Classical Economics: Principles and Criticisms

Classical Economics: Principles and Criticisms

Classical economics or classical political economy is one of the major schools of thought in economics that first flourished in Britain during the late 18th century and spread further in key European countries during the early-to-middle 19th century.

Economists such as Adam Smith, Anne Robert Jacques Turgot, Jean-Baptiste Say, David Ricardo, Eugen Böhm von Bawerk, Thomas Robert Malthus, and John Stuart Mill were credited for developing and expanding the principles of classical economic theory.

The theory helped countries in Europe transition from monarchy to democracy, thus paving the way for the emergence of capitalism. It generally focused on economic growth through economic freedom, specifically by highlighting the importance of laissez-fare, free or open market competition, and the transition from class-based social structures in favor of meritocracies.

The Principles of Classical Economics: Arguments and Assumptions

The primary assumption of classical economics is that a free-market capitalist economic system is a self-regulating economic system governed by the natural laws of production and exchange. For instance, the law of supply and demand allows the self-regulation of the business cycle. It essentially promotes a laissez-faire system in which the government has a very limited role in shaping the direction of the economy.

Before the rise of this school of thought, countries in Europe such as Britain followed a top-down and command-and-control approach in managing their economic affairs. Nevertheless, theories developed within classical economics served as early attempts at explaining the inner workings of capitalism.

Economists such as Smith and Turgot specifically developed their theories as alternatives to mercantilist and protectionist economic policies that dominated Europe. Note that mercantilism and protectionism center on driving economic growth by maximizing exports and minimizing imports to reach a current account surplus.

In his magnus opum “Wealth of the Nation” published in 1776, Smith argued that the wealth of any nation is determined not by the gold held in the coffers of its monarch but by its national income. This income was based on the labor of its citizens, organized efficiently by the division of labor and the use of accumulated capital.

Smith also argued that free competition and free trade without restriction or control from a government would best promote the growth of the economy. He noted that the society would benefit if each of its members can freely follow his or her own self-interest.

Both free competition and free trade would certainly create chaos from competitive selling and buying. However, Smith explained that the chaotic market condition would also naturally create an orderly system of economic cooperation in which economic participants strive to meet the needs of each other.

Another theory David Ricardo supported free competition and free trade. In his “On The Principle of Political Economy and Taxation,” he presented an idea now known as the theory of comparative advantage. According to him, comparative advantage allows a country to become an efficient producer by focusing on its specialization.

Through perfect competition and undistorted markets, countries would produce and export commodities in which they have a comparative advantage. Note that Smith also introduced the concept of absolute advantage in which he advised that it would be better to import from a country that produces a commodity cheaper than the domestic market.

The Criticisms of Classical Economics: Counterarguments and Limitations

One of the modern criticisms of classical economics involves a perceived lack of cohesion. Classical economists were not completely unified in their theories, ideas, and assertions, including their beliefs or understanding of markets. Of course, there are still notable common themes in the literature, including support for capitalism, free competition, and free trade.

Another argument against this school of thought in economics came from German sociologist and political theorist Karl Marx, specifically the Marxian economics and the corresponding concepts of socialism and communism. Of course, because classical economics argue for free competition and capitalism, it goes against the principles of socialism and capitalism.

The theory of supply-side economics also provided an opposing view. It argues that the most effective way to boost the economy is through government intervention policies and programs aimed at promoting business growth, specifically by lowering taxes and decreasing regulations or restrictions.

However, a major challenge to classical economics first emerged from the works of British mathematician and economist John Maynard Keynes and the corresponding Keynesian school of economics.

In his book “The General Theory of Employment, Interest, and Money” published in 1936, Keynes noted that economic systems based on capitalism and free-market are still susceptible to underconsumption and underspending. Hence, unlike the prescriptions from Smith and other classical economists, he argued for governments to have a more controlling role in managing their respective economies.

Adherents of Keynesian economics advocate for the promotion and subsequent creation of economic policies that involve government intervention in the economy. After the Great Depression and World War II, this school of thought replaced classical and neoclassical economics as the dominant economic theory among world governments.

Summaries of the Principles and Criticisms

The following are the principles or the major arguments and assumptions of classical economics:

• A free-market capitalist economic system is a self-regulating economic system governed by the natural laws of production and exchange.

• The law of supply and demand allows the self-regulation of the business cycle because it promotes a laissez-faire system in which the government has a very limited role in shaping the direction of the economy.

• Smith argued that the wealth of any nation is determined not by the gold held in the coffers of its monarch but by its national income.

• Free competition and free trade without restriction or control from a government would best promote the growth of the economy.

• The economy of the country will grow effectively if society allows individuals to pursue their self-interest, particularly by moving from class-based social structures in favor of meritocracies.

• Chaos from competitive selling and buying would eventually result in an orderly system of economic cooperation characterized by economic participants engaged in meeting the needs of each other.

• A comparative advantage allows a country to become an efficient producer by focusing on its specialization. Countries are also better off importing from a country that produces a commodity cheaper than the domestic market

Below are the major criticisms or the counterarguments and limitations of classical economics:

• Classical economists were not completely unified in their theories, ideas, and assertions, including their beliefs or understanding of markets.

• Marxian economics and the corresponding concepts of socialism and communism go against the principles of classical economics, which argue for free competition and capitalism.

• The theory of supply-side economics also asserts that the most effective way to boost the economy is through government intervention policies and programs aimed at promoting business growth, especially by lowering taxes and decreasing regulation.

• Keynes noted that economic systems based on capitalism and free-market are still susceptible to underconsumption and underspending.

• Adherents of Keynesian economics advocate for the promotion and subsequent creation of economic policies that involve government intervention in the economy.

• Unlike Keynesian economics, classical economics failed to explain the reason behind the Great Depression. It also did not provide solutions for resolving economic downturns.

FURTHER READINGS AND REFERENCES

  • Keynes, J. M. 1936. The General Theory of Employment, Interest and Money. London: Palgrave Macmillan
  • Ricardo, D. 1817. On The Principles of Political Economy and Taxation. London: John Murray
  • Smith, A. 1776. An Inquiry Into The Nature and Causes of the Wealth of the Nation. London: W. Strahan and T. Cadell