structural:scholar_edition
Liberal economic theory

Adam Smith 's The Wealth of Nations, published in 1776, followed by the French liberal economist Jean-Baptiste Say 's treatise on Political Economy published in 1803 and expanded in 1830 with practical applications, were to provide most of the ideas of economics until the publication of John Stuart Mill 's Principles in 1848. Smith addressed the motivation for economic activity, the causes of prices and wealth distribution, and the policies the state should follow to maximise wealth.

Smith wrote that as long as supply, demand, prices and competition were left free of government regulation, the pursuit of material self-interest, rather than altruism, maximises society's wealth through profit-driven production of goods and services. An " invisible hand " directed individuals and firms to work toward the nation's good as an unintended consequence of efforts to maximise their gain. This provided a moral justification for accumulating wealth, which some had previously viewed as sinful.

Smith assumed that workers could be paid as low as was necessary for their survival, which David Ricardo and Thomas Robert Malthus later transformed into the " iron law of wages ". His main emphasis was on the benefit of free internal and international trade, which he thought could increase wealth through specialisation in production. He also opposed restrictive trade preferences, state grants of monopolies and employers' organisations and trade unions. Government should be limited to defence, public works and the administration of justice, financed by taxes based on income. Smith was one of the progenitors of the idea, which was long central to classical liberalism and has resurfaced in the globalisation literature of the later 20th and early 21st centuries, that free trade promotes peace. Smith's economics was carried into practice in the 19th century with the lowering of tariffs in the 1820s, the repeal of the Poor Relief Act that had restricted the mobility of labour in 1834 and the end of the rule of the East India Company over India in 1858.

In his Treatise (Traité d'économie politique), Say states that any production process requires effort, knowledge and the "application" of the entrepreneur. He sees entrepreneurs as intermediaries in the production process who combine productive factors such as land, capital and labour to meet the consumers' demands. As a result, they play a central role in the economy through their coordinating function. He also highlights qualities essential for successful entrepreneurship and focuses on judgement, in that they have continued to assess market needs and the means to meet them. This requires an "unerring market sense". Say views entrepreneurial income primarily as the high revenue paid in compensation for their skills and expert knowledge. He does so by contrasting the enterprise and supply-of-capital functions, distinguishing the entrepreneur's earnings on the one hand and the remuneration of capital on the other. This differentiates his theory from that of Joseph Schumpeter, who describes entrepreneurial rent as short-term profits which compensate for high risk (Schumpeterian rent). Say himself also refers to risk and uncertainty along with innovation without analysing them in detail.

Say is also credited with Say's law, or the law of markets which may be summarised as " Aggregate supply creates its own aggregate demand ",and " Supply creates its own demand ", or "Supply constitutes its own demand" and "Inherent in supply is the need for its own consumption". The related phrase "supply creates its own demand" was coined by John Maynard Keynes, who criticized Say's separate formulations as amounting to the same thing. Some advocates of Say's law who disagree with Keynes have claimed that Say's law can be summarized more accurately as "production precedes consumption" and that what Say is stating is that for consumption to happen, one must produce something of value so that it can be traded for money or barter for consumption later. Say argues, "products are paid for with products" (1803, p. 153) or "a glut occurs only when too much resource is applied to making one product and not enough to another" (1803, pp. 178–179).

Related reasoning appears in the work of John Stuart Mill and earlier in that of his Scottish classical economist father, James Mill (1808). Mill senior restates Say's law in 1808: "production of commodities creates, and is the one and universal cause which creates a market for the commodities produced".

In addition to Smith's and Say's legacies, Thomas Malthus ' theories of population and David Ricardo 's Iron law of wages became central doctrines of classical economics. Meanwhile, Jean-Baptiste Say challenged Smith's labour theory of value, believing that prices were determined by utility and also emphasised the critical role of the entrepreneur in the economy. However, neither of those observations became accepted by British economists at the time. Malthus wrote An Essay on the Principle of Population in 1798, becoming a major influence on classical liberalism. Malthus claimed that population growth would outstrip food production because the population grew geometrically while food production grew arithmetically. As people were provided with food, they would reproduce until their growth outstripped the food supply. Nature would then provide a check to growth in the forms of vice and misery. No gains in income could prevent this, and any welfare for the poor would be self-defeating. The poor were, in fact, responsible for their problems which could have been avoided through self-restraint.

Several liberals, including Adam Smith and Richard Cobden, argued that the free exchange of goods between nations would lead to world peace. Smith argued that as societies progressed, the spoils of war would rise, but the costs of war would rise further, making war difficult and costly for industrialised nations. Cobden believed that military expenditures worsened the state's welfare and benefited a small but concentrated elite minority, combining his Little Englander beliefs with opposition to the economic restrictions of mercantilist policies. To Cobden and many classical liberals, those who advocated peace must also advocate free markets.

Utilitarianism was seen as a political justification for implementing economic liberalism by British governments, an idea dominating economic policy from the 1840s. Although utilitarianism prompted legislative and administrative reform, and John Stuart Mill's later writings foreshadowed the welfare state, it was mainly used as a premise for a laissez-faire approach. The central concept of utilitarianism, developed by Jeremy Bentham, was that public policy should seek to provide "the greatest happiness of the greatest number". While this could be interpreted as a justification for state action to reduce poverty, it was used by classical liberals to justify inaction with the argument that the net benefit to all individuals would be higher. His philosophy proved highly influential on government policy and led to increased Benthamite attempts at government social control, including Robert Peel 's Metropolitan Police, prison reforms, the workhouses and asylums for the mentally ill.