Adams Smith’s Contribution to Economics
The Philosophy of Free Markets
The philosophy of free markets emphasizes minimizing the role of government intervention and taxation in the free markets. Although Smith advocated for a limited government, he did see the government as responsible for the education and defense sectors of a country. From Smith comes the idea of the “invisible hand” that guides the forces of supply and demand in an economy. Every person, by looking out for themselves, inadvertently helps to create the best outcome for all. By selling products that people want to buy, a hypothetical butcher, brewer, and baker in this economy hope to make money. If they are effective in meeting the needs of their customers, they will enjoy financial rewards, and while they are engaging in enterprise for the purpose of earning money, they are also providing products that people want.
Adams Smith’s Contribution to Economics
Smith argued that this kind of system creates wealth for the butcher, brewer, and baker, in addition to creating wealth for the entire nation. A wealthy nation is one that is populated with citizens working productively to better themselves and address their financial needs. In this kind of economy, according to Smith, a man would invest his wealth in the enterprise most likely to help him earn the highest return for a given risk level. The invisible-hand theory is often presented in terms of a natural phenomenon that guides free markets and capitalism in the direction of efficiency, through supply and demand and competition for scarce resources, rather than as something that results in the well-being of individuals.
For Smith, an institutional framework is necessary to steer humans toward productive pursuits that are beneficial to society. This framework consists of institutions like a justice system designed to protect and promote free and fair competition. However, there must be competition undergirding this framework. For Smith, competition is the ‘desire that comes with us from the womb and never leaves us, until we go into the grave.
Smith on Gross Domestic Product (GDP)
The ideas in “The Wealth of Nations,” provided the genesis for the concept of gross domestic product (GDP) and transformed the importing and exporting business. Prior to the publication of the “The Wealth of Nations,” countries declared their wealth based on the value of their gold and silver deposits. However, Smith was highly critical of mercantilism; he argued that countries should be evaluated based on their levels of production and commerce. This concept was the basis for the creation of the GDP metric for measuring a nation’s prosperity. At the time that “The Wealth of Nations” was published, many countries were hesitant to trade with other countries. Smith argued that a free exchange should be created because both countries are better off from the exchange.12 As a result of this shift in attitudes toward trading, there was an increase in imports and exports. Smith also argued for legislation that would make trading as easy as possible.
THOMAS MALTHUS CONTRIBUTION TO ECONOMICS
In 1798 Malthus published anonymously the first edition of An Essay on the Principle of Population as It Affects the Future Improvement of Society, with Remarks on the Speculations of Mr. Godwin, M. Condorcet, and Other Writers. The work received wide notice. Briefly, crudely, yet strikingly, Malthus argued that infinite human hopes for social happiness must be vain, for the population will always tend to outrun the growth of production. The increase of population will take place, if unchecked, in a geometric progression, while the means of subsistence will increase in only an arithmetic progression. Population will always expand to the limit of subsistence. Only “vice” (including “the commission of war”), “misery” (including famine or want of food and ill health), and “moral restraint” (i.e., abstinence) could check this excessive growth.
Malthus’s thought reflects a reaction, amiably conducted, to his father’s views and to the doctrines of the French Revolution and its supporters, such as the English radical philosopher William Godwin. Widely read for such works as Political Justice (1793), Godwin took for granted the perfectibility of humankind and looked to a millennium in which rational people would live prosperously and harmoniously without laws and institutions. Unlike Godwin (or, earlier, Rousseau), who viewed human affairs from a theoretical standpoint, Malthus was essentially an empiricist and took as his starting point the harsh realities of his time. His reaction developed in the tradition of British economics, which would today be considered sociological (see economic sociology).
Malthus was an economic pessimist, viewing poverty as humanity’s inescapable lot. The argument in the first edition of his work on population is essentially abstract and analytic. After further reading and traveling in Europe, Malthus produced a subsequent edition (1803), expanding the long pamphlet of 1798 into a longer book and adding much factual material and illustration to his thesis.
At no point, even up to the final and massive sixth edition of 1826, did he ever adequately set out his premises or examine their logical status. Nor did he handle his factual and statistical materials with much critical or statistical rigour, even though statisticians in Europe and Great Britain had developed increasingly sophisticated techniques during Malthus’s lifetime. The 20th-century American sociologist and demographer Kingsley Davis remarked that, while Malthus’s theories were based on a strong empirical foundation, they tended to be weakest in their empiricism and strongest in their theoretical formulation. For better or worse, the Malthusian theory of population was, nevertheless, incorporated into theoretical systems of economics. It acted as a brake on economic optimism, helped to justify a theory of wages based on the wage earners minimum cost of subsistence, and discouraged traditional forms of charity.
Adams Smith’s Contribution to Economics
The Malthusian theory of population made a strong and immediate impact on British social policy. It had been believed that fertility itself added to national wealth; the Poor Laws perhaps encouraged large families with their doles. If they had “never existed,” wrote Malthus, “though there might have been a few more instances of severe distress, the aggregate mass of happiness among the common people would have been much greater than it is at present.” These laws limited the mobility of labour, he said, and encouraged fecundity and should be abolished. For the most unfortunate it might be reasonable to establish workhouses not “comfortable asylums” but places in which “fare should be hard” and “severe distress…find some alleviation
KARL MARX NEO-CLASSICAL CONTRIBUTION TO THE LABOR THEORY OF VALUE
Like the other classical economists, Karl Marx believed in the labor theory of value to explain relative differences in market prices. This theory stated that the value of a produced economic good can be measured objectively by the average number of labor hours required to produce it. In other words, if a table takes twice as long to make as a chair, then the table should be considered twice as valuable. Marx understood the labor theory better than his predecessors (even Adam Smith) and contemporaries, and presented a devastating intellectual challenge to laissez-faire economists in Das Kapital: If goods and services tend to be sold at their true objective labor values as measured in labor hours, how do any capitalists enjoy profits? It must mean, Marx concluded, that capitalists were underpaying or overworking, and thereby exploiting, laborers to drive down the cost of production. While Marx’s answer was eventually proved incorrect and later economists adopted the subjective theory of value, his simple assertion was enough to show the weakness of the labor theory’s logic and assumptions; Marx unintentionally helped fuel a revolution in economic thinking.
MARX’S SOCIAL-ECONOMIC SYSTEMS
While many equate Karl Marx with socialism, his work on understanding capitalism as a social and economic system remains a valid critique in the modern era. In Das Kapital (Capital in English), Marx argues that society is composed of two main classes: Capitalists are the business owners who organize the process of production and who own the means of production such as factories, tools, and raw material, and who are also entitled to any and all profits. The other, much larger class is composed of labor (which Marx termed the “proletariat”). Laborers do not own or have any claim to the means of production, the finished products they work on, or any of the profits generated from sales of those products. Rather, labor works only in return for a money wage. Marx argued that because of this uneven arrangement, capitalists exploit workers.
Keynesian and Neoclassical Economics
During the Great Depression of the 1930s, existing economic theory was unable either to explain the causes of the severe worldwide economic collapse or to provide an adequate public policy solution to jump-start production and employment. British economist John Maynard Keynes spearheaded a revolution in economic thinking that overturned the then-prevailing idea that free markets would automatically provide full employment that is, that everyone who wanted a job would have one as long as workers were flexible in their wage demands (see box). The main plank of Keynes’s theory, which has come to bear his name, is the assertion that aggregate demand measured as the sum of spending by households, businesses, and the government is the most important driving force in an economy. Keynes further asserted that free markets have no self-balancing mechanisms that lead to full employment. Keynesian economists justify government intervention through public policies that aim to achieve full employment and price stability.
The revolutionary idea
Keynes argued that inadequate overall demand could lead to prolonged periods of high unemployment. An economy’s output of goods and services is the sum of four components: consumption, investment, government purchases, and net exports (the difference between what a country sells to and buys from foreign countries). Any increase in demand has to come from one of these four components. But during a recession, strong forces often dampen demand as spending goes down.
Adams Smith’s Contribution to Economics
For example, during economic downturns uncertainty often erodes consumer confidence, causing them to reduce their spending, especially on discretionary purchases like a house or a car. This reduction in spending by consumers can result in less investment spending by businesses, as firms respond to weakened demand for their products. This puts the task of increasing output on the shoulders of the government. According to Keynesian economics, state intervention is necessary to moderate the booms and busts in economic activity, otherwise known as the business cycle. There are three principal tenets in the Keynesian description of how the economy works:
- Aggregate demand is influenced by many economic decisions public and private. Private sector decisions can sometimes lead to adverse macroeconomic outcomes, such as a reduction in consumer spending during a recession. These market failures sometimes call for active policies by the government, such as a fiscal stimulus package (explained below). Therefore, Keynesian economics supports a mixed economy guided mainly by the private sector but partly operated by the government.
- Prices, and especially wages, respond slowly to changes in supply and demand, resulting in periodic shortages and surpluses, especially of labor.
- Changes in aggregate demand, whether anticipated or unanticipated, have their greatest short-run effect on real output and employment, not on prices. Keynesians believe that, because prices are somewhat rigid, fluctuations in any component of spending consumption, investment, or government expenditures—cause output to change. If government spending increases, for example, and all other spending components remain constant, then the output will increase. Keynesian models of economic activity also include a multiplier effect; that is, output changes by some multiple of the increase or decrease in spending that caused the change. If the fiscal multiplier is greater than one, then a one-dollar increase in government spending would result in an increase in output greater than one dollar
References
Bhatia, H.L. (1978). A History of Economic Thought. New Delhi: Vikas Publishing House PVT. LTD
Jhingan, M. L., Girija, M. and Sasikala, L. (2003). History of Economic Thought, 3rd Edition. Delhi: Virinda Publications (P) Ltd.
Schumpeter, J. A. (1965). Economic Theory and Entrepreneurial History. In: Aitken, H.G.(ed) Explorations in enterprise. Cambridge, MA: Havard University Press
Adams Smith’s Contribution to Economics