Economist Knut Wicksell made his name among the Swedish public with a series of provocative lectures on the causes of prostitution, drunkenness, poverty, and overpopulation. A malthusian, the young Wicksell advocated birth control as the cure for these social ills. His image as a radical social reformer did much to attract the attention of the press and the Young Socialists with whom he sympathized. But his rejection of marx and marxism limited his popularity. Wicksell was not so much an innovator as a synthesizer. His integration and refinement of existing microeconomic theories helped earn Wicksell recognition as the “economists’ economist.” In his 1893 book, Value, Capital, and Rent, Wicksell analyzed and praised the Austrian theory of capital as elaborated by Eugen von Böhm-Bawerk. In the first volume of his Lectures on Political Economy Wicksell concluded that Böhm-Bawerk’s idea of roundaboutness did not make sense, and agreed with Irving Fisher that waiting was a sufficient explanation for interest rates. Wicksell also laid out marginal productivity theory, the theory that the payment to each factor of production equals that factor’s marginal product. Economists Philip Wicksteed, Enrico Barone, and John Bates Clark had already elaborated this theory, but Wicksell’s exposition of it was superior. Wicksell also emphasized that an efficient allocation of resources is not necessarily just, because the allocation depends on the preexisting distribution of income, and nothing guarantees that this preexisting distribution is just. Wicksell is best known for Interest and Prices, his contribution to the fledgling field now called macroeconomics. In this book and in his 1906 Lectures in Political Economy, volume 2, Wicksell sketched out his version of the quantity theory of money (monetarism). The standard view of the quantity theory before Wicksell was that increases in the money supply have a direct effect on prices—more money chasing the same amount of goods. Wicksell focused on the indirect effect. In elaborating this effect, Wicksell distinguished between the real rate of return on new capital (Wicksell called this the “natural rate of interest”) and the actual market rate of interest. He argued that if the banks reduced the rate of interest below the real rate of return on capital, the amount of loan capital demanded would increase and the amount of saving supplied would fall. Investment, which equaled saving before the interest rate fell, would exceed saving at the lower rate. The increase in investment would increase overall spending, thus driving up prices. This “cumulative process” of inflation would stop only when the banks’ reserves had fallen to their legal or desired limit, whichever was higher. In laying out this theory, Wicksell began the conversion of the old quantity theory into a full-blown theory of prices. The Stockholm school, of which Wicksell was the father figure, ran with this insight and developed its own version of macroeconomics. In some ways this version resembled later Keynesian economics. Among the young Swedish economists who learned from Wicksell were Bertil Ohlin, Gunnar Myrdal, and Dag Hammarskjöld, later secretary general of the United Nations. For much of his adult life, Wicksell depended on several small inheritances, grants, and the meager income earned through public lectures and publications. Not until 1886, when he was awarded a major grant, did he begin to pursue economics seriously. With financial support secured, Wicksell traveled to universities in London, Strasbourg, Vienna, Berlin, and Paris. By 1890 Wicksell had returned to Stockholm, but being “too notorious” and unqualified to teach—he held degrees in mathematics, but economics instructors were then required to have formal degrees in law and economics—he returned to freelance writing and lecturing. In 1900, when Wicksell was forty-eight years old, he was granted his first teaching position at the University of Lund, which he retained until his retirement in 1916. His quirky habits, friendly demeanor, and willingness to actively defend his beliefs earned him respect and popularity among his students. Throughout his lifetime Wicksell never lost his penchant for radicalism. He forfeited a professorship by refusing to sign the application with the conventional “Your Majesty’s most obedient servant.” In 1910 he was jailed for two months by the Swedish government for a satirical public lecture he delivered on the Immaculate Conception. In spite of his disdain for ceremony and fanfare, his common-law widow consented to an extravagant funeral upon his death at age seventy-four. Selected Works   1893. Value, Capital and Rent. Translated by S. H. Frowein. London: Allen and Unwin, 1954. Reprint. New York: Augustus M. Kelley, 1970. 1901. Lectures on Political Economy. Vol. 1. Translated by E. Classen. London: Routledge and Kegan Paul, 1934. 1906. Lectures on Political Economy. Vol. 2. Translated by E. Classen. London: Routledge and Kegan Paul, 1935. 1907. “The Influence of the Rate of Interest on Prices.” Economic Journal 17: 213–220. Available online at: http://www.econlib.org/library/Essays/wcksInt1.html   (0 COMMENTS)

  The American economist James Tobin received the 1981 Nobel Prize “for his analysis of financial markets and their relations to expenditure decisions, employment, production, and prices.” Many people regard Tobin as America’s most distinguished Keynesian economist. Tobin’s most important work was on financial markets. He developed theories to explain how financial markets affect people’s consumption and investment decisions. Tobin argued that one cannot predict the effect of monetary policy on output and unemployment simply by knowing the interest rate or the rate of growth of the money supply. Monetary policy has its effect, he claimed, by affecting capital investment, whether in plant and equipment or in consumer durables. And although interest rates are an important factor in capital investment, they are not the only factor. Tobin introduced the concept of “Tobin’s q” as a measure to predict whether capital investment will increase or decrease. The q is the ratio between the market value of an asset and its replacement cost. Tobin pointed out that if an asset’s q is less than one—that is, the asset’s value is less than its replacement cost—then new investment in similar assets is not profitable. If, on the other hand, q exceeds one, this is a signal for further investment in similar assets. Tobin’s insight was also relevant to his ongoing debate with Milton Friedman and other monetarists (see monetarism). Tobin argued that his q, by predicting future capital investment, would be a good predictor of economy-wide economic conditions. Tobin’s portfolio-selection theory is another of his contributions. He argued that investors balance high-risk, high-return investments with safer ones so as to achieve a balance in their portfolios. Tobin’s insights helped pave the way for further work in finance theory. Tobin did his undergraduate and graduate work at Harvard University, with an interruption to serve in the U.S. Navy during World War II. In 1950 he became an economics professor at Yale University, taking a leave of absence to serve as a member of President John F. Kennedy’s Council of Economic Advisers from January 1961 to July 1962. Tobin was quite proud of the 1962 Economic Report of the President that he helped to write. Tobin called the report, which was mainly written by chairman Walter Heller, along with Tobin, Kermit Gordon, Robert Solow, and Arthur Okun, “the manifesto of our [Keynesian] economics, applied to the United States and world economic conditions of the day.” Its counterpart in the Reagan years was the 1982 Economic Report. Always the partisan, although an honest and thoughtful one, Tobin said: “It is interesting to compare the two; we have nothing to fear.” Tobin was also an adviser to 1972 presidential candidate George McGovern. Like most other economists across the political spectrum, Tobin believed that government regulation often causes damage. “We should be especially suspicious of interventions that seem both inefficient and inequitable,” he wrote; “for example, rent controls in New York or Moscow or Mexico City, or price supports and irrigation subsidies benefiting affluent farmers, or low-interest loans to well-heeled students.” In 1970 Tobin was president of the American Economic Association. He is also the author of this encyclopedia’s article on monetary policy. Selected Works   1958. “Liquidity Preference as Behavior Towards Risk.” Review of Economic Studies 25, no. 67: 124–131. 1965. “On Improving the Economic Status of the Negro.” Daedalus 94, no. 4: 878–897. 1966. National Economic Policy. New Haven: Yale University Press. 1974. The New Economics One Decade Older. Princeton: Princeton University Press. 1988 (edited with Murray Weidenbaum). Two Revolutions in Economic Theory: The First Economic Reports of Presidents Kennedy and Reagan. Cambridge: MIT Press. 1990. “One or Two Cheers for ‘The Invisible Hand.’” Dissent (Spring): 229–236.   (0 COMMENTS)

  More than any other economist, Paul Samuelson raised the level of mathematical analysis in the profession. Until the late 1930s, when Samuelson started his stunning and steady stream of articles, economics was typically understood in terms of verbal explanations and diagrammatic models. Samuelson wrote his first published article, “A Note on the Measurement of Utility,” as a twenty-one-year-old doctoral student at Harvard. He introduced the concept of “revealed preference” in a 1938 article. His goal was to be able to tell by observing a consumer’s choices whether he or she was better off after a change in prices, and indeed, Samuelson determined the circumstances under which one could tell. The consumer revealed by choices his or her preferences—hence the term “revealed preferences.” Samuelson’s magnum opus, which did more than any other single book to spread the mathematical revolution in economics, is Foundations of Economic Analysis. Based on his Harvard Ph.D. dissertation, this book shows how virtually all economic behavior can be understood as maximizing or minimizing subject to a constraint. John R. Hicks did something similar in his 1939 book, Value and Capital. But while Hicks relegated the math to appendixes, “Samuelson,” wrote former Samuelson student Stanley Fischer, “flaunts his in the text.”1 Samuelson’s mathematical techniques brought a new rigor to economics. As fellow Nobel Prize winner Robert Lucas put it, “He’ll take these incomprehensible verbal debates that go on and on and never end and just end them; formulate the issue in such a way that the question is answerable, and then get the answer.”2 Samuelson is among the last generalists to be incredibly productive in a number of fields in economics. He has contributed fundamental insights in consumer theory and welfare economics, international trade, finance theory, capital theory, dynamics and general equilibrium, and macro-economics.     Swedish economist Bertil Ohlin had argued that international trade would tend to equalize the prices of factors of production. Trade between India and the United States, for example, would narrow wage-rate differentials between the two countries. Samuelson, using mathematical tools, showed the conditions under which the differentials would be driven to zero. The theorem he proved is called the factor price equalization theorem. In finance theory, which he took up at age fifty, Samuelson did some of the initial work that showed that properly anticipated futures prices should fluctuate randomly. Samuelson also did pathbreaking work in capital theory, but his contributions are too complex to describe in just a few sentences. Economists had long believed that there are goods that the private sector cannot provide because of the difficulty of charging those who benefit from them. National defense is one of the best examples of such a good. Samuelson, in a 1954 article, was the first to attempt a rigorous definition of a public good. In macroeconomics Samuelson demonstrated how combining the accelerator theory of investment with the Keynesian income determination model explains the cyclical nature of business cycles. He also introduced the concept of the neoclassical synthesis—a synthesis of the old neoclassical microeconomics and the new (in the 1950s) Keynesian macroeconomics. According to Samuelson, government intervention via fiscal and monetary policies is required to achieve full employment. At full employment the market works well, except at providing public goods and handling problems of externalities. james tobin called the neoclassical synthesis one of Samuelson’s greatest contributions to economics. In Linear Programming and Economic Analysis Samuelson and coauthors Robert Dorfman and Robert Solow applied optimization techniques to price theory and growth theory, thereby integrating these previously segregated fields. A prolific writer, Samuelson has averaged almost one technical paper a month for more than fifty years. Some 338 of his articles are contained in the five-volume Collected Scientific Papers (1966–1986). He also has revised his immensely popular textbook, Economics, nearly every three years since 1948; it has been translated into many languages. Samuelson once said, “Let those who will write the nation’s laws if I can write its textbooks.” In 1970 Paul Samuelson became the first American to receive the Nobel Prize in economics. It was awarded “for the scientific work through which he has developed static and dynamic economic theory and actively contributed to raising the level of analysis in economic science.” Samuelson began teaching at the Massachusetts Institute of Technology in 1940 at the age of twenty-six, becoming a full professor six years later. He remains there at the time of this writing (2006). In addition to being honored with the Nobel Prize, Samuelson also earned the John Bates Clark Award in 1947—awarded for the most outstanding work by an economist under age forty. He was president of the American Economic Association in 1961. Samuelson was born in Gary, Indiana. At age sixteen he enrolled at the University of Chicago, where he studied under Frank Knight, Jacob Viner, and other greats, and alongside fellow budding economists Milton Friedman and George Stigler, who were then graduate students. Samuelson went on to do his graduate work at Harvard University. Samuelson, like Friedman, had a regular column in Newsweek from 1966 to 1981. But unlike Friedman, he did not and does not have a passionate belief in free markets—or for that matter in government intervention in markets. His pleasure seemed to come from providing new proofs, demonstrating technical finesse, and turning a clever phrase. Samuelson himself once said: “Once I asked my friend the statistician Harold Freeman, ‘Harold, if the Devil came to you with the bargain that, in exchange for your immortal soul, he’d give you a brilliant theorem, would you do it?’ ‘No,’ he replied, ‘but I would for an inequality.’ I like that answer.” Selected Works   1938. “A Note on the Pure Theory of Consumers’ Behavior.” Economica, n.s., 5 (February): 61–71. 1939. “Interactions Between the Multiplier Analysis and the Principle of Acceleration.” Review of Economics and Statistics (May): 75–78. 1947. Foundations of Economic Analysis. Cambridge: Harvard University Press. 2d ed. 1982. 1948 (with William Nordhaus). Economics. 18th ed. New York: McGraw-Hill, 2004. 1948. “International Trade and the Equalization of Factor Prices.” Economic Journal 58 (June): 163–184. 1954. “The Pure Theory of Public Expenditure.” Review of Economics and Statistics (November): 387–389. 1958 (with Robert Dorfman and Robert Solow). Linear Programming and Economic Activity. New York: McGraw-Hill.   Footnotes 1. Stanley Fischer, “Paul Anthony Samuelson,” in John Eatwell, Murray Milgate, and Peter Newman, eds., The New Palgrave: A Dictionary of Economics, vol. 4 (New York: Stockton Press, 1987), p. 235.   2. Arjo Klamer, Conversations with Economists (Totowa, N.J.: Rowman and Allanheld, 1983), p. 49.   (0 COMMENTS)

  Although recognized equally for his contributions to economic policy, methodology, and the history of ideas, Lionel Robbins made his name as a theorist. In the 1920s he attacked Alfred Marshall’s concept of the “representative firm,” arguing that the concept was no help in understanding the equilibrium of the firm or of an industry. He also did some of the earliest work on labor supply, showing that an increase in the wage rate had an ambiguous effect on the amount of labor supplied (see supply). Robbins’s most famous book is An Essay on the Nature and Significance of Economic Science, one of the best-written prose pieces in economics. That book contains three main thoughts. First is Robbins’s famous all-encompassing definition of economics, still used to define the subject today: “Economics is the science which studies human behavior as a relationship between given ends and scarce means which have alternative uses” (p. 16). Second is the bright line Robbins drew between positive and normative issues. Positive issues are questions about what is; normative issues are about what ought to be. Robbins argued that the economist qua economist should be studying what is rather than what ought to be. Economists still widely share Robbins’s belief. Robbins’s third major thought is that economics is a system of logical deduction from first principles. He was skeptical about the feasibility and usefulness of empirical verification. In this view he resembled the Austrians—not surprising since he was a colleague of the famous Austrian economist Friedrich Hayek, whom he had brought from Vienna in 1928. In 1930, when Keynesianism was starting to take over in Britain, Robbins was the only member of the five-man Economic Advisory Council to oppose import restrictions and public works expenditures as a means of alleviating the depression. Instead, Robbins sided with the Austrian view that the depression was caused by undersaving (i.e., too much consumption), and he built on this concept in The Great Depression, which exemplifies his anti-Keynesian views. Although he remained an opponent of Keynesianism for the remainder of that decade, Robbins’s views underwent a profound change after World War II. In The Economic Problem in Peace and War Robbins advocated Keynes’s policies of full employment through control of aggregate demand. The London School of Economics was home to Robbins for almost his entire adult life. He completed his undergraduate education there in 1923, taught as a professor from 1929 to 1961, and continued to be associated with the school on a part-time basis until 1980. During World War II he served briefly as an economist for the British government. Although Robbins was an advocate of laissez-faire, he made numerous ad hoc exceptions. His most famous was his view, known as the Robbins Principle, that the government should subsidize any qualified applicant for higher education who would not otherwise have the current income or savings to pay for it. His view was adopted in the 1960s and led to an expansion of higher education in Britain in the 1960s and 1970s. Selected Works   1932. An Essay on the Nature and Significance of Economic Science. London: Macmillan. 1934. The Great Depression. London: Macmillan. 1934. “Remarks upon Certain Aspects of the Theory of Costs.” First published in Economic Journal (1934). Reprinted in James M. Buchanan and G. F. Thirlby, eds., L.S.E. Essays on Cost. London: Weidenfeld and Nicolson, 1973. Available online at: http://www.econlib.org/library/NPDBooks/Thirlby/bcthLS2.html 1939. The Economic Basis of Class Conflict. London: Macmillan. 1939. The Economic Causes of War. London: Jonathan Cape. 1947. The Economic Problem in Peace and War. London: Macmillan. 1971. Autobiography of an Economist. London: Macmillan.   (0 COMMENTS)

  David Ricardo was one of those rare people who achieved both tremendous success and lasting fame. After his family disinherited him for marrying outside his Jewish faith, Ricardo made a fortune as a stockbroker and loan broker. When he died, his estate was worth more than $100 million in today’s dollars. At age twenty-seven, after reading Adam Smith’s The Wealth of Nations, Ricardo got excited about economics. He wrote his first economics article at age thirty-seven and then spent the following fourteen years—his last ones—as a professional economist. Ricardo first gained notice among economists over the “bullion controversy.” In 1809 he wrote that England’s inflation was the result of the Bank of England’s propensity to issue excess banknotes. In short, Ricardo was an early believer in the quantity theory of money, or what is known today as monetarism. In his Essay on the Influence of a Low Price of Corn on the Profits of Stock (1815), Ricardo articulated what came to be known as the law of diminishing marginal returns. One of the most famous laws of economics, it holds that as more and more resources are combined in production with a fixed resource—for example, as more labor and machinery are used on a fixed amount of land—the additions to output will diminish. Ricardo also opposed the protectionist Corn Laws, which restricted imports of wheat. In arguing for free trade, Ricardo formulated the idea of comparative costs, today called comparative advantage—a very subtle idea that is the main basis for most economists’ belief in free trade today. The idea is this: a country that trades for products it can get at lower cost from another country is better off than if it had made the products at home. Say, for example, Poorland can produce one bottle of wine with five hours of labor and one loaf of bread with ten hours. Richland’s workers, on the other hand, are more productive. They produce a bottle of wine with three hours of labor and a loaf of bread with one hour. One might think at first that because Richland requires fewer labor hours to produce either good, it has nothing to gain from trade. Think again. Poorland’s cost of producing wine, although higher than Richland’s in terms of hours of labor, is lower in terms of bread. For every bottle produced, Poorland gives up half of a loaf, while Richland has to give up three loaves to make a bottle of wine. Therefore, Poorland has a comparative advantage in producing wine. Similarly, for every loaf of bread it produces, Poorland gives up two bottles of wine, but Richland gives up only a third of a bottle. Therefore, Richland has a comparative advantage in producing bread. If they exchange wine and bread one for one, Poorland can specialize in producing wine and trading some of it to Richland, and Richland can specialize in producing bread. Both Richland and Poorland will be better off than if they had not traded. By shifting, say, ten hours of labor out of producing bread, Poorland gives up the one loaf that this labor could have produced. But the reallocated labor produces two bottles of wine, which will trade for two loaves of bread. Result: trade nets Poorland one additional loaf of bread. Nor does Poorland’s gain come at Richland’s expense. Richland gains also, or else it would not trade. By shifting three hours out of producing wine, Richland cuts wine production by one bottle but increases bread production by three loaves. It trades two of these loaves for Poorland’s two bottles of wine. Richland has one more bottle of wine than it had before, and an extra loaf of bread. These gains come, Ricardo observed, because each country specializes in producing the good for which its comparative cost is lower. Writing a century before Paul Samuelson and other modern economists popularized the use of equations, Ricardo is still esteemed for his uncanny ability to arrive at complex conclusions without any of the mathematical tools now deemed essential. As economist David Friedman put it in his 1990 textbook, Price Theory, “The modern economist reading Ricardo’s Principles feels rather as a member of one of the Mount Everest expeditions would feel if, arriving at the top of the mountain, he encountered a hiker clad in T-shirt and tennis shoes.”1 One of Ricardo’s chief contributions, arrived at without mathematical tools, is his theory of rents. Borrowing from Thomas Malthus, with whom Ricardo was closely associated but often diametrically opposed, Ricardo explained that as more land was cultivated, farmers would have to start using less productive land. But because a bushel of corn from less productive land sells for the same price as a bushel from highly productive land, tenant farmers would be willing to pay more to rent the highly productive land. Result: the landowners, not the tenant farmers, are the ones who gain from productive land. This finding has withstood the test of time. Economists use Ricardian reasoning today to explain why agricultural price supports do not help farmers per se but do make owners of farmland wealthier. Economists use similar reasoning to explain why the beneficiaries of laws that restrict the number of taxicabs are not cab drivers per se but rather those who owned the limited number of taxi medallions (licenses) when the restriction was first imposed. Selected Works   1817. On the Principles of Political Economy and Taxation. In The Works and Correspondence of David Ricardo. 11 vols. Edited by Piero Sraffa, with the collaboration of M. H. Dobb. Cambridge: Cambridge University Press, 1951–1973. Available online at http://www.econlib.org/library/Ricardo/ricP.html   Footnotes 1. David D. Friedman, Price Theory: An Intermediate Text, 2d ed. (Cincinnati: South-Western Publishing, 1990), p. 618.   (0 COMMENTS)

  With The Wealth of Nations Adam Smith installed himself as the leading expositor of economic thought. Currents of Adam Smith run through the works published by David Ricardo and Karl Marx in the nineteenth century, and by John Maynard Keynes and Milton Friedman in the twentieth. Adam Smith was born in a small village in Kirkcaldy, Scotland, where his widowed mother raised him. At age fourteen, as was the usual practice, he entered the University of Glasgow on scholarship. He later attended Balliol College at Oxford, graduating with an extensive knowledge of European literature and an enduring contempt for English schools. He returned home, and after delivering a series of well-received lectures was made first chair of logic (1751), then chair of moral philosophy (1752), at Glasgow University. He left academia in 1764 to tutor the young duke of Buccleuch. For more than two years they traveled throughout France and into Switzerland, an experience that brought Smith into contact with his contemporaries Voltaire, Jean-Jacques Rousseau, François Quesnay, and Anne-Robert-Jacques Turgot. With the life pension he had earned in the service of the duke, Smith retired to his birthplace of Kirkcaldy to write The Wealth of Nations. It was published in 1776, the same year the American Declaration of Independence was signed and in which his close friend David Hume died. In 1778 he was appointed commissioner of customs. In this job he helped enforce laws against smuggling. In The Wealth of Nations, he had defended smuggling as a legitimate activity in the face of “unnatural” legislation. Adam Smith never married. He died in Edinburgh on July 19, 1790. Today Smith’s reputation rests on his explanation of how rational self-interest in a free-market economy leads to economic well-being. It may surprise those who would discount Smith as an advocate of ruthless individualism that his first major work concentrates on ethics and charity. In fact, while chair at the University of Glasgow, Smith’s lecture subjects, in order of preference, were natural theology, ethics, jurisprudence, and economics, according to John Millar, Smith’s pupil at the time. In The Theory of Moral Sentiments, Smith wrote: “How selfish soever man may be supposed, there are evidently some principles in his nature which interest him in the fortune of others and render their happiness necessary to him though he derives nothing from it except the pleasure of seeing it.”1 At the same time, Smith had a benign view of self-interest, denying that self-love “was a principle which could never be virtuous in any degree.”2 Smith argued that life would be tough if our “affections, which, by the very nature of our being, ought frequently to influence our conduct, could upon no occasion appear virtuous, or deserve esteem and commendation from anybody.”3 Smith did not view sympathy and self-interest as antithetical; they were complementary. “Man has almost constant occasion for the help of his brethren, and it is in vain for him to expect it from their benevolence only,” he explained in The Wealth of Nations.4 Charity, while a virtuous act, cannot alone provide the essentials for living. Self-interest is the mechanism that can remedy this shortcoming. Said Smith: “It is not from the benevolence of the butcher, the brewer, or the baker, that we can expect our dinner, but from their regard to their own interest” (ibid.). Someone earning money by his own labor benefits himself. Unknowingly, he also benefits society, because to earn income on his labor in a competitive market, he must produce something others value. In Adam Smith’s lasting imagery, “By directing that industry in such a manner as its produce may be of greatest value, he intends only his own gain, and he is in this, as in many other cases, led by an invisible hand to promote an end which was no part of his intention.”5 The Wealth of Nations, published as a five-book series, sought to reveal the nature and cause of a nation’s prosperity. Smith saw the main cause of prosperity as increasing division of labor. Using the famous example of pins, Smith asserted that ten workers could produce 48,000 pins per day if each of eighteen specialized tasks was assigned to particular workers. Average productivity: 4,800 pins per worker per day. But absent the division of labor, a worker would be lucky to produce even one pin per day. Just how individuals can best apply their own labor or any other resource is a central subject in the first book of the series. Smith claimed that an individual would invest a resource—for example, land or labor—so as to earn the highest possible return on it. Consequently, all uses of the resource must yield an equal rate of return (adjusted for the relative riskiness of each enterprise). Otherwise reallocation would result. George Stigler called this idea the central proposition of economic theory. Not surprisingly, and consistent with another Stigler claim that the originator of an idea in economics almost never gets the credit, Smith’s idea was not original. The French economist turgot had made the same point in 1766. Smith used this insight on equality of returns to explain why wage rates differed. Wage rates would be higher, he argued, for trades that were more difficult to learn, because people would not be willing to learn them if they were not compensated by a higher wage. His thought gave rise to the modern notion of human capital. Similarly, wage rates would also be higher for those who engaged in dirty or unsafe occupations (see Job Safety), such as coal mining and butchering; and for those, like the hangman, who performed odious jobs. In short, differences in work were compensated by differences in pay. Modern economists call Smith’s insight the theory of compensating wage differentials. Smith used numerate economics not just to explain production of pins or differences in pay between butchers and hangmen, but to address some of the most pressing political issues of the day. In the fourth book of The Wealth of Nations—published, remember, in 1776—Smith told Great Britain that its American colonies were not worth the cost of keeping. His reasoning about the excessively high cost of British imperialism is worth repeating, both to show Smith at his numerate best and to show that simple, clear economics can lead to radical conclusions: A great empire has been established for the sole purpose of raising up a nation of customers who should be obliged to buy from the shops of our different producers all the goods with which these could supply them. For the sake of that little enhancement of price which this monopoly might afford our producers, the home-consumers have been burdened with the whole expense of maintaining and defending that empire. For this purpose, and for this purpose only, in the two last wars, more than a hundred and seventy millions [in pounds] has been contracted over and above all that had been expended for the same purpose in former wars. The interest of this debt alone is not only greater than the whole extraordinary profit, which, it ever could be pretended, was made by the monopoly of the colony trade, but than the whole value of that trade, or than the whole value of the goods, which at an average have been annually exported to the colonies.6 Smith vehemently opposed mercantilism—the practice of artificially maintaining a trade surplus on the erroneous belief that doing so increased wealth. The primary advantage of trade, he argued, was that it opened up new markets for surplus goods and also provided some commodities from abroad at a lower cost than at home. With that, Smith launched a succession of free-trade economists and paved the way for David Ricardo’s and John Stuart Mill’s theories of comparative advantage a generation later. Adam Smith has sometimes been caricatured as someone who saw no role for government in economic life. In fact, he believed that government had an important role to play. Like most modern believers in free markets, Smith believed that the government should enforce contracts and grant patents and copyrights to encourage inventions and new ideas. He also thought that the government should provide public works, such as roads and bridges, that, he assumed, would not be worthwhile for individuals to provide. Interestingly, though, he wanted the users of such public works to pay in proportion to their use. Many people believe that Smith favored retaliatory tariffs. A retaliatory tariff is one levied by, say, the government of country A against imports from country B to retaliate for tariffs levied by the government of country B against imports from country A. It is true that Smith thought they might be justified, but he was fairly skeptical. He argued that causing additional harm to one’s own citizens is a high price to pay that tends not to compensate those who were harmed by the foreign tariff while also hurting innocent others who had no role in formulating the tariff policy. He wrote: There may be good policy in retaliations of this kind, when there is a probability that they will procure the repeal of the high duties or prohibitions complained of. The recovery of a great foreign market will generally more than compensate the transitory inconveniency of paying dearer during a short time for some sorts of goods. To judge whether such retaliations are likely to produce such an effect does not, perhaps, belong so much to the science of a legislator, whose deliberations ought to be governed by general principles which are always the same, as to the skill of that insidious and crafty animal, vulgarly called a statesman or politician, whose councils are directed by the momentary fluctuations of affairs. When there is no probability that any such repeal can be procured, it seems a bad method of compensating the injury done to certain classes of our people to do another injury ourselves, not only to those classes, but to almost all the other classes of them. When our neighbours prohibit some manufacture of ours, we generally prohibit, not only the same, for that alone would seldom affect them considerably, but some other manufacture of theirs. This may no doubt give encouragement to some particular class of workmen among ourselves, and by excluding some of their rivals, may enable them to raise their price in the home-market. Those workmen, however, who suffered by our neighbors prohibition will not be benefited by ours. On the contrary, they and almost all the other classes of our citizens will thereby be obliged to pay dearer than before for certain goods. Every such law, therefore, imposes a real tax upon the whole country, not in favour of that particular class of workmen who were injured by our neighbours prohibition, but of some other class. (An Inquiry into the Nature and Causes of the Wealth of Nations, par. IV.2.39) Some of Smith’s ideas are testimony to his breadth of imagination. Today, vouchers and school choice programs are touted as the latest reform in public education. But Adam Smith addressed the issue more than two hundred years ago: Were the students upon such charitable foundations left free to choose what college they liked best, such liberty might contribute to excite some emulation among different colleges. A regulation, on the contrary, which prohibited even the independent members of every particular college from leaving it, and going to any other, without leave first asked and obtained of that which they meant to abandon, would tend very much to extinguish that emulation.7 Smith’s own student days at Oxford (1740–1746), whose professors, he complained, had “given up altogether even the pretense of teaching,” left him with lasting disdain for the universities of Cambridge and Oxford. Smith’s writings are both an inquiry into the science of economics and a policy guide for realizing the wealth of nations. Smith believed that economic development was best fostered in an environment of free competition that operated in accordance with universal “natural laws.” Because Smith’s was the most systematic and comprehensive study of economics up until that time, his economic thinking became the basis for classical economics. And because more of his ideas have lasted than those of any other economist, some regard Adam Smith as the alpha and the omega of economic science. Selected Works   1759. The Theory of Moral Sentiments. Edited by D. D. Raphael and A. L. Macfie. Oxford: Clarendon Press; New York: Oxford University Press, 1976. Available online at: http://www.econlib.org/library/Smith/smMS.html 1776. An Inquiry into the Nature and Causes of the Wealth of Nations. Edited by Edwin Cannan. Chicago: University of Chicago Press, 1976. Available online at: http://www.econlib.org/library/Smith/smWN.html   Footnotes 1. Smith 1759, part I, section I, chap. I, para. 1; available online at: http://oll.libertyfund.org/192/39008/908774.   2. Ibid., part VII, section II, chap. iii, para. 12; available online at: http://oll.libertyfund.org/192/39125/909478.   3. Ibid., part VII, section II, chap. iii, para. 18; available online at: http://oll.libertyfund.org/192/39125/909484.   4. Smith 1776, book I, chap. 2, para. 2; available online at: http://oll.libertyfund.org/220/111839/2312795.   5. Ibid., book IV, chap. 2, para. 9; available online at: http://oll.libertyfund.org/220/111910/2313856.   6. Ibid., book IV, chap. VIII, para. 53; available online at: http://oll.libertyfund.org/200/111936/2316261.   7. Ibid., book V, chap. 1, para. 140 [OUP article ii, para. 12]; available online at: http://oll.libertyfund.org/200/111942/2316475.   (0 COMMENTS)

In 1978 American social scientist Herbert Simon was awarded the Nobel Prize in economics for his “pioneering research into the decision-making process within economic organizations.” In a stream of articles, Simon, who trained as a political scientist, questioned mainstream economists’ view of economic man as a lightning-quick calculator of costs and benefits. Simon saw people’s rationality as “bounded.” Because getting information about alternatives is costly, and because the consequences of many possible decisions cannot be known anyway, argued Simon, people cannot act the way economists assume they act. Instead of maximizing their utility, they “satisfice”; that is, they do as well as they think is possible. One way they do so is by devising rules of thumb (e.g., save 10 percent of after-tax income every month) that economize on the cost of collecting information and on the cost of thinking. Simon also questioned economists’ view that firms maximize profits. He proposed instead that because of their members’ bounded rationality and often contradictory goals and perspectives, firms reach decisions that can only be described as satisfactory rather than the best. Not surprisingly for one who believes that decision making is costly, Simon also worked on problems of artificial intelligence. After earning his Ph.D. in political science from the University of Chicago, Simon joined the school’s faculty. In 1949 he left for Pittsburgh, where he helped start Carnegie Mellon University’s new Graduate School of Industrial Administration. Selected Works   1957. Models of Man. New York: Wiley. 1958 (with James March). Organization. New York: Wiley. 1976. Administrative Behavior. 3d ed. New York: Macmillan. 4th ed., New York: Free Press. 1997. 1981. The Sciences of the Artificial. 2d ed. Cambridge: MIT Press. 1982. Models of Bounded Rationality and Other Topics in Economic Theory. 2 vols. Cambridge: MIT Press.   (0 COMMENTS)

  British economist Joan Robinson was arguably the only woman born before 1930 who can be considered a great economist. She was in the same league as others who received the Nobel Prize; indeed, many economists expected her to win the prize in 1975. Business Week was so sure of it that it published a long article on her before that year’s prize was announced. It did not happen. Was the Swedish Royal Academy biased against Robinson? Many economists believe it was, but not because Robinson was a woman. Rather, her political views became more left wing as she aged, to the point where she admired Mao Zedong’s China and Kim Il Sung’s North Korea. These extreme views should not have affected her chances of getting an award for her intellectual contributions, but they probably did. Robinson’s first major book was The Economics of Imperfect Competition. In it she laid out a model of competition between firms, each of which had some monopoly power. Along with American economist Edward H. Chamberlin, whose Theory of Monopolistic Competition had appeared only a few months earlier, Robinson began what is known as the monopolistic competition revolution. Many economists believe that most industries are neither perfectly competitive nor complete monopolies. Robinson’s and Chamberlin’s books are what led them to that belief. Robinson’s first book and early articles show a distinctive writing style. She was clear and analytical, and she managed to put complex mathematical concepts into words. Later in the 1930s Robinson became part of the “Cambridge Circus,” a group of young economists that included later Nobel Prize winner James Meade; Roy Harrod; Richard Kahn; her husband, Austin Robinson; and Piero Sraffa. These economists met regularly to discuss their work and especially to discuss John Maynard Keynes’s famous General Theory of Employment, Interest and Money (1936), both before and after it was published. Much of Robinson’s work published at that time, especially her Introduction to the Theory of Employment, clarifies ideas that Keynes had not made clear. Robinson was the first to define macroeconomics, which became a separate field of inquiry only with Keynes’s book, as the “theory of output as a whole.” In 1954 Robinson’s article “The Production Function and the Theory of Capital” started what came to be called the Cambridge controversy. Robinson attacked the idea that capital can be measured and aggregated. This became the position in Cambridge, England. Across the Atlantic, Paul Samuelson and Robert Solow defended the by-then traditional neoclassical view that capital can be aggregated. Robinson won the battle. As historian Mark Blaug puts it, Samuelson made a “declaration of unconditional surrender.” Yet most economists still think that aggregating capital is useful and continue to do it anyway. Whether or not Robinson’s gender prevented her from winning the Nobel Prize, it seems to have slowed her advance in academia. She taught at Cambridge University from 1928 until retiring in 1971, but in spite of a very productive career, she did not become a full professor until 1965. Perhaps not coincidentally, this was the year her husband retired from Cambridge. Selected Works   1933. The Economics of Imperfect Competition. London: Macmillan. 2d ed., 1969. 1937. Introduction to the Theory of Employment. London: Macmillan. 1942. An Essay on Marxian Economics. London: Macmillan. 1956. The Accumulation of Capital. London: Macmillan. 1962. Economic Philosophy. London: C. A. Watts. 1970. The Cultural Revolution in China. London: Penguin Books. 1971. Economic Heresies: Some Old-fashioned Questions in Economic Theory. London: Macmillan.   (0 COMMENTS)

  In 1990 American economists William F. Sharpe, harry markowitz, and merton h. miller shared the Nobel Prize “for their pioneering work in the theory of financial economics.” Their early contributions established financial economics as a separate field of study. In the 1960s Sharpe, taking off from Markowitz’s portfolio theory, developed the Capital Asset Pricing Model (CAPM). One implication of this model is that a single mix of risky assets fits in every investor’s portfolio. Those who want a high return hold a portfolio heavily weighted with the risky asset; those who want a low return hold a portfolio heavily weighted with a riskless asset, such as an insured bank deposit. A measure of the portfolio risk that cannot be diversified away by mixing stocks is “beta.” A portfolio with a beta of 1.5, for example, is likely to rise by 15 percent if the stock market rises by 10 percent and is likely to fall by 15 percent if the market falls by 10 percent. One implication of Sharpe’s work is that the expected return on a portfolio in excess of a riskless return should be beta times the excess return of the market. Thus, a portfolio with a beta of 2 should have an excess return that is twice as high as the market as a whole. If the market’s expected return is 8 percent and the riskless return is 5 percent, the market’s expected excess return is 3 percent (8 minus 5) and the portfolio’s expected excess return is therefore 6 percent (twice the market’s expected excess return of 3 percent). The portfolio’s expected total return would then be 11 percent (6 plus the riskless return of 5). Sharpe was a Ph.D. candidate at the University of California at Los Angeles and an employee of the RAND Corporation when he first met Markowitz, who was also employed at RAND. Sharpe chose Markowitz as his dissertation adviser, even though Markowitz was not on the faculty at UCLA. Sharpe taught first at the University of Washington in Seattle and then at the University of California at Irvine. In 1971 he became a professor of finance at Stanford University. In 1986 Sharpe founded William F. Sharpe Associates, a firm that consulted to foundations, endowments, and pension plans. He returned to Stanford as a professor of finance in 1993 and is now a professor emeritus there. Selected Works   1964. “Capital Asset Prices: A Theory of Market Equilibrium Under Conditions of Risk.” Journal of Finance 19 (September): 425–442. 1977. “The Capital Asset Pricing Model: A ‘Multi-Beta’ Interpretation.” In H. Levy and M. Sarnat, eds., Financial Decision Making Under Uncertainty. New York: Harcourt Brace Jovanovich, Academic Press.   (0 COMMENTS)

French economist J. B. Say is most commonly identified with Say’s Law, which states that supply creates its own demand. Over the years Say’s Law has been embroiled in two kinds of controversy—the first over its authorship, the second over what it means and, given each meaning, whether it is true. On the first controversy, it is clear that Say did invent something like Say’s Law. But the first person actually to use the words “supply creates its own demand” appears to have been James Mill, the father of john stuart mill. Say’s Law has various interpretations. The long-run version is that there cannot be overproduction of goods in general for a very long time because those who produce the goods, by their act of producing, produce the purchasing power to buy other goods. Say wrote: “How could it be possible that there should now be bought and sold in France five or six times as many commodities as in the miserable reign of Charles VI?”1 With this statement Say had the long run in mind. Certainly the long-run version is correct. Given enough time, supply does create its own demand. There can be no long-run glut of goods. But Say also said that even in the short run there could be no overproduction of goods relative to demand. It was this short-run version that thomas robert malthus attacked in the nineteenth century and john maynard keynes attacked in the twentieth. They were right to attack it. Say was the best-known expositor of Adam Smith’s views in Europe and America. His Traité d’économie politique was translated into English and used as a textbook in England and the United States. But Say did not agree with Adam Smith on everything. In particular, he took issue with Smith’s labor theory of value. Say was one of the first economists to have the insight that the value of a good derives from its utility to the user and not from the labor spent in producing it. Say was born in Lyons. During his life he edited a journal, operated a cotton factory, and served as a member of the Tribunate under the Consulate of Napoleon. He was the first to teach a public course on political economy in France and continued his stay in academia first at the Conservatoire des Arts et Métiers, and then at the College de France in Paris. Say was a friend of Thomas Robert Malthus and david ricardo. Selected Works   1803. Traité d’économie politique. Translated from the 4th edition of the French by C. R. Prinsep. A treatise on political economy; available online at: http://www.econlib.org/library/Say/sayT.html.   Footnotes 1. Say, A Treatise on Political Economy, book 1, chap. XV, para. 4.   (0 COMMENTS)