A Companion to the History of Economic Thought - Chapter 8 ppsx

112 D. P. O’BRIEN CHAPTER EIGHT Classical Economics Denis P. O’Brien 8.1 INTRODUCTION Classical economics ruled economic thought for about 100 years. It focused on macroeconomic issues and economic growth. Because the growth was taking place in an open economy, with a currency that (except during 1797–1819) was convertible into gold, the classical writers were necessarily concerned with the balance of payments, the money supply, and the price level. Monetary theory occupied a central place, and their achievements in this area were substantial and – with their trade theory – are still with us today. Those ideas developed amid an international economy free from major wars. However, the French wars of 1793– 1815 had a powerful influence on classical economics, leading to major problems with public finance, and to a significant national debt. Because convertibility of the note issue into gold was suspended, it was necessary to develop a theory of the operation of an inconvertible paper currency. 8.2 FOUNDATIONS The intellectual basis for virtually all classical economics is found in Adam Smith’s Wealth of Nations of 1776 (O’Brien, 1975). Earlier work, including that by Smith himself (his Theory of Moral Sentiments, 1759, and Lectures, 1763) and of David Hume (1711–76) can be seen in the context of the research program that Smith established. Apart from Adam Smith (1723–90), the most famous and influential figure was David Ricardo (1772–1823). There are several views of Ricardo. Schumpeter (1954) regarded Ricardo’s work as essentially a detour. The Sraffians regard it as the start of the only valid tradition in economics, running from Ricardo to Marx and thence to Sraffa. Alfred Marshall and Samuel Hollander (1979) have interpreted Ricardo as a neoclassical economist. Ricardo excelled in model building, but his restrictive type of model grafted uneasily on to the main part of classical economics, and the work of later writers CLASSICAL ECONOMICS 113 such as J. R. McCulloch (1789–1864) and J. S. Mill (1806–73) owed much more to Smith than to Ricardo. To interpret classical economics in terms of Smith and Ricardo alone is a mistake (O’Brien, 1988). Contemporary with Ricardo were T. R. Malthus (1766–1834), James Mill (1773–1836), Nassau Senior (1770–1864), Robert Torrens (1780–1864), and numerous writers on special topics, especially monetary theory. Most classical economists had intellectual interests besides economics. Few had academic employment. Journalism, the law, and business – especially banking – were mostly their occupations. Yet these writers formed a “scientific com- munity.” With the exception of the French economist J B. Say (1776–1832), they lived in the British Isles. They read the literary reviews of the day, and there was an active circulation of pamphlets. They met at the Political Economy Club and in other societies such as the [Royal] Statistical Society. Economics grew out of philosophy. Smith and Hume were the products of a distinctive Scottish philosophical school. The influence of Smith’s teacher, Francis Hutcheson, is discussed in Skinner’s contribution to this Companion. In addition, the utilitarian strain in the classical literature, usually associated with Jeremy Bentham (1748–1832), has its origins in this Scottish philosophical tradition, leading to Smith’s stress on the welfare of the laboring classes. Absorbed into this philosophical background were ideas from more narrowly economic literature that developed during the century before Smith’s great work. The most important example is the work of the physiocrats and A. R. J. Turgot (1727–1781) in France (Turgot, 1769), whose ideas and influence on Smith are described elsewhere in this volume. In some respects, what was borrowed from France merely reinforced ideas that Smith had developed earlier, as is clear from notes on lectures that Smith delivered in 1763. Smith’s debt to some of his English predecessors is not always so clear, although it is hard to ignore the likely influence of Bernard Mandeville’s (1660– 1733) Fable of the Bees (1714). Smith’s emphasis on individual self-interest as productive of social benefit reflects that of Mandeville. Smith avoids mentioning Mandeville and Sir William Petty (1623–87), who undoubtedly influenced Smith’s views on public finance, if only on the treatment of equality in taxation. The wide-ranging basic concepts of the Wealth of Nations set the agenda for the whole classical era. The individual pursues self-interest that, constrained by a framework of law, religion, and custom, and an inherent moral sense (sympathy), brings about a coincidence of private and public satisfaction. Competition in response to price signals allocates resources as capital pursues profit opportunities, and the search for greater output from the resources commanded by capital leads to specialization and division of labor, the mainspring of technical progress. Freedom of trade stimulates technical progress and widens the market, allowing disposal of the increased output – division of labor depends on the extent of the market. Ricardo, reading Smith with the mind of a model builder (Ricardo, 1815, 1817– 21), was to have a huge, if ultimately transient, influence on the way in which that agenda was developed. For Ricardo was concerned with two immediate 114 D. P. O’BRIEN practical problems, inflation and agricultural protection; and he found that the material in the Wealth of Nations failed to provide clear-cut answers. In the Bullion Controversy, the price level in relation to the balance of pay- ments was critical. Smith had argued that a rise in wages would ultimately raise the price level. But Ricardo concluded that, in an open economy on the gold standard, the price level could not rise permanently; after an initial increase, a balance-of-payments deficit would ensue, gold would flow out, the money sup- ply would be reduced, and prices would return to the initial level. This insight, it has been plausibly argued (Hollander, 1979; cf., Peach, 1988), led Ricardo to argue that profits would be compressed by a rise in wages. Applying the argument to agricultural protection, one could predict dire consequences for growth. Protection increased agricultural costs as inferior land was brought into use to feed a growing population; this meant a rising price of corn. For the laborer to purchase the same amount of corn, money wages would have to rise. Profits would fall and accumulation of capital would slow and ultimately stop. The economy would reach a stationary state. The landlords’ share of total output, rent, would increase as diminishing re- turns ensured a growing gap between total product and the net product shared between profit and wages. With wages at subsistence, profits would fall to a minimum. The landlords’ interests conflicted with the rest of society – to the extent, as Ricardo argued (wrongly, because he neglected the economic interests of individual landlords) that improvements in agricultural technology were against their interests. Ricardo’s model had a considerable impact on economic thought over perhaps two decades. But there was misunderstanding. Ricardo was believed to have developed theorems consistent with Smith’s basic program, in some instances correcting Smith’s conclusions. But it eventually became apparent that Ricardo had constructed an analytic framework that was qualitatively different from Smith’s, and classical economics developed along a path increasingly divergent from that laid down by Ricardo. Malthus’s work also enjoyed this ambiguous position in relation to the body of classical literature. Malthus’s core ideas go back at least to Cantillon, writing in about 1730. But Malthus provided the version of the population theory underlying classical economics, articulating a conflict between a geometric rate of increase of population and an arithmetic increase in food supply. This had the analytic advantage, especially for Ricardo, of leading to the conclusion that population would increase to the point at which wages were at subsistence, allowing the wage level to be treated as a constant. The second edition of his Essay on Population (1803) removed this certainty. Malthus introduced the idea that population might, or might not (if moral restraint, as distinct from vice, limited procreation), press up against the limits of the food supply. In this form the population theory was incorporated into nineteenth-century economics. According to Senior, population might be limited not by actual shortage, but by anticipation of it. J. S. Mill allowed Malthus an honored place in his Principles (1848) while denying that Malthus had attached any importance to his arithmetical and geometric ratios, restating the tautological CLASSICAL ECONOMICS 115 “tendency” as an economic law that could be modified only by the spread of methods of family limitation. To understand how all these threads fit together, it is best to look at the classical treatment of particular aspects of economic analysis. 8.3 VALUE AND DISTRIBUTION 8.3.1 Value Smith designed his value theory to produce a theory of relative price, on the basis of adding up the per-unit costs of the labor, capital, and land inputs into production, the valuation of the inputs being determined separately. He explained the value of commodities in long-run equilibrium, in terms of wages, profit, and rent. Market price fluctuated around long-run equilibrium price, with departures from long-run equilibrium eliminated by the mobility of capital in response to profit opportunities or losses. Ricardo attempted to replace Smith’s adding-up approach with a labor theory of value, creating problems for his contemporaries and successors. Even if capital amortization were treated as payments to stored-up labor, relative values could change without any change in labor input, if the capital–labor ratios were not uniform across all commodities. This would happen when wages rose and profits fell. Ricardo claimed that this would only produce variations of 6 or 7 percent in value. But the problems were tied up with the basic Ricardian model: for money wages were supposed to rise with the growth of population and the rising cost of obtaining food, thus altering values. Ricardo further posited an average capital– labor ratio, and the existence of a commodity produced under such conditions – the “Invariable Measure.” He then decided that gold would fit that specification, and treated agriculture as operating with the same capital–labor ratio. Thus a rise in wages would not, of its own, alter the money price of corn. If the money price of food did rise, this must signal the existence of diminishing returns in agriculture. In analyzing rent, Ricardo introduced one of the longest-lasting fallacies in the history of economics. Rent, he argued, was an intramarginal surplus, due to the existence of diminishing returns in agriculture. Economists now conventionally envisage this as a rising agricultural supply schedule, with an area of producer surplus lying between the supply schedule and the market price. Because rent was a surplus, Ricardo argued that it did not determine price but was determined by price. The argument neglected transfer earnings: to grow one crop, land had to be paid sufficient to prevent it being used for another crop. The cost of the land did enter into the cost of production when where there were many agricultural products, rather than the single product “corn” of Ricardo’s model. All this has to be seen in the context of Ricardo’s overriding aim – to produce a model of growth and stagnation. This was not understood by his contemporar- ies, who were concerned with relative price and saw no role for “Absolute Value” in terms of the “Invariable Measure.” McCulloch clearly envisioned an improved 116 D. P. O’BRIEN cost of production theory: accepting the elimination of rent from cost, he wrestled vainly with the problem of capital and the nature of profit. Torrens adopted a different approach and argued that relative amounts of capital, rather than labor, determined relative price. However, since the valuation of the capital turned out to depend upon the number of days of labor “stored up,” this was no advance. J. S. Mill’s treatment of the cost of production approach to value provides insight into Ricardo’s influence. First, Mill rejected Ricardo’s “Invariable Meas- ure” and insisted that value was only a relative term. Secondly, Mill emphasized the fluctuation of market price around the long-run natural (cost of production) price; but cost could vary with output, and some products could command a scarcity value. Cost of production comprised wages and profits (depreciation was seen as wages and profits incurred in the past); rent was not an element of cost of production. Things could only differ in relative value if they required more labor, or labor paid at higher wages, differed with respect to the capital– labor ratio, or were the products of industries that required a higher rate of profit. Ricardo’s influence is apparent both in the “getting rid of rent” and the recognition that varying capital–labor ratios would produce changes in relative values if average wages rose and profits fell: but his contributions only modified a basically Smithian cost of production approach. The French tradition of J B. Say had a wholly different approach, one consist- ent with the post-1870 approach to value theory: of the interaction of subjective valuation (underlying demand) and limitations in supply. Say argued that both goods and productive services derived their value from the utility of the final product. Price was determined by the intersection of a negatively sloped demand curve (described verbally) and a rising supply schedule. Say (1817) explained the declining demand schedule in terms of income dis- tribution, not utility. Two later writers developed the argument further. Nassau Senior explained the idea of diminishing marginal utility, although he did not relate it to a demand curve (Senior, 1836), while the Irish economist Mountifort Longfield put forward a strikingly modern subjective value theory (Longfield, 1834). Value depends upon demand and supply: cost of production limits supply, and demand depends upon diminishing marginal utility. Marginal utility varies between units of a commodity and between persons. Rather than relying upon income distribution to derive a negatively sloped demand schedule, Longfield derived it explicitly from diminishing marginal utility. Longfield was followed by others in this tradition (Black, 1945). 8.3.2 Distribution To avoid explaining prices by prices, the cost-of-production theorists had to provide a theory of the valuation of factor services. WAGES The main development followed two lines. One involved the concept of subsistence wages. Commentators disagree about the extent to which the subsistence was CLASSICAL ECONOMICS 117 physical, although if it were merely conventional (psychological) subsistence, including some luxuries, it is difficult to see why a fall in wages below that level should reduce population, unless perhaps through postponement of marriage. The concept of subsistence provided a theory of the long-run equilibrium wage. But the classical literature focused mainly on the market period, and the so-called wage fund. In the market period, the supply of labor could be taken as fixed; the wage rate was then determined by the intersection of a vertical market supply of labor and a demand curve for labor of unit elasticity, its position being depend- ent on the size of funds pre-accumulated to employ labor. Thus capital, not demand for commodities, constituted demand for labor. This approach left open many questions, including the determination of the size of the labor force given the population, the determination of the size of the wage fund itself (particularly as, in the classical analysis, a tax on wage goods was generally to be passed on, implying that it increased the size of the wage fund), and the division of a given stock of capital between fixed and variable capital. PROFIT Profit, as distinct from wages of management, was the return on capital, identi- fied as interest plus a risk premium. The source of the interest element in profit still needed analysis. Some writers recognized that capital increased total output, thus sensing that its reward must be linked in some way to productivity. But Samuel Bailey (1791–1870) and, more importantly, Nassau Senior developed the idea of time-preference, which limited the supply of this productivity-enhancing (and thus demanded) factor (Bailey, 1825; Senior, 1836). The combination of lim- ited supply and positive demand gave rise to a positive price for the services of capital. J. S. Mill’s more elaborate treatment analyzed the motives for saving, con- sidered the power to save out of income, and equated the rate of interest with the marginal supply price of saving. Longfield had argued that demand for capital at the margin could be identified with the marginal product of capital; Mill independently advanced the same argument. The level of profit was thus dependent on both the demand for investment (in relation to the available supply of investment funds) and the demand for consumption goods (which influenced the productivity of that investment), as the classicists from Smith onward recognized. Ricardo argued differently, that the rate of profit for the economy as a whole was determined by the marginal rate of profit in the agricultural sector. This was consistent with showing how diminishing returns in agriculture would bring the economy to a stationary state. His contemporaries felt that increasing manufacturing productivity would offset diminishing returns in agriculture. Ricardo’s view was arrived at by dividing the whole economy into one giant farm and a series of manufacturing tributaries. Then the profit-raising effect of innovation in any tributary would be swamped by both capital inflow and the effect of rising wages (due to agricultural dimin- ishing returns), both of which raised costs and lowered the relative value of (capital-intensive) manufactures. 118 D. P. O’BRIEN RENT The Ricardian theory of rent as intramarginal surplus was due at least equally to Sir Edward West, Malthus, and Torrens; all four men published in 1815. Given the classical treatment of rent, wages, and profits, the treatment of rel- ative shares was easily discernable. Wages would eventually reach subsistence (although perhaps not physical subsistence); but wage-earners would enjoy spells during which wages were greater than subsistence as capital accumulation ran ahead of population increase. Profits would fall to a minimum, as a result of both capital accumulation in relation to investment opportunities (Smith, Malthus, and J. S. Mill) and diminishing returns in agriculture (Ricardo). Rent would rise both as a share of national income and in absolute amount. 8.4 MONEY 8.4.1 Background Classical monetary theory focused on gold and silver money and bank notes, treating bank deposits as devices for increasing the velocity of circulation, even though the concept of the deposit multiplier was put forward in the 1820s by James Pennington (1777–1862) (Pennington, 1826–40) and Robert Torrens (1837). The theory, stemming from Hume (1752), became known as the price specie- flow mechanism: A country’s price level is a function of its money supply; the equilibrium price level depends upon its balance-of-payments equilibrium. If the price level is too high, an outflow of metal will reduce the money supply (and the price level) to equilibrium, and vice versa. Worldwide, the value of gold and silver depend on their cost of production. But the relative value of gold and silver on the one hand, and of commodities on the other, within a country, is defined by balance-of-payments equilibrium. This mechanism proved to be the pivotal idea in the two great monetary controversies of classical economics. 8.4.2 The Bullion Controversy In 1797 the Bank of England suspended convertibility of its notes into gold, leading to the first major controversy between those who believed that causality ran from the money supply to the price level and those who believed the money supply responded passively to the price level. Those in the first camp, the Bullionists, blamed the Bank of England for generating inflation by over-issuing notes. Following Hume, for the Bullionists causality ran from the money supply to the price level. But their policy prescriptions differed. Some held to this position rigidly, and their position has come to be called the Ricardian Definition of Excess: whenever there are two symptoms of excess (paper) money supply – a high value of gold bullion (a low value of bank notes) and a depreciated exchange rate – then, by definition, the currency supply (Bank of England notes) is excessive, and the Bank should contract its issues. CLASSICAL ECONOMICS 119 The other group of Bullionists, led by Henry Thornton (1760–1815), argued that while these tests were valid if the symptoms were sustained, they could, in the short run, arise from other causes (Thornton, 1939 [1802]), such as harvest failure or financial panic. Severe damage to the economy could be caused by contracting the note issue in response to transient causes of pressure. Nevertheless, both groups agreed that in the long run the Bank must restrict its note issue sufficiently to permit a return to convertibility of its notes into gold. The Anti-Bullionists, by contrast, argued that the Bank’s note issue was simply responding to “the needs of trade” as indicated by the “real bills” presented to it for discount. The “real bills” were bills of exchange resulting from real transac- tions in goods and services. Their position was not sustainable. First, many of the notes issued had nothing whatever to do with “real” transactions, but were ultimately a consequence of the Bank’s position both as the government’s bank and as lender of last resort to the financial sector, a position recognized since statements of it by Francis Baring (1797) and Thornton. Secondly, as Thornton pointed out, even had the Bank confined itself to “real bills,” the transactions to which they related had to take place at some absolute price level – and in the Bullionist analysis the price level depended on the money supply. Thirdly, Anti-Bullionists argued that the Bank could not over-issue its notes because it charged interest (discount) when issuing notes, so no one would demand notes for which they had no need. But, as Thornton indicated, there was an indefinitely large demand for loans and discounts if the rate that the Bank charged was less than the marginal rate of profit. Ultimately the Bullionist case triumphed. Convertiblity was progressively restored from 1819. However, the 1820s and 1830s witnessed a series of financial crises and brought convertibility into question, as the Bank of England became hard pressed for gold. The debate on the terms on which the Bank’s charter would be renewed in 1844 formed the basis of the next controversy. 8.4.3 The Currency and Banking Debate Issues from the Bullion Controversy reappeared in the Currency and Banking Debate. The Currency school, positing an endogenous cycle of real income (O’Brien, 1995), argued that if the money supply (Bank of England notes) were regulated in accordance with the Ricardian definition of excess – contracted whenever there was a balance-of-payments deficit – this could act countercyclically. A balance-of-payments deficit was due to a rising price (and income) level, indicating the need for monetary contraction. The Banking school’s prescription of allowing the money supply to respond to the “needs of trade” would magnify the cycle and, by intensifying the price-level rise that had produced the balance- of-payments deficit, result in a gold outflow endangering the convertibility of the note issue into gold. The Banking school maintained that the money supply depended on the price level, that the balance of payments did not depend upon the price level, and that deficits were self-reversing. Over-issue of notes was impossible if the Bank 120 D. P. O’BRIEN adhered to discounting only “real bills” – any over-issue would automatically return to the Bank under the so-called Doctrine of Reflux. Both disputants shared certain assumptions, including acceptance of the need for convertibility and of the key role of the Bank of England note issue in the money supply. Neither assumption went completely unquestioned. Thomas Joplin (ca. 1790–1847) argued that the country bank notes were not, as both the Bullionists and the Currency school believed, controlled by the high-powered money base of the Bank of England notes; even more damagingly, he argued that the predomin- ant influence on the price level was these country bank notes rather than those issued by the Bank (O’Brien, 1993). Joplin accepted that the link with gold should be maintained under normal circumstances. Members of the Birmingham school, notably Thomas Attwood (1783–1856), did not even go this far (Attwood, 1816–43). They urged an incon- vertible paper currency to inflate aggregate demand, with the aim of reducing unemployment. This idea had respectable antecedents: Hume and Malthus had argued that increases in the money supply would increase output and employ- ment. But inflation as a policy had few supporters – the experience of the Assignats in Revolutionary France had demonstrated the danger of hyperinflation. Aggregate demand was not ignored by the classical writers. Say’s Law provided an explanation of the underlying circularity of the economic system. But the classical writers, especially J. S. Mill in his Unsettled Questions (1844), re- cognized that outside a barter system there could be excess demand for money, and that market clearing in a monetary, as distinct from a hypothetical barter, economy was an equilibrium proposition. Monetary changes were not neutral – if the classical economists had believed they were, the Bullion and Currency and Banking Controversies would have been pointless. 8.5 TRADE 8.5.1 Smith and the gains from trade Perhaps the most prominent feature of classical economics is the central import- ance attached to trade, and the corollary that trade should be free of restrictions. The intellectual underpinnings of this position are complex. Adam Smith set the tone by offering a critique of existing restrictionist trade policy, sustained and defended as it was by interest groups. The basic grounds for Smith’s position, however, involved a blurring of the distinction between home and foreign trade. Specialization and division of labor increased output per head, but were limited by the extent of the market. Freedom of trade increased the extent of that market, allowing greater division of labor. International trade, like interregional trade, was thus based upon the source of supply being the producer with absolute advantage. An international outlet for the increased output was offered by trade – this was later called the Vent-for-Surplus doctrine – in exchange for goods (and raw materials) produced more efficiently abroad. But for sources of supply to be absolutely the most efficient, it was necessary for CLASSICAL ECONOMICS 121 factors to migrate to where they could work most efficiently, which labor could not. J. S. Mill explained that for trade to be based upon absolute advantage, labor would have to migrate in search of its highest productivity, as its output would have to be sold in the same market wherever it worked, but the return to capital would be higher, the lower the resource input. 8.5.2 Comparative advantage If resources were not fully mobile internationally, it was still possible for trade to yield advantages for all parties, even though some of them were not the most efficient in terms of resource use. This idea, developed as the principle of comparative advantage, is usually associated with Ricardo’s Principles of 1817. However, Robert Torrens published the idea two years before Ricardo (Torrens, 1815; Robbins, 1958). The argument was basically that if one country were gener- ally more efficient than another, it would initially run a balance-of-payments surplus and gold would flow to it. This would inflate its money supply and raise its price level, with this process continuing until both countries were in balance- of-payments equilibrium. The more efficient country would import those com- modities in which its productivity advantage was least, and export those in which its superiority was greatest. 8.5.3 The terms of trade Division of the gains from trade between countries depended on the terms of trade, but Ricardo left unexplained the forces determining them. J. S. Mill explored the limiting case where a small country traded at a larger one’s internal price ratio, in which all gains went to the smaller country. Senior attempted to explain the terms of trade via relative labor productivity in export industries – which left unresolved the question of which were the export industries, since this depended on the terms of trade. Torrens (1827) and Joplin (1828) perceived that the key resided in the reciprocal demand of each country for the products of its trading partners, and James Pennington identified the outer limits of the terms of trade as being the different comparative cost ratios of the trading countries. J. S. Mill explained the analysis of reciprocal demand completely, his analysis being permeated by a complete understanding of the importance of the elasticity of offer curves (as they are now called) for the terms of trade. TRADE POLICY These developments had important implications for the analysis of trade policy, and somewhat undermined the Smithian case for free trade. Torrens showed that unilateral free trade would lead to a balance-of-payments deficit, which would cause an outflow of metal, reducing the money supply, lowering the price level, and turning the terms of trade against the free-trade country (O’Brien, 1977). Moreover, the fall in the price level would increase the weight of fixed charges, such as taxes, and produce economic depression. Conversely, a country would benefit from protection. [...]... joint stock companies from Babbage ( 183 2) From John Rae (1796– 187 2) he borrowed material on invention and a remarkable treatment of capital (Rae, 183 4), to produce a theory of investment that involved the interaction of time-preference and the marginal productivity of investment Ricardo, drawing on John Barton (1 789 – 185 2), had advanced, in the third edition ( 182 1) of his Principles, a numerical example... if the assumption of constant outlay (a reciprocal demand curve of unit elasticity) were abandoned, and argued that Torrens’s case led to retaliation on the part of a country faced with new import duties on its exports, with the prospect of a tariff war, the original terms of trade restored, but international trade at much reduced levels – a welfare loss for all participants 8. 6 ECONOMIC GROWTH 8. 6.1... McCulloch, disagreed With the exception of Ricardo, there was general opposition to such taxes Nor was there any enthusiasm for taxing profits To Smith, CLASSICAL ECONOMICS 125 profits were undiscoverable and contained a necessary reward to risk-bearing that was part of the supply price of capital to different occupations Taxes on profits might also affect resource allocation; Ricardo argued that a tax on profits... Oxford: The Clarendon Press, 189 6 —— 1776 An Inquiry into the Nature and Causes of the Wealth of Nations, ed R H Campbell, A S Skinner, and W B Todd Indianapolis: Liberty Press, 1 981 Thornton, H 1939 [ 180 2]: An Enquiry into the Nature and Effects of the Paper Credit of Great Britain, ed F A Hayek London: George Allen & Unwin CLASSICAL ECONOMICS 129 Torrens, R 181 5: An Essay on the External Corn Trade... productively, was not conducive to economic growth At the core of the argument, specialization and division of labor – the source of labor productivity and the mainspring of technology – depended on the supporting capital and the extent of the market Smith’s immortal example of the specialization of tasks in pin manufacturing has tended to obscure the bigger point that division of labor was even more important... run and short run), together with a tax on rent, and one on interest on government securities, was the ideal tax system J S Mill favored only a limited use of direct taxes on houses, land, and increments of rental value The classical economists approached the analysis of taxation in two different ways The first was taxation of factor rewards – wages, profits, and rent The second was particular modes of. .. for them, although J S Mill flirted with cooperation Centralized and totalitarian socialism was completely foreign to their outlook 8. 8.1 Factories The classical economists were reluctant to endorse intervention in industrial organization Although they supported the regulation of child labor, they were ambiguous about regulation of women’s work, and opposed the limitation of factory hours – Torrens and... infrastructure, and coinage, and even advocated the regulation of inheritance and of leases He defended shipping restrictions (the Navigation Laws), and legal limitations on the rate of interest Here, he was not followed by later classical writers His advocacy of public health regulation and banking regulation was supported, and a number of writers went further – McCulloch advocating employer accident liability and... equal ability to pay Smith did not make the distinction; later classical economists adopted one standpoint or the other The benefit theorists included Hume, Bentham, and Say McCulloch and J S Mill both favored an ability -to- pay approach, although they meant different things by it For McCulloch, it meant equality of burdens on different sectors of the economy, so as not to distort the process of economic. .. would act as a disincentive to improvements in agricultural technology 8. 7.2 Revenue raising The income tax was a matter of serious controversy during the classical era Introduced in 1799, abandoned in 181 6, and then reintroduced in 184 2, it eventually became a mainstay of public revenue Characterized by widespread fraud and evasion, it found little support amongst the classical economists There was little . elimination of rent from cost, he wrestled vainly with the problem of capital and the nature of profit. Torrens adopted a different approach and argued that relative amounts of capital, rather than. modified a basically Smithian cost of production approach. The French tradition of J B. Say had a wholly different approach, one consist- ent with the post- 187 0 approach to value theory: of the interaction. (particularly as, in the classical analysis, a tax on wage goods was generally to be passed on, implying that it increased the size of the wage fund), and the division of a given stock of capital between