UG - B.A. - Economics (English) - 136 54 History of Economic Thought - BA (Economics) - 6176

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B.A. (Economics)
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136 54
HISTORY OF ECONOMIC THOUGHT

Authors:
Dr HL Bhatia, Ex-Reader, Sri Ram College of Commerce, Delhi
Units: (1.0-1.1, 1.2-1.3, 1.5, 1.6-1.10)
Dr Suman Lata, Lecturer, Department of Economics, Ginni Devi Modi Girls PG College, Modinagar, Ghaziabad
Units: (1.4, 2.2.1-2.3, 3, 4.0-4.1, 4.2-4.4, 4.6, 4.7-4.11)
Dr Biswaranjan Mohanty, Assistant Professor, Department of Political Science, SGTB Khalsa College, University of Delhi
Units: (4.5, 7.0-7.1, 7.2-7.2.1, 7.3-7.7, 8, 12.0-12.1, 12.3-12.5, 12.6-12.10, 13.0-13.1, 13.2-13.3, 13.5, 13.6-13.10)
Dr Priyanka Jaiswal, Associate Professor, Department of Economics, ILEAD College, Kolkata
Unit: (5, 10, 12.2)
Shreya Bhagwat, Guest Faculty, Deptt of Commerce, MP Bhoj Open University
Units: (7.2.2, 11, 14.3-14.5, 14.6-14.10)
Vikas Publishing House, Units: (2.0-2.1, 2.2, 2.4-2.8, 6, 9.0-9.1, 9.2-9.2.1, 9.4-9.8, 14.0-14.1, 14.2)
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Work Order No.AU/DDE/DE12-27/Preparation and Printing of Course Materials/2020 Dated 12.08.2020 Copies - 500
SYLLABI-BOOK MAPPING TABLE
History of Economic Thought
Syllabi Mapping in Book
Unit-1: Introduction: Nature - Approaches - Significance of History of Unit 1: Introduction to

Economic Thought. Economic Thought
(Pages 1-20)
Unit-2: Mercantilism: Main Characteristics - Thomas Mun. Unit 2: Mercantilism
(Pages 21-42)
Unit-3: Physiocracy: Natural Order - Primary of Agriculture - Social Unit 3: Physiocracy
Classes - Tableau Economique - Taxation. (Pages 43-60)
Unit-4: Classical School -I: Adam Smith - T.R. Malthus - David Ricardo - Unit 4: Classical School-I
J.S. Mill - J.B. Say. (Pages 61-100)
Unit-5: Classical School -II: Alfred Marshall - J.A. Schumpeter - Pigou. Unit 5: Classical School-II
(Pages 101-120)
Unit-6: Socialism: Introduction - Role - Karl Marx. Unit 6: Socialism
(Pages 121-136)
Unit-7: Schools of Socialism: Different Schools of Socialism: Utopian - Unit 7: Schools of Socialism-I
Christian. (Pages 137-146)
Unit-8: Fabian - Syndicalism - Guild Socialism. Unit 8: Schools of Socialism-II
(Pages 147-158)
Unit-9: Institutional Economics: Gunnar Myrdal - Thorstein Veblen. Unit 9: Institutional Economics-I
(Pages 159-168)
Unit-10: Romesh Dutt - Wesley Clair Mitchell. Unit 10: Institutional Economics-II
(Pages 169-178)
Unit-11: John Maurice Clark - John Kenneth Galbraith. Unit 11: John Maurice Clark and John
Kenneth Galbraith
(Pages 179-188)
Unit-12: Indian Economic Thought I: Thiruvalluvar - Gokale - Naoroji - Unit 12: Indian Economic Thought I
Ranade. (Pages 189-230)
Unit-13: Indian Economic Thought II: Nehru - Gandhi - E.V. Ramasamy - Unit 13: Indian Economic Thought II
Amartya Sen. (Pages 231-284)
Unit-14: Welfare Economics: Meaning - Education - Health - Poverty. Unit 14: Welfare Economics
(Pages 285-302)
CONTENTS
UNIT 1 INTRODUCTION TO ECONOMIC THOUGHT 1-20

1.0 Introduction
1.1 Objectives
1.2 Meaning of Economic Thought
1.2.1 Lack of Agreement in Economic Thought
1.3 Development
1.4 Nature and Approaches
1.5 Significance of the History of Economic Thought
1.6 Answers to Check Your Progress Questions
1.7 Summary
1.8 Key Words
1.9 Self Assessment Questions and Exercises
1.10 Further Readings
UNIT 2 MERCANTILISM 21-42

2.0 Introduction
2.1 Objectives
2.2 Introduction and Forms
2.2.1 Main Characteristics
2.3 Thomas Mun
2.5 Summary
2.6 Key Words
UNIT 3 PHYSIOCRACY 43-60

3.0 Introduction
3.1 Objectives
3.2 Evolution of Physiocracy
3.2.1 Main Ideas and Theoretical Concepts of Physiocrats
3.3 Natural Order
3.4 Primacy of Agriculture
3.5 The Circulation of Wealth and Social Classes: Tableau Economique
3.6 Taxation
3.7 Other Important Concepts of Physiocracy
3.9 Summary
3.10 Key Words
UNIT 4 CLASSICAL SCHOOL-I 61-100

4.0 Introduction
4.1 Objectives
4.2 Adam Smith
4.3 T.R. Malthus
4.4 David Ricardo
4.5 J.S. Mill and his Theory on Utilitarianism
4.6 J.B. Say
4.8 Summary
4.9 Key Words
UNIT 5 CLASSICAL SCHOOL-II 101-120

5.0 Introduction
5.1 Objectives
5.2 Alfred Marshall
5.3 J.A. Schumpeter
5.4 Pigou
5.6 Summary
5.7 Key Words
UNIT 6 SOCIALISM 121-136

6.0 Introduction
6.1 Objectives
6.2 Socialism: Meaning, Scope and Role
6.3 Karl Marx
6.3.1 Theory of Economic Development
6.5 Summary
6.6 Key Words
UNIT 7 SCHOOLS OF SOCIALISM-I 137-146

7.0 Introduction
7.1 Objectives
7.2 Different Schools of Socialism
7.2.1 Utopian Socialism
7.2.2 Christian Socialism
7.4 Summary
7.5 Key Words
UNIT 8 SCHOOLS OF SOCIALISM-II 147-158

8.0 Introduction
8.1 Objectives
8.2 Fabian
8.2.1 Rejection of Marxian Theory of Class Struggle
8.3 Guild Socialism
8.3.1 Main Tenets of Guild Socialism
8.4 Syndicalism
8.6 Summary
8.7 Key Words
UNIT 9 INSTITUTIONAL ECONOMICS-I 159-168

9.0 Introduction
9.1 Objectives
9.2 Gunnar Myrdal
9.2.1 Myrdal’s Model of Circular and Cumulative Causation
9.3 Thorstein Veblen
9.5 Summary
9.6 Key Words
9.7 Self Assessment Questions and ExerciseS
UNIT 10 INSTITUTIONAL ECONOMICS-II 169-178

10.0 Introduction
10.1 Objectives
10.2 Romesh Dutt
10.2.1 Criticism of British Economic Policy
10.2.2 Economic Ideas
10.3 Wesley Clair Mitchell
10.3.1 Economic Ideas of Wesley Clair Mitchell
10.3.2 Critical Estimate of Mitchell’s Economic Ideas
10.5 Summary
10.6 Key Words
UNIT 11 JOHN MAURICE CLARK AND JOHN KENNETH GALBRAITH 179-188

11.0 Introduction
11.1 Objectives
11.2 Economic Ideas of John Maurice Clark
11.3 Economic Ideas of John Kenneth Galbraith
11.3.1 Economic Ideas of John R. Commons
11.3.2 Economic Ideas of Wesley C. Mitchell
11.5 Summary
11.6 Key Words
UNIT 12 INDIAN ECONOMIC THOUGHT I 189-230

12.0 Introduction
12.1 Objectives
12.2 Thiruvalluvar
12.2.1 Economic Thoughts
12.3 Gopal Krishna Gokale
12.3.2 Agricultural Ideas
12.3.3 Foundations of Indigenous Capitalism
12.4 Dadabhai Naoroji
12.4.1 Drain Theory
12.4.2 Criticisms
12.4.3 Long-Run Relevance
12.5 Mahadev Govind Ranade
12.5.1 Agrarian Policy
12.5.2 Railway Investment
12.5.3 Methodology of Economics
12.7 Summary
12.8 Key Words
UNIT 13 INDIAN ECONOMIC THOUGHT II 231-284
13.0 Introduction
13.1 Objectives
13.2 Jawaharlal Nehru
13.2.1 Economic Policies of Nehru
13.3 Mahatma Gandhi
13.3.1 Gandhian Economics
13.4 E.V. Ramasamy
13.5 Amartya Sen
13.7 Summary
13.8 Key Words
UNIT 14 WELFARE ECONOMICS 285-302
14.0 Introduction
14.1 Objectives
14.2 Meaning of Welfare Economics
14.3 Education
14.4 Health
14.5 Poverty
14.7 Summary
14.8 Key Words
Introduction
INTRODUCTION
Economics describes and analyses the production, distribution and consumption
NOTES
of wealth. As a social science, economics comprises many schools of thought that
discuss the wide variety of ways of conducting the aforesaid analyses. The most
influential of these schools of thought in the 20th century included neoclassical
economics, Marxian economics and Keynesian economics. However, the influence
of economic schools of thought is not static, but rather, it is ever changing.
Throughout history, a wide range of economic thinking has held sway. This is also
true of India.
Throughout the history of human thought, India has produced important
economic theorists. Manu, Shukra and Chanakya were the great economic thinkers
of ancient India. Dadabhai Naoroji, Gopal Krishna Gokhale, R.C. Dutta, M.G.
Ranade, M.N. Roy and M.K. Gandhi emerged as great economic thinkers during
India’s struggle for Independence. Contemporary Indian economic thinkers include
Deen Dayal Upadhayay and Amartya Sen.
This book, History of Economic Thought, is divided into fourteen units
that follow the self-instruction mode with each unit beginning with an Introduction
to the unit, followed by an outline of the Objectives. The detailed content is then
presented in a simple but structured manner interspersed with Check Your Progress
Questions to test the student’s understanding of the topic. A Summary along with
a list of Key Words and a set of Self Assessment Questions and Exercises is also
provided at the end of each unit for recapitulation.
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Introduction to
UNIT 1 INTRODUCTION TO Economic Thought
ECONOMIC THOUGHT
NOTES
Structure
1.0 Introduction
1.1 Objectives
1.2 Meaning of Economic Thought
1.3 Development
1.4 Nature and Approaches
1.5 Significance of the History of Economic Thought
1.7 Summary
1.8 Key Words
1.0 INTRODUCTION
The history of economic thought studies the origin of economic ideas and their
interrelation in addition to tracing the contributions made by scholars and economists
in terms of theories and economic concepts starting right from the ancient times to
the present. In ancient Greece, scholars like Aristotle grappled with questions
related to acquisition of wealth and whether property should be left in the hands of
individuals. In the classical school of economic thought, several influential economists
propounded theories that changed the course of economic studies. Adam Smith’s
Wealth of Nations was the very first book that talked extensively about economic
matters. The central thesis of this book was that our individual need to fulfil self-
interest leads to societal benefits which he terms as the ‘invisible hand’.
In this unit, an analysis of the development and the approaches to economic
thought has been undertaken.
1.1 OBJECTIVES
After going through this unit, you will be able to:

 Understand the meaning of economic thought
 Discuss the development, nature and approaches of economic thought
 Describe the significance of history of economic thought
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Introduction to
Economic Thought 1.2 MEANING OF ECONOMIC THOUGHT
As human knowledge accumulates, it is analyzed and categorized into different

NOTES sciences. Economic science is also a result of the same process and includes
doctrines and generalizations which deal with economic phenomena of our life.
Economic science, like other sciences, has had to undergo a process of evolution
and is the result of innumerable contributions by various thinkers. In many cases,
specific contributions went unnoticed for a period of time, while certain other
contributions were recognized during the very life-time of their contributors. In
some cases the views of these thinkers had a great impact upon that moulding of
future patterns of economic thought. The role played by different thinkers in the
process of its evolution has been uneven. Some thinkers appeared like luminous
stars in the sky and dazzled everything in sight, while others appeared rather dim.
However, even when the contributions by some thinkers were not very spectacular
when they were made, every contribution has its own place and relevance in the
development of economic science and in improving our comprehension of economic
phenomena.
Ordinarily economic thought would be taken to cover the set of theories,
doctrines, laws and generalizations, and analyses applied to the study and solution
of economic phenomena and problems. It should be noted, however, the specific
contents of economic thought have normally commanded an uneven prominence-
some attracting more attention than the others; and the overall composition of
economic thought is also subject to a continuous variation. Economic thought is
not a given and fixed set of economic theories or tools and techniques of analysis.
Economics is a dynamic science, a feature that it acquires on account of various
reasons. This characteristic of it partly follows from the fact that it is a social
science. It brings forth a body of generalizations which, as in other sciences, involve
cause-effect relationships. But from amongst the set of causal forces at work, the
relevant ones have to be sorted out for the problem at hand; and similarly on the
side of effects a sifting process has to be undertaken. These tasks admit of a
difference of judgement and opinion. Since human society is a complex
phenomenon, a very large number of causes are likely to be at work in most cases
and different investigators could very well differ as to the choice of the most ‘relevant’
causes at work. Also investigations could unearth those forces which were hitherto
thought irrelevant or not of particular importance. Moreover, the identification of
the causal forces at work does not imply that these causes would not change till
their final outcome is encountered. Over time, the vary roles of specific forces are
likely to undergo a change. The responses of economic units (individuals, firms,
governments, etc.) would vary from one situation to the other in view of the prevailing
moral, political, religious and social philosophy as also the institutional framework
of the society.
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An economy is a dynamic phenomenon and therefore economic science is Introduction to
Economic Thought
a dynamic one. With social change, new economic questions present themselves.
And man’s thinking is influenced by his social and physical environment. Economic
thought develops along two lines. On the one hand, within the basic framework of
a given economy and its institutional setup, there is always a scope for deeper and NOTES
intensive investigation which provides a basis for further analysis and theorizing.
On the other hand, the very dynamism of an economy provides a basis for further
investigation. In a static and stagnant economy, there is not much scope for furthering
the science of economics. But a changing economy poses newer challenges which
economic thinkers have to meet. Normally, over time, a dynamic economy would
increase in complexity and would thus demand new and better tools and techniques
of analysis, as also a wider coverage of economic issues. A study of the history of
economic thought, therefore, covers both these aspects of the development of
economic science. The role and growth of each significant theory, the set of theories
and policy prescriptions provided by each school and even the significant
contributions by individual economists must be viewed in the context of the prevalent
economic environment. At the same time, the study must take note of the way
economic thought influenced the movement of economies and the resultant effects
on economic science itself. In this connection, it may be pointed out that an
important motivating force in the growth of economic science has been the concern
of the economists with the overall enhancement of ‘efficiency’ of the economic
system and economic welfare of the society as a whole or its particular sections.
The result is that economic science is always undergoing a change. Over
successive time intervals, specific sets of economic ideas, theories, doctrines, tools
and techniques acquire recognition and acceptance implying thereby that in different
contexts we have different systems of economic thought. The study of the history
of economic thought, therefore, automatically becomes a study of these various
systems of economic thought. In the words of Haney, the study of economic thought
‘may be defined as a critical account of the development of economic ideas,
searching into their origins, interrelations, and manifestations.’As would be expected,
to begin with most economic ideas and doctrines have been in a fluid form.
However, with the passage of time, there has been a development in the concepts
and tools and techniques of analysis. Old economic concepts acquired greater
precision and new concepts were continuously introduced to cope with the emerging
theoretical and practical problems. Along with the development of concepts there
has also been a sharpening of the tools and techniques of analysis.
In this connection, we should keep in mind the distinction between economic
ideas as such and economic science or economics proper. Economic ideas have
been there since time immemorial, but it is only recently that they assumed the
form of a system of thought which may be termed economic science or economics.
References to economic questions are scattered almost everywhere in old literature.
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Introduction to They are found in Plato, Aristotle, and others. Aristotle, for example, discusses
Economic Thought
currency, population and slavery. In India also, Kautalya is known for his discussion
of various economic questions. But in all these cases we have only fragments of
information and analysis. So long as we are not able to adequately generalize on
NOTES these economic ideas and economic views with any great significance, we cannot
claim the emergence of economic thought. In that sense, the time when these ideas
started getting crystallized into economic thought is around the time of mercantilism.
The birth of economic science might be said to have coincided with the rise of
physiocracy, because it is in this system that for the first time we find a comprehensive
economic theory. According to a widely held opinion, Adam Smith’s book An
Inquiry into the Nature and Causes of the Wealth of Nations (published in
1776) was the first systematic work of economic problems, while now modern
critics have been more and more persuaded and rightly so, to attribute that priority
to Richard Cantillon, author of Essia sur la nature du commerce, published in
1755. Economic thought is a body of economic ideas and generalizations which
can be seen to ‘belong’ to each other. There are theoretical underpinnings of the
economic investigations and policy prescriptions. There is a logical reasoning
involved in the process of arriving at conclusions, and there is also an aspect of
abstract theorizing. It is only at this stage of formation and cohesion that economic
ideas collectively become economic thought. It is not of course necessary that the
economic ideas in a system of economic thought must be conforming to each
other or that they must belong to one main body; it is the overall thinking process
which lends economic ideas the colour of mutual association and belonging and
therefore brings forth the phenomenon of economic thought.
Individual economic ideas are almost always problem-oriented. There are
generalizations about certain facts and problems and the desirable solutions thereof.
Among various problems which man faces in his daily environment, there are
economic problems also. Accordingly he has to try to solve them along with other
problems. We find, therefore, that traces of economic ideas have always been
there in the total thought system of mankind. There have been discussions of various
economic problems and their possible solutions. For example, in the beginning
there was a concentration of economic ideas on the economic problems connected
with slavery, agriculture, usury, and to some extent with trade, commerce, etc.
However, economic science as a science implies that the economic problems and
their solutions must be viewed in a totality, and their interrelationships must be
recognized. In economic science, there is a good deal of theorizing and generalization
about the nature of economic problems; the typical response which different
economic units (individuals, firms etc.) show to various stimuli are recognized and
categorized and the types of feasible and actual solutions get listed. There is also
a concern with the ‘efficiency’ of the economic system and the way in which it
could improve its working. All this involves the use of numerous concepts and
their definitions become progressively rigorous as time passes. The development
of economic science is accompanied by the introduction of new tools and
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sharpening of the old ones. Not only this, in the development of a science abstract Introduction to
Economic Thought
theorizing plays a prominent role and economics is no exception.
The place of abstraction in economics may also be noted via the distinction
between inductive and deductive methods of analysis. In the inductive method,
NOTES
economic phenomena are investigated and data are gathered, interrelationships
between different interacting forces are ‘found out’ and then corresponding
inferences and generalizations are derived. This approach proceeds on empiricism
and relies on ‘correct’ interpretation of the interrelations between economic forces.
On the other hand, deductive method relies on abstraction. A set of causes is
chosen as the one which is relevant to the problem in hand and the process of
interaction between these forces is determined on the basis of set rules. So long as
we have only economic ideas, there is hardly any generalization, or deductive
analysis or abstraction. On the other hand, in economic science proper, there is a
good deal of scope for generalizations, deductive analysis and abstraction. Actually,
even empiricism or inductive analysis becomes acceptable only if it satisfies well-
accepted rules of analysis and theorizing and when it uses acceptable techniques
and tools.
History of economic thought, therefore, is not basically a history of economic
ideas but that of economics proper, though for the sake of completeness a discussion
of the origin of important ideas may be included. Such a history of economics may
be attempted in numerous ways. One may, for example, take up important strands
of economic thought and pursue their development over time. We may, for example,
take up the development of the doctrine of laissez-fair, or that of economic welfare,
or the theory of utility, etc. Another approach could be to pursue the study of
economic thought in terms of ‘schools’, i.e., in terms of theories, inferences and
policy prescriptions which formed broad harmonious sets in themselves, had a
common set of premises, and which were put forth by identifiable groups of
economists. Examples would be of the ‘historical school’, the ‘Utopian socialists’
and the ‘marginalists’. Another approach could be to take up important
personalities, i.e., economists who made great and significant contributions to the
advancement of economic science or contributed in an important way to the
investigation of economic phenomena and empirical problems. It is obvious that
any one such approach would only serve particular purposes and may not be fully
satisfactory from other points of view. It would therefore be preferable if a blended
view of the development of economic science is taken in which due emphasis is
accorded to the individual economists, to the schools and also to the development
of important strands of economic thought.
Economic thought is closely related to economic environment. The growth
of economic science can be traced along with the growing complexity of the world
economies. Even in pure abstract theorizing, economics has its moorings in specific
economic framework of a society. Economic theorizing may be in the context of a
market economy, a centrally planned economy or an economy of some other
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Introduction to type. However, irrespective of the extent of economic theorizing, economic analysis
Economic Thought
does not lose its moorings of reality in the sense that it is always in the context of a
certain economic framework-real or assumed. For example, a good deal of
economic thought has developed in the context of a market economy and on the
NOTES assumption of ‘economic rationality’ on the part of individual economic units, though
economic science as a whole had its origin in the form of ‘political economy’-or
the study of the economic problems and their solutions which the society as a
whole or its representative, the government, faced. The development of economic
science is intimately related to the development of economic environment; and the
two interact with each other. Economics assumes the framework of technology
and resources available to the society as a whole as also the set of relationships
with other economies. The appropriate identification, description and analysis of
the responses of economic units is an important stage in the formulation of economic
generalizations. Now the exact nature of responses depends upon the institutional
framework of the society. As the institutionalists claim, there are two types of
responses by individuals, the natural or instinctive responses and the acquired
responses. The latter, when performed by a large number of individuals in a
particular way assume the form of social customs and behaviour. This way the
customs and behaviour get crystallized into institutions. Economic theorizing and
investigation, therefore, have to be in the context of and within the framework of
an economy. Through economic theorizing and investigation the efficiency of an
economy in the context of its particular institutional framework is judged and
remedial actions, if any, prescribed.
There are several reasons to believe that we should not expect a uniformity of
conclusions and opinion amongst economists on issues of either theoretical or
practical importance.
(a) Economics is a social science in which controlled experiments are next to
impossible. Accordingly there is always a possibility of difference of opinion
regarding the choice of relevant causal forces and the process of their
interaction. In the same way, in abstract theorizing, the choice of the relevant
factors and forces as also that of the limiting assumptions is important.
(b) There are chances that differences would exist with reference to the
assessment of facts, especially when they are mixed with other ones.
Determining the precise direction and strength of a particular force is a
matter of investigation, judgement and opinion. Relevant phenomena are
investigated and estimated with the help of available data and tools and
techniques of analysis. All these things are subject to a modification. Data
keep on changing; old data are replaced or supplemented by new ones.
Similarly, there is a constant improvement in the tools and techniques of
analysis.
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(c) Economic analysis admits a wide variety of methods. As a result, even with Introduction to
Economic Thought
given tools and objectives, the method of analysis may vary from one analyst
to the other and yield non-identical results.
(d) Apart from these reasons, differences arise on account of the purpose for
NOTES
which an economic investigation is being undertaken. This is more so in the
case of practical problems and their solutions. The cause-effect relationship
between different forces would be assigned to suit a particular philosophy
and purpose. Thus during the British colonial days, the Indian economists
were generally motivated by nationalist feelings and objectives and they
would look at the Indo-British economic relationship from the point of view
of Indian interests, while the same issues would be considered by the British
economists from a different angle.
(e) Another reason for the divergence of opinion arises on account of the
materialistic and idealistic attitudes of the economists. Economists, in the
ultimate analysis, are as much human beings and individuals as anyone else,
and they are quite frequently swayed by the final conclusions which they
would like to press forth.
Check Your Progress

1. In what context should the role and growth of each significant theory be
viewed?
2. Where are references to economic questions found in old literature?
3. In what context has a good deal of economic thought developed?
4. What is the development of economic science intimately related to?
1.3 DEVELOPMENT
Let us now look at the causes which account for a tardy development of economic
thought in its early phases.
We have noted earlier that human society is a complex phenomenon and is
subject to a large number of interacting forces. To begin with, therefore, economic
ideas were bound to be tied up with other ideas. Man’s activities are related to his
environment. Between environment and economic ideas, there is a close
relationship. Environment motivates thinking, and thinking in economic matters
brings forth explanations. Like most social disciplines, which have emerged over
time, economic ideas were also problem-oriented to begin with. Pure abstraction
came only later and even then the moorings of abstract analysis have always been
in the realm of reality. Accordingly, the tendency to bring in non-economic factors
in the study of economic problems slowed down the progress of economic science.
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Introduction to It is not to be claimed that with the passage of time, economic aspects of
Economic Thought
our life have got delinked from non-economic aspects. The interdependence
between the two is significantly strong even now and we should not expect
economic science to become fully detached from the considerations of non-
NOTES economic phenomena and social philosophy. As Taylor puts it, we cannot believe
in the possibility “that economic science, or theoretical work in it, is or has been or
can be so perfectly or absolutely scientific—objective, unbiased, neutral, and
throughout secure as opposed to ‘speculative’—as to make it possible to say,
generally, that the great contributions which have been made to its development
by great economists have been wholly uninfluenced by the political philosophies
shared, and often partly created, by those economists in their other roles as more
than that—human thinkers, in their human environments, about human life and
affairs in general.” What contributed to the development of economics as a separate
science was the ever-growing importance of economic phenomena as such.
It should be noted that in the early stages of economic development, the
share of economic problems in the totality of social life was a small one, both in
absolute and in relative sense, and therefore, there was not much to study by way
of pure economics. Early human civilization grew and prospered in warmer climates,
near areas where nature was bountiful. There was not much of a difficulty in
procuring the means of livelihood for the simple life which those people led. As a
result, economic problems did not appear as pressing as they did in later times.
‘Though economic phenomena existed in the relatively static life of primitive man,
economic life was so limited, in the earliest ancient cultures, and so monotonous
as virtually to preclude speculation in humdrum activities.’ Before the advent of
capitalism, economic organization was a simple one. Division of labour was not
carried sufficiently far and therefore a good deal of production was meant for self-
consumption. Exchange and marketing problems were simple and of limited
importance. On this account, therefore, there was a dearth of the complex economic
phenomena and the problems they create. For example, there was a lack of specific
problems of public finance and the matters of fiscal policy. The economic relations
between various individual economic units on the one hand and those between the
economic units and the State on the other hand were quite simple and left insufficient
scope for adjustment and manipulation. Accordingly, the volume and importance
of early economic thinking could be of only a limited significance. ‘Man cannot
begin to theorize about the economic process as long as this is of so simple a
character as to require no special explanation.’
Economic phenomena failed to command adequate attention till the
emergence of capitalism. Those who had the time and resources to advance the
study of economics, did not have enough of will and incentive to do so. Haney
elaborates this point by saying that interest in certain economic problems is
specifically conducive to the development of economics; but there were times
when some of the interests most conducive to economic study were specifically
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deprecated. The climate of opinion and the regnant system of values did not favour Introduction to
Economic Thought
growth. The degree of improvement in man’s material lot that was considered
desirable and to be expected was quite limited. The medieval theorist condemned
as a sin precisely that effort to achieve a continuous and unlimited increase in
material wealth which modern sciences applaud as a quality, and the vices of NOTES
which he reserved his most merciless denunciations were the more refined and
subtle of the economic virtues. ‘He who has enough to satisfy his wants’, wrote a
Schoolman of the fourteenth century, ‘and nevertheless ceaselessly labours to
acquire riches, either in order to obtain a higher social position, that subsequently
he may have enough to live without labour, or that his sons may become men of
wealth and importance-all such are incited by a damnable avarice, sensuality, or
pride.’ Two and a half centuries later, in the midst of a revolution in the economic
and spiritual environments, Luther in even more unmeasured language, was to say
the same.
This lack of interest in a number of problems naturally hindered the growth
of economics. The typical organization and philosophy were such that there was
not much concern about the economic welfare of the society as a whole. In some
cases, artisan and labour classes were even despised. The upper layers of social
groups were assured of a substantial share of the national produce, and they showed
little concern for the poverty of the masses. Accordingly there was a kind of
indifference or even aversion to the study of economic phenomena. Instead greater
attention was paid to fine arts, music and the like.
Till the close of Middle Ages, non-economic aspects of social life were
accorded a great importance. The weightage assigned to material well-being in
human life for the attainment of happiness was quite low. Instead a life which
conformed to a code of moral values was considered preferable to the one which
gave ‘undue’ weightage to material well-being. Materialistic gains at the cost of
other aspects of a ‘good’ life were looked at with disfavour. This philosophy in
which idealism played a predominant part prevailed in Western countries also till
mercantilist philosophy shifted this composition in favour of materialism. At the
same time, the Western economies started showing a kind of dynamism through
which the totality of economic phenomena grew. More and more economic
problems were faced, and attempts to solve the existing ones created yet additional
problems. Of course, it is not contended that idealism has vanished now and
materialistic outlook holds the ground, but there is certainly a sufficient concern
with materialistic aspects of our social life. There is now an active interest in
formulating the criteria for the efficient working of an economy and for studying its
actual performance in their light. So while in the past, economics was only a
problem-oriented study, now it also covers abstract theorizing and generalizations.
The contributions made by different schools of economic thought, and the meaning,
rationale, and logic of those contributions must be viewed in the context of the
economic institutions and framework which these schools assume. At the same
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Introduction to time, in numerous cases the actual theorizing and conclusions have been influenced
Economic Thought
by, the methods of the analysis and their underlying philosophy. Therefore, while
studying the history of economic thought and judging the worth of various
contributions this fact of interconnection between reality and theorizing must be
NOTES kept in mind.
Haney points out that the belief in the omnipotence of the State also
discounted the need to study economics. If the State could solve most of its own
economic problems and those of the ‘higher classes’ through the use of its political
power, there was hardly any need to emphasize the role of response to economic
forces by individual economic units. The problems of State were viewed more as
political problems. The same general point concerning indifference or aversion to
economic phenomena might be made with regard to financial matters, though with
some exceptions. Furthermore, as between nations also, the acquisition of wealth
was considered more a matter of political power and conquest rather than that of
economic relations.
Human beings have a natural fascination for distant and mysterious things as
compared with things which they have to deal with daily. Economic phenomena,
especially in the days of relative static and simple economic life, were slow in
arousing interest. Because of their nearness and the general superficial familiarity,
they were not singled out for special study. The things close by did not carry any
mystery and fascination.
But with the passage of time, the forces restricting the development of
economics have given way to those which favour it. The expanding economic
activities of modern governments are playing an active role in the development of
economic science. Their operations provide an important segment of the totality
of economic phenomena on the one hand and have helped in the provision of
necessary infrastructure for the growth of economic science on the other. It is now
realized the world over that the budgetary and other activities of the government
cannot be neutral in their effects on the economy. This is true not only of the
centrally planned economies, or of mixed economies, but also of the market
economies where the governments do not have any specific economic programme.
Though it is therefore realized that the least the government should do is to ensure
that its budgetary and other activities do not cause obstruction in the way of the
society in achieving its goals, in practice, the governments are actively engaged in
guiding and influencing their economies along ‘proper lines.’ For an efficient discharge
of its duties, a government should be in possession of relevant data. Accordingly,
these days governments have become an important source of all kinds of statistical
information. There is also an increasing output of these data in published form.
Along with the availability of data, there has been an expansion in the profession
of economists also. Knowledge of economics is now more widely spread. It is a
popular subject in the universities. There are also more and better computational
and other research facilities and an increasing use of mathematical and other
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techniques in assessing and investigating the role of different economic forces. Introduction to
Economic Thought
Formulations of abstract theories and models have helped in the development of
rigorous concepts. As a result of all these, the development of economic science is
now at a much faster rate than ever before.
NOTES
Check Your Progress
5. What kind of life was considered preferable around the close of the Middle
Ages?
6. What do the operations of modern governments provide?
1.4 NATURE AND APPROACHES
A study of economic ideas from earliest times to the present day is the concern of
the subject- ‘History of Economic Thought’. A ‘History of Economic Thought’, as
the title itself suggests, is a probe into the origin and growth of economic ideas. It
is a historical account of the development of economic doctrines as also of their
impact on economic institutions and activities. Thus the history of economic thought
deals with the origin and development of economic ideas and their interrelations.
Economic thought plays a pivotal role at least in the industrial environment of
today.
There is a difference between ‘History of Economic Thought’ and ‘History
of Economics’. History of economic thought deals with the development of
economic ideas. Economic ideas have been there ever since the birth of mankind.
History of economics deals with the science of economics. The history of economics
studies the origin and growth of commerce, manufacture, trade, banking,
transportation and other economic phenomena and institutions. In short it is a
study of the material or industrial development of the people in the past. Though
these are separate branches but there is close relationship between them.
Social dynamics is principally a product of ideas of man and environment.
The question whether it is environment which shapes ideas of man or vice versa
has been a moot controversy and reminds one of the classical problem regarding
whether the hen came first or the egg. But it is true that both ideas and environment
interact with each other. The economic ideas of people at any time are coloured
and conditioned by their environment. For example, the economic ideas of Plato
and Aristotle were influenced by the institution of slavery, for slavery was a part of
the Greek civilisation of the past. And the industrial revolution in England and the
development of the urban areas and the wage system provided the basis for the
socialist ideas of Karl Marx.
Professor Haney has defined the subject in the following words- “The subject
the History of Economic Thought may be defined as a critical account of the
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Introduction to development of economic ideas, searching into their origin, interrelations and
Economic Thought
manifestations.”
According to Schumpeter, “The sum of total of all the opinions and desires
concerning economic subjects, especially time and place float in the public mind.”
NOTES
According to Bell, “The History of Economic Thought is a study of the
heritage left by writers on economic subjects,”
Thus, the history of economic thought-”Traces out the historical changes of
attitudes, mentioning analytical performances in passing. Such history would need
to display the close association that exists within the attitudes of the public mind in
the sense defined; with the kind of problems that at any given time interest analysis
and from general attitude of spirit in which they approach their problems.”
The history of economic thought may be broadly classified into two parts -
first part deals with the origin and development of economic ideas before the
development of economics as a separate science and the second part deals with
the economic ideas since the birth of political economy as a separate science.
Theoretical Approaches: There are different theoretical approaches adopted
by scholars and philosophers from time to time in the study of the science of
economics or in analysing economic phenomena. These approaches are as under-
(i) Chronological Approach: In the chronological approach, economic ideas
are discussed in the order of time. Advantage of this approach is that it
ensures continuity and enables the reader to fix the time at which the
economic ideas have come into existence.
(ii) Conceptual Approach: In this approach, importance is given to the
development of economic concepts and ideas. The believers of conceptual
approach were not interested in the schools of thought which had popularised
a given idea.
(iii) Philosophical Approach: This approach was first adopted by Plato, the
Greek Philosopher. Afterwards it was adopted by early writers to discuss
economic ideas. Aristotle, Quesnay, Adam Smith and above all Mark, all
held definite philosophical views.
(iv) Classical Approach: Ricardo, Malthus and J.S. Mill were the economists
of the classical school. The classical economists believed that the laws of
economics are of universal application and that all economic laws could be
formulated by a simple process of reasoning from one fundamental principle.
The classical deductive approach has come in for a lot of criticism at the
hand of the historical school.
(v) Historical Approach: The historical school had its origin in Germany. The
historical approach lay emphasis on the inductive method. They believed
that the laws of economics are not universal in nature. They are relatively
conditioned by time, place and historical circumstances.
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(vi) The Neo-classical Approach: The Neo-classical approach wants to Introduction to
Economic Thought
improve the classical theories by suitably modifying them by taking into
account the modern developments in the theory of economics. The Neo-
classical approach is an attempt at the reconstruction of the classical theories.
The economists of this approach believed that Induction and deduction are NOTES
both necessary for the science, just as the right and left foot are needed for
walking.
(vii) Welfare Approach: The welfare approach aims at providing a basis for
adopting policies which are likely to maximise ‘social welfare’. Welfare
economics is concerned with the conditions which determine the total
economic welfare of a community. The welfare approach emphasises on
utility, demand and consumption.
(viii) Institutional Approach: The institutional approach is a twentieth century
phenomenon. Veblen was the founder of this approach. The advocates of
this approach assert that the “price system” should not be the central theme
of economics. They attach importance to group behaviour which is constantly
changing. They consider economic laws as relative. They believed that habits,
customs and legal forms are the chief factors of governing human behaviour.
(ix) Keynesian Approach: A major development in modern economics is
associated with the name of J.M. Keynes. Keynesian approach is termed
as Keynesian Revolution. The core of the Keynesian approach is that it
deals with the problems of the economy as a whole, and not only with those
of the individual consumer. One of the greatest contributions of Keynes
was to tie economic analysis to the great public problems of the day.
Significance of History of Economic Thought: The significance of the history
of economic thought lies in the benefits that accrue from it. The study of the subject
gives one an insight into the evolution of economic theory and the formulation of
policies which controlled economic life, from the earliest time to present day.
Thoughts of every age in the context of their surroundings have governed individual
actions and policies and are therefore, important for us. The chief advantages of
the study of history of economic thought have been very sell summed up by professor
Haney as under-
1. The study of ‘History of Economic Thought’ reveals that there is a certain
unity in thinking of man right from the earliest times to the present day. The
economic thought and this unity connects us with ancient times. Thinking is
the heritage of man. In every age, thoughts have been derived from the
environmental influences. Apparently, they look new but the fact remains
that there is a great continuity of ideas. It may be said that ideas belonging
to an age are drawn from those of earlier ages and under the influence of
different economic environment simply change in form and emphasis so as
to face problems of the times.
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Introduction to 2. In spite of a tremendous improvement in the science of economics, even
Economic Thought
today the nature and scope of economics is under dispute. The study of
economic thought assists us in tracing the origin and development of
economics, and in understanding its nature, scope and relationship with
NOTES other sciences. Economics, being a science, is dynamic and without studying
ancient thought we cannot correctly assess the developments that have taken
place in its nature and scope. So there is a great value in studying the history
of economic thought.
3. The study of economic thought leads to a change in the outlook of the
reader. He no more remains dogmatic. He starts examining and assessing
critically the practical value of each idea and theory in the context of his
own times and conditions. Thus it is clear that most of the economic ideas
are relative. They are conditioned by time, place and circumstances. Many
economic ideas of the past had their roots in institutional arrangements.
Aristotle justified slavery because slavery was an accepted social fact of
the Greek civilisation. Mercantilists’ theories of foreign trade, physiocratic
ideas about agriculture and Ricardian theory of rent are still studied.
4. The study of the history of economic thought reveals that there has never
been an age in which ideas have not developed. The presumption that Middle
Ages were dark ages leads one to think that no new ideas or philosophies
were developed during this period. Of course there are some writers on the
subject who deny continuity in the evolution of economic thought. They
regard the Middle Ages as a complete break because the thinker of Middle
Ages emphasised on the negative aspects of life. This however, is not totally
true. For even during that period there was speculation on economic topics
such as money, interest and the ideas of these thinkers were similar to those
of Greek thinkers of the past.
5. A study of economic thought provides a broad basis for comparison of
different ideas which proves to be of great value. It will enable a person to
have a well-balanced and reasonable judgment. He is neither guided by his
own fads nor does he lose courage and get confused by controversies. He
cares more for the progress of the science.
6. By a study of economic thought, one may be able to take an objective point
of view. He will realise that economics is quite different from economists
and that the two are separate entities altogether. While economics is a science,
economists are only human beings. The students will realise that economics
is one thing and economists are another. They may find differences of opinion
among individual economists. Discussion and controversies on the simplest
point may confuse them, but later they realise that economics is a science, a
systemised body of doctrines developed during the course of centuries,
encircled by the view of different economists and gain confidence without
caring for the personalities.
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7. By the study of the History of economic thought, students will realise that Introduction to
Economic Thought
old doctrines never die; they only fade away with a strange power of
recuperation in an appropriate environment. For example, some ideas of
Keynes, one the greatest of modern economists, may be traced back to
socialist writers such as Sismondi and Proudhon and to Malthus. NOTES
8. By the study of History of economic thought, we come to know the persons
responsible for formulation of the principles that constitute the framework
of economics as at present taught. It will also help us to know at what
period these principles were enunciated and what circumstances were
accounted for their enunciation just at that period.
9. The study of ‘History of Economic Thought’ also reveals the differences in
the points of view of various thinkers and shows how a particular point of
view has been built, difference in opinion and points of view are bound to
occur owing to the difference in the basic philosophy of life and the method
adopted by each thinker in studying a problem. Thus students analyse these
different philosophies that are accepted or rejected on their own merits.
The study of the subject undoubtedly proves to be a great guiding and
correcting factor. The significance of the study of the History of Economic
Thought can therefore, hardly be over-emphasised. It is an essential tool of
knowledge.
Check Your Progress

7. What does the history of economic thought deal with?
8. What does history of economics study?
9. Why were the economic ideas of Plato and Aristotle influenced by the
institution of slavery?
10. What do the two parts of history of economic thought deal with?
1.5 SIGNIFICANCE OF THE HISTORY OF

ECONOMIC THOUGHT
It is always helpful to have some knowledge of the history of thought of the subject
one is interested in. Every science grows and evolves over time and during the
process of its refinements and expansion, attracts numerous debate and
controversies which not only relate to the subject matter of the discipline itself, but
also to its application to the problems of actual life. As such a study of economic
thought enables a student of economics to realize that the current fluidities in
economic theories and inconclusiveness of various branches of thought are not
something to be disturbed about; it is not indicative of a weakness of the science,
but is a normal phenomenon with any science.
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Introduction to The study of economic thought lends a perspective to the subject and enables
Economic Thought
the student to have a wider view of what he is studying. It enables him to realize
that economics as a science is a comprehensive whole and that individual theories,
tools and techniques have their meaning, importance and rationale only in the
NOTES context of that overall totality. In the absence of a knowledge of the history of the
economic thought, a student is apt to be misguided into believing that the theories
he is studying are either final or have no relevance at all. This is more so because
each theory is presented on the basis of certain assumptions and in the context of
a given economic system with all the implied institutional factors. If a student gets
a feeling of the finality of a theory, he may not feel free to use his analytical abilities
for a deeper probe of the same.
Alternatively, he may be impressed by the abstraction of a theory and the
unrealistic assumptions upon which it is based and might therefore come to the
conclusion that every abstraction in economics is an equally useless exercise.
Secondly, a knowledge of economic thought enables a student to realize
that economics is a dynamic science. On the one hand, economic science moves
forth on account of the fact that new tools, techniques and concepts are being
added to the armoury of the economists and on the other additional economic
phenomena are being investigated and analysed. Moreover, the very dynamism of
the world economies lends an element of dynamism to economics also. By studying
economic thought a student is equipped to assign to current controversies and
debates the place they deserve. He is not bogged down or disheartened by the
heated controversies and differences of opinion. These things appear to him signs
of life within the science of economics and he knows that these are indicators of
continuous development and refinement.
Thirdly, a study of the history of economic thought brings home the fact that
economic aspects are only a part of the totality of our life. Economics is only one
of the social sciences. It does not explain the total behaviour of a society, nor does
it provide a total solution to any problem. There is a need to study economic
problems in the context of their overall social framework and the interdependence
of economics with other social sciences should not be lost sight of. This realization
also enables the student to appreciate the fact that similar problems would not
yield similar solutions in the hands of different economists. Economists are also
human beings living in a society, and the solutions which they offer must be
conditioned by the totality of their existence and views. There would be subjective
elements involved in the interpretation of economic phenomena and so they would
propose different solutions according to their personal views. An economist with
leftist views would advocate solutions which would be different from the ones
advocated by an economist of rightist views. Some solutions would take note of
the administrative and political difficulties in implementing the same, others would
not. In this way the contribution to economic science made by any individual
economist or a school of thought is to be appreciated only in the context of the
underlying philosophy.
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Introduction to
Economic Thought
Check Your Progress
11. What does the study of economic thought enable a student to do?
12. Which fact does the study of economic thought bring home? NOTES
1.6 ANSWERS TO CHECK YOUR PROGRESS

QUESTIONS
1. The role and growth of each significant theory, the set of theories and policy
prescriptions provided by each school and even the significant contributions
by individual economists must be viewed in the context of the prevalent
economic environment.
2. References to economic questions are scattered almost everywhere in old
literature. They are found in Plato, Aristotle, and others. Aristotle, for
example, discusses currency, population and slavery.
3. A good deal of economic thought has developed in the context of a market
economy and on the assumption of ‘economic rationality’ on the part of
individual economic units.
4. The development of economic science is intimately related to the development
of economic environment; and the two interact with each other.
5. Around the Middle Ages, a life which conformed to a code of moral values
was considered preferable to the one which gave ‘undue’ weightage to
material well-being.
6. The operations of modern governments provide an important segment of
the totality of economic phenomena on the one hand and have helped in the
provision of necessary infrastructure for the growth of economic science on
the other.
7. The history of economic thought deals with the origin and development of
economic ideas and their interrelations.
8. History of economics studies the origin and growth of commerce,
manufacture, trade, banking, transportation and other economic phenomena
and institutions.
9. The economic ideas of Plato and Aristotle were influenced by the institution
of slavery, for slavery was a part of the Greek civilisation of the past.
10. The first part deals with the origin and development of economic ideas
before the development of economics as a separate science and the second
part deals with the economic ideas since the birth of political economy as a
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Introduction to separate science.
Economic Thought
11. The study of economic thought enables a student to realize that economics
as a science is a comprehensive whole and that individual theories, tools
and techniques have their meaning, importance and rationale only in the
NOTES
context of that overall totality.
12. A study of the history of economic thought brings home the fact that economic
aspects are only a part of the totality of our life. Economics is only one of
the social sciences.
1.7 SUMMARY
 Economic science, like other sciences, has had to undergo a process of

evolution and is the result of innumerable contributions by various thinkers.
In many cases, specific contributions went unnoticed for a period of time,
while certain other contributions were recognized during the very life-time
of their contributors.
 Economics is a dynamic science, a feature that it acquires on account of
various reasons. This characteristic of it partly follows from the fact that it is
a social science. It brings forth a body of generalizations which, as in other
sciences, involve cause-effect relationships.
 The role and growth of each significant theory, the set of theories and policy
prescriptions provided by each school and even the significant contributions
by individual economists must be viewed in the context of the prevalent
economic environment. At the same time, the study must take note of the
way economic thought influenced the movement of economies and the
resultant effects on economic science itself.
 Individual economic ideas are almost always problem-oriented. There are
generalizations about certain facts and problems and the desirable solutions
thereof. Among various problems which man faces in his daily environment,
there are economic problems also.
 Economic thought is closely related to economic environment. The growth
of economic science can be traced along with the growing complexity of
the world economies. Even in pure abstract theorizing, economics has its
moorings in specific economic framework of a society.
 Economic analysis admits a wide variety of methods. As a result, even with
given tools and objectives, the method of analysis may vary from one analyst
to the other and yield non-identical results.
 Before the advent of capitalism, economic organization was a simple one.
Division of labour was not carried sufficiently far and therefore a good deal
of production was meant for self-consumption. Exchange and marketing
problems were simple and of limited importance.
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 Till the close of Middle Ages, non-economic aspects of social life were Introduction to
Economic Thought
accorded a great importance. The weightage assigned to material well-
being in human life for the attainment of happiness was quite law.
 Human beings have a natural fascination for distant and mysterious things as
NOTES
compared with things which they have to deal with daily. Economic
phenomena, especially in the days of relative static and simple economic
life, were slow in arousing interest.
 There is a need to study economic problems in the context of their overall
social framework and the interdependence of economics with other social
sciences should not be lost sight of.
1.8 KEY WORDS
 Physiocracy: It is an economic theory developed by a group of 18th-

century Age of Enlightenment French economists who believed that the
wealth of nations derived solely from the value of “land agriculture” or “land
development” and that agricultural products should be highly priced.
 Marginalism: It is a theory of economics that attempts to explain the
discrepancy in the value of goods and services by reference to their
secondary, or marginal, utility.
 Mercantilism: It is an economic policy that is designed to maximize the
exports and minimize the imports for an economy. It promotes imperialism,
colonialism, tariffs and subsidies on traded goods to achieve that goal.
 Materialism: It refers to a tendency to consider material possessions and
physical comfort as more important than spiritual values.
 Socialism: It is a political and economic theory of social organization which
advocates that the means of production, distribution, and exchange should
be owned or regulated by the community as a whole.
1.9 SELF ASSESSMENT QUESTIONS AND

EXERCISES
Short-Answer Questions
1. Along which two lines does economic thought develop?
2. How can the place of abstraction in economics be noted?
3. Write a short note on instinctive and acquired responses.
4. Why did economic problems not appear pressing in earlier times?
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Introduction to 5. How do the ‘History of Economic Thought’ and ‘History of Economics’
Economic Thought
differ?
6. What did the medieval theorists condemn?
NOTES 7. How is the study of economic thought helpful to a student?
Long-Answer Questions
1. Discuss the deductive and inductive methods of analysis.
2. Analyze the reasons responsible for lack of agreement in economic thought.
3. Explain why in the early stages of economic development, the share of
economic problems in the totality of social life was a small one.
4. Examine any four approaches used for analysing economic data.
5. Discuss how the lack of interest in a number of problems naturally hindered
the growth of economics.
1.10 FURTHER READINGS
Hajela, T.N. 2000. History of Economic Thought. New Delhi: Konark

Publications
Loganathan, V. 1998. History of Economic Thought. New Delhi: S. Chand and
Company.
Sankaran, S. 2000. History of Economic Thought. Chennai: Margham
Publications.
Desai, S.S.M. and N. Bhalerao. 1999. Economic History of Indian. New Delhi:
Himalaya Publishing House.
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Mercantilism
UNIT 2 MERCANTILISM
Structure NOTES
2.0 Introduction
2.1 Objectives
2.2 Introduction and Forms
2.3 Thomas Mun
2.5 Summary
2.6 Key Words
2.0 INTRODUCTION
Mercantilism is an economic policy that aims to increase exports and reduce imports
by a country in order to maximize gains thereby leading to an accumulation of
wealth. It promotes a large scale production of goods and services by employing
a large labour force at low wages. It lays emphasis on concepts like production,
balance of trade, a large population to provide labour, interest rates etc. It developed
as a means to increase wealth and hence the power of a nation to tackle with rival
nations and gain an upper hand over them by the maintenance of armies and navies,
both of which, required a huge amount of money.
2.1 OBJECTIVES

 Analyse the concept of mercantilism
 Discuss the main characteristics of mercantilism
 Describe the views of Thomas Mun on mercantilism
2.2 INTRODUCTION AND FORMS
Commercial activity in Europe started as early as the Crusades with the discovery of
silk, spices and other rare commodities. Trade picked up in the second half of the
middle ages with the rise of the ‘spirit of discovery’, the network of trade routes
multiplied as new lands were discovered, sea routes to the east were discovered by
the likes of Vasco da Gama. The 15th and 16th century saw great amassing of
wealth, rise of capitalism, and new economic practices. There was a shift from the
Mediterranean to the west Europe countries as the hub of commercial activity virtually
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Mercantilism ending the monopoly of the Turks on trade with the East. These nations were now
competing against each other in the quest for wealth and to meet their goals, extracted
all the wealth from their colonies. It was the Portuguese who established their
supremacy in trade with the east following their building a settlement in Goa in 1510.
NOTES This led to trade between Europe and China in the 16th century and later a Portuguese
establishment in Macau, South China, in 1557. This was followed by Dutch and
later Transatlantic trade of the English empire as well.
The commercial revolution spanning from the 16th to the 18th century was
marked by expansion, increase in trading activity and the rise of mercantile culture.
There was also a spurt in the banking sector and rise in investment apart from the
manufacturing sector. Close at the heels of the commercial revolution came the
industrial revolution in the middle of 18th century.
The following were the factors of the growth of commercial activities in
Europe.
(i) Geopolitical Factors
The fall of Constantinople in 1453 necessitated the discovery of new trade routes
as Turks controlled the Mediterranean region. The English altered their laws to the
advantage of their navy so that their mercantile aspirations would not be hampered.
A consequence of this was that the Hanseatic League that carried on trade in the
northern region of Europe became dysfunctional. Spain remained a dominant force
throughout this period because of its martial culture owing to the Reconquista and
carried on its expansionist policies. However, competition grew between the
European nations in their quest for wealth and greater power.
(ii) Monetary Factors
Trade grew as there was a greater need of precious metals with the introduction of
silver currency. The Europeans faced a crunch of gold and silver as these were spent
on trade with the East. With their ore mines also exhausted or containing metals too
deep seated to be extracted the only available choice was furthering trade.
(iii) Technological Factors
The maritime inventions and scientific discoveries from the 16th to the 18th century
helped the colonial expansion of European nations. The first atlas along with 53
other maps was published in a collection called Theatrum Orbis Terrarum in 1570.
These were created by Abraham Ortelius and published by Gilles Coppens de
Diest. By the end of 1572, Latin, French, Dutch and German editions of the atlas
emerged and stayed in vogue till 1612. Experiments were carried on in ship building
and skeleton based ship building, Galea and other tools for easy navigation emerged.
Issac Newton’s theories on motion published in the Principia helped sailors
manoeuvre using their knowledge of the motion of moon. By 1670, the earth was
measured in latitudes. There was now the quest to determine longitudes and the
British Parliament even announced a prize for this purpose in 1714.
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(iv) Sociological Factors Mercantilism
The development of mercantilism was the consequence of the amalgamation of

cultural, religious, political and economic factors. In order to examine these causes,
what may be highlighted is that in the start of the 16th century, Europe came NOTES
across great religious and intellectual awakening because of Reformation and
Protestantism.
Erasmus and Martin Luther who started these two movements, respectively,
gave a great stimulus to the concepts of individualism and private freedom. These
movements went a long way in evolving the ideas of property and contract rights,
which ultimately led to the growth of commerce and free exchange. Renaissance
played an even more important role and stressed on the element of humanism. It
challenged the medieval theologian idea that happiness in heaven should be preferred
over worldly happiness; rather, it asserted that happiness on this earth was to be
preferred over the promised pleasures of the other world.
In other words, it emphasized on the materialistic factor of human happiness.
A large number of writers, artists and philosophers emphasized the economic basis
of the society in their works, once the principles of humanism and individualism
were accepted. They shook the foundations of the edifice of the church theology.
In the economic sphere, the decline of feudalism contributed to the growth
of mercantilism. The feudal system was distinguished by economic self-sufficiency,
agricultural production and absence of exchange economy. The agriculturists were
needed to work free of charge on the fields of the lords for a stipulated period.
They were also required to work as soldiers for the lords during war times.
As there were no organized industries and even commercial crops were not in
much demand, these agriculturists worked for local self-sufficiency in food grains.
In the absence of organized markets, the manufacture was undertaken mainly to
meet the local requirements. This led to the development of an independent domestic
economy. It was based on local self-sufficiency. Especially, there was no effective
state organization. In the cities and towns, the guilds and municipalities tried to
regulate the trade between the various localities. The surplus acquired by the
manorial lords could be channelized only in trade, especially, overseas trade.
Mercantile activities first grew in the Scandinavian countries because of
their powerful navy that could sail through the deep sea even across the Atlantic.
Later, this efficiency came down to south-west Europe in Portugal and Spain,
which had the added advantage of access to the Mediterranean Sea. England
entered into the field in the 16th century.
Definition of Mercantilism
Mercantilism as an economic ideology started in Europe in the 18th century. It had
its roots in the commercial revolution that had started in the 16th century. Its main
aim was to increase a nation’s wealth by government regulation of all of the nation’s
commercial interests.
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Material 23
Mercantilism The commercial revolution was a phase of European economic extension,
which lasted from more or less the 16th century until the early 18th century. The
commercial revolution, along with other changes in the early modern period, had
spectacular effects on the world.
NOTES
No universal definition of mercantilism is completely satisfactory; however, it
may be thought of as a compilation of policies made to keep the state affluent by
economic regulation. These policies may or may not have been applied at the same
time or place. Mercantilist ideas have developed over the centuries in reaction to the
development of other theories of global political economy, namely liberalism and
structuralism, and as the global political economy itself has altered. Mercantilism is
an economic strategy where a nation tries to accumulate as much money as possible
and by whatever means necessary. It was thought that the richer the nation, the more
powerful it was. Mercantilism is an economic theory that states that the world only
contained a fixed amount of wealth and that to increase a country’s wealth, one
country has to take some wealth from another through having a higher import/export
ratio and through the actual conquest of new lands and resources. This was considered
essentially fair as an effort to achieve economic unity and political control. The
following concepts are also associated with mercantilism:
(a) Mercantilism refers to the supposed mercantilist period of European
history (approximately 16th–early 18th century) when the
contemporary idea of the ‘nation state’ was born.
(b) Economic gains by one nation state usually came at the expense of
other nation states (as states fought for territory), thus leading to a
zero-sum game. In a zero-sum game, for example, poker, what one
party wins is equal to what the other loses.
(c) The mercantilist phase of history overlaps with the phase of ‘classical
imperialism’, when war, conquest and colonial developments were
frequent occurrences.
Mercantilism: Expansion and Rivalries
With the increase of commerce, conflicting individual trading interests came to the
fore. Almost all of them looked for a strong central authority to look after them
against their competitors. In the absence of a national government, this was not
feasible and the relationship was definitely a weak link.
The growth of commerce and development of domestic economy gave rise
to the issue of labour and distribution. However, possibly the most significant
factor that stimulated the development of mercantilism was the materialization of
the exchange economy.
This resulted in the development of international trade and encouraged large-
scale production. For a fuller exploitation of the available economic resources, it
was felt that the economic life should be regulated. The urge for new markets resulted
in the discovery of new islands and countries and thus, the development of colonialism.
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In short, it can be said that mercantilism was motivated by factors like decline Mercantilism
of feudalism, lack of state organization, rise of free labour classes, competition

and development of exchange economy.
But, the greatest challenge came from industrial capitalism. The merchants
NOTES
carried on the business irrespective of national interest. When industrial capitalism
came in England, for instance, English foreign trade was dominated by the East
India Company, which was purchasing high quality cotton goods from India and
selling them in England and her colonies. This harmed the interest of Lancashire
cotton kills. From about the end of the 18th century, continuous pressure from the
industrialist capitalist of England led to the curbing of the activities of the East India
Company, and, finally, it closure. Industrial capitalism thus came to dominate the
Western economy, and England was at its head.
Forms of Mercantilism
The mercantilist policies took many forms. Domestically, governments tried to
encourage mercantilism through the following means:
 Offered capital to new industries
 Exempted new industries from guild rules and taxes
 Established monopolies over local and colonial markets
 Granted titles and pensions to successful producers
In the trade policy, the government assisted local industry by imposing tariffs,
quotas and prohibitions on imports of goods that had competition with local
manufacturers. Governments also forbade the export of tools and capital equipment
and the mass departure of skilled labour that would permit foreign countries, and
even the colonies of the home country, to compete in the manufacturing of
manufactured goods. Simultaneously, diplomats encouraged foreign manufacturers
to move to the diplomats’ countries.
Shipping was particularly significant during the mercantile period. With the
increase of colonies and the shipment of gold from the New World into Spain and
Portugal, the control of the oceans was thought to be crucially important to national
power. The governments of the era developed strong merchant marines since ships
could be used for merchant or military purposes. In France, Jean-Baptiste Colbert,
the minister of finance under Louis XIV from 1661 to 1683, increased port duties
on foreign vessels entering French ports and offered bounties to French shipbuilders.
In England, the navigation laws of 1650 and 1651 forbade overseas vessels
from engaging in coastal trade in the country and stressed that all commodities
imported from the continent of Europe be transported on either an English vessel
or a vessel registered in the country of origin of the commodities. In conclusion, all
trade between England and its colonies had to be carried in either English or
colonial vessels. The Staple Act of 1663 extended the Navigation Act by making
it essential that all colonial exports to Europe be landed through an English port
before being re-exported to Europe. Self-Instructional
Material 25
Mercantilism France, England, and other powers had strong navigation policies. These
policies were mainly directed against the Dutch, who controlled commercial marine
movement in the 16th and 17th century. During the mercantilist era, it was frequently
proposed, if not believed, that the principal advantage of foreign trade was the
NOTES import of gold and silver. According to this viewpoint, the advantages to one
nation were matched by expenditures to the other nations that exported gold and
silver, and there were no overall gains from trade. For nations almost regularly on
the verge of war, draining one another of precious gold and silver was thought to
be approximately as desirable as the direct advantages of the trade.
Essence of Mercantilism
The essence of mercantilism was exchange of commodities for profit. It needed
colonies as ready markets for buying and selling things at profit without competition.
In the commercial period America was colonized by the Spaniards, the Portuguese,
the British and the French.
It is not easy to state in which year or century Mercantilism came into existence
and died out. According to L.H. Haney, the period of mercantilism was 16th to
18th century. Alexander Gray revealed, that Mercantilism came into existence at
the end of fourteenth century or beginning of fifteenth century. Cannan has asserted
that Mercantilism proper only appeared in the 17th century. In fact it was in the
seventeenth century that maximum number of mercantilist writings appeared.
According to Newman, “The economic views which prevailed during the
period falling roughly between the end of middle age and the beginning of the
American Revolution have been named as the commercial or mercantile system
by Adam Smith.”
According to Haney. “Mercantilism comprises the economic views which
prevailed among European statesmen from sixteenth to the latter part of the
eighteenth century.”
The economic ideas and policies which were followed by European statesmen
from fifteenth century until the second half of the eighteenth century have been
described as mercantilism. Like other systems of thought, it was a system comprising
the views of many writers who were spread throughout Europe. It covered such a
long period that variations and amendments, refinements and improvements in the
views according to changing conditions of time and local circumstances were quite
natural. The early mercantilists believed that the wealth of a nation consisted in the
amount of bullion (gold and silver) possessed by it. So they suggested ways and
means to increasing the stock of gold and silver in the country.
It may be stated that the growth of money economy and the rise of nations
were the corner-stones of Mercantilism and it began to disappear with the industrial
revolution and the growth of political freedom
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Different Names of Mercantilism-Mercantilism prevailed in many countries Mercantilism
whose conditions were different and so the difference in the views of writers of
one country and those of other countries was bound to occur. That’s why
Mercantilism has been known by different names in different countries.
NOTES
A. It was known as metalism because of mercantilists’ emphasis to increase
the stock of gold, silver and valuable metals.
B. In France it was known as Colbertism, after the name of Colbert, the eminent
Finance Minister of Louis XIV.
C. In Germany and Austria it was known as Kameralism. In the words of
Haney’ “Kameral’s affairs concerned the economy of the prince and
Kameralism was the art which maintained and administered the royal income.”
D. The mercantilists thought that the wealth of the nation could be increased by
trade and commerce. They gave importance to trade and commerce hence
mercantilism is known as a commercial system.
E. The mercantilists were against free trade. They were in favour of balance
trade. Some writers have called it Restrictive System, owing to the restrictions
imposed on the commerce for securing favourable balance of trade.
For nearly three hundred years, mercantilism was a powerful force in England,
Holland, France, Germany, Austria, Italy, Spain and in almost every other European
nations.
Factors giving rise to Mercantilism- Many political, economic, social and
religious factors were responsible for the rise of mercantilism.
Political Factors- Toward the close of the middle ages, nationalism became a
strong force. Europe changed greatly due to reformation, renaissance, and inventions.
As a result of these developments, there was a fundamental political change. It
replaced feudalism with nationalism. It resulted in the emergence of strong nation
states. Feudalism came to an end and the king became all powerful. In order to
create strong and powerful states, the importance of economic unity was also
recognised. The merchant was an important source of money and wealth. Hence
the mercantilists tried to regulate the political and economic activities of the people.
Outside of the national boundaries, there was a problem of competition
with other growing states. Each state wanted to preserve its independence and
considered the other states as its rival. The strong feeling of nationalism was actually
responsible for this situation. It was felt that a strong nation must have well
equipped army and navy to defend itself and to protect its political interests in the
outer world. It was found that the existence of armed forces implied having adequate
financial resources, which in those days were equivalent to having adequate stocks
of precious metals (gold and silver). The merchant has started their trade to other
nations to acquiring gold and silver. Customs laws and navigation laws were used
in this direction as the chief tools. In order to maintain the armed forces, the
monarchy needed wealth, which could only be achieved through a favourable
Self-Instructional
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Mercantilism balance of trade. That’s why almost all the thinkers of this age emphasised the
importance of balance of trade.
Economic Factors- There were other factors, economic in character, which gave
rise to mercantilism. Toward the end of the 15th century, remarkable changes were
NOTES
also taking place in the economic set-up of the society. Feudalism as a method of
organising agricultural production was losing ground, due to modern changes in
farming methods. Consequently income of feudal lords having been reduced, they
had to resort to trade and manufacture. Trade proved to be of such vital importance
that it shook the very foundation of socio-economic set up of the Middle Ages.
During the Middle Ages, money was scarce and emphasis was laid on self-
sufficiency. The result was that there was little exchange. But from 16th century
onwards, exchange economy became the rule. Markets developed and money
was used in exchange. The sphere of exchange was widening as internal as well as
foreign trade were fast developing. The fast growing exchange and trade
necessitated the use of money which was made available in abundance in the form
of gold and silver by the discovery of the new world. Inflation was the natural
consequence. Rising prices hit the government and the labour classes hard. The
need of the government grew to such an extent that the revenue obtained from the
royal estates and prerogatives proved inadequate and therefore option had to be
taken to increase taxation and undoubtedly the development of the industry and
commerce provided fertile ground for it. Accompanied with the expansion of
commerce & trade and increased supply of money, there started an era of cheap
means of transport, improved agricultural methods and rise in population. Most of
the mercantilist views were the outcome of these developments.
Religious Factors- During the Middle Ages, both economic and political life
was dominated by religion and ethics. The Church was more powerful than the
king. The king led a luxurious life. The reformation movement raised a voice against
the supremacy of Roman Catholic Church and challenged the absolute authority
of the Pope in religious and political matters. Protestantism gave more rational
meaning to Christianity and pointed out the importance of money, economic efforts
and thrift in man’s life, as against Catholicism which preached total detachment of
man from material things. In Europe, the king and the flourishing merchant class
adopted the protestant religion, broke all the relations with the Roman Catholic
Church and established their own churches.
The power of the Church declined and one of the monarch’s rivals for
political power was thus removed. The king had a feudal military service which
used to fight in times of war. These lords were given land to maintain themselves.
Similarly, the church was the biggest landed proprietor. The king used to derive
revenue either from the feudal lords or from his own estates. Now the king started
imposing taxes. He started maintaining a mercenary army. To the king, wealth
acquired from international trade was more important than the wealth acquired
from natural economy.
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Cultural Changes- Europe was undergoing sharp changes in terms of culture Mercantilism
too. The renaissance gave a new light and learning to the people. According to the
theological teachings of the Middle Ages, the miserable life on this earth was not to
be considered source of worry, as it will be compensated by the pleasures in
heaven. But under the impact of the reformation and the renaissance, people were NOTES
made to realise that this life was more important than the life of the other world.
These ideas were depicted in the literary and art works. Writers, artists and
philosophers, all were trying to immortalise the new ideas. In ‘Utopia’, the book
by Sir Thomas More, outlined an ideal state of society and threw a challenge to
the existing pattern of society. As a consequence, money came to occupy a place
of pride in human relations and materialism started gaining strength day by day.
Scientific and Technological Changes- In the field of science and technology,
great advancements and inventions were made which helped in strengthening
mercantilist philosophy and policies. The discovery of mariner’s compass and
invention of printing were of far reaching importance. Navigation had become
easier and it led to the discovery of new continents. Columbus discovered America.
A new sea route to India was established in 1948. The discoveries opened up the
gates to a great variety of raw materials, a wide market and a wider field for
regional specialisation. Consequently the cost of transportation had been reduced
and scope of foreign trade was extended. The invention of printing press helped in
the spread of new ideas and knowledge.
All the above factors provided an atmosphere for mercantilist views to flourish
and gain strength every day. The mercantilists were practical men. They were
interested in practical problems. Their main problem was the creation of a strong
state. That is why it has been said by Schmoller that mercantilism is merely “state
making” on the economic side. Mercantilism was not an end in itself. It was only
an economic means for a political end, the end being creation of strong state. The
mercantilists regarded wealth as a source of a nation’s power. They saw in the
wealth secret of nation’s strength.
General outlines of Mercantilism- The fundamental aim of the mercantilist
was to make his country strong. It was felt that a strong country must have well-
equipped army and navy to defend itself and to protect its political interests in the
outer world. It was found that maintaining armed forces implied having adequate
financial resources, which in those days were equivalent to having adequate stocks
of precious metals. The state power was the military power which in turn needed
wealth. Only wealthy country could have and maintain strong forces and nation’s
unity is a pre-requisite for state’s power. In general it is believed that mercantilism
aimed at strong power, though as noted above, Schmoller believed it to be national
unity. To Eric Roll, the mercantilist theory was nothing but the philosophical
expression of the capital needs of the rising merchant class. They needed a strong
state to protect them and they needed capital for trade which in those days consisted
of gold and silver.
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Mercantilism Mercantilists regarded money and bullion as the sign of wealth. They believed
that if country has mines, it can get gold and silver and it can accumulate those
precious metals by imposing restrictions on export of gold. But if a country has no
mines, it can get gold and silver only through trade. Trade must be conducted and
NOTES regulated in such a way that gold and silver may come into the country. In order
that a country may have more bullion, there must be a “favourable balance of
trade.” In other words, there should be an excess of exports over imports.
According to mercantilists, trade was the most important occupation.
Industry and manufacture were ranked second in importance Agriculture was least
important of all. Though agriculture might feed the population it brought no money
in the form of gold and silver into the country. Therefore, they thought that it was
not as important as trade and industry.
The economic doctrine of mercantilists was characterised by the following
features. In their policies:
(i) Mercantilists gave importance only to nation advantages;
(ii) Mercantilists laid great emphasis on national policies for increasing stock of
precious metals;
(iii) Their aim was maximum export and minimum imports;
(iv) They sought favourable balance of trade by direct promotion of export and
restriction of imports;
(v) The ultimate aim was the creation of a strong and powerful state.
Economic Ideas of Mercantilism- Mercantilist writers have differences of opinion
on many theories which generally describe as mercantilist theories. Mercantilism
was rooted in practice. As a practical philosophy, it was products of the minds of
statesmen, civil servants and business leaders of the day. According to Professor
Scott, Mercantilism connotes a system of doctrines, but it will not be unfair to say
that theorisation on economic matters was hardly the business, with which the
mercantilist writers were concerned in the 15th and 16th centuries. In simple words,
in the domain of thought, emphasis was shifted from political and religious to
economic matters and for this, the credit should be given to earlier mercantilists
alone. The earlier literature was scattered and fragmentary and it was only in the
17th century when mercantilist thought, was published in the form of books. To
Eric Roll, the mercantilist theory was nothing but the philosophical expression of
the capital needs of the rising merchant classes.
We shall now discuss in detail the views of the mercantilists. Their main
views are clustered in the following concepts-
1. The Role of Money- Money was considered to be the most important
source of strength to the nation. The mercantilists were of the view that
money, usually in the form of precious metals or treasure, had played an
important role in determining the economic well-being of a nation. Therefore,
the mercantilists paid a lot of attention to the accumulation of precious metals.
Self-Instructional
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It was felt that an adequate supply of gold and silver in the form of bullion was
essential to the safety of a nation. It has been said that mercantilists grossly Mercantilism
confused money with wealth. But it is only fair to say that they regarded
precious metals as a sign of wealth. According to Child, “That gold and silver
should be taken as the measure and standard of riches was well founded.”
NOTES
Nearly all the mercantilists recognised precious metals as the most important
form of wealth. They advocated storing of wealth in the form of precious
metals because gold and silver were durable and they had high value per
unit. According to William Patty, “The great and ultimate effect of trade is
not wealth at large, but particularly abundance of silver, gold and jewels,
which are not perishable nor so mutable as other commodities, but are
wealth at all times and places, so as the raising of such, and the following of
such trade, which does store the country with gold, silver and jewels etc., is
profitable before others.”
Mercantilists believed that there was a close relationship between production
or employment and quality of money in circulation. They were aware of the
existence of employed labour and natural resources in the country. So they
believed that the increase in the supply of money would help in increasing
production and export of manufactures. Hence their emphasis on the ways
and means of increasing the stock of precious metals by maximising exports
and minimising imports. In the words of Mun, “All nations who have no
mines of their own are enriched with gold and silver (acquired by increasing
export and decreasing imports).” Columbus declared in unequivocal terms,
“Gold is a wonderful thing, whoever possesses it is master of everything he
desires. With the gold one can get soul into paradise.”
2. Nationalism- Nationalism was the pivot on which their main ideas were
centered and they emphasised on the national strength and prosperity.
Schmoller and Heckscher felt that the stress was on national economic
unity, which naturally implied the enhancement of the power of the state.
Every aspect of life was made subject to regulation by the ruler. The
mercantilists believed that state intervention was necessary for the proper
management of society’s economic affairs.
Military aggrandisement and the exploitation of new countries were the chief
aims. Economically, the expansion of commerce and trade, and politically,
success in wars were the natural goals which could not be achieved without
a strong navy.
Low wages and cheap food were considered essential for decreasing the
cost of production and thus for enlarging the volume of exports. With the
object of maximising exports and minimising imports, the government put
heavy import duties to discourage imports of foreign goods and granted
bounties and other tax concessions to encourage exports.
In Mercantilism, the government allowed direct importation of foreign
workers in order to establish new industries. It fixed prices and wages in
order to encourage production. It passed navigation Acts to encourage Self-Instructional
Material 31
Mercantilism shipping and the activities of the Navy. It offered various privileges to trading
companies. It also helped in the establishment of colonies in order to secure
raw materials as well as a market for the finished goods. As there was so
much of economic activity and regulation by the state, mercantilism has
NOTES been described as a policy of perpetual governmental activity.
3. Balance of Trade- Foreign trade was considered to be the only source of
acquiring gold and silver. Thomas Mun was fully convinced that all those
nations which did not possess their own mines could become rich after
getting gold and silver from foreign countries through trade. He declared
that the ordinary means to increase our wealth and treasure is by foreign
trade. They advocated foreign trade as a tool for increasing a nation’s wealth
and treasure.
The idea of balance of trade was the central doctrine in mercantilist thought.
While talking of a favourable balance of trade, almost all of them did not
signify whether they meant an overall favourable balance of trade, or a
favourable balance with each country. Thomas Mun was the only exception
who was very clear about it.
The mercantilists believed that state intervention was necessary to promote
favourable balance of trade. With the object of achieving a favourable balance
of trade, the mercantilists followed a policy of discrimination, regulation and
protection in the matters of trade. The mercantilists gave priority to commodities
with a high labour requirement in their scheme of exports because there was
an abundant supply of unskilled labour. The mercantilist’s ideal seemed to be
zero imports, and exports only in exchange for the precious metals. The export
of raw materials was to be restricted; the imports, especially of luxurious
items, were to be kept to the minimum. However, in practice, they believed in
importing only if it was essential: if commodities could not be produced
domestically or if their production would require the transfer of resources
from export industries. According to Child, the trade which employed shipping
must be encouraged more than others, “for besides the gain accruing by the
goods, the freight, which is in such trades often more than the value of the
goods is all profit to the nations.” Sir Thomas Mun also held the same view.
Although they did not mention it specifically, the mercantilists always referred
to an overall balance of international payments.
4. Population- Mercantilists favoured a large and rapidly increasing population
for making the nation militarily strong and for increasing its productive
capacity. They believed that an increasing population meant both an increase
in potential number of soldiers and sailors and an increase in the number of
productive workers .They felt that cheap and abundant supply of labour
force would help in keeping the cost of production low thus enabling the
country to compete successfully with the world market. According to
Davenant, “people are the real strength of a country”.
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5. Production- The ideas of mercantilists on production were most primitive Mercantilism
in their nature. The felt that the process of production was one which involves
the application of human labour to resources. Consequently, they advocated
an increase in both labour and resources of production. Mercantilists
regarded agriculture as insignificant. They argued that agriculture did not NOTES
contribute directly to the strength and prosperity of the nation like foreign
trade. Mercantilists believed that foreign trade and commerce were the
most productive professions and that agriculture was the least productive.
Artisans occupied second place after the merchants. They believed that in
the national interest, manufacturing industries were more closely associated
with foreign commerce than with agriculture therefore it must receive
maximum attention from the government. They also drew distinction between
productive and unproductive labour. According to mercantilists,
manufacturers, farmers and merchants belong to the productive category
while professional persons such as doctors, lawyers, shopkeepers, stock
brokers and clergymen were included in the unproductive category. Petty
revealed that labour is the father and active principle of wealth as land is
mother. Davenant considered labour as the most important factor and
declared that “the wealth of all nations arises from the labour and industry
of the people.” Thus it is clear that land and labour were the only factors of
production which were given importance by mercantilists.
6. Rate of Interest- Among the mercantilist writers, there were two main
streams of thought on the subject of interest- one justifying the charging of
interest while the other opposing it. Thomas Mun was the leader of those
who were in favour of interest taking. In his view, money lending provided
capital to poor merchants. The mercantilists advocated a low rate of interest
on economic grounds. They believed that economic development could
proceed effectively only if interest rate was low and rate of interest could be
low only if the supply of money was adequate. Further, labour and other
sources of production would be fully employed only if the money supply
was adequate. So they argued that the accumulation of wealth would tend
to lower the rate of interest and increase the availability of credit. Thomas
Mun and his followers said that the rate of interest would be high or low
depending upon industrial conditions of the country. Manley and Locke
declared that the scarcity of money makes the rate of interest high while
plenty of money makes it low. Most of the writers were against a high rate
of interest. Davenant considered interest to be an unearned income. Further
he told, “The users who are the true drones of a commonwealth living upon
honey without of the labour, should be taxes.”
7. Wage and Rent- The mercantilists were primarily preoccupied with the
problem of production. They did not give much importance to the problems
of distribution, especially those related to the payment of wage and rent.
Petty said that the value of labour depended upon its product but as these
Self-Instructional
Material 33
Mercantilism ideas were not developed at all, they can only be treated as casual remarks.
According to Cantilon, the value of labour equals that of material which is
required for subsistence of labour. Thus, he gave the basis for the subsistence
theory of wages.
NOTES
8. Taxation- The mercantilists were in favour of the multiple tax system. Based
on the basic principle, each should pay according to the benefits received
from the state. Grotius and Pufendorf announced that man should be taxed
in accordance with the benefits received in the form of protection. While
Hobbes said that man should be taxed on expenditure incurred by him.
Petty’s views on taxation were most scientific. To use his words, “it is
generally allowed by all that men should contribute to the public charge, but
according to their share and interest that they have in public places, that is,
according to their Estate and Riches.” Some other mercantilists, who were
directly employed by the state, also expressed their views on the subject.
Generally the mercantilists favoured low custom excise duties, a tax on
interest etc. Their chief canon of taxation was that of equality.
9. Value- Value was regarded as an intrinsic quality of commodity. It depends
upon the utility of the commodity or it depends upon the satisfying power of
human being. In the mercantilist literature, one comes across two types of
value (1) intrinsic value (2) Extrinsic/ Market value. Intrinsic value depends
on human needs and desires and the power of commodities to satisfy human
wants and extrinsic value depends upon cost of production. Earlier writers
regarded value as the intrinsic worth of commodity. They emphasised the
subjective aspect called utility. The later writers regarded value as extrinsic,
they called it artificial value or exchange value. Locke and Fortrey had
drawn distinctions between natural value depending on cost and market
value depending on demand and supply.
Decline of Mercantilism
Mercantilism declined in England and other parts of the world towards the end of
eighteenth century. The following were the main reasons for the decline of
mercantilism:
(i) Under the influence of the teachings of Adam Smith, the ‘policy of plenty’
began to replace the ‘policy of power’.
(ii) The development of banking, both domestic and international, reduced the
importance of bullion (gold and silver) and coins.
(iii) The expansion of market economy showed that real estates, factories and
machinery were more important items of wealth than gold and silver.
(iv) The economic growth that took place during the Industrial Revolution made
it possible for the society to rely on competitive forces and laissez faire and
rather than promoting and regulating monopolies.
(v) The great progress made in science and technology taught people that a
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34 Material country could become richer not only by impoverishing its neighbours but
also by mastering the forces of Nature in a more efficient way. It was also Mercantilism
found that the wealth of all nations could be increased simultaneously.

(vi) During the period of mercantilism, economic life was highly regulated. There
were many regulations protecting the quality of goods. But these regulations
NOTES
which were once necessary ultimately became a barrier to progress so the
regulations were withdrawn. But we should remember that the doctrines of
mercantilism have not completely disappeared from the current scene. There
are ideas and policies extant today that resemble the ideas of mercantilism.
Criticism of Mercantilism- Mercantilist theories and policies have been criticised
by a host of writers. In fact, the decay of mercantilism began when some of the
mercantilist writers who were more liberal in their views started decrying the policies
adopted by Colbert in France and by the king of England. The storm of criticism
against mercantilism was strong in France. The main causes of conflicts were (i) a
miserable condition of agriculture, (ii) unfair taxes and (iii) a degenerated court. These
causes led to violent protests against the policies of Colbert. William Petty, Locke
and Dudley North were the main among these writers. William advocated freedom
of trade; Locke put forward the advantages of individual liberty and challenged the
basic assumptions of mercantilism. Dudley North stated that wealth did not consist
of only gold and silver. He gave primary importance to domestic trade, agriculture
and industry. He did not favour the granting of special privileges to any particular
group of merchants. The decay of Mercantilism began around the end of 18th century
when Adam Smith’s book The Wealth of Nations was published.
It is claimed that mercantilism was not a scientific system of thought. The
criticism against mercantilism and their policies were as under-
1. The Mercantilists are accused of a static approach in which the gain
of one nation could be only at the loss of the other.
2. The mercantilists went wrong in supposing that a favourable balance
of trade was the only source for bringing prosperity to the country.
3. They laid too much stress on gold and silver and neglected the
importance of other commodities.
4. It is also claimed that the mercantilists were only resounding the
aspirations of the rising merchant classes and the state power was
advocated because it was both compatible with and essential for
merchant power.
5. They overestimated the importance of commerce and underestimated
the usefulness of agriculture and other branches of human industry.
6. Their ideas regarding ‘value’ and ‘utility’ were vague and abstruse.
7. Their ideas about capital and interest were imperfect.
8. They advocated lower wages because it was through lower wages
that the cost of production could be kept low and exports could be
made at high profits.
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Mercantilism 9. The most misleading doctrine of mercantilism was the often repeated
proposition that a country can get rich only at the expense of other
countries.
10. They emphasised a large and dense population, abundance of money
NOTES
and foreign trade with a surplus balance.
11. The mercantilists regarded money and bullion as the sign of wealth.
Adam Smith challenged the mercantilists. According to Smith, the
wealth of nations can be increased by adopting the principle of “division
of labour”.
Mercantilist system has its own weakness. As an economic policy, it lacked
universal application and as a body of doctrine, it could not provide proper guidance
to the statesmen of the time. They confused the means and the end by over
emphasising the importance of bullion as if it had such great magic power as to
make it the only worthy end of national policy. They were in favour of increasing
the total productivity of the nation; they regarded wealth and labour that produce
it, as the ultimate goal of human existence.
While studying the ideas of mercantilism, one should therefore not overlook
the circumstances and problems of their times. Like all other philosophies, mercantilism
was essentially a product of its age. Mercantilists were under the circumstances,
reasonably right in believing that money was needed for expanding commerce and
trade. Being traders, they needed adequate funds for expanding trade and they
emphasised on increasing the supply of money without caring much for inflation
possibilities. Haney has remarked, “They are far from a mass of absurdities.” Their
emphasis on exports was mainly because of the fact that war was an everyday
happening in that period and they considered self –sufficiency an urgent necessity for
a country. To meet the requirement of the time, the balance of trade theory may be
justified as a temporary measure, and not permanent national policy. Similarly their
belief that the interests of the state and the individual were opposed to each other
was necessarily moulded by their feeling that state should be absolute in all matters
so that a country may gain in strength and compete with other countries without any
obstructions created by individual interests. Thus mercantilism was a body of policies
“designed by government, regulation of commerce and industry to secure a large net
profit for the state as a profit in the shape of treasure.”
Their loyalty to the state also flowed from trading interests and as commercial
capitalism gradually gave place to industrial capitalism, theoretical argument and
thinking shifted in favour of laissez-fair and free trade.
Mercantilists were not only practical administrators and traders, they also
put forward such ideas which led to the development of various economic theories
in modern times.
Important mercantilists- Mercantilists came from different walks of life. Thomas
Mun was an English Merchant, J.B Colbert was a France Minister, Philipp Wilhelm
Von Hornick was a Pamphleteer, Antonio Serra was an Italian. Antoine De
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36 Material
Montchrestien was a manufacturer of hardware in France.
Mercantilism
Check Your Progress

1. What was the commercial revolution spanning from the 16th to the 18th
century marked by? NOTES
2. What was the development of mercantilism a consequence of?
3. List the means through which governments tried to encourage mercantilism.
4. What did the fast growing exchange and trade during the Middle Ages
necessitate?
5. List two features of the economic doctrine of mercantilists.
6. Why did mercantilists favour a large and rapidly increasing population?
7. What do intrinsic and extrinsic value depend upon?
2.3 THOMAS MUN
Sir Thomas Mun was an English merchant. He was born in England in 1571, he
was the most prominent writers of his times and he served on the board of the East
India Company. A merchant by profession, he was to a very great extent responsible
for shaping the trade policies of England during his time. He has given systematic
statement on mercantilists’ principle in his book “England’s Treasures by foreign
trades”. Thomas Mun was a prince among mercantilists. It has been rightly said by
Alexander Grey that Mun has perhaps reached the closest to being the perfect
mercantilist. He was an ardent advocate of the accumulation of treasure which
would give the country enough strength to defend itself from foreign powers and
also for averting a war. Further he said that accumulation of treasures could be
possible only by reduction of imports and encouraging the exports. He suggested
heavy import duties on the goods of domestic consumption and moderate duties
on export goods.
In this book, he has clearly stated the theory of balance of trade. He stated
the theory of balance of trade in the following words, “the ordinary means to
increase our wealth and treasures is by foreign trades, wherein we must ever
observe this rule: to sell more to strangers yearly than we consume of theirs values”.
Mun has suggested following methods by which a country would have favourable
balance of trade-
1. He recommends the cultivation of waste lands. This step would help
in reducing the imports of hemp, flax and tobacco.
2. He advised a frugal use of natural wealth so that more might be left for
export.
3. He suggests that with regard to exports, “we must consider our
neighbour’s necessities.” Not only that, promotion of exports requires
that proper attention must be given to the price of commodities. If the
goods are necessities and the foreign buyer cannot buy it from any Self-Instructional
Material 37
Mercantilism other source, then they may be sold at a high price. As for other
goods, it is better to sell as cheap as possible rather than close the
market.
4. Mun suggests restraint on domestic consumption of foreign goods as
NOTES
it would also help in reducing in imports. Not only that, he advised
people to refrain from unnecessary change of fashion.
5. Mun also suggests that, the value of a country’s exports could be
increased by confining them to her own ships. In other words, Mun
was aware of the importance of the service, or invisible forms in the
balance of trade. So he emphasised the earnings from shipping
services. It must be noted that when Mun wrote his book, the
Navigation Act of 1660, which restricted the use of foreign ships, had
not been passed.
6. He said that the trade with distant countries should be considered
more profitable than trade with nearer lands. Mun encouraged trade
with far off countries.
7. He also suggests that England should be made a distributing centre so
that it would help her to increase shipping, trade and the King’s customs.
8. He also suggests that manufacturers of foreign material such as velvets
and silk should be allowed to be exported free. This would provide
employment and increase exports.
9. Mun also suggests that in certain cases they could allow the exports
of money itself. His point of view is this: money begets trade. He
argues that merely keeping the money in the country will not make a
quick and ample trade.
10. Mun suggests that the fishing in the adjacent seas should be developed
by the English people. In those days, fishing was the main industry of
the Dutch. It was the “Golden mine” of the Dutch on which all their
political and economic power was based.
11. In the last, he suggests that, “we must make efforts to make the most
we can of our own.”
Thomas Mun also suggested that England should engage in three cornered
trade, that is, purchase goods from one foreign country and then sell them at profit
to another. He also contributed to the theory of money and interest. In the opinion
of Mun, money supply and trade and commerce go together. Mun did not favour
the idea of accumulation of money to a limitless extent. He said that it would
ultimately affect the balance of trade adversely. When large amounts of money are
accumulated in the country, it results in an increase in prices and thus adversely
affects the balance of trade. He also recognised the importance of taxation for the
purpose of national defence.
Mun was in favour of industry and was against idleness and luxury. He
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38 Material
spent most of their time in idleness and pleasure, smoking, drinking. Mun was also Mercantilism
aware of the fact that money was only a means to an end and that it would not
serve its purpose if enough goods and services were not available for buying. His
question was, “what shall we do with our money?” .Thus, he was aware of the fact
that money by itself was barren. NOTES
Check Your Progress

8. List any two methods suggested by Mun through which a country would
have favourable balance of trade.
9. What did Mun suggest with regard to manufacturers of foreign material?

QUESTIONS
1. The commercial revolution spanning from the 16th to the 18th century was
marked by expansion, increase in trading activity and the rise of mercantile
culture.
2. The development of mercantilism was the consequence of the amalgamation
of cultural, religious, political and economic factors.
3. Governments tried to encourage mercantilism through the following means:
 Offered capital to new industries
 Exempted new industries from guild rules and taxes
 Established monopolies over local and colonial markets
 Granted titles and pensions to successful producers
4. The fast growing exchange and trade necessitated the use of money which
was made available in abundance in the form of gold and silver by the
discovery of the new world.
5. The economic doctrine of mercantilists was characterised by the following
features. In their policies-
 Mercantilists gave importance only to nation advantages;
 Mercantilists laid great emphasis on national policies for increasing stock
of precious metals;
6. Mercantilists favoured a large and rapidly increasing population because
they believed that an increasing population meant both an increase in potential
number of soldiers and sailors and an increase in the number of productive
workers.
7. Intrinsic value depends on human needs and desires and the power of
commodities to satisfy human wants and extrinsic value depends upon cost
of production.
Self-Instructional
Material 39
Mercantilism 8. Mun has suggested following methods by which a country would have
favourable balance of trade-
(i) He recommends the cultivation of waste lands. This step would help in
reducing the imports of hemp, flax and tobacco.
NOTES
(ii) He advised a frugal use of natural wealth so that more might be left for
export.
9. He also suggests that manufacturers of foreign material such as velvets and
silk should be allowed to be exported free. This would provide employment
and increase exports.
2.5 SUMMARY
 The commercial revolution spanning from the 16th to the 18th century was
marked by expansion, increase in trading activity and the rise of mercantile
culture. There was also a spurt in the banking sector and rise in investment
apart from the manufacturing sector.
 The development of mercantilism was the consequence of the amalgamation
of cultural, religious, political and economic factors. In order to examine
these causes, what may be highlighted is that at the start of the 16th century,
Europe came across great religious and intellectual awakening because of
Reformation and Protestantism.
 Mercantile activities first grew in the Scandinavian countries because of their
powerful navy that could sail through the deep sea even across the Atlantic.
 Mercantilism is an economic strategy where a nation tries to accumulate as
much money as possible and by whatever means necessary. It was thought
that the richer the nation, the more powerful it was.
 Shipping was particularly significant during the mercantile period. With the
increase of colonies and the shipment of gold from the New World into
Spain and Portugal, the control of the oceans was thought to be crucially
important to national power.
 The mercantilists thought that the wealth of the nation could be increased by
trade and commerce. They gave importance to trade and commerce hence
mercantilism is known as a commercial system.
 The fast growing exchange and trade necessitated the use of money which
was made available in abundance in the form of gold and silver by the
discovery of the new world. Inflation was the natural consequence. Rising
prices hit the government and the labour classes hard.
 In the field of science and technology, great advancements and inventions
were made which helped in strengthening mercantilist philosophy and
policies. The discovery of mariner’s compass and invention of printing were
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40 Material
 The mercantilists paid a lot of attention to the accumulation of precious Mercantilism
metals. It was felt that an adequate supply of gold and silver in the form of
bullion was essential to the safety of a nation.
 In Mercantilism, the government allowed direct importation of foreign
NOTES
workers in order to establish new industries. It fixed prices and wages in
order to encourage production. It passed navigation Acts to encourage
shipping and the activities of the Navy.
 Among the mercantilist writers, there were two main streams of thought on
the subject of interest- one justifying the charging of interest while the other
opposing it. Thomas Mun was the leader of those who were in favour of
interest taking. In his view, money lending provided capital to poor merchants.
The mercantilists advocated a low rate of interest on economic grounds.
 Mercantilist system has its own weakness. As an economic policy, it lacked
universal application and as a body of doctrine, it could not provide proper
guidance to the statesmen of the time. They confused the means and the
end by over emphasising the importance of bullion as if it had such great
magic power as to make it the only worthy end of national policy.
 Mun suggests that with regard to exports, “we must consider our neighbour’s
necessities.” Not only that, promotion of exports requires that proper attention
must be given to the price of commodities.
 Mun was in favour of industry and was against idleness and luxury. He
praised the industrious Dutch and deplored the idleness of his countrymen
who spent most of their time in idleness and pleasure, smoking, drinking.
2.6 KEY WORDS
 Humanism: It is a philosophical stance that emphasizes the value and agency

of human beings, individually and collectively.
 Renaissance: It refers to the revival of European art and literature under
the influence of classical models in the 14th–16th centuries.
 Structuralism: It is a general theory of culture and methodology that implies
that elements of human culture must be understood by way of their
relationship to a broader system.
 Reformation: It was a major movement within Western Christianity in
16th-century Europe that posed a religious and political challenge to the
Catholic Church and in particular to papal authority, arising from what were
perceived to be errors, abuses, and discrepancies by the Catholic Church.
 Feudalism: It was a way of structuring society, in Medieval Europe between
the 9th and 15th centuries, around relationships that were derived from the
holding of land in exchange for service or labor.
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Mercantilism  Colbertism: It is an economic and political doctrine of the 17th century,
created by Jean-Baptiste Colbert, the Controller-General of Finances under
Louis XIV of France. Which is sometimes seen as its synonym.
NOTES
EXERCISES
1. List the concepts associated with mercantilism.
2. Write a short note on the challenge posed by industrial capitalism to
mercantilism.
3. How were cultural factors responsible for the rise of mercantilism?
4. List any four reasons for the decline of mercantilism.
5. Why did mercantilists regard agriculture as insignificant?
6. Why did Mun not favour the idea of accumulation of money to a limitless
extent?
1. Discuss any two factors of the growth of commercial activities in Europe.
2. Analyze the expansion of mercantilism and the related rivalries.
3. Describe the different names by which mercantilism was known in different
countries.
4. Discuss the concept of balance of trade in mercantilism
5. Explain the reasons for the criticism of mercantilism.

Publications
Company.
Publications.
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Physiocracy
UNIT 3 PHYSIOCRACY
Structure NOTES
3.0 Introduction
3.1 Objectives
3.2 Evolution of Physiocracy
3.3 Natural Order
3.4 Primacy of Agriculture
3.5 The Circulation of Wealth and Social Classes: Tableau Economique
3.6 Taxation
3.7 Other Important Concepts of Physiocracy
3.9 Summary
3.10 Key Words
3.0 INTRODUCTION
Physiocracy is the collective name of those economic principles and policies which
developed in France during the 18th century. The term physiocracy means ‘Rule
of Nature’. Economic thinkers who contributed to the growth and development of
physiocracy have been designated as physiocrats. In other words, the physiocrats
were a group of writers who developed a body of economic theory in France in
the eighteenth century. Their publication covered the period from 1756 to 1778.
Physiocrats have been regarded as ancestors of the ‘French Revolution.’ Physiocrats
developed the doctrine that agriculture was the sole source of all wealth, the only
productive occupation. Though the physiocrats wrote only for a relatively short
period, their ideas had a profound influence on the economic thought. That is why
they are regarded as the founders of the science of political economy. Physiocracy
may be defined as a reaction against Mercantilism and its concepts.
3.1 OBJECTIVES

 Understand the evolution, main ideas and theoretical concepts of physiocracy
 Discuss the concepts of natural order, Tableau Economique, primacy of
agriculture and taxation in physiocracy
 Describe the other important concepts, criticism and decay of physiocracy
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Physiocracy
3.2 EVOLUTION OF PHYSIOCRACY
Physiocracy had its root in the then existing economic conditions of France which
NOTES were mainly the result of mercantilist policy. There were many economic, political
and social factors responsible for its origin. We enumerate these factors in brief in
the following paragraphs-
1. Physiocracy was basically a revolt of the French against mercantilism. At
that time, the condition of agriculture was miserable. There was need for an
economic theory to prove that the pursuit of mercantilist policies was harmful
to the progress and wealth of the nation. And the physiocrats provided the
theoretical basis to attack mercantilism. The main objective of physiocrats
was to recognise the French economy by means of tax reform and by
promoting a system of efficient and large scale farming.
2. The policy followed during the supremacy of Louis XV and Louis XVI
under the blind influence of the maxim ‘I am state’, led to steep deterioration
of economic and social conditions in France. Corruption and degeneration
of the court life was at its height. The king was interested in leading a luxurious
life with its accompaniments of pomp, extravagance and debauchery. The
finances of French Government were in bad shape. The unnecessary wars
and the luxurious life at court made the government bankrupt and the
government started borrowing loans under unfavourable conditions. Heavy
taxes were imposed to replenish the treasury. Loans and taxes were two
main sources of revenue of the state. The income from other sources was
very meagre. Under the heavy weight of taxes, the trading communities
had also suffered a great deal. Recurring and continuing wars added fuel to
the fire. In 17th century, all these conditions provided ample reasons to the
thinkers especially to Boisguilbert and Vauban who gave ideas which were
quite new and which showed a ray of hope to people of France. Physiocracy
was the direct outcome of the miserable conditions in France.
3. The tax system of France had seen the worst system of taxation in her
economic history during the reigns of Louis XV and Louis XVI. The direct
tax system was prevalent in those days in France. Taxes were regressive in
character. The religious class and the nobles, who owned nearly two thirds
of land, were exempted from paying taxes on their agricultural lands while
the farmers had to pay heavy taxes. Since the clergymen and nobles were
exempted from the tax, the burden fell upon peasants and artisans.
4. The worst of all taxes was a tax which was levied on salt. According to law,
every person above the age of seven was required to purchase at least 7lbs
of inferior quality salt yearly. This salt could be used only for eating purposes.
Any person who used it for any other purpose was to pay heavy fine. At
that time, taxes were imposed several times from the manufacturing stage
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to its final disposal to the consumers. These taxes increased the price of Physiocracy
commodities. Again farmers were required to pay the charges for the use of
roads and bridges. The tax collections were highly atrocious in their attitude
towards peasants. The tortured life led by farmers gave further impetus to
the physiocrat policies and doctrines. NOTES
5. The French peasants were exploited by the nobles and other wealthy classes
by a number of methods. The landowners took a large share of the produce.
The Government levied heavy taxes. The cultivators had to pay certain
other duties which narrowed down the market for their produce. The markets
for agricultural commodities were restricted because mercantilist policies
were in favour of manufactured goods.
6. Mercantilist policies had outlived their importance. In England, agriculture
was being revolutionised with the introduction of large scale farming and
scientific techniques of production. So in France too attention was diverted
to the strengthening of agriculture. Cantillon emphasised the importance of
domestic trade and regarded landowners as the only independent producers.
This led people in France to realise that trade and manufactures had been
given too much importance at the cost of agriculture. These trends in the
thinking of the people further shook the roots of mercantilism and enhanced
the importance of agriculture.
7. Many subjective forces were also responsible for the change in the mercantilist
policies. People would have started criticising these policies even during the
reign of Louis XIV. Political Theorists started speculating more rational and
simple laws which would be based upon principles of justice. The political
and moral philosophers of those times underlined the importance of the
individual in their discussion. They emphasised that man must be at the centre
of philosophy and politics. The natural science made a great headway and a
tendency to apply their methods of economic and social problem developed.
The influence of England and English Thought, which was almost unknown to
the people in France during the reign of Louis XIV were felt in later years to
the extent that many books written by English authors were translated in French.
Physiocracy was thus a cumulative result of all these factors.
In the publication of Philosophie Rurale by Quesnay and Mirabeau, the doctrines
of the Physiocratic school were expounded in an elaborate manner. Dupont’s
Physiocratie published in 1767 and Turgot’s Reflexions published in 1769 were
the most influential and important. It was in these writings that the physiocrats
enunciated and developed their doctrines. In its theoretical aspect, physiocracy
contained the following ideas- the concept of natural order, concept of net product
(primacy of agriculture) and the circulation of wealth (social classes and Tableau
Economique).
Self-Instructional
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Physiocracy
Check Your Progress

1. What was the main objective of physiocrats in France?
NOTES 2. Why were the markets for agricultural commodities restricted?
3. Which ideas did physiocracy contain in its theoretical aspect?
3.3 NATURAL ORDER
The doctrine of the law of nature was first propounded by the Greek and Roman
moralists and jurists. According to this doctrine, man was a living being, a member
of universal human society, who was impelled by the impulse of self-preservation
and produced those things which are provided by nature such as land, tree, forests
etc. and which were necessary for physical existence. According to Roman jurists,
man is free and equal in the natural stage. John Locke said “by the law of nature
mankind are one community and make up one society.”
The concept of natural order which was developed by physiocrats was
quite different from that of the Greek and Roman jurists and philosophers of the
past and physiocrats were not familiar with the modern revolutionary ideas. In
fact, physiocracy has been described as ‘the science of the natural order.’
According to the physiocrats, the natural order is an ideal order given by God.
Natural order was quite different from the positive order made by man. In other
words, the society which was governed by the laws of nature was an ideal society
and the society which was governed by positive laws made by government was
an imperfect society. The natural order was quite evident to the intelligent people.
The moral and religious philosophy of physiocrats was reflected in their concept
of natural order. They believed in God. And they considered that the natural order
is the work of God. According to Quesnay, “Natural order is merely the physical
constitution which God himself has given the universe.” They considered that only
the natural order will increase happiness of mankind.
According to physiocrats, the human society was governed by two kinds of
laws- natural laws and positive laws. Natural laws were those laws which
guaranteed natural rights to man and were governed by human society in those
days when there was no state or legislature. On the other hand, positive laws were
the creation of man and they were obligatory simply because a penalty was attached
to them. The positive laws were therefore strictly subordinate to the natural laws.
The term natural stands in contrast to a social order which might be the
creation of man himself. However, the natural order is not equivalent to the state
of nature. It includes the elements of a civil life. “Property, security and liberty
constitutes the whole of the social order.” The physiocrats were not against the
progress of civilisation. They believed in the interdependence of all classes and of
their final dependence upon nature.
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The natural order implied that only under conditions of freedom, man can Physiocracy
enjoy the maximum happiness and derive maximum advantage in economic matters.
It followed there should be minimum interference of government in economic affairs.
It must confine itself to such things as protecting life and property. In other words
they advocated laissez faire. According to physiocrats, the aim of all economic NOTES
effort should be to secure the greatest amount of pleasure with the least possible
outlay. When everyone does this, the natural order will be better assured instead
of being endangered.
The interest of individual is best served in a free system and the interest of
individual and the community were the same. The physiocrats believed that the
individual interests were identical with the interests of the society and every man
could be trusted to find out for himself the best way of attaining maximum advantage.
The physiocrats were opposed to almost all forms of government restrictions.
They advocated laissez faire. It means freedom of business enterprise at home
and free trade abroad. According to this doctrine, the only function of government
is to protect life, liberty and property. So there will not be much work for
government. Laissez faire does not mean that nothing will be done. There will be a
lot of scope for individual effort. The only thing is that the functions of government
will be reduced to the minimum. In short, the natural order was the best and
the most advantageous order for the physiocrats.
Check Your Progress

4. What did the natural order imply?
5. What should be the aim of all economic effort according to the physiocrats?
3.4 PRIMACY OF AGRICULTURE
Mercantilists advocated that the source of wealth lay in foreign trade and that it
consisted of precious metals. According to physiocrats, land occupied a
predominant position as an agent of production. They thought that agriculture was
supreme among all occupations. To them, the origin of all wealth lay in agriculture
and this wealth consisted of real produce. According to physiocrats, agriculture
produced much more than what was required to satisfy their needs. Whatever
was produced in excess of the produce, required for the sustenance of the farmers,
was used for meeting the needs of the persons engaged in commerce, industry and
other professions. They introduced the idea of surplus resulting from the reward of
nature which they called net product. In agriculture alone, the wealth produced
was greater than wealth consumed. To them, commerce and industry are the
branches of agriculture. Le Tronsne said, “labour applied anywhere except to land
is absolutely sterile for man is not a creator.”
Though the physiocrats described that industry, trade and professions were
sterile, they never said that they were useless. By sterility they meant the incapacity Self-Instructional
Material 47
Physiocracy to produce a surplus. In other words, industry was unproductive in the sense that
it produced no extra wealth. Sterile class, to them, consisted of those who drew
their incomes second hand or who exchanged or transferred value without the
creation of any surplus. They simply reproduced the value consumed in the form
NOTES of raw material and subsistence for workers. Consequently commerce, industry
and foreign trade were sterile or unproductive.
They believed that the fruits of earth were given by God while the products of
the arts were wrought by man who is powerless to create. In agriculture, nature
cooperated with man and helped in the creation of a surplus, the net product. The
physiocrats divided the society into three classes, namely, the proprietors, - to whom
the land belongs and to whom the net product is paid; productive class, the farmers
who cultivate the soil; and thirdly sterile or unproductive class. There is still another
class, i.e. the wage earners who do not get a place in the physiocratic classification.
According to the physiocrats, the entire nation depends upon the farmer’s
capacity to invest a large capital and produce a large net product. The lower the
capacity of the cultivators to invest capital, the smaller will be the size of net product,
and the smaller the size of the net product, the greater will be the suffering of the
nation. They advocated a light tax on agriculture. They also desired that the
government should avoid such measurements which adversely affect the investment
in agriculture.
It is clear from the above discussion that only labour engaged in agriculture
operations is productive and the labour engaged in all other occupations is
unproductive.
3.5 THE CIRCULATION OF WEALTH AND

SOCIAL CLASSES: TABLEAU ECONOMIQUE
The physiocrats advanced their theory of circulation of wealth in society which is

based upon the concept of net product. They were the first to attempt and analyse
in a systematic way, the circulation of wealth in economy. The credit of putting the
whole idea in a systematic and coherent form goes to Quesnay. Quesnay has
studied Harvey’s theory of blood circulation and extended this biological idea to
the field of economics. By attempting an analysis’ of this phenomenon, a synthesis
of production and distribution was attained. This laid the foundations for a number
of future fields of study in economies. The ideas regarding the circulation flow of
wealth have been given by Quesnay in 1758 in the form of table called the Tableau
Economique. The Tableau Economique is a graphical representation of the way in
which the circulation of wealth takes place.
In the words of Mirabeau, “There have been, since the world began, three
great inventions which have principally given stability to political societies,
independent of many other inventions which have enriched and adorned them.
The first is the invention of writing, which alone gives human nature the power of
Self-Instructional
48 Material
transmitting without alteration, its laws, its contracts, its annals and its discoveries. Physiocracy
The second is the invention of money, which binds together all the relations between
civilized societies. The third is the economical table, the result of other two, which
completes them both by perfecting their object; the great discovery of our age but
of which our prosperity will reap the benefit.” The circulation of wealth, represented NOTES
by Quesnay, has been compared with the revolution which has been caused in
biology by the discovery of the circulation of the blood.
Social Classes
To illustrate the economic table, Quesnay has divided the society into the following
three classes-
 The Productive class- Productive class consists of the cultivators of soil.
They extract wealth from the soil and pay rent to the landlords who pay the
expenses of cultivation or make annual advances to cultivators for seeds,
subsistence of farmers and their families, maintenance of livestock and
implements
 The Proprietary class-The class of proprietors includes the owners of
the land (landlords), the king, his councillors, the nobility and clergy.
 The Sterile class- This class consisted all those engaged in non-agricultural
occupations. Merchants, artisans, craftsman, manufacturers, shopkeepers,
domestic servants and other professionals formed this class.
Of the above three classes, farmers belong to the productive class because
soil is the only source of wealth. After classifying the society into the above three
classes, Quesnay traced the circulation of wealth (income) among the three classes
of society in the following manner:
The general idea conveyed by the table is that the proprietors of the land
contribute to production by expenses on improvement of land and by advances to
maintain the cultivators. The cultivators, in turn, are able to procure surplus over
and above all these expenses. This is the net product which goes to the landowners
by way of rent. Out of these receipts, the landowners may and should make fresh
annual advances to the cultivators which will enable them to produce a similar net
product next year also. It is obvious that if the landowners fail to return these
annual advances, agricultural production will fail and there will be reduction in the
rent income also. The landowners divide their rent income by spending it on
industrial goods and agricultural products (for food). The industry similarly divides
its expenditure on food and raw material from agriculture and upon expenditure
within the industrial sector. Agriculture sector provides food to the landowners
and raw material to the industry and obtains finished industrial goods from industry.
In this way, year after year, the circular flow is maintained. We can explain this
flow of wealth with the help of the following example:
All wealth is produced by the productive class (the farmers). Let us suppose
the value of the total produce in any year is equal to 10 million francs. Of this, the
Self-Instructional
Material 49
Physiocracy agricultural class (farmers) require four million francs for their maintenance. These
4 million francs do not circulate. The remaining produce of worth 6 million francs
is distributed in the following manner:
Since the productive class requires manufactures, it buys them from the
NOTES
sterile class for 2 million francs. The remaining 4 million francs pass into the hands
of landowners and the government in the form of rent and taxes. The proprietary
class lives on these 4 million. It spends 2 million on food and other 2 million on
manufacture. According to the physiocrats, the sterile class produced nothing but
still received 4 million francs (two million from productive class and two million
from proprietary class). The sterile class uses the four million francs for buying
necessaries of life and the raw materials of industries from the productive class.
Thus, the 4 million francs which come into the hand of the sterile class return to
their starting point, the agriculturists. Thus the original 10 million francs replaced in
the hand of the productive class. The cycle is complete. And the process goes on
indefinitely. Thus, agriculture forms the basis of social life. And it is clear that the
prosperity of the entire nation depends upon agriculture whose prosperity should
be promoted under the following conditions:
 Freedom of cultivation means that agriculture should be free from all
sorts of impositions.
 Uninterrupted and unrestricted circulation of commodities, agricultural
as well as manufactured throughout the nation.
 Freedom of foreign trade.
Quesnay’s Economic Table is regarded as a pioneering attempt at ‘National
Income Analysis’ and ‘mathematical economics’. Leontief, who has developed
the famous input-output analysis, has adopted the same principle of Quesnay’s
economic table. It may be interesting to note here that Karl Marx was the only
first rank economist of the 19th century who recognised the merit of Quesnay as
an economist. In fact in a general way, Quesnay’s net product is similar to that of
Marx’s surplus value. Schumpeter has made this point clearly in the following
words, “Exactly as Quesnay let land alone be productive of surplus value so Marx
let labour alone is productive of surplus value.”
Check Your Progress

6. What is the Tableau Economique?
7. Who does the class of proprietors include?
8. What is the general idea conveyed by the Tableau Economique?
3.6 TAXATION
The physiocratic theory of taxation is bound up with the theory of the net product.
According to them, national income was shared by the producer, the proprietors
Self-Instructional
50 Material
and the artisans. But the sovereign is the fourth sharer of the national income. They Physiocracy
believed that only the output of land provided a surplus. So they argued that taxes
should be paid from the net product, for it was surplus. And they said that landed
proprietors must bear the burden of taxation because the product goes to them.
They said that one-third of the net product was to be paid by the proprietors in the NOTES
form of taxes.
Taxes were required for meeting the expenses of the state. The physiocrats
argued that taxes must be paid liberally to the sovereign. They recognised that the
sovereign was a co-proprietor of land not only because of the age old tradition but
also due to the fact that the state really contributed to the advances made by the
proprietors in originally preparing the land for the cultivation , in maintaining and
improving its fertility. It does this through the construction and maintenance of
roads, bridges, canals and other public works essential to the prosperity of
agriculture. Thus the landed proprietors and the king belonged to the class of
landowners with similar rights and duties and share in the revenue.
The physiocrats advocated a single tax on the net product from the land.
While anticipating all possible objections which could be levelled against a single
tax on land, they tried to provide an explanation for each one of them. Regarding
the objection that to make one single class to bear the burden of taxation was not
just, and the burden of tax should be equally distributed among all classes, they
said that statesman’s ideal was not equal taxation, but the complete abolition of all
taxation, which could only be achieved by taxing the net product. The greatest
advantage of a single tax on land as suggested by the physiocrats was that it was
not arbitrary. It was regulated by a natural form.
These ideas of physiocrats had a great hand in the French Revolution. The
distrust of indirect taxes is the direct result of their system. Their theory of taxation
is regarded as excellent demonstration of the superiority of directs taxation over
indirect taxation. The most interesting thing in the entire discussion was that they
wanted the state to adjust its needs according to its revenue.
3.7 OTHER IMPORTANT CONCEPTS OF

PHYSIOCRACY
Now we will discuss some other important concepts of physiocracy.

1. Functions of the state- In the ‘natural order’ of physiocrats, the functions
of the state would be reduced to the minimum. There would be very little
legislation. From their writings, it can very well be inferred that they wished
to reduce legislation to the barest minimum-abolition of useless laws and
promulgation of laws which were essential for the preservation of the natural
order. According to Quesnay, “Government should be centralised in a single
person, who however should be guided by the laws of nature. They wanted
every law to be an expression of that Divine wisdom which rules the universe,
Self-Instructional
Material 51
Physiocracy and therefore the state was to be the ‘law giver’ not the ‘law maker’. Thus
they wanted to see the maximum authority with minimum legislative activity.
According to Thomas Aquinas, “All those things that behave according to
nature are best, for in everything nature operates for what is best. Now
NOTES every natural government is performed by one only.” He further said that as
government by one ruler is best, so is government by a tyrant the worst.
They said that the chief of the state should be protective sovereign and not
a tyrant. They believed that the government run by many persons leads to
discord and commotion. They were not in a favour of democratic
government. Similarly, they did not support a parliamentary form of
government. “Their ideal was neither democratic self-government… nor
parliamentary regimes both were detested.” And a government of third
type of traders, artisans, manufacturers and merchants also did not suit
them. The best form of the government which they advocated was single
authority, vested with sovereign powers, but acting in conformity with the
laws of nature and deriving the positive laws from these natural laws.
The physiocrats were in favour of a national assembly but without any
legislative power. The national assembly would be just a council of state
whose main concern would be to look after the public works and to
apportion the burden of taxation. According to physiocrats, the main function
of the state was to do all that was necessary for the preservation of the
natural order and to protect the private property. The second important
function of the state was that of imparting instruction and educating public
opinion. The third and most important function of the state was construction
and maintenance of public works.
2. Trade- Physiocrats regarded that all kind of exchange was unproductive.
According to them, exchange implied only a transfer of commodity which
was equal to value. Thus, it is not a means of increasing wealth for one gives
as much as other receives but it is a means of satisfying wants. Accordingly,
industry and commerce were considered unproductive. The mercantilists
thought that foreign trade is the only means of increasing the wealth of nation.
But the physiocrats thought that foreign trade produced no real wealth. To
them foreign trade was also held unproductive. But the physiocrats were
not entirely against foreign trade, they said that a country should exchange
with other countries those goods which it cannot produce and those are in
excess of its own consumption.
The physiocrats attacked mercantilism which aimed at a favourable balance
of trade. But they favoured free trade. They believed that laissez faire
would lead to the disappearance of commerce altogether. The freedom of
trade, which they advocated, was quite in conformity with their concept of
the natural order. The natural order implied that each one would have the
freedom of buying and selling wherever and whenever he chose. Free trade
implied the total abolition of all those measures which the mercantilists had
Self-Instructional
52 Material
suggested and which aimed at restricting the exports of commodities to Physiocracy
foreign countries and checking the free exchange of commodities. Their

concept of free trade led to the theory of free trade enunciated by Walras.
The physiocrats believed that free competition with foreign merchants alone
could secure the best possible price, and only the highest price would enable NOTES
them to increase their stock of wealth and to maintain their population by
agriculture. So the physiocrats must be regarded as the founders of free
trade. Their concept of free trade was a reaction to the policy of restricted
trade as practised and advocated by the mercantilists.
3. Interest- The physiocrats allowed interest on the loans which were taken
for agricultural purposes, because such loans were productive. They were
not in favour to allow any freedom to the money lenders. They wanted the
rate of interest to be fixed by the government.
4. Population- On the subject of population, the physiocrats said that the
multiplication of men was a natural corollary to the natural order. Some
physiocrats were optimistic and favoured the enlargement of population.
But some of them were afraid of over-population. Riviere said that -”As it
is in the physical order that men thus united in society multiply promptly, by
a natural and necessary parallel to that multiplication they are reduced to
lack the means of subsistence if they do not, at the same time, multiply those
means of cultivation”
5. Value- Condillac was the only physiocrat who regarded value as the
foundation of the science of economics. He emphasised that value was
based upon utility. According to him, “value is not an attribute of matter, but
it represents our sense of its usefulness, and this utility is relative to our
need. It increases or decreases according to expansion and contraction of
our needs. Thus Condillac has laid the foundation of the phychological theory
of value. He was also aware of the fact that value increases with scarcity
and reduces with abundance.
6. Wage- The views of Condillac were far more advanced regarding wages
as compared to other physiocrats. The physiocrats believed in the Iron
Law of Wages. For instance, Turgot said that the wage of workers is only
equal to what is necessary for his subsistence. Condillac did not refer to an
‘Iron Law of wage’ But according to Condillac, “wage represent the share
of the product which is due to the workers as co-partners.” He believed
that wares were determined by the force of demand and supply.
Criticism and Decay of Physiocracy
Physiocracy was basically a revolt of the French against mercantilism. Physiocrats
had their own weaknesses.
 Their views on interest, value and wages was not clear.
 Physiocrats recognised absolute royal authority as the best form of
government and advocated the total exclusion of the three classes of society- Self-Instructional
Material 53
Physiocracy nobility, merchants and manufacturers, peasantry and the labouring population
–from participation in political matters; while on the other hand they were
ardent advocated individual liberty.
 They were wrong in considering agriculture alone as the productive
NOTES
occupation because commerce and industry are equally important and
productive as agriculture.
 They regarded manufacture and exchange as unproductive although they
are created from utility, which is one form of production.
 The physiocrats did not have a correct notion of production. According to
modern economists, production meant the creation of utilities. But physiocrats
did not understand this simple truth. According to them, creation of new
commodities is production.
 They believed in individual freedom. They did not want restriction of any
type in the life of individuals.
 They made important contributions to the theory of taxation. They advocated
direct taxes rather than indirect taxes which affected the poorer people of
the French society of their time badly.
 The physiocrats advocated complete freedom of trade and industry. But
absolute freedom of trade and industry are not advisable. If we follow the
laissez –faire doctrine, there will be little scope for social action.
 The aim of physiocrats was to develop agriculture. They regarded land as
the only source of wealth. For them land alone yielded a surplus. It followed
that the land owner alone should bear the burden of taxation.
 They extolled unrestricted competition in all commercial dealing and
exchanges, and at the same time they refused liberty to money lending and
advocated governmental regulation of the rate of interest.
 They regarded commerce as necessary and beneficial and, at the same
time, as a financial burden upon the people.
 The weakest point of the physiocratic system was its theory of distribution.
According to them, rent is free gift of nature. But Ricardo has pointed out
that rent arises not because nature is generous but because it is niggardly.
The Italian writer Galiani attacked the idea of natural order while Condillac
refused the idea that manufactures are sterile. There were many influences that
worked against it. Their views on monarchy and despotism were not popular.
There principles did not appeal to many a thinking people. The commercial and
manufacturing classes were their vehement critics.
Contributions of Physiocrats
The physiocrats have made theoretical and practical contributions in the economic
theory. The following are contributions to economic theory made by the physiocrats-
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54 Material
 The idea that every social phenomenon is subject to law and that the object Physiocracy
of scientific study is to discover such law.

 Economic development was a major concern of the physiocrats. They
realised the importance of agriculture in securing a surplus for capital
NOTES
formation. Therefore, they emphasised the need for transferring traditional
agriculture into the large scale agriculture based upon technologically
advanced methods.
 The idea that personal interest, if left to itself, will discover what is most
advantageous for it, and that what is best for the individual is also best for
everybody. But this liberal doctrine had many advocates before the
physiocrats.
 The concept of free competition, resulting in the establishment of ‘bon prix’,
which is the most advantageous price for both parties, and implies the
extinction of all usurious profits.
 The physiocrats had realised the interdependence of different classes in the
economy. Quesnay described the circulation of wealth among different
classes which have been a model for the modern input-output analysis of
Leontief and general equilibrium analysis of Walras.
 An imperfect but searching analysis of production, and of the various division
of capital. An excellent classification of incomes and of the laws of their
distribution.
 The physiocrats were the first who analysed capita and realised the
importance of capital formation in economic development.
 A number of arguments which have long since become classic in favour of
landed property.
Ø The freedom of labour,
Ø Free trade within a country and an impassionate appeal for the freedom
of foreign trade;
Ø Limitation of the functions of the State;
Ø A first-class demonstration of the superiority of direct taxation over
indirect.
 They put economics on a scientific basis by applying scientific methods and
by separating it from other sciences, notably jurisprudence;
 Their emphasis on the surplus or net product was notable, especially in
connection with the later development of the rent concept;
 They argued for capital formation through reduced consumption by the
wealthy.
 They made important contributions to the theory of taxation;
Self-Instructional
Material 55
Physiocracy  Their thought shows much progress towards a true social point of view, in
that they saw, at least in an abstract way, the interdependence of individuals,
and centered attention on producing and circulating the necessities of life;
 Their emphasis on land was influential, for weal or woe, in bringing about
NOTES
the later threefold classification of the factors of production.
Table 3.1 Difference between Mercantilism and Physiocracy
Mercantilism Physiocracy
1 Mercantilists regarded money and Physiocrats believed that natural resources
bullion as the sign of wealth. They and production power are real wealth.
believed that Gold, silver and valuable
metals are the source of prosperity and
power
2 According to Mercantilists, trade is the According to Physiocrats, agriculture is the
most productive occupation. They most productive occupation. The
wanted expansion of foreign trade. They physiocrats regarded foreign trade as evil.
aimed at maximising exports and They wanted to reduce foreign trade.
minimising imports.
3 The mercantilists thought that foreign But the physiocrats thought that foreign
trade is the only means of increasing the trade produced no real wealth. Physiocrats
wealth of a nation. According to them, said that a country should exchange with
only raw materials should be imported other countries those goods which it cannot
and finished commodities should be produce and those that are in excess of its
exported. own consumption.
4 The mercantilists were in favour of To physiocrats, foreign trade was
balance of trade. Therefore, they unproductive. They said that the balance of
suggested that import should be lesser trade in not always possible.
than exports.
5 The mercantilists believed in regulation The physiocrats advocated freedom of trade
of trade and industry. and industry. They did not want any type of
state intervention in foreign trade.
6 According to mercantilists, agriculture Physiocrats believed that agriculture is
is unproductive and only trade is productive and trade and commerce are
productive. sterile.
7 The mercantilists were in favour in The physiocrats advocated a single tax on
multi tax system. the net product from the land.
8 The mercantilists allowed interest on The physiocrats allowed interest on the
capital . loans which were taken for agricultural
purposes, because such loans were
productive.
Despite the criticism, physiocrats occupy an important place in the history
of economic thought. In spite of their short span of existence, their overall influence
was far reaching. In the words of Alexander Gray, “Even an admirer of Smith may
have no scruples in finding in the physiocratic group the real beginnings of modern
economics.” in the field of taxation by advocating a single tax on land, they laid
bare principles of shifting and incidence of taxation. Schumpeter said “ it was
however the physiocrats who made the great branch through which lay all further
progress in the field of analysis by the discovery and intellectual formulation of the
circular flow of economic life”
Self-Instructional
56 Material
Physiocracy
Check Your Progress

9. What did free trade imply for the physiocrats?
10. Why should physiocrats be regarded as the founders of free trade? NOTES
11. What did the physiocrats advocate regarding the political participation of
the three social classes?
12. What was weakest point of the physiocratic system?

QUESTIONS
1. The main objective of physiocrats was to recognise the French economy

by means of tax reform and by promoting a system of efficient and large
scale farming.
2. The markets for agricultural commodities were restricted because mercantilist
policies were in favour of manufactured goods.
3. In its theoretical aspect, physiocracy contained the following ideas- the
concept of natural order, concept of net product (primacy of agriculture)
and the circulation of wealth (social classes and Tableau Economique).
4. The natural order implied that only under conditions of freedom, man can
enjoy the maximum happiness and derive maximum advantage in economic
matters.
5. According to physiocrats, the aim of all economic effort should be to secure
the greatest amount of pleasure with the least possible outlay.
6. The Tableau Economique is a graphical representation of the way in which
the circulation of wealth takes place.
7. The class of proprietors includes the owners of the land (landlords), the
king, his councillors, the nobility and clergy.
8. The general idea conveyed by the table is that the proprietors of the land
contribute to production by expenses on improvement of land and by
advances to maintain the cultivators.
9. Free trade implied the total abolition of all those measures which the
mercantilists had suggested and which aimed at restricting the exports of
commodities to foreign countries and checking the free exchange of
commodities.
10. The physiocrats believed that free competition with foreign merchants alone
could secure the best possible price, and only the highest price would enable
them to increase their stock of wealth and to maintain their population by
agriculture. So the physiocrats must be regarded as the founders of free trade.
Self-Instructional
Material 57
Physiocracy 11. The physiocrats advocated the total exclusion of the three classes of society-
nobility, merchants and manufacturers, peasantry and the labouring population
–from participation in political matters; while on the other hand they were
ardent advocated individual liberty.
NOTES
12. The weakest point of the physiocratic system was its theory of distribution.
3.9 SUMMARY
 Physiocracy had its root in the then existing economic conditions of France
which were mainly the result of mercantilist policy. There were many
economic, political and social factors responsible for its origin.
 The policy followed during the supremacy of Louis XV and Louis XVI
under the blind influence of the maxim ‘I am state’, led to steep deterioration
of economic and social conditions in France. Corruption and degeneration
of the court life was at its height.
 Mercantilist policies had outlived their importance. In England, agriculture
was being revolutionised with the introduction of large scale farming and
scientific techniques of production. So in France too attention was diverted
to the strengthening of agriculture.
 In the publication of Philosophie Rurale by Quesnay and Mirabeau, the
doctrines of the school were expounded in the system in an elaborate manner.
Dupont’s Physiocratie published in 1767 and Turgot’s Reflexions
published in 1769 were the most influential and important.
 According to the physiocrats, the natural order is an ideal order given by
God. Natural order was quite different from the positive order made by
man. In other words, the society which was governed by the laws of nature
was an ideal society and the society which was governed by positive laws
made by government was an imperfect society.
 The physiocrats were opposed to almost all forms of government restrictions.
They advocated laissez faire. It means freedom of business enterprise at
home and free trade abroad. According to this doctrine, the only function of
government is to protect life, liberty and property.
 According to physiocrats, land occupied a predominant position as an agent
of production. They thought that agriculture was supreme among all
occupations. To them, the origin of all wealth lay in agriculture and this
wealth consisted of real produce.
 The ideas regarding the circulation flow of wealth have been given by Quesnay
in 1758 in the form of table called the Tableau Economique. The Tableau
Economique is a graphical representation of the way in which the circulation
of wealth takes place.
Self-Instructional
58 Material
 The general idea conveyed by the table is that the proprietors of the land Physiocracy
contribute to production by expenses on improvement of land and by

advances to maintain the cultivators. The cultivators, in turn, are able to
procure surplus over and above all these expenses.
NOTES
 The physiocratic theory of taxation is bound up with the theory of the net
product. According to them, national income was shared by the producer,
the proprietors and the artisans. But the sovereign is the fourth sharer of the
national income.
 In the ‘natural order’ of physiocrats, the functions of the state would be
reduced to the minimum. There would be very little legislation.
 The physiocrats were in favour of a national assembly but without any
legislative power. The national assembly would be just a council of state
whose main concern would be to look after the public works and to
apportion the burden of taxation.
 The physiocrats allowed interest on the loans which were taken for
agricultural purposes, because such loans were productive. They were not
in favour to allow any freedom to the money lenders.
 The physiocrats believed in the Iron Law of Wages. For instance, Turgot said
that the wage of workers is only equal to what is necessary for his subsistence.
 The physiocrats advocated complete freedom of trade and industry. But
absolute freedom of trade and industry are not advisable. If we follow the
laissez –faire doctrine, there will be little scope for social action.
 The physiocrats had realised the interdependence of different classes in the
economy. Quesnay described the circulation of wealth among different
classes which have been a model for the modern input-output analysis of
Leontief and general equilibrium analysis of Walras.
3.10 KEY WORDS
 Physiocracy: It is an economic theory developed by a group of 18th-

century Age of Enlightenment French economists who believed that the
wealth of nations derived solely from the value of “land agriculture” or “land
development” and that agricultural products should be highly priced.
 Mathematical Economics: It is a model of economics that utilizes math
principles and methods to create economic theories and to investigate
economic quandaries.
 Laissez faire: It is an economic system in which transactions between
private groups of people are free from or almost free from any form of
economic interventionism such as regulation and subsidies.
 Natural Order: It encompasses the natural relations of beings to one
another in the absence of law, which natural law attempts to reinforce. Self-Instructional
Material 59
Physiocracy  Despotism: It is a form of government in which a single entity rules with
absolute power.
 Monarchy: It is a form of government in which a person, the monarch, is
head of state for life or until abdication.
NOTES

EXERCISES
1. Write a short note on the French tax system during the seventeenth century.
2. What did the doctrine of the law of nature state?
3. In which three classes did physiocrats divide society?
4. Under what conditions should the prosperity of agriculture be promoted?
5. What were the three important functions of the State, according to
physiocrats?
1. Discuss the reasons for steep deterioration of economic and social conditions
in France during the reign of Louis XV and XVI.
2. Analyze the concept of the natural order.
3. Elaborate upon the primacy of agriculture in physiocracy.
4. Discuss the three classes of society as given by Quesnay.
5. Explain the views of Condillac on ‘value’ and ‘wages’.
6. Describe the differences between mercantilism and physiocracy.

Publications
Company.
Publications.
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Classical School-I
UNIT 4 CLASSICAL SCHOOL-I

Structure NOTES
4.0 Introduction
4.1 Objectives
4.2 Adam Smith
4.3 T.R. Malthus
4.4 David Ricardo
4.5 J.S. Mill and his Theory on Utilitarianism
4.6 J.B. Say
4.8 Summary
4.9 Key Words
4.0 INTRODUCTION
The Classical school of economic thought flourished sometime around the late
eighteenth century with Britain as the centre. Its main thinkers and contributors are
Alfred Marshall, J.B. Say, Adam Smith, David Ricardo, John Stuart Mill and
Malthus. These eminent thinkers basically advocated that the market systems were
primarily self-regulating systems and that freedom of the market was essential with
minimum intervention by the state. They came up with important theories regarding
markets, exchange and the creation of wealth in societies that culminated in the
developments of the discipline of economics. In this unit, an analysis of the theories
formulated by the aforementioned economists has been undertaken.
4.1 OBJECTIVES

 Discuss Adam Smith’s significant theories and contributions to the field of
economics
 Examine Malthus’ Theory of Population and Market Gluts
 Describe Ricardo’ theory of value and distribution in addition to Mill’s theory
on Utilitarianism and J. B. Say’s Law of Markets
4.2 ADAM SMITH
Adam Smith is the founder of the classical school. He has been described as the
“father of political economy”. His work “Wealth of Nations” is generally regarded
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Classical School-I as the starting point of classical school. Thomas Robert Malthus, David Ricardo,
J.S. Mill and J.B. Say are the leading economists of the classical school.
Adam Smith was born in Kircaldy, Scotland on 5th June, 1723. He studied at
Glasgow University under Hutcheson from 1737 to 1740. And from 1740 to 1746,
NOTES
he continued his study at Oxford University. For three years he delivered free lectures
on English and political economy at the University of Edinburgh. In 1751, he became
Professor of Logic and then of Moral Philosophy at Glasgow University. After
teaching for more than a decade, he became a private tutor to the Duke of Buccleuch.
He travelled for two years on the continent. During the 10 months he spent in Paris,
he came into contact with thinkers and statesmen of the status of Quesnay, Dupont
and Turgot. In 1778, Smith was appointed as commissioner of customs in Edinburgh
and remained on this post until his death in 1790.
In 1751, Adam Smith was appointed on the chair of Moral Philosophy. In
1759, Smith published his Theory of Moral Sentiments. In 1776, he published his
Wealth of Nations (An Inquiry into the Nature and Causes of the Wealth of
Nations). Adam Smith’s Wealth of Nations was a challenge to mercantilism. Smith
was the first economist to deal with economic problems in a systematic manner.
Adam Smith, first of all, emphasises the importance of labour as the source
of wealth of a nation. According to him, the wealth of a nation can be increased by
adopting the principle of ‘division of labour’ and division of labour is limited by the
size of the market. The size of the market depends upon the volume of international
trade. Division of labour necessitates exchange. This leads on to a discussion of
the means of exchange and value. After discussing the problem of value and price
in his book, Adam Smith discusses the problem of wage, profit and rent. In the
last section of his book, he discusses the problem of public finance.
Influences that Shaped Smith’s Thought-There are many influences that had
an impact on Smith’s economic-cum-philosophical thought. We may summarise
these influences as –
I. Mercantilism and Physiocracy- According to Haney, Adam Smith built
upon the work of his predecessors. He stated, “Adam Smith was acquainted
with the writing of mercantilists, and the physiocrats; and he stood upon
their shoulders,”
 Mercantilism- Smith’s Wealth of Nations is a ringing challenge to
mercantilism. Smith’s theories evolve as a criticism of mercantilists’ basic
theories i.e. wealth as treasure, foreign trade and favourable balance.
 Physiocrats- The impact of the physiocratic economic doctrine on Smith
is not so easy to establish. Much can be said for and against the physiocratic
influence on Smith. It is pointed out that the physiocratic thought did shape
Smith’s views. During the 10 months he spent in Paris, he came in contact
with thinkers and statesmen of the status of Quesnay, Dupont and Turgot.
Smith had frequent meetings with Turgot, and had discussions on economic
questions because at that time Turgot was preparing his Reflexions, which
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was published only three years later. Smith was certainly acquainted with Classical School-I
the writings of the physiocratic thoughts and with many of its leaders. In
fact, Smith had many views which were similar to those of the physiocrats.
Smith’s thoughts run parallel to those of the physiocrats as regards natural
laws, beneficent providence, laissez-faire, self-interest and problem of NOTES
surplus. These fundamental conceptions formed the ground work of the
political economy of smith and the physiocrats. In conclusion it can be
said that physiocracy in general was not much different from Smith’s views.
It is because physiocrats and Smith worked in essential similar political
and economic climate.
II. The Founder of Political Economy- The founders of political economy
include all those thinkers- mainly English and French- who prepared the
ground for all classical systems. Adam Smith is acknowledged as the founder
of classical political economy-classical economics. Thus we have to
distinguish between the founder of political economy-Petty and classical
economists Smith, Ricardo and others.
In the theory of money, Smith stands grateful to Hume, Locke and Stuart.
Smith’s historical interests were inspired by Stuart. Smith took over the
problems of public finance and some of the solutions from Petty and Stuart.
Cantillon’s Essay is most systematic statement of economic principles before
the appearance of the Wealth of Nations. Petty had stated the central
problem of value. Petty, Stuart and Cantillon, in particular, may be regarded
as Smith’s predecessors. The effects of physiocrats on the development of
economic thought were very similar to those of English economists. Eric
Roll states, “The two contributors are united a single system in Adam Smith.”
III. Smith’s Immediate Predecessors- Hutcheson, Hume, Tucker and Ferguson
were the chief predecessors of Smith. Smith’s emphasis on self-interest and
the related tendencies in his thought stimulated by the spirit of Mandeville’s
well known Fable of the Bees. Smith states that ordinarily the “natural” action
of private self-interest leads to the most perfect organisation of social and
economic relations and to the greatest welfare of all. Mandeville also clearly
expressed the concept of division of labour. And he was perhaps the first to
employ the word “divided” and “division” in relation to division of labour.
Francis Hutcheson was one of Smith’s teachers at Glasgow University and
had a deeper influence on Smith. Smith may well have got from Hutcheson
some purely economic ideas i.e. ideas on division of labour, value, money
and taxation. Hutcheson distinguished utility from value, stating that natural
basis of all value or price is some of sort of use. According to him, wealth is
differentiated from utility by labour. When labour is added to utility, we get
value. Hutcheson was an ardent advocate of religious, political and economic
liberty. To him may be traced Smith’s theory of morals, sentiments, and
ideas on the subject of values, interest and money. Adam Smith derived his
faith in the natural order from Hutcheson. Self-Instructional
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Classical School-I Josiah Tucker was another writer who influenced Smith. Tucker wrote
several essays on subjects relating to commerce and taxation. He also
emphasised the significance of labour. Tucker believed in a large population
and suggested a tax on celibacy. He held that self-interest, if given free play,
NOTES would be beneficent for the society. It may, thus, be inferred that Smith
drew freely upon his views for his Wealth of Nations. Ferguson, a
contemporary and friend of Smith, might have also influenced Smith on the
subject of taxation. His maxims of taxation were not the same, but they
must have influenced Smith’s canon of taxation.
IV. Environmental influence: The last quarter of the eighteenth century, in
particular, is full of events that mark the beginning of a new era in economic
and political organisation. These events include the beginning of the Industrial
Revolution which meant expansion of industrial capitalism, partnership
between the leaders of industry and the scientists, the struggle for
independence and the American Declaration of Independence that
weakened the old colonial system.
In the field of politics, the ideas of liberalism were gaining ground in England
long before the French Revolution. Economic theory had also acquired a
new content and new method, much earlier than Adam Smith appeared on
the scene. In fact, the fifty years around the end of the eighteenth century
marked great social changes – new form of production, of social relations,
of government and of social thought making spectacular progress. Thus,
the environmental forces came to play a significance role and all this
influenced the smith’s thought.
V. The Role of Travels and clubs-At the age of fourteen, Smith went to
Glasgow, where the philosopher Hutcheson deeply affected him. At Glasgow,
Smith discussed the effects of bounty on the exports of corn, talking to
merchants and convincing many of the advantages of free trade. Smith then
went to Oxford on scholarship and he studied classics there. In about 1764,
he travelled to Switzerland and France, where he had a chance to meet
Quesnay and Turgot. Discussion with Turgot on economic topics influenced
both (Smith and Turgot).
The clubs and associations had their influence on Smith. Smith joined the
club at Glasgow and Edinburgh. It was common for intellectuals to meet at
clubs in the eighteenth century to discuss fine art and trade. The questions
of economic importance were generally discussed at the clubs.
Smith’s Economic Ideas
Smith’s thought is mainly embodied in his creation Wealth of Nations. The basics
of his economic thoughts are summarised thus:
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Significance of labour- According to mercantilists, the main source of wealth Classical School-I
was trade. For the physiocrats, land (the bounty of nature) holds the central place.
According to them, it was only land that was productive. The mercantilists like
Petty considered labour as the father and active principle of wealth while land was
considered the mother. NOTES
In the starting of his book, Smith accepted the importance of labour and
said that labour is the source of whole wealth. This thought of Smith is the basis of
Wealth of Nations. The First paragraph of the Wealth of Nations is starts with
“The annual labour of every nation is the fund which originally supplies it with all
the necessaries and conveniences of life which it annually consumes and which
consists either in the immediate produce of that labour, or in what is purchased
with that produce from other nations.” He did not undermine the importance of the
role played by nature in production. He simply meant that while physical
environment is unchangeable, labour is variable, and that the wealth of nations
varies with the variation in the labour factor. Smith regarded the labour as the
exclusive force upon which the wealth of nation depends.
Smith makes labour the cause and also the measure of value. Smith lays
emphasis on labour as “productive labour’. According to Smith, productivity
included any addition to exchange value i.e. productivity of labour was the value
which it added to the materials on which it worked. There is an important point to
be noted here. All exchange value was not considered. The exchange value in
relation to vendible commodities was considered. The unskilled servants, public
officials and professional men were taken to be unproductive.
Division of labour- Smith is not the originator of the idea of division of labour-
the traces of it have been found from the Greeks. The emphasis which Smith laid
on the labour factor was mainly a reaction against the physiocratic doctrine.
According to Smith, “the greatest improvement in the productive powers of labour,
and the greater part of the skill, dexterity and judgement with which it is anywhere
directed or applied, seems to have the effects of the division of labour.” Under the
head of division of labour, Smith dealt with the different aspects of the separation
of different trades and employment.
Division of labour refers to the specialisation of labour in different industries or
different processes within the same industry. Adam Smith has illustrated division of
labour with the help of pin-making industry. “one man draws out the wire; another
straightens it; a third cuts it; a fourth points it; a fifth grinds it at the top of receiving the
head; to make the head requires two or three distinct functions; to put it on a peculiar
business;…and the important business of making a pin is in this manner divided into
about 18 distinct operations.” if one man performed all the above operations, that is
if there was no division of labour, man could not make more than twenty pins. But on
the other hand, if division of labour was practised, the average production of each
man was 4800 pins. This process of division enables each man to produce at least
240 times as many pin as he would if he worked alone.
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Classical School-I The division of labour is an expression of man’s constant need for the co-
operation and help of his fellows. He says that “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.” Society is bound together by mutual exchanges which
NOTES are motivated by self-interest and which are based on division of labour. This
tendency of mutually satisfying each other’s want is common to all men.
Smith was well aware of the limitation of the scope and extension of labour.
According to him, the division of labour is necessarily limited by the nature of
occupation, the extent of market and the quality of capital available. He made well
known assertion that division of labour is limited by the extent of market- the
larger the market (exchange), the greater the division of labour. A larger market
means greater demand. If there is wide demand for a good, it will be produced on
a large scale and there will be a lot of scope for the application of division of
labour. In those industries which produce goods for international market, there
will be great scope for division of labour. Self-sufficiency (no exchange) and division
of labour do not go together. The application of division of labour depends upon
the nature of goods. For example, the scope for division of labour is not as great
in agriculture as in the case of manufacturing industry.
Smith believed that division of labour increased productivity. Division of
labour has the following advantages-
 Division of labour will increase the output per worker.
 By doing the same kind of work constantly, the worker gets a great skill
in his particular line. Practice makes a man perfect.
 A man can work continuously on a single operation. He need not spend
time in changing tools or passing from one process to another. Thus it
saves time since one does not have to change his job frequently and
 Division of labour prepares the way for introduction of machinery. It
will result in the invention of great number of machines which facilitate
labour. In other words, division of labour is the mother of invention.
Division of labour simplifies work and it is possible to make use of machines
for each process. Smith was not unaware of some disadvantages of division of
labour. For instance, extreme division of labour would result in monotony of work.
By doing the same work again and again, man would not find pleasure in his work.
He would be bored with the same job.
Money- After disposing of the subject of division of labour in the first three chapters,
Smith takes up the subject of money. He attacked mercantilists because they over-
emphasised the role of money in an economy. According to Smith, “a nation’s true
wealth consists not only in its gold and silver but in its land, houses and consumable
goods of all different kinds.” Money is a medium of exchange which is essential to
trade and commerce. It did away with the inconveniences of barter- it facilitates
exchange and without it large scale commerce would not be possible. It was, therefore,
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66 Material
Money only serves as an instrument for the circulation of wealth and for the Classical School-I
measurement of value. Money does not add to the revenue of society but it is a
great wheel of circulation. It facilitates the circulation of goods. Although the gold
and silver coins that circulate in an economy form a valuable part of the capital of
the country, they are dead stock and produce nothing. Smith linked money to a NOTES
highway over which the goods (produce) of a town is carried, but which itself
does not produce a blade of grass.
Value- According to Smith, there are two kinds of value: (1) value- in -use (2)
value- in- exchange. Value-in-use expresses the utility of some particular object,
in modern analysis, the capacity of a thing to satisfy wants. Value in exchange is the
power of purchasing other goods. Smith points out the things which have the
greatest value-in-use e.g. air and water have generally little or no value of exchange.
And like this diamond has little value-in-use but it has great value-in-exchange.
The determination of value (value-in-exchange) has been one of the central
problems in economics. Smith believed that labour was the real source of value.
According to him, the value of the things depended on the amount of labour
expended upon its production. In other words “The value of any commodity,
therefore to the person who possesses it, and who means not to use or consume
it himself, but to exchange it for other commodities, is equal to the quality of labour
which it enables him to purchase or command. Labour, therefore is the real measure
of exchangeable value of all commodities.” Adam Smith emphasised that “Labour
is the real measurement of the exchange value of all commodities.” This is the
famous labour theory of value.
Smith said that in an early crude state of the society, when the process of
accumulation of capital had not started and the land was not appropriated by
anyone, labour was both the determinant as well as the measure of value. But
since the time of accumulation of capital started, and the system of proprietorship
of land began, element of profit and rent came to be included into price and thus
according to Smith, in all prices there is an element of rent and wage.
We must also note that Smith made a distinction between natural price and
market price. When the price just covers the ordinary rate of interest, wages and
profits expended in preparing and marketing the commodity, it sells at the natural
price. In simple words, natural price is that price which covers natural rates of interest,
wages and rent. Thus, the concept of natural price is essentially “the cost of production”
theory of value. Opposed to the natural price is the market price, which is determined
by the forces of demand and supply through the competition among the buyers and
sellers. The market price may be below or above natural price.
Wage- According to Smith, wage is determined by the bargaining power of employers
and wage earners. Employers, being limited in number, can easily organise themselves
to form associations whereas the organisation of labour is not possible. The employers
consistently try not to raise wages of labour above the actual rate. Hence, wages
depend on the bargaining strength of both the parties. Since bargaining strength is on
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Classical School-I the side of employers, the labour gets only as much wage as will be sufficient to
support him and his family. This is the subsistence level. According to Smith, “Masters
cannot reduce wages below a subsistence rate.” He observed that the market
level might be higher than the subsistence level whenever the society was progressing
NOTES and the funds for employment were expanding more rapidly than the population.
Since this fund is dependent on the national wealth, the wage of labours will only
increase with the increase in national wealth. In the stationary state, wages may be
low. Thus, Adam Smith has taken into account both demand for labour and supply
of labour in the determination of wages. We find in it the trace of the wages-fund
theory and the Malthusian theory of the Population.
Adam Smith has also analysed the problem of wage differences. He has
given the following reasons for differences in money wage-
 Agreeableness of the employment
 The cost of learning skill
 The constancy of employment
 The trust reposed in the workmen
 The probability of success.
Smith has a soft corner for labour. He said that no society could flourish if
its labouring classes were poor and miserable. Thus labour class must be tolerably
well-fed, clothed and lodged. Smith recognises the role of labour, land and capital
in production.
Profit- Like wages, profit also depends upon the increasing and decreasing state
of wealth in a country. Under the condition of competition, an increase in capital
will lead to a decline in the rate of profit and vice versa. Adam Smith made certain
exceptions to the statement that wage and profits moved in the opposite directions,
since wages rise with an increase in the capital stock and fall with a decrease in
capital stock. The capital stock determined the wages and demand for labour. In
a developing society, (in new colonies) both wage and profit may be higher and in
the stationary state, both wages and profit may be low. Profits vary from day to
day on account of changes of price and fortune. Thus the average rate of profit is
not easy to determine. But profits closely follow interest on money. Smith tried to
prove that profit is equivalent to the total return on capital and interest is a constituent
element in profit.
Interest- Smith discusses profit and interest together. A part of profit is paid as
interest to the capitalist. Interest arises when the capitalist does not himself employ
his capital, but lends it. Interest is the price paid by the borrower to the capitalists.
According to Smith, “Interest is the compensation which the borrower pays to
the lender, for the profits which he has an opportunity of making by the use of the
money.” Interest is treated as a part of profit. The borrower pays interest if he
makes profit. He believed that interest would vary with profit.
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Smith said, “Minimum interest must be something over and above what is Classical School-I
sufficient to compensate the occasional losses to which lending is ordinarily

exposed.”
Rent –Rent is a payment for the natural produce of land. It is a price paid for the
NOTES
use of land. Smith said, Rent was a mere extortion. This rent is the highest price a
tenant cay pay to the landowner. Land varies with fertility and situation. If land is
far away from the market, much more labour is required by the tenant. Thus the
surplus (rent) left over for the landowner is diminished. Differences in fertility
generate differences in rents. Superior fertility means higher rent.
Smith’s ideas on rent are not clear-cut. Smith was inconsistent while discussing
the relation between rent and price. Smith states that the amount of rent depends
upon price and price depends on rent- a contradiction.
Capital-Smith had realised the importance of the role of capital in the economic
development of a nation. He treated capital as an important source of national
wealth. Besides division of labour and money, capital plays a great role in
production. He was aware of the fact that capital accumulation is essential for the
industrial development of a nation. Smith holds the view that the accumulation of
“stock” (capital) depends upon the extent of the application of division of labour
which is necessarily limited by the extent of market, the density of population and
the machinery of commerce. The division of labour is itself governed by the amount
of capital accumulated. The accumulation does not only determine the amount of
industry but also its efficiency. In the opinion of Adam Smith, “the portion of the
income that was saved was immediately employed as a capital.” In other words,
an act of saving at once becomes an act of investment. In this way, saving is equal
to investment. Smith did not pay much attention to the problem of hoarding.
Smith has classified capital in three portions which sets the labour in motion.
 The first portion is that portion of the stock of an individual of a society
which yields revenue, as contrasted with that portion of the stock which
is used for immediate consumption.
 The second portion of capital is the fixed capital. It affords a revenue or
profit without circulating or changing masters, e.g. buildings, machines,
improvement of land, instruments of trade which facilitate and save
labour.
 The third portion is the circulating capital which affords a revenue or
profit only by circulating or changing hands, e.g. money, stock for
provision, raw material, partly manufactured goods and finished products
According to him, fixed capital is derived from the circulating capital, which
is itself derived from ‘lands, mines and fisheries.’ All these types of capital set
labour in motion which operates upon natural resources and produces food and
raw products for industry.
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Classical School-I The analysis of Smith reveals a distinction between the gross and net revenue
of the society. The gross revenue of all the inhabitants of a great country, he says,
“comprehend the whole annual produce of their land and labour; net revenue
which remains to them after deducting the expenses on maintaining first, their fixed
NOTES and secondly, their circulating capital or without encroaching upon their capital,
they can place in their stock reserved for immediate consumption or spend upon
their subsistence, conveniences and amusement.” Capital of the nation may be
employed in four different ways-
 In procuring the rude produce annually required for the use and
consumption of the society.
 In manufacturing and preparing that rude produce for immediate use
and consumption
 Transporting either the rude or manufactured produce from one place
where they are abound to those where they are wanted.
 In dividing in particular portion of either into such small parcels as
constitute the occasional demands of those who want them.
Smith believed that investment in agriculture is the most productive form of
capital investment because in agriculture “nature labour along with man.” Industry,
manufactures and domestic and foreign trade come next. The capital invested in
agriculture not only sets in motion a great quantity of productive labour but also
add a much greater quantity of annual produce to the real wealth of the country.
Free Trade- Smith advocated free trade. Free trade means that trade as among
countries is not subject to restrictions. Smith was opposed to the mercantilist
theory of balance of trade. Smith did not accept the mercantilist view that foreign
trade is advantageous because it acquires gold and silver. According to him, gold
and silver, just like other commodities and in the natural course of trade, will come
to any country as other commodities do. Therefore, he does not agree that the
export of gold and silver should be restricted. According to him, the only advantage
from foreign trade is that it carries out surplus commodities and brings in
commodities which are in demand. He treated foreign trade as domestic trade
and considers it as much responsible for extending division of labour.
He believed that foreign trade would promote greater division of labour.
Smith conceived the economic world as a great natural community created by
division of labour. Smith believed in the natural organisation of the economic order
under the influence of personal interest. He believed that the interest of individuals
coincided with the interest of the society. He argues that every individual knows
his interest best and is more competent to realise his interest and better understands
the direction of his own action than the government. He illustrated the idea of the
harmony of interest with this example-”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.” He was a great advocate of laissez faire –non-
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intervention by government in business. According to him, governments are wasteful, Classical School-I
corrupt and incompetent. So he advocated minimum role for the government.

Role of Government – Smith advocated minimum role for the state in economic
affairs. He considered non-intervention by government in economic matters as a
NOTES
wise policy. In his view, governments are always and without any exception, the
greatest spendthrifts in the society. According to Smith, state could perform only
the following three major functions-
 To protect society from foreign attacks
 To establish the administration of justice within the country
 To erect and maintain the public works and institutions that private
entrepreneurs cannot undertake privately.
It is to be noted that non-intervention for Smith was a general principle and
not an absolute rule. He justified legal control over interest rates, compulsory
elementary education, state administration of post offices, and control over the
issue of paper money by bankers. Though he advocated free trade, he favoured
two kinds of protectionist tariffs-
 Those tariffs that protect a domestic industry essential to the defence of the
country. He says, ‘Defence’ is more important than opulence.
 Those that equalise the tax burden on a particular domestic industry by
imposing a tariff on imports of that good.
Smith also suggested that if free trade is to be introduced in a country after
a long period of protectionism, it should be done gradually in order to avoid
unemployment.
Canon of taxation
Canon means a standard by which a thing is judged; it means a criterion. Therefore,
canons of taxation are the criteria of taxation. According to Smith, the revenue of
the sovereign is derived from two sources- (1) Funds, land and capital of the state
and (2) taxes . Adam Smith has laid down four canons of taxation:
1. Canon of Equity- It can also be called the canon of ability. Smith stated it
as: “The subject of every state ought to contribute towards the support of
the government as nearly as possible in proportion to their respective abilities,
that is, in proportion to the revenue which they respectively enjoy under the
protection of state.”
2. Canon of certainty- Tax which each individual is bound to pay ought to
be certain, and not arbitrary. The time of payment, manner of payment,
quantity to be paid ought all to be clear to every person. The government
and the tax payer should have knowledge about how and when and what
taxes are to be levied. It is good for government because it provides a sort
of correct estimate about prospective income. The certainty about taxes is
good for taxpayers because he knows where he stands.
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Classical School-I 3. Canon of Convenience –The manner and the time of tax payment should
be convenient to the taxpayer. The idea is that the taxpayer should be
psychologically and financially prepared for the onslaught of the tax. Smith
stated, “Every tax ought to be levied at the time or in manner in which
NOTES it is mostly likely to be convenient for the contributor to pay it.”
4. Canon of Economy- This canon states that the cost of the tax collection
should be the minimum possible. The revenue from a tax should be much
more than the cost of its collection. Smith stated, “Every tax ought to be
so contrived as both to take out and to keep out of the pockets of the
people as little as possible over and above what it brings into the public
treasury of the state.” Taxation is an act of production. Therefore, both
production and taxation imply the practice of economy. Every producer
would try to produce at the lowest cost. In the matter of taxation also there
is need to practise economy. This is a modern version of the canon of
economy.
Critical Estimate of Adam Smith’s Contribution to Economic thought – In
spite of his important contributions, Adam Smith could not escape criticism. Among
the criticism raised against Smith, the following are the most important:-
1. We find that Adam Smith did not give anything new to the development of
economic thought as the concept of division of labour is as old as Plato and
Xenophon.
2. He appears to be quite confused in his analysis of value
3. Smith’s argument relating to wage led to no definite conclusions in so far as
a tenable theory of wages is concerned. He has given many ideas but without
any strong conviction.
4. Smith’s approach is essentially materialistic. His concept of wealth is extremely
narrow. He does not regard wealth as a means to the higher ends of life.
5. Smith was dominated by self-love, self-interest, and shrewd choices of a
scotch trader. Thus, Smith’s Individual is really an unreal one.
6. His economics appears to be a mixture of individual and social points of
view, although on the whole, he has adopted the individual point of view.
This is two-fold criticism. (i) It is impossible to build a consistent theory of
economic value on a mixed basis which shifts back and forth because wealth
and expenses, as seen by the individual businessman and welfare and human
costs as seen by the social scientists differ; (ii) for the most part, Smith
proceeds from the entrepreneur point of view. He warns the clashes of
interest but for a solution he relies chiefly on the self-interest businessmen.
He mentions real cost but without explanation, he shifts for contractual
payments for wages and rent and develops no theory of profit. Capital
remains the fund of the capitalistic employer.
7. Smith’s theory of distribution is sketchy and incomplete.
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8. The philosophical basis of Smith’s theory is not relevant to modern time. It Classical School-I
is in the context of “natural order”- laissez fair, self-interest invisible hand

that Smith’s theory of development is supposed to operate. In developing
countries, the state has come to dominate the development process. These
countries, in particular, do not swear by natural order and what it embodies. NOTES
9. Smith point out that as the economy moves towards the stationary state,
the sequence of development is first agriculture then manufactures and finally
commerce. For Smith, this sequence is according to the natural course of
things. This sequence of development of different sectors is illogical in modern
economic planning, all the sectors must go hand in hand.
10. Smith does not discuss rate of interest separately- It is included in profit as
the modern economic theory gives importance to rate of interest. The rate
of interest is a constituent of cost, and interest earnings are a part of national
income.
Notwithstanding the above criticism, we should note that Smith gave Political
Economy a definition and made it a distinct science. He was the founder and
father of political economy. And “he brought labour and capital into prominence,
along with the land factor emphasised by the physciocrats.
Adam Smith was the first development economist who realised the
importance of capital accumulation in economic development. Adam Smith’s labour
theory of value was the foundation for Mark’s theory of surplus value, which the
latter used as a weapon to attack capitalism.
The Wealth of Nations was written during that period of his life, when he
was most active and busy with the study of the subject. Wealth of Nations was a
remarkable book and without it, the development of economic thought in the years
that followed could not have been possible. It must be said that Smith was responsible
for chalking out the outline of economic inquiry, for determining its scope, and
arranging the chief problems in the field of production, value and distribution. Besides
this achievement of Smith’s book, the more important were its socio-philosophical
implications. He was the first to give a systematic statement on the harmony of
social interests and also for introducing a utilitarian tradition in economic science.
Check Your Progress

1. How can the wealth of a nation be increased, according to Adam Smith?
2. In what way do Smith’s thoughts run parallel to those of the physiocrats?
3. What does the “natural” action of private self-interest lead to?
4. What were the main sources of wealth for the mercantilists and physiocrats?
5. List two advantages of division of labour.
6. What role did Smith advocate for the state in economic affairs?
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Classical School-I
4.3 T.R. MALTHUS
Thomus Robert Malthus was born in 1766. He came from a very respectable
NOTES family. He was the youngest son of the family. He received excellent education.
After studying philosophy and theology at Cambridge, he graduated with honours
in 1788 and was soon made fellow at Jesus College. In 1805, he was appointed
as the professor of History and political economy in the college founded by East
India Company in England. He remained on this post until his death in 1834.
Malthus is famous for his theory of Population. But another significant contribution
of Malthus to economic analysis is theory of market gluts where he discusses the
problem relating to the inadequacy of aggregate demand.
The main works of Malthus:
 An Essay of on the Principle of Population
 The Principle of Political Economy
Chief Influences on Malthus: Thoughts of Malthus were mainly moulded by
the condition of England.
(i) England had seen agricultural prosperity during the first half of the eighteenth
century but at the end of the century, agriculture was in the grip of a serious
crisis. It appeared as if the population had increased to such an extent that
the land fell short for their requirements.
(ii) Industrial revolution had bought in its trail unemployment, poverty, disease,
riots etc. Partly as the result of these evils, various socialistic schemes were
springing up especially in France.
(iii) The English poor law was also defective both in terms of subsistence and
administration. It had therefore become necessary to investigate into the
problem of population growth and Malthus did this work successfully. Prior
to Malthus, it was generally believed that a rapidly increasing population
necessarily led to prosperity and that the wealthiest and strongest countries
were often the most populous. In Malthus’s own times, the government as
well as the employers favoured a dense population for recruitment to the
armies and the factories.
Malthusian Theory of Population: As we know Mercantilists and Mirabeau
had always regarded a large population as advantageous. They never entertained
any fear of overpopulation because they thought that population will automatically
be controlled by the means of subsistence. Malthus did not agree with this. A
discussion on the subject between father and son led to the publication of the first
edition of the An Essay on the Principle of Population in 1798 anonymously.
The Malthusian theory of population is a well-known theory about the growth of
population. The first edition of the essay attracted the widest attention. The idea
put forward by him in the essay has come to be known as the Malthusian law
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(theory) of population. The Malthusian theory of population discusses the relationship Classical School-I
between population and supply of food. In simple words, all that the theory states
is that population increases at a faster rate than food supply. Malthusian theory of
population is based on the following two fundamental assumptions-
NOTES
 Food is necessary for the existence of man
 Passion between the sexes is necessary and will remain nearly in its present
state.
On the basis of the above two assumptions, Malthus stated that “the power
of population is indefinitely greater than the power in the earth to produce
subsistence for men.” Population, when unchecked, increases in a geometric ratio
(i.e. at the rate of 2,4,8,16…) while the supply of food increases only in an arithmetic
ratio (i.e. at the rate of 2,4,6,8, 10 etc.) Malthus believed that the population of the
country, when unchecked, would double itself in every twenty five years. But food
supply will not increase as fast as population on account of the influence of the law of
diminishing returns on land. He further said that if population will increase at a fast
rate, there will not be enough food for all. Because the population outgrows food
supply. The growth of population has to be checked. This can be done by the
application of some checks by nature or by man himself or by both.
The successive edition appeared in a revised form. The second edition of
the essay was published in 1803. In this edition, Malthus altered his arguments to
a great extent and the discussion appeared to be more mature. In the first edition,
he stated only two checks on population but in the second edition, he introduced
a third check i.e. moral restraint. It may be interesting to note that Malthus did not
mention a tendency to diminishing returns in agriculture until second edition of the
essay. His main point was that the pressure of population on food supply was ever
present. In the second and subsequent editions, Malthus made his statements more
carefully and with great caution. He summarised his doctrine into three propositions-
(i) Population is necessarily limited by the means of subsistence.
(ii) Population invariably increases more than the means of subsistence unless
prevented by some powerful and obvious check and
(iii) The checks which repress the superior power of population and keep its
effects on a level with the means of subsistence are resolvable into more
restraint, vice and misery.
In the first edition Malthus has spoken of two kinds of checks on population
growth-
(i) Preventive Checks- Those checks which are applied by men for checking
population growth are called preventive checks. Preventive checks are major
checks to control birth rate. Malthus suggested that those who cannot afford
the upbringing of children should either postpone marriage or never marry.
Malthus disapproved of vice as a preventive check. These include
prostitution and birth control, both of which reduced the birth rate.
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Classical School-I (ii) Positive Checks- War, famine, starvation and diseases are the positive
checks on population. They increase the death rate. If population is not
checked by the preventive methods, then it will be checked by natural
phenomenon such as famine, starvation and death. Thus, Malthus presents
NOTES a dark and pessimistic picture about the future of mankind.
In the second edition of the essay, Malthus added a new check called ‘Moral
Restraint’. By moral restraint, Malthus simply meant the postponement of marriage.
He did not approve of the birth control methods preached by neo-Malthus’. By
‘check’ Malthus might have even meant the means of establishing and adjustment
between the population and the means of subsistence. The Malthusian theory of
population was popular for nearly a century. It formed the basis of action for many
governments.
Malthus considers the poor to be entirely responsible for their poverty and
misery. Poverty and misery are the natural punishments for the poor class because
they have failed to restrict their numbers. It follows from the above view that the
government should not provide relief to the poor by means of “Poor Laws”. If aid
is given to the poor then more children would survive and provoke the problem of
hunger and misery. So Malthus suggested the gradual abolition of “Poor Laws”.
The ideas of Malthus were incorporated in the Poor Law Amendment of 1834.
The new poor law abolished all relief for able-bodied people outside work houses.
Criticism: The Malthus doctrine has been criticised on many points. The following
are the main points of criticism:-
1. According to Malthus, population in a geometric progression. He has tried
to prove that population doubles itself every 25 years. Even though there is
no historical proof for this. Population does not grow in the manner suggested
by Malthus. His ratios have been proved wrong by history.
2. His doctrine has been criticised on the point that the means of subsistence
increase in arithmetical progression. The Malthusian theory is based on the
law of diminishing returns. He has overlooked the possibilities of scientific
improvement in agriculture for example, Agrarian Revolution took place in
England along with the industrial revolution that brought about a huge increase
in the production of agricultural products and food supply.
3. It is true that in many countries population has increased at a rapid rate. But
food supply has also increased and people have not died of hunger in those
countries. In fact, the standard of living today is much higher than it was a
century ago.
4. Malthus has overemphasised the relationship between population and food
supply. The problem of population as a whole is then not one of size, but of
efficient production and equitable distribution, i.e. it is not a problem of
numbers alone but of wealth.
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5. This is an age of International Trade and Commerce. If a country does not Classical School-I
grow enough food grains itself, it can import food grains from other countries.
6. Malthus’ doctrine has been further attacked in respect of positive checks.
According to him, when population outgrows the means of subsistence,
NOTES
excessive population must die of starvation. He has tried to prove how
insufficient nourishment leads to hunger and deaths due to epidemics,
infanticide etc. He has named these as positive checks. But the truth is that
insufficiency of food is due to incapacity of production and due to excessive
population.
7. Positive and Preventive checks are heterogeneous in nature and some of
them have no relation to subsistence. Take the case of war or disease as
positive checks. If the population is swept off by war, it cannot be treated
as a check because it does not involve a relation between food and
population.
8. In civilised societies, people try to maintain an equilibrium between population
and subsistence by reducing their birth rate through the application of
preventive checks. But crowding in cities is not always due to limited
subsistence. Malthus admitted that some customs and religious practices
have operated as checks on population growth and they had no relation to
food supply.
9. Malthus has also overlooked the importance of standard of living in checking
population. Haney stated, “Putting the idea of checks and rate of increase
together and easily falling into two positive statements, the limitations and
abstraction are forgotten. He knew what had happened: he saw what was
happening but was influenced by surroundings his vision as to what was to
happen unduly obscured.”
10. It has further been pointed out that Malthus failed to distinguish between the
desire for offspring and the desire for sexual gratification.
11. Malthus thought that any addition to population is undesirable but “Every
mouth brings with it a pair of hands”. Since man is the source of labour,
large numbers may sometimes mean greater wealth, strength and power.
Despite these criticisms it would be fair to say that the Malthusian theory of
population, if seen in its entirety, is still intact. He should be given credit for laying
bare the fact that excessive population was a danger to society.
Though the Malthusian theory of population does not apply to most of the
western countries which are highly industrialised, it applies to most underdeveloped
countries like India and China which are dominated by agriculture. In the poor
countries of the world, overpopulation is a real danger. That is why many countries
of the world today have adopted birth control measures and other family planning
programmes.
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Classical School-I Other Economic Views of Malthus: Although Malthus is chiefly known for his
theory of population, his views on rent, market glut, overpopulation and value are
of great significance. We discuss, in brief, Malthusian Views on these topics in the
following paragraphs:
NOTES
Rent: Malthus did not enunciate a specific theory of rent. Despite this, no account
of his contribution to the development of economic thought can be complete without
reference to his views on rent. The views of Malthus on rent are found in An
Inquiry into the Nature and Progress of Rent. Malthus defended the Corn Laws
and emphatically stated that the reason for high prices of food were population
growth and progress. The growth of population leads to scarcity of food, for the
production of which, good land has become scarce. Consequently, price of the
produce raised from the already cultivated land rises due to an increase in the rate
of rent. Adam Smith and J.B. Say regarded rent as a monopoly return; they stated
that monopoly was the sole cause of rise in price. Adam Smith described landlords
as Monopolists who loved to reap what they had not sown. In this regard, he was
in complete disagreement with Ricardo. According to Malthus, rate of rent increased
because of the following factors:-
(i) There was shortage of fertile land.
(ii) This necessitated the cultivation of lands of low fertility.
(iii) The produce in each case is sold at natural price. The price of produce in
each progressive country would be equal to the cost of production on land
of the poorest quality actually in use.
Naturally, land with higher fertility will get rent. Thus, Malthus more or less
anticipated the Ricardian theory of Rent.
Value: The contribution of Malthus to the theory of value is negligible. In fact, he did
not develop the theory of value. He was somewhat confused about it. At one point
he criticised Adam Smith’s theory of value and at another point in his earlier writings,
he used Smith’s definition of value, that is, he describes value as the power to
command other goods, including labour. He also stated that the amount of labour
that is necessary for the production of commodities determines their value. But he
later developed a cost of production theory which includes profit. In simple words,
Malthus defined value as the amount of (Stored and current) labour plus profit.
Market Gluts or Over-Production:- The Malthusian theory of Gluts is one of
the less known but more important contributions of Malthus to economic theory.
In his theory of market gluts he discusses the problems relating to inadequacy of
aggregate demand which later proved to be the foundation stone of Keynesian
economics. Ever since the 1930s, aggregate demand has become a central problem
in economics and Malthus is regarded as the forerunner of modern thought. In his
analysis of effective demand, Malthus differed from Ricardo and other classical
writers. According to the classical economists, a supply creates its own demand
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and, demand its own supply. This theory was particularly stated by J.B. Say. The Classical School-I
idea expressed by Say was further developed by Ricardo and other writers which
implied that in the long run adjustment takes place between demand and supply
and therefore, there is no possibility of over production. There may be over-
production and under-production in the short run, but generally over production NOTES
in the long run was hardly possible. The view can be elaborated further. In their
opinion, if the supply of any commodity is more than its demand, it will be balanced
by another’s demand being in excess of supply. Consequently, market gluts are
impossible and the accumulation of capital at a rate greater than investment
opportunities may not be possible.
Malthus was interested in the volume of output day by day in real world. In
the opinion of Malthus, the level of output at any time depended upon effective
demand. According to him, effective demand is that demand at which the cost plus
the profit for the businessmen covered and the production is determined by this
demand. In other words, production depended on the existence of effective demand
is, demand which enabled the producer to cover cost plus profit.
Malthus argued in favour of unproductive consumption in order to maintain
and increase effective demand. “It is absolutely necessary that a country with
great powers of production should possess a body of unproductive consumers.”
Since the wages of workers are so low they cannot demand many goods. The
capitalists, if they want can consume the excess of products. But the capitalists are
more interested in saving and accumulation of capital. Their actual habits and mode
of living do not give them enough opportunities for unproductive spending on
sufficient scale.
Adam Smith and Ricardo were in favour of saving and capital accumulation
without limit, Malthus argued against it because rapid accumulation of capital would
result in the reduction of unproductive consumption and this in turn would check
the progress of wealth. Malthus was not against saving as such. He suggested that
a proper balance must be maintained between saving and consumption. In the
class of unproductive consumers, Malthus included landlord, soldiers, Judges,
lawyers, menial servant, physicians, surgeons and clergymen.
Malthus used the concept of effective demand to show that the economic
system was not self-adjusting. Unless a large body of unproductive consumers
was maintained, there would be periodic over-production, gluts in the market and
stagnation. Thus for the first time in the history of English economic thought, Malthus
has pointed out the possibility of crises in the form of trade cycle because of the
inherent defects of the capitalist system. Many modern writers regarded Malthus
as a forerunner of many under-consumption theories. Thus, Malthus had some
insight into one of the most important problems of the modern economy, the
maintenance of the level of aggregate demand.
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Classical School-I The contribution of Malthus to Economic thought
Malthus holds a unique place in the history of economic thought. The contribution
of Malthus in economic thought is as under-
NOTES 1. He was the first economist to throw light on the dangers of excessive
population
2. Malthusian theory of population has introduced a dynamic factor into
economics. Before Malthus, most of the economic analysis was based on the
assumption of “other things being equal” but Malthusian theory of population
made it an unrealistic assumption for population was always changing.
3. Malthus was the first economist to devote an entire book to the study of the
principle of population. Malthusian theory of population has become a
starting point for all modern studies of the problem. He has been rightly
described as the “founder of modern demography”.
4. Malthus collected a lot of historical and statistical data to illustrate his theory.
He used his knowledge of mathematics and desired to prove the strength of
his argument, justifies his claims for being included among the founders of
historical economics.
5. His entire analysis of the causes of over-production and the principle of
effective demand shows that he possessed a keener insight into these
subjects than others, especially Ricardo. His views were more akin, in this
respect, to modern thinking.
6. Malthus is the forerunner of many under-consumption theories of trade cycle.
7. In his essay he provides a clue to understand the problems of social reform
in their true perspective, especially those relating to wages, poor law etc.
The importance of his essay is all the more enhanced by the fact that it
provided the basis to Darwin’s ‘Law of the Survival of the Fittest’. As Darwin
himself acknowledged that his theory was merely the doctrine of Malthus applied
with manifold force to the whole animal kingdom, we can conclude with the
memorable remarks of Lord Keynes that “If only Malthus, instead of Ricardo had
been the parent stem from which the nineteenth century economics proceeded,
what a much wiser and richer place the world would be today.”
Check Your Progress

7. List the assumptions on which the Malthusian theory of population is based.
8. Why did Malthus suggest the gradual abolition of “poor laws”?
9. To which countries does the Malthusian theory of population apply?
10. List the factors responsible for the rise in rent.
11. Why did Malthus use the concept of effective demand?
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Classical School-I
4.4 DAVID RICARDO
In the classical school of economics, Ricardo is considered one of the greatest

theorists. Adam Smith is known as the founder of the classical school and David NOTES
Ricardo is the last representative of the classical school of economics. Ricardo
has a very significant place in the history of Economic thought.
Ricardo was born in 1772 in a Jewish family in England. He was the third of
the seventeen children. His father was a stock broker in bills of exchange and
public securities. In 1786, he entered his father’s business. David Ricardo was the
founder of the Political Economy Club, which was established in 1921. He died in
1823 at the age of fifty-one. Ricardo is known for his Principle of Political
Economy, published in 1810 but he had written a number of pamphlets and essays
too.
David Ricardo’s main works:-
 Principles of Political Economy was published in 1810.
 His first pamphlet The high price of Bullion: A proof of depreciation of
Bank Notes was published in 1800,
 An Essay on the Influence of a Low Price of Corn on the profits of
Stock was published in 1815.
 Proposal for an Economical and Secure Currency was published in 1816.
 First edition of On the Principle of Political Economy and Taxation
appeared in 1817.
 The second edition of On the Principle of Political Economy and Taxation
was published in 1819.
 On Protection to Agriculture was written in 1822.
 Plan for the Establishment of National Bank, his last work, was published
in 1823 after his death.
Ricardo and Malthus were both pessimist thinkers in the history of economic
thought. It is notable that the institutional environment of Adam Smith was different
from that of Malthus and Ricardo. During the period of Ricardo, industrial revolution
had gained strength with all its attendants’ evils. Developments in exploration,
progress in colonisation and improvement in the means of transportation had created
additional opportunities for investment. Industrial revolution had given way to the
factory system in which workers were considered just like other inputs. There
was rise in the price of grain due to depreciation of money and increased urban
population. To meet the needs of the increasing urban population, inferior lands
were brought under cultivation and land rents were increasing. Thus, the economy
of the day could be described as the capitalistic economy due to the large
employment of capital.
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Classical School-I The Principle of Political Economy and Taxation
Adam Smith had addressed the question of ascertaining the nature and causes of
the wealth of Nations. He wanted to analyse the origin and growth of a nation’s
NOTES wealth in aggregate. Ricardo believed that political economy was an enquiry into
the law which determined the division of the produce of industry among the classes
who contribute to its formation. Ricardo was mainly concerned with the study of
the problems of distribution and their solutions. In the preface of his book, On the
Principles of Political Economy and Taxation, Ricardo said, that “To determine
the laws which regulate this distribution, is the major problem in Political Economy.”
According to him, the produce of the earth is the return of the united application of
labour, machinery and capital. This produce should be divided among the land,
the owner of the stock of capital necessary for its cultivation and labour by whose
industry it is cultivated. He named these shares respectively as rent to land, profit
to capital and wages to labour. He declared that the determination of the laws
which regulate their proportion is the major problem in political economy. Ricardo
has shifted the emphasis from investigating the nature and causes of wealth
(manufacture/production) to its distribution. According to Eric Roll, “The main
achievement of Ricardo is to be found in the theory of value and distribution”.
Value: Ricardian theory of value is basically a labour theory of value. Ricardo was
not concerned with absolute values but with relative value. He says that although
the employment of capital does not affect relative value, the difference in the
proportion of fixed and circulating capital in different industries affects relative
value. Ricardo has recognised two forms of value like Adam Smith, (i) Value-in-
Use (ii) Value-in –Exchange. He says that “utility is not the measure of exchangeable
value although absolutely essential to it.” He points out that for a commodity to
have a value of exchange, it must have utility. According to Ricardo, the value of
commodity depends upon two things. (i) scarcity, and (ii) labour cost (quantity of
labour required to obtain them). Ricardo assumed that there are some commodities,
the value of which is determined by scarcity alone. Quantity of these commodities
cannot be increased by labour and therefore their value cannot be lowered by an
increase in supply. Rare pictures and statues, scarce books and coins belong to
this category. In fact, he considered such commodities so limited in number that he
has not given any consideration to them. For the valuation, he has considered the
commodities of the second group. He therefore, holds that all such reproducible
commodities are exchanged for each other in proportion to the amount of factor
inputs (labour) required to obtain them. Ricardo was aware that labour was not of
uniform quality and that different types of labour were paid at a different rate in the
market. According to Ricardo, the value of labour is the only factor which causes
variation in the ratio of goods exchanged for each other. Adam Smith applied
labour theory of value to early stage of society. In the early stage, the value of
these commodities depends almost exclusively on the comparative quantity of
labour expanded on each. Ricardo said that the relative labour inputs not only
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determined relative values in a primitive society, but also in a modern society having Classical School-I
land and capital as factors of production in addition to labour. In fact he believed

that labour was the foundation of value in all stages of society.
He divided the value into two parts- (i) natural value and (ii) market value.
NOTES
Ricardo has made distinction between Natural Price and Market Price. By natural
value he means the point around which market value fluctuates and ultimately
tends to equalise with it. The natural value is the long-term tendency. He has not
been able to give an accurate and clear definition of natural value. Market value is
actual short-term manifestation. Market value may deviate from the natural value
because of temporary fluctuations of demand and supply. According to him, the
deviation of market value is not permanent, it is only accidental. If Market Price
rises above the normal (value) price, profit will rise and more capital will be used
to produce the commodity. On the other hand, if market value falls below the
normal price (value), profit will fall and capital will not be used to produce or less
capital will be used to produce the commodity. Thus the supply would be reduced
tending to bring the market value in accord with natural value. In other words, in
the short-run, price depends on demand and supply and in the long–run, price of
commodities depends upon the production cost. And the relative cost of production
of two commodities is proportional to the respective amount of labour necessary
to produce those commodities. The labour theory of value or the cost of production
theory of value has been criticised on the following grounds:
(i) There is difficulty in measuring labour cost of production. Of course, Adam
Smith used time as the measuring rod but all of the labour is not equally
efficient, some are more efficient than others. The less skilled may take
longer than the skilled over a particular piece of work and so put more
labour into it.
(ii) Labour may be misdirected. Misdirected labour does not count as labour.
So in order to get over the problem, Marx defined the amount of labour
required as “Socially necessary labour”.
(iii) Influence of demand is not considered in the labour theory of value which is
the main weakness of the value theory.
In fact, the labour theory of value became a powerful means in the hands of
Karl Marx to disclose that there was exploitation of labour in a capitalist economy.
Marx found that the value of commodity depended on the amount of labour required
for its production.
The theory of value, as put forward by Ricardo, produced many opponents.
Torrens Hallander, Bailey and Malthus were chief among them. In all three editions
of his book, he is found making desperate efforts for arriving at a definite conclusion.
He even introduced the time element in his theory of value at the suggestion of
McCulloch but he could not improve upon it. In fact he was not satisfied with his
own analysis.
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Classical School-I The Theory of Distribution:-Ricardo considered distribution as the problem for
political economy to analyse. His chief contribution lies in furthering the investigation
of distribution problem and in his effort to correlate the theory of distribution with the
theory of value, he was the first to make a scientific attempt to analyse the problem
NOTES of distribution. He devotes his main attention to factoral distribution and frame laws
which determine the share of different factors (share of wage, profit and rent) which
contribute to the national income in a comprehensive manner.
His greatest significance lies in the fact that his theory of distribution turned out
to be the focal point of future development in economic theory. He has summed up
the scheme of distribution in the following words, “Profit depends on high price or
low wages, wages on the price of necessaries, and price of necessaries chiefly on
the price of food.” The exchange value of food is determined by its cost of production
in terms of labour at the margin of land utilisation. In the long run, wages tend to
equal the exchange value of food and rates of exchange are equalised by competition.
The remainder of the marginal product goes as profit, the rate of which, is also
equalised by competition. It is in the more productive lands that rent arises.
Theory of Rent:
At the time when Ricardo formulated his theory of rent, rent was an important
subject in England. Ricardo’s whole theory of distribution is very closely bound
with land as a factor of production and rent is the income which goes to it. In his
doctrine of rent, Ricardo has made use chiefly of the law of diminishing returns in
agriculture. Rent can be divided into two phases, (i) Cultivation of Lands of Inferior
Quality or Extensive Cultivation, (ii) Low Diminishing Return and Intensive
Cultivation.
According to Ricardo, “ rent is that portion of produce of the earth which is
paid to the landlord for the use of original and indestructible power of the soil.”
He has not included any payment received by the landlord for the capital invested
in or on his land i.e. on building, drain, hedges, fence, fertiliser etc. in this category.
The main reason why Ricardo used the term rent in such a restricted manner is
that he stated that land is not unlimited, it is available in limited quantity and is non-
uniform in quality. Due to an increase in population, land which is less advantageously
situated or is of an inferior quality is called into cultivation and rent is however,
paid for the use of it. When land of an inferior degree of fertility has been brought
under cultivation, rent immediately commences on that of the first quality land and
the amount of that rent will depend upon the difference in the quality of these two
portions of land.
Ricardo explained his theory of land with the help of a hypothetical example
of colonisation. Suppose some people go to a new country and settle down there.
They will cultivate all the best lands available at the first time of the first settlement
so no rent will be paid for the use of land. Suppose another batch of people go
and settle down in this new country after some time. Naturally the demand for
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agricultural produce will increase, so the second degree lands will have to be Classical School-I
cultivated in order to meet the needs of the growing population. As population

goes on increasing, less fertile land will come into cultivation and it is at this point
that rent will be paid on the most fertile land. The amount of rent will be determined
by the difference in the quality of the two lands. The land that is just able to meet NOTES
its expenses of production is known as a non-rent or marginal land. Rent is thus
the fertility differential of two lands. In other words, Rent indicates the differential
advantage of superior land over the marginal land.
As to the question of how rent arises in intensive cultivation, Ricardo held
that the difference between the return from two levels of investment of labour and
capital will be rent. He has explained this in the following words:
If there is land No. 2, No. 3, No. 4 or No. 5 or the inferior lands are
cultivated, capital can be employed more productively in those lands which are
already under cultivation. If we double the quantity of capital, we will find that by
doubling the original capital employed on No. 1, the produce will not be doubled,
it will not increase by 100 quintal and it may be increased by 70 quintal and by
employing same capital on land No. 2, we can obtain more than land no. 1. The
quantity which we obtained from land no 2 will not exceed the quantity that we
obtained from land No.1. In such a case, capital will be preferably employed on
the old land and will equally create rent, for rent is always the difference between
the produce obtained by the employment of two equal quantities of capital and
labour.
It has been stated that rent arises due to a difference in the fertility levels of
land. Besides fertility, rent may also arise on account of situational advantage.
Some lands enjoy situational advantage. For example, if land is nearer to the market
place the produce of that land reaches the market easily so there will be no transport
cost. Thus, the producer save transport cost in such a case. Even if all lands are
equally fertile, lands possessing situational advantage command some superiority
over other lands. Thus rent arises on account of differences in fertility and in situation.
While discussing the relationship between rent and price, Ricardo has stated
that rent does not enter price. According to him, rent is determined by price. Rent
is high because the price (of corn) is high. Price is high not because rent is high.
Ricardo has come to the conclusion that rent does not enter price because according
to him, there are some no-rent lands. But still their produce has a price on the
market and rent does not enter price here because of the marginal lands do not get
any rent at all.
Criticism of Ricardian Doctrine of Rent
Ricardian theory of Rent has been criticised on various scores-
1. Some critics have objection against the order of cultivation described by
him. According to him, the most fertile land and most favourably situated
lands will be cultivated first. This assertion gives an impression that fertility
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Classical School-I is the only factor which gives rise to rent but this impression is obviously
wrong because Ricardo himself said at more places than one that if all lands
were equally fertile, there would be no rent.
2. According to Ricardo, the best lands are cultivated first but there is no
NOTES
historical proof of this. Best lands are not always cultivated first.
3. It is assumed that rent is a payment for the use of the original and
indestructible power of the soil. But it is difficult to decide which powers
of the land are original and which are the result of human action. Fertility of
land can be improved by adopting better farming methods and appropriate
techniques of production.
4. Ricardo stated that rent is determined by price and that it does not enter
price. It has been attacked by many economists.
5. Arthur Young and H.C. Carey have tried to demolish the Ricardian doctrine
by saying that owing to the progress of science even the worst lands have
been turned into the most fertile ones.
6. Ricardian theory is based on perfect competition. But in the real world
imperfect competition is the rule.
7. Ricardo in his theory does not assume rent land. In reality no such land
exists, though there may be a marginal land which just covers the cost of
producing output.
8. Ricardo over-emphasised the role of diminishing returns. This law will hold
good only if other factors including the level of technology are kept constant.
But historically improvements in agriculture have resulted in increasing returns
per unit labour in the most advanced country.
Wages: After explaining the rent and the share of landlord in the national income,
Ricardo proceeds to discuss the determination of wages. Wages are the price of
labour. Like all other commodities, labour has its natural price (subsistence wage)
and market price. According to him, “the natural price of labour is that price which
is necessary to enable the labourers, one with another, to subsist and to perpetuate
their race, without either increase or decline.” Thus the natural price of labour
depends on the price of food, necessaries and conveniences of life required by the
labour and his family. If the price of food and necessities rise, wages will rise and
when the price of food and necessities fall, wages will fall.
The market price of labour is that price which is really paid for it from the
natural operation of the proportion of the supply to the demand. The market rate
of wages is determined by the forces of demand and supply. If there is an abundant
supply of labour, market price of labour will be low and if there is scarcity of
labour, market price of labour will rise.
Ricardo stated that demand for labour is determined by the amount of capital.
He said that the demand for labour will increase in proportion to increase in capital;
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in proportion to the work to be done will be the demand for those who do it but Classical School-I
we must note that market price will fluctuate around the natural price.
Ricardo believed that in the long run, both natural and market price of labour
and because of the increase in the cost of producing food for increasing population
NOTES
money wages would tend to rise. Improvements in agriculture and import of food
grain would lower the cost of living only temporarily. But ultimate money wages
will rise in order to meet the increasing cost of food grains.
Ricardo’s idea is that in the long run, the wages of workers will enable them
to live only at a subsistence level of wages. When the market price of labour rises
above the natural price, there will be expansion in the families of the workers. As
population increases, wages will come down to their natural price and when the
market price of labour is below the natural price, poverty and misery will reduce
the working population and wage rates will rise. Thus in the long run workers will
receive wages at minimum subsistence level.
Profits: Ricardo has not given a clear-cut theory of profit. He has treated profit
and interest as one thing. Ricardo has not given a complete discussion of the
sources from which profit arise and has not analysed the various components of
profit. According to him, “profit consists of interest and entrepreneur’s gain.” He
treats profit as the residual income received by the entrepreneurs. Ricardo firmly
believed that wages increased at the expenses of profit. In brief, the doctrine can
be stated in his own words that profits depend on high and low wages. In other
words, whenever there was an increase in wages profit would fall and vice versa.
Thus according to Ricardo, wages and profits are diametrically opposed to each
other. Ricardo believed that in the long run money wages would rise and the rate
of profit will tend to fall.
It may be interesting to note here that though Ricardo believed that “the
interest of the landlord is always opposed to that of the consumer and manufacturer.”
and the interests of workers and employers are always opposed, he never
advocated state intervention to reduce the conflicts of interest. Ricardo believed
that profits must be sufficient to afford an adequate compensation for their trouble
and risk, and hence he admits that there must definitely be minimum limit to profits.
Money: Ricardo was a practical man. He was concerned about the urgent currency
problem of his day. Ricardo wrote on currency problems at a time when the Bank
of England introduce inconvertible paper standard and the market price of gold
was increasing. Ricardo tried to explain why the market price of gold was rising
and suggested that price of gold and other commodities are rising due to printing
of Bank Notes or increasing quantity of money in the market. He proposed that
the Bank of England should reduce the quantity of Notes in circulation so long as
the price of bullion does not come down to its normal level. Ricardo however, did
not believe in the complete withdrawal of paper currency.
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Classical School-I In short, he advocated gold bullion standard in which only the Bank Notes
would be in circulation which would be convertible into gold bars in larger amounts
at a fixed rate. So much was the truth in his arguments that the Bullion Committee
accepted his suggestions.
NOTES
Ricardo advocated that Bank of England should restore the gold standard.
He believed the gold standard by acting as a check on the over-issue of currency
would curb inflation. He also advocated economy in the use of gold and silver. To
eliminate the cost of coinage and to economise gold, Ricardo suggested a sort of
gold bullion standard. Ricardo’s currency reform was adopted by parliament in
1819 and gold standard was introduced in 1921. Gold Standard remained the
dominant monetary standard in Britain and many other countries for over a century,
except during the major war periods and great financial crisis.
International Trade: In the matter of international trade, Ricardo was the true
follower of Adam Smith but as an advocate of free trade, he appeared to be more
resolute than Adam Smith or the physiocrats.
The chief contribution to the science so far as the theory of international
trade is concerned “was his discovery of the laws governing the movement of
money from one place (country) to another, and the admirable demonstration
which he has given us of this remarkable ebb and flow”. He explained the working
of laws as follows: If a country has an adverse balance of trade, excessive money
will be exported and the scarcity of money will be experienced in the country. The
scarcity of money will lead to an increase in its value and price will fall, low price
will stimulate exports and ultimately the money that was sent abroad will come
back. Consequently price will rise, exports will be curtailed and imports will increase,
thus leading to exports of money. The cycle will go on. Ricardo thus held the
under that automatic operation of the economic forces, the balance of trade will
itself come to position of equilibrium. It may be pointed out that this position of
equilibrium may not establish so quickly as Ricardo thought. It may take some
time before price may rise or fall under the influence of quantity of money. But
under the system of foreign exchange, it is necessary to wait until the price responds
to the changes in the quantity of money and hence his point appears to be correct.
Accordingly money either seldom leaves a country or if it leaves at all, it is only for
a short period. He therefore insisted that precious metal for international trade
were mere lubricants that neither leave nor stay in any country permanently.
The theory of comparative cost is the major contribution of Ricardo to the
theory of foreign trade. Adam Smith advocated free trade competition in foreign
trade and his theory of trade was based on difference in absolute cost. But Ricardo
developed the theory of comparative cost. According to Ricardo, “Trade might
be taken place of the advantages of both trading countries, even when one of
them was more efficient in the production of both commodities exchanged. The
theory of comparative cost may be stated as follows: Under competitive conditions
a country tends to specialise in those commodities in the production of which it
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88 Material
In the recent times, Benham has stated the law as follows: “The principle of Classical School-I
comparative cost or comparative advantage points out that two countries will gain
by specialisation and trade, provided that each has a comparative advantage of
lower comparative cost in the commodities it exports.”
NOTES
Ricardo advocated that an efficient country should export those goods whose
comparative cost is the lowest and it should import those goods whose comparative
cost is the highest. He advocated free trade policy. Ricardo believed that under a
system of perfectly free commerce, the pursuit of individual advantage is admirably
connected with the universal good of the whole.
Ricardian theory of comparative cost is based on two fundamental
assumptions-
 Ricardo assumed that labour and capital did not flow between countries.
 He assumed the law of constant costs rather than increasing costs as
output extended.
The theory of comparative cost given by Ricardo has been criticised on the
ground that it is based on the labour theory of value. Not only that, the theory is
based on the assumption of full-employment.
Ricardo provided the foundation stones of socialism. The Ricardian theory
of value is the starting point of modern socialism. Marx developed his theory of
surplus value only on the basis of the labour theory of value. There are different
opinions regarding the contribution of Ricardo to economic thought. According to
Gide and Rist, “Next to Smith, Ricardo is the greatest name in the economics.
Ricardo is the supreme example of abstract reasoning. He will be remembered as
the master of deduction in economics. In the opinion of Haney, “One of Ricardo’s
greatest services lay in the fact that, more than any predecessor; he separated
economics from other branches of knowledge, and from ethics and from government
in particular. With Ricardo political Economy became Economics.” According to
Eric Roll, “The main achievement of Ricardo is to be found in the theory of value
and distribution. Ricardo succeeded even more than Smith in isolating the chief
categories of the economic system. He left to his successors many unsolved
problems, but he also indicated ways in which they might be solved.
Check Your Progress

12. What did Ricardo believe regarding the political economy?
13. What does Ricardo mean by natural value?
14. State the two phases of rent.
15. What did Ricardo propose for the Bank of England?
16. What did Ricardo advocate regarding imports and exports by a country?
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Classical School-I
4.5 J.S. MILL AND HIS THEORY ON
UTILITARIANISM
NOTES John Stuart Mill was a 19th century philosopher, political economist and civil
servant.
Mill’s essay On Liberty (1859) gave a new dimension to utilitarianism and
is one of the classical defences of freedom in the English language. Mill is a transitional
thinker who essayed his ideas at a time when the English political society was in a
state of flux, of transition from laissez faire to collectivist legislation. Beginning with
a negative view of liberty, he comes closer to a positive one when he recommends
‘state regulation in the overall interests of society. He starts with a definition of
liberty as ‘being left to oneself’. ‘All restraint qua restraint is an evil’. He assumed
the existence of two different spheres of human action: those which concern himself
(self- regarding) and those which concern others (other- regarding). He claims
complete freedom of conduct for the individual in all matters not affecting the
community. The only part of the conduct of anyone, for which he is amenable to
society, is that which concerns others. Community has a right to coerce the individual
if his conduct is prejudicial to its welfare. Critics have said that Mill divides the
indivisible. Every action of the individual has in its very nature some social
consequences. Mill as ‘the prophet of an empty liberty and an abstract individual.
He had no clear philosophy rights, through which alone the conception of liberty
attains a concrete meaning; he had no clear idea of that social whole in whose
realization the false anti-thesis of state and individual disappears.
Mill was painfully aware of the anomaly of a ‘tyranny of the majority’ tyranny
of the prevailing opinion and feeling in modern democracies. He had a peculiar
horror of the mob mind, of the tyranny of the crowd. To offset this, he made an
eloquent plea for freedom of thought, discussion and toleration of opinion. He
was a champion of individual or personal liberty. His primary purpose was to
protect the individual even his eccentricities and oddities against the attacks of
society. He contends that social and ‘political progress depends largely on the
originality and energy of the individual and his free choice. Of course, he recognized
the utility of some modest form of state regulation in the interest of the common
good and came closer to socialistic ideas.
Mill declares that pleasures be at variance not only in quantity but also in
quality. He drew a distinction between superior and inferior pleasures. Mill did not
talk about with Bentham that pleasure was the only grounds and purpose for
individual’s events. He held that individual happiness did not give him utmost
happiness; on the other hand it was the group happiness, which gave highest
gladness and joy to the individual. Thus, he thought that happiness comes from
outer surface and not from surrounded by. This was in absolute dissimilarity to
Bentham’s view that enjoyment comes from inside. Mill greatly tapering down the
bay between self- interest and general contentment. He held that the utilitarian
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90 Material
standard is not the manager own maximum gladness, but the maximum amount of Classical School-I
pleasure altogether.
Bentham was of the opinion that individual happiness was the only decisive
factor for all human actions. Mill initiated the idea of good life as more than a life
NOTES
dedicated to happiness. He positioned the ethical ends above the human being
contentment and thus attempted to endorse righteous life. He also distorted the
state into an ethical end.
Mill also differed from Bentham in justifying private property. The justification
of private property came from the English utilitarians. Its great exponent Jeremy
Bentham maintained that right to property was a major condition of achieving the
greatest happiness. He advocated equal distribution of property in order to strike
a balance between security and equality. Mill defended private property as essential
for the welfare of the people. He wrote: ‘The institution of property when limited
to its essential elements , consists in the recognition, in each person, of a right to
the exclusive disposal of what he or she have produced by their own exertions,
or received either by gift or by fair agreement , without force or fraud; from
those who produced it. The foundation of the whole is the right of producers to
what they themselves have produced.
Mill in his work on utilitarianism modified the views of Bentham for the
betterment of the society. He recommended numerous rudiments which were
opposed to the hedonist doctrine of Bentham. It was with the austerity of Bentham’s
morals and synchronized utilitarianism with common sense that Mill made
utilitarianism extra human and less consistent.
Mill’s ideas of liberty also are at variance from Bentham’s concept of liberty.
Whereas Bentham did not connect any significance to the liberty because it did
not in any method add to the maximum happiness of the maximum number of
people. He was fond of more in giving importance to safety than freedom. Mill, on
the other hand measured liberty is necessary for the accomplishment of the standard
of utility and declared that minority rights could be secluded only when all take
pleasure in liberty.
Both Mill and Bentham differed in justifying public and private interests.
Bentham tried to set up identity between public and personal interests through the
concept of super-added pleasures and pains. Mill considered these as outer
authorization and therefore wanted to find this association on the basis of some
interior sanctions and emotions of conscience. He therefore said that that the
happiness and soreness concepts when restricted to oneself alone were outer, but
when these related to ‘others’ these were interior and as such has bearing on
sense of right and wrong.
From different diverse perspectives Mill obtained a dissimilar stand. Thus,
he situated for public voting as against secret voting developed by’ Bentham. He
preferred extraordinary treatment of women, while Bentham did not think something
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Classical School-I of the kind. Mill was more anxious with the abolition of imperfection in the
obtainable legal system. Mill was more troubled with the social and economic
harms facing the society. Both justified democracy but for dissimilar reasons. While
Bentham recommended and suggested it because of character of man, Mill justified
NOTES because of the situation of man. Bentham talked about unicameral legislature while
Mill went for bicameral system. Mill was a great winner of the individual liberty
and stood for limiting government meddling in the life of the individual.
Check Your Progress

17. State the two spheres of action as assumed by Mill.
18. What did Mill write in defence of private property?
4.6 J.B. SAY
Jean Baptiste Say was born in Lyons on January 5, 1767. He was a French economist.
He can be called the founder of the French Classical School. He is considered an
exponent of Adam Smith’s ideas on the continent. Say put Smith’s ideas to a proper
scrutiny and modification wherever necessary. In 1831, he joined the Collège de
France as Professor of Political Economy. Just after 14 years of the publication of
the Wealth of Nations, in 1803 his book Traite d’ Economic Politique (Treatise on
Political Economy) was published. He did not merely repeat the ideas of Smith but
carefully reviewed them. He developed some of them and emphasised others. His
book became quite popular and was used as a textbook in a number of American
colleges. His book was translated in many languages. In this book, he has logically
arranged and explained the ideas of Smith. He died in 1832.
Main Works of Say:
 A Treatise on Political Economy was published in 1803
 Catechism of Political Economy was published in 1817
 A Complete Course on Practical Political Economy was published in
1828-29
To J.B. Say, ideas about the nature and the scope of political economy
were quite clear. He says that political economy was primarily a study of wealth.
According to him, Political Economy studied and discovered the laws which govern
wealth. The study of economics is classified by him into the three main parts: (i)
Production (ii) Distribution (iii) Consumption of wealth. Ricardo adopted deductive
method throughout his analysis but Say was in favour of the inductive method. He
argued that methods similar to those used in natural sciences might be followed in
political economy. According to J.B. Say, Political Economy was a purely theoretical
and descriptive science. The law of political economy had a universal validity. To
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him, an economist had no normative role to play. He stated that “the duty of Classical School-I
economists is to observe, to analyse and to describe but not to give advice”.

Further he believed that the laws of economics were of universal application.
Productive and unproductive labour: The physiocrats believed that amongst
NOTES
the agents of production only land is productive in the sense that only agriculture is
the productive occupation. Even under the influence of physiocrats, Adam Smith
attributed special productivity to agriculture but Say refuted the idea. He believed
that “Nature is forced to work along with man” not only in agriculture but
everywhere. While Smith gives priority to agriculture, Say gives top priority to
manufacture. To Say, production is not the creation of matter, but creation of
utilities. According to him, labour will either provide some service or would impart
utility to some matter.
According to Smith, service of doctors, Judges, lawyers and actors, the
producers of manufactured articles are unproductive labour. Say found fault with
Smith for including only material things as wealth of economics. Say considered
even services such as advice of a doctor as “product”. The doctor gives advice
only after taking fees for consultation. Its production consisted in saying it and its
consumption in hearing it; accordingly any labour which is directed towards the
creation of utility is productive, whether it results in a service or modification of
matter. To Say, if produce of the labour is meant to be sold in the market in
exchange for something else, it is a productive labour. The idea that economic
activity consists of the production of material as well as immaterial goods has been
put humorously by Robbins in the following words- “We do not say the production
of potatoes is economic activity and the production of philosophy is not.”
Say’s Market Law: Say is widely known for his ‘law of markets’. His theory of
market was considered a great contribution.
During the days of J.B. Say, some businessmen and even economists thought
that general over-production and unemployment were common occurrences. Say
tried to disapprove this belief by his law of markets. Say’s market law states that
supply creates its own demand. Say stated that “it is production which creates
market for goods.” In other words, whatever is produced represents the demand
for another product. Additional supply is additional demand. Thus products are
always exchanged against other products. When a product is produced, it offers a
market for other products, from the moment it is created. On the basis of the
above reasoning, Say said that there is no possibility of excess supply of a product
so that there cannot be any general over-production. It implied that there will not
be any mass unemployment and an economy will always be at a full employment
equilibrium.
Say admits that there is no possibility of general over-production. There will
be no such thing as deficiency of ‘aggregate demand’. Thus, Say’s Law of Markets
denies the possibility of general over-production. Say’s law is basically a long run
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Classical School-I tendency. Say’s theory of market was considered a great contribution for a very
long time.
Implications of Say’s Law of Markets:
NOTES i. As ‘supply creates its own demand,’ there will be no general over-
production. It implies that there can be no general unemployment.
ii. According to this law, it will be profitable to have wide markets for they will
increase the demand for goods and raise their prices.
iii. Everyone should be interested in the prosperity of everyone else. ‘It is foolish
to divide the nation into producers and consumers; everyone is both.’
iv. The law of Markets has been used in support of Free Trade doctrine. When
we buy something from foreigners, we will be selling something to them
simultaneously and thus a market will be created for them.
v. Say was interested in the development of industry.
vi. Say’s Law became the basis for the laissez-faire policy of the government.
As supply creates its own demand, it implies that there is automatic adjustment
of the economy. So there is no need for State interference in economic
matters.
Criticism:
J.B. Say holds an important place in the history of economic thought. Say’s ‘Law
of Markets’ was accepted as the true explanation of working of the economic
system by most of the economists of the classical school. Malthus was the only
classical economist who opposed Say’s Law that “supply creates its own demand.”
He argued that demand might be deficient and cause unemployment.
Further we can show that Say’s law of market is unrealistic from the following
argument. Say stated that supply will create its own demand on the assumption
that the incomes that are earned by people in the process of production are
completely consumed. But we know that when there is an increase in income the
entire income will not be consumed, a portion of it will be saved. Due to this, there
may be deficiency of demand and supply will not create its own demand.
Haney stated that, “he was no Smith or Ricardo; he was no mere populariser
...the theory of political economy would have been different without J.B. Say.”
Check Your Progress

19. How has Say classified the study of economics?
20. List two implications of Say’s Law of Markets.
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Classical School-I
QUESTIONS
1. According to Smith, the wealth of a nation can be increased by adopting NOTES

the principle of ‘division of labour’ and division of labour is limited by the
size of the market.
2. Smith’s thoughts run parallel to those of the physiocrats as regards natural
laws, beneficent providence, laissez-faire, self-interest and problem of
surplus.
3. Smith states that ordinarily the “natural” action of private self-interest leads
to the most perfect organisation of social and economic relations and to the
greatest welfare of all.
4. According to mercantilists, the main source of wealth was trade. For the
physiocrats, land (the bounty of nature) holds the central place. According
to them, it was only land that was productive.
5. Division of labour has the following advantages-
 Division of labour will increase the output per worker.
 By doing the same kind of work constantly, the worker gets a great skill
in his particular line. Practice makes a man perfect.
6. Smith advocated minimum role for the state in economic affairs. He
considered non-intervention by government in economic matters as a wise
policy. In his view, government are always and without any exception, the
greatest spendthrift in the society.
7. Malthusian theory of population is based on the following two fundamental
assumptions-
 Food is necessary for the existence of man
 Passion between the sexes is natural and will remain nearly in its present
state.
8. If aid is given to the poor, then more children would survive and provoke
the problem of hunger and misery. So Malthus suggested the gradual abolition
of “Poor Laws”.
9. The Malthusian theory of population applies to most of the underdeveloped
countries like India and China which are dominated by agriculture.
10. According to Malthus, rent arose because of the following factors:
 There was shortage of fertile land.
 This necessitated the cultivation of lands of inferior fertility.
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Classical School-I  The produce in each case sold at natural price. The price of produce in
each progressive country would be just equal to the cost of production
on land of the poorest quality actually in use.
11. Malthus used the concept of effective demand to show that the economic
NOTES
system was not self-adjusting.
12. Ricardo believed that political economy was an enquiry into the law which
determined the division of the produce of industry among the classes who
contribute to its formation.
13. By natural value Ricardo means that point around which market value
fluctuates and ultimately tends to equalise with it. The natural value is the
long-term tendency.
14. Rent can be divided into two phases: (i) Cultivation of Lands of Inferior
Quality or Extensive Cultivation, (ii) Low Diminishing Return and Intensive
Cultivation.
15. Ricardo proposed that the Bank of England should reduce the quantity of
Notes in circulation so long as the price of bullion does not come down to
its normal level.
16. Ricardo advocated that an efficient country should export those goods whose
comparative cost is the lowest and it should import those goods whose
comparative cost is the highest.
17. Mill assumed the existence of two different spheres of human action: those
which concern himself (self- regarding) and those which concern others
(other- regarding).
18. Mill wrote: ‘The institution of property when limited to its essential elements
, consists in the recognition, in each person, of a right to the exclusive
disposal of what he or she has produced by their own exertions, or received
either by gift or by fair agreement , without force or fraud; from those who
produced it.
19. The study of economics is classified by Say into the three main parts: (i)
Production (ii) Distribution (iii) Consumption of wealth.
20. The implications of Say’s Law of Markets are:
 As ‘supply creates its own demand,’ there will be no general over-
production. It implies that there can be no general unemployment.
 According to this law, it will be profitable to have wide markets for they
will increase the demand for goods and raise their prices.
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Classical School-I
4.8 SUMMARY
 Adam Smith, first of all, emphasises the importance of labour as the source
of wealth of a nation. According to him, the wealth of a nation can be NOTES
increased by adopting the principle of ‘division of labour’ and division of
labour is limited by the size of the market.
 In the theory of money, Smith stands grateful to Hume, Locke and Stuart.
Smith’s historical interests were inspired by Stuart. Smith took over the
problems of public finance and some of the solutions from Petty and Stuart.
 Smith lays emphasis on labour as “productive labour’. According to Smith,
productivity included any addition to exchange value i.e. productivity of
labour was the value which it added to the materials on which it worked.
 According to Smith, there are two kinds of value: (1) value- in -use (2)
value- in- exchange. Value-in-use expresses the utility of some particular
object, in modern analysis, the capacity of a thing to satisfy wants. Value in
exchange is the power of purchasing other goods.
 Like wages, profit also depends upon the increasing and decreasing state
of wealth in a country. Under the condition of competition, an increase in
capital will lead to a decline in the rate of profit and vice versa.
 Smith advocated free trade. Free trade means that trade as among countries
is not subject to restrictions. Smith was opposed to the mercantilist theory
of balance of trade. Smith did not accept the mercantilist view that foreign
trade is advantageous because it acquires gold and silver.
 Smith’s argument relating to wage led to no definite conclusions in so far as
a tenable theory of wages is concerned. He has given many ideas but without
any strong conviction.
 The Malthusian theory of population discusses the relationship between
population and supply of food. In simple words, all that the theory states is
that population increases at a faster rate than food supply.
 Malthus considers the poor to be entirely responsible for their poverty and
misery. Poverty and misery are the natural punishments for the poor class
because they have failed to restrict their numbers. It follows from the above
view that the government should not provide relief to the poor by means of
“Poor Laws”.
 Malthus defended the Corn Laws and emphatically stated that the cause of
high prices of food was the population growth and progress. The growth of
population heads to the scarcity of food for the production of which good
land become scarce.
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Classical School-I  Malthus used the concept of effective demand to show that the economic
system was not self-adjusting. Unless a large body of unproductive
consumers was maintained, there would be periodic over-production, gluts
in the market and stagnation.
NOTES
 Ricardo was not concerned with absolute values but with relative value. He
says that although the employment of capital does not affect relative value,
the difference in the proportion of fixed and circulating capital in different
industries affects relative value.
 Ricardo’s idea is that in the long run, the wages of workers will enable them
to live only at a subsistence level of wages. When the market price of labour
rises above the natural price, there will be expansion in the families of the
workers.
 The theory of comparative cost is the major contribution of Ricardo to the
theory of foreign trade. Adam Smith advocated free trade competition in
foreign trade and his theory of trade was based on difference in absolute
cost. But Ricardo developed the theory of comparative cost.
 The primary purpose of Mill was to protect the individual even his
eccentricities and oddities against the attacks of society. He contends that
social and ‘political progress depends largely on the originality and energy
of the individual and his free choice.
 Mill in his work on utilitarianism modified the views of Bentham for the
betterment of the society. He recommended numerous rudiments which
were opposed to the hedonist doctrine of Bentham.
 According to J.B. Say, Political Economy studied and discovered the laws
which govern wealth. The study of economics is classified by him into the
three main parts: (i) Production (ii) Distribution (iii) Consumption of wealth.
 Say’s market law states that supply creates its own demand. Say stated
that “it is production which creates market for goods.” In other words,
whatever is produced represents the demand for another product.
 The law of Markets has been used in support of Free Trade doctrine. When
we buy something from foreigners, we will be selling something to them
simultaneously and thus a market will be created for them.
4.9 KEY WORDS
 Classical Economics: It refers to the school of thought of economics that

originated in the late 18th and early 19th centuries, especially in Britain. It
focused on economic growth and economic freedom, advocating laissez-
faire ideas and belief in free competition.
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 Canons of taxation: These refer to the administrative aspects of a tax. Classical School-I
They relate to the rate, amount, method of levy and collection of a tax.
 Natural Price: It is the (intrinsic) value of a commodity with respect to the
costs of production, as distinguished from the fluctuating market value.
NOTES
 Market Price: It refers to the amount of money for what an asset can be
sold in a market. The market price of a commodity is closely linked with the
demand and supply factors of the commodity.
 Protectionism: It is the economic policy of restricting imports from other
countries through methods such as tariffs on imported goods, import quotas,
and a variety of other government regulations.
 Political economy: It is a social science that studies production, trade,
and their relationship with the law and the government. It is the study of
how economic theories affect different socio-economic systems such as
socialism.
 Socialism: It is a political and economic theory of social organization which
advocates that the means of production, distribution, and exchange should
be owned or regulated by the community as a whole.

EXERCISES
1. Which ideas did Smith get from Hutcheson?
2. List the events that marked the beginning of a new era in economic and
political organization.
3. What does ‘division of labour’ refer to?
4. What is the division of labour marked by?
5. Write a short note on value-in-use and value-in-exchange.
6. List the ways in which capital of the nation may be employed.
7. State the three propositions of Malthus’ theory of population.
8. List any three of Ricardo’s main works.
9. Why did Ricardo use the term rent in a restricted manner?
10. How do Mill and Bentham’s ideas differ?
1. Discuss any two influences that shaped Smith’s thoughts.
2. Analyze Smith’s concept of ‘division of labour’.
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Classical School-I 3. Describe the three portion of capital that set the labour in motion.
4. Explain why Smith was opposed to the mercantilist theory of balance of
trade.
NOTES 5. Examine the four canons of taxation.
6. Discuss Malthus’ concept of market glut.
7. Elaborate upon the criticism of the Ricardian theory of rent.
8. Explain Mill’s theory on utilitarianism.

Publications
Company.
Publications.
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Classical School-II
UNIT 5 CLASSICAL SCHOOL-II

Structure NOTES
5.0 Introduction
5.1 Objectives
5.2 Alfred Marshall
5.3 J.A. Schumpeter
5.4 Pigou
5.6 Summary
5.7 Key Words
5.0 INTRODUCTION
In the previous unit, you studied about the classical school of economics, its main
thinkers and the important concepts formulated by them. The discussion is continued
in the present unit with an overview of the contributions made by three eminent
economists namely Alfred Marshall, Joseph Schumpeter and Arthur Cecil Pigou.
5.1 OBJECTIVES

 Understand Alfred Marshall’s theories and laws of economics
 Discuss Schumpeter’s methods of study and innovation theory
 Describe Pigou’s economics of welfare, hypothesis and liquidity trap among
other important concepts
5.2 ALFRED MARSHALL
Alfred Marshall was one of the greatest economists of his generation. He was the
founder of the neoclassical school and was the first economist to rename political
economy as economics. He is the one who gave value to the study of human
wants and expenditure. His Principles of Economics is a masterly description
and a modern adaptation of old ideas. He was the founder of the “Cambridge”
school of Neoclassicism and author of most winning book, Principles of
Economics (1890).
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Classical School-II Early years
Alfred Marshall was born at Clapham in London in 1842, and belonged to a
humble background. His father was William Marshall, who worked as a clerk at
NOTES the Bank of England. Alfred Marshall was educated at Merchant Taylors, a non-
residential private school, and obtained distinction in school, as his records indicate
a strong ability and skill for mathematics. With the financial support of his uncle,
Marshall joined St. John’s College at Cambridge University in 1862, to pursue
Mathematics. He ended up achieving the second highest score in Cambridge’s
mathematics exam in 1865. After a short period as a substitute teacher in Bristol,
Marshall was elected as an associate of St John’s at the end of 1865. Marshall
spent some years as a tutor, and was finally selected as lecturer in moral sciences
at St. John’s in 1868. His intellectual comfort shifted during this period. He moved
from mathematics and grew fascinated in moral beliefs and ethics, then metaphysics,
and finally altercated towards economics.
Marshall claims that he had come up with the neoclassical theory of value
on his own, before reading Jevons’ 1871 book. The latter is carefully dated, as
Marshall reassessed Jevons’ thesis for the Academy in 1872. Due to this reason,
most historians have dismissed Marshall’s claim as an overstated possession.
In 1875, Alfred Marshall went on a tour of the United States of
America, financed by a small inheritance left by his uncle. He got engaged to
Mary Paley in 1876, and they got married in 1877. According to Cambridge
rules and regulations in place, marriage meant both had to resign from their positions
at the university. Then the couple shifted to Bristol, where Marshall secured the
positions of Foundation Principal and Professor of Political Economy at the recently-
created Bristol University College in 1876. Due to his administrative obligation,
Alfred allocated Mary to take over the work for the economics class. This finally
helped to construct, Economics of Industry in 1879, a book written together by
Alfred and Mary. That same year, Marshall had two of his small tracts, Pure
Theory of Foreign Trade and Pure Theory of Domestic Values, privately printed
for distribution among economists. These are the first of Marshall’s works to
contain diagrams - the famous Marshallian “offer curves” are introduced in the
first, and demand-and-supply diagrams and the theory of consumer’s rent,
introduced in the second.
Overwork and ill-health provoked Marshall to resign from Bristol in 1880.
The couple then stayed for a short period in continental Europe, to help Marshall
recover. It was here that Marshall began writing the Principles of Economics, in
1882, which later become his most famous work. The Marshalls returned to
England and taught at Bristol for a year again. In 1883, Alfred Marshall was
hurriedly appointed to replace the late Alfred Toynbee at Balliol College, Oxford.
He remained at Oxford for two years.
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He was elected as Professor of Political Economy at Cambridge University Classical School-II
in 1885 on the death of Henry Fawcett. From this position, Marshall supervised
Cambridge economics for the next two decades. Marshall helped design Balliol
House, where they moved in 1886.
NOTES
Marshall gave indication to parliamentary commissions for Depression of
Trade in 1886, Gold and Silver in 1887, Aged Poor in 1893, Local Finance in
1897 and Indian Currency in 1899. He was the member of the Labour Commission
and wrote an important message of economic policy and trade in 1908.
The Principles
Alfred Marshall’s Principles of Economics was published in July, 1890. It was
the first book published in Britain with a “net book agreement” - that is, the publisher
Macmillan compelled booksellers to agree not to discount book price at retail.
Marshall was bothered about the poorer students who would not be able to buy
the book without discount. But Macmillan declared that without the agreement,
the publishers’ price would be much higher. In the end, it was agreed that Principles
of Economics will be sold at a fixed price of 12s 6d.
The title page contained his famous saying, that “Nature does not make
jumps” and Marshall visualized this to be simply the theoretical part that it would
be tagged along by other volumes applying the theory to specific topics - foreign
trade, money and banking, business cycles, growth, taxation, regulation, trade
unions etc. The Principles was divided into six books.
Definition of Economics
According to Marshall, economics and political economy are both a study of
normal dealing of life. It is on the one side a study of assets and on the other
important side, a part of the study of man. It deals with the financial aspects of
man and not social, political or religious aspect of his life. It describes their regular
business of life, which consists of earning and spending money for the fulfilment of
their necessities of life such as food, clothing and shelter. According to him, wealth
is only a means to well-being. Hence he has given chief importance to man and
secondary to wealth.
Method
As far as the method of study of economics is concerned, he considered induction
and deduction both as useful characteristics of economics and according to him,
both complement each other. Both induction and deduction are essential for
scientific thought, as the left and right foot are both needed for walking.
Marshall was the great paraphraser of the method of partial equilibrium.
The forces manipulating an economic activity are abundant and it is very challenging
to examine all of them to reach at a complete description of the phenomenon.
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Classical School-II Consequently, the best process is to keep other forces constant, and study the
forces inducing the phenomenon. Thus all the other forces are reduced to inaction
by the phrase “other things being equal”.
NOTES Wants and Satisfaction:

Marshall evaluates the features of wants and distinguished between necessities,
comforts and luxuries. He believed that expenditure as the starting and end of all
the economic activities and so he talks about spending first and production
afterwards.
Utility and Demand: - A rational consumer wishes to maximize satisfaction from
his consumption. The amount of satisfaction is closely connected to the amount of
the goods consumed by the consumer.
Marshall has given equal importance to marginal utility with subjective real
cost in theory of value. Marshall stated that supply and demand both determine
the value. Demand is measured by marginal utility, whereas supply is measured by
real cost. Marshall equated supply and demand to two blades of a pair of scissors.
As per Marshall, the price of a commodity is not determined by supply alone or
demand alone but by both demand and supply curve.
Marshall’s Theory of Value and Time Element
Marshall’s theory of value lays emphasis on both supply and demand as forces
prevailing value, which is recognized as the Dual theory of value. It is necessary to
note down that the hypothesis highlights the role of edge. Price is measured by the
services of supply and demand at the edge. It is trivial efficacy and trivial price of
manufacture that manage the cost.
Marshall classified value into four kinds
(i) Market place value,
(ii) Short term value,
(iii) Long term value
(iv) Secular value.
The market price of a product may be defined as the cost decision at a
particular episode. In the case of market value, the contribution is fixed and price
depends primarily on demand.
Law of Diminishing Marginal utility
Demand is based on the law of retreating marginal utility. Marshall confirmed the
law thus, “the added benefit which a person obtains from a given boost of the
supply of a thing, weaken with every raise in the stock that he already has”.
Demand refers to the demand of a commodity at an exact price, other
things being the same. The individual demand curve can be directly taken from the
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rule of diminishing marginal utility. Assuming the marginal utility of money to be Classical School-II
constant as the satisfaction from the additional units of a commodity diminishes,

the price offered to additional units will fall. Hence the demand curve slopes
downwards.
NOTES
These individual demand curves can be summed up together to develop
market demand curve. The market demand curve symbolizes the sum total of
order of all the customers for a product at different prices. On the beginning of
retreating utility, Marshall has developed the rule of replacement.
Up to now customer actions have been scrutinized with reference to only
one commodity. In reality, the consumer has to select between more than one
commodities. A balanced consumer will pay out his money in such a way that his
total pleasure is utmost. They will go on replacing one product for another till they
get optimum satisfaction.
Elasticity of Demand
Marshall introduced the concept of the “elasticity of demand” to economics.
According to him, the elasticity of demand in a Market is great or small as the
amount demanded increased more or less for a given fall in price and reduces
much or little for a given rise in price. He explains how elasticity differs along the
demand curve –declaring it as inelastic at very high and very low prices, and quite
elastic at mediator prices. He also explains the comparative inelasticity of essential
goods.
He illustrates five degrees of elasticity—perfectly elastic, unitary elastic,
greater elastic, less elastic and inelastic. He explained that the demand for luxurious
goods was highly elastic, for comforts elastic and for necessities, it is inelastic.
Formula to measure Elasticity of Demand:
Elasticity of demand =
Marshall was the first to define price elasticity of demand. Marshall gave
three types of price elasticity—unit, greater than unit and less than unit elasticity.
He also listed the factors affecting price elasticity of demand naming price level,
nature of commodities, and various uses of commodities, substitute goods, time,
taste and preference.
Consumer Surplus
Marshall introduced the term consumer surplus to economic literature in 1879
“consumers’ surplus”, or as he also called “Consumers’ Rent” he defines the excess
of the price which a customer would be willing to pay rather than go without the
thing, over that which he actually does pay is the measure of this surplus satisfaction
and can be called consumer surplus. Thus the concept of consumer surplus has
become the basis of welfare economics.
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Classical School-II
NOTES
Representative firm
His second version of the Principles came out in June 1891, with the rescheduling
some chapters. Among the major changes in the second edition is the introduction
of the “representative firm”. It go through more changes, passing through eight
editions overall.
As defined by Marshall, a ‘Representative firm’ has the following
characteristics:
1. A representative firm will be an average firm. It has a fair amount of
internal and external economics
2. It is neither declining nor increasing.
3. Its management is neither very efficient nor inefficient.
4. It is neither old nor new.
5. It is neither earning super normal profits nor incurring losses.
6. There can be more than one such firm.
The Principles was not written as a course book or a book on classroom
instruction. Marshall brought out his Fundamentals of Economics of Industry in
1892 which was basically a simplified description of the Principles, for young
students and the wider public. But it was the Principles that become the major
dissertation and brought English Neoclassicism to universities all over the world.
Factors of Production
According to Marshall, land and labour are the two leading factors of production.
Capital is the subordinate factor of production. Entrepreneur is just a variety of
labour. Consequently, land and labour are the major factors of production. Man
being active, is the central force behind all activities relating to production and
consumption, but nature plays a substantial role as he is shaped by his surroundings
and environment.
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Division of Labour Classical School-II
Marshall held that enlarged demand for produce and extension of the market lead
to division of labour. Division of labour and development of machinery went on
collectively. Technology offers numerous rewards viz., avoids repetitiveness and NOTES
mitigates the strain of muscles.
In order to achieve optimum saving in production, each individual should be
persistently employed so that the proficiency and capacity may be used in a most
excellent way. In short, Marshall identified the significance and the reward of division
of labour.
Law of Returns
Alfred Marshall has explained that, “A raise in assets and labour functional in the
farming of land causes in general a less than proportionate raise in the amount of
manufacture raised, unless it happens to agree with a development in the art of
cultivation.”
Marshall said that cultivation was subject to the law of diminishing proceeds
in the long run and the business division was subject to the law of growing returns.
As per Marshall, “the division which natural world plays in manufacturing shows
an inclination to diminishing returns, the part which man plays shows a tendency to
growing return”.
Marshall acknowledged the Law of Increasing Returns hence “A raise of
labour and wealth go ahead usually to better organization which raise the
effectiveness of the work of labour and principal.” In manufacturing, a raise in unit
of labour and capital would reflect more than proportion raise in manufacture.
Marshall explained the Law of Constant Returns in the following way: “If
the actions of the laws of rising and diminishing profits are balanced, we have the
law of constant return and an enlarged manufacture is achieved by labour and
gives up increased just in section”.
From the Laws of Returns, he arrived at a certain policy ending. He indicated
that according to the law of increasing returns, industry would yield more
economically. But he stated that the difficulty was that it would become a tool of
power politics and it might not be put to appropriate use.
Later years
At Cambridge University, Marshall amplified the importance of economics in
the Moral Sciences Tripos and the History Tripos, and later pressed Cambridge
to create the separate “Economics and Political Sciences” Tripos. This new tripos
was permitted by the university in 1903, and started in 1905.
Marshall took retirement in 1908. Against everyone’s expectations, Marshall
suggested Arthur Cecil Pigou as his successor as Professor of Political Economy
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Classical School-II at Cambridge rather than Herbert Foxwell. After retirement, Marshall set about
completing his long-planned companion volume of the philosophy, applying the
basic theory to definite areas. But due to his illness and other interruptions, progress
was slow. His first companion volume, Industry and Trade, came into view in
NOTES 1919 and the second, Money, Credit and Commerce, in 1923. But by this time,
Marshall had already prepared a methodical layout of action and it is assumed
that the latter volume was in fact paved by Mary Paley and the third volume, on
economic progress, never went further than a rough sketch. Marshall died on
July 13, 1924.
Check Your Progress

1. Name the first book published in Britain with a “net book agreement”.
2. What does economics describe?
3. State the five degrees of elasticity illustrated by Marshall.
4. What should an individual do to achieve optimum saving in production?
5.3 J.A. SCHUMPETER
Schumpeter was born in 1883 in Moravia in the Austrian province. He received

the degree of Doctor of law in 1906 from the University of Vienna. In his initial
years he practiced law but later he decided to specialise in Economics. He studied
Economics from professors Weiser, Philippovich and Bohm-Bawerk. During the
seminars, he came into contact with Mises Bauer, Semary and Hilferding. He
started teaching in 1909 at the University of Czernoitz, Graz (Austria), Bonn
(Germany), Columbia and Harvard. He was famous for his achievements. He
was the president of Econometric Society from 1937 to 1941 and of the American
Economic Association in 1949.
He worked as minister of finance in the Austrian government, the president
of a private bank, and a professor, before being compelled to leave his home
country, due to the rise of the Nazis.
In 1932, he moved to the United States to teach at Harvard. Fifteen years
later, in 1947, he became the first immigrant to be elected president of the American
Economic Association. Born in Austria to parents who owned a textile factory,
Schumpeter was very familiar with business when he took admission in the
University of Vienna to study economics and law. He was one of the talented
students of Friedrich von Weiser and Eugen von Bohm-Bawerk, published the
book Theory of Economic Development at the early age of twenty-eight. In
1911, he got professorship in economics at the University of Graz. He was also
minister of finance in 1919. With the rise of Hitler, Schumpeter left Europe and the
University of Bonn, where he was a professor from 1925 until 1932, and moved
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to the United States. In that same year he joined at Harvard, where he stayed till Classical School-II
his retirement in 1949. He became president of the American Economic Association

in 1948. He died in the year 1950.
Influences NOTES
Schumpeter was influenced by Walras’ general equilibrium analysis and the analysis
of capitalist process of Fisher and Clark. And at the same time Weiser and Bohm-
Bawerk influenced him in his idea relating to marginal productivity, order of goods,
and opportunity costs etc.
He was a Marxist. But the scrutiny that led Schumpeter to his conclusion
was totally different from that of Karl Marx. Marx believed that capitalism would
be destroyed by its opponents whom entrepreneurship had allegedly exploited,
and he enjoyed the view. But Schumpeter believed that capitalism would be shattered
by its successes, that it would generate a large scholarly class that made its living
by attacking the very bourgeois system of private possessions and freedom so it is
necessary for the intellectual class’s survival. Unlike Marx, Schumpeter did not
enjoy the demolition of capitalism.
Capitalism, Socialism, and Democracy are much more than projections of
capitalism’s future. It is also a spotless protection of capitalism. Undeniably,
Schumpeter was among the first to place a clear concept of entrepreneurship. He
distinguished inventions from the entrepreneur’s innovations.
Schumpeter was a great figure in the history of economic thought. His work
in the History of Economic Analysis, completed by his third wife, Elizabeth Boody,
and published after his death in 1954 is quite remarkable. In this book, Schumpeter
made some notorious comments about other economists, arguing that Adam
Smith was imitative, Alfred Marshall was puzzled, and Leon Walras was the greatest
economist of all time.
Joseph Alois Schumpeter was an economist who was regarded as one of
greatest intellectuals of the 20th century. He is best known for his theories
on business cycles and capitalist development and for bringing in the thought of
free enterprises.
Schumpeter’s Contribution
 The theory of Economic Development (1912)
 Business Cycles-Two volumes (1939)
 Capitalism, Socialism and Democracy (1942)
 Ten Great Economists (1951)
 Essays (1951)
 Imperialism and Social Classes (1951)
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Classical School-II  History of Economic Analysis (1954)
 Economic Doctrine and Method (1957)
Methods of Study
NOTES
As per Schumpeter’s view, both inductive and deductive methods are compulsory
for the study of economic science. Deductive methods are effective in price theory
and inductive method was appropriate for the study of organisation of economics.
Historical method was the most important for him. He has accepted mathematics
as an essential means in the science of economics.
Over his many years in public life, Schumpeter developed informal
contentions with the other great intellectuals of the west, including John Maynard
Keynes, Irving Fisher, Ludwig von Mises and Friedrich Hayek. His work initially
was outshined by some of his contemporaries.
Renowned Principles
Schumpeter is recognized for his 1942 book Capitalism, Socialism, and
Democracy as well as for the theory of dynamic economic growth known
as creative destruction. He is also attributed with the first German and English
references to methodological individualism in economics.
Creative Destruction
Schumpeter made many contributions to economic science and political theory,
but by far his most enduring legacy came from a six-page chapter in Capitalism,
Socialism, and Democracy entitled “The Process of Creative Destruction.”
Schumpeter invented the term ‘creative destruction’ to define how the old
is being persistently swapped by the new. Schumpeter offered a new, distinctive
vision into how economies grow, explaining that economic growth is not steady
and passive but rather jerky and sometimes unpleasant.”
The same process of industrial mutation—if I may use that biological term—
that incessantly revolutionizes the economic structure from within, incessantly
destroying the old one, incessantly creating a new one. This process of creative
destruction is the essential fact about capitalism,” he said.
Role of Entrepreneur
According to him, in any economic development, an entrepreneur plays a significant
part. Schumpeter is believed to be the first scholar to acquaint the world with the
theory of entrepreneurship. He derived the German word Unternehmergeist,
meaning entrepreneur-spirit, adding that these entities organised the economy
because they are liable for carrying innovation and technological transformation.
Schumpeter’s arguments abruptly diverged from the prevailing practice.
He highlighted the fact that markets do not passively tend toward equilibrium
until profit margins are wiped out. Instead, entrepreneurial innovation and
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experimentation constantly destroy the old and introduce new equilibrium, making Classical School-II
possible higher standards of living.

In many respects, Schumpeter saw capitalism as a method of evolution within
the social and economic hierarchy. The entrepreneur becomes the revolutionary,
NOTES
upsetting the established order to create dynamic change.
The praise for innovations and explosion of economic activity belonged to
entrepreneur and in a world full of hazard and uncertainty; only excellent
entrepreneurs will be successful by introducing innovative ideas. Hence an
entrepreneur played a significant role in determining the rate of economic growth
of any country and in their absence there will be hurdles in the growth rate.
Schumpeter’s Innovation Theory
He has developed innovation theory of trade cycle which is based on his ideas that
include the invention of new product, opportunity of a new market, reorganisation
of an industry and progress of new methods of production.
As he assumes that these innovations can decrease the cost of production
and may alter the demand curve. Hence innovations may bring about changes in
economic conditions.
But his theory has been criticised on many accounts. His full employment
theory is an unrealistic assumption as no country in this world has achieved full
employment and innovations are usually financed by the promoters and not by
banks.
Capitalism and socialism
Schumpeter agreed with Marx that capitalism planted the seeds of its own
destruction, due to inner disagreement. The economic and social foundations of
capitalism fell down on account of the destruction of the industrial structure and
the decay of the entrepreneurial function. The sophisticated unemployed groups
were not in favour of the capitalist class, and labours also organised themselves to
fight against capital and the intellectuals supplied the leadership. All these factors
led to the gradual decay of capitalism and supported the movement towards
socialism.
As an economist, Schumpeter occupies an exceptional position. He founded
no school and hardly had any follower. He was a class by himself. He possessed
mastery over all branches of economics. He was autonomous in his ideas and
style. Despite the originality of ideas and expression, his writings suffer from
uncertainty and lack of consistency. “The result of complication, diversity and
universality of his mind was that he could not fully incorporate his ideas”, and that
is why he could not gain the place which was held by his colleagues, especially
Keynes.
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Classical School-II
Check Your Progress
Check Your Progress

NOTES
5. Name the notable economists by whom Schumpeter was influenced.
6. What is Schumpeter best known for?
7. Who invented the term ‘creative destruction’?
5.4 PIGOU
Arthur Cecil Pigou was a British economist (1877-1959) and a disciple of Alfred
Marshall. He prospered as a professor of Economics at the University of
Cambridge. After Marshall he become the leading Neo-classical economist. He is
the founder of “welfare economics”. Being part of the Cambridge school, Pigou
used common tools derived from neoclassical economics, such as marginalism,
amongst others.
He remains an underappreciated contributor to the discipline of economics.
Its most prominent years began from around the 1800s over to the work of John
Maynard Keynes. Pigou’s influence on the field is even superior to his own research.
Pigou broke new ground in the regulation of welfare economics, for in his books
Wealth and Welfare (1912) and The Economics of Welfare (1920), he used
measures of national income and its allocation in order to understand how wealth
and welfare are interrelated. He is also remembered for making a distinction
between different degrees of price discrimination. His most durable contribution
being the conceptualization of a corrective tax, immensely referred to as a Pigovian
tax.
He was the son of an army officer and was educated at Harrow and King’s
College, Cambridge. He started off with reading history but later went on to
study economics under Alfred Marshall as part of the Moral Science Tripos, rapidly
becoming a prized scholar. Through Marshall’s efforts, Pigou began lecturing
himself in economics in 1901, became a member of King’s in 1902 and won the
popular Adam Smith Prize in 1903.
Pigou was considered one of the best students of Alfred Marshall. When
Marshall retired as a professor of political economy in 1908, he was named as
Marshall’s substitute. Pigou was responsible for disseminating many of Marshall’s
ideas and thereby presented the leading hypothetical basis for what came to be
known as the Cambridge school of economics.
Pigou applied his economic investigation to a number of other problems,
including tariff policy, unemployment, and public finance. He also served on the
Royal Commission on Income Tax (1919–20).
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Economics of Welfare Classical School-II
Pigou provided the first organized hypothetical basis of welfare economics and
unified the normative problems with the progressive ones. He delivered a foundation
for state interference at places here reserved and social net product deviated but NOTES
his policy proposals were all value based as his study was more normative than
theoretical. Though it was the first clear analysis of welfare economics, was criticized
on many grounds.
Welfare is reflected in a person’s mental condition or awareness which are
made up of his satisfactions or utilities. The basis of welfare, therefore, is essentially
the level to which an individual’s basic needs are met.
Social welfare is deliberated as the core of the welfare of all the people in a
society. Subsequently overall welfare is a very broad, complex and an unfeasible
idea. Pigou set the limits of the assortment of his study to economic welfare.
According to him, economic welfare is by no means a directory of aggregate
welfare as several other components, like the excellence of work, one’s
surroundings, human relations, prestige, accommodation, and public safety are far
away from economic welfare.
Pigou, therefore, described economic welfare as ”that part of social (general)
welfare that can be brought directly or indirectly into relation with the measuring
rod of money.” Thus economic welfare, in the Pigovian sagacity, comprises the
aspiration of utility resulting from the usage of negotiable goods and services.
Pigovian Welfare Conditions
Pigou reflected that economic welfare and national revenue as basically
synchronized. It is on this basis that he arranges two situations for maximization of
welfare. The first incident states that welfare is upsurged when national income
rises. An upsurge in the national income signifies an escalation in welfare. Pigou
argued that in maximum cases the national income would upturn even though the
disutility of work also rises.
Second, for welfare maximization, the sharing of the national income is
similarly essential. If national income rests steady, flowing of income from the opulent
to the deprived would ensure welfare. According to Pigou, such allocations mean
a minor amount to the prosperous than to the deprived, as a consequence the
financial situation of the former is improved. This welfare circumstance is based on
the double Pigovian postulates of ‘equal capacity for satisfaction and retreating
marginal utility of income.’
He argued that different people obtain the same pleasure out of the same
real income and that ”people now rich are different in kind from the people now
poor having in their original nature greater capability for enjoyment.” With income
subject to moving back to marginal utility, and transfers of income from the rich to
the poor will boost social welfare by satisfying the more passionate wants of the
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Classical School-II latter at the expense of the less intense wants of the former. Thus it is equal economic
opportunity that maximizes welfare.
Dual Criterion
NOTES To find up gradation in social welfare, Pigou implements a dual criterion:
First, a rise in the national revenue ‘brought about either by increasing some
goods without diminishing others or by relocating factors to activities in which
their social value is higher,’ is regarded a development in welfare without dropping
the share of the poor.
Secondly, any restructuring of the economy which adds to the share of the
poor without sinking the national income is also considered a development in
social welfare.
Assumptions of Pigovian Conditions
(1) Each person tries to maximize on his contentment from his expenses on
different goods and services.
(2) Satisfactions are comparable interpersonally.
(3) The law of diminishing marginal utility of income applies. It means that the
marginal utility of income decreases as income rises. As a consequence, the
growth in utility of a surplus volume of income to a deprived man is superior
to the cost of utility to an opulent man from the similar extent of revenue.
(4) There is equivalent capability for satisfaction. It follows that different people
gain the same satisfaction out of the same real income. Given this theory, it
is possible to satisfy the Pigovian circumstances of maximum social welfare
on the basis of his double measure.
Pigou effect
Pigou was generally critical of Keynesian macroeconomics and developed the
thought of the Pigou effect on real money stability. He advocated that the economy
would be more self-stabilizing than Keynes projected. The term was named
after Arthur Cecil Pigou by Don Patinkin in 1948.
Actually wealth was defined by Arthur Cecil Pigou as the summing up of
the money supply and government bonds divided by the price level. He argued
that Keynes’ General Theory was lacking in not specifying a link from “real
balances” to current consumption and that the totalling of such a “wealth effect”
would make the economy more “self-correcting” to drops in aggregate
demand than Keynes’ forecast. As the result is received from changes to the “Real
Balance”, this evaluation of Keynesianism is also called the Real Balance effect.
As the universal price falls, the real money stability with the households and
firms improves, which is equivalent to rise in their real wealth. This causes their
expenditure and asset spending to rise, which leads to a rise in the collective
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demand and thereby to an increase in actual income. Therefore, a drop in the Classical School-II
price set off a rise in the actual income. This is explained by the cycle given below:
NOTES
Pigou’s hypothesis and the liquidity trap

An economy in a liquidity trap cannot use monetary incentive to increase output
because there is little relation between personal income and money demand. John
Hicks considered that this might be another cause for steadily high unemployment.
However, the Pigou effect creates a method for the economy to break away from
the trap:
Pigou accomplished that equilibrium with employment below the full

employment rate could only occur if prices and income were sticky.
Pigovian tax
The notion of externalities is established by A.C. Pigou. He contended that the
government should intervene to correct them by taxing undertakings that harm the
entire economy and finance activities that help the society as a whole.
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Classical School-II A Pigovian tax is an administration price on any activity that generates
socially negative externalities. An externality is an action that forms an injurious
effect on others in a society but not basically on the individual who indulges in that
activity.
NOTES
For example, pollution is an externality. Motorists of non-compliant
automobiles don’t suffer rightly from their smoke, but everybody behind them
does. Their drain also upsurges pollution in the community.
The government induces Pigovian taxes on non-compliant vehicles to levy a
greater fee on the drivers to pay off for the suffering they cause. The revenue from
the tax is often used to improve the external cost. Preferably, a Pigovian tax will
cost the manufacturer the same amount of harm that it causes others.
The main dispute against Pigovian tax is that externalities are hard to calculate.
The distortive effects of an imperfectly set tax, especially added with the
administrative costs of implementation, outweigh any potential benefit. But with
the costs of pollution and climate change so large and extensive, the wrong increase
in the cost of pollution is almost certainly better than none at all.
Later Years
He was a great climber who loved mountains and climbing, and also introduced
climbing to his many friends, such as Wilfrid Noyce and others. An illness affecting
his heart developed in the early 1930s, however, and this affected his vigour,
curtailing his climbing and leaving him with phases of weakness for the rest of his
life. Pigou gave up his position as professor in 1943, but remained an associate of
King’s College till his death. In his later years he gradually became more of a
recluse, coming occasionally from his rooms to give lectures or to take a walk.
Pigou never married. He had good friendships, particularly in his later years.
He had a penchant for complaining about politicians.
Check Your Progress

8. What is Pigou’s most durable contribution?
9. What does economic welfare, in the Pigovian sagacity, comprise?
10. State any two assumptions of the Pigovian conditions.
11. Why can’t an economy in a liquidity trap use monetary incentive?

QUESTIONS
1. Alfred Marshall’s Principles of Economics was published in July, 1890.

It was the first book published in Britain with a “net book agreement”.
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2. Economics describes the regular business of life, which consists of earning Classical School-II
and spending money for the fulfilment of their necessities of life such as
food, clothing and shelter.
3. Marshall illustrates five degrees of elasticity—perfectly elastic, unitary elastic,
NOTES
greater elastic, less elastic and inelastic.
4. In order to achieve optimum saving in production, each individual should
be persistently employed so that the proficiency and capacity may be used
in a most excellent way.
5. Schumpeter was influenced by Walras’ general equilibrium analysis and the
analysis of capitalist process of Fisher and Clark. And at the same time
Weiser and Bohm-Bawerk influenced him in his idea relating to marginal
productivity, order of goods, and opportunity costs etc.
6. Schumpeter is best known for his theories on business cycles and capitalist
development and for bringing in the thought of free enterprises.
7. Schumpeter invented the term ‘creative destruction’ to define how the old
is being persistently swapped by the new.
8. Pigou’s most durable contribution is the conceptualization of a corrective
tax, immensely referred to as a Pigovian tax.
9. Economic welfare, in the Pigovian sagacity, comprises the aspiration of utility
resulting from the usage of negotiable goods and services.
10. The assumptions of Pigovian conditions are:
 Each person tries to maximize on his contentment from his expenses on
different goods and services.
 Satisfactions are comparable interpersonally.
11. An economy in a liquidity trap cannot use monetary incentive to increase
output because there is little relation between personal income and money
demand.
5.6 SUMMARY
 Marshall claims that he had come up with the neoclassical theory of value
on his own, before reading Jevons’ 1871 book. The latter is carefully dated,
as Marshall reassessed Jevons’ thesis for the Academy in 1872.
 Marshall gave indication to parliamentary commissions for Depression of
Trade in 1886, Gold and Silver in 1887, Aged Poor in 1893, Local Finance
in 1897 and Indian Currency in 1899.
 According to Marshall, economics and political economy are both a study
of normal dealing of life. It is on the one side a study of assets and on the
other important side, a part of the study of man.
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Classical School-II  Marshall was the great paraphraser of the method of partial equilibrium.
The forces manipulating an economic activity are abundant and it is very
challenging to examine all of them to reach at a complete description of the
phenomenon.
NOTES
 Marshall’s theory of value lays emphasis on both supply and demand as
forces prevailing value, which is recognized as the Dual theory of value. It is
necessary to note down that the hypothesis highlights the role of edge.
 Marshall introduced the concept of the “elasticity of demand” to economics.
According to him, the elasticity of demand in a Market is great or small as
the amount demanded increased more or less for a given fall in price and
reduces much or little for a given rise in price.
 According to Marshall, land and labour are the two leading factors of
production. Capital is the subordinate factor of production. Entrepreneur is
just a variety of labour. Consequently, land and labour are the major factors
of production.
 Schumpeter was influenced by Walras’ general equilibrium analysis and the
analysis of capitalist process of Fisher and Clark.
 As per Schumpeter’s view, both inductive and deductive methods are
compulsory for the study of economic science. Deductive methods are
effective in price theory and inductive method was appropriate for the study
of organisation of economics.
 Schumpeter derived the German word Unternehmergeist, meaning
entrepreneur-spirit, adding that these entities organised the economy
because they are liable for carrying innovation and technological
transformation.
 Schumpeter agreed with Marx that capitalism planted the seeds of its own
destruction, due to inner disagreement. The economic and social foundations
of capitalism fell down on account of the destruction of the industrial structure
and the decay of the entrepreneurial function.
 Pigou applied his economic investigation to a number of other problems,
including tariff policy, unemployment, and public finance.
 Social welfare is deliberated as the core of the welfare of all the people in a
society. Subsequently overall welfare is a very broad, complex and an
unfeasible idea.
 Pigou was generally critical of Keynesian macroeconomics and developed
the thought of the Pigou effect on real money stability. He advocated that
the economy would be more self-stabilizing than Keynes projected.
 The notion of externalities is established by A.C. Pigou.ÿþ He contended
that the government should intervene to correct them by taxing undertakings
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that harm the entire economy and finance activities that help the society as a Classical School-II
whole.
 The main dispute against Pigovian tax is that externalities are hard to calculate.
NOTES
5.7 KEY WORDS
 Neoclassical Economics: It is an approach to economics focusing on the

determination of goods, outputs, and income distributions in markets through
supply and demand.
 Capitalism: It is an economic and political system in which a country’s
trade and industry are controlled by private owners for profit, rather than
by the state.
 Elasticity: It is the measurement of the percentage change of one economic
variable in response to a change in another. An elastic variable is one which
responds more than proportionally to changes in other variables.
 Representative Firm: It is a model firm not necessarily in existence which
as an abstract construction is used to illustrate the operations of a market as
a whole.
 Welfare Economics: It is the study of how the allocation of resources and
goods affects social welfare.

EXERCISES
1. List any two characteristics of a representative firm.
2. How did Marshall explain the Law of Constant Returns?
3. Write a short note on Schumpeter’s arguments about market equilibrium.
4. List the two Pigovian welfare conditions.
5. What is a Pigovian tax?
1. Discuss Marshall’s Law of Diminishing Marginal Utility.
2. Elaborate upon Marshall’s Law of Returns.
3. Explain Pigou’s economics of welfare.
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Classical School-II

NOTES Publications
Company.
Publications.
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Socialism
UNIT 6 SOCIALISM
Structure NOTES
6.0 Introduction
6.1 Objectives
6.2 Socialism: Meaning, Scope and Role
6.3 Karl Marx
6.5 Summary
6.6 Key Words
6.0 INTRODUCTION
Socialism is a philosophy characterised by collective ownership of property by

the society. It believes in the idea that whatever the people produce is a social
product and they are entitled to a share in it. Moreover, it can be used to meet the
requirements of the society as a whole. Socialism stands in complete contrast to
the capitalist ideology which perpetuates exploitation of the working class poor by
assigning control of property in the hands of the powerful few while depriving the
poor of even the basic necessities. This unit provides an overview of the meaning
and scope of socialism.
6.1 OBJECTIVES

 Discuss the meaning, scope and role of socialism
 Describe the ideology of Karl Marx and his theory on economic development
6.2 SOCIALISM: MEANING, SCOPE AND ROLE
Socialism refers to any economic or political theory that states that property and
natural resources should be owned and managed by the community rather than by
individuals.
The term “socialism” has been functional to diverse economic and political
systems all through history, which includes utopianism, anarchism, Soviet communism
and social democracy. These systems differ far and wide in their formation but
they share disagreement to an unhindered market economy, and the faith that
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Socialism public possession of the means of manufacture will lead to a better sharing of
wealth and a more democratic society.
Socialism is a social, political and economic system in which every person
in the community has an equal share of ownership. An ownership of this type is
NOTES
granted through a democratic system of supremacy. Socialism has also been
established through a cooperative system in which each member of the society
owns a share of communal resources.
Communal good can also be interpreted to mean taking care of people
who can’t add to social development such as children, caretakers, and the elderly.
The term socialism refers to any system in which the production and
distribution of goods and services is the common responsibility of a group of
people. Socialism is based upon economic and political theories that promote
collectivism. In a state of socialism, there is no privately owned property.
Socialism was developed by Karl Marx in the period between capitalism and
communism. In socialism, goods are made and distributed by workers, so the
money belongs to the workers rather than private owners. For example, a bakery
pays all the staff the same amount of money based on the profitability of the business.
This can be considered as a socialist economy in a corporation.
Socialism exists within some countries as in the entire economic system or
within factions such as in corporations, healthcare and public education.
Socialism depends on the efforts of each individual of the society. Members
of the society pool together to activate factors of production, and profits are shared
equally by all members. Its vital gain is that all members work equally, and individuals
who can’t contribute are benefited as well. Since the government controls the
functions entirely, misapplication is possible.
Types of Socialism
There are different forms of socialism around the world, and they all differ when it
comes to thoughts on how best to transform capitalism into a socialistic structure.
In addition, the different types of socialism highlight the various aspects of social
democracy. Following are some types of socialistic systems:
1. Democratic socialism
Democratic socialism is a political philosophy that supports and promotes political
democracy. In this system, factors of production are under the administration of
an elected management. Major services like housing, drinking water, electricity
are provided by government, while free market mechanism is used to provide
consumer goods.
2. Revolutionary socialism
The principle of revolutionary socialism is that socialism can be brought only by
the defeat of the existing political and social structure. Socialistic system can’t
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come into view if capitalism is in active role. Revolutionaries rely on the belief that Socialism
the pathway to a purely socialistic structure necessitates a lot of struggle. In such

a system, the factors of production are retained and run by workers through a
well-built federal structure.
NOTES
3. Libertarian socialism
Libertarian socialism is anti –capitalist and works on the theory that people are
always rational, self-regulating, and self-directed. If capitalism is taken away, people
naturally turn to a socialistic system because it is able to meet their needs.
4. Market socialism
Market socialism is an economic system, where the production process is under
the control of common workers. The workers make a decision regarding how
resources should be distributed. The workers sell off what is in excess or give it
out to members of the society, who then distribute resources based on a free
market system.
5. Green socialism
Green socialism is also known as Eco-socialism, which is concerned with shielding
of natural wealth and relates to both Ecology and communism. Large cooperatives
in a green socialistic society are preserved and run by the public. In addition,
green socialism encourages the expansion and usage of public transportation, as
well as the meting out and sale of locally grown foodstuff. The production process
is focused on ensuring that every individual of the community has adequate access
to necessary goods. Moreover, the public is assured to get viable pay.
Gains of Socialism
1. Absence of exploitation
A socialistic structure ensures that no worker is ill-used. A socialistic system believes
that each individual is assured to access necessities, even those that are already
subsidized. Consequently, the system helps to curtail poverty levels in society.
Furthermore, each person has the same right to access health care and other
essential social aspects, such as education.
2. Elimination of discrimination
Socialism condemns discrimination and argues that every person has the right to
do whatever they like. If there are jobs that should be done and there is no one to
perform them, a higher reward is provided. Natural resources are protected for
future generations.
Drawbacks of Socialism
1. Dependency on cooperative membership
The major drawback of socialism is its dependence on cooperative sharing to get
things done. Additionally, competitive people in the community are viewed in an
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Socialism adverse light. The society expects collaboration and not competitiveness. According
to the socialistic system, competitive individuals lean towards causing social
turbulence for personal advantage.
2. Absence of competitiveness and innovation
NOTES
Socialistic systems do not reward innovative ventures or competitiveness.
Subsequently, a socialistic structure does not give boost to entrepreneurial ventures.
Difference between Socialism and Capitalism
Capitalism is based on forces of free market and the socialistic structure is based
on their coherent foundation. Moreover, they also differ because of their implicit
or stated goals, as well as the ownership structure, and the production process.
Structurally, a free market structure and socialism can be differentiated on
the basis of rights to property as well as control of the production process. Under
a capitalistic economic system, enterprises and private individuals control the means
of production, together with all the profits. In a socialistic pattern, government has
complete control over the resources which are used in the production process.
Private property is overlooked, but where it subsists, it is in the form of consumer
goods.
While capitalism is reliant on the choices of individuals who stimulate
economic activities, a socialistic system controls the economic activities by forces
of demand and supply.
Origin
Socialism emerged as a political ideology and as a reaction to the growing capitalist
system. It presented an option to classical liberation which intended at improving
the condition of the working class and creating a more democratic society. In its
prominence on community ownership of the means of production, socialism
contrasted piercingly with capitalism (private enterprises), which is based on a
free market system and private ownership.
The roots of socialism go back to the ancient Greek era, when a
logician Plato depicted a type of cooperative society in his dialog, Republic (360
B.C.). In 16th-century England, Thomas More drew Platonic ideals for his Utopia.
According to this book, Thomas More depicted a fantasy island where money no
longer played important role and all people lived and worked communally.
During the late 18th century, the industrial revolution brought about drastic
changes as the invention of steam engine brought variations in both economic and
social sector. The invention first affected the Great Britain followed by rest of the
world. Factory owners became wealthy whereas labourers gained no profit and
continued to live in increasing poverty. The labourers were compelled to work for
more hours in unhealthy conditions.
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Utopian Socialism Socialism
Utopian socialism can be described as a political as well as social idea of the mid-
19th century based on the principles advocated by Robert Owen, a communist.
A sketch was made for a new city with the intention to create a new utopian NOTES
community in Indiana, based on the ideology advocated by Robert Owen.
The city was intended to give “intellectual and moral reward to every human
being.”
Socialists like Henri de Saint-Simon, Robert Owen and Charles Fourier
presented their own models for social organization based on teamwork rather
than rivalry. On the other hand, Saint-Simon argued for an arrangement where the
state controls manufacture and allocation for the advantage of all the members of
a society, both Fourier from France and Owen from Britain, proposed a system
based on small cooperative, not a centralized state.
Owen was the owner of the textile mills in Lanark, Scotland. He moved to
the United States in 1825 to instigate an experimental society in New Harmony,
Indiana. His cooperative was based on the philosophy of self-reliance, collaboration
and community possession. The experiment fell flat, and Owen had to face major
financial losses. There were a number of small cooperatives and agricultural
communities were working across the United States inspired by Fourier’s theories.
One of these lasted till the 1930s at Red Bank, New Jersey.
Influence of Karl Marx
Among modern thinkers, Karl Marx is certainly the most influential philosopher of
socialism. According to him, Owen and Fourier’s visions are dreamy and unrealistic
hence he termed them as “Utopian”. For Marx, society was made up of two
classes: The first were the bourgeoisie who owned the means of production and
used that money power to take advantage of the labour class and the second were
the proletariats or the working class that lived in abject poverty.
Marx and his collaborator Friedrich Engels in “The Communist Manifesto”
argued that true “scientific socialism” could be established only after a revolutionary
class struggle, with the workforce emerging on top.
Marx died in 1883. Even after his death, his ideas influenced socialist thought
to a great extent. His ideas were taken and used by various political parties such
as the German Social Democratic Party and leaders like Vladimir Lenin and Mao
Zedong.
Marx highlighted the clash between capitalists and the labour that came to
dominate most communist thought, but other brands of socialism continued to
grow. For example, Christian socialism or collective societies which formed around
Christian religious ideology. According to anarchism, both private enterprises and
governments are harmful and unnecessary. Social democratic system can be
improved and achieved through gradual political improvement rather than revolt.
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Socialism Socialism in the 20th Century
In the first half of the 20th century—mainly after the Russian Revolution in 1917,
the Soviet Union came to represent social democracy and emerged as the two
NOTES most dominant communist movements throughout the world.
By the closing stage of the 1920s, Lenin’s revolution had given stimulus to
the foundation of the Communist Party of the Soviet Union.
Soviet Union and other communists joined services with other socialist
movements in resisting fascism. After World War II, this coalition dissolved as the
Soviet Union established socialist regimes across Eastern Europe.
In the late 1980s, with the downfall of the Soviet Union in 1991, socialism,
as a worldwide political force, was greatly diminished. Only China, Cuba, North
Korea, Laos and Vietnam remained communist states.
In the 20th century, socialist democratic parties won hold in many European
countries by pursuing more centrist beliefs. Their ideas called for a gradual
recreation of public reforms such as education and healthcare through the processes
of elected government within a largely commercial system.
Socialism in the United States
Socialism began in the United States with the utopian communities in the early 19th
century. The Socialist Party of America was established in 1901and reached its
peak of support in 1912, when Eugene V. Debs won 6 percent of the vote in that
year’s presidential election. The Socialist Party never enjoyed the same
accomplishment as in Europe but social improvements like Security and Medicare
became a well-accepted part of American society.
Some open-minded politicians in the United States have embraced a variation
on social democracy called democratic socialism. This calls for following socialist
activities such as single-payer health care, free college tuition and higher taxes on
the wealthy.
Socialist movement in the United States was relatively weak in comparison
with Canada and Europe. There is a wide range of interpretations and definitions
of socialism, and the lack of a common understanding of what socialism is or how
it looks in practice reflects its complex evolution. Still socialist parties and their
ideas continue to influence policy in nations across the world.
Check Your Progress

1. What does socialism depend on?
2. What is the major drawback of socialism?
3. How did socialism diminish as a political force?
4. What did Marx and Engels state about “scientific socialism”?
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Socialism
6.3 KARL MARX
Karl Heinrich Marx was born on the 5th May, 1818 in Trier.1 He was a German
philosopher, sociologist, historian, political economist, political, theorist and NOTES
revolutionary socialist who developed the socio-political theory of Marxism. His
ideas have since played a significant role in both the development of social science
and also in the socialist political movement. He published various books during his
lifetime with the most notable being The Communist Manifesto (1848) and Capital
(1867–1894), many of which were co-written with his friend, the fellow German
revolutionary socialist Friedrich Engels.
Born into a wealthy middle class family in Trier, Prussia, Marx went on to
study at both the University of Bonn and the University of Berlin, where he became
interested in the philosophical ideas of the Young Hegelians. Following the
completion of his studies, he became a journalist in Cologne, writing for a radical
newspaper, the Rheinische Zeitung, where he began to use Hegelian concepts of
dialectical materialism to influence his ideas on socialism. Moving to Paris in 1843,
he began writing for other radical newspapers, the Deutsch-Französische
Jahrbücher and Vorwärts! as well as writing a series of books, several of which
were co-written with Engels. Exiled to Brussels in Belgium in 1845, he became a
leading figure of the Communist League, before moving back to Cologne, where
he founded his own newspaper, the Neue Rheinische Zeitung.
Exiled once more, in 1849 he travelled to London where, living in poverty,
he proceeded to continue writing and formulating his theories about the nature of
society and how he believed it could be improved, as well as campaigning for
socialism and becoming a significant figure in the International Workingmen’s
Association.
Marx’s theories about society, economics and politics, which are collectively
known as Marxism, hold that all society progresses through class struggle. He
was heavily critical of the current form of society, capitalism, which he called the
‘dictatorship of the bourgeoisie’, believing it to be run by the wealthy middle and
upper classes purely for their own benefit, and predicted that, like previous
socioeconomic systems, it would inevitably produce internal tensions which would
lead to its self-destruction and replacement by a new system, socialism. Under
socialism, he argued that society would be governed by the working class in what
he called the ‘dictatorship of the proletariat’, the ‘workers state’ or ‘workers’
democracy’. He believed that socialism would, in its turn, eventually be replaced
by a stateless, classless society called pure communism. Along with believing in
the inevitability of socialism and communism, Marx actively fought for the former’s
implementation, arguing that both social theorists and underprivileged people should
carry out organised revolutionary action to topple capitalism and bring about socio-
economic change.
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Socialism While Marx remained a relatively obscure figure in his own lifetime, his
ideas and the ideology of Marxism began to exert a major influence on socialist
movements shortly after his death. Revolutionary socialist governments following
Marxist concepts took power in a variety of countries in the 20th century, leading
NOTES to the formation of such socialist states as the Soviet Union in 1922 and the People’s
Republic of China in 1949, whilst various theoretical variants, such as Leninism,
Trotskyism and Maoism, were developed. Marx is typically cited, with Émile
Durkheim and Max Weber, as one of the three principal architects of modern
social.
Marxian theory of development is based on the premise of the nature of production
function, technological progress and the way the process of capital accumulation
takes place. All these together influence the wage rate determination and
accumulation of profit in the economy thereby consequent upon the dynamic
behaviour of the economy.
In his Das Kapital (1867), Marx maintains that the production of goods
takes place under the control of a capitalist and on his behalf, does not alter the
general character of that production. According to him, labour is a process in
which both man and nature participate. He argues that the labour power gives
value to a commodity produced. However, the unearned income of the labour is
retained by the capitalist as profit. Karl Marx terms this as the exploitation of
labour. This injustice caused to the labour class can be eliminated only when the
factors of production are transferred from the capitalist to the working class.
According to Marx, technology inevitably replaces labour and machines
help the capitalist to earn greater profits. Thus, technological advancement results
in increase in unemployment and furthering accumulation of capital. But this will
also result in the reduction of investment opportunities and rate of profit. Therefore,
the ruling capitalist class becomes an imperialist class. Under capitalism, income
inequalities will grow. Growth would be unbalanced and business cycles would be
more violent due to increase in unemployment, poverty and under consumption
among the masses. The working class will revolt against the capitalist class thereby
resulting into an end of capitalism and rise of communism.
The theory of development is based on certain assumptions such as the
capital accumulation, technological progress and the production function.
Materialistic interpretation of history
According to Karl Marx, the foundation and evolutionary cause of all social life is
materialism. Historical development is determined and influenced by the economic
condition and non-economic forces have very little influence on these events. The
mode of production determines the general character of social and political process
of life and the class structure is related to the relations of production which is
characterized by the following:
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 Division of labour in a society, skills possessed by the labour in the social Socialism
content with respect to degree of freedom

 Knowledge about the availability of resources in the economy
 Technological progress NOTES
According to Marx the entire history of human kind is divided into four different
social systems.
 Primitive communism
 Slave age
 Feudalism
 Capitalism
During the age of primitive communism, the factors of production belong to
the community which also enjoys control over the resources. Individuals utilize the
resources as per their needs. But in the other stages, the control of resources is
restricted to a smaller class. This class also controls the society. The society gets
divided into two classes, viz., the dominant class and the depressed class. Such a
kind of division of society also creates tensions and conflicts. Hence, the control
of resources results into a change in the structure of the society. But the basic
structure relates to production, exchange and distribution. This also influences the
shape of life. Friedrich Engels mentions that the ultimate cause of social change
and political revolution is sought in the mode of production and exchange.
Surplus value
According to Karl Marx, labour is the only source of value of a community. The
factors of demand and supply determine the value of a commodity only in the
short run but in the long run the amount of labour used in the production of a
commodity determines this value.
Karl Marx divides the society in two classes, viz., the working class and the
capitalist class. The capitalist class owns the resources and purchases labour
services from the working class and the working class sells its labour to the capitalists.
The commodity produced by the labour is sold at a price in the commodity market
and the labour is paid some wages for producing the commodity. The difference
between the price by the commodity and the wages paid to the labour is the
surplus value which is retained by the capitalist. According to Marx, capitalists are
interested in producing those goods and services that generate more surplus value
for them rather than socially useful commodities. Thus capitalism believes in the
exploitation of labour which is nothing but the surplus value generated by the
workers. The surplus value generated by the labour during the process of production
is used by the capitalist class for reinvestment which furthers the process of
production under capitalism.
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Socialism The capitalist tries to increase the surplus value which leads to the capitalist
development. Hence, it is the surplus values generated by the labour class which
has a great role to play in the development of a society.
Process of production
NOTES
According to Karl Marx, it is the process of production in an economy that
determines the evolution of society. Under capitalism, the value of a commodity
consists of three elements. These are the constant capital, variable capital and
surplus value. The constant capital represents machinery and material and remains
constant during the process of production. Labour power represents the variable
capital and changes with production. Finally, the surplus value is the value added
to the production which according to Marx is equal to the profit. This occurs
because the worker is not paid wages equal to the amount of value added during
the process of production, but only subsistence wages.
If we suppose that the following is the production function:
Q = f (K, N, L, T, Z)
where Q is the amount of output
K is the capital stock
N is the amount of land
L is the amount of labour
T is the technical knowledge and technical interaction representing relations
of production Z is the entire socio-cultural and institutional set-up of the society
Accordingly,
Q = ( + ) L + yK + nN
where, a L is the variable capital (v)
b L is the surplus value (Sv)
and (yK + nN) is constant capital (c).
Since, yK and nN are not separate amount
Thus,
Q = ( +) L + yK
where yK is K + N
The coefficients of production (,  and y) are responsive to the changes in
the relations of production and thus are not fixed over a period of time. In the
Marxian theory, changes in the techniques of production is not autonomous. As
Marx puts it, the additional capital termed in the course of accumulation serve
mainly as vehicles for the accumulation of new inventions and discoveries, or of
industrial improvements in general. An increase in the amount of gross investment
is shown by the rate of change of the relations of production. Any change in
technology displaces labour, that is c/v rises over a period of time due to increase
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in gross investment. This is known as the organic composition of labour change in Socialism
the stock of variable capital determines the demand for labour. Gross investment
also determines the labour capital ratio.
The supply of labour is exogenous and increases with an increase in
NOTES
population. Because technology displaces labour, with change in technology,
unemployment will increase and create a ‘reserve army of labour’. This reserved
army of labour facilitates movement of capital between the new and traditional
production activities. It also influences the bargaining power of labour and thereby
the amount of money wages. This results in exploitation of labour. Hence, with
growth of capitalism, there is a progressive deterioration in the conditions of the
labour class. According to Marx, ‘with the progress of industry, the modern labour
sinks deeper and deeper below the conditions of existence of his own class,
becomes a pauper and pauperism develops more rapidly than population and
wealth.’
Capital accumulation
The rate of capital accumulation is an important determining factor of economic
growth in the Marxian theory. Marx argues that the quantity of accumulated capital
is determined by the surplus value generated during the process of production.
This is due to the fact that the wages received by the workers are spent for
consumption. There is reinvestment in the society so as to maintain the stock of
capital. Thus, ‘all the circumstances that determine the mass of surplus value operate
to determine the magnitude of accumulation.’
Another factor contributing to the accumulation of capital is the productivity
of labour. As productivity of labour rises, the surplus value generated by labour
increases and therefore results into accumulation of capital. The capitalist forms
the elite class in the society as he is the owner of the capital. Higher the amount of
capital owned by a capital, higher is the position power and prestige in the society.
As Marx puts it, ‘to accumulate is to conquer the world of social wealth, to increase
the mass of human being exploited by him, and thus to extent both the direct and
indirect sway of the capitalist.’ The capitalist who has more advanced and efficient
technology is also the one who is able to generate larger amounts of surplus and
therefore is able to accumulate larger amount of capital.
After accumulating large amounts of capital, the capitalist spends on luxury
and conspicuous consumption, may be due to necessities of business show off
that may add to prestige. This kind of expenditure grows with the growth of
accumulated capital. The motive behind this kind of lavish and wasteful expenditure
is also to accumulate more capital.
The tendency to accumulate capital is normal and an important feature of
the working of capitalism. This results in the emergence and expansion of huge
enterprises that gain importance in the economy. This stimulates the concentration
of capital in a capitalist society and gradually results into the emergence of monopoly
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Socialism power. Gradually, this results into monopoly capitalism and imperialism. But at the
same time, the process of socialization of production is promoted, i.e., a large
group of workers begin to work together. This provides material condition for
transition to socialism.
NOTES
One important aspect of capital accumulation under capitalism that Marx
mentions is the cyclical nature of accumulation. There are cyclical crises from one
period to another resulting into another kind of crisis. At times, there is a situation
of overproduction or underconsumption or there may be an underutilization of the
capacity resulting in underproduction. There are phases of depression, recession,
recovery and boom through which the economy passes. When capitalism exhausts
its progress there is a collapse of the system and is replaced by a superior form,
i.e., socialism as a result of high level of unemployment, poverty and growing
inequalities.
Critical evaluation
The Marxian theory of economic development has been criticized on several
grounds. Some of these have been discussed as under:
 Marx argues that there is a tendency for the profit to fall as the organic
composition of capital rises. But Paul Sweezy argues that as organic
composition of capital rises, labour productivity increases. But this should
have the effect of creating an industrial reserve army of labour which results
into lowering of wages which in turn raises the rate of surplus value. Since
both the composition of capital and the rate of surplus value are variable,
the rate of profit would be indeterminate, though falling rate of profit is a
basic feature of capitalism.
 The Marxian theory has also been criticized on the ground that at best it
can be a synthesis of the historical evolution of the society during the process
of economic growth but cannot be a theory of economic growth.
 Marxian theory has been criticized in respect to the wages and poverty
among the working class. He argues that under industrial capitalism wages
tend towards subsistence level. However, the evidences are that in the
industrial societies, wages have had the tendency of upward movement.
 Another important criticism of the Marxian theory pertains to his assumption
about the collapse of the capitalist system being replaced by socialism.
Though revolutions have taken place in some countries such as Russia and
China it is not simple to carry through a socialist transformation in the
industrially advanced countries as the employment and wage levels are high.
Ernest Mandel has also argued that there has been a straight line progressive
evolution in the world starting from the first stages of fruit gathering and
ending with the most advanced capitalist or socialist industry.
 The recent experiences with former USSR, China and the East European
countries have shown that the social ownership of the factors of production
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and production decisions have resulted into growing inefficiencies in the Socialism
economy and the collapse of the system. There have been government
failures resulting into collapse of economies.
Despite these criticisms the Marxian theory is relevant from the point of
NOTES
view of the historical evolution of a capitalist society.
Check Your Progress

5. How does technological advancement results in increase in unemployment?
6. Which elements does the value of a commodity consist?
7. What does the capitalist spend on after accumulating large amounts of
capital?

QUESTIONS
1. Socialism depends on the efforts of each individual of the society. Members

of the society pool together to activate factors of production, and profits
are shared equally by all members.
2. The major drawback of socialism is its dependence on cooperative sharing
to get things done.
3. In the late 1980s, with the downfall of the Soviet Union in 1991, socialism,
as a worldwide political force, was greatly diminished.
4. Marx and his collaborator Friedrich Engels in “The Communist Manifesto”
argued that true “scientific socialism” could be established only after a
revolutionary class struggle, with the workforce emerging on top.
5. According to Marx, technology inevitably replaces labour and machines
help the capitalist to earn greater profits. Thus, technological advancement
results in increase in unemployment and furthering accumulation of capital.
6. Under capitalism, the value of a commodity consists of three elements. These
are the constant capital, variable capital and surplus value.
7. After accumulating large amounts of capital, the capitalist spends on luxury
and conspicuous consumption, may be due to necessities of business show
off that may add to prestige.
6.5 SUMMARY
 Socialism is a social, political and economic system in which every person

in the community has an equal share of ownership. An ownership of this
type is granted through a democratic system of supremacy.
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Socialism  Socialism depends on the efforts of each individual of the society. Members
of the society pool together to activate factors of production, and profits
are shared equally by all members.
 The principle of revolutionary socialism is that socialism can be brought
NOTES
only by the defeat of the existing political and social structure. Socialistic
system can’t come into view if capitalism is in active role.
 A socialistic structure ensures that no worker is ill-used. A socialistic system
believes that each individual is assured to access necessities, even those
that are already subsidized.
 Socialistic systems do not reward innovative ventures or competitiveness.
Subsequently, a socialistic structure does not give boost to entrepreneurial
ventures.
 Utopian socialism can be described as a political as well as social idea of
the mid-19th century based on the principles advocated by Robert Owen,
a communist.
 Owen was the owner of the textile mills in Lanark, Scotland. He moved to
the United States in 1825 to instigate an experimental society in New
Harmony, Indiana. His cooperative was based on the philosophy of self-
reliance, collaboration and community possession.
 In the late 1980s, with the downfall of the Soviet Union in 1991, socialism,
as a worldwide political force, was greatly diminished. Only China, Cuba,
North Korea, Laos and Vietnam remained communist states.
 Socialism began in the United States with the utopian communities in the
early 19th century. The Socialist Party of America was established in 1901and
reached its peak of support in 1912, when Eugene V. Debs won 6 percent
of the vote in that year’s presidential election.
 Marx’s theories about society, economics and politics, which are collectively
known as Marxism, hold that all society progresses through class struggle.
 Marxian theory of development is based on the premise of the nature of
production function, technological progress and the way the process of
capital accumulation takes place.
 According to Karl Marx, the foundation and evolutionary cause of all social
life is materialism. Historical development is determined and influenced by
the economic condition and non-economic forces have very little influence
on these events.
 Karl Marx divides the society in two classes, viz., the working class and the
capitalist class. The capitalist class owns the resources and purchases labour
services from the working class and the working class sells its labour to the
capitalists.
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 The rate of capital accumulation is an important determining factor of Socialism
economic growth in the Marxian theory. Marx argues that the quantity of
accumulated capital is determined by the surplus value generated during the
process of production.
NOTES
 The Marxian theory has also been criticized on the ground that at best it
can be a synthesis of the historical evolution of the society during the process
of economic growth but cannot be a theory of economic growth.
6.6 KEY WORDS
 Anarchism: It is a political philosophy and movement that is sceptical of

authority and rejects all involuntary, coercive forms of hierarchy.
 Communism: It is a theory or system of social organization in which all
property is owned by the community and each person contributes and
receives according to their ability and needs.
 Collectivism: It is a value that is characterized by emphasis on cohesiveness
among individuals and prioritization of the group over the self.
 Scientific Socialism: It refers to a method for understanding and predicting
social, economic and material phenomena by examining their historical trends
through the use of the scientific method in order to derive probable outcomes
and probable future developments.

EXERCISES
1. Define democratic socialism.
2. Write a short note on the differences between socialism and capitalism.
3. How are the relations of production characterised?
4. What have the recent experiences with former USSR, China and the East
European countries shown?
1. Analyze any three types of socialism.
2. Discuss the gains and drawbacks of socialism.
3. Elaborate upon the concept of surplus value
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Socialism
NOTES Publications
Company.
Publications.
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Schools of Socialism-I
UNIT 7 SCHOOLS OF SOCIALISM-I

Structure NOTES
7.0 Introduction
7.1 Objectives
7.2 Different Schools of Socialism
7.4 Summary
7.5 Key Words
7.0 INTRODUCTION
As discussed in the previous units, socialism is a populist economic and political

framework centred on the ownership of the means of production by the public
(also known as collective or common ownership). Such means include the
equipment, tools, and factories used to manufacture items that are meant to meet
human needs directly. Communism and socialism are umbrella words that refer to
two left-wing economic schools of thought; both reject capitalism, although the
‘Communist Manifesto’, a pamphlet by Karl Marx and Friedrich Engels in 1848,
precedes socialism by a few decades. There are different schools of thoughts of
socialism. In this units, we will discuss different schools of socialism namely, utopian
and Christian.
7.1 OBJECTIVES

 Explain the different schools of thoughts of socialism
 Discuss the utopian school of socialism
 Describe the Christian school of socialism
7.2 DIFFERENT SCHOOLS OF SOCIALISM
There are several types of socialism and no single definition captures all of them,
but the common feature shared by its different forms is social ownership. Forms of
socialism involve a number of economic and social systems marked by social
ownership and democratic control of companies’ means of production and
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Schools of Socialism-I organisational self-management, as well as socialism-related political theories and
movements. Let’s discuss two of the significant schools of socialism.
NOTES When in the latter half of the 19th century, the revolutionary dogmas of Marx and
his school had become most conspicuous in the social movement, the earlier systems
became known, by way of distinction, such as Utopian socialism. Under this term
were included the doctrines and projects of Robert Owen. The name was in some
sense justified by the ideal societies that were advocated and put to all practical
tests by these thinkers and their followers. But while Plato and Thomas Moore
and Tommaso Campanella had constructed their fanciful commonwealths with no
expectation of their being realized, the 19th century Utopians were profoundly
convinced that their several systems were destined in no distant future to effect an
entire transformation of social life. In the governmental reforms that were so much
at issue in their time, these philosophers had little or no interest. According to
them, the political would disappear with the social evils when society should be
reorganized on the proper principles. These utopian socialists believed that all the
schools found in history evidence that the normal course of mankind in progress
toward its goal had been checked and deflected by ignorance and error concerning
the principles of collective life—a correct understanding of those principles would
bring naturally the resumption of progress.
All agreed that an important, if not the most important, source of the ills that
afflicted mankind was poverty and its consequences. All agreed that the ‘prevalence
of poverty was due largely, if not exclusively, to the exaggerated recognition of
self-interest as the ‘mainspring of human action, and that the existing system of
industry and commerce, based upon this principle and operating by unrestricted
competition, must unendingly increase the misery of the race. All scored the injustice
of unearned wealth as vehemently as they lamented the sufferings of undeserved
poverty’. All denounced the existing capitalistic system. Robert Owen, however,
found capital indispensable, subject to the regulations imposed by his system.
Owen maintained that when his simple rational laws for the creation of what is
good for men should prevail, there would be no ‘useless private property’; but St.
Simonians announced as the most important means to the realization of social
justice that the right to unearned property, so far as it depended on inheritance,
must be abolished. The error that has led men astray, so the Utopians, all argued,
has been the assumption that nature designed the individual rather than the group
to be the basis of social existence. Society is not a deliberately created service of
previously isolated men for the promotion of their several selfish interests; it springs
from the feeling not from the reason of mankind. Sympathy the ‘sense of alikeness—
brings men inevitably together’ and ‘benevolence—willing the good of all—is the
natural principle of association’. ‘These basic factors have been almost wholly
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lost sight of in the theory and practice of social life. Rivalry, competition, strife and Schools of Socialism-I
war,’ (The unit of this new order is to be a community of with the endless exploitation
of the weaker by the stronger have become the accepted methods for determining
the relations of individuals and of peoples to one another. The internal affairs of the
NOTES
community are to be directed to one another. To change all this and restore the
reign of nature’s peace and order to humanity, is the proclaimed purposes of all
the Utopians).
The projects of the various schools for the achievement of this end had
some things in common, but were; for the most part widely divergent from one
another. Owen and the Owenites chiefly devoted themselves to the improvement
of conditions in the industrial world. Philanthropic devices for the benefit of the
labourers were managed by precept and by example upon the obdurate British
factory owners, and the legislation that was at last secured, against the bitter
opposition of the laissez-faire economists, received hearty support from the
Owenites. The most characteristic feature of their work, however, was the
establishment among the working classes of cooperative societies for the supply
of their needs. This form of voluntary association for the production and exchange
of commodities, attained great prominence and wide vogue in the 1820s and the
1830s. Cooperation was hailed as the much-desired expedient for escaping the
evils of the strife between capital and labour. The success of this device confirmed
Owen in his belief that he had solved the problem of society in general, and he set
forth with fanatical fervour his scheme of a reorganized world.
The unit of this new order is to be a community of families numbering from
500 to 3000 persons, living on a tract of land large enough to support the members.
The internal affairs of the community are to be directed by a council consisting of
all the members from thirty to forty years of age; relations with other communities
are in the charge of a like council of the members from forty to sixty years. Unions
of these primary communities will be constituted under similar councils for larger
areas. All the councils are to act in conformity to the code that Owen formulates,
the basis of which is the fundamental law of nature that the individual’s character is
not formed by himself, but is the result of the circumstances and education to
which he has been subjected. The chief prescriptions of the code are those that
insure the ‘same general routine of education, domestic teaching and employment’
to all children of both sexes, who are put from birth under the care of the community.
Members who, despite their education, fail to act rationally are to be removed to
the hospitals for physical, mental or moral invalids, where their cure is to be affected
by the mildest possible treatment. If any directing council contravenes the
fundamental laws of human nature it will be supplanted by a new one consisting of
the members of the community between twenty and thirty or over sixty years of
age. It is not explained how this substitution is to be effected, and there is nowhere
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Schools of Socialism-I in the scheme, save in the clause referring to the hospitals, any suggestion of coercive
government. What is to become of the existing political systems of the world is not
discussed, but the thought is not obscure that they will fade, imperceptibly away in
the light of the new order.
NOTES
Robert Owen’s project for escape from the evils of civilization took shape
in that form of communal life which became famous as the phalange. His primary
concern was with agricultural rather than industrial production, with the household
rather than the factory. The true principles of association he worked out in an
elaborate system wherein much acute and suggestive reflection was made useless
by incoherent presentation and pedantic terminology. The outstanding feature of
his social philosophy was the doctrine of what he has called passionate attraction.
According to this doctrine, the passions or feelings of men, rather than their reason,
must be considered the basis of every kind of association, and particularly of that
cooperative union through which the primary needs of physical life are satisfied.
Naturally ‘all men dislike the incessant, monotonous labour that produces’ the
necessities of life. Naturally every man finds ‘relative if not absolute pleasure in
some species of labour or in some alternation in species of labour’. Ignorance or
disregard of these basic facts accounts for the evils of social life whether in ancient
or in modern times. Slavery, serfdom and the wages system, with the governmental
institutions that accompany and sustain them, are but different forms of the distortion
that results from the effort of certain classes, by deliberate liberate association, ‘to
put all the repellent labour of social life upon others and retain the agreeable for
themselves alone.
Robert Owen said that the way out is to transform the social organization in
the light of the principles that Owen has discovered. Labour must be made attractive,
and therefore productive beyond all comparison with earlier ages. Every variety
of taste, talent and other endowment must be recognized and utilized in the
proportion that science shows to be requisite for the harmony of the whole and
the happiness of the individual members. The typical association for this end is a
group of five hundred families, fifteen to eighteen hundred persons, voluntarily
united in a community which Owen called, true socialism. It should include
capitalists, labourers and persons of talent, each contributing as he is able to the
productiveness and agreeableness of the community’s life.
Through the organization and specialization of the functions essential to the
industries, occupations suited to every taste would be available with the result that
every member would labour with the zest of pleasure. ‘Passional attraction’ rather
than competitive greed for gain would rule the community life. No wages should
appear in the system. Every species of necessary labour must be performed by
the members, participation of all in the generally repulsive kinds being stimulated
in various in genius ways. Every member of the community must be a shareholder,
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whose part in the profits shall be determined in accordance with a scale that assigns Schools of Socialism-I
a fixed proportion to capital, to labour and to talent. But every member must be
guaranteed a minimum return sufficient to free him from anxiety for himself or his
family, and every member must possess the right to labour in such occupations as
NOTES
are adapted to his preference and his capacity.
In the words of Robert Owen, with the establishment of such a system of
social organization Owen believes that poverty will disappear, true liberty will be
assured to every individual, the real natural rights of man will be recognized,
happiness and order will be universal, and consequently government, so far at
least as its coercive activities are concerned—armies, scaffolds, prisons, courts of
justice—will have no longer any cause for existence. There never appears in Owens
writings the slightest suggestion of revolutionary violence. His conviction is unfaltering
that the great truths he has revealed will make their way by their own virtue.
Christian Socialism was a new belief of Christianity, which can also be termed as
modern Christianity. It was a movement which was started in the mid-19th Century.
This movement emphasises on the application of social principles of Christianity to
modern industrial life. Christian Socialism can also be termed as Laissez Faire
Individualism. It means the demand of all Christian activists on behalf of all other
individuals of society—impoverished or wealthy, for the development of social
programmes in all the political and economic activities. Therefore, Christian
socialism can be referred to as any movement that attempts to amalgamate the
basic objectives of socialism with religious and ethical beliefs of Christianity.
Role of Henri de Saint-Simon in Christian Socialism
Henri de Saint-Simon was a French Businessmen who is known for his contribution
in the sociology. He was born in an impoverished aristocratic French family on
October 17, 1760 in Paris, France. His school education was very irregular and
at the age of seventeen he got admitted to the military. He was the part of the army
troop sent to help the American Colonies to participate in their war of independence.
He also posted as a captain of the artillery at Yorktown in 1781. At the time of
French revolution, he visited France where he bought up a new land with the help
of friend. He was active in the French revolution and got imprisoned in the Palais
de Luxembourg during reign of terror and became enormously rich because of the
depreciation of revolutionary currency. He proceeded to live a life of grandeur.
Within several years he had brought himself close to bankruptcy. He turned to the
study of science, attending courses at the École Polytechnique and entertaining
distinguished scientists.
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Schools of Socialism-I In his first published work, Lettres d’un habitant de Genève à ses
contemporains (‘Letters of an Inhabitant of Geneva to His Contemporaries’,
1803), Saint-Simon proposed that scientists should take the place of priests in the
social order. By 1808, he was insolvent and was living mainly on the kindness of
NOTES
friends in the last 17 years of his life. Among his many later publications were De
la réorganisation de la société européenne (‘On the Reorganization of European
Society’, 1814) and L’industrie (‘Industry’, 1816–18, in collaboration with
Auguste Comte). In 1823, in a fit of despondency, Saint-Simon attempted to kill
himself with a pistol but succeeded only in putting out one eye.
Henri de Saint-Simon presented ‘New Christianity’ with special concern
for the poor. His followers used to believe that the basis of social development
would be a spirit of association or connection with religion as the controlling power
that would gradually replace the prevailing essence of egotism and antagonism in
society. They were of belief that the inheritance rights must be ended due to which
the capital available in economy is in the hands of the prospective capitalists and
can be used at the time of disposal of society.
Christian Socialism in Britain
In Britain, Christian Socialism was first used by some British men like Frederick
Denison Maurice, novelist Charles Kingsley, John M. Ludlow and many others.
They all started a movement that took shape in England immediately after the
failure of Chartist agitation of 1848. The main motive for the movement was to
arrange support for ‘the Kingdom of Christ’, ‘its true authority over the realms of
industry and trade’ and ‘for socialism its true character as the great Christian
revolution of the 19th century’.
Contribution of John M. Ludlow
John M. Ludlow, bought up and educated in France, was inspired by the writings
of Philippe-Joseph-Benjamin Buchez (one of the disciple of Saint Simon) and the
emergence of cooperative societies in France, and thus enlisted the churchmen to
promote the application of Christian principles in industrial organisation. The
followers of Ludlow strongly criticized socially conservative Christianity and laissez-
faire attitudes within the industrial sector. The benefit of the movement started by
Ludlow is that cooperation has substituted competition. With this motto the
Ludlow’s followers joined various cooperativist movement and helped many small
cooperative societies financially, which favoured co-partnership and profit sharing
in industry. They were responsible for establishing the Council for Promoting
Working Men’s Association and the Working Men’s College in London in 1854.
A lot of members kept working for cooperativism. In the 1880s and 1890s, number
of Christian Societies Organizations were formed in England.
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142 Material
Movement in France and Germany Schools of Socialism-I
In the latter 19th century, movements like that of Ludlow took shape among the
French Protestants. In 1888, The Protestant Association for the Practical Study
of Social Questions was established which stood in opposition with bourgeois NOTES
Protestantism and rejected a strict egalitarian socialism. While in Germany, in the
late 19th century, the movement for Christian social action became associated
with violent anti-Semitic agitation.
Movement in United States
The movement for Christian Socialism in United States was led by Henry James
Sr., who was the father of novelist Henry James and philosopher William James.
He argued the similarity in the objectives of socialism and Christianity in 1849. In
1889, the society of Christian Socialists was organized. The rise of the Social
Gospel Movement was observed in the early years of 20th century, which was the
result of Christian Socialism that emphasized the social aspect of salvation.
Check Your Progress

1. What was the primary concern in Robert Owen’s theories?
2. What would be the consequences of establishing utopian socialism according
to Robert Owen?
3. What do you mean by Christian Socialism?
4. Who was the inspiration of John M. Ludlow?
5. When was The Protestant Association for the Practical Study of Social
Questions established?

QUESTIONS
1. In Robert Owen’s writings, the primary concern was with agricultural rather
than industrial production, with the household rather than the factory.
2. In the words of Robert Owen, with the establishment of utopian system of
social organization Owen believes that poverty will disappear, true liberty
will be assured to every individual, the real natural rights of man will be
recognized, happiness and order will be universal, and consequently
government, so far at least as its coercive activities are concerned—armies,
scaffolds, prisons, courts of justice—will have no longer any cause for
existence.
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Material 143
Schools of Socialism-I 3. Christian Socialism means the demand of all Christian activists on behalf of
all other individuals of society—impoverished or wealthy, for the development
of social programmes in all the political and economic activities. Therefore,
Christian socialism can be referred to as any movement that attempts to
NOTES
amalgamate the basic objectives of socialism with religious and ethical beliefs
of Christianity.
4. John M. Ludlow was inspired by the writings of Philippe-Joseph-Benjamin
Buchez, one of the disciple of Saint Simon.
5. In 1888, The Protestant Association for the Practical Study of Social
Questions was established which stood in opposition with bourgeois
Protestantism and rejected a strict egalitarian socialism.
7.4 SUMMARY
 There are several types of socialism and no single definition captures all of
them, but the common feature shared by its different forms is social ownership.
 When in the latter half of the 19th century, the revolutionary dogmas of
Marx and his school had become most conspicuous in the social movement,
the earlier systems became known, by way of distinction, such as Utopian
socialism.
 Utopian socialism is a concept that is used to describe the initial currents of
modern socialist thought. It differs from the later socialist thought as it is
based on idealism instead of materialism.
 The Utopian socialist Robert Owen’s most prominent contribution to socialist
thought was the belief that the social behaviour of human beings is not rigid
or complete and that human beings have the liberty to settle themselves into
any kind of society that they liked.
 Robert Owen’s project for escape from the evils of civilization took shape
in that form of communal life which became famous as the phalange. His
primary concern was with agricultural rather than industrial production, with
the household rather than the factory.
 Through the organization and specialization of the functions essential to the
industries, occupations suited to every taste would be available with the
result that every member would labour with the zest of pleasure.
 There never appears in Owens writings the slightest suggestion of
revolutionary violence. His conviction is unfaltering that the great truths he
has revealed will make their way by their own virtue.
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144 Material
 Christian Socialism was a new belief of Christianity, which can also be termed Schools of Socialism-I
as modern Christianity. It was a movement which was started in the mid-

19th Century.
 Henri de Saint-Simon was a French Businessmen who is known for his NOTES
contribution in the sociology. He was born in an impoverished aristocratic
French family on October 17, 1760 in Paris, France.
 In Britain, Christian Socialism was first used by some British men like
Frederick Denison Maurice, novelist Charles Kingsley, John M. Ludlow
and many others.
 John M. Ludlow enlisted the churchmen to promote the application of
Christian principles in industrial organisation.
 The movement for Christian Socialism in United States was led by Henry
James Sr., who was the father of novelist Henry James and philosopher
William James.
7.5 KEY WORDS
 Laissez-Faire: It is an economic system in which transactions between

private groups of people are free from or almost free from any form of
economic interventionism such as regulation and subsidies.
 Anti-Semitic: It means feeling or showing hostility toward or discrimination
against Jews as a cultural, racial, or ethnic group.

EXERCISES
1. How did utopian socialism emerge?
2. Write a short note on the contribution of John M. Ludlow when it comes to
Christian Socialism.
1. Discuss the characteristics of utopian socialism.
2. Explain the role of Henri de Saint-Simon in Christian Socialism.
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Material 145
Schools of Socialism-I
Strauss, Leo and Joseph Cropsey. 1987. A History of Political Philosophy.

NOTES Chicago: University of Chicago Press.
Mcclelland, J. S. 1998. A History of Western Political Thought. London:
Routledge.
Coleman, Janet. 2000. A History of Political Thought. New Delhi: Wiley-
Blackwell.
Jha, Shefali. 2010. Western Political Thought: From Plato to Marx. New
Delhi: Pearson Education India.
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146 Material
Schools of Socialism-II
UNIT 8 SCHOOLS OF SOCIALISM-II

Structure NOTES
8.0 Introduction
8.1 Objectives
8.2 Fabian
8.2.1 Rejection of Marxian Theory of Class Struggle
8.3 Guild Socialism
8.4 Syndicalism
8.6 Summary
8.7 Key Words
8.0 INTRODUCTION
As discussed in previous unit, socialism is an economic and political philosophy

that is concerned with greater distribution equity and that seeks solutions that
require greater collaboration and social solutions. The idea of state control of the
means of production is frequently correlated with socialism. The goal is to run
business in the interest of society rather than in the interest of a few property
owners. There are several forms of socialism; we have already discussed Utopian
and Christian forms of socialism in the previous unit. In this unit, we will discuss
Fabian, syndicalism, and guild socialism in detail.
8.1 OBJECTIVES

 Explain the Fabian form of socialism
 Discuss the emergence of syndicalism
 Describe the significance of guild socialism
8.2 FABIAN
Fabianism is an English version of evolutionary socialism, which was conceived in

agreement with the new conditions and developments that came over England at
the end of the 19th century. This English version of socialism is essentially pragmatic
in outlook, flexible in approach and democratic method. It is the brain child of a
group of British intellectuals and differs sharply from Marxism in that it believes in
attaining socialism by slow, peaceful and flexible methods. E.M. Burns thus writes: Self-Instructional
Material 147
Schools of Socialism-II Perhaps the most important variety of contemporary socialism which
does not trace the paternity of its doctrines to Marx is Fabian socialism.
The principal sources of Fabian socialism were British and American.
They included the writings of Henry George, David Ricardo, and
NOTES John Stuart Mill. The most dominant idea derived from these sources
was the premise that most forms of unearned wealth are created by
society.
Fabianism originated in England in the last quarter of the 19th century.
Increasing democratization in the political sphere and the growth of collectivist
legislation in the economic sphere provided a congenial atmosphere for the evolution
of a new brand of socialism suited to the needs, temperament and traditions of the
English people.
Between the years 1865 and 1885 Great Britain had entered on a
period of change. The British constitution was turned into a democracy.
A democratic state which was prepared to take upon itself social
reform duties, a working class with economic influence and power, a
nation with a growing social conscience, could not be treated from
the stand point of revolution and class struggle. The fundamental
socialist concepts required a new basis and new methods more in
harmony with new conditions.
In the early eighties several socialist movements got underway in England.
Several organizations, active in the propagation of socialist ideas were formed of
which the Social Democratic Federation, the Socialist League, the Independent
Labour Party, and the Fabian Society were more prominent. The Fabian Society
saw the light of the day on 4 January, 1884: ‘a group of intellectuals who envisaged
the emergence of a socialist society in England. The society was named after
Roman general Fabius who, while fighting Hannibal adopted the policy of ‘wait,
and hit hard at the right moment’. Its prominent members included Sidney Webb,
G.B. Shaw, Graham Wall as, Sidney Olivier, A. Besant, H. Bland, W. Clark and
E. R. Pease, etc. They were highly educated men and women, widely read in
economics, politics and ethics. Thus the Fabian Society could boast of having on
its rolls distinguished scholars, administrators and statesmen. The Fabians were
primarily influenced by J. S. Mill, Henry George, and Karl Marx.
Henry George was considered as an American Social reformer. His
contribution to the study of Fabianism is very much significant. George is well
known for his book Progress and Poverty (1879). His far-reaching contribution
to the study of Ricardian theory of rent is commendable. He played a very pivotal
role in the field of British socialism. George’s seminal ideas influenced the thought
of Marx and Engels. Sydney Oliver, George Bernard Shaw, Sidney Web, H. G.
Wells also have played a very significant role under the ideas of Henry George.
Particularly the Fabians were attracted in terms of poverty and disparity of incomes.
To him, poverty is an evil concept and was found from parochial loyalties, economic
stagnation and political breakdown. Poverty can be prevented with the help of
state action and intervention. The Fabian Society was established in 4 January,
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148 Material
8.2.1 Rejection of Marxian Theory of Class Struggle Schools of Socialism-II
Henry George rejected Marxian theory of class struggle and revolutionary method
and he was influenced by his concern for social justice and a society free from all
forms of exploitation. Henry had developed socialist leanings in the later part of his NOTES
life. He wrote that ‘The social problem of the future we considered to be, how to
unite the greatest individual liberty of action with a common ownership in the raw
materials of the globe, and an equal participation of all in the benefits of combined
labour’. Henry George, the American philosopher, who wrote Progress and
Poverty in 1879, lectured in England in 1881 and greatly influenced the English
socialist thinkers. According to Lancaster, George influenced the Fabians in two
ways.
 Firstly, George’s glowing picture of a society without want fired their
enthusiasm for getting rid of unearned wealth.
 Secondly, George’s hint led them to find, quite readily, differential values
other than economic rent — in profits, salaries, and dividends, all of which
were unearned to precisely the same degree as the rent appropriated by
landlords.
Henry George was fully engaged and was committed to intensive and
extensive studies and research. In 1906, the he started the Fabian Summer School
to have lectures and discussions on politics and economics. The Fabian Research
Department was instituted in 1912 to study the various socio-economic problems
created by industrial capitalism. Henry said that ‘The object of the Fabians have
been to spread the socialist doctrine as they understand it, throughout the educated
middle class and to persuade the national and local governments of Great Britain
to put the doctrine gradually into practical operation.’
Major Tenets of Henry George
The major tenets of Henry George include:
 Emancipation of land and industrial capital: Henry George stated that
the Fabian Society had democratic socialists as its members. The basis of
Fabianism was hammered out in 1887 and was restated in 1919 with slight
modifications. Henry George wanted to reorganize the society by the
emancipation of land and industrial capital from individual ownership, and
the vesting of them in the community for the general benefit. The society
accordingly works for the extinction of private property in land the prevention
of appropriation of rent by individuals. The society further, works for the
transfer to the community of the administration of such industrial capital as
can be conveniently managed socially. Such transfer was deemed imperative
as industrial capital had become a monopoly in the hands of a class of
proprietors on whom the majority depended for a livelihood. Labour should
be duly rewarded. The idle class living on the labour of others could be
eliminated when rent and interest are not allowed to go into their pockets,
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Schools of Socialism-II but are made the rewards of labour. ‘For the attainment of these ends the
Henry George looks to the spread of socialist opinions and the social and
political changes consequent thereon, dissemination of knowledge as to the
relation between the individual and society in the economic, ethical, and
NOTES political aspects’.
 Democratic state: Unlike syndicalists and guild socialists, Henry George
was confident of the fairness and effectiveness of action by the State — the
democratic state. He looked upon the democratic state as the
‘representative, and trustee of the people’, ‘their guardian, their man of
business, their manager, their secretary, even their stockholder’. He
suggested the following measures to make the state ‘trustworthy’: (a)
Broadening the suffrage; (b) Securing a better trained civil service, and (c)
Equalizing educational opportunities. The state, according to them, was the
state civil service and it was the bounden duty of the civil service to act
efficiently and in a manner responsive to public wishes.
 Gradual reforms along ordinary parliamentary lines: George rejected
the Marxian theory of class struggle and the method of revolution and
expressed firm faith in achieving a socialist society through gradual reforms
along ordinary parliamentary lines. Fabian socialists advocated peaceful
and tempered social changes. Land, industry and financial institutions are to
pass from private ownership to the state by peaceful, gradual methods.
While Marxism is revolutionary, Fabianism is evolutionary. Instead of the
Marxian theory that the history of all hither to existing societies is the history
of class struggle, Henry George maintained that history demonstrates the
‘irresistible progress of democracy’ and ‘almost continuous progress of
socialism’.
 Transition from capitalism to socialism: Henry George regards the
transition from capitalism to socialism as a gradual process. He looks forward
to the socialization of industry by peaceful economic and political agencies
already at hand. Fabians see in the middle class a group that can be utilized
in developing the technique of administration on behalf of the new social
order. They also feel that an important step in the attainment of socialism is
the rise of the social conscience of the community in favour of the socialist
ideal.
 Economic basis of Fabianism: Henry George, also analyzing the economic
basis of Fabianism, rejected the labour theory of value of both the classical
economists and Marx and maintained that the community as a whole, and
not labour alone, creates value. The aim of socialism, as Henry conceived
it, is to obtain for all members of society the values which society creates,
and this aim is to be achieved by gradually transferring land and industrial
capital to the community, while making the state more fully representative
of the community. Thus, its aim is to transfer ownership, not to the workers
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as a class, but to society, for general benefit. Socialism maintained that
150 Material
democracy and socialism are complementary to each other, because both Schools of Socialism-II
are based on the ideas of equality and justice. Through democratic processes,
the socio-economic, cultural and political system of the society would
gradually change paving the way for socialism. Socialism should be brought
gradually, not through the short-circuiting path of revolutionary method. The NOTES
Fabian strategy is one of permeation, ‘Resolved to permeate all classes it
has not preached class antagonism. Resolved gradually to permeate it has
not been revolutionary, it has relied on the slow growth of opinion.’ Henry
George favours decentralization of power and greater municipalisation. He
writes that, ‘A democratic state cannot be a social democratic state unless
it has in every centre of the population a local governing body as thoroughly
democratic in constitution as the Central parliament’. Under the aegis of the
state local self-bodies should be allowed greater opportunities to work.
 Theory of land and rent: Henry George opposed the revolutionary theory
of Marxism. He holds that social reforms and socialist permeation of existing
political institutions can bring about the expected development of socialism.
He paid little attention to trade unionism and other labour movements. He
recognized the major tenet of Marxian philosophy which was the abolition
of private property. George questioned why there was chronic poverty in
spite of advancement of technology. He himself gave the answer, stating
that with the advance of technology, population grows. With the growth of
the population, land grows in value. The growing share of the output and
development of market economy is siphoned off by the owners of land and
natural resources. In this context, many English economists had criticized
the philosophy and ideas of Henry George. T.E. Cliff Leslie and Alfred
Marshall has vehemently criticized his basic ideas on economy. George
Bernard Shaw attempted to adopt Henry George’s view of land rent and is
considered as a huge and mounting subtraction from the income of workers.
George said that a tax is levied upon the production of a thing that must
constantly be produced by human labour. This labour will make supply
more difficult, raise prices, and the man who pays the tax is constantly able
to push the tax upon the consumer. Land has no role to constantly supply in
order to meet the demand. Its price is always a monopoly value and the tax
falls upon the land value which does not fall upon all land but only upon
valuable land and that its proportion to its value.
8.3 GUILD SOCIALISM
In its origins, guild socialism was a purely English theory. It was set forth by English
intellectuals in the first and second decades of the twentieth century. It is a socialist
system and movement aiming at industrial self-government and functional
democracy. It is the intellectual child of English Fabianism and French Syndicalism.
It is ‘a kind of anaemic version of French syndicalism’. Some describe it as a half-
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Schools of Socialism-II way between syndicalism and collectivism. It does not agree with syndicalism in
wanting to abolish the state by direct action; nor does it want the state to control
all of industry, as does the collectivism. But like the syndicalists, the guild socialists
were the most ardent advocates of workers’ control in industry. Unlike collectivists
NOTES (State socialists) they advocate withdrawal of state control from the economic
sphere. Guild socialists aim at the achievement of socialism with the guild as its
foundation. They want to extend the democratic principle to any and every form
of social action and in especial, to industrial and economic full as much as to
political affairs. The object of guild socialism is to make work more interesting and
the whole economic structure of society more democratic. The fundamental demand
of guild socialism is that the whole structure of society should be made democratic.
It was not until 1909 that the guild-socialist theory assumed a more practical
form. The Trade Unions played a prominent part in the great labour unrest during
the years 1909-12. Writers like AR. Orage and S.G. Hobson put forward the
proposal in the columns of the New Age that the guild idea should be adapted to
modern conditions on the basis of the existing Trade Union Organization. They
made vigorous attacks upon modern capitalism, criticized also the centralized
collectivism of contemporary socialism, and gradually reshaped the original Orage-
Penty proposals, for a restoration of medieval guilds, into an elaborate scheme for
national guilds, properly adjusted to modern political and economic conditions.
Their articles were later published in the book, National Guilds, An Enquiry
into the Wage System and the Way out. Penty, Orage and Hobson were members
of the Fabian Society and the Independent Labour Party, until they became
disillusioned with these organizations, upholding centralized political socialism.
Guild socialism offers an indictment of present society, based on industrialism.
They protest against the contemporary capitalist method of exploitation in which
the surplus value is pocketed by the capitalist. In return for the minimum wage, the
workers surrender all control over the organization of production. They advocate
the abolition of the present system which produces slave mentality in the workers.
They argue wages, profits, rents, and interest should be apportioned upon a
fundamentally different principle. They criticize the acquisitive nature of the mode
economic system which separates ownership from service to munity. Right to
property exists for its owner’s sake, unrelated to any full social function. They
protest against the dehumanizing consequences of the machine system. They attempt
to devise a system that develop workers not merely skill but also pride in their
work. Again, they criticize the contemporary political democracy based on the
principle of territorial representation.
The goals of the National Guilds League are the abolition of the Wage-
system, and the establishment by the workers Self-Government in industry, through
a democratic system of Nation-Guilds, working in conjunction with other
democratic functional organizations in the community. The general principles on
Self-Instructional which this statement of aims is founded may be reduced to the following three:
152 Material
 The principle of Functional Democracy Schools of Socialism-II
 The principle that industry should be administered by the common action

of workers both of hand and brain who carry on the industry
 The principle that power and responsibility in society should be related NOTES
and proportional to the importance of the functions which individuals
perform in the service of the community.
They advocate the setting up of guilds or cooperative associations in the
economic sphere. Each industry and each technical and cultural service would be
managed and controlled by guild which is defined by Drage as ‘a self-governing
association of mutually dependent people organized for-the responsible discharge
of a particular function of society’. The guild is a Trade Union modified in two
ways: it will be inclusive of all workers in an industry the unskilled workers as well
as the clerical, technical and managerial workers - and its chief function would be
not to protect the interests of its members, nor merely to secure better conditions
of work, but to carry on and control the industry. While trade union is organized
for militant purposes in a hostile society, the Guild will be organized for peaceful
purposes in a friendly society. With regard to prices of commodities, where the
interests of the consumers are involved, the Consumers’ Councils in collaboration
with the guilds will make the decisions.
State can exercise power only in a limited field such as defence, justice,
education, taxation and international relations. In general the National Guilds League
adopts a hostile attitude to the state. There is a tendency to relegate the State to
the role of an association of consumers, represented on a number of bodies elected
on a national basis for the purpose of negotiating with the big producing Guilds,
but according to Hobson, the state continues to be the representative of the
community at large. He ascribes a superior position to the state. As supreme
authority the state should settle disputes between guilds in the capacity of a court
of final appeal; when the guild congress proves unable to settle them.
They believe in the evolutionary methods of achieving socialism. The present
trade unions will be the guilds of tomorrow and become instruments of
transformation. The present trade unions have to perfect and strengthen themselves
and pursue the method of ‘encroaching control’ which is ‘wresting bit by bit from
the hands of the possessing classes the economic power, by a steady transference
of functions and rights from their nominees to representatives of the working class’.
In this respect they differ from syndicalists who advocate direct action and general
strike.
8.4 SYNDICALISM
Syndicalism is a form of revolutionary socialism which is essentially a French school

of thought of the French labour movement. It is both a body of social doctrine or
theory of social organization, and a plan of action. Syndicalism, loosely defined,
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Material 153
Schools of Socialism-II holds that the workers alone must control the conditions under which they work
and live; the social changes they need can be achieved only by their own efforts,
by direct action in their own associations, and through means suited to their peculiar
needs. Syndicalism places positive emphasis on the trade and industrial union
NOTES movement as the basis of the new industrial structure and on the producer rather
than the consumer.
The exponents of syndicalism were both the active leaders of the trade
Union movement and a group of brilliant intellectuals. While activists like Fernard
Pelloutier, Emile Pouget and others formulated the main tenets of syndicalism,
Georges Sorel, Hubert Lagardelle and Édouard Berth with their intellectual
brilliance provided its philosophical foundation. Sorel, the philosopher par
excellence of syndicalism, attempted to work out a synthesis between the
proletarianism of Marx, the anti-political associationism of Proudhon and the
intuitionism of Bergson. Socialism, according to Sorel, required organization of
the proletariat and not of the economic system. He was in favour of establishing an
industrial self-government of the working class. According to syndicalism, workers
should organize a general strike and paralyze the state. From the French
revolutionary tradition, syndicalists acquired their methods of violence and their
emphasis on the role of militant elite in the process of social transformation.
Syndicalists called themselves a ‘new school’ of socialism. This variety of socialism
is marked by certain distinct features and tenets.
Syndicalism is uncompromisingly opposed to the State and looks upon it as
a bourgeois and middle class institution. Irrespective of its form, the state is an
instrument of capitalist exploitation. All states are instruments of class rule. The
territorial, military state reflects the ideals of property-owners and serves their
interests. Workers cannot emancipate themselves unless they destroy the power
of the state. Reforms and concessions conceded by the state are mere palliatives.
The state, the syndicalists argued, is theoretically wrong because it embodies an
impossible ideal of social unity. Society is essentially pluralistic, and no political
constitution can make it otherwise.
Syndicalists not only dislike the middle-class state but also distrust middle-
class socialism which is a product of clever middle-class intellectuals out of touch
with the needs of the working class. Syndicalism claims to be the only school of
socialism which is the product of the workers themselves. It keeps alive among
workers an intense class consciousness and forbids any rapprochement between
the workers and the bourgeois. It is distrustful of the-middle class leadership and
its primary objective is to put the workers in power. Since the workers as producers
create value, they should be the controllers of society.
Syndicalists are deadly opponents of wars which they consider as the
outcome of the conflicting interests of the capitalists. The workers must keep out
of wars and unnecessary bloodshed and bend their energy for their own upliftment.
The police and the defence forces uphold the interests of the ruling capitalist class
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by breaking strikes of workers and by fighting wars with other nations. The
154 Material
oppressed working class have no country of their own; they have no need for Schools of Socialism-II
patriotism as such national spirit is as assiduously created by the ruling class to

mollify proletarian radicalism.
Syndicalism is a form of revolutionary socialism. Syndicalists are distrustful
NOTES
of political methods as a means of achieving their desired society. They do not
believe in peaceful, constitutional methods. They advocate violent and revolutionary
methods which they would call ‘direct action’. Strike, sabotage and boycott are
their chief forms for achieving direct action. Syndicalists differ from Marxists in
believing that the time is not far off when the working class would rise in revolt
against the capitalist class. Marx, they believe, was unduly optimistic in prophesying
that capitalists would fight the workers and thereby bring about own destruction.
What the capitalists would do is to make comprises and bargains for their
survival. In these circumstances the workers must carryon perpetual offence against
the employers through strikes, sabotage, destruction of machinery, boycott, label,
spoiling work through ‘go-slow’ methods. Syndicalists are ardent believers in direct
action. It is the only means of educating the workers and preparing them for the
final struggle. The general strike is the chief weapon.
The general strike is the final and mighty weapon which would paralyse the
state and make the workers the masters of society. The general strike is not
necessarily a striker of all workers. What is required is a strike on the part of a
sufficient proportion of the workers in key industries to secure the paralysis of the
capitalist system. Syndicalists rely on a conscious, militant minority who would
inspire and provide leadership to the otherwise passive majority. The syndicalists’
stress on elitism is akin to Lenin’s. In Sorel’s language, the general strike is to be a
‘myth’ to the workers. A myth being an idea which fills men with ardour and belief
in a better future.
Sabotage is a policy of injuring an employer’s property or enterprise through
sluggish, bungling, wasteful, or positively damaging acts: done either while the
worker remains on the job or in connection with strikes. It may take the non-
violent form of slow work for long hours, poor work for low pay, revealing the
secrets of the employer etc. The boycott of goods produced by non-union labour
and the placing of the Union label produced by syndicates themselves are some of
the other methods advocated by the syndicalists. All of this is in preparation for the
general strike which may fail today, but ‘today’s failure is a preparation for
tomorrow’s success’.
The syndicalist plan of action is direct, vigorous, and well defined, but the
structure of society which it seeks to achieve is extremely vague and nebulous.
Syndicalism is primarily a creed of opposition; its thrust is negative. As Coker
aptly put it, syndicalism offered a policy primarily of revolution, not of administration.
Under syndicalism, the syndicate is to be the basis of industrial organisation.
Syndicalists picture the future society as a free and flexible federation of autonomous
and distributive associations based on collective ownership and carrying on the
activities in accordance with the needs of the community. Workers assume control Self-Instructional
Material 155
Schools of Socialism-II of production and private capital is to be replaced by collective capital. Thus
syndicalists share the collectivist concept of property, the communistic principle of
distribution according to needs and the anarchist goal of statelessness. All means
of production, distribution and exchange will belong to the community and should
NOTES be controlled and managed by the syndicates of workers. National services like
highways, railways and post offices are to be placed in the hands of the National
Federation of Workers. Prisons and Courts are to be abolished, and punishment
is to take the form of social boycott.
Check Your Progress

1. Name some of the prominent socialist organizations of early eighties in
England.
2. What do you mean by guild socialism?
3. What are the goals of the National Guilds League?
4. Who formulated the main tenets of syndicalism?

QUESTIONS
1. In the early eighties several socialist movements got underway in England.

Several organizations, active in the propagation of socialist ideas were
formed of which the Social Democratic Federation, the Socialist League,
the Independent Labour Party, and the Fabian Society were more
prominent.
2. Guild socialism is a socialist system and movement aiming at industrial self-
government and functional democracy. It is the intellectual child of English
Fabianism and French Syndicalism.
3. The goals of the National Guilds League are the abolition of the Wage-
system, and the establishment by the workers Self-Government in industry,
through a democratic system of Nation-Guilds, working in conjunction with
other democratic functional organizations in the community.
4. Activists like Fernard Pelloutier, Emile Pouget and others formulated the
main tenets of syndicalism.
8.6 SUMMARY
 Fabianism is an English version of evolutionary socialism, which was

conceived in agreement with the new conditions and developments that
came over England at the end of the 19th century.
 Fabianism is essentially pragmatic in outlook, flexible in approach and has a
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156 Material
 Henry George was fully engaged and was committed to intensive and Schools of Socialism-II
extensive studies and research. In 1906, the he started the Fabian Summer
School to have lectures and discussions on politics and economics.
 Guild socialism is a socialist system and movement aiming at industrial self-
NOTES
government and functional democracy.
 It was not until 1909 that the guild-socialist theory assumed a more practical
form. The Trade Unions played a prominent part in the great labour unrest
during the years 1909-12.
 Guild socialism offers an indictment of present society, based on industrialism.
They protest against the contemporary capitalist method of exploitation in
which the surplus value is pocketed by the capitalist.
 Syndicalism, loosely defined, holds that the workers alone must control the
conditions under which they work and live; the social changes they need
can be achieved only by their own efforts, by direct action in their own
associations, and through means suited to their peculiar needs.
 Syndicalism is a form of revolutionary socialism. Syndicalists are distrustful
of political methods as a means of achieving their desired society. They do
not believe in peaceful, constitutional methods.
 The syndicalist plan of action is direct, vigorous, and well defined, but the
structure of society which it seeks to achieve is extremely vague and nebulous.
Syndicalism is primarily a creed of opposition; its thrust is negative.
8.7 KEY WORDS
 Associationism: It is a theory in philosophy or psychology which regards

the simple association or co-occurrence of ideas or sensations as the primary
basis of meaning, thought, or learning.
 Marxism: According to Marxism, there are two main classes of people:
The bourgeoisie controls the capital and means of production, and the
proletariat provide the labour. Karl Marx and Friedrich Engels say that for
most of history, there has been a struggle between those two classes. This
struggle is known as class struggle.

EXERCISES
1. What do you mean by Fabianism? How did it originate?
2. Briefly explain the major tenets of guild socialism.
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Schools of Socialism-II Long-Answer Questions
1. Describe the major tenets of Henry George.
2. Explain the emergence of syndicalism.
NOTES
Strauss, Leo and Joseph Cropsey. 1987. A History of Political Philosophy.

Chicago: University of Chicago Press.
Mcclelland, J. S. 1998. A History of Western Political Thought. London:
Routledge.
Blackwell.
Jha, Shefali. 2010. Western Political Thought: From Plato to Marx. New Delhi:
Pearson Education India.
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Institutional Economics-I
UNIT 9 INSTITUTIONAL
ECONOMICS-I
NOTES
Structure
9.0 Introduction
9.1 Objectives
9.2 Gunnar Myrdal
9.3 Thorstein Veblen
9.5 Summary
9.6 Key Words
9.0 INTRODUCTION
Institutional economics focuses on understanding the role of the evolutionary process

in influencing economic behaviour and the role of institutions. Its original emphasis
lay in the instinct-oriented dichotomy of Thorstein Veblen between technology on
one side and society’s ‘ceremonial’ sphere on the other. Its name and core elements
date back to Walton H. Hamilton’s 1919 American Economic Review article.
Institutional economics highlights a wider analysis of institutions and economies as
a result of the dynamic relationship between these different institutions (e.g.
individuals, firms, states, social norms). There are various thinkers who have given
their perspective on the topic. In this unit, we will discuss the thoughts of Gunnar
Myrdal and Thorstein Veblen.
9.1 OBJECTIVES

 Explain the concept of institutional economics
 Discuss the thoughts of Gunnar Myrdal
 Describe the philosophy of Thorstein Veblen
9.2 GUNNAR MYRDAL
Karl Gunnar Myrdal, born on 6th December 1898, was a Swedish economist
and sociologist. In 1974, he received the Nobel Memorial Prize in Economic
Sciences with Friedrich Hayek for ‘their pioneering work in the theory of money
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Institutional Economics-I and economic fluctuations and for their penetrating analysis of the interdependence
of economic, social and institutional phenomena’. As an economist, Myrdal made
early contributions to price theory, incorporating the role of uncertainty and
expectations on prices.
NOTES
Myrdal resists the approach of development poles because social system
and economic processes do not expand towards stability but, on the contrary,
factors have a propensity to cumulate to positive or negative cycles. In laissez
faire conditions in developing countries, there is a predisposition towards a negative
accumulation. In theory, Myrdal’s conjecture is a contradiction of the mono-causal
explanation of problems of developing countries by economic factors only.
Relatively, in a broad way, all social relations have to be incorporated. At the
national level (diverse stages of development between regions) as well as
international level (trade between industrialized and developing countries) differences
are inclined to boost because of the increase effects in the more developed areas
and contemporary or modern sectors and backwash effects in backward areas
(traditional sectors). The track of processes depends on the preliminary condition
and the factors causing the change. In the developing countries, augmented regional
dualism frequently is an outcome of circular causation.
Circular and Cumulative Causation (CCC) has been a significant principle
of political economy over the years. The origin of the concept goes back to
Thorstein Veblen (1857-1929) who utilized this in his test of the progression of
institutions. In another study, Gunnar Myrdal (1898-1987) examined the conditions
of African Americans and Asian underdevelopment throughout the lens of Circular
and Cumulative Causation (CCC).
Circular Cumulative Causation is a theory developed by Swedish economist Gunnar
Myrdal in 1956. This approach is multi-causal where the centre variables and
their associations are demarcated. The suggestion following it is that a change in
one structure of an institution will lead to consecutive changes in other institutions.
These changes are spherical in a way where they prolong in a cycle, several times
in a harmful way, there is no end and they continue this in every round. The change
doesn’t happen all at once but minutely because that would lead to confusion.
Gunnar Myrdal borrowed the theory from Knut Wicksell and developed it with
Nicholas Kaldor while working jointly at the United Nations Economic Commission
for Europe. Myrdal concentrated on the societal provisioning characteristic of
development, while Kaldor was focussed on the demand-supply relationship with
the manufacturing sector.
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Dynamics Institutional Economics-I
Myrdal mentioned the characteristics that are pertinent to the expansion process of
an economy such as availability of natural resources, past traditions of production
activity, national consistency, religious ideologies, economic, social, and political NOTES
leadership. Myrdal stated that the instant effect of closing down certain lines of
production in a community is a reduction in employment, income and demand.
Throughout the analysis of the multiplier, Myrdal noticed that other sectors of the
economy are also affected by the closure of these lines of production. Afterwards he
stated that the slimming down of the markets in that area tends to have a disheartening
consequence on new investments, which in turn reasons additional decline of income
and demand and, if nothing takes place to alter the tendency, there is a movement of
enterprises and workers towards other areas. Amongst the additional results of these
events, smaller quantity of local taxes are composed at a time when additional social
services is necessary and a vicious descending cumulative cycle has started and a
drift towards a subordinate level of development will be more non-breakable.
A status of non-equilibrium is shaped, or as Myrdal writes in his own words
about this as:
The notion of stable equilibrium is normally a false analogy to choose
when constructing a theory to explain the changes in a social system.
What is wrong with the stable equilibrium assumption as applied to
social reality is the very idea that a social process follows a direction
– though it might move towards it in a circuitous way – towards a
position which in some sense or other can be described as a state of
equilibrium between forces. Behind this idea is another and still more
basic assumption, namely that a change will regularly call forth a
reaction in the system in the form of changes which on the whole go
in the opposite direction to the first change. The idea I want to expound
in this book is that, on the contrary, in the normal case there is no
such a tendency towards automatic self-stabilization in the social
system. The system is by itself not moving towards any sort of balance
between forces, but is constantly on the move away from such a
situation. In the normal case a change does not call forth countervailing
changes but, instead, supporting changes, which move the system in
the same direction as the first change but much further. Because of
such circular causation as a social process tends to become cumulative
and often gather speed at an accelerating rate.’
Myrdal wrote in his Economic Theory and Underdeveloped Regions that
‘The disagreement progresses on a broad and methodological plane on the logic
that the theory is conferred as a multipart of broad structures of thought’ in order
to seize the social facts as they systematize themselves into a blueprint when viewed
under a bird’s-eye viewpoint into this general vision, the specific characteristic.
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Institutional Economics-I Added to this, Myrdal developed the Circular Cumulative Causation (CCC)
concept and was of the opinion that it makes diverse assumptions from that of
unwavering stability on what can be considered mainly significant forces directing
the development of social processes. These strengths characterize the dynamics
NOTES of these processes in two assorted ways. Hitherto, the provision of data or other
information regarding sole economies was further than the scope of his work. He
stated that in the regular case there is no such a propensity towards regular self-
stabilization in the social system. The system itself is not moving towards any sort
of equilibrium between forces, but is continuously on the budge away from such a
condition. In his succeeding writings, Myrdal mainly referred to ‘approach’, defining
it as something containing theories. By this term, Myrdal meant a compilation of
devices, like ‘the concepts, models and theories we use, and the way in which we
select and arrange observations and present the results of our research’.
Check Your Progress

1. Why does Myrdal resist the approach of development poles?
2. Name the characteristics that are pertinent to the expansion process of an
economy as mentioned by Myrdal.
9.3 THORSTEIN VEBLEN
The full name of Thorstein Veblen was Thorstein Bunde Veblen. He was born on
July 30, 1857 in Manitowoc County, Wisconsin, U.S. He died on August 3rd,
1929 near Menlo Park, California. Thorstein was an American economist and
social scientist. Thorstein’s approach was evolutionary and active tactics to the
learning of institutional economics. His one of the famous work in the field of
institutional economics was The Theory of the Leisure Class (1899). After this
theory, he earned recognition in literary circles. While analyzing the life of a wealthy
person, he invented two theories ‘conspicuous consumption’ and ‘pecuniary
emulation’ that are still widely used. Veblen was Norwegian. He didn’t know
English. He went to school, where he started learning English, but he spoke it with
a Norwegian accent. He completed his graduation from Carleton
College in Northfield, Minnesota within three years. He proved himself to be a
bright scholar. He further went to study philosophy at Johns Hopkins and Yale
universities, and was awarded Ph.D. from Yale in 1884.
When he was not able to find a suitable teaching job, he returned to his
father’s house in Minnesota, where he consumed his time in reading further
developments in institutional economics. He got married to Ellen Rolfe in 1888,
who belonged to a well-off and powerful family. He entered Cornell University in
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1891 as an alumna fresher student. There, he enthralled J. Laurence Laughlin so Institutional Economics-I
greatly that, when Laughlin was questioned to head the economics department at
the new University of Chicago in 1892, he took Veblen with him as an associate in
economics. At the age of 39, in the year 1896, he became a teacher. Ellen Rolfe
NOTES
took divorce from him and in 1914 he married to Anne Fessenden Bradley, a
divorcee whom he was knowing from many years. Anne had two daughters which
were brought up by Anne and Veblen according to Veblen’s practical ideas as
spoken in The Theory of the Leisure Class.
Literary Works and Career development of Veblen
The literary works of Thorstein include:
 He wrote his first book titled, The Theory of the Leisure Class, which
was published in 1899. It explains the crux of most of his thoughts. Veblen
wanted to apply Darwin’s evolutionism to the research of contemporary
economic life of a person. According to him, the industrial system needed
men to become diligent, efficient and cooperative, however, those who were
the top leaders of the business world were only worried about making
money and exhibiting their wealth; their viewpoint was survivalist, a residue
of savage past. Veblen examined the ‘modern survival of prowess’ in the
amusements, fashions, sports, religion, and aesthetic tastes of the ruling class.
The book gained the attention of and began to be read as a satire rather
than as science, earning Veblen a reputation of being a social critic.
 In 1904, he published The Theory of Business Enterprise, in which he
expanded on his evolutionary theme of the incompatibility between the
modern industrial process and the irrational means of business and finance.
 In 1914, he published his work, The Instinct of Workmanship and the
State of the Industrial Arts, where he explained his idea of business
enterprise being in conflict with the human tendency for useful effort; too
much of humankind’s energy was wasted through inefficient institutions.
 His work, An Inquiry into the Nature of Peace and the Terms of Its
Perpetuation (1917), made Veblen acquired an international following. He
maintained that modern wars were caused mainly by the competitive
demands of national business interests and that an enduring peace could be
had only at the expense of ‘the rights of ownership, and of the price system in
which these rights take effect’.
 Later in 1918, he joined the editorial staff of The Dial, a literary and political
magazine in New York, for which he wrote a series of articles published in a
book form as The Vested Interests and the State of the Industrial
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Institutional Economics-I Arts (1919). Another series of articles in The Dial was later published in the
book, The Engineers and the Price System (1921). These articles developed
Veblen ideas for reform of the economic system. According to him, engineers,
who had the knowledge to run industry, should take over its direction because
NOTES
they would manage it for efficiency instead of profit. This theme was central
to the brief Depression-era movement known as ‘technocracy’.
 His last book, Absentee Ownership and Business Enterprise in Recent
Times: The Case of America (1923), was an ill-written and repetitious
examination of corporate finance, in which he stressed again the contradiction
between the industrial arts and business enterprise.
 Among economists, Veblen had both admirers and critics, but more of the
latter. The scholarly analysis of modern industrial society owes much more to
Veblen’s German contemporary Max Weber, whose ideas are more complex
than Veblen’s. Even his closest disciples found his anthropological and historical
approach too vague, though they admired him for his original ideas.
Institutional socialism
With his critique of traditional static economic theory, Thorstein Veblen established
the groundwork for the view of institutional economics. Just as he was an economist,
Veblen was also a sociologist who opposed his contemporaries, who regarded
the economy as an independent, stable, and static body. Veblen disagreed with his
colleagues, as he firmly believed that social structures were significantly ingrained
in the economy. Rather than distinguishing economics from the social sciences,
Veblen considered the relationships between the economy and social and cultural
phenomena. The study of institutional economics usually considered economic
institutions to be the larger mechanism of cultural development. While economic
institutionalism has never been converted into a major school of economic thinking,
it has encouraged economists to examine economic problems from a social and
cultural perspective. It also encouraged economists to view the economy as an
object of bounded rationale that is evolving.
Concept of Conspicuous Consumption
Conspicuous consumption is an economic concept that defines and explains the
consumer’s habit of using products of a higher quality or quantity than could be
considered practical. In his book, The Theory of the Leisure Class, the American
economist and sociologist, Thorstein Veblen, coined this term (1899). By
considering the motivation to drive a luxury car rather than an economy car, the
idea of conspicuous consumption can be demonstrated. Any kind of vehicle (or
car in this case) offers transportation to a destination, but the use of a luxury car
often draws attention to the driver’s apparent wealth.
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The advantage of conspicuous consumption can be found within the notion Institutional Economics-I
that consumers derive ‘utility’ from the consumption of commodities, postulated

by economists. Two distinct characteristics of products were defined by Veblen
as providing utility. In other words, the first is what he called the ‘serviceability’ of
NOTES
the good that is, the good gets the job done (e.g., luxury and economy cars are
equally able to get to a given destination). The other characteristic of a good is that
it is ‘honourable’. Driving a luxury car illustrates that the consumer can afford to
drive a vehicle that can be admired by others. This appreciation comes not solely
from the ability of the car to get the job done, but from the obvious proof of wealth
it offers. The car is therefore an external display of the position of one in society.
A consequence of the twofold features of commodities are that such
conspicuous consumption is wasteful. He was not using the term, ‘wasteful’ in a
negative sense, but as a technical term signifying that producing luxury commodities
require extra assets than the making of a non-luxury commodity.
The essence of Veblen’s study of modern society was the fact that, on the
one hand, there is tremendous technical capacity for the manufacturing of products
and, on the other hand, business enterprise restricts the quantity produced to what
can be profitably sold. The role of advertising, in Veblen’s opinion, is to establish
a desire among consumers for products whose use shows status and prestige. The
gulf between customers’ expectations and technology’s productive potential is
minimised by ads. For this reason, Veblen regarded ads as waste, but waste that
is inherent in a modern economy focused on the concepts of business profit-making.
The awareness that all products have elements of serviceability and waste is an
important point in Veblen’s research. For instance, the fact that you drive a car
means that you are rich enough not to have to take public transport, but a luxury
car also has a higher status in society because it indicates that you do not have to
take public transport or drive an economy car.
Check Your Progress

3. What was the title of Thorstein Veblen’s first book?
4. How did Veblen differ from his colleagues on economic theory?

QUESTIONS
1. Myrdal resists the approach of development poles because social system

and economic processes do not expand towards stability but, on the
contrary, factors have a propensity to cumulate to positive or negative cycles.
Self-Instructional
Material 165
Institutional Economics-I 2. Myrdal mentioned the characteristics that are pertinent to the expansion
process of an economy such as availability of natural resources, past traditions
of production activity, national consistency, religious ideologies, economic,
social, and political leadership.
NOTES
3. Thorstein Veblen’s first book was The Theory of the Leisure Class, which
was published in 1899.
4. With his critique of traditional static economic theory, Thorstein Veblen
established the groundwork for the view of institutional economics. He
opposed his contemporaries, who regarded the economy as an independent,
stable, and static body. Veblen disagreed with his colleagues, as he firmly
believed that social structures were significantly ingrained in the economy.
9.5 SUMMARY
 Institutional economics focuses on understanding the role of the evolutionary

process in influencing economic behaviour and the role of institutions.
 Karl Gunnar Myrdal, born on 6th December 1898, was a Swedish
economist and sociologist.
 Myrdal resists the approach of development poles because social system
and economic processes do not expand towards stability but, on the
contrary, factors have a propensity to cumulate to positive or negative cycles.
 Circular and cumulative causation (CCC) has been a significant principle of
political economy over the years. The origin of the concept goes back to
Thorstein Veblen (1857-1929) who utilized this in his test of the progression
of institutions.
 Circular Cumulative Causation is a theory developed by Swedish economist
Gunnar Myrdal in 1956. This approach is multi-causal where the centre
variables and their associations are demarcated.
 The full name of Thorstein Veblen was Thorstein Bunde Veblen. He was
born on July 30, 1857 in Manitowoc County, Wisconsin, U.S. He died on
August 3rd, 1929 near Menlo Park, California.
 His work, An Inquiry into the Nature of Peace and the Terms of Its
Perpetuation (1917), made Veblen acquired an international following.
 Rather than distinguishing economics from the social sciences, Veblen
considered the relationships between the economy and social and cultural
phenomena.
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166 Material
 Conspicuous consumption is an economic concept that defines and explains Institutional Economics-I
the consumer’s habit of using products of a higher quality or quantity than

could be considered practical.
 The essence of Veblen’s study of modern society was the fact that, on the NOTES
one hand, there is tremendous technical capacity for the manufacturing of
products and, on the other hand, business enterprise restricts the quantity
produced to what can be profitably sold.
9.6 KEY WORDS
 Price Theory: It is an economic theory that states that the price for any
specific good or service is based on the relationship between its supply and
demand.
 Pecuniary Emulation: It is an effort to equal or surpass another in status
associated with wealth.

EXERCISES
1. Write a short note on the early life of Gunnar Myrdal.
2. Briefly explain the literary works of Thorstein Veblen.
1. Describe the dynamics of Myrdal’s model of Circular and Cumulative
Causation.
2. Describe the concept of conspicuous consumption in detail.
Myrdal, G. 1957. Economic Theory and Underdeveloped Regions. London:

University Paperbacks Publisher: Methuen)
Company.
Publications.
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Institutional Economics-I Coleman, Janet. 2000. A History of Political Thought. New Delhi: Wiley-
Blackwell.
Jha, Shefali. 2010. Western Political Thought: From Plato to Marx. New Delhi:
Pearson Education India.
NOTES
Websites
https://www.britannica.com
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Institutional
UNIT 10 INSTITUTIONAL Economics-II
ECONOMICS-II
NOTES
Structure
10.0 Introduction
10.1 Objectives
10.2 Romesh Dutt
10.3 Wesley Clair Mitchell
10.5 Summary
10.6 Key Words
10.0 INTRODUCTION
Romesh Dutt and Wesley Clair Mitchell are two of the most eminent economists.
Dutt and Mitchell’s contribution to the study of economy is immense with their
theories on land revenue and the self-generation theory respectively. They represent
more ideas when it comes to the field of institutional economics. Their theories, in
fact, has expanded the purview of institutional economics. In this unit, we will
discuss the life and theories of Romesh Dutt and Wesley Clair Mitchell in the
context of institutional economics.
10.1 OBJECTIVES

 Explain the contributions of Romesh Dutt and Wesley Clair Mitchell in the
context of institutional economics
 Discuss the life of Romesh Dutt and Wesley Clair Mitchell
 Describe the economic ideas of Romesh Dutt and Wesley Clair Mitchell
10.2 ROMESH DUTT
Romesh Chunder Dutt was an Indian Civil Servant born on 13th August 1848 in
an eminent Bengali Kayastha family. He was also known as economic historian,
writer and translator of holy books, Ramayana and Mahabharata. His family
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Institutional was well-known for their literary and academic achievements. He was a son of
Economics-II
Thakamani Dutta and Isam Chunder Dutt, the Deputy Collector in Bengal. He
studied in various Bengali District schools, and later at Hare School, Calcutta.
After his father’s early demise in an accident, he was took care of by his uncle,
NOTES Shoshee Chunder Dutt, a talented writer, who became his custodian in 1861. He
was influenced by his uncle, who used to sit with him and discuss pieces from the
works of the English poets. The well-known poet of Bengal in nineteenth century,
Toru Dutt, was his relative. He went on to take admission in the University of
Calcutta, Presidency College in 1864. He passed examination in 1866, ranked
second in order of merit and won a scholarship. After completing his education he
went to England for further study with his two friends without taking permission
from his family.
He passed the examination of ‘ICS’ and worked at various administrative
posts. At that time, the only Indian to qualify for the Indian Civil Service
was Satyendra Nath Tagore. He intended to follow the path of Tagore. He joined
Indian Civil Service in 1869 and in 1899, he was elected as the president of the
Indian National Congress. Later, he was also appointed as a lecturer of Indian
History at the University of London. After returning to India he worked on various
administrative posts and was appointed commissioner of the burden division in
the year 1894. After completing successful 26 years of government service he
took retirement from the ICS post and plunged into writing.
In his writings, Romesh Dutt criticized British government for their failure to improve
the economic conditions of India. During the colonial times, India was a non-
industrialized country, but due to British economic policy, the handicraft production
came down sharply. However, industrial production was not increased to support
the current economic condition. Hence, the Indian economy was forced to depend
on farming.
The Peasantry of Bengal was his first book written on the economic problem
of farmers in 1875. The ideas developed in this book were further expanded in his
Indian Famines, Their Causes and Prevention, published in 1901. In this book,
he talked about the over-assessment of land revenue and petitioned the government
for the extension of the Permanent Settlement to the Ryotwari areas and also for a
permanent fixation of rents payable by the ryots to the mediators. His essential
contribution to the field came in the form of The Economic History of India
under Early British Rule: From the Rise of the British Power in 1757, to the
Accession of Queen Victoria in 1837 and The Economic History of India in
the Victorian Age. The theory on land revenue was included in his famous Open
Letters to Lord Curzon on Famines and Land Assessments in India to which
Lord Curzon’s Government gave an official reply in the form of Resolution of
1902. Later, he started speaking in the support of the member of the London
Indian society or the East Indian Association contesting for the House of Commons.
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He also worked as the London correspondent for a Calcutta (Kolkata) based Institutional
Economics-II
journal, The Indian Mirror.
According to him, India was not getting any benefits from British colonialism.
For instance, trains, which were introduced by British, were used to transport
NOTES
goods made in British factories, thus, killing the traditional transportation services
of India. As per his view Indian economy was not underdeveloped, but its progress
was blocked by British. He did not agree with the Marxist belief that British
colonialism was progressive.
His economic thoughts can be found in his two important books. The Economic
History of India under Early British Rule: From the Rise of the British Power
in 1757, to the Accession of Queen Victoria in 1837 and Indian Famines,
Their Causes and Prevention. His first book deals with the economic colonization,
while the second one deals with the condition of agriculture and reason and cure
of famines in India. According to him there is a close relationship between political
and economic situations. The main reason for Indian poverty were:
 Low productivity.
 Tax system.
 Breakdown of cottage industries
The cause of low productivity was adverse climate, soil infertility, traditional
agricultural techniques, population, lack of education, low agricultural price, land
tax system, and overall agrarian structure. Agrarian structure of the country was a
great obstacle for economic development and welfare of the country. The Indians
were paying 40 percent more tax than the tax payers of Great Britain. Thus, in
many ways the sources of national income were reduced and the Indian Industries
gradually declined. Hence, the poverty of India was due to self-centred and unsound
financial plan of British.
R. C. Dutt suggested many measures to get rid of poverty from India. He
designed a complete overhaul of the economic structure of the Indian society. The
major suggestions were:-
 Restoration of cottage industries to remove underemployment.
 Conservation of irrigation amenities to reduce reliance on monsoon
 Interest rate should be lowered on public debt.
 Reduction in government expenditure.
 Decrease of purchase stores in England.
Dutt recommended a plan of improvement in the land revenue system.
 Land agreement should not exceed more than 30 years.
 The cess on land tax should not go beyond 6 percent.
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Institutional  The areas, where the permanent settlement had not been introduced,
Economics-II
the profits collected by landlords on the behalf of the state, should not
go above 15 percent of the produce.
 Those area where the land revenue was collected as per the state
NOTES
directions should not exceed 20 percent.
He also suggested the removal of excise duties on the Indian mill industries,
decrease on the rate of interest on public money owing, creation of sinking fund,
sharing of civil and military expenses by Britain. Larger employment of Indians in
civil services, prohibitions of railway constructions with the state loan, etc.
As a civil servant and as an open-minded political leader of the liberal school,
Dutt was an epitome of the new generation of cultured Indians. Romesh Dutt was
all that the rising Indian intelligentsia aspired to be and was regarded as one of the
builders of modern India. He combined history, politics and economics to display
the impact of British rule in India and the reason of India’s poverty. He not only
analyzed the cause, but also recommended remedies. His experience as an
administrator helped him in assessment of economic conditions of India. Thus, he
secured an important place in the economic political history of India. R. C. Dutta
expired on 30th November 1909.
Check Your Progress

1. What was the first book of Romesh Chunder Dutt?
2. In which work Dutt presented his theory on land revenue?
3. Name the reasons for Indian poverty as claimed by Dutt.
10.3 WESLEY CLAIR MITCHELL
Wesley C. Mitchell was one of the greatest figures of the institutional school. He is
recognized for his pain taking studies of ‘green backs’ and ‘business cycles’. He
was born in rural Illinois on August 5th, 1874 and was the eldest son of a Civil War
veteran. Though he came from a poor family, he manages to receive university
education. Wesley Clair Mitchell took admission at University of Chicago in 1896,
at first to study classics, but later on gravitated towards Economics. At Chicago,
Mitchell came under the influence of Thorstein Veblen and John Dewey and received
his Ph.D. in 1899 under J. Laurence Laughlin and Adolph C. Miller on financial
matter. After serving the Columbia University for few years, he occupied many
important positions. He was also a visiting professor at the University of Oxford,
California and Cornell for his outstanding contributions to the science of economics;
he received honorary degree from the Harvard, Columbia, Paris, Princeton, California
and Pennsylvania universities. Some of Mitchell’s outstanding works include:
 A History of the Greenbacks (1903)
 Gold, Prices, and Wages under the Greenback Standard (1908)
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172 Material
 Business Cycles, The Problem and its Setting (1913) Institutional
Economics-II
 ‘Human Behavior and Economics: A Survey of Recent Literature’ (1929)
 The Backward Art of Spending Money (1937)
 Measuring Business Cycles (1946) NOTES
Mitchell was a founder of the National Bureau of Economic
Research (NBER) in 1920 and was its first director of research. After taking
responsibility of the NBER’s founding study on income redistribution, Mitchell
directed the NBER towards quantitative studies of the U.S. business cycles for
which that organization has become famous.
He was responsible for building Columbia into one of the most notable
fortress of the American Institutionalist School during the inter-war period. His
students, carried on much of Mitchell’s work in the post-war period. Although
Mitchell followed the institutionalists in which he has nothing to do with agent-
based theory, his work was full of hypothetical insights about society and the
economy. He died on October 29th, 1948.
Mitchell’s economic ideas included:
 Method of Study
 Institutional Approach
 Theory of Economic Guidance
 Economic Welfare and Planning
 Business Cycle.
Method of study
Mitchell gave importance to quantitative analysis in economic study. Through this
quantitative method, he was able to give a methodical account of recurring
fluctuations. He was not interested in the old methodological argument that existed
between historical and classical schools. He expanded the range of economics
beyond the constraints of equilibrium.
Institutional approach
As per Mitchell each human being has a gut feeling which is different from person
to person. The conduct of an individual that results from inherited capacities is an
irrational form of behaviour. According to Mitchell, these associations—arts, writing,
speech and religion provide a standard behaviour, habits of feeling, acting and
thinking that are accepted by the community and finally implanted in a social
institution. Social organizations are powerful manager to direct human behaviour.
They are the picture of past achievements of human mental prowess. They form
the foundation for the balanced behaviour of a person. Mitchell suggested America
did not need to look inside the individual and evaluate the pleasant and unpleasant
Self-Instructional
Material 173
Institutional characteristics. In its place, he asked to look outside the individual that is, towards
Economics-II
the habits which had been gradually moulded by the society.
Mitchell analyzes the foundation and growth of institutions and traditions
and supplemented them with wealth, banking and labour problems. In his later
NOTES
studies, he highlighted the physical aspect of economic activities. According to
him, the traditional economic theory was imperfect because it lacked an institutional
approach. Mitchell was sure that the institutional approach would help develop
economics into a science of human behaviour and in turn, economics would become
influential in bringing about social change. He felt that the use of money would
widen the scale of economic theory.
Theory of economic guidance
Mitchell, in his hypothesis of economic guidance, puts forward the thought that the
beginning of corporate enterprise estranged ownership and management. As a
result, power was concentrated in the hands of a few directors and management.
Those who control the dealings of a corporation do it for their own interests.
When he wrote about this theory in 1913, he found that the government cannot be
held responsible for this.
Economic welfare and planning
Mitchell thought that if economics became a science of human behaviour, it would
focus more on human welfare than resources. So, he recommended that in
economics two things namely, determinants of welfare and the means to be
employed to increase it, should be examined. For Mitchell, welfare did not simply
mean overflowing supply of goods, but also a suitable working life, full of interesting
activities. The principle of welfare should be developed in such a way so as to be
beneficial for many lines of works by quantitative methods. He considered economic
planning the most important and difficult task. He believed that planning by business
alone would not succeed. He made it clear through lectures and talks, that planning
was essential for an orderly economy but piecemeal planning was faulty because
it overlooked the fact that the economic and social processes were interconnected.
He was of the observation that the work of the national planners was for the
fulfilment of what the majority desired.
Business cycle
Mitchell’s greatest work was his study of business cycles in his book, Measuring
Business Cycles. In his work, he composed huge statistical data and with the help
of that he carried out a deep study of the individual cycles, group of cycles, and
parts of the cycle. He made use of the frequency curves. Further, he made a
proportional study of the different trends of changes in the prices during the period
of the cycle. The study is an assessment of the existing theories, followed by a
review of general economic association and a detailed statistical analysis of various
economic factors like prices, interest rate, etc. According to Mitchell, the study of
Self-Instructional trade cycles is not considered as a branch of economic theory. However, the
174 Material
study of trade cycles was more essential and productive for gaining knowledge Institutional
Economics-II
about the working of modern economic system. He recognized business cycles to
the inequity between production and distribution. When imbalances occur, it results
in superfluity in the market. Men and machines are unemployed. Business cycles
return because there is no proper business planning. Business fluctuations are NOTES
provoked by factors such as expansion of markets, domination, migration of people,
etc.
As per the self-generation theory given by Mitchell, each stage of a trade
cycle would automatically generate the other. According to him, the business crises
were one feature of a recurrent cycle. A crisis was probably be followed by
depression, depression by recovery, recovery by prosperity, prosperity by crisis,
and so on. Certain factors like internal political conditions, changes in the monetary
and banking systems, war, peace, new industrial methods, international relations,
etc. were responsible for the slackening or quickening the phases of trade cycle.
He indicated that different trades were affected by the trade cycle in diverse ways.
Mitchell confirmed that during the restoration period, there would be an increase
in the price level, high business prospects, and increased level of manufacturing
and demand for goods, with hike in the level of employment. Business optimism,
increased investment, and heavy orders for machinery lead to additional increase
in the price level. Later on due to the operation of two factors namely, continuous
increase in the functioning cost and stress on the money and investment markets, a
crisis or recession occurs.
According to him, the present economic order which is characterized by
high funds investment, middlemen, elasticity of credit, and lack of adjustment, was
responsible for trade cycles. Mitchell’s treatment of trade cycles is more detailed,
practical, and genuine, since it is based on statistical and historical proofs. Although
studies in different aspects of the problem had been made by other economist, it
was only Mitchell who provided an analysis of all the phases of trade cycles on the
basis of statistical data. Regardless of several merits, the theory is not without its
criticism. It has been criticized by modern writers on several counts. Firstly, it
simply takes other issues behind. Furthermore, it treats cyclical fluctuations as the
movements of a machine. In the view of Homan, it is a static theory in which
economic institutions are a relatively stable factor not highly variable.
Mitchell, who made a complex study of business cycles, was certainly the leading
advocate of institutionalism. His Measuring Business Cycles is a masterwork in
economic literature. Mitchell’s use of the statistical methods and quantitative analysis
has made economists more practical in their studies. According to him, inductive
method should be practiced in the study of economic problems. Since collection
of facts is more scrupulous, exhausting and time consuming, he had earned even
more admiration from American economists. He had realized that the modern
economic life was quite complex and its problems could not be handled effectively
Self-Instructional
Material 175
Institutional with the help of conventional analysis. He, therefore, begged to incorporate study
Economics-II
of all connected institutions such as history, statistics, sociology, etc. Mitchell had
strong deep understanding and believed that advances in economics and other
social sciences can and will help to reduce flaw of the economic system such as
NOTES repetition of depressions and joblessness, disparity of opportunity, concentration
of power, and material uncertainty.
Check Your Progress

4. When and where was Wesley C. Mitchell born?
5. What is the self-generation theory?
6. Why has Mitchell’s economic theory been criticized?

QUESTIONS
1. The Peasantry of Bengal was Romesh Chunder Dutt’s first book written
on the economic problems of farmers in 1875.
2. Dutt presented his theory on land revenue in his famous Open Letters to
Lord Curzon on Famines and Land Assessments in India.
3. The reasons for Indian poverty as claimed by Dutt were:
(a) Low productivity
(b) Tax system
(c) Breakdown of cottage industries
4. Wesley C. Mitchell was born in rural Illinois on August 5th, 1874.
5. As per the self-generation theory given by Mitchell, each stage of a trade
cycle would automatically generate the other. According to him, the business
crises were one feature of a recurrent cycle. A crisis was probably be followed
by depression, depression by recovery, recovery by prosperity, prosperity
by crisis, and so on.
6. Mitchell’s economic theory has been criticized by modern writers on several
counts. Firstly, it simply takes other issues behind. Furthermore, it treats
cyclical fluctuations as the movements of a machine. In the view of Homan,
it is a static theory in which economic institutions are a relatively stable
factor not highly variable.
10.5 SUMMARY
 Romesh Chunder Dutt was an Indian Civil Servant born on 13th August
1848 in an eminent Bengali Kayastha family. He was also known as economic
Self-Instructional historian, writer and translator of holy books, Ramayana and Mahabharata.
176 Material
 Romesh Dutt was influenced by his uncle, who used to sit with him and Institutional
Economics-II
discuss pieces from the works of the English poets.
 In his writings, Romesh Dutt criticized British government for their failure to
improve the economic conditions of India.
NOTES
 The cause of low productivity was adverse climate, soil infertility, traditional
agricultural techniques, population, lack of education, low agricultural price,
land tax system, and overall agrarian structure.
 R. C. Dutt suggested many measures to get rid of poverty from India. He
designed a complete overhaul of the economic structure of the Indian society.
 As a civil servant and as an open-minded political leader of the liberal school,
Dutt was an epitome of the new generation of cultured Indians.
 Wesley C. Mitchell was one of the greatest figures of the institutional school.
He is recognized for his pain taking studies of ‘green backs’ and ‘business
cycles’.
 After taking responsibility of the NBER’s founding study on income
redistribution, Mitchell directed the NBER towards quantitative studies of
the U.S. business cycles for which that organization has become famous.
 Mitchell analyzes the foundation and growth of institutions and traditions
and supplemented them with wealth, banking and labour problems. In his
later studies, he highlighted the physical aspect of economic activities.
 Mitchell thought that if economics became a science of human behaviour, it
would focus more on human welfare than resources. So, he recommended
that in economics two things namely, determinants of welfare and the means
to be employed to increase it, should be examined.
 Although studies in different aspects of the problem had been made by
other economist, it was only Mitchell who provided an analysis of all the
phases of trade cycles on the basis of statistical data.
10.6 KEY WORDS
 Permanent Settlement: Also known as the Permanent Settlement of

Bengal, it was an agreement between the East India Company and Bengali
landlords to fix revenues to be raised from land that had far-reaching
consequences for both agricultural methods and productivity in the entire
British Empire and the political realities of the Indian countryside.
 Ryots: It refers to Indian peasants or tenant farmers.
 Sinking Fund: It is a fund containing money set aside or saved to pay off a
debt or bond. A company that issues debt will need to pay that debt off in
the future, and the sinking fund helps to soften the hardship of a large outlay
of revenue.
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Material 177
Institutional
Economics-II 10.7 SELF ASSESSMENT QUESTIONS AND
EXERCISES
NOTES Short-Answer Questions

1. Write a short note on the early life of Romesh Dutt.
2. Why did Romesh Dutt criticize British economic policy in India?
1. Describe the contributions of Romesh Dutt to the study of economics.
2. Discuss the economic ideas of Wesley Clair Mitchell.

University Paperbacks Publisher: Methuen)
Company.
Publications.
Blackwell.
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178 Material
John Maurice Clark and
UNIT 11 JOHN MAURICE CLARK John Kenneth Galbraith
AND JOHN KENNETH

NOTES
GALBRAITH
Structure
11.0 Introduction
11.1 Objectives
11.2 Economic Ideas of John Maurice Clark
11.3 Economic Ideas of John Kenneth Galbraith
11.3.2 Economic Ideas of Wesley C. Mitchell
11.5 Summary
11.6 Key Words
11.0 INTRODUCTION
In the previous unit, you learnt about the ideas of the American economist Wesley
Clair Mitchell and the Indian economic historian Romesh Chunder Dutt. In this
unit, we will discuss the ideas of John Maurice Clark and John Kenneth Galbraith.
John Maurice Clark was a twentieth century American economist whose
work combined the rigor of traditional economic analysis with an “institutionalist”
attitude. His ideas in many ways anticipated those of John Maynard Keynes. John
Kenneth Galbraith was an American economist and public intellectual who was
known as a proponent of public spending and a defender of American capitalism.
11.1 OBJECTIVES

 Discuss the economic ideas of John Maurice Clark
 Explain the concepts of the accelerator principle and workable competition
 Describe the economic ideas of John Kenneth Galbraith
11.2 ECONOMIC IDEAS OF JOHN MAURICE

CLARK
John Maurice Clark was born on November 30, 1884 in Northampton, Mass.,
U.S. He died on June 27, 1963 in Westport Conn. He was an economist in Self-Instructional
Material 179
John Maurice Clark and America whose work on trusts brought him universal fame and whose ideas
John Kenneth Galbraith
projected the ideas of John Maynard Keynes. Clark completed his graduation
from Amherst College in 1905 and was awarded a Ph.D. from Columbia University
in 1910.
NOTES
In his career, Clark was posted at quite a lot of institutions, including at the
University of Chicago (1915–26); he returned to Columbia in 1926 and retired in
1953. Clark’s father was also an American economist named John Bates Clark.
Clark collaborated with his father in 1912 to review an earlier work of Clark
senior entitled The Control of Trusts.
As an economist, Clark’s name has been mainly linked with industrial
economics and competition. He is possibly best known for his concept of workable
competition, as developed in his work Competition as a Dynamic Process
(1961). The book discusses the elasticity of the economic system, the restrictions
to power in market, and the importance of possible competition; these ideas were
also stressed in his father’s writings. Clark argued that perfect competition cannot
be attained theoretically; this idea became accepted by antitrust scholars all over
the world.
In 1923, Clark established his theory of the acceleration principle under the
Economics of Overhead Costs which focused on the concept that investment
demand can vary harshly if consumer demand fluctuations exhaust current output
size. His following study of differences in demand of consumer as a basis of
deviations in aggregate demand elevated some of the concerns later cured by
Keynes. An across-the-board theorist, Clark also studied the economic costs of
war, public works, and the labour market.
Acceleration Principle by John Maurice Clark
The accelerator principle, as advanced by J.M. Clark, refers to the accelerated
effect on investment of a small change in the demand for or output (sales) of
consumption goods. The principle elucidates that the need of rise in national income
mostly results in large investment outlay and the reason behind the amount of
outlay reviewing hinges not on the total level of commerce activity, but on whether
that level is increasing or decreasing. Thus, a change in national income or output
results in a change in investment. However, a small change in national income or
output leads to an accelerated change in investment.
The acceleration principle is based on three main assumptions. These are as follows:
(i) Investment has both autonomous and induced components.
(ii) Investment is subject not on the total level of output or demand, but on the
amount of rise in NNP or in total demand. If the rate of increase is growing,
investment outlay will rise; if the frequency of income is constant, investment
will be constant; if the rate of growth declines, investment will decrease.
(iii) The acceleration principle also highlights the instability of investment as
compared with other mechanisms of cumulative demand. It suggests that
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180 Material
any change in percentage of aggregate demand may effect in considerable John Maurice Clark and
higher changes in percentages of spending of investment.
The accelerator principle of investment is that investment depends upon the
growth of output and implies that investment will be unstable. Investment will fall
NOTES
simply because output grows at a slower rate. For investment to remain stable,
output growth must be constant rate.
Concept of Workable Competition
The situation of workable competition was proposed by Clark to represent a
situation where in a specific industry monopolistic power exists, but there is enough
competition which protects consumers from being abused due to the existing
monopoly. This is a ‘workable’ alterative to the theory of perfect competition. For
example, we can say that the Indian telecom industry is in a state of workable
competition as monopolistic power exists with a few big companies, however,
there is enough competition between these companies to protect consumer interest.
In the situation of workable competition, the following conditions arise:
(i) In the long term, selling price on normal should be equivalent to or not
pointedly above normal costs of production, so that profits do not noticeably
surpass a normal interest return on investment. Prices should be responsive
to basic reductions in costs.
(ii) In so far as normal costs of production are affected by the measures or
volumes of plants and firms, the preponderance of industry output should
be from plants and firms of the most efficient scale or with closely comparable
technical efficiency.
(iii) The industry should not have chronic excess capacity, that is, significant
plant capacity which is persistently unused even in periods of high general
economic activity.
(iv) The industry’s sales-promotion costs should not be substantially greater
than what is needed to keep buyers informed of the availability,
characteristics, and prices of products.
(v) The industry should be adequately progressive in introducing more
economical production techniques and improved products, thereby balancing
the costs of progress with the gains.
The first three of these aspects are easy to assess than the others, certain
simplifications are likely relating to the workability of different market structures:
 Unregulated single-firm monopolies tend to generate unworkable market
performance, mainly in the form of output restriction, prices well above
costs, and consequent excess profits. They have undesirable effects on the
uses to which resources are put and on income distribution.
 Oligopolies with high seller concentration and also very high barriers to
entry tend towards unworkable performance, like that of single-firm
Self-Instructional
Material 181
John Maurice Clark and monopoly. In general, however, they do not show significant degrees of
technical inefficiency resulting from inefficient plant scales or excess capacity.
 Oligopolies with fairly high seller concentration but only moderate barriers
to entry are also prone to unworkable performance of the sort just
NOTES
mentioned, but not to as high a degree.
 Oligopolies with only reasonable seller absorption and moderate-to-low
blocks for entry have a habit of inclining towards workable performance
both in price-cost relations and in technical efficiency, excluding that certain
of them may have repeated long-lasting additional volume due to intermittent
over entry by competing firms.
 Industries of atomistic structure have a habit of bending normally toward
workable performance except they agonise from critical competition as
described above.
Concept of Public Works
A public utility is an organization that delivers certain types of services to the
public, including public transportation, sanitation, electricity, water, and similar
services. In many countries such businesses are owned and operated by the state,
however, in the United States they are mostly owned by private businesses and
are operated under close governmental regulation. In India, an example of a public
utility would be the Indian Railways.
The classic explanation for the need to regulate public utilities is that they
are enterprises in which the technology of production, transmission, and distribution
almost inevitably leads to complete or partial monopoly, that is, they are natural
monopolies. The monopolistic tendency arises from economies of scale in the
particular industry, from the large capital costs typical of such enterprises, from
the inelasticity of demand among consumers of the service, from considerations of
the excess capacity necessary to meet demand peaks, and other considerations.
It is often also the case that the existence of competing parallel systems of local
telephones or natural gas, for example, would be inordinately expensive, wasteful,
and inconvenient. Given the tendency to monopoly and the potential therefore of
monopolistic pricing practices, public regulation has for more than a century been
applied to certain classes of business.
In practice, regulation aims to ensure that the utility serves all who apply for
and are willing and able to pay for its services, that it operates in a safe and
adequate manner, that it serves all customers on equal terms, and that its rates are
just and reasonable. In the United States, all states have regulatory commissions,
and the American Federal Government has several, including the Interstate
Commerce Commission, the Civil Aeronautics Board, the Federal Power
Commission, the Federal Communications Commission, and the Securities and
Exchange Commission.
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182 Material
11.3 ECONOMIC IDEAS OF JOHN KENNETH John Kenneth Galbraith
GALBRAITH
John Kenneth Galbraith was born on October 15, 1908 at Iona Station in Ontario, NOTES
Canada. He died on April 29, 2006 at Cambridge in Massachusetts, U.S. He was
a Canadian-born economist in America and public servant recognised for his
support of public expenditure and for the literary quality of his writing on public
affairs. Galbraith graduated from University of Toronto’s Ontario Agricultural College
in 1931 and completed his Ph.D. from the University of California, Berkeley in
1934. Galbraith became a U.S. citizen in 1937. He worked at Harvard and
Princeton Universities until 1942.
During the Second World War, and the post-war period, Galbraith was
posted in a variety of government posts and served as editor of Fortune magazine
from 1943 to 1948 before recommencing his academic career at Harvard in 1948.
He was a well-known a politically active liberal academician with an aptitude for
interacting with the reading public. Galbraith became a key advisor to President
John F. Kennedy and was appointed as Ambassador to India from 1961 to 1963,
after which he resumed his career at Harvard; Galbraith became professor emeritus
in 1975. He also continued his involvement in public affairs, and in 1967–68 he
was national chairman of the Americans for Democratic Action.
Galbraith’s major works included American Capitalism: The Concept of
Countervailing Power (1951), in which he questioned the competitive ideal in
industrial organizations. In his popular critique of the wealth gap, The Affluent Society
(1958), Galbraith faulted the “conventional wisdom” of American economic policies
and called for less spending on consumer goods and more spending on government
programs. In The New Industrial State (1967) Galbraith envisioned a growing
similarity between “managerial” capitalism and socialism and called for intellectual
and political changes to stem what he saw as a decline of competitiveness in the
American economy. Among his many other works were The Great Crash, 1929
(1955), The Liberal Hour (1960), Ambassador’s Journal (1969), A Life in Our
Times: Memoirs (1981), The Anatomy of Power (1983), Economics in
Perspective: A Critical History (1987), and The Culture of Contentment (1992).
Galbraith for his services to the public was awarded the American Presidential Medal
of Freedom twice, in 1946 and again in the year 2000.
Galbraith’s American Capitalism
In American Capitalism: The Concept of Countervailing Power, published in
1952, John Kenneth Galbraith determined that the economy of America was
managed by a trio of big business organizations, big labour, and an activist
government. He defined the actions of the industry groups and unions as
countervailing power. He compared this system with the era preceding the Great
Depression, when big businesses had comparatively free restraint over the economy.
Self-Instructional
Material 183
John Maurice Clark and Galbraith’s The New Industrial State
Galbraith lengthened his examination of the role of power in monetary life, arguing
that very few businesses in the United States is suitable for the model of perfect
NOTES competition. The ‘conventional wisdom’ in economic thought represents economic
life as a conventional competitive market that is governed due to the choices of
independent consumers. The production control process runs from consumers of
merchandises to the establishments that manufacture those merchandises. This
process is overturned and industries start exercising control over consumers by
advertising and related salesmanship activities.
The overturned process relates only to the industrial system, that is, the
manufacturing core of the economy in which each industry contains only a few
very powerful companies. It does not apply to the market system in the Galbraithian
dual economy. In Galbraith’s view, the main function of market relations in this
industrial system is, not to limit the control of the corporate leaders, but to help as
a tool for the application of their power. Furthermore, the power of these companies
ranges into commercial culture and politics, letting them exercise substantial effect
upon popular social attitudes and value judgments. That this power is exercised in
the short sighted interest of expanding commodity production and the status of the
few is both inconsistent with democracy and a barrier to achieving the quality of
life that the new industrial state with its affluence could provide.
John Roger Commons was born on October 13, 1862 at Hollandsburg in Ohio,
U.S and died on May 11, 1945 at Fort Lauderdale in Florida. He was economist
of America who turned into the leading authority on U.S. labour in the first half of
the 20th century. He did his studies at Oberlin College and at Johns Hopkins
University and taught at the University of Wisconsin from 1904 to 1932. Some
famous works of his include A Documentary History of American Industrial
Society, 10 volume in 1910–11, and History of Labour in the United States, 4
volume in 1918–35. Commons’ theory of the growth of the American labour
movement in relations of fluctuations in the market structure was largely accepted.
After the First World War, Commons widened his name with the publication of
Legal Foundations of Capitalism in 1924 and Institutional Economics in 1934.
He was the author of many changes in legislation in the American state of Wisconsin
that made the state an example for other states. Some of the legislation included
lawful rights for labour unions, compulsory unemployment insurance, compulsory
workers’ compensation, and government regulation of utilities. He also made
notable contributions to the federal government in the areas of civil service, public
utilities, and unemployment insurance and contributed to the design of the Social
Security Act of 1935, the U.S. government’s first comprehensive program to fund
old-age benefits through payroll taxes.
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184 Material
11.3.2 Economic Ideas of Wesley C. Mitchell John Maurice Clark and
We’ve already studied about Wesley Mitchell in the previous unit. Let us briefly
recapitulate his life and career once again.
Wesley Clair Mitchell was born on August 5, 1874 in Rushville, Ill., U.S. NOTES
and died on October 29, 1948 in New York, N.Y. Mitchell was an American
economist recognised for being the world’s leading expert on business cycles.
Mitchell completed his education from the University of Chicago, where he started
following the thoughts of Thorstein Veblen and John Dewey on Institutional
Economics. In his career, Mitchell taught at various universities, including the
University of Chicago from 1900 to 1902, the University of California from 1902
to 1912, Columbia University from 1913 to 1919 and again from 1922 to 1944,
and the New School for Social Research, New York City from 1919 to 1921. In
spite of his wide-ranging career of teaching, Mitchell was mainly dedicated to his
interest of economics research.
In 1920, Mitchell helped to organize the National Bureau of Economic
Research and was its director of research until 1945. He served as the chief of the
price section of the War Industries Board during the First World War, as chairman
of President Herbert Hoover’s Research Committee on Social Trends, and as a
member of the National Planning Board (1933) and of the National Resources
Board (1934–35). Under Mitchell’s leadership, the Social Science Research
Council, of which he was chairman (1927–30), and the Bureau of Educational
Experiments, greatly influenced the development of quantitative studies of economic
behaviour in the United States and abroad.
Among his publications are Business Cycles (1913), Business Cycles: The
Problem and Its Setting (1927), The Backward Art of Spending Money (1937),
and Measuring Business Cycles (1946), co-written with A.F. Burns.
Check Your Progress

1. What is Clark best known for?
2. What is the accelerator principle?
3. What did Galbraith question in his work American Capitalism: The
Concept of Countervailing Power?
4. List some famous works of John Roger Commons.

QUESTIONS
1. John Maurice Clark is possibly best known for his concept of workable
competition, as developed in his work Competition as a Dynamic Process.
Self-Instructional
Material 185
John Maurice Clark and 2. The accelerator principle, as advanced by J.M. Clark, refers to the
accelerated effect on investment of a small change in the demand for or
output (sales) of consumption goods.
3. In American Capitalism: The Concept of Countervailing Power,
NOTES
Galbraith questioned the competitive ideal in industrial organizations.
4. Some famous works of John Roger Commons include A Documentary
History of American Industrial Society, 10 volume in 1910–11, and
History of Labour in the United States, 4 volume in 1918–35.
11.5 SUMMARY
 John Maurice Clark was born on November 30, 1884 in Northampton,

Mass., U.S. He died on June 27, 1963 in Westport Conn. He was an
economist in America whose work on trusts brought him universal fame
and whose ideas projected the ideas of John Maynard Keynes.
 As an economist, Clark’s name has been mainly linked with industrial
economics and competition. He is possibly best known for his concept of
workable competition, as developed in his work Competition as a Dynamic
Process (1961).
 In 1923, Clark established his theory of the acceleration principle under the
Economics of Overhead Costs which focused on the concept that investment
demand can vary harshly if consumer demand fluctuations exhaust current
output size.
 The accelerator principle, as advanced by J.M. Clark, refers to the
accelerated effect on investment of a small change in the demand for or
output (sales) of consumption goods.
 The situation of workable competition was proposed by Clark to represent
a situation where in a specific industry monopolistic power exists, but there
is enough competition which protects consumers from being abused due to
the existing monopoly. This is a ‘workable’ alterative to the theory of perfect
competition
 Public utility, is an organization that delivers certain types of services to the
public, including public transportation, sanitation, electricity, water, and
similar services.
 The classic explanation for the need to regulate public utilities is that they
are enterprises in which the technology of production, transmission, and
distribution almost inevitably leads to complete or partial monopoly, that is,
they are natural monopolies.
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186 Material
 John Kenneth Galbraith was born on October 15, 1908 at Iona Station in John Maurice Clark and
Ontario, Canada. He died on April 29, 2006 at Cambridge in Massachusetts,
U.S.
 Galbraith’s major works included American Capitalism: The Concept of
NOTES
Countervailing Power (1951), in which he questioned the competitive ideal
in industrial organizations.
 In American Capitalism: The Concept of Countervailing Power,
published in 1952, John Kenneth Galbraith determined that the economy of
America was managed by a trio of big business organizations, big labour,
and an activist government.
 Galbraith lengthened his examination of the role of power in economic life,
arguing that very few businesses in the United States is suitable for the
model of perfect competition.
 John Roger Commons was born on October 13, 1862 at Hollandsburg in
Ohio, U.S and died on May 11, 1945 at Fort Lauderdale in Florida.
 Commons was the author of many changes in legislation in the American
state of Wisconsin that made the state an example for other states. Some of
the legislation included lawful rights for labour unions, compulsory
unemployment insurance, compulsory workers’ compensation, and
government regulation of utilities.
 Wesley Clair Mitchell was born on August 5, 1874 in Rushville, Ill., U.S.
and died on October 29, 1948 in New York, N.Y. Mitchell was an American
economist recognised for being the world’s leading expert on business cycles.
 In 1920, Mitchell helped to organize the National Bureau of Economic
Research and was its director of research until 1945.
 Among Mitchell’s publications are Business Cycles (1913), Business Cycles:
The Problem and Its Setting (1927), The Backward Art of Spending
Money (1937), and Measuring Business Cycles (1946), co-written with
A.F. Burns.
11.6 KEY WORDS
 Oligopolies: These are market structures with a small number of firms,

none of which can keep the others from having significant influence.
 Monopolies: These are market structures characterized by a single seller,
selling a unique product in the market.
 Public utility: It is an organization that maintains the infrastructure for a
public service.
 Regulation: It refers to rules made by a government or other authority in
order to control the way something is done.
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Material 187
John Kenneth Galbraith 11.7 SELF ASSESSMENT QUESTIONS AND
EXERCISES
NOTES Short-Answer Questions

1. List the assumptions of the acceleration principle.
2. Discuss the arguments made by Galbraith’s in The New Industrial State.
3. Write a short note on the economic thoughts of Wesley C. Mitchell.
1. Discuss the economic ideas of John Kenneth Galbraith.
2. Explain the concept of workable competition.
3. Examine the economic ideas of John Maurice Clark.

University Paperbacks Publisher: Methuen.
Company.
Publications.
Blackwell.
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188 Material
Indian Economic
UNIT 12 INDIAN ECONOMIC Thought I
THOUGHT I
NOTES
Structure
12.0 Introduction
12.1 Objectives
12.2 Thiruvalluvar
12.3 Gopal Krishna Gokale
12.3.2 Agricultural Ideas
12.4 Dadabhai Naoroji
12.4.1 Drain Theory
12.4.2 Criticisms
12.5 Mahadev Govind Ranade
12.7 Summary
12.8 Key Words
12.0 INTRODUCTION
In the previous units, we studied the ideas of various economists on institutional
economics. In this unit, we will study the economic thought of Indian thinkers. The
Grand Old Man of India, Dadabhai Naoroji, was an early Indian political and social
leader who became one of the founding members of the Indian National Congress. In
terms of economic theory, he is best known for his drain of wealth theory which critiqued
British rule in India. Likewise Gopal Krishna Gokhale was one of the founding social
and political leaders during the Indian Independence Movement. His economic ideas,
along with Thiruvalluvar and Mahadev Govind Ranade are also discussed in the unit.
12.1 OBJECTIVES
 Explain the economic thoughts of Indian thinkers
 Discuss the economic ideas of Thiruvalluvar and Gopal Krishna Gokhale
 Describe the economic theories of Dadabhai Naoroji and Mahadev Govind
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Ranade Material 189
Indian Economic
Thought I 12.2 THIRUVALLUVAR
Thiruvalluvar, was a well-known Tamil poet and philosopher, also known

NOTES as Valluvar. His birth place and date is still unknown, but his parents’ names were
Bhagavan and Aadhi. There is not much known about his family background,
religion or birth place. Uncertainty still persist, it is believed that he lived in the
town of Mylapore (present-day Chennai). It is believed that he may belong to
either Jainism or Hinduism because during his times Hinduism, Jainism and
Buddhism were the only three religions, which flourished in the Indian sub-continent.
He is known for his work, Tirukkural, which is a collection of couplets on morals,
social and economic matters, and love. This book is considered as a brilliant and
widely appreciated work of the Tamil literature. No reliable information is accessible
about Valluvar, the intellectual of Tamil literature. His life and background are
variously inferred from his works and by different biographers. The assumption
about Valluvar’s life is mainly inferred from his work, Tirukkural. According to
Zvelebil, Valluvar was perhaps a learned Jain with diverse leanings and close
association with the early works of Tamil classical period and some knowledge of
the Sanskrit legal and educational manuscript.
All major Indian religions, as well as Christian missionaries of the 19th century,
have claimed him as inspired from their tradition. He has inspired many researchers
down the ages by his ethical, social, political, economic, religious, philosophical, and
spiritual spheres. He has been respected for his literary works, which are considered
as classics of Tamil culture. In the 19th and early 20th century, European writers and
missionaries variously dated the Valluvar to exist between 400 and 1000 CE.
According to Blackburn, the ‘current scholarly consensus’ dates the text and the
author to around 500 CE. In 1935, the Tamil Nadu government officially documented
31 BCE as the year of Valluvar. As recommended by Maraimalai Adigal, the Valluvar
Year was added to the calendar. Thus, the Valluvar year is calculated by adding 31
to any year of the Common age.
Valluvar’s teachings intimate both the cultural values and textual values in
the 13th to 14th Century Tamil Nadu. Valluvar’s text can be interpreted and
exercised in other ways. Regardless of scholars signifying that Valluvar is either a
Jain or a Hindu, almost every religious group in India, as well as Christianity, has
claimed the work and its author as one of their own. However, these claims are
not supported academically and are constantly disproved by scholars. For example,
the Christian claims have cropped up only after the regal missionaries came to
India, so they have been ignored. Valluvar is worshiped as a deity and saint by
various communities throughout the Southern province of India. Several
communities, together with those in Mylapore and Tiruchuli, worship Valluvar as
the 64th Nayanmar of the Saivite tradition. There are many temples totally devoted
to Valluvar from corner to corner of Southern part of the country. The most eminent
temples are in Mylapore, Chennai built in the early 16th century. The government
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of Tamil Nadu celebrates the 15th of January as Thiruvalluvar Day in the poet’s
190 Material
respect as part of the Pongal celebrations. Thiruvalluvar Day was first celebrated Indian Economic
Thought I
on the 17th and 18th of May 1935. Valluvar’s works have also influenced the
South Indian classical music and popular culture. Carnatic musicians and composers
such as Mayuram Viswanatha Sastri and M. M. Dandapani Desikar have tuned
select couplets in the 19th and 20th centuries. NOTES
Even though researchers vary over the assessment of the era of Tirukkural,
it is normally believed that it belonged to the Sangam Age in Tamil Nadu, which is
dated around 3rd Century A.D. His work is regarded as realistic idealism.
Tirukkural contains three important parts Aram (virtue), Porul (wealth), Inbam
(love), which are necessary for ultimate salvation or vitu, which follow Dharma
(religion), Artha (polity), Kama (love), and moksha (salvation) respectively—
which are the four foundations of Hinduism. The book was divided into: (i)
Arathuppal (ii) Porutpal and (iii) Kamathuppal.
Tirukkural is structured into 133 chapters, each containing 10 couplets (or
kurals), for a total of 1,330 couplets. The 133 chapters are grouped into three
parts or books:
 Part I–Aram: Dealing with virtues independent of the surroundings
(Chapters 1 to 38)
 Part II-Porul: Chapter dealing with Polity (Artha), in other words, virtues
with respect to the surroundings (Chapters 39 to 108).
 Part III-Inbam: The chapter deals with Kama or virtues related to
conjugal human love (chapters 109 to 133)
The Tirukkural text has been converted into numerous Indian and global
languages. It was translated into Latin by Constanzo Beschi in 1730, which helped
make the work known to European scholars. Tirukkural is one of the most
respected contributions to the Tamil literature. Valluvar is honoured and well-
regarded in the Tamil culture as is revealed by his work, which has been called by
nine diverse names: Tirukkural (the sacred kural), Uttaravedam (the
ultimate Veda), Thiruvalluvar (eponymous with the author), Poyyamoli (the false
less word), Vayuraivalttu (truthful praise), Teyvanul (the divine
book), Potumarai (the common Veda), Muppal (the three-fold path),
and Tamilmarai (the Tamil Veda). Valluvar was a realistic thinker. He did not mix
spiritualism with earthly things. The political philosophy of Thiruvalluvar is applicable
across times even today. Porutpal consists of 7 parts, further it has 70 verses/
couplets. They include politics-25, ministry-10, defence-2, wealth-1, army-2,
friendship-17, and citizens-13 respectively.
Valluvar’s economic thoughts are found in his never-ending contribution, Tirukkural,
a book of principles. Valluvar’s top seven economic ideas are: factors of
production, agriculture, public finance, poverty and begging, wealth, ethics, and
welfare state.
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Material 191
Indian Economic  Factors of production: Thiruvalluvar has made many passing references
Thought I
about the factors of production viz., Land, Labour, Capital, Organisation,
Time, Technology, etc. For example, he had said: ‘Unfailing harvest,
competent body of men, group of men whose wealth knows no diminution,
NOTES are the components of an economy’, (Kural 61). According to him,
performing the work at the proper time, with appropriate technology is a
key to conquer the world. He has also insisted on the need for saving. As
profit cannot be made without capital.
 Agriculture: Valluvar considered agriculture to be the most fundamental
economic activity. According to him, the agriculturists were the real
‘intellectuals’ and ‘capitalists’—the important ingredients of an economy.
 Public finance: Valluvar has elaborated on public finance under the captions
public revenue, financial administration, and public expenditure. He
mentioned these as:
o Creation of wealth
o Collection of revenue
o Management of revenue
o Public expenditure
Valluvar didn’t support taxing the public. The three main sources of revenue
are: (1) Wealth that comes by itself; (2) Customs duties; (3) Tributes paid
by the defeated kings, i.e., ‘reparation’. In case of public expenditure,
Valluvar endorsed a balanced approach towards budget, with focus on
defence, social service, and public works. Valluvar was also against taking
external support. According to him a country should be self-sufficient,
otherwise it cannot be considered as independent country.
 Poverty and begging: As per his views, poverty is the main reason for all
the suffering. He considered begging as the greatest curse of society.
 Wealth: According to him, wealth is only means not an end. He supported
gaining wealth by noble and honourable means. He opposed hoarding wealth
and described it as profitless richness. He considered production to be the
real wealth and labour as the greatest resource.
 Ethics: His entire teachings were based on morals. He was against illegal
methods of achieving the objectives. He regarded drinking, gambling, and
prostitution as the evils that did harm to the socio-economic life of a society.
 Welfare state: He advocated for welfare state, where there will be no
poverty, illiteracy, and disease. The features of such a welfare state are:
o No disease
o Abundant wealth
o Good crops
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192 Material
o Happiness Indian Economic
Thought I
o Security for the people
However, according to Valluvar, the most important feature of a peaceful
state is ‘wherein there are no several parties, where there are no internal NOTES
dissensions; where there are no internal enemies’.
Check Your Progress

1. Which year is regarded as year of Valluvar?
2. Mention the diverse names Tirukkural?
3. What is the significance of 15th January in Tamil Nadu?
12.3 GOPAL KRISHNA GOKALE
Gopal Krishna Gokhale was born on 9 May 1866 at Katulk in Ratnagiri. The
economic condition of the family was so bad that on his father’s death, he could
continue his studies only because his elder brother sacrificed his own education.
He obtained his B.A. degree in 1884 and joined the Law College in Bombay, but
could not complete the course. Gokhale was greatly influenced by the ideas of
M.G. Ranade, whom he regarded as his master in political and public life; Dadabhai
Naoroji, who was his hero; and famous Bombay lawyer, Pherozeshah Mehta.
Immediately after his graduation, Gokhale joined the Deccan Education Society,
Poona (Pune), as a Life Member. When the Fergusson College was opened in
1885, he was called upon to lecture there. He retired in 1902 specifically to devote
himself to public life. In 1889, he became a member of the Indian National
Congress. In 1890, he was elected Honorary Secretary of the Sarvajanik Sabha,
Poona, of which Ranade was the most influential member. In 1893, he became the
Secretary of the Bombay Provincial Conference. In 1895, he became Joint
Secretary of the Indian National Congress along with B. G. Tilak.
As noted earlier, Gokhale’s economic and social ideas constitute a part of his
political thinking. He was not an economist in the strict sense of the term. Neither
was he a social thinker with deep sociological insight. However, as a leader of the
Congress and as a member of the legislature, Gokhale had to ponder over many
socio-economic issues of the time which, in turn, gave birth to his economic and
social ideas. These ideas reflected his way of thinking which considerably influenced
the process of social change of his time.
As far as his economic ideas are concerned Gokhale owes much to M. G.
Ranade and Professor List, a German economist. Both Ranade and List differed
from the classical economists such as Adam Smith and Ricardo. Ranade argued
that ‘Political Economy being a Hypothetical Science, its propositions are not
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Material 193
Indian Economic based upon axiomatic truths like those of Euclid and do not absolutely and
Thought I
universally hold good, like the latter, true in all times.’ Therefore, if a particular
economic policy was suited to England it was not necessarily valid for India as
well. It was on this ground that Ranade opposed the policy of free trade in India
NOTES as advocated by the classical English economists. Ranade noticed that in Germany
it was because of state initiative that the country was able to transform itself into a
first rate modern power, and hence he pleaded that the state should take initiative
in accelerating the process of industrialisation. Like Professor List, Ranade thought
that the trade policy of the country is integrated with its general economic policy
and therefore he felt that ‘the government should guarantee or subsidise private
efforts till private enterprise could support itself...should advance loans to private
capitalist at low interest and help them in the choice of places and the selection of
the form of investment.’
According to Ranade, the grave problem before India was that of poverty
and it could not be removed until the process of industrialisation set in. The policy
of free trade and open competition, as followed by the British administrators,
were not conducive to the growth of industrialisation in India and hence Ranade
advocated state intervention in the economic life of the country. Moreover, there
was no point in having a surplus budget while the budget of the common man
failed to balance itself. During a period of budgetary surplus, Gokhale recommended
that the state adopt the following measures:
 A reduction in state demand on land by 25 to 30 per cent
 The creation of a fund of millions of sterling to rescue the Indian
agriculturists from the load of debt
 The activation of co-operative credit societies through establishing
agricultural banks on Egyptian model
 The promotion of industrial and technical education and the sanctioning
of the increased expenditure for this purpose
 Free and compulsory primary education
 Improvement of the finances of the local bodies
In 1905, Gokhale founded the Servants of India Society with the object of
training men to devote themselves to the service of India as national missionaries
and to promote by all constitutional means the national interests of the Indian
people. In 1908, Gokhale founded the Ranade Institute of Economics. Gokhale
was a front rank Reformer; he deprecated the caste-system and untouchability,
pleaded for the emancipation of women and championed the cause of female
education. In Gokhale’s opinion, the introduction of Western education in India,
with its liberalising influence, was a great blessing to the people. He was a firm
believer in the theory that mass education was a prerequisite to national political
consciousness. He advocated that primary education should be free in all schools
throughout India at once. As for Gokhale’s ideas on nationalism and the conduct
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194 Material
cooperate with the Government in reforms and obtain through constitutional means Indian Economic
Thought I
and by persuasion and advance over the reforms granted until, finally, India became
a self-governing Dominion within the British Commonwealth of Nations. While
appreciating the benefits of British rule in general, he never failed to criticize unjust
policies and high-handed actions of the Government. NOTES
In his opinion, the economic results of British rule in India were absolutely
disastrous, resulting in frightful poverty. According to him, the greatest need of the
hour in India was industrial education. In agriculture, he pleaded that old methods
should be changed as much as possible. There was a crying need to introduce
agricultural science and improved agricultural implements. Regarding the textile
industry, Gokhale acknowledged that the handloom was doing good work and
had some future before it, yet the main work would have to be done by machinery.
He made extensive use of the public platform for communicating his ideas on
social, economic and political reform. Some of his memorable speeches were
made in the Imperial Legislative Council, especially on the Annual Budgets from
1902 to 1908. Gokhale paid frequent visit to England His first visit (1897) was in
connection with the Welby Commission. His evidence was noted for his analysis
of the leading facts in the history of Indian Finance, his examination of the constitution
and expenditure of the Indian Army and his emphasis on the subordination of the
interests of the taxpayers to those of the European services and the exclusion of
Indians from the higher branches of public service.
Fig 12.1 G.K. Gokhale
Source: http://en.wikipedia.org/wiki/File:GKGokhale.jpg
Among the early figures in the Indian National Congress Gokhale’s position
was very high. He was feared by the Government and respected by the people. In
politics he belonged to the moderate group opposed to the extremist school led by
Tilak. He, however, placed equal emphasis on social reform as on political progress.
For nearly three decades Gokhale dedicated his rare qualities to the exclusive service
of his country and his people in a way which few could lay claim to.
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Material 195
Indian Economic 12.3.2 Agricultural Ideas
Thought I
Gokhale was of the opinion that it was of no use to have surplus budget when the
budget of the common man failed to balance itself. If there was to be a surplus
NOTES budget the surplus must be devoted to the work of promoting development functions
of the state. Gokhale was also aware of the state of the agricultural life in India. He
saw that the agricultural industry in India was in a serious depression and the crop
yield per acre was low. In such circumstances, he resented the increase in the land
revenue demanded by the state. He made it clear that he regarded land revenue
and the indirect taxes as together placing an unbearable burden on the poor. He
wanted the state to give importance to irrigation and scientific agriculture as measures
for agricultural prosperity. He disapproved the excise duty on cotton textiles which
in his opinion was imposed to counter balance the duties on imports. Gokhale
thought that such a duty further burdened the poor.
Following the German economist Professor List’s ideas, Gokhale pleaded
protection for the new industries in India on the ground that she was an industrially
backward country. Gokhale observed:
...he (List) says that when a country is industrially backward...comes
into vortex of universal competition-competition with countries which
use steam and machinery... in their production-the first effect is to
sweep of local industries and the country is thrust back on agriculture
for some time. But then, he says, comes in the duty of the state.
When such a situation is reached, the state should step forward and
by a judicious system of protection it should foster such industries
are capable of being fostered so that the country may once again
enter on its industrial path with the aid of the latest appliances and
ultimately stand successfully the competition of the whole world.
India should follow this advice of List.
In short, Gokhale stood for the industrial development, advocated state
initiative to further the process of industrialisation, demanded protection for infant
industries, and thus paved the way for capitalist development.
Gokhale did not stop at merely criticizing the fiscal policy of the British government
but also advocated the cause of Swadeshi. However, he did not identify Swadeshi
with boycott. For Gokhale, the Swadeshi movement was both a patriotic and an
economic movement. So far as its patriotic aspect concerned it meant devotion to
motherland but the movement on its mate. It ensured a ready consumption of such
articles as were produced in the country and furnished a perpetual stimulus to
production by knowing up the demand for indigenous things. To Gokhale, the
question of production was a question of capital, enterprise and skill and whoever
could help in one of those fields could be called a worker in the Swadeshi cause.
Gokhale did not mind even to seek governmental cooperation for the cause of the
Swadeshi movement. Through the Swadeshi movement, Gokhale sought to lay
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the foundations of indigenous capitalism.
196 Material
In the sphere of social reforms, Gokhale sided with Ranade. Like Ranade, Indian Economic
Thought I
Gokhale also believed that social reforms must go along with political reforms. As
early as in 1890, Ranade had advocated certain reforms, namely:
 Not more than a year’s income should be expended on the marriage
NOTES
ceremonies of son or daughter.
 The boys should not be married before the ages sixteen, eighteen or
twenty and the girls before the ages of ten, twelve and fourteen.
 Polygamy should be prohibited.
 No one should marry after the age of sixty.
 Efforts should be made to promote female education.
By and large, Ranade believed that all these reforms should be introduced
gradually, and the state might be utilized to bring about social change through
legislative procedure whenever it was absolutely necessary. But on an average,
Ranade believed, that ‘popular initiation’ rather than ‘imposed laws’ would be
helpful in reforming the society. However, it must be noted here that Ranade was
not totally against the state-intervening to promote social reforms as Tilak was.
Gokhale followed Ranade in this respect. He was of the opinion that the state
must help the progressive elements in the society. He thus supported the motion
on the Civil Marriage Bill. With the support of an influential and enlightened minority
Gokhale wanted the state to proceed with measures of social change. Gokhale
pleaded for state-intervention to regulate the social and economic life of the country.
Thus, the role that he envisaged for the state was very different from the role
assigned to the state by classical liberalism.
Check Your Progress

4. Which policy of the classical English economists was opposed by M.G.
Ranade?
5. Why did Gokhale found the Servants of India Society?
12.4 DADABHAI NAOROJI
In terms of economic theory, Dadabhai Naoroji is best known for the concept of
the drain theory. During the last two decades of the 19th century and the first
decade of the 20th century, the drain theory came to be seen as the symbol of
Indian economic nationalism. Its basic message, namely that the financial mechanism,
by which British rule in India was maintained, led to a transfer of wealth and
income from India to Britain, imposing a ‘bleeding drain’ on the Indian economy,
was not confined to scholarly writing. It was stated in speeches at public meetings,
presidential addresses of the Indian National Congress and editorials of leading
daily newspapers, notably the Amrita Bazar Patrika. For nationalistic Indians, it
became an article of faith, and for some, it still is.
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Indian Economic
Thought I
NOTES
Fig 12.2 Dadabhai Naoroji
Source: http://en.wikipedia.org/wiki/File:Dadabhai_Naoroji,_1892.jpg
12.4.1 Drain Theory

The drain theory was first developed by Dadabhai Naoroji in a series of speeches
and writings subsequently published in 1901, in a volume entitled Poverty and
un-British Rule in India. Marginal contributions to the theory were also made by
R.C. Dutt, G.S. Iyer, G.K. Gokhale and P.C. Ray. Posterity, not without reason,
has tended to look on the drain theory as the brainchild of Naoroji.
Naoroji himself makes no great claim to originality. On the contrary, he
purports to regard the concept of economic drain as well-established, attributing
it to a number of British writers to whom he amply acknowledges his debt. These
include Sir John Shore, who said in his minute to the Fifth Report of the Eastern
Indian Company in 1787 that the company’s trade produced no equivalent returns
to India; Mr Frederick John Shore, a Bengal civilian, who said in 1837 that India
had been drained of a large proportion of the wealth she once possessed; and Mr
Saville Marriot, a Commissioner of Revenue in the Deccan, who stated in 1837
that most of the evils of ‘our’ in rule in India arose directly from, or might be traced
to, the heavy tribute which the country paid to England. These concepts, namely
trade with no equivalent returns, the drain of wealth, and annual tribute, formed
the core of the theory of external economic drain, which Naoroji made his own.
Neither Naoroji himself nor his followers attempted to develop the drain
theory in a formal or rigorous way. It was stated in a number of different versions
and remains open to a variety of interpretations. It has, for example, been regarded
as an expression of patriotic fervour against foreign rule, as an exercise in the
economics of imperialism, as an outdated product of mercantilism and as an
anticipation of recent neo-Marxist theories of unequal exchange. However, if one
only looks at the form in which it was developed by Naoroji and his immediate
followers, the theory appears to have contained a stable core. This emerges clearly
from some recent characterization of the drain theory by two authors whose basic
points of view are quite different. The first is Bipan Chandra:
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198 Material
In the opinion of Indian national leadership, one of the most important Indian Economic
causes of the poverty in India was the drain of wealth to England … Thought I
In fact, a great deal of the national agitation during the period under
study was based on the drain theory or the belief that a part of the
national wealth or of its total annual product was being exported to NOTES
England for which India got no adequate economic or material return.
Or in other words, India was being compelled to pay an indirect tribute
to the English nation.’
The other is Barber, who describes the drain theory stated by Indian
nationalists as consisting in the belief that ‘the unilateral transfers that India was
compelled to make to British, systematically stripped the country of resources and
thus perpetuated poverty’.
On the whole, writings by Indian nationalists in this period do not suggest
that they were using ‘drain’ as a catch-all term for the evils of foreign rule but
rather show that they had a fairly specific sort of drain in mind. As Dharma Kumar
has pointed out, whether or not there was a drain from Indian depends on the
question of whether India received value for the sterling payments made or whether
it was forced to pay too much, and this is a question which can only meaningfully
be discussed item by item. According to Indian writers, the most important item
was the remittance to England of a proportion of salaries, incomes and savings by
civil, military and railway employees of British origin, as well as by professionals,
such as lawyers and doctors. These, together with the payment in sterling by the
government of India of the pensions and furlough allowances of British officials,
constituted a heavy burden on the resources of a very poor country. The excessive
sterling cost of Indian administration was attributed to British policies such as that
of excluding Indians from the higher ranks of the civil services.
Raja Ram Mohan Roy had suggested in as early as 1831 that government
expenditure could be greatly reduced by appointing Indians in place of Europeans
in most administrative and judicial posts. British colonial rulers showed even less
enthusiasm for such an approach than the East Indian Company had done. Efforts
in this direction were made by Lord Ripon, who was sympathetic to Indian
aspirations, but they were scuttled by the pressure of official opinion, which favoured
keeping the civil services white. Illustrative of the gulf between the British and the
Indian points of view was the controversy over lowering the maximum age limit for
recruitment to the civil service, which became a point of widespread debate in
India during the 1880s. Between 1853 and 1883, only twelve Indians had been
recruited. The gradual lowering of the maximum age limit for candidates, from
twenty-three to twenty-two, then to twenty-one and subsequently to nineteen,
had, it was felt, made competition increasingly difficult for Indians, who on average
graduated at a higher age than their British counterparts. It was said on the British
side that the main reason for the change was to encourage English candidates to
sit for the examination and go out to India when still fairly young but Indians, not
without reason, regarded it as a deliberate step to exclude them. Gopal observes
that there were few matters on which Indian opinion was more bitter or unanimous
Self-Instructional
Material 199
Indian Economic than on the reduction of the age limit, the feelings aroused being entirely
Thought I
disproportionate to the numbers affected.
The privileges of civil servants of British origin were also increased over
time. In 1893-94, they were granted exchange compensation to the tune of 15-20
NOTES
per cent so as to maintain the gold value of the remittances, a step which was
criticized by Gokhale as contributing to an increase in the drain. A number of
arguments were advanced by Indian economists in favour of recruiting Indians to
the civil services. One, of course, was that it would reduce the drain. Another was
that it would increase efficiency. After all, Adam Smith had taught that monopoly
breeds inefficiency. Why then should Britain be a monopoly supplier of
administrative service when Indians would foster learning and contribute to India’s
long-run development. As far as this particular item is concerned, the drain theory
does appear at this distance of time to have had a certain measure of justification.
Another item about which Indian opinion was much concerned was military
expenditure. Just as in the case of civil servants, the remittances of a proportion of
salaries, incomes and savings by British military personnel and the payment in
sterling by the Government of India of pensions and other allowances of British
army officers, constituted an item of drain, so did the cost of military stores supplied
to India and the various military charges paid in England by the Government of
India. All these items formed part of the so called Home Charges. In 1880, the
Indian tax payer supported 130,000 Indian and 66,000 British troops. Lord
Salisbury described India as ‘an English barrack in the Oriental seats from which
we may draw any number of troops without paying for them’.
One important reason why the army cost so much, was the rule, laid down in
1858 and strictly adhered to afterwards, that there should be one British to every
three Indian soldiers in India and that no Indian should hold a commission. Not only
the expenses of the Indian army itself but also those incurred on account of British
troops stationed in India had to be paid for from the Indian budget. Furthermore,
Indian troops were often used by the British in imperial wars for the British colonialists.
Frequently, either in the whole or a very large part of the expenses incurred in such
wars had to be paid for out of Indian revenues. Indian troops served in Persia during
1856–57, twice in China during 1857-60 and during the Boxer rebellion of 1900
where they shared in the siege of Peking, in the Abyssinian campaign of 1864, the
second Afghan war in 1878, the Egyptian expedition of 1882 and on many other
occasions elsewhere. As Lawrence observed in 1864, India was treated quite
differently from the colonies. ‘No one would think of asking any of the latter to pay
a portion of the expense of Afghanistan. No statesman would charge Canada or
Australia.’All this not only imposed a considerable burden on the Indian budget but
also involved payments to be made partly or wholly in sterling.
It was considerations of this kind that a number of Indian economists and
writers, notably G.K. Gokhale, were drawing attention to. Subsequent research
has borne out quite clearly that they had a point. Davis and Huttenback sum up:
Self-Instructional
200 Material
India was a poor country and it was being asked to subsidize imperial Indian Economic
defence out of all proportion to its position. Not only was it being Thought I
forced to bear a substantial portion of the costs that should have fallen
on other parts of the empire, but it was also being asked to shoulder a
portion of the British burden as well. India paid the direct costs of both NOTES
Indian and British troops in India, as well as some fraction of the cost
of Indian troops used in largely imperial adventures. The sub-continent,
thus, supported a military reserve for the entire British Empire.
The third item which Naoroji and some of his followers included in the drain
was remittances made in sterling of interest on loans for construction and
maintenance of public works, such as railways, irrigation works, etc. The case for
regarding this item as drain is, however, much less convincing. Naoroji himself
was aware of this and stated:
I must not be misunderstood; I consider these loans as one of those
things for which India is under special obligations to England. I do
not allude to this item in any spirit of complain … I only mean that the
interest, even supposing it to be all earned by the railways, though
forming part of the exports of India, is not part of the commerce of
India.
However, such a qualification was not required in the case of interest on
unproductive debts such as those required for military expenditure. The refusal to
accept interest payments as a genuine item of international commerce reflected
Naoroji’s ‘physiocratic’ view of the role of services. That payments for invisible
exports were just as legitimate as those for merchandise remained a foreign idea
to him. A similar difficulty prevented him from appreciating that payments for
transport services formed part of national income, in the same way as the value of
goods transported.
12.4.2 Criticisms
Let us now turn to criticisms of the drain theory, and start by considering the
British response which, not surprisingly, was hostile. Earlier views, such as those
of Sir John Shore, on which Naoroji had drawn attention when developing the
theory, were no longer looked on with favour. Instead, the drain theory was seen
as an attack on the foundations of British rule in India. Official spokesmen for the
government and academics rallied to defend the Raj.
The most cogent reply was given by Sir Theodore Morrison in Economic
Transition in India, which was published in 1911 and favourably reviewed by
Keynes in the same year in Economic Journal. Morrison did not, however, question
the validity of the concept of an economic drain. His definition of the drain as the
value of that part of India’s ‘exports in goods or money for which she receives no
material equivalent’ was not much different from Naoroji’s own definition. That
India received no ‘equivalent’ return for part of its exports was common ground
between Indian exponents of the drain theory and its British critics. Their difference
was on how large a part this really was.
Self-Instructional
Material 201
Indian Economic Drain theorists, according to Morrison, had greatly exaggerated the
Thought I
magnitude of the drain. In part, this was because when calculating the export
surplus, they had failed to allow for relevant deductions. For example, they failed
to take into account the fact that part of the export ‘surplus’ was balanced by
NOTES invisible imports such as shipping services, insurance charges and expenditure by
Indian students and travellers abroad. Neither, claimed Morrison, had they taken
imports of gold and silver into account.
Secondly, a part of the so-called drain represented interest on foreign capital.
The capital itself, argued Morrison, was productive. It was used to build railways
and irrigation works, tea plantations and jute mills. All these not only contributed
to national income but also made long-run economic growth possible. Rather than
complain about a drain, Indians should be grateful to British investors for making
good the deficiency in India’s domestic capital resources. The benefit to India was
all the greater because the British connection enabled it to borrow in the world’s
cheapest capital market. Borrowing in India, even if it were feasible, would have
been far more expensive. Indeed, the saving to India on account of cheapness of
its public dept was ‘not very far from being enough to wipe out the whole of the
political drain’.
As regards other items of the Home Charges, Morrison admitted that India
was treated differently from other colonies, but claimed that the amount involved
was not high. More important, India gained the benefits of good government:
peace and order, security against foreign aggression, and a modern, efficient
administration. India had thus got an administration ‘favourable to economic
evolution’ and cheaper than she could provide it herself.
Morrison’s critique of the drain theory is only ‘good in parts’. That Indian
statistical estimates of the magnitude of drain were usually biased upwards has
already been observed. On the other hand, Morrison’s own treatment is selective
and one-sided. Take for example his observation that Indian writers had forgotten
to take the import of bullion into account when calculating the export surplus. This
is not true of, say, Gokhale who, in his presidential address to the Indian National
Congress of 1905, when describing the ‘great and ruinous drain of wealth from
the country’, referred to ‘the net excess of exports over imports’ (including
treasure). Similarly, when drawing attention to the low rates of interest at which
loans were available in the British capital market, he fails to mention that G.V.
Joshi, a well-known exponent of drain theory, had made the same point. Joshi had
come out in favour of sterling rather than rupee loan being made to finance such
enterprises as railway construction, both because sterling loans were cheaper, and
because India’s capital resources being limited, diverting them from industrial
investment would be undesirable. Again, the case for Indianisation of the services,
which was central to the nationalist argument, is not taken up by Morrison at all.
Indian criticisms of the Drain Theory
Criticism of the drain theory was not confined to British writers. A number of
Self-Instructional
202 Material Indian nationalist writers, too, argued against one or other aspect of it. Bankim
Chandra Chatterjee, in a number of essays published in the influential Bengali Indian Economic
Thought I
Journal, Bangadarshan, examined the drain theory from the point of view of the
agricultural economy of Bengal. There was one element of the theory that he, like
others, did accept, namely that remittances from salaries earned in India by
government officers of European origin drained wealth away from the country. NOTES
However, the view that such drain led to increased poverty in India was, he held,
quite mistaken. Chatterjee anticipated Morrison in arguing both that the amount
involved was small and that it was more than compensated for by the good
administration resulting from British rule. Furthermore, argued Chatterjee, poverty,
especially in rural Bengal was not increasing. While Bengal was poor compared to
some European states, there was no reason to believe that Bengal was poorer
than she had been in the past. On the contrary, there was ample evidence to
suggest that wealth was increasing. Improved administration itself had helped to
bring this about. There was now less fear among people at large of robbery, burglary
and foreign attack or of government officials who were no longer free to rob
ordinary people of their savings by hook or by crook. ‘If someone wishes to save
he can be confident that he and his progeny would be able to enjoy the fruits of it.’
Higher levels of security and savings had encouraged an increase in population.
This, in turn, had led to an increase in the extent of cultivation.
Another reason for improved prosperity, according to Chatterjee, was an
increase in the volume of trade. Those who thought an increase in trade meant a
loss of wealth were simply confused. This applied equally to exports and imports.
Chatterjee went on to attack the argument of unequal exchange, which was an
element in some versions of ‘drain’ and indeed is still with us. For Chatterjee, ‘if
we spend `6 in buying British cloth, we are getting a commodity in exchange for it.
If we spend more than the fair price for it, we lose. But if we cannot buy that cloth
for less than `6 from elsewhere the price is not unfair. Hence, the country does not
lose. Again, domestic production is not necessarily more advantageous than imports.
If we had bought `6 worth of cloth from a domestic weaver, the money would, it
is true, have remained in the country rather than being remitted abroad.’ This
suggests that Chatterjee is not particularly relevant, for one must consider the
price per unit at which the cloth is sold. ‘If the domestic weaver could have sold
the cloth at the same price (`6), we would have bought from him, not from a
foreigner. But in that case, the foreigner would not have tried to sell it either.
Consumers gain by buying from the cheaper imported source.’
What about the loss to the weaver? Because imported cloth was cheaper
and Indian consumers bought foreign cloth in preference to the domestic product,
weavers lost their trade. But the answer, suggests Chatterjee, was for them to
take up other trades. ‘Some lines of production faced reduced demand but for
others was increased demand. There was also increasing demand for Indian goods
in British markets. The problem, if any, was the reluctance of our countrymen to
change their traditional occupation, not the increase of trade. Neither by import
nor by export were foreign traders taking our money away. On the contrary, our
wealth was increasing because of foreign trade.’ Self-Instructional
Material 203
Indian Economic A much more influential dissident from the theory was Ranade, who expressed
Thought I
his views on the ‘drain’ in his inaugural address at the first Industrial Conference at
Poona in 1890. He did agree that expenses for the purposes of administration,
defence and payment of pensions to British officers stationed in India could ‘so far
NOTES as they are not necessary for the defence and good government of India’ represent
an element of drain. As against this, however, we have to take into account ‘the
fact that we are enabled by reason of this British connection to levy an equivalent
tribute from China by our opium monopoly’. Ranade regarded the drain question
as essentially a political one. He exhorted his readers not ‘to divert and waste
your energies in the fruitless discussion in the question of tribute, which had better
be left to our politicians’. There were many and more serious impediments to
India’s industrial progress: the want of proper organization, leadership, banking
systems and a trained labour-force.
This sub-section looks back at the debate on the drain theory and considers its
long-run relevance. The sub-section consists of three brief remarks. The first of
these is methodological and concerns the economics analysis of unilateral, i.e.,
non-commercial, capital payment made by one country to another. In modern
economic literature, such payments have been discussed under the rubric ‘the
transfer problem’. A well-known instance is Keynes’ analysis of the economic
consequences of the payment by Germany of war reparations imposed by the
Treaty of Versailles following the end of the First World War. This analysis pays
considerable attention to the link between such capital transfer and the terms of
trade. Neither Naoroji nor Dutt analyzed the problem from this point of view.
However, some other Indian writers on the drain do show an awareness of the
relevance of its trade theoretic aspect. This they derived from their reading of J.S.
Mill who had always been a favourite among Indian economists and who had
brought out the link between reciprocal demand and commodity terms of trade.
Thus, Iyer refers to the drain as arising not only out of a direct unrequited outlay
but also because ‘it forces India to exchange her produce on less advantageous
terms, as pointed out by J. S. Mill in a well-known passage’. The passage in
question reads as follows: ‘A country which makes regular (non-commercial)
payments to foreign countries, besides losing what it pays, loses also something
more, by the less advantageous terms on which it is forced to exchange its production
for foreign commodities’. Had Iyer, or others of the school, developed the point,
they could perhaps have made a contribution to trade theory. As it is, it remains
peripheral to their analysis of drain.
The second point concerns the magnitude of the drain. As we have seen,
Naoroji saw ‘drain’ as a continuing transfer of resources from India to England
without India getting any equivalent economic return. Accordingly, the excess of
exports over imports, ‘unrequited exports’ as he called it, appeared to him to be
an appropriate way of measuring the drain. In the writings of Naoroji and his
Self-Instructional followers, as Bipin Chandra has observed, this excess was ‘simultaneously referred
204 Material
to as the proof of the existence of the drain, the form of its remittance and the Indian Economic
Thought I
measure of its extent’. Using this general approach, estimates of the drain were
computed for various periods by Naoroji himself and others. They were expressed
either in terms of rupees or sterling, and also a proportion of Indian revenue, either
gross or net. Despite using a common methodology, the estimates varied widely NOTES
among themselves. A widely publicized figure was due to R.C. Dutt, who found
that on average ‘one-fourth of the revenues derived in India was annually remitted
to England’. Thus, during the last decade of Queen Victoria’s reign, a sum of £159
million out of total revenue of £647 million was remitted. In recent years, a number
of historians have tried to re-estimate the drain. In their view, the export surplus
measure, even with adjustments, leads to over-estimates of drain. Instead, they
define the drain as that part of Home Charges, which could be regarded as
unnecessary or unproductive. They also tend to express the drain as a proportion
of national income rather than of public revenue. The resulting estimates are low.
According to Mukherjee (1972: 205), during 1870-1900, the drain was only
between .04 and .07 per cent of India’s national income. Charlesworth (1982)
points out that even if all Home Charges are regarded as unproductive, the drain
would still ‘barely exceed 0.5 percent of national income’. These findings have led
to a certain downgrading of the drain theory in recent historical writing.
Military expenditure was the greatest single burden on Indian revenues,
running at around 40 per cent of the Government of India’s gross expenditure; yet
the primary functions of the Indian army was to keep India secure so that this
revenue could continue to be collected. As in the case of expenditure on famine
policy, there was no attempt, either conscious or implicit, towards developing a
cost-benefit approach.
In retrospect, perhaps the most important contribution of the drain theory is
the insight that it offers about the relationship between economic development and
the balance of payments. During the last few decades, developing countries in
their initial phase of accelerated growth have almost invariably experienced
difficulties with their balance of payments. Despite lacking this experience to guide
them, exponents of the drain theory could still sense that there was a certain
incongruity between India’s economic backwardness and her persistently
favourable balance of trade. In late 19th century, India was a very poor country
with a near-zero rate of economic growth. The export surpluses that continued to
accrue were not a sign of impending take-off but rather of an investment pattern
that retarded growth. The drain theory, at least indirectly, shows some inking of
what was going on; the complacent official view shows hardly any. The basic
weakness of the theory was pointed out by Ranade. While there is little double
that the financial arrangements imposed on India by British rule involved an element
of drain, it is unlikely that this was either the root cause of poverty or the binding
constraint on economic growth in India. Pre-occupation with ‘drain’ had the effect
of narrowing the focus of Indian economic thought and diverting attention from the
more pressing concerns to which Ranade wished to draw attention.
Self-Instructional
Material 205
Indian Economic
Thought I
Check Your Progress
6. When was drain theory first developed?
NOTES 7. In which journal Bankim Chandra Chatterjee examined the drain theory
from the point of view of the agricultural economy of Bengal?
12.5 MAHADEV GOVIND RANADE
All of Ranade’s economic writings address a single problem: poverty. He did not
make any attempt to measure the extent of poverty, but stated that it was widespread
and endemic, and regarded it as self-evident. In the inaugural address of the First
Industrial Conference in Poona in 1890, Ranade stated:
We need only to walk throughout our streets, and study the most
superficial aspects of our economic situation, and the fact forces
itself upon us that we are a people of little resources. Many millions
among us scarcely earn a couple of annas a day. Many millions more
are always underfed, and live on the borderland of famine and slow
death, into which the failure of a single monsoon precipitates them.
Both in assuming the existence of mass poverty and in emphasizing the
close link between poverty and famine, Ranade represented the mainstream view
of Indian economic writing. However, unlike others, such a Naoroji or Dutt, Ranade
regarded poverty as a legacy from the pre-British era. It is, he suggests, ‘not of
yesterday, and is not the result solely of foreign conquest and competition. It is an
old, old inheritance. Indeed, the heightened awareness of poverty was itself seen
by Ranade as an aspect of the progress that had come about under British rule: ‘If
we feel it more keenly now, we feel it because we are roused from the sleep of
ages, and our eyes have learnt to see, and our ears have learnt to hear’. Here, as
often in Ranade’s writing, we bear an individual and distinctive note.
The question of whether poverty in the 19th century was more widespread
or intense than that which had existed in earlier times, remained for Ranade an
open question but not an interesting one. It concerned specialist historians rather
than economics. In the inaugural address of the First Industrial Conference in
Poona in 1890, Ranade stated: ‘The question of our comparative improvement or
decline under foreign rule is similarly a question of antiquarian history. The practical
question for us all to lay to heart is not the relative, but the absolute poverty and
the present helplessness of the country generally.’
Looking back in anger or despair would not help. The problem was how
we could remedy that helplessness, and one had to begin by a diagnosis, by looking
at the causes of poverty. The most important cause, according to Ranade, was
overdependence of the Indian economy on agriculture. Again, Ranade made no
extravagant claims for the past nor did he attempt to ascribe all economic ills to the
British conquest. The traditional Indian economy had not represented a state of
Self-Instructional
206 Material
balanced growth either. In the inaugural address of the Industrial Conference in Indian Economic
Thought I
Poona in 1890 Ranade stated:
The coordination of industries, which regulates the due proportions
of men who plough the soil and raise raw produce, with those who
manufacture this produce and others still, who exchange and distribute NOTES
it, and the interplay of whose three-fold activity makes a nation thrive,
was never a very strong factor of our collective social polity.
Like nearly all pre-modern societies, India too had been predominantly
agricultural. However, the position had worsened. In the same conference, he
continued: ‘There can be no doubt that, whatever may have been our improvement
in other respects, we have in recent times become more than ever dependent
upon the single resource of agriculture, precarious and contingent as that resource
is upon influences we cannot control or count upon with certainty.’
This had occurred as a result of increasing economic contact with the outside
world. Freedom of exchange and competition from the products of modern
manufacturing industries had led to a decline of output and employment in indigenous
craft industries. Because the machine-made, imported goods were cheaper than
the corresponding products of domestic handicraft, the decline itself was inevitable.
Even if the Government of India had not helped the process in any way, British
merchants and manufacturers would eventually have asserted their predominance
in the Indian market. However, the government’s efforts in support of the interests
of British products helped to make the process of disintegration of domestic industry
far quicker than need have been the case, and prevented the transition from occurring
in a more orderly and gradual fashion. An example of such customs duties on
cotton, silk and woollen manufacturers and on wrought metals, which threw out of
employment a very large number of skilled artisans. They were compelled to
compete in the labour-market with poorlypaid agricultural workers. The outline of
the process was an increasing dependence on agriculture.
Every class of artisans, the spinners, weavers and dyers, the oilmen, the
papermakers, the silk and sugar and metal workers, etc., who are unable to bear
against western competition, resort to the land, leave the towns and go into the
country and are lost in the mass of helpless people who are unable to bear up against
scarcity and famine. But the indirect and long-run effects of the process could be
even more damaging. The progress of ‘ruralisation’ in modern India means its
rustication, i.e., a loss of power, intelligence and self-dependence, and is distinctly a
retrograde move. There were a few developments, for example, the growth of
seaports, and military and railway stations, which had the opposite effect but they
were too weak to counterbalance the economic forces tending towards ‘ruralisation’.
Industrial development was needed to halt and reverse the process.
In much of his writing, Ranade appeals to a version of what has come to be
known in the recent literature of development economics as the balanced growth
argument. Taking a cue from the German school of historical economics led by
Friedrich List, he defines economic development as the full and all-round
Self-Instructional
Material 207
Indian Economic development of the productive powers of society. This requires a proper
Thought I
coordination between different sectors, which alone can assure adequate and
sustainable demand for the output of each sector. In the terminology used by List,
coordination is required in particular between ‘agarstaat’ and ‘industriestaat’,
NOTES and more generally between rural and urban employment. Given the initial conditions
of the Indian economy, a substantial increase in industrial employment and output
is therefore a necessary condition for sustained economic growth to occur.
Fig 12.3 Mahadev Govind Ranade
Source: http://en.wikipedia.org/wiki/File:Mahadev_Govind_Ranade.jpg
Rather than trying to correct the present imbalance, however, official
economic policy in India often tended to make it worse. This was one of Ranade’s
most frequent complaints against the government’s economic policy, especially in
his earlier writings. India was to devote all its energies to raise the raw exports,
and canals, railroads and improved communications were to be pushed on at any
cost to facilitate the export of raw articles and the import of English manufacturers.
India’s own industrial needs were of comparatively no consequence. And he makes
the point even more strongly in the following passage: This dependency has come
to be regarded as a plantation, growing raw produce to be shipped by British
agents in British ships, to be worked into fabrics by British skill and capital, and to
be re-exported to the Dependency by British merchants to their corresponding
British firms in India and elsewhere.
A second argument which is related to, though logically distinct from, the
first is based on the concept of ‘stages of growth’. Again, Ranade borrows from
Prof List who describes a sequence of historical stages through which an economy
typically must pass: hunting, agriculture, agriculture plus manufacture plus
commerce. Ranade adapted the scheme to Indian conditions by distinguishing
between an existing stage of agriculture plus handicraft and one of agriculture plus
manufacture plus commerce, which he held out as the next stage to which India
should aspire to proceed. Taxonomy of this kind can at best be no more than
Self-Instructional
suggestive but it provided Ranade with a useful handle to press for industrialization.
208 Material
It explains too why he tended to think of industrial growth invariably in an open Indian Economic
Thought I
economy context.
Thirdly, manufacturing industry allowed more scope than most other sectors
for what Ranade called ‘art manipulation’; in other words, the application of modern
NOTES
technology to the production process. This helps explain why a society’s aggregate
output per head is found to be directly related to the proportion of its labour force
engaged in manufacturing, a point duly noted by Richard Jones, one of Ranade’s
favourites among the English economists. A closely related argument rests on the
concept of development as learning. Manufacturing activity was a more effective
source of learning than traditional agricultural pursuits and, according to Ranade,
perhaps more effective than formal education itself. When the country was (thus)
enabled to obtain a new start, and factories and mills on a small or large scale
were set up all over the land, the present paralysis would give way to a play of
energies which would far more effectively than schools and colleges give a new
birth to the activities of the nation.
It was Ranade’s understanding of economic development as a historical
process that inspired his vision of India’s industrialization. There can be no doubt
that the permanent salvation of the country depends upon the growth of Indian
manufacturers and commerce and that all other remedies can only be temporary
palliatives. The process of economic development consists generally in a switch
away from primary to secondary production and more generally from commodities
where value added in production was low to those where it was significantly high.
It also involved active participation in the world economy. Other economists of his
time, or ours, who have proposed industrialization as a means of achieving economic
growth in developing countries, have often concentrated their attention on the
domestic market and favoured substitution as the basic underlying strategy.
Some have even looked on autarky as a necessary condition for developing
countries to achieve autonomous development. Ranade on the other hand had an
open economy framework in mind and looked to export-oriented growth. In the
Industrial Conference in Poona in 1893, Ranade stated:
What we have to do … is to learn by organized co-operation to compete
with the foreigner, and take in as much raw produce from abroad as
we need, and work it up here, and to send in place of our exports of
raw produce, the same quantities in less bulky but more valuable
forms, after they have undergone the operation of art manipulation,
and afforded occupation to our industrial classes.
While much of the raw materials would be domestically supplied, the import
of raw materials from abroad to be used in the production of manufactured goods
in India was also envisaged. In the early stages of industrialization this would help
to ensure that the quality of exported manufactures was maintained at a high level.
We have to improve our raw materials, or import them when our soil is unsuited to
their production.
Self-Instructional
Material 209
Indian Economic The same reasoning led Ranade to welcome imports of skill and capital
Thought I
equipment from abroad. We should, he said ‘Import freely foreign skill and
machinery, till we learn our lessons properly and need no help. This last statement
incurred the wrath of nationalists such as Tilak, whose journal Kesari published
NOTES an article on the evils of foreign capital under the title ‘Mahadev in singing the
praise of foreign capital is a traitor to his country.’ Ranade was not traitor. He was
simply a development economist who saw clearly that difficulties in achieving
industrial growth in such a country as India could arise simply from the long practice
of agriculture itself. ‘We have rusticated too long; we have now to turn our apt
hands to new work, and bend our muscles to sturdier and honest labour. In that
task both foreign trade and foreign capital could be helpful.
The task of industrializing India would not be easy. The difficulties in the way,
political and social as well as economic, were formidable. Among the economic
obstacles to industrialization it was a deficiency of investment finance which Ranade
emphasized the most. ‘Just as the land in India thirsts for water, so the industry of the
country is parched up for want of Capital. Capital desirous of investment and content
with low interest is a national want. The deficiency in supply of investment funds was
partly due to low savings. A considerable proportion of gross savings was proportion
was used to hoard precious metals. In an address to the Indian Industrial Conference
in 1890, Ranade presented estimates of the magnitude of hoarding.
Every year, we import in treasure bullion, gold and silver of the value
of 12 crore worth, i.e. 3 crore of gold and 9 crore of silver. The
whole of the gold disappears, and is absorbed by the soil and of the
silver 7 crore are sent by us to the Mint every year, and the rest is
absorbed like gold. Since 1834, this absorbing process has secured
the virtual destruction of nearly 450 crore of wealth which might
have been turned to better account.
The saving of 450 crore in fifty years by twenty-five crore of people was not,
Ranade observed, a sign of great prosperity but we have made our position worse
by buying it or using it unproductively. The shortage of aggregate savings was
aggravated by deficiencies in institutional arrangements for industrial finance. The
amount of savings available was almost entirely in the hands of men in a few large
‘Presidency’ towns who had few connections with the rest of the country. The habit
of forming joint stock organization was not developed and available savings were
invested in government stocks or in the Presidency, exchange and post office savings
banks, rather than industry. In a way, therefore, India had more capital than it could
handle. There is capital ready to hand awaiting secure investment. There is the broad
ready expanse of industry, which is thirsting for capital and offering the most secure
investment for its fruitful employment. What is required is the necessary skill and
patience which will adjust the capacity of the one to the wants of the other, and make
both work in a spirit of harmony and cooperation.
Apart from inappropriate government policies and deficiencies of industrial
finance, Ranade pointed to the lack of an entrepreneurial tradition as a constraint on
Self-Instructional development. He believed that contemporary Indians by and large had insufficient
210 Material
enterprise and ambition and tended, for religious reasons, to decry the pursuit of Indian Economic
Thought I
wealth as an aim of life. In these circumstances, government had an important role to
play in encouraging the process of industrialization. According to the doctrine of
laisses-faire, the government should not intervene in the economy. The only exceptions
permitted were those required for the purpose of carrying out the basic duties of NOTES
government; protecting citizens against external attack, and preserving law and order.
Intervention to enforce contracts was right and proper, not so intervention in aid of
private industry. Ranade did not reject that principle outright. In certain circumstances,
he thought, it might actually help industry to grow much more than active intervention
would have done. This was not, however, the case in India. Because of historical
circumstances, much of Indian industry was in a state of decline or even collapse. It
was essential, stated Ranade, for government to take steps that could help private
domestic industrial enterprise to grow.
In his inaugural address at the Industrial Conference at Poona in 1890
Ranade set out what these steps should be. In the address, as in other passages
dealing with the role of the state, Ranade’s was preoccupied with the problem of
credit. According to Ranade, it is the state’s role in facilitating the flow of financial
resources into industry that is most emphasized. This is to be done in a number of
ways. As Ranade saw it, to a large extent the problem was one of encouraging
existing investible funds to flow in the appropriate direction. The Post Office and
Savings Banks deposits, for example, were already there. ‘All the government has
to do’s is to organize committees of Indian capitalists at the district or city level
and to empower them to receive deposits at fixed rates and lend them at slightly
higher rates on the security of land or house property. The excess would provide
for a gradual amortization of the debt within a definite time, together with insurance
charges and working expenses.
Another useful device would be for government to guarantee a certain
minimum level of interest on loans advanced for investment in industry. These
could come from either domestic or foreign investors. In the latter case, the
aggregate supply of investment funds for industry would increase. Ranade was
fond of pointing out that this did not represent a new departure for the government
which had been promoting foreign investment in railways under a guarantee system,
to be described later in this unit.
In most cases direct expenditure by the state would not be necessary. The
state need not expend its funds. The funds will be forthcoming to any amount if it
only promises to organize the Agency and set it at work. In a few instances, where
domestic production enjoyed sufficient natural advantage, Ranade approved of
more direct forms of encouragement by government which, however, still fell short
of direct state control. This could take the form of pioneering new industries talking
the ‘Java system’ as a model: ‘The Dutch Netherlands Government have shown
the way in Java, and with less selfish motives the same method might well be tired
in regard at least, to the industries allied with agriculture, sugar-refining, oil-pressing,
tobacco-curing, silk-rearing, etc.’
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Indian Economic The system was one of encouraging the planting of remunerative crops and
Thought I
manufacturing them for the European market, by private agency, which was also
responsible for bearing risks. However, the government, apart from advancing loans
at a low interest, also helped in the choice of location and in selecting the form of
NOTES investment. Something on these lines could also be tried in other selected fields, but
‘not at State expense departmentally. In yet other cases, the government could help
domestic industry simply by extending its own custom to the products of domestic
industry of a satisfactory standard of quality, instead of confining its purchase of
required stores only to foreign sources, as was standard practice at the time.
In sum, by loan advance, guarantees, guidance and custom the government
under the supervision of official experts would help and guide private efforts
especially in the development of those industries in which India possessed special
advantages. Among these, apart from the agricultural industries already mentioned,
were iron, coal, paper, glass and beer (Essays on Indian Economics). Such help
was not intended to be extended permanently but only in the transitional period till
private enterprise could support itself.
Ranade was one of the few economists in modern India to recommend the
state’s assistance with labour migration as a means of economics development.
Migration, he thought, would help relieve the pressure of population on the land.
During the last two decades of the 19th century, when most of Ranade’s economic
essays were written, while population in India grew fairly slowly mortality rates
were high and the expectancy of life at birth declined. Ranade believed that given
the dependence on the land for livelihood even a low rate of population growth
could have very adverse consequences. The growth of population does not
represent to the same extent growth in material comforts, and this has led to the
absorption of waste lands till, in some parts of the country, the last margin has
been reached and millions die or starve when a single harvest fails.
While the growth of manufacturing industries would help diversity the
occupational structure and reduce the degree of dependence on the agriculture,
this would take time. In the shorter run Ranade suggested policies to encourage
internal and foreign migration of labour. Both had in fact been occurring for a long
time past. Internally, people migrated from poor and thickly populated agricultural
tracts to more sparsely populated areas. This helped to improve the regional
distribution of population from an economic point of view. However, internal
migration could not be compared ‘in its immediate and remote bearings on national
prosperity’ with emigration abroad. Again, quite a large number of Indian did
immigrate to the British, French, and Dutch overseas colonies. This, thought Ranade,
augured well for the future of India and should be encouraged by every means,
both by the government of India and by private organization such as the Western
India Association. Here Ranade referred to the recent success of Wakefield in his
schemes of colonization by British settlers in Australia and New Zealand and also
to schemes of colonization by Chanakya and practised by ancient rulers in India.
The latter had not only encouraged entire village communities to move en masse
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but also helped them financially to settle in their new homes. Guilds of traders and
artisans from distant places had, for example, been induced to settle in new towns Indian Economic
Thought I
by free gifts of land and houses. Such schemes had operated within India but
something along these lines could also be done. Ranade believed, to encourage
Indians to emigrate overseas. Among the countries he mentioned as having a high
demand for labour and hence offering good prospects for Indian emigration are NOTES
Mauritius, Natal, Trinidad, Jamaica, British Guiana, Burma and Australia.
Apart from its direct effect in reducing the pressure of population on the
land, emigration abroad would also bring some indirect benefits to the Indian
economy. One such would be to increase the level of aspirations among the Indian
population at large. Emigration overseas, or even the prospect of it, could help
break up ‘the old thraldom of prejudice and easy satisfaction and patient resignation’
and give rise to ‘new aspirations and hopes’ (Essays On Indian Economics).
Another indirect effect would be to stimulate the demand for Indian goods abroad.
Because of the influence of cultural patterns on consumption Indian settled abroad
would provide a good market, among others, to Bombay mill-owners for cloth
and to Indian shippers for transportation (especially when travelling to an African
destination). For this purpose it was desirable that emigrants should come not
simply from poor and unskilled classes but rather than from relatively prosperous
middle-class and professional people. Doctors, lawyers, artisans, even priests of
different sects, these were the kind of people Ranade had in mind. As he saw it,
such people would also find it relatively easy to find profitable employment
overseas, especially in African countries.
In the list of measures which Ranade wanted government to adopt in order to
help the growth of domestic industry, there is a notable omission: protective tariffs.
The omission is a little surprising, since France, Germany and the USA had used
tariffs to help their manufacturing industries to develop in the face of foreign competition
and these were the countries Ranade usually held up as models for India to follow.
One possible explanation could be that Ranade had been converted by
classical political economy to a faith in free trade. And indeed there is evidence in
his writing that he had considerable respect for free trade as a general principle.
However, the free trade argument in his view did not contradict the case for
protection being extended to infant industries. Adam Smith, he writes, was really
arguing for fair trade rather than free trade while J.S. Mill accepted protection for
new ‘infant’ industries as being within the framework of the classical political
economy tradition. Ranade even quotes Mill as approving of exceptions to free
trade ‘where time is required to ascertain whether new industries are or are not
adapted to the natural resources of new countries. India, suggests Ranade, may
fairly demand such a ‘breathing time.’
Indeed, the measures described earlier, which Ranade wished government
to undertake by way of encouraging industrial growth, were all applications of this
argument. An infant industry argument on the same lines for a protective tariff on,
say, iron or sugar would therefore have been logically quite consistent with Ranade’s
position on matters of policy. His silence may rather have been due simply to a Self-Instructional
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Indian Economic belief that in the circumstances prevailing at the time a proposal for protective
Thought I
tariff for Indian industry had little chance of success. Whatever the exceptions
admitted by Mill, economic opinion in British ruling circles was almost unanimous
in its adherence to free trade. Because of this, and because India did not have a
NOTES government of her own, approval for tariffs or subsidies for Indian industry was
hardly feasible. In the Indian Industrial Conference in Poona in 1890 he stated:
It is not open to us to adopt certain plans of operation which, however
much they might be condemned on abstract grounds, have been
followed with practical success in many of the most enlightened
Countries of Europe and America. We cannot, as with the Government
of these countries, rely upon Differential Tariffs to protect Home
Industries during their experimental trial. We cannot expect the
Government here to do what France or Germany does for their Shipping
Trade, and their Sugar Industry, and ask Government Bounties and
subsidies to be paid out of general Taxes.
Ranade would indeed have come out in favour of protective tariffs ‘if he
had not realised that to ask for a tariff in 1890 would be almost equivalent to
asking the British to leave India.’ Ranade, it is true, frequently proposed economic
policies which were against the official line, but as a realist he liked to have a
‘sporting chance’. It was ‘useless to divert our energies in fruitless discussion and
seek victory over Free Trade.
While government action was necessary to give the process of industrial
growth in India an initial push, such action still remained peripheral to the process
itself. No amount of government aid to industry could foster growth unless the
people learnt to help themselves. ‘After all Government help can do but little. We
have to resolve to work earnestly and perseveringly with a purpose and organisation
which will conquer all obstacles.’And similarly, ‘State help is after all a subordinate
factor in the problem. Our own exertion and our own resolution must cover the
difficulties, which are chiefly of our own creation.’
Thus, for Ranade, organised private effort always remained the basic means
to industrial growth. In the circumstances in which India was placed at the time,
state help of certain kinds was essential if domestic private industry was to thrive,
but such help could not substitute for private effort, as to running an industrial
enterprise as just another government department. Ranade did not regard it as an
inefficient solution; he did not regard it as a solution at all: industries simply could
not be run like that.
To sum up, Ranade was neither a radical nor an enthusiast: and unlike some
latter-day development economists he did not put his trust in any one magic solution
such as the socialist path, laissez-faire, technology transfer, big push, or foreign
aid. He had a clear-headed understanding of the difficulties hindering the industrial
development of India. As he saw it they were due in part to the rigid and doctrinaire
attitudes of a foreign government which lacked any real commitment towards
India’s economic advance, but they were also the legacy of a stagnant past.
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In a country with an ancient civilisation based on millennia of agriculture the Indian Economic
Thought I
diversity and change of occupation that industrialisation would mean was a very
arduous undertaking. It presupposes a change of habits, it postulates the previous
growth of culture and a spirit of enterprise, an alertness of mind, an elasticity of
temper, a readiness to meet and conquer opposition, a facility of organisation, NOTES
social ambition and aspiration, a mobile and restless condition of Capital and Labour
all which qualities are the slow growth of centuries of freedom and progress.
Ranade’s historical approach to the study of economic growth precluded
his ever supposing that such things could be acquired overnight. He was saying
that they could eventually be acquired and that it was time to start. While Ranade’s
writing concentrates on the difficulties in the way, he had not doubt about long-run
success provided that certain necessary steps were taken. This optimism was
inspired by a conviction that the natural advantages which India enjoyed were no
less remarkable than the difficulties she faced. ‘Natural aptitudes, undeveloped
but unlimited resources, peace and order, the whole world open to us, our
marvellous situation as the emporium of Asia, these priceless advantages will secure,
if we endeavour to deserve it by striving for it.
Towards the end of his life, Ranade came to believe that even in the shorter
run, the prospects for industrialisation were reasonably bright. Here he parted
company with fellow economists such as Dutt or Naoroji who took a more pessimistic
view. Writing around the turn of the century, Ranade observed that at least the tendency
towards increasing dependence on agricultural pursuits appeared to be over. During
the ‘last twenty years there has been a clearly distinguishable departure from the, till
then, unimpeded process of ruralising a vast continent. It appeared to him that a
turning of the tide in the direction of industrial progress had already begun. At the
time, Ranade did not have a great deal of evidence to support this judgement but he
could see some hopeful signs: jute and paper mills in Bengal, cotton mills in Bombay,
Nagpur and Ahmedabad and ‘pioneer attempts’ at developing an iron industry in
various parts of the country. Not only were natural resources in abundant supply,
demand was increasing every day ‘in volume and urgency’. Dr Watts’ Report
provided technical grounds for being hopeful about the availability of raw materials
for India’s industrial growth. Ranade’s natural optimism supplied the rest. The real
danger, as he saw it, lay in a failure of nerve, in a tendency ‘to turn back from our
present opportunities to a past which cannot be recalled. Ranade, especially in his
later writings, often warned his countrymen against this danger.
Ranade associated the predominance of agriculture with stagnation. To his mind
such predominance spelt ‘rustication’, a loss of power, intelligence and self-
dependence. The way to economic growth lay in an all-round and balanced
development of productive powers. For an underdeveloped economy such as India,
this implied the growth of industry and trade, especially of manufacturing industry
and foreign trade.Agricultural growth remained extremely important not only because
Self-Instructional
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Indian Economic an overwhelming proportion of the population derived their livelihood from it, but
Thought I
also because many of the industries in which India had a natural advantage were
based on agriculture. The future, however, lay in industrialization. It is in this perspective
that Ranade’s writings on agrarian policy can best be understood.
NOTES
Traditionally, questions of agrarian policy in India have been seen as closely
related to the appropriate method of assessing land-revenue. Ranade wrote a number
of papers on this topic and proposed certain far-reaching reforms to the existing
system. It is on his proposals for reform that our discussion in this section will
concentrate. Here, as on issues of industrialisation, his emphasis was on how sustained
increases in production could best be achieved. The existing system for the assessment
of land revenues in India was, in his view, quite inappropriate for this purpose, for it
had the effect of discouraging productive investment on the land.
Development of agricultural on capitalist lines alone could unleash the
productive powers of land. That was a long run process but legislation on land
revenue could help in initiating it. For this purpose, he stated, a permanent ryotwari
settlement fixed in grain to be commuted into money values every twenty or thirty
years can alone furnish a solution of the agricultural problem. Ranade proposed
that the revenue on land should be fixed permanently as a proportion of the gross
staple produce, the proportion being based on the principle of dividing the net
profits in kind half and half between the government and the private holder. Since
the government required cash rather than grain for its own transactions, these
‘kind’ payments would be commuted into money values in accordance with the
prevailing trend in prices, some allowance being made for increased costs of
production. All that the government would have to do was to maintain accurate
statistics of changes in prices. Ranade claimed three substantial advantages for his
proposed scheme. In the first instance, it would reduce friction between the sowcar
(moneylender) and the ryot (peasant) and create incentives for all concerned to
undertake productive investment in land.
Secondly, under the permanent settlement, the land would pass into the
hands of those fit to put it to right and proper use. The existing policy was hopelessly
struggling ‘to keep a poverty-stricken peasantry in possession of the soil and divorce
the natural union of capital and land. When this policy yielded place to the new
dispensation, the indifferent and lazy ryot would make way for better people who
would take his place to the advantage of the general interest. In course of time the
prudent and thrifty classes would succeed to the ownership of land and a class of
landlords would spring up all over the country, in whose interest it would be to
make the most of the resources of the soil and of the great public works constructed
by the government. Nor would small peasant farming vanish altogether, creating a
horrendous problem of landlessness. ‘A complete divorce from the land of those
who cultivate it is a national evil and no less an evil is it to find one dead level of
small farmers all over the land’. Both evils could be avoided by creating a system
with a relatively small number of large landed estates on the Prussian model, together
with a mass of productive peasant farmers.
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Thirdly, under the new order of things the peasants would have no reason to Indian Economic
Thought I
complain, as they had under existing circumstances, about the burden of the land
tax when prices were low, for if prices fell, the assessment in money would fall
also and thus not press very hard on the ryots.
NOTES
Ranade examines two objections that might be raised against his proposal.
The first is the possibility of a scarcity of revenue by virtue of loss of ‘unearned
increment’. He rejects this objection because if, on account of general prosperity,
there was a rise in prices, the money commutation of the grain assessment would
also rise in the same proportion, thus compensating the revenue for increased demand
of expenditure. The government would, moreover, be ‘free to levy special rates for
facilities or irrigation actually supplied by it at public expense.’ What is more, under
the present system there was little incentive for agricultural improvement and hence
little scope for increase in revenue. With the extension of the permanent settlement,
the increment, earned or unearned, would be so great that the direct and indirect
taxes would yield a sure and certain increased income from all sources, which would
make up more than the deficiency arising from the loss of this unearned increment.
The other objection is that the Indian peasant is so thriftless, unenterprising
and ignorant that no government measures could ever better his condition. Ranade’s
answer was based on ‘historical’ reasoning. That Ranade in general preferred a
historical-inductive to a logical deductive approach to economics is brought out
elsewhere in this Unit. The limitations of the latter approach, he thought, were
particularly important when dealing with problems that involved dynamic change.
A study of historical experience could be more relevant here. Ranade had studied
several European societies for the purpose of gaining insight into the process of
economic development. In the early 1880s he frequently cited England. France
and Germany as examples of progress, and also used these examples to bring out
the economic virtues of an independent peasantry. These virtues–thrift, exertion,
technical innovation–could however come into play only after impediment arising
from the prevailing institutional structure had been removed. To the charge that the
Indian peasant was lacking in the virtues mentioned. Ranade’s reply was that the
same had been true elsewhere. The French peasant, for example was not always
the abstemious and prudent citizen that he now is; there was a time when Arthur
Young mourned over the condition of the Agricultural classes of France. The magic
of property and of free institutions has worked all this wonderful change.
The great principle underlying all reforms was ‘to remove whatever had
hitherto hindered the individual from obtaining that degree of well-being which he
was capable of reaching by exertions, according to the best of his ability. If the
principle was applied to India the same result would follow. Two other aspects of
Ranade’s approach to agrarian policy merit attention. One is related to the question
whether land revenue was a rent or tax, a hardy perennial in Indian economic
thought. British officialdom was inclined to the view that in India the state was, and
had always been, the ‘universal landlord’ and hence that its revenue from land was
in the nature of a rent paid by the tenant.
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Material 217
Indian Economic Ranade held that this view was simply wrong and consistently argued that
Thought I
land-revenue was a tax. The state had no proprietary rights in either cultivated or
waste lands. Its interest was confined to a claim for a share of the produce, which
was not of the nature of a monopoly of differential rent. This view, states Ranade,
NOTES had the support of contemporary opinion such as that of the Court of Directors,
the Secretary of State and judicial decisions without number. He could have cited
too the authority of J.S. Mill, who, in a Return on Indian Tenures to the House of
Commons in 1859, had stated that land throughout India was generally regarded
as private property, subject to the payment of revenue. This view was also,
according to Ranade, in accordance with the judgement of ancient lawgivers in
India. Some British writers, like James Mill, had indeed accepted the contrary
view, and regarded the state as an all-embracing landlord. This Ranade attributed
to their ‘utilitarian aggressiveness’, which as he saw it, was not unrelated to the
despotic element inherent in imperial regimes. Such writers had only too readily
accepted the claims of Muslim emperors that the state owned the land, leaving
tenants only temporary and tenuous rights to their holdings. The British should give
up the authoritarian practice of the Muslim rulers and should go back to the more
moderate claims of the government characteristic of the best in Hindu tradition. In
his book, Essays on Indian Economics, Ranade states:
The Government must retrace its steps, forget its Mohammedan
antecedents of absolutism, and return to the old Hindu traditions,
where the King’s power was restrained in all directions by the rights
of the people, among whom the king was more of a father and a
manager than a conqueror or a sovereign lord, and cultivated land
belonged in absolute right to private owners who paid as tax a fixed
share of the produce to the king like any of his other subjects for the
expenses of protection.
Whether land belonged to private individuals or the state could make a
difference to the rate at which land-revenue is assessed. In a system where land is
recognised as being privately owned the competition of landlords among themselves
helps prevent that level from being too high. But in British India, where land was
held to be monopoly of the state, no such check could operate; and its absence
had led to enhancement of land-revenue assessment all over the country, to an
extent of which the government itself was now ashamed. The re-establishment of
the private ownership of land was absolutely necessary for the achievement of
agricultural prosperity. The state monopoly of land and its rights to increase the
assessment at its own discretion were the two most pre-eminent obstacles in the
way of the growth of material prosperity ashamed. Ranade’s scheme was designed
to remove both obstacles together.
A second question which was closely related to Ranade’s proposed solution
to the agricultural problem concerned the viability of small farming. He was
concerned not so much with the general question of whether agriculture enjoyed
economics of scale, as with the more restricted one of whether, in the conditions
actually prevailing in India, small farming was remunerative. That it was not was
Self-Instructional
218 Material
suggested by the facts that a large proportion of the peasants, 50-60 per cent Indian Economic
Thought I
according to Ranade, were dependent on sowcars for both production and
consumption loans and that they usually found it impossible to repay their debts
from ‘the net gain of agricultural industry. While the sowcars often charged exorbitant
rates of interest they bore risks and provided an essential service. The sowcar NOTES
was as necessary to the ryot ‘as the seed he sows or the rain from the heavens
that irrigates his fields.’ Without the sowcar, agricultural industry would come to a
halt and he was just as indispensable for the business of government, for a large
proportion of the land revenue, though directly paid by the ryots was actually
advanced by sowcars. The reforms that Ranade was proposing were designed to
end the helplessness of the ryots and to create a situation whether other, more
organised and productive, forms of agricultural finance had a chance to develop.
The state had an essential role to play in the process of transition. In Essays on
Indian Economics, he states:
Let the State interfere not merely with a minimum piecemeal dose of
judicial reform, but by the whole dispensation of a large administrative
relief. If it subsidizes or guarantees private banks against risk during
the first experimental years, and enables them to rid the peasantry of
their ancestral debts, and if at the same time it allows the land revenue
to be redeemed or permanently settled at a moderate figure once for
all, it will provide an ample fund for agricultural relief improvement
without the necessity of borrowing a single rupee of fresh loans.
The ryot had to be emancipated and inspired with a sense that the land was
his own, just as much as his home or clothes. The ‘magic of property’ would do
the rest.
Ranade’s solution to the ryots’ problems was not the only one proposed. A
large body of opinion, both in British ruling circles and among Indian nationalists,
was inclined to the view that the ryot could survive without much more extensive,
and continuing, help from government than Ranade envisaged. Legislation protecting
the peasants against exploitation by sowcars was the answer. A number of such
measures had in fact been enacted, especially following the Deccan riots of the
early 1870s. With one of the most important of these measures, the Deccan
Agriculture’ Relief Act of 1879, Ranade himself was closely associated.
In its immediate objective, that of relieving the ryots’ financial position, the
act, by all accounts, achieved considerable success. In a review of its working,
Ranade wrote that the act had helped the ryots to a growth in the standard of life,
more variety of pursuits, a more assured sense of property in land, greater self-
control, greater intelligence to cope with the Savkars, and increased facilities to
borrow money when needed. On the other hand, the total amount of credit had
declined, since creditors were less willing to lend on the security of personal
property, but against critics such as Sir Raymond West he argued that this was the
aftermath of famine, and represented a necessary transition to a more secure system
of rural credit. It was such a secure and permanently sustainable system that
Ranade’s own proposals were designed to achieve. Relief measures, backed by Self-Instructional
Material 219
Indian Economic judicial reform, could only provide a temporary palliative. And even the best of
Thought I
them had drawbacks. The Stamp and Court Fees Acts, for example, helped to
organize the judicial administration of debt relief measures on a formal basis but
they also made debts more costly, for a renewal not only involved payments for
NOTES stamps, court fees, lawyers’ fees, etc. but increased the principal itself by the
amount of interest accrued on the law costs. To the existing uncertainties of nature
which affected decision-making in agriculture they added a new type of uncertainty.
‘The recuperative powers of nature and art are limited and cannot stand the dead
weight of prohibitive rates of interest made necessary by disorganized credit, and
the uncertainties and delays and expenses of civil proceedings’.
Government interference in the conditions determining land tenure, either
through legislation or the courts, could provide relief to the ryots but could not
provide a long-run solution to the agricultural problem. A long-run solution had to
accept the realities of the situation and be economically viable. Inequalities between
individuals and groups in respect of wealth and income were largely the result of
differences in savings rates, education, intelligence, skills and foresight. Such
differences could not be eliminated b social action, which should instead attempt
to increase the general or average level of attainment. Perfect equality was not
feasible, nor perhaps was it desirable, for ‘dead mediocrity’ was the likely outcome.
There was a place for the rural elite, the men of wealth and enlightenment who
would make ‘high farming’ productive and provide leadership in agricultural
innovation. Others would follow. This was the rationale of the two-tier system of
farming that Ranade proposed.
To conclude, Ranade’s approach to economic policy was guided by an over-
riding objective: the development of productive capacity. This applied to agriculture
as much as to industry. In both, government had a vital role to play, but its role was
to initiate, encourage and allow, rather than direct, take over or control. And the
encouragement should be given to domestic producers, who had difficulty in gaining
access to capital and were deficient in entrepreneurial skills, rather than to foreigners
who did not suffer any such lack but had political clout with the government of India.
The government, Ranade pointed out, had taken active steps to encourage the
cultivation of cinchola, tea, coffee, tobacco and seri-culture. It practice was to start
the enterprise on its own responsibility and when success was assured, to hand it
over to ‘foreign adventurers’. The state had also sold wastelands outright at nominal
prices and created freehold estates in favour of the European planter class ‘while
steadily refusing the grant the same boon to the native population’. This, stated
Ranade, amounted to a bounty to foreign investors who had neither shared in the
cost of land development nor borne the risks involved. It simply created a foreign
monopoly in a national field of investment. The demands on government that Ranade
was making on behalf of the Indian ryots were far less onerous.
While Ranade’s proposals for industrial development were enthusiastically
received by Indian economists, his plea for capitalist development of agriculture
gained little support. Even Ranade’s followers tended to disagree. Among them
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220 Material
was G.V. Joshi, who favoured small peasant farming, which was to be maintained Indian Economic
Thought I
by vigorous tenancy legislation, cheap credit, and a low land tax. Such a policy
required just the kind of continuing, long-run, legal and financial government
intervention in agricultural activity which Ranade had criticised. Although Ranade’s
views were not supported by government, either, and even the government of NOTES
Bombay did not adopt his land policy, they were not entirely without effect.
Beginning from 1884, for example, the Bombay government did take some steps
to reform the laws governing land-revenue assessment. The line among which it
proceeded was to introduce a large element of permanency. The classifications of
soil that had been evolved were accepted as fixed: no enhancement of tax was to
be made on account of improvements effected by the holder; changes of assessment
were to be made only on consideration of such things as a change in the general
level of prices, benefit accruing from the building of railways and similar public
works; and limits were imposed on the amount of reimbursement at any one time.
During the last quarter of the 19th century, railway investment in India was a
controversial topic. Should there be further extensions to the existing railway
network or should public funds be diverted instead to other items such as education
or irrigation works? This was the focus of the controversy, which continued well
into the present century. Throughout, British trading interests extended considerable
pressure on the Secretary of State for India to continue spending substantial sums
for railway development. Indian opinion on the other hand wanted a temporary
halt to public investment in railways and the meagre sums allocated to irrigation,
education and ‘welfare’ items to be increased. Gokhale, Ranade’s pupil and protégé,
whose views on various economic topics will be considered in a later section,
summed up the Indian view in a rhetorical question: ‘Are railway all? Is education
nothing? Is irrigation nothing?’
To understand the lack of enthusiasm for railways that is typical of Indian
economists one must go back to the early history of railway development. The
basic impetus to railway construction in India had come from the needs of the
Lancashire mills for good, clean Indian cotton. The carrying of cotton by cart over
long distances led to dirt getting mixed up with it. The problem could only be
solved by railway transport. The other main consideration was military strategy.
Railways were necessary to ensure quick, reliable movement of troops and stores.
They were an investment in Empire. It was the coming together of these two
distinct strands that started off railway construction in India, from around 1850
onwards. The construction of railway lines was carried out entirely by private
railway companies started by English merchants in the 1840s. They were under
contract to the authorities in India, represented initially by the East India Company
and later by the government of India. These early contracts had a number of
somewhat unusual features, the two most important being: firstly, the government
of India agreed to make land for railway construction available to the railway
companies, on a ninety-none-year lease, free of cost. Secondly, the companies Self-Instructional
Material 221
Indian Economic were given guaranteed interest on the capital they invested, at a rate ranging between
Thought I
4.5 and 5 per cent annum, as well as a guarantee against exchange losses, one
rupee being exchangeable at 1s.10d. Railway development under these contracts
is known in Indian economic history as the Old Guarantee System (1844-69).
NOTES
As elementary economic theory would lead us to expect, it encouraged over-
capitalisation and high construction costs per mile, which turned out to be far higher
than in England, Canada or Australia. The assurance given to the companies that
operating losses, if any, would be paid by the government of India out of public
revenue, did little to improve their incentive to economise on operating costs either.
The system was scrapped in 1869 and during the next decade railway construction
was controlled by the state and financed by the state largely out of loans. However,
towards the end of the decade the fall in the exchange value of the rupee threatened
the budgetary position of the government, which had a heavy burden of sterling
commitments to meet. This was compounded by the costs of providing relief to
victims of a number of famines which occurred during 1874-9. The government
found in increasingly difficult to appropriate revenue surpluses for railway development
and from the early 1880s once again entered into financial partnership with private
British railway companies. This time, however, the railway lines remained the property
of government while the companies, which were responsible for operating the railways,
were guaranteed a certain rate of interest, usually 3.5 per cent, on the amount of
their capital contribution and paid a 40 per cent share of net profit. The principle of
compensation for variation in rupee-sterling ratio was not abolished, but modified
somewhat, with the railway companies bearing a part of the exchange risks involved.
This system, known as the New Guarantee System, was less inefficient and, for the
Indian tax payer, less onerous than the old system had been, though the net earnings
of railway companies exceeded the guaranteed interest for the first time only in the
closing year of the century (1899-1900).
It is from this context that Ranade’s views on the desirability or otherwise of
public investment in railways derives their main interest. Government and its
spokesmen emphasised the enormous economic and social benefits that such
investment was bringing about. Indian opinion was more sceptical. Ranade tried
to provide a reasoned assessment of both benefits and costs. Prima facie, he said,
railways are a good thing. They provide a cheap form of passenger transport,
facilitate internal and external trade, and may even help promote national solidarity.
When, however, as was the case in India ‘their extension is made the ultima thule
of State action on its economic side a closer look at feasible alternative forms of
investment was appropriate. There were several such alternatives to be considered,
depending on the context. Part of the government’s case for extension of railways
was that by facilitating the quick transport of food grains to drought affected areas
it would provide protection against famine. Indian writers on the other hand tended
to argue that for this purpose irrigation canals were a more effective form of public
works than railways. On this issue, Ranade sided with the government, mainly on
the ground that the irrigation works then being considered for protection against
Self-Instructional famine were mostly of a non-perennial type.
222 Material
In years of drought and scanty rainfall, the water supply of irrigation works, Indian Economic
Thought I
with the exception of such of them as are supported by the perennial streams of
the Himalayas or in the Madras Deltas, generally fails, and the works do not in
consequence afford the anticipated relief in times of scarcity. Railways, on the
other hand, are equally serviceable at all times. Again, in some districts of India, NOTES
owing to the absence of perennial streams of suitable sites for the storage of water,
irrigation works could not be established at all. In such placed too railways were
‘the only means for provision against famines and scarcity. More generally, however,
irrigation was not the only relevant alternative to be considered. Public expenditure
could also be undertaken for the specific purpose of encouraging industrial
development. And here, according to Ranade, the case for continued large-scale
investment in railways was relatively weak. ‘Facilities of communication are certainly
desirable advantages, but more desirable still is the capacity to grow higher kinds
of produce, and develop manufacturing and industrial activities.
Analytically, the question of which form of investment is more desirable can
only be settled by applying specific decision criteria for public investment. This
was not the way in which Ranade, or other economists of his time, looked at such
questions. It is, however, to Ranade’s credit that he did not confine his attention to
the direct contributions of the investment to output and employment but also
considered the extent to which it could indirectly help the long-run process of
learning. The long-run view favoured investment in industry rather than transport,
for ‘The construction of railways can never be compared, in their educating influence,
to the setting up of mills or Steam or Water Power Machinery for the production
of manufactured produce in all parts of the country.
The direct economic benefits of railway investment had not been conspicuously
high either. The financial return to government was relatively low, largely because of
the high cost of construction, land being given British construction companies free of
charge and large sums paid in sterling as compensation for arrears of interest. For
Indian industry the immediate results had been largely negative: ‘The railway policy
pursued by the government has ... except in a few Presidency towns, killed our local
indigenous industries and made people helpless than before, by increasing their
dependence and pressure on agriculture as their only resource’ (Essays On Indian
Economics). It is important to note that Ranade’s objection was neither to the railways
as such nor even to the sudden and intense competition form imported goods that
indigenous industries had to face as a result of their extension. Competition was,
after all, a natural result of the opening up of India’s economy to foreign trade. And
as Ranade had pointed out when discussing problems of India’s industrial development
it was not simply foreign versus indigenous competition that was involved but rather
the competition of science and skill against idleness and ignorance. ‘If…’ states
Ranade, ‘…railways had been built by private enterprise unassisted by public funds,
no objection could be urged against the effects of this foreign competition’. That,
however, was not the case.
Self-Instructional
Material 223
Indian Economic Ranade said that it was extremely unlikely that such an arrangement could
Thought I
have represented an optimal economic allocation of resources from the point of
view of Indian society, even though political and military advantages accruing to
government were substantial.
NOTES
In common with other Indian economists of his time, Ranade emphasized
that resources used for investment in railways could have been used elsewhere. In
particular, railway investment was seen as a substitute for investment in industry.
Both development economists and economic historians now usually think of
investment in railways and in industry as being complements rather than substitutes.
The development of infrastructure, such as transport, is expected to contribute to
industrialization in the long run. Though Ranade did not directly address this
argument he was aware of it. A recurrent theme in his writings was that the very
considerable expenditures that had been made by government on public works
were not yielding a satisfactory rate of either financial or economic return. This he
attributed to low economic growth, for which in turn the lack of progress in
manufacturing industry was held to be definitely responsible. Given the special,
long-standing and formidable obstacles faced by Indian industry the extension of
infrastructure would not, he believed, suffice for growth of occur.
Direct steps by government to encourage private investment in industry
were necessary. The development of railways per se would not lead to accelerated
economic growth ‘for unless they are accompanied by other and more important
measures conducive to a better organisation of national industries, they do not add
to the intensive strength of the country, which along furnishes a firm foundation to
its expansive greatness. Moreover, for the purpose of industrial development, it
was not just the construction of railways that mattered. The structure of railway
rates was relevant, too. Freight rates had been so designed that raw materials
destined for, and manufacturing good originating at, the ports were charged at a
lower rate than similar goods travelling over the same distance between two places
in two places in the interior of the country. Such a policy was hardly calculated to
stimulated domestic industrial growth. On the contrary, it tended to increase the
cost of production of manufactured goods in India and to impede the development
of new industrial centres. This might help explain why the impetus to economic
growth coming from the development of infrastructure in transport figures so little
in the writings of Ranade and other Indian economists of his time.
Ranade’s economic writings were almost invariably addressed to specific problems
of Indian economic policy. On occasion, however, he also discussed the question
of the appropriate analytical framework in which such problems could best be
studied. His writings on methodological issues are of interest not primarily for their
intrinsic merit but rather because of their influence on the actual course of Indian
economic thought in this century. Specially, it helped to divert it away from the
tradition of classical political economy and towards the historical-institutional
Self-Instructional approach favoured by the German School.
224 Material
Ranade’s chief objection to the classical school of economics was that the Indian Economic
Thought I
truth of its propositions depended crucially on certain underlying assumptions being
valid. Because those assumptions reflected conditions in England, but not necessarily
those elsewhere, classical political economy had only limited, rather than universal,
applicability. In an oft-quoted passage, he suggested that the basic assumptions NOTES
underlying ‘the truths of economic science’ not only might not apply to India, they
did not. In his book Essays on Indian Economics, Ranade stated:
With us an average individual man is, to a large extent, the very
antipodes of the economical man. The family and the caste are more
powerful than the individual in determining his position in life. Self-
interest in the shape of the desire of wealth is not absent, but it is not
the only nor principal motor. The pursuit of wealth is not the only
ideal aimed at. There is neither the desire nor the aptitude for free and
unlimited competition except within certain predetermined groves or
groups. Custom and State regulation are far more powerful than
competition, and status more decisive in its influence than contract.
Neither capital nor labour is mobile, and enterprising and intelligent
enough to shift from place to place. Wages and profits are fixed, and
not elastic and responsive to change of circumstances. Population
follows its own law, being cut down by disease and famine, while
production is almost stationary, the bumper harvest of one year being
needed to provide against the uncertainties of alternate bad seasons.
In a society so constituted the tendencies assumed as axiomatic, are
not only not imperative but also are actually defected from their proper
direction.
The sentiments expressed by Ranade in this passage have been frequently
repeated since and some have been used by sociologists to show that economists
do not apply to the developing countries (but see Dasgupta 1974). Ranade states
almost as ‘a fact of life’ that factors of production are immobile, not being ‘enterprising
and intelligent enough’ to move from one place to another. In his paper on ‘Indian
Foreign Emigration’ on the other hand, he argues that although considerable migration
occurred in India, from the more congested areas to those more thinly populated,
internal migration did not offer enough scope for the movement of labour and that for
relieving the pressure of population on the land emigration abroad would be a more
effective remedy. Quite a large number of Indians, he observes, immigrated to the
British, French and Dutch overseas colonies, but with encouragement from the
government of India as well as from voluntary organisations many more would follow
suit. This clearly assumes that labour is enterprising and intelligent enough to shift
from place to place and should be given every encouragement to do so. A fortiori,
this can be supposed to be true of capital.
The question of how far labour and capital are mobile is itself part of a
larger and more complex question, how far human behaviour is motivated by self-
interest. Economic analysis does indeed assume that in situations which come into
its province self-interest plays a strong and usually predominant part. In the passage
quoted, however, Ranade goes beyond this by attributing to economists the far
Self-Instructional
Material 225
Indian Economic stronger view that the pursuit of wealth is the only ideal aimed at by human beings,
Thought I
rather than being one among others. There is little evidence that Adam Smith and
his followers ever held such a view. When it comes to suggesting policies to encourage
economic development in India, Ranade himself usually, if only implicitly, makes
NOTES the assumption of self-interested behaviour. We have already seen an instance of
this in his discussion of a policy for emigration. In considering whether to move or
not, people do not think only in terms.
Check Your Progress

8. Which problem was focussed upon by Ranade in his writings?
9. What was necessary for the achievement of agricultural prosperity according
to Ranade?
10. Why did Ranade believe railways to be good for India?

QUESTIONS
1. In 1935, the Tamil Nadu government officially documented 31 BCE as the

year of Valluvar.
2. The diverse names of Tirukkural are Tirukkural (the sacred
kural), Uttaravedam (the ultimate Veda), Thiruvalluvar (eponymous with
the author), Poyyamoli (the false less word), Vayuraivalttu (truthful
praise), Teyvanul (the divine book), Potumarai (the common
Veda), Muppal (the three-fold path), and Tamilmarai (the Tamil Veda).
3. The government of Tamil Nadu celebrates the 15th of January
as Thiruvalluvar Day in the poet’s respect as part of the Pongal celebrations.
4. M.G. Ranade opposed the policy of free trade in India as advocated by the
classical English economists.
5. In 1905, Gokhale founded the Servants of India Society with the object of
training men to devote themselves to the service of India as national
missionaries and to promote by all constitutional means the national interests
of the Indian people.
6. The drain theory was first developed by Dadabhai Naoroji in a series of
speeches and writings subsequently published in 1901, in a volume entitled
Poverty and un-British Rule in India.
7. Bankim Chandra Chatterjee, in a number of essays published in the influential
Bengali journal, Bangadarshan, examined the drain theory from the point
of view of the agricultural economy of Bengal.
8. All of Ranade’s economic writings address a single problem: poverty.
Self-Instructional
226 Material
9. The re-establishment of the private ownership of land was absolutely Indian Economic
Thought I
necessary for the achievement of agricultural prosperity.
10. Ranade believed railways are a good thing since they provide a cheap form
of passenger transport, facilitate internal and external trade, and may even
NOTES
help promote national solidarity.
12.7 SUMMARY
 Thiruvalluvar, was a well-known Tamil poet and philosopher, also known

as Valluvar. His birth place and date is still unknown, but his parents’ names
were Bhagavan and Aadhi. There is not much known about his family
background, religion or birth place.
 In the 19th and early 20th century, European writers and missionaries
variously dated the Valluvar to exist between 400 and 1000 CE.
 Valluvar’s teachings intimate both the cultural values and textual values in
the 13th to 14th Century Tamil Nadu. Valluvar’s text can be interpreted
and exercised in other ways.
 Several communities, together with those in Mylapore and Tiruchuli, worship
Valluvar as the 64th Nayanmar of the Saivite tradition.
 Even though researchers vary over the assessment of the era of Tirukkural,
it is normally believed that it belonged to the Sangam Age in Tamil Nadu,
which is dated around 3rd Century A.D.
 Tirukkural is structured into 133 chapters, each containing 10 couplets (or
kurals), for a total of 1,330 couplets. The 133 chapters are grouped into
three parts or books.
 Valluvar’s economic thoughts are found in his never-ending contribution,
Tirukkural, a book of principles.
 Valluvar’s economic thoughts are found in his never-ending contribution,
Tirukkural, a book of principles. Valluvar’s top seven economic ideas are:
factors of production, agriculture, public finance, poverty and
begging, wealth, ethics, and welfare state.
 Gokhale’s economic and social ideas constitute a part of his political thinking.
He was not an economist in the strict sense of the term. Neither was he a
social thinker with a deep sociological insight.
 As a leader of the Congress and as a member of the legislature, Gokhale
had to ponder over many socio-economic issues of the time which, in turn,
gave birth to his economic and social ideas.
 Gokhale did not stop at merely criticizing the fiscal policy of the government
but also advocated the cause of Swadeshi. However, he did not identify
Swadeshi with boycott.
Self-Instructional
Material 227
Indian Economic  Gokhale pleaded for state-intervention to regulate the social and economic
Thought I
life of the country. Thus, the role that he envisaged for the state was very
different from the role assigned to the state by classical liberalism.
 During the last two decades of the 19th century and the first decade of the
NOTES
20th century, the drain theory came to be seen as the symbol of Indian
economic nationalism.
 The basic message of the drain theory, namely that the financial mechanism,
by which British rule in India was maintained, led to a transfer of wealth and
income from India to Britain, imposing a ‘bleeding drain’ on the Indian
economy, was not confined to scholarly writing.
 The drain theory was first developed by Dababhai Naoroji in a series of
speeches and writings subsequently published in 1901, in a volume entitled
Poverty and un-British Rule in India.
 British saw the drain theory as an attack on the foundations of British rule in
India.
 Criticism of the drain theory was not confined to British writers. A number
of Indian nationalist writers, too, argued against one or other aspect of it.
 Bankim Chandra Chatterjee, in a number of essays published in the influential
Bengali Journal Bangadarshan, examined the drain theory from the point of
view of the agricultural economy of Bengal.
 There was one element of the drain theory that Chatterjee, like others, did
accept, namely that remittances from salaries earned in India by government
officers of European origin drained wealth away from the country.
 Mahadev Govind Ranade (1842–1901) has been variously described as
the father of Indian economics, the greatest Indian economist since Chanakya
and the originator of the optimistic school among Indian economists.
 Ranade’s work was a formative influence on Indian economics thought
during the first half of this century.
 Both in assuming the existence of mass poverty and in emphasizing the
close link between poverty and famine, Ranade represented the mainstream
view of Indian economic writing. However, unlike others, such a Naoroji or
Dutt, Ranade regarded poverty as a legacy from the pre-British era.
 In much of his writing, Ranade appeals to a version of what has come to be
known in the recent literature of development economics as the balanced
growth argument.
 Taking a cue from the German school of historical economics led by Friedrich
List, Ranade defines economic development as the full and all-round
development of the productive powers of society.
 It was Ranade’s understanding of economic development as a historical
process that inspired his vision of India’s industrialization.
Self-Instructional
228 Material
 Ranade associated the predominance of agriculture with stagnation. To his Indian Economic
Thought I
mind such predominance spelt ‘rustication’, a loss of power, intelligence
and self-dependence.
 For Ranade, the way to economic growth lay in an all-round and balanced
NOTES
development of productive powers. For an underdeveloped economy such
as India, this implied the growth of industry and trade, especially of
manufacturing industry and foreign trade.
12.8 KEY WORDS
 Constanzo Beschi: Also known by his Tamil name of Vîramâmunivar, he

was an Italian Jesuit priest, missionary in South India, and Tamil language
littérateur.
 Swadeshi: A part of the Indian freedom struggle, the Swadeshi movement
was an economic strategy aimed at removing the British Empire from power
and improving economic conditions in India by following the principles of
self-sufficiency or Swadeshi.
 Free Trade: It means international trade left to its natural course without
tariffs, quotas, or other restrictions.
 Physiocratic: It describes people who believe that the inherent natural
order governing society is based on land and its natural products are the
only true form of wealth.

EXERCISES
1. Briefly comment on everything that is known about Valluvar.
2. What was Dadabhai Naoroji’s drain theory?
3. All of Ranade’s economic writings address a single problem: poverty. Discuss
briefly.
4. Write a short note on Ranade’s objection to the classical school of
economics.
1. Discuss the economic thoughts of Valluvar.
2. Describe G.K Gokhale’s economic and agricultural ideas.
3. Discuss how military expenditure was a drain on the Indian budget during
the British period.
Self-Instructional
Material 229
Indian Economic 4. Ranade was one of the few economists in modern India to recommend the
Thought I
state’s assistance with labour migration as a means of economic development.
Explain.
NOTES
Gokhale, G.K. 1908. Speeches of the Honourable Mr. G. K. Gokhale, C. I. E.

Madras: G. A. Natesan & Co.
Naoroji, Dadabhai. 1917. Dadabhai Naoroji’s Speeches and Writings. Madras:
G. A. Natesan & Co.
Medema, G. Steven and J. Samuels Warren. 2012. The History of Economic
Thought. London: Routledge.
Barber, J. William. 2009. A History of Economic Thought. Connecticut: Wesleyan
University Press.
Wood, Diana. 2002. Medieval Economic Thought. Cambridge: Cambridge
University Press.
Publications.
Websites
https://www.economicsdiscussion.net
Self-Instructional
230 Material
Indian Economic
UNIT 13 INDIAN ECONOMIC Thought II
THOUGHT II
NOTES
Structure
13.0 Introduction
13.1 Objectives
13.2 Jawaharlal Nehru
13.3 Mahatma Gandhi
13.4 E.V. Ramasamy
13.5 Amartya Sen
13.7 Summary
13.8 Key Words
13.0 INTRODUCTION
In the previous unit, you learnt about the ideas of Ranade, Dadabhai Naoroji,
Gokhale and Thiruvalluvar. In this unit, we will discuss the economic ideas of
Jawaharlal Nehru, Mahatma Gandhi, Periyar and Amartya Sen.
Jawaharlal Nehru, India’s first Prime Minister, shaped post independent
India’s economic trajectory for many years. The influence of Mahatma Gandhi,
the father of the nation, on Indian society cannot be denied. Similarly, E.V.
Ramasamy, also known as Periyar, was hugely influential in southern India. The
Bengali economist Amartya Sen on the Nobel Prize in Economics for his work in
welfare economics. The ideas of all these men will be discussed in detail in the unit.
13.1 OBJECTIVES

 Explain Nehru’s economic policies
 Analyze the mixed economy model
 Discuss Gandhi’s view of trusteeship
 Assess Gandhi’s view of the state
 Describe Gandhi’s view of ethics
 Evaluate Gandhi’s opposition to the use of machinery
 Discuss the ideas of Periyar Self-Instructional
Material 231
Indian Economic  Analyze Amartya Sen’s concept of welfare economics
Thought II
 Examine Amartya Sen’s approach to poverty
NOTES 13.2 JAWAHARLAL NEHRU
The life of Jawaharlal Nehru is a record of tireless endeavours and true devotion
to his country. His mental efforts were determined by rationality and he was
historically inclined. Both these features were based on his high scientific knowledge
since his days as a student. These preconditions also enabled him well to deal with
the economic problems in India. However, in relation with Nehru’s statements on
the economic policies, one have to realize that he did not produce a complete
system of economic theory, but rather contributed many ideas. He always discussed
economic problems in comparison with the political and social questions, with the
tasks of the national liberation movement and the aims of an independent India.
Fig 13.1 Jawaharlal Nehru
Source: http://en.wikipedia.org/wiki/File:Nehru1.jpg
Background of Economic Ideas

As an Indian student in England, Nehru witnessed the political controversies about
economic development in Europe and Asia. He was politically influenced by Bal
Gangadhar Tilak and Bipin Chandra Pal, and was impressed by the personality of
Gopal Krishan Gokhale. After his return to India, socio-economic problems
continued to attract his interest. His public statements on Indian economic problems
were first seen during the discussion on the Fiji Indenture System, which drew his
attention to the conditions of Indian labourers in the manufactories and in the
mines. During his travel in Uttar Pradesh in about 1920 he had his first experience
with rural poverty. He strongly criticized the feudal settlement systems and the
exploitation by the zamindars and talukdars. He also observed that these systems
were maintained by the colonial administration, and that the class of feudal
collaborators was a menace for a future independent India.
Nehru faced a similar situation when he dealt with problems of industrial
development in India. The dependence of Indian industries on England and the
Self-Instructional underdevelopment of the Indian economy became evident for him. These
232 Material
perceptions in economics mainly determined Nehru’s economic approaches up to Indian Economic
Thought II
the late 1920s. In the 1920s, Nehru also showed a remarkable interest towards
the socioeconomic developments in the Soviet Union. In many respects, the
economic difficulties in India and Russia appeared similar, and he tried to understand
how the experience in Russia could be used for the solution of Indian problems. NOTES
After 1928, a weary change in his economic approach took place. Nehru became
concerned with the problems of industrialisation more and more and came to the
conclusion that this process was in accordance with the economic laws of history.
However economic progress and industrialization to his mind could only proceed
if colonial rule and dependence were abolished.
During the Calcutta Congress of 1928, Nehru declared himself a socialist
and since that time, his economic ideas were in accordance with what he called
the ‘socialist pattern of life.’ Nehru believed that a socialist pattern of society only
could be achieved by planned economic development and building the capacities
of the public sector. Moreover, Nehru’s considerable criticism of the prevailing
conditions in Indian agriculture and rural life turned his views to the problem of
socialism and peasantry. From the early 1930s, these problems became more and
more important for him. To his mind, in an independent India, feudal conditions in
agriculture would become the biggest obstacles in politics and the greater
productivity of labour could only be reached by abolishing feudal exploitation of
the rural population.
Nehru’s ideals of a ‘physical planning’as distinguished from financial planning
demanded a simultaneous development of agriculture, villages, cottage industries
and heavy industry based on a system of harmonizing. One important point in his
basic approach to economic policy was to make adequate preparations for
changing the entire economy of India, while buying time by allowing labour intensive
productions. He believed that agricultural growth should be achieved through small
peasant proprietors whose dependencies were to be remedied through cooperative
methods of production and a network of social services and an adequate rural
education. This framework rounded Nehru’s basic economic approaches. In 1936,
he stressed the main ideas of his approaches in the Presidential Address at the
Lucknow Congress again and summarized them as follows:
‘I am convinced that the only key to the solution of the world’s
problems and of India’s problems lies in socialism, and when I use
this word I do not use it in a vague humanitarian way but in the
scientific, economic sense. Socialism is, however, something even
more than an economic doctrine, it is a philosophy of life and as such
it appeals to me also. I see no way of ending the poverty, the vast
unemployment, the degradation and the subjection of the Indian people
except through socialism.’

At the time of independence, the Indian economy was in an appalling condition
underdeveloped and highly reliant on external resources for finish goods and
Self-Instructional
services. India was predominantly an agro-based economy, characterized with Material 233
Indian Economic extremely low per capita income, widespread poverty and recurrent famines. The
Thought II
overwhelming majority of people were illiterate, lived in extreme poverty and did
not have any access to basic healthcare. There was widespread unemployment
and underemployment, with people having an inadequate and unbalanced diet,
NOTES living in primitive housing, facing class and caste oppression and a heavy burden
of land revenue, rent and debt. Moreover, the partition of India brought about a
large share of problems, including a rift in the agricultural and the industrial sectors.
After Partition, the majority of the agricultural lands fell in Pakistan, while the
corresponding industries remained in India. This problem can clearly be seen in
the difficulty faced by the Jute industry soon after partition. The agricultural areas
of jute were in Pakistan, while jute factories were in India. This affected production
in both India and Pakistan. It was in this context that Nehru formulated the
economic policies of independent India. His economic policies had the wide-
ranging objective of addressing urgent economic needs and achieving the long
term goal of becoming a ‘just and self-reliant’ economy. As Nehru wrote in his
autobiography, “Our final aim can only be a classless society with equal economic
justice and opportunity for all, a society organized on a planned basis for the
raising of mankind to higher material and cultural levels.”
Early economic reforms: Immediately after being given the responsibility of
becoming the first Prime Minister of independent India in 1947, Nehru launched a
number of economic reforms. In order to remove economic disparities in India
between the landlords and the landless class, he introduced laws regarding land
redistribution. After winning independent India’s first general election, he started
the process of centralized planning by introducing the first five-year plan in 1951.
The plan determined the mode of government expenditure and grants in important
development sectors like agriculture, industries and education.
The ideology guiding Nehru’s economic policies: Nehru’s economic policies
have often been considered to be Socialist in nature. There cannot be any doubt
that socialism did play a very important role in Nehru’s ideological make-up.
Similarly, his short visit to the Soviet Union convinced him about the need for India
to adopt centralized planning. However, at the same time, it is also significant to
note that Nehru himself denied any kind of explicit socialist leanings in the economic
policies implemented by him. Nehru advocated a kind of mixed economy. Nehru
felt that any kind of unquestioned ideological devotion to any form of economic
theory would be detrimental to India’s development. Although an idealist, Nehru
wanted a practical approach to India’s development, where whatever economic
policy that suited the country would be adopted. On the one hand, as someone
who was deeply influenced by Gandhiji, Nehru believed that the rural economy
needed to be developed. At the same time, Nehru understood that heavy industrial
development would be the best way to serve India’s economic interests.
The industrial policies of Nehru: In Nehru’s view, a balance between the rural
and urban sectors of the Indian economy was important. Thus, his economic policies
were constructed with this balance in mind. Nehru did not think that there was any
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contradiction between the two sectors both could go hand in hand. Intending to Indian Economic
Thought II
exploit the natural resources of the country for the benefit of the people, Nehru
identified the area of hydroelectricity as his focus and directed the construction of
large dams, which he said would become the ‘temples of modern India.’ He felt
that such large dams would not only harness energy, but would also help support NOTES
irrigation to a great degree. For Nehru, dams were the symbol of collective growth
it was a common platform where agriculture and industrial engineering could meet.
Nehru and Foreign Investment: Although inspiring industrialists to provide a
boost to India’s development, Nehru had strict reservations about foreign
investment. As a former freedom fighter who had fought for India’s freedom and
an ardent nationalist, Nehru was wary of any attempt by foreign powers to
recolonize India. British India’s industrial policy was one where India was an
exporter of resources but an importer of finished goods. The colonial British
government deliberately undermined indigenous industries by creating policies to
make the Indian economy dependent on foreign finished goods. Therefore, when
India became independent, Nehru consciously followed an industrial policy of
self-sufficiency. He firmly believed that India was self-sufficient to bolster her own
growth. Although he did not officially decry the possibility of foreign investment in
direct terms, Nehru stressed that the sectors of foreign investment would be
regularized and that there would be strict rules in place by the government to
control the terms and conditions of foreign investment. Moreover, Nehru underlined
that the key sectors of the Indian economy would always remain in the hands of
the government.
The question of state control in Nehru’s economic policies: The most
important aspect of Nehru’s economic policy was the degree of state and central
control on the industrial and business sectors of the country. Nehru believed in
centralized planning and emphasised that the state would control almost all key
areas of the country’s economy. There were rigorous state laws and license rules
that were put in place which held back the free execution of industrial policies.
Nehru’s views on rural economy: Nehru’s views on the rural economy were
deeply influenced by Gandhiji. Like Gandhiji, Nehru believed that the rural and
cottage industries of India played a major role in the economic fabric of the country.
Nehru firmly believed that small scale industries and the cottage industry were the
solutions to the serious problem of unemployment and underemployment that
remained a continuous topic of concern throughout his lifetime, and indeed, continues
to remain a problem even today. Most of Nehru’s cottage industry development
programs were meant as a part of community development.
Nehru and Foreign Investment: Although inspiring industrialists to provide a
boost to India’s development, Nehru had strict reservations about foreign
investment. As a former freedom fighter who had fought for India’s freedom and
an ardent nationalist, Nehru was wary of any attempt by foreign powers to
recolonise India. British India’s industrial policy was one where India was an
exporter of resources but an importer of finished goods. The colonial British Self-Instructional
Material 235
Indian Economic government deliberately undermined indigenous industries by creating policies to
Thought II
make the Indian economy dependent on foreign finished goods. Therefore, when
India became independent, Nehru consciously followed an industrial policy of
self-sufficiency. He firmly believed that India was self-sufficient to bolster her own
NOTES growth. Although he did not officially decry the possibility of foreign investment in
direct terms, Nehru stressed that the sectors of foreign investment would be
regularized and that there would be strict rules in place by the government to
control the terms and conditions of foreign investment. Moreover, Nehru underlined
that the key sectors of the Indian economy would always remain in the hands of
the government.
Nehruvian Mixed Economy
A mixed economy usually is an economic system where both the public and the
private sector direct the economy. Mixed economies reflect the characteristics of
both market driven liberal economies and state controlled socialist economies.
Nehru favoured the mixed economy approach towards development, but he did
not regard the mixed economy as a ‘half-way house’ between the capitalistic or
liberal and the communistic or socialist forms of economic organization. For Nehru,
the mixed economy was an amalgamation of the two economic systems and since
it was free from both their dogmatic approaches, the mixed economy represented
a higher form of economic organization. Nehru also took the position that the
continuous exceptional growth of science and technology that resulted in
phenomenal changes in human activity and the modes of production could only be
absorbed by the mixed economy, which alone possessed the flexibility and resilience
to do so.
Types of Economic Systems
Any economic system must address four fundamental questions. One can
differentiate among the various economic systems based on how they answer
these questions. The four fundamental questions are as follows:
 What goods and services should be produced?
 How should the goods and services be produced?
 Should producers use more human labour or more capital (machines) for
producing things?
 How should the goods and services be distributed among people?
A capitalist or market driven economy answers these questions by the forces
of demand and supply. In a capitalist economy only those consumer goods that
are in demand and can be sold for profit in the domestic or foreign markets are
produced. For example, if televisions and cars are in demand, they will be produced,
Moreover, if labour is cheaper than capital, more labour-intensive methods of
production will be used and vice-versa. In a capitalist economy, the goods produced
are distributed among people on the basis of their purchasing power, which is the
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ability to buy goods and services, and not on the basis of what people need. Poor Indian Economic
Thought II
people in a country like India require housing, but since the poor do not have the
purchasing power, their needs will not be counted by the market. Thus, housing
for the poor will not be produced and supplied by market forces.
NOTES
A socialist economy answers these questions in a radically different manner.
In a socialist economy, the goods and services produced is decided by the
government based on what people need. The assumption of socialist economies is
that the government knows what people need. For example, the rich may desire
luxury items, but the government will use the resources not to produce luxury
items for the rich, but rather use resources to produce goods which are needed by
the poor. Similarly, the distribution of goods in a socialist country is also based on
what people need and not on what they can afford to purchase. Ideally, a socialist
nation would provide free education, health care and other civic amenities to all its
citizens.
In a mixed economy, the question of what goods and services need to
produce and distributed is answered by both the market and the government. In a
mixed economy, ideally speaking, the market will provide whatever goods and
services it can produce well, and the government will provide essential goods and
services which the market fails to do.
Salient Features of Mixed Economy
The capitalist economy did not appeal to Jawaharlal Nehru. For Nehru, the
‘acquisitive society’ was not suited for the present age and sought its replacement
by “a classless society, based on co-operative effort, with opportunities for all.”
Nehru observed that “the strongest urge in the world today is that of social justice
and equality” and came to the conclusion that any social structure that was based
on the possession of land and capital by a few with ‘the others living on the verge
of existence’ stood ‘self-condemned’ and had to be changed.
Although Nehru took the view that the capitalist system had outlived its
relevance, he did not approve of a system where the state controlled the entire
means of production because of two reasons, one of which was institutional and
the other was historical. The institutional reason was that he felt the introduction of
complete control over the means of production was not possible without introducing
‘authoritarianism’ and ‘totalitarianism,’ both of which he despised as a staunch
democrat. Nehru sought a system which could “realize economic growth and
social justice without the sacrifice of freedom and the democratic rights of the
common citizen.” He also felt that with every little growth that took place in the
economy, the system would increasingly gravitate towards “monopolies and
aggregations of economic power.” He wanted to change the course of history but
in a manner that did not break sharply with the country’s geographical, historical,
religious, economic and social background. Thus he favoured a mixed economy
characterized by the following features:
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Material 237
Indian Economic (i) a balance between the market economy and the planning mechanism
Thought II
(ii) a clear demarcation of the boundaries of public sector and private sector
so that the crucial and strategic sectors are invariably in the public sector
NOTES (iii) while profit motive influences decision-making in the private sector, the
economic viability criteria for investment decisions in the public sector is
based on social cost-benefit analysis
(iv) the ownership of means of production as between the public sector, private
sector, joint sector and the cooperative sector is so decided that there is a
balance between personal and social incentives and sectional and general
interests
(v) there is occupational freedom and freedom of consumers’ choice
(vi) the government intervenes to prevent undue concentration of economic
power, and monopolistic and restrictive trade practices
(vii) the government endeavours to take care of the consumption levels and
objectives of the weaker sections of the society through the public distribution
system (PDS), poverty alleviation programmes, etc.
(viii) social objectives of equity, employment, balanced regional development,
family welfare are emphasised
(ix) the dogmatic rigidities of socialism are avoided and a pragmatic approach
to decision-making for promoting economic growth is usually adopted
(x) the mixed economy is not merely an economic concept, it is a economy
where the rights of the individual are respected and protected subject only
to the requirements of public law and order and morality
Analysis of Nehru’s Mixed Economy
Different from the path taken by the majority of the former colonial and dependent
countries of Asia, the development of native capitalism in India at the end of the
19th and the beginning of the 20th centuries was not only accompanied by the
alignment of primarily bourgeois forces for leading the national liberation movement,
but at the same time also by the emergence of socio-political concepts on the
future rule of the bourgeoisie after national independence. These concepts implied
fundamental changes in the political and the economical structures as well as a
gradual social transformation by structural reforms and thus contained important
guidelines for an original social-political strategy of development to overcome
underdevelopment.
The needs and demands of the native bourgeois resting upon bourgeois-
democratic ideals and reflecting the interest of the nation as a whole were the
starting point for Nehru’s thoughts. His idea arose from the ideological struggle
with imperialism, the outdated social structure of which Nehru and the grouping of
the Indian National Congress (INC) led by him regarded the personification of an
undemocratic system. According to his concept, a democratic social system should
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be established, guarantying each member of society equal opportunities for Indian Economic
Thought II
development. But this system had to combine in a natural way the efficiency of
state administration with the individual freedom. Since 1929, Nehru’s thoughts
have decisively influenced the formulation of an economic and political programme
marking the guidelines of INCs economic policy till the present time. NOTES
The concept of the Mixed Economy was based on the aim to push forward
the development of the productive forces by means of co-existence of a state
capitalist and a private capitalist sector and by the application of planning and
other regulation measures, to guarantee social progress and create the conditions
of the development of native capitalism with the help of the state. In the history of
economic theory, the concept of mixed economy represented the attempt to show
the rising bourgeoisie in the developing countries a way how to adapt to the new
situation in the utilization of capital and the consolidation of the capitalist system
after the accession to power. The efficiency of this concept lies in the theoretical
reasoning of state capitalism, which is now fairly spread in all developing countries
with capitalist orientation, from a non-Marxist point of view.
The historical roots of this concept go back to the end of the 19th and the
beginning of the 20th centuries, when as a result of the upswing in the national
liberation movement new political and ideological trends emerged. As you studied
previously, the leading members of the INC started to analyse the exploitative
character and the economic effects of the British colonial rule in India. The
discussions focused on the ‘Drain-Theory’ by Dadabhai Naoroji, based on the
knowledge that there is a permanent drain of India’s wealth to England without
India receiving an adequate equivalent. The criticism of British policy about the
field of industrialization necessarily led to the demand to abolish the British colonial
rule and receive material independence. Several Indian economists as M.G. Ranade
(1842–1901) and G.K. Gokhale (1856–1915) supposed that the development of
independent India required the active participation of the state to protect the native
production against foreign competition and to support the national private
enterprises. Other Indian scholars like R.C. Dutt (1848–1909) believed that in an
independent Indian state poverty and economic backwardness can only be
overcome by a quick development of industry.
Although the majority or the INC members had a rather corresponding
point of view in regard to the participation of the state in developing the national
economy, their ideas of the practical forms of state participation proved to be
rather vague. Starting from his youth, Nehru had been dealing with the economic
and political problems, but his interest in history, policy and economy was even
intensified during the time of his studies in England from 1907 till 1912. There he
got to know Fabian thoughts and had the opportunity to study the concepts of the
petty bourgeois socialists. During these years Nehru–as he frankly confesses–
was attracted by the Fabians and socialist ideas.
After his return from England his interest in economic and political topics
was again roused in connection with the situation of workers in India and the Self-Instructional
Material 239
Indian Economic British colonies. At the beginning of the twenties he thoroughly studied the situation
Thought II
of the peasantry in India and critically investigated the economic and social
conditions in the countryside. In his spectacular speech at the annual INC session
in Lahore in 1929, he discussed India’s social problems in detail and pilloried the
NOTES defects of the existing social conditions. He emphasized that neither high crop
yields nor people; most of them still living in mud cottages, could prove the glory
of the British Empire and the existing social system.
Since 1929, the efforts to change the social conditions have also found their
expression in the resolutions of the INC by demanding ‘to make revolutionary
changes in the present economic structure of the society and the inequalities in
order to remove poverty and ameliorate the conditions of the masses.’
With particular interest Nehru followed the revolutionary changes in Soviet
Russia, especially those in the backward areas of Middle Asia mainly with regard to
the application of certain experiences in view of similar or merely presumed similar
conditions in both countries. Thus, he wrote in 1928 ‘Russia thus interests us because
it may help us to find some solution for the great problems which face the world
today. It interests us especially because conditions there have not been, and are not
even now, very dissimilar to conditions in India. Both are vast agricultural countries
with only beginnings of the industrialization and both have to face poverty and illiteracy.
If Russia finds a satisfactory solution for these, our work in India is made easier.’
The resolution on ‘Fundamental Rights and Economic Policy’ of INCs annual
session in Karachi in 1931 represented an important stage in creating general
economic and political guidelines. In twenty different items, general bourgeois-
democratically demands were formulated, among them were the control of key
industries and natural resource by the state and the agricultural reforms. The left
wing INC members, led by Nehru and S. C. Bose, participated to a great deal in
drafting this resolution, which was of special interest for Nehru not only because
of its content, but also because of the clarity of thought.
In his biography he wrote ‘So far the congress had thought along purely
nationalist lines, and had avoided facing the economic issues, except in so far as it
encouraged cottage industries and swadeshi generally. In the Karachi resolution
(on fundamental rights and economic policy) it took a step, a very short step, in a
socialist direction by advocating nationalization of key industries and services and
various other measures to lessen the burden on the poor and increase it on the
rich.’ This was not socialism at all, and a capitalist state could easily accept almost
everything contained in that resolution. At its session in Faizpur in December 1936,
the INC completed this programme by a detailed agricultural programme containing
basic demands of the rural masses (reduction of rents, abolition of feudal dues and
debt repayment).
A programmatic highlight was the All India Conference of Congress Socialists
in Patna in 1934, at which Nehru submitted a draft resolution already containing
the fundamental thesis of his later concept of mixed economy. At this conference it
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240 Material
life of the country to be planned and controlled by the State, socialization of the Indian Economic
Thought II
key and the principal industries and state to have monopoly of foreign trade.’
After these demands had been rejected by the Congress Working Committee
during the following weeks, Nehru found himself forced to defend his concept of
NOTES
establishing a new economic structure in the independent India in disputes with the
elder comrades as well as with representatives of big business lasting for years.
W.R. Kidwai refers to the toughness of these disputes when he writes. Nehru was
bitterly opposed by the members of his own working committee as much as by the
big business who adopted the practical strategy of boosting the right wing Congress
leaders to protect their business interests, which were likely to be threatened by
the socialist doctrine held by the Congress President. Regardless of what Nehru
thought and believed in, the position of big business never stood threatened and
they felt completely secure for they knew that the talk of socialism and nationalization
was merely a posture for many and even those who genuinely had faith in socialist
ideology would find themselves incapable to act effectively. Quite obviously there
had already been two different groupings opposing each other in the INC with
regard to the strategy and tactics of the national liberation movement by the midst
of the thirties, and Nehru as a mouthpiece of the most progressive forces left them
in no doubt about the social character of the economic and political programme to
be drafted, by confessing himself bluntly to socialism as scientific economic system.
The foundation of the National Planning Committee (NPC) in 1938 initiated
by the left wing around J. Nehru and S.C. Bose was another important step towards
the formulation or the economic and political concepts in the INC. During the
following time, the activities of the NPC contributed to the fact that even before
receiving national sovereignty, disputes on fundamental economic and political
problems included broad masses. Although there happened to be practically
considerable differences of opinion between the different groupings, being
temporarily represented in the NPC by more than 350 members, they were able
to arrive at compromises in many cases. But the whole report was finished only in
1949, because the NPC had been existent in name only for several years due to
the imprisonment of its president J. Nehru in 1940.
The memorandum of the leading representatives of the Indian big bourgeoisie,
which contained their concept of the future development of independent India,
reflected the different strategic and tactical positions within the bourgeois especially
their grown power and self-reliance. In this second part of the so-called Bombay
Plan, which was published in 1945, the representatives of big businesses explained
their view on the role of the state in economy. In this memorandum they oriented
to limit the state sector to the key branches of the industry including defence and
infrastructure and to leave all remaining branches open for the access of private
capital. After having founded and developed state enterprises, it was possible for
private capitalists to take them over.
These diverse concepts were the verbal expression of the advancing process
of formation within the bourgeois class during the forties. As a result of the Self-Instructional
Material 241
Indian Economic concentrator of the economic power in favour of native concern groups during the
Thought II
Second World War, the right wing of the INC, which supported a rather
unrestricted development of the private sector, was significantly strengthened.
Therefore, the representatives of petty and middle bourgeoisie and their concepts
NOTES were faced with stubborn opposition by the representatives of big businesses.
Two Principles of the Future Economic Policy of Nehru
During the rather vehement disputes between the both major groupings in the
INC the left wing under the leadership of Nehru stood up mainly for the following
two principles:
 Maximum increase of production by all available means and
 Prevention of a concentration of economic power in private hands
The results proved very soon that even a policy of manoeuvring and
compromises was not the right means to realize the aspired role of the state only
approximately. The development of state capitalism strengthened the positions of
the national private capital. As early as 1964, the alarming tendencies in the
concentration of production and capital forced Nehru’s government to form a
Monopoly Inquiry Commission, which impressively documented in a comprehensive
study the accumulation of economic power by 75 native monopolies. A small
upper stratum of the propertied classes, including several dozen of monopolies,
managed to use the enormous efforts of the society in building up a national economy
for the accumulation of private wealth.
Conflict between the state and the private sector
Nehru realized the aggravating conflict between the state and the private sector
and vehemently opposed all the attempts at transforming the state sector into an
appendage to private capital. Thus, he stated at Parliament in December 1963
that the state sector dominates in the Indian economy because it is the more
important one for the economic policy. Otherwise it would be of no use to have a
state sector in economy, because it would only serve as an appendage to the
private sector. The deceleration of India’s progressive development, marked by
the strengthening of monopoly and big bourgeoisie and the temporary loss of
INCs monopoly of power in several parliamentary elections demonstrated the
limits of ‘democratic socialism’ and the fact that essential social reforms are not
possible by means of ‘harmonizing the class differences’. Nevertheless one can
say those four decades after independence INC can start its further strategic
reflections from positive results in development.
Ideas of autocratic rule of the private capital
The state sector as the main item of the concept of mixed economy has proved its
strategic importance for the strengthening of India’s independence and is now one
decisive factor of the power and productivity of the national economy. Nehru’s
ideas of a ‘socialist economic order’ in the sense of democratic socialism were
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mainly reflected in the concept of mixed economy. They were not in contrast to Indian Economic
Thought II
the class interests of the Indian bourgeoisie class, but on the contrary contributed
to a great extent to their fulfilment. The concept of mixed economy proved to be
an important instrument of the ruling class in creating favourable conditions for an
independent capitalist development. It may be considered to be Nehru’s historical NOTES
credit that he broke the aspired autocratic rule of the private capital by developing
a productive private sector, that he laid the basis for the planned development of
the economic structure and popularized the vision of an independent modern
national economy among the people of India.
Check Your Progress

1. What were Nehru’s ideals of physical planning?
2. What was the concept of mixed economy based on?
13.3 MAHATMA GANDHI
M.K. Gandhi was a man of action, a realist and a pragmatist. He was a humanist
who had tremendous faith in the essential goodness of man. He was not a politician.
In his own words, he was not a politician masquerading as a religious man, but a
religious man, who had been dragged into politics because of his great concern for
his fellow human beings. He, therefore, practiced whatever he professed and never
asked anyone to follow anything that he had not practised in his own life. He did
not believe in arm-chair theorizing or system-building. Thus, it is intuition and action
rather than logic and system-building, which characterizes the political philosophy
of Gandhi. He entered the hot-bed of politics to emancipate the people from the
yoke of foreign domination. Swaraj, therefore, was the most important thing, which
he kept in the forefront of his political programme. To achieve Swaraj, Gandhi
adopted certain means and worked out his programme with the help of these
means. The principles, which were followed by Mahatma Gandhi, were woven
into a political philosophy by his followers. Gandhi did not differentiate between
thought and action; for him, to think was to act.
With his novel method of non-violent struggle against the British imperialists,
Gandhi became a dynamic force in the political and spiritual life of India. The
Indians could have never fought the British with force, because it would have been
suppressed by still greater force, which the British commanded. The symbolic use
of the weapons of non-violence and satyagraha were responsible for spreading
patriotic fervour throughout the country. The British were not prepared for such
an attack and had to surrender. During this period, Gandhi became the most vital
force and his life and activities were identified with India’s struggle for national
independence. His spiritual and moral impact was so great that after his
assassination the Manchester Guardian rightly commented that ‘he was a saint
among politicians and a politician among saints’. Gandhi’s sincerity of purpose, his
Self-Instructional
Material 243
Indian Economic devotion to duty and the noble principles that he practiced, made him the ideal of
Thought II
many national leaders in India. Humayun Kabir had rightly said that Gandhi was
an objective student of reality and that his method was essentially experimental
and scientific. Jawaharlal Nehru, who was a close associate of Gandhi for many
NOTES years, once said, ‘We are associated (with him) seldom in logical debate and
argument or philosophical discourses, we were associated in action’.
Influences on the Thoughts of Gandhi
Gandhi read little in the realm of political theory or political thought. But whatever
he read, he assimilated perfectly. He read the Bhagavad-Gita and gave it a novel
interpretation. He read in several times and considered it as the book of spiritual
reference. He learnt about truth and non-violence from the Bhagavad-Gita: He
was also influenced by Patanjali’s Yogasutra, the Ramayana and Mahabharata.
He read some of the Jain and Buddhist writings and was deeply influenced by the
principles of truth and non-violence. From the Upanishads, he got the inspiration
for his faith in non-possession. He read the New Testament of the Bible and was
greatly influenced by the ‘Sermon on the Mount’. The dying words of Jesus –
‘Father forgive them for they know not what they do’ awakened Gandhi’s faith in
the rightness and value of satyagraha.
The teachings of Lao-Tse and Confucius also influenced Gandhi’s thought
to some extent. Lao-Tse has taught the philosophy of non-assertiveness of ideal
life. From the writings of Confucius, Gandhi learnt the principles of reciprocity.
The principle means that men should not do to others what they would not have
done to themselves. Secular writers like Thoreau, Ruskin and Tolstoy also influenced
the moral and political philosophy of Gandhi. He learnt the principle of civil
disobedience from Thoreau. Ruskin instilled in Gandhi, respect for manual labour.
Tolstoy inspired him to think in terms of philosophical anarchism.
Comparing Thoreau and Gandhi, Pyarelal says, ‘that neither of these thinkers
was a system-builder but both were profound thinkers, truth-seekers and truth-
speakers. Both had a passion for truth and both represented a philosophy in action.
Both also believed in the ideal of voluntary poverty’.
The Philosophy behind Political Action: Spiritualization of Politics
Gandhi was not a politician in the ordinary sense of the term. But he exhibited
unusual tact and intelligence in choosing the time as well as the methods and
techniques to be used in launching his non-violence agitation. This made him the
ideal of all the political leaders, who were striving for India’s independence. The
greatest contribution of Mahatma Gandhi to political theory and politics is the
spiritualization of politics. He believed that if politics is to be a blessing for mankind
and not a course, then it has to be guided by moral and spiritual principles. The
leaders must be guided by a sense of sacrifice and service. Gandhi stressed the
importance of means and said that right and just means must be adopted to achieve
right and just ends. Only the right means, he believed, could lead to the right ends.
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Thus, according to him the ends and the means are the same things, looked at Indian Economic
Thought II
from different points of view.
Philosophical Anarchism
Gandhi believed in the essential goodness of man. Left unto himself, man can NOTES
develop his spiritual and moral personality. Man alone is capable of achieving
wonders in the world. The state should not interfere in the activities of the individual.
Gandhi believed that the state is an instrument of exploitation. It exploits and
oppresses the poor. The excessive interference of the state kills individual initiative
and action. The state originates in an essentially violent society but in a society
where the people are non-violent, orderly and disciplined, the state becomes
unnecessary. Gandhi believed that all initiative must come from within man. Anything
that is imposed by an external agency is evil, because it does not elevate the
human soul. It deprives and degrades the human soul and stands as a positive
hindrance to the spiritual and moral development of the individual’s personality. In
his introduction to Thoreau’s essay on Civil Disobedience, Mahatma Gandhi (quoted
by Prayelal) writes, ‘I heartily accepted the motto, that government is best which
governs least … carried out, it finally amounts to this, which also I believe, that
government is best which governs not at all’. Instead of state activity, Gandhi
preferred individual activity. The instruments of state, like force and coercion, rob
and individual action of its morality. Both Thoreau and Gandhi looked upon the
state as a soulless machine. The ideal society envisaged by Gandhi is a stateless
democracy. About the state of his imagination, he wrote in his Young India: ‘In
such a state (of enlightened anarchy) everyone is his own ruler. He rules himself in
such a manner that he is never a hindrance to his neighbour. In the ideal state,
therefore, there is no political power, because there is no state’.
In spite of his distrust for the state, Gandhi did not dogmatise it. He believed
that the state is necessary to perform certain functions for the good of the masses.
He wanted it to exercise minimum functions, transferring more and more functions
to voluntary associations. State action should be judged on its own merit and only
that action which promoted the welfare of the masses was to be justified. In
performing its functions, the state’s object should be to serve the masses and
these functions must be performed with minimum use of force. The state must
follow persuasive rather than coercive methods.
The Welfare Concept of the State
According to Humayum Kabir, Gandhi was an inheritor of the liberal tradition, of
the tradition of philosophical anarchism, and of the tradition of collectivism found
in socialistic thought which believed that the good things in life ought to be shared.
He would support a welfare state because of his great concern for the masses.
Gandhi would have liked the Five Years Plans and other method of planned
development if they could have originated of the people. But a plan, which increase
government post, favouritism, nepotism and opportunities, corruption and laziness,
would have been definitely rejected by him. He was, therefore, not in favour on Self-Instructional
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Indian Economic concentration of heavy industries and the grand multipurpose river valley projects
Thought II
which did not benefit the people in the proportion of the huge amounts spent on
them.
His concern for the misery and exploitation of human beings compelled him
NOTES
to start a vigorous agitation against untouchability in whatever form it might exist.
He condemned the practice of untouchability and broke the unhealthy practice of
the cast system by such means a temple entry and continuous propaganda against
untouchability. But at the same time, he upheld the Hindu ideal of the varnash-
rama dharma, according to which every person was to perform his allotted task in
the society, in accordance with his training and capacities. Gandhi’s ideal of
classlessness was not Marxian. He called himself a weaver and a cultivator by
profession and identified himself with those people with regard to food, dress,
speech and the like.
‘When the history of economic thought in India in recent times comes to be written,’
wrote Anjaria (1941-2) ‘Gandhi’s name will certainly occupy a place of honour in
it.’ However, he hastened to add, ‘It does not matter in this context whether we
call Gandhi an economist or not: that is partly, at any rate, a question of definition
of terms’.
Indeed, Gandhi was much farther off the mainstream of economics than
other Indian nationalist economists, such as Ranade, had been. Railways have
spread the bubonic plague and increased the frequency of famines in India,
machinery is a ‘grand yet awful invention’; a doctor or a lawyer should be paid the
same wage as a labourer, the law of supply and demand is ‘a devilish law’, tractors
and chemical fertilizers will spell ruin for India’, tractors and chemical fertilizers
will spell ruin for India. It is for voicing opinions such as these that Gandhi as an
economist is remembered. Even a sympathetic reader may find it difficult to take
such statements at their face value. This could help explain why, although Gandhi
has come to be accepted world-wide as one of the outstanding political and moral
thinkers of our time, his economic thought still attracts little attention. Some of the
methodological issue involved will be considered here. We begin by taking up a
question that is likely to strike a careful reader of Gandhi’s economic writings: do
they simply describe a dream of utopia, or are they meant to resolve problems of
the ‘real’ world?
Gandhi himself often likens his economic ‘model’ to Euclid’s definition of a
straight line but this is consistent with either interpretation. It could mean that like
the straight line ‘which cannot be drawn’ the Gandhian model relates to an ideal
economic order where people could well be motivated quite differently from those
in any society that we know of. However, it could also mean that ‘something like’
a straight line can be drawn, and in economics as in geometry, the postulational
method can help in achieving clarity in thought and in solving real life-problems, for
Self-Instructional
246 Material
‘we must have a proper picture of what we want before we can have something Indian Economic
Thought II
approaching it’. Both versions contain elements of truth.
Gandhi was not an academic but the charismatic leader of the Indian national
movement. He was inspired by a vision of ‘swaraj’ (self-government) which, for
NOTES
him, meant not just freedom from colonial rule but the achievement of self-reliance,
and self-respect, by the villagers who make up most of India’s population. His
economics was a part of this vision, which ruled out industrialization on western
lines as the ‘optimal’ path of economic development for India.
Thus, Gandhi was trying to describe an economic ideal to strive for rather
than simply an economic plan to implement. To that extent his economics was
utopian. However ‘utopian’ can also refer to something ‘impractical’ or even
‘impossible’. Gandhi’s economic thought was not ‘utopian’ in that sense. It was
currently meant to apply to an actual society, that of rural India in particular. It
would still apply only to a few selected aspects of that society while neglecting
others but that is true of all economic models. The case for this ‘pragmatic’ view of
Gandhian economics appears more plausible if we remember the context of his
writings.
Most of them appeared in daily newspapers or weekly journals, Young
India (in English), Navajiban (in Gujarati), and Harijan (in Hindi), and were
addressed to a mass audience whose attention he tried to capture by making his
points short and sharp. In this he succeeded and as a journalist, especially during
the 1920s and 1930s, he exercised considerable influence. Exaggeration was the
price of successful journalism. It must be remembered too that Gandhi’s writings
were produced and published in the heat of political battle. This led to simplified,
sometimes over-simplified, conclusions.
Yet another argument in favour of this interpretation is that Gandhi regarded
his conclusions on economic policy as only provisional. Thus, in his preface to
Hind Swaraj, he described the views expressed there as ‘mine, yet not mine’.
They were his only in the sense that he hoped to act according to them. If, however,
his views proved to be wrong he would have no hesitation in rejecting them.
Gandhi’s American biographer, Louis Fischer, notes this provisional aspect of
Gandhi’s ideas: he was always ‘thinking aloud’: ‘He did not attempt to express his
ideas in a finished form. You heard not only his words but also his thoughts. You
could, therefore, follow him as he moved to a conclusion’. In the same spirit he
came to admit that some of the things he had earlier condemned, e.g. railways,
motorcars, and machinery, could in certain circumstances confer benefits too, and
that they should not be prohibited altogether. Appropriate restrictions on their use
could perhaps provide adequate safeguards against misuse
Writings on Gandhian economics have usually focused attention on the specific
policies that he proposed. Opposition to modern manufacturing production based
on the use of machinery, advocacy of village industries, in particular, the spinning
wheel, boycott of foreign goods, it is with policies such as these that Gandhi’s
name is associated. In the argument presented in the unit, proper understanding of Self-Instructional
Material 247
Indian Economic his views requires a rather different emphasis. The structure of his arguments, the
Thought II
assumptions he made, and the principles of conduct that he appealed to, must be
regarded as of central importance. It is these, we believe, that make his specific
policy proposals comprehensible, not the other way round. One agrees with
NOTES Anjariawhen he says that ‘Gandhism is not just a series of disjointed maxims of
policy or a catalogue of urgent reforms and remedial measures’ and with Nanda
that ‘What is called Gandhism is…. only a distinctive attitude to society and politics
rather than an ideology; a particular ethical standpoint rather than fixed formulae
or a definitive system’.
From this point of view what really differentiates Gandhi’s approach to
economic issues from the mainstream tradition is his extraordinary emphasis on
the ethical aspect of economic behaviour. Indeed, he believed that economic and
ethical questions were inseparable. Replying to the poet Tagore, who had
reproached him for mixing these up, Gandhi wrote: ‘I must confess that I do not
draw a sharp or any distinction between economics and ethics’ (Young India 3
October 1921). They Could, Gandhi said be considered separately, as indeed
they usually were but for conclusions to be relevant and valuable, they should not.
Ethical and economic criteria must be considered together for either to be
valid. True economics never militates against the highest ethical standard just as all
true ethics, to be worth its name, must at the same time ‘be good economics’.
Since for Gandhi ethics also constitutes the essence of religion, the same two-way
relationship holds as between economics and religion, and even more generally
between economics and Dharma. ‘If dharma and economic interests cannot be
reconciled either the conception of that dharma is false or the economic interest
takes the form of unmitigated selfishness and does not aim at collective welfare’.
According to Gandhi, it is because standard economic analysis failed to take ethical
considerations into account that economics itself had become largely irrelevant for
either understanding behaviour or prescribing policy. Not only were the generally
accepted principles of economics invalid for policy making, if they were acted
upon they would make individuals and nations unhappy. ‘Economists do not take
men’s conduct into account but estimate prosperity from the amount of wealth
accumulated and so conclude that the happiness of nations depends on their wealth
alone’ . Accordingly he likens the economics that disregards moral and sentimental
considerations to ‘wax-works that being life-like still lack the life of the living the
flesh’.
For all his distrust of economic analysis Gandhi never relinquished a belief in
the vital importance of economic considerations for the life of individuals and nations
nor in the possibility that a less narrowly focused and more relevant economics
could be developed. He never gave up entirely, never ceased to ask: ‘Can we
evolve a new kind of economics?’
These beliefs are an integral part of Gandhi’s view of the nature of ethics.
The relationship between economics and ethics worked both ways. While economic
Self-Instructional
behaviour was laden with ethical concepts ethics had to descend from the clouds
248 Material
and become ‘good economics’. Ethics, Gandhi is saying, is not simply an exercise Indian Economic
Thought II
for philosophers. It must be relevant to the ‘ordinary business of life’ where one’s
options are limited by resource constraints. ‘No person in this world has found it
possible to maintain something which is a source of constant economic loss’. Trying
to carry out ethically good policies by methods involving continuing economic loss NOTES
was futile. Viable methods of financing projects had to be found. This helps explain
why Gandhi, who worked all his life for the cause of protecting animals, and cows
in particular, regarded schemes for conducting tanneries on sound economic lines
as essential for the cause to succeed. That required exploring possibilities of
profitable export, utilising by-products, and ‘putting bones, hides and intestines of
cows to practical use’ (CW 41: 449-50); also CW 51:428 and similar reasoning
explains why Gandhi strongly opposed a proposal that cotton spinners should
also be encouraged to weave. ‘It can be clearly shown that this involves an economic
disadvantage.’ He continues: ‘Whatever is basically harmful on economic grounds
is also certainly harmful from the religious point of view. Untainted wealth can
never be opposed to religion’.
On the whole we agree with Anjaria that ‘the Gandhian system of economic
thought cannot be adequately appraised merely in terms of current economic theory
which rests on certain limited assumptions. It is a challenge to those assumptions
themselves’. In that sense, Gandhi must be regarded as a dissident from the
economic tradition. There are, however, a number of methodological positions
which he held in common with that tradition. Among these his adherence to the
deductive method and to methodological individualism are especially note-worthy.
Gandhi was generally in favour of analytical reasoning based on the deductive
method applied to a set of postulates. His writings contain numerous references to
Euclid and Galileo whose approaches to problem solving he held out as models for
the social sciences. While he criticised economic analysis for failing to take ethical
considerations into account he was not against the method of abstraction as such.
Some ‘holist’ critics of economics maintain that human behaviour constitutes a single
‘organic’ whole. Hence they argue that even in principle, the economic aspect of it
cannot be isolated from all the others. On this view human behaviour can only be
observed or understood ‘as a whole’. Because the method of abstraction does not
apply, there cannot then be any such thing as ‘economic analysis’. That was not
Gandhi’s view. He remained committed to the validity of analytical reasoning based
on the method of abstraction. ‘Euclid’s straight line may not be capable of being
drawn on a blackboard. But the impossibility of the task cannot be permitted to alter
the definition’. The problem with the economic mode, as Gandhi saw it, was not that
it abstracted from some aspects of reality but rather that the particular aspects it
abstracted from were central to the phenomena under study. Ethical influences on
economic behaviour could not properly be treated as disturbing factors that ‘prevented
economic laws from having free play’. It was not reasonable to abstract from them
even as a first approximation. Nevertheless, if more appropriate assumptions were
made valid conclusions could be reached using the deductive method.
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Material 249
Indian Economic Again, Gandhi’s approach in ethics as in economics remains firmly rooted
Thought II
in methodological individualism. He opposed collectivist theories both of state
and society. While he often chided his countrymen for failing to live up to the high
moral norms of their own past, the norms themselves could not be derived from
NOTES tradition, custom or religious text. ‘It was good to swim in the waters of tradition
but to sink in them was suicide’ while ‘to respect a tradition even when it becomes
tyrannous spells not life but death and it should be discarded’ . Thus, Hinduism
was hemmed in by many old customs, some of which were praiseworthy but the
rest were to be condemned. The Ramayana and the Mahabharata had logical
and analytical truth but were not to be taken literally nor treated as historical
record. Gandhi’s belief in Hindu scriptures did not require him to accept every
word and every verse as divinely inspires, and he declined to be bound by any
interpretation, however learned it might be, if it was repugnant to reason or moral
sense . Even the Vedas were not exempt. ‘No matter what is credited with Vedic
origin if it is repugnant to the moral sense it must be summarily rejected as contrary
to the spirit of the Vedas and perhaps what is more as contrary to fundamental
ethics’. Gandhi had great respect for other religions, as he held for his own, and
often quoted from the Bible or the Quran to make a point. Yet they too were
subject to the same judgment: ‘I reject any religious doctrine that does not appeal
to reason and is in conflict with morality’. Because Gandhi often used religious
terminology (a ‘saintly idiom’ as it has been called) in his speeches and writings the
critical, individual and rational nature of his approach to religion has sometimes
been missed. Because it was only individuals who reasoned, had moral sense and
exercised moral choice, individual conscience remained for him the ultimate court
of appeal. Nation and society were not conceptually ‘prior’ to the individual
members of the aggregate. Rather, the morality of a nation depended on that of
individuals. ‘If the individuals who constitute a nation do not observe moral
principles, how can the nation become moral?’. And, similarly, ‘if the individual
ceases to count, what is left of society?’. Clearly, Gandhi did not subscribe to a
deterministic view of human action, either of the historical or the sociological kind.
For him ‘ultimately, it is the individual who is the unit’.
Gandhi also shared with the mainstream economic tradition a consequentialist
approach to choice. For him as for the economists the assessment of consequences
of various alternative courses of action is always the proper basis for choosing
between them. There is one important difference: Gandhi usually interprets
consequences in broader terms than the economist is apt to do. For Gandhi, they
include moral as well as strictly economic effects and effects on others as well as
on oneself. Nevertheless, it is to consequences that he looks rather than to any
one over-riding moral principle in terms which every alternative can be assessed,
for ‘it is not possible to enunciate one grand principle and leave the rest to follow
of itself’. A recurrent theme in Gandhi’s writings is that life is not one straight road.
‘There are so many complexities in it. It is not like a train which once started,
keeps on running’ (Nanda 1985: 146). Nor can one climb the Himalayas in a
Self-Instructional straight line. As a pluralist he believes that in any actual choice a number of different
250 Material
moral principles are usually involved and there could be conflict between them. Indian Economic
Thought II
‘(But) one’s life is not a single straight line; it is a bundle of duties very often
conflicting. And one is called upon continually to make one’s choice between one
duty and another’. The choice is often far from clear. ‘Relative dharma does not
proceed on a straight path, like a railway track. It has on the contrary to make its NOTES
way through a dense forest where there is not even a sense of direction’. Looking
at consequences helps us in finding a direction.
Consumption Behaviour: The Limitation of Wants
The concept of ‘limitation of wants’ is a typically Gandhian contribution to the
theory of welfare economics. This states that an individual’s welfare is best achieved
not, as economic theory suggests, by attempting to maximize the satisfaction of
multiplicity of desires subject only to the prevailing budget constraint but rather by
reflecting on his desires and trying to choose between them. The claim is supported
by arguments bearing on the relationships between desire, satisfaction, happiness
and welfare. While economic analysis often regards these more or less as synonyms,
according to Gandhi they are quite distinct concepts.
First not all kinds of happiness contribute to human welfare. That drink or
drugs can make people happy for a while is not, for example, a relevant
consideration for policy (CW 26: 175-6). Second, not all kinds of desire-
satisfaction contribute to happiness. Primarily this is because an individual’s desires
for goods and services do not form a fixed set such that their satisfactions would
make the happy: ‘We notice that the mid is a restless bid; the more it gets the more
it wants and still remains unsatisfied’.
Multiplying one’s daily wants in this fashion merely makes a person a slave
to an unending sequence of desires and there is no slavery equal to slavery to
one’s own desires (CW 73: 94). Such a process does not lead an individual to any
sustainable steady state consumption path. Those who are in the mad rush to
multiply wants, thinking that this will add to their real substance, are mistaken. On
the contrary, self-indulgence and the ceaseless multiplication of wants hamper
one’s growth because they are erosive of contentment, self-respect and peace of
mind. And it is from these that one’s long-run happiness can be found, not just
from obtaining what one likes at the moment. And what is true for the individual is
true also for society. Indeed, individuals may be impelled towards unlimited wants
not only by their own desires but also by the prevailing social ethos. In modern
Western society, state Gandhi, the basis of culture or civilisation is understood to
be the multiplication of all one’s wants.
‘If you have one room you will desire to have two rooms, three rooms and
the more, the merrier. And similarly you will want to have as much furniture as you
can put in your house, and so on endlessly. And the more you possess the better
culture you represent or some such thing’ (quoted in Iyer 1973: 384). Gandhi
regarded such a culture as flawed.
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Indian Economic Another reason why trying to maximize desire-satisfaction may not make
Thought II
an individual or a society happy is that the process of trying to satisfy a multitude
of wants has its own costs. Such an attempt requires the extensive use of machinery
which could lead to pollution of the environment and a loss of creativity in work.
NOTES Another usual characteristic is a ‘mad desire to destroy and time, to increase
animal appetites and go to the ends of the earth in search of their satisfaction’
(Young India, 7 August 1927).
Fig 13.2 M.K. Gandhi

Source: http://en.wikipedia.org/wiki/File:MKGandhi.jpg
Typically, a country pursuing the quest will be ‘made hideous by the smoke
and the din of mill chimneys and factories’ and its roadways ‘traversed by rushing
engines dragging numerous cars crowded with men mostly who know what they
are after, who are often absentminded, and whose tempers do not improve by
being uncomfortably packed like sardines in boxes’). Besides, in a country where
everyone had a car, ‘there would be very little room left for walking’.
Such things, observes Gandhi, are held to be symbolic of material progress
but ‘they add not an atom to our happiness’. Deliberate restriction of material
desires by individuals by means of ‘the utmost effort’ offers a more rational solution.
Another argument in favour of limiting wants turns on the adverse moral
consequences of economic growth. As we have seen, at the heart of the Gandhian
approach to economic issues is his belief that ethical and economic considerations
are inseparable. The objective must be to bring about improvements in both the
economic and the moral well-being of individuals, and thereby of society. But
material progress can itself affect moral standards. These ‘externalities’ must be
taken into account in the overall reckoning and a balance struck. Sometimes they
could be of a positive kind. This is likely to be the case when there is mass poverty.
‘No one has ever suggested that grinding pauperism can lead to anything else than
moral degradation’.
Millions of people in India live on only one meal a day. ‘They say that
Self-Instructional before we can think or talk of their moral welfare we must satisfy their daily wants.
252 Material
With these, they say, material progress spells moral progress’ .Gandhi agrees with Indian Economic
Thought II
‘them’; but, he argues, what is true of thirty millions is not necessarily true of the
universe. Indeed, such a deduction would be ‘ludicrously absurd’ for ‘hard cases
make bad law’.
NOTES
‘The only statement’, suggests Gandhi, ‘that has to be examined is
whether it can be laid down as a law of universal application that
material advancement means moral progress’. His answer is that it
cannot: both at the level of individuals and societies, there are too
many examples to the contrary. In general, Gandhi believes that material
affluence beyond a point not only does not imply but actively hinders
moral progress. Gandhi does not discuss whether, or how, one could
determine just where the point was located but he was convinced that
it does exist. For this reason, when discussing comparative standards
of living of different societies, Gandhi always asked questions about
moral as well as economic aspects. Neither literacy nor wealth per se,
without a moral backing, had any attraction for him as a ‘social
indicator’. To a correspondent who had pointed out Japan’s
achievements in terms of material progress and the level of literacy.
Gandhi responded: ‘And why are you so enamoured of the material
progress of Japan? I do not know whether the material had gone side
by side with the moral progress’. There are echoes here of Ruskin
who had written in Unto This Last: It is impossible to conclude, of
any given mass of acquired wealth, merely by the fact of its existence,
whether it signifies good or evil to the nation in the midst of which it
exists. Its real value depends on the moral sign attached to it just as
sternly as that of mathematical quantity depends on the mathematical
sign attached to it.
The limitation of wants appeared to be a way of avoiding adverse effects of
material progress.
Whichever of these various justifications of the doctrine of limitation of wants
one takes as primary, they have one thing in common, namely that such limitation
is not intended as a glorification of austerity but rather as an exercise in the
optimisation of overall individual welfare. In taking up such a position Gandhi
anticipated a basic theme of the recent literature against economic growth. Indeed,
he was one of the first writers to argue explicitly and in a systematic way that non-
economic aspects of welfare are important and that a single-minded pursuit of the
maximum satisfaction of material wants might not lead to the best of all possible
worlds. In developing this thesis Gandhi was influenced by Ruskin and Tolstoy but
he had a far more positive and practical approach than his mentors.
From a practical point of view the question of what things wants should be
limited to, is important. Gandhi appears to give different answers at different times.
In some of his early writings he appeals to the principle of what he calls satisfying
one’s ‘natural wants’. Each person should be able to satisfy all natural wants and
no more. These are conceived as minimal, or basic, needs. One ‘should make do
with the fewest possible articles… and in the smallest possible quantity… no more
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Indian Economic than what is absolutely necessary to pay the body its hire’ (CW 12: 387). However,
Thought II
natural wants will vary from one individual to another depending on metabolism. If
one person has a weak digestion and so requires only a quarter pound of flour for
his bread and another needs a pound, the former’s natural want will be
NOTES correspondingly lower. Natural wants also vary with climate. ‘Fiery whisky in the
north of the British Isles may be a necessity. It renders an Indian unfit for work or
society. Fur coats in Scotland are indispensable, they will be an intolerable burden
in India’. Some natural wants, according to Gandhi, could only be specified at the
village, rather than the individual, level. To this category belongs transport and
sanitation:
The roads should be so scrupulously clean in this land of crore of
barefooted pedestrians that nobody need hesitate in walking or even
sleeping in the streets. The lanes should be macadamized and have
gutters for letting out water. The temples and mosques should be
kept so beautifully clean that the visitors should feel an air of tranquil
holiness about them. The village should as far as possible, be full of
shady trees and fruit trees in and around them. It should have a
dharamshala, a school and a small dispensary. Washing and privy
arrangement should be such as may not contaminate the air, water
and roads of the village.
Elsewhere, especially in his later writings, Gandhi appears to take a rather
broader view of basic ‘needs’. The proliferation of material wants is still rejected
as a goal. One’s aim should rather be their restriction consistent with comfort,
which is less narrowly interpreted than natural want. Typical of this broader outlook
are passages such as the following: If by abundance you mean everyone having
plenty to eat and drink and to clothe himself with, enough to keep his mind trained
and educated. I should be satisfied. But I should not like to pack more stuff in my
belly than I can digest and more things than I can ever usefully use. But neither do
I want poverty, penury, misery, dirt and dust in India. And again, ‘Everyone must
have balanced diet, a decent house to live in facilities for the education of one’s
children and adequate medical relief’. For the same reason, spinners’ wages should
be adequate for ensuring ‘wholesome and nutritious food, necessary clothing,
comfortable houses and other amenities necessary for a happy home’. The tiller of
the soil should have ‘a sufficiency of fresh, pure milk and oil, fish, eggs and meat if
he is a non-vegetarian’, ‘adequate but not fine clothing (what would fine clothes,
for instance, avail him if he is ill-nourished and underfed?)’; facilities for sanitation,
comfortable housing, clean drinking water, dirt-free roads and a sense of
participation in decisions that affect his daily life.
More than half a century after Gandhi’ death, the bill of goods that he
prescribed as a minimum is still not one that the average Indian household is a
position to consume. The actual consumption of both rural and urban poor falls far
short of the limits to wants that Gandhi set. One the other hand, the affluent, even
many of those not so affluent, is often engaged in a frantic display of luxury
consumption in a way that Gandhi had supposed to be peculiarly ‘Western’. In
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254 Material
this perspective the limitation of wants can be seen as a means of reducing economic Indian Economic
Thought II
inequality. This aspect of the doctrine comes out clearly in some of Gandhi’s later
writing, for example in his statement that while he did not want to taboo everything
above and beyond the bare necessities, ‘they must come after the essential needs
of the poor are satisfied. First things must come first’. However, it remains NOTES
somewhat peripheral to the doctrine itself.
Consumption Behaviour: Swadeshi
Swadeshi means indigenous or home-grown. The Swadeshi movement was a
mass movement to encourage people, especially those living in cities, to develop
the habit of consuming Indian rather than foreign products. They were also urged
in particular to wear only khaddar, i.e. cloth made of yarn spun by villagers using
the charkha or spinning wheel. The movement was undertaken by the Indian
National Congress under Gandhi’s leadership. During the 1930s the movement
become wide-spread in some parts of India.
Gandhi did not regard Swadeshi merely in terms of political expediency but
sought to justify it by moral principles. The first relevant principle here is that of
neighbourhood. One has a moral duty to help one’s neighbours. While it is true
that we have duties to all humankind, the duties we owe to different segments of
humankind are not of equal importance. There is a hierarchy of duties based on
the degree of proximity. Individuals’ service to country and humanity consist in
serving their neighbours. They cannot starve their neighbours and claim to serve
distant cousins in the North Pole, for one must not serve one’s distant neighbour at
the expense if the nearest. This was the basic principle of all religions and or ‘true
and humane economics’.
The neighbourhood principle has a direct consequence for the interpretation
of Swadeshi, namely that local products should be preferred. Inhabitants of Bengal
should only consume cloth made in Bengal in preference to substitutes imported
from more distant parts. This was so whether the substitute concerned came from
Manchester or Japan or Bombay or Ahmedabad. ‘If Bengal will live her natural
and free life without exploiting the rest of India or the world outside, she must
manufacture her cloth in her own villages as she grows her corn there’. For the
same reason, by consuming cloth or ghee made in Calcutta rather than those
made locally the people (of Porbandar) were being ‘chained with fetters’.
Between counties, the neighbourhood principle translates as patriotism. It
is sinful to eat American wheat while a neighbouring grain dealer starves for want
of custom. An individual’s preference-ordering over commodity-bundles should
be guided by patriotism. ‘The law of each country’s progress demands on the part
of its inhabitant’s preference for their own products and manufactures’. For Indians,
there is an obligation to use Indian-made things whenever they are obtainable,
even though they may be inferior to foreign articles. For example, India produces
a sufficient quantity of leather. It is therefore my duty to wear shoes made out of
Indian leather, even if it is comparatively dearer and of an inferior quality, in
Self-Instructional
Material 255
Indian Economic preference to cheaper and superior quality foreign leather shoes. For the same
Thought II
reason products of Indian textile, sugar, or rice mills ‘must be preferred to the
corresponding foreign products’.
Comparisons of price or quality are not relevant for the kind of consumer’s
NOTES
choice decision Gandhi is talking about, but patriotism is.
‘We attend flag-hoisting ceremonies and are proud of our national
flag. Let me tell you our pride has no meaning if you do not like things
made in India and hanker after foreign ones.
If a particular commodity is not made in India at all, the patriotism
argument ceases to apply.
I would regard it as a sin to import Australian wheat on the score of
its better quality but I would not have the slightest hesitation is importing
oatmeal from Scotland if an absolute necessity for it is made out
because we do not grow oats in India.’
(Young India, 15 November 1928)
For the same reason the argument did not apply to English lever watches,
books or surgical instruments. Japanese lacquer work, Austrian Pins and pencils
of Swiss watches.
While this argument applies to all home-grown products, Gandhi singles
out the products of village industry for special attention. Within that category
Khaddar claimed pride of place. Indeed, the Swadeshi movement came to be
regarded primarily as a means of encouraging consumers to wear khaddar.
Accordingly, people, especially towns-people, were asked to buy khaddar in
preference to mill-made cloth and to boycott foreign cloth altogether. It was
specifically the use of foreign cloth that Gandhi sought to prevent, not just British
cloth and not all foreign goods, which he argued would be racial, parochial and
wicked.
Gandhi’s identification of Swadeshi with village industry, and with hand-
spinning, was based on a two-fold argument: that the urban population of India
owed a special moral duty towards the villages, and that this duty would be best
discharged by providing a market for village products and above all hand-spun
cloth. The first part of the argument is a logical consequence of the principles of
neighbourhood (there are few town or cities in India that are not surrounded by
villages) and patriotism (most Indians are villagers). Gandhi sought to support it
further by introducing another moral principle, that of historical justice. Both
economic and moral standards in the villages had declined through long neglect.
City people as a whole were partly to blame. Reparation had to be made. ‘We are
guilty of a grievous wrong against the villagers and the only way in which we can
expiate it is by encouraging them to revive their lost industries and arts by assuring
them of a ready market’ . We must, urged Gandhi, think of our household
consumption requirements in terms of ‘rural-mindedness’, which was ‘in
consonance with the true economics of our country’. The second part of the
argument had more to do with standard economic analysis.
Self-Instructional
256 Material
Spinning was a solution for rural unemployment. ‘The whole scheme of Indian Economic
Thought II
khadi rests upon the supposition that there are millions of poor people in India
who have no work during at least 4 months in the year’. Around three-quarters of
the Indian population, who were agriculturists tilling their own land, belonged to
the category. Even in a normal year, because agricultural work was seasonal, they NOTES
remained idle for a third of the year or more. This, Gandhi believed, was the
principal cause of their endemic poverty. Their normal life was lived on the border-
line of starvation. If there was crop failure or famine, the extent of involuntary
unemployment became much greater and many of them died of hunger and disease
(CW 28:11). For the ‘semi-starved’ but partially employed millions, spinning
provided a means of part-time employment as well as insurance against famine.
Thus, Gandhi saw spinning as a supplementary industry for agriculture rather than
as a means of employment for village artisans.
Why, one might ask, choose spinning, rather than some other subsidiary
occupation for agriculturists? Gandhi’s answer to this was strictly pragmatic.
Spinning had long been practised by villagers in the past. It required only a very
simple and low-cost implement and little technical knowledge or skill. It could be
easily learnt, did not require too much attention, could be done at odd moments
and, for these reasons, was suitable as part-time employment for masses of rural
people. Neither cattle breeding nor weaving, which had been suggested as possible
alternatives to spinning as a supplement to agriculture, enjoyed these advantages,
even though they were more remunerative. Spinning was ‘the easiest, the cheapest
and the best’. Again ‘the test of Swadeshi was not the universality of the use of
article which goes under the name of Swadeshi but the universality of participation
in the production or manufacturing of such article’. Judged by this test, spinning
had a potential unmatched by other contenders.
That cotton spinning was a specific remedy for agricultural unemployment
also implied that it was not recommended for universal adoption. It was not, for
example, meant for individuals who already had more remunerative employment,
such as urban workers in textile mills. It could not work in a district or region
which did not have large numbers of people with idle hours at their disposal.
Gandhi neither contemplated nor advised the abandonment of a single, healthy,
life-giving industrial activity for the sake of hand spinning. On one occasion, he
found that a number of women had been spinning who were not without occupation
or means of living. ‘Perhaps they spin in response to our appeal and because they
realize it is for the good of the country’. Nevertheless, Gandhi remained firm in his
resolve that their spinning should stop, ‘for the charkha movement had not been
conceived with such people in mind but only for able-bodied people who were
idle for want of work’. The operative principle was quite clear: if there were no
crises of semi-unemployed people there would be no room for the spinning wheel.
Gandhi’s pre-occupation with the need to find a subsidiary occupation for
farmers can be properly understood only if certain other considerations are kept
in mind. The first is his view that the possibility of bringing about improvements in
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Indian Economic agricultural production itself was very limited. Because an extremely high percentage
Thought II
of cultivable land in Indian was already under cultivation, there was little scope for
increasing the agricultural area. Also, if agriculture was to provide the sole means
of livelihood, one acre was estimated to be the minimum viable area for supporting
NOTES a household. In these circumstances, extension of cultivation was not a plausible
means of bringing about economic development in India.
To a number of nationalist economists, including Gandhi’s own political
mentor, G. K. Gokhale, improving the productivity of land already under cultivation
did appear to be a promising solution. Towards this end they advocated concerted
efforts, especially by government, to expand irrigation facilities so as to make
farmers less dependent on the vagaries of rainfall and also to encourage them to
adopt higher-yielding seed and improved agricultural practices. Gandhi did not
take up this line of argument, because of his belief that proposals for agricultural
improvements were ‘chimerical’ and not immediately available a belief came to
modify. He stated, ‘Till now I believed that improvement in agriculture was
impossible unless we had the administration of the State in our own hands. My
views on this are now undergoing modification. I feel that we can bring about
improvements even under the present conditions so that the cultivator my make
some measure of profit form the land even after paying his taxes… The time has
come to pay attention to agriculture.’
However, Gandhi continued to oppose the ‘industrialization’ of agriculture
by large scale use of mechanised techniques which were not only contrary to the
kind of village society he wished to bring about, but would also mean ‘trading’ in
soil-fertility for the sake of quick return’. This, he thought, would prove to be a
disastrous short-sighted policy resulting in virtual depletion of the soil. Without
such innovation, however, it is doubtful whether agricultural productivity in India
could be increased significantly.
The limitation of wants and Swadeshi both rest ultimately on the concept of
ethical preferences. People should seek not simply to maximize satisfaction of
self-interested desires subject to a budget constraint, but to achieve the long-run
goals both of individual happiness and of helping others. The problem is that people’s
actual preferences may differ from their ‘ethical preferences’. If Gandhian economics
were taken as relating only to an ideal economic order, the difference would not
much matter. However, that is not my reading. Gandhi himself was much concerned
about the difference between the actual preferences of urban Indians, especially in
the matter of clothing, and what he thought their ethical preferences should be. He
was not, however, entirely consistent in his analysis. In his more optimistic
movements he appeared to believe that a ‘true and national’ taste for khaddar
(i.e. an ethical preference) was already there in a latent form and hence that demand
was likely to lag only briefly behind supply. The use of khaddar itself ‘revolutionizes
our tastes’. All that was necessary was to ‘revive’ the national taste for khaddar
‘and you will find every village a busy hive’. More often he seemed unsure:
‘Khaddar has yet to become popular and universal’ or even despondent: ‘Khadi
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has not caught the fancy of the people’. After an initial spurt the demand for hand Indian Economic
Thought II
spun cloth failed to show any dramatic rise. Unsold stocks began to accumulate in
parts of the country where efforts to increase production of handspun cloth in the
villages had been a success. Gandhi’s conclusion was that khadi needed ‘a great
deal of propaganda’. After all, that was how all goods were sold. Textile mills ‘had NOTES
their own peculiar agencies and methods for advertising their wares’. In his
presidential address to the Indian National Congress in November 1924, Gandhi
criticized the proposition ‘that supply follows demand’. Appropriate means of
persuasion were necessary to encourage the consumption of khaddar.
Advertising campaigns were undertaken by the Congress and its agencies
in favour of khaddar. Wearing it was made a prerequisite for membership of
Congress. Exhibitions of village handicrafts were arranged to provide information
to townspeople. Gandhi himself addressed mass meetings and wrote in the press
in favour of khaddar. ‘We’, he declared, ‘are the salesmen of swaraj’. The urban
middle classes were particularly targeted. The ‘thinking portion’ of the population
had to give a lead; for ‘Khaddar which has to find a market must command
preference among enlightened men’. That remained the favoured strategy, with
‘the buying middle class at the one end and the manufacturing poor class at the
other’. Some attempts were also made to increase efficiency in production and
marketing and improve the quality of the product. Much to Gandhi’s disappointment,
none of these measures succeeded in bridging the gap between ethical preferences
and market demand. At an early stage of his campaign for khaddar Gandhi wrote
somewhat wistfully about Queen Elizabeth I, who had prohibited the import of
soft cloth from Holland, who herself wore coarse cloth woven ‘in her own dear
England’ and ‘imposed that obligation upon the whole of that nation’. Gandhi did
not however aspire to such an option for himself. Sales talk was permissible, force
never was. ‘We do not want to spread khadi through coercion. We want to do
our work by changing people’s sense of values and habits’. But this was not
enough for his cause to succeed.
Technology, Industrialisation and the Scale of Production
The central concern of Indian economic thought since Ranade had been the problem
of industrialization. Different views were held on what constrained industrial
development in India. For some it was economic drain. Others emphasised the
lack of trained labour, credit facilities and entrepreneurial traditions. Yet others put
the blame of the government for its failure to provide encouragement to Indian
industry. All agreed, however, the industrial development was the log-run solution
to poverty and famine. They agreed as well that the development of manufacturing
industry on modern Western lines was desirable. Indeed, most Indian economic
writing from the last decade of the 19th century onwards was concerned with
how to speed up this process. Gandhi, on the other hand, did not regard
industrialization as a goal that India should adopt. The overall vision which led
Gandhi to his doctrines of the limitation of wants and Swadeshi also led him to
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Indian Economic oppose modern industrial development. The use of machinery and large scale
Thought II
production in urban centres were, he thought, to be avoided as far as possible.
According to him the three essential characteristics of machinery are the
following: Firstly, it displaces human or animal labour instead of supplementing it
NOTES
or merely increasing its efficiency. Secondly, unlike human labour there is no limit
to its growth and expansion. Thirdly, it appears to have a law of its own, which
leads not only to labour being displaced but to it being displaced at an ever
increasing rate. This occurred not because such displacement was considered by
the users of machinery to be socially or economically desirable, but as a consequence
of the nature of technological progress per se.
Gandhi’s opposition to modern, machine-based industrial development is a
natural consequence of his characterization of machinery itself. ‘I am against
machines just because they deprive men of their employment and render them
jobless. I oppose them not because they are machines, but because they create
unemployment’. The answer to the question, discussed in classical political economy
since the time of Ricardo, of whether machinery leads to unemployment, was, for
Gandhi, self-evident. ‘If one machine does the work of a hundred men, then where
are we to employ those hundred men? ’. Now, one could argue that workers
thrown out of work by the introduction of improved machinery would find
employment elsewhere. Gandhi was perfectly aware of this argument. However,
he rejected it, firstly because opportunities of employment were, in his view, fairly
limited and secondly, because the division of labour resulted in workers having
very specific skill, which meant they could not easily be re-employed elsewhere in
the economy. The tendency of machinery to throw workers out of their jobs was,
Gandhi believed, a general one which operated everywhere, but its consequences
were particularly grave for a country such as India with its huge population. The
proliferation of mechanized industries in such a society would create large scale
unemployment with horrendous social effects.
Gandhi’s second main argument against the pursuit of industrialization by
means of machine-based production was that it would concentrate production
and distribution in the hands of the few. More specifically, it would lead to further
encroachment of the cities on the villages, making rural people even more dependent
on the cities than they already were. Gandhi’s vision of village swaraj could never
be achieved through such a process. Because industrial production would be
concentrated in a few urban centres, the economic as well as the political power
of the urban elite would be strengthened at the expense of the masses of the
villagers. Mass production in its usual sense, that is production by the fewest possible
number through the aid of complicated machinery, could not serve the interests of
the masses themselves. Gandhi’s solution was production by the masses through
self-employment ‘It is mass production in people’s own homes. If you multiply
unit production a million times would it not give you mass production on a
tremendous scale? Distribution could be equalised only when production was
localized, in other words when distribution was simultaneous with production.
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Furthermore, when production and consumption were both localised the pursuit Indian Economic
Thought II
of economic growth for its own sake, regardless of the consequences, would be
avoided; there would be no temptation to speed up production ‘indefinitely and at
and price.’
NOTES
Gandhi’s opposition to the use of machinery was neither total nor all inclusive.
In a way, his objection was to industrialisation in the sense in which it is usually
understood rather than to the use of machinery as such. ‘I am not against machinery
as such but I am totally opposed to it when it masters us’. However, ‘every machine
that helps every individual has a place’. His favourite example of a helpful machine
was Singer’s Sewing machine which supplemented human labour and increased
its efficiency but did not dispense with the labour itself. Another was surgical
instruments. Not only did he approve of such lifesaving appliances but also of the
complicated machinery used for making such appliances, for here such machinery
was absolutely essential. As he said ‘we want to cultivate the hand process to
perfection but where it is found to be absolutely necessary let us not hesitate to
introduce machinery’. Yet another example is sanitation. Asked by a correspondent
whether, because of his dislike of machinery, he opposed the adoption of flush
toilets Gandhi replied: where there is ample supply of water and moderns sanitation
can be introduced without any hardship on the poor, I have no objection to it, in
fact it should be welcomed as a means of improving the health of the city concerned.
At the moment it can only be introduced in towns.
A more important exception is the case of public utilities which could not be
undertaken by human labour. In such cases Gandhi would approve of mechanized
modern techniques. However, he would like them to be regarded as key industries
to be owned and operated by the state in the public interest. Thus, such cases are
to be treated as exceptional.
Gandhi remained, however, totally committed to his opposition to extensive
use of machinery for the production of basic necessities, ‘For food and clothing I
would be dead against industrialization. He maintained this position to the end,
strongly opposing the use of machinery for grinding corn, manufacturing cloth or
ploughing the land. If Gandhi were prime minister of India he would stop all machine
driven ploughs and flour mills and restrict the number of oil pressing factories. He
might perhaps not destroy the existing textile mills bit certainly would not help
them and in any case would not permit new ones to be set up (ibid.). Ideal villages
which are self reliant with regard to food, which have not a single flour mill and in
which the residents grow all the cotton they need and manufacture their own cloth,
right up to the stage of stitching garments in their own homes, should, he stated, be
awarded prizes and exempted from taxes.
Some have suggested that he was not really opposed to the use of machinery
but only to its mis-use. Gandhi himself complained in various writings that his
opposition to machinery was misunderstood for he was not against machinery as
such. Similarly, he observes that ‘machine power can make a valuable contribution
towards economic progress’. Nevertheless, the role that he ascribed to machinery Self-Instructional
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Indian Economic in the process of industrial development was a very limited one. ‘It is said that now
Thought II
India is going to be industrialised. But industrialisation of my conception has to be
carried out in the villages with the Charkha plying in every home and cloth being
produced in every village’ (CW 88: 84). Essentially this is a vision of self-employed
NOTES villagers producing their subsistence, including food and clothing, by manual labour,
using very simple tools and implements. This is very different from industrialisation.
He did, it is true, accept that some large scale private industry would continue, for
example in the production of cotton textiles. Trusteeship (which is theme of the
next section) would help ameliorate its ill effects.
Gandhi’s ideas on machinery are closely linked to his concept of Swadeshi.
Neither has had any significant effect on economic policy. Developing countries,
including India in particular, have not chosen to adopt village industries as an
alternative to modern industrialisation. Indirectly, however, Gandhi’s ideas about
technology have had some influence by providing a warning that mechanisation on
Western lines may not necessarily be the optimal solution for countries with a very
different resource-endowment. Instead, countries with plentiful labour and relatively
little capital might benefit by concentrating on light industries and on labour-intensive
techniques for producing their products. In the sense his ideas may have played
some part in encouraging the adoption of what has been called intermediate or
‘appropriate’, technology in highly populated but capital-poor developing counties.
Trusteeship and Industrial Relations
Gandhi’s theory of trusteeship was developed as an alternative to doctrines of
socialism and communism (the two words are used more or less interchangeably
in Gandhi’s writings) which started becoming popular in India following the Russian
revolution of 1917. These doctrines, wrote Gandhi, had brought to the forefront
the question of what ‘our’ attitude towards the wealthy should be. He took socialist
doctrine to mean essentially that the property of the rich – princes, millionaires, big
industrialists and landlords – should be confiscated and they should be made to
earn their livelihood as workers. Gandhi disagreed. All that one could legitimately
expect of the wealthy was to hold their riches ‘in trust’ and use them for the service
of society as a whole. ‘To insist upon more would be to kill the goose that laid the
golden eggs’.
The rationale of trusteeship was that everything on earth belonged to and
was from God. If an individual had more than his ‘proportionate’ share of wealth,
or talent, he became a trustee of that part for the people as a whole. The rich
should therefore use their talents to increase their wealth, for the sake of the nation.
Trusteeship, thus, was a form of moral responsibility but it was quite different from
either charity or benevolence and in a way it was an alternative to them. ‘If the
trusteeship idea catches philanthropy as we know it will disappear’.
Trusteeship is, by nature, voluntary. The wealthy should come to accept
their role as trustees. In the long run trusteeship could also be institutionalised,
leading to what Gandhi described as ‘statutory trusteeship’. A trustee should be
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able to nominate his successor (CW 83:7), for legal ownership would still be Indian Economic
Thought II
vested in the trustee and not in the state. ‘It is to avoid confiscation that the doctrine
of trusteeship comes into play, retaining for society the ability of the original owner
in his own right’ (quoted in Ganguli 1973: 277). However, the trustee’s choice of
successor would be subject to conditions which would serve both as a check on NOTES
the individual’s choice and as a signal of social approval. Thus, a proprietor who
held his property as a trust could not pass it on to his children by inheritance unless
the latter agreed to become trustees. If they were not prepared for this, the owner
should nominate some other person.
The concept of trusteeship implied among other things that industrial relations
should be built on cooperation rather than conflict. The mill owner should stop
looking on labour simply as a means of earning profit, but rather as partners in a
common enterprise. This implied in particular an obligation on the part of the
employers not only to pay a living wage but also to ensure a clean working
environment and provide facilities for cheap nutritious food, sanitation and
elementary education for workers’ children. But trusteeship implied obligations
for workers, too. In the prevailing system of industrial relations, while the capitalists
tried to obtain maximum work with minimum payment, the workers hit upon various
tricks whereby they could get the maximum pay for minimum work. The result
was that a rise in wages did not mean an improvement in efficiency. When a
system of trusteeship came to prevail, the mill hand would stop nursing ill will
towards his employer and come to regard the mill in which he worked as his own.
Such an approach had economic as well as ethical merit for if it came to be
accepted, strikes and lockouts would become infrequent, productivity would
increase, and the costs of maintaining a ‘heavy supervisory establishment’ to keep
workers in order, would no longer be required . Trusteeship could also lead in a
natural way to profit-sharing and to workers’ participation in management.
In bringing about a change from the existing system of industrial relations,
based on a conflict of interest, towards based on trusteeship, it was enlightened
industrialists who had to take the lead. Gandhi himself did not regard capital to be
the enemy of labour and in principle held their coordination to be ‘perfectly possible’.
However, as in most things in life, an ideal could only be realised approximately.
‘Absolute trusteeship is an abstraction like Euclid’s definition of a point, and is
equally unattainable. But if we strive for it, we shall go further in realizing a state of
equality on earth than by any other method’ (quoted in Ganguli 1973: 271). On
asking, towards the end of his life, if he knew of any industrialist who had fully
lived up to the ideal of trusteeship, Gandhi replied, ‘No, though some are striving
in that direction’. And while the success of this, as of any, enterprise depended on
voluntary participation rather than coercion, Gandhi believed some sanctions were
legitimate if some industrialist simply refused to behave as trustees, even after
being given every chance. Different kinds of sanction could be applied, depending
on circumstances. One was to bring the force of public opinion on erring
industrialists to mend their ways. This could be expressed by direct action from
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Indian Economic below, a form of what Gandhi called non-violent non-cooperation. If that too
Thought II
failed to persuade the owners of capital to act as trustees, depriving them of their
possessions by the exercise of state power might ultimately become necessary,
‘with or without compensation as the case demanded’. However, by and large,
NOTES peaceful and rational conversion to the principle of trusteeship would remain the
norm.
Gandhi put forward two main arguments in support of his belief that
trusteeship was a better way of dealing with problems on inequality and exploitation
than communism. The first argument was based on the unequal distribution of
ability. Gandhi believed that ‘although we are all born equal, that is to say, that we
have a right to equal opportunities, nevertheless we have not all the same abilities’.
Consequently, it was natural that some of us would be more fitted than others to
acquire material gain. Entrepreneurial ability was scarce and, properly harnessed,
could be socially valuable. If the rich were deprived of their wealth. This is known
as Communism’, and made to earn their living as manual workers ‘Society will
become poorer, for it will lose the gifts of a man who knows how to accumulate
wealth’. Depriving society of the services of such capable people would not be in
the interests of the country, especially if the country itself were poor and
underdeveloped. Trusteeship, on the other hand, tries to preserve such abilities
while utilizing them for the wider interests of society. Accordingly, Gandhi’s advice
to the eldest son of a prominent industrialist, who had been a friend and political
ally, was that if he was already engaged in business he should remain so, but
should use fair means and be trustee. Secondly, Gandhi justified trusteeship by the
principle of non-violence. The communist alternative of dispossessing the wealthy
of the means of production by confiscating their property violated that principle.
The soviet communist system, even though it had some good aims, such as the
elimination of exploitation of the poor by the rich, was based on the use of force
which was unethical, and because of this Gandhi had strong doubts about his final
success
Gandhi has been accused of double standards on this point, for as we have
seen he too approved of state ownership of industry if private owners failed to
accept a trustee role. However, as elsewhere, he was prepared to accept the
lesser of two evils. Private industrialists, he thought, should be encouraged to
cooperate with labour in a spirit of partnership and, given a chance, perhaps many
would. If trusteeship did not work a minimum of state ownership would be
necessary as a last resort but Gandhi, unlike the communists, did not regard this as
either inevitable or good in itself. He had the greatest fear of the power of the
state, which while apparently doing good by the minimization of exploitation can
do the greatest harm to mankind by destroying individuality, which lies at the root
of all progress (Ganguli 1973: 272). Elsewhere he describes the state as representing
violence in a concentrated and organized form. ‘The individual has a soul but the
State is a soulless machine’. In his opinion ‘the violence of private enterprise is less
injurious than the violence of the State’. Coercion by the state could only be a
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264 Material
There was one form of state intervention with property which Gandhi did Indian Economic
Thought II
not regard as coercion, namely, high rates of wealth or inheritance taxes.
Riches have not yet been sufficiently taxed. In this, of all the countries in the
world, possession of inordinate wealth by individuals should be held as a crime
NOTES
against Indian humanity. In England they have gone as far as 70 per cent of the
earnings beyond a prescribed figure. Why should there not be death duties.
Gandhi fails, however, to recognize that the argument based on the scarcity
of entrepreneurial talent which he had used against communism, applied in some
measure against such ‘democratic socialist’ methods as well.
Charity, Leisure and the Sanctity of Work
We begin this section by discussing Gandhi’s views on charity. As we have seen,
he rejected the view that individuals’ economic behaviour either was, or should
be, guided solely by self-interested preferences. One would therefore have expected
him to be favourably disposed towards charity, which economists themselves
regards as an exception to their rules; it is the classical example of non-self-
interested behaviour. Gandhi’s view of charity is more complex, however.
In an early piece of writing, Gandhi quotes in full a well-known passage
from the New Testament, 1 Corinthians, 13, which extols the virtue of charity.
Gandhi’s own writings show quite clearly that he had considerable doubt whether
what was usually regarded as charitable action represented a virtue at all. He
seems to have taken his cue from two particular statements in the biblical passage
he referred to, which suggested that the practice of charity must itself satisfy some
other norms in order to qualify as ‘true charity’. ‘And though I bestow all my
goods to the poor and though I give my body to be burned, and have no charity it
profits me nothing’ and again, ‘…charity vaunteth not itself, is not puffed up, doth
not behave itself unseemly…’. Gandhi, too, did not approve of charity irrespective
of consequences. Indeed he took it for granted that charity need not be a good
thing. ‘There is no reason to believe that charity per se is meritorious’. In order to
judge whether a particular charitable action is good or bad one must look to its
expected consequences for recipients, donors and society at large. The effects
that Gandhi was most concerned with were those on the incentive to work. For
this reason, the idea of giving free meals to a healthy person who had not worked
for it in some honest way was particularly abhorrent to him. Giving free meals to
the poor had long been an honoured Hindu custom. It was known as Sadavrata,
which literally means ‘the constant task’. Some European authors had written in
praise of Sadavrata, saying that the Indians had developed a system of feeding
the poor that was self-organized, providing an alternative to the work-house.
Gandhi world have none of this. The system, he maintained, had done no
good to India. Indeed, it was an evil custom which had degraded the nation and
encouraged idleness, hypocrisy and crime. If food were available without effort,
those who were habitually lazy would remain idle and become poorer (CW 28:
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Indian Economic 7). Philanthropic businessmen in contemporary India who sought to acquire religious
Thought II
merit by the practice of Sadavrata were actually committing a grievous wrong.
During a visit to Calcutta, Gandhi came across hundreds of hungry people
being provided with a free meal by a private philanthropist. The sight appeared to
NOTES
him: ‘neither ennobling nor honourable to those who had organized the meals for
the hungry people of Calcutta from day to day’ (CW: 27: 464-5). Perhaps the
donors did not know what they were doing but ‘were ignorant of the irreparable
harm they were doing to India by this misplaced benevolence’. Such misplaced
charity according to Gandhi, added nothing to the wealth of the country, whether
material or spiritual and only gave a false sense of merit to the donor. For the same
reason, he exhorted Parsi millionaires of Bombay not to give all their money to the
poor, for did they want to keep those crore of people dependent on their
Sadavratas.
Gandhi allowed an exception to this condemnation of Sadavrata. It was
commended for the lame, the crippled and those who were disabled by disease,
for such people could not work. Even in this case however, relieving hunger was
not the only objective. Preserving dignity and self-respect was no less important.
‘Even the disabled should not be fed with thousands of people watching them.
There should be a proper place, private and quiet for feeding them’ (CW 28:8).
The able bodied poor should have no ‘free lunch’. ‘By their efforts, by their
own work, these people should earn their livelihood and get their clothing, and
they must not be taught to depend on others for their necessaries’. Philanthropists
who wanted to help could open institutions where meals would be given under
clean, healthy surroundings to men and women who would work for them. The
ideal work, believed Gandhi, would be spinning cotton but they should be free to
choose any other work that was appropriate and feasible. But the rule should be
‘No labour, no meal’. The same principle applied to beggars. They should be
offered work and food but if they refused to work, they should not be given food.
Those who could not work because of physical disability should be taken to
institutions financed by the state, rather than left to live by begging, which only
encouraged fraud. The vast majority of street beggars were mere professionals idlers
‘when they are not much worse’, and those who have money to spare do an ill-
service to those beggars and to the country by giving them money, food or clothing.
Gandhi’s view of charity is in line with his consequentialist view of ethics. In
this respect it differs from the Buddhist view which regards the act of alms-giving as
conferring merit on the donor irrespective of consequences. It is also in keeping with
Gandhi’s ethical ‘pluralism’. There are a number of different moral principles which
could conflict: the principle of helping others justifies charity to beggars; the principle
of self-reliance requires beggars to work. Gandhi’s solution is a compromise between
the two, an exercise impractical reasoning from ethical principles.
As was usual with Gandhi, his remarks on charity were meant to apply
primarily to a specifically Indian context. They have, however, a more general
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aspect. Governments of Western countries are under increasing economic pressure Indian Economic
Thought II
to reform their existing schemes of welfare payments, proposals have recently
come up, for example, to link the eligibility of the unemployed to receive a dole to
their willingness to work if jobs are provided. Such proposals have been attributed
to a narrow ‘economic’ outlook and criticized on moral grounds. Gandhi would NOTES
probably have approved of them but for moral rather than strictly economic reasons.
Of some interest, too, are Gandhi’s views on leisure. A standard argument
in the debate on the costs of economic growth has been that GNP fails to take the
value of leisure into account and hence may actually lead to a lowering of the
quality of life. Gandhi’s position on the role of leisure is somewhat more complex.
In a properly functioning economy, he states, everyone would be in a position to
enjoy a sufficiency of leisure. Village swaraj is described as a place where
‘everybody is a toiler with ample leisure’. On the other hand, the principle of
limitation of wants applies just as much to leisure as to the consumption of goods
and services. Leisure is ‘good and necessary’ only up to a point (Harijan, 16
May 1936). Beyond that it becomes an indulgence which is contrary to religion
and ethics. Too much leisure could erode the human facilities. Whether the leisure
was voluntary or involuntary, as in the case of Indian agriculturists who were
unemployed for a third of the year, did not, Gandhi believed, make a fundamental
difference in this regard. He felt nothing but dread at the prospect of our being
able to produce all that we want, including our foodstuffs, ‘out of conjurer’s hat’
so that we could have leisure the livelong day.
This attitude comes out also in some of his writings on machinery, which
was referred to in the previous section. Industrial civilization based on the use of
machinery could enable greater output to be achieved with reduced working time,
a prospect that Gandhi did not welcome. ‘I know that socialists would introduce
industrialization to the extent of reducing hours to one or two in a day but I do not
want it’.
Underlying Gandhi’s ideas on charity and on leisure there is a common
thread. This is the concept of the sanctity of labour and especially ‘bread-labour’.
A term Gandhi borrowed from Tolstoy. This implies that every individual should
earn the basic necessities, such as food and clothing, by the performance of manual
labour. Even those who earn their livelihood by mental labour should do some
amount of manual labour.
For Gandhi, the distinction between manual and mental labour was not
quite as rigidly drawn as it was for Tolstoy, for physical labour too, provided
opportunities for the exercise of intelligence. Intention and purpose were important
and could help increase efficiency. Intelligent body labour was the highest form of
social services, ‘for what can be better than that a man should by his personal
labour add to the useful wealth of his country.’
Analytically, the distinction between physical and mental labour was less
fundamental for Gandhi than that between work and non-work. It was the sanctity
of work as such that lay at the heart of Gandhi’s argument. Self-Instructional
Material 267
Indian Economic
Thought II
Check Your Progress
3. Why did Gandhi develop his theory of trusteeship?
NOTES 4. What has been the central concern of Indian economic thought?
13.4 E.V. RAMASAMY
EV Ramasamy, popularly known as Periyar, or Thanthai Periyar, was an Indian

social activist and politician. He is known for his Self-Respect Movement and
Dravidar Kazhagam. He is also known as the ‘Father of the Dravidian movement’.
He did remarkable work against Brahmin supremacy and gender and class
inequality in Tamil Nadu.
Ramasamy started his political career by joining the Indian National Congress
in 1919, and when he realised that the party was only working in the interests of
Brahmins he resigned in 1925. E.V. Ramasamy propagated the ideology of self –
respect, women’s rights and the abolition of caste and rationalism. He was against
the exploitation and marginalisation of the non-Brahmin Dravidian people of South
India and the burden what he considered as Indo-Aryan India. His ideas
revolutionized Tamil society by helping to remove caste-discrimination. He also
brought new changes to the Tamil alphabet .The UNESCO described him as
“The prophet of the new age, the Socrates of South East Asia, father of social
reform movement and arch enemy of ignorance ,superstition and meaningless
customs’.
Early years
Erode Venkata Ramasamy was born on 17 September 1879 to a Kannada Balija
trader family in Erode, then a part of the Coimbatore district of the Madras Presidency.
E. V. Ramasamy’s father was Venkatappa Nayakar and his mother name was
Chinnathyee, Muthammal. He had one elder brother whose name was Krishnaswamy
and he also had two sisters named Kannamma and Ponnuthoy. He later came to be
known as “Periyar” meaning the ‘respected one’ or ‘elder’ in the Tamil.
E. V. Ramasamy married at the age of 19, and had a daughter who only
survived for 5 months. His first wife, Nagammai, died in 1933. E.V. Ramasamy
married for a second time in July 1948. His second wife, Maniammai, helped him
in his social work. And even continued social work after his death in 1973.
In the year 1929, Periyar announced the removal of his caste title Naicker
from his name at the First Self-Respect Conference of Chengalpattu. He could
speak three languages Kannada, Telugu and Tamil. He attended school only for
five years after which he joined his father’s business at the age of 12. He used to
listen to Tamil Vaishnavite gurus who gave discourses in his house enjoying his
father’s generosity. At a young age, he began questioning the noticeable
Self-Instructional contradictions in Hindu mythological stories. As Periyar grew, he felt that people
268 Material
used religion only as a mask to mislead innocent public and therefore decided to Indian Economic
Thought II
alert people against superstitions and priests.
Member of Congress Party (1919–1925)
He resigned from the chairmanship of Erode Municipality and quit his business NOTES
before joining the Indian National Congress in 1919. After joining the Congress,
he sincerely joined positive programs spreading the use of Khadi, picketing toddy
shops, boycotting shops selling foreign cloth, and eradicating untouchability. In
1921, he was taken into custody while protesting against toddy shops in Erode.
Later on, his wife and his sister also joined the protest, and the administration was
forced to come to a compromise. He was once again arrested during the Non-
Cooperation movement and the Temperance movement. In 1922, Periyar
advocated for reservation in government jobs and education. Hence, he was elected
as the President of the Madras Presidency Congress Committee during the Tirupur
session, where he advocated for reservation. His attempts were not accepted in
the Congress party due to favouritism and indifference, which led him to resigning
from the party in 1925.
Vaikom Satyagraha (1924–1925)
According to the existing caste system in Kerala and all over the India, low-caste
Hindus were not allowed to enter into temples. In Kerala, they were not even
allowed to walk on the roads that led to the temples. In Feb 1924, Periyar decided
to promote movements against untouchability. In Kerala, a committee was formed
people of different castes to fight untouchability. In 1924, they decided to begin a
‘Keralaparyatanam’ movement to allow temple door open for everyone and the
right to use public roads for every Hindu irrespective of caste or belief. The
movement gained support and popularity in all over -India from far and wide.
On 1 October 1924, a group of savarnas (forward castes) submitted a
request to the Regent Maharani Sethulakshmi Bai of Travancore with about 25000
signatures to allow everyone entry in the temple. Gandhiji also supported them in
this movement and met with the Regent Maharani. This procession of savarnas
was led by Mannath Padmanabhan Nair. Vaikom Satyagraha was a Satyagraha
against untouchability and caste discrimination in Hindu society.
Thus, protest and demonstrations took place. And as on 14 April, Periyar
and his wife Nagamma reached at Vaikom. They were immediately taken into
custody and imprisoned for participation. In spite of Gandhi’s protest to non-
Keralites and non-Hindus taking part, Periyar and his supporters continued to
give support to the movement until it was withdrawn. He received the title Vaikom
Veeran, given by his supporters who participated in the Satyagraha.
Self-respect
Periyar’s belief of self-respect was based on his ideology of an ideal world and a
unanimously accepted one. The self-respect movement as all the three movement
Self-Instructional
merged into one. Material 269
Indian Economic 1. Women’s right
Thought II
2. Dalit Resistance
3. Freedom movement
NOTES Periyar advocated for the rights of the women throughout his life; he argued
that women should be given their justifiable position in society as the equal of men
and that they should be given good education and also have equal right in property
as men had. He was eager that women should understand their human rights and
be commendable citizens of their country.
He criticised the double standards of society for women and argued that it
should apply also to men, or not at all for both genders. While fighting against this,
he also advocated getting rid of the Devadasi system.
In 1925, E.V Ramasamy initiated the self-respect movement in Tamil Nadu.
It was also called the Dravidan movement which demanded equal rights for the
backward caste. According to him, the development of self-respect in an individual
will bring a halt to caste-discrimination. His beliefs teach us that human activities
should be based on realistic thinking. Freedom means respect to feelings and
activities considered correct by human beings on the basis of cause. There is not
much difference between ‘freedom’ and ‘self-respect’.
International Travel (1929–1932)
E.V. Ramasamy toured Malaya from December 1929 to January 1930, to spread
the self-respect beliefs. During the same month, he went to Singapore. In December
1931, he went for a tour of Europe, along with S. Ramanathan and Erode Ramu,
to personally educate himself with their political systems, social movements, and
way of life, economic and social progress and management of communal bodies.
He travelled to Egypt, Greece, Turkey, the Soviet Union, Germany, England, Spain,
France and Portugal, stayed in Russia for three months. During his return to India,
he halted at Ceylon and returned back by November 1932.
The tour helped him to develop the political ideology of the social concept
of Self-Respect. The communist system of the Soviet Union impressed him a lot
to deal with the social ills of the country. On socio-economic issues, Periyar was
highly influenced by Marxism, but he did not agree with the idea of abolishing
private ownership. After his return, he formed an alliance with the communist leader
M. Singaravelar, and began to work on socio-political system incorporating
communist and self-respect principles.
Opposition to Hindi
In 1937, when Chakravarthi Rajagopalachari became the Chief Minister, he
introduced Hindi as an essential language of study in schools. As a result, there
was opposition to Hindi all over the state by Tamil politicians and Tamil nationalists.
E.V. Ramasamy planned anti-Hindi protests in 1938 which ended with several
arrests by the Rajagopalachari government.
Self-Instructional
270 Material
President of the Justice Party (1938–1944) Indian Economic
Thought II
A political party the South Indian Libertarian Federation (referred to as the Justice
Party) was founded in 1916, mainly to go up against the economic and political
power of the Brahmin groups. The party’s goal was to provide social justice to the NOTES
non-Brahmin groups. To gain the support of the people, non-Brahmin politicians
began to propose the philosophy of equality among non-Brahmin castes. And
when the government introduced Hindi to be taught in the school system, E.V.
Ramasamy planned opposition to this policy through the Justice Party. After 1937,
the Dravidian movement derived considerable support from the student community.
Opposition to Hindi played a vital role in the politics of Tamil Nadu. When the
Justice Party weakened in mass support, E.V. Ramasamy took over the leadership
and become president of the party and was sent to jail for opposing Hindi in 1939.
Dravidar Kazhagam (1944–onwards)
During a party meet in 1944, Periyar, as the leader of the Justice Party, declared
that Justice Party would from now onwards be known as the Dravidar Kazhagam,
or “Dravidian Association”. However, others who were disagreed with him started
a clone group, claiming to be the actual Justice Party. The Dravidar Kazhagam
fought for the elimination of untouchability and it also focused their attention on
women’s education, women’s liberation, child marriage, widow marriage, mercy
homes and orphanages.
Rationalism
According to E.V. Ramasamy, wisdom lies in thought and any view appealing to
reason as a source of knowledge can be considered as rationalism. He stated that
no other living being harms or degrades its own class. But man said to be a rational
living being, does this evil.
E.V. Ramasamy accused the capitalists to be responsible for their control
on machineries and creating problems for labour. According to his beliefs,
rationalism, which has to lead the way for peaceful life to all, had resulted in causing
poverty and worries to the people because of dominating forces. He said that
there is no use of acquiring titles or increasing wealth if one has no self-respect or
scientific knowledge.
Social reform and eradication of caste
According to Periyar, the duty of an administration is to run the social organization
capably, while the philosophy of religion was to organize the social system.
According to Periyar, the Christian and Islamic religions were fulfilling this role,
and the Hindu religion is totally unsuitable for social progress.
Periyar advocated for a place where neither the name nor the circumstances
or its conditions involve difference among people. He further advocated for the
modernisation of villages by providing amenities such as schools, libraries, radio
Self-Instructional
Material 271
Indian Economic stations, roads, bus transport, and police stations. As per Periyar, he felt that a
Thought II
small group of silly people created caste distinctions to rule over Indian society.
Tamil language and writing
NOTES According to Periyar, Tamil, Telugu, Malayalam, and Kannada came from the
same mother tongue of Old Tamil. He also said that the Tamil language is called by
four different names since it is spoken in four different Dravidian states. However,
the current understanding of Dravidian languages contradicts such claims.
Periyar also suggested that if words of the North Indian language (Sanskrit)
are separated from Telugu, Kannada, and Malayalam, only Tamil will be left. On
the Brahmin usage of Tamil, he stated that the Tamil spoken by the Andhras and
the Malayali people was far better than the Tamil spoken by the Brahmins. As per
his belief, the Tamil language will make the Dravidian people unite under the flag of
Tamil culture, and that it will make the Kannadigas, Andhras and the Malayalees
be cautious. This will continue until there is an end to North Indian domination.
Comparisons with Gandhi
Periyar and Gandhiji both cooperated and confronted each other in the socio-
political sphere. In the Vaikom Satyagraha of 1924, Periyar and his followers give
importance to the difference in point of view between Gandhi and himself on the
social issues such as fighting against untouchability laws and abolition of the caste
system. On the Temple Entry issue, Gandhiji never supported the opening of
Garbha Griha to Harijans as a result of his Hindu belief. Periyar and his followers
emphasised that Periyar was the genuine fighter for the elimination of Untouchability
and the true fighters for Hairjans, whereas Gandhi was not. But this did not stop
Periyar from having trust in Gandhi on certain matters.
Religion and atheism
Periyar opposed the evils of religious influence on society, mainly what he regarded
as Brahmin control. At an early age he realised that some people used religion only
as a cover to mislead innocent people and considered it as the mission of his life to
make people aware against superstition and priests. According to him, Hinduism
was a religion with no idiosyncratic holy book or origin, but an imaginary belief
preaching the “supremacy” of the Brahmins, and the inferiority of the Shudras, and
the untouchability of the Dalits.
In 1955, Periyar was taken into custody for his communal action of burning
pictures of Lord Rama in public places as a symbolic objection against the Indo-
Aryan domination and degradation of the Dravidian leadership according to the
Ramayana epic. According to him, those who belongs to lower caste and are
considered untouchable within the Hindu communities should convert to other
faiths such as Islam, Christianity, or Buddhism.
Self-Instructional
272 Material
Followers and influence Indian Economic
Thought II
After Periyar’s the death in 1973, his wife become the new head and took the
charge of the Dravidar Kazhagam, Then Tamil Nadu Chief Minister M.
Karunanidhi opened Periyar’s Rationalist Library and Research Institute on his NOTES
birthday. This library contained his rationalist works and manuscripts and also had
his recorded speeches. Over the years, Periyar’s ideology has influenced Tamil
Nadu’s party politics. Both the major political parties in Tamil Nadu, DMK and
AIDMK, consider themselves to be Dravidian parties inspired by Periyar.
13.5 AMARTYA SEN
Amartya Sen is well known for his book Development Economics. In the book,
he laid the foundation of welfare economics. He also received the Nobel Prize for
his study in welfare economics, becoming the first Indian economist to win the
prestigious prize. Many aspects of his research have helped improve the condition
of the poorest of the poor. For example, his research about the causes of famine
and the remedies provided by him to prevent shortages of food has found practical
implementation. Sen has also sought to explain the reason behind famine and stated
that in democratic countries famines do not occur frequently. His research also
gives information on the lower rate of women employment and the reasons for it.
His empirical research paper also influenced international organizations that deal
in food crises around the world.
Development Economics
Improving the quality of life and the economic wellbeing of people are the core
issues in Sen’s thought. According to Sen, rights have to be defined so that citizens
particularly the poorer sections of the society can appropriate their rights to the
full extent. For him, welfare economics can regulate and formulate policies. It will
ensure the wellbeing of the society. He executed certain practical policies for the
development of the nation which is based upon capacity and differentiation.
According to Sen, this will result in useful alternatives for improving the condition
of the poor. For Sen, states have an active role to play as far as the economy is
concerned. He said that it could be generalized and regularized for a country’s
prosperity. Through such policies jobs can be retained and support of incomes
can be materialized. This can help in improving quality of life and economic well-
being for a community.
Sen in his book Development Economics stated that most cases of
starvation and famines across the world arise not from people being deprived of
things to which they are entitled, but from people not being entitled, in the prevailing
legal system of institutional rights, to adequate means for survival’. His research
found that in many famines where millions of people have died, there was no
overall decline in food availability, and starvation occurred as a consequence of
Self-Instructional
Material 273
Indian Economic shifts in entitlements resulting from exercising rights that were legitimate in legal
Thought II
terms. The inadequate of agricultural productivity and aggregate of food supply
can adversely affect a citizen’s entitlement to food. The incidence of starvation of
deaths among population groups was happened due to entitlement failures and
NOTES overall food shortages. The people are not able to trade their labour power or
skills. This study found inadequate and generalized the situations of insecure food
entitlements which does not result from market failure. You will learn more about
the linkages of poverty, and starvation in the subsequent sections.
Fig 13.3 Amartya Sen

Source: http://en.wikipedia.org/wiki/File:Amartya_Sen_NIH.jpg
Poverty, Equality and Development

A broader understanding of poverty needs to look beyond the income approach.
One of the most influential concepts in this regard has been the notion of human
capability. According to Amartya Sen, ‘Poverty of a life, in this view, lies not
merely in the impoverished state in which the person actually lives, but also in the
lack of real opportunity given by social constraints as well as personal
circumstances-to choose other types of living. Even the relevance of low incomes,
meagre possessions, and other aspects of what are standardly seen as economic
poverty relates ultimately to their role in curtailing capabilities (that is, their role in
severely restricting the choices people have to lead valuable and valued lives)’.
For Sen, the freedom of opportunity available to people is influenced by
their personal circumstances as well as social situations. The personal circumstances
that significantly matter are not just access to ‘means’ like income or wealth but
also the access to basic needs and amenities, like food, clothing, shelter, education
and health services, safe drinking water and sanitation to list a few. Along with
these material means of well-being, it is the actual states of well-being or ‘outcomes’
achieved by the person, like nutritional status, educational and health achievements
that also impact upon the real opportunities available.
Self-Instructional
274 Material
Sen believes that personal circumstances are found to be embedded in Indian Economic
Thought II
social situations. Social, political and economic relations and inequalities determine
how resources are distributed and what choices are available to different sections
of the society. Some of the most visible examples of these are based on caste,
class and gender disparities that constrain the real opportunities available to people. NOTES
Deprivations in the form of access to basic needs, actual states of well-being and
social inequalities have a great role to play in the creation of economic poverty.
On the other hand, economic poverty often reinforces these deprivations. And the
circle is difficult to break. Thus, a uni-dimensional approach to poverty as essentially
income poverty overlooks the other dimensions of deprivation that makes inequality
of opportunity persist and poverty replicate itself.
According to Sen, the major dimensions of poverty that persist in India
relate to deprivations in nutritional, educational and health achievements, access
to basic needs and amenities, quality of physical environment and various social
inequalities like caste and gender disparities. In this context, some of the other
targets given in the millennium development goals (MDGs), besides reduction in
headcount ratio, give a sense of the challenge facing contemporary India in terms
of poverty. Sen has continuously asserted that India’s progress has been much
slower than needed to meet the targets in the reduction of incidence of mortality
and morbidity among women and children, reduction of hunger and improvement
in nutritional status, reduction of gender and caste-related disparities and
improvement in general living conditions in terms of better access to basic amenities.
India may not achieve many of these targets in spite of the likelihood of it becoming
an economic superpower by 2015. It means that in the absence of effective
measures directed at bridging the gaps, the regions doing better in terms of human
development will be better placed to seize the benefits of growth. The result can
be one of growing economic inequality in India. Such a scenario cannot be
considered conducive (either to the process of rapid economic growth or the
prospect of India becoming economic superpower) if the growing inequalities
lead to increasing regional and social conflicts within India.
Hunger and Malnutrition in India
According to Sen, hunger and malnutrition are outcomes of food insecurity or the
inability to access adequate food and nutrition. Hunger-related poverty remains one
of the major deprivations in India. In 2001-03, every fifth Indian (20 per cent) WIIS
found to be undernourished. Sen’s research found that the rate of decline in the
proportion of the undernourished through the 1900s was much slower in comparison
to the decline in poverty-headcount ratio. In fact, the proportion of undernourished
people remained stagnant at 2 per cent in the second half of the 1990s and the
number of the undernourished actually increased. As a result, it is most likely that
India is going to miss the millennium development goal in this regard.
For Sen, an even greater cause of concern is the status of malnutrition among
children. Malnutrition directly affects the development of the child by retarding
Self-Instructional
Material 275
Indian Economic their physical and cognitive growth and increases the risk of infection and disease.
Thought II
Malnutrition also affects cognitive and motor development in children, thereby
influencing educational attainment, labour productivity and future income earning
ability. If lack of income means vulnerability to food insecurity and malnutrition,
NOTES then the latter also reduces the lifetime-earning potential. A recent report stated
that about 40 per cent of Indian children are malnourished with another 20 per
cent being stunted.
The deprivations relating to hunger and malnutrition, morbidity, mortality
and the physical environment often reinforce each other and the general condition
of economic poverty. To give an example, an illness like diarrhoea is one of the
major causes of infant deaths in India, along with malaria, pneumonia and measles
contributing to the high infant-mortality rates. Diarrhoea also leads to loss of
absorption of nutrients, causing severe malnutrition among children. On the other
hand, malnutrition has been estimated to be associated with about half of all child
deaths and more than half of child deaths from diarrhoea (61 per cent). India’s
achievements in terms of the proportion of population having access to either of
these basic facilities are woefully low.
Sen has also stated that there is also gender dimension to hunger and
malnutrition in India. Half of the country’s women suffer from anaemia and the
prevalence of anaemia is even higher among the pregnant women. Anaemia is one
of the major causes of maternal mortality and also contributes to nearly 30 per
cent of babies being born underweight. The low birth weight means that there is
greater risk of growth retardation, most of which occurs by the age of two and is
often irreversible. In 1998-99, about 37 million children, almost one half of children
below the age of three, were chronically undernourished. Approximately, 18 per
cent of the children were severely underweight. Overall, two out of three children
were moderately or severely malnourished. A greater prevalence of
undernourishment can be seen among the children from scheduled-caste and
scheduled-tribe communities. The rate of decline of undernourishment among these
sections of the population was also found to be lower in comparison to the general
population in the 1990s. It leads to the widening gap in terms of nutritional status
among these communities and the general population. A similar observation could
be made about the divergence between rural and urban areas, in the 1990s, in
terms of nutritional status. The overall picture that emerges is one of growing urban-
rural, inter-caste, male-female and economic class disparities in nutritional status
in the 1990s.
It is the dark irony of our times that hunger and malnutrition are so pervasive
in the country, while the Indian economy has achieved self-sufficiency in food
grain production. The Indian government maintains buffer food grain stocks to
guard against serious food shortages arising from drought and other crop failures.
But in 2001, starvation deaths were reported from various parts of the country as
more than 13 states were affected by drought. This happened at a time when the
Food Corporation of India was finding it difficult to manage the millions of tonnes
Self-Instructional
276 Material
of surplus food grain rotting in its warehouses. Similar cases have been reported in Indian Economic
Thought II
the following years and have led to the ‘Right to Food’ campaign. Chronic hunger
and malnutrition are not as visible and shocking as starvation deaths but they happen
to be more widespread and persistent.
NOTES
Civil and Political Rights: Promoting Economic Security
In his writings, Sen has also argued that civil and political rights can reduce the risk
of major social and economic disasters by empowering individuals to complain,
ensuring that these views are disseminated, keeping government informed and
precipitating a policy response. According to Sen, civil and political rights give
people the opportunity to draw attention forcefully to general needs and to demand
appropriate public action. Whether and how a government responds to needs
and sufferings may well depend on how much pressure is put on it, and the exercise
of political rights (such as voting, criticizing, protesting, and so on) can make a real
difference. Sen’s empirical research has also illustrated the ways in which the
denial of civil and political rights can function as an obstacle to human development.
Sen has asserted that civil and political rights can function to promote
economic security. He has articulated the view that no major famine has occurred
in any country with a democratic form of government. He has suggested that this
statement applies not only to the affluent countries of Europe and America, but
also to the poor but broadly democratic countries such as India and Botswana;
while the incidence of famines in India until independence in 1947 (for example,
the Bengal famine in 1943 killed between 2 and 3 million people) contrasts with
the post-independence experience following establishment of a multiparty
democratic system – providing inter-temporal evidence of the positive impact of
democracy in reducing the risk of famine. In order to achieve economic
development, Sen said that justice has to inclusive and humane. It helps to remove
inequities. To him, justice must be free from the pre-eminence of the will of middle-
of-the-road and one that touches lives that people actually live. In the process, it
takes global concerns into account for economic development.
Check Your Progress

5. When did Periyar join the Indian National Congress?
6. According to Amartya Sen, what are the major dimensions of poverty that
persist in India?

QUESTIONS
1. Nehru’s ideals of a ‘physical planning’as distinguished from financial planning

demanded a simultaneous development of agriculture, villages, cottage
industries and heavy industry based on a system of harmonizing.
Self-Instructional
Material 277
Indian Economic 2. The concept of the Mixed Economy was based on the aim to push forward
Thought II
the development of the productive forces by means of co-existence of a
state capitalist and a private capitalist sector and by the application of planning
and other regulation measures, to guarantee social progress and create the
NOTES conditions of the development of native capitalism with the help of the state.
3. Gandhi’s theory of trusteeship was developed as an alternative to doctrines
of socialism and communism (the two words are used more or less
interchangeably in Gandhi’s writings) which started becoming popular in
India following the Russian revolution of 1917.
4. The central concern of Indian economic thought since Ranade had been the
problem of industrialization.
5. Periyar resigned from the chairmanship of Erode Municipality and quit his
business before joining the Indian National Congress in 1919.
6. According to Sen, the major dimensions of poverty that persist in India
relate to deprivations in nutritional, educational and health achievements,
access to basic needs and amenities, quality of physical environment and
various social inequalities like caste and gender disparities.
13.7 SUMMARY
 As an Indian student in England, Nehru witnessed the political controversies

about the economic development in Europe and Asia. He was politically
influenced by Bal Gangadhar Tilak and Bipin Chandra Pal, and was
impressed by the personality of Gopal Krishan Gokhale.
 Immediately after being given the responsibility of becoming the first Prime
Minister of independent India in 1947, Nehru launched a number of economic
reforms. In order to remove economic disparities in India between the
landlords and the landless class, he introduced laws regarding land
redistribution.
 After winning independent India’s first general election, he started the process
of centralized planning by introducing the first five-year plan in 1951. The
plan determined the mode of government expenditure and grants in important
development sectors like agriculture, industries and education.
 Nehru’s economic policies have often been considered to be Socialist in
nature. There cannot be any doubt that socialism did play a very important
role in Nehru’s ideological make-up. Similarly, his short visit to the Soviet
Union convinced him about the need for India to adopt centralized planning.
However, at the same time, it is also significant to note that Nehru himself
denied any kind of explicit socialist leanings in the economic policies
implemented by him. Nehru advocated a kind of mixed economy.
Self-Instructional
278 Material
 The concept of Mixed Economy was based on the aim to push forward the Indian Economic
Thought II
development of the productive forces by means of co-existence of a state
capitalist and a private capitalist sector and by the application of planning
and other regulation measures, to guarantee social progress and create the
conditions of the development of native capitalism with the help of the state. NOTES
 The state sector as the main item of the concept of mixed economy has proved
its strategic importance for the strengthening of India’s independence and is
now one decisive factor of the power and productivity of the national economy.
 A mixed economy usually is an economic system where both the public and
the private sector direct the economy. Mixed economies reflect the
characteristics of both market driven liberal economies and state controlled
socialist economies.
 Nehru favoured the mixed economy approach towards development, but
he did not regard the mixed economy as a ‘half-way house’ between the
capitalistic or liberal and the communistic or socialist forms of economic
organization.
 For Nehru, the mixed economy was an amalgamation of the two economic
systems and since it was free from both their dogmatic approaches, the
mixed economy represented a higher form of economic organization.
 Nehru also took the position that the continuous exceptional growth of
science and technology that resulted in phenomenal changes in human activity
and the modes of production could only be absorbed by the mixed economy,
which alone possessed the flexibility and resilience to do so.
 According to Humayum Kabir, Gandhi was an inheritor of the liberal
tradition, of the tradition of philosophical anarchism, and of the tradition of
collectivism found socialistic thought, that the good thing of life ought to be
shared. He would support a welfare state because of his great concern for
the masses.
 Gandhi would have liked the Five Years Plans and other method of planned
development if they could have originated of the people. But a plan, which
increase government post, favouritism, nepotism and opportunities,
corruption and laziness, would have been definitely rejected by him. He
was, therefore, not in favour on concentration of heavy industries and the
grand multipurpose river valley projects which did not benefit the people in
the proportion of the huge amounts spent on them.
 Gandhi himself often likens his economic ‘model’ to Euclid’s definition of a
straight line but this is consistent with either interpretation. It could mean
that like the straight line ‘which cannot be drawn’ the Gandhian model relates
to an ideal economic order where people could well be motivated quite
differently from those in any society that we know of. However, it could
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Indian Economic also mean that ‘something like’ a straight line can be drawn, and in economics
Thought II
as in geometry, the postulational method can help in achieving clarity in
thought and in solving real life-problems, for ‘we must have a proper picture
of what we want before we can have something approaching it’.
NOTES
 Gandhi was trying to describe an economic ideal to strive for rather than
simply an economic plan to implement. To that extent his economics was
utopian. However ‘utopian’ can also refer to something ‘impractical’ or
even ‘impossible’.
 Gandhi’s economic thought was not ‘utopian’ in that sense. It was currently
meant to apply to an actual society, that of rural India in particular. It would
still apply only to a few selected aspects of that society while neglecting
others but that is true of all economic models.
 From this point of view what really differentiates Gandhi’s approach to
economic issues from the mainstream tradition is his extraordinary emphasis
on the ethical aspect of economic behaviour. Indeed, he believed that
economic and ethical questions were inseparable.
 The concept of ‘limitation of wants’ is a typically Gandhian contribution to
the theory of welfare economics. This states that an individual’s welfare is
best achieved not, as economic theory suggests, by attempting to maximize
the satisfaction of multiplicity of desires subject only to the prevailing budget
constraint but rather by reflecting on his desires and trying to choose between
them.
 The central concern of Indian economic thought since Ranade had been the
problem of industrialization. Different views were held on what constrained
industrial development in India. All agreed that the industrial development
was the log-run solution to poverty and famine. They agreed as well that the
development of manufacturing industry on modern Western lines was
desirable. Gandhi, on the other hand, did not regard industrialization as a
goal that India should adopt. The overall vision which led Gandhi to his
doctrines of the limitation of wants and Swadeshi also led him to oppose
modern industrial development.
 Gandhi’s theory of trusteeship was developed as an alternative to doctrines
of socialism and communism (the two words are used more or less
interchangeably in Gandhi’s writings) which started becoming popular in
India following the Russian revolution of 1917. These doctrines, wrote
Gandhi, had brought to the forefront the question of what ‘our’ attitude
towards the wealthy should be. He took socialist doctrine to mean essentially
that the property of the rich – princes, millionaires, big industrialists and
landlords – should be confiscated and they should be made to earn their
livelihood as workers. Gandhi disagreed.
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 Gandhi’s view of charity is in line with his consequentialist view of ethics. In Indian Economic
Thought II
this respect it differs from the Buddhist view which regards the act of alms-
giving as conferring merit on the donor irrespective of consequences. It is
also in keeping with Gandhi’s ethical ‘pluralism’. There are a number of
different moral principles which could conflict: the principle of helping others NOTES
justifies charity to beggars; the principle of self-reliance requires beggars to
work. Gandhi’s solution is a compromise between the two, an exercise
impractical reasoning from ethical principles.
 EV Ramasamy, popularly known as Periyar, or Thanthai Periyar, was an
Indian social activist and politician. He is known for his Self-Respect
Movement and Dravidar Kazhagam.
 In Feb 1924, Periyar decided to promote movements against untouchability.
 Periyar advocated for the rights of the women throughout his life; he argued
that women should be given their justifiable position in society as the equal
of men and that they should be given good education and also have equal
right in property as men had.
 When the Justice Party weakened in mass support, E.V. Ramasamy took
over the leadership and become president of the party and was sent to jail
for opposing Hindi in 1939.
 E.V. Ramasamy accused the capitalists to be responsible for their control
on machineries and creating problems for labour. According to his beliefs,
rationalism, which has to lead the way for peaceful life to all, had resulted in
causing poverty and worries to the people because of dominating forces.
 Amartya Sen is well known for his book Development Economics. In the
book, he laid the foundation of welfare economics. He also received the
Nobel Prize for his study in welfare economics, becoming the first Indian
economist to win the Nobel Prize in economics. Many aspects of his
research have helped improve the condition of the poorest of the poor.
 Sen in his book Development Economics stated that most cases of
starvation and famines across the world arise not from people being deprived
of things to which they are entitled, but from people not being entitled, in the
prevailing legal system of institutional rights, to adequate means for survival’.
 His research found that in many famines in which millions of people have
died, there was no overall decline in food availability, and starvation occurred
as a consequence of shifts in entitlements resulting from exercising rights
that were legitimate in legal terms.
 Sen believes that a broader understanding of poverty needs to look beyond
the income approach.
 According to Amartya Sen, ‘Poverty of a life, in this view, lies not merely in
the impoverished state in which the person actually lives, but also in the lack
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Indian Economic of real opportunity given by social constraints as well as personal
Thought II
circumstances-to choose other types of living. Even the relevance of low
incomes, meagre possessions, and other aspects of what are standardly
seen as economic poverty relates ultimately to their role in curtailing
NOTES capabilities (that is, their role in severely restricting the choices people have
to lead valuable and valued lives)’.
 According to Sen, the major dimensions of poverty that persist in India
relate to deprivations in nutritional, educational and health achievements,
access to basic needs and amenities, quality of physical environment and
various social inequalities like caste and gender disparities.
 According to Sen, hunger and malnutrition are outcomes of food insecurity
or the inability to access adequate food and nutrition.
 Hunger-related poverty remains one of the major deprivations in India.
 Sen has also stated that there is also gender dimension to hunger and
malnutrition in India. Half of the country’s women suffer from anaemia and
the prevalence of anaemia is even higher among the pregnant women.
13.8 KEY WORDS
 Bourgeoisie: Bourgeoisie is a French term used in the fields of political

economy, political philosophy, sociology, and history, which originally denoted
the wealthy stratum of the middle class that originated during the latter part
of the Middle Ages. In Marxist philosophy, bourgeoisie denotes the social
class who owns the means of production, and whose societal concerns are
the value of property and the preservation of capital, in order to ensure their
economic supremacy in society.
 Trusteeship: It refers to an economic policy under which the rich will possess
all their wealth in trust for the good of the people.
 Swaraj: It means self-rule or home rule.
 Swadeshi: Swadeshi is a Hindi term meaning self-sufficiency. During the
Indian independence movement the Swadeshi movement was an economic
strategy aimed at removing the British Empire from power and improving
economic conditions in India by following the principles of Swadeshi which
entailed boycotting British products and the revival of domestic products
and production processes.
 Famine: It refers to a situation of extreme scarcity of food.
 Welfare economics: Welfare economics uses microeconomic methods to
assess well-being from distribution of productive factors as to desirability
and economic efficiency within an economy, often relative to competitive
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general equilibrium. It examines social welfare, however measured, in terms Indian Economic
Thought II
of economic activities of the individuals that compose the society that is
being considered.
NOTES
EXERCISES
1. Discuss the background that framed Nehru’s economic thinking.
2. What was Gandhi’s philosophical anarchism?
3. What was Gandhi’s concept of welfare state?
4. What was Gandhi’s view on charity?
5. Write a short-note on the life of Periyar.
6. What was the Vaikom Satyagraha?
7. In what way is hunger-related poverty one of the major problems in India?
1. At the time of independence, the Indian economy was in an appalling
condition. Discuss.
2. Examine the economic policies of Nehru.
3. Nehru did not regard the mixed economy as a ‘half-way house’ between
the capitalistic or liberal and the communistic or socialist forms of economic
organization. Discuss.
4. The concept of mixed economy was based on the aim to push forward the
development of the productive forces by means of co-existence of a state
capitalist and a private capitalist sector. Comment.
5. The Gandhian system of economic thought cannot be adequately appraised
merely in terms of current economic theory which rests on certain limited
assumptions. Discuss.
6. The concept of ‘limitation of wants’ is a typically Gandhian contribution to
the theory of welfare economics. Discuss.
7. A broader understanding of poverty needs to look beyond the income
approach. Discuss.
8. In his writings, Sen has also argued that civil and political rights can reduce
the risk of major social and economic disasters. Comment.
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Indian Economic
Thought II 13.10 FURTHER READINGS

NOTES University Paperbacks Publisher: Methuen.
Company.
Publications.
Blackwell.
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Welfare Economics
UNIT 14 WELFARE ECONOMICS

Structure NOTES
14.0 Introduction
14.1 Objectives
14.2 Meaning of Welfare Economics
14.3 Education
14.4 Health
14.5 Poverty
14.7 Summary
14.8 Key Words
14.0 INTRODUCTION
Welfare economics is the learning of how the distribution of wealth and goods
affects social welfare. It communicates straight to the study of financial efficiency
and income distribution, as well as how these two aspects affect the overall well-
being of people in the economy. In practical terms, the study of welfare economics,
includes tools to monitor public policy to attain advantageous social and economic
results for all of society. However, this field is a microeconomic study is depended
on selected norms regarding how welfare can be defined, measured, and compared
for individuals and society as a whole. Reaching the pareto efficiency is considered
the ultimate level in welfare economics. Pareto efficiency is the situation of economy
where no resources can be used any more to benefit one individual without making
another individual worse off in their situation. Aiming a move of taking the economy
towards Pareto efficiency might be an overall improvement in the social welfare,
but it does not provide a specific target. It does not really mention the manner in
which economic resources are to be allocated and used by individuals and markets
to really maximize social welfare. Welfare economists to achieve this objective
have theorised different types of social welfare functions. The public policy for
social welfare is then worked around to maximize the value of these functions. In
this unit, you will learn about the meaning of welfare economics and then learn
how education, health and poverty affects and functions in the realm of welfare
economics.
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Welfare Economics
14.1 OBJECTIVES

NOTES  Explain the meaning of welfare economics
 Discuss the role of education
 Describe the role of health
 Examine poverty and its relationship with welfare economics
14.2 MEANING OF WELFARE ECONOMICS
Economics has both positive and normative character. In learning the positive
aspects of economies, especially in microeconomics, the general concern is
optimum allocation of resources at the micro levels, i.e., how individual consumers
and firms maximise their objective functions— consumers their utility function and
firms their profit function. From the analysis of these aspects of economic theory,
it may appear that if all individual firms optimise their resource allocation with a
view to maximising their profit function, the total output of goods and services
available to the society will be maximum. And, when all individual consumers
optimise their resource allocation to maximise their utility function, the total utility
enjoyed by the society as a whole will be maximum. In other words, if both firms
and consumers maximise their respective objective functions, the total economic
welfare of the society will be maximum. This however may not be true because
private and public interests can and do conflict. Therefore, optimisation of resource
allocation from an individual’s point of view may not conform to the tests of optimum
allocation of resources from society’s point of view. Positive microeconomics leaves
unanswered many economic problems regarding maximization of social welfare.
Nor does it suggest appropriate policy measures that can maximise the economic
well-being of the society as a whole. The branch of economic analysis which is
concerned with these problems is called welfare economics.
As regards the origin of welfare economics, it is very difficult to point out
the period in the history of economic thoughts which marks the beginning of welfare
economics. Nor is it reasonable to associate the emergence of welfare economics
with any particular economist, because ‘welfare economics does not appear at
any time to have wholly engaged the labours of any one economist.’1 Some believe
that Pigou’s Wealth and Welfare and his later work Economics of Welfare mark
the emergence of welfare economics as a separate branch of economics. But Hla
Myint has pointed out, in his Theories of Welfare Economics, that the classical
economist had a great deal to say on a subject which could reasonably be brought
within the compass of welfare economics. Many textbooks, however, commence
discussion on welfare economics with Pareto.
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Definition of Welfare Economics Welfare Economics
Welfare economics is the study of economic welfare of the members of a society

as a group. In the words of Oscar Lange, ‘Welfare economics is concerned with
the conditions which determine the total economic welfare of a community.’2 NOTES
Reder defines ‘welfare economics’ as that ‘branch of economics science
that attempts to establish and apply the criteria of propriety to economic policies.’3
In his survey of welfare economics, Mishan defines ‘theoretical welfare
economics’ as ‘that branch of study which endeavours to formulate propositions
by which we may rank on the scale of better and worse, alternative economic
situations open to society’4 The function of welfare economics is to evaluate the
alternative economic situations and determine whether one economic situation yields
greater economic welfare than others. Welfare economics may also be defined as
that branch of economic science which evaluates alternative economic situations
(i.e., alternative patterns of resource allocations) from the viewpoint of economic
well-being of the society as a whole.
Nature of Welfare Economics
Economists hold different views on the question whether welfare economics is a
positive (pure) or normative (applied) science. Although welfare economics has been
closely associated with positive economics from the inception of economic thinking,
‘at one point in economic thought, it was felt that welfare economics was unscientific;
that it was normative and was hence a branch of Ethics. . . .’5 It was also argued that
welfare economics is concerned with ‘what ought to be’ and, hence, it is ‘normative’
in character. This view, however, has not been universally held.
Pigou, for example, was concerned, in his Economics of Welfare, with the
causes of economic welfare and did not make any policy recommendation. Pigou’s
Economics of Welfare is, therefore, a positive study.6
A widely held view on this issue is that welfare economics is both a positive
and a normative science. Positive economics is primarily concerned with understanding,
explaining and predicting the working of the economic system. Welfare economics is
a positive science insofar as it attempts to explain and predict the outcome of the
functioning of the economic system. Welfare propositions ‘may be subjected to test
in the same way as those of positive economics,’ though testing welfare propositions
is much more difficult than the propositions of general positive economics.7 The
information gained through positive analysis is useful in devising appropriate policy
measures to maximise the welfare of the society. The task of normative economics is
to determine ‘what ought to be’. Welfare economics is a normative science in that it
provides guidelines for policy formulations to maximise social welfare. Maximisation
of economic welfare presumes a welfare function which consists essentially of value
judgements. Given the welfare function, welfare economics, as a normative science,
provides guidelines for appropriate policy measures.
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Welfare Economics The Concept and Measurement of Social Welfare
The term ‘welfare’ has been defined in many diverse ways, perhaps, because it is
extremely difficult to give it a precise meaning. The difficulty arises from the fact
NOTES that welfare of an individual or of a group of individuals depends on diverse and
immeasurable factors including social, political, economic and philosophical attitude
of the people towards life and society. In economics, however, the concept of
welfare is used in a narrow sense: it is limited to only economic welfare. Even the
term economic welfare eludes a precise definition. Nevertheless, economists have
tried to give it a concrete meaning.
Cardinal Utility Approach: Social Welfare Is Sum of Individual Utility
The concept of economic welfare used in economic literature is synonymous to
utility or happiness.8 The economic welfare of an individual, thus, equals the total
utility he derives from the goods and services that he consumes, the leisure that he
enjoys, and deeds that he performs, but not all of these. Economic welfare of an
individual equals the total utility derived from only those goods and services and
only that part of leisure and deeds which can be exchanged for money or can be
brought under the measuring rod of money.
On the basis of this concept of individual welfare, Bentham defined social
welfare as ‘the sum total of the happiness (or welfare) of all the individuals in
society.’9 Following Benthamite doctrine, Pigou defined social welfare as the
arithmetic sum of the individual welfare. In a nutshell, social welfare, i.e., the
aggregate of welfare of society, was regarded (by the economists of cardinal utility
tradition) as the arithmetic sum of the cardinally measurable utilities of the individual
members of society.
The concept of social welfare based on cardinal utility has however met with
certain serious objections. First, it is argued that utility cannot be cardinally measured
and, hence, cannot be added to obtain the aggregate welfare. That is, the concepts
that cannot be quantified cannot be added together. It is therefore meaningless to
define social welfare as the sum of the individual welfare. This objection is universally
accepted. Second, since ordinal measurement of utilities is not possible, interpersonal
comparison of utilities is not possible in an objective or scientific way. It would
therefore not be possible to determine how a change in existing pattern of resource
allocation affects the aggregate welfare unless it is unrealistically assumed that all
individuals have identical income utility and commodity utility functions.
Owing to these problems, Benthamite and Pigovian concept of social welfare
had become inoperational as it could not be used objectively in any policy formulation.
Therefore, the cardinal utilitarian thesis that the welfares of different individuals could
be added up to arrive at the welfare of society had to be abandoned.
Pareto’s Approach: Social Welfare as Social Optimum
It was Vilfred Pareto, an Italian economist, who broke away from the cardinal
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288 Material
cardinal utility concept and additive utility function on the ground of their limitations Welfare Economics
mentioned above. With the rejection of cardinal utility thesis, the attempts to quantify
the social welfare ended, at least temporarily, perhaps because welfare is not an
observable quantity like a market price or an item of personal consumption.
NOTES
Pareto introduced a new concept, i.e., the concept of social optimum. This
concept is central to Paretian welfare economics. The basic idea behind this concept
is that while it is not possible to add up utilities of individuals to arrive at the total
social welfare, it is possible to determine whether social welfare is optimum.
Conceptually, social welfare is said to be optimum when nobody can be made
better-off without making somebody worse-off. In the words of Boulding, ‘a social
optimum is defined as a situation in which nobody can move to a position which he
prefer without moving somebody else to a position which is less preferred.’10
The basic point in regard to the concept of social optimum which need to be
noted is that social optimum does not define (or determine) a quantity or magnitude
of welfare. It is rather associated with the question whether the magnitude of social
welfare from a given economic situation can be or cannot be increased by changing
the economic situation. The test of increase in social welfare is that at least one
person should be made better-off without making anybody else worse-off.
However, it is difficult to conceive economic policies which can improve the
welfare of an individual without injuring another. To overcome this problem, the
economists, viz., Kaldor, Hicks and Scitovsky, have evolved the compensation
principle. This principle states that the person who benefits from an economic
policy or reoganisation must be able to compensate the person who becomes
worse-off due to this policy and yet remain better-off.
To conclude, modern welfare economics does not attempt to quantify the
total social welfare. It concerns itself with only the indicators of change in welfare.
It analyses whether total welfare increases or decreases when there is a change in
economic situation. This approach is based on the premise that while cardinal
measurement of utility is not possible, expression of utility in ordinal sense is possible
and it is an adequate guide to change in the welfare of an individual. It is this
principle on which the modern welfare criteria are based.
Check Your Progress

1. Why is the following statement considered to be false: ‘if both firms and
consumers maximise their respective objective functions, the total economic
welfare of the society will be maximum’?
2. What are the questions that are unanswered by positive microeconomics?
3. How has Pigou defined social welfare?
4. State the compensation principle given by Kaldor, Hicks and Scitovsky.
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Welfare Economics
14.3 EDUCATION
Education is related to the growth of human skills and awareness of the individuals
NOTES or work force. The educational opportunities provide the quantitative expansion
as well as the qualitative improvement in the lifestyle of the people. It has a substantial
influence in the development of economy. Education is also called as human capital
and outlay on education of the persons as outlay in man or human capital. The
significance of educational capital or human capital is state by Prof. Harbison in
his words as: ‘Human resources consti-tute the ultimate basis of production human
beings are the active agents who accumulate capital, exploit natural resources,
build social, economic and political organisations, and carry forward national
development. Clearly, a country which is unable to develop the skills and knowledge
of its people and to utilise them effectively in the national economy will be unable
to develop anything else.’
The contribution of education in development of economy is huge because no
country can achieve rational financial development without focussing and developing
their human capital. Training and development improves the comprehension skills
and knowledge of the individual as well as the world. It helps in improving the
standard of living and provides extensive communal benefits to both the individual
and the civilisation. Higher education increases profitability and innovativeness of the
individual and inculcates in individuals entrepreneurial initiatives and power-driven
developments. These cumulatively add to the development of economy of a nation
or state. It undertakes an extremely critical position in safeguarding finances, general
progress as well as improving income delivery. Better levels of intellectual skills of
residents of the country give enormous optimistic results on the subsequent
development of economy. Financial forecasters also acknowledge that investing in
education, or human capital, is a critical constituent in the process of a nation financially.
Statistical researches provide very deep and reliable confirmation that well educated
and professionally skilled experts are more profitable and that they obtain higher
incomes. In developing economies, education faces several hurdles in the form of
increasingly changing technologies which alters the marketplaces as well as the low
availability and access to up-to-date training facilities.
The role of education in the society can be categorised as:
 Ethical Progress: Value education or the good education system can be
considered to be the basis of personality and ethics in the mind of an
individual. Value education teaches humans a sense of modesty, bravery,
honesty, acceptance, courteousness, genuineness, fellow-feeling, love, spirit
of service and sacrifice and power of judgement between evil and moral
which, in actual sense, forms an honourable and intelligent character in
humans.
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 Cultural Growth: The cultural legacy along with the ancient custom is sturdily Welfare Economics
conserved and sheltered by education. Ethics are essential in culture and

education works for the improvement and superiority of culture. It is
recognized that ethics are the lively side of culture. As such, teaching ethics
shows a significant role in the cultural development and refinement. NOTES
 Expansion of Optimistic Approach: Nurturing an optimistic and broader
approach is the achievement of education. A good education system broadens
the attitude of learners on the way to life. This broader attitude supports
them to encounter the difficulties and eventualities of life confidently and
bravely. This attitude drives them to be concerned in communal service and
compromise their self-centred purposes for a the benefit of the society.
 Development of Democratic Values: Value education helps in nurturing
democratic qualities like freedom, equality, communal living, righteousness,
co-operative living, peaceful co-existence, respect to others, and self-
respect, distribution of accountability, etc. These are essentials for the
development of a nation and progress of the society.
 Giving Direction to Nature: Redirection of human nature towards positive
mindset is vital for the development of the individual and the society.
Education helps in re-routing of natures and needs for building up of the
individual personality and advancement of the society. Education shapes an
individual’s personality and modifies his behaviour by channelizing his desires,
instincts and urges in a desirable direction.
 Resolving Conflicts and Contradictions: In our contemporary society
information is considered supreme which contributes rise to continuous
disputes between conventional and innovative theories, traditional and
innovative values of life. Quality education protects the society by carrying
out its part as a rescuer help solve clashes among people through informed
debates, discussions and facts.
 Acting as a Basis of Humanitarianism and Altruism: Quality education
is said to be the comprehensive basis of humanitarianism and selflessness. It
stands for harmony, goodwill and understanding. It helps in nurturing the
association of man and unity and understanding of the world. It dismisses
negative traits like discrimination, mistreatment, bribery, tragedy, self-
centredness and hot-headedness. Therefore, it forms the basis of altruistic
values and altruistic temper. It inspires people to hold the saying ‘to live and
let live’. Therefore, it leads to contentment, harmony and serenity by refining
an enormous trust in superlative values of life-truth, goodness and beauty.
 Advancement of Personality: Personality is a part of final truth. To retain it
is the need of the hour in order to live in harmony with the definitive truth in the
world. Education provides nourishment to the personality for building it for a
flawless and honourable use for the sake of the development of the society.
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Welfare Economics  Maintaining Harmony: Quality education is important for maintaining
synchronization among diverse characteristics of personality of the individual.
It principally aims at developing the complete man/woman, the complete
psychological and sociological creature. As such, different characters are
NOTES synchronised by importance of education for creating a man/woman
complete who can add significantly to the speed of advancement of the
society and the nation at large.
 Creating an Awareness: Quality education is desirable for producing a
sense of realisation to the centre point of man within man in the current
culture, which is clear by a movement of de-culturalisation, dehumanization
and disaffection from the typical social life. Thus, ethical awareness is essential
to be educated by quality education to protect the society from all forms of
calamities and misfortunes.
Hence, it is supposed that if the future of the world is to be protected from
huge crisis, quality education to children is the finest way. The structure of future
world rest on mainly on the basis of values. Education is the excellent pathway
over which mass of values can be managed with the students; the promising citizens
in a country.
To ensure education for the society, in an economy, the government can
many different steps .Major initiatives taken by the Government in the education
sector are as follows:
 In 2020, India’s public broadcaster Prasar Bharati entered into a MoU
with the Ministry of Electronics and Information Technology to launch
51 direct-to-home (DTH) education TV channels.
 The ‘KAPILA’ Kalam Program for IP (Intellectual Property) Literacy
and Awareness Education has been launched, which is expected to create
awareness on patenting of inventions.
 Two facilities—Innovation & Incubation Centre and Sports Complex—
in IIT Jodhpur has been launched.
 The Strengthening Teaching-Learning and Results for States (STARS)
project with a total cost of 5,718 crore (US$ 775.99 million) has
been approved for implementation; the project will also receive financial
support worth US$ 500 million from the World Bank.
 An MoU was signed between the Indian Sign Language Research and
Training Centre (ISLRTC) and the National Council of Educational
Research and Training (NCERT) to provide textbooks and other
educational materials in sign language for hearing-impaired children.
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 The Gyan Circle Ventures, a MeitY funded Technology Business Welfare Economics
Incubator (TBI) of Indian Institute of Information Technology, Sri City

(Chittoor), Andhra Pradesh has been launched to foster innovation and
entrepreneurial spirit in institutions.
NOTES
 According to Union Budget 2020-21, Government allocated 59,845
crore (US$ 8.56 billion) for Department of School Education and
Literacy.
 Revitalising Infrastructure and Systems in Education (RISE) by 2022
was announced in Union Budget 2020-21 with a proposed outlay of
3,000 crore (US$ 429.55 million).
 Under Union Budget 2020-21, Government proposed apprenticeship
embedded degree/diploma courses by March 2021 in about 150 higher
educational institutions.
The achievements of the Government in the past four years:
 In private equity (PE) and venture capital (VC) funding, companies in
the education sector attracted US$ 500 million by end of 2019.
 In February 2020, Indian Institute of Technology, Delhi signed a
memorandum of understanding (MoU) with New Zealand universities
to establish a New Zealand Centre at the institute with an investment of
US$ 50,000 each from both parties.
 Central Board of Secondary Education (CBSE) introduced artificial
intelligence as a subject in class ninth from the session 2019-20.
14.4 HEALTH
Health has been recognised as a factor which leads to the rise in the wealth of a
nation at the individual and community levels. Moreover, it is a definite truth that
better health condition influences economic activity and economic growth. The
difficulty of involvement of human resources to growth of economy has been the
source for numerous debates and studies. Till now education was measured as the
key factor of human resource development. Withe reference to the neo-classical
theory, the growth of economy is reliant on the subsequent factors of a) Stock of
capital, b) Stock of labour c) Productivity. There are four factors of society which
is affected by the health: Labour Productivity, Labour Supply, Education and
Investment. Let’s discuss each of these here in this section.
 Labour productivity: Population having a good health status can yield
more within a certain defined time period. High production rate is dependent
on the health of person along with their physical and mental wellbeing. Persons
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Welfare Economics with better status physically and mentally can use technology more effectively
and they are likely to be flexible about their job too.
 Labour supply: There is direct relation between labour supply and health
in some work areas. Good health condition decreases the amount of days
NOTES
spent as sick, therefore increasing the number of productive working days.
In this context it impacts results on labour supply along with incomes. In
instances where wages are linked to output, a healthy employee can yield
more, thus improving wages and through this mode the labour supply. On
the contrary, a healthier status assures lifelong incomes as opposed to having
to take retirement or quit the job due to health reasons.
 Education: According to the theory of human capital, as much as people
are educated can reach greater standards in relation to their productivity
and incomes. Being healthier can help these individuals attain advanced
educational qualifications which will help them increase their productivity in
future even more.
 Investment: Investment in health affects the country at the micro level but
somehow it also has effects at the macro level and the GDP and growth rate
of country. The healthier the population tends to be, they will invest more in
the areas of economy and if the population is not healthy then the people
will spend more on the health treatments and will save less and invest less.
Some of the major initiatives taken by the Government of India to promote
Indian healthcare industry are as follows:
 In Union Budget 2020 21, 35,600 crore has been allotted for nutrition-
related programmes.
 The Government has announced 69,000 crore expenditure for the
health sector that is comprehensive of 6,400 crore for PMJAY in
Union Financial plan 2020–21.
 The Government of India aims to increase healthcare spending to 3% of
the Gross Domestic Product (GDP) by 2022.
 In February 2019, the Government of India established a new All India
Institute of Medical Sciences (AIIMS) at Manethi, District Rewari,
Haryana at a cost of 1,299 crore (US$ 180.04 million).
 The Union Cabinet approved setting up of National Nutrition Mission
(NNM) with a three-year budget of 9,046 crore (US$ 1.29 billion)
to monitor, supervise, fix targets and guide the nutrition related
interventions across ministries.
 On September 23, 2018, Government of India launched Pradhan Mantri
Jan Arogya Yojana (PMJAY), to provide health insurance worth
500,000 (US$ 7,124.54) to over 100 million families every year.
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294 Material
 In August 2018, the Government of India approved Ayushman Bharat- Welfare Economics
National Health Protection Mission as a centrally sponsored scheme

contributed by both center and state Government at a ratio of 60:40 for
all States, 90:10 for hilly Northeastern States and 60:40 for Union
Territories with legislature. The center will contribute 100% for Union NOTES
Territories without legislature.
 The Government of India launched Mission Indradhanush with an aim
of improving coverage of immunisation in the country. It aimed to achieve
atleast 90% immunisation coverage by December 2018 and cover
unvaccinated and partially vaccinated children in rural and urban areas
of India.
The achievements of the Government in health sector are as follows:
 As of July 2019, around 125.7 million families enrolled as beneficiaries
under Pradhan Mantri Jan Arogya Yojana (PMJAY). The scheme
enrolled 16,085 hospitals, including 8,059 private hospitals and 7,980
public hospitals. It included 19 AYUSH packages in the treatment
scheme.
 As of September 2019, about 50 lakh people received free treatment
under the Ayushman Bharat-Pradhan Mantri Jan Arogya Yojana.
 The number medical colleges in India increased to more than 560 in
November 2020 from 412 in Financial Year 2016.
 According to Sample Registration System Bulletin-2016, India has
registered a 26.9% reduction in Maternal Mortality Ratio (MMR) since
2013.
 In November 2020, National Telemedicine services completed 8 lakh
tele-consultations since its launch, enabling patient-to-doctor consultations
from the limits of their home, as well as doctor-to-doctor consultations.
14.5 POVERTY
Poverty is said to exist when persons want resources to fulfil their basic needs. In
this framework, the identification of poor requires a proper definition of what
constitutes being poor. In one conception, it may be defined as those not having
things which are ‘essential for existence’ or as generally as those ‘replicating the
dominant standard of living in the community.’ The first standard would protect
only those people near the margin of hunger or death; the second would extend to
people whose nutrition, housing, and clothing, though adequate to preserve life,
do not measure up to those of the population as a whole.
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Material 295
Welfare Economics The problem of definition is further compounded by the non-
economic connotations that the term poverty has acquired. Poverty has been
related, for example, with poor health, low levels of education or skills, an inability
or an unwillingness to work, high rates of disruptive or disorderly behaviour, and
NOTES improvidence. While these qualities have frequently been associated to be with
poverty, their presence in the meaning of poverty would tend to make complex
the relation between them and the helplessness to provide for one’s basic needs.
Although poverty is a phenomenon as old as history of humans, its importance has
transformed over time. There are different types of poverty that may be categorised
on the basis of different factors as time or duration (long- or short-term or cyclical)
and distribution (widespread, concentrated, and individual).
 Cyclical Poverty: Cyclical poverty denotes to the type of poverty that
may be common through the population, but the existence itself is of partial
duration. Prices would rise because of scarcities of food, which bring
widespread, albeit temporary, misery.
 Collective Poverty: In comparison to cyclical poverty, which is provisional,
common, collective poverty includes quite an everlasting inadequacy of
revenues to protect basic needs. It is a condition that may be as broad as to
define the regular level of life in a society or that may be focused in
comparatively big groups in an otherwise wealthy society. Both widespread
and focused collective poverty may be communicated from generation to
generation, parents passing their poverty on to their children.
 Case Poverty: Case property is similar to the collective property in terms
of its permanent or long-term nature however dissimilar from it in terms of
circulation. Case poverty discusses the incompetence of a specific
or family to safeguard elementary wants even in communal environments.
This incapability is normally connected to the deficiency of some basic aspect
that would allow the specific person to maintain himself or herself.
Causes of Poverty
 Growing Population: Population is growing in India at a fast speed. This
growth is largely due to lessening in death rate and rise in birth rate. The
population of India was 84.63 crores in 1991, increased to 102.87 crores
in 2001, as per the last census in 2011 was around 121 crores and in 2020
was close to 138 crores. This burden of population shows limitation in the
mode of development of economy.
 Unemployment Rate: There is a constant rise in population which results
into the situation of long-lasting unemployment and disguised unemployment
in India. The type of unemployment prevailing in India is the educated
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296 Material
unemployment and disguised unemployment. Poverty is just the replication Welfare Economics
of unemployment.
 Capital Deficiency: Capital is required for locating up industry,
transportation and other plans. Lack of capital creates gaps in development.
NOTES
 Under-developed economy: It is the main cause of poverty. The Indian
economy is under-developed due to little proportion of development which
means that there is less income and less resources to be re-distributed.
 Rise in Price: The upright rise in prices has impacted the deprived critically.
They end to become poorer.
 Net National Income: The net national income of our country is pretty
low in relation to the population. Low per capita income indicates the level
of poverty.
 Rural Economy: The majority of the economic interest lies in rural areas
of economy in India. There is a huge backwardness in Indian agriculture. It
has boundless burden of population. The income generated in agriculture is
little and disguised unemployment is more in agriculture.
 Lack of Trained Labour: In India, untrained labour is in plentiful and
skilled labour is fewer because of inadequate industrial education and training.
 Obsolete Societal foundations: The societal arrangement of our country
is occupied of obsolete customs like caste system, laws of inheritance and
succession. These obstruct the development of economy.
 Lack of effective Industrialists: For development of industries, intelligent
and competent industrialists are desired. In India, there is scarcity of efficient
industrialists. Inadequate development of industrial areas is another major
cause of poverty.
 Improper use of Natural Resources: India has large amount of natural
resources like iron, coal, manganese, mica etc. It has continuing flowing
rivers that can produce hydroelectricity. There is plenty of human resources.
But there is no proper utilisation of the resources available.
 Lack of Infrastructural Development: The means of transport and
communication have not been correctly developed. There is inadequate
road transport and the railway network is less dense in relation to the
geographical terrain and the rate of population of India. Due to absence of
suitable development of road and rail transport, there are defects in agricultural
marketing. Industries do not get power supply and raw materials in time
and finished goods are not properly marketed.
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Material 297
Welfare Economics Measures to Eradicate Poverty in India
The following are the measures that can be used to eradicate poverty in India:
 Control in Population Growth: There is a rapid increase in the population
NOTES of India. The population is growing at the rate of 1.8%. For the elimination
of poverty, the population growth rate should be pulled down.
 Growth in Opportunities for Employment: There should be brought in
place different measures to resolve the problems of unemployment and
disguised unemployment. There is a need for progress in agriculture. In
rural areas, there must be growth of small scale and cottage industries to
generate employment.
 Equitable distribution of Income: Simple increase in manufacturing and
putting regulations on growth of population will not eliminate poverty in
India. It is indispensable that inconsistency in the distribution of income
should be reduced.
 Problem of Distribution: The public distribution system (PDS) should be
secured to eradicate poverty. Deprived sections should be able to buy food
grains at subsidised rates and in reasonable quantities.
 Increase in the output of the Deprived: To eradicate poverty, it is
indispensable to intensify the output level of the poor. The poor should be
provided with more employment. The investment in the public areas need
to be increased and private sectors to generate employment.
 Alterations in procedures of Production: India should implement labour
intensive techniques of manufacturing. To achieve progress in mechanical
fields, the power of our young population should be utilised by providing
them employment and basic sustainable level living standards.
 Constancy in Price Level: Constancy in price levels helps to eradicate
poverty. If prices tend to rise continuously, the poor will become poorer.
So the government should do its best to keep the prices under control and
take regulatory steps to ensure that the market doesn’t become too volatile.
Check Your Progress

5. What are the democratic qualities which can be nurtured through value
education?
6. How is there a direct relation between labour supply and health?
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298 Material
Welfare Economics
QUESTIONS
1. If both firms and consumers maximise their respective objective functions, NOTES
the total economic welfare of the society will be maximum. This however
may not be true because private and public interests can and do conflict.
2. Positive microeconomics leaves unanswered many economic problems
regarding maximization of social welfare. Nor does it suggest appropriate
policy measures that can maximise the economic well-being of the society
as a whole.
3. Pigou defined social welfare as the arithmetic sum of the individual welfare.
4. Kaldor, Hicks and Scitovsky’s compensation principle states that the person
who benefits from an economic policy or reoganisation must be able to
compensate the person who becomes worse-off due to this policy and yet
remain better-off.
5. Value education helps in nurturing democratic qualities like freedom, equality,
communal living, righteousness, co-operative living, peaceful co-existence,
respect to others, and self-respect, distribution of accountability, etc. These
are essentials for the development of a nation and progress of the society.
6. There is direct relation between labour supply and health in some work
areas. Good health condition decreases the amount of days spent as sick,
therefore increasing the number of productive working days.
14.7 SUMMARY
 Optimisation of resource allocation from an individual’s point of view may

not conform to the tests of optimum allocation of resources from society’s
point of view.
 Positive microeconomics leaves unanswered many economic problems
regarding maximization of social welfare. Nor does it suggest appropriate
policy measures that can maximise the economic well-being of the society
as a whole. The branch of economic analysis which is concerned with these
problems is called welfare economics.
 As regards the origin of welfare economics, it is very difficult to point out
the period in the history of economic thoughts which marks the beginning of
welfare economics. Nor is it reasonable to associate the emergence of
welfare economics with any particular economist, because ‘welfare
economics does not appear at any time to have wholly engaged the labours
of any one economist.’
Self-Instructional
Material 299
Welfare Economics  Welfare economics is the study of economic welfare of the members of a
society as a group.
 Economists hold different views on the question whether welfare economics
is a positive (pure) or normative (applied) science.
NOTES
 A widely held view on this issue is that welfare economics is both a positive
and a normative science.
 The term ‘welfare’ has been defined in many diverse ways, perhaps, because
it is extremely difficult to give it a precise meaning. The difficulty arises from
the fact that welfare of an individual or of a group of individuals depends on
diverse and immeasurable factors including social, political, economic and
philosophical attitude of the people towards life and society.
 The concept of economic welfare used in economic literature is synonymous
to utility or happiness. The economic welfare of an individual, thus, equals
the total utility he derives from the goods and services that he consumes,
the leisure that he enjoys, and deeds that he performs, but not all of these.
 The concept of social welfare based on cardinal utility has however met
with certain serious objections. Owing to these problems, Benthamite and
Pigovian concept of social welfare had become inoperational as it could not
be used objectively in any policy formulation.
 It was Vilfred Pareto, an Italian economist, who broke away from the cardinal
utility tradition and gave a new orientation to welfare economics.
 Pareto introduced a new concept, i.e., the concept of social optimum. This
concept is central to Paretian welfare economics. The basic idea behind
this concept is that while it is not possible to add up utilities of individuals to
arrive at the total social welfare, it is possible to determine whether social
welfare is optimum.
 Modern welfare economics does not attempt to quantify the total social
welfare. It concerns itself with only the indicators of change in welfare. It
analyses whether total welfare increases or decreases when there is a change
in economic situation.
 Education states to the growth of human skills and awareness of the
individuals or work force. The educational opportunities provide the
quantitative expansion as well as the qualitative improvement in the lifestyle
of the people. It has a substantial influence in the development of economy.
Self-Instructional
300 Material
 Health has been recognised as a factor which leads to the rise in the wealth Welfare Economics
of a nation at the individual and community levels. Moreover, it is a definite

truth that better health condition influences economic activity and economic
growth.
NOTES
 Poverty is said to exist when persons want resources to fulfil their basic
needs. In this framework, the identification of poor requires a proper
definition of what constitutes being poor.
 The problem of definition is further compounded by the non-
economic connotations that the term poverty has acquired.
14.8 KEY WORDS
 Welfare economics: It is the study of economic welfare of the members

of a society as a group.
 Economic welfare: For individuals, it equals the total utility he derives
from the goods and services that he consumes, the leisure that he enjoys,
and deeds that he performs, but not all of these.

EXERCISES
1. Write a short note on the origin of welfare economics.
2. Briefly explain the nature of welfare economics.
3. Why did the concept of social welfare, based on cardinal utility, meet with
certain serious objections?
4. Write a short note on the factors of society which is affected by the health:
5. What are the different types of poverty?
1. Explain concept and measurement of social welfare including cardinal
approach and Pareto’s approach.
2. Examine the role of education in our society.
3. Discuss the causes of poverty in India and measures to eradicate it.
Self-Instructional
Material 301
Welfare Economics

NOTES Publications
Company.
Publications.
Endnotes
1 Mishan, E.J., in his “A Survey of Welfare Economics” in Survey of Economic Theory,
Vol. I, London, Macmillan,1965, p. 154. Welfare Economics (ed.) by Kenneth J. Arrow
and Tibor Scitovsky (London, George Allen and Unwin Ltd.), pp.26–28.
2. Oscar Lange, “The Foundations of Welfare Economics,” Econometrica , Vol. 10, 1942,
Reprinted in Readings in
3. M.W. Reder, Studies in the Theory of Welfare Economics (New York, Columbia
University Press, 1947), p. 13.
4 E.L. Mishan, “A Survey of Welfare Economics” in Survey of Economic Theory, Vol.
1 (London, Macmillan, 1965), p. 156.
5 Reder, op. cit., p. 13.
6 . M.D. Little has however shown in his A Critique of Welfare Economics (Oxford
University Press, 1975) that Pigou’s Economics of Welfare cannot be regarded as a
purely objective study of the causes of welfare.
7 E.J. Mishan, op. cit. , p. 157.
8 For details see, I.M.D. Little, A Critique of Welfare Economics, Second edn. (Oxford
University Press, 1957), Chapter 1.
9 Ibid. , p. 7.
10 K.E. Boulding, “Welfare Economics”, in A Survey of Contemporary Economics, Vol.
II.
Self-Instructional
302 Material

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ALAGAPPA UNIVERSITY

[Accredited with ‘A+’ Grade by NAAC (CGPA:3.64) in the Third Cycle

Directorate of Distance Education

HISTORY OF ECONOMIC THOUGHT

"The copyright shall be vested with Alagappa University"

Vikas® is the registered trademark of Vikas® Publishing House Pvt. Ltd.

Unit-1: Introduction: Nature - Approaches - Significance of History of Unit 1: Introduction to

UNIT 1 INTRODUCTION TO ECONOMIC THOUGHT 1-20

UNIT 2 MERCANTILISM 21-42

UNIT 3 PHYSIOCRACY 43-60

UNIT 4 CLASSICAL SCHOOL-I 61-100

UNIT 5 CLASSICAL SCHOOL-II 101-120

UNIT 6 SOCIALISM 121-136

UNIT 7 SCHOOLS OF SOCIALISM-I 137-146

UNIT 8 SCHOOLS OF SOCIALISM-II 147-158

UNIT 9 INSTITUTIONAL ECONOMICS-I 159-168

UNIT 10 INSTITUTIONAL ECONOMICS-II 169-178

UNIT 11 JOHN MAURICE CLARK AND JOHN KENNETH GALBRAITH 179-188

UNIT 12 INDIAN ECONOMIC THOUGHT I 189-230

UNIT 1 INTRODUCTION TO Economic Thought

After going through this unit, you will be able to:

As human knowledge accumulates, it is analyzed and categorized into different

Check Your Progress

1.4 NATURE AND APPROACHES

Check Your Progress

1.5 SIGNIFICANCE OF THE HISTORY OF

1.6 ANSWERS TO CHECK YOUR PROGRESS

 Economic science, like other sciences, has had to undergo a process of

1.8 KEY WORDS

 Physiocracy: It is an economic theory developed by a group of 18th-

1.9 SELF ASSESSMENT QUESTIONS AND

1.10 FURTHER READINGS

Hajela, T.N. 2000. History of Economic Thought. New Delhi: Konark

After going through this unit, you will be able to:

2.2 INTRODUCTION AND FORMS

The development of mercantilism was the consequence of the amalgamation of

of feudalism, lack of state organization, rise of free labour classes, competition

found that the wealth of all nations could be increased simultaneously.

Check Your Progress

2.3 THOMAS MUN

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2.4 ANSWERS TO CHECK YOUR PROGRESS

2.6 KEY WORDS

 Humanism: It is a philosophical stance that emphasizes the value and agency

2.8 FURTHER READINGS

Hajela, T.N. 2000. History of Economic Thought. New Delhi: Konark

After going through this unit, you will be able to:

Check Your Progress

3.3 NATURAL ORDER

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3.4 PRIMACY OF AGRICULTURE

3.5 THE CIRCULATION OF WEALTH AND

The physiocrats advanced their theory of circulation of wealth in society which is

Check Your Progress

3.7 OTHER IMPORTANT CONCEPTS OF

Now we will discuss some other important concepts of physiocracy.

foreign countries and checking the free exchange of commodities. Their

of scientific study is to discover such law.

Check Your Progress

3.8 ANSWERS TO CHECK YOUR PROGRESS

1. The main objective of physiocrats was to recognise the French economy

contribute to production by expenses on improvement of land and by

3.10 KEY WORDS