neoliberalism – thinking liberal

The unravelling of neoliberalism brings economic hardship

The economic reforms in China led by Deng Xiaoping were central to the neoliberal project. Picture by Brücke-Osteuropa – Own work, Public Domain, https://commons.wikimedia.org/w/index.php?curid=8341309

Distracted by the war in Ukraine, and then a holiday, I have not commented on economics for quite a while. And yet economic developments over the last few months have been dramatic. Inflation, long dormant in the developed world, is rising after more than two decades of quiescence; growth is stalling. The expected bounce-back from the covid-19 pandemic is not happening. Given my longer period of silence on this, I am going to take a longer perspective than usual.

One of the most striking things about the politics of the last decade or so is the backlash against the global economic liberalisation of the 1990s and early 2000s. The left labels this liberalisation as “neoliberalism”, the right prefers “globalisation”. Both lay all society’s ills at its door (perhaps that’s not fair on the right, some of whom add “wokeism” to the world’s evils). The left emphasises rising inequality within countries, with the rise of a fabulously rich elite while many struggle to make ends meet. The right would rather emphasis the dislocation of working class communities and values as economic change takes it toll, and especially the movement of peoples and the consequent mixing of cultures. Both have a point. But they overlook the many benefits that global liberalisation has brought. There has been an unprecedented closing of the gap between rich and poor nations, as countries like China and India exploit the opportunities of global trade. Developed countries have experienced a flexibility of supply that has ensured the stability of prices, and eased the process of technological development which in turn has has brought the world mobile phones and much else that has transformed life in so many ways. Along with these came an assumption of perpetual economic growth.

But now the liberalisation is going into reverse. We can take Russia’s war on Ukraine an extreme result of this – it is part of Russia’s rejection of globalisation in a search for national identity, sovereignty and prestige. But the signs are everywhere: America’s trade wars with China and Britain’s rejection of the European Union are but two examples. Just to show that this is trend is global we can add China’s extreme policies to fight the pandemic, which involve its physical isolation, as another case in point. The inflation crisis is one result. Economic policy makers are dealing with unfamiliar problems. Flexibility of global supply chains had been hard-wired into the way they viewed the world. Interest rates were kept low; many countries exploited the ease with which government budget deficits could be maintained. There was almost no such thing as fiscal or monetary policy being too loose, as global supply could respond to almost any level of domestic demand, or so it seemed. Now this comfortable world is gone. Policymakers must now manage think about the sustainability of supply alongside the level of supply. Retrenchment of some sort, though higher interest rates or tighter fiscal policy, looks inevitable.

The first thing to understand about all this is that the ending of the era of globalisation is not just the result of a political backlash. It follows a change of global economic conditions. The most important, and yet least acknowledged, is global convergence. Behind the success of globalisation was a huge global opportunity. In Asia vast numbers of people were engaged in massively unproductive agricultural activity. As these people were moved to more productive activities, especially in manufacturing, world productivity advanced. Japan led the way, followed by South Korea, Taiwan and others, but China’s impact has dwarfed all of these – indeed Deng Xioaping’s application of neoliberalism with Chinese characteristics has been more transformative of the world economy than any single Western country’s policies. Global trade was essential to making all this happen, as the developing economies were able to export surplus production, and developed economies experienced the benefits of cheap imports as a result. But this is largely played out. The main population shifts in China and East Asia have happened, and these countries are experiencing a demographic transition too, as population growth goes into reverse. Other less developed economies have potential (notably South Asia and Africa), but the gains here are harder to unlock, and must be spread more widely, now that there are many more developed economies. The potential gains from global trade, at least for fully developed economies, as well as China’s, have diminished drastically.

Other trends can be added to this. Demographic change in the developed world and China is widely acknowledged, even if its full consequences are rarely given due weight. There are other factors, which I have talked about in this blog. The saturation effect of developed economies, as a growing proportion of spending moves from fulfilling physical needs to status goods, and the not unrelated Baumol effect as a growing share of economic activity moves into activities that are not susceptible to productivity gains. The overall conclusion is clear: economic growth, in the way that we have generally understood it, is over. That is not to say that wellbeing cannot be improved and poverty reduced – but doing so will require much more attention to the distributional effects of policies, and much of the achievement will be through “soft” quality of life effects, rather than increased individual consumption.

But we can’t abandon economic liberalism. Economic efficiency is still important. In fact it is more important than ever as we need to make the most out limited resources. In many contexts the efficiency of the market economy and private capital cannot be improved on. We still need capitalism, but it has to be better managed. Meanwhile the challenges posed by environmental change and demography mean that society must endure more disruption, of the sort that many on the right will resist. Immigration into developed countries remains necessary; we must reduce our carbon footprint by reducing car use and building wind farms in our backyards.

But liberals must face up to a number of challenges. Firstly monopoly capitalism and excessive corporate power must be confronted and managed. Second, excessive levels of wealth and income must be taxed and redistributed. This requires more international cooperation, especially around the closing of tax havens, and pushing the boundaries of privacy rights. Third, the pubic sector must be better managed, with solutions tailored to individual people rather than being the subject of organisational empires. This implies more devolved decision-taking in the public realm, but within a culture of openness and adherence to the rule of law to keep corruption at bay. And fourth we need more democracy – not just voting but meaningful public engagement and consultation – especially at a local level. All of these things run counter to the model of neoliberalism developed in the 1980s and dominant in the following decades in the West. There is a growing common ground between liberals and socialists, though movement is required by the latter too if this is to work.

The era of neoliberalism brought huge economic benefits, and the world is missing them now that era is over, even if neoliberalism brought many problems with it. But that is mainly because economic conditions have changed, and we have new economic priorities. We need a a new understanding of economic liberalism in order to take human society forward.

Neoliberalism’s three blind spots and how we move on

In my last proper post I examined the idea of neoliberalism, a set of ideas that is at the heart of modern economic policy. I concluded by saying that most people think it has failed. But how can we move on?

The first point to make is that the two central insights of neoliberalism seem as valid as ever. The first is that markets provide the best way of processing information on complex human needs and how to meet them – and they do this far better than bureaucracy. The second is that governments and regulators are beset by dysfunctional incentives – and tend to serve the interests of elites and client groups, rather than the people as a whole.

This is the starting point for those that continue to defend the philosophy, though rarely by that name. They suggest that the problems that have arisen since the 1990s have much more to do with the advance of technology and globalisation than anything else. This is a rather pessimistic view. It suggests that society in the 1990s was faced with the choice of embracing technological change, with the benefits to health and wellbeing that resulted, or a futile attempt to keep change at bay for the sake of social stability. It is hard to think of any society that has successfully followed the latter path. The collapse of blue-collar and white-collar middle-income jobs was pretty much inevitable. And countries that seem to be more successful in embracing this change, like Germany, have done so by adopting policies that have undermined their global neighbours’ attempts to do the same thing. Germany preserves swathes of middle-ranking jobs only by exporting large quantities of manufactured goods to other countries compared to what it imports. By this pessimistic view, the world is being swept forward by technological change and governing elites are powerless to stop it. We may be alarmed at the political backlash, but any new leadership that this sweeps into power will most likely make things worse than better.

There is doubtless some truth to this. It is very striking how the political backlash seems bereft of new economic thinking. The right wants to create higher national boundaries and limit free trade between countries. This thinking recalls policies that deepened and prolonged the Great Depression in the 1930s. The left wants to expand state control. The Labour manifesto in Britain in the recent general election recalls to me the failed development policies in places like India in the 1950s and 1960s before a turn to neoliberalism unleashed massive growth. That isn’t entirely fair, of course, as both left and right also indulge in some new thinking. But it is really quite worrying that the only new idea on the left that has any currency is universal basic income – an idea that has no chance of meeting the huge expectations being placed on it.

But there are clear problems with neoliberal thinking. I think the three key blindspots are capital markets, Baumol’s disease and human organisational capacity. Add these together and you get pointers to what a post-neoliberal economic philosophy might look like.

First: capital markets. Hayek’s insights on the efficiency of markets does not to apply to assets, as distinct from goods and services. The market value of assets does not reflect their future economic worth. Bubbles build and burst, creating ruin in their wake. The problem is as old as the capital markets themselves – but that does not stop these markets from causing society’s resources from being allocated inefficiently. Another problem is that asset price inflation reinforces a gap between the haves and have-nots, and, in Britain, between the young and the old. Neoliberals (like the Economist newspaper) often say that the sky-high prices of land in popular cities simply reflect the laws of supply and demand, and that we should build more homes where people want to live. Whatever the truth of this, it is surely clear that excessive levels of personal debt are a large part of the problem – as well as the issue of human organisational capacity that I will come to. This causes the prices at which supply and demand balance to be much higher than they would be otherwise.

To cut a long story short, modern developed economies (especially the Anglo-Saxon ones) place far too much reliance on private debt, and this leads to instability and inequality. The risks associated with state debt, by comparison, look easier to manage. One leg of the neoliberal system of economic management, monetary policy, is broken.

The second issue is what economists call Baumol’s disease. This idea has been in circulation for decades, and is taught to economics undergraduates. It is amazing how little its implications seem to be understood. Baumol pointed out that as productive sectors of the economy develop in efficiency, the less productive sectors bulk up in proportion. Agriculture used to account for the bulk of the British economy; but as it became more efficient it eventually sunk to a small fraction of it. The same is now happening to manufacturing. As we become more efficient the bulk of jobs will be in sectors where high productivity is impossible or undesirable. And in the current situation they will increasingly be in sectors where market solutions have been found wanting. These include healthcare, education and law enforcement. These sectors are dominated by government and the public sector. We must expect the public sector to grow, and we must learn how to manage this, rather than trying to push the boundaries of the state back.

My third issue is what I have rather clumsily called human organisational capacity. The human brain can only handle a limited number of connections efficiently. And humans are at the centre of human organisations. Artificial intelligence won’t change that; it will simple extend the reach of what individual humans can do. This human capacity sets limits to the size and scope of human organisations. Organisations that grow eventually face a stark choice. They either become staggeringly inefficient, or their operating systems have to be very lean, requiring few people to operate them. Commercial organisations are forced into the latter category by competition. Dealing with a large corporation now, like Google, Amazon or PayPal is extremely frustrating for ordinary human beings, unless you manage to stick to the automated procedures that they prescribe – which are unable to handle any degree of complexity. Modern technology is allowing these commercial organisations to extend their reach by cherry-picking things that are simple to deal with, and leaving behind the difficult ones. This is creating a hollowing-out effect that is one of the big drivers of inequality.

Governments, meanwhile, are left to pick up the pieces. But they are subject to similar limitations. They have to choose between monstrous inefficiency or simplification. As tight finances force them into the latter course, power accretes to an elite in geographically concentrated centres of power. Neoliberals tend to shrug at this, and simply say that this is price we pay for a more efficient society. But I think it points in a different direction: to towards the decentralisation of political power, and the development of local democracy. One country has taken this idea further than any other: Switzerland. But if you go there you do not find grinding poverty as people are forced to choose between local control and drawing the benefits of modern society. You find one of the most prosperous societies in the world, with economic activity geographically spread out. One key thing to note: the Swiss have not just found ways to devolve political power to relatively small units, but they have also found ways to involve their citizens in taking responsibility for the society that they live in.

All this raises many, many questions. But the overall direction of travel is clear. We need to expand the scope of the public sphere (I am being careful not to use the word “state”), but also to shrink it geographically and allow people to take more ownership of it. Markets are useful, but we need democracy too.

The rise and fall of neoliberalsim

The left loves to frame politics in terms of abstract nouns. And as is the human way, they are happier talking about what they are against rather than what they are for. Two abstract nouns in particular are top of the left’s hate list: “austerity” and “neoliberalism”. For the left’s challengers, it is usually best ignore this war on the abstract. It convinces few, after all – the left is much more effective when it campaigns on the concrete: food banks and bedroom tax, for example. Yet abstract ideas have their place, and it is worth exploring them more deeply sometimes. Austerity I will leave for now; I want to look a little more deeply at neoliberalism.

To most on the left “neoliberalism” is a scattergun term to brand all right and centre economic thinking that prevailed from the 1980s, after the collapse in confidence in the system known as “Keynesianism”, though Maynard Keynes would have disapproved of much of it. But if we are to understand what was actually going on we need to distinguish it from neoclassical economics, which was an important strand of thinking in this period. As its name suggests, neoclassical thinking harks back to classical economics, that evolved in the late 19th and early 20th century, before Maynard Keynes revolutionised economic thinking. This saw economies as self-correcting systems that did not need state interventions. At any point an economy is in an equilibrium, and any attempt to shift it would be self-defeating. Attempts to kick against this system would simply lead to such ills as inflation and unemployment.

Keynesianism fell out of favour in the stagflation of the 1970s, following the collapse of the Bretton Woods system of managed exchange rates and the an explosion in the price of oil. Some economists used this to go back to classical ideas, saying that Keynesianism was a big mistake. In America these economists were often based in Chicago and the Midwest – and were known as “freshwater” economists in contrast to the “saltwater” sort on the American east and west coasts. They turned to the idea of “real business cycles”, which proposes that the fluctuations from boom to recession are driven by changes to the “real” economy in equilibrium – and not a process of disequilibrium, as Keynes had suggested. So, for example, in pre-industrial societies the cycle might reflect the effect of weather and plague. In the modern age economists call this changes to technology. The true heroes of a neoclassical economy are the entrepreneurs who advance the productivity that make us all wealthier – the American author Ayn Rand was something of a hero. The state and taxes were loathed.

In spite of some rather superficial empirical studies which provided some evidence to support it, real business cycle theory is almost self-evident nonsense. Modern economies are almost never in equilibrium; state interventions are frequently helpful. Neoclassicism kept going because it was politically convenient to a certain class of wealthy American, who funded supportive institutions – and it was, and remains, politically influential amongst US Republicans. It lost all credibility to everybody else in the aftermath of the financial crash of 2008-2009, when the neoclassicists had nothing helpful to say. It was also clear by then that their advice in such places as Russia (post the fall of communism) and Iraq (post the US invasion) had been disastrous – they had advised the Republican US government to stand back and let things take their course – it was the economic wing of neoconservatism. Still, almost no idea is completely without merit. Technology has important implications for the workings of macroeconomics, and yet it is almost universally ignored by macroeconomists, who think that the economy worked much the same way in 1900, 1950 and 2000, and that all changes are explained by decisions in fiscal and monetary policy. In fact if you want to understand why Keynesianism worked so well in the 1950s and so badly in the 1970s, technology provides the most convincing explanation.

So, what is neoliberalism? It is an altogether more subtle economic analysis that sought to built on the insights of Maynard Keynes rather than throw them out. Indeed their ideas evolved into something referred to as “neokeynesianism”. At its heart are two ideas. First is that markets function as processors of information, and are the most efficient way that information about supply and demand can communicate and coordinate in our highly complex society. This is an idea developed by the Austrian economist (and sparring partner of Keynes) Friedrich Hayek, and who is the patron saint of neoliberalism (and much more pragmatic than his leftist critics pain him – he formed a common front with Keynes during the war). The second is that the incentives of people who manage institutions that are not subject to market forces, such as regulators and governments, are generally not aligned to the public good. These insights lead to the conclusion that even well intentioned state interventions often do more harm than good – and that it is best to try and design such interventions so that they work closely with market forces, aligning incentives and making better use of information.

Neoliberals sought to repair the tattered state of the Keynesian conventional wisdom with the idea of “equilibrium unemployment” – a state of the economy at which any increase in demand would simply lead to inflation – with the insight that the level of this equilibrium could be much higher than what was conventionally regarded as full employment. It depended on the state of labour markets and technology – best addressed through “supply-side” policies, which often meant deregulation. In the 1970s, they said, the trouble arose from over-managed labour markets (the effect on trade unions in particular) and technological disruption (especially the relative rise of energy prices) that rendered much of the industrial economy obsolete.

In terms of economic management, neoliberals liked free capital markets, including floating exchange rates (in contrast to Keynes’s preference for managed international capital flows, exemplified by the Bretton Woods system). They disliked the use of fiscal policy (i.e. the deliberate management of government budgets to regulate deficiencies in demand), as it was rendered useless by misaligned incentives – there would be a tendency to let booms run too long. They did like the idea of “automatic stabilisers”, being tax and benefit policies that tended to increase or reduce demand according to the state of the business cycle – and as such accepted a large state sector – unlike the neoclassicists. Instead they preferred to regulate demand through government intervention in interest rates, delegated to arms-length central banks (an idea which neoclassicists hated, incidentally – they want to leave interest rates to the market). Like their Keynesian predecessors, they thought that inflation was the critical sign of whether or not supply and demand in an economy were in balance – though they developed the idea that inflation could be built on expectations, as well as simply mis-matched supply and demand (i.e. if people expected inflation to be high, they would demand extra wages, turning this into a self-fulfilling prophecy). For all their scepticism of government, they still saw it as playing a central role in the management of the economy – and searched for optimal levels and designs of intervention.

Neo-liberalism became the conventional economic wisdom in the 1990s, all the way through to the great financial crash. This period saw an unprecedented advance in living standards across our globe. So why do most people think it has failed? Because the picture in developed economies in that period is much more mixed. In the US in particular, the economic gains have been concentrated amongst the wealthy, with large companies amassing unprecedented levels of profit. The destruction of many industries through technological obsolescence and globalisation left a huge legacy in ruined lives and failing local communities. And finally there was the crash itself, which most neoliberals had failed to see coming and to head off – and whose fall-out they proved ill-equipped to deal with.

And yet. The main advance in human well-being in the neoliberal ascendancy came in the developing world – and the adoption of neoliberal insights was clearly responsible for this – in China, India, and many other countries. And the failure of attempts to defy neoliberalism, in France under Francois Hollande and, more dramatically, by the Kirchners in Argentina, has led to local revivals of neoliberal ideas. Something has clearly gone wrong, but is the whole system really rubbish?

I will examine that question in a future post.

French lessons for British social democrats

Opposition has brought a certain coherence to the British left. There is nothing like a hate-figure being in power to bring about a sense of unity. And the idea that runs through the left’s thinking on the state is social democracy. But last weekend’s electoral disaster for the French Socialists, and the rise of Marine Le Pen’s National Front should give them pause. The left is becoming is becoming disenfranchised from the working class.

What do I mean by social democracy? It is the coming together of several elements. The first is the conventional understanding of western democracy and the rule of law – in contrast to a more radical revolutionary style. The second is a grudging acceptance that the private sector is the primary motor of the economy – but heavily managed to prevent its excesses damaging society, including strong protection for employees’ job security. Next is strong, national government, setting standards that apply across the whole country, rather than the chaotic and inconsistent approaches that come from bottom-up policy. Then there is a faith in large public services, covering health, education, railways and much more. A strong social, state-funded safety net is added to it. And it is all funded by high levels of taxation, with a strong progressive element.

In Britain I have noticed that a historical narrative has built up around this idea. Social democracy’s breakthrough moment was the Labour government of 1945 (after the perceived success of the country’s state directed war effort). Something like a consensus built up around it, as economic growth allowed the scope the social democratic system to be extended. Then disaster struck in 1979, when a new breed of politicians, the “Neoliberals” were allowed to take over. Mrs Thatcher’s government started to dismantle the social democratic apparatus. Tony Blair’s Labour government wasn’t much better. But at least Mr Blair’s public sector “reforms” were balanced by Gordon Brown’s creeping extension of the scope of public services. In 2010 the Tory-led coalition of Tories and the neoliberal wing of the Liberal Democrats has continued the dismantling process. But the neoliberal ideology is a demonstrable failure – leading to the financial crisis and escalating inequality. The new Labour leadership, under Ed Miliband, has shown interest in reviving the old social democratic system, but it is being urged to be more radical. Social democrats within the Lib Dems hope that the party’s current leadership will be up-ended and the party will never again be associated with Tory government.

My aim here is not to challenge this flawed narrative, though I choke when I’m told that privatised industries like energy, telecoms, water and even the railways all better run when under public ownership. I want to draw parallels between this social democratic vision of society and France. For surely the country where these ideas have been carried through most thoroughly is France. Of course the Left would rather talk about the Scandinavian countries, Denmark and Sweden especially. But these are small, homogenous countries which do not make good parallels – and never mind the often rose-tinted spectacles.

But France is a big, diverse country like Britain. It’s anti-capitalist attitudes are deeply embedded. It combines a very efficient private sector with a strong central government run by a very well-educated and brainy elite. More than half the national income is paid in tax. And in 2012 the Socialists were swept back into power in a landslide. But now the economy is sliding and the Socialists are deeply unpopular. The working classes are defecting en-masse to the anti-establishment, anti-immigrant, anti EU National Front. What are the lessons?

But first a word of caution. It is commonplace for Anglo-Saxon commentators to write the French economy off as a basket case. It is not. Slow growth is probably an affliction that all developed economies will have to deal with. It was no accident that France weathered the 2007/09 crisis better than most developed economies – and just how secure is the new growth in Britain and the USA? Still, it has some big problems.

There are important lessons for the left in both strategy and tactics. Strategically the toughest lesson is than not all neoliberal inspired ideas are rubbish. The world economy is changing, thanks to trade and, above all, to technology. National economies must adapt to this. Developed economies are already highly dependant on global trading – shutting it off would mean a step backwards and reduced living standards. Accepting it means that industry has to reshape, causing job losses in obsolete industries. The neoliberal approach of letting market forces shape the change, by allowing struggling business to go bust and not getting in the way of new industries to take their place, is the quickest and cleanest way of adapting to this change. Fighting it means declining tax revenues, which means putting pressure on the public services and the social safety net. By pretending that there is an alternative to the globalised market economy, all the left does is build up false expectations about what can be achieved. That is the first cause of the Socialist failure in France. Too many on the British left don’t understand this basic, strategic problem.

The tactics are just as important. In France the Socialists have become part of a distant elite, remote from struggling working-class communities. They are full of clever intellectual answers, but they don’t feel the pain. Hence the appeal of the National Front. The British left too is too attached to its own intellectual sphere, sustained by Westminster think-tanks, and various left-wing publications – as well as intellectual cells in universities and (to a lesser extent) insulated public services like schools and hospitals. Strategy is set by using opinion polls and focus groups, not by politicians in the hard grind of finding solutions for hard-pressed local communities.

There is a tactical blind alley here. The focus group approach is telling politicians to respond to working class (and much middle class) anger by taking a tougher line on immigration, the EU and so on. To be fair on the left, they are resisting this temptation. But it isn’t just the pollsters and focus groups that are pulling politicians in that direction: any politician who spends serious time with the public understands that the pollsters aren’t making this up. The problem is that pandering to this anger also leads to false expectations; for very good reasons the politicians can’t deliver, and if they did the public would not like the result.

How to win back working-class communities while staying true to liberal instincts? Well you won’t find the answer in grand reforms and new laws promulgated in London or Paris. It isn’t about crafting the right sort of attack material to wound the right. It is about politicians winning trust by getting out into their local communities, meeting people and facilitating solutions that people can see. The choice of the word “facilitating” is important. It is about helping people to help themselves, not creating new government schemes (though these have a place). It is about mediating between different interest groups, not stoking up fights. People are much more realistic than many give them credit for. They appreciate honest facilitators and mediators more than people who just stoke up anger. But they are suspicious of elites that would rather talk to focus groups than their local electors, or who want to make their name with some new national reform – rather than helping to sort out a local housing estate, or bring together local ethnic groups.

It’s a hard road, but it is one the left must embrace if they are to avoid the fate of the Socialists in France.

What is neoliberalism? The left’s muddle does not help reverse its progress

Political movements tend to be united by what they oppose, rather than any positive things they stand for. Today the political left unite against a universal enemy, which they name “neoliberalism”. The word is bandied about much as “socialism” is by the political right. But what is it? And is it a useful descriptive term? I believe it is, but that the left is muddled by what it is and is not.

According to Wikipedia neoliberalism started its life in the 1930s as a middle path between classical liberalism on the one hand, and the state planning ideologies of fascism and communism on the other. Classical liberalism advocated a minimal state, and, in practice, a world in which big capitalist corporations could thrive. It was widely blamed for the economic catastrophe that followed 1929 in capitalist economies. Neoliberalism stood for something called a “social market”, backed by a strong state. Nowadays, the left make no real distinction between classical liberalism and neoliberalism. This speech by Susan George in 1999, and posted recently on Facebook by a friend, illustrates this quite well – a lot of what she rails at should in fact be defined as classical liberalism. This is interesting, and not necessarily wrong. Neoliberal ideas have provided cover for a lot of classical liberal ideas – and neoliberals have seen state socialism as their main enemy, rather than unfettered capitalism.

I think it is best to understand neoliberalism in terms of three core ideas:

Markets are an unbeatable information exchange. Markets are idolised, because they are seen as the most efficient possible way of reconciling the masses of information that modern societies require to keep moving. This idea of the market as an information exchange, famously advanced by Freidrich Hayek, is a very powerful one, and an advance on the rather abstracted ideas of classical economists.
People respond to incentives. Pretty much all human behaviour, good or bad, can be understood as a response to external incentives. This is often developed into the idea of all people being independent agents rationally responding to the opportunities around them according to a set of pre-defined preferences – often referred to as homus economicus. However, the idea is deeper and stronger than this theoretically convenient way of looking at things.
Direct state management is inefficient. This actually follows from the previous two ideas, but takes on a life of its own in the minds of its followers. The state is incapable of processing information about people’s wants and needs with the efficiency of a market; the state’s officers generally respond to their personal incentives, often simply to secure a stable and easy job. Result: gross inefficiency. When any of the known theoretical weaknesses of markets are presented to neoliberal advocates, their response is often to accept them, but to point out that to try and solve them through a state managed solution would make things even worse.

There is a general view, supported by Ms George’s speech, that neoliberalism took hold in the 1980s, under Britain’s Margaret Thatcher and America’s Ronald Reagan’s political leadership, and the economist Milton Freidman providing theoretical heft. From these beginnings it developed into an orthodoxy across the developed world that, according to the left, still grips the political establishment today. The financial crisis of 2007-09 has not drained it of power, as the left thinks it should have done.

There is some puzzlement on the left as to how this neoliberal takeover happened. Ms George paints a glowing picture of the Keynesian consensus that preceded it, and derides any idea that neoliberal ideas had any real persuasive power in their own right. She resorts to a sort of conspiracy theory of coordinated and determined vested interests. Well, I was there, and voted for Mrs Thatcher in 1979 (though not afterwards), and find the rise of neoliberal ideas entirely unsurprising. Britain, in particular, was in a miserable state: and the “Keynesian” consensus was an evident failure. It had failed to respond to the changed world that followed the oil crisis, resulting in unemployment and inflation. We were surrounded by national bureaucracies and nationalised industries of an inefficiency that today people would find unbelievable. Much of what they said, especially about state directed solutions, rang true. Many politically powerful vested interests opposed the change – but the neoliberals were pushing at an open door in the world of ideas.

Trying to put all this in perspective is made harder by the following things that have accompanied the rise of neoliberalism:

There has been a dramatic change to the industrial and economic base to developed societies since 1945 (well since long before that, of course). In the first phase manufacturing industry advanced, in such a way that much of the capacity built to support the war effort could be readily redeployed (in contrast to what followed the 1914-18 war); this was the basis of an unambiguous economic miracle that lifted many out of poverty. In the second phase, from the 1980s, manufacturing industry became much more efficient, while the appetite for its production hit saturation; the economy switched to services. This has created huge dislocation, and, more recently, the disappearance of mid level jobs. It has driven overall growth in wealth, but also tended to increase inequality. Neoliberal policies have helped this transition forward, but were not the underlying cause of it.
Capitalist corporations have remained as strong as ever, and have grown increasingly able to press forward their interests in the political system, especially in America. They are not fundamentally neoliberal in outlook (their aim is to rig markets and not empower them, but they usually camouflage their lobbying in neoliberal terms. We should be careful not to exaggerate their power though. The corporations have not had it all their own way: their life expectancy has dramatically reduced over the period. Neither are these faceless corporations entirely managed for the benefit of a small elite; they have also benefited armies of employees, and their institutional shareholders are often pension funds that likewise transmit their gains to ordinary people.
A lot of theoretical economists have got carried away with their models based on homus economicus, and these have become a soft target for neoliberalism’s critics. But often these criticisms amount to criticising the tactics and not the strategy: about how people respond to incentives, and not the idea that incentives drive behaviour.

Ms George manages to be muddled by all of these things, leading to a speech that can only be called paranoid. I suspect many on the left share her views, though, and feel that they have been vindicated by the events of the decade and a half since. This muddle, and their failure to clear identify and advocate alternative approaches to the neoliberal consensus, means their persuasiveness is doomed to be very limited.

Meanwhile political centrists seem to be trying to recover something of the original neoliberal outlook: the social market. The use of market mechanisms within a society that is still dominated by the state. As somebody who tends to the political centre I would like to say that this offers the most constructive way forward. But I have to point out that the great financial crisis of 2007-09 resulted from the collapse of just such a middle way philosophy, in the world of finance and banking. While the left blames it on rampant capitalism and greed, cack-handed state intervention was just as much of a problem, and the combination was lethal. It was a neoliberal project in the original sense of the word.

Where does that leave us? A lot of what neoliberals say is true. We need to grow up and recognise that. But a lot of it isn’t; and its failures are currently more important that its successes. Our societies’ institutions have not kept pace with the changed nature of society and the economy. But it will require a large dose of state direction, especially in education and housing, to fix this.

Capitalism, crony capitalism and neoliberalism. What’s in a word?

Are the Occupy protesters on to something? Or is theirs just a hopeless battle against abstract nouns?

I have been rather exercised about some abstract nouns recently. First was the word “Neoliberalism” selected by Simon Titley of the Liberator as one of three Bad Ideas to have infected British politics over the last 30 years, sweeping along the Liberal Democrat leadership with the rest of the mainstream. The other ideas were the “Westminster Bubble” (the idea promoted by a lazy media that only ideas that have taken hold in Westminster matter), and that the Westminster elite have a monopoly of political wisdom (expressed by contempt both for grassroots activists). Neoliberalism had a starring role in the previous month’s Liberator when Mr Titley and David Boyle roped it into their narrative of what went wrong with British politics in their article “Really Facing the Future”. Mr Titley felt he had written enough already on the subject to explain what he meant by neoliberalism – unfortunately before I have been subscribing to Liberator.

Another tiresome abstract noun has been even more prominent: “Capitalism”. This has been the main target of Occupy. It was recently brought into further focus by Tory MP Jesse Norman in an FT article based on his pamphlet “The Case for Real Capitalism“. This pamphlet is not a particularly coherent or convincing piece of work, though to be fair he does say that a longer, and presumably better argued, version is in preparation. But by harnessing a couple of qualifiers (“crony” and “good”) he tries to make sense of capitalism, and brings neoliberalism into the picture too. It’s good place to start a probe into whether these words have any useful purpose.

In Mr Norman’s picture the world has been suffering from “crony capitalism”. He identifies various strands (e.g. “narco-capitalism”, taking it well beyond what I would call “crony” capitalism, which should really involve cronyism – business leaders being too close to political leaders. Still he does offer a workable definition of bad capitalism:

Crony capitalism is what happens when the constraints of law and markets and culture cease to be effective. Entrepreneurship and value creation are replaced by rent-seeking, and certain groups become enormously wealthy without taking risk. These factors in turn lead to long-term economic underperformance, and sometimes to social unrest.

Apart from the use of “crony” and the economics jargon of “economic rent” (which means profits accruing to a business over and above the opportunity costs of inputs) this is quite useful. Something that is recognisably capitalism – an economy based mainly on private enterprise – can look like this, and when it does, it is bad. But capitalism doesn’t have to be this way – hence Mr Norman’s employment of “good capitalism”. This version emphasises the need for free competition and the consistent application of the rule of law. But that by itself is not enough.

Mr Norman contrasts “good capitalism” with our friend “neoliberalism”, which does not have a moral dimension. Like Mr Titley, he does not bother to define neoliberalism. But from context I can identify it with what the FT writer and economist John Kay called “the American Business Model” in his 2002 book The Truth about Markets which was part of my Christmas reading. This elevates the simplifying assumptions of classical economics (rational behaviour, consistent and stable preferences, perfect competition, and so on) into a moral value system. In particular it idealises a ruthless focus on maximising personal gain in the framework of impartially enforced rules (property rights in particular). This way of thinking remains very popular in America, with the Chicago School giving it considerable intellectual heft. But it has never taken off in Europe, and Britain is very much part of Europe on this issue, as in so much else. The emphasis on personal gain – greed – and antipathy to social solidarity are too much for all but a lunatic fringe to accept. And that includes Conservatives like Mr Norman. Good capitalism has a moral dimension – and one that celebrates the virtues of hard work and social responsibility.

Meanwhile the use of “neoliberalism” on the British left (including Mr Titley) clearly does not conform to the definition that Mr Norman uses. Within its scope are swept Margaret Thatcher, Tony Blair, Gordon Brown and the “Orange Book” Liberal Democrats such as Nick Clegg. But none of these are or were Chicago School types. Apart from Mrs Thatcher, maybe, all see a huge role for government in our society and would expand its remit. But they have criticised the way producer interests have captured public services, profoundly undermining its quality.

Another issue needs to be mentioned here: and that is financial explosion in the UK and US that occurred in the period 1997-2007, and which ended so badly in the current crisis. This is closely associated with greed in the public’s minds, of bankers mainly, but also chief executives and (whisper it) all those ordinary members of the public that racked up credit card and mortgage debt. This is swept into the general idea of “capitalism” and “neoliberalism”. And indeed neoliberal ideas were used to justify the behaviour of many of the more egregious participants. But true believers in neoliberalism have little difficulty in shrugging such criticism off. To them what caused the crisis was excessive government intervention (e.g. by encouraging subprime lending in the US) and the failure to uphold proper open markets (through the implicit government guarantee of banking activities, for example).

All of which renders the words “capitalism” and “neoliberalism” as useless abstract nouns. There is little consistency in their use between the different political factions; their use by one faction is misunderstood by the other in an endless cycle of talking at cross purposes. The Occupy movement seems particularly bad at this.

To make headway in the political debate we need to move on from the abstract to the practical. What is the best way of providing health and education services? What should the scope be of social insurance? How can we get private businesses to invest more in the future and distribute their profits (or economic rents if you prefer) more equitably?