Classical Liberalism and the Future of Public Policy
Chapter 2: Market Failures ‘Old’ and ‘New’: The Challenge of Neo-Classical Economics
INTRODUCTION Economic theory enjoys a vexed relationship with the classical liberal tradition. On the one hand the writings of Adam Smith are often invoked to illustrate how a complex process of social coordination may occur without guidance from a centralised system of command and control. On the other hand, however, the tools of modern neo-classical economics highlight a wide array of ‘market failures’ thought to justify corrective government interventions. Even critics of the market economy appear confused about the relationship between economic theory and classical liberal conclusions. For many, the fully rational agents that populate the models of contemporary economics present a distorted view of human nature in order to deduce market liberal policies (for example, Barber, 1984; Ramsey, 2004). What such critics often fail to recognise, however, is that these very models of rationality are also used by contemporary economists to highlight the supposed weaknesses of an unregulated market system and to make the case for widespread government action. As Frank Knight (1982: 57) once remarked: ‘Critics of the enterprise economy who do not have a fair understanding of how the machinery works cannot tell whether to criticise it because it doesn’t work according to the theory or because it does.’ Much of this confusion about the status of classical liberalism arises from differing interpretations of ‘equilibrium’ in economic theory. To those working within the mainstream of neo-classical economics the equilibrium standard is a benchmark against which to judge the performance of ‘real-world’ market institutions. From a classical liberal...
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