Understanding 'Classical' Economics

Heinz D. Kurz, Neri Salvadori

• Publisher: Routledge
• Year: 2002
• ISBN:
  9781134724956
• Edition: 1
• Topic: Betriebswirtschaft
• Subtopic: Business allgemein

The 'classical' approach to economic problems, which can be traced back to Adam Smith and David Ricardo, has seen a remarkable revival in recent years. The essays in this collection argue that this approach holds the key to an explanation of important present day economic phenomena. Focusing on the analytical potentialities of classical economics, the contributors illustrate how an important element of understanding its approach consists of developing and using its explanatory power.

1
UNDERSTANDING ‘CLASSICAL’ECONOMICS
An introduction

Ludwig Wittgenstein once remarked, ‘The classifications made by philosophers and psychologists are as if one were to try to classify clouds by their shape.’ We do not pretend, of course, to know whether this is a fair assessment of the situation in the disciplines mentioned. We rather ask whether it would be true if it were applied to economics. More particularly, we ask whether classifying economic ideas in distinct analytical approaches to certain economic problems and even in different schools of economic thought is a futile enterprise. The title of this book implies that we think that it is not. We are especially convinced that there is a thing that may, for good reasons, be called ‘classical’ economics, which is distinct from other kinds of economics, in particular ‘neoclassical’ economics.

This view could immediately be challenged in terms of the indisputable heterogeneity and multi-layeredness of the writings of authors in the two groups. Moreover, whilst with regard to some aspects an author might be classified in one group, with regard to some other aspects he or she might be classified in the other group. Therefore, it should be made clear from the outset that we are not so much concerned with elaborating a classification of authors, which in some cases would be an extremely difficult, if not impossible, task. We are concerned rather with classifying various analytical approaches to dealing with certain economic problems, especially the problem of relative prices and income distribution. What we have in mind is a particular rational reconstruction of ‘classical’ economics which, in our view, is useful both for an understanding of certain important arguments found in several classical authors and for the development of these arguments. Our interest in these approaches is thus not purely and not even predominantly historical; we consider them rather as containing the key to a better explanation of important economic phenomena. Our concern with classical economics is therefore first and foremost a concern with its analytical potentialities which in our view have not yet been fully explored. If we were of the opinion that they had already been exhausted our interest in classical economics would be moderate. Hence an important element of ‘understanding’ classical economics, as we conceive it, consists of developing and using its explanatory power.

In this chapter an attempt will be made to specify what we mean by classical economics and to show that it is not an evanescent concept. We begin, in the next section (pp. 3–6), with a brief discussion of the complexity of most economic problems and of economic theory as an attempt to come to grips with that complexity. This leads us to the identification of a first characteristic feature of classical economics: its long-period method. As we shall see in the following section (pp. 6–7), a version of this method was also shared by all major marginalist authors until the late 1920s. However, the similarity of the methods adopted by two theories must not be mistaken for a similarity in the content of the theories. This aspect is dealt with in the subsequent two sections. The first (pp. 7–9) turns to the scope and content of traditional classical economics, whereas the second (pp. 9–13) is devoted to traditional neoclassical economics. The emphasis is on the sets of data, or independent variables, on the basis of which these theories attempt to explain the respective unknowns, or dependent variables, under consideration. It will be seen that in this regard classical economics differs markedly from neoclassical economics, the main difference being the way in which income distribution is determined. These two sections also raise the question of whether the sets of data contemplated by the theories are compatible with the long-period method or whether there exist tensions and contradictions between the method and content of a theory. It is argued that, whilst traditional classical theory can be formulated in a consistent way, traditional neoclassical theory faces insurmountable difficulties in this regard. The latter come to the fore in the shape of inconsistencies that undermine the logical foundation of the approach to the problem of income distribution in terms of the demand for and the supply of the factors of production collaborating in the generation of the social product, when there are produced means of production, i.e. ‘capital’, among these factors. The following section (p. 14) turns to the attempts of neoclassical authors from the late 1920s onwards to remedy this defect and at the same time render the theory more ‘realistic’, and indeed ‘dynamic’, in terms of models of temporary and intertemporal equilibria. It can be argued, however, that these alternatives are beset by a number of methodological difficulties and do not escape the problem of capital, the stumbling block of earlier, i.e. long-period, neoclassical theory. The final section deals with some more recent attempts to come to grips with economic change; some approaches belonging to the classical and some approaches belonging to the neoclassical tradition will be summarized. It is shown that long-period reasoning is flourishing in contemporary economics and that there is no reason to believe that it will be abandoned soon.

ECONOMIC SYSTEMS IN MOTION AND THE LONG- PERIOD METHOD IN THE CLASSICAL AUTHORS

As is well known, the concern of the classical economists from Adam Smith to David Ricardo was the laws governing the emerging capitalist economy, characterized by wage labour, an increasingly sophisticated division of labour, the co-ordination of economic activity via a system of interdependent markets in which transactions are mediated through money, and rapid technical, organizational and institutional change. In short, they were concerned with an economic system in motion. The attention focused on the factors affecting the pace at which capital accumulates and the economy expands and how the growing social product is shared out between the different classes of society: workers, capitalists and landowners.

How to analyse such a highly complex system characterized by a dense network of interdependences and feedbacks, vis-à-vis which the observer might easily get lost in a myriad of facts and considerations, failing to see the wood for the trees? The ingenious device of the classical authors to see through these complexities and intricacies consisted of distinguishing between the market or actual values of the relevant variables, in particular the prices of commodities and the rates of remuneration of primary inputs (labour and land), on the one hand, and natural or normal values on the other. The former were taken to reflect all kinds of influences, many of an accidental and temporary nature, whereas the latter were conceived of as expressing the persistent, non-accidental and non-temporary forces governing the economic system. The classical authors did not consider the ‘normal’ values of the variables as purely ideal or theoretical; they saw them rather as ‘centres of gravitation’, or ‘attractors’, of actual or market values. This assumed gravitation of market values towards their natural levels was seen to be the result of the self-seeking behaviour of agents and especially of the profit-seeking actions of producers. In conditions of free competition, that is, the absence of significant and lasting barriers to entry in and exit from all markets—the case with which the classical authors were primarily concerned—profit seeking involves cost minimization. This was well understood by the authors under consideration, hence their attention focused on what may be called cost-minimizing systems of production.

The method of analysis adopted by the classical economists is known as the long-period method or the method of long-period positions of the economy. Any such position is nothing but the situation towards which the system is taken to gravitate, given the fundamental forces at work in the particular situation under consideration. A discussion of how the classical economists conceptualized these forces, or determining factors, is deferred to a later section. Here it deserves to be mentioned that in conditions of free competition the resulting long-period position is characterized by a uniform rate of profits (subject perhaps to persistent inter-industry differentials), uniform rates of remuneration for each particular kind of primary input in the production process (such as different kinds of labour and natural resources), and prices that are assumed not to change between the beginning of the uniform period of production and its end, that is, static prices. Such a situation is to be understood as reflecting the salient features of a competitive capitalist economy in an ideal way: it expresses the pure logic of the relationship between relative prices and income distribution in such an economic system. The prices are taken to fulfil the condition of reproduction: they allow producers to just cover costs of production at the normal levels of the distributive variables, including profits at the ordinary rate. These prices have aptly been called also prices of production (Torrens, Ricardo). We might also talk of ‘prices of reproduction’.

A frequent misunderstanding of the notion of the long-period position should be mentioned. According to it the classical economists’ view was ‘static’: they dealt with a given and immutable economic world and were able to say nothing useful either about how that world had come into being or about how it would develop. In short, they are said to have been concerned exclusively with analysing a given system of production, turning a blind eye both to the question of the genesis of that system and the path it would take in the future. In this view classical economics is static, not dynamic. Such an interpretation overlooks, first, a very special property the classical economists attributed to a long-period position, i.e. that the actual system gravitates around such a position. This is a property which is most certainly obtained on the assumption that the dynamic process of the actual system converges to the long-period position at a speed that is sufficiently large compared with the rate at which technological change tends to upset any such position. However, the classical economists did not ask for convergence of the actual system to the long-period position. They were indeed less demanding: in their view gravitation means market values of prices and the distributive variables never moving ‘too far away’ from natural levels. Second, the classical economists were not concerned only with studying the properties of a given system of production. They were also interested in which system would emerge as a result of the choices of profit-seeking entrepreneurs from a set of technical alternatives at their disposal, where this set was taken to reflect the technological knowledge available at a given time and place. For example, with new methods of production becoming available alongside the growth in technological knowledge, the economic system was envisaged as gravitating towards a new long-period position, characterized by a new set of relative prices and new levels of the distributive variables. That is, it was assumed that the new long-period position would make itself felt immediately: the short-run adjustment processes triggered would propel the economy towards that position.

Analysing economic change and development in these terms involves, as indicated, a short cut. The adjustment process to any such position is simply taken for granted. This is perhaps expressed too strongly, because the classical economists put forward an argument in support of the supposed gravitation of market values to their natural levels. The discussion of this problem in Smith and the authors following him is based on essentially two propositions. First, the market price of a commodity depends on the difference between current supply and ‘effectual demand’ for that commodity, where the latter is defined as ‘the demand of those who are willing to pay the natural price of the commodity’ (Smith, WN I.vii.8). If the difference is positive, negative, or zero, the market price is taken to be lower, higher, or equal to the natural price. A positive (negative) deviation of the market price from the natural price is reflected in a deviation of the actual levels of the distributive variables from their normal levels and especially in a positive (negative) deviation of actual profits obtained in the industry from normal profits. Second, this latter deviation provides an incentive to profit-seeking producers to reallocate their capital. Profit rate differentials trigger movements of capital (and labour) and, as a consequence, adjustments in the composition of production: the output of a commodity increases (decreases) if the market price is above (below) the natural price. These movements tend to annihilate the deviations and (re)establish a uniform rate of return on the capital invested in the various industries of the economy. Accordingly, in a long-period position actual outputs equal ‘effectual demands’ and actual prices are at their normal levels.

The above argument in support of the assumed gravitation process cannot, of course, replace a proper dynamic theory, not least because there are particular difficulties the earlier authors were not aware of. For example, it cannot be presumed that a positive (negative) difference between market and natural price is equivalent to an above (below) normal rate of profit, since the positive (negative) difference between the respective prices of the inputs entering into the production of the commodity under consideration may be even larger (cf. Steedman 1984). The question at issue is whether such a possibility does not prevent the ultimate tendency of the market price to gravitate towards the natural level, by causing the output of the commodity to decrease, thereby raising the market price even more.¹

Ever since the advent of systematic economic analysis in the seventeenth and eighteenth centuries economists have aspired to elaborate a proper dynamic theory, and many ingenious and hard-working people have made great efforts in this regard. However, given the complexity of the object of their analyses—a socio-economic system incessantly in travail—they realized that the long-period method was the best they had. The latter indeed quickly proved to be a powerful tool in studying certain properties of complex interdependent systems, that is, systems which would be extremely difficult to model and analyse in a dynamic framework even with the advanced tools of modern mathematical economics. Moreover, the classicals themselves occasionally ventured probing steps in the direction of such a dynamic analysis. Think, for example, of David Ricardo’s discussion of the introduction and diffusion of improved machinery in the additional chapter ‘On machinery’ in the third edition of his Principles, published in 1821. However, a general dynamic analysis of the highly complex system under consideration was regarded as impossible at the time. The analytical tools available did not allow of such a dynamic theory, paying due attention to all relevant interdependences. The long-period method was seen as the best available in order to come to grips, however imperfectly, with an ever-changing world characterized by on-going technical progress, the depletion of natural resources, a changing distribution of income, etc. Long-period analysis was devised precisely to overcome the impasse in which the social scientist found himself, confronted with a reality which, at first sight, looked impenetrable, made up of a myriad of relationships between people and natural objects. The long-period method introduced some transparency to the complex object of study and allowed the theorist to derive a large number of interesting insights into the functioning (and the sources of malfunction) of the economic system. Because of its fecundity the long-period method was almost universally adopted in political economy until the 1930s.

This does not mean that there was no interest among economists in short-run problems; there was, of course. However, the important point is that the short-period analyses elaborated by the majority of authors dealing with such problems had—as their backbone, so to speak—fully specified long-period theories. In other words, the long-period theory was considered the core of economic analysis, from which there derived several short- period analyses designed to tackle special problems of a short-run nature, such as the implications of a capital stock not fully adjusted to the other data of the system or a sudden increase of the quantity of money in circulation.

THE ADOPTION OF THE LONG-PERIOD METHOD IN TRADITIONAL NEOCLASSICAL THEORY

The appeal exerted by the long-period method can be inferred from the fact that all early major marginalist authors, including William Stanley Jevons, Léon Walras, Eugen vo...