Volume 8, Number 1, 2003
Federal Reserve Bank of Dallas
David Hume—Foundations of the Classical School of Economics
David Hume is primarily known as a
philosopher and chronicler of English history. Less well
known is his work on economic theory and several political
economy issues, some of which remain salient today. Studying
his economic work enables us to see how he reshaped John
Locke’s quantity theory of money and how he influenced
the great Adam Smith, Hume’s close friend and fellow
Scottish Enlightenment philosopher. Hume is one of the pillars
of the classical school of economics, primarily founded by
Smith. This issue of Economic Insights offers some of Hume’s
economic theorizing for those who want to pursue the intellectual
history of modern economic theory.
| — |
Bob McTeer
President and Chief Executive Officer
Federal Reserve Bank of Dallas |
David Hume – Foundations of the Classical School of Economics
Adam Smith is the founder of the classical school of economics,
but economic theorizing predates Smith. The philosophic foundations
of classical economics are found in the work of the Scottish
Enlightenment thinkers of the early to mid-18th century,
centered around the University of Edinburgh. Notable among
these great thinkers and writers is David Hume.
Hume was born in Edinburgh, Scotland, on May 7, 1711. The
extent to which Hume influenced Smith, his close friend,
has to be inferred from their respective writings, but the
warmth and depth of their relationship is incontestable.
Smith said of Hume:
Upon the whole, I have always considered
him, both in his lifetime and since his death, as approaching
as nearly to the idea of a perfectly wise and virtuous
man as perhaps the nature of human frailty will admit.
(Goldberg 1961)
Like Smith, Hume tried to use
Isaac Newton’s method
of analysis in his inquiries. Hume also borrowed from philosopher
John Locke’s epistemology as he related mostly moral
concerns. Hume saw such moral concerns as the thread that
connected his various writings, which included political
economy.
While we shouldn’t overemphasize Hume’s economic
influence on Smith, their relationship—especially in
light of the similarities of some of their analyses—is
intriguing. As Roll (1953, 117–18) writes:
In recent years the tendency has
even arisen to regard him [Hume] as the most important
of the pre-Smithian economists….[T]hey [Hume’s
economic essays] are all clearly written and often contain
an excellent summary and synthesis of the ideas of his
predecessors. In that respect, however, Cantillon’s Essai
sur la nature du commerce en général,
published in 1755, but written over twenty years previously,
is superior.
It is impossible to know whether
Smith was more influenced by Cantillon’s book or by personal discussions with
Hume. Schumpeter (1954, 124) argues that Hume did influence
Smith, and Rothbard (1995, 430) suggests that Hume was one
of Smith’s mentors. O’Brien (1975) gives Hume
a large role in the development of classical economic thought
because of his participation in spreading natural law philosophy.
On the question of self-interest’s role in human affairs,
Hume seems to have influenced Smith greatly. For Hume, and
for much of the Western world after him, self-interest became
the primary motivating force that explained most of social
reality (Herman 2001, 170). Hume’s early book expounding
his idea of self-interest, A Treatise of Human Nature (1734),
may have cost him a university teaching position. The work
so horrified other philosophers that some—notably Francis
Hutcheson— actively sought to deny him such a position.
He later repudiated this first book. However, this was not
the last time Hume offended prevailing sensibilities and
challenged majority opinion on an issue.
Hume’s view that self-interest could be channeled
profitably only through economic cooperation and competition —making
civil society a possibility so long as the rule of law prevailed— was
a pillar of Smith’s thinking as well.
In this regard, Hume’s
influence on Smith is both clear and profound. Government
is required, they argued,
because instinct may cause people to act against their interests,
even though they are driven primarily by those self-interests
(Rotwein 1987, 693).
Philosophers see Hume as a direct
link between the empiricist political philosophy of Locke,
the French laissez- faire
Physiocratic movement led by Francois Quesnay and early British
political economy. Hume’s economic views overlapped
both the mercantilist and classical traditions, depending
on the topic he addressed, but were generally pro-free trade
and antimercantilist. Because of his extreme skepticism and
presumed atheism, as well as his view of human nature, academe
was closed to him. He pursued instead a career in public
life, traveling for tutoring positions, becoming British
chargé d’affaires in Paris and eventually becoming
undersecretary of state. He retired from public life in 1769
and returned to Edinburgh.
Hume’s most important foray into economic theory was
his discussion of the price-specie-flow mechanism. The movement
of specie (gold and silver) between countries balances trade
and automatically adjusts international trading partners’ domestic
price levels. As such, its intellectual lineage comes directly
from the quantity theory of money—traceable back to
Locke—as it was applied to international trade balances.
Hume’s economic writings were usually concerned with
the idea of economic growth and its causes, perhaps another
example of an intellectual focus that he bequeathed to Smith.
Hume was sometimes inconsistent in his economic theorizing.
In one place he might praise the growth of the money supply,
while in another he would correctly show that larger supplies
of money lead to rising prices. Smith might also have taken
from Hume the deeply flawed labor theory of value, as Hume
routinely argued that only labor conveyed value. On balance,
Hume favored “hard money”— that is, money
made of precious metals that had “intrinsic value.” He
also seemed to support ultrasound banking, as when he praised
the Bank of Amsterdam for its policy of 100 percent specie-backed
deposit reserves (Rothbard 1995, 428).
While arguing that an increase in the money supply is neutral
regarding the rate of interest, he also concluded that, in
the long run, such a continuing increase might actually lower the
interest rate. Although Hume had insights into many important
economic issues, his analysis was primarily one of comparative
statics, or examinations of equilibrium positions. He seldom
discussed in detail the microeconomic adjustment processes
that occur between these equilibria, with the exception of
his essay Of Money.
Smith’s analysis of economic growth and society owes
a great deal to his having read Hume’s massive The
History of England. Hume wrote the four-volume work
between 1754 and 1762 while librarian at the Advocates’ Library
in Edinburgh after failing for the second time to secure
a university appointment at Glasgow. Hume contended that
commercial society’s birth and growth generated more
benefits than costs, a stance he developed while writing
his history of Britain. He was not a typical advocate of
laissez-faire capitalism, though, even supporting some mild
protectionist policies, as did Smith in his Wealth of
Nations.
For Hume, and then Smith, commercial
society was a form of social contract, a method of controlling
human passions
in a way that increased output that all might share, regardless
of the effect on individuals. Smith based his own “system
of natural liberty” on this idea, which Hume so skillfully
demonstrated in his writings. Unsurprisingly, both men were
opposed to gross restrictions on international trade, and
Hume in particular worked out his specie-flow mechanism in
part to discredit protectionist, mercantile doctrine. After
he and Smith had finished with it, mercantile theory was
intellectually dead, although its protectionist tendencies
have always been a part of international trade policy and
remain so for many nations even today. It is perhaps fitting
that Hume died in 1776, the year Smith published his famous
work of political economy, Wealth of Nations, most
of which Hume told Smith he agreed with. Coming at the beginning
of the classical period, Hume’s own economic writings —as
well as his impact on Smith— make him still worthy
of careful study by anyone interested in the history of ideas
generally and in the evolution of economic theory specifically.
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Robert L. Formaini
Senior Economist |
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| Sources and Suggested
Reading
Goldberg, Bruce (1961), “Ayn Rand’s ‘For
the New Intellectual’,” New Individualist
Review 1 (3): 21.
Herman, Arthur (2001), How
the Scots Invented the Modern World: The
True Story of How Western
Europe’s Poorest Nation Created Our World
and Everything in It (New York: Crown
Publishing Group).
Hume, David (1987), Essays, Moral, Political,
and Literary, ed. Eugene F. Miller (Indianapolis,
Ind.: Liberty Fund), www.econlib.org/library/lfbooks/hume/
hmmpl26.html.
——— (1993), Selected Essays,
ed. Stephen Copley and Andrew Edgar (New York:
Oxford University Press).
O’Brien, D.
P. (1975), The Classical
Economists (Oxford: Clarendon Press).
Roll, Eric (1953), A History of Economic
Thought (Englewood Cliffs, N.J.: Prentice-
Hall).
Rothbard, Murray (1995), Economic Thought
Before Adam Smith: An Austrian Perspective
on the History of Economic Thought, vol.
1 (Hants, UK: Edward Elgar).
Rotwein, Eugene (1987), “David Hume,” in The
New Palgrave: A Dictionary of Economics,
vol. 2, ed. John Eatwell, Murray Milgate and
Peter Newman (New York: Stockton Press), 692–95.
Schumpeter, Joseph (1954), The History of
Economic Analysis (New York: Oxford University
Press). |
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Public Debt: Does Anything Ever Really Change?
But though the injury that arises to commerce
and industry from our public funds will appear,
upon balancing the whole, not inconsiderable,
it is trivial in comparison of the prejudice
that results to a state considered as a body
politic, which must support itself in the society
of nations, and have various transactions with
other states in wars and negotiations. The ill
there is pure and unmixed, without any favorable
circumstance to atone for it; and it is an ill
too of a nature the highest and most important.
We have indeed been told, that the public is
no weaker on account of its debts, since they
are mostly due among ourselves, and bring as
much property to one as they take from another.
It is like transferring money from the right
hand to the left, which leaves the person neither
richer nor poorer than before. Such loose reasoning
and specious comparisons will always pass where
we judge not upon principles. I ask, Is it possible,
in the nature of things, to overburden a nation
with taxes, even where the sovereign resides
among them? The very doubt seems extravagant,
since it is requisite, in every community, that
there be a certain proportion observed between
the laborious and the idle part of it. But if
all our present taxes be mortgaged, must we not
invent new ones? And may not this matter be carried
to a length that is ruinous and destructive?
In every nation there
are always some methods of levying money more
easy than others, agreeably
to the way of living of the people, and the commodities
they make use of…. Duties upon consumptions
are more equal and easy than duties upon possessions.
What a loss to the public that the former are
all exhausted, and that we must have recourse
to the more grievous method of levying taxes!…
It will scarcely
be asserted, that no bounds ought ever to be
set to national debts, and that
the public would be no weaker were twelve or
fifteen shillings in the pound, land-tax, mortgaged,
with all the present customs and excises. There
is something, therefore, in the case, beside
the mere transferring of property from the one
hand to another. In five hundred years, the posterity
of those now in the coaches, and of those upon
the boxes, will probably have changed places,
without affecting the public by these revolutions….The
funds, created and mortgaged, will by that time
bring in a large yearly revenue, sufficient for
the defense and security of the nation: money
is perhaps lying in the exchequer, ready for
the discharge of the quarterly interest: necessity
calls, fear urges, reason exhorts, compassion
alone exclaims: the money will immediately be
seized for the current service, under the most
solemn protestations, perhaps of being immediately
replaced. But no more is requisite. The whole
fabric, already tottering, falls to the ground,
and buries thousands in its ruins. And this,
I think, may be called the natural death of public
credit; for to this period it tends as naturally
as an animal body to its dissolution and destruction.
—“Of
Public Credit,” Economic
Essays, 207–14. |
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Paper Money and Sound Banking
This [the dearness of things due to excessive
quantities of money] has made me entertain a
doubt concerning the benefit of banks and paper-credit,
which are so generally esteemed advantageous
to every nation. That provisions and labor should
become dear by the increase of trade and money
is, in many respects, an inconvenience; but an
inconvenience that is unavoidable, and the effect
of that public wealth and prosperity which are
the end of all our wishes. It is compensated
by the advantages, which we reap from the possession
of these precious metals, and the weight, which
they give the nation in all foreign wars and
negotiations. But there appears no reason for
increasing that inconvenience by a counterfeit
money, which foreigners will not accept of in
any payment, and which any great disorder in
the state will reduce to nothing. There are,
it is true, many people in every rich state,
who having large sums of money, would prefer
paper with good security; as being of more easy
transport and more safe custody. If the public
provide not a bank, private bankers will take
advantage of this circumstance; as the goldsmiths
formerly did in London, or as the bankers do
at present in Dublin. And therefore it is better,
it may be thought, that a public company should
enjoy the benefit of that paper-credit, which
always will have place in every opulent kingdom.
But to endeavor artificially to increase such
a credit, can never be the interest of any trading
nation; but must lay them under disadvantages,
by increasing money beyond its natural proportion
to labor and commodities, and thereby heightening
their price to the merchant and manufacturer.
And in this view, it must be allowed, that no
bank could be more advantageous, than such a
one as locked up all the money it received, and
never augmented the circulating coin, as is usual,
by returning part of its treasure into commerce.
A public bank, by this expedient, might cut off
much of the dealings of private bankers and money-jobbers;
and though the state bore the charge of salaries
to the directors and tellers of this bank (for,
according to the preceding supposition, it would
have no profit from its dealings), the national
advantage, resulting from the low price of labor
and the destruction of paper-credit, would be
a sufficient compensation. Not to mention, that
so large a sum, lying ready at command, would
be a convenience in times of great public danger
and distress; and what part of it was used might
be replaced at leisure, when peace and tranquillity
was restored to the nation.
—“Of
Money,” Essays, Moral,
Political, and Literary |
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The Virtue of Foreign Trade
If we consult history, we shall find, that
in most nations foreign trade has preceded
any refinement in home manufactures, and given
birth to domestic luxury. The temptation is
stronger to make use of foreign commodities
which are ready for use, and which are entirely
new to us, than to make improvements of any
domestic commodity, which always advance by
slow degrees, and never affect us by their
novelty. The profit is also very great in exporting
what is superfluous at home, and what bears
no price, to foreign nations whose soil or
climate is not favorable to that commodity.
Thus men become acquainted with the pleasures
of luxury, and the profits of commerce; and
their delicacy and industry being once awakened,
carry them on to further improvements in every
branch of domestic as well as foreign trade;
and this perhaps is the chief advantage which
arises from a commerce with strangers. It rouses
men from their indolence; and, presenting the
gayer and more opulent part of the nation with
objects of luxury which they never before dreamed
of, raises in them a desire of a more splendid
way of life than what their ancestors enjoyed.
And at the same time, the few merchants who
possessed the secret of this importation and
exportation, make great profits and, becoming
rivals in wealth to the ancient nobility, tempt
other adventurers to become their rivals in
commerce. Imitation soon diffuses all those
arts, while domestic manufacturers emulate
the foreign in their improvements, and work
up every home commodity to the utmost perfection
of which it is susceptible. Their own steel
and iron, in such laborious hands, become equal
to the gold and rubies of the Indies.
When the affairs of society are once brought
to this situation, a nation may lose most of
its foreign trade, and yet continue a great
and powerful people. If strangers will not
take any particular commodity of ours, we must
cease to labor in it. The same hands will turn
themselves towards some refinement in other
commodities which may be wanted at home; and
there must always be materials for them to
work upon, till every person in the state who
possesses riches, enjoys as great plenty of
home commodities, and those in as greater perfection,
as he desires; which can never probably happen.
—“Of
Commerce,” Selected
Essays, 163–64. |
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Do Low Interest Rates Stimulate Economic Activity?
Nothing is esteemed a more certain sign of
the flourishing condition of any nation than
the lowness of interest: and with reason, though
I believe the cause is somewhat different from
what is commonly apprehended. Lowness of interest
is generally ascribed to plenty of money. But
money, however plentiful, has no other effect,
if fixed, than to raise the price of labor.
Silver is more common than gold, and therefore
you receive a greater quantity of it for the
same commodities. But do you pay less interest
for it? Interest in Batavia and Jamaica is
at 10 percent, in Portugal at 6, though these
places, as we may learn from the prices of
every thing, abound more in gold and silver
than either London or Amsterdam.
Were all the gold
in England annihilated at once, and one and
twenty shillings substituted
in the place of every guinea, would money be
more plentiful, or interest lower? No, surely:
we should only use silver, instead of gold.
Were gold rendered as common as silver, and
silver as common as copper, would money be
more plentiful, or interest lower? We may assuredly
give the same answer. Our shillings would then
be yellow, and our halfpence white; and we
should have no guineas. No other difference
would ever be observed; no alteration on commerce,
manufactures, navigation, or interest; unless
we imagine that the color of the metal is of
any consequence…. If the multiplying
of gold and silver fifteen times makes no difference,
much less can the doubling or tripling of them.
All augmentation has no other effect than to
heighten the price of labor and commodities;
and even this variation is little more than
that of a name. In the progress towards these
changes, the augmentation may have some influence,
by exciting industry; but after the prices
are settled, suitably to a new abundance of
gold and silver, it has no manner of influence.
An effect always holds proportion with its
cause. Prices have risen near four times since
the discovery of the Indies; and it is probable
gold and silver have multiplied much more:
but interest has not fallen much above half.
The rate of interest, therefore, is not derived
from the quantity of the precious metals. Money
having chiefly a fictitious value, the greater
or less plenty of it is of no consequence,
if we consider a nation within itself; and
the quantity of specie, when once fixed, though
ever so large, has no other effect than to
oblige every one to tell out a greater number
of those shining bits of metal for clothes,
furniture, or equipage, without increasing
any one convenience of life.
—“Of
Interest,” Selected
Essays, 177–79. |
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Why Commerce Encourages Both Low Profits and Low Interest Rates
Low interest and low
profits of merchandise are two events, that
mutually forward each
other, and are both originally derived from
that extensive commerce, which produces opulent
merchants, and renders the monied interest
considerable. Where merchants possess great
stocks…it must frequently happen, that,
when they either become tired of business,
or leave heirs unwilling or unfit to engage
in commerce, a great proportion of these riches
naturally seeks an annual and secure revenue.
The plenty diminishes the price, and makes
the lenders accept of a low interest. This
consideration obliges many to keep their stock
employed in trade, and rather be content with
low profits than dispose of their money at
an under-value. On the other hand, when commerce
has become extensive, and employs large stocks,
there must arise rivalships among the merchants,
which diminish the profits of trade, at the
same time that they increase the trade itself.
The low profits of merchandise induce the merchants
to accept more willingly of a low interest,
when they leave off business, and begin to
indulge themselves in ease and indolence. It
is needless, therefore, to inquire which of
these circumstances, to wit, low interest or
low profits, is the cause, and which the effect?
They both arise from an extensive commerce,
and mutually forward each other.
—“Of Interest,” Selected
Essays, 184–85. |
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Insights
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