Review of Political Economy

ISSN: 0953-8259 (Print) 1465-3982 (Online) Journal homepage: https://www.tandfonline.com/loi/crpe20

Nicholas Kaldor on Adam Smith and Allyn Young

Ramesh Chandra

To cite this article: Ramesh Chandra (2019): Nicholas Kaldor on Adam Smith and Allyn Young,
Review of Political Economy, DOI: 10.1080/09538259.2019.1685798

To link to this article: https://doi.org/10.1080/09538259.2019.1685798

Published online: 19 Nov 2019.

Submit your article to this journal

Article views: 31

View related articles

View Crossmark data

Full Terms & Conditions of access and use can be found at

https://www.tandfonline.com/action/journalInformation?journalCode=crpe20
REVIEW OF POLITICAL ECONOMY
https://doi.org/10.1080/09538259.2019.1685798

Nicholas Kaldor on Adam Smith and Allyn Young

Ramesh Chandra∗
Independent Economist, Glasgow, UK

ABSTRACT ARTICLE HISTORY

Nicholas Kaldor was much influenced by the Smith-Young view of Received 29 July 2019
increasing returns. The objective of this paper is to critically Accepted 20 October 2019
examine Kaldor’s interpretation of Smith and Young. In particular,
KEYWORDS
five questions are addressed: (1) Does Smith’s Wealth of Nations Increasing returns;
have nothing much to contribute in terms of disequilibrium theory disequilibrium theory;
or increasing returns after the middle of chapter four? (2) Did Smith Nicholas Kaldor; Adam Smith;
and Young have a sectoral view of increasing returns in the sense Allyn Young
that they saw increasing returns being confined to manufacturing
only? (3) Does the Youngian growth mechanism need to be JEL CLASSIFICATIONS
supplemented with Keynesian aggregate demand so that growth B11; B20; B31; O10; O20
does not fizzle out? (4) What are the important policy differences
between Kaldor and the Smith-Young analysis of increasing
returns? (5) Finally, what explains Kaldor’s interventionist bent of
mind and his dirigiste approach to policy making?

1. Introduction
Nicholas Kaldor (1908–86) made important contributions in several areas of economics
and policy. His contributions have come in for lavish praise in the literature. For
example, Luigi L. Pasinetti (1981, p. 59) wrote:
Nicholas Kaldor is probably one of the most original and provocative theoretical economists
of the twentieth century, as well as one of the most radical advisers on taxation policies to
many governments. His contributions to economic theory range over a wide field: from
the theory of the firm to welfare economics, from capital theory, international trade, tariff
policy to trade cycle and economic growth theory and monetary and taxation policy. But
he probably will be most remembered for his theory of income distribution and his advocacy
of an ‘expenditure tax’.

Similarly, Hahn and Matthews (1994, p. 901) note that ‘his range was wider than that of
almost any other economist of our time’. Pressman and Holt (2008) point out that Kaldor
embraced cumulative causation, and moved away from equilibrium analysis, in his bid to
understand how actual economies work. His three policy proposals – an industrial policy
for England, an expenditure tax, and an incomes policy as a means of controlling inflation
– are based on the principle of cumulative causation. The Economist (20th January, 1979)
described him as the ‘best known economist in the world not to have received the Nobel

CONTACT Ramesh Chandra ramesh56chandra@yahoo.com

∗
Ramesh Chandra is an independent economist who received his Ph.D in Economics from the University of Strathclyde in
2001.
© 2019 Informa UK Limited, trading as Taylor & Francis Group
2 R. CHANDRA

Prize’. His biographer, Anthony P. Thirlwall (1987, p. 333) described his eight volumes of
Collected Essays as ‘a lasting monument and testimony to his energy, creativity and
endeavour’. He never wrote a grand treatise in the tradition of Smith, Ricardo, Marx or
Marshall though ‘he had the vision, the intellect and the gift for writing’ (Anthony
P. Thirlwall 1987). John E. King (2007, p. 3) wrote that his thinking after the Second
World War shifted from theoretical problems to policy issues such as principles of war
finance and post-war reconstruction.
By 1945 Kaldor was no longer merely a theorist. He had emerged as an applied economist of
great talent and energy, and had acquired a taste for providing policy advice that he would
retain for the rest of his life.

This paper, however, critically examines his perspective on increasing returns, particularly
with respect to his interpretation of Adam Smith and Allyn Young. In his later years,
Kaldor challenged the neo-classical orthodoxy, particularly the equilibrium theory and
its static method. In his famous 1972 Economic Journal article, he talked about the irrel-
evance of equilibrium economics in explaining ‘the manner of the operation of economic
forces’, criticising the assumptions on which it was based.1 He believed that economic
theory should be more concerned with cumulative change than with the problem of
optimum allocation of resources. Every change in the use of resources or the organisation
of productive activities creates opportunities for further changes which would not have
otherwise existed. Under such circumstances the notion of allocating scarce means
between alternative uses falls apart. In his scathing attack on equilibrium economics,
Kaldor was deeply influenced by Young (1928), who was his teacher at the London
School of Economics, and the first three chapters of Adam Smith’s Wealth of Nations,
which are devoted to the principle of the division of labour.
According to Kaldor (1972) economic theory went astray from the middle of chapter
four when Smith suddenly got fascinated by the distinction between the use and exchange
value of a commodity on the one hand, and between the real and money prices on the
other.2 From then on, Smith gets diverted to the question of how values and prices for
products and factors are determined. Kaldor seemed to imply that the Wealth of
Nations had nothing much to contribute, after the middle of chapter four, in terms of dis-
equilibrium theory or increasing returns.3
Kaldor also extensively drew from Allyn Young’s 1928 paper on increasing returns and
economic progress. In that paper Young (1928), building on Smith ([1776] 1976), argued
that while it is true that the division of labour depends on the size of the market, the size of
the market also depends on the division of labour. In other words, the division of labour

1
“[T]he basic assumptions of economic theory are either of a kind that are unverifiable – such as that producers ‘maximise’
their profits or consumers ‘maximise’ their utility – or of a kind which are directly contradicted by observation – for
example, perfect competition, perfect divisibility, linear-homogenous and continuously differentiable production func-
tions, wholly impersonal market relations, exclusive role of prices in information flows and perfect knowledge of all rel-
evant prices by all agents and perfect foresight. There is also the requirement of a constant and unchanging set of
products (goods) and of a constant and unchanging set of processes of production (or production functions) over
time” (Kaldor 1972, p. 1238).
2
See also “What is Wrong with Economic Theory” (Kaldor 1975).
3
Echoing Kaldor’s views, his biographer Thirlwall (1987, p. 325) observes: “Unfortunately … having concentrated on the
division of labour and the creative functions of markets in the early chapters of The Wealth of Nations, Smith turned
his attention to how the prices of goods and factors of production are determined, and through the rest of the book
assumed, in effect, constant costs, as did Ricardo and the other classical economists. The ground was laid for the
theory of value.”
 REVIEW OF POLITICAL ECONOMY 3

depends on the division of labour itself so that ‘change becomes progressive and propa-
gates itself in a cumulative way’. The process of change is endogenous (in the sense that
it arises from the very forces engendered within the economic system), and takes the
system away from equilibrium rather than closer to it. Young also stated that given
elastic demand for every commodity, an increase in demand would lead to an increase
in supply and vice versa.
However, Kaldor interpreted the Smith-Young conception of increasing returns as
being confined to manufacturing. Kaldor was of the view that manufacturing needs to
be promoted through protection, subsidies, dual exchange rates, selective employment
tax, etc. He also felt that in Young’s theory an increase in supply may not automatically
lead to an increase in demand unless it is supplemented by Keynesian effective demand
through credit expansion to finance ‘induced’ investment. Thus while Kaldor was
influenced by the Smith-Young view of increasing returns, he had important differences
as well.
The objective of this paper is to critically examine Kaldor’s interpretation of Smith and
Young. In particular, five questions are addressed: (1) Does Smith’s Wealth of Nations
have nothing much to contribute in terms of disequilibrium theory or increasing
returns after the middle of chapter four? (2) Did Smith and Young have a sectoral view
of increasing returns in the sense that they saw increasing returns being confined to man-
ufacturing only? (3) Does the Youngian growth mechanism need to be supplemented with
Keynesian aggregate demand so that growth does not fizzle out? (4) What are the impor-
tant policy differences between Kaldor and the Smith-Young analysis of increasing
returns? (5) Finally, what explains Kaldor’s interventionist bent of mind and his dirigiste
approach to policy making?

2. Smith’s Contribution Beyond Chapter Three

Kaldor (1972) lamented that economic theory went wrong from the middle of chapter four
of the Wealth of Nations, the first three being devoted to the principle of the division of
labour. In the fourth chapter, Smith first discusses the evolution of money and its link
with the division of labour. As an economy advances in exchange and the division of
labour, barter becomes cumbersome, and one commodity (e.g., a metal such as gold)
comes to be used as money. In the later part of the chapter Smith explores the principles
which regulate the exchangeable values of commodities.4 In particular, Smith addresses
himself to three questions: (a) What determines the real price of a commodity? (b)
What are the different parts of this price? (c) Why the market price sometimes diverges
from this price? After dealing with these matters in chapters 5–7, Smith, in chapters 8–
11, turns his attention to the theory of distribution, i.e., the circumstances which naturally
determine the rates of wages, profits and rent.
The subsequent developments in the theory of price and distribution have been
traced back to Smith’s interest in this subject. As Kaldor (1972, p. 1241) points out:
4
Note that Smith was more concerned with the exchangeable value of a commodity than its use value, presumably because
the division of labour arises in the process of exchange. (For that matter he talked of money in the first part of chapter 4
because money facilitates exchange, and thereby the division of labour.) He may not have developed the “use” aspect or
the “utility” orientation of the value theory as it would have diverted attention from his main task of explaining economic
change over time. However, Smith has been criticised for neglecting this aspect of the value theory.
4 R. CHANDRA

‘One can trace a more or less continuous development of price theory from the subse-
quent chapters of Smith through Ricardo, Walras, Marshall, right up to Debreu and the
most sophisticated of present day Americans’. Similarly Joseph Schumpeter (1954,
p. 189) observed:
The rudimentary equilibrium theory of Chapter 7, by far the best piece of economic theory
turned out by A. Smith, in fact points toward Say, and through the latter’s work, to Walras.
The purely theoretical developments of the nineteenth century consist to a considerable
degree in improvements upon it.

Kaldor (1972, p. 1241) observed that ‘the basic assumption of this theory is constant costs
or constant returns to scale’.5 He believed that with Smith and Ricardo, this assumption
was implicit in the notion of ‘natural price’ determined by the costs of production, irre-
spective of demand considerations. With the neoclassicals it was explicit in their assump-
tion of linear-homogenous production functions. This assumption was ‘one of the
required “axioms” necessary to make the assumptions of perfect competition and profit
maximisation consistent with one another’ (Kaldor 1972).
Did Smith abandon the assumption of increasing returns in rest of the Wealth of
Nations? This paper argues that this is not the case. Firstly, Smith’s foray into value and
price theory partly arose because he was grappling with the index number problem so
that intertemporal and interspatial comparisons of aggregate economic change could be
made. He was searching for an invariant measure of value in terms of which the value
of other commodities could be expressed. Smith (1776, Vol. I, p. 37) observes:
Equal quantities of labour, at all times and places, may be said to be of equal value to the
labourer. In his ordinary state of health, strength and spirits; in his ordinary degree of his
skill and dexterity, he must always lay down the same portion of his ease, his liberty, and
his happiness. The price which he pays must always be the same, whatever may be the quan-
tity of goods which he receives in return for it … Labour alone, therefore, never varying in its
own value, is alone the ultimate and real standard by which the value of all commodities can
at all times and places be estimated and compared. It is their real price; money is their
nominal price only.

Schumpeter (1954, p. 188), in his History of Economic Analysis, notes that although Smith
has been credited with a labour theory of value (or rather three incompatible labour the-
ories), his theory of value is no labour theory at all. He also notes that Smith was ignorant
of the index number method which had already been invented by then, and therefore
chose labour as a numeraire.
However, Smith was clear that labour was the rule of exchangeable value in only an
early and rude state of society preceding the accumulation of stock and appropriation
of land. In such a society, if it requires two man days of labour to kill a beaver and one
man day to kill a deer, then one beaver will exchange for two deer. But once stock has accu-
mulated and land has become private property, the natural price of every commodity
resolves itself into three component parts, namely wages, profit and rent, all determined
according to their natural rates. But does this cost of production theory of price imply
constant costs? In Smith, as a result of productivity gains arising out of the division of
labour, the natural price of a commodity has a tendency to fall in the long run (WN, II,

5
See Hicks (1989) for a fuller discussion of the assumption of constant returns to scale.
 REVIEW OF POLITICAL ECONOMY 5

271–2).6 Also, with progress of improvements, the real price of manufactures tends to fall
(WN, I, 269). Thus the notion of natural price based on a cost of production theory does
not necessarily lead to constant costs, contrary to what Kaldor thought. Moreover, since
the division of labour depends on the extent of the market, demand considerations are
not altogether missing from Smith’s falling long-run supply curve.
Secondly, Smith had an evolutionary perspective towards society. He viewed a system
in a state of internally generated change. It is true that Smith made a few observations in
his price and distribution theory which may be akin to equilibrium economics. For
example, he argued that the market price of a commodity had a tendency to gravitate
towards its natural price in the long run. He also stated that the rate of profit in
different employments tends towards equality. But he regarded these as ‘tendencies’ and
not definite end results. These tendencies are attributed to the operation of competition,
but competition also leads to economic change. On balance, whether competition pro-
duces equilibrium or change depends on the relative strength of these forces. Young
pointed out that forces of disequilibrium are continuously defeating the forces producing
equilibrium.7 Thus economic equilibrium is not a true characterisation of a competitive
economic system; it acquires plausibility if Smith’s theory of economic evolution is
ignored (Richardson 1975, p. 351).8
Thirdly, Smith made a deep study of systems, conditions and institutions to arrive at
the arrangements best suited for economic progress.9 Indeed, much of the Wealth of
Nation is devoted to such a study, which Kaldor overlooked perhaps because he
thought that the book took a wrong turn after chapter 3. Smith’s conclusion was that
all systems based on preferences and restraints retard, rather than accelerate, the progress
of society to true wealth and greatness. For example, slavery discouraged inventiveness as
most inventions were the work of freemen. Similarly, agricultural systems tried to promote
agriculture by putting handicaps on manufacturing and commerce. But this only tilted the
terms of trade against agriculture, thereby achieving a result opposite to the true intention
of this system. Smith also criticised mercantilism which, by protecting industries, bred
monopolies at home and diverted resources from more productive uses to less. Moreover,
this system wrongly considered production, and not consumption, as the end of all indus-
try and commerce. Further, it considered wealth to consist of precious metals such as gold
and silver, and therefore advocated interference in foreign trade to build up an export
surplus. Smith pointed out that chief benefit of foreign trade was not the import of gold
and silver, but the division of labour resulting from the enlarged market.
Thus the system of natural liberty is the best from the point of view of growth. This
system naturally establishes itself once all systems of preferences and restraints are
taken away. Each man is allowed to pursue his own interest his own way provided he
does not violate the laws of justice. Excessive greed of man is controlled through the oper-
ation of competition. The state is freed from superintending the industry of the private

6
See also Young (1990, p. 45) who draws downward sloping demand and supply curves, where the demand curve is
described as the reciprocal of the supply curve of other industries. Given elastic demand for other goods, the increased
production of the good in question results in continuous shifts in its demand curve.
7
“[T]he counter forces which are continually defeating the forces which make for economic equilibrium are more pervasive
and more deeply rooted in the constitution of the modern economic system than we commonly realise” (Young 1928,
p.533).
8
See also Chandra (2004a) for elaboration of the theme that Smith was not chiefly an equilibrium theorist.
9
See Chandra (2004b) for an elaboration of Smith’s institutional approach.
6 R. CHANDRA

people, and directing it towards employments most suitable to the interest of society. Lib-
erated from such unnecessary attentions, the state confines itself to three main functions,
namely defence, justice and public works. While facilitating growth, such a system is also
fair to the poor since even an ordinary worker can enjoy a standard of living many times
higher than an African king.
Finally, Smith also made a deep analysis of the motive power of self-interest and the role
it plays in economic progress. Each man has an inborn desire to better his condition, ‘a
desire which comes with us from the womb, and never leaves us till we go to the grave’
(WN, I, 363). Smith tells us that bodily needs of man are easily satisfied, so he wants to
become rich to gain status, rank and recognition in society. Thus self-interest of each
man propels him to become rich, and he can only become rich by saving and accumulat-
ing.10 Since each man is the best judge of his own self interest, he should be left free to
pursue it. Institutional arrangements should ensure two things: liberty and security.
Once these are provided, the natural effort of each individual to seek economic betterment
is such a powerful motive that it is capable of taking, not only him, but the whole society to
riches and prosperity. Smith, therefore, placed great emphasis on the provision of liberty
and security in his system of natural liberty. Comparing Britain’s relative prosperity in
comparison to Portugal and Spain, Smith observed that while in Britain industry was per-
fectly secure (and as free or freer than any other part of Europe), in the other two countries
industry was neither free nor secure (WN, II, 50).
To summarise the discussion so far, Smith had much to contribute after the middle of
chapter four of the Wealth of Nations. Nor did Smith abandon increasing returns for the
rest of the book. As we have seen Smith’s foray into value partly arose as he was grappling
with measuring aggregate economic change, or the index number problem. His natural
price has a tendency to fall in the long run as a result of improvements brought about
by the division of labour. This implies falling long-run costs rather than constant costs.
Smith’s evolutionary approach, his analysis of the motive power of self interest, and the
institutions best suited to growth, all point to the fact that he did not give up on increasing
returns. Smith linked the study of increasing returns with the institutional-motive factors;
he linked their fuller realisation to the system of natural liberty.11

3. Increasing Returns: Sectoral or Generalised?

Kaldor interpreted Smith and Young as saying that while manufacturing is subject to
increasing returns, agriculture is a diminishing returns sector.12 Admittedly, Smith did
give the impression that the division of labour was better carried out in manufacturing
than in agriculture. For example, his pin-factory illustration is taken from manufacturing,
and not from agriculture. Smith argued that if each man were to undertake all the oper-
ations of pin making, his output would be minimal. If each worker, on the other hand,
10
“Capitals are increased by parsimony, and diminished by prodigality and misconduct” (WN, I, 358).
11
Perhaps Kaldor’s remark that economic theory went wrong after chapter three of the Wealth of Nations was not meant
seriously. What he may have actually meant was that increasing returns and the division of labour no longer played a part
in understanding the evolution of economies and their growth performance particularly where they are faced with
supply-side constraints such as labour and foreign exchange shortages. See Thirlwall (1987, pp. 190–191).
12
Perhaps Kaldor, while regarding manufacturing as subject to increasing returns in line with Smith, did not invoke his
support for his view that manufacturing is special. As we shall see, he arrived at this view of special nature of industry
on empirical grounds and because of its greater elasticity of demand.
 REVIEW OF POLITICAL ECONOMY 7

specialises in a particular process or operation, this would have a dramatic impact on total
output and per worker productivity. Similarly, in each line of manufacture when different
trades join hands to produce a final product (e.g., a woollen garment), the impact on pro-
ductivity is equally dramatic. The nature of agriculture, however, is different; it does not
admit of so many subdivisions of labour, nor of so complete a separation of one business
from another, as manufactures. ‘It is impossible to separate so entirely, the business of
the grazier from that of the corn farmer, as the trade of the carpenter is commonly separated
from that of the smith’ (WN, I, pp. 9–10). Smith also pointed out that nations differed from
each other more in the state of their manufacturing than of their agriculture (WN, I, 10).
However, Smith did not say that manufacturing should be promoted vis-à-vis agricul-
ture or within manufacturing one industry should be favoured at the cost of another. In
fact Smith was against all favours and privileges. In his system of natural liberty,
favours and privileges find no place. He criticised the mercantilist policy of favours to
industry as it diverted resources from more productive uses to less. Any artificial direction
of economic activity would also diminish the total revenue of a country, reduce its saving
and investment rates, and therefore, the pace of economic progress. Smith (1776, I, p. 479)
writes:
The industry of a society can augment only in proportion as its capital augments, and its
capital can augment only in proportion to what can be gradually saved out of its revenue.
But the immediate effect of every such regulation is to diminish its revenue, and what dimin-
ishes its revenue is certainly not very likely to augment its capital faster than it would have
augmented of its own accord, had both capital and industry been left to find out their natural
employments.

Because mercantilist regulations favoured industry at the expense of agriculture, Smith in

fact talked of giving priority to agriculture. This priority was to arise in the natural course
of things and not as a result of a deliberate policy of favours to agriculture. Smith observed
that in the natural course of things, capital of a country is first employed in agriculture,
then in manufacturing and finally in foreign commerce (WN, I, 405). This natural
sequence results from the desire of investors for security so that the capital employed
remains, as much as possible, under their view and command. Moreover, subsistence,
in Smith’s opinion, is prior to conveniency and luxury; so the progress of the country is
prior to the increase of the town (WN, I, 402). Mercantilist favours to industry upset
this ‘natural progress of opulence’. Some scholars (e.g., Hollander 1971, 1973; Reid
1989) have argued that the priority to agriculture in Smith is also in response to higher
rates of return in agriculture than in manufacturing.
Buchanan and Yoon (1999, 2000) have shown that the Smithian proposition relating
the division of labour to the size of the market is best understood in terms of a generalised,
rather than sector-specific, notion of increasing returns. They (Buchanan and Yoon 2000,
p. 46) point out:
In its minimalist formulation, the Smithean proposition does not normatively imply or
require any classification or distinction among separate industries or sectors of the
economy. It implies only that a larger economic nexus is more efficient than a smaller one
because specialisation is more fully exploited.

As for Young (1928), he had a macroeconomic notion of increasing returns. He pointed

out that if we look for increasing returns under individual firms or industries, even if they
8 R. CHANDRA

are large, we are likely to miss them. He also stressed the need to view the industrial oper-
ations as an interrelated whole.13 Increasing returns lie outside a particular firm or indus-
try, and mainly take the form of pecuniary external economies.14 As the size of the market
expands, because of productivity gains, reductions in costs and prices become possible.
Thus the system transmits pecuniary external economies in the form of reduced costs
and prices. The greater the competition, the more effective is their transmission. It is
important to realise that this result is not conditional on the presence of perfect compe-
tition, only that more competition is preferred to less. Young, like Smith, therefore stressed
the need for competition in the realisation of increasing returns.
Young also had an inclusive view of the market size. In his view market is better under-
stood in terms of buying power rather than in terms of area or population. He (Young
1928, p. 533) argued:
In an inclusive view, considering the market not as an outlet for the products of a particular
industry, and therefore external to that industry, but as the outlet for goods in general, the
size of the market is determined and defined by the volume of production.

This implied the view of market as ‘an aggregate of productive activities, tied together by
trade’. Thus Young viewed all sectors, including agriculture, in a trade relationship with
each other.
This inclusive view of the market, in Young’s opinion, also implies reciprocal nature of
trade relationships. For example, growth of a sector constitutes a demand for the products
of other sectors, and growth in these sectors generates demand for the original sector. Thus
the rate at which one sector grows depends on the rate at which other sectors grow, and
vice versa. Since the elasticities differ across sectors, different sectors will grow at different
rates, some faster than the others. But the important point is that increasing returns are
better realised, not by taking a narrow or sectoral view, but by looking at the economy
as an interrelated whole. A narrow view of increasing returns only leads to promotion
of a particular sector at the cost of others, upsetting the reciprocal trade relationships.
This hinders, rather than facilitates, the realisation of increasing returns in the broader
Youngian sense.
Finally, did Young view agriculture as a diminishing returns sector in the sense that it
could be made the basis for gloomy prospects for the economy as a whole? Young was of
the view that the law of diminishing returns taken as a statement of tendency was not
wrong, but taken as a prophecy it was certainly mistaken.15 While population had
increased considerably, real rents in the older parts of the world had not increased.
Young believed that although the law of diminishing returns was operative, it had been
counteracted by other powerful factors such as improvement in agricultural techniques

13
“[T]he mechanism of increasing returns is not to be discerned adequately by observing the effects of variations in the size
of an individual firm or of a particular industry, for the progressive division and specialisation of industries is essential part
of the process by which increasing returns are realised. What is required is that industrial operations be seen as an inter-
related whole” (Young 1928, p.538).
14
Young built on Marshall’s distinction between internal and external economies but stated that this was a partial view of
the matter as the summing up of all internal economies of individual firms does not give us the available external econ-
omies. Secondly, as the external environment changes continuously, Marshall’s representative firm loses its identity and
becomes a specialised firm. Thus increasing returns do not result from any relationship between prime (variable) and
supplementary (fixed) costs as Marshall thought.
15
For an elaboration, see Young (1929) [Reprinted in Mehrling and Sandilands (1999), pp. 115–134] and Ely et al. (1926),
especially the chapter on the rent of land written by Young.
 REVIEW OF POLITICAL ECONOMY 9

and revolution in the means of transport. Young also believed that the principle of dimin-
ishing returns operated in an exceedingly elastic manner, and did not pose any fixed or
rigid barrier to economic progress. Thus even if agriculture is regarded as a diminishing
returns sector, it does not constitute a formidable barrier to economic progress, contrary
to what some of the classical authors such as Ricardo and Malthus believed.
To sum up, both Smith and Young had a sophisticated understanding of increasing
returns and the general prospects for economic progress. Both emphasised the role of
competition in their fuller realisation. Both emphasised a framework of ‘no favours, no
handicaps’. Kaldor, on the other hand, thought that since increasing returns are
confined to manufacturing only, this sector needs to be promoted at the cost of
others.16 This led him to suggest dirigiste policy measures totally at odds with the
Smith-Young approach. Perhaps his emphasis on manufacturing owes something to his
empirical bent of mind which led him to give prominence to Verdoorn’s Law.17
Kaldor regarded manufacturing as an engine of growth, and taking a cross section of
twelve developed countries over the period 1952/54 to1963/64, Kaldor estimated a
strong correlation between GDP growth and manufacturing growth. This leads to
Kaldor’s first growth law which states that there exists a strong relationship between
manufacturing growth and overall growth. Kaldor’s second law, which is also known
as Verdoorn’s Law, states that there is a strong positive (causal) relationship between
the growth of manufacturing output as the independent variable and the growth of
manufacturing productivity.18 Kaldor also found that the growth of manufacturing
employment was strongly dependent on the growth of manufacturing output. Kaldor
later conceded that there could be a two-way causation between manufacturing produc-
tivity growth and manufacturing output growth in a framework of circular cumulative
causation. He also suggested that manufacturing growth may itself be driven by export
growth.19
Thus while being influenced by the Smith-Young approach to increasing returns,
Kaldor’s emphasis on manufacturing perhaps shows the overriding influence of
Verdoorn’s Law on his thinking and of the idea that manufacturing is an engine of
growth, even though the Smith-Young framework is opposed to a policy of favours and
privileges.20 While in the Smith-Young approach winners and losers emerge from the

16
For a self-generating growth process in Young commodities have to be produced competitively with the assumption of
elastic demand. This, apart from his empirical mind set, may have led Kaldor to emphasise the promotion of industry
through policy intervention.
17
For a fuller discussion of Kaldor’s growth laws, of which the second is also known as the Verdoorn’s Law, see Thirlwall
(1987), Chapter 7. Thirlwall mentions that Kaldor was the first to use the term Verdoorn’s Law in print although he
had heard Arrow use it in conversations in connection with models of learning-by-doing. Although Verdoorn wrote
his paper in 1949, it was neglected for a long time possibly because it was published in Italian.
18
Kaldor’s growth laws were first articulated in his lectures at Cambridge and Cornell universities in 1966. See Causes of the
Slow Rate of Economic Growth in the United Kingdom (Kaldor 1966) and Strategic Factors in Economic Development (Kaldor
1967).
19
Herein lies a contradiction in Kaldor’s thinking. If manufacturing growth depends on export growth, it is better to
promote exports in a neutral policy framework (which does not discriminate between domestic production and
exports) if efficient industrialisation is the objective.
20
Perhaps Kaldor also thought that Allyn Young’s reasoning regarding elasticity of demand and supply provided the under-
pinnings to Verdoorn’s law. As his biographer Thirlwall (1987, pp. 184–185) observes: “Kaldor, in the spirit of Allyn Young,
his early teacher at the LSE, conceived of returns to scale as a macroeconomic phenomenon related to the interaction
between the elasticity of demand for and supply of manufactured goods. It is this strong and powerful interaction which
accounts for the positive relationship between the growth of manufacturing and productivity growth, otherwise known
as Verdoorn’s Law.”
10 R. CHANDRA

growth process itself and cannot be identified a priori for policy purposes, Kaldor’s empir-
ical bent of mind led him to use policy to promote exports and manufacturing.21 Another
factor was that income and price elasticities of demand were greater in manufacturing
than in other activities, so in his opinion, policy needed to promote manufacturing.

4. Youngian Growth Mechanism and Keynesian Aggregate Demand

Young considered the supply-demand apparatus as partial tools, and did not regard them
as suitable for the study of increasing returns. If, nevertheless, one insisted on using them
they are better used in a reciprocal sense. He assumed that commodities are produced
competitively under conditions of increasing returns, and the demand for each commod-
ity is elastic in the special sense that a small increase in its supply will be attended by an
increase in the amounts of other commodities which can be had in exchange for it. ‘Under
such conditions an increase in the supply of one commodity is an increase in the demand
for other commodities, and it must be supposed that every increase in demand will evoke
an increase in supply’ (Young 1928, p. 534).
Kaldor agreed that while an increase in demand may evoke an increase in supply, the
reverse may not always be true. Kaldor (1972) also felt that elasticity of demand by itself
may not ensure a perpetuation of the Youngian growth mechanism unless it is supple-
mented by the Keynesian theory of income generation. Kaldor reasoned that an increased
offer of a good facing elastic demand will lead to a diversion of purchasing power from
other products. So the deficiency of aggregate demand has to be made good by
‘induced investment’ which either takes the form of increased stocks of traders in the
case of agricultural commodities or increase in the capacity of manufacturers. Thus,
according to Kaldor (1972, p. 1252), there is an important role for a ‘monetary and
banking system which allows the money supply to grow in automatic response to an
increase in demand for credit’.
In a letter to Kaldor written in 1978, Currie insisted that an increase in investment in
the Keynesian sense is not the key to increase in aggregate demand.22 Kaldor’s argument
regarding the substitution of purchasing power in favour of a good facing elastic demand
assumed that there was no slack in the system, an assumption not in accordance with
reality in developing countries. In Currie’s opinion, an increase in supply could come
from previously underutilised factors, so a Keynesian-type boost to investment may not
be necessary. In Currie’s (quoted in Sandilands 1990, pp. 298–299) words:
Is there not, in your observation, an implicit assumption that there is no slack in the system –
a useful expository assumption but hardly in accordance with reality, especially in LDCs? If
the increased supply came from the work of previously underutilized factors, there need be
no diminution in the aggregate production of goods and hence, in the Sayian sense, in aggre-
gate demand … [I]t is not the increase in investment in the Keynesian sense that is the key
but the increase in output arising from (a) the economies of scale induced by actual growth

21
See Douglass Wass (1987, p. xiii) who stated: “Kaldor’s empiricism and his passionate moral sense were the two factors, I
think, that impelled him to seek to contribute to public-policy making.”
22
Currie’s letter to Kaldor dated January 16, 1978 is reproduced in Sandilands (1990), pp. 298–303. Sandilands does not
publish Kaldor’s reply but states: “Kaldor’s subsequent writings on Allyn Young basically repeat his earlier interpretations,
but Currie continued to explore the subtle reasoning of Young’s seminal but little understood article in a number of sub-
sequent publications, notably in his book on economic advisers, completed in 1979, and in a paper published in 1981”
(Sandilands 1990, p. 303).
 REVIEW OF POLITICAL ECONOMY 11

(b) the taking up of slack (unemployed labour) or (c) the possible economies of more round-
about production (a special Harrod Domar case of increased productivity from division of
labour and specialization).

Currie (1997) also criticised Kaldor for his one-thing-at-a-time thinking. While Young
was thinking in barter terms, Kaldor shifted the premises to a money economy. Currie
agreed that the provision of enough additional money helps the barter system to work
out more smoothly; nevertheless, the barter mechanism is constantly working under the
money system to stimulate demand and supply. For example, even in a period of recession,
improvements and cost reductions are continuously occurring. This has the impact of
increasing real demand, which in turn leads to an increase in production. Currie (1997,
p. 419) points out that in every recovery while money flows are important, ‘what is lost
in the explanations are the improvements, the economies of scale, and the spread of
knowledge in the catching up process that activate thousands and even millions of
producers’.
In his leading-sector model of growth, Currie (1974) makes an important distinction
between Keynesian monetary demand and Sayian inter-sectoral demand.23 While the
former may be effective in stimulating an economy undergoing depression, it may have
little impact in an economy where the slack is due to low mobility and low utilisation
of equipment, and where institutional barriers to greater mobility and better utilisation
exist. In such an economy, expansion of monetary demand may lead only to inflation.
By contrast, measures to ensure better mobility or better combination of factors are
likely to increase real output even if aggregate money demand were to be falling (Currie
1974, p. 4).
Young (1928) had stated that the division of labour in large part depends on the divi-
sion of labour. From this Currie (1981, p. 55) concluded that the main cause of growth
is growth itself. ‘Just as growth has a tendency to beget growth, so, it would seem, a
given rate of growth has a tendency to continue at that rate’. Thus given the institutional
and policy framework, the same rate of growth has an inherent tendency to perpetuate
itself. This happens through the working of what he termed as the ‘Youngian multiplier’.
Given the reciprocal nature of exchange, a change in a given sector sets into motion a
cumulative process which is not confined to the sector where it initially occurred.
Expansion in the output of a sector constitutes a demand for the products of the rest
of the economy; expansion of the rest of the economy in turn stimulates the original
sector. As Currie (1983, p. 45) explains: ‘The multipler effect arises because a constant
rate of growth, through compound interest, leads to progressive increase in absolute
figures and hence is more truly a multiplier than the multiplier of Keynes’. So while
the Keynesian autonomous expenditure multiplier eventually fizzles out, the Youngian
multiplier is endogenous in character, and keeps the economy in a state of self-perpet-
uating growth.
The process of endogenous change is inbuilt in the Youngian reciprocal demand mech-
anism. Improvements are occurring continuously, making for endogenous expansion of
the overall market, even in an economy caught in a recession. Thus while additional
money creation may be helpful in the smooth working of the barter system, the Keynesian
mechanism diverts attention from the endogenous forces of demand to the exogenous
23
For an assessment of Currie’s leading-sector strategy see Chandra (2006).
12 R. CHANDRA

elements. According to Currie (1997, p. 419): ‘What a theory of growth has to explain is
the underlying but strong tendency toward increasing returns in the whole economy, so
that deviations from the trend are largely self-correcting’.
Why did Kaldor underestimate the potential of the reciprocal-demand mechanism to
produce self-sustaining growth? Again his empirical bent of mind had something to do
with this. In the aftermath of the Great Depression, Kaldor was influenced by the Keynes-
ian revolution. So he wanted to supplement Youngian analysis with Keynesian insights.
Even Young had stated that business cycles are caused by mismatches, not in aggregate
demand and supply, but in individual demand and supply. In the expansion phase of
the business cycle, excessive credit expansion in certain sectors (e.g., luxury products)
leads to a situation where the structure of capacity and demand become mismatched.
Therefore, Young advocated an activist monetary policy based on central bank discretion
(rather than rules) to control the business cycle. He also emphasised the collection and
dissemination of information in this regard so that businesses do not over-expand. He
also advocated public works on their own merit even if they are not linked to additional
money creation. While Young, in line with Smith, was happy to leave growth to compet-
itive forces of the market, controlling the business cycle required intervention aimed at
specific sectors or industries.

5. Kaldor’s Dirigiste Mind-set

In this section, we analyse Kaldor’s interventionist approach to policy.24 Although he was
influenced by the Smith-Young approach to increasing returns, his interventionist
approach to policy is out of line with this framework. To start with, Kaldor was in
favour of continuing the war-time controls such as rationing, price controls, import con-
trols and controls over capital outflows. He also wanted public ownership in key indus-
tries. In a series of letters in The Times, he propagated planning, and was critical of the
Labour government for running a planned economy without a plan.
Kaldor believed that manufacturing was an engine of growth. The basic reason, in his
opinion, for differences in cross-country growth rates was the different rates of growth of
manufacturing. Thus manufacturing was special, for it was not only subject to increasing
returns (while other sectors were not), it was a sector where major labour saving advances
in technology took place. For these reasons Kaldor felt that there was a strong observed
relation between productivity growth and output growth in manufacturing (Verdoorn’s
Law), a relation not generally observed in other sectors. Thus Kaldor wanted to
promote manufacturing through a policy of subsidies and protection to this sector. He
opposed Britain’s entry into larger European Economic Community arguing that a
country which started weak in the growth race would continue to suffer disadvantage
through the application of the principle of circular cumulative causation. He also
warned that Britain might become the Northern Ireland of Europe if it entered the com-
munity on the wrong terms. In his paper ‘The Nemesis of Free Trade’, Kaldor (1978a)
argued that free trade may be a good policy under constant costs but under conditions
of increasing returns it may lead to greater benefit to some countries (or regions) at the
24
For details of Kaldor’s dirigiste policy approach see Thirlwall (1987), particularly Introduction, Chapters 4 and 9, and Thirl-
wall (1989).
 REVIEW OF POLITICAL ECONOMY 13

cost of impoverishment of others. Thus Kaldor seemed to agree with Myrdal (1957) that
international free trade only accentuated international inequalities; and developing coun-
tries would therefore be better off if they industrialised behind tariff and non-tariff barri-
ers. In Kaldor’s (1978a, p. 239) opinion, protectionism was not only a good policy for
developing countries, but it was good even for a country like Britain. In the initial
stages of her industrial revolution free trade suited Britain perfectly. But in the face of
increasing protectionism by countries such as Germany, France, United States and
Japan, ‘British exports were chased from pillar to post, as one market after another
became closed’. Kaldor comes to the conclusion that had Britain not been ideologically
wedded to free trade, the living standards would have been much higher, even though
with the spread of the industrial revolution to the rest of Europe and North America
her industrial pre-eminence would have declined.25
To give a boost to manufacturing and manufacturing exports, Kaldor (1964) recom-
mended a system of dual exchange rates. In Kaldor’s opinion, a uniform devaluation to
boost exports was not only fraught with danger but also uncertain of success, given the
inelastic nature of world demand for primary exports as well as inelastic demand for devel-
oping country imports. Under the dual exchange rate system the fixed official rate would
apply to primary commodity exports and all essential imports, while a free market rate
would apply to non-essential imports and exports of manufactured goods. To ensure
that primary commodity export proceeds are surrendered at the official rate, state
owned marketing boards could be instituted. However, apart from the administrative
problems, the policy of a dual exchange rate discriminates against agriculture and agricul-
tural exports. If the agriculture sector constitutes an important source of demand for the
products of the industrial sector, this policy may ultimately go against the long-term
growth prospects of the industrial sector itself.26
As a tax adviser, to Britain and many developing countries, Kaldor favoured expendi-
ture tax on the grounds that expenditure is a better measure of ability to pay than income,
particularly when spending power also depends on accumulated wealth. Apart from the
administrative feasibility of implementing such a tax, the wisdom of treating saving and
consumption differentially from the point of view of growth is also doubtful. Smith had
highlighted the virtues of thrift, but he did so only because accumulation as a motive
was such a strong force that it was capable of taking not only an individual but the
whole society to wealth and riches.27 In any case, Smith did not say that savings needs
to be promoted by interfering with the system of natural liberty. It is important to

25
“But I have little doubt that with a protected home market we could have enjoyed much higher growth rates and as a
result we would now have much higher living standards and more secure employment. Even a 1 per cent addition to our
annual growth rate in the century following 1873 would have meant that our living standards today would be nearly
three times higher than what they are” (Kaldor 1978a, p. 241).
26
Kaldor (1967) recognised the role of agricultural surplus in economic development. In a two-sector framework, he rec-
ognised that limits on industrial growth could arise from the rate of land saving technical progress in agriculture (to offset
diminishing returns). Kaldor also developed a structuralist theory of inflation recognising that agricultural bottlenecks
could boost inflation in the Latin-American context. At the same time, he made policy recommendations which favoured
industry and discriminated against agriculture, turning the internal terms of against it. This is another contradiction in
Kaldor’s thinking.
27
Smith did not always have a negative attitude towards consumption of the rich. After all, it is the desire for trinkets and
baubles, and not subsistence, which motivates man to accumulate and become rich. Smith also criticised the restrictions
on the import of luxuries, and advised governments to look after their own economy rather than watching over the
economy of the private people. In the Theory of Moral Sentiments, consumption of the rich is seen as a means of distrib-
uting subsistence to the poor.
14 R. CHANDRA

realise that he emphasised saving as a motive but not as a policy.28 Thus promotion of
saving ultimately arises from the notion that the main constraint on growth is saving.
By contrast, in the Keynesian thinking, saving is not seen as a constraint on investment.
Likewise, in the Smith-Young endogenous growth framework, saving and investment are
not seen as major constraints on growth. In this demand-based view they are more an
effect than a cause of growth. Differential treatment to saving implies that growth is
resource constrained, and this contradicts Kaldor’s own thinking which emphasises the
resource generation (or creative) function of markets as opposed to their function of allo-
cating a ‘given’ volume of resources.
In his famous essay on the ‘Causes of Slow Rate of Economic Growth in the United
Kingdom’, Kaldor (1966) stressed labour shortage as the major constraint in manufactur-
ing.29 One of the reasons for introducing Selective Employment Tax (SET) on services was
to speed up the transfer of labour to manufacturing, which was viewed as an increasing
returns sector, from the services sector which was not. This also amounted to subsidising
manufacturing at the cost of putting a handicap on services. This was quite similar to the
Pigovian idea of subsidising increasing returns industries and taxing the diminishing
returns industries to maximise social gains. Pigou based his analysis on the assumption
that it is indeed possible to classify industries in this way. However, as Clapham (1922)
demonstrated, any empirical attempt to identify such industries only leads to empty eco-
nomic boxes.30 Kaldor’s obsession with manufacturing led him to promote manufacturing
at the expense of handicaps to other sectors. But he failed to realise that winners and losers
emerge from the growth process itself and cannot be identified a priori. As Young noted,
different industries have different elasticities of demand and supply, and for that reason
rates of growth are likely to differ among them. But it does not imply that it is possible
to pick and promote winners on an a priori basis.31 As Buchanan and Yoon (2000,
p. 46) observe:
There may be a generally acknowledged prediction to the effect that nonsymmetery rather
than symmetry will characterize patterns of specialization that emerge as the effective size
of the market expands. But precisely because these patterns remain necessarily emergent
rather than already realized, empirical observation offers little assistance in prior
identification.

Moreover, favours to industry represent a distortion in the inter-sectoral trade relation-

ships, and therefore are inimical to growth. For example, protection to industry implies
disprotection to exports and agriculture.32 This implies that undeveloped agriculture

28
Smith believed that although some people in society may be spendthrift, man by nature was parsimonious, so much so
that “the principle of frugality not only seems to predominate, but to predominate very greatly” (WN, I, 363). Thus public
prodigality is to be feared more than the private prodigality. “Great nations are never impoverished by private, though
they sometimes are by public prodigality and misconduct” (WN, I, 363). In general, frugality and good conduct of most
people in society is sufficient not only to compensate private extravagance but also the public misconduct of
governments.
29
The diagnosis of a labour constraint on manufacturing was termed “wrong” even by his biographer Thirlwall (1987, p. xv).
30
Clapham in his stimulating article challenged economists to classify a commodity like hats in accordance with the laws of
returns. He believed it was impossible to classify hats into boxes of constant, decreasing and increasing costs; if an econ-
omist visiting a hat shop tried to do so, he may end up with “empty economic boxes”.
31
In Currie’s (1981, p. 54) opinion Clapham’s position comes closest to Young “who was reluctant to speak of an industry of
increasing returns even as an hypothetical example”.
32
Studies on the effective rate of protection suggest that protection to industry leads to negative effective protection to
exports and agriculture. Moreover, the larger the variation of protection rates within industry the larger is the distortion
to the economy in terms of effective protection rates.
 REVIEW OF POLITICAL ECONOMY 15

would constitute a drag on manufacturing demand. Also, an inward-oriented framework

created by protectionism to industry is unfavourable to exports, both from agriculture as
well as manufacturing.33 Further, favours to industry may also tilt the terms of trade
against agriculture thereby distorting the inter-sectoral allocation of resources. Thus the
policy of favours to manufacturing and restraints on other sectors is no different from
the mercantilism which Smith had criticised.34
Kaldor’s interventionist bent of mind requires an explanation. First, he was deeply
influenced by the Keynesian revolution. Although in his initial years as an academic he
was influenced by Robbins and Hayek, he gradually discarded the narrow Austrian
view of economics and the libertarian philosophy it implied. Kaldor was one of the first
converts from the LSE to the Keynesian way of thinking, but believed in a more dirigiste
approach to policy making than Keynes (Thirlwall 1987, p. 11). Secondly, Kaldor was also
attracted to Myrdal’s theory of cumulative causation35 which views market forces and
international trade as promoting inter-regional and international inequalities.36 In line
with Myrdal, Kaldor believed that an inward-oriented model of growth in a planned
framework was the best strategy for developing countries. Thirdly, Kaldor was a professed
socialist, and his concern for the underdog and for social justice attracted him to the left of
the political spectrum. Although not a revolutionary, he believed in democratic means to
bring about change. Perhaps for that reason he was attracted to the Labour Party, and con-
tributed effectively in its policy formulation. He also influenced policy through the impor-
tant positions he occupied when Labour was in power.37 Lastly, with his attack on
neoclassical equilibrium theory, he also seems have discarded the neoclassical stress on
markets in favour of intervention.38

6. Conclusions
To Kaldor’s credit, he emphasised a disequilibrium approach to economics. He regarded
equilibrium economics as largely irrelevant to the nature and the manner of the operation
of economic forces. He emphasised the creative function of markets as opposed to their
33
Although Kaldor realised the importance of export growth in stimulating the manufacturing sector, the inward-oriented
policies he recommended were ultimately unfavourable to export growth. Exports are best promoted in a neutral frame-
work where policies do not discriminate between export and domestic production (See, for example, World Bank 1987).
This requires moderate tariffs (preferably uniform rate of tariff), absence of quantitative restrictions, and realistic
exchange rates (i.e., absence of multiple or overvalued exchange rates).
34
Some authors (e.g. Thirlwall 1987) would like to make a distinction between favours to particular industries and favours to
the entire sector, where Kaldor is seen to have made a case. In their opinion, the current distortion in the allocation of
resources could perhaps be justified to build the future or dynamic areas of comparative advantage.
35
For a comprehensive study of the theory of cumulative causation see Toner (1999).
36
As Kaldor (1978a, pp. 237–238) stated: “This is a point which Adam Smith – who laid the strongest emphasis on the
benefits of ‘the division of labour’ which depend ‘on the extent of the market’ – certainly did not perceive”. See also
his Okun Memorial Lecture on ‘Interregional Trade and Cumulative Causation’ (Kaldor 1985, pp. 55–79).
37
“When the Labour Party assumed power in 1964 he was the natural choice for appointment as a Special Adviser to the
Chancellor of the Exchequer. During the period of the labour government 1964–70, Kaldor probably exerted more
influence on economic policy-making in the United Kingdom, directly and indirectly, than any other economist this
century, bar Keynes” (Thirlwall 1987, p. 6). Thirlwall also mentions that Kaldor’s appointment, along with that of his Hun-
garian compatriot Thomas Balogh, was not well received in the press. They were depicted as the “Hungarian Mafia” or the
“Terrible Twins” about to launch an East European economic experiment on the British people by squeezing out the cap-
italist class.
38
Kaldor was right in criticising the neoclassical orthodoxy, and its assumptions. But the neoclassical emphasis on markets
was not entirely incorrect, although it may have arisen from the wrong premises. The Smith-Young approach also stresses
competition and markets, but only as instruments for realising increasing returns, and not as instruments to bring about
Pareto-optimal results. Perhaps Kaldor was guilty of throwing out the baby with the bath water.
16 R. CHANDRA

allocative role. This implied that resource creation function of the market is more impor-
tant than the optimum allocation of given resources. The allocation problem, in his
opinion, elevated the principle of substitution to the centre stage, and ignored the comple-
mentarity of different factors of production. He disliked the idea that production is supply
constrained, or resource constrained, instead of being demand constrained. He also rec-
ognised that accumulation of capital is more a by-product than a cause of increase in pro-
duction. All this is much in line with the Smith-Young approach to increasing returns.
Again to Kaldor’s credit, his advocacy of industrialisation under protection was in tune
with the mainstream post-war development strategies expounded by such luminaries as
Rosenstein-Rodan (1943, 1961), Nurkse (1953) and Myrdal (1957) who advocated an
import-substitution model of development. After all no country with the exception of
Britain and Hong Kong had industrialised without protecting its industries. As Balassa
(1980) [Reprinted in Meier (1989)] has shown it is not import substitution per se but
the more difficult second-stage import substitution (as it is almost entirely out of tune
with a developing country’s comparative advantage) which has ill effects. The first stage
import substitution is easy and can always be justified on infant industry grounds. The
second stage is much more difficult requiring sophisticated skills and technological capa-
bilities. Moreover, Kaldor retracted from many of his earlier views regarding labour short-
ages and dual exchange rates. For example, in 1967 Kaldor retracted from the view that the
UK growth was constrained by labour shortages. Similarly, the dual exchange rate system
while promoting manufactured exports also hurt agriculture. So the argument for the dual
exchange rate, which went back to 1964, was never repeated again. He made several pro-
posals like price support and stabilisation mechanism for agricultural products. Again, the
need to continue war-time controls into the post-war period was specific to Britain during
the 1940s and early 1950s. Finally, his expenditure tax proposals were based on equity or
ability to pay principle. In his opinion ability to pay was better measured by spending
power rather than income particularly when property owners spent from their accumu-
lated wealth. The proposal put forward in his book An Expenditure Tax (Kaldor 1955)
was complementary to his earlier work on the minority report of the Royal Commission
on the Taxation of Profits and Income constituted in 1951 of which Kaldor was a member.
While an expenditure tax was outside the terms of reference of the Royal Commission, and
therefore not implemented in Britain, it was introduced for the upper income groups in
India and Ceylon (now Sri Lanka) where he gave tax advice during 1956–58. In the
light of experience, Kaldor (1978b) later admitted that he had underestimated both avoid-
ance and evasion as well as political objections to the expenditure tax system (See also
Thirlwall 1987, p. 127).
However, Kaldor was wrong in thinking that increasing returns are confined to man-
ufacturing and special efforts should be made to promote it. Although Smith admitted that
the division of labour is better carried out in manufacturing than in agriculture, he did not
say that manufacturing needs to be promoted through subsidies or protectionism. In fact
he was bitterly opposed to all such mercantilist favours. As for Young, he viewed produc-
tive activities as an interrelated whole. He defined market in an inclusive sense of total
volume of production in which all activities are tied together by trade. He recognised
the reciprocal nature of exchange, which implied interdependence of various sectors of
the economy. Young was aware that favouring one sector at the cost of another would
upset and distort these inter-sectoral relationships. The aim of policy should be to facilitate
 REVIEW OF POLITICAL ECONOMY 17

exchange rather than distort it. To facilitate exchange, and to enlarge the total exchange
nexus, Smith had advocated several measures such as investment in transport and com-
munications, opening up to international trade and removal of restrictions on mobility
of labour (e.g., apprenticeship and settlement laws).
The Smith-Young framework leads to a policy of ‘no favours, no handicaps’. By con-
trast, Kaldor had a dirigiste mind set. Although he recognised the creative function of
markets, his policy prescriptions had the opposite effect of restricting the market forces.
His policy prescriptions such as continuation of war-time controls, an expenditure tax,
selective employment tax (SET), subsidies, tariff and non-tariff barriers to promote indus-
tries were mostly illiberal in character. As stated above, he retracted from many of these
proposals in the later years. While for Smith international trade and domestic economic
growth were two sides of the same coin,39 in Kaldor, international trade is viewed with
suspicion and, in line with Myrdal, is thought to promote international inequalities
rather than the general opulence of society.
It is also doubtful whether Kaldor fully understood Smith’s institutional context of
growth. Smith laid a lot of stress on institutional arrangements promoting liberty and
security. The system of natural liberty, which ensures both, is best suited to promote
growth. In this system, various forms of preferences and restraints find no place. This
system also provides the fullest expression to the motive power of self-interest. The exces-
sive greed of man is kept in check through the operation of competition in a framework of
justice. The state confines itself to a few basic tasks such as defence, justice and public
works. In Smith, therefore, increasing returns cannot be seen apart from the institutional
context. In Kaldor, on the other hand, a proper understanding of this context is missing.
He was influenced by the Smith-Young approach to increasing returns, but his dirigiste
policy approach is a far cry from the Smithian concept of natural liberty or the Smith-
Young stress on competition. It would therefore appear that his empirical mind-set and
the moral imperative to make things happen through policy overrode other considerations
such as his reading of the history of economic thought. Perhaps not too much weight
should be placed on his references to his predecessors.

Acknowledgements
The author is grateful to Roger J. Sandilands for reading through an earlier version of this paper. He
is also indebted to two anonymous referees for their constructive criticisms. The usual disclaimer
applies.

Disclosure statement
No potential conflict of interest was reported by the author.

References
Balassa, B. 1980. ‘The Process of Industrial Development and Alternative Development Strategies.’
Princeton University, International Finance Section, Essays in International Finance 141
(December): 4–12. Reprinted in Meier (1989).

39
See, for example, Myint (1977) who argued that Smith presented a unified analysis of foreign trade and domestic growth.
18 R. CHANDRA

Buchanan, J. M., and J. Y. Yoon. 1999. ‘Generalized Increasing Returns, Euler’s Theorem and
Competitive Equilibrium.’ History of Political Economy 31 (3): 511–523.
Buchanan, J. M., and J. Y. Yoon. 2000. ‘A Smithean Perspective on Increasing Returns.’ Journal of
the History of Economic Thought 22 (1): 43–48.
Chandra, R. 2004a. ‘Adam Smith and Competitive Equilibrium.’ Evolutionary and Institutional
Economics Review 1 (1): 57–83.
Chandra, R. 2004b. ‘Adam Smith, Allyn Young and the Division of Labour.’ Journal of Economic
Issues 38 (3): 787–805.
Chandra, R. 2006. ‘Currie’s “Leading Sector” Strategy of Growth: An Appraisal.’ Journal of
Development Studies 42 (3): 490–508.
Clapham, J. H. 1922. ‘Of Empty Economic Boxes.’ Economic Journal 32 (September): 305–314.
Currie, L. 1974. ‘The “Leading Sector” Model of Growth in Developing Countries.’ Journal of
Economic Studies 1 (1): 1–16.
Currie, L. 1981. ‘Allyn Young and the Development of Growth Theory.’ Journal of Economic Studies
8 (1): 52–60.
Currie, L. 1983. ‘The “Multiplier” in Economic Literature.’ Journal of Economic Studies 10 (3):
42–48.
Currie, L. 1997. ‘Implications of an Endogenous Theory of Growth in Allyn Young’s
Macroeconomic Concept of Increasing Returns.’ History of Political Economy 29 (3): 413–443.
Ely, R. T., T. S. Adams, M. O. Lorenz, and A. A. Young. 1926. Outlines of Economics. New York: The
Macmillan Company.
Hahn, F., and R. Matthews. 1994. ‘Nicholas Kaldor (Lord Kaldor) 1908–1986.’ Economic Journal
104 (July): 901–902.
Hicks, J. 1989. ‘The Assumption of Constant Returns to Scale.’ In Kaldor’s Political Economy, edited
by Tony Lawson, J. G. Palma, and John Sender. London: Academic Press.
Hollander, S. 1971. ‘Some Implications of Adam Smith’s Analysis of Investment Priorities.’ History
of Political Economy 3: 238–264.
Hollander, S. 1973. The Economics of Adam Smith. London: Heinemann.
Kaldor, N. 1955. An Expenditure Tax. London: Allen & Unwin.
Kaldor, N. 1964. ‘Dual Exchange Rates and Economic Development.’ In Essays on Economic Policy
II. London: Duckworth.
Kaldor, N. 1966. Causes of the Slow Rate of Growth in the United Kingdom. Cambridge: Cambridge
University Press.
Kaldor, N. 1967. Strategic Factors in Economic Development. New York: Ithaca.
Kaldor, N. 1972. ‘The Irrelevance of Equilibrium Economics.’ Economic Journal 82 (December):
1237–1255.
Kaldor, N. 1975. ‘What is Wrong with Economic Theory.’ Quarterly Journal of Economics 89 (3):
347–357.
Kaldor, N. 1978a. Further Essays on Applied Economics. London: Duckworth.
Kaldor, N. 1978b. ‘A New Look at the Expenditure Tax.’ In Collected Economic Essays 7. New York:
Holmes and Meier.
Kaldor, N. 1985. Economics Without Equilibrium. Cardiff: University College Cardiff Press.
King, J. E. 2007. ‘Kaldor’s War.’ Discussion Paper 25/07. Department of Economics, Monash
University, Australia.
Mehrling, P. G., and R. J. Sandilands, eds. 1999. Money and Growth: Selected Papers of Allyn Abbott
Young. London: Routledge.
Meier, G. M., ed. 1989. Leading Issues in Economic Development. 5th ed. Oxford: Oxford University
Press.
Myint, H. 1977. ‘Adam Smith’s Theory of International Trade in the Perspective of Economic
Development.’ Economica 44: 231–248.
Myrdal, G. 1957. Economic Theory and Underdeveloped Regions. Oxford: Gerald Duckworth.
Nurkse, R. 1953. Problems of Capital Formation in Underdeveloped Countries. Oxford: Basil
Blackwell.
Pasinetti, L. L. 1981. ‘Portrait: Nicholas Kaldor.’ Challenge 23 (6): 59–61.
 REVIEW OF POLITICAL ECONOMY 19

Pressman, S., and R. Holt. 2008. ‘Nicholas Kaldor and Cumulative Causation: Public Policy
Implications.’ Journal of Economic Issues XLII (2): 367–373.
Reid, G. 1989. Classical Economic Growth: An Analysis in the Tradition of Adam Smith. Oxford:
Basil Blackwell.
Richardson, G. B. 1975. ‘Adam Smith on Competition and Increasing Returns.’ In Essays on Adam
Smith, edited by A. S. Skinner, and T. Wilson. Oxford: Clarendon Press.
Rosenstein-Rodan, P. N. 1943. ‘Problems of Industrialisation in Eastern and South-Eastern Europe.’
Economic Journal 53 (June-September): 202–211.
Rosenstein-Rodan, P. N. 1961. ‘Notes on the Theory of the ‘Big Push’.’ In Economic Development for
Latin America, edited by Howard S. Ellis, and Henry C. Wallich. London: Macmillan.
Sandilands, R. J. 1990. The Life and Political Economy of Lauchlin Currie: New Dealer, Presidential
Adviser, and Development Economist. Durham: Duke University Press.
Schumpeter, J. A. 1954. History of Economic Analysis. London: Allen and Unwin. (1982).
Smith, A. (1776) 1976. An Enquiry into the Nature and Causes of the Wealth of Nations, edited by E.
Cannan. Chicago: University of Chicago Press.
Thirlwall, A. P. 1987. Nicholas Kaldor. New York: New York University Press.
Thirlwall, A. P. 1989. ‘Kaldor as a Policy Adviser.’ In Kaldor’s Political Economy, edited by Tony
Lawson, J. G. Palma, and John Sender. London: Academic Press.
Toner, P. 1999. Main Currents in Cumulative Causation: The Dynamics of Growth and
Development. London: Macmillan.
Wass, D. 1987. ‘Foreword.’ In Thirlwall (1987).
World Bank. 1987. World Development Report. New York: Oxford University Press.
Young, Allyn. 1928. ‘Increasing Returns and Economic Progress.’ Economic Journal 38 (December):
527–542.
Young, A. A. 1929. ‘Economics.’ In Encyclopaedia Britannica 1928. London: Encyclopaedia
Britannica Company. Reprinted in Mehrling and Sandilands (1999), pp. 115–134.
Young, A. A. 1990. ‘Nicholas Kaldor’s Notes on Allyn Young’s LSE Lectures, 1927–1929.’ Journal of
Economic Studies 17 (3/4): 18–114.