Richard Cantillon (1680-1734), an Irish-French banker/merchant predating Adam Smith, is arguably the founder of modern economics. The book he wrote shortly before his demise, Essay on the Nature of Trade in General, officially published in 1755, was an influential and highly citied document, before it was overshadowed by the retardation of economics that would follow in the form of Adam Smith’s Wealth of Nations (1776).
Cantillon rescued economic analysis from its traditional conflation with politics and ethics. In the words of Friedrich Hayek, “this gifted independent observer, enjoying an unsurpassed vantage point in the midst of the action, coordinated what he saw with the eyes of the born theoretician and was the first person who succeeded in enterating and presenting to us almost the entire field which we now call economics.”
Thought Experiments (The Ceteris Paribus Method)
Unlike natural sciences where one can isolate the effects of a single variable by holding others constant, economics does not lend itself to such experimentation. Cantillon compensated by using Gedanken-experiments: he analyzed the effects of changes to a single variable by assuming other variables to be constant. Thus, through these thought experiments, Cantillon introduced the ceteris paribus method that would become a mainstay in economics.
Value and Price
Cantillon maintained that it was the subjective valuation of the consumers that determined the prices of goods, rather than the intrinsic value of these goods. (Intrinsic value, here, approximately refers to the value of labor and capital that enter into the production.) In a competitive market, laborers and entrepreneurs move in and out of various lines of production, until selling prices match production cost. Thus, in the long term, prices tend towards the intrinsic value.
However, neither is intrinsic value something that spontaneously exists, nor does price automatically approach this intrinsic value. The cost of production does not determine selling price. Rather, it is the price offered by the market that determines the magnitude of the production cost that can be incurred.
Uncertainty and Entrepreneurship
Cantillon emphasizes the role of entrepreneurship. The market is not characterized by stasis or perfrect information; it is filled with uncertainty. The entrepreneur bears this uncertainty by investing his resources and hoping to make a profit. The market is never exactly at equilibrium, but the entrepreneur serves an equilibriating function by forecasting, investing, and helping adjust supply according to the demands of different markets. Profits are a result of successful uncertainty-bearing, accurate forecasting, and effective/efficient production.
Population Dynamics
According to Cantillon, the long-run wage rate depends on population, which depends on the population growth rate. The population growth rate, in turn, depended on factors such as natural resources, cultural preferences, and technological development. Cantillon acknowledged the human tendency to mulitply without limit as well as the ability of culture to alter this tendency. It is not in the purview of economics to determine whether it is better to have a large population of poorer people or a smaller population with a higher standard of living. That is a choice depended on the values of the citizens.
Spatial Economics
Cantillon also founded the field of spatial economics. Spatial economics deals with distances (transportation costs and location of activities) and areas (geographical development and market boundaries). His work integrated location theory into microeconomic analysis. He realized that even when money and monetary prices were at equilibrium, the prices of produce in cities would be higher by the amount of associated transportation costs and risks than they would be near the location of production.
Money and Process Analysis (The Cantillon Effect)
Cantillon noted that inflation (expansion of the supply of money) affected price levels in a non-uniform, heterogeneous manner. Those who gain access to new money early are able to increase their spending according to their preferences at prevailing prices, thus exerting upward pressure on the prices of these items. Those who do not receive the new money at all or receive it after prices have increased suffer a loss in their purchasing power. (See Effects of Inflation: Wealth Redistribution).
Furthermore, because the early recepients do not make purchase decisions in proportion to their previous allocation (that is, they might purchase different goods in different proportions with the new money), all price levels do not rise to the same degree. If the new money is allocated to consumption, prices of different goods will rise according to their new demand. The same is true if the new money is allocated towards investments.
The effect on interest rates also depends on who gets the new money first. If it goes to the lenders, an increase in availability of loanable funds would cause a drop in interest rates. If it goes to the borrowers instead, the interest rates would rise.
International Monetary Relations
Cantillon did not believe in the existence of an equilibrium distribution of money among different countries. He was a semi-equilibrium analyst, believing that the economy went through endless disequilibrium cycles. More export/less import would lead to more inflow of money, which would lead to domestic price increases. This would result in more export/less import and thus, more outflow of money. With less money in circulation, the domestic prices would fall, and thus there would be more export/less import. And so on.
References
- Murray Rothbard, Economic Thought Before Adam Smith (1995), Chapter 12.
- Richard Cantillon, Essay on the Nature of Trade in General (1755).