The Lost Science of Classical Political Economy

By Michael Hudson

There is a seeming riddle in the recent evolution of economic thought. It has become more otherworldly and abstract, more detached from the reality of how economies are running deeper into debt to a financial oligarchy. The global economy itself is polarizing between creditor and debtor nations, financial core and periphery (even as the United States manages to play both sides of this street). Yet academic orthodoxy treats this as anomalous, side-stepping the two key features of today’s economic crisis: the “magic of compound interest” multiplying debts owed by the bottom 90 percent of the population to savers among the top 10 percent, while industrial capitalism is turned into a “tollbooth economy” by privatizing rent-extracting privileges on what used to be the public domain.

Academic rationalizers of today’s economic policy use models that deny that such as failure could exist in the first place. Yet mathematically inclined economists claim that their discipline has become a science. It may seem natural enough for the hallmark of science to be mathematics, but the real issue should not be universals but rather how nations are diverging economically and how this is a result of policy, not the presumably automatic workings of “free markets.” The mathematical boys confuse social sciences grounded in history and jockeying for political power with the universals of physics. We should be glad that they finally have dropped equilibrium theorizing, but game theory and chaos mathematics still do not address the key causal dynamics at work.

Pseudo-science wielded on behalf of special interests turns mathematical abstraction into a vehicle to strip away what used to be the major concern of classical political economy, and indeed economic reform, over the past two centuries. The aim of classical value and price theory was to isolate land rent, monopoly rent, and financial interest and fees (and “capital” gains) as a free lunch accruing to privilege.
Chicago School practitioners of free-market mathematics crow that “there is no such thing as a free lunch,” distracting attention from economic reality by dropping the history of economic thought and economic history itself from the curriculum. The very idea that there is such a thing as a free lunch is deemed heretical. This idea now governs academic departments and monopolizes the most prestigious economic journals, without publication in which it is difficult for junior faculty ever to rise to tenured positions in their universities. The aim is to censor the perception that today’s economy is all about getting a free lunch by obtaining legal privileges, as exemplified by the recent U.S. health care HMOs, the bailouts over banks deemed “too big to fail” and other beneficiaries of government largesse.

Most wealth through the ages has come from privatizing the public domain. Europe’s landed aristocracy descended from the Viking invaders who seized the Commons and levied groundrent. What is not taken physically from the public domain is taken by legal rights: HMO privileges, banking privileges, the rezoning of land, monopoly rights, patent rights everything that falls under the character of economic rent accruing to special privilege, most recently notorious in the post-Soviet kleptocracies, and earlier in the regions of the world colonized by Europe. (The word “privilege” derives from the Latin, meaning “private law,” legis.) These bodies of privilege are what make national economies different from each other.

Classical economists, the original “liberals”, were reformers with a political agenda. The “scientific” mathematizers seek to strip away their agenda, above all by exiling the analysis of rent extraction and special privilege to the academic sub-basement of institutionalism, claiming that a sphere of study that is not mathematized cannot claim the mantel of scientific method. The problem with this reactionary stance is that attempts to base economics on the “real” economy focusing on technology and universals are so materialistic as to be non-historical and lacking in the political element of property and finance. By the 1970s, for example, economic observers were talking about the convergence of the Soviet Union and America on the ground that each used virtually the same technology, along with Japan and Western Europe. For that matter, as early as the Bronze Age (3200-1200 BC) the economies of Mesopotamia (Sumer and Babylonia), Egypt, the Indus Valley and other regions all shared a similar technology, but each had entirely different economic and social systems. A “real” economic analysis focusing on their common denominators would miss the distinct ways in which each accumulated wealth in the hands of (or under the management of) a ruling elite different modes of property and finance, and hence with what the classical economists came to classify as “unearned income.”

Mathematizing economics and its claims to become a science overlooks these institutional differences, including the land rent and other revenue that John Stuart Mill said landlords made “in their sleep.” What this approach leaves out of account is the social policy wrapping for technology. If we lived back in 1945 and were told of all the marvelous technological breakthroughs of the past half-century, we would imagine that societies would now be living a life of leisure. Why has this not occurred? The reason is largely to be found in the predatory behavior that has enriched the finance, insurance and real estate (FIRE) sectors.

For classical and Progressive Era economists, the word “reform” meant taxing economic rent or minimizing it. Today it means giving away public enterprise to kleptocrats and political insiders, or simply for indebted governments to conduct a pre-bankruptcy sale of the public domain to buyers (who in turn buy on credit, subtracting their interest payments from their taxable income). The global economy is being “financialized,” not industrialized in the way that most economic futurists anticipated would be the case a century ago.
One would think that this should be the focus of economic theory and the mathematics it uses backed by appropriate statistical categories so that the mathematics would have something empirically quantitative as their subject matter, not merely Greek letters. That this has not occurred should throw the whole mathematical fad in question as being fundamentally dishonest and captured by the special interests. And this political use of mathematics merely as a rhetorical ploy should not be welcomed as science. It is simply deception.

The problem is not mathematics as such, but the junk economics and junk statistics used by the mathematicians who have captured the discipline of economics. For contrast, one need only turn to the 19th century’s rich toolbox of economic concepts developed to analyze today’s most pressing problems. What could be more relevant, for example, than the question of whether the exorbitant salaries and bonuses that bankers pay themselves are unfair, and how much they should fairly charge for their services? To answer this question the 13th-century Schoolmen developed the theory of Just Price. For the next six centuries down through the late 19th century, economists refined the distinction between technologically necessary costs of production and “free lunch” exploitation, using the labor theory of value to define intrinsic costs (reducible to labor, including that embodied in the capital goods and other materials used up in production) and the complementary concept of economic rent (unearned income above these costs, that is, market price less cost value).

To what extent does our burdensome and intrusive debt overhead grow faster than the economy¹s ability to pay, and what is the best policy to deal with excessive debts? Already in 1776, Rev. Richard Price dealt with the “magic of compound interest”, its tendency to grow exponentially (“geometrically”) while the economy grew at only simple (“arithmetic”) rates. This idea survives only in the form that Malthus borrowed in his 1798 population theory.

The overburden of public debt prompted Adam Smith to comment that year that no government ever had repaid its debts, and to propose means to keep it in check by freeing the American colonies that were a major source of conflict with France, for instance, and most of all, by paying for wars out of current taxation so that populations would feel their immediate cost rather than running into debt to international bankers such as the Dutch. Interest on Britain’s public debt absorbed three-quarters of its fiscal budget after the Napoleonic Wars. Writers such as Malachy Postlethwayt analyzed how this debt service added to the cost of living and doing business. His logic along these lines is part of the lost science of classical political economy.

The early 19th-century French reformer St. Simon proposed that banks shift from making straight interest-bearing loans to “equity” loans, taking payment in dividends rather than stipulated interest charges so that debt service would be kept within the means to pay. (Islamic law already had banned interest.) This became the inspiration for the industrial banking policies developed in continental Europe later in the century. St. Simon influenced Marx, whose manuscript notes for what became Vol. III of Capital and Theories of Surplus Value collected what he read from Martin Luther to Richard Price on how debts multiplied by purely mathematical laws independently of the “real” economy¹s ability to produce a surplus. The classical concept of productive credit was to provide borrowers with the means to pay. Unproductive debts had to be paid out of revenue obtained elsewhere.

This distinction threatened the financial sector’s option of making unproductive loans. More congenial were the Austrian School and marginal utility theorists who depicted debt as a voluntary trade-off of present consumer utility (“pleasure,” not need) for future income that presumably would rise, thanks to the prosperity brought in the train of technological progress. Interest paid by consumers was treated as a psychological choice, while industrial profit was treated as a return for the widening time it presumably took to produce capital-intensive goods and services. The ideas of “time preference” and the “roundabout” cycle of production were substituted for the simpler idea of charging a price for credit without any out-of-pocket cost or real risk undertaken by bankers. The world in which economic theorists operated was becoming increasingly speculative and hypothetical.

Financial analysis turned away from viewing interest as a form of economic rent income achieved without a cost of production. After the Napoleonic wars ended in 1815, Britain’s leading bank spokesman, David Ricardo, applied the concept of economic rent to the land in the process of arguing against the agricultural tariffs (the protectionist Corn Laws) in his 1817 Principles of Political Economy and Taxation. His treatment deftly sidestepped what had been the “original” discussion of rentier income squeezed out by the financial sector.

4 Responses to The Lost Science of Classical Political Economy

  1. much of todays so called scientific economic theory is rather religion or charlatanry.someone

  2. "Today it means giving away public enterprise to kleptocrats and political insiders, "Education is also their next target:http://nycpublicschoolparents.blogspot.com/2009/12/charter-schools-new-polo-ponies-of.htmland (sad sack behavior for a billionaire)https://www.lulu.com/commerce/index.php?fBuyContent=7214189

  3. Michael, you show my ignorance and brilliance as well. I think the question of rents isn't rent or no rent, but how much rent and from where did the value of rent come. Clearly we are living in a rigged society. In the town where I live there is a new public transit train. The city has pretty much put a bunch of nonsense in the way of redevelopment of the area, as it is the old town area. It has been my feeling for years that TPTB here have favored special groups and as the ownership of this area is fragmented, the special groups are not presently in possession of the property that would massively increase in value under a free use policy. That will change, but not before they starve out the value of the current property. The next scheme is the stock market. In sum there is very little real growth in the capacity of stocks to produce income if you analyze the S&P, but Wall Streets ability to draw income out of the business of stocks is being supported by the trendline compound gain fable. Thus we now have a Federal Reserve attempting to inflate enough to keep the illusion of compound values intact. 10% in a 3% inflation arena with a 1.75% or less dividend rate doesn't compute for long.Then there is the interest equation. What is funny is the real nature seems to prevail. Discount anything over 70 years or so and you will find the gain of the portfolio is closer to the risk free rate of interest, 3%. Even that is unsustainable and loss should occur when the gig is up. Insured deposits are maybe a bad idea.I have seen referenced in the past portions of the Constitution meant to enforce what you have mentioned. I think there was a 2 year limitation on war and there wasn't supposed to be a standing national army. I believe the founding fathers didn't mean for money to be created by banks through debt and had some idea of prohibiting that. A real study based upon what you wrote in the USA should go into the prohibitions of Titles of Nobility. There is a guy named David Dodge who claims to have found near proof an amendment to the constitution, what he called the original 13th amendment, passed with the retification of Virginia somewhere around 1812. It banned people whol accepted Titles of Nobility from holding office or working in the government. These Titles are nothing more than state granted privileges. De Vattel spoke in his 1750's writings of imperfect and perfect rights and what they were. We are told to a person that driving was a privilege, which is something the Constitution prohibits states granting. In short, every major economic event in the US has centered around banking in one form or another. I would have to believe the compound interest factor and pulling the public into the scheme has been the major cause of much of it along with massive fraud.

  4. Astrologers will be as mathematical as you like, and draw charts as precise as you like. But in their defense, they probably have a better track record of predicting recessions than do most working economists.