Economic Thinkers

18th Century Economic Thinking - The birth of Modern Economic thinking

In the 16th to 18th Century, the main economic logic at the time "mercantilism". The belief by governments was that a country could only get rich at the expense of making another country poorer. This meant high levels of government control and preventing goods imported from outside their country and focused on more favourable balance of trade, wealth measured by levels of precious metal e.g. gold and silver and overall economic nationalism (i.e. self sufficiency) . This, in Smiths view, made individuals worse off as prices would be higher compared to if free trade was allowed and countries could specialise.

Adam Smith is often considered the "father of modern economics". His book, "The Wealth of Nations" introduced many of Smith's ideas on why some nations were richer than others. He identified the idea of Free Trade as the key idea.

In this book, he identified the ideas of Laissez Faire (french for "Let it Be"). In this observation he believed that private individuals and private enterprise interact and that free markets will always fulfil societies desires. This is because consumers will pay for a good the price they value the good for and firms that are able to sell it for that price will do so.

Smiths ideas centred around the idea of "Specialisation", that is, if firms and countries focus on producing goods they can produce at the lowest possible cost by focusing on only what they are good at, this means goods are cheaper and the most people can benefit from the consumption.

Smiths views of Laissez Faire and Free Trade set the basis for Free Market Economies. That is the societies Economic well being is maximised when individuals, not governments, are allowed to interact freely and individuals choices will best allocate resources. For example, if it costs country A $10,000 to produce 1 car and country B $5000 to produce the same car, then it makes no sense for country A to waste resources on producing the car, when country B can do so cheaper. Similarly, if shop C sells bread for $1.50 and shop D sells the same bread for $1, then consumers will purchase the bread for $1. This forces the shop selling the bread to make a choice. They can lower their price to the same as shop D or stop selling bread and start selling something else if they want to make a profit.

The Wealth Of Nations, Book IV, Chapter V, Digression on the Corn Trade, p. 540, para. b 43.

"[The rich] consume little more than the poor, and in spite of their natural selfishness and rapacity…they divide with the poor the produce of all their improvements. They are led by an invisible hand to make nearly the same distribution of the necessaries of life, which would have been made, had the earth been divided into equal portions among all its inhabitants, and thus without intending it, without knowing it, advance the interest of the society, and afford means to the multiplication of the species."

Smiths main ideas were at the time were based on the idea that any government intervention in markets prevents Free Trade from happening and causes inefficiencies. Taxes make products more expensive and less affordable or not allowing imports from other countries may lead to countries people being made worse off in the long run.

Smith acknowledged in his work that in this system, some people will get rich whilst others remain poor, but this is a price worth paying for individual freedoms. He also acknowledged however, (despite some people arguing he did not) that some goods can't effectively be provided by a free market and therefore governments must provide these.

Adam Smith and the Specialisation and Division of Labour

Adam Smith, introduced the concept of specialization and the division of labour in his seminal work "An Inquiry into the Nature and Causes of the Wealth of Nations" (1776). His ideas on specialization and the division of labour are fundamental to classical economic theory and have had a profound influence on how we understand productivity, economic growth, and industrial organisation. Let’s explore the key components of these ideas.

The division of labour refers to the breakdown of the production process into smaller, distinct tasks, with workers specializing in each task. According to Adam Smith, this process leads to a significant increase in productivity. He observed that when workers focus on one specific task, rather than trying to produce an entire good from start to finish, they can do their jobs more efficiently and effectively.

Example of a Pin Factory:

Smith famously illustrated this concept through the example of a pin factory. He noted that in such a factory, rather than having one worker make an entire pin, the production process was divided into distinct operations, one worker drawing out the wire, another straightening it, a third cutting it, and so on. Through this division of labour, workers were able to produce thousands of pins a day, compared to the few pins a single worker could make if they were responsible for the entire process.

Benefits of Specialisation and Division of Labour

Adam Smith highlighted three key advantages of the division of labour:

Increased Dexterity of Workers - When workers repeatedly perform the same task, they become more skilled and efficient in performing that specific job. As a result, their productivity improves, and the quality of their output may increase as well.

Time-Saving - By having each worker focus on a single task, there is less time wasted in switching between tasks or setting up tools for different stages of production. Specialised workers can continue working on their specific part of the production line without unnecessary interruptions.

Innovation and Mechanisation - Smith observed that when workers specialise in a particular task, they often become experts and more innovative in finding ways to perform their job more efficiently. This innovation can lead to the invention of tools, techniques, or machinery that further improves productivity. The division of labour lays the groundwork for technological advancements, as specialized workers think of ways to make their own work easier.

The Impact of Division of Labour on Productivity and Economic Growth

Smith argued that the division of labour is one of the main drivers of economic growth. By increasing worker productivity, it allows economies to produce more goods in less time. This increased productivity leads to more wealth being generated in the economy, creating a positive feedback loop that promotes further growth.

Expanding Markets - One of the preconditions for the division of labour, according to Smith, is the extent of the market. As markets grow and demand for goods increases, it becomes more efficient to divide labour. In small, local economies, the scope for division of labour is limited, but as economies expand and markets grow through trade, the opportunities for specialisation increase.

Wealth of Nations - Smith believed that specialisation and division of labour contributed to the wealth of nations. A country that encourages these practices will produce more goods, generate more wealth, and improve the standard of living for its people. In this context, economic growth is linked to both the increase in productivity and the expansion of trade.

19th Century Economic Thinking - The Growth in Free Markets and increasing role of Business

The 19th Century seen an increase in the belief in free markets and specialisation. Across many countries, the Industrial Revolution was driven by the concepts of free markets and private ownership of enterprise. This also seen the creation of Classical Theories of Microeconomics.

Say's Law

Say's law stated that in order to be able to buy something, the buyer must have sold something first. That is to say in order to consume, you must have produced something first. (Think circular flow of Income) . For example, if someone creates a product, they will be keen to sell that product as quickly as they can. From these sales, the firm can pay wages and profits for the owner. This view helped develop the idea that the best way to achieve economic growth is through increasing production and business activity. The assumption underpinning this view was that business owners were rational and that the aim of maximising their own profits, will in turn create jobs and improve societies overall economic well being. For Say, money was a means of payment to improve economic well being, not the end point.

Say also believed that the success of one industry or business will promote growth with more businesses and this will increase the prosperity of a region. This forms the basis of the free market thinking that Governments should focus on encouraging the environment for firms and businesses to grow and other industries to grow from that.

This is also why, Say reasoned that, the encouragement of consumption does not benefit an economy. In fact, he argued that this will actually harm an economy, because this will reduce the wealth and prosperity of an economy. Put simply, its like buying things on a credit card and not having a salary. Eventually you will run out and have no means of repaying the credit card bill.

Classical Theory Assumptions

During this period, Classical Economists developed the ideas of Utility and Rational Decision Making. Utility refers to the fact that an individual values a good based on the satisfaction they receive from consuming that good. From this individuals choose to consume the goods that maximise their own satisfaction. They do this because they are Rational Decision Makers and take decisions that maximise their own interests. In the classical view, if every individual focuses on maximising their own interests, society best interests will be achieved. If firms focus on maximising their own profits by producing goods that will sell and for the lowest price and consumers focus on buying goods that give them the most utility (satisfaction). If the value a firm can produce the good for is equal to the value of the satisfaction an individual places on the good, then the transaction will take place. This interaction will therefore automatically maximise the economic well being of society and answers the Basic Economic problems of What to produce and For Whom? Firms will produce the goods that will sell and consumers who value the good at that price and are able to pay the price will be able to.

Marx Criticism of Capitalism - The Communist Manifesto

It was during this time, that Philosophers such as Karl Marx observed the inequalities and large disparities between those that owned the means of production and those who provided their labour (the workers). Marx observed problems with capitalism. He believed that owners of firms aim was to minimise their costs in order to maximise their profits. To do this, "capitalists" forced workers to accept lower wages and at the same time increasing the output of each worker. This excess, he believed, was what allowed capitalists to make higher profits. This exploitation of workers was the first problem.

The second problem Marx observed was Alienation. He observed that the capitalist model naturally created social classes and social hierarchy. The workers were forced to work towards to aims and objectives of the "Bourgeoisie" who owned the factors of production. This, Marx believed, caused the workers to not be able to determine their own futures as an economic entity and instead, work for the "Bourgeoisie" whose objective was aimed at exploiting the workers to maximise their profits. This, Marx suggested, created workers that are Alienated from the economic system and a system that lacked equity.

The final problem Marx observed was Revolution. Marx believed that workers in a Capitalist society would eventually revolt and overall the ruling classes to replace the system with a fairer system. The "Communist" states that have existed since Marx's work, do not represent the full views of what Marx believed. Marx believed in a democratic order and a system based on collective decision making, with the shared ownership of the Factors of Production.

Marx's work focused on the unfair ownership of the factors of production and the resulting social structure that arises from the Laissez Faire approach theorised from the Classical View of the economy. This view has paved the way for the belief of Planned Economies and the allocation of resources are decided by economic bodies (centralised or decentralised governments for example) instead of individuals.

20th Century Economic Thinking - The Birth of the "Macroeconomic Policy"

The 20th Century started with an increase in workers demanding more rights in their work. Political Parties, such as the 1906 creation of the Labour Party in the UK or the rise of collective bargaining of trade unions, sought to seek better working conditions for workers. This saw increasing industrial strikes and laws aimed at protecting workers rights. Add on to this many people returning from World War 1 demanding more rights after fighting for their country. Whilst this increased costs for firms, the 1920s saw huge amounts of economic growth (Roaring 20s) the aim of these movements was to improve equity and fairness within the economic system.

Friedrich Hayek and the Classical Perspective

However in 1929, the stock market crashed and that lead to the "Great Depression". Many economies across the world saw large downturns in their economic output. Unemployment skyrocketed and levels of poverty increased rapidly around the world. This was on the back on the "roaring 20's", which had created a lot of wealth.

Classical Economists, such as Fredrick Hayek at the time suggested that governments should let the economy "correct itself over time". In fact, some governments actually enacted austerity measures (increased taxes and decreased government spending) on the belief that this will create stability in government finances and helped to manage their debt. Therefore, many governments refused to implement additional policies to boost the economy and reduce unemployment and poverty. Classical Economists (such as the Austrian School of Economics) argued at the time, that a downturn in economic activity or Recession, was simply the economy correcting itself due to previous Mal Investments (Bad investments) and Gluts in certain sectors of the economy.

"The Road to Serfdom" is a political and economic book written by the Austrian-British economist Friedrich A. Hayek, published in 1944. In the book, Hayek argues that the rise of centralized economic planning and government control, particularly in socialist or collectivist systems, leads inevitably to the erosion of individual freedoms and the establishment of authoritarianism or totalitarianism.

John Maynard Keynes and Keynesian Economic Thinking

During the time after the great depression, John Maynard Keynes observed that these economies " weren't correcting itself" and identified many reasons why this wouldn't happen. In 1936, Keynes published his book "The General Theory of Employment, Interest and Money". Keynes noticed that laws and the increasing power of Trade Unions caused prices to be fixed at a certain level and that Businesses could not lower their costs (such as wages) in order to become profitable again as was the case earlier on. In this book, he critiqued the ideas of Laissez faire and promoted the belief that Demand creates Supply and that governments need to intervene to fix the economy when there is a recession. Keynes also observed that individuals did not act rationally. Instead, Keynes suggested that markets are guided by the animal spirits of the Bull and the Bear. The term "bull" represents optimism, confidence, and aggressive risk-taking whereas the term "bear" symbolizes pessimism, fear, and caution. Therefore when the economy was in a boom, people acted on optimism, confidence was high and higher spending and investment would causes large "booms" in economic activity. During a bust or recession, confidnece was low and pessimism was higher and households and firms were more cautious about the future and may sell off assets to minimise losses.

Keynes believed that markets could not always be relied upon to self-correct efficiently, as classical economics suggested. The behaviour of bulls and bears, driven by psychological factors, could lead to market instability. This belief formed the basis for Keynes’ advocacy of government intervention to stabilise economies and smooth out the booms and busts caused by fluctuating market sentiment.

For example, during a recession, by increasing their government spending, Governments can restart economic activity, create jobs and therefore stimulate economic activity. This, Keynes believed, will allow a government to achieve their economic objectives and help the economies recover quickly from an economic downturn as left alone, the economy would not achieve this.

Keynesian Economics became popular throughout much of the post-world war era in many economies. Large government and government-owned industries became common in many developed economies. More countries had government-owned businesses and many jobs were provided by the public sector. The main belief for many governments at the time (both left and right) was that governments can manage the economy and use policies such as fiscal policy (government spending and levels of taxation) and monetary policy (use of interest rates and the money supply) to manage economic activity and achieve their macroeconomic objectives.

1960's: This rise in Monetarism and moving away from Keynesianism

During the 1960´s, Monetarism emerged as an opposing view to Keynesianism and demand side management. This school of thought was championed most famously by Milton Friedman. Monetarist main argument was that in order to achieve Economic Growth (and naturally as a result, low inflation and low unemployment), governments should avoid demand side policies (such as increasing the money supply through government spending or lowering interest rates) and instead allow central banks to focus solely on increasing the money supply in line with economic growth. The belief was that if the money supply was too high, this would simply lead to inflation as more money would be chasing too few goods, simply leading to prices rising (inflation).

In the view of Monetarists or ¨New Classical¨ economists, governments should steer clear of any form of intervention policies such as fiscal and monetary policy, as this intervention will simply lead to inflation. This view formed the basis for much of the Economic thinking of the 1980's onwards, especially from politicians such as US president Ronald Ragen and UK Primeminister Margret Thatcher. This lead to sweeping changes such as privatisation of government owned businesses and high levels of deregulation in certain markets and industries.

Economics in the 21st Century

Evolution in Economic Thinking and Overlapping with other subjects

How you are getting "Nudged" without realising

Looking at the Starbucks menu to the left. From the information, pick one of the drinks. Now you may want a GRANDE just because you like coffee. However, lets imagine you are looking for a healthy option or you are looking for the cheaper option. In this instance you are more likely to chose a drink and make it TALL as this product offers the lower calories and is a cheaper price.

Those of you who may visit Starbucks often however, will know that they offer more than just TALL and GRANDE sizes.

Lets look at the menu below

With the VENTI size added now you have an additional point of reference or information.

Lets say from the first menu you wanted an ICED CARAMEL MACCHIATO. If you were given the first menu, you would most likely choose the TALL option a its cheaper and healthier, relative to the GRANDE.

However, when you add in the option of VENTI, the option of GRANDE doesn't look as unhealthy (250 calories v 350 calories for VENTI) and the price is only an additional 0.75c whereas a VENTI is an additional $1.35.

This is an example of ¨anchoring¨ and is a method businesses use to nudge you without you even knowing it.

The above is an example of Behavioural Economics - the discipline involved with looking at psychology of economic decision making, that is that people do not always act rationally. Nudging is one example of how governments can use techniques to change consumers behaviour or to help make better choices.

Classical economic theory was based on the assumption that humans are rational beings and this is the basis for their decision making. Behavioural economics is aimed at breaking down this assumption and helping us understand why individuals may make decisions that are not rational.

Changing Economic Priorities and challenging Conventional Economic Thinking

Kate Raworth and Doughnut Economics

Kate Raworth is a renowned economist and author who has challenged conventional economic thinking with her groundbreaking concept of Doughnut Economics. Her work offers a fresh perspective on how we should approach economic development in the 21st century.

The Doughnut Model

At the core of Raworth's ideas is the Doughnut, a visual representation of the sweet spot for humanity. The inner ring of the doughnut represents social foundations, such as food, housing, education, and healthcare, which everyone should have access to. The outer ring represents planetary boundaries, like climate change, biodiversity loss, and pollution, which we must not overshoot.

The goal is to ensure that everyone enjoys an adequate standard of living without overexploiting the planet. This means shifting our focus from endless growth to well-being and regeneration.

Key Principles of Doughnut Economics

Beyond GDP: Raworth criticises the sole reliance on Gross Domestic Product (GDP) as a measure of progress. She argues for a more comprehensive set of indicators that reflect social and environmental well-being.
Regenerative and Distributive Economy: She advocates for an economy that not only meets the needs of the present but also restores and regenerates natural resources. It should also be distributive, ensuring that benefits are shared equitably.
Systems Thinking: Raworth emphasizes the interconnectedness of social, economic, and environmental systems. She encourages us to think holistically and consider the long-term consequences of our actions.
Human-Centered Economics: Doughnut Economics places people at the center, focusing on well-being and quality of life rather than solely on economic growth.

Implications for the 21st Century

Raworth's ideas have significant implications for how we shape our economies and societies. The main problems facing global economies today are the need to:

Reduce inequality and poverty
Protect the environment and combat climate change
Create more resilient and sustainable communities
Foster innovation and entrepreneurship

In essence, Doughnut Economics offers a roadmap for a more just, equitable, and sustainable future. It challenges us to rethink our economic priorities and to build a world where everyone thrives within the planetary boundaries.

The circular economy is a transformative economic model that aims to eliminate waste and pollution by keeping products and materials in use for as long as possible. Unlike the traditional linear economy, which follows a "take-make-dispose" pattern, the circular economy emphasizes reuse, repair, refurbishment, and recycling. By designing products with durability and recyclability in mind, and by creating systems to recover and reprocess materials, this model seeks to minimize resource consumption, reduce environmental impact, and stimulate innovation.

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