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CHAPTER 2
“LAISSEZ-FAIRE”: THE ECONOMIC LIBERAL PERSPECTIVE
Overview
This chapter outlines the liberal perspective in International Political Economy (IPE), linking the
recent rise of the economic liberal view to its historical roots. We trace the broader idea of
liberalism from eighteenth century France, through nineteenth century England, to the twenty–
first century. We also consider some events that shaped this point of view such as the case of the
nineteenth-century Corn Laws and the Great Depression.
After discussing the ideas of Friedman and Hayek, we date the rise of neoliberalism in practice
to the early 1980s and trace its connection to globalization. There is also a discussion of some
critiques of globalization in the 1990s and 2000s from liberals themselves and from global
activists. The final section of the chapter highlights differences between orthodox and heterodox
economic liberals, especially in light of the global financial crisis of 2008-2009. We stress,
however, that due to entrenched beliefs, influential supporters, and other reasons, economic
liberalism itself continues to strongly influence state policies.
Key Terms
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economic liberalism
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rent-seeking
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orthodox economic liberals
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heterodox economic liberals
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new constitutionalism
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ordoliberalism
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Teaching Tips
• This chapter contains many quotations that can be used effectively in class to bring out the
power and complexity of liberal ideas. Instructors may also want to bring into class other pithy
quotations. Smith and Keynes provide especially good material for understanding the
complexity of these thinker’s views and student reaction to them.
• This chapter traces the evolution of liberal ideas and discusses their consequences for state–
market relations and different policies. Some students will be confused by the fact that
classical liberalism and conservatism are nearly synonymous, in the sense that these terms are
sometimes used in IPE. It is a good idea to address this confusion right at the start. Ask
students to carefully distinguish between classical liberalism and economic liberalism as we
understand it today. Ask them why they think there is now so much tension between orthodox
economic liberals and those who, in U.S. politics today, are considered “liberals.”
• It is good to ask the question “What makes Mill and Keynes liberals?” This is a controversial
question with respect to Keynes, but the quotations provided (and especially the suggested
reading by Skidelsky) make the answer clear.
Sample Essay Questions
1. Adam Smith and John Maynard Keynes are both liberals, in the broad sense in which this
term is used in IPE. Explain what views Smith and Keynes share regarding the market, the
state, human nature, and power. How do they differ?
2. Explain the key assumptions and assertions of classical liberalism.
3. How do liberals such as David Ricardo view international trade? Why do they hold this
opinion? Explain how the Corn Laws debate in nineteenth-century Britain illustrates the
conflict between mercantilist and economic liberal views of international trade.
4. John Stuart Mill and John Maynard Keynes thought that government could and should play a
positive role in correcting problems in the market. Discuss the specific types of “market
failures” that Mill and Keynes perceived and the types of government actions they advocated.
What kinds of policy recommendations do you think Mill and Keynes would favor today?
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Explain.
6. Economic liberal values and policies have been relatively more popular in the United States
than in other developed countries. Why?
7. In what ways does ordoliberalism differ from neoliberalism?
Sample Multiple-Choice Questions
1) Adam Smith favored “laissez–faire” policies, where individuals, guided by the “invisible
hand,” would produce social benefits. The invisible hand stands for
2) Which of the following best states Smith’s ideas related to moral sentiments?
d) Serving one’s own interests in a competitive society means competing to best serve the
interests of industrial society.
3) David Ricardo favored free international markets. Which of the following ideas about free,
open markets is not associated with Ricardo?
4) John Stuart Mill is most noted for changing liberalism to reflect
a) the need for less state regulation of the economy.
5) Which of the following is not one of the main elements of capitalism listed by the authors?
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d) the right to private property
e) markets coordinate society’s economic activities
6) Embedded liberalism can be summed up in which of the following statements?
d) The state needs to intervene in the economy because markets fail.
7) In the liberal view today, a hegemon is
d) a strong capitalist nation that uses its power to exploit less developed countries.
8) Which of the following statements about the views of President Reagan and Prime Minister
Thatcher is incorrect?
a) They both favored market deregulation.
9) This supporter of globalization argues that if a country wants to benefit from globalization, it
must put on a “golden straightjacket,” i.e., the country must adopt economic liberal policies
and accept some limits on state sovereignty.
10) Heterodox economic liberals recommend all of these policies except
a) more redistribution of wealth to the lower social classes.
11) Who admitted before a U.S. congressional committee in 2008 that his assumptions about
financial markets and banks were flawed?
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12) Ordoliberals would agree with each of the following statement except which one?
d) The market requires an appropriate set of legal and political institutions.
13) Compared to neoliberals, heterodox economical liberals are less likely to believe in
a) the efficient market hypothesis.
Suggested Readings and Links
Bhagwati, Jagdish. In Defense of Globalization. Oxford: Oxford University Press, 2005.
Birch, Kean. A Research Agenda for Neoliberalism. Northampton, MA: Edward Elgar, 2017.
Bourguignon, François. The Globalization of Inequality. Princeton, NJ: Princeton University
Press, 2015.
Gaus, Gerald, Shane D. Courtland, and David Schmidtz. “Liberalism.” In the Stanford
Encyclopedia of Philosophy (Spring 2018 Edition), ed. Edward N. Zalta, at
https://plato.stanford.edu/archives/spr2018/entries/liberalism/.
Hayek, Friedrich A. The Road to Serfdom. Chicago: University of Chicago Press, 1944.
Keynes, John Maynard. Essays in Persuasion. New York: W.W. Norton, 1963.
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Kuttner, Robert. Can Democracy Survive Global Capitalism? New York: W.W. Norton, 2018.
Mueller, Jerry. The Mind and the Market: Capitalism in Western Thought. New York: Anchor
Books, 2003.
Yergin, Daniel, and Joseph Stanislaw. The Commanding Heights. Paperback ed. New York:
Simon & Schuster, 2002.
Audiovisual Resources
Capitalism. Part 1, Adam Smith: The Birth of the Free Market. Ilan Ziv, dir. Brooklyn, NY:
Icarus Films, 2015.
Commanding Heights: The Battle for the World Economy. William Cran, dir. Invision
Productions Limited in association with Heights Productions and WGBH Boston. Boston:
WGBH Boston Video, 2002. For related resources, see the website
http://www.pbs.org/wgbh/commandingheights/lo/index.html.
Free to Choose. A PBS TV series by Milton Friedman, originally broadcast in 1980. Watch the
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Masters of Money. Three episodes on John Maynard Keynes, Friedrich Hayek, and Karl Marx.
BBC Open University, 2012. “BBC economics editor Stephanie Flanders examines how
three extraordinary thinkers, Keynes, Hayek and Marx, helped shape the 20th century” (BBC
website).
Supplementary Materials
These supplementary discussions for Chapter 2 were written by Professor Ross Singleton
and originally appeared in the 4th edition of this textbook. They are:
• “The Market Model”
The Market Model
At the heart of the liberal perspective lies the market as the means of allocating scarce resources
among competing uses. An appreciation of the market mechanism in this regard requires a basic
understanding of the market as captured in the following market model. The market model
consists of a demand model representing the consumers (buyers) and a supply model
representing the producers (sellers).
The demand for a particular commodity (the willingness and ability of consumers to pay for the
commodity) depends on the price of the commodity, the prices of related goods (substitutes and
complements), the income of consumers, consumer tastes and preferences, the number of
consumers, consumer expectations regarding future prices, and other considerations. The
quantity of the commodity demanded increases when the price of the commodity decreases,
holding other determinants of demand constant. This is depicted as a movement along the
demand curve, from P1, Q1 to P2, Q2 in Figure 3–1. As the price of a commodity falls,
consumers will substitute more of that commodity for other goods, which now cost relatively
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The supply of a particular commodity (the willingness and ability of producers to supply the
commodity) depends on the price of the commodity, the prices of resources needed to produce
the commodity, production technology, the number of producers, and other factors. The quantity
of the commodity supplied increases when the price of the commodity increases, holding other
determinants of supply constant. This is depicted as a movement along the supply curve, from
P1, Q1 to P2, Q2 in Figure 3–2. The profit-maximizing response to a higher price is to expand
production. The direct relationship between price and quantity supplied reflects the law of
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The market is in equilibrium at the price at which the quantity demanded and the quantity
supplied are in balance. In Figure 3–3, P1 and Q1 are the equilibrium price and quantity,
respectively.
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Market-Based Resource Allocation
Using this simple model, we can now describe how resources are allocated and reallocated via
the market. Assume that consumer tastes and preferences turn in favor of the particular
commodity, the market for which is depicted in Figure 3–4. The demand for this commodity will
increase. The demand curve will shift to the right to Demand. At price P1, a shortage of the
commodity (Q3 – Q1) will be created as the quantity demanded exceeds the quantity supplied.
The shortage in turn will cause the price of the commodity to rise, and as the price rises,
These resources will be bid away from other lesser-valued uses. Consequently, resources will be
reallocated away from other uses and to this use in accordance with changing consumer tastes
and preferences. No central agency or authority oversees this resource reallocation process;
rather, this reallocation occurs in response to the incentives created by the higher price for the
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commodity. That is, producers increase production in an effort to increase their profitability, not
out of concern for the well-being of consumers and not because they have been directed to do so
by a central planning authority. Yet the producer’s self-interested behavior ultimately serves
consumers, who are able to enjoy more of the commodity. In the long run, the profits made by
producers in this market will attract entry by new producers into this industry. When those new
firms enter (bringing resources with them), the supply of the commodity will expand to Supply
and the price will eventually fall to P1 and the associated equilibrium quantity will expand to Q3.
In the long run, consumers will enjoy more of the product while paying only the original price.
(Students of economics will recognize the implicit assumption that the market in question is a
constant-cost market—a market in which entry has no effect on input prices.)
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Economic Efficiency
The concept of economic efficiency is central to the study of IPE. Public policies, and even
entire economic systems, are evaluated based on their “efficiency.” But what does this term
mean? It is a slippery term, in part, because of the various meanings implied or intended by its
use. Efficiency may mean one thing to an economist, another to a sociologist, and something else
again to a political theorist.
Economists’ conceptions of economic efficiency include allocative, production, and dynamic
efficiency. Allocative efficiency concerns the allocation of scarce resources among competing
uses—a fundamental task that every society must undertake in one way or another. We will use
the market model we have developed to illustrate the concept of allocative efficiency in some
detail in the following paragraphs. First, however, it is important to note, if only in passing, the
additional meanings of this term as commonly used by economists. Production efficiency
concerns how well resources are used in a particular use. How efficiently is steel produced? How
efficiently are health care services delivered? When production efficiency exists, goods and
services are produced at the lowest possible cost. Dynamic efficiency concerns the rate of
technological progress in an industry or within an economy. Technological progress is, in large
part, the result of investment in research and development (R&D). Dynamic efficiency exists
when the current level of investment in R&D results in an optimal rate of technological progress.
We will have more to say about dynamic efficiency in Chapter 10.
The allocation process using the market is decentralized in the extreme—no one is in charge.
Rather, the interactions of individual consumers and producers as reflected in demand and supply
result in an efficient allocation of resources (absent the many well-known causes of market
failure, including monopoly, externalities, public goods, and information problems). Recall that
the demand curve represents the prices that consumers are willing and able to pay for additional
units of a commodity. Economic theory suggests, in turn, that the price a consumer is willing and
able to pay for an additional unit of a commodity reflects the additional or marginal benefit the
consumer anticipates from consuming that unit. The demand curve, then, is a marginal benefit
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supply—the marginal benefit (MB) of the last unit produced exactly equals its marginal cost
(MC), as in Figure 3–5 for commodity A.
The significance of this outcome can best be appreciated if we consider the notion of opportunity
cost. The opportunity cost of using resources in one use is the benefit foregone of not using those
resources in their best alternative use. For example, the opportunity cost of reading this
paragraph is the benefit you otherwise would have realized from using your time (a very scarce
resource) in its best alternative use (perhaps watching a rerun of Seinfeld, or working on a cure
for malaria). The marginal cost of producing an additional unit of commodity A, say, the fourth
unit in Figure 3–5, is $3. This implies that there is some other use for the resources necessary to
produce this fourth unit of A that would yield a marginal benefit of $3. Should resources be
allocated to produce the fourth unit of A? Yes! The marginal benefit of the fourth unit is $8. The
$3.50. If resources are allocated to the production of this unit, a welfare loss of $2.50 will be
sustained. Resources should have instead been allocated to their best alternative use, where $6 in
marginal benefit would have been realized rather than the $3.50 in marginal benefit realized by
the production of the ninth unit.
The magic of the market is that the equilibrium level of output is also the social welfare–
maximizing level of output. The market process, then, results in an efficient allocation of
resources.
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Efficiency Versus Equity
The question remains: Is an efficient allocation of resources necessarily an equitable (fair)
allocation of resources? In fact, the concept of allocative efficiency is based on a very particular
(some might say peculiar) definition of social welfare. Recall that social welfare is defined as
total benefit minus total costs. Further, marginal benefit is reflected in the price that consumers
are willing and able to pay. Unless a consumer is both willing and able to pay, his or her
preferences regarding the allocation of resources will not be reflected in the market. Consumers
“vote” (on resource allocation) with their dollars. The more dollars any individual possesses, the
more votes she can cast. The particular allocation of resources to the production of various goods
and services, then, reflects a particular distribution of income. If income is redistributed, then a
different efficient allocation of resources will be realized. The question that opens this paragraph
can then be answered: An efficient allocation of resources is also an equitable allocation of
resources if income is distributed in an equitable manner.
Market justice also means that those of us who might be disadvantaged regarding our ability to
contribute to national output due to circumstances beyond our control (physical or mental
disability, born to a drug-addicted single mom, discriminated against in the workplace based on
race or religion, etc.) will earn very little income and therefore have little access to the goods and
services produced within our own economy. We will be on the outside looking in. There are, of
course, ways of taking the hard edges off market justice—income supplements to the poor or,
better yet, enhancing economic opportunity via training, education, and public works programs,
for instance. Perhaps this is what President George H. W. Bush meant by “compassionate
conservatism.”
While market justice can be harsh, it does undeniably create strong incentives to be productive.
By establishing a direct link between effort and reward, individuals are rewarded for their hard
work, their investment, their creativity, their drive, their dependability, their adaptability, and
their willingness to take risks. Margaret Thatcher, the British Prime Minister who instituted
liberal reforms in Great Britain, in effect argued that market justice would promote the “vigorous
virtues” of individual initiative, deferral of gratification, personal responsibility, independence,
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and entrepreneurship. Attending to the needs of the poor is recognized, then, as something of a
balancing act. Providing government income or housing or other supplements dulls incentives
and undermines the “vigorous virtues” by severing the link between effort and reward.
Against the liberal notion of market justice stands the ideal of distributive justice as associated
with structuralism. The essence of distributive justice is captured in Karl Marx’s dictum, “From
each according to his ability and to each according to his need.” In a society that really adheres
to the principle of distributive justice, income is determined by the needs of the various members
Or does the would-be brain surgeon choose not to undertake the arduous years of necessary
training, knowing that her efforts will not lead to commensurate monetary rewards? Does the
mill worker fail to show up on Mondays and Fridays? Does the entrepreneur bother to innovate?
Who invests? In other words, what about incentive? Also, how is relative need assessed, and by
whom? The state? Who controls the state apparatus? Won’t these interests have unchecked
power? Won’t growing dependency on the state wither the “vigorous virtues” and undermine the
dynamism of the economy? Asking these obvious questions reveals some of the concerns about
distributive justice that have been voiced by liberal critics. Nevertheless, the appeal of
distributive justice is undeniable. It is a dream that has driven revolutions.