History of Economic Doctrines

Seminar 8

Jeremy Bentham - 1748-1832

A lawyer, not an economist per se; Bentham was focused on reforming the criminal justice system. Bentham believed that:

Criminals are merely trying to maximize their utility--get their jollies?
"The punishment should fit the crime;" i.e., punishment should be proportional to the harm done.

Bentham reintroduced utilitarianism, which was a "new" version of the Epicureanism of ancient Greece. In Bentham's version, the utilitarian philosophy favored social policies that would yield "the greatest good for the greatest number of people." [Actually a quote from Helvetius.]
One objection to utilitarianism, from the Russian novelist Fyodor Dostoyevsky: If everyone else on earth would gain if you cruelly tortured an innocent baby to death, should you do so? Many (most?) of us would say, "NO!"
Nevertheless, many social policies in all societies are based at least in part on utilitarian principles.

Thomas Robert Malthus - 1766-1834

Malthus was a minister who theorized that uncontrollable population growth dooms humankind to a razor's edge existence. The pessimism in Malthus's work account for a widspread assumption that it inspired the English historian and essayist Thomas Carlyle to condemn economics as the dismal science. This has been shown to be incorrect. The fact is that Carlyle was a racist who coined the "dismal science" label when he attacked John Stuart Mill’s book, On Liberty, which advocated an end to slavery, with equal rights for all men and women, and guarantees of rights to privacy, and freedom of speech, religion, and the press.

Malthus and Aggregate Demand

In a long-running disagreement with David Ricardo, Malthus’ emphasized swings in business activity as resulting from "underconsumption" by the wealthy (the poor consumed all their income), which led to "gluts." Malthus' notion of "gluts" was a precursor of the emphasis on Aggregate Demand that is central to Keynesian economics.

Malthus believed that disparities in the distribution of income could leave some production unpurchased. In his view, the poor would be forced to spend all their income to survive, but the rich, once they satisfied their desires for luxuries, might not spend all of their income, raising a potential specter of "underconsumption." This idea is echoed in Karl Marx’s theory of business cycles, and Malthus’s concerns that aggregate demand might be inadequate to ensure full employment was cited by John Maynard Keyes as an early insight into some concepts Keynes expressed in his General Theory (1936).

Important Point: Production generates income for the producer, so production (GDP?) = income (national income?).

Theory of Population

This was Malthus’s major contribution - he claimed that people are instinctively prone to breeding surplus.

Human growth is exponential, while growth in the food supply is not.
Population may initially grow at an increasing rate, but tops off at the carrying limit of the environment.
Natural state of economy: living on a razor’s edge; any good times will not last. In the long run, the population reaches a desperately overcrowded state, and people will be on the brink of starvation. Wars over territory erupt.
Malthus identified as positive checks on population such events as war, disease, famine, and pestilence. The only preventive check that Malthus favored was abstinence, but he was skeptical that this would work. Malthus vehemently opposed such preventive checks as birth control or abortion.
Ex: This graph illustrates how life descends to a desperate state:
When rabbits were first released in Australia each had plentiful resources and faced few natural predators. Thus, the population explodes and this in turn, starts putting pressure on the limits of the habitat and only the strong survive. The dogs released by the aborigines when they arrived in Australia centuries earlier had become Australian wolves - dingoes. When rabbits became plentiful, the dingo population grew as an echo of the explosive growth path of rabbits. Both populations ultimately reach the desperate state.
Malthus’ theory eventually influenced many other disciplines, and inspired Charles Darwin’s theory of evolution.
Social Darwinism- we owe nothing to the rest of human kind; the best will survive and the inferior will sink to the bottom. Some social Darwinists [eugenicists?] proclaimed that human beings over time will get weaker due to our increased care for the sick and disabled. This view hardens the hearts of those advocates of capitalism who believe that people owed no one anything. [Ex: Ayn Rand and some libertarians.]

Aside: Jonathon Swift’s A Modest Proposal advocated eating Irish children to solve Ireland’s famines.

Another Aside: The Malthusian specter is constantly raised. An example is Paul Ehrlich’s book The Population Bomb which predicted overpopulation in Africa, Asia, and South America.

1976 -- Economist Julian Simon challenged the dire predictions of Paul Ehrlich, the author of The Population Bomb, a best seller. Because of a view that population would press against the carrying capacity of the environment, Ehrlich had predicted skyrocketing prices for basic resources and minerals (e.g., oil, copper, iron). Simon allowed Ehrlich to choose 10 basic resources, and they made a bet about future prices. Simon won by predicting that, after adjusting for inflation, these mineral prices would not increase over the period 1976-1986. Simon won handily, because the price of each of these resources fell, even before allowing for inflation.

NOTE: Ben Wattenberg and some other demographers cite recent slowing of the growth of population to support their predictions that the world’s population will stabilize at roughly 9 billion over the next century or so.

Why did Malthus’ dire predictions not come true?

Malthus did not foresee that (1) technology growth or (2) birth control would be likely checks to the population.

Technological advances: Malthus severely underestimated the rate of technological advance, especially in agriculture, which has, on average, outstripped the growth of population.
Birth control:
1. Malthus viewed this as immoral and unacceptable
2. Abstinence is the only way out, but it will likely not work to curb population growth.

Two views of children

Children as investment goods:
1. Example: in agriculture, children can help work in the fields.
2. Retirement: Parents can "guilt-trip" children into being homemade pensions.
Children as consumption goods.
1. If people are prosperous, children are closer to consumption good.

Sociobiology: With a greater percentage of children surviving fewer children are needed to pass genes forward. Therefore, improving child survival decreases the need for many children.

Women’s income:

Malthus saw women as passive non-decision makers (inferior?)
If prosperity increases, the opportunity for women’s income increases, resulting in an increase in the opportunity cost of having children.

Children are [statistically] inferior goods:

If income increases and a person consumes more of a product, then the product is a normal good.
If income increases and a person consumes less of a product, then the product is an inferior good.

Issue: Poor people have more children than do prosperous people. Are children inferior goods?

Birth control appears to be income elastic.
The opportunity cost of having a baby for a successful working mother who enjoys her job is greater than that of a poor mother who doesn’t enjoy her job or have a successful career.
There is a diminishing marginal utility for children, so the wealthier women stop having them after a relatively small number.
Males in most species don’t care for their young as much as females because males can have more offspring than females. [Sociobiology explanation.]
Thomas Shelling at Harvard has done simulations for populations in which people choose the sex of only their first child. Assumes that, say, one-fourth of parents will at first choose boys because they will ensure the future welfare of the family. However, the lack of girls will ultimately create demand for girls and change the cycle in the girls’ favor
Example: The one-child policy in China led to female infanticide because boys were perceived as better providers when parents reached old age. However, as women become scarcer, people are shifting back to choosing girls to ensure that they will have grandchildren who will care for them, or perhaps for reasons of sociobiology.
Conclusion: Prosperity cuts rate of population growth while leading to longer lifespan due to better health care. In turn, the population is stabilizing.

David Ricardo - 1772-1823

Although David Ricardo is undoubtedly best known today for his development of the law of comparative advantage, he analyzed numerous other issues with logic that imparted a distinctly Ricardian flavor to much subsequent analysis that lingers to this day.

Ricardo’s "Iron Law of Wages"

David Ricardo hypothesized a fixed wages fund that is set before the production period. All income in excess of the wages fund goes to landowners as business profits and interest. Thus, the wage rate (set in the graph below) is inversely proportional to the supply of labor.

[In modern parlance, Ricardo’s demand curve for labor is a rectangular hyperbola. Each rectangle drawn from a point on the curve to the two axes absorbs the same area as any other rectangle so drawn.]

Ricardo relied heavily on a variant of Thomas Malthus’ theory of population. He assumed that the supply of labor would be influenced primarily by the size of the population so that wages would tend to be close to subsistence levels in the long run.

Ricardo’s Theory of Land Rent

Suppose there are various types of land ranging from hostile (ex: Arctic tundra or Gobi desert) to hospitable (ex: fertile American Midwest) and that a tenant farmer, located at the edge of the productive land must rent from a landlord. Ricardo terms the area at the border dividing productive from hostile land as "marginal land."

Ricardian Land Rent

Land at the margin draws zero economic rent because any attempt by a landlord to collect rent will cause the tenant to move to slightly worse land. Given this, Ricardo concluded that rent is positively [proportionally?] related to the productivity of more fertile land relative to the marginal land.

Suppose a plot of productive land produces 100 bushels, while marginal land produces only 20 bushels of wheat. The land owner will receive 80 bushels for rent of land. Landowners cannot charge for land at the margin because the renter will just move right outside of the productive land and produce roughly 20 bushels. Furthermore, competition among peasants will ultimately drive rent for the productive land to 80 bushels given 100 bushels of production.
Rent and the Corn Laws: England’s Corn Laws were barriers that protected British grain producers from foreign competitors. Thomas Malthus favored the Corn Laws, asserting that high prices helped peasant farmers. On the opposite side, David Ricardo viewed land rent as an unearned surplus and opposed the Corn Laws, arguing that higher prices for grain increased the cost of food to workers and merely increased the rental incomes of landlords.

Ricardian Income Distribution

Note: The enclosure movement in England (roughly 1500-1850) closed common lands and created a system of private land ownership whereby peasants were kicked off the land or charged rent to maintain small farms.

ASIDE: von Thünen - An Alternative Theory of Rent

Johann Heinrich von Thünen (1780-1850) helped explain why very fertile land in the middle of nowhere is usually much cheaper than less fertile land in a more favorable location. He argued that the value of rent was based largely on the location of land and its ability to decrease transaction costs. Although fertility does play a role in determining land rent, it seems clear today that von Thünen’s theory is far more general, and far superior, to Ricardo’s theory of land rent. [See Ronald Coase for a more detailed treatment of the theory of transaction costs.]

Ricardo on Taxation

Land Taxes:

Ricardo’s characterization of land rent as an unearned surplus hinted that taxing rents would not alter the productive use of land. This strand of thought was expanded by the American economic thinker Henry George (1839-1897), who asserted that a "Single Tax" on land rent would be adequate to pay for all of government.

Ricardian Equivalence

The size of the government is determined by how much government spends on goods and resources (relative to national income, or "shmoo"). If the economy is at full employment, government spending reduces private consumption and investment. How the government finances its spending is irrelevant. [See the crowding-out hypothesis for more discussion of this perspective.]

Federal Government Budget Constraint:

G = T + ΔB + ΔMB

The federal government can cover its spending by Taxing, borrowing (bonds), or by printing Money. [Government Spending = Taxes + Change in national debt + Change in Monetary Base*]

Aside: Printing monetary base (currency or bank reserves) results in an even larger increase in the money supply because banks make loans when they get new deposits. These loans become "demand deposits" (checking account money) when the banks make the loans. Thus, the "new money" (sometimes called "hot money") printed by the government goes through a money multiplier process. In the United States, the Treasury Department printed this "new money" until 1951, at which time the Federal Reserve System took over the issuance of new money.

government budget constraint

State and local governments must tax or borrow to cover their outlays. The federal government budget constraint is a mathematical specification that total federal outlays (the sum of its spending on goods and services, plus transfer payments and interest on debt) must equal the sum of (a) tax revenues (including funds secured through the sales of assets), (b) net new national debt (bonds issued by the Treasury and held by parties external to the federal government), and (c) new monetary base (cash in the hands of the non-banking public plus reserves in the banking system). In rough summary, federal outlays are financed by taxing, borrowing, or printing. If G = outlays and T = taxes and B = bonds (national debt) and MB = the monetary base, then the federal budget constraint is G = T + ΔB + ΔMB. Note that this equation dispenses with the legal fiction that the Federal Reserve System is not an agency of government. For the purposes of the budget, the Fed’s open market operations determine the respective parts of government spending not covered by taxes but which are covered by borrowing and "printing." See also fiscal federalism.

budget deficits

A budget deficit exists when government revenue is less than its outlays, and may be financed by the federal government: (a) by having the Treasury issue bonds, which entails an increase in government debt, or (b) by printing new money (monetary base), whereby the central bank purchases the Treasury bonds. The budget equation for the federal government can be summarized as G = T + ΔB + ΔMB. In the United States, whether the budget deficit (G-T) is covered by net new national debt (Δ in Treasury bonds) or by printing monetary base (ΔMB) is determined by the open market operations of the Federal Reserve System.

Lesson: Want smaller government? Tax cuts won’t work. Government spending must be decreased to reduce the size of government.

Flaw: Ricardo did not consider the possibility of a less-than-fully employed economy. A Keynesian multiplier effect may cause national income to grow more than proportionally when government spending is increased. [See fiscal policy and the Great Depression for discussion.]

These web pages are significantly edited and elaborated versions of student notes based on lectures by Ralph Byrns, 2002-2006.