Economic Thought and the Role of the State in Late Development

by Ralf Kroessin

UNIVERSITY OF KENT AT CANTERBURY

Economic Thought and the Role of the State in ‘Late Development’:

Friedrich List and the Japanese ‘Miracle’

Ralf Kroessin

(MA by Research in International Relations), 1998 Preface:

Despite vanishing recognition for the economic importance of the nation-state – especially in the age of so-called globalisation - states can play and have played a vital part in economic development. The case of Friedrich List and the impact of his ideas on the Japanese economic development, which is often referred to as a ‘miracle’, prove the crucial importance of addressing other economic traditions.

The German 19th century economic thinker advocated state-led development through the fostering of ‘infant industries’ and; importantly, through the promotion of the ‘productive forces’ of the national economy as a whole. List’s idea of a national system of political economy was attacking Smith’s and Ricardo’s cosmopolitical economics. Based on the concept of historicism, List and the German Historical School essentially argued that universal economic laws were non-existent and, thus, states had the right to intervene into the economy. Particularly in the case of late-developing countries, the promotion of national economic development was regarded to be critical to their success in ‘catching-up’ with the industrialised and developed world.

List, however, was a liberal nationalist and his concept of economic nationalism - which was often but unjustifiably regarded as ‘neo-mercantilist’ - together with the ideas of the German Historical School, provided a tremendous intellectual stimulus for Meiji Japan. Consequently, Japan’s leadership systematically fostered economic growth and industrialisation, and turned Japan into a state, where national economic development is the prime objective.

In the Japanese capitalist-developmental state a unique collaboration across the public and private divide between the elite bureaucracy, industrial leaders and the long ruling political party, the LDP, has facilitated a ‘miraculous’ economic development. List, therefore can be regarded as the intellectual godfather of the capitalist-developmental state and the Japanese economic ‘miracle’, which in itself demonstrates that there is a variety of approaches to economic development that continue to drive forward history. C O N T E N T S

INTRODUCTION

CHAPTER 1 “COMPETING ECONOMIC DOCTRINES”

1.1 The Origin of the Classical School of Economics
1.1.1 The Founder of Economics: Adam Smith
1.1.2 Malthus, Ricardo, and Say’s Law
1.2 Marxist Analysis of Economics
1.3 The Keynesian Revolution
1.4 Hayek and the Market Mechanism
1.5 Conclusion

CHAPTER 2 “FRIEDRICH LIST”

2.1 Life and Times
2.2 Economic Organisations and the Unification of Germany
2.3 “Das Nationale System der Politischen Ökonomie”
2.4 Conclusion

CHAPTER 3 “ECONOMIC DEVELOPMENT: FREE TRADE OR STATE INTERVENTION”

3.1 Advantages of Late Development
3.2 The Development Debate
3.3 State Versus Market
3.4 The Developmental State
3.5 State Autonomy And Capacity
3.6 Conclusion: List Versus Smith

CHAPTER 4 “CASE STUDY: INTERPRETING THE JAPANESE SUCCESS”

4.1 How Political Economy Came To Japan
4.1.1 Feudal Tokugawa Japan and the Preparation for Industrialisation
4.1.2 The Meiji Restoration and the Foundation for Administrative Guidance
4.1.3 Western Learning: Laissez Faire Versus Protectionism
4.1.4 Following the German Example
4.2 Economic Bureaucrats and the Tradition of Administrative Guidance
4.3 Economic Reconstruction During The Occupation
4.4 Conclusion: Miracle Japan and the MITI - Interdependence or Free Markets?

CHAPTER 5 “CONCLUSION: LISTIAN STATE-LED DEVELOPMENT AND THE CONTINUATION OF HISTORY

6. BIBLIOGRAPHY INTRODUCTION

In recent years the politico-economic phenomenon of globalisation has been vividly discussed in the media and the scientific community. Within this global framework, political progress and economic development are normally thought to be facilitated through system of liberal democracy and market forces respectively, while the state is meant to play a subordinate role. However, the reality appears to be different: the nation state has increasingly become more influential in shaping ‘people’s’ ideas and perceptions about their collective destiny, or perhaps never even ceased to be important. For instance, the collapse and fragmentation of the Soviet Union or Yugoslavia are very powerful examples amidst a multitude of other cases where ‘national’ communities have decided to determine their own future. It is important, though, to point out that nationalism exists in all forms or shapes. Not only the irrational, aggressive type such as fascism, or the non-progressive conservative nationalism are prevalent, but benevolent and rational versions can be found.

But not just the present day suggests the often overlooked importance of the nation state in the field of global politics and economics, history itself can reveal certain insights to us. Thus it will be argued in this dissertation that the nation-state has been critical in the formation and achievement of political and economic goals and continues to do so, despite the growing myth of globalisation. In order to argue the case, it is essential to identify relevant examples of a continuously important role of the state in the modern world. Yet the objective of this research has to be more clearly defined to ensure the validity of the argument: therefore, the main focus of this dissertation will be provided by an analysis of the relationship between state and economic development.

Hence, this dissertation deals with the question of the role of the state in economic development and thereby suggests that the nation state, in spite of the growing interdependence of states and markets, or even perhaps due to this synergy, still can play a very important part in the formation and achievement of political and economic objectives. East Asia, and Japan in particular, has been selected to illustrate this argument as a case study. Thus, at the heart of this dissertation stands the rather pragmatic than theoretical framework of what is often referred to as economic nationalism. Consequently, it is vital to assess the relationship between economics , national economies and nationalism. As David Levi-Faur points out: “In an era of ‘cascading interdependence’ (read globalization), the neglect of nationalism - its interaction with the economy and its effects on policy making - impairs our ability to grasp the full significance of the notion of the nation-state and to analyse the current changes in its economic roles.”

Thus, without denying the existence of malignant aspects or types of nationalisms, or even idealising it, rational and enlightened nationalism has been existing and importantly can be associated with economic imperatives and policies. Particularly through an analysis of the economic role of the state in economic development, the future of economic nationalism in the age of globalisation can be evaluated. This brings us to the German economist Friedrich List, whose work is widely regarded as ground breaking in the field of the political economy of the nation state. Even though he writes in the 19th century, List’s analysis is still extremely relevant today. He was a political and economical practitioner rather than a pure theorist which invests him with the unique quality of being applicable to the assessment of the economic role of the nation state in the past and present day.

List was a liberal, enlightened nationalist and is often, but unjustifiably, associated with the practice of neo-mercantilism. He was one of the pioneers of the ‘infant industries’ conception, but more importantly attacked Adam Smith and the liberal principle of ‘laissez faire’ also on a theoretical level: not simply just exchangeable value but productive forces account for the wealth of a country. List then carries on to formulate a theory of economic development which, in contrast to Smith’s free enterprise system, was based on the promotion of productive powers through the state. (This obviously violates much that is nowadays taught in economics in the Anglo-American world, where the market mechanism is regarded as an ‘all-cure’). But it can be argued that late-developing countries have to be allowed to shape their own economic future especially as there are no universally valid economic laws as postulated by the liberal economists. This brings us to an exciting example of late development: East Asia and particularly Japan. Arguably Japan has since the Meiji Restoration of 1868 followed a path of developmental capitalism in which the state through the promotion of infant industries, the fostering of productive forces, and administrative guidance etc. has actively intervened into the economy in order to achieve the national objective of development and industrialisation. David Williams, therefore, regards Friedrich List as the ‘godfather of the Japanese Miracle’ .

Hence, one of the main objectives of this dissertation is demonstrate that dominant strands in mainstream economic thought have neglected or attacked any role for the state in promoting development. However, the case of List and the impact of his ideas on Japan, prove the vital importance of addressing other economic traditions. Thus, it will be shown that in the past and present the nation state can continue to be an essential actor in the economy. It has to be pointed out, however, that this assessment is focusing on the success of the East Asian economies, and here especially on Japan and its statist vision on economic management.

In chapter 1, the competing, mainly Anglo-American, economic theories are presented in order to illustrate the role these theories envisage the state to play, which is a restricted one and exercised only in special circumstances. After this the discussion leads over to a comparison with the teachings of Friedrich List in chapter 2. List underlines the main objective of this dissertation by elaborating both a practical and theoretical framework within which the state is essential to economic development, especially for late-developing countries. List, therefore, provides us with an alternative view of economic development and suggests statist guidance to achieve national economic objectives. Chapter 3, hypothetically, follows the well-trodden path of associating the main ideologies or IR-paradigms of realism, liberalism and structuralism with economic theories (economic nationalism or mercantilism, laissez faire and Marxism respectively), which are widely used to differentiate between various debates within the discipline of International Political Economy, only to conclude that this kind of analogy is often incorrect, misleading and unsustainable.

The development of Japan, which was certainly inspired by List’s teachings, clearly shows that state and market are interdependent and various economic tools have been utilised by the government to facilitate late-development. Japan is then identified as a plan-rational state, a concept elaborated by Chalmers Johnson to describe this process of state-led development. In sum, the synergy of state and market, which has been facilitated by government initiatives, policies and programmes has brought this tremendous economic success, industrialisation and high-speed growth to the East Asian developmental states.

Hence, chapter 4 illustrates the dissertation’s central argument about the essential role of the state in economic development as a case study. It will be demonstrated how western political economy came to Japan, and how it was adopted and effectively ‘Japanised’. The influence of List and the German Historical School are of particular importance as they had a more visible impact on the formation of government policy throughout the later stages of the Meiji period than other, especially Anglo-American, economic theories. The continuity of the state’s involvement in the economy, leading to a blurring of the public and private spheres of economics, will be shown. From the Meiji period, over to the inter-war years, and finally to the period of war and occupation, the state, through its bureaucratic apparatus, has increasingly succeeded in guiding and steering the economic activity of the nation. Hence, this has effectively led to the high-speed growth, and rapid and diversified industrialisation of Japan, which is often - but unjustifiably - referred to as a ‘miracle’.

Chapter 1 “Competing Economic Doctrines”

This chapter provides a history of economics via a comparison of the principal competing Anglo-American doctrines – ‘Anglo-American’ here denotes economic theories which are derived from the tradition of the framework of Adam Smith’s analysis of economics. In the context of this dissertation, this comparative economic history is essential to the investigation and assessment of the importance of the state in economic development. As these Anglo-American doctrines are widely regarded as the dominant strands in mainstream economic thought, the main objective of this chapter, therefore, is to identify the role these doctrines envisaged the state to play in economic development. Hence, it will be argued that the Anglo-American economic theories are essentially market-driven, and are ignoring or even attacking other economic traditions. It is important to point out that chapter 2, however, is an integral part of this discussion as the contradictions and convergence of the Anglo-American and Listian economic conceptions will play an essential role in the later evaluation of development strategies used in Japan. Important, here, is a critical comparative analysis of the common theoretical framework which is given through the paradigms of International Relations. This, hence, can be regarded as a useful tool for our understanding of IR, particularly with the reality of the economic pragmatism and practice, which has helped Japan and East Asia to develop so successfully, in mind. However, the simplifications of IR are still widely – but as later chapters will underline, quite unjustifiably - imposed on the study of political economy. But as this chapter is a discussion of economic doctrines, and not of the IR-paradigms, this inquiry should not go beyond the question about the role of states in economic development.

1.1 The Origins of the Classical School of Economics

Between the end of the Middle Ages and the publication of Adam Smith’s ‘An Enquiry into the Nature and Causes of the Wealth of Nations’ the conditions for the establishment of the classical system of political economy both in terms of theory and practice were generated. Various social, political and technological changes were significant in this the era as the medieval world was swept away. As Roll exemplifies:

“The growth of the national states, anxious to destroy both the particularism of feudal society and the universalism of the spiritual power of the Church, resulted in a greater concern for wealth and a quickening of economic activity. The loosening of the central doctrinal authority, caused by the Reformation, and the progress of the concept of natural law in jurisprudence and political thought prepared the ground for a rational and scientific approach to social problems; and the invention of printing created new possibilities of intellectual intercourse. Feudalism also became inadequate in its regulation of production.”

In Britain this can be seen in the enclosure movement which co-revolutionised the methods of farming, leading to quasi-market oriented agricultural production and subsequently to rural overpopulation. The new commercial tendency was accompanied by maritime discoveries, resulting in the expansion of domestic and foreign trade.

Not only the development of trade but the transformation of the organisation of production was significant: a primitive form of capitalist production, merchant or commercial capitalism evolved. This novel system meant the manufacturing of goods on the small scale where the merchant functioned as the supplier of raw materials and as the distributor of the end product to the market - small workshops and home manufacturing was the standard at the time, industrial production was still unknown. It is here important for this dissertation to emphasise the interconnected development of the state and merchant capitalism. “Monopoly was the outstanding way in which the rising nation-states sought to increase trade and to create sources of revenue for themselves.” The East India Company is one of the best examples for the new founded collaboration of state and merchants. Furthermore, the increasing expansion of the European powers and the colonisation of the Americas, Africa and Asia made trade easier, even more lucrative and the ‘exploration’ mechanism more efficient.

However, the growing link between the trading interest and the state brought the development of economic practices and commercial policies into existence, which were transcending the traditions embedded in the Canon Law of the Middle Ages and the negative world view on commerce and trade began to change. Yet, it can be differentiated between two different tendencies in economic practice: already in the Middle Ages bullionism, the treasuring of precious metals and proper mercantilism emerged,, before commercial capitalism began to appear in the 17th century.

“Yet mercantilism was neither a scientific school nor a scientific theory - there were no schools at all in our sense of the world - and we distort the picture if we seek already in this period what was in fact the consequence of a specialised discipline after it had properly constituted itself. Its importance for analysis in the field of social science fell short of its importance of a means for the creation of national economic units.”

Thus, the essence of mercantilist teachings was its emphasis on trade and the emerging states. Hence, at the heart of mercantilist policies lay merchant capitalism and its objective in foreign trade to sell as many goods as possible and to buy as little from other countries as absolutely necessary. This resulted in the accumulation of wealth in form of precious metals. Protective measure such as import duties, privileges, monopolies, etc. were used to fortify the national economy further against other economic units. Heckscher identified mercantilism with state-making as its economic policy was designed to secure political unification and economic power through state intervention. However, clearly not production but foreign trade was identified as the source of national wealth, and the gold and silver accumulated was often not reinvested productively. Hence, this tendency was generating the inherent structural weakness which later led to the collapse of mercantilist economies in favour for the emerging industrial capitalism. But the importance of mercantilism lay in its nation-building characteristic, as Roll argues: “The building-up of nation-states is put in the forefront, and monetary, protectionist, and other economic devices are regarded merely as instruments to this end. State intervention was an essential part of mercantilist doctrine. ... It must also be conceded that a great deal of mercantilist literature from Mun, the enlightened English merchant, to Hornick, the Austrian nationalist lawyer and privy councillor, claims to speak in the interests of nationalist advancement.”

In sum, while mercantilism played a vital role in the establishment of states as economic entities, it is very important to point out that only wealth in form of precious metals was regarded as true wealth. Productive forces as such, as Adam Smith was one of the first to emphasise, were largely ignored and foreign trade was regarded as the main source of national wealth. Thus it is unjustified to define economic policies focused mainly on state-building generally as mercantilist or neo-mercantilist (see chapter 2.4) without looking into the way and nature of the creation and accumulation of wealth.

Thus, the driving force of change and development for the social, political and economic foundations of the post-medieval world was the transformation of the mode of production from feudalism to commercial and finally industrial capitalism. This economic development was accompanied on the intellectual level by enlightened political thought, scientific rationality, individualism, the forerunners of liberalism, and particularly in France, by the Physiocratic School.

In the light of this argument it appears to be necessary before the actual discussion of the classical system to look briefly at three outstanding scientific ‘discoveries’. Firstly, Isaac Newton’s revolutionary concept of scientific methodology enabled scholars to analyse, explain and formulate theories about all different types of phenomena - including the increasingly complex world of economics. Secondly, in terms of political theory John Locke’s notion of natural law and the inherent importance of the individual’s right to their own person and property, protected through the social contract, is of extreme importance for the development of capitalism. Lastly, the Physiocrat Francois Quesnay

“discarded the mercantilist belief that wealth and its increase were due to exchange. They transferred to the sphere of production the power of creating wealth ... . Having discovered its (the surplus or produit net, the author) origin in a manner which was an advance on the English mercantilists, they went on to add, ..., an analysis of its circulation among the different classes of society.”

Hence, the Physiocrats came to the conclusion that there are two socio-economic classes, one which is productive, and one which is unproductive. They regarded surplus as a concrete material wealth of useful goods and in one particular branch of production, agriculture, the surplus as the difference between goods produced and consumed was the clearest. But the problem with the Physiocracts was that they insisted that only the agricultural classes produced true ‘wealth’ and that the manufacturing and commercial classes merely manipulating it in a sterile way. Nevertheless, Physiocracy was a pioneering application of scientific principles to the world of economics and Adam Smith, even though he criticised their emphasis on agriculture, was deeply impressed by Quesnay’s ideas. “The notion of circulation of wealth he gladly accepted and acknowledged, but the idea that industry was somehow sterile and barren struck him as a peculiar construction of the world. After all, had he not grow up in Kirkcaldy and Glasgow where one could see wealth being created at every hand in the workshops and factories of craftsmen?”

In fact the world had changed and revolutions had taken place: in technological terms spinning and weaving machines, and steam engines had been invented in the 18th century. A general wave of industrialisation began to sweep predominantly through Britain. Politically, with the American Declaration of Independence of 1776, mercantilism, which was fuelled by the colonial system of the British Empire, found its limits and proved to be inadequate. Adam Smith’s ‘An Inquiry into the Nature and the Causes of the Wealth of Nations’ was published in the same year and it signified a revolution in the social science, or more precisely, founded the scientific discipline which is nowadays regarded as economics. The remains of the Middle Ages were washed away by the French Revolution only a few years later. Hence the whole quality of economic and political thinking had changed which reflected the transformation of society from feudal to capitalist - even though Smith was still analysing and writing from a perspective of the pre-industrial capitalist era.

1.1.1 The Founder of Economics: Adam Smith

Adam Smith was born in 1723 in Kirkcaldy, Scotland and was educated at Oxford to become a professor of logic and moral philosophy at the University of Glasgow. Later he was offered a private appointment as a travel companion for the young Duke of Buccleuch which secured him a generous pension and enabled him to concentrate fully on his research and writing until he died in 1790.

Smith was the first academic economist. This claim is based on the much higher degree of complexity and systematic thinking he was capable of in comparison to his predecessors. Already as a student he followed the tradition of enlightenment which is shown in his ‘Essay on Astronomy’ (probably written before 1758). Natural Law, individualism and Newton’s world view were then forming Smith’s thinking and work. However, he was a philosophical economist and as his famous work ‘The Theory of Moral Sentiments’ (1759) shows, his interest in human behaviour will dominate his later writings. “It is useful to understand that Smith, together with his good friend David Hume, belonged to a coterie of philosophers called the Sentimentalists. These philosophers argued that the distinguishing mark of man was not reason, but feelings, or sentiments ... . Man is by nature a social being, argues Hume, and society has its origins in instinct and feelings and not in intelligent self-interest as was argued by the rationalists like Hobbes. For Hume, as for Smith, the social process starts with instinct, develops through feelings and emotions, and only finally comes under the direction of the intellect.”

In Smith’s behavioural analysis the pain-pleasure principle is the leading motive for human conduct. However, he argues in the ‘Theory of Moral Sentiments’ that human beings derive satisfaction not only from their own pleasures, but from a sympathy type of fellow feeling. Here lies the inherent problematique of Smith’s ideas as a whole: “... Smith has derived the self-seeking, materialistic behaviour which is needed to energize a progressive, laissez-faire economy from fellow feeling - a paradox which haunts all his thinking on economics.” This has been called the Adam Smith dilemma and as can be seen from his later work on economics, ‘The Wealth of Nations’, the conflict between the sympathy for others in the ‘Moral Sentiments‘ and “... Smith the economist [who] is popularly seen as a high priest of materialism,” has not been fully resolved.

However, almost twenty years elapsed before Smith wrote his major book on economics and even here the influence of various sources can be felt. David Hume and Smith’s teacher Hutcheson, a naturalist who believed in the superiority of natural over man-made law, have left their mark on his social philosophy, but especially the physiocratic school, even though Smith criticised them, influenced him with their emphasis on laissez faire. As Roll underlines: “... Smith’s treatment of the question of the question of value and of all the problems that flow from it, owes much to the whole body of economic thought which had already developed.” In particular, Petty, Steuart and Cantillon have to be mentioned in connection with Smith’s economic background.

Smith’s main work, ‘The Wealth of Nations‘, is divided into five books dealing with problems of production, distribution, exchange, capital, different economic policies, previous systems of political economy and public finance. In the centre of Smith’s practical philosophy stands his analysis of behaviour as developed in the ‘Moral Sentiments’. According to Smith, each man is his best judge of his own interest and should therefore be free to pursue it in his own way. If left on their own people would not only improve their own situation but also general welfare:

“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. We address ourselves, not their humanity but to their self-love, and never talk to them of our necessities, but of our advantages.”

Hence, as Smith believed in natural order and balance he stated that an ‘invisible hand’ promotes human welfare through self-interest. As a consequence of this assumed natural order any intervention into human affairs is harmful. Subsequently, the government should abstain from meddling with economy and society and only has the duty to defend the state from foreign aggression, to establish an administration of justice and to maintain public works and institutions which are not profitable enough for private enterprises. Interventionism was in Smith’s laissez faire opinion only legitimate in cases of national security. This has led to the coining of the term ‘night-watchman state’, as Smith claims that “government can rarely be more effective than when it is negative, ... he becomes a strong opponent of all forms of state interference with the ordinary business of industry and commerce.” Thus, concerning the economy the natural order will lead to a profit-driven society. Exchange takes place to facilitate the satisfaction of the different individual interests, argues Smith. “It is the maxim of every prudent master of a family, never to attempt to make at home what it will cost him more to make than to buy... . What is prudence in the conduct of every private family, can scarce be folly in that of a great kingdom.” This is particularly important as Smith viewed the state just as the aggregate of individuals, and therefore a different conclusion, based for example on the nationalist understanding of the state as a special economic unit, made no sense to him. Moreover, from here we can deduce Smith’s free trade position easily, as trade and exchange of goods were generally regarded by him to be in the human nature.

According to Smith the division of labour is the engine of economic development, but it is limited by the extent of the market - both inter-regionally and internationally. As a consequence of trade the market is widened and increases the division of labour even further. This results in the assumption that commodities will be produced in countries where they can most efficiently, subsequently, each country will naturally have an absolute advantage in the production of particular commodities. Hence, trade allows countries to buy products they do not possess an absolute advantage in from abroad cheaper than at home. Therefore, international trade can take place on equal terms, a concept further developed in David Ricardo’s ‘Theory on International Trade and the Comparative Advantage’. However, this meant that the mercantile system of protection, monopolies, industrial regulations, privileges, etc. which still in part dominated commerce and industry could be politically and ideologically attacked and finally broken up, based on the newly emerged economic science.

The classical school of political economy was at first a revolutionary intellectual movement and in sum “Adam Smith has been viewed primarily as the source of laissez faire ideas. The benefits of economic freedom can be argued on the basis of three axioms: 1) Individuals desire to maximise their wealth. 2) Individuals know better than governments how to maximise their wealth. 3) National wealth is the sum of individual wealth. This is an effective argument for free trade and it never really requires an understanding of the microeconomics of demand and supply.” But in the light of arguments about the special role of the state in industrial development, which emerged in the mid 19th century in late-developing countries such as the USA and Germany, we have to ask ourselves about the universal validity of the axioms of classical economics. (See chapter 2 and 3). However, at the time Adam Smith’s work had a powerful impact on businessmen and politicians alike and thereby prepared the way for a full development of industrial capitalism. In this sense Smith represented the interests of the new capitalist class and economic liberalism facilitated the breakthrough of the Industrial Revolution, particularly in Britain.

But not just the practical application of Smith’s economic doctrine caused fundamental change, but provided an answer to the question about the source of wealth. “The great advance in economic thought which is due to Smith is the emancipation from mercantilist and physiocratic fetters ... The mercantilists had found it (the source of wealth, the author) in foreign trade. The physiocrats had gone further and had shifted the origin of wealth from the sphere of exchange to that of production ... With Smith labour as such becomes the source ... . The wealth of a nation, he said, will depend upon two conditions: first, the degree of productivity of labour to which it is due; and secondly, the amount of useful labour, that is to say, labour productive of wealth, which is employed.”

In his investigations about the source of wealth Smith realises that the increasing division of labour (his famous example of the pin factory) leads to an increase of productivity. He tries to transform this production into the social element of abstract exchange value, based on the presumption that human beings are led by their ‘instinct’ to trade and exchange. But as Roll argues, Smith generalised and deduced from the existing conditions of his time a perpetually operating economic law. “But Smith’s purpose was propagandist. He emphasised the influence of the market on productivity in order to demonstrate that trade had to be freed as a prerequisite to the development of productive power, and not merely to the full use of the existing powers of production.”

But the central problem discussed by Adam Smith is, after he defined value through labour, the question of exchange: money was invented after barter proved to be unacceptable for more complex financial transactions. Yet, he finds two different values. One he called value in use, which refers to the utility of the good. The other is the value in exchange, which signifies the power of a good to purchase other goods. Obviously, there are some problems inherent to Smith’s theorising about ‘value’ which led in the late 19th century to the marginal utility doctrine. “It seems established that the earliest theory which Adam Smith held regarded ‘labour’ as the whole source of value and the quantity of labour embodied in each commodity as the measure of that value.” Nevertheless, Smith’s analysis of the division of labour leads to the problem that that it is no longer the product of one’s own labour that determines wealth, but the amount of other people’s labour which this product can command. Therefore, due to the confusion about the nature of value it is left to later economists to clarify the problem. As O’Brien states there are already in the early stages of the classical doctrine different types of value theories: “firstly, the ‘cost of production’ theory of value which so far as classical economists are concerned, originated with Adam Smith; secondly, the Ricardian theory of value; and thirdly the subjective value theories associated especially with the work of J.B.Say.”

However, the labour theory of value in the ‘Wealth of Nations’ is the cornerstone for all later classical economists and leads to further discussions about capital and distribution, even though the confusion between price and value cannot be overcome by Smith. He argues: “Labour alone is the ultimate and real standard by which the value of all commodities can at all times and places be estimated and compared.” Hence labour becomes the real and money the nominal price of commodities. Smith then carries on with his theory of capital and distribution and discusses wages, profit and rent. Yet again, he encounters problems explaining the capitalist’s profit with the labour theory of value sufficiently and only later it was Marx’s argumentation of the surplus value which offered an apparent solution to the phenomenon.

In short, Smith’s theory of distribution is based on a mixture between labour and cost-of-production theories, where wages are determined by subsistence, profit related to interest rates and rent depends on the price of the agricultural products, i.e. is purely differential. Moreover, capital accumulation can take place through the employment of productive labour - here, Adam Smith differentiates between productive and unproductive labour. Roll underlines: “This distinction, which began with the physiocrats and was implied in mercantilist thought (it is inherent in any search for the ‘causes’ of wealth), remained one of the most important parts of classical thought.”

Hence, we can understand the merits of the classical revolution as it reflected the changed nature of society and economy. Capitalist production, in Smith’s eyes, is the foundation for welfare and wealth. A new system of social categories or classes, productive and unproductive labourers, was introduced. This gave the emerging capitalist society a powerful cutting edge, but detrimental social forces and conflicts between the new and the old classes were predetermined.

Adam Smith, though, was a philosophical economist who believed in the natural balance and had a generally optimistic outlook. “In a sense the whole wonderful world of Adam Smith is a testimony to the eighteenth-century belief in the inevitable triumph of rationality and order over arbitrariness and chaos. Don’t try to do good, says Smith. Let good emerge as the by-product of selfishness.”

1.1.2 Malthus, Ricardo and Say’s Law

The classical school of political economy was brought into existence by Adam Smith, who with his emphasis on production, value and distribution established the structure of economic science. David Ricardo (1772-1823) and Thomas Malthus (1766-1834) based their work on Smithian assumptions but developed new aspects of the classical doctrine. Particularly in France Jean Baptiste Say (1767-1832), who translated ‘Wealth of Nations’, was one of Smith’s most faithful disciples, propagating ‘laissez faire’. The most important part of his work was his strong belief in the market mechanism which supposedly made general gluts impossible to imagine. Accordingly, Say’s law is manifesting that production under free market competition will always generate an equivalent demand for goods produced: supply simply creates its own demand!

But Smith’s and Say’s optimism was criticised particularly by Thomas Malthus whose work reflected the increasing deterioration of social conditions for the labourers in the high days of the Industrial Revolution. However, the implications of the Malthusian doctrine was not social reform but an attack on the proto-welfare state with its Poor Laws. Malthus argued in his ‘Essay on the Principles of Population’ (1798) that the population finds its limits in the means of subsistence. However, increasing production of foods leads to an increase in population, but population tends to increase in geometrical progression (1,2,4,8,16,...), whereas food supply at best can only increase in arithmetical progression (1,2,3,4,5,6,...). This asymmetry results in a natural balance in Smithian fashion as subsistence checks the population growth and subsequently should not be interfered with through welfare legislation etc. Yet Malthus was partly proved wrong as he did not anticipate the Green Revolution with its fertilisers and new agricultural machinery. However, his importance lies in his analysis of the possibility of general gluts which somehow shed a more pessimistic and even realistic light on the almost naive belief in the ever-healing market mechanism of Smith and Say.

Possibly the most important of the classical economists was David Ricardo whose scientific methods - even though as a stockbroker he had only a practical background and was no academic - were highly abstract and theoretical. “The importance of Ricardo is that of every great scientific pioneer. He 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.”

Nevertheless, Ricardo starts his ‘Principles of Economy and Taxation’ (1821) with a further development of the Smithian labour theory of value, reflecting the changed nature of production from pre-capitalist to industrial capitalist. Hence, he recognises the complications caused by capital, which was later used by Marx to formulate his exploitation theory. Furthermore, Ricardo realises the difference between value in use and value in exchange and comes to the conclusion that as prices change, value is different from price. With his ‘Iron Law of Wages’ this observation finds further expression, as Ricardo states that the value of labour is variable as well, based on the supply and demand and the price of food. In essence this leads to a cost of production theory of value, contradicting Smith’s early pure labour theory.

Moreover, Ricardo as a representative of the new capitalist class puts forward a theory on rent which reflects in quasi-Malthusian fashion a problematic outlook for industrial capitalism. Accordingly, he formulated the ‘Law of Diminishing Returns’: in the times of further industrialisation the landowner benefits from an increasing demand for agricultural products from the growing workforce. Hence there is no absolute rent, but it is purely differential. As a consequence more infertile land has been ploughed up to meet growing demand. Therefore, the price is dictated by the highest cost of production, leading to higher rent on the more fertile lands. The Capitalist, however, as prices for subsistence are rising, has to pay higher wages. Thus, profits for the capitalists are diminishing, whereas the landowner’s rent is rising. Therefore, as Britain at the time was still a mainly agricultural country, Ricardo was painting a gloomy picture for the future, which could only be remedied by a stronger position of capitalism within the economy.

Most importantly for the purpose of this study, Ricardo’s work is of outstanding importance for the emerging free trade policies which brought Britain at the time to a quasi-domination of the economic world. His theory of international trade, centred around the concepts of the comparative advantage, was based on the assumption (expressed in the famous ‘cloth and wine’ example) that:

“the same rule which regulates the relative value of commodities in one country, does not regulate the relative value of commodities exchanged between two or more countries. … The quantity of wine which [Portugal] shall give in exchange for the cloth of England, is not determined by the respective quantities of labour devoted to the production of each, as it would be, if both commodities were manufactured in England, or both in Portugal...”

Hence, even if a country possessed an absolute advantage in the production of certain commodities it could be still more advantageous to import the respective product from abroad as long as it was relatively less efficient in the production of the commodity than of another. As O’Brien points out, Ricardo established “a theory of gain from trade which was clearly distinguished from that based upon absolute advantage.” In essence, Ricardo’s theory provided expanding British industry with an ideology in order to propagate free trade and to improve the production conditions for the rising capitalist class. Obviously, the main argument backed up by his theory of trade and the comparative advantage was the liberalisation of imports of British industrially manufactured goods into possibly countries on the verge of industrialisation (USA, France, Germany ...) for a reduction of agricultural protectionism on the British side. Even if there had been an absolute advantage for British grain, the comparative advantage was pointing at the manufacturing sector instead of occupying valuable productive resources in agriculture. In this sense Ricardo was vehemently criticising the Corn Laws, based on his theory of International Trade and the Law of Diminishing Returns, and was campaigning against the inherent protectionist policies laid down in parliament by the politically still dominant landowner class.

However, Ricardo was not only actively involved as a member of Parliament in the politics of his day but played an outstanding role as a pioneer of scientific economics.

“Several streams of thought have their origin in his work. One the one hand the Marxian theory, though in a distorted form, makes use of the imperfections of classical political economy as expressed by Ricardo. At the same time, the disintegration of the labour theory of value begins with Ricardo’s immediate followers. His emphasis on distribution raised the question of class relations and directed attention to social and historical factors in economic analysis.”

Yet another important development in economic thought shifted the emphasis away from the classical concepts of production, supply and cost. The marginal revolution of the 1870’s with the publications of Jevons, Menger and Walras gave economics a new perspective without denying the basic premises of the classical school. The modern neo-classical theory was now mainly concerned with consumption, demand and utility. The marginal utility concept was introduced to exemplify that in order to explain demand, it was not necessary to determine the average utility of goods, but the marginal utility which falls with the consumption of the respective good. This meant a clear break from the labour theory of value. Now, the neo-classical school, and here Alfred Marshall (1842-1924) in particular, began to develop the subjective theory of value since they had realised that the price of the good was determined by it’s subjective perception of utility. Subsequently, the microeconomic approach of classical and especially neo-classical doctrine continued to shape thought and policy making for well into the first half of the 20th century.

1.2 Marxist Analysis of Economics

In the heyday of the Industrial Revolution capitalism did not only find approval but also criticism from different quarters. Particularly the socialist critique based on the deteriorating social conditions for workers and the increasingly influential liberal philosophy, formulated a new ideology which was challenging the newly established status quo. Already in the early 19th century French Utopians of the likes of Saint Simon, Fourier, Sismondi and Proudhon were creating both the theoretical foundations for the new communist ideology and model villages to put their ideas to the test. In Britain, however, the socialist pioneers stood in the tradition of the classical school and based their analysis on the assumptions made by David Ricardo. Writers such as Bray, Gray, Thompson, Hodgskin and especially Robert Owen have to be mentioned as the forerunners of Marx, who all used the classical conclusions to point to a revolutionary morale.

Karl Marx, born 1818 in Trier, Germany, initially focused on philosophy and was a follower of Friedrich Hegel. Hence, based on a critical evaluation of the historical-dialectic concept of Hegelian philosophy, Marx later developed a new socio-economic theory. Yet Marx was not the revolutionary right from the start as he seemed to be destined for an academic career. However, his disillusionment with the reactionary academic establishment forced him to take refuge in journalism where he felt to be able to express his political and philosophical ideas. But Marx’s criticism of the worsening social conditions of the workers caused by the expanding industrial capitalism was suppressed by the Prussian government and after a only short editorship of the liberal ‘Rheinische Zeitung’ he was forced into exile. He lived for a short while in Paris and in Brussels where he became friends with Friedrich Engels (1820-95) and they jointly wrote the ‘Communist Manifesto’(1848). Then he had to emigrate to London and it was in the British Library where he started the systematic study of political economy. Subsequently, Hegelian philosophy started to become fused with Ricardian economics to a revolutionary political ideology and economic doctrine. “Utilitarianism and early English Socialism, French Socialist thought, and the beginnings of German radicalism were the inspirations of Marx’s youth.” Subsequently, Marx expressed these new ideas and published ‘The Critique of Political Economy’ in 1859 and ‘The Capital, Vol.1’ appeared in 1867 - volume 2 and 3 were published by Engels after Marx’s death in 1883. The basic assumptions of the Marx’s analysis of economics are, firstly that history is a process of constant change caused by inherent contradictions within the socio-economic system itself. This leads secondly to the conclusion that the economic system itself is constituted by social productive relationships. As a result Marx and Engels formulated a materialist concept of history. In this dialectical historical materialism modes of production or types of economic order are competing in the Hegelian sense of thesis and antithesis to form a synthesis.

“History progressed through a series of stages, each characterised by its mode of production or economic system, from slavery and feudalism to capitalism and, finally, communism. At each point, historical change resulted from the internal contradictions which characterised all class societies. This occurred when the class system itself, the ‘relations of production’ became a constraint upon the further development of production techniques and innovation, the ‘forces of production’, and was reflected in a social revolution through which a new mode of production emerged.” .

Subsequently, history and society can only be explained in terms of what Marx called the economic base which conditioned the legal and the political superstructure:

“The materialist conception of history starts with the principle that production, and with production the exchange of the products, is the basis of every social order; that in every society that has appeared in history the distribution of products, and with it the division of society into classes or estates, is determined by what is produced, and how the product is exchanged. According to this conception the ultimate cause of all social changes and political changes are to be sought not in the minds of men, but in changes of the mode of production and exchange; they are to be sought not in the philosophy, but in the economics of the epoch considered.”

Nevertheless, the economist Marx was a Ricardian and agreed with the premises of the labour theory of value. However, he criticised the Classical School for their approach to the distribution of power through the class system. Moreover, Marx encountered the logical problems of the labour theory of value as soon as he tried to explain the labourers wages and the capitalist’s profit with the tools of classical economics. Essentially, he raised certain objections about their validity as reality had shown that labour itself had become a commodity, or at least was treated like it.

Furthermore, Marx identified a number of far reaching problems inherent to the classical doctrine. Firstly he criticised the distribution of power in the capitalist system through a class society, which was secondly interconnected with an uneven distribution of wealth. He put forward the question why the exchange value of labour is less than that of its product. Like every other commodity, analysed Marx, labour is formed and measured by the amount of labour required for its production or in this case for the reproduction of the physical power of the labourer, i.e. it is determined and embodied in the labourers need for subsistence. However, when a capitalist employs a labourer, the phenomenon arises that human labour can be expended in a longer time which is required to reproduce it. Its here where the surplus value, the capitalist’s profit comes into existence. Therefore, the labourer is exploited as “the surplus labour of one man becomes the condition of existence of others.” Based on Ricardo’s ‘Law of Diminishing Returns’, despite increasing productivity, Marx expected the capitalist’s profits to fall as wages have to rise to keep up with increasing food prices. Thirdly, Marx had great insights about the development of the temporary economics which he called ‘Laws of Motion’ of a capitalist system. He realised that the only way in which the profit-driven capitalist economy under the pressure of competition and rising wages can maintain itself was through expansion. “But growth implies the second prediction of the Marxist model: the ceaseless quest for new techniques. It was no accident that industrial capitalism dates from the Industrial Revolution, for Marx made clear, technological progress is not merely an accompaniment of capitalism, but a vital ingredient.” Hence, the concentration of wealth in the forms of industrial monopolies and giant corporations was an inevitable tendency of capitalism, leading to an impoverishment of the masses, the creation of a class conscience and finally to revolution.

Fourthly, conflicts between production and consumption, and the falling tendency of the rate of profit are inherent to capitalism according to Marx’ analysis. “The purpose of capitalist production is the creation of surplus value and the transformation of parts of it to new capital. This process depends only on the size of the working population and on the rate of exploitation. ... The product which contains surplus value has to be sold.” Competition, underconsumption, overproduction etc. can therefore upset the system. Even though such a tendency can be counteracted by an increased degree of exploitation, reduction of wages below the value of labour, increase of the industrial reserve army (the unemployed), or different financial organisation of the capitalist business, at one stage only a crisis can be the solution to the inherent conflicts of capitalist economy. Equilibrium can therefore temporarily be re-established but in a business cycle the next crisis is already determined as capitalism means the continuing expansion of the productive powers of society.

“All that is common sense and substantially sound. We find practically all the elements that ever entered into any serious analysis of business cycles, and on the whole very little error. Moreover, it must not be forgotten that the mere perception of the existence of a cyclical movement was a great achievement at the time. … But he also used it in a different sense. Believing that capitalist evolution would someday disrupt the institutional framework of capitalist society, he thought that before the actual breakdown occurred capitalism would begin to work with increasing friction and display the symptoms of fatal illness. … And he displays a tendency to link those recurrent crises with this unique crisis of the capitalist order. He even suggests that the former may in a sense looked upon as previews of the ultimate breakdown.”

Yet, coincidentally in the year of Marx’s death an economist was born who was to revolutionise the way we used to think about business cycles and economics as a whole. Moreover, his importance lies in the achievement of ‘taming’ capitalism, and therefore - against all predictions of historical materialism – prolonging its life beyond the expectations of the late 19th century social revolutionaries.

1.3. The Keynesian Revolution

John Maynard Keynes was born in 1883 as the son of the Cambridge lecturer in logic and economics, John Neville Keynes. Gifted with many talents he went to Eton and studied at King’s College, Cambridge. In1908 he entered the Civil Service and was assigned to the India Office. Intellectually unchallenged and disappointed with his work he left for an academic career and began to lecture economics at King’s. In 1913 he published his first work on economics, the ‘Indian Currency and Finance’ which Schumpeter regards as “the best English work on the gold exchange standard.”

At the beginning of the First World War he was drafted into the Treasury, at first to a junior position, but he quickly rose through the ranks and made himself a name as an outstanding economic genius. His biographer, Roy Harrod, notes that Keynes was regarded to have contributed more to winning the war than any other person in civil life with his work to finance the British war effort. After the end of the war he took part in the Paris Peace Conference as Deputy for the Chancellor of the Exchequer on the Supreme Economic Council, and as representative of the Treasury. But without real influence on the outcome of the talks he resigned, realising that the Versailles Treaty was going to lay the foundation for a resurgence of economic nationalism and militarism – instead of concentrating on rebuilding and restabilising Europe:

“The Council of Four paid no attention to these issues, being preoccupied with others, - Clemenceau to crush the economic life his enemy, Lloyd George to do a deal and bring home something that would pass muster for a week, the President to do nothing that was not just and right. It is an extraordinary fact that the fundamental problems of a Europe starving and disintegrating before their eyes, was the one question in which it was impossible to arouse the interest of the Four. Reparation was their main excursion into the economic sphere, and they settled it as a problem of theology, of politics, of electoral chicane, from every point of view except that of the economic future of the states whose destiny they were handling.”

Keynes’ ‘Economic Consequences of the Peace’ was a best-seller and brought him internationally the reputation of being a brilliant but somewhat unorthodox thinker and economist. However, he continued to pursue many other interests: he debated in the Bloomsbury Circle, lectured at Cambridge, wrote a highly acclaimed book on mathematical probability , speculated very successfully in the foreign exchange and commodity markets, became chairman of a life insurance company, and married a Russian ballerina. In 1923 he published ‘A Tract on Monetary Reform’ in which he emphasised that Britain should not return to the pre-war gold standard, even though a big majority of public figures were campaigning for it. After its reintroduction he protested and prophesised in his Pamphlet ‘The Economic Consequences of Mr.Churchill’ an over-valuation of the Pound and heavy unemployment. “As so often he was right. He called for large-scale government expenditure and public works to cope with unemployment, even though this would mean a large Budget deficit, but he could not provide a theoretical justification of this ‘potentially unsound’ idea, and was largely ignored.” Throughout his subsequent work a clear interest in business cycles is present, especially during the years of depression and high unemployment, which was leading to an evaluation of the appropriate roles of individuals and governments in the quest for a high and stable level of economic activity. As Roll points out, this: “… led Keynes into an appraisal of the agenda of the state and a consequent modification of the doctrine of laissez-faire (not an abandonment as the title of his best-known pamphlet, ‘The End of Laissez-Faire’ (1926) might suggest.)”

However, in 1930 he wrote the ‘Treatise on Money’ which was almost like a prelude to his grand work, ‘The General Theory of Employment, Interest, and Money’ which appeared in 1936. Yet, even though struck by ill health he returned to the Treasury at the outbreak of World War II and helped to co-ordinate war finances and particularly the ‘Lend and Lease Treaty’. In ‘How to Pay for the War’ (1940) he made radical new proposals on the problem of internal war finance as he suggested a compulsory saving scheme through the automatic investment of a portion of every earner’s income in government bonds. Later he was the British Chief negotiator in the Bretton Woods Conference, leading to the establishment of the International Monetary Fund and Worldbank, perhaps not quite in the way as suggested by Keynes, but the international economic balance of power had clearly shifted towards the USA. In 1946, at the age of 62, John Maynard Keynes died of a second heart attack and the world lost a man, who was regarded by politicians and economists alike as a truly outstanding genius who was to revolutionise the economic thinking of the world in the years to come.

The Keynesian Revolution was certainly inspired by a closer investigation into business cycles, particularly by the analysis of the Great Depression of the late 20s and early 30s. Here Keynes’s contribution was to emphasise that modern economics were not really working according to the laws of the classical school.

“The implied assumption of the classical system (which becomes explicit in the law of the market developed by James Mill, Say, and, to some extent, Ricardo) is that the economic system spontaneously tends to produce full employment of given resources. Keynes’s theory is built upon a rejection of this assumption. The Classics … virtually ignored the problem of the crisis. They also failed to analyse specifically the possibility that there may be different levels of economic activity with the same amount of resources. … But when the classics develop their theory of value and distribution for what Keynes called a special case, that of full employment, they did so because they thought that their analysis of the mechanism of exchange and their theory of capital accumulation had already proved that the economic system invariably tended toward full employment. This tendency, which was implied in the inevitable correspondence between supply and demand is most dogmatically expressed in Say’s law.”

Keynes’s reassessment of Say’s law was based on the analysis of business cycles and on the recent contraction of the economy in the Great Depression, and importantly on the relationship between saving and investing. He argued that the structure of the economy had changed since the early days of industrial capitalism: in Ricardo’s time only wealthy landlords and capitalists were investing into their businesses. Saving simply implied accumulation of investments. With increasing industrialisation and a wider distribution of wealth, saving became open to all levels of society. This coincided with an enlargement of and depersonalisation of businesses, which were now looking for new capital not just from their owners but also from private savers. Therefore, saving and investing became separated, which Keynes regarded as a critical development.

“In short, said the classics, full employment is the normal state of affairs. Full employment exists provide that all the savings generated by a fully employed economy are invested, and the rate of interest is a mechanism which ensures that this will happen. … Unfortunately, said Keynes, it is ‘a nonsense theory’. The main reason why it is nonsense is that it fails to take account of the changes in income that result from any change in investment or saving; it fails to see that what people want to save, and what they actually do save, are in certain circumstances quite different things.”

Moreover, this meant the rejection of the general belief that the economy would undergo a see-saw like movement of contraction and expansion. There was no automatic recovery as the classical economists expected after the price of labour would fall at the bottom of the cycle, leading to a safety mechanism that made investments more lucrative again. Hence, the economy was exposed to the possibility of boom and bust, but could stagnate as well. Keynes explained in his ‘General Theory’ that the economic equilibrium could even manifest itself in a state of prolonged depression and increasing unemployment, lower productivity and a decreasing tendency to save would lead to a total contraction of national income. This theory was clearly backed up by a statistical analysis of private savings: in 1929 the Americans saved $3.7 billion, whereas in 1933 the savings had completely dried up.

“Keynes had explained how an economy in the trough of an depression could fail to generate its own automatic recovery. … But when you turned the Keynesian proposition around, it spelled troubled at the top of the business cycle as well. … It meant that every boom was constantly threatened with collapse. … Hence in the final analysis, the economy hung on the amount of investment which business carried out. When investment was low, the economy shrank in size; when investment was high it permitted the cycle of contraction to begin. Riches and poverty, boom and slump, all depended on the willingness of business to invest.”

However, Keynes regarded capitalism not as doomed as Marx did but started the debate about government intervention. Breaking with the tradition of classical economics he proclaimed that the government had to, in case private enterprise was not able to expand, play an active economic role as investor and employer. Government spending, or ‘priming the pump’, was an obvious break from the norm as far as the laissez-faire understanding of economics at the time was regarded, but according to Keynes a controlled market economy was the objective, not a planed one:

“If the treasury were to fill old bottles with bank notes, bury at suitable depth in coal mines which are then filled up to the surface with town rubbish, and leave it to private enterprise on well-tried principles of laissez-faire to dig the notes up again …, there need be no more unemployment and with the help of the repercussions, the real income of the community would probably become larger than it is. It would, indeed, be more sensible to build houses and the like; but if there are practical difficulties in the way of doing this, the above would be better than nothing.” This implied government action of a type and scale never thought of before. Only in the United States an economic program called the ‘New Deal’ had been brought into action by President Roosevelt already in the early 1930’s. In a way Keynes’s ‘General Theory’ was a defence and theoretical explanation of the need for government intervention. Public spending, even if it may lead to a budget deficit, was now made a legitimate policy tool to combat unemployment. Keynes’s key argument here was the multiplier effect which had first been developed by R.H.Kahn in 1931. Based on the marginal propensity to consume, Keynes argued, an increase in the income would lead to higher consumption and therefore to a stimulation of national economy as a whole. Accordingly, government spending would have a overall positive effect through the respective multiplier: private businesses in turn would start to invest, employ more workers, leading to an increased effective demand and the national income would subsequently rise again by even several times more than the original government investment.

In concluding, Keynes’s main achievements are firstly the partial rejection of classical economics which only covers a special case in the capitalist system, and secondly the taming of capitalism itself through anti-cyclic public spending, again in contrast to the prevailing laissez-faire ideas, and finally the prevention of financial crises and unemployment through government control of credit and currency. Moreover, it was Keynes’s scientific discovery, based on the observation that the factors determining the behaviour of the whole economy are not merely a multiplied version of the behaviour of individual economic actors, that coined the distinctive terminology of macro and micro economics. But we have to bear in mind that, “For while Keynes espoused a policy of managing capitalism, he was no opponent of private enterprise. … In review ‘The General Theory’ was not a radical solution; it was rather a explanation of why an inescapable remedy should work. If an economy in the doldrums could drift indefinitely, the price of government in action might be graver by far than the consequences of bold unorthodoxy.”

Finally, as the political reality particularly in Germany, Scandinavia and Britain has shown, Keynesianism had become a popular policy tool via social legislation and monetary control through the government from the 1950s onward. To fight unemployment, co-ordinate the market economy, establish a welfare state and create economic stability dramatic steps have to be taken, which were to revolutionise the way we are thinking about the economy and the state: “The central controls necessary to ensure full employment will, of course, involve a large extension of the traditional functions of government. … Furthermore, the modern classical theory has itself called attention to various conditions in which the free play of economic forces may need to be curbed or guided.”

1.4 Hayek and the Market Mechanism

One of Keynes’s most vehement critics was Friedrich Hayek. He was born in 1899 in Vienna and had academic interests in a wide field from psychiatry and psychology, genetics, to philosophy, politics and economics. After serving in the First World War he work as a civil servant before taking up an academic career. After his PhD in political science he went to the USA as a research assistant which was to influence the way he was thinking about politics and economics considerably. On his return to Austria he started lecturing and became the first director of the Austrian Institute of Business-Cycle Research in 1927. He moved to Britain to lecture at the London School of Economics and acquired British citizenship in 1938 where he remained until 1950. After a short period at the University of Chicago he returned to Europe and took on a professorship at the University of Freiburg/Breisgau. In 1974 he was jointly awarded the Nobel Price in economics. Friedrich Hayek died in 1992.

The economist stood in the tradition of the Austrian school which was founded by Carl Menger (1840-1921), Friedrich von Wieser (1851-1926) and Eugen Böhm-Bawerk (1851-1914). Their work was contrasted sharply with both the classical school and the German Historical School (see chapter 2). The Austrian School claimed with Carl Menger’s publication of ‘The Principles in Economics’ (1871) that the classical labour-theory-of-value was incorrect and that value derives from utility.

“Although Carl Menger was among the acknowledged pioneers of marginalism, there is a distinction in his work which became the special mark of the Austrian School. … Menger emphasised the network of linkages between the production of different goods and the role of human action and market transactions in achieving a coherent structure within the network. … Every individual act involves a choice, and the combination of individual’s choices produces highly complex structures, knowledge of which is never complete nor certain. … Menger’s subjective theory of value and his aversion to the pretence of mathematical precision is in direct opposition to the formalism which was to become the primary feature of the alternative marginalism of neoclassical microeconomics.”

Moreover, Menger’s criticism focused on the German Historical School as well, as they rejected important assumption of the classical economists: Smith’s motive of self-interest and money making could not be as easily refuted as the Historical School claimed, since it was the most persistent and most clearly observable driving force in the capitalist system. The so-called ‘Methodenstreit’ raged between the scholars of the Historical School who argued that a deduction of economic laws solely from the self-interest motive was not justified, but an induction from historical facts should determine certain principles instead, and the classical and Austrian school. Furthermore, Menger carried on to emphasise the subjective nature of economic values and the wrongs of the belief in the mathematical correctness of social science.

In the tradition of the Austrian school especially Friedrich Hayek, together with Ludwig von Mises, continued to formulate a liberal philosophy which regarded all socio-economic data as subjective phenomena. Hence, only in the context of individual choices in the market place a general understanding of the functioning of economics is possible. As Steel points out: “Human action and reaction are in constant play, and the Austrian analysis founded upon dynamic market processes, where decisions are formulated in the presence of uncertainty and with the potential for error, and where entrepreneurship determines the flux of ever-changing relative prices which are indispensable as a guide to give coherent direction to economic activity.”

At the time of Hayek’s active work both neo-classical microeconomics and Keynesian macroeconomics were prevalent and Hayek regarded both as methods of static analysis which were incapable to evaluate the dynamic nature of society and economics. Therefore, the aim of Hayek’s approach to economics was to provide the basis for an understanding of the manner of coherent human interaction in society and economy.

In the growing intellectual shadow of Keynes he published ‘Money Theory and the Trade Cycle’ in 1933 which rejected the view that money and the availability of credit did not affect the structure of production, and shows how an injection of credit can cause changes in the relative price of goods which might lead to a dangerous over-investment. Therefore, Hayek stressed the importance of his concept of ‘neutral money’ since the natural reallocation of resources and prices would be dealt with by the dynamic market mechanism. Monetary disturbances through government control of finances in general then could lead to a distortion of price which are carrying important information about the future of the economy, which in turn might have a overall negative effect on the economic development if distorted. ‘The Pure Theory of Capital’ (1941) carries on to investigate business cycles, the role of capital and entrepreneurial activity. Hayek’s analysis stood again in opposition to Keynes’s ‘General Theory’ which he regards as misleading and even damaging as the Keynesian macroeconomic policy and the advocated government spending might lead to a disturbance of the market mechanism. In 1935 he published ‘Collectivist Economic Planning’, a condemnation of socialist planned economies on the grounds that the economic process of allocating resources is so highly complex a problem that it is insuperable – again highly and vehemently praising the free market as the only all-cure.

This line of investigation and subsequently the political belief is continued in his best-known work, ‘The Road to Serfdom’ (1944). Hayek argues that not necessarily dictatorship leads to planning, but rather planning to dictatorship, because dictatorship is the most effective way of enforcing the plan. Even in an initially democratic society the consensus over a planned economy can lead to a delegation of power. At the stage when the planning body becomes fully institutionalised as an instrument of key political power, a dependency is created which is “scarcely distinguishable from slavery.” However, Hayek’s ‘propaganda’ is not only focused on just the Soviet type of planning or on the actual development of totalitarianism in Nazi-Germany, but even Keynesian macroeconomic government intervention is regarded as potentially dangerous – yet a decline into economic dictatorship and totalitarianism is not inevitable. Subsequently Butler underlines the neo-liberal viewpoint:

“One of the most powerful themes of ‘The Road to Serfdom’ is that even modest economic planning has the effect of slowly but inexorably eroding the values and attitudes which are vital if freedom is to exist. When it is believed that jobs can be created by government and not by employers serving the customer; when we suppose that incomes can be made secure and unaffected by constant changes of the market; and when the government starts to protect the monopolies and special privileges of special groups for whatever reason, the erosion of liberty has begun. Long before, people see their future lying with governmental protection and direction, instead of the free and competitive economy.”

In 1960 ‘The Constitution of Liberty’ appeared and was a restatement of the principles and the practice of liberalism in modern terms, laying down the framework for a liberal society and neo-liberal economics. He argues that the working of society and economy is such a complex mechanism that it exceeds the capability of an individual to comprehend, therefore it is impossible to plan the economy successfully. Individual freedom should subsequently not be inhibited as thereby the social and economic system or order respectively is robbed of its unique ability to allocate resources efficiently through the market place and to overcome new problems.

Hence, Hayek’s key framework is the market mechanism and only it is capable to establish order and provide the necessary adjustments. “We are only beginning to understand on how subtle a communication system the functioning of the advanced industrial society is based – a communications system which we call the market and which turns out to be a more efficient mechanism for digesting and dispersing information than any that has been deliberately designed.” However, Friedrich Hayek remains the leading propagator of the neo-liberal school of thought for which the market is the key ideological concept. In sum, free trade, the spirit of free enterprise, government abstinence from monetary policies and large scale public spending, and an independent price mechanism through the market are the essential factors which are constituting the neo-liberal framework. Nevertheless, the inherent problem of Hayek’s economics lies in the ideological overvaluation of the market mechanism. The theoretical approach, generally, leads into a sensible direction as the market can basically provide a sound procedure to allocate resources in contrast to pure economic planning, but Hayek completely degrades and negates the role of the state in for example an underdeveloped economy or in times of recession, when perhaps sensible state intervention might be necessary.

Hayek’s writings and insights were all based on the concept of liberty, and in sharp contrast to the at the time prevailing Keynesianism he initiated a renaissance of liberalism. His neo-liberal economic doctrine, based on the omnipotent market mechanism found special expression in the Reagan and Thatcher governments which came closest to Hayek’s ideal of limiting government intervention to the fostering of conditions which encourage private enterprise. Consequently, the essence of the neo-liberal renaissance meant a revitalisation of macroeconomic policy modelled on the principles of free trade, laissez faire and the market mechanism, which was before almost exclusively dominated by Keynesian ideas and tools. Liberalism and classical economic thought, hence, through Hayek’s achievement were allowed again to participate in the great 20th century debates about de-colonisation, economic policies, globalisation and the future of capitalism.

1.5 Conclusion

The function of this chapter was to underline the differences and similarities of the principal dominant economic doctrines, especially in the context of the inter-paradigm debate of International Relations. The Anglo-American doctrines presented (Classical liberalism, Marxism, Keynesianism and neo-liberalism) are widely regarded to be the dominant strands in mainstream economic thought and are mainly - with Marxism as the exception - propagating the market mechanism by a greater or lesser extent for economic development. Robert Gilpin, for example, summarises accordingly that “[o]ver the past century and a half, the ideologies of liberalism, nationalism, and Marxism have divided humanity. … The conflict among these three moral and intellectual positions has revolved around the role and significance of the market in the organisation of society and economic affairs. Through the evaluation of the strengths and weaknesses of these three ideologies it is possible to illuminate the study of the field of international political economy.”

However, another aim of this chapter was to demonstrate that the clear-cut structure of IR with its emphasis on the three world views of realism, liberalism, and structuralism cannot be imposed on the study of International Political Economy, because of the actual close theoretical relationship between the different economic doctrines. Hence, the supposed difference between, for example, structuralism and liberalism is not necessarily reflected in economic theory. This dissertation has pointed out that the Marxist economic analysis is inherently using the classical presumptions of the labour-theory-of-value to lead to a different, revolutionary moral, but Marx himself stands out as a Ricardian economist. This clearly implies that, as Smith and Ricardo are the founding fathers of classical or liberal economic thought, that there must be a certain overlap in the essence between Marxist and liberal economic theory.

Furthermore, economic nationalism measured by the same standards is usually identified as part of the ‘realist’ paradigm, and accordingly connected with mercantilist or neo-mercantilist economic practices. However, as the discussion of economic history has shown that mercantilism sees wealth solely in terms of specie, accumulated through foreign trade, and therefore is not compatible with the concept of the labour theory of value (Adam Smith) or theories of productive forces (Friedrich List). Hence, the often produced argument that any type of economic nationalism does not need to rely on capitalist methods of production, distribution and exchange in general – because it is bending the well-established rules of the international economic system - , in order to set it equal to mercantilism, has to be regarded as unsubstantiated. But, as the discussion of List’s concept of economics in the following chapter will demonstrate, in order to reach nationalistic economic objectives effectively and quickly, a certain type of capitalism can be necessary. Capitalism itself, however, does not necessarily have to incorporate the principle of free trade as this ‘political’ concept itself was mainly motivated by global and domestic political and economical interests of Britain as the oldest and leading industrial nation in the 18th and 19th century.

However, this dissertation is not about IR theory, but rather intends to deal with an analysis and an improvement of our understanding of the type of economic development which has set in in the Japan of the late 19th century. This short and obviously very simplified discussion of the IR paradigms, therefore, only serves the purpose of highlighting the difference of the nature of Japanese developmental capitalism – and does not do IR justice, but this is certainly neither the function nor the intention of this dissertation to do so. However, even though the IR paradigms may altogether appear right and helpful for the study of International Relations, it has to be pointed out that, in the light of the analysis in the following chapters, a more flexible approach is important for the understanding of political economy, particularly since the economic pragmatism practised in East Asia has borrowed ideas across the ideological divide. Economic policies can, as chapter 3 and 4 will emphasise, subsequently, deviate from the clear cut structure of the inter-paradigm debate of IR, because economic theories themselves, as this chapter will demonstrate, have been developed in correspondence and interdependence to each and another. Therefore, it will be concluded that the often quoted paradigms of International Relations cannot be easily applied to the study of International Political Economy as this will only lead to a misinterpretation of economic realities.

Thus, the paradigmatic approach of, for example Robert Gilpin can only be regarded as doubtful. Not just the fact that the economic thinkers presented in this chapter are in an antagonistic relationship to the well-known inter-paradigm debate is of importance for the dissertation as a whole, but the evaluation of the economic thought of Friedrich List (see chapter.2.4 in particular) plays a essential role in the assessment of the phenomenal process of economic development in Japan (chapters 3 and 4). List himself, as the following chapter will explain, is certainly a propagator of economic nationalism but was a political liberal. Hence, the inter-paradigm debate does not seem to be applicable to this discussion about the role of the state in economic development, because the policies implemented are often coming from wide range of different economic doctrines as the Ricardian roots of Marxism and the liberal nature of List economic nationalism are illustrating.

In conclusion, this chapter has shown that it is of vital importance to address other economic traditions such as Friedrich List’s concept of a national system of political economy, as the mainstream, Anglo-American economic doctrines have neglected or even attacked any role for the state in promoting economic development.

Chapter 2 “Friedrich List”

“Between each Individual and entire Humanity stands the Nation.” (List, 1841)

Friedrich List, the civil servant, professor, politician, political prisoner, businessman and journalist made his mark as an agitator for protective tariffs, German unification, the Zollverein and the construction of railway systems. The aim of this chapter is therefore to elaborate the influences on List’s ideas, his intellectual development and the impact of his own thought on subsequent economic practices. As we will see, his ideas of economic nationalism were an inspiration to the political unification and the industrial development of Germany and Japan, arguably the first Newly Industrialising Countries (NIC) of their time.

Within the context of the whole dissertation, this chapter serves the purpose of presenting the alternative economic tradition chapter 1 postulated: as the dominant Anglo-American strands in mainstream economic thought have neglected and attacked any role for the state in promoting economic development, Friedrich List’s ideas, this dissertation argues, prove the vital importance of addressing other economic traditions. State-led economic development and industrialisation through the promotion of infant industries, protective measures, administrative guidance and industrial policy within a mainly market-based economy, opposed to ‘laissez faire’, market mechanism without state-intervention and free enterprise, are issues which are usually ignored by the mainstream economic thinkers. However, this chapter will present Friedrich List and his concept of a national system of political economy, which have been decisive to the economic rise of Germany and Japan, in order to point out that the state can play an essential part in economic development. However, it is important to view Friedrich List in the circumstances of his life and time. His work can only be fully evaluated in the light of Germany’s development from economic and political fragmentation to industrialisation and nation building. List himself underwent a long personal development process, from a follower of cosmopolitical economics to the co-founder of economic nationalism - although he was a liberal, enlightened nationalist. The changes and contradictions in List’s life, thus, require a detailed biographical analysis.

List’s main achievement can be seen in the popularisation of new economic strategies in contrast to the classical free trade doctrine, and his analysis of development and underdevelopment in a time when Britain’s capitalism dominated the world. But List was not a pure academic, but he rather was, as Keith Tribe has pointed out, a politico-economic journalist. However, he was neither the first nor the last German 19th century economist to criticise Adam Smith’s free trade doctrine, both romanticism and the German Historical School condemned laissez faire. In the early 19th century Germany was a semi-feudal agricultural country and industrial capitalism was not far advanced. But in fear of the social forces capitalism and liberalism were able to set free, or bluntly put, afraid of the socio-political repercussions of the French Revolution, some German writers and economists wanted to preserve the traditional society and the status quo in their home country. Derived from Johann Gottlieb Fichte’s concept of nationalism and Edmund Burke’s conservative criticism of liberalism a rather illogical school of ‘romantics’ evolved. Friedrich Gentz (1764-1832) and Adam Müller (1779-1829), for example, argued that the state is an organic and natural entity, not just the aggregate of the people living within the same territory, and therefore finds legitimate expression in the nation state. They idealised the Middle Ages and feudal society, and held it as unacceptable that self-interest in the Smithian sense could be the driving force of history and economics. The paternal state and the national community’s welfare are the real underlying reasons and subsequently they demanded a strong state and patriotism. Economic autarky, as envisaged by Fichte, had to be achieved. Free trade as such destroys national cohesion and the nation state as an economic unity, therefore, had to stop following ‘laissez faire’ policies. List was neither a romantic nor a typical classical economist as he did neither represent the landed interests of the conservatives, nor the vested interests of the newly emerged capitalist class, the bourgeoisie: he was an agitator for industrial capitalism, even though the economic backwardness of Germany made him “... the apostle of economic nationalism. List’s association with romanticism is attributable to the fact that the nationalism which he was forced to adopt brought him in opposition to Smith’s doctrines.”

The German Historical School, on the other hand, analysed economics from the mid 19th century onwards with their method of historical empiricism. Importantly, as we will see, Friedrich List uses especially this methodology in a basic form first, based on the concept of historicism. Hence, he and his methodology are regarded as precursors of the German Historical School, which had a tremendous influence on the development of both Germany and Japan.

2.1 Life and Times

Friedrich List was probably born on August 6th, 1789 as the son of a tanner and smallholder in Reutlingen, at the time an autonomous Imperial city, in the small state of Würtemberg. After leaving school he entered his father’s business, but he was an unsatisfactory apprentice and disliked the work, so he looked for a different career. In 1805 he secured himself the position of a junior clerk in the local government where he learnt the rudiments of public administration. Even though without university qualifications, he worked hard on his promotion and finally after different stages he was appointed Director of Finance (Rechnungsrat) in the Ministry of the Interior in 1816. List had already taken up journalism and had written several memoranda criticising the inefficient public administration when he co-founded the political journal Würtembergisches Archiv. His main political ambition at the time was the improvement of public administration and the reform of the constitution of Würtemberg. In the meantime List grew famous for his competence in matters of public economy and administration and progressive members of the government, especially von Wangenheim, the Minister of Education, when restructuring the Universitity of Tübingen in 1817, appointed him Professor of Public Administration to promote reforms.

But as a non-academic List was despised by the university establishment and as a critical propagator of reforms which the reactionary nobility and bureaucracy regarded as revolutionary he lost the support of his influential friends. Official inquiries were made into his lectures, but List - even though he worked apparently hard on his academic career - was still maybe more interested in his journalistic work and general political reform. Consequently he went to the Frankfurt Easter Fair after the winter semester 1818/19. There, as a well-known man, he was asked to draw up a petition to the Federal Diet on behalf of a deputation of merchants. From now on he played on essential role in establishing a Union of Merchants and Manufacturers and in promoting industrialisation. In the mean time his university career came to an end when he resigned over the dispute and criticism about his teachings in Tübingen and List never again held any public office in Germany. But “... he at last felt able to speak his mind freely... As the secretary of the Union of Merchants he broke out of the narrow confines of Würtemberg to play a political role on a larger stage .”

In List’s journalistic work his political ambitions had already been expressed but now he was in the position to influence the development of Germany from a cultural to a political unity by propagating a national parliament instead of a loose assembly, a constitutional and centralised government, a national army and a Federal Court of Appeal together with other federal institutions to foster the arts, science and education. At the time, though, Germany consisted of 39 sovereign entities united in the Deutscher Bund (German Confederation) with Austria and Prussia as the most powerful states competing for domination. But every single state exercised complete control over social and economic affairs, fiscal policy, legal matters, coinage, transport and tariffs. The members of the Union of Merchants and Manufacturers experienced difficulties resulting from those internal tariffs and felt that an economic revival after the Napoleonic Wars was only possible if an agreement between the German states could be reached to trade freely within the territory of the German Confederation and to protect domestic ‘infant’ industries from foreign competition. Even though List, as he stated in “The National System of Political Economy”, was in his younger years a follower of Adam Smith’s free trade doctrine , he grew convinced that here a real advance for his nationalist cause could be made. As Szporluk emphasised, List “... brought into nationalist thought and politics a new component or dimension - to wit the idea of ‘Germany’s’ economic unity. List’s program was novel and highly original, for it took as its premise the rise of industrialism following the Industrial Revolution in Britain and also accepted the political ideas and ideals of the French Revolution.” The new ideological connection between economics and the nation as opposed to Smith’s individual perspective was made. As Secretary of the Union of Merchants and editor of their weekly periodical Organ für den deutschen Handels-und Fabrikantenstand List, after the petition to the Federal Assembly had not brought the wanted success, tried to promote his economic aims by approaching the rulers of various German states directly. But only little success could be made again, yet

“its labours had not entirely been in vain. List’s vigorous propaganda had forced German statesmen to recognise that a multiplicity of internal tariffs posed a problem which could not be ignored. Between List’s retirement as secretary of the Union of Merchants and the founding of the Zollverein hardly a year passed without some negotiations taking place either for the formation of a regional union or for the inclusion of new territories in the Prussian Customs system.... When the Zollverein was founded in 1834 it was a very different organisation from the one envisaged by List. It was not established by the German Confederation as List had proposed. It was founded by Prussia its members accepted the Prussian tariff which List regarded as far too liberal to give German manufacturers adequate protection against foreign competition.”

In this period almost all of List’s time and devotion was spent on affairs of the Union of Merchants, but in July 1819 he returned to Würtemberg and was asked to stand as a candidate at the next general elections. However, had to wait until December 1820 to gain a seat in the lower house of the Würtemberg assembly. This was another opportunity for him to air his opinion on German commercial and political unity and reform. But only after a short while in parliament List was confronted by the police with one of his earlier pamphlets and charged with insulting the King, and other revolutionary ‘demagougeries’. List protested, but as his biographer Henderson states: “failed to appreciate that for years he had been a thorn in the flesh of many senior civil servants and some influential ministers of state.” Under pressure List was expelled from the assembly, found guilty and sentenced to 10 months fortress-imprisonment. There was an outcry on the side of the liberals about the miscarriage of justice and List escaped before he could be arrested. He moved to Strasbourg and stayed in several other German states and in Switzerland. Then he left for Paris where he met the hero of the American War of Independence, General Lafayette, and won his support. In 1824 List returned to Würtemberg and appealed to the king for a pardon, but he was jailed and had to serve 5 months in prison before - on the condition of his emigration - he was released.

In 1825 together with his wife and children Friedrich List travelled to America and joined Lafayette’s entourage who had invited him earlier to come with him. Here he had the opportunity and the privilege in Lafayette’s presence to study the development of the United States and to talk to many prominent politicians, scholars and businessmen. He started, unsuccessfully, some business adventures of his own, he published a number of articles and pamphlets supporting liberal rights and economic protectionism. It was here where List clearly developed most of the thoughts and knowledge he later voiced in “The National System“.

In the USA there already existed a ‘school of national economics’ and Alexander Hamilton (1757-1804) was their outstanding writer. He was the first US-Secretary of the Treasury and tried to re-establish America politically and economically after the War of Independence. “Hamilton advocated a nationally directed and controlled economy and... he believed that the economy should be invigorated and protected by bounties and tariffs, by canals and roads and other public improvements built by the federal government ... .”

Yet Hamilton stood in the centre of a debate against the agricultural south and the proponents of the physiocratic tradition, namely Jefferson and Madison who argued for the import of manufactured goods as they held agriculture for the real source of value. Even morally they were convinced that only in an agrarian society virtue could be preserved - and practically it was possible for the expanding population of the USA to occupy more land in the west. But Hamilton rejected the agrarian arguments of Jefferson and proposed in his ‘Report on the Subject of the Manufacturers’ (1791) the development of domestic industries. First, he simply used Smith to refute the physiocratic tendencies, based on the assumption that only through a flourishing manufacturing industry a nation can increase its wealth. As Tribe argues, the Report, “did involve the foundation of ‘protectionist’ as opposed to ‘free trade’ arguments, but this did not mean that principles established in the ‘Wealth of Nations’ were also rejected. The Report argues that the development of agriculture and manufacture must be joint, but with manufacture taking the leading position in stimulating their mutual development and thereby increasing domestic demand for raw produce.” However, he ends at a different conclusion than Smith, bearing the special circumstances of the USA as a late developing country in mind: only through the protection of infant industries in the USA from foreign manufacturing nations economic development was possible. “Hamilton’s ideal was a free economy - free, that is, insofar as curbs upon individual initiative were concerned, but not free in that sense that government abstained from interference of any kind. He insisted only that the interference of government be benevolent and in the interest of the national welfare.” Yet he realised that the cosmopolitical vision of a system of perfect liberty was desirable but at the time simply an illusion. Britain was firmly established as the leading industrialised nation and trade on equal terms was impossible. Hence, governmental guidance was necessary and Hamilton departed from the Smithian-Ricardian principle of absolute and comparative advantage as a trade policy. “The argument that Hamilton than went on to develop, and which became the basis of protectionist doctrine, suggested that the only means that a nation like the United States had available to secure the eventual benefits of joint development of agriculture and manufacture was a system of protective tariffs....”

In his personal intellectual development Hamilton was, obviously, still embedded in the mercantilist tradition as he aimed to unify the USA politically and economically. He shared the mercantilist policy of tariffs and bounties, but more importantly, “instead of measuring the wealth of a nation by the quantity of precious metals it contained, Hamilton took the yardstick of productive capacity.” Here, he clearly breaks free from mercantilism and acknowledges the principles of capitalist production laid down by Smith, yet he cannot share his free trade conclusions. In short, Hamilton became the theoretical and practical ‘founding father’ of the American system, for the first time combining Smithian assumptions about industrialisation with protectionist principles.

At the time of List’s arrival in the United States the debate between the protectionist, industrialising North and the free-trading, agrarian South was at full flow and after the end of the Napoleonic Wars commercial competition with Europe sharpened again. In 1827 he was invited to write about the American economy and we can be sure that he consulted Hamilton’s Report which was repr