Economic theory—in the form in which we have it today—is just about two hundred years old. Considering its age, it has made remarkable progress. We have travelled far since the days of the pioneers. There is hardly any field of economic theory which has escaped some kind of reformulation or retouching at some stage in its career over the last century and a half.
Yet who among us would have the temerity to suggest, despite all the developments that have taken place in this or that field, that we have succeeded as yet to hit upon a determinate goal which economic theory is expected to lead up to ? We have travelled far, but we have not always travelled along routes that are convergent. We have had ‘epochs’ of economic theory—Classical, Marginalist and Modern—each having a distinct terrain, and not quite assimilated into the other.
There is indeed a certain lack of continuity in the development of economic theory. The reason for this is perhaps partly political. Partly also it must lie in the very nature of our science. The function of economic theory is to raise questions concerning economic phenomena as they emerge in society from time to time, and to indicate the mode of answering them. The character of economic theory is thus molded by the type of questions that assume importance in a given environmental setting—though it is of the nature of ‘theory’ that once it is derived, it takes a form which makes it transcend the particular setting that gives it birth.
Why do prices rise? How do trade restrictions affect the prices of goods and the economy as a whole? What is the significance of a market for the development of an economy? How do movements of prices affect the earnings of different classes of a society—and how does distribution of wealth in its turn affect economic growth? What sort of relation exists between the growth of wealth and the growth of numbers? These are some of the questions that cropped up in England in the late eighteenth century and early nineteenth, as she was passing through a stage of what is known as Industrial Revolution. Attempts at answering questions such as these with reference to Planning and Economic Growth
the particular setting in which they arose gave birth to Classical Political Economy. Man’s struggle against nature and his triumph in securing higher standards of living, impediments to progress created by injudicious regulatory laws, the dampening effect of population growth, the possible conflict in social relations that the process of growth tends to generate—these constitute the background against which the classical system developed, and it is against this background that classical theories have to be seen if they are to be judged properly.
Here was a small island, already commercially developed, which was in the midst of large scale technological innovations, supported by a spirit of enterprise never before experienced elsewhere, where population was growing fast and pressing on the ‘means of subsistence’, where the unbalance thus created between the price of agriculture and the price of manufacture was further accentuated by restrictions on the import of corn and other mercantilist devices. The problem was to show the way how the spirit of enterprise that was released in the wake of the industrial revolution might have full play, and adequate resources might be mobilized to give effect to all the technical progress that had been taking place in the field of manufactures. In this perspective the characteristic classical theories would all appear to fall into their places. Combine Smith’s theory of division of labour with the Ricardian theory of rent and the Malthusian theory of population, and you have via the labour theory of value an explanation of the movement of ‘corn’ prices via-à-vis manufactures. Follow it up with the classical theory of surplus, conceived either in terms of Smith’s ‘productive labour’, or in terms of Ricardo’s ‘net revenue’, and you have the role of capital as the determinant of economic progress. The theory of foreign trade comes in as part of the system in so far as an extension of the market, like innovations, tends to keep up the volume of investible surplus and hence of capital.
The initial impulse to progress comes from saving. Where enterprise exists, the saving that generates in the economy is turned towards the formation of capital. Income increases and with it the investible surplus. There is, however, the retarding effect of growth of numbers, the degree of retardation depending upon the relative rates of capital accumulation and population growth. If accumulation and, with it, innovations proceed at a pace fast enough to overbear the retarding effect of population growth, the economy progresses. If it does not, the economy stagnates.
Here there is a parting of ways. Adam Smith envisages a progressive economy with his eyes fixed on technological innovations and division of labour, while Ricardo is apparently depressed by the prospects of diminishing returns in agriculture, rising cost of labour and falling rate of profit.
Tendencies in Economic Theory
Now, whatever the approach, the policy implication was the same. The market must be widened through free trade—on Adam Smith’s argument because a wider market would offer greater scope for division of labour, while on Ricardo’s because an extension of foreign trade, in so far as it facilitated the import of ‘corn’ would reduce wages and raise profits. Classical theory thus not only provided answers to the specific problems that England faced at the time, it also suggested policy prescriptions which played an important part in reorienting its economy to suit the circumstances. The economy needed-free trade and Theory rationalized it.