The current economic crisis has shaken belief in the capacity of neo-liberal “free market” policies. Tom Orsag examines where neo-liberalism came from—and where it is going
The re-emergence of worldwide capitalist economic crisis in 1974, after a 25-year post-war boom, saw the economic orthodoxy of Keynesianism unceremoniously ditched in favour of neo-liberalism.
At one level, it is a ruling class ideology, pure and simple. At another level, neo-liberalism is the product of the contradictions of late capitalism.
That ideology has been given free reign since then, and been applied vigorously by governments of all stripes in the 1980s and 90s. In fact, it is an economic orthodoxy that harks back to the laissez faire market capitalism that prevailed before the Great Depression in the 1930s.
The Depression saw the spectacular failure of laissez faire, un-regulated market economic ideology. State intervention arose in this era and a new orthodoxy, Keynesianism, followed, which argued for state control and spending, as the way to protect capitalism from its own in-built destructive tendencies.
Old orthodoxy and a new one
The beginning of the 20th century had seen market capitalism transformed into monopoly capitalism and imperialism.
Russian revolutionaries Nikolai Bukharin and Lenin pointed out how state intervention was now seen as necessary to provide large scale infrastructure for capitalist production, modern warfare and the intertwining of the two. They dubbed this the era of monopoly state capitalism in the lead up to World War I.
The trend toward statisation was accelerated in the drive towards war in the mid-1930s, first in Germany and Japan, then in Britain and the US. State intervention, especially in arms production, provided a basis for renewed profitability and capital accumulation.
British economist John Maynard Keynes, previously an economic liberal, codified the trend of state regulation and intervention into an economic theory.
After World War II, Keynesianism reflected the new reality of capitalism. National economies were increasingly dominated by near-monopolies that worked with the state in the struggle for global dominance against their rivals in other nations. Keynesianism became the explanation for the post-war boom but was not the cause of it, although thats what mainstream economists claimed that Keynesianism had overcome the boom-bust cycle of capitalism.
The boom, however, would be more comprehensively and profoundly explained by Marxists such as T N Vance, Tony Cliff and Mike Kidron, who argued it was due to a Permanent arms economy.
As an economic practice, Keynesianism was not put to any real test until the economic crisis of 1974. It proved incapable of dealing with it.
The now orthodox Keynesian response of more government spending and tax cuts did not work. The system was faced with a combination of recession and rising inflation, known as stagflationstagnation and inflation. The Keynesians were at a loss to provide answers.
As British economist Francis Cripps said suddenly they realised that nobody really understands how the modern economy works. Nobody really knows why we had so much growth in the post-war world.
Governments which had paid lip service to Keynesian policies, without needing to use them during the long post-war boom, were left trying to deal with a recession with policies that did not work.
Within four years Keynesianism had been replaced as the orthodoxy by re-packaged versions of the ideas it had pushed aside four decades earlier.
There had always been some economic liberal economists who resisted the post-war Keynesian view. This minority, led by Friedrich von Hayek and Milton Friedman, continued to push the old doctrine of laissez faire. They remained marginal so long as state intervention generated economic growth and maintained profitability.
Once those Keynesian policies, ceased to work in 1974, the ideas of Hayek and the economic liberals came into their own, as they argued their neo-liberal policies could improve profit rates and accumulation.
In its first phase, this re-birth of old ideas took the form of monetarism an argument that it was money supply that determined everything about the economyproduction, employment and the prices of goods. The American Milton Friedman, from the Chicago School, the central monetarist theorist argued that inflation could only be controlled simply by restricting the growth of the money supply, along with limiting government intervention and giving free rein to market forces.
The quantity of money theory has existed for over 200 years. Friedman had revived the quantity of money theory in the 1950s. The 1974 crisis allowed him his day in the sun.
Within a decade, this voodoo economics proved unworkable and the emphasis shifted to even harsher critics of state intervention.
These ideas, marginal for so long, became popular with supporters of capitalism so quickly for a number of reasons.
Neo-liberalism as ruling ideology
Partly there was simple apologetics. The working class upsurge of the late 1960s and early 1970s challenged the legitimacy, effectiveness of and desirability of capitalism. The mainstream economic defence against any working class challenge had been that Keynesian state intervention could deliver rising living standards for all without the need for class struggle. That claim fell apart in the face of the 1974 recession.
The neo-liberals turned the argument upside down. State intervention was now the problem rather than the solution.
Monetarism was especially pleasing for those who dealt with finance rather than production. Under the new orthodoxy, any way of making money was beneficial, even by speculators and spivs.
There was also a sense of desperation within capitalist circles in the mid-1970s, when for the first time since the 1930s, recessions hit all the major Western economies at the same time. Governments found themselves increasingly powerless as crisis erupted on a scale not known for almost 50 years.
In Australia, the Whitlam Labor government oversaw a jump in unemployment from virtually nil to an intolerable 5 per cent in a few short months. Inflation ran at 22 per cent. The share of profits in the Gross National Product had fallen from a traditional 13-15 per cent to under 10 per cent. The capitalists and their media were apoplectic and turned on the Whitlam government with a vengeance.
His government began introducing monetarist measures in 1975, as it jettisoned Keynesianism to try to manage the crisis. The federal budget by treasurer Bill Hayden became notorious for cuts in public spending, public works, social welfare and the budget deficit, setting a pattern for the Fraser Liberal government to follow.
The Callaghan Labour government in Britain, in the northern summer of 1976, abandoned its commitment to use the power of government to maintain full employment and economic growth. It crawled to the IMF for loans in exchange for further cuts in public spending. So three years before the Tory Thatcher was elected, Labour abandoned Keynesianism.
In France, the socialist Mitterand government reversed its previous Keynesianism in the recession of 1982 and unemployment increased to almost four million.
The reborn free market approaches argued for by Friedman and Hayek seemed to offer a way out. They claimed the economy would resolve its own problems if it were freed from distortions to the marketwhether these came from state intervention or from supposed trade union interference with the flexibility of the labour market.
Unemployment would have to rise and settle at the natural rate necessary to prevent wages eating into profits.
The other variants of state interventionStalinism in Eastern Europe and developmentalism in Latin Americasuffered a similar fate. As it became clear that state intervention could not prevent economic crisis in any of the world regions, neo-liberalism began to fill the ideological vacuum that the crisis of Keynesianism generated.
Economic crises always express themselves in political convulsions. The crisis of 1974 created the demon-child of neo-liberalism.
The Labor governments elected in the 1980s in Australia, New Zealand and Spain were all shorn of any idea of Keynesian policies. All that mattered was how fast, how thoroughly and how effectively they embraced the market and implemented neo-liberal policies.
The massive post war expansion of the system saw a massive expansion of trade at about twice the speed of economic output. The amount of money flowing between banks in different countries came to dwarf the foreign exchange deposits of national governments. A handful of multi-national giants came to dominate the aircraft industry, the computer and software industries, the motor industry, telecommunications and ship building. Labor governments surrendered any idea of controlling capitalism.
The neo-liberal policies took a massive toll on working conditions and living standards. Job security gave way to deregulation, casualistion, unpaid overtime. Welfare benefits and social spending gave way to user-pays. Public ownership gave way to privatisation.
The working class is still paying a cost for those policies today. We can only guess at what new horror economic orthodoxy this latest crisis will produce. The crisis has been proclaimed as the death of neo-liberalism and its true that the ideology of the free market has taken a huge hit.
Yet the policies being pursued by governments attempting to manage the crisis accept the very ideology that precipitated the crisis, as they rush to protect profits and bail out the banks and the speculators, while unemployment rises, millions are losing their houses and watch their life savings disappear.
Their solutions are not solutions at all. It is the blind competition of the market that produces the devastating crises of capitalism. We need to both fight against the job losses and the wage cuts as they try to make us pay for their crisis, and fight to change the system so production is democratically planned to meet human needs not profit.