Laissez-faire is a French phrase meaning to “leave alone”. Proponents of laissez-faire economics reject government intervention in the economy to allow the market to operate in an optimal manner while critics argue this approach leads to large inequalities and negative externalities^[i]. 

What are the basic principles of Laissez-faire economics?

A laissez-faire economy is characterised by the free working of the market forces^[ii] of demand and supply without any form of government intervention as well as relatively lower taxation. Supporters of laissez-faire argue that intervention is not required as the natural market is perfect and is a self-regulating system which allows for the most efficient allocation of resources. They argue that intervention in the form of regulation or taxes would hinder businesses and slow down economic growth.

What are the advantages of Laissez-Faire economics?

A laissez-faire model gives firms more autonomy to operate due to the absence of government regulation and excessive taxation. As such, firms are more efficient, enabling them to lower their costs of production. Lower costs mean firms make more profits, which incentivises them to invest more in the economy. This may create a positive multiplier effect^[iii]or a trickle-down effect^[iv] whereby a firm’s expansion leads to greater derived demand for labour. Consequently, unemployment falls and average incomes increase. With higher incomes, consumers can now increase their consumption, increasing their material living standards and allowing firms to make even more revenue. In addition, the government picks up a fiscal dividend as a result of increased tax revenues from income and corporation taxes. This helps lower the budget deficit and stave off the risk of austerity^[v] measures. The government can use its extra revenue to invest in public services such as education and healthcare or invest in infrastructure helping to improve living standards.

Due to the competitive nature of the free market, a laissez-faire approach may also encourage increased innovation as firms always look to profits maximise and gain more market share. Innovation may lead to technological advancement and more efficiency. Thus, firms will be more price competitive and may also diversify their range of products giving consumers better quality products and more choice.

Lower taxes and regulation gives firms and consumers more purchasing power allowing them to consume and invest more. Furthermore, less regulation may also limit corruption as it gives bureaucrats less powers. This helps limit regulatory capture^[vi] and gives the government more tax revenue to invest in the economy.

The laissez-faire model can also avoid some of the unintended consequences, such as the growth of the underground economy, created by government intervention. It also prevents governments from building up unsustainable levels of debt, keeping the economy stable in the long term.

What are the disadvantages of Laissez-Faire economics?

Without government intervention the free market can create copious amounts of negative externalities such as pollution which can severely damage consumers and the environment. These effects may lower living standards and add to the enhanced greenhouse effect contributing to global warming. There may also be instances of asymmetric information whereby one party involved in a transaction has more information than the other. This can lead to economic agents exploiting each other for personal gain. Besides, asymmetric information can also lead to the overconsumption and overproduction of demerit goods such as cigarettes or alcohol which damages health and lowers life expectancy as well as putting further pressure on the NHS.

The free market can lead to massive inequalities of income and wealth as there is no government intervention to protect the most vulnerable in society. This can lead to severe social problems such as extreme poverty and a lack of social mobility. Moreover, inequalities can lead to an increase in crime and deprivation, further lowering living standards.

The laissez-faire model can also lead to monopolies taking over certain industries. This actually inhibits competition and may hurt consumers with lower quality products and higher prices by restricting supply. This reduces the purchasing power of consumers, lowering their consumption and material living standards.

In practice, no country can truly be a fully laissez-faire economy. To prevent market failure^[vii] and fund government operations, most countries need to have some forms of regulation and taxation. Most countries operate as a mixed economy where the state and the market forces both manage the allocation of resources.

Footnotes:

[i] Negative externalities -  when the production or consumption of a product results in a cost to a third party.

[ii] Market forces - the economic factors affecting the price of, demand for, and availability of a commodity.

[iii] Positive multiplier effect – when an initial injection into the circular flow of income leads to a more than proportionate increase in national income.

[iv] Trickle-down effect – providing tax cuts to the rich and corporations to increase production and jobs and improve the overall economic conditions of the country and its entities.

[v] Austerity - difficult economic conditions created by government measures to reduce public expenditure.

[vi] Regulatory capture - a form of government failure where those bodies regulating industries become sympathetic to the businesses they are supposed to be regulating.

[vii] Market failure - when the free market fails to allocate resources to the best interest of society, leading to inefficient and inequitable allocation of scarce resources.

Bibliography:

What Is Laissez-Faire Economic Theory? (thebalancemoney.com)

Laissez-faire Economics: What it is & Example (boycewire.com)