Written by John Hajek, IPA Campus Coordinator — Melbourne University
1. Adam Smith (1723–1790)
“It is not from the benevolence of the butcher, the brewer, or the baker that we expect our dinner, but from their regard to their own interest” – Adam Smith
If you have ever heard the phrase “the invisible hand”, or read that the division of labour is limited by the extent of the market, you have encountered the enduring and pervasive influence of Adam Smith on the field of economics. Although not the first scientist of political economy, Smith’s 1776 magnum opus, The Wealth of Nations (or, technically, An Inquiry into the Nature and Causes of the Wealth of Nations) was the first major and comprehensive treatise that synthesised economics into a mainstream science, and represented the foundation of the classical school of economics. As capitalism replaced feudalism, Smith, for the first time, focused his inquiry on the wealth of the nation, not on the interests of the sovereign.
Although a towering figure of the Scottish Enlightenment, Smith is not correct about everything: for example, he espouses the fallacious and now-defunct labour theory of value, which has been superseded by a subjective theory of value. However, writing a ground-breaking work in 1776, Smith’s insights into human behaviour, the dynamics of commerce and the benefits of the division of labour are laudable. His aphorism that “it is not from the benevolence of the butcher, the brewer, or the baker that we expect our dinner, but from their regard to their own interest” marks perhaps the most important principle in free market economic thought: that self-interested individuals pursuing profit will inadvertently serve the public interest as long as exchanges are voluntary and constrained by competition. Conversely, Smith is also sceptical of the ability of ostensibly altruistic actors to actually serve the public interest: “I have never known much good done by those who affected to trade for the public good.”
Adam Smith provides the first compelling case for unrestricted international trade, writing that “it is the maxim of every prudent master of a family, never to attempt to make at home what it will cost him more to make than to buy… What is prudence in the conduct of every private family can scarce be folly in that of a great kingdom.” With this statement, Smith slices through the fallacy that the role of an economy is to provide employment; rather, its proper role is to provide the cheapest abundance of goods and services to its citizens. Similarly, Smith demolishes mercantilism – the doctrine that a nation’s standard of living can be measured by the piles of gold it hoards through exports – and proves instead that access to cheaper, better and more goods and services through imports is the real benefit that we derive from free international trade.
Perhaps most importantly, Smith introduced into the discourse of economics the concept that markets were self-regulating: the free interaction of many buyers and sellers with diverse and competing interests coupled with market prices was sufficient to ensure that resources were allocated efficiently and that shortages and surpluses were extremely rare. Smith was therefore the first major thinker to prove that central economic planning was unnecessary, and in fact destructive to the economic harmony that naturally results from laissez-faire capitalism.
2. Milton Friedman (1912-2006)
“Those of us who have been so fortunate as to have been born in a free society tend to take freedom for granted and regard it as a natural state of mankind. It is not. It is a rare and precious thing: most people throughout history – most people today – have lived in conditions of tyranny and misery; not of freedom and prosperity” – Milton Friedman
This is perhaps nobody more responsible for persuading people of the virtues of economic liberalism than Milton Friedman. As a leading light in the Chicago School of Economics, Friedman not only spearheaded the revolt within the economics profession against Keynesian interventionism, but also became perhaps the world’s first celebrity economist. He appeared on talk shows, wrote regular columns in Newsweek and published books such as Capitalism and Freedom (1962) and Free to Choose (1980), which extolled the virtues of free markets to a wider audience.
What makes Milton Friedman probably the most influential free market economist of the last century was his sheer intellect combined with his uncanny ability to articulate complex economic principles in a clear, concise and tangible manner. Watching Friedman explode economic fallacies and steamroll opponents in the many lectures, debates and talk shows in which he participated, all while remaining calm, logical and cheerful, is simply a thing of beauty.
His pedagogical style was always accessible and, often with the help of his TV series Free to Choose and the eponymous book (1980), he managed to explain the most important principles underlying free market thought. He popularised the now-canonical aphorism that “there is no such thing as a free lunch” and in turn inoculated millions of readers and viewers against the kind of economic excuses that politicians use to offer people something for nothing. Similarly, he stressed the fact that government spending is usually a zero-sum game, simply involving the confiscation of resources from one person in order to give them to another, while voluntary free market exchanges of goods and services are in fact mutually beneficial, as neither party would agree to the transaction if they didn’t both benefit.
By the same token, he repeatedly promoted a timeless reason for the inherent inefficiency of government as compared with the private sector when he explained the four ways to spend money: spending your own money on yourself, spending your money on someone else, spending someone else’s money on yourself, and spending someone else’s money on someone else. Private individuals engage in the first kind, and therefore have a strong incentive to maximise quality and minimise cost. Government, however, engages in the fourth type, and therefore has no strong incentive to maximise quality or minimise costs.
Moreover, Friedman was a standing rebuke to the charge that advocates of free market capitalism only love big business and instead championed the welfare and sovereignty of the consumer. He fiercely opposed subsidies to business as well as bailouts to struggling companies such as Chrysler, and insisted that capitalism was not a profit system, but a profit and loss system, with the losses being just as important as the profits. As Friedman explained, whereas profits tell a firm that it is allocating resources efficiently and adding value, a loss sends the opposite signal and performs the function of weeding out inefficient businesses that destroy wealth.
But the achievement of which Friedman himself was proudest was his instrumental role in the abolition of the US military draft in 1971. He not only argued that it was beyond the scope of legitimate government to conscript individuals’ labour services, but proved that forcing the US military into the market place by cutting off its guaranteed stream of young men would actually help it to remain the strongest force in the world.
3. Friedrich Hayek (1899–1992)
“The argument for liberty is not an argument against organization, which is one of the most powerful tools human reason can employ, but an argument against all exclusive, privileged, monopolistic organization, against the use of coercion to prevent others from doing better.” – Friedrich Hayek
Friedrich August von Hayek will perhaps be best remembered as one half of what economic historian Nicholas Wapshott called “the clash that defined modern economics”: Friedrich Hayek versus John Maynard Keynes. As prominent economists during the Great Depression, Keynes argued that crises were caused by individuals’ “animal spirits” and that aggressive government expenditure was the best way to restore economic prosperity. Hayek, on the other hand, argued that economic fluctuations are a result of a system-wide misallocation of capital resources (which he termed “malinvestment”) caused by loose monetary policy and rapid credit expansion.
According to Hayek, recessions are in fact a return to economic health; a painful but necessary period of readjustment as the economy abandons its unsustainable investment trajectory and is restored to a healthy structure of production. Hayek’s legacy survives in the largely fruitless attempts of governments to combat the recent Global Financial Crisis with reckless stimulus spending.
Hayek was awarded the Nobel Prize in Economics in 1974 for this seminal work on the role of credit expansion and economic fluctuations, which exonerates the free market as the cause of economic crises. All of this is awfully dry of course, compared to the simple, convenient panacea proffered by Keynes, which helps to explain why Keynes’ approach is more popular with political elites.
Hayek’s critique of government intervention as a tool of alleviating economic crises also overlapped with his contribution to the free market critique of socialism and economic central planning. Hayek’s 1945 essay, The Use of Knowledge in Society, explains how, given that the immense knowledge necessary to produce all the goods and services that we need in the correct quantities is dispersed among vast numbers of people, economic harmony and efficiency only occurs when millions of individuals can freely make their own economic plans while conveying knowledge to each other via the price system. In this sense, the price system emerges as an example of spontaneous order, which he referred to as ‘the result of human action, but not the execution of any human design’.
A Hayekian conception of the transmission of knowledge through freely fluctuating market prices helps us to explain the effortless “emergent order” of market economies, whereby well stocked supermarket shelves are the norm, and large shortages and surpluses are extremely rare. Moreover, it also explains the economic chaos and poverty that is invariably a feature of the socialist command economy: bureaucratic central planners simply do not have access to the knowledge about their subjects’ preferences and plans necessary to allocate resources efficiently. For Hayek, this was an indictment of socialism, as well as less pervasive Keynesian-style economic interventionism, and his contempt for the central planner’s mindset can be gleaned from the titles of his books The Fatal Conceit and The Pretence of Knowledge.
Apart from his persona as a very technical economist, Hayek is perhaps better known as a political theorist and defender of classical liberalism. He most famously condemned central planning as the gradual surrender of individual autonomy and a slippery slope towards totalitarianism in his polemic The Road to Serfdom. This was very poignantly written during World War II, as much of Europe was torn apart by rival strains of totalitarianism and central planning.
4. Ludwig von Mises (1881–1973)
“A society that chooses between capitalism and socialism does not choose between two social systems; it chooses between social cooperation and the disintegration of society. Socialism: is not an alternative to capitalism; it is an alternative to any system under which men can live as human beings.” – Ludwig von Mises
If you asked the average person to give a reason why socialism does not work, most people would probably respond that when everyone is paid the same, there is not incentive to work hard and be productive. And it is true that this presents an enormous problem for socialism. However, Ludwig Von Mises’ (1881-1973) critique is far more sweeping, systematic and deadly, rather than just a criticism of socialism’s ethos and fetishism of equality.
Rather, Mises explains in his landmark 1920 essay, Economic Calculation in the Socialist Commonwealth, the insurmountable problem of socialist calculation: the fact that without market prices generated by millions of buyers and sellers freely exchanging according to their self-interest, central planning bodies are simply incapable of deciding the most important uses of scarce factors of production.
To illustrate: how do I know, as a manufacturer of widgets, whether to produce my goods out of steel or aluminium? In a free market, entrepreneurs can determine the best decision through market prices: if aluminium has a higher market price than steel, it means that there are more important and pressing alternative uses for aluminium in the economy. Unless using aluminium will allow you to sell your widgets at a higher price (meaning that consumers value it more and are willing to outbid alternative users of aluminium for this scarce resource), more than compensating for your increased costs (meaning you will make more profits from using aluminium), you should use steel. This represents the most efficient allocation of scarce resources with alternative uses.
As Mises explained, when a central planning body has coercive control over the allocation of resources, it is impossible to determine these market prices, as resources are just treated as object of transfer, rather than objects of exchange. Subsequently, massive shortages, surpluses and gross resource misallocation are permanent results of a socialist economy. How does anyone actually know that it is more efficient to make a car body out of steel than gold? Nobody could know, except with market prices. So no, it is not simply a matter of putting the right planners in charge, or putting the means of production under “democratic control”. Thanks to Mises, we know that socialism is always doomed to fail.
Mises, a Jewish Austrian, became the leading figure of the Austrian School of Economics before fleeing Nazi Germany and moving to the United States of America in 1940. Friedrich Hayek was one of his most promising students and later developed Mises’ bsuiness cycle theories. He was the first scholar to recognise that economics is part of a larger science of human action. In 1949, Mises published his magnum opus Human Action, one of the most comprehensive and magisterial economic treatises ever written. The title is a tribute to his concept of methodological individualism known as ‘praxeology’, which manages to build an incredibly sophisticated understanding of economics based on one very simple premise: humans act purposefully. According to Mises, this human action and thus interaction – the foundation of a free market economy – is what forms the basis for human civilisation.
Mises other published works include Socialism: An Economic and Sociological Analysis and Bureaucracy, both thorough demolitions of the follies of economic central planning.
5. Arthur Laffer (1940-present)
“What I’m not saying is that all government spending is bad. It’s not – far, far from it, but there is no free lunch, as a former colleague of mine used to say. There is no public tooth fairy. Father Christmas does not work on the Treasury staff this year. You can never bail someone out of trouble without putting someone else into trouble.” – Arthur Laffer
If you have even a cursory knowledge of economics, there is a good chance you will have heard of the Laffer Curve. Well – as you might have guessed by now – the curve takes its name from American economist Arthur Laffer. A student of Yale and Stanford universities, Laffer is considered the father of supply-side economics: a school of thought that posits consumers will benefit from an overall increase in supply of goods and services at lower prices created by the expansion of productive capital and of businesses from investment. Thus, Laffer advocates for low taxes and reducing regulation as the best way to provide entrepreneurs with the ability and the incentives to expand business operations and increase output of goods and services.
The Laffer Curve itself is based on an unassailable piece of logic: at a 0% tax rate, the government will raise $0 dollars of revenue. However, at a 100% tax rate, the government will also raise $0 of revenue, as nobody will bother to earn or report any income if it will all be taken. As it turns out, there is not a linear relationship between tax rates and tax revenues, as too many people seem to think. Therefore, a revenue-maximising level of taxation will be somewhere between 0% and 100%. What this means is that eventually, an increase in the tax rate will reduce the amount of revenue that the government collects.
Conversely, cutting tax rates can also increase the revenue that the government collects. According to Laffer, fiscal policy is not necessarily a trade-off between encouraging free enterprise and economic expansion with low taxes, at the cost of underfunded vital public services. Instead, cutting taxes can incentivise growth in production and result in governments collecting more tax revenue to provide services.
Laffer was instrumental in writing California Proposition 13, a law that limited the amount of property taxes the state government could levy. This helped to turn the tide against ever growing state taxes across America. He also played a vital role in President Ronald Reagan’s tax revolution of the 1980s as a member of the President’s Economic Policy Advisory Board. Consistent with the Laffer Curve, the Reagan Administration cut income tax without facing to a corresponding decrease in revenues.
Laffer has also published An Inquiry into the Nature and Causes of the Wealth of States, (a reference to the full title of Adam Smith’s magnum opus, The Wealth of Nations) which examines in huge detail the changes in tax policy of the 50 US states over recent decades. Consistent with his supply-side hypothesis, Laffer finds that significant increases in state taxes were virtually always followed by weaker state economies, a reduced share of US total GDP, more unemployment, urban decay and population loss coupled with lower state government revenues.
6. Thomas Sowell (1930-Present)
“Since this is an era when many people are concerned about ‘fairness’ and ‘social justice,’ what is your “fair share” of what someone else has worked for?” – Thomas Sowell
Thomas Sowell is probably the most influential and prolific social economist alive today, particularly within conservative and libertarian circles. Although Sowell has written and taught widely on economics in the broadest sense, with his supremely instructive books such as Basic Economics and Knowledge and Decisions, Sowell is better known – in some sense, more notorious – for his focus on the economics of race, gender, age, housing, immigration, poverty, welfare, discrimination and inequality. In 2002, Sowell was awarded the National Humanities Medal for his ‘prolific scholarship melding history, economics and political science’.
What makes Sowell’s work so insightful is the fact that in his study of socioeconomic phenomena, he never succumbs to the temptation to lose sight of real human beings among the data. For example, in amidst all the obscurantism about economic inequality, ‘the top 1%’ and so on, Sowell explains that actual individuals move up and down the income ladder throughout their lives, so snapshots of income inequality at one point in time are uninformative and misleading. For example, over a 20-year period, more individuals who started in the bottom 20% of income earners were in the top 20% than remained in the bottom. Sowell thus debunks the notion of an enduring class of aristocrats remaining at the top: instead his analysis of economic mobility is far more illuminating than any of the platitudes one is likely to hear about “the top end of town”.
This is just one among hundreds of issues through which Sowell slices like a red-hot knife. A critic of affirmative action and race-based quotas, Sowell’s exposition and analysis of historical records shows that time and again, government intervention aimed at improving the living standards of minorities has in fact been a failure. In his highly instructive books such as Economic Facts and Fallacies and Applied Economics, Sowell effortlessly takes apart popular myths like the male-female wage gap and the disappearing American middle class, constantly overturning received wisdom with a seemingly unlimited arsenal of facts and statistics.
Sowell can write volumes on the demographic and socioeconomic differences between Jews in Brooklyn in 1880 compared with Italians in Brooklyn, or the fact that the British watch industry is still dominated by descendants of Huguenots who emigrated from France in the 17th century. It is truly incredible. His other interesting facts include that 75 per cent of Californian doughnut stores are owned and operated by Cambodians, and while Chinese Malaysians are a numerical minority in Malaysia, they receive almost all of the country’s engineering and science degrees. One of Sowell’s points is that people should seek to improve their positions through hard work and ambition, not through government intervention and policies like affirmative action.
One could go on forever with Sowell’s apparent omniscience about the history and socioeconomic state of just about every demographic group ever. But the point is this: we often hear that socioeconomic discrepancies are by definition an injustice, and that political action is necessary to crush them. If Sowell’s work can be distilled into one message, it is that the human race is a tapestry of diverse, disparate creatures with different cultures, aspirations, ages, abilities and life stories. There is no reason to expect them to turn out the same or to fit anyone’s model of equality, and it is not an injustice that they do not.
By allowing us to understand this and providing chapters crammed full of salient facts and statistics to prove it, Sowell’s ground-breaking scholarship can provide inoculation against demagoguery and socioeconomic fallacies.
7. Frederic Bastiat (1801-1850)
“Life, liberty, and property do not exist because men have made laws. On the contrary, it was the fact that life, liberty, and property existed beforehand that caused men to make laws in the first place.” – Frederic Bastiat
After every hurricane, earthquake and cyclone, you might hear the odd commentator and even some economists – usually votaries of the late John Maynard Keynes – note that, while this is of course a tragedy, the destruction caused by the natural disaster will necessitate the rebuilding of homes and businesses, which will stimulate employment and make us wealthier! As it turns out, these advocates of destruction have fallen victim to a fallacy that was totally debunked by French economist Frederic Bastiat back in 1850, in his essay Ce qu’on voit, et ce qu’on ne voit pas (in English, That Which is Seen, and That Which is Not Seen).
In this essay, Bastiat introduces The Parable of the Broken Window, in which a shop owner’s window is broken. At this point, the sloppy economist rejoices, for after all, the shop owner will have to pay the glazier to replace his window. The glazier will receive this payment (let us say $200) as income, and will then be able to spend this on bread at the baker, who will in turn spend it on shoes from the cobbler, and so on. This destruction has stimulated employment and income and we are all the wealthier for it.
Except that Bastiat was not a sloppy economist. He taught us that the mark of a good economist is that he or she looks past the immediate effects on specific, visible individuals and considers the overall effects on the entire community, most of which are much harder to see.
As Bastiat points out, what if the shop owner had not had his window broken? The $200 that he would have had to spend at the glazier is now left to him to spend as he wishes. Suppose he wants to purchase new clothes – the $200 now provides income and employment to the tailor, who might buy bread from the baker, or shoes from the cobbler, and so on. Alternatively, he might leave it in the bank, in which case it will be lent out to another individual to open a new shop, necessitating the purchase of glass from the glazier. As you can see, the community is simply one window poorer in the first scenario, but we can never see the transactions that didn’t happen because of it. Destruction, as Bastiat pointed out, never makes us wealthier. As economist Henry Hazlitt points out in Economics in One Lesson, the ability to account for these less visible ramifications is the most important difference between a good and bad economist.
The Parable of the Broken Window is also linked to another important economic concept that Bastiat helped develop – that of opportunity cost, a fundamental idea in microeconomic theory that shows the relationship between scarcity and choice. Opportunity cost refers to the cost of the next best alternative foregone when one alternative is chosen over others. Although the term was not coined until almost 60 years after his death, by German economist Friedrich von Wieser, Bastiat’s work is the first known explanation of this concept in all but name. It is important because for every decision that an individual makes – be it in our financial or personal lives, there is an alternative which is rejected, and which has a cost associated it.
Bastiat devoted his career to exposing ‘economic sophisms’. Perhaps the best-known example is his raffish economic satire, The Petition of the Candle Makers, who complain that they cannot compete with the unfair competition of free light from the sun, and therefore implore the French government to require the closing of all curtains, shutters, blinds, fissures, cracks, and windows to increase the demand for candles and wax, and theus stimulate the economy. Keep the obvious absurdity of Bastiat’s parable in mind whenever you hear that we need to prevent cheaper imports from entering the country to keep domestic producers on a “level playing field”.