Table of Contents
- A brief history of laissez-faire
- The basic principles of Laissez-faire
- The good of Laissez-faire
- The bad of Laissez-faire
What’s it: Laissez-faire is a political-ideological concept that rejects government intervention on the economy. This term, in French, means “let it be.” Its supporters see the state intervention is a barrier to economic growth and development.
A brief history of laissez-faire
This term is associated with Boisguilbert and Legendre. Both objected to the mercantilist policies of 17th century France at Colbert.
Physiocrats are eager to follow the doctrine of a little disruption in the economy. It is said that free internal and external trade will be of great benefit.
Who are Physiocrats?
They were members of 18th-century French economists who believed that agriculture was the source of all wealth. Physiocrats argue agricultural products should be highly valued. Apart from advocating adherence to social institutions’ natural order, they also emphasize free trade.
Adam Smith, The Wealth of Nations (1776), describes the economy of laissez-faire in terms of the “invisible hand.” A free-government-intervention market will provide the maximum benefit for all.
This concept gained momentum in the 19th century. Industrial growth in Britain and America in the late 19th century took place in a laissez-faire capitalist environment.
However, the laissez-faire period ended at the beginning of the 20th century. It is marked by the emergence of several government regulations related to business, such as anti-competition regulations.
The basic principles of Laissez-faire
The laissez-faire theory advocates the absence of government intervention in the economy. Adam Smith believes that minimal intervention is an essential prerequisite for the market to function efficiently.
Market mechanisms allocate resources in the most efficient allocation way. Price becomes a signal for supply and demand in the market. Changes in supply and demand will eventually lead to equilibrium, the point at which social benefits are maximum. Such equilibrium will not be achieved if the government intervenes.
However, Smith is also concerned about the weakness of this theory. If the market mechanism dictated everything, it would likely create a lazy, but financially strong, feudal class.
Basic laissez-faire ideas
The laissez-faire economy promotes free and competitive markets. Some of the basic ideas for laissez-faire are:
- The economy should work based on supply and demand forces. Both represent the individual (consumer) and business interests. Hence, the intersection of supply and demand (equilibrium) is the best for individuals and businesses.
- The economy should be free from government intervention. Intervention tends to cost either party, whether consumer or business. That, in turn, leads to socially suboptimal benefits.
- The private-enterprise economy is the best because it is most efficient at allocating resources. Private ownership of a resource and freedom to use creates a strong incentive to take risks and work hard.
- The government’s job is to ensure that market systems and mechanisms work. That is, for example, through enforcing property ownership. Income or wealth distribution policies shouldn’t’ exist because individuals would work hard to produce what is best for them. Likewise, intervention through competition regulations will only damage the work of the market mechanism.
- International trade must operate freely. The state should not impede it through protective policies, such as tariffs and subsidies. Free trade will ultimately bring prosperity and result in an efficient allocation of resources at the international level.
The economy should operate under the forces of supply and demand.
The supply force works for business interests. Likewise, the demand force works for the benefit of the consumer (individual). Ultimately, if there is no intervention, it will do the best for both.
Intervention – such as price control, protectionism, or antimonopoly – benefits one party but costs the other. As a result, the market output will not provide the maximum social benefit.
Businesses try to maximize profits in meeting consumer needs. They do their best and produce the best products to meet those needs, whether in price or quality. They also have an interest in being innovative to be competitive.
On the other hand, individuals try to satisfy their needs and wants. They have the money, and for that, it’s free to choose which product is the best. Some may choose an inexpensive product, while others consider quality more.
The two interests (business and individual) meet in the market. Their interaction determines which product is best for both and at what price and quantity.
The good of Laissez-faire
Like other political and economic ideologies, laissez-faire also has pros and cons. Among the advantages of the laissez-faire concept are:
- No tax
- Accelerating innovation
- More autonomy
Since taxes don’t exist, firms and households have greater purchasing power. They don’t need to set aside money just to pay taxes. For households, that means they can buy more goods and services. For businesses, that means more profit to distribute to owners or as internal capital for expansion needs.
No tax also means less corruption among bureaucrats.
Minimal government intervention encourages competition. To win the competition, companies must provide superior products to the market. If not, their position could be threatened by competitors.
The need to be competitive always drives companies to be more creative and innovative in their operation. This leads to technological advances, in addition to economic growth.
Interventions sometimes benefit one party and harm another. Take price controls, for example.
It favors suppliers when set above the equilibrium price (price floor), as in the minimum wage. At other times, a price ceiling policy keeps prices below equilibrium and benefits more to buyers. In the end, such interventions will only result in disequilibrium and less maximal social benefits.
The laissez-faire economy gives businesses more space and autonomy. There is no restriction from government regulations and policies, which makes their activities more difficult. Such an environment provides the company with a greater incentive to maximize profits.
The bad of Laissez-faire
Critics have argued that laissez-faire has some weaknesses. Laissez-faire attitudes have long been considered brutal and uncaring.
The concept is based more on the unrealistic assumption that humans are naturally good and do not need government oversight to control bad behavior.
Laissez-faire raises two main problems in the economy:
- Widening economic inequality
- Ignoring the public interest
Widening income inequality
The presence of absolute autonomy creates a situation of chaos for both producers and consumers. Such a situation ultimately leads to income and wealth inequality.
Capital owners control the economy. On the contrary, those who are poor continue to be poor and pass it on to the next generation. Often, corrupt behavior leads owners of capital to perpetuate wealth. They prevent the poor from obtaining capital and improving their lives. As a result, inequality contributes to a vicious cycle of poverty.
In the business sector, competition ultimately produces one winner. Seeking to maximize profits, the dominant firm may find ways to eliminate competitors and become a monopolist.
Competition reduces company profits—the tighter the competition, the lower the profit potential. Therefore, if there is no intervention, the company naturally wants to eliminate competition and become a monopolist.
The monopolist has absolute power over the market. As the sole supplier, they determine the quantity, quality, and price of products.
Ignoring the public interest
The laissez-faire economy fails to represent the interests of all sections of society. This system only serves capital owners.
Public goods are unlikely to be distributed equally among the people. Positive externalities, such as education and health care, do not spread through society.
Conversely, people tend to be exposed to negative externalities. The absence of interventions – such as antimonopoly regulations – provides an opportunity for collusive behavior among businesses. They are free to form cartels and act like monopolists.
Also, the profit motive encourages companies to minimize costs. It encourages environmentally unfriendly behavior such as disposing of waste and overexploiting natural resources.