The term “classical economics” was coined by the German political philosopher and economist Karl Marx, who stated “that by classical Political Economy, I understand that economy which, since the time of W. Petty, has investigated the real relations in bourgeois society” (Marx 1954, p. 85n.). Classical economics included, for example, the physiocrats, the English economist David Ricardo, and partly the Scottish economist Adam Smith; it excluded such authors as Thomas Robert Malthus and Jean-Baptiste Say, whom Marx considered “vulgar economists” dealing with “appearances” only.
Generally, economists and scholars have not adopted Marx’s definition of classical economics. According to other interpreters there was no deep cleavage between earlier and later economists. The continuity thesis was expressed most forcefully by Alfred Marshall around the turn of the eighteenth century and in contemporary times by John R. Hicks and Paul A. Samuelson. Marshall perceived the classical economists as essentially early and somewhat crude demand and supply theorists, with the demand side in its infancy. The received Marshallian interpretation was challenged by Piero Sraffa, first in his introduction to volume I of his edition of Ricardo’s works and correspondence (1951), and secondly in his Production of Commodities by Means of Commodities: Prelude to a Critique of Economic Theory (1960), in which he reformulated the classical approach to the theory of value and distribution and showed that its analytical structure is fundamentally different from later marginalist (or neoclassical) analysis.
The classical economists were concerned with the laws governing the emerging capitalist economy, characterized by the stratification of society into three classes of workers, landowners, and the rising capitalists; wage labor as the dominant form of the appropriation of other people’s capacity to work; an increasingly sophisticated division of labor within and between firms; the coordination of economic activity via a system of interdependent markets in which transactions are mediated through money; and significant technical, organizational, and institutional change. In short, they were concerned with the production, distribution, and use of wealth of an economic system that was incessantly in motion. How should one analyze such a system? The ingenious device of the classical authors for seeing through the complexities of the modern economy consisted of distinguishing between the “actual” or “market” values of the relevant variables—the distributive rates and prices—and their “normal” or “natural” values. The former were taken to reflect all kinds of influences, many of an accidental or temporary nature, about which no general propositions were possible, whereas the latter were seen to express the persistent, nonaccidental, and nontemporary factors governing the economy, which could be systematically studied.
The method of analysis the classical economists adopted is known as the method of long-period positions of the economy. Any such position is one toward which the system is taken to gravitate as the result of the self-seeking actions of agents, thereby putting into sharp relief the fundamental forces at work. In conditions of free competition, that is, the absence of significant barriers to entry or exit from all markets, the resulting long-period position is characterized by a uniform rate of profits (subject, perhaps, to persistent inter-industry differentials reflecting different levels of risk) and uniform rates of remuneration for each particular kind of primary input. Competitive conditions were taken to engender cost-minimizing behavior of profit-seeking producers.
The determination of the general rate of profits, the rents of land, and the corresponding system of relative prices constitute the analytical core of classical political economy. It was meant to lay the foundation of all other economic analysis, including the investigation of capital accumulation and technical progress; of development and growth; of social transformation and structural change; and of taxation and public debt. The pivotal role of the theory of value and distribution can be inferred from the fact that the latter is typically developed right at the beginning of major classical works.
The classical concept of production starts from the following interrelated premises. First, human beings cannot create matter, they can only decompose or recompose and move it. Production involves productive consumption, and the real cost of a commodity consists in the commodities necessarily destroyed in the course of its production. This concept of physical real cost, according to Sraffa, differs markedly from later marginalist concepts, with their emphasis on “psychic cost.” Second, production consists essentially of a circular flow: Commodities are produced by means of commodities. This idea was advocated by William Petty and Richard Cantillon and was most effectively expressed in François Quesnay’s Tableau économique (Aspromourgos, 1996). It is in stark contrast with the “Austrian” view of production as a oneway avenue leading from the services of original factors of production to consumption goods. Third, all property incomes—profits and rents—are explained in terms of the social surplus; that is, those quantities of the different commodities that are left over after the necessary means of production used up and the means of subsistence in the support of workers have been deducted from the gross outputs produced during a year. In this conceptualization, the necessary real wages of labor are considered no less indispensable as inputs and thus “agents of production” (James Mill 1826, p. 165) than raw materials, tools, or machines. Fourth, profits, rents, and relative prices are explained essentially in terms of magnitudes that can, in principle, be observed, measured, or calculated. The objectivist orientation of classical economics has received its perhaps strongest articulation in a famous proclamation by William Petty, who, in his Political Arithmetick, published in 1690, stressed that he was to express himself exclusively “in Terms of Number, Weight, or Measure” (Petty 1986, p. 244).
The classical economists proceeded essentially in two steps. In a first step they isolated the main factors that were seen to determine income distribution and the prices supporting that distribution in specified conditions; that is, in a given place and time. The theory of value and distribution was designed to identify in abstracto the dominant factors at work and to analyze their interaction. In a second step, the classical authors turned to an investigation of the causes that, over time, systematically affected the factors at work from within the economic system. This was the realm of the classical analysis of capital accumulation, technical change, economic growth, and socioeconomic development.
The rate of profits is the ratio of two bundles of heterogeneous commodities, the social surplus (exclusive of rent), and the social capital. In order to be able to compare these bundles, a theory of value was needed. With a circular flow the values of commodities can only be determined by means of simultaneous equations, a tool not available to the classical economists. They therefore approached the problem of value and distribution in a roundabout way, typically by first identifying an “ultimate measure of value” by means of which heterogeneous commodities were meant to be rendered commensurable. Several authors, including Smith, Ricardo, and Marx, had reached the conclusion that labor was the sought standard and thus arrived at some version of the labor theory of value. This was understandable in view of the unresolved tension between concepts and tools. However, it is far from clear how these labor values could be ascertained in a circular framework except by solving a system of simultaneous equations. In fact, with the benefit of hindsight, contemporary economists know that the labor theory of value landed the classical approach in an impasse and was one of the reasons for its premature abandonment and the rise to dominance of marginalist theory.
Yet, as Sraffa (1960, p. 6) showed, the classical economists were correct in assuming that a coherent determination of the general rate of profits and prices was possible in terms of the two sets of data on which they based their theory of value:
- the system of production in use, described in terms of the methods of production and productive consumption actually employed; and
- the real wage rate (or, alternatively, the share of wages).
This can be shown as follows: Let Ti, Mi and F i designate the inputs of three commodities—tools (t ), raw materials (m ), and the food of workers (f )—employed as means of production and means of subsistence in industry i (i = t, m, f ), and T, M and F the total outputs in the three industries. Denoting the value of one unit of commodity i by pi (i = t, m, f ), one has the following system of price equations:
(Tt pt + Mt pm + Ft pf (1 + r ) = Tpt
(Tm pt + Mm pm + Fm pf)(1 + r ) = Mpm
(Tf pt + Mf pm + Ff pf)(1 + r ) = Fpf
Flukes apart, these equations are independent of one another. Fixing a standard of value, for example, pf = 1, provides a fourth equation and no additional unknown, so that the system of equations can be solved for the dependent variables: the general rate of profits and prices. The distribution of the surplus must be determined at the same time and in the same way as are the prices of commodities.
With the rate of profits determined on the basis of data (1) and (2), the classical authors turned to the problem of the accumulation of capital and thus of the growth of the system. They typically assumed that the process of economic expansion was not constrained by an insufficient supply of labor, because the workforce needed was seen to be created endogenously, either via some population mechanism, as in the case of Malthus, or via the labor-displacing effects of machinery, as in the case of Marx’s “industrial reserve army of the unemployed” (Marx 1977, p. 600). Ricardo discussed both mechanisms and also analyzed the case in which capital accumulates and the population grows, but there is no technical progress. Due to diminishing returns in agriculture, a rise in differential rents paid on intramarginal lands will, for a given real wage rate, entail a falling rate of profit. (The theory of intensive diminishing returns was later taken up by the marginalist economists who thought that the underlying principle could be generalized from agriculture to all industries and to all factors of production [labor, land, and capital] alike and a theory be elaborated in terms of a single principle only: that of relative scarcity.)
The classical authors also discussed different forms of technical progress. In Adam Smith capital accumulation increases the extent of the market and thus allows for an ever deeper division of labor. This increases labor productivity due to gains of specialization and induced inventions of machinery and thus engenders growing levels of income per capita. Smith’s endogenous growth mechanism is a virtuous circle. Other classical authors were somewhat less optimistic. Ricardo, in the chapter on machinery in the Principles (1821) contemplated the case of a kind of mechanization that is gross output reducing: While labor productivity rises, total employment and the output-capital ratio (or maximum rate of profits) fall. This case reappears in Marx’s discussion of the rising organic composition of capital and, given the share of wages, falling tendency of profitability. In 1967 Richard Goodwin formalized some of the classical ideas on accumulation and distribution in terms of an adaptation of the predator-prey model developed in the theory of animal populations.
The classical economists advocated trade liberalization. According to Smith the specialization pattern of an economy would follow its absolute cost advantages. Via an opening of domestic and foreign markets trade would allow a deeper division of labor and thus enhance productivity growth. Ricardo showed, contrary to Smith, that what really mattered were comparative advantages and not absolute ones. Assume that one of two economies is able to produce all commodities at lower unit costs. Only this economy would export and the other one import. This would, however, engender a specie-flow mechanism with prices in the former economy rising and in the latter one falling. Ricardo’s theory of money, a version of the quantity theory, was an integral part of his trade theory. Sooner or later some prices in the latter economy would have fallen below the levels in the first one and thereby reverse the competitive situation. This would relate precisely to those commodities in the production of which the second economy has a comparative advantage.
Since the publication of Sraffa’s Production of Commodities by Means of Commodities there has been a revival of the classical approach. For a summary account of what has been achieved, see, for example, the work of Heinz D. Kurz and Neri Salvadori.
SEE ALSO Capitalism; Capitalism, Managerial; Chicago School; Competition; Competition, Marxist; Economics, Institutional; Economics, Islamic; Economics, Keynesian; Economics, Neoclassical; Economics, Neo Ricardian; Economics, New Classical; Economics, New Keynesian; Economics, Post Keynesian; Institutionalism; Libertarianism; Marginalism; Market Economy; Marx, Karl; Mill, John Stuart; Ricardo, David; Smith, Adam; Stockholm School
Garegnani, P. 1987. Surplus Approach to Value and Distribution. In The New Palgrave: A Dictionary of Economics. Vol. 4, eds. John Eatwell, Murray Milgate, and Peter Newman, 560–574. London: Macmillan.
Goodwin, Richard. 1967. A Growth Cycle. In Socialism, Capitalism and Economic Growth, ed. C. Feinstein. Cambridge: U.K.: Cambridge University Press.
Kurz, Heinz D. 2004. The Surplus Interpretation of the Classical Economists. In A Companion to the History of Economic Thought, eds. W. J. Samuels, J. E. Biddle, and J. B. Davis, 167–183.
Kurz, Heinz D., and Neri Salvadori. 1995. Theory of Production: A Long-Period Analysis. Cambridge, U.K.: Cambridge University Press.
Kurz, Heinz D., and Neri Salvadori. 1998a. Understanding “Classical” Economics: Studies in Long-Period Theory. London: Routledge.
Kurz, Heinz D., and Neri Salvadori, eds. 1998b. The Elgar Companion to Classical Economics. 2 vols. Cheltenham, U.K., and Northhampton, MA: Edward Elgar.
Marx, Karl. 1954. Theories of Surplus Value. Moscow: Progress Publishers.
Marx, Karl. 1977. Capital. Vol. 3. Moscow: Progress Publishers.
Mill, James. 1826. Elements of Political Economy. 2nd ed. London: Harry G. Bohn.
Quesnay, François. 1972. Quesnay’s Tableau Economique. Eds. M. Kuczynski and R. L. Meek. London: Macmillan. (Orig. pub. 1759).
Ricardo, David. 1951–1973. The Works and Correspondence of David Ricardo. 11 vols. Ed. Piero Sraffa with the collaboration of M. H. Dobb. Cambridge, U.K.: Cambridge University Press.
Smith, Adam. 1976. An Inquiry into the Nature and Causes of the Wealth of Nations. Oxford: Oxford University Press. (Orig. pub. 1776).
Sraffa, Pierro. 1960. Production of Commodities by Means of Commodities: Prelude to a Critique of Economic Theory. Cambridge, U.K.: Cambridge University Press.
Heinz D. Kurz
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What It Means
“Classical economics” refers to the ideas of the first wave of modern economists, whose work spanned the late eighteenth century and much of the nineteenth century. The classical period of economic thought began with the publication in 1776 of the Scottish philosopher Adam Smith’s An Inquiry into the Nature and Causes of the Wealth of Nations , the book whose theories gave rise to the modern study of economics. After Smith the most prominent figures generally included in the category of classical economists are David Ricardo, Thomas Malthus, John Stuart Mill, and Karl Marx.
The classical economists differed on many issues, but together they laid the foundation for all economic study to follow. Smith introduced the idea of analyzing the complicated processes involved in a nation’s production of goods and services, and the later classical theorists refined, added to, and reconsidered the picture of economic activity that he had drawn.
When Did It Begin
There was no systematic study of economic activity until after the Middle Ages (the period from about 500 to about 1500), when nation-states in Europe (such as England, France, Spain, and Portugal) began building power through wealth that was often amassed by traders. With the growing role of traders, economies were transitioning from being controlled by the nobility to being run by private individuals (a system that came to be called capitalism). This first phase of capitalism (which spanned the sixteenth through eighteenth centuries) was dominated by an economic theory called mercantilism. The mercantilists believed that a nation’s wealth equaled the amount of precious metals, such as gold and silver, that its government possessed. Therefore, the European nations attempted to establish a favorable balance of trade, which meant that they intentionally exported more goods than they imported, thus ensuring that they brought in more gold and silver than they sent to other countries.
Adam Smith (1723–90), writing in Scotland, formulated his book An Inquiry into the Nature and Causes of the Wealth of Nations (published in 1776) as an argument against mercantilism. One of his chief goals was to show that a nation’s wealth was not simply equal to its stockpiles of precious metals. In Smith’s view, everything that a nation produced for sale should be taken into account when judging that nation’s wealth. Therefore, he said, it was healthy economic activity, and not gold stockpiling, that governments should worry about promoting.
More Detailed Information
Economic health, in Smith’s view, arose naturally from market activity (a market is any place where buyers and sellers come together). Self-interest led businesses to seek profits, which meant that they would naturally want to charge consumers as much as possible for their goods or services, while paying their workers as little as possible. The business owners’ desires for profits would be balanced, however, by the self-interest of consumers and workers, who wanted, respectively, to pay as little as possible for goods and services and to be paid as much as possible for their labor. When there were multiple businesses competing for customers as well as for workers, prices fell and wages rose until there was just enough profit to keep a business in operation. Thus, the market itself ensured that the goods and services people wanted were produced with maximum efficiency and at a fair price. Smith called this phenomenon the “invisible hand” that guided capitalism.
Smith revolutionized thinking about capitalism by showing that the public interest (the greatest good for all people in a society) could be promoted at the same time that individuals had no motive other than self-interest. He believed that the government should refrain from intervening in market processes as much as possible and should instead trust the invisible hand to guide the economy.
David Ricardo (1772–1823), writing in England during the early nineteenth century, developed some of his most important theories in response to the idea of government intervention in foreign trade; he specifically objected to Great Britain’s Corn Laws, which restricted imports of grain. Ricardo focused on the interaction of capitalists (those who used land for speculative business purposes), laborers, and landlords (those who owned land). The capitalists used some of their profits to pay rent to the landlords and some to pay the laborers their wages. When the government protected the profits of capitalists (in the instance of the Corn Laws, these were tenant farmers) through import restrictions on grain, it meant that more grain needed to be grown within England to feed the population. Because the amount of farmland was limited, it became more sought-after, and landlords were able to charge the farmers higher rents. Meanwhile, Ricardo argued, the laborers’ rates of pay were bound to be fixed at subsistence levels (allowing them to pay only for the bare necessities). The landlords therefore were the only ones making increased profits in this scenario, because the capitalists would be paying more rent and would still have to pay the same wages to workers. This would result in a decline in profits for capitalists and possible economic stagnation. Ricardo’s view was that, because of this process, economic expansion inevitably led to shrinking profits over time even without harmful trade restrictions.
Thomas Malthus (1766–1834), a friend of Ricardo, dealt extensively with the troubling side of economic activity. He first rose to prominence by theorizing that mass starvation would overtake England in the future as a result of overpopulation. Later he focused on the idea that an economy could collapse if there was a “general glut,” a situation in which there were more goods and services produced than people wanted to buy. Ricardo and subsequent economists dismissed this theory, but it came back into prominence in the twentieth century, when Malthus’s ideas seemed to be borne out by the Great Depression (the worldwide economic crisis that started in 1929 and lasted through the rest of the following decade).
The German political philosopher Karl Marx (1818–83) and the English philosopher John Stuart Mill (1803–73) both focused on the flaws in capitalism, but they came to very different conclusions. Marx built on Smith’s and Ricardo’s ideas to argue that capitalists derived their profits by exploiting workers, paying them less than they deserved given the amount of value they contributed to the goods and services that were produced. In Marx’s view competition and economic growth would inevitably cause capitalists’ profits to shrink, forcing them to exploit workers further. As shrinking profits forced more capitalists out of business, economic power would be concentrated in the hands of a few. Meanwhile, the working class would be larger and more dissatisfied than ever, so that revolution and the downfall of capitalism would become inevitable.
Mill, meanwhile, agreed that capitalism did not result in a fair distribution of rewards, but he did not prophesy the system’s collapse. Instead he argued that income could be redistributed without harm coming to the overall economy.
One idea that united all of the classical theorists was a basic agreement on how the value of a good or service was created. Classical economists tended to view value as the sum of the labor that went into the production of a good or service. Beginning in the late 1800s economists started to reconsider this idea, called the labor theory of value. This reconsideration of value inaugurated a new school of thought called neoclassical economics, which continued, with certain major adjustments, to represent the views of mainstream economists through most of the twentieth century.
The neoclassicists viewed value not simply in terms of the amount of labor required to produce a good or service but also in terms of the amount of satisfaction a product gave the consumer. Consumers were seen as rational decision makers who took into account the satisfaction they would get out of buying one product versus another. The greater amount of satisfaction a product gave per unit of cost, the greater its value to consumers. While this issue marked an advancement over classical economists’ ideas, the neoclassical school continued to build on the basic ideas pioneered by the first modern economists.
Classical economic concepts were not, in fact, subjected to wholesale reevaluation until the Great Depression, which seemed to refute many of the assumptions that economists had long made. The ideas of the British economist John Maynard Keynes (1883–1946) departed greatly from classical theory and revolutionized economics in the 1930s and 1940s. In subsequent decades, however, the neoclassicists strove to integrate his ideas with their own. Thus, classical economics lives on.
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