6
DAVID HUME (1711–1776)
Why mercantilism is wrong
He is the greatest philosopher ever to have written in the English language. He argued that reason was a slave to the passions. He made big contributions to historiography, most notably in his massive History of England, published in 1754–61. And he was a staunch atheist, convincingly refuting arguments in favour of the existence of God.
It is less well known that Hume also thought about economics. He was a good friend of Adam Smith (1723–90), and the two discussed economic matters at length. Yet Hume’s writings on this subject were pretty much ignored during the 19th century. Joseph Schumpeter argued that while Hume contains plenty of “force and felicity”, his work “formulated the results of previous work” rather than containing “any novelties”. One historian has noted that Hume’s discussions of economics are “casual”. Perhaps Hume’s work in philosophy, politics and history had overshadowed everything else.
By the 20th century, however, economists had once again realised the importance of Hume’s writings on economics. Milton Friedman, one of the most famous economists in living memory, said this of Hume’s theory of inflation: “We have advanced beyond Hume in two respects only: first, we now have a more secure grasp on the quantitative magnitudes involved; second, we have gone one derivative beyond Hume.” Robert Lucas, also an important economist in the 20th century, described two works published in 1752, Of Money and Of Interest, as the “beginnings of modern monetary theory”. And Friedrich Hayek noted that, along with Richard Cantillon, “David Hume began the development of modern monetary theory.”1
Hume was born in 1711 to a not especially rich family in Edinburgh. He entered the university around the age of 12 but found most of the lectures boring. In his twenties Hume told a friend that “there is nothing to be learnt from a Professor, which is not to be met with in Books”. True to his word, he set out on a course of vigorous self-directed learning. He worked so hard that before long he was suffering from severe mental illness. A doctor diagnosed Hume’s ailment as the “Disease of the Learned”.
It was around 1750 that Hume met Adam Smith for the first time. Hume was a dozen years Smith’s senior. The two met shortly after Smith had finished studying at university, but before he had found an academic post. Historians still puzzle over why Smith and Hume were friends. Hume was a loud man who liked to have a good time (he was known for his lavish dinner parties, at which he bragged of his “great Talent for Cookery”; Monty Python’s “Philosophers Song” claimed that “David Hume could out-consume Wilhelm Friedrich Hegel”) while Smith was a quiet, absent-minded fellow. But Smith said of Hume that he was “approaching as nearly to the idea of a perfectly wise and virtuous man as perhaps the nature of human frailty will admit”. In 1776, shortly after the publication of Smith’s Wealth of Nations, the author comforted Hume on his deathbed. Some historians have speculated that Smith and Hume were a couple, though Gavin Kennedy, a Smith expert, calls the idea “a mite more tabloid than the evidence justifies”. It is however without doubt that Hume and Smith had an extremely strong friendship.
Steer well clear
Why was Hume considered an “infidel”? Time and again he made arguments which sounded almost atheistic. His famous tome A Treatise of Human Nature (1739–40) was especially controversial. Compared with other countries at the time Scotland was a progressive place. But there were limits. It would have been unthinkable for Hume to be appointed to a professorship at a university. Some people, including Francis Hutcheson, Smith’s teacher, worked hard to prevent Edinburgh University from hiring him. As far as religion was concerned, even Smith distanced himself from Hume’s views.
And so to Hume’s economic writings. To be fair, not everything he wrote was super-smart. He seems to share the simplistic notions of population growth that would later make Thomas Malthus a household name (see Chapter 11). His views on banks would also fall well outside the economics mainstream today. As would his views on value, which like most economists of the time he considered to be determined by labour input alone.
Hume’s writings on public finances are also pretty ropey. He was writing at a pivotal moment in the economic history of the West: public debt, in a word, became economically significant. In the 1690s the British government became one of the first in the world to be considered a reliable borrower. From 1699, the earliest year of available data, to 1750, Britain’s debt-to-GDP ratio rose from 20% to 76%.2 The borrowed money was being used in part to build up the navy, which would eventually cement Britain’s place as the world’s most powerful country.
Hume was terrified by what was going on. In Of Public Credit, published in 1752, he listed all sorts of problems that would surely result from the accumulation of public debt. The poor would be taxed heavily in order to fund repayments. The owners of the government bonds would be able to sit doing nothing while repayments rolled in–which was immoral. In a letter in 1769 he wrote, probably facetiously, that he was hoping for a “public Bankruptcy”. He worried that Britain would go to “ruin”. As the historian J. A. G. Pocock puts it, Hume was convinced that “national debt could reach the point of subverting the whole fabric of society”.
Today conservative commentators deploy Hume to argue in favour of more austere fiscal policy. Yet Hume’s theories about credit do not stand up to much scrutiny. He doesn’t really get beyond the notion that “debt is bad”. Britain, of course, did not go bankrupt. The evidence suggests that the British government’s management of its public debt was fairly prudent–indeed, it may have laid the groundwork for Britain’s economic development over the ensuing decades. So Pocock is surely right that Hume’s views on the public finances represent “a blockage in his economic thinking”.
Getting better
If these were Hume’s only contributions to economics, he would not be in this book. But his theory of money marks him out as one of the great economic thinkers. The fundamental idea is the “neutrality of money”, which is less complicated than it sounds. The key question that Hume is asking is this: “Is money the same thing as wealth?”
Many people writing around Hume’s time were clear: the answer to that question was a definite “yes”. The most extreme version of mercantilism–which this book has termed “bullionism”–held that a nation was richer if it held higher quantities of gold and silver (or, in the terminology of the day, “specie” or “bullion”). All sorts of policy recommendations flowed from that conclusion. Most importantly, it was essential for a country to have a trade surplus–ie, for its exports to exceed its imports. Having a trade surplus would mean that more specie would be flowing in to the country than out. As the stock of specie grew, the country would get richer. Simple. The global trading system, by this logic, was fundamentally zero-sum. For every “winner” country with a trade surplus, there must be a “loser” country with a trade deficit. Today, President Donald Trump thinks in much the same way.
Hume does not agree with the bullionist theory of money–nor with the conclusions that flow from it. He sees the wealth of a country and the amount of money in a country as entirely separate things. The wealth of a country consists in what its inhabitants can consume–food, clothes and luxuries. Money, on the other hand, simply allows those things to be exchanged for one another–“only… a method of rating or estimating… labour and commodities”. As Hume puts it, “[t]he greater or less plenty of money is of no consequence; since the prices of commodities are always proportioned to the plenty of money.” Historians quibble over whether Hume was truly the “first” person to identify this idea. John Locke and Sir William Petty also have a good claim. What is clear, however, is that Hume explained it better than anyone.
The theory goes something like this.3 Imagine that a pirate turns up in Britain with a big bag of gold that he has looted from abroad. He spends that money on food, drink and clothes, thus adding to the stock of money in the economy. Now you have more money chasing the same quantity of goods and services in the economy. The result of the pirate turning up is not that Britain ends up producing more goods and services overall, but that the average price of those goods and services goes up.
For modern economists, especially those on the right of the political spectrum, this is a crucial idea. Economists such as Milton Friedman argued that increasing the supply of money could not lead to more prosperity. That was of great relevance for the sorts of debates occurring in the 1970s, when rapid growth in the money supply coincided with high rates of unemployment and inflation. Theories derived from Hume were intellectual ballast for the argument that the only way, for example, to lower unemployment was to enact reforms to the labour market.
Economists still battle over the extent to which the quantity theory of money is true. But it is generally accepted that printing money excessively and irreversibly will cause inflation, rather than merely boosting the production of goods and services. Just look at what happened to Weimar Germany in the 1920s, Zimbabwe in the 2000s or Venezuela in the late 2010s.
This account of Hume’s economic thought, however, does him some injustice. Robert McGee, a historian, distinguishes, rightly, between an “original, crude” theory and the “later, more sophisticated theory” of the relationship between the money supply and prices. The “original, crude” theory is the one just outlined. On this account an increase in the money supply rushes through the economy, evenly and immediately, having no effect on production, but a big effect on inflation.
The “later, sophisticated theory” is the one that Hume actually believed. For one thing he reckoned that a given increase in the money supply would not lead to a proportional increase in prices–so a 5% rise in the money stock does not lead to a 5% rise in prices. Perhaps it might lead, say, to a 3% rise in prices. Nor did he think it happened immediately.
Hume’s theory also has important distributional consequences. Think back to the example of the pirate. When he spends his gold, he is able to take advantage of the current price levels. But at the end of the process, the people receiving that gold must spend it at the new prices. So the gold in the pirate’s hand can buy more stuff than the gold in the hands of the people who receive it a few days later.
The nail in the mercantilist coffin
Hume’s idea had important consequences for international trade, through a channel commonly associated with Hume today: the “price-specie-flow mechanism”.
Hume first articulated his “price-specie-flow” mechanism in a letter to Montesquieu in 1749. He expanded on these ideas in his work Of the Balance of Trade, published in 1752. It shows that the bullionist objective of a permanent trade surplus is not only silly, it is impossible. No country can have much of an “advantage”, relative to other countries, for long.
Why is that? If one country exports more than it imports, this means that more specie is arriving into that country than is leaving the country.4 Over time, in other words, the country is accumulating specie. Think back to Hume’s theory about specie and price levels. The exporting country will, as a result of inflows of specie, see a rise in price level. A rising price level means that, in future, producers in that country will demand more gold for their wares. For instance, chair-makers were once happy to sell a chair for one gold coin, but now they demand two, in part because the cost of everything else that they need to buy has gone up.
The chair-makers’ more extravagant demands make their goods less competitive on foreign markets. But because they simultaneously have more money, they are willing to buy more from abroad. This situation plays out across the economy as a whole. Exports fall and imports rise.
The reverse process is true for the country that originally had the trade deficit: thanks to fall in specie, their goods become more competitive abroad, so their exports go up. So global trade is brought back into balance. Margaret Schabas and Carl Wennerlind, two historians, lyrically say that “[l]ike the oceans, money… is always at sea-level, floating to the nation with the most advantageous exports.”5
Do Hume’s writings on money make sense? The first thing to point out is that, in the real world, things do not quite work like that. That is in part because of complications which Hume does not consider, or which he could not have known about. Britain managed to have a pretty consistent trade surplus in the 19th century, seemingly in violation of Hume’s theory of self-regulation. The flow of investment from Britain to its large empire offset the inflow of money from its exports. And in today’s more open global capital markets, countries are able to run large trade deficits almost indefinitely, for as long as they can borrow the money required to offset them.
Still, at the time it was an important insight from Hume. As Robert Formaini argues, Hume “worked out his specie-flow mechanism in part to discredit protectionist, mercantilist doctrine”. Indeed it struck at its very heart. The accumulation of gold, the great objective of bullionism, is ultimately self-defeating, since the accumulating country will simply become less and less competitive over time.
What, no citation?
But here is a puzzle. As mentioned above, Smith was a good friend of Hume, so the two must have discussed the theory. In the Wealth of Nations Smith appears to accept Hume’s notion of the “neutrality” of money, noting that “[t]he increase of the quantity of gold and silver in Europe, and the increase of its manufacturers… have scarce any natural connection with one another.” Indeed, in a lecture series, he goes further than that, noting that “Mr Hume… proves very ingeniously… that whenever money is accumulated beyond the proportion of commodities in any country, the price of goods will necessarily rise.”
However, despite its apparently anti-mercantilist implications, Adam Smith barely mentions the price-specie-flow theory in his Wealth of Nations. Why not? Frank Petrella, a historian, offers probably the best explanation. For one thing the “price-specie-flow” idea seems to suggest that economic growth is naturally self-correcting–any country that does well in the short term is sowing the seeds of an economic slowdown. As Hume puts it, “[t]here seems to be a happy concurrence of causes in human affairs, which checks the growth of trade and riches, and hinders them from being confined entirely to one people.” Smith’s Wealth of Nations is all about how the wonders of the division of labour would lead to people getting richer and richer. How could he possibly entertain a theory that seemed so pessimistic?
Moreover, study Hume’s theories more closely, and actually there do appear to be some mercantilist undertones. Hume, after all, accepted that there might be a time-lag between the accumulation of specie and a rise in prices. As he put it: “Between the acquisition of money and rise of prices… the encreasing [sic] quantity of gold and silver is favourable to industry.” A mercantilist reading this might well think, “Aha!–so Hume does accept that accumulating specie is a good thing.” If so, then targeting a trade surplus is good public policy.
Smith could not risk such an interpretation, suggests Petrella, since it might “have legitimised mercantilist theory and policy”. As the chapter on Smith argues, the Wealth of Nations was a full-frontal attack on mercantilist theory and practice. Smith did not want to acknowledge that mercantilism had any useful parts whatsoever. Petrella argues convincingly that “Smith… subsumed both naïve and sophisticated mercantilist thinking under an easily destroyed straw man of his own creation, the ‘commercial’ or ‘mercantile’ system.”
Perhaps, then, we have the best explanation of why Hume is today known almost exclusively as a philosopher rather than an economist. It is hard to overestimate the impact of the Wealth of Nations in shaping the popular understanding of economics. A theory ignored by that great book was always going to be one that everyone else ignored, at least for a while. It is one of the ironies of history that Hume’s undeserved obscurity in economic matters came at the hands of his best friend.