Laissez-faire Economics: What it is & Example
What is Laissez faire Economics
Laissez-faire economics is characterised by the absence of government involvement in economic activities. For example, regulations, subsidies, tariffs, quotas, and other government-granted privileges.
Laissez-faire economics is where there is no such government interference. Regulations are virtually non-existent, government provides no assistance to businesses, and it allows free trade with no restrictions.
- In laissez-faire economics, the government has no involvement in economic activities
- Governments only purpose under laissez-faire economics is to provide a legal system as well as military protection of the nation and its citizens.
- Laissez-faire essentially means ‘let us be’ or ‘leave us alone’, and was originally told to King Louis XIV by the French capitalists in the 18th century.
Origins of Laissez-faire Economics
By definition, laissez-faire translates to ‘let do’. It’s origins are said to have come from 18th century France, under the rule of King Louis XIV. The French King asked capitalists how he could support the economy. Their response: “Leave us alone“.
The French physiocrats had an important part in the development of laissez-faire economics. The term ‘Physiocrat‘ originates from ancient Greek, meaning, rule by nature. They called for freedom from government interference, with a firm belief in a natural order. From their view point, nature would achieve the most efficient outcome. They had three main goals. Firstly, the promotion of free trade. Second of all, free enterprise. And third of all, the end of government privileges. Their beliefs created the foundation for ‘laissez-faire economics‘.
Laissez-faire Economics and the Legal System
At the heart of Laissez-faire economics is the belief that governments should have little involvement in the economic activities of its population. Instead, governments role is to act as a facilitator of trade through the legal system, as well as the enforcement through policing and defence.
Contract enforcement is a prime example. Two parties may agree upon a sale of a good. However, one side may not comply with the agreement. For example, one person may purchase an iPhone. They may not receive the product. Disputes can then arise. Governments would then be responsible for resolving such issues. In essence, the government is an unbias third party who can rule on who has a legal claim.
Laissez-faire economics and Property Rights
Property rights are another important part of laissez-faire economics, with the government enforce these rights. Without such, economic activity diminishes.
For example, if there are no legal rights to property, people will result in violence. As in many third world nations, blood and wars secure property rights. Instead of battles and wars, disputes are instead fought in the court of law.
The legal system ensures that a trade between two parties can take place. Without such, businesses will be more reluctant to trade. But what if the other party fails to live up to their bargain? There is nothing to stop them from running away with the product.
The government assigns property rights to the people. The legal system then cements these rights into law. In doing so, people are more confident. This then incentivizes economic activity.
Why Laissez-Faire Is Preferable to Government Intervention
Laissez-faire economics requires limiting government involvement. There are calls for the government to expand its remit. Whether it is to correct market failures or redistribute income. This is the opposite of laissez-faire ideology. Government intervention goes against the principle of laissez-faire.
When governments step in, it impacts upon supply and demand. Prices are then affected. For example, governments may require an occupational license. This may be to ensure a quality service.
This comes at a cost. As it limits the amount of practicing laborers, costs increases. An Obama White House report concluded that:
“The evidence on licensing’s effects on prices is unequivocal: many studies find that more restrictive licensing laws lead to higher prices for consumers”.
If there are restrictions on the supply of labor, costs increase. This is because supply and demand fluctuate to reach an equilibrium. The relationship between supply, demand, and prices are crucial.
By reducing the supply of labor, its price is artificially inflated. There may only be a few hairdressers. If they are busy, they can charge higher prices. Only when excess demand ceases, will prices reach an equilibrium.
Occupational Licensing Has a Cost
As a result of lower supply and higher cost of entry, prices increase. There are a limited number of specialists to choose from. Businesses are then under less pressure to reduce prices.
There are additional costs for testing that need consideration. An upward pressure on prices results. This removes consumers from the market.
Kleiner and Kudrle (2000) found that licensing in dentistry raised prices for consumers and earnings of dentists. They estimated prices to be higher in states with high restrictions. States could expect higher prices of 11 percent.
Higher prices reduce demand. If the price of a general check-up is high, many will go without. This doesn’t benefit the population. What could have been a simple service becomes a complex job.
A simple filling could turn into a root canal job. So rather than protecting the consumer, it can make the situation worse. The same can occur if there is a gas leak. The customer may be reluctant to call a technician due to high prices. This can have damaging effects. Such reluctance may result in carbon monoxide poisoning.
Agricultural Subsidies and Protectionism
The federal government spends more than $20 billion a year on farm subsidies. About 39 percent of the nation’s 2.1 million farms receive subsidies. The lion’s share goes to the largest producers of corn, soybeans, wheat, and rice.
These subsidies have created a floor for food prices. This is a win-win for farmers. When supply exceeds demand, the government steps in to make up the difference. This prevents prices from falling, but at the cost to the consumer.
Inefficiency of Subsidies
There are 141 million taxpayers in the USA. They are paying for $33 billion worth of subsidies, costing $234 per person. Does this work out as a net benefit to the customer? Well, research by the CBO and the Department of Agriculture both conclude no correlation between crop and food prices. Farm subsidies and crop insurance don’t lower food prices.
In part, this is because most of the subsidies go to big, secure, farmers. Agriculture subsidies give them a guaranteed income. They do not need to worry about the harvest.
They know the minimum amount of dollars per acre they receive from crop insurance. Keep expenses below that amount and make a profit. What other business receives such guarantees?
Farmers receive a guaranteed income no matter how efficient they are. To use taxpayers money to reduce the incentives is folly. By creating a safety net, farmers do not have the same incentives. Harvest fluctuations are not a problem. They will receive the same income no matter. As a result, they don’t need to invest in efficient and healthy ecosystems for next year.
The Impact of the Minimum Wage
The minimum wage is an idea that has lasted centuries. As humans, we crave justice and fairness. Such moral values have underpinned the debate for the minimum wage for decades. However, what is fair and just?
New Zealand introduced the first minimum wage laws in 1894. She was later followed by Australia in 1896. The US joined the party later in 1938 when Franklin D. Roosevelt introduced the nation’s first federal minimum wage. The policy has grown popular over time. The negative effects have not always been as dramatic as some have predicted.
Big Businesses Aren’t Exploitative, They Just Follow Supply and Demand
The absence of a minimum wage is but a subsidy to big business. A subsidy which allows businesses to pay their employees less. At least that is the argument. However, this is not true. Alabama, for example, has no state minimum wage. The state must abide by the federally legislated $7.25. Surely we would expect big companies like Walmart to pay the minimum $7.25?
In 2016, Walmart was paying its employees (including Alabama) a minimum wage of $10. Not exactly $15, but far from being “exploitative.”
Target also pays its employees above the federal minimum wage. It increased worker pay to $13 in 2019. This happened without the coercive force of government. In part, the tightening labor market has encouraged such companies to increase pay. The supply of laborers is much smaller. Therefore, a higher salary is used to attract what laborers are available.
This is simple supply and demand. When the supply of workers is low, the salary offered will be high. When the supply of such workers is high, the salary offered will below. This does not make businesses exploitative. Rather, it follows the rules of supply and demand.
Higher Wage, Lower Benefits
A simple explanation is that when companies pay more, employees receive more. In part, this is true. However, this doesn’t improve employees living standards. In 2018, Amazon announced that it would pay a minimum wage of $15 an hour. This came at a cost. Employees lost bonuses, and the company cut its stock unit program. Many are now worse off as a result. An employee interviewed by Wired said they would be $1,400 out of pocket.
The argument that the minimum wage doesn’t cause unemployment can be valid. However, that doesn’t mean that there are no negative effects. An employee may receive $8 in wages and $4 in additional benefits. This may cover health care, childcare, pension payments, or bonus payments. If the minimum wage increases to $10, these benefits reduce to $2. That means less for pensions. Less for childcare. Less for bonuses. In many cases, the workers are worse off as a result.
In 2016, the UK introduced a “National Living Wage” to improve living standards and bring workers out of poverty. Businesses reacted by withdrawing certain benefits. They removed Sunday pay rates, and food outlets removed free lunches for staff. As companies reform their “pay and reward” structures to offset the costs, many workers are left worse off.
The Importance of Laissez-faire economics
Governments interfere in several negative ways. The minimum wage, agricultural subsidies, and occupational licensure are just a few. What we can tell from these examples is that governments distort supply and demand.
When government interferes, it can increase demand (rent controls). It can also increase supply (agricultural subsidies). By contrast, it can decrease demand (consumption taxes). As well as decrease supply (occupational licenses). By interfering in supply and demand; excessive supply/demand results.
Restricting Government Involvement in Supply and Demand
Government interference in the market is inefficient. It creates a constant state of dis-equilibrium. For example, occupational licenses create an under-supply.
By limiting the amount tenants pay for rent, governments can inflate demand. This is because the price is artificially deflated. Rental control laws come at a cost. The supply of rental housing is more or less set. So it is not as reactive as other markets. With that said, some landlords may seek to sell their properties. This is so that they can extract maximum value.
At the same time, those who remain in the market let the quality diminish. The rental income received is often insufficient for the upkeep. What happens as a result is reduced quantity and quality of housing available. This is one of the most widely agreed-upon conclusions by economists. 93 percent of economists agree.
FAQs on Laissez faire Economics
An example of laissez-faire economics is where nations remove all trade barriers. For example, most nations levy a tax on imported goods, usually at varying rates depending on the product. Laissez-faire economics removes such barriers and instead allows the market to decide.
By removing government interference, businesses have no rules or regulations to discourage investment. It makes it easier for businesses to buy land, build factories, hire employees, and create new goods and services. So in short, it has a positive impact as businesses are more eager and willing to invest.
One of the downsides to laissez-faire economics is that it can create huge shifts in the economy. As laissez faire is more flexible due to the lack of restrictions, it means some businesses can go bankrupt quickly if demand shifts at an equal pace. Whilst it may open up new industries, it is the old ones which face a sharp shock. For example, the manufacturing industry in the developed world has been declining for many years. Governments have done much to support the industry which could have easily been destroyed within a few years. Instead, the shift has been more gradual and therefore prevented hundreds of thousands of job losses at once.
Paul Boyce is an economics editor with over 10 years experience in the industry. Currently working as a consultant within the financial services sector, Paul is the CEO and chief editor of BoyceWire. He has written publications for FEE, the Mises Institute, and many others.