Early History of Deregulation

& the Beginning of Laissez Faire Economics

Abstract: From its historical inception, major social problems have ensued due to the application of the principles of unregulated free market ‘laissez faire’ capitalism. It started with history’s first Ponzi scheme, and followed with peasant starvation and the French Revolution. Shortly thereafter British proponents of the theory convinced their government to deny assistance to the Irish during their Potato Famine when over 10% of their population died due to lack of food. Further the US would have dissolved as a country, if the founders had continued to adhere to the decentralized freedoms of ‘laissez faire’ capitalism.

Ironically, the individuals that laid the foundations of modern economic theory were major players in these early occurrences. Who were these significant theorists and what were their dubious social contributions? It begins in the early 18th century with John Law and Richard Cantillon. Their partnership created the Mississippi Bubble, the Ponzi scheme that almost bankrupt French economy. Drawing upon his experience with Law, Cantillon wrote an essay that is considered to be the 1st modern treatment of economic theory.

Building upon this essay, Francois Quesnay articulated the first theory of laissez faire capitalism. To presumably raise money for the French government, his followers were allowed to deregulate the economy. This led to widespread starvation. Desperate, the peasantry began rioting. These massive social disturbances were a significant contributing factor that helped ignite the French Revolution. Adam Smith, who wrote the classic work justifying a free market economy, cites both Quesnay and Cantillon as significant influences upon his theories.

Could these early disastrous experiments with deregulating the economy indicate that some government controls are necessary to protect the citizenry from the predatory inclinations of international speculators? Which parents would allow their children to follow their natural inclinations without guidance or supervision? Which doctor would allow a patient’s body to heal itself rather than provide treatment? Would adults be considered responsible if they consistently followed the ‘natural’ course of non-interference?

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A public debate regarding the necessity of government regulations has been ongoing for at least the last 3 centuries. What is the role of government? When should the state step in to guide the course of affairs and when should they let events take their ‘natural’ course? When is government intervention counter-productive and when is it essential?

In recent times, most public discourse on the topic has employed logic to determine the answer to these questions. However, the most impeccable logic, when divorced from empirical evidence, can lead to unsound conclusions. Plus, the unstated assumptions behind the arguments frequently favor one class of citizens over another. The purpose of this paper is to explore some of the relevant issues behind deregulation from a historical perspective to better understand the motives of those framing the debate.

Capitalism: Definitions

Those advocating the most limited role for government are labeled free market or ‘laissez faire’ capitalists. To promote greater clarity, let’s define some terms.

“Capital: wealth employed in or available for producing more wealth.” Those who are living at subsistence levels spend all their assets to survive. They have no capital. Only those with a surplus have wealth-generating capital. Of course, those with a large amount of capital have a greater potential for generating wealth. In general parlance, capitalists are those with an abundance of capital, not those with a small saving account.

“Capitalism: an economic system in which the means of production and distribution are for the most part privately owned.” A communist system is not capitalist because the state runs the economy. Kingdoms and empires that are dominated by a military aristocracy are not capitalist systems either. In both of these cases, the public sector runs the economy.

Military aristocracies ruled most nations-states prior to the 17th century. There were neither capitalist nor communist states. Then came the Netherlands. After breaking free from Spanish influence, the Dutch became a nation ruled by merchants in the late 1600s. Perhaps for the first time in history, the merchant class, not the military class, ruled a major world power.

How did this happen? There is a 2nd definition of capitalism: “the possession and concentration of private capital and its resultant power and influence.” The concentration of large amounts of private capital in the accounts of prominent businessmen allowed them to influence the course of events. Increasingly larger concentrations of private capital eventually enabled the merchant class to replace the military class as the rulers of the country. Because war profiteering generates enormous wealth, business and military leaders frequently join forces towards a common end.

Despite their alliance, the intrinsic motivations of these 2 fundamental classes are very different. Accumulating territory motivates the military class. They do not produce goods and services, but instead take what they want by virtue of their martial prowess. In contrast, profits motivate the merchant class. While they might employ military might to maximize revenue, the merchant class produces goods and services to generate profit. With the advent of the merchant class, the topic of discussion shifted from ‘military conquest’ to ‘maximizing wealth’.

Intuitively, wealth is measured by the value of an individual’s possessions. According to the traditional military mindset seizing the wealth of others was the best way to become rich. According to the traditional merchant mindset, producing sought after goods and services was the best way to accumulate wealth. However sometimes a good idea needs investors. Investors produce no goods and service. They simply provide investment capital to the entrepreneur upon which they expect a good rate of return.

With the increase in shipping technology and advent of exorbitant profits from international trade for European merchants, investors began funding shipping as a way of generating wealth. The common expression, ‘when my ships come in’ is a reflection of this time period.

Of course, there were always investment risks. The father in the classic fairy tale Beauty and the Beast lost his entire fortune investing in overseas ventures. Instead of bringing profits, the boats shipwrecked and he lost everything. He gambled and lost. In this sense, investment is a form of financial gambling. It appeals to economic risk-takers.

There is yet another way of generating capital, which we will call ‘gaming the system’. In this case, those with capital neither produce goods and services, nor do they invest their money in legitimate enterprises. Instead, they attempt to take advantage of the economic system to maximize their wealth. A significant number of ‘laissez faire’ capitalists were and are of this variety. They want(ed) government out of the way so that they could more easily ‘game the system’. The first proponents of deregulation were this type of capitalist.

To better understand the historical context of the call for deregulation, let us first examine the preceding time period, when government regulations were the method by which absolute monarchies increased the political power of their kingdoms.

Mercantilism

Mercantilism was the prevalent economic theory and practice of the European nations from the 16th to the 18th centuries. It coincided with and was in part a theoretical response to the increase in overseas trade and colonialism. The theory promoted government regulation of the national economy to augment state power at the expense of rival powers. The governments in most cases were absolute monarchies.

National wealth was measured by the quantity of precious metals, especially gold and silver, that a monarch possessed. Possessing wealth was more important than circulating it. The ‘savings’ were frequently held in reserve to wage war or to fend off military aggression. This intentional accumulation of wealth set the stage for the ensuing capitalist economy. Instead of sitting on wealth, the capital was employed to generate more capital.

International trade was regulated to maximize the monarchy’s metal reserves. In this regard, the king’s economic advisors focused upon a positive balance of trade, i.e. more money coming into the national economy than leaving. This strategy was probably a response to the prior era, when national wealth flowed east to purchase Southeast Asian spices and Chinese silks, with little exported goods in exchange. To achieve a positive balance of trade, duties were charged on imported goods. Additional tariffs were imposed on products that competed with local manufacture and products. These ‘protectionist’ measures were designed to strengthen the national economy.

Colonies were meant to be an exclusive source of wealth for the mother country. They supplied both raw materials and a market for manufactured goods. This trade exchange was tightly regulated. Both commerce with foreign powers and colonial manufacture of goods was forbidden, if it competed with home industry.

Due in part to the Black Death of the 14th century, a nation’s population was considered to be of utmost importance. The absolute monarchies that were prevalent during this time period considered an increasing population to be the solution to many their problems. A large population supplied a labor force, a market for goods, and soldiers. The larger the population, the larger the army for defense or foreign aggression. Further, a large labor pool depressed wages because of job competition. Accordingly, a nation’s population was considered another measure of a nation’s wealth according to the mercantilist philosophy.

Because of the significance of maritime commerce to a nation’s wealth during the colonial period, manning merchant shipping fleets and a national navy was of utmost importance. Due to the cramped quarters, dangerous and uncertain conditions and a long time away from home and family, it was difficult to find enough volunteers for this unpleasant business. Owing to the importance of international trade, the absolute monarchies had no qualms about requiring excess population to serve on their ships. These unfortunate individuals included criminals, the unemployed, vagrants, political opponents, religious dissidents and African slaves. Able-bodied men were even kidnapped from wedding parties to supply the manpower for national shipping. In other words, mercantile policy favored the aristocracy and viewed the lower classes as the possessions of the monarchy.

Because the agricultural peasantry and craftsman were his possessions, the king was obligated to protect and feed them, just as he would his soldiers or livestock. With this function in mind, the government maintained a tight control on the price of grain to ensure that bread was affordable for the masses.

Further national police ensured that the quality of the flour was high. In other words, they protected the peasantry against unscrupulous practices of grain merchants. These businessmen were considered to be the ‘most cruel enemies of the people’, as they frequently mixed chalk and/or crushed bones with the flour to add bulk to their product.

In general, the mercantile period can be characterized as a time when the national economy was tightly regulated to maximize the wealth and thereby the power of the monarchy. The accumulation of precious metals was considered to be more important than making money from capital investments. Due to the prevalent belief in the ‘divine right of kings’, the monarch owned the land and all that it contained, including the humans. His duty was to protect his possessions. This included safeguarding the local industries as a source of national wealth and providing affordable and nutritious sustenance for the agricultural workforce. Guarding the national health was the number one priority.

John Law (1671-1729) & the 1st Ponzi Scheme?

One of the reasons that mercantilism was a successful policy for so many centuries was because of the wealth flowing in from the colonies. This influx of funds generated a nearly automatic positive balance of payments. The wealth generated from their colonies enabled the many absolute monarchs to wage nearly continuous war against each other to increase or defend the territory under their control.

By the 18th century, this somewhat artificial source of income had exhausted itself for some of the major powers. Further many of the treasuries were nearly depleted due to the endemic warfare. The monarchs were looking, almost desperately, for new sources of income or strategies to bolster their national economies and their wealth so that they could continue to wage war or at least protect themselves from aggressors. On the losing end of the Spanish War of Succession (1701-1714), France was perhaps the most desperate. Enter John Law.

Born into a Scottish banking family, John Law began studying the family business at the age of 14. After his father died when he was but 19, he traveled to London where he spent much of the family wealth on gambling. In 1694 at the age of 23, he killed another man in a duel over a woman. He was sentenced to death and was incarcerated. He was freed on an appeal, and escaped to the Continent.

In 1705, Law published a treatise called ‘Money and Trade Considered, with a Proposal for Supplying the Nation with Money’. He believed that increasing the money supply could be the source of great wealth for a nation. He further theorized that notes backed by precious metals would increase money supply. To this end, he urged the establishment of a national bank to create credit.

The central bank would manufacture money by issuing notes (rather than gold and silver) guaranteed by the government. Land, gold and silver in the national treasury backed these notes, at least theoretically. In this way, paper money could be employed as credit. In this way, Law’s proposal would supply the nation with money.

Many of these ideas were not new. Many mercantilists of the time believed in the importance of money as a creative force and that increasing the money supply would stimulate national productivity, which would in turn generate more political power. Further Italy, the Netherlands and England had already been circulating paper money to avoid the problems created by shortages of silver and gold.

Law differed from his contemporaries on one key point. He believed in creating a national bank as the agency to manufacture money. He first proposed his novel ideas to the Scottish government, who rejected it.

He found more receptive ears on the Continent. France had accrued a huge war debt due to wars waged by Louis XIV. Further these wars had depleted France’s precious metals. They simply did not have enough silver and gold to coin more money. Their national debt was rising and their economy was falling. Providentially, Louis XIV died in 1715, a little over year after Law had established a presence in Paris.

A tall, good-looking man, Law had been a regular at high-stakes gambling parties where he had forwarded his novel ideas. He promised to reduce national debt and provide new wealth to the country through the creation of a central bank that was to manufacture paper money backed by the authority of the Crown.

The appeal of Law’s theories was irresistible to a nation in terrible financial shape. His promises got the attention of the Duke of Orleans, the regent to the new king of France, Louis XV. Desperate for a novel economic solution that didn’t require gold from the national treasury, he gave Law permission to put his theories into practice.

In 1719, Law established the 1st central bank of France, the Banque Générale. For this privilege, Law granted low interest rates on the national debt and public loans. As a further indication of the intimate relationship between the public and private sectors, the government supplied three quarters of the bank’s assets. The bank immediately began issuing paper notes. Guaranteed by Louis XV, the cash-starved populace gobbled them up. This infusion of capital provided a major stimulus to the stagnant French economy.

Simultaneously, Law was given a trade monopoly in North America. This enterprise was called the Mississippi Company, as it included the enormous Mississippi River Valley. By this time in history, joint-stock companies, i.e. corporations, had become a common device for attracting money and spreading risk. Law began selling shares in a company dealing in North American real estate.

By exaggerating the potentials of Louisiana land, Law was able to attract an increasing number of investors, large and small. This almost immediate infusion of capital drove the stock values up. Many were amassing huge fortunes. Due to the rapid accumulation of wealth, the term ‘millionaire’ was employed for the first time.

Because of the rapid turnaround in the French economy combined with this almost miraculous generation of riches, Law was lauded as an economic genius and savior of the French economy. To reward him, the Duke of Orleans allowed the Mississippi Company to absorb the French East Indies and China Company. Further he granted Law a monopoly over all French overseas trade and appointed him as the Controller General of France. This was early in 1720.

By the end 1720, the prosperity that Law’s manipulations had created began to unravel. The unregulated bank had issued more notes than their assets supported. This imbalance led to runaway inflation that especially affected food prices, which ignited unrest in the lower classes. Further, the undeveloped New World real estate didn’t generate the anticipated income and the speculative bubble popped.

There was a run on the bank. Creditors were turned away because of insufficient funds. Fortunes were lost; saving accounts eliminated, and the French economy was in shambles again. Held accountable for this disastrous state of affairs, Law fled France, ended up in Venice, where he died a poor man.

John Law’s get-rich-quick scheme has been deemed the ‘Mississippi Bubble’.  It was one of the first economic bubbles based upon unregulated, under-funded investor speculation. It was probably the first Ponzi scheme with out-of-control investments fueling profits, not the production of real goods and services. As with other speculative bubbles, the entire economy suffers, not just the investors. The boom is intoxicating to investors and the bust is even more devastating, at least to those who are unable to get out in time.

Though Law’s experiment failed, his theories live on 300 years later. For instance, he is credited with increasing the money supply through credit and anticipating futures speculation. Note that futures speculation is merely another type of gambling – a method to get rich that produces nothing of worth. In other words, this influential capitalist introduced some new techniques to become wealthy by ‘gaming the system’.

There are a few noteworthy aspects of this historical event. There are a few reasons that circumstances spiraled out of control. Lack of regulation stands out. The government-sponsored bank was manufacturing money without any intrinsic value. The Mississippi Company was providing inflated profits by circulating investment capital. The profits were not based upon providing goods and services. Poorly funded speculation drove up real estate values to unsustainable levels. When the astute pulled out, there was neither capital nor value to sustain the economic bubble. The collapsing house of cards jolted France’s entire economy, not just the investors. Three centuries later unregulated and under-funded investments in North American real estate created a similar economic bubble, which almost took the global economy down. This was the Great Recession of 2007-08.

A second feature bears noting. The investors were only interested in generating fabulous profits, not the common good. In the same year 1720 that the French ‘Mississippi Bubble’ popped, the ‘South Sea Bubble’ popped in England, with equally disastrous consequences for the national economy. Almost a century before in 1637, the Tulip Bubble crippled the Dutch economy.

In each of these cases, including the more recent Great Depression and Great Recession, investment speculators go into a trance, where all they can think of is instant wealth. The collective welfare of the greater society is forgotten in the obsession with accumulating riches. This material disease has the potential to infect all classes and races of humans. It is a universal human tendency to get carried away in mass movements, whether financial bubbles or warfare.

As these examples indicate, when humans are left to their own devices, they have the potential to enter a destructive Pulse. What’s the solution to this negative human tendency that has a real potential to undermine the national or even international economic health?

Could it be that the government must take actions to prevent it from spreading and infecting a wider population, just like with Ebola or any other infectious disease? Is it possible that the state must act as the agency to protect the common good? Must the government act as the parent to the child, providing boundaries to prevent the citizenry from injuring themselves through the reckless pursuit of wealth? Is regulation necessary to balance this innate human tendency?

Richard Cantillon (1680-1734): the 1st Modern Economist

Richard Cantillon was John Law’s business partner and one of those who amassed an enormous fortune on the Mississippi Bubble. This experience inspired Cantillon to write an essay. Many claim that Cantillon’s essay was the first modern work on economics.

This essay provided essential inspiration for the French physiocrats led by Francois Quesnay. In turn, Adam Smith cites both Quesnay and Cantillon as significant inspirations to his classic work. Adam Smith, an academic, wrote the first book advocating a free market economy. Published in 1776 and called Wealth of Nations, Smith’s work has exerted a tremendous influence upon national financial policy. Many claim that it was the most influential economics book ever written.

Who was Cantillon? And why was his essay so influential? Exploring the answers to these questions will shed some light on the underlying motivations of laissez faire capitalists.

Cantillon was an Irishman of Norman descent, but spent most of his life in France and the Netherlands. Like Law, he also came from a banking family. For most of his early life, he primarily operated as a large-scale financier in many population centers including Amsterdam.

However, much of his wealth came from the collapse of John Law’s Mississippi Company. Cantillon became rich by buying low and selling high. He bought shares in Law’s company in the beginning when they were relatively cheap and then sold them at the peak, just when the bubble was about to burst. To maximize his income, he then charged his borrowers high interest rates. This experience exerted a heavy influence upon him and probably catalyzed many of his economic theories.

After the collapse, criminal charges were filed against Cantillon and he was the subject of murder threats. In 1935, his house burned to the ground with him in it. Some say a terminated chef murdered him and then set his house on fire. Others say that disgruntled investors got revenge for the loss of their personal fortunes. Another account states that he faked his murder to escape creditors and lived out his life in Suriname. Whichever account is true, it is evident that Cantillon’s role in the collapse of the Mississippi Bubble was highly suspect, verging on criminal.

In 1730, a decade after the collapse, Cantillon wrote ‘Essay on the Nature of Commerce in General’. Published only in 1755 due to French censorship, this essay probably inspired Quesnay’s famous Tableau économique, the ‘Bible’ of the Physiocrats. His treatment of population exerted a significant influence on Adam Smith and by extension Malthus. Due to his widespread impact, some call Cantillon the ‘father of enterprise economics’ and deem his work the ‘cradle of political economics’. Many say that it was the first modern economic treatise.

Why?

Cantillon employed a value-free approach to economics that is typical of scientific analysis. His work was the first treatise on economics that was devoid of nationalism and religion. Further, his explanation of relationships didn’t involve politics or ethics. Like Descartes, he employed simple models to make his points.

Some of his ideas came from his relationship and experience with Law, including the importance of increasing the money supply to create national wealth. Other concepts were his own. For instance, his treatment of the theory of money was of pioneering importance. He also proposed theories regarding wages, prices, and interest; the workings of currency circulation; and the role of precious metals in the international economy.

While his theories were important, his causal methodology set the standard for future economic literature. Modeling his approach upon the physical sciences of Descartes and Newton, Cantillon believed that he was uncovering the ‘natural laws’ of economics. If indeed they were ‘natural’, they were also immutable. Just as God and human motivations were unnecessary factors in the equations of physics, they were equally unimportant to the ‘natural’ economic laws. Just as the physical universe worked perfectly without human intervention, so did the economic universe work perfectly without government intervention. Although Cantillon didn’t specifically articulate these notions, his articulation of ‘natural’ economic laws set the stage for ‘laissez faire’ capitalism of the following generation of economists.

Let’s consolidate to aid retention. Both Law and Cantillon came from families that had grown rich from investment banking, i.e. earning money by charging interest on loans to individuals and nations. Their early exposure to the banking system inspired some innovative perspectives.

Sometimes historians characterize Law as a millionaire ‘high stakes’ gambler and Cantillon as a ‘high stakes’ financier/speculator. Their common monetary risk-taking bond and banking backgrounds led them to enter into a common enterprise – the Mississippi Company. Due to their deep understanding of the financial structure, they were able to persuade individuals and a nation to invest in their ‘real estate business’. Within a few years, it became evident that this was one of history’s first Ponzi schemes. Both grew rich and were disgraced socially due to their involvement in this obviously criminal enterprise.

The writings of both Law and Cantillon were primarily focused upon generating a new source of wealth for the merchant and ruling classes. Their historical actions indicate that they were primarily focused upon financial prosperity of the nation’s leaders, not the well-being of the working class.

Their personal history indicates that they were primarily interested in ‘gaming the system’, not in producing goods and service. However, their desire to ‘game the system’ produced deep insights into the essence of economics. Their valid insights laid the foundations for modern economic theory.

Francois Quesnay (1694-1774): the ‘Natural’ Economic Order

Francois Quesnay was probably the most prominent of Cantillon’s economic offspring. He was the influential leader of the Physiocrats, a prominent 18th century economic school that inspired many of Adam Smith’s theories. Smith regularly met with Quesnay when he lived in France from 1764 to 1766. Smith even cites Quesnay’s influence in his writings.

Quesnay’s most famous work, Tableau économique, was published in 1758, just 3 years after Cantillon’s Essai first came into print. As an indication of direct modeling, Quesnay’s treatise contains a diagram of the flow of goods and services between different classes of society that is probably derived from a simpler flow chart in Cantillon’s work. Quesnay built upon and refined Cantillon’s theories, thus justifying the ‘cradle of economics’ designation.

Quesnay’s physiocrats were the first to employ the phrase ‘laissez faire’ in reference to economic theory. As an Englishmen, Smith never used this French phrase in his writings. However those who believe in this ‘laissez faire’ capitalism generally consider his book justifying the free market economy to be the first and classic articulation of their system.

Although their economic philosophies are based on the same essential structure, these early theoreticians came from entirely different backgrounds. Both Law and Cantillon were major players in the international investment banking game. Smith was an academic, while Quesnay was the court physician of the French royalty including Louis XV.

As the royal physician, Quesnay noticed that the body frequently heals itself without external intervention. He applied the same principles to economics. Drawing from Cantillon, he believed that divinely ordained ‘natural’ laws would be most effective at healing the national economy. In this regard, he and his followers wanted to set up a physiocracy (Greek for ‘Government by Nature’), hence the name of their school.

Quesnay advocated rule of nature, instead of human intervention. He believed that trade and industry should be allowed to follow a natural course without government interference. As with the body, the best strategy was to allow the financial system to heal itself ‘naturally’.

While focused upon national prosperity like his predecessors Law and Cantillon, Quesnay postulated that the ‘wealth of nations’ would lead to general prosperity for all members of society. He further claimed that allowing these natural laws to operate freely was the best way to ensure the greatest happiness. In other words, economic competition free from restrictions maximized social satisfaction. Following Quesnay, Adam Smith took the same tack.

The Chinese Influence & Wu wei, the ‘natural way’

In addition to Cantillon, Quesnay drew inspiration from China. His infatuation with Chinese culture inspired him to write books in praise of their systems. His followers even deemed him the ‘Confucius of Europe’

He was impressed that the Chinese Empire was a meritocracy. Rather than a military aristocracy running the country as in the European kingdoms of the time, a scholarly class that had passed rigorous national exams administered the empire. The Chinese Emperor both took and followed the recommendations of his Confucian advisors. Perhaps Quesnay hoped in similar fashion that the absolute monarchs of Europe would also respect the wisdom of the scholarly class, such as his physiocrats.

He also admired their uniform tax system and universal education. Some even credit his writings in praise of the Chinese system with the institution of universal education in European nations.

The Chinese economic system probably made the biggest impact upon Quesnay. According to his understanding, the Imperial Government valued the agrarian population as the source of their power. While honoring the contribution of the peasant class, the Confucian officials didn’t interfere in their business. The Confucians followed the ‘natural’ policy of wu wei towards their citizenry. In other words, they allowed natural patterns to unfold.

Perhaps inspired by the Confucians, the physiocrats led by Quesnay theorized that agricultural labor was the real source of value. In this regard, they were repudiating the current mercantilist view that possession of gold and balance of trade determined a country’s wealth. Quesnay perceived the active process of labor as more important than the fixed accumulation of capital.

This insight into the value of process might have led him to theorize that ‘circulating’ capital was better for the economy than ‘fixed’ capital. Too much fixed capital, such as savings, can even harm the system by slowing the money supply. Keynes developed a similar theory a century later. However, Turgot and Smith, who followed Quesnay, believed like the mercantilists that savings was an unqualified benefit to society. This was the standard belief until Keynes proposed his theory.

As a doctor, Quesnay understood that a body in equilibrium was a healthy body. In similar fashion, his writings stress economic equilibrium as a sign of financial health. Like most economists, he wanted to avoid boom-bust cycles that are the bane of society. Later economist adopted this same perspective.

By stressing agriculture, the physiocrat philosophy was a rationalization of medieval values, when farming still dominated the economy. However by this time in history, manufacture and foreign trade had supplanted agriculture as the dominant commercial force in Europe. The Chinese situation was entirely different. During this historical time period, the Chinese had deliberately withdrawn from international trade in order to better attend to the needs of their massive agrarian population. In this way, the physiocrats’ emphasis upon the prime importance of agricultural was behind the times and was discarded by later theorists.

Laissez Faire (Free Market) Capitalism

While his agrarian emphasis is just a historical footnote, the Chinese philosophy of wu wei as transmitted through Quesnay’s writings took a permanent hold on Western consciousness. After reading Quesnay’s writings on Chinese business, Vincent Gourney, another prominent physiocrat, translated wu wei as ‘laissez faire laissez passer’, French for ‘leave it alone, let it pass’. This phrase was eventually truncated to ‘laissez faire’. The sense of the French phrase was ‘allow it to happen’ – ‘let it be’ or ultimately ‘let nature run its course’. In other words, no medical intervention on the body and no government intervention with the economy. Allow these systems, one biological and one economic, to heal themselves ‘naturally’.

Although employed by the French physiocrats, Adam Smith, Ricardo or Malthus did not use the phrase ‘laissez faire’. It only came into popular English usage after James Mill defined the phrase in his English dictionary of 1812.

The physiocrat’s ‘laissez faire’ philosophy was a direct attack on the preceding economic theory – mercantilism. Recall that mercantilist philosophy held that the government should make intentional choices to maximize national economic advantage. In this regard, the monarch and his advisors maintained a tight control on business to maximize the power of the nation. Tariffs protected local industry from foreign competition and state-sponsored monopolies enriched the royal treasury, while inhibiting efficiency. Further, the hoarding and accumulation of gold and silver as the source of wealth contracted the amount of money in circulation. The government also subsidized what they considered to be important enterprises, rather than allowing the market to determine the direction. On the national level, toll roads inhibited the flow of goods and traditional guilds limited competition. In short, human intervention inhibited competition as well as the free flow of trade. Adhering to ‘natural laws’ was proposed as an antidote to an over-abundance of ‘human laws’. The physiocrats even claimed that the many regulations of mercantilism violated both the physical and moral order of the natural system.

However the physiocrats did not believe in anarchy or democracy. Instead they advocated a strong central government, as they had in China. Quesnay even wrote a book in favor of Oriental despotism. In this regard, the physiocrats called for an enlightened or ‘legal’ despotism. They just wanted to alter the status quo, not overthrow it. Instead of allowing the economy to run itself, they felt that the role of the ‘enlightened’ king was to enforce the unfolding of natural lawsby providing boundaries under which commerce could operate freely.

Quesnay’s stress on following the ‘natural order’ repudiated Locke’s ‘social contract’. Embodied in the notion of a social contract is the idea of choosing whether or not to follow a leader. If a king doesn’t follow the terms of the agreement, the citizenry has the right to break the contract. The American colonists employed Locke’s philosophy to justify breaking away from England. In contrast, the physiocrats’ call for a ‘legal despotism’ validates the status quo with the monarchy and the upcoming merchant class at the top of the ‘natural order’. Ultimately, the laissez faire philosophy of ‘let nature take its course’ even repudiates the idea that humans can make positive choices to maximize future potentials.

Following are some of the many theories that the physiocrats proposed regarding these ‘natural laws’. The only role of the state is to protect ‘life, liberty and property’, i.e. defend private property rights and administer justice. Individuals pursuing selfish interests advance the general good. Free economic markets lead to a natural system of liberty. Business should be free from duties, tariffs, regulations and subsidies.

The ongoing Scientific Revolution certainly inspired many of these new ideas. Newton’s discovery of ‘natural material laws’ was part of the inspiration for adhering to ‘natural economic laws’. Part of the inspiration for free trade and free competition came from the ‘freedom of thought’ associated with the scientific method. Freedom from religious dogma of; freedom from superstitious thinking; freedom from old ways of thinking; and freedom from government restrictions.

These were the theories of the physiocrats, the first proponents of laissez faire capitalism. But as every engineer knows, theories must be tested to see if they work. Let’s see what happened when the physiocrat philosophy was put into practice.

Deregulation & the French Revolution

One of the prime tenets of laissez faire capitalism is that economic freedom maximizes popular satisfaction for all. That’s the theory. Let’s see how well it works in practice.

To produce more value from the land, Quesnay persuaded Louis XV to give ‘laissez faire’ economics a try. In 1754, the government eliminated tolls and restraints on the sale and transport of grain. The experiment met with more than a decade of success. Then in 1768, there was a poor harvest. Due to the economics of supply and demand, the cost of bread rose so high that there was widespread starvation. Aggravating the situation, merchants exported grain for better profits elsewhere. Due to the disastrous consequence of laissez faire economics for the French populace, the government revoked free trade in 1770.

However, the physiocrats were not finished. In 1774, Turgot (1727-1781), a follower of Quesnay, gained an appointment as Comptroller Minister of Finance to French King Louis XVI. He employed his position of authority to reintroduce the physiocrat’s ‘laissez faire’ economic policies into the system.

Edicts were issued in September 13, 1774 to liberate the grain trade from government restrictions. By manipulating the market through hoarding and such, speculators immediately drove the price of grain up. Again this led to shortages, price rises, and even starvation. Due to these desperate circumstances, the agrarian peasantry revolted all over France. Historians have identified over 300 locations where uprisings occurred. This internal turbulence was so widespread and intense that it is deemed the Flour War. This popular revolt was settled by reinstituting price controls.  Even though the Flour War only lasted from April to May 1775, social unrest became a permanent feature of the French political landscape.

One of the reasons for the spontaneous intensity of this popular revolution was that deregulation violated the traditional ‘moral economy’. During mercantile times, the government’s duty was to enforce the laws of property and the laws of morality. In terms of the moral economy, this meant that the king ensured that the peasantry had access to grain for their bread and that it was affordable. To this end, the government had a police force to ensure grain purity and prevent hoarding. Turbot removed police regulation from the grain trade. Most historians claim that the deregulation of grain along with its disastrous consequences, such as famine and starvation, was one of the contributing factors to the French Revolution.

Contributing to the instability, Turgot had guilds banned in 1775. Guild members immediately rioted. They claimed that this action would undermine quality and shift power to impersonal corporations. This social turbulence due to laissez faire practices contributed to Turbot’s fall from power.

Turbot also introduced universal taxation, another policy of the physiocrats. Prior to this point,the royalty was not subject to taxation. Before his prestigious appointment, Turbot had worked as an administrator of the poorest and most highly taxed region in France. His experience reinforced his belief that tax reform was essential to the continuation of the French status quo. In fact, he was convinced that the only alternative to radical reform was revolution.

While the lower classes resorted to rioting to communicate their dissatisfaction, the upper classes simply pressured the King to remove Turbot from office. Evidently they were not pleased that his reforms required them to contribute a small fraction of their inherited wealth to promote social wellbeing. In other words, the ruling class chose to implement the parts of the physiocrat economic philosophy that benefited them and thwart the implementation of parts that were to their disadvantage. History proved Turbot’s conviction regarding reform or revolution to be correct in 1789.

The Count de Vergennes, the French foreign minister under Louis XVI, engineered the free trade treaty of 1786. Cheap English textiles flooded France. This undermined the income of the peasant weavers, leading to more unrest in the lower classes.

These early experiments with deregulation in France led to starvation, high prices for food and a severe reduction in local income. The popular dissatisfaction due to lack of government restrictions set the stage for the popular uprisings of 1789 that became the momentous French Revolution. In other words, the ‘natural’ unrestricted economic system contributed to a ‘natural’ people’s revolution, certainly not a hoped for consequence.

Let us examine yet one more example of how unregulated laissez faire capitalism ‘maximizes social satisfaction’. In 1843, James Wilson founded the newspaper ‘The Economist’ in Britain. His periodical became an influential voice for laissez-faire capitalism. Shortly thereafter, the Irish Potato Famine struck in 1845. Although over 10% of Ireland’s population subsequently died of starvation and another 10% migrated to the US to escape this dire consequence, Wilson opposed food aid for starving farmers. Standing by the ‘natural economic laws’, he wrote, “It is no man's business to provide for another.”

The question becomes whose ‘social satisfaction’ does laissez-faire capitalism promote? Certainly not the Irish farmers. Instead, it is manifestly clear that laissez faire capitalists don’t feel any sense of social obligation to the less fortunate. Not only don’t they have a sense of compassion, they are philosophically opposed to assisting those in need. ‘Natural’ processes such as starvation or revolution will presumably take care of the problem.

These early examples reveal some of the disastrous consequences of laissez faire capitalism for the populace, the common folk. Laissez faire capitalism can also be bad for the health of nations.

After the United States broke away from England, lawmakers set up a new government under the Articles of Confederation. These articles were designed to maximize the personal and economic freedom of both states and individuals. It became immediately apparent that this freedom from the restrictions of a centralized government threatened the very political existence of the new nation. 

With no source of real revenue and dependent upon the states, the United States was facing economic default and dissolution. Perceiving the potential for disastrous consequences, representatives from all states joined together at the Constitutional Convention with the intent of strengthening their new country.

One of their goals was to prevent dependency upon the international community, specifically European economy and finance. To this end, a centralized government was set up to deliberately promote science, invention, industry, commerce and education. Tariffs protected national trade from foreign competitors. Rather than relying solely upon free market to strengthen their nation, the government invested in enterprises that would promote the overall good. This included railroads, canals and even Lewis and Clark’s famous exploration of the interior.

When has absolute human freedom ever been successful?

This historical analysis indicates that some of the results of an unregulated free market economy are Ponzi schemes, Revolution, and the dissolution of the state. However, this document is not a call to a return to the over-regulation of the mercantile system. Instead it is important to find a balance between too much and not enough.

In practice, every nation combines mercantilist protectionist policies with free market capitalism. Mercantilist measures tend to maximize the interests of the national economy, while unregulated free market capitalism tends to maximize the profits of international business, frequently at the expense of local business. As the noted economist Maynard Keynes suggests: a case-by-case analysis is required to determine whether government intervention is necessary or whether to rely upon the ‘natural laws’ of laissez faire/free market capitalism.

Is it possible that the best course of action is somewhere in the middle, rather than at either extreme? Could it be that the government should act like responsible parents in the sense of providing their children freedom within reasonable boundaries? Which parent expects positive results from granting a child absolute freedom to follow natural laws? Most parents provide guidelines within which their offspring can find their own course.

Is it possible that when the health of the nation is out-of-balance that the government should act as a doctor in the sense of providing an appropriate medicine or passing appropriate legislation to address the cause? Which responsible doctor allows his patient’s body to heal itself through natural causes? While respecting natural processes, the entire medical profession is oriented towards a proactive response, whether medicine, surgery or even counseling a change of lifestyle. Which nation or empire has ever been successful by allowing the merchant class absolute freedom to pursue profit?

 

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