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Classical Liberal EconomicsThe Makings of the Modern Global Economy

ThomasCole,�ConsummationofEmpire,� TheCourseofEmpire (1836)

The Path to ModernityThe Enlightenment began around the mid-17th Century and stretched into the late 18th century, laying the groundwork for the Modern Era.

RenaissanceEra(14th to17thCentury)

EnlightenmentEra(Early17th-late18th

Century)

MedievalEra(5th to14thCentury)

ModernEra(Early17th-late18th

Century)

Enlightened Political PhilosophyAlongside the Scientific Revolution, Enlightenment thinkers brought forth new ideas that challenged traditional institutions and thinking.

Francois-MarieArouet,aka“Voltaire”1694-1778

ThomasHobbes1588-1679

Charles-LouisdeSecondat,BarondeMontesquieu1689-1755

Jean-JacquesRousseau1712-1778

AdamSmith1723-1790

JohnLocke1632-1704

Menhaverights!

Adam Smith, Book I, Chapter 1

• Opening quote: “The greatest improvement in the productive powers of

labour, and the greater part of the skill, dexterity, and judgement with which it is any where directed, or applied, seem to have been the effects of the division of labour.”

Smallmanufacturersandcraftsmenwereoftenskilledinallaspectsofproduction.

The Pin Factory

Adam Smith, Book I, Chapter 1

• “In every improved society, the farmer is generally nothing but a farmer; the manufacturer, nothing but a manufacturer.”

• How and why, then, does Smith see agriculture and labor as different in the degree of specialization, and with what implication?

Adam Smith, Book I, Chapter 1

• “though the poor country, notwithstanding the inferiority of its cultivation, can, in some measure, rival the rich in the cheapness and goodness of its corn, it can pretend to no such competition in its manufactures”.

England

France

Poland

Adam Smith, Book I, Chapter 1

• To what three factors does Smith attribute ”the great increase in the quantity of work” through the division of labor?

• SPECIALIZATION:Theincreaseofdexterityineveryparticularworkman

• EFFICIENCY:Thesavingofthetimewhichiscommonlylostinpassingfromonespeciesofworktoanother

• TECHNOLOGY:Theinventionofagreatnumberofmachinestofacilitateandabridgelabor,andenableonmanetodotheworkofmany.

The Fruits of Division of Labor

• Specialization saves time and enhances overall gains from exchange (gains from trade)

“The woolen coat, for example, which covers the day-labourer, as coarse and rough as it may appear, is the produce of the joint labour of a great multitude of workmen… How many merchants and carriers, besides, must have been employed in transporting the materials from some of those workmen to others who often live in a very distant part of the country!”

Prince, Pauper, or African King

• ”The accommodation of an European prince does not always so much exceed that of an industrious and frugal peasant, as the accommodation of the latter exceeds that of many an African king, the absolute master of the lives and liberties of ten thousand naked savages.”

Adam Smith, Book I, Chapter 2

• Market exchange among humans is the result of self interest, not benevolence or wisdom.

• “the propensity to truck, barter, and exchange one thing for another… is common to all men, and to be found in no other race of animals.”

Adam Smith, Book I, Chapter 2

• “The difference of natural talents in different men is, in reality, much less than we are aware of… The difference between the most dissimilar of characters, between a philosopher and a

common street porter, seems to arise not so much from nature, as from habit, custom, and education.”

“Amongmen…themostdissimilargeniusesareofusetooneanother”

Adam Smith, Book I, Chapter 3

• “As it is the power of exchanging that gives occasion to the division of

labor, so the extent of this division must always be limited by the extent of that power, or, in other words, by the extent of the market.”

Adam Smith, Book I, Chapter 3

• The division of Labour is limited by the extent of the market.

• “There are some sorts of industry, even of the lowest kind, which can be carried on no where but in a great town. A porter, for example, can find employment and subsistence in no other place.”

Adam Smith, Book I, Chapter 3

• “As by means of water-

carriage a more extensive market is opened to every sort of industry than what land-carriage alone can afford it, so it is upon the seacoast, and along the banks of navigable rivers, that industry of every kind naturally begins to subdivide and improve itself…”

Specialization & Gains from Trade

David Ricardo expanded on Smith’s ideas, emphasizing that the greatest gains from trade are found when a country pursues its area of comparative advantage.

DavidRicardo

Factors of Production

lA producer’s area of specialization depends on their natural factor endowments (e.g., land, labor, or capital).

l In addition, there may be other determinants of economic advantage (e.g., technology, education).

Gains from Trade

A producer will experience the greatest gain by focusing on those factors and areas of production that yield the highest return.

Gains from Trade

What are Ricardo’s observations about the production of wine and cloth in England and Portugal?

Absolute AdvantageIf a producer is superior in a given area of production, domestic production is the best course of action. Below, each country has an obvious area of advantage in production.

Country United Kingdom United States

Workers available 200 200

Wheat bushels per worker 100 200

Tons of iron per worker 250 150

Total wheat production 20,000 40,000

Total iron production 50,000 30,000

Leveraging Your Best Advantage

Classic sexist example: If a lawyer can type faster than his secretary, should he do his own typing? Why or why not?

JamesSpader &MaggieGyllenhaal developacloseworkingrelationshipin�TheSecretary.� Intheend,alawyercanmaximizethebenefitstohisfirmifheexerciseshisorhermostlucrativetalents.

Specializationmakessensewheneachcontributorhasauniqueability,butwhathappensifapersonhasmultipleareasofadvantage?

Comparative AdvantageWhen a producer is superior to others in multiple areas of production, the area of comparative advantage is the one that offers the best return. Below, the U.K. is better at producing both wheat and iron, but should focus on iron for a greater return.

Country United Kingdom United States

Workers available 200 200

Wheat bushels per worker 150 100

Tons of iron per worker 250 150

Total wheat capacity 30,000 20,000

Total iron capacity 50,000 30,000

Opportunity CostThe lost potential gain from a course of action not taken is the “opportunity cost.”

Opportunity CostThe lost potential gain from a course of action not taken is the “opportunity cost.”

Policy Implications

Policy Implications

The writings of Smith, Ricardo, and other liberal economists encouraged

Great Britain to specialize

and abandon trade

protections in favor of freer trade relations boosted national wealth through increased gains from trade

(i.e., the Wealth of Nations).

Liberalizing Trade

• Corn Laws (1815-1846)

• Navigation Acts (1651-1849)

• Cobden Chevalier Treaty (1860)

The Industrial Revolution

• The 18th and 19th centuries brought technological

innovations in energy

(coal to steam), production (machinery), transportation

(railroads), and communications.

The invention (or perfection) of the steam engine by Thomas

Newcomen (1712) made it possible to harness the power of

combustion to increase productivity and speed up the transportation of goods in the

economy.

TechnologicalChangeandIndustrialRestructuring

Shifting Global ProductionPercent Shares of Industrial Production, 1 CE -2017 CE

Final Observation

Liberal economic thinking asserts the seemingly paradoxical view that individuals operating freely in the pursuit of their own self

interest can achieve the greatest possible collective benefit.

ThePursuitofSelfInterestasanIdealEquilibrium

“Greedisgood!”GordonGekko,WallStreet(1987)

Thank You