Laissez-faire policies, self-adjusting market system, and neoliberalism

Classical political economics was in part a discourse for the rising bourgeoisie, and as such most of its members – that accepted some version of the labor theory of value and that distribution was conflictive – were for laissez-faire policies. That was certainly the case of the Physiocrats, and of Adam Smith and David Ricardo, the two most accomplished of the British political economists.

However, the classical analytical scheme did not assume full employment of labor or that the economic system was self-adjusted. Competition meant that market prices fluctuated around the natural prices, but those did not imply efficient allocation of resources. The notion that markets are self-adjusting with a tendency to full employment was a development of the last quarter of the nineteenth-century, and part of the so-called Marginalist Revolution. Marginalism also implied that each factor of production, capital and labor, received a share of income in accordance with the services rendered in production. Distribution was harmonious and not conflictive.[i] However, that did not imply that marginalist authors were all for laissez-faire.

It is clear that laissez-faire policies – leaving markets to its own devices without government intervention – could theoretically lead to efficient outcomes in the new theoretical scheme. But many marginalists authors believed that imperfections were relatively common in the real world and that under these circumstances some degree of government intervention was required. Market imperfections were a central reason for government intervention, before the Keynesian Revolution. In addition, most marginalists believed that economics was a science, technical in nature and not an art that required understanding of political factors, like class interests, wage bargaining, the power of capitalists, etc. These were imperfections, and they required government intervention. That was certainly the dominant view within marginalism associated with Cambridge University in England, and with its main academic figure Alfred Marshall.[ii]

Marginalists were part of a late nineteenth-century trend that believed in the power of experts, technocrats, in a period in which economics was becoming professionalized, and independent of the moral sciences. They were policy advisors. Simplifying considerably, one may say that classical authors were for laissez-faire, but not for the self-adjusting nature of capitalism, while marginalists were for the notion that markets are self-regulated, but less keen on hands-off governments. The conjunction of the two, the notion that laissez-faire capitalism is self-adjusting, was a distinctive feature of some of the marginalist authors, in particular the ones associated with the Austrian school, with Ludwig von Mises and his disciple Friedrich Hayek. That is, it is only with the rise of neoliberalism that laissez-faire and the self-adjusting nature of capitalism become associated.[iii]

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[i] The notion that distribution is harmonious and not conflictive as assumed by classical authors precedes marginalism or neoclassical economics, and was fundamentally developed in the period after the abandonment of Ricardian economics by pamphleteers and political economists that were afraid of the social implications of the work by David Ricardo, and the development of Socialist theories. Nassau Senior is probably the key author, and Frédéric Bastiat and Harriet Martineau the popularizers of the new dogma. Karl Marx referred to these post-classical authors as vulgar economists, and the term seems fitting.

[ii] Arthur Cecil Pigou, Marshall's main disciple, and John Maynard Keynes' teacher, was concerned exactly with the imperfections caused by externalities that required some sort of government intervention. These would be taxes or subsidies, depending on the nature of the externalities.

[iii] Later, in the 1940s after encountering insurmountable problems with his theory of cycles and the notion of capital, when he distanced himself from economics, Hayek exposed a different argument in favor of laissez-faire policies based on complexity and unintended consequences of government intervention. In this case, the argument was that government failures were worse than market failures or imperfections.

Beyond Laissez-faire? Seriously?

As I noticed, posting will continue a bit slow for a while. So this is a bit old. Noah Smith suggests that the profession is leaning in a liberal, meaning moderately lefty, direction. He tells us, however, that:

"although there’s a growing consensus that something about U.S. economic policy needs to be changed in a more liberal direction, there isn't any consensus on what. Laissez-faire may have reached the end of its shelf life, but we don’t yet know what is going to replace it."

He praises Reagan-Thatcher's policies for their simplicity. I guess Occam's Razor is the criteria here. Not uncommon, as I noted before, that was Krugman's defense of free trade not long ago. He might be right on the lack of consensus on what to do, even though his minimal program from the discontented seems plausible enough, more fiscal expansion, less free trade agreements, higher wages (start with the minimum) and more regulation of finance.

Note, however, that this policy consensus, is open to a lot of dissensus, and not only on details of policy (e.g. more fiscal expansion where, infrastructure, health, defense? Do we increase the taxes on the wealthy too? And so on). The vast majority of those that now defend these policies do it from an essentially unreconstructed marginalist view (mostly New Keynesians). So the policy defense does not stem from different models (Mankiw, a New Keynesian as much as Krugman and DeLong would not endorse any of these 'left' policies), but from their policy preferences. I would suggest that left leaning economists using mainstream models have a harder time showing that their policy prescriptions are coherent with their theory (they need all kinds of imperfections, and ad hoc assumptions).

But that's not the surprising thing in Noah's piece, at least to me. He's nonchalant about the assumption that the shelf life of laissez-faire policies has somehow expired. It is true that Keynes had suggested that laissez-faire was dead long ago, in 1926. But that proves exactly the policy resilience of laissez-faire. In fact, I would argue that the theoretical persistence of misguided (illogical and lacking evidence) mainstream positions often results from the advantage that these models provide for defending laissez-faire.

So laissez-faire is doing fine. And note that austerity is doing fine, in the US, in Europe, in Latin America, and is still being pushed by the IMF in their actual programs (forget the research department suggesting that sometimes it doesn't work; these views never apply to the real world). FTAs are also doing fine, and pushes for increasing the minimum wage or for more regulation of finance continue to be contested and fought back fiercely. We're far from the end of laissez-faire.