Marshall's Economics: Equilibrium and Evolution
This section will explore in some detail the way in which Marshall set about assembling his ‘well-known’ theory of relative prices, and the role that equilibrium and evolutionary processes were intended to play in this construction. The following sections extend this discussion to factor price determination and a consideration of the significance of Marshall’s often neglected applied studies of industry. Marshall’s indirect influence on the later development of the Cambridge approach to macroeconomics piloted by Keynes will then be noted. The question of Marshall’s legacy in terms of the development of economic analysis is then reconsidered by way of some concluding observations.
Marshall’s overall approach to the formulation of economic analysis was stated directly in the Preface to his Principles:
The Mecca of the economist lies in economic biology rather than in economic dynamics. But biological conceptions are more complex than those of mechanics; a volume on Foundations must therefore give a relatively large place to mechanical analogies; and frequent use is made of the term ‘equilibrium’ which suggests something of statical analogy ... This fact, combined with the predominant attention paid in the present volume to the normal conditions of life in the modern age, has suggested the notion that its central idea is ‘statical’, rather than ‘dynamical’. But in fact it is concerned throughout with the forces that cause movement: and its key-note is that of dynamics, rather than statics (Principles: xiv).[1]
According to Marshall’s account, the ‘mechanical’ or ‘equilibrium’ component of his economics was completed in the years 1867-1879, in a largely unpublished form, beginning with a ‘translation’ of Mill’s version of Ricardo and Smith’s doctrines into mathematics.[2] Marshall claimed that the development of these aspects of his analytical framework occurred before he had become familiar with the work of Jevons, being inspired largely by his familiarity with the work of Antoine Augustin Cournot and Johann Heinrich von Thunen. However, Jevons’s influence on Marshall’s thinking was undoubtedly more than Marshall was willing to admit. Also important were the ‘new views’ on economics emanating from Germany, where the prevailing texts had settled on a demand and supply partial equilibrium approach not that dissimilar to the one later assembled by Marshall, and which included demand functions formulated without delving deeply into the fundamental causes of ‘utility’ (Streissler 1990).
Questions often arise as to the reasons for the delay until 1890 in the publication of the first edition of the Principles. In part, this was due to bouts of ill health and a heavy workload at Cambridge and Bristol. However, perhaps the most important reason for the delay is captured in Keynes’s observation:
Marshall.. .arrived very early at the point of view that the bare bones of economic theory are not worth much in themselves and do not carry one far in the direction of useful, practical conclusions. Holding these views and living at a time of reaction against economists when the faults of his predecessors, to which he draws attention above, were doing their maximum amount of harm, he was naturally reluctant to publish the isolated apparatus of economics, divorced from its appropriate applications (Keynes 1924: 34—35).
Marshall’s abstract equilibrium models could not, in their existing form, incorporate in a meaningful way the observations on human behaviour and social progress that Marshall had gathered on his intellectual journey to political economy. During the period leading up to the writing of the Principles, Marshall was an increasingly keen observer of industry and student of economic history, two elements that he believed were indispensable to useful economic analysis.
Given his enthusiastic embrace of evolutionary modes of thinking, it is not surprising that Marshall turned to the ‘speculations from biology’ in his endeavour to breathe life into his ‘isolated’ equilibrium models. By the 1890s, his system of ‘economic biology’ came to epitomise a methodological ideal, reflecting an ambition to introduce a mode of thinking that departed in several important respects from that which Marshall associated as originating from the ‘mathematical-physical’ sciences, which failed to take into account the changing nature of ‘man’ and institutions. This theme was repeated throughout the successive editions of Marshall’s Principles, and reiterated in his methodological essays, as instanced in the following passage:
But the catastrophes of mechanics are caused by changes in the quantity and not in the character of the forces at work: whereas in life their character changes also. ‘Progress’ or ‘evolution’, industrial and social, is not mere increase and decrease.
It is organic growth, chastened and confined, and occasionally reversed by the decay of innumerable factors, each of which influences and is influenced by those around it; and every such mutual influence varies with the stages which the respective factors have already reached in their growth (Marshall 1898b: 317).
Importantly, it was Marshall’s ambition to create a unity between his system of economic biology dealing with qualitative change and the mechani?cal models he had developed well before the publication of the Principles.[3] Marshall’s partial equilibrium analysis of relative prices founded on demand and supply schedules is developed in Book V of the Principles. Formal mathematical representation of the theory is largely relegated to mathematical notes and appendices, reflecting Marshall’s views on the role of mathematics in economic discourse:
But I know I had a growing feeling in the later years of my work at the subject that a good mathematical theorem dealing with economic hypothesis was very unlikely to be good economics: and I went more and more on the rules—(1) Use mathematics as a shorthand language, rather than an engine of inquiry.
- (2) Keep to them till you have done. (3) Translate into English. (4) Then illustrate by examples that are important in real life. (5) Burn the mathematics.
- (6) If you can’t succeed in 4, burn 3. The last I did often (Marshall to Bowley,
- 27 February 1906, quoted in Whitaker 1996: volume III, 130).
The underpinnings of the demand and supply schedules are developed in Books III and IV of the Principles, and an understanding of the content of Book V requires a close consideration of these earlier books. Before proceeding, some general points relating to Marshall’s partial equilibrium analysis and the nature and role of competition should be noted.
From the outset, Marshall cautions that a chief difficulty in economic theorising arises in the treatment of time, which is recognised as being continuous and irreversible. It is in this setting that Marshall developed his familiar time period analysis, which was essentially a device which breaks down the analysis into different time frames which had the effect of allowing some events and quarantining others temporarily into the ceteris paribus clause. Despite the flickering of ‘general equilibrium’ tucked away in the mathematical notes in successive editions of the Principles, Marshall held firmly to the view that economic problems needed to be treated ‘a bit at a time’, both by market participants and by those who were seeking to analyse their behaviour and develop useful policy recommendations.[4]
Unlike the later Walrasian conceptualisations, Marshall stresses that if an equilibrium is in fact to be reached, it would be the outcome of actions taken by market participants formulated on the basis of information revealed in their market dealings with each other. Competition in this context is not defined in terms of a particular market structure or configuration, but rather as a behavioural activity which was a form of organisation that evolved through time. The unceasing process of adaptation and reorganisation associated with economic change ensures that market structure was itself a transitory configuration. Competition was not simply a vehicle which ensured that only the ‘fittest’ would survive within the evolutionary context; competition was correlated most directly with the ideal of economic freedom that was to enable individuals to develop and realise their capabilities and which both allowed and inspired the business enterprise to adapt to the ever-changing economic environment. As such, competition as an activity resembled much more closely the classical conceptualisations, departing markedly from the later ‘neoclassical’ definitions based on a particular market structure (Kerr 1993).
In order to avoid common misinterpretations of Marshall’s economics, it is particularly important to dismiss the notion that Marshall was seeking to construct a theory of competitive equilibrium. The notion of ‘much free competition’ used in Marshall’s simple example of a fishing industry undergoing a once-and-for-all change in demand (in Book V, Chapter 3 of the Principles) is highlighted as being a provisional assumption. Even within the confines of ‘free competition’, the assumption of perfect knowledge, which Marshall associates with ‘perfect’ competition, is explicitly excluded (see, for example, Principles: 540). Similarly, while free competition was likely to be characterised by a large number of competitors, these encompass competitors with businesses of all sizes (Principles: 397). Once Marshall’s analysis in the Principles ventures beyond the simple fishing market example, and manufacturing and large-scale production are encountered, a market structure far removed from anything resembling pure competition emerges. In his discussion of manufactures in Chapter XII of Book V of Principles, Marshall drew a distinction between what could be termed ‘general’ and ‘particular’ markets, with ‘general’ markets being portrayed as the sum total of the ‘particular’ (or ‘special’) markets of the firms in the industry. Significantly, manufactures were seen as being ‘adapted to special tastes’, and thus tended to be confined ‘more or less to its own particular market’ (ibid.: 457-458). Essentially, Marshall’s partial equilibrium industry analysis did not in any sense imply, or indeed require, the existence of pure or perfect competition, or even the classical notion of free competition.
A distinguishing characteristic of Marshall’s analysis of market demand is that, while familiar concepts such as marginal utility are to be found, the demand schedules are not derived in any systematic way from choicetheoretic approaches based on constrained utility optimisation principles. Instead, they are premised more on empirical generalisations than on any particular behavioural assumptions, or as Shove (1942: 307) surmised, one may hazard a guess that Marshall began with the objective demand and supply schedules, the phenomenon of the market place, and worked back from them to their psychological basis, not (as was the case with Jevons) the other way around. The essentially ‘timeless’ approach to utility maximisation often attributed to Jevons could not be accepted by Marshall, as it excluded the role of habits (routines) and expectations that were ultimately connected with history. This perspective is reiterated most directly in Chapter II of Book III, where, for example, emphasis is placed on the essentially evolutionary processes that linked wants and activities as being at the heart of the decisionmaking of consumers.
These evolutionary dimensions become even more apparent in the treatment of industrial structure and transformation in Book IV of the Principles. Here, Marshall combined ‘speculations from biology’ with Adam Smith’s insights into the relationship between the division of labour and economic efficiency and progress. In particular, Marshall sought to understand how the organisation of business is shaped by the interrelationships between specialisation, competition, and the transfer of knowledge. The transitory landscape of industrial structure was the outcome of cumulative routinisation and specialisation made possible by the division of labour on the one hand, and creativity through innovation on the other.[5] The actions of business enterprises were not informed by, nor constrained by, technical relations encoded in given production functions. Instead, the acquisition of knowledge was of central importance, with both internal and external economies playing a substantive role, being essentially knowledge-based. The task Marshall set himself was to construct supply schedules that could play the key role in his proposed long- period equilibrium analysis, and which were derived and interpreted in a manner that was consistent with what he understood to be the realities of industrial structure and transformation as laid out in Book IV (and elsewhere) in the Principles. The latter clearly required an ‘evolutionary’, as opposed to a ‘mechanical’, perspective.
The first issue to be resolved was that there appeared to be no logical reason why the presence of scale economies would not lead to monopolisation of industries, something that was inconsistent with his observations of industry, as Marshall indicated in a letter to A.W. Flux (dated 7 March 1898):
My confidence in Cournot as an economist was shaken when I found his mathematics re I.R. [Increasing Returns] led inevitably to things which do not exist and have no relation to reality. One of the chief purposes of my Wander- jahre among factories, etc., was to discover how Cournot’s premises were wrong. The chief outcome of my work in this direction, which occupied me a great deal between 1870 and 1890, is in the ‘Representative firm’ theory (Marshall quoted in Pigou 1925: 406—407; italics in original).
This ‘complication’ could not simply be dismissed by assuming that economies of scale were exclusively external to individual firms, a rationalisation explicitly rejected by Marshall. Instead, Marshall’s explanations drew on a biological analogy, where the growth process of firms was likened to the growth of trees in a forest, from which Marshall inferred that the full life of a firm seldom lasts very long, as it is likely to ‘ere long quickly to decay’ having lost the exceptional energy (or creative faculty) that enabled it to rise (Principles: 287). As a result, emerging firms would eventually draw on their greater youthful vitality and outperform their more mature rivals, thus restraining and eventually arresting the capacity of established firms to exploit the opportunities that arose from returns to scale and to gain a greater share of the market. Marshall’s increasing awareness of the emergence of joint-stock companies became apparent from the sixth edition of the Principles (published in 1910) where it was recognised that the general rule of eventual stagnation is far from universal. However, Marshall did not consider that this qualification substantially altered his general proposition, as he suggested that it was ‘likely’ that joint-stock companies would eventually lose much of their progressive force. As noted below, the significance and impact of large-scale business organisations was considered in much more detail in Marshall’s applied studies of industry presented in Industry and Trade (Marshall 1919).
If accepted, Marshall’s life-cycle theory of the firm analogy implied that a position of long-period equilibrium for an industry coincided with a situation in which individual firms are at disequilibrium, with some businesses rising and others falling (Principles: 378). Therefore, the notion of the ‘marginal’ or ‘equilibrium’ firm could not have any operational role in the derivation of long-period normal supply conditions. It is in this context that Marshall introduced the much maligned and misunderstood concept of the representative firm, an analytical or statistical construct which, in terms of the biological analogy, describes the characteristics that may distinguish a tree found in a particular forest at a point in time from other trees at different stages of development or decline. As the industry experiences growth, the representative firm would be growing at the same rate as that of the industry as a whole, being shaped by, and changing with, those factors that determine the pattern of growth in the industry as a whole. Its role was to determine how costs for a diversified industry could be measured in the calculation of long-period normal market prices. In order to investigate how the industry as a whole may respond to a given change, we simply analyse how the hypothetical representative firm is likely to react (ibid.: 317).
Marshall’s representative firm theory was, therefore, intended to assist him in bridging the gap between evolutionary conceptualisations of ‘organic’ change and mechanical notions of equilibrium as states of adjustment to circumstances through time, leading writers such as Shackle (1965: 36) to conclude that Marshall’s peculiar triumph was his creation of a unity out of the conceptions of equilibrium and of evolution. However, Marshall had to concede that the long-period equilibrium method, when confronted with the evolutionary dimensions of economic activity outlined above, led to ‘unsatisfactory results’, exposing ‘imperfections in our analytical methods’ (Principles'. 809):
It must however be admitted that this theory is out of touch with real conditions of life, in so far as it assumes that, if the normal production of a commodity increases and afterwards again diminishes to its old amount, the demand price and the supply price will return to their old positions for that amount ... For, when any casual disturbance has caused a great increase in the production of any commodity, and thereby has led to the introduction of extensive economies, these economies are not readily lost. Developments of mechanical appliances, of division of labour and of the means of transport, and improved organisation of all kinds, when they have been once obtained are not readily abandoned (ibid.: 807-808).
While Marshall’s long-period analysis could conceivably indicate equilibrium positions ex post, it could not describe the process by which the equilibrium positions may be attained or sustained. This would suggest that the long-period supply schedule that Marshall derived from the representative firm theory did not have a meaningful expository role to play in the determination of long-period values unless the existence of the more fundamental evolutionary forces, reflected through biological analogies, were denied. The difficulties arose because of the inability of comparative static equilibrium analysis to take account of what Marshall understood to be the qualitative nature of economic change and irreversibility of events taking place in historical time. It needs to be emphasised that these ‘unsatisfactory results’ were not contingent upon the type of market structure being considered, or whether the scale economies were of the internal or external variety.
Marshall proposed that a more satisfactory framework in which these evolutionary economic processes could be examined would be provided in a ‘second volume’ of the Principles. However, the promised volume failed to materialise, and the defence of equilibrium analysis in the Preface to the Principles becomes more pronounced as we move through the eight editions, and the detailed discussion of the ‘imperfections in our analytical methods’ were relegated to an appendix in the later additions of the Principles.[6] At the same time, Marshall’s system of economic biology remained intact through the revised editions of the Principles, and the economic biology Mecca continued to be avidly proclaimed and defended. Marshall’s intention of establishing a scheme of economic biology was not so much a discarded intention, but rather an unfulfilled ambition that as a result faded with the passing of time.
- [1] The opening sentence of the quoted statement first appeared in the Preface to the fifth edition of thePrinciples (1907), with an earlier rendition found in Marshall (1898b: 318).
- [2] Many of these early publications are assembled in Pigou (1925), and with insightful commentary inWhitaker (1975).
- [3] It should be noted that some indications of the role and content of Marshall’s system of economicbiology can be found in the first edition of the (Marshalls’ 1879) Economics of Industry.
- [4] For further discussion of the inconsistency between general equilibrium representations and the notionof evolution resting on the possibility of localised change, see Raffaelli (2008).
- [5] As emphasised in the introduction, this is part of a general philosophical idea that resurfaces throughout Marshall’s intellectual career, starting from the early philosophical papers composed in the 1860s.
- [6] In the first four editions of the Principles, the subject matter of what became Appendix H was locateddirectly in the long-period equilibrium analysis in Book V Again, the subsequent banishment of thismaterial to the appendices cannot be simply dismissed as an inconsequential element of the rather extensive rearrangement of the contents of the fifth edition. Its effect was to push to the background a detaileddiscussion of issues which most directly challenged the usefulness of the equilibrium analysis found inBook V of the Principles.
