Economic Thought, Lecture 5

Cantillon and Turgot

Ekelund---Tolleson

• Last week Raymond asked about Rothbard’s criticism of Ekelund and Tolleson’s book on mercantilism.

• Rothbard’s basic criticism is that the book ignores the role of ideology in the transition from mercantilism to free trade.

• E &T say that because Parliament supplanted the king, it was harder to lobby for special privileges. You had to approach more people.

E & T Continued

• It isn’t clear whether this is true, but even if it is, changes often don’t come about just through people trying to maximize their economic interests.

• Rothbard also doesn’t like the concepts of rent-seeking and transactions cost.

• There isn’t a fixed cost for a good or service beyond which everything is wasteful rent.

• The importance of transactions costs is exaggerated.

Cantillon and Turgot

• Why does Rothbard emphasize Cantillon and Turgot so much?

• A key theme of his book is that Adam Smith was not the founder of economics.

• Rothbard has shown that the Spanish Scholastics and others made important advances in economics. But a defender of the traditional view could say, “No one before Smith devoted a whole book just to economics”. Rothbard can point to C & T in response.

Richard Cantillon

• Rothbard’s fundamental criterion for evaluating an economist is, how close did he come to Austrian insights?

• Richard Cantillon (early 1680s –1734) was an Irishman who moved to France. He was involved in John Law’s Mississippi Bubble and died under odd circumstances.

Cantillon the Pioneer

• Rothbard considers him the father of modern economics.

• Around 1730, Cantillon wrote An Essay on Commerce in General

• Cantillon, in contrast with previous writers, separated questions of morals and values from a description and analysis of the economy.

Method

• Cantillon used thought experiments. E.g., he imagined that the entire world consisted of a single estate.

• He then added assumptions to make his model more and more realistic. This is called the method of successive approximations.

• Approximations like this are examples of ceteris paribus assumptions.

Cantillon on Price

• Once he dropped the assumption that there was only one estate in the world, Cantillon had to consider price. At what rate would goods be exchanged?

• He sometimes talked about the “intrinsic value” of a good, but he wasn’t really a cost-of-production theorist.

• He emphasized the role of the utility of a good in determining price.

Utility

• The so-called intrinsic value of a good didn’t really affect price.

• Price is determined by consumer demand for a product. Demand in turn depends on the subjective valuations of consumers.

• The importance of “intrinsic value’ or cost-of-production is that when the businessman compares this with price, he can determine whether he is making a profit. Cantillon didn’t have the later Austrian view that costs are also determined by demand.

The Entrepreneur

• Cantillon pointed out the importance of uncertainty. An entrepreneur has to pay his workers and other costs, but he must estimate that he will get enough from sales to make a profit.

• Thus, the entrepreneur is the bearer of uncertainty. He doesn’t upset things, as Schumpeter later thought, but balances different markets because he helps supply and demand to adjust.

Population

• Cantillon had a much better population theory than Malthus. He had the basic idea of an optimum population. This is the population that, given the state of technology and resources, will produce the most goods. Note that Rothbard accepts this idea.

• Cantillon didn’t say the optimum population is ethically desirable. How you rank more people with fewer resources against fewer people with more resources is a question of ethics.

Population Continued

• Population will vary according to consumer demand, especially by the rich, for products.

• If goods require a lot of labor to produce, there will tend to be more people.

Spatial Economics

• Cantillon was also a pioneer in location economics.

• Bulky goods will be priced lower near where they are produced because of the cost of transporting them.

Spatial Economics Continued

• People will tend to gather in a central market where many goods can be sold instead of spreading out in many small markets. Supply and demand will tend to adjust markets to their proper size.

• Cantillon didn’t support complete free trade. Government is needed to guide people to the best locations for markets.

Money

• Cantillon’s most important contribution was in the theory of money.

• Suppose new money is introduced into the economy. Those who get it will spend it on products they want.

• Those people will in turn spend the money they get on what they want.

Money Continued

• Money will thus gradually spread through the economy. As it does so, the prices of the goods that are demanded more will rise.

• This means that it will be harder for those who haven’t gotten the new money yet to buy these goods. There is a shift of goods to those with the new money.

Cantillon Effects

• The effects of money’s spreading in stages through the economy are now called Cantillon effects. New money doesn’t leave everything in the same relative positions.

• He had the concept of velocity of circulation. Money that keeps getting spent is to an extent equivalent to more money.

• Depending on whether lenders or borrowers get the new money, interests rates will tend to fall or rise.

Contradiction of Mercantilism

• Cantillon saw that mercantilism leads to a contradiction

• A nation is supposed to try to accumulate gold and silver.

• If it does this, prices of goods in the economy will tend to rise. This make imports cheap and exports costly. As a result, gold and silver will tend to flow out of the country.

Turgot

• Turgot (1727-1781) is one of Rothbard’s favorite economists. He came from a family of royal officials. He was an important royal official himself.

• Rothbard considers Turgot worthy of a brilliancy prize. He wrote less than 200 pages on economics but arrived a t many insights.

• He was a supporter of laissez-faire, but he believed in trying to convince the king to adopt his policies.

Benefits of Free Trade

• Turgot argued in favor of free trade, both domestically and between nations. There were internal tariffs in France.

• Trade only takes place if both parties expect to benefit from it.

• The free market uses the local knowledge that people have. A centrally controlled system can’t do this. This is a basic idea that Hayek developed.

Turgot on Value

• Turgot used the method of successive approximations to arrive a theory of value.

• He had the basic insight that a person will rank goods according to their subjective utility to him.

• He anticipated, although he didn’t fully state, diminishing marginal utility, the ordinal nature of utility, and opportunity cost.

Diminishing Returns

• Turgot worked out the Law of Returns.• Suppose you need several factors of production to

make something.• If you keep increasing one of the factors, while

holding the others constant, you won’t indefinitely increase the amount of the good that is made.

• You will reach a point where the additional factor adds less than before to production. Eventually, the new factor will contribute nothing.

Capital and Interest

• Cantillon stressed that the entrepreneur bears risk.

• Turgot added that the entrepreneur must accumulate capital. Ding so enables him to pay workers and the other factors of production. Because he has done so, he can then sell the goods, hoping for a profit. This is where he assumes the risk.

Capital and Interest Continued

• The capitalist advances money to the workers now. He has to wait to get his money from the sale of the goods.

• Money now is worth more than money in the future. Because the workers get their money now, they are willing to pay the capitalist a premium. This is the rate of interest.

More on Interest

• Turgot thus had a the crucial concept of time preference.

• Time preference is also the basis for interest on money loans. Again, money now is worth more than money later.

• The rate of interest in production, i.e., the premium paid by workers and other factors for not having to wait for their money, will tend to equal the rate of interest on loans.