Neoliberal pseudo-science

The Global Financial Collapse, which is rapidly becoming the Global Economic Collapse, is provoking deserved criticism of the neoliberal ideology that has dominated the world for three decades. Prime Minister Kevin Rudd, in his recent debunking of neoliberalism in The Monthly, says markets need to be managed, but clearly many free-marketeers will resist reforms. We therefore need to be very clear. This was not an imperfection. It was not an unfortunate episode in an otherwise glorious record. Neoliberalism is flawed at its core, its performance was mediocre at best, and its failure was inevitable.

The core problem with neoliberalism is that there is no justification, in theory or in evidence, for the claim that free markets produce desirable results, let alone optimal results. This claim arises from the neoclassical theory of free markets, and is the foundation of the neoliberal ideology.

The assumptions on which the neoclassical theory is built are blatantly and hopelessly unrealistic. For example, we are all supposed to be able to predict the future, to have complete information, to have timely information, to sensibly digest vast amounts of such information, and to be coldly rational, never responding to fashions or the insecurities that marketers constantly cultivate and milk. There should be no economies of scale, beyond an ill-specified point of diminishing returns, so Henry Ford and Bill Gates should never have become rich. Furthermore the central neoclassical conclusion, that free markets tend to an optimal equilibrium state, is a prescription for stasis that bears no resemblance to the behaviour of modern economies.

Nor is the neoclassical theory even remotely a useful first approximation. If one changes any of the above assumptions to be more realistic, one predicts a system full of instabilities, which is a more reasonable description of a modern economy. Systems theorists will appreciate the difference. Rather than being a near-equilibrium system, an economy is a far-from-equilibrium system. This means it is a nonlinear, self-organising system that might be in a state of deterministic chaos or, short of that, a state called complexity. Complex systems have very many possible states, not just one optimal state. Optimality cannot even be sensibly defined. The central neoclassical conclusion, an optimal general equilibrium, is lost: there is no assurance at all that free markets will deliver optimal results. Neoclassical economics is pseudo-science.

This implies there is no single best way to organise an economy. We can and should organise our economy the way we want. Markets are clearly powerful, and they do have the considerable merit of distributing the processing of economic information, as Hayek pointed out. However markets will go where the profit is. If it’s profitable to exploit people and trash the planet, then people will be exploited and the planet will be trashed.

If we want markets to benefit people and nurture the Earth, we need to ensure that benefiting people and nurturing the Earth are profitable. Markets might then become powerful allies in saving us from our imminent peril, rather than the engines of our destruction. To bring this about we must manage markets. This is nothing new, most markets are managed, for good or ill. In fact many markets are managed to produce perverse results, for the temporary benefit of minorities, so if we just eliminated perverse incentives we would be well on the way to a better world. We could also actively counter many of the mechanisms that at present promote wild instabilities, which include recessions and unrestrained growth. We would find, as well, that we could live very much more efficiently and lightly on the Earth, if we made that our goal, rather than the short-term enrichment of minorities. We could then cease to foul our nest, and the living world could thrive around us.

So much for theory, what about evidence? Stephen Bell (in Ungoverning the Economy) pointed out a decade ago that Australia’s economic performance since 1980 (marking the start of neoliberal dominance) has never equalled the post-war performance up to 1974 (GDP growth 5.2 per cent, inflation 3.3 per cent, unemployment 1.3 per cent (!), current account deficit 2.4 per cent of GDP). Paul Keating never had such a beautiful set of numbers. Figures for the whole OECD tell a similar story. That was the era of Keynesian intervention. Where is the evidence that neoliberalism is superior?

The problems of the late 1970s were not just due to oil shocks. Steve Keen (in Deeper in Debt) has pointed out there was also a debt bubble. What was needed was better management of credit and efforts to reduce oil dependence, not the simplistic neoliberal deregulation that has given us a series of financial crises and disastrously greater oil dependence.

Neither is there any evidence to support the current near-universal and reflexive worship of free trade. Free trade has enriched the wealthy in rich and poor countries, and given modest or no benefit to ordinary people in those countries. A study by the US Center for Economic and Policy Research (Weisbrot, M., D. Baker, and D. Rosnick, The Scorecard on Development: 25 Years of Diminished Progress (PDF 281KB)) shows that from 1980 to 2005 the GDPs of 175 countries increased by an average of 1.09 per cent per annum, compared with 2.47 per cent for 109 countries 1960-1980. In Latin America the latter period was worse even than the Great Depression. Little wonder they are leading the world in rejecting neoliberalism. Even such increase in GDP as there has been in the latter period has involved not just wealth creation, but wealth extraction, from people’s working conditions, public assets and the natural environment.

Ricardo’s 19th-century theory of comparative advantage, which still seems to be the touchstone of simplistic thinking about trade, applies to a world where capital is not internationally mobile, there are no trade imbalances, wages are similar in trading partners and there is no unemployment. You don’t need a fancy theory to tell you that jobs follow the money. That’s why the rich economies have been hollowed out by offshoring.

If free trade were such a great thing, then the benefits should jump out of compilations like those quoted. Instead the economic record is one of mediocrity and/or failure. At the same time quality jobs have been exported, manufacturing has dwindled, our rural areas have suffered decades of outright depression, most people work longer hours in less secure jobs, the current account deficit continues to grow and the private debt to GDP ratio is twice what it was before the great depression. The benefits of the mining boom have been squandered. Peter Costello will come to be seen as Australia’s most deluded and irresponsible treasurer (closely followed by that world’s-greatest, Paul Keating).

On top of all that, the planet is under major assault, thanks to the mania for unlimited material growth. It’s not just global warming: fresh water is polluted and scarce, forests and biodiversity are dwindling, soils are degrading and being lost, pollinators are dying rapidly in many areas, and pollution extends from pole to pole and up the food chain in an ever-more exotic cocktail of noxious chemicals. That’s our life-support system I’m talking about. Our children’s development is adversely affected by growth hormones from meat and hormone mimics from the chemical industry. Our processed diet is monotonous and unbalanced, and we are increasingly fat and unhealthy.

The problems with neoliberalism thus run far deeper even than the global financial crisis, which is already the worst economic event since the great depression, and we don’t yet know where the bottom is. And neoliberalism is only the latest manifestation of laissez-faire, rich-people-know-best, blind, greedy and polluting industrialism and parasitic financialism that have been messing up the world and people’s lives for more than a century. Yes there have been great benefits, but there has also been great excess and the costs have not been properly counted, and they are now catching up with us with a vengeance.

We can do much better. The idea of managing markets to improve the quality of life of everyone transcends both old-fashioned capitalism and old-fashioned socialism. If we free ourselves from the nonsense about free markets, we can harness markets to accomplish the goals of social democracy without the clumsiness and inefficiency of big government redistribution programs. The economy can work directly to enhance social welfare and the environment instead of assaulting them and then grudgingly offering some inadequate bandaids.