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What is Economic Liberalism theory of Political Economy?


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 In contrast to mercantilism, the underlying theme of economic liberalism is that economic policies should improve citizen's standard of living, not increase state power. The economic liberalism was championed by Adam Smith and later, David Ricardo. 

Adam Smith: The Wealth of Nations

Actually, the term mercantilist was first given by Adam Smith in his book The Wealth of Nations. He championed the idea of market economy. 

He argued that manufacturers were more important than accumulation of metals for states. Countries could achieve economies of scale by specializing in good that they could produce more efficiently. Smith believed in market which provided general welfare. Competition among entrepreneurs provide a wide range of products at lower prices for consumers. And most importantly, market works under an 'invisible hand' which transforms individual greed into social prosperity. Government should be limited to provide nation defense and public goods such as rail, road, schools, etc. 

David Ricardo: On the Principles of Political Economy and Taxation

Ricardo added that free trade was beneficial because in specializing, countries achieved a "comparative advantage". 

Comparative Advantage 

Suppose a country could produce everything at inexpensive prices. But the country could still benefit more by specializing in whatever it could produce more efficiently. It's specialization depends upon cost of factors of production which are land, labor, capital, technology and energy. The specialization provides an avenue to minimize the "opportunity cost".  

For example, suppose you are a successful freelance web developer and blogger who caters to clients . You are good in coding as well as writing. But the coding pays you much higher than writing but the latter takes most of your time. In order to increase your income, you want to focus more on coding rather than time consuming freelance writing work. You hire a content writer to do the blogging work and you focusing more on coding projects. In this way, you have minimized the opportunity cost and increased your income. 

Thus, comparative advantage doesn't mean doing everything better than anyone else. It simply means weighing the opportunity cost. 

Economic Liberalism in 21st Century

The world has changed from Smithian world. Today, there are transnational corporations (TNCs) and MNCs who do the bulk of global trade. Their enormous capital often distort the market competition and make the trade favorable to these MNCs and TNCs. For example, Google has become a monopoly in internet search and there is almost non-existent competition. They dictate the terms and conditions for businesses and they have unapparelled power to influence not only businesses but public perception too. 

Neoliberal Economists

Neoliberals too favor free market and minimal government intervention in economic affairs, but they see a greater role of international economic institutions such as IMF or World Bank than classical economic liberals. 

They argue that free movement of capital and labor produces more good than harm, although inefficient economies and industries may suffer. They believe economic efficiency is more important than economic equality. 

Problems with Neoliberal Policies

  • Unfettered competition may trigger speculation that drives up the prices of assets above their value, and when such bubbles burst, they cause economic distress. For example, the US Subprime Lending Crisis 2008. 
  • Unregulated capitalism creates economic inequality. The rich becomes richer and poor becomes poorer. For example, the richest 1% own 44% of the global wealth, according to Credit Suisse Wealth Index. 
  • The global integrated financial system creates havoc worldwide when one country's economy flounders, as it happened during the US Financial Crisis 2008. The US crisis became a global crisis.
  • National governments often find it difficult to raise the workers' wages as can be seen with Indian government which has so far not able to fix a minimum wage policy. If Indian government increases the labor prices, the companies will soon move their operations to those countries where labor cost is less. 

Angered by the injustices of industrial revolution, Karl Marx and Engels offered a revolutionary alternative to capitalism.

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