Winner of the New Statesman SPERI Prize in Political Economy 2016

Tuesday 15 August 2023

Economics and neoliberalism


In an idle moment I was reading through the Stanford Encyclopedia of Philosophy, as one does, I came across this paragraph from Kevin Vallier’s entry on neoliberalism:

“One is on better ground arguing that neoliberalism is a twentieth century revival of classical liberal ideas in response to certain unique twentieth century challenges. Neoliberalism arose in the late 1940s as a response to three twentieth century ideologies that advocated large states: communism (as the most prominent form of socialism), fascism, and social democracy. Neoliberals sought to confine state power to a range of functions much more limited than that undertaken by extensive states of these three varieties. Hayek’s work on informational systems was a response to communist central planning. Friedman’s monetarism was a response to Keynesian macroeconomic policy. And Buchanan’s public-choice research program was a response to the economics of general equilibrium and market failure economics.”

I’m too untutored to comment on the first sentence, but I found the rest interesting because I have always argued that one of the best ways to critique neoliberalism is by using academic economics. [1] Here I wrote:

“Indeed, it is difficult for me to see how any effective critique of neoliberalism could not be based at least in part on economics”

I think many on the left would find this idea strange, because they often see neoliberalism as being in part derived from what they often call ‘neoclassical economics’. This is where the paragraph from Vallier comes in. The authors he quotes were involved in two simultaneous projects. One was to argue within economics itself, and the other was to use economic ideas in their more political writing. They were very successful at both, but there are important limits to that success within economics. If you look at current academic economics, Friedman largely failed in his attempt to discredit Keynesian macroeconomic policy (see below). [2]. While public choice theory has been very successful in taking economic methods into political science, it has not stopped economists talking a great deal about market failure and how the state can intervene in the market to deal with that failure.

As a result, academic economics is very different from the economics neoliberal proponents like to talk about. I have sometimes joked that neoliberal interpretations of economics are what you might get from attending a first year course on economics and missing half the lectures. Yet because economic ideas are very powerful, a selective use of that theory can be pretty persuasive, and the individuals like Hayek or Friedman were very good at doing just that. But because they were selective in order to persuade, their ideas become very vulnerable to a more general use of economic theory and evidence.

The most obvious example concerns the market itself. While economists will stress the efficiency advantages of exchange through markets, they are also experts on how and why markets fail to produce an efficient outcome, and how the state can best intervene to deal with those failures. A classic example is externalities like pollution. And while efficiency [3] is good to have, that does not mean that the resulting allocation is optimal from a social perspective, and much of public economics and plenty of macro is about looking at social welfare.

Discussions of neoliberalism as an ideology or set of political ideas generally focus on the primacy of markets as a central idea. But it may be a mistake to take what neoliberals say about markets as true of actual markets. One of the most egregious examples of this is justifying CEO pay as being ‘determined by the market’, when in reality CEO pay is generally fixed by a committee of board members and external CEOs. What is the difference between this and having wages fixed by a commission set up by government? Yet few would describe public sector wages set by public sector review bodies as determined by the market.

Colin Crouch in a very interesting book defined neoliberalism as “a political strategy that seeks to make as much of our lives as possible conform to the economist’s ideal of a free market” Yet economist’s ideal of a free market (an efficient market discussed above) requires ‘perfect competition’, which means that there are very many producers, none of whom has the power to set prices. Yet neoliberals (unlike ordoliberals) seem very relaxed about monopoly power when it comes to firms. [4] In contrast neoliberals are happy to attack monopoly power when it comes to workers and unions, but this is a classic example of a selective use of ideas from economics. Crouch recognises this by talking about market-neoliberals and corporate-neoliberals, but I think this exposes rather than resolves the problem. 

Perhaps neoliberals like to stress markets because a key part of any market are the corporations or companies that produce goods, and they want to support the interests of these corporations or companies relative to the interests of both workers and the state. I have argued that a better way to describe neoliberalism in practice (policies pursued in the US and UK by Reagan and Thatcher and subsequent governments) is that neoliberalism uses concepts from economics to promote the interests of capital (corporations and companies). 

Take privatisation for example. While in some cases privatisation did introduce competition (and therefore the idea of a competitive market), others did not. The water industry, for example, remains very close to the economist’s definition of a natural monopoly where competition is impossible. There is no market where different firms compete to sell consumers water, but just a single provider that sends out bills every quarter, which is exactly what happened when water companies were publicly owned.

What a privatised water industry introduces that a nationalised water industry does not have is profit maximisation designed to provide dividends to shareholders. So neoliberals will extol the virtues of profit maximisation as ensuring efficient production. It sounds like using economics to justify privatisation, but again it’s selective. In a monopoly a profit maximising firm will set prices too high, and for the same reason may invest too little. That is why privatisation is typically coupled with an industry regulator, but regulatory agencies can easily be captured, so the net effect on efficiency of privatisation is unclear. So privatisation of natural monopolies is not about creating markets, or using economics in an impartial way, but instead selectively applying particular economic ideas to create new private capital.

Another aspect of neoliberalism in practice, reducing taxes on the wealthy, is even more interesting in this respect. Again, this has nothing to do with markets, but involves the selective use of bits of economics to pursue political ends. The standard justification for reducing taxes is that it increases incentives to supply labour, but that applies to the worker on the shop floor as much as the CEO. Both are ‘wealth creators’. To use economic jargon, all taxes are distortionary (reduce efficiency), not just those on high incomes.

This example is particularly interesting because, as Vallier notes, what is called ‘trickle down economics’ is not part of the neoliberalism of Hayek or Friedman. Nor is it obviously in the interests of corporations or companies as entities, because lower top rate taxes do not help increase profits. Indeed one theory about why CEO pay is so high is that it is the result of low top rate taxes (see here), and high CEO pay represents a (small) deduction from profits.

The distinction between capital (in the form of companies or corporations) and the wealthy (CEOs or shareholders) may seem pedantic, but I would argue it becomes central to the development of neoliberalism. Although some on the left like to call the governments of Johnson or Trump neoliberal, they are not like the neoliberalism of Thatcher or Reagan. Thatcher helped create the EU’s single market because this benefited UK capital involved in international trade, but Johnson by promoting Brexit did the opposite, because he was backed by very wealthy individuals (especially newspaper owners) who had their own individual interest in leaving the EU. Free trade and free movement of labour benefits capital, but Trump attacked both.

Ironically I think you can use arguments often associated with Buchanan to explain this apparent paradox. Buchanan wanted to suggest that the state would not be able to successfully correct market failures because of the incentives individual politicians faced would lead them to depart from the public interest. But in principle the same can happen to politicians who start off wanting to promote the interests of capital, but find the incentives they face (through donations from wealthy individuals or pressure from newspaper owners) lead them to promote policies that act against the interests of capital. It is why some neoliberals could pretend to themselves that Brexit was a good idea by imagining that labour or environmental regulations were more onerous to firms in general than the red tape associated with trade under Brexit. It was nonsense, but the incentives they faced pushed them in that direction.

Even if I have convinced you that academic economics can be a very effective tool for critiquing ideologies such as neoliberalism [5], this has an obvious downside, which is that academic economics can in turn be influenced by, and in some cases distorted by, ideologies. How do those outside academic economics know to what extent this continues in academic economics today? What stops ideology permanently influencing academic economics is evidence. Economics in academia, more now than perhaps ever before, is an evidence based discipline. So it is appropriate that in assessing the influence of ideology on mainstream academic economics we look at the evidence.

As I have already mentioned, Friedman’s arguments against Keynesian fine tuning never had widespread academic support, and have very little now. Across the globe central banks move interest rates month by month in an attempt to regulate the business cycle. [6] As I have also noted, many academics study market failure. Another example was austerity, which was opposed by the majority of academics, a majority that came close to a consensus as the evidence came in. On the left, many economists in the 60s and 70s argued maintaining very low unemployment was essential, and prices and incomes policies should be used to contain inflation. Once again, evidence was not on their side, and that approach lost favour among economists.

A response I often get when I make these arguments is why do we hear so much from economists that support right wing policies. The answer to that is straightforward: just look at who controls the means of information. Few people would argue that medicine was ideologically biased because we heard so many medics in the media arguing against lockdowns. Equally the media chooses among academic economists based on the ideas they want to see promoted, and not on whether they represent the academic consensus, as Brexit clearly showed.

[1] That critique is unlikely to be complete, as economic theory has its limitations, such as its focus on individual behaviour.

[2] The New Classical Counter Revolution was a more successful attack on Keynesian policy, for reasons I discussed here. It too proved temporary.

[3] An efficient outcome is pareto optimal, which means no individual’s position can be improved without harming someone else. Pareto optimal allocations can also be very unfair.

[4] I note here Will Davies’s account of how ideas about the virtues of competition, and the need to break up monopolies, changed within the University of Chicago from the 1930s until the 1980s.

[5] Needless to say it can also do the same for left wing ideologies.

[6] This is fine tuning aggregate demand. The fact that central banks use interest rates while the Keynesians of post-WWII period used fiscal policy is, in my view, of secondary importance here.

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