one | two | three | four
1. classical economy 2. neoclassical economy
3. Karl Marx
4. Joseph Schumpeter
5. ordoliberalism
6. keynesianism
7. critical rationalism
8. philosophical criticism
9. monetarism
1. classical economy John Stuart Mill 1.4.1 John Stuart MillInformation about biographical data can be found, as everybody knows, at Wikipedia: John Stuart Mill.
The work Principles of Political Economy, first published in 1848, can be divided into two parts. The first part is a summary of the classical economic theory. All the misleading concepts of the classical theory we can found in this work and sometimes, as for instance the concept that the value of a commodity depends on the labour materialised in this commodity, even in an accentuated form. Concerning basic economic concept he falls back to the level of David Ricardo. However, there is a big difference between David Ricardo and John Stuart Mill. The issues addressed by David Ricardo are very limited while John Stuart Mill in the second part addresses a wide range of issues.
The misleading concept of the materialised labour and the concept that "capital" is accumulated labour is only a variation of a more general error in thinking; the idea that saving is the condition for investments. David Ricardo represents the worst version of this error; Jean -Baptiste Say the light version.
For Jean-Baptiste Say, saving is as well the condition for investments, but at least, it is not consumed income of the past wherever this income comes from. In the version of David Ricardo, and this version had tragic consequences in Marxism, savings always derives from labour and even the value of money depends on the value materialised in money.
The unclear and misleading ideas about "capital" and money lead to an infinite number of errors in thinking. We are not going to discuss these issue again here. For a more detailed discussion, see the booklet downloadable from the start of this website or interest rates.
In the classical theory, money was only needed for transaction purposes, in other words, an abstract value, money, can be changed to a concrete value, any kind of commodity. The value of the money derives from the past and is fixed by the supply and demand. People assume, that the relationships of the past will be the same in the future, what at least in the short run is true. However, that doesn't mean that the commodities changed for money have to exist and actually most of them don't exist. People assume that the money they get in the form of wages, profit on capital, rent etc. has the same value in the future as in the past, in other words, that someone will produce in future what they need or want. This assumption is of course mostly correct in the short run, but it is clear that money is a claim to a PRODUCTIVE POTENTIAL, not a claim on real existing products. From that, we can deduce, that we can increase the amount of money as long as there is a productive potential. There is no need, in the case that there is a productive potential, for saving. Money can be produced as well by the central banks.
Some may believe that all this are irrelevant theoretical speculations. They are wrong. If someone believes that the productive potential can be increased by saving, then he would promote saving. This can under certain conditions worsen the situation, as we see nowadays in Greece, we are still in 2015. Saving is not the solution if the resources must be reallocated. Away from unproductive use in the public administration to productive use, in other words to the production of things where there is a real demand.
If we understand by saving the production of capital goods instead of consumer goods, it is a useful definition in a situation of full-employment or in a situation of misallocation. The definition of savings as not consumed income of the past is misleading, see interest rates.
This means as well that it is impossible to transfer through savings consumption to the future. Saving alone has no impact. If people start to save and to put their money under the pillow in the hope that the can buy something with that money they eventually will find that nobody produces in the future the products they want to buy.
If the savings are actually invested in capital goods allowing to produce the consumption goods needed in the future, there are two problems. First, in general, these savings are not needed. What is actually needed is money and money can be printed by the central banks, what they are doing right now, in the year 2015. Second it is hard to see why investors will invest now if people save more. When people save, they reduce the consumption and the investors will reduce investments. Even if they are smart enough to predict the future, they will not pay any interest rate in the meantime.
John Stuart Mill sticks to the worst version of the savings concept. Present labour depends on past labour.
What capital does for production is to afford shelter, protection, tools, and materials which the work requires, and to feed and otherwise maintain the labourers during the process. These are the services which present labour requires from past, and from the produce of past, labour. Whatever things are destined for this use - destined to supply productive labour with these various prerequisites - are capital. |
The central sentence is: "These are the services which present labour requires from past, and from the produce of past, labour." He assumes that only labour produces a value. Otherwise, he could have said as well "...which present labour requires from past,..., labour, capital and rent etc.". If capital is the result of past labour, there are two options. The workmen were not paid with the full value of what they had produced, the Ricardo/Marx version or the workmen themselves saved a part of what they produced and invested it. He sticks to the first version.
We put aside for the moment that savings can derive from any kind of income. The problem is the word "past" because that's not what actually happens in reality. Normally, investments are financed with loans and a loan consists of MONEY. This money CAN derive from prior savings, in this case, the banks acts like an intermediate. They collect money and borrow it to others. In this case, we have a reduction of consumption in favour of investments. Something rarely needed, because modern companies are always in a kind of unemployment. There is no need to decide whether to produce consumption goods or capital goods. Both can be produced. Following this logic, an increase in investment would lead to a decrease in consumption. That's not the case in reality.
In reality, the banking system would generate the money and savings will happen in the FUTURE when the loan is paid back. It is true indeed that the productivity of labour depends, if we put aside for the moment services, on tools, machines, building, infrastructure etc. However, their production doesn't depend on prior labour, but on time and the time needed to produce them depends on know-how.
If an investment is profitable, it is profitable in both cases. In the case that it is financed with savings of the past and in the case that is is financed with money and of something can be produced, doesn't depend on the way it is financed, but on capacities of the economy.
The idea of saving is generally wrong in the classical theory, but John Stuart Mill sticks to the worse version of this error.
The fund from which saving can be made is the surplus of the produce of labour, after supplying the necessaries of life to all concerned to production, including those employed in replacing the materials and keeping the fixed capital in repair. More than this surplus cannot be saved under any circumstances. |
Savings alone is already a problem, because savings, as non-consumed income of the past, is not needed for investments. For a detailed discussion see interest rates. To say that this saving is part of the produce of labour is still worse.
The condition of investment is a profitable project and that project is financed with money. Where this money comes from is irrelevant. The idea that saving alone leads to growth is, unfortunately, incorrect. If it were so easy, the problems of the world could be easily resolved by saving. Some nations would have a hard time for a while, but there would always be light at the end of the tunnel. Unfortunately, things are more complicated than that. It is much harder to detect profitable project and realise them than finding money to finance them. The classical theory assumes that detecting profitable project and realise them is not the problem and that the problem is to find "capital", actually money. Unfortunately, this is not the case. In the real world, it is the other way round.
As already described, see interest rates, this basic error of thinking leads to a lot of other errors. See as well the booklet downloadable from the start of this website.
All accumulation involves the sacrifce of a present, for the sake of a future good. |
This would be true if savings, not consumed income of the past, were the conditions for investments. In this case, a sacrifice is necessary in order to invest. People would reduce consumption in the present, that is the sacrifice, in order to be able to consume more in the future.
This is not even true even for an individual market player, a company or a household. Both can borrow money for investments as well as for consumption, and the banking system can easily generate this money.
(One possibility of how the banking system can create money is if someone earns 3,000 dollars a month and gets his wages at the end of the month, he has at the beginning of the month 3,000 dollars in his bank account. For the sake of simplicity, we assume that each day, he withdraws 100 dollars. Then on the second day, he has 2,900 dollars in his bank account, the third day 2,800 and so on. On average 1,500 dollars. If the bank knows that, and they know it, they can borrow 1,500 dollars. If millions of people behave like that, they can borrow a lot of money and there is no need that anybody saves money or makes a sacrifice.)
As we already said, from the basic misleading concept follows a lot of other errors. Here is the next one.
This is the fundamental motive underlying the effective desire of accumulation, and is far more important than any other. It is, in short, the test of civilization. In order to induce the laboring-classes to improve their condition and save capital, it is absolutely necessary to excite in them (by education or religion) a belief in a future gain greater than the present sacrifice. It is, to be sure, the whole problem of creating character, and belongs to sociology and ethics rather than to political economy. |
It is much more probable that this is not the test of civilisation, but the way to hell. This is only true from a microeconomic perspective. If a single market player, a household, saves money, he has a good chance to find an investor how pays him some interest rates and he will be better off in the future. BUT IF EVERYBODY SAVES, they will find no investor at all or only some who pay very little interest rates. First of all, because saving reduces consumption and the less people consume, the less investors will invest. Secondly, because an increase in savings doesn't lead automatically to an increase in investment and thirdly, savings are not needed at all. Investments are financed with MONEY and it is completely irrelevant where this money comes from.
That's the reason a pension system based on individual capital stocks will not work. There is no way to transfer present consumption to the future by saving.
Sometimes, the theory of John Stuart Mill is even more erroneous than the theory of David Ricardo.
In the discussion into which we are now about to enter, I shall use the terms money and the precious metals indiscriminately. This may be done without leading to any error; it having been shown that the value of money, when it consists of the precious metals, or of a paper currency convertible into them on demand, is entirely governed by the value of the metals themselves: from which it never permanently differs, except by the expense of coinage, when this is paid by the individual and not by the state. |
It seems that he didn't understand really, the function of gold in a monetary system where gold backs the paper currency. Paper currency was never backed by gold in the sense that all the paper money, fiat money, could be converted into gold. If they had asked the banks to change their money for gold, all the banks would have gone bankrupt. The convertibility of paper money to gold in a fixed exchange rate guarantees that the value of a certain amount of gold always corresponds to the same amount of money. In case that people can buy more with gold that with paper money, they will change the paper money in gold and that leads to a reduction of money until the purchasing power is once again the same and there is no need anymore to change paper money for gold.
The amount of gold is fixed by nature; therefore, it is more stable, but it would be impossible to increase the amount of money in case that the national income increases and more money is needed for transaction purposes if gold would back the whole paper money.
The convertibility of paper money into gold has, therefore, the function of a fine tuning.
[By the way: Not even "money" is backed by paper money. If all the customers of banks withdraw the money they have in their bank accounts, all banks will go bankrupt. Banks know that people never withdraw all their money in cash and a certain amount of this money remains on their bank account. This money they can use to grant credits, what they actually do.]
The same mechanism works as well at an international level. If a country exports more than it imports, the currency of the exporting country gets "harder", the money of the importing country "weaker". (For a unit of the currency of the country where the exports exceed the imports must be paid more and more.)
The exporters would be confronted with the situation, something that actually happens in case of a system with flexible exchange rate, that they would lose money if they convert the weak money to their national currency. (Example: In the moment they export their was 1:3. For three units of the foreign currency, they get 1 unit of their national currency. However, if the interest rates changes to 1:4, they must have four units of a foreign currency in order to get one unit of their national currency.)
It is obvious that a country with a deficit in its trade balance can only pay with his own currency. The supply of this currency on the currency markets increases, the value of this currency decreases.
In a gold standard, both banks guarantee to convert the respective currency to gold at a fixed exchange rate. If the currency of the country with a negative balance of trade loses value, they will go to the respective central bank and change the money for gold and this gold they will change to the respective national currency. This way the exchange rate will never change, but the country with the negative balance of trade reduces its amount of money, that leads to a decrease of all kind of prices, wages, profits, rent etc. That will result in the reduction of imports from the balance of trade if once again balanced.
The problem with this kind of system is that the whole burden of structural adjustments lies on the prices of the country with the deficit in the balance of trade and this is the reason this system was abandoned in 1973.
However, the fact that John Stuart Mill didn't understand the gold standard is not the real problem. The basic error of John Stuart Mill is the idea that money is a claim to commodities already produced. That's not the case. Money is a claim on a part of the productive potential. If someone has saved 30 dollars to buy in the future a chocolate cake, it is very probable that the chocolate cake is not already produced at the moment he saved the money. If all the confectioner go on holiday the days before he wants to buy his chocolate cake, he will not get one. The same is valid for investments. This is trivial, apparently, but very few people understand that.
If money is only a claim on a part of the productive potential in the future, it is clear that money is not backed by the production of the past. This is valid for consumption as well as for investments.
The classical/neoclassical theory and all the lines of thinking based on the concept of the classical/neoclassical theory assume that the accumulated capital or saving is a restriction on further investments. ("All accumulation involves the sacrifice of a present, for the sake of a future good.") This is not true at all and besides that it would be foolish.
If a confectioner needs a second stove, more commercial space, more employees, etc. because the demand increases he can take a loan. The banking system will create this money through the mechanisms already explained several times. The confectioner will buy or let build what he needs, will employ people unemployed and will pay back the loan, in other words, eliminate the money created when the loan was granted with the money he will earn in the future. For a more detailed discussion see interest rates.
(It is important to understand these mechanisms. Most people think that a bank is an intermediary that collects the money from the savers and borrows this money to lenders. In this logic, investments depend on savings. This is an entirely misleading concept. Banks don't need the money of the savers; they can borrow it directly from the central banks and the central banks can produce any amount of money.)
There is no sacrifice from anybody needed. The only thing that will happen is that people who were unemployed before no have a job and produce something. If the classical logic were true, the situation would be really bad. In this case, the confectioner had to save the money first, reduce consumption and demand and create unemployment, and only after years of saving, he could respond to the increasing demand.
[Besides that, if we follow the classical logic any kind of investment, even in case of unemployment, it is only possible if other investments are displaced or the prices fall. A certain amount of the national income requires a certain amount of money for transaction purposes. The more products we buy, the more money we need, simplifying, in our wallet. At least, if the price level remains the same. If the prices didn't fall proportionally, something that never happens, some companies will go bankrupt what leads to an increase in unemployment. In other words, without an increase in the amount of money economic growth is only possible, if the machines that substitute old machines are more efficient and cost the same. In other words, through technological progress.]
That way, Keynesian theory and classical/neoclassical theory and all the lines of thinking based on classical/neoclassical concepts get to completely different conclusions. For the classical/neoclassical theory saving is the condition for investment. For Keynes, it is only a reduction of demand and not needed for investments. Therefore, Keynes recommends a redistribution of income because poor people save less.
Classical/neoclassical theory considers an unequal distribution of income and, therefore, more savings as a condition for growth. Keynesian theory considers an unequal distribution of income as a hindrance to growth.
People who want to earn money with money will like the paragraph below. The truth, however, is different and that's the nowadays problem of this business concept. If money is not scarce, there is no need to pay a price for it.
The only thing that can be sais is that there is a better guarantee that money is used in a profitable way if it is kept artificially scarce and a sacrifice is needed to obtain money for investment purposes. If money is actually "free" and available at any amount, the amount of money will increase, because many companies will be found who better wouldn't like to be founded. A credit that is not paid back increases the amount of money. For a more detailed description see interest rates.
In the following paragraph, he describes who are the borrowers and who are the lenders, but he is completely unaware of the fact that the banking system can generate money itself. There is no need for lenders.
In [ordinary] circumstances, the more thriving producers and traders have their capital fully employed, and many are able to transact business to a considerably greater extent than they have capital for. These are naturally borrowers: and the amount which they desire to borrow, and can give security for, constitutes the demand for loans on account of productive employment. To these must be added the loans required by Government, and by land-owners, or other unproductive consumers who have good security to give. This constitutes the mass of loans for which there is an habitual demand.
Now, it is conceivable that there might exist, in the hands of persons disinclined or disqualified for engaging personally in business, a mass of capital equal to, and even exceeding, this demand. In that case there would be an habitual excess of competition on the part of lenders, and the rate of interest would bear a low proportion to the rate of profit. Interest would be forced down to the point which would either tempt borrowers to take a greater amount of loans than they had a reasonable expectation of being able to employ in their business, or would so discourage a portion of the lenders as to make them either forbear to accumulate or endeavor to increase their income by engaging in business on their own account, and incurring the risks, if not the labors, of industrial employment. |
This is the long version of the simple statement savings = investments, whereby the interest rates balance savings and investments.
[The sentence "...Interest would be forced down to the point which would either tempt borrowers to take a greater amount of loans than they had a reasonable expectation of being able to employ in their business..." ist very strange. Actually, it is enough that the interest rates covers the risks and the administration costs of the banks and that the loan is paid back. That is the "reasonable expectation". More is not needed nor economically useful.]
The paragraph starts with a critical assumption: "In [ordinary] circumstances, the more thriving producers and traders have their capital fully employed, and many are able to transact business to a considerably greater extent than they have capital for." That the David Ricardo version, the worse variation of the basic error. There are two errors in one sentence. The first error is that producers have always their capital fully employed and many are able to enlarge their business. The second error is that they need savers are needed to borrow them capital.
The idea of Jean-Baptiste Say that a lack of demand is a lack of production is not very convincing and refuted by Keynes, but, at least, Jean Baptiste Say realised that there is a problem. Producers can have a problem with fully employ their capital if there is no demand.
Moreover, the second error is a consequence of the already discussed fundamental error, the assumption that investments require prior savings.
We actually don't know how this strange idea came into the world. What possible explication could this be? A landowner can indeed save part of his corn for further consumption or seed it and get more corn in the future. In this case, the increased consumption of the future is indeed based on a sacrifice of the past. The difference between money and corn is, that "capital" or money, the terms are never exactly defined in the classical theory, is not a productive factor in the sense of a market economy, because it is not scarce and have therefore no price in the meaning of a market economy, see interest rates. Corn is actually scarce, is a productive factor and has, therefore, a price. It seems that the classical authors had something like that in mind.
The second possibility is that the classical authors assumed that full-employment is always given. In this case, the only was to produce more capital goods, in other words, to invest, is at the expense of the production of consumer goods and consumption is reduced, if people save. That's why the correct definition of saving is produced capital goods instead of consumer goods.
The next paragraph is really interesting because it reveals that the public understood very well the nature of credit, although it didn't succeed in correcting the erroneous ideas of John Stuart Mill regarding savings. The public understood very well that credits can make something out of nothing and credit is actually capital and credit is not, not al all, the permission to use the capital of others.
We can learn that very often, people who think on their own without opening any book get to the right answer than people who read many books and finally get completely confused.
| As a specimen of the confused notions entertained respecting the nature of credit, we may advert to the exaggerated language so often used respecting its national importance. Credit has a great, but not, as many people seem to suppose, a magical power; it cannot make something out of nothing. How often is an extension of credit talked of as equivalent to a creation of capital, or as if credit actually were capital. It seems strange that there should be any need to point out, that credit being only permission to use the capital of another person, the means of production cannot be increased by it, but only transferred.
John Stuart Mill, Principles of Political Economy, Book III, Chapter XI |
No, not at all. The people are right and John Stuart Mill is completely confused. Lo realmente curioso en este párrafo es esto: "...How often is an extension of credit talked of as equivalent to a creation of capital, or as if credit actually were capital..."
The paragraph reveals that the public understood very well that there is no difference between a one hundred dollar note derived from prior saving and a 100 dollar note freshly printed by the central bank.
A relationship between an increased amount of money, what leads to lower interest rates and misallocation is possible, although the classical theory never mentions a casual relationship. A possible causal chain could be this one. It is thinkable that low-interest rates, although never actually happened, leads to an increased consumption financed by loans or to very risky investments. It the credit is not paid back, the money will eternally circulate and that can lead to an increase in inflation. Central banks will then reduce the amount of money by increasing the interest rates and that will have the effect, that even profitable investments will be no longer possible.
The Austrian school actually argues with similar causal chains, but the argumentation is trivial. It is obvious that the "social control" is stronger if investments are financed by prior savings and over investments, investments that are not profitable enough to pay back the loan, are less probable. However profitable investments are less probable as well. The best change to avoid any kind of overinvestment is not investing at all. The sick would die from his disease but from the medicine. We will return to this issue when talking about Friedrich Hayek.
En su teoría sobre las tasas de provecho supone un escenario poco realista.
The tendency of profits to fall as society advances, which has been brought to notice in the preceding chapter, was early recognized by writers on industry and commerce; but, the laws which govern profits not being then understood, the phenomenon was ascribed to a wrong cause. Adam Smith considered profits to be determined by what he called the competition of capital. In Adam Smith's opinion, the manner in which the competition of capital lowers profits is by lowering prices; that being usually the mode in which an increased investment of capital in any particular trade lowers the profits of that trade. But, if this was his meaning, he overlooked the circumstance that the fall of price, which, if confined to one commodity, really does lower the profits of the producer, ceases to have that effect as soon as it extends to all commodities; because, when all things have fallen, nothing has really fallen, except nominally; and, even computed in money, the expenses of every producer have diminished as much as his returns. |
It is indeed, a problem of the theory of David Ricardo and Karl Marx that the "capitalists" can accumulate the capital squeezed out from the workmen. One would assume that competition would lower the prices until nothing of the added value is left.
David Ricardo assumes that the profit decreases because a growing population requires more food and that therefore, the price rises with the result that higher wages must be paid, see David Ricardo. Actually, the problem of David Ricardo starts earlier. Competition will have the effect that prices will be low and the added value, therefore, low as well. In a situation of very strong competition actually zero.
The fact that all prices fall doesn't change the situation. Not at all. If all the prices fall, the producer or the company will indeed have lower costs, but competition will oblige them to pass the reduction of costs to their customers. That is of no help. Not at all.
In any kind of theory, as wrong as it may be, there is some truth. John Stuart Mill realised for instance, that insecurity is a problem, although the situation is a little bit different. Insecurity wouldn't be a problem if people had only one choice. Consuming or saving/investing their money. In this case they would consume it if they esteem investments too risky and there would be no lack of demand. The problem is, that they had a third choice, investing in something as liquid as money itself, the stock market. We will talk about that in the chapter about Keynes.
The other element, which affects not so much the willingness to save as the disposition to employ savings productively, is the degree of security of capital engaged in industrial operations. In employing any funds which a person may possess as capital on his own account, or in lending it to others to be so employed, there is always some additional risk over and above that incurred by keeping it idle in his own custody. This extra risk is great in proportion as the general state of society is insecure: it may be equivalent to twenty, thirty, or fifty per cent, or to no more than one or two; something however, it must always be; and for this the expectation of profit must be sufficient to compensate. |
Actually, the problem is still more complicated. Although no savings are needed to invest, money is enough wherever it comes from; the investor won't take a loan if he is not sure that he can pay back the loan. In a situation of great insecurity, the central banks can offer money for free as they do nowadays, we are still in 2016, companies won't invest. In this case, only the government can invest, see governmental activities.
The classical theory is, therefore, really very wrong. The problem is not only that savings are not needed, but investments can also be financed with money, the real problem is that even if the financing of investments is no problem, it is possible that due to insecurity, that real investments are not high enough to reach full employment.
If all persons were to expend in personal indulgences all that they produce, and all the income that they receive from what is produced by others, capital could not increase. Some saving, therefore, there must have been, even in the simplest of all states of economical relations; people must have produced more than they used, or used less than they produced. |
This is not only wrong because the basic assumption is wrong. It is wrong because the real problems fade from view. Greece has nowadays; we are still in 2015, structural problems and more saving, in contrary to what we read every day in the newspaper, hear on talk shows and to what is assumed in "scientific" papers will not resolve the problem.
It is often said that expansive fiscal policy won't work in the case of structural problems if the people are not able to produce the products needed and demanded or are not able to produce them at competitive costs and quality. This is actually true, but the same is valid for the classical recipes.
It is a strange kind of fact that accumulation of capital is a big issue in the classical theory, but the destruction of capital is never mentioned, although it is a relevant issue. The more capital is destroyed, the higher must be the savings if we follow the classical logic.
Concerning money, destruction is not a big issue. Money is created when a loan is granted and destroyed, if it is paid back. The fact that some lenders won't pay back the credit, doesn't impede other lenders to grant credits, because they don't depend on the savings of the savers, but on the monetary policy of the central banks, who can produce money at any amount.
Following the classical logic, any kind of change in the economic structure would lead to a catastrophe. Firstly, this is because people had to increase savings in order to buy new machines, acquire new know-how, buy new raw materials, find new ways of distribution and marketing etc.. In the case of a structural change, the economy as a whole would destroy capital and increase savings at the same time. New branches would depend on the savings of obsolete branches.
In a time of structural changes, many companies of the old branches, nowadays, for instance, the newspaper, we are still in 2015, will go bankrupt. Their savings is zero and their capital, printing machines, trucks, warehouses, etc., will be destroyed, if people read the newspaper online.
The reality is different. The new branches finance their innovation with money, wherever this money comes from. They don't care if the money comes from prior savings or is freshly printed by the central banks. The only thing that matters to them is the question if they can pay back the loan. Google didn't need the savings of other branches. Google could attract the resources needed with money.
John Stuart Mill introduced hoarding. Hoarding means that the saved income doesn't lead nor to consumption nor to investment. This idea is irrational in classical thinking and a problem for the classical theory. In classical theory, hoarding doesn't make any sense because of the preference for the consumption in the present and only if saving increases the consumption in the future, because their savings yield a profit, people will save. In other words, people will only save if the saving are absorbed by an investment that yields a profit.
With hoarding, we have the same problem as with insecurity. People will not hoard anything, at least in the version of classical theory we find in textbook, if hoarding yields no profit and in the case of insecurity, if any investment seems to bee too risky, people won't save, they will consume.
However, already David Ricardo breaks with that classical logic. In the theory of David Ricardo "capitalists" invests independently from the profit. For an unknown reason, "capitalist" never enjoy their lives and consume what they earned. They prefer to accumulate their capital even if this leads to nowhere.
A fundamental theorem respecting capital, closely connected
with the one last discussed, is, that although saved, and the result of saving, it is nevertheless consumed. The word saving does not imply that what is saved is not consumed, nor even necessarily that its consumption is deferred; but only that, if consumed immediately, it is not consumed by the person who saves it. If merely laid by for future use, it is said to be hoarded; and, while hoarded, is not consumed at all. But, if employed as capital, it is all consumed, though not by the capitalist. Part is exchanged for tools or machinery, which are worn out by use; part for seed or materials, which are destroyed as such by being sown or wrought up, and destroyed altogether by the consumption of the ultimate product. |
Hoarding doesn't exist in the classical theory. It is a behaviour considered irrational under the assumptions of classical theory. Equally non-existing is insecurity.
Not in the classical theory, but, in reality, hoarding can be a rational behaviour, although it plays no role in Keynesian theory, albeit Keynes mention it. People will hoard to be prepared for disasters in the future. That contradicts Say's Law.
Say assumes that any kind of production will lead to a consumption that corresponds to the value of the production and that therefore, unemployment, due to a lack of demand is impossible. That is only true if people don't hoard part of the value they produced. Hoarding is independent of the type of interest.
Concerning insecurity, the situation is different in Keynesian theory. In classical theory, people have no choice. They consume their income or they save it for investments. In Keynesian theory, they have a third possibility. They can invest it in the stock market and stocks are almost as liquid as money itself, can be converted at any day at any moment to money. In case of insecurity, people will, therefore, invest in stocks. That's what the actually, in 2015, do. Whatever amount of money the central banks inject in the market, they invest it in stocks and not in real investments. For a more detailed explanation see the booklet downloadable from the start of this website.
We have already said that terms like classical theory or neoclassic theory don't make sense. The theory of Adam Smith differs a lot in content, methodological approach and philosophical background from David Ricardo and it is hard to see any similarity between Alfred Marshall and Vilfredo Pareto.
Related to economics, John Stuart Mill is a mix of Adam Smith and David Ricardo /Thomas Malthus, because he sticks to some basic concepts of David Ricardo/Thomas Malthus like the "iron law of wages".
Related to economics, There is nothing new in the theory of John Stuart Mill, but the writing On Liberty can be compared with the very famous essay of Immanuel Kant, What is Enlightment?
Concerning the "iron law of wages", he totally agrees with David Ricardo. Concerning the philosophical background, he totally disagrees.
The converse case occurs when, by improvements in agriculture, the repeal of corn laws, or other such causes, the necessaries of the laborers are cheapened, and they are enabled with the same [money] wages to command greater comforts than before. Wages will not fall immediately: it is even possible that they may rise; but they will fall at last, so as to leave the laborers no better off than before, unless during this interval of prosperity the standard of comfort regarded as indispensable by the class is permanently raised. Unfortunately this salutary effect is by no means to be counted upon: it is a much more difficult thing to raise, than to lower, the scale of living which the laborers will consider as more indispensable than marrying and having a family. According to all experience, a great increase invariably takes place in the number of marriages in seasons of cheap food and full employment. John Stuart Mill, Principles of Political Economy, page 217 |
It is obvious that his prognostics don't fit with reality. In industrialised countries, the population is decreasing. Beside that it is doubtful whether his theory is true concerning the 19th century. He assumes, for whatever reason, that only the population of poor people increases if their income exceeds subsistence level. It is to assume that this was valid for rich people as well. Therefore, even rich people, following this logic, should get poorer and poorer until they reach subsistence level.
As with any economic texts, mixed with many concepts completely wrong, there are suddenly some statements, which are very true, perhaps even more accurate than John Stuart Mill was aware of.
It is actually true that most models in economics, based on equations/functions or a verbal description, implicitly argues with competition. If there is a greater supply of a productive factor, wages, profits, rents etc., the price of this productive factor will decrease. If there are 1000 workmen and the employers needs 500 hundred, the 500 willing to do the job for the lowest wage will get it. If demand exceeds supply, the buyers willing to pay the highest price will get what they want. Any kind of equilibrium in any market is based on competition.
The problem is this sentence: "The political economist justly deems this his proper business: and, as an abstract or hypothetical science, political economy can not be required to do, and indeed can not do, anything more."
John Stuart Mill affirms, and this is correct, that any kind of modeling abstracts and simplifies reality. In his example "customs" play no role in economic thinking. "Customs" can be a lot of things: the political system, the education system, the organisational structure, the religion and so on. He states, this is correct as well, that all that cannot be described in a "scientific" way. It is to suppose that by science he understands the formulation of modells allowing to make "precise" prognostics, at least inside the narrow assumptions of the model.
With the degree of modelling, the issues taken into account is reduced. In the end, we get kind of a parallel world, whose analysis is irrelevant. The model takes into account what can be modelled, regardless of the question, if the parameters taken into account by the model are relevant or not.
He justifies this approach by saying that economics is a hypothetical science. This is not a justification for this kind of approach. We prefer a correct description of the reality to a hypothetical one that is incorrect. A more "heuristic" approach, as the one of Jean-Baptiste Say, that leads to a correct description of reality, is more useful than a hypothetical approach, as the one of David Ricardo, that leads nowhere.
The preference for modeling, especially for mathematical modeling, is due to the fact that this looks more "scientific", albeit it is highly irrelevant when it comes to make concrete affirmations about reality, see mathematical modeling.
Political economists generally, and English political economists above others, have been accustomed to lay almost exclusive stress upon the first of [two] agencies [competition and custom]; to exaggerate the effect of competition, and to take into little account the other and conflicting principle. They are apt to express themselves as if they thought that competition actually does, in all cases, whatever it can be shown to be the tendency of competition to do. This is partly intelligible, if we consider that only through the principle of competition has political economy any pretension to the character of a science. So far as rents, profits, wages, prices, are determined by competition, laws may be assigned for them. Assume competition to be their exclusive regulator, and principles of broad generality and scientific precision may be laid down, according to which they will be regulated. The political economist justly deems this his proper business: and, as an abstract or hypothetical science, political economy can not be required to do, and indeed can not do, anything more. John Stuart Mill, Principles of Political Economy, página 204 |
Principles of Political Economy was first published in 1848, in other words before the formation of what is called today the neoclassical theory in the Cambridge version.
The question whether economics is nomothetic science, in other words, a science who tries explain the economic phenomenon by universally valid laws, "......laws may be assigned to them...", and whose object can be described by laws will be discussed later on by Alfred Marshall, the founder of mathematical modelisation. Alfred Marshall avoided, as we will see later on, the term economic laws and preferred to use the term tendency.
We can deduce from this paragraph that the question whether economics is a nomothetic science, looking for laws, or an idiographic science like history, that tries to understand an economic phenomenon as a singular situation to be understood taking into consideration the individual circumstances of a certain region in a certain time was discussed long before Alfred Marshall.
For obvious reasons, see mathematical modeling, what we found in textbooks nowadays follows the first methodological paradigma: economics as "abstract or hypothetical science". That's the reason economics becomes more and more irrelevant. Nobody cares about an "abstract or hypothetical science" if it never delivers useful results.
Related to economic theory John Stuart Mill shares all the misleading concepts of the classical economy in their worst version.
As an economist John Stuart Mill is irrelevant, because he contributed almost nothing to economic theory. He is more relevant as one of the founders of liberalism.
