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Laissez-Faire and the Classical Economists
Lecture 3


The Classical Economists


  1. Liberalism - confusing term

    1. United States

      1. Liberal - strong and active state role in society

      2. Helping the poor and solving social problems

      3. "Conservatives" - in theory are pro business and pro markets

    2. Liberalism - Book - it means markets, i.e. conservative

      1. Markets

        1. Fear the heavy hand of government

        2. Liberate the individual from state oppression

        3. Believe in freedom, individual rights, and free markets

        4. Free competitive market, diffuses power and preserves freedom

      2. India, Mexico, and China embraced more markets

        1. Stimulate economic growth and raise living standards

    3. Central planning (Church was oppressive during Middle Ages)

      1. State - unite everything under the authority of a monstrous owner

      2. Presents one viewpoint

      3. Vaclav Havel - the market is natural, the essence of life, while the state is arrogant and monstrous

    4. Tension between state and market

      1. Coercion and freedom

      2. Authority and individual rights

      3. Autocratic dogma and rational logic

  2. Hayek's - Road to Serfdom (1944)

    1. Socialism and growing gov. are threats to individual liberty

    2. Gov. provides greater economic security

      1. A slippery slope

    3. Little economic security leads to demand for more security

      1. Slid all the way

    4. State grows so large that individual liberty is gone

    5. Another Problem - moving towards a market too quickly

      1. Moving from a strong state (communism) to a weak state

      2. Cause a backlash and a return to authoritarian rule

      3. Example: Russia - citizens equate the market with the Mafia

        1. Mafia has active role in new markets

  3. Smith - The Wealth of Nations - view of politics, power, and freedom

    1. Freedom from state authority - unlawful arrest

    2. Freedom of speech or freedom of the press

    3. Right of democratic participation in government

    4. Liberals are optimistic about human nature

      1. If power is diffused, then corruption weakens

      2. If power is concentrated, then freedom is sacrificed

      3. Monopolies in the market or tyrants in the state

    5. Role of the state - Laissez-faire capitalism

      1. Laissez faire - "let be"

      2. Basic legal system

      3. Assure national defense

      4. Coin money

    6. "invisible hand" - the cooperative, constructive side of human nature

    7. People working in harmony

      1. Even when competing for the same customers or products

      2. No need for gov. interference

      3. Be suspicious of people who use state power in the "public interest"

  4. International trade - mutually advantageous

    1. Countries specialize in production where they have low relative costs

      1. World gains from free trade

      2. Free commerce makes nations efficient

      3. Liberals - efficiency is almost highly valued as freedom

      4. Encourage innovation

      5. Simulates industry

      6. No cutthroat competition for wealth and power

    2. Nations restricts free international markets

      1. Tariffs - tools for concentrating wealth and distilling power

  5. Britain's Corn Laws - a system of tariffs and regulations that restricted food imports into Great Britain

    1. Enacted in 1815

      1. Britain needed to be self-sufficient in food

      2. After Napoleon was defeated

      3. Napoleon never attempted to cut off food supplies

    2. Members of parliament were elected from landholders (not citizens)

      1. Strong agricultural interests

    3. Hurt manufacturing

      1. Food prices are higher

      2. Employers increased the wages they paid workers

      3. Increased business costs and squeezed profits.

    4. Reformed parliament in 1832

      1. Manufacturing had more power

      2. Repealed the Corn Laws

      3. Boom in the Victorian (British) economy

        1. Cheaper food (can import food)

        2. Foreigners sell food and in turn can buy British manufactured goods

        3. Remember - money flows in opposite directions of traded goods

    5. Britain embraced a liberal view of trade for the rest of the century

  6. John Stuart Mill (1806-1873) - state should correct market failures

    1. Assist the poor

    2. Centralize information, but decentralize power, thus the national gov. advises and assists

    3. Parents had a moral obligation and legal duty to educate their children

      1. Outweighed the rights of parents

      2. Poor - do not make them pay for education!

      3. Give grants (vouchers) to individuals to pay the charges of schools

    4. Leave most education in private hands

      1. Have some state schools as models of good practice

      2. Too much state involvement in education was "dangerous"

  7. John Maynard Keynes (1883-1946)

    1. Pronounced "canes"

    2. Keynesian Theory of economics - combines state and market forces to help economy grow and prosper

      1. Influenced by Great Depression

      2. "Invisible hand sometimes errs in catastrophic ways"

      3. Paradox of thrift

        1. You are worried that you might be unemployed next year

          1. Reaction - save more and spend less

        2. If everyone behaves in this way?

          1. Less purchased, less produced, fewer workers needed, and less income created

          2. Makes the recession and unemployment worse

    3. Keynesian - gov. picks up slack from economy

      1. Recession - lower taxes or increase gov. spending

        1. Lowers unemployment

      2. Business cycle - increase taxes or decrease gov. spending

        1. Lowers inflation

    4. State should spend and invest of offset individuals during economic downturns

      1. Even if the jobs did not contribute to society

      2. Dig a hole and cover it up again

      3. Not as aggressive as mercantilism or communism

    5. Gov. programs

      1. Unemployment insurance - temporary income to unemployed

      2. Social security - income to retired workers

      3. Bank deposit insurance - prevent bank runs

        1. Bank runs can destroy a healthy bank

      4. Improve transportation and communication

        1. Cheap transportation allows regions within a country to specialize

        2. Roads, sea ports, railroads, etc.

      5. Promote education and training

      6. Liberals today - state has role:

        1. Distribute and equalize incomes

        2. Preserve the environment




  1. Hegemony - one country dominates the other countries

    1. Source of wealth, power, and economic growth

    2. Hegemon has three advantages

      1. Industrial and agricultural production

      2. A strong financial system

      3. Dominates international trade

    3. Hegemony - richest and most powerful nation establishes the institutions for international trade

    4. Three modern hegemonies

      1. The United Provinces (Holland) 18th century

      2. Great Britain 19th century

      3. United States after WWII

    5. International markets are public goods

      1. Free trade

      2. Peace and security

      3. Balance of powers

      4. System of international payments (money system)

      5. Also creates international institutions

    6. Public goods are costly to provide

      1. Free-riders - individuals and nations benefit from the international system without paying for it

    7. Hegemon provides the international public goods, even taking free riders into account.

      1. Hegemon benefits outweighs the cost

      2. When a hegemon arises, the world economy tends to grow and prosper

      3. Stimulates wealth creation from markets

    8. U.S. supports a system of free trade

      1. After WWII, U.S. was the largest industrial producer

      2. European factories were in ruins

        1. U.S. greatly benefited from free trade

    9. Costs of hegemony tend to rise and weaken the hegemon's base of wealth and power.

      1. If the hegemon fails, the public goods disappear

      2. The world economy stagnates or declines

    10. Interesting theory - a rich and powerful nation gains control after a world war

      1. Hegemon falls into decline

      2. Harmonious relationships break down, and then war follows

      3. A new hegemon rises

  2. Bretton Woods System

    1. Bretton Woods, New Hampshire

    2. Created a system of international trade - open markets and free trade

      1. Create the International Monetary Fund (IMF) and World Bank

        1. IMF helps countries with balance of payment problems

        2. Country has more money leaving then entering country

        3. Balance of payment includes all flows of money

          1. Trade, investment, and actions of central bank

    3. U.S. dollar becomes international reserve currency

      1. Nations can convert U.S. dollar into gold

        1. Form of a gold standard

        2. Note - was illegal for U.S. citizens to hold gold

      2. U.S. gov. held the world's gold

        1. Military purchases from World War I and II

    4. President Nixon ended the Bretton Woods System

      1. Trade deficits would cause gold to leave the U.S.

    5. U.S. is a selfish hegemon

      1. U.S. dollar is international currency

      2. Abuse the system

      3. U.S. runs up large international debts

        1. Pays for debt by printing dollars

        2. Other nations hold the U.S. dollars as wealth

        3. Other debtor nations cannot do this

        4. Other nations buy U.S. federal gov. securities


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