Classical Economists & the Concept of Rent

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Even though feudalism and serfdom had been in decline since the 12th century, it took the French Revolution and the ensuing Napoleon War in the late 18th and early 19th centuries to finally uproot the antiquated rent-seeking practices from Western Europe for good. Around the same time, mercantilism was also replaced by the economic liberalism (经济自由主义) as espoused by classical economists but rent-seeking did not recede into history with mercantilism.

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[About Economic Liberalism] Economic liberalism is an economic system based on strong support for a market economy and private ownership of capital assets. Within the system, individual agents (e.g. consumers and producers) are completely free to follow his own interest when making economic decisions. The market will then reach its equilibrium based on interactions of demand and supply. Although economic liberalism can also be supportive of government regulation to a certain degree, it tends to oppose government intervention in the free market when it inhibits open competition.

 

Economic liberalism contrasts with protectionism because of its support for free trade and open markets. Historically, economic liberalism arose in response to mercantilism and feudalism. Today, economic liberalism is also generally considered to be opposed to non-capitalist economic systems, such as socialism and planned economies.

 

[About Classical Economics] Classical economics is a school of thought that emerged under economic liberalism. It flourished, primarily in Britain, in the late 18th and early-to-mid 19th century. Its main thinkers include Adam Smith, Jean-Baptiste Say, David Ricardo, Thomas Robert Malthus, and John Stuart Mill. Their theories were developed during a period in which the political economy was evolving from feudalism and serfdom to state-led mercantilism. Driven by concerns over how the workings of the market were distorted by the rent-seeking behaviours of the merchants supported by the state, the classical economists reoriented economics away from an analysis of the ruler's personal interests to broader national interests. Adam Smith, for example, identified the wealth of a nation not with the king's treasury but with the annual national income produced by labour, land, and capital. In his vision, productive labour was the true source of income, while capital was the main organizing force, boosting labour's productivity and inducing growth. Adam Smith's The Wealth of Nations published in 1776 is thus usually considered to mark the beginning of classical economics.

 

By the early 19th century, the classical economists had also had seen the first economic and social transformation brought about by the Industrial Revolution: rural depopulation and the precariousness and poverty of a burgeoning urban working class. These changes raised the question of how a society could be organized around a system in which every individual sought his or her own (monetary) gain. As pragmatic liberals, the classical economists subscribed to a theory of market economies as largely self-regulating systems, governed by natural laws of production and exchange (famously captured by Adam Smith's metaphor of the invisible hand). Even though they saw a role for the state in providing for the common good, they advocated the freedom of the market and warned repeatedly of the dangers of monopoly while stressing the importance of competition. Externally, they also advocated free trade, which distinguishes them from their mercantilist predecessors, who embraced protectionism.

 

Ricardo and James Mill systematized Smith's theory. Their ideas became economic orthodoxy in the period 1815–1848, after which an "anti-Ricardian reaction" took shape that eventually became marginalist/neoclassical economics. The definitive split is typically placed somewhere in the 1870s, after which neoclassical economics became the new orthodoxy also in the English-speaking world.[1]

 

By the early 19th century, with the spread of industrial revolution, new issues relating to exploitation of workers emerge as more Europeans began migrating to towns and cities and working in factories. Mounting dissents over low wages and poor living and working conditions soon led to Karl Marx’s socialist conception of class struggles between the bourgeoisies (i.e. the capitalist class资产阶级) and the proletariats (i.e. the working class工人阶级). The dominant exploitative rentiers were no more the land-owning aristocrats or the monopolist state-sponsored merchants but the entrepreneurial capitalists.

 

By the end of the 19th century, with the shift from the land-based agrarian economy to the urban-based industrial economy, rent-seeking became increasingly associated with big businesses which had grown to excessive size because of the absence of state intervention as espoused by economic liberalism. In the US, for example, big wigs like John Rockefeller, JP Morgan and Andrew Carnegie dominated the industries. Often referred to as “robber barons”, these corporate bosses were able to pursue unethical and unfair business practices aimed at eliminating competition and extracting extraordinary profits. Corruption was also widespread with political parties serving the interests of these big businesses instead of the electorates.

 

The late 19th and early 20th century period, known as the “Belle Époque” (Beautiful Era美好时代) in Europe and “Gilded Age” (镀金时代) in the US, was therefore one of extreme social disparity for the West despite rising overall economic prosperity as a result of the industrial revolution.

 

[About Belle Époque] The Belle Époque was a period of Western European history between the end of the Franco-Prussian War in 1871 and the outbreak of World War I in 1914. The period was characterized by optimism, regional peace, economic prosperity and technological, scientific and cultural innovations. It was considered by some as a golden age for Europe preceding World War I. In the Great Britain, for example, the period of Belle Époque coincided with late Victorian era and early Edwardian era, both of which stand out as a time of peace and plenty especially for the aristocrats, the gentry and a bourgeoning middle class comprising of entrepreneurial business owners. However, under that veil of prosperity, the advent of Industrial Revolution and the rapid increase in population and urbanization also resulted in rising incidence of poverty. Workers were paid subsistence level wages to work long hours in workhouses with appalling working conditions and child labour was prevalent. Shortage in housing also contributed to overcrowding and the emergence of slums. In contrast to the hardship of the working class, the aristocrats and the gentry were able to live a life of opulence from inherited assets. The Belle Époque was therefore also a period of drastic class divide.

 

[About Gilded Age] The Gilded Age (1870s – 1900) is the American parallel of Europe’s Belle Époque. It was a period when big wigs like John Rockefeller, JP Morgan and Andrew Carnegie dominated the American industries and political parties served the interests of the big businesses instead of the electorates’. Often referred to as “robber barons”, these corporate bosses were able to pursue unethical and unfair business practices aimed at eliminating competition and increasing profits.

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By the 1890s, as social disparity widened and problems of unsafe working conditions, child labour, and political and corporate corruption became increasingly widespread and entrenched, many Americans began to question the fairness of free-market capitalism. Efforts by reformist politicians to rein in these negative effects of industrialization led to the onset of Progressive Era lasting till 1920. During this period, the progressives sought to regulate private industry, strengthen protections for workers and consumers, expose corruption in both government and big business, and generally improve society. In the end, common sense ideas such as antitrust legislation, progressive income tax, minimum/living wage and collective bargaining/unionization laws were passed.

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Neoclassical Economists Treating Rent as Profit

 

Notably, right before the turn of the 20th century, a variant of classical economics known later as the Neoclassical Economics (新古典经济学) emerged. Like the classical economists, the neoclassical economists continued to embrace economic liberalism. One of the things they differed from the classical economists, though, was to treat land and capital as the same thing and therefore interchangeable. As a result, Smith’s concept of “rent” went away and rentiers could masquerade as capitalists and cloaked their unearned “rent” income as justifiable profit.[2]

 

[About Neoclassical Economics] Like classical economics, neoclassical economics is another approach to economics that emerged under economic liberalism. The approached focused on the determination of goods, outputs, and income distributions in markets through supply and demand, based on the following three assumptions:

-  People have rational preferences between outcomes that can be identified and associated with values.

-  Individuals maximize utility and firms maximize profits.

-  People act independently on the basis of full and relevant information.

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From these basic assumptions, neoclassical economists developed a wide range of theories covering various areas of economic activity. For example, the neoclassical theory of the firm is built on the assumption of profit maximization while the theory of consumption, the derivation of demand curves for consumer goods, and the derivation of labour supply curves are based on utility maximization. Market supply and demand are aggregated across firms and individuals. In the end, it is their interactions based on rational choice that will determine equilibrium output and price.

 

One important difference between the classical and neoclassical economics is that, while the former talks about utility, the latter focuses on marginal utility (边际效用). For example, a person’s decision to buy a second sandwich is based how much utility he will derive from the second sandwich after consuming the first one. This is known as the marginal utility of consumption. Similarly, a firm hires a new employee based on the expected increase in profits the employee will bring. This is known as the marginal productivity theory. Because of the introduction of marginalism and of the proposition that economic actors made decisions based on margins, the transition from classical to neoclassical economics has been called the "marginal revolution".

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The neoclassical school dominated the field, particularly of microeconomics, up until the Great Depression of the 1930s. Then, with the publication of The General Theory of Employment, Interest and Money (就业、利息和货币通论) by John Maynard Keynes (凯恩斯，约翰•梅纳德) in 1936, certain neoclassical assumptions were rejected. Keynes proposed an aggregated framework to explain macroeconomic behaviour, leading thus to the current distinction between micro- and macroeconomics. Of particular importance in Keynes' theories was his explanation of economic behaviour as also being led by "animal spirits". In this sense, it limited the role for the so-called rational (maximizing) agent in neoclassical’s rational choice theory.

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Together with Keynesian macroeconomics, neoclassical economics forms the neoclassical synthesis which dominates mainstream economics today.

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[About Marginal Productivity Theory] In the pre-capitalist society in the West, inequality was first explained and justified using religion. The narrative then was that those at the top of society were there because of divine right. To question that was to question God's will. However, with the Renaissance in the 14th century and the Enlightenment in the 18th century, which emphasized the dignity of the individual, the notion of divine right was gradually rejected. Then, with the onset of Industrial Revolution, which led to the emergence of a vast urban underclass, it became necessary to find new justifications for inequality, which intellectuals like Karl Marx attributed to exploitation. The theory that came to dominate, beginning in the second half of the 19th century – and still does today – was called "marginal productivity theory" which posited that those with higher productivity earned higher incomes that reflected their greater contribution to society. Henceforth, inequality was given legitimacy by the neoclassical marginal revolution.

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Great Depression: Economic Liberalism Taken to the Extreme

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By the 1920s, free-market capitalism under economic liberalism had been taken to the extreme particularly in the US where reckless speculation by everyone from millionaire tycoons to cooks and janitors caused the stock market to undergo rapid expansion and to hit its peak in August 1929. By then, the real economy was already contracting with production declining and unemployment rising. Even though the stock prices were already much higher than their actual value, they continued to rise. By October 1929, nervous investors began selling the overpriced shares en masse. The panic selling triggered the crash of the Wall Street stock market.[3] As bankruptcy rose, the US turned protectionist to save jobs. The rest of the world soon retaliated causing world trade to collapse. Governments responded with harsh public spending cuts which further depressed economic activities. What began as a financial market crisis in the US soon evolved into the Great Depression (大萧条1929 – 1939) through rapidly falling trade and investments.

 

Amid the rising social and economic chaos, the concept of “rent” as unearned income re-emerged when John Maynard Keynes famously dismissed a rentier as ‘the functionless investor’ who gained income solely from ownership of capital, exploiting its ‘scarcity value’. However, Keynes erroneously concluded that rentiers would lose the ability to extract rental income as capital would become less scarce over time.[4] In his epochal General Theory of Employment, Interest and Money published in 1936 in the aftermath of the Great Depression, he wrote that as capitalism spread, “it would mean the euthanasia of the rentier, and, consequently, the euthanasia of the cumulative oppressive power of the capitalist to exploit the scarcity-value of capital.”

 

The widespread hardship and pessimism in the 1930s also provided the room and opportunity for the rise of popular fascists (法西斯主义) and Nazis (纳粹主义) whose activist depression-fighting strategy and calls for national revitalization won the hearts of Italians and Germans looking for order and direction. By 1939, the world was at war with Italy, Germany and Japan.

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REFERENCES

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[1] See https://en.wikipedia.org/wiki/Classical_economics

[2] See Dustin Mineau. (2016). “Why Laissez-Faire Lovers Are the Real Anti-Capitalists.” Evonomics.com. 19 November, 2016.

[3] See History.com. (2019). “Great Depression History.” Extracted 11 June, 2019.

[4] See Guy Standing. (2016). “The left must combat rentier capitalism.” OpenDemocracy.Net. 5 September, 2016.