UCL ECON1006. HISTORY OF ECONOMIC THOUGHT. Hugh Goodacre.

2. SOME ROOTS OF ECONOMIC ANALYSIS

2.1 Balance of trade and wealth of nation 2.2 The Quantity Theory of Money

2.3 Efficiency in production

2.4 Measuring national income

2.1 Balance of trade and wealth of nation

Mercantilism (unfashionable term no single school of thought) / pre-classical economic thought: characteristics;
Wealth-getting no longer considered sinful Government (prince) the principal economic agent Commercial wars between nation states. Increases in nations wealth a zero sum game Colonialism; beginnings of slave trade. Beginnings of systematic analysis of economic issues. Initial discussions on nature of wealth of nation.
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What is wealth of nation? An initial answer: Bullionism: Wealth identified with gold / precious metals. Zero sum game:

England has no gold mines, so get gold from Spain; letters of marque, etc.
An early estimate of Englands national income (Petty, early 1670s) includes 60,000 taken from the Spaniards.

Wealth of nation: a more subtle definition.

A more elaborate form of mercantilism developed beyond bullionism to identify wealth with trade surplus. Antonio Serra. A brief treatise on the causes which can make gold and silver plentiful in kingdoms where there are no mines. 1613. Thomas Mun. Englands treasure by foreign trade. 1621 [published 1664].

Balance of trade. Precious metals (specie) were the means of international payment. balance established through specie movements. e.g. Muns example:

Exports

22,000

Imports Balance / inward specie flow / kingdom enriched

20,000 2,000 22,000

BALANCE:

22,000

The two columns balance by definition / accounting identity / assumption.

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Trade surplus / favourable balance of trade (BOT). Todays definitions: Balance of Trade (BOT): goods exports and imports (visibles) only. Balance of Payments (BOP): BOT + invisible exports and imports: services, freight, tourism, etc. + interest payments, capital movements, etc., etc. Either way, there is always by definition a balance, through international payments.
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Trade surplus / favourable balance of trade (BOT).

BOT / BOP distinction not yet made by Mun; in trade, he includes not only goods but also all aspects of merchants mark-up: insurance, freight, merchant gains, etc., i.e. invisibles.

(1) Exports (2) merchant gains, etc. (= invisible exports)

(3) Imports (4) Payments to foreigners for their merchant gains, etc. (= invisible imports) (5) Balance (movements of specie) 1+2 3+4+5

The two columns balance by definition / accounting identity / assumption: 7 1+2 = 3+4+5

Trade surplus / favourable balance of trade (BOT), contd

(1) Exports (2) merchant gains (invisible exports)

(3) Imports (4) invisible imports (5) Balance (movements of specie) 1+2 3+4+5

Policy conclusions: Bullionists: get gold from Spain, etc.; prevent gold exports. Ensure (5) > 0 and maximise! Mercantilists: OK to export gold in the course of expanding trade, e.g. buying goods for re-export. i.e. Maximise (1+ 2) - (3 + 4) 8

Balance of Trade (BOT) / BOP. Examples of merchants mark-up (Mun):

Exported from England to Italy Corn, per quarter Red herrings, per barrel Fetched from England by Italian merchants

12d (penny, pence) = 1s. (shilling). 20s. = 1.

Shipped to Italy by Englands merchants

Merchant's mark-up 25s = 100% 20s. = 100%

25s. 20s.

50s 40s

Remote or far countries trade far more profitable, e.g.

Price in England Pepper, 2s = [24d.] per pound Bought from the Dutch in Mark-up Amsterdam 20d. 4d. [= 16.7%] Bought in East Indies 3d. Mark-up 21d. [= 700%] 9

Supply, demand, competition: Muns example. P

S
twenty five in the hundred less in the price
100

S'

75

50

25

Theme: Note the international context of these beginnings of S & D analysis!

25

50

75

100

may raise above fifty upon the hundred in the quantity vented

2.2 The Quantity Theory of Money (QTM)

Topical issue in early modern period: influx of precious metals from Americas in 16th century rise in prices. first clear statements of QTM, i.e. M P
Problem for bullionists: this would mean price inflation, whereas, even for Mun, etc., more gold is in general good. But mercantilists argued that this inflationary pressure would be neutralised: Lack of M (i.e. gold, silver) is an obstacle to trade. Equivalently, more M quickens trade / drives trade, i.e. stimulates an increase in transactions (T). 11

Quantity Theory of Money (QTM) in early modern period, contd

Quickening / driving trade in terms of Fisher (1911) Equation of Exchange: Assume V = V, (as was normally assumed), we have: M.V = P.T so that P = M/T.V Gold / silver from Americas M1 > M 0 BUT this quickens trade T1 > T0 If we assume that M and T increase proportionately, then: M1/T1 = M0/T0 We thus have: P1 = M1/T1.V = M0/T0.V = P0 i.e. Increase of precious metals does not necessarily lead to price inflation.

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Note / preview: Assumption that V is stable: A characteristic of classical economics. Preview: challenged by Keynes hoarding, Liquidity Trap, etc. Estimating V today: Not measured directly; just use Equation of Exchange: Data for P Price Index (Consumer Price Index, Retail Price Index, etc.) Data for M Money Supply (Preview: Problem: M0? M1? M4?, etc.) Data for T Transactions within a given year i.e. Y (National Income) M.V = P. Y V = P.Y / M We have data for P, Y and M we just read off what V must be. i.e. V given as an identity; not measured directly.

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Pettys suggestion that V could be measured DIRECTLY. Petty suggests that V could be measured directly if enough data were available on transactions payments. He assumes V depends on frequency of payments of income: Estimates annual expense as 40m and assumes this is equal to income. If all income payments were weekly, as normal for wage-earners, then V would need to be 52, so 40m/52, or less than 1m, would be needed to drive the trade of the nation. If all payments were quarterly, as rent and tax payments were, then 40m/4 would be needed, i.e. 10m. Petty assumes a mixture of the two; crudely calculates: 10m + 1m = 11m. Halve this, and we have 5 m, which will be enough to drive trade.

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Efficiency in production
Beginnings of transition: from mercantilism focus on trade to classical focus on production. Mun: artificial trade more profitable than natural. (Arts = manufactures, technology.) Benefits of large population / number of people. Particularly those in arts. Early 17th century: promotion of technological progress. Advancement of useful learning (Bacon). Agricultural technology, etc.

Efficiency in production, contd Topical issue: Holland: small country, but a leading commercial power.

William Petty (1623-87) on the benefits of spatial compactness An early attempt at a theory of productivity. Focussed on fact that Holland was most dynamic European economy and most densely populated.

William Petty (1623-87) on the benefits of spatial compactness, contd

Pettys argument: Spatial compactness of population (as in Holland) living compactly gives conditions for: Economies of scale. Though note: administration / social overheads rather than production process itself. Technological progress. London the supreme example. Division of labour. Specialisation, etc.. (Nothing new in itself ancients too!)

William Petty (1623-87) on the benefits of spatial compactness, contd

Pettys policy proposals to increase compactness:

Multiply the people, i.e. encourage higher birth rate. Wealth of nation lies in high population popular idea at the time. Forced inward migration to England from Ireland (transplantation). Give England same advantages of population compactness as Holland.

2.4 Measuring national income Today:

Three measures:
Expenditure Income
Income

Product

Expenditure

Product (Output)
Quoted figure (UK) is average of all three.

Early modern anticipations:

Mun had already urged an annual account of balance of trade. Petty: first suggested theoretical framework for National Income accounting.
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National income: first attempt at theoretical framework: Petty, c. 1667.

Expenditure Personal expenditure of 6m persons at 6.67 per head m Income m

Rent of land 40 Yield on money and other personal estates The labour of the people

7 25 40

TOTAL

40

Note: Anticipates concept of factors of production: Land, Capital, Labour But Capital is weakly anticipated in Pettys Money and other personal estates: all kinds of things jumbled in housing, shipping, livestock, precious metals, merchandise, furniture, etc.

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LEFT HAND COLUMN: EXPENDITURE MEASURE:

Population: 6m
Expenditure per head: 6. 13s. 4d. p.a., or 4 d. per diem. Thus total expenditure is: 6m x 6 2/3 = 40m.
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RIGHT HAND COLUMN: INCOME MEASURE:

Income of landowners, i.e. rent:

8m p.a. The value of land is 18 years purchase, i.e.

8m x 18 = 144m
The rent therefore represents yield on land of 8 / 144 = 5.5 %.

Income on money and other personal estates

Value is estimated at 106m (by adding up housing, shipping, livestock, etc.) So at same yield as rent, the income (interest, etc.) would be 5.5 % of 106m = 5.89m. But these earn more than rent, so suppose it to yield 7m 22

RIGHT HAND COLUMN: INCOME MEASURE, contd. We now have: Income of landowners: 8m. Income on money, etc.: 7m i.e. These account for 15m of income. Total expenditure is 40m. So wages must account for the rest: i.e. 40m 15m = 25m. i.e. Wages are estimated as the residual.
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Motivation for the calculation / Pettys political arithmetic: Pettys calculation (c. 1667) addressed monarchys need for war finance. (Second of three Anglo-Dutch wars, 1665-7.) This calculation indicated that a greater burden of tax could fall on wage-earners: 25 / 40 = 5/8, or 0.625. Method was largely excise, i.e. indirect taxation: beer and other goods consumed by labouring class. Less sensible to labourers than direct taxes. Remained a popular idea; avoid tax revolts. Note: Illustrated end of egalitarian ideals of Civil War period.
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The value of the people.

Yield on Land + Money, etc. =8+7 = 15m Value of = 144 + 106 = 250m So Yield is 15 / 250 = 6% Or equivalently: Value is 250 / 25 (= 16 2/3) times the annual yield. Yield on people is 25m. So value of the people must be 16 2/3 times 25m. = 417m There are 6m people, so their value is 417m / 6m = 69 each.
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The value of the people, contd Petty explicitly associates this concept with slave prices.

Various estimates in Pettys writings: African slave: 25 for adult, 5 for child.
He also estimates: The value of the Slaves, brought out of Africa, to serve in our American Plantations, Twenty thousand pounds (c. 1673). i.e. 20,000 / 25 = 800 adults?

Value of French and Irish: worth less than English. But note: value of Irish can increase with residence in England: Through prolonged residence in England / intermarriage with English, Irish can be transmuted into English. Value will increase from 7 to 10, i.e. 42%.

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Pettys Bank for war: there being 3 Years of Peace in these Nations for one of Warr, the said 3 Years Overplus will be 3324 Thousand Pounds; which, added to 2676 Thousand Pounds, will make a Bank of 6 Millions Pounds for the one Year of War.
Kings revenue Year 1 Year 2 Year 3 2.676m Revenue net of peacetime expenditure 1.108m

Peacetime expenditure 1.568m

Cumulative fund / bank for war 1.108m 2.216m 3.324m

i.e. in Year 3, total revenue of King: 2.676m + 3.324m = 6m Enough to fight a war.

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Characteristics of early modern economic thought

State still the principal economic agent.

War aims / raising finance for war still dominant concern fiscal-military:

90% state revenue was for war.

Economic issues not yet a distinct field of inquiry, let alone a discipline. Not differentiated from political, geographical, religious issues, etc.

Characteristics of early modern economic thought, contd

Pettys policy proposal illustrates all these characteristics:

State policies to multiply the people.

State action / forced inward migration to England from Ireland (transplantation).

Give England same advantages of population compactness as Holland.

Aim: Bank for war from 2m extra annual state revenue.

His compactness concept was spatial /geographical, concerned government and administration as well as economic ends; would also solve religious and political issues end Irish rebellions, etc.

Main themes: Overseas / open economy: Beginnings of economic discussions concern surplus and deficit internationally. Same for early QTM and Supply and Demand analysis. Colonialism, beginnings of slave trade, etc. War finance dominant in fiscal debates.

Crisis: Trade crisis with Holland in 1620s. Civil wars in England. War generally: kind of cycle!

Transition / forward pointers: Division of society into three great classes, each with own source of revenue.

Labour produces a surplus, which is distributed as rent and yield on money, etc..
Beginnings of wider theories of production / output / efficiency rather than just trade; i.e. away from mercantilism and transition towards classical tradition. Quantitative calculations and quantitative mode of expression; Pettys political arithmetic. Economic not yet separated from other spheres of discussion.

2. ROOTS OF ECONOMIC ANALYSIS summary.

2.1 Balance of trade and wealth of nation From bullionism to Mun, etc. Importance of overseas trade. Beginnings of Supply and Demand analysis. 2.2 The Quantity Theory of Money

Arguments against and for bullionism. Velocity of circulation and its measurement.
2.3 Efficiency in production Beginnings of transition from mercantilism to classical tradition. Example: Petty, Holland, and spatial compactness. 2.4 National income First attempt at calculation. Labour income as residual. Indirect taxation. Fiscal-military motivation.