The Encyclopedia of Libertarianism

Classical Economics

Classical economics refers to a school of economics, the most famous proponents of which were Adam Smith, Jean- Baptiste Say, David Ricardo, and John Stuart Mill. Writing from the end of the 18th to the middle of the 19th centuries, they shared an approach to economic questions that embraced market-oriented principles that were to revolutionize and transform Western civilization. The classical model of free trade, limited government, balanced budgets, the gold standard, and laissez-faire shaped orthodox economic thinking and was accepted by all nonsocialist economists until the Keynesian revolution of the 1930s. Today, the economic model put forward by these thinkers is again gaining popularity.

Adam Smith (1723–1790), one of the most important figures of the Scottish Enlightenment, is considered the founder of the classical model. He dubbed it “the system of natural liberty” in his magnum opus, The Wealth of Nations. Published in 1776, The Wealth of Nations was a declaration of economic independence against the prevailing doctrines of protectionism and state interventionism. Little progress had been achieved over the centuries because of the entrenched system known as mercantilism. The commercial and political powers believed that one nation gained only at the expense of another and therefore favored government-authorized monopolies at home and supported colonialism abroad, sending agents and soldiers into poorer countries to seize gold and other precious commodities. Smith carefully delineated the host of high tariffs, duties, quotas, and regulations that aimed at restraining imports, production, and employment.

Smith denounced high tariffs and other trade restraints as counterproductive. Trade barriers hurt the ability of both countries to produce, he maintained. For example, by expanding trade between Britain and France, traditional enemies, both nations would gain: “If a foreign country can supply us with a commodity cheaper than we ourselves can make it, better buy it of them.” Smith’s solution to the economic nationalism and isolationism that then prevailed was regarded as particularly controversial. It involved the free movement of labor, capital, money, and goods. Milton Friedman has noted that “Adam Smith was a radical and a revolutionary in his time—just as those of us who preach laissez faire are in our time.” Critics contended that Smith’s radical suggestions would lead to economic disaster and instability. To the contrary, Smith promised that the dismantling of the state regulation of trade, prices, and employment would lead to “universal opulence which extends itself to the lowest ranks of the people.”

His eloquent advocacy of natural liberty fired the minds of a rising generation. The Wealth of Nations literally changed the course of politics, dismantling the old mercantilist doctrines of protectionism and poverty. This revolution in economic policy was a fitting companion to the American Revolution of 1776 and accelerated the industrialization of Britain, then in its infancy.

The invisible hand, a term first used by Smith, best exemplifies his model of economic freedom. In The Wealth of Nations, Smith argued that if individuals were left to their own devices, pursuing their own self-interests, they would generate a self-regulating and highly prosperous society. George Stigler calls Smith’s invisible-hand doctrine the “crown jewel” of economics. “Smith had one overwhelmingly important triumph,” Stigler continued. “He put into the center of economics the systematic analysis of the behavior of individuals pursuing their self-interests under conditions of competition.”

The French laissez-faire school of Jean-Baptiste Say (1767–1832) and Frédéric Bastiat (1801–1850) advanced the classical model of Adam Smith by championing the boundless possibilities of open trade and a free entrepreneurial economy. J.-B. Say, known as the “French Adam Smith,” developed Say’s law of markets, which became the fundamental principle of classical macroeconomics. Say’s law, often characterized as “supply creates its own demand,” focused on the idea that savings, capital investment, and entrepreneurship—all elements of the supply side of the economy—are the keys to economic growth, and that rising consumption is the effect, not the cause, of prosperity.

Bastiat, a brilliant French journalist, was an indefatigable advocate of free trade and of laissez-faire policies, a passionate opponent of socialism, and an unrelenting debater and statesman. Bastiat was unrivaled in exposing fallacies, condemning such popular clichés as “war is good for the economy” and “free trade destroys jobs.” In his classic essay The Law, Bastiat established the proper social organization best suited for a free people, one that “defends life, liberty, and property … and prevents injustice.” Under this legal system, “if everyone enjoyed the unrestricted use of his faculties and the free disposition of the fruits of his labor, social progress would be ceaseless, uninterrupted, and unfailing.”

The British economists Thomas Robert Malthus (1766–1834), David Ricardo (1772–1823), and John Stuart Mill (1806–1873) continued the classical tradition in supporting the virtues of thrift, free trade, limited government, the gold standard, and Say’s law of markets. In particular, Ricardo vigorously and effectively advocated an anti-inflation, gold-backed British pound, as well as repeal of both the Corn Laws, England’s notoriously high tariff wall on wheat and other agricultural goods, and the Poor Laws, England’s modest welfare system.

Unfortunately, after Adam Smith, classical economics suffered from a serious flaw that provided ammunition to Marxists, socialists, and the critics of capitalism. Smith’s disciples, especially Malthus, Ricardo, and Mill, promoted an antagonistic model of capitalism that gave classical economics a baleful reputation, leading English critic Thomas Carlyle to label it “the dismal science.” Instead of focusing on Smith’s creation of wealth and harmony of interests, they emphasized the distribution of wealth, the conflict of interests, and a labor theory of value.

In his famous Essay on Population, Thomas Malthus asserted that pressures on limited resources and a tendency for the population to constantly increase would keep most workers close to the edge of subsistence. His thesis underlines the gloomy and fatalistic outlook of many scientists and social reformers who forecast poverty, death, misery, war, and environmental degradation due to an ever-expanding population and unbridled economic growth. Malthus remained true to Smith’s laissez-faire roots by opposing government programs to alleviate poverty and control population growth, but he failed to comprehend the role of prices and property rights as an incentive to ration scarce resources. He also misunderstood the dynamics of a growing entrepreneurial economy through the creation of new ideas and technology. Medical breakthroughs, the agricultural revolution, and economic growth have postponed the Malthusian Armageddon, perhaps indefinitely.

Apart from his many positive contributions to economics, David Ricardo created an alternative “distribution” model, where workers, landlords, and capitalists fought over the economy’s desserts. He endorsed a Malthusian “iron law of wages,” where wages are constantly under pressure from an excess supply of labor. In Ricardo’s fatalistic system, wages tend toward subsistence levels, there is a long-term decline in profits, and landlords reap unjust returns. Karl Marx and the socialists exploited Ricardo’s hostile system of class conflict and labor theory of value, concluding that all interest and profit obtained by capitalists must be “surplus” value unjustly extracted from the true earnings of the working class.

John Stuart Mill perpetuated the classical model and the Ricardian system in his Principles of Political Economy, the standard textbook until Alfred Marshall’s Principles of Economics. Mill wrote eloquently in support of Say’s law, free trade, the gold standard, and individual liberty, especially in his classic work, On Liberty. Yet his textbook is thoroughly steeped in Ricardian economics, where prices are determined by labor costs, wages and profits vary inversely, and long-run wages tend toward subsistence levels. Most significant, Mill separated the “immutable” laws of production from the “arbitrary” rules of distribution, which led intellectuals to support grandiose tax and confiscation schemes aimed at redistributing wealth and income, convinced that such radical measures can be accomplished without disturbing economic growth. Friedrich Hayek has commented of Mill’s economic conclusions: “I am personally convinced that the reason which led the intellectuals to socialism, was John Stuart Mill.” Regarding the classical model, Murray Rothbard observed that, “economics itself had come to a dead end … having thus given hostage to Marxism.”

It would not be until the subjectivist Marginalist Revolution in the 1870s, led by three theorists who had uncovered the theory of marginal utility at approximately the same time, Carl Menger in Austria, William Stanley Jevons in Britain, and Leon Walras in Switzerland, that the classical Ricardian system, especially the labor theory of value, was challenged and gradually replaced with a sounder model that became the core of neoclassical economics. Menger and the Austrians reversed the classical connection between value and cost. Prices, they maintained, are determined by the subjective evaluations of consumers, which in turn set the direction for productive activity. Furthermore, wage earners and producers of goods and services are paid according to the fruits of their labors based on their discounted marginal product. Thus, through the discovery of the principles of subjective value and marginal utility, the marginalists reversed the tide of Marxist socialism and restored the virtues of Adam Smith’s invisible hand and harmony of interests.

The classical model of Adam Smith faced another serious challenge during the Great Depression of the 1930s. In his book The General Theory of Employment, Interest, and Money, British economist John Maynard Keynes claimed that Adam Smith’s invisible hand only worked during times of full employment. During depressions, Keynes argued, the government should abandon free trade and the gold standard, run deficits, and engage in large public works and welfare projects. Effective demand and consumption became more important than supply and savings, contradicting Say’s law. After World War II, the Keynesian Revolution took the economics profession by storm, and the classical model was viewed only as a special case.

However, Keynesianism’s inability to deal with problems of inflationary recession and uncontrolled government spending and deficits during the postwar period led economists to reassess the classical model. Moreover, a theoretical counterrevolution—led by Milton Friedman of the Chicago School and Ludwig von Mises of the Austrian School—resurrected interest in the virtues of classical economics. Harvard’s N. Gregory Mankiw, who began his career as a Keynesian, surprised the profession by beginning his textbook with the classical model. Mankiw wrote, “in the aftermath of the Keynesian revolution, too many economists forgot that classical economics provides the right answers to many fundamental questions.”

 

Further Readings

Bastiat, Frédéric. The Law. New York: Foundation for Economic Education, 1998 [1850].

Glahe, Fred R., ed. Adam Smith and the Wealth of Nations: 1776–1976 Bicentennial Essays. Boulder: Colorado Associated University Press, 1978.

Kates, Steven. Say’s Law and the Keynesian Revolution. Cheltenham, UK: Edward Elgar, 1998.

Malthus, Thomas Robert. An Essay on the Principle of Population. New York: Penguin, 1985 [1798].

Mankiw, N. Gregory. Macroeconomics. 2nd ed. New York: Worth, 1994.

Mill, John Stuart. The Principles of Political Economy. New York: D. Appleton, 1884 [1848].

Ricardo, David. On the Principles of Political Economy and Taxation. Cambridge: Cambridge University Press, 1951 [1817].

Rothbard, Murray N. Classical Economics. Hant, UK: Edward Elgar, 1995.

Say, Jean-Baptiste. A Treatise on Political Economy. 4th ed. New York: Augustus M. Kelley, 1971 [1880].

Skousen, Mark. The Making of Modern Economics. New York: M. E. Sharpe, 2001.

Smith, Adam. The Wealth of Nations. New York: Modern Library, 1965 [1776].

Stigler, George J. “The Successes and Failures of Professor Smith.” Journal of Political Economy 84 no. 6 (December 1976): 1199–1213.

Originally published .