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Political Economy

Free Essays of Economics

Economy Exam “Political Economy”

Question: Jean Baptiste Say

Jean Baptiste Say (1767 – 1832) was a famous French scientist and economist, a representative of classical political economy. He was born in a family of Lyon merchant and educated in England. He was an employee of an insurance companys office in Paris. He participated in the bourgeois revolution in France. In 1794 1799, Say worked as a chief editor of the Paris Journal. In 1799, he was an official of the Finance Department of France. In 1818, Say founded the Department of Industrial Economics at the French Conservatory of Arts and Crafts, where he taught the course on the industrial economy. From 1830 until the last years of his life, he headed the Department of Political Economy at the University College de France (Paris).

Economic views of Jean Baptist Say were formed under the influence of the works of Adam Smith, whose ideas he had creatively enriched and deepened. Say led discussions with T. Malthus, D. Ricardo, and S. Sismondi. Analyzing and commenting on the teachings of his English teacher, he was the founder of his own school of economic thought in a classical political economy in France. Say was the supporter of the ideas of economic liberalism and the harmony of economic interests of market economy subjects. Say outlined his economic ideas in the following works: A Treatise on Political Economy (1803), England and the English (1814), The Catechism of Political Economy (1817), and The Full Course of Political Economy (1828 – 1829). Being most famous for the Say’s Law, the economist has become a symbol of the self-regulating market economy. Moreover, the attitude toward the law has become an indicator of differentiation of the supporters and opponents of active state intervention in economic life.

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Jean Baptist Says Importance in IPE

The importance of the economist in IPE could be best seen through the main concepts and ideas outlined in his writings.

He restricted the subject of political economy with benefits. The economist criticized Adam Smith for the fact that he made a substantial concession to a normative political economy side and was trying to tie abstract theory to practical recommendations for government officials. Say considered that the role of the scientist-economist was to describe and analyze economic processes and phenomena (how and why such a fact is a consequence of another) but not to teach and provide some advice on the methods and forms of management. The society also has to define these findings, agree with them, or reject them.

Say outlined his vision of the subject of political economy. He defined political economy as the science of the laws that govern production, distribution, and consumption of wealth. Economic laws are considered as well as the laws of nature. They are objective, neither established nor created by people, and arise from the nature of things. With its universal character, they know no borders, govern society, and severely punish those who act contrary to them.

Say expressed his opinion about the method of political economy. He considered that it is necessary to combine two scientific methods: inductive (logical conclusions from individual to general cases, from particular facts to generalized) and deductive (logical conclusions from general to individual facts).

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He completed the criticism of the physiocrats views on productive and unproductive labor. He considered that any work is productive if it is performed by forces of nature, capital, peoples labor, and people and thus has useful results. The work in the service sector (e.g. profession of teacher, doctor, etc.) does not create wealth but is productive because it promotes production. Intangible products are useful for people, have the same value and exchange, and can change in the corresponding proportions for material products.

Say did not admit work to be a cost basis of products. Moreover, the economist criticized Adam Smith for his wrong conclusion as to what the value of all materialized human labor is. Say said that the utility was the primordial value. Developing the utility theory, Say argued that production created utility which in turn enriched the products with value, which was seen as a measure of utility. The scientist defended the idea that the price of the object served as a correct indication of impairment, which people would recognize in the object if there was no influence on behalf of other circumstances.

The economist substantiated the theory of three factors of production, which was the most versatile variation of the classical theory of value, in which Say emphasized the decisive role of utility in shaping the value. According to this theory, the three main factors of production, i.e., labor, capital and land, form the value of goods and indicate the profits of the owners of these factors: laborers wage (the carriers of the work), entrepreneurs income (the owners of the capital), landlords rents. Based on this theory, there exists a harmony of economic interests between the owners of these factors, while they interact and complement each other in the production process.

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He identified the key role of machinery and technical progress in the creation of national wealth. Say said that with the help of machines there was a reduction of labor costs and the enhancement in the production of useful things. In his opinion, the machine in the beginning displaces workers, causes an increase in employment, and brings them the greatest benefit, lowering the value of production. Therefore, it is concluded that the working class is interested more than others in the technical improvement of production.

Say separated owners of capital from entrepreneurs, noting that the profit of the entrepreneur consists usually of two parts. The first part is the intended industrial profit or the interest on capital accumulated by means of time, production, and thrift. The second part presupposes the entrepreneurial income or profit from the use of capital as a reward for industrial skills, talent, spirit of order, and control.

The scholar developed the theory of markets, which he later called law of markets or Say’s Law. . The essence of this law is that the production not only increases the supply of goods but also gives rise to the adequate need for their consumption (demand) due to the need to cover production costs. In short, the offer creates a corresponding demand. In his discussion, Say relied on the fact that in the market economy, there happened the exchange of products for products and each seller acted at the same time as a buyer, thus making aggregate demand and aggregate supply interconnected.

He justified the possibility of the crisis-free market economy on the grounds of law of markets. According to Say, overproduction is impossible because the scale of public supply and demand always remains in balance. The production forwards the sales of products. Every product since its production creates sales of other products for the full amount of its value. However, the scientist admitted the possibility of proportions abuse between supply and demand in some markets. Moreover, he considered the acquired equilibrium between them only as a trend. According to Says suggestions, if some goods are not sold, it means that there are too many of them or there is a lack of other products. In order to sell products that are produced in abundance, it is necessary to increase the production of scarce goods. Accordingly, their additional offer will increase demand for other goods.

From the beginning, there appeared an argument around the law of markets, which did not reach a reasonable conclusion until today. Critics of the law believe that it is completely true only in a barter economy or the economy in which money does not play any independent role and serve only for the purpose of measuring value and exchange of goods and services. Indeed, if the products are purchased by products, the total overproduction of goods is impossible. However, as soon as the undeniable fact that money serves as a means of preserving value (which means that there are a money market and interest, the changes of which gradually balance the demand for money and money supply) is taken into account, the economic situation becomes more complicated. In terms of the existence of excess demand for money, there appears the possibility of general overproduction (excess supply) of all non-monetary items. With the flow of time, the excess demand for money will be eliminated with the enhancement of the interest rates, decrease in aggregate supply, or decrease of prices. However, before this happens, the overproduction of goods can be stored.

Conclusion

In the creation of the product, there are three main factors involved, labor, capital, and land, whose role is qualitatively clear, although numerically, their share of manufactured goods is not identical. After the implementation, the cost is divided into income, each of which is a reward for the work of a particular factor: wage for labor, income for capital, rent for land.

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In order to conclude, Say’s Law has become a kind of symbol of the self-regulating market economy, and the attitude toward it has become an indicator of differentiation of the supporters and opponents of active state intervention in economic life. During Says life, it already became the subject of heated debate with the participation of the most prominent economists of the time: Ricardo, Malthus, and Sismondi. Affecting the most fundamental processes of economic development, the questions raised by Jean Batiste Say in his works still have not found a clear solution. The complexity of the issues makes the scientists restore the scientific research .

Question: Bretton Woods System

The Second World War virtually destroyed the gold exchange standard system that led to the development of financial system adequate to the new conditions of functioning of the world economy and international economic relations. Such a system after a lengthy preparatory work was established and institutionally framed in 1944 in the city of Bretton Woods, USA, by the decision of the International Monetary and Financial Conference. The statutes of the International Monetary Fund (IMF) and the International Bank for Reconstruction and Development (IBRD) became the components of the Final Act signed at the conference .

IMF Statute defined the basic principles of the new monetary system that was called Bretton Woods. Unlike gold standard system, it was founded on the gold standard system, which later transformed into a gold-dollar standard system. Bretton Woods monetary system functioned until the mid-70s of the 20th century and played a significant role in deepening of the international division of labor, the internationalization of production, and intensive development of foreign economic relations.

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The basic principles of Bretton Woods monetary system were as follows:

  1. The role of gold as the universal equivalent, means of payment, and unit of account in international traffic remained in the new system. Bretton Woods Agreement (Article IV, Section I) declared: Parity exchange of all States Parties have to be expressed in gold, which is the general equivalent, and in U.S. dollars for their gold content at the time of 1 July 1944. However, this principle of the exchange agreement was not effectively fulfilled. In practice, the connection of all currencies to gold was indirect. Among the currencies of the countries that were part of the IMF, the U.S. dollar preserved only external convertibility to gold for the central banks of other countries. Since almost all the parities of currencies were fixed by the IMF in U.S. dollars, the relationship of the currencies with the monetary goods was performed according to the gold-dollar-national currency system. In this chain, dollar acted as a gold sign and a certain type of world money.
  2. Bretton Woods monetary system as the gold standard system was based on the principle of fixed exchange rates that was essential to the development of foreign trade. The official exchange rates were fixed by determination of their gold content (price scale), and according to this, they were firmly fixed to the dollar. They could not deviate by more than 1% in both directions without proper consent.
  3. Dollar, functioning in the mode of the gold standard, was equivalent to gold under a certain parity based on fixing the market price of gold: the gold content of the dollar was equal to 0.888 g; the price of 1 ounce (31.1 grams) of gold was equal to $35.
  4. An important rule of the Bretton Woods system was the prohibition of the free (private) sale of gold. Commercial operations with gold could be performed at the level of central banks based on the fixed prices. The control over the observance of the rules aimed at ensuring the stability of the monetary system was entrusted to the IMF. In case a country lost its ability to hold its currency to the dollar fluctuations within the specified limits ( 1%), it might resort to the following measures. First, it could use part of its reserves for stabilizing the foreign exchange market operations. Second, it could refer to the IMF asking for a target loan. Finally, the country could devalue its own currency. The change of the currencys value (price scale) by more than 10% could be fulfilled only with proper authorization from the IMF.

For a long time, the efficiency of the Bretton Woods gold-dollar-the currency system ensured the high level of confidence in the dollar as an international means of payment and reserve currency. Unlike all other currencies, the dollar retained anti-inflationary immunity on the Forex (foreign exchange) market, which was guaranteed by its convertibility to gold in central banks. This convertibility ensured the U.S. accumulation of a significant share (over 70% in the early post-war years) of centralized gold reserves. In 1949, the U.S. central gold reserves contained 24.6 billion dollars, that was 3.15 times higher than the total dollar amount placed in foreign banks. The extremely high share of the U.S. in world trade and export capital and deficit-free long-term balance of payments of the country should also be taken into account. It was believed that the dollar was the same as gold, but the dollar appeared to be even better than gold.

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In the late 60s and early 70s, the situation dramatically changed. The U.S. lost its competitive advantages on the world market: there arouse the account deficit, and the inflation began to develop. Moreover, national gold reserves drastically reduced: in 1971, they comprised 11.1 billion dollars, which was 6 times less than the mass of a dollar that was in interstate trafficking. There began a mass rush for gold as a more stable monetary asset. As a result, there formed a market price on the gold which exceeded in several times the official one.

In this situation, the USA completely lost their ability to ensure the exchange of dollars for gold at a fixed price; therefore, dollar failed to maintain its function of international reserve currency. Admitting the problem, on August 15, 1971, President Nixon decided to terminate the convertibility of the dollar into gold. This meant the actual collapse of the Bretton Woods system.

The fall of the Bretton Woods system was not caused only by the worsening of the Americas domestic economic situation, the currency of which belonged to the central system, but also by the change of the forces alignment in the global economy. The U.S. lost their monopoly position, which they held in the early post-war decades: in the late 60s and early 70s, there were three centers of world economic competition, the USA, Western Europe, and Japan. Polycentrism in the world economy came into conflict with the monocentrism based on the monopoly of the dollar in the sphere of international monetary relations. This conflict significantly undermined the foundations of the Bretton Woods system and gave rise to the need to create new, more effective world monetary system. The first step in this direction was the creation of the international payment instruments, Special Drawing Rights (SDR or SDRs), in the early 70s and therefore the transition to floating exchange rates and the replacement of the currency parity with the SDR currency basket. In accordance with the IMF decision, SDRs were released into circulation on January 1, 1970. Their value was determined by the average quantity of the market rate of the currency basket (initially of 16 and later of five leading currencies of the world).

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Bretton Woods regime has been in force for nearly thirty years. These were years of economic recovery in Western Europe and Japan, of the economic miracle, and the relatively moderate inflation in industrialized countries. However, with the growth of global economy, increased competition and inflation, a sharp upsurge in the volume of financial transactions not related to specific trade deals, and the crisis in key currency system, the U.S. dollar Bretton Woods monetary system was becoming less able to meet the needs of international trade and capital movements.

Conclusion

It became evident that under the Bretton Woods exchange system, there prevailed the currency inequality. The U.S. dollar took a privileged position. This enabled the USA to cover the balance of payments deficit largely due to short-term obligations of the U.S. banks to foreign government agencies and individuals. All in all, the United States became bankrupt. The investment balance (balance of capital flows) also developed not in favor of the United States. There took place a capital flow and thus a negative balance of payments. The chronic deficit of the payments balance led to the fact that the amount of dollars abroad exceeded greatly the U.S. gold reserve. There arouse a lack of confidence in the dollar and the desire to exchange dollars for gold. The USA began to lose their dominant position in the global production and international trade. As a result, the EEC, Japan, and other countries, payments balances of which resulted in a surplus, gained more power and influence. In this situation, overcoming the U.S. deficits would mean reduction of international liquidity that would interfere with international payments. The USA faced a choice: to incur large costs or change all currency rules. The USA have opted for a change in the rules, breaking 1968 dollar connection with gold and entering a floating exchange rate in 1971. Moreover, the principles of the Bretton Woods system undermined the development of the European and the euro-dollar market, where a huge amount of freely circulating dollars almost fell off the restrictions set by national agencies and the IMF currency. All this created a favorable environment for foreign exchange speculations. Under these conditions, the system of fixed exchange rates could not function effectively. As a result, the world started the transition to a new monetary system called Jamaican since it was the country where the basic principles of the system were produced.

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