and the satisfaction of their needs and wants, and propelled him into a systematic study of utility, and especially marginal utility, as it relates to price, value, the demand for products, the economy, and the market. His views on these matters were set out in his Theory of Political Economy, which appeared in 1871. Whereas the classical economists and Marx had largely ignored utility and marginal utility as factors in price and value (though Adam Smith had paid a certain amount of attention to these questions), Jevons made utility and marginal utility the centrepieces of his entire theory of price determination. Generally speaking, the value or price of a product is determined by the amount of utility or satisfaction people derive from it. As more and more of a product is offered and consumed, however, the utility that people derive from each successive unit will generally fall because there will be less utility or satisfaction derived from each additional unit. This was the crucial factor for Jevons. While utility is an extremely important factor in determining value and price, it is marginal utility that is the most important factor, since it shows how individuals will react as additional units of a product are offered and consumed. This caused Jevons to conclude (as summarized by Spiegel, p. 522): “cost of production determines supply; supply determines final degree of utility; final degree of utility determines value.”

64To illustrate this point, consider the consumption of food. Food generally provides a great deal of utility or satisfaction, particularly if people are hungry and there is not a lot of food available. As a result, people will usually pay high prices for the initial amounts of food they consume, prices that may be well above the actual cost of producing the food or the amount of labour embodied or congealed in its production. As more and more food is consumed, however, the amount of satisfaction or utility derived from each additional unit will decrease. People will be willing to pay less for each additional unit. Eventually a point will be reached where the consumption of additional units of food yields no satisfaction or utility whatsoever. After this point is reached the consumption of additional units of food may even produce “disutility,” or pain, because the consumption of more and more units of food will make people sick. In other words, marginal utility for most products falls progressively as additional units of a product are consumed. After a certain point is reached disutility or dissatisfaction could set in as additional units are consumed.

65It was this understanding of utility, and particularly marginal utility, that enabled Jevons to develop a theory of consumer behaviour and demand based on the conviction that the marginal utility for each additional unit of product will decrease as more and more units of a product are consumed. This is the essence of the neoclassical theory of demand, and therefore of price. It was but a short step from here to Jevons's conclusion that people will operate in markets in such a way as to equalize the marginal utilities for all the various products they want, demand, and consume.

66What excited Jevons about the theory of marginal utility was not only what he deemed to be its consistency with the way in which prices are determined in reality, but also the possibility of subjecting marginal utility theory to empirical verification and intensive mathematical treatment. On the one hand, Jevons believed that it was possible to derive demand curves for all products by asking people what prices they would be willing to pay for each additional unit of product based on the amount of satisfaction or marginal utility they derive from each successive unit. It is not difficult to see where this leads. It leads to the derivation of demand curves for all products in the consumers’ market and the producers’ market. On the other hand, Jevons believed that mathematics in general and differential calculus in particular could be used to great advantage because they were capable of dealing with infinitesimal increases and decreases in amounts, thereby making it possible to derive demand curves with exact scientific precision and mathematical accuracy. This strong reliance on mathematics and especially differential calculus eventually led to the development of input-output analysis, and the use of econometrics and econometric models in economics, a standard feature of economic theory, practice, and the economic age today.

67As the work of Jevons intensified, a very specific theory of individual behaviour in the market began to take shape. Consistent with the theory of utility and especially marginal utility, it was based on the assumption that people are concerned largely with maximizing their utility, marginal utility, and consumer satisfaction. This gave rise to the concept of “economic man,” the individual who is concerned first and foremost with getting as much satisfaction as possible from the consumption of products. According to this view, people will go on purchasing products and adjusting their purchases until the marginal utilities derived from the consumption of the last units of all products are equal. As Jevons put it (quoted by Roll, p. 380), “a person distributes his income in such a way as to equalize the utility of the final increments of all commodities consumed.” It is easy to see from this why Jevons was so excited about the use of mathematics and particularly differential calculus in economics. They provided an opportunity to get at the problem of price and price determination with the greatest precision possible.

68At the same time that Jevons was researching and writing about these matters in Britain, Carl Menger was studying very similar issues in Austria. In fact, Menger’s Grundsätze der Volkswirtschaftslehre (Principles of Economics) appeared in 1871, the same year as Jevons’s Theory of Political Economy. While Menger and Jevons shared a great deal in common, Menger went further than Jevons by applying his utility theory to a broader range of economic situations and problems. For example, Menger applied his theory of utility and especially marginal utility to different types of products, such as lower-order and higher-order products, arguing that people will generally provide for needs that bring them the greatest utility or satisfaction first, such as food, clothing, and shelter, and then turn their attention to other needs. However, they will do this in such a way that all needs are satisfied to an equal degree of satisfaction, fulfilment or marginal utility. In addition, Menger applied his theory of utility and marginal utility not only to products but also to money, arguing that money could be treated very much like products as far as price and value are concerned. This helps to explain why Menger’s theories generated a great deal of interest and enthusiasm in Austria and elsewhere in Europe shortly after his book was published, eventually leading to what is called the Austrian school of economics.

69This school has made many valuable contributions to economic theory and practice, and the development of the economic age, since it was first founded. These include the theory of utility and marginal utility, the theory of capital and interest rates, monetary and fiscal policy, and the development of capitalism, socialism, liberalism, and democracy. Successive generations of economists followed in the footsteps of Merger, including Friedrich von Wieser, Eugen von Böhm-Bawerk, Ludwig von Mises, Friedrich A. von Hayek, and Joseph Schumpeter. For example, von Wieser and von Böhm-Bawerk made valuable contributions to interest rate theory, and the study of money and banking, signalling the need to examine not only “the real economy” but also “the money economy.” Von Mises and von Hayek made valuable contributions to individualism and liberalism, primarily by examining the implications of marginal utility and demand theory in great depth, and making the case for alternatives to Marxism and communism.

70It is, however, Schumpeter who, many feel, made the most valuable contributions. He made especially valuable contributions to business cycle theory, the theory of economic development, the analysis of capitalism, socialism and democracy, the study of entrepreneurship, the behaviour of entrepreneurs and entrepreneurial elites, and the nature and importance of technological change. It was Schumpeter who named short, intermediate and long-term business cycles Kitchin, Juglar and Kondratieff cycles, after the scholars who first identified them. Schumpeter was also the first economist to give detailed attention to the roles that entrepreneurs, entrepreneurial elites, and entrepreneurial activity play in economic development. He also predicted the eventual collapse of capitalism, not because of its failures and internal contradictions, as Marx and the Marxists had, but rather because of its successes. According to Schumpeter, capitalism was destined to fail because enterprises would become too large and bureaucratic, innovation would become too depersonalized and institutionalized, and political power would be vested in a business class that was basically unfit to govern. He thus provided important insights into the rise, growth, power, and role of corporations and corporate elites in the economy, the world system, politics, and the economic age in the latter part of the twentieth century.

71As important as these contributions were, Schumpeter’s greatest contribution was reserved for the nature, role, and importance of technology and technological change in economic development. He contended that technological innovation is “the most important factor in economic development” because it occurs in clusters and triggers other possibilities. This is not far removed from the situation over the past 150 years or so, during which technological innovations in such fields as transportation, communications, industry, advertising, and computers have transformed economic practices and policies in every part of the world and all sectors of society. It is for reasons such as these that Schumpeter’s theories on a variety of economic issues are attracting a great deal of attention today among economists, policy-makers, and developmental authorities throughout the world.

72Given the evolution and importance of the Austrian school of economics, it is easy to see how important Menger’s contributions were to the history of economics and the economic age. Not only did he go further than Jevons in developing marginal utility theory and applying it to a variety of situations, he also triggered a school of economic thought and practice that has had a major impact on economics, and on economic policies and practices, since his own day.

73If Menger went further than Jevons, Léon Walras went further than either. Whereas Menger and Jevons were concerned largely with how prices are determined in specific markets and for particular products, Walras was concerned with how prices are determined for all markets, all products, and the economy as a whole. In the market for products, for example, consumers buy products that are produced by businesses and corporations. In the market for productive services consumers sell their productive capabilities to businesses and corporations, and receive incomes or revenue in return. Thus, consumers are buyers in the market for products and sellers in the market for productive services. It was the interrelatedness of markets and of the entire economic system that enabled Walras to conclude that it is possible in theory to develop a set of simultaneous equations showing how equilibrium is determined for all markets, products, and the economy as a whole. In order to do this, it was necessary to make many assumptions about the actions and motives of buyers and sellers, consumers and producers, as well as the general nature of the economy and economic system. On the basis of these assumptions Walras was able to show how it is possible to construct an elaborate “general equilibrium theory,” showing how equilibrium prices, values, and resource allocations are determined for all economic activities in society.

74Just as Menger’s work on utility and marginal utility spawned a school devoted to advancing his work, and exploring its implications for a variety of economic issues and problems, so Walras’s work on equilibrium theory and general equilibrium spawned a similar school. In his case, it was the Lausanne school, spearheaded by Walras’s principal successor, Vilfredo Pareto. Not only did Pareto build on Walras’s general equilibrium theory by showing how it is possible to derive “determinate values” for all unknowns in Walras’s set of simultaneous equations, he also advanced Walras’s theory of general equilibrium by showing how “optimal distribution” might be achieved for the economy through “perfect competition” and the free mobility of labour, capital, and other factors of production. This possibility, which has become known as Pareto’s optimum, strengthened the case for laissez faire economics, implying minimal governmental intervention in the economy and the market, making Pareto a champion of economic and political liberalism, and providing an alternative to Marxism. Many neoclassical economists, politicians, corporate executives, and members of wealthy elites have found Pareto’s ideas attractive.

75Pareto’s ideas countered the influence of Marxian economics in one other important respect. Whereas Marx and the Marxists believed that the unequal distribution of income and wealth among the main classes and interest groups in society are inherent in capitalism, Pareto believed that such unequal distribution results from the fact that individuals, institutions, interest groups, and classes are not endowed equally with resources, abilities, opportunities or power, in what has become known as Pareto’s law of income distribution. Pareto claimed that this law had been derived from empirical investigations of the distribution of income and wealth in many countries, rather than through abstract theorizing or pure economic analysis. Although there were vigorous attacks on the law, and these attacks were to play an important role in the development of welfare economics, Pareto clung to his convictions on this subject, although softening somewhat later in life. He argued that “aristocratic elites” are always bound to play a crucial role in economic development and in society because this is the inevitable consequence of the unequal distribution of income and wealth. It was Pareto’s views on these matters that did a great deal to sanction the policies and practices of ruling elites and the position of capitalists, corporations, and the capitalistic class in society, something that Marxists, but not only Marxists, found abhorrent.

76Despite these specific departures from general economic thought and practice, it is not difficult to see what happened as a result of the work of Jevons, Menger, Walras, Pareto, and others of the neoclassical school: economics largely returned to the classical philosophy of laissez-faire liberalism, assuming and even demanding minimal state involvement in the economy and the market, following its tumultuous encounter with Marx, Marxism, and Marxian economics. The pendulum had swung one hundred and eighty degrees, from concern with the supply side of the economy, the creation of wealth, and economic growth to the concern with the demand side of the economy, utility, marginal utility, price determination, equilibrium analysis, markets, and consumer and corporate behaviour. Whereas the classical economists put their emphasis on labour and production costs as the most important factors in determining value and price, Jevons, Menger, and Walras put their emphasis on utility, marginal utility, consumer and producer satisfaction, and equilibrium as the most important factors.

77It was left to Alfred Marshall, the British economist whom many consider the greatest of the neoclassical economists, to synthesize these two distinct approaches to value and price determination by developing a theory of value and price based on supply and demand, production costs, and utility. His views on this subject and many other matters were set out in his Principles of Economics, which first appeared in 1890. Marshall likened the process of price determination to the cutting action of a pair of scissors. It is impossible to determine whether the lower blade or the upper blade does the cutting because both blades play extremely important roles in the process. As Marshall put it (p. 84):

We might as reasonably dispute whether it is the upper or the under blade of a pair of scissors that cuts a piece of paper, as whether value is governed by utility or cost of production. It is true that when one blade is held still, and the cutting is effected by moving the other, we may say with careless brevity that the cutting is done by the second; but the statement is not strictly accurate, and is to be excused only so long as it claims to be merely a popular and not a strictly scientific account of what happens.
In much the same way, when a thing already made has to be sold, the price which people will be willing to pay for it will be governed by their desire to have it, together with the amount they can afford to spend on it. Their desire to have it depends partly on the chance that, if they do not buy it, they will be able to get another thing like it at as low a price: this depends on the causes that govern the supply of it, and this again on the cost of production.

78Drawing on his conviction that both supply and demand, that is, both production costs and utility, play important roles in determining value and price, Marshall was able to construct supply and demand curves for products, showing how prices are determined through the intersection of the curves. When quantity demanded is depicted on the horizontal axis and price is depicted on the vertical axis, the demand curve for most products will slope down to the right, because consumers will demand more of the products as the price falls, in accordance with utility theory and particularly marginal utility theory. With supply the situation is reversed. When quantity supplied is depicted on the horizontal axis and price is depicted on the vertical axis, the supply curve for the large majority of products will slope up to the right, because producers will have to pay more for the land, labour, and capital used in production, in accordance with the increased cost of wages, profits, and rent, and the law of diminishing returns. It is at the point where the demand and supply curves intersect that the price of products is determined. Marshall called this “the equilibrium price.” This, in Marshall's view, is the price that producers, consumers, and the market will always gravitate towards. A price above the equilibrium price will cause producers to bring more products to the market, in order to entice consumers to buy more products. This will cause a decrease in the price and a return to the equilibrium price. A price below the equilibrium price will cause consumers to demand more of the products in the market, causing an increase in the price and a return to the equilibrium price, as producers supply the market with more products. In both cases there is a tendency for prices to gravitate towards the equilibrium price whenever there is a deviation from it.

79What is true for consumer products is also true for producer products, according to Marshall, at least in theory if not always in practice. There is always a tendency to restore equilibrium prices once there has been a deviation from them. Whenever there has been a deviation from the equilibrium price, producers and consumers will adjust their actions and practices in such a way that equilibrium tends to be restored. It was but a short step from this to Walras’s “theory of general equilibrium” for all products, all markets, and the economy generally. Nevertheless, Marshall did not take this step because he was much more concerned with equilibrium conditions in specific markets, and for particular products and industries, often called partial equilibrium, than he was with general equilibrium in the economy as a whole.

80It was the fact that equilibrium theory, regardless of whether it focused on partial equilibrium or general equilibrium, could be applied to producers as well as consumers that eventually gave rise to the development of a theory of corporate behaviour commensurate with the theory of consumer behaviour pioneered by Jevons, Menger, and others. Marshall was in the forefront of this development. He contended that producers will seek to maximize their profits in the market in exactly the same way that consumers seek to maximize their marginal utility and consumer satisfaction. This led Marshall, in conjunction with many others, to develop the theory of the firm, based on the conviction that profit maximization and vigorous competition are the keys to a healthy corporate community and a vigorous economy. This was eventually parlayed into the belief that what is good for corporations is good for the economy and society, an idea that was to play a major role in the development of the economic age in the twentieth century, and has only recently been called into question as a result of corporate scandals and fraudulent accounting practices.

81While Marshall believed that there is a tendency in the economy and in markets to yield equilibrium prices for all products and all markets, he also believed that there are numerous exceptions to the general rule. These exceptions resulted from many factors, including increasing and decreasing returns to scale, consumers’ and producers’ surpluses, the escalating demand for urban land that was occurring in Britain and elsewhere in Europe in his day, and the fact that capitalists must be paid a “quasi-rent” for foregoing present consumption in order to realize potential profits. This led Marshall to differentiate between different types of market situations, such as the market for land, labour, and capital, the producers’ market, the consumers’ market, the general market, and so forth. It also caused Marshall to distinguish different time frames for markets, including the market period, the short period, and the long period. This made it possible for Marshall to examine the specific conditions and time frames obtaining in different market situations, as these could easily yield cases where the actual prices paid for products deviated from the equilibrium price.

82What particularly worried Marshall about all this was the fact that some producers might have advantages over other producers in specific market situations and over particular time frames. Moreover, producers might have advantages over consumers. This would interfere with the smooth functioning of the economy and markets, and therefore with the tendency towards equilibrium and the ability to reward all equally, without the need for much government intervention. This was especially true in the case of increasing returns to scale, in Marshall's view, since this could tip the scales in favour of certain producers over other producers, thereby putting them in a stronger position to exploit other producers as well as consumers. This caused Marshall to conclude that there are specific cases where state intervention is justified, since unregulated markets cannot always be expected to produce socially desirable results.

83As neoclassical economics gathered momentum in the latter part of the nineteenth century and the early part of the twentieth, a very specific vision of the ideal economic system began to emerge. It was a system based on the conviction that, generally speaking, equilibrium would be achieved in all markets, and the economy as a whole would function most effectively, when they were left to follow their own course, there was a great deal of competition between producers and consumers, and government involvement was kept to a minimum. Not only would this yield the best possible allocation of scarce resources of land, labour, capital, and entrepreneurship, it would also maximize producer and consumer satisfaction, and do so at or near full employment and on the basis of general equilibrium.

84While neoclassical economics shared many similarities with classical economics in this respect, especially the view that markets should be left alone rather than rigidly controlled, except in special cases and specific situations, it was designed to tackle a very different problem than classical economics had been. Classical economics had been designed to tackle the problem of how to create, augment, and distribute wealth among the three main classes of society, particularly in the case of a society characterized by rapid population growth, the pressure of population on the means of subsistence, the operation of the law of diminishing returns, and the ever-present danger of the stationary state. Neoclassical economics was designed to tackle the problem of how equilibrium could be achieved at or near full employment with optimal resource allocation, and the greatest possible producer and consumer satisfaction. It is easy to see from this how neoclassical economics acquired its name. Despite the fact that it focused on a very different problem than the one addressed by classical economics, it followed in the classical tradition in one quintessential respect. Like classical economics, it was based on the conviction that the economy and markets are self-regulating and self-correcting mechanisms, where “an invisible hand” and “enlightened self-interest” ensure that everything turns out for the best. While it might take time for adjustments to work their way out in specific market situations, and in the economy as a whole, these adjustments would be made without the need for government interference, except in the specific and limited cases identified by Marshall and others.

85In retrospect, it is clear that neoclassical economics made a number of very valuable and highly original contributions to the evolution of the economic age. For one thing, it focused attention on price determination, the economy, and markets. This led to intensive studies of the nature, functioning, and mechanics of the economy and markets, the relationship between buyers and sellers, supply and demand, different types of markets and market situations, and the determination of prices, value, production, distribution, and consumption, which lie at the core of all economic and market systems. For another thing, it produced a very specific understanding of the ways in which consumers and corporations behave in the economy and in markets, as well as the ways in which they should behave. In order for the economy and markets to function effectively, according to neoclassical theory, consumers should strive to maximize their consumer satisfaction, while corporations should strive to maximize their profits and compete as vigorously as possible because this produces the best possible results for the economy, markets, and society as a whole. This broadened and deepened economic thought and practice considerably by showing how they apply to citizens and corporations, and not just to macroeconomic questions of wealth creation and economic growth. Moreover, it caused a return to the notion that the economy and markets are self-regulating and self-correcting mechanisms, which function most effectively when they are left to their own devices. This signalled a return to the classical conviction that liberalism based on laissez faire is the most desirable political philosophy because it produces the most efficient and effective results. It also countered the Marxian conviction that laissez faire rewards the rich, perpetuates the status quo, penalizes the poor, exploits workers, and advances the interests of capitalists, capitalism, and the capitalist mode of production at the expense of everybody else.

86Despite the contributions made by neoclassical economics to the evolution of the economic age, the economic system visualized by the neoclassical economists did not jibe especially well with the kind of world that was unfolding in the first third of the twentieth century. Cracks and fissures were beginning to appear in the theoretical structure and practical policies of the neoclassical economists. In fact, a number of developments were occurring at the time that directly contradicted the arguments and expectations of the neoclassical economists.

87In the first place, it was becoming apparent that imperfect competition rather than perfect competition was the rule rather than the exception in the most advanced economies of the world. While Marshall was very cognizant of this fact and was indeed extremely worried about it, it was exactly the reverse of what the first generation of neoclassical economists had propounded. This caused a number of members of the second generation of neoclassical economists, including Piero Sraffa in Italy, Joan Robinson in Britain, and Frank Knight and E.H. Chamberlin in the United States, to focus their attention on imperfect rather than perfect competition, that is, on competition by a few firms rather than many firms in the marketplace, as well as on the theory of the firm under conditions of imperfect competition. This led to important studies of monopolies, duopolies, oligopolies, and monopolistic competition, situations where some producers enjoy considerable advantages over other producers as well as over consumers. At a time when new corporations were coming into existence, and existing corporations were expanding rapidly in size, stature, power and influence, this led to important changes in the laws governing market behaviour, in order to penalize discriminatory commercial, industrial, corporate, trading and trust practices, although it took a long time for these changes to work their way through into public policies and decision-making.

88In the second place, major inequalities were showing up in the distribution of income, wealth and resources, inequalities that were so large they simply could not be ignored. While this was consistent with the findings of Pareto and others, as well as the predictions of Marx and the Marxists, it was not consistent with the theories and system advocated by the large majority of neoclassical economists. Not only did these developments run counter to the belief that a freely functioning economy at or near full employment allocates resources most efficiently and equitably, but it also raised the spectre of Marxism once again. Was Marx right when he said that growing disparities in income, wealth, and resources would eventually spell the death knell for capitalism? In response to this problem, a number of second-and third-generation neoclassical economists, including A. C. Pigou, John Hicks and others, plunged into a protracted study of what became known as “welfare economics.” During the course of their studies they identified many cases where there could be major discrepancies and inequalities between the interests of one class and the interests of other classes, as well as between one class or industry and society as a whole. For example, some classes might put a great deal of energy, effort and money into making improvements in their productive capabilities, only to have other classes reap the profits. This often happened in agriculture, where farmers made improvements in their land and equipment, only to see landlords expropriate them and reap the benefits. Also, some producers and industries might cause a great deal of pollution and environmental deterioration, which would then have to cleaned up by others and society as a whole.

89Cases such as these, and others, necessitated and indeed justified government intervention in the economy and in markets. They also necessitated achieving much greater understanding of who actually gains and who loses from different types of economic actions and policies, as well as how economic systems can be created that maximize or optimize the welfare and well-being of all classes in society, and not just the rich and privileged class. This provided the theoretical justification that was needed to redistribute wealth, income, and resources on a more equitable basis. Many of these conclusions were bound up in the distinction that Pigou and other welfare economists made between “marginal social net product” and “marginal private net product.” This in turn led to the theory of public goods and the public sphere, cost-benefit analysis, the compensation principle, and, in advanced countries such as Britain and Sweden, the welfare state.

90Inconsistencies between welfare and laissez faire, and between perfect and imperfect competition, were not the only inconsistencies showing up in neoclassical economics between the 1890s and the 1930s. Consumers’ behaviour was not evolving in a manner consistent with neoclassical theory either. Rather than being based on rational factors such as utility, marginal utility, and careful calculation, there were many cases where it was based on irrational factors such as whims, fancies, fashion, mass marketing, envy, and emulation. This led to the development of alternative theories of consumption and consumer behaviour, notably the theories developed by Thorstein Veblen and others, who believed that institutional factors were far more important in determining and explaining consumer behaviour and consumption than utility, marginal utility, and careful calculation. These theories had a profound impact on economic thought and practice in the twentieth century, especially when consumption began to loom large as the most important factor in economic growth and development.

91Finally, by far the most devastating development as far as neoclassical economics was concerned was the revelation in the late 1920s and the 1930s that there was no self-regulating and self-correcting mechanism at work in the economy and markets, and that they did not tend towards equilibrium at or near full employment once there was a major deviation from it. In fact, precisely the opposite might be the case. The economy could get stuck at equilibrium levels far below full or near-full employment. This proved to be so damaging to neoclassical economics in the end that it provided the impetus for another revolution to take place in economics, a revolution every bit as powerful and pervasive as the Marxian and marginal revolutions of earlier generations.

Keynesian Economics

92The British economist John Maynard Keynes spearheaded the revolution in economic thought and practice that bears his name by producing yet another way of looking at the economy, markets, economic theory, and the role of government in public and private life. His was a revolution that was destined to have a profound effect on the economic age and the modern world system by swinging attention away from microeconomics, and its concern with consumer and corporate behaviour, price determination, market equilibrium, and supply and demand analysis, back to macroeconomics, and its concern with monetary and fiscal policy, national income analysis, saving, investment, consumption, economic growth, and, more fundamentally, government involvement in the economy and markets.

93What triggered the Keynesian revolution was the Great Depression (1929-39), and the accompanying debate among politicians, bureaucrats, policymakers, and economists with respect to what, if anything, to do about it. Following the stock market crash of 1929, Europe and North America, and the colonies that depended upon them, plunged into a period of protracted economic crisis and decline. Investment fell, unemployment soared, and national income plummeted, particularly in the United States, where national income fell from 87 billion US dollars in 1930 to 39 billion dollars in 1933 (Heilbroner, pp. 252-53).

94More importantly, most of the economies affected showed no signs of recovery. After one hundred years of economic theory and practice, involving concerted efforts by numerous economists to understand the functioning of the economy and the marketplace, US President Franklin D. Roosevelt was forced to accept in the 1930s that little was known about how the economy and markets functioned, or how the US economy could be lifted out of the Depression. All that could be done, in Roosevelt’s view, was to try something and, if it worked, try more of it, but, if it did not work, abandon it and try something else. This ran directly counter to the neoclassical economists’ belief that there was a self-regulating and self-correcting mechanism at work in the economy, causing a return to full or near-full employment once there was a major deviation. This simply was not happening.

95Keynes set out to explain why this was so and, more importantly, what should be done about it. He undertook an intensive study of some of the most important factors in the precipitation of the stock market crash and the Great Depression, including saving, investment, consumption, interest rates, income flows, the propensity to save, invest and consume, the supply of and demand for money, business cycles, and national income analysis. Whereas the neoclassical economists were more interested in “the real economy”, by which they meant such matters as the production, distribution, and consumption of goods, services and resources, and the prices paid for them, Keynes was interested in both “the real economy” and “the money economy,” as well as the intimate relationship between the two. This led Keynes to produce a number of extremely important books, pamphlets, and articles on these matters, including his Treatise on Money (1930) and, above all, The General Theory of Employment, Interest and Money (1936).

96While the classical and neoclassical economists were aware that fluctuations could take place in economic activity because of discrepancies between supply and demand, production and consumption, they believed that long-term overproduction and major gluts in markets were impossible because “supply creates its own demand.” As indicated earlier, this common view was known as Say’s law because it had been first articulated by the French economist Jean-Baptiste Say. The law was predicated on the conviction that excessive goods would always be taken off the market because prices for excessive goods would fall, thereby increasing the demand for them and causing them to be purchased. The only economists who had expressed reservations about the law were Malthus and Marx. As noted earlier, both Malthus and Marx believed that market gluts and long-term overproduction were possible, and would occur if there was too much unemployment in the economy, or if consumers saved too much and did not return enough of their income to the income stream. However, such views were discounted by Ricardo, Mill, and the neoclassical economists because they believed that unemployment would never reach such high levels and that consumers would never save too much of their income because it was always more advantageous for them to put it to productive use.

97Keynes disputed these assertions on the basis of his study of money, which he analyzed as both a store of value and a medium of exchange. Whereas the classical and neoclassical economists saw money largely as a medium of exchange, because of its purchasing power and its command over goods, services, resources, and especially labour, Keynes argued that money functions as a store of value as well, and that there are occasions when consumers and producers prefer to hold on to their money rather than spend it, seeing it as a hedge against poor future prospects, a decline in the value of their capital assets or a possible rise in interest rates. This “liquidity preference,” as Keynes called it, could cause more money to be taken out of the income stream in the form of saving than was returned in the form of consumption and investment, thereby causing national income to fall rather than rise. Once this downward process started it could become cumulative as consumers saved more and more of their incomes for precautionary reasons, thereby causing investment and consumption to slow down, and unemployment to increase. This would bring about further reductions in income, saving, investment, and consumption, as well as a great deal more unemployment and underemployment in the economy. This process could go on indefinitely if nothing was done about it. National income could get stuck at an extremely low level and just stay there.

98This is exactly what had happened during the early stages of the Great Depression, with the result that at its height consumption, saving, investment, and national income in most countries around the world were at lower levels than they had been for decades. According to neoclassical theory, this should have caused interest rates to fall, thereby drawing savings out, and inducing more investment, consumption, and economic growth. This would eventually reverse the downward spiral and cause the economy to return to full employment equilibrium as a result of the self-regulating and self-correcting mechanism. However, what happened in fact was the opposite. Interest rates fell, but nothing happened. Investment, consumption, income, and saving did not increase significantly, and there were chronically high levels of unemployment and underemployment in most economies.

99Keynes argued, quite rightly in retrospect, that, despite significantly lower interest rates, investment could not increase substantially because all the savings had been “squeezed out” of the economy during the downward spiral, as consumers struggled to cope with increased unemployment and reductions in their standard of living. In other words, there was no self-regulating and self-correcting mechanism at work in the economy; equilibrium could just as easily be established with a high level of unemployment as with a low level; and nothing would get better as long as nothing was done about it. In effect, the economic elevator could just as easily get struck in the basement or the ground floor as on the top floor. Keynes was right and the neoclassical economists were wrong.

100What, then, was to be done about it? As the Great Depression intensified and dragged on, pressure on governments to do something, anything, increased. According to Keynes, there was really only one thing to be done, once the neoclassical solution of doing nothing, while waiting for equilibrium to be restored at full employment, was rejected. Governments had to step in and “prime the pump” by spending money on a variety of public works projects and welfare programmes, in attempts to induce economic recovery and growth.

101Most governments did much that Keynes recommended, and some did so even before his ideas became influential. Roosevelt, for example, introduced the New Deal in 1933, when Keynes was barely heard of in the United States, increasing government spending on public works in order to increase incomes, reduce unemployment, stimulate savings and investment, and put money into the pockets of consumers. Most European governments followed suit. Whether these policies were successful or not is still debated among economists, politicians, government officials, and policy-makers today. While there is no doubt that income, saving, investment, employment, and interest rates increased in most countries from the mid-1950s onwards, a number of economists have contended that it was only when the first new orders for armaments and other war supplies came in that recovery was assured.

102In the years following Keynes’s death in 1946, economists intensified their efforts to flesh out and refine the Keynesian theory of employment, interest, and money. They did so by examining national income and expenditure, consumption, investment, savings, money, interest rates, and government intervention in the economy and markets in much greater detail. Their work became collectively known as Keynesian economics because it was based on intensive studies of the key economic variables Keynes had drawn attention to, including newly developed statistics of national income and national expenditure, consumption functions, investment functions, the marginal propensity to save, to invest and to consume, the multiplier, the accelerator, actual and anticipated rates of saving and investment, the marginal efficiency of capital, and interest rates. At the root of these studies was the attempt to come to grips with the dynamic, complex, ever-changing, and interrelated nature of the economy and markets, as well as “the real economy,” “the money economy,” changes in the quantity and value of money, fluctuations in industrial, commercial and financial activity, and business cycles. As their studies intensified Keynesian economists were led into detailed studies of the income stream, and the ways in which it changes over time in response to changes in saving, investment, interest rates, the money supply, and consumption. This made it possible to broaden and deepen understanding of the fundamental links and connections between microeconomics and macroeconomics, by way of the attitudes, expectations, and actions of consumers, savers, investors, corporations, and governments, as well as the complexities of consumption, investment, saving, government expenditure, and the economy as a whole. It also made it possible to produce a much more detailed portrait of the economy and the way it actually functions than had been possible in classical, Marxian or neoclassical economics.

103The Keynesians focused on aggregate demand for goods and services as the real engine of economic growth. While consumption formed the principal component of aggregate demand, strategic roles were reserved for saving, investment, and government expenditure. Saving was important because it constituted a withdrawal from the income stream that had to be replaced in some way if economic growth was to be sustained. Investment was important because, while it was highly volatile and unpredictable in nature, it provided the impetus for capital accumulation and economic growth. Saving and investment together were important because they were done by different groups of people, and there was no logical reason why they had to be equal or in balance. Government expenditure was important because it could be adjusted upwards or downwards depending on actual and anticipated conditions in the economy and markets. This in turn provided the justification that was needed for governments to play much stronger, more direct and active roles in the economy.

104Before Keynes and the Keynesians became influential the role of governments in most western economies had been, both in theory and in practice, limited in scope and largely political in character, focused on law-making, regulation, governance, and public policy. Economic intervention, where it occurred at all, was usually aimed at regulating monopolies, oligopolies, and imperfect competition, or providing limited amounts of welfare support to the poorest in society. Keynes and the Keynesians, however, contended that governments can and must play a major economic role in society by controlling monetary and fiscal policy, regulating business and industry, managing debts, deficits, and surpluses, stimulating economic growth, dealing with business cycles, and spending public funds to boost the level of aggregate demand, which they deemed to be the key to a healthy economy and vigorous economic life.

105According to Keynes, governments should realize budgetary surpluses in times of prosperity, in order to have the funds necessary to spend on economic stimulation and recovery during recessions and depressions. Interestingly, many governments have ignored this sage piece of advice in their haste to activate and accelerate economic growth. As a result, they now find themselves in a situation where they are unable to respond to unfavourable economic conditions and tardy rates of economic growth because they did not realize budgetary surpluses in good times, and are now burdened with debts and deficits.

106As the influence of Keynesian economics grew, the role of governments in the economic, commercial, financial, industrial and developmental affairs of nations grew accordingly. Combined with the demand for more government involvement in public affairs, greater control over business and industry, and the need for more social services manifesting themselves at the same time, the stage was set for a dramatic increase in the size and power of governments in many countries. Only in recent years, as governments have been confronted with extremely difficult financial and fiscal problems, and have grown very large and bureaucratic, have questions been raised about the ideal size of governments and their involvement in the economic affairs of nations, especially if, as many economists now argue, this impairs their ability to act objectively, impartially, and in the public interest.

107In retrospect, it is easy to see why the Keynesian revolution had such a powerful effect on the development of the economic age. Not only did the pendulum swing from microeconomic concern with individuals and corporations to macroeconomic concern with the economy as a whole, but also opinions on the role of government in society were radically transformed. Whereas the classical and neoclassical economists had expected governments to play a minimal role, the Keynesians expected them to play a central role. Without a great deal more government involvement in the economy and the marketplace, there was the risk that production and consumption would not be optimized, and that economic, industrial, financial, technological, commercial and social conditions would be far from ideal. In fact, they might even be negative and remain there without strong government involvement in the economy. This opened the doors for economic issues and concerns to become public issues and concerns, and not just private issues and concerns. This made them of central importance to governments, politicians, civil servants, and citizens, and not just to corporations, corporate executives, commercial and financial institutions, businesses, and consumers. Without this shift in opinion and attention, economic issues would not attract the media attention, political involvement, and citizen interest they do today.

108With the Keynesian revolution and Keynesian economics, all the prerequisites were in place to transport the economic age into full adulthood. Just as Adam Smith and Karl Marx had created the theoretical, practical, philosophical and historical foundations for the economic age, and the neoclassical economists had opened up a commanding place for consumers and corporations within it, so Keynes and the Keynesians drew governments fully into the economic equation. Once governments became actively involved, the economic age became all-inclusive in a way it never had been before. Indeed, governments became so fully immersed in the economic affairs of nations that their primary role came to be seen as economic rather than political, regardless of whether they were right of centre, left of centre, or situated squarely in the middle. All that was required now to complete the supremacy of the economic age was to extend it from western countries to the rest of the world. This happened with the next great epoch in economic thought and practice, development economics.

Development Economics

109Keynesian economics proved exceedingly popular after World War II. Economists, civil servants, politicians, statisticians, and policy-makers spent a great deal of time refining the Keynesian system, and fleshing out its various components. It was not long before an idea closely related to Keynesian economics started to attract attention, and begin to dominate economic and political thinking: the idea of “development.” Development came to be seen as the principal panacea for many of the world’s most difficult and demanding problems, and as the principal means of improving living standards. This was only natural in a world recovering from a severe depression and two major world wars, caught up with Keynesian economics, and preoccupied with macroeconomics and the rate of economic growth.

110The origins of the idea of development can be traced back more precisely to the need to bring about post-war recovery in Europe. The main vehicle devised to realize this, apart from the efforts and ingenuity of Europeans themselves, was the US European Recovery Program, better known as the Marshall Plan, initiated in 1947 following the urging of Secretary of State George C. Marshall. It involved billions of dollars of US investment in, and aid to, western Europe from 1947 to 1955.

111In 1949, buoyed by the early success of the Marshall Plan, President Harry Truman made “development” the centrepiece of his inaugural speech to Congress, in which he talked about the need for commitment to “development” in order to increase production, achieve prosperity and peace, and bring about fundamental improvements in “the underdeveloped countries of the world” (see the article by Sachs). Development was perceived and defined largely in economic terms, as requiring the building up of the economies of those countries, confirming the centrality of economics, economic growth, and economic issues in public policy, decision-making, and society generally. This had the effect of sustaining the tradition established by the classical, neoclassical and Keynesian schools of economics. It also had the effect of making the “underdeveloped” countries into a battleground, where the conflict between classical, neoclassical, Keynesian, and Marxian views of the nature of “development” was played out.

112Two of the first economists to address the theoretical and practical difficulties posed by development were Sir Roy Harrod and Evsey Domar. In the late 1930s and early 1940s they had created the multiplier-accelerator model of economic growth, drawing heavily on both neoclassical and Keynesian economics. According to Harrod and Domar, steady economic growth could be achieved most effectively when intended saving is equal to intended investment, and investment in any one period is equivalent to the change in national income multiplied by the capital-output ratio. While their model of economic growth was designed to address problems in western Europe and North America, especially as they struggled to achieve higher rates of growth after World War II, it had numerous implications for other countries since it focused on the importance of saving, investment, and capital formation as key factors in economic development.

113It was not long before economists were asking how development could be achieved in the “underdeveloped” parts of the world, a category generally understood to comprise sub-Saharan Africa, most of Asia, Latin America, the Caribbean, and the Middle East, although some economists also included eastern Europe. Indeed, as early as 1943 Paul N. Rosenstein-Rodan was examining what would be needed to achieve development specifically in eastern and southeastern Europe. He concluded that what was required, more than anything else, was a big push towards industrialization. This quickly became known as the “big push” theory of development, predicated on the conviction that development was needed across a whole range of industries at once, because progress in only one or two industries would not be sufficient to trigger development for the economy as a whole.

114Shortly afterwards, economists started to focus their attention on problems in the “underdeveloped” world outside Europe. These turned out to pose a far more formidable challenge than in North America or western Europe, largely because many of these countries lacked the economic, social, political, legal, and capital infrastructure, and the institutional capabilities, that had been built up in North America and western Europe since the seventeenth century. As economists increasingly travelled to these countries, and lived and worked in them for considerable periods of time, they began to study their problems and prospects on the ground, and to deal with the difficulties of development in greater detail. One of the first economists to do this was Ragnar Nurkse. While his theory of “balanced economic growth” was designed to deal with developmental problems and prospects in the underdeveloped parts of the world, it was heavily weighted towards industrialization and capital formation as the keys to development, much as Rosenstein-Rodan’s theory had been for eastern and southeastern Europe. According to Nurkse, saving, investment, industrial development, and the introduction of capital-intensive techniques were imperative if these countries were to pull themselves out of the trap of “underdevelopment.”

115The theories of Nurkse, Rosenstein-Rodan and others posed numerous problems for such countries as India when they actually applied these theories to their own situations, because they focused primarily on manufacturing, and tended to ignore agriculture and the intimate connections between the two sectors. Nevertheless, they opened the doors to much more theorizing about how development might be achieved, by such “development economists” as Albert Hirschman, Gunnar Myrdal, Arthur Lewis, Harvey Leibenstein, and Raúl Prebisch.

116According to Hirschman, “unbalanced” rather than “balanced” economic growth was the key, since all industries do not produce final products, and there are many backward and forward linkages that have to be taken into account in the developmental process. This quickly became known as “the lead-lag theory of development,” because some industries were seen as leading development and exerting a great deal of pressure on other industries to stop lagging and catch up. It will be recalled that when the industrial revolution occurred in Britain it was the cotton and iron industries that “led development” by creating backward and forward linkages that placed pressure on other industries to follow suit. In contrast to Hirschman’s theory of unbalanced growth, the theories proposed by Prebisch, Myrdal, Leibenstein and Lewis put much more emphasis on the dualistic nature of development. This dualism manifested itself in many ways, such as the dichotomies between agriculture and manufacturing, the “modern” sector and the “traditional” sector, export-oriented industries and import-oriented industries, and the domestic economy and the international economy. Development in this case was viewed as a process of breaking down the barriers between the various sectors of the economy and of society.

117In 1962, the United Nations formally committed itself to promoting development and published The Development Decade: Proposals for Action, which set out the rationale for the first “development decade” (1960-70). The intention was to promote development generally throughout the world, but especially in those parts of the world that were deemed to be “underdeveloped,” and to achieve well-defined objectives and priorities for each “development decade.” The majority of these objectives and priorities were economic in nature, and were influenced by what the development economists were saying about industrialization, modernization, lack of saving, investment and capital formation, the dichotomous character of “underdeveloped economies” and “underdevelopment” generally, and the problem of decreasing imports and increasing exports in the underdeveloped parts of the world. By this time, the world was increasingly being seen as divided into two very distinct parts: a “developed” world, where higher levels of development, complexity, and sophistication had been achieved, and an “underdeveloped,” “less developed” or “developing” world, where a great deal remained to be accomplished. This was the latest manifestation of the trend towards a divided world that had been steadily gathering momentum for hundreds of years.

118While the problems of development occupied the attention of economists, political leaders, governments, and international organizations, the Cold War was heating up. As indicated earlier, much of this conflict was waged in Africa, Asia, Latin America, the Caribbean, and the Middle East, and was largely fought over whether the capitalist or the communist economic system and model of development yielded more effective results. The communist approach to development, involving extensive public planning and government intervention in the economy, was well-known by this time, since it had been taking shape in the Soviet Union since the 1920s, and was being expounded by a number of prominent economists and scholars in the West as well. However, there was a dire need to set out a detailed statement of the capitalist approach to development. This occurred in 1960, when Walt Rostow, an American economist and economic historian, produced The Stages of Economic Growth. Subtitled A Non-Communist Manifesto, this popular publication established the theoretical and practical framework for the capitalist approach to development, as well as the historical justification for it.

119Rostow’s book came just in time for people in North America and Europe. The United States and the western world were locked in a fierce ideological battle with the Soviet Union and other communist countries over which approach to development produced the best economic, political and social results. According to Rostow, countries had to pass through five well-defined stages if they wanted to become “developed.” These stages were “traditional society,” “pre-conditions for take-off,” “the take-off,” “the drive to maturity,” and “the age of mass consumption.” (Rostow also referred to a possible “sixth stage,” which he called “beyond consumption,” but he said that it was difficult to visualize and define.) The first stage was seen as presenting major impediments to development because many traditional beliefs and attitudes had to be overcome. Each of the other stages required the realization of very specific economic goals and objectives. For example, in order to “take off,” countries had to increase investment from five percent to ten percent of national income, create new industries and expand old industries, reinvest profits, and revitalize and modernize agriculture. What emerges overall is a portrait of countries that increasingly focus attention on the development of their economies and high performance in key economic variables. While Rostow’s “capitalist theory of development” contrasted sharply with the “communist theory of development” because it carved out a prominent place for capital rather than labour in the overall scheme of things, it still resorted to “the economic interpretation of history,” and assuming the centrality of economics and economies to make its case.

120Prompted by Rostow’s theory, the theories of numerous developmental economists, the policies of many governments, and the actions of international organizations such as the United Nations, the International Monetary Fund, and the World Bank, the notion of development spread like wildfire throughout the world from the 1960s to the 1980s. Virtually all countries and governments in the world adopted an economic model of development, or some variation on it, as their principal decision-making device and modus operandi. They also accepted the conviction of economists, statisticians, and development theorists and practitioners that development could be measured with exact statistical precision. This led to numerous refinements in the theories and models of economic development, as well as the creation of economic indicators capable of measuring and evaluating successful economic performance. Most prominent among these indicators were high rates of economic growth, full or near-full employment, high levels of capital formation and technological development, controlled inflation and price stability, and a healthy balance of payments.

121These indicators made it possible to rank countries according to the level, rate, and state of their economic development. They also made it possible to compare one country with another in terms of economic performance. This strengthened the division of the world into two parts. As a result, the challenge facing the world was seen as one of making it possible for the “underdeveloped” or “developing” countries to achieve the same levels, rates, and states of economic development as the “developed” countries.

122It was about this time that the dependency theory of development made its appearance on the scene. Advanced by such economic and social thinkers as André Gunder Frank and Samir Amin, the dependency theory was based on the conviction that “developing” countries are poor not because they are incapable of achieving higher rates of saving, investment, and capital formation, or because they are saddled with a large “traditional” sector and a small “modern” sector, but because they have been dependent on developed countries for so long that they cannot break out of the cycle of dependency on these countries. They are dependent on developed countries not only for aid and resources, but also for markets and trade. They must rely on developed countries for manufactured goods, intermediate goods, financial resources, capital, and technology, as well as for markets and trade, so that the prices for their products fluctuate dramatically. The fact that this dependency has been going on for hundreds of years makes the problem chronic, acute and structural, rather than superficial and sporadic, with strong economic, political, social, cultural, psychological, institutional and historical causes and overtones. Frank called this “the development of underdevelopment,” the systematic cultivation of dependency through generation after generation of exploitation, colonialism, imperialism, oppression, and structuring of the economies of poor countries to advance the interests of rich countries.

123Directly and indirectly, this led to the creation of a number of “structural adjustment” theories, intended to break the dependency of developing countries on developed countries. Many economists and international organizations initially favoured “import substitution” as the best way to achieve this, largely by helping developing countries to build up their own productive capacities and reduce their dependence on imports from abroad through the creation of locally produced products. When this approach failed rather badly to produce the desired results, it gave the dependency theory of development and the need for structural adjustment much more credibility. More recently, and primarily as a result of globalization, the rapidly escalating importance of international trade and free trade, the creation of huge free trade zones, and pressure from the World Bank, the International Monetary Fund, and the World Trade Organization, there has been a tendency to put the emphasis on “export-led development” rather than import substitution as the key to overcoming the structural dependency of developing countries. Many economists and developmental theorists now believe that without the development of a strong export sector and more effective trading capabilities, developing countries will not be able to take advantage of the opportunities offered by globalization, international trade, and trade liberalization. What stands behind this, of course, is the need to develop a strong domestic economy capable of producing the goods, services, and resources that are needed to realize export-led development, as well as the ability of developing countries to sell their agricultural and industrial products in developed countries’ markets, and not be put at a competitive disadvantage by the huge subsidies and high protective tariffs of developed countries.

124This is largely where matters stand today. Countries in Africa, Asia, Latin America, and the Caribbean claim that it is not possible for them to increase their exports substantially and realize “export-led development” so long as the countries of Europe and North America erect high tariff walls and provide huge subsidies to their own agricultural producers. This practice has become so endemic and commonplace that a group of countries from Africa, Asia, Latin America, and the Caribbean created the G20 at the meetings of the World Trade Organization in Cancun in 2003, the so-called Doha Round, in an attempt to counter the power and influence of the G8 countries. Tired of being shut out of the markets of North America and Europe, they banded together to increase their bargaining power and make the case that things will not change for the better until the countries of North America and Europe reduce or eliminate their agricultural subsidies, lower their tariffs significantly, and eliminate other discriminatory protectionist measures.

125The record of development economics over the past 60 years and more is mixed. On the one hand, much has been learned about the process of development that is relevant to every country in the world, particularly as it relates to the pivotal roles played by saving, investment, capital formation, consumption, trade, technology, education, training, the multiplier, entrepreneurship, the interrelatedness of economic systems regardless of whether they are capitalist, socialist or communist in nature, and the use of different methods, tools, and techniques to solve particular problems of development. On the other hand, a great deal remains to be accomplished, particularly as the development problem has worsened in some parts of the world. Clearly, much more needs to be learned about how development can be achieved in Africa, Asia, Latin America, the Caribbean, and the Middle East, particularly when there are such major impediments as adverse historical factors, oppressive institutional, social and political structures, too much dependency on foreign markets, capital and countries, and, especially, an inability to overcome internal shortcomings and deficiencies.

Contemporary Economics

126While the economic age has been extended to all parts of the world and interest in development economics continues to be strong everywhere, there is no single body of economic thought and practice that is dominant today, as was the case in earlier periods of history. There are many reasons for this. In the first place, no economic or social thinker of the stature of Adam Smith, Ricardo, John Stuart Mill, Marx or Keynes has emerged over the past 60 years to put his or her stamp on economics, and give it a clear, comprehensive and unequivocal direction. In the second place, no single issue or set of issues has dominated the attention of economists as the theory of production, distribution, and consumption, price determination, general and partial equilibrium, or governmental involvement in the economy did in earlier periods. Finally, many changes have taken place in the world that have affected economic thought and practice in a whole series of diverse, bewildering and often contradictory ways, including the environmental crisis, computerization, commercialization, the creation of the European Union and other regional trading blocs, globalization, the financial turmoil caused by technology stocks and fraudulent accounting practices, the volatility in stock markets and economies, particularly in Southeast Asia and Latin America, the re-emergence of conservative political ideologies, the expansion of multinational corporations, colossal changes in communications, technology, and international relations, the terrorist attacks on the World Trade Center and the Pentagon, and the political and religious upheavals in Iraq, Afghanistan, and elsewhere in the world. This profusion of events, activities, organizations, and developments has caused economists to move in many different directions.

127Despite this, it is possible to divide contemporary economics into two fundamental components: mainstream and margin. The mainstream continues to be concerned with the issues and problems raised by the classical, neoclassical, Keynesian and development economists, particularly production, distribution, consumption, saving, investment, income, output, price determination, scarcity, resource allocation, equilibrium, development, and economic growth. The margin is concerned with many new issues and problems that have appeared on the global horizon in recent years, including the environmental crisis, the emergence of the global economy, the need to achieve “development with a human face,” the relationship between economics and ethics, and the need to create a very different type of economic system in the future.

128As far as the mainstream is concerned, interest in classical, neoclassical and Keynesian economics is still very strong, although not as strong as it was when these systems were created. On the one hand, adherents of classical and neoclassical economics continue to believe that there is a self-regulating and self-correcting mechanism at work in the economy and markets, tending to restore equilibrium once there has been a major deviation from it. On the other hand, adherents of Keynesian economics continue to believe that there is no such mechanism at work, which has profound implications for the role of government, the use of monetary and fiscal policy to solve particular types of economic and social problems, the management of debts, deficits and surpluses, and, especially, the division of politics into “right,” “left,” and “centre.”

129In recent years there has been, in particular, a revival of interest in neoclassical economics, with attempts to update it in light of contemporary experiences and present-day realities. This has led to renewed interest in price and value theory, equilibrium analysis under conditions of imperfection and monopolistic competition, and the distribution of income, wealth, and resources among the main classes and interest groups in society. Economists partial to this approach continue to put the emphasis on the need to broaden and deepen understanding of production, distribution, and consumption in markets, buyers and sellers, the unfettered working of the economy to maximize the interests of consumers and corporations, rationality, the choices available to consumers and producers, and Pareto optimums and efficiencies. This has stimulated interest in the work of the Austrian school pioneered by von Mises, Böhm-Bawerk, von Hayek, Schumpeter, and others. In its more contemporary formulation, this approach places greater emphasis on the individual, individualism, freedom from government restraint and control, laissez-faire economics, espousal of the market as the main vehicle for discharging economic functions, rejection of quantitative studies and public policies, and emphasis on both the supply side and the demand side of the economy. It is an approach that meshes well with many developments that took place in the world in the closing years of the twentieth century and first few years of the twenty-first, especially the revival of conservatism, globalization, commercialization, free trade, computerization, international trade, and the promotion of democracy and capitalism throughout the world.

130The same holds true for the Chicago school of economics, spearheaded by Milton Friedman. Like the Austrian school, the Chicago school places a great deal of emphasis on the individual, individualism, maximizing consumer satisfaction and choice, utility, consumer and corporate sovereignty, independence from government regulation, and reliance on the market to clear surplus commodities and restore equilibrium. Strongly opposed to Keynesian economics and increased government intervention, the Chicago school recommends relying almost entirely on monetary policy rather than fiscal policy to bring about changes in the economy. Being advocates of the quantity theory of money, members of the Chicago school believe that monetary changes have profound effects on economic activity and conditions, and that price changes generally reflect changes in the quantity of money. Consequently, central banks have a strategic and vital role to play. Through their ability to manage and control the money supply and monetary policies, they can affect all the main economic aggregates, whether investment, consumption, saving, interest rates, the velocity of money, capital accumulation or technological development. This is why many contend that “the Fed” (the US Federal Reserve Board) possesses more power and authority than the US government.

131The situation with respect to Keynesian economics, the other principal element in the mainstream of contemporary economics, is more difficult to pin down and explain. In recent years there has been a tendency for Keynesian economists to subdivide into three main groups: conventional Keynesians, pure Keynesians, and post-Keynesians. Much of the distinction between the first two groups revolves around how Keynes’s general theory is interpreted, as well as whether a static or a dynamic approach is taken to the theory. This has important implications for the amount of emphasis placed on the real economy as opposed to the money economy, and therefore on fiscal policy compared to monetary policy. Of greater interest is the work of the post-Keynesian economists. Spearheaded by the research and writings of Joan Robinson, Nicholas Kaldor, Michal Kalecki and others, and, like Keynes himself, largely though not exclusively based at the University of Cambridge, post-Keynesian economics is based on the belief that the capitalist system is inherently unstable, operates at far less than full capacity or full employment, is characterized by imperfect rather than perfect competition, is prone to unequal distribution of income, wealth, and resources, produces high levels of unemployment and underemployment, and has a built-in inflationary tendency. As a result, post-Keynesian economists tend to be very sceptical about the ability of markets and the economy to generate steady economic growth, and about the likelihood that individual and corporate actions in the producers’ and consumers’ markets will necessarily yield socially desirable results. The solution, in their view, is for governments to play a much more substantial, active and direct role in the economy and the marketplace, a role that would be even more extensive than was recommended by the first generation of Keynesian economists. They argue that this is necessary in order to counteract the power of large corporations and financial and commercial elites, and to redistribute income, wealth, and resources on a more equitable basis. This takes economics out of the realm of theory and places it squarely into the realm of “political economy,” political practice, and welfare economics. As a result, there is much more emphasis on reallocative monetary and fiscal policies, increased government expenditure on health, education, welfare, and social assistance, and improvements in labour productivity and wages.

132Much of the debate going on in the western world at present revolves around whether governments should use actual and projected budgetary surpluses, if and when these occur, to increase expenditure on social programmes, as opposed to cutting taxes for citizens and corporations. Proponents of the first line of action favour the post-Keynesian approach, whereas proponents of the second line of action favour the Chicago school’s approach. Regardless of the approaches favoured by economists, politicians, political parties or governments, however, there is no doubt that all have been strongly affected by the terrorist attacks on the World Trade Center and the Pentagon, the wars in Afghanistan and Iraq, and the war on terrorism. This may well favour the Keynesian approach to economics in the years ahead, since governments will probably be compelled to play a much larger, more direct and assertive role in society through the prevention of terrorism, the provision of numerous safety and security measures, and the protection of citizens from terrorist attacks. This will result in much more expenditure on defence, the rooting out of terrorists and terrorist organizations, the firming up and protection of borders, and a host of new policies on immigration and security.

133While the majority of economists continue to be interested in mainstream economics, and therefore in the real economy, the money economy, and the intimate connections between the two, there is growing interest in some of the new issues and problems that have arisen over the past few years to challenge orthodox economic thought and practice. The most obvious example of this is the environmental crisis. What has forced this crisis to the forefront of attention is the rapid deterioration of the natural environment, as well as the phenomenal growth of the world’s population compared to the finite carrying capacity of the Earth. This is having an important effect on economic thought and practice in every part of the world, affecting not only the problems that economists and development theorists are wrestling with at present, but also the problems they are likely to have to wrestle with in the future.

134Focused interest in the environment by economists started in the 1960s and 1970s with the appearance of a number of influential books and articles, including seminal publications by Paul Ehrlich and the Club of Rome. These twentieth-century updatings of Malthus’s theory of population signalled a return to the central problem of population growth as it relates to the means of subsistence and the finite carrying capacity of the Earth. Clearly, there are limits to the carrying capacity of the planet that must be taken fully into account in the formulation and implementation of all future economic, demographic and political policies, practices, strategies, and systems. By focusing on five key variables affecting people and countries in every part of the world—population, resources, industrial output per capita, food per capita, and pollution—the authors of the Club of Rome’s Limits to Growth (1972) constructed a dynamic model that, they claimed, demonstrated in scientific, statistical and quantitative terms how crucial it is to achieve “global equilibrium” among the five key variables if human welfare and environmental well-being are to be assured in the future. While there have been claims that the model was too simplistic and flawed to produce reliable results, the authors concluded that the future of humankind will be adversely affected if this situation is not addressed successfully in the future. Without the ability to keep population growth in check and to limit the pressure of human numbers on the finite carrying capacity of the Earth, the future of humanity is, in their view, bleak.

135This conclusion, however pessimistic, simplistic or flawed it might be, forced people and countries in every part of the world to become much more aware of the extent to which human numbers, and consumption demands and expectations, are exerting enormous pressure on renewable and non-renewable resources, and the globe’s fragile ecosystem. This subject was taken up in earnest when the World Commission on Environment and Development released its report, Our Common Future, in 1987. Chaired by Gro Harlem Brundtland, former Prime Minister of Norway, the Commission emphasized the need to make a strong commitment to “sustainable development,” development that takes the natural environment and future generations into account, in all future economic planning and decision-making. Since that time, public and private institutions in most if not all parts of the world have been paying much more attention to the need to contain economic growth within carefully controlled and well-defined limits, rather than allow it to take on a life and character all its own. This may well have an important impact on economic thought and practice in the future, as economists, statisticians, and development theorists delve much more deeply into the complex connections between economics and the natural environment, and how the environment might be incorporated into economic thought and practice. One consequence of this may be that economists will put an economic value on the natural environment and give natural resources specific monetary prices. This could have profound implications for economic thought and practice, with recognition of the fact that natural resources are exceedingly limited in supply and cannot be taken for granted or treated as given in economic theory. This would cause a severe break with the traditional practice of treating natural resources as “free goods” that stand outside the realm of economics and economies.

136If coming to grips with the environmental crisis is one direction in which economics is moving at present, achieving “development with a human face” is another. What is sometimes called “the alternative economics movement” places a great deal of emphasis on “economics as if people mattered,” to use E. F. Schumacher’s evocative phrase. According to proponents of this movement, there is a need to protect social and public spaces in modern economic systems, many of which cannot be described in economic terms but are nevertheless exceedingly important to the functioning of the economy, markets, and society generally. This movement views economics as an extremely important part, but only one part, of a vast social and human undertaking that includes ethics, morality, ecology, cosmology, humanism, and many other activities (see, for example, Daly, Townsend, Etizoni, Henderson, Schumacher, and Hunt). At the root of this movement is concern for civil society, and the need to ensure that people are able to participate actively and fully in the public and private policy-and decision-making processes affecting their lives.

137Yet another development in contemporary economics is the concern for “the new economy,” “the global economy,” “economic security,” and the possible emergence of an entirely different type of economic system in the future. This is because economics and economies are being radically transformed as a result of colossal developments in technology, communications, information, information systems, globalization, commerce, finance, terrorism, and trade. Rather than being based on machinery, equipment, industry, products, and factories, the “new economy” will be based on knowledge, information, ideas, the internet, cyberspace, a variety of protective measures, and increased volatility and uncertainty. For those who subscribe to this view, the electronic revolution going on in the world today is every bit as powerful and pervasive as the agricultural and industrial revolutions of earlier times, and is causing humanity to switch from depending on animals and machines to depending on electricity and electronic forms of communications. Many believe that developments in this area will eventually make traditional approaches to economics, as well as the methods, models, and techniques devised by past generations of economists, obsolete.

138While it is still too early to say which direction the “new economy” will move in, there is no doubt that economics will move in some very different directions in the future. Despite this, many of these directions may hark back to issues and problems encountered by economists in earlier periods: dramatic fluctuations in economic activity, business cycles, shortcomings in economic growth, recessions, depressions, economic volatility, and instability. Developments as dynamic as these are so complicated and diffuse that it will take an economist of the stature of Adam Smith, Ricardo, John Stuart Mill, Marx or Keynes to pull them all together into a coherent and comprehensive system of thought and practice. Nevertheless, this does not alter the fact that we are living in an economic age. Regardless of whether it is powered by electronics, information, ideas, technology, products, machines or the internet, this age is driven by the belief that economics and economies in general, and economic growth and development in particular, constitute, and should constitute, the centrepiece of society, and the principal preoccupation of municipal, regional, national and international development. This belief, which has progressively broadened, deepened and intensified as a result of a whole series of theoretical and practical developments since the industrial revolution began, plays the dominant role in the world, and keeps the economic age functioning and intact.

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