Front Page Titles (by Subject) II: Economic Analysis - Literature of Liberty, Spring 1981, vol. 4, No. 1
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II: Economic Analysis - Leonard P. Liggio, Literature of Liberty, Spring 1981, vol. 4, No. 1 
Literature of Liberty: A Review of Contemporary Liberal Thought was published first by the Cato Institute (1978-1979) and later by the Institute for Humane Studies (1980-1982) under the editorial direction of Leonard P. Liggio.
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Because of its significance for a sound and stable social system and economy, scholarship dealing with economic analysis has received repeated and detailed coverage in past issues of Literature of Liberty. The current set of summaries combines both abstract perspectives (on the issues of general equilibrium, business cycle theory, subjective cost theory, the possibility of economic calculation under “market socialism) with more concrete historical and ethical studies of such topics as the history of interest group maneuvering for workmen's compensation legislation, child labor and the Factory Acts, minimum wage legislation, neo-mercantilism, and the interplay of ethical ideology and economic science. Both perspectives are necessary for understanding comprehensively and in detail the workings of any economy.
The common perspective unifying the opening group of summaries is that of the Austrian school of economics and its characteristic method of analyzing economic reality in terms of methodological individualism and the science of praxeology or human purposive action. This approach can be observed most easily in the Wiseman and Vaughn treatments of subjective cost theory. Whereas orthodox neoclassical microeconomics treats costs as if they were objective and measurable prices (which interpretation would allow social engineers to intervene, assist ailing economies, and make effective public policy recommendations through “scientific” cost-benefit analyses), Austrian-oriented economists stress the subjective, psychological interpretation of costs as nonobjective forgone “opportunity costs.” The Austrian praxelogical analysis of costs, profits, interest rate theory, money, and human action in general, is generally leery of any mathematicism on the principle that objective measurement distorts the more subjectivist, nonquantifiable reality of human valuing and purposive action. Not only do individuals possess their economic “values” in a subjectivist manner that defies intersubjective comparisons of utility, but each of their values may be in the process of changing. Human action and valuation, in short, occurs in a dynamic world of human process and “kaleidic” change, rather than a static world of unchanging physical laws. [Steven N.S. Cheung's The Myth of Social Cost (San Francisco: Cato Institute, 1980) gives an insightful treatment of costs from another perspective.]
The remaining more concrete summaries are of value for the light they shed on the workings of political economy. Of especial importance for current economic trends are Chris Tame's study of today's revival of neo-mercantilism. This study shows the perennial relevance of Adam Smith's dissection of vested interest legislation. E.G. West continues Smith's spirit by his unravelling of governmental resistance to economic science consensus in regard to the dangers of legislating a minimum wage.
Austrian vs. Neoclassical Economics: Equilibrium
“General Equilibrium and Beyond: I, The ‘Austrian’ Perspective on the Crisis.” The Public Interest, (Special issue 1980):11–122.
Neoclassical economic theory is currently in crisis. Despite essentially sound historical roots, its historical development has produced a misunderstanding of the workings of market capitalism. We need to reconstruct our economic understanding by studying neoclassical historical roots and by heeding the insights of the “Austrian” school of economics.
In the development of mainstream economics, late nineteenth-century insights into demand-side factors were subordinated to concern with market equilibrium conditions. Consequently, the key elements of the role of the entrepreneur, the dynamics of the market process, and the nature of competition were overlooked, misunderstood, or miscast.
While not denying the usefulness of the concept of equilibrium as a tool of analysis, Austrian economists (Menger, Mises, Hayek, etc.) view the really important aspects of the market economy to be those concerning the nature and function of market processes. Whereas the Austrian tradition has adhered to these historical roots, the neoclassical static model of perfect competition diverted attention from market processes. By losing sight of these processes, neoclassical economists have tended to misunderstand the requirements for, and benefits of, dynamic competitive markets.
This historical forgetfulness and inattention actually represents “…a failure to recognize the role of knowledge in the face of radical uncertainty, and of learning processes in dynamically competitive markets,” coupled with the “…failure to recognize the nature and significance of entrepreneurial discovery in an uncertain world.”
In addition, neoclassical concern with normative questions of social well-being suffers from flawed “aggregate” approach that illegitimately extends the notions of choice and well-being from the level of the individual to the level of the collective. More importantly, neoclassical economics ignores the key role of the market process in organizing information both to facilitate individual decision-making and to promote individual subjective and (thus, incommensurable) welfare. In this dynamic setting, market prices are always disequilibrium prices that make aggregative measurements inappropriate at the same time that they affect and are affected by individual decision-making.
“Economic theory needs to be reconstructed so as to recognize at each stage the manner in which changes in external phenomena modify economic activity strictly through the filter of the human mind.”
Frank Fetter & the Austrian school
“Frank A. Fetter and ‘Austrian’ Business Cycle Theory.” History of Political Economy 12(Winter 1980):542–557.
Frank Fetter (1863–1949) was a distinguished American economist at the turn of the century. A number of his contributions to economics (such as his pure time preference interest theory) were developed by members of the Austrian school of economics. In this essay, O'Driscoll argues that Fetter also independently discovered key elements of the Austrian school's theory of economic fluctuations. His contribution was, however, overlooked by the Austrians, despite their familiarity with his other work.
Irving Fisher's (1869–1947) name has long been associated with the effect of inflationary expectations on interest rates, expectations of high inflation leading to high interest rates. Fetter developed this analysis further than did Fisher, observing that inflation and deflation distort investment patterns. Investment that would never have taken place occurs during inflation. And investment is discouraged during deflation. Price fluctions are uneven and their unevenness interferes with resource allocation. Like the later Austrians, Fetter perseived a cycle as being constituted by fluctuations in real variables, such as investment and saving, though caused by monetary disturbance.
Fetter drew attention to the role of the fractional-reserve banking system in generating monetary disturbances and thus causing economic fluctuations. He opposed an “elastic currency.” He also distinguished between the effects of an inflation of the commodity base money and the effects of an inflation of bank credit. In this, he likewise anticipated later Austrian developments
Though his analysis was recognized and praised by such diverse contemporaries as Irving Fisher and Frank Knight (1885–1972), it stands as another lost and largely forgotten contribution in monetary economics. Not only the revival of Austrian economics, but recent theoretical and empirically work generally have highlighted a number of the problems analyzed by Fetter. His work is thus as relevant today as when it was written.
Subjective vs. Objective Costs
“Costs and Decisions.” University of York. Reprint Series: Economics, Numer 289. Reprinted for private circulation from Contemporary Economic Analysis (Vol. 2, Ed. by David A. Currie and Will Peters). Croom Helm, 1980, pp. 473–490.
Professor Wiseman is one of the surviving members of the London School of Economics “subjective costs” school, which, in turn, was influenced by the Austrian school). He comments on the implications of uncertainty and learning for the nature of economic decisions (the concept of “opportunity costs”). On this foundation, he then discusses “orthodox” economics and ways in which it can develop.
To obtain a satisfactory solution to the economic problem of the nature of costs, Professor Wiseman urges a “return to consistent development of the subjective cost tradition.” By contrast, the dominant “orthodoxy” treats opportunity costs as essentially “objective.” This belief in objective costs leads to a misunderstanding about the nature of the resource-allocation process and to inflated claims by economists as to their competence as “social engineers.” A better approach is to see opportunity-cost decisions as the subjective valuations of individuals. Methodological individualism is needed as the logic of individuals as they make subjective decisions in a world of change and uncertainty. Opportunity cost cannot have an “objective” existence; it is the rejected subjective plan of an individual—one that is never implemented at all. There is no reason why two individuals deciding on the same (“best”) course of actions should have the same opportunity costs.
The dominant or orthodox Anglo-American paradigm of “objective” opportunity costs ignores the fact that the relevant foregone alternatives (“costs”) are those perceived by the individual decision-taker and have no “objective” manifestation. This “objective” interpretation likewise sees resource allocation as some objectives and known-in-advance process, a rather simple process of maximizing measurable quantities. The crucial deficiency in the “objective” model is the absence of uncertainty. Everyone is assumed to have objective knowledge of future opportunity costs and future prices. But this, then is not a “decision” model. If all future prices (and so all future resource-allocations) are known with certainty, then there is no way in which present decisions can alter future prices or resource-use.
In short, the orthodox, objective model of costs does not explain the process by which resources are allocated between competing uses through time. It describes “equilibrium states,” not adjustment processes. The orthodox approaches cannot adequately deal with uncertainty since they assume a world in which decision makers (“clockwork Bayesians”) cannot experience surprise.
In the light of a more adequate interpretation of the decision process in terms of subjective opportunity costs, we see the need for a theory of learning in its entrepreneurial sense of identifying and acting upon new opportunities. Equilibrium or objective models are of little help in the real economic world of change, individual choice, and learning.
Prof. Wiseman believes that the Austrian school of economics (as in Israel Kirzner's Competition and Entrepreneurship and E.G. Dolan's The Foundations of Modern Austrian Economies) offers a more adequate theory of the market process. This school reveals the futility of policy prescriptions that pretend to predict and measure “objective” social welfare functions. Since evaluations are individuals' private or subjective evaluations, policy makers cannot perform cost-benefit analyses in any objective, measurable fashion.
The Significance of Subjective Costs
“Does It Matter That Costs Are Subjective?” Southern Economic Journal (Summer 1980): 702–715.
Although it has been neglected, the subjectivist interpretation of costs is an indispensable framework. The subjectivist understanding of cost has a history dating back to the origins of neoclassical economics itself, but few economist today are even aware of how the subjectivist tradition differs from orthodox neoclassical cost theory.
The concept of opportunity cost, the subjective value of alternatives foregone, was implicit in the writings of the founder of the Austrian school, Carl Menger (1840–1921); it was made explicit in the work of another Austrian, Friedrich von Wieser (1851–1926); it was further developed by Philip Wicksteed (1844–1927), and was explored in depth by economists at the London School of Economics during the 1930s and 1940s. Although opportunity cost is widely accepted by the economics profession, the subjectivist interpretation of costs is little discussed or appreciated today. To remedy this neglect, James Buchanan's 1969 book Cost and Choice traced the evolution of the subjective cost tradition from von Wieser onwards and demonstrated how “cost is an all-pervasive concept that reaches to the core of economic thinking. Economic decision making is an exercise in choosing among alternatives, and cost can only be understood to be a personal subjective evaluation of the consequences of choice.” Cost for the evaluator is the “rejected opportunity” which the decision maker must overcome before he can choose. As Buchanan puts it, “Cost consists therefore of his own (the individual's) evaluation of the enjoyment or utility that he anticipates having to forego as a result of choice itself.”
The implications of subjective costs for conventional neoclassical cost theory are many but are virtually all at odds with the more standard neoclassical microeconomics. One implication of significance is that cost “cannot be measured by someone other than the chooser since there is no way that subjective mental experience can be directly observed.”
Professor Vaughn argues four points: (1) that the only interpretation one can give to the concept of opportunity cost as the value of the next best alternative is a subjective one; (2) that it is only in full, timeless, certain, general equilibrium that subjective cost can be represented by “objective” money outlays and measurements; (3) that the real world, however, is never in equilibrium; and (4) that the real world's divergence from static equilibrium is most significant when economic theory is used for public policy.
When economic theory is used to formulate policy for real economies, to ignore the fact that the costs we are trying to measure are subjectively calculated by human beings (who make choices in partial ignorance and uncertainty about the future) will be risky. The arguments advanced by those who claim that cost/benefit analyses are objective or “close enough” (on the assumption that costs are identical to measured money outlays) are unconvincing. When costs and benefits are mainly subjective and evaluations are made by third parties who do not directly suffer the consequences of their choices, it is likely that public policy advice will have perverse effects on social welfare.
Socialist Economic Calculation
“Economic Calculation under Socialism: the Austrian Contribution.” Economic Inquiry 18(October 1980):535–554.
The publication in 1920 of Austrian free-market economist Ludwig von Mises's (1881–1973) article, “Economic Calculation in the Socialist Commonwealth,” launched a scholarly controversy between free-market and socialist economists during the period of 1920 to 1940. Known as the debate over “economic calculation under socialism,” its ostensible subject was whether it was possible for a real economy to operate efficiently without free markets and without private ownership of capital and land. The core issues for economic theory, however, ran deeper and are still unresolved some 40 years later. Professor Vaughn gives a clear overview of the debates, issues, personalities, and scholarship.
Economic theories of socialism during the 1930s were based on Walrasian general equilibrium models in which the government central planning board was to function as the price determiner or auctioneer. Socialists assumed that “market socialism” would achieve all the efficiencies characterizing the abstract model of perfect competition, and at the same time, avoid the serious market imperfections alleged against real capitalist economies (monopolies, externalities, business cycles, and unjust income and wealth distributions).
The Austrians, chiefly Ludwig von Mises and Friedrich Hayek (cf. Hayek's 1935 Collectivist Economic Planning), argued that socialism (even socialism with some market mechanisms allowed to price consumer goods) would fail to achieve the efficiency of real market capitalism. Mises and Hayek reasoned that the Walrasian models of perfect competition, which socialists employed to construct their economic theory, left out of consideration those vital features of real markets that were required to generate efficient outcomes. Specifically, the socialists' Walrasian model ignored three crucial features: (1) the entrepreneurial nature of the market adjustment process, (2) the importance of decentralized information in setting market- clearing signals for efficient supply and demand, and (3) the role of incentives and disincentives under varying market and non-market institutional settings.
A crude synopsis of the economic calculation debate runs as follows: Mises wrote an article arguing that rational or efficient economic calculation was impossible under socialism. Mises's article prompted those who favored socialism to try to refute him. (These included Fred Taylor, H.D. Dickinson, Oskar Lange, Abba Lerner, E.M.F. Dubin, and Maurice Dobb). Those arguing for “market socialism” were forced by Mises's analysis to construct an economic model that would show how a centrally directed socialist economy could be rationally administered. Mises chief allies in his theoretical defense of capitalism were the Austrian Friedrich Hayek and Lionnel Robbins (who was influenced by the Austrian school of economics). Hayek wrote two sophisticated and penetrating critiques of socialist planning but they were, in the main ignored. Mises seemed easy to refute, and so for twenty years, socialists continued to refute their version of his arguments, therefore avoiding consideration of the far more difficult issues raised by Hayek.
Professor Vaughn's discussion falls into four parts: (1) the first part examines Mises's 1920 article to identify the sources of the controversy: (2) the second part outlines the major developments in the economic theory of socialism during the 1930s; (3) the third part presents Hayek's criticisms of socialist economic programs; and (4) the fourth part summarizes the theoretical problems raised during the debate. This last section allows us to appreciate the relevance of the Austrian analysis as a contribution to current problems in economic theory.
Hayek's critique of neoclassical socialist economics was its inappropriate application of static Walrasian equilibrium models to the formation of a new economic order. The static equilibrium model omits considerations of the process by which equilibrium is approached, the effects of uncertainty on the conclusions of the model, and consideration of what constitutes economic information and to whom it is available. Each one of these omissions are sufficient to guarantee that an economic order resulting from conscious centralized planning according to the equilibrium model will differ substantially from the one envisoned by the socialist planners.
Hayek's major source of criticism against applying the general equilibrium model to socialist economics was his perception of the role of information in making economic decisions. Hayek pointed out that the real problem of any economic model is to show how the information and knowledge necessary for rational decision making which exists in millions of separate individuals (consumers with their preferences) can be transmitted to appropriate decision makers to permit an orderly economy to emerge. The free market's mechanism handles the problem of transmitting market knowledge because it takes advantage of decentralization of knowledge (“division of knowledge”) and decentralized decision making. Hayek argued that the burden of proof was on the socialists to show that centralized planning could improve upon the free market's production and use of information. Hayek analyses is of central importance to the growing literature of the “economic of information,” which asks “how individuals should and do behave when imperfectly informed.”
The Welfare State: Business & Labor
“Prelude to Welfare Capitalism: The Role of Business in the Enactment of Workmen's Compensation in Illinois, 1905–12.” In Compassion And Responsibility: Readings in the History of Social Welfare Policy in the United States (Chicago: University of Chicago Press, 1980):265–289.
It was during the Progressive era at the turn of the 20th century that modern, comprehensive welfare programs began to appear at the state level. Professionals and labor leaders were joined by businessmen who began to see such state compensation as a solution to certain of their problems of liability.
A first step to welfare policies was the reform of the common law where questions of liability, in the face of a rising number of on-the-job accidents, resulted in forty states creating commissions to examine the work-related injury. The law reflected a pre-industrial society which made suits difficult, but verdicts favoring employees were increasing.
Business groups, including insurance companies, began to favor the stability offered by state compensation. They were joined by a large number of Progressive reformers ranging from scholars to ministers. A major figure was Ernst Freund, a law professor at the University of Chicago. Born in Germany, he disapproved of the common law concept and favored compensation plans derived from European models.
Business groups seem to have played the major role in passing the Illinois law of 1911 which closely resembled a plan advocated by the National Association of Manufacturers. Originally opposed to state compensation, labor leaders began to change as the legal injunction was more frequently used against them.
Instead of trying to rework the common law tradition, business, labor, and the reformers turned to state-sponsored compensation. The support of business was crucial in this case. Other more radical Progressive proposals failed because they were opposed by the business community as radical, whereas compensation was not so viewed.
Child Labor and Capitalism
“Child Labor and the Factory Acts.” Journal of Economic History 40(December 1980):739–755.
The traditional view holds that a ruthless system of market laissez faire depended on and exploited child labor in early nineteenth-century Britain. Without state intervention, beginning with the Factory Act of 1833, the market forces of the industrial revolution allegedly held out little hope of improving the children's wretched condition. Supposedly, the Factory Acts diminished child labor, thereby improving the welfare of children. The economic and historical evidence, however, implies that the Factory Acts merely speeded up an earlier tendency of the market to reduce child labor. The chief causes of the decline in child labor were not laws but labor-saving technological improvements and rising family incomes.
The traditional view is distorted by the one-sided evidence of M. T. Sadler's Report of the Select Committee on the Bill for the Regulation of Factories (1832). But Sadler, the Leeds M.P., coached his witness to paint a lurid portrait of the textile industry which claimed that child labor was the major source of labor in the factory districts. The defense for the other side—the factory owners—was never carried out to balance the picture. During the 1840s and 1860s royal commissions and reformers aroused sympathy to extend legislation to regulate work hours, conditions, and educational opportunities for child miners, chimney sweeps, and virtually all industries. The traditional interpretation draws the unfounded conclusion that child labor decreased because of the legislative regulation rather than because of market innovations.
A close study of the statistical evidence for child employment debunks the belief that the Factory Acts prevented child labor in textile factories from increasing in importance. The apparently increasing proportion of child workers after 1838 actually resulted from the “half-time” system (employing more children but with fewer hours of work required) and from the decline in the implicit “tax” on child labor (the cost to the employers of the providing age certificates and the child education declined). For most of the nineteenth century improvements in labor-saving machinery (such as the self-acting spinning mule which eliminated the need for children to piece together broken threads). Increasing family income and wages further reduced the need for child labor, as did the shift to steam power. The Factory Acts, then did not cause the long-run decline in child labor. In the short-run, however, they may have reduced the proportion of children in the textile labor force.
It is not clear that the overall effects of factory legislation improved children's “welfare,” a controversial and hard-to-measure notion. It is fallacious to assume that simply because legislation may have displaced some children from the factory work force, it thereby removed them from all labor occupations (such as more onerous nonindustrial jobs and the “family economy”).
Children employed in nontextile industries did not undergo legislative regulations until the 1860s and 1870s. They thus provided an opportunity to observe what children's work was like in the absence of factory regulation. The census evidence shows that typically, children under 10 were not wage laborers in the unregulated industries. Nor were older children (up to the age of 14) significant percentage in the unregulated, nontextile factories. “Therefore the hypothesis that all British industry depended on children does not fit the facts.”
Prof. Nardinelli concludes that child labor in textile factories was not growing relative to adult labor even before the Factory Acts. In fact, it was declining without government intervention. “The legislation did not slow the replacement of adult by children; it accelerated the replacement of children by women.” The traditional history of child labor is distorted by concentrating on the early textile industries, a unique case. Originally, textile factories were located in rural areas to take advantage of water power. The rural location, the need for unskilled labor, and the immobility of adults under the Poor Laws led to a greater proportion of child labor only during this early stage of the textile industry. The later development of steam power allowed for urban location and factories to be located in the more populated cities and thereby diminished the need for nonadult labor.
Economics vs. Minimum Wage Politics
“The Unsinkable Minimum Wage.” Policy Review 11(Winter 1980):83–95.
Rarely has Western history seen a period in which the price of labor was not regulated in one way or another. In mercantilist times, authorities imposed maximum wage regulations; today, we legislate a minimum wage, ostensibly to protect workers whose skills are least favored by the market. In his article, Prof. West reviews the formidable objections raised by contemporary economists against government imposition of a minimum wage. Unfortunately, he comments, in this debate with politicians, economists win all the arguments and lose all the votes. He urges economists to marshall their new empirical findings in such a way as to influence policymakers.
One of the classic arguments favoring minimum wage legislation, contends that such laws safeguard the rights of students, who comprise a significant percentage of the part-time labor force yet whose minimal skills obtain rock-bottom wages for them in the market place. In rebuttal, research has demonstrated that minimum wage laws make many students un-employable at the required salary levels. They are thus deprived of funds to continue their education—which in turn contributes to a more poorly trained work force.
F. Ray Marshall, Labor Secretary under President Carter, has answered this type of argument simply by asserting that, since the market had “failed” to provide jobs, the public sector should step in with such schemes as the Job Corps. More accurately, of course, the government has failed to let the market provide student jobs. Somewhat contradictorily, Secretary Marshall also argues that a minimum wage is actually needed to displace young people in order to induce them into publicly sponsored training projects. Most policymakers explicitly consider formal education under public auspices superior to on-the-job training, a dubious assumption in the light of the results. The minimum wage may well prevent a substantial amount of on-the-job training for students, as well as for school dropouts.
Minimum wage advocates also hold it up as an effective means of fighting poverty. However, the uncertainty of its real effects makes its usefulness in this area highly dubious. Proponents usually argue that income gains outweigh any employment displacement, so that, over all, income distribution improves. However, those proponents have presented no empirical evidence.
Elitism motivates much of the supposed egalitarianism of minimum wage supporters. Secretary Marshall, for example, argued in 1978 that it made sense to put 30,000 youths out of work by passing a higher minimum, so that the government might better induce them into school and into federal job programs. These socially engineered schemes impoverish the nation, families, and individuals far more than simple unemployment.
Vested interests in the minimum wage form a powerful lobby from labor unions to government functionaries whose jobs depend on the existence of such laws. As a result, political expediency and the crassest self-interest may continue to control this area of public policy. Nonetheless, West concludes, economists have the duty to persevere.
Adam Smith vs. Neo-Mercantilism
“Against the New Mercantilism: the Relevance of Adam Smith.” Il Politico (Italy) 43, No. 4(1978):766–775.
Although his Wealth of Nations (1776) is one of the primary foundations of economics, Adam Smith's relevance to our time is not primarily as an “economist.” Smith's contributions were many: belles lettres, a speculative history of astronomy, his pioneering work in social psychology, The Theory of Moral Sentiment (1754), and his sociological observations and philosophy of history in such works as his Lectures on Jurisprudence. Smith's “economics” is actually a “political economy,” a comprehensive analysis “that took in the whole fabric of social life, its patterns of power, privilege and class in both their contemporary and historical setting.”
Interpreted as a far-ranging political economy, Smith's economics presents a sociological and political critique of this era's mercantilist system. Smith's exposure of the flaws in the older mercantilism of his day is especially relevant to our new twentieth-century revival of this dangerous system. There are instructive parallels between the old and new mercantilism. Both are harmful policies of state economic regulation to control trade and labor associations and attain “full” employment”, for the benefit of privilege interests who control legislation. Mercantilism in Smith's day and ours was a fatally conceived policy of economic protectionism, privilege, and exploitation.
What is the significance for us today of Smith's critique of mercantilism? Smith did not simply give an abstract economic analysis on how mercantilist obstacles hampered a competitive market system. He went deeper by radically exposing “the very driving motivation and political character of mercantilism,” the “wretched spirit of monopoly” and privilege chiefly practiced by merchants and manufacturers.
New scholarship (from both New Left historians and conservative “public choice” scholars) has dissected the true history of state intervention in the rise of the old and new mercantilism. Business interests build the corporate state by securing state intervention to preserve their protected niche from the risks of rival business competitors. Equally protectionist labor unions and class “new bureaucrats have joined in constructing modern neo-mercantilism and privilege. The implicit moral significant for our times of Smith's critiques of mercantilism is the “demystifying” of all the political and economic interests using protectionism. Smith's political economy allows us today to understand our contemporary social fabric as a whole.
In 1869 Smith's disciple, James E. Thorold Rogers, summed up the issue: “Smith's political economy was a war against privilege and monopoly as all honest political economy is whether it be privilege on the part of the landlords or masters, peasants or workmen.”
Laissez Faire and Moral Revolution
Moral Revolution and Economic Science: The Demise of Laissez-Faire in Nineteenth-Century British Political Economy. Westport, Connecticut and London, England: Greenwood Press, 1979
British political economy underwent a profound metamorphosis from the early to the later part of the nineteenth century. During the last quarter of that century economists abandoned the earlier policy of a nonactivist or limited state intervention in the economy. What undermined the economists' faith in Adam Smith's notion that an invisible hand would lead selfish men through a free market to maximize the social good? What caused laissez faire to fall mortally wounded while socialistic ideas were embraced?
The changes in pure economic theory (of value, wages, etc.) during the period did contribute to undermining laissez-faire, but they cannot explain the root cause. For example, the most devastating blow to the entire edifice of classical economics occurred with the introduction of the final (marginal) utility theory of value. This radically innovative value theory set economics on an entirely new foundation from Smith's and Ricardo's labor and cost-of-production theories. Marginal utility theory discredited such established fixtures of classical economics as the subsistence theory of wages, Malthus's population theory, the projection of a stationary state for the future, and the separate theories of distribution for land, labor, and capital.
But despite this revolution in pure economic theory, the later economists, Jevons, Marshall, and Sidgwick merely continued an earlier movement away from laissez faire. Jevons merely continued Bentham's view of utilitarianism: man was fundamentally a pleasure maximizer and the greatest happiness for the greatest number was the moral principle upon which social policy ought to be tested. The author argues that it was John Stuart Mill, the great heir of Jeremy Bentham, who was the principal architect to undermine laissez faire. Bentham certainly set the groundwork for this moral revolution, but he retained enough individualism to remain somewhat wedded to the limited government position of Adam Smith. It was left to Bentham's successor, Mill, to distill the collectivist implications of the principle of utility. Adam Smith's natural law or natural rights moral underpinning provided a buttress that led logically to his non-interventionist policy recommendations. But the principle of utility provides no such necessary connection with laissez faire. Thus, John Stuart Mill's frequent flirtations with the ideas of the Continental socialists and his virtual concession of the high moral ground to them becomes explicable.
Other factors besides utilitarianism, of course, contributed to the downfall of laissez faire. Nassau Senior and J.S. Mill provided additional amunition with their “art-science” distinction, the effect of which was to bifurcate economics. No longer would the positive science of economics have anything prescriptive to say to policy makers. This naturally undermined the whole intent of Adam Smith's Wealth of Nations, which was precisely to instruct legislators in how to maximize production by leaving the economy free.