Mercantilism and the Physiocracy

Early economic thought (pre-classical economics) (8^th century BC - 1776)

1. early pre-classical economics (Greeks, Scholasticism) (800 BC - 1500)

2. late pre-classical economics (1500-1776)

• Mercantilism, 16th - 18th centuries;

• Physiocracy, France, 1750 -1789

Late pre-classical economics spans from circa the year of 1500 to 1776. We can distinguish two main currents of economic thought in this period: Mercantilism, active in the whole Europe from 13^th to 16^th century and Physiocracy, a French school of economic thought, active from about 1750 to 1789. We discuss them in turn.

Important writers of this period (late pre-classical economics)

Thomas Mun, England's Treasure by Foreign Trade, 1664

William Petty, Political Arithmetic, 1690

Bernard Madeville, The Fable of the Bees, 1714

David Hume, Political Discourses, 1752

Richard Cantillon, Essay on the Nature of Commerce in General, 1755

Francois Quesney, Tableu Economique, 1758

The period between 1500 and 1750 was characterized by an increase in economic activity. Feudalism was giving way to increasing trade. Individual economic activity was less controlled by the custom and tradition of the feudal society and the authority of the church. Production of goods for market became more important and land, labor and capital began to be bought and sold in markets.

This laid the groundwork for the Industrial Revolution in the second part in the 18^th century. However, we have to remember, that still we are talking about pre-industrial world, where agriculture is the most important sector of the economy.

During this period from 16^th to the half of 18^th century, economic thinking developed from simple applications of ideas about individuals, households and producers to a more complicated view of the economy as a system with laws and interrelationships of its own.

Mercantilism.

Mercantilism is the name given to the economic literature and practice in Europe of the period between 1500 and 1750. Although mercantilist literature was produced in all the developing economies of Western Europe (and I should add some Eastern European, for example in Poland, economies too), the most significant contributions were made by the English and the French.

Whereas the economic literature of scholasticism was written by medieval churchmen, the economic theory of mercantilism was the work of secular people, mostly merchant businessmen, who were privately engaged in selling and buying goods. The literature they produced focused on questions of economic policy and was usually related to a particular interest the merchant and writer (in one person) was trying to promote.

For this reason, there was often considerable skepticism regarding the analytical merits of particular arguments and the validity of their conclusions. Few authors could claim to be sufficiently detached from their private issues and offer objective economic analysis. However, throughout the mercantilism, both the quantity (there were over 2000 economic works published in 16^th and 17^th century) and quality of economic literature grew. The mercantilist literature from 1650 to 1750 was of distinctly higher quality, these writers created or touched on nearly all analytical concept on which Adam Smith based his Wealth of Nations, which was published in 1776.

The age of mercantilism has been characterized as one in which every person was his own economist. Since the various writers between 1500 and 1750 held very diverse views, it is difficult to generalize about the resulting literature. Furthermore, each writer tended to concentrate on one topic, and no single writer was able to synthesize these contributions impressively enough to influence the subsequent development of economic theory.

Secondly, mercantilism can best be understood as an intellectual reaction to the problems of the times. In this period of the decline of feudalism and the rise of the nation-states, the mercantilists tried to determine the best policies for promoting the power and wealth of the nation, the policies that would best consolidate and increase the power and prosperity of the developing economies.

What is especially important here is the mercantilistic assumption that the total wealth of the world was fixed and constant. These writers applied the assumption to trade between nations, concluding that any increase in the wealth and economic power of one nation occurred at the expense of other nations (the rest of the world). Thus, the mercantilists emphasized international trade as a mean of increasing the wealth and power of a nation.

Using some modern game-theoretic language, we may say, that they perceived economic activity and international trade in particular as a zero-sum game, that is a game, where it is impossible for both players to win (In a two-person zero-sum game, the payoff to one player is the negative of that going to the other player). So according to mercantilists, it is impossible to increase a global wealth of the world in effect of international trade. It is a very sad assumption, and modern economists do not share it.

The goal of economic activity, according to most mercantilists, was production, not consumption, as classical economists would later have it.

They advocated increasing the nation's wealth by simultaneously encouraging production, increasing exports and holding down domestic consumption. Thus, in practice, the wealth of nation rested on the poverty of the many members of society. One again, they advocated high level of production, high level of export and low domestic consumption.

In addition, they proposed low wages in order to give the domestic economy competitive advantages in international trade. Most of the mercantilists held that wages (of the workers) should be set on the subsistence level, allowing workers to preserve their lives, but not to consume more than it is required to continue their lives. Higher wages would cause laborers to limit their work supply and national output; national wealth would fall, according to mercantilists.

Thus, when the goal of economic activity is defined in terms of national output and not in terms of national consumption, poverty for the masses benefits the nation. This is another sad consequence of mercantilist economic theory.

Third general point about mercantilism is their insistence on the notion of balance of trade.

Balance of trade figures, also called net exports, are the sum of the money gained by a given economy selling exports, minus the cost of buying imports.

A positive balance of trade is known as a trade surplus and consists of exporting more (in financial terms) than one imports. A negative balance of trade is known as a trade deficit and consists of importing more than one exports.

As we know today, neither positive nor negative balance of trade is necessarily dangerous in modern economies, although large trade surpluses or trade deficits may sometimes be a sign of other economic problems.

According to mercantilists a country should increase exports and discourage imports by means of tariffs, quotas, subsidies, taxes and the like in order to achieve a so-called favorable or positive balance of trade.

Production should be stimulated by government interference in the domestic economy and by the regulations of foreign trade.

Protective duties should be placed on manufactured goods from abroad; and the state should encourage the import of cheap raw materials to be used in manufacturing goods for export.

Why did the mercantilists argued for a positive balance of trade?

It is not an easy question to answer.

Many early mercantilists defined the wealth of nation not in terms of nation's production or consumption, but in terms of its holdings of precious metals such as gold or silver. They argued for positive balance of trade because it would lead to a flow of precious metals into the domestic economy to settle the trade balance. Remember here that later or most eminent mercantilists equated the wealth of nation with the overall production of the nation. While for early mercantilists the wealth of nation consisted of the precious metals accumulated in the domestic economy.

The first mercantilists argued that a positive balance of trade should be struck with each nation. A number of subsequent writers however argued that only the overall balance of trade with all nations was significant. Thus, England might have a trade deficit with India, but because it could import from India cheap raw materials that could be used to manufacture goods in England for export, it might well have a positive overall trade balance with all nations.

A related issue concerned the exports of precious metals or bullion (that is gold or silver in bars).

Early mercantilists recommended that the export of bullion be strictly prohibited. Later writers suggested that exporting bullion might lead to an improvement in overall trade balances if the bullion were used to purchase raw materials for export goods.

So much on the mercantilist concept of positive trade balance.

One more point about mercantilist theory concerns money.

The early mercantilists equated the wealth of nations with the stock of precious metals internally held in the country. They were very impressed with the significance of the tremendous flow of precious metals into Europe, particularly into Spain, from the New World, from America. It is therefore not surprising that they became to identify the wealth of nations with gold and silver.

However later mercantilists subscribed to a more sophisticated view and identified the wealth of nation with the nation's overall production. They were able to develop useful analytical insights into the role of money in an economy.

A central feature of this late mercantilist literature is the conviction that monetary factors, money supply, rather then real factors (such as quantity of labor, capital goods and the like), are the chief determinants of economic activity.

They maintained that an adequate supply of money is particularly essential to the growth of trade, both domestic and international. Changes in the quantity of money, they believed, generate changes in the level of real output. Therefore, in this view a positive balance of trade, which would effect in a flow of money into the domestic economy, would increase the production, the real output and therefore contribute to the increasing wealth of nation.

Classical economists and Adam Smith radically rejected this view, that monetary factors are main determinants of economic activity and economic growth in the second halt of 18th century.

Classical economists held that the level of economic activity and the rate of growth depend upon a number of real factors: the quantity of labor, natural resources, capital goods and the institutional structure of the society. Any changes in the quantity of money according to classical economists would not influence the level of neither output nor growth, but only the general level of prices.

Mercantilists held that money supply (not any non-monetary, real factor) was the main factor contributing to the wealth of nation.

So much on the assumptions of the mercantilistic economic doctrine, and we can move to the discussion of its contribution to the economic theory - theoretical contributions of mercantilists.

Probably the most significant accomplishment of the later mercantilists was the explicit recognition of the possibility of analyzing the economy. As we remember, the ancient and medieval thinkers were mostly engaged in moral, ethical analysis of the economy. It is just in mercantilistic writings, that economy becomes an object of a purely scientific, not moral analysis. They started to think about an economy as a subject of science, they realized that the laws of economy could be discovered by the same methods that revealed the laws of physics and other sciences. This was extremely important step toward subsequent developments in economic theory.

Many mercantilists saw an economy as a mechanical system and believed that if one understood the economic laws governing the economy, one could control the economy. Wisely proposed legislation could, in this view, positively influence the course of economic events and economic analysis would indicate what forms of government intervention would help the economy.

They however realized that government intervention must not be in contradiction with some basic economic truths such as the law of supply and demand.

Some of them correctly deduced, for example, that price ceilings set below the equilibrium prices lead to excess demand and shortages.

In addition, the later mercantilists frequently applied the concepts of economic man and the profit motive in stimulating economic activity - they said, that government cannot change the basic nature of human beings, and especially their egoistic drives. Therefore, politicians have to take these factors as given (that humans are egoistic and driven by profit motive) and try to create a set of laws and institutions that will channel these drives to increase the power and prosperity of the nation.

Many of the later mercantilists became aware of the serious analytical errors of their predecessors (that is early mercantilists). They recognized, for example, that stock of gold and silver is not a measure of the wealth of a nation, that it was not possible for all nations to have a positive balance of trade, and also that no one country could maintain a positive balance of trade over the long run.

What's more, some of them realized that trade can be mutually beneficial to nations and that advantages will occur in those countries that practice the division of labor in production.

An increasing number of writers recommended a reduction in the amount of government intervention, anticipating the prescriptions of Adam Smith and other classical economists.

We have to remember however, that none of these writers was able to present an integrated view of the operation of a market economy - the manner in which prices are formed and scarce resources are allocated. This was eventually achieved by Adam Smith and classical economists in the second half of 18^th century and in 19^th century.

The popular explanation of this failure of mercantilists to produce a systematic account of a market economy is that the mercantilists believed that there was a basic conflict between private and public interests or between private and public welfare.

Therefore, they considered it necessary for government to channel private self-interest into public benefits. Classical economists, on the other had, found a basic harmony in society between private, egoistic drives of individuals and social welfare. Even the later mercantilists who advocated market policies lacked sufficient insights into the operation of market to make an adequate argument linking private self-interest and social welfare.

Still, the writings of the later mercantilists were used by Smith to develop his analysis, and this is another significant contribution of the mercantilists.

So much on the analytical contributions of mercantilists to the economic theory.

The thought of some influential mercantilist writers.

Thomas Mun (1571-1641), director in one of the most important English trading companies, his most important book was England's Treasure by Foreign Trade, published after his death in 1664.

Mun was a typical mercantilist, he was a proponent of governmental policies that benefited a particular business interest. It is often said that his book is the classic example of English mercantilist literature.

Mun asserted in the tile of the book that England's treasure (the wealth of England) was gained by foreign trade. His thinking was typically mercantilistic in that he confused the wealth of nation with its stock of precious metals and therefore argued for a positive balance of trade and inflow of gold and silver to England.

He believed that government should regulate foreign trade to achieve a positive balance, encourage importation of cheap raw materials, encourage exportation of manufactured goods, use protective tariffs on imported manufactured goods and take other actions to increase population and keep wages low and competitive.

These are all classic mercantilistic policies.

But Mun also has refuted some of the cruder mercantilistic notions, such as a view that England should have a positive balance of trade with each country; he argued that the really important thing is to have a positive balance of trade with all countries.

So much on Mun's book.

Another mercantilist thinker, William Petty (1623-1687), was a sailor, physician, inventor, and what is most important for us, the first economic writer to advocate the measurement of economic phenomena.

His economic writings were not general treatises; they were the result of his practical interests in matters such as taxation, politics, money, and measurement.

His most important economic work, Political Arithmetic, was published after the death of the author in 1690.

Petty was apparently the first to explicitly advocate the use of what we would call statistical techniques to measure social and economic phenomena. He tried to measure population, national income, exports, imports, and the capital stock of England. His methods were very crude or simple indeed, but the tried to express economic events in terms of numbers, weight, and measure, which is a characteristic feature of modern economics. So we could say, that Petty is a precursor of contemporary methodological position of mainstream economics, which aims at statistical and econometric testing of theoretical propositions.

Later Adam Smith rejected Petty's political arithmetic because of the simplicity of Petty's methods and the problems of obtaining reasonably accurate data, and the process of quantification of economic analysis has stopped for nearly 100 years until the second half of 19^th century.

Another mercantilistic thinker Bernard Mandeville (c. 1670-1733) wrote a satirical poem entitled Fable of the Bees, or Private vices, Public Benefits (1714), which drew interest not only from economists but also from philosophers, psychologists, and other scientists.

In the poem, Mandeville argued against some widely shared at the time views about morality. According to these views, good society and accordingly good economy requires that people behave virtuously, that is altruistically for example. In other words, the popular opinion at the time was that people should care not only for their own good, but also for the good of other members of society, if you want to have a prosperous society with high standard of social welfare.

Mandeville argued that egoism and selfishness is a moral vice, but that social good, public benefit could result from selfish acts if these actions were properly channeled by government. On the other hand, if you would try to change people by moral persuasion, and try to build a society where people are driven by private virtues (not private vices as in the real societies) you would end up with much lower level of economic output, unemployment and economic depression. So private vices produce public benefits.

So, according to Mandeville, one should accept men and women as they are and not try to moralize about what they should be. It is the role of government to take imperfect humankind, full of vice, and by rules and regulations channel its activities toward the social good.

As a mercantilist, Mandeville had no concept of natural harmony, where the so-called “invisible hand” of the market, within appropriate institutional setting and without the need of government intervention, makes individual, egoistic actions also profitable for the whole society. Such a concept was later developed by Adam Smith.

He still insisted that government should regulate much of the economic activity, for example, regulate the foreign trade in order to create employment and to undertake various projects to provide employment for the poor. In Mandeville thought mercantilist ideas thus coexisted with his recognition of the importance of the beneficial effects of the markets.

David Hume (1711-1776).

He is now best known for his philosophical writing, but he also contributed to economics. He was a close friend to Adam Smith; his economic views are contained in nine essays published in 1852 as a part of a volume of Political Discourses.

Like many of his contemporaries Hume could be called a liberal mercantilist, he had one foot in mercantilism, but with the other stepped forward into classical political economy.

His most important contribution is known in international trade theory as the price specie-flow mechanism, where specie is simply the money in the form of coins rather than notes.

Hume pointed out that it would be impossible for an economy to maintain a favorable positive balance of trade continuously, as many mercantilists advocated.

A positive balance of trade would lead to an increase in the quantity of gold and silver (that is specie) within an economy (let's say English economy).

An increase in the quantity of money would lead to a rise in the level of prices in the economy with the positive balance of trade (English economy).

If England has a positive balance of trade, some other country or countries must be having negative balance, with a loss of gold or silver and a subsequent fall in the general level of prices in those countries.

Exports in England will decrease and imports will increase because its prices are relatively higher than those of other economies.

The opposite tendencies will prevail in an economy with an initial negative balance of trade.

This process will ultimately lead to a self-correction of the trade balances in all countries.

Thus, according to this theoretical, beautiful argument of Hume (price specie-flow mechanism), mercantilistic policy of advocating a positive balance of trade is self-defeating, it is impossible to have a positive or negative balance of trade in the long run.

It is a very strong, defeating argument against mercantilistic policy.

However, other mercantilists unfortunately paid little attention to Hume's argument, and they still held the view that a nation in the first place should care about its balance of trade.

But we still name Hume as a mercantilist because he believed that gradual increase in the money supply would lead to an increase in real production, real output, while it is characteristic feature of classical economists' thought that they maintained changes in money supply would change only the general level of prices.

Therefore, Hume was at least half-mercantilist.

A short summary about mercantilism.

Mercantilists made useful contributions to economic theory, the most important of which was their recognition that the economy could be formally, scientifically studied. They developed also some abstract models (such as Hume's price specie-flow mechanism) to discover the laws that regulated the economy. Along with Physiocrats they can be regarded as the first economic theorists.

The Mercantilists achieved the first insights into the role of money in determining the general level of prices and into the effects of foreign trade balances on domestic economic activity.

They also perceived exchange, especially international trade as a process in which one party gains at the expense of another. Therefore, they advocated intervention in the economy by the government.

Finally, the argument by David Hume, price specie-flow mechanism, put a final nail in the coffin of mercantilist economic theories, so to speak.

We should however remember that mercantilism could be interpreted not as an attempt to build an economic theory, but as a sort of rent-seeking activity.

The mercantilists according to this interpretation were driven not by the desire to discover the truth about the economy, but rather by profit motives to use government to gain economic privileges for themselves. They were generally merchants who favored government granting of monopolies that would enable the merchant-monopolists to charge higher prices.

This is only a suggestion, but there may be some truth in this interpretation also.

Physiocracy, France, 1750 -1789

Although mercantilism was a predominant economic school in 18^th century France, a new but short lived movement called Physiocracy (or Physiocratic school) began there, in France around 1750.

It provided significant analytical insights into the economy, perceived the interrelatedness of the sectors of the economy and analyzed the working of non-regulated markets. Thanks to these achievements, the influence of physiocracy on subsequent economic thought was considerable.

Historians of economics often arbitrarily group thinkers with divergent ideas into a school of thought, usually because of a single similarity in their thought.

However, the writings of physiocratic school express remarkably consistent views on all major points. There are three reasons for this, and thus these are three reasons for calling physiocracy - the school of economic thought.

We shall not call mercantilism a school of economic thought, since mercantilistic writings were extremely diverse and widely scattered in time and space. Mercantilists were united by the insistence of the balance of trade as an indicator of country opulence, of country prosperity, but in many other aspects of their works their views were incoherent, inconsistent or simply opposing to one another. So mercantilism was rather a deeply internally diverse movement in the history of economics, than a school of economic thought

First reason for calling the physiocratic movement school of economic thought is that physiocracy developed exclusively in France. There were no physiocratic writers in other countries.

Second reason, is that ideas of physiocrats were presented over a relatively short period, from about 1750 to 1780s. Somewhat ironically, we may say that no one was aware of physiocratic ideas before 1750 and after 1780, only a few economists had heard of them.

Finally, third reason is that physiocracy had an acknowledged, charismatic intellectual leader, Francois Quesnay (1694-1774), whose ideas were accepted virtually without question by his fellow physiocrats. There was no such leader in mercantilist movement for example. The writings of other physiocrats were mainly designed to convince the reader of the merits of Quesnay's economics.

So physiocracy was a school of economic thought because it was a movement quite limited in space (that is geographically), time and the diversity of their ideas, it was a closely knit group of followers to spread the doctrines of the master - F. Quesnay.

The term “physiocracy” means “the rule of nature” or “the regime of nature”, “the authority of nature” and the like.

In 18^th century France many feudal institutions still remained, many more than for example in 18^th century England, and the king possessed absolute power. Economic policy in the early 18^th century was mainly mercantilistic, there were attempts to increase exports and reduce imports, thereby both achieving national self-sufficiency and accumulating the treasure. In addition, there were attempts to increase the population and to keep wages low, thus forcing people to work hard. Immigration of skilled workers was encouraged through subsidies. Trade, internal trade, was carefully regulated and new industries were set up, sometimes with foreign workers.

France in the 18^th century faced severe financial and economic problems. It was not until much, much later that deaths from famine, from hunger, from starvation, became outdated.

Throughout the century, the 18^th century, shortages of food were common.

The government resorted to numerous measures in order to deal with the problem, including price fixing, prohibiting speculation, and direct regulation and coercion of food producers. The main reason for shortages of food was the lack of internal movement of food, since there were some surpluses of food in some parts of the country and at the same time, shortages in others. The markets for food were very limited, in large part because of the governmental taxes and barriers.

The government also faced chronic financial difficulties, these being due to military expenditures incurred by French kings, Louis XIV and his successors.

The state was continually on the verge of bankruptcy. The clergy (that is people ordained for religious duties in the church), and the nobility (the aristocracy), who owned most of the nation's wealth, were largely exempt from direct taxation, and among those who were liable the burden of such taxes was very uneven. Collection of taxes was arbitrary and unjust.

A major reason for this was that the state did not have the administrative apparatus to collect them itself, but farmed the job out to private companies. These would pay an agreed sum to the state in return for the right to collect taxes, this process was inefficient and unjust methods of collection of taxes were often used.

Physiocratic ideas were developed mainly by Francois Quesnay in 1750s and 1760s.

By the time Quesnay turned to economics (he was in his 60s), he had gained a considerable reputation as a doctor, surgeon and physician. His position in the French court was as physician to Madame de Pompadour, mistress of Louis XV, and it was for his medical services that he received an aristocratic title and considerable wealth. After a few years, his interest in economics stopped and toward the end of his life he turned to mathematical investigations.

His medical background is important as it influenced his perspective on economics.

In turning to economics, Quesnay sought to analyze the pathology of society and to propose remedies. He focused on the circulation of money, a clear analogy with the circulation of blood within the body. It is tempting to suggest that the term “Physiocracy”, meaning the rule of nature, reflected the attitude of an experienced physician, medicine doctor, who knew the importance of working with nature in discovering a cure for a disease in the society and the economy.

Beside focusing on the circulation of money, equally significant, the Physiocratic system rested on a clear analysis of the structure of French society.

The main components of physiocratic thought:

• Concept of the “natural order”

• Concept of “net product”

• The theoretical model of the economy

• Policy implications and proposals

The concept of natural law or natural order.

The physiocrats like the later mercantilists developed their economic theories in order to formulate correct economic policies. Both groups believed that the correct formulation of economic policy required a correct understanding of the economy. Economic theory was therefore a prerequisite of economic policy.

The physiocrats' unique idea concerned the role of the so-called natural law in the formulation of policy. They maintained that natural laws governed the operation of the economy and that, although these laws were independent of human will, humans could objectively discover them - as they could the laws of natural sciences.

Those natural laws, which are independent of human will, but also objectively manageable to discover, made up the natural order. The natural order is, according to Quesnay, the one being made up of beneficial and self-evident, created by God, rules that govern the operation of society and the economy. The example of such a natural law would be in Quesnay's views:

- right to acquire property through labor

- the right to pursue one's own interest

- the right to survival

- Duty to respect other persons and property of others

- the right to voluntary exchange, etc.

Following these laws will ensure the happiness of mankind, Greatest possible abundance of goods, greatest possible liberty to make use of these goods, and harmony of interest between social classes as physiocrats thought.

Quesnay made a sharp distinction between the natural order as defined above and the positive order in the nature and society.

A positive order was human legislation, laws created by people, by governments.

What is important here, physiocrats held that where the positive order (human legislation) deviates from the perfect, created by God, natural order, the beneficial effect of the natural order will not come into full play. However, if the government in enlightened by reason, positive laws that are harmful to society will disappear. So this was the task that physiocrats were trying to perform - to advice the government, the king, to implement the kind of positive order, the state legislation, which is consistent with eternal, created by God, natural order.

The concept of “net product” and the theoretical model of the economy

Even though physiocratic theory was deficient in logical consistency and detail, the physiocrats did determine the necessity for building theoretical models by abstracting and isolating key economic variable for study and analysis. So they were early proponents of abstract model building in economics, their work was analytical, it was not some kind of story telling, but they tried to work scientifically by building models, very simple models, but nevertheless scientific models.

Using this procedure (modeling) they achieved significant insights into the interdependence of the various sectors of the economy on the levels both

The major concern of the physiocrats was with the macroeconomic process of development. They recognized that France was lagging behind other countries, and especially England in applying new agricultural techniques. Most of France was maintaining its old agricultural techniques in production, and while some areas of France were introducing advanced techniques, in overall the country was developing very unevenly.

To cope with this problem, the physiocrats like mercantilists wished to discover the nature and the causes of the wealth of nations and policies that would best promote economic growth. Physiocracy was an intellectual reaction to the widespread regulation of the economy that was promoted in 18^th century by French mercantilism.

The physiocrats focused not on money (as mercantilists did), but rather on the real forces leading to economic development. In reaction to the mercantilistic notion that wealth was created by the process of exchange (international exchange), they studied the creation of physical value and concluded that the origin of wealth was in agriculture or nature.

That is a fundamental conclusion of physiocratic thought - the origin of nation's wealth is in agriculture.

In the economy of 18^th century, more goods were produced than were needed to pay the real costs to society of producing those goods. Therefore, a surplus was generated. The physiocratic search for the origin and size of this surplus led them to the idea of natural or net product.

The agricultural production process provides a good example of a net product.

After the various factors of production - seed, labor, machinery, and the like - are paid for, the annual harvest provides an excess, a surplus. The physiocrats regarded this as resulting from the sole productivity of nature.

Labor, according to them, could produce only enough goods to pay the costs of labor, and the same held true for the other factors of production, with the exception of land.

So all other factor of production, beside land, are not productive, they do not produce any surplus over the costs of their use. Only land is productive factor of production and only agriculture is a productive sector of the economy. All other sectors (trade, manufacturing) are therefore not productive; they are sterile. They are (other factors of production and other sectors of the economy), but they are essential for other purposes in the economy, they are necessary in the economy, but they do not produce wealth.

Manufacturing covers subsistence and the costs of the inputs used up but does not produce a surplus. Land is productive in physiocratic meaning of the term, in that that it produces a surplus over the necessary costs of production, only land and agriculture yield a net product, a surplus.

Once more, production from land created the surplus that the physiocrats called the net product. Manufacturing, trade and other nonagricultural economic activities were considered non-productive, because they created no net product.

The belief that only agricultural production was capable of returning to society an output greater than the social costs of that output (cost of production) may seem very strange today.

We know today that other factors of production (capital, labor and others) are productive in the sense also.

The physiocratic view about the unique productivity of land may be explained by the fact that the physiocrats focused on physical productivity (that is a measure of physical quantity of output produced) rather than value productivity (a measure of money equivalent of the products). And physical productivity is best physically visible in agriculture, where plants grow, animals are raised and the like.

In addition, because large-scale industry had not yet developed in France in the middle of 18^th century, the productivity of industry was not apparent in the economy of the physiocrats.

The small employer with only a few employees did not seem to be making any surplus of revenues over the costs of production, and his standard of living was not significantly higher from that of his employees. Therefore, they could not see that the industry was productive in the same sense as agriculture was.

Having established that the origin of the net product was in land, the physiocrats concluded that land rent (rent derived from land) was the measure of the society's net product, society's wealth.

The relationship between agriculture and net product was explained by Quesnay in several versions of his main economic work, Tableau economique, the first version published in 1758.

Quesnay presented the creation of net product in the economy by means of quite complicated diagram. The simplification of the diagram shows the essence of the physiocratic analysis, their model of the economy.

The diagram shows three sectors of society: farmers, landowners (lendołners, king, aristocracy, the church) and artisans (craftsmen, skilled workers, mechanics, technicians).

There is no foreign sector, government sector or manufacturing sector above the artisan level. So the model is very abstract and simple.

The physiocratic analysis began with a net product at the beginning of the economic period of let's say 2 million pounds held by landowners.

This net product was paid to the landowner class as rent from economic activity in the previous period.

The physiocrats assumed that only land could produce an output greater than its costs of production and every year accumulated capital generates a gross production worth 5 million pounds. The costs of production in agriculture are 3 million pounds - 1 million is annual depreciation of fixed capital (agricultural machines) and 2 million is circulating capital (wages for agriculture workers, money for buying manufactured goods to agricultural production).

The circulating capital is shown as the number 2 in the farmers' column on the diagram.

So the net product is 2 million pounds at every year - since the annual production is worth 5 million and the costs of production are 3 million.

The net product it is paid as a rent from farmers to landowners - two millions go to the landowners, this is market by the number 2 in the central column.

Activities of artisans' results in products produced and the payments to factors of production in artisan production equal exactly the value of the goods produced.

These activities are not productive in the Quesnay''s meaning of the word `productive'.

The sterile class, artisans have one million pounds of circulating capital (this is shown as number 1 in the artisans' column).

Starting at the top center of the Quesnay's economic table, the landowners spend last year's net product of 2 million pounds by buying agricultural goods (food) from farmers for 1 million pounds and buying luxury goods from artisans (and paying another 1 million pounds for them)

This is represented by the lines A and B from the landowner column of the diagram, toward the columns representing the farmers and the artisans.

Thereafter, artisans buy food from the farmers for 1 million. This is represented by line C.

Farmers reconstitute their capital by buying manufactured goods from artisans for 1 million (remember, we said, that the fixed capital of the productive class is depreciating 1 million each year). This is line D.

Finally, artisans spend this 1 million received from farmers buying agricultural products (and paying 1 million) in order to reconstitute their circulating capital - this is shown by the line E. (remember that at the beginning of the period artisans had 1 million of circulating capital).

Summing up, the landowners, landlords, have spent all the money received as rent in order to consume food and luxury goods from the artisans.

The artisans have sold manufactured goods for two million pounds (units of money) and spent two millions in order to buy food and to reconstitute their capital.

The circulation process in the economy has allowed these two classes in the end to get what they had in the beginning (landlords spent all the money, and in the next period they will receive another rent form farmers, and artisans have one unit of circulating capital).

What about the productive class - the farmers? They have sold agricultural goods for 3 million (goods worth one million for landlords and worth two million for artisans).

In addition, they have still agricultural goods worth 2 million to reconstitute their circulating capital (wages for workers).

They have also bought the necessary manufactured goods in order to reconstitute their fixed capital (which is depreciating every year for 1 million).

Finally the money capital is reconstituted as well, since the farmers have 2 million pounds (they got 3 million pounds lines A, C, E) and spend 1 million (line D).

Every form of capital is thus reproduced in the economy, the process of circulation of goods and money reproduced the initial conditions of production.

And another year the process repeats itself reproducing the net product and capital.

This is the nature of the tableau economic by Francois Quesnay - a bold, creative conception of the interrelatedness of macroeconomic sectors with great simplicity.

The table presents how the natural product is generated in the economy, and how goods and money circulate between different sectors in the economy.

They made few efforts to develop a theory of the microeconomic theories of the markets and these cannot be considered as successful microeconomic theories.

The physiocrats considered Quesnay's tableau, the diagram, to be their main theoretical achievement. It gave a crude, simple, but clear representation of two main things.

First, it represents the flow of money incomes between the various sectors of the economy.

Second, it shows the creation and annual circulation of the net product throughout the economy.

The tableau economic, Quesnay's can be considered as first, very simple, macroeconomic model of the economy in the history of thought. It is a major methodological advance in the development of economics - a grand attempt to analyze economic reality by means of abstraction.

The tableau, table, was not only an abstract model to analyze the relationships between various sectors in the economy. The physiocrats also attempted to quantify the sensitivity of the economic system to various changes. For example by the use of the tableau, Quesnay showed that if a tax of 25 000  pounds were imposed on both sectors (that is on farmers and artisans), the result would be a decline in the annual product in agriculture from 2 million to 1 million 950 thousand pounds. The net product would decreased by 50 000 pounds in effect of taxes of 25 000 pounds. The result would be then economic decline, for less output would be produced the following year.

Similarly, he showed that a fall in the productivity (due to government intervention) would reduce output. So, the physiocrats also tried to quantify the effects of different changes in economic system on the national wealth, national output.

So much on the theoretical contribution of the physiocracy.

A few words on physiocratic economic policy.

The physiocrats thought that free competition led to the best price and that society would benefit if individuals followed their self-interest. Furthermore, they believed that the only source of a net product was agriculture; they concluded that the burden of taxes would ultimately rest on land as the sole productive factor.

For example, a tax on labor would be shifted to land because competition had already ensured that the wage of labor was at a subsistence level, the lowest possible level.

Because the physiocrats believed that a natural order existed that was superior to any possible human design, they conceived of the economy as largely self-regulating and thus rejected the controls imposed by the mercantilist system.

The proper role of government was to follow a policy of laissez-faire - which means to leave things alone, allow to do, in French. A laissez-faire policy demands that a government do not interfere into in the working of the free market at all.

In the hands of Adam Smith and classical economists this idea of laissez-faire policy, was of tremendous importance in shaping the ideology of Western civilization. We will talk about this laissez-faire policy many times in the following lectures.

Returning to some details of physiocratic economic policy, they maintained that the primary obstacles, barriers, to economic growth proceeded from the mercantilist policies regulating domestic and foreign trade. They objected particularly to the tax system of the mercantilists and advocated that a single tax should by levied on land. All other taxes should be abolished.

The most unfortunate of the many governmental regulations according to the Physiocrats, was the prohibition on the export of French grain, the seeds of wheat or rice, for example.

For physiocrats, it kept low the price of grain in France and in their view was therefore an obstacle to agricultural development. In the absence of the prohibition, if laissez-faire policy were introduced, the small-scale agriculture would be replaced by large-scale agriculture and the wealth and power of France would be increased. Laissez faire policy would lead to increased agricultural production and greater economic growth.

However, we may add, physiocrats did not foresee that soon, at the end of 18^th century in the effect of industrial revolution, the agricultural sector would start to lose its central role in the European economies and that the manufacturing and industry would start to be the most important sectors in the economy.

So to sum up the physiocratic economic policy, I will stress following points

First, they tried to Encourage Agriculture--Improve agricultural management and technique.

2^nd, they tried to Dismantle restrictive laws and regulations and to introduce the policy of laissez-faire

Third, they wanted to end artificial encouragement of manufacturing by the government.

4^th, they proposed to reform the tax system and to implement a single tax on the net product derived from land.

5th, they encouraged the domestic consumption as a mechanism to maintain income flows between the classes in the society.

And finally, they praised the free international trade, particularly in agricultural goods.

So much on the physiocracy.

The most important contribution of physiocracy was their recognition that the economy can be formally studied, by means of models, by means of abstract reasoning. Along with mercantilists, they were the first model builders in economics.

Their most abstract model, the economic table, tableau economique, shows the interrelatedness of various sectors of the economy, the process of generating the net product, and circulating of money between different classes of the society.

We should also stress that they are first advocates of a free market economy, they called not for intervention in the economy, but for laissez faire, a policy of not intervening in the working of the economy.

Farmers

Landowners

Artisans (sterile class)

2

2

1

1

1

1

1

1

A

B

C

D

E

5

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