The Three Major Schools of Economic Thought

- Why Should I Care?

These guys are dead. But their ideas are still relevant to this day.  What they wrote about economics is at the heart of our most controversial issues and debates. Free trade, recession, poverty… These three thinkers will help give you a better grasp of many of today’s pressing issues.

 - This Lecture Has 3 Parts

• Adam Smith and the Classics
• Karl Marx and the Marxists
• John Maynard Keynes and the Keynesians

- What is a Major School of Economic Thought?

A school of thought is like a school of fish! It is a group of people who think the same way about something. In economics, the main schools of thought are Classical, Marxist and Keynesian. In this chapter, we will discuss their main themes, key economic ideas, and their views on the role of the state in the economy, and if a free market is good or bad for peoples’ well-being.

• Adam Smith and the Classics

Adam Smith believed that the market economy regulates itself. He believed that when there are shortages, price increases will convince suppliers to produce more. He believed this system was fair and efficient. He argued that capital investment and innovation were the keys to economic growth and prosperity. This contradicted views that the accumulation of money (gold) was the only explanation of the wealth of nations.

Also, he argued that it was not immoral for individuals to pursue their own self-interest. This was very controversial at his time (1723 – 1790) and remains to be today. Smith argued that free-markets are a good thing because in the end, the system enables people to satisfy most of their wants and needs.

Smith coined the term Invisible Hand. Although the market economy may seem chaotic, he believed that the self-regulation of the economy did produce the right quantities at the right prices. He saw patterns where others saw chaos. He referred to an “invisible hand” that sets these prices and quantities without intervention from the State.

Division of labour is also a concept attributed to Smith. From visits to manufacturing plants, he noticed that new machinery was enabling workers to specialize more than before. He argued that production would increase if workers specialize in specific – albeit sometimes repetitive and boring – tasks. Smith uses an illustration of this, which has become widely known as the “pin story”. In the previous age of workshops, pins and nails were made from scratch at the same workstation. A pin was finished before the next one was made.

In the new age of factories, innovative machines were accelerating the pace of production. Each machine needed to be handled by a machinist. And each machine could execute only one task, over and over again. In this age of factories – the Industrial Revolution – the steps of production for many products, such as pins, were divided. The first worker cut a length of thin metal rods. The second worker milled the tips of the rods into a point. The third worker hammered out the pin heads. The fourth worker welded the pin rods to the heads. The fifth worker boxed the pins.

Smith observed that this new organization of labour, which depended on new machinery, increased the quantity of production immensely. More recent applications of this phenomenon were done by Henry Ford who was the first to use a rolling production line in the automobile industry, and by Michael Dell, who was the first to mass-produce personalized computer systems.

Even though he was right-wing, Smith and the Classical School of Thought believed the government should build roads and run schools. But they argued the government should not intervene in the market economy. Smith believed the market economy produced socially acceptable outcomes.

• Karl Marx and the Marxists

Karl Marx understood the principles of market self-regulation. But he believed this did not produce an economy that was good for ordinary people. Marx based his beliefs on the social reality of the Industrial Revolution in Europe (1818–1883).

Karl Marx’s main argument was that in a market economy, there was an unbalance of economic power between rich and poor. According to Marx, those who owned capital used their profits to buy even more capital. They quickly dominated the laborers who earned low wages. Marx coined this phenomenon as the Surplus Value of Labour. Marx explained that workers transformed land and capital into products. These products were sold at higher prices. Marx argued workers should own this added value of their own work instead of it becoming profit for capitalists.

The problem with this situation is that workers would eventually not have enough money to buy the ever increasing quantities of products the economy would make. Due to stagnant wages, and employment levels, the lack of overall demand would create an imbalance with supply. Endemic unemployment would be the sorry outcome.

According to Marx, economic crises and unemployment due to insufficient demand are inevitable.

To help workers get better wages, Marx and the Marxist School of Thought believed that the government should intervene in the economy, and the State should own and allocate resources such as Capital. This view inspired the political movement called Communism.

• John Maynard Keynes and the Keynesians

John Maynard Keynes was a firm believer in markets, most of the time. But, he also believed the market economy needed help from government to move out of severe economic downturns. We call this Government Intervention.

Keynes based this belief on the fact that the economy, in his time (1883 – 1946), was in fact in a depression, as of 1929. These hard times lasted for a decade. Widespread unemployment had decreased regular peoples’ ability to spend (aggregate demand). This sent the economy in a tailspin of factory shutdowns and poverty. Keynes was sensitive to the negative mood of consumers and investors. He called their herd behavior “Animal Spirits”.

The Classics argued that resources made idle would be eventually put to use in other sectors of the economy. They also argued that lower wages would help kick start the recovery. But Keynes argued that it would take more to put the economy back on track. He argued that the whole economy was in a slump, not only a few industries, a fact most did not consider because there were no statistics to measure the entire economy at the time. He also argued that lower wages would not help to sustain the economy.

The government should increase its’ spending if consumers and investors are not able to do so. Keynes and the Keynesian School of Thought believed that the government should intervene in the economy. But, they do not believe the State should own or allocate resources. Keynes argued in favor of stabilization policy which includes monetary policy and government spending. He invented macroeconomics and spurred the development of macroeconomic indicators of the economy such as Gross Domestic Product, the Unemployment Rate and the Consumer Price Index. 

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Green Policy

Our great three thinkers were not pressed, in their time, to discuss environmental matters. Pollution, hence, was not the main point of discussion in either of these economists’ main body of work. It would be wise not to try and guess what they would have to say in today’s world. However, one would be curious to see what they would say, if one had access to a time machine.

Keynes’ work however, should be noted. He argued, in times of prolonged economic downturns, for States to borrow large sums of money and to spend the money on all sorts of projects. When asked who would pay back this debt he quipped that it did not matter, we have to act now. “In the long-run, we are all dead”, he wrote (Tract, p. 65, in Patinkin, 1975).

We can surely suppose that most economists value human life above profits. Surely.

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Climate Change Solution 

Again, neither Smith, Marx, nor Keynes had to tackle the issue of Climate Change. One could guess what they would have to say about it, but it’s hard to say.

One could argue however that the Keynesian macroeconomic model can be used for simulating the impacts of government spending programs aimed at any type of stimulus. A package of policies, including government spending, to reverse Global Warming, could thus be modeled using the Keynesian framework. We will look into this later.

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Democracy Booster

It is interesting to note that both Smith and Marx lived in times which were drastically less democratic than today. Even Keynes, a loyal monarchist in his time, was a key advisor during World Wars I and II, periods of tyranny in Europe and across the globe.

These three thinkers, however, have one thing in common. They were trying to imagine a better world. Smith tried to explain important changes in the organization of production during the industrial revolution. Marx, tried to show a better way to organize production given the social shortfalls of industrialization. And Keynes tried his best to convince States to intervene in the economy in periods of prolonged downturns, for the betterment of many, not the few.

In the face of global warming, Marxist philosophy is gaining traction. The reason is that social inequalities have grown tremendously in the past few decades, and many people in the working class, what Marx called the Proletariat, are increasingly upset with the costs of global warming, while the wealthy elites, the Bourgeois class of the Marxist framework, have the capacity to maintain their lavish lifestyles. The 1 percent wealthiest people on the planet won't bear the brunt of the burden of a warming climate. While the rich keep flying around the world in gas-powered jets, the poor are suffering from floods and heat-waves. No wonder climate activists are intersecting with Marxist philosophy. The major caveat to all this is that Marxist politics in many parts of the world turned into totalitarian regimes, such as the USSR, and China. Marxism has a tendency to be quite seductive, especially for the disadvantaged, while being an efficient vehicle for a coup d'état.

- Wrap-Up

Adam Smith is said to be the father of economics. He was pro-market, was fascinated by the division of labour in industry, the accumulation of capital, and coined the term the invisible hand.

Karl Marx is the father of Marxism which spawned the communist political movement. He was furious about social inequalities and wished to abolish capitalism.

John M. Keynes was concerned with an ongoing recession that was not solving itself on its own. He fathered Keynesianism which convinced governments to intervene in slumping economies.

Summary Table

	Adam Smith	John M. Keynes	Karl Marx
Are market economies socially acceptable?	YES	YES	NO
Should the State intervene in the economy?	NO	YES, if recession	YES
Should the State own and allocate resources?	NO	NO	YES
Key Economic Idea	Invisible Hand	Government Intervention	Surplus Value of Labour

- Cheat Sheet

Spoken Word Without labour, wood does not become a chair. So pay workers their fair share or there won’t be any chairs.

Government spending: 
increasing government expenditures to stimulate the economy.

Surplus value of labour:
the monetary added-value brought to raw materials and other resources by the act of labour. Marx argued this added-value should be turned over to workers, not to capitalists.

Invisible hand:
a metaphor used by Adam Smith to explain that markets are not chaotic, and lead to stability in prices and production.

Division of labour:
Dividing work in specialized tasks in order to increase productivity of workers. Adam Smith insisted on the importance of this phenomenon during the Industrial Revolution.

- References and Further Reading

Heilbroner, R. (1953). The Worldly Philosophers. Simon & Schuster, 7th edition, 1999.

Patinkin, D. (1975). The Collected Writings of John Maynard Keynes: From the Tract to the General Theory. The Economic Journal,             85(338), 249-271.

Skousen, M. (2006). Big Three in Economics: Adam Smith, Karl Marx, and John Maynard Keynes. Armonk, NY.

 

- Think Piece

In 2008, a downturn in economic activity affected most Western countries. The unemployment rate soared to 9 percent in Canada and double that in the USA.

• What would Keynes have proposed to solve the unemployment?
• Would Karl Marx have agreed?
• What would Adam Smith propose?
• The Canadian federal government decided to spend its way out of the recession with specific programs in road construction and residential renovation. Would this be called Classical policy?

Submit 1 page essay in-class.