ECO 4119 POLITICAL
ECONOMY
Chapter 3
The Classical Liberal Perspective
Introduction
• Classical Liberalism envisions society as an aggregation of
autonomous individuals seeking to pursue their private
interests.
• All social interaction: voluntary exchanges among persons
• Its focus on individual choice as the primary determinant of
social outcomes
• The historical development of Classical Liberalism starts with
classical political economy, continues with the Austrian branch
of neoclassical economics, and culminating in a variety of
current bodies of thought including neo-Austrian economics,
public choice theory, new classical economics, law and
economics, new institutional economics, constitutional
economics, libertarianism, supply-side economics, monetarism,
and property-rights theory.
Architects of Classical Liberalism
Thomas Hobbes (1588-1679)
• English philosopher Thomas Hobbes was one of the first
social theorists to adopt the methods of the newly
emerging natural sciences for the analysis of human
behavior.
• The world as a mechanical system operating according to
precise laws of nature.
• He aimed at uncovering the natural laws governing
society by analyzing individual behavior.
• Humans need to satisfy their appetites and desires.
• Nonmaterial desires such as the need for social
recognition can matter, but desires were best met by the
pursuit of wealth.
Architects of Classical Liberalism
• By starting his analysis with the isolated individual in a state of nature,
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Hobbes portrayed society and government as secondary and artificial
creations.
The pursuit of private interests is presumed to be the only purpose of
human existence, with politics merely a necessary activity to maintain
social order.
Hobbes rejected the earlier Aristotelian notion of political activity as
the site of human development gained through participation in public
life.
Despite Hobbes’s strong commitment to individualism, he concluded
that government must have absolute authority to establish and
enforce laws.
The title of Hobbes major book Leviathan (1651) has become
synonymous with an authoritarian state.
Thus, although Hobbes was a founder of Classical Liberalism, his
conclusions about the scope of government authority have been
rejected by subsequent Classical Liberals.
Architects of Classical Liberalism
John Locke (1632-1704)
• English philosopher and physician
• Locke also assumed the self-interested and acquisitive nature
of humans, but he believed that the capacity for reason
enabled people to discover “natural laws”.
• Natural laws serve as guides both for restraining the pursuit of
self-interest and defining the proper role of government.
• Hobbes relied on government to establish and protect property
rights. Locke claimed that property rights existed before
government, so government’s authority was limited to
protecting those natural rights.
• In “Two Treatises of Government (1689)” Locke believed that
property rights were natural and therefore no person or
government could legitimately violate them.
Architects of Classical Liberalism
• His explanation of the origins of property rights seems to
support unlimited freedom to accumulate property and
therefore substantial inequality.
• However, Locke attached two “provisos” to the right to
obtain property: property must be used without spoilage
or waste, and any claim to property is valid only when
“there is enough, and as good left in common for others”.
• He argued that the use of money permits people to
accumulate wealth without spoilage and that the “enough
and as good” restriction becomes impractical once all
valuable land in a country has been claimed.
Architects of Classical Liberalism
• At the dawn of the capitalist era, liberal thinkers were confident
that individual rights and freedom would result in substantially
more equality than had existed under feudal domination.
• Locke’s defense of freedom to accumulate wealth was not
insensitive to those who lacked property.
• He argued that private property benefits all persons in society;
poor citizens are better off as wage laborers in a privateproperty system than if they were living in a society with
communal ownership.
• This shift from defending property as a natural right to
defending property for its social benefits is the beginning of a
split within Classical Liberalism that ultimately gave birth to a
new perspective--Modern Liberalism.
Architects of Classical Liberalism
Adam Smith (1723-1790)
• Adam Smith, a Scottish professor of moral philosophy,
was the first to articulate Classical Liberalism in the form
of economic theory rather than the political language of
Hobbes and Locke.
• In his first major work, The Theory of Moral Sentiments
(1759), Smith argued that humans are able, through
social interaction, to overcome their narrow self-interest
and view situations from the perspective of an “impartial
spectator”.
• The human capacity for sympathy would restrain
aggressive, selfish behavior and create a stable society.
Architects of Classical Liberalism
• Motivated by these concerns, Smith turned his attention from
moral philosophy to political economy.
• After being introduced to the idea of laissezfaire by a group of
French political economists known as the Physiocrats, he
concluded that a market society could not only withstand the
effects of acquisitive selfishness, but could actually steer this
“vice” into productive and socially beneficial channels.
• Without meaning to do so, self-interested individuals actually
promote the good of society by engaging their talents and
resources in the most profitable use.
• By the time he published The Wealth of Nations in 1776, Adam
Smith had substituted the market for individual conscience as
the mechanism for reconciling self-interest with an orderly and
prosperous society.
Architects of Classical Liberalism
• Although Smith is often portrayed as the champion of
capitalism, he was not completely optimistic about the market.
• He found self-interest compatible with the public good only
when competition prevailed, and he warned that businessmen
would constantly seek to suppress competition and deceive the
public to increase profits.
• Smith also expressed concern about the well-being of workers
in a market economy.
• While he recognized the tremendous efficiency gained by
dividing production into separate, routine tasks, he worried that
the monotony and mindlessness of factory jobs would render
workers “as stupid as it is possible for a human being to
become”.
Architects of Classical Liberalism
• Finally, Smith set the tone for subsequent classical
political economists with his fear that the dynamism and
growth of a market society would eventually come to an
end as profitable investment opportunities were
exhausted.
• Adam Smith’s legacy has been his defense of free
markets and nonintervention by government.
• Smith believed that government intervention should be
limited to three functions: law enforcement, printing of
money, and provision of certain public goods such as
harbors and roads.
Architects of Classical Liberalism
Thomas Malthus (1766-1834)
• A professor of history and political economy at the East
India College in England
• In contrast to Enlightenment thinkers, Malthus believed
that human misery was caused by nature rather than
badly organized institutions.
• In his book An Essay on the Principle of Population
(1798), Malthus claimed that population grows at a faster
rate than do food supplies because of the limited
availability of fertile land.
Architects of Classical Liberalism
• Malthus had little hope that humans would be capable of
exercising the restraint required to control population
growth, so positive checks such as “famines, plagues,
and wars” would be the effective controls on
overpopulation.
• Moreover, Malthus believed that government should not
attempt to interfere with the operation of these positive
checks.
• In addition to rejecting efforts to help the poor, Malthus
argued that the privileges and wealth of the upper classes
benefitted all of society.
Architects of Classical Liberalism
• Malthus represents a turning point in Classical Liberalism.
• The Enlightenment attack on aristocratic privilege evolved
into a defense of capitalist inequality.
• Later in the nineteenth century, Malthus’s ideas would
resurface as “social Darwinism”.
• Relying on the evolutionary theory of Charles Darwin,
Herbert Spencer (1820-1903) in England and William
Graham Sumner (1840-1910) in America claimed that the
human species evolves according to the principle of
“survival of the fittest”.
• Any attempts by government to aid the poor would cause
deterioration of the human gene pool by allowing unfit
members of the human species to survive and reproduce.
Architects of Classical Liberalism
Friedrich A. Hayek (1899-1992)
• He was born in Austria and spent most of his adult life in
England and America.
• He devoted himself to defending laissez-faire capitalism
against the challenges posed by Conservatives, Modern
Liberals, and Radicals.
• In The Road to Serfdom (1944), Hayek rejected the notion of a
middle ground between capitalism and socialism; the concept
of a “mixed economy” is untenable.
• Government intervention disrupts the smooth functioning of a
free-market economy, thereby generating the need for
additional corrective intervention.
• This vicious circle by which government-induced problems lead
to a larger role for government will eventually push society
toward socialism.
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Architects of Classical Liberalism
• He defended the market not because he believed in the power
of individual reason, but rather because of his skepticism about
the capacity of the human mind to obtain knowledge.
• Since each person can have detailed knowledge of only a
small portion of society, humans lack sufficient knowledge to
plan or direct the entire economy.
• Hayek praised the market for upholding individual freedom and
emphasized its ability to process and transmit vast amounts of
information about individual preferences, availability of
resources, and technology.
• Prices reflect the conditions underlying supply and demand, so
individuals are able to compensate for their personal lack of
knowledge by simply comparing prices.
Architects of Classical Liberalism
• Hayek’s distrust of human reason led him to oppose virtually all
government activity on the grounds that politicians and
bureaucrats cannot know what is best for society.
• Hayek warned that when government is permitted to expand its
activities beyond the protection of property rights, it will
inevitably become the tool of special interests.
• Hayek rejected the notion that economics can provide a
scientific basis for predicting or attempting to control the future
of the economy.
• The most that economics can accomplish is to demonstrate the
wisdom of free markets and minimal government.
Architects of Classical Liberalism
• Hayek also opposed efforts by economists to identify
market failures that might warrant government
intervention.
• He claimed that the efficiency of the market in processing
information, providing price signals to guide individual
choice, and encouraging innovation more than offsets any
inefficiency resulting from market failures.
• Government does not possess sufficient knowledge to
improve the workings of the market.
• Intervention is likely to cause greater disruption than the
market failure.
Architects of Classical Liberalism
Robert Nozick (1938-2002)
• A recent restatement of Classical Liberalism has been
undertaken by Harvard philosopher Robert Nozick in his book
Anarchy, State, and Utopia (1974).
• Nozick argues that the free market will create justice in the
distribution of rewards if the following three conditions are met:
(1) property must be acquired without theft, fraud, or coercion;
(2) transfers of property from one person to another must occur through
free exchanges, inheritance, gifts, or charity;
(3) any property holdings failing to meet the first two requirements must
be “rectified” through redistribution.
• While Nozick defends laissez-faire in principle, his commitment
to rectify past injustices leads him to acknowledge the
legitimacy of redistributive policies.
Architects of Classical Liberalism
• Nozick also dismisses any conception of justice linking reward
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with individual merit.
Nozick’s definition of justice: “from each as they choose, to
each as they are chosen”.
Each person’s reward should be determined by his or her
choices of what to offer in the market and by other people’s
choices to buy the person’s goods or services.
So long as people are free to choose, markets will tend to
generate inequality, but this inequality will be fair.
Attempts by government to interfere with market distributions
are the major cause of injustice.
Taxation is slavery, it forces citizens to work for the
government.
The only legitimate role of government is as a “nightwatchman”
protecting property rights and preserving individual liberty.
Principles of Classical Liberalism
• The essential features of Classical Liberalism are
contained in the definitions it gives to some of the most
controversial terms in political economy.
• Human Nature. Humans are self-interested and capable
of acting autonomously by using their capacity for reason
to discover the most efficient means to satisfy their needs
and desires.
• Society. Society is an aggregation of individuals and has
no goals or purposes of its own. The good society permits
individuals to pursue their private interests free from
arbitrary constraint.
Principles of Classical Liberalism
• Government. Individuals create government for the
purpose of protecting their rights as established by a
constitution. Beyond this function, government is best
when it governs least.
• Morality. No objective method exists for discerning which
values are superior to others; therefore, individuals should
be free to determine right and wrong based on their
personal preferences. The only valid social values are
those that all citizens would support. Since nobody wants
their property or civil rights to be violated, such violations
are wrong and should be illegal.
Principles of Classical Liberalism
• Freedom. Synonymous with autonomy and
independence, freedom is the absence of coercion by
government or by other people.
• Authority. Legitimate authority arises only through the
consent of individuals to relinquish a degree of their
autonomy. For example, authority in the workplace may
be consented to by employees in exchange for a wage.
Authority by government may be consented to by citizens
in exchange for protection of their rights to freedom and
property.
• Equality. Equality means that all citizens have the same
opportunity to engage in economic activity and the same
civil rights as established by the constitution.
Principles of Classical Liberalism
• Justice. Justice requires protection of property rights and
civil rights established by the constitution and punishment
of those who violate the rights of others.
• Efficiency. Efficiency is a situation in which no person can
be made better off without making someone else worse
off. In other words, resources are allocated to those
persons most willing and able to pay for them.
Classical Liberalism Today
• The Great Depression of the 1930s dealt a crushing blow to
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Classical Liberalism by persuading large numbers of citizens
that the free market could not be trusted to organize economic
activities.
Until the 1970s, Classical Liberals were absent from public
discourse. Exception: economics department at the University
of Chicago.
The 1970s, the crisis of the welfare state, high inflation+ high
unemployment = resurgence of Classical Liberal thought.
1980s + 1990s: Reductions in government spending, taxes,
regulations, and public ownership.
Three of the most prominent schools of thought in
contemporary Classical Liberalism: neo-Austrian economics,
public choice theory, and new classical economics.
Classical Liberalism Today
Neo-Austrian Economics
• The conquest of Austria by the German army during
World War II forced many intellectuals in that country to
emigrate.
• Ludwig von Mises (1881-1973) and Friedrich A. Hayek
were the principle carriers of Austrian economics to
England and the United States.
• Although neo-Austrians are committed to free markets
and personal liberty, they reject the neoclassical
assumption that individuals possess full information.
• If full information prevailed, then planners could
conceivably replicate the market, and the defense of
private property would be weakened.
Classical Liberalism Today
• Shortcomings of the markets: monopolistic elements,
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uncertainty, and externalities.
Their defense of the market rests not on its ability to allocate
resources efficiently at any single point in time, but on its role
as an engine for discovering and applying knowledge that will
raise standards of living.
Markets provide best information and incentives to innovate.
No planning agency or bureaucracy can match the dynamism
of entrepreneurs in pushing technology forward.
Government intervention will almost always be detrimental
because government caters to special-interest groups rather
than promoting the public good.
Classical Liberalism Today
• They join with Radicals in rejecting the neoclassical effort
to create a scientific economics analogous to physics.
• Neo-Austrians conclude that economics is largely a
completed project.
• The aim is to persuade other economists, politicians, and
the public that laissez-faire is the best policy.
• The neo-Austrian perspective has influenced mainstream
economics through the development of game theory to
illuminate situations in which decisions must be made
without full information.
Classical Liberalism Today
Public Choice Theory
• In recognition of the growing power of government in capitalist
societies, some Classical Liberal theorists have attempted to
analyze political decision-making by applying the same
principles of rational individual choice used to explain the
actions of consumers and firms.
• Rejecting the Modern Liberal view of government as an
impartial promoter of the wellbeing of society, public choice
theorists claim that voters, bureaucrats, and politicians behave
in the same fashion as do private consumers and producers:
they pursue their private interests, seeking maximum utility at
minimum cost.
• Citizens vote for candidates who will deliver the most benefits
and the lowest taxes.
Classical Liberalism Today
• Politics is viewed by public choice theorists as simply
economic activity conducted in the public sphere of
government instead of the private sphere of the market.
• This approach to political economy is sometimes called
the “Virginia school” because its leading proponents
taught at the University of Virginia in the 1960s, moved to
Virginia Polytechnic Institute in the 1970s, and finally
established a permanent base at George Mason
University in the 1980s.
• The most prominent public choice theorist is James
Buchanan, winner of the Nobel Prize in economics in
1986.
Classical Liberalism Today
• Public choice theorists uphold the Classical Liberal faith in
free markets, but they express concern that democratic
politics creates an avenue by which individuals and
groups can gain economic benefits while spreading costs
among all taxpayers.
• Because individuals can be expected to pursue their
interests by any means available, ending this abuse of
democracy requires strict constitutional limits confining
government to its appropriate role as protector of property
rights.
Classical Liberalism Today
New Classical Economics
• When Keynesian policies faltered in the early 1970s, Classical
Liberals were quick to fill the theoretical void.
• New classical economics describes the modern revival of
laissez-faire ideas from the nineteenth century.
• Some of its leading proponents are Thomas Sargent, Neal
Wallace, Robert Lucas, and Robert Barro.
• New classical economists focus on the role of expectations in
affecting individual behavior.
• Sargent and Wallace developed the theory of “rational
expectations” to demonstrate the fallacy of Keynesian efforts to
lower the rate of unemployment.
• Any deliberate effort by government to increase economic
activity will be frustrated by the reactions of citizens seeking to
defend their income against anticipated inflation.
Classical Liberalism Today
• Closely related to new classical economics are two other theoretical
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approaches: monetarism and supply-side economics.
The former, championed by Milton Friedman, seeks to revive the
classical idea that the amount of money in the economy affects prices
but not the level of employment or output.
Monetarists conclude that active monetary policy by the Federal
Reserve System can have no positive impact on unemployment and
therefore should be abandoned in favor of steady growth of the
money supply at a rate sufficient to accommodate increases in real
output.
Supply-side economics is so named because it rejects the Keynesian
focus on demand management and instead proposes to stimulate the
economy through deregulation, tax cuts, and privatization.
These policies mesh perfectly with the new classical goal of
minimizing the size and role of government.
An Assessment of Classical Liberalism
• By undermining superstition, tradition, and arbitrary
power, Classical Liberalism promoted a wider scope for
individual expression and cultural diversity.
• Pursuit of self-interest: mainspring of social and economic
progress.
• However, the changing nature of Western societies poses
several challenges to Classical Liberalism’s commitment
to the market as the primary institution for organizing
society.
• First, industrialization and urbanization have contributed
to a proliferation of “externalities” that cause the market to
allocate resources inefficiently.
An Assessment of Classical Liberalism
• Second, the large-scale production required to take advantage
of economies of scale associated with modern technology has
proven subversive to effective competition.
• Without competition, the market contains no mechanism for
guiding self-interest into socially useful channels.
• Third, the same self-interested behavior motivating individuals
and firms to compete in the market also drives them to form
groups and seek government protection against the
competitive pressures and instability of the market.
• The resulting politicization of the economy can be reversed
only by a government sufficiently powerful to override the
groups benefitting from political activity.
An Assessment of Classical Liberalism
• Classical Liberals face the paradox that a very powerful
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government may be necessary to minimize the role of
government.
The question of whether such a government could be trusted to
exercise its power judiciously remains unanswered.
Finally, Classical Liberalism fails to adequately recognize the
human desire for community and a sense of common purpose.
Individuals want to pursue their private goals and achieve
personal success, but they also exhibit commitments to
collective goals and the quality of public life.
In fact, with rising standards of living in Western societies,
“quality of life” issues have become more significant.
Personal income and wealth cannot secure a high-quality
lifestyle when public life is deteriorating.