Economics as a science dates back to the 1700s, and the market economy as we know it today also came into existence after the Industrial Revolution as well. Of course, there has been economic activity prior to that date and it is possible to explain the nature of it by using the current tools of economics, however, we could not talk about economic policy as we know it today. Mercantilism or other outdated ideas determined their era, however, they are now proved to be inefficient and illogical scientifically. Economics as a science is accepted to start with the “Wealth of Nations” of Adam Smith, dated 1776. In this book Smith states the principles of the free market, and how it maximizes both individual and societal prosperity. Smith argues that for the free market to function properly any kind of restriction imposed by governments or any kind of intervention to the markets should be lifted. Therefore, he argues that high levels of trade tariffs, abolishing private property, or excessive control by governments (taxation, entry barriers, etc.) actually decrease the efficiency of the markets. It is not hard to understand that he has a really fair point. When governments protect the right of private property while also encouraging trade and market participation (production), profit-seeking individuals will find ways of efficient economic production. This production will also increase the overall physical wellbeing of society via increasing employment and the chance of consumption. He argued that the self-correcting mechanism of the markets would always work during the recessions and the market would eventually come to the state of full employment. These ideas of Adam Smith constitute the base of laissez-faire capitalism, liberalism, and classical economics.
Before the Great Depression of 1929, the mainstream economic policy thought in the west was in line with the ideas of Smith and laissez-faire. Great Depression changed all that belief and gave way to Keynesianism, which advocates the necessity of limited participation of government to the markets. While the classical economists were waiting for the market to come to its equilibrium point by itself, thus saying no to government intervention, the toll of the crisis was getting higher and higher each day. Keynes basically argued that governments had to decrease tax rates and increase government spending during recessions to stimulate consumption and spending. By doing so people would have more money to spend, increasing the total demand for goods and services and later increasing demand for labor. The application of these policies eventually led to the end of the Great Depression.
Just when the economy was recovering from the Great Depression, the Second World War started. This resulted in a total disaster for consumption rate, but the government spending (also debt) was increasing due to military spending. The end of the Second World War gave way to the creation of today’s most important international economic institutions: International Monetary Fund (IMF), the World Banks, and the General Agreement on Tariffs and Trade (Became the World Trade Organization during the 1990s). These institutions are very important in the sense that they are responsible for the health of the international financial system. One of the main reasons why the Second World War started was due to Germany’s problematic economic situation. Germany had gone through a period of hyperinflation as the government’s decision to print money for its spending and foreign debt was very far from being the wisest decision ever made. Besides, the Treaty of Versailles did not take into consideration the sustainability of the country’s economy. World Bank, IMF, and WTO also have the aim of preventing such cases from happening again. It is also a fact that our economies are very interconnected, thus a crisis starting in a developing country can as well affect the developed world by its butterfly effect. These organizations’ main duty is to prevent such a case from happening.
The 1970s and 80s saw two major developments: the birth of neo-liberalism and the abolishment of the gold standard. The gold standard means that the value of the dollar was fixed to gold, thus the paper money at hand had an equivalent amount of gold in the banks. The abolishment of this system in 1971 by Nixon showed the beginning of the free-floating currency system as we have it today. Besides, the OPEC crisis of 1973 is worth mentioning here since it created the idea of supply-side recessions.
The rise of neoliberalism and monetarism is a whole different story. Throughout the 1950s and 60s, inflationary pressures built up in the Western world. Increasing government spending also results in increasing money supply since more money is being deposited in banks as income and is given as credit. This phenomenon made the politicians think that they should decrease the role of government and obstruct consumption to decrease inflation, meaning the popularity of Keynesianism would start to decrease until 2008. Government spending would decrease, interest rates would increase despite public opposition. Thatcher in the UK and Reagan in the USA represent this rise of neo-liberalism or “New Right” in politics with the Washington Consensus. The Monetarism of Milton Friedman is also very important here. Friedman’s school of thought was created as a response to Keynes. They basically argued the reason for the economic crisis lies in the monetary policy, money supply, and interest rates thus the intervention of government through spending and taxes are unnecessary.
The second half of the 20th century also saw Asia’s economic growth and its “Tiger Economies”. Each country has a different story for growth thus it will not be detailed.
Starting in the 1980s and accelerating during the 90s, globalization is also a very important item for understanding today. The creation of the World Trade Organization and the European Union all coincide in the 1990s. Globalization and increasing trade volume of countries accelerated economic growth especially for the developing part of the world, specifically China and India. The science of economics shows that trade is always a good thing for the partners. Globalization meant a more interconnected world but also resulted in increased income inequality for the past three decades when combined with the effects of neoliberalism. However, in the end, even though there is income inequality, globalization and neoliberalism also coincide with the times when society as a whole got more prosperous and richer. The rate of poverty decreased significantly with freer markets that lack government intervention and control up to a certain degree. During the 2010s, this trend in income inequality started to show its negative consequences via populist leaders gaining power. As of today, whether globalization is a good thing or whether the trade should be limited is being debated in the political sphere, as we can see from Brexit or the discourse of Trump.
When we come to the 2000s, we see a world in which monetarism and neoliberal ideas seem to defy Keynesianism. It looks like not controlled free markets will make the future bright and ensure economic growth. However, this changed with the financial crisis of 2008. When the crisis of 2008 hit the world economy, it was seen that the tools of Keynes were the best viable option for decreasing the effects of a recession. Massive support packages were accepted by governments and interest rates were put down at near-zero levels. The 2010s saw the slow recovery of the economy from 2008. Just when the economy was seriously recovering, the world now faces the biggest recession since 1929: the COVID 19 crisis. 2020 is determined by this recession and all the world leaders are looking for the best policies to decrease the severity of the recession.
– Skousen, M. (2016). The making of modern economics: The lives and ideas of the great thinkers. New York: Routledge.
-Acemoglu, Daron, et al. Macroeconomics. Pearson, 2019.