A History of Economic Thought: From Mercantilism to Keynesianism
Schools of Thought
Scientific theories are derived from the facts of experience acquired by observation and experiment. Science is based on what we can see, hear, and touch. Personal opinion or preference and speculative imaginings have no place in science. Science is objective and reliable knowledge. This view became popular during the Scientific Revolution that took place in the 17th century and was brought about by scientists such as Galileo and Newton.
Early Days of Capitalism and Liberalism
The economy of Europe was recovering from the decline it had suffered as the Roman Empire collapsed. Venice’s economic expansion was a series of innovations making economic institutions more inclusive. The most famous, the commenda, was a joint-stock company formed only for the duration of a mission. The commenda involved two partners: a sedentary partner, the one who stayed in Venice, and the one who traveled.
Spain stumbled with a new source of wealth and power: the Americas. In the 16th century, the power of Spain was bigger than all other European states by a good margin. In Europe, the formation of mini-empires, such as the French, English, and Swedish, began. Individually, these empires couldn’t gain on Spain, but together they could subordinate anyone.
The Dutch made some innovations in institutions and developed the financial system. Dutch finances were introduced to England in 1688, and the British passed control of the finances and monetary system from the king to Parliament. British finances improved, and the Bank of England was formed in 1694.
The Industrial Revolution
The Industrial Revolution changed the world. The British made many technological innovations that revolutionized production in 1750. English political institutions were in a better way compared with France and Spain. All three countries were ruled by absolutist monarchs: Elizabeth I in England, Philip II in Spain, and Henry III in France. But Parliament in England, the Cortes in Spain, and the Estates-General in France were demanding more rights and control over the monarchy.
The French Revolution was a radical affair and in 1789 changed French laws by proposing a new constitution. It created much violence, suffering, instability, and war. It prepared Europe for inclusive institutions and economic growth. In 1815, forces of Britain, Prussia, Russia, Austria, and the Netherlands went against France to determine which power would control the world. France clearly lost.
Social Science with Schools of Thought
Economic science was born with the new world of the Industrial Revolution. Adam Smith, David Ricardo, Alfred Marshall… believed that the market was the best mechanism to guide the economy. The intervention of the government wasn’t necessary. This is known as “laissez-faire laissez-passer.” Classical liberalism arrived in Britain in the 19th century after it became the world’s dominant industrial power. Other countries preferred protectionism or mercantilism.
The historical school of economics emerged in the 19th century in Germany. Its proponents said that history was the source of knowledge about human actions and economic matters. They saw economics as a historical analysis instead of one based on logic or mathematics.
The Second Industrial Revolution
About 1870, the Second Industrial Revolution started, characterized by new production techniques, the systematic application of science to industry, and the rise of chemical and new capital-led industries.
The Long Depression and the Welfare State
The Long Depression was a worldwide economic recession from 1873–1879. It was stronger in Europe and the US, which were experiencing strong economic growth from the Second Industrial Revolution. An important cause was the gold standard, which was the monetary system. London became the world’s financial center. The Long Depression of 1873 contributed to dissatisfaction with free trade and the gold standard. The welfare state was born in Germany in the 1880s.
The Great Depression of 1929
When the Great Depression started after the stock market crash in October 1929, economists in the classical tradition stood aside.
John Maynard Keynes
Keynes argued that the modern economy doesn’t necessarily find equilibrium at full employment; it can also find equilibrium with unemployment. There can be a shortage of demand. What was true for the individual employer wasn’t true for all. Reduced effective demand would increase unemployment. Unemployment can’t be blamed on high wages or trade unions.
Unemployment equilibrium could be stable and persistent. The government can and should take steps to overcome it. Keynes’ conclusion was that monetary authorities should intervene actively.
Keynesianism
After World War II, the world was divided into three parts:
- First World (Keynesian capitalism)
- Second World (socialist models)
- Third World (developmental capitalism)
Many industrialized countries established full employment and used public enterprises. The welfare state grew tremendously in size since the war. From 1950 to 1973, the average size of the public sector in industrial countries rose from 27 to 43 percent of GDP. By the 1950s, Sweden had pensions, health and industrial insurance, family allowances, and subsidized and compulsory school until age sixteen. The most rapidly growing sector of the economy was industry. The golden rule was that when wages keep pace with productivity, income distribution between capital and labor remains the same.
In the 1970s, unemployment in developed countries was at very low levels. Globally, economic growth was exceptionally strong.