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The market knows best. That's the core of the term laissez-faire. In an economy in which millions of people make billions of daily choices about their needs, wants and rational self-interest, a government can't bring order to that productive chaos any more than it can regulate a person's love life. This is how the philosophy goes. It believes that the best way ensure widespread prosperity is to step as far back as possible and let consumers make the right decisions for themselves.

But, still, many believe that capitalism needs some rules. After all, not everyone in an economy has the resources to pursue her own self-interest, and an unregulated marketplace is prone to manipulation, monopoly and robber barons. Effective regulation is used as a tool to prevent against those ills and help an economy reward a majority of citizens rather than just a privileged few.

These opposing views often clash with and, at times, complement, each other in modern economies: Welcome to the debate around laissez-faire economics.

What Is Laissez-Faire Economics?

Laissez-faire, a French term that roughly translates to "leave it alone," is a capitalist economic theory that argues that government should regulate the marketplace as little as possible. Market decisions are best made by workers, consumers and capitalists on an individual level without outside interference. This will let businesses grow with freedom, which in turn will lead to more prosperity for all.

When it comes to economic activity governments should, per the phrase, leave businesses and individuals alone.

The theory dates back to 18th Century France -- possibly even earlier -- but became most prominent when it was embraced and developed by the British economist John Stuart Mill and Scottish philosopher and economist Adam Smith. Considering that Smith is known as the Father of Modern Economics, his thoughts on this subject have had quite a lot of influence.

Laissez-faire dominated western economic thought during most of the 18th and 19th centuries, most notably during the Industrial Revolution. In the United States it reached its peak during the 1930s in a time known as the Lochner Era, named after a landmark Supreme Court case. It waned after that, but saw a resurgence among the political right during the mid- and late-20th century as a contrast with state-focused theories of socialism and communism.

Laissez-Faire Economics in Practice

The core of laissez-faire economics is non-intervention in finance, consumption and private contracts.

A laissez-faire state will focus instead on providing law, order and public safety. It will enforce contracts and arbitrate disputes, believing that a stable business environment depends on functioning courts. This government will also provide services like an army, police forces and fire fighting, since property protection and physical safety are also necessary to create wealth.

Beyond this, laissez-faire economic principles argue that a "natural economic order" or "natural state" should and will govern the marketplace.

Proponents argue that each individual is a fully empowered, rational economic actor. As long as the government leaves the market alone, consumers and workers will naturally make the best choices for their own, individual self-interest. In the aggregate this will lead to everyone pursuing their maximum benefit, which in turn will create the most wealth and public good.

Regulation, under this theory, can only interfere with that process. Whenever the government intervenes in any transaction it will prevent one or both parties from pursuing their best self-interest. This will, in turn, leave one or both parties at a loss compared to where they could have been if the government had simply stayed out. Even if the government's interference made one party wealthier (say, in the case of minimum wage laws) the harm is still disproportionate to any possible good.

As a result, laissez-faire economic ideals reject almost all forms of market regulation such as minimum wages, safety standards, working hours, environmental restrictions and taxes. This theory sees workplace regulation as an interference with the freedom of contract between a worker and a boss. If someone doesn't pay staff adequately, the workers can quit.

It sees product oversight, such as food inspections or seat belt requirements, as best solved through consumer choice. If you make a bad product, the market should put you out of business, not the government. If people want to buy a bad product, that's their business.

Most of all, it simply sees government regulation and oversight as an imposition on individual freedom and any imposition on individual freedom as necessarily counter-productive.

The Flaw of Laissez-Faire Economics

Strict adherence to laissez-faire economic principles has largely been abandoned by all developed nations.

The main criticism of laissez-faire economics is, ultimately, that it relies on a flawed premise. This theory only works as a basis for widespread prosperity if each individual in an economy actually is an equally empowered, individual actor capable of pursuing his own self-interest.

In reality, say critics of the theory, is that a capitalist system disproportionately empowers people with greater wealth. The more money someone has, the more freedom she has to reject a bad employment contract or choose a higher quality product. These are not freedoms enjoyed by those without means.

Further, an unregulated marketplace typically rewards anti-competitive behavior, crippling the very freedom of choice at the heart of laissez-faire economic theory. Under these conditions the average individual can't pursue the rational self-interest that laissez-faire economists claim will bring about widespread prosperity, say critics. Instead, workers and consumers are often forced into making choices against their best interest because all other options have been eliminated.

The best way to look at this is through example:

Employment and hiring

Laissez-faire economics argues that regulating work hours, with an eight-hour workday and a mandatory weekend, interferes with freedom of contract. If an individual worker wants a better schedule, he should be free to find an employer willing to give one to him.

In reality, individual workers typically have no such bargaining power. The terms of employment for almost all workplaces are set by the employer in a no-negotiation agreement known as an "adhesion contract." This is mainly because the two parties in an employment contract have vastly different stakes. Workers who walk away from a job may risk their livelihood. An employer may only risk its expected expense of staffing.

Anyone who thinks that workers should simply bargain for a shorter workweek has never applied for a job at Wal-Mart… or even as a corporate attorney ... say opponents of the laissez-faire approach.

Product choice

Laissez-faire economic philosophy argues that regulating the marketplace interferes with freedom of consumer choice. The best way to ensure low prices and quality products is to allow companies to freely compete for consumer dollars in an open marketplace.

In reality, this leads to price fixing and monopolization, say critics. Indeed, many companies in 19th century America quickly figured out that the best way to ensure higher profits was to limit consumer choice as much as possible, either by forming cartels or controlling the marketplace or by simply consolidating an entire market into one company. In either case, this practice eliminates the possibility of choice-driven competition as a natural form of regulation by eliminating all such competition.

Both of these examples demonstrate the core flaw of laissez-faire thinking, say its critics: Actors within a marketplace are not all equally empowered. Opponents argue that often individuals can't pursue their rational self-interest because, without adequate regulation, it is quite possible for no such choices to exist.

Laissez-Faire and the Tragedy of the Commons

The other problem with laissez-faire economics, say critics, is that it does not address collective action problems. This is most typically expressed as the tragedy of the commons.

In a hypothetical village (this example dates back to 1832 England) there is a wide grassy area shared by all the villagers called a commons. Shepherds graze their sheep on this commons, because it is free grazing land.

In theory this works well for everyone. The shepherds don't have to pay for land on which to graze and, as a result, the villagers get cheaper mutton and wool. In reality, as observed by Oxford economist William Forster Lloyd, commons are typically destroyed.

The reason is market incentive. The shepherds in this example share a limited supply of grass, because if it is eaten too fast the land will die and go fallow. But each has an unlimited potential for consumption, because each can keep growing her flock as it eats more.

The result is that, for each shepherd, any amount of grass that her sheep don't eat is a wasted resource. Worse, it will only serve to enrich her competition. And each shepherd knows this. So her incentive is to let her flock eat as much of the free grass as possible to maximize her gains and limit the amount left over for the other shepherds.

The end result of this process is that each shepherd has her flock eat the grass as quickly as possible, leading them to ultimately destroy the commons. One may argue that a more modern, and quite stark, example of this the story of the Aral Sea.

An unregulated marketplace has no mechanism to deal with collective action problems, argue critics of laissez-faire. Of course, proponents of the philosophy would disagree.