The social income

In his analysis of price determination, Cournot’s reasoning rested upon a market for good isolated from the rest of the economy. The problem for him was to show that this approach could be valid when he discussed the determination of the social income, defined as the sum of incomes which belong to members of society.

So far we have studied how, for each commodity by itself, the law of demand in connection with the conditions of production of that commodity, deter­mines its price and regulates the incomes of producers; we have considered the prices of other commodities and the incomes of other producers as given and invariable; but, in reality, the economic system is a whole of which all the parts are interconnected and interact with each other. An increase in the income of the producers of commodity A will affect the demand for com­modities B, C, etc., the incomes of the producers of these commodities, and, as a result, will cause a change in the demand for commodity A. Therefore, for a complete and rigorous solution of the problems relative to some parts of the economic system, it seems necessary to take the entire system into con­sideration. But this would surpass the powers of mathematical analysis and of our practical methods of calculation, even if the values of all the constants could be assigned to them numerically. The purpose of this chapter and of the following one is to show how far it is possible to avoid this difficulty, while maintaining some kind of approximation.

(1838, 99)

The principle of compensation of demands

Cournot’s core idea is that a change in price causes a change in producers’ income which compensates for the resulting change in consumers’ spending so that “the same... amount remains available for the demand for all other commodities” (1838, 101).

Suppose the price of an item rises from p₀ to p₁.

which is equal to the fall in income of the producers. Considering producers and consumers of the commodity altogether, it is apparent that “the same annual amount remains available for the demand for all other commodities” (1838, 101). Indeed, in general, the structure of demand for all the other goods will change. The distribution of the social surplus between producers of various commodities will change, but the change in social income will just be equal to p₀D₀ - p₁D₁,

which is the change in income of the producers of the commodity whose price itself changed.

Real and nominal changes in social income

Cournot defined social income as the sum of incomes received by the landowners, the capitalists and the workers, including the sums by means of which the State or individuals sustain the groups of individuals that some economists have described as unproductive, because their labour does not produce any material or saleable goods. To analyse the evolution of social income, changes in nominal and real income should be distinguished.

We saw that when an increase in the price of good A from p₀ to p₁ causes a fall in the income of producers equal to p₀D₀ - p_lD₁, the reduction in social income will be of an equal amount. Nonetheless, the effects of the price increase of good A on the purchasing power of consumers should be considered. Those who continue to purchase the good end up spending more. For them, it is as if the price of the good did not rise, while their income dropped by an amount equal to (p₁ - p₀) D,. To this amount, one should include a decline in the income of the producers of good A, that is, p₀D₀ - p₁ D₁. Overall, the amount p₀ (D₀ - D₁ ) represents the real change in social income, while the quantity p₀D₀ - p_lD₁ denotes the nominal change in social income.

This result can be obtained directly, Cournot (1838, 102) pointed out, by not­ing that production has fallen from D₀ to D₁ and that, as a result, a value equal to p₀ (D₀ - D₁ ) has been destroyed. Admittedly, the price of the commodity rose, which reduced the loss borne by the producers; but this gain is exactly balanced by the loss that this rise has caused to the consumers who bear it. Cournot reiterated that his calculations did not take into account the loss borne by consumers who no longer purchase good A due to the price increase and allocate their income to other uses.

Changes in social income and international trade

Drawing upon the principles discussed above, Cournot studied the effects of lifting an import ban on social income. His thesis is as follows: if country A is now able to export to country B a commodity M whose import was previously prohibited, the social income will rise in country A and fall in country B. Cournot aimed to oppose the view of those like Jean-Baptiste Say who intimated that removing trade barriers between two countries would necessarily lead to an increase in the national income of both countries.^[58]

Let us call p0 and D⁰ the price and the quantity produced of commodity M in country A, at the time when its export to country B was prohibited.

period, of the reduction in production in the sector producing the imported good. To understand the significance of Cournot’s analysis, it should be mentioned that his calculations rest on the fact that, in order to pay its imports of commodity M, country B will increase its exports to country A. Nevertheless, the demand for country B’s products other than M will not rise because the demand for domes­tic products will decline, especially given the fall of resources of M’s domestic producers.

Cournot (1863, 206) admitted that, in other circumstances, the importing coun­try would not be worse off. If the imported commodity was an intermediate good - raw material or input, for instance - instead of being a good of final consumption, its fall in price would likely foster the development of a new industry in country B. International trade would thus be more profitable for the importing country than for the exporting country. Cournot also pointed out that he did not consider the damage experienced by the consumers of country A who no longer buy commodity M and thus devote a portion of their incomes to less convenient uses. Moreover, he did not consider the fact that the consumers of country B paying less for commodity M make a better use of their incomes. Cournot measured changes in social income, not changes in well-being.

Cournot concluded cautiously that

if we have tried to overthrow Smith’s doctrine with regard to [trade] barriers, it is only for theoretical considerations, and not in the least to become the advocate of prohibitory and restrictive laws.

tempering the ardor of the spirit of innovation, without attempting an impos­sible struggle against the laws of Providence. Possession of a sound theory may help this effort of resistance to abrupt changes and assist in easing the transition from one system to another.

(Cournot 1838, 125)

Thus, it is important to understand the motivations behind Cournot’s thesis. His scenario is specific in that it involves two countries in an asymmetrical situation: country B removes the import ban of commodity M with no compensation received in return.

The difference between Cournot’s analyses and those of the classical econo­mists would only become apparent when John Stuart Mill published his Principles of Political Economy. The Englishman thus noted that his analysis of international values rested on the assumption that

The whole of the commodities which the two countries can respectively make for exportation, with the labour and capital thrown out of employment by importation, will exchange against one another.

(Mill 1848, 611)

Therefore, the real social income, in Cournot’s sense, does not change in Mill’s analysis. On the other hand, for Cournot, the total quantity of capital and labour employed in each country does change. These changes explain why the real social income change. Cournot and Mill’s approaches are different: Mill’s objective was to determine international values, while Cournot’s purpose was to study the effects of trade liberalisation on social income.

“Economic optimism” and laissez-faire

Cournot discussed what he called “economic optimism” for the first time in 1861 in Traite de l^,enchainement des idees fondamentales dans les sciences et dans l'histoire.

Economic optimism implies that it is always possible to determine the best outcome between various possibilities. As such, this notion is clearly differ­ent from that of Pareto optimum that the Italian economist later developed in his Cours d'economiepolitique and his Manuel d'economiepolitique. Cournot maintained that it was not always possible to determine best possible outcomes, because the interests involved may contradict each other and there is no reason to give priority to some at the expense of others. His typical example is that of non-renewable energies, which call for a trade-off between current and future generations. To solve this type of problem, one should be able to determine “what the future of humankind consist of; whether it would be better that the center of civilisation burns longer, or that it burns faster with a more intense ardor” (Cournot 1863, 267). Similar difficulties arise when the discussion is about issues such as population growth, the merits of small-scale or large-scale farming, or the distribution of the national product. Admittedly, these issues must be addressed and solved when necessary, but without following the rigour of scientific rules.

To define an optimum requires comparing baskets of goods of different propor­tions. To undertake such a comparison, is it enough to rely on market prices and decide that the good with the highest price is the best one? Cournot believed such a position was untenable, because the vagaries of fashion, the perversion of tastes and the distribution of income affect prices, so that they do not allow to compare the merits of different products: it is not possible to regard two products which cost the same price as economic equivalents.

Consider a thousand hectares of fertile land which were farmed to produce wheat and cotton and now used to grow tobacco to the greatest satisfaction of landowners who become richer and of capitalists who lay their hands on the best of all taxable products: is it good or bad in the economic sense?

(Cournot 1863, 270)

Cournot (1863, 269) concluded that it was impossible to “define the optimum, either with regard to production or the distribution of wealth”. But it would be incorrect to conclude that there is no way to scientifically determine an improve­ment or a worsening of the situation: the lack of definition of an absolute good does not preclude the definition of a relative good. If a change occurring within a part of the economic system does not affect the rest of the system, and if this change affects comparable magnitudes, it could be determined whether there is progress or not. “If change is about better matching each locality with each culture, so that the country produces more wheat and more wine, no one will hesitate to view this change as progress” (1863, 272).

Frederic Bastiat wrote:

let men work, exchange, learn, band together, act, and react upon one another, since in this way, according to the providential decrees, there can result from their intelligent spontaneity only order, harmony, progress, things that are good, better, and increasingly better, and still better to infinite degree.

(Bastiat 1851, 8)

It was against this thesis that Cournot reacted in his discussion of economic freedom.

Not only the demonstration has not been provided, but it is clear that it does not exist, given that it is easy to make assumptions or to mention real situa­tions for which the so-called agreement does not take place.

(1863, 277)

Competition does not necessarily incentivise individuals to conform to the gen­eral interest. The landowner will rule out innovations that can enhance the gross national product if they reduce his own net product. The capitalist will choose speculation over investment, if he can obtain a greater gain. As competition low­ers prices - and in particular the price of labour - it does not only harm those who directly suffer from it, but it affects society as a whole. Simply put, competition can cause production to be greater than demand.

Given that, under the regime of unlimited competition, each individual pro­ducer cannot have any significant influence on prices and total output, none of them can ward off the unfortunate fallouts of the general influence; and if one could resist by himself, he would only add an individual... loss to the... general loss.

(1863, 281)

Cournot’s suggestion was that an entrepreneur who realises that the total produc­tion of a good - which he only produces a small quantity - is excessive, is by no means encouraged to reduce his production, because such a scenario will not pre­vent prices from falling. Not only will he face some repercussions, but he will also lose some market shares.

The waste of natural resources is a typical example: the sailor kills the whale without worrying about a possible extinction of the species. In another instance, in the case of territory planning, the most profitable project is not necessarily the best possible outcome. The planning and development of a forest which would yield the highest annual wood output - measured in timbers, not thickets - and which would be more useful to society is a secular arrangement that no individual can accept: this project becomes less profitable when future returns are properly calculated based on the current interest rate. “If the interest on capital is one of the neces­sary conditions of our economic organisation, it can certainly result in a conflict between the general interest and the individual interest” (1863, 279).

Cournot concluded that public authorities should step in to regulate economic and social activity. In a closed economy, this intervention can apply to the produc­tion and distribution of wealth. In the former case, the State directly provides or subsidises activities aimed to increase production or facilitate the circulation of products; moreover, using taxation it can stimulate or penalise some activities.

It is possible to consider that, if public works are profitable, they can be built by private firms for their own benefit. A new road is directly useful to travelers, commercial carriers and people living in the vicinity of the road. It is also useful to consumers of goods whose price is reduced, and to entrepreneurs who use these goods as raw materials. The direct users will accept to pay a tariff, but the entrepre­neur who built the road would not be able to set a cost-covering tariff that allows him to profit from the indirect benefits. Considering that users enjoy very different benefits from the road, tariffs should be differentiated, which is no small task for a private firm. The benefits generated by a new road would only appear gradually, which can make the construction of the road a losing enterprise due to the discount affecting future revenues. These various reasons can explain why, in some situa­tions, a private firm will not be able to build public works, yet they could be useful to the community. The State should therefore intervene.

Because we know that individual interests and the general interest do not coin­cide, it is legitimate to ask “why governmental support would not be this additional force which allows... individual interests and the general interest to coincide?” (Cournot 1863, 294). However, in order to fund the subsidies granted to some activities, other industries must be taxed. Natural justice therefore requires that those who pay the tax must feel that their contributions to the general interest are an equitable compensation. Cournot did not believe it was possible to prove that it was the case. He concluded that “the maxim laissezfaire, assuming that it does not have the value of an axiom or a theorem (as some would like us to believe), must definitely prevail in most instances, as a motto of practical wisdom” (1863, 295).

Cournot de facto adopted the same stance when he dealt with the way govern­ment could influence income distribution. Some measures that reduce inequality, such as abolishing inheritance or establishing progressive taxation, can somehow be disincentivising. Thus, the criticism of conventional liberal positions did not lead Cournot to embrace radical policy proposals.

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