Original Sin or Wayward Practice? Living Standards as a Trickle-Down, Residual Consideration of Modern Economics

Abstract

This chapter investigates whether modern economics’ shortcomings with respect to inclusion, sustainability and resilience—its treatment of living standards as a residual consideration—can be attributed to the original conceptualization of liberal political economy or a subsequent misapplication of its founding principles. It finds that the discipline’s most influential early theorists and codifiers—Adam Smith, John Stuart Mill and Alfred Marshall—explicitly contextualized their insights about the power of market-based resource allocation in a larger perspective and complementary set of prescriptions. These emphasized the important role of institutions—legal and other norms, policy incentives and public administrative capacities in multiple domains—in helping to translate the increased economic growth enabled by market-based resource allocation into broad improvement in social welfare. Each of these pioneers considered increased production and national income, the wealth of a nation, as a means and not an end in itself. Each emphasized that the ultimate purpose of an economy is to advance the material well-being, or standard of living, of society as a whole. The chapter makes extensive reference to their original texts and traces how their shared view of the crucial institutional underpinnings of inclusion, sustainability and resilience got lost in translation during the evolution of eighteenth- and nineteenth-century political economy into twentieth-century economic science.

The first two chapters of this volume have examined shortfalls in the track record of modern economics with respect to three important dimensions of socioeconomic progress—inclusion, sustainability and resilience. I have argued that the evidence suggests a certain structural weakness or blind spot in liberal economic doctrine—a tendency to treat these considerations in both theory and practice as a residual, a natural outcome of increased economic efficiency and growth.

This chapter investigates where this imbalance in emphasis between efficient resource allocation and growth, on the one hand, and material well-being and broad progress in living standards, on the other hand, originated. Was it hard-wired into the principles of liberal political economy at conception? Did the liberal economic tradition always have such a tight focus on the technical functioning of markets—on prices, exchange, production, consumption and national income or “wealth” creation—and place much less emphasis on broader notions of material improvement in the human condition and the lived experience of the bulk of the population? Or did the residual treatment of the latter develop sometime later, in the refinement of the original doctrine and its translation into practice?

The natural first place to look for clues in this regard is the writing of Adam Smith, who is widely regarded as the founder of economics as an intellectual discipline and the father of capitalism. Smith is famous for having made the original comprehensive case for market-based economic systems in his opus An Inquiry into the Nature and Causes of the Wealth of Nations (TWN).¹ Familiar to many are his metaphor of the “invisible hand” to illustrate the superior economic efficiency of markets of individual actors pursuing their rational self-interest in self-organized, distributed fashion; his theory that the division and specialization of labour serve as the engine of productivity growth and wealth creation; and his critique of mercantilism and political restraints on domestic commerce and foreign trade.

The following passages elaborate on each of these foundational concepts. First, with respect to the “invisible hand”:

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 to their humanity but to their self-love, and never talk to them of our own necessities but of their advantages.²

Every individual is continually exerting himself to find out the most advantageous employment for whatever capital he can command. It is his own advantage, indeed, and not that of the society, which he has in view. But the study of his own advantage naturally, or rather necessarily leads him to prefer that employment which is most advantageous to the society.³

As every individual, therefore, endeavours as much as he can both to employ his capital in the support of domestic industry, and so to direct that industry that its produce may be of the greatest value; every individual necessarily labours to render the annual revenue of the society as great as he can. He generally, indeed, neither intends to promote the public interest, nor knows how much he is promoting it. By preferring the support of domestic to that of foreign industry he intends only his own security; and by directing that industry in such a manner as its produce may be of the greatest value, he intends only his own gain, and he is in this, as in many other cases, led by an invisible hand to promote an end which was no part of his intention.⁴

On the division and specialization of labour:

In general, if any branch of trade, or any division of labour, be advantageous to the public, the freer and more general the competition, it will always be the more so.⁵

It is the great multiplication of the productions of all the different arts, in consequence of the division of labour, which occasions, in a well-governed society, that universal opulence which extends itself to the lowest ranks of the people.⁶

On governmental intervention in commerce:

[Without trade restrictions] the obvious and simple system of natural liberty establishes itself of its own accord. Every man … is left perfectly free to pursue his own interest in his own way … The sovereign is completely discharged from a duty [for which] no human wisdom or knowledge could ever be sufficient; the duty of superintending the industry of private people, and of directing it towards the employments most suitable to the interest of the society.⁷

According to the system of natural liberty, the sovereign has only three duties to attend to … first, the duty of protecting the society from the violence and invasion of other independent societies; secondly … the duty of establishing an exact administration of justice; and, thirdly, the duty of erecting and maintaining certain public institutions and certain public works.⁸

These and other well-known quotations from TWN have established Smith in the popular imagination as a pure free-marketeer, the original exponent of a free enterprise system unfettered by distortionary government intervention. During the wave of enthusiasm for market reform that crested in the 1980s, 1990s and early 2000s, his public image underwent a revival of sorts. Adam Smith institutes, centres and student societies proliferated with the aim of spreading the gospel of capitalism, free markets and limited government. He was often cast as a kind of patron saint of neoliberalism, particularly by those with libertarian leanings.

In fact, this is a distorted or, at best, partial interpretation of TWN. A closer reading of the voluminous work reveals a rather eclectic and pragmatic approach to the role of markets and government regulation as well as the relationship between efficiency, productivity and wealth creation, on the one hand, and labour, social welfare and socioeconomic progress, on the other.

The Adam Smith of TWN is a heterodox analyst by modern standards. He did not assume that market actors left to their own devices could be counted on to ensure perfect competition and high rates of productivity growth, advance the broader interests of society, workers and the poor in particular, or self-regulate against market excesses and imperfections such as self-dealing and collusion. Indeed, he outlined an extensive critique and remedial agenda to the contrary. Taken in its entirety, TWN paints a balanced picture of what Smith considered to be the inherent strengths and shortcomings of “commercial society” (his precursor term for “capitalism”) as well as appropriate responses to these, including by governments.

His eclectic or “catholic” approach to such a complex subject spanning multiple social science disciplines was generally emulated by his successors and in particular the next two most important theorists of liberal economics’ first 150 years: John Stuart Mill and Alfred Marshall. This is no coincidence, since Smith, Mill and Marshall all considered themselves fundamentally to be moral philosophers who worked in the field of political economy in order to deepen understanding of the material aspects of what could be done to improve the human condition. They regarded themselves as engaging in the study of political economy as part of a broader enquiry into the drivers and determinants of social progress and the betterment of people as human beings. Even Marshall, the widely acknowledged father of neoclassical economics and most important bridge between the qualitative analysis of his classical predecessors and the quantitative approach of modern economists, deliberately placed his ground-breaking technical notation in annexes so as not to distract from understanding of the relevance of his work to the real world—to people.

Smith enumerated multiple imperfections in the markets he theorized and witnessed. In his view, these market imperfections or failures required countervailing intervention because they undermined growth in labour productivity and/or the equitable social distribution of its benefits. Some of these he viewed as inherent in human nature and thus markets themselves. Others he attributed to either the absence or poor design of government regulation in his country.

These extensive caveats about the natural attributes of markets and the shortcomings of those he witnessed in action in eighteenth-century Great Britain and Europe betray the popular caricature of Smith as a doctrinaire laissez-faire advocate. For example:

On the tendency of market actors towards collusion:

People of the same trade seldom meet together, even for merriment and diversion, but the conversation ends in a conspiracy against the public, or in some contrivance to raise prices.⁹

The interest of those who “live by profit” is “directly opposite to that of the great body of the people,” the workers and landlords. “Any profit-seeker will exploit their deeper knowledge of economic realities, as did stockjobbers and bankers.” “The mean rapacity, the monopolizing spirit of merchants and manufacturers” are constant characteristics of any capital-holder [according to Smith]. This structural fact meant that profit-seekers should always be mistrusted and counterbalanced. The interests of merchants are aligned with those of the public only under specific and rare conditions: only when traders are isolated and merchant collusion is structurally constrained.¹⁰

On the tendency towards exploitative labour practices, including forced labour:

Masters [employers] are always and every where in a sort of tacit, but constant and uniform combination, not to raise the wages of labour above their actual rate … We seldom hear of this combination, because it is the usual, and one may say, the natural state of things which nobody ever hears of.¹¹

Smith viewed the lengthy apprenticeships of the day as a form of servitude: “the epitome of the restrictions of the principles of competition and liberty.” It is unjust, he argued, that “during the continuance of the apprenticeship, the whole labour of the apprentice belongs to his master”. By prohibiting the apprentice from bringing his skills to market … the master took away the student’s ability to negotiate for better wages, conditions, or other terms of employment.¹²

Rent and profit eat up wages, and the two superior orders of people oppress the inferior one.¹³

Folly and injustice seem to have been the principles which presided over and directed the first project of establishing those [overseas] colonies; the folly of hunting after gold and silver mines, and the injustice of coveting the possession of a country whose harmless natives, far from having ever injured the people of Europe, had received the first adventurers with every mark of kindness and hospitality.¹⁴

On the tendency towards regulatory capture by rent-seeking employers and merchants:

The proposal of any new law or regulation of commerce which comes from this order ought always to be listened to with great precaution, and ought never to be adopted till after having been long and carefully examined, not only with the most scrupulous, but with the most suspicious attention. It comes from an order of men, whose interest is never exactly the same with that of the publick, who have generally an interest to deceive and even to oppress the publick, and who accordingly have, upon many occasions, both deceived and oppressed it.¹⁵

We have no acts of parliament against combining to lower the price of work; but many against combining to raise it.¹⁶

Whenever the legislature attempts to regulate the differences between masters and their workmen, its counsellors are always the masters.¹⁷

On the tendency towards speculation and instability in financial markets:

Men commonly overestimate their chances of success in risky ventures, with the consequence that too great a share of the nation’s stock of capital goes into such ventures.¹⁸

On the tendency towards usury and exploitative lending practices in financial services:

the greater part of the money which was to be lent [in the absence of regulation of rates charged by banks] would be lent to prodigals and projectors, who alone would be willing to give this high interest … A great part of the capital of the country would thus be kept out of the hands which were most likely to make a profitable and advantageous use of it, and thrown into those which were most likely to waste and destroy it.¹⁹

On the concentration of rents stemming from Great Britain’s system of land inheritance, including primogeniture and entail:

The former allocated all land to the first-born, even though “nothing can be more contrary to the real interest of a numerous family, than a right which, in order to enrich one, beggars all the rest of the children.” It also undermined productivity, because large plots could not be efficiently cultivated. Concentration was increased by entails, which constrained the sale of land over successive generations. Entails were “founded upon the most absurd of all suppositions … that every successive generation of men have not an equal right to the earth … but that the property of the present generation should be restrained and regulated according to the fancy of those who died perhaps five hundred years ago.”²⁰

If landed estates … were divided equally among all the children, upon the death of any proprietor who left a numerous family, the estate would generally be sold. So much land would come to market, that it could no longer sell at a monopoly price … The property rights crucial for development are those of the yeoman or small farm owner.²¹

On the risks of private management of public goods:

Private initiative cannot be trusted to take proper care of the roads.²²

Where there is an exclusive corporation, it may perhaps be proper to regulate the price of the first necessary of life.²³

These are not the observations and admonitions of a free market ideologue. They are the measured reflections of a keen and disinterested observer of human behaviour in the context of the commercial activity of his day. Smith clearly did not assume that government’s appropriate role was simply to get out of the way of private enterprise through deregulation and low or flat taxes. To the contrary, he outlined in TWN an extensive programme of what today we might call smart, pre-distributive regulation aiming to ensure broad labour force participation under conditions of decent work, including a living wage, since he viewed these as the essential prerequisites of rising productivity and broadly based socioeconomic progress.

For example, he saw the broad scope of government’s role in “establishing an exact administration of justice” as “that of protecting, as far as possible, every member of the society from the injustice or oppression of every other member of it”.²⁴ Furthermore:

On the regulation of monopolies and anti-competitive business practices:

To widen the market and to narrow the competition, is always the interest of the dealers. To widen the market may frequently be agreeable enough to the interest of the public; but to narrow the competition must always be against it, and can serve only to enable the dealers, by raising their profits above what they naturally would be, to levy, for their own benefit, an absurd tax upon the rest of their fellow-citizens.²⁵

Our woollen manufacturers have been more successful than any other class of workmen in persuading the legislature that the prosperity of the nation depended upon the success and extension of their particular business. They have not only obtained a monopoly against the consumers by an absolute prohibition of importing woollen cloths from any foreign country, but they have likewise obtained another monopoly against the sheep farmers and growers of wool by a similar prohibition of the exportation of live sheep and wool. The severity of many of the laws which have been enacted for the security of the revenue is very justly complained of, as imposing heavy penalties upon actions which, antecedent to the statutes that declared them to be crimes, had always been understood to be innocent. But the cruellest of our revenue laws, I will venture to affirm, are mild and gentle in comparison of some of those which the clamour of our merchants and manufacturers has extorted from the legislature for the support of their own absurd and oppressive monopolies. Like the laws of Draco, these laws may be said to be all written in blood.²⁶

On labour regulation in general:

[when] regulation … is in favour of the workmen, it is always just and equitable.²⁷

On prevention of wage fraud:

[requiring wages to be paid in money rather than in kind] imposes no real hardship upon the masters. It only obliges them to pay that value in money, which they pretended to pay but did not always really pay, in goods.²⁸

On a minimum, living wage:

No society can surely be flourishing and happy, of which the far greater part of the members are poor and miserable. It is but equity, besides, that they who feed, cloath and lodge the whole body of the people, should have such a share of the produce of their own labour as to be themselves tolerably well fed, cloathed and lodged.²⁹

By necessaries I understand, not only the commodities which are indispensably necessary for the support of life, but whatever the custom of the country renders it indecent for creditable people, even of the lowest order, to be without.”³⁰

On prudential financial regulation (of banks issuing fiat money):

[This] may, no doubt, be considered as in some respect a violation of natural liberty. But those exertions of the natural liberty of a few individuals, which might endanger the security of the whole society, are, and ought to be, restrained by the laws of all governments; of the most free, as well as of the most despotical. The obligation of building party walls, in order to prevent the communication of fire, is a violation of natural liberty, exactly of the same kind with the regulations of the banking trade which are here proposed.³¹

On public goods provision:

[Governments have a duty of] erecting and maintaining certain public institutions and certain publick works, which it can never be for the interest of any individual, or small number of individuals, to erect and maintain; because the profit could never repay the expence to any individual or small number of individuals, though it may frequently do much more than repay it to a great society.³²

This class of government duties “are chiefly those for facilitating the commerce of the society, and those for promoting the instruction of the people.” Smith supports the participation of the government in the general education of the people because it will help prepare them for industry, will make them better citizens and better soldiers, and happier and healthier men in mind and body. Public education is made necessary to check as far as may be the evil effects on the standards, mentality, and character of the working classes of the division of labor and the inequality in the distribution of wealth.³³

[Similarly, regarding public health,] it would deserve its [government’s] most serious attention to prevent a leprosy or any other loathsome and offensive disease, though neither mortal nor dangerous, from spreading itself among them.³⁴

On progressive taxation:

It is not very unreasonable that the rich should contribute to the public expence, not only in proportion to their revenue, but something more than in that proportion.³⁵

More specifically, he proposed special taxes on:

• luxury vehicles (carriages): so that “the indolence and vanity of the rich [be] made to contribute in a very easy manner to the relief of the poor”.³⁶

• monopoly profits: “the gains of monopolists, whenever they can be come at [are] certainly of all subjects the most proper” for taxation.³⁷

• land values: “Ground-rents, so far as they exceed the ordinary rent of land, are altogether owing to the good government of the sovereign … Nothing can be more reasonable than that a fund which owes its existence to the good government of the state, should be taxed peculiarly, or should contribute something more than the greater part of other funds, towards the support of the government.”³⁸

  Smith’s fundamental concern is the incidence of taxation: whom does the tax really affect and how does that impact productivity? Smith repeatedly emphasizes the negative effects of shifting the burden to the poor … He also opposes the taxation of labor for the same reasons: advocates fail to understand that the tax is passed onto the consumer through higher prices, without increasing productivity … Smith thus clearly opposes regressive taxes both on labor and on necessary consumption. The other systematic goal of taxation in Smith was to counterbalance asymmetries in wealth. Burdening the rich “more than in proportion” to their wealth and lightening the burden on the poor were criteria he applied repeatedly—not because morality demanded it, but because sound economics did.³⁹

Thus, Smith envisioned an important role for the state in enabling fair market competition and promoting social inclusion. Why did he go to great lengths to identify what he considered to be inherent market imperfections requiring countervailing government action?

Smith had a clear theory of change based on his belief that economic value fundamentally flows from the services applied by labour—by working people. His view in TWN is that, with few exceptions, restraint of competition—whether from monopolies, collusive business practices, concentration of rents, or legal barriers to trade—undermines the natural tendency of markets to promote the division and specialization of labour and hence growth in productivity, that is, economic output per unit of labour.

In his analysis, regulation of restrictive business practices and monopolies raises productivity growth by lowering barriers to entry, increasing competition and promoting more efficient allocation of resources. Regulation of other rents (e.g., land, financial system) ensures broader access to the factors of production within the economy, expanding the incentives for individual initiative and innovation, boosting labour productivity further. Labour regulation to ensure that wages reflect productivity ensures that a growing economy translates into a more educated, healthy and thus productive workforce, and this in turn increases the production and consumption of goods and services, that is, the “wealth”, of the nation. Finally, government support for the supply of affordable public goods—the “necessaries of life”—including but not limited to quality public education and a safe and healthy environment (Smith had the urban slums of his day in mind), enhances the well-being and capabilities of the workforce as a whole, increasing the productivity of the nation’s factories, trades and farms still further.

Thus, for Smith, unleashing the “animal spirits” of private enterprise by freeing up the “invisible hand” of markets was a necessary but not sufficient condition for optimizing both the productive output of nations and broad socioeconomic progress within them. As a moral philosopher and political economist, he considered the latter to be the ultimate objective of his enquiry. Recall that political economy or economics did not exist in his day as a separate intellectual discipline. He approached the topic as a subdiscipline within the larger intellectual canvas of moral philosophy, having as its fundamental purpose the improvement of the human condition across its moral and spiritual as well as material dimensions.

Accordingly, increasing the “wealth of nations” meant more to him than boosting production or what we today call GDP. It also meant enabling and justly compensating the entire workforce and clearing away discriminatory and outright exclusionary practices through the targeted application of anti-trust, labour, financial, education and social protection law and regulation. In TWN, Smith sketched the outlines of the institutional infrastructure that he thought should underpin market economies in order to optimize production and distribution simultaneously in recognition of their latent positive synergy. In this way, he anticipated the early- to mid-twentieth-century anti-trust, labour, financial system and social protection reforms of industrial economies and even Amartya Sen’s more recent emphasis on human capability and agency in economic development.

Thus, a fair reading of TWN suggests that the residual treatment of living standards and distributional considerations of modern economics does not have its source in the original “scripture” of liberal political economy. Next, we turn to the landmark work of two of the most influential theorists of liberal political economy’s pantheon in the century after Smith’s, John Stuart Mill and Alfred Marshall. In his 1848 Principles of Political Economy: With Some of Their Applications to Social Philosophy, Mill integrated and extended the work of the classical theorists of the late eighteenth and early nineteenth century, notably Smith, David Ricardo and Mill’s father James. In so doing, he set the stage for the advent of the neoclassical school in the late nineteenth century, which found its most comprehensive and authoritative expression in the work of Marshall, whose 1890 Principles of Economics synthesized and built upon the work of the early marginalists and W.S. Jevons in particular.

Mill’s Principles of Political Economy was the most widely used economics textbook for nearly a half a century until the appearance of Marshall’s Principles of Economics, which enjoyed this distinction for a similarly lengthy period. Both treatises combined specific theoretical innovations and refinements with a comprehensive overview of the field. As such, they are the best available nineteenth-century reference points for our continuing investigation into the origins of modern liberal economics’ structural underemphasis of inclusion, sustainability and resilience.

John Stuart Mill is considered one of the most important figures in all of liberalism. However, emulating his mentor and the pioneer of utilitarianism, Jeremy Bentham, he was sceptical of a general application of the notion of natural rights, stating in his earlier seminal work “On Liberty”,

It is proper to state that I forgo any advantage which could be derived to my argument [for liberty] from the idea of abstract right as a thing independent of utility. I regard utility as the ultimate appeal on all ethical questions; but it must be utility in the largest sense, grounded on the permanent interests of man as a progressive being.⁴⁰

Mill drew a distinction between individual actions that are by their very nature “personal” or “self-regarding”, that is, actions that pertain exclusively to the actor themself, and other conduct that is “social”, meaning behaviour that has consequences—whether immediate or distant—for other people.⁴¹

Whether conduct is purely self-regarding or generates externalities that potentially affect others is decisive for determining if and when society may intervene … Commerce is chief among the kinds of social conduct that Mill deems amenable to social regulation. He stipulates that “trade is a social act,” and as such, it belongs in a different class than the self-regarding freedoms defended in On Liberty [e.g., freedom of expression and religion].He states: “Whoever undertakes to sell any description of goods to the public, does what affects the interests of other persons, and society in general; and thus his conduct, in principle, comes within the jurisdiction of society.”⁴²

Mill’s Principles of Political Economy hews to the market-oriented tradition of Adam Smith in emphasizing that “laissez-faire should be the general practice: every departure from it, unless required by some great good, is a certain evil”.⁴³ He elaborated:

[E]very restriction of [competition] is an evil, and every extension of it, even if for the time injuriously affecting some class of labourers, is always an ultimate good. To be protected against competition is to be protected in idleness, in mental dullness; to be saved the necessity of being as active and as intelligent as other people; and if it is also to be protected against being underbid for employment by a less highly paid class of labourers, this is only where old custom, or local and partial monopoly, has placed some particular class of artisans in a privileged position as compared with the rest; and the time has come when the interest of universal improvement is no longer promoted by prolonging the privileges of a few.⁴⁴

Thus, as a moral philosopher, Mill like Smith saw the ultimate purpose of political economy as contributing to social progress and the moral and spiritual development of individuals. This larger perspective opened the door to a similarly clear-eyed, pragmatic assessment of the imperfections present and possibly inherent in markets as well as the legitimacy and indeed necessity at times of remedial societal and governmental action, notwithstanding his general view that “the great majority of things are worse done by the intervention of government, than the individuals most interested in the matter would do them, or cause them to be done, if left to themselves”.⁴⁵

Like Smith, Mill never formalized the many exceptions he enumerated to the general principle of laissez-faire in a specific theoretical construct, but his extensive discussion of such challenges and appropriate responses to them accounts for a substantial proportion of both his Principles of Political Economy and later works.

For example, Mill objected to Great Britain’s inheritance laws, describing them as

the feudal family, the last historical form of patriarchal life⁴⁶ … I see nothing objectionable in fixing a limit to what any one may acquire by the mere favour of others, without any exercise of his faculties, and in requiring that if he desires any further accession of fortune, he shall work for it.⁴⁷

Regarding private property more generally, in his autobiography Mill refers to the influence on his thinking of the St Simonian school of French philosophy:

Their criticisms on the common doctrines of Liberalism seemed to me full of important truth; it was partly by their writings that my eyes were opened to the very limited and temporary value of the old political economy, which assumes private property and inheritance as indefeasible facts, and freedom of production and exchange as the dernier mot [last word] of social improvement.⁴⁸

A pioneer of gender equality, he advocated changes in legal restrictions and customs (guild practices and social attitudes) that severely discriminated against women in regard to wages and employment opportunity:

This most desirable result would be much accelerated by another change, which lies in the direct line of the best tendencies of the time; the opening of industrial occupations freely to both sexes. The same reasons which make it no longer necessary that the poor should depend on the rich, make it equally unnecessary that women should depend on men; and the least which justice requires is that law and custom should not enforce dependence (when the correlative protection has become superfluous) by ordaining that a woman, who does not happen to have a provision by inheritance, shall have scarcely any means open to her of gaining a livelihood, except as a wife and mother. Let women who prefer that occupation, adopt it; but that there should be no option, no other carrière possible for the great majority of women, except in the humbler departments of life, is a flagrant social injustice.⁴⁹

He advocated government provision of public goods, invoking the existence of certain

“things of the worth of which the demand of the market is by no means a test.” These are sublime goods “whose utility does not consist in ministering to inclinations, nor in serving the daily uses of life, and the want of which is least felt where the need is greatest.” … These goods include matters of personal cultivation such as education. They also include non-immediate goods such as retirement or saving for the future that are so far off on the horizon that one cannot reasonably expect people to place any weight on them given the natural tendency to discount the future. They also include many instances that require overcoming a collective action problem such as agitating for higher pay or fewer hours for labor. In all these instances, Mill allows that there is some role for government intervention.⁵⁰

More generally, he viewed distribution as ultimately a social construct, a matter for societies to decide through their political processes:

The distribution of wealth … is a matter of human institution solely. The things once there, mankind, individually or collectively, can do with them as they like. They can place them at the disposal of whomsoever they please, and on whatever terms … Even what a person has produced by his individual toil, unaided by any one, he cannot keep, unless by the permission of society. Not only can society take it from him, but individuals could and would take it from him, if society only remained passive … The distribution of wealth, therefore, depends on the laws and customs of society. The rules by which it is determined, are what the opinions and feelings of the ruling portion of the community make them, and are very different in different ages and countries; and might be still more different if mankind so chose.⁵¹

These views are fundamentally at odds with the laissez-faire notion that government should intervene minimally in the economy. Like Smith, Mill clearly conceived of this principle as applying specifically to the exchange of goods and services in commercial activity. It was not to be extrapolated to the whole of political economy, but should, rather, be complemented by “human institution” to address related socioeconomic questions of fairness, human dignity and equitable participation in the benefits that market competition brings. He went so far as to suggest,

Whether “individual agency in its best form” or some variant of socialism will prove superior in satisfying these needs is a “mere question of comparative advantages, which futurity must determine.” The question of “which of the two will be the ultimate form of human society” remains open. Again we are thrown back—as in the question of liberty itself—on amorphous notions of “progress,” “development,” and “improvement” as the benchmarks of social policy.⁵²

Moreover, anticipating the arguments of contemporary ecological economics, Mill envisioned natural limits to the process of economic growth. He thought that national economies would at some point reach a “stationary state” in which productive output and population would stabilize at a high level of wealth and material comfort. He argued that “in those most advanced, what is economically needed is a better distribution” and added:

It is scarcely necessary to remark that a stationary condition of capital and population implies no stationary state of human improvement. There would be as much scope as ever for all kinds of mental culture, and moral and social progress; as much room for improving the Art of Living, and much more likelihood of its being improved, when minds ceased to be engrossed by the art of getting on. Even the industrial arts [technology] might be as earnestly and as successfully cultivated, with this sole difference, that instead of serving no purpose but the increase of wealth, industrial improvements would produce their legitimate effect, that of abridging labour. Hitherto it is questionable if all the mechanical inventions yet made have lightened the day’s toil of any human being. They have enabled a greater population to live the same life of drudgery and imprisonment, and an increased number of manufacturers and others to make fortunes. They have increased the comforts of the middle classes. But they have not yet begun to effect those great changes in human destiny, which it is in their nature and in their futurity to accomplish. Only when, in addition to just institutions, the increase of mankind shall be under the deliberate guidance of judicious foresight, can the conquests made from the powers of nature by the intellect and energy of scientific discoverers become the common property of the species, and the means of improving and elevating the universal lot.⁵³

To be certain, Mill like Smith was deeply sceptical of the ability of government to perform the functions of distribution well. He was wary of what he considered to be its natural tendency towards bureaucratic centralization and political capture by moneyed interests, and this led him to express a distinct (but not necessary fully confident) preference for voluntary associations to perform many of them. In this, he was presumably influenced by the analysis of Tocqueville, with whom he corresponded actively for a number of years.⁵⁴ However, he did not allow these practical considerations, informed as they were by the relatively underdeveloped state of public administration in mid-nineteenth-century Great Britain, to prevent him from highlighting the essential role he thought should be played by human institutions shaped by political rather than market processes, even if he did not package and advertise these arguments very coherently.

This dual approach—emphasizing simultaneously the importance of market signals in commercial exchange in order to raise an economy’s productive output, on the one hand, and the need for markets to be underpinned by an institutional infrastructure of rules and incentives to translate such increased output into broad-based improvement in material living standards and hence the human condition—was embraced and deepened by Alfred Marshall in both dimensions. Marshall was one of the conceptual pioneers and the original codifier of neoclassical economics. His models and reasoning remain at the foundation of much of economics scholarship and policy practice today.

In particular, Marshall integrated the perspectives of classical economists who emphasized production-related and particularly labour costs as a principal determinant of value and the later marginalist school that emphasized marginal utility, that is, the degree of additional satisfaction or value gained from consuming a given product or service relative to other choices. He expanded the application of mathematics to political economy, developing tools and models such as supply and demand curves to help one understand determinants of price and, on an aggregate level, market equilibria. In this way, he took the study of markets begun by Smith to an altogether new level, refining and codifying the work of the original marginalists W.S. Jevons, Leon Walras and Carl Menger.

This more rigorous approach to understanding the nature of markets and the decision-making behaviour of actors within them consolidated political economy’s evolution into a social science in its own right. The field’s name eventually changed to “economics”, and it came to be understood as the science of modelling rational decision-making under conditions of scarce or otherwise constrained choices.

Given Marshall’s pioneering emphasis on the technical workings of markets and the mathematical modelling of them, one might have expected him not to pay as much attention to the broader socioeconomic issues that weighed so heavily upon Smith and Mill. In fact, Marshall doubled down on their twin emphasis of the role of markets in raising productive efficiency and output, on the one hand, and the role of “human institutions” in improving distribution and social welfare, on the other. He, too, had come to the study of political economy from a wider vantage point, having earlier studied metaphysics, ethics and social philosophy in addition to maths and physics. This was reflected in his definition of economics, which remains one of the most cited:

Political Economy or Economics is a study of mankind in the ordinary business of life; it examines that part of individual and social action which is most closely connected with the attainment and with the use of the material requisites of well-being. Thus it is on the one side a study of wealth; and on the other, and more important side, a part of the study of man.⁵⁵

In this definition, the production–distribution, markets–institutions duality of approach is quite explicit. It flows coherently from Mill’s definition that political economy “investigate[s] the nature of Wealth, and the laws of its production and distribution”.⁵⁶

Marshall focused increasingly on the second part of this duality—the promotion of broad human welfare through stronger social institutions—as his work progressed across the eight editions of Principles of Economics and various other writings between 1879 and 1923. He underscored the importance of market limitations and imperfections and the role of government in most of the same areas emphasized by Smith and Mill cited above. He did so out of a similar larger philosophical conviction that “the growth of mankind in numbers, in health and strength, in knowledge, ability, and in richness of character is the end of all our studies”⁵⁷ as well as a pragmatic sense that “the health and strength of the population” are the basis of industrial efficiency and that man’s “vigour” is the source of all progress.⁵⁸ He saw the abject living conditions of much of the population in his day as both a moral stain and an economic opportunity cost:

There are vast numbers of people both in town and country who are brought up with insufficient food, clothing, and house-room; whose education is broken off early in order that they may go to work for wages; who thenceforth are engaged during long hours in exhausting toil with imperfectly nourished bodies, and have therefore no chance of developing their higher mental faculties.⁵⁹

Accordingly, he turned increasingly to distributional considerations and related enabling environment conditions. In the fifth edition of Principles, he added a long chapter entitled “Progress in Relation to Standards of Life”—an early reference to the modern term “standard of living”.⁶⁰ In Appendix K, he argued that “a certain minimum of means is necessary for material wellbeing” and suggested both there and in his earlier (1879) volume, The Economics of Industry—which was written with his wife and frequent collaborator Mary Paley—a decidedly multidimensional definition of well-being and economic progress not unlike the contemporary ones cited in Chap. 2:

True well-being or welfare requires, besides a necessary level of material wealth, a number of elements that are of fundamental importance for human nature. Quality of life is one, but a good quality of life can be achieved only by means of a good level of education, the true and most important engine of progress and welfare. Through education people can improve their condition both in the work place and in society. Through education people can improve in character and evaluate aspects of life that are not strictly “material”. And through education a nation can upgrade in the competitive international arena. Education therefore is a fundamental aspect of true welfare, its premise. But various other elements are also essential: a good quality of life requires a good place to live in (clean and spacious houses, green open spaces, good quality of air and so forth); a good place to work in and good labour conditions; good social relations; open opportunities for personal advancement. We cannot simply sum up all these components in the concepts of surpluses, nor of national dividend which, at most, can only be approximations.⁶¹

These necessaries, comforts, and luxuries are for a man’s children as well as for himself; indeed the chief of them is a good physical, mental and moral education for his children. Economic progress depends much on change in the Standard of Comfort of the people, and therefore on the strength of their family affections … Just as a man who has borrowed money is bound to pay it back with interest, so a man is bound to give his children an education better and more thorough than he has himself received.⁶²

To this end, he sketched a public policy reform agenda that mirrored those of Smith and Mill while reaching beyond them in important respects. For example, on a minimum, living wage:

When … the home of children is such that there is no considerable chance of their growing up to be good citizens, healthy in mind and body, the State is bound as a duty and for self-preservation to intervene. It may improve the home; or close it, and take charge of the family. In the rare cases in which when the wages of any kind of adult male labour are so low that, even when supplemented by the utmost earnings that wife and children are likely to bring in, they would not suffice to maintain a wholesome family life, then it may conceivably be advisable to prohibit such low wages.⁶³

An increase of wages … almost always increases the strength, physical, mental and even moral of the coming generation … an increase in the earnings that are to be got by labour increases its rate of growth; or, in other words, a rise in its demand-price increases the supply of it.⁶⁴

On investment in human capital:

Many of the children of the working classes are imperfectly fed and clothed; they are housed in a way that promotes neither physical nor moral health … At least they go to the grave carrying with them undeveloped abilities and faculties; which, if they could have borne full fruit, would have added to the material wealth of the country … many times as much as would have covered the expense of providing adequate opportunities for their development.⁶⁵

“There is no extravagance more prejudicial to the growth of national wealth than that wasteful negligence which allows genius that happens to be born of lowly parentage to expend itself in lowly work.” No change would be more conducive to a rapid increase of material wealth as an improvement in the schools, provided it be combined with an extensive system of scholarships. His observation was that “progress is most rapid in those parts of the country in which the greatest proportion of the leaders of industry are the sons of working men.”⁶⁶

The older economists took too little account of the fact that the human faculties are as important a means of production as any other kind of capital; and we may conclude, in opposition to them, that any change in the distribution of wealth which gives more to the wage receivers and less to the capitalists is likely, other things being equal, to hasten the increase of material production … if … it provided better opportunities for the great mass of the people, increased their efficiency, and developed in them such habits of self-respect as to result in the growth of a much more efficient race of producers in the next generation. For then it might do more in the long-run to promote the growth of even material wealth than great additions our stock of factories and steam-engines.⁶⁷

On public goods provision in areas “which must be regulated more or less by Government”:

Streets … Canals, Light houses (some); Surveys and information of all kinds which are beyond the reach of private effort: … Free parks and Recreative grounds etc … Markets … slaughter houses; fairs; cemeteries; action in the case of infectious diseases. The supply of meat, fruit, and other things which the consumer cannot test for himself at all or until too late to escape … Telegraphs, Telephones, Water, Gas, Electricity supply, Tramways Building on public streets, Railways Pipe lines, Agricultural drainage and Irrigation works, Educational and medical provisions on too large a scale for private enterprise, in which public and private foundations may well be mingled under public control. Universities[,] Museums[,] Art Galleries[,] Hospitals (with paying cards).⁶⁸

On environmental regulation and subsidies:

The most important capital of a nation is that which is invested in the physical, mental and oral nurture of its people. That is being recklessly wasted by the exclusion of, say, some ten millions of the population from reasonable access to green spaces, where the young may play and the old may rest. To remedy this evil is … even more urgent than the provision of old-age pension; and I wished the first charge upon the rapidly-growing value of urban land to be a “Fresh Air” rate (or general tax), to be spend [sic] on breaking out small green spots in the midst of dense industrial districts, and on the preservation of large green areas between different towns and between different suburbs which are tending to coalesce. I thought that the gross amount of the Fresh Air rate or tax should be about ten millions a year, till we have cleared off the worst evils caused by many generations of cruel apathy and neglect.⁶⁹

These theoretical principles regarding the critical importance of institutional reforms to advance public welfare and well-being were expressed by Marshall in qualitative rather than quantitative terms. They were not translated into supporting mathematical notation and graphs such as those he famously pioneered for modelling price determination and related consumer and producer behaviour in markets of exchange. However, he forcefully and repeatedly argued that higher investment by society in the skills and lived experience of the poor would ultimately have a major quantitative impact in the form of higher productivity and national economic output. It would influence the supply of and demand for a critical factor of production, labour, and thereby shape the positioning of these curves in key industries and across the economy over the medium to long term. In other words, these aspects of his Principles of Economics regarding social welfare promotion were part and parcel of his theory and not separate or subordinate observations.

In this way, Marshall deepened the holistic and, by modern standards, heterodox tradition of Smith and Mill. He took their two-track argument about strengthening market signals and economic growth, on the one hand, and institutions and broad social welfare, on the other, to a new level of sophistication, including by underscoring the latent synergy between the two.

However, he also unintentionally set the stage for the imbalance in emphasis between these two dimensions that was to emerge in succeeding decades. His very act of applying mathematical methods more rigorously to the modelling of behaviour in markets of exchange inspired successive waves of impressive scholarship aiming to refine and more broadly apply these neoclassical tools of analysis to this more quantifiable of the two domains. Such concentration of scholarly attention evolved to such an extent that the young field of “economics” rapidly became synonymous with, in essence, the study of the mechanics of price determination and equilibrium in markets composed of rational actors. This shift was reflected in the most commonly used definition of economics that emerged in the years following Marshall’s death, Lionel Robbins’s 1932 formulation: “Economics is the science which studies human behavior as a relationship between ends and scarce means which have alternative uses.”⁷⁰

The dual emphasis of Smith, Mill and Marshall is nowhere to be found in Robbins’s characterization of the field, and these men scarcely would have approved of it. But this is not to say that welfare considerations were not an ongoing focus of the profession. In fact, Marshall’s hand-chosen successor as professor of political economy at Cambridge University, Arthur Cecil Pigou, became the father of a new subdiscipline known as “welfare economics”. But whereas Marshall’s and his two predecessors’ focus on welfare and well-being was at the broad societal—that is, macro- and institutional—level, Pigou’s was mainly at the micro- or individual consumer or producer level. Pigou made this choice for very practical reasons; he was able to apply the rapidly evolving quantitative methods of his day far more readily to markets, prices and incomes than to the comparatively intangible and subjective domains of human institutions and notions such as equity and sufficiency. He explained,

Welfare is a thing of very wide range. It is necessary to limit our subject-matter. In doing this we are naturally attracted towards that portion of the field in which the methods of science seem likely to work at best advantage. This they can clearly do when there is present something measurable … The one obvious instrument of measurement available in social life is money. Hence, the range of our inquiry becomes restricted to that part of social welfare that can be brought directly and indirectly into relation with the measuring-rod of money.⁷¹

There is no guarantee that the effects produced on the part of welfare that can be brought into relation with the measuring-rod of money may not be cancelled by effects of a contrary kind brought about in other parts, or aspects, of welfare; and, if this happens, the practical usefulness of our conclusions is wholly destroyed. The difficulty, it must be carefully observed, is not that, since economic welfare is only a part of welfare as a whole, welfare will often change while economic welfare remains the same, so that a given change in economic welfare will seldom synchronise with an equal change in welfare as a whole. All that this means is that economic welfare will not serve for a barometer or index of total welfare. But that, for our purpose, is of no importance.⁷²

By contrast, for Marshall, welfare is not simply reduced to a measurable quantity but is something extremely complex; and the idea of measurability “should be always present” but “it should not … be prominent”.⁷³ As his protégé, Pigou was fully cognizant of the limitations of his own partial approach, which focused solely on what he called “economic welfare”:

[W]hat we wish to learn is, not how large welfare is, or has been, but how its magnitude would be affected by the introduction of causes which it is in the power of statesmen or private persons to call into being. The failure of economic welfare to serve as an index of total welfare is no evidence that the study of it will fail to afford this latter information: for, though a whole may consist of many varying parts, so that a change in one part never measures the change in the whole, yet the change in the part may always affect the change in the whole by its full amount. If this condition is satisfied, the practical importance of economic study is fully established. It will not, indeed, tell us how total welfare, after the introduction of an economic cause, will differ from what it was before; but it will tell us how total welfare will differ from what it would have been if that cause had not been introduced: and this, and not the other, is the information of which we are in search.⁷⁴

Despite the limitations of his approach, which he freely acknowledged, Pigou was working unambiguously in the two-lens production-and-distribution, growth-and-social-welfare political economy tradition of Marshall, Mill and Smith. He viewed economic welfare as being advanced by “any cause which, without the exercise of compulsion or pressure upon people to make them work more than their wishes and interests dictate, increases productive efficiency, and, therewith, the average volume of the national dividend, provided that it neither injures the distribution nor augments the variability of the country’s consumable income (emphasis supplied).” He also considered it being enhanced by “any cause which increases the proportion of the national dividend received by poor persons” (emphasis supplied), “provided that it does not lead to a contraction of the national dividend and does not injuriously affect its variability”⁷⁵ (emphasis supplied). He posited further that economic welfare will not be maximized if there is a divergence between what he called the marginal social net product and marginal private net product of economic activities.

Thus, Pigou was keenly interested in the determinants of distribution at the macroeconomic level, and he did not necessarily intend his partial pecuniary approach to define or dominate how economics would deal with larger distributional and ethical dimensions of social welfare, including those relating to inclusion, sustainability and resilience. But this turned out to be what happened, and while there has been plenty of scholarly debate among welfare and development economists over the years about these limitations⁷⁶ and possible alternative or additional avenues of enquiry,

The richness and complexity of the reflections developed by Marshall went lost in Pigou’s systematization [which focused on] … the sum of producers’ and consumers’ surplus that are measured in terms of money and maximized according to the doctrine of maximum satisfaction. The maximization of welfare (that is of consumers’ and producers’ surpluses and National Dividend) becomes simply the solution of an analytical maximization problem. The condition of welfare maximization is that marginal social costs (benefits) are equal to marginal private costs (benefits). If they are not equal (market failure), then there is scope for state intervention.⁷⁷

This gave the role of government a far narrower scope on matters of social welfare than that envisioned by Smith, Mill and Marshall and many of their contemporaries. Thus, remarkably, even the branch of modern economics called “welfare economics” ended up largely sidestepping broader considerations of social welfare, never developing a strong macro- and institutional component of the kind implied by the two-track framework of analysis of liberal economics’ most influential original theorists.

This is not to say that economic policy did not pursue the kinds of investments in people and related institutional and legal reforms advocated by Smith, Mill and Marshall. Major such reforms were introduced in Western countries in the latter part of the nineteenth and first half of the twentieth centuries. However, these were driven by rising social and political pressure, not the teachings and techniques of welfare economics. The neoclassical school had an important influence on the competition (e.g., anti-trust) and certain other reforms of this period, but it followed rather than led society when it came to the distributional agenda. To this day, it has not found a formula for integrating Smith’s, Mill’s and Marshall’s dual approach in its increasingly elaborate theoretical framework. If anything, this imbalance in emphasis in the way their founding principles were applied became more entrenched as the twentieth century wore on.

By contrast, classical liberal political economists and Smith in particular had a major influence on both market and social policy reforms in the early nineteenth century. Smith’s views and prescriptions on mercantilism and the Corn Laws (restricting the importation of cheaper grains), on the guild, apprenticeship, labour mobility and inheritance rules of his day, and on government’s role in taxation and public goods provision contributed to a policy shift in Great Britain and elsewhere, as illustrated by this account of Parliament’s early consideration of minimum wage legislation and reform of the Settlement Laws (restrictions on the movement and other rights of workers, women, illegitimate children, orphans and other poor or vulnerable people)⁷⁸:

In 1795–6, and again in 1799–1800, sudden increases in food prices set off an intense discussion of wage rates and poor relief. One episode—Samuel Whitbread’s proposed minimum wage legislation of 1795—provides a particularly clear illustration of the changing interpretation of Smith’s ideas. Whitbread was a reform M.P., and his bill would have given magistrates powers “to regulate the wages of Labourers in Husbandry” by fixing minimum wages. He was strongly influenced by Smith, and introduced the Commons debate on the bill by explaining that “he felt as much as any man … that the price of labour, like any other commodity, should be left to find its own level”. But he was prepared to countenance some “legislative interference” to protect the “rights” of the poor. Whitbread followed the Wealth of nations closely in his parliamentary presentation. Smith himself was tolerant, after all, of some wage regulation …

Whitbread’s Smith-inspired rhetoric was greeted, however, with a quite different interpretation of political economy. [Prime Minister William] Pitt answered Whitbread with a resounding defence of the “unassisted operation of principles”. He invoked “the most celebrated writers upon political economy” as testimony that the House should “consider the operation of general principles, and rely upon the effects of their unconfined exercise”. His solution was to remove restrictions on the “free circulation of labour”, and to begin reform of the laws of settlement. Whitbread and his friends pointed out that such reforms “would take a considerable time”; a barley loaf, meanwhile, cost rather more than “the whole of the labourer’s daily wages“. But “the present case”, for Pitt, was not “strong enough for the exception”.

There is something of Smith on both sides of the parliamentary debate … Smith was considered, like Whitbread, as a friend of the poor. In the Wealth of nations he describes “the liberal reward of labour” as the “necessary effect and cause of the greatest public prosperity”; in the “Early draft” he had written that a “high price of labour” was the “essence of public opulence.” Smith’s language, more generally, is quite different from Pitt’s. Pitt followed Smith in criticizing the law of settlements. But where Smith described an “evident violation of natural liberty and justice”, by which the “poor man” is “most cruelly oppressed”, Pitt saw no more than a “grievance”: “instances where interference had shackled industry”. Whitbread and his friends, like Smith, wished “to rescue the labouring poor from a state of slavish dependence”. The labourer should not “receive his due as an eleemosynary gift”; the dependence of the poor was especially evil because people who had received relief were excluded from the franchise, and thus from their constitutional rights. But for Pitt, the poor were concerned with prices and not with rights; the workman was prevented, at worst, “from going to that market where he could dispose of his industry to the greatest advantage”.⁷⁹

This story attests to TWN’s influence in not merely informing public policy debate but shifting its very frame of reference—with respect to both the role of markets and that of governments in advancing social welfare. Such was Smith’s paradigmatic influence that Pitt eulogized him and his treatise in a speech before the House of Commons soon after his death.⁸⁰

Looking back in 1881, Lord Acton, the eminent editor, historian and political adviser of Prime Minister William Gladstone, remarked, “government with the working class” was the irresistible consequence of Smith’s ideas of freedom of contract, and of labour as the source of wealth: “That is the foreign effect of Adam Smith—French Revolution and Socialism.”⁸¹ Similarly, Carl Menger, founder of the Austrian School of economics, characterized Smith as a friend of the poor and noted that he was quoted frequently by Louis Blanc, Ferdinand Lassalle and Karl Marx⁸²:

A. Smith placed himself in all cases of conflict of interest between the poor and the rich, between the strong and the weak, without exception on the side of the latter. I use the expression “without exception” after careful reflection, since there is not a single instance in A. Smith’s work in which he represents the interest of the rich and powerful as opposed to the poor and weak.⁸³

Of course, Smith was by no means solely or even principally responsible for the wave of social reform legislation that swept his own country and others during the early nineteenth century. But TWN had a powerful legitimating and political-base-broadening effect. As it came to dominate political economy discourse and pedagogy, it helped to accelerate the pace of reform in Great Britain and abroad.

Great Britain’s Parliament passed its first factory legislation in 1802 which

prevented apprentices under the age of 21 from working at night and for longer than 12 hours a day, and made provision for them to receive some basic education. Much of the labour in the nation’s burgeoning cotton mills was provided by “pauper apprentices”, who were often children below the age of ten. Many of them were orphans sent into factory employment by the Poor Law authorities, often very far from their home parishes. In the first decades of the 1800s, as many as a fifth of workers in the cotton industry were children under the age of 13.⁸⁴

Between 1819 and the 1880s, Parliament adopted a succession of increasingly expansive legislation regulating factories, mines, chimney sweeps and the provision of poverty relief, addressing many of the gaps criticized by Smith and Mill.⁸⁵ Indeed, by the mid nineteenth century, most European countries were legislating social and labour protections for specific vulnerable groups as summarized in Table 3.1.⁸⁶

Table 3.1 National legislation on social insurance before the German legislation of 1883

This was a period plagued by rolling waves of industrial unrest across Europe,⁸⁷ leading governments of many countries to pursue labour and social protection reforms in order to limit the risks to political stability. With an eye to its restive working class, the German government of Chancellor Otto von Bismarck became the first to adopt a comprehensive social insurance programme, beginning with his proposal in 1881 for old-age insurance:

The German system provided contributory retirement benefits and disability benefits as well. Participation was mandatory and contributions were taken from the employee, the employer and the government. Coupled with the workers’ compensation program established in 1884 and the “sickness” insurance enacted the year before, this gave the Germans a comprehensive system of income security based on social insurance principles. (They would add unemployment insurance in 1927, making their system complete.)⁸⁸

Following the passage of Bismarck’s reforms, the Nordic countries and others began to examine and adopt aspects of the new and more comprehensive German social security system. By the First World War, 32 countries had introduced some sort of legislation providing insurance or compensation for industrial accidents or occupational hazards, 18 countries had introduced sickness insurance or benefit schemes—Germany (1883), Norway (1909), the United Kingdom (1911) and the Netherlands being pioneers of compulsory schemes. Some sort of old-age, survivors’ or disability insurance or scheme was in place in 13 countries, whereas only seven countries had introduced unemployment benefit schemes.⁸⁹

These efforts by Western governments to widen the social benefits of industrialization were influenced by a growing political radicalization of the working class in many countries. Industrial strikes and trade unions proliferated from the 1860s to 1890s, since many of the limited reforms governments enacted suffered from weak implementation and enforcement. Marx’s Das Kapital appeared in 1867, inspiring much debate about the plight of workers and the possibility of a more equitable approach to organizing economies: socialism. The global economic depression of 1873–77 and ensuing stagnation up to and including much of the 1890s (e.g., the Panic of 1893 in the United States) exacerbated social pressures.

By the twentieth century’s second decade—which witnessed the economic and political convulsions of the First World War, Bolshevik Revolution, Spanish influenza and major industrial strikes such as those in the United Kingdom during the 1911–14 “Great Unrest” and those in the United States affecting the textile, coal and steel industries and even Boston’s entire police force—governments were seized by fears of civil unrest, political instability and the prospect of Bolshevik-style communist revolution. This was the febrile environment in which discussions began soon after the war on a new global “social contract” through the formation of the ILO. As the ILO’s second director, Edward Phelan, who in 1919 helped to draft its constitution, recounted:

The three Great Powers, the United States of America, Great Britain and France were … preoccupied with a critical post-war situation, more immediately dangerous than that which followed the Second World War. A revolutionary temper was widespread: the Bolshevik Revolution in Russia had been followed by the régime of Bela Kun in Hungary; the shop steward movement in Great Britain had honeycombed many of the larger trade unions and undermined the authority of their constitutional executives; the trade union movements in France and Italy showed signs of becoming more and more extremist; millions of men, trained in the use of arms, to whom extravagant promises had been freely made were about to be demobilised; the wave of unrest had spread even to such stable and peaceful democracies as the Netherlands and Switzerland. How gravely the situation was viewed may be indicated by the fact that during the [Versailles] Peace Conference itself, Clemenceau moved many thousands of troops into Paris as a precaution against rioting in the streets. The decision to give labour matters a prominent place in the Peace Treaty was essentially a reflection of this preoccupation. The Peace Conference accepted the proposals of its Labour Commission without much concern either for the generalisations of the Preamble or for the details of the proposed organisation. In other circumstances, it is indeed highly probable that some of the more daring innovations in the latter, such as the provision that non-Government delegates should enjoy equal voting power and equal status with Government delegates in the International Labour Conference, would have been considered unacceptable.⁹⁰

Following the First World War, the ILO Constitution was adopted as part of the Treaty of Versailles, alongside but separate from the part that established the League of Nations. Its brief preamble contained distinct echoes of the admonitions and principles of Smith, Mill and Marshall:

Whereas universal and lasting peace can be established only if it is based upon social justice;

And whereas conditions of labour exist involving such injustice, hardship and privation to large numbers of people as to produce unrest so great that the peace and harmony of the world are imperilled; and an improvement of those conditions is urgently required; as, for example, by the regulation of the hours of work, including the establishment of a maximum working day and week, the regulation of the labour supply, the prevention of unemployment, the provision of an adequate living wage, the protection of the worker against sickness, disease and injury arising out of his employment, the protection of children, young persons and women, provision for old age and injury, protection of the interests of workers when employed in countries other than their own, recognition of the principle of equal remuneration for work of equal value, recognition of the principle of freedom of association, the organization of vocational and technical education and other measures;

Whereas also the failure of any nation to adopt humane conditions of labour is an obstacle in the way of other nations which desire to improve the conditions in their own countries⁹¹;

In essence, the unfinished institutional development agenda advocated by the founding theorists of capitalism had become an international political priority of the highest order. Its underdevelopment and lack of international coordination had come to be perceived as a direct threat to peace and stability within and among countries.

Years later, US President Franklin D. Roosevelt reflected on his unanticipated role in helping to organize the ILO’s first International Labour Conference in 1919 in Washington:

I well remember that in those days the ILO was still a dream. To many it was a wild dream. Who had ever heard of Governments getting together to raise the standards of labor on an international plane? Wilder still was the idea that the people themselves who were directly affected—the workers and the employers of the various countries—should have a hand with Government in determining these labor standards.⁹²

Roosevelt was referring to the special governance arrangements of the ILO, which to this day allot governments and social partners equal voting rights (a 2:1:1 ratio for governments, worker organizations and employer organizations, respectively). The purpose was

to promote social progress and overcome social and economic conflicts of interest through dialogue and cooperation. In contrast to the revolutionary movements of the time, it brought together workers, employers and governments at the international level—not in confrontation, but in a search for common rules, policies and behaviours from which all could benefit. It included a number of unique features. Above all, it gave these economic actors equal power of decision with states, and it introduced new forms of international treaty concerned with social aims, along with new ways to apply them. Politically it drew on the main European democratic political currents of the time, in particular social democracy, Christian democracy and social liberalism, and actors from each of these perspectives participated in its work and contributed to its development.⁹³

In essence, the ILO was given the task of forging a new “social contract” to accompany and soften the rough edges of industrial capitalism along the lines envisioned by Smith, Mill and Marshall—to fill the institutional lacuna in liberal economic theory and practice through the creation of formal international labour and social protection norms ratified by governments and translated by them into national law and regulation. In the organization’s first 20 years, 67 conventions were adopted pursuant to tripartite agreement on such topics as hours of work, maternity protection, forced labour, minimum age, lead paint, night work, sickness insurance, accident protection, old-age insurance, and invalidity insurance.⁹⁴

In 1944, as part of its landmark Philadelphia Declaration, the organization’s tripartite constituents elaborated upon the nature and significance of the emerging universal social contract—this corpus of multilaterally agreed socioeconomic norms—constructed during the interwar period, and they began to look ahead. Of particular note, they affirmed a bedrock principle (contained in the first substantive clause) that “labour is not a commodity”⁹⁵ and framed a related series of individual economic rights and corresponding governmental responsibilities:

the Conference affirms that:

(a) all human beings, irrespective of race, creed or sex, have the right to pursue both their material well-being and their spiritual development in conditions of freedom and dignity, of economic security and equal opportunity;

(b) the attainment of the conditions in which this shall be possible must constitute the central aim of national and international policy;

(c) all national and international policies and measures, in particular those of an economic and financial character, should be judged in this light and accepted only in so far as they may be held to promote and not to hinder the achievement of this fundamental objective;

(d) it is a responsibility of the International Labour Organization to examine and consider all international economic and financial policies and measures in the light of this fundamental objective;

(e) in discharging the tasks entrusted to it the International Labour Organization, having considered all relevant economic and financial factors, may include in its decisions and recommendations any provisions which it considers appropriate.⁹⁶

The statement “labour is not a commodity” was an implicit criticism of not only the often parlous state of industrial working conditions but also the clinical way that labour was generally treated in liberal economics—particularly in the abstract mathematical models of neoclassical theory including the peculiarly circumscribed realm of “welfare economics”. Similarly, the assertion of individual economic rights and the notion that the “central” responsibility of economic policy is to create conditions conducive to the attainment of these for everyone can be read as an implicit rebuff of the imbalanced, “markets-first” way the field has taken forward the two-track framework of principles it inherited from Smith, Mill and Marshall.

An institutionalist school of economics did emerge during the interwar period as important social reforms were being adopted in industrialized countries. These scholars defined “institutions” broadly as “durable systems of established and embedded social rules that structure social interactions”,⁹⁷ encompassing governmental institutions as well as voluntary associations and informal customs and practices having an important bearing upon economic activity. The group argued that such “human institutions”, in the words of J.S. Mill, were important endogenous factors in economic progress and therefore should be more fully internalized in economic theory and practice.

The widely acknowledged founder of the field, Thorstein Veblen, argued that “an evolutionary theory of value must be constructed out of the habits and customs of social life”. He criticized the rationality assumption of the neoclassicists, maintaining that people were not “lightning calculators of pleasures or pains, who [oscillate] like a homogeneous globule of desire of happiness under the impulse of stimuli that shift [them] about the area, but leave [them] intact”.⁹⁸ Rather, they were driven by habits and custom and by whatever constituted achievement in the currently reigning system of status emulation (echoing Smith’s earlier opus, The Theory of Moral Sentiments). This led him to conclude that

marginal utility analysis, indeed the entire apparatus of neoclassical marginalism, was static. It therefore could not capture the important evolutionary, processual elements of the economy, including the changing institutional and power structures of society. Because mainstream economics was not an evolutionary science, Veblen argued in a famous essay, it had become little more than a sophisticated and subtle defense, albeit selectively, of existing institutions, the existing power structure, and the systemic and ideological status quo.⁹⁹

Another principal member of the school, John R. Commons, elaborated:

It is not only principles of mechanism and scarcity conceived as working themselves out automatically and beneficently, through commodities, feelings and individual selfishness, but also principles of the collective control of transactions through associations and governments, placing limits on selfishness, that [must be] … included in economic theory… [F]our verbs [describe such] guidance and restraint of individuals in their transactions. [Such institutions] tell what the individuals must or must not do (compulsion or duty), what they may do without interference from other individuals (permission or liberty), what they can do with the aid of the collective power (capacity or right), and what they cannot expect the collective power to do in their behalf (incapacity or exposure). In short, the working rules of associations and governments, when looked at from the private standpoint of the individual, are the source of his rights, duties and liberties, as well as his exposures to the protected liberties of other individuals.¹⁰⁰

For a time, it appeared that these pragmatic, empirically based perspectives desiring to better integrate market and institutional considerations might lead to a more explicit internalization of social welfare considerations in mainstream economics. However, this heterodox approach ultimately met with strong resistance:

It is widely known that the old institutionalists were hostile to the narrow vision of economics as the “science of choice” and the utility-maximizing version of “economic man”, which have prevailed for the second half of the twentieth century. [But] so keen to dismiss these criticisms, many mainstream economists have resorted to the dismissive tactic of describing any broader version of their discipline, or any approach that is not based on individual utility maximization, as “not economics”.¹⁰¹

In any event, by the 1930s this debate had been overshadowed by and largely absorbed into the intense focus of economists and policymakers on the dire macroeconomic crisis gripping the world. In the context of deflation, widespread unemployment and depressed levels of domestic demand and international trade, necessity became the mother of invention for macroeconomists, ultimately producing a revolutionary new theory and tool: respectively, John Maynard Keynes’s The General Theory of Unemployment, Interest and Money and Simon Kuznets’s and the US Department of Commerce’s national income (gross national product) accounts.

Keynesian demand management dominated the field during the generation following the Second World War, focusing on fiscal and monetary policy intervention to lessen the amplitude of the business cycle. This period also saw important innovations in the theory and empirical measurement and decomposition of economic growth. Both of these avenues of enquiry were concerned principally with the production side of the economy and made extensive use of national income accounting as a measurement tool and the aggregate production function as a conceptual model. At its simplest level, the latter posited that output was a function of key factor inputs (e.g., labour, capital, land and natural resources, technical progress). Both of these topics—Keynesian macro-management of the business cycle and the neoclassical aggregate production function (particularly its use in estimating the relative weight of factor inputs)—came under vigorous criticism that persists to this day. Nonetheless, both remain at the heart of the way that economies are generally conceived of today.

These and other elements of the dominant post-war framework of analysis—the so-called “neoclassical synthesis” combining these and other neoclassical and Keynesian elements—were primarily concerned with the growth and stabilization of productive output. They paid comparatively little attention to distribution and the role of institutions therein. To be certain, public policy and politics continued to make strong advances on this front, many industrialized countries adding considerably in the 1960s and 1970s to their health care, education, labour market, social security, environmental and other social programmes. However, the economics profession was primarily focused elsewhere, both before and after the stagflation of the 1970s brought to the fore in the 1980s the monetarist and deregulatory neoliberal agenda—which had even less interest in distribution and the social contract and indeed often sought to roll aspects of them back.

Institutional economics did experience a revival of sorts from the 1970s to 1990s, but with a microeconomic focus on such topics as transaction costs, information asymmetries and principal–agent incentive challenges in the decision-making behaviour of firms and consumers. Scholars such as Ronald Coase, Oliver Williamson, Albert O. Hirschman and Douglass North made important and celebrated contributions, but these remained some distance from the original macro-institutional, social welfare focus of Smith, Mill and Marshall.

This deepening of mainstream economics’ focus on production and GDP growth during the second half of the twentieth century, whether from a Keynesian or neoliberal perspective, had the effect of leaving unanswered the question raised by the ILO Philadelphia Declaration and the Universal Declaration of Human Rights regarding economic and social rights. How are governments to make these the “central aim” of economic policy? How are they to ensure that “all national and international policies and measures, in particular those of an economic and financial character” will be “judged in this light and accepted only in so far as they may be held to promote and not to hinder the achievement of this fundamental objective”.¹⁰²

The Universal Declaration of Human Rights was adopted in 1948, four years after the Philadelphia Declaration. It specified a set of economic rights that in 1966 were included in an international treaty, the International Covenant on Economic, Social and Cultural Rights (ICESCR), that has been ratified by over 170 countries:

• equal rights for men and women (Article 3);

• the right to work (Article 6);

• the right to just and favourable conditions of work (Article 7);

• the rights of workers to organize and bargain collectively (Article 8);

• the right to social security and social insurance (Article 9) and protection and assistance for the family (Article 10);

• the right to an adequate standard of living (Article 11), which includes: (i) adequate food, (ii) adequate clothing and (iii) adequate housing;

• the right to freedom from hunger (Article 11);

• the right to the highest attainable standard of physical and mental health, including the right to health care (Article 12);

• the right to education (Article 13).

The ICESCR is a legally binding instrument in which state parties assume responsibility to implement and maintain the rights guaranteed therein. Article 28 provides that the Covenant’s provisions “shall extend to all parts of federal States without any limitations or exceptions”.

The Universal Declaration, ICESCR and Philadelphia Declaration articulate a social contract, a commitment by governments to their citizens and the international community to place attainment of these economic rights at the heart of their economic and social policies. They are a modern manifestation of Smith’s, Mill’s and Marshall’s shared principle that markets are but a means to the fulfilment of the more fundamental objective of improving the general welfare of society, and that this requires a complementary project by governments to construct enabling institutions—legal and other norms, policy incentives, administrative capacities—that facilitate access for all to the opportunities and benefits of the increased economic growth that market-based resource allocation helps to generate.

Smith:

what improves the circumstances of the greater part can never be regarded as an inconveniency to the whole. No society can surely be flourishing and happy, of which the far greater part of the members are poor and miserable.¹⁰³

Mill:

many, indeed, fail with greater efforts than those with which others succeed, not from difference of merits, but difference of opportunities; but if all were done which it would be in the power of a good government to do, by instruction and by legislation, to diminish this inequality of opportunities, the difference of fortune arising from people’s own earnings could not justly give umbrage.¹⁰⁴

Marshall:

It is reasonable to suppose that the chief aim of the Government of a Western country is to promote the well-being of the people.¹⁰⁵

Unfortunately, these first principles and modern rights remain largely outside the field of vision of today’s economists, chief economic advisers, and ministers of finance and trade, who tend to engage with them only peripherally. This begs the uncomfortable question of whether a social contract is something apart from economics. Is it merely an aspirational moral and political statement? That would be a rather cynical reading of the intentions of the governments that signed up to these rights. It also would suggest a certain intellectual laziness on the part of economists and economic policymakers. Is it really not possible for the field to walk and chew gum at the same time as it was challenged to do by its founding fathers—to explicitly integrate market-based resource allocation and institutionally based promotion of inclusion, sustainability and resilience in the same growth and development model?

The world has been warned of the cost of this disconnect before—most memorably by Marx in the nineteenth century and Karl Polanyi in the twentieth century. In his 1944 treatise The Great Transformation: The Political and Economic Origins of Our Time, Polanyi argued that the capitalist economies which emerged in the late nineteenth and early twentieth centuries became “disembedded” or decoupled from the priorities of society—of people. Their self-regulatory, laissez-faire ethos disregulated society. “The origins of the cataclysm [of the 1920s and 1930s] lay in the utopian endeavor of economic liberalism to set up a self-regulating market system,” spawning a vicious circle of financial and economic instability and social and political tensions.¹⁰⁶

Echoing Smith, Mill and Marshall, Polanyi argued that markets needed to be re-embedded in society through “human institution”, e.g., labour, social protection, competition, financial and other regulation. He observed that these institutional innovations began to emerge organically in the nineteenth century in an effort to re-embed markets in social values:

Human society would have been annihilated but for protective counter-moves which blunted the action of this self-destructive mechanism. Social history in the nineteenth century was thus the result of a double movement … While on the one hand markets spread all over the face of the globe … on the other hand a network of measures and policies [arose] to check the action of the market relative to labor, land, and money … Society protected itself against the perils inherent in a self-regulating market system.¹⁰⁷

He diagnosed the underlying problem of liberal economics as a

distorted and obsolete conception of freedom. The liberal conception has yet to transcend its origins. Born into a cultural milieu in which the state represented the most serious obstacle to liberty, the liberal view of freedom has always been freedom from government. Liberal economic theory has been preoccupied with free (from government) enterprise and private property and neglectful of the vital changes in the social situation.¹⁰⁸

With the liberal, the idea of freedom thus degenerates into a mere advocacy of free enterprise—which is today reduced to a fiction by the hard reality of giant trusts and princely monopolies. This means the fullness of freedom for those whose income, leisure and security need no enhancing.¹⁰⁹

Looking ahead, Polanyi envisioned the possibility of realizing a set of positive rights and freedoms

made possible by the wealth created by industrialism as a way of life … Freedom can be made wider and more general than ever before; regulation and control can achieve freedom not only for the few, but for all. Freedom not as an appurtenance of privilege … but as a prescriptive right extending far beyond the narrow confines of the political sphere into the intimate organization of society itself.¹¹⁰

In this way, he anticipated the global social contract of economic and social rights established by multilateral agreement following the Second World War. However, if he were alive today, he no doubt would be disappointed with the continuing lack of traction of this agenda in economic theory and practice. Indeed, he might well view the persistence of this disconnect between society and economics, particularly in the context of our concurrent economic, environmental and geopolitical crises, as evidence of a new and equally disorderly Great Transformation in the making.

Simon Kuznets, the father of national income accounting and GDP, extended Polanyi’s basic point and applied it to the burgeoning field of development economics in the 1950s and 1960s. He is best known in this respect for his postulation of an inverted U-shaped relationship between growth and development, on the one hand, and inequality, on the other.¹¹¹ Many observers interpreted this “Kuznets curve” as suggesting the existence of a quasi-natural law of economic development in which inequality rises as a country begins to industrialize and then subsides upon reaching an advanced, or high-income, stage of development. However, neither the subsequent empirical evidence¹¹² nor Kuznet’s original writing on the subject¹¹³ supports this notion. Instead, both suggest that sociopolitical factors are the more decisive factor in changing the direction of the curve; at some point, a political backlash to rising inequality occurs that results in countervailing institutional reforms. My ILO colleague Sangheon Lee has referred to this as a “Kuznets moment”¹¹⁴—in effect a catch-up step change in the development of a country’s social contract.

The essential question raised by Polanyi’s and Kuznets’s analyses (and those of Smith, Mill and Marshall) still hangs over modern economics: how can the prevailing growth and development model be reformulated so that it is proactive rather than reactive when it comes to diffusing gains in living standards from growth and industrialization? How can it break the cycle of relying on “Kuznets moments” of disruptive political backlash by becoming more human and institutionally centred and less capital and market centred—that is, more bottom-up and less trickle-down? In other words, how can the social contract be more fully internalized in economic theory and instrumentalized in policy practice?

Keynes vigorously engaged with this question in his General Theory but primarily through the prism of macroeconomic policy rather than that of the many structural–institutional dimensions of the social contract emphasized by Smith, Mill and Marshall. He wrote that the social justice deficits or “outstanding faults of the economic society in which we live are its failure to provide for full employment and its arbitrary and inequitable distribution of wealth and incomes”.¹¹⁵ And he argued that this pathology required governments to be prepared to make active use of fiscal policy to countervail deficits in aggregate demand directly through their own spending as well as indirectly through redistribution of income and wealth via the tax code from richer to poorer households, which have a higher propensity to consume and thereby support demand and employment. It also required governments to keep interest rates low in order to encourage investment in productive capacity and discourage financing of rent-seeking activities primarily benefiting owners of existing assets—that is to say, the same wealthier households that have a lower propensity to consume and support aggregate demand than those of more modest means.

Keynes characterized this macroeconomic policy mix as spelling

the euthanasia of the rentier, and, consequently, the euthanasia of the cumulative oppressive power of the capitalist to exploit the scarcity-value of capital. Interest to-day rewards no genuine sacrifice, any more than does the rent of land. The owner of capital can obtain interest because capital is scarce, just as the owner of land can obtain rent because land is scarce. But whilst there may be intrinsic reasons for the scarcity of land, there are no intrinsic reasons for the scarcity of capital.¹¹⁶

For this reason, he argued,

The State will have to exercise a guiding influence on the propensity to consume partly through its scheme of taxation, partly by fixing the rate of interest, and partly, perhaps, in other ways. Furthermore, it seems unlikely that the influence of banking policy on the rate of interest will be sufficient by itself to determine an optimum rate of investment. I conceive, therefore, that a somewhat comprehensive socialisation of investment will prove the only means of securing an approximation to full employment; though this need not exclude all manner of compromises and of devices by which public authority will co-operate with private initiative. But beyond this no obvious case is made out for a system of State Socialism which would embrace most of the economic life of the community. It is not the ownership of the instruments of production which it is important for the State to assume. If the State is able to determine the aggregate amount of resources devoted to augmenting the instruments and the basic rate of reward to those who own them, it will have accomplished all that is necessary.

Thus, Keynes was no “socialist” in the strict sense of the term. Rather, he was grappling with the larger economy-wide or macroeconomic imperfections of the liberal economic model, analogous to the way Smith, Mill and Marshall deconstructed the largely microeconomic market failures and imperfections they witnessed in the “commercial society” of their day. Like them, he framed his critique in both moral and practical terms, in the interest of advancing social justice and economic growth and efficiency simultaneously: “For if effective demand is deficient, not only is the public scandal of wasted resources intolerable, but the individual enterpriser who seeks to bring these resources into action is operating with the odds loaded against him.”¹¹⁷

Indeed, Keynes regarded his theory as revitalizing classical liberal political economy by addressing one of its most fundamental blind spots—its excessive focus on market mechanics and corresponding inability to address the secular uncertainty chilling investment in productive capacity and accompanying underutilization of human resources—that is to say, the severe deficits of inclusion and resilience he witnessed in the macroeconomy around him during the 1920s and 1930s:

Our criticism of the accepted classical theory of economics has consisted not so much in finding logical flaws in its analysis as in pointing out that its tacit assumptions are seldom or never satisfied, with the result that it cannot solve the economic problems of the actual world. But if our central controls succeed in establishing an aggregate volume of output corresponding to full employment as nearly as is practicable, the classical theory comes into its own again from this point onwards. If we suppose the volume of output to be given, i.e. to be determined by forces outside the classical scheme of thought, then there is no objection to be raised against the classical analysis of the manner in which private self-interest will determine what in particular is produced, in what proportions the factors of production will be combined to produce it, and how the value of the final product will be distributed between them. Again, if we have dealt otherwise with the problem of thrift, there is no objection to be raised against the modern classical theory as to the degree of consilience between private and public advantage in conditions of perfect and imperfect competition respectively. Thus, apart from the necessity of central controls to bring about an adjustment between the propensity to consume and the inducement to invest, there is no more reason to socialise economic life than there was before.¹¹⁸

A more contemporary and arguably still the most direct and influential attempt to reconcile the liberal growth and development model with a human-centred perspective on social welfare is Amartya Sen’s work in the 1980s and 1990s on human capability and agency. Sen challenged the utility basis of welfare economics frontally:

What is missing from these traditional models, Sen argues, is a notion of what activities we are able to undertake (“doings”) and the kinds of persons we are able to be (“beings”). Sen calls this notion capabilities. Capabilities are the real freedoms that people have to achieve their potential doings and beings. Real freedom in this sense means that one has all the required means necessary to achieve that doing or being if one wishes to. That is, it is not merely the formal freedom to do or be something, but the substantial opportunity to achieve it.

In this way, the capability approach changes the focus from means (the resources people have and the public goods they can access) to ends (what they are able to do and be with those resources and goods). This shift in focus is justified because resources and goods alone do not ensure that people are able to convert them into actual doings and beings. Two persons with similar sets of goods and resources may nevertheless be able to achieve very different ends depending on their circumstances.¹¹⁹

Sen’s capabilities approach encompasses non-monetary (capabilities, functioning and agency) as well as monetary aspects of well-being. It considers the overriding objective of development to be the expansion of human capabilities rather than economic growth. In this way, he addressed an important blind spot in income- and GDP-based metrics of poverty and economic development: the lived experience of people. While growth may be necessary for development, it is not always sufficient.¹²⁰ Policy should therefore distinguish between growth-mediated (top- or trickle-down) and support-led (bottom- or level-up) development.¹²¹

Sen was not doctrinaire; he did not insist on only one defined set of important capabilities and did not exclude or minimize the importance of economic growth and the provision of basic needs and commodities. However, his critique of welfare economics and development strategy struck a lasting chord among economists and philosophers and has been translated into practical tools, most notably the UN Human Development Report (HDR). The HDR’s Human Development Index (HDI) measures life expectancy, mean and expected years of school, and per capita gross national income across 191 countries.¹²² It defines human development as being about “expanding the richness of human life rather than simply the richness of the economy in which human beings live. It is an approach that is focused on people and their opportunities and choices.”¹²³

Before he introduced his capabilities approach, Sen published extensively on related aspects of welfare economics, social choice theory and development economics. He participated in the ILO’s World Employment Programme (WEP), for which he conducted a landmark study on famines.¹²⁴ In it, he found that a drop in food production was often not the proximate cause of catastrophe; rather, it was inequality and vulnerability in other aspects of the economy which prevented equitable access to food supplies. In the 1970s, the WEP advanced the view that

the central objective of development is improvement in the well-being of the people. Thus development policies should focus on poverty eradication, meeting of the basic needs of the people and creation of remunerative employment and work opportunities … Perhaps the high point of the WEP was the World Employment Conference of 1976, which proposed the satisfaction of basic human needs as the overriding objective of national and international development policy. The basic needs approach to development was endorsed by governments and workers’ and employers’ organizations from all over the world. It influenced the programmes and policies of major multilateral and bilateral development agencies, and was the precursor to the human development approach.¹²⁵

The United Nations Development Programme’s (UNDP’s) original director of the HDR, Mahbub ul Haq, would later remark,

It is fair to say that the human development paradigm is the most holistic development model that exists today. It embraces every development issue, including economic growth, social investment, people’s empowerment, provision of basic needs and social safety nets, political and cultural freedoms and all other aspects of people’s lives. It is neither narrowly technocratic nor overly philosophical. It is a practical reflection of life itself.¹²⁶

Sen’s influence can be seen to this day in the growing interest in multidimensional poverty and “beyond-GDP” indices. But, as important as these and other more human-centred, lived-experience metrics are, they measure ex post outcomes. They do not define or prioritize the universe of relevant policy inputs that can be deployed to achieve such outcomes. Performance metrics like these can help show the way, but they are not a substitute for the internalization and instrumentalization of these considerations in policy itself.

In addition, Sen’s capabilities approach has been critiqued as being incomplete in the sense of missing or at least underemphasizing the important role of collective (not just individual) capabilities in advancing social welfare.¹²⁷ An economy’s productive transformation depends heavily on institutionally enabled norms, incentives and capacities that influence the organization of knowledge and work and inculcate behaviours and patterns of industrial relations and investment. These collective capabilities of societies can have a profound impact on both the pace and pattern of development, particularly with respect to access and inclusion and the concentration of rents and power. Yet they remain largely outside the focus of policy and practice.¹²⁸

The fact remains that the social contract remains largely disembodied from modern macroeconomics. The Washington Consensus neoliberal model of growth and development is widely criticized, but it remains the de facto frame of reference in government councils and university classrooms. The responsibility for this cannot be placed at the doorstep of the founders of liberal political economy; they clearly advised and expected the field of political economy to develop differently, placing parallel emphasis on markets and economic growth, on the one hand, and institutions that support broad improvement in social welfare, on the other. The abiding tendency of modern economics to assume the latter to be a residual outcome of former is clearly a case of wayward and mistaken practice rather than original sin.

Social concerns about such broader welfare considerations as inclusion, sustainability and resilience arguably loom larger today than ever before in the politics of countries. The world’s economies appear to be entering a period of particularly disruptive transformation driven by the concurrent forces of automation, climate change, population ageing and geopolitical conflict. These structural transformations exacerbate all three of these challenges. The standard policy toolbox of the past two generations, whether the macroeconomic stimulus agenda preferred by the left or the deregulatory cost-of-capital-reduction agenda preferred by the right, are an indirect response to them. Such strategies have been applied on and off for decades and proven to be blunt and largely ineffective instruments in addressing these challenges, even if they have been effective at times in addressing others (e.g., combating recessions and sluggish productivity growth).

The reason is that they operate through only one of the two channels, or tracks, envisioned by Smith, Mill and Marshall (and, in their own ways, Polanyi, Sen and—particularly with respect to financial system regulation, taxation and public investment—Keynes). Despite their important philosophical differences, the centre-left and centre-right traditions come at the problem from the same point of departure. Their remedies respond to concerns about the social quality of economic growth mainly via a strategy to expand its quantity through a strengthening of demand or supply or both, in the belief that the resulting increased output will eventually translate, or trickle down, into commensurate gains in broad living standards.

The complementary systematic institutional strategy advocated by Smith, Mill and Marshall remains the road not taken by modern economics, even if it has been forced on to the political agenda from time to time by restive polities, usually in times of crisis. The social, economic and environmental costs of failing to activate this second channel of liberal political economy more directly and fully are rising. Having established that the field’s original theoretical framing poses no inherent obstacle to doing so, I take up the question in the next chapter of how economic theory and policy practice should be reformulated to achieve such a rebalanced, more human-centred, growth and development model—one that accommodates living standards as an explicit rather than essentially residual feature.

ILO Director-General Edward J. Phelan signing the Declaration of Philadelphia at the White House in the presence of (left to right) President Franklin D. Roosevelt, Cordell Hull (US Secretary of State), Walter Nash (President of the 26th Session of the ILC), Frances Perkins (US Secretary of Labor) and Lindsay Rogers (ILO Assistant Director), Washington DC, May 17, 1944. Photo credit: ILO Archives

Indira Gandhi, Prime Minister of India, addressing the UN Conference on the Human Environment in Stockholm, Sweden, June 14, 1972. Photo credit: United Nations

Sadako Ogata (right), former UN High Commissioner for Refugees, and Professor Amartya Sen (left), economist and Nobel Prize laureate, present the “Report of the Commission on Human Security” to UN Secretary-General Kofi Annan, May 1, 2003. Photo credit: United Nations /Eskinder Debebe