Richard Cantillon (d. 1734)

Richard Cantillon was born probably between 1680 and 1690 in County Kerry, Ireland. He was the son of an Irish nobleman. He may have been a descendant of the Stuarts, and his family was quite involved with the Jacobite movement that sought to restore the Stuarts to the throne of England. Given this, it is not surprising that Cantillon had strong connections with France and spent most of his adult life there.

Cantillon was a brilliant financier, who made a huge fortune in a short period of time by lending money to speculators and speculating himself on the pound-livre exchange rate and on the value of Mississippi Company shares. The Mississippi Company was the huge colonial conglomerate formed by John Law to exploit the riches of the Mississippi territory in North America. Law's grandiose scheme attracted a huge number of investors, who drove the prices of his company's stock sky high. Cantillon, who bought a large quantity of stock early on at a moderate price, sold out before the stock's price peaked and then collapsed. Law had predicted that the wealth generated by his project would drive the French livre up against the pound sterling. Cantillon loaned large amounts of sterling to speculators who wanted to use it to buy livres. He himself foresaw a decline in the livre, so he acquired sterling. Law's project generated high inflation, which indeed drove the livre down. Thus, Cantillon made huge profits at an early age – and got enough lawsuits to last a lifetime, in the bargain.

According to the Marquis de Mirabeau, Cantillon wrote a number of books. However, only one survived to be published, and that 21 years after Cantillon was murdered in a house he had bought in London. His Essai sur la nature du commerce en général shows that Cantillon possessed a first-rate analytical mind. Niehans says that, "As a theorist he is indeed one of the shining stars of the classical galaxy" (24). He adds, "The combination of early financial success with analytical superiority makes him the Ricardo of eighteenth-century economics" (27).

Cantillon's major analytical contributions can be classified into three areas:

(1) Classical monetary theory. Cantillon developed a theory of commodity money that was correct in nearly all respects. The value of commodity money is determined by the (marginal) cost of production. Like Petty, he showed a firm understanding of the relationship of velocity to money demand. His brightest achievement in monetary theory was his discussion of the dynamic effects of an increase in the quantity of money on the economy – the effect on relative prices, expenditures, and interest rates. For example, Cantillon argued that the discovery of a new mine lowers the cost of producing money. Miners gain, and they increase the demand for goods. Manufacturing output rises, putting upward pressure on the demand for food. Food prices increase, providing the incentive to produce more. People on fixed incomes lose. As the process works its way through the economy, prices rise in general, and a trade deficit ensues.

(2) Land theory of value. Cantillon argued that the market price of a good fluctuates around its intrinsic value, which is given by the cost of production. Cost is composed of land, labor, capital goods, and raw materials. Capital goods and raw materials can be resolved into land and labor. Thus, the only prime costs are those of land and labor. Cantillon envisioned human reproduction as an "industry" transforming inputs into labor. This led him to formulate a population theory similar in most respects to the famous theory stated by Malthus. Cantillon argued that, with unlimited subsistence, men "multiply like mice in a barn." But subsistence is limited, and population will eventually expand until it reaches a stationary state. The subsistence wage depends on conventional living standards and social conditions. Cantillon conjectured that 1.5 to 6 acres of average land were required to support a person in the stationary state. Once a par value between land and labor is determined, the intrinsic values of all commodities can be reduced to land only. Since the market prices of goods fluctuate around the intrinsic values determined by costs, market transactions carry an element of uncertainty. The role of bearing risk is the economic function of the entrepreneur. Not until Jean-Baptiste Say was the entrepreneur to be treated so extensively as by Cantillon.

(3) The "Three Rents." Most importantly for the growth of economics, Cantillon developed a model of the flows of goods and money between sectors of the economy. He modelled a closed economy with two productive sectors: agriculture and manufacturing. The model contained three social classes: landowners, entrepreneurs (in agriculture and manufacturing), and hired workers. Cantillon then traced the flows between the social classes as agricultural and manufactured goods are produced. Although Cantillon developed his model verbally, it can be presented in the form of an input-output table or a circular flow diagram. The figure presented here shows how a total output of 600 livres is produced and distributed. The landlords spend their rent (100 l.) entirely on manufactured goods. (Cantillon assumed that their food consumption was a negligible part of agricultural production.) Agriculture sells half its product (150 l.) to manufacturers and buys one third of manufacturing output (50 l.) Agriculture uses half its own product, as does manufacturing (150 l.). Cantillon attempted to estimate the magnitude of the flows between sectors. Thus, his work was a precursor to national income accounting, input-output analysis, and, more directly, to the work of the first physiocrat, François Quesnay, who developed Cantillon's circular flow model into an elaborate Tableau Économique.

François Quesnay (1697-1774) and Physiocracy

The first school of economics was founded by French physician François Quesnay. Although the physiocrats called themselves les économistes, the title "physiocracy" was soon applied to their doctrines by outsiders. Physiocracy literally means something like "doctrine of the natural order." The physiocratic system was based on natural law concepts. The physiocrats were distressed at the sad state of French economic affairs and sought to apply natural law concepts to reforming French economic policy.

Natural law philosophers held the optimistic view that a beneficent Creator had set out natural laws which, if followed, would lead to social harmony. Faith in beneficence was largely of theological origin. However, events could take their beneficent "natural course" only in the rationally organized society which men were to create in obedience to Nature's precepts.

The theory of an ideal social order was the first form of liberalism. It was not the doctrine that selfish interests should be given absolute free play, despite the physiocratic slogan that has since come to imply that: laissez faire, laissez passer–let them do it. Rather, to the physiocrats, natural law was a code of exact rules to be discovered by use of "reason" as applied to facts of experience about people and their social relations. The goal was to establish an ideal legal order that placed equal restraints on all so as to give equal and maximum liberty to all. Then the interplay of interests could give rise to the maximum welfare of all.

Quesnay argued that the physical laws of nature are beneficent. There are two parts to his argument: (1) Only logically inevitable evils exist in the natural world; (2) men, endowed with "reason" and "free will," can adjust to the environment, enjoy its benefits, and avoid its evils. Human ills are due to man's abuse of free will, i.e., to his failure to follow reason. This thought pattern is an excellent example of the rationalistic enlightenment.

Nature prescribes to society certain courses of action necessary to maximize welfare. Men use reason to discover the best course. Physiocratic writings combined three sets of "laws": rules of prudence, rules of justice, and economic laws of process formed by linking together individual actions. The first two are ideal, the third is causal. The main interest of Quesnay was showing what the institutions of the natural order must be. The physiocrats supported monarchy, but not "absolute monarchy". The monarch should promulgate as statutes the rules of natural law. His power was to be checked by an independent judiciary, trained in natural law and having a veto power. Laissez faire was not inaction, but was action along lines specified by natural law. Rational policymakers alter the environment, and people respond predictably (mechanistically). Why? A harmony of interests exists–everyone benefits by going along. Physiocracy grew out of a highly stratified class society.

The clergy and nobility kept the peasants in abject poverty through taxation. The royal court spent extravagantly. Taxes and fees shackled the economy. The physiocrats sought to discover the laws of the creation of wealth and thus to change the structure of society to promote wealth creation. They hoped to rid France of unnecessary and counterproductive laws and replace them with laws consistent with the natural order.

The Tableau Économique

Quesnay developed the Tableau as a way to show the circular flow of spending and production. The Tableau demonstrates, given a particular set of assumptions, that the expenditures by landlords of the economy's net product (production in excess of costs) is necessary to the reproduction of an equilibrium output. It also demonstrates Quesnay's assumed primacy of the primary industries (agriculture, mining, and fishing). Quesnay's Tableau is based on numerous strong assumptions. He divides the economy into two sectors: productive and sterile. The productive sector consisted of primary industries. Quesnay assumed that the net product of agriculture equalled 100 percent of annual advances. The sterile sector included manufacturing, trade, and transportation. This sector produced useful goods and services (at least part of it did), but yielded no net product. Why did primary industries yield a net product, while other industries did not? The standard answer given for decades was that cooperation with bountiful nature yielded the surplus. Walter Eltis recently has challenged this convincingly, arguing that competition in the secondary industries was assumed to drive net product to zero. Why didn't it do so in the primary industries too? Because the costs of agricultural production were relatively fixed at cultural subsistence levels. Costs were largely paid in agricultural products. When agricultural productivity rose, so did the net product. Many of Quesnay's assumptions came from his close observation of French agriculture. His assumptions included the following: (1) Only landlords or wealthy farmers can afford the oxen or horses needed to produce a surplus. Horses were preferred, as they could plow more and fewer were needed. Oxen were cheaper and were used by sharecroppers. Entrepreneurial farmers used horses. La petite culture (oxen) costs and produces less than la grande culture (horses). (2) The return on la grande culture is much higher than on la petite. (3) Capital, not labor, is the key to agricultural productivity. Capital and entrepreneurs, not labor and land, limit production. The population expands endogenously through births and immigration when capital is plentiful. (4) Although competition prevents manufacturers from producing a net product, the wages of entrepreneurs include something akin to normal profit. Concerning the macroeconomy, Quesnay also made some assumptions: (1) The demand for manufactures and services depends on the expenditure of the net product of agriculture by landlords. The sterile sector depends on the productive sector for demand and for raw materials, but not vice versa. [Note how this differs from Steuart's assumption that manufacturing and agriculture depend on each other for demand, so that balanced growth is of utmost importance.] (2) It is necessary for landlords to spend their surpluses; if they do not, the government must 'despoil' them of the surpluses. Expenditure of rents affects the demand for both industrial and agricultural products.

The Tableau Économique

Expenditure by farmers Expenditure by landlords Expenditure by sterile sector

Previous year's net

2000 l. - - - - - - - - - - - > 2000 l.

1000 l. - - - - - - - - - - - > 1000 l. 1000 l.

500 l. - - - - - - - - - - - > 500 l. 500 l.

250 l. - - - - - - - - - - - > 250 l. 250 l.

125 l. - - - - - - - - - - - > 125 l. 125 l.

etc.

_______ _______ _______

2000 l. 2000 l. 2000 l.

The Tableau is based on the assumption that one half of revenues are spent on each sector. Thus, one half is spent within each sector. The 2000 livres ultimately spent on agricultural products produces 4000 livres worth of output: 2000 required to cover costs of production, including "interest" on farmers' capital (horses, plows, etc.) and 2000 paid as rent to landlords. The 2000 livres spent on sterile goods produces only 2000 l. worth of output. The 2000 l. going to landlords as rent really represents a return on capital rather than land; payment for investment in improvement of the land. (E.g., two years were needed to produce the first wheat crop.) The Tableau explains the physiocrats' antipathy toward saving, which they equated with hoarding specie. If landlords hoard, spending on agricultural goods declines, reducing next year's net product. Greater spending on the sterile sector also reduces the net product. If only landlords receive a social surplus, then they must ultimately pay all taxes (one way or another). Physiocrats supported a single tax on rent. Tax revenue could then be increased by reorganizing agriculture so that more farming was done by entrepreneurs (la grande culture). Political pressures killed both reforms.

Sources:

O.H. Taylor, Economics and Liberalism: Collected Papers.

Alfred F. Chalk, “Natural Law and the Rise of Economic Individualism in England,” Journal of Political Economy 59, August 1951: 330-47. Reprinted in RHET: 32-47.

Jürg Niehans, A History of Economic Theory.

Walter Eltis, Classical Theory of Economic Growth.