Liberty and the neoclassical fallacy

Abstract

Does liberty matter for economics? To address this question, I distinguish among three different types of liberty: Adam Smith’s, the neoclassical, and the so-called “classical liberal.” They differ in that the neoclassical and the classical liberal perspectives presume the existence, typically without noting it, of the four conditions that comprise the foundation of liberty, namely, secure property rights, enforcement of contracts, absence of government predation, and security. In contrast, Adam Smith sought to explain these foundations. In this article—an extraliterary review of one of the central themes of Acemoglu and Robinson (2019)—I draw the implications of Smith’s approach, and I explain why neoclassical economics—which takes the foundations of liberty as given—is unable to understand the work of Smith on this topic and, hence, on economic development. I also show that the neoclassical and the classical liberal approaches rest on a foundation of magic: they both presume the foundational conditions just noted but fail to explain how they arise. Put simply, the neoclassical approach has no explanation for the origin of liberty or of the mechanisms that sustain it. If markets require the four conditions of the foundation of liberty, then a complete explanation of the origin and development of markets must include an explanation of how these conditions come to hold. The Smithian economic perspective is especially important for today’s developing countries, most of which, at best, struggle to create the four foundational assumptions of liberty.