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Sunday, December 9, 2012

Physiocrats & mercantilists: The economic philosophies of the founding fathers (Rethinking Liberalism Part 10)

by John MacBeath Watkins

It is curious how confused people become about liberalism and the economic systems that can be associated with it.

As we've seen, liberalism was born when the old sources of government legitimacy, faith and tradition backed by force, were failing. Thomas Hobbes brought a fresh source of legitimacy in from the marketplace -- the sovereign deserves his job because he performs for you the valuable function of imposing order and thereby preserving you from violent death.

So, we might suppose capitalism is the natural economic system for liberal political systems. The trouble is, although markets have become entangled with capitalism in our minds, markets are much older. The terms capitalism, liberalism, and socialism are all 19th century inventions (use of the word 'capitalism' with its modern meaning dates from about 1850.)

Prior to that, people had markets, fought over trade routes, paid taxes and made arrangements for the common defense, for the construction of roads and bridges and ports and canals, in complete innocence of the possibility of a science of economics and of ideological battles that would one day be fought over what the best economic system is.

The United States was founded near the end of this period  of ideological innocence. Adam Smith's The Wealth of Nations, as we discussed in part 5 of this series, was published in 1776, the same year as the Declaration of Independence. His ideas were not immediately and universally adopted. In fact, the Virginia planter class that gave us presidents George Washington and Thomas Jefferson was influenced more by the French physiocrats. From Vernon L. Parrington's Main Currents of American Thought:
The conception that agriculture is the single productive form of labor, that from it alone becomes the produit net or ultimate net labor increment, and that bankers, manufacturers and middlemen belong to the class of sterile workers, profoundly impressed the Virginia mind, bred up in a plantation economy and concerned for the welfare and dignity of agriculture.
Franklin had first given currency to the Physiocratic theory in America a generation earlier, but it was Jefferson who spread it widely among the Virginia planters. He did more: he provided the new agrarianism with politics and a sociology. From the wealth of French writers he formulated a complete libertarian philosophy. His receptive mind was saturated with romantic idealism which assumed native, congenial form in precipitation. From Rousseau, Godwin and Paine, as well as from Quesnay and Condorcet, came the idea of political justice and the conception of a minimized political state, assuming slightly different forms from filtering through different minds. The early doctrine of laissez faire, laissez passer-a phrase given currency by Cournay, the godfather of the Physiocratic school-proved to be curiously fruitful in the field of political speculation, as in economics. From it issued a sanction for natural rights, the theory of progress, the law of justice, and the principle of freedom. The right of coercion was restricted by it to the narrowest limits, and the political state was shorn of all arbitrary power. "Authority," the Physiocratic thinkers concluded, "should only employ the force of the community to compel madmen and depraved men to make their conduct conform to the principles of justice."
But of course, while the physiocrats favored laissez faire, minimal regulation of the economy, they also considered agriculture the only producer of value. Alexander Hamilton was our first Secretary of the Treasury and is said to have been influenced by Smith. Hamilton was distinctly not a believer in laissez faire. He favored high tariffs to protect fledgeling American industry, a national bank, and public credit (the Sinking Fund Act of 1790 bailed out states in debt from the revolutionary war, established federal taxes to pay off those debts and in the process created a market for securities that would become an engine for economic growth.)

Hamilton's Report on the Subject of Manufactures, presented to congress in 1791, recommended means to stimulate the economy and ensure the nation's continued independence. It recommended policies similar to those of Jean-Baptiste Colbert, Louis XIV's finance minister, a pioneer mercantilist. Hamilton's report would become the basis for the American Way, sometimes called the American System, though it had little to do with the American System as the term applied to manufacturing with interchangeable parts. This interventionist approach to economic development was, however, associated with industrialization, and became associated with abolitionism. Both were in the Republican platform under Abraham Lincoln.

In short, the founding fathers were split between the physiocrats, who favored laissez faire policies but saw little value in industry, and the mercantilists, who saw value in manufacturing, banking, and commerce as well as in agriculture, but were interventionist in their policies.

Once you realize that the United States was founded by people who were not, in the modern ideological sense, capitalists, certain things start to make more sense. It's easy to see how Southern planters would take to the physiocrats' notion of all real value coming from the land, and a philosophy of laissez faire, laissez passer had a certain unsubtle appeal for owners of slaves at a time when much of the country was already questioning the validity of the institution of slavery.

Theirs was the losing side in the Civil War. It was the mercantilist side that won, the side that was more inclined to build railroads and the rolling stock that traveled them, to build ships and their steam engines, not the side where a few people lived like feudal lords and ladies, supported by the slave labor of people who were not even allowed to own themselves.

But even up to the Civil War, the modern style of individualist capitalism as a theoretical construct was not fully developed. Economists tended to talk about how classes of people would act, much as Marxists still do, rather than about how individuals make economic decisions.

It all sounded very erudite, but it did not explain why water, which we all need, is worth less than diamonds, which really aren't that useful.

A decade after the Civil War, the marginal revolution changed that. The theory of diminishing marginal utility gave economists who studied markets an actual, working theory of value, one that explained why diamonds cost more than water and a great deal else. Karl Marx, then reading everything he could in the British Museum and using what he learned to write Kapital, never formulated a response to it, nor did his own theory of value ever show itself as useful.

The Wikipedia explanation is pretty good, so I'll use that:
The “paradox of water and diamonds”, most commonly associated with Adam Smith[16] (though recognized by earlier thinkers).[17] is the apparent contradiction that water possesses a value far lower than diamonds, even though water is far more vital to a human being. Marginalists explained that it is the marginal usefulness of any given quantity that determines its price, rather than the usefulness of a class or of a totality. For most people, water was sufficiently abundant that the loss or gain of a gallon would withdraw or add only some very minor use if any; whereas diamonds were in much more restricted supply, so that the lost or gained use would be much greater.

That is not to say that the price of any good or service is simply a function of the marginal utility that it has for any one individual nor for some ostensibly typical individual. Rather, individuals are willing to trade based upon the respective marginal utilities of the goods that they have or desire (with these marginal utilities being distinct for each potential trader), and prices thus develop constrained by these marginal utilities.
Now capitalism had an explanation for how it worked, and it didn't need to talk about classes of people. It could even take its explanation down to the level of the individual. The marginalist's model of human nature is what we now think of when we think of capitalism having a concept of how the world works. It was sometimes called the "psychological" school of economics, and it gave economists a powerful tool for understanding the workings of markets and society that was not matched by Marxist thought.

Mercantilism could be evaluated with this new tool, and has not entirely died out. Modern Chinese economic policy resembles it more than just a little. The physiocrats, however, now look so far off track that they were not even wrong. They are simply irrelevant.

Yet the cultural legacy of those French thinkers and the Southern planters they influenced lives on. When conservative politicians rally voters against big-city values and ways of doing things, when they treat rural voters as the only "real Americans," part of that, it seems to me, echoes those old claims that only the soil produces anything of value. Of course, it also ties in with the more chilling doctrine of blood and soil, but we can't blame the physiocrats for everyone who admires rural values.

William Aiken Walker, who painted this, also served in the Confederate Army.

Links for this series:

Rethinking liberal theory 1: Thomas Hobbes, blasphemer and patriot
Rethinking liberal theory 2: The outlaw John Locke, terrorist, liberal, and advocate of freedom
Rethinking liberal theory 3: A compact to protect property, or a conspiracy to create meaning?
Rethinking Liberal Theory 4: John Milton and the many shapes of truth
Rethinking Liberal Theory 5: Adam Smith, moral philosopher of the marketplace
Rethinking Liberal Theory 6: Mythmaking and manufacturing
Rethinking liberal theory 7: Hegel, the end of history, and the triumph of the liberal idea
Rethinking liberal theory 8: Liberalism and individualism: The invention of the Util and the way west
Rethinking liberal theory 9 Property and freedom: Why language is the basis for the social contract 
Rethinking Liberal theory 10: Physiocrats & mercantilists: The economic philosophies of the founding fathers
Rethinking Liberal Theory 11:Stateless income, global capital, and the death of empires
Rethinking Liberal Theory 12:Capitalism:So much more than market
Rethinking liberalism 13: What is money? 
Rethinking Liberalism 14: Tribalism and the emerging new world order
Rethinking liberalism 15: The poverty of neoconservative philosophy
Rethinking Liberalism 16: More on the poverty of neoconservative philosophy

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