Hi-Stat Vox No. 4 (February 25, 2009)

“History” in Classical Economics, “Society” in Neo-Classical Economics: Towards a new conceptualisation in economic history

Osamu Saito

Professor, Institute of Economic Research, Hitotsubashi University

Photo : Osamu Saito

If defined as a long-run increase in national or regional product per capita, economic development is never a product of the modern era. Such development could also take place in the distant past. As Angus Maddison’s work unambiguously shows, it was a reality in both Europe and Japan where economic development, be its growth rate as low as 0.1% or 0.2%, did last for a century or two. According to a recent consensus, the economic transformation in Britain from the late eighteenth to the early nineteenth century, when the first Industrial Revolution is said to have taken place, was not as revolutionary as previously thought: GDP grew only at 1.7% per annum, which meant a mere 0.4% growth in per capita terms. Given such stylised facts, the modern can not easily be separated from the pre-modern. This leads us to consider what economic development is in the first place. The long-held view, which tries to relate economic development to something unique in modern society, may no longer be tenable. In order to find a clue for a new conceptualisation in economic history, therefore, I would like to take a cursory look at the history of economic doctrines from the eighteenth century to the present.

Classical Economics
Classical economists had their own historical perspectives. It goes without saying that the definition of classical economics can vary a great deal, from Adam Smith to John Stuart Mill; one may even include Marx if the labour theory of value is the criterion. However, what is meant here by classical economists includes a school that begins with Malthus and Ricardo as well as many post-war development economists who framed their questions in the resurgent classical tradition. For them, economics is a science about people’s living standards, and their thoughts are rooted in the Malthusian theory of population. In other words, it appears that the classical economists thus defined all shared the interpretation that history could be seen as a race between population and capital accumulation, or to use Malthus’s own metaphor, a race between the hare and the tortoise.

In particular, an interpretation based on the first edition of Malthus’s Principle of Population tends to emphasise the geometric nature of population growth set against the iron law of diminishing returns, thus tending towards pessimism. Ricardo, a friend of Malthus, also adopted the principle of population as absolute truth. He believed that while recognising a possibility that exceptionally advantageous circumstances could enhance the effect of capital accumulation for a period of time, ultimately no economy could escape the law of diminishing returns. In Malthus’s later years, however, a new perspective emerged: he turned our attention to a mechanism of self-restraint through nuptiality, thereby amending the pessimistic scenario. Subsequently, when a demographic transition progressed as envisaged by the late Malthus (who said in the sixth edition of the Principle that “if we could persuade the hare to go to sleep, the tortoise may have some chance of overtaking her”) and neo-Malthusians who advocated fertility control through contraception, economists began to focus on the particular sets of circumstances that are able to encourage the tortoise and hence to improve the standard of living. As for developing countries where people were still suffering from population pressure, some economists, like Arthur Lewis, modelled economic growth on the assumption of abundant labour, while others recommended socialist planning for heavy industrialisation. Among all those development economists’ endeavours, however, there was a tacit agreement that human history was a race between population and economy.

Indeed, it appears that this notion has been deep-rooted among scholars in various fields. A glance at the post-war historiography in economic and social history reveals how strongly their discipline has been affected by this classical notion. Although this is not quite apparent as far as Japan is concerned, it is clear that economic and social historians in the West have basically followed the Malthusian interpretation and similar ones by development economists. In their interpretations, what makes the phenomenon of economic development historical is cyclical changes in the population, on the one hand, and changes that took place outside the economy, on the other; one example of the latter is innovations in science and technology, which are undoubtedly favourable for capital accumulation. According to this view, it is the Industrial Revolution that separates the pre-modern from the modern mode of interplay between population and economy. However, empirical studies in recent years suggest that this view is too schematic.

Neo-Classical Economics
Let us now turn to neo-classical economics. Can we recognise a particular kind of “history” that neo-classical economics would imply? This is an interesting issue, although I do not recall such a topic having ever been discussed (it is hoped that historians of economic thought will take on this issue in the future). My sense is that while neo-classical economics is concerned with a particular kind of “society”, it is essentially a-historical.

The image of such a society is derived from the proposition that free transactions in the market will give rise to an efficient allocation of resources, postulating that there is a distinct type of social relations behind such market scenes. Undoubtedly, it is Hayek who argued most persuasively the case for such a type of society.

However, it is difficult to draw a clear image of history from his argument. With the self-regulating market mechanism alone, we cannot describe the actual process in history. Nor can we regard it as an end-product of the long historical process. In order to illustrate the points, I would like to have a look at the writings of John Hicks (not of Hayek), who took a somewhat different stance from the mainstream of neo-classical economics, although he himself made a great contribution to its formation. In his Theory of Economic History, Hicks maintains that:

“There is a transformation which is antecedent to Marx’s Rise of Capitalism, and which, in terms of more recent economics, looks like being even more fundamental. This is the Rise of the Market, the Rise of the Exchange Economy” (A Theory of Economic History, 1969, p.7).

On the face of it, this passage may suggest that for him, “the Rise of the Market” is an underlying concept of economic history: history should be seen as an evolutionary process of market growth. This interpretation is not completely wrong, but what he actually means by “transformation” is an extremely long-run process that takes us “back to a much earlier stage of history”. As the chapters of his Theory of Economic History show, the reality is that the market for goods existed for a very long time, and that it functioned well even in early stages of the process. In the words of the historian Fernand Braudel:

“There was a market economy well before the nineteenth and twentieth centuries… Prices have fluctuated since ancient times; by the twelfth century they were fluctuating in unison throughout Europe. Later on this concord became more precise within even stricter limits” (The Wheels of Commerce, 1982, pp.227-8).

What Braudel’s account implies is that medieval and early modern fairs where petty traders gathered are in a sense much closer to the concept of the efficient free market envisioned by the neo-classical economists, which is the view shared by Hicks himself (indeed, his true motivation for writing the Theory of Economic History was to depict the history as a transition from the flexprice economy of the early modern period to the fixprice economy of the present era). As far as the commodity market is concerned, therefore, its history from the early modern to the modern period may look as if it were “motionless”.

The Third Approach
It appears that neither the classical theories nor the neo-classical framework find much momentum for development within the economy. This is because the latter only contains the market mechanism that has been operating since the Middle Ages, while in the former it is changes in factors outside the economy that play a central role, i.e. changes in population, technological innovations, and the long-term effect of institutional reform (just as Ricardo argued for the abolishment of the Corn Law).

Of course, one may opt for institutional analysis, searching for historicity in the relationships between politics and the market. There, the main focus will be on how institutions were built. It is also possible to argue—this is the stance taken by Hicks—that the “Rise of the Market” approach becomes historical when the market mechanism penetrates into factor markets, land and labour, the territory “where its principles did not fit, or could only with difficulty be made to fit”. However, it is also possible to find signs of increasing returns at work in the economy itself, and it turns out that this was another tradition in economics.

The third approach may best be found in Marshall, who is usually regarded as one of the founders of neo-classical economics. It was he who discovered the notion of “external economies” in an effort to overcome the classical proposition centred on the law of diminishing returns. In addition, according to Allyn Young’s exposition, Marshall’s idea can be traced back to Adam Smith’s thesis on the division of labour. This thesis is not about the division of labour in the pin factory, but about the development of the division of labour at inter-industry levels. In other words, when a manufacturing process is divided up, each becomes a specialised, independent branch of the industry with new markets emerging between the specialised branches. This is an indirect, roundabout method of production, the economies of which are manifested in increasing returns. Given another theorem by Smith, “the division of labour is limited by the extent of the market”, it is likely that an appropriate rate of increase in population or the development of overseas markets, or both, will broaden the extent of the market, leading to the economies of roundabout production. This is the point made by Adam Smith in his thesis on the division of labour. The third approach, therefore, makes it possible to connect the concept of the market, which the neo-classical economists adhered to, with the history of output growth and improvements in the standard of living, which were the major concerns of the classical economists. It is important to realise that its dynamics is derived from market growth as a result of the growth of the division of labour among industries, rather than the allocation mechanism within an existing market. In any case, this is an approach that bridges the two traditions. It enables us to easily understand that the first Industrial Revolution was a revolution in the manufacturing sector of intermediate goods, and that growth accelerated in the subsequent processes of industrialisation. At the same time, Smith’s another theorem on the extent of the market makes it possible to understand the adverse impact of the population decrease that is currently taking place in developed nations.

This is the approach I took in my recent book, Economic Development in Comparative and Historical Perspectives (Iwanami Shoten, 2008). Of course, the approach does not exclude historical institutional analysis nor any “rise of factor markets” approaches; they are all complementary (in fact, the issue of factor markets is discussed in the book, along with the issue of skills). As the global history of economic development clearly shows, the modern processes of industrialisation in various parts of the world have never converged into a single image of capitalism. It is hoped that such a complementary approach will go a long way towards a better understanding of why the development path is multiple.

Original text in Japanese