The Making of the Classical Theory of Economic Growth

Anthony Brewer

• Publisher: Taylor & Francis
• Year: 2010
• Print ISBN: 9780415486200
• eBook ISBN: 9781136972263
• Edition: 1
• Topic: Business
• Subtopic: Business General
• Index: Business

This book collects together for the first time Anthony Brewer's work on the origins and development of the theory of economic growth from the late eighteenth century and looking at how it came to dominate economic thinking in the nineteenth century. Brewer argues that many of the earliest proponents of economics growth theory had no concept of it as a continuing theory.

This book looks at many of the key players such as Smith, Hume, Ferguson, Steuart, Turgot, West and Rae and is tied together with a rigorous introduction and a new chapter on capital accumulation.

Part I
The invention of economic growth

1
Introduction

The ‘classical’ theory of economic growth, magisterially set out in Adam Smith’s Wealth of Nations in 1776, marked an epochal change in the way we think about economic life and, indeed, about human society. Before the late eighteenth century, economic growth in its modern sense, that is, continuing growth in income and output over indefinitely long periods of time, was simply not up for discussion. Earlier writers, of course, worried about ways of improving economic performance, of increasing wealth and improving living standards, or of increasing the share of the nation or of the city in international trade. None of this is the same as the theory of continuing growth over the indefinite future found in Smith. Pre-classical writers did not consider economic growth in this sense and reject it. They did not consider it at all. It was not on the agenda.

Smith’s book changed all that. After the Wealth of Nations, growth rapidly came to be taken for granted, so much so that it is difficult for modern readers to recognize its absence from earlier writings. Modern economists, of course, do not talk about growth all the time. They frequently focus on the sort of questions that were under discussion before Smith. But growth is always in the background, so well recognized that it is often unnecessary to mention it. Before Smith it wasn’t mentioned, but because it had not occurred to anyone to consider it. Smith was not the first to write about economics. He was not the father of economics, as has sometimes been said, but he was, with Turgot (see below) the father of growth economics.

The essays collected here are an attempt to contribute to the understanding of this crucially important turning point in economic thinking. They were written over a period of time, but as part of a sustained effort to understand classical and pre-classical economic thinking on growth. They are not a random collection – they hang together to make up a consistent view – but they were written, and in most cases originally published, separately. Each essay, therefore, was written to stand on its own and to deal with a particular aspect of the story, leading to a small, but unavoidable, element of repetition between essays, for which I apologize. Each essay focuses on a topic on which I thought there was something to be said that was sufficiently substantial and original to justify publication. Well-known topics, where I saw no need to challenge the conventional wisdom, are passed over, or mentioned only in passing. This introduction, therefore, aims to provide a brief overview, linking together the essays and filling in the gaps. The previously published essays themselves are reproduced as they appeared originally, without any revision, because it would be confusing to have two versions of the same paper in the public domain.¹

The classical theory of growth

For present purposes, the classical theory of economic growth² has three essential features: (a) capital accumulation is seen as the primary source of economic growth, (b) population growth is treated as endogenous, and (c) invention or, in modern terms, technical change, is treated as secondary or relatively ignored. Each of these three deserves some discussion.

(a) The role of capital accumulation is central. Unpicking it, the argument goes like this. (i) People, on average, save. There are ‘prodigals’ who dissipate their wealth, but they are not typical. Spending by the state (especially on wars) is a greater danger, and there are catastrophes which destroy capital, but net saving is normal in ‘almost all nations, in all tolerably quiet and peaceable times’ (Smith 1976: 343). (ii) What is saved is invested, either by the saver or by someone to whom they have lent the money. Hence, capital accumulation is normal. (iii) The incentive to save (and invest) is the profit return on investment. The idea of profit as a regular form of income alongside wages and rent was new in the late eighteenth century. Earlier writers thought about profit as a form of wages or as an irregular gain made by merchants who buy cheap and sell dear. In the classical picture, capital investment is needed to employ workers and to provide them with materials. Owners of capital (or ‘stock’) seek out profits, so capital is mobile between different industries, with investment flowing to areas where profit is high and tending to equalize profits (allowing for risk) across the system. Saving, therefore, is directed by profit signals to where it is needed, and outputs of different goods match the demand for them. (iv) Accumulation of capital makes growth of output and employment possible and, since the economic system works to its full capacity, at least in normal times, accumulation ensures that growth actually takes place.

(b) Population was assumed to be endogenous. If capital accumulation makes it possible to employ more people, then population will (given time) expand in line with the demand for labour. The mechanism is ‘Malthusian’ (though it goes back well before Malthus). Population change is assumed to be a function of income levels. At ‘subsistence’ level, incomes are just enough to maintain the population from generation to generation, but no more. This is effectively a definition of ‘subsistence’. At lower levels of income, either people avoid having children that they cannot afford to support, or mortality rates increase, because of hunger and susceptibility to disease, to an extent which outweighs new births. When incomes rise above subsistence, the population starts to grow. In a static system with a constant capital stock, wages would settle at subsistence level, since higher (lower) wages would lead to an expanding (contracting) population and labour force and hence to more (less) competition for jobs, driving wages down (up) towards the subsistence level. In a growing system, the accumulation of capital allows growing employment, the growing demand for labour bids wages up, and in the long enough term, population grows in line with the demand for labour. This view fits with the classical view of capital and accumulation. The focus in classical economics is on working capital, required to pay the wage bill and to pay for materials in advance of the sale of the product. Capital accumulation is important primarily because it allows increased employment, not because of substitution of capital for labour or an increase in the capital–labour ratio, though some of the later classical writers did consider some degree of substitution. In the main story, capital accumulation leads to parallel, though not necessarily proportional, increases in both capital and labour.

(c) Technical change (‘invention’) is not wholly ignored in classical economics, but it plays a secondary role. Smith, for example, cited the invention of ‘machines which facilitate and abridge labour’ (1976: 17) as one of the consequences of the division of labour, which in turn requires capital accumulation. Invention thus falls into place in an account of growth driven by saving and accumulation.³ Before Smith, Adam Ferguson emphasized invention, though not, I would argue, to the extent of basing a story of growth on it (see chapter 5). Later on, John Rae criticized Smith’s theory and reversed the causal order. In Rae’s story, invention is the primary cause of growth, while saving and investment, though necessary, are passively induced by the profit opportunities created by invention (see chapters 11 and 12).

In the classical view, then, given a reasonable level of peace and security, the economy will grow over time as a result of the private, self-interested actions of individuals who seek only to better their own condition (Smith 1976: 341). No special external stimulus or policy change is needed, and no change in motivation or habits. It is an essentially quantitative conception of growth, driven by the growing quantity of accumulated capital. Any structural changes are the result, not the cause, of growth.

Before Turgot and Smith

The idea of continuing growth on the lines summarized above is not found before Turgot and Smith. That case is argued in detail in chapter 2, so I will not duplicate the argument here. That chapter, however, focuses on the specific question of the presence or absence of a concept of continuing growth, neglecting other ways in which earlier writers helped to set the scene for the emergence of the developed classical theory.

Richard Cantillon’s Essay on the Nature of Commerce in General was, arguably, the first attempt to understand the economy as an integrated system, held together by market exchanges. (For a fuller treatment of Cantillon, see Brewer (1992).) Turgot and Smith took much from him. In particular, his concept of intrinsic value (equilibrium price) is essentially the same as Smith’s natural price. In Cantillon’s account, if production of some particular good, agricultural or manufactured, exceeds (falls short of) demand, the price and hence the returns to that line of production will fall (rise), inducing a shift of production away from products in excess supply and towards those in short supply. Output thus adapts to demand, and returns are equalized (Cantillon 2001: 30). Cantillon’s version differs from Smith’s in that the return to capital plays no role in Cantillon – in the developed Smithian version, the focus is on the flow of capital between sectors, leading to equality in the profit rate (adjusted for risk and the like), but the effect, the adjustment of output to demand, is the same. Cantillon recognized that individuals need capital to be able to set up in business, and that they have to get an appropriate return on their investment (Prendergast 1991), but there is no sign that he saw the availability of capital as a constraint on the overall level of activity. In his account, the amount and fertility of the land is the ultimate constraint. The basis of the economy is an essentially unchanging agricultural sector. Manufacturing is not tied to the land in the same way, and a country can expand manufacturing output and employment if it is successful in export markets, importing food and other agricultural products to match. This, however, is a zero-sum game, with one country gaining at the expense of others, and is not at all like the continuing endogenous growth which Smith described.

François Quesnay took the next step forward, basing himself on Cantillon but emphasizing the need for capital as a key constraint in agriculture, which he regarded as the only productive sector. I argue in chapter 2 that he did not develop that insight into a theory of continuing growth. He was very pessimistic, probably unduly so, about the state of French agriculture and the French economy generally, arguing that output and population had fallen drastically over the preceding century or so. He blamed taxation which fell directly on farmers, together with restrictions on prices and on trade in grain, which held down agricultural returns. In his account, improved policies could bring about a fairly rapid and potentially large recovery, so his focus was on the short to medium term, not on long-term continuing growth.

The emphasis on investment as the key to growth was substantially new and represents a very important step towards Smith’s economics. Apart from the exclusive emphasis on agriculture, the other major difference between Quesnay and Smith from the present point of view is his treatment of profit and saving. In the numerical examples which carry the main thrust of Quesnay’s argument, an improvement of policy leads to an increase in farmers’ revenue. They are then assumed to invest the whole of this gain, leading to very striking economic expansion (in the numerical examples), but when leases come up for renewal the whole gain, including the profit (net revenue) derived from the new investment, is captured by the landlord in increased rent, bringing the expansion to a halt since the landowner is not assumed to invest out of the increased rent. Whether this is really the whole of Quesnay’s case is discussed more fully in chapter 2. The point here is to note how different this is from Smith’s (and Turgot’s) treatment, in which individuals, from many (unspecified) ranks in society, save as a matter of routine out of their normal income...

Table of contents

• Routledge Studies in the History of Economics
• Contents
• Acknowledgements
• Note on the text
• Part I The invention of economic growth
• Part II The Scottish tradition from Hume to Smith
• Part III Accumulation and growth
• Part IV Growth, saving and distribution
• Part V Epilogue
• Index