Oxford

The History of Economic Thought

Oxford University

Jonathan Bannon Maher

What are the similarities and differences between the economic ideologies of Kautilya, Plato, Lord Shang and Adam Smith? Is each economic ideology dependent on a specific time and place?

The economic philosophies of Plato, Kautilya, Lord Shang, and Adam Smith, when distilled and aggregated by category, are most abundantly expounded upon in division of labor, production, distribution, and ownership. In assessing the validity of each philosopher's economic architecture, it's important to acknowledge their geographic and temporal locations.

Plato, Kautilya, and Lord Shang, though living in separate geographic regions, each published a couple hundred years before the common era, while Adam Smith published on the eve of the American revolution. Kautilya in India, pioneered the country's economic system in Arthasastra, containing strategy and knowledge for the management of a kingdom. Plato in Greece, published books including The Republic, in response to faltering policies of Greek democratic rule. Lord Shang in China, provided his legalist philosophy in The Book of Lord Shang, and is credited with the rise of the powerful Ch'in dynasty, for which he was rewarded the Lordship of 15 cities. Adam Smith in Scotland, who authored the book An Inquiry into the Nature and Causes of the Wealth of Nations, is credited as the principal architect of the modern economy characterized by supply and demand driven production and prices, and freely chosen labor specialization.

A principal area of interest among the philosophers was the division of labor. Lord Shang believed that a centrally managed division of labor would produce a strong and prosperous nation. Kautilya believed in division of labor as determined by caste, with caste in turn determined by divinely ascribed differences among families and individuals. Adam smith advocated freely chosen labor specialization, believing education could offset natural ability, thus enhancing utility in a chosen trade. Plato believed that inherent ability was the driver of occupation selection and productivity.

Another core area of common economic interest among the philosophers was production. Adam Smith supported a market governed by supply and demand driven production and pricing. Lord Shang believed in centralized government control of production with an emphasis on military empire expansion, and limiting non-military activity to agriculture, explicitly prohibiting trade and arts. Plato believed production roles should meet the needs of society as determined by a philosopher king, explaining "We may suppose that one man is a husbandman, another a builder, some one else a weaver - shall we add to them a shoemaker, or perhaps some other purveyor to our bodily wants?" . Kautilya believed in centrally planned production to strengthen the state, then levying a tax of 1/6th of goods produced, and distributing to the needy from that supply during times of hardship.

Among the philosophers, public, private, or mixed property ownership was advocated. Adam Smith believed private property fostered competitive self-interest to improve the value of holdings. Kautilya advocated private property ownership in part so people could be confined rather than gathering to discuss politics. Plato believed in public ownership of community spaces and private ownership of property that individuals would be inclined to tend. Lord Shang believed in mixed public private land ownership and use, where land was to be used overwhelmingly for agriculture, and a ninth of each parcel was reserved for an overlord.

Each philosopher's theories were clearly informed and influenced by the history of their environment. Geographically, Lord Shang and Kautilya's rigidity in the administration of justice and regulation, may have been appropriate for a vast dispersed empire with limited communication infrastructure, while Plato in Greece and Adam Smith in Scotland lived in countries a tiny fraction of the size China and India. Temporally, Lord Shang, Kautilya and Plato lived at a time when agriculture was the principal driver of the economy, and the expansion of civilization was in its infancy, while Adam Smith lived during a time of increasing democratization and innovation in transit and education. Adam Smith also had the benefit of access to the writings and results of previously applied theories, and believed education could offset natural ability in part as a result of living in a time where there was dramatically more access to formal educational institutions than existed in the time of Plato, who comparatively diminished the role of education. Relative to Adam Smith, Kautilya lived during a less evolved time as evidenced by his "'law of the fishes' according to which the bigger ones swallow the smaller ones" All factors considered, each philosopher earned a legacy by producing ideas that delivered positive economic results for the environment in which they were developed.

If the economy is suffering from insufficient aggregate demand, where can additional demand come from, and what might Government do to encourage this?

The most important economic philosophers to consider when discussing aggregate demand, in descending order of relevance, are John Maynard Keynes, Milton Friedman, Adam Smith, and Karl Marx. John Maynard Keynes, who published his book, 'The General Theory of Employment, Interest and Money' in 1936, informed his philosophy with observations of the free market's inability during America's great depression to resolve mass unemployment. His work significantly built upon the results of the implemented theories presented in Adam Smith's book, 'An Inquiry into the Nature and Causes of the Wealth of Nations,' published in 1776, which is principally responsible for providing the architecture for the free market economy. Milton Friedman published many articles, but is best known for his theories on money supply, developed significantly in response to the work of Keynes whose philosophy proved incomplete in dealing with rising inflation and rising unemployment in America around 1970. Karl Marx, who is considered the father of communism, presented his philosophy in three books collectively known as, 'Das Kapital,' published in 1867, 1885, and 1894, in response to the global expansion of capitalism, which he viewed as unstable and exploitative.

Adam Smith believed that full employment is possible as long as workers accommodate their salary demands to current market conditions, Smith (1776). He also believed that economic growth resulted from the division of labor, which could be increased through international trade, with each country focusing on production best suited to their resources. Therefore, Smith believed aggregate demand could be increased through international trade that furthered the division of labor.

Keynes observed that Adam Smith's philosophy proved inadequate during the America's Great Depression, unable to resolve rising inflation and rising unemployment. Keynes explained that less aggregate demand would lead to less need for labor, resulting in less income for labor, causing less aggregate demand, and more unemployment, creating a downward spiral, Keynes (1936). Keynes proposed that the free market therefore required a government backstop to the downward spiral, and offered methods to stimulate aggregate demand.

Because Keynes observed that sometimes employers don't have enough demand for their products or services to hire at any wage level, he explained that aggregate demand, or total spending on goods and services, would correct the problem, thus increasing the employment level, Keynes (1936). Keynes became perhaps the principal proponent of government spending in periods of economic decline, including on infrastructure, education, and military. His philosophy was proven substantially correct when, following the publication of his work, aggregate demand was increased by the government through the development of public works projects, and the conduct of World Wars I & II, lifting America from the Great Depression.

The government can fund its increased spending through taxation, international or domestic borrowing, money supply expansion, asset sales, and savings. Government borrowing is not without side effects, as it may reduce funds available for borrowing by individuals and businesses, and potentially require increased taxes for repayment.

Because the marginal propensity to consume, which is the additional consumption per additional dollar of income, declines as incomes rise, Keynes viewed government spending at the best source of spending, providing comparatively consistent controlled impact. Keynes proposed a mathematical method for calculating total consumption in the economy, which he termed the consumption expenditure function, where total consumption is equal to consumption when income is zero, plus the marginal propensity to consume, which is the amount spent of each dollar of income, multiplied by disposable income, Keynes (1936). Therefore, if annual consumption is $4,000 with no income, and marginal propensity to consume is $0.50 per $1.00, and disposable income is $50,000, the individual's consumption would be $4,000+(0.50*50,000) or $29,000, and such modeling could potentially be used in conjunction with employer wage reporting to develop a country's aggregate demand calculations. Projections could then be run to determine the amount of government spending necessary to provide additional disposable income individuals to generate targeted aggregate demand. However, the function is oversimplified given that marginal propensity to consume isn't constant across income levels.

Another method Keynes proposed to increase aggregated demand is a short-term increase in taxes on imported goods to stimulate the purchase of domestically produced goods, Ramesh (2014). He also supported decreasing taxes in times of distress to provide consumers additional money to spend, Keynes (1936).

Keynes noted that demand expectations affect investment, which in turn affects employment levels, and aggregate demand, Keynes (1936). While not mentioned in the work of economist I've seen, an additional means of producing aggregate demand could include the government potentially making minimum order guarantees during a period of hardship, either referencing historical benchmarks or purchasing an additional percentage of total goods or services sold, and then distributing the surplus to foreign countries at cost or at a discount. Arranging for additional exports allows for the development of international trade relationships to be created or expanded that can continue in place after the initial expenditure of government resources, leaving a residual sustainable benefit.

Milton Friedman is considered the principal proponent of government control of the amount of money in circulation, known as Monetarism. Friedman believed that when the money supply was expanded, once individual held balances that satisfied their minimum reserve requirements, excess funds would be spent, thus stimulating aggregate demand, Friedman (1962). Conversely, if the money supply were contracted to prevent or reduce inflation in prices and wages, individuals would not spend until their reserve balances were again adequate. Friedman believed that ideally the central bank should expand the money supply at an average annual rate of 3%-5%. Friedman's acknowledged that increased employment would generally increase aggregate demand, however he explained there is a natural rate of unemployment, which is the rate at which there is no inflation, where prices would neither increase or decrease based on the level of employment, and therefore the government increasing employment beyond the natural rate would increase inflation.

Friedman explained that aggregate demand is stimulated when banks have cash available in excess of reserves, because they can then provide it to individuals and businesses to make purchases, Friedman (1962). Friedman's proposed control of the money supply is implemented through government purchase and sale of its own debt, generally to institutional lenders such as banks. When the amount of cash banks hold is lowered as a result of instead holding government debt, they have less money to lend, and conversely, when banks hold less government debt, they have more cash available. When the economy is down, interests rates on government debt should therefore be held low to encourage banks to instead hold cash to lend.

Karl Marx indirectly addresses aggregate demand in his critique of the capitalist system. Marx believed in centrally planned and controlled production, explaining markets that involved the sale of goods and services were inherently unstable and exploitative, and goods and service should instead provided by individuals according to ability, and to individuals according to need, Marx (1996). He believed that the surplus value contributed to employers came through the exploitation of labor. Marx also believed economic cycles could only occur as a result of imbalances in planning, Ramesh (2014). Therefore, there was no need to stimulate aggregate demand, only to recalibrate production planning to avoid economic cycles. However, in practice problems were created by the lack of purchasing power of workers and the breakdown of central production planning.

While aggregate demand can be stimulated through methods supported by the discussed economic philosophers, such theorists often oversimplify assumptions for the purpose of mathematical modeling, which seems to remove from the equations a degree of common sense. The global economic crisis of 2007-2008 was in part a result of stimulating aggregate demand through Friedman's expanded money supply, filling an economic balloon that burst, which was then was corrected for with Keynesian government spending in order to prevent the previously cited downward aggregate demand spiral. Increasing economic activity through the combination of the work of the two economic philosophers, ultimately led to increase debt levels and near catastrophes in many countries. The world requires that economic policies be more tightly calibrated around a long-term outlook to reduce the frequency and severity of economic cycles. Perhaps policy makers lack the context underpinning the models and are thus unable to fully project impact. Because economic policies are directly or indirectly set by politicians through appointments, perhaps the economic activity ought to be more directly controlled by individuals who are in positions for longer periods of time, rather than looking to boost the economy during their time in office, leaving the mess for someone else to resolve. Modern economic theories have built upon previous economic theories developed through economic cycles and changing domestic and global environments. Policy makers must forever be aware of each lever along with the environment and context in which it was developed, so that each may be utilized at the right time and in the right amount, to remedy economic ailments, and to moderate the volatility and frequency of economic cycles.