University of Virginia Library

ECONOMIC THEORY OF
NATURAL LIBERTY

“Natural Liberty” is an expression associated partic-
ularly with Adam Smith in his Inquiry into the Nature
and Causes of the Wealth of Nations (1776). It is often
associated with the idea of laissez-faire, or the doctrine
that government should intervene as little as possible
in the affairs of its citizens, especially in matters relat-
ing to economic life. In the hands of Adam Smith,
however, “natural liberty” is a much more subtle and
realistic concept than laissez-faire and indeed is the
basis of a whole theory of social organization. “Natural
liberty” implies the ability of each individual to do
what seems to him best in the circumstances in which
he finds himself without fear of threat or reprisal.

Political philosophers from Plato to Hobbes saw
society organized primarily through what might be
called legitimated threat. They were all convinced that
if everybody did what he pleased society would rapidly
fall apart and that the only thing that held it together
was the organization of a credible threat system in the
hands of the state. This would dissuade people from
doing antisocial things that they wanted to do, because
if they did so, they believed they would suffer penalties
inflicted by the state. The idea that society might be
held together by mutual self interest would probably
not have occurred to anybody earlier than the eight-
eenth century.

We can perhaps trace some origins of the idea in
the medieval and even later concepts of natural law
or of natural rights. These relations, however, are
tenuous. Christianity, it is true, did introduce the idea
that there was a higher law than that of the state, which
was the law of God. The enforcement even of the law
of God, however, depended on the fear of Hell—a
spiritual threat system of considerable credibility—and
while this undoubtedly operated to mollify the harsh-
ness of the material threat system, it is still a very
long way from the idea of natural liberty. Hobbes,
indeed, makes an important contribution by breaking
away from the spiritual threat system and supposing
that the state is a purely human institution which we
put up with for fear of finding something worse.
Hobbes, however, was very insistent that his
“Leviathan” must exercise a monopoly of coercive
power without which society would fall apart into the
state of nature in which life would be “... nasty,
brutish, mean, and short.” It would certainly never
have occurred to Hobbes that a man by following his
own interests could enhance the welfare of all.

Locke comes closer to the idea of natural liberty
in his concept of limited government and society based
on property. He comes close also to anticipating a
labor theory of value, which is an important element
of Adam Smith. He still gives a very large role to
government, however, and he lacks Adam Smith's ex-
traordinary insight on how society is organized through
exchange.

Other possible origins of the idea may be found in
the Newtonian celestial mechanics with its concept of
the universe ruled by differential equations rather than
by angels. The hope of discovering a celestial me-
chanics of society was close to the minds of the eight-
eenth century and undoubtedly influenced Adam
Smith. Another possible source would be Rousseau,
with his idealization of the noble savage and his feeling
that the coercive system of civilization thwarts and
distorts the natural harmonies of mankind. This senti-
ment is not wholly foreign to the optimistic bias of
Adam Smith, although he is too much of a canny
Scotchman to be taken in by it very much.

The most direct antecedent of Adam Smith's concept
of “natural liberty” is the doctrine of the physiocrats
or économistes of France. The very name “Physioc-
racy” means the rule of nature. The physiocrats made
a particularly important contribution in seeing society
as a whole of interrelated parts. François Quesnay, in
the Tableau économique (1758), develops the first con-
cept of national income as the sum of the geometric
series of continually smaller reactions, and so antici-
pated in a certain degree the Keynesian concept of
the multiplier. The peculiar physiocratic doctrine,
however, that all economic surpluses arose from agri-
culture and that manufacturing was “sterile,” pre-
vented them from achieving a complete theory of
economic equilibrium. Of the French thinkers at the
time A. R. J. Turgot had the most direct influence on
Adam Smith and may well have influenced Adam
Smith's ideas on the self-regulating character of the
economy. The physiocrats, however, still believed that
an absolute monarchy was the only means of reconcil-
ing the internal conflicts of a society and they did not
have a clear picture of the self-regulating character
of a price system.

We must conclude, therefore, that the idea of natural
liberty as a self-adjusting process in society, whereby
each individual by following his own interests or bent
promotes the total welfare, is an idea which owes so
much to Adam Smith that it seems only fair to give
him most of the credit for it.

The Wealth of Nations is rightly regarded as the first
great systematic exposition of economics and it is
essentially a study of how society is organized through
exchange. Adam Smith, oddly enough, does not have
any good theory about the origins of exchange, which
he attributes to some mysterious “propensity to truck,”
and it was not until a hundred years later that the
utility theorists achieved a reasonably satisfactory ex-
planation of how exchange originates, even though the
study of the social conditions under which exchange
becomes legitimate is still very underdeveloped and
requires much further work. His vagueness about the
origins of exchange, however, did not hamper Adam
Smith in discussing the consequences of exchange. He
sees very clearly that exchange develops a division of
labor, that the division of labor itself widens the mar-
ket, and that the widening of the market promotes
further exchange and further division of labor. We have
here a process with what today we call “positive feed-
back” and which leads, therefore, into “development,”
that is, a steady increase in productivity, in specializa-
tion, in the extent of the market and in the total per
capita output of commodities, which Smith regards as
the principal measure for the wealth of nations.

This process operates through the price system; that
is, the total set of all prices or ratios of exchange which
determines the terms of trade of any individual con-
ducting exchanges. Since an individual has an output
of the things which he sells into the market and an
input from the market of the things that he buys, his
terms of trade are the ratio of the quantity of what
he buys to the quantity of what he sells. In these days
we would describe this by some kind of index number.
Adam Smith did not have this device; nevertheless, his
concept is fairly clear. Whether a person will go on
producing what he is producing and exchanging it,

depends on the terms of trade which he experiences.
If these terms are poor, that is, if he is giving out a
lot and not getting very much in return, then he will
tend to shift his occupation to one in which the terms
are more favorable. This change of occupation, how-
ever, will have an effect on the terms of trade them-
selves, improving the terms of trade in the occupation
which he has left and worsening the terms of trade
in the one to which he has gone. This process will tend
to go on until nobody feels he can better his condition
by shifting to another occupation, or, more accurately,
until in each occupation the amount of resources
entering the occupation is just equal to the amount
leaving it. The price structure, which produced this
situation would be an equilibrium price structure, or
a structure of “natural prices” as Adam Smith called
them. We notice that the word “natural” here is not
merely a vague appeal to some divine order or order
of nature, but is a quite specific equilibrium concept
in the sense that if price structure is not at its natural
level, people will perceive those occupations with
“high prices” as unusually profitable and will move
into them, which will bring the price down, and will
perceive those occupations with “low prices” as un-
usually unprofitable and will move out of them, which
will bring the prices up. The natural price system,
therefore, is a system of mechanical equilibrium and
is in a very real sense a kind of celestial mechanics
of the social system.

In its sharpness, clarity, and operationalism, this
concept is far removed from the vague concept of
natural law and natural rights. It is this equilibrium
system, and not any presumed intervention from God
or nature, which constitutes the famous “invisible
hand” which turns the pursuit of private gain into
public welfare. This “invisible hand” has two aspects.
In the first place, it organizes the productive activities
of society so that people produce on the whole what
people want. Thus, if there is a shift in demand, say
from tea to coffee, the price of coffee will rise and
the price of tea will fall, production of coffee will
become unusually profitable and this will attract peo-
ple into it, production of tea will become unprofitable
and that will chase people out of it. Eventually the
production of coffee will be expanded and tea will
contract until the new structure of demand is satisfied
and the production of coffee and tea are once more
equally profitable or at least equal enough so that there
is no movement of resources from one to the other.
By contrast, if the visible hand of government attempts
to distribute commodities to people in accordance with
their demand, by some sort of rationing, in the absence
of any price-profit equilibrium mechanism, many de-
mands will be undersatisfied or overfulfilled, and the
political feedback from these dissatisfactions will be
slow and uncertain.

The second function of the “invisible hand” is to
promote economic development. It does this if it is
profitable to direct activity towards making things
more cheaply, that is, towards getting more output per
unit of input in production. If the price structure is
adapted to a previous level of technology, then the
innovators of superior technology profit because the
price, at least temporarily, will be higher than its
eventual new equilibrium. There is a certain dilemma
here in that if new processes can be imitated very
rapidly, there may be no advantage in introducing
them; they will be imitated so rapidly that the price
will fall immediately to the point where it is not
profitable to innovate. It is for this reason that we have
introduced a coercive, that is, a non-exchange element
into the system, such as the patent law or copyright,
which can protect the innovator against too rapid
imitation.

Adam Smith applied the concept of “natural liberty”
far beyond the realm of commodity exchange. He
applied it in Book Five of The Wealth of Nations to
education, to religion, and even to some extent to the
judiciary. In education, the idea that teaching is most
likely to be effective if the teacher is paid by results
is highly unpalatable to the educational establishment,
which has always looked with horror on the idea of
a free market in education. Nevertheless, Adam Smith's
arguments cannot be dismissed easily. If the teacher's
income does not depend on the performance of his
duties, there is a strong temptation for the students
to be neglected. At eighteenth century Oxford and
Cambridge, indeed, as Adam Smith observes “the
greater part of the public professors have for these
many years given up altogether the pretense of teach-
ing” (1937, p. 718). By contrast, he observes that:

(1937, p. 721).

The so-called “elective system” by which a student
at the university is free to choose whatever courses
he wishes, as long as he completes a sufficient number
of hours at sufficiently high quality, is a good example
of “natural liberty,” and the idea owes a good deal
to Adam Smith. The criticisms of the elective system—
they give a cafeteria education without consistency or
structure, and that the student could not be trusted
to know what was essential and what was nonessential—
led to substantial modifications of it in American

universities, which interestingly enough were chal-
lenged again during the 1960's in the name of liberty
by the student generation. This illustrates perhaps some
of the difficulties of the “natural liberty” concept.

In religion, also, Adam Smith advocated a separation
of church and state, and full religious freedom which
would allow any sect the right to compete in the
market of religious ideas for adherents. An established
religion violates natural liberty because it prohibits
people from going to “the church of their choice.”
Adam Smith, as a good eighteenth-century deist, was
suspicious of the excesses of enthusiasm in religion, as
indeed was his friend David Hume. Hume, however,
argued that the way to protect society against the
excesses of religious zeal was to set up an established
church in which the clergy were not dependent upon
the goodwill of the congregation for their pay, but on
the goodwill of the established order. Under these
circumstances there would be no payoffs for excessive
zeal on the part of the clergy and the church could
be relied on to be an instrument of the establishment.
By contrast, Adam Smith argued that free competition
in religion would force preachers to moderate their
views in order to attract new members to their congre-
gation, and that competition of churches for adherents
would force them to line up somewhere near the rea-
sonable middle. Thus he says:

(1937, p. 745).

In some degree both Adam Smith and Hume may
have been right. The state church, as in Scandinavia,
is apt to be an efficient producer of religious apathy,
and free competition in religion, as in the United
States, has tended to make the competing churches
more alike in the middle, though perhaps more extreme
at the edge. The history of religion in the United States,
however, also supports Adam Smith's contention that
natural liberty will lead to development, for in the
United States the rise of religion under a regime of
free competition has been spectacular, church mem-
bership having risen from perhaps 7 per cent in the
time of the revolution to about 64 per cent in the
1960's. There can hardly be a greater contrast indeed
between, say, the dead and formal Lutheran Church
where it is established in Scandinavian countries and
the vigorous and aggressive Lutheran Church of the
United States. Thus, in a field far removed from ordi-
nary economic activity we find substantial evidence
for the virtues of natural liberty and for the use of
exchange rather than coercion as a social organizer.

Natural liberty, however, has its limits, which are
fully recognized in principle by Adam Smith, though
modern economists and social thinkers might not agree
with him about exactly where the limits should be
drawn. Thus, he argues against allowing bankers to
issue notes of small denominations as follows:

(1937, p. 308).

The problem which Adam Smith is raising here is one
which economists later discussed very extensively
under the title of “externality.” The freedom of all
individuals to produce and exchange anything they like
with anyone they like at whatever price they can get,
only promotes the general welfare if there are no
effects outside the exchanging parties. If, for instance,
a man produces something to sell, but in the course
of producing it he creates a negative commodity, such
as air or water pollution which injures somebody else,
he should clearly be charged for this, if necessary
through the tax system. On the other side, if there are
activities which produce benefits to people for which
the producer cannot charge them, then, unless some
arrangement is made for compensating the producer,
he will not produce enough of this commodity because
he is only producing enough to meet the demands that
can be paid for. It is this kind of consideration which
has generally led to the subsidization of education,
which is supposed to be an industry which produces
benefits above and beyond the private benefits which
the educated person enjoys. Adam Smith recognized
this indeed and proposed that the state should subsidize
education of the poor.

Another possible case is that of public works, enter-
prises which either cannot be charged for easily or
which require a magnitude of enterprise which the
private sector is incapable of providing. Adam Smith
took rather an unfavorable view of private joint stock
companies which, he thought, were only capable of
dealing in occupations in which the operations could
be reduced to a routine. He did not anticipate the
enormous growth of the corporation, although oddly
enough for very good reasons. If it had not been indeed
for what Boulding has called the “organization revolu-
tion” (1968), that is, the marked increase in the econo-
mies of scale (that is, the ability to increase the size
of an organization without diminishing its efficiency)
which came about 1870 with the invention of the
typewriter, the telephone, and other means of internal
communication, as well as certain social inventions in
regard to corporate organizational structure, Adam
Smith would probably have been right.

The classic summary of his position comes on page
651 of The Wealth of Nations and it is worth quoting
it in full:

Another major criticism of the regime of natural
liberty is that it inevitably leads to a distribution of
power, income, and wealth in society which is unac
ceptably concentrated and unequal. The regime of
“natural liberty,” certainly as Adam Smith envisioned
it, implies private property in the means of production,
except, presumably, in human minds and bodies. Adam
Smith indeed took a very unfavorable view of slavery
even though it might be argued that the prohibition
of slavery involved a restriction on the natural liberty
of a man to sell himself for the compounded value of
his future labor. This, however, represents for Adam
Smith one of the desirable infringements on natural
liberty simply because he believed that slavery inevi-
tably produced economic stagnation and hence was
socially undesirable. This objection, however, did not
apply to private property in physical capital and
buildings, machines, and even in land. Here there was
every inducement for the owner to deal with his prop-
erty in the most profitable way, which usually meant
to improve it and to innovate with it.

Nevertheless, it is often claimed that while private
property in the means of production, especially given
a widespread achievement orientation in the society,
is highly favorable to the development process, the
price of this development is the increasing concen-
tration of property and power in the hands of a few.
There are many reasons for supposing this, the most
significant being perhaps that the rich man finds it
easier to save both as a proportion of his income and
as an absolute amount than a poor man. A man who
is living at the bare minimum level of subsistence
cannot save at all and hence cannot accumulate prop-
erty in any form or improve his condition. A man
whose income is above this level is able to save, and
the more he saves, the larger his income and the more
he is able to save. This tendency is accentuated if,
under the laws of inheritance, estates are unequally
divided among inheritors, as they are under conditions
of primogeniture. It is accentuated if the rich are
infertile as they frequently are. As the statistician
Francis Galton pointed out, heiresses are frequently
infertile, for this is why they are heiresses. In rich but
fertile families the riches tend to be dissipated among
the multitude of descendants. Economists have never
worked out an exact model which governs the dynamic
process of the entire distribution of wealth. However,
in the absence of positive intervention in the shape
of progressive income and inheritance taxation, the
tendency for wealth to accumulate into fewer and
fewer hands and its distribution to become more un-
equal seems to be quite strong and this is frequently
used as a justification for the restriction of the natural
liberty of the property-holder.

It is interesting to note that Adam Smith did not
hold this view and felt that development would actu-
ally increase equality. There is an extraordinary pas-

sage in Adam Smith's Theory of Moral Sentiments
(1759) in which he uses for the first time the expression,
the “invisible hand”:

(1966, pp. 264-65).

To the modern mind in the light of slums and ghettos,
famine, and destitution in many parts of the world this
sunny eighteenth-century optimism seems a little un-
real. Nevertheless, the point which Smith is making
cannot be dismissed as absurd. The principle that the
limits of the capacity of the belly makes it impossible
for the rich man to eat even five or ten times as much
food as the poor man applies increasingly with the
development of the mass production of commodities.
Thus, the same “capacity” principle applies to clothing.
One certainly has to look carefully these days to tell
a rich man from a poor man by his clothing. It applies
even to automobiles, where again there is a strong
tendency towards rough equality of distribution; the
rich man may have three or four superior cars, but
he cannot personally use one hundred times as many
automobiles as the poor man. With housing likewise,
the ever increasing cost of servants and maintenance
has made the palaces of the eighteenth century impos-
sible to maintain, and outside of the bottom 10 or 20
per cent of incomes, the United States has achieved
a rough equality in the amenity of the dwelling. In
the mass production society, just as practically every-
body has an automobile, so practically everybody has
a bathroom, just because this is the only way of dispos-
ing of the automobiles and bathrooms that are pro-
duced. This is not to argue against progressive taxation
or inheritance taxes or other devices for ameliorating
the tendency of a market society to increase inequali-
ties of wealth and income. It is worth pointing out,
however, that the real inequalities of income are much
less than they seem in money terms. Henry Ford may
have had a money income ten thousand times that of
his average worker, but he certainly did not live on
ten thousand times the scale.

The above considerations perhaps do not meet an-
other more subtle, but perhaps more fundamental
criticism of the regime of “natural liberty” which is
that it leads to a concentration of private and irre-
sponsible power. Even though the rich may not consti-
tute a very large burden on the developed society, the
concentration of the ownership of physical capital is
much greater than the concentration of incomes, sim-
ply because such a large proportion of total income,
something like 80 per cent, is derived from labor. The
rich property owners do exercise a power in society
which is disproportionate even to their income. This
power, it is argued, is essentially private and irre-
sponsible, and without the checks and balances of
political administration. This irresponsibility of private
power is particularly noticeable where it is based on
monopoly. Under a regime of perfect competition,
private economic power is very severely limited by
erosion through market forces. Under these circum-
stances, the owners of private capital simply have to
do what the market orders, otherwise, they will take
losses and will lose their capital. It has been pointed
out, for instance, by J. K. Galbraith in The New In-
dustrial State (1967) that under modern conditions with
large corporations and large concentrations of private
economic power, what he calls the “accepted se-
quence,” by which the desires of consumers are sup-
posed to govern the structure of production, no longer
operates as well and is replaced in part at least by
what Galbraith calls the “revised sequence.” According

to this, producers produce what is convenient for them
to produce and then through the arts of advertising
and mass persuasion they persuade the consumers to
take whatever the producers have produced. The in-
troduction of advertising and mass persuasion certainly
alters the regime of “natural liberty” in a way that
Adam Smith would never have imagined.

We see the same phenomenon in government where
according to the “accepted sequence” in a democratic
government, government is supposed to carry out the
will of the people as expressed by the voters. Under
the revised sequence the government decides what it
wants to do and proceeds to sell its people on its
policies in order to achieve their consent.

The existence of the “revised sequence” can hardly
be doubted; what is hard to evaluate is its quantitative
importance. It can be argued, for instance, that a good
deal of persuasive advertising is persuading consumers
to do what they want to do anyway, that is, by reveal-
ing previously unawakened desires. Whether it is a
good thing to awaken unawakened desires, of course,
is another matter altogether. Similarly, in the case of
government, there may be decisions and policies where
expertise is necessary for decision-making, and where
the general public do not possess this expertise. Hence,
the people either have to trust their government or
else have the policies “sold” to them by propaganda.
Furthermore, there have been some notable failures
of the “revised sequence” of which the Edsel automo-
bile is the classical example in the private sector and
perhaps the Vietnam war in the public sector. Cer-
tainly there was no grass-roots demand among the
voters for a war in Vietnam and the attempts to sell
it to the American people by the arts of persuasion
did not seem to be particularly successful.

Another aspect of the regime of “natural liberty”
which has received severe, and again not always justi-
fied, criticism is the famous argument for free trade.
Tariffs, and still more, quantitative restrictions, such
as quotas and licensing, are an interference with the
“natural liberty” of exchange, and Adam Smith, of
course, devotes a great deal of his argument to demol-
ishing the mercantilist case for extensive government
intervention in international trade relations. There are
two aspects of this intervention; the first is concerned
with the balance of trade or the balance of payments,
and the second with the protection of domestic indus-
try. By the balance of trade, economists usually mean
the excess of the value of exports of goods and services
over the value of the imports of goods and services
for a particular country. The balance of payments
includes items which are not payments for exports or
imports, such as the purchase or sale of securities, so
that in effect the balance of payments represents the
excess of payments in over payments out and hence
is equivalent to the increase in the country's liquid
assets on international account.

In regard to the argument about the balance of trade
or the balance of payments, Adam Smith argues with
great persuasiveness that the international payments
system is self-adjusting and requires very little attention
from government.

This part of the argument was made even more
clearly by David Ricardo, who demonstrated that there
was an equilibrium system at work in distributing the
money stock of the world among the nations. A nation,
for instance, which had an outflow of money, and a
consequent diminution in its money stock, would have
an internal deflation, to use the modern term, which
would discourage imports into it and encourage exports
out of it which would soon stop or even reverse the
drain of money. Similarly, a country with a positive
balance of payments, and which therefore is increasing
its money stock, would have some inflation which
would encourage imports and discourage exports and
again would stop or even reverse the flow of money
into it. Thus, movements in the balance of payments
tend to be self-correcting.

The structure of balance of payments simply reflects
the shift of liquid assets among owners. If a person
or a group or a nation has a positive balance of pay-
ments, this means that its expenditure of liquid assets
(money) is less than its receipts and he is increasing
his total stock of money. Similarly, if his balance is
negative, it means that he is decreasing his total stock
of money. If the total stock of money owned by all
holders together were constant, then the structure of
balance of payments would simply reflect the “surge”
of money stocks out of some pockets into others, as
at Christmas, for instance, household balances tend to
decrease and department store balances increase.

The view that these movements are self-correcting
has much to recommend it. The actual mechanism by
which these corrections were made, however is still
somewhat in dispute, particularly the relative role of
price changes and income changes. The processes of
adjustment themselves may also cause trouble. Even
in a homogeneous society with a common money, if
one person or a group is suffering from a negative
balance while another group has a positive balance,
the first group is likely to correct this by diminishing
its expenditures and the second is likely to correct their
situation by increasing their expenditures. Difficulties
may arise if these two reactions are not symmetrical,
as they may not be, for a negative balance produces
a greater sense of urgency than a positive balance. In
the international system, national economies may be
insulated from changes in the international balance of

payments by the national fiscal and monetary system,
especially by the respective Central Banks. Under these
circumstances, “natural liberty” may lead to perverse
consequences. The more extreme supporters of “natu-
ral liberty,” such as Milton Friedman of the University
of Chicago, have argued that if free markets were
allowed in foreign exchanges so that exchange rates
between different currencies could fluctuate according
to market forces, all balance of payments problems
would automatically be solved. This, indeed, may well
be true, but further questions arise as to whether spec-
ulative movements in foreign exchange markets would
not create even greater difficulties in the system of
international trade.

The problem of “protection” is quite different con-
ceptually from that of the regulation of the balance
of payments, although the two are sometimes confused
in practice. In its most general meaning “protection”
means the establishment or preservation of a certain
proportionate structure of industries in an economy
by means of government intervention. The interven-
tion may take the form of tariffs, imports, quotas,
and quantitative restrictions, especially on imports,
or direct subsidies—“bounties” as Adam Smith calls
them—or taxes. Perhaps Adam Smith's greatest contri-
bution to this controversy is a clear perception of the
economy as involving a total allocation among different
industries of rather fixed resources, so that if one indus-
try expands, another somewhere in the system must
contract. Hence he sees the problem not in terms of
the support or penalization of particular industries but
in terms of the distribution of industries in the total
economy. If, for instance, by imposing a tariff a country
expands a particular industry and so makes it larger
than it otherwise would be, Adam Smith sees clearly
that because this industry is larger something else must
be smaller.

In effect, what Adam Smith is saying is that the
burden of proof lies on those who would distort the
proportionate industrial structure of any economy
away from natural liberty. He does not say that no
distortions are permissible. Indeed, he is quite clear
that an absolutely free market society does not result
in the optimum proportional industrial structure of the
economy. He defends, for instance, the Navigation
Acts, on the grounds that a merchant marine larger
than the free market would give, is necessary for de-
fense. He likewise argues for subsidization of education,
or even of public entertainments in a gloomy country
like Scotland! He insists, however, that these distortions
must be justified in terms of the welfare of the society
as a whole, and not in terms of the welfare of particular
industries.

Ricardo again clarified the argument further in the
theory of comparative advantage, in which he pointed
out that import duties and other interferences with
international trade forced a country to diminish its
specialization in those industries in which it had the
best terms of trade.

Later, more sophisticated arguments for protection,
such as those of Friedrich List, do not for the most
part differ from Adam Smith in principle. List argued,
for instance, that certain industries contributed more
to the general development of a society than others,
and hence should be expanded through protection. This
argument is used frequently in the case of poor coun-
tries today who are seeking development. The facts
of each case may be difficult to establish, but Adam
Smith could not object to the principle. It is indeed
a special application of the principle of externality,
as noted above.

The possibility of purely speculative fluctuations in
prices and speculative distortions in the price structure
suggests still another possibly pathological condition
of the regime of natural liberty.

Organized markets, both in durable commodities
such as wheat and in financial instruments such as
stocks and bonds, are subject to speculative fluctuations
which may not correspond to any significant conditions
outside the markets themselves. The price of a com-
modity or financial instrument in an organized market
tends to be that at which the market is “cleared,” that
is, at which the owners of the item in question in toto
have no desire either to get rid of it or to accumulate
it. If there is increased aggregate desire to accumulate
the item, its price will rise. If then a rise in price
produces expectation for further rise, this will further
increase the desire to hold the item and it may increase
the price still further. This process of self-justified
expectations may go on until at some point people
realize that the price is “too high,” and the reverse
process easily sets in. This will force the price down
until it reaches some kind of floor at which the whole
process begins again. These speculative movements
introduce a degree of uncertainty into the productive
process which is most undesirable, and a strong case
can be made for some kind of “counter-speculation,”
some agency, for instance, which will buy and sell the
item at a fixed price for limited periods of time to
prevent these speculative changes.

The old gold standard itself was one such “counter-
speculative” arrangement under which the monetary
authorities effectively fixed the price of gold in terms
of the national currency within fairly small limits by
offering to buy and sell gold for the national currency
at a fixed price in unlimited quantities. This system
broke down eventually because it was increasingly felt
that it interfered with the “natural liberty” of govern-

ments to pursue other economic policies which they
regarded as more favorable to their people. If, how-
ever, we look at something like the price supports for
agricultural commodities which have been imposed in
the United States for the last thirty years, there is a
good deal of evidence that the reduction of uncertainty
for the producer which has resulted from the interfer-
ence of “natural liberty” of free markets has actually
created a very rapid rate of technological development
in American agriculture which might not have taken
place under the free market regime. These interfer-
ences with “natural liberty” are not, as Adam Smith
himself pointed out, necessarily inimical to the princi-
ple. They represent the correction of defects in the
system rather than a repudiation of the system itself.

Since the day of Adam Smith, the history of the idea
of natural liberty has been somewhat checkered. The
classical economists such as Ricardo, Nassau Senior,
and James Mill, of the generation after Adam Smith,
accepted the idea perhaps even more enthusiastically
than Adam Smith himself. Its impact on economic
policy, especially in Britain and in France, was consid-
erable, culminating in England in the repeal in 1846
of the Corn Laws, which had imposed a protective
tariff on the import of cereals. Even from the early
decades of the nineteenth century, however, we find
a rising tide of sentiment in favor of protection, espe-
cially in the United States and later in Germany. Nev-
ertheless, it was the mid-nineteenth century that saw
perhaps the greatest apostle of natural liberty, the
Frenchman, Frédéric Bastiat, whose pamphlets are still
classics of economic rhetoric, but who carried a belief
in laissez-faire far beyond the cautious limits of Adam
Smith. From the middle of the nineteenth century,
however, natural liberty not only comes into increasing
disfavor as a principle of government policy, but is
subject to increasing attacks both from the Protec-
tionists and from the Marxists.

The most severe criticism of the system of “natural
liberty” itself has come from the socialists, and espe-
cially from the Marxists. The socialist criticism is
many-sided and its psychological roots may be very
different from its formal intellectual exposition. Some
of it is a modern version of a very ancient feeling that
exchange is in some sense degrading, partly because
of its calculatedness, partly because it seems to be
unproductive in the sense that it seems to produce no
physical embodiment of value, especially where it
looks as if equal values are exchanged. The farmer or
the peasant, for instance, frequently feels that he is
the “real” producer and that the merchant is merely
trickly getting a profit out of moving around among
owners the real wheat or potatoes which the farmer
has actually produced. There is also a lingering feeling
from medieval times that trade is ignoble, that it is
unheroic and that the good man, whether the saint or
the soldier, acts for love or for glory and not for money.
The feeling that money is somehow grubby and ignoble
goes back a long way in history. Insofar, therefore, as
the regime of natural liberty is virtually co-terminous
with the organization of society through free exchange,
the delegitimation of exchange itself also attacks the
regime of “natural liberty.”

The Marxist criticism is more specific but also rather
less convincing than the more psychological reasons
for rejecting the exchange economy listed above. Marx,
in effect, turned the labor theory of value, which in
the hands of Ricardo was a rather sophisticated expla-
nation of what determined the equilibrium structure
of relative prices, into the theory of production and
exploitation. His argument roughly is that as it is active
labor that ultimately produces everything, labor is in
some sense entitled to the whole product; therefore
the income which accrues to the owners of capital as
profit or interest is derived from exploitation, that is,
it represents in reality a one-way transfer or a kind
of tribute which arises out of the peculiar power posi-
tion of the capitalist. Marx, then, is able to draw quite
effective pictures of the worker working twelve hours
a day, producing products of which he only gets, say,
half, because in effect he is working six hours for
himself and six hours for the boss. This is indeed a
radical criticism of the system of natural liberty and
it has resulted in the destruction of that system over
a considerable part of the world and its replacement
by centrally planned economies through a communist
revolution. Private property, at least in the means of
production, is expropriated by the state, acting, it
believes, on behalf of the working class. The state then
becomes the sole capitalist and the society becomes,
in effect, a one-firm state, or the state becomes a giant
corporation encompassing all economic activity.

The ultimate social balance sheet of the centrally
planned economies still remains to be drawn. They
have succeeded in creating a rate of development
approximately equal to the rate which the successful
capitalist countries have maintained at about the same
level of income. In some cases a communist revolution
and the establishment of a centrally planned economy,
especially in Eastern Europe, seem to have resulted
in a marked acceleration of the rate of development,
the earlier regimes having been remarkably incompe-
tent leftovers from feudal times. On the other side of
the ledger the human cost of the centrally planned
economy has often been very high. It has not solved
the problem of concentration of economic power.
Indeed, it has accentuated the problem, as in fact all
power is concentrated in the one corporation of the

state. Such a system slips easily into tyranny as it did
under Stalinism in the Soviet Union, and under Mao
Tse Tung in China. Capitalist societies, it should also
be said, are also capable of falling into tyranny, as,
for instance, in Haiti or Nazi Germany. This always
seems to go hand in hand, however, with a virtual
abandonment of the regime of “natural liberty,” and
the development of extensive governmental interven-
tion in the price system, especially through quanti-
tative restrictions. One could argue indeed that it is
quantitative restrictions that create the danger of tyr-
anny whether in capitalist or in socialist countries.

In recent years there has been an interesting move
within socialist countries towards what might almost
be described as a socialist version of “natural liberty,”
particularly in Yugoslavia, where the various enter-
prises have been given a great deal of independence
and are linked together by strictly market relationships.
In all socialist countries, furthermore, it has never been
possible to destroy either the consumer markets or the
labor markets, although there is not much consumer
sovereignty or labor sovereignty. Under socialism the
“revised sequence” of Galbraith operates with full
force, and consumers, while they have some freedom
of individual choice, in the mass have to accept what
the planners decide is good for them. The workers also,
while they have some freedom of occupational choice,
are severely restricted in their choice by the national
economic plan. The drawing up of the plans, of course,
is consummated by a great deal of public discussion
and supposedly by public modification. One suspects,
however, that a great deal of this talk by the “people's
representatives” is a political ritual designed to legiti-
mate the plan rather than to modify it, just as all too
often a voting system in a capitalist democracy serves
to legitimate the continuing policies of government
rather than to change them. The “rediscovery” of the
price system in the socialist countries, however, by such
economists as E. G. Liberman of the Soviet Union, is
a sign that the concept of natural liberty and the
organization of the society through free exchange is
not dead, even in the socialist world.

The rise of Keynesian economics in the capitalist
world has had an important effect in blunting the
socialist criticism and in correcting what may have
been the most serious defect in a purely market-
oriented society, which has been in the past the tend-
ency of these societies to slip down at intervals into
unemployment and depression. The Great Depression
of the 1930's was the culminating example of this kind
of defect. By 1933 in the United States, for instance,
unemployment was 25 per cent of the labor force. This
represented not only a serious waste in product un-
realized, but it was a social disaster in terms of disor
ganized lives, unnecessary poverty, and the loss of a
role in society which a job gives to a large portion
of the population. If this had persisted, there is little
doubt that the socialist criticism would have become
unanswerable, and that the defects of socialist societies
would have seemed mild in comparison to this over-
whelming defect of a market-based economy.

The challenge, however, produced a response in the
shape of what has come to be called the “Keynesian
Revolution,” even though J. M. (later Lord) Keynes
contributed to this revolution in the economic policy
of capitalist countries in a rather confused or at least
a confusing way. Nevertheless, an important revolution
in economic policy has taken place in the capitalist
world, based perhaps on two social inventions, the first
that of national income statistics which gave the policy
maker for the first time a reasonably clear picture of
what was happening in the total economy, and the
second, a very simple Keynesian-type model which
suggested that if the Gross National Product at full
employment was not absorbed in some way by house-
hold purchases, government purchases, voluntary busi-
ness investment, that is, the willingness of businesses
to increase the total stock of capital, and the interna-
tional balance, then forces would be set in motion to
reduce the GNP and create unemployment. Three
major policies were suggested by this model. The first
was the use of a deliberate government deficit (excess
of expenditure over receipts) to increase total con-
sumption when needed, and similarly, a surplus (excess
of receipts over expenditures) to diminish consumption
when the need is to prevent inflation. The second was
the use of the Central Bank and the monetary system
to encourage or discourage business investment. The
third was the direct increase or decrease of government
expenditure. The foreign balance is usually a small
item, but may cause trouble in preventing the other
adjustments.

The results of this revolution in policy may be judged
in part by contrasting the experience of the twenty
years following the end of the First World War with
the twenty years following the end of the Second. The
first period (1919-39) was a disaster; it produced the
Great Depression, Hitler, and ended in the Second
World War. The second period has not had a great
depression, the rich countries indeed have enjoyed
unprecedented rates of development, and though the
international system is almost unbearably costly and
very unsatisfactory, at least it has not yet degenerated
into another world war. The success of the last twenty
or twenty-five years, in comparison with the '20's and
'30's, cannot all be attributed to Keynesian modification
of the regime of “natural liberty,” but some of it at
any rate must be attributed to this. It is important to

realize, however, that Keynesian-type intervention is
in the interest again of correcting a defect in the system
of “natural liberty,” as expressed in its tendency if
uncorrected to fall into deflation, depression, and
unemployment, and has the result indeed of restoring
something much more like the classical economics. It
is something of a paradox, for instance, that the success
of a full employment policy reestablishes a regime of
scarcity in which it becomes highly apparent that an
increase in a military dollar, for instance, comes out
of something and somebody else and does not simply
come out of unemployment. Under Keynesian manip-
ulation, therefore, the economy looks much more like
the world of the classical economists than it did in the
doleful '30's, and the virtues of organization through
the market become all the more apparent. It is inter-
esting indeed that there has been a revival of interest
in the use of the market in fields like education, income
maintenance, and public works, where it has previously
been much neglected. After nearly two hundred years,
therefore, we can claim that the regime of “natural
liberty” is by no means dead. It has been many times
transformed but its transformations made it stronger
and more relevant.

“Natural liberty,” like many other institutions and
conditions of society, may have more to fear from its
self-appointed friends than from its enemies. The free
exchange of privately owned commodities through
mutually accepted bargains is a powerful organizer in
society, as we have seen, and there is no sense in
despising it or throwing it out of the window. On the
other hand, it is absurd to claim that the “market”
can do everything. It is dangerous to claim that it can
do more than in fact it can. Market institutions in
society must constantly be supplemented by institu-
tions involving legitimated threat, as in the law, and
by institutions which create legitimacy and commu-
nity. Without a setting of law and legitimacy, indeed,
the market institutions cannot function and will destroy
themselves. Furthermore, the market is subject to
pathologies of its own and there must be other institu-
tions in society outside the market which can correct
these. Government may not be the only one of these
institutions for correcting the deficiencies of the mar-
ket, but it is certainly the most important. Both the
invisible hand and the visible hand are necessary for
the healthy functioning of society.

BIBLIOGRAPHY

Kenneth E. Boulding, The Organizational Revolution: A
Study in the Ethics of Economic Organization (New York,
1954). John Kenneth Galbraith, The New Industrial State
(Boston, 1967). Friedrich List, The National System of Polit-
ical Economy (German ed., 1840; London, 1904; 1928).
David Ricardo, On the Principles of Political Economy and
Taxation (1817; London, 1917). Nassau W. Senior, An Out-
line of the Science of Political Economy (1836; New York,
1951). Adam Smith, An Inquiry into the Nature and Causes
of the Wealth of Nations (1776; New York, 1937, Modern
Library); idem, The Theory of Moral Sentiments (1759; New
York, 1966).

KENNETH E. BOULDING

[See also Economic History; Individualism; Law, Natural;
Marxism; Property; Socialism; State; Totalitarianism; Work.]