View source for Finance:Classical economics

{{short description|School of thought in economics}}
{{Economics sidebar}}
{{Capitalism sidebar}}
'''Classical economics''', '''classical political economy''', or '''Smithian economics''' is a school of thought in [[Finance:Political economy|political economy]] that flourished, primarily in [[Place:Kingdom of Great Britain|Britain]], in the late 18th and early-to-mid-19th century. Its main thinkers are held to be [[Biography:Adam Smith|Adam Smith]], Jean-Baptiste Say, David Ricardo, Thomas Robert Malthus, and [[Biography:John Stuart Mill|John Stuart Mill]]. These economists produced a theory of [[Finance:Market economy|market economies]] as largely self-regulating systems, governed by natural laws of production and exchange (famously captured by Adam Smith's metaphor of the invisible hand).

Adam Smith's ''[[Finance:The Wealth of Nations|The Wealth of Nations]]'' in 1776 is usually considered to mark the beginning of classical economics.<ref name="adam">Smith, Adam (1776) An Inquiry into the Nature and Causes of The Wealth of Nations. (accessible by table of contents chapter titles) AdamSmith.org {{ISBN|1-4043-0998-5}}</ref> The fundamental message in Smith's book was that the wealth of any nation was determined not by the gold in the monarch's coffers, but by its national income. This income was in turn based on the labor of its inhabitants, organized efficiently by the [[Social:Division of labour|division of labour]] and the use of accumulated [[Finance:Capital (economics)|capital]], which became one of classical economics' central concepts.<ref>{{Cite book|title=The MIT Dictionary of Modern Economics|publisher=MIT Press|year=1992|editor-last=Pearce|editor-first=David W.|pages=61–62}}</ref>

In terms of economic policy, the classical economists were pragmatic [[Social:Economic liberalism|liberals]], advocating the freedom of the market, though they saw a role for the state in providing for the [[Philosophy:Common good|common good]]. Smith acknowledged that there were areas where the market is not the best way to serve the common interest, and he took it as a given that the greater proportion of the costs supporting the common good should be borne by those best able to afford them. He warned repeatedly of the dangers of monopoly, and stressed the importance of competition.<ref name="adam" /> In terms of [[Finance:International trade|international trade]], the classical economists were advocates of [[Social:Free trade|free trade]], which distinguishes them from their [[Finance:Mercantilism|mercantilist]] predecessors, who advocated [[Finance:Protectionism|protectionism]].

The designation of Smith, Ricardo and some earlier economists as "classical" is due to a canonization which stems from [[Biography:Karl Marx|Karl Marx]]'s [[Philosophy:Critique of political economy|critique of political economy]], where he critiqued those that he at least perceived as worthy of dealing with, as opposed to their "vulgar" successors. There is some debate about what is covered by the term ''classical economics'', particularly when dealing with the period from 1830 to 1875, and how classical economics relates to [[Finance:Neoclassical economics|neoclassical economics]].

== History ==
The classical economists produced their "magnificent dynamics"<ref name=":1">Baumol, William J. (1970) ''Economic Dynamics'', 3rd edition, Macmillan (as cited in Caravale, Giovanni A. and Domenico A. Tosato (1980) ''Ricardo and the Theory of Value, Distribution and Growth'', Routledge & Kegan Paul)</ref> during a period in which [[Philosophy:Capitalism|capitalism]] was emerging from [[Social:Feudalism|feudalism]] and in which the [[History:Industrial Revolution|Industrial Revolution]] was leading to vast changes in society. These changes raised the question of how a society could be organized around a system in which every individual sought his or her own (monetary) gain. Classical political economy is popularly associated with the idea that free markets can regulate themselves.<ref>{{cite book
  | last1 = O'Sullivan
  | first1 = Arthur
  | first2 = Steven M. | last2 = Sheffrin
  | title = Economics: Principles in Action
  | publisher = Pearson Prentice Hall
  | year = 2003
  | location = Upper Saddle River, NJ
  | page = 395
  | isbn = 0-13-063085-3}}</ref>

Classical economists and their immediate predecessors reoriented economics away from an analysis of the ruler's personal interests to broader national interests. [[Biography:Adam Smith|Adam Smith]], following the physiocrat François Quesnay, identified the wealth of a nation with the yearly national income, instead of the king's treasury. Smith saw this income as produced by labour, land, and capital. With property rights to land and capital held by individuals, the national income is divided up between labourers, landlords, and capitalists in the form of wages, rent, and interest or profits. In his vision, [[Finance:Productive and unproductive labour|productive labour]] was the true source of income, while capital was the main organizing force, boosting labour's productivity and inducing [[Finance:Economic growth|growth]].

Ricardo and [[Biography:James Mill|James Mill]] systematized Smith's theory. Their ideas became economic orthodoxy in the period ca. 1815–1848, after which an "anti-Ricardian reaction" took shape, especially on the European continent, that eventually became [[Finance:Marginalism|marginalist]]/neoclassical economics.<ref>Screpanti and Zamagni (2005), pp. 100–04.</ref> The definitive split is typically placed somewhere in the 1870s, after which the torch of Ricardian economics was carried mainly by [[Finance:Marxian economics|Marxian economics]], while neoclassical economics became the new orthodoxy also in the English-speaking world.

Henry George is sometimes known as the last classical economist or as a bridge. The economist Mason Gaffney documented original sources that appear to confirm his thesis arguing that neoclassical economics arose as a concerted effort to suppress the ideas of classical economics and those of Henry George in particular.<ref>{{cite book | last = Gaffney | first = Mason | title = The corruption of economics | publisher = Shepheard-Walwyn in association with Centre for Incentive Taxation | location = London | year = 2006 | isbn = 0856832448 | url = http://w.masongaffney.org/publications/K1Neo-classical_Stratagem.CV.pdf | access-date = 2014-12-06 | archive-url = https://web.archive.org/web/20150612095955/http://w.masongaffney.org/publications/K1Neo-classical_Stratagem.CV.pdf | archive-date = 2015-06-12 | url-status = dead }}</ref>

=== Modern legacy ===
Classical economics and many of its ideas remain fundamental in economics, though the theory itself has yielded, since the 1870s, to neoclassical economics. Other ideas have either disappeared from neoclassical discourse <!-- Post-Keynesians especially advocate this; see section below on debate & Sraffans, and lectures by Steve Keen on history of economics --> or been replaced by [[Finance:Keynesian economics|Keynesian economics]] in the [[Finance:Keynesian Revolution|Keynesian Revolution]] and [[Finance:Neoclassical synthesis|neoclassical synthesis]]. Some classical ideas are represented in various schools of [[Finance:Heterodox economics|heterodox economics]], notably [[Social:Georgism|Georgism]] and [[Finance:Marxian economics|Marxian economics]] – Marx and Henry George being contemporaries of classical economists – and Austrian economics, which split from neoclassical economics in the late 19th century. In the mid-20th century, a renewed interest in classical economics gave rise to the [[Social:Neo-Ricardianism|neo-Ricardian school]] and its offshoots.

== Classical international trade economics ==
[[Biography:Adam Smith|Adam Smith]] refuted [[Finance:Mercantilism|Mercantilist]] thought with his most influential publication: ''[[Finance:The Wealth of Nations|An Inquiry into the Nature and Causes of the Wealth of Nations]]''.<ref name="adam" /> He argued against mercantilism, and instead favored free trade and free markets, while believing that this would favor the countries who participate in [[Social:Free trade|free trade]]. He elucidated that mercantilist policies would benefit domestic producers but not the country because it prevents consumers buying products at competitive prices, therefore directing cashflow ineffectively. Smith believed that deviating from free trade costs society in a similar manner as to how monopolies negatively affect competition in a market.

During the classical era and after Adam Smith, David Ricardo became a prominent economist with thoughts on international trade. Ricardo’s most famous economic theory was the theory of [[Finance:Comparative advantage|comparative advantage]] as the foundation of the international division of labor. He argued that international trade, in any case, would increase the [[Finance:Standard of living|standard of living]].<ref name=":1" /> His main idea on international trade was that while it does add to real output produced in a country, the main benefits are derived from the encouragement of specialization and the [[Social:Division of labour|division of labor]] on an international scale, leading to a more effective use of resources in all countries involved. One of Ricardo’s greatest assumptions and observations was that the [[Finance:Factors of production|factors of production]] are immobile between countries while [[Finance:Finished goods|finished goods]] are perfectly mobile, this assumption was critical to depict the advantages of international trade and specialization. His theory on international trade was weakened by how the [[Finance:Labor theory of value|labor theory of value]] clashes with the theory of comparative advantage. Ultimately both theories collide with a question on how the price is relatively determined and Ricardo simply stated that it does not hold in [[International trade theory|international trade theory]].

[[Biography:John Stuart Mill|John Stuart Mill]] would later come and solve this dilemma and further build upon Ricardo’s theory of comparative advantage. John Stuart Mill’s contribution to Ricardo’s theory of comparative advantage came about when he introduced [[Finance:Demand|demand]] to the equation. Mill introduced demand and was the first to promote the idea that demand and supply are functions of price, and the market equilibrium is where price is adjusted to where there is equilibrium between supply and demand.<ref name=":0" /> Overall, prior to Adam Smith and the classical economic wave, the main view of international trade was viewed negatively and not in favor of the countries who would participate in international trade with the economic policies of mercantilism. However, once Adam Smith, David Ricardo, and John Stuart Mill arrived with the classical wave of economics, international trade came to be viewed favorably and ultimately beneficial for all parties involved.

== Classical theories of growth and development ==
Analyzing the growth in the wealth of nations and advocating policies to promote such growth was a major focus of most classical economists. However, [[Biography:John Stuart Mill|John Stuart Mill]] believed that a future stationary state of a constant population size and a constant stock of capital was both inevitable, necessary and desirable for mankind to achieve. This is now known as a [[Social:Steady-state economy#John Stuart Mill's concept|steady-state economy]].<ref name=":0">{{cite book |last=Mill |first=John Stuart |edition=1st |date=2009 |orig-date=1848 |title=Principles of Political Economy. |url=http://www.gutenberg.org/files/30107/30107-pdf.pdf?session_id=2baaf051b057c6668713c94f36f64953633a6610 |format=PDF contains full book |location=Salt Lake City, UT |publisher=Project Gutenberg }}</ref>{{rp|592–96}}

[[Biography:John Hicks|John Hicks]] & Samuel Hollander,<ref>Hicks, John and Samuel Hollander (1977) "Mr. Ricardo and the Moderns", ''Quarterly Journal of Economics'', V. 91, N. 3 (Aug.): pp. 351–69</ref> [[Biography:Nicholas Kaldor|Nicholas Kaldor]],<ref>Kaldor, Nicholas (1956) "Alternative Theories of Distribution", ''Review of Economic Studies'', V. 23: pp. 83–100</ref> [[Biography:Luigi Pasinetti|Luigi L. Pasinetti]]<ref>Pasinetti, Luigi L. (1959–60) "A Mathematical Formulation of the Ricardian System", ''Review of Economic Studies'': pp. 78–98</ref><ref>Pasinetti, Luigi L. (1977) ''Lectures on the Theory of Production'', Columbia University Press</ref> and Paul A. Samuelson<ref>Samuelson, Paul A. (1959) "A Modern Treatment of the Ricardian Economy", ''Quarterly Journal of Economics'', V. 73, February and May</ref><ref>Samuelson, Paul A. (1978) "The Canonical Classical Model of Political Economy", ''Journal of Economic Literature'', V. 16: pp. 1415–34</ref> have presented formal models as part of their respective interpretations of classical political economy.

== Value theory ==
Classical economists developed a [[Finance:Theory of value (economics)|theory of value]], or price, to investigate economic dynamics. In political economics, value usually refers to the value of exchange, which is separate from the price.<ref name=":0" /> William Petty introduced a fundamental distinction between [[Finance:Market price|market price]] and natural price to facilitate the portrayal of regularities in prices. Market prices are jostled by many transient influences that are difficult to theorize about at any abstract level. Natural prices, according to Petty, Smith, and Ricardo, for example, capture systematic and persistent forces operating at a point in time. Market prices always tend toward natural prices in a process that Smith described as somewhat similar to gravitational attraction.

The theory of what determined natural prices varied within the Classical school. Petty tried to develop a par between land and labour and had what might be called a land-and-labour theory of value. Smith confined the labour theory of value to a mythical pre-capitalist past. Others may interpret Smith to have believed in value as derived from labour.<ref name="adam"/> He stated that natural prices were the sum of natural rates of wages, profits (including interest on capital and wages of superintendence) and rent. Ricardo also had what might be described as a cost of production theory of value. He criticized Smith for describing rent as price-determining, instead of price-determined, and saw the labour theory of value as a good approximation.

Some historians of economic thought, in particular, [[Biography:Piero Sraffa|Sraffian]] economists,<ref name="Bharadwaj">Krishna Bharadwaj (1989) "Themes in Value and Distribution: Classical Theory Reppraised", Unwin-Hyman</ref><ref name="Garegnani">Pierangelo Garegnani (1987), "Surplus Approach to Value and Distribution" in "The New Palgrave: A Dictionary of Economics"</ref> see the classical theory of prices as determined from three givens:
# The level of outputs at the level of Smith's "effectual demand",
# technology, and
# wages.
From these givens, one can rigorously derive a theory of value. But neither Ricardo nor Marx, the most rigorous investigators of the theory of value during the Classical period, developed this theory fully. Those who reconstruct the theory of value in this manner see the determinants of natural prices as being explained by the Classical economists from within the theory of economics, albeit at a lower level of abstraction. For example, the theory of wages was closely connected to the theory of population. The Classical economists took the theory of the determinants of the level and growth of population as part of Political Economy. Since then, the theory of population has been seen as part of [[Demography]]. In contrast to the Classical theory, the following determinants of the neoclassical theory value are seen as exogenous to [[Finance:Neoclassical economics|neoclassical economics]]:
# tastes
# technology, and
# endowments.

Classical economics tended to stress the benefits of [[Social:Free trade|trade]]. Its theory of value was largely displaced by marginalist schools of thought which sees "[[Finance:Use value|use value]]" as deriving from the [[Finance:Marginal utility|marginal utility]] that consumers finds in a good, and "[[Finance:Exchange value|exchange value]]" (i.e. natural price) as determined by the marginal [[Finance:Opportunity cost|opportunity]]- or disutility-cost of the inputs that make up the product. Ironically, considering the attachment of many classical economists to the free market, the largest school of economic thought that still adheres to classical form is the [[Finance:Marxian economics|Marxian]] school.

== Monetary theory ==
British classical economists in the 19th century had a well-developed controversy between the [[Finance:British Banking School|Banking]] and the [[Finance:British Currency School|Currency School]]. This parallels recent debates between proponents of the theory of [[Finance:Endogenous money|endogeneous money]], such as [[Biography:Nicholas Kaldor|Nicholas Kaldor]], and [[Finance:Monetarism|monetarists]], such as [[Biography:Milton Friedman|Milton Friedman]]. Monetarists and members of the currency school argued that banks can and should control the supply of money. According to their theories, inflation is caused by banks issuing an excessive supply of money. According to proponents of the theory of [[Finance:Endogenous money|endogenous money]], the supply of money automatically adjusts to the demand, and banks can only control the terms and conditions (e.g., the rate of interest) on which loans are made.

== Debates on the definition ==
The [[Finance:Theory of value (economics)|theory of value]] is currently a contested subject. One issue is whether classical economics is a forerunner of [[Finance:Neoclassical economics|neoclassical economics]] or a school of thought that had a distinct theory of value, distribution, and growth.

The period 1830–1875 is a timeframe of significant debate. [[Biography:Karl Marx|Karl Marx]] originally coined the term "classical economics" to refer to [[Finance:Ricardian economics|Ricardian economics]] – the economics of David Ricardo and [[Biography:James Mill|James Mill]] and their ''predecessors'' – but usage was subsequently extended to include the ''followers'' of Ricardo.<ref name="keynes11">''The General Theory of Employment, Interest and Money,'' [[Biography:John Maynard Keynes|John Maynard Keynes]], Chapter 1, [http://www.marxists.org/reference/subject/economics/keynes/general-theory/ch01.htm#1 Footnote 1]</ref>

[[Social:Neo-Ricardianism|Sraffians]], who emphasize the discontinuity thesis, see classical economics as extending from Petty's work in the 17th century to the break-up of the Ricardian system around 1830. The period between 1830 and the 1870s would then be dominated by "vulgar political economy", as Karl Marx characterized it. Sraffians argue that: the wages fund theory; Senior's [[Finance:Abstinence theory of interest|abstinence theory of interest]], which puts the return to capital on the same level as returns to land and labour; the explanation of equilibrium prices by well-behaved supply and demand functions; and [[Finance:Say's law|Say's law]], are not necessary or essential elements of the classical theory of value and distribution. Perhaps Schumpeter's view that John Stuart Mill put forth a half-way house between classical and neoclassical economics is consistent with this view.

[[Social:Georgism|Georgists]] and other modern classical economists and historians such as [[Biography:Michael Hudson (economist)|Michael Hudson]] argue that a major division between classical and neo-classical economics is the treatment or recognition of economic rent. Most modern economists no longer recognize land/location as a factor of production, often claiming that rent is non-existent. Georgists and others argue that economic rent remains roughly a third of economic output.

Sraffians generally see Marx as having rediscovered and restated the logic of classical economics, albeit for his own purposes. Others, such as Schumpeter, think of Marx as a follower of Ricardo. Even Samuel Hollander<ref name="Hollander2000">Samuel Hollander (2000), "Sraffa and the Interpretation of Ricardo: The Marxian Dimension", "History of Political Economy", V. 32, N. 2: 187–232 (2000)</ref> has recently explained that there is a textual basis in the classical economists for Marx's reading, although he does argue that it is an extremely narrow set of texts.

Another position is that neoclassical economics is essentially continuous with classical economics. To scholars promoting this view, there is no hard and fast line between classical and neoclassical economics. There may be shifts of emphasis, such as between the long run and the short run and between [[Finance:Supply and demand|supply and demand]], but the neoclassical concepts are to be found confused or in embryo in classical economics. To these economists, there is only one theory of value and distribution. Alfred Marshall is a well-known promoter of this view. Samuel Hollander is probably its best current proponent.

Still another position sees two threads simultaneously being developed in classical economics. In this view, neoclassical economics is a development of certain exoteric (popular) views in Adam Smith. Ricardo was a sport, developing certain esoteric (known by only the select) views in Adam Smith. This view can be found in W. Stanley Jevons, who referred to Ricardo as something like "that able, but wrong-headed man" who put economics on the "wrong track". One can also find this view in Maurice Dobb's ''Theories of Value and Distribution Since Adam Smith: Ideology and Economic Theory'' (1973), as well as in Karl Marx's ''[[Finance:Theories of Surplus Value|Theories of Surplus Value]]''.

The above does not exhaust the possibilities. John Maynard Keynes thought of classical economics as starting with Ricardo and being ended by the publication of his own ''General Theory of Employment Interest and Money''. The defining criterion of classical economics, on this view, is [[Finance:Say's law|Say's law]] which is disputed by [[Finance:Keynesian economics|Keynesian economics]]. Keynes was aware, though, that his usage of the term 'classical' was non-standard.<ref name="keynes11" />

One difficulty in these debates is that the participants are frequently arguing about whether there is a non-neoclassical theory that should be reconstructed and applied today to describe capitalist economies. Some, such as Terry Peach,<ref name="Peach">Terry Peach (1993), "Interpreting Ricardo", Cambridge University Press</ref> see classical economics as of antiquarian interest.

==See also==
{{div col}}
* [[Finance:Classical general equilibrium model|Classical general equilibrium model]]
* [[Philosophy:Classical liberalism|Classical liberalism]]
* Constitutional economics
* [[Finance:Neoclassical economics|Neoclassical economics]]
* Perspectives on capitalism
* [[Finance:Political economy|Political economy]]
{{div col end}}

== References ==
=== Citations ===
{{Reflist}}

=== Sources ===
{{refbegin}}
* Mark Blaug (1987). "classical economics," ''[[The New Palgrave Dictionary of Economics]]'', v. 1, pp.&nbsp;414–45.
* _____ (2008). "British classical economics," ''[[The New Palgrave Dictionary of Economics]]'', 2nd Edition. [http://www.dictionaryofeconomics.com/article?id=pde2008_C000157&q=classical&topicid=&result_number=6 Abstract.]
* Samuel Hollander (1987). ''Classical Economics''. Oxford: Blackwell.
* Ernesto Screpanti and Stefano Zamagni (2005). ''An Outline of the History of Economic Thought''. Oxford University Press.
{{refend}}

==Further reading==
* {{cite book |last=Cochrane |first=James L. |chapter=Classical Macroeconomics |title=Macroeconomics Before Keynes |url=https://archive.org/details/macroeconomicsbe00cochrich |url-access=registration |location=Glenview |publisher=Scott, Foresman & Co. |year=1970 |pages=[https://archive.org/details/macroeconomicsbe00cochrich/page/23 23–42] |oclc=799965716 }}
* {{cite encyclopedia |last=Skousen |first=Mark |editor-first=Ronald |editor-last=Hamowy |encyclopedia=The Encyclopedia of Libertarianism |title=Classical Economics |url= https://books.google.com/books?id=yxNgXs3TkJYC  |year=2008 |publisher= [[Company:SAGE Publishing|SAGE]]; [[Organization:Cato Institute|Cato Institute]] |location= Thousand Oaks, CA |doi=10.4135/9781412965811.n47 |isbn= 978-1412965804 |oclc=750831024| lccn = 2008009151 |pages=71–73 }}

==External links==
*[https://www.britannica.com/eb/article-9024233/classical-economics Classical economics], ''Encyclopædia Britannica''

{{History of economic thought}}
{{Economics}}

[[Category:Classical economics| ]]

{{Sourceattribution|Classical economics}}