Historical Analysis in Economics

Graeme Snooks

• Publisher: Routledge
• Year: 2019
• Print ISBN:
  9780415088251
• eBook ISBN:
  9781134880775
• Topic: Business
• Subtopic: Business General
• Index: Business

Neo-classical economics is frequently criticised for paying inadequate attention to historical processes. However, it has proved easier to make broad claims that `history matters' than to theorise with any depth about the appropriate role for history in economic analysis.
Historical Analysis in Economics considers what history can contribute to the science of economics: how would it matter if `history mattered?'

1

WHAT CAN HISTORICAL ANALYSIS CONTRIBUTE TO THE SCIENCE OF ECONOMICS?

Graeme Donald Snooks

INTRODUCTION

The most telling observation about modern economics is that the dimension of real time has been lost. As an abstract, deductive, and mathematical science, economics has focused upon shortrun, comparative-static analysis of both a partial and general kind. Within this frame of reference, economics has been highly successful. Microeconomic theory in particular – largely because of a more manageable scope of enquiry – is a very powerful tool for examining equilibrium conditions and outcomes. This is not at issue. What is of concern here is that the range of real-world problems which can be successfully analysed in this way is both limited – unnecessarily so – and limiting. The concerns of modern economics are not trivial, although there is some truth in Joan Robinson’s jibe about the importance of analysing the price of a cup of tea, but they do not include the really big issues confronting human society at the present, and which are likely to dominate our future. This is not meant to dismiss important shortrun problems such as inflation or unemployment – problems that economists currently are having difficulties resolving – just the context in which they are analysed. The big issue facing human society today is how to achieve a balance between population increase, economic growth, and the dwindling stock of unpolluted natural resources, without economic and social collapse. This is an issue about the dynamics of human society on both a regional and global scale – an issue that transcends shortrun equilibrium analysis. The problem for economics is that it has very little to say about longrun dynamic processes.

If the most important and pressing problems require a realistic analysis of the dynamics of human society, and if modern economics is unable to tell us much about this matter, then how seriously should society take this science? No doubt the answer to this question will vary according to one’s perspective. The concern in this book is more with what is required to give economics greater conviction when forced to face up to the larger issues confronting mankind. The argument here is that we should not abandon what has been achieved by deductive economics, rather we should augment it with an historical analysis of both shortrun and longrun economic problems – problems that are an integral part of the dynamic processes of human society. In this way it may even be possible to construct more realistic path-dependent models.

In order to highlight the limitations of economic theory in handling dynamic processes, this chapter will outline the timeless approach to economic change. It will be suggested that these limitations can be overcome by adopting an historical approach to economics in order to reconstruct real-world economic processes. The chapters in Parts II and III illustrate the way in which this can be achieved.

THE TIMELESS APPROACH

The limitations of the timeless approach to economic analysis can best be exposed by focusing upon the fundamentally important subject of economic growth. It is a subject of considerable interest to the profession, both past and present, but one that has proved frustratingly elusive for the deductive theorist. While growth has long been of interest to policy-makers, the first systematic treatment of the issue can be found in the works of the classical economists, including Adam Smith, Malthus, and Ricardo. This interest was carried forward by Marx; Schumpeter; Harrod and Domar; the neoclassicists, including Swan, Solow et al.; and more recently by the ‘new’ growth theorists. Without wanting to prejudge the outcome of the ‘new’ growth theory, it seems fair to conclude that the most impressive work on growth theory was produced before the First World War. The growth analysis of the classical economists – together with the work of those who relied heavily upon this foundation, including Marx and Schumpeter – was a central feature of their wider analysis of the capitalist economic system, and the insights it contains depend to a considerable degree on historical knowledge. Growth theory since the First World War, however, has been a highly specialized and largely detached area of study undertaken within the broader framework of economic analysis, rather than as an integral part of a grand system, and certainly without reference to historical reality. These more recent theories focus on a very limited number of variables and, as such, are of little use in explaining real-world, or historical, growth processes. What they can do, however, is to analyse a certain outcome, such as ‘steady state’, regular cycles, or convergence to or divergence from an equilibrium growth path. They can achieve this because they have been constructed to do so. As the perceived economic problems have changed, new models that can provide these outcomes have been constructed and then abandoned. There is no general theory that can encompass these ad hoc partial theories. No single theory can either explain all past growth outcomes (let alone processes) or successfully predict future growth outcomes.

The classical model of growth

What can the various growth models tell us about reality? Is it really possible to explain a process involving real time by adopting a timeless approach to model building? In order to address these and similar questions, a brief survey of the main types of growth models has been undertaken. The intention is to isolate and discuss the main features of these growth models in a general rather than a mathematical way. There are many good technical surveys elsewhere.¹

The growth models of the classical school were concerned to examine and explain the dynamic forces underlying the British economic system of the eighteenth century. This interest was stimulated by a desire to ensure, through appropriate policies, that the British population gained the greatest material benefit from these forces, not only for its own sake, but also to achieve the greatest general progress of human civilization.² In the generalized classical system – in which there is one sector, agriculture (although this can be expanded to include other sectors), three factors of production (land, labour, and capital), and three corresponding economic groups (landlords, workers, and capitalists) competing for shares of the social surplus – the various elements of production, exchange, distribution, and accumulation are integrated to explain not only how the economy operates at a point in time but how it changes through time.³

Central to the process of growth is the accumulation of capital, which is stimulated by that part of the social surplus – profits – that accrues to capital. Only capitalists invest their surplus, because workers expend their wages entirely on the means of subsistence, and landlords devote their rents entirely to unproductive consumption. During a growth phase, the sequence of causation is as follows: profits rise; funds are invested in capital equipment, possibly embodying a degree of technological change (resulting in a further division of labour); the demand schedule for labour (MP_L) shifts to the right; nominal wages rise; population increases; the margin of cultivation is extended; diminishing returns in agriculture are encountered; production costs rise; profits are reduced (rents increase); and the rate of capital accumulation and population growth decline until eventually the economy reaches the stationary state. Although the classical economists understood that technological change and trade would delay the tendency towards the stationary state by shifting the demand schedule of labour outward, they believed that the ultimate fate of the mature capitalist economy was stagnation.

The fundamental flaw in this model, which J.S. Mill was supporting as late as the mid-nineteenth century, is that it was based upon assumptions that were not closely related to reality during the Industrial Revolution. As is well known, the classical economists underestimated the role of both technological change and international trade in counteracting the move to a steady-state equilibrium. In part this was because they focused upon a pre-industrial economy, and in part because they did not understand (as many still do not) the dynamics of preindustrial societies. Had they been better historians they would have realized that the British feudal and medieval economic systems had experienced rapid growth (in per capita terms) involving technological change and international trade, as well as diminishing transaction costs owing to organizational change over prolonged periods of time. Technical change overwhelmed any tendency toward diminishing returns in agriculture, and international trade and foreign investment provided expanding opportunities for continued growth.

The timeless approach of the classical economists distorted their view, not only of the future, but also of the past. Their view of the past was obscured by the limitations of their abstract model, particularly concerning their theory of distribution. We have already seen that the classical economists regarded growth as a function of the proportion of the social surplus that found its way into the hands of capitalists, because both landlords and labourers used their shares unproductively. As feudal societies were dominated by powerful landlords, they argued, very little of the social surplus could have been invested productively, and hence feudal societies must have been unenterprising and largely stationary. This conclusion is important not because it was correct, which it certainly was not,⁴ but because it became the conventional wisdom in England about premodern societies that has been subscribed to by economist and non-economist alike. Indeed it is still the basis of the explanation employed by some eminent scholars today.⁵

Marx’s model of growth was a variation on the classical theme. While Marx accepted the importance of capital accumulation and its relationship to the rate of profits (rather than just the size of profits as in the classical model), he saw a greater role for technological change, which he regarded as the main driving force of the capitalist system, and the interaction with the world economy. On the other hand, he rejected the classical relationship between wages and population expansion, and substituted arguments about the ‘reserve army of labour’ and changing labour-force participation rates. Despite these changes to the classical argument, the outcome of Marx’s model was much the same. Although capitalists attempt to maintain profits through innovation, the growing capital intensity of production (owing to the labour-saving nature of innovation) reduces the profit rate, places increasing pressure on wage rates, increases unemployment, and finally causes the capitalist system to collapse after experiencing increasingly severe fluctuations. Despite the many insights that Marx’s economic system provided, it distorted his view of the past, present, and future. His view of reality was obscured, as it was for the other classical economists, by the inflexible use of theory. In Marx’s case this largely involved adherence to the principle of dialectical materialism, which was a philosophical/political, rather than an economic, explanation of social change. He was committed to the idea of destructive class conflict – rather than the classical idea of creative competition – and an economic system that would generate this conflict. It did not seem to occur to him that such a system was economically irrational. Ironically the centrally determined system that replaced capitalism in some countries, notably in Eastern Europe, under the inspiration, if not the direction, of Marx was economically irrational and, as a result, finally collapsed at the end of the 1980s.

The Schumpeterian growth model

Schumpeter’s growth model, like that of the classicists, was part of his theory of the entire capitalist system. Indeed, his concern was with dynamic processes underlying society as a whole. In his own words:

Economic development is so far simply the object of economic history, which in turn is merely part of universal history, only separated from the rest for purposes of exposition. Because of this fundamental dependence of the economic aspect of things on everything else, it is not possible to explain economic change by previous economic conditions alone. For the economic state of a people does not emerge simply from the preceding economic conditions, but only from the preceding total situation.⁶

Needless to say, this is in marked contrast to the more narrowly focused growth theory that has emerged since the First World War.

Schumpeter’s analysis begins with a discussion of ‘the circular flow of economic life’ in which all economic activity is repetitive, and undergoing a predictable routine. He focused upon an economic system in longrun general equilibrium, in which all factors are fully employed and which are ‘paid’ their marginal products, whether in the market or the household sectors. Economic growth only occurs when this longrun equilibrium is disturbed. And it is innovation that causes this ‘disturbance’: innovation embodied in new plant and equipment. Innovation of product or process in this model generates supernormal profits for the leading entrepreneur, which in turn encourages other entrepreneurs to follow suit. The original innovation may also call forth a series, or ‘cluster’, of complementary innovations. Accordingly there is a burst of investment financed by credit expansion, which in turn produces an increase in employment and output. As investment increases, and if there are no further innovations, profit rates fall until they reach normal levels, and new investment ceases. Once more we are in equilibrium.

As Schumpeter explains, the innovation-led boom ‘altered the data of the system, upset its equilibrium, and thus started an apparently irregular movement in the economic system which we conceive as a struggle towards a new equilibrium position’.⁷ In this model the progression from one equilibrium position to another passes through a cyclical movement of boom and depression. Schumpeter argues:

the boom … creates out of itself an objective situation, which, even neglecting all accessory and fortuitous elements, makes an end of the boom, leads easily to a crisis, necessarily to a depression, and hence to a temporary position of relative steadiness and absence of development.⁸

The boom involves a disequilibrium in which there is ‘overproduction’, ‘skewness’, ‘the appearance of disproportionality … between quantities and prices of goods’ and between new and old businesses and industries, and also speculation.⁹ The depression is an inevitable outcome of this disequilibrium and ‘the driving impulse of the process of depression cannot theoretically stop until it has done its work, has really brought about the equilibrium position … Nor will this process be interrupted by a new boom before it has done its work in this sense’ owing to the uncertainties about ‘new data’ which make the ‘calculation of new combinations impossible’.¹⁰

Schumpeter’s theoretical discussion of the growth process is clearly informed by observation of historical processes of change. In fact, it is probably the most successful and influential attempt to use an inductive–deductive approach in the history of economic analysis. This was due in part to Schumpeter’s training, which was both theoretical (without being mathematical) and empirical, and in part to his genius for observing and interpreting real economic processes. He was, as will be explained in Chapter 3, a ‘realist’ rather than a ‘gameplayer’. Accordingly, it is to Schumpeter rather than any other growth theorist that those who wish to reconstruct real-world growth processes turn.

Schumpeter’s overall grasp of reality was superior to that of the classical economists and Marx. He was able to distinguish between the capitalist and the entrepreneur, as well as between invention and innovation; he saw the connection between innovation and the rate of profit; he could see how technological change could prevent the emergence of the steady state; and he was able to integrate a theory of cyclical fluctuations with a theory of growth. His model does not just provide a method for thinking about causal relationships, it provides an unparalleled basis for understanding and reconstructing real, or historical, processes of change.

Keynesian and neoclassical growth models

Modern growth theory, which has emerged largely since the Second World War, can be distinguished from earlier work by its more abstract, ahistorical, and disembodied nature. The initial work by R.F. Harrod (1939) and E.D. Domar (1946) was inspired by Keynes’ General Theory (1936).¹¹ As is well known, the General Theory presented a macroeconomic model that attempted to show how it was p...

Table of contents

• Cover
• Half Title
• Title Page
• Copyright Page
• Dedication
• Table of Contents
• List of figures
• List of tables
• List of contributors
• Preface
• 1 What Can Historical Analysis Contribute to the Science of Economics?
• Part I The role of history in economics
• Part II Urbanization and economic development
• Part III Longrun issues in labour, business and banking
• Notes
• Bibliography
• Index