October 2004, Vol. 127, No.10
A history of economics
Book reviews from past issues
A history of economics
The Ordinary Business of Life: A History of Economics from the Ancient World to the Twenty-First Century. By Roger E. Backhouse. Princeton, NJ, Princeton University Press, 2002, 369 pp., $55/cloth.
Roger Backhouse, in his book, The Ordinary Business of Life, explains that economics does not have a founder because people have always thought about ideas we think of as economics. Throughout history people have probed how social economic policy might improve the lot of humankind.
The book pursues the origins of economic theory through a wide range of intellectual history. As various schools of economic thought construct divergent views of history, this book provides economists with an idea of how each theory fits into the bigger picture. Backhouse emphasizes that ethical presuppositions undergird modern economics as much as they did Homeric poetry and the Old Testament. Because economic ideas are an integral component of culture, the history of economics must touch on the histories of religion, theology, philosophy, mathematics, and science.
The author begins with a description of economic thought in the Mediterranean cultures and then examines the effects of Judaism, Christianity, and Islam. Prosperity in Homer’s age (c. 850 B.C.) meant a well-ordered estate. The people of the Periclean Age (479 to 431 B.C.) engaged in profit-making activities, like commodity speculation that we now associate with a commercial society. Plato (429–347 B.C.) recommended a just society organized on rational principles. The origin of the word economics comes from a book titled Oikonomikos (meaning household management), written by Xenophon (430–354 B.C.) in which he explains how a prosperous agricultural estate is the result of skilled organization.
The destruction of the Greek city-states actually resulted in the promulgation of Greek mathematics, science, and philosophy to the rest of the world. The Roman Empire (27 B.C. to 312 A.D.) articulated significant economic ideas in their commercial law, and the concept of Reasonableness, coming from Greek Stoicism, was found widely in Roman legislation.
Judaic and Christian ideals greatly influenced the Middle Ages that followed the Fall of Rome. In Judaism, "There was … a clear distinction between the pursuit of wealth…and the wealth that arose through following God’s commands." During the Middle Ages, Christianity exalted poverty as the highest expression of humility, but while working to educate the people and spread Christianity, Charlemagne, in the early 800s, urged better farming methods and set up money standards to encourage commerce.
The 9th century was the dark age of Christian Europe. Muslims controlled most of Spain. The Vikings dominated the north. Yet Christian Europe survived, primarily because of monastic cells and feudalism. The combination of highly disciplined religious orders with military power provided the basis for the European resurgence.
At the developing universities of the 12th century, scholars formulated ideas to guide society based on Biblical principles, Aristotelian ideas, and Natural Law (moral principles common to all). New lines of inquiry opened up in the 14th and 15th centuries when rational argument combined with traditional theology. The rise of Protestantism in the 16th century was a significant factor of economic growth in England and the Netherlands; and, more and more, natural law (moral principles) replaced cannon law. Machiavelli’s The Prince in the early 16th century departed from politics based on moral laws to politics distinct from morality altogether. In the 17th century, the contradictory passions Machiavelli described came to be known as "interests."
Academics in the early 17th century were looking for a firm foundation on which knowledge could rest independent of the church. Bacon and Descartes offered what they believed to be a better foundation for truth—namely, experimental science and a set of self-evident mathematical truths. The Royal Society, chartered in 1662, laid down procedures for how to conduct experiments and report results.
William Petty (1623–87), a pioneer in viewing economic phenomena from a quantitative perspective, estimated England’s wealth in terms of land, labor, and capital. Josiah Child and John Locke, also in the 17th century, examined monetary economics, analyzing the relationship between money supply and price level.
The 18th century Enlightenment owed greatly to the scientific revolution that embodied a belief in reason, progress, liberty, and tolerance. The scientific revolution was a worldview shift. Mechanical laws that governed the universe discovered by Copernicus, Kepler, Galileo, Descartes, and Newton, led to humanism, thus reducing God to a divine clock-maker who merely set the universe in motion. Morality came to be linked to utilitarianism.
Mercantilism—an economic policy that promoted the use of state power to build up industry, to maintain a surplus of exports over imports, and to accumulate large amounts of precious metals—prevailed in Europe from the 15th to the 18th centuries. The man often regarded as the founder of modern economics, Adam Smith (1723–90), denounced mercantilism. He argued that self-interest led to efficient use of resources and public welfare (the Invisible Hand). Backhouse mentions that Adam Smith’s emphasis on the importance of a capitalist society’s secure framework of law, morality, and property rights is an essential lesson for reformers moving from socialism to capitalism (for example, the former Soviet republics).
Smith’s ideas became the basis of so-called classical political economy, which placed doctrinaire laissez-faire at one end and Ricardian socialism at the other. Arnold Toynbee (1852–83) believed that ethics could not be separated from economics, inspiring a generation of Oxford students to pursue economic science from the vantage point of improving economic conditions for the common man.
In the early 20th century, the central figure in economics was Knut Wicksell of Sweden, who developed a business cycle theory by describing the relationship between money, credit, and prices. The boom of the 1920s set the stage for the Great Crash. Acknowledging the inadequacy of the dominant pre-war theories to explain the Depression and searching for guidelines to avoid another, economists examined Knut Wicksell’s business cycle. In Austria, Ludwig von Mises and Friedrich von Hayek translated Wicksell’s ideas into a monetary theory of the business cycle, advocating non-government intervention and a policy of ‘neutral’ money. In contrast, Swedish Erik Lindahl (and others) based their interpretation of Wicksell’s theory on expectations about the future and promoted government spending and monetary policy to reduce unemployment.
In England, thinking about money and the business cycle was rooted in the work of Alfred and Mary Marshall (1842–1924 and 1850–1944, respectively). They believed, similar to Lindahl, that "The chief cause of … [Depression] is want of confidence." Among Marshall’s followers was John Maynard Keynes (1883–1946). Keynes’ General Theory provided enormous stimulus to the idea that government should take responsibility for controlling economic activity. Keynes’ theory of economics largely dominated the field because it provided a framework that could be translated into very versatile mathematical models. A number of economists interpreted Keynes’ ideas through a system of equations. The most influential of these was John Hicks with the IS-LM model. John Hicks, in 1940, introduced the equation that has become the cornerstone of national-income accounting: GNP = C + I + G. He also restated the General-Equilibrium Theory in modern terms (introduced in the late 19th century), which came to be the central theoretical framework in the 1940s and 1950s.
During World War II, estimates of national income became formal systems of national accounts, leading to the first standard system of national accounts in 1953. The next year, Kenneth Arrow and Gerard Debreu published improved proof of the existence of general equilibrium. Questions their theory left unanswered were resolved in game theory (originally put forward by John von Neumann in the 1920s), which proved there will always be an equilibrium. Econometric models brought together Keynesian economics and national-income accounting, and Lawrence Klein’s large-scale macroeconometric models were used greatly for forecasting in the 1960s and 1970s.
Paul Samuelson’s theory of public goods (one person can benefit without reducing the benefits to another) fit well in the 1960s belief that the government should intervene at the macroeconomic level. Confidence in the econometric approach was strengthened with the advent of computers and renewed interest in game theory.
The Keynesian consensus concerning employment factors was overturned with Milton Friedman’s work on the natural rate of unemployment. This led to New Classical Economics of the 1970s—an explanation of the economy in terms of continuous market clearing, rational expectation, and the "real business cycle" based on "real" shocks to the economy, primarily shocks to technology. Also in the 1970s, economists focused on the study of law and economics, public-choice theory, property rights, and transaction costs. Over the years, the distinction has lessened between macro and microeconomics, and economists continue to look for a framework within which to resolve economic theoretical differences.
The question of the place of mathematics in economics is a major theme of the book. Doubts about the mathematization of economics have gone in cycles. At the end of the 19th century, Jevons and Walras maintained that economics was inherently mathematical. Carl Menger objected to mathematical economics, which he maintained was able only to show the relationship between quantities, not the essence of economic phenomena. Alfred Marshall, in his discussion of supply and demand and a money-based theory of utility, was also skeptical of mechanical explanations of economic change. The author points out that the goal of using econometric techniques and empirical data to build economic theory has never really been accomplished and that key economic assumptions are, and always have been, based on their being intuitively rational.
Schumpeter in the 1940s claimed there was no logical order to the jumble of applied fields of economics, and Backhouse declares that this is still the case—except that each of the fields increasingly relies on a theoretical core; and that, because of that theoretical core, one might say economists speak different dialects of a shared language.
Throughout his story, Roger Backhouse illuminates the human side of economics, showing how the economic sciences have never veered significantly from the goal of finding a way to improve the human condition.
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