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Full Employment and Laissez-Faire

As a consequence of their faith in Say's Law and the flexibility of wages and prices, the classical economists viewed full employment as the normal situation. They held this belief in spite of recurring periods of observed unemployment. By the mid-1800s, economists recognized that capitalist economies tend to expand over time but not at a steady rate. Instead, output and employment fluctuate up and down, growing rapidly in some periods and more slowly, or even declining, in others. Today we call these recurring ups and downs in the level of economic activity the business cycle. A period of rising output and employment is called an expansion; a period of declining output and employment is called a recession.

The occasional bouts of unemployment that accompanied the recession stage of the business cycle were not, however, viewed with alarm or seen as contradicting the classical model. Instead, such unemployment was attributed to external shocks (wars and natural disasters, for example) or to changes in consumer preferences.

[1] Because the economy required time to adjust to these events, there might be some unemployment in the interim. But such unemployment would be very short-term; it could not persist. Prolonged unemployment would result only if workers' unreasonable wage demands made it unprofitable for firms to hire them. Such unemployment was considered "voluntary"; that is, at the prevailing wage, the people preferred leisure to work. Because prolonged unemployment was regarded as an impossibility and short-term unemployment not deemed a significant social problem, the classical economists focused their energies elsewhere, on studying microeconomic issues and attempting to understand the forces underlying an economy's long-term rate of economic growth (the growth rate of potential GDP).

The classical theorists' belief in the economy's ability to maintain full employment through its own internal mechanisms caused them to favor a policy of laissez-faire, or government by nonintervention. Society was advised to rely on the market mechanism to take care of the economy and to limit the role of government to the areas where it could make a positive contribution—maintaining law and order and providing for the national defense, for example.

  • [1] Because the classical economists believed that supply created its own demand, they did not believe that it was possible to have a general surplus of goods and services throughout the economy. They recognized, however, that there could be an oversupply of individual products. For example, automobile manufacturers might miscalculate and produce too many automobiles for the prevailing market. In the short run this would result in unsold inventories and unemployment: The current number of workers could no longer be profitably employed by the automobile industry. In the long run, however, both problems would be eliminated. The surplus of automobiles would cause their prices to fall, which would shift labor and other economic resources out of the automobile industry and into some other industry, one characterized by shortages and rising prices.
 
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