ECON 307

 

The Physiocrats:  “The Rule of Nature”  (1756-1778)

 

 

Transition to Liberalism:

The Setting

 

The Doctrinal Transition: Mandeville and Hume (as we have discussed)

 

          In the century prior to 1776, liberal criticism of mercantilism reached a high pitch.

 

-          

Bernard Mandeville wrote a poem that attacked the moralists

 

- thought that selfishness could be good if it was "properly channeled" by the government

- said that if everyone was good, the economy would not do well

                   

 

          1705 - published “The Grumbling Hive; or Knaves Trun’d Honest”

 

          Individual vices (self-interest) produce public virtues (max. society’s welfare).

                                        (sort of a pre- Adam Smith).

 

                    Later became The Fable of the Bees.

                    Pub.  (Part I 1714 and Part II 1729)

 

        Also:  Hume's specie flow mechanism hurt mercantilism theory.

 

Self-interested man was also a precursor to liberal thought.

 

Institutional Transition

 

          Institutional changes that rent-seeking created gradually made rent-seeking and internal regulation by the central government less feasible.

 

i.e. There was an increase in the cost to parliament of supplying regulation:

 

          Parliament found it costly to legislate and even more costly to enforce economic regulation (the Tollison and Ekelund argument).

 

                             Therefore…deregulation.

 

 

SO - Both intellectual and institutional forces that led to the “liberal” revolution in England and in America.

 

In France, with “Colbertism”-  the liberal reaction to mercantilism was vast… a group of French economists called the

 

Physiocratsled the way!   Another man also influenced the intellectual scene, but he was not French -- was Richard Cantillon - we will discuss soon.

 

 

“Natural Law and Primacy of Agriculture”

 

Francois Quesnay:  The Physiocratic teachings were initiated about the middle of the eighteenth century by Francois Quesnay (1694-1774) a physician at the court of Louis XV and Madame de Pompadour.

Born in Méré to a family of laborers, Quesnay was orphaned at thirteen. He could not read until he was 11 but was eventually elected to the Academy of Sciences and hailed as the "Confucius of Europe" (see below), the "modern Socrates", by his disciples.

He was influenced by the works  of the Maréchal de Vauban, Pierre de Boisguilbert and Richard Cantillon.  In fact Schumpeter argued, long ago, that Quesnay’s tableau économique was based on Cantillon, but this claim has never been spelled out in detail and seems not to have been generally accepted, since many writers still write of the tableau économique as though it were Quesnay’s alone. But there is evidence that (a) the relation between Cantillon’s analysis of circulation and Quesnay’s tableau is too close to be a coincidence, but (b) that the use Quesnay put it to is quite different from its role in Cantillon’s system. (See for example, Cantillon, Quesnay, and the Tableau Economique, Anthony Brewer, Discussion Paper No. 05/577, October 2005  Department of Economics, University of Bristol).

 

Portrait of F. Quesnay

 

 

Government by Nature:  The term physiocracy points to the metaphysical foundations of his ideas – to his intention to establish the principles of a “government by nature.”  Although ---- Pierre Samuel DuPont de Nemours (a main protagonist of the ideas) coined the term in 1767.

   

There are “natural laws” and once we understand and grasp them we can follow them.

 

Ordre de la naturel (natural order): the laws underlying the physical world and operating independently of any interference on the part of man.

 

Ordre de la positif (positive, i.e.  human-idealized order) manmade order.

 

He included human instinct among the elements of physical nature – he made infringements of the will upon reason responsible for erroneous judgments and as the primary cause of immorality.

 

 

 

Why the "Confucius of Europe"?  Some believe that Quesnay was influenced by Chinese ideas and concepts  - hence in his lifetime he was known as the European Confucius (551 BC - 479 BC).  The doctrine and even the name of "Laissez-faire" (or a natural order) may have been inspired by the Chinese concept of Wu wei.

 

From Wikipedia:  Wu wei  is an important tenet of Taoism that involves knowing when to act and when not to act. Another perspective to this is that "Wu Wei" means natural action - as planets revolve around the sun, they "do" this revolving, but without "doing" it; or as trees grow, they "do", but without "doing". Thus knowing when (and how) to act is not knowledge in the sense that one would think "now" is the right time to do "this", but rather just doing it, doing the natural thing.

 

Quantitative Terms:  Quesnay derived the conviction that the highest degree of evidence could be claimed for laws expressed mathematically in quantitative terms --

 

This was reflected in the scheme of income distribution elaborated in Tableau economique:  “the heart and soul of physiocratic economics.” - More on this later.

Early Circular Flow Diagram:  Best way to trace out the effects of the policies in France was through a circular flow of income and expenditure. Thought to have lead the way for "general equilibrium theory" in mainstream macroeconomics which we will talk about later.

 

        Today's typical circular flow:

 

 

 

 

 

 

 

The natural state of the economy = balanced circular flow of income - this would emerge under laissez-faire.

 

Any policy which enlarged the circular flow was good for economic growth – and vice versa.

 

Quesnay then picked out a key factor in the circular flow process and analyzed the effects on this key factor  (as economists do today).

 

The exclusive productivity of agriculture:  The key factor he selected (and appears to be the largest fallacy of physiocratic doctrine) was the exclusive productivity of agriculture.

 

Must keep in mind that about the middle of the 18th century, agricultural production was still the main source of the French national income.  Of a total population of 25 million, nearly nine-tenths drew their livelihood from agriculture.  But the number of landowners was small, about 500,000 and about one-fifth of the land was owned by the church.

 

Taxes levied on this supplied the backbone of public revenue…while nobility and clergy enjoyed tax exemption.

 

Quesnay’s economic research was primarily motivated by the intention to show the fundamental errors underlying the policy of Colbertism (a form of mercantilism - whom we briefly discussed earlier) – Jean-Baptiste Colbert (August 29, 1619 September 6, 1683) served as the French minister of finance from 1665 to 1683 under the rule of King Louis XIV

 

Image:Jean-Baptiste Colbert.jpg  

 

He neglected agriculture and fostered manufacturing.  He had burdened the peasants with an intolerable load of taxation.

Colbert issued more than 150 edicts to regulate the different trades (industries). As an example:  one such law had the intention of improving the quality of cloth. The edict declared that if the authorities found a merchant's cloth unsatisfactory on three separate occasions, they were to tie him to a post with the cloth attached to him.

 

Back to Quesnay:  Wealth and Nature  He set out to demonstrate that agriculture was the only real source of national wealth and found philosophical support for that view in his proposition that the creation of wealth was exclusively due to the divine power of nature.

 

Tableau Economique:  Tableau Economique (published in 1758) was the foundation for the doctrine of the physiocrats......and the ancestor of the multisectoral input-output systems of Karl Marx, Piero Sraffa and Wassily Leontief and modern general equilibrium theory (now found in most macro models - Keynes and otherwise).

 

Basically it was a graphic presentation of a process designed to show how the exchange values supplied by nature and incorporated in the products of the soil were distributed in the course of a period of production among the main classes of the population.

 

The yields of agricultural production provided the elements of the distributive process.

In other words – this was a circular flow of income and expenditure.

 

The larger the flow the better.

 

 

The net product from agriculture was looked upon as the true source of real wealth. 

 

Manufacture and service industries considered “sterile” - this meant they did not produce any surplus.

 

Production meant creating a surplus; industry is productive if it makes more than is consumed in the process.

 

Manufacturing simply changes the form of goods…although they did become more useful in the process.

 

But only agriculture is capable of creating additional wealth.

 

 

A simplified version of Tableau – see below (from Wikipedia):

 

Three classes of sectors:

 

1)  A productive class of agriculturalists (perhaps also fisherman and miners).

 

2)  A sterile class consisting of merchants, manufacturers, domestic services, artisans and professional people.

 

3)  A proprietary class, including landlords and those who have the slightest title to sovereignty of any kind.

   

 

The net product (in money terms – net income) is produced entirely by the first group and may be used to support its own activities or those of the other two classes.

The flow of production and/or cash between the three classes started with the Proprietary class because they own the land and they buy from both of the other classes. The process has these steps:

  1. The farmer produces 1,500 food on land leased from the landlord. Of that 1,500, he retains 600 food to feed himself, his livestock, and any laborers he hires. He sells the remaining 900 in the market for $1 per unit of food. He keeps $300 ($150 for himself, $150 for his laborer) to buy non-farm goods (clothes, household goods, etc) from the merchants and artisans. This produces $600 of net profit, to which Quesnay refers as produit net.

  2. The artisan produces 750 units of crafts. To produce at that level, he needs 300 units of food and 150 units of foreign goods. He also has subsistence need of 150 units of food and 150 units of crafts to keep himself alive during the year. The total is 450 units of food, 150 units of crafts, and 150 units of foreign goods. He buys $450 of food from the farmer and $150 of goods from the merchant, and he sells 600 units of crafts at the market for $600. Because the artisan must use the cash he made selling his crafts to buy raw materials for the next year’s production, he has no net profit.

  3. The landlord is only a consumer of food and crafts and produces no product at all. His contribution to the production process is the lease of the land the farmer uses, which costs $600 per year. The landlord uses $300 of the rent to buy food from the farmer in the market and $300 to buy crafts from the artisan.

  4. The merchant is the mechanism for exporting food in exchange for foreign imports. The merchant uses the $150 he received from the artisan to buy food from the market, and it is assumed that he takes the food out of the country to exchange it for more foreign goods.

 

 

This method of distributing the progressively diminishing net product is continued until, upon the termination of the entire process, all surplus values have been absorbed and distributed among the three classes of the population.

 

The annual repetition of this essentially static process is made dependent upon the recurrent supply of the net product as a free gift of nature introduced from the outside into the economy.

 

 

 

Advances (capital investment):  A growth of the national wealth is expected to result only from increased investments applied to agricultural production, which Quasnay called "advances."  He divided them into four categories:

 

1)  Fundamental (one-time capital investment by landlords:  land clearing, drainage, etc.)

 

2)  Sovereign (one-time capital investment by the government:  roads, bridges, etc.)

 

3)  Primitive (investment on durable producer's goods:  cattle, horses, ploughs, etc.)  Also known as original advances.

 

4)  Annual (expenditures on wages of labor and non-durable producer's goods:  feed, seed, etc.)

 

These were picked up by A. Smith - original (primitive) and annual became Smith's fixed and circulating capital.  Today called fixed and variable.

 

 

 

Therefore                   Physiocratic Policy

 

Sought policies to encourage the accumulation of capital…which was slowed by excessive tax burdens.

 

Quesnay calculated that the trick was to meet the needs of the treasury while at the same time doing away with the unreasonable means of assessment (taxes) that prevented agricultural development.

 

 

Solution - Tax the Landlord:  The solution to both problems was simply to tax the landlord!

 

…since taxes can be paid only out of the net product (surplus) they should be levied against those who receive the net product.  At the same time the tax rate would be set to meet the fiscal needs of the state.

 

Another source of K-accumulation for agricultural investment was land rent, in so far as landlords were responsible for improvements to the land.

 

The mercantilist restrictions on free trade in agriculture kept farm prices (and therefore land rents) low by restricting demand.

 

Thus the physiocrats argued for free trade. Open up the borders and this will increase demand for agricultural products -- increasing their prices and the value of the land.

 

This would allow capital to flow freely into agriculture and enable the size of the circular flow to grow.

 

The Physiocrats liked private property.

 

The landlord was valuable…he made the initial investment in clearing land and improving it…so he was entitled to a share in the output.   Landlords were “good guys.”

 

Over the long run even they would be better off with the increase in taxes because of the increase in productivity.

 

 

 

Note the general equilibrium method – and the analogy to the human body.  If one part of the system is affected – this will eventually affect all parts of the system.

 

A distribution in production lead to disturbance in demand, they were mutually interdependent.

 

We should note that the starting point of Quesnay’s analysis was a  concept of physical productivity.

 

The net product was originally a physical magnitude – the excess of grain, etc., over  and above the seeds and other factors of production.

 

But he used a unit of value – where equal values were exchanged for one another.

 

 

 

 

Criticisms of Physiocracy

 

The ideas held up pretty well prior to the Wealth of Nations in 1776.

 

Modern criticisms come in two forms:

 

1)     Were the manufacturers really sterile?  The pure theory of the Physiocrats did not sufficiently accord with the facts of their day.  This argument centers on the charge that manufacturers were sterile.

 

Remember productive did not mean adding value or creating utility.

 

“The real essence of a ‘productive occupation’ says Ronald Meek, according to the normal Physiocratic use of the term, lay in the inherent capacity to yield a disposable surplus over necessary cost; and the real essence of a ‘sterile’ occupation lay in its inherent incapacity to yield such a surplus.”  The Economics of Physiocracy p. 379)

 

So manufactures were sterile in this sense only under conditions of free competition – competition would drive their surplus to zero.

 

They were perfectly willing to admit that under monopoly – manufactures might create a surplus.

 

So this is coming from modern day equilibrium theory -- in the long run, competition will drive down all profits to zero.  Today, however, the analysis includes the opportunity cost of the owner.  So zero economic profit does not mean a zero accounting profit.

 

Careful -- all of this assumes perfect knowledge, costless exit and entry, etc.

 

 

 

The Physiocrats real error was assuming that manufactures could never yield a surplus value over cost under competitive conditions.  In many cases, you can -- at least for a while, as the process changes continuously. 

 

 

Also, if competition wipes out surplus in manufactures, why doesn’t it do the same in agriculture?

 

 

This was a gift of nature (or God).

 

 

But while nature might explain a surplus of physical output, it cannot explain the existence of a value surplus.

 

 

*Need a general theory of value – which they did not have.  As they did not understand opportunity cost as well.

 

 

 

 

2) Their theory was overshadowed by normative (political) considerations …  arguably can be reduced to a rationalization of class interests.

 

(A)  Physiocrats were merely seeking to negate mercantilists and return to the old order. Remember that the mercantilists pushed manufacturing.

 

(B)  Physiocrats were reformists seeking to serve the needs and interests of the newly established commoner – landowners.

 

Probably both:

 

They maintained private property and the exalted position of the landlord – but conditions would be right for the emergence of agricultural capitalism.  

They greatly influenced Adam Smith and others.