ECONOMIC ISSUES, PROBLEMS AND PERSPECTIVES
ISSUES IN ECONOMIC THOUGHT
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ECONOMIC ISSUES, PROBLEMS AND PERSPECTIVES
ISSUES IN ECONOMIC THOUGHT
MIGUEL-ANGEL GALINDO MARTIN AND
CRISTINA NARDI SPILLER EDITORS
Nova Science Publishers, Inc. New York
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Published by Nova Science Publishers, Inc. New York
CONTENTS Preface
vii
Chapter 1
Making a Discipline: Economic Policy in Italy before Keynes Gianfranco Tusset
Chapter 2
Business Cycles in the Italian Tradition Cristina Nardi Spiller
21
Chapter 3
Endogenous and Exogenous Growth in Marco Fanno‘s Thought Mario Pomini
45
Chapter 4
Liberalism in the Economic Thought of Costantino Bresciani-Turroni Mikael De Gasperi
57
Chapter 5
The Contribution of Italian Scholars to the Theories of Income and Wealth Distribution Mauro Baranzini and Caterina Mari
71
From Utility to the Enjoyment of Life: The Bioeconomics of Nicholas Georgescu-Roegen. The Influence on the Italian Authors Stefano Zamberlan
99
Chapter 6
Chapter 7
Chapter 8
Chapter 9
Chapter 10
1
The City and the Urban Networks: The Contribution of Italian Urban Geography Paola Savi
117
Adam Smith on Education and Economic Growth: Direct and Indirect Effects Miguel-Angel Galindo Martin and María Teresa Méndez Picazo
135
Moral Traits of Adam Smith‘s Theories in Corporate Social Responsibility Evolution Inmaculada Carrasco
151
The Money Supply in Macroeconomics Peter Howells
161
vi Chapter 11
Chapter 12
Chapter 13 Index
Contents The Externality Debate and the Environmental Problems: Pigou, Coase, and the Austrian Approach José Luis Ramos-Gorostiza
185
An Approach to the Principles of the Economics of Innovation and Growth Sergio A. Berumen and Humberto Merritt Tapia
203
Life Cycle Hypothesis: Application for Dependence 225 Francisco Escribano Sotos, Raul del Pozo Rubio and Isabel Pardo García 243
PREFACE As it is well known, the present is rooted in the past. For this reason by studying the past, the authors can better understand not only some basic principles of the ideas proposed by modern economics, but also some make some recommendations to meet future economic problems of society.A huge literature has been developed on the theories and approaches of the most eminent economists. However, there is not much literature analysing contributions different from English-language on several concrete topics. For this reason, this book tries to cover this gap. In this sense, three aspects are considered: the contributions of Italian authors, Smithsonian approaches on education, growth and moral aspects, and, finally, some modern contributions. Chapter-1- This paper concerns the appearance in Italy of economic policy as discipline, before the leading contribution of Keynes. The authors will try to show that the economic policy idea as conceived by Italian economists evolved independently from pure economics analysis or, better, it grew because the discourse on economic policy was progressively excluded from pure and applied economics. This exclusion occurred as the debate, firstly on economic art and then economic policy, gradually shifted from trade policy to state intervention in trade policy, and then to state intervention for economic growth and wellbeing. Chapter-2- In the 1960s and 1970s, scholarly interest in economic fluctuations was keen. Later, attention waned, with a revival at the end of the century. After briefly outlining some of the leading contributions to this complex theme, the authors turn to the thought of certain representative Italian economists. In this context, the authors examine the approaches of Amoroso, Fanno, Menegazzi and Vito, and consider how their theories uncover new explanatory pathways. Effectively, as economic systems evolve, unexplored opportunities for enquiry may emerge from existing mechanisms or previously neglected elements. The authors are therefore convinced that these valuable theoretical contributions should not go to waste or be relegated to forgotten niches. Chapter-3- The business cycle theory was one of the main fields of macroeconomic research developed by Italian economists in the thirties. In the post-WWII period, general interest turned towards the theory of growth in the wake of Harrod's contributions. Fanno took full part in this theoretical turn, and made an original attempt at formulating a theory of cyclical growth. One of the main aspects that he tried to express was the real and endogenous character of economic growth. From this point of view, Fanno‘s theory of cyclical growth is
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not far off current theories of endogenous growth, in fact it is even more complete in certain aspects as it integrates the real part with the monetary part of the economic analysis. Chapter-4- This chapter will introduce the most significant aspects distinguishing the economic thought of Costantino Bresciani-Turroni. After a brief exam of the principal point of view produced by the well-know exegete of liberal thought, the authors are going to investigate the perspective from which Bresciani-Turroni draws up his vision in relation to the concept of freedom, the role of the State in the economy, the function of social welfare and social justice and his methodological approach. To conclude the author‘s dissertation, the authors will illustrate a suggestive analysis concerning an expansion of economy based exclusively on loans and credits. Chapter-5- In this paper the authors review and assess the contribution of Italian scholars to a number of theories of value and prices, as well as income and wealth distribution, starting from Thomas Aquinas and Ferdinando Galiani. Then the authors shall consider the classical School (Ricardo in particular) and its interpretation by Luigi L. Pasinetti in his 1960 seminal paper. The authors shall proceed, then, with a brief account of the approach to income distribution of the marginalist (or neoclassical) School, with reference to Vilfredo Pareto. But the authors shall above all concentrate on the contribution of the post-Keynesian School of income and wealth distribution, founded by Nicholas Kaldor, Richard F. Kahn, Joan V. Robinson and Luigi L. Pasinetti in the middle 1950s. The focus of their analysis was to investigate the relationship between the steady-state rate of profits on the one hand, and the saving propensities of the socio-economic classes and the growth rate of the economy on the other. It is worth noting that during these last 50 years about 100 Italian scholars operating within or outside Italy have published no fewer than 400 papers and 20 volumes in this field. The Anglo Italian post-Keynesian School of economic thought has gained a safe and sound entry in the history of economic analysis. In order to evaluate this vast scientific literature the authors divide the research program into seven specific lines: (1) the introduction of a differentiated interest rate on wealth of the classes; (2) the introduction of the monetary sector and of portfolio choice; (3) the introduction of the public sector and of the Ricardian debt/taxation equivalence; (4) the inclusion of other socio-economic classes; (5) the introduction of the micro-foundations; (6) the analysis of the long-term distribution of wealth and of the income share of the socio-economic classes; (7) other general aspects, in particular the applicability of the Meade-Samuelson and Modigliani Dual Theorem. As it may be seen, these research lines cover a wide spectrum of modern economic theorizing. Additionally they provide a bridge with alternative ways of problem-solving in economics. The references provided at the end of the paper include only part of the vast literature of this area. Chapter-6- Nicholas Georgescu-Roegen has experienced criticism directed at the theory of the behaviour of the consumer based on the usefulness and the excessive recourse to mathematical modelling. As such, he decided to address the complexity of human nature seeking new instruments of analysis resorting to the sciences of life and thermodynamics. In the essay, the authors analyze how from this criticism the Author manages to interpret the economic process in light of the entropy that sanctions an irreversible degradation of energy, one which he also extends to matter. Georgescu-Roegen states that man for his sustenance and his esosomatic evolution uses, through the economic system, matter and energy with a low entropy on the planet. As such, the relationship between man and the environment is neither only biological, nor only economic, but bioeconomic. And the last aim of the
Preface
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economic process is not to use resources and to discharge waste products into the environment, but is «the enjoyment of life». After having examined the progressive evolution of the concept of this author and the elements of the enjoyment of life, the authors highlight how the bioeconomical approach has been easily absorbed into the Italian tradition, where the theoretical contributions of analysis of the economic and social system in its entirety are numerous in order to realize the wellbeing of the individual and valuing the resources of the land in which they live. Chapter-7- Geo-economic analysis of urban territories studies the economic, social and political mechanisms that govern the organisation and differentiation of urban land use on the one hand, and the functioning of urban networks on the other. The geography of the city explains how economic functions, households and social groups locate within urban space, and proposes models of urban land use. The network approach, instead, views cities as nodes in urban systems of different scales, and analyses both the horizontal relationships (hierarchies, complementarities, and specialisations) between nodes in the network and the vertical relationships of nodes with their local milieu. This dual perspective is well established in the international literature, and serves as a reference point from which to discuss the contribution of Italian geography to the study of the urban phenomenon, with special emphasis on the geography of networks and the scientific role of the Scuola di Torino. Chapter-8- Adam Smith didn‘t develop his ideas about education in a chapter or in a concrete section of his work. His general research interests can be grouped into three sections: justice, moral and economics, and education can be included in all of them. In his analysis of justice, he considers that education exists in all kinds of societies and in their evolution the families, especially fathers, must be concerned about the education of their children. The reward of this effort to acquire education is that the salaries will be higher and must compensate the education expenditure. And considering an economic perspective, there is a relationship between education and the factors and variables that are growth-enhancing. In this sense, education is one element that can help to develop the division of labour‘s positive aspects and eliminate the negative ones. Economic advancement is achieved, among other things, through education. The main goal of this paper is to analyze all these relationships and show education‘s effects on those quantitative and qualitative factors, such as, division of labour, inequality, commerce, social strains, and social capital. It plays an important role in the economic growth process from Adam Smith‘s point of view. Chapter-9- During the last decades, companies have been increasingly paying attention to Corporate Social Responsibility (CSR) ambits, and literature about CSR has grown exponentially. In those works it hasn‘t been usual to see the connection between CSR and Adam Smith‘s thought. Smith is seen as the father of orthodox economy. But a part of Smith‘s writings has been forgotten in those establishments. The aim of this paper is to present Adam Smith as a profoundly ethical author, whose moral writings can lodge the more recent CSR standpoints. Some relations between Smith‘s moral thought and CSR will be established. Chapter-10- The notion that the quantity of money in an economy might be endogenously determined has a long history. Even so, it has never been part of mainstream economic thinking which has remained dominated by the view that the policymaker somehow controls the stock of money and that interest rates are market-determined. However, the need to design and operate a monetary policy that works for modern economies as they are currently
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constructed, has led to the emergence of the so-called ‗new consensus macroeconomics‘ in which it is recognised that the policymaker sets a short-term interest rate and the quantities of money and credit are demand-determined. This chapter looks at the way in which this ‗new consensus‘ is (at last) forcing a recognition, in the teaching of money, that the money supply is endogenously determined. It also shows how the authors can take this further by adding a banking sector to a model of the real economy in which the money supply is endogenously determined. Chapter-11- The aim of this chapter is, first of all, to survey the main theoretical positions with regard to the externality problem, paying special attention to Pigou‘s original formulation of external effects and to the differences between Coase and the Austro-Hayekian approach. In practice, the position of ―free market environmentalism‖ toward pollution fits the Austro-Hayekian ideas. For this reason, in the second place and by way of illustration, the possibilities and limitations of ―free-market environmentalism‖ viewpoint with regard to real pollution problems will be discussed. Chapter-12- Economic growth is a central concept in the economic theory. Modern societies refer to growth as an important determinant for rising standards of living. These effects can be observed not only in more goods and services, but also in brand new products and processes. Investment in human capital is looked upon the very source of long-term, sustainable economic growth. The purpose of this chapter is to provide a brief description of the economic growth, how to analyze its measurement, and also to review briefly the main schools of economic thought that have undertaken its analysis. Chapter-13- The aim of this chapter is to review theoretical background related to the life cycle hypothesis. The authors take into account new demographic situations, where life expectancy increases, elderly population increases, number of children decrease and, therefore, it will be necessary to consider who is going to care for elderly and dependent people. In this paper, the authors consider that savings can contribute to mitigate consequences of dependence, because people can use savings to obtain services related to dependence. The mathematical model proposed is an extension of the life cycle hypothesis. The authors analyze Modigliani‘s life cycle hypothesis and the authors use his analysis to introduce savings necessary to cover dependence; this revision will show the importance of savings and besides the authors will be able to discuss the need to finance long-term care services in the case of dependence.
In: Issues in Economic Thought Editors: M-A. Galindo, C. N. Spiller, pp. 1-20
ISBN 978-60876-173-9 © 2010 Nova Science Publishers, Inc.
Chapter 1
MAKING A DISCIPLINE: ECONOMIC POLICY IN ITALY BEFORE KEYNES Gianfranco Tusset University of Padua, Italy
ABSTRACT This paper concerns the appearance in Italy of economic policy as discipline, before the leading contribution of Keynes. We will try to show that the economic policy idea as conceived by Italian economists evolved independently from pure economics analysis or, better, it grew because the discourse on economic policy was progressively excluded from pure and applied economics. This exclusion occurred as the debate, firstly on economic art and then economic policy, gradually shifted from trade policy to state intervention in trade policy, and then to state intervention for economic growth and wellbeing.
JEL codes: B30, B41
1. INTRODUCTION In the mid-nineteenth century, Angelo Messedaglia1 and other scholars dealing with the question of what the state can do to increase national wealth maintained that, if a starting point existed, it should be the transformation of the then vague concept of economic art or science of public administration into a more solid and definitive discipline (Messedaglia, 1865-66, p. 15). A research programme with a strong ‗law and economics‘ characterisation was drawn up to induce Italian economists to investigate the
Department of Economics and Management, University of Padua (Italy). For correspondence: gianfranco.tusset @unipd.it 1 Angelo Messedaglia (1820-1901) was at that time an important economist-statistician at the University of Verona.
2
Gianfranco Tusset legislative and government measures targeted on regulating private economic relationships and to augment national wealth (Messedaglia, 1920, p. 11);
and it marked out a new area of studies, which at the end of that century was named economic policy. The evolution of this endeavor proceeded through conceptual stages, the first of which was the growth of trade policy studies as a consequence of the establishment of business schools (scuole di commercio)—the first of them being founded in Venice in 1868. Firstly, trade policy became a policy on international exchanges, duties, and customs, in a historical phase during which the state was gradually called upon to enact new interventionism in addition to its classic subsidiary functions. Only subsequently did trade policy evolve into international economic policy; that is, into an instrument for safeguarding the national interest. This introduced the last stage characterized by increasing attention towards all policies, not only trade policy, which might equally augment national growth. This paper seeks to show that the economic policy idea as conceived by Italian economists evolved independently from pure economics analysis; or, put better, it grew because the discourse on economic policy was progressively excluded from pure and applied economics. This ‗exclusion‘ occurred as the debate, firstly on economic art and then on economic policy, gradually shifted from trade policy to state intervention in trade policy, and then to state intervention for economic growth and well-being.
2. THE FIELD OF ECONOMIC ART In the textbooks2 of the mid-nineteenth century, science and practice—that is, pure economics and economic art—were not clearly related to separate fields of economic policy. Francesco Ferrara3 argued in his 1857 and 1858 academic courses that theory and practice, science and art, must be both treated as premises to the same syllogism, as two sides and phases of the same branch of human knowledge (Ferrara, 1935, p. 618).
According to Ferrara, the strict interdependence between the two concepts of theory and art meant that they could not be treated separately. However, given the youthfulness of economic science at the time, he did not exclude a later distinction between the two fields. The relevance of Ferrara‘s statements went beyond methodological disputes, because once the indissolubility between science and its applications had been posited, it was impossible to justify practices such as monopoly and protectionism by attributing them to the realm of praxis or applied economics instead of to pure theory. By rejecting any distinction between science and art, Ferrara excluded any justification of these practices contrary to laissez-faire. Other contemporaries seemed cautiously interested in the distinction between rational (pure) and applied economics proposed by Pellegrino Rossi4 and opposed by Ferrara. More 2 3
The textbooks written by Italian economists constitute our main source. Francesco Ferrara (1810-1900) was one of the most important liberal Italian economists of the nineteenth century. He held various political offices. He promoted publication of the first series of the Biblioteca degli Economisti.
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subtly, they differentiated between ‗pure economics‘ and ‗economic art,‘ where the latter did not coincide with ‗applied economics.‘ This proposal of a sharp separation caused misgivings in Angelo Messedaglia, because it would reduce science to a few and abstract principles […] while it would disproportionately enlarge the field of economic art (1851, p. 30).
On the contrary, observation and experience […] continuously subsidize speculative science, defining its boundaries (Ibid.).
In 1874, in the introduction to his Economia dei popoli e degli Stati, Fedele Lampertico5 wrote as follows concerning the proximity of pure and applied economics: The sole difference is that pure theory studies general rules, while applied economics focuses on particular rules. But every type of rule is a true object of science (Lampertico, 1874, p. 73).
However, he was aware that a third field existed: economic art, or the set of teachings of which one makes use applying the precepts established by rational and applied economics (1874, p. 74). Thus, economic art involved experimental research grounded on specific knowledge of facts and conducted to achieve specific objectives. For this reason, economic art was clearly demarcated from both pure economics and applied economics. Economists frequently resorted to categorization in pure economics, applied economics and economic art, even if it was interpreted or named in different ways. Antonio Ciccone6 did not take art to be the implementation of economic rules, but rather as customs on which those economic rules are founded (1874, p. 17). Luigi Cossa7 reversed applied economics and economic art, but he maintained the functional distinction between them in three areas. Moreover, he stated that science, art (applied economics) and practice (economic art) complement each another, and it is erroneous to believe that one can take the place of another (Loria, 1876, p. 8).
Concepts such as economic art were initially introduced into the economic lexicon in order to mitigate the inconsistencies between what the abstract rules of pure economics affirmed and how they were applied, especially in trade policies. In this regard Fedele Lampertico‘s thought was not so distant from Ferrara‘s: both rational and applied economics establish the ends of economics itself, although the former is entirely abstract and the latter is historicized. Obviously, because they were grounded on the operations of the market, neither rational nor applied economics raised the question of what instruments should be used to achieve economic objectives. However, when market failures emerged, or when the state 4
Pellegrino Rossi (1787-1848) taught Political Economy at College of France and Constitutional Law at la Sorbonne, Paris. 5 Fedele Lampertico (1833-1906) is mainly known for his five-volume Trattato di economia dei popoli e degli stati. 6 Antonio Ciccone (1808-1893) pursued his academic career at the University of Naples. 7 Luigi Cossa (1831-1896) was professor of Political Economy at the University of Pavia. He was associated with the reception and dissemination of the German School in Italy
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conditioned (international) markets, another discipline studying those ‗instruments‘— economic art, subsequently economic policy—was to gain ground.
3. COMPARATIVE COSTS THEOREM AND TRADE POLICY Impetus was given to the gradual constitution of economic policy as a field concerning the instruments to pursue political economy purposes by the strengthening of trade policy, which in the mid-nineteenth century consisted essentially in a policy of commercial treaties. According to many authors of that period, the general reliance on treaties to regulate exchanges between countries was one example of economic art used to push states towards free trade. By means of treaties, commercial relations among countries would approach the conditions depicted by the Ricardian comparative costs theorem, which in the meantime was becoming a fundamental principle of economic science. Trade agreements were conceived thus by Gerolamo Boccardo8, who, in his 1858 Manuale di storia del commercio delle industrie e dell’economia politica, described the lowering of duties by the German regions— known as Zollverein (1858, p. 352)—as a typical case of free trade achieved by means of commercial agreements. For Boccardo, the then English process of progressive abolition of customs barriers was the most advanced instance of free trade (1858, p. 358). In the mid-nineteenth century, the signing of trade treaties was conceived in practice as an instrument of free trade, and as affirmed by Angelo Marescotti9 in his Catechismo della economia politica (1861, p. 118), it had political implications: The wide extension of modern international trade, the innumerable, frequent and complex relationships linking distant marketplaces have produced an important new phenomenon unknown not only to the ancients but also to the last generation. We refer to that intimate and universal solidarity unifying peoples geographically very distant from each other (Boccardo, 1858, p. 382-3).
This quotation from Boccardo introduces the crucial question of who the true protagonists of commercial relations were: markets or states? Markets, clearly, because in those years trade policy was the set of political measures aimed at bringing real exchanges closer to those described by the free trade theory. This is a key point, because a few years after Boccardo‘s writings, trade policy was perceived in a very different way. Faith in the free-trade law did not change, as Cossa showed: Originating from property rights and from equality applied to economic relationships, the laissez-faire principle contributes to spreading useful discoveries, to strengthening peace and fraternity among people, and it represents a rational complement to other kinds of progress (Cossa, 1876, p. 78-9).
8
Gerolamo Boccardo (1829-1904) is mainly remembered for his four-volume Dizionario dell’economia politica e del commercio (1857-61). 9 Angelo Marescotti (1815-1892) taught Public Economics at Bologna from 1859 to 1881.
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What changed, however, was the idea that the principle could not or should not be subject to mitigation or adjustment in its real implementation. In his Elementi di economia politica, Cossa himself pointed out that, first, the change to free trade should be a gradual, and not a sudden movement, suitably enforced with regard to both timing and methods; second, it must be coupled with other measures mitigating temporary drawbacks […] affecting those industries exposed to the consequence of radical systemic changes (Cossa, 1876, p. 83).
The instrument which enabled this gradual opening of markets was once again the commercial agreement, all the more so if it included the reciprocity law. In the space of a few years, however, this accepted notion of the trade agreement changed: the latter no longer regulated market relationships, but rather state relationships. The change in the function of this basic economic policy instrument concealed a discontinuity in the discourse on economic policy or economic art. At first sight, the focus now shifted to the subject of trade policy, namely the state. This shift was recognized by economists and scholars, but it was nothing more than a change in the image of the state and its role in international economic relations. That the issue concerned the subject of international economic relations was confirmed by Bastable (1900, p. 5), who spoke of ‗international trade‘ as ‗trade between societies‘ i.e. between the different social organisms which sociology assumes as its field of investigation. Pure economics attributed subjectivity to markets; applied economics and economic art did so to states; and sociology to societies. Consequently, the same trade relationships changed subject according to the disciplinary perspective, thus confirming firstly that pure economics and economic art (or policy) were progressively distancing themselves from each other, and secondly that the new state‘s subjectivity needed a new disciplinary field. Why did this shift from market to state occur? Economic growth could be ensured by markets and states, the latter by means of protectionism. Governments found new rationales for intervening in markets because they seemed to yield inferior outcomes. Moreover, as a consequence of state intervention to regulate international exchanges, trade policy was transformed into a policy for a community progressively identified with the state. It was no longer a policy for markets. Shortly afterwards, in 1907, Luigi Fontana-Russo10 wrote: Now, speaking of trade policy, we mean that international exchanges occur between states and not between markets (Fontana-Russo, 1907, p. 13).
In the last decades of the nineteenth century, economic policy largely signified state intervention hinged on trade policy, although this was no longer purported to ensure solely the well-being of individuals, families, economic classes, but also the well-being of society as a whole, that is, of the state (Fontana-Russo, 1907, p. 13). This statist wave did not imply mercantilist resurgence; rather, it was the first symptom of the subsequent subjugation of trade policy to national economic objectives. This occurred when trade policy, and not just international exchanges, was seen as a source of national wealth.
10
Luigi Fontana Russo was Professor of Trade Policy and Customs Law at the Regio Istituto Superiori di Studi Commerciali.
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This evolution increased the then unclear difference between pure theory of international exchanges and trade policy. Economic art was no longer the field in which instruments to achieve pure economics objectives were devised. A passage in Pantaleoni‘s Principii di economia pura stressed that the implementation of Ricardian theorems in international exchanges concerned applied economics without any interest for us pure theoreticians (Pantaleoni, 1894, p. 215 note 1). The theory of international trade should be applied to markets; trade policy concerned state relationships, and was thus gradually excluded from pure economics. Two areas of research were emerging: the first on theories, and the second on policies.
3.1. On International Exchange Theory Before the free trade-protectionism debate is investigated to explain the market/state shift, it may be useful to outline how textbooks incorporated the theoretical research embodied in the Ricardo-Mill comparative costs theorem. Generally speaking, the Ricardian theory of comparative costs was the framework of almost all textbook sections on international trade. If free trade had advantages, they were depicted by the above-mentioned theorem. Barone wrote that: apart from its rudimentary form, which ignores many circumstances, and apart from a slight imprecision deriving from its focus on the concept of production cost and its neglect of utility or demand, Ricardo‘s reasoning was exact, and the comparative costs theorem has been widely confirmed by experience (Barone, 1915, p. 112).
At most, some integration or adjustment could be made to the theorem. The manuals bear traces of the broadening of analytical scope due to the Marshallian curves of reciprocal demand illustrated by Maffeo Pantaleoni11 in his Principii (1894, p. 236 ff.). In this regard, Augusto Graziani12 (1913, p. 141), when discussing the case of country monopolistic production, emphasised the reciprocity of demand, which contradicted the rule that the current value of imported and exported goods was based only on costs. In general, both supply and demand would influence international price-making: We cannot exactly speak of international normal value as the point on which market values converge, but we can assert that the change of international values determined by reciprocal demand ranges between boundaries fixed by the country‘s comparative costs (Graziani, 1913, p. 143).
11
Maffeo Pantaleoni (1857-1924), graduated in law at Rome and then pursued his academic career at several universities, among them Macerata, Geneva, and Rome. He was also Deputy (1901-04) and Senator (1923-24) in the Italian Parliament. Besides his well-known and influential 1889 Pure Economics, he wrote on public finance, banking, economic dynamics, and social topics. 12 Augusto Graziani (senior) (1865-1944) taught Political Economy and Public Economics at Naples University.
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Vilfredo Pareto,13 in both the Cours d’économie politique and the Manuale di economia politica, argued for the difficulty of applying a subjective notion of production cost to international trade. This could be done by envisaging a production cost as a sacrifice—a concept comparable to that of utility or ophelimity—although the problem of extending it to a country or community persisted (Pareto 1964a, p. 210-12). Among the other issues mentioned by Pareto were the different currencies used in international exchanges and the inclusion of transportation costs in price-making. For these various reasons, Pareto preferred a comparative costs theorem founded on the notion of price instead of cost. According to a purely economic approach, protection consists of nothing more than a specific application of the Ricardian theorem. This viewpoint is clearly expressed in Pareto‘s Manuale and Barone‘s Principi di economia politica. By contrast, if an applied perspective is adopted, protectionism is the main policy problem.
4. TRADE POLICY BETWEEN FREE TRADE AND PROTECTIONISM The changing conception of trade policy from market to state relationships can be better understood by investigating a subject recurrent in almost all the economics textbooks of the late nineteenth/early twentieth century: the free trade/protectionism debate. This involved four main topics: infant industry; national economies; the resurgence of protectionism; and comparison between liberal and protectionist systems. These topics are indicative of the increasing awareness among Italian economists that trade policy did not fall within the domain of pure economics, but rather within an undefined field different even from applied economics.
4.1. Infant Industry The infant industry theory is relevant to our purposes here because it was used to demonstrate the fallaciousness of a theoretical treatment of protectionism. Free trade and the corresponding rejection of protectionist policies were mitigated when countries had to deal with infant industries. This softening of liberalism did not convince everyone, however. Pareto admitted in his Manuale that protection could be useful to safeguard infant industries; but he equally acknowledged that there were no examples of infant industries which had renounced such protection when they had matured. Although stating that infant industry should be protected in its early phases so that it can learn from its own experience—the Mill-Bastable14 dogma, a legacy of Listian thought—may be acceptable in abstract, it reveals its fallaciousness in practice: All industries born under protection have always demanded even more protection, never renouncing it (Pareto, 1964b, p. 322).
13
Vilfredo Pareto (1848-1923) is considered one of the founders of the general economic equilibrium approach. See in particular his Cours d’Economie Politique (1896-97), Manuale di economia politica (1906) and Trattato di sociologia generale (1916). 14 The term is taken from M.C. Kemp (1960, p. 65-67).
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Infant industry protection should therefore be undertaken very cautiously, owing to the risk of its becoming permanent, not temporary. Similar arguments were developed by Pasquale Jannaccone,15 whose 1915 Lezioni di economia politica expressed all his scepticism concerning renunciation of the advantages of protectionism by infant industries: The metaphor of rising and developing industry does not correspond to reality because it is not easy to recognize when the industry can do without protection, also because the individual firms belonging to an industry are at different stages of development and of competitiveness. Thus, protectionism is invoked by those firms that are in less favourable conditions (Jannaccone, 1915, p. 510-11).
According to these authors, the infant industry theory was confuted in practice. Emilio Nazzani16 put forward similar views. In his Sunto di economia politica he wrote: The right of a country to protect its own industry is admissible only when it is temporary and 17 is useful to acclimatize a particular industry in one country (Nazzani, 1921, p. 140).
However, it is very difficult to reduce or to abolish a duty once it has been established, because of the opposition of interest groups advantaged by the duties (1921, p. 141). On a theoretical level, the protection of infant industry gave rise to more doubts than certainties. Italian economists were not convinced by the then more advanced theoretical explanation of protectionism. Put simply, they conceived infant industry as nothing more than an ordinary protectionist measure; and protectionism did not admit to theoretical explanation because, as we shall see in the next section, it had a historical characterization.
4.2. The Specificity of National Economies To return to Pareto, he seemed inclined to grant an autonomous field to applied economics, if not to economic policy. Notwithstanding his reservations about the infant industry theory, he recognized the difficulty of judging a priori the effect of either protectionism or free trade, even by comparing countries adopting different regimes, and this because of the many other circumstances distinguishing the countries. The effects on each country of either protectionism or free market are necessarily different: It is erroneous to cite the United States‘ prosperity as an example of the usefulness of protectionism, or the United Kingdom‘s wealth as a proof of the usefulness of free trade (Pareto, 1964b, p. 329-30).
This statement justified the creation of an autonomous discipline which analysed each national case individually. Nor did international exchange theory appear immune to criticism. The fact that Pareto made use of the notion of ‗exchange value‘ instead of ‗international 15
Pasquale Jannaccone (1872-1959) taught Statistics and Political Economy at the University of Turin. Emilio Nazzani (1832-1905) focused his studies on the classic theory of value. 17 Nazzani‘s book, Sunto di Economia Politica, went into its 16th edition in 1921. The first edition was dated late 1870s. 16
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value,‘ means that he referred, not to the ratio between the costs of two goods, but to certain notions of purchasing power, of equivalence between goods, of hindrances that must be overcome, etc. In short, international exchanges analysis went beyond comparative costs. Like Pareto, Enrico Barone18 argued in his Principi (1915) that the statement duty destroys richness—was a precept—among the most reliable of economic science—but he added —this does not mean that every kind of protection must be excluded a priori (Barone, 1915, p. 118).
He compared the destruction of wealth due to protection with the destruction, not necessarily of a lesser magnitude, that such protection would prevent. Being aware that he thus denied the primacy of economic free trade, Barone justified his position by recalling that real problems are very complex because of social circumstances. Protection therefore belongs among those ‗social,‘ or not strictly economic, problems that require a historical approach: all the economic and social conditions of a country being known at a given time, it must be ascertained whether free trade or protectionism is better for that country at that given time (Barone, 1915, p. 118).
A first conclusion can be drawn. According to both to Pareto and Barone, economic science states principles, sometime inalienable ones. But since it is unable to prove their universality, it postpones their confutation to another, not well defined, field of inquiry. The unprovable nature of these assumptions was justified by treating protection as a dynamic fact to which the equilibrium rules were not applicable. This was nothing but an exercise in rhetoric, however, because the dynamic facts introduced in the textbooks of the time were not explained by means of economic rules, but confined to the applied section (Barone 1915, p. 125). Protectionist policies were treated in separate chapters, if not in separate books. The theoretical absolutes were mitigated by empirical reasons. Because fluctuating capital and goods prices might change the terms of trade and, consequently, ‗reduce investments,‘ stabilization of the terms of trade by means of duties seemed the lesser evil in dealing with constant international price instability. Such price swings and ‗dynamic movements‘ would greatly mitigate the laissez-faire assumptions. Barone therefore agreed that protection involves wealth destruction, but this does not mean that it is to be condemned at every time and for every country (Barone, 1915, p. 128).
4.3. The Resurgence of Protectionism Many theories tried to explain the periodic resurgence of protectionism, but they were mostly historical or exogenous theories grounded on long movements or political factors. Barone did not approve of protectionism but he accepted it. This view highlights a question widespread at that time among free-trade theoreticians: why had protectionism been
18
Enrico Barone (1859-1924) was a military historian and economist. His main work is Il ministro della produzione nello stato collettivista (1908).
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maintained notwithstanding the lack of any theoretical validation for it? Achille Loria,19 in his Corso di economia politica, after ‗absolutely‘ condemning any ‗protectionist system,‘ put forward his own theoretical answer. He started by distinguishing two kinds of tariff or duty: agricultural duty and industrial duty, and attacked agricultural protections as sources of ‗unjustified gains‘ deriving from the cultivation of marginal lands. These duties raised landlord rents and damaged the rest of society (Loria 1927, p. 712). The application of tariffs to industrial goods was a different case, principally because it depended on the profit rate. According to Loria, protectionism exhibits a historical trend coinciding with the course of profit rates. When the latter decrease, because of either increasing wages or industrial crisis, capital owners tend to protect themselves by raising tariffs. However, Loria continued, the lugubrious outcomes of this anti-economic system soon manifest themselves: production decreases, wages drop to discouragingly low levels, and hence all duties became intolerable, tariffs collapse one after the other (Loria, 1927, p. 715-6).
Alternating free trade with protectionist tariffs was a ‗historical need‘ for industrial society about which the ‗pure laws of economics say almost nothing‘ (Loria, 1927, p. 718). Augusto Graziani, (1913), on discussing the resurgence of protectionism, provided a careful historical account of the phenomenon, ending with a description of the closure measures adopted during the latter half of the nineteenth century by the United States, continental Europe and Russia. He provided an interesting explanation for the phenomenon by linking it with the spread of economic theories, particularly Stuart Mill‘s and List‘s theories in Europe and Carey‘s proposals in the United States. By contrast, Camillo Supino20 at first sight seemed to espouse protectionist attitudes and widely discussed the topic in his textbook, Principi di economia politica, although it concerned more economic policy than pure economics (1923, p. 353). Supino‘s choice is understandable in light of his conception of scientific interests: that is, the economist must study the reasons why there exists a widespread contradiction between pure economic truth (see laissez-faire) and government conduct (1923, p. 353). Recognizing the advantages of free trade, he re-proposed the unanswered question: Aside from theoretical reasons, protectionism and free trade alternated in many countries, and the former now prevails. What are the causes of this contradiction between theory and reality? If free trade is generally beneficial, why is it not universally adopted? In what circumstances can protectionism be justified? (Supino, 1923, p. 316).
Supino worked out complex answers which are now summarised. Strictly agricultural and industrial countries did not need protectionist measures because they did not fear international competition. In those cases, free trade fully corresponded to the public interest (1923, p. 361). The context changed when an agricultural country tried to introduce changes in manufacturing. Protectionism appeared necessary in order to guarantee capital accumulation and the competitiveness of new industries. Once the economic transformation had ended, the 19 20
Achille Loria (1857-1943) pursued his academic career at the Universities of Siena, Padua, and Turin. He produced a deterministic theory of economic development. Camillo Supino (1860-1931), an evolutionary economist, is remembered for his studies on economic crisis and international monetary market.
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economy was opened anew, although individual tariffs might always be introduced to develop specific industries. Political reasons existed, beside economic ones, to explain protectionism. In fact, the exporting of certain goods (weapons) to specified countries was not permitted, foreign labour could not be employed, and so on. In pointing out the political character of protectionism, Supino clarified that it maintained the identity between government policy and private industrial activity. He stressed the political nature of fiscal duties aimed at increasing fiscal revenues, measures favouring commercial agreements, retaliation protectionist measures or, finally, action taken to prevent economic dumping (1923, p. 363). Differently from Stuart Mill‘s economic perspective, protectionism was interpreted in exclusively political terms, whereby protectionism was the outcome of the influence exerted by lobbies on the political apparatus. Protectionism expresses the spurious patriotism aimed at restricting economic activity within the national or imperial boundaries, defending the nation or the empire against the destructive influences of commercial cosmopolitism. Such protectionism was grounded on the interests of a capitalist class that preferred imperialism to labour division (Supino, 1923, p. 364).
Protectionism was therefore the result of a struggle among national productive groups— that is, landlords against manufacturers—or among industrial sectors. This was the product of sectorial interest, but since powerful and well-represented sectorial interest influences government, even if it causes more serious general damage, it is no wonder that protectionism, the emanation of these sectorial interests, prevails in almost every country (Supino, 1923, p. 364-5).
This analysis notwithstanding, Supino was not indulgent towards protectionism, although he accepted it in a temporary form enabling circulating capital to go elsewhere, fixed capital to wear out gradually and the workforce to change jobs, in order to avert a ruinous production crisis (Supino, 1923, p. 365).
When a protectionist measure could be considered temporary had to be ascertained. In the case of Supino, too, one notes that the explanation of the phenomenon— protectionism—was different from the scholar‘s belief in, or ideas about, the expediency of protectionist measures, as if economic theory might not be able to interpret economic reality.
4.4 Free Trade and Protectionist Systems Even though he did not espouse protectionism, Luigi Fontana-Russo came to different conclusions in his Trattato di politica commerciale: The economic progress achieved by the countries that adopted protectionism was enormous; maybe more rapid than that of countries which followed the opposite system and which are now gradually turning towards the protection offered by duties (Fontana-Russo, 1907, p. 185).
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The two systems, protectionism and the free market, would not lead to the same outcomes, which must be judged according to the nature of the countries considered, in view of the economic-social utility to be achieved and its effectiveness as an instrument designed to achieve special goals (1907, p. 186). Fontana-Russo did not ―think‖ like a theoretician attentive to universal law, but as a scholar of economic processes and of their evolution: Whereas free trade is grounded on a visionary cosmopolitism, protection is based on the development of a country‘s productive forces (Fontana-Russo, 1907, p. 193).
Although contradictory, this was an idea widespread among economists at the time: liberalism is the aim of protectionism (1907, p. 210). If we do not consider the timing of development processes, this statement might seem like a rhetorical device. In reality, it synthesizes the dynamic view according to which protectionism would guarantee a country‘s development potential that makes it more competitive in an open economy. Rather than incompatibility between protectionism and free trade, we must talk of different phases in a country‘s growth, and these phases did not necessarily result in a competitive free market, since each country, on attaining a certain stage of capitalistic evolution, finds a way to transform the competition regime into a coalition regime (Fontana-Russo, 1907, p. 240).
Moreover, the emerging trusts may condition governmental decisions, giving rise to new types of protectionism. Once again, the alternation between liberalism and protections appeared, without theory interpreting it. The idea that protectionism would mean a closed economy had been mitigated. Salvatore Majorana Calatabiano,21 in 1913, in the third volume of his Trattato, dwelled on commercial agreements, treating them as compromises between ‗the principle of fullest justice and freedom‘ and the trend of protecting national economies. Such instruments could represent a step towards a ‗larger centre of activities, of civilization, and of solidarity‘ (1913, p. 253). In Europe, the mechanism of agreements is always preferable to that of individual tariffs, as Calatabiano wrote, interpreting a fairly widespread point of view. Obviously, no economic theory can demonstrate the level to which protectionism must be brought for the purpose of subsequently furthering laissez-faire. Hence, protectionist policy and commercial agreements become objects of economic policy. In effect, political economy manuals and textbooks did not usually develop this topic. Majorana Calatabiano wrote: The supporters of protectionism do not consider themselves to be enemies of freedom and of natural harmonies; by distinguishing between pure science and applied science, they believe they can pay tribute to the theoretical elegance of the principles but, when faced with their implementation, they are hesitant (Majorana Calatabiano, 1913, p. 416).
21
Salvatore Majorana Calatabiano (1825-1897) taught at the Universities of Messina and of Catania. He was also Minister of Agriculture, Industry and Trade between 1876 and 1879.
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Of interest in this regard was the definition of commercial agreements proposed by Enrico Leone22 in his Lineamenti di economia politica dated 1925: they are acts of fair trade forming a policy midway between a free trade regime and protectionism. In reality, these treaties had little to do with ‗economic phenomenology,‘ being on the contrary acts of ‗economic interference;‘ that is, they interfered with economic facts, and did so to the point that, recalling the two above-mentioned lines of inquiry, an adjusted theory of trade policy lies outside the economic rules of minimum means characterising production and trade (Leone, 1925, p. 65-6).
Yet wise men judged this new trade policy based on the practice of juste milieu to be impossible. In contrast, by means of treaties, protectionism showed its specific essence by differentiating the autonomy behaviour of states according to the weight of the most influential interest groups (Leone, 1925, p. 71).
The conception of economic policy was progressively changing. Respect for the free market principle was no longer the focus of policy making. It had been replaced by issues concerning how the state should act in the international arena, and by comparison among national systems. The latter was similar to the struggle between ‗national egoisms,‘ analogous to the struggle between individual egoisms, as affirmed in 1920-21 by Ghino Valenti23 in his Principi di scienza economica (1921). Paradoxically, the resurgence of economic nationalism resulted in ‗individualism‘ being applied to state behaviours and relationships. If this confrontation was between subjects with unequal strength, the outcome was the monopolizing and the overwhelming of the weak by the strong. Hence the economist must not forget that theoretical principle […] does not fit with specific real facts. In fact, with regard to Political Economy and Economic Policy, he must consider, besides the aggregate or medium outcome, also the position of the individual subjects that produce the result (Valenti, 1921, p. 227).
If there was unevenness among national economies, one weak country was obliged to adopt measures aimed at strengthening national agricultural and industrial production, and at increasing exports, also by means of duties and tariffs serving this purpose (Valenti, 1921, p. 228). The field of economic policy seemed to have been clearly delimited. Moreover, it is significant that such authors stated in their textbooks that protectionism and the free market are systems with both advantages and disadvantages (Valenti, 1921, p. 242). The nineteenthcentury dogmatism was greatly weakened. A new rule was taking root, according to which the national economies could adopt short-term protectionist measures to the advantage of certain social groups:
22 23
Enrico Leone (1875-1940), professor at the University of Bologna, is manly remembered as a theoretician of revolutionary syndicalism. Ghino Valenti (1852-1920) was one of the most best-known Italian agrarian economists. He taught at Macerata University.
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Gianfranco Tusset No-one will ever be persuaded to espouse protectionism or free trade by the announcement of general principles; rather, they will be persuaded by individual interest in each fact (Valenti, 1921, p. 244).
The strengthening of the economic policy concept took place at the same time as the idea of nation was taking root and, as Arturo Labriola emphasized in his Manuale di economia politica, the nation was not ‗a homogeneous and compact entity.‘ The nation involved classes whose interests did not coincide but, rather, collided (Labriola, 1923, p. 400). Similar assertions were made by Enrico Leone: The state is not a pure jurisdictional organism, as thought by the economists of the ethicalhistorical school, for instance Roscher, List and others; it is a political institution that cannot escape from the influences and pressures of the strongest interest groups (Leone, 1925, p. 65).
Following Leone, political requirements allow the state to follow the way of power, sacrificing the economic minimum means and comparative costs principles: homo politicus rids himself of homo oeconomicus (Ibid.).
The outcome of this conceptual transformation was that protectionism became a problem internal to states and requiring appropriate interpretative instruments hitherto not used in pure economics. It is of interest to recall the attitude to protectionism taken by Alfonso De Pietri Tonelli,24 a strictly Paretian economist and, as such, inclined to accept only rigorous analyses. In his Lezioni di scienza economica razionale e sperimentale, he singled out the advantages deriving from protectionism and compared them with those arising from free trade. He emphasised in particular that ‗restrictionism‘ enables mapping the growth of specific sectors or productions, and also of some social groups rather than others (1921, p. 749-50). He reproposed the infant industry theory, adding a non-economic justification for protectionism. In fact, De Pietri Tonelli concluded that the whole of international trade, and even more the choice between free trade and restrictionism, should be analysed using sociological rather than economic instruments: Protectionism, which is mostly of a passionate nature and only partially of a scientific nature, could not be rationally explained (De Pietri Tonelli, 1921, p. 750).
As pointed out by Gustavo Del Vecchio25 in his 1924 Teoria del commercio internazionale, the idea that neither a general theory of economic freedom nor an equally general interpretation of protectionism existed was gaining ground. The choice between the two was the outcome of an ante-litteram cost-benefit analysis, where both costs and benefits concerned different social groups. Del Vecchio added that 24
Alfonso de Pietri Tonelli (1893-1952) taught Economics at Padua and Venice. He is best known for his studies on the stock exchange. To be mentioned here in particular is his Traité d’Economie Rationelle (1927). 25 Gustavo Del Vecchio (1883-1972) taught Economics at the Universities of Trieste, Venice, Bologna, and Rome. He was Treasury Minister in the postwar Einaudi Government (1947-48). Del Vecchio was known abroad for his attempt to include monetary services in Walrasian general equilibrium.
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each problem linked to protectionism finds a specific solution springing from a careful analysis of all the peculiar market conditions (Del Vecchio, 1924, p. 75).
Economic textbooks recorded this change. Augusto Graziani, (1925, p. 769) who cannot be accused of autarchic attitudes, in his Istituzioni di economia politica judged as inexpedient any hurried shift from protectionism to free trade. Moreover, he stressed the distinction between the protectionism which favoured a few group interests and fiscal protectionism, which, by increasing public revenues, brought advantages to the community as a whole. Fiscal duties constituted a kind of indirect taxation, and for this reason they were an integral part of every modern fiscal system (Graziani, 1925, p. 777).
5. TOWARDS ECONOMIC POLICY The debate on, and the experiences of, protectionism had made it clear that state intervention could be a useful means to increase national production. At the end of the nineteenth century, therefore, the time was ripe for the inclusion of economic policy sections in academic manuals. In 1892, Luigi Cossa‘s Introduzione allo studio dell’economia politica replaced the term ‗economic art‘ with the term ‗economic policy,‘ by which was meant the leading fiscal principles for the correct operation of the economic functions of State, Provinces and Municipalities. Hence economic policy had acquired its own autonomous area in the political field, although this had only partially occurred in the economic sphere. Cossa was one of the first to assert the conceptual independence of economic policy: The truth of science and the rule of art cannot co-exist, and confusion between them would only result in serious damage to the progress of both social economic science and the art of economic policy (Cossa, 1892, p. 63).
The uncritical and unconditioned acceptance of free trade in international exchanges would derive, according to Cossa, from the overlapping of political economy and economic policy. In face of the apologia for free competition, it was arduous to suggest radical authoritarian reforms that denied it. Rather, the complexity of phenomena must be considered. Economic policy could serve this purpose if it was kept apart from political economy or ‗social economy‘: On the one hand, science (pure economics) must maintain its general character and its independence from any practical goals, but at the same time it should be bereft of any pretension to translating its truths into practical rules […]; on the other hand, economic art (economic policy) must preserve the valuable contributions of different sciences in order to define relative rules open to profound changes (Cossa, 1892, p. 66).
Cossa stated that economic policy had a disciplinary autonomy even if the subject and the boundaries of this new area were not yet well defined. Economic policy involved the implementation of economic rules, although when dealing with money, credit, banking, trade, tariffs, economists had to forget their usual methods (Cossa, 1892, p. 67).
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In the early twentieth century, it was evident that a government‘s economic policies could not be limited to trade policy. Fontana-Russo wrote: If the state has the supreme task of preserving the economic organism as well strengthening its power, increasing the goods at the disposal of citizens […], it must make use of economic policy involving all the instruments influencing the production and redistribution of wealth. Hence, economic policy must be both an instrument of greater production and of better redistribution (Fontana-Russo, 1907, p. 147).
Fontana-Russo‘s statement highlights the crux on which economic policy was built. The need for a new discipline forcefully arose when so-called ‗economic art‘, and then trade policy, had to do with economic growth and its redistribution. The modern notion of economic policy appeared when the state was required to increase production by means of positive actions. Moreover, Fontana-Russo linked his idea of economic policy with increasing well-being, and not just output, thus showing interest in the redistribution issue. Even if trade policy was still the most important part of economic policy, the latter should also stimulate the more profitable productions, encouraging them during their first development, and easing their exports (Fontana-Russo, 1907, p. 148).
Trade policy was not sufficient for the new task of economic policy—augmenting production—which explains the increasing importance of transport policy, particularly in regard to railways, and of fiscal policy: Also fiscal policy may contribute to production by means of tributary exemptions. Clearly, notwithstanding the many examples, governments are at times faced with insurmountable difficulties due to budget constraints (Fontana-Russo, 1907, p. 149).
Fontana-Russo reinterpreted the opposition between protectionism and free trade by taking wealth distribution and well-being to heart: both systems may introduce distortions and iniquities. He was not guided ‗a priori.‘ It was true that the protectionist system would lead to worsening outcomes in wealth distribution, but these effects could be offset by proper tax measures: A wise finance can be used to mitigate plutocratic tendencies (1907, p. 149). The adequacy of Fontana-Russo‘s proposals does not matter here; or at least not as much as the conclusion that we may draw from them: economic policy from then onwards must be judged with regard to global production and distribution outcomes. Rational trade policy could increase production, while the negative outcomes in distribution matters could be counterbalanced by means of tax policy (Fontana-Russo, 1907, p. 150).
The term ‗economic art‘ was still being used by Ghino Valenti in the third edition of his manual, but in order to stress that it was transitional to economic policy: since the importance of Political Economy as art certainly concerns more the state than individuals, specific room must be given to economic art applied by state, named economic policy, meaning those rules and measures adopted by authorities aimed at promoting the growth of national wealth,
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including fiscal policy; that is, those principles belonging to the national economic code intended to guarantee the full satisfaction of public needs with the least sacrifice (Valenti, 1920, p 13).
Valenti deepened the conception of economic policy by treating it not as the mere application of pure economics principles, but as a discipline provided with its own rules and which changes according to the economic environment and following an ex lege empiricism (Valenti, 1920, p. 13). In fact, it concerned customs regime, monetary regime, banking, the rules of labour, social security, public services and so on (Valenti, 1920, p. 39). An analogous definition was provided by Leone: Economic policy is a particular aspect of the state‘s economic action. It involves the broad problem of the state‘s action towards general economic life and particularly trade (Leone, 1925, p. 38).
The transition from a vague notion of economic art to a modern definition of economic policy appeared to be accomplished, as Leone showed: The state‘s action has three forms: jurisdictional, when it is aimed at guaranteeing the right to economic transactions; fiscal, when it provides public revenues; and economic, when it orients exchanges according to the goal of maximum development of the national economy. The latter includes the right to interfere in ‗commercial acts‘ and to restrict free trade (Leone, 1925, p. 38-9).
5.1. International and National Economic Policy During the 1920s, the theory of international trade had been extending its range to encompass also strength ratios among states, thus testifying to the full economic subjectivity that states had acquired. The focus on ‗international trade policy‘ was replaced by the focus on ‗international economic policy,‘ the latter being better suited to expressing the state‘s intervention in fields other than trade, such as international migrations.26 Gustavo Del Vecchio, in 1924, gave the title of ‗international economic policy‘ to the section of his course on international trade in which he conducted economic analysis of war, its economic causes, and outcomes (1924, p. 30). The time was ripe for including the international role of the private sector alongside state intervention under the heading ‗international economic policy.‘ In 1912, Kobatsch wrote that international economic policy is the doctrine studying the evolution and the rules guiding ideas, tendencies and measures of the state and private individuals concerning the economic relationships of a country (economic entity) with foreign ones (Kobatsch, 1912, p. 12).
Economic policy was no longer either the discipline of international trade or the specific debate on protectionism; nor was it the field of ‗economic art‘ where exceptions to free trade 26
See R. Kobatsch (1912, p. 2).
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principles favouring specific interests or groups were singled out. It was becoming the field of the state‘s economic action, which considered international trade to be one of its components. The metamorphosis of trade policy occurred first in international economic policy and then in a more general discipline which comprised both as special cases. This transformation has been reconstructed in a book, Lezioni di economia applicata, which Del Vecchio devoted to economic policy.27 Del Vecchio viewed the state‘s economic intervention with little enthusiasm, to the point that he wrote: Economic policy is reduced to teaching not so much what the state must do but what it must not do, meaning that economic intervention, including necessary and appropriate actions, must be subject to certain limits (Del Vecchio, 1924, p. 85).
It is significant, however, that a liberal economist like Del Vecchio should ratify the status attained by the new discipline. Notwithstanding his negative view of the state‘s intervention, already in 1921-22 Del Vecchio recognized the many dimensions of economic policy: that is, agricultural, mining, industrial, trade, etc. Moreover, he affirmed their disciplinary interdependence: The problems of economic policy are mutually dependent and dependent on all political problems (Del Vecchio, 1924, p. 40).
Therefore, the state undertakes a certain activity in the economic field, participating fully in the production of income, and the study of this activity is the object of economic policy (Ibid.).
In accordance with the fashion of the time, Del Vecchio applied the Darwinian law of natural selection to the state: experience demonstrates that a government which dissipates the national wealth will be necessarily overwhelmed by other governments, which on the contrary show ability in public administration as occurs in enterprises (1924, p. 42). Thus, a first constraint on public activity was the social and political assent that allows the government to act. Consequently, economic policy is not the outcome of the public subject alone, but is also the result of community decisions approving or disapproving of the government‘s. Such remarks deterred Del Vecchio from endorsing the universality characterising trade policy inspired by Ricardian comparative advantages. He approached economic policy from a national and historical standpoint, because the constraints on the state‘s activity change in time and space (Del Vecchio, 1924, p. 45). Whilst trade policy disciplined the relationships between economic entities acting according to their individual interests, economic policy was ‗production policy,‘ that is, policy aimed at maximizing both the national and the per head product (1924, p. 48-9). Clearly, economic policy was substantially different from economic art: it no longer concerned the implementation of theoretical principles proposed by economic science. It was something new and autonomous. Although the liberal Del Vecchio did not adopt a theory of general public intervention, he accepted that the supply of public services, especially in the transport sector, had to change 27
See G. Del Vecchio (1933). This manual appeared in a non-definitive version in 1921-25.
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according to the ‗real conditions‘ of the country. The state‘s intervention should be proportionate to the growth and modernization of each individual country, and this made the question permeating the whole of Del Vecchio‘s treatment of economic policy more pressing: To what extent should the state intervene? Obviously, he did not give an answer valid for every time and place; he could only indicate the principles of private property, of contractual regime and of individual responsibility. A specific public field did not exist, but the state could intervene while respecting those general principles.
6. CONCLUSION In conclusion, two main aspects can be pointed out. Firstly, international features played an important role in forming the notion of economic policy. The state‘s growing role in regulating international economic relationships changed the image itself of the state, gradually improving intervention in increasing economic production. In some ways, internal economic policy can be understood as a development of international economic policy involving the state during the latter half of the nineteenth century. Secondly, the debate on protectionism increased awareness of the disciplinary autonomy of the research area comprising what was called ‗economic art‘, that is, the implementation of economic laws. Economic policy was born because policies were adopted ‗in spite of‘ the teaching of economic rules, not as a result of them. Economic policy grew out of theory. Lastly, something has to be said about the popularization of ideas, particularly of economic policy design, through academic textbooks. Probably, textbooks do not offer the most advanced theoretical analysis or concepts. They necessarily remain on the surface of the arguments but they can be very useful for investigating the evolution and transformation of ideas and theories over the decades, when we are interested in the discourse of a discipline or of part of it.
REFERENCES Barone E. (1915), Principi di Economia Politica, Rome, Italy: Athenaeum, 3rd ed. Bastable C.F. (1900), The Theory of International Trade with Some Applications to Economic Policy, New York, USA: The Macmillan Company. Boccardo G. (1858), Manuale di storia del commercio delle industrie e dell’economia politica, Turin, Italy: Tip. S. Franco and Sons. Ciccone A. (1874), Principi di Economia Politica, Naples, Italy: Jovene, 2nd ed., 3rd vol. Cossa L. (1876), Primi elementi di economia politica, Milan, Italy: Hoepli. Cossa L. (1892), Introduzione allo studio dell’economia politica, Milan, Italy: Hoepli. Del Vecchio G. (1924), Teoria del Commercio Internazionale. III. Problemi di politica economica internazionale, Padua, Italy: La Litotipo. Del Vecchio G. (1933), Lezioni di economia applicata. II. Politica economica, Padua, Italy: Cedam. De Pietri-Tonelli A. (1921), Lezioni di Scienza economica razionale e sperimentale, Rovigo, Italy: Industrie Grafiche Italiane.
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Ferrara F. (1935 [1857-58]), Lezioni di economia politica, II, Bologna, Italy: Zanichelli. Fontana-Russo L. (1907), Trattato di politica commerciale, Milan, Italy: Hoepli. Graziani A. (1913), Principii di economia commerciale, Naples, Italy: Alvano. Graziani A. (1925), Istituzioni di economia politica, Turin, Italy: Fratelli Bocca, 4th ed. Jannaccone P. (1915), Lezioni di economia politica, Padua, Italy: La Litotipo. Kemp M.C. (1960),―The Mill-Bastable Infant-Industry Dogma‖, The Journal of Political Economy, 68(1): 65-67. Kobatsch R.(1912), Politica economica internazionale, Turin, Italy: Bocca Editori. Labriola A. (1923), Manuale di Economia Politica, Naples, Italy: Morano. Lampertico F. (1874), Economia dei popoli e degli Stati. I. Introduzione, Milan, Italy: Treves. Leone E. (1925), Lineamenti di economia politica, II, Bologna, Italy: Zanichelli, 2nd ed. Loria A. (1927), Corso di economia politica, Turin, Italy: Unione Tipografico-Editrice Torinese, 1st ed. 1909; 2nd 1919; 3rd 1927. Luzzatti G. (1888), Lezioni di economia politica, Piacenza, Italy: Bertola. Majorana Calatabiano S. (1913), Trattato di economia politica. Vol. IIII, Rome, Italy: Loescher & C., 3rd ed. Marescotti A. (1861), Catechismo della economia pubblica, Bologna, Italy: Monti. Messedaglia A. (1920 [1851]), Della necessità di un insegnamento speciale politicoamministrativo e del suo ordinamento scientifico, Milan, Italy: Vallardi, 1851. In A. Messedaglia Opere scelte di economia e altri scritti, Vol. I, Verona, Italy: Accademia d‘agricoltura, scienze e lettere di Verona, 1920. Messedaglia A. (1865-66), Note di Economia Politica delle due parti dell’Economia Nazionale e della Scienza delle Finanze, Padua, Italy: Litografia Galeazzi. Nazzani E. (1921), Sunto di Economia politica, Forlì, Italy: Servadei, 16th ed. Pantaleoni M. (1894), Principii di economia pura, Florence, Italy: Barbèra, 2nd ed. Pareto V. (1964a [1896-97]), Cours d’Economie Politique, Geneva, Switzerland: Droz, Tome I et II. New edition by G.H. Bousquet and G. Busino. Pareto V. (1964b [1906]), Manuale di economia politica, Rome, Italy: Edizioni Bizzarri. Eng. ed. Manual of Political Economy, New York, USA: Augustus M. Kelley, 1971. Pareto V. (1916), Trattato di sociologia generale, Florence, Italy: Barbèra. Eng. ed. A Treatise on General Sociology, New York, USA: Dover, 1935. Supino C. (1923), Principi di economia politica, Milan-Rome-Naples, Italy: Albrighi, 6th ed. Valenti G. (1920), Principi di scienza economica, I. Introduzione allo studio dell’economia politica, Florence, Italy: Barbèra, 3rd ed. Valenti G. (1921), Principi di scienza economica, II. Le forme della produzione e dello scambio nell’economia moderna, Florence, Italy: Barbèra, 4th ed.
In: Issues in Economic Thought Editors: M-A. Galindo, C. N. Spiller, pp. 21-44
ISBN 978-60876-173-9 © 2010 Nova Science Publishers, Inc.
Chapter 2
BUSINESS CYCLES IN THE ITALIAN TRADITION Cristina Nardi Spiller* University of Verona, Italy
ABSTRACT In the 1960s and 1970s, scholarly interest in economic fluctuations was keen. Later, attention waned, with a revival at the end of the century. After briefly outlining some of the leading contributions to this complex theme, we turn to the thought of certain representative Italian economists. In this context, we examine the approaches of Amoroso, Fanno, Menegazzi and Vito, and consider how their theories uncover new explanatory pathways. Effectively, as economic systems evolve, unexplored opportunities for enquiry may emerge from existing mechanisms or previously neglected elements. We are therefore convinced that these valuable theoretical contributions should not go to waste or be relegated to forgotten niches.
JEL CODES: B00; B30; E20; E30; E40
1. INTRODUCTION Since indefinitely ancient times, natural and man-made disasters have caused suffering by destroying or wasting resources. More recently, speculative actions or inappropriate behaviour have caused sharp rises in the prices of certain real and financial assets. These shocks to the economic system have bolstered the conviction that business cycles are not merely a legacy of the (more or less distant) past. Indeed, it has become clear that economic fluctuations go hand in hand with the development of productive activities in capitalist economies, and characterise the processes of economic growth. *
Professor of Economics, Faculty of Law, University of Verona, Italy; Professor of Economics and Art Market, Faculty of Humanities, University of Verona, Italy and at Accademia di Belle Arti «C.B. Cignaroli», Verona, Italy. E-mail:
[email protected] 22
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Nevertheless, contrary to the ideas of Marx and Schumpeter, most contributions discuss growth and business cycles in a separate way. The reason for this distinction is the analytical complexity involved in dealing jointly with the two phenomena. In fact, growth is relatively slow and its impact becomes significant in the long term. On the other hand, the trends typically seen during periodic cycles often appear very rapidly, though they may turn around equally rapidly. Undoubtedly the distinctive features of economic cycles have changed; their negative effects have decreased in duration and intensity because of a more adequate productive and institutional apparatus. The disruptive effects of business cycles on the domestic economy can be seen in the form of fluctuations in investments, changes in public spending and private consumption, or great impasses of external origin. During the expansionary phase, the general rise in prices not only increases nominal values but after a short while distorts also the relative price structure. The prospect of easy gains, favoured initially by high stock market indices, may give rise to speculative bubbles that plunge the economy into crisis when they burst. The causes of economic fluctuations are real or monetary, while explanations are generally offered in endogenous, exogenous or endogenous-exogenous terms. Monetary and fiscal measures designed to counteract or moderate the frequency, intensity and duration of shocks may be inadequate and have an adverse effect on global expenditure. Hence measures to tackle stagflation1, witnessed in the recent experience of a number of economies, can actually contribute to high levels of unemployment. In the 1960s and 1970s, scholarly interest in economic fluctuations2 was keen. Later, attention waned, with a revival at the end of the century. In this chapter, after briefly outlining some of the leading contributions to this complex theme, we turn to the thought of certain representative Italian economists3. Their works, a series of original, personal formulations, deserve specific consideration rather than relegation to forgotten niches.
2. AN OVERVIEW The core of Malthus‘s approach (1798, ch.VI) to an explanation of effective demand failures and economic depressions consisted of an excess supply of goods on the market, a supply not matched by consumer demand. The end result was underconsumption, caused by the excess saving of the propertied classes who invested in production equipment. However, Malthus did not offer a theory of saving capable of defining an equilibrium position; neither did he account for the repercussions of investment on consumption (Mengarelli, 2000). On the other hand, classical economists like Smith (1776) and Ricardo (1821) claimed that excess production would be absorbed via the demand creating mechanism envisaged in Say‘s law (1802). Others claimed that the higher investments would cause unbalanced 1
We have already discussed the stagflation and slumpflation of the early 1970s that discredited Keynesian prescriptions (1936) in Nardi Spiller (1990; 2003a;b). See Schumpeter (1939); for an accessible yet accurate reference to topics related to business cycles, see the still valid Encyclopedia (1997). Economic theory has recently moved towards the study of economic fluctuations rather than business cycles, but the latter expression is considered a convenient shorthand. For an overview of the various economic mechanism that generate cyclic or chaotic dynamics in equilibrium, see Benhabib (1992). 3 For an overview of the areas of light and shade in Italian economic thought in the last century see Faucci (1990); Magliulo (1998) and Tusset (2004). 2
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accumulation of capital in relation to the normal structure of the economy and lead to a situation of overcapitalization (Wicksell, Cassell, Tugan-Baranoswki and Marx). Subsequently, Keynes focused his analysis on the savings paradox. The Physiocrats had already postulated a breakdown in the production cycle during the phase of creation and distribution of saving. However, this breakdown was not the result of an expansion of productive capacity due to excess saving. Rather it was due to an interruption of the flow of overall expenditure caused by hoarding money. Keynes‘s (1936) contribution, which as he himself admitted, owed much to Fisher‘s theory of underconsumption (1933)4, emphasized the role of animal spirits. Keynes confirmed the importance of the marginal efficiency of capital and set out unique policy prescriptions to overcome the critical phases. These measures consisted of massive State intervention in the economy in the form of expansionary fiscal policies5. Although the majority of theoretical interest has focused on real phenomena, analysis of monetary phenomena has nevertheless attracted special attention. Attwood (1817; 1964) suggested that monetary policy should be conducted through open-market operations. Mill (1848), in turn, demonstrated how expansionary phases were triggered by expectations of rising prices, while falling prices fostered crises by spreading panic. Marshall (1890) elaborated on Mill‘s analysis and extended his model to the various sectors of the economy, offering an in-depth treatment of waves of optimism and pessimism. Hawtrey (1913; 1919; 1928; 1940) highlighted how high levels of bank liquidity accommodated low interest rates and fostered advantageous loans and hence boosted output. As output continued to expand, costs rose also, and higher prices undermined domestic competitiveness. Consequently, interest rates increased, entrepreneurs got into debt, and the economy entered a crisis. In his attempt to regulate the economy, Hawtrey anticipated the prescriptions of monetarism mark I and mark II6 concerning the regulation of the money supply. The centrality of the interest rate was a theme underlined by the Austrian School, who rejected the notion that the business cycle was an inherent feature of a market economy, and instead argued that its principle cause was central government intervention in the money supply. Austrian School economists, following von Mises (1949), pointed to the role of the interest rate as the price of investment capital that guided investment decisions; some, after Wicksell (1898; 1911), called this the ‗natural‘ interest rate. The Austrian School7 argued that artificially low interest rates increased the demand for loans over and above the supply of willing lenders, just as artificially high interest rates created a situation in which the supply of willing lenders exceeded the demand for loans. As a result, economic agents borrowed and invested either too much or too little in long-term projects. Recessions corrected this misallocation of resources. Austrian School economists asserted furthermore that an imposed, artificially low interest rate forced the central bank to increase the supply of credit and generated inflation dynamics. Yet the inflation obliged the central bank to supply even more credit to maintain the low interest rate. Action of this sort prolonged the boom and had a 4
Cyclical trends, as Fisher noted, have been analyzed meaningfully by Vinci (1934). The latter author assumed in his analysis that the volume of output varied in relation to the velocity of change of profits and income. In his outline of the role of fiscal policy, Keynes (1936, pp. 254; pp. 544-545) noted the expansionary potential of better distribution of inheritance taxes. 6 See Tobin (1980). 7 Hayek‘s theory of business cycles received considerable attention. Hayek (1929; 1933; 1984) analysed the process of over-capitalization departing from monetary rather than real factors. 5
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negative impact on later stages in the cycle. From a Keynesian perspective, the Austrian vision assumed that the natural rate of interest was unique at any given time and could not be affected by policy. Yet it was unique if the system were assumed always to be at full employment. When unemployment was above the NAIRU (the post-Keynesian response to the NRU) then in theory monetary and fiscal policy could play a positive role rather than simply creating booms that necessarily collapsed on themselves. The Austrian School claimed that the natural interest rate was not affected by the employment rate, and attributed the absence of full employment to government interference in the labour markets, in the form of minimum wage laws, employment regulations, and taxes levied against employers; all such measures prevented the employment market from clearing fully. More recent approaches have favoured real business cycle models, new Keynesian economics and political business cycles. Real business cycle models posited that prices adjusted instantly to ensure market equilibrium, so that nominal variables (the money supply and the price level) did not affect real variables (employment and income). The real business cycle theory attempted to explain fluctuations in real variables by highlighting the importance of real changes in the economy, such as changes in technological progress. In its analysis of menu costs8, new Keynesian economics rejected the notion that prices and wages adjusted immediately to ensure market equilibrium and affirmed instead that aggregate demand was the key short-term determinant of national income. The stickiness of prices and wages justified the positive slope of the short-term aggregate supply curve, versus the vertical slope traditionally assumed in the mainstream. Fluctuations in aggregate demand thus resulted in short-term fluctuations in output and employment. The electoral-business-cycle literature essentially explained how economic trends were linked to choices made by administrations for electoral purposes designed to increase their political power and muster greater popular support. The political-business-cycle approach9 noted the advantage to be had by entrepreneurs in a capitalist system by not pursuing full employment, a situation that would undermine their bargaining power. Even though the factors that influence economic activity were numerous, those that determined investment remained of crucial importance. The shocks responsible for increases or decreases in income or employment acted on both the demand and the supply side, and the economy could not function efficiently until conditions of certainty were restored. Indeed, a favourable outlook made it possible to estimate future profit margins and hence fostered investment. Attractive interest rates and various types of tax break were not alone sufficient to promote entrepreneurial activity. The mechanisms at work in society, as Smith and the Physiocrats argued, were driven by the self-interested behaviour of economic agents. It was essentially business confidence10 underlying the dynamism of the economy that ensured 8
The stickiness of prices and wages was due not only to menu costs but also to the lack of coordination between the decisions of economic agents and the staggering of contracts over time. The efficiency theory and the insideroutsider theory were also part of this line of analysis. The efficiency theory highlighted the role of higher real wages in ensuring higher productivity, while the insider-outsider theory underlined the greater bargaining power of those in employment vis-à-vis the unemployed. We have already discussed these themes in Nardi Spiller (1996). 9 Kalecki (1990-93) argued that no democratic government under capitalism would allow full employment to persist, so recessions would be caused by political decisions. Persistent situations of full employment would give workers greater bargaining power, enabling them to increase wages and avoid doing unpaid work. 10 Crises were determined by the climate of instability in an economy. The climate of instability was fostered by abnormal transfers of capital, that both signaled a crisis and aggravated it. Abnormal movements of capital between countries were due to expectations of a devaluation, political upheaval, uncertainty in the banking
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investments were carried out and confirmed the role of animal spirits.
3. ACTIONS AND REACTIONS IN THE ECONOMIC SYSTEM ACCORDING TO AMOROSO Amoroso11 dedicated special attention to fluctuations in economic trends, which he approached from the perspective of economic mechanics. Fluctuations were of a cyclical nature, he argued, due to the existence of a principle at work in the economic system analogous to the principle of action and reaction in mechanics. In Amoroso‘s model, opposing forces at work in three sectors - production, commerce and banking – produced ‗reactions‘, both inside the sector in question (‗inertia reactions‘) and in other sectors (‗induced reactions‘)12. These reactions were brought about by the interplay of various forces in the economy: forces representing past experience (vested interests, resistance to change), forces determining current actions, and forces that shaped the future13. Reference to variables describing the future was a possible forerunner of expectations; although Amoroso did not examine their formation, effectively he introduced the modern concept of deterministic rational expectations. As ‗primary‘ forces gained momentum, cyclical movements were set in motion, each generating an opposing trend. Hence, a movement in one direction caused an equivalent movement in the opposite direction, which in turn produced new primary movements, comparable to the principle of action and reaction in mechanics. Although Amoroso was aware of the intrinsic difficulty of economic forecasting given the interplay between subjective and objective factors, he defended the innovative power of Pareto‘s theory (1906). Amoroso underlined how economic movements originated from forces expressing individual needs or tastes, and how such needs and tastes were in turn restricted by the existence of goods, the difficulty of obtaining the desired quantities of such goods, and any transformation processes the goods needed to undergo. Despite the gap between forces and constraints and vice versa, he argued that it was nevertheless possible to approach a situation of equilibrium, considered static from a Paretian perspective.
11
12
13
system, or fears of fiscal tightening. For a comprehensive analysis still of great relevance today see Fanno (1935). One of Luigi Amoroso‘s research topics was the continuation and extension of Pareto‘s approach in a dynamic environment. Amoroso‘s interests were broad ranging. He participated actively in economic and cultural life in Italy, particularly between the two World Wars. Amoroso (1886-1965) was professor at the Universities of Bari, Naples and Rome, as well as a member of the Accademia Nazionale dei Lincei and a fellow of the Econometrics Society. Amoroso‘s writings investigated topics of pure and financial mathematics, statistics and mathematical economics, but also contained the few examples of Italian economic past thought that were noted abroad (Keppler, 1994). Nevertheless opinions differed particularly with regard to the level of stocks. Fanno (1956) noted how possible variations were due principally to changes in the level of production, and how changes in the level of stocks affected prices. Fanno underlined the sterility of Amoroso‘s research (1940a) ‗which aimed to express in general analytical terms the reactions between stocks and prices, even though the price trend was similar, but not entirely parallel, to the output trend in volume terms‘ (Fanno, 1956 n. 3, p. 164). The guiding forces, in other words the forces shaping the future, consisted of political actions that influenced production processes. Amoroso therefore claimed that politics governed economics in the 20th century (Amoroso, 1932).
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Amoroso extended his approach14 to the dynamics of economic systems. He interpreted dynamics as the result of reciprocal actions and reactions in the three fundamental sectors (production, commerce and banking). The sectors were represented by the index of industrial and agricultural production, T, the general price level, P, and the rate of interest, J, a rate that included both the cost and the price of money (the discount rate15 and the actual interest rate). T, P, and J were functions of time, t. In Amoroso‘s analytical framework, two factors were of crucial importance: the performance over time of the indices, hence the upward or downward direction of the trend, and the speed of change. The speed of change was expressed by the derivatives T‘, P‘ or J‘ respectively. However, since output was a flow, inherently it was also a velocity, so T‘ effectively denoted the phenomenon of acceleration. Movements in T, P, and J represented actions in the three sectors (primary movements) which in turn gave rise to reactions in other sectors (induced movements). Amoroso ruled out the possibility of induced reactions within sectors, just as he excluded inertia reactions in the same sector - akin to the modern phenomenon of hysteresis - expressed as correlations between T and T‘, P and P‘, and between J and J‘. The links established in the system brought about induced reactions, and explained the correlations in production and commerce between T and P‘ and P and T‘; in commerce and banking between P and J‘ and between J and P‘; and in banking and commerce, between J and T‘ and between T and J‘. Basically, nine reactions existed in all: three were inertia reactions and the rest induced reactions. The identification of additional sectors would have yielded a broader typology of reactions. Certain reactions reflected the influence of the general outlook, other reflected preexisting conditions, or policy strategies and their related consequences. This explained the importance of the inertia reactions inside the three sectors, in a sense the roots of the past that constrained and conditioned the future. The reactions induced by the commerce sector pointed to the critical market trends: the levelling of product prices in relation to the future volume of output (a correlation between P and T‘) and the levelling of the price of capital (share prices) in relation to the flow of expected future income pro tempore capitalised at the interest rate expected in the imminent future by investors (a correlation between P and J‘). In the first case, future variations in output were discounted immediately, so prices increased or decreased according to whether the output trend slowed down or speeded up. So the action came about after the reaction in the opposite sense; the reaction, seen before the action, was a guiding reaction. The commerce reaction to the bank action confirmed the validity of the income capitalization principle16, one of the pivots of the financial system (Amoroso, 1961, p. 8). Hence the value of capital levelled in relation to the value of expected income pro tempore at the interest rate expected in the near future. Since the capital value of income varied inversely with the rate of 14
Thanks to a set of three functional equations, Amoroso later provided a theoretical foundation for the economic barometer. Amoroso (1949, p. 338) claimed that the barometer was originally conceived by Maffeo Pantaleoni (1857-1924), whose important writings were published in 1882, 1889 and 1912. The barometer was subsequently reconstructed at Harvard University. 15 On the relationship between the discount rate and prices Bresciani-Turroni‘s essay (1916) is still significant. 16 Later, Amoroso (1961) demonstrated that the difference between the market rate and the rate of capitalization represented for each share the index of mathematical expectations of future income, as dictated by the market at any particular time. This explained the origin of the marginal principle in investment, a principle that demonstrated how the market rate was not only the pivot of all actual prices but represented also the parameter linking the present to the future. See Rossi (1963, pp. 277-278 and p. 283).
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capitalization, this produced a reaction in the commerce sector opposed to the reaction in the banking sector. Again, it was a guiding reaction. The crucial reaction of production to commercial actions, as revealed by the correlation between T and P‘, was an expansion in output when prices rose and a reduction when prices fell. In this case, the reaction moved in the same direction as the action. In turn, the correlation between T and J‘, in other words the production reaction to the banking action, was in the opposite direction: the rising interest rate led to an increase in costs, which in turn tended to dampen the increase in output. Hence, reactions in production showed a phase delay, and appeared to be the result of an independent adjustment mechanism: seemingly, they were mechanical reactions. Banks mitigated the effects of an upward trend and boosted the effects in the opposite case. In the first case (a correlation between J and P‘), the bank reaction to the commercial action was emphasised. In fact rising prices pushed interest rates upwards, while falling prices caused the rate of interest to decline. The banking reaction to the production action (a correlation between J and T‘) was a reaction that preceded and guided the action that determined it, so Amoroso defined it a guiding reaction17. The behaviour of the banking sector underlined the centrality of the discount rate: manipulation of the discount rate was a key strategy in regulating productive activity and in the economic system in general18. After the reactions, interdependencies arose and gave rise to compensating price movements. Prices, interest rates and output trends generated waves of expansion or contraction, causing fluctuations throughout the economy characteristic of the business cycle. Let us now examine Amoroso‘s model in detail. His analysis departed from an initial state of ‗activism‘ (phase one) in the system (see Figure 1). Prices, output and the discount rate were rising inexorably, so their respective curves sloped upwards. However, the price trend actually conflicted with the upward direction of the other curves. When output rose, prices should have fallen, just as they should have fallen when the rate of interest rose (according to the law of income capitalization). Here, however, prices went up, at least up to a certain point. It was impossible for this situation to last. In fact, the price curve turned down and the system entered a phase of tension (phase two), in which the focus of analysis shifted to production: growth in output, unlike the other two movements, could not last indefinitely. Output tended to decrease with falling prices; the effects of the drop in output were exacerbated by higher interest rates, in turn associated with increased costs. The end result was a dip in the output curve, bringing on the ‗liquidation‘ phase (phase three). The process of liquidation boosted the demand for money, that in turn pushed up the interest rate: this contrasted with events in the production and commercial sectors, in the sense that the interest rate should have fallen. The turnaround was caused by the inevitable fall in the interest rate, driving the economy into a recession (the fourth phase), but not even the recession was eternal. If plant was idle, it meant that people were consuming hoarded goods (Amoroso, 1938, p. 8). 17 18
Price increases led to a decrease in the value of capital plus interest. The expansion of production required new plant, and was likely to result in monetary pressure. The bank anticipated this pressure and reacted by increasing the cost of money. Naturally the inverse occurred in the opposite case.
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Legend: P: commerce reaction (prices); T: production reaction (output); J: banking reaction (interest rate). Figure 1. Amoroso’s cyclical trend.
Nevertheless, the fall in prices conflicted with the reaction triggered by the fall in output and the interest rate. As a result, prices increased once more, heralding the start of the recovery (the fifth phase). In the production sector, rising prices were inconsistent with the low level of output and falling interest rates. A u-turn marked the start of an expansionary phase (phase six). The abundance of money characteristic of this phase lasted until the expansion absorbed the new monetary savings. Despite the falling interest rate and the reactions brought about by rising prices and growing output in the banking system, when the conflict reached a critical point the money curve turned down also (Rossi, 1963, p. 284). Hence the system returned to a state of ‗activism‘ (the seventh and first phases) and the cycle started over again19. For all its simplicity and elegance, Amoroso‘s scheme was apparently so restricted to mathematical conceptions that it dodged certain inevitable economic considerations. It was singular that with rising output, prices tended to fall, just as they fell when interest rates rise. Leaving aside the possibility of demand-pull inflation20, prices might also be affected by higher costs resulting from trade union disputes (wage inflation) and raw material costs (imported inflation). The existence of forms of monopoly might put pressure on prices and cause inflation. Furthermore, an increase in the interest rate on borrowed capital might have a negative impact on company balances, and companies might in turn pass on the higher costs in the form of higher prices. This kind of interest rate increase may be paradoxical, considering that raising the interest rate is a key instrument of anti-inflationary policy. 19
Changes in inventories did not produce an immediate increase in prices: prices increased only when the drop in inventories reached a certain level. So changes in inventories influenced not the velocity but rather the acceleration of prices. By formalizing these concepts, Amoroso (1940a;b; 1942) obtained a set of integraldifferential equations that he reduced to a system of second-order differential equations. 20 Amoroso related inflationary dynamics to the quantity of money in circulation, an independent variable. Deflation certainly could not be considered an independent variable: it was linked to the volume of commercial transactions, essentially a vast number of asymmetric movements (Amoroso, 1950, p. 96).
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Inflation may be a consequences of failure by the monetary authorities‘ to neutralize the contraction in the money supply, leave the money supply unchanged or even expand it. Fiscal policy may also kindle inflation by conditioning the level of development and of income growth. The situations of stagflation and slumpflation witnessed in the 1970s in particular (long after Amoroso‘s time) in fact refuted Amoroso‘s theory (and ran counter to Keynesian theory also). Sudden price increases are often coupled with stagnation or falling output, whereas following Amoroso, price increases boosted output, and falling prices – generally not considered negative – generated higher savings. Amoroso offered neither a theory of saving nor an account of the accumulation of capital, even though he introduced significant analytical innovations, namely the calculus of variations, derived from rational mechanics. Amoroso attempted to identify among economic phenomena an element corresponding to inertial force in mechanics, an element that would enable him to express economic dynamics based on static equilibrium in the form of an equation. He was well aware that force of habit (comparable to inertial force in mechanics) was created by customs and traditional patterns of behaviour for which there was no scope in mechanistic schemes. The author succeeded in formulating a mathematical equation that accounted for the level of satisfaction derived from the consumption of a good as well as for the effects of changes in habits (adjustment costs). In short, habit and worries have a direct impact on our sensitivity, independently of and even contrary to the satisfaction of needs pro tempore (Tusset, 2004, p. 118),
however the logic of behavior should leave room even for future expectations.
4. FANNO’S COMBINATION OF CYCLES AND TRENDS Fanno‘s model belongs21, together with Hicks‘s model, to the cycle-trend models. In models of this type, the potential growth path shows how the economy develops in a state of equilibrium and full employment of factors of production. It is somewhat surprising that Hicks (1950) overlooked the Italian author‘s contribution22, considering that Fanno (1947) effectively anticipated Hicks‘s cyclical model. Fanno assumed that stationary trends were unrealistic: only by combining cycles with long-term growth was it possible to interpret economic events as they unfolded. He therefore focused on progressive economies23. Fanno‘s conceptual scheme was based on the expansionary dynamics typical of capitalist economies. In such systems, investment essentially depended on the decisions of private 21
Marco Fanno (1878-1965) taught at the Universities of Parma, Sassari, Cagliari, Messina and Padua. He was driven away from his position at the University of Padua by the racial laws, but returned there after the Second War. Fanno achieved international fame through his studies on price theory, money, colonisation and business cycles. 22 For a comparison of the Fanno and Hicks models, see Nardi Spiller (1993a;b). For an analysis of Fanno‘s model see also Magliulo (1992). 23 By progressive economy, Fanno meant an economy in which output and income tended to grow at a rate assumed constant for ease of analysis.
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entrepreneurs. Fanno‘s model was based on three fundamental curves24: the potential growth curve, the secular growth curve and the actual growth curve. As economic processes took place, fluctuations in the curves were observed (Fanno, 1956, p. 354).
Legend: t: y: AP: ABS: BE: AB:
time; income; potential growth curve; secular growth curve; actual growth curve; stationary trend.
Figure 2. Fanno’s cyclical model.
The potential expansion of an economy was governed by three factors: population growth, technological progress in production, and the propensity to save. Nevertheless, these factors merely expressed the economy‘s potential for income generation when all available resources were exploited to the full. Essentially, Fanno anticipated Hick‘s ceiling (see figure 2, in a semi-logarithmic scale). The potential growth curve was the geometric locus of positions successive to Walras-Paretian equilibrium in a system during the process of growth; hence each point on the curve corresponds to the path along which firms make neither profits nor losses (Fanno, 1956, p. 44). The secular growth curve, which started after the potential growth curve and continued unbroken, indicated how the economy behaved when entrepreneurs received a satisfactory level of profit25, a level that justified past decisions and was sufficient to prompt new initiatives. The salient feature of the secular growth curve was its position parallel to the potential growth path, as would be expected. In fact, a lesser distance between the two paths would have implied a level of profit insufficient to stimulate new investment, while a greater 24
The relationships between the curves were neither immediate nor easy to understand. At least certain parts of Fanno‘s model, which was not presented in a formal format, required interpretation, as Marrama (1974, p. 225 and p. 228) asserted. 25 On the importance of profit and the monetary structure in Fanno, see Nardi Spiller & Pomini (2006; 2007).
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distance would have indicated opportunities to earn higher profits, thereby stimulating investment26. The growth profits were shown by the distance AP and BS (Figure 2). From a formal point of view, the straight line BS resembled the straight line in the model of Hicks (1950) representing the long term growth trend, notwithstanding a fine distinction: Hicks assigned a pivotal role to autonomous investment while in Fanno‘s model the line BS related to any form of investment that the potential growth curve made profitable, considering how27 profit plays a fundamental role in capitalist economies, and how current variations and above all forecasted variations tend, depending on their direction, to accelerate or delay economic activity. (Fanno, 1947, p. 103. He takes the basic concept up again in the 1956 edition, p. 119)
Investments were undertaken in fits and starts, rather than in continuous, infinitesimal amounts; consequently, adjustments in income, consumption, and saving followed each bout of investment. Cyclical profits accrued when wage adjustments and changes in the prices of the various inputs lagged behind changes in the prices of finished goods. Increases in income associated with developments in production processes reflected entrepreneurial behaviour. Indeed, the prospect of earning higher income was a factor evaluated by entrepreneurs undertaking investments in new plant for the purposes of growth. So there was a close link between opportunities to earn profit and the trend of economic activity. Fanno‘s analytical framework offered a global theory of the expansion of economic systems, and at the same time added a dynamic long-term interpretation to Keynesian analysis. A significant difference with respect to Harrod‘s approach is that Fanno provided a link between the secular growth curve and the potential growth curve in the form of the expected rate of profit28. Potential growth was achieved through investment. This link was of extraordinary importance: Fanno attempted to overcome the ambiguity inherent in approaches based on interaction between the multiplier and the accelerator, precisely because the values of these coefficients gave rise to cyclical trends in economic activity. In Fanno‘s model, a pivotal role was played by erroneous estimates: errors of measurement, quality and cost (Fanno, 1947; ch. III; ch. XI). Quality errors were seen when output failed to satisfy the tastes of consumers (direct goods) or the technical and economic needs of producers (producer goods). Measurement errors occurred whenever actual output was above or below the amount that could be sold, and exerted pressure on prices. Cost errors arose when forecasted production costs were lower than costs actually incurred, making the continuation of production ‗ruinous‘ (Fanno, 1947, pp. 297-298; 1956, pp. 311-312). To this analytical and operational framework, Fanno added another category of errors with far more significant consequences: time lags, in other words delays that magnified exogenous changes and anticipated mechanisms based on expectations. Naturally Fanno did not overlook the relationship between prices and profits, nor that between profits and the volume of global output (1947, ch. V; ch. VI; in particular ch. 6 in the 26
Cf. Marrana (1974, pp. 226-227). Fanno (1931) examined a situation where the economy was trapped in the recessive phase. Fanno (1956, p. 448) warned against the dangers of reckless deficit spending, although Haavelmo‘s approach offered an opportunity to expand the level of income and maintain a balanced budget. See Haavelmo (1945). 28 The warranted path of growth and the natural path of growth analyzed by Harrod (1948) had points of contact with the potential and the secular growth paths, as Fanno himself underlined in the updated version of his treatment (1956, pp. 51; pp. 58-59). 27
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1956 edition). Indeed, he considered expected – rather than actual - variations in profit responsible for differences in other factors. So forecasted changes in the level of profit became an active determinant of fluctuations (Fanno, 1947, p. 147; 1956, p. 179). Essentially, the function performed by the efficiency of capital in the Keynesian economy was fulfilled in Fanno‘s model by profit. In progressive economies, profit stimulated investment whenever the effective development of the system offered an adequate margin of remuneration to investment (Manfredini, 1969, p. 139). Fanno also pointed explicitly to the links between the wage trend and price dynamics: wages varied because of variations in prices (Fanno, 1947, p. 164), and brought about substantial changes in the level of consumption and profits, causing distortions in the process of accumulation throughout the system. Fanno‘s investigation of price dynamics demonstrated that the most accredited approaches of his day attributed a limited role to wage inflation. Essentially, Fanno aimed to propose a synthesis of the Keynesian (underconsumption) and Hayekian (over-investment) models: whereas recovery was spontaneous in normal cycles, in extended cycles the emergence of states of over-saving justified recourse to anticyclical policies designed to boost demand. Following Hayek (1929; 1933; 1984), the gap between investment and saving was due to the failure of banks to adopt neutral policies. Fanno considered such a gap possible irrespective of neutral behaviour29 or monetary intervention. Fanno, like Hicks, asserted that the economy could not reach the upper or lower ceiling during fluctuations due to bottlenecks and substantial technological innovation capable of stimulating new investment even during downswings. Nevertheless, a wide range of intermediate states was possible between the two extremes, each with its own unique features. Although Hicks introduced the possibility of cyclical growth linked to autonomous investment, he failed to the explain growth over time of such investment, raising understandable doubts. In Fanno‘s conceptual framework, the crucial element was investment of any type, whether autonomous or induced: this explains the importance of the Italian author‘s emphasis on the potential gains that encouraged entrepreneurs to undertake initiatives and make commitments. Similar aims stimulated the credit function, boosted profit expectations and encouraged the realization of investments. So profit played a central role in progressive economies: profit called for the accumulation of capital, and ensured that investments were undertaken in the subsequent cycle. Profit was not merely an ‗element‘ detached from the overall performance of the economy; it was strictly linked to other factors that determined the stability of the entire system. A situation of stability was not easily reached or maintained, considering the numerous causes of instability: wasting of human resources and materials, unbalanced public finances, unequal international relations, or distortions in exchange rates and interest rates. If these factors, collectively or individually, reached abnormal levels, they triggered centrifugal forces and caused serious malfunctions that could seldom be corrected. In this complex, multifaceted scenario, Fanno reconsidered the key role played by the central authority. The government had to be capable of removing obstacles to the demand and the overcoming structural problems in the market for goods and services. Economic policy choices had also to remedy any weaknesses in the fiscal apparatus, thereby relieving the 29
For a comparison of Fanno‘s and Hayek‘s analysis see Nardi Spiller (2000).
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burden on public finances. These objectives were pursued to ensure internal stability, and to stabilize the general trend in the international system. Thanks to the re-establishment and consolidation of credible conditions, attractive profits could rationally be expected and expansion became a feasible possibility.
5. CYCLICAL FLUCTUATIONS DUE TO INFRINGEMENT OF THE LAWS OF THE VITAL CIRCUIT IN MENEGAZZI’S MODEL Menegazzi‘s30 vision derived from a philosophical and economic context in which the author‘s Catholic faith played a central role. In his work, Menegazzi made implicit and explicit reference to the social doctrine of the Catholic Church, and to authors like Toniolo who had, before him, tackled similar themes31. Menegazzi described how the numerous, opposing forces at work in all societies (the forces that caused sectoral and territorial gaps or the destruction of value for instance) produced three types of rapid transformation: ‗methodological revolution‘, ‗scientific revolution‘ and ‗historical revolution‘ (Menegazzi, 1970, p. 3 and ff). Thus conflicts of interests and political and economic struggle grow, disintegrating community life, without being understood or affirming their own basic laws. We pass, in effect, from the most rigid determinism to the blindest of indeterminism, to the point of denying any constant principle in human life. (Menegazzi, 1970, p. 3 and 1975, p. 11)
Menegazzi claimed that the numerous different effects produced by these causes made it impossible to formulate a comprehensive mathematical model: a model is not determinable, both because of its innumerable variables, and because it excludes the essential relationships defining the aims to be attained. (Menegazzi, 1970, p. 5; 1975, p. 14)
Menegazzi‘s position was clear. He went on to present what he defined the ‗law of community order‘, in other words a functional hierarchy of values. He described such values as ‗ethical-political‘, ‗psycho-physiological‘, economic and financial (see Figure 3), and illustrated them in a detailed diagram to provide a more direct, explanatory framework for his complex reasoning (Menegazzi, 1967, p. 328; 1975, p. 89).
30
Guido Menegazzi (1900-1987) was an economist and a sociologist. He firmly believed in an economy half way between liberalism and collectivism; he desired to achieve economic and social equilibrium on a voluntary basis. He taught at several universities, ending with Verona campus of the University of Padua. He became Emeritus Professor in 1975. Even international observers considered the political policies traced by Menegazzi in his various writings a possible alternative to the orthodox liberal approach as well as a concrete substitute for the radical change brought about by the Russian Revolution. 31 Menegazzi (1966) acknowledged the thought of Giuseppe Toniolo (1845-1918), an outstanding scholar within the history of the Italian Catholic movement, and recognized his fundamental contribution. Toniolo (1893; 1908; 1947) noted how social turmoil was inevitable if the national and providential orders were not respected though human weakness, the origins of which were historical. The unrest tended to spread via religious, moral, civil, political and economic channels.
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Figure 3. Forces tending towards evolution and development to involution and recession in Menegazzi’s economic-social circuit.
Every human community was based on a ‗fundamental constitutional order‘, that functioned according to principles of scientific finalism32. This fundamental constitutional order ensured that the ‗operating social order‘ conformed to the ‗vital order of society‘ (Menegazzi, 1975, p. 16). Subsequently, Menegazzi formulated the ‗theory of the vital circuit‘ and identified the ‗law of reciprocal strengthening of values‘. These laws were essential for the development of national and international communities (ibid, p. 17). At a global level, nations were expected to ‗strengthen their values‘ on a reciprocal basis and to pursue equilibrium in the international system, by following a common path towards the creation of a shared structure, thus showing their willingness to participate in the international community. We can reasonably exclude any link between Menegazzi‘s model and the more recent cooperative game theory33, particularly if we consider the author‘s lectures and writings, and his dislike of mathematical models. Nevertheless, the principles underlying Menegazzi‘s approach are clear: cooperation yields positive results and brings benefits to the entire community. The pioneering aspect was the Menegazzi‘s tireless reiteration of the fact that without cooperation, distortions were inevitable, and tended to spread through every sector of the economy with grave consequences. In Menegazzi‘s model, every recession manifests itself as being due to the insufficient application or infringement of the laws of the vital community circuit, thus determining more or less grave malfunctions and devaluations. (Menegazzi, 1967, p. 329; 1975, p. 87)
When a ‗double‘ malfunction appeared on one ‗plane‘, in the form of a gap arising on that plane and a distortion produced subsequently by the inappropriate behaviour of economic
32
Scientific and ethical finalism contributed jointly to define the values of the ‗constitutional‘ and the ‗operational‘ ‗vital community order‘. 33 See Von Neumann & Morgestern (1944), who established cooperative game theory as a separate discipline.
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agents, the malfunction tended to spread to other planes in the system thanks to the law of negative solidarity34. Failure to respect the laws governing the functional hierarchy of financial, economic and human values produced malfunctions at both a national and an international level35; these in turn led to peculiar cycles of expansion and contraction. Booms and recessions intensified and evolved as the initial shocks spread through the economic and social circuit. Menegazzi explained how both expansion and recession were linked to the rational application of the laws of the vital circuit. If the laws were respected, the development of the system was assured. On the other hand, failure to comply with the laws led to recession, and a decline in both employment and output. It was true that, at a certain point, a turnaround would have been seen as autonomous forces and the actions of policy makers took effect. However the situation was bound to be unstable if Menegazzi‘s laws were not respected. The interdependence between output sectors reflected the vertical and horizontal organization of production; an expansion caused by economic factors had a monetary impact in the form of an increase in costs and hence prices, as well as a psychological impact in the form of a wave of optimism. However, expansionary phases could not continue indefinitely and some event would eventually invert the expansionary phase. As the growth rate started to decline, the economy would inevitably enter a crisis. Numerous factors could dampen growth: war, political unrest, poor harvests, or sudden increases in raw material prices. The factors that had a positive impact on the economy and triggered an upturn were not rationally ordered. If a production sector expanded and output exceeded demand, output had to be reduced and workers dismissed. If other sectors were unable to absorb the excess labour, unemployment resulted, and could lead to recession. Positive changes in entrepreneurs‘ expectations of future trends could restore output to previous levels, and the positive effects could spread to other planes. However, even in this optimistic case, any subsequent disturbances could trigger a downturn once more. Menegazzi acknowledged the existence of disequilibrium, in a manner reminiscent of Keynes, who considered general equilibrium an exception. Nevertheless, by means of his laws, Menegazzi effectively arrived at a state of general equilibrium as stressed by the Classical School. But, in his words, Classical equilibrium has no logical foundation: since subjective vital functions are excluded a priori, it is based on contradictory assumptions which define conflicting conditions. Thanks to the assumption of free competition, for example, the economy is atomised, but the assumption of prevailing hedonism propels agents in the direction of monopoly» (Menegazzi, 1967, p. VII; author‘s own italics).
34
35
Menegazzi‘s argument was based on a considerable number of complex and particular assumptions. The first ‗law of synergy‘ identified the ‗subjective vital equilibrium‘, the basis of the second law of ‗objective strengthening of values‘. The second law depended on a set of subjective movements, ordered functionally, and was related to the third law. The third law regulated the subjective states of equilibrium, and the objective strengthening of values according to the principles of hierarchy and solidarity, upon which the fourth and fifth laws were based. Each set of values, whether financial, economic or psycho-physiological was closely related to the other values, so every economic agent that determined values was bound by a relationship of solidarity to other agents. In the same way, the states of subjective vital equilibrium were functionally coordinated, and formed a hierarchy of values that mutually strengthened each other (Menegazzi, 1964; 1965; 1967, p. 285). Menegazzi identified the causes of shocks originating from international relationships as follows (1967, p. 329): differences between countries‘ factors of production, disparities between production and distribution systems, and imbalances between the various types of accumulation and capital investment.
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Menegazzi criticised business cycle models on the grounds that they considered only part of the picture. In fact None of the models integrally evaluates the economic-social circuit and the forces at work therein (Menegazzi, 1964, p. 171; author‘s own italics).
Only by referring to the fluctuations and the crises in the fundamental vital circuit of human societies, based on the well-known laws of subjective and objective strengthening of values (Menegazzi, 1964, p. 172),
was it possible to arrive at a unitary theory of dysfunctions and crises in the economic-social circuit, which includes, coordinates and integrates all the aforementioned partial theories in the light of a broader and more profound vision of economic-social reality (ibid., p. 172, author‘s own italics).
In Menegazzi‘s model, on the plane of financial values, monetary and credit factors produced differences between company costs and prices, and between the levels of saving and investment; on the plane of economic values, disparities emerged between economic potential and industrial development, due to the dynamics of the various productive sectors on the one hand and mismatches between production and consumption on the other; on the plane of human values, gaps were caused by psychological factors such as changes in tastes or expectations, waves of optimism or pessimism and so on. These interrelations between cause and effect pointed to a broader vision, a vision that surpassed Menegazzi‘s original model (1931). Though debatable as an explanation nowadays, in his earlier model Menegazzi identified as the principal cause of economic fluctuations the substantial lack of a mass of financial instruments necessary to accomplish the trade required to balance output and consumption (Menegazzi, 1931, p. 19).
In Menegazzi‘s later, extended version of the model, distortions emerged, developed and spread across several planes. Changes were not confined to one sector but rather ‗invaded‘ other planes, causing the shock to extend through the economy. This meant that malfunctions could not be explained solely by an insufficient supply of money. Indeed, a number of causes existed, depending on the plane in question; in any case each plane had a reciprocal relationship with all the other planes. By insisting on a framework of coherent and unitary coordination of the forces at work in the economy36, Menegazzi offered a fundamental explanation of the need for an order in 36
Here we should recall the overall importance of Menegazzi‘s vision of corporativism, as well as the role played by corporations in the general working of the economy. Menegazzi elaborated his thought during Fascism in Italy, a period characterized by its corporative and anarchical structure. In fact, corporatism was perceived as the result of cooperation between the nation‘s economic forces, coordinated by the State according to specific production policies designed to safeguard the domestic economy from political and monetary disturbances (Menegazzi, 1934, pp. 92-101). Menegazzi claimed that the role of the State was to guide the economy, rather
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which values adapted to economic dynamics in relation to the vital and spiritual needs of society. Menegazzi‘s vision dealt with a far-reaching scenario, the universal, manifold nature of human actions. The awareness that every human action was connected to, rather than isolated from, a highly structured context confirmed the importance of values essential for economic development; through solidarity, these values assured freedom and justice. Menegazzi‘s approach adhered closely to Catholic social doctrine, an integral being the concept and practice of solidarity. The Church‘s teaching set out also the principles of individual and collective behaviour; it was much more than a collection of works on social problems. Menegazzi‘s attempt to codify the laws regulating human behaviour was certainly not utopian; he formulated a precise set of rules governing logical behaviour. Failure to respect these laws resulted in disorders and possibly irreparable distortions if the disorders spread. He argued that the business cycle was the result of deviation from the trend, evidence of a lack of ‗vital synergy‘ that allowed destabilizing ‗entropic‘ forces to take over. From a global analysis, Menegazzi‘s model emerges not as an alternative to the Classical or Keynesian models, but rather as an approach based on the role and importance of human actions, an approach capable of offering a specific interpretation of the business cycle. In a world bent on robotization and depersonalisation of the individual, a model that places man at the centre of the system, that overcomes all forms of materialism (Menegazzi, 1970, p. 13), and that makes individuals aware of how distortions cause radical and potentially irreversible disruption is undoubtedly worthy of note.
6. CYCLICAL FLUCTUATIONS AND THE THEORY OF FORCED SAVING IN VITO’S THOUGHT Vito37 did not consider the distinction between exogenous and endogenous cycle theories correct. Instead, he argued that it was essential to verify the reactions of the economy, although later he did justify the distinction following developments in economic thought. The classical economists, convinced of the existence of equilibrium in the system, contemplated only serious external shocks. This explains the exogenous nature of classical approaches, in contrast to modern approaches that tended to consider cyclical phenomena endogenous.
37
than to act as a dominant economic agent; in other words the State was not ‗statist‘. The corporations were all of equal standing regardless of their production policies, however they were controlled to exclude privileges (Menegazzi, 1932, pp. 41-44; pp. 100-101). Initially, Menegazzi (1934, p. 301; 1936, pp. 84-86) argued that a controlled, corporativist economy was the only way not to hinder cooperation between peoples. Later he noted how corporativist approaches, particularly in the credit sector, could co-exist with forms of privilege. This convinced Menegazzi of the need for control by a single leader capable of restoring equilibrium to the system. He therefore proposed that the credit corporation should be controlled by the central bank (Menegazzi, 1936, pp. 89-90; p. 115), on the grounds that the workings of the corporativist system would influence financial behaviour and facilitate the task of supervision. Francesco Vito (1902-1968), a university teacher, dean and ultimately chancellor of the Università Cattolica del Sacro Cuore in Milan, was editor of the journal Rivista Internazionale di Scienze Sociali, and associate editor of the Enciclopedia Bancaria. He was firmly convinced of the link between economics and ethics, and treated issues of industrial organization, competition and development.
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Vito argued that any investigation of cyclical fluctuations and of the reactions set off by a shock38 should examine the structural characteristics of the economy, as well as relationships between nations. In his treatment, he underlined repeatedly that theories of over-saving and underinvestment had no place in the doctrine of cycles since they explained only recessions (Vito, 1954, p. 61). The impact of physical, economic, psychological, biological and technical factors was undisputable, and each could be a sufficient but not necessary condition for economic fluctuations (otherwise the various factors would be mutually exclusive). Vito considered monetary factors of lesser importance, even when the explanation of the cycle was based on a gap between saving and investment. The contrast with Hayek (1929; 1933; 1984) was evident, particularly where Hayek argued that a non-monetary theory of economic fluctuations was inconceivable. Vito (1933; 1934; 1954) assigned a central role to forced saving39, a phenomenon he explored from two points of view. In his review of the theory of forced saving, Vito noted how the various authors who examined forced saving in relation to economic fluctuations highlighted the consequences of coercively diverting wealth away from consumption and towards production after a change in the value of money. Despite accepting this approach, Vito40 singled out a second form of forced saving, a type that occurred regardless of changes in the value of money or the creation of credit: in industrialised economies a considerable portion of saving was undertaken by private firms41 (Vito, 1954, p. 160). Because of the importance of saving by firms, Vito argued that the propensity to consume was increasingly less applicable as an explanation for fluctuations. Such a view was shared by BrescianiTurroni (1951), who noted how forced saving took place regardless of the behaviour of banks. Although Vito accepted Wicksell‘s natural rate of interest as a ‗working hypothesis‘ (1954, p. 193), he noted how the economy tended to move away from this rate, due not only to the existence of money and banks but also to institutional factors that induced movements in unexpected directions in certain fundamental branches of the economic system such as saving and investment. Acceptance of the concept of the natural rate of interest, and of its characteristic function of balancing saving and investment, should not lead us necessarily to consider that forced saving and economic fluctuations occur only because money and banks exist. (Vito, 1954, p. 193) 38
The notion of equilibrium, originally borrowed from Newton‘s system of the world, was replaced by a principle used in modern physics, in other words the tendency of the constituent parts of a system to be interrelated (Vito, 1954, p. 89). 39 Hayek (1929; 1933; 1984) saw forced saving as the instrument that lengthened the production structure, an instrument that could not be justified by the rate of capitalization and that sooner or later would lead to a depression. He therefore considered forced saving detrimental. Schumpeter (1954) held an entirely different view. He saw forced saving as the only means by which to fulfill the plans of entrepreneurs and to make technological progress possible. Fanno (1947; 1956) saw the lack of forced saving as the cause of crises that were destined to endure until flows of spontaneous saving were sufficient to meet domestic production needs. Keynes accepted the idea of forced saving in his Treatise on Money but failed to take up this theme in the General Theory. 40 Vito considered forced saving the result of credit expansion. Forced saving subtracted a vast quantity of production resources from consumption, through changes in prices, various devices that diverted resources away from consumption and towards to investment, and saving imposed by the State. Another significant factor was the accumulation of undistributed profits. 41 Underconsumption theorists, who ascribed recessions to excess saving, argued that the tendency of entrepreneurs to opt for self-financing caused crises.
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Productive processes took time to mature, and most importantly required a continuous flow of saving until they reached maturity. According to Vito, it was possible to avoid recessions by substituting forced saving with a corresponding flow of voluntary saving sufficient to ensure that initial production processes were carried to term or that any interruptions in the expansion of credit were postponed until the completion of the various production processes (Vito, 1954, p. 184). Vito thus underlined how forced saving imposed coercively by firms through the accumulation of undistributed profits (in a situation of equilibrium in the system) could give rise to excessive expansion, and trigger a recession. This state of disequilibrium was not brought about by underconsumption: the cause was forced saving, since production processes were started without a guaranteed flow of continuous saving until completion. In a situation of expansion, it could be objected that the accumulation of saving would enable firms to cope with less fortunate times. This justified the positive attitudes towards policies to stabilize dividends seen in the 1950s42. Vito rejected such an approach: he challenged the validity of stabilization policies at a global level despite their appeal at the level of the individual firm. Undistributed profits could be ploughed back into the firms, or used to purchase bonds or shares: by lowering the interest rate, could lead to further expansion. So policies to support the investment of undistributed profits turned out to be incapable of stabilizing the cycle, and ultimately intensified both the expansion and the recession (Vito, 1954, p. 216)43. Vito‘s efforts to broaden the concept of forced saving to include not only the generally accepted monetary forced saving but also non-monetary forced saving in the form selffinancing were significant. In the process of investigating whether non-monetary forced saving gave rise to a disproportion between saving and investment, he noted how nonmonetary forced saving was just as responsible for cycles as monetary forced saving. Therefore controls on saving and investment designed to prevent fluctuations were destined to fail if conducted only through traditional monetary and credit policies based exclusively on discount rate manoeuvres.
7. CONCLUSION A number of other Italian authors have made contributions to the historical development of the theory of economic fluctuations, however we have not discussed their works here in order to underline models dealing with what we consider frontier aspects. We believe although the contributions discussed above are very diverse, they share a common platform, an awareness that economic cycles form an ineluctable component of market economies. They suggest that cyclical trends should be examined within the economic system as a whole. Furthermore, all the contributions underline the decisive role of endogenous variables in cyclical trends. 42
Meyer & Kuh (1957) proposed a theory of residual funds and emphasized the role of undistributed profits, rather than the interest rate, in determining the level of investment. 43 Here also it is clear how Vito perceived a link between economic life and the pursuit of ethical goals, i.e. the needs of mankind (Vito, 1945, p. 162). For a general survey of Vito‘s thought, see Parisi & Rotondi (2003), and also Quadrio Curzio (2007, pp. 315-324).
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Amoroso had a flair for mathematical methods, unlike the other authors examined here who avoided this type of reference frame. Whilst certainly attentive, their analysis was limited in its potential to explain wide-ranging and complex mechanisms. Economic phenomena are not easily ‗captured‘ in rigorous formulations, and the treatment of cyclical phenomena is complicated further by the number of contributing factors, despite the various well established connections. In relation to the contributions discussed here, we note how Amoroso placed economic dynamics at the heart of historical change, a tendency common to Italian and international scholars alike. Amoroso‘s deep-rooted conviction that cyclical economic trends were comparable to the principle of action and reaction in mechanics was evident in his desire to overcome ambiguity in the interpretation of economic phenomena and to overcome the reliance on purely monetary factors, despite the understandable perplexity surrounding his work. His contribution to the theory of business cycles was important, in so far as he emphasised the links between the various sectors of the economy and explained how reactions started when the action that caused it was still in progress. Amoroso‘s analysis was not only innovative, it was pioneering in the sense that he underlined the importance of what in modern terminology are known as deterministic rational expectations. Fanno concentrated on the realization of investment, underlining how self-interest boosted output and employment. Self-interest also stimulated credit and increased profit expectations, thereby encouraging investment. Fanno attached great importance to all forms of profitable investment, and saw investment as an indicator of the economic performance of a capitalist economy. He pointed out how changes in consumption affected investment in direct proportion to the length of the industrial process. By pointing to time lags, Fanno‘s ideas became a forerunner of approaches based on expectations. Menegazzi ‗s framework was distinctive in so far as it was grounded in philosophy and strictly linked to Catholic doctrine, in which Menegazzi had great faith. In his global vision, malfunctions on one plane affected not only that plane but spread to other planes, with pervasive and significant effects. This explains Menegazzi‘s great interest in human behaviour. He believed individuals should leave aside personal egotism and adapt to the laws of the vital order that he codified. Only by respecting Menegazzi‘s laws was it possible to overcome imbalances, while failure to respect his laws brought about economic fluctuations and serious crises. Vito focused his analysis on forced saving, and highlighted the role of self-financing, a phenomenon relevant not only for anti-cyclical policies but also for general investment strategies. In fact, control of saving and investment designed to prevent cycles was inadequate when conducted through traditional discount rate manoeuvres with no impact on selffinancing. The theories of the Italian authors discussed here uncover new explanatory pathways. Effectively, as economic systems evolve, unexplored opportunities for enquiry may emerge from existing mechanisms or previously neglected elements. We are therefore convinced that these valuable theoretical contributions should not go to waste.
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REFERENCES Amoroso, L. (1932). Economia e politica. Annuario per l’Anno Accademico 1932-33, Università degli Studi di Roma, Rome, Italy: Tipografia Pallotta, pp. 85-93. Amoroso, L. (1938). Principii di economia corporativa. Bologna, Italy: Nicola Zanichelli Editore. Amoroso, L. (1940a). Riflessioni sulla dinamica dei prezzi. Rivista Italiana di Scienze Economiche, vol. X (May), pp. 583-589. Amoroso, L. (1940b). The Transformation of Value in the Productive Process. Econometrica, vol. 8 (n. 1), pp. 1-11. Amoroso, L. (1942). Meccanica economica. Città di Castello, Italy: Macrì. Amoroso, L. (1949). Economia di mercato. Bologna, Italy: Zuffi. Amoroso, L. (1950). Riflessioni sulla politica monetaria. In Amoroso L., Ciclo, circolazione, politica monetaria. Edited by Venturi L., introduction by Vinci S., (1999, pp. 91-104). Turin, Italy: UTET. Amoroso, L. (1961). Si livellano i valori azionari al saggio d‘interesse di mercato? Economia Internazionale, n. 2, vol. XIV (May), pp. 3-13. Attwood, T. (1817). A Letter to the Right Honourable Nicholas Vansittart, on the Creation of Money, and on its Action on National Prosperity. Birmingham, UK: R. Wrightson. Attwood, T. (1964). Selected Economic Writings of Thomas Attwood. Introduction by Fetter F.W.. London, UK: London School of Economics. Benhabib, J. (1992). Cycles and Chaos in Economic Equilibrium. Princeton (USA), Princeton University Press. Bresciani-Turroni, C. (1916). Relazione fra sconto e prezzi durante i cicli economici. Giornale degli Economisti e Annali di Economia, vol. 56 (November), pp. 366-417. Bresciani-Turroni, C. (1951). Corso di economia politica. Milan, Italy: Dott. A. Giuffrè Editore. Encyclopedia, (1997). Business Cycles and Depressions. An Encyclopedia. New York & London, USA and UK: Garland Publishing, Inc. Fanno, M. (1931). Cicli di produzione, cicli di credito e fluttuazioni industriali. Giornale degli Economisti e Annali di Economia, vol. 27 (May), pp. 98-128. Fanno, M. (1935). I trasferimenti anormali dei capitali e le crisi. Turin, Italy: Einaudi. Fanno, M. (1947). La teoria delle fluttuazioni economiche. Turin, Italy: UTET. Fanno, M. (1956). La teoria delle fluttuazioni economiche. Second edition corrected and widened by the author.Turin, Italy: UTET. Faucci, R. (1990). Materiali e ipotesi sulla cultura economica italiana fra le due guerre mondiali. In Becattini G. (Ed.), Temi, problemi e scuole (1990, pp. 183-231). Turin, Italy: UTET. Fisher, I. (1933). The Debt-deflation Theory of Great Depression. Econometrica, vol. 1 (October), pp. 337-357. Haavelmo, T. (1945). Multiplier Effects of a Balanced Budget. Econometrica, vol. 13 (October), pp. 311-318. Harrod, R.F. (1948). Towards a Dynamic Economics. London, UK: Macmillan. Hayek von, F.A. (1929). Geldtheorie und Konjunkturtheorie. Wien und Leipzig, Austria: Hölder-Pichler-Tempsky.
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Hayek von, F.A. (1933). Monetary Theory and the Trade Cycle. London, UK: Jonathan Cape. Hayek von, F.A. (1984). Money, Capital and Fluctuations. Edited by McCloughry R., London, UK: Routledge G. & Kegan P. Ltd. Hawtrey, R.G. (1913). Good and Bad Trade. An Inquiry into the Cause of the Trade Fluctuations. London, UK: Macmillan. Hawtrey, R.G. (1919). Currency and Credit. London, UK: Macmillan. Hawtrey, R.G. (1928). Trade and Credit. London, UK: Longmans & Co.. Hawtrey, R.G. (1940). The Trade Cycle and Capital Intensity. Economica, vol. VII (Febraury), pp. 1-15. sir Hicks, J. (1950). A Contribution to the Theory of the Trade Cycle. Oxford, UK: Clarendon Press. Kalecki, M. (1990-93). The Collected Works of Michal Kalecki. 5 vols. Edited by Osiatynski J., Oxford, UK: Clarendon Press. Keppler, J.H. (1994). Luigi Amoroso (1886-1965): Economist, Italian Corporatist. History of Political Economy, vol. 26 (n. 4), pp. 589-611. Keynes, J.M. (1930). A Treatise on Money. London, UK: Macmillan. Keynes, J.M. (1936). The General Theory of Employment, Interest and Money. 2007, London, UK: Macmillan. Magliulo, A. (1992). La teoria del ciclo economico e la spiegazione della Grande Crisi. Il contributo di Marco Fanno. In Manfredini Gasparetto ML. (Ed.): Marco Fanno, l'uomo e l'economista (1992, pp. 195-231). Padua, Italy: Cedam. Magliulo, A. (1998). Marco Fanno e la cultura economica del Novecento. Florence, Italy: Editori Polistampa. Malthus, T.R. (1798). An Essay on the Principle of Population: or a View of its Past and Present on Human Happiness. 1826, London, UK: John Murray. Manfredini Gasparetto, ML. (1969). Il capitale nella disposizione pubblica e privata. Padua, Italy: Cedam. Manfredini Gasparetto, ML. (1982) (Ed.): Saggi di economia nell'attualità di Marco Fanno. Padua, Italy: Cedam. Marrama, V. (1974). Economia politica, Libro secondo: Statica e dinamica del reddito. Turin, Italy: UTET. Marshall, A. (1890). Principles of Economics. 1920, London, UK: Macmillan and Co. Menegazzi, G. (1931). Orientamenti nuovi nella politica monetaria e creditizia. Rome, Italy: Libreria del Littorio. Menegazzi, G. (1932). Premesse alla politica del risparmio in regime corporativo. Rome, Italy: Libreria del Littorio. Menegazzi, G. (1934). Dall’economia finanziaria al corporativismo razionale. Rome, Italy: Angelo Signorelli. Menegazzi, G. (1936). Direttive e deviazioni della politica economica e finanziaria. Rome, Italy: Angelo Signorelli. Menegazzi, G. (1964). I fondamenti del solidarismo. Milan, Italy: Giuffrè. Menegazzi, G. (1965). I nuovi fondamenti dell’ordine vitale dei popoli. Vol. I. Milan, Italy: Giuffrè. Menegazzi, G. (1966). Grandezza e attualità del pensiero economico-sociale di Giuseppe Toniolo. Studi Economici e Sociali, vol. 1 (n. 1), pp. 7-30.
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Menegazzi, G. (1967). I nuovi fondamenti dell’ordine vitale dei popoli. Vol. III. Milan, Italy: Giuffrè. Menegazzi, G. (1970). Il piano dello sviluppo solidale dei popoli. Milan, Italy: Giuffrè. Menegazzi, G. (1975). Laws and Models for a Vital Order and Mutual Development of Peoples. Centre for Studies and Research on Planning of Social-Economic Community Development of the University of Padua, Palazzo Giuliari. Verona, Italy: University of Verona. Mengarelli, G. (2000). Oscillazioni dei moderni sistemi produttivi e teorie del ciclo. Rivista Milanese di Economia, vol. 75-76 (July-December), pp. 5-23. Meyer, J. & Kuh, E. (1957). The Investment Decision. Cambridge Mass., USA: Harvard University Press. Mill, J.S. (1848). Principles of Political Economy with Some of their Applications to Social Philosophy. London, UK: Longmans. Mises von, L. (1949). Human Action: A Treatise on Economics. 1998, The Foundation for Economic Education. New York, USA: Irvington-on Hudson. Nardi Spiller, C. (1990). Struttura produttiva e dinamica dei prezzi. Introduction by Baranzini M., Padua, Italy: Cedam. Nardi Spiller, C. (1993a). Une Analyse Interprétative du Modèle Cyclique de Fanno. Rivista Internazionale di Scienze Economiche e Commerciali, vol. XL (n. 5), pp. 397-410. Nardi Spiller, C. (1993b). Le fluttuazioni economiche: punti convergenti e divergenti tra l‘apporto di Fanno e il contributo di altri studiosi. In Atti: Giornata di Studio dedicata a Marco Fanno (1993, pp. 43-54). Rome, Italy: MedioCredito. Nardi Spiller, C. (1996). Il passato prossimo della teoria economica nel dopo Keynes. Padua, Italy: Cedam. Nardi Spiller, C. (2000). Affinità e distinguo nell‘analisi sulle fluttuazioni cicliche tra Fanno e Hayek. Nuova Economia e Storia, vol. VI (n. 1-2), pp. 1-23. Nardi Spiller, C. (2003a). Lezioni di macroeconomia. Turin, Italy: G. Giappichelli Editore. Nardi Spiller, C. (2003b). The Dynamics of the Price Structure and the Business Cycle. The Italian Evidence from 1945 to 2000. Heidelberg-New York, Germany-USA: PhysicaVerlag. Nardi Spiller, C. & Pomini, M. (2006). La dinamica dello sviluppo economico nell‘approccio di Luigi Amoroso. Il Pensiero Economico Moderno, Vol. XXVI (n. 4), pp. 45-68. Nardi Spiller, C. & Pomini, M. (2007). Profit Rate Money and Economic Dynamics in Fanno‘s Thought. In Marcuzzo, MC. & Giacomin, A. (Eds.), Money and Markets. A Doctrinal Approach (2007, pp. 222-237). London, UK: Routledge. Pantaleoni, M. (1882). La traslazione dei tributi. Rome, Italy: Paolini. Pantaleoni, M. (1889). Pure Economics. 1898, London, UK: Macmillan. Pantaleoni, M. (1912). Cronaca. Giornale degli Economisti e Annali di Statistica, vol. XLIV (October), pp. 260-264. Pareto, V. (1906). Manuale di economia politica. Milan, Italy: Soc. Ed. Libreria, the book was being reprinted from French edition. Introduction by Amoroso L., 1965, Rome, Italy: Bizzarri. Parisi, D. & Rotondi, C. (2003). Francesco Vito. Attualità di un economista politico. Milan, Italy: Vita e Pensiero. Quadrio Curzio, A. (2007). Economisti ed economia. Per un’Italia europea: paradigmi tra il XVIII e il XX secolo. Bologna, Italy: Il Mulino.
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Ricardo, D. (1821). On the Principles of Political Economy and Taxations. 1898. London, UK: John Murray. Rossi, L. (1963). Elementi di economia. Vol. I: L’economia politica. Padua, Italy: Cedam. Say, J.B. (1802). A Treatise on Political Economy: or the Production, Distribution and Consumption of Wealth. With an Introduction by Biddle C.C., 1836. Philadlphia, USA: Grigg & Elliot. Schumpeter, J.A. (1939). Business Cycles. New York, USA: McGraw-Hill. Schumpeter, J.A. (1954). History of Economic Analysis. New York, USA: Oxford University Press. Smith, A. (1776). An Inquiry into Nature and Causes of the Wealth of Nations. 1904. London, UK: Dent & Sons,. Tobin, J. (1980). Asset, Accumulation and Economic Activity, Reflections on Contemporary Macroeconomic Theory. Oxford, UK: Basil Blackwell. Toniolo, G. (1893). La genesi storica dell‘odierna crisi sociale economica. Reprinted in Toniolo, G. Studi Economici e Sociali, Documenti, (2001, pp. 481-84.), vol. 36 (n. 4). Toniolo, G. (1908). Trattato di economia sociale. 1915. Florence, Italy: Libreria Editrice Fiorentina. Toniolo, G. (1947). Capitalismo e socialismo. Foreward by Majerotto S., Opera Omnia, Serie I, 1, Comitato Opera Omnia di G. Toniolo, (1952, pp. XXII-527). Città del Vaticano: Città del Vaticano. Tusset, G. (2004). La teoria dinamica nel pensiero economico italiano (1890-1940). Florence, Italy: Edizioni Polistampa. Vinci, F. (1934). Significant Developments in Business Cycle Theory. Econometrica, vol. 2 (n. 2), pp. 125-139. Vito, F. (1933). Il risparmio forzato come fondamento della teoria dei cicli economici. Milan, Italy: Arti Grafiche Milanesi. Vito, F. (1934). Il risparmio forzato e la teoria dei cicli economici. Rivista Internazionale di Scienze Sociali, vol. 5 (January), pp. 3-46. Vito, F. (1945). L’economia a servizio dell’uomo. I nuovi orientamenti della politica economica e sociale. Milan, Italy: Vita e Pensiero. Vito, F. (1954). Le fluttuazioni cicliche. Milan, Italy: Vita e Pensiero. Von Neumann, J. & Morgestern, O. (1944). Theory of Games and Economic Behavior. Princeton, USA: University Press. Wicksell, K. (1898). Interest and Prices. London, UK: Macmillan. Wicksell, K. (1911). Lezioni di economia politica. 1950. Turin, Italy: UTET.
In: Issues in Economic Thought Editors: M-A. Galindo, C. N. Spiller, pp. 45-56
ISBN 978-60876-173-9 © 2010 Nova Science Publishers, Inc.
Chapter 3
ENDOGENOUS AND EXOGENOUS GROWTH IN MARCO FANNO’S THOUGHT Mario Pomini* University of Padua, Italy
ABSTRACT The business cycle theory was one of the main fields of macroeconomic research developed by Italian economists in the thirties. In the post-WWII period, general interest turned towards the theory of growth in the wake of Harrod's contributions. Fanno took full part in this theoretical turn, and made an original attempt at formulating a theory of cyclical growth. One of the main aspects that he tried to express was the real and endogenous character of economic growth. From this point of view, Fanno‘s theory of cyclical growth is not far off current theories of endogenous growth, in fact it is even more complete in certain aspects as it integrates the real part with the monetary part of the economic analysis.
JEL CODES: B22, E32.
1. INTRODUCTION Marco Fanno was already well-known for his work on monetary theory when he advanced his theory of the business cycle in the post-WWII period. He had made early attempts at a formulation of the business cycle theory at the start of the thirties (Fanno 1931) and then came back to and fully developed it in his extensive book entitled La teoria delle fluttuazioni economiche, published in 1947. At the same time, he also formulated a theory on economic growth, following a path that was typical of a strand of the Italian school of thought *
Department of Economics, University of Padua, Italy. E-mail:
[email protected].
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on business cycle. Basically, the main aim of this book was to propose a unified theory of dynamic economics, a new theoretical approach which could deal with both short-term fluctuations and secular growth on a unified basis. While his business cycle theory was studied intensely by scholars in the area (Nardi Spiller 1993, Arena 1998, Magliulo 1998), his theory of growth was not given the same attention, possibly because it was considered to be merely secondary, used in support of his main topic of business cycle. However this is only partially true: the importance of his theory of growth is demonstrated by the fact that he included a new, long, fourth chapter called Le economie progressive in his subsequent definitive essay published in 1956, which was dedicated to his approach on economic growth. According to Fanno, this new chapter was devoted to formulating a new definition of the entire issue of economic fluctuations. This new approach hypothesised that economic fluctuations are no longer caused by the complexity and length of production cycles or errors in estimation by economic agents, as in the 1947 essay, but they are the direct consequence of the natural tendency of capitalist economic systems towards expanding consumption and income. These important changes show how open Fanno was to international debate on these matters, which had been enriched in the meantime by two important contributions: the essay by Harrod Towards a Dynamic Economics published in 1949 and that by Hicks , A Contribution to the Theory of the Trade Cycle, published in 1950. The theory of dynamic economics, both in relation to the economic cycle and to growth, took on a new form as a result of these two contributions which were duly analysed and discussed in the second edition of Fanno‘s book, and also in other works (Fanno 1952, 1956b, 1956c). This essay aims to make a critical analysis of the main aspects of Fanno‘s growth theory to highlight some original contributions that are highly topical. These ideas were set out in the final stages of his research career.
2. TOWARDS ENDOGENOUS GROWTH: FANNO’S PERSPECTIVE The theory of economic growth has been subject to alternating stages throughout its history. It was one of the most important areas of research for the authors of the Classical School, but was subsequently cast aside by proponents of the marginalist revolution who were more concerned with formulating a rigorous theory of economic behaviour than explaining the reasons behind the wealth or poverty of nations. This was fully formulated in a neo-classical growth model by Solow (Solow 1956) after WWII, in accordance with which the long-term growth rate is fully exogenous to the economic system since it depends on the growth rate of the population or on technical progress which functions as an exogenous trend. Studies on the theories of economic growth were taken up again in the second half of the eighties as the result of an attempt to go beyond the traditional vision of economic growth as an exogenous process, i.e. determined by factors that do not directly depend on economic variables. The traditional approach had mainly concentrated on the conditions that guarantee stability in the path to long-term growth, but the essential requirement for this, i.e. the decrease in the marginal product of capital and the accumulation factor, in general actually cancels out the growth rate in the long-term. In the long-term, the profit rate tends to zero and this leads to the cancellation of the accumulation and the growth (Pomini, 2006).
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Solow explicitly recognizes that the assumption of an aggregate production function with a variable capital/output ratio allows us, on the one hand, to approach the steady state position from an arbitrary given initial condition and, in so doing, to solve the problem posed by Harrodian instability. On the other hand, however, it produces undesired implications. The model presents only short-run or transitional dynamics driven by the accumulation of capital, but there is no growth in the very long period. The standard neo-classical growth model is able to overcome the problem of instability, but is silent about the forces that sustain the longrun growth. The mere accumulation of physical capital is not enough. In this way the Solovian framework shares with Ricardian tradition the pessimistic conclusion concerning the possibility of steady-state growth. Starting with the article of Paul Romer (1986) and Robert Lucas (1988), this traditional vision of growth was questioned and replaced by a new approach that aimed at showing the endogenous character of economic growth, which actually seemed to be backed up by empirical results. The theory of endogenous growth has developed along many different lines (Barro and Sala-i-Martin, 1995), but the main point is that long-term dynamics depend on the optimising behaviour of the economic agents. More specifically, technical progress is no longer exogenous, but becomes endogenous as a function of the economic resources that the economy dedicates to this purpose, taking shape in accordance with a variety of different mechanisms. With reference to Fanno‘s contribution, he attempts to go beyond the exogenous vision of economic growth as was emerging at the time, even though his thesis mirrored his personal perspective which was related to the debate in the early fifties on the relations between growth and economic cycle. The two characteristic aspects of both exogenous and endogenous growth are not mutually exclusive from this perspective, but can actually be integrated, even though the endogenous factor plays a crucial part. While it may be true that the system evolves in accordance with external forces in the long term, such as technological progress or population growth, Fanno believed that it was the entrepreneurs who created actual dynamic economics trends, as a result of their drive to find new ways of making a profit. Growth is endogenous to the extent that it is determined by the investment decisions of entrepreneurs who act in an optimising behaviour. In keeping with his neo-classical training, even Fanno therefore attempted to go beyond the exogenous models to offer a microfoundation for the theory of cyclical growth. There is also another aspect of endogenous growth that should be noted. Following a line taken by his teacher, Gustavo del Vecchio1, he also developed the implications for economic growth at the level of monetary phenomena. Just as the economic cycle is triggered, according to Wicksell, by the fact that the rate of profit becomes higher than the interest rate, even the expansion of the monetary base can accelerate or hinder economic growth through the change in prices, and therefore in profits in the long term. And this monetary element cannot be ignored either if we want to make a realistic representation of economic phenomena. If the attempt to found the endogeneity of growth forms a central part of Fanno‘s research project, differentiating it from the rival theories of economists such as John Hicks or Roy Harrod, we shall see how he tried to achieve this result, both as regards the real and the monetary aspects. 1
Gustavo del Vecchio (1883-1972) was one of the principal proponents of the Marshallian tradition in Italy. He was mainly interested in monetary theory and dynamic economics.
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2. THE DIFFERENT CATEGORIES OF THE GROWTH PATHS IN THE WRITINGS OF MARCO FANNO Many commentators (Nardi Spiller 1992, Arena 1998, Magliulo 1998) have noted that Fanno appears eclectic and that he aims to reconcile different points of view which are not necessarily consistent. However, he always retains an element of originality. This eclectism is also clear in his theory of growth which has neo-classical characteristics in addition to theoretical elements taken directly from the Keynesian approach. This was actually becoming more widespread in post-war Italy. Like other marginalist economists of this period such as Eraldo Fossati2, he was convinced that the neo-classical vision and the Keynesian vision did not actually conflict, but complemented one another, with each focusing on different aspects: the neo-classical vision focusing on the rules of operation of an ideal economy without frictions, and the Keynesian vision focusing on the real economy and its imperfect functioning. According to Fanno, it was essential to introduce the difference between stationary economies and progressive economies in order to understand economic fluctuations. An economy is stationary when the size of its economic variables does not change over time, and more specifically when new savings equal zero. A feature of the stationary economy is that there is no accumulation of capital and savings are only used to replace machines that have broken down. On the other hand, real income, consumption and the amount of equipment tend to increase over time in a progressive economy. In a footnote, Fanno (1956a, p. 5) explains that what he had in mind was growth in the stationary state, i.e. a situation where everything grows at a constant rate. While it may be true that fluctuations can occur in stationary economies due to delays in the execution of various production processes, these were hypothetical cases that did not actually occur in the real world. For Fanno, if the postwar business cycle theory was so different from the theory formulated in the thirties, it was due to the fact that the growth theory which then became a theory of cyclical growth was placed at the centre of the dynamic analysis (Fanno, 1952, p. 544). The topic of growth is discussed in depth by Fanno in the fourth chapter of his 1956 book. He proposes three definitions of economic growth, with each having a specific function within his dynamic model: potential growth, secular growth and finally, actual growth. According to Fanno, capitalist economies tend to expand spontaneously over time in accordance with three basic factors: increase in the population, technical progress and increase in savings. If you look closely, this is a return to the classical approach which could go back to Adam Smith. These three factors taken together define what Fanno calls the line of potential growth, a situation where the economy grows using all its resources, and specifically where there is no unemployment. It is the case of traditional neo-classical dynamic equilibrium, perfectly analogous with static equilibrium. In the words of Fanno, being as it is, a line that follows full employment, it is basically the geometric locus of the Walrasian-Paretian equilibrium of a system in expansion (Fanno, 1956b, p. 203).
2
Eraldo Fossati (1902-1962) was a prominent proponent of the second-generation Paretian school. He founded the journal Metroeconomica in 1949 which he headed until his unexpected death in 1962. This made him very well-known in international circles.
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Fanno‘s central notion can be expressed through the introduction of equation [1] where the national income is a function of workers‘ productivity (which depends on technical progress) and how many there are of them, L ,
Y L
[1]
The logarithmic derivative [1] then gives us an expression whereby the growth rate of the economy is the sum of the employed population and the change in productivity due to technical progress, i.e. the rate at which the path of potential growth moves,
Y L Y L
[2]
Equation [2] defines a completely hypothetical path as it would be difficult to find in real life. Fanno observes that adjustments in production volumes are not instantaneous but need time to be implemented in real economies. Due to these delays, lag times can differ, economic growth cannot occur along this line, but has to follow a trajectory that lies below it since it is out of phase on a time basis. This gives the secular growth line which is the second dynamic concept introduced by Fanno. From an analytical point of view, the secular growth line differs from the potential growth line because it represents a growth path in which not all the resources are actually employed, and therefore it will inevitably fall within the Keynesian type model. In the words of Fanno, Therefore while the potential growth line is one with full employment, it is a dead-end track at least with respect to capitalist systems, the secular growth line is a line with partial employment but it is on a through track of systems under development. And as such it is just the secular growth line of Keynesian-type economies. The secular growth line may therefore be considered as the geometric locus of the positions that follow the equilibrium of a Keynesian system under growth, in the hypothesis that unemployment maintains a constant ratio to the total population. […] (Fanno, 1956a, p. 47).
In addition, it is Fanno who moves his secular growth line closer to Harrod‘s guaranteed growth rate (Fanno, 1956b, p. 215), where the volume of savings equals the amounts used for investments at any time. Even in this case economic growth is regulated by savings that can be transformed in a broadening of the productive base. Fanno observes that the potential growth path and the secular growth path must have the same gradient, and therefore have the same growth rate. If not, the two lines will either diverge and therefore firms will never be capable of taking advantage of new opportunities to make profit, or they will tend to merge, in which case the delays and imperfections that characterise real economies will disappear. With his natural inclination towards realism, he rules out both of these extreme cases. Finally, Fanno introduces a third line of development of the economic system that he calls actual growth. This has a radically different tendency than the other two because it does not develop at a constant rate but marks out an unsteadier trajectory where there are periods
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of expansion and recession, resulting in cyclical tendencies. Where does this cyclical movement of actual growth come from? Says Fanno, Secondly, while the adjustment of production, income, savings to changes in investments and consumption to changes in income are instantaneous under secular growth because of the supposed constancy […] this can no longer be supposed under actual growth due to the lags to which the adjustment of each of these factors to the changes in investments are subject to, and therefore this must be taken into consideration. (Fanno, 1956, p. 62)
Therefore, even in the 1956 model, just as in the 1947 model, Fanno follows the traditional vision dating back to Samuelson (1939), which relates the non-linear tendencies of the economic system to the temporal phase shifts of the variables, especially regarding the capital stock variable. In Fanno‘s dynamic model, consumption adjusts after a period of delay with respect to income, while the new capital goods come into operation after two periods. These phase shifts in consumption and production determine the irregular tendency of actual income. In addition, the fluctuations are crucially dependant on the income multiplier and investment accelerator values, as it is common in these types of models. If their numerical value is low, the fluctuations will occur to a limited extent, if they are high, the economy will be subject to greater fluctuations from the secular growth line. Therefore, according to Fanno, the secular growth line is the central axis of gravitation along which and around which the actual line of growth must move, deviating from it every time the systems are induced to expand at a different rhythm to it, but at the same time forced to go back to it by the force of attraction that it exercises on the systems. (Marco Fanno, 1956, p. 63)
The relationships between the secular line which is exogenous, and the actual line which is endogenous, represent the original element of Fanno‘s theory of cyclical growth. The actual growth line, which basically maps out the tendency of the economic cycle, is determined by stimuli from the secular growth line considering the delayed adjustment of production capacity.
3. THE FIRST ELEMENT OF ENDOGENEITY: THE ROLE OF PROFIT The three lines of growth in consideration constitute the logical framework of his theory of cyclical growth, but no dynamic would be possible for Fanno without a further element which plays a crucial role: the existence of new opportunities for making profit. All the factors that stimulate the economic system, such as the multiplier of consumption or the accelerator of investments, would not be set in motion if there weren‘t an additional subjective element: the search for new opportunities to make profit by firms. Fanno returns to this element at various points in his 1956 book, believing that he could differentiate his approach from that of other authors such as Hicks and Harrod who were considered to be excessively mechanistic. Says Fanno, While the models of Harrod and Hicks are purely mechanical and do not take any account of the influence that profits may have, we, on the other hand, give a primary role to profits in our
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model, which we think essential to a model that wishes to identify the laws of development of the capitalist economic systems. (Fanno 1956b, p. 215)
The notion of profit is a constant reminder of the reasons behind new investments made by entrepreneurs and therefore to be added to dynamic economics. From this point of view, we can therefore observe that his theory is endogenous in character since it is the economic agents that determine economic system tendencies through their choices. However Fanno never tried to formalise the role of profit on investments directly, as other economists such as Kaldor tried to do. Even Fanno believed that investments depended on the profit aspect, but this element is never explained at an analytical level, that is why the dynamics are still controlled by the action of traditional factors such as delays, the multiplier and the accelerator. If he had managed to model the relation between investments and profits more explicitly, perhaps his theory of cyclical growth would have carried more relevance at an international level. For the purposes of constructing the cyclical growth theory, Fanno distinguishes between two types of profit: growth profit and cyclical profit. The definition alone gives an idea of the different functions assigned to these two profit types. Growth profits are those which give rise to economic growth and are conceptually defined by the distance between the line of secular growth and that of actual growth. When this distance becomes significant, firms begin to realise that it is time to make new investments in order to take advantage of new opportunities. In his words, ‖Growth profits, which can be gained each time the actual growth of the system is behind with respect to the secular growth which is ongoing, will encourage primary investments‖ (Fanno, 1956a, p. 178). If the multiplier and the accelerator offer the mechanism of this process and determine its course, the profits will supply it with the impulse, i.e. the stimulus necessary to put the process in motion. The formal relation between secular growth and actual growth, considering the distance between the two as the indication of a normal state of profit, was analysed by Terenzio Cozzi (1982), who showed how the relationship between these two elements could be compared to a conservative field. The function of growth profit is very important because this starts up the initial fluctuation stage in which actual production is greater than the secular production. Fanno then introduces a second category of profit: the cyclical profits. They are the profits that are made during the economic cycle and that hold up the secondary investments, even when the primary investments have served their purpose. In the initial phase of the economic cycle there is an excess of demand for the goods which hikes up prices due to the new investments, while at the same time salaries and the cost of raw materials remain constant. This is where cyclical profits come in, which increase the return from investments well above interest rate, and therefore their cost. These cyclical profits in turn induce the firms to increase their investments, and in this way a further increase in income is generated in accordance with a cumulative process. Then Fanno shows how these profits persist even when the growth profits have run out using his numerical examples, and so becoming the real regulatory engine of the economic cycle. Even the cyclical profits cannot last for long because at a certain point the cost of the factors will tend to increase, a sign that the expansion phase of the cycle is coming to an end.
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4. THE CYCLICAL INVESTMENTS AND FANNO’S SOLUTION TO HARROD’S INSTABILITY PROBLEM We have seen that Fanno‘s path of secular growth is not very far off the concept of Harrod‘s guaranteed growth rate which he had formulated in an attempt to extend the Keynesian theory over the long term. If there is to be equality between savings and investments, it means that even the production capacity of the system will have to adjust to cope with the increase in consumption over the long-term. But this, in turn, leads to a further increase in income, which can result in a distancing from the equilibrium trajectory due to the cumulative effects that the change in investment expenses triggered. If, in a wave of enthusiasm, the entrepreneurs predict that the level of income will be higher than the actual level, they will find themselves with less capital stock than the amount needed to realise the guaranteed growth rate. Production will strongly push its production capacity and the firms will therefore be pushed to increase their investment expenses. The system will receive a push up so the actual growth rate will tend to distance itself from the guaranteed growth rate. In Harrod, this movement upwards will find its upper limit in full employment, after which income cannot expand further due to the lack of work and capital. In the neo-classical context, the definitive answer to Harrod's instability problem came from Solow (1956) through the flexibility of the production function coefficients. Fanno was well aware of the limits of Harrod‘s model due to the instability problem caused by incorrect predictions. In his 1952 article, Le teorie delle fluttuazioni economiche, he noted that the basic weakness of Harrod‘s approach to both growth and the economic cycle laid in the instability. Says Fanno, [Harrod] therefore leaves the reason behind the tendency of systems to deviate from the warranted path in the shadows; generally he does not explain the conditions that determine the limits of centrifugal movements and their reversal. And even though the formulation of his model is very promising, it is incomplete and therefore does not work. (Fanno, 1952, p. 548)
Fanno‘s solution to the Harrod problem of reconciliating growth and cyclicity can be found in a deeper examination of the role of investments. Unfortunately Fanno did not provide a full analytical development of his insight, but limited himself to offering certain interesting numerical examples in the fourth chapter of his 1956 book. These examples lead to the definition of an second-order differential equation in which the new element is represented by what Fanno called cyclical investments, i.e. those investments in equipment that are made at the beginning of the cycle in which the available income is higher than the income produced. These investments that Fanno also called secondary, contribute to enhancing the effects of the primary investments due to the new expectations of profit triggered by the difference between secular growth and potential growth. Due to the increase in investments after a certain number of periods, with the amount depending on the action of the system parameters, the production capacity of the actual expansion path will exceed that of the secular expansion. Fanno‘s hypothesis is that the cyclical investment will return to zero in this case, and as a consequence the system will tend to fold back on itself, returning to its initial position. The calculations presented in the tables show that it is the cyclical investments that determine the fact that the actual expansion line first goes over and then goes
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under the secular growth line, therefore following a cyclical path. The secondary investments can be expressed through the following formula:
K v(Yt cYt 1 )
if
K s Ke
K 0
if
K s Ke
[3]
where Yt is the income at time t, v is the acceleration coefficient, c is the marginal inclination to consume, K s is the capital stock of the secular path and K e is the actual expansion path. As can be noted from [3], the extent of the new secondary investment, and consequently of the economic cycle, depends on the value of the accelerator: the higher the value of the accelerator, the greater the fluctuations in the economy will be. This is why Fanno is entitled to say that only growing economies (progressive economies) can develop in accordance with cyclical tendencies. With the introduction of the cyclical investments, linked to the difference between production capacity and secular capacity, Fanno manages to reach his objective: a theory of cyclical growth that does not have the Harrod instability problem.
5. A SECOND ELEMENT OF ENDOGENEITY: THE IMPORTANCE OF MONETARY FACTORS Considering that, within the conceptual framework based on the potential and secular growth lines, the driving force behind the expansionary process are real factors such as population growth or technical progress, at first sight it would appear that monetary factors have no influence on the long term trend. However upon closer examination we see that this impression is misleading: money too has a role to play in long-term economic relationships. Fanno actually considers the issue of the need for money in a progressive economy at the end of the chapter devoted to a detailed account of the theory of the supply of money, once again inspired by the quantity theory of money (Fanno, 1956a, ch. 9). It is interesting to note that this part was absent in the edition published ten years previously and therefore marks a further step forward in the reflection on the role of money begun by Fanno in 1912. The starting point is Fisher‘s traditional equation expressing the relationship between the volume of trade and the circulation of money i.e.,
Bk pR
[4]
where, using Fanno‘s symbols, B represents the stock of money, k is the speed of circulation, R is national income and p the general price level. Since by definition in progressive economies income varies at a constant rate, Fanno rewrites [1] directly in dynamic terms by transforming the identity into logarithms and deriving it with respect to time,
B k p R B k p R
[5]
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On the basis of [5], an exogenous change in income due, for example, to technical progress can be accommodated by the following mechanisms: a change in the monetary base, a change in the velocity of circulation or a change in prices. Fanno is careful to identify two special cases: when the adjustment comes about through a change in monetary variables or through a change in the price level. In progressive economies equilibrium in identity [5] can be maintained first of all by modifying one of the rates of the variables on the left side, through growth in the supply of money or an increase in the velocity of circulation. Fanno opts for the first mechanism since payment habits can only be partially and very gradually modified. The most appropriate instrument is undoubtedly a percentage change in the quantity of the money stock. If the currency is metallic then it is necessary to increase imports of metal; in the case of paper currency, the monetary authorities intervene by issuing new paper money. The most relevant argument which emerges from these initial considerations is a reassertion of the traditional theory. Effectively, if the two increasing ratios are equal and prices remain constant, the supply of money is neutral with respect to the secular expansion of the economies. This formulation changes drastically if the dynamic adjustment comes about through a change in prices. If the supply of money increases more than income, Fanno observes that prices tend to rise, with a positive impact on firms‘ expectations of profit, leading to an increase in the volume of output. Conversely, negative expectations of profit lead to a drop in output, since high profits boost the rate of production while a fall in profits holds it back. Fanno observes that the high level of profits in the first case tends to accelerate the rhythm of production; the low level of profits in the second tends to delay it. Therefore in the case of
B R k B R k
potential expansion and secular expansion tend to follow each other at a higher
rhythm than they would have with the concurrence of the known production factors only; in the opposite case they tend to follow each other at a lower rate. And in both cases therefore money, instead of remaining neutral, becomes a disturbing factor tending to modify the rhythm of secular expansion. Far from being neutral money becomes yet another factor which tends to modify the pace of long term growth and can permanently depress or increase the growth rate of the economy. It is interesting to note how Fanno assumes that the parameters which determine the velocity of circulation of money are not constant but rather vary in the different phases of the business cycle. So we see that even in the case of the quantity theory of money Fanno adopts an eclectic stance, departing from an orthodox vision and making theoretical changes to suit his capitalist approach in terms of an economy in which full employment is never reached owing to misjudgement by firms. In the long term, in Fanno‘s experience gained in the aftermath of the Great Depression, changes in the supply of money do not come up against the wall of inflation but rather contribute to the process of economic growth by creating new and unexpected opportunities for profit.
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7. CONCLUSION The business cycle theory was one of the main fields of macroeconomic research developed by Italian economists in the nineteen thirties. In the post-WWII period, general interest turned towards the theory of economic growth in the wake of Harrod's contributions which had shown that it was possible to extend the Keynesian model to the long-term. Fanno took full part in this theoretical turn, and made an original attempt at formulating a theory of cyclical growth. One of the main aspects that he tried to express was the real and endogenous character of economic growth. Even a highly important phenomena like growth must be analysed in accordance with the incentives offered by the economic operators in a market economy. From this point of view, Fanno‘s theory of cyclical growth is not far off current theories of endogenous growth, in fact it is even more complete in certain aspects as it integrates the real part with the monetary part. However Fanno did not provide an adequate formalization for his theory about the role of the distributive variables in his model, which definitely weakened his thesis. Macroeconomic variable tendencies are ruled by delays and exogenous parameters in his numerical examples, just as in the more traditional models from the nineteen thirties. This is probably why that even though his model was highly original, it just seemed to be a variation of Hicks model (1950) and not a new approach to the problem of cyclical growth. Also his peculiar solution to the instability problem of Harrod did not receive the attention that it deserved.
REFERENCES Arena, R. (1998). Marco Fanno. In Meacci F. (Ed.), Italian Economists of the 20th Century (pp. 114-133). Cheltenham: Edward Elgar. Barro, R., & Sala-i-Martin, X. (1995). Economic Growth. New York: McGraw-Hill. Cantarelli, D. (1996). Il magistero scientifico di Marco Fanno tra passato e futuro. Padua: Cedam. Cozzi, T. (1982). Marco Fanno e la teoria moderna del ciclo. In ML. Manfredini Gasparetto (Ed.), Saggi di economia nell'attualità di Marco Fanno (pp. 227-238), Padua: Cedam. Delli Gatti, D., & Gallegati, M. (1991). Credito, investimenti e fluttuazioni economiche: l‘economia sequenziale di Marco Fanno. Quaderni di Storia dell’Economia Politica, IX, 123-45. Fanno, M. (1912). Le banche e il mercato monetario. Roma: Athenaeum. Fanno, M. (1931). Cicli di produzione, cicli del credito e fluttuazioni industriali. Giornale degli Economisti e Rivista di Statistica, 7, 329-70. Fanno, M. (1947). La teoria delle fluttuazioni economiche. Turin: UTET. Fanno, M. (1952). Le teorie delle fluttuazioni economiche. Giornale degli Economisti e Annali di Economia, 11, 533-70. Fanno, M. (1956a). La teoria delle fluttuazioni economiche. Turin: UTET. Fanno, M. (1956b).Considerazione sullo sviluppo dei sistemi economici. Giornale degli Economisti e Annali di Economia, 15, 199-217. Fanno, M. (1956c). Lineamenti di una teoria dell‘espansione delle economie progressive. Economia Internazionale, 9, 212-29, 438-458, 609-626.
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Faucci R., (1990). Materiali e ipotesi sulla cultura economica italiana fra le due guerre mondiali. In G. Becattini (Ed.), Storia del pensiero economico: temi, problemi e scuole (pp. 183-231). Turin, : UTET. Harrod, R.F. (1939). An Essay in Dynamic Theory. Economic Journal, XLIX, 19-33. Harrod, R.F. (1948 ). Towards a Dynamic Economy. London: Macmillan. Hicks, J.A. (1950). Contribution to the Theory of the Economic cycle. Oxford: Clarendon Press. Lucas, R.E. (1988). On the Mechanics of Economic Development. Journal of Monetary Economics, 22, 3-42. Magliulo, A. (1990). Marco Fanno nel dibattito sul ciclo economico degli anni Trenta. Quaderni di storia dell’economia politica, 23, 131-45. Magliulo, A. (1998). Marco Fanno e la cultura economica del Novecento. Florence: Edizioni Polistampa. Manfredini Gasparetto, ML. (Ed.) (1982). Saggi di economia nell'attualità di Marco Fanno. Padua: Cedam. Nardi Spiller, C. (1992). L‘andamento del corso dei cambi e la dinamica inflativa nell‘analisi di Marco Fanno. In ML. Manfredini Gasparetto (Ed.) Saggi di economia nell'attualità di Marco Fanno (pp. 239-256), Padua: Cedam. Nardi Spiller, C. (1993). Une Analyse Interprétative du Modèle Cyclique de Fanno. Rivista Internazionale di Scienze Economiche e Commerciali, XL, 397-410. Nardi Spiller, C. & Pomini, M. (2007). Profit Rate, Money and Dynamic Economics in Fanno‘s Thought. In A. Giacomin & C. Marcuzzo (Eds.), Money and markets (pp. 223237), Abingdom, U.K.: Routledge. Puu, T. & Sushko, I. (2005). Business Cycle Dynamics. Berlin: Springer-Verlag. Romer, P. (1986). Increasing Returns and Long-run Growth. Journal of Political Economy, 94, 1002-1037. Samuelson, P. A. (1939). Interactions between the multiplier analysis and the principle of acceleration. Review of Economic and Statistics, 21, 75-78.
In: Issues in Economic Thought Editors: M-A. Galindo, C. N. Spiller, pp. 57-69
ISBN 978-60876-173-9 © 2010 Nova Science Publishers, Inc.
Chapter 4
LIBERALISM IN THE ECONOMIC THOUGHT OF COSTANTINO BRESCIANI-TURRONI Mikael De Gasperi* University of Verona, Italy
ABSTRACT This chapter will introduce the most significant aspects distinguishing the economic thought of Costantino Bresciani-Turroni. After a brief exam of the principal point of view produced by the well-know exegete of liberal thought, we are going to investigate the perspective from which Bresciani-Turroni draws up his vision in relation to the concept of freedom, the role of the State in the economy, the function of social welfare and social justice and his methodological approach. To conclude our dissertation, we will illustrate a suggestive analysis concerning an expansion of economy based exclusively on loans and credits. JEL CODES: B31, F01, F50, P10
1. INTRODUCTION The events that, at the end of the XVIII century, upset the existing social order in Europe led to the formation of a variegated and complex scenario in which ideologies such as liberalism, conservatism and socialism competed with one other. To date, it is impossible to clearly delineate the contours and the borders within which we can trace back the three different approaches. This must not astonish us because, as Wallerstein (1995) points out, ideologies are possible answers to a radical and complete change of Weltanshauung. In total accordance with such a formulation, we are little *
Scholarship Fellow, Faculty
[email protected] of
Law,
University
of
Verona
(Italy).
E-mail:
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persuaded to proceed into an attempt to determine a framework where we can contain the various traditions and their relative differences. On the contrary, it seems to us decidedly more useful to recall some chief aspects of the significant author who can be ascribable to liberal thought, analysing them from a diachronic perspective in order to subsequently focus on the thought of Costantino Bresciani-Turroni1 (1939, 1944, 1945, 1947, 1961).
2. AN OVERVIEW The work of Smith (1776) represents a milestone starting from which economic liberalism became the heart of economic theory. The Industrial Revolution marks, in a decisive way, the end of all the economic systems, fundamentally autarchic, based on the primary sector and on small handicraft works in favour of an organization with more subdivisions, pivoted around a factory system2. Such change, involved distortion of a social nature which manifested its effects through massive urbanization as well as imposing a ‗society of discipline‘ dictated by an inflexible structuring of production according to the logic of the succession of phases which characterized the layout of the capital intensive factories. As a consequence, the role of work division3 and laissez-faire4 became crucial. In such a scenario, no State intervention is desirable in the functioning of the economic system except to ensure correct and loyal respect for the common ‗rules of the game‘. Ultimately, the well-being of society is provided by the ‗wealth of the nation‘, a wealth that is remarkably increased when the people‘s acting is guided by the invisible hand and, most of all, by personal interest5. 1
2
3 4
5
Costantino Bresciani-Turroni (Verona 1862–Milan 1963) acquired his degree in Law at the University of Padova with a thesis concerning the relationship between economic evolution and monetary theory. Once graduated, he continued his studies in Germany, supported by the Laboratory of Political Economy directed in different periods by Adolph Wagner and Gustav Schmoller and attending, at the same time, the Laboratory of Statistics and Mathematics directed by Ladislaus Bortkiewicz. In 1908 he returned to Italy undertaking the role of Lecturer in Statistics at the University of Palermo. From 1919 to 1924, he held governmental offices on behalf of the Italian State. It was from this point onwards that he began to produce articles that explained the episodes of German hyperinflation during the period of the Republic of Weimar (essays subsequently collected in the volume Le vicende del marco tedesco). Between 1927 and 1940 he taught at the University of Cairo, founded a short time before. In 1945, he became president of the Bank of Rome and published Il programma economico-sociale del liberalismo, for the Italian liberal party. From 1947 to 1953 he held a managerial role at the new World Bank. In 1957, he was appointed professor emeritus, in conjunction with his withdrawal from academic activity. All translations of Italian citations are my own. It is not a case that we often resort to a benthamian panopticon project to describe in an incisive manner the atmosphere that characterizes the period and the environment. Broadly speaking, the metaphor of panopticon seeks to express that situation for which the entire sensible reality is perfectly visible, therefore controllable. It is precisely this condition which forces the individual to maintain an extreme rigour and the greatest discipline because it becomes impossible to escape the eye of the overseer. An interesting key-reading is defined by Foucault (1975) and Bauman (2005). Moreover, it must be highlighted how Marx (1867) recognised that Beccaria (1769) was the first person to grasp the importance of division of labour. The term ‗laissez-faire’ is generally attributed to Legendre in response to a question posed by Jean-Baptiste Colbert. In reality, the marquis of Argenson, half way through the XVIII century, had already maintained that ‗pour gouverner mieux, il foudrait gouverner moins‘. In this case, the perspective is typically dedicated to the market, considered the only institution in a position to guarantee the equilibrium between supply and demand. The introduction of the concept of self-interest represents an innovative element especially in light of the fact of Mandeville‘s contribution (1714). What is usually forgotten, however, is that Smith himself (1759) identified
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The subsequent contributions seemed to be extremely heterogeneous and vast. In these circumstances, it is interesting to recall the dilemma indicated by Keynes (1925) in which the question ‗Am I a liberal?‘ can be placed within the economic construct. Even Friedman‘s vision (1962) regarding the themes of justice and social order generated wide interest. Finally, the characterization of Rawls (1971) became noteworthy in relation to its theme of inequality. Keynes‘s contributions (1925, 1926, 1930, 1936) do not stop nowadays to arouse lively querelles which do not find a definitive solution. Often the analysis of contributions, centred around the Cambridge author, ultimately taken from a historical context in which the same were framed, delineating a reference context in antithesis with the mainstream6. In reality, such a taxonomy, typically Manichean, assumes instrumental and ideological contours, leading to a loss of incisiveness of the original message. As regards economic orthodoxy, Keynes proposed himself as a ―break away‖ element, as he recalled the action of the State when there was a strong contraction of the business cycle. Keynesian interventionism must not be absolutely interpreted as the interference of an institution superior in the functioning of market mechanisms, but must rather be considered as an intervention entirely aimed at the interruption of harmful vicious circles. In effect, it seems clear that during periods of marked recession, the market does not show those predicted homeostatic movements, thus making crisis situations endure which, self feeding, generate subsequent increasing contractions. We don‘t think that accepting the possibility of public intervention7 could represent, intrinsically, a reason for exclusion from the sphere of liberal ideology. Keynes himself (1925) admitted how his trust in the philosophy of free trade was radically reduced yet, at the same time, he maintained how this practice was the only one that, in the long term, would be valid and coherent from an intellectual point of view. What the British author actually denied was the existence of a ‗natural freedom‘ valid hic et nunc et semper that could confer ‗perpetual rights to those who possess or who purchase‘8. In other terms, all forms of government from above are inconceivable as they impose the perfect superimposition between private and public interests. To infer that ‗enlightened selfishness‘ operates always in the interest of the community appears to completely push the boundaries on all that is unacceptable9. After all, Keynes (1926) also refused the State Socialism not just in the principles that, with zeal, he tried to sustain10, but rather in order to propose a philosophical-intellectual reaction to a system that did not seem able to describe and seize that which was actually happening. We in this particular vision the deception that moved the entire capitalistic system, anticipating by two and a half centuries those themes dealt by happiness economics. 6 The contributions of the Neo-classical, and in particular by the Austrian, English and Lausanne Schools, constitute the theoretical basis of the economic thought between the XIX and XX century. For further information on this topic we refer, among others, to Besomi (1995) and Roncaglia (2001). 7 Moreover it must be clarified that, when we talk about public intervention, we do not mean as much the participation of the State in the capital of enterprises but rather a series of measures that could constitute a stimulus for the entire economic system. 8 Cfr. Keynes (1926). 9 In effect, Keynes himself argues the point by asserting that ‗it is not a correct deduction from the principles of economics that enlightened self-interest always operates in the public interest. Nor is it true that self-interest generally is enlightened; more often individuals acting separately to promote their own ends are too ignorant or too weak to attain even these. Experience does not show that individuals, when they make up a social unit, are always less clear-sighted than when they act separately‘. (Keynes, 1926, p. 280) 10 With regard to this, Keynes affirms that which is critical of ‗State Socialism, not because it seeks to engage men's altruistic impulses in the service of society, or because it departs from laissez-faire, or because it takes away from man's natural liberty to make a million, or because it has courage for bold experiments. All these things I applaud‘. (Keynes, 1926, p. 281)
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can therefore understand why the critique is not as much focused on solutions but rather on problems which in turn led to a search for such solutions, as if to say the State Socialism, where applied, would not lead in any way to the resolution of controversies and problems that haunt the manner of capitalistic production. Appearing from another viewpoint was Friedman (1962) who, attacking the liberal setting typical of the XX century, rose up to the State only as judge and regulator of controversies11. The founder of the School of Chicago defends his position by pointing to how for the liberal intellectuals of the XIX century, the principles of equality and well-being could only be achieved through the extension of freedom of the single individual, while the subsequent evolution tended to contrast the two conditions as well as recovering the interventionist and paternalist positions. Undoubtedly social organization and structure are based on an absolute nuclearism which is strongly individualizing: society on the whole is nothing more but a mere aggregate whose well-being is derived from the union of individual subjects‘ utilities. On the basis of this vision, the theories regarding social justice assume a typically reductionist valence as they are, as a last resort, referable to the Weberian model centred around protestant ethics and on the foolish ambitions of the blindfolded goddess. Therefore, it is not necessary to effect redistribution from above in favour of those less fortunate or less gifted. In this sense, all choices of economic policy in which the State‘s intervention favours redistribution or a stimulus for the economic system, are misrepresented. So, the concepts of welfare state and of deficit spending12 were rejected in favour of an ultraderegulated system in which the market, thanks to the action of homo oeconomicus, became the deux ex machina that moves everything and controls with absolute efficiency and effectiveness13. The action of the State becomes a kind of lubrificant that allows the perfect functioning of the entire mechanisms, reducing internal frictions. Rawls‘ contribution (1971) essentially set the objective of delineating a fair social theory of justice (in terms of opportunities) from a truly liberal perspective. In order to succeed in his intention, the American author assumed the well known ‗original position‘ in which all individuals, being free and subject to the same rules of the game, could decide in an equal way the most suitable form of social order14. The further assumption made with the intention of rendering the hypothesis plausible, resided in imagining a complete information asymmetry among individuals: the ‗veil of ignorance‘ that which involved different agents, did not allow the accomplishment of interpersonal comparisons or to know one‘s own position of advantage (in terms of endowment of material and immaterial capital) relative to other subjects. On these assumptions, Rawls (1971) stated, in prima facie, that the community would willingly accept principles of social justice such that the widest personal freedom subsisted compatibly with a condition of collective freedom. These principles guaranteed that benefits did not advantage just the most favoured people. This last position constitutes the so11
This recalls the definition of Nozick (1974) concerning the ‗ultra-minimum State‘. We can consider the policy of deficit spending as the driving forces of economic revival following the depression of the ‗30s in the XX century. 13 In this sense, Friedman states that ‗the widespread use of the market reduces the strain on the social fabric by rendering conformity unnecessary with respect to any activities it encompasses. The wider the range of activities covered by the market, the fewer are the issues on which explicitly political decisions are required and hence on which the issues on which it is necessary to achieve agreement‘. (Friedman, 1962, p. 24) 14 The assonances with the social contract already present in Locke and Rousseau emerge very strongly. For an overview on the theories of social justice and the welfare economics we refer, among others, to Binmore (1989), Fleurbaey (1996), Roemer (1996) and Acocella (2002). 12
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called ‗principle of difference‘15. Even if it shows features of extreme interest and of absolute originality, the rawlsian approach moves, in our opinion, towards a very steep and slippery crest. Admitting, indeed, the possibility of heightening of inequalities so that the most disadvantaged individuals could improve their relative position, can potentially justify a set of unscrupulous and dangerous economic, commercial and redistributive politicies. Moreover, on the epistemological field, the assumptions through which we reach these conclusions, weaken the framework of the theory as they present features of scarce adherence to sensible reality within which the subjects find themselves acting16.
3. LIBERALISM IN BRESCIANI-TURRONI’S THOUGHT In light of the most important contributions previously mentioned, we now propose the examination of influences that such questions exercise on the thought of Costantino Bresciani-Turroni (1939, 1944, 1945, 1947, 1961). The conception of liberalism typical of Bresciani-Turroni is evidently affected by the Mittel-European formation and atmosphere in which the author grew up and matured. Fundamentalist individualism, typical of Anglo-Saxon environments, is severely rejected, in favour of a holistic vision in which the advantage of the individual is completely subordinated by the collective interest. In effect, ‗is economic freedom useful to collectivity?‘. The way in which the question is formulated shows immediately that liberalism does not place […] the individual at the centre of the Universe but considers him a member of a collectivity, the interests of which prevail on those of the individual. (Bresciani-Turroni, 1945, pp. 68-69)
The refusal of the absolutization of the individual, that rises to be ontologically superior, upsets completely the constituted social architecture. The concept of freedom that is derived, follows a dynamic aimed at imposing constraints so that the choices of the single do not affect negatively the majority of individuals. It becomes therefore compulsory to highlight how the concept of freedom does not imply the absence of rules in order to reach one‘s own objectives (freedom in an absolute sense) but how the idea of freedom is essentially linked to a superior limit, defined by means of a set of insuperable constraints (freedom in a relative-relational sense)17. From this stems the refusal of the extremist position according to which the State must not intervene in the economic trends. From Bresciani-Turroni‘s viewpoint, the State must make itself creator and guarantor of a legal order that, assuring peaceful co-existence and absolute respect among the various institutional agents, allows the economic system to 15
A principle that the economist-mathematicians translate by the maximin social welfare function. As it has been well described by Acocella (2002), it must be said in addition that the most recent contribution by Rawls (1993) places itself in a more political perspective and aimed at locating the maximum equilibrium between ideologically opposed subjects. From just such a conflict emerges a harmony from which it becomes possible to erect an enduring social order that presents characteristics of equality and justice. Following the words of Rawls (1993), this approach takes the denomination of ‗overlapping consensus‘. 17 In this sense, the old Lockian distinction between freedom and licence is restored. The concept according to which the law does not limit freedom seems to be rather significant, but it keeps and expands upon it: it is precisely the absence of laws that lies behind the absence or limitation of the freedom of the single individual. 16
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develop harmoniously. Following such an approach, it becomes particularly interesting the intuition for which […] the order, as a legal organization […] varies according to the countries, and in the same country it is not static, but varies according to the needs that mature in the course of events, so that those limits are not strictly established just the once and for all. (Bresciani-Turroni, 1945, p. 83)
and furthermore if individual reactions occur precisely in the sense desired by the authorities, in this case, the process of adaptation completed, that necessarily demands a certain lapse of time, more or less lengthy, a new equilibrium will be created in conformity with the change in information, produced by the intervention […] the reactions of the individuals to a same measure of economic policy are very different according to circumstances of place and time. It is the same, in a particular way, for those State interventions which affect the rights of the individual, whose awareness, being the result of a long historical process, varies from country to country. (Bresciani-Turroni, 1944, pp. 124-125)
From this position, strong similarities are outlined with one of the pivots of the NeoInstitutionalist School that developed from the 70‘s of the XX century, whose greatest expression can be found in the contribution of North (2005). Starting from similar considerations, the American author elaborates the concept of a ‗non-ergodic‘18 society, in which the assumptions of a-historicity and of a-temporality become improbable and inadmissible. Such postulate leads to the determination of path dependant processes, that is they are due to the social-economic-institutional conditions in which they are carried out. Bresciani-Turroni is well aware of this aspect, so much so that he harshly criticizes the scientist definition positivist stance according to which it is possible to determine economic laws of a universal nature, valid in every space and for every time, by emphasizing how the result of a precise choice is conditioned by a set of other circumstances that determine its development19. Credit must therefore be given to Bresciani for having formalised so far in advance an intuition that represents a founding element of a successive strand of research that provokes, even today, a remarkable interest and heated debate. Hence, the intervention of the State is aimed at the protection of the maintenance of all necessary guarantees, so that there may be an efficient functioning of the economic system. In Bresciani-Turroni‘s opinion, the condition of umpire-judge does not constitute, however, a sufficient element for the maintenance of a high degree of efficiency. This is wherefore what the author indicates in 18
Indeed, according to North ‗a general characteristic of human history has been the systematic reduction in the perceived uncertainty associated with the physical environment and therefore a reduction in those sources of uncertainty to be explained […] part of the reason for our limited understanding is that there do not appear to be any fundamental ―power laws‖ in the social sciences comparable to those in the physical sciences. A more fundamental reason is the non-ergodic nature of the world we are continually altering […] but the world we live is non-ergodic a world of continuous novel change‘. (North, 2005, p. 16) 19 Of great significance, in this sense, appears the recollection of an approach of the great economist of the XVIII century, Ferdinando Galiani, according to whom every political economic measure must be subject to particular historic-environmental details (or institutional) in which it is applied. With regard to Galiani‘s though, we refer toNardi Spiller (1979; 1991).
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the execution of important public works, in money coinage and measures to guarantee monetary stability, public health, public education, transport coordination, trade treaties etc.. […] a task that essentially is up to the State since it could not be adequately carried out by private subjects. (Bresciani-Turroni, 1945, p. 85)
As already highlighted by Keynes (1936), the role of the State becomes active in a number of specific sectors considered sensitive and strategic and for which the action of the market does not lead to a satisfactory result. A definition, this, in open contrast to that subsequently presented by Friedman (and more generally taken from the whole NeoclassicalMonetarist trend) which marks in a decisive manner the ideological imprinting up to the present. The Besciani‘s vision is relevant as he contributes to destroying the myth according to which, in liberal Weltanshauung, the State must necessarily abdicate: making free the market, ceding every sphere of intervention. Another decidedly interesting theme addressed by Bresciani-Turroni (1945) concerns the problem of distribution of national income. The author is deeply aware of the relevance that equality holds for the maintenance of social order and for the achievement of an enduring economic equilibrium. From here, analysis focuses principally on the development of a number of critical considerations concerning the Socialist and National Socialist approaches as well as that which, from the ‗70s in the XX century, came to be known as Libertarian: as it seems unjust to identify within economic liberty the vulnus that generates situations of profound inequality, it likewise seems unreasonable to attribute the distribution of income relating to material and immaterial assets of the single individual, leaving to chance the assignment to allocate resources. The proposal of Bresciani-Turroni is aimed at benefiting the less affluent classes, in a perspective in which it is possible, in any case, to maintain rates of savings which would allow to preserve the dynamics of investments. From this stems the proposal of a fiscal system based on a set of progressive tax rates and on a mechanism of inheritance taxation for which gross incomes derived from a monopoly of certain economic positions, from political circumstances […], from war, from inflation or from speculation which offer no advantage to the collectivity, are targeted […] no individual has the right to inherit assets created by their ancestors; as such, without offending liberal principles, the State can impose a limit on that which a person may acquire thanks to the favor of others, without having worked for such gain. It is good that such a large fortune should be in part transfered to the State […] By this, it is meant that the disintegration of a large company, or of any other economic complex, will have to be avoided. (Bresciani-Turroni, 1945, p. 88)
For Bresciani-Turroni, the theme of salaries, analyzed with reference to social justice and equality, also finds an opportunity to be explored in greater depth. The author presents an extremely moderate viewpoint from which is possible to infer as the standing of the masses assumes a prominent role. Bresciani-Turroni dissented from the extremism of Neoclassical exegetes, because their vision specified in marginal productivity the only parameter to determine the remuneration of the work factor. In effect, besides the efficiency and productive criteria, Bresciani envisaged the possibility of using the salary lever as an
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incentive to increase productivity in a sort of efficiency wages theory20 ante litteram. However, the author is aware of the delicacy of the maneuver which is hinged on the level of salary as a starting point and on the environmental operative conditions. It is precisely these environmental conditions which constituted cause for profound reflection, revealing a deep and engrained sentiment of attention towards the ‗social issue‘ so that every true liberal is a sincerely convinced upholder of a wide-reaching form of social legislation (the expression of which indicates the complexity of laws and regulations relating to the protection of the working class: compulsory insurance against accidents, illness, unemployment, regulation of working hours especially with regard to women and children; protection relating to maternity and childhood; help for widows and orphans; work houses; after work, etc) […] even economic liberalism is expressed through the words of Mazzini: ‗it is necessary that the fruits of labor are given in their greater part to those who produce them‘, and therefore to rise up against any form of exploitation of the worker. (Bresciani-Turroni, 1945, p. 90)
Nevertheless Bresciani is aware of liberal principles, once again the great versatility of Italian author emerges, especially when he does not preclude to investigate events by different alternatives. A similar modus operandi counters decisively the vision of contemporary economic science, essentially founded on a positive stance scientism. The desire to borrow from the physics-mechanism the possibility of identifying a set of universal laws valid in every place and at every time, indicates in a crucial way the economic approach, where the objective becomes that of providing an origin to a social physics. In order to realize such a goal, the trends of moral philosophy, sociology and anthropology are gradually abandoned in favor of increasingly sub-divided and complex mathematical-statistic models. The definitive affirmation of this approach prevailed significantly between the XIX and the XX centuries, thanks to the contributions of Jevons (1871), Menger (1871) and Walras (1874). The aversion that met a similar vision in the work of Bresciani-Turroni (1944) was derived from the methodological education that the author received during his years spent in Germany at the School of Schmoller. The historicist School21 sustained the impossibility of separating economic analysis from the set of cultural, institutional and social phenomena of the period and of the place. Research of empirical regularity is permitted, but such a research is bound up with the historical climate which is investigated. The clash between the Austrian School (headed by Menger) and the historical School of Schmoller gave rise to the famous Methodenstreit. Such querelle persuaded Schmoller (1894) to assert it was possible to locate the bankruptcy of political economy between 1870 and 189022. In the criticism of Bresciani-Turroni is revealed the unease derived from the slavish application of a reductionist approach, purified of all the ethical and absolute components so that 20
The models of salary efficiency are linked, in all effects, to the position of the Structuralist School, to which we can also trace the contributions of Salop (1979), Weiss (1980) and Shapiro and Stiglitz (1984). This name is attributable to Phelps (1991). Bruno and Sachs (1985) can be considered the pioneers of the use of structuralist models. These latter two Authors analyze the effects of the oil related shock on internal employment in an open economy and considering the consequences of an unfavorable change in the regions of change. For more in-depth analysis, we refer to Nardi Spiller (1996). 21 For more in-depth information on this fascinating subject, we refer to Zanzi (1991). 22 Concept, the latter, which we can also find in Hasbach (1894).
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there is no longer space in our science for metaphysical entities ‗nature‘ and ‗natural rights‘ and for teleological visions. Nowadays, the economists are not concerned to explore whether economic liberty is or is not a natural right. They neither advise nor deprecate economic freedom […] In other words, economic science has ceased to be a whole of rules to govern the common goods and it is only an assembly of principles which are deduced from certain premises and which describe the connection between economic facts. (Bresciani-Turroni, 1944, p. 133)
Furthermore, it seems to point out how the Italian author is aware of the impossibility to leave the analysis of the individual behavior out of consideration to exam the collective wellbeing. From his perspective, it is only the deliberate wish and the lack of well defined rules of the game that leads the ‗individualist‘ approach in a direction where general interest is of secondary importance. The theme seems undoubtedly thorny, so it is necessary to discuss it in the total absence of a priori prejudice. In effect, it is precisely the lack of a well defined teleological doctrine that leads fatally to a misrepresentation of the role of the single individual within the economic system. Following a course in which the goal becomes ‗the good of the public‘, defined from ethical and moral principles23, and where the individual is considered fundamentally cellular to the social body in a framework of historical-culturalinstitutional reference which is well defined, it is possible to reach coherent solutions with the liberal principles in which social well-being does not correspond to the sum of individual wealth. Bresciani-Turroni (1944) stems the approach of the School of Manchester which distorts the concepts of the liberal classic economists. In facts, the School of Manchester‘s scholars were permeated by an optimism such as all the ‗defects‘ of harmony could be ascribed to a lack of economic freedom24. Finally, it seems to be necessary to conclude this brief escursus through the BrescianiTurroni's thought recalling the analysis which was devised by the author on the consequences of an economic expansion referable to an enlargement in credit25. Bresciani-Turroni identifies in elasticity rate of bank credit the upsetter element of the economic system. In effect, an increase in the request for credit, not counterbalanced by a corresponding augmentation in financial charges, triggering an acceleration in investments, always supported by the marginal efficiency of capital. Such a dynamic leads to a generally inflationary tension derived form a renewed capacity to purchase for all those actors within the economic system. A similar trend is, instead, amplified thanks to psychological factors or due to an exaggerated optimism which is diffused between industrialists, big traders and bankers when business is doing well and who, making on the whole grave forecasting mistakes, are often prompted to undervalue the risk associated with investment and speculation. (BrescianiTurroni, 1944, p. 234)
23
Aware of this aspect, Bresciani-Turroni asserts that ‗the economist simply states facts, leaving to the philosopher to give a judgment. The economist cannot fail to observe that one of the most remarkable facts in recent history of mankind is the growing importance, as an actual force, of a human universal conscience condemning certain policies which are in contrast with ethical ideals‘. (Bresciani-Turroni, 1939, p. 341) 24 The recall to Smith (1759) according to whom all the social groups depend upon the State, which guarantees them security and protection, appears meaningful. The Scottish author acknowledges as a recognized truth, even those who are less impartial, that all individuals are subordinated to the State, and they only pursue its own prosperity and its maintenance. 25 Such an explanation undoubtedly finds a basis in the approach of the Austrian School.
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The slowdown of inflationary dynamics begins whenever the limit of credit expansion has reached. At the same time the first difficulties begins to be revealed for certain companies. Owing to an unchanged need for funds due to commitments already undertaken by the company, a sudden growth in the rate of interest triggers a braking mechanism. On the labor market‘s side, the high remunerative levels become unsustainable thanks to a dilated price-salary spiral. Evident responses are produced in the unemployment rate and consequently on income and demand. The first strandings begin to appear followed by the first overdue bills and then a number of substantial failures so that optimism is met with pessimism; the increase in the interest rate forces large scale traders to liquidate their stocks of goods; prices fall. The crisis can be, depending on the individual case, serious to a greater or lesser degree. This impacts more violently on those companies which, during the period of expansion, had expanded to an exaggerated extent, thanks to the facility of bank credit. Often, the fall of a number of large companies drags behind it the downfall of the banks. (Bresciani-Turroni, 1944, pp. 234-235)
We think relating aspects subsist with the recession which burdens world economy since the fourth quarter of 2008. In our opinion, however, in order to make the explanation more contemporary, it becomes necessary to extend the credit expansion to the retail sector or to the final customer. The primigenial scheme found a place in a fordist system, typical of a supply economy characteristic of the modern age. The start of liquid modernity26 lead to overcoming the fordist paradigm and marked the organization with a system in which the consumption function played a principal role. From here is derived the notion that the expansion of credit in favor of the final consumer is justifiable as the only manner to sustain demand in a scenario of everlasting overproduction. With regard to the first explanation by Bresciani-Turroni, the origin of the inflationary tensions changes (with reference to speculation on commodities, for example) dampening the price-salary spiral. In effect, an opportunity for indiscriminate credit is indeed associated with low salaries. That doesn‘t change is the final result which endures an acceleration in the speed of expansion in a hyperfinanced, deregulated and globalized environment. It seems to us, moreover, that Bresciani-Turroni should receive acknowledgment for having highlighted how the abuse of recourse to credit, accompanied by an expansive monetary policy, constitutes a cause of fragility within the economic system, revealing the risks run when functioning beyond ones own possibilities. However, the causes of the crisis must be investigated during periods of disproportionate expansion. It is precisely by the light of recent events that we should underline how this lesson has been undervalued and is still far from being fully understood.
3. CONCLUSION The liberal manifesto of Bresciani-Turroni was affected decisively by the MittleEuropean atmosphere in the early years of 1900, in which the author received his own 26
Cfr. Bauman (2000).
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education. The concept of liberty was defined not in an absolute sense but in a relativerelational sense: it is only through a well defined legal corpus and to the presence of strong institutions that the individual and the collective were able to achieve their aims according to a mutual respect. The author confers particular attention to a holistic analysis of the economic system, never averaging the primacy of a discipline on the others. Such a characteristic makes the contribution rich from a methodological point of view as the phenomena are examined in a markedly pluralistic perspective. Furthermore, the historicism that Bresciani-Turroni breathed during his German years, persuades himself of continuous evolution in the relationship between individual, institution and economic policies, anticipating by twenty years the NeoInstitutionalist concept of ‗non-ergodicity‘. So, in many passages the potential risk of a nonintentional-consequences-of-intentional-actions (eterogenesi dei fini), which does not allow to attain the aim previously set, emerges expressly. As the State is the only institution able to obviate the opportunism of the single individual, according to Bresciani-Turroni, it becomes necessary to have a synergism between all the actors of economic system and the State itself. In effect, in Bresciani-Turroni‘s contribution, the interests of the collective are constantly placed before individual interest. The criticism that the Italian author developed around the vision in auge of economic science appears remarkably significant: in his vision the primacy of positive approach on the normative definition deprives the role of the economist of typical deontological baggage, in favor of a cold meanly a-moral scientist rationalism. It seems to us that the grandeur of Bresciani-Turroni emerges both in his lucid capacity to analyze in great depth, free from ideological props and culturally rich, and in his exceptional capacity to transmit his own thoughts and his own knowledge by a style always fluent, never redundant and at the same time incisive and articulate.
REFERENCES Acocella, N. (2002). Economia del benessere. Rome, Italy: Carocci. Bauman, Z. (2000). Liquid Modernity. Oxford, UK: Blackwell Publisher. Bauman, Z. (2005). Work, Consumeris and the New Poor. Buckingham, UK: Open University Press. Beccaria Bonesana, C. (1769). Elementi di economia pubblica. Iniziative Culturali ed Editoriali Bancarie ICEB. Varese, Italy: La Tipografica Varese. Besomi, D. (1995). Equilibrio distribuzione e crisi nel repertorio degli economisti. Napoli, Italy: ESI. Binmore, K. (1989). Social Contracts I: Harsany and Rawls. Economic Journal, 99, pp. 84102. Bresciani-Turroni, C. (1939). On the Limits of State Interference in Economic Affairs. Al Qanoun Wal Iqtisad, a. 9 n. 5, pp. 211-241. Bresciani-Turroni, C., (1944). Introduzione alla politica economica. In Bresciani-Turroni C., (2006). Liberalismo e politica economica (pp. 119-279). Bologna, Italy: Il Mulino.
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Bresciani-Turroni, C. (1945). Il programma economico sociale del liberalismo. In BrescianiTurroni C. (2006). Liberalismo e politica economica (pp. 67-118). Bologna, Italy: Il Mulino. Bresciani-Turroni, C. (1947). Lezioni di teoria economica. Milan, Italy: Casa editrice Ambrosiana. Bresciani-Turroni, C. (1961). Saggi di economia. Milan, Italy: Giuffrè. Bruno, M. e Sachs, J. (1985). Economics of Worldwide Stagflation. Cambridge, UK: Harvard University Press. Fleurbaey, M. (1996). Théories Économiques de la Justice. Paris, France : Economica. Foucault, M. (1975). Surveiller et Punir. Naissance de la Prison. Paris, France: Gallimard. Friedman, M. (1962). Capitalism and Freedom. Chicago, USA: Chicago University Press. Jevons, S. (1871). The Theory of Political Economy. London, UK: Macmillan. Keynes, J.M. (1925). Am I a Liberal?. In Keynes J.M. (1972). Collected Writings vol. 9 (pp. 272-294). London, UK: Macmillan. Keynes, J.M. (1926). The End of Laissez-faire. In Keynes J.M. (1972). Collected Writings vol. 9 (pp. 272-294). London, UK: Macmillan. Keynes, J.M. (1930). The Question of High Wages. In Keynes J.M. (1973). Collected Writings vol. 20 (pp. 3-16). London, UK: Macmillan. Keynes, J.M. (1936). The General Theory of Employment, Interest and Money. London, UK: Macmillan. Mandeville, B. (1714). The Fable of the Bees, or, Private Vices, Public Benefits. London, UK: Roberts. Marx, K. (1867). Das Kapital. Hamburg, Germany: Verlag von Otto Meissner. Menger, C. (1871). Grundsätze der Volkswirtschaftlehre. Wien, Austria: Braumuller. Nardi Spiller, C. (1996). Il passato prossimo della teoria economica nel dopo Keynes. Padova, Italy: Cedam. Nardi Spiller, C. (1979). La moneta in A. Smith. Un riferimento all'analisi anticipatrice di F. Galiani, «Annali della Facoltà di Economia e Commercio», Università di Padova, Serie I, vol. VIII, 1979, pp. 3-16. Nardi Spiller, C. (1991). La Théorie Economique et la Stratégie Politique de Genovesi, Galiani, Bandini, Beccaria, Verri et Ortes, «Rivista Internazionale di Scienze Economiche e Commerciali», 1991 n. 4, pp. 369-383. North, D.C. (2005). Understanding the Process of Economic Change. Princeton, USA: Princeton University Press. Nozick, R. (1974). Anarchy, State and Utopia. New York, USA: BasicBooks. Phelps, E.S. (1991). Seven Schools of Macroeconomic Thought. Oxford, UK: Oxford University Press. Rawls, J. (1971). A Theory of Justice. London, UK: Harvard University Press. Rawls, J. (1993). Political Liberalism. New York, USA: Columbia University Press. Roemer, J.E. (1996). Theories of Distributive Justice. London, UK: Harvard University Press. Roncaglia, A. (2001). La ricchezza delle idee. Rome-Bari, Italy: Laterza. Salop, S.C. (1979). A Model of the Natural Rate of Unemployment. The American Economic Review, n. 10, pp. 141-156. Schmoller, G. (1894). Volkswirtschaft, Volkswirtschaftslehre und Methode. Handwörterbuch der Staatswissenschaften. Sechster Band, pp. 527–563.
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Shapiro, C. & Stiglitz, J.E. (1984). Equilibrium Unemployment as a Worker Discipline Device. The American Economic Review, n. 3, pp. 433-444. Smith, A. (1759). The Theory of Moral Sentiment. London, UK: Millar. Smith, A. (1776). An Inquiry into the Nature and Causes of the Wealth of the Nations. London, U.K.: Millar. Wallerstein, E. (1995). After Liberalism. New York, USA: The New Press. Walras, L. (1874). Éléments d’économie politique pure. Lausanne, Switzerland: Corbaz. Weiss, A. (1980). Job Queues and Layoffs in Labor Markets with Flexible Wages. Journal of Political Economy, vol. 88, pp. 526-538. Zanzi, L. (1991). Dalla storia all’epistemologia: lo storicismo scientifico. Milan, Italy: Jaca Book.
In: Issues in Economic Thought Editors: M-A. Galindo, C. N. Spiller, pp. 71-97
ISBN 978-60876-173-9 © 2010 Nova Science Publishers, Inc.
Chapter 5
THE CONTRIBUTION OF ITALIAN SCHOLARS TO THE THEORIES OF INCOME AND WEALTH DISTRIBUTION Mauro Baranzini* and Caterina Mari**
ABSTRACT In this paper we review and assess the contribution of Italian scholars to a number of theories of value and prices, as well as income and wealth distribution, starting from Thomas Aquinas and Ferdinando Galiani. Then we shall consider the classical School (Ricardo in particular) and its interpretation by Luigi L. Pasinetti in his 1960 seminal paper. We shall proceed, then, with a brief account of the approach to income distribution of the marginalist (or neoclassical) School, with reference to Vilfredo Pareto. But we shall above all concentrate on the contribution of the post-Keynesian School of income and wealth distribution, founded by Nicholas Kaldor, Richard F. Kahn, Joan V. Robinson and Luigi L. Pasinetti in the middle 1950s. The focus of their analysis was to investigate the relationship between the steady-state rate of profits on the one hand, and the saving propensities of the socio-economic classes and the growth rate of the economy on the other. It is worth noting that during these last 50 years about 100 Italian scholars operating within or outside Italy have published no fewer than 400 papers and 20 volumes in this field. The Anglo Italian post-Keynesian School of economic thought has gained a safe and sound entry in the history of economic analysis. In order to evaluate this vast scientific literature we divide the research program into seven specific lines: (1) the introduction of a differentiated interest rate on wealth of the classes; (2) the introduction of the monetary sector and of portfolio choice; (3) the introduction of the public sector and of the Ricardian debt/taxation equivalence; (4) the inclusion of other socio-economic classes; (5) the introduction of the micro-foundations; (6) the analysis of the long-term distribution of wealth and of the income share of the socio-economic classes; (7) other general aspects, in particular the applicability of the Meade-Samuelson and Modigliani Dual Theorem. As it may be seen, these research lines cover a wide spectrum of modern economic theorizing. Additionally they provide a bridge with
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JEL CODES: B000, E200, E210, E25
1. INTRODUCTION The definition of ‗value‘ and the distribution of income and wealth have directly occupied economists for more than 250 years now, i.e. at least since the time of the physiocrats. But the issue of ‗value‘ and of income and wealth distribution goes back nearly 2500 years. In fact the topic of the ‗just price‘, ‗poverty‘ and ‗accumulation of capital‘ has been taken up already by the Greek philosophers. For instance Pasinetti maintains that: Aristotle (384-322BC) is credited with condemning the price of the single seller (or monopolist, in the etymological sense of the word […]) as contrary to justice, as it arises from artificial scarcity. He is also credited – from sentences such as ‗There will be reciprocity, ... as farmer is to shoemaker, so the amount of the shoemaker‘s work is to that of the farmer‘s work for which it exchanges (Nichomachean Ethics, 1133a 17; Ross, 1925) – with trying to find a sort of cost principle and, more specifically, a sort of labour principle underlying the notion of a just price. What is certain is that Aristotle explicitly faced the problem of what is called ‗commutative justice‘ in the pricing process; and in trying to single out a common standard on which to gauge the ‗equivalence‘ of what is given and what is received, he used various arguments, among which freedom from the artificial scarcities and labour costs appear to be the most prominent. (Pasinetti, 1986, p. 410)
These Aristotelian arguments were later on resumed, always according to Pasinetti‘s writing, by St Thomas Aquinas (1225-74), Albertus Magnus (1206-80) and John Duns Scotus (1266-1308). Always according to Pasinetti: The moral philosophers who, in the following centuries, dealt with the pricing problem did perfect the disquisitions of the Scholastic philosophers in many directions, and added further details; notable to this effect are the works of St Antoninus of Florence (1389-1458) and of Luis de Molina (1535-1600). But the basic approach, in spite of increasing sophistication, remained the same. (Pasinetti, 1986, p. 410)
These ancient and medieval philosophers had not in mind specific theories; they were simply trying to set a number of moral standards. The issue of ‗value‘ and of ‗prices‘ in Italy goes back to the medieval times, in particular to Thomas Aquinas (1225-74) who spells out clearly the ‗ethics behind justum pretium‘: […] St Thomas‘s main references are his Commentaires on Aristotle‘s Nichomachean Ethics, and his famous ‗Quaestio LXXVII‘ (Summa Theologiae, pt. II, 2), where the ethics behind justum pretium is spelt out. The Aristotelian flavour of the disquisitions is unmistakable. The historians have seen in the references to aestimatio an implicit admission of subjective elements, and in the reference to expenditures, and particularly to expensae et labores (in search for a standard of ‗equivalence‘ in ‗commutative justice‘), an explicit reference to the
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cost and, more particularly, to the labour principle in price determination. (Pasinetti, 1986, p. 410)
The first Italian scholar who broke with this tradition was Ferdinando Galiani (17281787) who ‗wrote as an economist, in the modern sense of the word, rather than a moral philosopher, yet as an economist still at the pre-theoretical stage. Anyone looking, from today‘s standpoint, at his rather sophisticated arguments can choose the hints to the theory of value he likes‘ (Pasinetti, 1986, p. 411). In fact, in the second chapter of Book One of Galiani‘s Della Moneta, first published in 1751, one finds clearly: the concept of utility, the concept of decreasing marginal utilities, and the relativity of these concepts; one can also see the concept of cost of production and, more particularly, the principle of labour cost (‗fatica‘, an expression corresponding to Adam Smith‘s ‗toil and trouble‘), which is defined as nothing less than ‗the only one that gives value to things‘ (‗l‘unica che dà valore alla cosa). (Pasinetti, 1986, p. 413)
These introductory arguments show that there is a long-standing tradition among Italian economists in the field of the theory of value and distribution (the latter at both functional and personal levels). Piero Sraffa and Luigi Pasinetti have widely contributed to the tradition of the Classical School, and to the theory of David Ricardo in particular. But it is with the Keynesian revolution that the Anglo-Italian School of economic thought acquires a significant relevance, when Cambridge and a number of Italian universities became the centre of excellence for the elaboration of the theories of profit determination and income distribution.
2. THE CLASSICAL SCHOOL ON INCOME DISTRIBUTION According to the classical, neo-Ricardian and post-Keynesian theories, demographic, economic, and technical factors come into play to determine income and wealth distribution. Additionally such distribution is made with a clear line of ‗priorities‘.1 This is due to the fact that the vision of the production process is different. In particular the classical and postKeynesian models consider a ‗closed system‘, within which a vital role is played by the ‗objective‘ relationships among the various sectors, as determined by the technology of production of the system. Within this framework commodities are, to a certain extent, primarily means of production (for other commodities) and only secondarily consumption goods for the fulfillment of both individual and public needs. Clearly, within this framework, ‗final‘ consumption fulfils a secondary function in the economic system, although more recent works (see, for instance, Gualerzi, 2002; Spaventa, 1962; Pasinetti, 1965, 1981 and 1993; Leon, 1967; Cozzi, 1969) have attempted to introduce the composition of demand as a crucial variable for the explanation of the long-term dynamic of the system. On the other hand the vision of the process, which is associated with a ‗scarcity‘ of the available resources, is quite different: the model is essentially static, and at the beginning of each period the resources available are exogenously given, so that the analysis ends up by 1
On this point see Baranzini and Scazzieri (1986, pp. 1-87).
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concentrating on the formulation of the criteria for the best utilization of these resources. For this reason, the aspect of circularity must be replaced with that of ‗uni-directionality‘. As we said, the distribution in the classical model is determined by demographic, technical and economic factors. 1. First, according to Ricardo, part of the product is allocated to wages. The ‗natural‘ wage-rate, for Ricardo, will be ‗at that level which in a given country and in a given state of society, besides allowing workers to live, induces them to perpetuate themselves ‗without either increase or diminution‘ (Pasinetti, 1960, p. 80). Hence the amount of wages which are distributed to the workers‘ class will be equal to the natural wages rate times the number of workers. 2. The second share of the product is allocated to the landlords‘ class, who own the land and/or the industrial assets. They receive the difference, for each piece of land or machinery characterized by a decreasing marginal productivity (and in which order they are employed) between its productivity and the productivity of the last unit employed. Obviously the last piece of land or machinery does not enjoy any rent at all. 3. Finally, profits represent a residual, like wages are in the post-Keynesian model (see below). In other words, what remains of total production or output will be attributed to the organizers of the production process, i.e. the capitalists or entrepreneurs. The process of growth and distribution is well summarized by Pasinetti as follows: Economic growth is brought about essentially by the capitalists. The three classes in which Ricardo divides society have different peculiar characteristics. Landlords are considered as an ‗unproductive class‘ [Principles, p. 270] of wealthy people who become richer and richer, and consume almost all their incomes in luxury-goods. Workers also consume everything they get but in a different kind of goods – ‗necessaries‘ – in order to live. Capitalists, on the other hand, are the entrepreneurs of the system. They represent the ‗productive class‘ of society. Very thrifty, they consume a small amount of what they obtain and devote their profits to capital accumulation. The process of transforming profits into capital, however, cannot go on indefinitely. Owing to the diminishing returns of new capital (and labour) applied to the same quantity of land, or to less fertile lands, rent increases over time, in real and in money terms, the money wage rate increases too, and consequently the profit-rate continuously falls. When the rate of profits has fallen to zero, capitalists are prevented from accumulating any more; the growth process stops and the system reaches a stationary state. As a matter of fact – Ricardo adds – the stationary state will be reached before the extreme point where all profits have disappeared because, at a certain minimum rate of profit, the capitalist will lose any inducement to accumulate. (Pasinetti, 1974, p. 6)
According to Pasinetti, the final outcome, i.e. the stationary state, may be delayed by new inventions and discoveries, which increase the productivity of labour, and/or by the capital outflows (towards the colonies or other countries). It could also be delayed by disasters like war, or by the import of cheaper food which account for most of the expenditure of the workers‘ class. But the stationary state will eventually be attained.
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3. THE MARGINALIST OR NEOCLASSICAL SCHOOL ON INCOME DISTRIBUTION The marginalist, or neoclassical theory of income distribution, became known in economic literature as the marginal productivity theory, was the result of a gradual process of refinement. The major scholars who contributed to its evolution were John B. Clark, Alfred Marshall, Vilfredo Pareto, Léon Walras, Philip H. Wicksteed and Knut Wicksell. The marginalist, or neoclassical theory of income distribution derives from Ricardo‘s marginal principle. As we have seen in the previous section, Ricardo in his main work On the Principles of Political Economy and Taxation (1817) introduced the marginal principle to determine rent, defined as ‗that portion of the produce of the earth, which is paid to the landlord for the use of the original and indestructible powers of the soil‘ (Ricardo, 1953, p. 67). Land, in Ricardo‘s formulation, is classified from the most to the less fertile and is subject to the law of diminishing returns. For any plot of cultivated land, as the quantity of labour employed on land increases, the produce per labourer decreases being employed on more exploited land. Rent on any plot of land is equal to the difference in the produce on that land and on the least fertile land still in cultivation, the marginal land. The marginal principle became the keystone of the entire marginalist, or neoclassical economic theory. The economists of the late XIX century applied it initially to the theory of exchange value and then, by extension, to the theory of production and distribution.2 As for the marginalist theory the problem of income distribution consists in the determination of the prices of the factors of production. Solutions were attempted by generalizing the application of Ricardo‘s law of diminishing returns from land to all factors of production and formalizing it. This generalization eventually led to emergence of the law of variable proportions. The law of variable proportions meant that as the amount of any factor of production increases, the amount of the other factors of production remaining constant, after a certain point is reached, the return per unit of that factor decreases. Marginalist economists eventually showed that given the supply of any factor of production, under competitive conditions, every factor obtains a remuneration which corresponds to its marginal product. The contribution of the Italian economist Vilfredo Pareto3 deserves particular attention. For the reason that, contrary to the other marginalist economists and not only, he did not confine his interest to the functional distribution of income. Pareto, the leader along with Léon Walras of the Lausanne School, in his early years at the University of Lausanne dedicated himself to the writing of his first treatise in economics, the Cours d’économie politique. The Cours was originally published in two volumes, the first in 1896 and the second the following year. The subject matter with which he opened the second volume of his 2
This way of proceeding was not without consequences. It confined this important branch of economic theory, that is the theory of income distribution, to play only a secondary role. 3 Vilfredo Pareto (1848-1923) was born in an aristocratic Genoese family. He studied mathematics and engineering at the University and Polytechnic of Turin. Very soon, as a result of his business activity as engineer for a railway company, he turned his interests from engineering to economics. In 1893, by the good offices of Maffeo Pantaleoni, and as a result of the visit of the head of the department of education of the Canton de Vaud, Eugène Ruffy, and the Chancellor of the University of Lausanne, Georges Favey, made to Pareto in Fiesole (Florence), the Italian economist was offered the chair of Political Economy vacated by the retirement of Léon Walras. From 1899, the inheritance of a considerable fortune led him to progressively reduce his teaching duties. This until 1911, when he resigned from his position to retire at Cèligny, on the Lake of Geneva, and assiduously dedicated himself to study and writing.
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Cours (sections 957-965) was the distribution of income.4 In this occasion Pareto was not interested in the functional distribution of income, which studies the distribution of income among the factors of production (labour, capital and land), but in the personal distribution of income, or size distribution, which studies the distribution of income among individuals or households. Pareto came to the conclusion that: […] la courbe de la répartition des revenus varie peu en moyenne, soit dans l‘espace, soit dans le temps, pour les peuples civilisé sur lesquels la statistique nous fournit des renseignements. C‘est l‘induction qui nous a fait connaître la forme de la courbe des revenus; c‘est la déduction qui va nous permettre d‘en tirer deux théorèmes fort importants. Le premier de ces théorèmes nous apprend que la répartition des revenus n‘est pas l‘effet du hasard. Le second nous fait connaître que pour relever le niveau du revenu minimum ou pour diminuer l‘inégalité des revenus, il faut que la richesse croisse plus vite que la population. Par là, nous voyons que le problème de l‘amélioration de la condition des classes pauvres est avant tout un problème de production de la richesse. (Pareto, 1964, p. 408)
Pareto‘s discovery became known in economic literature as Pareto‘s law. Of the formulae he proposed to represent the ‗law‘ that according to him governed the distribution of income, the most cited is probably:
N ( x)
A xa
where x is the level income and N(x) is the number of people having an income equal or greater than x. The economic and social implications of Pareto‘s law are far-reaching. If, as Pareto asserted, the distribution of income tends to be the same in any place and time, there is no institutional change or redistribution policy that reduces the degree of inequality of the personal distribution of income. This is the reason why Pareto‘s law did not remain buried among the pages of his Cours, but arouse great considerable interest among the economic profession giving rise to a large literature.5
4. THE POST-KEYNESIAN SCHOOL OF PROFIT DETERMINATION AND INCOME DISTRIBUTION 4.1. Introduction The contribution of the Italian school of thought to the Keynesian theory in general, and to the post-Keynesian analysis of income and wealth distribution in particular, is relevant. Their works span over half a century (1956-present). In fact the analysis of income and 4
Pareto‘s writings on the distribution of income are contained in G. Busino, Écrits sur la courbe de la répartition de la richesse, 1965. 5 On this point see Schumpeter, 1959, p. 859n.
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wealth distribution in growth models where the economic behaviour of classes (or dynasties) is externally given was initiated by the Cambridge (U.K.) post-Keynesian School. Nicholas Kaldor (1956) and Luigi Lodovico Pasinetti (1962) originally investigated the relationship between the steady-state rate of profits on the one hand, and the saving propensities of the social classes and the rate of growth of the economy on the other. Assuming two (but in fact n) identifiable classes of individuals6 who receive different factor payments, i.e. a working class who earns wages and interest payment on their savings, and a class of entrepreneurs who earn profits from their direct investments, in a much quoted paper, Pasinetti (1962) was able to generalize Kaldor‘s result. He came to the conclusion that the long-run equilibrium interest rate (P/K) is equal to the exogenously given natural rate of growth (n) divided by the pure capitalists‘ propensity to save (sc). In formulae P/K=n/sc. For the same token the share of profits in national income comes to be equal to P/Y= (n/sc)K/Y. In most post-Keynesian models of distribution the capital/output ratio (K/Y) is exogenously given by technical conditions, and is not supposed to change with variations in the distribution of income. In this way the latter is quite easily defined, independently of the tricky production function and of behaviour of the socio-economic classes, except of the entrepreneurs. Or, in other words, the behaviour of the working class, as it is represented by their propensity to consume and to save, as well by their pattern of accumulation, does not interfere with the distribution of income between profits and wages, or with the determination of the profit rate (as well as the wage rate). In a certain sense we find again the classical proposition: the capitalist class provides most of the savings held within the system and determines the path of capital accumulation of the whole society; through their behaviour they heavily influence the distribution of income among factors of production. Of course the non-entrepreneurial classes may, through their saving, consumption and accumulation behaviour, influence (as it seems logical) the distribution of income among classes and their accumulation of savings path. The decisions relative to investment and growth of the productive system then come to be taken by a sort of ‗entrepreneurial élite‘. The case of our modern and post-industrial societies is quite illuminating: public authorities, via their fiscal and monetary policies, try to reach a predetermined ‗required‘ rate of growth for the system that will allow them to check public expenditure and reach other economic policy goals. One may add that the idea of dividing society into distinct socio-economic groups with a different propensity to save is econometrically reasonable.
6
First, one may consider the propensity to save according to the level of disposable income: we know that the first three (low income) deciles have a negative propensity to save, while the top 10% has a very high propensity to save. In Switzerland from 1990 to 2000 it ranged from -60% for the first decile, to 30% for the richest decile. In Italy, over more or less the same time span, it was about -17% for the lowest quintile to about +52% for the richest quintile. Secondly, one may consider the type of income earned: wages, interest, profits and/or rent. As Dadda (2009) has pointed out, it is reasonable to postulate different rates of consumption and saving from different types of income. Thirdly, one may consider the age of the household‘s parents: empirical evidence suggests that, instead of the ‗hump-saving‘ of Modigliani, individuals in their
On this point see, for instance, Baranzini (1991, Chapters 1-4).
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twenties and thirties save more than the average, in their forties and fifties much less than the average (due to cost of their children‘s education) and slightly more than the average from the age of sixty onwards. Fourthly, one may consider different classes on the basis of their propensity to leave assets to their heirs. Menchik and David (1983) have shown that the elasticity of bequest with respect to a variation in the permanent disposable (annual) income 7 varies widely among social classes. For low-income brackets it is well below unity; for high income brackets it is well above two. This means that not only have different income groups a different propensity to save, but also a quite different willingness to leave assets to their heirs. In other words bequests seem to be luxury goods, and to increase more than proportionally with permanent income. Finally we may posit classes on the basis of their faith, country of origin, and/or residence (rural or urban). In Switzerland, for instance, Catholics and Protestants behave, in economic terms, quite differently: the former have more children, usually own their own house mainly in the countryside, marry at a younger age and save more than the latter, who have fewer children, marry later in life and typically live in rented city housing.
These arguments go to reinforce the hypothesis of the existence of different classes characterised by a different socio-economic behaviour. Post-Keynesian distribution theory now occupies, thanks to the seminal contributions of Kalecki, Joan Robinson, Kaldor and Pasinetti – along with a number of other younger scholars of Italian origins, an undisputed place in various textbooks of modern economic analysis. Stemming from the Kaldor/Pasinetti model we find a very high number of subsequent contributions branching out in many directions and covering many aspects of the wider research programme quite relevant for the general topic of income distribution, profit determination and wealth accumulation (life-cycle and intergenerational), both from a theoretical and applied point of view. The founding fathers of the Cambridge distribution theory not systematically spoke out on the development of their seminal papers. Kaldor was probably more active than Pasinetti, and after his 1966 Review of Economic Studies virulent reply to Samuelson and Modigliani, wrote a series of letters to colleagues and friends from the middle Sixties until 1982, when Kyklos published a special issue with the title 25 years of Kaldor’s income distribution theory. When directly challenged Pasinetti has commented upon the developments of the Cambridge theory of distribution. In fact he has replied to Samuelson and Modigliani (1966), Dougherty (1972), Nuti (1974), Campa (1975), Fleck and Domenghino (1987) and few others. Chapter VI of his volume Growth and Distribution published with Cambridge University Press in 1974 was entirely devoted to the then recent developments in this specific field. We divide this ‗research programme‘ into seven specific lines of research which have generated a vast literature reported in the bibliography at the end of this review: 1. The introduction of a differentiated interest rate on wealth of the classes. 2. The introduction of the monetary sector and of portfolio choice. 7
Using matched data of probate records and long-term tax reports in the State of Wisconsin, USA, in the years 1946-1964.
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The introduction of the public sector, and the Ricardian debt/taxation equivalence. The inclusion of other socio-economic classes. The introduction of the micro-foundations. The analysis of the long-term distribution of wealth and of the income share of the socio-economic classes.
We shall consider the main issues at stake for the above points here below.
4.2. The Introduction of a Differentiated Interest Rate on Wealth of the Classes This hypothesis rejects the equality, in the long-run, between the rate of profits that capitalists get from their investments and the rate of interest received by the workers on their deposits or loans to the capitalists. It all started with Pasinetti‘s assertion that: […] in order to say anything about the share and rate of profits, one needs first a theory of the rate of interest. In a long-run equilibrium model, the obvious hypothesis to make is that of a rate of interest equal to the rate of profit. (Pasinetti, 1962, pp. 271-2)
The assumption that the rate of interest received by the workers is equal to the rate of profits generated by the system (and perceived by capitalists) is of course obvious in a neoclassical world where individuals may be different due to their initial endowments, but where equilibrating mechanisms are always at work: in this case the differences between the various rates of return may be explained only in terms of risk differences bound to disappear in the long-run if the perfect information context remains valid. But if complete foresight exists as to all possible events in the neoclassical model, as Eichner and Kregel (1975, p. 1309) point out, in post-Keyensian theory ‗only the past is known, the future is uncertain‘. In other words, if we abandon the neoclassical approach, it may not be clear which particular mechanism make the interest rate equal to the rate of profits. Leaving for the moment aside considerations of analytical nature, several reasons may be put forward in support of a differentiated interest rate:
First, historically, the interest rate has been considerably lower than the average profit rate of the system, except for some periods characterized by recession or high inflation. In general a ratio of 2 to 3 is more likely to reflect the realities of the world than a ratio of 1 to 1. This observation implies one of two things: either the economy is not on an equilibrium growth path or there is no evident hope of ever achieving such a path. Second, one might argue that the act of saving and the act of investing are two distinct operations. They refer to two distinctive acts of appropriation: one is strictly connected with the wage rate and only indirectly with the average profit rate of the economy; the latter, on the contrary, is more directly connected with capital and its profit rate. One might also say that saving is essentially a passive act, while investment is more active. Not surprisingly a higher remuneration is normally attached to the active act of investing.
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Third, a different way of looking at the same phenomenon is to postulate that there is a risk factor associated with the act of investing. This risk should be reflected in the differential between the rate of interest on risk less savings and overall profit rate. Fourth, it may be said that investment, to be profitable, must be carried out in a certain minimum quantity. The workers, taken individually, are not able to exploit the profit opportunities of big investment. Their saving, accordingly, is likely to carry a smaller reward.
For these reasons a number of authors have assumed that the interest rate is not identically equal to the profit rate; typically it is assumed lower. It should be stressed that in the present context, by interest rate it is meant the rate at which the workers place their savings in the hands of the capitalists (or in the hands of the State in a socialist society). It is, in other words, the rate of return on workers‘ savings. The implications of the assumption of a different rate of return for the accumulated savings of the various classes are far-reaching. First of all it affects directly the distribution of income among classes, the overall saving ratio as well as the patterns of wealth accumulation. But it does not necessarily affect the value of the equilibrium rate of profits; or in other words the strength of the Cambridge Equation is often confirmed, depending on the way in which the differentiated interest rate is introduced. Not surprisingly a new research programme has been opened up along these lines. The number of contributions and comments is growing and, chronologically, starts with Kahn (1959), Laing (1969), followed by Balestra and Baranzini (1971), Harcourt (1972), Hu (1973), Maneschi (1974), Moore (1974), Pasinetti (1974, pp. 139-41), Campa (1975) and Pasinetti‘s reply (1975), Baranzini (1975, 1976, 1991), Gupta (1976), Mükl (1978), Riese (1981), Fazi and Salvadori (1981) and Pasinetti‘s reply (1983), Kaldor (letter to the first author, 15th February 1982, letter to Luigi L. Pasinetti, 4th March 1982, Nicholas Kaldor Papers, King‘s College Archives, Cambridge), Miyazaki (1986), Panico and Salvadori (1993), Teixeira (1998), Teixeira and Araujo (1991, 1996, 1997a), Texeira, Sugahara and Baranzini (1998, 2002). As it can be seen, the majority of scholars that have published in this field are Italian or of Italian origins, or have closely operated with the Italian academia. The results obtained within this context vary according to the specific assumptions made and to the framework of analysis adopted, although the basic results may well be obtained in both post-Keynesian and marginalist or neoclassical frameworks: a representative example is the neoclassical model developed in Balestra and Baranzini (1971) and the counterpart expounded in Gupta (1976). In fact in the former analysis the independence of the equilibrium profit rate with respect to the propensity to save of the workers is no longer valid (as it would be pointed out by Pasinetti three years later). Looking at the optimal growth, the paper develops two distinct arguments. First, in a traditional manner, the conditions under which there exists an interest rate that maximises per capita consumption are established. Second, the criterion underlying optimal growth may be seriously questioned. Instead of finding the path that maximises total consumption per capita, one may be more interested in the path that maximises workers‘ consumption, a reasonable criterion in a two-class economy. It is absolutely clear that workers‘ consumption is maximised and at the same time the consumption of the capitalists is zero. This obviously implies that sc=0 and that the rate of profit is equal to the rate of interest earned by the workers on their accumulated savings.
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But there is another important aspect concerning the long-term setting of society, i.e. the possible co-existence of the socio-economic classes. This was unearthed in the process of introducing the micro-foundations into the post-Keynesian model, a sort of life-cycle theory fitted into the Kaldor-Pasinetti model. As we showed in previous works8, in such a model where the transmission of inter-generational financial assets is a prerogative of the entrepreneurial class, the equilibrium rate of interest of the system turns out to be a function of the behavioural parameters of the entrepreneurs (or capitalists), but not of those of the other classes or of technology. The fact that under the constraint of utility maximisation the equilibrium interest rate is independent of the technological factors (i.e. of the capital/output ratio in this case) is particularly relevant, and seems to confirm once again the validity of the Cambridge Equation.
4.3. The Introduction of the Monetary Sector and of Portfolio Choice Since the early 1970s, quite a number of analyses have focused on the role of the monetary and financial variables in the post-Keynesian Cambridge distribution and accumulation model. These works were first a response to the then common belief that the Cambridge post-Keynesian model does not incorporate money. Jan Kregel is his paper with the eloquent title ‗Hamlet without the Prince: Cambridge Macroeconomics without Money‘ (1985) so stresses the lack of focus on money in the Cambridge models of distribution and accumulation: Keynes‘ General Theory was exclusively concerned with a monetary economy in which changing beliefs about the future influence the quantity of employment. Yet money plays no more than a perfunctory role in the Cambridge theories of growth, capital, and distribution developed after Keynes. This essay attempts to explain this paradox with reference to the relation between Keynes‘ monetary revolution and the value theory revolution which simultaneously occurred in Cambridge in the 1930‘s. (Kregel, 1985, p. 133)
Numerous other scholars share this view. Paolo Pettenati maintains that: It should be emphasized […] that whether money ‗matters‘ or not, the explicit introduction of variables representing the Government‘s budget and the rate of growth of the money supply into the neo-Keynesian models of distribution and growth is just not a question of greater or lower realism, but also a logical necessity. […] In other words, unless the behaviour of the monetary sector is taken into explicit consideration, we do not know whether the system is viable or not. (Pettenati, 1993, p. 393)
A second aim of the research done in this field was motivated by the desire to assess the neutrality or non-neutrality of money in these models of growth and distribution; thirdly it was aimed at assessing whether the equilibrium rate of interest, in a monetary context, would maintain the same characteristics as in the non-monetary model. In this framework we find the contributions of Kaldor (1966), Davidson (1968), Hu (1973), Baranzini (1975a), Ramanathan (1976), Kregel (1977), Skott (1981a, 1981b, 1989); but see also Darity (1981), 8
Baranzini (1991, Chapter 5).
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Kano (1985), Mastromatteo (1996, 2000), Delli Gatti e Gallegati (1990) and van Ewijk (1989, 1991). Again, including Pettenati, there is a representation of the Anglo-Italian School. As Ramanathan points out: The introduction of a monetary asset that competes with a capital asset substantially alters not only the behavioural characteristics of an economic system but the long run implications as well. For instance, in the standard two-class model with capitalists (or firms) and workers (or households), the proportion of capital held by each group is endogenously determined. If a monetary asset exists, then firms and households will not only save different proportions of their respective incomes and earn dividend income on capital assets but also have different demands for money. (Ramanathan, 1976, p. 389)
The way in which the demand for money is determined and introduced into the real model is hence crucial. But here another problem arises, making the introduction of money even more challenging. To quote Ramanathan again: The two groups [of consumers and savers] will thus respond differently in terms of money demand to changes in the inflation rate of return to capital. This in turn alters the portfolio composition in a dissimilar way with substantial impacts on capital accumulation and the balanced growth path of real and monetary variables. (Ramanathan, 1976, p. 389)
The results in general confirm the relevance of the monetary sector in growth models, but at the same time, in quite a few cases, they confirm the relative strength of the results obtained in the real models. This is the case of Baranzini (1975a); also Ramanathan (1976) shows that when a monetary sector is added, the condition for the Pasinetti theorem is empirically more plausible than that of the Meade-Samuelson and Modigliani Dual Theorem. Other analyses enquire into the optimal conditions for steady-state growth in the presence of money, while others consider the role of money in a model where individuals, or groups, try to maximize their utility function under given conditions (Hu, 1973), or the neutrality of money in a model which considers a different rate of interest for the socio-economic classes (Baranzini, 1971, 1975a).
4.4. The Introduction of the Public Sector Yet another line of research has been taken up by several authors who set themselves the task of answering the question:9 in what way will the post-Keynesian model be affected by 9
Panico and Salvadori start their review of the Cambridge post-Keynesian theory on the ‗public sector and international trade‘ by writing: Some other extensions of the Post Keynesian theory of growth and distribution have examined the influence of government activity and international trade. An article published in 1972 by Steedman introduced government activity into a model of growth and distribution which used Pasinetti‘s institutional distinction between workers and capitalists. Steedman moved from Meade‘s analysis of the ―Pasinetti‖ and ―dual theorem‖ to argue that in the presence of government activity a ―Pasinetti equilibrium‖ is still possible but, in general, an equilibrium in which the capital/output ratio is independent of the methods of production is not. Steedman characterized government activity in terms of fiscal policy interventions, introducing into the analysis different forms of taxation, government consumption and transfer payments to the workers. He assumed that the government budget is always
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the introduction of a public sector, with its own propensity to save, to consume, to accumulate, and to run into deficits or surpluses? This question is particularly important, since it was Keynes himself who underlined the necessity of a non-neutral public sector.10 The contribution in this field are those of Steedman (1972), Domenghino (1982), Fleck and Domenghino (1987, 1990), Pasinetti (1983, 1989a, 1989b), Dalziel (1989, 1991b, 1991-2), Mastromatteo (1989a, 1989b, 1994), Denicolò and Matteuzzi (1990), Araujo (1992, 1995), Araujo and Teixeira (2002), Teixeira (1991, 1998, 2009), Teixeira and Araujo (1991, 1996, 1997a, 1997b, 2004), Teixeira, Sugahara and Baranzini (1998, 2002). Steedman (1972) considers the case of a perfectly balanced government budget and states that the existence of government expenditure and taxes should not affect the validity of the Kaldor-Pasinetti theorem while, except in quite particular cases, it denies the possibility of the Meade-Samuelson and Modigliani Dual Theorem. Domenghino (1982) and Fleck and Domenghino (1987) analyse an extension of the Cambridge model that incorporates direct and indirect taxes and government spending, so arriving at a more generalized version of the Cambridge Equation according to which the workers‘ propensity to save determines, inter alia, the steady-state income distribution. Domenghino points out that: However Pasinetti‘s Theorem continues to be valid with government activity if one specific requirement is fulfilled: government must have a balanced budget. (Domenghino, 1982, p. 299)
In this case, obviously, the system has many similarities with the Kaldor-Pasinetti original two-class model. In the more general case in which the public sector does not show a balanced-budget situation, according to Fleck and Domenghino, two quite different ‗AntiPasinetti cases‘ may arise where:
the government under-spends a steady ratio of its tax income – here it is proved that the higher the workers‘ propensity to save, the lower the share of income going to capital, a result in line with the Kaldor-Pasinetti approach, and referred to as the ‗well-behaved Anti-Pasinetti case‘; or the public sector constantly overspends a fraction of its tax revenue (and accumulates a national debt at a steady rate) – here the higher the workers‘ propensity to save, the higher the share of steady-state profits, a result which has been labelled the ‗pathological Anti-Pasinetti case‘.
The point about this result is that in the presence of a non-balanced state budget the workers‘ propensity to save does determine the distribution of income between profits and wages. The results obtained by Fleck and Domenghino have been challenged by Pasinetti (1989a, 1989b), Teixeira and Araùjo (1991), and partly by Dalziel (1989, 1991b, 1991-2) who consider a corrected version of the two-class model with a central government which levies
10
balanced, so that no problem arises related to monetary policy and to the existence of financial assets issued by the government. (Panico e Salvadori, 1993, p. xxii) ‗It is surprising that the various authors, while trying so many extensions, should have paid so little attention to the role of Government taxation and expenditure, a topic on which Kaldor worked so much in his life.‘ (Pasinetti, 1989b, p. 26)
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direct and indirect taxes. For the case of a balanced-budget Pasinetti (1989a, 1989b) obtains the classic Cambridge Equation for which the long-run rate of profits is determined by the natural rate of growth divided by the capitalists‘ propensity to save, now corrected by the taxation parameter, independently of anything else. Other important aspects of the model are hence considered by Pasinetti, with particular reference to the way in which the deficit may be covered (monetary financing or debt financing) and to the links between the Ricardian and Kaldorian theory of distribution. From the early 1990s onwards a new stream of contributions in this field has appeared. First we might mention the (fairly arrogant) reply of Fleck and Domenghino (1990) to Pasinetti, with the title ‗Government Activity Does Invalidate the ―Cambridge Theorem of the Rate of Profit‖‘, Palley (1996a, 1996b, 1997, 2002), Commendatore (1993, 1997, 1999, 2002, 2003), Dalziel (1989, 1991a, 1991b, 1991-2), Mastromatteo (1989a, 1989b, 1994), Panico (1997, 1999), Panico and Salvadori (1993, pp. xiii-xxxi), Park (2002, 2006) Denicolò and Matteuzzi (1990), Araujo (1992, 1995), Araujo and Teixeira (2002), Teixeira (1991, 1998, 2009), Teixeira and Araujo (1991, 1996, 1997a, 1997b, 2004). Again, the Italian School of economic thought is well represented.
4.5. The Inclusion of other Socio-economic Classes Baranzini and Scazzieri (1997) draw upon the original Kaldor‘s model, as refined by Pasinetti (1962), in order to investigate features of structural economic dynamics that may have relevant implications for the long-run distribution of income and wealth among socioeconomic classes. In this way it is taken up a theme closely related to Joan Robinson‘s emphasis upon the fine structure of rents along an expanding path characterized by ‗technological disequilibria‘ with the coexistence of techniques of different degrees of efficiency (see Robinson, 1956: bk. 2; Quadrio-Curzio, 1993), and to Harcourt‘s (1972, p. 217) original remark on the significance of the equality between the rate of profit and the rate of interest. The authors stress that the post-Keynesian view of long-run distribution of income and wealth, as first expounded by Kaldor, and then by Pasinetti and others, retains the basic structure of classical economic theory while investigating its scheme of causal determination: profits are associated with the requirements of steady growth while wages become residual. A natural step would seem to be that of resuming a view of the economy in which a third class (not considered by Kaldor or Pasinetti) is introduced; in this specific case a class of rentiers whose income may be derived from both profits and rent. This assumption gives the model more flexibility and makes it more compatible with a vision of the economic system emphasising technological rigidities and market imperfections, as these features are often associated with the existence of distinct incomes or social classes. A possible way of extending the original two-classes two-incomes model has been suggested by Pasinetti (1977, p. 58). In fact he suggests a model with two classes of savers (the class of workers and the class of capitalists-and-rentiers) and three categories of income (wages, profits and rents). The validity of Pasinetti‘s result is, however, limited to the case in which total rent is a constant proportion of capitalists‘ profits. Otherwise, ‗a steady-state path would not exist, and we would be outside the scope of this kind of analysis‘ (Pasinetti, 1977, p. 58). The model that is put forward is based on the hypothesis that total net income, Y, is divided into wages, profits and rent; but total net savings are divided into three categories: workers‘ savings (Sw), capitalists‘ savings (Sc) and rentiers’ savings (Sr). Workers receive
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wage and profit payments, the latter in the form of interest on their accumulated savings. Capitalists are, as in the Kaldor-Pasinetti model, pure profit-earners. Rentiers receive interest of their accumulated savings and, at the same time, receive a rent. The latter includes all kinds of incomes which are not remuneration of labour, at the current wage-rate, nor do not derive from accumulated savings. It follows that the term ‗rent‘ refers, in the present framework, to a range of incomes that may include, among others, Ricardian rents and monopolists‘ extraprofits: such a general formulation may be justified by the fact that the purpose of these kinds of analyses is that of studying those characteristics of steady-state growth which do not depend on the differences among all such incomes. In addition, it may be important to add that one of the main aims of these works is also to focus on the long-run distribution compatible with steady growth, so that this definition of rent is independent of any particular assumption about production technology. This result may appear somehow surprising, since it suggests that when equilibrium savings are provided by workers and rentiers only, the conditions to be satisfied relatively to the distribution of income among wages, profits and rents is more flexible than in the case when the equilibrium savings are provided by workers and pure capitalists. The reason for this is that the long-run equilibrium condition = n/sr = r(1+) is related only to the ratio of rentiers’ total income to their capital stock; so that it becomes possible to allow for a trade-off between rent and rentiers’ profits. It may be worth mentioning that, according to Pasinetti (1977, p. 58), the long-run ratio of total rent to the profits earned by the capitalists-rentiers (a class which corresponds to our rentiers) has to be constant in steady-state. This result is a consequence of expressing the long-run equilibrium condition in terms of the rate of profits, r. Once we refer to the rentiers’ long-run ratio between total income and their capital stock, it becomes apparent that changes in may still permit the maintenance of a given full employment path, provided the interest rate varies accordingly. In 2001 Greg Hill, of the City Budget Office of Seattle, WA, USA, published yet another article along this line of research, with the title ‗The Immiseration of the Landlords: Rent in a Kaldorian Theory of Income Distribution‘, which however does not make any reference to the works previously published in this field. According to him, his model has been prompted by the desire to interpret the significance of the secular decline in rents as a share of national income and to specify the circumstances under which both the capital/output ratio and the wage share in national income may rise. In fact the author pursues Keynes‘s suggestive remarks about land‘s liquidity value and is able to prove that an increase in the demand for land reduces the equilibrium rate of profit and therefore the inducement to invest. Adding up, the introduction of a rentiers’ class into the two-class model of Kaldor and Pasinetti provides a modern view of the consideration of a third kind of income besides wages and profits. If on the one hand the validity of the Cambridge Equation is often considered, on the other the examination of structural dynamics explains why, under certain conditions, the capital/output ratio and the share of wages in national income rises, while at the same time the share of rents tends to decline. We cannot consider here a number of analyses that have introduced other classes of savers; maybe the most reputed is that of Tobin (1960) who develops a model with n classes of savers, each with its own propensity to save; but in his work the validity of the Cambridge Equation is not disproved.
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4.6. The Introduction of the Micro-Foundations The main features of the post-Keynesian, neo-Ricardian and marginalist growth models elaborated since the mid-1950s and which consider a class of ‗pure‘ capitalists (or rentiers) whose income is derived entirely (or mainly in certain cases) from capital, and a class of workers whose income is derived from both work and accumulated savings, are: 1. the saving ratio of the classes is exogenously given and hence independent, for instance, of the rate of interest earned on savings (both life-cycle and intergenerational); 2. little attempt is made to explain the ‗historical‘ importance of the inter-generational bequest of the system; and 3. the equality in the long-run equilibrium between the rate of profit earned by the entrepreneurs and the rates of interest earned by the other classes on their accumulated savings. The general purpose of this research line has been that of studying, essentially from a dynamic and historical point of view, the patterns of accumulation of capital in a two- or multi-class model incorporating the basic ingredients of the life-cycle theory and the possibility of the existence of an inter-generational bequest. The basic contribution to this analysis, namely the introduction of the life-cycle hypothesis into the traditional two-class growth model, was originally suggested by Samuelson and Modigliani (1966, p. 297) who, concluding their essay ‗The Pasinetti Paradox in Neoclassical and More General Models‘ admitted their uneasiness with the assumption of permanent classes of capitalists and workers (‗pure profit and mixed-income receivers‘ in their words) with given and unchanging saving propensities. To quote the two MIT economists: This assumption completely disregards the life cycle and its effect on saving and working behaviour. In the first place with a large portion of saving known to occur in some phases of the life-cycle in order to finance dissaving in other phases, it is unrealistic to posit values for (sc, sw) [the propensities to save of the two classes] which are independent of n [the rate of growth of the system]. (Samuelson and Modigliani, 1966, p. 297)
Soon a number of analyses took up this suggestion, like those of Britto (1969, 1972), Hahn and Matthews (1971), Atkinson (1971, 1974), Bevan (1974, 1979), Baranzini (1976, 1991), Faria (2001), Faria and Araujo (2002) and Teixeira, Sugahara and Baranzini (1998, 2002). The purpose of these contributions was not exclusively that of providing some microfoundations to the model of distribution, but also of providing a framework where the propensities to save of the various classes are no longer exogenously given, but are a function of the rate of interest and of other economic, demographic and institutional variables. In fact the essential contributions that the life-cycle theory can contribute in a society characterized by the presence of socio-economic classes with different income structures and different consumption and saving propensities, are manifold:
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1. More insight into the determination of the distribution of income among classes (at least when they all own a positive share of the capital stock) and determining the equilibrium variables of the model. 2. An understanding of the sort of reasons that may lead to historical class differences, to a different accumulation of capital (both life-cycle and inter-generational), and to the particular conditions under which a class may start accumulating intergenerational assets. 3. An elucidation of the applicability of the Meade-Samuelson and Modigliani condition (following which the capitalists‘ capital share vanishes in the long-run) or of the opposite condition (following which the workers‘ inter-generational capital share tends to zero). This should permit to determine when the equilibrium rate of interest is the same for all classes of the system and when there exists the possibility of multiple equilibria. 4. An assessment of the relative strength of the life-cycle versus the inter-generational capital stock and the conditions which favour one or the other of the capital stocks. 5. What are, in this context, the consequences of the introduction (both in a deterministic and stochastic context) of the hypothesis of an imperfect capital market, which is rather appealing in a two-class or multi-class context? Additionally, what are the consequences of the introduction of uncertainty (relative to the rate of return on accumulated savings) on the optimal consumption and accumulation rates of two classes; and how relevant is uncertainty in generating differences among classes, i.e. classes with a higher propensity to save (or to accumulate) than average. And finally, in what way will classes react, according to their risk-aversion, to the existence of different investment possibilities, with different rates of return and different expectations? There is no pretence that all relevant aspect of a life-cycle growth model with fixed technology and classes characterised by homogeneous socio-economic behaviour à la KaldorPasinetti have been analysed by the various scholars engaged in this kind of analysis. However in so doing this line of research has been extended a little further, as well as our knowledge concerning important aspects of economic growth, wealth accumulation and class distinction. A number of works have been elaborated in order to expand the life-cycle approach grafted onto the Cambridge post-Keynesian model of accumulation and distribution. Among these we find the early works of Ronald Britto, ‗The Life-Cycle Savings in a Two-Class Growth Model‘ (1969) and ‗On Differential Saving Propensities in Two-Class Growth Models‘ (1972). These are, in a sense, pioneering works; they do not, however, explicitly consider an inter-temporal consumption u-function or a bequest-function, so excluding the analysis of the overlapping generation model. The issue of inheritance is however explicitly considered by David Bevan in his ‗Savings, Inheritance and Economic Growth in the Presence of Earning Inequality‘ (1974). Here the process of concentration and dispersion of wealth are made a function of the (variable) level of earning inequalities. In this framework we want also to mention the work of W. A. Darity ‗The Simple Analytics of Neo-Ricardian Growth and Distribution‘ (1981). The so-called Brasilian, with strong Italian links, post-Keynesian School of economics (that includes, among the others, Joanilio Rodolpho Teixeira - the unquestionable leader -
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Francisco Galrao Carneiro, R. Sugahara, R. A. Araujo, S. Sarquis, M. Mollo, J. R. Faria and S. O. Benjuino) has recently explored other directions. First J. R. Faria in his ‗The Pasinetti Paradox in an Intertemporal Dynamic Model‘ (2001), and then J. R. Faria and R. A. Araujo in their ‗A Pasinettian Intertemporal Model with Government Sector‘ (2002). This last contribution is intriguing. After recalling that Fleck and Domenghino (1987, 1990) argue that the assumption of a balanced budget would be essential for the Kaldor-Pasinetti theorem to hold in an economy with government activity, Faria and Araujo stress that a number of analyses have proved just the opposite viewpoint, i.e. that the Cambridge theorem would be valid even with long-term unbalanced budgets.11 Following these lines of investigation Faria and Araujo (2002) study the relevance of the Cambridge Equation in the presence of a government sector when the assumption of fixed savings for all classes is relaxed. Their analysis has been written with the aim to elucidate the issue by introducing the life-cycle hypothesis into a three-class model including consumers, entrepreneurs and the state. It may be summarized as follows. Consumers are allowed to choose how much to consume and to save in order to accumulate wealth providing consumption in the future at each moment of time in an infinite-time horizon. As a result the average and marginal propensities to save are made endogenous. The neo-classical representative agent framework is then adapted to include most of the traditional features of the post-Keynesian distribution model, characterised above all by different socio-economic inter-generationally stable classes. Faria and Araujo conclude that the main result of their paper is that the Cambridge equation, i.e. the Kaldor-Pasinetti theorem, is consistent with their model. However the rate of profits is not determined by it. In this vein we provide micro-foundations for the two-class growth model of capital accumulation and income distribution. As Samuelson and Modigliani (1966) argued, the Cambridge equation applies to any system capable of a golden-age path, which is the case of our model. However, due to its intertemporal structure, the rate of profit is determined by the rate of time preference. This is a standard result in the neoclassical Ramsey-type models. Consequently, the Pasinetti paradox is no longer a paradox. (Faria and Araujo, 2002, p. 2)
In Faria and Araujo‘s (2002) model the Cambridge Equation provides the conditions for the determination of the capitalists‘ marginal propensity to save. The relevance of the marginal productivity of capital is that it provides the necessary conditions for the determination of the optimum quantity of capital in the economy.12 Moreover it is important to notice that the Cambridge Equation still holds true independently of the marginal productivity of capital or any other parameter related to the production function. But the functional relationship is here reversed. The Cambridge Equation determined the equilibrium value of the capitalists‘ propensity to save, for the case in which both classes co-exist in the system. Finally Faria and Araujo (2002) show that only taxation on profits affects the equilibrium profits rate and, as a consequence, capital accumulation (and its distribution among classes), wages and output. Contrariwise direct taxation of wages does not affect the 11
Among these works Faria and Araujo quote Pasinetti (1989a, 1989b), Dalziel (1989), Denicolò and Matteuzzi (1990) as well as Araujo (1992). 12 According to the two authors, Hu (1973) tries to formulate the optimal programme of capital accumulation in the framework of the post-Keynesian two-class growth model. However Hu considers a centrally planned economy, where the central planner performs the dynamic optimisation. That means that the propensities to save remain exogenous and ‗are not necessarily the optimal ones‘.
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equilibrium profits rate and/or capital accumulation and output. More importantly in this lifecycle framework the equilibrium distribution of income between wages and profits, as stated by the Kaldor-Pasinetti theorem, is not affected by the occurrence of sustained deficits or surpluses. Faria and Araujo (2002) point out that this result is consistent with the conclusions of Pasinetti (1989a, 1989b), Dalziel (1989), Denicolò e Matteuzzi (1990) as well as Araujo (1992).
4.7. The Analysis of the Long-Term Distribution of Wealth and of the Income Share of Socio-Economic Classes In this Section we focus on the long-term properties of the model, with particular reference to the functional distribution of income and to the share of income earned by the classes in equilibrium. A large number of authors have considered the adjustment time required for the economy to return to steady-state situations from any initial disturbance, and the stability and instability conditions in general. In this context the conditions under which one group of savers may not be able to hold a positive share of the total capital stock are also analysed, and the mechanisms at the basis of capital accumulation are brought into the forefront. Always within this context various authors (mainly working with neoclassical models, which seems appropriate for deriving complicated analytical results) consider longterm adaptations of wealth distribution between the two classes to their respective savingsupply functions, while at the same time it is postulated that the short-run saving-investment equilibrium is immediately realized. In this wide field of research we find, in chronological order, the following contributions: Tobin (1960), Stiglitz (1967), Britto (1968), Kubota (1968), W. W. Chang (1969), McCallum (1969), Colinsk and Ramanathan (1970), Furono (1970), Guha (1972), Mückl (1972, 1975, 1978), Steedman (1972), Meneschi (1974), Gupta (1977), Marrelli and Salvadori (1979), Vaughan (1979, 1988), Fazi and Salvadori (1981, 1985, 1993), O‘Connell (1985, 1995), Pasinetti (1983), Franke (1985), Taniguchi (1987), Miyazaki (1987, 1988, 1991), Baranzini (1991)and Samuelson (1991). As it was to be anticipated, the adjustment time that is required to arrive at the steadystate solutions (or to return to them in the case of initial disturbances) is, in general, quite long. For instance Atkinson in his paper ‗The Timescale of Economic Models: How Long is the Long Run‘ (1969) with some quite restrictive assumptions estimates that it would take several decades for the system to come back to the equilibrium situation. But even this result is quite understandable, since the Kaldor-Pasinetti steady-state (as any other long-term steady-state growth path) exhibits a fairly strong local and global stability, so that an external shock or disturbance will take a long-time to work its way through a modification of the distribution of income and wealth. But we should not forget that the scope of comparativestatic analysis is not primarily to consider the conditions under which the system may converge towards, or may be deviated from, its long-term steady-state growth path, but to enquire into the mechanisms that under general conditions are bound to influence and determine the distribution of income and wealth. However the analysis of the long-term properties of these models may still yield interesting insights, since, as Mückl (1975, p. 145) points out, it cannot be disregarded that in any adjustment process most, if not all, parameters of the model affect the distribution of income and wealth. In other words one should be aware
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of the fact that outside any equilibrium situation all variables and parameters come to play an equally important role in the determination of the evolution of the system. Taniguchi (1987) has shown that, in the specific case of the Kaldor-Pasinetti model, there exists a traverse from which one steady-state equilibrium approaches asymptotically a new long-run equilibrium path, provided the rate of profits is constant in the long-run; the conditions of existence of such a traverse also correspond to the stability conditions of the equilibrium situation of the model. If this were to be confirmed, the global stability of the model would be, once again, proved. Still another controversy about the long-term properties of the distributive model is the one that includes contributions by Maneschi (1974), Gupta (1977) and Mückl (1978). Maneschi in his paper on ‗The Existence of a Two-Class Economy in the Kaldor and Pasinetti Models of Growth and Distribution‘, using a generalized saving function tries to show that Kaldor‘s special assumption about the propensities to save of the two classes, would imply a dynamic equilibrium where the share of wages in national income turns out to be equal to zero. This would be a sort of Anti-Meade-Samuelson and Modigliani dual theorem, and would rule out the existence of the working class that earns wages and interest on their accumulated savings. Gupta (1977) came to the conclusion that Maneschi‘s findings may be obtained without the use of a ‗generalized saving function‘ or the neo-classical framework set up by Maneschi (1974). Mückl (1978) reassesses the whole issue and tries to demonstrate that Maneschi‘s and Gupta‘s conclusions about the possibility of an Anti-Dual Theorem (i.e. a state where just the capitalists can survive) is not possible. Very exceptional circumstances apart, Mückl shows that Kaldor‘s assumptions about the saving behaviour of the two classes lead to a definite steady-state solution, where only the working class survives. This solution may be derived whether one relies on neoclassical or on post-Keynesian assumptions. Therefore, as the author points out ‗Gupta‘s so called ―dual theorem‖ is neither dual nor equivalent to the homonymous theorem of Samuelson and Modigliani‘ (Mückl, 1978, p. 509).
5. CONCLUSION Summing up, we may stress that the contribution of Italian scholars to a number of theories of value and prices, as well as income and wealth distribution, starting from Thomas Aquinas (1225-1274) and Ferdinando Galiani (1728-1787) has been significant. Even the seminal representation and interpretation of Ricardo‘s classical theory of growth and income distribution provided by the Anglo-Italian scholar Luigi Lodovico Pasinetti in 1960 is worth mentioning. But Italian scholars have also contributed to the marginalist or neoclassical school of distribution, in particular Vilfredo Pareto of the School of Lausanne; his contribution deserves particular attention. This is due to the fact that he did not confine himself to the functional distribution of income, but extended it to the personal distribution. But it is in the field of the post-Keynesian theory of profit determination, income distribution and wealth accumulation that the Italian school of thought has provided significant if not major contribution. Over a span a more than 50 years the so-called Keynes-Kaldor-Pasinetti research programme has been developed and refined to include a number of issues associated with the determination of the rate of profits in a steady-state growth model compatible with full employment growth. The historical, demographic, institutional as well as the micro-
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economic aspects of these models have come under close scrutiny and a number of relevant questions seem to have received satisfactory answers. It is worth noting that about one hundred Italian scholars have contributed to this vast research programme. Still a number of research lines are at present under investigation and require further work.
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Nuti, D. M. (1974). On the Rates of Return on Investment. Kyklos, 27(2), pp. 345-366. O‘Connell, J. (1985). Undistributed Profits and the Pasinetti Dual Theorems. Journal of Macroeconomics, 7(1), pp. 115-119. O‘Connell, J. (1995). The Two/One Class Model of Economic Growth. Oxford Economic Papers, 47(2), pp. 363-368. Palley, T. I. (1996a). Inside Debt, Aggregate Demand, and the Cambridge Theory of Distribution. Cambridge Journal of Economics, 20(4), pp. 465-474. Palley, T. I. (1996b). Growth Theory in a Keynesian Model: Some Keynesian Foundations for the Theory of Growth. Journal of Post Keynesian Economics, 19(1), pp. 113-135. Palley, T. I. (1997a). Aggregate Demand and Endogeneous Growth: A Generalized KeynesKaldor Model of Economic Growth. Metroeconomica, 48(2), pp. 161-76. Palley, T. I. (1997b). Money, Fiscal Policy and the Cambridge Theorem. Cambridge Journal of Economics, 21(5), pp. 633-639. Palley, T. I. (2002). Financial Institutions and the Cambridge Theory of Distribution. Cambridge Journal of Economics, 26(2), pp. 275-277. Panico, C. (1997). Government Deficits in Post Keynesian Theories of Growth and Distribution. Contribution to Political Economy, 16(1), pp. 61-86. Panico, C. (1999). The Government Sector in the Post-Keynesian Theory of Growth and Personal Distribution. In G. Mongiovi, & F. Petri (Eds.), Value, Distribution and Capital: Essays in Honour of P. Garegnani (pp. 339-353). London and New York, UK & USA: Routledge. Panico, C., & Salvadori, N. (Eds.). (1993). Post Keynesian Theory of Growth and Distribution. Aldershot, UK: Edward Elgar. Pantaleoni, M. (1923). Obituary: Vilfredo Pareto. The Economic Journal, 33(132), pp. 582590. Pareto, V. (1964). Cours d’Économie Politique: Vol. 1. Oeuvres Complètes (G. Busino, Ed.). Genève, Switzerland: Librairie Droz. Pareto, V. (1965). Écrits sur la Corbe de la Répartition de la Richesse: Vol. 3. Oeuvres Complètes (G. Busino, Ed.). Genève, Switzerland: Librairie Droz. Park, M.-S. (2002). Growth and Income Distribution in a Credit Money Economy: Introducing the Banking Sector into the Linear Production Model. Cambridge Journal of Economics, 26(5), pp. 585-612. Park, M.-S. (2006). The Financial System and the Pasinetti Theorem. Cambridge Journal of Economics, 30(2), pp. 201-217. Pasinetti, L. L. (1960). A Mathematical Formulation of the Ricardian System. The Review of Economic Studies, 27(2), pp. 78-98. Pasinetti, L. L. (1962). Rate of Profit and Income Distribution in Relation to the Rate of Economic Growth. The Review of Economic Studies, 29(4), pp. 267-279. Pasinetti, L. L. (1965). A New Theoretical Approach to the Problems of Economic Growth. Vatican City: Pontificiae Academiae Scientiarum Scripta Varia, reprinted in 1965 by North Holland, Amsterdam, Holland, pp. 572-696. Pasinetti, L. L. (1974). Growth and Income Distribution: Essays in Economic Theory. Cambridge, UK: Cambridge University Press. Pasinetti, L. L. (1975). Determinatezza del saggio di profitto nella teoria Post-Keynesiana: Risposta al Professor Campa. Giornale degli Economisti e Annali di Economia, 9/10, pp. 639-647.
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Pasinetti, L. L. (1977). Reply to Stiglitz. In M. Morishima, Pasinetti‘s Growth and Income Distribution Rvisited. The Journal of Economic Literature, 15(1), pp. 57-58. Pasinetti, L. L. (1981). Structural Change and Economic Growth: A Theoretical Essay on the Dynamics of the Wealth of Nations. Cambridge, UK: Cambridge University Press. Pasinetti, L. L. (1983). Conditions of Existence of a Two Class Economy in the Kaldor and More General Models of Growth and Income Distribution. Kyklos, 36(1), pp. 91-102. Pasinetti, L. L. (1986). Theory of Value: A Source of Alternative Paradigms in Economic Analysis. In M. Baranzini, & R. Scazzieri (Eds.), Foundations of Economics: Structures of Inquiry and Economic Theory (pp. 409-31). Oxford and New York, UK & USA: Basil Blackwell. Pasinetti, L. L. (1989a). Government Deficit Spending is not Incompatible with the Cambridge Theorem of the rate of Profit: A Reply to Fleck and Domenghino. Journal of Post Keynesian Economics, 11(4), 641-7. Pasinetti, L. L. (1989b). Ricardian Debt/Taxation Equivalence in the Kaldor Theory of Profits and Income Distribution. Cambridge Journal of Economics, 13(1), pp. 25-36. Pasinetti, L. L. (1993). Structural Economic Dynamics: A Theory of the Economic Consequences of Human Learning. Cambridge, UK: Cambridge University Press. Pettenati, P. (1993). Pasinetti‘s Theorem in a Modern Institutional Framework. In C. Panico, & N. Salvadori (Eds.), Post Keynesian Theory of Growth and Distribution (pp. 229-37). Aldershot, UK: Edward Elgar. Quadrio-Curzio, A. (1967). Rendita e distribuzione in un modello economico plurisettoriale. Milan, Italy: Giuffré. Quadrio-Curzio, A. (1980). Rent, Income Distribution, Orders of Efficiency and Rentability. In L. L. Pasinetti (Ed.), Essays on the Theory of Joint Production (pp. 218-240). London, UK: Macmillan. Quadrio-Curzio, A. (1993). On Economic Science, its Tools and Economic Reality. In M. Baranzini, & G. C. Harcourt (Eds.), The Dynamics of the Wealth of Nations: Growth, Distribution and Structural Change: Essays in Honour of Luigi L. Pasinetti (pp. 246-71). Basingstoke, UK: Macmillan. Quadrio-Curzio, A. & Scazzieri, R. (Eds.). (1977-82). Protagonisti del pensiero economico (Vols.1-4). Bologna, Italy: Il Mulino. Ramanathan, R. (1976). The Pasinetti Paradox in a Two-Class Monetary Growth Model. Journal of Monetary Economics, 2(3), pp. 389-397 Ricardo, D. (1953). On the Principles of Political Economy and Taxation: Vol 1. The Works and Correspondence of David Ricardo (P. Sraffa, Ed. with the collaboration of M. H. Dobb, 2nd edition). Cambridge, UK: Cambridge University Press. Robinson, J. V. (1956). The Accumulation of Capital. London, UK: Macmillan. Samuelson, P. A. (1991). Extirpating Error Contamination Concerning the Post-Keynesian Anti-Pasinetti Equilibrium. Oxford Economic Papers, 43(2), pp. 177-186. Samuelson, P. A., & Modigliani, F. (1966). The Pasinetti Paradox in Neoclassical and More General Models. The Review of Economic Studies, 33(4), pp. 269-301. Schumpeter, J. A. (1959) History of Economic Analysis (3rd edition). New York: Oxford University Press. Skott, P. (1981a). An Examination of Kaldor‘s Growth and Distribution Models 1956-66. Unpublished thesis, University of Aarhus. Skott, P. (1981b). On the Kaldorian Saving Function. Kyklos, 34(4), pp. 563-581.
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Skott, P. (1989). Kaldor’s Theory of Growth and Distribution. Frankfurt am Main and Bern, Germany and Switzerland: Peter Lang. Spaventa, L. (1962). Effetti di variazioni strutturali nella composizione della domanda sulla produttività del lavoro e sulla occupazione. In L. Spaventa (Ed.), Nuovi problemi di sviluppo economico (pp. 256-81). Turin, Italy: Boringhieri. Steedman, I. (1972). The State and the Outcome of the Pasinetti Process. The Economic Journal, 82(328), pp. 1387-1395. Stiglitz. J. E. (1967). A Two-Sector Two Class Model of Economic Growth. The Review of Economic Studies, 34(2), pp. 227-238. Taniguchi, K. (1987). The Existence of Traverse in Pasinetti‘s Model of Growth and Distribution. Discussion Paper No. 11, University of Osaka Prefecture, Teixeira, J. R. (1991). The Kaldor-Pasinetti Process Reconsidered. Metroeconomica, 42(3), pp. 257-267. Teixeira, J. R. (1998). Luigi L. Pasinetti. In F. Meacci (Ed.), Italian Economists of the Twentieth Century (pp. 272-94). Cheltenham and Lyme, UK & USA: Edward Elgar. Teixeira, J. R. (2009). Growth, Distribution, Stability and Government Budget Surplus: the Extended Cambridge Equation Revisited. Economia, forthcoming. Teixeira, J. R., & Araujo, J. T. (1991). A Note on Dalziel‘s Model of Long-Run Distributive Equilibrium. Journal of Post Keynesian Economics, 14(1), pp. 117-120. Teixeira, J. R., & Araujo, J. T. (1996). A Post-Keynesian Model of Growth with Distributional Improvements. Socio-Economic Planning Sciences, 30(1), pp. 67-76. Teixeira, J. R., & Araujo, J. T. (1997a). A Pasinettian Amend to Growth and Distribution in an Open Economy. Metroeconomica, 48(2), pp. 205-209. Teixeira, J. R., & Araujo, J. T. (1997b). Policy Intervention and the Trade-Off Between Growth and Functional Distribution of Income. Analise Economica, 22, pp. 148-158. Teixeira, J. R., & Araujo, J. T. (2004). A Pasinettian Approach to International Economic Relations. Review of Political Economy, 16(1), pp. 117-29. Teixeira, J. R., Sugahara, R., & Baranzini, M. (1998). On Micro-Foundations for the KaldorPasinetti Growth Model with Taxation and Bequest. Anais do XXVI Encontro Nacional de Economia, 1, pp. 505-18; reprinted in 2002 in the Brasilian Journal of Business Economics, 28(1), pp. 9-23. Tobin, J. (1960). Towards a General Kaldorian Theory of Distribution. The Review of Economic Studies, 27(2), pp. 119-20. Vaughan, R. N. (1979). Class Behaviour and the Distribution of Wealth. The Review of Economic Studies, 46(3), pp. 447-465. Vaughan, R. N. (1988). Distributional Aspects of the Life-Cycle Theory of Saving. In D. Kessler, & A. Masson (Eds.), Modelling the Accumulation and Distribution of Wealth (pp. 193-235). Oxford, UK: Oxford University Press.
In: Issues in Economic Thought Editors: M-A. Galindo, C. N. Spiller, pp. 99-116
ISBN 978-60876-173-9 © 2010 Nova Science Publishers, Inc.
Chapter 6
FROM UTILITY TO THE ENJOYMENT OF LIFE: THE BIOECONOMICS OF NICHOLAS GEORGESCU-ROEGEN. THE INFLUENCE ON THE ITALIAN AUTHORS Stefano Zamberlan* University of Verona, Italy
ABSTRACT Nicholas Georgescu-Roegen has experienced criticism directed at the theory of the behaviour of the consumer based on the usefulness and the excessive recourse to mathematical modelling. As such, he decided to address the complexity of human nature seeking new instruments of analysis resorting to the sciences of life and thermodynamics. In the essay, we analyze how from this criticism the Author manages to interpret the economic process in light of the entropy that sanctions an irreversible degradation of energy, one which he also extends to matter. Georgescu-Roegen states that man for his sustenance and his esosomatic evolution uses, through the economic system, matter and energy with a low entropy on the planet. As such, the relationship between man and the environment is neither only biological, nor only economic, but bioeconomic. And the last aim of the economic process is not to use resources and to discharge waste products into the environment, but is «the enjoyment of life». After having examined the progressive evolution of the concept of this author and the elements of the enjoyment of life, we highlight how the bioeconomical approach has been easily absorbed into the Italian tradition, where the theoretical contributions of analysis of the economic and social system in its entirety are numerous in order to realize the well-being of the individual and valuing the resources of the land in which they live.
*
Research associate, Faculty of Economics, University of Verona, Verona, Italy. Editor in chief of the review ―Economia e Ambiente‖.
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1. CRITICISM OF THE THEORY OF UTILITY There is currently the wish from many areas for a reform of the economic system that protects principally the dignity of the individual and the quality of the environment. In order to undertake such reform, given that at a global level there is the political will to do so, it is necessary to revisit the theoretical basis on which the current economic analysis is based. In such a review one cannot, in my opinion, recall the work of Nicholas Georgescu-Roegen. He tried to provide a new foundation to the economic theory, managing to expand the bioeconomic position that reaches two fundamental and linked conclusions: the search of enjoyment of life for man as the final aim of the economic process and the protection of the environment as an essential element for a long-lasting future. During the first part of his career Georgescu-Roegen1 contributed to the inception of econometrics; subsequently, instead, his studies led him to a sharp criticism of the ―standard‖ economy and the excessive reliance on the mathematical modelization. Georgescu-Roegen (1950; 1954a; 1954b; 1958a; 1958b) tried to demonstrate, during the fifties, the fragility of the entire neoclassic economic theory based on a theory of the behaviour of the consumer excessively simplified and founded on arbitrary assumptions. The criticism of the Author regards the undefined meaning of the concept of utility, the assumption of the same utility, as it is understood today, as a foundation of the economic value and the excessive simplification of the man in homo oeconomicus in the theory of the behaviour of the consumer2. He asserts that before introducing the concept of utility, value or behavioural choices of the individuals, the necessities and the needs were analyzed. These latter are not precisely definable, but in recent analysis, not even the utility or the satisfaction are so. The behaviour of the individual is not based on research of the utility or ophelimity, but on his desires and his needs (Georgescu-Roegen, 1966, pp. 192-193). In order to fill the gap left by the demonstration of the inadequacy of the instruments used by the neoclassical economy, Georgescu-Roegen recovers an alternative approach reconnecting with the work of Menger and the previous contributions of Jevons and Walras3. The author proposes a return to and development of in-depth analysis of needs and desires, 1
Nicholas Georgescu-Roegen was born in Costanza, in Romania, in 1906. Thanks to scholarships, he graduated in mathematics in Bucharest (1923-1926), achieved a PhD in statistics at the Sorbonne of Paris (1927-1929) and began his activity of research in London (1930-1932) under the guidance of Karl Pearson. Having returned to Romania, he was appointed professor of statistics at the University of Bucharest but in 1934 he went to the USA at University of Harvard where, encouraged by Schumpeter and Leontief, he carried out his studies within the economic field. In 1937, he returned to his homeland where for 10 years he held important public office positions. In 1948 he fled his country because of the Communist Party and returned to America. In 1949 he was appointed professor of Economics at the Vanderbilt University of Nashville, where he remained until 1976, year of his retirement. The Author continued untiringly his research, with several trips abroad, until his death, which occurred on October the 30th, 1994. 2 This observation is not limited to the approach of Jevons and Walras, but extends also to the ordinalist reformulation of the theory of the behaviour of the consumer, begun by Pareto (1906) and brought to its conclusion by Allen and Hicks (1934). Cf. Georgescu-Roegen (1966, p. 134, p. 163, p. 171; 1975). 3 From the study of their works, Georgescu recalls, in his analysis, these 3 principles: the Principle of the Subardination of Wants; the Principle of Growth of Wants; the Principle of the Irreducibility of Wants (Georgescu-Roegen, 1966, pp. 194-196.)
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replacing the measurement of the utility on a cardinal or ordinal scale or, with a hierarchy of needs. With this approach the structure of the choice of the consumer becomes more complex: choices are no longer binary but multiple. Georgescu-Roegen seeking an alternative approach to the Theory of Choice will reach the formulation of the Directional Choice Theory. The Directional Choice is based on the ordinal ordering in contrast to the cardinal one, and it was arrived at with the aim of formulating a theory of the behaviour of the consumer excluding the measurement of the utility. With this approach, the utility is not eliminated but is seen only as the criterion with which it is possible to order, denying, instead, its measurability according to a cardinal scale4. The utility is projected onto a scale of values obtained from the information on the behaviour of the consumer, like market data, the prices and the amounts requested (Georgescu-Roegen, 1968)5. It is therefore possible to proceed to a not ambiguous representation of the several alternatives of the consumer, attributing a real number to each of them in order to identify in a complete way the degree of importance. Given the plurality of the needs of an individual, with this approach the several alternatives are comparable through a lexicographical ordering but they are not measurable in an ordinal sense. Georgescu-Roegen will reach three important elements: the rejection of the postulate of indifference between the choice of various combinations of assets, the impossibility of constructing an index of ophelimity for the purposes of ordering the several choices that however remain comparable, and, as a consequence, the impossibility of formulating a law of the question on the theory of choice (Georgescu-Roegen, 1968, pp. 263-264)6. In this way, an ―oversimplification‖ of the man in homo oeconomicus is avoided, distorting the same subject of the analysis7. The concept of needs is a changing concept, on which it is not easy to found a theory of value, even less a law of demand or the behaviour of the consumer. However, from our perspective, if we want to try to formulate a law we must, first of all, assess rigorously the foundation of such. Therefore he refuses the Neoclassical concept of utility which is a derived concept based on indefinite concepts (Georgescu-Roegen, 1966, pp. 212-213).
2. THE MECHANISTIC PARADIGM AND THE THERMODYNAMICS Georgescu-Roegen, seeking a solid base in order to produce a theory of utility and of the behaviour of the consumer, will address the complexity of human nature and biological 4
The author states that the analytical models that have been developed in a cardinalist way are not only useful, but it would prove disastrous to abandon them. However, these instruments must be used in economic analyses whilst respecting their limits (Georgescu-Roegen, 1966, p. 59). 5 This theory is based on the writings of the Italian engineer Antonelli (1886) that were successively expanded by Hicks and Allen (1934) – and also by Samuelson (1938) –, recalled explicitly by Georgescu-Roegen (1936; 1968, p. 255). 6 On fundamental aspects of Directional Choice Theory see Georgescu-Roegen (1966, p. 164, 165, p. 201, p. 240; 1968, p. 257). 7 Georgescu-Roegen (1966, p. 200) asserts: ‗This conclusion was reached not because it would constitute a more convenient approach or lead to a simpler scheme, but because it offers a more adequate interpretation of the structure of our wants.
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phenomena not by simplifying or outlining them but by searching for new instruments of analysis. The author criticizing the standard economy attacks also the mechanistic logic that has dominated western culture for almost three centuries, moulding science and modern society. Such formulation has lost with the passing of time its universal value first with the studies on mechanical statistics and entropy and then, in a more dramatic way, with the discovery of quantum mechanics. Yet, economic science has remained fixed on the mechanistic approach, displaying what he defines as the greatest example of ―epistemologic laziness‖. Georgescu-Roegen points out that the indiscriminate attachment to the mechanistic dogma have reduced the economic science to a timeless kinematics. A business ―cycle‖ follows another and all the negative phenomena are absorbed not leaving a long-lasting trace on the economy. The complete reversibility is the general rule. The economic process is seen as a self-sustaining, circular flow between ―production‖ and ―consumption‖. But he states that this formulation is fallacious: The crucial point is that the economic process is not isolated, self sustaining process. This process cannot go on without a continuous exchange which alters the environment in a cumulative way and without being, in its turn, influenced by these alterations. (GeorgescuRoegen, 1976, p. 4. See also 1971, p. 281)
Aware of the limits of the prevailing economic approach, Georgescu-Roegen engages himself in a deep reflection on the epistemology of economic science. This drives him to expand the scientific basis of reference of the economy, introducing an evolutionary vision and placing beside those arithmomorphic concepts typical of mathematical analysis, the changing concepts that he defines as dialectical concepts8. In traditional philosophical language, the aritmomorphic term is linked to «being», while the dialectics to «becoming». A phenomenon in evolution is a phenomenon that changes in an irrevocable way9. And the economy, being a phenomenon linked to man, is in continuous evolution. Therefore, he turns to the sciences of life: in fact, for the definition and development of these sciences, a great number of dialectic concepts are fundamental. In Western science it has been thermodynamics which have introduced the irreversibility of the phenomena10. With the second law of thermodynamics, known also as the law of entropy, the existence of an irrevocable degradation of the energy is accepted. The author opposes himself to the ―energetic dogma‖11, for which only energy is important, and extends degradation also to matter. ―Matter matters, too‖ repeats Georgescu-Roegen (1977) and arrives at the formulation of what he calls ―Fourth law of thermodynamics‖ that, in analogy with the second law, confirms the irreversible degradation of matter. To define ―law‖ this statement of fact has aroused 8
See Georgescu-Roegen (1966, pp. 21-29, 62-65, 79-83; 1971, pp. 31-35; 43-47). Some dialectical concepts are: good, justice, democracy, want. On their nature and relation with Hegel‘s logic see Georgescu-Roegen (1966, p. 23). 9 On difference between the reversible, irreversible and irrevocable process, see Georgescu-Roegen (1966, pp. 83-84). 10 See Georgescu-Roegen (1966, pp. 83-91; 1971, pp. 196-210; 1976, pp. 6-8). 11 Cf. Georgescu-Roegen (1979, p. 1024, p. 1025). The author makes reference to Brown, Bonner & Weir (1957, pp. 90-92, 95, 114).
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remarkable criticisms on a theoretical level, however from a practical point of view, it is undeniable: matter degrades in an irreversible way and man cannot recover it entirely. . It is necessary only to consider the practical impossibility of complete recycling of materials used in the production of goods12.
3. THE FUNDS-FLOW MODEL In the study of the process of production, Georgescu-Roegen developed his Funds-Flow model13. In this model the dynamic, and not circular movement of matter and energy within the economic system in relation to the natural environment, is synthesized14. The author proposes a subdivision in two categories of the productive factors: funds and flows. A fund is a factor that enters and exits from the productive process with its own unchanged efficiency. To ensure that this takes place, it is necessary that a certain amount of capital and work is employed in order to return the fund to the initial conditions. A flow, instead, is a factor that crosses the process and is used by the elements of the fund. A fund offers only its own service and cannot in any way be incorporated within the final products. The incoming flows, instead, can be accumulated in the funds (for their maintenance) or undergo some transformations in order to find themselves again materially in the outgoing flows (products or waste). An important condition is that if the fund elements remain unchanged, the production process can be activated only if there are sufficient inflow elements (Georgescu-Roegen, 1971, p. 64). This throws new light on the relationship between the productive process and the environment. The reproducibility of the productive process is linked to the flow elements that are derived, according to recent analysis, from the natural environment. The approach to the study of production based on the funds and flows model developed by Georgescu-Roegen is characterized therefore by two elements. The first element is the analytical representation of the productive process based on the temporal element (Zamagni, 1984, p. 323). The second element is the definition of the division between the processes within the productive system and those which are external, showing the close relationship and consequentiality, also in economic terms, between the productive system and the natural environment in which it is found. This highlights how the economic process is an open system, that draws resources and energy from the environment and reinserts it in the form of waste. The economic system can therefore be considered as a dissipative structure, recalling the theory of Ilya Prigogine (1961). However, the natural system, that is planet Earth, is a closed system, as it can only receive energy from outside, that is from the Sun. Unfortunately, from a practical point of view, for the economic process, the Earth is currently more similar to an isolated system. Indeed, there are not the technologies in place to exploit directly, in a convenient way and on a large scale, solar energy even less to determine an inflow or outflow of materials. From these last considerations, the importance of considering the material and energetic aspect of 12
On this impossibility see Georgescu-Roegen (1971, pp. 279-282; 1979, p. 1039). The author develops and takes up this outline on several occasions. Cf. Georgescu-Roegen (1965; 1969a and 1969b – now in 1976, pp. 61-70, 71-102, see especially pp. 84-96 –; 1971, pp. 211-275; 1979, pp. 1023-1058). 14 Georgescu-Roegen (1979) also proposes a simplified version that takes also into consideration the entropic vision of the economic process. 13
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economic processes in order to make them more efficient and as long-lasting as possible appears in a clear way.
4. THE ECONOMIC MYTHS AND THE “MIRAGE” OF THE STEADY STATE Using the law of entropy and the Fourth law of thermodynamics as reading keys of the economic process – considered as an opened subset of the isolated Planet Earth system – and bearing in mind the complimentary nature between the elements of fund and of flow in the analysis of production and consumption, Georgescu-Roegen identifies numerous ―economic myths‖, or common beliefs which are both erroneous and harmful to the environment and the future of mankind (Georgescu-Roegen, 1976, pp. 3-19). Among the most ancient myths is that of perpetual motion of the first type, that is the belief of being able to move objects without using energy. Then there is the myth of perpetual motion of the second type, which still persists today, that consists of the possibility of reusing the same energy several times. Current and held by the ―standard economists‖ as well as by marxists, is the myth of always being able to discover new sources of energy and of being able to use them for one‘s own goals. Another dangerous myth is to consider the economic process as a mechanical process, therefore predictable and with not irreversible effects. By its nature, therefore, it should not cause qualitative variations and would be incapable of influencing the matter and energy which are present in the natural environment. But the law of entropy tells us that it is just the opposite: with his activity, man accomplishes irreversible transformations. Therefore, the link between economic activity and entropy is indissoluble, a link that rejects another economic myth, the basis of which is that nothing can be made for free, or rather that everything has a price equal to its cost, deceiving us into reaching in this way a position of balance. Entropy teaches us, instead, than any action of men or of organisms, or in fact any natural process, must result in a deficit for the system in its entirety. This determines a progressive exhaustion of resources that gradually become more and more scarce. Another myth, among the most tenacious of the official economy – even if now criticised by many – confuses the truth on the impoverishment of the natural resources, sustaining that the mechanism of prices can compensate the shortage of any factor. Whether it relates to the earth, energy or raw materials, in the long term, what is really important is the energetic efficiency in their employment. The myth against which Georgescu-Roegen fought more harshly has been the ―mirage‖ of the steady state, according to which a steady world with a population with a zero rate of increase would heal the ecological problems generated by mankind. The author asserts that the crucial error of such a formulation lies in not seeing that, in a finite environment, not only growth, but neither a state of zero increase can continue endlessly. He bases such a thesis on the relationship between the demographic increase and the current use of resources and on the Fourth law of thermodynamics (Georgescu-Roegen, 1976, pp. 22-25). The only serious alternative in order to render human activity as sustainable as possible and to guarantee wellbeing for a long time is a decrease:
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the necessary conclusion of the arguments in favour of that vision is that the most desiderable state is not a stationary, but a decline one. (ibid, pp. 24-25; author‘s own italics)
The use of sources of energy and raw materials present in a finite supply creates a devastating environmental impact. The author urges a policy of prudence and conservation in anticipation of an economic reconversion based on energetic sources and renewable raw materials with a low environmental impact. According to Georgescu-Roegen , the great popularity in the West of the theory of the steady state is due above all to the fact that the populations of the developed countries are worried that the decrease can lead to a decrease of their standard of living. However, such fear is denied by the ―paradox of happiness‖ developed by Richard Easterlin (1974), who demonstrates how with the growth of material monetary wealth, the perceived well-being can also diminish.
5. THE ESOSOMATIC EVOLUTION OF MAN AND THE BIOECONOMIC APPROACH According to Georgescu-Roegen, economic politics should be an extension of biology (Georgescu-Roegen, 1974). From this point of view, he analyzed the relationship between man and the economic process from an evolutionistic perspective. This led him to embrace the definition of the evolution of the esosomatic human provided by Alfred Lotka, analyzing the past and future implications on the environment, and the perspectives of development of the human race (Georgescu-Roegen, 1966, pp. 98-101; 1971, pp. 306-315; 1976, pp. 25-28). The topic of the esosomatic evolution of man is defined by the author as one of the basic concepts of bioeconomics. Man, in order to make his life easier, has produced instruments foreign to his own body, precisely esosomatic, with which he has evolved allowing him to dominate the planet. The other animal species, instead, have evolved through mutations of their own organism with the creation of endosomatic organs, and therefore they depend for their own existence, directly or indirectly, only on the solar energy that feeds the various biological processes. Man, instead, for his maintenance and ever more complex development, uses principally fossil fuels as energy and minerals as raw materials; both of these resources are present in a finite and exhaustible supply on our planet. In order to better exploit these resources of the planet, man has created the economic system, hence the origin of the problems linked to human development: It is neither only biological nor only economic. It is bioeconomic. (Georgescu-Roegen, 1976, p. 25)
According to Georgescu-Roegen, bioeconomics should study the use that the economic system makes of the resources15 in order to develop a new economic formulation aimed at diminishing the use and waste of energies and not renewable raw materials and to maximize 15
The author identifies six problematic ―asymmetries‖ on which Bioeconomics should focus. See GeorgescuRoegen (1976, pp. 25-28).
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the use of energies and renewable matters. This is to avoid the degradation of the planet and to guarantee the availability of resources for future generations.
6. THE MINIMAL BIOECONOMIC PROGRAM In the current context in which the well-being in industrialized societies decreases, while the problems of inequality of distribution in the use of resources become more and more acute, Georgescu-Roegen (1976, pp. 30-35) proposes a ―minimal bioeconomic program‖ with which he provides some suggestions on the principal actions that mankind should take in order to put an end to the destructive use of natural resources and to guarantee mankind a better future in the pursuit of well-being. The eight points of this program can be summed up as such: 1) To prohibit the production of means of war. This, apart from avoiding mass massacres, would free up productive forces immensely. 2) To use resources, among which those made available by disarmament, in order to help the developing nations to reach a dignified standard of living. 3) To attempt to reduce the population of the Earth, taking it to a level so as to be able to satisfy its needs only through organic agriculture, based essentially on the solar energy. 4) Until man is able to control solar energy or another form of energy or a series of other forms of clean energy, all waste of energy must be avoided (excesses of illumination, heating, refrigeration, etc.) resorting to rigid regulation, if necessary. 5) The same should be applied to materials, discouraging the production of extravagant items and useless gadgets. 6) We must then move away from those purchases dictated only by fashion, defined by the author as bioeconomic crime. 7) Producers should concentrate on the planning and realization of assets made to last, repairable in a simple and economic way and as far as possible recyclable once their purpose has been exhausted. 8) And last but not least, man should reclaim his time, redefining it socially and diminishing the pressure exerted by the economic system. This minimal bioeconomic program must take into account both the present and future generations. However, the realization of ―healthy conservation politics‖ needs collaboration between all nations, rich and poor.
7. ENTROPY AND THE ECONOMIC PROCESS Georgescu-Roegen points out that what which man can use for his own aims is characterized by a low entropic state, that is from a structure with a high degree of order. In other words, man, in order to develop himself, has drawn on the low entropy contained in the materials and energy deposited underground.
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The low entropy contained within goods or a service, or employed for their production, is therefore represented as a fundamental element in the determination of its economic value. The law of entropy for the author is the scientific basis of value of use: the necessary condition, but not sufficient, because a thing that is useful is one which possesses a low entropy. All things considered, any material process associated with life consumes low entropy16. Entropy, according to this vision, being at the base of scarcity, becomes the ―physical substrate‖ of the economic value. Low entropy is needed but not sufficient alone for a thing to have value. But GeorgescuRoegen complains about the fact that the economists do not accept the physical utility as one of the causes of the economic value. Thermodynamics, instead, clarifies to us that the useful things also possess an economic value, not to be confused with the price, because they are scarce. Scarce not in the sense relating to the earth but because, first of all, the low entropy in our environment is decreasing in a continuous and unavoidable manner. Moreover, and the most important aspect in the economic process is this: a given amount of low entropy can be used only once. (Georgescu-Roegen, 1966, p. 94; 1971, 17 p. 278; author‘s own italics)
8. FROM THE MATERIAL TO THE IMMATERIAL FLOW OF THE «ENJOYMENT OF LIFE» The first conclusion which Georgescu-Roegen reaches with his physical analysis of the economic process is that this is subject to the law of entropy, therefore to the irreversible degradation of matter and energy, from forms usable by man to unusable forms (GeorgescuRoegen, 1976, p. 7). The second conclusion is that the economic process must also be subject to the First Law of Thermodynamics, that is to the Principle of Conservation of Matter-Energy: nothing is created and nothing is destroyed. The author states: Yet no one seems to have been struck by the question – so puzzling in the light of this law – ―what then does the economic process do?‖ All that we find in the cardinal literature is an occasional remark that man can produce only utilities, a remark which actually accentuates the puzzle. How is possible for man to produce something material, given the fact that he cannot produce either matter or energy? (Georgescu-Roegen, 1976, p. 53) Even if only the physical facet of the economic process is taken into consideration, this process is not circular, but unidirectional. As far as this facet alone is concerned, the economic process consists of a continuous transformation of low entropy into high entropy, that is, into irrevocable waste or, with a topical term, into pollution. (Georgescu-Roegen, 1971, p. 281; author‘s own italics)
The law of entropy, in this case, is not of use to us: if alone it is not sufficient to define the economic value, even less so to indicate to us the end goal of the same economic process. 16 17
Cf. Georgescu-Roegen (1966, p. 93; 1971, pp. 276-315; 1976, p. 227). See also Georgescu-Roegen (1976, pp. 96-102).
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From the material point of view, in fact, the economic process is limited to transforming resources of value into waste. Identification as the goal of the process of production of esosomatic instruments that allow man to evolve does not seem to be correct, considering the enormous production of extravagant and useless instruments. It is very rare that something is produced with the precise aim of allowing man to make an ―evolutionary leap‖. Georgescu-Roegen, therefore, asks himself: What could then be the raison d’être of such a process? The answer is that the true ―output‖ of the economic process is not a physical outflow of waste, but the enjoyment of life. (Georgescu-Roegen, 1966, p. 97; 1971, p. 282; 1976, p. 9; author‘s own italics)
He resolves in this way the paradox represented by the output of the economic process18. The enjoyment of life, being at the basis of the question, turns out to be complementary to the entropy in the determination of the economic value. The importance given by the author to this assumption makes appropriate to relate in full some of his affirmations: Without recognize this fact and without introducing the concept of enjoyment of life into our analytical armamentarium we are not in economic world. Nor can we discover the real source of economic value which is the value that life has for every life-bearing individual. (Georgescu-Roegen, 1966, p. 97)
Therefore, although he carries out his analysis on a material level, he sustains that the true product of the economic process is an intangible element, as he calls it: the still mysterious immaterial flux of the enjoyment of life. (Georgescu-Roegen, 1976, p. 9; 19 author‘s own italics)
9. THE ELEMENTS OF THE ENJOYMENT OF LIFE According to Georgescu-Roegen, the enjoyment of life goes beyond the general aseptic vital balance of a subject, comprising both the well-being derived from material goods as well as the well-being derived from the realization of aspirations and from the interests of an individual. Enjoyment is linked to the quality of the working time and the free time that the individual spends. The relational quality of life that an individual has the possibility of developing within a determined society is also implicitly included within this definition: We must come to realize that an important prerequisite for a good life is a substantial amount of leisure spent in an intelligent manner. (Georgescu-Roegen, 1976, p. 34)
18 19
Cf. Georgescu-Roegen (1971, p. 284). ‗The only feature it has in common with flow is that its dimension too contains the factor time.‘ (GeorgescuRoegen, 1966, p. 98, n. 10). Cf. Georgescu-Roegen (1971, p. 284).
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In this vision the ―income‖ of an individual acquires a different and deeper meaning, losing the dimension typically economic-material, referable to a monetary capacity. In the formation of well-being, that takes on a full meaning, are involved elements that cannot be reduced to a quantity, social and relational elements that allow only for a qualitative description. The points of contact of this position seem to be evident with the current studies on happiness and the importance of social capital20. In Georgescu-Roegen‘s opinion, the enjoyment of life is determined by three factors: two influence positively, while one decreases it. The flow of consumer goods and enjoyment of free time enhance quality of life while the stresses of work decrease it (Georgescu-Roegen, 1971, pp. 285-290). The first factor is the flow of consumer goods, without which there could not even be human life. The second factor considered, that characterizes this formulation, is the enjoyment of free time. First of all, we define free time as a ―value‖ in terms of income of time subtracted from work. In the second place, as the enjoyment of life grows with the increase in the flow of the goods consumed, the same happens with the increase in free time. In fact, the availability of a very low amount of free time because of an increase of the working time, can jeopardize the enjoyment derived from the consumption of goods, thus negating the possible positive results of that increase in income that had been achieved by working more. Moreover, we should consider that the impact of work on the enjoyment of life it is not only linked to the decrease in free time, but also to the disutility and stresses, mental and physical, linked to a profession. We arrive thus at the third factor: the stress of working. In this case, what renders a mental or manual job onerous is taken into consideration, for example: the monotony, the alienation, the environmental conditions, the working hours, the relational climate and so on. However, we must bear in mind that in the case in which the work carried out corresponds to the aspirations of the individual, allowing him to realize himself and to feel satisfied, the stress diminishes and it could, theoretically, be reset to zero and as such not impacting negatively on the enjoyment of life and even increasing it. Obviously these elements are linked to one another, the working activity, apart from the time that it requires, also conditions in an indirect way the possibilities of enjoying the remaining time and the consumption of goods. As such, the way in which free time is used can be reflected both in consumption and on the possibility of changing job, through, for example, training courses. However, the three factors that affect the daily enjoyment of life must be separated preliminarily if we wish to reach an analytic representation.
10. THE GENERAL EQUATION OF VALUE Georgescu-Roegen, a mathematician of excellence, was aware of the fact that the mathematical formulation of a concept is an instrument from which the economy cannot be separated, being a universal language through which the scientific research expresses itself and communicates all over the world. He therefore comes to elaborate a formulation of the enjoyment of life through what he defines as the general equation of value, even if he 20
Among the greatest exponents of this formulation we find the winner of the Nobel prize for economics, Amartya Sen and the winner of the Nobel prize for peace, Mohammed Yunus.
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perceives that this is only a symbolic representation, that is the mathematical symbols are not used in their most rigorous meaning, but more like pointers in order to summarize the imponderable elements that enter, with positive or negative valence, in the entity that defines daily enjoyment of life (Georgescu-Roegen, 1971, pp. 283-291). Considering that the enjoyment of life is increased by the flow of consumer goods and by the enjoyment of free time and diminished, instead, by the stresses of work, it can be written: e = Consumption Enjoyment + Leisure Enjoyment – Work Drudgery Explaining in terms of price and of categories of yield, the general equation of value becomes: Income = Royalties + Rent + Interest + Leisure Income or: Income = Net Product + Leisure Income – Wages In Georgescu-Roegen‘s opinion, this equation represents a general formulation because the several formulations of value by the previous greatest doctrines can be seen as particular cases referring to it21.
11. THE INHERITANCE OF THE THOUGHT OF GEORGESCU-ROEGEN Georgescu-Roegen died in 1994 and was able to counter argue in a rigorous and lucid manner against the majority of the criticism addressed at him, in particular concerning the Fourth law of thermodynamics. However, he was not able to complete an attempt to write a work that expressed in a complete and organic way his bioeconomic theory. Even not having created a school of thought, the influence of Georgescu-Roegen can be found in many scholars engaged in the analysis of the human social and economic development, including in Italy. From his Bioeconomics is derived the school of thought of the Ecological Economics founded by the former student Hermann Daly. Among the disciples of the author, are also Gabriel Lozada, still in the United States of America, Kozo Mayumi in Japan and Jacques Grinevald in France. Among the continuers of the concept of Georgescu-Roegen we find the Spaniard Juan Martinez Allier, who has been able to interpret the bioeconomic theory coherently, not limiting himself to a simple restatement, but making it merge without contradictions or breaches, into the actual current of the Ecological Economics. Experts of the bioeconomic concept are also John M. Gowdy in the USA, Charles Perrings in England and Joseph Constantine Dragan and Mihai C. Demetrscu in Romania22.
21
The author (1976, pp. 288-290) compares the general equation of value with the formulations of Ricardo, of the Neoclassical and of the Marx school. 22 Cf. Mayumi & Gowdy (1999), Dragàn & Demetrescu (1993; 1997).
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Jeremy Rifkin, one of the most asserted and read scientific communicators and interpreters of today‘s society, defined Georgescu-Roegen as a ―prophet and teacher‖ (Rifkin, 1989). It is probably precisely the activity of Rifkin that represents the most faithful commitment to the bioeconomic approach: to join scientific knowledge and the observation of truth in order to implement those political and economic choices aimed at achieving social wellbeing and environmental protection in the long term. With the passing of time and the sharpening of the environmental crisis, the criticism levelled against bioeconomics show more and more their fallacy yet nevertheless the concept of decrease wished for by GeorgescuRoegen still remains a taboo for the dominant economy.
12. THE INFLUENCE OF GEORGESCU-ROEGEN ON THE ITALIAN STUDENTS Whilst not always being evident or expressly recalled, the influence of the knowledge of Georgescu-Roegen and his works has represented an important moment in the evolution of the thought and of the paths of study of many Italian scholars. Some of them are cited by the author (1988) on occasion of a preface: Giacomo Becattini, Mercedes Bresso, Vittorio Castellano, Silvana De Gleria, Emilio Gerelli, Romano Molesti, Giorgio Nebbia, Giuseppe Palomba, Piero Tani and Enzo Tiezzi23. Stefano Zamagni and Mauro Bonaiuti are other two Italian authors that deserve particular mention. Zamagni (1982) drew up the introduction to the Italian edition of Energy and economic myths, he is the author of a volume on Georgescu-Roegen‘s theory of consumer‘s behaviour (1979), and of numerous essays at international level on the Roegerian contributions. Zamagni is currently one of the greatest Italian scholars of happiness and supporter of the centrality of man in the economic processes through that formulation that takes the name of ―civil economy‖24. Bonaiuti has instead published two volumes (2001; 2003) in which he presents a synthesis of the concept of Georgescu-Roegen, presents again some significant works of this author and delineates an implementation of the bioeconomic principles in today‘s economic order. Moreover, Bonaiuti, supporter of the decrease (2005)25. Many of the bioeconomic intuitions find their origin in the studies of the agrarian economy, a link that still has much to say. It wasn‘t merely by chance that the manifest Toward a human economics26, produced in October 1973 by Nicholas Georgescu-Roegen, Kenneth Boulding and Herman Daly, and undersigned by more than 200 economists, was published for the first time in Italy on a volume edited by the agrarian economist Giovanni Cannata (1974)27. Among the agrarian economists, must also be emphasized the contribution 23
Cf. Becattini (1973), Bresso (1982; 1993), Castellano (1966), De Gleria (1999), Gerelli (1971), Giampietro (1993; 1999), Molesti (1995; 2003; 2006), Nebbia (1997; 1998), Palomba (1970), Tani (1986; 1988), Tiezzi (1999). See also Pucci (1992) and Crivelli (1993). 24 On the Italian Classical authors of the XVIII century, see note 33. 25 Bonaiuti has contributed to introducing the Rougerian works to Serge Latouche, famous for his work on economic anthropology in which he supports convivial decrease and localism. 26 It was printed in the American Economic Review, 1974, Vol. 64 (n. 2), pp. 447, 449-450. 27 The translation Verso un’economia umana was published in: Cannata (1974, pp. 239-244); Economia e Ambiente, 1983, vol. II (n. 1-2), pp. 70-74; Georgescu-Roegen (1998, pp. 207-210).
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of Sergio Vellante. He supports that the Agrarian Economy, by analyzing and interpreting the productive processes pivoted on the biological cycles, cannot be assimilated to the standard economy28.
13. CONCLUSION The original bioeconomic approach could be inserted easily into the Italian tradition that has shown a particular propensity to the search for the well-being for the individual, through a society in which the economy meets the needs of the society, enhancing and protecting the country. This formulation has characterized the analysis of numerous Italian students of the past: from the Italian Classic authors of the XVIII century29 – Genovesi, Beccheria, Verri, Galiani – to Giuseppe Toniolo between the XIX and XX centuries, to Guido Menegazzi30 and Arrigo Serpieri in the second half of the XX century31, to name but a few. Such contributions, in the light of the principles of Bioeconomics and its rigorous scientific system, could be recovered, updated and used in order to propose new solutions on a human and eco-compatible scale, and guarantee a long-lasting development.
REFERENCES Antonelli, G.B. (1886). Sulla teoria matematica della economia politica. Pisa, Italy: Tipografia del Falchetto. 28
Vellante maintains therefore that in such a discipline, the bioeconomic approach is implicit, having as a starting point the conversion of solar energy through the chlorophyllian photosynthesis, an element on which the life of the planet is based. On this approach see: Nicolais & Vellante (2008); Vellante (2007). 29 In Enlightenment a complex theoretical approaches were forming and developing in Italy: the Scuola Napolitana – Genovesi, Filangieri, Galiani, Palmieri e Fuoco –, the Scuola Toscana – Bandini – and the Scuola LombardoVeneta – Beccaria, Verri, Ortes e Zanon –. This authors have special attention to local situations, and the promotion of agriculture to stimulate collective wealth. See Nardi Spiller (1991). This way to perceive the economic analysis, defined as ―civil economy‖, was analyzed, reworked and made topical by Zamagni and Bruni (2004). 30 Toniolo, sociologist and catholic economist, based his scientific activity on an interdisciplinary approach. He sustained that the well-being of the individual was provided by a combination of factors: economic, political and social. The objective of Toniolo was to show the foundations of an ―organic society‖ that would correspond to the aims of the individual, society, the State and civilization. (Toniolo, 1882; 1897). This formulation is shared by Guido Menegazzi (1965, pp. 534-535; 1966). According to Menegazzi, society had to be re-formed taking into consideration the ―vital order‖ based on the ―law of reciprocal strengthening of values‖. According to this law, the financial values are subordinate to those that are economic which in turn are subordinate to human needs (Menegazzi, 1970, pp. 72-98). Toniolo, Menegazzi and Georgescu-Roegen embrace the complexity of the individual and of society in their analyses and they move according to a well defined idea of purpose of the economic process and they reach analogous conclusions. According to Georgescu-Roegen, the final aim of the economic process is the enjoyment of life, that concerns the satisfaction of the physical, intellectual and relational needs of an individual. According to Menegazzi, the economic values must be appropriate to the ethical-spiritual values. On the basis of the religious or ethical viewpoint of an individual, the reference values can be derived. Finally Toniolo sustained that it was the ethical and spiritual values that favoured economic development and not the economy that determined civilization. 31 Arrigo Serpieri is the founder, in Italy, of Agrarian Economics according to the approach of ―Economia della Vita‖ mentioned above with reference to the biological components and to the transformation of solar energy conducted by vegetables. Among the agrarian economists, we should also remember Emilio Sereni, an original interpreter of the evolution of the agrarian landscape, and Manlio Rossi Doria, a high level scholar of the structure and problems of agriculture in Southern Italy. Cf. Serpieri (1957), Sereni (1961), Rossi Doria (2005).
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Menegazzi, G. (1970). Il piano dello sviluppo solidale dei popoli. Milan, Italy: Giuffrè. Molesti, R. (1995) (ed.). Economia e Ecologia. Pisa, Italy: IPEM Edizioni. Molesti, R. (2003) (ed.). Economia dell’ambiente e bioeconomia. Milan, Italy: Franco Angeli. Molesti, R. (2006). I fondamenti della Bioeconomia. Milan, Italy: Franco Angeli. Nardi Spiller, C. (1991). La Théorie Economique et la Stratégie Politique de Genovesi, Galiani, Bandini, Beccaria, Verri et Ortes. Rivista Internazionale di Scienze Economiche e Commerciali, Vol. XXXVIII (n 4), pp. 369–383. Nebbia, G. (1997). Nicholas Georgescu-Roegen economista radicale. Economia e Ambiente, Vol. XVI (n. 1-2), pp. 6-8. Molesti, R. (1998). Introduzione. In Georgescu-Roegen, N. (1992), Energia e miti economici. Second edition, Turin, Italy: Bollati Boringhieri, pp. 7-21. Nicolais, L. & Vellante, S. (2008). Tra bioeconomia e bioingegneria: quale sviluppo? Economia e Ambiente, Vol. XXVII (n. 1-2), pp. 7-16. Palomba, G. (1970). Tra Marx e Pareto. Naples, Italy: De Simone. Pareto, V. (1906). Manuale di economia politica. Milan, Italy: Soc. Ed. Libreria. Prigogine, I. (1961). Thermodynamics of Irreversible Processes. New York, USA: John Wiley and Sons. Pucci, L. (1992). Nuovo lusso e scarsità ―entropica‖: paradossi e prospettive. Il Pensiero Economico Moderno, Vol. XII (n. 4), pp. 77-86. Rifkin, J. (1980). Entropy: A New World View. Afterword by Nicholas Georgescu-Roegen. New York, USA: Viking Press. Second edition, revisited: Rifkin, J. (1989), Entropy into the Greenhouse World. Afterword by N. Georgescu-Roegen, New York, USA: Baniarn Books. Rossi Doria, M. (2005). La polpa e l’osso. Agricoltura risorse naturali e ambiente. Edited by Gorgoni, M., Naples, Italy: L‘Ancora del Mediterraneo. Samuelson, P.A. (1938). A Note on the Pure Theory of Consumer‘s Behaviour. Economica, Vol. V (February), pp.61-71. Sereni, E. (1961). Storia del paesaggio agrario italiano. Bari, Italy: Laterza. Serpieri, A. (1957). Scritti di economia agraria: 1946-1953. Florence, Italy: Le Monnier. Tani, P. (1986). Analisi microeconomica della produzione. Rome, Italy: NIS. Tani, P. (1988). Flow, Funds and Sectorial Interidpendence in the Theory of Production. Political Economy, Studies in the surplus approach, Vol. 4 (n.1), pp. 3-21. Tiezzi, E. & Marchetti, N. (1999). Che cos’è lo sviluppo sostenibile?. Rome, Italy: Donzelli. Toniolo, G. (1882). Dei remoti fattori della potenza economica di Firenze nel Medioevo, Milan, Italy: Hoepli. Reprinted in Toniolo, G. (1952), Opera Omnia. Edited by Comitato Opera Omnia di G. Toniolo, series I, Vol. IV, Vatican City: Angelo Belardetti Editore. Toniolo, G. (1897). Il concetto cristiano della democrazia, prima pubblicazione in ―Rivista internazionale di scienze Sociali e discipline ausiliarie‖, Vol. XIV, pp. 325-369. Reprinted in Toniolo, G. (1949), Democrazia Cristiana. Concetti e indirizzi, vol. I, Opera Omnia, series III, Vol. II. Edited by Comitato Opera Omnia di G. Toniolo, Vatican City: Angelo Belardetti Editore, pp. 17-90. Vellante, S. (2007). Bioeconomia e Mezzogiorno. Questione meridionale o euromeridionale?. Economia e Ambiente, Vol. XXVI (n. 6), pp. 3-14. Zamagni, S. (1979). Georgescu-Roegen. La teoria del comportamento del consumatore. Milan, Italy: Etas Libri.
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Zamagni, S. (1982). Introduzione. In Georgescu-Roegen, N., Energia e miti economici. Turin, Italy: Boringhieri, pp. 9-21. Zamagni, S. (1999). Georgescu-Roegen on Consumer Theory: An Assessment. In Mayumi, K. & Gowdy, J.M. (eds.), Bioeconomics and Sustainability, pp. 103-124. Zamberlan, S. (2005). Il pensiero di Nicholas Georgescu-Roegen: un nuovo fondamento epistemologico per la scienza economica. Il Pensiero Economico Moderno, Vol. XXV (n. 3-4), pp. 47-74. Zamberlan, S. (2006). La critica alle teorie dell‘utilità e del comportamento del consumatore di N. Georgescu-Roegen. Nuova Economia e Storia, Vol. XII (n. 1), pp. 49-73. Zamberlan, S. (2006). Una visione alternativa della teoria della produzione. Nuova Economia e Storia, Vol. XII (n. 2-3), pp. 35-62. Zamberlan, S. (2006). Economia e biologia. La Teoria Bioeconomica di Nicholas GeorgescuRoegen. Il Pensiero Economico Moderno, Vol. XXVI (n. 4), pp. 69-91. Zamberlan, S. (2007). Il «godimento della vita» nella teoria economica. Nuova Economia e Storia, Vol. XIII (n. 2-3), pp. 65-80. Zamberlan, S. (2007). Economia, ambiente e benessere sociale. Il Pensiero Economico Moderno, Vol. XXVI (n. 3), pp. 99-108. Zamberlan, S. (2007). Dalla critica dell’utilità al godimento della vita: il pensiero bioeconomico di Nicholas Georgescu-Roegen. Pisa, Italy: IPEM Edizioni.
In: Issues in Economic Thought Editors: M-A. Galindo, C. N. Spiller, pp. 117-134
ISBN 978-60876-173-9 © 2010 Nova Science Publishers, Inc.
Chapter 7
THE CITY AND THE URBAN NETWORKS: THE CONTRIBUTION OF ITALIAN URBAN GEOGRAPHY Paola Savi University of Verona, Italy
ABSTRACT Geo-economic analysis of urban territories studies the economic, social and political mechanisms that govern the organisation and differentiation of urban land use on the one hand, and the functioning of urban networks on the other. The geography of the city explains how economic functions, households and social groups locate within urban space, and proposes models of urban land use. The network approach, instead, views cities as nodes in urban systems of different scales, and analyses both the horizontal relationships (hierarchies, complementarities, and specialisations) between nodes in the network and the vertical relationships of nodes with their local milieu. This dual perspective is well established in the international literature, and serves as a reference point from which to discuss the contribution of Italian geography to the study of the urban phenomenon, with special emphasis on the geography of networks and the scientific role of the Scuola di Torino.
JEL CODES: O14; P25; R11; R12; R14
1. INTRODUCTION Urban geography is a relatively recent discipline, born in the early decades of the twentieth century when the importance of the urban phenomenon became apparent from a number of different standpoints (economic, social and political). Until the first industrial revolution, in fact, the demographic and topographical development of cities was of scarce
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relevance, urban land use was functionally undifferentiated, and relations between cities were mostly limited to trade. In the nineteenth century, with the onset of the industrial revolution, cities ceased merely to be centres of commercial, cultural and religious functions, and became manufacturing centres also. Factories, born of the industrial revolution, were located in cities and had a radical impact on the organisation of inner space and on the relations between cities and non urban territories. At the same time, the complexity of the industrial phenomenon led to the formation of dense networks of relations between cities, according to their individual functions and economic specialisations. Since its origins, urban geography has pursued this dual line of enquiry, focussing on the study of the city as a separate entity on the one hand, and on the analysis of the economic, social and political mechanisms that explain the organisation and functioning of urban networks on the other. Intra-urban analysis highlights how cities have, first and foremost, an areal dimension: economic functions, households and social groups locate following frameworks that urban geography has attempted to define, both by proposing models of urban land use and by conducting inductive and descriptive research. Intra-urban space is a complex and fluid reality shaped by transformations on the global economic and technological stage, and by the actions of local and supra-local actors. The network approach considers cities as nodes in urban systems of different scales, and analyses the horizontal relationships (hierarchies, complementarities, specialisations) that are established between nodes in the network and the vertical relationships of the nodes with their territorial milieu. The intersection of these two relationships gives rise to what is called urban dynamics. This dual analytical perspective is well established in the international literature and provides the basis for discussion in this paper. We examine the contribution of Italian geography to the study of the urban phenomenon, dwelling in particular on the geography of networks and the scientific role of a group of geographers from the University of Turin whose work has developed into a school of thought.
2. THE BIRTH AND EARLY DEVELOPMENT OF URBAN GEOGRAPHY IN ITALY: 1900–1950 In Italy, urban geography was born as an autonomous discipline with its own theory and methodology in the 1920s (Toschi, 1966; Cori, 1983; Cori, Corna Pellegrini & Dematteis, 1993). As Salinari‘s bibliographical survey (1948) of the period 1901–1941 highlights, until the immediate post-war period all that existed were studies on specific aspects of the urban phenomenon (the topographical development of cities; urban neighbourhoods; the role of geographical factors, particularly position, in the economic life of cities) and chapters dedicated to cities within treatises and compendiums of geography. There was little empirical analysis of Italian cities. Of the empirical studies, we can cite the work of Piero Gribaudi (Gribaudi, 1909) on the geographical position and the demographic and topographic development of Turin,
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effectively the first example of a systematic study of an Italian city, as well as the comparative analysis of Italian and American cities by Marinelli (1919). Among the promoters of the new line of enquiry, in addition to Gribaudi we remember Almagià, Roletto and above all Umberto Toschi, the most important Italian scholar of the first half of the twentieth century. Toschi departed from a series of empirical studies on the city of Bologna, and in the 1930s the early conceptual scheme he developed and the principles he defined provided the basis for new lines of research in urban geography. In its early days, Italian urban geography developed in the two directions that delineated at the international level methods and topics of research, also considering developments on the empirical front. In Italy, it was Toschi (1947, 1966) who established the distinction between the geography of the city and the geography of cities. The former approach focused on the analysis of single cities, underlining the morphological features that made each city a unique entity distinct from any other. The end product was the urban monograph that, as a rule, examined location (site and situation, topography, origin and historical development), growth (topographical, demographic and functional) and internal differentiation (morphological analysis, including the study of the form of the city and the urban plan)1. On the other hand, the geography of cities, or as Toschi defined it, poleogeography, studied the diversification of the urban phenomenon, and constructed typologies of cities on the basis of geographical features selected as discriminants (spatial distribution; size; origin and relationship with the natural environment; and economic functions). From the late 1930s onwards, Toschi‘s teaching contributed to the formation of an initial corpus of urban geography studies, consisting mainly of monographs of Italian cities; this line of research remained very popular until the 1960s. With the exception of Gribaudi‘s work on Turin, these monographs analyzed small towns rather than the major Italian cities. Acclaimed scholars (P. Gribaudi, Assunto Mori, and Almagià as well as Toschi) and promising young researchers (including Sestini, Scarini, Landini, Alberto Mori, and Baldacci) all contributed to the study of urban geography. The second theme, the geography of cities, was developed mainly in essays and more general works. Although Italian urban geography maintains the key distinction between the study of the city and the study of cities, current research themes and perspectives are a far cry from the innovative work produced in international circles in the first half of the 20th century; there is also a tendency to take a descriptive rather than an interpretative approach. As far as the geography of the city is concerned, in the early decades of the 20th century in the United States the first models of the location of functions within urban space were formulated. Empirical research conducted by the Chicago School of Urban Sociology (Burgess, Park and McKenzie) in the industrial cities of North America in the 1920s identified concentric rings within which economic activities and social groups located2. This field of research inaugurated by the Chicago School was labelled Urban Ecology owing to the fact that the authors borrowed processes and concepts from the natural sciences to explain the functional and social articulation of urban space. 1
The geography of the city embraces both urban geography and town planning. Toschi (1966) acknowledged the importance of collaboration between the two disciplines, although he identified separate fields of inquiry: geography studied the city itself, while town planning was concerned with intervention strategies for planners. In current terms, we can say that the former belongs to the field of inquiry, the latter to field of planning. 2 Chicago was considered a reference model, to which other USA cities were compared.
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The best known of the models, Burgess‘ Concentric Ring Model (Park, Burgess & McKenzie, 1925), presented urban space in five concentric rings formed through a process of invasion and succession. From the centre (the Central Business District), a social class or a type of functions progressively occupied the space left free by another class (or function) that, due to social accession or changes in the economic or social context, moved outwards towards higher quality areas and residences. As a result, central areas progressively deteriorated and were ultimately abandoned. This process led to marked spatial segregation: economic functions and social groups tended to cluster in separate areas. The minimisation of distances within social groups led to the formation of ghettos, or at the opposite end of the scale, exclusive neighbourhoods (Lando, 1988). Although Burgess‘s pattern was criticised for its rigidity3, it paved the way for a series of studies and alternative models of urban land use, including Hoyt‘s Sector Model (1939) and Harris and Ullmann‘s Multiple Nuclei Model (1945). In the former model, the structure of the city extended along major communication routes; in the latter model it developed in nonadjoining clusters. A number of factors conditioned the location of urban functions and residences: communication routes, real estate prices, the strategies of estate agents, and the well-known mechanism of external economies of urbanisation4. As far as the geography of cities is concerned, it was in the first half of the 20th century that the analysis of urban networks emerged. The birth of network geography is identified with the work of Christaller (1933), who devised a general theory to explain the spatial location of tertiary activities (particularly household services). More generally, Central Place Theory explained the spatial distribution of settlements in urban systems, and postulated that relationships between cities and between a city and its surrounding areas derived from their different functional specialization. Departing from a series of simplified assumptions and through a process of logical and deductive reasoning, Christaller devised a set of laws to explain the organisation of urban systems according to a hierarchy of levels determined by the supply of services of the different cities. In spite of the abstract nature of his model, Christaller introduced a series of innovations to the study of geography. His method, derived from economics, highlighted how the spatial organisation of urban networks was grounded on the functional and spatial division of labour, and how the territorial distribution of centres was determined by the economic convenience of consumers and suppliers (Conti, 1991). The most useful and innovative part of his theory was the definition of the concepts of threshold, range, order, market area and functional hierarchy, and the careful explanation of the interdependencies between central locations (Berry & Garrison, 1958)5. Only after the Second World War, following translation into English and circulation in the Anglo-Saxon world, did Christaller‘s Central Place Theory receive widespread acclaim. The geography of networks that developed in later decades was an offshoot of the work started by the German geographer, in both a positive and a negative sense. 3
The limits of the concentric model were evident even for Chicago, a city that developed on a substantially uniform plain and in a virtually concentric framework (Carter, 1994). 4 Anglo-Saxon urban geography developed various applications for models of urban land use, most of which were concerned with the spatial delimitation of the Central Business District rather the identification of the dynamic processes determining its development over time. See in particular Murphy & Vance (1954). 5 Among other things, the unrealistic initial assumptions, the theorems explaining the geometric model of the location of cities and the limited scope of empirical verification were too rigid and abstract to be confirmed in real life (Haggett, 1979).
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In the first half of the 20th century, alongside the work of Christaller, other models endeavoured to explain the formation of urban hierarchies. By evaluating the demographic dimension rather than the supply of services, it was seen that if urban centres were ranked in order of decreasing population size, the size of each centre was inversely proportionate to its position in the order. This relationship was formalised in Zipf‘s law (1949), also known as the Rank-size rule: Pr = P1 / rq Legend: Pr = population of the city ranked r r = rank of the city P1 = population of the largest city q = exponent equal to 1 Various interpretations of the rank-size rule existed. From an economic point of view, we can hypothesize that the dimensional distribution of the city was affected by economies of agglomeration and at the same time the minimisation of transport costs (Zipf, 1949). The former tended to concentrate, and the latter tended to disperse, population, production and consumption. In the event of equilibrium, Zipf‘s law with q = 1 would hold. Following Berry (1961), as a country‘s level of economic, political and social development became more complex, urban distribution tended to conform to the rank-size model that was assumed to represent a state of equilibrium in an urban system.
3. THE BOOM YEARS: 1950–1967 During the decade 1950–1960 Italian urban geography experienced a boom, as empirical research and attempts at theoretical modelling multiplied. Cori (1983) offered a number of explanations for this flurry of scholarly activity: the fashion for studies of the city that spread to other disciplines (geography, architecture, sociology, economics); the relative simplicity of the theme being suited to descriptive surveys as well as to theorizations; and the importance and visibility of the processes of urbanisation and urban polarisation that accompanied the rapid development of capitalism after the Second World War. Research tended to take up the themes pursued in earlier years, even though, within the two approaches defined by Toschi, new directions emerged. They will be more clearly defined in the subsequent decades. In the first current of research, the geography of the city, alongside traditional monographs based on morphological analyses6 the first urban monographs based on functional analyses appeared, the earliest and most significant example of which was Dematteis‘ study of Turin (1966). This was a new analytical approach that could be applied both to the study of the city, and as we shall see later, to the study of systems of cities. 6
The urban monographs focused principally on urban centres of limited importance and medium sized cities in Italy (above all in Central and Northern Italy) and overseas, and were authored by the young university geographers who established themselves after the Second World War: Nice, Ferro, Almagià, Fondi and Leardi.
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The new approach represented a significant step forward for the geography of the city. It complemented historical and morphological analyses by considering the economic weight and the functional diversification of the modern city, an approach Toschi himself had to some extent anticipated in his studies of the city. While morphological analysis had a unitary perspective, functional analysis of the city took a specialist approach: numerous sectoral studies offered in-depth analysis of single functions or critical issues7. Alongside functional monographs, studies on conurbations and city regions began to take shape, and represented the first efforts to broaden the horizons of urban geography to the analysis of the processes of expansion of the city, the relationship between the city and its environs, and the role of urban centres in coordinating territorial organisation. The stimulus for this type of research came from the rapid transformations of the cities in industrialised countries during Fordism. Although well established and popular as a theme overseas, in the 1950s it received little attention from Italian geographers8. The first systematic study was a survey of Italian conurbations by Sestini (1958), followed in the 1960s by the works of the Scuola di Torino that gave some idea of the fundamental role that this group of geographers would play in the development of urban studies. Toschi also indentified conurbations and city-regions as the most promising fields of inquiry in urban geography given the number of issues to resolve, particularly the city-country relationship and the urbanisation of rural landscapes. Research about urban land use remained unpopular in Italy, despite keen interest in this field overseas, particularly from an economic perspective. Departing from the generalisations of the School of Chicago, some spatial economists postulated a mechanism analogous to von Thünen‘s model of agricultural land to explain how locational rent applied to the city also (Dematteis, 1973). Using the same logical framework, Alonso (1964) formalised his model of urban land use9. He argued that bid-rent was determined by competition between urban functions to gain favourable location in order to minimise transport costs. Activities able to pay the highest bidrents located in the most accessible zone of the city, the centre (service activities), and in the ring surrounding the central district (industrial activities), whilst the households settled in peripheral areas. Since space at the centre was limited, rent was highest in this position and decreased towards the periphery (Vagaggini, 1982). The existence of several residential rings in a concentric system, typical of North American cities, was explained by considering the amount of land that each user required and the total amount of disposable income allocated to land, transport cost and other goods and services. The ability to pay bid-rent depended on the quantity of land required in relation to the desire to spend on other things. Assuming that the chosen quantity of goods and services was fixed at the minimun level, the remaining income would be divided between the quantity
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Industrial functions were analysed in the works of Russo on Cantù, Innocenti on Piombino, Cori on Pescara, Dagradi on Milan; commercial functions in the works of Dematteis on Turin and Vallega on Savona; tourist functions in the works of Brusa on Boario Terme, Vallega on Acqui Terme and Muscarà on Venice. Roletto (1952) studied Trieste as a regional centre; Pecora (1954) the urban region of Pavia; Toschi & Brambilla (1954) applied the concept of ‗urban area of influence‘ to Ivrea; Castaldi (1962) studied the Sorrento conurbation and Gambi (1960) the Strait of Messina conurbation. Alonso‘s reasoning departed from certain initial assumptions: space was homogeneous; agents had perfect knowledge of the market and behaved rationally; the most accessible positions were for all agents the most advantageous since they allowed minimisation of transport costs.
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of land required and transport costs (Vagaggini, 1982). A number of mathematical models of the supply and demand of urban land use were formulated on the basis of this reasoning10. Another theme that was to receive due attention in Italy only in later decades was the spatial segregation of human populations in cities in relation to status and social prestige. From an applicational perspective, the hypotheses of the Chicago sociologies, and in general, all hypotheses relating to the spatial segregation of human populations based on social status were tested empirically using appropriately indicators; as a rule, occupation was the parameter used to indicate the social status of the human groups11. After the first empirical research about Chicago by O.D. and B. Duncan (1955), studies on individual cities proliferated, particularly in the Anglo-Saxon world. All substantially confirmed the phenomenon of spatial segregation of social groups. A significant step towards the refinement of quantitative methodology was the advent of Factorial ecology, a new thread of research introduced in the 1950s and 1960s by the American geographer Brian Berry. His aim was to identify the ecological differentiation of residential areas within urban and metropolitan communities. Departing from Burgess‘ principle that social distance was also physical distance and that urban populations, from a residential point of view, tended to group according to social class, it was possible using appropriate statistical methods, such as factorial analysis and cluster analysis, to formulate models of residential segregation. Within the geography of the city also, as mentioned above, an interest in functional research led to typological classifications of cities based on their functions. Toschi (1956) gave a strong contribution to this type of research. Parallel to the functional approach, a new regional research approach focused on the analysis of urban networks. Although studies of this type were new to Italian geography, they were common in Anglo-Saxon environments. By the late 1960s, the geography of cities abandoned comparative analyses in order to introduce the new theoretical models, particularly Christaller‘s central place theory. The result was a shift towards functional research that acknowledged the functional and hierarchical relationships between cities and enabled the identification and description of urban networks in regional units. This innovative research perspective was introduced by the works of Bonetti (1964) who popularised central place theory in Italy, and above all Compagna (1967). Compagna recognised the need for a change of scale, a progression from the descriptions of single cities or the classifications of cities towards the study of the urban systems. Among the forerunners of this approach, which took shape fully in the 1970s, were Saibene, Corna Pellegrini, Ferro, Mainardi, Nice, Mori, Cori and Sestini. Effectively, the evolution of the urban phenomenon in the form of conurbations, metropolitan areas, city-regions and megalopolises made the separation between the geography of the city and the geography of cities increasingly anachronistic. Even though the city continued to be analysed as an isolated object, both from a traditional perspective and using the innovative methodologies, network analysis established itself as the most original and fruitful line of inquiry in urban geography. 10 11
For a detailed survey of these models, see in particular Mills (1987). In particular, the dissimilarity index measured the compatibility or incompatibility of a residential location between two socio-professional categories; the segregation index was an index of dissimilarity between a certain groups and the remaining socio-professional groups; the residential location quotient represented the relative concentration of a socio-professional category within an urban subarea.
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4. FROM THE GEOGRAPHY OF CITIES TO NETWORK ANALYSIS: THE FIRST STAGE OF DEVELOPMENT (1967–1983) The geography of cities evolved rapidly during the 1970s under the thrust of theoretical formulations and methodological innovations imported from abroad, such as central place theory, the urban economic base theory and the rank-size rule. This advance was paralleled by recognition of the importance of the city in economic and territorial development processes, and of the possibility of urban geography and the other territorial disciplines for territorial planning. Within the context of the geography cities, interest in poleogeography declined even though significant results were achieved with the introduction of quantitative methodologies relatively unfamiliar at the time in Italy, such as principal component analysis and cluster analysis. We can cite the typological analyses of Italian towns by Bottai and Costa (1979); the analysis of the urban profiles of Italian provinces (Ridolfi, 1978); and Saibene‘s study on human settlements and socio-economic development in the Mezzogiorno (Saibene, 1978). During the period, regional studies became much more common, reflecting the effects of their diffusion in the scientific community and also their versatility. In the 1970s, regional studies embraced many different fields of analysis, including: 1. The phenomenon of urbanisation in Italy, the problems of city-country relationship and of the transformation of rural spaces; 2. The topographical and functional expansion of the city, with associated phenomena such as the formation of conurbations and the creation of metropolitan type relationships; 3. Urban gravitational areas, created by commercial activities and services, commuting, road and rail traffic; 4. Urban networks, hierarchies and central place systems. The latter two areas of research converged in theoretical and methodological terms: both applied theories in vogue at the time (central place, urban economic base, rank-size rule), and made copious use of quantitative methods (analysis of graphs, gravitational and probabilistic models, factorial analysis and cluster analysis). From a scientific point of view, the importance of the concept of urban network lay in the transition from a descriptive to an explanatory level in the analysis of cities and the urban phenomenon in general. Behind visible appearances, there were mechanisms and economic forces at work that shaped the processes of urban development. Moreover network analysis offered a base for regional policy. In this sense, studies on urban networks were a useful tool of applied geography to transform territories and control regional disparities through the redistribution of urban functions and the containment of city development. Such was the case of the Mezzogiorno, considered by many Italian experts an urban question.
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5. THE POST-INDUSTRIAL CITY: URBAN DECLINE, PERIPHERAL GROWTH, AND URBAN RECENTRALISATION From the mid 1970s onwards, the urban systems of advanced economies recorded a slowdown in the process of concentrated growth that had typically been in progress since the industrial revolution. Metropolises and larger cities ceased to attract population from rural and less urbanised areas and began to experience outward migration, entering a phase of demographic decline. At the other end of the spectrum, many small settlements, even located in peripheral regions with respect to the traditional centres of urbanisation, recorded positive migration balances. During the same period, in the large urban and industrial agglomerations manufacturing employment declined steadily, due to the closure of plants in industrial sectors in crisis or obsolete (iron and steel, chemicals and petrochemicals, shipbuilding and textiles) and also to the relocation of manufacturing activities to peripheral areas (outside the metropolises or in developing countries). Urban decline and deindustrialisation have hit with particular severity historically industrialised regions and cities, above all in the United States (the East Coast) and Central and Southern Europe (the Ruhr, Manchester and Liverpool in Great Britain, the Lorraine in France). As well as affecting urban networks, urban decline and deindustrialisation had a marked impact on the organisation of intra-urban space, giving rise to the phenomenon of dismissed areas, which was proportional to the pervasiveness of the process of deindustrialisation. From an interpretational perspective, the phenomena of urban decline and peripheral growth undermined the capacity of traditional theories and models used in geography to interpret urban and territorial dynamics. To explain these territorial processes, Berry (1976) coined the term counterurbanisation to describe the new urban model determined by the residential decisions of citizens and characterized by progressive population deconcentration, a phenomenon that could lead to dispersion and ultimately the death of the city, thus removing the contrast between city and countryside12. Other authors formulated descriptive models, such as the urban life cycle model (van den Berg, 1982; Drewett, 1986) that identified four evolutional stages crossed by western cities during their transition from industrialisation to post-industrial maturity (urbanisation, suburbanisation, disurbanisation, reurbanisation). Each stage was characterised by a progressive shift of population and economic activities from the core to the ring of the urban region. The gradual saturation of residential areas, diseconomies of urbanisation and the desire to live in less congested areas were proposed as motives that drive residents of large cities to abandon the core in favour of suburban and extra-urban areas, leading to the decline of cities. Progress in transport technology, the extension of communication networks and decentralisation policies implemented by public authorities all fostered urban decline. The model also envisaged a stage of reurbanisation in which the urban population started to grow once more, due to return migration of middle and upper social classes to the core, partly as a result of urban regeneration policies. 12
In empirical terms, urbanisation and counterurbanisation are measured as a statistical ratio between migration balance and population size in centres. A significantly positive ratio indicates urbanisation, in case of a significantly negative ratio, counter-urbanisation prevails (Fielding, 1989, p.84).
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More drastic hypotheses concerning the future of large cities were not borne out in subsequent years. The location of strategic tertiary and quaternary functions (headquarters of large enterprises, banks, insurance companies, financial institutions and important cultural organisations), of high-tech industrial sectors and many specialised small and medium sized enterprises did not conform to the logic of spatial diffusion and set in motion processes of urban recentralisation. Counterurbanisation and the growth of ‗peripheral‘ regions were witnessed in Italy also (Cencini, Dematteis & Menegatti, 1983; Celant, 1988; Dematteis & Petsimeris, 1989). In Italy, however, urban decline and de-industrialisation occurred a decade later than in AngloSaxon reality, with less intense effects; even peripheral growth presented specific characteristics related to the distinctive features of Italian economic and territorial organisation. Not all these episodes were of a pathological nature: restructuring of industrial apparatus was coupled with the emergence of flexible manufacturing systems of small and medium sized enterprises located principally in North East and Central Italy, outside the Industrial triangle based on the metropolitan areas of Milan, Turin and Genoa (Fuà & Zacchia, 1983; Landini & Salvatori, 1989; Conti & Julien, 1991; Conti, 1996).
6. THE NETWORK ANALYSIS: THE RETICULAR METAPHOR In the context of the studies about the revaluation of peripheral areas in Italy, the Turin geographer Dematteis (1983, 1985a) introduced the reticular theory to describe the new, typically non-hierarchical territorial configurations taking shape in Italy (and in other regions of industrially advanced countries) during the 1970s and 1980s. This idea represented a step forward with respect to Christaller‘s traditional image of a hierarchical, areal urban network that had been refuted by empirical evidence; it was also an alternative to interpretations based on stadial models. The formation of new, non-hierarchical territorial structures was perceived not only as a consequence of the transformations seen in the economies of advanced countries from the 1970s onwards, but also as an indication of the endogenous capacity of development of places. Despite inconsistencies with empirical evidence, in its earliest versions, the reticular model was still grounded on traditional theories, particularly Christaller‘s Central Place Theory. As Dematteis explained (1985a, p.125), in central place and polarisation models, physical distance was not a determinant variable but rather a means for representing intersubjective relationships. Consequently, an increase in the average distance between elements in the urban system, typically seen during the process of counterurbanisation, was not sufficient to invalidate the model. The transition from territorial concentration to territorial deconcentration could therefore be considered merely a change of scale in the territorial organisation of urban systems. The anomalies in Christaller‘s model provided a starting point for the formalisation of the properties of the reticular model. Nevertheless, moving from a description of the formal features of the model to an analysis of the causes that explained the formation of reticular structures, the rigidity and simplicity of Christaller‘s model in relation to the complexity of the factors at work at an economic and territorial level became evident. The appearance of
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new territorial configurations characterised even by non-hierarchical relationships between urban centres was mainly due to the new location logic of industrial and tertiary activities. The location behaviour of industrial enterprises in the digital era was of particular significance (Conti, 1991; Camagni & Salone, 1993). Macro-scale phenomena such as the spread of information and communication technologies and globalisation of the economy afforded a greater level of flexibility to firms, and a growing concentration of managerial activities. No longer vertically integrated, the firms evolved towards network organizational models of various types, ranging from mere decentralisation of production and routine tertiary activities to more complex forms of division of labour between firms, such as networks of firms (Emanuel, 1990). The variety of corporate organisational models was matched by an equal range of location behaviours of firms and their different functions. Given the automation of production processes and the diffusion of ICT, the location of standard and commonplace production reflected simple cost differentials. Externalities in less urbanised areas (availability of low cost space, abundance and flexibility of the work force, collaborative local administrations, availability of infrastructure and so on) made such areas preferable to large cities, where diseconomies of agglomeration were created. As a result of these processes, many production and service functions, which were concentrated until the 1970s in metropolitan areas, spread throughout the territory, forming equipotential networks (Dematteis, 1990a). The spatial organization seen within metropolitan areas was thus replicated on a larger scale, and gave rise to supra-regional entities within which the complementarities between centres supplanted the traditional hierarchical relationships of Christaller‘s model. The network lacked an organisational centre and the distribution of functions was random over time. The future development of such centres thus depends on which sectors choose to delocate there, since the creation of combinations of activities capable of initiating self-accumulating growth processes is unlikely. The location of advanced tertiary activities and specialised manufacturing functions has not however adapted to the common logic, since both require proximity of essential functions (service to enterprise, specialist competences, a skilled labour force, and rapid and efficient infrastructure networks); on the contrary, it has fostered concentration processes in metropolitan areas, in old urban cities, industrial districts or high-tech clusters. Alongside equipotential networks, multipolar networks or stable local specialisations have thus taken shape (Dematteis, 1990a). High-level industrial or tertiary functions have located non-randomly in nodes of urban networks that accommodate local agglomeration factors and specific vocations, formed through long-term processes of historical and cultural sedimentation. Activities tend to group in stable clusters, triggering self-organizational growth; complementarities and interactions based on respective specialisations establish between nodes. The reticular space is therefore not entirely de-hierarchized. Alongside complementarities, relationships of dominance and dependence persist and underscore the role played by nodes and strategically functional regions capable of governing territorial economic development. Unlike the hierarchical models, in reticular structure the possibility of a centre emerging as a strong node does not relate exclusively to size but rather to the ability to manage and mobilize its resources. The very concept of territory comes into play, and requires rethinking: location choices are made not in an undifferentiated and equipotential
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space but rather in a territory differentiated by a vast and unrepeatable range of historical and functional situations (Emanuel, 1990a; Conti, 1993). The presence of reticular structures has been verified empirically for certain groups of services (for enterprises and households): using a variety of statistical procedures (such as functional profiles and multivariate analysis) researchers have examined the difference between effective location of centres and the theoretical location pattern of Christaller‘s model used as a reference. Methodologies of this type have been applied in empirical research conducted in regions of North West Italy (Emanuel, 1989; Emanuel, 1990a); the studies highlighted the co-occurrence of decentralisation and recentralisation of urban functions not envisaged in the reference model. Alongside hierarchical functional relationships that confirm the polarising function of Milan, Turin and the main urban centres for high ranking activities, networks of horizontal relationships of interdependence and complementarity are taking shape; they can be seen around metropolises and small to medium urban centres, as well as mono-production areas or industrial districts along the pre-Alpine band in Piedmont. In these centres, analysis of functional profiles reveals activities of a level superior in rank to those predicted by Christaller‘s model, and conversely a lack of basic and intermediate services.
7. RECENT DEVELOPMENTS IN URBAN NETWORKS In the 1990s, studies of urban networks went through a period of great dynamism. From a theoretical standpoint, attention focused on the search for a conceptual framework more relevant than Christaller type models. Although traditional models were not entirely to be dismissed on logical grounds, they appeared increasingly anachronistic in relation to factual reality. The complex mechanisms governing relationships between nodes and networks, between the global and the local level, and the emergence of the phenomenon of local development could not be explained by static and deterministic schemes based on the idea of equilibrium. The very concept of physical distance, though related to geographical scale in Christaller‘s model, was of scarce relevance in an age when the frictional value of physical distance and the principle of spatial contiguity had faded (Dematteis, 1990b). According to Dematteis (1991a; 1994; 2001) some of the more recent versions of the theory of systems, particularly the theory of autopoiesis (Maturana & Varela, 1985; 1987), the theory of complex self-organized systems (Lazlo, 1986; Bocchi & Ceruti, 1985; Dumouchel & Dupuy, 1983; Dupuy, 1987; Morin, 1977; 1980; 1986; Prigogine, 1997) provided interesting cues for analysis of the behaviour of urban systems, particularly the mechanisms regulating relationships between nodes and the network13. Dematteis inferred from studies of local development important methodological indications for the analysis of territorial systems on a local scale, particularly in terms of the role of local and non local actors in selforganization phenomena.
13
The theory of autopoiesis emerged during research conducted by Maturana and Varela on the organisation of living systems that makes it possible to understand the process of knowledge. The reasons for the success of the theory in the social sciences is probably because the work of the two Chilean neurobiologists cannot easily be locked in a discipline or defined simply interdisciplinary.
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Table 1. Urban phenomena explained through the concept of self-organisation Type of phenomenon Suburbanisation-periurbanisation Urban demographic dynamics Dynamics of internal urban space
Evolution of urban systems
Dynamics of actors
Urban policies
Specific phenomena Emergence of peripheral satellite towns Proliferation of suburban shopping centres Urban growth Urban decline and counter-urbanisation Morphological transformations Location of urban functions Location of socio-professional groups Spatial segregation Urban income – density ratio Impact of urban amenities on residential location Emergence of settlement systems and dynamic, (nonChristallerian) hierarchies Revision of Zipf‘s rank-size rule Revision of Van den Berg‘s urban life cycle model (identification of growth limit) Individual shopping mobility Spatial-temporal behaviour of individuals inside and outside urban areas Simulations of interactions between urban actors Bottom up planning models Assessment of the impact of urban policies Assessment of the impact of new transport and energy networks
The Turin geographer‘s reflections belonged to a current of research on territorial systems perceived as self-organising systems that developed during the 1990s, and spawned several models (Pumain, St Julien & Sanders, 1989; Bertuglia, Bianchi & Mela, 1998; Bertuglia & Staricco, 2000). The self-organising behaviours that these models attempted to explain are summarised in Table 1. The local territorial system, defined by Dematteis (1994, p.14) as an aggregate of actors that in various circumstances may effectively behave as a collective unit (even though not formally recognised as such), is basically a self-organising system. It is the sense of identity that gives the system its autonomy with respect to the external environment and enables it to function, stimulated but not conditioned by external inputs. As well as the horizontal dimension of external relations, local territorial systems also have a vertical dimension: their relationship with the local milieu, in other words the resources (economic and productive, professional, cultural and physical features) located in the node that shape its identity. The milieu can be defined as a permanent set of social and cultural features not reproducible in the short term, activated by local agents and fed into the external circuit, thereby involving the node in the dynamics of the network (Dematteis, 1993). Dematteis (p. 61) lists the following as examples of milieu conditions: qualitative and quantitative aspects of the labour market; availability of land; infrastructures; industrial atmosphere and entrepreneurial aptitude; environmental qualities; degree of elasticity and vulnerability of the local eco system; image and level of social conflict. The introduction of the concept of self-organization and autopoiesis in the analysis of urban systems and of territorial systems in general has opened new pathways for the empirical
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research, in directions previously pursued principally by Turin geographers. We can summarise these as follows: a) Research on the nature and functioning processes of urban milieu (Savi, 1996; Governa, 1997); b) The sustainability of development (Dansero, 1996) c) Urban competitivity and methods of measurement (Conti, 2000; Vanolo, 2003); d) Development processes of peri-urban areas (Emanuel, 1999); e) Urban planning and relationships between self-organisation and local governance (Governa, 2000; 2001; Salone, 1999; 2001; Savi, 2004).
8. CONCLUSION In the preceding paragraphs, we have attempted to provide an overview of Italian urban geography from its origins in the 1920s to the present day. In many ways the discipline has matured and evolved, abandoning the descriptive approach characteristic of the first half of the twentieth century in favour of the more modern theories and methods developed in the international arena. This is demonstrated by the dynamism of the late 1960s and 1970s, when new theories and statistical methods previously relegated to the margins of national geographic research were introduced in studies of the Italian urban system. The process of adjustment has been far from passive: on the contrary, in the last two decades Italian geography has made an original contribution to the discipline, principally thanks to the ability to interpret in a non-deterministic fashion the dynamics and specificity of the Italian urban system, and to relate distinct but complementary lines of research. This is the case of the Scuola di Torino, where urban analysis links up local development themes and results from the more recent theory of systems. In the future, promising research themes include the problem of urban competitiveness, particularly in the light of the current economic and technological transformations that now compel territories, and not only firms, to fight for their survival.
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Savi, P. (1996). Il Veneto: milieu locali e dinamiche di rete. Milan, Italy: Franco Angeli. Savi, P. (2004). Auto-organizzazione e governance nei sistemi locali territoriali. In Baranzini M., Filippi E., Savi P. & Tondini G. (Eds.), Analisi economica e società civile (pp. 569590). Padua, Italy: Cedam. Sestini, A. (1958). Qualche osservazione geografico-statistica sulle conurbazioni italiane. In AA.VV., Studi geografici in onore di R. Biasutti. Florence, Italy. Sjoberg, G. (1960). The Pre-Industrial City, Past and Present. New York, USA: Free Press. Toschi, U. (1947). Geografia urbana. Città di Castello, Italy. Toschi, U. & Brambilla F. (1954). La determinazione dell’area di influenza di Ivrea. Ivrea, Italy. Toschi, U. (1956). Esame di coscienza di uno studioso di geografia urbana. Bollettino della Società Geografica Italiana, 9, pp. 507-513. Toschi, U. (1966). La città. Turin, Italy: UTET. Vagaggini, V. (1982). Le nuove geografie. Genoa/Ivrea, Italy: Herodote. Vanolo, A. (2003). Per uno sviluppo policentrico dello spazio europeo. Sistemi innovativi territoriali nell’Europa sud-occidentale. Milan, Italy: Franco Angeli. Zipf, G.K. (1949). Human Behaviour and the Principles of Least Effort. New York, USA: Hafner.
In: Issues in Economic Thought Editors: M-A. Galindo, C. N. Spiller, pp. 135-150
ISBN 978-60876-173-9 © 2010 Nova Science Publishers, Inc.
Chapter 8
ADAM SMITH ON EDUCATION AND ECONOMIC GROWTH: DIRECT AND INDIRECT EFFECTS Miguel-Angel Galindo Martin1 and María Teresa Méndez Picazo2 1
University of Castilla-La Mancha, Spain 2 University Complutense, Spain
ABSTRACT Adam Smith didn‘t develop his ideas about education in a chapter or in a concrete section of his work. His general research interests can be grouped into three sections: justice, moral and economics, and education can be included in all of them. In his analysis of justice, he considers that education exists in all kinds of societies and in their evolution the families, especially fathers, must be concerned about the education of their children. The reward of this effort to acquire education is that the salaries will be higher and must compensate the education expenditure. And considering an economic perspective, there is a relationship between education and the factors and variables that are growth-enhancing. In this sense, education is one element that can help to develop the division of labour‘s positive aspects and eliminate the negative ones. Economic advancement is achieved, among other things, through education. The main goal of this paper is to analyze all these relationships and show education‘s effects on those quantitative and qualitative factors, such as, division of labour, inequality, commerce, social strains, and social capital. It plays an important role in the economic growth process from Adam Smith‘s point of view.
1. INTRODUCTION Most economic literature has been developed on the theories, ideas and problems that Adam Smith showed in his publications, such as the division of labour, the role of government, the economic growth, Smith‘s philosophy, and the invisible hand. But in relative terms, theoreticians have paid much less attention to studying the role of the relationship
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between education and economic growth, which is surprising in the case of Adam Smith, not only because he spent an important part of his life teaching but also it is a relevant factor that improves the effects of those variables that are growth-enhancing in the Smithsonian economic growth model. However, relevant literature has focused on education (Freeman 1969, Rostow 1990, Bowman 1990, Skinner 1995, West 1996, Roncaglia 2005). In general terms, Adam Smith had three interests in his writings: moral, justice and economics. All of them are related to society. The development of individuals‘ activities needs a moral and a justice basement to place the economic activity. In a society like Adam Smith described, individuals act like merchants with exchange being their main activity that increases wealth. Education is an important factor to be considered when the creation and the distribution of this new wealth are analyzed. The problem is that Adam Smith didn‘t develop his ideas or theory on education in a chapter or in a concrete section of his work. If we accept the previous division of his writings it is possible to accept different stages in his ideas on education. The first stage corresponds to justice and it is basically developed in his Lectures on Jurisprudence. Education exists in all kinds of societies and in their evolution the families, especially fathers, must be concerned about the education of their children. The reward to acquire education is that the salaries will be higher and must compensate the education expenditure. Other economics motives are not considered, except in the last report where he introduced ideas that he will develop in The Wealth of Nations. The second stage is moral. Although education is a positive factor for the society that promotes prosperity, there is a moral risk that must be considered: the families could try to put their children to work as soon as possible, sacrificing their learning to obtain a salary. This question is considered in The Theory of Moral Sentiments. The third and final stage is to develop the relations between economics facts that improve economic growth and education. This analysis is carried out in The Wealth of Nations. Education is one element that can help to develop the division of labour‘s positive aspects and eliminate the negative ones. In this sense, Smith was very interested in the happiness goal, and considered that human happiness is related to the advancement of humanity (Fleischaker 2004, p. 69) that is achieved through education among other things. But education can cause other behaviors that would affect negatively on economic growth, such as the effects on salaries or the difficulty in reducing inequality gaps. All these aspects will be analyzed in this paper. In the next section, Adam Smith‘s economic growth main ideas will be studied. Section three will analyze the relationship between education and economic growth, taking into account different variables and factors: division of labour, inequality, commerce, social strains. The effects of social capital will be developed in section four. In section five we will analyze the main characteristics of the education policy proposed by Adam Smith. We will finish with the main conclusions.
2. ADAM SMITH ON ECONOMIC GROWTH As O‘Brian (1975) states, Adam Smith was very interested in economic growth and he showed this interest not only in The Wealth of Nations but also in his Lectures on Jurisprudence. He moved away from a Physiocratic system concentrated on the circular
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income flows considering the existence of a growth spiral that depends on two elements: the behavior of economic elements and the existence of what nowadays is named ―rule of law‖. Adam Smith developed a supply-side economic growth model1 that includes the economic elements that he considered relevant. In the model he introduced a production function considering that output growth depends on three factors: population growth, investment and land growth. Population growth depends on the available sustenance, investment on the rate of savings generated basically by capitalists, and land growth on technological fertility‘s improvements of unproductive lands or the conquest of new lands. Technological progress could also be growth-enhancing and the division of labour plays a relevant role in the process. Technological progress facilitates the production tasks and increases the competitiveness of the firms. The origin of division of labour is the effect derived from the certain individuals‘ propensity to barter, because they consider that it is the best way to transform costs of transacting into benefits (Smith, WN, I.ii.1). So, ‗As it is the power of exchanging that gives occasion to the division of labour, so the extent of this division must always be limited by the extent of that power, or, in other words, by the extent of the market‘ (Smith, WN, I.iii.1). Considering this origin and limitation, division of labour is a cause and an effect of economic growth. The capital accumulation process increases population and employment, and the manufactured goods are widened. This extent of market drives the division of labour and the effects derived from this division enhance economic growth. Higher economic growth will extend the market facilitating a new division of labour. But it is necessary to take into account that this division doesn‘t always have a positive effect on economic growth. Adam Smith in the Book I of The Wealth of Nations analyses the positive effects and the Book V shows the negatives ones2. From the positive effects point of view, division of labour shows three effects: ‗The greatest improvement in the productive powers of labour, and the greater part of the skill, dexterity, and judgement with which it is anywhere directed, or applied, seem to have been the effects of the division of labour‘ (Smith, WN, I.i.1). In modern words, these effects would be: First to increase skill; second to save time in the transition from one task to other, facilitating the machines innovation; and third to facilitate the development of natural and acquired talents. As division of labour increases output (increases "the extent of the market") it induces the possibility of further division of labour and thus further growth. For this reason, Smith argued that growth was self-reinforcing as it exhibited increasing returns to scale. The negative effect of labour division is showed in Book V (Smith, WN, V.i.f. 47-51) being mainly a social cost and not an economic one. It is due to the monotonous simple task to be developed by the worker derived from such division3. Education is the basic factor that is able to reduce or to eliminate this negative effect that limits the economic growth
1
An economic growth model based on Adam Smith‘s ideas is developed by Eltis (2000, chapter 3). It can be considered that from a macro point of view the effects are extremely positive, but form a micro perspective the costs of the division of labour are also greatly negative. On this topic see Rosenberg (1990). 3 In his Lectures on Jurisprudence Adam Smith considers other effects: ‗A man has then time to study only one branch of business, and it would be a great disadvantage to oblige every one to learn the military art and keep himself in the practice of it. The defence of the country is therefore committed to a certain set of men who have nothing else do; and among the bulk of the people military courage diminishes. By having their minds constantly employed on the arts of luxury, they grow effeminate and dastardly‘ (Smith, LJ, p. 540). 2
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possibilities4. And it is such an important limitation to economic prosperity that Smith introduces an exemption to his laissez faire approach considering that the government must care about education. Despite the existence of increasing returns, Smith did not consider growth as eternally rising: he posited a ceiling (and floor) to this process under the form of the ‗stationary state‘ where population growth and capital accumulation were zero. When a certain development is achieved, the investment opportunities are decreased and the demand for higher salaries reduces profits5. The nations will achieve this steady-state but the moment to achieve it depends mainly on two factors: First, commerce facilities and investment opportunities, and second, facilitating private property security. Together with these economic factors, in Adam Smith‘s economic growth analysis it is also necessary to consider non economic factors that can be grouped in the ―rule of law‖ concept in a broad sense6. The main elements included in this second group of factors are the property protection (Smith, WN, III.ii.1), the law of primogeniture that hindered the division of lands (Smith, WN, III.ii.5) and a free trade, domestic and foreign (Smith, WN, III.iv.1). Mixing all these factors, economic and non economic, it is possible to promote economic growth, creating a virtual circle as shown in figure 1. Thanks to this process, a reduction price is possible and this would lead to an increase of living standards. For this reason, it is relevant to lag as much as possible the stationary state achievement. There are different ways to achieve this delay, such as higher savings, property protection… and education is also an important factor to take into account to reach such a goal.
3. EDUCATION AND ECONOMIC GROWTH The main problem in the analysis of Adam Smith‘s education effects on economic growth is that there is not a chapter dedicated to this topic in his most important books. Education appears and disappears in his analysis and it would seem that it is considered as a secondary variable. In The Theory of Morals Sentiments the reference to education is very scarce, only to show that the families must be concerned about the education of their children. But in his Lectures on Jurisprudence and The Wealth of Nations there are more references on this factor, and both books could be considered as complementary. In this sense, the former stresses the role of families in the education process of their members, and afterwards the effects of education on some economic relations, being the base and advance of the development shown in The Wealth of Nations. In this latter work, the sequence is the opposite, because Adam Smith stressed economic variables and after introduced the institutional role, based mainly on families and government activities.
4 5 6
In this sense, Winch (1978: 119) considers education as an antidote to the corrupting influence of division of labour trying to introduce ancient provisions for gymnastic exercises and music. We will see later that education is a factor that enhances the salaries increase. This problem is solved by Adam Smith considering that division of labour is able to control this rise. Following Kaufman et al. (2003, p. 3) ―rule of law indicator‖ includes the elaboration of fair and predictable norms that are the basis for social and economic interactions, being a way to protect property rights.
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Division of Labour
High Returns
Savings
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Activity Supply
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Population Source: Own elaboration. Figure 1.
In general terms Adam Smith considered at least five ways in which the education influence on different factors and variables would have indirect effects on economic growth: division of labour, reducing inequality, decreasing social strains, commerce, and capital social formation. All these relations are valid nowadays although modern theoreticians also concede a certain relevance to other factors, such as health or fertility. Figure 2 shows the main relations that we will develop. We will analyze in the present section the four first effects and in the next section we will focus the analysis on social capital. Starting with division of labour, in the previous section we have shown its positive and negative effects on economic growth. In general terms, the positive effects derived from this division are: the division of labour facilitates the accumulation of capital, the increase of employment and most important, the creation of mechanisms to control the tendency of salaries to increase, due to, among other factors, the higher education level of the workers. Considering this last point, both in his Lectures on Jurisprudence and in The Wealth of Nations, Adam Smith considers that the salaries must include, among other things, the education expenses, so better education will increase wages. The main problem derived from it is that it would increase prices, reducing the extension of the market and driving the economy to the undesirable ‗stationary state‘. The salaries control established by division of labour eliminates this negative indirect effect of education on economic growth. So, Adam Smith reached, thanks to the division of labour, an economic situation with high rate salaries and prices relatively low, two important conditions to achieve a sustainable growth. This is possible thanks to higher labour productivity as a consequence of the introduction of new and more efficient machinery in the production process. The accumulation of capital increases the production capacities of the workers, needing fewer amounts of workers to produce a higher quantity of products (Smith, WN, I.viii).
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Education
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Economic Growth
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Education topics
Salaries
Equality
Commerce
Social conflicts Source: Own elaboration. Figure 2.
This statement is not valid when the capacity of production reaches its limits, there are supply ‗shocks‘ or the accumulation of capital doesn‘t increase in a growing population. In theses cases, it is difficult to keep prices relatively low and the growth path is negatively affected. New innovations are needed and in this case, a wider education policy than defended by Adam Smith must be introduced to facilitate the transmission and acceptance of new technology. The concentration of the workers on a single and simple task has as additional positive effect: the specialist is able to develop new and better tools and production methods. The specializing process encourages workers to think about ways to improve their production tasks that would be not possible in a whole process. The introduction of these new machines increases firms´ competitiveness being growth-enhancing. In this field the theory of knowledge plays an important role. It is not our objective to analyze such a theory, but two topics must be considered. First, there is a division in the ‗knowledge‘ concept between ‗knowledge that‘ and ‗knowledge how‘. The former is included in the content of the science and the latter in the performance of that science. Second, education must be considered in the development process of the knowledge. It is necessary to improve education because it is not only necessary to create knowledge, but also to use and accept it. Workers with higher education are more able to use the new production forms and to improve them. Finally, another positive effect of the division of labour is that it intensifies the social networks. The individuals to satisfy their necessities need to make contacts among them. As we have noted previously, individuals act as merchants and this implies accepting social behavior rules and transmitting ideas among the people. In this sense, the social capital concept must be considered and we will analyze it in the next section.
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First, this process of division of labour presents also negative effects in social terms. The simple production task to be carried out by workers is converted into a monotonous activity and the way to avoid this harmful effect is to impose on individuals the need to acquire knowledge through education. Second, the introduction of these easy tasks in the production process is an incentive for ―employment of very young children‖ (Smith, LJ)7 so the possibility of reduction of such negative effects through education is neglected or reduced. For this reason, among others, institution activity is necessary, reducing the education pricing and establishing rules that increase the ages of children to be employed. The second variable to be considered is inequality. In this sense, two inequalities are considered: personal characteristics and personal income. The personal characteristics considered are mainly industry, capacity and diligence. In this sense, Smith considers that there are no differences among individuals‘ talents, ―difference between most dissimilar characters, between a philosopher and a common street porter, for example, seems to arise not so much from nature as from habit, custom, and education‖ (Smith, WN, I.ii.2). Facilitating education it is possible to maintain the talents among individuals and encourages the improvement of the sciences and arts. In this sense, the main result of the single tasks introduced in the production process as a consequence of the division of labour is the egalitarianism in the production activity and capabilities among workers. So, talents are maintained as the source of inequality among human beings that is possible to avoid through education. The second inequality to be considered is personal income. Following Cantillon´s Essays Smith considers that the salary must be related to education effort to learn an activity: ‗Education in the ingenious arts and in the liberal professions is still more tedious and expensive. The pecuniary recompense, therefore, of painters and sculptors, of lawyers and physicians, ought to be much more liberal; and it is so accordingly‘ (Smith, WN, I.x.b.9). This statement has important consequences on the economic growth process. Income distribution has been considered as a factor that is growth-enhancing. If prosperity is achieved mainly through the individual frugality, as Adam Smith states, savings play an important role in the process. In this case, more resources must be shifted towards those individuals that show higher propensity to save. Turgot in his Reflections (1766) considered that savings are converted in investment and facilitated the development of the economy because they can be used in different types of capital. If individuals spend their resources on luxury goods, the effect would be the opposite. Adam Smith followed Turgot‘s idea stating that savings make a nation more prosperous, maintaining jobs and creating more future jobs (Smith, WN, II.iii.,18). The incentive to save is encouraged by individuals who want to increase their fortune and this is possible when they have high qualifications. Individuals with high education will receive more resources that they will save and this fact facilitates the accumulation of capital that promotes economic growth. The main problem is when moral aspects are considered because it is always possible for individuals to achieve and finance the necessary education. In this case, the inequality gaps would continue, and the
7
In this sense Smith (LJ, p. 540) adds that in Scotland ―where the division of labour is not far advanced, even the meanest porter can read and write, because the price of education is cheap, and a parent can employ his child no other way at 6 or 7 years of age. This however is not the case in the commercial parts of England‖.
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government must provide the necessary education to avoid all these problems and limitations8. It is also possible to connect both previous factors, that is, considering the production factors mobility derived from the division of labour process, and inequality. Thanks to the specialization and the fragmentation of tasks, many occupations and professions are created. Workers have more possibilities to obtain a job and the gap among salaries is reduced. All these circumstances then, facilitate the mobility among professions of industries and diligent individuals (Young 1997, p. 145). And education again is a source that facilitates such mobility because it helps them to develop their capacities. According to Sen approach9 and based on Aristotle, individuals have two kinds of capacities: natural and acquired. The latter is obtained by the experience, social behavior, activities developed by individuals…., and education helps to develop their capabilities. All in all, higher education gives to individuals the possibility of improve their knowledge and their capacities, reducing not only the salary gaps but also facilitating the mobility of skilled workers, for instance a farmer‘s son could become an engineer, obtaining a higher salary than his father10. In this sense it is also important to note that in The Wealth of Nations the society described by Adam Smith is characterized by a situation in which every man lives exchanging, that is, ‗every human becomes in some measure a merchant‘ (Smith, WN, I.iv.1). The main consequence of this behavior is the increase of social relations and society wealth. And this increase must be transmitted through division of labour to all the components in a well governed society (Smith, WN, I.i.9). This implies, as we will note later, that a group of philosophers, in Adam Smith‘s terms, that is, individuals with high education, must advise government. A third factor to be considered is that societies with higher education have less social strains. It is widely recognized that nations with less social strains, strikes and social dissatisfaction have more possibilities to increase earnings and promote economic growth. As the individuals improve their education the society will be freer and ‗the more they are instructed, the less liable they are to delusions of enthusiasm and superstition, which, among ignorant nations, frequently occasion the most dreadful disorders‘ (Smith, WN, V.i.f.61). A final factor to be considered in this section is commerce. In this field two aspects must be considered. First, as we showed previously, higher education increases salaries and if the division of labour has not introduced efficient control mechanisms, the prices will also increase, reducing firms‘ competitiveness and negatively affecting on commerce. This reduction on commercial activity would reduce the nation prosperity. Second, a negative consequence of commercial activity is that it doesn‘t concede importance to education. As we have noted previously, the improvement of commercial activity thanks to division of labour introduction, would put up the price of education, encouraging families to put their children to work as soon as possible. Adam Smith was very critical with these behaviors. In this sense, Emma Rothschild states that the government supported education is ‗a 8
Adam Smith didn‘t try to achieve an equalitarian society through education. As we will note later, he defended different types of education depending on families rank and resources. Families with higher resources would have better education than families with fewer resources, so the inequality gap would be maintained. The main possibility to reduce it is through merchant activity or production efficiency. 9 See on this topic: Sen (1985, 1992), Nussbaum (1986) and Nussbaum and Sen (2001). 10 As we have indicated in footnote 8, this possibility would be very difficult to achieve, if there are different types of education, and some individuals have limits to obtain a superior education.
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consequence of economic advancement and not a requirement of further advancement‘, it is not ‗itself needed in the interest of commercial prosperity‘ (Rothschild 2001: 98). However, education plays an important role in further advancement. First, reduces the negative effects of the division of labour. Second, following Roncaglia (2005, p. 133), the share of productive workers in the total population depends on institutional elements and on customs, such as laws on primary public education, among other factors. Both variables, the division of labour and productive workers, are growth enhancing.
4. SOCIAL CAPITAL In the analysis of the relationship between education and economic growth it is also necessary to include other factors that are the base and the goal pursued by economic growth: liberty and happiness. Liberty is the solid base that must be built on in a prosperous country. To increase wealth it is necessary to improve exchange activity. This goal is better achieved in a society within many human beings live together. This requisite implies the existence of a social order and the progress of the rule of law, being the government the guarantor of the existence of a law system. When the wealth progress is analyzed two kinds of relations must be considered. First, the individuals‘ owner and the objects, those try to accurate the domain and the stability. Second, and more important for our analysis, the relation between the human being and the job, that tries to facilitate the exchange, to product more goods and to elaborate new goods. In this way the division of labour plays an important role that leads to the need to introduce relevant transformation in the social relations modifying the basement of human relations. All these modifications necessarily drive to alterations in the government and in the law system that determined the liberty and the justice. Adam Smith gave great importance to happiness in his writings. From a moral point of view, we must desire the happiness of human beings (Smith, TMS, IV.ii.2). But also, it has economic relations because ‗No society can surely be flourishing and happy, of which the greater part of the members are poor and miserable‘ (Smith, WN, I.viii.36). It seems that Adam Smith considered happiness as the main goal to achieve for politicians not economic growth. Later it would be an instrument to obtain an objective of superior rank that would be happiness. In this sense, he would follow Aristotle‘s idea shown in his Nichomachean Ethics that happiness is the supreme good and is not necessarily reached through wealth. Following Fleischacker (2004, p. 69) Smith presented human happiness basically as social matter and as different from Rousseau, the advancement in civilization contributes to human happiness, so it is possible to consider that education would be also a factor that would help to achieve that happiness. In this world that pursues liberty and happiness, the question about the possibilities of ―common people‖ to finance their education appears again. If the goodness of free market is accepted as well as the positive effects of education for individuals, promotion, higher salaries…, the final conclusion would be that everyone has to spend his own money to pay for his own education. But this possibility is not easy to accept due to the negative effects on division of labour and that the inequalities are not eliminated. For this reason, Smith considers that institutions, social capital in our case, would have an important role in this field.
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The social capital concept has been mainly developed by sociologists and economists that have recently introduced it in their analysis. There are different social capital definitions. Different definitions of social capital have been considered in literature. For example, Coleman (1990) highlights the social structure of the entities and their ability to facilitate some activities to the individuals; Narayan and Pritchett (1997) consider economic effects (contributes to increase income) and the strengthened linkages among individuals; Burt (1992) highlights the contacts among individuals and the possibility to use other kinds of capital; Portes (1995) considers the capacity of individuals to use scarce resources thanks to their membership in networks; finally, Putman (1993a) distinguishes between the linking relationships among dissimilar individuals that would be positive to society and the exclusive relations that would be negative for economic growth. The largest and most accepted definition states that social capital includes social networks and lager norms related to such networks that creates value in individual and collective ways (Putman and Gross, 2003, p. 14). So, in this concept not only institutions are considered, but also economic agents‘ behaviour in the society, taking into account the cooperation among them. In this sense, different topics and values must be included such as, honesty, mutual agreements… that enhance productivity and finally economic growth. Then social capital implies increasing trust and cooperation among individuals, building a more prosperous society, facilitating human transmission, the acceptation and assimilation of new technologies, and in many occasions, families and some associations transfer financial resources to their members, obtaining in this way funds to finance their knowledge acquisition or their investments (Putman, 1993b, Fukuyama, 1995, Woolcock and Narayan, 2000 and Woolcock, 2001). So, if this definition is accepted, social capital has indirect effects on economic growth, because it implies the introduction of an adequate legal structure (Chhibber, 2000, pp. 299-306)11. Social capital is different from other forms of capital. In this sense, Robison, Schmid and Siles (2002) state that the main difference is that social capital exists in a social relationship. In contrast, human capital used to reside in the individual alone, but that doesn‘t mean that human capital creation is not collective. Accepting the classification of Putman, we could consider in the first group (linking relationship) the Smith‘s sympathy concept developed in his The Theory of Moral Sentiments. In general terms, the central motivation of individuals in The Theory of Moral Sentiments is to be approved by others12. Sympathy creates a social link and the individuals observe the behaviour of others learning from it. An isolated human being has no sense of right or wrong (Smith, TMS). So, institutions must act to improve social relations and increase trust in the society. In this sense, it is also important to take into account that in general terms The Wealth of Nations carried out a system in that small enterprise could develop its activity. In his Theory of Moral Sentiments, Smith stated that the moral basis of enterprise and individual activity is based on ―mutual relations‖. For this reason Bruyn (1999), as well as Robison, Schmid and 11
12
The social capital concept is difficult to limit because is very ambiguous. There are very few data on it that difficult empirical research. On the other hand, some economists, for example Arrow (2000) and Solow (2000), consider that this is not a relevant factor and it can be included in a broad concept of human capital. Christian Garve, a German philosopher that had correspondence with Kant, stated that we must act considering the impression that we will cause in ―others‖. This ―others‖ corresponds to Smith and Hume ideas on spectator, but also to social relations included in the social capital concept (Kuehn, 2001).
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Siles (2002) consider that Adam Smith foreshadowed the concept of social capital when he employed sympathy to differentiate social preferences. It seems that Adam Smith considered that self-interest and the efficiency of the markets were not enough to build and achieve the ideal society. Civic and organizational institutions were necessary to build the structures in which we obtain and develop our livelihood. And social capital grows within these institutions. Adam Smith considered that social interaction enriched economy and this enrichment encouraged social welfare. Apart from these goals, institutions have also to transmit education among the citizens, because, as we have noted, it is a factor that enhances directly or indirectly economic growth. But there is a constraint that the institutions must be considered. The institutions must accept the rules or principles that guarantee a higher economic growth and finally a higher human happiness, that is, the existence of a free market, defense of property rights and the consideration that individuals act as merchants. In this sense, three aspects must be considered. First, individuals‘ behaviour to transmit and to receive education. Adam Smith (WN, V) included two kinds of families: those that have enough resources to pay their own education and low income families. The first one had enough time and resources to finance their education. If they do not receive the adequate education it is because they have used their resources wrongly not because the families have expended insufficient resources. The opposite case occurs in low-income families. Education takes too much time and children start to work as soon as they have possibilities to do it. Their jobs are so tedious that they are not interested in improving their knowledge. In this case the government must provide some education. Second, it is also necessary to realize the topics that must be taught. In this sense, Adam Smith in Book V of the The Wealth of Nations accepted different education depending on the income of the individuals. But everybody must receive a minimum education to avoid superstition and of division of labour negative effects. We will analyze this minimum education in the next section. Third, the division of labour needs the existence of a society previously built in which there were a government, classes division and the individuals‘ interest to progress. The interest concept is relevant in Smith‘s approach. From his point of view, it corresponds to the human being‘s aspirations in the society and to one‘s justifying his actions in the society. Considering the collective interests, Smith divided the society into three groups taking into account the ways to obtain incomes: those who live on rent (rent of land), those who live on wages (wages of labour) and those who live on profit (profit by stock) (Smith, WN, I.xi.p.7). This division is interesting for our purposes because each group has different interests and puts pressures on legislators and government on a different level. Landowners and workers coincide in general terms in the interest of justice progress and wealth. When the policy makers design a policy or a regulation of commerce, the proprietors of land never can mislead them. Workers have few possibilities to defend their situation when policies are introduced, because they don‘t have enough information and their education and habits cannot allow them to judge even though they had information over such measures. ‗In the publick deliberations, therefore, his voice is little heard and less regarded, except upon some particular occasions, when his clamour is animated, set on, and supported by his employers, not for his, but their own particular purposes‘ (Smith, WN, I.xi.p.9). The third class, those who live on profit, basically merchants and master manufacturers, are most interested in their own interests rather than in social ones. They try to widen markets
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and to narrow competition (Smith, WN, I.xi.p.10). Thanks to their innate trend to plot (Smith, WN, I.x.c.27) merchants try to influence legislators and the government to design laws that are positive for their interests that do not coincide with social ones. Government has to defend general interest against commercial interest: ‗But the mean rapacity, the monopolizing spirit of merchants and manufacturers, who neither are, not ought to be the rulers of mankind, though it cannot perhaps be corrected, may very easily be prevented from disturbing the tranquility of any body but themselves‘ (Smith, WN, IV.iii.c.9). To avoid this problem government must know the society‘s needs but also to introduce a new class of advisors, named ‗natural aristocracy‘ (Smith, WN. IV.vii.c.74). This group is not well defined by Adam Smith in his writings but it could correspond to those individuals that are characterized, as described in The Theory of Moral Sentiments, as a prudent man, real knowledge and skill in his profession, frugality and some degree of parsimony in all his expenditures (Smith, TMS, VI.i.6). In other words, Smith defends the advice of highly educated individuals that pursue the general interest. So, education is a way to eliminate ―corruption‖ in the design of laws that only benefits one of the social classes, improving the economic efficiency13.
5. EDUCATION POLICY In previous sections we noted that education plays a relevant role to reduce or to avoid the problems that could show the variables that have some influence on economic growth. So, it is important to design social actions that promote education transmission among individuals. In this sense, Adam Smith considered two main institutions that help to achieve this goal: families and government. In his Lectures on Jurisprudence and in The Theory of Moral Sentiments, Smith stated that the families have a great responsibility in the education of their sons and they have to overcome the temptation to look for an employ as soon as the children are able to work, thanks to the facilities derived from the division of labour14. He considered family education better than public education, because ‗Domestic education is the institution of nature; public education, to contrivance of man. It is surely unnecessary to say, which is likely to be the wisest‘ (Smith, TMS, VI.ii.I.10). The problem is that some families don‘t have the possibility of giving a complete education to their children. Then they decide to send them to schools, universities or educational trips. Smith was a critic on the knowledge taught at Universities and considered it fruitless to spend money on educational trips. Together families, government role must also be considered. The division of labour cannot appear and act alone in an empty system. It was necessary to have the existence of a society previously built in which there were a government, classes division and the individuals‘ interest to progress. So, it was necessary to have a ‗good government‘ to create the necessary conditions to introduce the division of labour and the rest of the factors that 13
Smith seems to follow Plato‘s idea on the necessity of a well educated government. From Plato‘s point of view the origin of society‘s problems is in the insufficient education of the governments. The best guardian must follow the apprenticeship till he reaches the stage of ―philosopher king‖. 14 The children were a valorous workforce and for this reason the schooling in many Europe zones was only during winter months and in the industrial areas, less than those months (Munk, 2000).
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promote wealth and progress. This didn‘t imply that Adam Smith trusted totally in the government efficiency in the case of education15. But ‗the education of the common people requires, perhaps in a civilized and commercial society, the attention of the publick more than that of people of some rank and fortune‘ (Smith, WN, V.i.f.52) and ‗For a very small expence the publick can facilitate, can encourage, and even impose upon almost the whole body of the people, the necessity of acquiring the most essential parts of education‘ (Smith, WN, V.i.f.54). In this sense, the individuals are divided into two ranks: high income and low income. Smith considers that common people ‗cannot be so well instructed as people of some rank and fortune‘, but at least they must receive a minimum education, that is ‗the most essential parts of education… to read, write and account‖ that ―can be acquired at so early a period of life‘ (Smith, WN, V.i.f.54). This essential education would be improved if the children of the common people ‗were instructed in the elementary parts of geometry and mechanics, the literary education of this rank of people would perhaps be as complete as it can be‘ (Smith, WN, V.i.f.55)16. It is worth noting that the topics to teach the ‗the common people‘ are not of ideological character. It seems that Adam Smith tried to avoid those topics that could incite superstition of individuals or the introduction of ideology from the State or policy maker. If someone wants to complete this minimum formation he must use his own resources to get it and the teachers compete among them offering their services. So, there will be two types of education17: Minimum that everyone needs and a superior one for those interested in improving their formation and must pay for it. This position implies a break to low-income families to achieve better jobs and a support to maintain certain inequality among individuals. It is also an incentive, in a society pursuing self-interest, to many fathers to not spend their resources in the education of their sons, urging them to get a job. So, following this education policy it is very difficult to reduce the inequality among the individuals. That doesn‘t mean that everybody must have equal goods and resources. To avoid this situation, Adam Smith considered the role of the State to facilitate the education to the poor. Following Rawls (1971), it is necessary that this ‗common people‘ considers that their long-term expectations would improve and they will be able to achieve this goal. For this reason, using more resources to finance education, as well as the possibility of learning not only scientific but also humanistic topics, have to be considered. This is not implying that a compensation principle must be followed or that everybody must receive high education. It is necessary to give the opportunity to individuals to reduce the natural inequalities if they are able to reduce or to avoid them. To use funds to supply high education to individuals that are 15
Smith states that ‗Those parts of education, it is to be observed, for the teaching of which are not publick institutions, are generally the best taught‗(Smith, WN, V.i.f.16). 16 It is worth noting, that Adam Smith criticized several times the Universities (‗In England the publick schools are much less corrupted than the universities‘ (Smith, WN, V.i.f.17); ‗Nothing but the discredit into which the universities are allowing themselves to fall, could ever have‘ (Smith, WN, V.i.f.36); as well as travels in which the young ‗returns home more conceited, more unprincipled, more dissipated, and more incapable of any serious application either to study or to business, then he could well have become in so short a time, had he lived at home‘ (Smith, WN, V.i.f.36). 17 This idea on education is similar to Plato‘s. He considered two groups of education receptive: those who work in the production process and those who have government responsibilities. Former only need a limited education necessary to develop their activities. A wider education is needed for the second, to achieve in the best way the state‘s objectives.
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not able to use it in an efficient way is a waste because this expenditure is very difficult to recover by the society. But Rawls states (1971) that education differences make difficult the achievement of a ―just society‖. Probably, Adam Smith had the same idea that Rawls exposed two centuries latter. Members of rich families, being or not able to obtain and use efficiently education will not have education constraint, because they are able to expend their resources to finance it. Poor families were on the opposite side. To avoid this situation the State activity was necessary in an attempt to encourage the poor to improve their education facilitating the ―just society‖ achievement in Rawls terms. Another issue to consider is the education topics. It is questionable that empirical topics are the best education that individuals can receive and Dickens in his celebrated book Hard Times showed the dangers derived from obtaining only an empirical education, not only for ―common people‖ but also for families with some rank and position. Individuals need also a humanistic formation to complete their education because it helps them to search for a more just and equitable society. In this case, Smith didn‘t consider that such education would necessarily develop in schools, but rather through inculcation in the arts which have the capacity to humanize the citizenry. And in this case, the State can play again an important role.
6. CONCLUSIONS Education is an important factor that enhances indirectly economic growth in Adam Smith‘s analysis through different factors: division of labour, inequality, reducing social strains, commerce and social capital. Division of labour facilitates the mobility among professions and the introduction of new technical processes, and the workers must be sufficiently skilled to take advantage of both. Among other effects, education also reduces the gap of talents and of salaries, increasing the equality among human beings; reduces social conflicts; could have negative effects on commerce if the increase of salaries leads to higher prices; and finally increases trust and confidence. But in an opposite sense, there are some problems associated with education. First, the salaries will increase and if the control established by the division of labour is not efficient, it would increase prices affecting negatively on economic growth. Second, the type of education those individuals must receive is important. Differences in the education process will maintain inequality gaps. This doesn‘t mean that everybody has to obtain the same salary, but to have the same opportunities to achieve it, developing their innate capabilities. Third, societies with higher commercial activity would increase the price of education, encouraging families to put their children to work as soon as possible. However, that is not to say that Smith would have forgotten his moral ideas and didn‘t try to improve the poor situation reducing the negative effects derived from ‗‘the uniformity of his stationary life‘ (Smith, 1776, V.1.178). He considered that it was necessary to facilitate the education transmission among individuals if we wish to encourage prosperity. For this reason it is acceptable for the government to have a role in a free market. The expenditure derived from its activity is recovered in economic and moral terms. Economic because as we noted previously, individuals would be more productive and less socially troubled, enhancing
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economic growth. And moral because it is a way to reduce the two types of inequality: personal and income.
REFERENCES Arrow, Kenneth J. (2000). Observations on Social Capital. In Partha Dasgupta & Serageldin, Ismail (eds.), Social Capital. A Multifaceted Perspective, (pp. 3-5). Washington: The World Bank. Bowman, Rhead S. (1990). Smith, Mill, and Marshall on Human Capital Formation. History of Political Economy, Vol. 22 (2), Summer, 239-259. Bruyn, Severyn T. (1999). The Moral Economy. Review of Social Economy, vol. 57, 1. Burt, G. (1992). Structural Holes. Cambridge: Harvard University Press. Chhibber, Ajay (2000). Social Capital, the State and Development Outcomes. In Partha Dasgupta & Serageldin, Ismail (eds.), Social Capital. A Multifaceted Perspective, (pp. 269-309). Washington: The World Bank. Coleman, J. (1990). Foundations of Social Theory. Cambridge: Belknap Press/Harvard University Press. Eltis, Walter (2000). The Classical Theory of Economic Growth. Houndmills: Palgrave Fleischacker, Samuel (2004). On Adam Smith’s Wealth of Nations. Princeton: Princeton University Press. Freeman, R D. (1969). Adam Smith, Education and Laissez-Faire. History of Political Economy, Vol. 1 (1), Spring, 173-86. Fukuyama, Francis (1995). Trust: The Social Virtues and the Creation of Prosperity. New York: Free Press. Kaufman, Daniel, Kraay, Aart & Mastruzzi, Massimo (2003), Governance Matters III: Governance Indicators for 1996-2002. World Bank Policy Research Working Paper, 3106, June, Washington: The World Bank. Kuehn, Manfred (2001). Kant. A Biography. Cambridge: Cambridge University Press. Munk, Thomas (2000). The Enlightenment. A comparative social history 1721-1794. New York: Oxford University Press. Narayan, D. & Pritchett, L. (1997). Cents and Sociability: Household Income and Social Capital in Rural Tanzania. World Bank Research Working Paper No. 1796, Washington: The World Bank. Nussbaum, Martha C. (1986). Nature, Function and Capability: Aristotle on Political Distribution. Brown University. Nussbaum, Martha C. & Sen, Amartya K. (Eds.) (1993). The Quality of Life. Oxford: Oxford Clarendon Press. O´Brian, D. P. (1975). The Classical Economics. Oxford: Oxford University Press. Portes, A. (1995). Economic Sociology and the Sociology of Immigration: A Conceptual Overview. In Alejandro Portes (ed.), The Economic Sociology of Immigration: Essays on Networks, Ethnicity and Entrepreneurship, (pp. 1-41). New York: Russell Sage Foundation. Putnam, Robert D. (1993a). Making Democracy Work. Princeton: Princeton University Press.
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Putnam, Robert D. (1993b). ―The Prosperous Community‖, American Prospect 13, Spring: 35-42. Putman, Robert D. & Gross, Kristin A. (2003). Introducción. In Robert D. Putman (Ed) El declive del capital social (pp. 7-34). Barcelona: Galaxia Gutenberg. Rawls, John (1971). A Theory of Justice. Cambridge: Harvard University Press. Robison, Lindon J., Schmid, A. Allan & Siles, Marcelo E. (2002). Is Social Capital Really Capital? Review of Social Economy, vol. 60, 1. Roncaglia, Alessandro (2005). The Wealth of Ideas. Cambridge: Cambridge University Press. Rostow, W.W. (1990). Theorists of Economic Growth from David Hume to the Present. Oxford: Oxford University Press. Rothschild, Emma (2001). Economic Sentiments. Adam Smith, Condorcet, and the Enlightenment. Cambridge: Harvard University Press. Rosenberg, N. (1990). Adam Smith and the Stock of Moral Capital. History of Political Economy, vol. 22, Spring,1-17. Sen, Amartya K. (1985). Commodities and Capabilities. Amsterdam: Noth-Holland. Sen, Amartya K. (1992). Inequality Reexamined. Oxford University Press, Oxford. Skinner, Andrew S (1995). Adam Smith and the Role of the State: Education as a Public Service. In Stephen Copley & Sutherland, Kathryn (eds), Adam Smith's Wealth of Nations: New interdisciplinary essays (pp. 70-96). Manchester: Manchester University Press. Smith, A. (1759). The Theory of Moral Sentiments. Oxford: Oxford University Press; reprinted, Liberty Press (1982). Smith, A. (1776). Lectures on Jurisprudence. Oxford: Oxford University Press (1978). Smith, A. (1776). An Inquiry into the Nature and Causes of the Wealth of Nations. Oxford: Oxford University Press (1976). Solow, Robert M. (2000). Notes on Social Capital and Economic Performance. In Partha Dasgupta & Serageldin, Ismail (eds.), Social Capital. A Multifaceted Perspective (pp. 325-424). Washington: The World Bank, Washington. Turgot, Anne Robert Jacques (1766). Reflections on the formation and distribution of richness. Reprinted by A. M. Kelley, New York (1971). Young, Jeffrey T. (1997). Economics as a Moral Science. Aldershot: Edward Elgar. West, Edwin G. (1996). Adam Smith on the Cultural Effects of Specialization: Splenetics versus Economics. History of Political Economy, Vol. 28 (1), Spring, 83-105. Winch, Donald (1983). Adam Smith’s Politics: An Essay in Historiographic Revision. Cambridge: Cambridge University Press. Woolcock, M. (2001). The place of social capital in understanding economic and social outcomes. Canadian Journal of Policy Research, 2 (1), 11-17. Woolcock, M. & Narayan, D. (2000). Social capital: implications for development theory, research and policy. World Bank Research Observer, 15 (2), 225-249.
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Chapter 9
MORAL TRAITS OF ADAM SMITH’S THEORIES IN CORPORATE SOCIAL RESPONSIBILITY EVOLUTION Inmaculada Carrasco University of Castilla-La Mancha, Spain
ABSTRACT During the last decades, companies have been increasingly paying attention to Corporate Social Responsibility (CSR) ambits, and literature about CSR has grown exponentially. In those works it hasn‘t been usual to see the connection between CSR and Adam Smith‘s thought. Smith is seen as the father of orthodox economy. But a part of Smith‘s writings has been forgotten in those establishments. The aim of this paper is to present Adam Smith as a profoundly ethical author, whose moral writings can lodge the more recent CSR standpoints. Some relations between Smith‘s moral thought and CSR will be established.
1. INTRODUCTION During the last decades, Corporate Social Responsibility (CSR) has become one of the most accepted concepts in the business world. Its acceptance has grown since the business world has changed. The concept of CSR has been transformed during the last decades of the 20th Century: it has been progressively rationalized and related to different ambits of business activity. We can define Corporate Social Responsibility (CSR) as the ethical and legal compromises and duties of the enterprise with their groups of interest. These compromises and duties come from the impacts of the enterprise‘s activity over the social, labour, environmental and human right ambits. (De la Cuesta and Valor, 2003: 7). Therefore, CSR is referred to as the voluntary integration of social and environmental matters into the businesses, with a long-term vision of
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business; with doing the right things (Ethics in all the ambits of business); with the consideration of people as the most valuable asset of business. But the notion of CSR is not a new one. CSR foundations are immersed in the moral theories of authors as Adam Smith who knew and applied the ideas of the person known as CSR‘s father, Robert Owen. During the 18th and 19th centuries, scholars tried to give the Economy the character of Science drawing it up to experimental sciences. The search for abstract, objective, and universal models, as those of natural sciences, without any space for values, began the breaking-off between Economics and Ethics, the discipline from which Economics was born. Conventional and orthodox economics has neglected our component of Quixote. Many authors have advice about the lags that this fact can cause. Elster (1998) explains how human emotions can help to explain certain behaviours when rationality is not enough. Emotions usually combine with other motivations, as the rational self-interest, to produce economic behaviours. Akerlof (1997) explains that social interaction models can give a base to integrate social factors and consumer rational behaviour axioms, producing models more realistic than neoclassical ones. Therefore, we have to reconsider the 18th and 19th century economist‘s human and social concerns, that were scorned by the triumph of utilitarianism. The present chapter is based on the work of Min-Dong (2008) that explains the different steps given by the economic literature on the evolution of the CSR concept. Over this schema, some relations between CSR and CSR concept evolution and the ethics of Adam Smith have been sought. A chronological plan has been followed. The paper begins with the study of the presence of Smith‘s moral on the birth of CSR thinking (section two). In section three, CSR and CSR concept developments during decades of the 1950s to the 1970s are studied. Finally, section four is devoted to the 1980‘s and 1990‘s theoretical points of view on CSR. The chapter finishes with a section devoted to conclusions.
2. SMITH AND THE CSR ORIGIN Most scholars centre the CSR concept‘s first attempt of theorisation about the 1950s, so the CSR concept is a relatively modern one. But the CSR approach is not so new. Owen, the utopian socialist, was one of CSR‘s founders. Owen was concerned about the working conditions of his employees which he labelled as inhuman, because of the precarious health conditions in the workplace and the exhausting and long working days. Owen improved their work conditions, reducing working days, limiting those of women and children, creating communities based on collective property, where production and consumption were made in common. He was also worried about the food, housing and education of his workers, even proposing a system of education for adults (Carrasco, 2007). In his autobiography, he affirms to have had friendships with some teachers of Edinburgh and Glasgow Universities that, at the time were enriched with the moral philosophy revival, led by Hume and Smith (Gordon, 1993). So that, we can think that Owen knew Smith‘s moral approaches.
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Indubitably, Owen‘s thinking and acting is in the core of CSR, and we can say that the presence of Smith in this CSR birth is indirect, by Owen.
3. FIRST THEORIES ABOUT CSR: THE 1950´S, 1960´S AND 1970’S DEVELOPMENTS One of the first attempts to formalize the relationship between corporations and society, from a normative orientation, explains that ―social responsibilities of businessmen connect to the obligations of businessmen of applying policies, making decisions and following the lines of action that are desirable in terms of the objectives and values of our society‖ (Bowen, 1953). The main objection to this argument come from Friedman who sees CSR as an additional business cost factor that made the financial equilibrium more difficult to maintain. In this sense, Friedman (1962 and 1970) sees CSR as a ―subversive doctrine‖ and he says that the sole responsibility of the business is to increment profits. The explanation of Bowen relies on the idea that during the first half of the twentieth century, some changes in the institutional environment of business were instituted, forcing and persuading businessmen to be concerned about their social responsibilities. In 1970, Baumol tried to reconcile social and economic interests of corporations, stating that CSR is consistent with stockholders‘ interests. In this line, Wallich and McGowan (1970) explained that even if stockholders‘ interest is to maximize profits, they want (i) to maximize them not in one company, but in a diversified portfolio, and (ii) to maximize them in the long term. When stockholders diversify their portfolios to spread their risk, they don‘t want to maximize profit in one of their companies if this implies having to externalize costs to others of their shared companies. Consequently, investors want to maximize a social profit. On the other hand, when we consider long term, we have to take into account the surrounding society that supports business activity and therefore, the well-being of its environment. This point of view shifts from a normative to a positive rationale, and it support CSR as being coherent with the business self-interest. This idea connects with the moral ideas of Adam Smith that were scorned until the triumph of utilitarianism in economic thought. Sen (1989) explains that one of the main defects of contemporary Economics is the reduction of the wide smithian view of humans. Before Smith proposes his famous idea of the ―invisible hand‖ in the Wealth of Nations, he had written about the necessity of maintaining an ethical behaviour in order to maximize long-term growth in the Lectures on Jurisprudence (pp. 327–328). In these Lectures, he presents the idea that ―honesty is profitable‖, as shown, when Smith says that if a salesman makes a considerable number of commercial deals, his goal is not to obtain the maximum benefit in each deal, but to obtain a maximum of the total deals. So, to lie or to cheat can make the number of future deals fall, diminishing the total benefit. Honourable behaviour has a commercial logic.
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Nevertheless, we cannot forget that in Smith‘s thought, the search for self interest is a means for common well-being. John Stuart Mill, Robert Owen and other classical English authors worried about the same thing.
4. ADVANCES IN THE CSR CONCEPT DURING THE 1980S AND 1990S The studies about CSR during the 1980s were guided by Carroll‘s model of Corporate Social Performance (1979). It presented economic and social goals of corporations as compatibles: the framework of total social responsibility of business includes economic, legal, ethical and discretionary categories. Companies can choose a reactive, defensive, accommodative or pro-active strategy for each of those categories. This work is focussed on the relations of the corporation with its environment, and tries to give a clear framework of reflection for scholars and managers. The lack of a model makes it difficult to apply and test it in practical (empirical) terms. Later on, the Strategic Management focus gave the CSR theories the possibility of being redefined. Within the stakeholder‘s perspective, there is no difference between business social and economic goals, because the main problem for a company is its long-term survival. For achieving that goal, the manager has to look after not only the shareholder‘s interest, but also the interest of other stakeholders such as employees, the government, or customers (Clarkson, 1995; Jones, 1995). Under this theory we can see once again Smith‘s idea of ethic‘s profitability. Smith defended the ethical behaviour of salesmen as a means for a goal: the maximization of income in the long term. The Strategic Management paradigm opens the focus from the short term to the long term: the goal of a business is no longer the maximization of profit, but the maximization of profit in the long term. As Min-Dong (2008, p. 11) affirms, the attempt to adapt CSR to the stakeholder framework has forced researchers to specify more clearly CSR; as a consequence of that, and due to the expansion of stakeholder categories, the concept of CSR has been expanded to incorporate for example, environmental responsibility, diversity, affirmative action, or transparent account practices. Some connections with Smith‘s morals can be formulated.
4.1. The Role of Sympathy in Smith’s Moral Theory Sympathy is one of the key elements in Smith‘s moral theory. For example, ambition comes from the perception that other men sympathize more with our joy than with our sorrow, conducting us to the pursuing of richness and the prevention of poverty. But the excessive growth of self-interest can corrupt moral sentiments (Smith, 1790, p. 9). Sympathy can be seen as another invisible hand that directs society through remedies for non desirable consequences of free market economy (child labour, colonial slavery, etc.) (Clark, 2008). For Smith, sympathy has a central role in his moral theory, because it is the clue of moral evaluation: actions, attitudes or passions of other people are morally correct if one sympathizes with them, and they are morally wrong if an impartial spectator cannot sympathize with them. Sympathy is also in the core of benevolence and justice.
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If judgment of moral or immoral comes from the comparison of one sympathizing or not, then we can conclude that one cannot be moral or immoral in a vacuum. The label of moral or immoral comes from a social context. Consequently, a businessman‘s deals are judged from two perspectives: (i) The agents of this society that sympathise or not with social results of the businessman‘s acts. In this line, for a salesman, ethics is efficiency. (ii) The businessman‘s perspective, that sympathises or not with the possible results of deals he makes. He can feel benevolence, kindness, justice, and other ―social passions‖ or virtues. From this point of view, the search for self interest is always the search of maximum profit? Is it not possible that salesmen‘s deals would be restricted by the existence or not of feelings of sympathy with the results of their actions? In accord with Haldane (2008), Smith doesn‘t oppose self regarding to another regarding interest as an alternative for rational action. From this perspective, a businessman‘s decisions can be influenced not only by an economic rationality, but also by a virtue-ethics rationality that has as a result a virtuous behaviour. This vision opens the possibility of justifying CSR from a different perspective according to the morals of Smith.
4.2. Social Responsibility and Sympathy with Nature The treatment of sympathy in Smith‘s ethical theory, also allows the extension of its implications in one of the lastly referred ambits of CSR: environmental responsibility. Even if Smith is not an environmentalist, his ethical theory, characterized by its anthropocentrism and utilitarianism, serves to defend non-anthropocentric and non utilitarianism ethical arguments (Frierson, 2007). Therefore Smith is a philosophical resource for environmental ethics (Frierson, 2006). Contrary to this standpoint, some authors (Varner, 1998) argue that Smith‘s moral philosophy doesn‘t allow the possibility of explaining sympathy with non-sentient and transorganismic entities (species, ecosystems), so that, we cannot explain moral worth to Nature as a whole. Frierson‘s theory disagrees with the previous one. He explains that, even if we have to assume that Smith didn‘t devote many efforts to apply his ethics to natural holes, he admits the possibility of feeling benevolence to Nature, even more, to the universe: ―…though our effectual good offices can very seldom be extended to any wider society than that of our own country; our goodwill is circumscribed by no boundary, but may embrace the immensity of the universe‖ A. Smith. (Theory of Moral Sentiments VI. ii. 3, p. 235)
More strongly, Frierson (2006: 244) affirms that in the History of Ancient Physics, Smith admits that the preservation and prosperity of species (rather more than individuals) is an end itself. Even Nature itself can be taken to have a separate interest from those of the individual organisms that live in it.
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The argument of those that don‘t believe that Smith‘s theory of sympathy could be extended to Nature can be summarised, following Frierson (2006, p. 256) as follows: (1) One can sympathize only with the feelings of the object of one‘s sympathy; (2) Non-sentient entities have no feeling; therefore (3) There is nothing with which one can sympathize in the case of non-sentient entities; therefore (4) Sympathy with non-sentient entities is impossible. But Frierson (2006, p. 257) explains that the introduction of sympathy in Smith‘s ethical theories has the purpose of making possible moral evaluation of the object of one‘s sympathy: an action, an attitude or a passion can be judged as morally improper insofar as one can sympathize with it. Moreover, he continues, one has moral regard to Nature when one feels that he is unable to sympathize with another person who fails to have some passions as respect, humility or the ability to cherish Nature. Thus, moral regard to Nature, and environmental values can be defended without needing a strict sympathy to Nature. The treatment of sympathy in Smith‘s moral theory is important to explain certain social passions, as benevolence, kindness or justice: benevolence and kindness require sympathy to their objects, and justice needs a kind of indirect sympathy, because one has to be able to feel sympathy to the victim of injustice. So that, benevolence, and other passions or virtues as humility, awe, delight, aesthetic appreciation, respect can be applied to Nature, as we can talk about justice towards nature. Sympathy is a sentiment that allows people to discern between what is right or not. Then no rational principles or calculus of pleasure are needed for this moral classification. Ethical judgements are ultimate based on laws that govern sympathy, not on principles that guide abstract reasoning (Frierson, 2006, p. 466). If we assume that it is possible to feel sympathy to Nature, an ethical regard for Nature is possible within Smith‘s moral theory. There is no lack of rationality in this behaviour.
5. CONCLUSION During the last decades, companies have been increasingly paying attention to CSR ambits, and literature about CSR has grown exponentially. In those works, it hasn‘t been usual to see the connection between CSR and Smith‘s thought. Smith is usually seen as the father of orthodox economy. The aim of this chapter was to present Adam Smith as a profoundly ethical author, whose writings can lodge the more recent CSR standpoints. Some relations between Smith‘s moral thought and CSR can be established. Firstly, in a very indirect way, Smith could be present in the birth of CSR. If we assume (i) that one of the fathers of CSR is R. Owen, and (ii) that Owen knew and shared the moral principles of Hume and Smith. As a result, we can infer that Smith‘s moral thought could impregnate CSR‘s origin. Secondly, we find another relation between Smith and CSR in the 1970s‘ writings about CSR—if we assume (i) that stockholders diversify their portfolios to spread their risk, (ii) that they want to maximize profit in the sample of their shared companies, and (iii) that they want to maximize profit in the long term. Then, if the maximization of profit in one of their companies implies externalizing costs to other shared companies, investors want to maximize
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a social profit. That is, corporations have to incorporate externalities in their decision functions. The company‘s environment becomes relevant for it. On the other hand, when managers consider long-term goals of the corporations, they have to think about the corporation‘s impact on its environment, which is the ground that supports the company‘s activity. In both arguments, we can find a link with Smith‘s moral theory, when he explains in the Lectures on Jurisprudence that the ethical behaviour of the salesman is good for the longterm stability of sales activity. Lastly, we can find new relations between Smith and CSR in the more recent developments of CSR if we consider one of the key elements in Smith‘s moral theory: sympathy. Sympathy permits moral evaluation, so actions, attitudes or passions of other people are morally correct if one sympathizes with them, and they are morally wrong if an impartial spectator cannot sympathize with them. Sympathy is also in the core of benevolence and justice. The consideration of sympathy and the possibility of making moral judgements, give us new possibilities to relate CSR to Smiths‘s moral theory. First of all, because agents of one society can or cannot sympathise with social results of the acts of a businessman, who has to consider their reactions in order to maintain the business activity on the long term. In this line, for a salesman, ethics is efficiency. Ethical behaviour is, therefore, a means for an end: maximizing profit in the long term. But, on the other hand, the businessman is going to judge his actions, on whether he can or cannot sympathize with the results of them. By means of sympathy, people can feel benevolence, justice, kindness and other virtues which can constitute a self limitation for a person‘s behaviour. From this perspective, a businessman‘s more rational goals could be the long-term profit maximizing, restricted to his own moral evaluation of the results of his actions. Subsequently regarding another‘s interest is not an irrational behaviour, but a restriction in the search for the self interest. The theory of sympathy, and the possibility that businessmen act following a ―rational virtue-ethics behaviour‖ presents moral excellence as a goal. Because of this perspective, to apply CSR in business, is not an irrational economic behaviour. The treatment of sympathy in Smith‘s moral theory even allows defending sympathy with nature, and therefore, one of the traits of CSR is more difficult to justify from a rational point of view. Some authors consider that it is not possible to defend this argument; Smith doesn‘t let the possibility of feeling sympathy with non-sentient creatures, because one sympathizes with the feelings of the object of the sympathy. Contrarily, others think that Smith proposes the construct of sympathy to permit moral evaluations of the object of one‘s sympathy. As a result, one can or cannot sympathise with the consequences on the natural environment from business activities; therefore, concern about nature is possible in a smithian perspective. In conclusion, several features of Smith‘s morals can be found in the different definitions of Corporate Social Responsibility.
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REFERENCES Akerlof, G.A. (1997). Social Distance and Social Decisions. Econometrica, vol. 65, nº 5, 1005-1027. Baumol, W. J. (ed.) (1970). A New Rationale for Corporate Social Policy. New York: Committee for Economic Development. Bowen, H. (1953). Social Responsibilities of Businessmen. New York: Harper. Carrasco, I. (2005). Ética, cultura y economía. ICE, N. 823, junio, 189-198. Carrasco, I. (2007). Corporate Social Responsibility, values and cooperation. International Advances in Economic Reseach, 13, 454-460. Carrol, A. B. (1979). ―A three-dimensional conceptual model of corporate performance. Academy of Management Review, N. 32, 946-967. Clark, T. (2008). Becoming everyone – The politics of sympathy in Deleuze and Rorty. Radical Philosophy, No. 147, 33-44. Clarkson, M. B. E. (1995). A stakeholder framework for analyzing and evaluating corporate social performance. Academy of Management Review, N. 20, 92-117. De la Cuesta, M. & Valor, C. (2003). Responsabilidad social de la empresa. Concepto, medición y desarrollo en España. Boletín ICE Económico, N. 2755, 7-19 Dobson, J. (2007) Applying virtue ethics to business: The agent-based approach. Electronic Journal of Business Ethics, vol. 12, No 2, 1-11. Elster, J. (1998). Emotions and Economic Theory. Journal of Economic Literature, vol. XXXVI, 47-74. Friedman, M. (1962). Capitalism and Freedom. Chicago: University of Chicago Press. Friedman, M. (1970) The Social Responsibility of Business is to Increase its Profits. The New York Times Magazine, 13 September. www-rohan.sda.edu Frierson, P. R. (2006). Adam Smith and the possibility of sympathy with nature. Pacific Philosophical Quarterly, 8 (4), 442-480. Frierson, P. (2007). Metastandards in the ethics of Adam Smith and Aldo Leopold. Environmental Ethics. Vol. 29, N. 2, 171-191. Haldane, J. (2008) Ethics, Politics and Imperfection. New Blackfriars. DOI: 10.1111/j.17412005.2007.00204.x Jones, T. M. (1995) Instrumental stakeholders theory: a synthesis of ethics and economics. Academy of Management Review, N. 20, 206-221. Min-Dong, P. L. (2008). A review of the theories of corporate social responsibility: Its evolutionary path and the road ahead. International Journal of Management Reviews, vol. 10 (1), 53-73. Sen, A. (1989). Sobre ética y economía. Madrid: Alianza Editorial. Smith, A.(1982). The Glasgow Edition of the Works and Correspondence of Adam Smith. Vol. V. Lectures on Jurisprudence- report dated 1766, ed. R.L. Meek, D.D. Raphael and P.G. Stein. Indianapolis: Liberty Fund. Ediction online licensed by Oxford University Press. http://www.oll.libertyfund.org Smith, A. (1790: The Theory of Moral Sentiments. The Liberty Fund. http://www.econlib.org. Wallich, H. C. & McGowan, J. J. (1970). Stockholder interest and the corporation‘s role in social policy, in Baumol, W. J. (ed.). A New Rationale for Corporate Social Policy. New York: Committee for Economic Development.
Moral Traits of Adam Smith‘s Theories … Varner (1998) In Nature’s Interests?. New York: Oxford University Press.
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Chapter 10
THE MONEY SUPPLY IN MACROECONOMICS Peter Howells* Bristol Business School, University of West of England, United Kingdom
ABSTRACT The notion that the quantity of money in an economy might be endogenously determined has a long history. Even so, it has never been part of mainstream economic thinking which has remained dominated by the view that the policymaker somehow controls the stock of money and that interest rates are market-determined. However, the need to design and operate a monetary policy that works for modern economies as they are currently constructed, has led to the emergence of the so-called ‗new consensus macroeconomics‘ in which it is recognised that the policymaker sets a short-term interest rate and the quantities of money and credit are demand-determined. This chapter looks at the way in which this ‗new consensus‘ is (at last) forcing a recognition, in the teaching of money, that the money supply is endogenously determined. It also shows how we can take this further by adding a banking sector to a model of the real economy in which the money supply is endogenously determined.
1. INTRODUCTION For many years, the role of money and monetary policy in macroeconomics has been represented by the IS/LM model, developed originally by Sir John Hicks (1937) to capture the essential ideas of Keynes‘s (1936) General Theory in a simple and tractable form. Its survival as the centrepiece of intermediate macroeconomics for so long is testimony to its versatility: it captures a very large number of simultaneous relationships in a very compact way. There are few aspects of macroeconomic policy that cannot be explored using the model. Unfortunately, *
Professor of Monetary Economics, Centre for Global Finance, Bristol Business School, UWE Bristol. UK
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the way in which central banks actually behave and the way in which monetary policy is transmitted to the rest of the economy are foremost amongst them. In the rest of this article we look at the way in which money is represented in the IS/LM model and why this fails to capture the current reality, in which the policymaker sets interest rates and the money supply is endogenously determined. We do this in the next section. In section 3 we look at why the money supply is endogenous in modern economies. In section 4 we review some recent attempts, related to what is often called the ‗new consensus macroeconomics‘, to construct a model of monetary policy in macroeconomics which avoids the pitfalls and misrepresentations of the LM curve. In section 5 we look at an issue which is sometimes overlooked in discussions of endogenous money and we shall see that it has resurfaced in recent work on the design of monetary policy rules. We conclude in section 6.
2. MONEY IN THE IS/LM MODEL In the IS/LM model, the LM curve traces combinations of the rate of interest and level of real income at which the money market is in equilibrium. This reference to market equilibrium implies independent supply and demand schedules. The supply side is the simpler of the two since the money supply is regarded as fixed by some external agent (the ‗policymaker‘) and independent of the rate of interest. In practice, the exogeneity of the money stock in the LM curve is rarely explained in macro textbooks. However, if we were to press for an explanation, the chances are it would resemble the ‗base-multiplier‘ model in which the central bank (independently or under government direction) sets the size of the monetary base and this in turn determines the stock of broad money as a multiple of the base.1 Formally: Ms = Cp + Dp
(1)
where Ms is the broad money stock and Cp and Dp are the non-bank private sector‘s holdings of notes and coin and bank deposits respectively. Next: B = Cb + Db + Cp
(2)
where B is the monetary base and Cb and Db are banks‘ holdings of notes and coin and deposits with the central bank. If we combine Cb and Db and refer to them as bank ‗reserves‘ (R), then we have: B = R + Cp
(3)
and we can express the quantity of money as a multiple of the base:
M Cp Dp B R Cp 1
An interesting account of the origin and development of this model is given by Humphrey (1987)
(4)
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Cp Dp M Dp Dp If we now divide through by Dp then we have: R Cp B Dp Dp
(5)
Now let Cp/Dp = α and let R/Dp = β, then we can write:
M 1 B
(6)
where α is the non-bank private sector‘s ‗cash ratio‘ and β is the banks‘ reserve ratio.
1
Finally, if we multiply both sides by the base, then we have M B
(7)
The insight here is that the broad money supply is a multiple of the monetary base and can change only at the discretion of the authorities since the base consists entirely of central bank liabilities. All of this is assuming that α and β are fixed, or at least stable, and above all independent of the size of the base.2 We can now make this model explicit in the familiar diagram from which we derive the LM curve:
Interest rate
Ms
i3 i2
Y3
i1
Y2 Y1 Q of money M = B x multiplier
Figure 1. Money market equilibrium.
2
In fact, many years ago, Paul Davidson (1988) introduced a distinction between ‗base-endogeneity‘ and ‗interest endogeneity‘. The latter arises as a result of α and β varying inversely with interest rates. This creates a positive association between the rate of interest, the multiplier and hence the money supply (for a given size of base). The result is a positively-sloped money supply curve (and a flatter LM schedule). The conventional meaning of an endogenous money supply, however, assumes endogeneity of the base as we see below.
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The demand for money, however, is more complex in being related (positively) to the level of nominal income and (negatively) to a rate of interest. In Figure 1, we show such a demand curve drawn for each of three levels of income. For each level of income, there is a corresponding rate of interest (Y1/i1; Y2/i2; Y3/i3), enabling us to draw an upward-sloping LM curve in interest-income space. In the General Theory the interest rate link comes about because agents desire to avoid a capital loss (or benefit from a capital gain) as the rate of interest rises (or falls) and the current rate of interest functions as a guide, albeit a very uncertain one, as to what the next movement in interest rates is likely to be. In these circumstances, all that is needed in Figure 1 is a representative interest rate for which Keynes, reasonably enough, took the long bond rate. In more recent accounts, however, the interest link is often made through an opportunity cost argument. Here the demand for money is negatively related to the rate of return that can be earned on other assets. This poses greater problems when it comes to the choice of interest rate since (if money is non-interest bearing) we have to decide what is an appropriate alternative asset but, more seriously, when money does earn interest, as most deposits do these days, then ‗the‘ interest rate has to be a spread term (e.g. bond minus deposit rate). But if money market equilibrium (and the resulting LM curve) require a spread term, it is hard to see how that same spread term can then be used to explain the behaviour captured by the IS curve when we bring IS and LM together. But let us assume that money does not pay interest (a reasonable enough assumption in the 1930s). There remain major problems. For example, Hicks (1980) himself drew attention to the problems of combining a stock equilibrium (the LM curve) with a flow equilibrium (the IS curve) as well as the model‘s contradictory demand for a real and nominal interest rate while Moggridge (1976) warned students that the model downplayed dramatically Keynes‘s emphasis upon uncertainty – as regards the returns from capital spending and the demand for money – by incorporating them into apparently stable IS and LM functions respectively. And it gets worse when we focus on the LM curve itself. If interest rates are market-determined, what is the role of the Governing Council of the ECB (or the MPC at the Bank of England and the FOMC at the US Federal Reserve)? If the transmission of policy effects relies upon the quantity of money why do central banks make no mention of the money stock? If ‗loose‘ monetary conditions lead to a fall in interest rates in the IS/LM model, why does the financial press predict a rise in interest rates when the consensus is that monetary policy is too slack? If stocks of money (and credit) can change only at the deliberate behest of the policymaker, why is the relentless growth of consumer debt a recurrent theme in the media? The shortcomings of the IS/LM model are often accepted as the price to pay for a useful teaching device, but these questions are regularly raised by enthusiastic but confused students who try to follow developments as reported in the media. And, as the fashion for policy transparency spreads amongst central banks with impressively informative websites, the students‘ confusion can only increase. The failure of the LM curve to allow a realistic discussion of monetary matters derives from the initial and fundamental assumption that the money supply is exogenously determined in the manner described above and shown in Figure 1. In fact, governments have never shown much interest in the money stock and certainly never in its absolute value. In 1967, when the UK government required a loan from the IMF, a condition of the loan required a restriction on the rate of ‗domestic credit expansion‘ (roughly the loans that were the credit counterparts of bank deposits). Notice that the focus was on credit and its growth
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rate. Furthermore, when it came to imposing restrictions the UK government relied upon ‗lending ceilings‘ and not on any reduction in (the rate of growth of) the monetary base. When, in 1981–85, the first Thatcher government introduced the Medium Term Financial Strategy which included explicit money growth targets, the policy instrument was the official rate of interest, intended to operate on the demand for bank loans. Even the Bundesbank, whose public stance on monetary policy involved frequent reference to monetary aggregates, used the management of short-term interest rates as the policy instrument (Clarida and Gertler, 1994; Geberding et al, 2005), a situation that continues under the ECB (Smant, 2002; ECB 2004). In practice, policymakers set the rate of interest at which they supply liquidity to the banking system and, to maintain that rate of interest, reserves are supplied on demand. In effect, central banks are using their position as monopoly suppliers of liquidity to set the price rather than the quantity. And with the price set and maintained as a matter of policy, the quantity of reserves is demand-determined, determined by whatever banks need to support the deposits created by the demand for net new loans at prevailing interest rates. Two quotations, from different central banks (respectively the Bank of England and the US Federal Reserve), make the point clearly: In the United Kingdom, money is endogenous - the Bank supplies base money on demand at its prevailing interest rate, and broad money is created by the banking system‘ . (King, 1994, p. 261)
And from much earlier: …in the real world banks extend credit, creating deposits in the process, and look for the reserves later‘ (Holmes, 1969, p. 73)
A recent (and topical) illustration of just how important the interest rate is as a policy instrument (as opposed to the money stock) was also shown by a report in the Financial Times in the early days of the recent crisis. Central banks have been forced to inject massive doses of liquidity in excess of $100bn into overnight lending markets, in an effort to ensure that the interest rates they set are reflected in real-time borrowing....The Fed is protecting an interest rate of 5.25 per cent, the ECB a rate of 4 per cent and the BoJ an overnight target of 0.5 per cent. (FT 11/08/07, p. 3. Emphasis added)
Charles Goodhart, an economist who has spent his entire career working with and advising central banks, summarises the process like this (Goodhart, 2002):
The central bank determines the short-term interest rate in the light of whatever reaction function it is following; The official rate determines interbank rates on which banks mark-up the cost of loans; At such rates, the private sector determines the volume of borrowing from the banking system;
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Banks then adjust their relative interest rates and balance sheets to meet the credit demands; Step 4 determines the money stock and its components as well as the desired level of reserves; In order to sustain the level of interest rates, the central bank engages in repo deals to satisfy banks‘ requirement for reserves.
And most significantly of all, the rate of interest as policy instrument and the consequent endogeneity of money lies at the heart of what is now called the ‗new consensus macroeconomics‘.3 It is often supposed that the key to understanding the effects of monetary policy on inflation must always be the quantity theory of money... It may then be concluded that what matters about any monetary policy is the implied path of the money supply... From such a perspective, it might seem that a clearer understanding of the consequences of a central bank‘s actions would be facilitated by an explicit focus on what evolution of the money supply the bank intends to bring about – that is by monetary targeting... The present study aims to show that the basic premise of such a criticism is incorrect. One of the primary goals ... of this book is the development of a theoretical framework in which the consequences of alternative interestrate rules can be analyzed, which does not require that they first be translated into equivalent rules for the evolution of the money supply‘. (Woodford, 2003, p. 48. Second emphasis added).
We look next at how we got to this position. Why do central banks set the price rather than the quantity of reserves?
3. WHY IS THE MONEY SUPPLY ENDOGENOUS? For the money supply to be endogenous, two conditions must be fulfilled. The first is that the causes of monetary expansion (or contraction) must lie with other variables within the economy, as opposed to being at the discretion of some external agency (‗the policymaker‘). The second is that, in order to respond to these forces, commercial banks must be able to obtain reserves on demand, or be able to economise on their need for reserves. In either event, reserves must not be a constraint.4 As regards the former, the argument begins with an accounting identity and a behavioural observation. The former is that loans and deposits appear on opposite sides of banks‘ balance sheets and thus, ignoring changes in bank capital, a change in loans must be matched by a change in deposits. The latter is that banks respond to demands from the non-bank private 3
See, for example, Charles Bean‘s (2007) list of defining features of the NCM. Further references to the inability of the money aggregates to exert any independent influence on the economy can be found in Chada (2008), Goodhart (2007), Meyer (2001) and Woodford (2007a, 2007b). 4 Which of these applies in modern monetary regimes and to what extent has been the subject of much debate between so-called ‗structuralists‘ (banks can innovate to economise on reserves) and ‗accommodationists‘ (central banks will always supply reserve on demand). These two positions were originally identified and analysed by Pollin (1991). It seems reasonable to suppose that banks can adjust their need for reserves to some degree in the short-run but continuous expansion of the money supply must eventually involve accommodation by the central bank.
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sector for credit not a demand for deposits. Hence ‗loans create deposits‘ rather than the other way round. As an alternative to the base-multiplier model, this focus on the credit counterparts of the money supply can be captured in a simple ‗flow of funds‘ model. As with the earlier case we begin with a definition of broad money: Ms = Cp + Dp
(8)
In changes: Ms = Cp + Dp
(9)
Given the balance sheet identity, then it follows that the change in deposits must be matched by the change in loans which can be decomposed into lending to the private sector (BLp) and to government (BLg). Dp = Loans = BLp + BLg
(10)
Substituting [10] into [9] yields Ms = Cp + BLp + BLg
(11)
Until the recent crisis, the UK government deficit has generally been ‗fully-funded‘, that is by the sale of government bonds, rather than borrowing from banks. With BLg = 0, money growth is explained entirely by bank loans to the non-bank private sector. However, the flow of funds model has its origin in the 1970s when the UK faced very large public sector deficits whose financing posed a potential problem. The fear was ever-present that the government might fail to sell the required volume of bonds, forcing it into residual financing from the banking sector. For this reason, the model was usually presented in a way that spelled out the monetary implications of the public sector deficit. Let the annual deficit (a flow) be represented by PSNCR, then: BLg = PSNCR - Cp - Gp ± ext
(12)
where Gp is the net sale of government bonds (‗gilts‘) to the general public and ext is monetary effect of official transactions in foreign exchange by the central bank (and thus equal to zero in a floating exchange rate regime). Substituting [12] into [11] gives Ms = Cp + BLp + PSNCR - Cp - Gp ± ext This is then tidied up (the change in notes and coin cancel) and re-ordered to give the conventional presentation: Ms = PSNCR - Gp + ext ± BLp
(13)
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Once we accept that ‗loans create deposits‘ (and not the other way round) it is a fairly simple task to link the demand for credit to the state of the economy, or the ‗state of trade‘, as it is commonly described. Assuming normal conditions in which real output is growing, then there will be a demand for net new loans to finance the increasing production and consumption, matched by a corresponding increase in deposits. If we add to this the common condition of positive inflation then there will be further demand for new loans since the demand for credit (like money) is a demand for real magnitudes. Although the endogeneity of the money supply was recognised many years ago5 and had powerful supporters in the not so distant past (e.g. Kaldor 1970, 1982, 1985; Kaldor and Trevithick, 1981; Davidson and Weintraub, 1973) it was Basil Moore who did most to promote the cause of endogenous money as a challenge to the monetarist revival of the 1980s. His book, Horizontalists and Verticalists (1988) included a chapter in which he tested the hypothesis that it was firm‘s demand for working capital which explained the growth of bank lending (and thus the expansion of deposits). This triggered further empirical work which was broadly supportive of the link between the growth of credit and industrial production (e.g. Moore, 1989; Cuthbertson and Slow, 1990; Palley, 1994; Hewitson, 1995). This notion, that the growth of credit and money reflects changes in nominal output, is important when it comes to the analysis of the role of money in the macroeconomy. For many economists in the post-Keynesian tradition it reverses the causality of the Quantity Theory of Money. Instead of money causing inflation (if its growth rate exceeds the growth of real output), it is the change in nominal income that determines monetary growth. The money stock is no longer the ‗cause‘ of anything interesting but merely the passive response to changes elsewhere in the economy. However, the innocence of money in this respect relies fundamentally on the link with production and there are two recent trends, at least in the UK, that raise questions about the uniqueness of this link. The first is that measures of total transactions in the UK economy show a steady and dramatic increase in total transactions relative to GDP between 1980 and 1998, and a slow increase since then. Many of these nonGDP transactions represent transactions between financial institutions as the UK financial sector grew faster than the rest of the economy. But they also include loans to households for the purchase of (largely secondhand) houses. The period in question covers two substantial property booms and one slump. The second is that bank lending to households increases much more rapidly over the period than lending to non-financial corporations with the result that both stocks and flows of bank lending have been dominated by the household sector since 1990. What all this means is that credit (and money) may expand for reasons which may not be closely related to economic activity. The notion that some variable wider than production or GDP, say total transactions, may be driving loan expansion is in principle testable. In 2001 Caporale and Howells published a paper in which they investigated simultaneously the causal relationship between three variables: total transactions, loans and deposits. The method they used (see Toda and Yamamoto, 1995) also enabled them to explore any direct link between transactions and 5
e.g. Wicksell (1898), Schumpeter (1911). It is also of some interest that the exogeneity/endogeneity of money was an issue long before – during the so-called ‗Great Inflation‘ in England between 1520 and 1640. Many contemporaries blamed it upon the arrival of gold from Spanish discoveries in the ‗New World‘. But there were others who held that the inflation had ‗real‘ causes (most commonly population growth) and that the import of precious metals (as well as debasement of the coinage) were endogenous responses. For a detailed discussion see Arestis and Howells (2002) and Mayhew (1995).
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deposits, by-passing the loan creation process. The study focused solely on the UK, using quarterly data from 1970 to 1998. The findings confirmed again the loan → deposit link but were not strongly supportive of the view that total transactions (rather than GDP) ‗caused‘ the loans. Transactions did though ‗cause‘ deposits. What the tests also revealed is that there appeared to be some causal feedback from deposits to loans, which has to be interpreted as meaning that the willingness to hold deposits, i.e. the demand for money must also be playing some role here. This is an interesting result in the light of an issue which has just been rediscovered and which we return to in section 5 below. The first condition for the endogeneity of the money supply, namely that the cause of change must lie within the economic system, is satisfied therefore by the notion that it is loans that cause deposits and that, at a given rate of interest, the demand for loans depends upon the current level of economic activity (somehow defined). But this leaves us with the question of why banks are not reserve-constrained in their response to the demand for credit. Why is it that central banks respond passively by supplying the reserves required to accommodate the behaviour of loans and deposits? There are several parts to the explanation and we can usefully divide them into two groups. The first consists of technical difficulties confronting a policymaker who wishes to manage the size of the monetary base within pre-determined quantitative limits; the second consists of undesirable consequences that would most likely follow if such management were indeed feasible. The base multiplier model is summarised in equation 7 and we said at the time that a fundamental insight it appeared to offer was that the money supply could change only at the discretion of the authorities who would have complete control over the size of the base, since its components were all liabilities of the central bank. The implicit assumption here is that the central bank must know and be able to control its liabilities, much like a household or a firm. But matters may not be so simple. In most monetary regimes, the public sector banks with the central bank. In the course of a normal working day, there will be large spontaneously flows between the public and private sectors. A net flow from the government results in an increase in the bank deposits of the nonblank private sector matched by an increase in banks‘ deposits at the central bank. In the notation of section 2, we have an increase in the base since Db is a component (see equation [2]) while government deposits, Dg, are not. Recall also that banks‘ reserve ratio, R/Dp, is a very small fraction. Adding Db and Dp in identical amounts to the numerator and denominator respectively, will lead to a noticeable increase in this ratio and thus to banks‘ liquidity. The same will happen in reverse when the non-bank private sector makes net payments to the government. The point is that there will be inevitable fluctuations in central bank liabilities, caused by spontaneous transactions between the public and private sectors. The first step in ‗knowing‘ and ‗controlling‘ fluctuations in the base requires, therefore, precise predictions of these flows. For the Bank of England, the prediction errors can be seen in the open market ‗fine tuning‘ operations that the Bank has to engage in order to offset the effects of what it calls ‗autonomous‘ flows in sterling money markets. These operations are reported the Bank of England Quarterly Bulletin.6 These same autonomous factors are identified by the ECB (2004) and their fluctuating nature is described on pp.88-89. The difficulties involved in anticipating these magnitudes is implicit throughout the ECB‘s discussion of the various open market techniques available to it (2008, ch.3).
6
Usually towards the end of the opening article called ‗Markets and Operations‘.
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Set aside for the moment, the difficulties involved in knowing the path of the base where there are large spontaneous flows between the public and private sectors. Consider now the difficulties of controlling it. Control requires compensating transactions between the public and private sectors. So, for example, reducing the rate of increase in the size of the base requires net sales of government debt to the nonbank private sector. And since the policymaker is aiming at a precise quantity target for the base, this requires sale by auction in order to ensure the precise quantity of the sale. Such auctions would be difficult and costly to organise with the costs and difficulties increasing with the shortness of the period over which the reserve target had to be achieved. For example, a regime which allowed averaging over a month would be more feasible than one which required the target to be achieved at the close of each day. But even so the administrative costs of frequent auctions would be considerable. The requirement for an auction method of bond issuance is just another way of saying that if the target is a quantity then the price must be market-determined. The price here, of course, is the rate of interest that banks will bid for reserves, effectively the overnight interbank rate. Given that banks‘ requirements for reserves are inelastic, the fluctuation in short-term rates could be very severe indeed. Most central banks would find wild fluctuations in interest rates more disruptive than fluctuations in the size of the base. The evidence for this (apart from the fact that it is the choice that central banks universally make in practice) is that bond auctions are invariably accompanied by a minimum price stipulation. Even in the depths of the financial crisis in December 2007, when the Federal Reserve introduced its emergency Term Auction Facility in order to calm money markets, it set a minimum bid rate ( see Taylor and Williams, 2009, p. 69). The authorities would rather limit the quantity sold than accept a rise in interest rates beyond a certain point. By recognising that strict monetary base control would result in very volatile short-term interest rates, we have already acknowledged that the adverse side effects could be considerable. These would include a number of institutional changes. For example, the overdraft system whereby lenders agree a credit ceiling and then charge borrowers on a daily basis for only the fraction of the facility that is used, is widely regarded as a cheap and flexible method of providing short-term credit to firms. But it makes the extent of borrowing (and the resulting deposit creation) a discretionary variable in the hands of banks‘ clients. Knowing that they might be reserve-constrained, it seems unlikely that banks would expose themselves to the risk that they could face a substantial surge in loan demand in a situation of reserve shortage.7 Another possibility in a base-targeting regime is that banks would build up holdings of ‗excess‘ reserves in periods of feast in order to protect themselves in future periods of famine. In addition to reducing the authorities ability to impose a reserve shortage, operating with a generally higher reserve ratio than is essential to protect against liquidity risk amounts to a tax on bank intermediation. This tax is substantial if reserves pay no interest (as is the case with notes and coin). But even where deposits with the central bank do pay interest, it is invariably at a rate which is less than banks could earn on assets that they could hold if they were not carrying excess reserves. 7
The conventional wisdom in the UK is that about 60 per cent of overdraft facilities are in use at any one time, meaning that this source of credit could almost double at the discretion of borrowers. Consider now that a reserve shortage and the consequent restriction of other forms of credit would make it almost certain that the demand for overdrafts would surge, the risk faced by banks operating such a system are clear.
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In modern economies, the money supply is endogenously determined and now we know why. In the next section we turn to recent efforts to incorporate a realistic version of the monetary sector into a simple macroeconomic model.
4. MONEY IN A MORE REALISTIC MODEL Attempts to develop a ‗macroeconomics without an LM curve‘ are now various starting, implicitly, with Clarida et al (1999) and more explicitly with Romer (2000). More recently we have seen a new framework for the teaching of monetary economics developed by Bofinger, Mayer and Wollmershäuser [BMW] (2005) and by Carlin and Soskice [CS](2005) who have since incorporated it in an intermediate level textbook (2006). The flavour of all these attempts is best understood by looking at Romer (2000) who basically took the IS part of the IS/LM model, and dispensed with the LM curve by simply treating ‗the‘ rate of interest on the vertical axis as an exogenously-determined policy instrument. Subsequent developments are essentially refinements and extensions of this approach. What follows is based, largely, on what Carlin and Soskice call the IS/PC/MR model in their 2006 textbook. The C-S book is doubly interesting since it represents one of the first attempts to introduce a more realistic treatment of money into a mainstream textbook. This requires the treatment to provide not just a sensible framework for the discussion of money and policy but also to be consistent with the modelling of the external sector and economic growth and a wide range of topics covered later in the book. It is also interesting because it starts from a position which embraces more wholeheartedly the essence of the new consensus than, for example, Romer (2000) whose discussion of the policy (interest) rate still relies upon the central bank controlling the stock of narrow money with a view to setting this rate. As the name of the model implies, it is based on three equations. The first is the familiar IS equation:
Yt 1 A rt
(14)
where A is autonomous demand and rt is the real rate of interest, in the previous period.8 The second is a conventional short-run Phillips curve:
t 1 t (Yt 1 Yt*1 ) ..
(15)
wherein inflation in the next time period depends upon current inflation (the inertia is due to price stickiness rather than inaccurate expectations) and the pressure of aggregate demand. We then require a third equation, a ‗monetary rule‘ equation, which sets the interest rate rt. This could take the form of a Taylor rule or it could be written more generally as the rate of interest that minimises a loss function of the kind: 8
Notice that the real rate of interest determines output with a one-period lag. Realistically, in the following equations we should introduce a further lag from output to inflation. However, we have omitted this lag for convenience of exposition.
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inflation, πt+1%
SRPC (πt = 6%) SRPC (πt = 5%)
B 6% 5%
F F’
SRPC (πt = 2%)
πT = 2%
A MR Y*
output
Figure 2. Monetary Policy and the Monetary Rule.
L (Yt 1 Yt*1 )2 (t 1 T )2 ..
(16)
Note that with λ=1 the policymaker is giving equal weight to output and inflation gap losses and that the effect of the quadratic term is to make overshoots and undershoots equally objectionable. Next, we substitute the Phillips curve (15) into the loss function (16) and differentiate with respect to Y:
L (Yt 1 Yt *1 ) {t (Yt 1 Yt *1 ) T } 0 .. Y
(17)
Substituting the Phillips curve back into this equation gives:
(Yt 1 Yt*1 ) (t 1 T )
(18)
This shows the equilibrium relationship between the level of output (chosen by the policymaker in the light of preferences and constraints) and the rate of inflation. If we wish to see this in diagrammatic form, then the starting point is Figure 2. The policymaker is assumed to have an inflation target (πT) of 2 per cent. Initially, the economy is in equilibrium at A, with inflation running at that level. Output is at its ‗natural‘ level (on a long-run vertical Phillips curve) so there is no output gap to put positive (or negative) pressure on inflation. An inflation shock is introduced which moves the economy to B at which inflation is 6 per cent. In order to return to target, the central bank raises the real interest rate9 and pushes output below its natural level and we move down the short-run 9
Carlin and Soskice (p.84) make the same point as Romer, that the central bank strictly speaking sets the nominal interest rate but does so with a view to achieving a real interest rate. Since it reviews the setting of this rate at
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Phillips curve (drawn for πt = 6) to the point labelled F. Notice that F is selected because the central bank is at a point tangential to the best available indifference curve at that combination of output and inflation. The indifference curves are shown by the dashed lines. The indifference curve represents the output/inflation trade-off (the degree of inflation aversion) for that particular central bank. (A more inflation averse central bank would have a different indifference map and would move the economy to a point on PC (πt = 6) to the left of F).10 As the inflation rate falls to 5 per cent, the short-run PC shifts down to (πt = 5). The central bank can then lower the real interest rate, allowing output to rise, so the economy moves to F’ and by this process (described as following a monetary rule) the central bank steers the economy back to equilibrium at A. The next step is to introduce the IS curve and the real rate of interest. This is done in the upper part of figure 3. To begin with, the economy is in equilibrium, shown in both panels by the point A. Notice that in the upper panel, this includes a real rate of interest identified as rs (a ‗stabilising‘ rate of interest which maintains a zero output gap). In the lower part, we then have a replay of figure 2. There is an inflation shock which takes the economy from equilibrium at A to a rate of inflation of 6 per cent (at B). In figure 2a, the central bank now raises the real rate of interest (to r') which has the effect of moving us up the IS curve to C at which the level of output is reduced. (In the lower panel we move down the SRPC πt = 6 curve to a point, corresponding to F in figure 2, at which the reduction in demand pressure lowers inflation to 5 per cent). As inertia is overcome, contracts embrace 5 per cent and the Phillips curve shifts down to SRPC (πt = 5), the real rate is reduced allowing some expansion of output. We are now at point D on the IS curve (and at a point corresponding to F’ in figure 2) but since we are still to the left of Y* inflation continues to fall. For as long as we remain to the left of Y*, the Phillips curve will continue to shift (and the real rate of interest can be lowered further) until inflation comes back to target at 2 per cent. The next step is to incorporate the banking sector. A summary of the system we are trying to model is provided by Goodhart (2002):
10
The central bank determines the short-term interest rate in the light of whatever reaction function it is following; The official rate determines interbank rates on which banks mark-up the cost of loans; At such rates, the private sector determines the volume of borrowing from the banking system; Banks then adjust their relative interest rates and balance sheets to meet the credit demands; Step 4 determines the money stock and its components as well as the desired level of reserves;
regular, short, intervals, and the behaviour of inflation is a major factor in the decision, it is reasonable to see it as setting a real rate. The indifference curves in figure 1 are segments of a series of concentric rings centred on A. If the central bank‘s loss function gives equal weight to inflation and output (as in the loss function [16]), the rings will be perfect circles. If the central bank puts more weight on inflation, the rings will be ellipsoid (stretched) in the horizontal plane. Hence greater inflation aversion on the part of the central bank would create a tangent ‗further down‘ the PC, to the left of F.
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In order to sustain the level of interest rates, the central bank engages in repo deals to satisfy banks‘ requirement for reserves.
Figure 4, based on Palley (1994, 1996), Fontana (2003, 2006), Howells (2009) and Bain and Howells (2009), embraces these requirements in four quadrants. In QI the central bank sets an official rate of interest, r0.
r0 r0 ..
(19)
Real interest rate, r % r’
C D A
rS
a
IS
Y* Inflation, πt+1%
output, Y PC (πt = 6) PC (πt = 5)
6 PC (πt = 2)
5
b
πT=2
Y*
MR
output, Y
Figure 3. The IS/PC/MR Model.
This official rate determines the level of interbank rates on which banks determine their loan rates by a series of risk-related mark ups. We make two simplifications. The first is that
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interbank rates are conventionally related to the official rate so that the mark-ups are effectively mark-ups on the official rate. The second is that we can represent the range of mark-ups by a single, weighted average, rate. This is shown as m.
rL r0 m .
(20)]
In QII banks supply whatever volume of new loans is demanded by creditworthy clients at the loan rate rL. Notice that the loan supply curve, LS, denotes flows, consistent with what we have said about the flow of funds being positive at the going rate of interest. This is further confirmed by the downward-sloping loan demand curve, LD, showing that the effect of a change in the official rate is to alter the rate of growth of money and credit. At r0, loans are expanding at the demand-determined rate L0. (21)
LS = LD
LD f ( ln P , ln Y , rL ) .
(22)
QIII represents the banks‘ balance sheet constraint (so the L=D line passes through the origin at 45o). In practice, of course, ‗deposits‘ has to be understood to include the bank‘s net worth while ‗loans‘ includes holdings of money market investments, securities etc. At r0 the growth of loans is creating deposits at the rate D0. LS = LD = L0 = D0
(23)
The DR line in QIV shows the demand for reserves. The angle to the deposits axis is determined by the reserve ratio. In most developed banking systems this angle will be very narrow, but we have exaggerated it for the purpose of clarity.
DR
R D . D
(24)
In a system, like the UK, where reserve ratios are prudential rather than mandatory, the DR line will rotate with changes in banks‘ desire for liquidity. Even in a mandatory system, the curve may rotate provided that we understand it to represent total (ie required + excess) reserves. Thus one of the model‘s strengths is that can show changes in banks‘ liquidity preferences either induced by changes in central bank operating procedures (as in the UK in April 2006),11 or as an autonomous response to changed market conditions (see section 5).
11
See Bank of England, The Framework for the Bank of England's Operations in the Sterling Money Markets (the ‗Red Book‘) February, 2007.
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Peter Howells Interest rate
Real interest rate, r
LS
rL m
QV
{ r0
QIV
IS QI LD
L0
Reserves
inflation, π%
output, Y
LRPC C
QII
QIII
Y*
QVI
D0
SRPC (π = πT)
LD line DR line
Deposits
πT
Y*
MR
output, Y
Figure 4. The Monetary Sector and the IS/PC/MR Model.
Finally, in QI again we see the central bank‘s willingness to allow the expansion of reserves at whatever rate (here R0) is required by the banking system, given developments in QII-QIV. R0
R ( D0 ) . D
RS = R D .
(25) (26)
How do we combine this with the analysis of Carlin and Soskice (or BMW) in figure 3? The key lies in QI. Recall that the rate of interest in QIV is the official rate, r0, (usually a repo rate). We have already agreed that r0 can reasonably interpreted as a real rate of interest which is what is required by the IS curve.12 All that we have done in QI is add a mark-up, m, in order to convert r0 into a loan rate, rL. Since the IS curve represents an equilibrium between investment and saving, there should be no objection to showing changes in equilibrium output to be dependent upon changes in the loan rate. This is directly relevant to investment spending and while one may object that the rate paid to savers is different, this objection could be made to any single rate of interest on the vertical axis. We are bound at accept that any single rate is a proxy for a spread term.13 In figure 4, therefore, we show (in QI-QIV) a 12
As we noted above, it was a widespread criticism of the IS/LM model that while the behaviour summarised in the IS curve required a real rate, the relationships in the LM curve depended upon a nominal rate. 13 Although the LM curve was traditionally drawn for a single rate of interest (usually the bond rate), this was strictly correct only if money‘s own rate was zero. Strictly, the rate should have been a spread term incorporating the rate on money and the rate on non-money substitutes.
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banking system in flow equilibrium (loans and deposits are expanding at a rate which satisfies all agents at the current level of interest rates and banks can find the appropriate supply of reserves to support this expansion). Constraints of space prevent us from detailed demonstrations of the way in which the model(s) in these six quadrants can be used to illustrate the conduct of monetary policy. But two examples may be possible. First of all, consider the case that we had in figures 2 and 3 where there is an inflation shock and the policymaker raises interest rates in order to steer the economy back to πT/Y*. In QIV, the official rate (r0) is raised. With a constant mark-up, this raises the loan rate, rL in QI. Transferred to QV, this moves the economy up the IS curve and the sequence of events that we saw in figures 2 and 3 begins. If we return to the monetary sector, the rise in interest rates raises the cost of credit and reduces the flow demand for new loans, and so deposits grow more slowly, accompanied by a slower rate of growth in required reserves which the central bank accommodates. As the rate of inflation (in QVI) falls, the policymaker can reduce the rate of interest and the expansion of money and credit returns progressively to normal levels as the real economy converges on the policymaker‘s π/Y target. This sounds like a reasonable description of how the monetary sector and the real economy interact in normal circumstances in modern economies where the money supply is endogenous and the policymaker is targeting the rate of inflation but is mindful of output losses. Furthermore, we can use the model to illustrate abnormal circumstances of the kind that we have experienced recently. In QI, for example, we can show the effect of an increase in banks‘ mark-up over the policy rate. This corresponds to recent experience whereby banks becoming concerned about each other‘s creditworthiness raise interbank rates, from which many other bank products are priced. The effect in the rest of the model is as if the policymaker had increased the official rate and we can follow through the deflationary effects. We can also show the recent reductions in policy rates by the ECB, The Fed and the Bank of England, as an attempt to hold the market rate, rL, down to an appropriate level in the face of the increase in m. The fuller discussion in Howells (2009a and 2009b) shows how the model can be used to illustrate other aspects of the credit crunch.
5. THE DEMAND FOR ENDOGENOUS MONEY At the beginning of section 3, we described the flow of funds model of money supply determination as being more helpful than the base-multiplier model in understanding the money supply process since it focused upon (a) flows and (b) the credit counterparts of the money supply. However, the model suppresses one, potentially, important issue.14 This is the question: ‗what has become of the demand for money?‘ Consider: the model explains changes in the money stock as the sum of the flow demand for net new loans. But the demand for loans originates with a subset of the non-bank public who have an income-expenditure deficit while the resulting deposits must be held by a wider population who are making a portfolio 14
By way of comparison, standard representations of the base-multiplier model suppress discussion of the determination of the key ratios α and β. These are complex portfolio decisions and failing to consider them as the outcomes of maximising behaviour on the part of the non-bank public and banks respectively makes the model profoundly ‗uneconomic‘.
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decision. We appear to have two decisions being made by (partially) different groups of agents and with clearly different motives. And yet, as if by magic, they must coincide. The answer, as pointed out by Cuthbertson some years ago is that ‗There is an implicit demand for money in the model, but only in equilibrium ... the FoF model delivers an implicit equilibrium demand for money function‘. (Cuthbertson, 1985 p. 173. Emphasis in the original). This debate (the missing demand for money) received a boost a few years later when Basil Moore (1988) published what was for many years the seminal work on endogenous money, Horizontalists and Verticalists.15 Moore‘s position was quite simply that in regimes where the money supply is endogenous, there is no independent demand for money. Money will always be accepted, in whatever quantity, because of its special role as a means of payment. Hence, whatever deposits loans may generate, they will always be willingly held. This gave rise to a lively debate (Goodhart, 1989, 1991; Moore 1988b, 1991, 1997; Howells, 1995, 1997) in which Moore was accused of misunderstanding the demand for money (accepting money in exchange for goods and services is not the same as the portfolio decision to go on holding it) and of denying that agents have preferences about how they hold wealth.16 But Moore was not alone in thinking that in an endogenous money environment the demand for money was irrelevant. A similar argument had appeared in Kaldor and Trevithick (1981) and was implicit in Kaldor (1985). The main target was the naive monetarism of the first UK Thatcher government. Their interest in the supply of money, therefore, was to show that it could never be in excess supply in a way that threatened the stability of the price level. After all, if it were possible for the demand for credit to result in a stream of new deposits which were in some sense `excessive' in relation to demand, then this opened the troublesome possibility that the desire to run down these deposits would result in an increased demand for goods and services and the whole monetarist sequence could re-emerge whereas if the money supply were endogenously determined (let us say by passively responding to the growth of nominal income) then the causality is reversed. Thus Kaldor‘s purpose was an attack on the Quantity Theory and all its works rather than a thorough discussion of the dilemma we have posed here. Nonetheless a mechanism was required that would ensure the permanent equilibrium referred to by Cuthbertson. The device that Kaldor envisaged for the reconciliation of deposit creation with money demand was the automatic use of excess receipts of money for the repayment of overdrafts. Thus, the individual actions of borrowers taking out new loans (or extending existing ones) could threaten an `excess' creation of deposits ex ante, but the actions of other (existing) borrowers in immediately repaying some of their debt would mean that the net deposits which resulted ex post would be only what people wished to hold. ‗Automatic‘ is the keyword. It is the way that overdrafts work that the size of the debt is automatically reduced by the receipt of payments and this will (`automatically') reduce the quantity of new deposits that are actually created. The problem is that not everyone has an 15
The title was chosen to emphasise the difference between an exogenous money supply, conventionally represented by a vertical money supply curve in interest-money space (as in figure 1 above) and an endogenous money supply which could be represented by a horizontal money supply curve. Unfortunately, the contrast is misguided and has led to much confusion and error in attempts to represent an endogenous money supply in a simple diagram. (See Howells, 2001, pp. 159-167 and the references cited therein). 16 The fact that the demand for money does play some role in determining an endogenously created money supply is suggested by causality tests that suggest some feedback from the change in deposits to the flow of new lending. It is not simply he case that ‗loans create deposits‘.
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overdraft, an observation made by Cottrell (1986) and by Chick (1992, pp. 204–5). And it is not sufficient to argue that some people somewhere (e.g. virtually all firms) do have overdrafts. Once it is accepted that the first round recipients of ‗new‘ money may not wish to hold it, then the genie threatens to leave the bottle. The question remains: how are the ‗excess‘ balances to be disposed of? It is significant that many of the contributors to this debate regarded themselves as ‗postKeynesians‘ since the endogeneity of money has been a cornerstone of post-Keynesian economics for many years (Fontana, 2003, p. 291). And for many of them, the significance of this endogeneity, as it did for Kaldor, lay in its reversal of the classical notion that changes in the quantity of money were causally responsible for changes in the price level alone (at least in the long-run). In post-Keynesian circles, the debate has subsided somewhat in recent years. This may hint at a consensus, and if it does then the consensus is probably based on two foundations. The first is the notion that money does have special characteristics which mean that the willingness to hold it is to some degree elastic, even with unchanged values in other variables. Ironically, there are echoes here of Laidler‘s (1984) ‗buffer stock‘ notion: the demand for money is not a point demand but a range. But this leaves the question of what happens in those circumstances (which maybe exceptional) when the ex ante change in deposits resulting from loan demand, differs so far from the willingness of agents to hold this extra liquidity that it breaches the limits of the buffer? The consensus here appears to involve an adjustment in relative interest rates that has a distinctly Keynesian ring to it. Take the case where the demand for credit creates new deposits in excess of those demanded in present circumstances. Agents, individually, attempt to run down their deposit holdings by buying assets. Collectively, this is self-defeating—causing only a redistribution of deposits. However, the redistribution is accompanied by a rise in asset prices and a fall in their yields. The return on bonds falls, relative to money‘s own rate. This change is the well-known mechanism traditionally cited in the textbook account of how changes in money supply are reconciled with money demand. Its effect is relevant here, in so far as a fall in the rate on nonmoney assets moves us down the money demand curve and yields a one-off increase in the demand for our excessively growing deposits. However, non-money assets are the liabilities of non-banks. They are liabilities issued by non-banks as a means of raising funds. To some degree, therefore, they are substitutes for bank loans. As the rates on corporate bonds and short-term paper (for example) fall relative to the rate charged on bank lending, so there is a fall in the price at which the economic units whose liabilities these are can raise new funds. If the yield on existing corporate bonds falls, new bonds can be issued with these lower yields and bond finance becomes cheaper, at the margin at least, relative to bank finance. With the cheapening of a partial substitute for bank finance, the demand curve for bank lending shifts inward and the demand for bank credit falls. It is this change in relative interest rates that brings the ex post demand for bank lending (and the ongoing flow of new deposits) into line with the community‘s increasing demand for money. Ultimately, the flow of new loans is matched by the willingness to hold the new money (as it must be). But the process by which the excess growth (in this example) involves agents individually trying to divest themselves of excess money balances and changes in interest rate spreads, both of which may have some effect on aggregate demand. It is no longer clear that changes in the money supply are entirely passive.
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However, while this debate has subsided in post Keynesian circles it has resurfaced recently, with interesting echoes of the earlier discussion.. Towards the end of section 2 we noted that the endogeneity of the money stock is now widely accepted as part of the new consensus macroeconomics and that one consequence of this is an ambivalence about the role of monetary aggregates in the determination of output and inflation. (See also footnote 3). So far as the conduct of monetary policy is concerned, the ECB is unusual in including a ‗reference value‘ for the growth of M3 as part of its ‗two-pillar‘ strategy. But even the ECB has expressed recent doubts as to whether the evolution of M3 provides any useful information, over and above that contained in the variables that it monitors as part of the second pillar (Atkins, 2007). The current revival of interest in the information content of monetary aggregates has its origins in recent upheavals in credit markets where conventional interest rate differentials have broken down. The best known and most dramatic example is the jump in LIBOR relative to the UK policy rate (and similarly in the USA and eurozone) in August 2007. But a recent paper by Chada et al (2008) looks at the behaviour of a different spread, one which has some affinity with the bank loan – deposit spread that we have just seen playing an important role in the reconciliation of the demand for loans and the demand for money. The spread in question is described as the ‗external finance premium‘ (EFP) and is defined as ‗...the difference between the opportunity cost of internally generated finance and the cost of issuing equity or bonds‘ (Chada et al., p. 3). Looking at US data from 1992 to 2007, the paper shows that the growth of real M2 and the EFP are positively correlated until about 1995 whereafter the correlation turns negative. In other words, increases in real money balances seem to lead to a compression of the EFP and they interpret this as evidence of money supply shocks dominating the market from the mid 1990s. As possible causes of such shocks they offer changes in the value of collateral (offered for bank loans) and costs of screening applications for such loans. The argument in brief, therefore, is that changes in bank lending behaviour can cause increases (or decreases) in liquidity which in turn cause changes in interest rate spreads which ultimately have an impact on aggregate demand (and may diverge from what was intended in the setting of the policy rate). For this reason, policymakers do need to take account of what is happening to the monetary aggregates as well as to the policy rate. In section 4 of their paper they show how the policymaker needs to be able to offset changes in the EFP and how a rule, incorporating changes in money can be formulated to achieve that. Although this particular perspective on why money aggregates might matter even when the money supply is endogenous, has evolved quite independently of the earlier debate in the post Keynesian literature, the similarities are quite striking. The proximate cause of new deposits is net new lending. If the demand for credit (at a given rate of interest) depends solely upon the evolution of nominal income, then the money stock is a passive reflection of events elsewhere in the real economy. But if the demand for loans is subject to shocks which are independent of the path of nominal income then there is a change in interest rate differentials which have an effect on aggregate spending. Furthermore, the sources of the shocks are not so very different. In Chada et al (2008) it is changes in the value of posted collateral and/or changes in banks‘ screening of loan applications. The possibility that asset price bubbles might influence the demand for credit independently of the requirements of the real economy must strike any observer of recent events as an obvious possibility. But this is not so very different from the earlier debate in the post Keynesian literature as to whether
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loan demand is driven solely by the ‗state of trade‘ or whether it is better explained by recourse to some broader range of transactions including asset purchases.
6. CONCLUSIONS The debate as to whether the money supply is exogenously or endogenously determined goes back a long way. Almost certainly, it is impossible to answer this without reference to a particular context. One might imagine, for example, that a money supply consisting solely of coins minted from precious metals is more likely to be exogenous than one that consists almost entirely of bank deposits. But even in the former case, as we have seen, there is room for debate. While one can certainly trace the argument that the money supply must be endogenous in a modern economy back to the end of the nineteenth century, it has been the post Keynesian economists like Kaldor, Davidson, Moore (but others too) who have done the most, in the last forty years, to develop a monetary economics founded on the interaction of banks‘ commercial interests with the needs of their customers. And throughout this period, central banks have, as a matter of practice, set interest rates and allowed banks and their customers to negotiate their preferred outcomes. In the circumstances, it is difficult to know why macroeconomic textbooks have persisted for so long with the fiction that the money supply is exogenously determined and in so doing have exposed generations of students to misinstruction. For a graduate student interested in methodology and/or the history of economic thought, there is a thesis waiting to be written. The imperative to design and conduct an optimal monetary policy in the real world, however, has finally forced a reappraisal in the form of the ‗new consensus macroeconomics‘ and this, at last, is beginning to force a realistic treatment of money in the latest textbooks. It is curious though that what is hailed as a ‗consensus‘, appears to make no reference to almost two generations of earlier work, even when that work touches on issues that are now coming into focus again. There is another thesis waiting to be written.
REFERENCES Arestis, P & Howells, P G A (2002). The 1520-1640 ―Great Inflation‖: an early case of controversy on the nature of money. Journal of Post-Keynesian Economics, 14(2), pp. 181-204. Atkins R (2007). ECB demotes money supply in inflation forecasts. Financial Times, 13th July. Bain, K & Howells, P G A (2009). Monetary Economics: Policy and its Theoretical Basis.London: Palgrave. Bean, C (2007). Is there a New Consensus in Monetary Policy?. In Arestis, P. (ed), Is there a New Consensus in Macroeconomics.London: Palgrave, 167-185. Bofinger, P, Mayer, E & Wollmerhäuser T (2006). The BMW Model: a new framework for teaching monetary economics. Journal of Economic Education, 37 (1), 98-117.
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Carlin, W & Soskice, D (2005). The 3-Equation New Keynesian Model – a graphical exposition. Contributions to Macroeconomics, 5 (1), 1-27. Carlin, W & Soskice, D (2006). Macroeconomics: Imperfections, Institutions and Policies. Oxford: Oxford U.P. Chada, J S, Corrado, L & Holly, S (2008). Reconnecting Money to Inflation: the Role of the External Finance Premium. Cambridge Working Papers in Economics, 0852, November. Chick, V (1992). Keynesians, Monetarists and Keynes. In P. Arestis & Dow, S. C. eds., On Money, Method and Keynes: Selected Essays. London: Macmillan, 193-205. Clarida, R & Gertler, M (1994). How the Bundesbank Conducts Monetary Policy. NBER Working Paper, 5581. Clarida R, Calli, J & Gertler, M (1999). The science of monetary policy: a new Keynesian perspective. Journal of Economic Literature, 37, 1661-1707. Cottrell, A (1986). The Endogeneity of Money and Money-Income Causality. Scottish Journal of Political Economy, vol. 33(1), 2-27. Cuthbertson, K (1985). The Supply and Demand for Money. Oxford: Blackwell. Cuthbertson, K & Slow, J (1990). Bank Advances and Liquid Asset Holdings of UK and Commercial Companies. Department of Economics, University of Newcastle, mimeo. Davidson, P (1988). Endogenous money, the production process and inflation analysis. Economie Appliquée, vol. XLI(1), 151-69. Davidson, P & Weintraub, S (1973). Money as Cause and Effect. Economic Journal, 83 (332),1117-32. ECB (2004). The Monetary Policy of the ECB. Frankfurth: ECB. ECB (2008). The implementation of monetary policy in the euro area: General Documentation on Eurosystem monetary policy instruments and procedures. Frankfurt: ECB. Fontana, G (2003). Post Keynesian Approaches to Endogenous Money: a time framework explanation. Review of Political Economy, 15 (3), 291-314. Fontana, G (2006). Telling better stories in macroeconomic textbooks: monetary policy, endogenous money and aggregate demand. In M Setterfield (ed), Complexity, Endogenous Money and Macroeconomic Theory: Essays in honour of Basil J Moore (353-67). Cheltenham: Edward Elgar. Gerberding, C, Seitz, F & Worms, A (2005). How the Bundesbank Really Conducted Monetary Policy. North American Journal of Economics and Finance, December, 16 (3), 277-92. Goodhart, C A E (1989). Has Moore become too horizontal?. Journal of Post Keynesian Economics, vol. 12(1), 29-34. Goodhart, C A E (1991). Is the concept of an equilibrium demand for money meaningful?. Journal of Post Keynesian Economics, vol. 14(1), 134-136. Goodhart, C. A. E. (2002). The endogeneity of money. In P. Arestis, Desai, M. & Dow, S. C. (eds), Money, Macroeconomics and Keynes: Essays in honour of Victoria Chick (14-24), vol. 1. London: Routledge. Goodhart, C A E (2007). Whatever Became of the Monetary Aggregates?. National Institute Economic Review, 200, 56-61. Hewitson, G (1995). Post Keynesian monetary theory: some issues. Journal of Post Keynesian Economics, 9, 285-310.
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Hicks, J R (1937). Mr Keynes and the ―Classics‖: A suggested interpretation. Econometrica, Vol. 5, 147-159. Hicks, J R (1980). IS-LM: An explanation. Journal of Post Keynesian Economics, Vol. 3 (2), 139-154. Holmes, A (1969). Operational Constraints on the Stabilization of Money Supply Growth. In Controlling Monetary Aggregates,. Boston MA: Federal Reserve Bank of Boston, 65-77 Howells, P G A (1995) The Demand for Endogenous Money. Journal of Post Keynesian Economics 18(1), Fall 1995, 89-106 Howells, P G A (1997). The Demand for Endogenous Money: a rejoinder. Journal of Post Keynesian Economics, 19(3), 429-435. Howells, P G A (2001). The Endogeneity of Money. In Arestis, P & Sawyer, M C (eds), Money, Finance and Capitalist Development (134-178). Cheltenham: Elgar. Howells, P G A (2009). Money and Banking in a Realistic Macro-Model. In Fontana, G & Setterfield, M (eds), Macroeconomic Theory and Macroeconomic Pedagogy (169-187). London: Palgrave. Humphrey, T M (1987). The Theory of the Multiple Expansion of Deposits: What it is and Whence it Came. The Federal Reserve Bank of Richmond, Economic Review, 73, 3-11. Kaldor, N (1970). The new monetarism. Lloyds Bank Review, 97 (July), 1-18. Kaldor, N (1982). The Scourge of Monetaris. Oxford: Oxford U P Kaldor, N (1985), How monetarism failed. Challenge, vol. 28 (2), 4-13 Kaldor, N & Trevithick, J (1981). A Keynesian perspective on money. Lloyds Bank Review, January, 1-19. Keynes, J M (1936), The General Theory of Employment, Interest and Money. London: Macmillan King, M (1994). The transmission mechanism of monetary policy. Bank of England Quarterly Bulletin, August, 261-267. Laidler, D. (1984). The Buffer Stock Notion in Monetary Economics. Conference Proceedings: Supplement to the Economic Journal, vol. 94, 17-34. Mayhew, N J (1995). Population, Money Supply and the Velocity of Circulation in England, 1300-1700. Economic History Review, 48 (2), 238-57. Meyer, L (2001). Does Money Matter?. Federal Reserve Bank of St Louis Review, 83, 1-15. Moggridge, D (1976). Keynes. London: Fontana, appendix. Moore, B J (1988a). Horizontalists and Verticalists. Cambridge: Cambridge U P. Moore, B J (1988b). The Endogenous Money Supply. Journal of Post Keynesian Economics, vol. X(3), 372-85. Moore, B J (1989), The Endogeneity of Money, Review of Political Economy, 1 (1), 64-93. Moore, B J (1991). Has the demand for money been mislaid?. Journal of Post Keynesian Economics, vol. 14(1), 125-133. Moore, B J (1997). Reconciliation of the Supply and Demand for Money. Journal of Post Keynesian Economics, 19(3), 423-428. Palley, T I (1994). Competing Views of the Money Supply Process: Theory and Evidence. Metroeconomica, vol. 45(1), 67-88. Palley, T I (1996). Accommodationism, structuralism and superstructuralism. Journal of Post Keynesian Economics, 18(4), 585-94.. Pollin, R (1991). Two theories of money supply endogeneity: some empirical evidence. Journal of Post Keynesian Economics, vol. 13(3), 366-396.
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Romer, D (2000), Keynesian Macroeconomics without the LM curve. Journal of Economic Perspectives, 2 (14), 149-169. Schumpeter, J A (1911). The Theory of Economic Development, trans. R Opie. Cambridge MA: Harvard U P. Smant, D J C (2002). Has the European Central Bank Followed a Bundesbank Policy? Evidence from the Early Years. Kredit und Kapital, 35 (3), 327-343. Taylor, J B & Williams, J C (2009). A Black Swan in the Money Market. American Economic Journal, 1 (1), 58-83. Toda, H Y & Yamamoto, T (1995) Statistical Inference in Vector Autoregressions with Possibly Integreted Processes. Journal of Econometrics, 66, 225-50. Wicksell, K (1936 [1898]). Interest and Prices: a study of the causes regulating the value of money . London: Macmillan. Woodford, M (2003). Interest and Prices: Foundations of a Theory of Monetary Policy. Princeton: Princeton U P. Woodford, M (2007a). Does a .Two-Pillar Phillips Curve. Justify a Two-Pillar Monetary Strategy‘. Paper presented at Fourth ECB Central Banking Conference. Woodford, M (2007b). The Case for Forecast Targeting as a Monetary Policy Strategy. Journal of Economic Perspectives, 4, 3-24.
In: Issues in Economic Thought Editors: M-A. Galindo, C. N. Spiller, pp. 185-202
ISBN 978-60876-173-9 © 2010 Nova Science Publishers, Inc.
Chapter 11
THE EXTERNALITY DEBATE AND THE ENVIRONMENTAL PROBLEMS: PIGOU, COASE, AND THE AUSTRIAN APPROACH José Luis Ramos-Gorostiza University Complutense, Spain
ABSTRACT The aim of this chapter is, first of all, to survey the main theoretical positions with regard to the externality problem, paying special attention to Pigou‘s original formulation of external effects and to the differences between Coase and the Austro-Hayekian approach. In practice, the position of ―free market environmentalism‖ toward pollution fits the Austro-Hayekian ideas. For this reason, in the second place and by way of illustration, the possibilities and limitations of ―free-market environmentalism‖ viewpoint with regard to real pollution problems will be discussed.
1. INTRODUCTION Although the notion of externality had been clearly suggested by Sidgwick and Marshall, the externality debate began effectively in 1920 with Pigou‘s The Economics of Welfare. Soon afterward, the Pigouvian vision of market-failures was sharply criticized by Knight, but the fact is that it took root among economists. Indeed, it eventually ended up forming a ―Pigouvian tradition‖ in textbooks, which usually identified Pigou as a firm advocate of State intervention via taxation in order to correct environmental external effects. Moreover, optimal Pigouvian taxes became an essential component of the theory of environmental policy. In 1960, Coase published his famous article ―The Problem of Social Cost‖. He criticized the method of framing the external effect problem by way of a theoretical model which automatically implies the need for state intervention, and advocated for an alternative approach based on institutional assumptions. More recently, some Austrian economists—
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taking Hayek‘s works as a starting point—have disassociated themselves from Coase‘s approach, defending the strict liability rule for cases of environmental damage. The purpose of this chapter is, first of all, to survey the different theoretical positions with regard to the externality problem which has been previously alluded to, with special attention to the differences between Coase and the Austro-Hayekian approach. In practice, the position of ―free-market environmentalism‖ toward pollution fits the Austro-Hayekian ideas. For this reason, in the second place and by way of illustration, possibilities and limitations of the ―free-market environmentalism‖ viewpoint with regard to real pollution problems will be discussed.
2. THE PIGOUVIAN TRADITION: STATE INTERVENTION THROUGH PIGOUVIAN TAXES In his Principles of Political Economy (1883), Sidgwick referred explicitly to positive externalities in production using the famous example of the lighthouse. He also referred to timber companies affecting ―atmosphere through deforestation‖1. Later, in 1890, Marshall defined ―external economies‖, linked to ―an increase in the scale of production of any kind of goods‖, as ―those dependent on the general development of the industry‖ [Marshall (1994, p. 221)]. However, Pigou would be the first economist who discussed externalities extensively in Part II of The Economics of Welfare (1920), as an additional case of ―market failures‖: ―The general problem of this Part is to ascertain how far the free play of self-interest, acting under the existing legal system, tends to distribute the country‘s resources in the way most favourable to the production of a large national dividend, and how far it is feasible for State action to improve upon ‗natural‘ tendencies‖ [Pigou (1962, p. xii)].
That is, sometimes the market did not lead to an efficient allocation of resources. In these situations—such as when external effects exited—the Government could act in order to improve economic results in social terms2. Pigou‘s starting point was the distinction between social marginal net product and private marginal net product, because—precisely—the divergences between the two products gave rise to an externality. On the one hand, the social marginal net product was defined as: ―the total net product […] due to the marginal increment of resources in any given use or place, no matter to whom any part of this product may accrue. It might happen, for example, […] that costs are thrown upon people not directly concerned, through say, uncompensated damage done to surrounding woods by sparks from railway engines. All such effects must be
1 2
See Papandreou (1994) for a brilliant history of the notion of externality. ―[The] adjustment of institutions to the end of directing self-interest into beneficial channels has been carried out in considerable detail. But even in the most advanced States there are failures and imperfections. […] There are many obstacles that prevent a community‘s resources from being distributed among different uses or occupations in the most effective way […] [This study] seeks to bring into clearer light some of the ways in which it now is, or eventually may become, feasible for governments to control the play of economic forces in such wise as to promote the economic welfare‖ [Pigou (1962, pp. 129-130)].
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included —some of them will be positive, others negative elements— in reckoning up the social net product‖ [Pigou (1962, p. 134)].
On the other hand, the marginal private net product was ―that part of the social net product […] which accrues in the first instance […] to the person responsible for investing resources there. In some conditions this is equal to, in some it is greater than, in others it is less than the marginal social net product‖ [Pigou (1962, p. 134-5)].
The divergences between social marginal net product and private marginal net product occurred because, in some occupations, ―a part of the product of a unit of resources consists of something, which, instead of coming in the first instance to the person who invests the unit, comes instead, in the first instance, as a positive or negative item, to other people‖ [Pigou (1962, p. 174)].
Basically, the divergences could be summarized in two general cases: those featuring contractual ties—as occurred with the example of tenants and owners put forward by Pigou— and those where no legal ties existed between the causers and the affected parties (the lighthouse, the smoke production, etc.)3. When contractual links existed, Pigou considered that it was possible to arrive at solutions through voluntary agreements. But in the absence of contractual links, ―it is […] possible for the State, if it so chooses, to remove the divergence in any field by ‗extraordinary encouragements‘ or ‗extraordinary restraints‘ upon investments in that field. The most obvious forms which these encouragements and restraints may assume are, of course, those of bounties and taxes‖ [Pigou (1962, p. 192)].
Therefore, Pigou did not defend State intervention through taxes in any case: this was only a possibility that he suggested in order to eliminate divergences between the private and social products. In fact, as we have seen, he also referred to negotiation as a possible solution in specific cases. But, as Aguilera (1994, pp. 386; 388) has shown, textbooks reduced Pigou‘s contribution to Pigouvian taxes, presenting Pigou as a ―stubborn advocate of state intervention via taxation‖. Optimal Pigouvian taxes were widely developed in both mathematical and graphical form: the Pigouvian tradition had been born.
3
Knight (1976[1924]) criticized one of Pigou‘s alleged examples of market failure. His famous criticism –which to some extent anticipated Coase‘s position– was so convincing that Pigou removed it from subsequent editions of his book. Pigou analyzed an example of alternative roads between two points, one poorly surfaced but broad and subject to constant costs, the other well surfaced but narrow and subject to increasing costs. The second road would be over-utilized –because in equilibrium the average cost of travelling by either road would be the same–, so Pigou recommended a tax on vehicles using it to achieve an efficient allocation of traffic, that is, to avoid congestion. However, Knight proved that this example was not a failure of the market at all, but a failure of government to specify accurate property rights for scarce resources. Pigou‘s result hinged on free access to a resource.
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3. COASE: RECIPROCITY AND EXTERNAL REORDERING OF RIGHTS In ―The Problem of Social Cost‖ Coase criticized the method of framing the external effect problem by way of a non-institutional model which automatically implies the need for State intervention, the real possibilities of which are not discussed. In fact, in the Pigouvian tradition ―market failures‖ are identified by comparing reality with a theoretically ideal model. Against this, Coase (1988) proposed comparing institutional realities: the market, which in order to function demands well defined property rights and low transaction costs, and the state, which faces the problems endemic to the political process, the costs of administration, of information, of vigilance and control, etc. Thus, against the formal, non-institutional and rigid treatment of the Pigouvian tradition (which eventually made it into the manuals), Coase proposed a comparative analysis of concrete, imperfect institutional alternatives, with, as a selective criterion, the obtaining of the greatest monetary value from final production: the differing possibilities of public intervention would have to be compared both amongst themselves and also with the market solution, bearing in mind the context in which the externality took place (amount of transaction costs and degree of definition of property rights). Consequently, neither the need for public intervention to take place nor the form which it would take would necessarily follow from the simple existence of an externality. As can be seen, Coase‘s approach4 is characterized by its flexibility, a flexibility born of the vision of externality as a reciprocal problem (contrasting with the unidirectional conception underlying the Pigouvian tax and the strict liability rule): avoiding one injury brings about another and, therefore, the best thing might not always be to act against the cause of the externality; in any case, ―the value of what is obtained as well as the value of what is sacrificed to obtain it‖ must be weighed in each situation [Coase (1988, p. 96)]5. In summary, whatever solution is finally chosen in taking on an externality problem, it must take into account both the cause and the receiving end of the problem. Coase is aware that the assignment of rights is fundamental for the efficiency of an economic system when transaction costs are high, and does not hesitate to support judicial reorderings of these rights when it permits an improvement in total production value6.
4
Along with the discussion of traditional environmental policy instruments, current manuals tend to include, as an alternative option opposed to state intervention and on the same level of ideal abstraction, the so-called Coase theorem coined by Stigler (1966). Stigler eliminated from the Coasian proposal its essence, which is to advocate a richer vision of reality as institutional reality: what is relevant is to compare alternative and imperfect institutional solutions. Thus, in his Nobel acceptance speech, Coase referred to this ―theorem‖ with a certain disdain. 5 Later, Coase (1988, p. 155) clarified this: ―The cost of exercising a right (of using a factor of production) is always the loss which is suffered elsewhere in consequence of the exercise of that right – the inability to cross a land, to park a car, to build a house, to enjoy a view, to have peace and quiet, or to breathe clean air‖. 6 For a critique of this viewpoint see Vira (1997). Vira (1997, p. 773), in the tradition of critical institutionalism, has argued that ―the analysis of institutions and institutional change cannot be conducted within the realm marketbased calculations of economic efficiency. Efficiency is defined by the structure of institutions, so is inappropriate as a guide to institutional performance; institutional evaluation requires making explicit value judgments‖.
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4. HAYEK: STRICT LIABILITY AND INTERNAL INSTITUTIONAL CHANGE According to the interpretation of Cordato (1992a,1992b), Hayek‘s work on the knowledge problem would serve to justify what is in fact the current position of the modern Austrian School regarding externalities – strict liability and internal changes at the institutional level – which differs clearly from Coase‘s position7. It can be deduced from Hayek‘s analysis that the purpose of economic policy must be simply to define an institutional framework which permits the pricing system to disseminate available knowledge to the maximum degree possible [Hayek (1976a, pp. 79-80)]. In other words, the legal framework must help improve the certainty with which economic decisions are taken: certainty regarding the future of legal rights and obligations eliminates the decision-making process in the market, which can be a serious source of errors. Given that future prospects, in themselves charged with uncertainty and often incorrect, are an important part of the information reflected in any price, not adding uncertainty to the economic system is one way that the legal framework can contribute to the greater diffusion of knowledge. Furthermore, the ―rules of the game‖— among them property rights — must be independent of the aims of agents and must clearly delimit a field in which they can act without interference from others [Cordato (1992a, p. 220)]. Apart from this, for Hayek the process of institutional change is an evolutionary one, such that in the long term institutions survive and keep adapting as long as they are useful to society. Cultural evolution is conceived as a process of group, not individual, adaptation, in which there is no pre-established plan or direction and which is never linear, continuous or uniform, since errors and regressions appear in the short term. Individuals adapt to their surroundings, to facts and to concrete circumstances by subjecting themselves to norms which govern their actions and are not the result of design, seeing possible future benefits in these norms in advance. The rules of behaviour are immersed in a process of selection, trial and error, so that those which have contributed to the survival, growth and expansion of a society remain and will probably be incorporated—imitated—by other societies. Finally, there is a tendency in the long run toward institutional efficiency through a ―natural selection‖ process. In view of experience, modes of behaviour are modified or new ones are tried out [Hayek (1979, pp. 17–21)]8. The practical implication of these ideas concerning a good part of the normative level of society—spontaneous origin, evolutionary-efficient character and exact mode of operation unknown—becomes resistance to deliberate reforms and modifications in the existing institutional structure. The contrary position (―constructivist rationalism‖), according to Hayek, does not recognize the limits of reason and the complex nature of knowledge in 7 8
For a critique of Cordato‘s Austrian interpretation of the Coase (1988) article, see Gunning (2000a, 2000b). The response to this critique can be found in Cordato (2000). Buchanan (1977, p. 31) shares with Hayek a fondness for methodological individualism and the liberal tradition, but dissents from his optimistic evolutionism, though accepting the fact that many institutions originate spontaneously: ―the forces of social evolution alone […] no guarantee that socially efficient results will emerge over time‖. According to Buchanan, all institutions are susceptible to premeditated reform, and it cannot be assumed – as it is by Hayek – that institutions formed by invisible hands will be efficient, while those deliberately designed will tend to be inefficient. Before making assertions of this type, it‘s necessary to delineate criteria for evaluation of existing norms and institutions [Vanberg (1994)].
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society, supposing that the human mind is capable of voluntarily designing and modifying all or a great part of the complex institutional structures on which social order rests.
5. DIFFERENCES BETWEEN COASE AND HAYEK From the Austrian perspective a serious difference appears between the analyses of Hayek and Coase. For Coase, property rights—in a context of elevated transaction costs— would always be subject to modification in order to obtain a more efficient result, and therefore judges and politicians would play a prominent role. Conversely, for Hayek any economic analysis must be carried out in the context of existing property rights at the given moment. In accordance with the purpose of minimalizing uncertainty, once property rights are clearly defined they must be strictly defended and treated as givens when formulating normative prescriptions. This does not mean that property rights remain unaltered over time: the Austrians allow for internal and progressive changes in the property rights structure, resulting from proper social and market interaction, but oppose all property rights modification from outside (since they believe it impossible to possess the necessary information for taking a decision of this type). Moreover, the Hayekian conception of institutional origin and evolution reinforces the idea of opposition to ―external‖ intervention on the institutional level. Hayek grants great importance to informal rules of spontaneous origin, which favour mutual adjustment and coordination of individual actions, permitting interaction with others without having to worry every moment about our behaviour9. In other words, Hayek maintains that social institutions, habits and customs, traditions and other types of ordinary conduct store wisdom, knowledge of action, ―know-how‖, experience accumulated by generations and generations: in this sense, institutions make social life possible and are a key resource by which individuals may involve themselves in a world they know very imperfectly. Nonetheless, in many cases neither the reason for their present form nor exactly how they operate is known [Hayek (1979, p. 17); Hayek (1960, pp. 27-28)]. On the other hand, the idea that property rights must not be externally modified by any means once they are well defined, leads the Austrians to justify strict liability in the case of external effects. Whoever has ―the right to‖ must always be compensated by whoever violates this right. If property rights are well defined and external causes can be easily and separately identified, the rigorous application of the strict liability rule gives the agents a solid framework in which to evaluate the possible consequences of their decisions and activities a priori so that they tend to internalise potential negative external effects ex-ante. In contrast, as we have already seen, Coase emphasizes the reciprocal character of external effects, pointing out that always acting upon the generating agent of the externality didn‘t necessarily lead to a minimization of social cost: alternative institutional solutions should be compared, so as to choose that which allows obtaining the greatest net value in monetary terms. Nonetheless, according to the Austrian interpretation, this choice—which could lead to a fixed reorganization of property rights by a tribunal—would be impossible 9
Hayek (1960, p. 22) cites a quote from philosopher and mathematician Whitehead which is very illustrative in this respect: ―Civilization advances by extending the number of important operations which we can perform without thinking about them‖.
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from the Hayekian perspective, given the information problem this would imply. Prices— including those derived from competitive markets—do not include complete and totally truthful information on the social costs of opportunity. For one thing, time constantly brings new information and changes in the old, making the market process one of permanent learning, one always ―open‖. For another, at any moment the prices being generated reflect incomplete and sometimes incorrect information; first, because changes produced in the information can only be reflected in prices with a certain time lag; second, because price formation depends on decisions based in part on agents‘ future expectations, for which prices will reflect errors in forecasts10. Note the clear difference in focus between the strict liability rule (which adjusts itself to the ―A causes damage to B and in any case must compensate B for it‖ plan) and Coase‘s position, which emphasizes the reciprocal nature of externality problems and, thus, advocates comparison—given a concrete institutional context—of the total product obtained through alternative social solutions (from voluntary agreements to government regulations). For example, a new mill affects established watercourse uses, because the owner of the mill site builds a dam that overflows the lands of upstream neighbours. Under a regime of strict liability, an actor is liable for harms that he causes, whether he acts carefully or not, so the owner of the mill site is subject to the duty to pay damages to the overflowed owners. However, from the Coasian perspective, a court should look for a solution that would make the total river usage most valuable under circumstances of bargaining difficulty. To sum up, the Coasian solution can require external reordering of property rights to minimize the social cost of environmental damage, whereas the Hayekian position requires internal adjustments of property rights, which occur at the level of business innovation and technological change (such as technology that allows for the casual direction of environmental damage to be determined). Property rights naturally arise in these circumstances and strict liability is use as the fundamental corrective instrument for environmental damage once these property rights arise. However, in relation to the coercion power required to enforce the rules, there are fewer differences than might appear at first sight between Coase‘s approach and the Austro-Hayekian perspective. Coase relies on the court to settle the externality disputes and the court not only decides on the property rights, but also enforces the decision. In the case of the strict liability rule associated with the AustroHayekian perspective, the primary mechanism to enforce it is also the state coercion power (that is, some form of public protection of the rights is always necessary). Therefore, both the imposition of legal liability for damages and the Coasian solution depend on the legal process. But the range of judicial decisions is different in each case. In the Coasian approach the range is wider: Coase highlights the reciprocal nature of externalities and requires –at times– acting upon the receiving agent, which leads to an externally generated adjustment of property rights. The Austro-Hayekian approach, on the other hand, focuses on a unidirectional ―polluter pays‖ principle where the generator of the damage always compensates those affected in a ‗strict liability‘ sense.
10
Langlois (1985) and Kirzner (1992a; 1992b) offer a global vision of the modern Austrian School‘s elaboration on the knowledge problem and its relation to rationality.
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6. THE AUTRO-HAYEKIAN APPROACH IN PRACTICE: FREE MARKET ENVIRONMENTALISM AND POLLUTION PROBLEMS Free market environmentalism was born at the end of the 1970s in the United States as a radical proposition for the conservation of nature, urging the downplaying of governmental activism in favour of markets and replacing prohibitions and administrative regulations with property rights and voluntary exchanges. Concretely, extension of private property rights and a freely functioning market were proposed as the best way of protecting the environment. Now, more than two decades later, free market environmentalism is established and already widespread in the United States, with practical proposals for diverse problems, from forests and ivory trafficking to water shortages. Furthermore, Anderson and Leal‘s book, published in 1991 and perhaps the best synthesis of current thought, has been widely disseminated and recently revised [Anderson & Leal (2001)]11. In contrast to the ―market failure‖ proposition, to which a great portion of environmental economic literature inspired by the Pigouvian tradition subscribes, and in contrast to the ―scientific management‖ myth which dominated the American Conservation Movement for decades, free market environmentalism springs from a harsh critique, driven by Buchanan [Buchanan & Tullock (1962)], of public-supported governmental action. Thus, much attention is dedicated to documenting, with real examples, failures of public management of natural resources, highlighting the high costs of administration and control of public policy, the rigidity and administrative inertia before scenarios of change and diversity, the lack of information in decision making, the perverse behaviour of bureaucratic agencies, and –in general– the problems associated with the political process and the ballot box, such as the ―rent seek‖ of cohesive pressure groups or the tendency toward a short time frame in political decisions. For another thing, the cause of environmental problems is not in so-called ―market failure‖ but in the absence of markets, or more concretely, in the absence of well defined private property which would permit markets to function. For this reason, the objective should be the extension of market institutions into environmental resources which were formerly outside their scope: ―At the heart of free market environmentalism is a system of well-specified property rights to natural and environmental resources‖ [Anderson & Leal (2001, p. 4)].
The key to establishing adequate initiatives for private action is to establish property rights that are well defined, enforced and transferable. Property rights create powerful incentives to preserve the value of that which is owned. As a consequence, discipline is imposed on resource users because the wealth of the property owner is at stake if bad decisions are made [De Alessi (1998)]. In fact,
8
Outstanding contributions to early free market environmentalism are Baden & Stroup (1981), Smith (1981; 1986), Anderson (1983) and Deacon & Johnson (1985). In the 1990s this way of thinking was developed in works such as Block (1990), Brubaker (1995), Greve & Smith (1992), Nelson (1995) and Kreuter & Simmons (1995). More recently, collective works such as Yandle (1999), Adler (2000) and Leal (2001) stand out.
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―market prices signal increasing scarcity and provide rewards for those who mitigate resource constraints by reducing consumption, finding substitutes and improving productivity‖ [Anderson & Leal (2001, p. 3)].
Free market principles have already been successfully used to improve nature conservation. For example, in Zimbaue and Bostwana, where ivory trading is legal and elephants are quasi-private property, the elephant population has thrived, because local people have a strong interest to prevent poaching [Kreuter & Simmons (1995); Smith (1981)]. Another area in which market solutions have been successfully applied is water conservation. Water marketing can provide a mechanism for improving efficiency and environmental quality. In fact, water markets have lead to a more efficient allocation of water resources in western states such as Utah, Colorado or New Mexico, which faced recurrent water shortages. However, a clearer definition of water rights and the elimination of unnecessary impositions on water transfers would improve the results [Anderson (1983); Anderson & Johnson (1986); Wahl (1989)]. One final example of the free market environmentalism applications is park services, which have long been provided by private groups. For instance, North Maine Woods, Inc., is an association of twenty landowners formed in 1974 which manages recreational activities on 2.8 million acres of mostly private commercial forest [Smith (1986, pp. 381-387)]. Given the movement‘s clearly political orientation, practical conclusions stand out more than theoretical foundations. Despite this, according to its own promoters, free market environmentalism counts among its intellectual bases the Austrian School, the perspective of public choice and new institutional economics. In particular, the authors who have most influenced its proposals are Hayek, for his ideas concerning the problem of knowledge and the difficulty of centralized planning, Buchanan, for his analysis of the political process through conventional assumptions about the behaviour of the economy, and Coase, for his emphasis on the importance of the private property rights structure for the functioning of an economic system [Nelson (2001); Anderson & Shaw (1999)]12. Nonetheless –as we have seen– Coase‘s central idea and the ideas developed from Hayek‘s work by the modern Austrian School, presented together as a coherent justification of free market environmentalism, are not fully compatible in reality. Specifically, in the case of negative external environmental effects, the conclusions derived from Coase‘s ―The Problem of Social Cost‖ are very different from the practical implications of Hayek‘s work on the problem of knowledge. As opposed to the Coasian vision of externality as a reciprocal problem and the consequential acceptance of any reordering of property rights which leads to greater gross production value, Hayek‘s ideas, according to Cordato‘s Austrian interpretation [Cordato (1992a; 1992b; 2000)], lead to the application of strict liability and reject all ―external‖ intervention, judicial or governmental, in the structure of property rights. In fact, the position of free market environmentalism toward pollution fits the AustroHayekian model. It is based on the principle of strict liability and confides in the ability of entrepreneurs (―enviro-capitalists‖) to find legal and technical innovations that help resolve 12
Fred L. Smith Jr. also claims Hayek, Buchanan and Coase as the theoretical underpinnings of free market environmentalism [―The Future of Environmental Policy: Free Market Environmentalism: an exclusive interview with Fred L. Smith Jr.‖, written by Bonner Cohen, Environment News, May 1, 1998], and authors such as Anderson (1982), Shaw (1994), Anderson & Shaw (1999), or Adler (2000), for example, insist on the same idea.
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environmental problems. In parallel, solutions which are market-based but controlled by public petition, such as transferable emission permits or economic instruments, are scrutinized from a radical scepticism toward governmental action. Pollution concerns challenge the free market environmentalism paradigm. In principle, ―the problem with waste disposal is that it creates a competing use for disposal media‖ [Anderson & Leal (2001, p. 126)]. Consequently, so long as there are clearly defined property rights to the waste streams and the relevant disposal media, there is no problem. However, confronted with air or water pollution, pure solutions based on property rights are sometimes difficult to apply due to the state of current technology, which frequently does not permit their clear definition. Furthermore, transaction costs in these cases tend to be high. Confronted with these difficulties associated with pollution problems, there are three possible options. In the first place are governmental regulations, which free market environmentalism rejects as much for their inefficiency as for their offering ample opportunities for rent seeking. In the second place are market-oriented economic instruments (―market based environmentalism‖) such as transferable emission permits, which can be considered Coase-inspired. From the free market environmentalist perspective these are suspect, called ―too governmental‖ [Anderson & Leal (2001, p. 463)], since although in theory they allow environmental objectives to be reached at low cost, they leave a wide margin in which the political process can act: determination of environmental priorities, and global emission levels, distribution of permits, control and vigilance work, etc13. Finally, in the third place, is the strict liability option, preferred by free market environmentalists14 since it acts through the initiative of the individuals involved and implies an ordinary tribunal decision on legal-private rules: ―There is a rich history of common law cases that illustrate how people have protected themselves from pollution‖ in the absence of federal regulation [Anderson & Leal (2001, p. 138)]. Furthermore, there are notable attractions to the strict liability rule: it is in line with the principle of ―the polluter pays‖, it implies a considerable incentive for prevention, and it permits decentralization of protection decisions. In itself, it eliminates to a great extent the problem of special interest groups bringing pressure upon the political apparatus. Certainly, there are times when it is not possible to identify the sources and effects of the polluting activity –and thus the strict liability rule is not applicable15– but free market 13
14
15
As Daly (1999, p. 39) points out, ―the bubble concept and its variants absolutely require an initial social, collective decision limiting the aggregate use of an environmental source or sink to an amount judged to be within environmental carrying capacity [...] Another political decision must be made about the initial distribution of this newly created right among users‖. Free market environmentalism is not such a singularly defined paradigm that takes only the position of strict liability and endogenously defined property rights. But this position, linked to free market environmentalism advocates closest to the modern Austrian School, is perhaps the main one. As it is pointed out in the final section of this chapter, according to Friedman (1994), this is the position maintained by important authors, such as Anderson, Leal, F. L. Smith or Shaw. The most immediate difficulty associated with the application of the strict liability rule to ecological damage problems is that it is not always possible to clearly and directly establish the causal relation between the agent and the damage done. In fact, a certain incompatibility exists between the legal (almost deterministic) and scientific (based on probability) notions of causality. Additional difficulties are, for example, the definition of what is considered ―indemnifiable damage‖, determining its monetary value, and the fact that the insurability of liability for environmental damage caused by normal business operations is problematic (because of the existence of ―moral hazard‖, difficulties in identifying the covered risk and calculating the probability of its materializing, or possible positive correlation between insured environmental risks). These difficulties associated with the application of the strict liability rule to ecological damage cases suggest that strict liability and conventional environmental policy instruments should be seen as complements.
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environmentalists closest to the modern Austrian School‘s propositions emphasizes that, generally speaking, the imposition of administrative regulations does not solve the problem either, or assure a more efficient result. Thus, instead of granting strict liability a complementary role, as is customary, in respect to conventional environmental policy instruments (reinforcing, for example, the functioning of emission permit markets or creating incentive for compliance with waste dumping standards) [Segerson (1995, p. 289)], free market environmentalism, which is cynical of any government involvement, sees it as the basic mechanism for confronting pollution problems. On the other hand, free market environmentalism advocates closest to the modern Austrian School‘s propositions rejects all external reorganization of property rights, confiding in the market process to bring about their internal evolution. Thus, for example, as population and commercial activity increase, clean air and water are more valuable and businesses have greater incentive to innovatively define and apply rights to these resources. In other words, management creativity makes the evolution of new forms of property rights acquisition possible: as barbed wire made the establishment of private property on the vast, treeless prairies of the American west in the 19th century economically feasible [Anderson & Hill (1975)], in the future new technology may make it possible to trace sources of pollution so that ―owners‖ of that pollution can be identified. As we have seen, in the case of high transaction costs Coase leaves the door open to judicial or governmental reorderings of the property rights structure which permit a greater total production value. Nonetheless, underlying free market environmentalism is the idea that known and certain damage is preferable to the uncertainty of intervention in the institutional area which could create more serious problems than that which it attempted to correct. Given the cost of public intervention (administrative rigidity and inertia, the impossibility of possessing sufficient knowledge – especially in respect to processes of change –, unpredicted and unwanted long range effects, special interest group actions, etc.), it‘s best to let the social and market process change of its own accord, readapting itself little by little: business activity will end up bringing about the legal and technical innovations required to solve the problems. Evidently, in an industrial world the continuous and rapid technical and social changes cause property rights, which in previous circumstances appeared unmistakably well delineated, to be poorly defined [Schmid (1995)]. The archetypal case is that of an aquifer where, as extraction and drilling technology progressively improves, the modification of real content of extraction rights is vital so that they do not end up undefined in practice, thus setting in motion the tragedy of free access described by Hardin (1968) which leads to the appearance of external effects and the overuse and depletion of the resource. At the outset, with rudimentary ―pick and shovel‖ technology, no limitation is necessary and any property owner may drill as much as he likes there; later a minimum distance between wells must be established; in time perhaps this distance must be augmented; and finally unified management becomes necessary16. In the same way, property rights can be created (as a result of a change in demand or technology) for a resource that formerly did not exist – such as radio waves17.
16
See the Ciriacy-Wantrup (1969, pp. 1323-1324) discussion of the need for readaptation to technical change in the institutional framework, referring to aquifer management in India. 17 In ―The Federal Communications Commission‖, Coase (1959) shows how the simple creation of rights to radiophonic frequencies avoided the problem of interferences – another case of external effects – making public regulation unnecessary.
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In summary, adaptation to changes in social organization and adjustments with respect to the use of scarce resources are vital. But this work, according to free market environmentalism, essentially belongs to the business imagination. This fully coincides with the Austrian perspective: ―Demographic conditions, technology and preferences, and consequently particular environmental scarcities continually change, so will the costs and benefits associated with internalisation efforts that, in turn, lead to ‗entrepreneurial response‘: creation of ‗new property rights‘ to generate and preserve a scarcity rent‖ [Stocker (1997, p. 5)].
The state must limit itself to guaranteeing maximum institutional flexibility, meaning a regulatory structure sufficiently open to reform and change: ―The institutional underpinning must first and foremost make sure that people (have strong incentives to) come up with different problem solutions, so that a competition for problem solution is fostered, a discovery process stimulated and ensured. It is [...] decisive that the institutional structure leaves enough leeway for an endogenous evolutionary development, especially for solutions ‗from below‘. [...] Rather than directly evaluating different options (as is the case in Coasian analysis) [...] it gets imperative to create an institutional environment in which the affected agents can easily come up with many different proposals for the problem 18 solution‖ [Stocker (1997, pp. 10, 12)] .
Returning to the aquifer example, the southern California case is a good example of the endogenous evolution of regulations. For a long time the tendency was to consider – starting from the thesis of Olson (1971) on collective action, the Prisoner‘s Dilemma idea and Hardin‘s confusing ―tragedy of the commons‖ – that practically the only effective option for resolving problems of common-pool resource management – where exclusion is difficult and use is subtractive – was some kind of public intervention. Nonetheless, a large amount of work published since the mid-1980s shows that, in circumstances favourable to cooperative play, the solution may come from within, in other words, the very users are capable of defining credible agreements a priori, readapting them to changes over time [Ostrom (1990)]. California has no general law regulating exploitation of subterranean water across the entire state. Thus, aquifers remain under local control so that they are managed through institutional agreements specific to each zone. So it is with the seven aquifers located in the Los AngelesOrange County-Riverside area, a semiarid region with irrigation and a high level of urbanization. This does not involve comprehensive institutional design in the sense of trying to respond simultaneously to all possible problems, but incremental, evolving designs, constantly redefined as new problems arise. What exists is experimentation, feedback, learning and adaptation in a process in which users participate directly [Blomquist (1995)].
18
North (1994, p. 49) expresses himself similarly: ―The ideal incentive framework [...] will provide a hospitable environment for the creative designing by entrepreneurs of new institutions to solve new problems‖.
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7. CONCLUSION Coase focuses on externalities from the perspective of reciprocity, advocating flexibility in their treatment according to concrete institutional circumstances, and admits external reorderings of property rights if they lead to a greater total production value. Nonetheless, the importance Hayek gives to the question of dispersed, unexpressed and inexpressible knowledge argues equally for endogenous, progressive property right structure changes, fruit of the very interaction of the market and the entrepreneurial imagination (in other words, derived from the course of spontaneous evolution on the institutional level, without any administrative intervention). In fact, not only does this mean that no external intervention— state or judicial—can obtain the necessary information to bring about changes in the rights structure that improve total production value, but also that a stable framework of rights and obligations produces certainty in agent decisions, so that the information contained in prices (which in part reflects expectations of individuals when they make decisions) has a smaller component of error, thus favouring better resource allocation in the economy. In keeping with this position, the strict liability rule is established as the basic mechanism in cases of externalities. Moreover, the Hayekian conception of a great number of basic social institutions— spontaneous in their origin and evolutionary in their character—reinforces resistance to ―external‖ intervention in the property rights framework. Hayek gives maximum importance to the set of norms of general behaviour linked to the judicial process and exemplified in British Common Law: these rules constitute an incalculable accumulation of tacit and inexpressible knowledge and tend to be efficient by virtue of the ―natural selection‖ process; consequently, premeditated institutional designs should be distrusted and institutional reform and intervention in the evolutionary process met with scepticism. In fact, Hayek fears going farther than necessary in the absence of sufficient knowledge as the rational constructivists would have us do. In practice, free market environmentalism has essentially assumed the practical implications derived from Hayek‘s work as far as externalities are concerned. Perhaps for this reason, concrete references to Coase‘s work as theoretical support, frequent at the end of the 1970s—see, for example, Burton‘s prologue to Cheung (1978)—today have disappeared, as Daly (1999, p. 35) points out with surprise. Currently, Coase is only alluded to in a generic way, to justify the intellectual respectability of the foundation of free market environmentalism. Thus, for example, Anderson & Leal (2001) makes explicit reference only to Hayek‘s work. Nonetheless, from an environmental point of view, the practical prescriptions derived from Hayekian ideas pose difficulties. First, the strict liability rule applied to ecological damage cases presents limits which suggest that it essentially be seen as a complement to— and not a substitute for—conventional environmental policy mechanisms (economic instruments and administrative regulations). Second, the need to readapt the institutional framework in the face of continual and rapid changes (technological, demographic, etc.) generally requires—even though the leading role is given to entrepreneurial creativity—the state playing an active role. Faced with these difficulties, two positions have emerged amongst free market environmentalism advocates. From the perspectives closest to the modern Austrian School‘s
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propositions, there remains a total rejection of economic environmental policy instruments— including transferable emission permits—and any type of public intervention. This position —which is in fact the position maintained by the Austrian economists [i.e. Rothbard (1982); Cordato (1997)]—could be assimilated into what Friedman (1994) calls ―libertarian environmentalism‖, in which—according to this author—the work of Anderson & Leal (2001) would also fit19. Opposed to this is the more pragmatic posture of those who accept state regulation as a necessary evil when confronting certain pollution problems (faced with the practical impossibility of defining rights with available technology) and who see in economic instruments—such as transferable emission permits—a way of moving toward the growing role of the market and the development of property rights. Thus, as Hill (1997, p. 395) points out: ―market-based environmentalism can be a smoke screen for statists and radical environmentalists who simply want to force their preferences on an unsuspecting public. However, it can also represent an intelligent effort by people who understand and believe in markets to facilitate the development of private property rights so that markets can operate‖.
REFERENCES Adler, J. H. (Ed.) (2000). Ecology, Liberty and Property: A Free Market Environmental Reader. Washington D.C.: Competitive Enterprise Institute. Aguilera, F. (1994). Pigou and Coase Reconsidered. Land Economics, 70 (3), 386-390. Alchian, A. (1965). Some Economics of Property Rights. Il Politico, 30 (4), 816-829. Alchian, A., & Demsetz, H. (1973). The Property Right Paradigm. Journal of Economic History, 33 (1), 16-65. Anderson, T. L. (1982). The New Resource Economics: Old Ideas and New Applications. American Journal of Agricultural Economics, 64 (5), 928-934. Anderson, T. L. (1983). Water Crisis: Ending the Policy Drought. Washington D.C.: Cato Institute. Anderson, T. L., & Hill, P. J. (1975). The Evolution of Property Rights: A Study of the American West. Journal of Law and Economics, 18 (1), 163-179. Anderson, T. L., & Leal, D. R. (1997). Enviro-Capitalists: Doing Good While Doing Well. Lanham: Rowman & Littlefield. Anderson, T. L., & Leal, D. R. (2001). Free market environmentalism (2nd edition). New York: Palgrave. Anderson, T. L., & Johnson, R. (1986). The problem of instream flows. Economic Inquiry, 24, 535-554.
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Friedman (1994, p. 486) believes that, as much for Anderson and Leal as for other free market environmentalism advocates, the ―end is the reduction of government, not because politicized decisions about scientific issues are likely to lead to counterproductive environmental policies, but because government action, being antithetical to ‗freedom‘, is inherently undesirable‖. Nonetheless, Sagoff (1992) believes that Anderson and Leal only defend the market for instrumental reasons – for efficiency of allocation – whereas true libertarians favour a free market for intrinsic reasons: it embodies liberty. For her part, Shaw (1994, p. 478) points out that free market environmentalism ―offers what I believe libertarians want – an approach to solving problems that does not rely heavily on government‖.
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Anderson, T. L., & Shaw, J. S. (1999). Is Free Market Environmentalism ‗Mainstream‘? In J. S. Shaw (Ed.), A blueprint for environmental education. Bozeman: Property and Environment Research Center [pdf]. http://www.pers.org/pdf/fmemain.pdf. Baden, J., & Stroup, R. L. (Eds.) (1981). Bureaucracy vs. the Environment: The Environmental Costs of Bureaucratic Governance. Ann Arbor: University of Michigan Press. Barzel, Y. (1989). Economic Analysis of Property Rights. New York: Cambridge University Press. Block, W. (1990). Economics and the Environment: A Reconciliation. Vancouver: The Fraser Institute. Blomquist, W. Institutions for Managing Groundwater Basins in Southern California. In: A. Dinar & E. Tusak (Eds.), Water Quantity / Quality Management and Conflict Resolution (pp. 43-59). Westport, Connecticut: Praeger. Brubaker, E. (1995). Property Rights in the Defense of Nature. Toronto: Earthscan. Buchanan, J. M. (1969). Cost and Choice. Chicago: Markham Press. Buchanan, J. M. (1977). Freedom in a Constitutional Contract. College Station: Texas A&M University Press. Buchanan, J. M. (1981). Introduction: L.S.E. Cost Theory in Retrospect. In: J.M. Buchanan & G. F. Thirlby (Eds.), L.S.E. Essays on Cost (pp. 1-19). New York: New York University Press. Buchanan, J. M., & Tullock, G. (1962). The Calculus of Consent. Ann Arbor: University of Michigan Press. Cheung, S. N. S. (1978). The Myth of Social Cost: A Critique of Welfare Economics and the Implications for Public Policy. London: The Institute of Economic Affairs. Ciriacy-Wantrup, S. V. (1969). Natural Resources in Economic Growth: the Role of Institutions and Policies. American Journal of Agricultural Economics, 51 (5), 1314-1324. Coase, R. H. (1959). The Federal Communications Commission. Journal of Law and Economics, 2 (1), 1-40. Coase, R. H. (1988). The Problem of Social Cost. In R. H. Coase, The Firm, the Market and the Law (pp. 95-156). Chicago: The University of Chicago Press. Cordato, R. E. (1992a). Knowledge Problems and The Problem of Social Cost. Journal of the History of Economic Thought, 14 (Fall), 209-224. Cordato, R. E. (1992b). Welfare Economics and Externalities in an Open Ended Universe: a Modern Austrian Perspective. Boston: Kluwer Academic Publishers. Cordato, R. E. (1997). Market-Based Environmentalism and the Free Market: They‘re Not the Same. Independent Review, 1 (3), 371-386. Cordato, R. E. (2000). Chasing Phantoms in a Hollow Defense of Coase. Review of Austrian Economics, 13 (2), 193-208. Daly, H. (1999). Free Market Environmentalism: Turning a Good Servant into a Bad Master. In H. Daly (Ed.), Ecological economics and the ecology of economics: essays in criticism (pp. 34-45). Cheltenham: Edward Elgar. Deacon, R. T., & Johnson, M. B. (Eds.) (1985). Forestlands: Public and Private. San Francisco: Pacific Institute for Policy Research. De Alessi, L. (1998). Private Property Rights as the Basis for Free Market Environmentalism. In P.J. Hill & R.E. Meiners (Eds.), Who owns the environment? (pp. 1-35). Lanham: Rowman & Littlefield.
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Demsetz, H. (1967). Toward a Theory of Property Rights. American Economic Review, 57 (2), 347-359. De Serpa, A. C. (1993). Pigou and Coase in retrospect. Cambridge Journal of Economics, 17, 750. Eggertsson, T. (1990). Economic behavior and institutions. Cambridge: Cambridge University Press. Foss, N. J. (2002). Coase vs Hayek: Economic Organization and the Knowledge Economy. International Journal of the Economics of Business, 9 (1), 9-35. Friedman, J. (1994). On libertarian anti-intellectualism: rejoinder to Shaw and Anderson & Leal. Critical Review, 8 (3), 483-492. Furubotn, E. G., & Pejovich, S. (1972). Property Rights and Economic Theory: A Survey of Recent Literature. Journal of Economic Literature, 10, 1137-1162. Greve, M. S., & Smith, F. L. (Eds.) (1992). Environmental Politics: Public Costs, Private Rewards. New York: Praeger. Gunning, J. P. (2000a). Roy Cordato‘s ‗Austrian‘ Critique of Coase on Social Cost. Review of Austrian Economics, 13 (2), 175-192. Gunning, J. P. (2000b). The Property System in Austrian Economics: Ronald Coase‘s Contribution. Review of Austrian Economics 13 (2), 209-220. Hardin, G. (1968). The Tragedy of the Commons. Science, 162, 1243-1248. Hayek, F. A. (1960). The Constitution of Liberty. London: Routledge & Kegan Paul. Hayek, F. A. (1976a). The Use of Knowledge in Society. In F. A. Hayek, Individualism and Economic Order (pp. 57-91). London: Routledge & Kegan Paul. Hayek, F. A. (1976b). Economics and Knowledge. In F. A. Hayek. Individualism and Economic Order (pp. 33-56). London: Routledge & Kegan Paul. Hayek, F. A. (1976c). The Meaning of Competition. In F. A. Hayek. Individualism and Economic Order (pp. 92-106). London: Routledge & Kegan Paul. Hayek, F. A. (1979). Law, Legislation and Liberty: Vol. 1. Rules and Order. London: Routledge & Kegan Paul, 1979. Hill, P. J. (1997). Marked-Based Environmentalism and the Free Market: Substitutes or Complements?. Independent Review, 1 (3), 387-396. Kirzner, I. M. (1992a). Prices, the communication of knowledge and the discovery process. In I. M. Kirzner, The meaning of market process: essays in the development of modern Austrian economics (pp. 139-151). London: Routledge. Kirzner, I. M. (1992b). Knowledge problems and their solutions: some relevant distinctions. In I. M. Kirzner, The meaning of market process: essays in the development of modern Austrian economics (pp. 163-179). London: Routledge. Knight, F. H. (1976). Sofismas en la interpretación del coste social. In: F. H. Knight, Ética de la Sociedad Competitiva (pp. 203-225). Madrid: Unión Editorial. Kreuter, U., & Simmons, R. T. (1995). Who Owns the Elephants? In: T. L. Anderson & P. J. Hill (Eds.), Wildlife in the Marketplace. (147-165). Lanham: Rowman & Littlefield. Langlois, R. (1985). Knowledge and Rationality in the Austrian School: An Analytic Survey. Eastern Economic Journal, 9 (4), 309-330. Leal, D. R. (Ed.) (2001). Conservative Conservation: Policy Proposals for the New Century. Bozeman: Pacific Research Institute for Public Policy. Marshall, A. (1994). Principles of Economics (8th edition). London: Macmillan.
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Moss, L. (1991). The Chicago Intellectual Property Rights Tradition and the Reconciliation of Coase and Hayek. Eastern Economic Journal, 17 (2), 145-156. Nelson, R. H. (1995). Public Land and Private Rights. Lanham: Rowman & Littlefield. Nelson, R. H. (2001). Free-market environmentalism: A Brief History and Overview [pdf]. Paper adapted from a speech to the 2nd Annual Meeting of the Coalition of Western Academic Centers, June, Otter Rock, Oregon, 2001. http:// www.publicpolicy. umd.edu/faculty/nelson/CEI%20-Free%20Market%20Environmentalism.pdf North, D. C. (1994). Constraints on Institutional Innovation: Transaction Costs, Incentive Compatibility and Historical Considerations. In: V. W. Ruttan (Ed.), Agriculture, Environment and Health: Sustainable Development in the 21st Century (pp. 48-70). Minneapolis: University of Minnesota Press. Olson, M. (1971). The Logic of Collective Action. Cambridge, MA: Harvard University Press. Ostrom, E. (1990). Governing the Commons: The Evolution of Institutions for Collective Action. Cambridge, MA: Cambridge University Press. Pasour, E. C. (1996). Pigou, Coase, common law, and environmental policy: implications of the calculation debate. Public Choice, 87 (3-4), pp. 243-258. Papandreou, A. (1994). Externality and Institutions. New York: Clarendon. Pigou, C. A. (1962). The Economics of Welfare. London: Macmillan. Rothbard, M. (1982). Law, property rights and free market environmentalism. Cato Journal, 2 (1), 55-100. Sagoff, M. (1992). Free-Market versus Libertarian Environmentalism. Critical Review, 6 (2-3), 211-230. Shaw, J. S. (1994). Real People Prefer Free-market environmentalism: Reply. Critical Review, 8 (3), 475-482. Schmid, A. A. (1995). The Environment and Property Right Issues. In D. Bromley (Ed.), The Handbook of Environmental Economics (pp. 45-60). Oxford: Basil Blackwell. Segerson, K. (1995). Liability and Penalty Structures in Policy Design. In D. Bromley (Ed.), The Handbook of Environmental Economics (pp. 272-294). Oxford: Basil Blackwell. Simpson, A. W. B. (1996). «Coase v. Pigou» Reexamined. The Journal of Legal Studies, 25 (1), 53-97. Smith, R. J. (1981). Resolving the Tragedy of the Commons by Creating Private Property Rights in Wildlife. Cato Journal, 1 (2), pp. 439-468. Smith, R. J. (1986). Special Report: The Public Benefits of Private Conservation. In Environmental Quality: the 15th Annual Report of the Council on Environmental Quality (pp. 363-429). Washington D.C.: Government Printing Office. Stigler, G. J. (1966). The Theory of Price (3rd edition). New York: Macmillan. Stocker, F. (1997). Can ‗Austrian Economics‘ Provide a New Approach to Environmental Policy? Working Paper 15/1997, Fondazione Eni Enrico Mattei Note di Lavoro, Milano. Vanberg, V. J. (1994). Spontaneous market order and social rules: A critical examination of Hayek‘s theory of cultural evolution. In V. J. Vanberg, Rules & Choice in Economics (pp. 77-94). London: Routledge. Vira, B. (1997). The Political Coase Theorem: Identifying Differences between Neoclassical and Critical Institutionalism. Journal of Economic Issues, 31 (3), 761-779. Wahl, R. W. (1989). Markets for Federal Water: Subsidies, Property Rights, and the Bureau of Reclamation. Washington, D.C.: Resources for the Future.
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Yandle, B. (Ed.) (1999). The market meets the environment: economic analysis of environmental policy. Lanham: Rowman & Littlefield.
In: Issues in Economic Thought Editors: M-A. Galindo, C. N. Spiller, pp. 203-223
ISBN 978-60876-173-9 © 2010 Nova Science Publishers, Inc.
Chapter 12
AN APPROACH TO THE PRINCIPLES OF THE ECONOMICS OF INNOVATION AND GROWTH Sergio A. Berumen1 and Humberto Merritt Tapia2 1
2
Universidad Rey Juan Carlos, Spain Instituto Politécnico Nacional, Mexico
ABSTRACT Economic growth is a central concept in the economic theory. Modern societies refer to growth as an important determinant for rising standards of living. These effects can be observed not only in more goods and services, but also in brand new products and processes. Investment in human capital is looked upon the very source of long-term, sustainable economic growth. The purpose of this chapter is to provide a brief description of the economic growth, how to analyze its measurement, and also to review briefly the main schools of economic thought that have undertaken its analysis.
1. INTRODUCTION Economic growth, defined hereinafter as the increase in a nation‘s Gross Domestic Product (GDP), is a fundamental issue in Economics. It helps us to measure a country‘s economic achievements in a period, or its ability to increase its output in the long-run 1. In the twentieth century, economic growth was clearly perceived by many Western nations through the thirty-year long sustained growth experienced at the end of the Second World War (Aghion and Howitt, 1998; Scherer, 1999). However, economic theory was relatively unable to offer a reasonable explanation for such a phenomenon. For example, economists at that time tended to explain growth through simple quantitative changes operated in the ratio of capital and labor (Stern, 1991). Although 1
This definition is akin to those existing in many economic textbooks such as Mankiw (2002), Samuelson and Nordhaus (2002) and Parkin (2003).
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this approach was commonly accepted in most academic circles, some scholars began to show signs of discomfort, specially in relation to the differential rates of growth that were observed between industrialized and industrializing countries (Hahn and Matthews, 1964). And then, in 1986, Paul Romer set up the basis for a new approach by paying closer attention to the role played by more qualitative factors such as knowledge (Verspagen, 2005). Romer has looked at the impact of cumulative technological capabilities (i.e., human capital) on productivity and growth, and he realized that technical change was not as exogenous as formerly believed but, instead, it stems endogenously from growth itself (Fagerberg, 1994, p. 1170). In this context, the purpose of this chapter is to introduce the main theoretical concepts that define the economics of innovation, knowledge, and growth. It expects to serve as a preliminary guide to this important process. The chapter is structured in four sections. The first section discusses the theoretical aspects of economic growth. The following section presents some indicators used to measure knowledge‘s impact on the economy. The third section analyzes the three principal schools of thought in economic growth; namely, the classic approach, the neoclassic school and the neoschumpeterian thought. This chapter finishes with a brief summary of the concepts presented.
2. ECONOMIC GROWTH: THEORETICAL ASPECTS Jovanovic (2001) points out three main causes in economic theory that explain growth in the standards of living: i) the progress of science and productive knowledge; ii) the growth of individual skills; and iii), the incentives. In relation to these causes, Scherer (1999) and Verspagen (2005) argue that productive knowledge is increasingly seen as one of the main factors behind economic growth, which is materialized through better production techniques, more efficient processes, and the use of cheaper inputs and methods, all of which help to create (or substantially improve) new products and services. Many studies in the field of innovation and technical change has produced very detailed analyses regarding the way in which knowledge determines innovation, and specially in relation to the effect of learning on innovation2. Kenneth Arrow (1962), for example, argues that gross investment in capital goods benefits from the cumulated improvements in labor‘s quality, which stems from day-to-day learning during production. Arrow names this process as ―learning by doing‖. Arrow was among the first scholars who identify this kind of externalities in production (Hall, 1994). These externalities, which are called ―knowledge spillovers‖, appear from the continuous interplay between physical investments in machines and equipment and the workers‘ knowledge. That is, firms producing capital goods learn at the same time as they manufacture new equipment, businesses investing in this equipment learn by using it—though firms not currently investing in this capital can also learn from the experience of others—and all this new knowledge becomes itself an input for the economy as a whole. Hall (1994: 327) points out that this process enhances the effectiveness of physical inputs globally—and because the effectiveness of the inputs is enhanced at the same time as the aggregate capital stock increases, a given increase of all inputs can yield a more than proportional increase of the aggregate output; that is, increasing returns at the macro-level 2
See, for example, the classical works of Kaldor (1957) and Arrow (1962).
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appear. Another way in which knowledge is turned into innovations is through the processes of creativity, appropriability, and diffusion of skills and abilities that help solve technical and economical problems. In the specialized literature on technical change, a knowledge-based economy is defined as one in which growth is dependent on the creation, diffusion and use of knowledge (Heng, et al., 2002; Verspagen, 2005). For the Organization for Economic Cooperation and Development (OECD), ―a knowledge-based economy is defined as one where knowledge (codified3 and tacit4) is created, acquired, transmitted and used more effectively by enterprises, organizations, individuals and communities for greater economic and social development‖ (OECD, 2000a, p. 13). On the other hand, Rogers (2001) argues that innovation must be seen as a social process in which the joint venture of many economic agents with different productive skills and intellectual capabilities determine the process‘ success. From a commercial perspective, Low and Abrahamson (1997) also agree in pointing out that human skills are an essential component of innovation. For Nonaka and Takeuchi (1995), in order for learning and so that knowledge be effective, it becomes necessary that the mechanisms of acquisition of information, comprehension and skills also be efficient. Yet, an absence of effective skills among workers is still capable of causing damaging effects in a knowledge-based economy because an insufficient (or a very low) level of technological capabilities can hamper growth because the implementation of new ideas asks for a minimum level of skills and resources from productive agents, as Jovanovic argues: ―{…} to put new ideas into practice requires resources and skill. True, some technologies are so user friendly that their use demands no skill at all; to use a light bulb, for instance, all you have to do is screw it in. But you cannot do much with a computer if you have no education and no experience with computers‖ (Jovanovic, 2001, p. 4099).
In practical terms the acquisition of productive skills requires a formal training process and a solid education background, education being the most important factor for the success of those economies willing to be based on knowledge (OECD, 1996; 1998; World Bank, 1998). The role played by education in a knowledge-based economy has been enhanced in the literature on National Innovation Systems (NIS)5. Under the context of a NIS, education is seen as a crucial platform to support the innovative capabilities of a country (Lundvall, 1992; Nelson, 1993). Although education is an important component of a NIS, the institutional milieu is also crucial to support the innovative capabilities of that system. In this perspective, a functional institutional framework tends to facilitate the transformation of knowledge into commercial innovations. For example, the instrumentation of public policies to promote
3
Tacit knowledge is that one which is not expressed by codes (i.e., codified) because is produced by experience, observation and routines, and is normally embedded in workers moving from one firm to other. See Nonaka and Takeuchi (1995) and Grimaldi and Torrisi (2001). This is the type of knowledge to which Kenneth Arrow refers to in his model (Arrow, 1962). 4 Codified knowledge is that one which is expressed in a formal, explicit and uniform manner, and for this reason it is possible to put into the form of patents, books, papers, etc. (ibid). 5 According to Mowery and Oxley (1997, p. 154), National Innovation Systems can be understood as the network of public and private institutions within an economy that fund and perform R&D, translate the results of R&D into commercial innovations and effect the diffusion of new technologies.
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industrial innovation has better chances of succeeding when the institutional context is functional, all of which improve the effectiveness cumulative social knowledge. Also, nations can use a number of fiscal policies such as employment incentives, industrial subsidies and regulatory rules and norms to set up, at a macroeconomic level, the appropriate conditions that help spur innovation through knowledge-intensive investments6 (OECD, 2007). In relation to the instrumentation of this type of policies, a small group of countries in the OECD area stands up because of their successful application of plans and programs focused on promoting knowledge and innovation. These nations are Sweden, Finland, Japan, Switzerland, South Korea, the United States and Germany. The key for their success in promoting innovation-led growth has been their persistent and increasing investment, as percent of GDP, in research and development (R&D). That is, the amount of money spent by these nations on R&D during the last decade exceeds the average percent of the OECD area, as Figure 1 shows. It is worth mentioning that the current economic growth of some OECD members (namely Finland, South Korea and Sweden) is being increasingly supported by sustained investments in Information and Communication Technologies (ICTs). As pointed out by Shapiro and Varian (1999), ICTs are actually facilitating and accelerating the adoption and diffusion of the accumulated knowledge. According to Luc Soete (2001), ICTs represent the first global technological transformation with which modern societies have been confronted. In his opinion, ICTs‘ impact on globalization lands in five lines of development: i) in finance because capital is the ultimate (intangible) global tradeable good; ii) in the far-ranging deregulation move, leading not only to the liberalization of trade and investment flows but also to the deregulation of many intermediate services which are central in the organization of markets and transactions; iii) in the practice of formalized (and publicly announced) international cooperation agreements among firms; iv) in the free exchange of information and knowledge about new products and markets, that is conveyed by academic activities and media; and v), in the stock of expertise, experiences, and personal networks that have developed over the years in international relations and business, mainly through the activities of internationalized business services but also through personal contact and cultural links (Soete, 2001, pp. 2627). The impact of ICTs on a knowledge-based economy is larger when new products and services such as the Internet and the mobile telephony are considered. Interestingly, these technologies were themselves a result of knowledge-intensive processes. Therefore, it is necessary to evaluate the role played by technological infrastructure on innovation (Tassey, 2004); or as Shapiro and Varian has pointed out, ―infrastructure is to information as a bottle is to wine: the technology is the packing that allows the information to be delivered to end consumers‖ (Shapiro and Varian, 1999, p. 8).
6
Khan (2001, p. 22) defines investment in knowledge as expenditures directed towards activities with the aim of enhancing existing knowledge and/or acquiring new knowledge or diffusing knowledge. According to Khan, education and software expenditures, training, innovation and industrial design expenditures should also be additional components of the total investment in knowledge.
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Notes: Due to data availability problems the following OECD countries are not included: Luxembourg, Norway, Czech Republic, New Zealand, Hungary, Portugal, Turkey, Greece, Poland and Slovak Republic. _/ 1 1996 instead of 1995 for Japan and Switzerland; _/ 2 1999 instead of 2000 for Denmark and Sweden; _/ 3 2002 for Australia, 2003 for Iceland, Italy, Mexico, Sweden, United Kingdom, EU-15 and EU-25. Source: OECD (2006) Science, Technology and Industry Outlook 2006, p. 23 [Data are available online at: http://dx.doi.org/10.1787/118284326103] Figure 1. Gross Expenditures on R&D (as % of GDP) for selected OECD Members: 1995, 2000 and 2004.
From an enterprise‘s viewpoint, economic growth and development in an ICT age will be determined by increasing levels of interrelation and interconnection with cumulative knowledge being the key factor to survive. In the following section we will discuss how economic theory formally describes the process of knowledge accumulation. In the meantime, we will present some indicators that will be useful in measuring the economics of innovation and knowledge.
3. SOME INDICATORS FOR THE KNOWLEDGE-BASED ECONOMY Traditionally, the measurement of knowledge has been a nuisance for the economic modeling of innovation because of the difficulties in handling the term ―knowledge‖. In this respect, Kenneth Boulding (1966) regrets to acknowledge that there is a lack of an
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appropriate word to describe mind‘s content without having to discuss whether this content actually relates closely to the mind‘s structure. Given the difficulties in establishing a cardinal measurement of ―knowledge,‖ most existing economic models use proxy indicators to that purpose 7. These indicators generally group around four main categories8: 1. Knowledge Creation, which can be approached by: a) the percentage of GDP spent on R&D (i.e., the intensity of R&D conducted in the economy); b) the number of researchers per capita (i.e., the availability of human resources needed for R&D); and c), the number of patents per capita (i.e., the overall quality of the NIS by the scientific output it creates). 2. Knowledge Acquisition/Transfer, which can be approached by: a) the percentage of total imports that goes to technology balance of payments (i.e., the intellectual content embedded in imports from other countries); b) the number of head and regional offices in a country (i.e., the amount of firm-specific knowledge brought in by multinationals and regional firms); and c), the size of the knowledge intensive business services sector (to provide intermediate products and services to firms, thereby perpetuating innovative practices and services from global sources). 3. Knowledge Diffusion, which can be approached by: a) ICT spending as a percentage of GDP (i.e., the intensity of resources put into developing information infrastructure); b) Internet access cost as a percentage of GDP per capita (i.e., the affordability of ICT services, which will determine the usage of a country's ICT network); and c), the percentage of workforce with at least secondary school education (i.e., the linguistic skills to tap onto ICT network). 4. Knowledge Application, which can be approached by: a) the percentage of workforce with university education (i.e., the ability of workforce to seek out, process and use relevant information); b) the percentage of ―knowledge workers‖ in workforce (i.e., jobs that demand and allow workers to apply knowledge extensively); and c), the World Competitiveness Yearbook ranking of entrepreneurship (i.e., the ability of the economy to create new business models for generating, acquiring, diffusing and applying new ideas and processes). It is worth stressing that these indicators are becoming a standard in OECD evaluations of innovation capabilities within a NIS (see, for example, OECD, 2006). Therefore, the use of indicators allows the comparison of innovative performances between countries and the true contribution of knowledge-intensive sectors to economic growth in a given nation. This aspect of growth is important when evaluating the degree of acquisition of knowledge and skills in a knowledge-based economy (see, for example, OECD, 1996; 1998; 2000b; 2007). Once we have seen the importance of measuring knowledge, we now shall discuss the main theoretical approaches that support the empirical analysis of economic growth.
7
Ian Steedman has critically reviewed the theoretical treatment of knowledge in those models belonging to the socalled ―New Growth Theory‖ (NGT). For him, there is a faulty assumption if the stock of knowledge is defined as homogenous, because, he argues, it may well not be cardinally measurable, and therefore these models cannot yield convincing conclusions (Steedman, 2001, p. 10). 8 A useful taxonomy in this field has been provided by Heng and colleagues (2002).
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4. THE CLASSICAL APPROACH TO TECHNICAL CHANGE The first formal approach to the analysis of economic growth was foreseen just in the beginning of the II Industrial Revolution at the end of the eighteenth century in England (Stern, 1991). In that time England was experiencing a demographic boom as a result of unprecedented improvements in people‘s welfare9. Nonetheless, the effects of this population explosion did not take long to alarm perceptive observers, specially to Thomas Robert Malthus. Malthus became famous due to his dismal thoughts on the economic consequences of the British overpopulation. To support his hypotheses, Malthus had to peer painstakingly at the births‘ and deaths‘ statistics available at that time in the English churches. By doing this, he set up the basis of statistical analysis in economics. But Malthus‘ work in population statistics led him to formulate the first-ever theory of economic growth (Scherer, 1999, pp. 10-16). The synthesis of the Malthusian vision of economic growth is as follows: economic growth (Y) is determined by the quantity of workers engaged in production (L), which, in turn, depends on population (N). That is, economic growth is a function of the size of population and the capital involved10, as the following equation suggests:
Y f ( K , L( N )) In this approach, an increase in population (N) lowers workers‘ productivity because the capital stock is fixed ( K ). A peculiar feature of this model is that it assumes that population will grow exponentially if it is not fettered, while food and meals will show a slower growth rate (Malthus, 1803[1999]). Formally the equation that explains the population growth rate in the Malthusian scheme is:
N (t ) N 0e rt Under a population explosion trend, wages tend to decline and thus becoming insufficient to guarantee life. In that case workers cannot survive. This situation triggers a population-cut mechanism which tends to steer the economic system back to the original equilibrating point. This process is better explained in Figure 2, which shows how the growth process begins at point A, where the economy is in equilibrium. In this point the productivity curve (CP1) intersects the subsistence wage. In this scheme technical change is modeled as an exogenous event which translates the productivity curve toward an upper value (CP2), moving the economy up to a new equilibrium (point B). As a result, population grows and both capital and real GDP per hour tend to diminish. The process finishes at point C when real GDP per hour returns to its former subsistence level. 9
Parkin reports that after being relatively stable for several centuries, the population of Britain increased by 40 percent between 1750 and 1800 and by a further 50 percent between 1800 and 1830. Parkin attributes this population expansion to improvements in diet and hygiene (Parkin, 2003, p. 557). 10 The logic of this situation rests on the fact that workers had to get a subsistence real wage as large as to keep them alive, but in case it was not large enough as to maintain life they clearly had no incentives to work for any patron offering such a low wage (Costabile and Rowthorn, 1985).
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Real GDP per hour
210
CP2
Population grows and Capital per hour declines B
Technical Change
C
A
CP1
Subsistence Real GDP
Capital per hour of labor Figure 2. Classical Growth Model.
According to the abovementioned figure, if productivity were enhanced by an unexpected innovation, workers would suffer in the long-term because enhanced productivity would stimulate people to fathering more children, and thus increasing total workforce. So, wages would have to plummet as a consequence of overpopulation. In this point, new wages would be insufficient to guarantee the new workers‘ subsistence pushing the unemployed workforce to starving, cutting down the excess in population, and thus returning wages to the former equilibrium level. This is Malthus‘ model in a nutshell. Needless to say that Malthus‘ dismal forecast has never materialized because he (wrongly) assumed that population grows unfettered when real GDP per hour exceeds workers‘ subsistence wages11. Yet, this theoretical mistake took years to overcome and economic growth was not satisfactorily explained until a more comprehensive understanding of the economic forces determining productivity growth was available, as seen next.
5. THE NEOCLASSICAL APPROACH TO TECHNICAL CHANGE Due to the rapid recovery of the world economy in the aftermath of the Second World War, economic growth began to capture the attention of academic circles (Amable, 1994). Although the explanations to the phenomenon existing at that time were suitable to explicate the trajectories shown by the post-war economies, they began to exhibit various theoretical
11
For a more detailed discussion on the classical model, see Scherer (1999, pp. 8-16).
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and interpretative deficiencies. Consequently, a change in the theoretical approach to economic growth emerged in the mid-1950s: the neoclassical approach (Mankiw, 2002). The neoclassical school of economic growth follows the classical perspective on production by considering labor and capital (the traditional inputs in production) prone to exhibit decreasing returns if used in isolation from each other, but it represents a reassessment of the classical theory by proposing that GDP per capita tends to grow when technical change induces new investment and saving rates which, in turn, tend to raise capital per hour of labor. This approach is known as the theory of balanced growth, or steady-state growth (Hall, 1994; Scherer, 1999). Even though Roy Harrod and Evsey Domar are acknowledged as the pioneering contributors of this approach, the analyses produced by Frank Ramsey in the mid1920s in Cambridge can be seen as the true origin of the neoclassical theory of economic growth (Aghion and Howitt, 1998). The neoclassical theory of economic growth assumes that capital (K) is cumulative whereas labor (L) may or may not be so. This implies that without an upward trend in the use of input L—or under a constant pace of technical change—growth will sooner or later come to a halt due to decreasing returns in the use of K, which is the only cumulative input (Hall, 1994). However, economic growth based only on capital accumulation tends to provoke a declining rate of return which cancels out any long-term incentive to invest. Under these conditions, only exogenous factors may spur growth (Scherer, 1999; Verspagen, 2005). Given that growth depends crucially on technical change in the neoclassical perspective, it is then possible to distinguish two types of modeling in this school: those models in which all technological activity is exogenous to the system, and those in which technical change is actually endogenous. We shall discuss the first type in the first place.
6. NEOCLASSIC MODELS OF EXOGENOUS GROWTH The neoclassic approach assumes a well-behaved and simplified production function (i.e., homogenous of degree 1 with decreasing returns for each input). Under these assumptions, output per worker (Q/L) will tend to zero in case of lack of innovations (Gregersen and Johnson, 2000). The most prominent exemplar of the neoclassic model of exogenous growth is Robert Solow‘s (1956; 1957). For Solow, capital accumulation alone (without technical progress) tends to reduce future returns on capital, and thus curbing the incentives of longterm investment. In such a case, investment will barely cover fixed capital depreciation and the necessary equipment for day-to-day operations. We shall now describe this model in more detail. According to Gregersen and Johnson (2000), labor (L) and technical progress (A) grow at a constant exogenous rate. All savings resulting are invested, and output (Q) is dependent on labor (L) and capital (K). Moreover, the involved production function exhibits constant returns to scale in total output but decreasing returns in individual inputs. The equation describing this situation is:
Q A K L , ( 1)
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Transforming this equation into its logarithmic form and deriving it with respect to time, we will have the following expression12:
A Q K L (1 ) A Q K L In the equation shown above, Å/A is the residual‘s rate of growth, α is the capital‘s share
in total output (Q) and K
, L
K
L
represents the rate of growth in either variable K or L
across time. On the other hand, Å/A involves a measure of technical progress (as in Solow‘s model); so, it becomes necessary to know what part of that change (which corresponds to an increase in productivity) is explained by K and what part is explained by L. It is worth pointing out that Solow defines all changes in output attributable to capital as a level effect, whereas changes attributable to labor are defined by Solow as growth effects (Solow, 1957: 319). These conditions are shown in the following equation, which is a rearrangement of the previous one.
Q K Q L A (1 ) A Q K Q L According to Solow, level effects are determined either by increases (or cuts) in the propensity to save, or by increases in capital caused by agents‘ investments. Growth effects are induced, in turn, either by an exogenous variation in the population‘s rate of growth, or by a technological innovation13. In such a case, these conditions will make capital scarcer in relation to labor, and thus raising its productivity. Under the neoclassical model, the capital‘s share in the production function is a key variable in the economic phenomenon of growth. Moreover, technical progress can neutralize capital‘s decreasing returns, allowing the economic system a sustained growth, although still keeping its exogenous character. In spite of its functionality, Solow‘s model still falls short of providing relevant explanations regarding the role played by the residual in the production function. Neoclassic theorists have searched for more robust explanations in order to solve this unpleasant shortcoming, and among the several approaches proposed, endogenous models stand up by their formality and theoretical rigor. We shall next discuss the approach proposed by Paul Romer (1990).
7. NEOCLASSIC MODELS OF ENDOGENOUS GROWTH When Paul Romer published his pioneering paper in 1986, most scholars were still adherents of the neoclassical school of balanced growth that assumed technical change as an 12
In Solow‘s equation, α and β are the inputs‘ shares in total output and constant returns to scale are present when these shares add up to one, see Scherer (1999) and Gregersen and Johnson (2000). 13 This is a neutral technical change in Harrod‘s sense (see Hall, 1994, p. 318).
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exogenous factor (Amable, 1994; Scherer, 1999). But Romer‘s focus on increasing returns from human capital and knowledge challenged this perception and from 1986 onwards, knowledge is seen as one of the most important factors behind the sustained growth observed in the world economy during the last quarter of the past century (World Bank, 1998). Romer is now acknowledged as one of the main contributors to the ―New Growth Theory,‖ which aims at analyzing the endogenous role of knowledge and innovation on growth (Verspagen, 2005). In a historical perspective endogenous growth models are not new, however, Kaldor (1957) and Arrow (1962) were among the first economic theorists to model the effects of learning on productivity. A few years later, Romer (1986; 1990) and Lucas (1988) began to model increasing returns in industrial output, focusing on human capital and knowledge‘s effects on productivity, and Romer‘s 1990 paper has become the standard reference for modeling endogenous technical change due to his formal treatment of knowledge. We now shall discuss this model more formally14. Romer's approach is based on three elements: i) technical change lies at the heart of economic growth; ii) technical change arises mostly because of intentional profit-seeking actions taken by entrepreneurs responding to market incentives; and iii), plans for transforming raw materials are different from other economic goods in the sense that, once created, no extra cost has to be incurred in using them repeatedly. Romer‘s model envisages a closed economy comprising three sectors: the research sector producing new technological knowledge in the form of designs for new producer durables, the intermediate goods sector which produces a range of producer durables and the final goods sector. Technical knowledge, denoted Ω, is measured in terms of the number of designs extant and each new design thus adds 1 to the current value of Ω. Producer durables comprise a set {X} = {x1, x2, x3,.., xΩ…x()},where x is the output level and the numbers i = 1, 2, ... label the goods. Within the set, x{Ω + 1)... x() take zero values until further new knowledge has been generated. Final output Q is produced with a Cobb-Douglas production function, where HQ is human capital in producing Q:
Q H L a Q
b
x i 1
(1a b ) i
The aggregate labor force L is assumed constant, as is overall human capital, H, of which HQ forms one part. In the former equation, designs are treated as discrete, indivisible objects but if problems of indivisibility and uncertainty are ignored, the index i on x can be treated as a continuous variable and the equation rewritten as:
Q H L x(i) (1ab ) di a Q
b
0
14
The following discussion draws on the helpful interpretation of Romer‘s model provided by Hall (1994, pp. 334338).
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This function is homogeneous of degree one, allowing output in the final goods sector to be described in terms of a competitive firm. In the intermediate goods sector, each producer durable is produced by a different firm which has bid successfully for the patent on the design for the good and thereafter manufactures it exclusively. Inputs into production are the design and capital goods converted from output sacrificed from consumption on a one-for-one basis. As a simplifying assumption, labor inputs are set at zero. Given its monopoly position on design i, firm i faces a downward sloping demand curve along which x(i) units of i are at any point rented at a rate of P(i) per unit per period. Assuming no depreciation, the value of a unit of good i is the Present Discounted Value (PDV) of the rental income stream it generates. In the final goods sector, the representative firm‘s profit, expressed in units of output, is:
[H
a Q
Lb x(i ) (1ab ) P(i) x(i )] di
0
It is important to stress that the former equation must be differentiated with respect to x(i) and set equal to zero to maximize this with respect to the quantities of each producer durable hired, which after rearrangement implies an (inverse) aggregate demand function for durables:
P(i) (1 a b) H Qa Lb x(i)( ab ) For given values of HQ and L, this is a constant elasticity demand curve for each i which the monopoly producer of each durable takes as given in setting its profit-maximizing output level and price. Each firm will already have invested in acquiring the design for the durable, but this is a sunk cost. In making its forward looking choices, it takes as given HQ, L and r (the interest rate on loans measured in units of current output), to choose an output level x to maximize at every date its revenue less variable cost. Its revenue, P(x)x is its flow of rental from final goods producers and from the former equation equal to:
P( x) x (1 a b) H Qa Lb x ( ab ) To make each unit of the durable, J units of output are sacrificed from consumption. Variable costs thus total rJx, implying a constant marginal cost of rJ. Each monopolist's price, RJ/(1-a-b) is a mark-up over marginal cost determined by the elasticity of demand. Total capital K, the aggregate of producer durables in use, is found by multiplying the quantities of each type of capital employed in production by the output foregone in producing each unit.
K J x(i ) i 1
The aggregate K changes according to the accounting rule (where C(t) is consumption):
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dK (t ) Q(t ) C (t ) dt Research sector output comprises increases in technological knowledge, dΩ/dt, and is generated with inputs of existing knowledge and human capital located in the sector. If researcher m has an amount of human capital Hm and access to a portion Ωm of the total stock of knowledge implicit in previous designs, the production rate of new designs by m will be zHmΩm, where z is a productivity parameter. All researchers are assumed to have free access to all knowledge (Ω) at any given time. Thus we observe that HΩ is total human capital in research:
d z H dt Implicit in this formulation are two further and crucial assumptions: i) devoting more human capital to research leads to an increase in the rate of production of new designs, since [d(dΩ/dt)/dHΩ] = zΩ > 0; and ii), adding to the stock of knowledge, Ω, yields growth in the marginal productivity of human capital in research at a rate constant and proportional to Ω itself. This is so because the marginal productivity of HΩ, dΩ/dHΩ, is rising at the rate (d/dt)(dΩ/dHΩ), which is zΩ15. On the other hand, the market for designs is competitive, so the price for designs is bidden up by potential users until it is equal to the present value of the net revenue that a monopolist expects to extract from it. Then, at every point in time the excess of revenue over marginal cost must be just sufficient to cover the interest cost on the initial investment in the design, that is:
(t ) r (t ) P In the former equation, Π(t) is monopolist's profit, and PΩ the cost of producing a new design. This condition determines whether a new design will be produced or not (i.e. depending on whether its costs will be covered or not). Finally, consumers are endowed with fixed quantities of labor and human capital, own the existing durable goods producing firms and an implication of their intertemporal maximizing behavior used in the analysis is that consumption grows at the rate (r-d)/s, where d is the subjective discount rate and s is the intertemporal rate of substitution. The model produces as a result, if Ω is fixed, the following equations:
Q ( H Q ) a ( L )b K (1ab) J ( ab1) H Qa Lb X #
15
(1ab )
Hall (1994, p. 337) points out that this rising productivity in research reflects beneficial spillovers, which also has the effect of preventing the returns to human capital from falling and hence prevents migration from research to manufacturing as Ω grows.
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where the symmetry of the model implies that all existing durables will be supplied at the same level, x#. The model behaves like the neoclassical growth model with labor— and human capital-augmenting technical change. If Ω grows at an exogenously specified exponential rate, the economy converges on a balanced growth path on which the rate of supply of durables and the ratio of K to Ω would be constant. Since both K and Ω are growing, human capital wage in final output will also rise. To identify the characteristics of the model, in this case solve the equilibrium conditions along the balanced growth path, it can be shown that the cost of producing a new design PΩ is:
P [
( a b) ](1 a b) H Qa Lb x# (1 a b) r
In equilibrium, the return on human capital in both research and manufacturing (wH) must be the same as the marginal productivity of human capital in each sector otherwise it would pay some units of human capital to relocate. The wage in the research sector is simply all the income generated there (PΩ, zΩ), and to equalize returns to human capital in both sectors, HQ = H - HΩ must be chosen so that wH and PΩ, zΩ both equal the marginal product of human capital in the final goods sector, so:
a H Q( a1) Lb x#
(1a b )
From the former equation, one can observe that the marginal product of HQ grows in proportion to Ω. Therefore, rising productivity of human capital in the research sector is essential to prevent human capital from migrating to manufacturing. This in turn is vital to ensure that the research engine of growth is maintained and that sustained, non-slowing growth can persist, as the following term implies:
H Q (1 / z )r {a /[(1 a b)(a b)]} Recalling that Ω grows at the exponential rate zHΩ when HQ = H - HΩ is fixed. If r is fixed, x# is also fixed (an implication of monopoly pricing). Besides, Q grows at the same rate as Ω if L, HQ and x# are fixed. If x# is fixed, K and Ω grow at the same rate, since total capital usage is Ωx#J. Let g stand for the common growth rate of Ω, K and Q, Then:
g (dQ / dt ) / Q (dK / dt ) / K (d / dt ) / zH which, together with H Q (1 / z )r {a /[(1 a b)(a b)]} implies:
g zH zH [a /(1 a b)(a b)]r Importantly, this equation predicts that, along balanced growth paths, countries with greater stocks of human capital (H) will experience faster rates of economic growth. It also
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suggests that economic growth will be faster, the greater is the productivity of human capital employed in research (HΩ). Hence, Romer‘s model is useful to understand the role that human capital plays in productivity, as well as to understand why growth rates differ. An important characteristic of endogenous growth models is that knowledge arising from any particular productive process is prone to get a widespread diffusion and become a sort of ―public good16‖. Therefore, once knowledge is amply available to society it becomes a nonrival, non-exclusive good (OECD, 1992, p. 51). Given that the stock of new knowledge tends to grow from producers‘ initial endowments (due to learning effects), it is necessary to protect their intellectual rights in order for them to guarantee their investment returns before this new knowledge becomes ―public knowledge‖ (Verspagen, 2005). As Hall (1994) points out, Romer‘s model is also useful to explain interest rate‘s role in growth. Interestingly, his approach relates human capital formation to interest rate through investments in education. Then, a higher interest rate implies a higher opportunity cost of investing in education to acquire human capital and hence tends to discourage investment in it. In spite of these important contributions, Romer‘s approach to economic growth is not exempted of criticisms. One of these critiques is concerned with the practical measurement of endogenous growth, as pointed out by Stern (1991, p. 127), it may be difficult to identify a knowledge-producing sector in real economies. Besides, endogenous growth models still exhibit limitations to explain the mechanism under which knowledge determines innovation. For example, Verspagen (2005) points out that growth models based on the neoclassical approach wrongly assume growth as a stable and orderly process, which is something that real world experience clearly denies. Hence, we shall next consider the evolutionary approach to economic growth.
8. NEOSCHUMPETERIAN MODELS OF ECONOMIC GROWTH A quick look at the history of economic development tells us that Adam Smith was the first economist in noting how technology spurred workers‘ productivity. In describing technical innovations in eighteenth century England, Smith saw how new technology became embedded in faster and more efficient machines, which were the result of the necessities presented by the increasing division of labor in the British manufacturing (Scherer, 1999, pp. 8-10). A hundred years later, Karl Marx stressed the social character of technical change by noting that capitalism had succeeded in creating the necessary incentives to capital accumulation by means of taking advantage of innovations in the production of merchandises (Rosenberg, 1982, pp. 34-51). More recently, Schumpeter (1912; 1950), in thinking about growth, introduces two fundamental concepts into economic theory. First, innovation is the main factor behind economic development because it stimulates growth though material prosperity17. Second, innovation does not come out of nothing, it asks for entrepreneurs with a strong commitment 16
Romer (1990, p. S74) argues that public goods are both non-rival and non-excludable. He also points out that because public goods are non-excludable, they cannot be privately provided or traded in markets. 17 Schumpeter argues that economic development depends on the entrepreneurs‘ ability to recombine production, so he distinguishes five different cases: i) the introduction of new products, ii) the introduction of new industrial processes, iii) the exploitation of new markets, iv) the conquest of new sources for raw materials, and v), new forms of industrial organization (Schumpeter, 1950, p. 83).
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to exploit market opportunities. That is, innovative entrepreneurs are prone to establish new directions in economic activity. In Schumpeter‘s view, this process of ―creative destruction‖ is the essential fact about capitalism (Schumpeter, 1950, pp. 81-86). Schumpeter‘s insight into innovation helped to create an important economic school that highlights the punctuated, and sometimes turbulent, character of economic growth. This thought has been dubbed as neoschumpeterian or evolutionist (Fagerberg, 1994; Nelson and Winter, 1982; Scherer, 1999; Verspagen, 2005). At the core of the neoschumpeterian approach is a redefinition of technological change itself. Contrary to the neoclassical view which regards technological change as either the choice of one technique to replace another from an existing set, or a change in the productivity of one or more of the given techniques available, neoschumpeterian economists define the process of technological change as the search for new and hitherto unknown techniques to add to the known set. Thus, economic growth is dependent on technological innovation. Economic models based on this approach emphasize three elements in the social context that determine growth: i) the institutional milieu in which technical change takes place and prosper; ii) the role of demand in growth; and iii), the existence of organizational and industrial processes which are heavily dependent on agents‘ ―bounded rationality18‖. For some neoschumpeterian scholars, the rate of economic growth in the long-term should be compatible with the equilibrium in the balance of payments. This assumption introduces a Keynesian component into the analysis by linking the income elasticity of demand for exports and imports as a result of the widespread mobility of international capitals for innovation investments. In this perspective, Bart Verspagen (1993) proposes a simple approach to encompass trading interdependencies between economies that can help modeling the growth path between developed (North) and developing countries (South). To this end, Verspagen suggests that technical change in the South is a non-linear function of its initial condition in the technological gap. The existence of this gap may encourage innovation in the South to the extent that a developing country may be capable of (successfully) imitating proven technologies. Nonetheless, if this gap is too large (larger than a certain threshold), technological diffusion becomes harder to achieve as the imitative capabilities of the South tend to diminish if the technological gap widens. For a given initial state, the imitative intensity will depend on internal learning capabilities. This implies that developing countries should have an institutional base to identify, adapt and improve the imported technology. Therefore, Verspagen sees technology acting directly and indirectly on economic growth (Verspagen, 1993, p. 127). The direct effect is linked to the enhancement of the stock of technological knowledge that can be harnessed by firms. The indirect effect is associated with rising exports, that is:
yi ti xi
18
i s, n
In this respect, it is worth emphasizing that the assumption that firms maximize profits may no longer be meaningful in a complex decision space with an objective function in unbounded time. Firms are assumed by neoschumpeterian economists to be profit seeking rather than profit maximizing (see, for example, Nelson and Winter, 1982, pp. 24-30).
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where yi is the rate of growth in output, ti is the rate of growth in technological capabilities and xi is the rate of growth in exports for country i. This equation states that the rate of growth for country i depends on the rate of technical change and the increase in exports. The rate of growth in exports for a given country is a function of its achieved level of technological capabilities (i.e., its international competitiveness) as well as of the rate of growth of the world economy (z), namely,
xs L (
Ts ) z Tn
xn L(
Tn ) z Ts
If Tn > Ts, then L(Tn/Ts) = G, and the technological gap will be positive; which means that exports in the North will grow at a higher rate than the international economy. The rate of technical progress in the North, tn, is a function of its autonomous rate of innovation (βn) and of the technological learning associated with productive learning (i.e., learning by doing). This kind of learning is called the ―Verdoorn effect,‖ which is represented by the term λy n in the following equation:
tn n yn A distinctive feature of this model is how technical change in the South (ts) evolves,
ts s ys a GeG / Where aGe-G/δ indicates the international diffusion of technology, and G = L(Tn/Ts) is the technological gap19. This equation demonstrates the existence of a non-linear relationship between the technological gap (G) and the rate of technical change in the South. Technology gap may stimulate the international diffusion of technology if developing countries take advantage of the imitation possibilities. Apart from the level of the technological gap, this stimulus also depends on the parameter δ, which represents a measure of the ―intrinsic learning capability‖ of the South. The maximum level in the rate of technology diffusion toward the South is reached when G = δ. Any increase in this critical value diminishes technology diffusion due to the widening of the technological gap (Verspagen, 1993, p. 133). Then, the larger the value of δ, the stronger the international diffusion of technical progress, for any given level of the technology gap G. The learning capability of the South (δ) depends on its institutional and productive frameworks, especially in relation to the institutions devoted to the development of science and technology (Verspagen, 1993: 134). According to this approach, if the intrinsic learning capability in the South is very limited, international diffusion of technology will be deficient. On the other hand, the very existence of the technological gap draws an asymmetric competitive line between North and 19
It is worth stressing that in Verspagen‘ model, the Verdoorn effect tends to create dynamic and positive incentives for the country with the fastest rate of growth.
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South. The weaker competitive position of the South generates a lesser dynamism in demand and fewer stimuli to growth. The global result on economic growth will depend on both the rate and direction of the competitive effect and the technology diffusion effect. Even though the findings derived from Verspagen‘s model look robust, one should be very cautious in assuming that the existence of a technological gap between North and South can instantly spur technology diffusion (see, for example, Fagerberg, 1994, p. 1150; Scherer, 1999, pp. 35-36). However, growth convergence between North and South may well be stimulated by the existence of appropriate institutional and technological capabilities in the South. Yet, if the technological gap keeps on growing due to differences in productivity between North and South, a growth convergence cannot be guaranteed. In such a case, convergence will be possible only if the South accelerates its innovation effort (Archibugi and Pietrobelli, 2003).
9. CONCLUSION Since 1945, the world economy has attested an incessant appearance of new and better technologies that have enhanced people‘s welfare. This impressive technological progress has been the result of the knowledge accumulated by the society through the years. And those nations that have learnt how to take advantage of it have achieved impressive rates of economic growth as well. Since that time, economists have painstakingly searched for useful explanations to this phenomenon. In this search, they have produced several approaches and theories, from which those concerned with the role that scientific knowledge plays in economic growth stand out. Cumulative scientific knowledge can be found in several forms, such as new and better products, faster and more efficient processes, new and cheaper materials and components, cleaner and more efficient sources of energy, and so on. All these features of economic growth have been summarized in the term ―knowledge-based economy‖, showing us that growth no longer depends exclusively on large endowments of land, raw materials, or investments in traditional capital or unskilled labor, but on an efficient administration of the input ―knowledge‖. In this chapter we identified and exposed the most important theories dealing with economic growth. Our principal aim was to stress the importance of human capital in growth by linking the effects of cumulative learning and knowledge on technical change and innovation. One should be borne in mind, however, that the dynamics of knowledge creation, exchange and diffusion remains surprisingly poorly understood, even for the most advantaged schools of economic thought. Yet, this should represent a challenge rather than a weakness for the economists interested in studying this fascinating process.
REFERENCES Aghion, P. & Howitt, P. (1998). Endogenous Growth Theory, Cambridge, USA: The MIT Press.
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Amable, B. (1994). Endogenous Growth Theory, Convergenece and Divergence. In G. S. Editor, & L. S. Editor (Eds.), The Economics of Growth and Technical Change (pp. 2044). Aldershot, UK: Edward Elgar. Archibugi, D. & Pietrobelli, C. (2003). The Globalization of Technology and its Implications for Developing Countries: Windows of Opportunity or Further Burden?. Technological Forecasting and Social Change, 70, 861-883. Arrow, K. J. (1962). The Economic Implications of Learning by Doing. Review of Economic Studies, 29, 155-173. Boulding, K. E. (1966). The Economics of Knowledge and the Knowledge of Economics. American Economic Review, 56, 1-13. Costabile, L. & Rowthorn, R. E. (1985). Malthus‘s Theory of Wages and Growth. Economic Journal, 95, 418-437. Fagerberg, J. (1994). Technology and International Differences in Growth Rates. Journal of Economic Literature, 32, 1147-1175. Gregersen, B. & Johnson, B. (2000). How Do Innovations Affect Economic Growth? Some Different Approaches in Economics. In C. E. Editor & M. M. Editor (Eds.), Systems of Innovation: Growth, Competitiveness and Employment, (pp. 326-353). Cheltenham, UK: Edward Elgar. Grimaldi, R. & Torrisi, S. (2001). Codified-tacit and General-specific Knowledge in the Division of Labour Among Firms: A Study of the Software Industry. Research Policy, 30, 1425-1442. Hahn, F. H. & Matthews, R. C. O. (1964). The Theory of Economic Growth: A Survey. Economic Journal, 74, 779-902. Hall, P. (1994). Innovation, Economics and Evolution, London: Harvester Wheatsheaf. Heng, T. M., Chin, T. H., & Choo, A. (2002). Mapping Singapore's Knowledge-Based Economy. Economic Survey of Singapore, 2002, 56-75. Jovanovic, B. (2001). Economic Growth: Theory. In N. J. S. Editor, & P. B. B. Editor (Eds.), International Encyclopedia of the Social and Behavioral Sciences (pp. 4098-4101). Amsterdam: Elsevier. Kaldor, N. (1957). A Model of Economic Growth. Economic Journal, 67, 591-624. Khan, M. (2001). Investment in Knowledge. STI Review, 27, 19-48. Low, M. B. & Abrahamson, E. (1997). Movements, Bandwagons, and Clones: Industry Evolution and the Entrepreneurial Process. Journal of Business Venturing, 12, 435-457. Lucas, R. E. (1988). On the Mechanics of Economic Development. Journal of Monetary Economics, 22, 3-42. Lundvall, B.-A. (1992). National Systems of Innovation: Introduction. In B.-A. L. Editor (Ed.), National Systems of Innovation (pp. 1-19). London: Pinter. Malthus, T. R. (1803[1999]). An Essay on the Principle of Population. Oxford: Oxford University Press [Oxford World's Classics 1999 edition]. Mankiw, N. G. (2002). Macroeconomics. New York: Worth Publishers. Mowery, D. C. & Oxley, J. E. (1997). Inward Technology Transfer and Competitiveness: The Role of National Innovation Systems. In D. A. Editor, & J. M. Editor (Eds.), Technology Globalisation and Economic Performance (pp. 138-171). Cambridge, UK: Cambridge University Press. Nelson, R. R. (1993). National Innovation Systems: A Comparative Analysis. New York: Oxford University Press.
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Nelson, R. R. & Winter, S. G. (1982). An Evolutionary Theory of Economic Change. Cambridge, USA: Harvard University Press. Nonaka, I. & Takeuchi, H. (1995). The Knowledge-Creating Company. New York: Oxford University Press. OECD (1992). Technology and the Economy. Paris: OECD. OECD (1996). The Knowledge-Based Economy. Paris: OECD. OECD (1998). Technology, Productivity and Job Creation: Best Policy Practices. Paris: OECD. OECD (2000a). Korea and the Knowledge-based Economy: Making the Transition. Paris: OECD. OECD (2000b). Science, Technology and Industry Outlook 2000. Paris: OECD. OECD (2006). Science, Technology and Industry Outlook 2006. Paris: OECD. OECD (2007). Innovation and Growth: Rationale for an Innovation Strategy. Paris: OECD. Parkin, M. (2003). Economics. Boston: Addison-Wesley. Rogers, E. M. (2001). Theory of Innovation. In N. J. S. Editor, & P. B. B. Editor (Eds.), International Encyclopedia of the Social and Behavioral Sciences (pp. 7540-7543). Oxford: Elsevier. Romer, P. M. (1986). Increasing Returns and Long-Run Growth. Journal of Political Economy, 94, 1002-1037. Romer, P. M. (1990). Endogenous Technological Change. Journal of Political Economy, 98, s71-s102. Rosenberg, N. (1982). Inside the Black Box: Technology and Economics. New York: Cambridge University Press. Samuelson, P. A. & Nordhaus, W. D. (2002). Economics. New York: McGraw-Hill. Scherer, F. M. (1999). New Perspectives on Economic Growth and Technological Innovation. Washington: Brookings Institution Press. Schumpeter, J. A. (1912). Theorie der Wirtschftlichen Entwicklung. Munich: Verlag Dunker und Humbolt. Schumpeter, J. A. (1950). Capitalism, Socialism and Democracy. New York: Harper & Row. Shapiro, C. & Varian, H. R. (1999). Information Rules: A Strategic Guide to the Network Economy. Boston: Harvard Business School Press. Soete, L. (2001). The New Economy: A European Perspective. In D. A. Editor, & B.-A. L. Editor (Eds.), The Globalizing Learning Economy, (pp. 21-44). Oxford: Oxford University Press. Solow, R. M. (1956). A Contribution to the Theory of Economic Growth. Quarterly Journal of Economics, 70, 65-94. Solow, R. M. (1957). Technical Change and the Aggregate Production Function. Review of Economics and Statistics, 39, 312-320. Steedman, I. (2001). On ‗Measuring‘ Knowledge in New (Endogenous) Growth Theory. Conference Paper, Pisa, Italy: The Growth Theory Conference. 5-7 October 2001. Stern, N. (1991). The Determinants of Growth. Economic Journal, 101, 122-133. Tassey, G. (2004). Policy Issues for R&D Investment in a Knowledge-Based Economy. Journal of Technology Transfer, 29, 153-185. Verspagen, B. (1993). Uneven Growth Between Interdependent Economies. Aldershot, UK: Avebury.
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Verspagen, B. (2005). Innovation and Economic Growth. In J. F. Editor, D. C. M. Editor, & R. R. N. Editor (Eds.), The Oxford Handbook of Innovation (pp. 487-513). Oxford: Oxford University Press. World Bank (1998). World Development Report 1998: Knowledge for Development. Washington: World Bank.
In: Issues in Economic Thought Editors: M-A. Galindo, C. N. Spiller, pp. 225-242
ISBN 978-60876-173-9 © 2010 Nova Science Publishers, Inc.
Chapter 13
LIFE CYCLE HYPOTHESIS: APPLICATION FOR DEPENDENCE Francisco Escribano Sotos, Raul del Pozo Rubio and Isabel Pardo García Universidad de Castilla-La Mancha, Spain
ABSTRACT The aim of this chapter is to review theoretical background related to the life cycle hypothesis. We take into account new demographic situations, where life expectancy increases, elderly population increases, number of children decrease and, therefore, it will be necessary to consider who is going to care for elderly and dependent people. In this paper, we consider that savings can contribute to mitigate consequences of dependence, because people can use savings to obtain services related to dependence. The mathematical model proposed is an extension of the life cycle hypothesis. We analyze Modigliani‘s life cycle hypothesis and we use his analysis to introduce savings necessary to cover dependence; this revision will show the importance of savings and besides we will be able to discuss the need to finance long-term care services in the case of dependence.
INTRODUCTION The aim of this chapter is to review theoretical background related to the life cycle hypothesis. This revision will reveal the importance of savings, and besides we will be able to discuss the need to finance long-term care services in the case of dependence. Spanish Law 39/2006, Promoción de la Autonomía Personal y Atención a las personas en situación de Dependencia, defines dependence as ―a permanent situation in that persons who, for age reasons, disease or disability, besides their physical, mental or hearing autonomy having decreased, they then need attention from other people or important aids to carry out
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activities… or in the case of people with intellectual disability or mental disease, other aids for personal autonomy‖. We can see in Table 1 the results obtained in Spain through a survey of disability, personal autonomy and dependence situations in 2008. Some relevant results are the following:
Amount of disabled persons is about 3. 8 million; it is 8.5 percent of population. A total of 608,000 persons with a disability live alone in their home. 1.39 million people are not able to do activities of daily living without aid. 269,000 people live in residences for the elderly, residences for the disabled, psychiatric hospitals and geriatric hospitals, with some disability.
Table 1.1. Percentage population according to disability and age range at home
Both Moderate disability 1.29% 1.70% Severe disability 3.28% Total disability
Total Men 0.99% 1.15% 2.23%
Women 1.57% 2.23% 4.30%
65-79 years old Both Men Women 3.34% 2.51% 4.02% 4.90% 3.47% 6.08% 7.56% 5.59% 9.18%
80 years old and more Both Men Women 4.47% 4.11% 4.67% 7.59% 5.46% 8.80% 29.52% 20.08% 34.87%
Source: Inebase EDAD 2008.
We can see in this table the disability situation of the Spanish population. For the elderly group (+ 80 years), dependence increases. According to these data and considering population evolution and aging, it is necessary to provide cover to dependence. Theoretical framework considers consumption and savings and tries to offer instruments or financial alternatives for people in general and for policy maker, too. The aim is to reduce uncertainty, add information when people make decisions, independent of their age1,and to inform about assistances and care in case of dependence to maintain the well-being level and quality of life. In the future, the percentage of the population who will need care will increase and adequate relation between public and private finance should be considered. Public system should guarantee access to the necessary people, but individual thrift is the right way to consolidate supply of services to improve quality of life and the population‘s welfare. According to new demographic situations, where life expectancy increases, elderly people increase, and number of children decrease, it will be necessary to consider who is going to care for elderly and dependent people. In this paper, we consider that savings can contribute to mitigate consequences of dependence, because people can use savings to obtain services related to dependence. Keynes points out different reasons to save and some of them are related to dependence. Among others reasons Keynes points out: 1
Reserves to cover unforeseen events. To cover necessities in the future
Young people should consider the possibility of being dependent in the future, too.
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To feel independent and to develop activities To enjoy a higher income in the future To leave bequest to heirs By avarice To create reserves to develop new projects or speculative activities.
The first three reasons are directly related to the wish to cover contingencies or unforeseen events, and indirectly, the fourth and the fifth reason. If we take into account demographic changes, long-term care will be more and more important in the future and dependence will be a contingency to cover. In this sense, individual thrift and national savings are important to contribute to the solution of this problem. For it, we analyze Modigliani‘s life cycle hypothesis and we use his analysis to introduce savings necessary to cover dependence. First, we analyze the consumption function of Keynes; after this, we introduce the life cycle hypothesis (LCH), permanent income hypothesis (PIH) and Ricardian equivalence hypothesis (REH). We finish introducing some assumptions in LCH. These assumptions are introduced to analyze how to cover contingency of dependence, and we explain the life cycle hypothesis applied to dependence. Finally, some conclusions are shown.
1. CONSUMPTION AND SAVINGS. KEYNESIAN ANALYSIS In the 40s and 50s, Keynesian was the most important theory to explain savings. According to this point of view, disposable income is defined as the difference between income and taxes (independent taxes are direct or indirect). In this sense, consumption depends linearly on disposable income as follows:
C Co c * Y D Co is autonomous consumption, it is to say, necessary consumption independent from level income; ―c‖ is marginal propensity to consume, it is to say, percentage of disposable income allocated to consume. Keynes sets up a concrete value to this variable and justifies it in the next way: ―a typical modern society probably would consume more or less 80 percent of any increment of their income…‖ (Keynes, 1981).
Y D Y t *Y T Where, Y is total income, t percentage of direct taxes and T indirect taxes. According to this, savings (S) can be defined as disposable income minus consumption.
S Y D C Y D Co c * Y D Co (1 c) * Y D Where (1-c)=s, being s marginal propensity to save. This variable represents how much savings change when disposable income changes, too.
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In this model, income is the principal factor to explain private savings as aggregate savings (Modigliani, 1985). However, this explanation has not been useful to explain how saving has evolved after the Second World War, and this theory has been refuted by different authors, among them, Kuznets (1946), Brady and Friedman (1947) and Goldsmith (1951). To overcome limitations of the Keynesian model, different theories are developed later: Modigliani‘s life cycle hypothesis (1954); Friedman‘s permanent income hypothesis (1957) and Barro- Ricardo equivalence hypothesis (1974).
2. MODIGLIANI’S LIFE CYCLE HYPOTHESIS (LCH) Modigliani‘s life cycle hypothesis is developed in two works written by Modigliani and Brumberg: ―Utility Analysis and the Consumption Function: as interpretation of cross-section data‖ (1954), and ―Utility Analysis and the Aggregate Consumption Function: an attempt at integration‖ (1979). The aim of these papers was to show that empirical regularities could be explained in terms of rational maximization of utility, understanding that consumers do an optimum allocation of consumption throughout their lives, as Irving Fisher’s thought (1930) (Modigliani, 1986). Modigliani‘s life cycle hypothesis in an extension of Keynesian analysis and considers that utility consumption and utility savings2 are maximized. In this model consumption does not depend on current income, but depends on income received throughout one‘s labour lifetime. Agents are not myopic because they take into account a wide perspective; they consider disposable resources throughout their lifetime. Modigliani (1986) defines income or disposable resources as ―current value of labour income plus bequest received, when it exists‖. This hypothesis is developed according to the next assumptions. Given an individual agent, where N is his labour lifetime; L is his death age; Y is annual labour income (this is the only income received). Besides, there is no bequest, return of saving and interest discount rate are zero and there are no liquidity limitations. Income is distributed between consumption and savings. We can define consumption as total income received throughout the labour lifetime; consumption is distributed fairly along the lifetime; it is to say labour lifetime (N) and retirement lifetime (L-N). (L is life expectancy.)
C
Y *N L
Savings or deferred consumption is:
S Y C Y
Y *N LN Y *( ) L L
And accumulated savings or accumulated wealth3 in a period of time is: 2 3
Like deferred consumption. If there was bequest or additional resources, it would be included in this variable.
Life Cycle Hypothesis: Application for Dependence
Sacumt Wacumt t * S t * Y * (
229
LN ) L
We can see this in graph 3.1. It is important to define consumption as a function of income and wealth too. The reason is to avoid limitations related with assumptions that labour income is the only income received and there is no bequest. Given this, we can rewrite the following expression:
Ct
Wt Y * (N t) Lt Lt
equivalent to:
Ct *Wt * Y
con 0 , 1
In this expression we can see that as income as wealth or accumulated savings are related directly to consumption. α and β coefficients are inversely proportionate to death age; when death age increases, α and β decrease and then, consumption is lower. β is proportionate to labour age; when retirement age increase and therefore labour lifetime increases, β increases too and consumption is higher.
Source: Own elaboration. Graph 3.1. Modigliani‘s life cycle hypothesis.
According to some conditions we can include in these expressions inheritances, other incomes or interest discount rate different from zero and structure and meaning would not change (Lera, 1995).
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3. PERMANENT INCOME HYPOTHESIS (PIH) Permanent income hypothesis is an alternative model to life cycle hypothesis; this model is developed by M. Friedman (1957). According to Friedman, to assume that consumption depends on current income implies some myopia and some irrationality. When agents are rational, permanent income is considered. Permanent income can be defined as the sum of current income plus transitory income. In this sense, current income is regular income and transitory income is uncertain income. Given both are uncertain, proportion of consumption derived from transitory income will be lower than consumption derived from regular income. Under these assumptions permanent income can be calculated as average of income in the last period and the increase between current and last period; given we do not know if increase will be kept in the future, this variable is weighted lower:
Yp Yt 1 * (Yt Yt 1 ) * Yt (1 ) * Yt 1
where 0 1
In this model, like in life cycle model, if a percentage of permanent income is consumed (c), consumption function will have the following expression:
C c * Yp c * Yt 1 c * * (Yt Yt 1 ) c * * Yt c * (1 ) * Yt 1 There are several differences between permanent income hypothesis and life cycle hypothesis, according to the aim of this paper we are going to consider two. First question is related to period of time considered. For LCH period of time considered by an individual agent is finite, up to L, it is to say, death age. For PIH period of time considered is infinite, it is so because Friedman defines theoretically permanent income as ―the volume that a unit of consumption could be consume keeping his wealth intact‖ (Friedman, 1957); therefore wealth stands intact and permanent income implies a constant income, covering agent lifetime and his issues. Second question is related to savings. For PIH, savings let to families smooth consumption between bad and good years, while LCH consumption is smoothed too but in this case consider labour span and retirement span.
4. RICARDIAN EQUIVALENCE HYPOTHESIS (REH) With Friedmann we can consider Barro, who belongs to the new classical economy. Consumption function proposed by Barro is known as Barro-Ricardo equivalence hypothesis as it acknowledges Ricardo‘s analysis, for whom public expenditure finances with taxes has the same result as public expenditure finance with public debt. If public expenditure increases and to finance it, taxes increase, consumption will decrease. If it is financed with public debt, according to Keynesian analysis the result will be positive, but it is not true according to the Barro analysis. For this, consumers are rational agents and they know taxes will increase in the future and therefore to avoid a consumption decrease, agents start to save at the same moment that public expenditure increases. This situation is similar when taxes are reduced but the public expenditure level is maintained, because in this case it has to be financed with
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public debt. Increase of disposable income does not imply a consumption increase because it will be saved. The reason is that permanent income does not change, there is just one question: when are taxes paid? For Barro and Hall, shifts in aggregated consumption are random and there is an only a possibility to influence its behaviour, when changes are unexpected. Therefore fiscal policy is inefficient when financed with taxes and public debt. To reach this conclusion two assumptions are made about agent behaviour4: 1- consumption of agents depends on family permanent income and they consider future generations; 2- consumers act under rational expectative, they do not have any problem related to information or consumer myopia (de Juan, 2000).
5. PROPOSAL: LIFE CYCLE HYPOTHESIS APPLIED TO DEPENDENCE (LCHD) Considering Modigliani‘s life cycle hypothesis we are going to introduce some assumptions; the principal aim of them is related to necessity to finance dependence but there are two other secondary aims: maintain quality of life and well-being of dependent people and equilibrium between public and private finance. We are going to denominate this extension like life cycle hypothesis applied to dependence (LCHD). These assumptions are two in number: 7. We introduce another income, named retirement income or retirement pension; this income will be constant along retirement span (L-N). 8. We define consumption and saving according to different assets to cover dependence. Introduction of these assumptions let us establish a model where importance to cover dependence is shown.
1. Introduction of Retirement Income or Retirement Pension In LCH Y has been defined like income obtained along labour lifetime and was the only income. In this case, is introduced Y2 like retirement income obtained in the retirement span and defined like a proportion of labour income (Y); therefore:
Y2 k * Y
where 0 k 1, and k cons tan t
Y2 Y To calculate consumption and savings expressions two periods of time are differentiated: labour span and retirement span. This assumption implies defining two consumptions and two 4
These assumptions are very different to Keynesian thought.
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savings, one for labour span (C1, S1) and another for retirement span (C2, S2); both are deducted from income of each period of time (Y e Y2). As consumption labour as savings labour are according to principles exposed in LCH. In retirement span, a proportion of pension or retirement income is allocated to increase consumption and the other to create a remaining amount to finance dependence in case of necessity. Retirement income is just used in retirement span, increase of consumption and savings for dependence, while labour income finance consumption along lifetime agent. Variables related to consumption are defined as follows:
C1
Y *N L
C2 C1 CY2 C1 jY2 Where j represents proportion of retirement income (Y2) directed to consume, and then, consumption increases from C1 to C2. ∆C2 can be defined as:
CY2 jY2 j * k * Y Total consumption for period 2 will be:
C2 C1 CY2 C1 jY2 C1 j * k * Y
Y *N N j * k *Y Y * ( j * k ) L L
Therefore, savings proportion of this retirement income will be (1-j), named savings for dependence or remaining for a year (S2). Variables related to savings are defined as:
S1 Y * (
LN ) L
S 2 (1 j ) * Y2 (1 j ) * k * Y S2 will be applied to cover dependence because S1 let maintain consumption as labour span as retirement span. Accumulated savings or accumulated wealth in a period of time can be calculated, too; but in this case it is necessary to distinguish between before age retirement and after age retirement:
Life Cycle Hypothesis: Application for Dependence
LN ) if t N L LN Sacumt Wacumt N * Y * ( ) (t N ) * C2 (t N ) * S 2 L
233
Sacumt Wacumt t * S t * Y * (
if t N
We can see graphically in the graph 6.1. In this case it is possible at the end of individual agent lifetime there is an accumulated remaining amount that can be used to cover and finance dependence in case of necessity. This remaining amount can be calculated as: L
Total Re maining ni * S 2 ( L N ) * S 2 i N
It is important to define consumption as a function of income and accumulated wealth, too. For it, these expressions are used:
Source: Own elaboration. Graph 6.1. Modigliani‘s life cycle hypothesis with retirement pension..
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C1
Wt Y * (( N t ) K * ( L N )) C Y2 * ( L N ) Re maining Lt L t Lt L t if t N
C Y2
Wt Y * (( N t ) K * ( L N )) C1 * ( L t ) Re maining LN LN LN LN
expression equivalent to:
Ct * Wt * Y where
Re maining (1 j ) * k * Y In these expressions as wealth (Wt) as income (Y) maintain a direct relation with consumption. Coefficient α and δ maintain the same relation with age retirements and death; however, λ has a negative effect on consumption. There is an obvious reason: in this case a proportion of income and savings are applied to cover dependence and they can not be used for consumption.
2. Definition of Consumption and Saving according to Different Assets to Cover Dependence At this point we are going to suppose that an individual agent can decide two different measures related to consume or save; these assumptions will allow agent to make different measures to anticipate and cover dependence. Any individual agent has to decide about application of income obtained; according to LCHD labour income and retirement income. First question analysed is ―consume or save5‖; and then, a second question is analyzed, ―how much to consume and how much to save6”. In consumption two different types of consumptions are defined, pure consumption (Cpure) (daily goods, primary necessity goods…) and investment consumption (Cra) (main residence, second residences, other properties or other real assets) named real assets consumption. Analytically is shown in the following expression:
C Cra C pure Cra ra * C C pure (1 ra) * C
5 6
Savings like deferred consumption. Income can be applied to investment but we suppose income is just applied to consume or to save.
Life Cycle Hypothesis: Application for Dependence
235
Where ―ra” is the constant for real assets consumption, since consumption depends on income, real assets consumption (especially main residence) will be a proportion of obtained income. For the other side, the proportion not consumed will be applied to savings and, in this case, two different types of saving are defined, too: pure savings (Spure), and precaution savings (Spr), because monetary income is used to acquire financial assets to cover a contingency7, and in the case contingency happens, there will be an outlay8 or services9.
S S pr S pure S pr pr * S S pure (1 pr ) * S In this expression pr is the constant to precaution savings, since savings depends on income, precaution savings (pension plan, dependence insurance …) will be a proportion of obtained income, too. Real assets consumption and precaution savings are a proportion of agent wealth, but, above all, is a protection reserve because, both, can be applied to cover dependence contingency or any eventuality. This reserve will be called precaution investment. A diagram about this is shown:
Source: Own elaboration. Graph 6.2. Precaution investment derived from consumption and savings.
7
In this paper contingency is refereed to the possibility that a person can turn intoa dependent; however retirement contingency will be considered. 8 Like income or capital (as to plan pension as to insurance). 9 When financial asset is like insurance.
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Francisco Escribano Sotos, Raul del Pozo Rubio and Isabel Pardo Garcia Whose mathematical expression is:
Ipr Cra S pr ra * C pr * S According to our analysis a question can be made: How does precaution investment or precaution savings cover contingency of dependence, in the LCHD model? It is supposed that age when dependence occurs will be after retirement, because it is in this lifetime period when population can need aid for activities of daily living. This age is D, being D higher than 65 years (D>N). After this moment, to maintain quality of life and wellbeing, above all in utility terms, level of consumption will increase (up to CD), and level of savings can be compromised because dependence cost is high. Dependence cost is a theme discussed and studied nowadays. Several papers study costs related to long-term care and national systems health, as national level like (Casado and López (2001), Casado (2006), Costa-Font and Gil (2008), Bolancé et al (2006), Ministerio de Trabajo y Asuntos Sociales (2004), Moragas et al (2003), Comas and Wittenberg (2003)) as international level (Campbell e Ikegami (2000), Cadette (2000), Comas-Herrera (2004), Patxot and Costa (2003), Bolhaar, Lindeboom and Van Der Klaauw (2008), Colombo and Tapay (2004), Finkelstein and McGarry (2006), Andrews (2007), …). In general, these papers show costs that service necessaries to maintain well-being of dependent agent imply. Introduction of dependence cost and precaution investment in life cycle hypothesis allow us to analyze LCH to dependence, whose diagram is as follows:
Source: Own elaboration. Graph 6.3. Life cycle hypothesis applied to dependence.
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237
Areas related to consumption (main residence + real assets), savings (pension plan or similar) and total remaining should cover, by financial equivalence, dependence cost area. To calculate dependence cost10 (Dc) dependence level (Deplevel) of dependent subject is used. So, total amount to mitigate effect of dependence can be calculated as area between dependence consumption (C’) and consumption function of life cycle. Mathematically is: L
Dc f (C ' ) f (C )dt D
Where
C ' f ( Deplevel , t ) C f ( Rt , Y , t ) And graphically
Source: Own Elaboration. Graph 6.4. Dependence cost.
Dependence cost DC allows us to analyze two questions. First, how to avoid having resources compromised, and second, that these resources are enough to cover this contingency. 10
Cost does not depend on individual income.
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According to LCHD two different instruments are suggested to finance dependence without compromising resources. However, a necessary condition must be achieved: agent must want to cover dependence. These assets derive from consumption and savings classification made before; on one side, precaution assets acquired with savings; for the other side, the possibility to obtain profit with real assets obtained with consumption. The aim is that the cost to be dependent is, in financial terms, equivalent to precaution investment.
DC Ipr To reach it, some equations can be established: 1.
L
DC Total Re maining ni * S 2 ( L N ) * S2 iN
2.
DC Cra ra * C
3.
DC S pr pr * S
4.
DC S pr Cra pr * S ra * C
In the following, these identities are analyzed to show advantages and disadvantages: 1. DC Total Re maining
L
n * S
iN
i
2
( L N ) * S2
At first, finality of total remaining generated is to cover dependence, when it happens. Ideal situation would be this remaining above all financial necessities related to dependence; however, when retirement pension is low and there is a big dependence, it is possible that resources are not enough to cover necessities. When this happens there are other options. 2. DC Cra ra * C The meaning of this equation is to liquidate net wealth of the dependent subject to obtain incomes that allow the person to maintain a consumption proportional to dependence level and quality of life, in utility terms, similar to previous level. Under this, suppose there are two assumptions. We are assuming an important real investment by subject, as a main residence. This assumption is corroborated in Spain for all age levels and above all for the population that can suffer dependence. For people older than 65 years, 90 percent have the property of their main residence. Average value is 203.634 € for people between 64 and 75 years old, and this average decreases to 192.323,87 € for people older than 75 years11. Second assumption is that the owner or heirs wish to liquidate net wealth to cover dependent cost.
11
Source: Encuesta Financiera de las Familias (Banco de España, 2005) and own elaboration.
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There are different assets to eliminate uncertainty and allow one to liquidate net wealth (main residence, pension, inverse mortgage or cession to rent), to cover necessary services demanded by the dependent subject. The advantage of this option is net wealth of the older people is high; therefore, net wealth can be applied to cover dependence in case of necessity. In this sense, public sector can guarantee a basic cover for everybody, and, at the same time, users can pay a contribution. However, if there is no precaution savings and subject wishes to maintain utility consumption similar to period before dependence, net wealth can be used to finance additional services derived from dependence. Principal disadvantage is inheritance from a double point of view: from owner and from heir. From owner‘s point of view, there is an intention to leave inheritance. In this sense and according to Patxot (1994), inheritances are explained because parents to calculate their wellbeing consider children‘s well-being. This assumption can explain that subject does not want to liquidate net wealth, although quality of life decreases. From heir‘s point of view, perhaps does not wish to loss his bequest. Therefore, is evident that both, predecessor and heir must wish to liquidate net wealth and use profits to finance dependence services. 3. DC S pr pr * S This equation represents that dependence contingency has been anticipated and different measures have been taken to cover it. In Spr are included assets that allow a periodic income in the future or services used to avoid loss of well-being in dependant subjects. Related to previous option, there is a difference derived from income allocated to mitigate dependence. In this case, resources come from, on one side, savings derived from labour income (Spr=pr*S), and on another side, percentage of savings derived from retirement income (S2=(1-j)*k*Y). So, limitations related to inheritance are got over. Two disadvantages can be shown. First, it is necessary that the subject wish to cover dependence contingency, because precaution must be considered along labour lifetime, when agent is young and does not expect to be dependant in the future. Second comes from uncertainty related to dependence because to cover dependence can mean a high monetary cost and opportunity cost, too. 4. CD S pr Cra pr * S ra * C The last one is a mixture between previous ones. This option is useful when necessities related to dependence are not covered completely by an only option. It is a good option when incomes are lower because investment in real assets is lower and savings allocated to financial assets increase since there are necessities more important than covering dependence in the future.
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6. CONCLUSION According to LCHD some conclusion can be shown: 1.
2.
3.
4.
5.
6.
Savings rate is positive and constant (if income is constant) before retirement, maximum level is reached just in the moment of retirement. After this moment, saving rate continues being positive but lower, because retirement income is lower than labour income. At the same time, dissaving is generated as a consequence of consumption financed with accumulated savings up to retirement moment. Actually, a consumption level that is more or less constant supposes a different pattern of savings and income in different periods of time. In the first labour lifetime, income is low and the agent has to get into debt to keep level consumption constant and then, savings is zero or negative (by debts). In the medium and at the end of labour lifetime, the situation changes; labour income increases, reaches the maximum and savings is positive, debts are cancelled, consumption level is maintained and it is possible to accumulate wealth to finance consumption along retirement span. In the retirement period, if level consumption is maintained, since income is zero in this period (LCH) or positive but lower than labour income (LCHD), there will be debts and accumulated savings will have to be used. Derived from the previous one, wealth is accumulated along the lifetime of the subject and a maximum is reached in the retirement moment; after this moment, wealth is decreasing down to zero according to LCH. However, according to LCHD it will not be zero because there is a remaining amount to cover dependence cost. According to the life cycle hypothesis, at the end of lifetime, savings have been consumed, but this hypothesis has not been proved in several researches [Kotlikoff (1988), García Durán (1992), Gale and Scholz (1994)]; in these papers this theory has just explained 31 percent of total wealth. However, researchers in favour of LCH point out some solutions to explain dissavings in elderly people; one of them is explained by Davies (1981), who justifies there is a cost to use (=spend) all disposable resources before death that maintain a positive savings without using in this moment. Finance instruments suggested are allocated to cover completely the dependence cost, guarantee an income or service necessities for the dependent agent guaranteeing quality of life. Of course, it is necessary not to compromise resources of the dependent subject. Since elderly people and heirs prefer to bequeath; the best option to cover dependence is to do provisions along the labour lifetime. These provisions avoid uncertainty in the case that dependence happens and solve another problem related to informal care. In previous years, care of the dependent subject has been developed by women through informal care but this option is not possible in the future because nowadays percentage of women incorporated in the labour market has increased a lot. Proposal of LCHD overcomes limitations pointed out by Friedman (PIH) and REH (Barro). Related to PIH there is a difference between permanent and current income, but this difference is not important in LCHD. In this case, consumption level and
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saving level are not derived from an only income, but they are derived from several incomes, regular and transitory. On the other hand, since subjects wish to have a good quality of life after retirement and leave a bequest, the best option to cover dependence contingency is precaution saving. According to Barro, dependence financing will imply more public expenditure, and then the individual agent will increase savings. But according to LCHD it will not be a problem, because an increase of savings leads to ability to finance the dependence cost.
REFERENCES Ando, A. & Modigliani, F. (1957). Test of the life cycle hypothesis of savings: Comments and suggestions. Bulletin of the Oxford University Institute of Statistics, 19, 99-124. Ando, A. & Modigliani, F. (1963). The life-cycle hypothesis of saving. Aggregate implications and tests. American Economic Review, 53, 55-84. Argandoña, A. (1995). Factores determinantes del ahorro. Ekonomi Gerizan. El papel del ahorro e inversión en el desarrollo económico, vol. 1, 3-60. Barro, R.J. (1974). Are Government Bonds Net Wealth?. Journal of Political Economy, 84, 1095-1107. Barro, R.J. (1978). The Impact of Social Security on Private Saving. Evidence form the U.S. Time Series. Washington .American Enterprise Institute. Bernheim, B.D. (1984). Dissaving after retirement: testing the pure life cycle hypothesis, Working Paper No. 1409. National Bureau of Economic Research. Cox, D. (1987). Motives for Private Income Transfers. Journal of Political Economy, vol. 95, 3, 508-546. Danzinger, S., Van der Gaag, J., Smolensky, E. & Taussing, M. (1983). The cycle hypothesis and the consumption behaviour of the elderly. Journal of Post Keynesian Economics, vol. 5, 208-227. Davies, J.B. (1981). Uncertain Lifetime, Consumption, and Dissaving in Retirement. Journal of Political Economy, vol. 89, 3, 561-577. Friedman, M. (1957). A Theory of the Consumption Function. New Jersey: Princeton University Press. Gale, W. G. & Scholz, J.K. (1994). Intergenerational Transfers and the Accumulation of Wealth. Journal of Economic Perspectives, vol. 8, 4, 145-160. Galindo, M.A. (2003). Keynes y el nacimiento de la Macroeconomía. Madrid. Síntesis. Garcia-Durán, J.A. (1989). Herencias o ciclo de vida. Revista de Economía, 4º trimestre, 97101. Heijdra, B.J. & Romp, W.E. (2008). A life-cycle overlapping-generations model of the small open economy. Oxford Economic Papers 60 (1), 88-121 Keynes, M. (1936). Teoría general de la ocupación, el interés y el dinero. México: Fondo de cultura económica [1987]. Kotlikoff, L.J. (1988). Intergenerational Transfers and Savings. Journal of Economic Perspectives, vol. 2, 2, 41-58.
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Kotlikoff, L.J. & SUMMERS, L.H. (1981). The Role of Intergenerational Transfers Aggregate Capital Accumulation. Journal of Political Economy, vol. 89, 4, 706-732. Juan, O. de (2000). Macroeconomía intermedia. Albacete: Bomarzo. Labeaga, J.M. & Osuna, R. (2007). Expenditures at retirement by Spanish households, Documento de trabajo nº 36. Serie Nuevos Consumidores CÁTEDRA Fedea – BBVA. Lera, F. (1995). Insuficiencias de la teoría del ciclo vital en el comportamiento del ahorrador. Documento de Trabajo nº 9705. Universidad Pública de Navarra. Méndez, F. (2006). Setenta años de la Teoría general de Keynes. Una revisión crítica. Documento de trabajo de la Facultad de Ciencias Económicas y Empresariales. Modigliani, F. (1966). The lifecycle hypothesis of saving, the demand for wealth and the supply of capital. Social Research, vol. 33, 2, 160-217. Modigliani, F. (1986). El ciclo vital, el ahorro individual y la riqueza de las naciones. Papeles de Economía Española, 28, 297-315. Modigliani, F. (1988). The role of intergenerational transfers and life cycle saving in the accumulation of wealth. Journal of Economic Perspectives, vol. 2, 2, 15-40. Modigliani, F. (1990). Recent Declines in the Savings Rate: a Life Cycle Perspective. Revista de Politica Economica, 80, 5-41. Modigliani, F. & CAO, S.L. (2004). The Chinese saving puzzle and the life-cycle hypothesis. Journal of Economic Literature, 42 (1), 145-170 Patxot, C. (1994). Efectos del envejecimiento de la población sobre el ahorro, Doctoral Ph not published, Barcelona: Universidad de Barcelona. Yaari, M.E. (1965). Uncertain lifetime, life insurance, and the theory of the consumer. Review of Economic Studies: Journal of the Society for Economic Analysis, vol. 32, 1, 137-150.
INDEX A accelerator, 31, 50, 51, 53 accommodation, 166 accounting, 166, 214 achievement, 63, 138, 148 acquisition of knowledge, 208 activism, 27, 28, 192 actual growth rate, 52 actual output, 31 adaptation, 62, 89, 189, 196 adjustment, 5, 6, 27, 29, 50, 54, 89, 130, 179, 186, 190, 191 affirmative action, 154 affirming, 33 age, 66, 77, 78, 88, 128, 141, 207, 225, 226, 228, 229, 230, 232, 234, 236, 238 aggregate demand, 24, 171, 179, 180, 182, 214 aggregate supply, 24 aggregate supply curve, 24 aggregates, 166, 180 agriculture, 106, 112 alienation, 109 alternatives, 64, 101, 188, 226 alters, 82, 102 ambiguity, 31, 40 ambivalence, 180 analytical framework, 26, 31 anthropology, 64, 111 aptitude, 129 aquifers, 196 Aristotle, 72, 142, 143, 149 articulation, 119 aseptic, 108
assets, 21, 63, 74, 78, 81, 82, 83, 87, 101, 106, 164, 170, 179, 231, 234, 235, 238, 239 assignment, 63, 188 assimilation, 144 assumptions, 9, 35, 60, 62, 80, 89, 90, 100, 120, 122, 185, 193, 211, 215, 227, 228, 229, 230, 231, 234, 238 asymmetry, 60 attacks, 102 attitudes, 10, 15, 154, 157 Australia, 207 Austria, 41, 68 authority, 32 authors, vii, viii, ix, x, 4, 8, 13, 33, 38, 39, 40, 46, 50, 80, 82, 83, 84, 88, 89, 111, 112, 119, 125, 152, 154, 155, 157, 193, 194, 228 automation, 127 autonomous consumption, 227 autonomy, 13, 15, 19, 129, 225 availability, 106, 109, 127, 129, 208 averaging, 67, 170 aversion, 64, 87, 173 awareness, 7, 19, 37, 39, 62
B background, x, 205, 225 baggage, 67 balance of payments, 208, 218 balance sheet, 166, 167, 173, 175 balanced budget, 31, 83, 88 balanced state, 83 Bank of England, 164, 165, 169, 175, 177, 183
244
Index
bankers, 65 banking, x, 6, 15, 17, 24, 25, 26, 27, 28, 161, 165, 167, 173, 175, 176, 177 bankruptcy, 64 banks, 32, 38, 66, 126, 162, 163, 164, 165, 166, 167, 169, 170, 173, 174, 175, 177, 179, 180, 181 bargaining, 24, 191 barter, 137 behavior, 29, 65, 137, 142, 200, 215 beliefs, 81, 104 benchmarking, 131 biological processes, 105 birth, 120, 152, 153, 156 births, 209 bonds, 39, 167, 179, 180 borrowers, 170, 178 borrowing, 165, 167, 170, 173 branching, 78 breaches, 110, 179 breakdown, 23 Britain, 209 broad money, 162, 163, 165, 167 business cycle, vii, 21, 22, 23, 24, 27, 29, 36, 37, 40, 45, 46, 48, 54, 55, 59 business model, 208
C calculus, 29, 156 capital accumulation, 10, 74, 77, 82, 88, 89, 137, 138, 211, 217 capital employed, 214, 217 capital goods, 50, 204, 214 capital intensive, 58 capital outflow, 74 capitalism, 24, 121, 217, 218 Catholic Church, 33 Catholics, 78 causal relationship, 168 causality, 168, 178, 194 central bank, 23, 37, 162, 163, 164, 165, 166, 167, 169, 170, 171, 172, 173, 174, 175, 176, 177, 181 channels, 33, 186 childhood, 64 children, ix, x, 64, 78, 135, 136, 138, 141, 142, 145, 146, 147, 148, 152, 210, 225, 226, 239 circular flow, 102 circulation, 28, 53, 54, 120 classes, viii, 5, 14, 22, 63, 71, 74, 76, 77, 78, 79, 80, 81, 82, 84, 85, 86, 87, 88, 89, 90, 145, 146
classification, 144, 156, 238 clean air, 188, 195 clean energy, 106 clients, 170, 175 closed economy, 12, 213 closure, 10, 125 cluster analysis, 123, 124 clusters, 120, 127 codes, 1, 205 coercion, 191 collaboration, 96, 106, 119 collateral, 180 collectivism, 33 College Station, 199 colonisation, 29 commerce, ix, 25, 26, 28, 135, 136, 138, 139, 142, 145, 148 commercial bank, 166 common law, 194, 201 communication, 120, 125, 127, 200 communication technologies, 127 Communist Party, 100 community, 5, 7, 15, 18, 33, 34, 59, 60, 124, 179, 186 comparative advantage, 18 comparative costs, 4, 6, 7, 9, 14 compatibility, 123 compensation, 147 competition, 10, 12, 15, 35, 37, 122, 146, 196 competitive conditions, 75 competitive markets, 191 competitiveness, 8, 10, 23, 130, 137, 140, 142, 219 complement, 3, 4, 197 complementarity, 128 complexity, viii, 15, 22, 46, 64, 99, 101, 112, 118, 126 compliance, 195 components, 18, 64, 112, 142, 166, 169, 173, 206, 220 composition, 73, 82 comprehension, 205 compression, 180 concentration, 87, 123, 126, 127, 140 conception, 7, 10, 13, 17, 61, 188, 190, 197 conceptual model, 158 concrete, vii, ix, 33, 135, 136, 188, 189, 191, 197, 227 conditioning, 29 confidence, 24, 148 conflict, 28, 48, 61, 129
Index conformity, 60, 62 confrontation, 13 confusion, 15, 164, 178 consensus, x, 61, 161, 162, 164, 166, 171, 179, 180, 181 conservation, 105, 106, 192, 193 consolidation, 33 constant rate, 48, 49, 53 consumer goods, 109, 110 consumers, 31, 82, 88, 120, 206, 215, 228, 230, 231 consumption function, 66, 227, 230, 237 contiguity, 128 contingency, 227, 235, 236, 237, 239, 241 contradiction, 10 control, 37, 40, 106, 124, 138, 139, 142, 148, 169, 186, 188, 192, 194, 196 convergence, 220 conversion, 112 conviction, 21, 40 corporations, 36, 153, 154, 157, 168 corporativism, 36 correlation, 26, 27, 180 correlations, 26 corruption, 146 cost-benefit analysis, 14 costs, 6, 7, 9, 14, 23, 24, 27, 28, 29, 31, 35, 36, 72, 137, 153, 156, 170, 180, 186, 187, 188, 192, 196, 214, 215, 236 country of origin, 78 covering, 78, 230, 239 creativity, 195, 197, 205 credit, x, 15, 23, 32, 36, 37, 38, 39, 40, 65, 66, 161, 164, 165, 166, 167, 168, 169, 170, 173, 175, 177, 178, 179, 180 credit market, 180 creditworthiness, 177 crime, 106 critical analysis, 46 critical value, 219 criticism, viii, 8, 64, 67, 99, 100, 110, 111, 166, 176, 187, 199 cues, 128 cultivation, 10, 75 currency, 54 customers, 154, 181 cycles, 22, 24, 29, 32, 35, 38, 39, 40, 46, 112 Czech Republic, 207
245
D daily living, 226, 236 data availability, 207 dating, 50 David Hume, 150 death, 48, 100, 125, 228, 229, 230, 234, 240 deaths, 209 debt, viii, 23, 71, 79, 84, 164, 170, 178, 230, 240 decentralisation, 125, 127, 128 decentralization, 194 decision making, 189, 192 decisions, 12, 18, 23, 24, 29, 30, 47, 60, 77, 125, 153, 155, 177, 178, 189, 190, 191, 192, 194, 197, 198, 226 deconcentration, 125, 126 decreasing returns, 211, 212 deduction, 59 deductive reasoning, 120 defects, 65, 153 defence, 137 defense, 145 deficit, 31, 60, 84, 104, 167, 177 definition, 13, 17, 46, 51, 52, 53, 60, 62, 63, 67, 72, 85, 102, 103, 105, 108, 120, 144, 167, 188, 193, 194, 203 deflation, 41 deforestation, 186 degradation, viii, 99, 102, 106, 107 deindustrialisation, 125 delusions, 142 demand curve, 164, 175, 179, 214 demand-pull inflation, 28 democracy, 102 demographic change, 227 Denmark, 207 density, 129 deposits, 79, 162, 164, 165, 166, 167, 168, 169, 170, 175, 177, 178, 179, 180, 181 depreciation, 211, 214 depression, 38, 60 deregulation, 206 derivatives, 26 destruction, 9, 33, 218 determinism, 33 devaluation, 24 developed countries, 105 developing countries, 125, 218, 219 developing nations, 106 deviation, 37
246
Index
diet, 209 differential equations, 28 differential rates, 204 differentiation, ix, 117, 119, 123 diffusion, 124, 126, 127, 189, 205, 206, 217, 218, 219, 220 diminishing returns, 74, 75 direct investment, 77 direct taxation, 88 direct taxes, 227 directionality, 74 disability, 225, 226 discipline, vii, 1, 4, 8, 16, 17, 18, 19, 34, 58, 67, 112, 115, 117, 118, 128, 130, 152, 192 discomfort, 204 discontinuity, 5 discourse, vii, 1, 2, 5, 19 disequilibrium, 35, 39 dispersion, 87, 125 disposable income, 77, 122, 227, 231 dissatisfaction, 142 dissaving, 86, 240 disseminate, 189 dissipative structure, 103 distortions, 16, 32, 34, 36, 37 distribution, viii, 16, 23, 35, 63, 71, 72, 73, 74, 75, 76, 77, 78, 79, 80, 81, 82, 83, 84, 85, 86, 87, 88, 89, 90, 106, 119, 120, 121, 127, 136, 141, 150, 194 distribution of income, 63, 72, 75, 76, 77, 80, 83, 84, 85, 87, 89, 90 disutility, 109 divergence, 187 diversification, 119, 122 diversity, 154, 192 division, ix, 11, 58, 103, 120, 127, 135, 136, 137, 138, 139, 140, 141, 142, 143, 145, 146, 148, 217 division of labor, 217 domestic credit, 164 domestic economy, 22, 36 dominance, 127 dumping, 11, 195 duties, 2, 4, 8, 9, 10, 11, 13, 15, 75, 151 dynamism, 24, 128, 130, 220
E earnings, 142 earth, 75, 104, 107 ecology, 123, 199
economic activity, 11, 24, 31, 104, 136, 168, 169, 218 economic behaviour, 46, 77, 78, 87, 152, 157 economic crisis, 10 economic cycle, 22, 39, 46, 47, 50, 51, 52, 53 economic development, 10, 37, 110, 112, 124, 127, 217 economic efficiency, 146, 188 economic goods, 213 economic growth model, 136, 137 economic performance, 40 economic policy, vii, 1, 2, 4, 5, 8, 10, 12, 13, 14, 15, 16, 17, 18, 19, 60, 62, 77, 189 economic problem, vii economic resources, 47 economic systems, vii, 21, 26, 31, 40, 46, 51, 58 economic theory, x, 11, 12, 58, 75, 84, 100, 203, 204, 207, 217 economic transformation, 10 economic welfare, 186 economics, vii, viii, ix, 1, 2, 3, 5, 6, 7, 8, 10, 14, 15, 17, 24, 25, 37, 46, 47, 51, 59, 72, 75, 87, 109, 111, 120, 121, 135, 136, 152, 158, 171, 179, 181, 193, 199, 200, 204, 207, 209 education, vi, 43, 135, 136, 137, 138, 141, 145, 146, 148, 149, 150, 181 egalitarianism, 141 elaboration, 73, 138, 139, 140, 191, 229, 233, 235, 236, 238 elasticity, 65, 78, 129, 214, 218 elasticity of demand, 214, 218 elderly, x, 225, 226, 240, 241 elderly population, x, 225 elucidation, 87 emission, 194, 195, 198 employees, 152, 154 employment, 24, 35, 40, 49, 64, 81, 104, 125, 137, 139, 141, 206 endogeneity, 47, 163, 166, 168, 169, 179, 180, 182, 183 energy, viii, 99, 102, 103, 104, 105, 106, 107, 112, 129, 220 England, 110, 141, 147, 161, 168, 169, 175, 183, 209, 217 enlargement, 65 enthusiasm, 18, 52, 142 entrepreneurs, 23, 24, 30, 31, 32, 35, 38, 47, 51, 52, 74, 77, 81, 86, 88, 193, 196, 213, 217 entrepreneurship, 208 entropy, viii, 99, 102, 104, 106, 107, 108
Index environment, viii, 17, 25, 58, 66, 99, 100, 102, 103, 104, 105, 107, 119, 153, 154, 157, 178, 192, 196, 199, 202 environmental conditions, 64, 109 environmental crisis, 111 environmental impact, 105 environmental policy, 185, 188, 194, 195, 197, 198, 201, 202 environmental protection, 111 environmental resources, 192 environmentalism, x, 185, 186, 192, 193, 194, 195, 196, 197, 198, 201 epistemology, 102 equality, 4, 52, 60, 61, 63, 79, 84, 86, 148 equilibrium rate of interest, 81, 87 equity, 180 ESI, 67 ethics, 37, 60, 72, 152, 155, 157, 158 Europe, 10, 12, 57, 125, 130, 146 European Central Bank, 184 evil, 9, 198 evolution, viii, ix, 2, 6, 12, 17, 19, 34, 58, 60, 67, 75, 90, 99, 102, 105, 111, 112, 114, 123, 135, 136, 152, 166, 180, 189, 190, 195, 196, 197, 201, 226 evolutionism, 189 excess supply, 22, 178 exchange rate, 32, 167 exclusion, vii, 1, 2, 59, 196 execution, 48, 63 exercise, 9, 61, 188 expenditures, 72, 146, 206 expertise, 206 exploitation, 64, 196, 217 exports, 13, 16, 218, 219 external environment, 129, 193 external relations, 129 external shocks, 37 externalities, 157, 186, 189, 191, 197, 204 extraction, 195
F failure, 29, 32, 35, 40, 164, 187 faith, 33, 40, 78 family, 75, 146, 231 famine, 170 fears, 10, 25, 105, 167, 197 Federal Communications Commission, 195, 199 feedback, 169, 178, 196 feelings, 155, 156, 157
247
fertility, 137, 139 finance, x, 16, 86, 141, 143, 144, 145, 147, 168, 179, 180, 206, 225, 226, 230, 231, 232, 233, 238, 239, 240, 241 financial crisis, 170 financial institutions, 126, 168 financial resources, 144 financial sector, 168 financial system, 26 financing, 38, 39, 40, 84, 167, 241 Finland, 206 firms, 8, 30, 38, 39, 49, 50, 51, 52, 54, 82, 127, 130, 137, 140, 142, 170, 179, 204, 206, 208, 215, 218 fiscal policy, 16, 17, 23, 24, 82, 231 flexibility, 52, 84, 127, 188, 196, 197 flexible manufacturing, 126 floating, 167 fluctuations, vii, 21, 22, 24, 25, 27, 30, 32, 36, 38, 39, 40, 46, 48, 50, 53, 169, 170 focusing, 48, 213 food, 74, 152, 209 Fordism, 122 forecasting, 25, 65 foreign exchange, 167 forests, 192 fossil, 105 fragility, 66, 100 framing, 185, 188 France, 2, 3, 37, 43, 68, 110, 114, 125, 132, 133 free market economy, 154 free trade, 4, 5, 6, 7, 8, 9, 10, 12, 13, 14, 15, 16, 17, 59, 138 freedom, viii, 12, 14, 37, 57, 59, 60, 61, 65, 72, 198 full employment, 24, 29, 48, 49, 52, 54, 85, 90 functional analysis, 122 functional approach, 123 functional hierarchy, 33, 35, 120 funds, 39, 66, 103, 144, 147, 167, 175, 177, 179
G game theory, 34 GDP, 168, 203, 206, 207, 208, 209, 210, 211 GDP per capita, 208, 211 generalization, 75 generation, 4, 30, 48, 87 geography, ix, 117, 118, 119, 120, 121, 122, 123, 124, 125, 130 Germany, 43, 58, 64, 68, 92, 97, 131, 206 global trade, 206
248
Index
globalization, 206 goals, 12, 15, 39, 77, 104, 145, 154, 157, 166 gold, 168 goods and services, x, 32, 122, 178, 203 governance, 130, 134 government, iv, 2, 10, 11, 16, 18, 23, 24, 32, 59, 82, 83, 88, 135, 138, 142, 143, 145, 146, 147, 148, 154, 162, 164, 167, 169, 170, 178, 186, 187, 191, 195, 198 government budget, 82, 83 government expenditure, 83 government intervention, 23 government policy, 11 grants, 190 graph, 229, 233 gravitation, 50 Great Britain, 125 Great Depression, 41, 54 Greece, 207 gross investment, 204 group interests, 15 groups, 11, 18, 77, 78, 82, 120, 123, 128, 129, 145, 147, 151, 169, 178, 193 growth rate, viii, 35, 46, 49, 52, 54, 71, 165, 168, 209, 216, 217 growth theory, 46, 48, 51 guardian, 146 guidance, 100
H happiness, 59, 105, 109, 111, 136, 143, 145 harm, 61, 65 harmony, 61, 65 health, 139, 152, 236 heating, 106 hedonism, 35 hierarchy of needs, 101 higher education, 139, 140, 142 higher quality, 120 historical character, 8 honesty, 144, 153 hospitals, 226 household sector, 168 households, ix, 76, 82, 117, 118, 122, 128, 168, 242 housing, 78, 152 human actions, 37 human activity, 104 human capital, x, 144, 203, 204, 213, 215, 216, 217, 220
human development, 105 human nature, viii, 99, 101 human resources, 32, 208 human values, 35, 36 humility, 156 Hungary, 207 hygiene, 209 hyperinflation, 58 hypothesis, x, 38, 46, 49, 52, 60, 78, 79, 84, 86, 87, 88, 168, 225, 227, 228, 230, 231, 236, 240, 241, 242 hysteresis, 26
I Iceland, 207 ideal, 48, 65, 145, 188, 196 identification, 26, 120, 123, 129 identity, 11, 53, 54, 129, 166, 167 ideology, 59, 147 illumination, 106 image, 5, 19, 126, 129 imagination, 196, 197 imbalances, 35, 40 IMF, 164 imitation, 219 imperialism, 11 implementation, 3, 5, 6, 12, 15, 18, 19, 111, 182, 205 imports, 54, 208, 218 imprinting, 63 inadmissible, 62 incentives, 55, 192, 196, 204, 206, 209, 211, 217, 219 inclusion, viii, 7, 15, 71, 79 income distribution, viii, 71, 73, 75, 78, 83, 88, 90 incompatibility, 12, 123, 194 increasing returns, 137, 138, 204, 213 independence, 15, 80 independent variable, 28 indeterminism, 33 India, 195 indication, 51, 126 indicators, 123, 204, 207, 208 indices, 22, 26 indifference curves, 173 indifference map, 173 indirect effect, 139, 144, 218 indirect taxation, 15 individual action, 178, 190
Index individualism, 13, 61 industrial revolution, 117, 118, 125 industrial sectors, 11, 125, 126 industrialisation, 125, 126 industrialized societies, 106 industry, 7, 8, 14, 141, 186 inefficiency, 194 inelastic, 170 inequality, ix, 59, 63, 76, 106, 135, 136, 139, 141, 142, 147, 148, 149 inertia, 25, 26, 171, 173, 192, 195 infant industries, 7, 8 infinite, 88, 230 inflation, 23, 28, 29, 32, 54, 63, 79, 82, 166, 168, 171, 172, 173, 177, 180, 181, 182 inflation target, 172 infrastructure, 127, 206, 208 inheritance, 23, 63, 75, 87, 239 inheritance tax, 23, 63 initial state, 27, 218 innocence, 168 innovation, 32, 137, 191, 204, 205, 206, 207, 208, 210, 212, 213, 217, 218, 219, 220 insight, 52, 87, 163, 169, 218 instability, 24, 32, 47, 52, 53, 55, 89 institutional change, 76, 170, 188, 189 institutions, 67, 143, 144, 145, 146, 147, 186, 188, 189, 190, 192, 196, 200, 205, 219 instruments, viii, 3, 4, 6, 12, 14, 16, 36, 99, 100, 101, 102, 105, 108, 188, 194, 195, 197, 198, 226, 238, 240 insurance, 64, 126, 235, 242 integration, 6, 151, 228 interaction, 31, 145, 152, 181, 190, 197 interactions, 127, 129, 138 interdependence, 2, 18, 35, 128 interest groups, 8, 13, 14, 194 interest rates, ix, 23, 24, 27, 28, 32, 161, 162, 163, 164, 165, 166, 170, 173, 174, 177, 179, 181 interference, 13, 24, 59, 189 internal change, 189 international migration, 17 international relations, 32, 35, 206 international trade, 4, 5, 6, 7, 14, 17, 82 interrelations, 36 intervention, vii, 1, 2, 17, 18, 19, 23, 32, 58, 59, 60, 62, 63, 119, 185, 187, 188, 190, 193, 195, 196, 197, 198 intervention strategies, 119 interview, 193
249
intuition, 62 inventions, 74 investment, 22, 23, 24, 26, 29, 30, 31, 32, 35, 36, 38, 39, 40, 47, 50, 52, 53, 65, 77, 79, 80, 87, 89, 137, 138, 141, 176, 206, 211, 215, 217, 234, 235, 236, 238, 239 investment capital, 23 investors, 26, 153, 156 invisible hand, 58, 135, 153, 154, 189 involution, 34 iron, 125 IS-LM, 183 isolation, 211
J Japan, 94, 110, 206, 207 jobs, 11, 141, 145, 147, 208 judges, 190 judgment, 65, 155 just society, 148 justice, ix, 12, 37, 59, 60, 61, 72, 102, 135, 136, 143, 145, 154, 155, 156, 157 justification, 2, 14, 193
K Karl Pearson, 100 Keynes, v, vii, 1, 23, 35, 38, 42, 43, 59, 63, 68, 81, 83, 85, 90, 95, 161, 164, 182, 183, 226, 227, 241, 242 Keynesian model, 37, 55, 73, 74, 77, 81, 82, 87, 228 Keynesians, 179, 182 knowledge acquisition, 144 knowledge-based economy, 205, 206, 208, 220 Korea, 222
L land, ix, 74, 75, 76, 85, 99, 117, 118, 120, 122, 129, 137, 145, 188, 220 land use, ix, 117, 118, 120, 122, 123 landscape, 112 landscapes, 122 language, vii, 102, 109 laws, 10, 19, 24, 29, 33, 34, 35, 36, 37, 40, 51, 61, 62, 64, 120, 143, 146, 156 lawyers, 141 learning, 136, 144, 147, 191, 196, 204, 205, 213, 217, 218, 219, 220
250
Index
legislation, 64 leisure, 108 lending, 165, 167, 168, 178, 179, 180 liberalism, 7, 12, 33, 57, 58, 61, 64 liberalization, 206 Libertarian, 63, 201 life cycle, x, 86, 225, 227, 228, 229, 230, 231, 233, 236, 237, 240, 241, 242 life cycle hypothesis, x, 225, 227, 228, 229, 230, 231, 233, 236, 240, 241 life expectancy, x, 225, 226, 228 lifetime, 228, 229, 230, 231, 232, 233, 236, 239, 240, 242 limitation, 61, 137, 138, 157, 195 line, 24, 31, 47, 48, 49, 50, 51, 52, 73, 82, 83, 85, 86, 87, 118, 119, 123, 153, 155, 157, 175, 179, 194, 219 linear function, 218 links, 26, 32, 40, 84, 87, 130, 187, 206 liquidate, 66, 238, 239 liquidity, 23, 85, 165, 169, 170, 175, 179, 180, 228 liquidity preference, 175 living standards, 138 loans, viii, 23, 57, 79, 164, 165, 166, 167, 168, 169, 173, 175, 177, 178, 179, 180, 214 locus, 30, 48, 49
M machinery, 74, 139 macroeconomic policy, 161 macroeconomics, x, 161, 166, 171, 180, 181 maintenance, 62, 63, 65, 85, 103, 105 management, 165, 169, 192, 195 manufactured goods, 137 manufacturing, 10, 118, 125, 127, 215, 216, 217 mapping, 14 marginal product, 46, 63, 74, 75, 88, 215, 216 mark up, 174 market economy, 23, 55 market failure, 3, 186, 187, 188, 192 market incentives, 213 marketing, 193 markets, 4, 5, 6, 56, 145, 165, 192, 193, 195, 198, 206, 217 Marx, 22, 23, 58, 68, 110, 115, 217 materialism, 37 mathematical methods, 40 mathematics, 25, 75, 100 meals, 209
measurement, x, 31, 101, 130, 203, 207, 217 measures, 2, 4, 5, 10, 11, 13, 16, 17, 22, 23, 24, 59, 63, 145, 168, 234, 239 media, 164, 194, 206 men, 13, 59, 104, 137, 154 metals, 168, 181 metamorphosis, 18 metaphor, 8, 58 methodological individualism, 189 Mexico, 193, 203, 207 migration, 125, 215 military, 9, 137 minimum price, 170 minimum wage, 24 mining, 18 misunderstanding, 178 mobile telephony, 206 mobility, 129, 142, 148, 218 modeling, 207, 211, 213, 218 modern society, 102, 227 modernity, 66 modernization, 19 modus operandi, 64 monetary aggregates, 165, 180 monetary base control, 170 monetary expansion, 166 monetary market, 10 monetary policy, ix, 23, 66, 83, 161, 164, 165, 166, 177, 180, 181, 182, 183 monetary policy instruments, 182 monetary targeting, 166 money markets, 169, 170 money supply, x, 23, 24, 29, 81, 161, 162, 163, 164, 166, 167, 168, 169, 171, 177, 178, 179, 180, 181, 183 monopoly, 2, 28, 35, 63, 165, 214, 216 moral hazard, 194 moral standards, 72 motion, 25, 50, 51, 104, 126, 195 motivation, 144 motives, 125, 136, 178 movement, 5, 25, 33, 50, 52, 103, 164, 193 multiplier, 31, 50, 51, 56, 162, 163, 167, 169, 177 music, 138 mutual respect, 67 myopia, 230, 231
N narrow money, 171
Index nation, 11, 14, 36, 58, 141, 142, 203, 208 national debt, 83 national income, 24, 49, 53, 63, 77, 85, 90 national product, 11, 15 nationalism, 13 natural resources, 104, 106, 192 natural sciences, 119, 152 natural selection, 18, 189, 197 nature conservation, 193 negative outcomes, 16 negative valence, 110 neglect, 6 negotiation, 187 Netherlands, 92 network, ix, 117, 118, 120, 123, 124, 126, 127, 128, 129, 205, 208 New Zealand, 207 nodes, ix, 117, 118, 127, 128 North America, 119, 122, 182 Norway, 207
O objectives, 3, 5, 6, 33, 61, 147, 153, 194 OECD, 205, 206, 207, 208, 217, 222 oil, 64 open economy, 12, 64, 241 opportunism, 67 optimism, 23, 35, 36, 65, 66 optimum allocation, 228 organism, 14, 16, 105 Organization for Economic Cooperation and Development, 205 orientation, 153, 193 originality, 48, 61 output gap, 172, 173 output per worker, 211 overpopulation, 209, 210 overproduction, 66
P Pacific, 158, 199, 200 painters, 141 paper money, 54 parameter, 26, 63, 84, 88, 123, 215, 219 parameters, 52, 54, 55, 81, 89 parents, 77, 239
251
Pareto, viii, 7, 8, 9, 20, 25, 43, 71, 75, 76, 90, 95, 100, 114, 115 Parliament, 6 passive, 79, 130, 168, 179, 180 patents, 205, 208 pathways, vii, 21, 40, 129 patriotism, 11 peri-urban, 130 permanent income hypothesis, 227, 228, 230 permit, 85, 87, 157, 192, 194, 195 personal autonomy, 226 pessimism, 23, 36, 66 phase shifts, 50 phenomenology, 13 Phillips curve, 171, 172, 173 philosophers, 72, 142 physical environment, 62 physical sciences, 62 physics, 38, 64 planning, 106, 119, 124, 129, 130, 193 plants, 125 Plato, 146, 147 Poland, 207 policy choice, 32 policy makers, 35, 145 policy making, 13 policy rate, 177, 180 political power, 24 politics, 25, 105, 106, 158 pollution, x, 107, 185, 186, 193, 194, 195, 198 poor, 35, 106, 143, 147, 148 population, 30, 46, 47, 48, 49, 53, 76, 104, 106, 121, 125, 137, 138, 140, 143, 168, 177, 193, 195, 209, 210, 212, 226, 236, 238 population growth, 30, 47, 53, 137, 138, 168, 209 population size, 121, 125 portfolio, viii, 71, 78, 82, 153, 177, 178 portfolios, 153, 156 Portugal, 207 positive attitudes, 39 positive correlation, 194 positive externalities, 186 poverty, 46, 72, 154 power, 14, 16, 24, 25, 62, 137, 191 praxis, 2 prediction, 169 prejudice, 65 present value, 215 pressure, 27, 28, 31, 106, 171, 172, 173, 192, 194 pressure groups, 192
252
Index
prestige, 123 prevention, 154, 194 price instability, 9 prices, viii, 9, 21, 22, 23, 24, 25, 26, 27, 28, 29, 31, 32, 35, 36, 38, 47, 51, 54, 66, 71, 72, 75, 90, 101, 104, 120, 139, 140, 142, 148, 179, 191, 193, 197 primacy, 9, 67 primary sector, 58 principal component analysis, 124 private firms, 38 private sector, 17, 162, 163, 165, 167, 169, 170, 173 probability, 194 problem-solving, viii, 72 producer goods, 31 producers, 31, 214, 217 production costs, 31 production function, 47, 52, 77, 88, 137, 211, 212, 213 production technology, 85 productive capacity, 23 productivity, 24, 49, 64, 74, 88, 139, 144, 193, 204, 209, 210, 212, 213, 215, 216, 217, 218, 220 productivity growth, 210 professions, 141, 142, 148 profit, 10, 24, 30, 31, 32, 40, 46, 47, 49, 50, 51, 52, 54, 73, 74, 77, 78, 79, 80, 84, 85, 86, 88, 90, 145, 153, 154, 155, 156, 157, 213, 214, 215, 218, 238 profit margin, 24 profitability, 154 profits, viii, 23, 30, 31, 32, 33, 38, 39, 47, 50, 51, 54, 71, 74, 77, 79, 80, 83, 84, 85, 88, 90, 138, 153, 218, 239 program, viii, 71, 106 progressive tax, 63 property rights, 4, 138, 145, 187, 188, 189, 190, 191, 192, 193, 194, 195, 196, 197, 198, 201 proposition, 77, 192 prosperity, 8, 65, 136, 138, 141, 142, 143, 148, 155, 217 protectionism, 2, 5, 6, 7, 8, 9, 10, 11, 12, 13, 14, 15, 16, 17, 19 Protestants, 78 psychiatric hospitals, 226 public administration, 1, 18 public debt, 230, 231 public education, 63, 143, 146 public finance, 6, 32, 33 public goods, 217 public health, 63 public interest, 10, 59
public policy, 192 public sector, viii, 71, 79, 82, 83, 167, 169, 239 public service, 17, 18 purchasing power, 9
Q qualifications, 141 quality of life, 108, 109, 226, 231, 236, 238, 239, 240, 241 Quantity Theory of Money, 168 quantum mechanics, 102
R race, 105 radio, 195 range, 17, 32, 60, 85, 120, 127, 128, 171, 175, 179, 181, 191, 195, 213, 226 rate of return, 80, 82, 87, 164, 211 rational expectations, 25, 40 rationality, 152, 155, 156, 191, 218 raw materials, 51, 104, 105, 213, 217, 220 reading, 58, 104 real assets, 234, 235, 237, 238, 239 real estate, 120 real income, 48, 162 real rate of interest, 171, 173, 176 real wage, 24, 209 realism, 49, 81 reality, 8, 10, 11, 12, 13, 36, 58, 59, 61, 118, 126, 128, 162, 188, 193 reason, vii, x, 3, 15, 22, 52, 59, 62, 74, 75, 76, 85, 137, 138, 141, 143, 144, 146, 147, 148, 167, 180, 185, 186, 189, 190, 192, 197, 205, 227, 229, 231, 234 reasoning, 6, 33, 122, 123, 156 recall, 14, 36, 58, 59, 65, 100 recalling, 9, 13, 65, 88, 103 reception, 3 recession, 27, 34, 35, 39, 50, 59, 66, 79 reciprocity, 5, 6, 72, 197 recognition, x, 124, 161 recollection, 62 reconcile, 48, 153 reconciliation, 178, 180 recovery, 28, 32, 210 recycling, 103 redistribution, 16, 60, 76, 124, 179
Index reference frame, 40 reflection, 53, 64, 102, 154, 180 reforms, 15, 189 regeneration, 125 region, 122, 125, 196 regional policy, 124 regulation, 23, 64, 106, 145, 194, 195, 198 regulations, 24, 64, 191, 192, 194, 195, 196, 197 rejection, 7, 101, 198 relationship, viii, ix, 26, 31, 35, 36, 51, 53, 58, 67, 71, 77, 88, 99, 103, 104, 105, 119, 121, 122, 124, 129, 135, 136, 143, 144, 153, 172, 219 relativity, 73 relevance, 2, 25, 51, 63, 73, 82, 88, 118, 128, 139 religious function, 118 rent, 74, 75, 77, 84, 85, 122, 145, 192, 194, 196, 239 repo, 166, 174, 176 reserves, 162, 165, 166, 169, 170, 173, 174, 175, 176, 177, 227 resistance, 25, 189, 197 resolution, 60 resource allocation, 197 resource management, 196 resources, ix, 21, 23, 30, 38, 48, 49, 63, 73, 99, 103, 104, 105, 106, 108, 127, 129, 141, 142, 145, 147, 186, 187, 195, 205, 208, 228, 237, 238, 239, 240 restructuring, 126 retail, 66 retaliation, 11 retirement, 75, 100, 228, 229, 230, 231, 232, 233, 234, 235, 236, 238, 239, 240, 241, 242 retirement age, 229 retirement pension, 231, 233, 238 returns, 50, 147, 164, 177, 209, 211, 212, 215, 216, 217 returns to scale, 211, 212 revaluation, 126 revenue, 83, 214, 215 rewards, 193 rings, 119, 120, 122, 173 risk, 8, 65, 67, 79, 80, 87, 136, 153, 156, 170, 174, 194 Romania, 100, 110 rule of law, 137, 138, 143 Russia, 10
S sales, 157, 170 sanctions, viii, 99
253
satellite, 129 satisfaction, 17, 29, 100, 112 saturation, 125 savings, x, 23, 28, 29, 48, 49, 50, 52, 63, 77, 80, 84, 85, 86, 87, 88, 90, 137, 138, 141, 211, 225, 226, 227, 228, 229, 230, 231, 232, 234, 235, 236, 237, 238, 239, 240, 241 scarce resources, 144, 187, 196 scarcity, 72, 73, 107, 193, 196 school, x, 2, 14, 45, 48, 76, 90, 110, 118, 146, 147, 148, 203, 204, 211, 212, 218, 220 schooling, 146 scientific knowledge, 111, 220 sculptors, 141 Second World, 120, 121, 203, 210, 228 secondary school education, 208 securities, 175 security, 65, 138 sedimentation, 127 segregation, 120, 123, 129 self-interest, 24, 40, 58, 59, 145, 147, 152, 153, 154, 186 self-organization, 127, 128, 129 seller, 72 separation, 3, 123 severity, 125 shares, 39, 47, 189, 212 shock, 36, 38, 64, 89, 172, 173, 177 shortage, 104, 170 short-term interest rate, x, 161, 165, 170, 173 side effects, 170 Singapore, 221 skills, 204, 205, 208 slavery, 154 slumpflation, 22, 29 smoke, 187, 198 social behavior, 140, 142 social capital, ix, 109, 135, 136, 139, 140, 143, 144, 145, 148, 150 social change, 195 social class, 77, 78, 84, 120, 123, 125, 146 social conflicts, 148 social context, 120, 155, 218 social contract, 60 social costs, 191 social development, 121, 205 social distance, 123 social fabric, 60 social group, ix, 13, 14, 65, 117, 118, 119, 120, 123 social institutions, 190, 197
254
Index
social justice, viii, 57, 60, 63 social life, 190 social network, 140, 144 social order, 34, 57, 59, 60, 61, 63, 143, 190 social phenomena, 64 social policy, 158 social problems, 37 social relations, 142, 143, 144 social responsibility, 154, 158 social rules, 201 social sciences, 62, 128 social security, 17 Social Security, 241 social status, 123 social structure, 144 social theory, 60 social welfare, viii, 57, 61, 145 socialism, 57 software, 206 solidarity, 4, 12, 35, 37 South Korea, 206 space, ix, 5, 18, 62, 65, 117, 118, 119, 120, 122, 125, 127, 129, 152, 164, 177, 178, 218 Spain, 135, 151, 185, 203, 225, 226, 238 spatial location, 120 specialization, 120, 142 specific knowledge, 3, 208 spectrum, viii, 71, 125 speculation, 63, 65, 66 speech, 188, 201 spillovers, 204, 215 Spring, 149, 150 stability, 32, 33, 46, 63, 89, 90, 143, 157, 178 stabilization, 9, 39 stagflation, 22, 29 stakeholders, 154, 158 standard of living, 105, 106 standards, x, 195, 203, 204 state intervention, vii, 1, 2, 5, 15, 17, 185, 187, 188 statistics, 25, 100, 102, 209 steady-state growth, 47, 82, 85, 89, 90, 211 steel, 125 stimulus, 51, 59, 60, 122, 219 stock, ix, 14, 22, 50, 52, 53, 54, 85, 87, 89, 145, 161, 162, 164, 165, 166, 168, 171, 173, 177, 179, 180, 204, 206, 208, 209, 215, 217, 218 stock exchange, 14 strategies, 26, 40, 120 strength, 13, 17, 80, 82, 87 stress, 16, 84, 88, 90, 109, 214, 220
structural characteristics, 38 structuralism, 183 structuralists, 166 structuring, 58 students, 112, 164, 181 subjectivity, 5, 17 subsistence, 209, 210 substitutes, 176, 179, 193 substitution, 215 superimposition, 59 supervision, 37 suppliers, 120, 165 supply, x, 6, 18, 22, 23, 24, 29, 36, 51, 53, 54, 58, 66, 75, 89, 105, 120, 121, 123, 137, 140, 147, 161, 162, 163, 165, 166, 175, 177, 178, 181, 216, 226, 242 supply curve, 163, 175, 178 surplus, 115 survival, 130, 154, 161, 189 sustainability, 130 sustainable economic growth, x, 203 sustainable growth, 139 Sweden, 206, 207 Switzerland, 20, 69, 77, 78, 92, 95, 97, 206, 207 symbols, 53, 110 symmetry, 216 sympathy, 144, 145, 154, 155, 156, 157, 158 symptom, 5 synthesis, 32, 111, 158, 192, 209 systemic change, 5
T Tanzania, 149 targets, 165 tariff, 10 tax policy, 16 taxation, viii, 71, 79, 82, 83, 84, 88, 185, 187 taxonomy, 59, 208 teachers, 147, 152 teaching, x, 18, 19, 37, 75, 119, 136, 147, 161, 164, 171, 181 technical change, 195, 204, 205, 209, 211, 212, 213, 216, 217, 218, 219, 220 technological change, 191, 218 technological progress, 24, 30, 38, 47, 220 technology gap, 219 tenants, 187 tension, 27, 65 territory, 127
Index textbooks, 2, 6, 7, 9, 12, 13, 15, 19, 78, 162, 181, 182, 185, 187, 203 textiles, 125 thermodynamics, viii, 99, 102, 104, 110, 114 thinking, ix, 152, 153, 161, 178, 190, 192, 217 thoughts, 67, 209 threshold, 120, 218 timber, 186 time frame, 182, 192 time lags, 31, 40 total product, 74, 188, 191, 195, 197 trade, vii, 1, 2, 3, 4, 5, 6, 7, 9, 10, 13, 14, 15, 16, 17, 18, 28, 36, 53, 63, 85, 118, 168, 173, 181, 206 trade agreement, 5 trade policy, vii, 1, 2, 4, 5, 6, 7, 13, 16, 17, 18 trade union, 28 trade-off, 85, 173 trading, 193, 218 tradition, ix, 47, 73, 99, 112, 168, 185, 187, 188, 189, 192 traditions, 58, 190 traffic, 124, 187 training, 47, 109, 205, 206 traits, 157 trajectory, 49, 52 transaction costs, 188, 190, 194, 195 transactions, 17, 28, 167, 168, 169, 170, 181, 206 transfer payments, 82 transformation, 1, 14, 18, 19, 25, 33, 107, 112, 124, 143, 205, 206 transformation processes, 25 transformations, 103, 104, 118, 122, 126, 129, 130 transition, 17, 124, 125, 126, 137 translation, 111, 120 transmission, 81, 140, 144, 146, 148, 164, 183 transport, 16, 18, 63, 121, 122, 125, 129 transport costs, 121, 122, 123 transportation, 7 treaties, 4, 13, 63 trial, 189 triggers, 66, 209 trust, 59, 144, 148 Turkey, 207
U uncertainty, 24, 62, 87, 164, 189, 190, 195, 213, 226, 239, 240 unemployment, 22, 24, 35, 48, 49, 64, 66 unemployment rate, 66
255
uniform, 120, 189, 205 unique features, 32 United Kingdom, 8, 161, 165, 207 United States, 8, 10, 110, 119, 125, 192, 206 universality, 9, 18 universe, 155 universities, 6, 33, 73, 146, 147 university education, 208 urban areas, 125, 129 urban centres, 121, 122, 127, 128 urban life, 125, 129 urban population, 123, 125 urbanisation, 120, 121, 122, 124, 125, 129 urbanization, 58, 196
V vacuum, 155 valence, 60 variables, ix, 24, 25, 33, 39, 46, 48, 50, 54, 55, 81, 82, 86, 87, 90, 135, 136, 138, 139, 143, 146, 166, 168, 179, 180 vegetables, 112 vehicles, 187 velocity, 23, 26, 28, 54 velocity of circulation, 54 versatility, 64, 124, 161 vested interests, 25 vision, viii, 24, 33, 36, 37, 40, 46, 47, 48, 50, 54, 57, 59, 60, 61, 63, 64, 67, 73, 84, 102, 103, 105, 107, 109, 151, 155, 185, 188, 191, 193, 209 vulnerability, 129
W wage rate, 74, 77, 79 wages, 10, 24, 32, 64, 74, 77, 83, 84, 85, 88, 90, 139, 145, 209, 210 war, 17, 35, 48, 63, 74, 106, 118, 210 war economies, 210 waste disposal, 194 water resources, 193 water rights, 193 weakness, 33, 52, 220 wealth, viii, 1, 2, 5, 8, 9, 16, 18, 38, 46, 58, 65, 71, 72, 73, 76, 78, 79, 80, 84, 87, 88, 89, 90, 105, 112, 136, 142, 143, 145, 147, 178, 192, 228, 229, 230, 232, 233, 234, 235, 238, 239, 240, 242 wealth distribution, viii, 16, 71, 72, 73, 76, 89, 90
256 weapons, 11 welfare, 60, 209, 220, 226 welfare economics, 60 welfare state, 60 wells, 195 western culture, 102 winter, 146 withdrawal, 58 women, 64, 152, 240
Index workers, 24, 35, 49, 74, 79, 80, 82, 83, 84, 85, 86, 87, 139, 140, 141, 142, 143, 145, 148, 152, 204, 205, 208, 209, 210, 217 working conditions, 152 working hours, 64, 109 workplace, 152 World Bank, 58, 149, 150, 205, 213, 223 World Development Report, 223
