A brief history of economic theory
Economic theory has its roots in antiquity. As early as the 18th century BC, the Babylonian King Hammurabi’s Code includes references to property rights, contracts, credit and economic justice.
In subsequent centuries, various cultures in the Middle East, Greece, China and elsewhere developed financial concepts, which laid the basic foundation for the development of scientific economic thought.
In the 14th century, the Tunisian philosopher Ibn Khaldun examined important topics, such as the division of labour, the profit motive and international trade.
During the 18th century, the Scottish philosopher Adam Smith established the fundamental principles of capitalism, which is based on free trade and limited government intervention in markets, and postulates, as a basic axiom, the pursuit of individual interest as the driving force of economic development.
During the 19th century, Karl Marx and Thomas Malthus expanded on various aspects of Smith’s work, while economists Leon Walras and Alfred Marshall used mathematics and statistics to express concepts such as economies of scale.
In the 20th century, two economists, the British John Maynard Keynes and the American Milton Friedman, laid the foundations for modern mainstream economic theories.
The former challenged the then prevailing neoclassical thinking, arguing that governments should actively intervene in the economy, especially during times of recession, even if this involves running state budget deficits.
The latter was a supporter of free market capitalism and an advocate of minimal government intervention.
Friedman opposed the Keynesian school of thought, especially its focus on fiscal policy to stabilise the economy, arguing that monetary policy was more effective.
He emphasised, however, the importance of a stable framework and was critical of active monetary policy interventions.
More recent theories, such as that of the Indian economist Amartya Sen, concentrate on incorporating morality into calculations of social welfare and economic efficiency.
Modern governments use economic theories to guide their decisions on monetary and fiscal policy, market regulation, social welfare and other matters. Keynesian ideas significantly influenced economic policies, especially after the end of the second world war, when the role of governments in the recovery of economies was catalytic.
To this day, the theories of Keynes, Friedman, and more recent economists, such as Sen, influence the policies of governments. Friedman’s ideas, for example, regarding the role of the free market and the limitation of government intervention have led many governments to pursue policies of deregulation and privatisation, with mixed results.
At the same time, Sen’s ideas have influenced governments to pay more attention to issues of equality and sustainability.
In summary, the evolution of economic thought has constantly contributed to the formulation of economic policies. Although the results have not always been the desired ones, contemporary governments continue to rely on economic theories, and new ideas will not stop to influence and guide the development of economic policies.
Andreas Charalambous and Omiros Pissarides are economists