What Is a Laissez-Faire Economy, and How Does It Work?

What Is Laissez-Faire?

Laissez-faire is an economic theory dating back to the 18th century that opposes any government intervention in business affairs. The driving principle behind laissez-faire economics is that the less the government is involved in the economy, the better off business, and society as a whole, will be.

It is a French term that translates to "leave alone," or more literally to "let you do."

Laissez-faire economics is a key component of free-market capitalism.

Key Takeaways

Laissez-faire is an economic philosophy of free-market capitalism that opposes government intervention.
The theory of laissez-faire was developed by the French Physiocrats during the 18th century.
Laissez-faire advocates that economic success is inhibited when governments are involved in business and markets.
Later free-market economists built on the ideas of laissez-faire as a path to economic prosperity, though detractors have criticized it for promoting inequality.
Critics argue that markets do need a certain degree of government regulation and involvement.

Understanding Laissez-Faire

The underlying beliefs that make up the fundamentals of laissez-faire economics include the idea that economic competition constitutes a "natural order" that rules the world. Because this natural self-regulation is the best type of regulation, laissez-faire economists argue that there is no need for business and industrial affairs to be complicated by government intervention.

As a result, they oppose any sort of federal involvement in the economy, which includes any type of legislation or oversight; they are against minimum wages, duties, trade restrictions, and corporate taxes. In fact, laissez-faire economists see such taxes as a penalty for production.

Laissez-faire is often associated with libertarian views on the economy, where government plays an extremely limited role. In fact, one of the key characteristics of laissez-faire economics is that the government should only be involved with the following three functions:

Protecting the national borders via a standing army
Protecting private property rights and personal freedom via a police force and judiciary
Producing public goods that serve society, such as parks and libraries, that the market would not be incentivized to produce on its own

History of Laissez-Faire

Popularized in the mid-1700s, the doctrine of laissez-faire is one of the first articulated economic theories. It originated with a group known as the Physiocrats, who flourished in France from about 1756 to 1778. These thinkers tried to apply scientific principles and methodology to the study of wealth and economic production.

These economists argued that a free market and free economic competition were extremely important to the health of a free society. They believed the government should only intervene in the economy to preserve property, life, and individual freedom; otherwise, the natural, unchanging laws that govern market forces and economic processes—what later British economist Adam Smith, dubbed the "invisible hand"—should be allowed to proceed unhindered.

Unfortunately, an early effort to test laissez-faire theories did not go well. As an experiment in 1774, Turgot, Louis XVI's Controller-General of Finances, abolished all restraints on the heavily controlled grain industry, allowing imports and exports between provinces to operate as a free trade system. But when poor harvests caused scarcities, prices shot through the roof; merchants ended up hoarding supplies or selling grain in strategic areas, even outside the country for better profit, while thousands of French citizens starved. Riots ensued for several months. In the middle of 1775, order was restored, and with it, government controls over the grain market.

Despite this inauspicious start, laissez-faire practices, developed further by such British economists as Smith and David Ricardo, ruled during the Industrial Revolution of the late 18th and early 19th century. And, as its detractors noted, it resulted in unsafe working conditions and large wealth gaps.

Only at the beginning of the 20th century did developed industrialized nations like the U.S. begin to implement significant government controls and regulations to protect workers from hazardous conditions and consumers from unfair business practices. However, it’s important to note that these policies were not intended to restrict business practices and competition.

Criticism of Laissez-Faire

Laissez-faire advocates argue that if individuals serve their own interests first, societal benefits will follow. One of the chief criticisms of laissez-faire is that capitalism as a system has moral ambiguities built into it; it does not inherently protect the weakest in society.

As such, detractors feel laissez-faire actually leads to poverty and economic imbalances. The idea of letting an economic system run without regulation or correction in effect dismisses or further victimizes those most in need of assistance, they say.

The 20th-century British economist John Maynard Keynes was a prominent critic of laissez-faire economics, and he argued that the question of market solutions versus government intervention needed to be decided on a case-by-case basis.

Pros and Cons of Laissez-Faire

Pros

Reduces government involvement in business, which is thought to be inefficient and stifling
Encourages self-responsibility and innovation
Promotes free markets and competition

Cons

Lack of regulations can harm consumers and the environment
Can generate negative externalities
Competition naturally leads to wealth inequality
May incentivize bad actors

What Does "Laissez-Faire" Mean Literally?

Laissez-Faire, in French, literally means "let you do." Legend has it that the origins of the phrase "laissez-faire" in an economic context came from a 1681 meeting between the French finance minister Jean-Baptise Colbert and a businessman named Le Gendre. As the story goes, Colbert asked Le Gendre how best the government could help commerce, to which Le Gendre replied "Laissez-nous faire," meaning "let us do." The Physiocrats popularized the phrase, using it to name their core economic doctrine.

What Is an Example of Laissez-Faire?

An economy would follow the principles of laissez-faire if it followed an approach where the government was not at all involved in the workings of the economy, business, or markets. Instead, the free market would regulate not only prices but also discipline producers to remain good actors. In reality, such an economy does not exist. All economies, even in countries with highly libertarian values, have some degree of government regulation and intervention.

What Is Laissez-Faire Capitalism?

In laissez-faire capitalism, companies could operate with a pure profit motive and not have to worry about government regulation or taxation. This, of course, could create negative externalities and information asymmetries that can allow producers to behave as bad actors and get away with it. Proponents of laissez-faire say that costly and exhaustive regulation is not needed since the market would weed out such bad actors. In reality, however, bad actors may continue operating for a long while.

The Bottom Line

Laissez-faire refers to an economic theory opposed to government intervention in the market. A central element of free-market capitalism, laissez-faire posits that businesses and society as a whole are significantly better off without government involvement. The idea dates back to 18th century France, and is popular in countries with libertarian values in the present.