Theories of economic history


     “Economic theory is nothing but an idea or a principle that aim to describe how an economy works”.


Adam Smith was 18th century economist who was renowned as a “Father of modern Economics” and a major proponent of ‘Laissez Faire’ economic policies. Smith is most famous for his work “The Wealth of Nation” (1776) although his first work being “The Theory of Moral Sentiments” (1759). He changed the import and export business and created the concept of what is now known as Gross Domestic Product (GDP).


Classical Economic theory developed shortly after the birth of western capitalism and industrial Revolution. This theory helped countries to migrate from monarch rule to capitalistic democracies with self-regulation.The basic idea of Classical theory is that ‘economy is self-regulating’. The majority of classical thinkers favoured free trade.

It is a traditional theory where more emphasis is given on organizations rather than employees working in. The organization is considered as a machine and the employees as components of that machine. It is assumed that the absolute control should be vested in a central authority only, in order to have a centralized and integrated system.

The Classical theory of Adam Smith drastically begun to fall in 1890s with the writings of German Philosopher Karl Marx and Labour theory emerged as a direct challenge to Classical theory.


Mercantilism is an economic practice by which governments attempt to increase their power at the expense of its rival nations. These governments ensured that the exports exceed the imports, so that they accumulate wealth (mostly gold and silver). 

In this principle, wealth is considered as finite and trade as mere zero-sum game. It was a prevalent economic system in the western world from 16th century to 18th century. Gold and silver considered as indispensable so that, if a nation did not possess mines, it would get it through means of trade. Countries which have the possession of colonies, use their colonies as a market place to export goods and make the colonies to supply raw materials to their home nation. This what happened in British India. British sold their products finished goods in India and made India as a mere supplier of raw materials. Mercantilism provided a favourable climate for the early growth of capitalism.

The western European countries exclusively employed the theory of mercantilism most particularly- Britain, France, Spain, Portugal, Italy & Germany. Since colonies were very much essential for their benefits, Colonized parts of North America, South America, Africa and Asia were involuntarily involved with mercantilism. The cunning and monopolistic trading companies of English East India Company and French East India Company were born out of mercantilism philosophy. Commercial rivalries resulted in military conflicts, notably Anglo-Dutch War. The complexity of mercantilism caused wide friction between England and American colonies which ultimately lead to American Revolution.


The poverty that prevailed in India during 19th century is not because of internal factors but the colonial rule that was draining the wealth and prosperity of India. Dadabhai Naoroji was the first one to state this which later become popularly known as ‘Drain of Wealth Theory’. He mentioned this theory in his book “Poverty and Un-British Rule in India” in 1867. R.C.Dutt wrote a book “Economic History of India” with the central theme being Drain of Wealth. 

After the Battle of Plassey, England gradually acquired the absolute control over Indian economy. The constant flow of wealth from India to England for which India did not get an adequate economic, commercial or material return has been descried as drain of wealth. The colonial government was utilizing Indian resources, revenues for the development of Britain. Naoroji stated that British had drained 200 – 300 million pounds of Indian money.   


Time Value of Money is the concept that money available at the present time is worth more than the same amount in future, due to its potential earning capacities.


Labour theory was an early attempt by leading economists to explain why goods were exchangedcertain relative prices on the market. The best-known advocates of labour theory were Adam Smith, David Ricardo and Karl Marx. The labour theory of Value is used to explain the relative differences in market prices. This theory stated that the value of produced economic good can be measured objectively by the average number of labour hours required to produce it. Marx understood the labour theory better than Adam Smith and contemporaries. Marx objective Labour theory proved to be incorrect and the later economists adopted subjective labour theory.


 Theory of Value:

According to Aristotle, economics is concerned with household and that economics deals with the use of things required for good life. He also views economics as a practical science and as a capacity that fosters habits that expedite the actions. In the Politics, Aristotle views labour as a value but does not give value.

Theory of Money:

Money has a different value than other goods. Money’s value was imposturous. This value is not determined by people but by the king. When government controls money instead of people it is a form of artificial monopoly.

KEYNESIAN ECONOMICS: (John Maynard Keynes)

Keynesian economics is an economic theory of total spending in the economy and its effect on output and inflation. This theory was developed by British economist John Maynard Keynes during 1930s in an attempt to understand the Great Depression. Keynesian economics is considered as ‘demand side’ theory that focuses on the changes in the economy. 

Keynes was very critical of Classical economics arguments that natural economics forces and incentives would be sufficient to help the economic recover. Keynesian economy recommends fiscal and monetary policy to manage economy and fight unemployment. Keynesian economics was used to refer the concept that optimal economic performance could be achieved and economic slumps prevented by influencing aggregate demand through active policies of government.