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UNDERSTAND THE THEORIES BEHIND FREE-MARKET FUNDAMENTALISM - ARE THEY SOUND, DO THEY WORK?

The twentieth century saw massive upheavals in military, political and economic affairs. Public attention is naturally drawn towards critical events like the Russian Revolution, World Wars One and Two, the Great Depression and the collapse of the Soviet Union.

But maybe the most interesting struggles were acted out behind the scenes through the collision of opposing philosophies. The biggest drama of the twentieth century was the huge confrontation between ideas which were derived from the thinking of Karl Marx and theories of free-market, capitalist economics, the roots of which go back to Adam Smith in the eighteenth century.

More recently, from the late 1980's, there have been seismic shifts in the strategies adopted by governments in the developed world, and particularly in the economic superpower, the United States of America. These shifts have been magnified by the creation of global financial markets and the influence of US and European-dominated international bodies like the World Bank, the International Monetary Fund and the World Trade Organisation.

Although such shifts do not reach the headlines or the consciousness of most people, they do have fundamental effects on the lives of billions of people in developing and rich countries.

Everybody knows that the 'West' won the war of ideologies - this was clear from the collapse of the Soviet system under its own inefficiency and the strains of the arms race with America. After the fall of the Berlin wall, there was a general assumption that the world would settle down to a period of peace and prosperity, safe in the knowledge that the best economic system had won - the American Century was upon us.

But behind the curtains within the Western capitalist world, another vitally important but almost invisible war of ideas is being waged.

Keynesian versus neo-classical free-market ideas

The two contemporary opposing groups of philosophies are those originating from John Maynard Keynes, on the one hand, and the classical and neo-classical thinkers originating from Ludwig von Mises, Friedrich von Hayek and the Austrian School of economics.

Keynes' theories suggested that active government policy could be effective in managing the economy. Rather than seeing unbalanced government budgets as wrong, Keynes advocated what has been called countercyclical fiscal policies, that is policies which acted against the tide of the business cycle: deficit spending when a nation's economy suffers from recession or when recovery is long-delayed and unemployment is persistently high - and the suppression of inflation in boom times by either increasing taxes or cutting back on government outlays. He argued that governments should solve short-term problems rather than waiting for market forces to do it, because "in the long run, we are all dead."

This contrasted with the classical and neoclassical economic analysis of fiscal policy, typified by the Austrian school. Fiscal stimulus (deficit spending) could actuate production. But these schools believed that the side-effects of this would "crowd out" private investment. First, it would increase the demand for labour and raise wages, hurting profitability. Second, a government deficit increases the stock of government bonds, reducing their market price and encouraging high interest rates, making it more expensive for business to finance fixed investment. Thus, efforts to stimulate the economy would be self-defeating. Worse, it would be shifting resources away from productive use by the private sector to wasteful use by the government.

The Keynesian response is that active fiscal policy is only appropriate when unemployment is persistently high. In that case, the crowding out is minimal. Further, private investment can be "crowded in": fiscal stimulus raises the market for business output, raising cash flow and profitability, spurring business optimism. To Keynes, this accelerator effect meant that government and business could be complements rather than substitutes. Second, as the stimulus occurs, gross domestic product rises, raising the amount of saving, helping to finance the increase in fixed investment. Finally, government outlays need not always be wasteful: government investment in public goods that will not be provided by profit-seekers will encourage the private sector's growth. Thus, government spending on such things as basic research, public health, education, and infrastructure could help the long-term growth of potential output.

Keynes's opponents do not agree: invoking public choice theory, classical and neoclassical economists doubt that the government will ever be this beneficial and suggest that its policies will typically be dominated by special interest groups, including the government bureaucracy. Thus, they use their political theory to reject Keynes' economic theory.

A supporter of Keynesian philosophy was J.K.Galbraith, who served in several US administrations and was recognised by most as one of the seminal thinkers of his time. Although he was a former president of the American Economic Association, Galbraith was considered an iconoclast by many economists. This is because he rejected the technical analyses and mathematical models of neoclassical economics as being divorced from reality. Rather, following Thorstein Veblen, he believed that economic activity could not be distilled into inviolable laws, but rather was a complex product of the cultural and political milieu in which it occurs. In particular, he believed that important factors such as advertising, the separation between corporate ownership and management, oligopoly, and the influence of government and military spending had been largely neglected by most economists because they are not amenable to axiomatic descriptions. In this sense, he worked as much in political economy as in classical economics.

(Our thanks to on-line encyclopedia Wikipedia for the references)

The fundamental differences

The key differences between these schools are their attitudes towards government and the free market. Keynes and his followers asserted that government had an important role to play in managing cycles in the economy, stimulating demand in times of recession and curbing it in boom times. The free-market thinkers believed in the efficacy of the market and its ability to self-correct. They were deeply suspicious of government and politicians, believing that they were self interested and incapable of understanding the complexities of supply and demand.

The pre and post-war periods saw a general application of Keynesian ideas, but with frequent skirmishes between the opposing camps. The followers of the Austrian school, Von Mises and Von Hayek in particular, developed a following in Britain and America which proselytised vigorously and found ardent followers amongst some academics and politicians.

Keynes had a fearsome reputation as a talented debater and Friedrich von Hayek, a leader of the neo-liberal school, refused to discuss economic matters in person with him on several occasions. However, after reading Hayek's The Road to Serfdom Keynes wrote, "In my opinion it is a grand book ... Morally and philosophically I find myself in agreement with virtually the whole of it: and not only in agreement with it, but in deeply moved agreement." Keynes was known, however, to open his letters with such complimentary language. He concluded the same letter with the prophecy, "What we need therefore, in my opinion, is not a change in our economic programmes, which would only lead in practice to disillusion with the results of your philosophy; but perhaps even the contrary, namely, an enlargement of them. Your greatest danger is the probable practical failure of the application of your philosophy in the United States."

The victory of capitalism and 'The end of history'

Matters began to come to a head in the 1980's and 1990's, accelerated by the collapse of the Soviet Union and the 'victory' of capitalist philosophies. American politicians and writers proclaimed the triumph of free-market capitalism as marking the arrivals of a new world order and the American century. Francis Fukuyama, an American neo-liberal thinker proclaimed 'the end of history'; postulating that a perfect and permanent politico/economic system had come to pass, melding freedom, democracy and free-market ideals.

In the heady, triumphal atmosphere of the 1980's, it was apparent to many that Good had triumphed over Evil and that a new and wonderful era had dawned.

Into this hothouse came a troupe of academics from several disciplines, whose ideas greatly influenced radical conservative politicians Margaret Thatcher and Ronald Regan, both convinced that a political and economic revolution was needed.

Maths, Economics and Genetics couple and produce a Theory

Several threads of science came together to create a remarkably potent and revolutionary range of ideas.

From the science of genetics came the notion of the selfish gene - that animals and all of animate creation were the creatures of their genetic components, which were selfishly driven to perpetuate themselves by manipulating the behaviour of the vehicles that carried them. The most famous proponent of the theory of selfish genes is Oxford professor Richard Dawkins, who.propounded that human behaviour was little more than the result of the selfish impulses of their genes.

A crude analogy can be found in the old saying about a chicken being just an egg's way of making more eggs. In a similar inversion, Dawkins describes biological organisms as "vehicles" or survival machines, with genes as the "replicators" that create these organisms as a means of acquiring resources and copying themselves. People could thus be understood by mathematical modelling and their behaviour predicted by understanding the nature of their genes.

From mathematics came Game Theory, an elaborate set of constructs designed to understand and predict the behaviour of competitors in a complex 'game' - in this case, the Cold War. The realisation that humans might be self-interested creatures, each seeking to optimise their advantage in competition with their fellow beings aroused huge excitement - Game Theory could be applied alongside genetics to understanding human behaviour.

When the 21-year old John Nash wrote his 27-page dissertation outlining his "Nash Equilibrium" for strategic non-cooperative games, the impact was enormous. On the conceptual side, he spawned much of the literature on non-cooperative game theory which has since grown at a prodigious rate - threatening, some claim, to overwhelm much of economics itself.

From economics and political science came a huge distrust of government as being simply the domain of self-interested politicians and the exciting idea that only the free market could handle the complex task of allowing people en masse to register and pursue their interests. Remove inefficient and corrupt governments and real democracy - that of the market - would enable people to get what they wanted. Out of the window went Keynesian ideas of governments as the regulators of economic affairs on behalf of society. Also dumped was any idea of a social contract or even of the existence of society itself. This belief is what drove Margaret Thatcher to her famous statement, "There is no such thing as society, there are individual men and women, there are families".

Amongst the heroes of neo-liberal free-marketeers are Milton Friedman, Nobel Lauriate, one-time professor at the home of neo-classical economics, the University of Chichago and latterly at the Hoover Institute; James Buchanan and Murray Rothbard.

Friedman's political philosophy, which he himself considered classically liberal and libertarian, stressed the advantages of the marketplace and the disadvantages of government intervention, strongly influencing the outlook of American conservatives and libertarians. He adamantly argued that if capitalism, or economic freedom, is introduced into countries governed by totalitarian regimes, political freedom would tend to result. He lived to see his laissez-faire ideas embraced by the mainstream, especially during the 1980s, a watershed decade for the acceptance of Friedman's ideas in many countries. His views of monetary policy, taxation, privatization and deregulation informed the policy of governments around the globe, especially the administrations of Ronald Reagan in the U.S., Brian Mulroney in Canada, and Margaret Thatcher in Britain.

Friedman's political positions were buttressed by a large number of technical articles covering a wide range of topics in economics and economic history, which gained the grudging respect of specialists by the early 1960s. His intellectual leadership of the Chicago School, which came to dominate theoretical economics by the 1970s, further strengthened his stature.

James Buchanan received a Nobel Prize in 1986 for his work on public choice, which essentially denigrated the role of government as a useful participant in the economic life of the market. His work was very influential in free-market economics. His Nobel Prize citation noted:

Individuals who behave selfishly on markets can hardly behave wholly altruistically in political life. This results in analyses which indicate that political parties or authorities that to at least some extent act out of self-interest, will try to obtain as many votes as possible in order to reach positions of power or receive large budget allocations. This type of analyses has become universal in recent years, and is perhaps the most widely known aspect of public choice theory.

Murray Rothbard attempted to meld Austrian free-market economics with classical liberalism and individualist anarchism, and is credited with coining the term "anarcho-capitalism". He was probably the first to use "libertarian" in its current (U.S.) pro-capitalist sense. He was a trained economist, but also knowledgeable in history and political philosophy.

An example of his attitudes to contrary thinking, typical of ardent free-marketeers, can be found in the website of the Von Mises Institute. His paper entitled "Keynes, the man" is a superb piece of unpleasant snide.

The elision of the apparently disparate threads of Gene, Game and Free-market politico-economic theory in the 1980's and 1990's has had huge impacts on the world, including:

The dominance of a fervent belief that the free market is the most efficient vehicle for serving human needs. This dogma is centered in the US and promoted internationally by the IMF and World Bank. This has resulted in massive deregulation of global financial markets, privatisation of public services in many countries in conjunction with significant tax cuts. On the international stage, the World Bank and IMF have made it conditional that poor countries introduce privatisation, remove all barriers to 'free' trade and allow the unimpeded movement of capital as a condition for receiving aid.
A belief in the power of numbers and measurement as a substitute for more human and direct methods of control of complex systems. One offshoot is the idea that providing government can set targets and measure progress towards them, people in public services and business can be freed up to achieve results in any way they want. This has resulted in the growth of huge consultancies and a complex mess of 'bent' numbers in UK public services.
The withdrawal of governments from influence over the operation of the markets, leaving them with foreign policy and residual powers to set up and police legal systems that will enable free markets to operate and private property to be protected. This has left millions of ordinary people at the mercy of powerful operators in the market, and (ironically) without any protection from government.

These effects have been most strongly felt in the countries that initiated free-market ideas, in particular, the US and UK. But they have been felt world wide through the influence of the United States and its dominance of the policies of international bodies like the World Bank and the sheer economic clout of global investment banks, many of them US-owned.

The philosophies of free-market economics, or what opponent George Soros describes as market fundamentalism, are massively supported by a very large numbers of institutes and foundations, all with the purpose of filling the media and airwaves with the passionate voices of 'freedom', free markets and democracy. These institutes, and neo-liberal publications such as The Economist, proselytise vigorously for freedom of markets and attack contrary ideas with religious fervour.

Northern Rock

So that readers do not think that all of the above is the figment of a heated imagination, Dr. Matthew Ridley the ex - chairman of Northern Rock - who presided over the biggest UK banking disaster in living memory - was a geneticist whose views exactly match the free-marketeers' views. Dr. Ridley was also a journalist who used to work for the Daily Telegraph and The Economist.

Here is a summary of his positions on people, Game Theory and free markets:

Ridley's core argument, which he explains at greater length in his books, is that humans, being the products of natural selection, act only in their own interests. But our selfish instincts encourage us to behave in ways that appear altruistic. By cooperating and by being perceived as generous, we earn other people's trust. This allows us to advance our own interests more effectively than we could by cheating, stealing and fighting. To permit these beneficial genetic tendencies to flower, governments should withdraw from our lives and stop interfering in business and other human relations. Ridley produced a geneticist's version of the invisible hand of the market, recruiting humanity's selfish interests to dole out benefits to everyone

After 25 years of free-market economics, what have been the results?

We have experienced over 25 years of free-market capitalism. Its effects are most marked in the 'Anglo-Saxon economies and in global financial markets. These philosophies also dominate the institutions of global economics, the World Bank, IMF and World Trade Organisation, which have a huge impact on the relations between rich and poorer nations.

Strong resistance to free-market fundamentalism has come from some Northern European countries, Holland, Germany, and the Scandinavian nations. Japan and South-East Asian countries (after a disastrous flirtation with free-market ideas) have latterly gone their own way, as has China. All of these countries embrace some version of capitalism, but diverge strongly from neo-classical dogma in their views about the role of government in the development and regulation of the economy.

Questions

Can market fundamentalism bring more stability and predictability to the world economic and financial system than collaboration between governments and central bankers to manage cycles and shocks?

What has happened to the distribution of income and wealth in 'free-market' countries such as America and Britain?

What impacts has the dominance of market fundamentalism had on the poorer emerging economies of the third world?

And what about the ex- Soviet bloc countries, especially Russia - has adopting free-market principles liberated their economies and brought democracy and freedom?

What has happened to the nations that resisted market fundamentalism and followed more communitarian, social market paths? How have they performed over the last 25 years?

In short - what have been the benefits and penalties of the massive global free-market experiments of the last two or three decades - and for whom?

Interested readers can make a start in searching for clues in this website - just click on neo-liberal free-market economics rules - but does it work? and Spreading the true gospel

Last: Here is our take on free-market fundamentalism.....

The idea that people are simply self-seeking consumers capable only of pursuing their immediate interests simply cannot be borne out. People are much more complex and are capable of a wide range of collaborative and altruistic behaviours. The range of differences between individuals is huge and the potential range of their social and economic behaviours equally so.

Cultural factors and environmental pressures are massively important in establishing national and individual differences. It is the complex interactions between these factors and genetic make-up that explain differences, not simply genes. Thus members of the human race in Holland, Sweden, Denmark, Finland and Japan behave very differently towards their societies than do many Americans and Britons.
Free-market proponents have not (do not wish to?) understood the range of alternative roles that governments can play in the lives of societies. For example, Scandinavian governments play the role of equal partners with the representative bodies of capital and labour in formulating national policy. Implementation is delegated to industry and labour representatives and local government. This, quite different, philosophy obviously works very well, creating equal wealth and healthy societies, with little inequality, excellent public health and education. Possibly this is why these alternatives are so frequently and bitterly attacked by the fundamentalists.
What's sauce for the goose...... Despite the fact that the United States is the home of market fundamentalism, the US government is one of the most protectionist in the world. Any foreign company that has the temerity to mount an acquisition bid for an American company which is in a 'sensitive' market will see its attempts blocked. Congress, in defining 'sensitive' includes the country of origin as well as the industry - so ports are off limits, as is China. The 'Washington Consensus' of 1989, which has created a set of rules to be observed by the World Bank and IMF when making loans to poor and emerging countries, has created a straightjacket which looks remarkably like a neo-liberal charter. However, when the US economy encounters problems, the government becomes hugely protectionist and pushes the national cause by all means, totally contrary to the conditions of the Consensus and all free-market tenets. The full ten conditions of this consensus are attached as an Addendum to this article.
One country that has been relatively faithful to free-market principles is the UK. The effects are quite marked:
- The UK economy has become extremely unbalanced, with dominance by global investment banks and a concentration of speculative and asset stripping financial institutions - all to the detriment of science, technology and engineering industries, which have either failed through underinvestment or sale to foreign buyers.
- The UK is suffering from a permanent and growing balance of payments deficit, as the growth of exports in finance and services has signally failed to fill the hole left by the massive plunge in technology and manufactured products.
- The failure of high-knowledge industries is having a serious effect on research and development, university science and skilled employment.
- Inequality and social deprivation have burgeoned since the introduction of market fundamentalism under Margaret Thatcher and subsequently under New Labour. The richest 1% now own more than 25% of national wealth. The bottom fifty percent own a mere four percent of wealth.
- The UK government has clearly lost any influence over the financial markets and is subject to constant bullying from the financial sector. This leaves an almost toothless regulatory system and millions subject to exploitation by the financial services industries.
- Etc, etc - there is plenty more, see this website and most newspapers!
Markets have no morals. This means that unfettered free-market economies will foster gross excesses as people struggle to serve their interests. In an amoral society, it is now well proven that the strongest win and the weak and poor stay that way - in ever greater numbers. Free-market advocates have tried to justify their beliefs by advancing the idea of the selfish gene as an explanation for why people must behave in an amoral fashion - acting out the tenets of Game Theory in their pursuit of advantage over others. As is becoming apparent, societies that have most enthusiastically embraced market fundamentalism are suffering from its consequences. Gross inequality and a crumbling of the public infrastructures are but two of the symptoms. Keynes warning to Von Hayek seems very prescient: "Your greatest danger is the probable practical failure of the application of your philosophy in the United States."
Neo-classical economic thinking is simplistic, rigid and results in the creation of simple axioms. Life is far more complex, economics is not a bounded pure science - it is a social science and must encompass the contributions of psychology, anthropology, sociology, history, ethics and the practical observation of the real world. The understanding of most complex problems of society and human life cannot adequately be reduced to simple rules and either/or equations. As one acute observer said: "The only people who still believe simple neo-classical axioms are either economists - or psychopaths".
The market is very efficient in creating choice in such domains as consumer goods. But, we should know by now that over-lightly regulated markets create gross abuses and are completely ineffective when it comes to matters like national transport strategies. The free-market health system of the United States is hugely expensive and has created public health outcomes that are markedly worse than those of social market countries. Totally free global markets also create exploitation by the rich and powerful and gross inequalities between nations.
TINA - the idea that there is no alternative to free-market theory - is patent rubbish. There are always alternatives, and seeking them brings progress. The 'end of history' was a sterile, anti-learning creed.
Free-marketeers and their sponsors have created an enormous movement which noisily promotes their creed and equally loudly vilifies any opposition or deviation. Why? Could it be that what lies behind all of the noise is fear - anxiety that the system of consumerism and the dominance of huge global companies and financial institutions might collapse if people begin to understand what lies behind the propaganda, exhortation and advertising? What is certain is that the free-market system will have to adapt mightily as key resources become scarce - otherwise the ensuing competitive blood bath could seriously jeopardise the very future of the human race and the planet with it.

Postscript

Francis Fukuyama has recently confessed that he does not believe most of what he wrote in 'The End of History' - especially that the current politico-economic system cannot be improved upon.

John Nash, who was suffering from paranoid schizophrenia when he developed some of his Game Theory ideas is now thankfully recovered and has said that he "Over-emphasised rationality" and that he believes that human beings are much more complex than the predictable, gene-driven calculating machines portrayed in Game Theory.

The research of professor Napoleon Chagnon, which he claimed proved that gene theory really did dictate the behaviour of humans, has been substantially discredited. Chagnon's work amongst aboriginal Indians aroused enormous exciterment amongst gene theory followers. He claimed to be able to predict the aggressive behaviour of members of the Amazonian Yanamamo tribe towards each other by understanding their genetic relationships.

It would appear that the Yanamomos' behaviour was more credibly explained by the interventions of the researchers.

Addendum - the Washington Consensus

The Washington Consensus is a phrase initially coined in 1989 by John Williamson to describe a relatively specific set of ten economic policy prescriptions that he considered to constitute a "standard" reform package promoted for crisis-wracked countries by Washington-based institutions such as the International Monetary Fund, World Bank and U.S. Treasury Department

The consensus included ten broad sets of recommendations:

Fiscal policy discipline;
Redirection of public spending from indiscriminate (and often regressive) subsidies toward broad-based provision of key pro-growth, pro-poor services like primary education, primary health care and infrastructure investment;
Tax reform - broadening the tax base and adopting moderate marginal tax rates;
Interest rates that are market determined and positive (but moderate) in real terms;
Competitive exchange rates;
Trade liberalization - liberalization of imports, with particular emphasis on elimination of quantitative restrictions (licensing, etc.); any trade protection to be provided by low and relatively uniform tariffs;
Liberalization of inward foreign direct investment;
Privatization of state enterprises;
Deregulation - abolition of regulations that impede market entry or restrict competition, except for those justified on safety, environmental and consumer protection grounds, and prudent oversight of financial institutions; and,
Legal security for property rights.

The application of the Washington Consensus has had mainly negative effects on the indigenous economies of poor countries and very positive ones for developed countries, large global corporations and investment banks.

Following torrents of criticism from many quarters, including Nobel Lauriate economist Joseph Stiglitz, ex of the World Bank, Williamson wrote:

It is difficult even for the creator of the term to deny that the phrase "Washington Consensus" is a damaged brand name). Audiences the world over seem to believe that this signifies a set of neoliberal policies that have been imposed on hapless countries by the Washington-based international financial institutions and have led them to crisis and misery. There are people who cannot utter the term without foaming at the mouth.

My own view is of course quite different. The basic ideas that I attempted to summarize in the Washington Consensus have continued to gain wider acceptance over the past decade, to the point where Lula* has had to endorse most of them in order to be electable. For the most part they are motherhood and apple pie, which is why they commanded a consensus (amongst whom?-author)

*President Lula of Brazil, whose beneficial policies have been a sensible and pragmatic mix - in no way following Washington Consensus purism.