Money, Finance and Crises in Economic History

The Long-Term Impact of Economic Ideas

Annalisa Rosselli, Nerio Naldi, Eleonora Sanfilippo

• Publisher: Routledge
• Year: 2018
• ISBN:
  9781351611657
• Edition: 1
• Topic: Business
• Subtopic: Business General
• Index: Business

Recently, students and scholars have expressed dissatisfaction with the current state of economics and have called for the reintroduction of historical perspectives into economic thinking.

Supporting the idea that fruitful lessons can be drawn from the work of past economists, this volume brings together an international cross section of leading economists and historians of economic thought to reflect on the crucial role that money, crises and finance play in the economy. The book draws on the work of economists throughout history to consider afresh themes such as financial and real explanations of economic crises, the role of central banks, and the design of macroeconomic policies. These themes are all central to the work of Maria Cristina Marcuzzo, and the contributions both reflect on and further her research agenda.

This book will be of interest to researchers in the history of economic thought, and those who wish to gain a deeper understanding of the variety and diversity in approaches to economic ideas throughout history.

Part I

The working of a monetary economy

1 Continuity and change in the transition from the classical to the neoclassical theory of normal prices

Bertram Schefold

1 Introduction¹

Adam Smith (1776) possessed a tool in his approach to the theory of value which, in his hands and in the hands of his classical successors, led to a theory of growth and accumulation that became the foundation block of political economy. However, it lost its most fruitful application when the neoclassicals replaced growth and accumulation with equilibrium analysis, focused on full employment and the marginal productivity theory of distribution with its questionable claims to justice, and when the classical concept of competition, based on the tendency to (not the achievement of) the uniform rate of profit was replaced by the new concept of competition, in which firms were simply price-takers. The result was that increasing returns, external effects and the analysis of the causes of technical process were lost and out of sight for a long time. However, this paradigmatic change, also associated with the less important shift from an “objective” theory of value to a “subjective” theory – did not at once entail the abandonment of the concept of natural or “normal prices” of production, i.e. the use of prices based on a uniform rate of profit. Only the explanation of the level of this rate changed with the change in the perspective on distribution and employment. Normal prices ceased to be the central concept of the analysis of long-period positions or long-term equilibria much later with the advent of intertemporal equilibrium theory, based on the dating of commodities and factors, and the introduction of futures markets (Garegnani, 1976). Intertemporal theory takes the quantities of capital goods produced in the past and available as inputs (endowments) at the beginning of the first period of the intertemporal equilibrium as given. They are scarce in different degrees; therefore their relative prices will change as more of the initially scarce endowment is produced, hence the rate of profit in the classical sense is not uniform and prices are usually not normal in the beginning. However they will tend towards normality in later periods, if there are no obstacles to the convergence of rates of profit such as sudden changes in endowments and if the time horizon is sufficiently far away. The “old” neoclassicals, prior to this change in the method of analysis, had, with the exception of Walras, assumed instead that the relative quantities of capital goods were adjusted to future production from the start, and future production to demand, so that prices could be normal.

Before we turn to the neoclassical analysis of normal prices, we want to show in what follows how Smith used the concept of natural price and we shall recall briefly how the concept was modified by his classical successors (Section 2 – readers well acquainted with the modern revival of classical theory may skip this section). We then turn to our main contribution, the discussion of how this concept of natural price was still present among the early neoclassicals or “old” neoclassicals, as I prefer to call them (to distinguish them from the later neoclassicals) who used the modern concept of intertemporal equilibrium (Böhm-Bawerk’s use of intertemporal equilibrium was different, as we shall see). We mainly focus on Böhm-Bawerk (Section 3) and conclude with shorter remarks on Marshall and Walras (Section 4).

2 Essentials of the classical theory of value

At the origin of the Smithian theory of value, there is the distinction between market price and natural price. The natural price results from the pressure of competition in the long run, which reduces the price to the cost of production. This consists of the cost of the means of production, including a normal profit. Effectual demand is the quantity of the commodity demanded at the natural price by consumers who are ready, and able, to pay it. It is therefore a point in the modern diagram for the curves of supply and demand, but these curves did not exist yet at the time of Smith. If the supply deviated temporarily from the natural level, or was short or excessive, and similarly, if demand deviated given the supply, then the market price would tend to rise or fall. This obvious mechanism was not described in a formal manner, but illustrated by anecdotes (the black cloth, which rose in price when the subjects mourned their king and showed their loyalty by displaying black flags, or the price of bread, which rose in a beleaguered city). The price would return to its natural level after the elimination of these disturbing causes; the price “gravitated” to its normal level, and the analogy with astronomy suggested oscillations of the market price around the natural price according to “forces” of supply and demand. We shall later explain the difference between this traditional notion and the explanation of supply and demand in terms of curves in more detail. We are used to associating supply and demand curves with Marshall, but the difference between them and the classical notion was best illustrated by Böhm-Bawerk (Section 3).

We are now concerned with the natural price. Smith approached it in two ways, which seemed to involve a contradiction in the eyes of Karl Marx, but this is not the case, at least in principle (there were ambiguous formulations in Smith’s text). On the one hand, Smith developed the model of a society where land is free and capital is insignificant, so that commodities are produced by labour alone. The examples of beaver and deer suggested that he was thinking of barter among the members of a tribe of Native Americans but Smith knew that he would then have had to discuss gift-giving rather than barter. The example really is a model, based on abstractions from reality. The barter goes on as if a modern commercial rationality prevailed and the hunters calculated the time spent on each prey, hence abstraction is made from the traditions of an Indian tribe which might regulate exchange according to conventions. On the other hand, abstraction is also created from modern complications, which derive from the production with capital and land. Under the circumstances, it is clear that commodities will exchange according to labour values. Since no other factors besides labour are involved in production, the labour value – here the direct labour embodied in a commodity – will be equal to the labour commanded by (or needed for the purchase of) the same commodity. This measure in terms of labour commanded was also used by Smith when he turned to the production by means of labour, land and capital. But then prices, although still expressed in terms of labour by being measured in terms of labour commanded, will stand above labour values, and this would lead to confusion as long as an adequate terminology was not reached.

The problem here was not the contradiction between two different principles for determining the price of a commodity (labour embodied versus the adding up of all the cost components), but the inadequate formalisation of the process of adding up, which led to two difficulties: as Ricardo would observe, adding up suggested that the components could move independently of each other. But if the system had a given surplus, and if we abstract from land, the rise of wages would entail a fall in profits, with given techniques of production. Hence, the conflict of distribution was not properly visible in Smith. Moreover, the procedure created the mistaken impression that the cost of the commodity could always be resolved into a series of past and present costs in terms of labour, capital and land, but Sraffa showed by means of his reduction to dated quantities of labour that this was not possible in a system with circular production (e.g. given the existence of at least a basic commodity), unless the rate of profit was lower than the maximum rate of profit, where the wage rate would have reached zero; moreover, the reduction became impossible with joint production.

The details of Sraffa’s analysis need not be reproduced here (see Sraffa, 1960; Schefold, 1989). But we shall write down the main formulas when we shall have discussed Ricardo. As regards Smith, it suffices to recall his theory of the natural prices of the factors. The wage of labour is a subsistence wage, regarded by Smith as quite variable according to historical circumstances. The rate of profit is uniform, but the level is not well explained. Smith believed that it would gradually fall with competition, but Ricardo would point out that, if the techniques were the same, the level of the rate of profit depended on the surplus left after the payment of wages so that profits were a residual. Smith characterised rent as derived from a monopoly, and it is in fact clear that the landlord could not demand a rent, if he had not the soil in his sole possession, but this is only a restatement of the distribution of property and not sufficient to explain the level of rents.

Ricardo, when discussing value, got rid of rent by introducing his differential theory of it and by looking at the cost of production on the marginal land, where rent was zero. By “value” he really meant the natural price, which would ultimately prevail, and this was equal to labour cost or labour embodied (taking account of the produced means of production) if the rate of profit was zero. Ricardo was fascinated by the influence changes of distribution had on relative prices, although he knew that the corresponding deviation of prices from labour values (to use the Marxian term) was only of a limited extent. If there were, described in modern terminology, two industries, one capital-intensive and one labour-intensive, and if the rate of profit rose, the natural price of the capital-intensive commodity had to rise, because more profits had to be earned on the capital. At the same time the cost would be reduced, to the extent that labour was used, in that the rise in the rate of profit implied, with given methods of production in the economy as a whole, a fall in the rate of wages. In the capital-intensive industry the effect of the rise of profit could be expected to prevail. The surprising implication was that the price of the commodity produced in the labour-intensive industry fell. For there, the fall of the wage rate would be of greater importance than the rise in the rate of profit so that the relatively bigger component of cost was reduced.

The consideration was not exact, insofar as the extent to which the wage rate would fall in consequence of the rise in the rate of profit, given unchanged methods of production, had not been determined in the first place. For that purpose, a standard had to be fixed in terms of which prices were expressed. Without such a standard, all that one could say was that the price of the capital-intensive commodity would rise relative to that of the labour-intensive commodity. Ricardo concluded that this mechanism would become most perspicuous, if a commodity of intermediate capital composition was chosen as the numéraire. He spoke of an “invariable” measure of value, which was inept, for all measures of value are invariable by definition. He meant that the ideal numéraire was one where the fundamental causes for deviations of its price from its original value, in consequence of the change in the rate of profit, were absent. This consideration can be rendered precise, following Sraffa, and I gave my account of the reasoning many years ago (Schefold, 1989, 2014).

In order to measure capital, Ricardo would speak of “the time it takes to bring a commodity to market.” If nuts are collected by two workers, the value of the nuts will be equal to two units of labour. If a worker produces a machine and another worker then uses the machine to produce cloth, the value of the cloth will also be equal to two units of labour if the rate of profit is zero, but if it is positive and if wages have to be advanced, the cost of cloth will rise because profit has to be earned on the wage advanced for the first ...

Table of contents

• Cover
• Half Title
• Title Page
• Copyright Page
• Table of Contents
• List of figures
• List of tables
• List of contributors
• Acknowledgements
• Introduction
• Part I: The working of a monetary economy
• Part II: Perspectives on macroeconomics in our century
• Index