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The group known as the Physiocrats reacted powerfully to the ideas of the French mercantilists. The Physiocrats declared agriculture the only source of economic wealth and attempted to remove trade restrictions from corn and other sectors. In other words, since real wealth came from the land, it followed that the wisest thing government could do would be to keep its hands off business. This idea was expressed in the slogan ‘laissez-faire’ (`let people do as they choose’).
A remarkable depiction of the economy as a circular flow, still used in today’s texts, was made by François Quesnay, Louis XIV's court physician. He stressed that the different elements of the
economy are as integrally tied together as are the blood vessels of the body.
Classical Economics: Adam Smith
1776, the year that Americans associate with the signing of the Declaration of Independence, also marked the publication in England of one of the most influential books of our time an Inquiry into the Nature and Causes of the Wealth of Nations, known as the
Wealth of Nations written by Adam Smith. The book earned the author the title ‘the father of economics’.
Smith objected to the principal economic beliefs of his day. He differed from the physiocrats who argued that land was the only source of wealth. He also disagreed with the mercantilists who measured the wealth of a nation by its money supply and called for government regulation of the economy in order to promote a ‘favorable balance of trade’.
In Smith’s view, a nation's wealth was dependent upon production, not agriculture alone. How much it produced, he believed, depended upon how well it combined labor and the other factors of production. The more efficient the combination, the greater the output, and the greater the nation’s wealth.
The heart of Smith’s economic philosophy was his belief that the economy would work best if left to function on its own without government intervention. In those circumstances, self-interest would lead business firms to produce only those products that consumers wanted, and to produce them at the lowest possible cost. They would do this, not as a means of benefiting society, but in an effort to outperform their competitors and gain the greatest profit. But all this
self-interest would benefit society as a whole by providing it with more and better goods and services, at the lowest prices.
To explain why all the society benefits when the economy is free of regulation, Smith used the metaphor of an ‘invisible hand’:
“Every individual . . . neither intends to promote the general interest, nor knows how much he is promoting it. He intends only his own security, his own gain. And he is in this led by an invisible hand to promote an end which was no part of his intention. By pursuing his own interest he frequently promotes that of society more effectually than when he really intends to promote it.’
The ‘invisible hand’ was Smith’s name for the economic forces that we today would call supply and demand, or the marketplace.
His idea of the importance of the division of labour for the efficient production, and other sections dealing with the factors of production, money and international trade are as meaningful today as when they were first written. Smith’s Wealth of Nations contains some of the best descriptions of the principles upon which the market economy is based.
Classical Economics: David Ricardo
David Ricardo (1772-1823) is one of history's most influential economists, from whose thinking both neoclassical and modern economics derive. Born in England, Ricardo made a fortune on the London Stock Exchange. This wealth gave him the time to write and to serve in Parliament's House of Commons. His most famous work,
Principles of Political Economy and Taxation (1817), marked him as the greatest spokesman for classical economics since Adam Smith.
One of Ricardo’s contributions lay in a thorough analysis of the nature of economic rent – a theory that survives almost intact today. He also presented a careful analysis of the labor theory of value. But his major contribution was his analysis of the laws of income distribution in a capitalist economy.
Ricardo is especially famous in international economics for demonstrating the advantages of free trade. Free trade is a policy in which tariffs and other barriers to trade between nations are removed. To prove his point, Ricardo developed a concept we now call the law of comparative advantage. Comparative advantage enabled him to demonstrate that one nation might profitably import goods from another even though the importing country could produce that item for less than the exporter.
As Member of Parliament, Ricardo pressed the government to abandon its traditional policy of protection. Though he did not live to achieve that goal, his efforts bore fruit in the 1840’s when England became the first industrial power to adopt a policy of free trade. There followed 70 years of economic growth during which the nation became the world's wealthiest industrial power.