In 1879 as Karl Marx was becoming popular in Europe Alfred Marshall wrote The Economics of Industry. Marx was a reaction to the principles of Adam Smith. Karl Marx focused on the distribution of an existing pie where Adam Smith sought the benefits for all of an expanding pie. Marx saw the profit motive as leading to increasing alienation of workers and the inevitable collapse of capitalism.
Marshall’s obsessive effort to understand how business worked led to his most important discovery. The economic function of the business firm in a competitive market was not only or even primarily to produce profits for owners. It was to produce higher living standards for consumers and workers. How did it do this? By producing and distributing more goods and services of better quality and at lower cost with fewer resources. Why? Competition forced owners and managers to constantly make small changes to improve their products, manufacturing techniques, distribution, and marketing. The constant search to find efficiency gains, economize on resources, and do more with less resulted over time in doing more with the same or fewer resources. Multiplied over hundreds or thousands of enterprises throughout the economy , the accumulation of incremental improvements over time raised average productivity and wages. In other words, competition forced businesses to raise productivity in order to stay profitable. Competition forced owners to shares the fruits of these efforts with managers and employees, in the form of higher pay, and with customers, in the form of higher quality or lower prices.
The implication that business was the engine that drove wages and living standards higher ran counter to the general condemnation of business by intellectuals. Even Adam Smith, who famously described the benefits of competition in terms of an invisible hand that led producers to serve consumers without their intending to do so, had not suggested that the role of butchers, bakers, and giant joint stock companies was to raise living standards. Although Karl Marx had recognized that business enterprises were engines of technological change and productivity gains, he could not imagine that they may also provide the means by which humanity could escape poverty and take control of its material condition.
From Grand Pursuit – The Story of Economic Genius by Sylvia Nasar
Sylvia Nasar’s book traces the development of economics from Adam Smith through Milton Friedman. The book gives a background of the key developers of economic theory by relating their thinking to their personal development and the history of their time.
Unlike the hard sciences where laboratory conditions can prove or disprove a theory in a short period of time, the impacts of economic theory only play out at the speed of history. All too often in the development of economics, rational and mathematical models are humbled by the development of history and the unexpected genius of people who respond much different in the real world than the mechanical objects they are treated as by the brilliant but flawed theories of those intellectuals who confuse thought with understanding, and knowledge with wisdom.