August 20th, 2015
Have A Question?
In The Economic History of the World in Three Lessons, I suggested that the world-changing effects of free market capitalism fully account for the high standards of living we enjoy today. Hence, the entire field of economics merely consists of subsets, subchapters and specifics (and challenges) related to this phenomenon. You may have asked yourself, “Why stop at Capitalism and Adam Smith? Aren’t there many different types of systems and theories that make up the social science of economics? Isn’t economics just a confusing and technical pseudo-science, which contradicts itself at every turn?” Well, let’s take a look.
As I have mentioned, Adam Smith was the first person to really explain how free-markets lead to wealth creation (and improved standards of living). He is known as “The Father of Modern Economics,” because he was the first to describe how things actually work in everyday life; rather than just how people believe things “should be.” Prior to Smith, philosophers dabbled in political theory (a sort of economics), but they mainly approached the world through a filter of “morality.” That is not to say that Smith’s Wealth of Nations was based on immorality; in fact, his first (and more popular) work, focused specifically on what made for a good and respectable person in society (The Theory of Moral Sentiments). However, prior to Smith, most of the study of human social systems focused on what philosophers thought the world “should be,” rather than how life actually worked.
Smith’s work was soon followed by what is known as “Classical Economics.” This was a movement characterized by a string of ad hoc and hodge-podge theories, which focused on specific parts of economic systems, with no real unifying or general framework. They tried to explain things like the value of labor, supply vs. demand, the factors of production, trade policy, the limits of population growth, and models of resource depletion.
In the mid 1800’s, the “Socialist Movement” emerged in response to the miserable conditions of certain working-class groups (particularly in England). Since these conditions seemed to coincide with the new industrial age, this movement sought to address the problem. This movement viewed the history of societies as a class struggle between “oppressors” and the “oppressed.” They felt that any capitalist profits represented value (and wealth) stolen from “labor.” Therefore, the socialists, Capitalism did not really create new wealth, it simply exploited workers to generate profits for the “capitalists” (and make them unfairly rich). Often referred to as Marxism (Karl Marx was an important founder of this movement), it suggested that collective ownership of capital and an equal distribution of all production was the answer to the problems they perceived.
In the late 1800’s, what is known as “Neo-Classical Economics” emerged. The major contribution of this movement was a new concept of value. This school of thought introduced the concepts of marginal utility, marginal cost, and preferences to more precisely measure value and prices (get your brain ready, we will get into this at another time).
In the late 1800’s and early 1900’s, the “Austrian School of Economics” (you may have heard of this one) emerged. It was unique because instead of using math, formulas and graphs to demonstrate economic systems, the movement focused on deductive reasoning and logic to explain the true nature of human-economic interactions. Austrian Economics developed what became know as “the Science of Human Action.” Austrian Economics became very critical of the Socialist Movement (Marxism, Communism, etc.), because, they argued, all collectivism was in direct contradiction to the true incentives of human action. In other words, if you remove the incentive, there is little to no production. Before the Austrian School movement could really settle the matter, World War I broke out.
WWI introduced an age of setbacks for the ideas and proponents of free markets, personal liberty and capitalisms in general. The economic destruction of the war resulted in acute misery in many parts of the world (particularly Eastern and Western Europe and Russia). In the midst of this desperation, people were drawn to the relief of suffering promised by collectivist leaders. There were Marxist uprisings in Russia, Germany, Finland, Hungary and even Latin America. In some places, “socialism” took root (i.e. Russian/Soviet Union); in other places, it morphed into National Socialism and Fascism (Nazi Germany and Italy). Almost always, these collectivist uprisings led to totalitarian states, where private property was confiscated and personal liberty eliminated.
Meanwhile, the U.S. had been relatively unscathed by the war, in comparison to other regions. In fact, there was an unprecedented boom in American during the 1920’s, but this ended with the stock market crash of 1929. The economic recession that ensued encouraged the collectivist voices in the U.S. to assert themselves. Even though the economy soon began to recover from recession, the “Progressive Movement” did not let the crisis go to waste. They had already set into motion plans to drastically intervene in the economy. As a result, the 1930’s witnessed the largest expansion of top-down government intervention in the history of the U.S. (up until then). This intervention stifled economic recovery and the nation suffered for another decade.
Keynesian Economics (named after John Maynard Keynes) came to life in the 1930’s. This “General Theory” unified most all of the aspects of an economy into one model. It did a great job explaining how interest rates, the money supply, inflation/deflation, taxes, business, consumers and governments all combined to make up the total economy. Unfortunately, politicians quickly focused on one particular aspect of Keynesian economics, in order to justify massive intrusions into free markets. Keynes had suggested that during times of recession and depression, consumers and business were in no position to move the economy forward on their own. Therefore, his theory proscribed government intervention (deficit spending, printing money, manipulating interest rates, etc.) to step into this void and ignite the economy. Consequently, Keynesian policies have been credited for saving the U.S. economy from Great Depression (although the facts do not bear this out). Keynesian Economics has dominated economic policy in the Western world ever since.
By the end of the 20th century, the debate over Capitalism vs. Collectivism had been settled. Collectivism had proven a disastrous failure everywhere it had been tried (don’t even argue with me on this point, it is way too easy to defend). Unfortunately, the U.S. has never been able to return to true free-market capitalism. Progressivism has firmly rooted itself since the 1930’s, using Keynesian Economics as its justification (John Maynard Keynes must be rolling over in his grave, since much of his General Theory has been conveniently ignored).
So there you have it, a survey of the major Economic Schools of Economic thought in one lesson. You see, it’s not that complicated! If you think that was easy, stay tuned for what’s next—it is important for The Future of Your Wealth!