It is noteworthy that during the latter half of the 18th century, theory about the development and nature of political economy was the most favored subject by social scientists, especially those who were concerned with the close association of the economy and the state. Among these social scientists were Karl Marx, David Ricardo, Max Weber, and Adam Smith. These theorists belonged to different schools of thought, and hence considerably differed both in theoretical formulations as well as predictability models.
Below, we shall discuss some of the schools that have a direct impact in the development of the study of political economy. There are generally three schools of thought in the study of political economy: 1) Liberalism, 2) Realism, and 3) Historical Structuralism. Here we shall tackle only one major theoretical perspective (including their strands) that is being widely used by many countries as a practical guide to their economic policies. It is liberalism. Liberalism was borne out of the economic disorientations of the mercantilist system.
In this type of system, a country (European power) had to expand overseas in order to establish colonies. The colonies would serve as sources of raw materials (for production) as well as items of trade for the “mother” country. The colonies were not allowed to trade with countries other than the “mother” country. In this system, the mother country could preserve its comparative advantage with other countries (the products that it has only the capability to produce). For example, if the colony had large deposits of precious metals, the mother country could use it to finance trade deficits or to increase its wealth.
Added to that, in this type of system, precious metals, not efficiency is the operating mechanism for economic and political development. This assumption was challenged by French social theorists. Many of these theorists believed that the economy should be left open, laissez-faire. The state should not intervene in the workings of the market; price and wage controls would be unnecessary because the market itself is a self-adjusting machine. Doing otherwise would severely cause prices of basic goods to skyrocket, encourage economic recessions and worst heighten rebellions.
Adam Smith expanded the laissez-faire concept and added the concept of the “invisible hand” (Smith, 1904:430) According to him, the market is a place of exchange between seller and buyers. The primary aspiration of sellers is to increase their net profit; the primary goal of buyers is to procure goods/services at the lowest possible prices. Higher prices would be good for the seller and “bad” for the buyer, and hence when they engaged in an economic transaction, a negotiation of prices occurs. Both the seller and buyer would concede some portions of their income/savings, and stuck to a price that would both benefit them.
Hence because of the self-interests of both the sellers and buyers, the market could efficiently work, that is, being able to distribute goods/services at just prices to the consuming public. The market therefore is the “invisible hand” because its actions are hidden from the eyes of both the seller and buyer. Hence the fundamental assertions of liberalism are as follows: 1) there is a central concern on individual freedoms, 2) the role of the state is to protect individual rights and freedom from others, and 3) the state should be the servant of the collective will and hence could be done by establishing democratic institutions.
Liberalism does not explain the nature of war and peace though it is influential in explaining the nature of political economy (especially those that concern the relationship of consumers and firms, government and firms, competition and restraint, and optimization and underutilization of resources – the goal is efficiency and cost-minimization).