Phyllis Deane - The Evolution of Economic Ideas (Livro) PDF

MODERN CAMBRIDGE ECONOMICS
THE EVOLUTION OF ECONOMIC IDEAS

MODERN CAMBRIDGE ECONOMICS
Editors
Phyllis Deane Gautam Mathur Joan Robinson
Also in the series

Michael Ellman
Socialist Planning
Joan Robinson
Aspects of Development and Underdevelopment
Amiya Kumar Bagchi
The Political Economy of Underdevelopment
THE EVOLUTION OF
ECONOMIC IDEAS
Phyllis Deane
Professor of Economic History in the University of Cambridge and
Fellow of Newnham College
CAMBRIDGE
UNIVERSITY PRESS
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© Cambridge University Press 1978
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and to the provisions of relevant collective licensing agreements,
no reproduction of any part may take place without the written
permission of Cambridge University Press.
First published 1978

Reprinted 1979,1980,1982,1984,1988,1993
A catalogue recordfor this publication is available from the British Library
Library of Congress Cataloguing in Publication Data
Deane, Phyllis.
The evolution of economic ideas.
(Modern Cambridge economic series)
Includes index.
1. Economics — History. I. Title.
HB75.D29 33o'.o9 77-88674
ISBN 978-0-521-21928-0 Hardback

ISBN 978-0-521-29315-0 Paperback
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the accuracy of such information thereafter.
SERIES PREFACE
The modern Cambridge Economics series, of which this book is

one, is designed in the same spirit as and with similar objectives
to the series of Cambridge Economic Handbooks launched by
Maynard Keynes soon after the First World War. Keynes' series,
as he explained in his introduction, was intended 'to convey to
the ordinary reader and to the uninitiated student some con-
ception of the general principles of thought which economists
now apply to economic problems'. He went on to describe its
authors as, generally speaking, 'orthodox members of the Cam-
bridge School of Economies' drawing most of their ideas and
prejudices from 'the two economists who have chiefly influenced
Cambridge thought for the past fifty years, Dr Marshall and
Professor Pigou' and as being 'more anxious to avoid obscure
forms of expression than difficult ideas'.
This series of short monographs is also aimed at the intelligent
undergraduate and interested general reader, but it differs from
Keynes' series in three main ways: first in that it focuses on
aspects of economics which have attracted the particular interest
of economists in the post Second World War era; second in that
its authors, though still sharing a Cambridge tradition of ideas,
would regard themselves as deriving their main inspiration from
Keynes himself and his immediate successors, rather than from
the neoclassical generation of the Cambridge school; and third
in that it envisages a wider audience than readers in mature
capitalist economies, for it is equally aimed at students in deve-
loping countries whose problems and whose interactions with the
rest of the world have helped to shape the economic issues which
have dominated economic thinking in recent decades.
Finally, it should be said that the editors and authors of this
Modern Cambridge Economics series represent a wider spec-
trum of economic doctrine than the Cambridge School of
Economics to which Keynes referred in the 1920s. However, the
object of the series is not to propagate particular doctrines. It
is to stimulate students to escape from conventional theoretical
ruts and to think for themselves on live and controversial issues.
PHYLLIS DEANE GAUTAM MATHUR JOAN ROBINSON
CONTENTS
v
Series preface page
Introduction ix
1 Origins of modern economics i
2 Adam Smith's theory of value 19
3 Origins of modern growth theory 29
4 Classical monetary theory 44
5 Ricardo on value, distribution and growth 60
6 Scope and methodology of classical political
economy 71
7 T h e marginal revolution and the neo-classical
triumph 93
8 The neo-classical theory of value 115
9 The Marxian alternative 125
10 Neo-classical orthodoxy in the inter-war period 143
11 Monetary theory in the neo-classical era 163
12 The Keynesian revolution 175
13 Twentieth-century growth theory 190
14 Methodological divisions in economics since
Keynes 205
Index of names 227
Subject index 230
INTRODUCTION
There are basically two approaches to a study of the development

of ideas in a discipline. The first concentrates on the dialectical
sequence of change in the theories, concepts and analytical
techniques which constitute the substance of the discipline; the
second traces the historical process of change in the way suc-
cessive generations of scientists have adapted their explanatory
techniques to a solution of the problems they regarded as impor-
tant and soluble. The two approaches are not mutually exclu-
sive, they overlap, and most historians of economic thought have
taken both into account. But they raise different sets of questions.
The approach from the first aspect is primarily concerned with
a rational justification and critique of the theoretical basis of
economic analysis in successive epochs; the second with explain-
ing the historical process of innovation and adaptation in the
analytical framework which economists have typically accepted
as appropriate to the pursuit of their enquiries. The predominant
trend in recent histories of economic thought has been towards
increasing the emphasis on the first approach. Schumpeter's
History of Economic Analysis and Blaug's Economic Theory in
Retrospect are among the more widely known examples of the
genre. This book, mainly intended for students committed to a
systematic study of economic theory, shifts the weight of its
emphasis in the direction of the second approach and seeks to
interpret the history of economic thought as a process of change
in the ideas of successive generations of economists.
A prime difficulty in pursuing this kind of socio-historical
approach in a study of the evolution of economic ideas lies in
specifying the relevant economic consensus, the analytical frame-
work which a given generation of economists accepts as auth-
oritative. It would appear that it is easier to do this for one of
the natural sciences. According to Sir Karl Popper, for example,
'A scientist engaged on a piece of research in, say, physics, can
x Introduction
attack his problems straight away. He can go at once to the heart
of the matter; that is to the heart of an organized structure. For
a structure of scientific doctrines is already in existence; and with
it the generally accepted problems situation.'1 Philosophers of
science concerned with how and why successive generations of
practising scientists cling to, or rearrange, or alter the explan-
atory techniques in which they have been trained, have used the
word 'paradigm' to denote the doctrinal core that the majority
of practising scientists are prepared to take for granted. Thomas
Kuhn, for example, has defined a paradigm in its generally
accepted connotation as a disciplinary matrix '"disciplinary"
because it refers to the common possession of the practitioners
of a particular discipline; "matrix" because it is composed of
ordered elements of various sorts each requiring further
specification',2 though he also identifies a broader, sociological,
use for the term in which 'it stands for the entire constellation
of beliefs, values, techniques and so on shared by the members
of a given community'.3
Since Kuhn popularised the term by elevating the concept of
a paradigm to a key role in a theory of scientific progress, in which
'normal' cumulative advance is punctuated by revolutionary
episodes defined as paradigm-switches, it has become a somewhat
sensitive category. In the intense controversy sparked off by
Kuhn's theory of scientific revolution his concept of a paradigm
has been attacked as ill-defined,4 as being inapplicable to most
scientific disciplines, and as implying that the theories embraced
by different generations of scientists were so heavily rooted in
dogmatism as to be outside the range of rational confrontation.5
Those who prefer to stress the continuities rather than the
1
K. Popper, The Logic of Scientific Discovery (1959), Preface.
2
T. S. Kuhn, The Structure of Scientific Revolutions (1969), p. 182.
3
Ibid, p. 175. Both references are to the postscript added to the second
(1969) edition.
4
A sympathetic critic has distinguished 21 different senses in which Kuhn used
the term in the first edition of his Structure of Scientific Revolutions (1962): see
Margaret Masterman, 'The Nature of a Paradigm', in I. Lakatos and A.
Musgrave (eds.), Criticism and the Growth of Knowledge (1970). Less sympathetic
critics have felt it sufficient evidence of Kuhn's confusion to point to this fact or
to select the senses which they choose to attack.
5
E.g. K. Popper, 'Normal Science and its Dangers', in Lakatos and Musgrave
(eds.), op. cit., p. 54'His schema of normal periods dominated by one ruling theory
(a "paradigm" in Kuhn's terminology) and followed by exceptional revolutions
seems to fit astronomy fairly well. But it does not fit, for example, the evolution
of the theory of matter; or of the biological sciences since, say, Darwin and
Pasteur.'
Introduction xi
discontinuities in scientific progress (a preference which tends
to be associated with an interest in the logic of discovery as
opposed to the sociology of knowledge) react particularly strongly
against the notion of a total paradigm-switch, and/or deny that
it is ever possible to express the full range of explanatory
techniques available to a discipline at any one time in a systematic
network of ideas. Both objections have considerable force in
the context of economics. Among the philosophers of science
the sharpest reaction to Kuhn's use of the paradigm concept
has been associated with its irrational or sociological con-
tent. Those whose interest in the history of intellectual develop-
ment is focused on a critical appraisal of past theories in terms
of their approximation to absolute or objective truth have little
use for a theory which postulates a significant irrational element
in the common framework of ideas accepted by scientists at a
given point of time.8 To the extent that economic theory
is regarded as 'value-free' this objection also has force for
economics.
More recently, economists unwilling either to take a dogmatic
view of what constitutes progress in economic theory, or to
abandon the search for the holy grail of objective internalist (i.e.
rationalist) criteria of progressive change, have been attracted by
the 'methodology of scientific research programmes' suggested
by Imre Lakatos. This approach, which brings normative method-
ological criteria to the fore, interprets the history of science
in terms of a continuous competition between alternative re-
search programmes, rather than as a succession of conjectures and
refutations on the one hand, or of total paradigm-switches on
the other.7 As was demonstrated by the papers presented to the
economics sessions of a colloquium inspired by Lakatos, attempts
to interpret the evolution of particular sub-sets of economic ideas
as sequences of competing research programmes can yield new
insights and unusual perspectives on the way certain theories
have developed.8 One of the contributors, Mark Blaug, went so
far as to conclude that' if we have regard to professional rather
than popular opinion' the 'externalist' (i.e. socio-psychological)
6
E.g. K. Popper again: 'The Myth of the Framework is, in our time, the
central bulwark of irrationalism', Lakatos and Musgrave (eds.). op. cit., p. 56.
' See Imre Lakatos and Alan Musgrave (eds.), Criticism and the Growth of
Knowledge (1970), p. 177: 'Kuhn's conceptual framework for dealing with con-
tinuity in science is socio-psychological: mine is normative... Where Kuhn
sees "paradigms", I also see rational "research programmes".'
8
Spiro Latsis (ed.), Method and Appraisal in Economics (197b).
xii Introduction
factors are redundant to the history of scientific progress in
economics and 'a Lakatosian "rational reconstruction" would
suffice to explain virtually all past successes and failures of
economic research programmes'. 9 Such a judgment, however,
seems to rest on a rather narrower definition of a professional
economist than I would wish to adopt, and to beg the question of
how one defines success or failure.
The upshot of the debate on Kuhn's theory of scientific revolu-
tions seems to be that there is a strong element of 'rhetorical
exaggeration'10 in his concept of a paradigm which fully deter-
mines both the world-view of practising scientists and the re-
search agenda of 'normal' scientific activity and also in the
associated notion of a scientific revolution involving a total
paradigm-switch. What the Kuhnian interpretation did bring
out, however, more effectively than any other, is the connection
between the socio-historical development of professional schools
of thought and the intellectual development in the theoretical
content of a discipline. Nor is it necessary to embrace Kuhn's
theory of scientific revolutions to find the concepts of a ' para-
digm' and of an intellectual 'revolution' convenient description
categories to apply in a review of the evolution of economic ideas
which seeks to take into account the socio-historical context of
their development. No doubt there are dangers in using a term
such as paradigm which may imply that the average economist's
repertoire of theories and concepts is a more fully articulated
system than it in practice is: just as there are dangers in applying
the term revolution to highlight the discontinuities in a process
of continuous conceptual change. But it is scarcely in dispute
that there have been ruling paradigms in economics in that the
textbooks describe a related set of theories, concepts and analy-
tical techniques accepted as authoritative (though not necessa-
rily as beyond criticism) by a majority of economists; and that
there have been radical changes in the structure of economic
9
10
Ibid, p. 177.
The term is Touimin's. See Stephen Toulmin, Human Understanding, Vol.
1 (1972), pp. 105-6: 'If we are to make the theory of paradigms and revolutions
fit the historical evidence. . .we can do so only on one condition. We must face
the fact that paradigm-switches are never as complete as the fully-fledged
definition implies: that rival paradigms never really amount to entire alternative
world views; and that intellectual discontinuities on the theoretical level of
science conceal underlying continuities at a deeper methodological level. This
done, we must ask ourselves whether the use of the term "revolution" for such
conceptual changes is not itself a rhetorical exaggeration.'
Introduction xiii
doctrines which determine the generally accepted problem
situation. The questions which arise when one approaches the
history of economic thought from this angle are, for example:
when did economics acquire a sufficiently coherent and well-
attested paradigm to rank as a distinct discipline? What were
the distinguishing characteristics of successive paradigms?
How revolutionary were the changes attributable to periods
of significant conceptual innovation? How do we explain
the success or failure of alternative paradigms in gaining a
hold over the minds of a majority of economists? These
are the kind of questions that will be raised in this
book.
Moreover, whatever may be the case for the natural sciences,
there is no doubt that in the social sciences the attraction of a
paradigm, and the factors in its displacement, depend to a
considerable extent on forces beyond the range of logical eval-
uation of its explanatory power. Political economy, born out of
philosophy and ethics, has always been a discipline with strong
normative implications in spite of a persistent effort on the part
of its practitioners to develop its scientific and objective aspects.
The philosophical and ideological premises of an economic
theory thus play an important role both in its initial acceptance
and in its tenacity. More important still perhaps in dislodging a
ruling orthodoxy is the fact that both the empirical content of
the economic problem and the boundaries of the discipline are
changeable. Economic processes, for example, change through
time with economic, social and political institutions. Theories and
concepts may drift away from objective truth because the nature
of economic reality is changing; and critical appraisal of the
relative superiority of economic theories (whether competing at
particular points of time or ruling in different epochs) must be
conditioned by the knowledge that economists' views on the scope
of the discipline, as well as on its problem priorities, shift
inevitably with changes in the character of the political, social and
economic context. It may be that changes in the doctrines which
practising economists regard as orthodox are more often the
result of an autonomous change in the problem-situation, leading
to changes in the form of explanation, than of objective research
designed to test the logical or empirical validity of existing
theory.
The current paradigm for economics - the set of micro and
macro theories, concepts, techniques and problems purveyed in
xiv Introduction
the orthodox textbooks" - has come under increasing attack in
recent years for reasons that will be considered later in this book.
The result is that the discipline is in the throes of what Kuhn's
model would categorise as a ' methodological crisis' such as typi-
cally precedes a complete paradigm-switch. Even a non-Kuhnian
interpretation would indicate that some kind of paradigm change
was in the air because both the textbook doctrines and their
practical applications are being increasingly subjected to fund-
amental criticism. Students in faculties where orthodox theory
is being actively questioned by individuals of acknowledged
stature in the profession12 are finding it particularly hard to
digest a textbook-authenticated paradigm which appears to be
already disintegrating.
The object of this book is neither to paper over the cracks nor
to suggest ways of identifying a new paradigm awaiting its cue
in the wings, but, by tracing some of the historical antecedents
and parallels to contemporary theoretical controversies, to put
them into perspective and to interpret some of the major issues
at stake. The political quality of much of the contemporary
methodological debate springs from profound disagreements
about what economics is, and about what problems the economist
should be concerned to solve - disagreements that will confirm
some observers in their belief that economics is not a science at
all, possibly not even a definable discipline. However, starting
from the position that economics is a discipline whose terms of
reference, theories and analytical techniques are defined by an
invisible college of authoritative practitioners (i.e. economics is
what economists do), I postulate that shifts in economists' views
about what problems they ought to be solving, as well as how they
ought to be solving them, are the key to understanding the
historical changes that have taken place in the ruling paradigm
for economics. From this angle of vision I have looked at the way
leading theorists have adapted their theories and concepts - and
with them the research orientation of the discipline - to major
changes in the problem-situation confronting them. I have not
" There are of course plenty of unorthodox textbooks on the market, some
of which are finding their way into the undergraduate reading lists in some
strength (e.g. Joan Robinson and John Eatwell, An Introduction to Modern Econo-
mics, 1973), but they have not yet succeeded in displacing the conventional texts
which most examiners can confidently be expected to accept, if not enthusias-
tically to approve.
12
By the leaders of the institutional establishment as well as its self-styled
heretics. See below pp. 222-3.
Introduction xv
tried to be in any sense exhaustive, either in the range of theories
or in the leading theorists discussed, for two reasons - first be-
cause the book was designed as one of a series of deliberately
short student texts, and limitations of space thus made it neces-
sary to select both the theories and the theorists considered.
The second reason was that certain schools of thought, or
theories, or writers, seemed to illustrate more effectively than
others the main themes implicit in my starting point.
In consequence this book focuses particularly on the evolution
of economic ideas in three distinctive branches of economic
theory - value, growth and money. And because it was usually
easier to trace that evolution from teacher to pupil I have more
often focused on English (even Cambridge) theorists and their
problem situations than on continental or American examples.
I am conscious of the fact that the story could have been told
with a different cast of characters and a different batch of inte-
llectual problems. But on the assumption that critical students
will have other, more comprehensive, sources to draw upon they
should benefit by testing the arguments in alternative contexts.
The object is not to provide readers with a complete account of
the evolution of any one branch of theory, nor to identify all who
have made a major contribution to its progress, but to illustrate
the way economists' views on the scope and methodology of their
discipline - and hence the assumptions and questions underlying
their theories - have been subject to a variety of intellectual,
historical and ideological influences.
A number of people have read one of the many drafts of this
book, have rescued me from some shocking errors of logic or
misconception or have helped to clarify some of its more opaque
passages or to put the argument into better order. I am parti-
cularly grateful to Joan Robinson (who has combed patiently
through several drafts), Geoff Harcourt, Don Moggridge, Sue
Howson, Donald Winch, Colin Day and Mark Blaug. They are
of course in no way responsible for the new confusions which
have emerged in the process of redrafting or for my obstinate
errors of omission. The quotations from Lionel Robbins, The
Nature and Significance of Economic Science, and The Collected
Writings of John Maynard Keynes are by permission of Macmillan,
London and Basingstoke.
ORIGINS OF MODERN ECONOMICS
Ideas have been developed about economics - economic con-

cepts and theories that might seem familiar to the students of
twentieth-century textbooks - longer probably than written
records survive to attest. Schumpeter, for example, refers to
Kung Fu Tse (i.e. Confucius 551-478 B.C.) and Meng Tzu (372-288
B.C.)' from whose works it is possible to compile a comprehensive
system of economic policy' and who used 'methods of monetary
management and of exchange control that seem to presuppose
a certain amount of analysis'. 1 The standard histories of eco-
nomic thought generally begin with references to Plato and
Aristotle (sometimes also to the Old Testament) before launching
into a discussion of theories of the just price: and it has become
conventional to divide the history of western economic thought
into four distinctive epochs:
(1) Classical Greek; the ideas of this period have come down to
us embedded in political philosophy focused on the ethical
problems of the aristocratic slave-based city-state.
(2) Mediaeval scholastic; in this period scholarship was a clerical
monopoly and medieval economic ideas are to be found in
essentially theological treatises where the focus of interest was
moral rather than political and acquisitive motives were
regarded as inherently disreputable. T h e scholastic discus-
sions of the practice of usury, for example, or of a just price,
were often concerned with deriving moral precepts of
individual economic behaviour relevant to the context of a
market economy, rather than with explaining the way the
exchange economy actually worked, or ought to work.
(3) Mercantilist; this was the period when the economic problems
of warring nationalist-monarchical states and the growth of
capitalist commerce stimulated a stream of political pamph-
1
J. Schumpeter, History of Economic Analysis (1954), p. 53.
2 Origins of modern economics
lets focused on ways of increasing national wealth and power
through regulation of trade.
(4) Modern; in the eighteenth century, beginning with the
French physiocrats (who called themselves economistes) and
with Adam Smith, we find the origins of a systematic study
of economics as a distinctive discipline, a specialised tech-
nique of analysis, a science or a quasi-science.
The economic ideas which emerged in the first two of these
epochs are mainly of historical or antiquarian interest. For the
Greek philosophers and the medieval scholastics the study of
economics was peripheral to their political or theological interests
and their approach had little in common with modern economic
thinking. It is difficult to imagine a modern economic theorist
gaining any direct stimulus or inspiration from their techniques
of analysis or policy conclusions. With the mercantilists, however,
and particularly with the later generations of mercantilists it was
different. Twentieth-century economists do not hesitate to
acknowledge an intellectual debt to them. It may be that today's
theorists distort the thought processes of their predecessors by
reformulating yesterday's problems, concepts and analyses in
modern terms; but they may still clarify their own ideas and
sharpen their message by so doing. When looking back in this
way, it is not hard to accept Sir William Petty, say, as an economist
in the modern idiom or to link some of today's textbook theories
and concepts directly to mercantilist writings of the late seven-
teenth and eighteenth centuries.
There were two main factors impelling educated men to take
a lively interest in macroeconomic policy problems in the late
sixteenth and seventeenth centuries. On the one hand, there
were the needs of national governments to raise revenue on the
scale required to finance mercenary armies and standing navies
(or to subsidise allies) in the balance of power manoeuvres which
dominated international politics after the end of the religious
wars. On the other hand there was the growing realisation by
merchants and bankers, operating on widening domestic and
international markets, of their dependence on the specifically
economic policies of governments. It became increasingly obv-
ious that governments, producers and consumers were operating
in an economic system of complex mutual interdependence and
correspondingly important to explain the nature of the system.
It was the seventeenth-century Political Arithmeticians (e.g.
Graunt, Petty and King) who began the modern tradition of
Origins of modern economics 3
empirical economic enquiry, consciously modelled on the natural
sciences, deliberately objective in approach. Over the next half
century or so a swelling stream of pamphlets and books (not
always as objective) bearing on economic questions were pub-
lished: Joseph Massie, for example, is reported to have amassed
a library of 2,500 tracts and manuscripts on 'trade' by the mid
eighteenth century.2 Strictly speaking, however, the mercantilist
economists were writing not about economic science as it came
to be called later but about political economy. So although one
can find mercantilists such as Barbon (Discourse on Trade) or
Cantillon (Essay on the Nature of Trade in General) or Gervaise
(System of the Theory of the Trade of the World) who offered explicit,
theoretical explanations of the operations and logical inter-
relations of some aspect of the macroeconomic system, the
avowed motive behind most mercantilist writings was to justify
specific policy prescriptions of one kind or another. For the most
part, the mercantilists were pamphleteers whose writings were
designed as propaganda instruments focused on definite policy
issues. In so far as they had begun to adopt common theories
of the way the economy operated these were usually implicit in
their writings rather than explicit - a by-product of their efforts
to influence the politicians.
True, the seventeenth-century mercantilists had inherited or
developed a basis of economic theory in the modern sense, even
if this was often sketchy. For example, they had long ago
abandoned the scholastic notion that the ' value' of a commodity
was the price at which it ought to sell on the market (the Medieval
Just Price) in favour of the idea that it was the price at which
it actually did sell.3 They thought of economics as the art of
managing a household and, by natural extension, political econ-
omy as the art of managing a State. They had worked out the
elements of a clear, if rudimentary, theory of supply and
demand. They developed theories of the interest rate which took
into account such factors as the yield of investment in capital stock
and the supply of loanable funds.4 Most of them focused
2
W. Letwin, Origins of Scientific Economics.
3
But see Raymond de Roover, 'The Concept of the Just Price: Theory and
Economic Policy', Journal of Economic History (1958), who concludes that the
just price was often equated by the scholastics to the competitive market
price.
4
Samuel Hollander, The Economics of Adam Smith, op. cit., p. 70,findsevidence
for the late seventeenth century of a breakthrough in mercantilist understanding
of the process of saving and of the role of the rate of interest.
primarily on the external trading relationships of the nation,
though this did not prevent them from discussing at length a wide
range of economic variables and problems such as production,
prices, money, interest, tariff policy, the relief of the poor, etc.
The later mercantilists became increasingly concerned with
problems of growth and development. In the debates on the East
India trade, for example, it was apparently accepted that the
desirability of any branch of trade depended more on its con-
tribution to the national aggregate of production or employment
than to the balance of overseas trade.5
Nevertheless it must be admitted that mercantilist economics
does not amount to either a systematic discipline or a coherent
doctrine, even if we confine our attention to the late seventeenth
and eighteenth centuries when it can be said to have acquired
its distinctive methodological and doctrinal characteristics.6 The
most famous, and the most systematic exposition of the economic
doctrine of mercantilism at its eighteenth-century maturity is to
be found in Book iv of Adam Smith's Wealth of Nations. But it
was set up there by Smith only to be shot down; and his account
needs to be taken with some reserve. It was a reflection of those
aspects of mercantilism against which he was reacting, rather
than an accurate synthesis of the doctrine as seen by its most
sophisticated exponents. Subsequent rehabilitations of the doc-
trine whether by Schmoller or Cunningham in the later nine-
teenth century, or by Keynes in the twentieth, are also suspect
as being highly selective accounts. It is only relatively recently
that historians of economic thought have begun to examine the
mercantilist pamphlets on their own terms in order to build up an
objective picture of the mercantilist assumptions and analytical
apparatus.
The results of these researches suggest that although it is
possible to identify certain characteristics of mercantilist thought
which effectively distinguish it from classical political economy
- e.g. its bias towards state intervention in the economy, its stress
on overseas trade as the prime mover in economic development
and its tendency to assume underemployment of labour - it does
not seem to have developed either a solid tradition of systematic
economic inquiry and explanation, or a coherent set of generally-
accepted principles of economic theory. It was not until the
5
A. Coats, 'In Defence of Heckscher and the Idea of Mercantilism', Scandi-
navian Economic History Review (1957), p. 187.
6
I.e. its generally accepted techniques of analysis and a priori principles.
eighteenth-century philosophers - primarily the physiocrats and
Adam Smith - began systematically, and not merely incidentally,
to apply to economic phenomena their theories of the natural
order underlying the real world that economic theory began to
develop into a unified system of explanation, a definitive tech-
nique of analysis.
In effect, Adam Smith and the physiocrats were contempor-
aneous and cross-fertilising, Both saw economic society as an
organic unity. Both were philosophic system-builders concerned
to establish the nature of the laws underlying the total socio-
economic order - as it was and especially as it ought to be. Both
classified the primary agents in the economic process on the same
lines - viz as labourers, landlords and capitalists. Both operated
with essentially pre-industrial analytical concepts, e.g. their con-
cept of capital was of 'a stockpile of food and implements accu-
mulated before the process of production began and subsequently
advanced to labourers in anticipation of the returns from the final
output'. 7 Both saw growth as the main economic problem and
both emphasised the importance of the domestic market in
economic development in contradistinction to the mercantilist
pre-occupation with overseas trade. Both reacted against the
mercantilist obsession with a favourable balance of trade and
emphasised real capital accumulation as the key to faster growth
that did not have to depend on 'beggar-your-neighbour'
policies.
However, they emerged with different systems of explanation
and a different bias in their policy prescriptions. Whereas the
physiocrats analysed the economic system in terms of a circular
flow best illustrated by Quesnay's Tableau Economique, Adam
Smith analysed it less schematically in terms of a natural complex
of harmony-promoting forces. Whereas the physiocrats assigned
primacy to agriculture in generating economic development,8
Adam Smith rested it on the division of labour.
The case for beginning a study of the evolution of economic
ideas with Adam Smith rather than with the physiocrats does not
rest, however, either on the innate superiority of his analytical
7
A. W. Coats, 'Adam Smith: The Modern Re-Appraisal', Renaissance and
Modern Stitdies, Vol. vi (196a), p. 38.
8
See R. L. Meek, 'Ideas, Events and Environment: the Case of the French
Physiocrats', in R. V. Eagly (ed.), Events, Ideology and Economic Theory (1968), for
an analysis of the way the distinctive quality of physiocratic theory stemmed from
the structure and organisation of the contemporary French economy and the
problems involved in its development.
framework, or on his claims to chronological priority in the
unified methodological approach which both shared. No doubt
Francois Quesnay has as much right as Adam Smith to be re-
garded as a founder of modern political economy. Indeed his
concept of a circular flow of incomes and his Tableau Economique,
which can be interpreted as a kind of input-output table, will
strike economists used to operating with social accounting tools
of analysis as more relevant to modern macro-economics than
any part of mainstream classical political economy from Smith
onwards.
However, although few of the contributions which Adam
Smith made were original in the sense that they cannot also be
found in the published text of some eminent predecessor, he is
the author to whom all orthodox nineteenth-century classical
economists (on the continent of Europe as well as in Britain)
consciously traced back the science they professed. The Wealth
of Nations was an immediate best-seller. By 1800 the book had
gone through nine English editions and had been published in
the USA, Ireland and Switzerland. By the end of the first decade
of the nineteenth century it had been published in the Danish,
Dutch, French, German, Italian, Spanish and Russian languages.
It was the undisputed, internationally accepted, bible of the new
science of political economy not only for orthodox economists
but also for theoretical revolutionaries who broke out of the
orthodox stream. J. S. Mill's Principles published in 1848 was
explicitly patterned on the Wealth of Nations. ' It appears to the
present writer' Mill explained in his Preface 'that a work similar
in its object and general conception to that of Adam Smith, but
adapted to the more extended knowledge and improved ideas
of the present age, is the kind of contribution which Political
Economy at present requires.' Karl Marx too had no doubt where
modern economics effectively began. Adam Smith' must be given
credit' he wrote' for having more closely determined the abstract
categories and for having securely labelled the differences ana-
lysed by the physiocrats'.9 In effect, Adam Smith provided the
infant science of political economy with itsfirstgenerally accepted
system of theories, concepts and analytical techniques, its first
paradigm or disciplinary matrix.10 He gave it a methodology, a
conceptual system and an ideological slant which determined the
9
K. Marx, Theories of Surplus Value, Part i.
10
See the quotations from T. S. Kuhn, above p. vii.
main problems which economists studied, the analytical frame-
work within which they normally discussed these problems and
the policy bias implicit in their solutions for nearly half a century:
and his model attracted lip-service if not close conformity for a
good deal longer still.
Adam Smith, however, was far from being a specialist econ-
omist. He was an academic philosopher for whom political econ-
omy was a branch of moral philosophy. For him, as also for some
of his eminent successors it was merely one section of a general
theory of society involving philosophy, psychology, ethics, law
and politics. Like other eighteenth-century philosophers, he had
a strong propensity to generalise - in his own words 'to account
for all appearances from as few principles as possible'.11 The
method to which all his contemporaries committed to a scientific
approach consciously aspired was that of Isaac Newton, whose
system Smith described as 'the greatest discovery that ever was
made by man, the discovery of an immense chain of the most
important and sublime truths, all closely connected together, by
one capital fact, [gravity] of the reality of which we have daily
experience'.12 It was by the same kind of ordered thought-system
based on a few plausible, because self-evident, assumptions that
Adam Smith set out to explain the everyday phenomena of
economic behaviour. 'Systems' he wrote 'in many respects re-
semble machines. A machine is a little system, created to per-
form, as well as to connect together, in reality, those different
movements and effects which the artist has occasion for. A
system is an imaginary machine, invented to connect together in
the fancy those different movements and effects which are in
reality performed.'13 In effect, then, Adam Smith was fully com-
mitted to the rational14 theistic mechanistic views of his time, to
the view of society as a sublime machine which left to itself will
tend to maximise social welfare. 'Human society, when we con-
template it in a certain abstract and philosophical light appears
like a great, an immense machine, whose regular and harmo-
11
A. Smith, Theory of Moral Sentiments, ed. D. D. Raphael and A. L. Macfie,
Glasgow (1976).
12
A. Smith, Essays on Philosophical Subjects (1795) p. 93.
13
Ibid. p. 44.
14
See, however, T. D. Campbell, Adam Smith's Science of Morals (1971), for a
discussion of the difference between Smith's 'rationalism' and that of contem-
porary moral theorists with whom he took issue.
nious movements produce a thousand agreeable effects.'15 The
'great architect' of this agreeable machine was a benevolent
deity variously called by him the great director of the universe,
the final cause, the divine being, the great judge of hearts, provi-
dence, an invisible hand, and very occasionally quite baldly God.
Smith's first major work The Theory of Moral Sentiments was
written when he was Professor of Moral Philosophy at the Uni-
versity of Glasgow and was first published in 1759. The Wealth of
Nations originated in a set of lectures written after he had
resigned his professorship, i.e. during the period 1767-76, when
he was a gentleman of independent means;16 and he planned,
but never found the time, to write a book on jurisprudence,
possibly because he took the appointment of Commissioner of
Customs in 1778.
His fundamental theory of society is set out at length in the
Theory of Moral Sentiments. Basically the argument is that society
is designed to a Divine Plan, which operates so as to maximise
human happiness by means of the interplay of certain moral
sentiments which are among the 'original passions of human
nature'. Social and unsocial, selfish and altruistic motives all play
their 'necessary part of the plan of the universe' for social
harmony. 'The happiness of mankind as well as of all other
rational creatures, seems to have been the original purpose
intended by the Author of nature when he brought them into
existence... But by acting according to the dictates of our
moral faculties, we necessarily pursue the most effectual means
for promoting the happiness of mankind.'17 The moral senti-
ments which ensure that men by responding to their natural
feelings and personal ambitions will fulfil the divine plan are
beneficence - including sympathy, generosity, kindness, friend-
ship - which 'cannot be extorted by force'; justice, the enforce-
ment of which is often necessary and always socially approved;
and prudence - including industry and frugality - 'that great
purpose of human life we call bettering our condition'.18 These
virtues ' have no tendency to produce any but the most agreeable
effects'.19 The essential cement for the system is the individual's
15
A. Smith, Theory of Moral Sentiments, op. cit., p. 316.
16
He resigned his professorship in 1764 to take up a post as tutor to the Duke
of Buccleuch with whom he travelled in France in the mid 1760s and from whom
he got a pension of £300 a year which enabled him to be independent over this
period.
17 18
Moral Sentiments, op. cit., p. 166. Ibid, p. 50.
19
Ibid, p. 264.
active concern for the social esteem of his contemporaries. For

'Nature, when she formed man for society, endowed him with
an original desire to please, and an original aversion to offend
his brethren.'20
As a basis for an abstract theory of society these assumptions
about the strategic factors in human behaviour are debatable but
not implausible. The need for social approval has been recog-
nised by sociologists and psychologists as a powerful human
incentive. The moral virtues of beneficence, justice and pru-
dence might not be equally high in the social scale of virtues for
all communities, but there is no obvious reason to reject the
assumption that they were important in eighteenth-century Bri-
tain. For Smith the essential justification for their universality was
their success.
In the middling and inferior stations of life, the road to virtue and that
to fortune, to such fortune, at least, as men in such stations can reason-
ably hope to acquire, are, happily in most cases very nearly the same.
In all the middling and inferior professions, real and solid professional
abilities joined to prudent, just, firm and temperate conduct, can very
seldom fail of success.21
Armed with their instinctive moral virtues or ideals, individuals

are thus impelled to amass their own fortunes in ways that tend
to maximise the total income of the community as well as their
own.
In the Wealth of Nations the basic framework of this theory of
society is taken for granted and Adam Smith goes on to work
out a special case of its application - the economic case. A great
deal has been written on the relationship between these two books
and in particular about certain inconsistencies which appear
when one sets them side by side. The debate may seem a little
pedantic for it would not be altogether surprising if Smith had
shifted his ground in certain respects in the period of a decade
and a half that elapsed between the writing of the two books. On
the other hand, the fact that he brought out a new edition of the
first, long after the publication of the second, without disposing
of the apparent inconsistencies, would seem to suggest that he did
not himself attach any importance to these issues. In many ways,
however, the Wealth of Nations is a more substantial, more mature,
20
Ibid, p. 116.
21
Ibid, p. 63. However, he goes on to note that' In the superior stations of life
the case is unhappily not always the same' and that 'flattery and falsehood too
often prevail over merit and abilities'.
io Origins of modern economics
and more original book than the Theory of Moral Sentiments, for
he worked into the former a great deal of illustrative material
about the real world and a certain healthy scepticism about the
'agreeable effects' produced by that 'immense machine'. So that
although the Theory of Moral Sentiments is essentially a set of
armchair speculations derived from conventional philosophical
abstractions, the Wealth of Nations is focused on the behaviour-
patterns of real people within the constraints of existing
institutions.
Thus by the time he came to write the Wealth of Nations, Adam
Smith still had a clear view of the 'natural order' to which the
economic system ought to approximate but was prepared to admit
to certain flaws in its operation in the real world. The 'great
architect' needed some cooperation from the economic policy
makers to allow his machine to work in the most effective way.
Hence Smith advocated an extensive programme of reforms
designed to bring the economic system closer to the system of
natural order which would maximise the social product. Govern-
ments in practice were inefficient and incompetent. Masters
and workers were in constant conflict. Merchants and manufac-
turers found their interests opposed to farmers and landlords.
To quote: 'rent and profits eat up wages, and the two superior
orders of people oppress the inferior one.'22 And again in a very
famous passage: 'People of the same trade seldom meet to-
gether, even for merriment and diversion, but the conversation
ends in a conspiracy against the public, or in some contrivance
to raise prices. It is impossible indeed to prevent such meetings,
by any law which either could be executed, or would be consistent
with liberty and justice.'23 As for those prudent moral sentiments
that were assumed in the Theory of Moral Sentiments to be so
widespread, by the time he had taken a hard look at the facts
of economic life Smith was prepared to concede that: 'Men
commonly over-estimate their chances of success in risky ven-
tures with the consequence that too great a share of the nation's
capital goes into such ventures.'24
In effect, the Wealth of Nations was the result of subjecting to
empirical test in one sphere of human activity the theory of
society that had been developed in the Theory of Moral Sentiments:
and it was in applying this kind of essentially scientific analytical
technique to the study of economics that Adam Smith achieved
A. Smith, Wealth of Nations, Vol. 11, p. 67.
23
Ibid, Vol. 1, p. 130. " Ibid, p. 110.
a revolutionary impact on the discipline he helped to found. If
we were to define a theoretical science as a set of 'general laws
which can serve as instruments for systematic explanation and
dependable prediction>25 and a scientific methodology as a tech-
nical apparatus for logically or empirically verifying these laws
it would be too much to say that Adam Smith had founded a
science of economics. But it is reasonable to claim that he had
at any rate made the first steps in this direction by devising a
system and testing it. By postulating a logical system of economic
relationships based on an underlying law of human nature (ana-
logous to Newton's law of gravity), he set the course of theoretical
political economy towards a system-building discipline. Schum-
peter criticised him for too hastily dropping the mercantilist
propositions and hence failing to develop an adequate theory of
international economic relations.26 However, what accounted for
the tremendous impact that this book had on economic thought
was not its components which, taken out of context, are easily
criticised, but the way it built up into a logically interdependent
whole, the first unified socio-economic model.
Also important no doubt in explaining the book's powerful
impact on contemporary and nineteenth-century thought was
the fact that its policy bias was peculiarly attractive to the en-
trepreneurs of an expanding industrialising economy. Para-
doxically, although Smith thought of himself as a critic of the
mercantile and manufacturing classes - and he certainly had
some fierce criticisms to make - it was those classes which pro-
duced his most enthusiastic supporters. The book was actually
written in the context of an essentially preindustrial economy and
showed little sign of anticipating the revolutionary changes that
were beginning to take place in the organisation, technology and
structure of the British economy. There is no reference to any
of the new textile inventions or to the coke-fired iron industry,
though the Wealth of Nations was still being substantially revised
and added to up to 1783 or 1784. The only reference to the cotton
industry as such is a curious glancing allusion to its under-
development at the time of Christopher Columbus.27 Smith knew
presumably about the Carron iron works which set up a coke-fired
blast-furnace near Falkirk in 1769 - for the company maintained
a warehouse in his home town of Kirkcaldy. He was probably
25
Ernest Nagel, The Structure of Science (1961), p. 450.
26
Schumpeter, op. cit., p. 376.
27
Wealth of Nations, Vol. 11, Bk. iv, p. 63.
familiar with an essay by his friend Edmund Burke praising 'the
spirited, inventive and enterprising traders of Manchester' and
drawing attention to the ' iron works of such magnitude even in
their cradle which are set up on the Carron'.28 Yet when he
selected an industry to illustrate his observations on technical
progress he chose what one writer has called his ' silly little pin
factory', and a nailery. On the other hand, as we shall see
in Chapter 4, he had identified a crucial link between indus-
trialisation and sustained economic growth, viz the continuous
scope for increasing returns in manufacturing industry as a result
of increasing specialisation of labour.
It is not surprising that Adam Smith's vision of the economic
system was of an essentially pre-industrial economy, for it took
a generation and more for the industrial revolution to produce
generally the distinctive organisational, structural and techno-
logical changes that were its most significant consequences. In
particular, for example, in Smith's theory technical progress was
associated not primarily with new machinery, or new processes,
or new products, but with improvements in the organisation and
equipment of the labour force due to specialisation. In so far as
he would have visualised embodied technical progress he would
have seen it as embodied in the labour force rather than in
machinery or plant.29 By capital he generally meant circulating
capital, i.e. capital invested in stocks of goods or work in progress,
the most important capital of his day, rather than fixed capital.
The strategic variable in the whole Smithian system is the division
of labour, the extension of which he saw as dependent on the
opening up of new sources of demand. He devoted a whole
chapter to the proposition ' that the division of labour is limited
by the extent of the market'.
In these respects, i.e. in emphasising the primary importance
of the labour force in economic development and in treating the
size of the market as a more important constraint on growth than
the supply of natural resources, he followed in the main stream
of mercantilist tradition. But in focusing on the primary impor-
28
Quoted R. Koebner, 'Adam Smith and the Industrial Revolution', Economic
History Review (igsg), p. 386.
29
For a modern definition of 'embodied technical progress' see e.g. R. Solow,
'Investment and Technical Progress', in K. J. Arrow, S. Karlin and P. Suppes
(eds.), Mathematical Methods in the Social Sciences, e.g. p. 60: 'Investments in
technology affect output only to the extent that they are carried into practice
either by net capital formation or by the replacement of old-fashioned equipment
by the latest models.'
tance of the domestic market (rather than the overseas market)

he was closer to the French physiocrats than to the English
mercantilists, for in a pre-industrial economy emphasis on the
domestic market means an emphasis on agriculture as a major
source of, though not necessarily the motive power for, economic
growth.' The different progress of opulence in different ages and
nations' he wrote in the introduction to Book iv 'has given
occasion to two different systems of political ceconomy, with
regard to enriching the people. The one may be called the system
of commerce, the other that of agriculture.'30 The one that is to
say was the mercantilist system, the other the physiocratic system.
But the physiocrats had seen agriculture as the only source of an
economic surplus large enough to lift the circular flow to a higher
level of national output: for them the manufacturing sector was
' sterile' in the sense that it yielded no surplus. Smith went beyond
this essentially pre-industrial viewpoint to argue in favour of what
might be called a strategy of free' balanced' growth, in which' the
obvious and simple system of natural liberty' would maximise
growth so long as the Divine Plan was allowed to operate without
hindrance; e.g.
every system which endeavours, either, by extraordinary encourage-

ments, to draw towards a particular species of industry a greater share
of the capital of the society than what would naturally go to it; or, by
extraordinary restraints, to force from a particular species of industry
some share of the capital which would otherwise be employed in it; is
in reality subversive of the great purpose which it means to promote.
It retards instead of accelerating, the progress of the society towards real
wealth and greatness; and diminishes, instead of increasing, the real
value of the annual produce of its land and labour.31
In essence then Adam Smith provided political economy with
an organised structure of assumptions, a problem orientation
and a value system. What was the substance - the long-term
significance - of this paradigm and what accounted for its
powerful and tenacious impact?
First of all, Smith articulated political economy firmly within
the ambit of moral philosophy as a normative study of society.
As a moral rather than a natural, a philosophical rather than
a logical or mathematical discipline it moved away from the
empirical-quantitative bias of the political arithmeticians. As a
normative study it gave intellectual backing to the political-
propagandist predilections of eighteenth-century pamphleteers.
30 31
Wealth of Nations, Vol. I, p. 395. Wealth of Nations, Vol. 11, p. 184.
In effect he set the pattern for an abstract deductive science
proceeding from a few general principles, ultimately of an in-
trospective or philosophical, rather than of an empirically
verifiable nature. True there is a continual appeal to history in
the Wealth of Nations but it is what Dugald Stewart (his pupil,
disciple and first biographer) called 'conjectural history' rather
than recorded history. Its role, like that of the references to
economic and social conditions of other countries at earlier stages
of development, was to illustrate rather than to verify the
philosophical arguments.
Smith's basic philosophical premises were materialistic and
mechanistic, as evidenced by his assumption of an 'agreeable
machine' designed by a 'divine architect' and powered by the
natural and universal human instinct for self-preservation and
self-advancement. His problem was to explain economic devel-
opment, to elucidate 'the nature and causes of the wealth of
nations'. His analytical method was to describe the 'natural'
economic order by abstracting from the conflicts and imperfec-
tions which hindered its beneficent operations in the real world
and by deducing logically its propensity to maximise economic
welfare. The ideological bias implicit in his choice of assumptions
and methodology was towards policies designed to minimise
interference by authority (church or state) with individual free-
dom: it led unequivocally towards individualism and laissez-faire
and away from collectivism and state intervention.
It is not hard to explain why Adam Smith's paradigm for
political economy had such an instant success. For one thing, it
gave intellectual status and appeal to the subject by unifying its
basic theories and by systematically relating it to academic
philosophy in a way that no other writer had succeeded or even
attempted to do before. The task of exploring and extending this
essentially simple and relatively comprehensive system of analysis
became a challenge to educated minds, irrespective of their
political predilection or affiliations.
In addition, it formulated the primary economic problem in
terms that seemed appropriate to a society that was beginning
to expand in population and wealth and to industrialise. Econ-
omic growth and change were the topical questions of the day.
Smith's system of classification of the basic economic relationships
of society, his emphasis on the pivotal significance of the char-
acteristic social pattern of capitalism — landlords, labourers and
capitalists, with their characteristic forms of income - rents,
wages and profits - had special relevance for the emergent capi-
talist societies of Western Europe. His anatomy of the exchange
economy illuminated the interdependence of incomes and prices
with an unprecedented cogency and realism. E.g.:
As the price or exchangeable value of every particular commodity, taken
separately, resolves itself into some one or other, or all of these three
parts; so that of all the commodities which compose the whole annual
produce of the labour of every country, taken complexly, must resolve
itself into the same three parts, and be parcelled out among different
inhabitants of the country, either as the wages of their labour, the profits
or their stock, or the rent of their land. The whole of what is annually
either collected or produced by the labour of every society, or what
comes to be the same thing, the whole price of it, is in this manner
originally distributed among some of its different members. Wages,
profit, and rent, are the three original sources of all revenue as well as
of all exchangeable value. All other revenue is ultimately derived from
one or other of these.32
Thus, having formulated the economic problem in terms that
his contemporaries regarded as relevant, having analysed the
factors of production into categories they recognised as realistic,
Adam Smith produced a reasoned solution to the fundamental
problem of capitalist society; i.e. how order rather than chaos
can emerge from the uncoordinated activities of a myriad
of individuals each pursuing his own self-interest. T o quote
again:
As every individual, therefore, endeavours as much as he can both to
employ his capital in the support of domestic industry, and so to direct
that industry that its produce may be of the greatest value; every indivi-
dual necessarily labours to render the annual revenue of society as
great as he can. He generally, indeed, neither intends to promote the
public interest, nor knows how much he is promoting it. By preferring
the support of domestic to that of foreign industry, he intends only his
own security, and by directing that industry in such a manner as its pro-
duce may be of the greatest value, he intends only his own gain, and
he is in this, as in so many other cases, led by an invisible hand to pro-
mote an end which was no part of his intention... By pursuing his
own interest he frequendy promotes that of the society more effectually
than when he really intends to promote it.33
Finally, of course, a part of the success of the Smithian para-
digm - possibly the larger part of its tenacity - can be attributed
to the nature of the implicit policy prescriptions. Sir Karl Popper,
32
Wealth of Nations, Vol. 1, p . 54.
33
Wealth of Nations, Vol. 1, p. 421.
in an essay on the testing of theories34 distinguishes three types
of theory: (i) logical and mathematical theories which can be
refuted by logical testing; (2) empirical and scientific theories
which can be tested by experimental methods; and (3) philoso-
phical or metaphysical theories which are irrefutable by defin-
ition and not open to empirical experiment. In the main, Adam
Smith's theory of the economic order falls into the third category
and Popper proposes a series of critical questions in relation to
this type of theory, e.g. 'Does it solve the problem? Does it solve
it better than other theories? Has it perhaps merely shifted the
problem? Is the solution simple? Is it fruitful? Does it perhaps
contradict other philosophical theories needed for solving other
problems? '35 The Smithian paradigm would have stood up quite
well to a barrage of questions of this kind in the late eighteenth
and early nineteenth centuries. But for a theory of the economic
system, which inevitably implies a set of economic policy pre-
scriptions, the users of the paradigm may reasonably be expected
to apply another critical question, viz 'Does the policy work?'
There seems little doubt that in the capitalist societies of the
eighteenth and early nineteenth centuries, and a fortiori for the
first country to experience an industrial revolution, the policy
appeared to work to the extent of maximising the output of
material goods and services. The reduction of incompetent state
intervention, of restrictions on internal and external trade and
on the movement of capital and labour could be seen to have
positively assisted the process of economic growth. Whether it
achieved other policy desiderata, e.g. a just and/or politically
stable distribution of wealth within economic society, was of
course another matter. And it was no accident that the only
totally different alternative paradigm offered during the nine-
teenth century, the Marxian system, was focused on the failure
of orthodox political economy to prescribe for a desirable
distribution of wealth.
As far as mainstream political economy was concerned how-
ever the Smithian paradigm was revised, amended and extended
piecemeal during the nineteenth and twentieth centuries: but the
ideological bias has lasted virtually intact in some schools of
thought right down to the modern neo-classical orthodoxy. The
following passage, for example, written in 1943 by an eminent
34
K. Popper, 'On the Status of Science and Metaphysics', in Conjectures and
Refutations (1963).
a5
Ibid, p. 199.
American theorist of the Chicago school is almost unadulterated
Adam Smith:
The practical relevance of economic theory is chiefly to the problems
of social action. But in a free society the objective of social control is
not usually to make individuals behave in one particular way rather than
in another; it is simply to create the conditions under which individuals
will be able to realize their individual objectives to the maximum
degree, i.e. to act harmoniously, with a minimum of conflict and mutual
frustration.36
FURTHER READING
A short list of books and articles designed to refer the student to some
of the most accessible primary sources and to a few of the secondary
sources bearing on issues raised in the text is appended to each chapter.
A more complete and usefully annotated bibliography will be found in
Mark Blaug's book referred to below.
Primary literature
Adam Smith, The Theory of Moral Sentiments, Glasgow edition, ed. by
A. L. Macfie and D. D. Raphael (1976).
Adam Smith, An Inquiry into the Nature and Causes of the Wealth
of Nations, ed. Cannan, 2 vols. (1950). See also the Glasgow edition,
edited with an introduction by R. H. Campbell and A. S. Skinner
(.976).
Secondary literature
M. Blaug, Economic Theory in Retrospect (1964).
Marian Bowley, Studies in the History of Economic Theory before i8jo
(1973)-
T. D. Campbell, Adam Smith's Theory of Morals (1971).
D. C. Coleman (ed.), Revisions in Mercantilism (1969).
Samuel Hollander, 'On the Interpretation of the Just Price', Kyklos
Samuel Hollander, The Economics of Adam Smith (1973).
J. Ralph Lindgren, The Social Philosophy of Adam Smith (1973)-
R. L. Meek (ed.), Precursors of Adam Smith 1750-1775 (1973).
R. L. Meek, The Economics of Physiocracy (1962).
Raymond de Roover, 'The Concept of the Just Price: Theory and
Economic Policy', Journal of Economic History (1958).
J. Schumpeter, History of Economic Analysis (1954).
36
F. H. Knight in a review of E. M. Maclver, Social Causation, reprinted in On
the History and Method of Economics, p. 145.
Andrew S. Skinner and Thomas Wilson, Essays on Adam Smith (1975).
J. Viner, 'Adam Smith and Laissez-faire' in idem, The Long View and the
Short (1950).
J. Viner, 'English Theories of Foreign Trade before Adam Smith' in
idem, Studies in the Theory of International Trade (1937)-
ADAM SMITH'S THEORY OF VALUE
Whatever the philosophical or methodological approach econo-

mists have taken to their discipline, whatever view they have
taken of its scope, objectives and analytical techniques, the theory
of value - with its associated theory of distribution - has been a
key feature of the disciplinary matrix or paradigm to which they
have chosen to conform.1 The prevailing concept of value and
the use made of it has altered, chameleon-fashion, to match the
currently accepted economic doctrines. In pre-mercantilist
periods, when it would be an exaggeration to say that there was
an explicit theory of value, the concept of value reflected current
attitudes to economic questions. For example, in medieval-
scholastic doctrine the value of the commodity tended to be
identified with the morally right price. In a static, parochialised
economic and social order the just price would equal the custo-
mary price, reflecting a socially accepted scale of values, and the
whole community would know what the fair price ought to be.
However when the market became more dominant in economic
life, there was an increasing tendency for the concept of the just
price to coincide with the normal (competitive) market price,
including an element of normal profit. For this too became a
customary price which could be justified as being the proper one.
Realists such as Thomas Aquinas did not hesitate to identify the
actual market price, even when inflated by temporary scarcity,
with the just price.2
As the exchange economy extended its range, domestically and
internationally, the possibility of prices fluctuating and of
1
Cf. L. Robbins, The Nature and Significance of Economic Science, p . 73: ' T h e
most fundamental propositions of economic analysis are the propositions of the
general theory of value. No matter what particular "school" is in question, no
matter what arrangement of subject-matter is adopted, the body of propositions
explaining the nature and the determination of the relation between given goods
of the first order will be found to have a pivotal position in the whole system.'
2
Raymond de Roover, Journal of Economic History (1958), op. cit., p. 420.
20 Adam Smith's theory of value
yielding variable profits to the lengthening line of merchants
involved in the distribution process became more common and
more socially acceptable. To equate value with actual price
charged - whatever that was - was not to explain it, however, and
some writers began to develop an explanation by taking into
account factors on the side of demand and supply. Nicholas
Barbon, for example, asserted in the seventeenth century that:
'the market is the best Judge of Value. . .Things are just worth
so much as they can be sold for, according to the Old Rule, Valet
Quantum Vendi Potest'; and 'The Value of all Wares, arriveth
from their Use and the Dearness or Cheapness of them, from
their Plenty and Scarcity.'3 Even in the pre-classical, pre-paradigm,
era of political economy, however, when theories of value were
at best rudimentary, implicit rather than explicit, it was clear that
the concept of value was inextricably involved with questions
relating to the social distribution of income and in particular with
the question of profit. Abnormal profits were often held to be
morally disreputable in the pre-mercantilist era while in mer-
cantilist and later periods they came to be justified by an appeal
to a supposedly objective concept of value.
When Adam Smith came to embark on his systematic analysis
of the nature and causes of the wealth of nations, the concept
of value had already developed a long way from the moralistic-
customary levels of discussion and the philosophers had already
identified some of the building blocks relevant to a full theory
of value. Francis Hutcheson, for example, Smith's teacher and
predecessor in the Glasgow Chair of Moral Philosophy, brought
out clearly the demand and supply aspects necessary to an ex-
planation of value, e.g. 'we shall find that the prices of goods
depend on these two jointly, the demand on account of some use
or other which many desire and the difficulty of acquiring, or
cultivating for human use'. He seemed to assign to use a primary
role: 'The natural ground of all value or price is some sort of
use which goods afford in life' and he defined use in terms which
approximate to the modern economists' notion of utility, i.e. as
'not only a natural sub-serviency for our support, or to some
natural pleasure, but any tendency to give any satisfaction, by
prevailing custom or fancy, as a matter of ornament or distinc-
3
Nicholas Barbon, A Discourse of Trade (i960), ed. J. L. Hollander (1938), pp.
20 and 100. See R. L. Meek, Studies in the Labour Theory of Value, for a discussion
of value theory before Adam Smith; and Marian Bowley, Studies in the History
of Economic Theory before i8yo, for a detailed discussion of the development of
value theory in the seventeenth century.
Adam Smith's theory of value 21
tion'. On the supply side he listed effort, skill and the producer's
social status among the factors determining scarcity value (or
value in exchange):
Not only a great labour, or toil, but all other circumstances which pre-
vent a great plenty of the goods or performances demanded... Price
is increased by the rarity or scarcity of the materials in nature, or such
accidents as prevent plentiful crops of certain fruits of the earth; and
the great ingenuity and nice taste requisite in the artists to finish well
some works of art, as men of such genius are rare. The value is also
raised, by the dignity of the station in which according to the custom of
a country, the men must live who provide us with certain goods or
works of art.4
Smith himself brought in income distribution on the demand
side of the account in his 1762/3 lectures when he listed the
following three determinants of market price:
First the demand, or need for the commodity. There is no demand for
a thing of little use; it is not a rational object of desire. Secondly, the
abundance or scarcity of the commodity in proportion to the need of
it. If the commodity be scarce, the price is raised, but if the quantity
be more than sufficient to supply the demand, the price falls. Thus it
is that diamonds and other precious stones are dear, while iron, which
is more useful, is so many times cheaper, though this depends principally
on the last cause, viz: Thirdly, the riches or poverty of those who
demand.5
It is, however, one thing to list the determinants of value (or
price) and another to combine them in a theory of value, i.e. an
explanation of the way value (or price) comes to be what it is.
It is something else again to produce a theory of value which is
consistent with an overall theory of economic behaviour, e.g. an
explanation of the 'nature and causes of the wealth of nations'.
There has been a running debate, beginning with Ricardo's
Principles, about the nature and internal consistency of Adam
Smith's theory of value and although his exposition of it leaves
much room for argument the differences often shed more light
on the methodological commitments of the protagonists than on
Adam Smith's own beliefs. Thus, for the neo-classical economists
for whom the marginal revolution had brought the concept of
utility firmly back into the theory of value, it was Smith who had
4
F. Hutcheson, System of Moral Philosophy (1755), Vol. 11, pp. 53-4- These
passages are quoted and discussed by H. M. Robertson and W. L. Taylor in
'Adam Smith's approach to the theory of value', Economic Journal (June 1957).
5
Lectures on Justice, Police, Revenue and Arms by Adam Smith Reported by a
Student in 1763, ed. E. Cannan, p. 176.
led the classical economists away from the concern with utility
and scarcity which was already apparent in mercantilist thinking
and into an inadequate cost of production theory of value.
According to Schumpeter, for example, Smith 'was not primarily
interested in the problem of value' in the sense of a 'causal
explanation of the phenomenon of v a l u e . . . What he wanted was
a price theory by which to establish certain propositions that do
not require going into the background of the value phenomenon
at all.'6 Indeed, some of Smith's statements lend themselves to
interpretation as a mere 'adding u p ' theorem whereby natural
price (i.e. value) is explained in terms of a summation of the
natural wages, profits and rents entering into the exchangeable
value of a commodity. In short, his theory of value and his theory
of distribution both stem from the doctrine of the invisible hand
which tends to bring about a naturally - and by definition
harmoniously - integrated set of exchange relationships in both
commodity and factor markets. 7
Recently, however, there has been a tendency to see more
dimensions in Smith's analysis, partly perhaps because the mid
twentieth century methodological debate has encouraged re-
searchers in economic thought to re-examine primary sources
from a more neutral stance. In a recent monograph on The
Economics of Adam Smith, Samuel Hollander, for example, con-
cludes both that 'there was less emphasis on utility and scarcity
in mercantilist economic thought than has been read into it by
subsequent commentators', 8 and that Smith explained exchange
value in traditional terms taking full account of utility and
scarcity.9 Marian Bowley has also re-examined Smith's theory of
value or natural price as set out in his Lectures and the Wealth
of Nations and sees a continuity between Adam Smith's explana-
tion of the price mechanism and the scholastic school's analysis
of the just price. She argues that Smith demonstrated the re-
source allocation function of divergencies between market and
natural prices and so solved the difficulty, apparent in the school-
men's discussions, of finding a way to reconcile both market and
supply prices to the just price concept. 10 More recently still Dr
6
J. Schumpeter, History of Economic Analysis (1954), p. 309.
7
See the passage quoted on p. 15 above.
8
Samuel Hollander, The Economics of Adam Smith (1973), p. 134.
9
Ibid, p. 137.
10
Marian Bowley, Studies in the History of Economic Theory (1973), op. cit., pp.
126-7. For another recent rehabilitation of Smith's theory of value see S. Kaushil,
'The case of Adam Smith's value analysis', Oxford Economic Papers (March
O'Brien has argued that the apparent shift from a predominantly
utility-scarcity explanation of value in the Lectures to an essen-
tially cost-of-production explanation in the Wealth of Nations,
reflected Adam Smith's need to accommodate a theory of distri-
bution with his theory of value: 'Without the concept of marginal
productivity there was no very obvious way of linking distribu-
tion to value except by a cost of production theory of value.'11
• There are four prime inter-related difficulties involved in
devising an acceptable theory of value. The first lies in explaining
how and why a commodity acquires value. Another lies in dis-
entangling the complex, shifting relationships between value
considered as some intrinsic, lasting (though not necessarily
constant attribute) of a commodity or service on the one hand,
and its market price, whether expressed in money terms or in
terms of some other commodities or services, on the other.
Another lies in relating the theory of value to a theory of the
distribution of incomes. The fourth lies in actually measuring
value in operational terms — for if value is not measurable the
theory is not testable.
Adam Smith faced all these problems in the following passage
with which he opened his discussion of value in Book 1 of the
Wealth of Nations.
The word VALUE, it is to be observed, has two different meanings, and

sometimes expresses the utility of some particular object, and sometimes
the power of purchasing other goods which the possession of that object
conveys. The one may be called 'value in use'; the other, 'value in
exchange'. The things which have the greatest value in use have fre-
quently little or no value in exchange; and on the contrary, those which
have the greatest value in exchange have frequently no value in use.
Nothing is more useful than water, but it will purchase scarce anything:
scarce anything can be had in exchange for it. A diamond, on the
contrary, has scarcely any value in use; but a very great quantity of other
goods may frequently be had in exchange for it.
In order to investigate the principles which regulate the exchangeable
value of commodities, I shall endeavour to shew.
First, what is the real measure of this exchangeable value; or, wherein
consists the real price of all commodities.
1973). Marxist writers have generally been more sympathetic in their critique than
the orthodox neo-classicists. See e.g. R. L. Meek, Studies in the Labour Theory of
Value (1956 and 1973), and M. Dobb, Theories of Value and Distribution since Adam
Smith (1973). But it is noteworthy that Meek in the preface to his second edition
considers that he may have over-estimated and over-simplified Smith's contri-
bution (Meek, op. cit., 1973 edn, p. iii).
11
D. P. O'Brien, The Classical Economists (1975), p. 78.
Secondly, what are the different parts of which this real price is
composed, or made up.
And, lastly, what are the different circumstances which sometimes
raise some or all of these different parts of price above, and sometimes
sink them below their natural or ordinary rate; or, what are the causes
which sometimes hinder the market price, that is, the actual price of
commodities from coinciding exactly with what may be called their
natural price.12
There were thus two aspects of value or price to be explained

and related - the actual market price and the natural price. Smith
explained the first of these in terms of a simple supply and
demand mechanism in a competitive market. He agreed that
when demand exceeds supply it will be factors on the side of
demand (competition between buyers) which effectively deter-
mine price - taking into account such influences as incomes ('the
wealth and wanton luxury of competitors') and special market
conditions such as war or harvest failure; and that when supply
exceeds ' effectual demand' it will be competition among sellers
that sets the price - taking into account such constraints as
the possibility of adding to stocks (e.g. the perishability of
commodities).13
To express the relationship between value, as a relatively
long-lasting quality, and market price, as a relatively transient
phenomenon dependent upon the conditions of a particular
market, Smith invoked the concept of a 'natural' price defined
in effect as price in long-run stable equilibrium, e.g.
The natural price, therefore, is, as it were, the central price, to which
the prices of all commodities are continually gravitating. Different acci-
dents may sometimes keep them suspended a good deal above it, and
sometimes force them down even somewhat below it. But whatever may
be the obstacles which hinder them from settling in this center of repose
and continuance, they are constantly tending towards it.14
The concept of a natural price gives Smith's theory of value a

pivotal position in his general theory of a harmonious economic
order in which the self-interest of individuals operating in a freely
competitive market economy tends naturally to produce an
optimum allocation of resources and thus to maximise total
output. At the same time it connects his theory of value with his
theory of distribution by linking the commodity markets to the
12
Wealth of Nations, Vol. I, p. 30.
13 14
Ibid, Vol. 1, pp. 58-9. Ibid, Vol. 1, p. 60.
factor markets, though in so far as he had a theory of distribution
it was a mere byproduct of his theory of value.
There is in every society or neighbourhood an ordinary or average rate
both of wages or profit in every different employment of labour and
stock. This rate is naturally regulated, as I shall show hereafter, partly
by the general circumstances of the society, their riches or poverty, their
advancing, stationary, or declining condition; and partly by the par-
ticular nature of each employment.
There is likewise in every society or neighbourhood an ordinary or
average rate of rent, which is regulated too, as I shall show hereafter,
partly by the general circumstances of the society or neighbourhood in
which the land is situated, and partly by the natural or improved
fertility of the land.
These ordinary or average rates may be called the natural rates of
wages, profit, and rent at the time and place in which they commonly
prevail.
When the price of any commodity is neither more nor less than what
is sufficient to pay the rent of the land, the wages of the labour, and
the profits of the stock employed in raising, preparing, and bringing
it to market, according to their natural rates, the commodity is then
sold for what may be called its natural price.15
T h e natural price is in effect the crucial element in the allo-
cative mechanism postulated by Smith for he went on to argue
that whenever the market price of a commodity stood above the
natural price, viewed as a sum of natural factor prices, it would
tend to attract the factors of production into the industry con-
cerned: and whenever it stood below, it would induce factors of
production to withdraw. It thus tends to maximise output and
to minimise long-run costs: ' T h e natural price, or the price of
free competition.. .is the lowest which can be taken, not upon
every occasion, indeed, but for any considerable time together.' 18
The natural price is then an abstraction which reflects real value
in terms of a relationship between minimum costs and effective
demand in a free market economy where the distribution of
incomes is partly determined by the initial social and economic
circumstances and partly by social and economic change.
Measuring value, however, so as to be able to make compari-
sons between countries or over time raises another set of prob-
lems. For prices are normally expressed in money terms and
money itself is a variable yardstick. So Smith distinguished be-
tween a real price and a nominal price. ' T h e same real price is
always of the same value; but on account of the variations in the
15 16
Ibid, p. 57. Ibid, p. 63.
value of gold and silver, the same nominal price is sometimes of
very different values.' 17 What is needed is a numeraire which is
itself relatively stable over time and space. Smith discussed corn
as a solution. ' T h e rents which have been reserved in corn have
preserved their value much better than those which have been
reserved in money, even where the denomination of the coin has
not been altered.' 18 Similarly, in a poor, stagnant, economy the
amount of corn required to provide for the subsistence of a
labourer is relatively invariable: but in a growing economy 'a
society advancing to opulence' this too will become a variable
amount. In the end Smith came down to the view that: 'Lab-
our. . .is the only universal, as well as the only accurate measure
of value, or the only standard by which we can compare the values
of different commodities at all times and at all places.' 19 There
has been a good deal of argument as to what precisely Smith
meant by his labour measure of value and since he never actually
applied the measure empirically there is plenty of scope for
debate.
On balance the discussion in the Wealth of Nations seems to
suggest that it was not the labour embodied in a commodity that
Smith regarded as 'the only accurate measure of value' in a
capitalist economy but the labour commanded by a commodity.
Were he to apply the measure, that is to say, he would presumably
be looking not for data on the labour involved in producing the
good in question, but on the amount of labour for which it could
currently be exchanged on the market. Of course, as Smith points
out, in 'the early and rude state of society which precedes both
the accumulation of stock and the appropriation of land', the
labour embodied in and the labour commanded by a commodity
would come to the same thing. But in a capitalist economy, where
'the whole produce of labour does not always belong to the
labourer' the two indices part company unless (as Ricardo later
noted) wages m6ve in step with the productivity of labour or, to
put it another way, wages constitute a constant fraction of the
total value of production. 20 T o quote Smith again:
The value of any commodity, therefore, to the person who possesses

it, and who means not to use or consume it himself, but to exchange
17 18
Ibid, pp. 35-6. Ibid, p. 36.
19
Ibid, p. 38.
20
See below p. 61 for the relevant quotation from Ricardo. The point is also
made by M. Dobb, Theories of Value and Distribution since Adam Smith. See his
footnote on p. 49 making the point by numerical example.
it for other commodities, is equal to the quantity of labour which it

enables him to purchase or command. Labour, therefore, is the real
measure of the exchangeable value of all commodities.
The real price of everything, what everything costs to the man who
wants to acquire it is the toil and trouble of acquiring it. What everything
is really worth to the man who has acquired it, and who wants to dispose
of it or exchange it for something else, is the toil and trouble which it
can save to himself, and which it can impose upon other people.21
To sum up then: most of the confusion, the textual problems

and the apparent inconsistencies raised by subsequent debate
about what Adam Smith ' really' meant in this context hinge on
questions which he did not set out to answer or on a reformu-
lation of his questions in terms of a different disciplinary matrix.
If we now go back to the questions which he posed at the outset
of his investigation into 'the principles which regulate the
exchangeable value of commodities' in a capitalist society22 the
answers are as follows:
(1) The real measure of the exchangeable value of commodi-
ties is the labour currently commanded by these goods in the
market: for it is this which is the ultimate measure of real income,
of poverty or wealth. E.g.
Every man is rich or poor according to the degree in which he can afford
to enjoy the necessaries, conveniences, and amusements of human life.
But after the division of labour has once thoroughly taken place, it is
but a very small part of these with which a man's own labour can supply
him. The far greater part of them he must derive from the labour of
other people, and he must be rich or poor according to the quantity of
that labour which he can command, or which he can afford to
purchase.23
(2) This 'real price' of each commodity and of the national

output as a whole can be resolved into components which reflect
the rewards of the factors - land, labour and capital - involved
in its production. Smith's formal definition of price as a sum
of wages, profits and rent has already been quoted on p. 15
above.24
This and similar passages have often been adduced as evidence

that Smith held a pure 'cost of production' theory of value.
21
22
Quoted above, pp. 23-4.
23
24
See the first quotation on p. 15.
However it can also be regarded as no more than a breakdown
of the components of value, with taxonomic rather than ex-
planatory significance.
(3) Finally, Smith found the reasons for the divergence be-
tween the market price of commodities and their natural prices
or real value either in purely transitory conditions affecting parti-
cular markets where supply had not yet adjusted to 'effectual
demand' or to imperfections in the market (monopoly, govern-
ment intervention, etc.). In the long run and in a stable com-
petitive exchange economy where individuals were free to pursue
their own self-interest costs would be at a minimum, supply would
be fully adjusted to 'effectual demand' and market prices would
tend to coincide with real values in commodity and factor markets
alike.
Running through the whole of Smith's analysis of value (as of
other questions) was a strong normative content. Its main thrust,
that is to say, was towards economic policies which militated
against any kind of interference with the free market - whether
in the form of private monopoly or combination or government
intervention. It was also, and in this it was sharply distinguished
from Ricardo's theory, primarily designed to serve the purposes
of an inquiry into the conditions of economic progress.
FURTHER READING
(See also references at end of Chapter 1.)
Maurice Dobb, Theories of Value and Distribution since Adam Smith (1973).
Ronald L. Meek, Studies in the Labour Theory of Value (1973).
H. M. Robertson and W. L. Taylor, 'Adam Smith's Approach to the
Theory of Value', Economic Journal (1957).
ORIGINS OF MODERN GROWTH
THEORY
The leading writers on economic issues - theoretical, empirical

or polemical - have always defined the subject of their investi-
gations in the light of current economic problems. The central
economic problem for Adam Smith, as for most other economists
in the eighteenth and early nineteenth centuries was how to
explain, and to prescribe policies for, economic growth. The
mercantilists, for example, were keenly aware of inter-country
differences in economic strength and of the fact that trade
expansion or trade decline could alter, and indeed had altered,
the balance of economic power and the relative ranking of
countries. They were also prone to believe that economic expan-
sion could be promoted by appropriate state intervention. The
message of Mandeville's Fable of the Bees for example was that:
' Private Vices by the dextrous Management of a Skilful Politician
may be turned into Public Benefits/1
The mercantilists however were concerned not so much with
a sustained process of economic growth resting on a growth in
output per head, as with economic expansion in the limited
aggregative sense of an increase in total output. In other words
they were interested in GNP as an indicator of national opulence
or national power. Accordingly they saw growth in the total labour
force as the primary condition of economic progress. Relatively
few of them discussed the possibility that an increase in popu-
lation might be associated with a fall in output per head2 and the
majority of them favoured active pro-natalist policies. Perhaps
if their man-land ratios had been less favourable and their
mortality rates less crippling they would have seen some of the
implications for productivity and hence long-term growth, of
1
Concluding sentence of the essay on 'A Search into the Nature of Society'
added to the 1723 edition of the Fable.
2
B. F. Hoselitz (ed.), Theories of Economic Growth. Spengler (p. 28) quotes
Cantillon as one of the few who did notice this.
30 Origins of modern growth theory
these policies. The fact remains, however, that it is difficult to
identify anything, however sketchy, corresponding to the basic
elements of a mercantilist theory of economic growth as a con-
tinuous process. For the mercantilists, promoting the economic
strength of the nation seemed to depend essentially on manipu-
lating the international power structure and achieving a surplus
on the balance of payments.
The physiocrats developed more fruitful ideas in this context.
Like the mercantilists they saw the economy as a whole, an
interdependent whole, and focused on aggregate output rather
than average product but they developed a more systematic
technique of analysing the mechanics of the interdependence of
the individual sectors. Quesnay's Tableau Economique for exam-
ple, was designed to illustrate diagrammatically the way expen-
ditures in one sector generated incomes in other sectors.
Although some later writers (e.g. Marx) appreciated the analy-
tical insight involved in Quesnay's Tableau it was not until the
macroeconomic model-builders of the mid twentieth century
claimed him as their predecessor that it began to be seriously
discussed by modern economists. When in 1955 Professor Phillips
translated the data of the Quesnay Tableau into a modern input-
output matrix it took on a new significance for many modern
economists.3 In this form it can be seen as a static closed Leontief
system, a circular flow model in which the sectors were farmers,
landlord and artisans.
Quesnay, however, had a continuous process in mind - for
example he traced the expenditure of the landlord class back to
the rents received in the previous period - and his Tableau
Economique provided the analytical framework for a distinctive
theory of growth. The physiocrats started from the pre-industrial
assumption that the only productive class in the community was
the agricultural sector. The artisan (manufacturing) class added
nothing to the value of the social product beyond the value of
its labour and so was deemed * sterile': the landlords produced
nothing: neither the 'sterile' nor the 'proprietary' classes added
anything to the social surplus. However the productive class (the
farmers) generated a surplus which gave rise to three sorts of
capital outlays from which the next season's output stemmed viz
(1) avarices annuelles or working capital (i.e. outlays on preparing,
planting, cultivating and harvesting the land, on maintaining
3
A. Phillips, 'The Tableau Economique as a Simple Leontief Model', Quarterly
Journal of Economics (1955).
Origins of modern growth theory 31
farm workers and animals etc.); (2) avances primitives (i.e. re-
placement or maintenance of agricultural tools, implements,
cattle etc.); (3) avances foncieres (i.e. maintenance or supple-
mentation of overhead capital of a semi-permanent character
such as land improvement, drainage, hedges, buildings). Some
physiocrats also distinguished a fourth kind of capital investment,
avances souveraines, corresponding to what we might now call
social overhead capital (e.g. highways, canals, rivers, ports etc.)
generally provided out of the government's share in the gross
national product.
Maintaining the level of agricultural output (and hence of
GNP) depended under the physiocratic system on maintaining
these 'avances', and more especially on the avances annuelles.
Should the amount available for avances annuelles in a given
period diminish, either because the agricultural surplus held over
from the previous period was lower, or because there was a
redistribution of income in the direction of the 'consuming'
classes rather than the * investing' classes in the community, then
GNP must fall. An expansion in output depends on raising the
level of the agricultural surplus and making a larger sum
available for capital formation than was necessary to maintain the
current level of working capital (avances annuelles) or to replace
fixed or overhead capital (avances primitives or foncieres). The
prime mover in this system, the factor generating economic
growth, is thus the agricultural surplus and it is on capital
accumulation in agriculture that economic development essen-
tially depends. An increase in the surplus could take place either
as a result of technical improvements in agriculture, or a reduc-
tion in agricultural taxation, or a fall in the rate of interest, or
a freeing of the restrictions and tolls on domestic or international
trade. So some physiocrats advocated putting a legal ceiling on
the rate of interest in agriculture. Others advocated lightening
the tax burden on the agricultural sector or spreading the tax
burden so that it encouraged expenditure on primary products
at the expense of processed products (manufactures) or services.
Most were in favour of freeing trade from the numerous internal
tolls that hindered the movement of agricultural produce in
France, and also of institutional reforms (e.g. longer leases) and
other measures which might encourage the adoption and
diffusion of improved agricultural techniques. The key to growth,
however, in the physiocratic system was the rate of capital
accumulation.
In view of Adam Smith's interest in the physiocrats, whom he
met on his visit to France, and with whose laissez-faire policy
prescriptions he sympathised more than with the interventionist
propensities of the English mercantilists, it is not surprising to
find that the Smithian theory of growth has some affinities to this
model. Professor Hicks has distilled what he calls Smith's 'pure
economic model' in a form which brings out the similarity rather
well. Although this distillation is clearly a greatly simplified
interpretation of the Smithian message it also pinpoints some of
the features that are of interest to modern growth theorists.4
Briefly, Hicks' version starts with an initial capital stock given
by last year's harvest and expressed as a certain quantity of corn.
This provides the resources which the labour force is to
transform into more corn in the current period - the period
being the agricultural year. The size of the initial capital stock
(the amount of corn carried over from last year) determines the
number of labourers that can be employed. Then the output of
the current year Xt depends on last year's output Xt~u the
productivity of the average labourer (p) and the amount con-
sumed (as food and as seed) by each labourer (w): so that
Xt = (p/w)Xt-i. If the product of the average labourer (p) is larger
than the corn he uses up (w) then Xt will be larger than Xt-t and
the economy will be growing at the rate (p/w)-i. Conversely, if
the wage rate of (corn consumed by) the average labourer rises;
or if any corn is taken out of this process to unproductive (non
corn-producing) sectors then the agricultural surplus will be
reduced i.e. Kt = kXt-i where k represents the fraction left after
all non-productive * leaks' are accounted for. Then the capital
available to finance corn production next year Kt will be only part
of this year's production and the wages fund, i.e. the stock of wage
goods available to support next year's labour force, will be
correspondingly reduced. The number of labourers employed
will be Ktjw so that Xt = (p/w)Kt = k(p/w)Xtzl. The growth rate of
the economy is now only k(p/w) — i, so that a positive growth rate
hinges on productivity rising faster than the wage rate and the
level of unproductive consumption.
When the Smith model is put into this kind of form it resembles
a highly simplified modern growth model but it is only a dynamic
model under very special assumptions. If p and w and k were
4
J. R. Hicks, Capital and Growth, pp. 36-8. See also W. T. Eltis 'Adam Smith's
Theory of Economic Growth', in Essays on Adam Smith, ed. Andrew Skinner and
Thomas Wilson (1975).
regarded as constants and p > w it could constitute the model for
a regularly progressive economy. Smith however gives no
indication that he regards them as constants. 'It follows' says
Hicks 'that Smith's model though it looks like a growth model
is not a growth model in the modern sense. It does not exhibit
a sequence.' 5
Putting Smith's theory in this purely economic format, how-
ever, does not capture either the spirit or the novelty of his
approach to an explanation of growth. For one thing he did not
attempt to visualise the growth process in exclusively economic
terms. For another he explicitly rejected the physiocratic view
that the only productive sector in the economy, the only source
of a social surplus, was the agricultural sector. Writing as he did
on the threshold of the first industrial revolution, he perceived
more clearly than any of his predecessors had done, the wide
scope for increasing returns in industry. In commenting on the
physiocratic model which he described as 'the nearest approxi-
mation to the truth that has yet been published upon the sub-
ject of political economy' 6 he wrote: ' T h e capital error of this
system, however, seems to lie in its representing the class of
artificers, manufacturers and merchants, as altogether barren and
unproductive.' 7 He then went on to shift the emphasis from the
landed classes to the manufacturing classes as the main source
of economic growth, which he saw as depending on two main
inter-related elements: (1) the productivity of labour arising out
of specialisation; and (2) the accumulation of capital by saving
out of profits. T h e crucial requirements for growth, that is to say,
were that there should be increasing subdivision of labour,
raising average productivity, and that savings out of profits
should be more than enough to maintain existing capital.
In both respects he regarded the manufacturing classes as
having an advantage over the landed classes. Thus he said of the
first of his two sources of growth:
The improvement in the productive powers of useful labour depend,

first, upon the improvement in the ability of the workman; and secondly
upon that of the machinery with which he works. But the labour of
artificers and manufacturers, as it is capable of being more subdivided,
and the labour of each workman reduced to a greater simplicity of
operation than that of farmers and country labourers, so it is like-
5
6
Op. cit, p. 39, n. 1.
7
Wealth of Nations, Carman edn, Vol. 11, p. 176.
Ibid, p. 172.
wise capable of both these sorts of improvement in a much higher
degree.8
On his second source of growth, capital accumulation he wrote:
The increase in the quantity of useful labour actually employed within
any society, must depend altogether upon the increase of the capital
which employs it; and the increase of that capital again must be exactly
equal to the amount of the savings from the revenue, either of the
particular persons who manage and direct the employment of that
capital, or of some other persons who lend it to them. If merchants,
artificers and manufacturers are, as this system seems to suppose,
naturally more inclined to parsimony and saving than proprietors and
cultivators, they are, so far, more likely to augment the quantity of useful
labour employed within their society and consequently to increase its
real revenue, the annual produce of its land and labour.9
Finally he observed as a fact of life, confirming his assumptions,
that incomes per head earned in trading and manufacturing
activities are higher than average incomes in the agricultural
sector and he used this fact as another reason for emphasising
the crucial importance of the non-agricultural sectors in econ-
omic growth. Thus:
though the revenue of the inhabitants of every country was supposed
to consist altogether, as this [physiocratic] system seems to suppose, in
the quantity of subsistence which their industry could procure to them;
yet even upon this supposition, the revenue of a trading and manufac-
turing country must, other things being equal, always be much greater
than that of one without trade or manufactures... A small quantity of
manufactured produce produces a great quantity of rude produce. A
trading and manufacturing country therefore naturally purchases with
a small part of its manufactured produce a great part of the rude
produce of other countries; while on the contrary a country without
trade and manufactures is generally obliged to purchase, at the expence
of a great part of its rude produce, a very small part of the manufactured
produce of other countries.10
T h e empirical evidence for this proposition was Holland, a
trading and manufacturing country with relatively limited
natural resources, then in Smith's estimation the most affluent
country in the world. The explanation though not explicit in
this context can be found in his argument connecting the division
of labour and the size of the market opened up by international
trade. 11
8 9
10
Ibid, pp. 174-5. Ibid, p. 175.
Ibid, p. 175.
11
See e.g. the chapter in Book 1 of the Wealth of Nations entitled 'That the
Division of Labour is limited by the extent of the Market'.
The keystone of Adam Smith's theory of growth was capital

accumulation associated with an increasingly specialised and
hence productive labour force. On his account capital accumu-
lation provided both the employment opportunities which deter-
mined the extent of the market for manufactured goods (and
thereby the scope for specialisation of labour) and the machinery
which was one element in the increasing productivity of the
labour force.
This great increase of the quantity of work, which, in consequence of
the division of labour, the same number of people are capable of
performing, is owing to three different circumstances; first to the in-
crease of dexterity in every particular workman; secondly to the saving
of time which is commonly lost in passing from one species of work to
another; and lastly, to the invention of a great number of machines which
facilitate and abridge labour, and enable one man to do the work of
many.12
The growth process generated by these twin elements - capital
accumulation and division of labour - was likely to continue so
long as product per head grew faster than consumption per head,
for this would ensure a continuing surplus, a rising demand for
labour and hence a growing population.13
It is worth noting in the light of later developments in eco-
nomic theory two crucial links in this analysis. The first is that
Smith did not entertain the possibility of savings lying unspent
in normal conditions: 'In all countries where there is tolerable
security, every man of common understanding will endeavour
to employ whatever stock he can command, in procuring either
present enjoyment or future profit.'14 In going on to argue that
'a man must be perfectly crazy' who does not spend his surplus
either on present consumption or on investment in fixed or
circulating capital he laid the foundation for what later became
known as Say's Law, viz that supply creates its own demand. The
second crucial link in Smith's view of a continuous growth process
was that connecting the demand for labour with the growth
of population, because 'the demand for men, like that for any
other commodity necessarily regulates the production of men;
quickens it when it goes on too slowly, and stops it when it
12
Wealth of Nations, Vol. I, p. 9.
13
See ibid, pp. 81-2: 'If this demand [for labour] is continually increasing, the
reward of labour must necessarily encourage in such a manner the marriage and
multiplication of labourers, as may enable them to supply that continually
increasing demand by a continually increasing population'.
14
Ibid, p. 267.
advances too fast'.15 Here of course he was anticipating in part
at any rate Malthus' theory of population.
Finally Smith did not expect growth to go on for ever. The
long-term limits to growth were apparently set by natural re-
sources which would ultimately put limits on population growth.
'In a country fully peopled in proportion to what either its
territory could maintain or its stock employ, the competition for
employment would necessarily be so great as to reduce the wages
of labour to what was barely sufficient to keep up the number
of labourers, and, the country being fully peopled, that number
could never be augmented.'16 There are various references in the
Wealth of Nations to what later came to be called the 'stationary
state' but they do not amount to a systematic explanation of the
transition from a growing to a non-growing economy. It seemed
to be self-evident to Smith that a country which ' had acquired
that full complement of riches which the nature of its soil and
climate, and its situation with respect to other countries, allowed
it to acquire'17 would stop growing. His own focus of interest
however lay not on that distant horizon but on the more imme-
diate problems raised by the short-term and surmountable limits
to growth set by political rather than economic factors.
This then was the nub of the eighteenth-century growth prob-
lem: how to identify the economic policies which would promote
rather than retard the growth of national output. Like the physio-
crats Smith had seen beyond the limited mercantilist horizons
to a world in which economies could grow by generating an
annual surplus and using it to increase next year's output. Here
was the real breakthrough that permitted a theory of modern
economic growth. The peculiar virtue of Adam Smith's analysis,
for a historical period in which the first industrial revolution was
beginning spontaneously to take shape, was that it offered a
natural explanation for international income differentials and for
differing growth rates; natural in the sense that it was inherent
in the capitalist economic system he described. Thus:
The natural effort of every individual to better his own condition, when
suffered to exert itself with freedom and security, is so powerful a
principle, that it is alone, and without any assistance, not only capable
of carrying on the society to wealth and prosperity, but of surmounting
a hundred impertinent obstructions with which the folly of human laws
too often incumbers its operations; though the effect of these obstruc-
15 16
" Ibid.
dons is always more or less either to encroach upon its freedom, or to
diminish its security.18
In sum, the distinctive features of Adam Smith's theory of

economic growth were: (i) his emphasis on the role of labour
specialisation and its relation to the size of the market; (ii) the
importance he attached to the role of the manufacturing sector
in accelerating the pace of productivity growth for three reasons
- (a) because there was more scope for division of labour in
manufacturing, (b) because the commercial and manufacturing
sectors tended to save a relatively high proportion of income, and
(c) because the demand for their products was less readily satiated
than the demand for, e.g. foodstuffs; and (iii) the way he made
the growth of population, output and productivity all hinge on
the rate of growth of capital accumulation. No one before him
had produced as complete and plausible an explanation of the
process of economic development for a country in the early stages
of unprecedentedly rapid industrialisation. In the event,
however, it was the third of these characteristics - the pivotal
importance of capital accumulation - which had the most power-
ful impact on the subsequent evolution of growth theory.
The classical economists who followed Smith, for example,
accepted as axiomatic his emphasis on capital accumulation but
developed the argument along a narrower line to a more pessi-
mistic conclusion. The most distinctive feature of classical
growth theory was that it came to see the growth process as an
inexorable movement in the direction of a stationary state. The
argument rests essentially on the Malthusian population prin-
ciple (already foreshadowed by Smith) and the law of historically
diminishing returns. It is perhaps not surprising that it should
have taken this form. In the first quarter of the nineteenth
century the Census returns showed the British population to be
growing at an accelerating rate. At the same time the enclosure
movement was slowing down because the surplus of cultivable
land in the form of wastes or commons was rapidly being ex-
hausted. In this context growth theory tended to stress the
tendency of diminishing returns (generated by the pressure of
a rapidly rising population on a limited stock of natural re-
sources) to outrun the pace of technical innovation. Agriculture
was still the premier industry and even the remarkable burst of
innovation in manufacturing and transport that characterised
18
Ibid, Vol. 11, p. 43.
the late eighteenth and nineteenth centuries affected a relatively
small sector of national economic activity.
Briefly, then, the classical theory of the growth process ran as
follows. An economy will tend to expand so long as natural
resources are abundant in relation to the population dependent
on them, for capital will be attracted by the profit opportunities
of investing in resources not fully exploited and the labour force
will grow in response to the demand associated with increasing
capital accumulation. However, given land (hence natural re-
sources) in fixed supply, and given population (hence labour
force) tending to increase whenever average wages rise above
the conventional subsistence minimum, the increase in total
wages will tend to squeeze down total profits - the source of
the nation's investible surplus. As profits (hence investment)
fall and the demand for labour accordingly declines, average
wages will sink back to subsistence level, but total wages will
continue to press on total profits while population increases.
When the working population reaches the point at which total
wages equal total product minus rent, i.e. where profits drop
to zero, new net investment will cease because there is no longer
any incentive to invest. When average wages drop below the
conventional subsistence level, poverty or moral restraint will
curb the population increase. And with zero net investment and
a static population the stationary state will have been reached.
Of course, technical progress, making labour more productive,
will set the growth process off again but as soon as wages rise
above the conventional subsistence level the tendency for popula-
tion to rise will recur and set in motion the retardative factors
that lead back to a stationary state (probably at a higher real
wage because the conventional subsistence minimum tends to
shift upward).
Classical dynamics was thus essentially the theory of the pro-
gression towards the stationary state. Not all classical economists
explained this progression in terms of the same mechanism but
all saw it as an imminent historical necessity in the long run.
The most rigorous and internally consistent version of the
classical theory of growth was Ricardo's. Like Adam Smith, he
saw capital accumulation (defined in terms of employment of
productive labour) plus technical progress (defined as labour-
saving or labour-improving innovation) as the two motive
forces promoting growth. Like Adam Smith he saw the price
of corn as ultimately determining the subsistence level in all
industries19 but he went further than Adam Smith in spelling out
the mechanism of the interaction between agriculture and the
rest of the economy. The heart of the Ricardian system was the
theory that the yield of corn per acre of land (taken a proxy for
a kind of composite agricultural productivity) was the ultimate
determinant of the rate of return on capital invested in all
sectors of the economy. Given free competition the rate of profit
or the return on investment tends to be the same in all uses. Now
in agriculture corn is both input and output, capital as well as
product so that the money rate of return on agricultural invest-
ment cannot diverge from the corn rate of return: and since
in long-run equilibrium the rate of return on investment in
agriculture must equal that of all other industries the' total profits
of the farmer regulate the profits of all other trades'. However,
with population tending to press on limited agricultural resour-
ces the long-term rate of return on investment in agriculture
(and hence in other industries) must inevitably decline. To
quote: 'With the progress of society the market price of labour
has always a tendency to rise because one of the principal com-
modities by which its natural price is regulated [corn], has a
tendency to become dearer from the greater difficulty of pro-
ducing it'.20 Ricardo was prepared to allow that in the short
period the natural price might diverge from the market price of
labour, e.g. because competition among capitalists for labour
would drive market wages up, but held that in the long run
any increase in market wages, above the 'natural' rate (deter-
mined by the conventional subsistence minimum) would raise
the labour supply.
The virtue of this system was its extreme simplicity and - given
acceptance of the necessary simplifying assumptions - its
completeness and consistency. It was essentially a two-factor
(almost a one-factor) model of growth. Land, being ultimately
fixed in supply, could be left out of the growth equation. Capital,
being defined in terms of the labour it gave employment to,
would automatically grow at the same rate as the labour force,
i.e. employment grows in step with the wages fund. Assuming
equality of return to capital and labour in all industries made it
19
See e.g. Wealth of Nations, Vol. 11, p. 11: 'the money price of corn regulates
that of all other home-made commodities'; and Vol. 1, p. 187: 'Corn.. .or what-
ever else is the common and favourite vegetable food of the people, constitutes,
in every civilized country, the principal part of the subsistence of the labourer.'
20
Sraffa (ed.), Works and Correspondence of David Ricardo, Vol. 1, p. 93.
possible to analyse the growth process essentially in terms of the
growth of one industry - agriculture - and one product - corn.
Assuming an elastic supply of labour meant that growth was
generated by the rate of technical progress and the level of thrift
and limited by the stock of natural resources. For if technical
progress raised the productivity of labour or a change in savings
habits increased the supply of capital, the resultant increase in
the demand for labour would eventually increase the supply
sufficiently to raise output to the full new potential - u p to the
point at which the increased labour demand for consumption
goods outran the capacity of the agricultural industry to produce
more corn. In the end, assuming savings habits constant (or all
profits devoted to capital accumulation), the national growth rate
depended essentially on the outcome of the conflict between
technical progress in agriculture and diminishing returns in
agriculture.
Actually in the third edition of his Principles published in 1821
Ricardo showed signs that he was beginning to move away from
some of the artificial simplications of this model for he was
beginning to develop a concept of capital as a factor of production
substitutable for and not merely complementary to labour. In the
chapter called 'On Machinery' he analysed the effects of
substituting fixed capital for labour and recognised that this
could in fact result in unemployment a n d ' a diminution of gross
produce'. However, the significant conclusion he drew from it
was more directly concerned with his theory of income distri-
bution than with his theory of growth viz: 'that the substitution
of machinery for human labour, is often very injurious to the
interests of the class of labourers.' 21 He turned away from
drawing the implications of this for fluctuations in growth. He
suggested, for example, that for the economy as a whole the
introduction of machinery is too gradual to be disruptive. He
stressed its dependence on the price of labour: 'Machinery and
labour are in constant competition, and the former can fre-
quently not be employed until labour [i.e. the share of wages in
national product] rises.'22 And he stressed its long-run growth-
promoting effects through increasing profits and hence capital
accumulation.
These savings, it must be remembered are annual, and must soon create
a fund, much greater than the gross revenue, originally lost by the
21
Ibid, p. 388. ** Ibid, p. 395.
discovery of the machine, when the demand for labour will be as great
as before, and the situation of the people will be still further improved
by the increased23 savings which the increased net revenue will still enable
them to make.
In sum then, what did the classical economists provide in the
way of building blocks relevant to growth theory? First, of course,
they provided a check list of factors which can be expected to
determine the pace of growth in income per head in any economy
and which are therefore candidates for inclusion as the elements
of any growth theory, viz: natural resources, population, capital,
technology and the institutional setting of economic activity.
Second, they developed certain propositions concerning the rela-
tionships between these elements. For example, since natural
resources are assumed limited, their combination with other
factors of production (capital and labour) can be expected to lead
to historically diminishing returns. On the other hand technical
progress, which raises output per unit of input and can be
expected to continue indefinitely, can offset the effects of
diminishing returns. So the pace of economic growth depends
on the balance between these two underlying forces. Third, they
suggested some ranking in the growth-promoting properties of
the different elements, some crucial factors on which to focus.
Without exception the classical economists (including their most
unconventional follower, Marx) put capital accumulation as their
crucial dynamic factor with labour following a close second.
Succeeding generations of growth theorists have suggested
different kinds of relationships between the elements and denned
the elements themselves differently. It is not surprising in retro-
spect to find that the classical economists who wrote when agri-
culture was still the premier industry expected the balance to be
tipped by diminishing returns and saw the ultimate condition as
being that of the stationary state: and that the neo-classical
economists, writing when primary production had ceased to be
the typical form of economic activity, were prepared to assume
without argument that the balance would always be tipped in the
long run by increasing returns.24
23
24
Ibid, p . 396.
J. S. Mill illustrates a kind of transitional stage in this context. E.g. in the
1848 Principles, p. 751, he wrote that 'hitherto it is questionable if all the
mechanical improvements yet made have lightened the day's toil of any human
being'; but he anticipated considerable improvements in political and social and
institutional factors which would make the inevitable stationary state an agreeable
way of life - one in ' which while no one is poor, no one desires to be richer or
Conventionally, moreover, classical growth theory assumed
that natural resources and institutions could be regarded as
constants (even over the long term) and that the crucial changes
were those taking place in technology (treated by all except Marx
as an exogenous variable) and in the inputs of capital and labour.
Capital however was generally defined in such a way that it was
a complement to labour (and not a substitute for it) so that the
rates of growth of the inputs of capital and labour were always
in step. These assumptions permitted the development of a fairly
general and easily manipulable sort of theory with which the
classical economist could be sure of never getting out of his
analytical depth. Only Marx was bold enough to introduce tech-
nical and institutional change into his theory as variables, to
define capital in a more disaggregated way, and to take explicit
account of the influence of technological change on the way
capital and labour were combined in the productive process. The
effect was to make his theory more complicated, to reduce its
generality and internal consistency by comparison for example
with the Ricardian model but to give it a certain realism and an
unquestioned dramatic power.25
FURTHER READING
Primary literature
Quesnay's Tableau Economique, ed. for the Royal Economic Society by
Marguerite Kuczynski and Ronald L. Meek (1972).
T. R. Malthus, First Essay on Population, reprinted for the Royal Econ-
omic Society (1966).
David Ricardo, On the Principles of Political Economy and Taxation, Vol.
1 of Works and Correspondence of David Ricardo, ed. for the Royal
Economic Society by Piero Sraffa with the collaboration of
M. H. Dobb (1951).
Adant Smith, Wealth of Nations, op. cit.
W. A. Eltis, 'Adam Smith's Theory of Economic Growth', in Essays on
Adam Smith, ed. Skinner and Wilson, op. cit.
W. A. Eltis, 'Francois Quesnay: A reinterpretation', Oxford Economic
Papers (1975).
has any reason to fear being thrust back by the efforts of others to push
themselves forward' (Principles, pp. 748-9).
25
See below, Chapter 9 for a discussion of the Marxian model.
B. F. Hoselitz (ed.), Theories of Economic Growth (i960).
A. Lowe, 'The Classical Theory of Economic Growth' Social Research
(•957)-
A. Phillips, 'The Tableau Economique as a Simple Leontief Model',
Quarterly Journal of Economics (1955).
CLASSICAL MONETARY THEORY
The British classical economists who took up the torch which

Adam Smith lit with the Wealth of Nations and who set out to
perfect the 'science' of political economy won for their discipline
a more significant prize than recognition as a minor academic
subject. They turned it into a system of thought which com-
manded wide political respect: for the questions which gave
direction and shape to their theoretical enquiries were questions
of urgent practical concern to contemporary policy makers.
When they found the analytical apparatus they had inherited
from Smith lacking it was generally because it failed to provide
them with the technique they needed to analyse current econ-
omic policy problems. The issues which dominated the first
decade of the nineteenth century and which first drew Ricardo
into active economic controversy were problems of monetary
policy.
Monetary theory and monetary controversy have always
evolved in intimate relation with real-world policy needs and
economic debate on domestic, as distinct from international
monetary issues, has generally been associated with a failure of
the authorities responsible for regulating the money supply to
steer a confident course between the Scylla of inflation and
the Charybdis of deflation. So, although writers on economic
questions have analysed the role of money in the economy for
as long as they have been interested in the workings of an
exchange economy, it is easy enough to decide where modern
British monetary theory essentially begins, viz in the controversy
set off by the problems involved in supplying the economy with
the abnormal needs for money and credit facilities, necessitated
by the prolonged French and Napoleonic wars of the late eigh-
teenth and early nineteenth centuries. Additionally, moreover,
this was a period in which the industrial revolution was gathering
momentum, population growth and urbanisation were accelerat-
Classical monetary theory 45
ing and when there occurred an abnormally high concentration
of spectacularly poor harvests. There were thus three levels of
monetary problem emerging at this period: first, the relationship
between changes in the supply of money and the general level
of economic activity or the rate of foreign exchange; second, the
problem of the relation of the stock of an acceptable medium of
exchange to the flow of payments to be made; and third, the
problem of the availability of credit in relation to the possibilities
of expanding business. Not surprisingly the problems of mone-
tary policy loomed larger and demanded a more understanding
helmsman than the existing monetary institutions were able to
supply.
It was when paper notes, particularly small banknotes, began
to rival coin as an everyday medium of exchange and thus to lift
the ultimately technological constraints on the supply of money
imposed by the accessible stock of monetary minerals that the
problems of monetary policy began to assume their modern
shape. Eighteenth-century writers became increasingly pre-
occupied by the inflationary danger involved in the issue of
paper money,1 though all the while Bank of England notes were
redeemable in gold (and other bank notes in either gold or Bank
of England notes) the traditional assumption that 'real' money
was metallic money could continue to support monetary analysis.
The break came when the Bank of England snapped the auto-
matic link between its notes and the precious metals for which
they were in principle exchangeable, by suspending cash pay-
ments. From the Suspension of Cash Payments which began in
1797, and the essentially new problems of practical policy with
which it presented the Bank, dates the emergence of a new
branch of economic theory which developed largely independ-
ently of the mainstream economic doctrine stemming directly
from Adam Smith's Wealth of Nations. The Suspension shattered
the traditional mould of banking practice and called for a basic
reappraisal of customary ideas on money and banking.
The challenge was met first by Henry Thornton, a practising
City banker and MP, who had been giving thought to these
questions even before he was called to give evidence to the 1797
parliamentary committee on the Suspension and who published
in 1802 an Enquiry into the Nature and Effects of the Paper Credit
1
E.g. David Hume's essays 'Of Money' and 'Of Balance of Trade', published
in his Political Discourses (1752), were concerned with the balance of payments
implications of an excess issue of paper currency.
46 Classical monetary theory
2
of Great Britain. Thornton's book was the first systematic expo-
sition of a theory of money and credit on modern lines. It
embodies the development and first application of a number of
ideas which were eventually to fall into place as integral features
of monetary theory - though some of them were neglected by
mainstream nineteenth-century theorists and were brought into
play again only in the twentieth century. Thornton, for example,
presented the first complex analysis of the self-correcting balance
of payments mechanism, through which an increase in paper
currency circulating in a gold-standard country would, by raising
its price level relative to that of its trading partners, reduce ex-
ports and raise imports, and, via the resulting disequilibrium in
its balance of trade, lead to an export of bullion (and a tendency
to convert gold coin into bullion) and so to a fall in the domestic
circulation of gold-backed paper and coin. He recognised that
real effects could flow from monetary causes in the short run (e.g.
that inflation of the currency could stimulate trade and industry
and deflation might reduce output) and that conversely a growth
in output and trade would stimulate the volume of credit ad-
vanced and of currency in circulation. He described (without so
naming it) the increase in liquidity preference which results from
political 'consternation' or economic uncertainty and ascribed to
this the internal drains of 1793 and 1797. He noted the relative
rigidity of money wages and inferred that a scarcity of money
would raise unemployment.
Two things condition the character of monetary theory which
emerges at a given period - the nature of the existing monetary
institutions and the form in which the practical policy problems
present themselves. Thornton started, as did all the other
theoretical economists of his day, from Adam Smith's Wealth of
Nations but he did not find himself retaining much of the
Smithian foundations. For by the end of the century, the British
credit system had developed so significantly from the system
confronting Adam Smith that the latter's account was seriously
out of date. In particular, the numbers and importance of the
English note-issuing country banks had greatly expanded and
the Bank of England had acquired a central role in the credit
structure which made it the effective lender of last resort and
2
The LSE edition edited with an introduction by F. A. v. Hayek and published
in 1939 contains in addition his evidence given before the Committees of Secrecy
of the Two Houses of Parliament on the Bank of England, March and April
1797, and reports his 1811 speeches on the 1810 Bullion Report.
custodian of the liquid reserves of all other banks in the system.
Meanwhile the overseas trade was assuming a rapidly increasing
direct importance in determining the level of British economic
activity; and Britain's role in the international economy had so
expanded as to become a dominating factor in the international
exchanges. The long wars that broke out in 1793 accentuated
these developments stemming from an industrial revolution
based on an expansion both of overseas markets and of overseas
sources of food and industrial raw materials. So, in contrast to
Adam Smith who had assumed, for example, that all notes were
automatically convertible into specie, that the typical source of
paper credit was 'real bills' (i.e. bills backed by the sale of real
commodities), that the effects of an increased issue of notes would
have a local rather than national or international impact and that
no special central significance attached to the role of the Bank
of England in the credit structure, Thornton discussed a more
complex and more integrated set of monetary institutions, where
convertibility into specie was suspended, where the Bank of
England's role was pivotal and where the effects of a divergence
between the market price and the mint price of bullion worked
themselves out on the international exchanges.
By the last decade of the eighteenth century British monetary
problems were the problems of an economy already started on
a process of unprecedentedly rapid economic expansion and
change, faced with the need to finance a major war and to
transfer massive subsidies to foreign allies, but lacking the insti-
tutions or the know-how to formulate and execute a consistent
set of monetary policies at the national level. The Bank of
England, originally set up in 1694 to meet the financial needs of
the central government, enjoyed monopolistic powers (it was the
sole joint stock bank in England and the only issuer of notes in
the metropolis) but had not yet accepted the public responsi-
bilities today assumed to attach to a Central Bank. In addition to
the Bank of England, the Bank of Ireland, the three Scottish
chartered banks and a multitude of country banks in England,
Ireland and Scotland also exercised rights to issue their own
bank notes, without any legal restraint other than the interest
maximum of 5 per cent imposed by the Usury Laws (a limit which
may have helped to check advances when money was scarce and
borrowers pessimistic but which was a positive incentive to
excessive borrowing during times of inflation). The credit system
therefore lacked the kind of centrally dispensed discipline and
protection which emanates from a responsible Central Bank and
was endangered by the existence of numerous small and
financially weak linksin the chain of confidence. The marvel was
not that such a vulnerable system was prone to severe financial
crisis but that it survived so many crises without more disastrous
consequences. Its remarkable stability probably resulted from the
buoyancy of the export trade associated with relatively large
reserves of bullion in the country generally and in the Bank of
England in particular.
The debate set off by the Bank's suspension of convertibility
in February 1797 began on a limited scale in the course of
parliamentary inquiries conducted by both Houses of Parliament
in March and April of that year. It gained general momentum
and political importance in 1800-1 when the value of commodities
in terms of gold and/or silver depreciated sharply on the foreign
exchanges3 and when for the first time an essentially monetary
explanation for fluctuations in the exchange rate was accepted
by informed observers. It became a major issue of political
economy in the next decade leading up to the Bullion Commit-
tee's Report of 18104 and continued until the country went back
to convertibility and on to a formal gold standard after the ending
of the war. The 'bullionist controversy', as the debate has since
been labelled, hinged on a fundamental difference of opinion
between the bullionists, who attributed the rise in the price of gold
bullion primarily to an over-issue of paper-credit (i.e. to
monetary mismanagement by the Bank of England), and the
anti-bullionists, who found a sufficient circumstantial explana-
tion in the effects of a major war - in particular to massive
overseas expenditures by the British Government accompanied
by a severe check to the expansion of British exports in the first
decade of the nineteenth century. The bullionist position was
taken by Thornton, Ricardo, Horner, Wheatley, Malthus,
Mushet and Huskisson and indeed by most of the leading
members of the early nineteenth-century community of econo-
mists. The essence of their view was that the main cause of the
depreciation of the pound in terms of bullion was the inflationary
policy of the Bank of England in issuing too much paper money;
3
By May 1800 gold bullion was selling on the Hamburg exchange at 9 per cent
above the Mint price; by the autumn of that year the premium on gold bullion
had risen to 10 per cent.
4
Report of the Select Committee on the High Price of Gold Bullion, Parliamentary
Papers (1810), Hi (349).
and that the only effective way of restoring monetary stability was
to impose on the Bank the constraint of redeeming its notes in
gold (i.e. of returning to convertibility) as soon as possible.5 The
opposite view was that taken by the Directors of the Bank and
some leading Cabinet Ministers who denied that it was possible
for notes to be issued in excess of needs: (a) because the credit-
worthy borrowers to whom alone the Bank was ready to advance
loans would not borrow more than they could profitably use; and
(b) because most of the loans were extended on the security of
'real bills', thus ensuring that the notes would return to the bank
in liquidation of these loans within a very few months, i.e. as soon
as the goods in question were sold.
Thornton's Paper Credit, however, was written before the
bullionist controversy had taken shape and is a more balanced
exposition of fundamental economic principles than any of the
pamphlets, speeches or letters-to-the-editor which flooded forth
when political opinion polarised on these issues. It was also
written at a time when the Suspension of Cash Payments was
regarded as an abnormal restriction associated with a war that
was not expected to last much longer and before the monetary
reasons for rising prices evidently outweighed the combined
effects of two bad harvests in rapid succession plus a war-caused
shock to British exports. So far from castigating the Bank for a
propensity to issue too much paper, Thornton began by criticising
it for having, in the crises of 1793 and 1797, been too ready to
contract its note issue on occasions when an abnormal demand
for liquidity (for precautionary reasons) had led to hoarding and
hence shortage of gold coin and a crisis of confidence in the banks
which could easily have been rectified by a more liberal issue of
banknotes.6 Belief in discretionary monetary policy, however,
inevitably hinged on confidence in the competence and skill of
the monetary authority exercising it and Thornton was to lose
much of his confidence in the ability of the Directors of the Bank
to manage an inconvertible currency in the public interest. In
1809 the exchange value of the pound began to deteriorate
again, a fact which was reflected in a widening of the diver-
gence between the notional mint price of gold and the market
5
There were of course differences of opinion about what was' possible' in this
context for it hinged essentially on a view of the fragility of business confidence.
The bullionist view was stated formally in the Report of the 1810 Bullion
Committee.
6
H. Thornton, Paper Credit, op. cit., p. 97 and p. 127.
price7 and which stimulated Ricardo's first venture into print
in the shape of an article on 'The Price of Gold' published
anonymously in the Morning Chronicle of 29 August 1809.
This new rise in gold prices renewed the bullionist controversy
and led to the formation of the Bullion Committee of the House
of Commons which was appointed in February 1810 and reported
later in the same year.8 Thornton was himself a member of the
Bullion Committee and as we may judge by his speeches when
the Report was debated in the House of Commons, he was by
then frankly dismayed by the inability of the Directors of the
Bank to appreciate the link between the supply of paper money
and the international value of the currency. He was then quite
clear that a failure to arrest the over-issue of paper money would
lead to a progressive depreciation of the currency which it might
be impossible to reverse when peace came and made it possible
to restore convertibility.
Ricardo joined the bullion controversy in 1809 with a series of
articles and replies to critics in the Morning Chronicle and his
position was crystallised in his 1810 pamphlet on The High Price
of Bullion, a Proof of the Depreciation of Bank Notes which was
reprinted in 1811 with an appendix dealing with some of the
criticisms made by reviewers of the first edition.9 In contrast to
Thornton, who dealt as readily with the complex interaction
between real and monetary causes and effects, that were the
substance of the problems confronting practising bankers, as he
did with the quantity theory and its international applications,
Ricardo simplified the issues and went straight into an abstract
theoretical exposition of the problem in a long-term framework
of analysis.
The question at issue in the bullion controversy and to which
Ricardo addressed himself in The High Price of Bullion was
whether or not the fall in the international exchange value of the
paper pound (the fall, that is in its gold value) reflected a
corresponding fall in its domestic value and was a direct result of
7
The mint parity price was £3. 17. 10Y2 and the market price did not diverge
from it until 2 years after the 1797 Suspension when it began to rise, reaching
£4. 6 in January 1801. Thereafter it was stable again until 1809 when it reached
£4. 12. 10H.
8
Report from the House of Commons, Select Committee on the High Price of
Gold Bullion (1810). This was reprinted in 1919 and again in 1925 by P. S. King
(London) with an introduction by Edwin Cannan. It has subsequently been
republished by Frank Cass (1969).
9
These are reprinted in Vol. in of the Sraffa edition of Ricardo's works.
an excess supply of money in the form of Bank of England notes.

Was the wartime inflation, that is to say, simply an unavoidable
consequence of the war (and the consequent disruption of over-
seas trade), aggravated from time to time by a poor harvest, or
was it caused by monetary policy and was the depreciation of the
currency on the foreign exchanges a fair reflection of the excess
of the money supply over the demand for it?
Ricardo's answer to the question was a monetarist answer.
In saying. . .that gold is at a high price, we are mistaken; it is not gold,
it is paper which has changed its value. Compare an ounce of gold, at
£3. 17s. iod to commodities, it bears the same proportion to them
which it has before done; and if it do not, it is referable to increased
taxation, or to some of those causes which are so constantly operating
on its value. . . In every market of the world I am compelled to part with
£4. 1 os in bank-notes to purchase the same quantity of commodities
which I can obtain for gold that is in £3. 17s. iod of coin.10
Much of his pamphlet repeated arguments already expounded
in Thornton's Paper Credit; for example, his analysis of the
factors governing the national and international distribution of
the precious metals, or of the' natural' limits on the money supply
of a country adhering to the gold standard, or on the relation
between the country bank note issues and the Bank's own note
circulation. Characteristically, however, he swept aside, as un-
important or irrelevant, all qualifications which Thornton had
noted to the simple monetary explanation. For example, he
minimised the suggestion that the depreciation of the currency
could have been due to a shift in the balance of trade, by a
pseudo-statistical argument similar to that he was to use later to
arrive at his labour theory of value:
Mr. Thornton has told us that an unfavourable trade will account for
an unfavourable exchange; but we have already seen that an unfavour-
able trade, if such be an accurate term, is limited in its effects on the
exchange. That limit is probably four or five per cent. This will not
account for a depreciation of fifteen or twenty per cent."
And he dismissed the notion that an increase in the note issue
could ever add to the national stock of productive capital by
10
D. Ricardo, The High Price of Bullion, a Proof of the Depreciation of Banknotes,
reprinted in The Works and Correspondence of David Ricardo, ed. by P. Sraffa and
M. Dobb, Vol. in, p. 80. Ricardo worked on the assumption that the general
purchasing power of gold was invariable. See below p. 67.
11
Ibid, p. 83. The rationale behind this opinion was that a shift in the balance
of trade would have price effects which would raise the demand for exports but
lower the demand for imports with only minor effects on the price of gold.
means of a somewhat circular reasoning: for having explained
that 'I am here speaking of an excess of their notes of that
quantity which adds to our circulation without effecting any
corresponding exportation of coin, and which, therefore, de-
grades the notes below the value of the bullion contained in the
coin which they represent', 12 he went on to assert that
however abundant may be the quantity of money or of bank-notes;
though it may increase the nominal prices of commodities; though it
may distribute the productive capital in different proportions; though
the Bank, by increasing the quantity of their notes, may enable A to
carry on part of the business formerly engrossed by B and C, nothing
will be added to the real revenue and wealth of the country...
There will be a violent and an unjust transfer of property, but no bene-
fit .whatever will be gained by the community.13
In the end he laid the responsibility for the inflation and the
depreciating exchange rate squarely on the shoulders of the
Directors of the Bank, though he was prepared to allow that it
was not self-interest but too great a subservience to government
demands and a failure to appreciate the consequences of their
policy that accounted for their behaviour:
If the Bank directors... hod acted up to the principle which they have avowed
to have been that which regulated their issues when they were obliged to pay their
notes in specie, namely, to limit their notes to that amount which should prevent
the excess of the market above the mint price of gold, we should not have been
now exposed to all the evils of a depreciated, and perpetually varying currency.H
There was, of course, considerable force in Ricardo's monetary
explanation for the depreciating exchange rate after 1809. Napo-
leon's continental blockade was of course hindering exports as
well as imports, but the domestic output of consumer goods was
rendered more inelastic than usual by the relatively high
proportion of the adult male labour force caught u p in the war
effort; and the denial on the part of the Bank's Directors and
their ministerial allies of any connection between its large loans
to the Exchequer, the suspension of cash payments and the
downward trend in the exchange rate, was evidence that the
nation's monetary authorities did not know what they were doing.
T o most reputable economists (Thornton included) Ricardo's
analysis, and the Bullion Report which it closely resembled,
seemed entirely appropriate to the contemporary policy prob-
lem. Partly perhaps because it seemed at the time to hit the
12 13
Ibid, p. 92, n. Ibid, p. 93.
14
Ibid, p. 95 (Ricardo's italics).
contemporary nail so neatly on the head, and partly no doubt
because of Ricardo's 'staggering' authority among early nine-
teenth-century economists,15 the doctrinaire monetarist line
became the basis of orthodox monetary theory and Thornton's
more qualified and subtle exposition of the complex interaction
betwen real and monetary factors, as set out in Paper Credit, fell
out of sight. What was thus lost from the subsequent legislation,
which leaned heavily on the Ricardian interpretation, was Thorn-
ton's vision of a discretionary note issue managed by a Central
Bank which adjusted its circulation, while giving explicit con-
sideration to the real as well as the monetary effects of its
policies. What was lost from mainstream theorising was any
serious attempt to analyse the effects of variations in the demand
for money (changes in liquidity preference), and (at least until
Wicksell took it up at the end of the nineteenth century) any
attempt to integrate the monetary influences exerted on the rate
of interest by the banking system, and the 'real' influences on
the rate of profit on capital.
Superficially, the debate between the Currency and Banking
Schools which led up to the 1844 Bank Charter Act was a con-
tinuation of the earlier bullionist controversy. Actually, however,
the Currency School, following the Ricardian hard line, went
further than most of the bullionists, and the supporters of the
Banking School (Tooke in particular) echoed many of the argu-
ments of Thornton's Paper Credit. For most bullionists it was
generally held sufficient to restore internal convertibility in order
to keep the supply of money broadly in line with the demand
for it, leaving the Bank some discretion to make certain that it
was dealing with a fundamental disequilibrium in the balance of
payments before contracting its note issue. For the Currency
School, mistrustful of giving any discretion to the Directors of
the Bank, it was essential to devise a technique of making the
paper circulation not merely redeemable in gold, but so rigidly
attached to the national stock of gold that the note issue would
automatically fluctuate with fluctuations in the stock. While recog-
nising the virtues of a mixed currency as a means of economising
in monetary gold they insisted that the rules of the gold standard
demanded that the mixed currency should be made to behave
exactly as if it were a pure metallic currency.
On the other side of the fence, the Banking School developed
more sophisticated arguments than the anti-bullionists had used.
15
See the quotation from Malthus on pp. 80-1 below.
Like some of the bullionists the Banking School were content to
assume that convertibility would suffice to safeguard the note
issue and to keep the balance of payments in long-term equi-
librium. They emphasised the problem of defining money for the
purpose of controlling the money supply and pointed out that
bills of exchange and cheques were as much media of exchange
in early nineteenth-century England as banknotes and coin; as
a corollary they argued that it was the whole credit policy of the
Bank and not merely the amount of cash in circulation that was
relevant. They insisted on distinguishing between short-term
disequilibria which called for a relaxed credit policy to sustain
confidence, and long-term disequilibria which called for defla-
tionary measures to stem an outflow of gold: the corollary of this
argument was their advocacy of an adequate gold reserve which
would permit the Bank to ride out temporary deficits without
reducing its power to deal with more deep-seated problems.
Finally they argued that the amount of money in circulation was
as much a consequence of the demand for money as of the supply.
In sum, their arguments had more in common with Thornton's
approach than with Ricardo's.
The leading exponent of the Banking School side of the
argument was Thomas Tooke16 but, not being a theorist, he has
had less attention from the historians of economic thought than
the substance of his arguments deserved.17 However, his analysis
was less rigorous and less consistent than Thornton's had been
and carried even less weight with most contemporary economists
and politicians. In the event it was the 'currency principle' that
prevailed and Sir Robert Peel's Bank Charter Act of 1844 owed
more to Ricardo's prescriptions than to those of any other leading
economist.18
The Act recognised the need to centralise the control of the
nation's money supply (money being defined as metallic money
plus a convertible note issue); and it formally established the
Bank of England as the primary monetary authority. At the same
16
See especially his Inquiry into the Currency Principle (1844).
17
For a sympathetic modern interpretation of Tooke's argument see David
Laidler, 'Thomas Tooke on Monetary Reform', in B. Corry (ed.). Essays in Honour
of Lord Robbins (1972).
18
The contemporary theoretical supporters of the Act were Robert Torrens,
James Pennington and S. J. Loyd (Lord Overstone). Its leading theoretical oppo-
nent was J. S. Mill. By the 1830s the Directors of the Bank had ranged themselves
on the side of the Currency Principle and were looking for a way of tying
changes in the note circulation to changes in the gold stock.
time, however, it deliberately restricted the role of the monetary
authority to that of protecting the nation's bullion reserves. Thus
it set a maximum to the country bank note issues, which were
eventually to be wholly absorbed by the Bank, and it divided
the Bank itself into a Banking Department and an Issue
Department.19 The Issue Department was given the function of
exchanging notes for coin or bullion (and vice versa) all notes in
circulation being fully backed by gold apart from a fixed fiduciary
issue covered by securities. The Banking Department was sup-
posed to act as banker to the public, to other banks and to the
government.
The importance of the Bank Charter Act for the evolution of
monetary theory was that it determined, for a further 70 years
at least, certain crucial features of the institutional framework
within which British monetary policy was expected to operate.
Its impact indeed went far beyond the British economy for it
bound the monetary authority of the leading trading nation and
the most advanced industrial state to abide by the rules of the
international gold standard. For a generation and more the Bank
of England, now recognised as the nation's Central Bank -
though with a deliberately restricted role - turned firmly away
from any notion that it ought to have some discretionary re-
sponsibility for controlling the money supply in favour of the
view that its duty was to respond in robot fashion to the signals
generated by the balance of payments. If gold showed a tendency
to flow out of the country to finance a deficit on international
account the Bank's duty was to raise its discount rate (so instantly
checking the outflow of capital and eventually restricting the
domestic credit supply if the disequilibrium proved at all per-
sistent) and vice versa if gold flowed in. Beyond that it had no
business to go and was expected to pursue its banking activities
19
This separation of powers within the Bank reflects Ricardo's views expressed
in his Plan for the Establishment of a National Bank (reprinted in the Sraffa edition
of Ricardo's Works Vol. iv) which began: 'The Bank of England performs two
operations of banking, which are quite distinct, and have no necessary connec-
tion with each other; it issues a paper currency as a substitute for a metallic
one, and it advances money by way of loan to merchants and others.' Ricardo,
however, proposed peeling off the note-issuing powers of the Bank altogether
and giving them to a currency board - leaving the Bank to carry on its deposit
business. In some respects, indeed, Ricardo's advice was more than a century
ahead of its time, e.g. his proposal for the form gold convertibility should take
(i.e. an exchange of bullion rather than coin against paper) - first advocated in a
pamphlet entitled Proposals for an Economical and Secure Currency (1816) and
reprinted in his Pri-nciples a year later - was not adopted in England until 1928.
in accordance with generally accepted principles of sound profit-
maximising commercial banking, subject of course to the indirect
limitation on its credit policy imposed by the ceiling on the
fiduciary issues.
That the Bank Charter Act was able to establish the ground
rules of British monetary policy for so long was due partly to the
fact that it was not wholly inflexible; for example, in each of the
three major crisis years 1847, 1857 and 1866, rising panic was
contained when the legal limits on the fiduciary issue were
temporarily lifted by Government directive so 'breaking the
Bank Act'. But its persistence was largely due to the way the
economic problem presented itself to policy makers in the mid
and later nineteenth century. The notion of a fully automatic
gold-backed currency fitted comfortably into the prevalent laissez-
faire, free trade, economic philosophy: and the built-in limita-
tions on domestic credit policy came under strain only rarely for
an economy with a normally strong, secularly-expanding, surplus
on international current account. It proved seldom, if ever,
necessary to respond to an autonomous external drain of gold
by pushing the appropriate credit restrictions through to an
extent which could be seen to be seriously threatening the level
of domestic economic activity. Conversely, when an expansion
in domestic activity led to an internal drain on the Bank's gold
reserves (often associated initially with an external drain due to
rising imports) a relatively modest rise in interest rates was
normally sufficient to offset the drain by attracting foreign short-
term capital and gold inflows. However, in practice the limits on
the money supply proved less rigid than the authors of the Act
had intended, for the steady development of the use of cheques
as a means of payment had the effect of circumventing the legal
limits on the note issue.
With the day-to-day problems of monetary policy appearing
less urgent and intractable than they had seemed in the war and
immediate post-war era, and with the basic institutional frame-
work operating in what was normally, if not invariably, a reason-
ably satisfactory manner, the need to innovate in monetary
theory diminished in relative importance, and classical monetary
thinking settled into a quiescent acceptance of a rather loose
analytical framework. It was John Stuart Mill who best synthe-
sised the classical orthodoxy in this as in so many other areas and
who wrote the main textbook purveying the ideas developed in
the first half of the nineteenth century to English (and often
American) readers embarking on a systematic study of economics
in the second half.
The chief question on which the classical economists focused
in this context was characteristically enough the question of value,
viz 'what determines the value of money?' It was not a sharply
focused question, for while it defined money in a very concrete
sense (i.e. basically as a metallic cash currency plus convertible
paper treated as a kind of de facto money) the yardstick by which
its value might be assessed was left open and it was discussed in
terms of ill-defined concepts such as 'purchasing power' and
'general prices'. Two theories of the value of money were con-
ventionally distinguished - a short-run theory which was a
(sometimes quite loose) variant of the quantity theory and a long-
run theory which hinged ultimately on the cost of production
of the precious metals. In neither case was much attempt made
to establish strong causal links in the process of determination
of the value of money. Most authors seemed content with an
explanation which asserted that the value of money could be
explained in the same way as the value of any other 'commodity',
and that it depended on market supply and demand for the stock
of money in the short run, and the cost of production of the
newly-mined increment of the stock of metal in the long run. In
effect, then, at this very superficial level of analysis the theory
of money was merely a special case of the general theory of value.
However J. S. Mill, in his textbook synthesis of orthodox
theory revealed more complexities in the special case of money
in the context of a modern credit-based economy. For after
stating the simple proposition that 'the value of money, other
things being the same, varies inversely as its quantity; every
increase of quantity lowering the value, and every diminution
raising it in a ratio exactly equivalent',20 and after introducing
the concept of the 'rapidity of circulation' or 'the efficiency of
money', he went on to admit that the simple demand and supply
proposition ' must be understood as applying only to a state of
things in which money, that is, gold or silver, is the exclusive
instrument of exchange and actually passes from hand to hand
at every stage, credit in any of its shapes being unknown'.21
Indeed the qualifications to the proposition 'that the value of the
circulating medium depends on the demand and supply, and is
in the inverse ratio of the quantity' were such that 'under a
20
J. S. Mill, Principles of Political Economy, Toronto edition, Vol. m, p. 512.
21
Ibid, p. 514.
complex system of credit like that existing in England, render
the proposition an extremely incorrect expression of the fact'.22
Mill then went on to argue at some length that it is spending,
not credit policy as such, which drives up prices and that the
'amount of purchasing power which a person can exercise is
composed of all the money in his possession or due to him, and
of all his credit.. .and the portion of it which he at any time does
exercise, is the measure of the effect which he produces on
price'23 to explain the changes in the level of prices (value of
money) associated with cyclical fluctuations in economic activity.
Similarly, Mill, after blandly expounding the classical doctrine
of the long-term or 'natural' value of money as a function of the
cost of production of the precious metals, went straight into the
further admission that: 'this doctrine only applies to the places
in which the precious metals are actually produced'.24 The value
of money 'considered as an imported commodity' was then
explained in terms of the theory of international values, i.e. as
dependent on the exchange values (after allowing for transport
costs) between the exports of the countries importing bullion and
the imports of the countries exporting it.
Mill's monetary analysis thus came closer to Thornton's real-
istic and broadly based interpretation and qualified Ricardo's
narrowly abstract quantity theory in significant respects. His
admissions and qualifications opened up the theory of money
from the closed position in which Ricardo had left it more than
he or his contemporaries seem to have thought worth discussing.
For he diluted the traditional emphasis on the supply of money
as the crucial factor determining prices in the short term; he
adopted (implicitly if never explicitly) a wider concept of money
as the relevant variable influencing price trends, and he recog-
nised that the durability of bullion, and the vast world stock of
non-monetary (as well as of monetary) gold or silver already in
existence, greatly attenuated the link between the cost of pro-
duction at the mines and the long-run value of money in
England.
Given this degree of defection from the simple quantity-theory
line of analysis it is not surprising to find that Mill was also highly
critical of the rigidities of the Bank Charter Act,25 quoting with
22 23
Ibid, p . 5 1 6 . Ibid, p . 5 4 0 .
24
Ibid; p. 523.
25
On this he showed considerable foresight, e.g. ibid, p. 672: 'The function
of banks in filling up the gap made in mercantile credit by the consequence of
approval some of Tooke's and other Banking School strictures
on it, and drawing attention to the dangers to domestic
confidence which might result from a too automatic and in-
flexible contraction of credit in response to a temporary dis-
equilibrium in the balance of payments and which could actively
precipitate a commercial crisis. On the other hand, he remained
as blind as Ricardo had been (and less percipient than Thornton)
towards the possibility that a deliberate expansion of credit might
stimulate economic activity in times of depression and hence
actually increase output rather than prices. This line of thought
thus tended to fall out of the range of orthodox classical doctrine
and with it went the prospects of developing any new ideas on
the question of positive monetary management of the economy.
FURTHER READING
Primary literature
Edwin Cannan (ed.), The Paper Pound of iygy-1821: The Bullion Report
8th June igio, 2nd edition reprinted (1969).
J. S. Mill, Principles of Political Economy, Toronto edn, Vol. 111 (1966).
David Ricardo, The High Price of Bullion, in Vol. in, Works, ed. Piero
Straffa(i966).
Henry Thornton, Enquiry into the Nature and Effects of the Paper Credit
of Great Britain, ed. F. A. von Hayek, LSE Reprint (1939).
B. A. Corry, Money Savings and Investment in British Economics 1800-50
(1962).
F. W. Fetter, The Development of British Monetary Orthodoxy fjgj-1875
(1965);
R. Harrington, 'The Monetarist Controversy', Manchester School of Social
and Economic Studies (1971).
D. Laidler, 'Thomas Tooke on Monetary Reform', in B. Corry (ed.),
Essays in Honour of Lord Robbins (1972).
R. S. Sayers, 'Ricardo's Views on Monetary Questions'; in Papers in
English Monetary History, ed. T. S. Ashton and R. S. Sayers (1953)-
J. Viner, 'English Currency Controversies', in Studies in the Theory of
International Trade, op. cit.
undue speculation and its revulsion, is so entirely indispensable, that if the Act
of 1844 continues unrepealed, there can be no difficulty in foreseeing that its
provisions must be suspended, as they were in 1847, in every period of great
commercial difficulty as soon as the crisis has really and completely set in.'
RICARDO ON VALUE, DISTRIBUTION
AND GROWTH
The abnormal inflationary pressures associated with the Napo-

leonic Wars had shown up monetary theory as an area in which
Adam Smith had clearly failed to provide the kind of theoretical
framework appropriate to the analysis of urgent policy problems.
The other economic policy issue dominating the early decades
of the nineteenth century was the question of agrarian protection
embodied in the Corn Laws. The issues raised here went to the
heart of Smith's disciplinary framework for economics and
inspired more fundamental attempts to revise orthodox eco-
nomic theory. It was in this context that Ricardo turned his
attention to a systematic study of the principles of political econ-
omy. His Essay on the Influence of a Low Price of Corn on the Profits
of Stock appeared in 1815, the same year as Malthus' Inquiry into
Rent and West's and Torrens' pamphlets on the same subject. In
effect, the policy issues were beginning to hinge on questions
relating to the distribution of the national product between rents,
profits and wages and those who drew their economic theory
from the Wealth of Nations found it inadequate for these pur-
poses. Uppermost in Ricardo's mind when he focused on the
price of corn and the level of profits was the danger that a high
price of corn (the chief wage-good) would depress profits by
pushing up the share of wages in the value of output and
thereby reduce resources for investment and hence retard
growth. The original preface of his Principles of Political Economy
and Taxation, designed as an expansion and systematic elabora-
tion of his Essay on Profits, stated categorically that the principal
unsolved problem of political economy was to determine the laws
which regulate the distribution of the national product between
rent, profit and wages.1
1
It was his friend James Mill who prodded him into expanding the Essay into
a general theory. The first edition of Ricardo's Principles appeared in 1817 and
there were two further editions in 1S19 and 1821. The definitive variorum
Ricardo on value, distribution and growth 61
T h e level of profits was crucial for Ricardo (as indeed for
Smith) because it was what determined the level of capital accu-
mulation and hence the rate of economic growth. Adam Smith,
however, had explained the general level of profits in simple
supply and demand terms which made it depend on the flow of
savings into capital accumulation on the one hand and the
opportunities for profitable investment on the other. Profits
would then fall either if wages rose faster than prices or pro-
ductivity, or if opportunities for profitable investment failed to
keep pace with the rate of capital accumulation. For Ricardo this
interpretation seemed incomplete. It led to some puzzling loose
ends and some inconvenient circularities in the argument. One
such loose end related to the effect of capital accumulation on
profits. Smith's analysis had led to the conclusion that, unless
opportunities for new investment expanded faster than available
investible funds, increasing capital accumulation would lead to
competition between capitalists and to a falling rate of profit. Yet
the evidence did not suggest that interest rates were tending
to fall in spite of a marked increase in the national level of
capital accumulation in the late eighteenth and early nineteenth
centuries. T h e question obscured by Smith's argument was the
relation between profits (including interest) and rent in a
growing economy, for returns in one lcind of investment might
rise at the expense of returns from another.
Another problem was that, although Smith's labour-com-
manded measure of value was a convenient index for one who
was primarily interested in comparing total real income as
between countries or over time, it contained an inconvenient
circularity from the point of view of those concerned with trends
in the relations between rents, profits and wages over time in a
growing economy. As Ricardo pointed out in the first chapter
of his Principles, which took issue at once with Smith's theory
of value:
if the reward of the labourer were always in proportion to what he
produced, the quantity of labour bestowed on a commodity, and the
quantity of labour which that quantity would purchase, would be equal,
and either might accurately measure the variations of other things; but
they are not equal; the first is under many circumstances an invariable
standard, indicating correctly the variations of other things; the latter
is subject to as many fluctuations as the commodities compared with it.2
edition is contained in P. Sraffa (ed.), The Works and Correspondence of David
Ricardo, Vol. I (1951).
2
Ricardo, Principles, Sraffa edn, Vol. 1, p. 14.
62 Ricardo on value, distribution and growth
Worse still, from Ricardo's point of view, Smith had argued that
a rise in the price of corn would, by pushing up wages, raise the
prices of all other commodities, for this line of argument left
indeterminate the effects of a rise in corn prices, or wages, on
profits.
The Ricardian theory of value and distribution was developed
therefore to explain the principal unsolved problem of political
economy as Ricardo then saw it, viz the way changes in the
relative shares of land, labour and capital would interact with the
process of capital accumulation and thus with the growth of
output. Ricardo's theory had four distinctive though not neces-
sarily original elements: it was their synthesis as the foundation
of a single macroeconomic model of economic development and
distribution that was original. The distinctive elements were: (i)
a new theory of rent, (ii) a postulate connecting the impact of
diminishing returns in agriculture with the rate of profit, (iii) a
subsistence theory of wages and (iv) a labour measure of value.
The analysis was conducted throughout in real terms - actually
generally in commodity terms by the device of reducing all
transactions to a single common denominator, corn.
(i) Ricardo's Theory of Rent. The theory of rent - a theory of
differential rents in agriculture - was essentially the same as the
theory propounded in 1815 by three other economists -
Malthus, West and Torrens. Ricardo acknowledged his debt to
Malthus and West in the preface to his Principles. It was a new
theory in that it had not been elaborated by Adam Smith. It
started from the assumption that land is specialised and in fixed
supply but that it is not all in use. As population grows and
capital accumulates new land is taken up. The cost of production
of corn will vary with the fertility of the soil and its situation in
relation to the market, but price must of course be high enough
to cover the cost of production on the least productive piece of
land in use - on the marginal land as we would now say. On this
marginal land production will just cover costs and there will be
no rent payable in the Ricardo model. On better land a surplus
will be obtainable which will accrue directly to the owner of the
land if he cultivates it himself or will be paid by tenants competing
for the better pieces of land. In this model therefore rent is
price-determined rather than price-determining and is a surplus
over and above the basic cost of production determined by
capital and labour inputs required by the marginal land. To quote
Ricardo: 'Corn is not high because a rent is paid, but a rent is
paid because corn is high'.3 To the passage stating that'rent does
not and cannot enter in the least degree as a component part of
its price', he added the footnote 'The clearly understanding this
principle is, I am persuaded, of the utmost importance to the
science of political economy.'4
The attraction of this theory from Ricardo's point of view was
that it explained differences in the amount of rent yielded by
different lands and at the same time simplified his theory of
value and distribution by eliminating rent as a factor in the
determination of value. Its attraction from the point of view of
some of his followers - economists and politicians - was that it
provided a rationale for policies which might be detrimental to
the land-owning classes. Ricardo himself denies indignantly that
he was the enemy of the landlords (having prudently converted
most of his investments into land he was a substantial landed
proprietor himself) but it is not difficult to find passages that
served in the purposes of those who were: e.g. 'Independently
of these improvements [in agricultural technology], in which the
community have an immediate and the landlords a remote
interest, the interest of the landlord is always opposed to that of
the consumer and manufacturer'5; and later in the same para-
graph: 'All classes, therefore, except the landlords, will be injured
by the increase in the price of corn.'6
(ii) Diminishing returns and the rate of profit. Ricardo's theory of
differential rent then, explained the way progressively less
favourably situated or less fertile lands would be taken into
cultivation as population grew and with it the demand for food.
The same argument underlay the law of diminishing returns and
Malthus' population theory. Ricardo carried the argument
further, however. As population rises and poorer lands are taken
into cultivation, or as additional units of labour are applied to
existing scarce land, the share of wages tends to rise and the share
of profits to fall. When the increasing difficulty of growing corn
on land of progressively worsening quality has driven the wage
share to the level where total wages equals total product minus
rent, profits will be reduced to zero, and the stationary state will
have been reached.
The natural tendency of profits then is to fall; for, in the progress of
society and wealth, the additional quantity of food required is obtained
3 4
5
Ibid, p. 335.
6
Ibid, p. 336.
by the sacrifice of more and more labour. This tendency, this gravitation as
it were of profits, is happily checked at repeated intervals by the improve-
ments in machinery connected with the production of necessaries, as
well as by discoveries in thescienceof agriculture, which enable us to relin-
quish a portion of labour before required, and therefore to lower the price
of the prime necessary of the labour. The rise in the price of necessaries,
and in the wages of labour is, however limited; for as soon as wages
should be equal... t o . . . the whole receipts of the farmer, there must be
an end of accumulation; for no capital can then yield any profit whatever,
and no additional labour can be demanded, and consequently popula-
tion will have reached its higher point. Long indeed, before this period,
the very low rate of profits will have arrested all accumulation and al-
most the whole produce of the country, after paying the labourers, will
be the property of the owners of land and the receivers of tithes and taxes.7
(iii) Subsistence theory of wages. Ricardo took the view that wages
as the price of labour were determined in the same way as that
of any other commodity. Its 'natural price' is that 'which is
necessary to enable the labourers one with another, to subsist and
to perpetuate their race without either increase or diminution.'
This in its turn depended on 'the quantity of food, necessaries
and conveniences become essential to him from habit'. 8 A high
rate of wages would stimulate an increase in population which
would eat up more and more of the total product after payment
of rent and reduce the proportion left for profit. T h e inducement
to invest and hence the demand for labour would then decline
and wage rates fall back to subsistence levels. Thus, taking explicit
account of the influence of social and customary factors on the
level of subsistence, he held the view that the market price of
labour will always tend towards the subsistence price, though it
might differ from it at particular times and places in relation to
the short-term forces of supply and demand. T h e original
Malthusian population theory had been formulated largely in
terms of a kind of physical subsistence minimum. Ricardo's way
of formulating it - treating the worker's subsistence level as a
function of ' habit and custom' - made it possible to explain
secularly rising real wages without having to abandon the
theorem he found so useful for analytical purposes - that wages
were supply-determined in the long run, independently of the
demand for labour.
(iv) The Labour Measure of Value. Possibly the most distinctive
and fundamental element in Ricardo's system, however, was the
measure of value that he adopted. He distinguished as did Adam
7 8
Ibid, pp. 120-1. Ibid, p. 93.
Smith between natural price (= value) and market price and he
started explicitly from a cost theory of value which he also
attributed to Smith. 'Utility then is not the measure of exchange-
able value, although it is absolutely essential to it... Possessing
utility, commodities derive their exchangeable value from two
sources: from their scarcity, and from the quantity of labour
required to obtain them.'9 Scarcity, however, is a factor in natural
price, or value, only for a few unique products like works of art
or particular kinds of wine, i.e. for commodities in fixed supply
or in conditions where competition is restricted. For all other
commodities the real foundation of value is human labour. 'I
confess it fills me with astonishment' he wrote in a letter to
Malthus in 1818
tofindthat you think... that natural price, as well as market price, is deter-
mined by the demand or supply... In saying this do you mean to deny
that facility of production will lower natural price and difficulty of produc-
tion raise it?...If indeed this fundamental doctrine 10of mine were
proved false I admit that my whole theory falls with it.
His whole theory, that is to say, was developed in terms of the
long-term or natural price (real value) of things and with this in
view he settled on a cost-of-production theory of value.
Having successfully developed a theory which eliminated rent
from cost of production he was left with the task of explaining
value in terms of wages and profits. In the end he managed to
reduce everything (or nearly everything) to its labour cost. He
argued that in practice the long-term exchange value of goods
would vary in proportion to the labour spent on producing them
- including of course not only the direct labour cost but also the
labour embodied in the fixed capital used up in their
production.
Put like this of course it approximates to a simple labour theory
of value and many writers have assumed that that was all the
Ricardian theory of value amounted to. Actually it was more than
that. In reducing capital to its embodied labour he divided it into
two classes - circulating and fixed capital. There was no difficulty
in measuring circulating capital in terms of labour; by generally
accepted definition it was the amount of corn, or the wages fund,
available to sustain the current labour force. Fixed capital,
however, has another dimension, its durability: i.e. the fact that
it increases the length of the productive process; and to the extent
9 10
Ibid, pp. 1 i—i2. Sraffa edn, Vol. vn, pp. 250-1.
that some commodities are produced with more fixed capital than
others, their relative value will differ for another reason than
their direct labour cost.' It is hardly necessary to say that commo-
dities which have the same quantity of labour bestowed on their
production, will differ in exchangeable value, if they cannot be
brought to market in the same time.'11 He then illustrated his
point with a numerical example showing that, at a given rate of
profit, capital locked up in the production process for two years
would require twice the profit accruing on the same amount of
capital turned over in one year.
Ricardo thus recognised explicitly that differences in the dura-
bility of fixed capital and differences in the fixed capital/labour
ratio introduce another factor into the determination of the
long-term exchange values of commodities. There is a plaintive
much-quoted passage for example in which he said:' Mr. Malthus
shows that in fact the exchangeable value of commodities is not
exactly proportioned to the labour which has been employed on
them, which I not only admit now but have never denied.'12 And
again in a letter to James Mill dated 1818 he insisted that there
are only two causes 'at all stages of society' why exchangeable
value varies: 'one the more or less quantity of labour required,
the other the greater or less durability of capital' and that 'the
former is never superseded by the latter but is only modified by
it'.13 But because he regarded variations in the input of fixed
capital as representing in practice a mere fraction of variations
in cost relatively to the input of labour,14 he chose generally to
ignore it and sometimes to write as though the input of labour
was the sole measure of value that one need take into account.
He did, however, explain that if one takes into account the fixed
capital component one must recognise that a rise in wage rates
relative to profit rates could raise the values of commodities made
with low capital/labour ratios (or low fixed/circulating ratios -
which amounts to the same thing) relatively to those made with
high capital/labour ratios. To quote:
12
" Sraffa edn, Vol. i, p. 37. Sraffa edn, Vol. I, p. xxxviii.
13
Sraffa edn, Vol. vn, p. 377.
14
See e.g. Sraffa edn, Vol. 1, p. 36: 'The greatest effects which could be
produced on the relative prices of these goods from a rise of wages, could not
exceed 6 or 7 per cent; for profits could not, probably, under any circumstances,
admit of a greater general and permanent depression than to that amount.'
Hence Stigler's description of Ricardo's theory as a 93 per cent labour theory
of value. G. Stigler, 'Ricardo and the ninety-three per cent labour theory of
value', reprinted in Essays in the History of Economics.
This difference in the degree of durability of fixed capital, and this
variety in the proportions in which the two sorts of capital [fixed and
circulating] may be combined, introduce another cause, besides the
greater or less quantity of labour necessary to produce commodities, for
the variations in their relative values - this cause is the rise or fall in the
value of labour.15
Conscious therefore that he was simplifying, but convinced
that he was not straying far from practical reality, Ricardo mea-
sured the relative value of a commodity in terms of the quantity
(man-hours) of labour embodied in its production. This en-
abled him to explain profits as a residual after accounting for
labour's share in national income net of rents. He differed from
Adam Smith both in the form and in the objective of his measure
of value. Smith - interested in growth more than in distribution
of the national income - was looking for a kind of price deflator
that would enable him to measure relative real incomes: so he
adopted a labour-commanded measure of value (the amount of
corn which would command a given quantity of labour). What
Ricardo wanted was a measure of value which would be inde-
pendent of changes in the division of the social product so that
he could use it in a theory of distribution. For if a rise or fall
in wages could of itself alter the value of total product it would
be impossible to predict the effect on profits. With Ricardo's
model however a rise in wages had no effect on prices or national
product but was associated with a corresponding fall in profits.
It was a theory which abstracted from differences in capital
structure and was applied to the long-run pricing of reproducible
goods under perfect competition.
Ricardo's basic model was formulated in real terms.
Transforming it to money terms raised another set of problems,
for it became necessary to distinguish changes which affected the
relative real values of commodities from changes affecting their
relative money values. In the end Ricardo cut through these
difficulties with a characteristically bold simplification by assum-
ing that the value of gold was invariant in relation to commo-
dities. ' T o facilitate, then, the object of this enquiry, although
I fully allow that money made of gold is subject to most of the
variations of other things, I shall suppose it to be invariable, and
therefore all alterations in price to be occasioned by some
alteration in the value of the commodity of which I may be
speaking.' 16 The rationale (if it can really be so called) for this
15 16
Sraffa edn, Vol. 1, p. 30. Ibid, p. 46.
proposition was the further assumption that gold was a 'stan-

dard' commodity in the sense that its conditions of production
involved an input mix of labour and fixed capital which approxi-
mated to the average for most other commodities.17
However, Ricardo never solved to his own satisfaction the
problems associated with devising a measure of value. In the
Principles he was looking for a measure of relative variations in
value and seems to have accepted that the problems of devising
an absolutely invariable measure were insoluble. Towards the
end of his life he was working on a paper on 'Absolute Value
and Exchangeable Value* which remained unfinished. Ricardo's
last letter to James Mill was indeed a characteristically modest
critique of a paper written by the latter's son, John Stuart, on
the measure of value.18 The letter ends:
Beg him to consider this and to let me know if I am wrong in my
critique on his paper. I have been thinking a good deal on this subject
lately but without much improvement - 1 see the same difficulties as
before and am more confirmed than ever that strictly speaking there
is not in nature any correct measure of value nor can any ingenuity
suggest one, for what constitutes a correct measure for some things is
a reason why it cannot be a correct one for others.19
All of which makes it the more surprising to find John Stuart
Mill's famous statement in his Principles; 'Happily, there is
nothing in the laws of value which remains for the present or
any future writer to clear up; the theory of the subject is
complete.'20 However, what this apparently complacent state-
ment reflected was two things - first a shift of problem-focus
and second a more eclectic, more realistic approach to economic
theory on the part of the younger Mill. He was not concerned,
as Ricardo had been, to explain the level and rate of profits as
a function of wages in order to justify an anti-Corn Law policy.
By the time Mill wrote his Principles the Corn Laws had been
repealed and he was interested in analysing the wage-depressing
effects of population growth. As far as profits were concerned,
moreover, he had abandoned Ricardo's concept of them as a
residual after determining wages and quoted approvingly Nassau
17
Ibid, p. 45: 'May not gold be considered as a commodity produced with
such proportions of the two kinds of capital as approach nearest to the average
quantity employed in the production of most commodities?'
18
Sraffa (ed.), The Works and Correspondence of David Ricardo, op, cit., Vol. IX,
PP- 385-7-
19
Sraffa edn, Works, Vol. ix, p. 387. Ricardo died less than a week later.
20
J . S. Mill, Principles, V o l i n , Collected Works, p . 456.
Senior's view of them as a reward for abstinence; he went on to
distinguish between net profits (which were a reward for risk
taking) and interest, which was the reward for waiting and thus
measured' the comparative value placed in the given society upon
the present and the future'. Finally, because Mill did not share
Ricardo's propensity for abstract theorising and model building,
his theory of value was expounded in a less rigorous way which
permitted him fruitfully to explore various qualifications and
exceptions to Ricardo's highly simplified framework of analysis.
Thus he was among the first economists to analyse such questions
as economies of scale, the effects of social status and education
in setting up non-competing groups in the labour force, the
applications of the labour theory of value to joint products, and
the implication of alternative uses for land for the assumption
that rent could be excluded from cost of production.
In sum then, Ricardo followed Adam Smith in adopting a
cost-of-production theory of value but achieved greater rigour
and consistency by process of abstraction. In the end he made
value hinge ultimately on one factor of production - unskilled
labour - and on this foundation constructed a general theory of
the long-run relative exchange values of reproducible goods in
a competitive exchange economy. Given the extreme simplicity
of its assumptions the model described a complete and logically
coherent set of relationships which were consistent with Ricardo's
intuitive conclusions concerning the interdependence of profits
and wages. However, whenever it became necessary to take into
account the possibility that there might be more than one kind
of labour, land or capital, or that there might be variable pro-
portions in the input mix for different commodities, or that
there might be variable periods of production, the model ran
into insuperable difficulties. Its applicability that is to say was
limited to a fairly narrowly defined analytical purpose.
FURTHER READING
Primary literature
D. Ricardo, An Essay on the Influence of a Low Price of Corn on the Profits
of Stock, Vol. iv, Works, ed. Piero Sraffa (1966).
D. Ricardo, Principles of Political Economy and Taxation (ed. Sraffa), op.
cit. (1970).
M. Blaug, Ricardian Economics (1958).
M. Dobb, Theories of Value and Distribution since Adam Smith (1973).
R. L. Meek, Studies in the Labour Theory of Value (1973).
George J. Stigler, Essays in the History of Economics (1964).
SCOPE AND METHODOLOGY OF
CLASSICAL POLITICAL ECONOMY
By the first decade of the nineteenth century, thanks to Adam

Smith, the study of political economy had acquired recognition
as a distinctive 'scientific' discipline.1 His pupil Dugald Stewart
was giving a named course on political economy in the University
of Edinburgh in the 1800s and in 1805 T. R. Malthus was ap-
pointed Professor of Modern History and Political Economy to
teach East India Company cadets at Haileybury College.
More important still, a self-conscious intellectual community
of economists had begun to emerge in Western Europe. Its
members were a fairly heterogeneous group, whose common
ground lay in the fact that, having read the Wealth of Nations,
they were concerned both to apply its analysis to current eco-
nomic problems and to develop, criticise and extend its basic
theory wherever necessary. Though two of the group's leading
members - James Mill and J. R. McCulloch, both Scottish
journalists - had been to Edinburgh University where Smith's
pupil Stewart was lecturing on political economy, it is fair to say
that they were all qua economists self-educated and mutually-
educating men who had started from the same text-book. The
British members in the first two decades also included Jeremy
Bentham, an academic philosopher, a contemporary of Adam
Smith whom he resembled in the sheer breadth of his intellectual
interests; and there was Ricardo the Jewish stockbroker whose
formal education had ended at the age of 14. On the continent,
there was J. B. Say who published a two volume Traite d'economie
politique (first edition 1803) expounding the Smithian paradigm
to a Parisian audience until he had to carry on his work in
Switzerland, when the Napoleonic regime made it politically
unwise to advocate laissez-faire doctrines in France; there was
1
It is of course open to question whether economics is, or was, a science. What
is relevant here is that Adam Smith and his successors among the classical
economists thought it was.
72 Methodology of classical political economy
also J. C L. Simonde de Sismondi, a Genevan by birth, who
published his first major work on economics, Richesse commerciale
in 1803, and that too was primarily an exposition of the doctrines
of Adam Smith. These men formed the nucleus of an intellectual
community whose members discussed, corresponded and de-
bated in print about the application of the new theory to current
economic problems in the first two decades of the century. By
the end of the 1820s there were Chairs of Political Economy at
Oxford (Nassau Senior was appointed to the Drummond
Professorship in 1825) and at the newly-formed London Univer-
sity. McCulloch who had been giving the Ricardo memorial
lectures to a distinguished audience of bankers, merchants and
MPs since 18242 was offered the London Chair in 1827.
However, although political economy based on the Smithian
paradigm had achieved a certain measure of academic recog-
nition (it still had very little status within the universities) its
fashionable appeal, and above all its attraction to active thinkers
depended not on its academic reputation, but on its immediate
relevance to contemporary policy problems. The problems which
engaged the attention of the community of economists in the
early nineteenth century were urgent and puzzling questions,
related to such basic issues as economic growth (the population
explosion), commercial policy (the corn laws) and inflation (the
high cost of bullion). It was the conviction that political economy
could provide a simple and effective method of analysing these
complex problems, and hence a reasoned route to useful policy
prescriptions that brought to McCulloch's lectures men such as
the Chancellor of the Exchequer, the Lord Mayor of London and
a bevy of Bank Directors, and that induced an acute mind such
as Ricardo's to retire from a lucrative Stock Exchange practice
to write a book on the principles of political economy and
taxation.
So how did Smith's analytical framework stand up to the
pressure of changing events in an industrialising economy and
to the sustained critique of a group of lively intellects? In parti-
cular how did the views of the scientific community of economists
on the scope and methodology of their subject change through
2
McCulloch was lecturing in Edinburgh, Liverpool and London (twice-weekly
in the West End and thrice weekly in the City in 1824). In 1825 the students at
the City class alone numbered 240 and at the newly formed City of London
Literary and Scientific Institution he had an audience of nearly 800. See D. P.
O'Brien, / . R. McCulloch, a Study in Classical Economics (1970), pp. 52-3.
Methodology of classical political economy 73
time? For although the formal qualifications of a professional

economist were still extremely vague (they were far from precise
even at the middle of the twentieth century) the existence of a
self-conscious community of economists, dedicated to the scien-
tific study of political economy, was illustrated by the establish-
ment in 1821 of the Political Economy Club. This was a dining
club whose members were pledged to ' regard their own mutual
instruction and the diffusion among others of just principles of
Political Economy as a real and important obligation', and which
met several times a year to discuss ' some doubt or question on
some topic of Political Economy' proposed in advance by its
members.3 Membership of the Club was limited and although not
all its members would have thought of themselves as primarily
economists, even in an amateur sense, all those who have made
seminal contributions to English classical economic thought were
active members at some time in their career.
For all the early members of the Political Economy Club, the
acknowledged starting point was Adam Smith. According to
McCulloch, it was in the Wealth of Nations that
the fundamental principles that determine the production of wealth

were established beyond the reach of cavil and dispute. In opposition
to the Economists, Dr. Smith has shown that labour is the only source
of wealth; and that the wish by which all individuals are actuated, by
augmenting their fortunes and rising in the world, is the cause of wealth
being saved and accumulated.4
However, as McCulloch went on to point out, there were 'errors'

in Smith's analysis which were rectified by subsequent econo-
mists. The most important of these (apart from the fact that
Smith was not always doctrinaire enough for the taste of McCul-
loch who complained of his readiness to admit 'that individual
advantage is not always a true test of the public advantageousness
of different employments') related to his 'erroneous opinions'
on rent and value. The 'true theory of rent' was elucidated by
Malthus and West in pamphlets published independently of each
other in 1815, though (again according to McCulloch) it had al-
ready been ' discovered and fully explained by Dr. James Ander-
3
See Political Economy Club Centenary Volume (1921), for extracts from regu-
lations, lists of members, of questions discussed and their proposers, and for
extracts from the diary of one of its members, J. R. Mallet, covering the period
1823-37.
4
J. R. McCulloch, The Literature of Political Economy. A Classified Catalogue
(1845), LSE Reprints (1938), p p . 12-14.
5
son in a tract on the "corn laws" published in 1777'. T h e theory
of value and with it the theory of distribution was worked out
by Ricardo in his Principles the appearance of which ' formed a
new era in the history of the science.. . Mr. Ricardo has traced
the source and limiting principle of exchangeable value, and has
extracted the laws which determine the distribution of the various
products of art and industry among the various ranks and orders
of society'. 6 It is fair to add that Ricardo also succeeded in
integrating the 'true theory of rent' into his theory of value and
in stamping his personal imprint on it so effectively that it has
come down to posterity as the Ricardian theory of rent.
McCulloch's assessment, of Smith as the founder of the science
of political economy and Ricardo as the disciple who amended
and corrected the fundamental principles only in so far as they
related to the theory of value and distribution, was the accepted
contemporary view and accords with the account which Ricardo
himself gave in the Preface to his Principles. There Ricardo made
clear that he was not setting out to write a comprehensive treatise
on the principles of political economy which would replace the
Wealth of Nations, but to deal with a problem which the master
has left in some confusion mainly because he had failed to
appreciate the ' true doctrine of rent'. He was not, in other words,
creating a new paradigm, but offering a solution to a crucial
problem arising within the framework of the current orthodoxy.
To determine the laws which regulate this distribution [of the national
product], is the principal problem in Political Economy: much as the
science has been improved by the writings of Turgot, Stuart, Smith, Say,
Sismondi and others, they afford very little satisfactory information
respecting the natural course of rent, profits and wages.7
Nevertheless the Ricardian analysis made a larger contribution
to the trend of economic thought, and to the methodology of the
discipline, than this modest claim might suggest. Of all the early
nineteenth-century economists none made a more powerful
impact on the minds of other economists 8 (then and after) than
5
The references are to James Anderson, An Inquiry into the Nature of the Corn
Laws, extensively annotated by McCulloch, ibid, pp. 68-70; T. R. Malthus, An
Inquiry into the Nature and Progress of Rent and the Principles by which it is Regulated
(1815); and Sir Edward West, An Essay on the Application of Capital and Land (1815),
e
annotated ibid, p. 33. McCulloch, op. cit., p. 16.
7
D. Ricardo, On the Principles of Political Economy and Taxation (1819), Sraffa
edn, Vol. 1, p. 5.
8
Unlike Adam Smith, Ricardo did not score a popular success - his analysis
was too abstract, too little polemical to catch the popular imagination.
did Ricardo. McCulloch saw the publication of the Principles as
opening 'a new era in the history of the science'.9 Ricardo was
the mentor of Karl Marx who described him as 'the last of the
scientific economists' and the main inspiration attracting the
young Alfred Marshall to the systematic study of economics in
the 1860s. Modern economists differ widely in their evaluation
of him but there is no doubt that he made, and still makes a
powerful direct impact on his professional readers. The contro-
versy as to whether Ricardian economics 'conquered England as
completely as the Holy Inquisition conquered Spain' (which was
the way Keynes described it) or whether 'the Ricardians were
always in a minority in England' (which was Schumpeter's inter-
pretation), or whether (according to Marx) the year 1830 marked
the end of Ricardian economics, is more a reflection of the
differences in the way economists have interpreted the essential
nature of the Ricardian message than of any doubt about his
fundamental importance in setting the course not only of main-
stream classical economics but also of Marxian and neo-classical
economics. For it was not in suggesting a new total vision of the
way the economic order operated (he was content to accept
without argument Adam Smith's basic philosophical assump-
tions), or in advocating any specific economic theory or policy,
that Ricardo put his distinctive stamp on his professional succes-
sors; it was in developing a new technique of economic analysis.
In effect Ricardo was the first specialist economist. Most of the
other leading economists had been philosophers, students of
society in the round. Their economics was embedded in philo-
sophical disquisitions and long historical digressions which may
have leavened them for the contemporary general reader but
which obscure the message for the modern reader interested
in the essential structure of the economic analysis. Ricardo,
however, started and finished with the economic problem and
refused to be side-tracked by philosophical, sociological or
historical considerations. In this undoubtedly he over-simplified
the practical economic problems which he considered, by ab-
stracting them from their social and political context. And it is
arguable that he helped to narrow the scope and significance of
economic thought by giving it a rationale for developing inde-
pendently of the other social sciences. In so doing, however, he
laid the foundations of a distinctively economic technique of
9
J. R. McCulloch, op. cit., p. 16.
analysis which represented the beginnings of modern economic
science - the beginnings of economics as a technique of analysis
rather than as a collection of philosophical axioms and historical
or pseudo-historical generalisations.
His first serious excursion into print (apart from some short
pieces in the Morning Chronicle) was in January 1810 when he
published a short pamphlet on wartime inflation entitled The
High Price of Bullion. As an active participant in the money market
one might have expected Ricardo to have based his argument
on facts rather than on generalisations. But he began by an
explicit attempt to formulate 'the laws that regulate the distri-
bution of the precious metals throughout the world'; and starting
from the simple postulate that merchants are always out to maxi-
mise their money gains he propounded the law that 'a depre-
ciation of the circulating medium is the necessary consequence
of its redundance' and that 'this depreciation is counteracted
by the exportation of the precious metals'. From these first prin-
ciples (which he illustrated by reference to the events in Britain
since 1797 when the Bank of England was permitted to issue
unconvertible notes), he went on to develop a theory of interest
in opposition to the prevailing view 'that the rate of interest and
not the price of gold or silver bullion is the criterion by which we
may always judge of the abundance of paper money; that if it
were too abundant interest would fall and if not sufficiently so
interest would rise'. Against this he set what came to be the
typical classical argument ' It can I think be made manifest that
the rate of interest is not regulated by the abundance or scarcity
of money but by the abundance or scarcity of that part of capital
not consisting of money.' His remedy for inflation, based on this
very general reasoning process (which his Bank of England
opponents derided as 'wholly theoretical'), was the remedy that
eventually prevailed as the financial orthodoxy of the nineteenth
century and as the basis of the international gold standard, viz
'The remedy which I propose for all the evils of our currency,
is that the bank should gradually decrease the amount of their
notes in circulation until they shall have rendered the remainder
of equal value with the coins which they represent.'10
Ricardo's characteristic approach to the urgent economic issues
of his day was thus to begin by trying to formulate the laws
underlying the relevant categories of economic behaviour, to
develop a theory based on a few precisely stated assumptions and
10
See below, Chapter 4, for a fuller exposition of his line of analysis.
to illustrate it by reference to the facts of the contemporary world.

From this essentially abstract reasoning process he deduced
practical policy conclusions. He went his own way in his profes-
sional as in his private life, owing little to any other writer, except
of course to the extent that a critique of Adam Smith formed
the starting point for much of what he wrote, and that his
arguments with contemporary economists, especially with James
Mill and with Malthus, helped to clarify and crystallise his own
thoughts. His first major pamphlet outside the financial contro-
versy in which he became involved while still a practising stock-
broker was the Essay on the Influence of a Low Price of Corn on
the Profits of Stock (1815) written to oppose the prevailing ortho-
doxy that low corn prices would lead via lower agricultural
profits to a fall in profits generally. The Principles was originally
planned as an enlarged version of this Essay but in October 1815
he announced in a letter 'his determination "to concentrate all
the talent" he possesses upon the subject on which his opinions
"differ from the great authority of Adam Smith, Malthus etc."
namely "the principles of Rent, Profit and Wages".'11
It was his talent for consistent economic logic, severe in its
simplifications but unrivalled in its capacity for synthesis, that
won the unstinted admiration of his major contemporaries and
was imitated by his successors - most effectively by those whose
training enabled them to use the mathematical short-cuts which
this simple logic facilitated. Schumpeter has analysed vividly the
virtues and the vices of this methodology. Ricardo's interest, he
wrote
was in the clear-cut result of direct, practical significance. In order to
get this he cut that general system to pieces, bundled up as large parts
of it as possible, and put them into cold storage - so that as many
things as possible should be frozen and 'given'. He then piled one
simplifying assumption upon another until, having really settled every-
thing by these assumptions, he was left with only a few aggregative
variables between which, given these assumptions, he set up simple one-
way relations, so that, in the end the desired results emerged almost as
tautologies.12
This, Schumpeter went on to say, is exactly the same method as

that adopted a century later by Keynes - although their results
and views on economic policy were poles apart.
When Ricardo began to rethink in his own terms the Smithian
11
Sraffa, Ricardo Works, vol. 1, p. xiii.
12
J. Schumpeter, History of Economic Analysis, pp. 472-3.
orthodoxy he took for granted the general analytical model of the
economic system that Adam Smith had worked out and focused
his attention on certain sectors of this model which he found
particularly unsatisfactory - originally with the forces determin-
ing the distribution of the national product between rent, profits
and wages, and then with the theory of value which he found
he had to work out before he could deal effectively with his
starting-problem.13 Having in effect accepted Smith's view of
capital accumulation as the prime motive force in the growth
process he was primarily concerned to explain the trend in profits
which by providing both the resources and the incentive for new
investment provided the key to the problem of how and whether
the growth of output would be maintained indefinitely. Where
he diverged from Smith was in recognising that in order to
explain why profits rose or fell it was necessary to develop a
theory of the distribution of the national product between profits,
wages and rent. The reason why he had to grapple first with the
concept of value was that he needed to be able to explain the value
of the national product independently of the sum of profits,
wages and rent, if he was to explain how it came to be distributed
between these components.
Current economic conditions helped to shape the research
priorities of the invisible college of economists. It was not alto-
gether surprising that distribution began to assume a special
importance in the first half of the nineteenth century. For Adam
Smith, writing on the threshold of the industrial revolution,
before the escape from economic stagnation became an accepted
fact of life in the latter decades of the eighteenth century, the
problem of sustaining growth had dwarfed all others. In the
relatively rapidly expanding, industrialising and transforming
economy of the period following the Napoleonic wars, the prob-
lem of the associated changes in distribution of the national
income between the different income or power groups of social
classes in the community assumed a major importance. Robert
Torrens expressed the rationale for the classical interest in distri-
bution in practical rather than theoretical terms in the preface
to the 1829 edition of his Essay on the External Corn Trade:
13
Sraffa notes, in p. xiv of his introduction to Vol. 1 (1970) of The Works and
Correspondence of David Ricardo (ed. P. Sraffa and M. H. Dobb), that in the early
correspondence with Mill, when Ricardo (under Mill's pressure) was beginning
to rough out an outline for the Principles, there was no reference to Value. That
came first somewhat obliquely in a letter to Mill dated 30 December 1815 saying:
' Before my readers can understand the proof I mean to offer they must under-
stand the theory of currency and of price.'
The study of Political Economy, if it did not teach the way in which labour
may obtain an adequate reward, might serve to gratify a merely
speculative curiosity, but could scarcely conduce to any purposes of
practical utility. It claims the peculiar attention of the benevolent and
good, mainly because it explains the causes, which depress and elevate
wages, and thereby points out the means, by which we may mitigate
the distress, and improve the condition, of the great majority of
mankind.14
This was also a crucial problem for Karl Marx. And the debate
between Malthus and Ricardo reflected the shift in the political
and economic power structure between the landed gentry and
the manufacturing interests as industrialisation gathered
momentum.
However, if one were to try to account for the importance of
Ricardo in the development of economic thought - an import-
ance which would be admitted by admirers and detractors alike
- one does not find the answer either in the ' topical' character
of his message, or in the originality of his ideas or concepts, nor
even in the superiority of his theoretical analysis. It lies rather
in his capacity to construct out of familiar conceptual materials
a simple, consistent, and (within its limits) logically satisfying
macroeconomic system which, though severely simplified,
seemed to contemporary economists to establish the essential
'landmarks' needed for the analysis of complex real-world
problems. 15 He inspired Marx as well as Marshall, both of whom
were seduced by the internal consistency of his system and sought
to make it more general. He showed for the first time how a simple
analytical model of the economy, operating with a very few,
precisely defined, readily intelligible, strategic variables, could be
employed to analyse complex economic processes and justify
unambiguous policy prescriptions.
His methodology in effect was mathematical rather than his-
14
R. Torrens, On Wages and Combination (1834) p. 1. Quoted in Lionel Robbins,
Robert Torrens and the Evolution of Classical Political Economy (1958), p. 249.
Lord Robbins notes that this passage was repeated in at least three other of
Torrens' publications.
15
See, for example, McCulloch's note on Ricardo's Principles in his Literature
of Political Economy, p. 17: ' Mr. Ricardo's is not a practical work... It is not even
a systematic treatise, but is principally an inquiry into an elucidation of certain
fundamental principles, most of which had previously been undiscovered. And
though it be often exceedingly difficult, or, it may be, all but impossible, to
estimate the extent to which these principles may in certain cases be modified
by other principles and combinations of circumstances, it is obviously of the
greatest importance to have ascertained their existence. They are so many
land-marks to which to refer; and can never be lost sight of even in matters
most essentially practical.'
torical or philosophical. I have suggested that the debate between
Malthus and Ricardo reflected the power struggle between the
landed gentry and the manufacturing interests. It was also a
reflection of a methodological issue of some importance in the
development of economic thought - viz the problem of whether
economics should draw its characteristic techniques of analysis
from the moral or philosophical sciences or from the mathe-
matical or rational sciences. McCulloch has referred to 'the
mathematical cast he [Ricardo] has given to his reasonings'.16
Malthus, who wrote his Principles of Political Economy (1820) as a
reply to Ricardo's Principles, took up the methodological issue in
the opening sentence of his introduction:' The science of political
economy resembles more the sciences of morals and politics than
the science of mathematics.'17 And he went on to say that: 'The
principal cause of error, and of the differences which prevail at
present among the scientific writers in political economy, appears
to me to be a precipitate attempt to simplify and generalize.'18
His own objective was to steer a judicious middle course between
those who ' seem to be satisfied with what has already been done
in political economy' and those who having questioned certain
aspects of the Smithian orthodoxy had allowed their predilection
for ' simplification and generalization' to lead them to erroneous
conclusions. However he followed Ricardo's lead in focusing on
'some important yet controverted points' in the current ortho-
doxy rather than in attempting 'to frame a new and complete
treatise' and most of his Principles was devoted to a discussion
of the theoretical issues which Ricardo had raised, viz the nature
and measure of value, and the theory of rent, wages and profit.
It was only in the final section that he came back to what he along
with most of the other classical economists accepted, following
Smith, as the primary objective of political economy, viz 'to trace
the causes which are most effective in calling forth the powers
of production in different countries'.19
It is worth noting, however, that even while preparing to
demonstrate Ricardo's errors, Malthus frankly recognised his
importance as the leading authority among the contemporary
community of economists: 'I have so very high an opinion of
Mr. Ricardo's talents as a political economist, and so entire a
conviction of his perfect sincerity and love of truth, that I frankly
own I have sometimes felt almost staggered by his authority,
16
17
Op. cit., p. 17.
T. Malthus, Principles of Political Economy (1820), from the Sraffa edition of
Ricardo's Works Vol. 11, p. 5.
18 19
Ibid. Ibid, p. 300.
20
while I have remained unconvinced by his reasonings.' Cer-
tainly no other economist who followed Adam Smith in the
classical school had quite the authority and influence on his
colleagues that Ricardo had, and it was his methodological bias
rather than that of Malthus which set the pattern for the' science'
of economics (as opposed to the 'art' or practical applications
of economics) for mainstream English economic thought. Hence-
forth economics was to be regarded by the leading theoretical
economists as a primarily deductive abstract, rather than induc-
tive historical science.
In spite of their common origin as disciples of Adam Smith,
Malthus and Ricardo started with two basic differences of atti-
tude - (a) radically different ideological preconceptions which
led them to widely divergent conclusions on policy, and (b)
differing intellectual approaches which so shaped the routes by
which they reached these conclusions as to make them at times
virtually incapable of getting on the same wavelength of discus-
sion. Living as they did in a period of transition to modern
economic growth one represented the old world and the other
the new. Parson Malthus the Professor reached back for inspi-
ration beyond Adam Smith to the Physiocrats. He accepted that
land was the ultimate source of economic progress and that the
national interest depended on maintenance of the traditional
social structure in which the landed interest was the keystone.
Ricardo, the city businessman saw no escape from stagnation
except through active development of domestic and international
trade and believed that ' the strength of England and the well-
being of its people proceeded from the abundance and cheapness
of British capital'.21
In the debate between them Ricardo, in spite of his practical
stockbroker background, emerges as the abstract and a priori
theorist, concerned to identify the basic long-term trends and
equilibrium conditions of the economic system, while Malthus,
in spite of his mathematical academic training was preoccupied
by the causes and consequences of day-to-day changes in the real
world. A letter from Ricardo in January 1817 identified this
difference:
It appears to me that one great cause of our difference of opinion, on
the subjects we have so often discussed, is that you have always in your
mind the immediate and temporary effects of particular changes -
20
Ibid, p. 12.
21
J. Hollander and Gregory (eds.). David Ricardo's Notes on Malthus' Principles
of Political Economy, pp. xxiii-xiv.
whereas I put these immediate and temporary effects quite aside,
and fix my whole attention on the permanent state of things which will
result from them.22
T o which Malthus responded a few days later
I really think that the progress of society consists of irregular move-
ments, and that to omit the consideration of causes which for eight or ten
years will give a great stimulus to production or population, or a great
check to them, is to omit the causes of the wealth and poverty of nations
- the grand object of all enquiries in Political Economy.23
Their contemporary, Robert Torrens summed up the difference
more tersely as follows:
If Mr. Ricardo generalizes too much, Mr. Malthus generalises too little.
If the former occasionally erects his principles without waiting to base
them upon a sufficiently extensive induction from particulars, the latter
is so occupied with his particulars, that he neglects that inductive pro-
cess which extends individual experience throughout the infinitude of
things, and imparts to human knowledge the character of science.24
In the end the winner in the battle for dominance over English
economic thinking was Ricardo. Perhaps it was because Malthus,
in spite of his gift for identifying and formulating the crucial
economic problem of his day, was less clearheaded and logical
than Ricardo. Perhaps it was because Malthus failed - except on
the population problem and then originally only by accident 25 -
to appreciate as clearly as Ricardo the structural changes taking
place in the industrialising economy and failed accordingly to
appeal to the decision takers who were gradually taking over
economic and political power. Perhaps it was because, as Blaug
22
P. Sraffa a n d M . H . D o b b , The Works and Correspondence of David Ricardo,
Vol. VII, p. 120.
23
Ibid, p . 122.
24
Robert Torrens, An Essay on the Production of Wealth (1821), pp. iv-v.
25
Malthus' first Essay on Population was published as an anonymous pamphlet
in 1798 to refute the rosy predictions of the philosopher-idealists (e.g. Rousseau,
Condorcet and Godwin) who argued that all that stood in the way of an ideal
egalitarian organisation of society was private ignorance and public inertia. When
the first Census (1801) results became available to confirm conclusively the views
of the pessimistic side in the perennial population debate, Malthus, who had
shared the view of most of his contemporaries, when the first edition was
published, that in fact the population of England had increased little during the
eighteenth century, found himself a kind of prophet without having prophesied.
His 'principle of population' suddenly assumed urgent topical importance and
he set about expanding the pamphlet into a book (1803) which became the bible
of the pessimistic school and a justification for those who wanted to rationalise
a tightening up of the relatively generous system of Poor Relief opened up by
the Speenhamland system.
has suggested, Ricardo happened to win aggressive disciples.
Whatever the reason it was Ricardo the amateur political econo-
mist not Malthus the academic who was the effective successor
of Adam Smith in establishing a school of economics and in
providing the text to which professional economists referred
constantly for nearly half a century.26
A little over a century later the fashion cycle in economics had
turned full circle again when Maynard Keynes launched his
celebrated attack on classical economics and claimed direct des-
cent from Malthus, lamenting the fact that' it was Ricardo's more
fascinating intellectual construction which was victorious and
Ricardo who, by turning his back so completely on Malthus's
ideas; constrained the subject for a full hundred years in an
artificial groove'.27 And again: 'If only Malthus instead of
Ricardo had been the parent stem from which nineteenth
century economics proceeded, what a much wiser and richer
place the world would be today.'28
Ricardo's technique of abstract reasoning from a priori postu-
lates, his propensity for logical-mathematical rather than
philosophical-historical theories had important implications for
the methodology of orthodox economic theory. In the first place,
it helped to draw theoretical economics away from the real world
by encouraging the theorist to depend on a type of theory which
called for logical refutation rather than empirical verification.29
To the extent that succeeding economists adopted this technique
they could (and often did) explore, develop and even test their
theories without reference to any empirical data other than the
'stylised facts' embodied in generally accepted starting postu-
lates. One of Malthus' persistent objections to the Ricardian
26
For further discussion of the methodology and impact of Ricardian econ-
omics see M. Blaug, Ricardian Economics: A Historical Study (1958); F. W. Fetter,
'The Rise and Decline of Ricardian Economies', History of Political Economy
(Spring 1969); and N. B. de Marchi 'The Empirical Content and Longevity of
Ricardian Economies', Economica (1970).
27
J. M . K e y n e s , Collected Writings Vol. x . Essays in Biography, p . 8 7 .
48
Ibid, pp. IOO-I . The passage quoted from Malthus on p. 80 above reflects
Keynes' own view of the nature of economic science.
29
Cf. K. Popper, 'On the status of science and of metaphysics', in Conjectures
and Refutations (1963), p. 197:' Whenever we find a mathematical theory of which
we do not know whether it is true or false we test it, first superficially and then
more severely, by trying to refute it. If we are unsuccessful we then try to prove
it or to refute its negation. If we fail again, doubts as to the truth of the theory
may have cropped up again, and we shall again try to refute it, and so on,
until we either reach a decision or else shelve the problem as too difficult for
us.'
method was that it failed to pay sufficient attention to the facts
of experience:
The tendency to premature generalization among political economists
occasions also an unwillingness to bring their theories to the test of
experience. The first business of philosophy is to account for things as
they are. A comprehensive attention to facts is necessary, both to prevent
the multiplication of theories, and to confirm those which are just.30
In the second place, the use of the Ricardian technique per-
mitted economic theory to develop independently of other social
sciences. For although the stylised facts adopted as starting
assumptions by economic theorists often contained an element of
social psychology or sociology there was no longer an incentive
to require that these any more than the economic facts were
empirically verified in any scientific sense. Exceptions to the
starting postulates could be put aside in a ceteris paribus clause
and subsequently ignored.
Nassau Senior was the first major classical economist to exploit
this technique after Ricardo. In his Outline of the Science of
Political Economy published in 1836 he postulated four propo-
sitions which could be substantiated 'empirically' from the per-
sonal observation of any armchair theorist and from which an
integrated economic theory could be deduced by a logical reason-
ing process. 31 His four propositions were as follows:
(1) That man desires to obtain additional wealth with as little sacrifice
as possible [i.e. an income-maximisation principle].
(2) That the Population of the world, or, in other words, the number
of persons inhabiting it, is limited only by moral or physical evil,
or by fear of a deficiency of those articles of wealth which the
inhabitants of each class of its inhabitants lead them to require [i.e.
a modified Malthusian population principle].
(3) That the powers of Labour and of the other instruments which
produce wealth, may be indefinitely increased by using their
Products as means of further production [i.e. a principle of capital
accumulation].
(4) That agricultural skill remaining the same, additional Labour em-
ployed on the land within a given district produces in general a less
proportionate return, or, in other words, that though, with every
increase of the labour bestowed, aggregate return is increased, the
30
T. R. Malthus, Principles of Political Economy, reprinted in Vol. n of The Works
and Correspondence of David Ricardo, ed. Sraffa and Dobb, p. 10.
31
The four 'fundamental propositions' had been developed in his introduc-
tory lecture at Oxford in 1826. See Marian Bowley, Nassau Senior and Classical
Economics (1937), pp. 42-52. They are listed and discussed in Nassau W. Senior,
An Outline of the Science of Political Economy, 1938 edn, p . 26.
increase of that return is not in proportion to the increase of the
labour [i.e. a principle of diminishing returns].
From these 'empirically induced' postulates or axioms Senior
set out to develop the analytical apparatus of an exact science with
universal validity. He also moved in the direction of a deliberate
narrowing of the scope of so-called scientific economics by
making a distinction (which McCulloch rejected as too narrow
but which the neo-classical theorists were to lean heavily upon)
between the 'science' of economics and the 'art' of
economics.
The business of a Political Economist is neither to recommend nor to
dissuade, but to state general principles, which it is fatal to neglect, but
neither advisable, nor perhaps practicable, to use as the sole, or even
the principal, guides in the actual conduct of affairs... To decide in each
case how far those conclusions are to be acted upon, belongs to the art
of government, an art to which Political Economy is only one of many
subservient Sciences.32
Later Senior was to concede that an 'art' of political economy
was a possibility, but not until the 'science which states the laws
regulating the production, accumulation, and distribution of
wealth, or in other words the science (as distinguished from the
art) of Political Economy itself had been much more compre-
hensively and clearly elaborated. 33
However, according to Senior, the premises on which the
whole of the science of political economy depended were not
derived by observation (as in the natural sciences) or by hypo-
theses (as in the logical—mathematical sciences) but by a process
of introspection. This is how what Senior chose to call t h e ' mental
sciences' could base their principles on positive premises in spite
of the fact that it was not open to them to verify their hypotheses
by formal experiment. 'When we direct our attention to the
workings of our own mind, that is to say, when we search for
premises by means of consciousness instead of by means of
observation, our powers of trying experiments are much
greater.' 34 In effect Senior was seeking to lay the foundations of
a positive science of economics - a science based on positive
premises analogous to those of the natural scientist rather than
on the a priori hypotheses of the logician.
32
Nassau Senior, An Outline of the Science of Political Economy, 1938 e d n , p . 3.
33
See Bowley, op. cit., p p . 49 et seq., for a discussion of Senior's views o n this
issue.
34
Lectures 1847-52, p . 3 1 .
The consequence, however, of this narrowing of the scope of
' pure' or ' scientific' economics was to confine it to such problems
as could be solved by applying a process of logical-mathematical
reasoning (based on a few simple introspectively derived postu-
lates) to a handful of strategic variables, and to limit the range
of economic problems which economists qua economists would
consider themselves competent to study. Two of the principal
problems which have traditionally preoccupied political econo-
mists - the economics of welfare and of development - were
effectively excluded on this specification from the central core
of 'scientific' economics and were relatively neglected by the
mainstream theorists until well into the twentieth century.
It was John Stuart Mill, however, who formalised the Ricardian
methodology and who wrote the systematic treatise on political
economy which was designed to bring the Wealth of Nations up-to-
date. In so far as English classical political economy fashioned
a new paradigm out of the Ricardian innovations it was J. S.
Mill who expounded it explicitly and comprehensively in a text
book which remained for almost half a century the authori-
tative starting point for students of political economy, in much
the same way as Adam Smith's Wealth of Nations had been over
the previous half century or so. This was the textbook with which
Alfred Marshall began his study of economics and from which
he moved on to Ricardo and it had no serious rival either in
Britain or the USA until Marshall's Principles appeared in the
1890s.
Actually Mill must have been one of the first major nineteenth-
century economists not to begin the study of political economy
from the Wealth of Nations. His father James Mill, who had acted
as midwife to Ricardo's Principles over the years 1815-17, began
to teach his 13 year old son political economy in 1819 by lecturing
him daily and making him write and rewrite these lectures until
they met with parental approval.35 Not that John Stuart was
altogether unprepared for the discipline. His father had started
teaching him Greek at the age of 3 (he had read the whole of
Herodotus before he was 8), then went on to arithmetic, history,
Latin, mathematics (he was grappling with the calculus at 11) and
then logic (at 12). By the time he was 15 he was privileged to spend
35
See J. S. Mill's own account of this process in his Autobiography: 'In this
manner I went through the whole extent of the science, and the written outline
of it which resulted from my daily compte rendu served him afterwards as notes
from which to write his Elements of Political Economy.'
a summer at Ricardo's Gatcomb house discussing political econ-
omy on walks with the master himself. After that formidable
father, Ricardo 'who by his benevolent countenance and kind-
liness of manner, was very attractive to young persons'36 must
have exerted a deep impression on this highly intelligent and
over-educated lad. Ricardo's critique of a paper written by John
Stuart Mill (then aged 17) on the difficult problems of
principle involved in measuring value has already been
referred to above,37 and illustrates the quality of their
intellectual relationship. On the other hand, the younger
Mill also came under the influence of Jeremy Bentham (another
close friend of his father's); and this early contact, plus
the sheer breadth of his education, helped to ensure that
John Stuart would inherit an eighteenth century approach to
political economy as a branch of social philosophy.
J. S. Mill's definition of the scope and methodology of econo-
mics is contained in an essay 'On the Definition of Political
Economy' which was written in 1831 and subsequently published
among his Essays on Some Unsettled Questions of Political Economy
in 1844. He began by making the point that the definition of a
science (a branch of knowledge) depends (1) on what its prac-
titioners actually do:
The definition of a science has almost invariably not preceded, but
followed, the creation of the science itself. Like the wall of a city it has
usually been erected, not to be a receptacle for such edifices as might
afterwards spring up, but to circumscribe an aggregation already in
existence;38
and (2) on their philosophical preconceptions:
The definition of a science must indeed be placed among that class of
truths which Dugald Stewart had in view, when he observed that the
first principles of all sciences belong to the philosophy of the human
mind... If we open any book, even mathematics or natural philosophy,
it is impossible not to be struck with the mistiness of what we find
represented as preliminary and fundamental notions, and the very in-
sufficient manner in which the propositions which are palmed on to us
as first principles seem to be made out, contrasted with the lucidity of
the explanations and the conclusiveness of the proofs as soon as the
writer enters upon the details of his subject.39
36
J. S. Mill, Autobiography (1873), p . 54.
37
38
See above, p. 68.
J . S. Mill, Essays on Economics and Society. Collected Works of J. S. Mill, V o l .
iv, p. 310.
39
Ibid, p. 311.
By the 1830s, however, political economy could be regarded

as a relatively well-established science in the sense that its prac-
titioners shared a common set of concepts (though they were not
always able to agree on their definitions), common rules of
procedure and scientific values (in spite of their methodological
disputes) and were broadly agreed on what were the problems
political economy ought to be trying to solve (though they might
differ on the order of priorities to attach to the catalogue of
problems). The proceedings of the Political Economy Club to
which all leading nineteenth-century British economists and
some of their continental contemporaries belonged at one time
or another, bear witness to the existence of a community of
economists and illustrate their common and disputed ground.
J. S. Mill did not become a member himself until 1840 but he
knew the leading economists of the day and was well-equipped to
express their views. He made the distinction between a ' science'
and an 'art', for example, in the same terms as Senior did.
Science is a collection of truths; art, a body of rules, or directions for
conduct.. .Science takes cognizance of a phenomenon, and endeavours
to discover its law; art proposes to itself an end and looks out for means
to effect it. If, therefore, Political Economy be a science, it cannot be
a collection of practical rules; though, unless it be altogether a useless
science, practical rules must be capable of being founded on it.40
Having divided the whole of human knowledge into two divi-
sions - physical science and moral or psychological science - Mill
set economics firmly in the camp of the latter and further defined
it as one of the social sciences. However, it is distinguished from
the other social sciences in that it starts from the premise that
men are motivated solely by the desire to acquire and consume
wealth41 'and aims at showing what is the source of action into
which mankind, living in a state of society, would be impelled,
if that motive.. .were absolute ruler of all their actions' except
to the extent that it is modified by what he called the 'two
perpetually antagonizing principles to the desire of wealth' viz
'aversion to labour and desire of the present enjoyment of costly
indulgences'. Not of course that economists really believe that
men are solely motivated by economic aims 'but because this is
the mode in which science must necessarily proceed. When an
effect depends upon a concurrence of causes, those causes must
be studied one at a time.'42
40 41
Ibid, p. 312. Hence Mill's use of the abstraction the 'economic man'.
42
Ibid, pp. 321-2.
On Mill's definition, political economy was characterised as
essentially an abstract science, reasoning from 'assumptions not
facts' analogously to other abstract sciences like geometry.
Geometry presupposes an arbitrary definition of a line 'that which has
length but not breadth'. Just in the same manner does Political Economy
presuppose an arbitrary definition of man, as a being who invariably
does that by which he may obtain the greatest amount of necessaries,
conveniences and luxuries, with the smallest quantity of labour and
physical self-denial with which they can be obtained in the existing state
of knowledge.43
It is worth noting that the same technique is common in some
of the natural sciences using mathematical methods.44
Except to the extent that facts open to the observation or
introspection of any educated observer provide the basis for some
of the fundamental postulates of economics, empirical evidence
was relevant to the science of political economy as denned by Mill
only for the purpose of verifying theories. It played no part in
the discovery of scientific truth in economics because experim-
entation is simply not possible and because real life is too complex
to throw up 'general laws'. To those who advocated a historical
method of approach he replied: 'History, by itself, if we knew
it ten times better than we do, could... prove little or nothing:
but the study of it is a corrective to the narrow and exclusive
views which are apt to be engendered by observation on a more
limited scale.'45 And finally to the Malthusian objection to the
Ricardian technique he answered: 'The error.. .does not arise
from generalizing too extensively. .. but in making the wrong
kind of assertion', i.e. in predicting
an actual result when he should only have predicted a tendency to that
result - a power acting with a certain intensity in that direction... What
is thought to be an exception to a principle is always some other and
distinct principle cutting into the former; some other force which
impinges against the first force and deflects it from its direction.46
43
Ibid, p . 326.
44
S e e E. N a g e l , The Structure of Science (1961), p . 131: ' I t is c o m m o n , if n o t
normal for a theory to be formulated in terms of ideal concepts such as the
geometrical one of straight line and circle, or the more specifically physical ones
of instantaneous velocity, perfect vacuum, infinitely slow expansion, perfect
elasticity and the like. Although such "ideal" or "limiting" notions may be
suggested by empirical subject matter, for the most part they are not descriptive
of anything empirically observable.'
45
J. S. Mill, Essays on Economics and Society, op. cit., p . 3 3 3 , n .
48
Ibid, p . 337-8.
go Methodology of classical political economy
Nevertheless, although Mill shared Senior's view of the narrow
limits of 'scientific political economy', and indeed originally
propounded a somewhat more abstract definition of its method-
ology than Senior, his Principles of Political Economy with Some
of their Applications to Social Philosophy (1848) was, as its title
suggests, more in the tradition of Adam Smith than of Ricardo.
He began writing it in 1845 - as a spare time activity when he was
a full-time civil servant, and in competition with other writings
- and finished it in under 2 years. It was a conscious attempt to
produce a synthesis of classical economic theory, for a lay rather
than a professional audience, to apply it to current socio-economic
problems and to link it explicitly to its sociological-philosophical
context of ideas.
The 'Wealth of Nations' is in many parts obsolete and in all, imperfect.

Political Economy, properly so called, has grown up almost from
infancy since the time of Adam Smith; and the philosophy of society,
from which practically that eminent thinker never separated his more
peculiar theme, though still at a very early stage of its progress, has
advanced many steps beyond the point at which he left it. No attempt,
however, has yet been made to combine his practical mode of treating
his subject with the increased knowledge since acquired of ks theory,
or to exhibit the economical phenomena of society in the relation in
which they stand to the best social ideas of the present time, as he
did, with such admirable success, in reference to the philosophy of his
century.47
This was the lacuna which Mill set out to fill in his Principles.
In spite of (perhaps because of) its long-standing success as a
textbook Mill's Principles has had a bad press from the economics
profession generally. Much has been written about the incon-
sistencies and the lack of rigour in his argument some of which
can be traced back to his persistent effort to reconcile conflicting
or disparate theories. The section on ' T h e Noxious Influence of
Authority' with which Jevons concluded his Theory of Political
Economy (1871) was clearly aimed at Mill: ' I protest against
deference for any man, whether John Stuart Mill, or Adam
Smith, or Aristotle being allowed to check inquiry. Our science
has become too much a stagnant one, in which opinions rather
than experience and reason are appealed to.' 48 And in similar
vein Foxwell complained that his influence was 'distinctly
47
P r e f a c e t o J. S. Mill, Principles of Political Economy, p . xcii.
48
W . S. J e v o n s , Theory of Political Economy (1871), e d . R. D . Collison Black
(1970), p. 261.
49
soporific'. Marx disliked him heartily. Later economists have
been less openly hostile or more sympathetic, but they seem to
feel a need to explain away the success of the Principles.50
The fact is that the community of professional economists was
no more ready to grapple with the wider social and philosophical
issues raised by Mill in what he saw to be a natural development
of the Ricardian paradigm than to stomach Marx's theoretical
reformulation of it. There were some authorities who (in more
Malthusian tradition) were attracted by a historicist methodology
of the kind currently fashionable in Germany (e.g. Ashley, Cliffe
Leslie and Ingram) and the historical school of economists en-
joyed a considerable prestige in the later decades of the nine-
teenth century. But the mainstream theorists chose to pursue
the narrower path opened up by Ricardo, to follow the goal of
logical consistency, to sharpen their mathematical tools and to
limit their attention (in their professional, or as they preferred
to call it 'scientific', capacity) to the kind of economic problems
that were soluble in these terms. In so doing, however, they
revolutionised the classical methodology.
J. S. Mill was the last in the line of major English philosopher-
economists in the tradition of Adam Smith, economists for whom
economics was merely one of the moral sciences (though the most
highly developed of the social sciences) and only part of the wider
field of knowledge over which they felt themselves competent to
practice.31 He prefaced his Principles with the declaration that' for
practical purposes Political Economy is inseparably intertwined
with other branches of social philosophy. Except on matters of
mere detail, there are perhaps no practical questions, even
among those which approach nearest to the character of purely
economical questions, which admit of being decided on econo-
mical premises alone.'52 When he distinguished the 'art' of econ-
omics from the 'science' and insisted that economics was an
49
'Whenever Marx mentions Mill's name (which does not happen very fre-
quently) he never forgets to add some derogatory comment.' Bela Balassa.
'Karl Marx and John Stuart Mill', Weltwirtschaftsliches Archiv (1959), p. 117.
50
See e.g. J. Viner, The Long Vieu< and the Short, p. 329; J. Schumpeter, History
of Economic Analysis, p. 380; L. Robbins, Evolution of Modern Economic Theory,
pp. 167-8.
51
Until Marshall persuaded the University of Cambridge to establish a separate
Economics Tripos in the early 1900s, political economy was merely one option
in the Moral Sciences Tripos. When Jevons was appointed Professor at Man-
chester in 1866 it was as Professor of Logic and Political Economy.
52
Mill, Principles, op. cit., p. xci.
abstract system of a priori reasoning based on the hypothetical

assumption of an 'economic man' he did not intend either to
confine his own studies to economic problems within these
narrow limits, or to imply that the' scientific' problems of political
economy were any more prestigious than its normative or pres-
criptive aspects. However, even those classical (and neo-classical)
economists who did not share Mill's range of scholarship and who
regarded themselves as professional economists in the narrowest
contemporary sense of that term would have taken it for granted
that the normative and prescriptive aspects of the subject were
as much (for some more so) their business as the abstract, 'pure'
or 'scientific' aspects. It was theoretical economics that was pro-
gressively to narrow its scope in the neo-classical era.
FURTHER READING
Primary literature
T. R. Malthus, Principles of Political Economy, reprinted with Ricardo's
Notes, Vol. II of Works and Correspondence of David Ricardo, ed. Piero
Sraffa (1951).
J. S. Mill, ' O n the Definition of Political Economy', Essays on Economics
and Society, Vol. 1 of Collected Works of J. S. Mill, Toronto edition
(1967).
David Ricardo, Principles of Political Economy and Taxation, op. cit.
Nassau Senior, Principles of Political Economy with some of their Applications
to Social Philosophy (1848).
M. Blaug, Ricardian Economics: A Historical Study (1958).
Marian Bowley, Nassau Senior and Classical Economics (1937).
A. W. Coats, ' T h e Role of Authority in the Development of British
Economies', Journal of Law and Economics (1964).
F. W. Fetter, ' T h e Rise and Decline of Ricardian Economies', History of
Political Economy (1969).
J. M. Keynes, 'Thomas Robert Malthus', in Essays in Biography, re-
printed for the Royal Economic Society, Vol. x, Collected Writings of
John Maynard Keynes (1972).
N. B. de Marchi, ' T h e Empirical Content and Longevity of Ricardian
Economies', Economica (1970).
D. P. O'Brien, The Classical Economists (1975).
Alan Ryan, / . S. Mill (1975).
Pedro Schwartz, The New Political Economy of J. S. Mill (1972).
THE MARGINAL REVOLUTION AND
THE NEO-CLASSICAL TRIUMPH
It is generally accepted that the British classical economists of the

first half of the nineteenth century constituted an identifiable
school of economic thought. They shared a distinctive framework
of economic ideas, shaped by a particular set of axioms and
theories and generally characterised by a strong bias towards
economic policies favouring economic individualism and laissez-
faire. Whether this school of thought constituted a 'scientific
community' in the sense that T. S. Kuhn uses the term in his
analysis of the structure of scientific revolutions or whether it is
better described as a 'pre-paradigm school' may be open to
question. In Kuhn's view a scientific community consists of the
practitioners of a scientific specialty who share a common para-
digm. 'To an extent unparalleled in most other fields they have
undergone similar educations and professional initiations; in the
process they have absorbed the same technical literature and
drawn many of the same lessons from it. Usually the boundaries
of that standard literature mark the limit of a scientific subject
matter.'1
Certainly nineteenth-century economists drew their basic
assumptions and techniques from the same textual sources -
Adam Smith, David Ricardo, Nassau Senior and John Stuart Mill
being the main links in a clearly perceptible continuity of thought
- though there was as yet no formally recognised education as an
economist. The doubt, however, is not whether the nineteenth-
century community of economists shared' similar educations and
professional initiations' but whether they were the practitioners
of a scientific specialty. The doubt remains in the twentieth
century, in spite of the fact that economists rarely now debate
the question 'is economics a science?' which typically provided
the opening lecture of university courses in economic theory as
1
T. S. Kuhn, The Stnicture of Scientific Revolutions (1969), p. 177.
94 Marginal revolution and neo-classical triumph
recently as the 1930s. The basic problem of identifying the
scientific community of economists is that economics was (is) not
the exclusive preserve of a group of academic theorists and
empirical research workers (amateur or professional) but the
active concern of a heterogeneous collection of journalists,
bankers, civil servants, politicians and others whose attempts at
the objective explanation and/or prediction of economic beha-
viour give them as much claim to form part of the intellectual
community of economists as the academics. An intellectual or
scientific revolution in economics involves converting this wider
group to the new orthodoxy as well as the academic teachers and
the researchers labouring under their supervision. This indeed
is what is implicit in the term, the marginal revolution, applied
by historians of economic thought to the methodological changes
that took place in orthodox economics in the fourth quarter of
the nineteenth century.
The 1850s and the 1860s were a period of relative prosperity
for the British economy and of relative consensus (or compla-
cency) in British economic thought. Although the Ricardian
theories of value and distribution had come under influential
attack, Ricardo's analysis of the benefits of international trade,
his views on monetary policy and the ideological bias in favour
of an individualist free market economy which he had inherited
from Adam Smith still dominated orthodox economic thinking.
The Political Economy Club had begun debating questions which
began ' Was Ricardo right.. . ?' within a few years after the
master's death, but the leading economists - Nassau Senior, John
Stuart Mill and even Karl Marx - accepted his original' authority'
while often dissenting from him in detail and sometimes quite
extensively. With hindsight one can perceive the widening cracks
in the doctrinal facade of classical political economy. Nassau
Senior had already brought the notion of utility squarely back
into his theory of value in the 1840s. Stanley Jevons presented
his ' Brief Account of a General Mathematical Theory of Political
Economy' to the British Association for the Advancement of
Science in 1862. But little notice was taken of either of these shifts
of emphasis away from an exclusively cost-of-production theory
of value, nor indeed of the work of Gossen the German theorist
who had published in 1854 a book which elaborated two basic
laws - (1) the principle of diminishing utility; and (2) maximisa-
tion of satisfactions as the aim of all human conduct - and
formulated them in full geometrical and algebraic terms.
Marginal revolution and neo-classical triumph 95
It seems as though the time had to be ripe for the acceptance
of a new paradigm and when the time was ripe it emerged
independently in several places at once. In 1871 Jevons published
his Theory of Political Economy which was an attempt to produce
an explicitly mathematical theory of economic science inspired
by Bentham's felicific calculus.2 In the same year the Austrian
economist Menger produced his Principles of Economics also elabo-
rating a subjective theory of value. Like Jevons, Menger made
his theory of value hinge on marginal utility as the determinant
of the ratios at which goods were exchanged, though he was no
mathematician and relied on a careful precise verbal logic.
Finally, in 1874, again independently, the French economist
Walras published the first part of his Elements of Pure Economics
which presented marginal utility analysis in formal mathematical
terms as a set of demand and supply functions with a determinate
equilibrium: three years later he published the second part of
this work - a theory of production which applied the same
techniques of general equilibrium analysis to the problem of
pricing factors of production. Meanwhile in Cambridge, Alfred
Marshall who was then teaching political economy to Cambridge
students reading for the Moral Sciences Tripos in the 1870s had
already begun to graft marginal utility analysis on to the
Ricardian system.
The so-called marginal revolution involved a wide-ranging
transformation of the characteristic methodology of analytical
economics by means of what was essentially a mathematical tool
derived from the calculus. 'The Theory of the Economy thus
treated' wrote Jevons in the Preface to the first edition of his
Theory of Political Economy
presents a close analogy to the science of Statical Mechanics, and the
Laws of exchange are found to resemble the Laws of Equilibrium of a
lever as determined by the principle of virtual velocities. The nature of
Wealth and Value is explained by the consideration of indefinitely small
amounts of pleasure and pain, just as the Theory of Statics is made to
rest upon the equality of indefinitely small amounts of energy.3
For Walras also the conscious analogy with physical science and
the central concept of equilibrium were essential features of a
1
R. D. C. Black, 'Jevons, Marginalism and Manchester', Manchester School
(March 1972), p. 7, describes it as 'a pure theory of economic science with the
aid of the differential calculus of De Morgan and the felicific calculus of
Bentham'.
3
W. S. Jevons, Theory of Political Economy (1871), 4th edn, 1911, p. vii.
new kind of methodology which helped to determine not only
the techniques of analysis appropriate to economic theory but
also, in the end, the kind of questions on which the theorist
normally focused. He defined pure economics (i.e. theoretical
economics as distinguished from applied economics or social
economics) as an ideologically neutral, ' physico-mathematical'
science primarily concerned with the ' theory of the determina-
tion of prices under a hypothetical regime of perfectly free
competition '.* He carried the marginal apparatus to its logical-
mathematical conclusions by applying it to markets in general -
not merely to consumer behaviour - thus linking the markets in
commodities with the factor of production markets in a mutually
dependent system of equations relating prices and quantities.
His original contribution was to demonstrate mathematically
the conditions for general equilibrium of the market economy.
Menger too, though he rejected the artificial construct of a
unique and determinate market equilibrium and was concerned
primarily with consumer goods markets, was also trying to evolve
a general economic theory based on marginal analysis and
focused on the problems of price determination in competitive
markets.
It is easy to over-dramatise the concept of a 'marginal revolu-
tion' in economic theory by attributing it primarily to three
innovative thinkers, each of whom exploded independently
into print at roughly the same time (early 1870s) and by dating
from this 'multiple discovery' a transformation in the 'entire
constellation of beliefs, values, techniques and so on, shared by
the members' of the scientific community of economists. 5 Those
who interpret the marginal revolution of the 1870s as a paradigm
change in this sweeping sense usually fall into one of two
schools of thought. Either they believe that the paradigm-shift
represented a disastrous evasion of the real problems facing
economists - a retreat from socially 'relevant' political economy
into sterile formalism. Or they believe that it was the crucial stage
in the creation of a genuinely scientific unified theory of
economic behaviour which became for the first time a testable
theory - not only logically verifiable in the most rigorous mathe-
matical sense of the term but also empirically testable. Both
4
L. Walras, Elements of Pure Economics, translated by W. Jaffe (London 1954),
p. 40.
5
See T. S. Kuhn, op. cit. (1969), p. 175.
schools of thought may be fortified in their convictions by con-
trasting ideological preconceptions which they tend to project
freely on to the agents in the ' multiple discovery' and, even more
freely, on to their disciples.
On the face of it, the marginal revolution in economics fits
rather uneasily into the grand role of a total Gestalt shift. For one
thing the three agents in the so-called revolution - Jevons, Walras
and Menger - did not share the same constellation of beliefs,
values, techniques etc. Menger in particular stood apart from the
other two. It is debatable indeed whether Menger and his
followers were even marginalists in the sense in which this term
is generally applied to Jevons, Walras and the neo-classical school
generally.6 For another thing their direct influence on the subse-
quent development of orthodox economists' views on the scope
and methodology of economics was clearly rather limited. Jevons
died before he was 50, he was better known to his contemporaries
as an applied economist than as a theorist and his Theory of
Political Economy never became as widely accepted as a text as did
either Mill's Principles or Marshall's Principles. Walras proved too
mathematical to be accessible to the majority of economic
theorists until relatively recent times. His Elements did not even
get into an English translation until 1954. Finally and in the third
place it took more than twenty years for the methodological
innovations associated with the marginal revolution to make
sufficient impression on the current economic orthodoxy to jus-
tify the view that a substantive new paradigm was taking over.
On the other hand, the reality of a revolution does not depend
on all its agents being cast in the same mould - the mould being
that to which the heirs of the revolution subscribe - and it
remains true that the work of Jevons, Walras and Menger
marked the beginnings of a major change in economists' views on
the scope and methodology of their discipline. The change can
plausibly be categorised as a paradigm-shift in the narrower
sense of Kuhn's concept, i.e. as a pervasive change in the typical
criteria, exemplars and procedural rules accepted as normal by
professional economists, which brought with it new ways of
6
Erich Streissler, 'To what extent was the Austrian School marginalist', in
Black, Coats and Goodwin, op. cit., pp. 160-75. Cf. also Blaug in the same sym-
posium, p. 9: ' Whichever version we adopt [of the new paradigm implicit in the
"marginal revolution"], it is difficult to sustain the thesis that Jevons, Menger
and Walras were really occupied with the same paradigm.'
formulating, ranking and tackling the critical unsolved problems
on the academic research agenda. The key to the paradigm-
shift thus interpreted was the application of marginal analysis.
The characteristic techniques of marginal analysis were ap-
plied first to value theory in terms of the concept of utility, a
concept with which the classical economists were thoroughly
familiar, but which, because they had not yet devised a way of
quantifying it, they had tended to leave out of their theories of
value and exchange. It was then found applicable to theories of
production and distribution as well as to theories of value and
exchange and a wide area of theoretical economics was thus
brought within its range. In essence, as Boulding has pointed out,
the marginal analysis was no more than a ' detailed spelling out
of the theory of maximisation - that is the theory that the
optimum position of the variables of any economic organisation
is that given by the, maximum position of that variable which
measures desirability or preference',7 i.e. utility or output.
The marginal revolution had significant implications for both
the scope and methodology of orthodox economic theory. For
in providing the theorist with a convenient set of analytical tools
that were easily and effectively applied over a wide range of uses
it changed the problem orientation of economic orthodoxy and
(in the process though not necessarily by design) associated with
that orthodoxy significant philosophical and ideological tenden-
cies. Briefly, the marginal analysis is designed to find the most
efficient allocation of competing resources, of scarce means with
alternative ends. At the optimum position marginal values are
equalised, i.e. the gains to be derived from putting a unit of a
resource to one use exactly equal the losses involved in with-
drawing it from another. This can be applied right across the
board - to the allocation of a fixed income among a range of
consumer goods, or of a fixed outlay among a set of factors of
production, or of time between work and leisure. Wherever
diminishing returns are obtainable from putting a given unit of
income or time or productive resources to a particular use the
optimum result is obtained when values are equalised at the
margin. Within the conventional assumptions of the marginal
analysis it can be logically shown that perfect competition leads
to equimarginal allocation of expenditures and resources.
Armed with this technique the neo-classical economists were
7
K. Boulding, The Skills of the Economist, p. 34.
able to produce a logically consistent explanation of the deter-
mination of commodity and factor prices in a market system and
to define the conditions for maximising consumer satisfactions.
They were even capable in principle of quantifying inputs and
outputs into the economy at micro and macro levels, for by
defining value as equivalent to price in a perfectly competitive
market they could measure the value of consumers' satisfactions
and the marginal product of labour or capital in objective addi-
tive terms. The analytical power and range of the new technique,
the plausible simplicity of its basic assumption - that consumers
and producers would naturally behave so as to maximise their
satisfactions or profits in a competitive market - was immensely
attractive to students of 'pure' economics, i.e. to the academic
theorists who were more dedicated to scientific truth, defined as
abstract theory, than to political programmes. Not surprisingly
then, the half century before the First World War, when the
neo-classical orthodoxy - the heir to the marginal revolution -
was effectively established in Britain and the USA, was also the
period when the leaders in the discipline tended more often to
be academics than otherwise.8
In spite of their mathematical origins the marginal techniques
developed in this period were fully accessible to non-numerate
economists; but they did lend themselves readily to mathematical
expression and abstraction - a quality that then (as now) helped
to attract to the profession distinguished graduates in mathe-
matics who went on to make major contributions to economic
theory.9 As economics became more professionalised and more
academic, its innovating theorists tended more and more to focus
on abstract theoretical problems and to abstract their models
from the real world. The focus of the marginal analysis was the
market and the neo-classical theorists accordingly narrowed the
scope of their subject matter so as to be almost exclusively
confined to a study of market processes. Consequently, although
individual neo-classical theorists may have been, and some cer-
tainly were, as strongly activated by political and social objectives
as any of their predecessors among the classical economists, they
8
See George J. Stigler, 'The adoption of the marginal utility theory', in Black,
Coats and Goodwin, op. cit., for evidence to support the hypothesis that
'Economics became primarily an academic discipline in the last decades of the
nineteenth century*.
9
Neither Marshall nor Keynes had formal academic qualifications in econo-
mics. Both were Cambridge Wranglers, i.e. first class honours graduates in
Mathematics.
ioo Marginal revolution and neo-classical triumph
concentrated most of their attention qua economists on abstract
theoretical issues which had no immediate connection with the
urgent contemporary questions of practical policy.
Among the reasons which Kuhn in his study of scientific
revolutions in the natural sciences has identified as typically
important in inducing a scientific community to reject one dis-
ciplinary matrix in favour of another are: (i) the emergence of
a 'methodological crisis' due to the failure of the current
orthodoxy to deal effectively with problems that have come to
be regarded as crucially important; (ii) the ability of the new
paradigm to resolve the problems that led its predecessor into
crisis; and (iii) its superior quantitative precision. Reference has
already been made to the relatively precise mathematical
techniques and (in principle) quantifiable concepts associated
with the new marginal analysis and in the following Chapters we
shall consider some of the problems that the neo-classical
economists could be said to have solved more effectively than
their classical predecessors.
As for the incidence of 'methodological crisis', there is plenty
of evidence for a sharpening of the debate on the scope and
methodology of mainstream economics in the 1870s and 1880s.
Jevons referred in his Theory of Political Economy to ' the mono-
tonous repetition of current questionable doctrines' and in an
article published in 1876 lamented that 'one hundred years after
the first publication of the Wealth of Nations we find the state of
the science to be almost chaotic. There is certainly less agreement
now about what political economy is than there was 30 or 50 years
ago'.10 A year later, in 1877, the Professor of Political Economy
at Oxford, Bonamy Price, was so disenchanted by the scientific
pretensions of the discipline that he proposed dropping its
annual contribution to the British Association for the Advance-
ment of Science.11 No doubt it is arguable that the differences
between the supporters of competing paradigms (e.g. the his-
toricists and the marginalists) were similar to theearlier differences
between Malthus and Ricardo or between Senior and McCulloch.
But they were on a different scale, the area over which the
protagonists would admit agreement was generally narrower, the
loss of professional prestige was greater and the resolution of
10
W. S. Jevons, 'The Future of Political Economy', Fortnightly Review (1876),
p. 620.
11
A. W. Coats, 'The Historicist Reaction in English Political Economy
1870-90', Economica (1954).
the conflict had wider implications for the orthodox view of
the methodology and scope of economic science.
One might, of course, expect that methodological crises -
divisive methodological controversies polarising opinion among
the leading practitioners in the discipline - would be a frequent
occurrence for economics. In the changing social, institutional
and economic context in which the policy problems arise, the
need for revolutionary new ways of interpreting and analysing
reality must appear more often than in the natural sciences
simply because the shape and content of the economic policy
problems that successive generations of policy makers regard as
fundamental change constantly. It is surprising indeed, and may
reflect the strength of ideological constraints on social scientists'
freedom of intellectual manoeuvre, that revolutions in the dis-
ciplinary matrix of economic thinking do not take place more
often than they apparently do.
In the event, the fact that the neo-classical economists of the
period up to 1914 were able to retain unimpaired the classical
bias towards economic individualism and laissez-faire, and the
ideological overtones which this gave to the policy conclusions
deducible from their analyses, may have had more to do with the
success of the neo-classical paradigm than its problem-solving
qualities. The problems of value and distribution which had
preoccupied the Ricardians were solved, or, more accurately, one
might say swept under the carpet, by simple process of definition.
The problems of growth were outside the effective range of
marginal analysis and further consideration of them was con-
sciously postponed.12 At the same time, the very jargon of pure
economic theory, e.g. the notions of 'rationality', or 'perfect'
competition, of an 'optimum' allocation of resources, helped to
accentuate its ideological overtones and to lend ostensible
'scientific' support to a political status quo which depended on
accepting a philosophy of economic individualism and harmony.
It took a couple of decades or so before the neo-classical
12
See e.g. Jevons, in the preface to the first edition of his Theory, op. cit., p.
44: ' But I believe that dynamical branches of the Science of Economy may re-
main to be developed, on the consideration of which I have not at all entered.'
Marshall was possibly more far-sighted in envisaging a theory of economic growth
which would escape from the more static analogies of equilibrium theory, e.g.
in an article on 'Distribution and exchange', Economic Journal (March 1898), p.
43: 'And therefore in the later stages of economics when we are approaching more
nearly to the conditions of life, biological analogies are to be preferred to
mechanical, other things being equal.'
paradigm began to supplant its classical predecessor in the text-
books and so to overcome the challenge of its chief contemporary
rivals - the historicists. T h e new leader however was not Stanley
Jevons, who had launched the first successful attack in England
with his Theory of Political Economy (1871), but Alfred Marshall.
Marshall did not publish his Principles of Economics, the bible of
the English neo-classical school, until 1890; but by then he had
been teaching economics for twenty years in Cambridge, Bristol
and Oxford, and he had indoctrinated the inhabitants of half the
economic chairs in England. 13 T h e formal and explicit definition
of the new orthodoxy's position with regard to the methodology
and scope of the discipline appeared in John Neville Keynes'
Scope and Method of Political Economy14 which was published,
appropriately enough, in the same year as Marshall's Principles.
Neville Keynes was one of Marshall's earliest pupils and a col-
league at Cambridge: he was also the father of John Maynard.
T h e tone of J. N. Keynes' methodological treatise reflected the
success of the revolution, it was the tone of a peacemaker rather
than a disputant, judicious rather than declamatory, expository
rather than argumentative.' I have endeavoured' he wrote in the
Preface
to avoid the tone of a partisan and have sought in the treatment of

disputed questions to represent both sides without prejudice. Whilst
making no attempt to bring about a complete reconciliation between
opposing views, I have been able to show that the nature of the oppo-
sition between them has sometimes been misunderstood and its extent
consequently exaggerated.15
Neville Keynes distinguished three concepts of political econ-
omy in order to bring into focus the interpretation which he
clearly regarded a fundamental:
(1) a positive science, i.e. 'a body of systematized knowledge'
.. .'concerned purely with that is'. . .'the whole province of
which is to establish economic laws or uniformities'. This is
what he equated unequivocally to 'economic science'. 16
13
Keynes, in his Memoir on Marshall published in the 1924 Economic Journal,
quoted a newspaper report on Marshall to the effect that: 'half the economic
chairs in England are occupied by his pupils and the share taken by them in
general economic instruction in England is even higher than this'.
14
J. N. Keynes, Scope and Method of Political Economy, went through four
editions: 1890, 1897, 1907 and 1917 and was reprinted in 1930 as a classic. The
references which follow are to the 1930 reprint.
15
Ibid, p. vi.
16
J. N. Keynes, op. cit., p. 53, n.
(2) a normative or regulative science: 'a body of systematized
knowledge relating to criteria of what ought to be and con-
cerned therefore with the ideal as distinguished from the
actual'.
(3) 'an art, a system of rules for the attainment of a given end'.
He did not have a great deal to say about (2) which seems to
have been defined largely to distinguish (and exclude it explicitly
from) positive economics: though it is significant that he was
prepared to call it a 'science'. An appendix on (3) effectively
dismissed this concept from the discipline with the conclusion
that 'a definitive art of political economy, which attempts to lay
down absolute rules for the regulation of human conduct will
have vaguely defined limits and be largely non-economic in
character'17 (my italics).
Thus, while deliberately refraining from drawing exclusive
boundaries and while freely admitting that political economy
shades off into other social sciences and draws heavily on the
moral sciences, Neville Keynes stressed again and again the need
to distinguish sharply between what he called positive economics,
i.e. economic science, and all other conceivable aspects of political
economy. It was positive economics that he regarded as the prime
function of the professional economist, the logical starting point
and essential prerequisite for any normative or policy-making
considerations or for any related empirical enquiry (such as
economic history). It was only behind the barrier of abstract and
restrictive assumptions which marked off positive economics that
the economist could hope to conduct precise, rigorous, analysis
and come up with universal, (in principle) quantifiable laws.
Outside its well-defined limits economic laws turned into ten-
dencies and non-economic factors could be at least as important
as economic factors in determining actual economic behaviour.
In effect, then, the historical school was politely relegated to a
sort of interdisciplinary no-man's-land, as being more concerned
with ethics and policy precepts (i.e. with the second and third
concepts of political economy) than with pure, universally valid
(rather than historically relative) economic science.18
The other recurrent methodological controversy which Neville
17
Ibid, p. 82.
18
Ibid, p. 26: 'if it be granted that political economy is directly concerned with
what ought to be then most of the rest may be said logically to follow'; 'the rest'
in this context being the historical school's insistence on realism, historical
method, social and ethical standpoints, relativity of economic doctrine, etc.
Keynes effectively disposed of was the argument about whether
inductive or deductive techniques were appropriate to political
economy: this was an issue which had greatly exercised
nineteenth-century economists who were anxious to establish the
scientific credentials of their discipline, and its re-emergence
could perhaps be regarded as evidence of a sharpening of the
sense of professional insecurity which Kuhn finds characteristic
of periods of methodological crisis. It was then generally accepted
that the natural sciences relied largely on inductive techniques
and the historicists (claiming their authority from Bacon) took
an extreme position in insisting that economic laws could achieve
scientific validity only to the extent that they were originally
derived from, as well as verified by, empirical observation. This
was a reaction against the deductive method of the Ricardians
who had deliberately reasoned a priori rather than a posteriori in
basing their theory on a handful of assumptions about the
propensities guiding human behaviour - assumptions verified, if
at all, only by introspection. 19
Characteristically Neville Keynes wrapped up this controversy
by seeing room for both inductive and deductive techniques in
economic science. He categorised it as a quantitative science,
heavily dependent on mathematical methods in its deductive
(abstract) methods and on statistical methods in its inductive
(concrete) aspects. However, although agreeing in principle with
the view that the theorist should base his reasoning on realistic
principles 20 he effectively gave equal weight to 'generality and
simplicity' as criteria for the economist's choice of assumptions.
In effect, he claimed deductive theory and objective positive
economics as the heart and core of the scientific discipline of
economics, while fully recognising the appropriateness of testing
theory against historical fact and of developing the kind of theory
which could be applied to the solution of current policy
problems.
Finally, Neville Keynes dealt with the ideological issues that
19
See, for example, J. S. Mill' On the Definition of Political Economy' (written
in 1831), in Vol. I of the Collected Works of J. S. Mill (Toronto edition), p. 326:
'Political Economy therefore reasons from assumed premises which might be
wholly without foundation in fact and which are not pretended to be universally
in accordance with it.'
20
E.g. he quotes (op. cit., p. 231) with approval Bagehot's assertion that
'Nothing but unreality can come of political economy till we know when and
how far its first assertions are true in matter of fact and when and how far they
are not.'
were involved in the methodological debate by absolving classical
and neo-classical economic theory from ideological bias. The
classical economists had based their normative judgments on
traditional English philosophical foundations which embodied a
mixture of eighteenth-century natural law doctrine and Bentha-
mite utilitarianism. They had been totally frank about their
ideological commitment to laissez-faire. Keynes had noted that
' independently of differences fh regard to the scope and method
of political economy, the dominant German school [i.e. the his-
toricists] is distinguished from the older English economists by
a difference of attitude towards laisser faire and government
interference'21 However, he referred back to methodological
pronouncements of the classical school economists to demons-
trate that they too regarded political economy as ' a science, not
an art or a department of ethical enquiry. It is described as
standing neutral between competing social sciences. It furnishes
information as to the probable consequences of given lines of
action, but it does not itself pass moral judgments, or pronounce
what ought or ought not to be.'22 And in an Appendix to this
chapter Neville Keynes went on to justify the characteristic clas-
sical assumption of laissez-faire on non-ideological grounds,
pointing out that even among English economists their tradi-
tional adherence to laissez-faire was subject to numerous quali-
fications and exceptions and giving two ostensibly 'value-free'
reasons for the free-competition assumption: (a) because free
competition and the absence of government interference repre-
sented what was theoretically the 'simplest' case; and (b) because
' in modern economic societies laisser faire has been as a matter
of fact the general rule'. Nevertheless he went on to claim
ideological neutrality for positive economics, insisting that
' neither laisser faire nor any other maxim of conduct can form
an integral portion of its teaching'. This claim to ideological
neutrality came to constitute one of the main characteristics of
the neo-classical school.
One of the characteristics that a successful new orthodoxy
might reasonably be expected to exhibit is a greater measure of
success with the problems that its predecessor had stumbled
over.23 However, it is not easy to identify the specific problems
21 22
J. N. Keynes, op. cit., p. 25. Ibid, p. 13.
23
Cf. Kuhn, op. cit, p. 153:' Probably the single most prevalent claim advanced
by the proponents of a new paradigm is that they can solve the problems that
have led the old one to a crisis.'
that may have precipitated a methodological crisis - if only be-
cause the failures of the old orthodoxy tend to have a cumulative
effect in discouraging its practitioners. More important still for
economics is that its practitioners are never the exclusive judges
of its success, and when economists fall into popular disrepute
for having failed to come up with patently useful policy pre-
scriptions, which the narrower scientific community would admit
to be outside its professional competence, the resulting sense of
professional insecurity may sow its own seeds of methodological
doubt.
The puzzle that persistently teased the classical economists was
of course the problem of value. Adam Smith found it necessary
to devote Chapters v-vn of the first Book in his Wealth of Nations
to 'the principles which regulate the exchangeable value of
commodities'. Ricardo had to produce a theory of value before
he could begin to grapple with his target problem of the dist-
ribution of incomes; and as we have seen, he was still struggling
with value theory when he died. True J. S. Mill found the theory
of the subject 'complete'. 24 But his readers might have been
forgiven for remaining unconvinced by this assertion for Mill
himself both affirmed and rejected Ricardo's labour theory of
value and referred to the effects of demand and supply without
making it at all clear how these might interact to determine actual
value.25
One way in which the leaders of an intellectual revolution can
establish their position, however, is to reformulate the problems
troubling the traditional orthodoxy and provide answers to what
are really a different and apparently more relevant set of ques-
tions. The marginal revolution drew its inspiration from mathe-
matical rather than philosophical techniques of analysis and it
had the effect of diverting the attention of economists from their
search for the meaning of value - a search which had deep
philosophical implications - and to focus instead on the deter-
minants of market price. Jevons, for example, set intrinsic value
24
See, e.g. the passage quoted on p. 68 above.
25
Ibid, p. 477: 'The value of commodities.. .depends principally.. .upon the
quality of labour required for their production'; p. 479:' the value of a commodity
is not the name of an inherent and substantive equality of the thing itself, but
means the quantity of other things which can be obtained in exchange for it';
and on p. 471: 'The value at any particular time is the result of supply and
demand; and is always that which is necessary to create a market for the existing
supply.'
aside as a nonentity: 'the word value, so far as it can be correctly
used merely expressed the circumstances of its exchanging in a
certain ratio for some other substance', and focused instead on the
concept of utility 'as the subject-matter of economics'.26 He thus
went on to develop a theory of exchange rather than of value.
He adopted a mathematical tool - the differential calculus - to
analyse the behaviour of the utility-maximising individual and
was inspired by mechanical analogies in developing his concepts.
With these analogies in mind he explicitly set out to develop a
theory of political economy which used the concepts and ana-
lytical techniques of 'the science of statical mechanics.'27
Jevons had hit on the crucial innovation contained in the
'marginal revolution' by demonstrating that it was the marginal
increment of utility on which exchange-value or price depended,
but it was Alfred Marshall who, by jettisoning Jevons' philoso-
phical hedonism and by bringing supply as well as demand into
the equation of price, fathered the neo-classical paradigm. The
Marshallian theory of value is discussed below in Chapter 8. For
the moment what needs to be said is that the mature neo-classical
school replaced the fragmented, often vaguely-defined, philo-
sophically-oriented analysis of the classical school with an inte-
grated theory of value-in-use and value-in-exchange in which
market price was mathematically determined by the intersection
of the schedules of supply and demand. The framework was set
out in Book v of Marshall's Principles the section which he
regarded, with reason, as containing the real nub of his own
special contribution to economic theory.28
In the event, the neo-classical theory of value (really a theory
of market prices more than anything that the classical economists
would have defined as value) became more than a theory of price,
it became a theory of the allocation of scarce resources to specific
uses under the dual incentives of utility maximisation for the
consumer and profit maximisation for the producer, using con-
26
W. S. Jevons, Theory of Political Economy, Penguin edn ed. R. D. Collison
Black (1970), p. 127 (Jevons' italics). See also W. S. Jevons, Principles of Economics,
ed. H. Higgs (1905), p. 49.
27
See the quotation on p. 95 above.
28
See his introduction to the second edition of his Principles of Economics; 'To
myself personally, the chief interest of the Volume centres on Book v: it contains
more of my life's work than any other part: and it is here more than anywhere
else that I have tried to deal with the unsettled questions of the science' (my
italics).
io8 Marginal revolution and neo-classical triumph
cepts, criteria and techniques of analysis that could be applied
analogously throughout the economic system. In the Marshallian
system then, to quote one of its later disciples:
The principle of mutual determination everywhere supersedes the idea
of a single determinant or a one-way chain of causes. The conditions
of demand are everywhere given equal status with those of supply. The
determination of 'market' values and 'natural' value, of value under
monopoly and value under competition, of value under constant and
under diminishing returns, of rent, wages and profit, is no longer seen
as a series of separate problems, sharply distinguished from each other
and each with a separate 'law' appropriate to itself - all are subsumed
under the single unifying idea of the balance at the margin, a balance
of small increments of receipts and outgoings, payments and costs,
differing in its manifestations and giving different results in different
cases, but common to them all, with the principle of substitution acting
everywhere as a master-key. All this is entirely foreign to Ricardo's
manner of thinking and to Mill's.29
T h e explicitly mathematical orientation of the new school and
its claims to quantitative precision may indeed have contributed
to its success not only directly but by adding to its aesthetic
qualities - its greater generality, for example, and the fact that
the same tools and concepts could be applied over virtually the
whole range of the problems on which the neo-classical econo-
mists elected to concentrate, viz the problems associated with the
allocation of scarce resources to given ends. Finally it can be said
that the neo-classical approach illuminated an important aspect
of the economic process which had only dimly been perceived
before. By demonstrating mathematically the total interdepen-
dence of the economic system - the fact that everything depends
on everything else - the new school revealed new regularities and
interconnections and suggested new and more fruitful tech-
niques of analysis. Even for the non-mathematical economist
there was a special attraction in its unrivalled effectiveness as a
technique of analysis over an important, if restricted, range of
economic problems. Efficient economic decision making (at the
macro or micro level) depends to a considerable extent on a
clarification of the relationship between alternative ends and
scarce means. T h e notion of an integrated system in which
changes in prices and quantities, in demand and supply, could
be interpreted as a system of opposing forces and handled with
the techniques of static mechanics provided a remarkably
29
G. F. Shove, ' Marshall's Principles in Economic Theory', Economic Journal
(1942), p. 303.
effective technique of analysis and generated a whole range of
fruitful though simple tools (e.g. the concept of elasticity) which
enabled the academic conceptual apparatus to be put to direct
practical use in sorting out the crucial issues involved in many
real-world policy problems.
There is thus no shortage of explanations for the attraction
of the marginal techniques of analysis which distinguished the
neo-classical school that emerged from the marginal revolution
and began to dominate mainstream economic thought in the later
decades of the nineteenth century. It effectively bypassed the
problem of value which had most persistently bogged down its
predecessor; it offered superior quantitative precision to either
the classical or the historicist system of thought; it revealed more
effectively than either alternative the phenomenon of economic
interdependence; it had special qualities of generality and sim-
plicity which were peculiarly satisfying to the more mathematically
minded economist; and it opened up new analytical horizons for
even the mathematically untrained economist with an interest in
the public policy problems of resource allocation. There are
interesting analogies here with the reasons suggested by Kuhn
as being commonly responsible for the success of a new paradigm
in the natural sciences.
But the problems faced by the social sciences have intimate
political affiliations to a degree that is not true of the natural
sciences and there is another factor to be taken into account in
evaluating a new paradigm - its ideological implications. It may
be that this was more important than any other single factor in
accounting for the neo-classical triumph. For although the new
disciplinary matrix had special attractions for the mathematical
economists, the majority of practising economists were more at
home in a philosophical or logical or historical than in a mathe-
matical framework of analysis. Moreover the new matrix was a
particularly powerful medium only in relation to one set of econ-
omic problems - the allocation problems - with the result that the
problems of choice, of' economising', rapidly became the primary
problem for the professional economist. With some distinguished
exceptions 30 the new school detached itself progressively from
questions of welfare and income distribution (which were laden
with normative implications) and confessed itself defeated by
the problem of growth and development which had been the
30
e.g. A. C. Pigou, Economics of Welfare, (1920) and J. A. Schumpeter, Theory
of Economic Development (1912).
leading questions for most classical economists from Adam
Smith to J. S. Mill.
One can see the reflection of this shift of emphasis for example,
in Neville Keynes' readiness to concede the position of the his-
torical school on the question of economic development. For
example he admitted that: ' T h e theory of economic progress is
exceptional in its almost entire dependence upon an historical
method of treatment, a n d . . . it is more distinctly subordinate
than are other portions of economic doctrine to general
sociology'. 31 And he went on to conclude:
This accords with the view... that when we come to deal with problems
of economic growth and progress, the appropriate method becomes less
and less deductive and more and more inductive. For it is to be observed
that mechanical analogies (dynamical as well as statical) naturally suggest
deductive methods of investigation while biological and evolutionary
analogies suggest inductive methods.32
He returned to this theme in the chapter dealing with the
connections between economics and economic history. E.g.: 'In
more general problems relating to economic growth and pro-
gress the part played by abstract reasonings is reduced to a
minimum and the economist's dependence upon historical gene-
ralizations is at a maximum. Theories of economic growth and
progress may indeed be said to constitute the philosophy of
economic history.' 33
This narrowing of the range of their discipline was a high price
for the broader scientific community of economists to pay
(however well it might fit in with the predilections of the more
mathematically minded among them) and it needed some very
special justification to convert the applied economists as well as
the theoreticians to this relatively restrictive framework. One
attraction no doubt was the fact that the ideological implications
of the neo-classical paradigm were more palatable than any
conceivable alternative. English economists, nurtured in a tradi-
tion whose philosophical premises included the doctrine of social
harmony and whose political bias was in favour of free trade and
a minimum of government intervention found their laissez-faire,
economic individualist ideology under increasing strain in the
1870s and 1880s. There were various reasons for this: British
industry was faced with intensifying international competi-
tion abroad and increasing labour problems at home; the social
and economic problems associated with an urbanised industrial
31 32
Op. cit., p. !45. Ibid, p. 149. «• Ibid, p. 283.
economy seemed to call for a revision of traditional dogma
concerning the role of government in the economy; the process
of constitutional reform was extending the vote to the working
classes at a point in time when the incomes gap between rich and
poor was becoming, if not wider, at least more obvious. In these
difficult circumstances, a methodology which took as its central
examplar a demonstration of the optimal allocation of scarce
resources in a perfect market and substituted a 'scientific' con-
cept of equilibrium for the out-dated philosophical assumption
of the 'natural law' was well worth some narrowing in the scope
of the discipline. For it permitted economists to justify an
ideological bias towards the status quo of income distribution on
ostensibly non-political grounds.34
The alternatives open to them were much less attractive. The
Marxian alternative which is discussed below in Chapter 9 lay too
far outside their cultural tradition to be a serious competitor. A
less heretical development of the Ricardian tradition might also
have led in dangerous directions. Some of Ricardo's own state-
ments for example carried some disturbing implications for those
disposed to pursue them to socio-political conclusions: e.g. his
statement in the Essay that' the interest of the landlords is always
opposed to the interest of every other class in the community'.35
Then there was his labour theory of value which by putting wages
and profits in inverse relation to one another suggested the
rationale for an inherent capital-labour conflict.36 Even J. S.
Mill's bland efforts to broaden the horizons of economic philo-
sophy by bringing it into relation with other social sciences, and
his tendencies towards a kind of liberal socialism, carried some
uneasy potential when looked at from the point of view of the
laissez-faire economic individualist. Finally, the historicists who
took their inspiration from Germany shared the German his-
toricists' bias towards a state-directed economy which was
anathema to most English and American economists.
In the event, although the marginal revolution was in no sense
exclusive to English-speaking economists, the basic textbook for
the new paradigm was not Walras' mathematically rigorous
34
Cf. G. Myrdal, The Political Element in the Development of Economic Theory
(1953 edn), p. 192: 'The perpetual game of hide-and-seek in economics consists
in hiding the norm in the concept.'
35
See also the passages quoted on p. 63 above.
36
According to H. S. Foxwell, for example, 'it was Ricardo not Owen who
gave the really effective inspiration to English socialism'. See his introduction to
A. Menger, The Right to the Whole Produce of Labour (1899), p. lxxxiii.
Elements ofEconomics but Marshall's Principles of Economics, readily
comprehensible to the intelligent layman with no mathematical
expertise.37 For in reading Marshall's Principles the English or
American economist, reared on a diet of Adam Smith, Ricardo
and Mill would soon find himself on familiar ground. For
Marshall, though a mathematician by training and intellectual
approach, deliberately kept his mathematics in the background
of his economics, insisted that his theory was subordinate to its
applications and wrapped it all up in a mass of descriptive and
historical material that was aimed more at laymen than at
academic economists. Even his demand and supply curves were
relegated to a footnote where the mathematically squeamish
economist could conveniently ignore them.
Moreover, although the Marshallian analysis was conceived
within a general equilibrium framework, it was brought into
relation with the real world by Marshall's special technique of
partial equilibrium analysis. Instead of seeking a solution to the
problem of how the economy as a whole brought its demand and
supply into equilibrium, as Walras had done, Marshall proceeded
to look at a series of cross-sections. He considered, for example,
how an individual firm in an industry would find its equilibrium
price or output if one assumed away the complications arising
outside its own special conditions of demand and supply. Partial
equilibrium analysis thus explains the determination of prices in
a particular market assuming all other markets frozen (ceteris
paribus that is to say). By starting from an analysis of the demand
and supply conditions of an individual producer Marshall tried
to bring economic theory into relation with the practical problems
of actual business situations. By adopting the theoretical device
of the 'representative firm' he was able to go on to state the
conditions for the equilibrium of the output of a whole industry
without having to make the assumption that all the individual
firms in the industry were in equilibrium.38 From there he went
37
It is not difficult to explain the failure of Walras' book to convert the
scientific community of English speaking economists to a new framework of
analysis. The mathematical superstructure of his general equilibrium theory -
his rigorous solution to the problem of the mutual interdependence of all prices
and quantities in producing a general market equilibrium - was tough enough
to daunt all but the mathematically expert theorist. The virtually total detachment
of his idealised economic system from concrete economic problems or data would
deter the applied economist from taking it at all seriously.
38
The rationale for the assumption was by analogy with the biological variety
of trees in a forest - some growing, some dying, some static - so that it was
convenient to think in terms of a representative unit, e.g. a 'representative firm'
on to provide his explanation of prices in long-run equilibrium
which became the lynch-pin of neo-classical theory. Whatever
business men might say about the relevance of the neo-classical
simplifying assumptions relating to their actual motives and
decision-making processes, they were able to recognise their own
concepts and problems in the economist's interpretation of them:
they were operating, that is to say within the same categories and
in the same kind of language.
For the economists in his audience, as well as for the under-
graduates who had a reading-list of classical economists to
digest, Marshall's Principles had the supreme advantage that it
did not pretend to overturn the classical orthodoxy - merely to
complement and modernise it. Moreover, it may be relevant in
evaluating the impact of the Marshallian system on contemporary
economists to recall the strength of the historical tradition among
the rank and file of British and American economists in the latter
decades of the nineteenth century,39 and Marshall's high respect
for the role of economic history as a branch of applied economics.
Book 1 of the Principles was a broad historical survey which ran
to 120 pages in the 4th edition: and although it had been slimmed
by the 8th edition to less than 50 pages Marshall never lost his
strong interest in economic history. It was easier for those who
had some sympathy with the historicist viewpoint to be seduced
by Marshall's Principles than to accept either Jevons' Theory or
Walras' Elements.
whose cost conditions approximated to the average for the industry and whose
profits in equilibrium approximated to the industrial norm. The problem effec-
tively sidestepped by this theoretical abstraction was that in the real world the
existence of economies of scale could be expected to lead to a disproportionate
growth in the size of the more successful firms, thus destroying the competitive
conditions on which the whole analysis was based.
39
According to Blaug 'The dominant view among English economists in the
seventies and eighties was that of the Historical School (M. Blaug, Economic Theory
in Retrospect, 2ndedn, p. 305). J. B. Parrish,'The rise of economics as an academic
discipline', Southern Economic Journal (July 1967), documents the dependence of
American universities on economists who had had their post-graduate study in
Germany where the historicist school was dominant. By 1900 however 'Interest
of American scholars had shifted to the leading British economists whose theo-
retical contributions became widely adopted in this country' (p. 5).
FURTHER READING
Primary literature
H. S. Foxwell, 'The Economic Movement in England', Quarterly Journal
of Economics (1888).
W. S. Jevons, Theory of Political Economy (1871).
J. N. Keynes, The Scope and Method of Political Economy, LSE Reprints
(1930).
Alfred Marshall, Principles of Economics, 8th edn (1952).
A. C. Pigou (ed.), Memorials of Alfred Marshall (1925).
Leon Walras, Elements of Pure Economics, translated by W. Jaffe
(•954)-
R. D. C. Black, 'Jevons, Marginalism and Manchester', Manchester School
of Social and Economic Studies (1972).
R. D. C. Black, A. W. Coats, Craufurd D. W. Goodwin, The Marginal
Revolution in Economics O973).
A. W. Coats, 'The Historicist Reaction in English Political Economy,
1870-1890', Economica (1954).
R. S. Howey, The Rise of the Marginal Utility School i8yo-i88g (i960).
T. W. Hutchison, 'Positive' Economics and Policy Objectives (1964).
T. W. Hutchison, A Review of Economic Doctrines /870-/929 (1953)-
J. M. Keynes, 'Alfred Marshall', in Essays in Biography, op. cit.
J. M. Keynes, 'William Stanley Jevons', in Essays in Biography, op. cit.
G. Myrdal, The Political Element in the Development of Economic Theory
(>953)-
L. Robbins, 'The Place of Jevons in the History of Economic Thought',
Manchester School of Social and Economic Studies (1936).
G. F. Shove, 'Marshall's Principles in Economic Theory', Economic
Journal (1942).
8
THE NEO-CLASSICAL THEORY OF

VALUE
As we have seen, Ricardo had been concerned by two shortfalls

in his theory of value. T h e first was that a labour theory of value
did not seem able to explain changes in value through time: for
as soon as one admits the possibility of capital with differing
degrees of durability (different lives that is) being involved in the
production process, then a general rise in the share of wages could
alter relative prices independently of relative labour inputs by
raising the prices of labour-intensive products relative to capital-
intensive products. T h e second was that he had no answer to the
question of what determined absolute value, for there was no
commodity whose value was not dependent on its own costs of
production: 'that is, there is none which is not subject to require
more or less labour for its production'. 1 As far as the founders
of the marginal revolution were concerned, Ricardo's problems
in both of these respects were of his own making. His labour-
embodied theory of value had led English classical economics into
a cul de sac from which there was no escape unless one were
prepared to start from a new set of premises and with a new set
of analytical tools.
Jevons fired the opening broadside in the attack on the classical
orthodoxy. T h e Preface to the second (1879) edition of his Theory
of Political Economy ends with the following peroration:
When at length the true system of Economics comes to be established,

it will be seen that that able but wrong-headed man, David Ricardo,
shunted the car of Economic science on to a wrong line - a line, however,
on which it was further urged towards confusion by his equally able and
wrong-headed admirer, John Stuart Mill. There were Economists such
as Makhus and Senior, who had a far better comprehension of the true
doctrines (though not free from the Ricardian errors) but they were
driven out of the field by the unity and influence of the Ricardo-Mill
school. It will be a work of labour to pick up the fragments of a
1
Ricardo, Principles, Sraffa edn, op. cit., Vol. 1, p. 44.
116 The neo-classical theory of value
shattered science and to start anew, but it is a work from which 2they must
not shrink who wish to see any advance of Economic Science.
The way out of the Ricardian impasse was to reformulate the
problem of value in terms quite different to those the classical
economists had in mind. To begin with, for example, it was
necessary to abandon the search for a definition of absolute or
intrinsic value. Value, according to Jevons, implies a relation. 'A
student of Economics has no hope of ever being clear and correct
in his ideas of the science if he thinks of value as at all a thing
or an object, or even as anything which lies in a thing or an object.
Persons are thus led to speak of such a nonenity as intrinsic
value. '3 The marginalists then shifted the whole emphasis of their
enquiries from value to exchange, from' natural' price which had
been the focus of interest for classical economists to 'market'
price. Significantly, for example, Jevons did not attempt a theory
of value. He set out instead to expound a theory of exchange.
Having thus disclaimed all interest in value as such, the mar-
ginal utility theorists had no further use for the abstractions
involved in the classical cost-of-production theories of value.
Ricardo's labour theory of value was promptly jettisoned on three
main grounds, viz its failure to explain either (a) the prices of
goods in fixed supply (such as works of art or vintage wine) or
(b) the prices of goods in excess supply or (c) differences in prices
due to the heterogeneity of labour (the wages of labour of
differing skills can be explained only in terms of the value of their
products). They then proceeded to argue that in Jevons' words
'value depends entirely upon utility', and in particular on mar-
ginal utility. To quote Jevons again:
In order that there may be no possible mistake about this all-important
series of relations, I will restate it in a tabular form as follows:-
Cost of production determines supply;
Supply determines final degree of utility:
Final degree of utility determines value.4
It was left to Alfred Marshall to develop these seminal ideas

into a more extensive framework of analysis which opened up
a whole new way of thinking about economics. Whereas the
classical school, obsessed by the problem of defining 'natural'
price, or long-term equilibrium supply price, had fallen back
exclusively on a cost-of-production theory, and whereas Jevons
2
Jevons, op. cit., Pelican edn, ed. R. D. Collison Black, p. 72.
3 4
Ibid, p. 127. Ibid, p. 187 (Jevons' italics).
The neo-classical theory of value 117
had swung in the opposite direction and asserted dogmatically
that 'value depends entirely on utility', Marshall produced a
theory which took both aspects into account simultaneously. 'We
might as reasonably dispute whether it is the upper or the
underblade of a pair of scissors which cuts a piece of paper as
whether value is governed by utility or cost of production', he
wrote.5 The scissors analogy is Marshall's own but it does not
really do justice to the quality of his synthesis. For it implies that
the two blades of the scissors move, in a sense, independently of
one another and the beauty of the Marshallian solution was that
it showed the total interdependence of demand and supply on
each other. The components of cost, for example, are all
determined by an interaction between cost and utility. The result
was a completely integrated theory of value in use and value in
exchange, applying similar criteria and similar techniques of
analysis to an impressively wide range of economic problems.
Starting from the analogous assumptions of utility maximisation
for the consumer and profit maximisation for the producer he
constructed interdependent theories of (a) demand, based on
marginal utility analysis and (b) production, based on marginal
productivity analysis.
Of course, in emphasising the interdependence of prices
throughout the system and in defining the equilibrium price in a
competitive market at the point of intersection of the demand
and supply curves, Marshall was following much the same line
of argument as Walras. Indeed Walras went further than Mar-
shall by defining a general equilibrium system for the economy
as a whole. He showed that it was possible to construct a com-
prehensive set of simultaneous equations, one equation for
each unknown, by which in principle all unknown prices and
quantities in the system could be solved. The result was a rigo-
rously formal mathematical model which no one, not even
Walras, seemed able to relate to the daily decisions taken by real
people. Marshall by contrast was actively interested in the causes
and consequences of the behaviour of consumers and firms in
the real world. His partial equilibrium analysis enabled him to
focus on cross sections of the total economy, to analyse the
determination of price in a particular market, for example, while
assuming all other markets frozen and thus to fix attention on
the behaviour of the individual firm or the individual consumer.
5
A. Marshall, Principles of Economics, 8th edn, (1952), p. 290.
His theory of value, moreover, exhibits a constant preoccupation
with the element of time, a problem wholly excluded from the
timeless general equilibrium solution. For example he noted in
Book v that 'The element of time is a chief cause of those
difficulties in economic investigations which make it necessary for
man with his limited powers to go step by step; breaking up a
complex question, studying a bit at a time, and at last combining
his partial solutions into a more or less complete solution of the
whole riddle.'6 In effect then, by breaking down the problem of
price determination into more manageable proportions Marshall
introduced into it a time dimension which no previous economist
had been able to take into account. He distinguished explicitly
but theoretically between four periods of time relevant to the
problem of price determination: (i) the market period in which
supplies are absolutely fixed; (2) the short period in which supply
can be increased only within the limits of the existing stock of
capital; (3) the long period in which capital can be replaced; and
(4) the secular period in which normal price is affected 'by the
gradual growth of knowledge, of population and of capital and
of the changing conditions of demand and supply from one
generation to another'. 7 His own price theory was primarily
concerned with the third of these periods.
In sum, then, the Marshallian theory of value and distribution
turned away from the macro problems posed by the classical
economists to focus on the problem of analysing market prices
in long-term competitive equilibrium. In this essentially micro
theory of market prices the behaviour of consumers and pro-
ducers was analysed in terms of their marginal utility and cost
functions. The individual parties to an exchange transaction were
assumed to adjust the quantities offered or demanded to the
point where their marginal preferences and costs coincided with
given market prices and these in turn were assumed to reflect
the combined preferences and costs over the economy as a whole.
Value was thus equated to the price determined by this balance
at the margin and could therefore be measured by the normal,
i.e. the equilibrium, price. The problem of distribution was solved
by the same kind of mechanism. Profit-maximising entrepre-
neurs were seen as engaged in a continuous process of substitution
as between factors of production - machinery for labour, skilled
labour for unskilled labour, etc. - weighing up the costs and
6 7
Ibid, p. 304. Ibid, pp. 314-15.
returns of alternative combinations; the most profitable tech-
nique being that which equated costs and returns at the margin.
As a theory of distribution, however, Marshall's solution was
less than satisfactory for it made the normal returns to factors
of production depend on their marginal costs and rewards in
conditions of long-term competitive equilibrium. Labour fitted
fairly readily into the marginal cost /marginal revenue system of
equations. 'Wages tend to equal the net product of labour; its
marginal productivity rules the demand price for it; and, on the
other side, wages tend to retain a close though indirect and
intricate relation with the cost of rearing, training and sustaining
the energy of efficient labour.' 8 Land, Marshall allowed, was
different, being in fixed supply: 'the stock of land (in an old
country) at any time is the stock for all time'. 9 T h e loose end in
the system was capital which Marshall tried to dispose of by
adopting the device already used by Nassau Senior and J. S. Mill,
of treating interest as a reward for abstinence or 'waiting'. T h e
trouble was, however, that this glossed over the distinction
between capital accumulated by past generations (what kind of
cost or sacrifice is involved in lending inherited capital?) and
capital accumulated out of current savings. Characteristically
Marshall identified the loose end himself by recognising that the
return to the stock of capital already in existence was analogous
more to rent of land (he dubbed it a quasi-rent) than to the wages
of labour:
the income that is derived from a factory, a warehouse, or a plough
(allowance being made for wear-and-tear, etc.) is governed in the same
way as is the income from land. In each case the income tends to equal
the value of the marginal net product of the agent: in each case this is
governed for the time by the total stock of the agent and the need that
other agents have of its aid.10
T o make the net return to capital a function of the flow of
savings was to adopt a simplification that might serve well enough
for a theory of prices but was not very helpful in a theory of
distribution.
This, however, was the device Marshall adopted - though ex-
pressing some doubts and qualifications. That he was aware of the
ideological implications of the stratagem is apparent from his
remarks on the labour theory of value. ' If we admit that it is the
product of labour alone, and not of labour and waiting, we can
8 9
Ibid, p. 442. Ibid, p. 445.
10
Ibid, p. 444.
no doubt be compelled by inexorable logic to admit that there
is no justification for interest, the reward of waiting; for the
conclusion is implied in the premise.' 11 He then went on to rebut
the Marxian case as being based on 'a series of arguments in a
circle' with a circular argument of his own illustrating only too
well how the conclusions of economic analysis may be determined
by its assumptions:
if it be true that the postponement of gratifications involves in general
a sacrifice on the part of him who postpones, just as additional effort
does on the part of him who labours; and if it be true that this
postponement enables man to use methods of which the first cost is great;
but by which the aggregate of enjoyment is increased, as certainly as
it would be by an increase of labour; then it cannot be true that the value
of a thing depends simply on the amount of labour spent on it.12
T h e advantage, however, of explaining profits as a price (for
a combination of waiting, risk-bearing, entrepreneurial skill etc.)
was to make it possible to apply to the factor markets a similar
range of techniques to those applied to the commodity markets
and to merge the theory of production and distribution into an
integrated theory of prices. Marshall's successors went on to
develop this technique on lines that he would almost certainly
have regarded as too far-fetched, for there are many passages
in which he refers to the limitations of the method which he
describes as ' T h e statical theory of equilibrium' and which he
thought of as being fully applicable only on the assumption of
a stationary state, e.g.
when pushed to its more remote and intricate logical consequence, it
slips away from the conditions of real life. In fact we are here verging
on the high theme of economic progress; and here therefore it is
especially needful to remember that economic problems are imperfectly
presented when they are treated as problems of statical equilibrium and
not of organic growth.13
There were losses as well as gains involved in the re-structuring
and re-orientation of value theory associated with the adoption
of the neo-classical paradigm. On the credit side was the con-
sistency, precision and elegant simplicity of analysis permitted
by the use of the marginal technique and the new tools that
developed within its ambit (e.g. elasticity and rate of substitution
concepts and, later, indifference curves and production func-
tions). For those who could tolerate the assumptions involved in
11 12
Ibid, p. 487. Ibid, p. 488.
13
Ibid, p. 382.
treating capital as a factor of production complementary to
labour and conceptually independent of the labour embodied in
it, it became possible to explain the processes of production and
distribution in marginal productivity terms analogous to the
marginal utility analysis of consumers' behaviour; and thus to
develop a two-dimensional concept of value measurable in terms
of the price resulting from the totality of transactions in a
competitive market. Perhaps also there was a net advantage in
having diverted the attention of theoretical economists from the
insoluble, metaphysical problem of measuring absolute value. It
could also be argued (though this is more debatable) that it
related the economist's pure theory of economic behaviour to the
actual behaviour of decision makers in a real market.
On the debit side of the account was the way it narrowed the
scope not only of value theory but of economic theory generally.
Certain problems which might reasonably be expected to come
within the range of a satisfactory theory of value were not so
much solved as shelved out of sight, e.g. the theory of distribution
or the role of expectations in determining values. The problem
of distribution which had so preoccupied the classical economists
was allowed to drop out of the theoretical economist's research
agenda as being somehow out of range. Thus the pattern of
income distribution was assumed given and the assumption
frequently forgotten, so that the strong normative implications
of the neo-classical theory concerning the optimum allocation of
economic resources were able to carry as illicit baggage the
presumption that the closer the economic system conformed to
the operations of a perfectly competitive market the nearer it
would come to an optimal distribution of incomes. By refusing
to confront the problem of value in terms wider than those of
market prices and by postulating that economic theory was value-
free and hence objective, the neo-classical economists effectively
prejudged a considerable area of economic policy.
Actually, however, not all neo-classical economists carried the
notion of a value-free economics to its logical conclusions. The
pragmatic Marshallian tradition of partial equilibrium analysis,
inspired by constant concern with real world problems and
conditions, permitted a less rigid kind of theorising to thrive
on the strength of the neo-classical theory of value. Pigou, for
example, Marshall's disciple and successor, went on to work
out a welfare theory which fully faced up to the possibility of
divergences between marginal private social cost or benefit and
social cost or benefit. Joan Robinson, another pupil from the
same stable, developed a theory of imperfect competition from
a Pigovian starting point, using and indeed extending the full
paraphernalia of the marginal analysis.
In line with the growing trend towards a more positive formu-
lation of economic theory, however, Hicks and Allen succeeded
in emptying the Marshallian demand curve of some of its classical
heritage of armchair psychology by making it unnecessary to
assume that consumers were capable of measuring utility in a
cardinal (additive) sense. They demonstrated by means of the
indifference curve technique that to explain the downward slope
of the demand curve it was sufficient to assume that consumers
were capable of choosing between products, and hence of rank-
ing them, i.e. of measuring the strength of their desires for
different commodities in an ordinal (relative) sense. They thus
offered an alternative criterion to the principle that a consumer
maximises his satisfaction from a given income by laying it out
in such a way that the marginal utility of his expenditure on each
good is proportionate to its price.14 Given an indifference curve
which describes the consumer's preferences for different combi-
nations of any pair of goods, and a price line which reflects the
price ratio between the goods in question it can be shown that
a consumer maximises his satisfaction at their point of tangency,
i.e. where the marginal rate of substitution between the two
products is exactly equal to their price ratio. Finally, the positive
economists took a further step away from the subjective, intro-
spective assumptions underlying traditional demand theory by
adopting the ' revealed preference' approach to analysing con-
sumer behaviour.
In sum, the key to the shift from a classical to a neo-classical
value theory can be interpreted in terms of another shift in
problem focus. Whereas Ricardo had been primarily concerned
to explain the share of profits in the national product -
essentially because he regarded profits as the engine of growth
for a capitalist economy — the neo-classical economists were con-
tent to let the answer to the question of what determined the
factor distribution of incomes come out as a logical by-product
of their assumptions about the prices of factors in long-term
14
The concept of indifference curves can be traced back to Edgeworth and
Pareto but it was the article by R. G. D. Allen and J. R. Hicks, 'A reconsideration
of the theory of value', Economica (1934), which first used the technique as a
criterion for maximisation of consumers' satisfactions.
The neo-classical theory of value i23
competitive equilibrium. In a perfectly competitive private enter-
prise economy where the agents have full knowledge and per-
fect foresight it is a condition of equilibrium that the returns to
labour and capital will equal their marginal products. However,
for the benefit of those who persisted in asking what determined
the rate of profits at a particular point of time they provided
answers which represented a natural extension of the marginal
supply and demand analysis on which their theory of exchange
was based. Thus they interpreted the return to capital as a reward
to the capitalist for postponing consumption (just as the return
to labour was a reward for the disutility of effort) and defined
the long-term rate of profit (not distinguished from the long-term
rate of interest) in terms of the intersection of the marginal
productivity schedule of capital facing investors and the marginal
rate of time preference for savers. The difficulties of defining the
marginal product of capital (or of labour for that matter), the
problems arising from the fact that both capital goods and labour
are heterogeneous inputs, and the influence on the distribution
of factor incomes of the bargaining situation in factor markets,
could conveniently be ignored as beside the point if the object
of the model was to explain the values at which commodities and
factors exchanged in a perfectly competitive market and to draw
implications for an optimum allocation of scarce resources with
alternative uses.15 Consequently, although the neo-classical
theory of prices fell short of a theory of value and had little of
substance to contribute to a theory of distribution, it was not
empty of significance even for those whose practical interests lay
in the problems of planning for a socialist or a mixed, rather than
a private enterprise, economy - as was evidenced by the lively
debate on the economics of socialism in the inter-war
period.16
15
Cf. Keynes' discussion in his chapter on 'the marginal efficiency of capital'
of the Marshallian theory; 'It is evident from the above that Marshall was well
aware that we are involved in a circular argument if we try to determine along
these lines what the rate of interest actually is' (General Theory, p. 140, my italics).
In a footnote to this passage however Keynes asks 'But was he not wrong in
supposing that the marginal productivity theory of wages was equally circular?'
18
See C. J. Bliss, 'Prices, Markets and Planning', Economic Journal (March
1972), for an account of this debate in the course of an article reviewing twentieth-
century progress in price theory.
FURTHER READING
Primary literature
W. S. Jevons, Theory of Political Economy, op. cit.
Alfred Marshall, Principles of Economics, op. cit.
M. Friedman, 'The Marshallian Demand Curve', in idem, Essays in
Positive Economics (ig4g).
Tapas Majumdar, The Measurement of Utility (1958).
G. J. Stigler, Essays in the Theory of Economics, op. cit.
THE MARXIAN ALTERNATIVE
In 1867 while Alfred Marshall the young mathematician was busy

transcribing the basic theory of Mill and Ricardo into abstract
mathematics there was published in Germany the first volume
of Karl Marx's massive reconstruction of political economy — Das
Kapital.1 Marx had been working his way through 'the confoun-
ded ramifications of political economy' in the British Museum
Reading Room since 1850 and had already published (again in
Germany) a substantial sample of his new theory, illustrating his
distinctive methodological approach, in 1859 under the title: Zur
Kritik der Politischen Oekonomie.2 Like both J. S. Mill and Marshall
he was an innovative follower of Ricardo. Unlike Mill and
Marshall he deliberately set out to replace the classical system
of thought with a new integrated set of theories, concepts and
analytical techniques - a new disciplinary matrix. However, he
remained throughout his life outside (and virtually ignored by)
the English-speaking community of economists and had little or
no influence on the subsequent evolution of mainstream econ-
omic thought.
Yet Marxian economics descended directly from the English
classical school. Marx shared the classical interest in growth and
began, as Ricardo had done, by recognising value and income
distribution as the key to understanding growth. He accepted
Ricardo's labour-quantity theory of value and his theory of the
falling rate of profit and snapped up his hints on technological
unemployment. Following the classical example he classified the
1
Marx, after completing a conventional doctorate in philosophy at the Univer-
sity of Berlin in 1841 spent a stormy few years as a political journalist, moving
between Paris, Brussels and Cologne, pursued incessantly by continental police,
before settling in London in 1849 to be pursued by bailiffs rather than police and
to earn a spare living as economic correspondent for the New York Tribune.
2
Published in English under the title A Contribution to the Critique of Political
Economy (1904). Now available in an edition introduced and edited by Maurice
Dobb and published in 1971 by Lawrence and Wishart.
126 The Marxian alternative
economy into three socio-economic groups - landlords, capital-
ists and workers - and focused on an analysis of the movements
in rents, profits and wages as between the three classes of income
recipients: like Ricardo he set rent on one side and expounded
a labour theory of value in terms of equilibrium prices in long-
period perfect competition leading to a uniform and eventually
declining rate of profit. He took over Ricardo's assumption of
a capital-using bias in technical change. But he came to totally
different conclusions. How? How, given what was apparently the
same conceptual starting point and the same analytical tools, did
he manage to produce a theory of the evolution of the capitalist
system that was right outside the mainstream of English economic
theory fathered by Ricardo and Smith?
The answer to this question has three main facets - first that
he did his thinking in a different philosophical context and hence
with different philosophical premises, second that he had a
different scientific objective - different problems to solve, that is
to say - and third that he adopted a different methodological
approach to political economy.
The salient characteristic which Marx shared with Adam
Smith, Jeremy Bentham and J. S. Mill and which distinguished
him from Ricardo (and most subsequent economists) was that
he was a philosopher first and an economist second - a social
scientist rather than a 'pure' economist. For Marx, political
economy was merely one branch (if the most important) in the
study of human social behaviour in the round. He came to the
study of economics with a rigorous training in philosophy, history
and law, and strong political motivation and an insatiable appetite
for empirical knowledge.3 However, Marx's continental upbring-
ing plus his uncompromisingly critical approach to orthodox
doctrine of all kinds (philosophical, historical or economic) en-
sured that he would move off in a direction totally divergent from
the mainstream of economic ideas. Like Adam Smith he set out
to analyse the conditions of human progress, particularly human
progress in the material sphere. But whereas Adam Smith's
philosophical preconceptions led him to adopt an analytical frame-
work based on the assumption that progress tended to evolve
'naturally' out of a god-given harmony of individual sentiments
and motives in human society, Marx started from the framework
3
See e.g. his letter dated 1868 to his daughter Laura: 'I am a machine
condemned to devour books and then to hurl them transformed on to the
dunghill of history.'
The Marxian alternative 127
of the Hegelian dialectic which envisaged progress as a product
of continuous conflict - revolution and counter-revolution. Even
so, Marx deliberately inverted the orthodox Hegelian dialectic,4
bringing the material world (rather than the world of spirit) to
the fore and explaining the progress of human society in terms
of man's struggle with nature and of the changing pattern of
human relationships (conflict and combination) associated with
man's struggle to improve his material conditions of life.
Marx's study of political economy thus grew out of his political
interests and was, according to his own account, a corollary of
his critical re-examination of the Hegelian philosophy of law
which he undertook in 1843-44.
My inquiry led me to the conclusion that neither legal relations nor
political forms could be comprehended whether by themselves or on the
basis of a so-called general development of the human mind, but that
on the contrary they originate in the material conditions of life, the
totality of which Hegel, following the example of English and French
thinkers of the eighteenth century embraces within the term 'civil
society': that the anatomy of this civil society, however, has to be sought
in political economy.5
From then on he and his collaborator, Frederick Engels, con-
centrated on an intensive study of political economy. When the
continental political reaction that came to a head at the end of
the decade of the 1840s cut short his career as a political journalist
he resumed his studies in London in 1850. As he wrote in 1859
in the preface to his Critique of Political Economy:
The enormous amount of material relating to the history of political
economy assembled in the British Museum, the fact that London is a
convenient vantage point for the observation of bourgeois society, and
finally the new stage of development which this society seems to have
entered with the discovery of gold in California and Australia, induced
me to start again from the very beginning and to work carefully through
the new material.
Political economy - in the sense that contemporary classical
economists would have defined it - constituted the heart and core
of the Marxian message. Like Adam Smith and J. S. Mill, Marx
related his economics explicitly to the broader framework of his
philosophical, social and political thinking, of which it was always
4
'My dialectic method is not only different from the Hegelian, but is its direct
opposite' (Afterword to the 2nd German edition of Das Kapital, reprinted by
R. C. L. Tucker, in The Marx-Engeb Reader, p. 197).
5
Preface to A Contribution to the Critique of Political Economy, ed. Maurice Dobb
(1971), p. 20.
an integral part; like most of the classical economists he adopted
a hypothetical-historical style of exposition when describing the
essential characteristics of a modern economic system; and like
Ricardo (and the later macro-economists) he saw the process of
production (rather than of exchange or consumption) as the
fundamental determinant of the character of an economy and
the main subject of study for an economist. 'We have proceeded
from the premises of political economy', he wrote in 1844, 'We
have accepted its language and its laws.'6 However that was before
he developed his own version. He went on in subsequent decades
to mount a systematic critique of orthodox political economy,
beginning with an essay on Sir William Petty,7 and to produce
an analysis which differed from mainstream economic analysis
as it developed in the second half of the nineteenth century in
two main respects: (a) in confronting a different primary objec-
tive; and (b) in adopting a different methodology.
Marx's objective as he described it in the Preface to Volume
1 of Das Kapital, was to discover the laws of motion of the modern
economic system: 'it is the ultimate aim of this work to lay bare
the economic law of motion of modern society'.8 This was an even
more ambitious target than Adam Smith had confronted in his
'inquiry into the nature and causes of the wealth of nations', for
it was an attempt to analyse a dynamic social system by developing
an organic and not merely a mechanical interpretation of human
society. For Marx the analogy of a machine was not helpful in
explaining the historical process of socio-economic change in
which the capitalist mode of production was merely one stage in
a continuously developing system of social and economic
relationships. He drew his inspiration, the philosophical orien-
tation which determined his view of human society, from the
Hegelian dialectic with its dramatic sequence of conflict, con-
tradiction and revolutionary change, each new stage in the
sequence carrying its own seeds of dissolution and replacement.
In explaining how his critique of the Hegelian interpretation of
6
Economic and Philosophical Manuscripts of 184.4, reprinted in R. C. Tucker, The
Marx-Engels
7
Reader, p. 56.
Most of his history of economic theory (originally designed to constitute
Vol. iv of Das Kapital) did not appear in print until the twentieth century. It
is now available under the title Theories of Surplus Value, published in English in
3 Parts by Lawrence and Wishart (1968-72).
8
K. Marx, Capital. A Critique of Political Economy, Vol. 1, Lawrence and Wishart
(1970), p. 10. This is the edition (translated from the 3rd German edn by Samuel
Moore and Edward Aveling) that is referred to in this book.
'civil society' led him to a reconstruction of orthodox political

economy Marx wrote:
The general conclusion at which I arrived and which, once reached,
became the guiding principle of my studies can be summarized as
follows. In the social production of their existence men inevitably enter
into definite relations, which are independent of their will, namely
relations of production appropriate to a given stage in the development
of their material forces of production. The totality of these relations of
production constitutes the economic structure of society, the real
foundation, at which arises a legal and political superstructure and to
which correspond definite forms of social consciousness.9
The result was a new kind of political economy, conforming
to a paradigm unique of its kind, impressive in the sheer range
of its explanatory ambitions. Engels put the Marxist assessment
succinctly in his speech at the Highgate graveside in 1883: 'Just
as Darwin discovered the law of development of organic nature,
so Marx discovered the law of development of human history...
But that is not all. Marx also discovered the special law of motion
governing the present-day capitalist mode of production and the
bourgeois society that this mode of production has created.'10
So when Marx settled down in the British Museum to make
a systematic study of classical political economy he was armed
with a set of premises and a set of questions which had emerged
out of his training in political philosophy and his interest in
political science. He approached Ricardo, for example, as he did
Adam Smith and the Physiocrats, with the intention of working
out for himself the laws of motion of contemporary capitalist
society (as typified more particularly in England and America)
but with his mind made up about which were the crucial variables
and links in the whole process of social evolution. Naturally he
found Ricardo's analysis particularly useful, for Ricardo, by
focusing on the question of the distribution of the total national
product, provided exactly the right starting point for Marx's
central economic problem - the origins of the surplus.
But Marx did not intend to stop there. He differed from
Ricardo in that he looked forward as well as backward, that he
took a dynamic view of contemporary society and that he
regarded its organisational relationships not as given constants
but as endogenous to his model of economic change. He was
interested not merely in how the national product was distributed
9
Contribution to the Critique of Political Economy, op. cit., p. 20.
10
Reprinted in Tucker, op. cit., p. 603.
but also in why it was so distributed and especially in how it arose.
He accepted the conventional classical assumption of competition
as a distinctive characteristic of the contemporary economic
system, but he embodied in his model an explanation of the way
it developed inevitably out of past systems of economic organi-
sation and the way it would, equally inevitably, merge into the
monopoly-capitalism of the mature capitalist economy. He
criticised orthodox political economy for having failed to explain
the laws of motion of capitalist organisation, e.g.' The only wheels
which political economy sets in motion are avarice and the war
among the avaricious - competition.'11 He reacted vigorously against
the tendency of contemporary economists to present 'produc-
tion, as distinct from distribution, etc... .as governed by eternal
natural laws which are independent of history, and at the same
time bourgeois relations are clandestinely passed off as irrefutable
natural laws of society in abstracto'.12
Marx therefore saw the task of the political economist as being
primarily an investigation into the long-term development of
modern economic society; and since he saw its organisational
developments and corresponding social relationships as both
cause and effect of economic growth in the material sense there
was no reason to bottle up the social aspects of change in a set
of ceteris paribus assumptions. The production relationship that
he identified as being both the most distinctive and the most
significant feature of the contemporary economic scene, and the
key to its further development was the capital-labour relation-
ship, i.e. the separation of producers into two social classes, those
owning the instruments of production (and extracting the profit)
and those actually producing physical output in return for wages.
It was this basic relationship of the capitalist economy that made
it capable of generating increases in production and productivity
on a scale unknown in previous epochs and also sowed the seeds
of the class struggle and social revolution which would eventually
transform the capitalist economy into a communist economy.
Ricardo with his rather narrow unemotive approach to econ-
omic analysis provided Marx with a skeleton that called strongly
for some social flesh and blood: and with a skeleton of the right
formal shape for Marx's needs. For Ricardo, who was not
concerned with the broader social implications of his analysis, far
11
From Economic and Philosophic Manuscripts of 1844, reprinted Tucker, op. cit.,
P- 57-
12
Critique of Political Economy, ed. Dobb, p. 192.
less conscious of its revolutionary implications, wrote in simple
abstract language and was astonished when people drew obvious
socio-political conclusions from it. He was particularly annoyed,
for example, with Malthus and others who called him the enemy
of the landowners. It seemed absurd to him that anyone could
take his precise economic logic, based on simplified carefully-
defined premises, as a critique of the social order or the capitalist
system, both of which he took as given, outside his terms of
reference. So he could write, for example:
Each year the capitalist begins his operations, by having food and neces-
saries in his possession of the value of 13,000 I. all of which he sells in
the course of the year to his own workmen for that sum of money, and,
during the same period, he pays them the like amount of money for
wages; at the end of the year they replace in his possession food and
necessaries of the value of 15,000 I., 2,000 I. of which he consumes
himself, or disposes of as may best suit his pleasure and
gratification.13
Which was a perfect springboard for Marx's exploitation theory

of profits.
It is fair to say that Ricardo never had a theory of the deter-
mination of profits. Indeed this is not what he had in mind. He
was trying to understand what determined the way the national
product was distributed, and having dealt with rent on the basis
of a theory which enabled him to explain it separately he
proceeded to construct a theory of the relation between profits,
wages and total product. His successors then dealt with the
resulting gap in economic theory in ways which matched their
ideological preconceptions on the one hand and their intellectual
interests on the other. T h e direct classical succession developed
a theory of profit (not at all clearly distinguished from interest)
which made it a reward for the role played by the capitalist in
the productive process. According to Mill for example: ' T h e
gross profits from capital, the gains returned to those who supply
the funds for production, must suffice for three purposes. They
must afford a sufficient equivalent for abstinence, indemnity for
risk, and remuneration for the labour and skill required for
superintendence.' 14 T h e neo-classical economists as we have al-
13
14
Ricardo, Principles, Sraffa edn, Vol. 1, p. 388.
J. S. Mill, Principles, Toronto edn, Vol. 1, p. 401. But sec also, p. 411, a
passage which harks back to the Ricardo interpretation and supports the Marxist
route: 'The cause of profit, is that labour produces more than is required for its
support.'
ready seen were less interested in explaining the distribution of

the national product than in developing a theory of market prices
and resource allocation. Accordingly they extended the classical
line of thought implied in Mill's definition by treating profits
(analogously to wages) as determined by demand and supply for
a factor of production. This permitted them to exclude as
irrelevant the socio-political considerations tnat were unavoid-
able in an extended consideration of the distribution problem.
Here the route followed by Marx diverged sharply and signi-
ficantly from the orthodox classical route. For Marx never lost
sight of the socio-economic distribution problem, and, following
the trail suggested by Ricardo's treatment of rent - as a surplus
attributable to the institutional fact of property ownership -
proceeded to explain profits in terms of the class structure of
capitalist society in which a proletarian wage-earning class
confronted the classes owning the capital and land which con-
stituted the means of production. That this was the crucial dif-
ference between the Marxian alternative and the classical
orthodoxy was recognised plainly by Marshall who pointed
out that the conclusions of 'William Thompson, Rodbertus,
Karl Marx and others' flowed inexorably from their initial
assumptions.
They argued that labour always produces a 'Surplus' above its wages
and the wear-and-tear of capital used in aiding it: and that the wrong
done to labour lies in the exploitation of this surplus by others. But this
assumption that the whole of this Surplus is the produce of labour,
already takes for granted what they ultimately profess to prove by it;
they make no attempt to prove it; and it is not true.15
Neither the notion that the development of economic relation-
ships is the main determining factor in history, nor that the
historical process can be fruitfully analysed as a continuous
conflict between the classes in possession of society's economic
resources and the classes dependent on them for subsistence,
were new ideas. Karl Marx had found a similar approach in the
French writer Saint-Simon (himself a leading eighteenth-century
aristocrat dispossessed by the Revolution) and in the Swiss
economist Sismondi who had predicted that the class struggle
which would eventually emerge from the over-production crises
of capitalist society would be catastrophic in its effects. T h e dis-
15
Alfred Marshall, Principles of Economics, 8th edn. (1952), p. 487. Of course
the orthodox neo-classical route also stemmed from its particular package of
assumptions as Marshall went on to illustrate. See above p. 120.
tinctive feature of Marx's treatment of these ideas was that he
embodied them in a socio-economic model of economic devel-
opment in which everything followed logically from that single
central hypothesis. It was the capital-labour relationship that
permitted large-scale accumulation of capital and technical pro-
gress, that produced economic growth and economic cycles, that
determined both the structural characteristics of the economy
and the lines of its further development.
Marx thus went on to adopt in a much more complete sense
than Ricardo had ever done, the labour-quantity theory of value,
which he developed into a theory of profits or surplus value.
Whereas Ricardo had introduced this theory as a convenient
hypothesis, a deliberate simplification, which permitted him to
explain relative variations in the long-run natural prices of com-
modities in terms of variations in their labour inputs, to Marx the
labour embodied in commodities was the essence as well as the
measure of their values. Under the capitalist system labour power
itself becomes a commodity which worker sells to employer at a
market value determined by its supply cost, i.e. the amount of
socially necessary labour time required to maintain the labourer.
'The labour-time materialised in the use-values of commodities
is both the substance that turns them into exchange-values and
therefore into commodities, and the standard by which the
precise magnitude of their value is measured. . . Regarded as
exchange-values all commodities are merely definite quantities
of congealed labour-time. 'ie The difference, however, in the value
of the labour embodied in a commodity (including the cost of
labour embodied in capital and other inputs used up in the
production process) and the value of the labourer's product was
' profit, the specific mark characterizing the form of surplus-value
belonging to the capitalist mode of production'. Here then was
the key to the whole process of capitalist development, for surplus
value provided both the resources for capital accumulation (and
hence growth) and the motive power for the inherent conflict
between classes by which capitalism would eventually be
destroyed.
Marx developed his own theory of value, then, in a historic and
social frame of analysis distinguishing three essentially abstract
stages of development, three basic types of economic system. In
16
Contribution to the Critique, op. cit., p. 30. Marx repeated the last sentence of
this passage in Vol. 1 of Capital, op. cit., p. 40.
a pre-capitalist society where producers own their own means of
production and there are no distinct classes of capital owners (or
landowners), the exchange value of a commodity depends quite
simply on the quantity of labour required for its production -
including the labour embodied in the capital stock and raw
materials used up by the process of production. Thus far he
followed lines of argument indicated by Smith and Ricardo. In
the early stages of capitalism, with the emergence of a social class
enjoying a monopoly of the factor of production capital (or
analogously land) the privileged class can use its monopoly
powers to 'compel the working class to do more work than the
narrow round of its own life-wants prescribed ',17 and to extract
a new form of income via profit on capital: at this stage the
exchange values of commodities are still strictly proportionate to
the quantities of labour embodied in them, but the capitalists (e.g.
the medieval master craftsmen or farmers employing paid
labour) have been able to divert to themselves the value of the
additional working time they have coerced the labourers into
putting out. Finally in a fully developed capitalist society, where
the application of capitalistic methods of production has changed
not only the distribution of incomes but the organisation of the
productive process itself, the exchange value of commodities is
determined by their fixed capital as well as their direct labour
costs of production and the whole of this surplus value is trans-
formed into profits. So as technological progress increasingly
hinges on replacing men by machines, the share of living labour
in the national product (the wage-bill) falls and the share of dead
labour (labour embodied in capital equipment) rises, and the
system becomes less and less capable of maintaining full employ-
ment of the labour force.
The social frame is set by the relations between the factors
of production. The value of commodities arises out of a chain
of socially cooperative activities - production, distribution and
exchange. To quote: 'If.. .we bear in mind that the value of
commodities has a purely social reality, and that they acquire this
reality only insofar as they are expressions or embodiments of
one identical social substance, viz human labour, it follows as a
matter of course that value can only manifest itself in the social
relation of commodity to commodity.' Labour power itself is
transformed into a commodity in the fully developed capitalist
17
Capital, Vol. i, pp. 309-10.
system as envisaged by Marx. Thus the source of surplus value
is the fact that in a developed capitalist economy where labour
power itself is transformed into a commodity, its purchaser can
sell its output at a higher price than he has paid for the embodied
labour time.18
Marx thus classified the expenditures generating the annual
gross product of the capitalist economy (i.e. its annual value-
added) as consisting of three components - variable capital (equi-
valent to the wage-bill), constant capital (equivalent to deprec-
iation plus raw materials i.e. to outlays on capital and other inputs
used up in the production process) and surplus value (which
accrued to the capitalist property-owner). He was able to explain
why the competitive capitalist entrepreneur seeking to maximise
his total profits did not bid up wages, by postulating the existence
of an industrial reserve army of the unemployed providing
increasing competition for vacancies. The classical economists
would no doubt have justified this postulate by an appeal to
the Malthusian principle of population, but Marx's ideological
preconceptions did not sit easily with a theory which could be
held to imply that poverty could be alleviated by greater chastity
on the part of the poor and more extravagant consumption on
the part of the rich. In effect the Malthusian approach ran
counter to the whole thrust of the Marxian argument that modern
(capitalist) growth hinged on the ability of the working classes
to produce a surplus to their subsistence needs, and on the power
of the capitalist class (landlords and industrialists) to appropriate
the whole of that surplus and convert it into productivity-
promoting capital investment. Indeed Marx started from the
assumption of a persistent bias towards labour-displacing tech-
nical progress in mature capitalist economies. Like Ricardo he
assumed that wages were determined by the level of subsistence
of the labourer (i.e. that they were supply-determined) the mech-
anism being as follows: first that as capitalist enterprise grows at
the expense of pre-capitalist enterprise it creates an unemployed
fringe, and second (more importantly) that the process of capi-
talist accumulation involves a continuous change in the 'organic
18
Marx did not distinguish analytically between rent and profit and rejected
Ricardo's theory of rent as falling 'into a two-fold historical error: on the one
hand, he assumes that the productivity of labour in agriculture is absolutely the
same as in industry, thus denying a purely historical difference in their actual stage
of development. On the other hand, he assumes an absolute decrease in the
productivity of agriculture and regards this as its law of development' (Theories of
Surplus Value, Pt 2, op. cit., p. 244).
composition of capital' away from variable capital, which main-
tains the labour force, and in favour of constant capital, i.e. that
part of capital expenditure which is devoted to raw materials and
fixed capital. In other words, productive outlays in a capitalist
economy are increasingly spent on 'dead labour' rather than
'living labour'. When the industrial reserve army begins to
diminish, the capitalists respond to the emergence of labour
scarcities by investing in capital-using technical innovations which
raise output per head.19
In effect, Marx adopted the classical cost-of-production expla-
nation for the long-term exchange value of commodities and
made cost of production a function of their labour inputs. In so
doing he ran into the same sort of problem as Ricardo had faced
in accounting for the possibility of variations in the composition
of inputs. For if the proportion of constant to variable costs varied
as between industries the factors determining commodity prices
could also vary, since capitalists would seek a price that covered
total costs and not merely variable costs, and equilibrium market
prices would not necessarily be equivalent to the value of labour
inputs, however these were defined.
It was crucial to Marx's thesis, however, that 'the only source
of surplus value is living labour' and he had therefore to face
the implication that the competitive pressures which tended to
equalise the rate of profit on capital put to different uses in a
capitalist economy, would bring variations in the rate of surplus
value. Indeed, if the prices at which goods were marketed in a
capitalist economy depended solely on their variable capital costs,
and if there was a uniform rate of profit on total capital outlays,
then the rate of profit per man employed would be higher in
labour-intensive industries than in capital-intensive industries -
which was not a realistic outcome.
To simplify the exposition of Volume 1 of Capital Marx expli-
citly set aside this problem (or rather postponed it to Volume
in) by assuming that the prices of commodities would match the
value of the labour time embodied in them.20 In Volume m he
relaxed the assumption that prices of production were always
19
E.g. in a footnote on p. 407 of Capital Vol. 1, Lawrence and Wishart (1970):
' It is one of the greatest merits of Ricardo to have seen in machinery not only
the means of producing commodities, but of creating a "redundant
population".'
20
See Capital, Vol. 1, p. 220, n.: 'We have in fact assumed that prices = values.
We shall, however, see in Book in that even in the case of average prices the
assumption cannot be made in this very simple manner.'
equivalent to real (i.e. to labour-embodied) values and argued
that although aggregate surplus value and aggregate profit both
depended solely on labour input, actual profits were shared out
among capitalists in proportion to their total capital outlays.
Commodities produced by relatively capital-intensive methods
were accordingly sold at prices which were typically above their
labour values and commodities produced by relatively labour-
intensive methods sold below their values. Overall (and for
commodities produced with a capital composition which matched
the national average), however, the sum of the prices of pro-
duction would equal the sum of the labour values embodied in
their production process.
An enormous volume of literature has grown up around
Marx's solution to the so-called' transformation problem', i.e. the
problem of relating prices of production to real values. In the
end, however, the assumption that the value of output and
amount of the social surplus stemmed basically from the labour
time embodied in the production process remained a matter of
faith rather than of falsifiable fact or logic.21 All that the solution
was designed to achieve was to explain, in terms of the specific
historical characteristics of the capitalist system, why the classical
'natural price' of a commodity was not necessarily a faithful
reflection of the amount of labour time embodied in it. Com-
petition among capitalists ensured that commodities would be
sold at cost of production, including an average profit, and this
price could be above or below 'value' if the cost of production of
particular goods included a larger or smaller element of constant
capital. Value itself was determined by the starting assumption
in the analysis and the rate of surplus value (the rate of ex-
ploitation) could then be explained by the historically specific
characteristics of mature capitalism in which the owner of the
means of production typically bought the worker's labour power
and thus diverted to himself the social surplus of the
community.
The theory of surplus value represents the most significant
difference between the Marxian alternative and the orthodox
classical succession. It is here that we find expressed most clearly
and unambiguously the 'dreadful heresy' of a necessary conflict
between the interests of capital and labour. It is of course an
21
See e.g. Capitol, Vol. 1, p. 186: 'We know that the value of each commodity
is determined by the quantity of labour expended on and materialised in it, by
the working-time necessary, under given social conditions, for its production.'
inevitable corollary of the assumptions on which the problem is
formulated, just as the role assigned to the industrial reserve
army is a corollary of Marx's assumptions about the character of
technical progress. Whether these opening postulates are more
analytically useful than other simplifying assumptions depends
on whether they are either more realistic, or more helpful in
illuminating the crucial forces at work within the economic
system. And this again depends on the objective of the analysis.
Marx was using this theory as a tool for historical explanation
and for prophesy, i.e. as a means of explaining the evolution of
the capitalist system through time, real historical time. So one way
of assessing its usefulness is to consider how effectively it
explained the way the economic system was developing at the
time he wrote, and how accurately it predicted its further
evolution.
Marx's vision of capitalism as an exchange economy with
private ownership of the means of production, and with the
population divided into two parts, one part owning the means
of production, and the other compelled to sell to that part its
labour, was a realistic enough description of the industrial organ-
isation that emerged from the first industrial revolution. The
classical economists, though they would not have emphasised the
institutional aspects of this set-up in quite the terms Marx did,
were saying much the same thing when they described the class
structure. What was special, however, about the Marxian analysis
was that it treated these institutional characteristics of the system
not as a static datum but as a crucial factor, the crucial factor in
its evolution. Because techniques of production in the industrial
economy were leading to economies of scale, because capitalists
were obliged by competition to maximise the size of their units
of production (rather than their short-run profits) in order to
reap the fullest economies of scale, they were forced to keep
reinvesting their profits in larger and larger enterprises. When
the economy's productive resources had been sufficiently con-
centrated to remove the necessity for competitive accumulation
by the successful few, the stage of 'monopoly capitalism' would
be reached in the Marxian model and the system would become
more and more vulnerable to economic crises arising from an
imbalance in the demand for capital goods and consumption
goods. Capitalists faced by a persistent tendency to over-
production and a falling rate of profit, would find it more and
more difficult to extract a surplus, to fund either consumption
or further investment; and intensifying economic crises would
lead inexorably to social revolution. In the Marxian model,
therefore, accumulation is stimulated not by an innate psycho-
logical propensity on the part of entrepreneurs, but by the social
pressures of competitive society. These same pressures drive the
capitalists to hold down wages where they can and to innovate
by introducing labour-saving equipment where they cannot.
Again, from the vantage point of the middle of the nineteenth
century, the assumption that technical change was labour-
displacing and capital-intensifying was a realistic enough assump-
tion on the face of it.
So Marx offered a vision of an economy expanding under
competitive pressure, increasing its fixed capital stock at the
expense of the labour force, concentrating the nation's capital
in fewer and fewer hands, steadily increasing the scope of the
large-scale, capital-intensive enterprise, running into successive
crises as opportunities for technical progress accelerate the pace
of capital formation, so that the resulting overproduction drives
prices down and the rate of capital formation then contracts; and
so generating a situation of chronic underemployment punctu-
ated by severe depressions. It was a remarkably accurate set of
prognostications.22 For the first time economists were presented
with a model which explained both growth and fluctuations of
the economy in terms of the reactions between the institutional
environment and the technique of production that emerged
from the industrial revolution.
Of course Marx's predictions did not always come out right in
the event. His theories of the steady worsening of the living
conditions of the labour force, of progressively worsening capi-
talist crises and of the falling rate of profit have not all been borne
out by events. If the rate of profit has now sunk to unprece-
dentedly low levels in modern capitalist societies it is for reasons
other than those envisaged in Marx's theory. The class struggle
between proletariat and capitalists no longer ranks as the main
source of socio-economic conflict in modern mixed capitalist
societies. Where workers are sufficiently well-organised to with-
draw their labour, ownership of the means of production no
longer guarantees to the capitalist command over the social
22
For an admiring assessment of Marx's predictive powers see the article by
W. W. Leontief, American Economic Review Supplement (March 1938). Reprinted
in Leontief, Essays in Economics (1966), e.g. 'Marx was the great character reader
of the capitalist system' (ibid, p. 78).
surplus. The fact is that Marx failed to envisage either the insti-
tutional changes which were to improve the bargaining position
of the labour force and replace the capitalist economy by a mixed,
semi-socialist type of economy, or the technological changes
which were as often capital-saving (or neutral) as capital-using,
or the demographic changes which were to ensure that the labour
force would grow more slowly than the stock of capital. However,
detailed, accurate predictions of long-run economic change are
subjects for economic astrology rather than economic science,
and the original Marxian economic categories and socio-economic
relationships have a limited relevance in a twentieth-century
context. What Marx was trying to do was to predict - within a
historically specific framework of institutional, technological and
demographic change - where the capitalist system was going.
Given his mid nineteenth century starting point his logical
sequences were cogent and, even where the reasoning was
faulty, often his gift for direct observation and his extraordinary
erudition kept the end-product convincing.
Given the real qualities and range of the Marxian analysis,
the interesting question, of course, is why did it make so little
impression on mainstream economics? It has to be remembered
first that it was none of Marx's intention to convert the scientific
community of economists to a new research programme. He was
not an applicant for membership of the Political Economy Club
and the audience for which he wrote was the continental socialist
intellectuals and the literate working classes. His ultimate objec-
tive was not to prescribe policies that would enable the capitalist
system to work more efficiently, but to assist the proletariat to
transform a system of productive relations that had immensely
advanced the material potential of mankind but was now out-
running its usefulness and moving towards catastrophe. 'No
social order is ever destroyed before all the productive forces for
which it is sufficient have been developed, and new superior
relations of production never replace older ones before the
material conditions for their existence have matured within the
framework of the old society.'23 His scientific work was published
in German in a turgid, diffuse, often vituperative prose (largely
posthumously published and possibly for that reason repetitious
and disorganised) and presented an economic theory expressly
23
Preface to his Contribution to the Critique of Political Economy, ed. Dobb, op.
cit, p. 21.
designed to stimulate the revolutionary movement that would
eventually and inevitably destroy the capitalist system.
It is difficult to imagine any of the leading nineteenth-century
British and American economists (reared in a philosophical tradi-
tion which assumed a natural social harmony and in an economic
tradition which trusted laissez-faire), finding enough common
ground with this continental philosopher (starting from the
premise of natural social conflict and determined to assist in the
inevitable social revolution), to follow his argument beyond its
fiercely polemical preface. Had any of them done so he would
have found himself grappling at once, not only with an un-
palatable set of premises but with a new set of concepts, an
unfamiliar technique of analysis and a totally new language.
No doubt the fact that neither Marx nor Engels nor any of their
more distinguished followers were at all concerned to convert the
intellectual community of economists to their way of thinking
helped to prevent a school of Marxian economists from devel-
oping in Western Europe or in the USA in the late nineteenth
or early twentieth centuries. There must be some direct persua-
sion in the process of conversion to a new paradigm. Possibly
also the fact that the' invisible college' of economists had already
developed a disciplinary solidarity militating against any criticism
that did not involve acceptance of certain fundamental princi-
ples, also had something to do with the failure of the Marxian
model to have even the most diluted impact on mainstream
economic thought. But it is difficult to escape the conclusion that
the main factor was ideological. The neo-classical attempt to
develop a value-free economic science seemed right because the
totality of' bourgeois economists' as Marx would have called them
accepted certain implicit commitments - a bias towards the status
quo in property institutions, laissez-faire and economic indivi-
dualism - without serious question. True, it constrained positive
economics within a restricted scope - leaving economic develop-
ment virtually outside its range and producing a dispropor-
tionate emphasis on micro-economics. But the areas where
neo-classical economics scored its greatest triumph, e.g. in the
realm of allocation theory, were regarded as important by the
community of economists when the neo-classical paradigm
assumed its dominance over mainstream economic thought: and
in these areas Marxian economics had nothing to contribute.
When, in the inter-war period, advanced capitalist economies
were confronted with problems of persistent unemployment and
trade depression, so that increasing government intervention
began to seem not only acceptable but actually desirable and the
ideological commitments that had seemed so unquestionable in
the pre First World War era began to crack; and when in the
post Second World War era the problems of economic develop-
ment in the underdeveloped countries were found to be condi-
tioned at least as much by political and social as by economic
factors; then it became easier for bourgeois economists to ex-
amine the Marxian model on its scientific merits.24 By that time
however the organisational structure of capitalist society had
changed completely, the structure of developing countries was
something different again and the communist countries faced
problems that could never have been foreseen in the nineteenth
century, so that the original Marxian model was no more relevant
than the Marshallian model.
FURTHER READING
Primary literature
Karl Marx, Contribution to the Critique of Political Economy, ed. Maurice
Dobb (1971).
Karl Marx, Capital, Vols. 1-111 (1970).
Karl Marx, Theories of Surplus Value, Pts i-in (1962-72).
R. C. Tucker (ed.), The Marx-Engels Reader (1972).
M. Dobb, On Economic Theory and Socialism: Collected Papers (1955).
G. Duncan, Marx and Mill: Two Views of Social Conflict and Harmony
('973)-
D. Horowitz (ed.), Marx and Modern Economics.
M. C. Howard and J. E. King, The Political Economy of Marx (1975).
R. L. Meek, Economics and Ideology (1967).
J. Robinson, An Essay on Marxian Economics (1942).
Paul A. Samuelson, 'Understanding the Marxian Notion of Exploita-
tion: A Summary of the So-Called Transformation Problem between
Marxian Values and Competitive Prices', Journal of Economic Literature
(1970-
J. A. Schumpeter, Ten Great Economists (1951).
24
By the late 1960s, the orthodox histories of economic thought and textbook
introductions to economics generally included a respectful discussion of the
Marxian model. More important still, it was by then common for the pillars of
the neo-classical orthodoxy to engage in serious and live debate on theoretical
issues raised by Marx.
10
NEO-CLASSICAL ORTHODOXY IN THE

INTER-WAR PERIOD
It is the function of an economic theory to bring some aspects

of reality sharply into focus at the expense of making simplifying
assumptions that are patently untrue of the real world. Classical
and neo-classical theory, for example, assumed an unchanging
political and social environment and by so doing made it easier
to isolate the inter-connections between the distinctively economic
factors in the economic process. Walrasian general equilibrium
theory exploited mathematical tools of analysis to illuminate the
overall interdependence of commodity and factor markets, but
could be applied to the study of the real world only on the
assumption that most of the inter-relationships were constant.
The Marshallian partial equilibrium analysis made the stability
assumptions less crucial by focusing on the behaviour of the
micro-units in the economic system (the individual consumer or
firm) and through the additional assumption of the 'represen-
tative firm' sought to extend its scope to cover the market
situations of whole industries.
The neo-classical framework of analysis defined in Marshall's
Principles of Economics (1890) established the main foundation of
orthodox economic thought for roughly half a century after its
publication. The scientific community of economists reared in
this tradition found themselves endowed with an integrated set
of theories and tools of analysis which were useful and flexible
over a wide range of currendy interesting problems. There was
a lot for them to do both in applying the techniques to current
problems and in tying up loose ends in the theory. For unlike
J. S. Mill, Marshall had encouraged his pupils to see theoretical
economics as a developing, rather than as a developed, subject
and had himself footnoted many of the salient deficiencies in his
theory.
The methodological views characteristic of the neo-classical
orthodoxy at what was probably the fullest extent of its power
144 Inter-war developments in orthodoxy
over the minds of mainstream economists were denned for the
profession by Lionel Robbins' The Nature and Significance of
Economic Science first published in 1932. Its essential message was
the same as that given by Neville Keynes roughly four decades
before. It was that the claim of economics to be a scientific
discipline rested exclusively on its positive aspects, that the main
achievement of the economists was a system of abstract analysis
based on logical inference from simple postulates and capable
of universal applicability. Economics, insisted Robbins' is entirely
neutral as between ends'. 1
There are many such echoes of Neville Keynes' earlier state-
ment in Robbins' book. Robbins rejected for example the hedon-
istic doctrines with which Jevons supported his subjective theory
of value without rejecting the theory itself: 'the hedonistic trim-
mings of the works of Jevons and his followers were incidental
to the main structure of a theory w h i c h . . . is capable of being set
out and defended in absolutely non-hedonistic terms'. 2 H e
acknowledged the close links between economic history and
economic theory and the value of empirical research generally
in very much the same terms as Neville Keynes had done: e.g.
'Economic Theory describes the forms, Economic History the
substance': 3 and again 'Realistic studies may suggest the problem
to be solved. They may test the range of applicability of the
answer when it is forthcoming. They may suggest assumptions
for further theoretical elaboration. But it is theory and theory
alone which is capable of supplying the solution.' 4
However, Robbins made the case in a more confident and more
extreme form, which tended to emphasise its distinctive
methodology and the restrictions which it placed on the scope
of the subject. He brushed aside the methodological controver-
sies which Neville Keynes had tried to expound in a balanced
'non-partisan' spirit. For example, the aim of the essay is des-
1
Cf. Neville Keynes' description of political economy as 'standing neutral
between competing social sciences' (J. N. Keynes, Scope and Method of Political
Economy, p. 13).
2
L. Robbins, The Nature and Significance of Economic Science, p. 85. Cf. J. N.
Keynes, op. cit, pp. 91-2, n.: 'The outcome of Jevons's conception of a calculus
of pleasure and pain is a theory of utility, whose economic importance it would
be difficult to exaggerate. Still, this theory does not itself constitute the central
theory of economics. It should be regarded as an essential datum or basis of
economic reasonings rather than as itself an integral portion of the science at
all.'
3
L. Robbins, The Nature and Significance of Economic Science, p. 39.
4
Ibid, p. 120.
Inter-war developments in orthodoxy 145
cribed as' not to discover how Economics should be pursued - that
controversy, although we shall have occasion to refer to it en
passant, may be regarded as settled as between reasonable people
- but rather what significance is to be attached to the results which
it has already achieved.'5 The references ' en passant' bundled the
institutionalists and the historicists up with all other critics of
neo-classical orthodoxy6 as ideologically rather than scientifically
motivated: for example, it is asserted that the main attacks on
orthodox economic science ' have been political in nature. They
have come from men with an axe to grind - from men who
wished to pursue courses which the acknowledgment of law in
the economic sphere would have suggested to be unwise.. .The
only difference between Institutionalism and Historismus is that
Historismus is much more interesting.'7 Or, again 'We have had
the Historical School. And now we have the Institutionalists
...sterile and incapable of helpful comment' in face of the
great depression.8
Having asserted (as Neville Keynes had done) the primacy of
positive economics and having dismissed the methodological
critics, Robbins examined the question of the scope of economic
science or 'pure' economics. In this he certainly achieved greater
precision than any of his predecessors though by deliberately
narrowing it. He rejected 'the traditional approach to Econo-
mics . . . by way of an inquiry into the causes determining the pro-
duction and distribution of wealth',9 because 'a change in the
aggregate of production is not a definitive conception... When-
ever the generalisations of economists have assumed the form
of laws, they have related not to vague notions such as the total
product, but to perfectly definite concepts such as price, supply,
demand, and so on.'10 Attempts to measure the social product
in macroeconomic terms or to discuss either its development
through time or its distribution as between individuals or groups
5
Ibid, p. 72.
6
Marxism is never explicitly confronted, though the' materialist interpretation
of history' is specifically disowned and there is a nice passage (p. 151) in which
Lenin is visualised as the one dissentient voice in an imaginary Committee on
State regulation of the rate of discount in which the other Members were Mr
Hawtrey, Buddha and the Head of the US Steel Corporation.
7 8
Ibid, pp. 82-3. Ibid, pp. 114-15.
9
Ibid, p. 64. There is a footnote here quoting Cannan, Wealth, p. v: "The
fundamental questions of economics are why all of us taken together are as well
off as we are and why some of us are much better off and others much worse
off than average.'
10
Ibid, pp. 66-7.
were dismissed as irrelevant except possibly to monetary theory:
e.g. ' Both the concept of world money income and the national
money income have strict significance only for monetary
theory - the one in relation to the general theory of indirect ex-
change, the other to the Ricardian theory of the distribution of
the precious metals.' For the rest national income estimates
have 'conventional significance' only. 'They do not have an
exact counterpart in fact and they do not follow from the main
categories of pure theory.' 11
So modern theorists, according to Robbins, had tended to
abandon the traditional approach and to divide the
central body of analysis into.. .a theory of equilibrium, a theory of
comparative statics and a theory of dynamic change. Instead of regard-
ing the economic system as a gigantic machine for turning out an aggre-
gate product and proceeding to enquire what causes make this pro-
duct greater or less, and in what proportions this product is divided,
we regard it as a series of interdependent but conceptually discrete
relationships between men and economic goods; and we ask under
what conditions these relationships are constant and what are the
effects of changes in either the ends or the means between which they
mediate and how such changes may be expected to take place through
time.12
Even Adam Smith is said to have made his main contribution
to economic science in this limited framework:
although Adam Smith's great work professed to deal with the causes of
the wealth of nations, and did in fact make many remarks on the general
question of the conditions of opulence which are of great importance in
any history of applied Economics, yet from the point of view of the his-
tory of theoretical Economics, the central achievement of this book was
his demonstration of the mode in which the division of labour tended
to be kept in equilibrium by the mechanism of relative prices.12
Just as Ricardo's system 'which, in this respect, provides the
archetype of all subsequent systems, is essentially a discussion of
the tendencies to equilibrium of clear-cut quantities and rela-
tionships. It is no accident that wherever its discussions have
related to separate types of economic goods and ratios of
exchange between economic goods, there the generalisations of
Economics have assumed the form of scientific laws.'13 As a study
of these market relationships Robbins claimed for economics
great prognostic power because it was based on inferences from
a few universally applicable postulates. 14
11 n
13
Ibid, p. 67. " Ibid, pp. 78-9.
On the face of it Robbins' own definition of economics as ' the
science which studies human behaviour as a relationship between
ends and scarce means which have alternative uses'15 was wider
than earlier orthodox definitions in that it was not limited to
goods and services actually exchanged on a market. In practice
however it involved accepting a much narrower range of ques-
tions as being within the range of the economist qua economist
to answer. Macroeconomic concepts were held to be relevant only
to monetary theory. Welfare economics was excluded by the
insistence that it is impossible to make inter-personal compari-
sons of satisfactions - still less to aggregate them. A theory of
economic development was virtually excluded by Robbins (as it
had been by Neville Keynes) because it must involve assumptions
that are relative to time and place and/or must take account of
changes in social and political organisation. 'How can we predict
the substance of the political indifference systems? '16
Within this limited sphere, however, Robbins made confident
claims about the superior (at times seemingly infallible) prog-
nostic power of positive economics in relation to practical prob-
lems. Some of his illustrations of its universal applicability and
virtual infallibility may appear less convincing today than they
did in the early 1930s and some now seem curious in the context
of a book written at the time of the great depression. For example,
on the trade cycle, he wrote that' it becomes more and more clear,
for purely analytical reasons, that, once the signs of a major boom
in trade have made their appearance, the coming of slump and
depression is almost certain'.17 And after a scathing reference to
Wesley Mitchell's empirical researches on business cycles he
concluded: 'Meanwhile, a few isolated thinkers, using the des-
pised apparatus of deductive theory, have brought our know-
ledge of the theory of fluctuations to a point from which the
fateful events of the last few years can be explained in general
terms, and a complete solution of the riddle of depressions within
the next few years does not seem outside the bounds of
probability.'18 But perhaps the most characteristic of the claims
of neo-classical economists to infallibility at this period was in
relation to wages policy. For example: 'It is a well-known gener-
alisation of theoretical Economics that a wage which is held
above the equilibrium level necessarily involves unemployment
and a diminution of the value of capital. This is one of the most
elementary deductions from the theory of economic equilibrium.
15 16
Ibid, p. 16. Ibid, p. 134.
18
" Ibid, p. 126. Ibid, p. n 5 .
The history of this country since the War is one long vindication
of its accuracy.'19
In the end, however, having eschewed all value judgments as
being irrelevant to the thought process of the economist qua
economist, Robbins admitted that his view of the 'nature and
significance' of economic science rested on an ultimate valua-
tion - the affirmation that rationality and ability to choose with
knowledge is desirable.20 It is arguable, moreover, that there
were other, less explicit, value judgments determining his choice
of the problems to which the economist was capable of finding
a valid solution, the distinction he drew between' basic postulates'
and 'subsidiary assumptions' and the kind of complications that
he was prepared to allow ceteris paribis to take care of. For an
interest in the theory of economic development and in welfare
economics tends to be associated with a readiness to approve
government intervention in the economy; and a sharp focus on
the analysis of price determination in a freely competitive
economy tends to accompany a bias towards laissez-faire and
economic individualism. Actually Robbins was quite frank about
his ideological biases in these respects though he tended to
relegate them to footnotes and deliberately to disassociate them
from his economic analysis.21
The ideological premises which determined Robbins' choice of
the questions that the scientific economist was competent to
answer, his selection of methodology and of simplifying assump-
tions were the preconceptions of most 'reasonable people' (in
Robbins' sense: orthodox economists) when the first edition of
his book was in the writing, though by the time the second
edition appeared, the depths of the great depression had exten-
sively revised the political and social attitudes of those reared
in the classical orthodoxy. The General Theory gave theoretical
expression to some of these ideological shifts and the war and
its aftermath completed the revolution. Robbins' objections of
19 20
Ibid, p. 146. Ibid, p. 157.
" E.g. p. 125, n., on economic planning ends with 'Scratch a would-be planner
and you usually find a would-be dictator'. See also p. I42n on inter-personal
comparisons: 'It does not make me a more docile democrat to be told that /am
equally capable of experiencing satisfaction as my neighbour; it fills me with
indignation'; and on p. 147 on minimum wage policy:' As private individuals we
may think that such a system of preferences sacrifices tangible increments of the
ingredients of real happiness for the false end of a mere diminution of
inequality'.
principle to attempts to measure social income aggregates, to
make inter-personal comparisons, to formulate a primarily econ-
omic theory of economic development were as valid after the
Second World War as they had been before. The difference was
that questions about ' how factors of production are distributed
between the production of different goods by the mechanism of
prices and costs, how given certain fundamental data, interest
rates and price margins determine the distribution of factors
between production for the present and production for the
future \ 22 had taken second place (even for academic economists)
to questions of the relationships between macroeconomic aggre-
gates, problems of welfare economics and the determinants of
economic growth.
Meanwhile, however, some progress had been made within the
neo-classical framework by economists engaged in modifying it
along lines already suggested by Marshallian authority or in
picking up some of the theoretical loose ends footnoted by
Marshall himself. One such contribution was Piero Sraffa's
Economic Journal article ' The Laws of Returns under Competitive
Conditions' published in 1926.23
The Marshallian analysis represented a theory of optimal
resource allocation based on the convenient assumption of per-
fect competition - implying that each individual firm could sell
as much as it chose without affecting the market price and that
its profits would always tend towards a normal level because as
soon as they rose above that level they would attract competition
from new firms. The beauty of this set of assumptions was that
it made it possible to infer the output of a commodity from its
price and that it illustrated a stable market in which price would
always tend towards an equilibrium value: given perfect compe-
tition (and abstracting from the implications of the way income
was distributed), economic welfare could be shown to be fully
maximised. It was the assumption of perfect competition that
justified the elegant demand and supply analysis of Book v of
Marshall's Principles. It also gave neo-classical theory its strong
normative bias in spite of the claims by its exponents to value-free
analysis, for the equality of the rate of return in each resource
in all uses which defines competition is also the condition for
22
Ibid, p. 71.
23
It had already been published in somewhat different form in Italian: 'Sulle
relazione fra costo e quantita prodotta', Annali di Ecorwmia (1925).
24
maximum output from given resources. T h e perfectly compe-
titive economy, that is to say, could be shown to display a
' natural' efficiency, again provided that one accepted the income
distribution as being outside one's frame of reference.
T h e difficulty was however that as soon as the analysis began
to go beyond the static situation of a single time period, as soon
as the possibility of abandoning the assumption of an upward
sloping supply curve or horizontal demand curve was considered,
the theory began to disintegrate. In particular it proved difficult
to keep it consistent with either increasing or diminishing re-
turns. Marshall himself saw the dilemma but as a problem in
mathematics rather than in economics. He referred to it in a
footnote:
Abstract reasonings as to the effect of the economies in production,
which an individual firm gets from an increase of its output are apt to
be misleading, not only in detail, but even in their general effect. This
is nearly the same as saying that in such cases the conditions governing
supply should be represented in their totality. They are often vitiated
by difficulties which lie rather below the surface, and are especially
troublesome in attempts to express the equilibrium conditions of trade
by mathematical formulae. Some, among whom Cournot himself is to
be counted, have before them what is in effect the supply schedule of
an individual firm; representing that an increase in its output gives it
command over so great internal economies as much to diminish its
expenses of production; and they follow their mathematics boldly, but
apparently without noticing that their premises lead inevitably to the
conclusion that, whatever firm first gets a good start will obtain a mono-
poly of the whole business of its trade in its district. While others
avoiding this horn of the dilemma, maintain that there is no equilibrium
at all for commodities which obey the law of increasing return; and some
again have called in question the validity of any supply schedule which
represents prices diminishing as the amount produced increases.25
But the problem of course is not merely a problem in mathe-

matics: it is a problem of economic logic. If a firm can be
subject to increasing returns what is to stop it from expanding
indefinitely and destroying perfect competition? If an industry
(i.e. the group of firms producing a particular commodity) is
subject to diminishing returns, so that increasing costs react on
the prices of the products of other industries and thus reduce
the demand for the product of the industry in question, how can
one analyse its price and output behaviour in terms of partial
24
See e.g. G. Stigler, Essays in the Theory of Economics, p. 265.
** Marshall, Principles, op. cit., p. 380, n.
equilibrium analysis in which the factors affecting demand and
supply operate independently? For it is only by ignoring such
interactions between industries that we can isolate the demand
and supply factors for a particular industry and discuss them
independently of their interactions with other industries and with
each other. If their interactions are significant then the only
way of analysing them is by means of the complex system
of simultaneous equations embodied in a general equilibrium
analysis.
This in effect was what Sraffa brought out in his famous
article. The problems of diminishing returns and increasing
returns are asymmetrical but both are very damaging to the
Marshallian partial equilibrium analysis based on competitive
assumptions. If there is an input in absolutely scarce supply it
is unlikely that a single competitive industry will absorb the whole
of that input or that it will have no substitutes. Hence all
industries requiring the scarce input or supplying substitutes for
that industry's output will be interdependent as to costs and
prices.26 If there are increasing returns attributable to internal
economies of scale, the notion of the representative firm is of no
use to us and there is no reason to expect the factors on the
side of supply and demand to lead to long-term competitive
equilibrium.
In short, what Sraffa showed was that the laws of returns which
Marshall had used as the basis of his theory of supply, cannot
be reconciled with the Marshallian theory of value except under
certain highly restrictive assumptions. For when unit cost is
dependent on the size of output, the conditions which determine
the demand curve are liable to affect the conditions which deter-
mine the supply curve (and vice versa) except on certain highly
restrictive assumptions: viz (i) in cases where the production of
an individual commodity uses the whole supply of a scarce
26
See P. Sraffa,' The Laws of Return under Competitive Conditions', Economic
Journal (December 1926), p. 539: 'if in the production of a particular commodity
a considerable part of a factor is employed, the total amount of which is fixed
or can be increased only at a more than proportional cost, a small increase in
the production of the commodity will necessitate a more intense utilisation of
that factor, and this will affect in the same manner the cost of the commodity in
question and the cost of the other commodities into the production of which that
factor enters; and since commodities into the production of which a common
special factor enters are frequently, to a certain extent, substitutes for one
another (for example various kinds of agricultural produce), the modification in
their price will not be without appreciable effects on demand in the industry
concerned.'
factor (so that its cost cannot affect demand through its reactions
on the output and cost of competing industries using this factor)
and (ii) in cases where increasing returns are external to the
individual firms in an industry so that they will all operate under
the same cost conditions. Apart from these special cases, as Sraffa
showed, if diminishing returns exist 'it becomes necessary to
extent the field of investigation so as to examine the conditions
of simultaneous equilibrium in numerous industries'. And if
internal economies exist and generate increasing returns, then
there is no such thing as 'normal' profit for an industry and no
sense in the concept of a 'representative firm'. Either way the
Marshallian theory of value under competitive conditions is
shown to be inapplicable.
Finally, Sraffa indicated a way out of the Marshallian dilemma.
He suggested that instead of trying to explain the market equi-
librium of the industry, value theory should focus on the market
equilibrium of the firm. Instead of starting from the level of a
'representative firm' faced with an infinitely elastic demand
curve, theory should begin with an individual producer faced
with a downward sloping demand curve.
The clue was already in Marshall who had pointed out that
' when we are considering an individual producer, we must couple
his supply curve - not with the general demand curve for his
commodity in a wide market - but with the particular demand
curve of his own special market.' 27 Sraffa followed this tip to its
logical conclusion by arguing that 'it is necessary, therefore, to
abandon the path of free competition and turn in the opposite
direction, namely towards monopoly.' 28 By focusing on the situa-
tion of the individual firm it was possible to escape from the
problems raised by diminishing returns (which, at most, apply
to an industry as a whole rather than to individual firms) and
hence to use the familiar techniques of partial equilibrium ana-
lysis. By focusing on an individual firm faced by a downward
sloping demand curve it was possible to reformulate the condi-
tions of stable equilibrium in spite of increasing returns. The
effective obstacle, that is to say, to the explosive growth of an
individual firm under conditions of increasing returns is the fact
that it cannot supply a larger quantity of goods to the market
without lowering its prices.
T h e Sraffa article set off a hectic debate on problems of price,
27
Marshall, Principles, op. cit., p. 37911.
28
P. Sraffa, op. cit., p. 542.
cost and output which eventually shifted the whole emphasis of
orthodox microeconomic analysis by opening the door to a theory
of imperfect competition - a theory which was at once more
relevant, on the face of it, to the real world of the inter-war period
and more helpful in defining the conditions of long-period
equilibrium in very general terms. In 1933 Joan Robinson pub-
lished her classic Economics of Imperfect Competition which blended
the Marshallian theories of monopolistic and perfect competition
into a more general, more integrated, and more realistic theory
of value: in this more general theory pure competition and pure
monopoly figure as special limiting cases. The new theory formed
the basis for the modern theory of the firm.29
Under the Marshallian theory of production with its focus on
the conditions of supply for the industry of representative firms
producing a single commodity there was actually very little scope
for analysing the pricing behaviour of the individual firm. Under
perfect competition all it had to do was to keep down its costs
and produce the output which would be most profitable at
given market prices. Adoption of the evidently more realistic
assumption of imperfect competition showed a way out of this
theoretical impasse. 'The notion that every firm is facing a falling
demand curve for its own product and that profits are maximised
at the output for which marginal revenue is equal to marginal
cost provided an explanation for a situation in which firms could
work their plants at less than full capacity and still earn a profit'.30
The new theory provided explicit theoretical expression for the
output-restricting and price-raising tendencies inherent in the
monopolistic or imperfectly competitive market and led to an-
other hectic theoretical controversy on the question of the best
way of regulating monopoly prices. However it also blew a great
hole in the normative implications of neo-classical analysis by
showing that the natural tendencies of the market do not inevit-
ably lead to an optimal distribution of scarce resources. The
notions of consumer's sovereignty and maximum productivity
which could be attached to analyses based on the assumption of
perfect competition sat uneasily in an analysis based on the con-
trived variety of products in an imperfectly competitive market.
29
Joan Robinson, has since abandoned the method of static equilibrium
analysis on which her Economics of Imperfect Competition largely depended and
now disowns much of the modern theory of the firm to which it led. See the
preface to the 2nd (1969) edition.
30
Joan Robinson, Economics of Imperfect Competition, 2nd edn (ig6g), p. vi.
However, Joan Robinson's theory of imperfect competition
was rooted deep in the Marshallian tradition and followed a trail
already indicated by Pigou, Marshall's successor in the Cam-
bridge chair, in his Economics of Welfare (1920).31 It used the tech-
niques of partial equilibrium analysis to analyse the behaviour
of one firm in isolation from the rest of industry. It sharpened
the tools of marginal analysis, in particular by its use of the
concept of marginal revenue, which became the keystone of a
new theory of long-run imperfectly competitive equilibrium. In
effect, the equilibrium conditions of the firm under imperfect or
monopolistic competition, as outlined by John Robinson, differ
from those under perfect competition in a number of significant
ways: (i) in that marginal cost is less than price at the equilibrium
output; (ii) in that the firm is always operating under conditions
of falling average costs when the firm and the industry are in
equilibrium; (iii) in that the producer has more than one set of
average cost and revenue curves to choose from in deciding on
his equilibrium output; and (iv) in that the way equilibrium is
established when there are too few or too many firms in the
industry is more complex, because a change in the number of
firms alters the elasticity of demand for each firm as well as the
average level of prices in the market. As a result of marginal costs
being less than price at the equilibrium output it can be said that
resources are not allocated as well as they might be. And because
each firm confronts its own individual sales curve, different from
that of other firms, because the commodity it produces is
differentiated in some sense from the commodities produced by
its competitors, it follows that the price charged by each firm in
the industry does not have to be the same as that of every other
firm.
The new theory could be integrated with the old, however, by
regarding perfect competition on the one hand and monopoly
on the other as being the two limiting cases of the one theory.
The more firms there are in an industry the less effective are their
attempts to attach to themselves a loyal clientele, until ultimately
the number is so large that their attempts are entirely ineffective:
31
In her own later judgment this analysis was based on 'a shameless fudge.
I postulated that a firm could find out the conditions of demand for its product
by trial and error - that is I treated the conditions of demand as being unchanged
for an indefinitely long period and I assumed that experiments with prices would
leave no traces in market conditions. The whole analysis, which in reality consists
of comparisons of static equilibrium positions is dressed up to appear to represent
a process going on through time' (ibid, p. vi).
that is, as the number of firms grows and differentiation becomes
less emphatic the demand curve of each firm becomes flatter and
flatter until when all are perfectly elastic we merge into perfect
competition. Conversely, of course, if entry into the industry
becomes less and less easy and the number of firms shrinks as
a result of amalgamations and natural deaths, the demand curve
of each producer becomes steeper and steeper until it merges
into the case of pure monopoly. Clearly for anyone brought
up in the Marshallian school a restatement of the theory of
competition in a form which embraced the perfectly competitive
case at one end of the spectrum and monopoly at the other end,
and which permitted continued use of the techniques and
concepts of partial equilibrium analysis, was an immensely attrac-
tive development. The fact that it seemed to reflect the practical
problems of real firms in a real world made it even more attractive
to those of Marshall's disciples who believed with the master that
economic theory ought always to be founded on facts, to be
relevant to current policy issues and to be intelligible to the
practical man.
The interesting thing about this new development, this aban-
donment of perfect competition as the central assumption in
analysing the formation of output and prices in favour of imper-
fect competition, is that it took place independently in two places
at once - in Cambridge, England and in Cambridge, Massa-
chusetts. As with the marginal analysis of the 1870s the reaction
to orthodox economic thinking in the late 1920s, early 1930s,
developed in two quite separate academic centres. While Piero
Sraffa was writing his seminal article Edward Chamberlin was
already working on a Harvard doctoral thesis which constituted
the starting point for his Theory of Monopolistic Competition (1933),
published in the same year as Joan Robinson's Economics of
Imperfect Competition, and presenting essentially the same theory
with differences of detail and presentation.32
32
It was as Marshall would have put it 'the product of the age'. See the letter
to L. L. Price dated August 1892 and printed in Memorials, ed. A. C. Pigou, pp.
378-9: 'In the early seventies when I was in my full fresh enthusiasm for the
historical study of economics I set myself to trace the genesis of Adam Smith's
doctrines. .. And then I grew to think that the substance of economic thought
cannot well be to any great extent the work of any one man. It is the product
of the age. Perhaps an exception should be made for Ricardo: but everything
of importance that was said in the five generations 1740-65, 1765-90, 1815-40,
1840-65, 1865-90 seems to be to have been thought out concurrently more or less
by many people.'
The printed controversy which took place when the authors
became aware of the coincidence of their views has tended to
over-emphasise the differences between their approaches. Seen
in long-term perspective what is interesting about these two books
is not their differences but their similarities. While both held to
Marshallian partial equilibrium techniques of analysis, both
dropped the perfect competition assumption and both did so by
shifting the focus of their price theory from an industry to an
enterprise context. Marshall had begun with the commodity and
had called the list of firms producing it an industry. His object
was to show the way outputs and prices came into equilibrium
for each commodity. The notion of a representative firm was
merely a device by which the behaviour of a whole industry could
be seen in terms of the producing units of which it was composed.
Chamberlin and Robinson, however, focused attention not so
much on the commodity (and hence the industry) as on the firm.
They analysed the behaviour of the individual firm - each firm
producing a commodity more or less differentiated from that
produced by other firms. Joan Robinson still used the concept
of the industry to cover the case of a group of firms producing
broadly similar commodities which are close substitutes for each
other: however, what she was really concerned with was not the
conditions governing the production and distribution of parti-
cular commodities but the decisions of the firm considered as a
profit-maximising unit. Similarly, Chamberlin referred to the
'group of firms' composing a given 'industry' but in practice he
proceeded on the assumption that 'both demand and cost curves
for all products are uniform throughout the group'. So that his
idea of an industry was just a group of identical firms. In short,
both Chamberlin and Robinson substituted a theory of the firm
for the Marshallian theory of the market.
The concept of perfect competition with all its normative
implications had not disappeared from active service, however.
Wherever problems of the optimum allocation of resources are
paramount economists have tended to revert to the assumption
that the market is competitive in the sense that there is no
over-riding monopoly power on the market. It remains the
standard, basic, model of microeconomic analysis.33 Moreover,
33
See e.g. G. Stigler, in an article originally published in the February 1957
Journal of Political Economy: 'Today the concept of perfect competition is being
used more widely by the profession in its theoretical work than at any time in
the past.' Reprinted in Stigler, Essays on the History of Economics, p. 267.
although, on the face of it, the assumption of imperfect compe-

tition was a more realistic approximation to the conditions of
the capitalistic economy of the twentieth century it would be a
mistake to imagine that its adoption necessarily involved a more
realistic type of economic theory. In some ways the methodology
of Joan Robinson's kind of analysis represents a purer kind of
theorising than anything in Marshall. Marshall had always tried
to keep as close as possible to the facts of the real world and
although he had by his later editions shifted a good deal of the
rambling complexities of the real world into extensive append-
ices, the argument of the Principles never attains the remorseless
streamlined logic of Joan Robinson's Economics of Imperfect Com-
petition. For this was among the earliest exercises in systematic
economic model building, a method which set the fashion for a
good deal of subsequent theorising. A major reason why Joan
Robinson's book had such a dramatic and powerful impact on
English economic thinking was almost certainly the distinctive
methodology of the Robinsonian approach, i.e. in the careful
preliminary spelling out of definitions and assumptions, the
systematic recourse to diagrammatic reasoning techniques and
the deliberate abstention from attempts to confuse abstract logic
with real sequences of events. What her book provided was a
handy ' box of tools' for the analysis of microeconomic questions
in the Marshallian tradition.
Marshall had indeed introduced his undergraduate audiences
to the use of diagrammatic techniques of exposition in his earliest
lectures, though in his Principles, which was deliberately angled
at a wider readership than professional economists or students,
he had carefully relegated even his simple demand and supply
curves to a modest footnote. However, in his Pure Theory of
Foreign Trade (1879) which was designed for an academic
audience (and was privately published at the instigation of Henry
Sidgwick, his Professor at Cambridge) he made his position
clear:
The pure theory of economic science requires the aid of an apparatus

which can grasp and handle the general quantitative relations on the
assumption of which the theory is based. The most powerful engines
for such a purpose are supplied by the various branches of mathematical
calculus. But diagrams are of great service, wherever they are applicable,
in interpreting to the eye, the processes by which the methods of
mathematical analysis obtain their results. It happens that with a few
unimportant exceptions all the results which have been obtained by the
application of mathematical methods to pure economic theory can be
obtained independently by the method of diagrams.34
The other area in which the existence of a Marshallian loose

end stimulated his disciples to make a significant dent in the
current orthodoxy during the inter-war period was in the theory
of consumer's behaviour. Again the solution depended heavily
on mathematical techniques of analysis. Marshall's theory of
consumers' demand was founded on his famous law of demand,
i.e. that ' the greater the amount to be sold the smaller the price
at which it is offered in order that it may find purchasers; or in
other words, the amount demanded increases with a fall in price
and diminishes with a rise in price'. From this he went on to
derive the characteristically downward sloping demand curve
and went on at a later stage to develop the notion of consumers'
surplus.
Now there are several fundamental and disputable assump-
tions implicit in this theory. The first is a law which Marshall
describes as due to a 'familiar and fundamental tendency of
human nature', viz that 'the additional benefit which a person
derives from a given increase in his stock of a thing diminishes
with every increase in the stock he already has'. In other words
it is based on Marshall's 'law of satiable wants or diminishing
utility'. The second is that an increment in utility (i.e. marginal
utility) can be measured independently and absolutely of the
individual concerned. The third is that it can be measured in
money terms (and it is the second and third assumptions that
provide the rationale for the consumers' demand price). The
fourth assumption (implicit in the third) is that the marginal
utility of money is constant, or in other words that the unit of
measurement is stable. The Marshallian theory of consumers'
behaviour thus depended on the assumption that utility was
measurable in cardinal terms. A consumer with given tastes and
a given money income, confronted by a system of market prices,
over which he has no influence, will maximise his total utility by
ensuring that a marginal unit of expenditure in each direction
brings in the same increment of utility. Which means that in
equilibrium marginal utilities will be proportional to prices.
The assumption that the marginal utility of money was con-
stant however meant in effect ignoring the consequences of
34
A. Marshall, The Pure Theory of Foreign Trade (1879), LSE Reprints, 1930,
p. 4.
changes in the consumer's income level on the price he was
prepared to pay. It meant making the consumer's demand for
a good independent of his income. Generations of economists,
Marshall included, regretted this unrealistic assumption. But it
was not until 1934 when an article by J. R. Hicks and R. G. D.
Allen appeared in Economica that a way out of the dilemma was
suggested.35 The solution was to abandon the idea of measuring
utility and to analyse consumers' behaviour in terms of their
preference for different goods as expressed graphically in the
notion of an indifference curve. Hicks and Allen did not invent
the indifference curve. That appeared first in the literature in
1881 when it was introduced by Edgeworth to illustrate a contract
curve between Crusoe and Man Friday and was revived by Pareto
around the turn of the century in his Manual of Political Economy
as a device for illustrating the individual's scale of preference
for combinations of certain goods. However, the advantage of
the indifference curve approach over the Marshallian theory of
demand was that it did not involve measuring the consumer's
utilities in any absolute sense, only ordering them in the light
of his preferences, preferences that were assumed to have been
revealed by the choices he actually made.
The new way of analysing consumers' demand and the new
theory of value to which it gave rise was elaborated and form-
alised by Hicks in his classic Value and Capital (1939). The new
theory was at once more general and more precise. Henceforth
it was possible to start from the assumption that the consumer
preferred one collection of goods to another without measuring
the extent to which he preferred it. Allen and Hicks demonst-
rated by means of the indifference curve technique that it was
sufficient to assume that consumers were capable of choosing
between products and hence of ranking them, i.e. of measuring
the strength of their desires for different commodities in an
ordinal (relative) sense, in order to explain the downward slope
of the demand curve. They thus succeeded in emptying the
Marshallian demand curve of some of its classical heritage of
armchair psychology by making it unnecessary to assume that
35
Actually the Hicks-Allen solution had been anticipated by an article by
Slutsky that had been published in Italian in the July 1915 issue of the Giornale
degli Economists which seems to have been overlooked by English-speaking
economists. R. G. D. Allen and J. R. Hicks, 'A reconsideration of the theory of
value', Economica (1934). See also R. G. D. Allen, 'Professor Slutsky's Theory of
Consumers' Choice', Review of Economic Studies (February 1936).
consumers were capable of measuring utility in a cardinal (addi-
tive) sense; and offered an alternative criterion to the principle
that a consumer maximises his satisfaction from a given income
by laying it out in such a way that the marginal utility of his
expenditure on each good is proportionate to its price. Given an
indifference curve describing consumers' preferences for dif-
ferent combinations of any pair of goods, and a price line which
reflects the price ratio of the goods in question, it can be shown
that a consumer maximises his satisfaction at their point of
tangency, i.e. where the marginal rate of substitution between the
two products is exactly equal to their price ratio. It was also
possible with the new technique to distinguish clearly between
the income effects and substitution effects of a consumer's reac-
tion to a change in the price of a particular commodity.
However, the new theory stuck close to the Marshallian tra-
ditional methodology. Indeed from some points of view the
changes seem almost entirely terminological and expository.
Instead of diminishing marginal utility we have diminishing
marginal rate of substitution. Instead of proportionality of mar-
ginal utilities to prices we have as equilibrium condition the
tangency of the price line to the indifference curve. According
to the new theory the marginal rate of substitution between two
classes of goods (as expressed by the slope of the indifference
curve) is equal in equilibrium to the ratio of prices. In essence,
that is to say, the indifference curve approach as worked out by
Allen and Hicks represented a development and an extension
of Marshallian concepts and methods. Its path-breaking quality
was due largely to the fact that it introduced a new analytical
concept which seemed to free Marshallian value theory from
some of its more awkward assumptions and the innovation was
rapidly incorporated into the textbooks.
So both of the two major theoretical development in micro-
economics that emerged in the inter-war period - the theory of
imperfect competition and the theory of consumers' demand
based on indifference curves - represented revisions of the
orthodox Marshallian theory rather than frontal attacks on it.
Some of the faithful had begun to see before the end of the period
that these piecemeal revisions were undermining the whole
structure of the microeconomic analysis of the Principles. Hicks
for example in 1939 described the new work on imperfect com-
petition as involving ' the wreckage of the great part of economic
theory'. Some - even more faithful - went on adhering to the old
techniques. The cardinalist school (who adhered to the assump-
tion that utilities were measurable in money terms) fought a
determined rearguard action against the ordinalists (with their
less restrictive assumption that utilities could be ordered in re-
vealed preference rankings but not measured) who played happily
with their indifference curves. As late as 1956/57, Sir Dennis
Robertson, the most distinguished of the cardinalist school, was
insisting in his lectures to Cambridge undergraduates that the
concept of measurable utility made good economic sense and was
refusing to clutter up his lectures on demand with any treatment
of the indifference curve analysis which by then was standard fare
in the textbooks.36
The real onslaught on the traditional orthodoxy of the early
twentieth century however came from another side, by way of
the theory of money to which Marshall had never made a major
published contribution, though he had given a great deal of
thought to monetary questions in preparing his Cambridge lec-
tures or in response to various parliamentary committees and
Royal Commissions.37 But as in other directions, it was Marshall's
own teaching that gave his ablest pupils the first scent of a new
trail which was to lead them to displace and reconstruct those
parts of the conventional analysis which had outgrown their
usefulness. The pupil who has most claim to the title of having
effectively overthrown the neo-classical orthodoxy was John
Maynard Keynes, who had sat appreciatively through Marshall's
1906 lectures on money and who bore witness in 1924 to the
importance, originality and insight of Marshall's contributions to
the theory of money.38
36
D. Robertson, Lectures on Economic Principles, Vol. 1, Lecture vi.
3T
Marshall's Money, Credit and Commerce (1923), was published in his old age
and (to quote Keynes) 'its jejune treatment, carefully avoiding difficulties and
complications, yields the mere shadow of what he had had it in him to bring forth
twenty or (better) thirty years earlier'. Essays in Biography, J.M.K. Collected
Writings Vol. x, p. 190.
38
Ibid, pp. 189-95. See also below p. 168 for Keynes' warm obituary tribute to
the importance, originality and insight of Marshall's contributions to monetary
theory.
FURTHER READING
Primary literature
R. G. D. Allen and J. R. Hicks, 'A Reconsideration of the Theory of
Value', Economica (1934).
J. R. Hicks, Value and Capital, 2nd edn (1946).
Lionel Robbins, The Nature and Significance of Economic Science, 2nd edn
('936)-
Joan Robinson, The Economics of Imperfect Competition, 2nd edn (1969).
Piero Sraffa, 'The Laws of Returns under Competitive Conditions',
Economic Journal (1926).
G. L. S. Shackle, The Years of High Theory (1967).
11
MONETARY THEORY IN THE

NEO-CLASSICAL ERA
Although the later classical theorists, such as J. S. Mill, had been

aware that theories formulated in real/physical terms could not
be applied to the complex system of credit prevailing in the
leading commercialised countries, they settled rather readily for
the relatively simple monetarist doctrines they had inherited
from Ricardo. Nor were their immediate successors among the
neo-classical theorists much inclined to explore the links between
the supply of money and the level of output to which Thornton
had drawn attention at the beginning of the nineteenth century.
The main reason for this blind spot was no doubt the fact that
economic policy problems originating in the financial sector did
not present themselves in such an urgent and acute form as they
had in the early years of the nineteenth century or as they were
to do in the twentieth century inter-war period. Whatever the
reason, the Ricardian example of separating the problems of
price determination into two separate compartments of analysis
was carried over into the neo-classical paradigm. The structure
of relative prices was explained in real, micro, terms - as depen-
dent on marginal cost and/or utility - essentially in terms applic-
able to a competitive barter economy in long-term equilibrium.
The absolute price of each commodity or the general level of
prices, was given a monetary, macro, explanation dependent on
a short-term fixed relationship between the stock of money and
the stock of commodities. As a result real and monetary theory
developed independently of each other and the former took
precedence over the latter in the textbooks.1
1
Cf. J. M. Keynes' obituary memoir of Marshall, listing among his main
contributions to monetary economics an analysis of the link between the supply
of money, the rate of interest and prices: ' It was an odd state of affairs that one
of the most fundamental parts of Monetary Theory should, for about a quarter
of a century, have been available to students nowhere except embedded in the
form of question-and-answer before a Government Commission interested in a
transitory practical problem' (J. M. Keynes, Collected Writings, Vol. x. Essays in
Biography, p. 192).
164 Monetary theory in the neo-classical era
Nowhere did this dichotomy between real and monetary
theory show u p more clearly than in the classical theories of the
rate of interest. T r u e to their Ricardian origins the classical
theorists put their main efforts into developing theories of value
and distribution in long-term competitive equilibrium: the neo-
classicals focused even more narrowly on the theory of markets
- a micro theory of prices - also in long-period competitive equi-
librium. The rate of interest for long-term loans was explained
as the price of capital, its level governed on the one hand by the
demand of entrepreneurs for capital to invest (hence dependent
on the marginal productivity of capital); and on the other by the
supply of uncommitted real capital resources (hence dependent
on the supply of gross savings). In short, the real rate of interest
was a function of the twin exogenous forces of productivity and
thrift. T h e possible influence of monetary policy on these
variables did not come into the picture at all, for in the long
run money was irrelevant and could realistically be ignored as
having no lasting effect on the fundamental tendencies of real
factors.
Side by side with this theory of the way real economic resources
were produced and distributed or allocated in the long run, the
classical economists had accepted a short-term theory of a market
for credit where the rate of interest was a function of the demand
and supply of loanable funds. In the original version of this
theory, as developed by Thornton, overall monetary equilibrium
was held to depend on the real rate of return to physical capital
being equivalent to the market rate of return on loanable funds
and there was thus an explicit (if unexplained) connection be-
tween the money market and the commodity markets. However,
the real gap in nineteenth-century thinking on this point (at least
until Wicksell) lay in the lack of any systematic attempt to explore
the relationship between the market rate of interest (which would
be directly influenced by the monetary authorities) and the 'real'
or ' natural' rate of interest which Ricardo had called the rate of
profits on stock. Conventional classical doctrine treated the
former as a sort of shadow of the latter, in effect denying the
possibility that the actions of the monetary authorities operating
under the gold standard rules would be able to create a diver-
gence between the market rate and the real rate for any appre-
ciable period. Thus the classical school steadfastly refused to
allow that changes in the money supply might have any effect
on the rate of interest persistent enough to affect the accumu-
Monetary theory in the neo-classical era 165
lation of real capital. The orthodox quantity theorist argument
was that an increase in the money supply would raise the prices
of all commodities without affecting the rate of profit (hence of
interest) in any but the very short run. In evidence before the
Lords Committee on the Resumption of Cash Payments (1819),
for example, Ricardo had insisted that: 'Reduction or Increase
of the Quantity of Money always ultimately raises or lowers the
Price of Commodities, when this is effected the Rate of Interest
will be precisely the same as before; it is only during the Interval,
that is before the Prices are settled at the new Rate, that the Rate
of Interest is either raised or lowered.'2
However, even when applied to the short term, the classical
quantity-theory level of analysis left loose ends which could be
held to have implications for the long-run assumption that money
could be treated as neutral, merely a veil behind which the real
factors and tendencies worked towards their long-run equilib-
rium position. The implication of the orthodox quantity-theory
doctrine, for example, was that an increase in the quantity of
money would in the first instance lower interest rates as well as
raise prices and a decrease would have the opposite effect. Yet
empirical evidence, as Tooke demonstrated in his History of Prices,
suggested that in fact interest rates had generally been low when
prices were falling and high in times of rising prices. If it were
really true that a restrictive credit policy (a high discount rate)
could lead to rising prices, and an expansive policy to falling
prices, then not only was the conventional role of monetary policy
as prescribed by the quantity theorists suspect, but doubt was also
cast on the self-equilibrating characteristics of the classical
monetary system.
It was this loose end and its implications for both monetary
policy and orthodox monetary theory that bothered Wicksell in
the 1890s. The preface to his Interest and Pricesfirstpublished in
German in 1898 illustrates his bewilderment. 'If the Quantity
Theory is false - or to the extent that it is false - there is so far
available only one false theory of money and no true theory... It
is no exaggeration to say that even today many of the most
distinguished economists lack any real logically worked out
theory of money.'3
The result of Wicksell's inquiry into the relation between
2
Sraffa edn, Works etc. of David Ricardo, Vol. v, p. 445.
3
Knut Wicksell, Interest and Prices, translated by R. F. Kahn (1936), p. xxiii.
interest and prices was to suggest a new theory of interest and
price determination which gave more causal substance to the
quantity-theory framework of analysis and integrated the ortho-
dox monetary theory of interest with the orthodox real theory
of interest. T h e basic question for Wicksell was 'why do prices
rise or fall?' T h e key to its solution he found in the relationship
between the market or money rate of interest (manipulable by
monetary policy) and the 'natural' or 'real' rate of interest
(dependent on the marginal productivity of physical capital). For
if the monetary authorities should set the market rate below the
natural rate this would put an artificial premium on capital
expenditure financed by credit, so pushing u p prices, which will
go on rising cumulatively until the shortage of loanable funds
has pulled u p the market rate to match the natural rate. Con-
versely, of course, if the monetary authorities set a market rate
which is above the natural rate, investment expenditures will be
postponed and prices will tend to fall until the slack demand for
funds brings down the money rate.
Wicksell therefore concluded that his inquiry fully vindicated
the quantity theory and at the same time explained' the observed
fact that rising prices have seldom been associated with low or
falling rates of interest, that far more often they are associated
with high or rising rates of interest and that falling prices accom-
pany falling interest rates'. 4 In effect he argued that the rate
of interest was the crucial link in the quantity theory argument
which made prices depend on the money supply, for
an increase or relative diminution in the stock of money must always

tend to raise or lower prices - by its opposite effect in the first place on
rates of interest. But monetary conditions are only one factor in the
situation... The other factor, which is often of more weight, takes the
form of the independent movements of the natural capital rate itself,
which must necessarily, but in general only gradually, be accompanied
by corresponding movements of the money rate.5
On the other hand, as was ultimately recognised by the

twentieth-century theorists who pursued the same trail - his
theory destroyed the rationale for the assumption that money can
be conveniently treated as neutral in analysing changes in real
output and investment for it showed that manipulations of short-
term interest rates could be expected to have considerable effects
on actual economic activity. It also, as Wicksell himself noted, had
4 5
Ibid, Preface. Ibid, p. xxviii.
practical implications for the active role of monetary policy which
were at variance with the current orthodoxy: ' Banks and credit
institutions have hitherto exerted only an involuntary influence
on prices, and consequently it has sometimes been in a favourable
direction and sometimes in an unfavourable direction. Now,
however, they will be able in full consciousness to pursue their
objective, to the indisputable benefit of the world economy.'8
Significantly, however, Wicksell's Interest and Prices seems to
have been largely ignored by mainstream theorists in English
speaking countries and was not translated into English until the
1930s - by which time the problems of monetary policy had
assumed a dominant importance and the world was ripe for a
revolution in monetary theory. Indeed before he died in 1926
Wicksell had himself begun to doubt whether his own theory was
adequate to explain the wartime inflation and the ' puzzling price
fluctuations' of the 1920s. In the words of his compatriot B. Ohlin
he had come ' more and more to doubt the solidity of what had
been regarded as the cornerstone of his monetary theory: the
idea that if the money rate coincided with a normal rate, which
brought about equality between savings and investment, the
commodity price level would remain constant'.7
Wicksell was not the only theorist to find traditional monetary
theory inadequate as a basis for explaining or prescribing for the
chaotic monetary problems of the 1920s. The 1914-18 war had
shattered the international gold standard, though the complexity
of the national and international problems confronting the post-
war world was such that it took time for the fact that it was
impossible to put the clock back to penetrate to the majority of
informed observers. The disruption of world trade and payments
patterns - the need for massive unrequited transfers of capital
in the form of reparations and loan repayments, the persistent
weakness of sterling whose unique strength had made it the
keystone of the pre-1914 gold standard, the sudden swings in the
direction taken by 'hot money' movements, the national hyper-
inflations and balance of payments disequilibria - all combined
to present a thoroughly confusing context of empirical evidence
about the way the national and international monetary systems
were operating. On the other hand, this was precisely the envi-
6
Ibid, p. 176.
7
Ibid, p. xix. The evidence is in Wicksell's last paper, originally published in
Ekonomisk Tidskrijt 1925 and reprinted as an appendix to the Kahn translation,
op. cit.
ronment to challenge theoretical economists to a systematic recon-
sideration of the concepts and theories which had constituted
the traditional orthodoxy on monetary issues for over a century,
and to get heretical ideas a hearing among respectable
academics.
Meanwhile, however, even before the outbreak of the First
World War, there was developing in Cambridge a lively intel-
lectual interest in monetary economics, nurtured by Marshall's
direct, if unsystematic, teaching. It was out of this fertile, open-
minded, monetary theorising begun by Marshall and continued
after his retirement by his successors, Pigou and then Robertson,
and by such active disciples as Hawtrey, Lavington and Keynes,
that the most influential of the twentieth-century heresies grew.
John Maynard Keynes - whose first major publication was a
monograph on Indian Currency and Finance (1913) - testified to
the quality and stimulus of the Cambridge oral tradition in
monetary theory in his 1924 obituary Memoir of Alfred
Marshall. 8 Regretting the master's postponement of publication
of his theory of money 'until extreme old age', Keynes insisted
that: ' T h e r e is no part of Economics where Marshall's originality
and priority of thought are more marked than here, or where
his superiority of insight and knowledge over his contemporaries
was greater.' 9 He then went on to list his contributions to this area,
and it is interesting to note, in view of what has been said above
about the conventional neo-classical dichotomy between real and
monetary theory, that Keynes gave primary importance to
Marshall's
exposition of the Quantity Theory of Money as a part of the General Theory

of Value. He always taught that'the value of money is a function of its
supply on one hand, and the demand for it, on the other, as measured
by ' the average stock of command over commodities which each person
cares to keep in a ready form'. He went on to explain how each
individual decides how much to keep in a ready form as the result of
a balance of advantage between this and alternative forms of wealth.10
Keynes' own Tract on Monetary Reform (1923) appeared before
Marshall died, in the same year as the latter's Money, Credit and
Commerce, and did not depart from the basic Marshallian quantity-
theory framework of analysis. However, it reacted - significantly
8
Reprinted in Essays in Biography, Vol. x of Collected Writings.
9
Ibid, p. 189.
10
Ibid, p. 191 (italics in the original). See also the quotation from Marshall on
p. 170 below.
in the light of the later Keynesian theorising - against some of
the values traditionally associated with the quantity theory, for
example against the belief that it was always better to run the risk
of deflation than of inflation;11 and also against the equally
solidly-entrenched notion (given a legal backing in the 1844 Bank
Charter Act) that the prosperity of the economy depended on
the strength of the foreign exchanges and hence that domestic
policies ought to be subordinated to the over-riding objective of
maintaining a stable exchange rate. Here too, Keynes reacted
against the classical and neo-classical schools' obsessive concen-
tration on the economics of long-term equilibrium with his
famous quip: 'In the long-run we are all dead. Economists set
themselves too easy a task if in tempestuous seasons they can only
tell us that when the storm is long past the ocean is flat again.'12
Finally, as Moggridge and Howson have noted, the policy in-
ferences drawn in the Tract are more interventionist in sym-
pathy than was consistent with the traditional Marshallian
quantity-theory approach.13
The Tract was, of course, a polemic. However, in the univer-
sities the theorists had already begun to subject the variables of
the quantity theory to a closer scrutiny than had been fashionable
in the halcyon pre-1914 era, in an effort to elucidate their causal-
significance. The Cambridge School, under the direct influence
of Marshall, began by shifting the emphasis of the so-called
'equation of exchange' so as to convert the tautologous formu-
lation associated with Irving Fisher i.e. MV= PT, into a beha-
vioural formulation, e.g. M=kY, where k is the proportion of
the public's income which it chooses to hold in the form of cash
balances. In a purely formal sense the Marshallian k is merely
the reciprocal of V, and of course Y = PT but the new formu-
lation reflected a view of the causal relationships involved, in
particular the strategic importance of changes in the behaviour
of income velocity; or, to put it another way, on the demand for
cash balances.
Cambridge theorising, however, was never sufficiently abstract
11
See J. M. Keynes, Collected Writings, Vol. iv, p. 36: 'Thus inflation is unjust
and deflation is inexpedient. Of the two perhaps deflation is, if we rule out
exaggerated inflations such as that of Germany, the worse: because it is worse,
in an impoverished world to provoke unemployment than to disappoint the
rentier.'
12
Ibid, p. 80.
13
D. E. Moggridge and Susan Howson,' Keynes on Monetary Policy, 1910-46',
Oxford Economic Papers (July 1974), pp. 232-3-
or precise to be captured in a simple algebraic formula and one
needs to go back to the verbal exposition to pick up the threads
leading to its later development - in particular to note its focus
on the psychological motives for holding or parting with cash
balances and its explicit awareness of the fact that there were
stocks of wealth considerations as well as flow of income con-
siderations entering into the decisions made at any point of time.
Both clues are present in Marshall's statement that

currency held in the hand yields no income: therefore everyone balances
(more or less automatically and instinctively) the benefits which he would
get by investing some of it either in a commodity - say a coat or piano
- from which he would derive direct benefit: or in some business plant
or stock exchange security, which would yield him a money income.14
Also in Marshall (already expressed in evidence to the Indian

Currency Committee of 1899) is a scepticism about the stability
of the velocity of circulation of money, the assumption which
underlies the naive quantity theory, e.g.: 'This "quantity doc-
trine" is helpful as far as it goes; but it does not indicate what
are the "other things" which must be assumed to be equal in
order to justify the proposition: and it does not explain the causes
which govern "rapidity of circulation".' 15
T h e Cambridge approach to the quantity theory had the effect
of stressing a quality of money which had been ignored in earlier
versions, viz its role as a store of value. T h e original neo-classical
formulation of the equation of exchange was a way of describing
(without explaining) a simple relationship between the level of
money in circulation and the level of prices, given a situation
where the velocity of circulation was institutionally determined
and money was needed merely as a medium of exchange. Once
it was recognised that the demand for money might be affected
not only by its need for immediate transaction purposes but also
by its usefulness as a store of value for later purchases, then it
was no longer possible to treat velocity as an essentially exogenous
variable, for the demand for cash balances would then depend
not only on the level of activity and on institutional factors, but
also on trends in the supply of money and prices, and on
entrepreneurial expectations vis-d-vis all these variables. T h e
use of the equation of exchange for predictive or explanatory
purposes must then depend crucially on the assumptions made
14
A. Marshall, Money Credit and Commerce (1923), pp. 38-9.
15
Ibid, p. 48.
about the links between V and M or P, i.e. on a theory of money
which had not as yet been satisfactorily worked out.
The other direction in which monetary theory developed in
the igaos was along the path already indicated by Wicksell at the
end of the 1892-i.e. an attempt to analyse the connections
between prices, interest, savings and investment in such a way
as to bridge the classical dichotomy between the orthodox mone-
tary theory of the factors affecting the general price level and
the orthodox real theory of factors affecting investment, output
and relative (as opposed to general) prices. The fact is that the
problems of the inter-war period took a different shape from the
pre-war problems. Apart altogether from the new importance of
monetary issues, narrowly defined, it was increasingly obvious
that the major real problems (above all the problems associated
with chronic unemployment) were affecting and being affected
by monetary factors in ways that the existing corpus of economic
theory did little to illuminate. In effect, the questions that con-
cerned most economists (at any rate in Britain and Sweden) had
changed radically in form and it was no longer convenient to
attack them with analytical concepts and theories drawn from two
separate, and at times mutually inconsistent, intellectual com-
partments. Nor was it merely that the theory of markets was
relevant only to long-run problems, whereas the questions that
currently mattered were all cast in a short-run context; in the
event, the received theory of money was as unsatisfactory as a
tool for analysing short-term problems as the received theory of
markets.
The other feature of the inter-war period which encouraged
a radical reconstruction of orthodox monetary theory was that
the institutional context was plainly different from that presumed
in nineteenth-century quantity-theory doctrine. The skills in
monetary management which the Bank of England had been
developing, almost clandestinely, in the quarter century before
1914 and the greatly increased scope for open market operations
implicit in the enormous weight of the National Debt were two
examples of the changed situation in the United Kingdom: in
the United States the most important new fact was the Federal
Reserve System. Clearly it was time for economists to think in
terms not only of a more sophisticated and active monetary policy
but also in terms of a more complex gamut of monetary
influences on output and employment.
The Swedish School made important strides along the Wick-
sellian path in the 1920s and 1930s while in England the lead
was taken by D. H. Robertson and J. M. Keynes working as col-
leagues and in such close consultation that, as Robertson wrote
of his Banking Policy and the Price Level (1926): 'neither of us now
know how much of the ideas is his.. .and how much is mine'.
Keynes' principal contribution to the revision of orthodox mone-
tary theory came four years later in the form of his two volume
Treatise on Money (1930) a work which seems in some ways to have
been 'overtaken by events'. It was the most academic and least
polemical of all Keynes' books, a richer and more developed
version than Robertson's Banking Policy had been of the inno-
vative ideas that they and others had been working on in the
1920s.16 But it did not seem to contemporaries to fill the gap
lamented by the Macmillan Committee (of which Keynes was
himself a member) and which noted that 'there are no general
principles universally accepted as to the mode in which monetary
institutions and activities affect the economic situation, still less
as to the precise degree of their importance as compared with
other causes'. Indeed Keynes' Preface to the Treatise suggested
that his own ideas had already overtaken it by the time it came
into print. Then when the General Theory appeared, beginning
with a dramatic rejection of the classical frame of thought in
which the Treatise was unquestionably set, it seemed to those who
had embraced the Keynesian revolution that the latter was no
longer relevant and it slipped quietly off the core-course aca-
demic reading lists.
Recent research into the nature of the Keynesian revolution,
however, has tended to reinstate the Treatise not merely as being
the more complete and systematic exposition of Maynard Keynes'
contribution to monetary theory, but also as being an integral
part of the revolution in ideas that was characteristically Key-
nesian. Sir John Hicks, for example, has pointed out that the
General Theory relates to a closed economy and that it is the
Treatise which contains Keynes' contribution to the theory of
international money.17 Leijonhufvud has argued that the essen-
tial Keynesian break with tradition shows up between the Tract
16
There are many echoes of D. H. Robertson in the Treatise but it is here that
the differences between Keynes and Robertson began to be most clearly denned.
After publication of the Treatise Robertsonian and Keynesian monetary theories
explicitly and increasingly diverged.
" John Hicks, 'Note on the Treatise', Critical Essays in Monetary Theory (1967),
p. 189.
- which respected the traditional boundary between monetary
theory (dealing with the value of money and the demand for
output at the macro-level) and value theory (with its focus on
relative prices) - and the Treatise which effectively abandoned
this 'traditional compartmentalization'.18 Others, however, have
stressed the rejection of the Quantity Theory which distinguishes
the General Theory from the Treatise as the crucial break with
monetary tradition:19 and there is evidence that Keynes himself
saw his escape from the 'confusions of the Quantity Theory,
which once entangled me' as the breakthrough which enabled
him finally to integrate the theory of money with the 'funda-
mental theory of value', and thus to construct a completely
new theory of the monetary economy.20
By the time he came to write the General Theory, however,
Maynard Keynes had adapted his analytical techniques to the
fact that he was endeavouring to answer a different set of ques-
tions and to prescribe for a different range of policy issues, within
a different institutional context, to those confronting the neo-
classical economists who had taught him his trade. The policy
problem which had come to occupy the centre of Keynes' atten-
tion by the 1930s was not the problem of fluctuations in the value
of money, but the problem of mass unemployment, which led
him to focus in the General Theory on what determined the level
of output. In a real world subject to continuous change and often
deep uncertainty, the importance of money lay in its being a
refuge for those who wanted to postpone a definitive commit-
ment of their real resources either to consumption or to invest-
ment; and the crucial variables that needed identification were
not the quantity of money in circulation or the factors through
which it affected the price level, but the market and real rates
of return from investment and their impact on the level of
economic activity. With those considerations in mind Keynes
fashioned new analytical tools and methodological techniques in
the field of money. Some of the new tools and techniques passed
into the commonly accepted heritage of all economists, whether
18
Axel Leijonhufvud, On Keynesian Economics and the Economics of Keynes
(1968), p. 22.
19
E.g. Donald Winch, Economics and Policy (1969); Don Patinkin,' The Collected
Writings of John Maynard Keynes: From the Tract to the General Theory',
Economic Journal (June 1975), p. 260; Lord Kahn, On Rereading Keynes (1975), 4th
British Academy Lecture on Keynes.
20
See the preface to the French Edition of the General Theory, reprinted in
J. M. Keynes, Collected Writings, Vol. vn, p. xxxiv.
or not they were persuaded to follow his overall change of
methodological emphasis and to focus on a historical short term
rather than on a long-term equilibrium economics. In the mone-
tary sphere, for example, Keynes' liquidity-preference analysis
(itself a development of the Cambridge cash-balance version of
the quantity theory) has become a conventional part of the
orthodox textbooks and has generated a whole new branch of
monetary theory concerned with the choice of an optimum
portfolio of assets. In the event, these Keynesian developments
in monetary theory were merely a part of the more radical
reconstruction of economic theory which arose out of his attempt
to arrive at a general system of analysis appropriate to a twentieth-
century monetary economy.
FURTHER READING
Primary literature
J. M. Keynes, A Tract on Monetary Reform, Vol. iv of The Collected
Writings of John Maynard Keynes, ed. E. Johnson and D. E. Moggridge
for the Royal Economic Society (1971).
J. M. Keynes, A Treatise on Money, Vols. v and vi of Collected Writings,
ed. E. Johnson and D. E. Moggridge (1971).
D. H. Robertson, Banking Policy and the Price Level (1926).
Knut Wicksell, Interest and Prices, translated by R. F. Kahn (1936).
E. Eshag, From Marshall to Keynes. An Essay on the Monetary Theory of the
Cambridge School (1963).
D. E. Moggridge and Susan Howson, 'Keynes on Monetary Policy,
1910-46', Oxford Economic Papers (1974).
D. Patinkin, Money, Interest and Prices (1969).
D. Winch, Economics and Policy (1969).
12
THE KEYNESIAN REVOLUTION
The academic community of economists had by the early 1930s

reached a sufficient disciplinary solidarity in their commitment
to marginal analysis, and the associated analytical techniques, to
provide the learned journals with a steady flow of articles that
were often incomprehensible to the laymen, and sometimes too
abstract either for the increasing body of empirical researchers,
or for the broad fringe of economics graduates who continued
to provide professional advice and explanation in their capacities
as journalists, politicians, bankers, governmentofficials,etc. Never-
theless, the common objective of the purest of theorists was still
to provide a framework for the explanations or predictions
that could assist policy makers to formulate rational economic
policies. The fact is that the problems which professional econo-
mists have accepted as important have never been denned
exclusively by an academic community. When economic science
fails effectively to focus on the problems which society at large
regards as important, all practising economists are vulnerable to
the sense of intellectual insecurity that spreads through the rank
and file of the profession.
In the 1930s the problem that dominated the mature capitalist
economies was the problem of intense, persistent, trade de-
pression, associated with widespread, unprecedentedly heavy
unemployment. The unemployment problem was already
chronic in Britain and some other Western European countries
in the 1920s. By the 1930s it was universal in capitalist
economies; and it was aggravated rather than relieved by laissez-
faire economic policies. Even Britain, the last stronghold of
free trade, adopted a protectionist strategy in the 1930s. Even
in the United States, the proverbial home of economic indi-
vidualism, the New Deal licensed an unprecedented level
of government intervention. The ideological bias associated
with the neo-classical paradigm was becoming an anachro-
176 The Keynesian revolution
nism,1 and Robbins'view that the cause of Britain's difficulties since
the War was due to wages being 'held above the equilibrium
level',2 though still shared by many politicians and officials pro-
vided little practical guidance to policy makers. This then was the
context in which Keynes produced his new theory. In what sense
did it constitute a new paradigm?
John Maynard Keynes himself certainly viewed his theory as
a complete break with current orthodoxy. The first chapter of
the General Theory consists of a single dramatic paragraph saying
just that. Like Marshall before him he set out deliberately to make
the economic theory in which he had been brought up more
general, i.e. more useful over a wider frame of reference in its
explanatory power. Unlike Marshall, however, he saw himself as
an innovator rather than an adaptor: though this was perhaps
more a difference in temperament or of starting-point3 than a
difference of substance. Marshall, that is to say, changed more
than he was prepared to admit of the basic classical model and
Keynes retained more than might appear of the neo-classical
tradition.
Keynes took issue with what he chose to call 'classical' theory
but which embraced neo-classical theory,4 i.e. with the current
economic orthodoxy. A major objection to orthodox economic
1
Keynes had consigned the laissez-faire ideology to the lumber-room of
'vulgar economics' as early as November 1924 in a lecture on 'The End of
Laissez-faire'. See J. M. Keynes, Collected Writings, Vol. ix,e.g. p. 277: 'I have said
that it was the economists who furnished the scientific pretext by which the
practical man could solve the contradiction between egoism and socialism which
emerged out of the philosophising of the eighteenth century and the decay of
revealed religion. But having said this for shortness' sake, I hasten to qualify it.
This is what the economists are supposed to have said. No such doctrine is really
to be found in the writings of the greatest authorities. It is what the popularisers
and the vulgarisers said.'
2
Quoted above, pp. 147-8.
3
Keynes was conscious of a real struggle to free himself from classical theo-
retical ruts. See e.g. a letter to Harrod dated 30 August 1936: 'What some people
treat as unnecessarily controversial is really due to the importance in my own
mind of what I used to believe, and of the moments of transition which were for
me personally moments of illumination' (J. M. Keynes, Collected Writings, Vol.
xiv, pp. 84-5).
4
'"The classical economists" was a name invented by Marx to cover Ricardo
and James Mill and their predecessors, that is to say for the founders of the theory
which culminated in the Ricardian economics. I have become accustomed,
perhaps perpetrating a solecism, to include in " the classical school" the followers
of Ricardo, those, that is to say, who adopted and perfected the theory of the
Ricardian economics, including (for example) J. S. Mill, Marshall, Edgeworth and
Prof. Pigou' (footnote to Chapter 1 of the General Theory, p. 3).
The Keynesian revolution 177
theory in the context of the 1930s was that it assumed an economy
which was tending towards full employment - not of course that
the economy was necessarily in a position of full employment,
but that its eventual equilibrium was a full employment position.
But for Britain in the prolonged depression of the inter-war
period, with unemployment averaging 10 per cent of the insured
labour force even in the prosperous years, the assumption
seemed blatantly to disregard the crucial problem of economic
policy.
It was thus the classical theory of employment with which
Keynes took issue first in his second chapter, which is a critique
of what he chose to specify as 'the postulates of classical econ-
omies'. These on his account were fourfold:
(1) That the real wage is equal to the marginal product of labour;
(2) That the real wage is equal to the marginal disutility of the
existing employment;
(3) ~ which is a logical corollary of (2) - that there is no such thing
as involuntary unemployment in the strict sense; i.e. that all
the unemployed could get employment merely by accepting
a fall in wages, and
(4) that supply creates its own demand in the sense that the
aggregate demand price is equal to the aggregate supply
price for all levels of output and employment.
With the first of the postulates he did not quarrel. With the
second and its logical corollary the third, he came into head-on
clash. The implication of the second classical assumption, that the
real wage equals the marginal disutility of labour, is that an
individual could increase his employment by revising his notion
of the disutility of labour and accepting a lower wage. At a
macroeconomic level it implies that ' if labour as a whole would
agree to a reduction of money-wages more employment would
be forthcoming'. Keynes' objections to these assumptions were
based partly on an appeal to facts:' It is not very plausible to assert
that unemployment in the United States was due either to labour
obstinately refusing to accept a reduction of money wages or to
its obstinately demanding a real wage beyond what the produc-
tivity of the economic machine was capable of furnishing.'5 Of
course the facts were not necessarily in conflict with the classical
assumption for this was not that there could never be any invol-
untary unemployment or depression but that there would not
5
General Theory, op. cit., p. 9.
be any involuntary unemployment when the economy was in
long-run equilibrium. Pigou, for example, whose Theory of
Unemployment Keynes chose as his target in his attack on classical
theory recognised that in times of depression (i.e. in a position
of disequilibrium) real wages could be falling while unemploy-
ment was rising.
More significantly, however, Keynes objected that classical
theory failed to take account of the role of money in the situation,
and in particular of the fact that money wages did not necessarily
move in the same way as real wages. Wage bargains he pointed
out are made in money terms and money wage rates do' not
determine real wage rates, and
the struggle about money wages primarily affects the distribution of the
aggregate real wage between different labour-groups, and not its
average amount per unit of employment.. .The effect of combination
on the part of a group of workers is to protect their relative real wage.
The general level of real wages depends on other forces of the
economic system.6
Only on very special assumptions concerning the flexibility of
wages, prices and interest rates could it be argued that a wage
cut would necessarily lead to an increase in employment.
T h e other postulate of the classical economists with which
Keynes took issue at the outset of his General Theory was Say's
Law - the proposition that for the economy as a whole supply
necessarily creates a demand of equivalent magnitude. In its
plainest form it states t h a t ' the whole of the costs of production
must necessarily be spent in the aggregate, directly or indirectly,
on purchasing the product'. 7 Here, as elsewhere in his assault
on the current orthodoxy, Keynes was setting u p what Dennis
Robertson was to describe a s ' a composite Aunt Sally of uncertain
age ' 8 for he did not really believe that many of his contemporaries
actually accepted Say's Law. It was crucial to his own position,
however, because it was tantamount to the proposition that there
was no real obstacle to full employment and as such, he believed,
was one of the tacit assumptions which prevented the classical
theorists from thinking clearly about the economic situation in
which they found themselves in the 1930s. If Say's Law (read as
an economic law rather than as a logical consequence of certain
6 7
8
In the course of a debate on the General Theory in the 1937 Economic Journal.
Keynes admitted the justice of the quip. J. M. Keynes, Collected Writings, Vol. xiv,
p. 215.
restrictive assumptions) had fallen into disuse among contem-
porary theorists before Keynes proceeded to demolish it so devas-
tatingly, it was because classical and neo-classical theory had
largely turned away from the macroeconomic questions to which
it was relevant, i.e. from questions of the demand and supply for
output as a whole. This, however, did not prevent the implicit
assumptions from exerting a stranglehold on conventional econ-
omic analysis when the macro-economic policy issues of the
inter-war period forced their way into the centre of economic
discussion. For example, the official 'Treasury view' that a public
works programme would increase rather than relieve the unem-
ployment problem by diverting funds from private productive
investments to unproductive public investment, was largely jus-
tified by an appeal to Say's Law.9
There is no real doubt, both that Maynard Keynes intended
to revise radically the analytical framework of the discipline, and
that the publication of the General Theory marked the beginning
of a revolution in economic ideas. However, whether the revo-
lution was what Keynes had intended and exactly how destructive
it was of the neo-classical paradigm are matters of considerable
current controversy.
Beginning then with his own view of what he was doing in the
General Theory, he claimed to show that the classical theory was
based on postulates that were applicable to a special case - the
case of an economy in which the natural forces were such that
aggregate demand would always adjust to aggregate supply so
as to produce a persistent tendency towards full employment.
'The classical theorists resemble Euclidean geometers in a non-
Euclidean world who, discovering that in experience straight
lines apparently parallel often meet, rebuke the lines for not
keeping straight - as the only remedy for the unfortunate col-
lisions which are occurring.'10 What was needed was a new model
of economic reality which started from the facts of experience,
i.e. a system with a persistent tendency towards something less
than full employment. He then developed a theory in which the
level of employment depended on (i) the propensity to consume,
(ii) the marginal efficiency of capital, (iii) the quantity of money
and (iv) the level of wages. The key factors in the system were
(a) the 'principle of effective demand' which acted through the
propensity to consume and the rate of new investment to set a
9
See L. L. Pasinetti, Growth and Income Distribution (1974), p. 35.
10
General Theory, p. 16.
ceiling to the level of economic activity, and (b) the role played
by money as 'the link between the present and the future' in
reflecting past and present uncertainties about the future on the
part of lenders and borrowers, and reflecting them on the rate
of interest and hence of investment. The system was enriched
by the introduction of a set of concepts which were novel not in
origin but in the dynamic use to which they were put, viz the
marginal propensity to save and its inverse the multiplier,
liquidity preference which made the demand for money hinge
on choices between stocks of assets as well as flows of income
and expenditure, and the marginal efficiency of capital which
depended on the relation between the supply price of assets and
the variable expectations of investors.
It is a testament both to the tenacity of the ruling paradigm
and to the capacity of some of the most enthusiastic converts to
a new set of ideas to reinterpret the ideas of the master in the
light of the conventional wisdom in which they were trained that
the Keynesian theory has come to be interpreted by the textbooks
in exactly the opposite sense to which Keynes saw it himself, i.e.
it is treated as a special case of neo-classical theory, the case of
unemployment equilibrium.11 The argument runs that, with a
given money wage rate, the equilibrium levels of aggregate income
and the rate of investment are determined by (i) the propensity
to consume, (2) the investment demand schedule (denned on
conventional neo-classical lines with investment a decreasing
function of interest), (3) liquidity preference and (4) the quantity
of money: with (1) and (2) being stable functions in the short
run and (3) being stable (and highly elastic) at low interest rates.
From this standpoint the special assumptions which justify the
Keynesian theory within a neo-classical framework are rigid
money wages, a 'liquidity trap' (in which the demand for money
becomes infinitely elastic at low interest rates and so prevents
rates from falling when the supply of money increases), plus,
possibly, a low interest elasticity of investment.
The novelty of the General Theory, then, boils down to Keynes'
use of the 'psychological' concepts of the consumption function
and liquidity preference, his treatment of the role of effective
demand in generating output changes (rather than price changes
as in the general classical case where prices and wages are flex-
" For a detailed analysis of the way Keynesian economics differs from the
economics of Keynes see A. Leijonhufvud, On Keynesian Economics and the Econo-
mics of Keynes (1968).
ible), in making the demand for money hinge on choices between
assets rather than between flows of income and expenditure, and
in shifting the stress from savings to investment as the primary
cause of capital accumulation.12 It is a corollary of this reinter-
pretation of the General Theory that more than one Keynesian has
doubted that Keynes understood the significance of his own
analysis.13
It is debatable, however, whether Keynes would have accepted
modern Keynesian economics as the textbooks expound it. For
one thing he did not regard the tentative assumptions necessary
to absorb his general theory into the neo-classical framework
as valid in themselves. He was quite explicit for example in
regarding the stable wage assumption as merely a preliminary
expository convenience with no relevance for the logic of his
argument.14 Nor did he believe in the actuality of the liquidity
trap and referred to it as hypothetical possibility only in order
to show how easy it would be for a farsighted public authority
to fill the gap in investment by borrowing from the banking
system at nominal rates.15
But more important than the restrictive assumptions that have
been attached to Keynesian economics, is the fact that his depar-
tures from the neo-classical paradigm were more radical in
spirit than the modern interpretation allows. In particular, for
example, he was in revolt against the tendency, implicit in the
mechanistic analytical techniques of marginal economics, to-
wards visualising economic science as capable of providing a
vehicle for scientific prediction by analogy with the natural
sciences.' Economics' he maintained, in a letter to Harrod in 1938,
'is essentially a moral science and not a natural science.'
I mentioned before that it deals with introspection and with values. I
might have added that it deals with motives, expectations, psychological
uncertainties. One has to be constantly on guard against treating
the material as constant and homogeneous. It is as though the fall of
the apple to the ground depended on the apple's motives on whether
12
See e.g. James Meade, 'The Keynesian Revolution', op. cit., ed. Milo Keynes
(1975), p. 82: 'Keynes's intellectual revolution was to shift economists from
thinking normally in terms of a model of reality in which a dog called savings
wagged his tail labelled investment to thinking in terms of a model in which a
dog called investment wagged his tail labelled savings.'
13
E.g. P. Samuelson in K. Lekachman (ed.), Kevnes' General Theory: Reports of
Three Decades, p. 321; and L. Klein, The Keynesian Revolution (i960), p. 83.
14
General Theory, p. 27: 'The essential character of the argument is precisely
the same whether or not money-wages, etc. are liable to change.'
15
General Theory, p. 207.
it is worthwhile falling to the ground, and whether the ground
wanted the apple to fall, and on mistaken calculations on16the part of the
apple as to how far it was from the centre of the earth.
Hence his emphasis on psychological propensities and on expec-
tations under uncertainty. Investment he argued, for example,
'depends on two sets of judgments about the future, neither of
which rests on an adequate or secure foundation - on the
propensity to hoard and on opinions of the future yield of
capital assets'.17 His own view of the object of an economic model
was that it was a vehicle for analysis rather than for prediction.
'The object of a model is to segregate the semi-permanent or
relatively constant factors from those which are transitory or
fluctuating so as to develop a logical way of thinking about the
latter, and of understanding the time sequences to which they
give rise in particular cases'.18 His primary concern was with states
of disequilibrium rather than of equilibrium and although - true
to his classical upbringing, he made frequent use of the concept
of equilibrium in his General Theory - it was a short-period
equilibrium rather than a long-period equilibrium that he had in
mind.
It can be said that there were three respects in which the
General Theory broke away from the classical mould and gener-
ated a new economics. The first was in the questions it asked,
the second was in its conclusions and the third was in the route
to these conclusions. The central question on which Keynes
focused, as has already been stressed, was a question which
neo-classical theory had so far failed effectively to confront, viz
what were the determinants of the supply and demand for
aggregate output.
The iconoclastic conclusion of his analysis was that there was
no invisible hand translating private self-interest into social
benefit. This was the nub of the Keynesian heresy. It had already
been formulated in 1924 in the lecture which provided the basis
for the essay on The End of Laissez-faire - though the leading
classical and neo-classical economists from John Stuart Mill on-
wards were there exonerated by Keynes from having subscribed
to the ideological doctrine of laissez-faire.19 In 1934 while he was
16
J. M. Keynes, Collected Writings, Vol. xiv, pp. 297-300.
17
J. M. Keynes, 'The General Theory of Employment', Quarterly Journal of
Economics (1937), Reprinted in Collected Y/ritings, Vol. xiv, p. 218.
18
J. M. Keynes, Collected Writings, Vol. xiv, pp. 296-7.
19
J. M. Keynes, Collected Writings, Vol. ix, p. 281: 'Economists no longer have
any link with the theological or political philosophies out of which the dogma
primarily engaged in drafting the General Theory Keynes put the
point more aggressively in a BBC talk on the theme 'Is the
Economic System Self-Adjusting?' in which he argued that those
who believed the system embodied significant tendencies towards
self-adjustment had behind them 'almost the whole body of
organised economic thinking and doctrine of the last hundred
years' and went on to range himself unequivocally on the side
of the heretics with this statement: 'There is, I am convinced, a
fatal flaw in that part of the orthodox reasoning which deals with
the theory of what determines the level of effective demand and
the volume of aggregate employment: theflawbeing largely due
to the failure of the classical doctrine to develop a satisfactory
theory of the rate of interest.'20 The really shattering conclusion
to emerge from the General Theory in the context of the 1930s
was that a cut in wages, far from relieving unemployment as the
classical theory implied, could actually increase it by reducing the
level of effective demand.
The method was to set up an aggregative model of the economy
as a whole - so simple in basic construction that it was readily
intelligible to the average student or interested politician, deli-
berately relevant to contemporary economic problems and con-
vincing in the range of its vision. According to Pigou: 'Nobody
before him... had brought all the relevant factors, real and mone-
tary at once, together in a single scheme, through which their
interplay could be coherently investigated.'21 Keynes concen-
trated attention on national expenditure-income and income-
expenditure relationships which were superficially easier to un-
derstand and to manipulate than the classical quantity-theory
relationships. He demonstrated in a way that had never been so
dramatically and clearly brought out before, the dependence of
aggregate expenditure on itself in its income-generating capacity.
In so doing he filled a large gap in classical theory and added
a new dimension to economic analysis. Macro-economics as we
know it today starts from Keynes' General Theory.
When one examines in detail the innovations introduced by
the General Theory into current economic thought one can trace
many of them back to earlier writers as Keynes did himself.
Malthus had recognised a link between effective demand, con-
of social harmony was born, and their scientific analysis leads them to no such
conclusions.'
20
J. M. Keynes, Collected Writings, Vol. xni, p. 489.
21
Quoted by Haberler in Lekachman (ed.), op. cit., pp. 290-1.
sumption and total output as long ago as 1820 when in his Principles
of Political Economy he had formally denied Say's Law. Hobson
pursued the same line of thought by pointing to the tendency
for production to outrun consumption as a consequence of
over-saving. The Swedish school of economists, focusing in the
early 1930s on the problem of the gap between savings and
investment, developed a theory of monetary equilibrium which
was essentially the same as that which emerged from the General
Theory. In some ways indeed the Swedish school, with their
explicit distinction between ex-ante and ex-post concepts of savings
and investment brought out more clearly than Keynes himself
was to do the dynamic significance of the savings-investment
disequilibrium - viz that it is the divergence beteween planned
lending and planned investment which accounts for the gap
whereas ex-post savings and ex-post investment are always equal.22
The concept of the multiplier had been formally expounded
by R. F. Kahn in an article published in the 1931 Economic
Journal.23
However, it was in its broad outlines - (a) in the way it formu-
lated the fundamental theoretical problem as one of accounting
for the level of economic activity rather than of prices, (b) in
its method - the national-income-expenditure framework of
analysis and (c) in its policy implications for deliberate demand-
management on the part of the political and monetary authority
- that the General Theory produced a revolution in economic
ideas. Whether or not the revolution took the shape which
Keynes would have approved is of course another matter.
No doubt the principal reason why the General Theory had such
a powerful impact on the community of professional economists
inside and outside the universities, internationally as well as in
Britain, was that the time was ripe. Its abstractions seemed more
relevant to the conditions of the 1930s than the competing
theories. Its analysis gave a theoretical basis for policy-
22
According to G. L. S. Shackle, The Years of High Theory, p. 144, Myrdal's
Monetary Equilibrium, written 5 years or more before the appearance of Keynes'
General Theory 'anticipated the General Theory in almost every respect except that
of its huge impact on economics and the world'.
23
As Dr Moggridge has noted in his account of the Cambridge debates which
preceded and helped to shape the General Theory, Kahn's article was stimulated
by a line of thought already suggested by Keynes and H. D. Henderson in the
1929 essay Can Lloyd George do it? and was in Keynes' hands as early as ^30 -
before publication of the Treatise but too late to affect its exposition. See The
Collected Writings of John Maynard Keynes, ed. D. E. Moggridge, Vol. x m , p. 340.
prescriptions that were more in tune with existing political trends
in a world that was already in massive retreat from a laissez-faire
ideology. It thus attracted the interest of economists over a very
wide spectrum of political affinity. Marxian economists who had
been unable to come to terms with socially complacent starting
assumptions which took for granted the legendary virtues of
laissez-faire competitive capitalism, welcomed this breath of fresh
air. Sweezy, for example, in a warm obituary written in 1946
suggested that Keynes' greatest achievement was that of libera-
ting Anglo-American economics from the 'tyrannical dogma' of
Say's Law, and of exploding 4once and for all the myth of a
harmony between private and public interests which was the
corner-stone of nineteenth century liberalism'.24 Liberal econo-
mists on the other hand were attracted by the profoundly capita-
listic nature of Keynesian philosophy, offering as it did both an
antidote to social revolution and an analytical framework which
could ' swallow the classical system as a special case \ 25 Many more
academic economists uncommitted to either ideological extreme,
found it intellectually stimulating to identify with Keynes'
attempt to modernise economic theory without jettisoning the
familiar Marshallian methodological techniques and concepts.
For applied economists, particularly the growing number of
empirical research workers, a prime attraction of the Keynesian
system was that it was a coherent system of thought which lent
itself readily to quantification and statistical testing. It opened a
whole new programme of research with particularly exciting
possibilities for those whose interest in economics was policy
oriented. It is doubtful whether the new system could have
seduced so many theorists and empirical research workers away
from the neo-classical orthodoxy in which they had been trained,
or could have inspired so many practical policy makers with
confidence that economics, had, after all, something useful to
contribute to their decisions, if it had not been focused on a more
urgent set of questions than the Marshallian ones. The classical
economists had asked what determined prices and output in
particular commodity markets and at the level of the individual
producer or industry: they examined the behaviour of the indi-
vidual consumer. As by-products of this analysis they drew macro-
economic inferences and they suggested general welfare
24
P. Sweezy in Lekachman (ed.), op. cit., p. 301.
25
P. Samuelson in Lekachman (ed.), op. cit., p. 318.
criteria for policy makers to take into account. But most of the
time they were looking at the economy in terms of the behaviour
of its atomistic particles and the way these reacted on each other.
Except in relation to monetary theory - which was never fully
integrated with the basic theories of demand, production and
distribution - their techniques of analysis were micro-economic
rather than macro-economic. By starting f-om the national,
aggregative level of analysis Keynes focused on problems that
academics and politicians alike regarded as important and he
tackled them by making assumptions «drawn from a close and
acute observation of the way the economic system was working
in his own time.
In view of the developments that have taken place in Keynesian
economics in the 1950s and 1960s and in the immense volume
of statistical and econometric research that stemmed from these
developments it may be worth emphasising that Keynes' commit-
ment to realism did not imply an anti-theoretical bias. On the
contrary he accused Marshall, for example, of confusing his
models with superfluous realism and of 'being unnecessarily
ashamed of lean and abstract outlines'. Most of all, however, he
objected to the attempts of the econometricians such as Schultz
and Tinbergen, to quantify their models in order to use them
as a basis for prediction. 26
In chemistry and physics and other natural sciences the object of the
experiment is to fill the actual values of the various quantities and
factors appearing in an equation or a formula; and the work when
done is once and for all. In economics this is not the case and to convert
a model into a quantitative formula is to destroy its usefulness as an
instrument of thought.27
For Keynes the role of the statistician was not to turn economic
models into forecasting instruments but to test their relevance
and validity.
On the other hand, although the Keynesian theory was not
intended to displace the neo-classical theories at the micro-
26
In his Presidential Address to the Econometric Society Don Patinkin noted
that 'the statistical revolution as represented by Clark's and Kuznets' national
income estimates precedes the "Keynesian Revolution" as represented by the
General Theory' and criticised Keynes for not having been more active in pressing
the UK authorities to follow the US example1 in setting up an official national
income unit as early as 1932. See 'Keynes and Econometrics: on the interaction
between the macroeconomic Revolutions of the Interwar Period' (Econometrica,
November 1976, p. 1104).
27
J. M. Keynes, Collected Writings, Vol. xiv, p. 299.
economic level of analysis, and although Keynesian economics

has retained more of the neo-classical framework than Keynes
had intended, the elements of a distinctively Keynesian model
have been indelibly written into modern economic thought and
have to a large extent determined the way it has developed. The
revolution in ideas about the role of government in the economic
system - in particular the deliberate attempt to influence the level
of effective demand, which was a feature of all advanced capitalist
economies in the post Second World War era - was facilitated by,
and guaranteed a central importance in economic thought for,
the Keynesian macroeconomic variables and relationships. The
Keynesian model turned out to be an operational model which
constituted the basic prototype for all later macroeconomic gen-
eral equilibrium and dynamic models. The systematic rethinking
of the assumptions underlying classical economic theory, which
was an inevitable consequence of its confrontation by a vigorous
competing system, effectively broke the stabilising effect of ortho-
doxy, so that neo-classical theory itself gained a new lease of life
and began to take off in new, non-Keynesian directions. Finally
the sheer range of the Keynesian model made it a convenient
frame of reference against which to consider almost any problem
in pure or applied economics.
Nevertheless, as Professor Leijonhufvud has now shown,28 in
the event Keynesian economics turned into something wholly
different from the economics which Keynes expounded in the
General Theory and which was a development of theories which
he had worked out in his Treatise on Money (1930). He has argued
that the familiar income-expenditure theory which is a basic
component of the orthodox macroeconomic texts published in
the 1950s and 1960s is substantially different in structure and
emphasis from the original Keynesian model. In particular, for
example, the emphasis on the superior effectiveness of fiscal
policy as opposed to monetary policy is a subsequent develop-
ment and is not reflected in the arguments of the General Theory.
The assumptions that wages are rigid and that savings (and
indeed investment too) are interest-inelastic - assumptions which
have been used to justify the modern neo-classical contention that
Keynes' so-called 'general' theory is merely a special case of the
traditional neo-classical theory of markets - are not, it turns out,
necessary assumptions in Keynes' own theory.
28
A. Leijonhufvud, On Keynesian Economics and the Economics of Keynes (1968).
Leijonhufvud's interpretation of 'what Keynes really meant'
is of course debatable and has indeed already been revised: but
it brought sharply into question the pedigree of much of
contemporary macroeconomic theory which currently passes for
Keynesian economics. More recently, since the publication of the
Collected Works of John Maynard Keynes, edited for the Royal
Economic Society by Elizabeth Johnson and Donald Moggridge,
it has been possible to draw extensively on Keynes' less accessible,
or hitherto unpublished, letters and papers to assess his views:
and the debate stimulated by Leijonhufvud accordingly con-
tinues. Of particular interest, for example, is Moggridge's note
on Keynes' response (in a letter dated 31 March 1937) to Hicks'
well-known formulation of the Keynesian model of the relation-
ships between savings, investment, income and the rate of
interest.29 For as Moggridge points out, one of the points at which
Keynes took issue with Hicks' formulation (which in the event
became basic to the textbook version of orthodox Keynesian
economics) was its treatment of expectations as given by the
current level of income. This suggested for the model an un-
realistic degree of predictive potential by in effect ignoring the
influence of uncertainty on investment decisions - a device which
has frequently characterised Keynesian economics, but was mis-
sing a vital point as far as Keynes was concerned.
In the event then, the macroeconomic concepts and theories
associated with the Keynesian revolution inspired a variety of
theoretical and empirical research programmes30 and there are
wide divergencies between the basic assumptions and analytical
techniques adopted by economists who would regard themselves
as working within a Keynesian tradition. Partly because of the
intervention of the war which raised totally different policy
29
Hicks' article 'Mr. Keynes and the Classics' appeared originally in Econo-
metrica (1937), but has since been reprinted in J. R. Hicks, Critical Essays in
Monetary Theory (1973), which also reprints Keynes' letter. Moggridge's note on
this matter is contained in an appendix to D. E. Moggridge, Keynes (1976).
30
That is to say the Keynesian revolution did not lead the economics profession
into the kind of narrowly constrained research tradition that is implied in Kuhn's
concept of Normal Science and which in the Kuhnian model of scientific
revolutions marks the success of a new paradigm. Cf. I. Lakatos, 'Falsification
and the Methodology of Scientific Research Programmes', in I. Lakatos and A.
Musgrave (eds.), Criticism and the Growth of Knowledge (1970), p. 155: ' The history
of science has been and should be a history of competing research programmes (or, if you
wish, "paradigms"), but it has not been and must not become a succession of periods of
normal science. "Theoretical pluralism" is better than "theoretical monism": on
this point Popper and Feyerabend are right and Kuhn is wrong.'
problems from those which the General Theory was designed to
analyse, and partly because Keynes died before the peacetime
problems assumed their distinctive shape - and indeed before
the academic economists had effectively digested the revolution-
ary quality of his message - the General Theory never became the
bible of the 'new economics' in the way that Marshall's Principles
had done. It graduated rapidly to the status of a 'classic' which
the average undergraduate of the 1950s and 1960s absorbed
through secondary sources (guides to Keynes or macroeconomic
texts) rather than in the original.31
FURTHER READING
Primary literature
J. M. Keynes, The General Theory of Employment, Interest and Money, Vol.
VIII, in Collected Writings of John Maynard Keynes (1971).
J. M. Keynes, 'The General Theory of Employment', Quarterly Journal
of Economics (1937).
Milo Keynes (ed.), Essays on John Maynard Keynes (1975).
L. Klein, The Keynesian Revolution (i960).
Axel Leijonhufvud, On Keynesian Economics and the Economics of Keynes
(1968).
R. Lekachman, Keynes' General Theory after Three Decades (1964).
D. E. Moggridge, Keynes (1976).
Don Patinkin, ' T h e Collected Writings of John Maynard Keynes: From
the Tract to the General Theory', Economic Journal (1975).
31
It became conventional to describe the General Theory as being' too difficult'
or' badly written' - a convention which owed more to the inability of the teachers
to reconcile its contents with orthodox Keynesian economics than to the expo-
sitory deficiencies of a book which in its first edition was read with excitement
and enthusiasm by the rank and file of the economics profession.
13
TWENTIETH CENTURY GROWTH

THEORY
The theory of economic growth was not a promising area in

which to apply marginal techniques of analysis. It therefore fell
largely outside the scope of what the neo-classical orthodoxy
which triumphed as a result of the marginal revolution chose to
define as 'pure economic science'. At the beginning of the
twentieth century, however, one man, far ahead of his time in
theoretical interests and insight, was working in Europe on a
theory of economic development which was essentially a theory
of cyclical growth. Joseph Schumpeter's Theory of Economic
Development was first published in Germany in 1911 but was
not translated into English until 1934. By then English and
American economists were deeply concerned by problems of
trade cycles and secular stagnation in the mature capitalist
countries from which developed a new interest in analysing the
economic development of industrial society. But it was not until
after the Second World War when the condition of the under-
developed countries became a primary policy issue that econo-
mists began to study growth again in the form in which it had
interested Adam Smith, Karl Marx and the classical economists
generally, i.e. as an inquiry into the nature and causes of the
wealth of nations.
Unlike most of his contemporaries among English speaking
economists, Schumpeter was well-acquainted with the works of
both Marx and Walras as well as Marshall, and, of course, of the
members of the Austrian school in which he was trained.1 His
ideas on economics thus developed in an unusually open frame-
work of theories, concepts and methodological techniques.
While recognising, with Marx, that 'the social process is really
one indivisible whole', he shared Marshall's view that an econo-
1
The Austrian school developed out of Carl Menger's contribution to the
marginal revolution and among its most influential ideas was Bohm-Bawerk's
theory of capital.
Twentieth century growth theory 191
mist should develop explanations for economic variables. T o

quote:
When we succeed in finding a definite causal relation between two
phenomena, our problem is solved if the one which plays the 'causal'
role is non-economic. We have then accomplished what we, as econo-
mists, are capable of in the case in question and we must give place to
other disciplines. If, on the other hand, the causal factor is itself eco-
nomic in nature, we must continue our explanatory efforts until we
ground upon a non-economic bottom.2
However, like Marx he looked to 'business cycles for material
with which to build the fundamental theory of capitalist reality' 3
and to history, sociology, and political science for the basis of his
assumptions concerning the nature and structural characteristics
of economic development. His Theory of Economic Development
(1911) was an outline of the theoretical model which was basic
to all his analysis of economic growth; and his later books Business
Cycles (1939) and Capitalism Socialism and Democracy (1943) put
empirical flesh on to these bare bones and set them within the
broader context of the social process as a whole.
Classical theory had produced models which set u p a mech-
anism, rather than a reason, for economic expansion and growth
- though it was a mechanism which was destined eventually to
run down: neo-classical theory took total output for the economy
as a whole as given and focused on the problem of ensuring the
optimum allocation of resources in a stationary state. What
Schumpeter set out to do was to identify an endogenous source
of productivity growth and a mechanism which would generate
long-term continuity, but persistent fluctuations, in the growth
of total output. He found an answer in the character of the
profit-maximising entrepreneur and in the act of innovation -
the latter being widely defined to include any change in the
method of production which was expected to add to profits, e.g.
new machines, new processes, new products, new markets or
sources of inputs, industrial reorganisation and so on. Unlike the
neo-classical theorists he was more interested in conditions of
disequilibrium than of equilibrium and he brought the credit
mechanism purposefully within his explanations for real
sequences of events.
T h e novel characteristic of the Schumpeterian theory then was
the emphasis it put on technical progress in the growth process.
2
J. Schumpeter, Theory of Economic Development (1934), pp. 4-5.
3
Schumpeter, History of Economic Analysis, p. H35.
192 Twentieth century growth theory
In effect the result of trying to explain economic development
as a phenomenon that takes place in spurts and slumps, instead
of in terms of a long-term trend, was to focus his interest on the
cyclical impact of technical progress, on the psychology of crises
and on the role of the entrepreneur in initiating or imitating
innovation. It is through the decisions of the entrepreneur that
technical progress gives direction and momentum to capital and
it is his psychology (his readiness to take the lead in pursuit of
profits associated with 'those tragi-comic aberrations of the
frightened business world' which break the boom) that causes the
growth process to fluctuate. Labour is a passive element in
Schumpeter's system and 'Capital is nothing but the lever by
which the entrepreneur subjects to his control the concrete goods
which he needs, nothing but a means of diverting the factors of
production to new uses or of dictating a new direction to
production.' 4
Schumpeter begins with the concept of a stationary state, i.e.
he 'describes economic life from the standpoint of a "circular
flow" running on in channels essentially the same year after year,
similar to the circulation of the blood in an animal organism.' 5
This quasi-equilibrium starting point is characterised by the fact
that labour, capital and output are all growing at the same rate
and just enough capital is being annually accumulated to equip ad-
ditions to the labour force at a constant capital-labour ratio. T h e
circular flow is periodically broken, either by a new discovery,
or by the emergence of a few gifted entrepreneurs capable of
recognising already existing opportunities for profitable new
investment. These entrepreneurs persuade the banking system
to advance them credit, so inflating the supply of money, raising
prices and creating the forced savings necessary to finance the
additional capital formation. 6 Their example attracts imitators
and their investment may create new opportunities for innova-
tion in other sectors of the economy or stimulate new research
or invention so that innovations tend to cluster in time. The
sheeplike trail of less gifted imitators and the working out of the
cost-reducing possibilities of a given cluster of innovations tends
to overproduction and recession (sometimes precipitated by
panic) but not before the system has been lifted to new levels of
productivity and to a higher capital-labour ratio. It was crucial
5
* Theory of Economic Development, p. 116. Ibid, p. 61.
6
The mechanism suggested here resembles Keynes' analysis, but lacks the
multiplier link between savings and investment.
to Schumpeter's theory (and added to its realism) that there
should be enough imperfection in the competitive system to
permit an innovating entrepreneur to reap super-normal (mono-
poly) profits from his risk-taking: for if competition (and fore-
sight) were quite perfect, imitation would be instantaneous and
profits at once forced back to normal levels, leaving no incentive
for technological change. However, given a degree of hindrance
to instant imitation (often supported by institutional constraints,
e.g. patent laws), growth takes place in bursts of creative activity
where entrepreneurs, attracted by the monopoly profits of inno-
vation, get credit from the banking system to expand investment,
and earn supernormal profits until they are forced by compe-
tition into overproduction and contraction.
None of the classical theories had visualised growth going on
forever. Most saw output per head reaching an upper asymptote
in the form of a stationary state, brought about by diminishing
returns to new investment and a falling rate of profit, as the stock
of capital expanded faster than the supply of labour and natural
resources. In the end Schumpeter also visualised a slowing down
in the growth process but he attributed it to changes in the
institutional context of economic activity. He saw the growth in
the scale of production leading to a bureaucratisation of cor-
porate enterprise and a change in the character of the entre-
preneur. He thus came in his Capitalism, Socialism and Democracy
(1943) to an explanation for secular stagnation which hinges with
the rest of his theory on the psychology of the innovating
entrepreneur.
Not surprisingly, economists in the inter-war period were more
interested in theories of stagnation than theories of growth and
theories of secular stagnation began to proliferate. Some were
no more than a reversion to classical growth theories of the
gradual drift towards the stationary state as the race between
diminishing returns and increasing returns was steadily tipped
in favour of the former. Others developed within a more speci-
fically Keynesian framework. In its simplest form the stagnation
thesis that became popular in the 1930s states that in a mature
capitalistic economy (mature in the sense that it is exploiting
the full level of technological know-how and enjoys average
incomes well above subsistence level) the opportunities for
investment are unlikely to keep pace with the growing supply
of savings and of labour. With incomes (and hence savings) rising
continuously the economy faces problems not only of recurring
cyclical unemployment but also of growing chronic un-
employment.
There are various versions of this theory, but the best known
is Alvin Hansen's, which he illustrated by reference to the world's
most technologically progressive and high-income economy - the
United States. Basically Hansen's argument was that a mature
economy tends to confront increasingly diminishing returns to
investment and that in the American case this tendency, which
first became obvious in the 1930s, was due to a combination of
four characteristically twentieth-century causes - one of which
made the supply of new savings relatively abundant and three of
which weakened the demand for loanable funds. They were: (1)
the rise in both personal and corporate savings ratios; (2) the
declining rate of population growth; (3) the end to the expansion
of the geographical frontier; and (4) the tendency for inventions
to become capital-saving rather than capital-absorbing. It was the
historical coincidence of these four factors that gave the Hansen
argument its cogency. The rate of profit is likely to fall faster if
both labour supply and natural resources fail to grow in step with
capital formation: and the contraction of new investment
opportunities will be more serious when the propensity to con-
sume is falling.
The contrast between the inter-war stagnation thesis and the
classical theory of the stationary state is that the former saw a
decline in the rate of population growth as a reason for the
falling rate of return on capital in mature societies, and the latter
saw a rising population (associated with diminishing returns from
land and a constant real wage) as the cause of a fall in the share
of profits. The classical economists (with the exception of
Malthus) were prepared to assume full employment as normal.
The heirs of the Keynesian Revolution were not. To them it was
the gap between potential and effective productivity that
determined actual productivity in the long run. 'The problem
of our generation' said Hansen in his presidential address to the
American Economic Association 'is above all the problem of
inadequate private investment outlets.'7 According to this view,
a rapidly growing population demands more capital resources
(construction, residential building, public utilities) than a station-
ary population and hence stimulates a high rate of investment.
A high-income community with a slowly growing population and
7
A. Hansen, 'Economic progress and declining population', American
Economic Review (1939).
a substantial heritage of fixed capital has a relatively high
propensity to save and to consume personal services (with little
capital content), plus a relatively large scope for capital-saving
innovation or for financing new investment by liquidating old
capital in competing uses. Moreover, the other side of the
high propensity to save, i.e. a low propensity to consume, tends
to depress entrepreneurial expectations and inhibit the flow
of innovation. In addition to these deficiencies on the side of
demand, the development of capitalism has raised a series of
barriers to the exploitation of potential productivity in the form
of restrictive practices by businesses or trade unions, and of
government intervention through taxation, regulation or direct
participation.
It is easy to see why this theory gained popularity amongst
economists in a period of chronic unemployment and depressed
entrepreneurial expectations though it depended on a series of
untested and possibly untestable propositions of doubtful gener-
ality. How does one test empirically, for example, the propo-
sition that mature economies are characterised by a rising ex-ante
propensity to save? Ex-post savings showed a historical decline,
reflecting the decline in ex-post investment. Moreover, by formu-
lating the relation between average incomes and the marginal
propensity to save in these aggregative terms, the stagnation
theory obscured the fact that the national propensity to save
depends on the distribution of incomes between groups with a
high propensity to consume and groups with a high propensity
to save. A redistribution of incomes in favour of the former might
be expected to check the inexorable slide to stagnation. The
declining rate of population growth was clear for all to see
(though as it turned out it was not irreversible), but its effect on
the capital-intensity of the production process was a presumption
for which there was no empirical evidence. Similarly there was
no a priori reason or empirical evidence to justify the assumption
that a new trend for innovations to be capital-saving had suddenly
appeared in the inter-war period. Finally, the concept of the
frontier as used in the context of Hansen's theory is a relative
one, and neither migration of industry nor the discovery of new
resources is necessarily associated with or dependent on the
opening up of new geographical territory.8
8
E.g. the discovery (or exhaustion) of minerals may be as significant as the
extension (or closing) of the land frontier in determining the scope for new
investment.
19*5 Twentieth century growth theory
By the time the Second World War was over, growth theory
was in vogue again on a level of relative importance that recalled
Adam Smith and was stimulated by contemporary problems that
were as far removed as they could be from the problems of the
1930s. They were the problems of low-income countries strug-
gling to get on to a path of sustained growth for the first time
or of high-income countries trying to expand investment in
conditions of near full employment. Neither the stagnation
theories nor the cyclical growth theories seemed to have much
relevance to these problems and a spate of new growth theories
developed on neo-classical or Keynesian foundations.
Meanwhile, however, there had been two developments in
analytical technique which ensured that the growth theories of
the 1950s and 1960s would be methodologically different to all
previous thinking in this field. The first was the Keynesian
revolution, i.e. the development of macroeconomic analysis. The
second was the development of econometrics - a combination of
theoretical and statistical analysis.9 The first development stimu-
lated a type of growth theory that was formulated in broad
aggregative terms i.e. in the familiar Keynesian national income
aggregates. The second created a demand for theoretical con-
cepts that were selected and defined in empirically measurable
forms.
As it happened, modern growth theory itself split into two
separate lines of development which have taken divergent routes
and constitute different branches of economic theory. The first
route has been directed mainly to the problems of developing
countries and has been concerned to formulate theories which
can be applied to particular cases to yield conclusions of relevance
to practical policy formulation. This route, close in spirit to Adam
Smith's trail, was taken by W. Arthur Lewis, for example, in his
Theory of Economic Growth, and a long line of development eco-
nomists.10 The second route was almost exclusively theoretical,
in aim as well as in scope, and has been empirically tested,
9
This development led in the early 1930s to the formation of the Econometric
Society, an international society committed to the promotion of an essentially new
area of economic research characterised by 'unification of the theoretical-
quantitative and the empirical-quantitative approach to economic problems'. See
R. Frisch's editorial in the first issue of Econometrica (1933).
10
Some of these theories are reviewed in H. Chenery, 'Comparative Advan-
tage and Development Policy', American Economic Review (1963), reprinted (1965)
in Royal Economic Society/American Economic Association, Surveys of Economic
Theory.
if at all, in terms of the data relating to mature capitalist
countries.
Both routes have embraced a wide variety of issues and models
in the field of economic development, but while the former has
drawn heavily on theories of international trade and optimum
resource allocation the second route has been almost exclusively
macroeconomic in orientation. It is the second route that is
generally accepted, as being the mainstream of the theory of
economic growth. It dates effectively from an article by Harrod
published in the 1939 Economic Journal (and subsequently deve-
loped as a set of lectures published in 1948 as Towards a Dynamic
Economics) which was essentially an attempt toextract the long-run
dynamic implications of Keynes' primarily static and short-run
analysis. It consists, in Harrod's own words 'in a marriage of the
"acceleration principle" and the "multiplier" theory'. Evsey
Domar was independently developing a similar framework of
analysis in the United States in the early 1940s and the' Keynesian
dynamics' that is the simple basis of most modern growth models
has therefore generally been called the Harrod-Domar
model.
The broad purpose of the growth theory that stemmed from
this source was to explain the fluctuating behaviour of per capita
income through time, to introduce into the Keynesian static
system the hypotheses that would generate an equilibrium path
of growth and to illustrate the effects of instability in the system
on the actual path of growth. In the Harrod-Domar formulation
this was achieved by adopting the Keynesian assumption that
saving is a function of income, introducing the concept of the
capital stock, i.e. the notion that investment is capacity-creating
as well as income-generating, and linking to the latter the effects
of the quality of entrepreneurial expectations on investment
decisions. Steady growth then depends on effective demand
growing at the rate warranted by the growth of the capital stock.
It is the failure of entrepreneurs to predict the growth of demand
accurately enough to make the right investment decisions that
throws the economy off the equilibrium path of growth. Thus
the actual rate of growth for a given economy can be explained
as a function of entrepreneurial expectations on the one hand
and the factors determining the natural long-term growth of
demand (i.e. the growth of population and technical progress)
on the other.
At the heart of the Harrod-Domar model was what Joan
Robinson has succinctly described as the ' simple piece of arith-
metic' which stems from the twin assumptions fixing savings as
a proportion of income and output as a proportion of the capital
stock.11
When a constant proportion of income is added to capital every year and
capital bears a constant ratio to income then income expands contin-
uously at a constant proportional rate. Thus when 10% of net income
is invested every year and the stock of capital isfiveyears purchase of
net income then the stock of capital, the rate of investment per annum
and net income per annum all expand cumulatively at 2 per cent per
annum.
This truism gave Harrod his basic dynamic equation, G = s/v
where G is the actual growth rate, s is the propensity to save and
v is the capital-output ratio. The distinctive feature of his model
however was the introduction of entrepreneurial expectations;
and given perfect foresight on the part of entrepreneurs, an
economy could find its equilibrium growth path. Thus his second
dynamic equation defined a 'warranted' growth rate which
equates planned savings and required investment and so justifies
entrepreneurial expectations. How fast the rate of growth would
be over the long run, however, would depend on the basic under-
lying factors governing the growth in labour supply and producti-
vity, viz the growth of population and technical progress. Harrod
then completed his model by postulating a' natural' rate of growth
representing the feasible long-term growth rate in total output.
The significant characteristic of Harrod's (as of Domar's)
theory of growth was that it rested on the capacity-creating as
well as the income-generating properties of new investment. Its
demonstration of the logical possibility of steady economic
growth in a model based on the twin assumptions of a fixed
capital-output ratio and a fixed savings-income ratio was of
particular interest to planners trying to identify feasible growth
targets and to draw relevant policy conclusions for developing
countries. For, to the extent that the state can determine the
savings-output ratio, and that the capital-output ratio reflects
the current state of technology, it may be possible to manipulate
the rate of investment to match a desired growth target. In
practice it turned out to be less of a magic formula than it at first
seemed, for the assumption of a rigid capital-output ratio was a
singularly inappropriate starting-point for a developing country.
11
J. Robinson, 'The model of an expanding economy', Economic Journal
(March 1952), p. 42.
For the industrialised capitalist market economies to which the
Harrod model was designed to apply, however, the most striking
implication that emerged from it was that growth was likely to
be steady only on very special assumptions. Not only was it
possible - as Keynes had shown - for planned investment to
diverge from the level warranted by the actual level of effective
demand, when this did occur in the context of Harrod's model
the divergence was likely to widen violently before being brought
back on line. In a typically uncertain world, changes in the rate
of growth of demand or of technical improvements would
normally take entrepreneurs by surprise, raising (or lowering)
the actual rate of growth of incomes by comparison with the
expected rate of growth. If entrepreneurs find that the actual
rate of growth G falls short of the rate of growth for which they
were planning they will see themselves as having ordered too
much capital equipment - and by cutting back their investment
plans will tend to reduce the actual rate of growth still further.
Conversely if the actual rate of growth exceeds the expected rate,
producers will find themselves running short of stocks, or of
equipment, and will adjust their orders upwards, thus inflating
the actual rate the more.
Thus an initial, even modest, divergence between expectations
and events will falsify the expectations of entrepreneurs and push
them into cumulative slump or cumulative boom. Unless the rate
of growth on which investors base their decisions corresponds
exactly with the rate of growth in output actually achieved, the
disappointment of entrepreneurial expectations will set in
motion centrifugal forces driving the economy towards boom or
slump. What Harrod had done in effect was to introduce into
the simple model of an expanding economy given by a constant
relationship between the savings/income and capital/output
ratios, a cyclical element which stemmed from the Keynesian
analysis.
The explosive instability of the Harrod model was of course
a result of the simplicity and rigidity of its assumptions. In the
real world neither the multiplier nor the accelerator could be
expected to operate with undiluted ferocity. There are leakages
in the multiplier when part of expenditure goes out of the
domestic income stream to imports or when it is diverted into
taxation. Only a proportion of each year's new expenditure on
investment goods is directly induced by the rise in incomes: some
of it is autonomous in the sense that it is independent of the rate
2OO Twentieth century growth theory
of growth of output (e.g. government expenditure) and may
actually be a stabilising influence on changes in investment
demand. However many of the post Second World War devel-
opments in growth theory, most of which owed their stimulus
to Harrod's basic model, have been focused on attempts to
develop a model of steady growth which did not have to creep
along the knife-edge growth path implied by the assumption that
both the savings ratio and the capital output ratio are fixed.
From the Harrod-Domar beginnings in dynamic theory there
sprang an enormous and varied progeny of growth models.
Many of them dropped the assumption of fixed factor propor-
tions in search of more realistic assumptions concerning the
rates of growth of capital and labour. For as soon as attempts
were made to use the model to analyse the process of long-term
economic growth it became necessary to explore the causes and
consequences of changes in the ratio and in technology. This led
on to models illustrating the resulting structural changes and
their influence on the income-generating power of the economy:
and thence to models (of increasing mathematical complexity)
which take account of monetary factors, or of different varieties
of technical progress, or that define alternative criteria for steady-
state growth or maximal growth paths.
There has, however, been a deep rift between the directions
taken by the two main varieties of growth theory since the Second
World War. On the one hand there has been the neo-classical
direction taken by the production function theorists who have
applied marginalist techniques of analysis to Keynesian-type
aggregates and who have been prepared to make non-Keynesian
assumptions about the way savings decisions govern the rate of
capital formation. On the other is the direction generally
associated with the modern Cambridge school which stands
closer to the Harrodian version and has a predilection for
assumptions which are either Keynesian or Ricardian in their
inspiration.
The neo-classical school sought to escape from the rigidities
and the instability problems associated with the Harrod-Domar
model by postulating an aggregative production function with
two flexible inputs - capital and labour - which are smoothly sub-
stitutable over the whole range defined by current technology,
and where movements in factor input prices would automatically
ensure that the available capital and labour would be fully em-
ployed. Obviously this is unrealistic but they would argue that
price adjustments and factor substitutions clearly do take place
in the real world in response to technological change and relative
factor scarcities, and that when changes in underlying conditions
create imbalances between demand and supply it is reasonable
to suppose that the system will generate the appropriate price
signals and responses to shift the input-mix back in the direc-
tion of the optimum.12 In effect, the assumptions of perfect
substitutability between factors, perfect foresight and a total
absence of constraints on the real wage or interest rate, makes
it possible to define a stable equilibrium growth rate in which the
warranted growth rate is tied to the natural growth rate by factor
price shifts which induce appropriate variations in the input-mix.
The attractions of this type of model for the ordinary research
economist are its great simplicity, its use of Keynesian macro-
economic aggregates on the one hand and microeconomic tech-
niques of analysis on the other (both familiar ingredients in any
comprehensive economics principles course) and the fact that it
seems to lend itself readily to empirical tests and predictions. Its
disadvantages are that it is designed for full-employment
situations, that it says nothing about the mutual interactions
between growth and factor income distribution or about the role
of entrepreneurial expectations and that its analytical results are
ambiguous because it provides no practical means of distin-
guishing between changes in the input-mix that are a conse-
quence of changes in relative factor scarcities (i.e. a movement
along the production function) and those which are a con-
sequence of technological progress (i.e. a shift in the production
function). Of course the objections of those who reject the neo-
classical model, because it does not provide a suitable framework
for the questions they require a theory of growth to answer, tend
to revolve around its choice of assumptions. Those who share
the Ricardian (and Marxian) interest in the changing pattern of
income distribution associated with capitalist economic develop-
ment, for example, have been particularly critical of the mea-
sure of capital implicit in the production function approach and
of the assumption that capital goods are 'malleable'-which is
needed to postulate continuous substitutability between factors.
12
Cf. Samuelson's statement of faith: 'Until the laws of thermo-dynamics are
repealed, I shall continue to relate outputs to inputs, i.e. to believe in production
functions. Until factors cease to have their rewards determined by bidding in
quasi-competitive markets, I shall adhere to (generalized) neo-classical approxi-
mations in which relative factor prices are important in explaining their market
remunerations.'
The Cambridge school made their escape from the Harrodian
rigidities and instability problems by altering instead the assump-
tions concerning the savings coefficient. Their approach is clas-
sical (or Marxian) in that they insist on analysing growth in
relation to changes in factor income distribution, and Keynesian
in that it makes investment depend on entrepreneurial expec-
tations rather than on saving. So they disaggregate the national
savings ratio by assuming that profit recipients and wage earners
are likely to save different proportions of their income (the
simplest version of this is that capitalists save all their profits
and wage earners spend all their wages). Thus Kaldor's model
for example, postulates a savings-income ratio which is depen-
dent on the distribution of incomes.13 They ridicule the neo-
classical assumptions necessary to treat labour and capital as
smoothly and continuously substitutable, e.g. the assumption that
real capital, i.e. fixed capital, is like putty, homogeneous and
malleable, as easily transferred from one use to another as putty.
Above all, they reject as untenable the neo-classical assumption
that the prices of labour and capital are proportional to their
marginal productivity, on the grounds that there is a profound
ambiguity in the concept of capital, physical or financial capital,
i.e. capital as a real input into the productive process, or capital
as a property owned by certain individuals; for this carries with it
a corresponding ambiguity in the concept of a price for capital
- interest as the expected rate of discount on financial assets or
actual profit on the current stock of assets.
It is indeed there that the basic difference of viewpoint between
the neo-classical and post Keynesian schools comes to a crunch
and the protagonists are clearly seen to be fighting on different
battle grounds. For in the extreme neo-classical world where
competition and foresight are perfect, and the past and the
future melt into one, the rate of discount and the rate of profit
are indistinguishable. In this kind of context we can focus on the
supply side of the growth process and analyse the contribution
that capital accumulation, labour and technical progress make to
the rate of growth of aggregate output within the empirical
framework of the national accounts, and develop explanatory or
predictive models whose success or failure, when applied to
real-world data, may tell us something about the way actual
13
Nicholas Kaldor, 'Alternative Theories of Distribution', Review of Economic
Studies (1956).
economies have behaved in these respects. If one is concerned,

however, to assess the role of demand and entrepreneurial expec-
tations in the growth process, and if one believes that changes
in the distribution of incomes between factors of production
(representing social classes) are also a crucial part of the ex-
planation for variations in national rates of economic growth,
then one needs an entirely different set of abstractions to those
embodied in the timeless neo-classical framework.
Probably the most distinctive general characteristics of the
Cambridge school's approach to growth theory are that its models
tend to be explanatory rather than predictive, involving be-
haviouristic rather than mechanistic assumptions, and strongly
concerned with directions of causation through time rather than
with mutually determining sets of variables. They focus (as
Keynes did) on the causes and mechanism of change rather than
the conditions of equilibrium and they stress the need to develop
theories which are designed to apply to specific types of economy
and to particular periods of historical time i.e. to construct
'historical' or causal models. Joan Robinson, one of the leading
exponents of this approach, describes it in the following terms:
To build up a causal model, we must start not from equilibrium relations

but from the rules and motives governing human behaviour. We there-
fore have to specify to what kind of economy the model applies, for
various kinds of economies have different rules... The independent
elements in the model must correspond with the features of reality which
are given independently of each other, either by the brute facts of nature
or by the freedom of individuals to decide how they will behave.14
She then goes on to list the ' determinants of equilibrium' for a

modern capitalist society under seven main headings - (1) tech-
nical conditions, (2) investment policy, (3) thriftiness conditions,
(4) competitive conditions, (5) the wage bargain, (6) financial
conditions and (7) the initial stock of capital and the state of
expectations formed by past experience.
A post-Keynesian growth model is thus less general, takes into
account a much wider range of variables, links them together
much less rigidly, and since it is designed for analytical rather
than for predictive purposes, the process of verification is more
often logical than experimental. One result is that it is not easy
to describe the main features of a generalised post-Keynesian
growth model and individual members of the school tend to
14
J. Robinson, Essays in the Theory of Economic Growth, p. 34.
develop highly distinctive models of their own and sometimes
indeed a succession of own-models. The particular assumption
that distinguishes the post-Keynesian approach most strongly is
its use of a Keynesian-type investment function which implies
that investment determines savings rather than savings invest-
ment. However, it is not possible to define a specific list of assump-
tions or axioms which distinguish a typically post-Keynesian
approach. What is noticeable however is that the typical model
in this genre is less easy to quantify, and hence less easy to test,
or to apply empirically using a standard analytical technique such
as that generated by a neo-classical production function model.
Again the choice between the different varieties of model
depends partly on the questions to which an answer is sought,
partly on the analytical concepts and techniques followed by the
theorists and partly on their preconceptions as to which set of
simplifying assumptions is most palatable. In each of these
respects there is often a strong ideological bias to the choices
made and the debates between opposing schools of thought
accordingly tend to generate more heat than light. It is doubtful,
however, whether either of these two major strains of pure theory
have yet succeeded in influencing current economic policy nor
do they show much interest in reconsidering their basic premises
on more realistic lines.
FURTHER READING
Primary literature
E. V. Domar, Essays in the Theory of Economic Growth (1957).
Alvin Hansen,' Economic Progress and Declining Population', American
Economic Review (1939).
R. F. Harrod, Towards a Dynamic Economics (1948).
J. V. Robinson, The Accumulation of Capital (1956).
J. Schumpeter, The Theory of Economic Development (1951)-
A. K. Sen (ed.), Growth Economics (1970).
M. Kalecki, Theory of Economic Dynamics (1954).
F. H. H a h n a n d R . C. O. Matthews,'The Theory of Economic Growth',
Economic Journal (1954).
J. A. Kregel, The Theory of Economic Growth (1972).
14
METHODOLOGICAL DIVISIONS IN
ECONOMICS SINCE KEYNES
Use of the term Keynesian Revolution to characterise the impact

of Keynes' General Theory on the evolution of economic ideas
follows a convention approved by Keynes and his contemporaries
and rendered commonplace by subsequent usage. There is a
similar textbook tradition justifying the use of the term Marginal
Revolution to denote the change-over as between the two systems
of economic analysis - classical and neo-classical - which were
sufficiently different in their leading questions, assumptions and
techniques of analysis to imply an intellectual shift of revolu-
tionary proportions. It may be unhelpful to stretch the Kuhnian
analogy of a scientific revolution too far: but there is no doubt
that the neo-classical system of thought which stemmed from the
adoption of marginal techniques of analysis brought with it a
radical and far-reaching change in the disciplinary framework
and research priorities of the professional economist. The hall-
mark of the neo-classical economist is his formulation of the
fundamental economic problem as primarily a question of op-
timal allocation of scarce resources, his mastery of marginal tech-
niques of analysis designed to solve the problem of maximising
output or utility, and a conceptual apparatus in which the
assumption of long-term competitive equilibrium plays a crucial
role. These are the professional attributes of any contemporary
economist faced with a problem soluble at the microeconomic
level as many of the current public policy problems certainly are.
Whatever the Keynesian Revolution did then it did not displace
the neo-classical paradigm in the standard textbooks for that
remains the foundation of a wide area of orthodox economic
theory today. So what effect did it have on the views of the
scientific community of economists concerning the scope and
methodology of their discipline? The obvious, though not the
complete, answer to this question is that it added an extra dimen-
sion to orthodox economic doctrine by providing it with a new
206 Methodological divisions in Economics since Keynes
integrated set of theories, concepts and tools for analysing macro-

economic problems. Basically this involved two things: (i) the
conceptualisation of the notions of aggregate demand and aggre-
gate supply, which enabled Maynard Keynes to make the prin-
ciple of effective demand the key concept in his theory of
economic activity;1 and (2) integrating monetary theory into the
core of a general theory of macroeconomic activity instead of
treating money as an artificial veil which could conveniently be
ignored, or neutralised, by those seeking to analyse the real forces
driving the capitalist economy.
At the same time, Keynes' general theory used many of the
traditional techniques of classical economics; e.g. the typical a
priori assumption based on nothing more solid than introspection
and/or casual observation, such as the 'fundamental psycholo-
gical law' underlying the consumption function; or the maxi-
mising propensities that are assumed to underlie the behaviour
of his consumers, businessmen or speculators; e.g. also the
comparative-static techniques and the framework of equilibrium
analysis in which the whole argument is formally couched. Like
all other classical and neo-classical economists he accepted as
given (and therefore as outside the range of problems susceptible
to economic analysis) the whole social and economic power-
structure and distribution of wealth, though it is fair to say that
this assumption was more realistic in a short-period framework
of analysis than in the neo-classical long period.
We take as given the existing skill and quantity of available labour, the
existing quality and quantity of available equipment, the existing
technique, the degree of competition, the tastes and habits of the
consumer, the disutility of different intensities of labour and of the
activities of supervision and organisation, as well as the social structure
including the forces, other than our variables set forth below, which
determine the distribution of the national income.2
Keynes' general theory was thus an outcrop of (if also a reaction

against) the Marshallian neo-classical orthodoxy. This is hardly
surprising. For he was nearly 53 when the first edition of the
General Theory was published. He had been a Cambridge don for
more than a quarter of a century and an Editor of the Economic
Journal for almost as long. He had acquired a formidable repu-
1
See e.g. General Theory, p. 32: 'The idea that we can safely neglect the
aggregate demand function is fundamental to the Ricardian economics, which
underlie what we have been taught for more than a century.'
2
Keynes, General Theory, p. 245.
Methodological divisions in Economics since Keynes 207
tation as a Treasury official (heading the Treasury delegation to
the Peace conference in 1919). While publishing a stream of
economic heresies in the late 1920s and early 1930s he was
appointed a member first of the Macmillan Committee on Fin-
ance and Industry and later of the Economic Advisory Council.
Although Keynes seems to have felt an increasing sense of
detachment from the community of academic economists who
had been his teachers or in his own age-set there seems little doubt
that his intellectual prestige was almost as 'staggering' as
Ricardo's had seemed to Malthus - even among those who dis-
agreed with him.3 The impact of the Keynesian revolution was
thus largely confined to the (younger) heirs of the neo-classical
orthodoxy and left virtually unscathed the adherents of the
Marxian alternative. True, contemporary Marxists welcomed
the Keynesian shift of emphasis from the theory of prices to the
theory of income determination - for they had no interest in the
theory of prices and no competition to offer to the neo-classical
theory of resource allocation. But at least in the initial stages they
seem to have got little direct stimulus from Keynes' macro-
economic framework.4
From one point of view then, the Keynesian revolution can be
assessed as simply a major extension to the neo-classical para-
digm, adding a macroeconomic dimension to the myopically
microeconomic vision of mainstream economic doctrine. This is
the way it could reasonably be interpreted by the majority of
North American and British economists who have absorbed
Keynesian concepts and aggregative techniques of analysis into
a neo-classical or a general equilibrium framework. The fact that
Keynesian economics as it is expounded in the textbooks on
which most of today's undergraduates are reared, or as it is
embodied in the income-expenditure model which is the ac-
3
See Keynes' account, in a letter to Harrod dated 30 August 1936, of his own
sense of detachment from orthodox economists: 'experience seems to show that
people are divided between the old ones whom nothing will shift and are merely
amazed by my attempts to underline the points of transition so vital in my own
progress, and the young ones who have not been properly brought up and
believe nothing in particular... I have no companions it seems, in my own
generation, either of earliest teachers or of earliest pupils' (J. M. Keynes, Collected
Writings, Vol. xiv, p. 85). Nevertheless, as Dr Moggridge attests, by 1939, Keynes
- on the evidence of his mother's scrapbook 'was by far the most distinguished
economist of his generation, both within "the profession " and amongst the larger
public' (Milo Keynes (ed.), Essays on John Maynard Keynes, p. 177).
4
See e.g. P. M. Sweezy, 'The First Quarter Century', pp. 312—13, in R.
Lekachman, Keynes' General Theory. Reports on Three Decades.
cepted framework of economic analysis for most business and
government economists, does not much resemble the economics
of Keynes, is beside the point for those who would favour this
interpretation.
Looked at however in the context of recent methodological
debate, it might seem that the most characteristically Keynesian
break with the classical heritage - a difference which is currently
the distinctive badge of the modern post-Keynesians, was a
change in the formulation of the central economic question.
Keynes was interested in the problems of an economy in a state
of disequilibrium and in the process of its change through time,
rather than in the forces which were tending to bring the eco-
nomy into a hypothetical equilibrium.5 For, as he saw it, in time
- i.e. real historical time, subject to all the shocks and aberrations
of a continuously changing world - there was no reason to sup-
pose either that an economy would ever approach an equilibrium
in the classical sense, or that there was any concept of an equi-
librium towards which it might be tending, that might help to
explain the actual pace and directions of economic change in the
short period within which all the economic policy problems
inevitably arise. Even the best informed entrepreneur is incap-
able of making rational economic decisions when 'there is no
scientific basis on which to form any calculable probability what-
ever' and where the expectations themselves are subject to
sudden and violent change. 'I accuse the classical economic
theory' wrote Keynes, in an article written shortly after the
General Theory was published, 'of being one of those pretty
polite techniques which tries to deal with the present by ab-
stracting from the fact that we know very little about the future.'6
Nevertheless orthodox economics in the post Second World
War era, in spite of its Keynesian legacy, has abandoned neither
its general equilibrium nor its quantity-theory traditions. Equili-
brium theory has taken on a new lease of life, largely under the
inspiration of Sir John Hicks, building on Walrasian and
Keynesian foundations; and general equilibrium economics now
attracts distinguished theoretical talents. In spite of having been
'thoroughly discredited' by Keynes the quantity theory has
staged a theoretical come-back (a monetarist counter-revolution),
largely at the hands of Milton Friedman (also building on
5
Quarterly Journal of Economics (February 1937). Reprinted in J. M. Keynes,
Collected Writings, Vol. xiv, pp. 109-23.
6
Ibid., p. 115.
Keynesian foundations), in a post-war world where the economic
questions have changed and the problem of the price level is
again a dominating policy issue, comparable in importance to,
if not actually over-riding the unemployment problem. At the
same time the self-professed Keynesians, the theorists who are
the direct products of the 'new economics' of the Keynesian
Revolution, have followed the path of macroeconomic income-
expenditure analysis in a direction which, as Leijonhufvud has
convincingly demonstrated 'is antithetical to monetary ap-
proaches and unrelated to value theory'7 and indeed is now a
long way off the course set by Keynes in the Treatise and the
General Theory. In particular the integration of monetary and
value theory which Keynes hoped to achieve is as far off as ever it
was, while some of his keenest disciples have tended to denigrate
the significance of monetary policy and to neglect monetary
theory.
However, we are too near the doctrinal debates triggered off
by the General Theory to assess its ultimate impact at all reliably.
All we can usefully do at this stage is to try to identify some of
the ways in which opinions on the scope and methodology of
economics have developed since Keynes and look at the leading
strands in the current methodological controversies. If there
really is a new paradigm waiting its cue already in the wings,
waiting its opportunity to turn methodological confusion into a
clearly defined research programme for the economics profes-
sion, these controversies contain the materials of which it will be
woven as well as the material destined for the scrap heap. But
before considering doctrinal differences, it is worth noting that
the intellectual environment in which economic ideas and
theories are now developing differs in important respects from
that of the 1930s.
For one thing, economists are currently challenged by a dif-
ferent set of questions from those which were interesting Keynes
at the time he wrote the General Theory, because the most urgent
economic problems dominating the post Second World War
period differ from those of the inter-war period. Perhaps the
most radical and far-reaching of the underlying shifts have been
those associated with the changing role of government in the
economy. There remain of course profound ideological differ-
ences between economists as to the extent to which, and the ways
in which, they believe government should use its power to
7
Leijonhufvud, op. cit., p. 31.
21 o Methodological divisions in Economics since Keynes
intervene in the economic system: and naturally these differences
tend to be associated with the school of theory with which they
identify. Nevertheless, the sheer weight of government expen-
ditures and assets in a modern industrial society is such that it
has transformed the context within which economic policy
decisions are made and economic theories formulated. Thus
there is debate, for example, as to whether monetary policy or
fiscal policy is the most effective channel of government in-
fluence, or as to whether government should attempt to direct
or stabilise economic change. But that it must play a conscious
managing role in the allocation of the nation's economic re-
sources is scarcely in dispute.
There were also certain other consequences of the new envi-
ronment which influenced the shape of the economic questions
to which post-war economists were reacting. One of these was
a loss of interest at the empirical and theoretical level in the
traditional capitalist problem of economic crises. For when the
weight of exogenous government expenditures reached its post-
war levels, business cycles, trade cycles and building cycles were
so flattened as to be virtually invisible in the time series. In these
circumstances, the emphasis which Keynes' theory of money had
attached to the effects on the level of economic activity of relative
price changes as between investment goods and consumption
goods (an essential key to the explanation for industrial fluctua-
tions) fell into the background, and the main stream of Key-
nesian economics went on to develop within a neo-neo-classical
framework of analysis the prototype of which was the aggregative
production function model.
Secondly, the problem of unemployment ceased to be a leading
problem in the same sense as it had been in the inter-war period,
for experience in the 1950s suggested that any government that
was prepared to adopt the appropriate fiscal policy could so
manage demand as to generate any level of employment that it
chose. However, by the same token, since fiscal policy was
apparently sufficient to eliminate unemployment, the role of
monetary policy and the range of monetary theory was corres-
pondingly attenuated. Keynes' passionate concern with the level
of interest rates and with the need to hit the appropriate rate
to maintain full employment was not shared by his post-war
successors. The bridge he built between monetary theory and
value theory has fallen into disuse and the classical dichotomy
has opened up again - mirrored by the dichotomy between
macro-economics and micro-economics. The dichotomy is still a
challenge to modern theorists but it is the general equilibrium
school, not the mainstream Keynesian succession, that is taking
it up.
Thirdly, the problem of inflation has reappeared in more acute
guise in the 1960s and 1970s than ever before. The orthodox
Keynesians saw it as a trade-off against unemployment, and the
Phillips-curve analysis formalised this viewpoint. More impor-
tant, however, from the point of view of monetary theory has
been the revival and development of quantity-theory analysis
stimulated by the chronic post-war inflation. Just as neo-classical
economics had, in effect, swept the unemployment problem out
of court by assuming full employment, so Keynesian economics
ignored the dangers of inflation by assuming stable prices.8 To
those who are concerned by the problem of chronic inflation and
its implications for economic behaviour, therefore, orthodox
Keynesian economics is irrelevant and Milton Friedman's re-
statement of the quantity theory holds considerable attractions.
The other change in intellectual environment that requires
notice is the professionalisation of the discipline of economics
which gathered momentum in the mid-decades of the twentieth
century. To begin with, there has been a remarkable expansion
in the number of practising professional economists. The water-
shed for the United Kingdom can be dated within the Second
World War. During the war the majority of academic economists
moved into government service to take an active part qua econo-
mists in organising the national war effort. It was a task which
economists reared in the neo-classical tradition were peculiarly
well-equipped to perform for it was essentially a problem of
optimal resource allocation.9 In peacetime the economist's role
in economic policy making is necessarily subordinate to that of
the politician because the multiplicity of (often conflicting) policy
objectives makes it impossible to take the value judgments as
given. In wartime the victory objective over-rides all else and the
optimising techniques of the economist were allowed maximum
8
Keynes himself had been particularly intrigued by 'the apparent asymetry
between Inflation and Deflation' and Book v of the General Theory developed a
theory of prices as a corollary of his theory of employment. As Leijonhufvud
and others have now demonstrated, however, orthodox Keynesian economics
often bears little resemblance to the economics of Keynes.
9
In conditions of total war even the most doctrinaire adherents to the laissez-
faire tradition were freed from their ideological objections to government inter-
vention in the economic process.
scope. The result of this active involvement of economists in the
war effort was to increase both their prestige and their practical
experience of applying their training to the solution of real-world
problems.10
The most prestigious of all the British economists both in
official and in academic circles was John Maynard Keynes, and
the War enabled him and his devotees (a small band at the outset)
to introduce the innovations of the General Theory to the wider
circle of practising economists outside the universities as rapidly
as (more rapidly than indeed) they converted most teaching
academics still struggling to absorb the complex theoretical im-
plications of the General Theory. Keynes' How to Pay for the War,
first published in 1939 as a series of articles in the Times was a
direct application of the General Theory. Since that date econo-
mists in government service have been continuously engaged in
applying and adapting to their policy-oriented analysis the
Keynesian body of macroeconomic ideas.
The accident of war thus gave Keynes and his closest disciples
a unique opportunity to demonstrate the operational usefulness
of his macroeconomic conceptual framework, not only to the
informed public and to the official civil servants, but also to the
majority of academic economists who came under his direct
personal influence in the government service. During the war
years senior members of the profession (such as Dennis Robert-
son and Lionel Robbins) who had initially resisted the General
Theory found themselves working in harness with younger
Keynesian converts (such as E. A. G. Robinson, J. E. Meade,
J. R. N. Stone, A. K. Cairncross) in a methodological harmony
which economists have rarely displayed in peacetime when they
conduct their arguments remotely through the pages of the
learned journals and select their own research agenda. In wartime
the order of priority of the problems requiring solution was
firmly imposed from outside: and they were envisaged primarily
(though never exclusively) as macroeconomic problems.
In the immediate post-war period the context of economic
policy formation was similar in many ways to the wartime context.
The problems of reconstruction and of conversion to a peacetime
economy demanded a continuing high level of government inter-
10
Though the prestige was considerably shaken by the unsuccessful experi-
ments of the 1960s (see e.g. M. M. Postan, 'A Plague of Economists?', Encounter,
1968) its persistence is attested by the increasing extent to which economists have
been employed in the policy-making departments of government or business.
vention. The policy objectives were different from those of war
but their order of priority was again generally accepted. There
were few objectors to the view that the main danger to the post-war
economy was that of runaway inflation, and the objective of
stabilisation assumed the kind of over-riding quality that had
attached to the victory objective. It called for tight economic
controls, controls which the post-war Labour government, with
its built-in ideological bias towards government intervention,
was politically attuned to maintain. Significantly, the post-war
governments published (1947-51) an annual Economic Survey
making explicit quantitative macroeconomic forecasts for the
subsequent year.
The high tide of prestige and influence in economic policy
making which the academic economists enjoyed in wartime,
began to turn, however, as the nation's economic problems re-
verted to their more complex peacetime shape. For one thing
most of the leaders of the profession moved rapidly out of
Whitehall to resume their university careers. For another, the
falsification of many of the quantitative forecasts that had been
boldly published in the Economic Survey strained the credibility
of those who were trying to apply to the more open peacetime
economy, predictive techniques that had worked rather well in
the tightly controlled conditions of total war. And for another,
the steady dismantling of war-time controls in response to public
demand tended to reduce the number of issues on which the
technical skills of the economist were the major ingredient in
successful policy making. The Conservative governments of the
1950s followed their political bias by putting into reverse the
economic dirigisme of the war and post-war period.
However, the return to peacetime conditions did not reduce
the number of practising economists - as first it merely shifted
the main field of their operations back to the universities and
research institutes. When government in the 1950s stopped pub-
lishing the quantitative economic forecasts that were still being
set up at the Treasury, an independent body - the National
Institute of Economic and Social Research - took up the task in
its Economic Review. The wartime trickle of newly trained econo-
mists expanded into a flood as soon as the universities returned
to normal. Economics was a popular option for the ex-servicemen
who returned as mature students on government grant, or to take
up an opportunity that they had never even considered in the
more straitened circumstances of the pre-war period. In the great
post-war expansion of the universities and the colleges of ad-
vanced technology the social sciences in general, and economics
in particular, attracted a disproportionate number of students.
The other consequence of the war and the heavily controlled
post-war era was that it generated an unprecedented and irre-
versible flow of statistical data, data designed to measure the
levels, structure and growth in the nation's economic activity in
relation to a Keynesian macroeconomic framework. A Central
Statistical Office, set up in 1941 within the War Cabinet Office,
embarked at once on the task of producing an integrated set of
national income and expenditure accounts to fit the Keynesian
model. A small elite constituting the Prime Minister's Statistical
Section answered directly to the keystone of the wartime power-
structure. Henceforth it would have been virtually impossible to
test macroeconomic theories or to carry out substantive empirical
research outside a Keynesian analytical framework, for the aggre-
gative data, were available in that form and no other. This, if
nothing else, ensured that the formal Keynesian model became
the prevailing orthodoxy to which normal scientific work in
macro-economics had to conform.11
The textbooks were already being rewritten in the 1940s so as
to incorporate the conceptual apparatus of the General Theory and
to give macro-economics at least an equal prominence to micro-
economics as part of the economist's basic training, though with-
out trying to integrate the two forms of theory. The first
introductory textbook in the new tradition was Hicks' The Social
Frameworkfirstpublished in 1942.12 Because of its immediate and
obvious relevance to urgent contemporary national policy
problems, macro-economics rapidly took a popular position in
undergraduate teaching and in Workers' Educational Associa-
tion and other adult education courses. The fact that many of
the spate of new statistical series, currently being published in
official sources, were conceptually linked to the Keynesian system
made macro-economics a favourite area of research for applied
economists inside or outside the universities. A whole vast pro-
gramme of applied research projects unfolded out of theorems
11
The above narrative relates to development in the UK but a similar story
could be told for other western countries. A national income unit had been set
up in the US before the war and American official statistics took the same
Keynesian form as did, eventually, those of all other capitalist economies. Cf.
D. Patinkin, 'Keynes and Econometrics', Econometrica (November 1976).
12
It went into a 4th edn in 1971.
and hypothesis based on the Keynesian income-expenditure
model and overshadowed the microeconomic puzzles which had
been occupying economists in the inter-war period.
With the Master dead, however, long before the implications
of his theoretical innovations had been fully explored, and with
the problems assuming totally new shapes, it is not surprising that
the implementation of the Keynesian Revolution took off in
directions which were not altogether consistent with the original
message of the General Theory.
The mainstream economic doctrines of the post Second World
War era are thus a mixture of the neo-classical micro-economics
which developed out of the marginal revolution, and the macro-
economics which developed out of the Keynesian revolution.
Within a broadly accepted disciplinary framework, however,
there is considerable doctrinal controversy and a wide variety of
theorists, concepts and assumptions in continuous dispute. The
liveliness of the debate is an encouraging sign for it is this kind
of critical attitude to current theory that distinguishes the scien-
tific from the pre-scientific tradition.13 It is thus neither surpris-
ing, nor necessarily regrettable, if Keynesian economics turned
out to be different from the economics of Keynes, and Marxian
economics to diverge from the gospel of Das Kapital. Marx how-
ever lived long enough to deny that he was a Marxist, whereas
Keynes died in 1946, in what was still a war-dominated econo-
mic situation, before he or his followers had begun to formu-
late the typical economic problems of the post Second World
War era in the analytical framework of the General Theory.
The variety of methodological approaches to economics cur-
rently being articulated in the learned journals and even ex-
pounded to students through introductory texts, has encouraged
attempts to map the doctrinal battleground and to set contem-
porary controversies in systematic perspective. Probably the most
popular criterion of classification is an ideological yardstick, its
use justified in the eyes of its users by the tendency of left-wing
sympathisers to focus on questions relating to the distribution of
income as between social classes, and to favour policy implications
involving a relatively high degree of government economic
13
Cf. K. Popper, Conjectures and Refutations (1957), p. 50: 'The scientific tradi-
tion is distinguished from the pre-scientific tradition in having two layers. Like
the latter it passes on its theories: but it also passes on a critical attitude towards
them. The theories are passed on, not as dogmas, but rather with the challenge
to discuss them and improve upon them.'
intervention.14 One interesting example of its use is Paul David-
son's attempt to define 'five relatively homogeneous schools of
thought' on post-Keynesian macroeconomic monetary and
growth theory, along a spectrum from socialist extreme left to
laissez-faire extreme right.15 The disadvantage of most attempts
at an ideological classification of economic theories, however, is
that they tend to reveal more about the political and intellectual
bias of the compiler and his mentors, than about the methodo-
logical qualities of the economic doctrines thus labelled. Indeed,
as an aid to an objective understanding of the nature and scope
of the methodological issues currently dividing the makers of
economic theory, the ideological yardstick may be positively
misleading. To stigmatise as extreme right in a political sense,
for example, all those who use 'well-behaved production func-
tions' as tools of analysis is to drift into theological rather than
scientific ways of thought. The fact that the ideological impli-
cations that are commonly inferred from a particular economic
theory have undoubted bearing on its acceptance by economists
or politicians, and possibly even on its survival value in current
academic research programmes, does not justify the presump-
tion that the leading economic theorists select their methods of
analysis, and their problem-focus, in accordance with ideological
rather than with logical or scientific criteria.
Nevertheless there is a crucial methodological split between a
positive and a normative approach to economic science under-
lying the current debate between the neo-classicals (sometimes
called the neo-neo-classicals) and the post-Keynesians (sometimes
called the' Cambridge School'): and this division reflects a funda-
mental difference of viewpoint on whether economic theories
should express the personal value judgments of the theorists and
be relevant to a particular social and institutional context, or
whether theories should in principle be formulated in purely
objective terms and take account of ethical values and historical
contexts only at the point at which they are applied to empirical
14
The natural inclination of some theorists to propagate their ideas through
polemical as well as logical arguments adds of course to the popularity of the
ideological criterion.
15
Paul Davidson, Money and the Real World (1972), pp. 2-4. Davidson distin-
guishes five schools in the spectrum of modern macroeconomic monetary and
growth theory, viz: socialist radical, neo-Keynesian (approximating to what I have
called post-Keynesian), Keynes' school, neo-classical-bastard Keynesian and
monetarist-neoclassical.
analysis. Thus, the positive economist can be said to be more
concerned with 'how' than with 'why', with the logic and internal
consistency of his models than with their realism, with mechanical
analogies than with biological analogies, with systems of inter-
dependent functional relationships rather than with causal
sequences. To quote Milton Friedman, a leading modern expo-
nent of this methodology: 'Positive economics is in principle
independent of any particular ethical position or normative
judgements... Its task is to provide a system of generalisations
than can be used to make correct predictions about the conse-
quence of any change in circumstances. Its performance is to be
judged by the precision, scope and conformity with experience
of the predictions it yields."6 On the other hand, as Myrdal has
pointed out, many of the basic concepts of economics are already
loaded with normative implications, so that economic theories are
never in practice value-free, however austerely objective the
intentions of the theorists.17
Among the common characteristics of a positive neo-classical
economist then, we can list the following:
(i) His emphasis on logical consistency - sometimes reflected in
a tendency to move in the direction of abstract mathematical
models and, in particular, models of general equilibrium,
(ii) His disregard for the realism of his basic assumptions on
the grounds that the acid test of his theory is whether it works,
i.e. whether its implications (descriptive, explanatory or pre-
dictive) are confirmed by experience. This is sometimes re-
flected in a tendency to develop sophisticated techniques of
quantification and statistical analysis. In the end, of course,
however powerful the techniques, it is still the empirical validity
of the assumptions which determines the significance of the
statistical conclusions. For example, among the assumptions
that underlie Denison's quantitative analysis of inter-country
differences in growth rates is the assumption that factor pro-
ductivities are measured by factor returns i.e. that wages, for
example, are normally equal to the value of the marginal product
of labour.18 If this is not true (and it is only in perfectly
competitive micro equilibrium that it is a logically defensible
16
M. Friedman, ' T h e Methodology of Positive Economies', in Essays in Positive
Economics (1953), p. 4.
17
G. Myrdal, The Political Element in the Development of Economic Theory (1953),
See the quotation cited in n34, p. 111 above.
18
E. Denison, Why Growth Rates Differ (1967).
19
assumption ) then what Denison explained is not why growth
rates differ but how the calculated growth rates differ on certain
assumptions. It is indeed of the essence of formal equilibrium
analysis that it is more concerned with relationships between
variables than with directions of causation. According to Frank
Hahn for example 'equilibrium theory in general and the neo-
classical theory in particular has nothing causal to say'.20
(iii) Finally, a third hallmark of a positive theorist is a disincli-
nation to take account of changes in motivations, institutions,
information systems, cultural attitudes and indeed of the whole
complex of factors affecting economic ends and associated beha-
viour. Samuelson's theory of revealed preference, for example,
was a typical neo-classical solution to the problem of explaining
consumer behaviour: the trick is to assume that preferences are
revealed by actual choices made in the market - though to do so
leaves one without any explanation for, e.g., lag effects, incon-
sistencies in preferences or collective desires.21
Among the characteristics which distinguish the post-Keynesian
methodology from its neo-classical counterpart are first that the
post-Keynesians have closer affinities to Marxian and Ricardian
methodology than do the neo-classicals. Like Marx's theory of
the evolution of the capitalist system the post-Keynesian type of
model owes little to the mechanical analogies of the neo-classical
system and recognises the possibility of organic change. Again
like Marx, the post-Keynesians favour sociological categories of
analysis (e.g. workers and capitalists) whereas the neo-classical
school restricts itself to producers and consumers and asks
sociologically-oriented questions about the distribution of aggre-
gate income between social classes. They hark back to Ricardo,
and to ideas prevailing before the marginal revolution, in em-
phasising the interdependence of production rather than the
interdependence of markets. They are more interested in
technological and institutional relations, that is to say, than in
19
As Marshall recognised. See e.g. his Principles of Economics, pp. 429-30: 'The*
doctrine that the earnings of a worker tend to be equal to the net product of
his work, has by itself no real meaning; since in order to estimate net product,
we have to take for granted all the expenses of production of the commodity
on which he works, other than his own wages.'
20
F . H . H a h n , The Share of Wages in the National Income, p . 3.
21
Cf. K. Boulding, Economics as a Science, pp. 118-9: 'One of the most
peculiar illusions of economists is the doctrine of what might be called the
"Immaculate Conception" of the indifference curve, that is the doctrine that
tastes are simply given and we cannot inquire into the process by which they
are formed.'
commodity and factor relations. They adopt the Keynesian
assumptions that investment decisions are independent of savings
decisions, that equilibrium depends on savings being equal to
investment, and they explain investment (as Keynes did) in terms
of animal spirits, or expectations, or technical dynamism. They
reject the notion that consumers' sovereignty can ever be effective
so long as the initiative lies with the producer.22 Above all they
reject the timeless aggregative production function approach,
with its assumptions of perfect substitution between factors,
wholly impersonal market relations, perfect knowledge and fore-
sight, and exclusive dependence on prices in information flows.
In place of a production function approach they prefer an
accounting approach in which 'capitalists get what they spend
and workers spend what they get' and where the structural
characteristics of the economy under study can be specified in
principle in considerable detail. Their object is not primarily to
predict but to analyse and explain, and they do not therefore
attempt to force their variables into a readily quantifiable form.23
In the event it has been the neo-classical approach that has so
far offered most scope for the ambitious researcher looking for
specific puzzles to solve with sophisticated mathematical and
statistical tools. Partly because the post-Keynesians have set their
faces against quantifying the unquantifiable, and against manipu-
lating questionable data with powerful mathematical or econo-
metric tools, their growth models remain essentially theoretical
constructs from which their authors may or may not draw a
selection of speculative policy conclusions. Their disciples have
been mainly, like the creators of the models, theoreticians; and
the post-Keynesians have failed to spawn a numerous follow-
ing of applied researchers. Paradoxically enough it is the neo-
classical school with its consciously unrealistic assumptions
that has provided most of the exemplars, and the standardised
rules, and the stock of ready-made puzzles for an endless empiri-
cal research programme; while the 'historical' growth models,
whose assumptions the post-Keynesians have deliberately sought
to make directly relevant to the real world24 have only rarely been
22
J. Robinson, Preface to the 2nd e d n of Economics of Imperfect Competition,
p. xii.
23
Joan Robinson's determinants of equilibrium listed on p. 203, for example,
would be hard to quantify in principle - still harder in practice.
24
Not always convincingly. Cf. Worswick's comments on modern growth
theory: 'Facts hardly ever occur in this literature: the nearest we get is what
Professor Kaldor has called stylised facts, which sometimes means no more than
confronted with real-world data and systematically tested. At the
moment, for example, a research student setting out to investi-
gate empirically a problem in the field of economic growth finds
himself provided with an articulated set of neo-classical theories,
concepts and research tools and a stock of data collected with
these concepts and tools in mind. However convinced he may be
of the superior insight of the heretics, he needs an immense
self-confidence in his own ability to create the tools and the data
to match these untested theories and concepts, and to abandon
the well-stocked neo-classical tool box. Not surprisingly therefore,
the so-called 'new' economic history, for example, is almost
exclusively neo-classical in technique, though the theoretical
concern with a historical approach to the analysis of economic
growth is peculiarly post-Keynesian.
The other major branch of theory in which the route taken
by the heirs to the Keynesian revolution does not seem to lie in
the direction indicated by Maynard Keynes, is in the sphere of
monetary theory. Here the main arena of conflict is between
the Keynesians (widely interpreted), on the one hand, and the
monetarists rather than the general equilibrium theorists on the
other: although both the two latter groups tend to assume that
the price system has a self-equilibrating tendency in the long run
and both tend to stress price-theoretical rather than institutional
factors in explaining the process of inflation. On the other hand,
all three groups are a product of the Keynesian revolution, in that
they pose questions concerned with the process of income
determination, and with levels of aggregate demand and output,
which are not at all the questions that were posed by the tradi-
tional quantity theorists.
New developments in monetary theory are thus currently
proceeding along three main lines.
(i) There is the general equilibrium school, which aims at
producing an integrated theory of money and prices in which the
theory of money is one branch of the theory of prices.25 They
stress the real as opposed to the nominal stock of money and see
convenient assumptions without which determinate solutions of theoretical
problems cannot be obtained' (G. D. N. Worswick, 'Is Progress in Economic
Science Possible?', Economic Journal, March 1972, p. 78).
25
See R. W. Clower (ed.), Monetary Theory, p. 20: 'In all such neo-Walrasian
models money appears as just one among many analytically indistinguishable
commodities in a world where trading activities are costlessly co-ordinated by a
central market authority in such a way that all feasible trades ultimately can be
carried out directly without the use of exchange intermediaries.'
its main effects in inducing a corresponding change in the real
level of domestic expenditure. These ideas hark back to the late
nineteenth-century neo-classicists, and particularly to Walras,
and have a strong abstract mathematical bias.
(2) There is the Keynesian school, which sees financial short-
term assets as being such close substitutes for money that they
are virtually indistinguishable from it. They envisage the effects
of a change in the money supply on expenditure decisions as
taking place through interest rates rather than prices - in the
form of a weakening ripple across the whole range of financial
assets from short to long. In so far as they accept the quantity-
theory formulation of the relation between money supply and
prices, they see the direction of causation running as readily
from an increase in prices to an increase in money supply, as in
the opposite direction.26 The implication of their analysis is that
the effect of monetary policy, taken by itself, on investment or
consumption decisions (and hence on the levels of either econ-
omic activity or prices) is rather weak and unpredictable,27
especially since liquidity preference is highly sensitive to the state.
of expectations and hence unstable. Their views have clear links
with those of the early nineteenth-century Banking School and
with the relatively realistic analysis of J. S. Mill.
(3) Finally, there are the monetarists, for whom money is a
unique kind of asset, substitutable as readily for real as for
financial assets, the demand function for which is in real terms
(i.e. after allowing for the rate of inflation) rather stable. In this
model a change in the money supply will have pervasive direct
effects on all planned expenditures whether on consumer goods,
or investment goods, or financial assets. The implication of this
analysis, which is a modern version of the Currency School
quantity theory, is that monetary policy has a powerful effect (for
good or ill) on the level of economic activity and of prices.
In sum, it is not surprising that the monetarists and the Key-
nesians, for example, fail to agree on monetary theory, because
they are essentially arguing about different concepts within a
different methodological framework. They agree neither about
26
See e.g. Kaldor's view given in evidence before the Radcliffe Committee: ' I t
cannot be emphasized too strongly that there is no direct relationship in a m o d e r n
community between t h e a m o u n t of money in circulation.. . a n d t h e a m o u n t of
money spent on goods a n d services per unit of t i m e ' (Committee on t h e Working
of t h e Monetary System, Principal Memoranda of Evidence, Vol. 3, p . 146).
27
Hence their tendency to advocate incomes policies and/or fiscal policies as
part of the solution for the modern stagflation problem.
'what is money?', for example, nor about what is the mechanism
of the economic system. They take diametrically opposed views
on most methodological issues (equilibrium v. disequilibrium
analysis, for example, or the relevance of institutional factors).
They differ most fundamentally on ideological issues i.e. on the
extent to which the market economy is inherently stable or on
the degree of State intervention which is in principle desirable.
True, some of their assertions and counter-assertions about what
actually happened in the past to key economic variables are
empirically testable and some have actually been tested.28 So some
of the more extreme versions of both theories have been knocked
out of the academic debate: and on some practical policy issues
(e.g. that the lags and complexities in the monetary mechanism
are such as to make monetary policy unsuitable for 'fine tuning'
purposes) there is broad agreement by a majority on both sides.
On the other hand, theoretical disagreements of this funda-
mental kind are not really susceptible to empirical test. For even
where the protagonists can agree on which are the crucial vari-
ables to be tested and how to match the theoretical concepts with
empirical constructs, the economic system does not stand still. So
if, say, the income velocity of money can be shown to have been
relatively stable in the recent past, this does not establish that an
appropriate change in monetary policy, or in institutional factors,
or in expectations, would not cause it to become highly unstable
in the future.
For the applied economist, a viable system of economic theory
is one which structures questions about economic behaviour in
ways that make it possible to generate reliable predictions and
hence successful prescriptions in the problem areas that policy
makers consider important. It is in this respect that orthodox
economics is currently disappointing the professionals. Evidence
for a generalised professional unease can be found in the recent
spate of 'laments for economics' uttered not only by the usual
complainants at orthodox theory (e.g. economic historians and
empirical analysts who lose patience when the theory gets too
abstract or radical economists with their ideological objections)
28
See, e.g. C. A. E. Goodhart, 'The Importance of Money', Bank of England
Quarterly Bulletin (June 1970), e.g. p. 169:' It is no longer possible to aver, without
flying in the face of much collected evidence, that the interest-elasticity of
demand for money is, on the one hand so large as to make monetary policy
impotent, or on the other hand, so small that it is sufficient to concentrate
entirely on the direct relationship between movements in the money stock and
in money incomes while ignoring inter-relationships in the financial system.'
but also by some of the leaders in the economic establishment,
viz the President of the American Economic Association, the
President of the Royal Economic Society, the President of the
Economic Section of the British Association, the President of
the Econometric Society and various 'elder statesmen'.29
Three persistent and interdependent themes have been
stressed in these critiques. They are that substantial further
progress in economic science depends on:
(1) A much broader base of systematically collected data. Mor-
genstern, for example, draws an analogy with the Newtonian
breakthrough which would have been impossible without the
substantial foundation of careful observation and measurement
laid down by preceding astronomers: 'Describing the economy
may be more difficult since we know that our economies are
subject to tremendous and rapid changes, while up to Newton
and for Newton's purposes the sky could be considered static.'30
(2) Opening up the discipline to receive the theories, concepts
and new ideas generated in allied disciplines (e.g. sociology and
psychology). Phelps Brown for example, argues for
the removal of the traditional boundary between the subject matter of
economic and other social sciences. Specialisation there must be, and
there are clearly some activities that are primarily for the economist to
study; but in trying to get to the heart of them he cannot separate
certain propensities as properly economic31from those studied by the
social psychologist or social anthropologist.
(3) Taking account of the fact that economics, like other social
sciences is confronted by a different kind of system from that
under investigation in the physical sciences. Not only is it in a
state of constant flux, its development is subject to a high degree
of uncertainty and auto-correlation. Of all the innovations that
Keynes tried to introduce into economic thought it was the notion
of taking uncertainty into account that proved most difficult to
absorb into the neo-classical paradigm. For a world of uncertainty
is a world in perpetual disequilibrium, and the neo-classical con-
cept of a self-regulating system becomes irrelevant. As a result
29
See e.g. F. H. Hahn, Econometrica(igjo); W. Leontief,' Theoretical Assump-
tions and Non-Observed Facts', American Economic Review (March 1971); E. H.
Phelps Brown, 'The Underdevelopment of Economies', Economic Journal (March
1972); G. D. N. Worswick, 'Is Progress in Economic Science Possible?', Economic
Journal (March 1972); O. Morgenstern, 'Descriptive, Predictive and Normative
Theory', Kyklos (1972); Hahn, op. cit. (1970).
30
Morgenstern (1972), op. cit., p. 701.
31
Phelps Brown (1972), op. cit, p. 7.
the orthodox mainstream economics born out of a marriage of
neo-classical and Keynesian ideas has tended to drop this awk-
ward element overboard. Similarly, positive economics tends to
lose sight of the fact that where the form of an accepted economic
theory is one of the factors determining the economic behaviour
it is supposed to explain, it is hard to rise to the objective
standards possible in the natural sciences. Boulding puts this
point more trenchantly thus: 'objectivity in the sense of inves-
tigating a world which is unchanged by the investigation of it is
an absurdity'.32
Those who have studied Karl Marx's theories may be tempted
to note at this point that his performance on at least two of
these issues was manifestly more promising than mainstream
economic theory has ever been. He was factually better informed
than most modern theorists, less rigidly confined to narrowly
economic concepts and categories, and more dynamic, if also
more deterministic, in his approach to model-building. They may
therefore feel justified in concluding that the new paradigm for
economic science is most likely to emerge out of a development
of the Marxian alternative. Certainly there has recently been a
notable revival of interest in Marx on the part of leading main-
stream theorists33 as well as a resurgence of interest in Marxian
economics among some of the younger economists who - being
'not properly brought up' as Keynes put it, may be more open
to revolutionary new formulations of economic theory than their
elders. On the other hand, the insights into economic and social
behaviour yielded by intensive study of mid-nineteenth-century
conditions in Western Europe, are no more likely to contribute
to a well-founded system of theory appropriate to the later
twentieth century mixed capitalist economy, than the existing
basis of economic information, inadequate though it may be.
The theoretical controversies between the neo-classical and
post-Keynesian schools of thought have also contributed to the
renaissance of interest in Marxian economics, because the latter
have developed a theory of growth and distribution which draws
not only on Keynes but also on Ricardian and Marxian assump-
32
K . B o u l d i n g , Economics as a Science, p . 121.
33
See e.g. Paul Samuelson, Journal of Economic Literature (1971 and 1972). Cf.
also M. Morishima's reinterpretation of Marx: Mane's Economics: A Dual Theory
of Value and Growth, in which he argued that' Marx's theory of reproduction and
Walras' theory of capital accumulation should be honoured together with the
parents of the modern dynamic theory of general equilibrium' (p. 1).
tions. The link with Ricardian economics has been formally
demonstrated in a theoretical essay by Piero Sraff a, Production of
Commodities by Means of Commodities (i960), representing an
attempt to suggest a basis for a theory of value and distribution
outside the framework of marginal analysis. The link with Marx
goes through the Polish Marxian economist Kalecki, whose
macroeconomic dynamic model, originally published in Polish in
1933, foreshadowed many of the ingredients of the Keynesian
system. His visit to England in the late 1930s permitted a cross-
fertilisation of ideas with the immediate Cambridge disciples of
Keynes and as a result, according to Joan Robinson, his Essays
on the Theory of Economic Fluctuations (1939) ' filled several gaps
in Keynes' formulation of the theory of employment'. 34
Which, if any, of the current efforts to formulate a more
effective analytical framework for economics is likely to lay the
foundations of a new paradigm for the discipline it is impossible
to judge. In the end, however, what is necessary to achieve a
revolution in economic ideas, is to convince the conventionally-
trained economist that the new disciplinary matrix not only solves
the newly-important problems, but also deals with the old more
elegantly and effectively than the existing matrix. The new heresy
has to build up an impressive stock of practical research achieve-
ments to its credit before it will dislodge the grip of the
prevailing orthodoxy, and it is useless to reiterate that the latter
fails to provide a meaningful answer to the really significant
problems. While the hard core of the neo-classical research
programme continues to supply the basic kit of techniques,
concepts and theories applicable to a wide range of practical
problems at both the micro and macro level, and while the basic
empirical data continue to be compiled in the appropriate form,
it is hard for graduate students to make the necessary leap to an
alternative macroeconomic framework, however strongly they
feel the need for a problem-shift. As far as the professional
economist is concerned, his vested interests in preserving as much
as possible of the hard-won technical skills in which he had been
trained, makes it likely that the new paradigm will involve a
marriage between schools rather than a total rejection of any one.
34
Joan Robinson, 'Kalecki and Keynes', in Problems of Economic Dynamics and
Planning. Essays in honour of Michal Kalecki, p. 338. See also L. R. Klein's essay on
'The Role of Econometrics in Socialist Economics' in the same volume for a
discussion inter alia of the extent to which the Kalecki model based on Marxian
premises anticipated much of the Keynesian model.
It is probably true also that economists will have to learn a great
deal more about the behaviour of individuals in the economic
aspects of their lives, and about the basic mechanism of the
economic process, before they can begin to formulate better
theories of a kind that are actually testable. It may be that they
will have to abandon their search for axioms and formal theorems
until they can base them on assumptions that are themselves
empirically falsifiable.
FURTHER READING
M. Blaug, The Cambridge Revolution. Success or Failure? (1974).

K. Boulding, Economics as a Science (1970).
R. Clower (ed.), Monetary Theory (1969).
M. Friedman, ' T h e Methodology of Positive Economies', in idem, Essays
in Positive Economics (1953).
F. H. Hahn, ' T h e Winter of our Discontent', Economica (1973)-
G. C. Harcourt, Some Cambridge Controversies in the Theory of Capital
(I972)-
J. R. Hicks, The Crisis in Keynesian Economics (1974).
N. Kaldor, ' T h e Irrelevance of Equilibrium Economies', Economic
Journal (1972).
Milo Keynes (ed.), Essays on Keynes, op. cit.
O. Morgenstern, 'Descriptive, Predictive and Normative Theory', Kykfos
(I972).
M. Morishima, Marx's Economics. A Dual Theory of Value and Growth
('974)-
L. L. Pasinetti, Growth and Income Distribution: Essays in Economic Theory
(1974)-
J. V. Robinson, ' T h e Second Crisis of Economic Theory', American
Economic Review (1972). Also in her Collected Economic Papers, Vol. iv.
P. Sraffa, Production of Commodities by Means of Commodities. Prelude to a
Critique of Economic Theory (19Gb).
INDEX OF NAMES
Allen, R. G. D., 122, 159-60, 162 Davidson, P., 216

Anderson, James, 73-4 Darwin, C , viin, 129
Aquinas, Thomas, 19 De Marchi, N. B., 83n, 92
Aristotle, 1, 90 De Morgan, 95
Ashley, W. J., 91 Denison, E,, 217-18
Ashton, T. S., 59 De Roover, R. 3, 17, 19
Aveling, E., i28n Dobb, M., 23n, 42, 70, i25n, 142
Domar, E., 197-fl, 200, 204
Bacon, F., 104 Duncan, G., 142
Bagehot, W., io4n
Balassa, B., 91 Eagly, R. V., sn, 8
Barbon, N., 3, 20 Eatwell, J., xiv
Bentham, J. R., 71, 87, 95, 126 Edgeworth, F., i22n, 159, 1760
Black, R. D. C , 9on, gsn, 97n, 114 Eltis, W. T., 32n, 42
Blaug, M., ix, xi, 17, 70,82-3,92, Engels, F., 127, 129, 141
226 Eshag, E., 174
Bliss, C. J. i23n
Bohm-Bawerk, E. von, 19011 Fetter, F. W., 59, 83n, 92
Boulding, K., 98, 2i8n, 224n, 226 Feyerabend, P., i88n
Bowley, M., 17, 2on, 22, 84n, 92 Foxwell, H. S., 90, i n , 114
Brown, E. H. Phelps, 223 Friedman, M., 124, 208, 211, 217, 226
Bucdeuch, Duke of, 8n Frisch, R., 196
Buddha, 14511
Burke, Edmund, 12 Gervaise, I., 3
Godwin, W., 82n
Cairncross, A. K., 212 Goodhart, C. A. E., 222n
Campbell, T. D., 7, 17 Goodwin, C. D. W., 97n, 114
Cannan, E., 17,2in, 33n, son, 59, Gossen, H., 94
Cantillon, R. 3, 29 Graunt, J., 2
Chamberlin, E., 155-6 Gregory, T. E., 81 n
Chenery, H., ig6n
Clark, C , i86n Harcourt, G. C, 226
Clower, R. W., 22on, 226 Haberler, G., i83n
Coats, A., 4n, 92, 97n, loon, 114 Hahn, F. H., 204, 218, 223n, 226
Coleman, D. C, 17 Hansen, A., 194-5, 204
Columbus, Christopher, 11 Harrington, R., 59
Confucius, i Harrod, R. F., 176n, 197-200,204,2O7n
Condorcet, Marquis de, 82n Hawtrey, R. G., issn, 168
Corry, B., 54n Hayek, F. A. von, 46n, 59
Cournot, A., 150 Heckscher, E., 4
Cunningham, W., 4 Hegel, G., 127-8
228 Index of names
Henderson, H. D., 18411 Leijonhufvud, A., 172-3, i8on, 187-9,
Herodotus, 86 209, 211 n
Hicks, J. R., 32, 122, 159-60, 162, 172, Lekachman, R., 18m, 189
188, 208, 214, 226 Lenin, i45n
Hobson, ]., 184 Leontief, W., 3on, 43, 139, 223n
Hollander, J. L., 2on, 8in Leslie, T. E. C, 91
Hollander, S., 3, 17, 22 Letwin, W. 3n
Homer, F., 48 Lewis, W. A., 196
Horowitz, D., 142 Lindgren, J. R., 17
Hoselitz, B. F., 29n, 43 Lloyd George, 184
Howard, M. C , 142 Loyd, S, J., see Overstone, Lord
Howey, R. S., 114 Lowe, A., 43
Howson, S., 169, 174
Hume, David, 45 McCulloch, J. R., 71-5, 7gn, 80, 100
Huskisson, W., 48 Macfie, A. L., 7n, 17
Hutcheson, F., 20, 21 Maclver, E. M., 17
Hutchison, T. W., 114 Majumdar, T., 124
Mallet, J. R., 73n
Ingram, J. K., 91 Malthus, T. R., 36,42,53,62,65,66,71,
73. 74n> 77> 79-% 89> 9 2 . I 0 ° . >'5.
Jaffe, W., g6n 131, 194, 207
Jevons, W. S., 90, 9m, 94-7, 100, 10m, Mandeville, B., 29
102, 106-7, " 3 ' "4> I15~l&> I24> '44 Marshall, A., 75, 79,86,9m, 95,97, ggn,
Johnson, E., 174, 188 loon, 102, 107-8, 113-14, u6seq, 124,
125, i32n, 143, I4gseq, i63n, 168—70,
Kahn, R. F., i65n, i67n, 173, 184 176, 186, 189, 190, 2i8n
Kaldor, N., 202, 2ign, 22m, 226 Marx, Karl, 6, 30, 41, 42, 75, 79, 91, 94,
Kalecki, M., 204, 225 125-42, i76n, 190, 191, 215, 218,
Karlin, S., i2n 224
Kaushil, S., 22 Masterman, M., x
Keynes, J. Maynard, 4, 75,83, 92, ggn, Massie, J., 3
102, 114, I23n, 163, 168-g, 172-4, Matthews, R. C. O., 204
176-89, 192, 197, 199, ao6seq, 215, Meade, J., 18m, 212
219-20, 223seq. Meek, R. L., 5n, 17, 2on, 23n, 28,42,70,
Keynes, J.Neville, 102-6, no, 114, 142
144—5, '6i Meng, Tzu, 1
Keynes, Milo, 181 n, 189, 2O7n, 226 Menger, A., i n n
King, Gregory, 2 Menger, C , 95-7, igon
King, J. E., 142 Mill, James, 6on, 66,68,71,77,7811,86-7
Klein, L., 18m, 189, 225n 17611
Knight, F. H., 17 Mill, J. S., 6, 41, 54n, 56-g, 68-g, 86-g2
Koebner, R., i2n 93-4, 97, 104, 106, 108, 109, i n , 115
Kregel, J. A., 204 119, 125, 126, 131—2, 142, 143, 163
Kuczynski, M., 42 i76n, 182, 221
Kung Fu Tse, 1 Mitchell, Wesley, 147
Kuznets, S., i86n Moggridge, D. E. M., 169, 174, i84n
Kuhn, T. S., x, 93, g6n, g9, 100, 104, 188, 189, 2O7n
n, 109, i88n Moore, S., i28n
Morgenstern, O., 223, 226
Laidler, D., 54n, 59 Morishima, M., 224, 226
Lakatos, I., x, xi, i88n Mushet, D., 48
Latsis, S., xi Musgrave, A., x, xi, i88n
Lavington, F., 168 Myrdal, G., i n n , 114, i84n, 217
Index of names 229
Nagel, E., 1 in, 8gn Schmoller, G. von, 4

Newton, I., j , u , 223 Schultz, H., 186
Schumpeter, J. A., vi, 1, 11, 17, 22, 75,
O'Brien, D. P., 23, 72n, 92 77, 9m, iogn, 142, 190-3
Ohlin, B., 167 Schwartz, P., 92
Owen, Robert, 11 in Sen, A. K., 204
Overstone, Lord, 54-n Senior, Nassau, 68-9, 72, 84-5, 88, 92,
93-4, 100, 115, 119
Pareto, V., i22n, 159 Shackle, G. L. S., 162, 1840
Parrish, J. B., Ii3n Shove, G. F., io8n, 114
Pasinetti, L. L., i7gn, 226 Sidgwick, Henry, 157
Pasteur, L., xn Sismondi, J. C. L. Simonde de, 72, 74,
Patinkin, D., I73n, 174, i86n, 189, 132
21411 Skinner, A. S., 7, 17, 18, 32n
Peel, Sir Robert, 54 Slutsky, E., isgn
Pennington, J., 54n Smith, Adam, 2, 4, 5seq, 12, 17, 18,
Petty, Sir William, 2, 128 19-28, 29, 32seq, 36-8, 39, 44, 46-7,
Phillips, A., 3on, 43 60-2, 7iseq, 86, 90, 93, 106, 109, 126,
Pigou, A. C , uon, 114, 121-2, 154, 128, 129, 134, 146, 190, 196
i55n, 168, i76n, 178, 183 Solow, R., i2n
Plato, 1 Spengler, J., 29
Popper, Sir Karl, ix, x, xi, 15-16, 83n, Sraffa, P., 42, 59, 149, 151-2, 155, 162,
i88n,2i5n 225, 226
Postan, M. M., 2i2n Stewart, Dugald, 14, 71, 87
Price, Bonamy, 100 Stigler, G. 66n, 70, ggn, 124,
Price, L. L., Stone, J. R. N., 212
Streissler, E., 97n
Quesnay, F., 5, 6, 30, 42 Suppes, P., i2n
Sweezy, P., 185, 207
Raphael, D. D., 7, 17
Ricardo, David, 21, 26, 28, 38-40, 48, Taylor, W. L., 21, 28
50-5, 58-9, 6oseq, 69, 7iseq, 86-7, Thompson, W., 132
91-2,93-4, 100, 106, 108, 111,115-16, Thornton, Henry, 45seq, 52,53-4,58-g,
122, 125-6, i29seq, 146, i55n, 163-5, 163-4
i76n, 207, 218 Tinbergen, Jan, 186
Robbins, L., ign, 54n, 7gn, 9111, 114, Tooke, T., 53-4, 59, 165
144-9, '6 2 ' '76, 212 Torrens, Robert, 54n, 62, 78-9, 82
Robertson, D. H., 161, 168, 172, 174, Toulmin, S., ixn
178, 212 Tucker, R. C, i27n, 142
Robertson, H. M., 21, 28 Turgot, Baron de, 74
Robinson, E. A. G., 212
Robinson, J. V., xivn, 122, 142, 153-7, Viner, J., 18, 59, 9m
162, 198, 203, 204, 2ign, 225, 226
Rodbertus, J. K., 13a Walras, L., 95-7, 111-12, 113, 114, 117,
Rousseau, J. J., 82n 190, 221, 224n
Ryan, A., 92 West, Sir Edward, 62, 73, 74n
Wheatley, J., 48
Saint-Simon, C.-H., 132 Wicksell, K., 53, 164, 165-8, 171, 174
Samuelson, P., 142, 18m, 20m, 224n Wilson, T., 18, 32n
Say, J. B., 71,74 Winch, Donald, I73n, 174
Sayers, R. S., -jg Worswick, G. D. N., 2ign,
SUBJECT INDEX
abstinence, 69, 119, 131 bullion, 46, 49, 55, 76

accelerator, 197, 199 mint price of, 47, 48, 49, 50
agriculture see also gold, silver
productivity of labour in, Bullion Committee Report, 46n, 48n,
role in economic development, 5,13, 73
3oseq, 37, 39seq bullionist controversy, 48-53
see also surplus, agricultural
allocation theory, 141, 164 calculus
see also resource allocation and opti- differential, 95n, 107
mum resource allocation felicific, 95
anti-bullionist of pleasure and pain, i44n
see bullionist controversy California, 127
American Economic Association, 223 Cambridge, University of, xv, gin, 95,
armchair theory, 84, r 22, 159 102, 155, 161, 168, i84n, 206
assets portfolio analysis, 174, 221 Wranglers, 99
assets, choice of, 180-1 Cambridge (Mass.), 155
astronomy, x, 223 Cambridge School, 169-70, 174, 200,
Aunt Sally, 178 202-3, 2 | 6- 2 2 5. 2 2 6
Australia, 127 capital, 5, 12, 19011, 192
Austrian school, g7n, 190 accumulation of and growth, 30-1,
32seq, 78, 84,
balance of payments, 45-6, 51, 54-5,59, circulating, 66—7
.67 constant, 135-6
Bank Charter Act, 53-6, 58, 169 durability of, 65-7, 115
Bank of England, 45seq, 76, 171 fixed, 40, 65-6, 134, 202
notes see money, paper marginal efficiency of, i23n, 179, 180
Bank of Ireland, 47 malleable, 201-2
Banking School, 53, 59, 221 organic composition of, 135-6
banks overhead, 30
country, 46, 47, 51, 55 return to, 119-20
Scottish chartered, 47 working, 30
Berlin, University, I25n variable, 135-6
biological analogies, 101,110,1 ian, 217 capital-output ratio, ig7seq
sciences, x Carron iron works, 11,12
bourgeois society, 127 Census of population, 37, 82n
economists, 141, 142 cash balance theory, 169-70, 174
Bristol, University of, 102 Cash Payments
British Association for the Advance- Suspension of, 45seq
ment of Science, 94, 100, 223 Resumption of, 165
British Museum, 125, 127 Central Bank, 47-8, 53-4
Brussels, Central Statistical Office, 214
Subject index 231
Charybdis, 44 development economics, 85, 141, 147,

cheques, 56 149, 196
Chicago school, 17 diagrammmatic techniques of analysis,
circular flow of incomes, 192 •57-8
class struggle, 130, 132-3, 139-40 dialectic, 127-8
Classical Greek economic ideas, 1 diamonds, 23
classical school of economics diminishing returns, 37, 40, 41, 63-4,
see political economy, classical 84-5, 98, 108, 150-2, 193, 194
collectivism, 14 diminishing utility
Cologne, I25n see utility
Committees of Secrecy, 46 disciplinary matrix, x, 6, 101, 125, 225
comparative advantage, ig6n see also paradigms
comparative statics, 146, 206 disequilibrium, 167, 178, 182, 184, 191,
competition 208, 222, 223
free or perfect, 98, 101, 105, 121,130, distribution of incomes, 109, 111
149, 150, i52seq theory of, 21-2, 40, 94, 98, 224
imperfect, 122, i53seq in Adam Smith, 22seq
constant returns, 108 in Ricardo, 6oseq, 78seq, 106
consume, propensity to, 179, 194 in neo-classical theory, 118-23
consumers' behaviour, theory of, in Marx, i32seq
q, 218 and propensity to save, 195, 202
sovereignty, 153, 219 Divine Plan, 8, 13
consumption function, 180, 206
convertibility, 48, 54, 55n East India trade, debates on, 4
corn, 26, 32, 38-9, 60, 62-3, 77 • Econometric Society, 223
Corn Laws, 60, 68, 72, 74 econometrics, 186, 196, 219, 225n
credit, 45seq, i64seq, 191-2, 193 Economic Advisory Council, 207
crises economic man, 88n, 92
capitalist, 139, 192 economic science, Jin, 85-6, 93, 104,
economic, 210 148, 157, 175, 181, 190, 215-16
see also methodological crisis 220n, 226
Crusoe, Robinson, 158 economies of scale, 69, 113n, 151
currency depreciation, 49—50 Economistes or Economists see
see also inflation Physiocrats
Currency School, 53, 221 education, 69
cycles in economic activity efficiency, 150
business, 147, 191, 210 elasticity, 120
trade, 147, 190, 210 employment, theory of, 177seq, 225
building, 210 employment
see also growth, fluctuations in full, 177, 179, 201, 210, 211
enclosures, 37
deductive theory see methodology equilibrium
deflation, 44-5, 169, 211 concept of, 11, 154, 182, 208
demand general, 95-6, 112, 117-18, 143, 151,
effectual, 24 187, 208, 217, 220-1, 224n
effective, 179, 180, 183, 197, 206 growth path, igSseq
demand and supply of the firm, I52seq
curves, 112, 117, 122, 124, 150-2, long-run competitive, 113, 116, 119,
'57 2
122-3, ' 5 ' . '53-4' '64. 205
theory of, 3, 95, iO7seq, 122-3, '3 > market prices, 117-18, 136, 149
149-52. 158-61 monetary, 164, i84n
demand-management, 184 partial, 112-13, ii7seq, 143, 150-1,
depreciation, 135
'54-5
232 Subject index
equilibrium (cont.) Haileybury College, 71
theory, lorn, 120, 146, 148, I5oseq, Hamburg, 48
171, 203, 208, 218, 22a, 226 harvests, 24, 45, 49, 51
static-, 153, 15411 Harrod-Domar model, ig7seq
unemployment-, 180 hedonism, 107, 144
theory, 10m, 120, 146, 148, isoseq, Highgate, 129
171, 203, 208, 218, 222, 226 historical
see also disequilibrium approach, 14, 89, 110, 113, 128, 137,
Euclidean geometers, 179 140, 203, 219-20
exchange school, 103
theory of, 116 historicism or historicists, 91, 100, 102,
foreign, 45, 4gseq, 169 104, 105, 109, 111, ii3n, 114, 145
expectations, 121, 170, i8oseq, 188,195, history
201, 203, 208, 219, 221, 222 conjectural, 14
external economies, 152 economic, 110, 113, 144, 220
see also economies of scale Holland, 34
Falkirk, 11 ideological bias or issues in economics,

I0
fiduciary issue, 55-6 xiii, 6, 14, 94, 101, 104-5, 9>
firm I I O - I I , 135, 141-2, 148, 175, 182,
representative, 112, 143, 151—3 204, 209, 211, 213, 215—17, 222
theory of, I52seq income distribution
fiscal policy, 187, 210, 22m see distribution of incomes
fluctuations, industrial incomes policy, 22 m
see cycles increasing costs, 150
foresight, 123, 193, 199, 201, 202, 219 increasing returns, 12, 150-2, 193
see also expectations Indian Currency Committee, 170
France, 32 indifference curve analysis, 120, 122,
Federal Reserve System, 171 159-61, 2i8n
free trade, 175 individualism, 14,93,101,110,111,141,
frontier, geographical, 194-5 '48> '75
inductive theory see methodology
Gatcomb, 87 industrial reserve army, 135
geometry, 89 Industrial Revolution, 12,16,36,44,47,
Glasgow, University of, 8, 20 78, 138
gold, 26, 45, 50-1, 53-4, 56-7, 127 industry, concept of, 156
standard, 46, 55, 164, 167 see also firm, representative
as a measure of value, 67-8 inflation, 44seq, 76, 167, 169, 2it, 213,
see also bullion 221
government intervention, 14, 105, no, innovation, 191 seq, 195
148, 175, 187, 209-10, 212-13, input-output, 30
215-16, 222 Institutionalism or Institutionalists,
see also laissez-faire 145
gravity interest
Newton's law of, 7, 11 theories of, 3,53,76,120,131,164seq,
growth 202, 221
balanced, 13 see also Usury Laws, capital (return
fluctuations in, 139, 147, igiseq, to)
i97seq see also cycles internal drain, 46
knife-edge path of, 200 internal economies, 150
natural, 197-8, 201 see also economies of scale
theory of, 13, 29-42,109-10,120,149, interpersonal comparisons, 147, 149
190-204, 224 inter-war period, 141-2, 143-61, 163,
warranted, 197-8, 201 I7iseq, 209, 210
Subject index 2
33
invisible college, xiv, 78, 141 theory of, 96, 118, 156, 171, 187
invisible hand, 8, 15, 22, 182 -price see price
Marshallian economics, 107-8, 112,
joint products, 69 122, 124, 142, i49seq, i55seq, 206
Just Price, theory of, 1,3, 19, 22 see also Marshall
Marxian or Marxist economics, 16,23n,
Keynesian economics, i8oseq, 187-8, 75, i n , 120, 125-42, I45n, 185,201,
193, 197, 199-201, 207-15, 22oseq, 202, 207, 215, 218, 224, 225, 226
226 mathematics and mathematical tech-
post-, 202-3, 208, 2'6> 218-20, 224, niques in economic analysis, 77,
225 79-80, 83, 89, 95seq, 99-100, 104,
Revolution, 172-4, 175-89, 196, 108,112,143,150,157-8,217,219,221
2O5seq, 215, 220 maximisation
Kirkcaldy, 11 incomes, 84
satisfactions, 94, 99, 122
labour utility, 98, 107, 117
division of, 5, 12, 33, 34, 35 profits, 107, 117, 153
non-competing groups in, 69 mechanical analogies, 95, 107, 108, 110,
proletarian, 132 128, 181, 203, 217, 218
-power, 133-5 mercantilist(s), 1-4, n , 13, 22, 29-30,
specialisation of, 33, 37 32, 36
theory of value see value Methodology
laissez-faire, 14, 18, 32, 56, 71, 93, 101, scientific, 7, 11, 21511
105, no, 111, 141, 148, 175, I76n, in the natural sciences, ix-x, 85, 89
185, 21 in, 216 of scientific research programmes, xi
land, 38, 39, 62, 69, 81, 119 deductive or inductive, 81, 82, 104,
landed gentry, 79-80 no
landlords or landowners, 63, i n , methodological crisis, xiv, 100,101,106,
126, 131, 135 226
liquidity preference, 46, 174, 180, microeconomics, 118, 141, 156, 157,
221 160, 186, 2 0 1 , 2 i i , 215
liquidity trap, 180, 181, 221 model-building in economics, 79, 157,
loanable funds, i64seq, 194 182, 191, 203-4, 217, 219-20, 224
London, i25n, 127 monetary theory and policy, 44-59,
London University, 72 146, 161, 163-74, 209, 210, 220-2,
long period analysis, 118, 169, 174, 206 226
see also time in economics money, marginal utility of, 158-9
see also monetary theory and policy
machinery, 12, 33, 35, 118, 134 money, hot, 167
Ricardo on, 40-1, 64, i36n money, paper, 45seq, 76
Macmillan Committee, 172, 207 monetarism, 51, 53, 59, 163, 208, 2i6n,
macroeconomics, 2, 79, 118, 145, 147, 220
l8
•49- 177. '79. 3> i86seq, 196, 197, monopolistic competition (or market)
201, 2o6seq, 211-14, 216, 225 see monopoly, imperfect competi-
Malthusian population theory, 37, 63 tion
Manchester, 12, 9m, 95n monopoly, 108, 134, 150, I52seq, 193
manufacturing, role in development, -capitalism, 130, 138
33 seq see also competition, imperfect
Marginal Revolution, 21, 93seq, 107, moral restraint, 38
109, 114, 190, 205, 215, 218 moral sciences, 91, 103, 181
marginalism and marginalists, 95n, Tripos, 91 n, 95
97seq, 114, 175, 181, 200, 225 Morning Chronicle, 50, 76
market(s) multiple discovery, 96-7
size of and division of labour, 34-5 multiplier, 180, 184, ig2n, 197, 199
234 Subject index
nailery, 12 Political Arithmeticians, 2, 13
Napoleonic wars, 44, 60, 78 political economy, 3, 6, 13, 20, 44, 63,
National Debt, 171 100, 102-3, I 0 4" I 2 6 , i44n
national income accounts, 146, 183, classical, 37seq, 7iseq, 94, 107, 109,
184, i86n, 196, 202, 214 115, 116-17, 122, I25seq, 129, 135,
National Institute of Economic and 138, 163-5, 169, 176, 190, 191,
Social Research, 213 206
natural law, 111 Political Economy Club, 73, 88, 94, 140
liberty, 13 Population
order, 10 Census of, 37
natural resouces growth of, 36, 62, 64, 68, 72, 194,197
see land Mathusian theory of, 36,37,63-4,82,
natural sciences, xiii, 3, 89, 100, 181-2, 8
4. >35
186 population growth, 62, 64, 68
see also methodology of positive economics, 85, 102-4, 105, 114,
neo-classical theory, 21, 41, 75, 85, 141, 144-5, '47> 216-18, 224, 226
99seq, 115-23, 141, 143-61, 163-74, predictions in economics, 139-40, 170,
q, i8oseq, igoseq, 200-4, 181-2, 186, 188, 201, 202-3, 2I7>
q q 219, 222, 223n, 226
neo-neo-classical economics, 21 o, 216 preferences, consumers', 118, 122, 159
New Deal, 175 revealed, 122, 161, 218
normal science, x, 188 see also indifference curves
normative theory, criteria or implica- Prime Minister's Statistical Section, 214
tions, xi, xii, 13, 92, 103, 105, 109, price, see also value
i2i, 149, 155-6, 216, 217, 226 customary, ig
equilibrium, 117
optimum resource allocation, 98, 101, market and natural, 22, 24seq, 39,65,
121, 123, 149, 153, 156, 191, 197, 116-37
205, 211 real and nominal, 25-6
orthodox economics, 97-8, 100, 102, theory of, 96, 107-8,117-18,120,123,
105-6, 113, 115, 128-9, 137, 142, 132, 136-7, 164, 207, 220
i43seq, 155, 160-1, 165, 171, 172, Tooke's History of, 105
176-7, 178, 185, 187, i8gn, 190, see also Just Price
q production
over-production, 132, 192 mode of, 128
over-saving, 184 process of, 128, 137
Oxford, University of, 72, 84n, 100, social relations of, I2gseq
102 theory of, 95, 98, 120, 153
-functions, 120, 200-1, 204, 210, 216,
paradigm(s) 219
in economics, xii-xiv, 6,13,16,18, 72, productivity, marginal, 23, 117, 119,
74, 86,95seq, 107, 120, 141, i75seq, 121, 123, 202, 217—18
180, 181, 188, 205, 209, 223-5 professional economists, 73, 92, g3~4,
Kuhn's theory of, x-xiv, 93, io5n, 99- '57. 175. l84> 205, 211-12, 225
109, i88n profit(s), 10, 15, 22, 25, 27, 33,35,38-40,
-switch, x, xii, 96-8, 101-2 53,6oseq, 122-3,131-2,134seq, 202
Paris, I25n abnormal, 20
perishable commodities, 24 exploitation theory of, 131, 137
Phillips-curve analysis, 211 falling rate of, 61, 63-4, 125, 138-9
Physiocrats, 2, 5-6, 13, 30-1, 33, 34, 36, normal, 149, ig3
81 share of, 6oseq, 122, 137
pin factory, 12 proletariat, 132, I3g, 140
planning, 123, I48n protectionism, 175
2
Subject index 35
quantitative methods, 104, 186 methodology, x, 7, 11, i88n
see also statistical methods revolution, Kuhn's theory of, x-xiv,
quantity theory of money, 50, 52, 57-8, 100, i88n, 205
i65seq, 183, 208-9, 211, 220-1 scissors analogy, in Marshall, 117
quasi-rent, 119 Scylla, 44
secular stagnation, theories of, 190,
Radcliffe Committee, 221 '93-5
rational research programmes short-period analysis, 39, 118, 169, 206
methodology of, xi see also time in economics
real bills doctrine, 47, 49 silver, 26, 48, 57-8
rent, 10, 14, 22, 25, 27, 6oseq, 73, 132 see also bullion
Ricardian theory of, 62seq, 73-4, social science, 88, 91, 103, 105, 109, 111,
"35n 14411, 214, 223
reparations, 167 paradigms in, xiii
restrictive practices, 195 social harmony, 8, no, 126, 141, 142,
returns, laws of, I4gseq i82~3n
see also constant, increasing, dimini- see also Divine Plan
shing returns social costs or benefits, 121-2
Ricardo memorial lectures, 72 socialist economics, 123, 142, 216,
22 n
Ricardian economics, 75, 83n, 94, 95, 5
115, 146, 163, i76n, 200, 201, specie, 47
2o6n, 224-5 see also bullion
methodology of, 77seq, 83-4,89, 111, stagflation, 22 m
218 standard commodity, 68
see also Ricardo stationary state, 36, 38, 41, 63, 120, 191,
risk-taking, 69, 120, 131, 193
Royal Economic Society, 42, 23 statistical methods, 104, 217
statistical analysis in economics, 186,
satiable wants, law of, 158 ,96
see also utility, diminishing stylised facts, 83, 2ign
saving subsistence level, 38, 64, 135
and growth, 34-5, 40 supply and demand see demand and
and the return to capital, 119 supply
supply of, 164 surplus
and investment, 181 seq, 184, ig3seq, agricultural, 13, 31-2
202, 204, 219 social, 137, 139-40
forced, 192 -value see value
savings-output (or savings-income) Sweden, 171
ratio, ig8seq Swedish School, 171, 184
Say's Law, 35, 177-9, l84> l 8 5
scale, economies of scale technical progress, 12, 38, 40-2, 126,
see economies of scale •33-4. 135-6. I39-4O. I9' s e q.
scarcity, 22
Scholastic economics, 1, 3, 19, 22 textile inventions, 11
science Theory of Moral Sentiments see Adam
definition of, 87 Smith
economics as a, 71, 74, 76, 80, 81, time in economics, 118, 182, 208
88-g2, 93-4, 96, io2seq, 105,181,186 trade cycle see cycles in economic
normal, x, 188 activity
see also economic science trade unions, 195
scientific transformation problem, 137, 142
community of economists, 72-3, 88, Treasury, 207
93-4, 96, 106, 110, 140, 143, 205 view, 179
236 Subject index
uncertainty in economics, 18oseq, 223-4 labour, 2on, 23n, 26-7, 65seq, 106,
unemployment or underemployment, H I , 115-16, 119-20, 125, i33seq
4 6 . "35. '39. Hi. >7'. '73- '75-183> subjective, 95
195, 209, 210 Jevons', 106-8, 116
cyclical, 194 Keynes', 173
involuntary, 177-8 Marshall's ii7seq, I5iseq, i59seq,
technological, 125 168
United States, 171, 175, 177, 194 Marx's, 133-7
urbanisation, 44, 110 Mill's, 68, 106
Usury Laws, 47 Ricardo's, 6oseq, 78seq, 106, 115
usury, 1 Smith's, igseq, 60-2, 65-7,
see also interest value-free economics, xi, 105, 121,141,
utilitarianism, 105 149, 217
utility, 20seq, 94, 98, 107, 116-17, '44 velocity of incomes or money, 169-71,
diminishing, 94, 158 222
measurement of, 122, 124, 158-60 vintage wine, 116
marginal, 95, 98seq, 107, 114, 116, vulgar economics, i76n
117, 118, 158-9, I163
wages, 15, 22, 25, 27, 36, 38, 39,40,46,
value, 6oseq, 115, 116, 119, 178-9
absolute, 68, 106, 115-16, 121 -fund, 32, 39
exchangeable, 22seq, 68, 99, 106-7, -goods, 60
" 7 . 133 Walrasian economics, 143, 208
invariable standard ol, bi neo-, 22on
market, 108 see also Walras
measure of, 23, 25-7, 61-2, 6iseq, War Cabinet Office, 214
64seq, 87, 118 water, 23
surplus-, i28n, i32seq Wealth of Nations, 4, 6, 8, 9seq, 14, 36,
in use, 22, 39, 108 44, 71, 73, 74, 86, 90, 100, 106, 146
see also price see also Adam Smith
value, theory of, welfare theory, 86, iai, 147, 148, 149
cost of production, 23, 27, 65,69,94, Whitehall, 213
116, 136 workers or working class, 126,134,135
classical, 94, 98 see also labour
neo-classical, 115-23 Workers' Educational Association, 214

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MODERN CAMBRIDGE ECONOMICS

THE EVOLUTION OF ECONOMIC IDEAS

Also in the series

Cambridge University Press

Published in the United States of America by

© Cambridge University Press 1978

This publication is in copyright. Subject to statutory exception

First published 1978

A catalogue recordfor this publication is available from the British Library

Library of Congress Cataloguing in Publication Data

ISBN 978-0-521-21928-0 Hardback

Cambridge University Press has no responsibility for the persistence or

The modern Cambridge Economics series, of which this book is

There are basically two approaches to a study of the development

Ideas have been developed about economics - economic con-

active concern for the social esteem of his contemporaries. For

Armed with their instinctive moral virtues or ideals, individuals

tance of the domestic market (rather than the overseas market)

every system which endeavours, either, by extraordinary encourage-

Whatever the philosophical or methodological approach econo-

The word VALUE, it is to be observed, has two different meanings, and

There were thus two aspects of value or price to be explained

The concept of a natural price gives Smith's theory of value a

The value of any commodity, therefore, to the person who possesses

it for other commodities, is equal to the quantity of labour which it

To sum up then: most of the confusion, the textual problems

(2) This 'real price' of each commodity and of the national

This and similar passages have often been adduced as evidence

The leading writers on economic issues - theoretical, empirical

The improvement in the productive powers of useful labour depend,

The keystone of Adam Smith's theory of growth was capital

In sum, the distinctive features of Adam Smith's theory of

The British classical economists who took up the torch which

an excess supply of money in the form of Bank of England notes.

The abnormal inflationary pressures associated with the Napo-

proposition was the further assumption that gold was a 'stan-

By the first decade of the nineteenth century, thanks to Adam

time? For although the formal qualifications of a professional

the fundamental principles that determine the production of wealth

However, as McCulloch went on to point out, there were 'errors'

to illustrate it by reference to the facts of the contemporary world.

This, Schumpeter went on to say, is exactly the same method as

By the 1830s, however, political economy could be regarded

The 'Wealth of Nations' is in many parts obsolete and in all, imperfect.

abstract system of a priori reasoning based on the hypothetical

It is generally accepted that the British classical economists of the

to avoid the tone of a partisan and have sought in the treatment of

THE NEO-CLASSICAL THEORY OF

As we have seen, Ricardo had been concerned by two shortfalls

When at length the true system of Economics comes to be established,

It was left to Alfred Marshall to develop these seminal ideas

In 1867 while Alfred Marshall the young mathematician was busy

'civil society' led him to a reconstruction of orthodox political

Which was a perfect springboard for Marx's exploitation theory

ready seen were less interested in explaining the distribution of

NEO-CLASSICAL ORTHODOXY IN THE

It is the function of an economic theory to bring some aspects

But the problem of course is not merely a problem in mathe-

although, on the face of it, the assumption of imperfect compe-