Learning Outcomes
By the end of this section, you will be able to:
- Explain the origins of the market economy.
- Define wealth according to classical liberal theory.
- Describe Adam Smith’s argument regarding the three levels of analysis.
The Enlightenment and the Industrial Revolution marked the introduction of new concepts that fundamentally transformed European societies and the world. Enlightenment thinkers freed human beings from an unquestionable religiosity, superstitions, and social rigidity. Absolutism could no longer be defended on the basis of God’s will and divine providence. The ideas of anthropocentrism, or the argument that human beings are the most important component of the Universe; rationalism, which is the belief that reason rather than experience is the foundation of knowledge; and scientism, or the view that inductive methods of the natural sciences are the only source of genuine knowledge, prompted changes that culminated with the French Revolution and the Declaration of Independence of the Thirteen Colonies. Movements toward political democratization and economic development based on these ideas have since been diffused to the four corners of the world.
The Enlightenment period promoted the idea of civilization as opposed to savagery. Societies that reflected anthropocentrism, rationalism, and scientism were the first to reap the benefits of the Industrial Revolution, including the development of the market and social progress, and to embody the idea of civilization. These societies were initially located in Western Europe and were then propagated to the colonized world, accompanying the migration movement and the birth of industrialization. Societies based on traditional religion and superstition, where family relationships defined power and politics, were considered savage. In University of Denver emeritus professor David P. Levine’s words, “Civilization is an important concept in political economy. . . . Civilized society provides its members with opportunities not otherwise available; but it also confronts them with dangers.”16
One of these opportunities is wealth creation. Enlightenment thinkers rejected the mercantilist idea that wealth is finite, proposing that wealth could in fact be created. The concept of wealth had been transformed. As Levine puts it, “Producing wealth is a special sort of activity. It is one that employs some of our assets to produce commodities: goods and services valued in the market.”17
This change in the perception of what constituted wealth had an enormous impact on political economy. If wealth is understood as the extent to which the market values a good or service, and if the creativity and industriousness of the human mind is boundless, then wealth is infinite.
More than 200 years later, we still employ Enlightenment ideas about the concept of wealth. Adam Smith played an important role in defining our understanding of wealth creation, the functioning of the market, and the role of the government in a market-based society. His beliefs in science and in human beings’ inclination toward progress are key to his account of political economy. Adam Smith laid the foundation for liberalism, the dominant economic practice that persists today, in his classic work The Wealth of Nations (1776). He rejected mercantilism, suggesting that monarchy’s insistence on the balance of trade surplus through trade barriers would hurt the economy. According to Adam Smith, the best approach to the economy was a laissez-faire one, in other words, the free-market approach in which governments do not interfere in the market and let things take their own course.
Adam Smith developed his argument in The Wealth of Nations using different levels of analysis. First, he focused on the individual level and argued that self-interested individuals, or in other words, individuals focused on advancing their personal interests, tend to make decisions that will maximize results to their own benefit. Thus, if governments guarantee individuals the freedom to produce and trade as they please, society will be better off in the long run.
His second level of analysis examined the state. Adam Smith argued that countries should dedicate themselves to the production of what they produce best, following their comparative advantages. For example, he argued that given France’s geographic characteristics and the developed skills and abilities of its people, France can produce better cheese and wine than, for example, Great Britain, and at a lower cost. Therefore, he argued, France should produce cheese and wine. On the other hand, given Great Britain’s geographic characteristics and traditions, the British can produce better quality wool than the French, and therefore Smith argued that the British should produce wool and not cheese and wine.
At the international level of analysis, Smith argued that if countries stick to their comparative advantages, international trade should allow individuals in different countries to have access to the best products at the lowest costs. This would eliminate the need for trade barriers and result in a system of free international trade. In this case, both the French and the British would get the best cheese, wine, and wool at the lowest cost.
Adam Smith’s assumption regarding the benefits of a laissez-faire economy has accompanied the mainstream understanding of political economy since the publication of The Wealth of Nations. According to Adam Smith, the accumulation of capital in preindustrial societies allowed for the emergence of the Industrial Revolution, which produced consumable goods for society and elevated the quality of life of industrialized nations.
The ideas promulgated by Adam Smith and other political economists slowly promoted trade liberalization in Europe. Britain moved toward free trade in the 1780s with the repeal of the Corn Laws, trade restrictions such as tariffs and quotas on imported corn and food. The Corn Laws intended to keep corn prices high and favor domestic producers of food.18 Several European states followed Britain’s move and similarly promoted trade liberalization. Nevertheless, Britain returned to protectionist policies during the Napoleonic Wars (1803–1815), a series of battles fought by the French Empire and its allies, led by Napoleon I, against several European countries that formed various coalitions. The costs of war are high, and as war expenses accumulated, the British government levied tariffs on imported goods to generate revenues and pay for the costs of war. The end of the Napoleonic Wars culminated with the Congress of Vienna (1814–1815), a peace conference to reconstruct European relations after the downfall of Napoleon I. The Congress of Vienna led to the Concert of Europe, a general consensus to promote equilibrium among the five great European powers (Austria, France, Prussia, Russia, and the United Kingdom). It prevented another war from breaking out in Europe from 1815 to 1914.
The Concert of Europe period saw the flourishing of trade liberalization. Moreover, improved technology and the advent of new players in the international commodities market increased competition, and domestic pressure in favor of protectionist policies led the recently unified Germany to defect from the free-trade regime and return to protectionism in the 1870s.
In general terms, international trade picked up from the late 19th century until World War I. After World War I, protectionist policies became the rule again until the end of World War II, when the bases of the current international financial system were established.