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The political economy of development
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classical economics

English school of economic thought that originated during the late 18th century with Adam Smith; it reached maturity in the works of David Ricardo and John Stuart Mill. The theories of the classical school, which dominated economic thinking in Great Britain until about 1870, were primarily concerned with the dynamics of economic growth. They emphasized economic freedom, laying stress on such ideas as laissez-faire and free competition.

Many of the fundamental concepts and principles of classical economics were set forth in Smith's An Inquiry into the Nature and Causes of the Wealth of Nations (1776). Strongly opposed to the mercantilist theory and policy that had prevailed in Britain since the 16th century, Smith argued that free competition and free trade, neither hampered nor coddled by government, would best promote the economic growth of a nation. As he saw it, the entire community benefited most when each of its members followed his own self-interest. In a free enterprise system, individuals make a profit by producing goods that other people are willing to buy. By the same token, individuals spend money for goods that they want or need most. Smith demonstrated how the apparent chaos of competition, the welter of buying and selling, is transmuted into an orderly system of economic cooperation by means of which, under individual freedom as opposed to central direction, the nation's needs are supplied and its wealth is increased.

In analyzing the workings of free enterprise, Smith introduced the rudiments of a labour theory of value and a theory of distribution. Both these ideas were taken up by Ricardo to be elaborated and refined in his treatise Principles of Political Economy and Taxation (1817). In his labour theory of value, Ricardo emphasized the tendency of the value (i.e., price) of goods produced and sold under competitive conditions to be proportionate to the labour costs incurred in producing them. He fully recognized, however, that over short periods price depends on supply and demand. This notion became central to classical economics, as did Ricardo's theory of distribution, which divided national product among three social classes: wages for labourers, profits for owners of capital, and rents for landlords. Taking the limited growth potential of any national economy as a given, Ricardo believed that a particular social class could gain a larger share of the total product only at the expense of another. These and other Ricardian theories were restated by Mill in Principles of Political Economy (1848), which marked the culmination of classical economics. In his treatise Mill managed to relate abstract economic principles to social conditions of the real world and thereby gave them a new authority.

The teachings of the classical economists attracted much attention during the mid-19th century. The labour theory of value, for example, was adopted by Karl Marx, who worked out all of its logical implications and combined it with the theory of surplus value founded on the ethical postulate that human labour alone creates all value and thus constitutes the sole source of profits. More significant were the effects of classical economic thought on free-trade doctrine. The most influential was Ricardo's principle of comparative advantage, which states that every nation should specialize in the production of those commodities it can produce most efficiently and should import everything else. This idea implies that if all nations take full advantage of the territorial division of labour, total world output would invariably be larger than it would be if nations tried to be self-sufficient. The comparative-advantage principle became the cornerstone of 19th-century international-trade theory.