April 1st, 2015
There are numerous economic schools of thought that dictate individuals’ view of the free markets and role of governments. Moving forward, an understanding of the historical and modern views of said institutions will enable better-informed decisions about how we govern society for the optimal level of overall welfare.
There is a world of economic discovery ahead of us. Economists continue to develop new theories, which will eventually sprout new schools of thought. In order to keep up with the ever-changing field of economics, it is vital to look forward with a keen understanding of what is in the past. In 1848, Thomas Carlyle coined the term “dismal science” to describe the field and the concept of supply and demand (Skousen, 2001, p. 81). However, economics is far from a “dismal science” and placing it into a specific category like how Carlyle did can only hinder advancement of new ideas.
Economics as a philosophy was birthed in 1776 out of Adam Smith’s Inquiry into the Nature and Causes of the Wealth of Nations. Known as the father of economics, Adam Smith founded the Classical school of economics, which brought about the new age of capitalism. (Patton, 2000). Fun fact: the term capitalism wasn’t actually coined until 1867 by Karl Marx in his book, Das Kapital (Skousen, 2001, p. 134). Classical economists favor laissez-faire, or free markets. They argue against market intervention and instead, rely on the “invisible hand” to guide markets into optimal productivity. In other words, the well-being of society is best achieved when individuals act in their own self-interests. Classical economists focused on individuals and believed the value of commodities was determined by its labor inputs. While the logic of economics began with classical economics, there is hardly anyone who still adheres to this school of thought.
Classical economists saw free markets as “‘mutually beneficial’ (Smith), or ‘naturally harmonious’ (Say and Bastiat)” for each individual actor (Skousen, 2001, p. 132). Capitalism enjoyed a positive connotation until 1848, when Karl Marx published The Communist Manifesto. In said publication, Marx focused not on individuals, but classes. Taking from the classical economists’ belief that commodity value came from the amount of labor, Marx determined that capitalists exploited the working class. Thus, the Marxist Revolution was born, where free markets were believed to be bad for the worker and maximum market intervention was good. This notion of market intervention is why socialist governments try to maintain full control over their economies. The Marxist school of thought still has its followers today, and they may be closer than you think. If you’re a student at NYU, feel free to check out the Marxist Student Association on campus.
The two polar ends of the economic spectrum were laid out relatively early compared to the others. Once the extremities were introduced, new schools of thought emerged as mediums between the polar ends. Neoclassical economics and Austrian economics arose out of the marginalist revolution in the 1870s. Carl Menger realized that commodity value came from the consumer’s demand and the marginal utility of additional units of a commodity (Skousen, 2001, p. 170). He and the Austrian economists broke away from the classical school with this idea and provided a more modern alternative to both polar schools. This alternative included free markets with imperfect actors. Since the actors behind the “invisible hand” are imperfect, the market needs occasional government intervention (Roche, 2014). It is imperative to understand that Austrian economics and neoclassical economics are not the same thing. Neoclassical economics spans over multiple schools of economic thought, with Austrian economics being one of them.
If classical economics rested on the far right of a line, and Marxist economics on the far left, then Keynesian economics would be in the middle. John Maynard Keynes revolutionized capitalism in 1936 with his book, The General Theory of Employment, Interest and Money. Unlike the classical and neoclassical economists before him, Keynes did not believe that capitalism was inherently stable (Patton, 2000). Keynesian economists believe that “sticky” prices and wages tip the balance of supply and demand, giving rise to the business cycle with its booms and busts. With this in mind, governments should be stimulating demand using fiscal and monetary policy during recessions. Keynesian economists believe that deficit spending and lower interest rates help to stimulate demand and encourage recovery during recessionary periods (Simpson, 2011). This means Keynesian economists encourage governments to play an active role in market intervention during recessionary periods.
After maintaining the limelight for some time, Milton Friedman rejected Keynesian economics with his own Monetarist school. Beginning in the 1950s, Milton Friedman and the Monetarists argued that “the Keynesian notion that governments can ‘manage’ demand” was “destabilizing and likely lead to inflation” (Simpson, 2011). Instead, Friedman trusted that individual self-interests would properly guide the market and market intervention should only occur to keep inflation under control. Governments could control the money supply, thus keeping prices and inflation stable at a certain rate.
Since the emergence of the Monetarist school, many new schools of economic thought have emerged. One of my personal favorites is the Behavioral School, which focuses on the overlap between psychology and economics. How does human thought process affect the economy, and are actors even aware of the consequences of their decisions? There are many new questions to ponder, and I hope that this article has interested you in digging deeper. Like the title suggests, this article is brief and just scratches the surface of the many different schools of economic thought. I wrote this article not as an in-depth reference guide for readers to refer to, but as a catalyst for deeper exploration in what I believe to be a fascinating history of economics. I hope this article has shed some light on all the different ways one can approach “the dismal science,” and perhaps convinced you that it is, in fact, far from dismal. Should you want to dig deeper into the subject of historical economics, I highly recommend reading Mark Skousen’s The Making of Modern Economics: The Lives and Ideas of the Great Thinkers.