Economy
Stefan Groitl
Classical liberalism and the laissez-faire
policy
Seminar paper
Classical liberalism and the laissez-faire policy
The political ideology of classical liberalism is a coherent vision how society should be
organized. It became the dominant political philosophy in the middle of the nineteenth
century (Hudelson, 1999, p.38). But it is important to distinguish between the different forms
of liberalism. It has different meanings, depending on the century the expression was used. In
the eighteenth and nineteenth century it can be labeled as ‘classical liberalism’ (Hill, 1964,
p.394). In the twentieth century it can be denoted as ‘welfare liberalism’ (Hill 1964, p.394).
The main difference between these two is the extent of governmental action (Hill, 1964,
p.394). Core features of the classical liberalism are the liberty of individual citizens and the
commitment to free markets and free trade, which are seen as the best way to organise
economic life (Hudelson, 1999, p.37). Some important representatives of the classical school
are Smith, McCulloch, Senior, Cairnes, Ricardo and Mill (Taylor, 1972, p. 27).
Classical liberalism draws on the economic science of Adam Smith (Hudelson, 1999, p.37).
Among the classical liberalists, he is the first one in time and of particular significance
(Taylor, 1972, p.19). In The Wealth of Nations, he argued, that individual work and free trade,
achieved through the operation of the invisible hand, is the best way to advance the wealth of
a nation (Schotter, 1985, p.44). More precisely, an optimal social state is created through
barter and exchange of free individuals (Schotter, 1985, p.28) and natural order together with
individual freedom (Taylor, 1972, p.19). A perfectly competitive market economy will
determine a Pareto optimal competitive equilibrium outcome (Schotter, 1985, p.12). Given
limited resources, there can be no outcome that leaves all members of society better or at least
as well off, as the outcome of a freely competitive market (Schotter, 1985, p.12). But the
invisible hand theory has its limitations (Schotter, 1985, p.28). The theory states, that there
must not be externalities in the economy. The utility each consumer gets from the goods he
consumes, must be independent of the utility from goods consumed by others (Schotter, 1985,
p.28).
To describe where Adam Smith could be classified in the history of economists, Skousen
(2009) recommends the pendulum formula. It categorizes every economist along a political
spectrum, from extreme left to extreme right. In this approach, Karl Marx is located as radical
on the extreme left-hand side, Adam Smith as conservative on the extreme right-hand side.
John Maynard Keynes is placed as liberal in the middle (Skousen, 2009, p.7).
1 The expression ‘laissez-faire’ first appeared when the famous French mercantilist minister,
Jean-Baptiste Colbert, asked a group of businessmen what he could do for them. One of the
men, a merchant called Legendre (Keynes, 1926, p.18), is supposed to have replied, ‘Laissez
nous faire’ meaning ‘Leave us alone’ (Skousen, 2009, p.48). The first writer, who used this
expression, was Marquis d´Argenson about 1751 (Keynes, 1926, p.18), but it was used by
several French authors in subsequent years. There exist different other expressions with a
similar meaning, such as ‘laissez passer’ or ‘Pour gouverner mieux, il faudrait gouverner
moins’. The latter means ‘in order to govern better, we ought to govern less’ (Skousen, 2009,
p.48) and is originated from Marquis d´Argenson (Keynes, 1926, p.19).
One of the earliest statements of laissez-faire is originated from Adam Smith, whose famous
hands-off policy is often connected to laissez-faire, although he never used the phrase
(Skousen, 2009, p.48), as well as it is not to be found in the works of Ricardo or Malthus
(Keynes, 1972, p.20). According to him, the “sovereign should never attempt to control or
influence the economic decisions of private individuals and should limit itself to three tasks”
(Gibson, 2011, p.9). These three tasks include the national defence, protection from each
other and administering justice as well as maintaining certain public works and institutions
(Gibson, 2011, p.9). The state is in a reactive position, compared to the leading one in the
welfare liberalism (Gibson, 2011, p.9). Smith was a free trader and an opponent of many trade
restrictions during the eighteenth-century, but even his famous work about the invisible hand
didn´t reflect the economic dogma of laissez-faire (Keynes, 1926, p.20). He supported a view
of maximal economic freedom in terms of microeconomic behaviour of individuals and firms
and minimal macroeconomic state intervention (Skousen, 2009, p.8). He was also described
as ‘the great apostle of laissez-faire’ (Taylor, 1972, p.18) by Alexander Gray and Charles Rist
mentioned ‘the laissez-faire doctrine preached by the school of Adam Smith’ (Taylor, 1972,
p.18). Compared to other countries, the ones that have adopted Smith´s vision of laissez-faire
capitalism have achieved the highest standard of living (Skousen, 2009, p.8).
It is important to clarify that the Classical School was not rigidly committed to the concept of
laissez-faire. In England, according to Taylor (1972), only in the work of Herbert Spencer is it
possible to find evidence to support this principal. For a vast amount of classical economists,
even when they did not support the laissez-faire idea in public, intervention was a necessary
evil and needed specific justification (Taylor, 1972, p.24). An exception is John Stuart Mill,
who wrote in his fifth and final book of the Principles of Political Economy about grounds
2 and limits of laissez-faire and non-interference principles. In this chapter and in his later
writings the exceptions to laissez-faire were so numerous and far-reaching, that some
economists located him on the socialist side (Taylor, 1972, p.23).
Laissez-faire was criticised by John Maynard Keynes, a British economist. According to him,
it represented the “do-nothing” policy, prevalent during the Depression years and government
should rescue the laissez-faire capitalism (Skousen, 2009, p.48). Keynes supported individual
freedom, but was a proponent of macroeconomic state intervention and nationalisation of
investment (Skousen, 2009, p.8). Laissez-faire was never understood as a “do-nothing”
policy, but as a way to abolish the old system of regulations and special privileges. Thus
Adam Smith and other laissez-faire economists at this time aimed to enhance the general
welfare (Skousen, 2009, p.48).
During the Great Depression in the 1930s, the classical economists who defended the laissezfaire policies argued with the Marxists and socialists, who were in favour of overthrowing the
old system. Amid this intellectual conflict, Keynes appeared with a new proposal, which
required government intervention in the monetary and fiscal field to stabilize the market
economy (Skousen, 2009, p.3). After the second world war, and after Milton Friedman
demonstrated that the Federal Reserve, a government creation, was the source of the Great
Depression, the self-regulating market economy of Smith experienced a comeback (Skousen,
2009, p.3).
Taylor (1972, p.53) states, that laissez-faire played a major role in the mindset of the
nineteenth century in England but lost its dominance in the years from 1865 to 1885 (Taylor,
1972, p. 51). During this century, the rights and obligations of every individual were
emphasized. According to Taylor (1972, p.53), the strong religious currents of this century
could be related to the belief in individualism. England in the nineteenth century came closer
to experience an age of laissez-faire than any other society (Taylor, 1972, p.64). Besides the
economic textbooks, laissez-faire had additional support. It must be admitted, that it
experienced support from several economists and also the reasonable public, for the lack of
opponent proposals. Keynes describes both, Protectionism and Marxian Socialism, as
“examples of poor thinking, of inability to analyse a process and follow it out to its
conclusion” (Keynes, 1926, p.34). According to him, the scientific deficiencies of these two
schools contributed to the prosperity of laissez-faire in the nineteenth-century (Keynes, 1926,
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