Battle of Economic Ideas – Part I


By Ravi Saraogi, IFMR Investments

The power of ideas cannot be undermined. While the people and the events linked to them may wither, ideas can live for eternity. It is perhaps for this reason that John Maynard Keynes had written, “…the ideas of economists and political philosophers, both when they are right and when they are wrong, are more powerful than is commonly understood. Indeed the world is ruled by little else…[1] In this blog series, we attempt to trace the evolution of economic ideas that have shaped history and influence policy discourse even today.

The evolution of economic ideas has been complex. The fundamental problem which these ideas try to answer is- how best to organize society so as to satisfy unlimited human wants with finite resources. The solution to this ‘economic problem’ differs based on different schools of economic thought and this sets the ground for these ideas to battle for primacy. It is, of course, a gargantuan task to trace the historical development of such ideas. In doing so, we are guilty of prioritizing brevity over detail.


This first post in this series will trace the origin of modern philosophy during the Age of Enlightenment (1650s-1780s) which was a precursor to the emergence of the modern economic thought during the Classical Liberal era (1750s to 1880s). The second post will give an overview of the Marxian and Keynesian backlash against the classical liberal ideas which reached a crescendo in the first half of the twentieth century. The third and final post will comment on the partial re-incarnation of classical liberal ideas through the neo-liberal counter-revolution and conclude with how the contemporary economic debate is poised.

Age of Enlightenment (1650s-1780s)

Prior to the Age of Enlightenment, the question of how to organize society was primarily answered through the doctrine of ‘Divine rights of the King to rule.’ Under this doctrine, kings and noblemen gained their political legitimacy by asserting that they derived their right to rule directly from God. James I, the King of England from 1603-1625, in a speech to the Parliament in 1610, said, “The state of monarchy is the supremest thing upon earth; for kings are not only God’s lieutenants upon earth, and sit upon God’s throne, but even by God himself they are called gods.” [2] Thus, the defining trait of this doctrine was that a king had divine powers to rule. Two important corollaries flow from this- there is no separation between the Church and the State and, reason is based on religion.

This changed during the Age of Enlightenment. The political legitimacy of an absolute monarch was challenged through the separation of the Church and the State, and scientific reasoning was given prominence in the discovery of truth over religion. A prominent figure in this era was Rene Descartes (1596-1650), a French philosopher and mathematician considered to be the father of modern philosophy[3]. In many ways, Descartes epitomized the zeitgeist of the Age of Enlightenment when he said he will research and write on philosophy “as if no one had written on these matters before.”[4] He famously remarked, “I think, therefore I am[5] and in his magnum opus, Discourse on Method, wrote that knowledge is built on the foundation of rules of thought, the first being, “never to accept anything for true which I did not clearly know to be such. [6]

It is not difficult to see that anybody adopting Descartes’ methodology would immediately call into question several “truths” of the Middle Ages[7]. In his pursuit for truth, Descartes considered any belief that did not “exclude all ground of doubt[8] as false. Thus, thinkers like Descartes laid the foundation for an intellectual renaissance during the Enlightenment era.

Another prominent thinker during the Enlightenment era was John Locke (1632-1704) who played a significant role in changing the political discourse. Locke, an English philosopher and physician, advocated the natural rights hypothesis, under which, all individuals have a natural right to life, liberty and property as long as they do not infringe on someone else’s rights. This was a radical thought which ran counter to how individual rights were perceived prior to the Enlightenment era – as being wholly subservient to the “divine” rights of kings. Locke further developed his ideas on natural rights through the doctrine of ‘social contract’ in which each individual enters into a contract with the State for the preservation of their rights.

The political doctrine which flows from Locke’s individual rights hypothesis is that of ‘government by consent’, an idea he detailed in his magnum opus Two Treatises of Government. Maurice Cranston, in his brief biography on Locke[9], wrote, “One key word in this whole book is ‘consent’. The idea that the authority of a king or other ruler rested on the consent of the people he ruled was a controversial one in the seventeenth century…. Indeed, the Divine Rights of Kings was a widely accepted belief throughout Europe….. it was Locke more than any other theorist who overthrew belief in the Rights of Kings.”

Though what Locke said would now appear commonplace, it must be understood that “a lot of things which we take for granted today were new and remarkable when he (Locke) first said them.”[10] Think about how revolutionary the ideas about natural rights of individuals were when society was just progressing from its feudal vestiges. Also, his views regarding government by consent was in stark opposition to the established doctrine of the divine rights of the kings.

A prominent event during the Enlightenment era was the Glorious Revolution (1688-1689) which was a battle between the notion of the divine rights of kings to rule and the Parliament of England. The outcome of this Revolution was the abolition of absolute monarchy in England through the promulgation of the Bill of Rights in 1689. Locke’s ideas played an important role in the Revolution and he is often referred to as the “philosopher of the Glorious Revolution.[11]

Locke’s ideas on natural rights of individuals and limited government also echoed prominently in the American Declaration of Independence in July 4, 1776, when thirteen erstwhile British colonies declared their independence and jointly formed the United States of America. The founding fathers of the United States of America were strongly influenced by Locke’s natural rights hypothesis as is evident in the drafting of the Declaration of Independence, which includes the following, “We hold these truths to be self-evident, that all men are created equal, that they are endowed by their Creator with certain unalienable Rights, that among these are Life, Liberty and the pursuit of Happiness.”[12]

Thus, the Age of Enlightenment was truly an era which took a decisive break from the past, particularly in ideas relating to political philosophy. The convulsions during this era served as a blow on the feudal institutions of the Middle Ages and a stepping stone towards the era of Classical Liberalism.

The Golden Age of Classical Liberalism (1750s to 1880s)

In continuation of the process of emancipation of the individual from his political masters, the Classical Liberal era was a time in history when ideas of individual liberty in all spheres of life – political, civil and economic, was gaining ascendancy. The Classical Liberal era also witnessed the birth of modern economic theory through the work of Adam Smith, a key figure in the Scottish Enlightenment movement of the eighteenth century. The credo of the Classical Liberal era is often summarized in Smith’s famous ‘invisible hand’ hypothesis, as per which, actions undertaken for individual benefits also leads to unintended social benefits. This is also captured in what is perhaps the best known quote from Smith’s magnum opus An Inquiry into the Nature and Causes of the Wealth of Nations, which was published in 1776[13], “It is not from the benevolence of the butcher, the brewer, or the baker that we expect our dinner, but from their regard to their own interest.”[14]

In Smith’s world, individuals endowed with their natural rights trade with other such individuals based solely on their self-interest, and such voluntary individual actions in a marketplace feeds into betterment of the entire society. Thus, Smith’s theories provided a justification for the government not to intervene in the functioning of the market[15].

It would be important to ruminate here on how far the world had come from the pre-Enlightenment era. While thinkers like Locke set in motion the unshackling of the individual from political slavery, Smith’s theories provided a justification for the individual’s economic freedom. Thus, the classical liberal period saw a proliferation of two key ideas – political freedom through democratic ideas, and economic freedom through free-market laissez-faire ideas. A key event which encapsulated these ideas was the Industrial Revolution (1760-1820).

Source: Hoppe, Hans-Hermann, 2013, From the Malthusian Trap to the Industrial Revolution, Mises Circle Feature

The Industrial Revolution has rightly been categorized as one of the most important event in history[16]. Robert Emerson Lucas Jr., who won the Nobel Memorial Prize in Economic Sciences in 1995, said, “For the first time in history, the living standards of the masses of ordinary people have begun to undergo sustained growth…. Nothing remotely like this economic behaviour has happened before.”[17]  The reason for this “sustained growth” was that through the Industrial Revolution, mankind was able to, for the first time, break free from the ‘Malthusian trap’.

Elucidated by Thomas Robert Malthus, an English scholar, the trap refers to the gloomy conclusion one derives when the process of population growth is compared to the process of growth in the supply of cultivable land (or food supply)– while the former grows geometrically, the latter grows arithmetically. In his 1798 treatise[18], Malthus wrote, “…. the human species would increase in the ratio of 1,2,4,8,16,32,64,128,256,516, etc. and subsistence as 1,2,3,4,5,6,7,8,9,10, etc. In two centuries and a quarter the population would be to the means of subsistence as 512 to 10; in three centuries as 4096 to 13, and in two thousand years the difference would be incalculable.

Thus, for most of history, the increase in population was hostage to the rate of increase in food supply. Though there is a tendency for the population growth to outstrip growth in food supply (due to the former’s geometric rate of increase compared to the latter’s arithmetic increase), any “excess” growth in population resulted in famines, after which, the population again realigned with the growth in subsistence. What this also meant is that for most of history, per capita income remained stagnant as any increase is subsistence was accompanied by increase in population[19].

As highlighted by economic historian Gregory Clark, “….there is no sign of any improvement in material conditions for settled agrarian societies as we approach 1800. There was no gain between 1800 BC and AD 1800 — a period of 3,600 years.[20] This changed during the Industrial Revolution when the human race escaped from the Malthusian trap. The Industrial Revolution was characterized by rapid increase in both per capita income and population made possible by the attainment of a critical mass of technological improvements and capital stock not witnessed until then. This contributed to the ‘Great Divergence’, which refers to the rapid increase in the wealth and power of Western civilisation, leaving behind the civilizations of India, China, Japan and the Ottomans.

One cannot help but feel awed by a phenomenon so divergent from what had been observed for the entire recorded history. The factors responsible for the Industrial Revolution continue to be debated. However, even if one can disagree on the weightage, it cannot be denied that the emergence of reason and political liberty during the Enlightenment era and free trade policies of the Classical Liberal era were enabling factors for the Industrial Revolution. It was as if starting from the Enlightenment era, the lid on what Keynes termed as “animal spirits” blew off and set in motion a phenomenon never witnessed before.

The world was a very different place in the latter half of the nineteenth century as compared to the seventeenth century. Political ideas changed. Feudal institutions form the Middle Ages were attacked. Modern economics was born and the Industrial Revolution saw mankind finally break the gloomy Malthusian trap. One would almost have thought the future could only see a further strengthening of the classical liberal ideas of liberty through the deepening of the political-economic structure of democratic-capitalism. However, as subsequent events would reveal, beneath the rosy story of Industrial Revolution, another revolution was fomenting. And when it erupted, it shook the edifice of classical liberalism right down to its foundation.

To be continued in the second part of this blog series.

[1] Keynes, John Maynard, 1936, “The General Theory of Employment, Interest and Money”, Ch. 24, Concluding Notes, p. 383-384

[2] http://www.h-net.org/~hst201/SpeechParl.htm

[3] http://www.iep.utm.edu/descarte/

[4] Descartes, René, 1649, Passions of the Soul

[5] Descartes, René, 1637, Discourse on Method, Part II

[6] Ibid.

[7] The Middle Ages refers to the period from the 5th to the 15th century

[8] Descartes, René, 1637, Discourse on Method, Part II

[9] Cranston, Maurice (1966), John Locke and Government by Consent, Political Ideas – Edited by David Thomson, p. 75

[10] Ibid.

[11] Ibid.

[12] http://www.ushistory.org/declaration/document/

[13] Co-incidentally, the same year as the American Declaration of Independence

[14] Smith, Adam, 1776, An Inquiry into the Nature and Causes of the Wealth of Nations, Book 1, Chapter 2

[15] It should be noted that Smith was not opposed to all government intervention. In his writings, he has expounded several areas where he sees a role for the government.

[16] Nardinelli, Clark, 2008, Industrial Revolution and the Standard of Living, The Concise Encyclopedia of Economics, Library of Economics and Liberty

[17] Lucas, Robert E., Jr., 2002, Lectures on Economic Growth. Cambridge: Harvard University Press. pp. 109–10

[18] Malthus, Thomas Robert, 1798, An Essay on the Principle of Population as It Affects the Future Improvement of Society

[19] Which is to say that any increase in numerator was accompanied by an increase in the denominator in the computation of per capital income

[20] Clark, Gregory, 2007, A Farewell to Alms: A Brief Economic History of the World, Princeton University Press