A closer look at the Physiocrats, the founders of political economy
Branko Milanović is an economist specialised in development and inequality. His newest book is “Capitalism, Alone: The Future of the System That Rules the World”
This article is cross-posted from Branko’s Substack blog
Physiocrats. It is well-known in history of economic thought that the founders of political economy, the Physiocrats and Quesnay in particular, thought that only agriculture is productive and manufacturing is “sterile”. Their use of the word “sterile”, and insistence on it, is unfortunate because the reality of what they argued is more sensible and sophisticated.
What they meant by “sterility” of manufacturing is that the price of manufactured goods decomposes into depreciation of capital, subsistence wage, “normal” return to the capitalist (which they, rather generously, assumed to be 10% per year) and even “recompense” for entrepreneurship. So why is it different from what economists believe today? In effect we use exactly the same components. But for the Physiocrats there was no surplus (on top of these four components which they saw as simple inputs) which could be taxed to provide income for the elite: the people who do not directly participate in the process of production, namely landlords, clergy and government officials.
In a certain way, it was quite sensible: one cannot tax subsistence wages, nor can he tax profit that is at a “normal” rate if he believes that driving it below that rate will result in no production being undertaken at all. However, absence of surplus in manufacturing was at odds with what was observed in France at the time. As Georges Weulersse, the author of the most detailed analysis of physiocracy (see below), explains, large fortunes—by definition made of accumulated surpluses—existed in manufacturing. Yet Physiocrats stubbornly refused to admit that, and argued that these fortunes existed only because of special protection given to individual industrialists. Manufacturing, they held, could not produce surplus on its own without state protection.
It was only in agriculture that existed a surplus that could be taxed: ground rent. For in agriculture, price decomposes into depreciation, return to capital advanced by the tenant-farmer, subsistence wages paid to the hired labor and…the rent. Rent is not an income necessary to bring forth output. It is (as the nice formula has it) price-determined, not price-determining. It is the only net income which can be taxed and used to maintain a civilized society that needs government for the protection of property and administration of justice, and clergy for the provision of spiritual sustenance.
Physiocrats, quite consistently with this view, argued in favor of policies that would raise agricultural production through longer land-leases (so that tenant farmers have incentive to invest in land improvement), freedom of movement of grain (laissez-passer) and freedom of exports. Such measures would increase both the quantity of agricultural output and the relative price of food, and therefore doubly yield a greater net product, the goal of economic activity as defined by the
This is, in essence, the logic behind the view that only agriculture is productive, which, without looking at it more closely, seems strange to the modern ear. But thinking of it, poses the all-important question: what is net income? There is no general answer to that question. It depends on what the social structure is, and what is the goal of economic activity. Incomes that Physiocrats disregarded, i.e., wages, depreciation, interest, and entrepreneurial profit, are all parts of the gross value added as presently defined. Their and our components were not different. It is just that they were not interested in the components, like wages, that appear to us to be a valuable goal of economic activity.
SNA and online work. And indeed the same questions regarding the definition of gross value added are discussed today: how should GDP account for the use of exhaustible resources, or should it include net income from financial services and insurance. (For a nice book on GDP measurement, see Diane Coyle’s GDP: A Brief, but Affectionate History; for a tough review of the book, see Moshe Syrquin’s long essay here.) When the System of National accounts (SNA) and GDP in its more or less current version were defined, Simon Kuznets thought that transportation services should be considered an intermediate good and not included in value added. This was not accepted even if Kuznets’ logic was impeccable: if you use bus, metro, or your own car to go to work, depreciation of the car and the expense of gas etc. have to be deducted from your wage. Travelling to work is a means, not a goal. Kuznets’ argument reappears rather unexpectedly today with the “explosion” of online work during and after the pandemic. Online work reduces the travel cost but since we have decided that transportation to and from workplace should be counted as value added, less of commuting traffic lowers GDP. We thus have a paradoxical situation that what is clearly an improvement in the welfare of workers is counted as a reduction of GDP.
Output of goods only. There was a very important difference between the System of National Accounts and the System of Material Balances used in centrally-planned economies. The difference was due to what was considered to be the goal of economic activity. SMB excludes all activities that result in non-material output: government administration, education and health services. Gross output in centrally-planned economies was thus systematically lower than when expressed in the SNA. The difference was estimated at between 10 and 15 percent, and in some cases even 20 percent.
On the other hand, given that productivity growth is slower in education and health than in the production of material goods, underestimation of gross output in socialist countries was combined with an overestimation of the rate of growth. We thus had, judged from the standpoint of SNA, two opposite biases in centrally-planned economies: lower level of output, but its higher rate of growth.
Surplus value. The SMB claimed to have been based on Marx’s view of productive labor, but this is not obvious because we do not know what exactly was seen by Marx to be the goal of economic activity in socialism. Marx believed that “productivity” (and thus the goal) is a historic concept, defined from a systemic point of view. In a capitalist system, productive is the worker who produces surplus value for the capitalist. This is the origin of Marx’s famous example of an opera singer who is a productive worker if he is hired by a capitalist, but not when he works for himself. Productivity of labor is not, according to Marx, deducted from labor being embodied in goods as opposed to services but from labor’s contribution to what is the goal of economic activity in a given system. Under capitalism, it is profit. So if the opera singer generates profit for the impresario who employed him, he is a productive worker. Similarly, if the goal was to provide net income for the elite as Physiocrats thought, and if the only source from which this can be extracted is agriculture, the correctly defined net product is indeed as they defined it.
What we call value added or useful output in one system is not necessary the same as what we call useful output in the other. It depends on what the ruling ideology tells us is the reason why we engage in economic activity at all.
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