Political economy is a very old subject of intellectual inquiry but a relatively young academic discipline. The analysis of political economy (in terms of the nature of state and market relations), both in practical terms and as moral philosophy, has been traced to Greek philosophers such as Plato and Aristotle as well as to the Scholastics and those who propounded a philosophy based on natural law. A critical development in the intellectual inquiry of political economy was the prominence in the 16th to the18th century of the mercantilist school, which called for a strong role for the state in economic regulation. The writings of the Scottish economist Sir James Steuart, 4th Baronet Denham, whose Inquiry into the Principles of Political Economy (1767) is considered the first systematic work in English on economics, and the policies of Jean-Baptiste Colbert (1619–83), controller general to Louis XIV of France, epitomize mercantilism in theory and in practice, respectively.

Political economy emerged as a distinct field of study in the mid-18th century, largely as a reaction to mercantilism, when the Scottish philosophers Adam Smith (1723–90) and David Hume (1711–76) and the French economist François Quesnay (1694–1774) began to approach this study in systematic rather than piecemeal terms. They took a secular approach, refusing to explain the distribution of wealth and power in terms of God’s will and instead appealing to political, economic, technological, natural, and social factors and the complex interactions between them. Indeed, Smith’s landmark work—An Inquiry into the Nature and Causes of the Wealth of Nations (1776), which provided the first comprehensive system of political economy—conveys in its title the broad scope of early political economic analysis. Although the field itself was new, some of the ideas and approaches it drew upon were centuries old. It was influenced by the individualist orientation of the English political philosophers Thomas Hobbes (1588–1679) and John Locke (1632–1704), the Realpolitik of the Italian political theorist Niccolò Machiavelli (1469–1527), and the inductive method of scientific reasoning invented by the English philosopher Francis Bacon (1561–1626).

Many works by political economists in the 18th century emphasized the role of individuals over that of the state and generally attacked mercantilism. This is perhaps best illustrated by Smith’s famous notion of the “invisible hand,” in which he argued that state policies often were less effective in advancing social welfare than were the self-interested acts of individuals. Individuals intend to advance only their own welfare, Smith asserted, but in so doing they also advance the interests of society as if they were guided by an invisible hand. Arguments such as these gave credence to individual-centred analysis and policies to counter the state-centred theories of the mercantilists.

In the 19th century English political economist David Ricardo (1772–1823) further developed Smith’s ideas. His work—in particular his concept of comparative advantage, which posited that states should produce and export only those goods that they can generate at a lower cost than other nations and import those goods that other countries can produce more efficiently—extolled the benefits of free trade and was pivotal in undermining British mercantilism. About the same time the utilitarianism of Jeremy Bentham (1748–1832), James Mill (1773–1836), and Mill’s son John Stuart Mill (1806–73) fused together economic analysis with calls for the expansion of democracy.

Smith’s notion of individual-centred analysis of political economy did not go unchallenged. The German American economist Friedrich List (1789–1846) developed a more-systematic analysis of mercantilism that contrasted his national system of political economy with what he termed Smith’s “cosmopolitical” system, which treated issues as if national borders and interests did not exist. In the mid-19th century communist historian and economist Karl Marx (1818–83) proposed a class-based analysis of political economy that culminated in his massive treatise Das Kapital, the first volume of which was published in 1867.

The holistic study of political economy that characterizes the works of Smith, List, Marx, and others of their time was gradually eclipsed in the late 19th century by a group of more narrowly focused and methodologically conventional disciplines, each of which sought to throw light on particular elements of society, inevitably at the expense of a broader view of social interactions. By 1890, when English neoclassical economist Alfred Marshall (1842–1924) published his textbook on the Principles of Economics, political economy as a distinct academic field had been essentially replaced in universities by the separate disciplines of economics, sociology, political science, and international relations. Marshall explicitly separated his subject—economics or economic science—from political economy, implicitly privileging the former over the latter, an act that reflected the general academic trend toward specialization along methodological lines.

In the second half of the 20th century, as the social sciences (especially economics but also political science) became increasingly abstract, formal, and specialized in both focus and methodology, political economy was revived to provide a broader framework for understanding complex national and international problems and events. The field of political economy today encompasses several areas of study, including the politics of economic relations, domestic political and economic issues, the comparative study of political and economic systems, and international political economy. The emergence of international political economy, first within international relations and later as a distinct field of inquiry, marked the return of political economy to its roots as a holistic study of individuals, states, markets, and society.

As many analyses by political economists have revealed, in actual government decision making there is often a tension between economic and political objectives. Since the 1970s, for example, the relationship between the United States and China has been replete with difficulties for both countries. China consistently has sought integration into the world economy—an effort best illustrated by its successful campaign to join the World Trade Organization (WTO)—but has resisted domestic political liberalization. The United States often has supported China’s economic reforms because they promised to increase trade between the two countries, but the U.S. government has been criticized by other countries and by some Americans for “rewarding” China with most-favoured-nation trading status despite that country’s poor record of upholding the basic human rights of its citizens. Likewise, China’s government has faced domestic criticism not only from supporters of democracy but also from conservative Chinese Communist Party members who oppose further economic reforms. This example reflects the complex calculus involved as governments attempt to balance both their political and their economic interests and to ensure their own survival.

The relationship between political economy and the contemporary discipline of economics is particularly interesting, in part because both disciplines claim to be the descendants of the ideas of Smith, Hume, and John Stuart Mill. Whereas political economy, which was rooted in moral philosophy, was from the beginning very much a normative field of study, economics sought to become objective and value-free. Indeed, under the influence of Marshall, economists endeavoured to make their discipline like the 17th-century physics of Sir Isaac Newton (1642–1727): formal, precise, and elegant and the foundation of a broader intellectual enterprise. With the publication in 1947 of Foundations of Economic Analysis by Paul Samuelson, who brought complex mathematical tools to the study of economics, the bifurcation of political economy and economics was complete. Mainstream political economy had evolved into economic science, leaving its broader concerns far behind.

The distinction between economics and political economy can be illustrated by their differing treatments of issues related to international trade. The economic analysis of tariff policies, for example, focuses on the impact of tariffs on the efficient use of scarce resources under a variety of different market environments, including perfect (or pure) competition (several small suppliers), monopoly (one supplier), monopsony (one buyer), and oligopoly (few suppliers). Different analytic frameworks examine the direct effects of tariffs as well as the effects on economic choices in related markets. Such a methodology is generally mathematical and is based on the assumption that an actor’s economic behaviour is rational and is aimed at maximizing benefits for himself. Although ostensibly a value-free exercise, such economic analysis often implicitly assumes that policies that maximize the benefits accruing to economic actors are also preferable from a social point of view.

In contrast to the pure economic analysis of tariff policies, political economic analysis examines the social, political, and economic pressures and interests that affect tariff policies and how these pressures influence the political process, taking into account a range of social priorities, international negotiating environments, development strategies, and philosophical perspectives. In particular, political economic analysis might take into account how tariffs can be used as a strategy to influence the pattern of national economic growth (neo-mercantilism) or biases in the global system of international trade that may favour developed countries over developing ones (neo-Marxist analysis). Although political economy lacks a rigorous scientific method and an objective analytic framework, its broad perspective affords a deeper understanding of the many aspects of tariff policy that are not purely economic in nature.

The study of domestic political economy is concerned primarily with the relative balance in a country’s economy between state and market forces. Much of this debate can be traced to the thought of the English political economist John Maynard Keynes (1883–1946), who argued in The General Theory of Employment, Interest, and Money (1935–36) that there exists an inverse relationship between unemployment and inflation and that governments should manipulate fiscal policy to ensure a balance between the two. The so-called Keynesian revolution, which occurred at a time when governments were attempting to ameliorate the effects of the worldwide Great Depression of the 1930s, contributed to the rise of the welfare state and to an increase in the size of government relative to the private sector. In some countries, particularly the United States, the development of Keynesianism brought about a gradual shift in the meaning of liberalism, from a doctrine calling for a relatively passive state and an economy guided by the “invisible hand” of the market to the view that the state should actively intervene in the economy in order to generate growth and sustain employment levels.

From the 1930s Keynesianism dominated not only domestic economic policy but also the development of the post-World War II Bretton Woods international economic system, which included the creation of the International Monetary Fund (IMF) and the World Bank. Indeed, Keynesianism was practiced by countries of all political complexions, including those embracing capitalism (e.g., the United States and the United Kingdom), social democracy (e.g., Sweden), and even fascism (e.g., the Nazi Germany of Adolf Hitler). In the 1970s, however, many Western countries experienced “stagflation,” or simultaneous high unemployment and inflation, a phenomenon that contradicted Keynes’s view. The result was a revival of classical liberalism, also known as “neoliberalism,” which became the cornerstone of economic policy in the United States under President Ronald Reagan (1981–89) and in the United Kingdom under Prime Minister Margaret Thatcher (1979–90). Led by the American economist Milton Friedman and other proponents of monetarism (the view that the chief determinant of economic growth is the supply of money rather than fiscal policy), neoliberals and others argued that the state should once again limit its role in the economy by selling off national industries and promoting free trade. Supporters of this approach, which influenced the policies of international financial institutions and governments throughout the world, maintained that free markets would generate continued prosperity.

Opponents of neoliberalism have argued that the theory overlooks too many of the negative social and political consequences of free markets, including the creation of large disparities of wealth and damage to the environment. In the 1990s one focal point of debate was the North American Free Trade Agreement (NAFTA), which created a free-trade zone between the United States, Canada, and Mexico. Since it went into effect in 1994, the agreement has generated a good deal of controversy about whether it has created or eliminated jobs in the United States and Canada and about whether it has helped or harmed the environment, labour conditions, and local cultures in Mexico.

Comparative political economy studies interactions between the state, markets, and society, both national and international. Both empirical and normative, it employs sophisticated analytic tools and methodologies in its investigations. Rational-choice theorists, for example, analyze individual behaviour and even the policies of states in terms of maximizing benefits and minimizing costs, and public-choice theorists focus on how policy choices are shaped or constrained by incentives built into the routines of public and private organizations. Modeling techniques adapted from econometrics are often applied to many different political economic questions.

Political economists attempting to understand domestic macroeconomic policy often study the influence of political institutions (e.g., legislatures, executives, and judiciaries) and the implementation of public policy by bureaucratic agencies. The influence of political and societal actors (e.g., interest groups, political parties, churches, elections, and the media) and ideologies (e.g., democracy, fascism, or communism) also is gauged. Comparative analysis also considers the extent to which international political and economic conditions increasingly blur the line between domestic and foreign policies in different countries. For example, in many countries trade policy no longer reflects strictly domestic objectives but also takes into account the trade policies of other governments and the directives of international financial institutions.

Many sociologists focus on the impact that policies have on the public and the extent of public support that particular policies enjoy. Likewise, sociologists and some political scientists also are interested in the extent to which policies are generated primarily from above by elites or from below by the public. One such study is so-called “critical political economy,” which is rooted in interpretations of the writing of Marx. For many Marxists (and contemporary adherents of varying strands of Marxist thought), government efforts to manage different parts of the economy are presumed to favour the moral order of bourgeois values. As in the case of tax policy, for example, government policies are assumed to support the interests of the rich or elites over those of the masses.

Ultimately, comparative analysts may ask why countries in certain areas of the world play a particularly large role in the international economy. They also examine why “corporatist” partnerships between the state, industry, and labour formed in some states and not in others, why there are major differences in labour and management relations in the more-industrialized countries, what kinds of political and economic structures different countries employ to help their societies adjust to the effects of integration and globalization, and what kinds of institutions in developing countries advance or retard the development process. Comparative political economists also have investigated why some developing countries in Southeast Asia were relatively successful at generating economic growth whereas most African countries were not.