The fatal inconsistency within neoliberalism

The collapse of Carillion had some important implications for public sector outsourcing, as I discussed here, but I tend to agree with Will Hutton that the real lessons lie elsewhere. He writes

“While some public sector delivery is outstanding, notably in parts of the NHS, the general pattern is more patchy. It is for this reason that governments for decades have been contracting the private sector to deliver goods and services. Trying to extend that principle is not unreasonable if high-quality private sector partners step up to the mark: the problem is they are in such short supply.”

In other words the problem is not so much with outsourcing, if sensibly done by a government that does not automatically think private is best and a civil services able to write good contracts and effectively monitor quality. The problem is with the poor quality of so much British capitalism. Carillion is not just one bad apple, of course: this is a lesson that should have been learned from the financial crisis, and RBS in particular,

But how can that be, when the market ensures that only the most efficient firms survive? That idea, that the market ensures that only the most efficient prosper, is a central message of neoliberal ideology, and it has held UK and US governments under its sway since the time of Thatcher and Reagan. But that ideology contains a large and deep internal contradiction, which applies particularly to large firms like Carillion. To see what that contraction is, we need to talk about ordoliberalism and Ronald Coase.

Ordoliberalism is widely known as the German version of neoliberalism. It too celebrates the benefits of the market. It, like neoliberalism, ignores many of the failures of markets that Colin Crouch eloquently outlines and which economists spend a lot of time studying. But ordoliberalism does recognise one potential problem with their market ideal which neoliberalism ignores, and that is monopoly. Crouch makes a similar distinction in talking about market-neoliberals and corporate-neoliberals.

This distinction is important for reasons that go way beyond the textbook problem with monopoly: that prices are too high and output is too low. To see why it goes beyond that we need to turn to Ronald Coase. He was a British economist who subsequently worked at Chicago. His first major article was "The Nature of the Firm" written in 1937 which introduced the concept of transaction costs to explain the nature and limits of firms. The key point that Coase made relevant for our discussion is that, in theory, much of what firms do could instead be done by markets. For a non-economist this probably sounds strange, so I will briefly try and explain the idea.

In principle the activities of any firm could be duplicated by all its employees, including managers, becoming self employed. The worker who worked for a firm would become a self employed person who signed a contract with the self-employed manager. Furthermore, the self employed manager would not have to work with a fixed set of self employed workers, but for each task they could create a market for the task which any self employed person could bid to fulfil.

Coase asked why we have firms rather than this more market based setup. His answer is transactions costs. A typical worker employed in a firm has to do whatever (within reason) a manager asks them to do. This can vary, often at very short notice, depending on the needs of the firm. Replacing this with a large number of specific short term contracts would be very inefficient, because it takes time to write and read contracts (transactions costs). You could add search costs and many other costs that make the self employed contracting model normally inefficient.

You can see exactly these tensions, between the advantage of the market versus internalising activities within a firm, played out when a firm decides to outsource any of its activities. But these tensions have a darker side. To what extent have firms internalised the market so that they can exploit customers (traditional monopoly), exploit workers (if one large firm is the only potential employer for many workers i.e. monopsony), or as a vehicle for managers to exploit shareholders.

There are two paths you can travel once you recognise all this. The first, and more ordoliberal, is to distrust monopoly of any kind, and be highly skeptical of large firms and their creation through mergers. The second is to assume that firms are always right, and that large firms exist simply because they are more efficient at doing what they do than the same firm broken up. Given the darker side mentioned above, there is no logical reason to take the second path. Skepticism about large firms is the right path to take. The second path, where you presume that there are always good reasons why large firms exist, makes no logical sense, unless your goal is for whatever reason to defend these large firms. It is the path that neoliberalism took.

Will Davies has a fascinating paper 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 under the influence, among others, of the work of Ronald Coase. It shows how many of the leading actors during that period chose the second path. Economics is rich enough that, if they so wish, an economist can always invent reasons why monopolies might be efficient, and so earn lucrative fees for so doing.

Thus neoliberalism that might have started as extolling the virtues of the market ends up as “a consultancy racket, in which corporations purchase complex models to justify their chosen strategy”, to quote Will Davies more recently. This is what I meant when I wrote back in 2016.

“It is important that those who use the term neoliberalism today recognise this contradiction. It does not mean that using the term neoliberalism to describe the dominant ideology is wrong, but it is a mistake to assume the ideology has not be moulded/adapted/distorted by those in whose interest it works. These changes have made it intellectually weak at the same time as making it politically strong.”

There are important mistakes that those opposing neoliberalism can make if they do not see this point. They involve opposing anything your opponent appears to favour. Thus, for example, because neoliberals preach the virtues of the market but in practice are normally simply pro-business, this does not mean that you should always oppose markets: you can be pro-market and anti-neoliberal. More generally, just because neoliberals can use ideas from economics to argue their case does not mean there is something wrong with economics (as opposed to some economists). Louis Zingales, from Chicago, exemplifies both points, and is not afraid to make the distinction between pro-market and pro-business in public.

This is all related to the distinction between ideas and interests. While it is right to recognise that interests are to some extent based on ideas, it is also important to see that ideas can change in time to reflect interests. How an ideology based on seeing markets through rose colored spectacles turned into an ideology justifying crony capitalism is at least part of the story of neoliberalism. These compromises with power allowed the ideology to become dominant, but at the same time it also made it rather easy for it to be subverted by different kinds of plutocracies, such as those represented by Brexit and Trump.

Neoliberalism, Mirowski and me

Philip Mirowski is a historian who has written a great deal about both the history of economics as a discipline and about neoliberalism. He knows much more about the history of both subjects than I do. I was therefore somewhat dismayed that, in responding to some comments on his 2014 paper “The Political Movement that Dared not Speak its own Name: The Neoliberal Thought Collective Under Erasure” (pdf), he chose to start by making some comments on my recent blog post discussing neoliberalism.

He didn’t like it, for two main reasons. First, he disagrees with my definition. I have no problem with that, because I would never have the nerve to try and offer a definitive summary of the term. As I wrote in that post, I was just saying what I mean by the term when I use it. I’ll come to why he thinks that it was - to use his own words - ‘untutored’ later.

The second “more glaring error is to counterpose the beliefs of orthodox economists, who judiciously accept or reject various doctrines on the basis of their empirical relevance without bias, to those of the Neoliberals, grounded as they are in an impetuous ‘ideology.” In particular, he takes objection to my suggestion that economics can be used to critique neoliberal ideology. Here unfortunately there seems to be little correlation between his criticism and what I actually wrote.

He suggests that what he calls the ‘Neoliberal Thought Collective’ (NTC) has many more representatives in the economics profession than I could imagine. But how does he know what I imagine? At no point do I say that all economists are free of neoliberal ideology, and in the past I have argued exactly the opposite. But the fact that some economists might be neoliberal in outlook does not mean that economics cannot be used to critique neoliberalism. It is a category error that anyone who understood economics should not make. More on this below.

He also rather oddly says that I provide no example of how economics can be used in such a critique. It is odd because I give an example in the post. What he might be suggesting is that this actual/potential critique has not been effective politically, but that is something very different. It may just reflect that economists tend to be ignored when what they say is inconvenient, which is something I have talked about elsewhere.

Having said all that, in a tit for tat style, let me revert to Daniel Dennett’s rules, and say that I actually agree with some key points from Mirowski’s paper referenced above. First, we both agree that neoliberalism exists! Second, one of the key points I wanted to make in my post was that neoliberalism was not the same as mainstream economics. On page 8 of the paper he writes: “First, and this cannot be stressed enough, however much they sound alike, Neoliberalism and neoclassical economics are two completely different schools of thought.”

The way he sometimes describes it the NTC can sound like a great conspiracy, but another way of putting it would be to say that many neoliberal thinkers see themselves as part of a very political project. That is a third area of agreement: in my post I described it as a political movement or ideology. Fourth, I also agree that the lack of any self-identified group calling themselves neoliberal is not an issue.

What about definitions. In the paper (page 22) he outlines 11 ideas that the NTC believes in. I suspect one problem he had with my short definition (“hates ‘big’ government, dislikes any form of market interference by the state, favours business interests and opposes organised labour.”) is that it sounds libertarian. But I put ‘big’ in inverted commas for precisely that reason: neoliberals can be quite happy to use state power to achieve their objectives. They are not libertarian, which is a fifth point we agree on.

I have no wish to argue with his 11 statements, partly because I do not see neoliberalism as being particularly “coherent and consistent”. If there is a difference of emphasis between us, it is that he stresses support for the market and I stress dislike of the state interfering in (or undertaking what could be) market activities. One reason I would give for this difference is the corporation itself. It is possible (although not desirable, for reasons outlined many years ago by Ronald Coase) to set up ‘internal markets’ within corporations, or even break up corporations into a set of markets activities. This is not part of the neoliberal agenda: item (9) of his list of neoliberal beliefs is “Corporations can do no wrong—by definition.”

Another reason may be more personal, and that is austerity. Once you use basic macroeconomic theory (theory which Mirowski describes in his response as “just a sequence of faddish enthusiasms”) to see why the various reasons used to justify austerity make no sense, you are left with two explanations for why neoliberals would want to champion it. One is a dislike of the idea that state action might be needed to ‘mend’ the market, and the other is what I call ‘deficit deceit’: using austerity to shrink the state. At least a majority of academic macroeconomists, and possibly a clear majority, now view 2010 austerity outside the Eurozone periphery as a mistake, which does not fit well with the idea that economists are part of the heartland of the NTC?

Austerity is an example of where economics is really important to any critique of neoliberalism. It is here where I fundamentally disagree with Mirowski. Indeed, it is difficult for me to see how any effective critique of neoliberalism could not be based at least in part on economics. Take Mirowski’s second neoliberal belief: " “The market” is an information processor, and the most efficient one possible—more efficient than any government or any single human ever could be." Any economist should distinguish between an ideal market and any actual market. An important part of economics involves outlining the conditions under which markets are ideal in organising exchange, and the consequences of any departures from that ideal. That distinction is something an ordoliberal would recognise (at least in the case of the degree of competition/monopoly), but is generally ignored by neoliberals.

So if you want to analyse, for example, why setting up internal markets in the NHS, or privatising NHS activities, might or might not work, you need economics to understand when markets work well and when they do not. They might not work well, for example, if information about quality is difficult to obtain. (Economics is not the only discipline you would require: you would want to talk about motivations, and how a market ethos can damage shared goals, for example.) More generally the idea that you can critique an ideology which puts such faith in all markets without using the discipline that studies market efficiency seems strange to me.

Another example concerns the minimum wage. The neoliberal view would be that this a bad policy which will only reduce employment. It is economists who have both gathered the evidence and developed the theory to show otherwise. If economists were hopelessly embroiled in the NTC, why would this happen? I’m not arguing that it is not possible for economists to be influenced by neoliberal or ordoliberal ideology (the apparent opposition of most economists to the introduction of the minimum wage in Germany might be a case in point), but just that it has not happened to the extent Mirowski imagines, and it certainly has not become embedded in economic theory. When he says at the end of his response here that “it seems likely that opposition to neoliberalism will not arise from within modern economics, either” he almost has to be wrong.

Let me end with the example I gave in my original post and he appeared to ignore: capital requirements for banks. A substantial increase in capital requirements is a simple way of avoiding another financial crisis, and furthermore, because of its simplicity, a way that can hope to survive against relentless political pressure from banks. That the idea makes sense in terms of basic theory means that even economists like John Cochrane support it. In his time at All Souls in Oxford he would certainly have talked to the economist who has recently been pretty vocal in his calls for higher capital requirements in the UK. Mirowski overestimates the extent to which neoliberal ideas have become “embedded in economic theory”, and underestimates the power that economic theory and evidence can have over even those academic economists who might have a neoliberal disposition. If the tide of neoliberal thought is going to be turned back, economics is going to be important in making that happen.