The Dismal Science as We Know It

1. The Dismal Science as We Know It

2. Overarching Themes in Economic Thought Valueprices  microeconomics Distribution  factor prices Growth Macro-stability…and its discontents ‘flation BOOM and bust Economic Organization Role of Market Role of State

3. Wisdom of the Ancients • Oikonomia: run harmonious households&communities Heraclitus (~535 – 475 bc) Harmony thru conflict  Self – regulating market Pythagorus (~582 – 507 bc) Harmony thru numbers  Equilibrium Democritus (~460 – 370 bc) • Diminishing marginal utility • Time preference  present value

4. Plato (~427 – 347 bc): preserve the status quo“…the State is the soul writ large.” First principles: • Human inequalities  division of labor {good}  social stratification { scientific breeding} • Private property  acquisitiveness {bad}  turbulence Wealth  corruption

5. Plato’s Ideal Republic: A stationary state Society parallels the mind …the State is the soul writ large • The elite: Communal property/communal women • Philosophers • Soldiers • Shared Austerity Thinking Philosophers Soldiers (Response to scarcity) Fighting No incentive to advance Workers Craving Merchants

6. Aristotle (384 – 322 bc): focus on individual Human inequality  distributive justice …according to individualmerit In opposition to Plato: • Educate, don’t regulate • Private Property >> Communal Property • Productivity  Progress • Peace (communal property  quarrels) • Pleasure in ownership • Philanthropy (give your own stuff as you wish) But … Acquisitiveness for acquisitiveness sake is wrong • Lending at interest is unnatural • Barren money shouldn’t earn money

7. Aristotle on Money ...money is a sort of medium or mean; for it measures among other things excess or defect, e.g., the number of shoes which are equivalent to a house or a meal. As a builder is to a cobbler, so must so many shoes be to a house; for otherwise there would be no exchange. But this is impossible, unless the shoes and the house are in some way equalized. Hence arises the need for a single universal standard of measure-ment. This standard is in truth the demand for mutual services, which holds society together. Aristotle on Usury ...moneymaking from retail trade is unnatural, a mode by which men gain from one another. The most hated sort is usury, which makes a gain out of money itself and not from the natural use of it. For money was intended to be used in exchange, not to increase at interest. The term usury, which means the birth of money from money, is applied to the breeding of money because the offspring resembles the parent. Wherefore of all modes of making money this is the most unnatural.

8. Skipping a millennium or so… Medieval economics…Scholastics: • Preserve feudal status quo  fixation on usury • Escape clauses (per St. Thomas Aquinas) • “Damage suffered”  reward of waiting • “Escaped gain”  opportunity cost • Salamanca school: • “Just price”  Natural price  Supply – Demand Renaissance Nation-state Mercantilism: Build internal market! Policy…theory  Fixation on gold (according to Smith) {Money  Credit…Money  Capitalism/Keeping Score} Favorable balance of trade  Zero-sum view of economic life Gold outflow  downward pressure on employment • Colbert (French minister, late 17th century): REGULATE!!! • Hamilton (American minister, late 18th century): • Promote manufacturing via tariff • Export led growth: a theme common to mercantilists

9. Mercantilists: Zero – Sum Mental Set Mun • Director, East India Company • Defended company against charge it sent gold abroad  Its trade enriched the nation • “Prince” must not hoard the inflow of money lest there be deflation and depression • Role of the “war chest.” • Advocate of export led growth Thomas Mun 1571 - 1641

10. Surveyed … and divided up … Ireland among Cromwell’s soldiers • Physician/Social Scientist in Bacon’s empirical tradition • Secretary to Hobbes • Collected statistics/advised on Irish economic development • Founder of Royal Society • Petty’s analytical economics • Promoted consumption tax • tax incidence, however, falls on land • Value from land and labor, with equivalence based on land required for subsistence •  Anticipation of labor theory of value • Build pyramids to keep people employed (when all else fails) •  Government as employer of last resort •  Anticipation of Keynes • Early quantity theory of money • “Too little” money constrains trade • Increased velocity helps offset scarcity of gold and silver • Don’t debase the currency: Quantulumcunque concerning money (1682) … see questions and answers • Anticipated discount rate equating annual rents to land price • Division of labor  efficiency • Advocate of laissez-faire: physician do no harm • William Petty • 1623 – 1687 • Fitzmaurice • Landsdowne

11. Transition from Mercantilism to Smith • John Law (1671 – 1729) Money  Power … and paper money employs more people • Innovated paper money backed by value of land (Note the circularity) Mississippi Company, 1717 (owned half of lower ‘48) • A pyramid scheme that collapsed • Lesson learned: Monetary expansion  INFLATION • David Hume (1711 – 1776) • Price inertia  Short-run non-neutrality of money Spread of impacts from few merchants to economy in general Inflation  capitalist profits first  expansion  progress • Long-run neutrality of money • Specie flow mechanism Trade surplus self-destructs

12. Richard Cantillon(1680? – 1734?): Patron saint of Austrian Econ Irish banker in Paris … rode the Mississippi bubble …Essai, 1755/Rediscovered by Jevons,1880: “The cradle of political economy” (Jevons) • Land theory of value… labor equated to land needed to maintain subsistence: market price reverts to value Circular flow model of economic activity • Landowners – ENTREPRENEURS – Workers • Balance achieved by free market … or by central planner Estimates of flows  precursor of NI accounts Monetary theory: anticipation of Quantity Theory of Money • Concept of velocity • Dynamic effects of monetary injection (gold mining): Income effect  Increase spending  Increased price Prosperity first  Stagflation later … Austrian flavor

13. Themes in Monroe’s Selections from Cantillon’sEssai • Circular flow … automatic, iterative adjustment of supply to demand and of demand to earnings from supply • Cost-of-production theory of value  Intrinsic price • Labor and land inputs are costs • Labor cost translated to amount of land needed for subsistence and reproduction  Land theory of value • Market price fluctuates with Supply and Demand but reverts to “value” • Price fluctuations  risk for entrepreneur • Interactive adjustments … Austrian flavor – Human Action • Interdependencies among stages of production with risk at each stage • Interdependencies between products: prices of substitutes (meat and bread) move together • Kinked consumption function: Consumption rises more with increased income than it falls with decreased income • Money Spending  Prices • Velocity of circulation matters  no strict relation between M and P • Prices up  imports rise  “resource curse” • “Proprietors” of money earn interest (likened to rent) • Interest rate depends on risk to lender and return to entrepreneur

14. Cantillon: Recognition of Spatial Costs • Costs of transport enter into values and prices • Transport costs  Hierarchy of Places • Villages • Market Towns Extent of the market • Cities  the division of labor • Capital City (but he doesn’t elaborate on productivity) • Money flows from villages to market towns …to capital Prices are higher where money is more plentiful • Paper money depends on credibility/confidence • Lesson from Mississippi bubble

15. Cantillon’s Allusion to John Law & Mississippi Bubble …a Bank with the complicity of a Minister is able to raise and support the price of public stock and to lower the rate of interest when the steps are taken discretely, and thus pay off the State debt. But these refinements which open the door to making large fortunes are rarely under-taken for the sole advantage of the State…The excess of banknotes do not upset the circulation, because being used for the buying and selling of stock they do not serve for household expenses… But if some panic or unforeseen crisis drove the holders to demand silver from the Bank, the bomb would burst and it would be seen that these are dangerous operations.

16. Transition to Smith: The Physiocrats Fixation on agriculture – Manufacturing & commerce sterile Champions of laissez – faire What would you do if you were king? • François Quesnay (1694 – 1774) … “nothing” • Physician to Mme. de Pompadour • Leader of group: disciples and associates including Mirabeau, Dupont, Turgot, … and Smith • Tableau Economique self-reproducing Input-Output table Initially: Landlord has cash; farmer has grain; artisan has stock of goods Landlord buys and food and manufactures • Zig – zag to balance flows  An input-output table • Agriculture  increased wealth (counter to Colbert’s favoring mfg) • Taxes ultimately borne by landlords  tax land rents directly • Hoarding (of money) threatens economic stability { Keynes} • Free trade/free competition most profitable for the nation • Turgot, 1774: Attempted “revolution from above” but failed (land tax) The tableau: http://homepage.newschool.edu/~het/essays/youth/tableausum.htm

17. Physiocrats on Interest Quesnay: finance “knows neither king nor nation”  Control interest Turgot: • Interest depends on opportunity cost of not employing loanable funds agriculture • Capital would be withdrawn if interest were controlled  Interest viewed as cost of production  Smith’s costs-of-production theory of value Turgot on Instability in Tableau Economique(business cycle) “Disorder in distribution and expenditure” • Lower classes must have wherewithal to consume enough to reproduce … anticipates Malthus and Keynes • Otherwise, the Circular Flow breaks down … Marxian Disproportion Crisis