Cantillon's Political Economy

The global economic and financial crisis has shattered the incomes and employment of a number of economies. This deep-rooted crisis has prompted economists to question the vali­dity of mainstream (neoclassical) economics and has hastened the search for alternatives. This note contributes to strengthening the broad theoretical frame­work of the surplus approach of classical economics as an alternative to neoclassical economics. The precursors of the classical school include William Petty, Richard Cantillon, Francois Quesnay, Adam Smith and David Ricardo. However, it was submerged and forgotten with the advent of neoclassical ­(marginalist) economics in the 1870s. In 1960, Piero Sraffa revived this approach through his Production of Commodities by Means of Commodities. This note strengthens this approach by examining Richard Cantillon’s work wherein concepts such as social surplus, social classes and “economy as a circular process” find a strong presence.

Though written in the 18th century, Cantillon’s sole opus Essai sur la Nature du Commerce en General (Essay hereafter) contains, what can be considered as, the first system of political economy. This characteristic of the Essay was highlighted by stalwart economists such as Marshall (1920: 625) and Schumpeter (1954: 562). Recent scholarship on Cantillon notes the centrality of social surplus and social classes in the Essay (Aspromourgos 1996, 1997; Brewer 1992; Murphy 1986, 2009). Of them, Brewer 1992, Murphy 1986 and Murphy 2009 attempt to read Cantillon’s Essay with a neoclassical lens. This view is not tenable for (1) textual evidence points otherwise, (2) Cantillon carefully studied and built on the work of William Petty, the founder of the surplus approach, and (3) classical economists such as Quesnay and Smith ­borrowed significant concepts from Cantillon. Be that as it may, we now turn to describe the system of political economy which is present in Cantillon’s Essay.

This note is divided into the following sections. Section 1 provides a short ­biographical sketch of Richard Cantillon. Section 2 examines how Cantillon conceptualised production, distribution and exchange of the social surplus. In Section 3, we move on to see how money, interest and prices were related in the Essay. Section 4 summarises the system of international trade and finance of Cantillon. Finally, Section 5 concludes the entire discussion and suggests how adopting the surplus approach in general and Cantillonian political economy in particular can aid the way an economy is conceptualised and analysed.

1 Who Was Richard Cantillon?

Richard Cantillon was born in Count Kerry in Ireland. The actual date of his birth and death are unknown. Based on secondary sources, it appears that ­Cantillon was born sometime between 1680 and 1690 (Murphy 1986). Owing to the political instability in Ireland, he along with some of his family members migrated to France. In France, Cantillon involved himself in banking and financial activities owing to the large banking network his family possessed. His bank had branches in Paris, London and Amsterdam. Later he made huge fortunes by investing money in the Missi­ssippi scheme and by speculating on exchange rates. Cantillon is widely belie­ved to have died in a fire which engulfed his house on 14 May 1734. However, Murphy provides several reasons which indicate that Cantillon orchestrated a fire so as to get away from legal issues (Murphy 1986: 282-97).

Cantillon’s skills as an astute banker and merchant is reflected in his work; the details pertaining to monetary circulation, formation of market prices, working of bills of exchange, etc, deserve ­special praise. Lionel Robbins, who was fond of the history of economics, ­provides one instance of Cantillon’s devotion to facts:

He used to travel around in a carriage with an accountant to keep his observations on the economic phenomena that he witnessed. From time to time he would get out of the carriage, and, according to Mirabeau, he would taste the soil to see what sort of fertility, what chemical composition, it was of, and he would then presumably tell his accountant to take a note of this (Robbins 2004: 79).

The importance of Cantillon’s Essay has been pointed out by economists as varied as Alfred Marshall, Frederick Engels, Henry Higgs, Joseph Schumpeter and Lionel Robbins. However, as the introductory paragraphs of this ­arti­cle indicate, these authors have not carried out a detailed study of the Essay. In addition, Cantillon’s work remains grossly under-acknowledged in the works of Adam Smith and in Karl Marx’s monumental survey of previously ­existing political economy, Theories of ­Surplus-Value (3 Volumes).

2 Production, Distribution and Exchange

Cantillon considers the surplus produced in agriculture as the chief source of income in the economy. Surplus, according to Cantillon, refers to the “overplus of land”. Once the production process is completed and the produce is exchanged in the market, this surplus is distributed as rents, profits and wages. However, often, part of the wages was paid in terms of physical produce. Like other classical economists, Cantillon also considers wages to be at the level of subsistence. This level, however, was not a ­biological minimum but one that was determined by specific historical and cultural factors. Landowners received rent because they owned land. Whatever was left over after rent and wages were paid was kept aside as profits by the farmer, who, Cantillon designated as an entrepreneur. Thus, Cantillon writes:

The farmers have generally two-thirds of the Produce of the Land, one for their costs and the support of their Assistants, the other for the Profit of their Undertaking...The Proprietor has usually one-third of the produce (Cantillon 1755: 43).

Owing to the central role played by agriculture (and therefore, land) in the eco­nomy which Cantillon examined, he classified its inhabitants into (1) proprietors, nobles and landowners, (2) entrepreneurs, and (3) hired workers (see also Aspromourgos 1996: 82; Dasgupta 2009: 177). This is, in fact, one of the initial accounts of social classes in the history of economic theory. For, in Cantillon’s times, it was common to classify the inhabitants based on their ranks or positions. Social classes, as it will be presently seen, play a crucial role in Cantillon’s system of political economy. As is evident, the categories of income which Cantillon identified were linked to his notion of social classes. However, a one-to-one correspondence between incomes and social classes did not exist. The landowners received rents; the entrepreneurs received profits and the hired workers received fixed incomes. In Cantillon’s scheme, labourers were seen as entrepreneurs without capital who were “compelled to offer him [the landowner] their labour in order to live” (Cantillon 1755: 5). Entrepreneurs who made profits comprised farmers, merchants and artisans. The amount of profit they made depended on the ­market prices prevailing. Hence, they were considered to be risk takers by Cantillon. He writes: “The circulation and exchange of goods and merchandise as well as their production are carried on in Europe by Entrepreneurs, and at a risk” (ibid: 47). Hired workers referred to courtiers, ­generals, domestic servants, etc, who were emplo­yed by the nobles and/or landowners.

Incomes (claims on the surplus)1 could only be distributed once the produce was exchanged in the markets. These market towns, as they were called, acted as an intermediary between producers and consumers. The formation of prices received considerable attention from Cantillon; he makes a distinction bet­ween intrinsic values and market prices. This distinction is a significant methodological contribution to economics (in particular, to classical economics), as Michel Foucault also notes (Foucault 1970: 167), which later Quesnay, Smith and Ricardo employed in their respective analyses. Intrinsic values, for Cantillon, were based on observable and measurable production conditions. For example, the acres of land that went into cultivation and the number of labourers or the amount of labour time necessary for cultivation was easily observable. However, market prices referred to the prices which prevailed in the actual marketplace. These market prices would vary depending on the number of buyers and sellers and based on how much the buyers wanted to purchase. Cantillon presents a vivid description of how market prices are formed:

Prices are fixed by the proportion between the produce exposed for sale and the money offered for it; this takes place in the same spot, under the eyes of all the villagers of different villages and of the Merchants or Entrepreneurs of the Town. When the price has been settled between a few the others follow without difficulty and so the market price of the day is determined (Cantillon 1755: 13).

Hence, the produce brought to the market would be sold at the existing market price. Since the farmer has no way of knowing these market prices in advance, he carries out farming at a risk. The market prices would vary according to how much the buyers wanted to consume and how much they were willing to pay. The ability to pay, in turn, was determined by the incomes they received which was determined by their role in the production process. Moreover, the market prices would influence the future production decisions of the farmer. This is one of the reasons why Cantillon is considered to have visualised the economy as a circular process between production and consumption.

According to Cantillon, these market prices would “ebb and flow” around the intrinsic values. Despite offering an explanation of the formation of market prices, he stresses that the “method of fixing Market prices has no exact geometrical foundation” (ibid: 119). It is precisely this realisation – that market prices have no exact foundation and that they hover around intrinsic values – which prompted the subsequent classical economists to focus on, what are known as, natural prices or long-run normal prices.

3 Money, Interest and Prices

At the outset, it must be pointed out that money, in Cantillon’s times and scheme, referred to commodity money, i e, gold, silver and copper. His contribution to monetary economics is well documented in the literature (see Blaug 1978: 21; Bordo 1983: 242; Rima 2009: 58). This is particularly because of his analysis of inflation and how it has differential effects on the inhabitants of the economy; this is referred to as “Cantillon effect”.

In the Essay, Cantillon notes that the distribution of social surplus among various social classes and their subsequent expenditure causes money to circulate. This circulation takes place between town and country and across and within social classes. The idea of an economy as a circular process is to be found in the following passage where Cantillon describes the circulation of money in ­an economy:

The circulation of this money takes place when the Landlords spend in detail in the City the rents which the Farmers have paid them in lump sums, and when the Entrepreneurs of the Cities, Butchers, Bakers, Brewers, etc. collect little by little this same money to buy from the Farmers in lump sums Cattle, Wheat, Barley, etc. In this way all the large sums of money are distributed in small amounts, and all the small amounts are then collected to make payments in large amounts, directly or indirectly, to the Farmers, and this money large or small always passes in return for services (Cantillon 1755: 125-27).

To put it differently, Cantillon recognised the social nature of production and consumption; social because if one social class abstained from taking part in the process of circulation, other social classes would also be affected. In other words, he was very aware of the inter­dependence present in an economy. Owing to the central role played by farmers, as indicated in the passage above, Cantillon asserted that social surplus must “be considered as the principal sources or so to speak the mainspring of circulation of money in a State” (ibid: 123). More importantly, through the ­concepts of social surplus and economy as a circular process, Cantillon was able to identify the crucial links between, what is now known and distinguished as, the real economy and the monetary economy.2

According to Cantillon, an increase in quantity of money in a state tends to increase the market prices of commo­dities. The quantity of money in an ­economy could be increased by mining more gold, silver or copper. But, to increase mining, either the mining area (land) had to be increased or the number of labourers had to be increased. This increase would lead to an increase in the surplus arising from the mines; consequently the incomes of those involved in mining would increase. That is, it leads to an increase in the total rents, profits and wages in the economy. In “proportion to their gains”, the consumption expenditure of those involved in mining rises. They consume more food and clothing and of better quality. This increased consumption of food and clothing will “consequently give employment to several Mechanicks who had not so much to do before...” (ibid: 163). In other words, a rudimentary multiplier mechanism is in process, where increase in incomes induce an increase in consumption and this increase in consumption causes more employment and further, this increase in employment leads to more incomes and so on. At the same time, all this unusual increase in the consumption of meat, wine, wood, etc, would raise their prices. This is why Cantillon writes that:

Increased money will bring about increased expenditure and this will cause an increase of Market Prices in the highest years of exchange and gradually in the lowest (ibid: 161).

However, Cantillon did not propose that a doubling of money in circulation would result in a doubling of prices. Instead, he maintained that: “...by doubling the quantity of money in a State the prices of products and merchandise are not always doubled” (ibid: 177). He provides an analogy to illustrate this point: “A River which runs and winds about its bed will not flow with double the speed when the amount of its water is doubled” (ibid). In fact, he posited that, “The great difficulty...consists in knowing in what way and in what proportion the increase of money raises prices” (ibid: 161). Further, he argued that the increase in prices would depend on the manner in which the increased incomes affected “consumption and circulation”. Depending on the taste and preference of the person whose income had increased, consumption would ­differ. This meant that the consumption of certain products rose and the ­consumption of some products fell. As ­Cantillon succinctly puts it:

It [consumption] will be directed more or less to certain kinds of products or merchandise according to the idea of those who acquire the money. Market prices will rise more for certain things than for others however abundant the money may be (ibid: 179).

Therefore, an increase in money will lead to an increase in market prices based on the production and consumption structure of the economy.

For Cantillon, the rate of interest referred to the cost of borrowing money, which was “settled” by the borrowers and lenders. Interest originates because production takes time (see below). At the same time, the level of production activity in the economy also has an effect on the rate of interest because it creates the demand for credit. The rate of interest was determined by the quantity of money in circulation. Although, Cantillon pointed out that no simple rule could be laid down regarding the movement of rate of interest based on the quantity of money.

Similar to the formation of market prices for commodities, “the interest of Money in a State is settled by the proportionate number of Lenders and Borro­wers” (ibid: 199). That is, the rate of interest depends on the quantity of money available for lending and the quantity of money demanded by borrowers. The quantity available for lending depends on the quantity of money in circulation in a state. The demand for credit would depend on the consumption levels and production capacity in the economy. An abundance of money in the state, subject to certain qualifications, lowers the rate of interest. This enables the entrepreneurs to borrow easily in order to “set people on work and to establish Manufactories in the hope of profit” (ibid: 191). Entrepreneurs require credit so as to purchase inputs for carrying out production. Low interest rates provide entrepreneurs with easy access to credit. This would lead to more production in the society. However, the loan could be repaid only after the product was sold in the market; it is in this sense that ­production is considered to take time.3 The time elapsed between borrowing and repayment together with the risks involved in sales and production provided the rationale for interest. More­over, regardless of whether the borrowing was made in cash or kind, the entrepreneurs should have enough left over after payment of interest otherwise they would become bankrupt (ibid: 203). Additionally, it is because of the uncertainty involved in production as well as in sale or exchange that the entrepreneurs were “required to pay 20% or 30% profit or interest on the amount of money or value of the produce or merchandise lent to him” (ibid: 203). Thus, the limits of the rate of interest were set by the “fears of the Lenders and the needs of the Borrowers” (ibid: 209). The “fears of the Lenders” was determined by the amount of collateral the borrower possessed, which generally would be a function of their income. Owing to the presence of people with varying degrees of “fears” and “needs”, there would always exist several rates of interest at any point in time in a state. This is why Cantillon writes:

there are in a State many classes and channels of Interest or Profit, that in the lowest classes Interest is always highest in proportion to the greater risk, and that it diminishes from class to class up to the highest which is that of Merchants who are rich and reputed solvent (ibid: 211).

During Cantillon’s time, the notion that too much money lowered interest because “when money is plentiful it is more easy to find some to borrow” was commonplace (ibid: 213). Cantillon poin­ted out that this need not be the case because the changes in the rate of interest would depend on which factor caused the increase of money in circulation. For example, if the increase in money comes from moneylenders, then it will lower the interest by increasing the number of moneylenders. Cantillon seems to be referring to those moneylenders who make money from buying and selling financial instruments. On the other hand, if the increase in money (expenditure) comes from the side of the consumers, it will raise the rate of interest “by increasing the number of entrepreneurs who will have employment from this increased expense, and will need to ­borrow to equip their business in all classes of interest” (ibid: 215). In short, an increase in quantity of money need not always lower the interest rates.

4 International Trade and Finance

The mechanism of international trade presented by Cantillon indicates how, in an economy, social classes interact with each other owing to “need and nece­ssity”, which leads to circulation of income within the state and also results in an inflow or outflow of money. Canti­llon employed the concept of social classes to describe the process of ­international trade. Production of commodities for foreign trade is a process which requires the joint effort of landlords, farmers, merchants, artisans, labourers and the bankers. However, production becomes viable only when the consumption of commodities take place in such a way that the market prices for these commodities cover the intrinsic value. Further, the proceeds from foreign trade facilitate as well as increase the circulation of money in the economy. In other words, the concept of an economy as a circular process between social production and social consumption is all the more strengthened when the economy engages in international trade.

As long as adequate quantities of the commodity are consumed and proper prices are paid by the foreign consumers, international trade will continue. As pointed out earlier, an increase in market prices could result from an increase in the money in circulation. Cantillon, however, maintained that the gains from trade would not go on forever as gains from trade over time would give rise to an inflow of money. This increase of money in circulation would raise domestic prices and make the products internationally expensive. In this manner, the gains from trade would result in a reversal of position for that country – eventually the country would face losses from trade.

The easy availability of money and the presence of financial institutions clearly promote international trade. Owing to the fact that it was international trade which determined international flows of money, Cantillon posited that, “the inequality of Money in the different States...is always respective to the balance of Foreign Trade” (ibid: 159). Financial instruments such as bills of exchange and bankers notes proved very helpful in carrying out international trade by economising on the need for international flows of gold and silver.

5 Conclusions

Thus, in Cantillon’s Essay we notice the clear emergence of a system of politi­cal economy comprising the systems of (a) production, distribution and exchange, (b) money, interest and prices, and (c) international trade and finance. ­Cantillon’s system was, of course, limi­ted by the extant historical conditions. However, this way of conceptualising the economy clearly identifies the inter­dependence present in the economy, especially the real-monetary and domestic-international linkages. This interdepen­dence is conceptualised by employing the concepts of social surplus, social classes and economy as a circular process. In fact, the recent global finance crisis made it explicit that developments in the financial sector can have permanent effects on the real sector – on output, employment and incomes. One of the lessons which Cantillon’s Essay teaches us is that overlooking interconnections in the economy can often have disastrous effects. In this context, his analysis of inflation carries great merit; it makes the examination of the production and consumption structure in an eco­nomy a prerequisite in inflation analysis.

Notes

1 Wage income, if equated with customary subsistence, does not form a part of the surplus.

2 Although today the analysis of money, interest and prices is studied under the umbrella of monetary economics, in the 17th and 18th centuries, these topics were discussed mainly in connection with foreign trade and had strong links with production, employment and consumption. It is, in fact, the economists of the 19th century living in an era of monetary stability, who considered money to be “neutral” (Vilar 1991: 17), and hence as having no permanent effects on real variables such as output, employment, consumption, etc.

3 Cantillon writes “a capable Journeyman Hatter with no capital may undertake the same ­Manufacture by borrowing money and materials and abandoning the profit to anybody who is willing to lend him the money or entrust him with the beaver, wool, etc, for which he will pay only some time later when he has sold his hats (Cantillon 1755: 203).

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